Cost-Plus Pricing: Formula, Worked Examples, Pros and Cons, and How Government Cost-Plus Contracts Work

Cost-plus pricing is the simplest way to set a price: work out what something costs you, then add a fixed percentage for profit. It's how most small manufacturers quote, how contractors bill materials and how the federal government buys research and complex work it can't price in advance. This guide is for US makers, contractors, distributors and firms bidding on government work. It covers the formula, how to build a proper overhead rate, worked examples, where cost-plus beats value-based pricing and where it doesn't, and how federal cost-plus contracts work after the 2026 rule changes.

Quick answer

Cost-plus price = full unit cost × (1 + markup %). Full cost means direct materials, direct labor and a share of overhead. A part with $21.90 of full cost and a 25% markup sells for $27.38. In federal contracting, cost-plus means the government reimburses allowable costs plus a fee — but the fee can't be a percentage of cost.

• Build an overhead rate (annual overhead ÷ direct labor hours) before you add a markup

• A 25% markup on cost is a 20% gross margin on price

• Pros: simple, defensible, covers costs; cons: ignores customer value and rewards inefficiency

• Federal CPFF fee caps: 10% general, 15% R&D, 6% architect-engineer

• Since 2026, fixed-price is the federal default; large cost-type contracts need agency-head approval

What cost-plus pricing is

Cost-plus pricing (also called markup pricing or cost-based pricing) sets the selling price by adding a predetermined profit to the cost of producing or buying a product or service. The profit is usually a percentage of cost, called the markup. If you know your full cost per unit is $40 and you want a 30% markup, your price is $52.

It's popular because it's easy to calculate, easy to explain to customers and almost guarantees that each sale covers its own costs. A cabinet shop that quotes every job at full cost plus 20% knows that, if its cost estimate is right, every job contributes profit. Retailers use a version of it when they double a wholesale cost ("keystone" pricing), and distributors when they add a set percentage to every supplier invoice.

The word "plus" hides the real work. Cost-plus pricing is only as good as the cost figure underneath it, and the cost most small businesses forget is overhead: rent, supervisors, equipment, insurance and the office. If you mark up only materials and direct labor, the markup has to cover all of those before it produces any profit, and it often doesn't.

There's also a second meaning. In contracting, cost-plus describes a contract where the buyer pays the seller's actual costs plus a fee, rather than agreeing a fixed price upfront. Private construction projects and many federal research and defense contracts work this way. We cover both meanings in this guide, starting with pricing.

The cost-plus pricing formula

There are two common forms, and they give the same answer:

• Price = unit cost × (1 + markup) — for example, $40 × 1.30 = $52.
• Price = unit cost + (unit cost × markup) — $40 + $12 = $52.

Unit cost should be full cost: direct materials + direct labor + allocated overhead per unit. Direct materials are the parts and raw materials that end up in the product. Direct labor is the wages and payroll costs of the people who make it. Overhead is everything else needed to run production that you can't trace to a single unit, which IRS Publication 334 describes for manufacturers as indirect labor and factory overhead.

Markup and margin are not the same. A 30% markup on a $40 cost gives a $52 price and $12 of profit, which is 23.1% of the price. If your target is a gross margin on price, use price = cost ÷ (1 − margin) instead, or convert: markup = margin ÷ (1 − margin). Our markup guide has a full conversion table, and the gross profit margin guide shows how the margin appears on your books.

How to calculate a cost-plus price, step by step

Here's a small machine shop pricing an order for 2,000 aluminum mounting brackets.

Cost-plus pricing for a machined bracket

1. 1

   Direct materials per unit

   Aluminum bar stock, fasteners and finishing: $6.40 per bracket, including inbound freight and a 3% scrap allowance.

2. 2

   Direct labor per unit

   Each bracket takes 15 minutes of machinist time. At a loaded labor cost of $32 an hour (wage plus payroll taxes and benefits), that's 0.25 × $32 = $8.00.

3. 3

   Overhead rate

   Annual shop overhead (rent, utilities, supervisor, machine depreciation, maintenance, insurance) is $180,000, spread over 6,000 direct labor hours a year: $30 per direct labor hour.

   Tip: Use realistic hours you'll actually bill, not the theoretical maximum.

4. 4

   Overhead per unit

   0.25 hours × $30 = $7.50 per bracket.

