Types of Contracts in Project Management: Are you aware of the same?
As a project manager, you should be aware of the different types of contracts and the legal aspects of projects. You cannot shrug your shoulders and claim it isn't part of your JD!
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Imagine having to outsource a process or product to third party sub-contractors or vendors in the middle of your project. What type of contract do you draft out for the third-party service provider?
Situations like these are why project managers need to have a good understanding of contracts to be able to handle contractual negotiations effortlessly.
There are three basic types of contracts:
Fixed Price Contracts:
These are 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 contract. The buyer is in the least risk category as the price is already fixed and the seller has agreed to this. There must be fully detailed specifications, checklists, project scope statements from the seller side which the buyer will use.
Often, sellers may try to cut the scope to deliver the projects on time and within budget. If the project is finished on time with the desired quality, the project is over for that contract. However, if the project is delayed and there are cost overruns, then the seller will absorb all the extra costs. Fixed price contracts are typically used in government based projects. Advantages of fixed price contracts include minimizing risk for buyers. The major disadvantage of Fixed Price Contracts is that the seller starts cutting scope in order to finish on time and within budget.
Below are a few types of fixed contracts:
- Fixed Price Incentive Fee (FPIF) – If project ends sooner, an additional amount is paid to the seller.
- Fixed Price Award Fee (FPAF) – If the performance of the seller exceeds expectations, 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? Fixed price contracts would be out of the question since you are not sure what you need out of the project. In such cases, ideally you would need to opt for cost reimbursable contracts.
Under a cost reimbursable contract, the seller will work for a fixed time period, and will raise the bill after finishing work. A major drawback of this type of contract is that the seller can raise an unlimited or unknown amount which the buyer is compelled to pay.
This is why cost reimbursable contracts are rarely used.
Below are a few types 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 a percentage of fee over cost. Always beneficial for the seller.
- Cost Plus Fixed Fee (CPFF) – A fixed amount (for seller) is agreed upon before work commences. Cost incurred on the project is reimbursed on top of this.
- Cost Plus Incentive Fee (CPIF) – A performance-based extra amount will be paid to the seller over and above the 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 a CPIF contract.
Time and Material Contracts or Unit Price Contracts:
Unit price contracts are what we call an hourly rate. For example, if the 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 contract 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.
As Project Manager, it is your responsibility to enter into the right kind of contract with a service provider to reduce risk and have the job delivered on time.
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