Fixed Price With Economic Price Adjustment Contracts: Everything You Need to Know
A fixed price with economic price adjustment contract allows for changes in price, either positive or negative, under certain circumstances. 3 min read
A fixed price with economic price adjustment contract allows for changes in price, either positive or negative, under certain circumstances. When a contract of this nature is in place, price adjustments can be made when there are market fluctuations that are beyond the seller's control.
Fixed Price Contracts
A fixed price (FP) contract includes a set price for a product or service. It can also include additional incentives when a company meets or exceeds specified objectives on certain projects.
The simplest and most common form of fixed price contracts is purchase orders. When working with fixed price contracts, there is more risk for the seller. This is because if there are any price increases, the seller is responsible for covering those increased costs and cannot charge the buyer a higher rate than the one originally agreed to pay.
The three most common types of fixed price contracts include:
- Firm fixed price, or FFP
- Fixed price incentive fee, or FPIF
- Fixed Price with economic price adjustment, or FP-EPA.
Firm Fixed Price (FFP)
Firm fixed price contracts are the most common type of fixed price contract. These are most favored by many organizations because the price cannot be changed unless the scope of the expected work is changed. If there are any cost increases for the project that are because of the actions of the seller's performance, the seller is responsible for covering those additional costs.
Fixed Price Incentive Fee (FPIF)
Fixed price incentive fee contracts allow for a bit more flexibility for both the buyer and the seller. With this type of contract, sellers have the ability to receive additional compensation for higher performance when certain metrics are met. This should be outlined and agreed upon ahead of time.
In most cases, these incentives will be related to metrics such as:
- Technical performance.
However, there is still a cap, or price ceiling, with an FPIF contract. Any accrued costs that exceed this cap are the seller's responsibility. There are a number of different variations on the FPIF contract. The seller and the project manager should agree to these terms before work commences.
Fixed-Price Contract With Economic Price Adjustment
A fixed price contract with economic price adjustment allows for changes in the price, either positive or negative, under certain circumstances. When a contract of this nature is in place, price adjustments can be made when there are market fluctuations that are beyond the seller's control.
Price increases cannot exceed the price ceiling, which must be reasonable and agreed to by both parties before work begins. There should also be provisions set in place for price reductions when rates fall below certain thresholds that have been set forth in the contract.
There are generally two types of price adjustments that can be made under an FP-EPA contract:
- Adjustments that are made based on an actual increase or decrease in costs associated with specific labor or materials.
- Adjustments that are made based on standard costs or indices that are specifically laid out in the service contract.
When Should FP-EPA Contracts Be Used?
FP-EPA contracts are usually only appropriate when there is reasonable doubt regarding the stability of certain conditions over the extended period of a project, such as:
- Market stability
- Labor conditions.
Additionally, contracts of this nature should only be used when the contingencies that would normally be included in a firm fixed price contract can't be easily identified and covered separately in that contract. Because FP-EPA contracts can be difficult to administer, they are not a typical choice under normal circumstances.
Difference Between an FP-EPA Contract and an FP Contract
At the core, FP-EPA contracts are quite similar to regular FP contracts. The main difference is that FP-EPA contracts allow for special provisions for price adjustments to be made under certain circumstances.
Both the buyer and the seller will need to agree to these requirements at the beginning of the contract agreement. This is so there is no confusion about when price adjustments are allowed. It's a necessity to address the uncertainty that is common in certain markets.
The economic conditions of the market will change over time. FP-EPA contracts are most common when a project is expected to last for a long period of time, usually several years. Therefore, there need to be contingencies in place to adjust for the changing market during the course of the contract.
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