Contract
Types
PMP Exam Topic
What is Contract?
A contract is a legally binding agreement between two or
more parties that outlines the terms and conditions
under which goods, services, or results will be provided. It
specifies the rights and obligations of each party.
Contract and Project Management
Website
Project Project
Charter Requirement Web
SEO
Development
Site On Page
Client
Contract
Payment
Off Page Outsource
APIs
Vendor
Contract
Contract and Project Management
Client Contract (Input to Project Requirements and Charter):
● A formal agreement between the client and the organization initiating the
project. This contract outlines the project's scope, objectives, deliverables,
and the expectations for the final product or service.
Vendor Contract (Executed by Project Team):
● A legally binding agreement between your organization and an external
vendor or service provider. This contract is used to procure goods, services,
or expertise needed for the project that cannot be sourced internally. It
specifies the terms of engagement, including scope, cost, timeline, and
quality standards.
Project Manager : Buyer or Seller ?
Project
Client Vendor
Manager
Client
Buyer Seller
Contract
Buyer Seller Vendor
Contract
Contract Types
Contract types are defined by the way costs, risks, and
responsibilities are allocated between the buyer and
seller in a project. They determine how payment will be
made, how project risks are shared, and how changes to
the scope or requirements are handled.
Contract Types
Cost Time and
Fixed Price
Reimbursable Material
Key Parameters for Contract Type Selection
● Clarity of Work
● Complexity of Work
● Predictability of Estimate or Solution
● Degree of Control Needed by Buyer in Contract Execution
● Flexibility Needed for Change in Scope
● Buyer Cost Control
Fixed Price
Fixed Price Contract
A legally binding agreement where the seller agrees to deliver a project or
service at a predetermined, fixed cost. The price is set regardless of the
actual costs incurred during the project, making it one of the most
predictable and stable contract types for buyers.
Characteristics of Fixed Price Contract Type
● Clear Requirements: The project scope, deliverables, and requirements
must be well-defined and agreed upon before the contract is signed.
● Minimal Scope Changes: Limited flexibility for changes once the contract
is in place; any changes typically require a formal change order process.
● Fixed Price: The price is predetermined and fixed, providing cost
predictability and stability for the buyer.
● Risk to Seller: The seller assumes the risk for any cost overruns
● Low Buyer Involvement: The buyer has minimal day-to-day involvement.
Fixed Price: Best Use Cases
● Low Complexity Projects: Ideal for projects with low to moderate
complexity, where requirements are stable and well-understood.
● Government and Commercial Contracts: Commonly used in
government and commercial sectors where budget predictability is
crucial.
● Examples
○ Construction Project Contract
○ Software Implementation Contract
Variants of Fixed Price
❑ Firm Fixed Price (FFP): The most common type of contract where the
price is set and does not change unless the scope changes. It is favored by
buyers because it minimizes surprises and risks.
❑ Fixed Price Incentive Fee (FPIF): Offers a fixed price but includes
incentives for the seller based on performance metrics such as cost,
schedule, or technical performance.
❑ Fixed Price with Economic Price Adjustment (FP-EPA): Includes a
clause for adjusting the price based on economic factors such as inflation
or changes in commodity prices, making it suitable for long-term
contracts.
Cost Reimbursable
Cost Reimbursable Contract
A contract in which the buyer agrees to reimburse the
seller for all legitimate and allowable costs incurred
during the project. In addition to cost reimbursement, the
seller may receive an additional fee, incentive, or award
based on performance or achieving specific objectives.
Characteristics of Cost reimbursable Contract Type
● Flexible Scope: Suitable for projects where the scope of work is not well-
defined or is expected to change during execution.
● Cost Transparency: All costs incurred by the seller are reimbursed by the
buyer, including materials, labor, and other expenses.
● Buyer’s Control: Regular oversight is required to approve expenses and
manage cost.
● Risk Allocation: The buyer assumes the majority of the financial risk
since all costs are reimbursed.
Cost Reimbursable : Best Use Cases
● High Complexity Projects: Ideal for projects with significant uncertainty,
complex requirements, or high levels of risk where the scope cannot be
fully defined at the start.
● Research and Development (R&D) Projects: Commonly used in R&D,
where the outcomes are uncertain, and costs can vary significantly during
execution.
● High Level of Trust: Requires a high level of trust between the buyer and
seller, as the buyer must rely on the seller’s cost reporting and project
management practices.
