What Is a Unit Price Contract & When to Use It?

Not all construction jobs can be perfectly priced at the outset. Often, the scope of work is hard to pin down until a project gets underway. This is where a unit price contract may be appropriate. A unit price contract breaks down and prices discrete parts of an entire project into quantifiable “units,” rather than determining a fixed project price. Should a project grow in scope, a contractor can bill for additional units, thereby protecting its profitability.

What Is a Unit Price Contract?

In a unit price contract, a construction company prices individual portions, or units, of work to estimate a total project cost. Each unit is based on several variables, in combination or on their own, such as materials, labor and overhead. If the scope of a project changes along the way, units can be added or removed. A unit price contract, typically used for public construction projects, is especially handy for projects with an incomplete scope of work and that involve repetitive tasks and resources. A unit price contract also helps remove a contractor’s risk of submitting an inaccurate estimate during the bidding process.

Unit Price vs. Lump Sum Contract

A unit price contract, also known as a measurement or remeasurement contract, bases project costs on the number of units necessary for completion. Costs are accrued incrementally as the project progresses. A lump sum contract, also known as a stipulated sum, reflects a total fixed fee for an entire project.

Key differences:

Unit price and lump sum contracts have several key differences, especially when it comes to pricing flexibility. With unit price contracts, companies price portions of work, but don’t nail down a total price. In the end, the amount billed for and paid reflects work completed. A unit price contract can be used for all or part of a project. In a lump sum contract, a company and customer agree on a predetermined price for an entire project. This type of contract is typically used for well-defined, small-scale projects in which changes are rare. Cash flow is easier to predict in a lump sum contract.

Key Takeaways

• Unit price contracts are based on predetermined costs applied to discrete bundles of work.
• A unit price includes costs for materials, labor and overhead, among other variables.
• A unit price contract is useful for projects in which the full scope of work may be unclear.
• Businesses should consider the pros and cons of a unit price contract to determine whether it makes sense for a particular project.

Unit Price Contract Explained

In a unit price contract, a company determines the costs of specific units of work without knowing exactly how many units will be necessary to complete a project. Consider a construction company that is working with a real-estate developer to build homes in a new residential subdivision. Project units might include costs for feet of lumber, bundles of shingles, yards of cement and other materials. It would also include the different types of labor required, along with their associated rates. Overhead costs such as equipment leasing, taxes and profit are also baked in. Each of these separate items are added together to calculate a unit price.

What Is the “Unit” in a Unit Price Contract?

The “unit” in a unit price contract is a predefined block of work that encompasses the labor, material, equipment, overhead and profit to complete it. Units typically include raw materials, like lumber for a building or asphalt for a road, and labor, such as an electrician’s hourly rate. Units must be specific and consistent for accurate pricing; any variation calls for a separate designated unit.

When to Use Unit Price Contract

A unit price contract is useful for projects that can be easily and logically split into bundles of work and for which the final scope of work is unclear. Should a project require more work than originally estimated, the contractor can add and bill for pre-priced units, thereby preserving profitability. Unit price contracts are typically used in public works projects. They can also be used to determine costs for only certain portions of a project that can be easily quantified.

What Costs and Considerations Go into Pricing a Unit?

Unit price contracts require a granular assessment of all expenses associated with a specific unit of work. The upfront work of detailing units and their costs takes time but provides a level of transparency that makes for easier invoicing, particularly if a project grows in scope. It also ensures a contractor still profits. Unit price contracts capture the following expenses.

• Material costs: The cost of materials required for a unit of work is perhaps the easiest to price. If paving a road, for example, a unit can be one square foot of asphalt. In more complex projects, such as the residential subdivision example, materials would include lumber, concrete and steel.
• Labor costs: Labor — anyone involved in a project’s construction — is another critical element in determining a unit’s cost. Labor may include architects, project supervisors, equipment operators, electricians and plenty more, some of whom are salaried and others with hourly rates.
• Overhead costs: All construction businesses have overhead costs — the non-revenue-generating costs of staying afloat. These include rent, supplies, utilities, fuel for company vehicles, insurance, taxes and personnel costs for roles like accountants, marketers and maintenance staff. Overhead costs, which can be tricky to calculate per unit, are typically determined for the overall project and spread across the units.
• Partner costs: Some companies engage with other businesses on a project; these partner costs need to be factored into the unit cost as well. For example, perhaps a construction company outsources all of its plumbing work to a subcontractor. The cost of paying the plumber may be a unit price based on the plumber's rate and number of hours needed.
• Permit and inspection costs: Construction jobs often require various permits in order to operate legally. Some also require inspections for health and safety purposes. The costs of these permits and inspections may be considered overhead if they’re applicable to the entire business. Or they may be allocated directly to an individual project, such as a building permit for a single house.
• Taxes: State and local sales taxes are typically applied as a percentage of the project cost. Other taxes might apply more broadly and count as overhead, such as property tax on buildings and land used for the business.
• Profit: Finally, the fun part. All companies want to earn a profit on the work they do, and that should be factored into the unit cost as well. Often this will be a percentage mark-up, but it could also be a flat fee.

