Know Your Project Contract Before Signing

Depending upon the nature of business, it is often seen that many organizations outsource some portions of their work to a third party vendor instead of doing on its own. And to define a clear working procedure between the two parties they agree to sign a contract, which is a legal agreement between your organization and the service provider or vendor, where both the parties are bound to abide the terms and conditions stated in the contract.

A contract is a mutually agreed legal document where one party is the service provider i.e. seller and the other one is the receiver or the buyer of the services, products or something of a value as agreed upon in the contract.

Contracts can be signed with various vendors outside of the project to get the required services as per the project needs. You may require outsourcing of some complex work due to unavailability of competent resource in your organization, so you need to sign a contract with a third party vendor to

get the work done.

Before moving forward on various types of contracts, let’s assume that as per your project requirement, you need to outsource the work of one of the complex module from a third party organization and for that reason you are going to sign a contract with a company who won the bidding process. So, let’s discuss various contracts which may suit your project.

Which type of Contracts Suits you?

Broadly, there are three types of contracts, Fixed Price Contracts, Cost Reimbursable Contracts and, Time and Material Contracts. Let’s discuss those contracts in detail.

Fixed Price Contracts (FPP)

This is one of the common contracts mostly used in the construction business. It is also called lump sum contracts, as the cost is fixed for a specific work, product or services the buyer receives from the seller.

So, if you are thinking to choose this type of contract for your project, then make sure that the scope of your project is well defined. Because you cannot estimate the cost if the complete scope of the work is unknown to you.

In a fixed price contract, the seller has to take a higher level of risk as the price is fixed from the buyer, so in case the expense exceeds, the seller has to bear the extra cost. While in the case of profit the seller will not disclose to the buyer. The seller is legally bounded to deliver the agreed work in a specific time period within the predefined price.

The fixed price contracts are further divided into three categories.

  • Firm Fixed Price Contracts −This is a straight forward contract commonly used by many organizations. The buyers set the price firmly in exchange of exact product or service from the seller. The cost will remain fixed unless the buyer changes the scope of the work. The Seller is obliged to complete the work within the fixed budget and in case of any variances, the extra cost will be borne by the seller itself.

For example, after rounds of discussions, the seller agreed to complete the work in $500000 within 12 months. So, once the contract is approved by both the parties the seller is duty-bound to complete the work within the defined cost and schedule.

  • Fixed Prices Incentive Fee Contracts − Including the fixed price, an additional incentive will be given to the seller based on his performance that may be the schedule, cost or quality.

For example, you can prepare the contracts mentioning that if the seller will complete the work before 2 months, an additional $20000 will be given to him.

  • Fixed Price with Economic Adjustments Contracts −In case of long-term multi-years projects, this fixed price with economic adjustments contracts protects the seller from any inflation. The buyer agrees to increase the total cost in final adjustments at a predefined rate in case of changes in inflation or cost of any specific commodities increases.

For example, in case of a construction project, 4% of the project cost can be increased if the price of iron bar will increase in next financial year.

Cost Reimbursable Contracts

In this type of contract, the buyer is obligated to reimburse all the expenses of the seller spends in completing the given work including an additional amount as profit. This type of contract normally uses where the scope of the project is uncertain or having very few requirements.

It is further divided into three categories.

  • Cost plus Fixed Fee contracts −In this type of contracts, the buyer will pay the total expenses of the seller including a predefined percentage of total cost as fixed fee. Generally, these types of contracts are used for highly complex and risky projects where the numbers of bidders are very less.

For example, a contract can be signed to pay the total expenses plus an amount of $10000 as a fee.

  • Cost plus Incentive Fee Contracts −Including the total cost of the seller, the buyer also provides a predefined incentive fee based upon the seller achieves certain performances as defined in the contract. These types of contracts are used to encourage the seller to complete the project under budget.

For example, if the project completes by saving 20% from the allocated budget, then 80% of the saving amount will go to the seller and 20% will remain with the buyer.

  • Cost plus Award Fee Contracts −Here, the buyer will pay all the expenses of the seller plus an extra amount as award provided the seller achieves certain performance criteria agreed in the contract.

For example, when the seller completes the work by matching the predefined quality measures, then the buyer will award him $20000 as award fee.

Time and Material Contracts

In this type of contract, the buyer will have to do pay-per-hour or per-item basis. This is generally used in service sectors for short duration projects. Normally the seller charges the labor hours from the buyer.

For example, the buyer will pay the seller an amount of $25 per hour for a senior developer.

It is also advisable to take opinions from experts inside or outside the organisations before choosing the appropriate contracts. Another important thing is whichever contract you choose, make sure that both the parties are mutually agreed to its terms and condition by providing their consent. The contract is not valid until it is signed by the appropriate authority from both the sides.

Samual Sam
Samual Sam

Learning faster. Every day.