As a project manager you should know the different types of contracts and their inner meaning. You can’t tell that it is not your responsibility and accountability. It’s not like procurement is less important in the project management. Never! Just imagine, in the mid-way of your project if some process you need to outsource to third party sub-contractors or vendors, what type of contract you will do with that third party? Unless and until you know the contract processes and their consequences, you can’t do it really. So, as a project manager, you must know the contract processes, may be in your organization, there is a separate department like procurement or purchase, but at least you should know the processes involved there. What are the contracts? What is the type of contracts? When to do what? And how? Let me explain you how many types of contracts are there in the project management.
There are three types of contracts:Fixed Price Contracts:
This contract is also known as Lump sum contracts. The seller and the buyer agree on a fixed price for the project. The seller is bound to accept high risk in this type of contracts. The buyer is in least risk category as the price is already fixed and there is an agreement on the same from seller side as well. There must be fully detailed specifications, checklists, project scope statements from the seller side which buyer will use. Sometimes it seems that a seller try to cut the scope to deliver the projects on time and within budget. And this is a threat really for the buyer. If the project is finished on time with the desired quality, project is over for that contract. However, if the project is delayed and there are cost overruns, then the seller will absorb all that extra costs. Fixed price contracts are typically used in government based projects. Advantages of fixed price contracts include throwing all the risk on the seller, disadvantages is that the seller starts cutting scope in order to finish on time and on budget.
Below are few kinds of fixed contracts:
- Fixed Price Incentive Fee (FPIF) – If project finished little bit earlier, an additional amount to be paid to the seller.
- Fixed Price Award Fee (FPAF) – If the performance of seller exceeds as planned earlier an additional amount (say 10% of the total price) will be paid to the seller.
- Fixed Price Economic Price Adjustment (FPEPA) – The fixed price can be re-determined depending on the market pricing rate.
Cost Reimbursable Contracts:
What you will do when the scope of the work is not clear. You can’t go for a fixed price contracts. Never! You don’t know what you have to do for the project; ideally you will go for cost reimbursable contracts. The name is self-explanatory here. The seller will work for a fixed time period and after finishing the work he will raise the bill and the buyer will pay the amount after this. This is almost negative for a buyer. A seller can raise the unlimited or unknown amount which the buyer has to pay. Seller is advantageous in this type of contract and buyer is not. That’s why it is rarely used in the real world. A buyer never wants to go for the same unless the situation demands.
Below are few kinds of cost reimbursable contracts:
- Cost Plus Fee (CPF) or Cost Plus Percentage of Costs (CPPC) – The seller will get the total cost they incurred on the projects plus they will get a percentage of fee over cost. Always beneficial for seller.
- Cost Plus Fixed Fee (CPFF) – A fixed amount (for seller) will be there before starting of the work plus they will get the cost incurred on the projects.
- Cost Plus Incentive Fee (CPIF) – A performance based extra amount will be paid to the seller plus actual cost they have incurred on the projects.
- Cost Plus Award Fee (CPAF) – The seller will get a bonus amount plus the actual cost incurred on the projects. Very similar to previous one!
Time and Material Contracts or Unit Price Contracts:
Unit price contracts are what we call an hourly rate. For example, if seller spends 1,200 hours on a project, and his or her charges are $100 an hour, the seller will be paid for $120,000 by the buyer. This type of contracts is typical in freelance work. The main advantage of this type of contract is that the seller will make money for every hour he spends on the project.
Now, the bottom-line is as a project manager you should obviously know which contract you will select for your seller so that you can manage them effectively and accurately within budget.