Project Procurement Management: Contract Types for PMP Exam
Project Procurement Management is usually considered more difficult to most Aspirants as many project managers do not have sufficient knowledge and experience in dealing with contracting issues — contract administration, contract types, contract closure, etc. This post will expound on the various types of contracts that are mentioned in the PMBOK® Guide.
A contract is required if the organization needs to purchase resources/services from outside the company. The type of contract needed depends on a number of factors, namely,
- can the scope of the resources/services be well defined
- type of resources/services needed
- complexity of the resources/services
- frequency of changes needed
- type and magnitude of risks involved
Generally speaking, there are three major types of contracts to be used in procurement management:
- Cost Reimbursable (a.k.a. Cost Plus)
- Fixed Price
- Time and Material (a.k.a. Unit Price)
Below we will discuss these types of contracts, their pros and cons and when project managers are advised to use a particular type of contract.
Cost Reimbursable (a.k.a. Cost Plus)
Cost Reimbursable contracts is a type of contractual agreement in which the buyer agrees to pay for the actual cost of the materials/services plus an additional fee (maybe) for meeting/exceeding expectations. The risk is higher on the buyer as the buyer needs to bear the risk of over budget.
Listed below are the common forms of Cost Reimbursable Contracts:
- Cost Plus Fixed Fee (CPFF) — the buyer would need to pay the actual cost of the work plus a fixed fee calculated based on the initial estimation
- Cost Plus Incentive Fee (CPIF) – the buyer would need to pay the actual cost of the work plus an incentive fee if the performance of seller meets mutually agreed pre-defined performance targets (objective evalution)
- Cost Plus Award Fee (CPAF) – the buyer would need to pay the actual cost of the work plus an award based on subjective evalution on the seller’s performance by the buyer
- Cost Plus Percentage of Costs (CPPC) – the buyer would need to pay the actual cost of the work plus a fee calculated based on a percentage of actual cost
- [not mentioned in PMBOK® Guide] Cost Contract – no profit would be earned by the seller and this type of contract is seen as a kind of volunteering service for NGO
Cost Reimbursable contracts are suitable where the project is complex and the scope is not very well defined and changes are expected. If the scope increases the cost would increase and the buyer needs to bear all. Project Manager would make use of Cost Reimbursable contracts when completing the tasks on schedule is top priority.
Fixed Price contracts is a type of contractual agreement in which the buyer agrees to pay for the a fixed agreed total price. The risk is higher on the seller. Incentives may be offered according to mutual agreement. The risk is higher on the seller as the seller needs to absorb any omissions, reworks, inflation and other external risks.
Listed below are the common forms of Fixed Price Contracts:
- Firm Fixed Price (FFP) – a fixed price is set for the seller to complete the contract scope unless there is a change in the scope where amendments to the contract is needed
- Fixed Price Incentive Fee (FPIF) – the buyer would need to pay a fixed price for the completion of the project plus awarding an incentive if the buyer meets or exceeds the agreed metrics (e.g. cost saving from the cost ceiling, schedule, performance, scope, etc.)
- Fixed Price with Economic Adjustment / Economic Price Adjustment (FPEA / FP-EPA) – a fixed price contract in which inflation is taken into account, usually for contracts that span several years. This contract type offers more protection for cost increase on the seller side.
Fixed Price contracts are suitable where the project is simple and the scope is very well defined and changes are not expected. Project Manager would make use of Fixed Price contracts when controlling costs is top priority.
Time and Material (T&M) a.k.a. Unit Price
Time and Material contracts is a type that is somewhere between Cost Reimbursable and Fixed Price. It is a contractual agreement that specifies the price based on a per-hour or per-item basis only without fixing the total amount. A ceiling price may be put in the contract. The risk is similar on both seller and buyer.
Time and Material contracts are suitable where the project is small or the scope is expected to be highly variable at the time of signing the contract. Project Manager would make use of Time and Material contracts when the project is not well defined at the beginning of the project in order to keep the cost to be under control (e.g. by limiting the project scope based on funding availability).
Conclusion: Contract Types
Aspirants would need to remember that there 3 major types of Contracts:
- Cost Reimbursable (a.k.a. Cost Plus) — risk on buyer, for complex/not well-defined projects
- Fixed Price — risk on seller, for simple/well-defined projects
- Time and Material (a.k.a. Unit Price) — risk similar on both sides, usually for small projects or there is trust between the two parties