Are Reimbursable Pricing Contracts the Best?

Contract Reimbursement Types

There are many types of reimbursement methods for project contracts:

• Unit price – the contracting party (typically “Contractor”) is reimbursed for a set price per unit of completed work.
• Cost reimbursable – the Contractor is reimbursed for costs plus some markup for overhead and profit. These may be know as “Time-and-Material” or “Time-and-Equipment” contracts.
• Guaranteed maximum – the Contractor is reimbursed for costs plus markup up to some fixed amount.
• Firm fixed price (lump sum) – the Contractor is reimbursed based on a defined method (e.g., percent complete, progress milestone completion, fixed payment schedule) up to a fixed price.
• Combinations of several of these:
  • Cost reimbursable for direct costs (installation costs) with fixed-price overhead
  • Unit price for direct work and fixed-price overhead
  • Lump sum with partial cost reimbursement

The combinations are now numerous.

Cost-Reimbursable Contracts

Often contractors believe that a reimbursable method of payment is the best choice. Why not think that? You, in theory, are covered for all of your costs and you your overhead and profit are covered by a markup that applies to all costs!

Clients are More Hesitant

It’s no longer so simple. Clients have caught on to this problem. Here are some reasons why Clients are not so willing to award contracts with this method of reimbursement:

1. The more the Contractor spends the more they charge for overhead and profit.
2. If a Contractor spends more because of poor labor productivity, the Client pays more.
3. If a Contractor requires frequent rework from errors in installation, the Client pays more.
4. Unless the Contractor and Client have a relationship, the Client may not trust that the Contractor has the Client’s interests at heart. The Client wants the project completed at a reasonable price (or lowest cost). Does the Contractor care about reasonable or lowest?
5. If the Contractor’s cost forecast increases every week or month for a long time, the Client cannot reasonable forecast its own funding needs.

Clients are Smarter

Clients have grown more skeptical and more resistant to this reimbursement method. Even when they do allow it, contract terms are added that represent the Client’s attempt to maintain some control. Here are some methods they may use to help manage costs:

1. The Contractor paperwork burden may be considerable. Perhaps more than in the past, Clients require receipts for every expense and often audit labor through verification of certified payroll. This typically requires more staffing by the Contractor and more burden to check that all cost is supported by a receipt.
2. More detailed reporting. Fixed-price contracts typically require progress reporting (and that reporting continues to increase). Reimbursable contracts require even more and at a more granular level. This often includes details material cost forecasting and details of Contractor labor productivity.
3. Indirect costs may be fixed price rather than reimbursable. This includes staffing costs and any costs not directly related to production of the work product.
4. Contracts may include incentives for under running budgets and penalties for overrunning budgets. This is designed for Contractors to have an incentive to manage costs.
5. Fee, which may include multiple items (profit, overhead, some or all indirect costs), may be fixed. Rather than being “cost plus a markup”, reimbursement becomes “cost plus a fixed fee”. The higher the Contractors cost the lower the fee as a percentage of costs.
6. Contracts may include terms that do not reimburse the Contractor for errors. Costs for mistakes in installation are to the Contractor’s account.
7. Clients may have a more active roll in day-to-day management. The Contractor can’t easily hide internal issues or errors.
8. Other contract language that increases the Client’s control over the Contractor’s ability to exceed the budgeted costs.

Some Contractors still believe that cost-reimbursable contracts are the ultimate solution. With increases in the documentation, more Client involvement in day-to-day management, possible financial penalties for overruns, and more trends toward partial reimbursement with fixed fee or overhead, contracts with “reimbursable” pricing methods are not a guarantee of profit.

When to Use Reimbursable-Cost Contracts

So when does this reimbursement type make sense? Here are some examples:

1. When the scope if not clearly defined. Most Clients will accept a better reimbursement method (better for the Contractor) when the scope is not clear. This may include some form of conversion in reimbursement type as the scope is defined more fully.
2. For renovations or modifications. Projects that involve renovation or modifications to a processing plant, for example, are similar to those with poorly defined scope.
3. Demolition projects. These are more difficult to estimate and the unknowns are more extensive.
4. When the Client and Contractor have a long-term relationship. The relationship should mean that there is trust on both sides.
5. When the Contractor is the only choice. Some sole-source Contractor work become take-it-or-leave-it for the Client.

As in many things in life, when considering a reimbursable contract and thinking it may be the best, be careful what you wish for.