5. 5

   Full unit cost

   $6.40 + $8.00 + $7.50 = $21.90.

6. 6

   Add the markup

   A 25% markup gives $21.90 × 1.25 = $27.38 per bracket, or $54,750 for 2,000 units — $10,950 of profit on the order.

The overhead rate is the step that makes or breaks cost-plus pricing. Allocating overhead by direct labor hours suits a shop where labor drives most activity. If machine time drives your costs, use machine hours instead; if materials dominate, some businesses allocate overhead as a percentage of material cost. Whatever base you pick, use it consistently and recalculate at least once a year, because overhead per hour rises sharply when work slows down. If the shop above only sells 4,500 direct labor hours next year, the same $180,000 of overhead becomes $40 an hour, and the bracket's full cost jumps to $24.40.

That's also cost-plus pricing's trap: when sales fall, full cost per unit rises, and a strict cost-plus price rises with it, exactly when customers are hardest to win. Many shops set the overhead rate from a normal year's volume and accept lower profit in a slow year rather than chasing prices up.

Try it — the bracket at a 25% markup

Cost PriceMarkup

Cost Price₹21.90

Profit per Unit₹5.48

Equivalent Margin20%

Selling Price₹27.38

Open the full Markup Calculator (PDF, save, compare)

Cost-plus pricing examples by business type

Cost-plus shows up across industries with different cost bases and typical markups. The markups below are illustrative ranges to show the method, not industry standards; your own overhead and competition decide yours.

Notice that the markup has to do different jobs. A retailer's 100% markup pays for the store, staff and marketing out of a single percentage on stock. A machine shop that has already built overhead into full cost needs a much smaller markup, because what's left is genuinely profit. Comparing raw markups across businesses tells you little unless you know what the cost base includes.

Cost-plus vs value-based and competitive pricing

Cost-plus is one of three broad ways to set prices. The other two start from the customer and the market rather than your costs.

Three ways to set a price

	Cost-plus	Value-based	Competitive (market)
Starts from	Your full cost	What the result is worth to the customer	What rivals charge
Best for	Custom work, manufacturing, contracts with open books	Specialist services, unique products, clear ROI	Commodity products, crowded local markets
Main risk	Leaves money on the table; rewards high costs	Hard to estimate value; harder to justify	Race to the bottom; ignores your own costs
Data you need	Accurate costs and overhead rate	Customer research and outcomes	Current competitor prices

Starts from

Cost-plus

Your full cost

Value-based

What the result is worth to the customer

Competitive (market)

What rivals charge

Best for

Cost-plus

Custom work, manufacturing, contracts with open books

Value-based

Specialist services, unique products, clear ROI

Competitive (market)

Commodity products, crowded local markets

Main risk

Cost-plus

Leaves money on the table; rewards high costs

Value-based

Hard to estimate value; harder to justify

Competitive (market)

Race to the bottom; ignores your own costs

Data you need

Cost-plus

Accurate costs and overhead rate

Value-based

Customer research and outcomes

Competitive (market)

Current competitor prices

In practice, good pricing uses all three. Cost-plus gives you a floor: the lowest price at which a job still covers its full cost and earns your minimum profit. Market prices tell you whether that floor is competitive. Value tells you how far above the floor you can go. A sign shop that calculates a $480 cost-plus price for a storefront sign, sees local competitors at $550–$650 and knows the sign will bring in new customers for years has room to quote $600.

If your cost-plus price lands well above the market, it isn't the formula that's wrong; it's a signal that your costs, overhead or volume need attention. If it lands well below what customers happily pay, you're probably undercharging.

Advantages and disadvantages of cost-plus pricing

Advantages

• Simple and fast. Once you have a cost model and an overhead rate, quoting is arithmetic. Staff can price jobs consistently.
• Covers costs. If the estimate is right, every sale contributes to overhead and profit.
• Easy to justify. Customers, especially businesses and governments, accept a price built from documented costs, and it suits open-book relationships.
• Stable in cost-driven markets. When material costs swing, prices move in step, which customers in construction and manufacturing often expect.