Variants of Cost Reimbursable
❑ Cost Plus Fixed Fee (CPFF): The seller is reimbursed for all allowable
costs and receives a fixed fee as a percentage of the initial estimated cost
or sometime actual cost.
❑ Cost Plus Incentive Fee (CPIF): Similar to CPFF, but includes an incentive
based on performance, with a cost-sharing formula between the buyer
and seller.
❑ Cost Plus Award Fee (CPAF): The seller is reimbursed for all legitimate
costs, but the majority of the fee is based on meeting broad and
subjective performance criteria.
Time and Material
Time and Materials (T&M) Contract
A hybrid contract type that combines elements of both
Fixed Price and Cost Reimbursable contracts. In a T&M
contract, the buyer pays for the actual time spent and
materials used by the seller, with labor billed at an
agreed-upon rate and materials billed at cost.
Characteristics of Time and Material Contract Type
● Flexible Scope: Ideal for projects where the full scope of work cannot be
defined upfront and may evolve during execution.
● Cost Variability: Costs are not fixed; they vary depending on the time
spent and materials used.
● Buyer’s Control: High level of buyer involvement is needed to manage
and approve the time spent and materials used.
● Risk Allocation: The buyer assumes the financial risk related to cost
overruns due to time or material increases.
Time and Material: Best Use Cases
● Projects with Uncertain Scope: Ideal for projects where the scope is
unclear or expected to change, requiring ongoing adjustments.
● Agile and Iterative Projects: Well-suited for projects using agile or
iterative methodologies, where deliverables and scope evolve over time.
● Short-Term or Urgent Projects: Commonly used for short-term projects
or tasks that need to start quickly without detailed upfront planning.
● Specialized Expertise: Effective for acquiring specialized skills or
expertise that are not available in-house, with the flexibility to adjust
resource levels as needed.
Variants of Time and Material
● Standard Time and Materials (T&M): The buyer pays for the actual time
spent and materials used, with labor billed at pre-agreed rates and
materials billed at cost.
● Time and Materials with Early Termination Clause: Includes a clause
that allows the buyer to terminate the contract early.
● Capped Time and Materials: A not-to-exceed limit or cap on the total
cost. Once the cap is reached, the buyer is not obligated to pay for
additional time or materials.
● Time and Materials with Performance Incentives: Combines the T&M
model with performance-based incentives.
Comparison of Contract
Types
Criteria Fixed Price Cost Reimbursable Time and Material
Clarity of Work High clarity required; Low clarity; suitable for Moderate clarity; flexible
scope must be well- projects with uncertain to accommodate evolving
defined. scope. scope.
Buyer Cost Predictability High; cost is fixed and Low; costs can vary Moderate; labor rates are
predictable. based on actual fixed, but total cost varies
expenses. with time and materials.
Risk Allocation Risk is primarily on the Risk is shared; buyer
Risk is primarily on the buyer. controls costs by
seller. managing time and
materials.
Engagement Level of Low; minimal day-to-day High; requires active High; requires active
Buyer involvement. involvement in cost monitoring and approval
management. of time and materials.
Complexity Level Low to Moderate; best for High; ideal for complex Moderate to High; suitable
projects with clear projects with uncertain for projects with evolving
requirements. scope. scope or specialized
expertise.
Advice for Buyer Project
Manager
Buyer Project Manager : Fixed Price
● Define Scope Clearly: Ensure that the project scope, deliverables, and
requirements are thoroughly defined and agreed upon upfront to avoid
costly change orders.
● Minimize Scope Changes: Avoid making changes after the contract is
signed, as modifications can lead to additional costs and delays.
● Monitor Quality Closely: Even though costs are fixed, maintain oversight
to ensure the seller does not cut corners to stay within budget.
Buyer Project Manage: Cost Reimbursable
● Establish Clear Cost Reporting: Set up detailed cost tracking and
reporting mechanisms to maintain transparency and control over
expenses.
● Engage Actively: Be prepared for high involvement in monitoring
progress, approving costs, and managing scope changes.
● Set Performance Incentives: Consider adding incentives to encourage
the seller to control costs and meet performance targets.
Buyer Project Manager : Time and Material
● Fix Labor Rates: Negotiate and agree on labor rates upfront to maintain
some control over costs.
● Monitor Time and Expenses: Actively track time spent and materials
used to prevent budget overruns and ensure project efficiency.
● Use Caps or Not-to-Exceed Clauses: Consider setting a cap on total
project costs to limit financial exposure and manage budget risks.
● Be Flexible with Scope: Leverage the flexibility of T&M contracts to adapt
to evolving project needs and requirements.
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