Types Of Contracts In Software Project Management: Everything You Need to Know
The types of contracts in software project management can include fixed price, firm fixed price, fixed price incentive fee, fixed price with economic price adjustments, purchase orders, cost reimbursable, cost plus fixed fee, cost plus incentive fee, cost plus award fee, cost plus percentage of cost, time and materials, and unit price contracts.3 min read
2. Purchase Orders
3. Cost Reimbursable Contract
4. Unit Price Contract
5. Time and Materials Contract
The types of contracts in software project management can include fixed price, firm fixed price, fixed price incentive fee, fixed price with economic price adjustments, purchase orders, cost reimbursable, cost plus fixed fee, cost plus incentive fee, cost plus award fee, cost plus percentage of cost, time and materials, and unit price contracts.
Fixed Price Contracts
With fixed price contracts, also known as lump sum contracts, the buyer and service provider agree on a fixed price for the services in question. This type of contract is low-risk for the buyer, but high-risk for the seller since the time and costs of the project could exceed the fixed price. For this reason, a fixed price contract should include a detailed scope of work that clearly outlines what the buyer can expect for the agreed-upon price. When the contract is signed, the seller must complete the task or deliver the goods as agreed or risk being in breach of contract. Types of fixed price contracts include the following:
- Firm Fixed Price Contracts: This type of fixed price contract is typically used in government and partial government projects where the scope is defined in detail. This makes it easy to create a request for proposals and to compare the bids you receive. The downside for this contract is that deviating from the defined scope can be expensive.
- Fixed Price Incentive Fee Contracts: With this type of fixed price contract, the buyer also offers a performance-based incentive as an extra payment to the seller. Performance can be measured for this purpose by various metrics, including time, cost, or performance.
- Fixed Price Award Fee Contracts: As with the fixed price incentive fee, this type of contract offers a bonus for exceeding a specific performance metric. For example, if the seller delivers the product early, he or she could be eligible for a bonus equal to 10 percent of the total contract.
- Fixed Price With Economic Price Adjustment: With this type of contract, although the price is fixed, it can be readjusted with fluctuations in the market.
Fixed price contracts are commonly used on a deliverables basis for outsourcing and turnkey procurement.
A purchase order is a specific type of contract that is used only to purchase goods and commodities.
Cost Reimbursable Contract
When the scope of a project is unclear or subject to change, you should consider a cost reimbursable contract. This document, sometimes called cost disbursable, is also useful when the risk of a specific project is high. The seller provides work for a fixed time period or project, then increases the bill to create profit after finishing the work.
The amount of profit in this type of contract is often based on performance metrics detailed in the document itself. The downside of this type of contract lies with the buyer, who carries the risk for this type of contract since he or she pays all costs. The full cost of the contract won't be defined until the work is done. For this reason, few businesses opt to use a cost reimbursable contract.
Types of cost reimbursable contracts include the following:
- Cost Plus Percentage of Costs/Cost Plus Fee: With this variation, the seller receives a defined percentage of the total cost of the project upon completion. This is also an arrangement that mainly benefits the seller.
- Cost Plus Fixed Fee: The seller receives costs incurred plus an additional flat fee that is fixed in the contract. This amount is received when the contract is fulfilled regardless of performance.
- Cost Plus Incentive Fee: This is a performance-based fee paid on top of actual costs. It is a flat amount rather than a percentage.
- Cost Plus Award Fee: Similar to a cost plus incentive fee, this contract provides an award on top of the costs incurred.
Unit Price Contract
This type of contract, also called an hourly rate contract, combines elements of fixed price and cost contracts. A unit price contract pays a specified hourly rate for every hour spent on the project. It is commonly used by freelancer workers.
Time and Materials Contract
This contract is used when labor is the main deliverable and typically provides the seller an hourly rate.
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