Contract type selection is one of the most consequential decisions in construction. The choice between time and materials and fixed price determines who bears risk, how changes are handled, and whether the project stays on budget.
Neither contract type is inherently better. The right choice depends on scope clarity, project complexity, and risk tolerance.
Here’s how to decide.
What is a Time and Materials Contract?
A time and materials (T&M) contract pays the contractor for actual labor hours and materials used on the project, plus a markup for overhead and profit.
How T&M Billing Works
- Labor: Predetermined hourly rates that include wages, overhead, and profit
- Materials: Actual material costs plus a markup (typically 15-35%)
- Equipment: Rental rates for equipment used on the project
Example Calculation
Base labor cost: $75/hour
Loaded labor rate (with 15% markup): $86.25/hour
Materials: $10,000 at cost + 25% markup = $12,500
Total for 100 labor hours: $8,625 + $12,500 = $21,125
Key Characteristics
- Scope flexibility: High = accommodates evolving requirements without contract renegotiation
- Risk bearer: Owner bears primary financial risk for cost overruns
- Budget certainty: Low = final cost unknown until project completion
- Change handling: Changes absorbed through ongoing billing with no formal change orders needed
What is a Fixed Price (Lump Sum) Contract?
A fixed price contract establishes a single predetermined cost for the entire project scope, including all labor, materials, markup, and contingency.
How Fixed Price Billing Works
Payments are typically tied to project milestones:
- 10% at contract signing
- 20% after foundation completion
- 30% after framing
- 30% after mechanical/electrical
- 10% at final completion
Retainage (a portion held back until substantial completion) provides performance incentive.
Key Characteristics
- Scope flexibility: Low = changes require formal change orders and price adjustments
- Risk bearer: Contractor bears primary financial risk for cost overruns
- Budget certainty: High = total cost known from project start
- Change handling: Formal change order process required for any scope deviation
T&M vs Fixed Price: Key Differences
| Factor | Time and Materials | Fixed Price |
|---|---|---|
| Scope Flexibility | High | Low |
| Owner Risk | High | Low |
| Contractor Risk | Low | High |
| Budget Certainty | Low | High |
| Change Orders | Minimal formal process | Required for changes |
| Documentation Burden | High (detailed tracking) | Lower |
| Best For | Uncertain scope | Well-defined scope |
When to Use Time and Materials Contracts
T&M contracts work best when accurate cost estimation isn’t possible upfront:
Renovation Projects
Renovation work regularly uncovers hidden conditions—structural issues, outdated wiring, plumbing problems that weren’t visible during assessment. T&M allows these discoveries to be addressed without contentious change order negotiations.
Emergency Repairs
When rapid response is needed, there’s no time for detailed scope development. T&M enables work to begin immediately while costs are documented as they occur.
Uncertain Scope
Complex infrastructure projects, R&D facilities, and projects dependent on evolving technology often can’t be fully specified upfront. T&M accommodates scope evolution without constant contract renegotiation.
Volatile Material Prices
When material costs are unpredictable due to tariffs, supply chain disruptions, or market conditions, T&M protects contractors from getting squeezed by price increases after contract signing.
Fast-Track Projects
Projects that must begin before design is complete benefit from T&M flexibility. Work proceeds while scope develops, without waiting for fixed-price bidding.
When to Use Fixed Price Contracts
Fixed price contracts make sense when scope is clear and risks are understood:
Well-Defined Scope
When project requirements are thoroughly documented with detailed specifications, fixed price provides budget certainty for both parties.
Straightforward Builds
Standard construction with few variables—tract homes, simple commercial buildings, repetitive structures—suit fixed price bidding.
Experienced Contractors
Contractors who have completed similar projects can accurately estimate costs and confidently accept fixed-price risk.
Budget-Focused Owners
When the owner needs a hard budget ceiling with no flexibility, fixed price provides the certainty required for financing and planning.
Understanding Risk Allocation
Fixed Price Risk
The contractor absorbs all cost overruns and delays. If material prices increase, labor takes longer than planned, or unforeseen conditions arise, the contractor pays. This incentivizes contractors to inflate bids to cover potential risks.
T&M Risk
The owner pays for all actual costs incurred. If the project runs over, the owner pays more. This can feel like an open checkbook without proper controls.