Disadvantages

• Ignores demand and value. Two jobs with the same cost can be worth very different amounts to customers; cost-plus prices them the same.
• Rewards inefficiency. If your costs rise, so does your profit in dollars. That's why buyers dislike, and federal law bans, contracts that pay a percentage of cost.
• Depends on accurate costing. A wrong overhead rate or a missed cost line flows straight into every price.
• Circular in slow periods. Lower volume raises overhead per unit, which pushes prices up just when demand is weak.
• Can undercut your premium. If your work is better than the competition's, a cost-plus price may hide that from customers.

Cost-plus contracts in private work

In construction, engineering, software development and custom manufacturing, cost-plus is often a contract type rather than a pricing formula. The customer agrees to pay the contractor's actual costs for the work plus a fee, which can be a fixed dollar amount or a percentage of cost. Customers choose it when the scope can't be fully defined at the start, such as a renovation behind old walls or a prototype nobody has built before.

Private cost-plus contracts are legal with either fee type, but owners usually protect themselves in three ways. A guaranteed maximum price (GMP) caps what the owner will pay; costs above it fall on the contractor, and savings below it may be shared. Open-book accounting gives the owner the right to see invoices, timesheets and subcontracts. A clear definition of reimbursable costs spells out what counts: whether the contractor's office overhead, owned equipment, supervision and warranty work are billable, and at what rates.

For the contractor, the attraction is lower risk; you're paid for what the work actually costs. The trade-off is more paperwork, less upside and an owner who can question every line. If you quote cost-plus work, keep job-cost records good enough to survive an audit, agree labor rates and equipment rates in writing, and price your fee so it covers the head-office overhead the contract won't reimburse. Our guide to writing a construction bid covers fixed-price bids, the more common alternative.

How federal cost-plus contracts work

The federal government calls these cost-reimbursement contracts. Under the Federal Acquisition Regulation (FAR), the government pays the contractor's allowable incurred costs, up to a ceiling set in the contract, plus any fee. They're meant for work where requirements can't be defined well enough, or costs estimated reliably enough, for a fixed price: research, early development, complex services and some defense production.

The main types are:

• Cost contract — reimburses allowable costs with no fee.
• Cost-sharing contract — no fee, and the government pays only part of the allowable costs; the contractor accepts this because it expects other benefits from the work.
• Cost-plus-fixed-fee (CPFF) — reimburses costs plus a fee negotiated at the start that doesn't change with actual cost (it can change only if the work itself changes).
• Cost-plus-incentive-fee (CPIF) — the fee moves up or down by formula depending on how actual allowable cost compares with a target cost.
• Cost-plus-award-fee (CPAF) — a base fee plus an award fee the contractor can earn, in whole or in part, for excellent performance against criteria in the award-fee plan.

What's banned. Federal law prohibits the cost-plus-a-percentage-of-cost system (41 U.S.C. 3905 and 10 U.S.C. 3322), and FAR 16.102 repeats it: profit that grows with every dollar spent gives the contractor a reason to spend more. Prime contracts other than firm-fixed-price must also forbid cost-plus-percentage-of-cost subcontracts, which matters if you're a small subcontractor: your subcontract can be cost-reimbursement with a fixed fee, but not a percentage-of-cost markup.

Fee caps. The same statutes cap the fee on a CPFF contract at 10% of estimated cost (excluding fee), 15% for experimental, developmental or research work, and 6% of estimated construction cost for architect-engineer services on public works or utilities. These are ceilings; contracting officers negotiate fees using structured profit analysis, and actual fees are often well below them.

Who can use them. Before awarding a cost-reimbursement contract, the agency must have a written acquisition plan approved above the contracting officer, government resources to monitor the work, and a contractor accounting system adequate to segregate and allocate costs. Cost-reimbursement contracts aren't allowed for buying commercial products or commercial services. For a small business, the accounting system is usually the hurdle: you'll need job-cost accounting, timekeeping that ties every hour to a contract, and indirect cost pools (fringe, overhead, general and administrative) that you can defend.

Which costs count. Only allowable costs are reimbursed. FAR Part 31 sets the cost principles; for example, entertainment and social activity costs are unallowable (FAR 31.205-14), and so are alcoholic beverages (FAR 31.205-51). Unallowable costs still have to come out of your fee or other revenue, so keep them in separate accounts from day one.

