In which contract the buyer pays the seller for the actual costs incurred in a project plus a fixed fee?

– See All Project Management Key Concepts –

Contracts are a legal agreement or relationship between two or more parties. An agreement might not involve a contract – if we’re making an agreement such as kicking off a project or initiating a project with a project charter that’s just an agreement, and it doesn’t necessarily involve a contract. However every contract we make will involve an agreement, and you’ll see these terms come up and be used in the PMBOK guide and PMP exam.

You’ll see agreements come up and the use of these contracts that we’re going to go over now. There are a few different types of contracts that you’ll see in use and you might have questions on these on the PMP exam.

Fixed Price Contracts

First of all we’ve got fixed price contracts, and within that we’ve got Firm Fixed Price (and you might see these abbreviated as well so just be ready for that) you’ve got FFP, firm fixed price. Fixed Price Incentive Fee (FPIF), Fixed Price with Economic Price Adjustments (FPEPA).

We also have cost reimbursable contracts, and for these we’ve got Cost Plus Fixed Fee (CPFF), Cost Plus Incentive Fee (CPIF) and Cost Plus Award Fee (CPAF) and then lastly we’ve got Time and Material contracts. Let’s go over them in a bit more detail.

Fixed price contracts are a total price, for a defined product. In other words, what are we delivering? We know exactly what we’re delivering and we also know exactly what it’s going to cost. This is used when the requirements are really well defined and no significant changes to the scope are expected. If the scope does change then obviously we would have to change the price under those scenarios. The most commonly used contract type is the firm fixed price or FFP. This won’t change unless the scope of works changes.

Fixed price incentive fee or FPIF, this allows for deviation from performance with financial incentives tied to achieving those agreed-upon metrics. If the project be done by our provider under a certain level of cost, then maybe we provide an incentive fee on top of whatever we’re paying them to get it done. For example if they can get it done in 20 days instead of 40 days and then maybe we would pay them a little bit of an incentive fee – especially useful if it’s an urgent project. With FPIF the price ceiling is set and all costs above that price ceiling are the responsibility of the seller. We might say we’re going to pay you 1 million dollars, but if it goes over that 1 million dollars then all of those costs are yours. But if it goes under 1 million dollars then that’s the incentive – they could have those costs or a portion of those costs given back to them.

Fixed price with economic price adjustments (FPEPA) is when we think that the project is going for a long time and the conditions might change over the project. If that project is going for a long time and the conditions actually change over time – most commonly you might see currency changes, or even price changes for some of the materials that you might be buying, maybe there’s the price of iron or commodities that will often change over time, and this builds in a contingency for those price adjustments.

Cost Reimbursable Contracts

Next we’ve got our cost reimbursable contracts. This type of contract involves payments or reimbursements to the seller for all legitimate actual costs incurred for completed work, plus a fee representing seller profit. So for our seller, what did it cost them to complete the work, and then the little bit extra is the profit associated to the seller. We what it cost them and then any extra is just the the cost of them doing business that’s what we’re paying them to provide all of that service. This is best used if the scope of work is expected to change significantly during the execution of a contract, because they’re obviously taking on all of that cost themselves and we simply pay the extra part on top of all of that cost.

Cost plus fixed-fee is cost of to provide all of the work, time and materials, and then it’s just a fixed fee on top of that.

We might have a cost plus incentive fee, where the seller is reimbursed for all allowable costs for performing the work, and receives a predetermined incentive fee based on achieving certain performance objectives. So it’s not just a fixed fee on top of what they’re doing, but maybe if they complete it early then they get a little bit extra as well – a performance fee or an incentive fee.

Cost plus award fee, or CPAF is where the seller is reimbursed for all of their legitimate costs and the majority of the fee is earned based on the satisfaction of certain subjective performance criteria. So again we pay them for the costs of doing their work, and then we say well how happy were we with that work? Were we really happy? And then we pay them a lot, or we only a little bit happy, and that might be a subjective or it could be an objective criteria that we lock in as part of the contract.

Lastly we’ve got time and materials or T&M. You might see a hybrid type of contractual arrangement with aspects of both cost reimbursable and fixed price contracts. This might be used for staff, for acquisition of experts or for any outside support where a precise statement of work cannot be quickly prescribed. You might need to have some costs assigned, maybe an incentive fee or maybe a fixed fee on top of that, or maybe it is just a flat fee fixed price contract that you’re seeing. Maybe there’s an incentive fee on top of that, it could be all of the different aspects that we’ve seen as part of the contract so far.

And those are all the different contracts that you’ll see in the PMP exam.

– David McLachlan

– See All Project Management Key Concepts –

What is cost

What are the four types of contracts?

What are the types of contract in project management?

What is cost