PMP Study and the Types of Contracts

If you're a project professional, you're aware of the various types of contracts and the licit features of projects. For instance, if you've to outsource a product/process to third-party subcontractors or vendors in the middle of your project, then what sort of contract will you leverage for the service provider.

Scenarios like this are why project professionals require to have a sound knowledge of various contract types so they can tackle contract negotiations seamlessly.

In this blog, we will see the three fundamental contract types and give instances to aid you in understanding when you would leverage them.

Fixed Price Contracts

Fixed-price contracts are also called Lump Sum contracts. The buyer and seller make a deal on a fixed rate for the project. The seller often agrees on a high-level risk in this contract type. The buyer is on the minor risk list as the seller's accepted price is fixed. 

However, ensure this sort of contract has fully detailed properties, project scope statements, and checklists from the seller, which the buyer will leverage.

With this kind of contract, sellers may strive to cut the scope to deliver the projects within time and budget. If the project is completed on time with the required quality, the project is over for that contract. However, if the project gets delayed and there are expense overruns, the seller will take in all the extra expenses.

Here are a few types of fixed-price contracts:

Fixed Price Award Fee (FPAF): If the performance of the seller surpasses expectations, an extra cost, i.e., 10% of the total rate, has to be paid to the seller.

Fixed Price Economic Price Adjustment (FPEPA): The fixed price can be considered based on the market pricing rate.

Fixed Price Incentive Fee (FPIF): Though the price is fixed, the seller is given a performance-based bonus. The bonus can be dependent on one/more project metrics like time, performance, or cost.

Cost Reimbursable Contracts

What do you do when the work scope is vague? Since you're not sure what the project needs, a fixed-price contract is out of the book. Here is where you will need to leverage a cost-reimbursable contract.

What is a cost-reimbursable contract?

It's also called a cost disbursable contract, leveraged when the project is high-risk, or the scope isn't clear. The buyer pays all costs; hence the buyer endures all the risk. 

Under this type of contract, the seller works for a fixed time and raises the bill, indicating the contract's profit once the work is done. The price may be dependent on chosen project performance or other metrics.

A major downfall of a cost-reimbursable contract is that the seller can increase an unknown or unlimited rate the buyer is forced to pay. This is why this type of contract is rarely leveraged.

Here are a few types of cost-reimbursable contracts:

Cost Plus Fixed Fee (CPFF): The seller is paid a fixed rate that is accepted upon prior work start. The project cost incurred is reimbursed based on this, irrespective of project performance.

Cost Plus Award Fee (CPAF): The seller will receive an incentive including the actual project cost incurred; this contract is similar to a cost-plus incentive fee (CPIF) contract.

Cost-Plus Percentage of Costs (CPPC) or Cost-Plus Fee (CPF): The seller will receive the total amount they incurred amid the project in addition to a percentage of the fee over cost; this is always advantageous for the seller.

Cost Plus Incentive Fee (CPIF): A performance-based incentive fee will be paid to the seller over and above the expense they have incurred on the projects. With this contract type, the incentive is an encouraging aspect for the seller to fulfill or surpass the project's performance metrics.

Time and Material Contracts

It, also known as Unit Price Contracts, is a hybrid of fixed price and cost-reimbursable contracts. For instance, if the seller spends 1200 hours on a project at $100/hour, the seller will be paid $120K by the buyer. This type of contract is typical for freelancers, and the main benefit is that the seller makes money for every hour spent working on the project.

Concluding Thoughts

As a project professional, you must land the correct contracts with various service providers to minimize risk and deliver the project within time. You must always consider the appropriate contract to offer optimum value for money and time spent on the work while safeguarding it from risks.