Every construction contract includes a compensation method, which is the basis for how you get paid and how much financial risk you carry. Choosing the right construction contract payment method up front helps prevent disputes down the line.
The right choice depends on the size and scope of your project. The five main compensation methods are:
- Time and materials
- Fixed price
- Unit price
- Cost of the work plus a fee
- Guaranteed maximum price
Quick Decision Guide: Which Construction Payment Method Fits Your Project?
The right compensation method depends on how well your project is defined, how much pricing certainty the owner needs, and how much financial risk you’re willing to assume. These rules of thumb can help you narrow it down.
If your project… | Recommended Payment Method |
Has a simple and clearly defined scope | Fixed Price (Stipulated Sum) |
Has evolving or uncertain scope | Time and Materials |
Includes repetitive work with changing quantities | Unit Price |
Is large or complex | Cost-Plus |
Needs budget certainty with flexibility | Guaranteed Maximum Price (GMP) |
Time and Materials: Pay for What You Use
The time and materials method is relatively straightforward. Your compensation is based on payment for cost of labor, equipment, materials, and services, plus a fee to cover overhead and profit. The fee might be a percentage figure. This method works well for small projects or projects where it is difficult to anticipate the exact scope.
Owners sometimes view time and materials contracts as open-ended because the final cost isn’t known at the start of the project. Without proper guardrails, the scope and price could sprawl beyond expectations. A not-to-exceed amount or cost cap can provide additional certainty.
Recommended AIA Documents:
- A104™ – Abbreviated Agreement Between Owner and Contractor is a stand-alone agreement for projects of limited scope that offers payment options including a stipulated sum or cost of the work plus a fee.
- For larger projects, A103 – Agreement Between Owner and Contractor, Cost Plus Fee Without Guaranteed Maximum Price.
- For custom residential jobs, A110™ – Agreement Between Owner and Contractor for a Custom Residential Project.
Fixed Price (Stipulated Sum) Contracts
A fixed price contract, also called a stipulated sum, is one in which you agree to complete the project for a specific amount. That sum covers labor, materials, equipment, and overhead and profit. The terms of the contract should specify the conditions under which the contract sum may change; if it does, you execute a change order. This method works best when the scope is well defined and you can comfortably determine what it will take to cover costs and profit. Owners often prefer fixed price because they know the project cost before work begins.
Recommended AIA Document: A101® – Agreement Between Owner and Contractor is the standard owner-contractor agreement for fixed price work.
Unit Price Contracts
Unit price contracts are common for civil, utility, and infrastructure projects where quantities can’t be accurately determined before work begins.
A unit price contract is similar to a fixed price contract, except that a fixed price is set for a unit of work, which is then repeated for each unit performed. This method suits projects with repetitive work items where quantities may vary, such as laying pipe or roadway where the contractor charges per foot or per mile completed.
Cost-Plus Contracts: Actual Costs Plus a Fee
A cost of the work plus fee agreement, also called cost plus, is most often used for large or complex projects.
The owner pays you for the costs required to perform the work, including labor, materials, equipment, temporary facilities, and other items specified in the agreement. You also receive a fee, which can be a lump sum, a percentage of the cost of the work, or determined in another way. The fee generally covers overhead and other costs not compensated directly.
Before work begins, contractors typically prepare a control estimate to help the owner understand the anticipated project cost. As work progresses, that estimate is updated when payment applications are submitted.
Because the amount you spend has a direct economic consequence to the owner, your contract will likely require you to keep detailed records, substantiate all costs, and give the owner and the owner’s auditors access to your accounts throughout the project.
Guaranteed Maximum Price (GMP) Contracts
A contract with a guaranteed maximum price (GMP) is a cost-plus arrangement in which you guarantee that the contract sum will not exceed a specified amount, plus any additions or deductions provided for in the contract documents.
Because the contractor assumes the risk of costs over the GMP, these contracts are often described as “at-risk” agreements. Many GMP contracts also include a bonus provision or a shared savings provision if the project comes in under the GMP.
The same record-keeping and administrative responsibilities that apply to cost-plus agreements apply here. This structure is most often used on large projects where payment is based on the cost of the work plus a fee and the owner requires a maximum price.
Recommended AIA Documents:
- A102™ – Agreement Between Owner and Contractor, Cost Plus Fee with Guaranteed Maximum Price is the standard form for GMP agreements.
- A103 – Agreement Between Owner and Contractor, Cost Plus Fee Without Guaranteed Maximum Price covers cost-plus work without a GMP.
Retainage and Schedule of Values: How Payments Flow During Construction
Regardless of which compensation method applies to your project, two payment provisions shape how money moves: retainage and the schedule of values.
Retainage is a percentage of each progress payment that the owner withholds until the end of the project (or another contract milestone). It gives the owner financial security against incomplete or defective work, and the owner releases it as part of the final payment process. Your agreement should specify how much retainage will be withheld and how it will be released, and the retainage should be consistent with applicable state laws.
The schedule of values is a line-item breakdown of the contract sum across the portions of your work, and it’s a practical tool for tracking progress and planning cash flow for both parties. For stipulated sum and GMP contracts, you will typically prepare a detailed schedule of values, agreed upon with the owner, before work begins. Each payment application is based on an updated schedule of values as work is completed.
Choose the Right Method Before You Sign
Each compensation method carries different implications for cost exposure and administrative burden. The decision doesn’t just affect your compensation; it also affects the provisions built into the rest of your agreement.
AIA Contract Documents offers a range of agreements to match your project’s compensation structure. An Unlimited Subscription gives you on-demand access to the full library of agreements and forms so you can start every project with a strong foundation.
