Project Management

Unit 5: Customer Management

Table of Contents
1. Contract Management

Introduction to the Unit

In this unit, we will learn about the concept of Contract Management in the overall context of Project
Management.

We will focus on understanding the different types of contracts and the different phases of the
Contract Management Process.

Objectives
Upon completion of this unit, you will be able to:

 Explain the process of contract management

 Identify the different types of contracts
 Identify the different phases of the contract management process

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Contract Management
Table of Contents
1. Objectives
2. Introduction
3. Types of Contracts
4. Phases of Contracting
5. Summary

Objectives
Upon completion of this segment, you will be able to:

 Explain the process of contract management

 Identify the different types of contracts
 Identify the different phases of the contract management process

Introduction
In the previous segment, we learned about the concept of risk management, the steps for creating a
risk management plan and the strategies for mitigating risk. In this segment, we will focus on the
concept of contract management in the overall context of project management.

Before moving to the concept of contract management, let us briefly understand what are contracts
and their various types.

Irrespective of the size of the project being managed, one needs to have a basic understanding of
the various types of contracts that are used when buying from external organisations or and third
parties.

A contract is basically a promise exchanged between two or more parties—to do, or to refrain from
doing, an act—that is intended to be enforceable by law.

In the context of project management, contracts typically involve the exchange of money in return
for goods and services.

Types of Contracts
The following are, broadly, the three types of contracts used in project management:

Fixed-price or lump-sum contracts

In this type of a contract, a well-defined deliverable is agreed upon—between the buyer and the
seller—at a fixed price. Here the component of risk is higher for the sellers as they may incur losses
due to unforeseen reasons such as increased costs or delayed deliverables.

These types of contracts can also be problematic for the buyer who may have to pay more for the
requested changes if the seller is no longer willing to compromise around what it perceives as
changing requirements.

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A variation of this type of a contract could be the fixed-price plus incentive contract, which may
include an incentive or a bonus for early or timely completion of the project.

Cost-reimbursable contracts

In this type of a contract, all the costs incurred—by the seller—during a project are borne by the
buyer. Here the component of risk is higher for the buyer as the final cost is uncertain. If problems
arise during the execution of a project, the buyer has to spend more.

The advantage of such a contract is that the buyer has a bigger scope of making changes to the
project while it is being executed. At the same time, the disadvantage of such a contract is that the
seller has very little incentive to be efficient and productive and to deliver the project in time.

Not surprisingly, such a contract is most often used in projects where there is a lot of uncertainty
associated with the final deliverable.

There are three types of cost-reimbursable contracts:

Cost plus fee (CPF): Here the seller is reimbursed for acceptable costs plus a fee that is calculated
as a percentage of costs. As is apparent, this model offers little incentive to the seller to complete
the work in time.

Cost plus fixed fee (CPFF): In this type of a variant, all acceptable costs are borne by the buyer
along with a fixed fee, which allows the seller to make a profit. The fixed fee acts as an incentive for
the seller to complete the project faster.

Cost plus incentive fee (CPIF): In this type of a contract, all acceptable costs are borne by the
buyer in addition to an incentive fee for exceeding the performance criteria specified in the contract.
This can prove to be a win-win situation where, both, the buyer as well as the seller can make
substantial savings if the performance criteria is exceeded.

Time and Materials (T&M) contracts

A third type of contract is a mix of the fixed-price and the cost-reimbursable model. Time and
materials is a standard phrase in a contract for construction in which the buyer pays the seller based
on the work completed by the seller’s resources and for the materials used in the construction,
irrespective of the quantum of work required to complete the construction.

T&M contracts are seldom used because of the lack of an upper limit for the cost that has to be
borne by the buyer. However, these contracts score in situations where time is of essence and it is
not possible to invite bids from potential sellers.

Another situation in which this contract scores—over the other two—is where the original fixed price
contractor leaves the work mid-way and another contractor is called in to repair the damage and
complete the project.

At times, T&M contracts may carry a guaranteed maximum price, which puts an upper limit on what
the seller may charge but, at the same time, also allows the buyer to bear lesser costs if the project
is completed faster.

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Contract Management
Having understood the various types of contracts, let us now understand the concept of contract
management.

Contract management is simply the management of contracts signed with the clients, sellers,
partners or employees. It comprises negotiations over the terms and conditions of the contract,
ensuring compliance with the same and documenting and approving any changes or amendments
that may occur during the implementation or execution of the contract.