Worked example: fixed fee vs incentive fee

CPFF. A small engineering firm wins a research contract with $800,000 of estimated cost. The statutory cap would allow a fee of up to $120,000 (15% for research), but the negotiated fixed fee is 8%, or $64,000. If allowable costs come in at $880,000 (and the agency approves funding above the original estimate), the firm is reimbursed $880,000 and still earns $64,000, so its fee falls to 7.3% of actual cost. If costs come in at $750,000, the fee is still $64,000, or 8.5% of cost. The fee doesn't reward or punish cost performance; only reputation and future awards do.

CPIF. A different contract has a target cost of $500,000, a target fee of $40,000, a minimum fee of $15,000, a maximum fee of $60,000 and a 70/30 share ratio (the government bears 70% of any overrun or keeps 70% of any underrun; the contractor bears or keeps 30%). If actual cost is $540,000, the $40,000 overrun cuts the fee by 30% × $40,000 = $12,000, to $28,000. If actual cost is $460,000, the fee rises by $12,000 to $52,000. Here the contractor has a real incentive to control cost.

The CPIF example (target cost $500,000, 70/30 share)

$40,000

Target fee

min $15,000 · max $60,000

$28,000

Fee if cost is $540,000

30% of the $40,000 overrun comes off

$52,000

Fee if cost is $460,000

30% of the $40,000 underrun is added

What changed for federal cost-plus contracts in 2025–2026

Federal contract-type rules changed significantly over the past year, so check the current text before you bid.

The FAR overhaul. Under the Revolutionary FAR Overhaul, the FAR Council issued rewritten "model deviation" text for each FAR part, which agencies have been adopting through class deviations. For Part 16 (contract types), agencies such as the Department of Energy and the National Archives adopted the new text by class deviation in January 2026. The rewrite keeps the ban on cost-plus-a-percentage-of-cost contracting and keeps the core cost-reimbursement types, but reorganizes where some of them sit.

Fixed-price is now the default. Executive Order 14402, signed April 30, 2026, made fixed-price contracts the default and preferred type. The FAR Council revised the Part 16 model text in July 2026 to implement it. Agencies must now consider fixed pricing even for parts of a requirement, and contracts that aren't firm-fixed-price (including cost-reimbursement contracts) at or above set values need a written justification approved by the agency head: $100 million for the Department of Defense, $35 million for NASA, $25 million for the Department of Homeland Security and $10 million for other agencies. According to a Greenberg Traurig summary of the deviation, approvals have been required for new solicitations since July 15, 2026. Cost-reimbursement contracts must also have a contracting officer's representative assigned to monitor cost control.

Federal contract-type changes, 2026

January 2026

Agencies begin adopting the rewritten FAR Part 16 text by class deviation

April 30, 2026

Executive Order 14402 makes fixed-price contracts the default and preferred type

July 1, 2026

FAR Council revises the Part 16 model text to implement the order

July 15, 2026

Agency-head approval required before new solicitations for covered non-fixed-price contracts

By July 15, 2027

Justifications due for existing covered contracts with 18+ months left (per Greenberg Traurig summary)

What it means for small businesses. Most small-business awards fall below these thresholds, but the direction is clear: expect more fixed-price and hybrid contracts, and more scrutiny when an agency picks a cost-type vehicle. If you price federal work, you'll need to be able to bid both ways: a defensible cost build-up for cost-reimbursement work, and the risk judgment to commit to a fixed price. The SBA's federal contracting pages are the starting point for registering and finding set-aside work.

Common cost-plus pricing mistakes

Marking up materials and labor only. Without an overhead allocation, your markup has to pay for rent, equipment and the office before it makes a profit. Build full cost first.

Using an overhead rate from a busy year. Overhead per hour climbs when volume drops. Set the rate from realistic annual hours and review it every year.

Confusing markup with margin. A 25% markup is a 20% margin. Quote in the language your customer uses.

Applying one markup to everything. Rush jobs, small orders and complex work cost more to handle than their direct costs suggest. Many shops use a minimum order charge or a higher markup on small runs.

Billing unallowable costs on government work. Entertainment, alcohol and similar costs can't be charged to a federal cost-type contract. Keep them in separate accounts so they never reach an invoice.

Pricing below the market without noticing. If your cost-plus price is far below competitors', test a higher price. Cost is the floor, not the ceiling.

