In which type of contract does a contractor assume the greatest cost risk?

In a firm-fixed price contract, the contractor agrees to complete the project for a specific price, which means they bear the full responsibility for any cost overruns or unexpected expenses that may arise during the completion of the project. This type of contract puts the onus of financial risk on the contractor because they must manage all costs to ensure they do not exceed the agreed price.

If the project encounters unforeseen challenges, such as supply chain delays or increased material costs, the contractor cannot increase the price charged to the client; they must absorb those additional expenses. This structure incentivizes the contractor to efficiently manage resources and keep costs down since their profit depends on the effective management of the project within the fixed price.

In contrast, other types of contracts, such as cost plus incentive fee and cost plus fixed fee contracts, involve the client covering costs directly or providing additional compensation based on performance, which reduces the level of financial risk for the contractor. Time and materials contracts also share the cost risk between the contractor and the client, as clients pay for the actual worker hours and materials used, which can lead to less risk for the contractor concerning project costs.