Types of Contracts PDF

Types of Contracts FIXED-PRICE CONTRACTS COST-BASED CONTRACTS Ø Firm Fixed-Price Ø Cost plus incentive fee Ø Fixed-price with escalation...

Types of Contracts FIXED-PRICE CONTRACTS COST-BASED CONTRACTS Ø Firm Fixed-Price Ø Cost plus incentive fee Ø Fixed-price with escalation Ø Cost-sharing Ø Fixed-price with redetermination Ø Time and materials Ø Fixed-price with incentives Ø Cost plus fixed-fee ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 14  Fixed Price Contract A Fixed-Price Contract (also known as a “lump sum” or “fixed fee” contract) is an agreement between two parties in which the buyer agrees to purchase goods or services for a set price, regardless of the actual cost to produce them. Ø The vendor assumes all risks associated with the completion of the project according to the agreed specifications and timeline. Ø This type of contract provides both parties with a clear understanding of the financial obligations involved, without room for any negotiation on the agreed price ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 15  Firm Fixed-Price (FFP) Ø Most basic contractual mechanism Ø Price stated does not change § Regardless of environmental changes Ø Can be obtained using § Price quotation § Supplier response to RFP § Negotiations Ø Simplest and easiest contract ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16 Ø Supplier bears financial risk in rising market, Buyer assumes financial risk in declining market Ø Supplier may add contingency fee / clause if uncertainty is high Ø Important for buyer to understand underlying market conditions Example: A company hires a contractor to build a bridge for a set price of $2 million. Regardless of any cost overruns, the contractor must complete the project for that price. ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17  Fixed-Price with Escalation Ø Used for longer-term contracts −Where costs are likely to increase over time Ø Escalation clauses allow either price increase or decrease in base price Ø Should be tied to an independent, well-established published third- party index Example: A construction company signs a contract to build a facility for a fixed price of $5 million, but the contract allows for price adjustments based on changes in material costs, such as steel or concrete prices in the market. ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 18  Fixed-Price with Redetermination Ø Used when parties cannot accurately predict labor or material costs and quantities required upfront Ø Target price is determined using “best guess” estimates Ø At a predetermined time, buyer and supplier review actual experience and redetermine the fixed price Example Project: Commercial building, Terms: Initial Fixed Price: $10 M, Duration: 12 months, Redetermination Period: Every 6 months. The contract price can be adjusted based on predefined criteria (e.g. bank rates, material costs, labor rates) ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 19  Cost-Based Contracts A cost-based contract is an agreement where the supplier is reimbursed for actual costs incurred, along with additional fees or rewards Ø Also known as a cost-plus contract, the final price depends on estimated quantities of items needed for the project Ø Used when there is a high risk of large supplier contingency fee that would be included in fixed-price contract Ø Lower risk of economic loss for supplier −Economic risk is transferred from supplier to buyer Ø But can result in much lower cost to buyer ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 20 Ø Need to include terms and conditions that require supplier to carefully monitor and control costs Ø Parties must agree on allowable costs from all variable costs Ø Generally applicable when goods and/or services are expensive, complex, or important to buyer and there is high degree of uncertainty ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 21  Cost-Sharing Allowable costs are shared between parties on predetermined percentage basis Key is identification of a firm set of operating guidelines, goals, and objectives, Need to spell out expectations clearly Important during periods of rising prices Example: A technology firm and a client collaborate on developing new software. Allowable Costs: $400,000 (for development, testing, and project management), Cost Sharing Agreement: The client covers 70% of costs above $300,000 ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 22  Time and Materials Ø Generally used in plant and equipment maintenance agreements −Costs cannot be determined prior to actual repair −Based on agreed upon hourly labor rate plus overhead and profit percentage Ø Requires “not to exceed” amount Ø Low buyer control over estimated maximum price Example: A graphic design agency hired to create marketing materials. Labor Rate: $100 per hour, Estimated Hours: 20 hours, Material Costs: $2,000 (for printing and supplies). ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 23  Summary: Types of Contracts ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24  Desirability of Contract Types ©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 25