Most organizations will have a project at some point that will require outside expertise. The hiring or contracting of this expertise to complete a project or specific tasks will require a legal contract.
These contracts generally fit in one of following categories:
Time and Materials Contracts
Fixed Price Contracts
Cost Reimbursable Contracts
Time and Materials Contracts
Time and Material (T&M) Contracts are generally utilized for when there is some variability in the scope of work.
Under a T&M contract hourly labor rates are agreed to and the amount of effort and scope are variable. This characteristic makes it both a fixed and variable contract, where the hourly labor rate is fixed and the total effort, scope or duration are variable.
In a T&M agreement the buyer (contracting party) bears a majority of the risk as the total cost is unknown and often uncapped. There are ways the buyer may limit exposure, for example adding a not to exceed clause to cap total expenditure.
Fixed Price Contracts
Fixed price contracts are generally utilized when there is a defined amount of effort or scope of work. Once the project or task is contracted by the parties under a fixed price agreement the seller (party providing the services) is legally required to complete the task or project for a set price and often within a set term.
In general the seller bears the majority of the risk although through certain sub-types both parties can share some of the risk.
There are several sub-type variations of this contract type:
Firm Fixed Price Contract (FFP)
Fixed Price Incentive Fee Contract (FPIF)
Fixed Price with Economic Price Adjustment Contracts (FP-EPA)
Firm Fixed Price (FFP)
Under a FFP contract the price is set and is not subject to change unless the scope changes.
Fixed Price Incentive Fee (FPIF)
A FPIF contract provides the seller a financial incentive for achieving certain metrics or milestones. Often these incentives are related to cost, schedule, quality or some measurable performance metric.
Fixed Price with Economic Price Adjustment (FP–EPA)
A FP-EPA contract provides for the adjustment to the contract price due to changed economic or business conditions. Often these contracts are tied to statistics related to inflation, currency, commodities or other costs.
Cost Reimbursable Contracts
Cost Reimbursable Contracts are often utilized when there is high risk or a high level of ambiguity in the scope. The seller is reimbursed for completed work plus a fee. The fees are often paid if the seller meets or exceeds the selected thresholds or project objectives.
The buyer bears the majority of the risk as they pay the seller for all costs, although through certain sub-types both parties can share some of the risk.
There are several variations of this contract type:
Cost Plus Fixed Fee Contract (CPFF)
Cost Plus Percentage of Cost (CPPC)
Cost Plus Incentive Fee Contract (CPIF)
Cost Plus Award Fee (CPAF)
Cost Plus Fixed Fee Contract (CPFF)
In a CPFF contract, the seller is paid for all their cost incurred plus a fixed fee.
Cost Plus Percentage of Cost (CPPC)
In a CPPC contract the seller is paid for all costs incurred plus a percentage of these costs as the sellers cost rise.
Cost Plus Incentive Fee Contract (CPIF)
In a CPIF contract, the seller is reimbursed for all costs plus an incentive fee based upon achieving specific performance goals. It is commonplace for the incentive to be a percentage of savings. Under CPIF the incentive fee usually is calculated based on a formula defined in the contract.
Cost Plus Award Fee (CPAF)
In a CPAF contract the seller is paid for all his legitimate costs plus some award fee. This award fee will be based on achieving satisfaction of specific performance objectives described in the contract. Under a CPAF agreement the award fee is dependent on the satisfaction of the client and is evaluated subjectively.
There is no one right or wrong contract type and individual organizational policies and project objectives often determine the best fit. As always in addition to selecting the most appropriate contract type, it is important to perform proper due diligence and select a partner (seller) that is experienced, honest and knowledgeable as the true goal is a successful project.
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