Project Management Contracts: Everything You Need to Know
Project management contracts, also known as procurement contracts, are signed when a business outsources the delivery of goods or services. They are common in the construction industry and are divided into three categories: fixed-price, cost-reimbursable, and time and materials contracts.3 min read
Project management contracts, also known as procurement contracts, are signed when a business outsources the delivery of goods or services. They are common in the construction industry and are divided into three categories: fixed-price, cost-reimbursable, and time and materials contracts.
Basics of Procurement Contracts
Businesses need reliable suppliers to ensure that the needed goods or services are obtained consistently at the right time. To meet these needs, the organization might need to sign a procurement contract with a supplier. The contract explains the relationship between the buyer and seller and minimizes the chances of misunderstandings.
Not all organizations need to outsource, however, and it is important for companies to carefully weigh the pros and cons of outsourcing. Your business will need a procurement contract in the following situations:
- You lack the expertise to do that particular job.
- You don't have the capacity to handle the procurement needs.
- You can save money by hiring.
Procurement contracts can be divided into three categories:
- Fixed-price or lump sum contracts
- Cost-reimbursable contracts
- Time and materials contracts
A fixed-price contract obligates the seller to provide goods or services at a fixed price. The contract mentions the quality, timing, and price of the goods or services. It also lists milestones and penalties for missing deadlines.
This kind of contract is ideal when the scope of the work is known. Since the seller accepts a big risk by setting a price for future transactions, he must price his goods or services with this in mind. The seller has to control costs to be able to make a profit and will incur additional costs if the project is delayed.
Fixed-price contracts can take a few different forms:
- Fixed-price incentive fee: Apart from the fixed fee, an extra fee is paid depending on performance.
- Fixed-price award fee: In addition to the fixed fee, a bonus is paid in case the seller exceeds expectations.
- Fixed-price contract: The fee is fixed regardless of performance. These contracts are normally offered by governments.
- Fixed-price economic price adjustment: The prices are re-adjusted depending on prevailing market conditions.
The disadvantage of fixed-price contracts is that in desperation to get business, a vendor may promise to offer goods at low prices. However, because of unforeseen changes in the economy, the seller might end up incurring losses and being forced to compromise the quality of the goods supplied. On the other hand, many buyers prefer fixed-price contracts because they help the buyer to accurately estimate project costs and plan ahead of time.
Cost-reimbursement contracts are the agreements of choice when the scope of the project is not known. The contract stipulates that the buyer will cover all the supplier's expenses related to the contract. In addition, the buyer gets a profit that is calculated depending on a pre-agreed metric. Unlike in fixed-price contracts, it is the buyer who bears all the risks in this contract type.
Because these contracts give sellers the freedom to claim for unlimited expenses, deals done using this contract type are fraught with disputes and legal battles. This contract type is rarely used.
There are a few different types of cost-reimbursement contracts:
- Cost plus fixed fee contract: After paying the seller a fixed fee before the project starts, the seller is paid for costs incurred during the project.
- Cost plus incentive fee contract: In addition to covering the expenses, the buyer will pay a fee based on performance. The seller is thus motivated to do quality work.
- Cost plus award fee contract: The seller is given a bonus on top of the actual costs.
Time and Material Contracts
Time and materials contracts are also known as unit price contracts or hourly rate contracts and are used by freelancers. These are a combination of the fixed-price and cost-reimbursable contracts. The seller is paid a unit fee for each labor hour or material unit spent on the work. The contract doesn't have a start or completion date. It is suitable for projects where the buyer does not know when the project will start and where expenses can be tracked reliably.
Progress Payments and Change Management
To avoid running into cashflow problems, most suppliers want payments made in real-time when they provide the services as opposed to being paid after the completion of the project. A payment schedule is normally included in the contract, and it should specify how changes to the project will affect payments.
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