Most of the projects include a huge amount of capital investment on purchasing the equipment and
machinery. Organisations can also get these equipments on a contractual basis.

Hence, the Project Manager needs to negotiate with the suppliers on quality, delivery schedule,
price, payment schedule, service and other relevant legal contractual aspects. This process of
deliberation is known as negotiation.

Contracting has three phases, namely:

 contract planning,
 contract negotiations, and
 contract administration

Contract planning

Contract planning should be done at the project scheduling stage. The process of contract planning
includes the preparation of resource plans. There are some important considerations in the contract
planning stage, namely:

 Work Break Down (WBS) and packaging;

 requirement of resources, mainly equipment and manpower, for various work packages;
 type and number of contracts to be awarded and to whom;
 technical, financial and operational capabilities of the contractor;
 scope of work for each contractual job;
 method of contracting, that is, ICB, LCB, open tender, limited tender and so on;
 choosing from suitable and comparable parties; and
 ensuring that obligations of both the parties are reasonable.

Contract negotiations

The negotiator brings the buyer and the seller face to face. All assumptions and parameters related
to price are analysed. Eventually, a more realistic picture emerges, which is agreed upon by, both,
the buyer as well as the seller.

The following aspects should be kept in mind at the time of contract negotiations:

Price-related terms: Price can be fixed or adjustable during the contract period. Fixed price is
generally applicable under stable market conditions and in the case of firm specifications and
product schedule.

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Adjustable price applies to unstable labour market conditions and uncertain specifications and
product schedule. A suitable price-adjustable clause is agreed upon and included to take care of
such situations.

Payment terms: Any of the payment terms—which include advance, credit for a specified period,
cash on delivery and retiring documents through that bank—may be mutually selected. The method
of retiring a document through a bank is adopted by the supplier to obviate any delay in payment
after receipt of the consignment. The process involves the following steps:

 Dispatch document in the form of railway receipt, RR (in case of rail transport), consignment
note (in case of road transport) or bill of exchange (in case of ocean transport) is sent by the
supplier to its banker, after receiving the indicated amount, with a request to handover the
document to the purchasing company. In the document, the supplier puts his/her name as
consigner and consignee. The supplier signs on the back of the document (like in the case of
a bearer cheque).
 A letter is also written to the consignee to retire the document from the bank.
 The recipient company gets the document after making the specified payment and collects
the consignment from the transporter after producing the dispatch document.
 The bank charges some fee from the consigner for providing this service.

Delivery conditions: These may include information about the mode of delivery, the quantity and
the time of delivery.

Agency for inspection: It is to be mutually agreed whether inspection is to be done by a third party
or by the buyers or the suppliers.

Cancellation: A contract may be cancelled due to default by the vendor (upon failure to perform as
agreed upon in the contract while making deliveries), at the convenience of the buyers or through
mutual consent. In a situation where the seller is not at fault, it needs to be ensured that he/she
does not suffer any loses.

Quantity: Quantity may be fixed or variable; however, in case of variable quantity, the lower and
upper limit needs to be specified.

Contract administration

Contract administration involves managing our contracts to make sure that we comply with and fulfil
the contract conditions. Good contract administration ensures customer satisfaction and minimises
disputes.

It can be summarised as the process of systematically and efficiently managing contract creation,
execution and analysis for the purpose of maximising financial and operational performance and
minimising risk.

Various problems may arise during the execution of the contract. These can typically include the
following:

 Extra work including excess quantities of work.

 Deleted work including lower quantities of work.
 Non-compliance with specifications.
 Delays in time schedules.
 Late payments.

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 Taking over of completed works.

 Warranties.
 Contract close out.

As and when the problems arise, they must be sorted out immediately based on the provisions of
the agreed contract.

In this way, contract management plays an important role in the project life cycle and necessitates
active involvement of the Project Manager through the planning, negotiation and administration
phases.

Summary
In this segment, you learned that:

 contract is a formal and legally binding agreement in which two parties promise each other to
do or to refrain from doing certain acts aimed at achieving a common objective,
 contracts can be broadly summarised as fixed-price contracts, cost-reimbursable contracts
and time and materials contracts;
 contract management refers to the practice of managing the contracts that have been signed
with the clients, sellers, partners or employees; and
 contracting consists of three stages, namely planning, negotiations and administration.

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