These types of contracts have a preset price for a specific product or service, which means that(a) If the vendor completes the product or service as defined in the contract, they will receive the agreed to price.
FP contracts are good to use for products or services that a seller creates repeatedly on a regular basis.
FP contracts place the most Risk for the Seller, hence it should only be used when the seller is confident in the process it takes to complete a product or service.
This is the most common type of fixed-price contract, where it is strictly followed to have a precise and accurate Scope. The Price is set upon the buyer’s request.When to Use?
For a repeated product or service.
Example can be that of an automobile manufacturer, where the manufacturer knows all the costs associated with the automobile till its completion, and is able to deliver the automobile at the preset Firm Fixed Price. Hence, he would enter into an FFP contract with the buyer.
This type of contract is like the FFP contract, but in addition it also offers an incentive if the product or service exceeds an expectation. For instance, if the Seller delivers the product earlier than the scheduled time, the Buyer might give the Seller an incentive Fee.
In the example of the automobile manufacturer that we’ve illustrated above, he might get an incentive from the buyer as a token of appreciation, if he’s able to deliver the product a week earlier to its actual schedule.
An FP-EPA is similar to an FFP, except that, the seller could increase the price of the overall contract, if the product or service is predominantly dependent on an input with a price that is governed by supply and demand.
Let’s revisit the example of the automobile manufacturer (Seller), who could adjust the overall contract price based on the gasoline cost, in case the buyer requests the automobile with a year’s gas supply. Since the automobile manufacturer (Seller) has no control over the cost of the gasoline and any unpredictable increase in the gasoline costs by the time the automobile is ready to be delivered, would increase the overall contractual price. Note that only the part of the contract related to the gasoline costs would increase and not the cost of the automobile itself.
The cost re-imbursement contracts are different from the FP contracts, where the Seller can charge for all legitimate expenses related to completing the product or service, a well as charge a fixed fee as profit.When to Use?
CR/CP contracts are good to when the seller is not assured in the process it takes to complete a product or service.
For instance, developing a website or a mobile application. Even though there are several applications available in the market, there is no absolute template to define the exact time and cost it would take develop a website or mobile application.Who is at Risk?
The Seller has more flexibility to complete the Scope of the work, but if the Scope costs more than projected, the Buyer runs at Risk.
In a CPFF contract, the Seller can charge the buyer for all genuine expenses related to completing the product or service. In addition the Seller can also charge a Fixed-Fee percentage of the overall contract price, which is set when agreeing to the contract terms, and this Fixed-Fee percentage remains the same even if there is an increase in the legitimate service or product expenses.
To better understand this, let’s relate the example of the application developer, who could provide all genuine or legit costs, such as the estimated hours for programming, in the initial estimate. Based on this initial estimate, the application developer (Seller) would include a fixed fee that is a percentage of the legitimate costs. The buyer at the end would be responsible for all the genuine costs that incurred plus the fixed fee percentage.
In a CPIF contract, both the Seller and buyer take up the risk. What happens is the Buyer is responsible for the legitimate costs of the product or service as per the CR contract rule, but if the Seller does not accurately calculates or presents the estimates, both the Seller and Buyer split the responsibility of costs that are higher or lesser than the estimate. In addition, if the Seller produces and delivers the deliverable beyond the expectations or requirements agreed in the contract, the Buyer then will provide an incentive fee. This motivates the Seller to deliver the quality product or service within or ahead of schedule.
CPAF contract is very much analogous to the CPIF contract, except that the award fee is solely at the buyer’s discretion. The buyer would set the pre-determined requirements or expectations in the contract for the Seller. If the Seller meets those requirements, to the buyer’s satisfaction, then he awards the Seller.
Revisiting the example of the application developer, if he enters an agreement with the buyer, who at his own discretion, sets certain minimum requirements to check on quality or schedule for instance, to award the Seller, in case if accomplished.
In T&M contracts, the Buyer will pay the Seller for all reasonable time and material it takes to complete the product or service. T&M contracts can take either the form of fixed-price contracts or cost re-imbursement/cost plus contracts.
T&M contract can be more like a fixed-price contract when the Buyer sets the firm constraints on costs. For instance, the buyer will say, this product or service cannot cost more than USD 200K to complete.
T&M contracts can be similar to a CR/CP contracts, when the Buyer agrees to pay for all the legit expenditure.When to Use?
T&M contracts are typically used when the scope of work cannot be well defined during the contract formation.
Relating to the example of the application developer, the buyer wants the developer (Seller) to develop a new software application, which will be a breakthrough in the market, for which he is not really sure of the scope as to what type of technology to be used, or what the UI/UX should look like. So he could enter a T&M contract that states that he’ll pay for all the reasonable time and material up to a certain amount of cost. If the project exceeds that limit then it will not be reimbursed, unless there is a new contract or addendum for the change.
Essential elements to contracts that can help the Buyers and Sellers create a win-win situation but not limited to: