A procurement contract is an agreement between a vendor and a buyer for works to be executed by the vendor according to requirements set by the customer. Part of the contract is the responsibilities and roles that each party. Besides, it has terms and conditions that bide the parties. Some of the terms may include payment, parts and designs, milestones, and timelines. Alexander Lubka explains the three types of contracts discussed below to take into count some of these terms.
Fixed Price Contracts
A fixed-price procurement contract has a clear statement of the work to be done and the cost of the same. The seller agrees to undertake the work at the said price.
“With this type of contract, the vendor bears all the risk.” Alex Lubka Stated.
An example of such a contract is a purchase order. The buyer establishes the characteristics, quantity, and date of the deliverables. He or she also states the agreed price for the goods. The seller cannot adjust any of these terms at any point during execution.
There are three sub-types under fixed-price contracts:
- Firm-fixed-price: The price remains as initially set unless the scope of work changes
- Fixed-price incentive fee: If the seller out-performs particular metrics, he gets some extra cash payment
- Fixed-price with economic price adjustment: For contracts that run for several years, both parties agree to factor in inflation and other economic factors that might affect the cost of the project.
Cost Reimbursable Contracts
With this type of contract, the buyer pays the seller the actual cost of executing the agreed works. The costs could include equipment and materials. It may also cover indirect costs such as electricity, fuel, and repairs for equipment. The vendor makes a profit by charging a fee on top of the costs or asking for a price incentive for the work
“This type of contract is ideal in cases where the scope of works is not clear at the start of the contract or the risk involved is too large for the seller to accept a fixed price.” Alexander Lubka added.
An example of such a scenario is exploration works for an energy firm or a contract for designing a new product.
Time and Material Contract
Time and material contract is a hybrid of cost-reimbursable contracts and fixed-price contracts. It is typically used where the buyer cannot generate a clear statement of the work to be executed. This type of contract is ideal for service level agreements where the number of hours may vary depending on the need.
Here is an example; a business consultancy may charge their services using an hourly rate when unsure how many hours the customer may need for a particular project.
“Most buyers are worried about cost overruns if their requirements exceed a particular limit. Most firms vary the pricing such that the more hours a customer uses, the cheaper the cost per hour. Others establish a ceiling beyond which the price cannot exceed.” Alexander Lubka concluded.
The choice of contract type depends on the scope of the works and risks. Both parties need to find a sweet spot where each party is comfortable before settling on any type of contract for the success of the project.