Contract and its types (FP, CR, T and M)

Contract

A contract represents a mutually binding legal agreement that obligates the seller to provide the specified products, services or results and obligates the buyer to provide the monetary or other valuable consideration in return

Some important points to note about contracts are,

• A contract can also be referred to as an agreement, an undertaking or a purchase order
• Contract is formal, written and legally binding document
• Contract Manager or Procurement Manager is responsible for creating and managing contracts
• Changes in the contract needs to be documented and approved by all parties involved including the Contract Manager

There are essentially three types of contracts,

1. Fixed Price Contract
2. Cost Reimbursable (CR) or Cost-Plus Contract
3. Time and Materials Contract

Fixed Price (FP) Contract

Fixed Price Contracts, as the name suggests, signify that you would pay a fixed amount regardless of how much it costs the vendor. There are three variants of the Fixed Price contract,

1. Fixed Price Plus Incentive Fee (FPIF)

This contract includes an incentive over and above the fixed price if a performance goal is achieved. An example is that the seller shall be paid an incentive of $50,000 if the contract is fulfilled before the target end date

2. Fixed Price Plus Award Fee (FPAF)

This contract is the same as FPIF except for the fact that an award amount has a fixed maximum cap. An example is that the seller shall be paid an award of $5,000 for each day that the job is finished prior to the target end date. The maximum limit of the award is $50,000

3. Firm Fixed Price (FFP)

The Firm Fixed Price contract is the vanilla version of the Fixed Price contract. It doesn’t include any award or incentives. This contract is used when the scope is very well known. A fixed price will be paid to the vendor on the agreed upon terms. An example of such contract is that the buyer will pay $100,000 for a service to be provided by the seller for the duration of 12 months

4. Fixed Price with Economic Cost/Price Adjustments (FPEPA)

It could be confusing to see ‘Fixed Price’ and ‘Cost Adjustments’ in the same line which is precisely what differentiates this contract from others. It is still a fixed price contract but has a special provision to make adjustments based on the economic conditions. An example of such a contract is when you have a very long-term project that will last for 25 years and will be executed in different countries that have their own currencies. This calls for Economic Cost Adjustments during the course of the project and specialized verbiage needs to be included to address the same

Cost Reimbursable (CR) or Cost-Plus Contract

Cost Reimbursable contracts too have three variants of their own,

1. Cost Plus Fixed Fee (CPFF)

This contract means that the seller is paid the costs involved in accomplishing the work and a fixed fee on top of it. An example of such contract is that the buyer will pay for all costs plus a fee of $10,000

2. Cost Plus Award Fee (CPAF)

This contract means that the seller is paid the costs involved and an award fee based on the buyer’s evaluation of the seller’s performance. The award has a fixed maximum cap. An example of such contract is that the buyer will pay for all costs plus an award fee of maximum $10,000 based on seller’s performance

3. Cost Plus Incentive Fee (CPIF)

This contract means that the seller is paid the costs involved and an incentive fee if the buyer’s set goals are met. An example of such contract is that the buyer will pay for all costs plus an incentive fee of $5,000 if the product, service or result is delivered 2 weeks early

Time and Materials Contract (T and M)

Time and Materials is typically used to contract labor especially when the scope of work is not clear. Time means the seller is paid on a per hour basis and material means the seller is paid for the equipment, machinery, raw materials, office spaces being utilized. It is generally used for smaller projects. An example of such contract is that the buyer will pay $30 per hour plus material cost

Quick Snaps

Fixed Price (FP) Contract

• Seller has a strong incentive to control cost
• Risk is with seller so requires less effort for keeping track
• Seller can quote less initially to get the contract but the change requests can be very expensive later in the project
• The scope needs to be clearly defined and the Statement of Work should have all the details

Cost Reimbursable (CR) or Cost-Plus Contracts

• Seller can quote less fee as the cost is covered by the buyer
• All seller invoices must be audited by the buyer increasing the overall buyer efforts
• Seller may not focus on cutting costs since they are reimbursable so this can turn out to be costly for buyer

Time and Materials (T and M) Contracts

• Scope need not be finalized before the contract is awarded
• May prove out to be costlier for larger projects
• Seller’s work needs to be monitored timely increasing the overall buyer efforts
• Just like Cost Reimbursable contract, the seller may not focus on cutting costs

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