Managing T&M Risk
Not-to-exceed (NTE) clauses cap total costs, providing budget protection while maintaining flexibility. Regular cost monitoring and approval workflows prevent runaway spending.
Hybrid Approaches: GMP and T&M with Cap
Hybrid contracts balance flexibility with budget protection:
Guaranteed Maximum Price (GMP)
The owner pays actual costs plus a fee, capped at an agreed maximum. The contractor absorbs costs exceeding the GMP. Savings below the cap are typically split 50-50.
GMP works well for large, complex projects where owners want cost protection but contractors need flexibility to manage uncertainties.
T&M with Not-to-Exceed (NTE)
A standard T&M contract with a maximum budget ceiling. Work proceeds on T&M basis, but costs cannot exceed the NTE amount without explicit approval.
This preserves T&M flexibility while giving owners budget certainty.
Common Mistakes in Contract Selection
Using Fixed Price for Renovation
Renovation projects almost always uncover hidden conditions. Fixed price contracts lead to disputes when reality differs from assumptions.
Treating T&M as Open Checkbook
Without proper tracking, monitoring, and approval workflows, T&M costs can spiral. Implementation of controls is essential.
Inadequate Scope Definition
Fixed price contracts require thorough scope development. Rushing this step leads to excessive change orders that negate the budget certainty fixed price was supposed to provide.
Relying on Paper-Based T&M Tracking
Paper tickets get lost. Handwriting is illegible. Approvals are delayed. Digital T&M tracking eliminates these problems and reduces change order processing time by 50% or more.
Generalizing Contract Terms
Vague language leaves room for interpretation and disputes. Specify exact terms—hourly rates, markup percentages, approval thresholds, change order procedures.
Best Practices for T&M Contract Management
Document Everything
- Daily timesheets with detailed work descriptions
- Material receipts and delivery tickets
- Photo documentation of work performed
- Equipment usage logs
Get Approvals in Real-Time
Don’t wait until month-end to get signatures. Daily or weekly approvals keep everyone aligned and prevent disputes.
Use Digital Tracking
Mobile apps with GPS verification, photo documentation, and digital signatures create defensible records that hold up to scrutiny.
Establish Clear Communication
Regular cost updates prevent surprises. Weekly status reports keep owners informed of spending against budget.
Set Approval Thresholds
Define what requires owner approval: individual expenses over $X, cumulative spending beyond Y% of estimate.
Frequently Asked Questions
What is a time and materials contract?
A time and materials contract pays contractors for actual labor hours and materials used, plus a markup for overhead and profit. Labor is billed at predetermined hourly rates, and materials are billed at cost plus markup (typically 15-35%).
When should I use T&M vs fixed price?
Use T&M when scope is uncertain, project requirements may evolve, or accurate upfront estimates aren’t possible (renovation, emergency repairs, complex infrastructure). Use fixed price when scope is well-defined, the project is straightforward, and budget certainty is the priority.
Who bears more risk in a fixed price contract?
The contractor bears primary risk in fixed price contracts. Cost overruns, delays, and unforeseen conditions are the contractor’s problem, the owner pays the agreed price regardless.
What is a GMP contract?
A Guaranteed Maximum Price (GMP) contract is a hybrid where the owner pays actual costs plus a fee, capped at an agreed maximum. The contractor absorbs costs exceeding the GMP. Savings below the cap are typically split between owner and contractor.
How do I protect my budget with a T&M contract?
Include a not-to-exceed (NTE) clause that caps total costs. Implement regular cost monitoring, require approvals for significant expenses, and use digital tracking to maintain visibility into spending.
Key Takeaways
- 85% of projects experience cost overruns—contract type selection is critical risk management
- T&M: High flexibility, owner bears risk, best for uncertain scope and renovation
- Fixed price: Budget certainty, contractor bears risk, best for well-defined scope
- GMP: Hybrid approach balancing flexibility with budget ceiling
- Renovation projects: Almost always better suited for T&M due to hidden conditions
- Documentation is essential: Digital T&M tracking reduces disputes and accelerates approvals
- NTE clauses: Provide budget protection while maintaining T&M flexibility
The wrong contract type can turn a profitable project into a dispute. Match the contract to the project’s characteristics—scope clarity, risk tolerance, and need for flexibility—and implement the controls that make it work.
