Type of Contract in Project Management: Do you know the same thing?
As a project manager, you must be aware of the different types of contracts and legal aspects of the project. You can not shrug and claim it’s not part of your JD!
Imagine having to outsource a process or product to a third-party subcontractor or vendor in the middle of your project. What type of contract do you create for a third service provider?
The situation like this is why the project manager needs to have a good contractual understanding to be able to handle contractual negotiations easily.
There are three basic types of contracts:
Fixed Price Contract:
This is also known as the Lump Sum contract. Seller and buyer agree a fixed price for the project. Sellers are bound to accept high risk in this type of deal. Buyers are in the lowest risk category because the price has been determined and the seller has agreed to this. There should be detailed specifications, checklists, project scope statements from the seller to be used by the buyer.
Often, sellers may try to reduce the scope to deliver the project on time and within budget. If the project is completed on time with the desired quality, the project is over for the contract. However, if the project is delayed and there is a cost overrun, then the seller will absorb all the extra charges. Fixed-price contracts are usually used in government-based projects. The advantages of fixed price contracts include minimizing risk for buyers. The main disadvantage of a fixed-price contract is that the seller begins to cut the scope to complete on time and within budget.
Here are some types of fixed contracts:
Fixed Cost Incentive Fee (FPIF) – If the project ends sooner, the additional amount is paid to the seller.
Fixed Price Award Fee (FPAF) – If the seller’s performance exceeds expectations, the additional amount (say 10% of the total price) will be paid to the seller.
Fixed Price Price Economic Price (PEPA) – The fixed price can be determined back depending on the market price level.
What will you do if the scope of work is not clear? The fixed price contract will come out of the question because you are not sure what you need from the project. In such a case, ideally, you need to choose a reimbursement contract.
With a cost reimbursement contract, the seller will work for a certain period and will raise the bill upon completion of work. The main disadvantage of this type of contract is that the seller can raise an unlimited or unknown amount to be paid by the buyer.
This is why the cost of contract replacement is rarely used.
Here are some types of cost reimbursement contracts:
- Cost Plus Fee (CPF) or Cost Plus Percentage of Cost (CPPC) – Seller will get the total cost incurred on the project plus a percentage of cost above the cost. Always useful for retailers.
- Cost Plus Fixed Fee (CPFF) – A fixed amount (for the seller) is agreed upon before the job begins. Expenditures incurred on the project are replaced on top of this.
- Cost Plus Incentive Fee (CPIF) – The amount of performance-based extra will be paid to the seller over and above the actual costs incurred in the project.
- Cost Plus Award Fee (CPAF) – The seller will get the bonus amount plus the actual cost incurred for the project. Very similar to the CPIF contract.
Contract Time and Materials or Contract Unit Price:
Unit price contract is the rate we call the hourly rate. For example, if the seller spends 1,200 hours on a project, and the cost is $ 100 per hour, the seller will be paid $ 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 spent on the project.
As a Project Manager, it is your responsibility to enter into the right kind of contract with the service provider to reduce risk and let the job on time.