Unit Price Contract Example

Let’s dig deeper into a road-paving example in which a county government hires a contractor to repave a portion of a 50-mile highway. A likely unit of work might encapsulate all the expenses associated with paving one mile. Material costs would include asphalt and concrete. Labor costs would likely include the people involved in paving: a project manager, equipment operators, road workers and the employees who redirect traffic. Costs for overhead, inspections and taxes are factored in as well. So, let’s say one unit costs $1 million. As the project gets underway, the original ask is for 20 miles of road to be repaved, for which the contractor charges $20 million. Midway through the job, the county expands the scope of work by 10 miles. That’s an additional 10 units of work, or $10 million, bringing the total project cost to $30 million. The contractor remains profitable and the county government is able to easily expand its scope of work and understand the amount required to add on the 10 miles.

Pros and Cons of Unit Price Contracts

Businesses should consider the pros and cons of a unit price contract to determine whether it’s the right choice for a particular project.

Among the pros, a unit price contract makes estimating, tracking costs and billing easier and more transparent — once the upfront work of creating the unit prices is done. Another pro lies in a unit price contract’s flexibility and transparency. If the customer decides to expand a project, the contractor adds additional units to the contract, increasing the project’s cost and the contractor’s profit. The contracting company also knows what added costs to expect. This open-ended nature of a unit price contract also allows a project to begin sooner since it allows for changes along the way.

At the same time, a unit price contract might not be the best choice when the work or materials can’t easily be quantified in discrete units. Some companies may be wary because the total cost of a project isn’t established at the outset. Similarly, unit pricing can be difficult when different components of a unit might vary. Consider, for example, building houses. Houses can vary widely in size and quality, making it very difficult to establish a set price per house unless the designs are consistent.

Manage Unit Price Contracts With NetSuite

Unit price contracts are part of a domain known as project accounting, which handles financial transactions related to managing a project, including costs, billing and revenue. For accurate and efficient accounting, consider project accounting software. It’s particularly useful when it’s part of an overall enterprise resource planning (ERP) platform, delivering accurate accounting and billing throughout a project’s lifecycle, manages internal and external approvals and monitors project profitability. ERP tools connect software from around your business so data from different modules, such as payroll, supply chain and more, all integrate into one digital space. By connecting this information, you’re better able to create unit prices, and then track expenses including labor, materials and more. It can also automate processes such as invoice matching and revenue recognition.

Conclusion

A unit price contract estimates costs based on quantifiable, predetermined units of work. A unit price includes costs of labor, material, equipment and overhead, with profit also built in. Should a project grow in scope, a contractor can bill for additional units and stay profitable. Unit price contracts are typically used for public construction projects that involve materials-heavy, repetitive work. It’s also useful for projects with a certain degree of uncertainty about the ultimate scope of the work. Financial management software, especially as a part of an ERP platform, can help you track project costs, maintain accurate billing and aid with other aspects of project accounting.

Unit Price Contract FAQs

What are the 4 types of contracts?

There are a variety of construction contracts. Two of the most common are unit price contracts, in which costs are based on units of work, and fixed or lump sum contracts. Alternatively, pricing methods like time and materials contracts and cost-plus contracts take a blended approach. Both factor in the cost of various units. A time and materials contract, for example, might have different hourly rates for staff assigned to the project based. A cost-plus contract adds a margin on top of the cost of units — for example, cost of labor and materials plus 25%.

How are payments made in an item rate unit price contract?

In an item rate unit price contract, each item — or unit — has a set price. The amount owed to the construction company is calculated by multiplying the rate for a unit by the number of those units used.

How do you price construction?

Construction contracts can be priced using a variety of approaches. Some of the most common are unit price, lump sum, cost-plus and time and materials. Prices are based on the costs of materials, labor, overhead and other factors.

What is a unit price example?

An example of a unit price is yards of concrete. A construction company might charge $100 for a cubic yard of concrete. If 10 cubic yards are used, the total cost for concrete would be $1,000.

What is the difference between lump sum and unit price?

A unit price contract, also known as a measurement or remeasurement contract, bases project costs on the number of units required by a project. Costs are accrued incrementally, as the project progresses. A lump sum contract, also known as a stipulated sum, reflects a total fixed fee for an entire project.

How does unit price work?

In a unit price contract, a construction company determines the cost for specific units of work without knowing exactly how many units will be necessary to complete a project. Each unit has a predetermined price, which typically includes labor and materials. If a project expands in scope, then the number of units required are added to the contract.