Procurement contract types are an important aspect of Procurement Management as outlined in the PMBOK (r) guide. You will be asked a few questions about the topic during your PMP(r). This post will explain the three major types of contracts in the PMBOK (r).
Fixed price contractFirm fixed-price contract (FFP).
Fixed price with economic adjustment contract (FPEPA)
Fixed price incentive contract (FPIF).
Contract cost reimbursableCost plus fixed-fee contract (CPFF).
Cost plus percentage fee contract (CPPF)
Cost plus incentive fee contract (CPIF)
Cost plus award fee contract (CPAF).
Time and material contract
Fixed Price Contract (FP).
Fixed price contracts are sometimes also known as lump sum contracts. The seller will pay a fixed amount to the buyer for the work described in the contract. Before any project work can begin, both parties sign the contract.
When the scope of work is clear, a fixed price contract can be used. Both the buyer and seller agree on the amount of time and resources required to complete the project. Only formal change control procedures can alter the scope and budget.
The seller will not be reimbursed if they spend more money or labor than expected to complete the project. The FP contract is legally binding and the seller must complete their project even if it results in a loss. Fixed Price contracts are therefore at the seller’s risk.
Firm Fixed Price Contract (FFP).
FFP is the most popular type of fixed price contract. FFP contracts are a fixed price contract where the buyer pays the specified price, regardless of any costs incurred by the seller. The seller is able to take great pride in completing the project as quickly and cheaply as possible, since he or she bears the risk.
These two diagrams illustrate the relationship between buyer’s price and seller’s cost.
Source: http://www.pmbypm.com/firm-fixed-price-contract/
Fixed Price with Economic Price Adjustment (FP-EPA),
The FP-EPA contract can be a variation on the FP contract. It allows the seller to adjust the contract’s price based upon economic factors.
Before the contract can be signed, these factors must be agreed upon and predefined by both parties. These are economic factors that are beyond the control of both the buyer and the seller.
Here are 2 examples of when FP-EPA agreements can be helpful:
If oil is a major input in the project, and the price suddenly rose, the seller can adjust the contract’s price based on the increased oil prices.
If the project is multi-national and the currency or interest rates of one country suddenly rise, the seller can adjust the project prices to reflect the increased costs.
FP-EPA contracts are most commonly used for fixed price contracts that span multiple years. There is a direct correlation between uncertainty levels and the length of a project. The market can be affected by many factors, so the seller must be able to raise the price of the project in order to adapt to market conditions.
The downside to using FP-EPA contracts is the amount of administrative work required to implement them. The benefits to the seller of being able to adjust prices to meet economic conditions outweigh any administrative work.
The formula for FP-EPA is as follows:
New price of contract = old cost of contract * (1 + inflation rate).
Fixed Price Incentive Fee Agreement (FPIF).
The FPIF contract is a variation on the FP contract that allows for price flexibility. The seller and buyer will negotiate performance incentives. If the seller meets the requirements, they will receive a bonus.
The FPIF can also include a negative incentive. A penalty can be applied to sellers who fail to meet performance standards.
In a FPIF, c