You should be aware of the various types of contracts and the legal aspects of projects as a project manager. Consider the possibility of having to outsource a process or product to third-party subcontractors or vendors in the middle of a project. What kind of agreement would you use with the third-party service provider? In situations like this, project managers must have a thorough understanding of a wide range of contract types in order to successfully negotiate contracts.
In this article, we will define the three basic contract types and provide examples to help you understand when you would use each one.
Contracts with a Fixed Price
These are also referred to as lump-sum contracts. The seller and buyer reach an agreement on a fixed price for the project. In this type of contract, the seller frequently accepts a high level of risk. The buyer is in the least risk category because the price agreed upon by the seller is fixed. Make certain that this type of contract includes fully detailed specifications, checklists, and project scope statements from the seller’s side that the buyer will use.
With this type of contract, sellers may attempt to reduce the scope in order to complete the projects on time and within budget. If the project is completed on time and with the desired quality, the contract is terminated. However, if the project is delayed and there are cost overruns, the seller will bear all of the additional expenses.
The following are some examples of fixed-price contracts:
Fixed Price Incentive Fee (FPIF) Despite the fact that the price is fixed, the seller is given a performance-based incentive. The incentive can be based on one or more project metrics such as performance, cost, or timeliness.
Award Fee at a Fixed Price (PDF)
If the seller’s performance exceeds expectations, an additional sum (i.e., 10% of the total price) will be paid to the seller.
Economic Price Adjustment at a Fixed Price (FPEPA)
The fixed price can be recalculated based on the market pricing rate.
Contracts with Cost Reimbursement
What should you do when the scope of the project is unclear? Because you don’t know what the project will entail, a fixed-price contract is out of the question. This is where a cost-reimbursable contract would come in handy.
When the project scope is uncertain or the project is high risk, a cost-reimbursable contract, also known as a cost reimbursable contract, is used. Because the buyer bears all costs, he or she also bears all risks. A cost-reimbursable contract requires the seller to work for a set period of time and then raise the bill after the work is completed—a fee that represents the contract’s profits. The fee may be based on project performance or other metrics.
One significant disadvantage of this type of contract is that the seller can raise an unlimited or unknown amount that the buyer is obligated to pay. Because of this, cost-reimbursable contracts are rarely used. The following are some examples of cost-reimbursable contracts:
CPF (Cost Plus Fee) or CPF (Cost Plus Percentage of Costs) (CPPC)
The seller will receive the total cost of the project plus a percentage of the fee over cost; this is always advantageous to the seller.
Cost-plus a set fee (CPFF)
The seller is paid a fixed amount that is agreed upon prior to the start of work. The cost incurred on the project is reimbursed on top of this, regardless of project performance.
Cost Plus Incentive Fee (CPIF) (CPIF)
A performance-based incentive fee will be paid to the seller over and above the actual cost, they have incurred on the projects. With this type of contract, the incentive is a motivating factor for the seller to meet or exceed the project’s performance metrics.
Cost Plus Award Fee (CPAF) (CPAF)
The seller will get a bonus amount (the award fee) plus the actual cost incurred on the projects; this type of contract is very similar to a CPIF contract.
Time and Material Contracts or Unit Price Contracts
Unit price contracts are what we usually call hourly rate contracts. This contract is a cross between a cost-reimbursable and a fixed-price contract. For example, if the seller spends 1,200 hours on a project at $100 per hour, the buyer will pay the seller $120,000. This type of contract is common among freelancers, and the main benefit is that the seller is paid for each hour spent working on the project.
Conclusion
It is your responsibility as Project Manager to enter into the appropriate contacts with a variety of service providers in order to reduce risk and deliver the project on time. You should always think about the right type of contract to get the most out of the time and money you put into the project while protecting it from as many risks as possible.
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