Join Bob McGannon for an in-depth discussion in this video Exploring contract types, part of Project Management Foundations: Procurement (2014).
- Selecting the contract type to use for procuring products for your project sometimes reminds me of watching acrobats. As a project manager it can seem like I'm on a rocking ship, standing on a big medicine ball, while juggling running chainsaws. Okay, it's rarely that bad. But it is a bit of a balancing act between time, project risk, and the nature of the product and service you require. The three primary Contract Types are Fixed price, Cost Plus, and Time and materials, often just called T&M, and they each give you things to balance.
Let's start with the Fixed price contracts. As the name indicates, the price is Fixed or agreed to up front, for the products and or services to be obtained. For this type of contract to work you as the Buyer must understand your needs and provide detailed information on what you want to procure. The Seller needs to be specific regarding the products/services they are providing. It's possible to establish financial incentives for meeting or exceeding agreed project milestones.
And in addition, there could be penalties for missed milestones. When setting up a Fixed price contract I recommend you have both incentives and penalties to demonstrate a balanced perspective. Fixed price contracts are best when you have very specific and known requirements and the product you are procuring is not new or innovative, such as new PCs, or the purchase and set up of a backup generator for a building. Government agencies have a tendency to use Fixed price contracts, as this helps them with budget planning, especially for multi-year contracts.
Fixed price contracts typically favor you as the buyer, as the seller needs to commit to the fees upfront for the agreed scope of work. A savvy seller will include risk-based contingency in their price to the buyer to cover unexpected costs. Changes in scope can be accommodated through a formal change-management process. If the change is approved, the price of the contract will increase and project documentation adjusted, if necessary. Now, let's examine Cost Plus contracts, sometimes called Cost Reimbursable contracts.
With this contract type the costs collected for work completed are reimbursed to the seller, plus a fee representing a pre-agreed seller's profit. There could also be incentives for meeting or falling below the agreed costs, schedule, or other performance targets. A Cost Plus contract is good for you to use when flexibility in project scope is desired. You can then redirect your seller if the scope changes during the project. I also recommend using Cost Plus contracts when project risk is high, as there could be surprises that surface, which will need to be addressed by a more flexible contract model.
An example where a Cost Plus contract would be appropriate is a new application system with relatively fixed, know requirements. The last contract type to examine is Time and Materials. T&M contracts are great for staff augmentation and to obtain specialist resources. T&M contracts are typically used for services only, versus products. For example, obtaining the services of Specialist engineers, or Experienced project managers to guide a complicated project.
The price is fixed for the labor rate of a given resource or resource type, the number of days to be billed remains open. Although there are often "Not to exceed" terms in the contract, as in, "The work is not to exceed 100 days," "unless specific authorization is given by the buyer." The work to be performed is defined at a high level in T&M contracts, but the duration or resulting price of specific deliverables is not specified. With a T&M contract you need to monitor work performance to insure you are receiving value for money and obtaining results in a timely fashion.
The seller will work on whatever you tell them to work on as they will be paid for their effort. As the buyer, you need to insure the seller is being directed to work on deliverables that you want completed. In the next three videos in this chapter I will provide you with more detail for each contract type, so you can be ready to jump on that medicine ball and start juggling.
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- Define project procurement.
- Distinguish when to use vendors and partners.
- Compare and contrast building versus buying.
- Identify different types of contracts.
- List types of payment approaches.
- Test your market.
- Build and use a request for information (RFI).