What is a fixed-price contract, and does it actually stay fixed?

A fixed price contract is largely what it sounds like, with caveats that are important to understand. People sometimes feel a fixed price contract means the number is the number and it cannot change. That is not in fact the case. At root, a fixed price contract defines a certain scope of work and puts a number on that fixed scope, which means that within reason and wherever feasible to do so, a contractor is responsible for charging you only that price for the work that is in that scope.

The two contract types

There are two primary types of contracts: fixed bid, and cost plus, sometimes referred to as time and materials.

A lot of people feel that a cost plus contract gives them more transparency into the numbers, and for some people that is very important. They want to know what every small detail cost, what the sheet of drywall cost, any little detail. I would caution homeowners against getting wrapped up in the physical cost of the materials. A 2 by 4 costs what a 2 by 4 costs. We have little to no control over that, and the same is true of drywall and copper piping. These materials can and will fluctuate constantly, and trying to understand each industry and why those materials are going up and down can be maddening. It is a layer that none of us really needs to involve ourselves in too much. If those amounts are astronomical, or they change during the bidding and proposal phase, then maybe it is worth looking into, and maybe even exploring alternative products if that is an option.

The reality is that a contractor is not going to spend eight plus hours researching where he can save an extra ten cents per 2 by 4, because the time it takes to research and locate that just negated the cost savings to the client. From a client's perspective that can sound like the contractor does not care. There is only so much time in the day, and that time has to be charged to something — to your job, or distributed among multiple jobs.

How cost plus works, and where it has holes

In a cost plus contract, if I as the contractor am going to hire a subcontractor and it is going to cost me $2,000, I figure out what my operational costs are, add those to that number, and that is the number I give you. Sometimes people think that is just a markup. Yes, it is a markup, because we have to get paid for the time it takes to get the bid from the subcontractor, to talk through any questions and requests for information, to receive the bid, and then to qualify it. Qualifying the bid means reading through it like a contract administrator and making sure they have included everything we wanted them to include. If we are getting multiple bids from different subcontractors, we need to make sure those are qualified against each other — do they all match, do they all offer the same thing — because without that we cannot know if we are comparing apples to apples. That qualification process is something we spend a lot of time and effort on. That markup happens to each item in the proposal. People sometimes call this open book: here is what my subcontractor is charging me for the drywall, and here is my rate on top of it.

We see two holes in this. One is the more honest approach, and the other is the back door approach that not a lot of people actually see.

The honest one: if you really think about it, there is inherently not a lot of incentive for a contractor to finish your job on time or to do their best to save you money. The longer they stay on a project, the more things you add, or the less work they do up front to figure out the details, the more they simply get to hand you all of the bills that come in, and charge you for their time on top of that. If they do not spend a lot of time on their written scope of work, you are the one paying that difference.

The more dishonest one, which we have seen over the years and heard about from subcontractors who have these relationships: the contractor makes a deal with the subcontractor to inflate the bid amount. Take the drywall contractor as a totally random example. Instead of charging $2,000, the contractor arranges for him to charge $3,000. The contractor shows that to the client and lowers his own rate, which maybe makes him look really good. Once the drywall is done, the subcontractor discounts his invoice to the contractor, and the contractor pockets the difference. That is probably less common than the honest contractor. Either way, it is still kind of like an open checkbook, and we do not feel there is enough motivation for a contractor to keep you on track.

Why we work exclusively on fixed price

In the state of California, at least at the time of writing, a fixed price contract is the only legal contract type for a remodel project. We still see people not use this contract type, and it is not legal. There are certain types of cost plus contracts that are legal in construction, but they are designed more for new construction projects and generally do not apply to remodeling, or what we call a home improvement contract.

The significant benefit to the client is this: if we say we are going to do something, and we specify the product, and we say we are going to provide and install that product, we basically have to do that.

The escalation clause

The one caveat is something that is not in everyone's contract, but we put it in ours because it protects us. An escalation clause says that if a product has escalated in price from the time we bid the project to the time we are in construction and actually making the physical purchases — we are not going to buy those things ahead of time — beyond a stated figure, say 5%, we can take that material item back to the homeowner. Here is our original quote from the manufacturer and the date we bid it, and here is the new quote, and it is 7% more. In that case the client may be responsible to pay the difference, or the contractor can help by offering a different solution, a different product, or a different approach to try to get that percentage back.

