5th Edition PMBOK® Guide—Chapter 12: Procurement Contract Types


In the process 12.1 Plan Procurement Management, the organization looks to the company policies, procedures, and guidelines regarding the types of procurement contract that would be available and decides which type of contract would be best for the particular project at hand.  More than one type may be used, depending on the procurement involved.

The purpose of this post is to outline the three basic types of procurement contract by indicating what kind of projects they are normally used for, and whether they are advantageous to the buyer or seller.

Fig. 1   Procurement Contract Type

  Contract Type Type of Project Favors
1. Fixed-price Scope well-defined, risks relatively low Buyer
2. Cost-reimbursable Scope not well-defined, risks relatively high Seller
3. Time and Material (T&M) Often used for staff augmentation Neutral

Let’s take discuss each of these contract types in turn.

1.  Fixed-price

If the scope is relatively well-defined, and the risks on the project are relatively low, then the fixed-price contract specifies, as the name implies, a fixed price for the product, service, or result obtained by the seller.  If you consider this from the seller’s standpoint, you can see why it is advantageous to the buyer.  Even if the cost to the seller exceeds the amount of money that the seller is going to get from the buyer, that amount of money is going to stay the same, so the seller is going to have to produce that product at a loss.

One of the next posts in this series will discuss the various sub-types of fixed-price contract that add various incentives in order to align more closely the interests of the buyer and the seller so that it becomes a win-win situation.

If the scope is well-defined, then the seller has a chance to make a good estimate as to how much it will take to produce the product, and that is why this type of more predictable project is also more suitable for this type of contract.

2.  Cost-reimbursable

On the other hand, if the project scope is NOT as well-defined, or has higher risks involved, then the best type of contract may be the cost-reimbursable contract.  The contract specifies that all legitimate contract costs incurred by the seller for completed work, plus an agreed-upon fee for the seller’s profit, will be paid by the buyer.  It is pretty obvious why this is advantageous to the seller, because the profit is guaranteed.

Since the buyer is therefore at a cost disadvantage, there are various sub-types of cost-reimbursable contract that add various incentives in order to align more closely the interests of the buyer and the seller so that it becomes a win-win situation.  These will be discussed in later post in this series.

An example of a cost-reimbursable project is the contract awarded to Northrop Grumman by NASA to create the Lunar Module or LM for the Apollo Program.  The project being one for a vehicle that had never, ever been produced before, the scope was very uncertain and the risk was extremely high.  A fixed-price contract would have been impossible to accept from a business standpoint.  I forget what the cost of the program turned out to be, but it was more than double than what the original budget was, if I remember right from watching From The Earth to the Moon series on HBO on the history of the Apollo Program.

3.  Time & Material

Time & Material contract takes characteristics from both types of contracts, in that the price per hour of the resource provided or the price per quantity provided is fixed, but the number of hours or the number of units, is open-ended.  It is used for outside support of the project, typically in the form of temporary staff augmentation or sometimes for expert judgment (such as legal advice from attorneys).

 

Time & Material contracts can be freely used with either the fixed-price or cost-reimbursable contract.  The next post will discuss some of the sub-types of the fixed-price contract.

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