5th Edition PMBOK® Guide—Chapter 12: Fixed Price Procurement Contracts

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.

In the last post, I described the three basic types of procurement contract:  a) the fixed price, b) the cost-reimbursable, and c) time & material.  The purpose of this post is to describe the various sub-types of this first type of contract, the fixed price procurement contract.

Fig. 1   Fixed-Price Procurement Contract Subtypes

  Fixed-Price Contract Subtype Description Cost increase is responsibility of …
1. Firm fixed-price (FFP) Most common type of contract Seller
2. Firm fixed-price incentive fee (FPIF) Financial incentive awarded to seller if performance target reached Seller (above price ceiling)
3. Fixed price with Economic Price Adjustment (FP-EPA) Pre-defined final adjustments to the contract price due to changed conditions Buyer (but based on external conditions)

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

1.  Firm fixed-price (FFP)

This is the most common type of fixed-price contract, and this is a pure fixed-price contract, in that the price of the procurement received from the seller does not change unless the scope of work changes.  Any cost increase on the part of the seller producing the procurement above the amount of the fixed-price contract is the responsibility of the seller, who is nonetheless obligated to complete the effort even at a loss.

2.  Firm fixed-price incentive fee (FPIF)

This type of fixed-price contract awards a fixed-price for the procurement, but then adds an incentive which is a fixed amount IF the seller achieves a performance target, which could be related to the cost, schedule, or technical performance of the seller.  In this type of contract, there is a ceiling price established so that if the cost of the procurement turns out to be greater than the ceiling price, the costs above the ceiling price are the responsibility of the seller.  This aligns the incentives of each side more closely, because the seller has an incentive to get the work done faster, better, or cheaper, but the buyer also is protected because the cost of the procurement is limited to a fixed amount (the ceiling price plus the incentive fee).

3.  Fixed price with Economic Price Adjustment (FP-EPA)

This type of fixed-price is usually used when the project spans a number of years.  The procurement costs a fixed-price, but adjustments are allowed to the cost IF there are changes in economic conditions that would affect the cost of commodities such as increases in inflation.  The Economic Price Adjustment or EPA is tied to some reliable financial index, which is used to adjust the final price.  This aligns the incentives of each side in that the seller is compensated for increases to the seller’s own costs that are out of its control due to the economy, but the buyer is protected because the cost of the procurement is limited to the fixed amount plus the EPA.

4.  Conclusion

All three of these fixed-price contracts tend to be more favorable to the buyer because the risk of any increases cost of production are born by the seller, but the seller is compensated somewhat if the seller is able to make performance targets (in the case of the firm fixed-price incentive fee or FPIF contract) or if there are economic conditions outside of its control (in the case of a fixed-price with Economic Price Adjustment or FP-EPA contract).

In any case, the fixed-price may be amended by mutual agreement of the buyer and seller if the scope of the procurement increases.

Next week, I will discuss the three subtypes of the next category of contract, the cost-reimbursable contract.


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