The contract defines the roles and responsibilities, make things legally binding and mitigate risks. A contract is an entire agreement between both parties. It also includes terms regarding payments, reporting requirements, marketing literature, proposal, and procurement statement of work, among others. Changes to the contract are made formally in writing. For a legal contract, we should have an offer, acceptance of that offer, consideration, legal capacity and legal purpose.
The project manager selects the type of contract basis the purchase of a product or a service, the completeness of the statement of work, the level of effort and expertise the buyer can devote to the seller, whether incentives are involved for the seller, the enterprise environmental factors, etc.
The three broad categories of contracts are:
Fixed price (FP)
Time and Material (T&M)
Cost Reimbursable (CR)
Fixed Price (FP, Or Lump Sum, Or Firm Fixed Price)
The acquiring of goods or services with well-defined specifications or requirements and when there is enough competition to determine a fair and reasonable fixed price, these are the situations where a fixed price contract is used. These are the most common types of contracts. The seller bears additional costs if the costs are more than agreed upon costs. The buyer has the least cost risk in this type of contract. The seller is duly concerned with the specifications provided in the procurement Statement of Work (SOW).
A fixed price contract is inappropriate when either of the parties (buyer or the seller) do not have an exper or past experience to prepare the procurement statement of work or have detailed accounting records.
There are situations where companies are not having a complete know-how of the tasks to be done and even when the scope is incomplete, they ask the sellers to provide a fixed price. This leads to:
Forcing the seller to accept a high level of risk.
Seller needs to add a huge amount of reserves to cover their risks and the buyer then pays more than otherwise required.
Fixed Price Incentive Fee (FPIF)
In an FPIF contract, profits are adjusted based on the seller meeting performance criteria in a progressive manner such as completing the work in a cheaper way, faster and better. FPIF contract involves successive targets given to the sellers, in which the target for the incentive is changed after the first target is reached.
FIXED PRICE AWARD FEE (FPAF)
In FPAF contract, the buyer pays a fixed price plus an award amount (a bonus) based on performance. This is very similar to an FPIF contract, except the total possible award amount is determined in advance and apportioned out based on performance.
Fixed Price Economic Price Adjustment (FPEPA)
If there are uncertainties about future economic conditions (future prices) for contracts that exist for a multi-year period, a buyer might choose a fixed-price contract with economic price adjustments. Future costs of supplies and equipment that the seller might be required to provide under contract might not be predictable.
Time And Material (T&M) Or Unit Price
In this type of contracts, the buyer pays on a per-hour basis or per-item basis. Time and material contracts are frequently used for service efforts in which the level of effort cannot be determined when the contract is awarded.
Procurement Documents (BID Documents)
Once the contract type is selected and the procurement statement of work has been created, the buyer can put together the procurement document, which describes the buyers needs to the sellers. The different types of procurement documents include:
Request for proposal (RFP);
RFPs request a detailed proposal on how the work will be accomplished, who will do it, etc.
Invitation for Bid (IFB);
IFB usually just requests the total price to do all work.
Request for Quotation (RFQ);
RFQs request a price quote per item, hour, meter, or other unit of measure.
The objective is to provide the seller a clear picture as much as possible. The procurement documents should include:
Information for sellers
Background information about the purpose of the buyer wanting to get the work done
Procedure for trying to win the work
Guidelines for preparing the response
The formats for responses
Source selection criteria the criteria the buyer will use to evaluate responses from the sellers
Procurement statement of work
Proposed terms and conditions of the contract (legal and business)
Source Selection Criteria
Source selection criteria are included in the procurement documents to give the seller an understanding of the buyers needs and to help the seller decide whether to bid or make a proposal on the work. Source selection criteria become a basis for the buyer to use in evaluating bids or proposals.
The source selection criteria include:
Number of years in business
Understanding the need
Price or life cycle cost
Quality of past performance
Ability to complete the work on-time
Project management ability
The following are additional terms, the project manager must be familiar with:
This is an agreement between the buyer and prospective sellers identifying the information or documents they will hold confidential and control, and who in the organization will gain access to the confidential information.
Teaming Agreement (Joint Venture):
Often two sellers believe that their chance of winning work from a buyer will be enhanced if they join forces for one procurement. In this case, they will sign a teaming agreement with each other to address the legal and business aspects of the arrangement.
The contract terms and conditions are most commonly created by the buyer, who may even put their terms and conditions into the standard format that is used over and over for similar procurements. These types of standard contracts need no further legal review if used as they are.
Special Provisions (Special Conditions):
The project manager must be able to read and understand standard terms and conditions and to determine what needs to be added, changed, or removed from the standard provisions. By doing so, the project manager can make sure the resulting contract addresses the particular needs of the customer.