CONTRACT is one of the very popular form of AGREEMENT. It binds SELLER to provide something of value and obligates BUYER to compensate in value, typically monetarily. Contract shall contain Type of Contract, Scope, Schedule, Price, Terms & Conditions (T&C), Termination clause, Change management clause, Incentive clause for higher performance, Penalty clause for under-performance etc., Contract is legally enforceable i.e., If any party (seller or buyer) feel cheated on the agreement by other party, they can approach court of law. But it is highly suggested to try all means like negotiation, mediation and arbitration before taking legal step.
Contract types are broadly divided into Fixed Price (FP), Time & Materials (T&M), and Cost Reimbursable with former two being most popular across industries. Major variants of these contacts shall contain Incentive / Penalty clauses based on concrete quantitative performance measures; typical performance targets are based on SCHEDULE, COST & TECHNICAL. All the major contract type variants are given below:
1. FIXED PRICE (FP): As the name suggests, the price is FIXED for the specified PRODUCT, SERVICE or RESULT. This contract type requires clear and non-volatile requirements. Requirement Changes would typically call for re-negotiating on the PRICE.
a) Firm Fixed Price Contracts (FFP): The price is fixed firm. Most commonly used contract type. Favored by buyer if the scope if firm.
b) Fixed Price Incentive Fee contracts (FPIF): The price is fixed, with incentive for over performance and / or penalty for under performance.
c) Fixed Price with Economic Price Adjustment Contracts (FP-EPA): Applicable for long term projects. It is a fixed price contract, with special provision for final price adjustment due to inflation; tied to clear financial index like inflation index, share market index, dollar exchange rate etc.,
2. Cost Reimbursable (CR) contracts: In these contracts, all applicable COSTs are reimbursed along with an agreed FEE representing seller profit. These contracts are inherently flexible to requirement changes.
a) Cost Plus FIXED FEE contracts (CPFF): Reimburses actual costs + agreed fixed fee
b) Cost Plus Percentage of cost contracts (CPPC): Reimburses actual costs + agreed percentage fee on actual expenses. More popular over CPFF, as seller gets rational fee based on volume of work.
d) Cost Plus incentive fee contracts (CPIF): Reimburses actual costs + agreed fee (fixed or percentage) adjusted with incentive or penalty fee.
e) Cost Plus AWARD fee contracts (CPAF): The seller is reimbursed for all legitimate costs, but the majority of the fee is earned only based on the satisfaction of certain broad SUBJECTIVE performance criteria defined and incorporated into the contract. The award fee is decided at the discretion of buyer.
3. Time & Materials (T&M): The seller charges for TIME and AMOUNT of materials (including travel) used as per agreed RATE. The rates are fixed for every category of resources and includes profit. Rates are charged like DOLLAR per Hour, DOLLAR per ton... These contracts are inherently flexible to requirement changes. This contract is often used in staff augmentation for dynamic requirements like maintenance project. T&M contracts have characteristics of both FP & CR contracts. They resemble FP with predefined unit labor or material ratesand at the same time resemble cost reimbursable as Time & Cost are OPEN ended. Many buyers place ‘not-to- exceed’ (ceiling) values and time limits placed on all T&M contracts to prevent unlimited cost growth.
In the context of Project Management
, the often asked question is who should manage (control) the project. The logical answer is the project should be managed by the party taking more risk. In FP, the cost & time is certain for buyer; but seller bears risk of cost & time overrun (there may be penalty for time overrun). Hence in FP, more risk taken by seller. In Cost reimbursable contract, buyer takes more risk as the overall time & cost is OPEN ended. In T&M, some risk is taken by seller as they need to bear the differences between agreed RATE Vs. Market RATE; but more risk is taken by buyer as still the time & cost is OPEN ended. In nutshell, FP is managed by seller; cost reimbursable and T&M are managed by buyer.
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