Official references

• FAR 16.102 — CPPC prohibitedPolicies on contract types
• FAR Overhaul — Part 16 model deviation textFixed-price default, covered-contract thresholds
• FAR 15.404-4 — Profit and fee limitsStatutory CPFF fee caps
• 41 U.S.C. § 3905 — Cost contractsStatute behind the CPPC ban and fee caps
• FAR Part 31 — Contract cost principlesAllowable and unallowable costs
• SBA — Federal contractingGetting started with government contracts

What to do next

Build a full-cost model for your three most common jobs or products, including an overhead rate from last year's real hours, and run each through the markup calculator to see the price and margin your markup produces. Compare those prices with what the market charges, and use the break-even calculator to check how many jobs a month cover your overhead. If you sell services by the hour, our guide on how to price your services shows how to turn the same cost build-up into an hourly or project rate.

This is general information, not legal or tax advice — confirm on the official source or with a professional.

Frequently asked questions

What is the cost-plus pricing formula?

Price = unit cost × (1 + markup percentage). Unit cost should be the full cost of making or buying one unit, including direct materials, direct labor and a share of overhead. If a part costs $21.90 to make and you add a 25% markup, the price is $21.90 × 1.25 = $27.38, leaving $5.48 of profit per unit.

What is an example of cost-plus pricing?

A contractor buys $8,000 of materials for a kitchen remodel and bills them at cost plus 15%, or $9,200. A machine shop totals materials, labor and overhead for a bracket at $21.90 and quotes $27.38 with a 25% markup. A federal agency pays a research firm its allowable costs plus a fixed fee agreed at the start. All three add a margin to cost.

What are the disadvantages of cost-plus pricing?

It ignores what customers are willing to pay, so you can underprice valuable work or overprice commodity products. It depends on accurate cost data, including an overhead rate that changes with volume. And in contracts, paying a percentage of cost rewards spending more, which is why federal law bans cost-plus-a-percentage-of-cost contracts.

Is cost-plus-percentage-of-cost allowed in government contracts?

No. Federal law (41 U.S.C. 3905 and 10 U.S.C. 3322) and the FAR prohibit the cost-plus-a-percentage-of-cost system, because the contractor's profit would rise with every extra dollar spent. Prime contracts other than firm-fixed-price must also bar such subcontracts. Federal cost-type contracts use a fixed, incentive or award fee instead.

What is the maximum fee on a cost-plus-fixed-fee contract?

By statute, the fee can't exceed 10% of the contract's estimated cost (excluding fee) for most cost-plus-fixed-fee contracts, 15% for experimental, developmental or research work, and 6% of the estimated construction cost for architect-engineer services on public works. Negotiated fees are usually well below these caps.

What is the difference between cost-plus and fixed-price contracts?

In a fixed-price contract the seller agrees a price upfront and keeps any savings or absorbs any overrun. In a cost-plus contract the buyer pays actual allowable costs plus a fee, so the buyer carries most of the cost risk. Since 2026, federal rules make fixed-price the default and require extra approval for large cost-type contracts.

Sources & verification

Figures on this page were checked against the sources below when it was last reviewed on 12 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify

1. 1.FAR 16.102 — Policies (cost-plus-a-percentage-of-cost prohibited) — Acquisition.gov (GSA / FAR Council) · accessed 12 October 2026
2. 2.FAR Overhaul — Part 16, Types of Contracts (model deviation text) — Acquisition.gov (FAR Council) · accessed 12 October 2026
3. 3.FAR 15.404-4 — Profit — Acquisition.gov (GSA / FAR Council) · accessed 12 October 2026
4. 4.41 U.S.C. § 3905 — Cost contracts — Legal Information Institute, Cornell Law School (U.S. Code) · accessed 12 October 2026
5. 5.FAR 31.205-14 and 31.205-51 — Entertainment and alcoholic beverage costs — Acquisition.gov (GSA / FAR Council) · accessed 12 October 2026
6. 6.FAR 16.301-3 — Limitations (cost-reimbursement contracts) — Acquisition.gov (GSA / FAR Council) · accessed 12 October 2026
7. 7.Revolutionary FAR Overhaul implements fixed-price contracting preference under FAR Part 16 — Greenberg Traurig · accessed 12 October 2026
8. 8.Publication 334 (2025), Tax Guide for Small Business — IRS · accessed 12 October 2026
9. 9.Federal contracting — U.S. Small Business Administration · accessed 12 October 2026