Clients sometimes push back and ask what the good of a fixed bid contract is then. A contractor cannot stay in business being responsible for every moving target, and all of these are moving targets. We are doing our best to keep it all on track, and for the most part we do. It is extremely rare that we use this clause. We have probably used it a handful of times over 20 years, and more than half of that handful was during Covid, when lumber prices were increasing 40 plus percent. The other thing to understand is that the contractor is not the one receiving the benefit of that additional cost. The client ultimately receives the lumber that cost 40% more, and while that might sting in the beginning, the value of that lumber stays with the house. It does not stay with the contractor.

The written scope of work

The most important thing in a fixed price contract is the written scope of work. Before you start working with a contractor, ask to see a past or example scope of work from a project they have done, and look at the level of detail in it. It has to be understandable. It has to be bulletproof. Read it and make sure you truly understand it.

I do not want to diminish the contract itself, but a written scope of work should be the single most important document you have as a consumer outside of the contract. The contract, done correctly, is mostly what the license board dictates we all have to have anyway — I think eight or ten pages that every contractor is required to use. Our contract is around 15 pages, and ten of those are almost verbatim mandated by the state. Everybody is going to have those pages. It is still a very important document and it effectively governs all the other documents, but the subsequent document is the written scope of work.

Material specifications, allowances and budgets

After that come your material specifications, and this is probably the number one thing we see people get wrong. The contractor does not figure it out, the client does not know it needs to be figured out, and it produces the largest share of change orders we see on fixed bid contracts — allowances and budgets, because real materials were never selected.

If a bid has a lot of allowances or budget items, those are not real products and those are not real numbers. Say a contractor gives you a bid and everything has an allowance next to it. It is a fixed bid, so all those numbers are fixed, but with no specifications behind them, that is simply what you have to spend. If you spend more, you pay more, and you will likely pay the contractor more on top of that, because they will put markup on the additional cost to manage it.

Take a countertop budget of $2,500. You have seen the slab you like and it is around $2,500, so that sounds great. Depending on the layout, the overall size, what is necessary for waste, and the seams, you may need two slabs, or three. Now you are at $7,500 in material, and a typical contractor is going to put their margin, markup, overhead and so on over that. You could be getting an eight to a $10,000 bill, very simply, from what was not defined. That change order is not really a change order at all. It is reconciling an allowance. This is also how a lot of contractors present fixed bid contracts to get their foot in the door and make the numbers look good, and then things change constantly once you are in the project, because nothing was figured out or selected before construction started.

A fixed bid contract is still a very safe way of getting good numbers. Get a written scope of work, and have everything you possibly can specified, with real materials and real selections, so there is no guesswork once you are in the project.

Above all of it is trust

We believe very strongly in the fixed bid contract, and there are contractors who will disagree, and that is okay. Some of the contractors doing cost plus contracts are absolutely doing the right thing and treating their clients well. If you take a step back above the contract discussion, it really comes down to trust. It comes down to interviewing your contractor rather than worrying about cost. On an initial phone call, you should not be trying to figure out what a contractor's costs are before you have even met them and understood who they are. Do you believe they are going to serve you well, and are they a good fit for you and your project? That matters even more than the contract, because at the end of the day most contracts have some sort of hole in them.

Spend time interviewing the contractor. Ask about their process. Ask if you can see samples of their contracts and their written scopes of work. These are the things people do not ask for, and then they receive them at the very end, when they already feel invested. Ask for them early, read them, and make sure you understand what you are going to receive before you get to the end.

When you are going to spend hundreds of thousands of dollars on what is likely the largest investment of your lifetime, you want to make sure that is protected and that it is being done right. Trust the contractor, and do your homework on contract types and what is allowed in your state. Different types of contracts are allowed for different types of projects, and it can be confusing. You should have a contractor familiar enough with this process — contract is in the word contractor, they are supposed to be familiar with contracts. Do not let somebody put flashy numbers in front of you, make you feel good, and then twist things once you are in construction.

If there is anything you want to know about contracts, sample contracts, or written scopes of work, reach out to us and we can help you understand what those should look like.

This post is informational only. Rules and laws change all the time, and nothing here is meant to direct you. It reflects information at the time of writing, and you should check your own local rules and requirements.