Last Updated on November 24, 2022 by Tayyaba Khan
A contract is primarily a legal agreement between two parties i.e, a seller and a buyer. In project management, the agreement is between the company and the vendor. It consists of all agreed terms and conditions, stating the rights and obligations of both sides.
When the two parties decide to work together then they both have certain expectations from the other party. The contract is made to help protect the rights of both parties. So that if there is an issue, then legal actions can be taken by the unsatisfied party.
A project manager usually handles these contracts and the legal aspects of the project. It is required when they have to outsource a process or product from a third-party subcontractor to finish the project. Most students undergoing project management training learn about these courses in the curriculum.
There are a variety of contracts that are used in different situations and in this article we’ll be looking at some of the major types of contracts used in project management. There are 3 main types of contracts that are required in different types of situations. Project managers should have knowledge about these contracts to deal with the third party.
Table of Contents
Fixed Price Contracts
- Fixed Price Contract, also called a Lump-Sum Contract, is made in cases when the buyer and the seller agree on a fixed price for the project.
- The seller has to complete the work within the stipulated time and price, whereas the buyer has to pay the fixed price within the given time.
- The seller understands the requirements and possible risks, then comes up with a fixed price quotation that includes fully detailed specifications, checklists, and project scope statement for the buyer.
- The buyer falls in the least risk category, while the seller often accepts a high level of risk in such contracts.
- Once the contract is finalized, it will use change requests for any kind of changes to be made.
- If the project gets delayed and there are cost overruns, then the seller has to bear these extra costs.
- This contract is useful for controlling the cost. The supplier makes the bidding with the lowest possible price and gets extra revenue when there are any changes in the scope.
Types of Fixed Price Contract
The fixed-price contract is divided into 3 categories that have been explained below.
- Firm Fixed Price Contract – In this type of fixed-price contract, the vendor has to complete the task within the stipulated time and price. Any increase in the cost will be handled by the vendor itself.
- Fixed-Price Incentive Fee Contract (FPIF) – In this type of fixed-price contract, even though the cost is fixed, the vendor will receive some incentive for performing the task as per the requirements.
- Fixed-Price with Economic Price Adjustment Contracts (FP-EPA) – This type of contract is done when the fixed price contract is for more than one year. In such cases, the vendors will have less risk.
Cost Reimbursable Contracts
- In this type of contract, the buyer agrees to pay all the actual costs of the project incurred by the vendor and also provides a fee for the vendor’s profit.
- The buyer pays both the direct and indirect costs incurred by the vendor. The direct costs may include the cost of resources, equipment bought, labor salaries, etc. Whereas the indirect cost includes administrative and general overhead costs.
- It also includes some incentives, if the vendor delivered the work based on scope, quality, and within the time.
- This kind of contract is used when the requirements are not clear, and the team does not have the clarity of how the product will be developed.
- It is used for new research and development, where there is no guarantee of the predicted outcome.
- A major drawback of this contract is that the seller can raise an unknown amount which the buyer is compelled to pay.
Types of Cost Reimbursable Contract
There are a few types of cost-reimbursable contracts that have been explained below.
- Cost Plus Fee (CPF)/ Cost Plus Percentage of Costs (CPPC) – In this type of contract, the seller will pay the total cost incurred during the project and also a percentage of the fee over cost to the vendor.
- Cost Plus Fixed (CPFF) – The seller pays the cost incurred in the project and a fixed amount that is agreed upon before the commencement of the work.
- Cost Plus Incentive Fee (CPIF) – The seller will pay the cost incurred in the project and incentive fees based on the performance of the vendor. This incentive is the motivating factor for the vendor.
- Cost Plus Award Fee (CPAF) – This is similar to the CPIF contract. Here the seller will pay the cost incurred in the project and a bonus amount or an award fee to the vendor.
Time and Material Contracts
- This is a popular contract used for regular purchases for standard items like temporary manpower or materials required for the project.
- In this contract, the suppliers are selected based on their capabilities and experience.
- There will be a negotiated price for such supplies and the final price will be for the amount of quantity purchased by the buyer.
- It is a pretty simple contract. The buyer pays for the amount they buy.
All the contracts have their own benefits. Choosing the right contract can prevent project managers from losing money. Time & Material is a good contract when outsourcing a product or service, the fixed-price contract is a good choice when the scope is fixed, and when the scope is not fixed, specially during product development, the cost-reimbursable contract is the best one to go for.
Even the vendors should also select the contracts with fewer risks and that provide good value for time, money and effort invested. These contracts are necessary to maintain the vendor-customer relation and to manage the work effortlessly.
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