Types of contract in project management

Types of contract in project management

It is often more efficient to outsource certain project activities to external contractors than for your project team to take them on themselves. In fact, it may prove cost effective to contract out the entire contracting process itself to a dedicated contract management company.
 

Make or buy?

A make-or-buy analysis should include indirect as well as direct costs

A make-or-buy analysis is a good way of determining the cost-effectiveness, or otherwise, of producing a particular product or service within your organization. This analysis should include indirect as well as direct costs. For example, it should include the cost of managing the project's purchasing process as well as the cost of purchasing an actual product. Your make-or-buy analysis should also take into account your organization's possible future needs as well as the project's immediate ones.

Contract types

There are a number of contract types available to project managers, involving varying levels of risk for buyers and for sellers. Contract types generally fall into one of three broad categories, the risk for the buyer rising from one to the next:

1. fixed-price or lump-sum contracts

2. cost-reimbursable contracts

3. unit-price contracts

1. Fixed-price or lump-sum contracts

This contract type involves payment of a fixed total price or lump sum for a well-defined product. Fixed-price or lump-sum contracts may also include incentives for meeting or exceeding specific targets - for example, project schedules. Risks entailed in this contract type vary according to whether the contract is

• firm fixed price

• fixed-price incentive

Firm fixed price (FFP) contracts, without any incentive, represent the lowest possible risk factor for the buyer. This factor increases slightly for fixed-price incentive (FPI) contracts. Conversely, FFP contracts represent the highest possible risk for the seller and slightly less risk if the contract is an FPI contract.

2. Cost-reimbursable contracts

In this type of contract, the seller is reimbursed for actual costs, both direct and indirect. Indirect costs are usually calculated as a percentage of direct costs. Cost reimbursable contracts often include incentives to be paid in the event of specific project goals, such as schedule targets or total cost being met or exceeded. Different subtypes within this contract type present different risk levels for both buyer and seller:

• cost plus percentage of costs (CPPC) contracts entail the highest possible risk for the buyer, and the lowest possible risk for the seller

• cost plus fixed fee (CPFF) contracts represent, for the buyer, a comparatively high risk level, and, for the seller, a comparatively low one

• cost plus incentive fee (CPIF) contracts entail a moderate risk level for both buyer and seller

3. Unit-price contracts

Unit-price contracts carry the greatest risk for the buyer

In this contract type, the seller is paid a fixed amount for each unit of service. For example, the seller could be paid a fixed amount per hour for professional services. The number of units needed to complete the work determines the total value of the contract. This type of contract should be avoided, as it carries the greatest risk for the buyer.