Key Takeaways

  • In software project management, contracts define the scope, payment terms, and risk allocation between buyer and seller.
  • Common types include fixed price, purchase orders, cost reimbursable, unit price, and time and materials contracts.
  • Fixed price contracts may include variations such as firm fixed price, fixed price incentive, award fee, or economic price adjustment.
  • Cost reimbursable contracts shift cost risk to the buyer and can be structured with fixed fees, incentives, or awards.
  • Unit price contracts are based on agreed rates per unit of work, while time and materials contracts charge for labor and resources used.
  • Additional formats like retainer agreements, framework agreements, and hybrid contracts offer flexibility for ongoing or evolving projects.
  • Choosing the right contract type depends on project scope clarity, risk tolerance, and performance expectations.

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. 

Purchase Orders

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. 

Additional Contract Types in Project Management

Beyond the common structures, project managers in software development often use additional contract formats to meet specific needs:

  • Retainer Contracts: These establish a recurring payment for ongoing access to services, often used when continuous technical support or consultation is required over the project lifecycle.
  • Framework Agreements (Master Service Agreements): Set overarching terms for future work orders or projects. Useful for long-term vendor relationships where multiple software deliverables will be commissioned over time.
  • Hybrid Contracts: Combine elements of fixed price and time & materials to balance cost predictability with flexibility. For example, a core scope might be fixed price, while change requests are billed hourly.
  • Incentive-Based Contracts: Include explicit rewards for exceeding key performance indicators, such as meeting accelerated timelines or achieving above-standard quality benchmarks.
  • Service-Level Agreements (SLAs): Though often part of another contract type, SLAs define specific performance and uptime requirements for software products, ensuring accountability in ongoing service delivery.

These structures are particularly relevant in agile or iterative software development, where scope can evolve and adaptability is crucial. When selecting among the different types of contracts in project management, consider the level of uncertainty, the importance of flexibility, and how performance will be monitored and rewarded.

Frequently Asked Questions

  1. What factors should influence my choice of contract type in project management?
    Consider the clarity of the project scope, budget flexibility, risk allocation, and whether incentives for performance will drive better outcomes.
  2. Are hybrid contracts common in software projects?
    Yes. Many software projects use hybrid models to balance the predictability of fixed price contracts with the adaptability of time and materials arrangements.
  3. How do framework agreements work?
    They set terms and conditions for a long-term collaboration, allowing multiple projects or work orders to be initiated without renegotiating the base agreement each time.
  4. When is a retainer contract appropriate?
    Retainers work well when ongoing access to expertise or support is essential, such as continuous maintenance or feature updates for a deployed software system.
  5. What’s the role of a Service-Level Agreement in project contracts?
    An SLA defines performance metrics like system uptime, response times, and support quality, ensuring service providers meet agreed standards after project delivery.

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