Types of procurement contracts describes the types of contracts during the procurement process.
Eventually every organization may not be able to do all the work in your project. It could be because of your organization is not focusing on those type of sub tasks or projects.
For example a telecom operator after generating the bills, he may outsource the work of printing the invoices to the printing vendor, who can perform the sub project to complete printing of invoices for the end subscribers. Since printing is not his main focus of business, the telecom operator outsource the sub task to another vendor.
So as a project manager you need to understand different types of procurement contracts that can be useful to outsource any sub project or tasks to another vendor.
In the procurement contract there would always minimum two parties. One who request for services, and the other who sell the services. In the rest of the blog post we call the party who request the services as buyer. And we call the party who sell the services as seller.
Also to understand the types of procurement contracts, you need to understand actually the procurement process happens and also the use of procurement documents in this process.
Types Of Procurement Contracts
In short there are primarily three types of procurement contracts. They are
- Fixed price contracts (FP)
- Cost-Reimbursable contracts
- Time and Material contracts
These main types of procurement contracts are further classified as follows.
- Fixed price contracts (FP)
- Firm Fixed Price (FFP) contracts
- Fixed Price Plus Incentive Fee (FPPI) contracts
- Fixed-Price with Economic Price Adjustment (FPEPA) Contracts
- Cost-Reimbursable contracts
- Cost Plus Fixed Fee (CPFF) contracts
- Cost Plus Award Fee (CPAF) contracts
- Cost Plus Incentive Fee (CPIF) contracts
- Time and Material contracts
Fixed Price contracts
Fixed price contracts are always helpful when both the parties understand scope and also design their ways of working to properly scope the project.
The primary pricing model of the fixed price contract is that the buyer will pay a fixed price for the work the seller is going to deliver.
However there are few types of fixed price contracts that vary a little from this definition based on the nature of the requirement of contract.
Firm Fixed Price (FFP) contracts
Also called as lump sum contract and is considered the most simpler types of procurement contracts.
In simpler terms fixed price means the buyer is going to pay a fixed amount regardless of how much it is going to cost the seller.
Eventually fixed price contracts are used when scope is clear for both the parties. Moreover fixed price contract make the seller contractually bound to complete the tasks that are contractually agreed.
In fixed price contracts, once the contracts signs, the seller bears the complete risk, because they must complete the tasks within agreed time and cost.
In the FFP contracts, except the fixed price the buyer is not going to give any additional fee or incentive to the seller. Hence this type of contract is called as Firm Fixed Price (FFP) contract.
Fixed Price Plus Incentive Fee (FPPI) contracts
Though FPPI contracts are also awarded with fixed price, however the buyer is going to pay the an incentive fee based on the performance or KPI agreed by both the parties.
For example, the buyer might setup an incentive fee if the seller team is going to complete an acceptable delivery ahead of the schedule.
Fixed Price with Economic Price Adjustment (FPEPA) Contracts
Similarly, FPEPA is also a fixed price contract. However fixed price with economic price adjustment (FPEPA) contract are relevant when the contract is a multiyear contract.
The only difference between FFP and FPEPA is the inflation factor, that may change during every year.
In cases where there is a considerable difference in the inflation year on year, both the parties agree that inflation would also be considered on the fixed price.
Depending on the geographical location of the seller, the inflation rate may change. For example it could 2%, 3% or 4% inflation on the fixed price. Please note that the inflation is usually compounded year on year.
Cost Reimbursable contracts
Eventually the primary model of cost reimbursable contracts are asking the buyer to pay for the cost incurred by the seller in completing the work. The cost reimbursable contracts are of 3 types.
Cost Plus Fixed Fee (CPFF) contracts
As the name says CPFF contract asks the buyer to pay for the cost incurred by the seller to complete the work and on top of that the buyer is going to pay a fixed fee.
Cost Plus Award Fee (CPAF) contracts
Indeed CPAF contract is similar to CPFF. However instead of paying a fixed fee, the buyer agrees with seller to pay an award fee based on the buyer’s evolution of performance of the seller.
Cost Plus Incentive Fee (CPIF) contracts
In cost plus Incentive fee (CPIF) contracts, the buyer will pay for the work the seller is doing.
In addition to that, there will be KPI s in the contract for the buyer to pay the seller, if they meet any or all of the performance indicators.
This contract can be even more complex to include multiple levels of performance indicators for each KPI.
Time and Material (T & M) contracts
Eventually in time and material contracts, the buyer pays for the seller labor cost as well as additional cost for the material required in the project.
This is a combination of fixed price and cost reimbursable contracts. Let me explain how.
The time says that the buyer pays the seller for the cost of the labor. Meaning the buyer pays for seller for the effort (number of hours) spent on the project.
The material part is about the all the non-manpower expenses in the project. The seller provides invoices for these expense to the buyer to release the amount for the non-manpower expenses.
When both buyer and seller both are not have full clarity about the scope, T&M contract will give better results.
Conclusion
To summarize, we have seen different types of procurement contracts between the buyer and seller.
Have you understood, as a project manager are you going to be at buyer side or seller side?
The simple answer could be a project manager could be working with either the buyer side or seller side. It does not matter as long as you understand the type of contract and what goes in the contract clearly and work for it.
Also we have seen fixed price contracts are more useful when both the buyer and seller has full clarity on the scope of the project.
On the other hand, cost reimbursable and time & material contracts are handy when scope is not that clear to both the buyer and seller.
Finally please observe the acronyms mentioned above. Because PMP exam may refer these contracts with the acronyms.
Refat Mustafaa
Good job!