Having basic knowledge about the different types of contracts can help you in efficient management of your program or project. The three most common types of contracts which you’ll come across in managing activities are:
- Fixed price contracts
- Cost reimbursable contracts
- Time and materials contracts
1. Fixed Price Contracts
Fixed price contracts are also known as lump sum contracts. These contracts basically involve agreement of price, for the sale of specific good or service. Bigger risk in this type of contract lies with the seller. Both the buyer and seller intend to make profits, even under circumstances such as rising prices or delay in the delivery of service or good.
It is necessary that the deliverable good or service is well defined in such contracts. Fixed price contracts can sometimes prove to be disastrous for both buyers and sellers. Sellers profit is often lost, as they have to compromise with buyers’ demands. Sometimes, buyers may be required to pay more, if there are change requests, to which the supplier is not willing to recognize.
2. Cost-Reimbursable Contracts
This contract specifies that, all the costs incurred by the seller, during the development of project, have to be endured by the buyer, and thus costs are reimbursed to the seller.
All the permissible costs will be stated in the contract. In cost-reimbursable contracts, higher risk lies with the buyer, because of uncertainty of final cost. Buyer has to spend more amount, if any problems develop during project development. These contracts are mostly used, if the final deliverable involves high uncertainty. Three types of cost-reimbursable contracts are generally seen.
1. CPPC (Cost plus percentage of cost)
In this type of contract, sellers will be reimbursed with permissible costs and a fee calculated on cost percentage.
2. CPFF (Cost plus fixed fee)
In this contract, the allowable costs are charged to the buyer, including fixed amount at the end of the agreement.
3. CPIF (Cost plus incentive fee)
All permissible expenses are charged to the buyer and an incentive is also provided, if the performance exceeds the specification in contract.
3. Time and Materials Contracts
Time and Material contracts typically include both fixed-price contract and cost-reimbursable contract features. They can be related to cost-reimbursable contracts, because in this type of contract, the final cost of the project is not known. They can be associated with even fixed-price contracts, if unit costs are used.