Types of Contract inProject Management Ali Heydari
Table of Contents• Why should we know types of contract?• What is Contract?• Types of Contracts• Fixed Price or Lump Sum Contracts• Cost-Reimbursable Contracts• Kinds of cost-reimbursable contracts• Time and Material (T&M) Contracts
Why should we know types of contract?• Whether you’re managing a small project or a large complex program you need a basic understanding of the different types of contract you’re likely to encounter when buying from external organizations and 3rd parties.
What is Contract?• A contract is an exchange of promises between two or more parties to do, or refrain from doing an act, which resulting contract is enforceable in a court of law.• In the project or program context, contracts typically involve the exchange of money in return for goods or services.
Types of Contracts• There are three basic types of contract you’re likely to come across in managing your projects and programs:1. Fixed price or lump sum contacts2. Cost reimbursable contracts3. Time and materials (T&M) contracts
1-Fixed Price or Lump Sum Contracts• In this type of contract a specific price is agreed for the good or service being sold. In project terms, the buyer and seller will agree on a well-defined deliverable for a specific price.• In this type of contract the bigger risk is borne by the seller. They must make sure they make a profit even given some unknowns such as increasing costs or delays in creation of the deliverable.
Cont…• Fixed price contracts can be catastrophic for both buyer and seller if there isn’t a well defined deliverable.• Firstly, often the sellers profit is eroded as they compromise to meet the buyer’s demands.• Secondly, the buyer may have to pay more for change requests when the supplier is no longer willing to compromise around what, in their eyes, appear to be changing requirements.
Cont…• Another type of contract you might encounter is the fixed-price plus incentive contract.• Here the contract includes an incentive or bonus, typically for the early or on-time completion of the deliverable.
2-Cost-Reimbursable Contracts• In this type of contract all the costs that the seller incurs during the project are charged back to the buyer, and thus the seller is reimbursed costs. The costs which are allowable will be defined in the contract.• In this type of contract more risk is carried by the buyer as the final cost is uncertain. If problems arise during the execution of the project then the buyer will have to spend more.
Con…• The advantage of this type of contract to the buyer is that obviously scope changes can be easily made to the work being done.• One problem with this type of contract is that the seller has very little incentive to be efficient and productive and complete the work quickly.• It should come as no surprise that this type of contract is most often used when there is a lot of uncertainty associated with the final deliverable.
Kinds of cost-reimbursable contracts• There are three kinds of cost-reimbursable contracts you should understand:1. Cost plus fee (CPF) or cost plus percentage of cost (CPPC)2. Cost plus fixed fee (CPFF)3. Cost plus incentive fee (CPIF)
Cost plus fee (CPF) orcost plus percentage of cost (CPPC)• Here the seller is reimbursed for allowable costs plus a fee that’s calculated as a percentage of costs.• Obviously, there is no incentive for the seller to complete the work quickly with this type of contract.
Cost plus fixed fee (CPFF)• Here all allowable expenses are charged back plus a fixed fee at the end of the contract.• The fixed fee is how the seller makes their profit.• The aim of the fixed fee is to encourage the seller to complete the work as quickly as possible.
Cost plus incentive fee (CPIF)• Here all allowable expenses are charged back and in addition an incentive fee for exceeding the performance criteria specified in the contract.• The incentive fee is designed to encourage increased cost performance by the seller. There is the potential of both buyer and seller saving if the performance criteria is exceeded.
3-Time and Material (T&M) Contracts• This type of contract is a cross between fixed-price and cost-reimbursable contracts.• This is opposed to a fixed-price contract in which the buyer agrees to pay the contractor a lump sum for construction no matter what the contractors pay their employees, sub-contractors and suppliers.
Con…• Time and materials is a standard phrase in a contract for construction in which the buyer agrees to pay the contractor based upon the work performed by the contractors employees and subcontractors, and for materials used in the construction (plus the contractors mark up), no matter how much work is required to complete construction.
Con…• Time and materials contracts are not common because of the lack of an upper limit for the price paid by the buyer.• However, if there is no time to send the job out for bids and complete construction, a time and materials arrangement can save time.• It is also a common arrangement where the original fixed price contractor abandons the work and another contractor must repair any damage caused by the first contractor and complete the work.
Con…• Many time and materials contracts also carry a guaranteed maximum price, which puts an upper limit on what the contractor may charge, but also allow the buyer to pay a lesser amount if the job is completed more quickly.