What Is Firm Fixed Price Contract: Everything You Need to Know
If you're wondering, "what is a firm fixed price contract," it's the type of contract in which the person buying a product or service pays the seller a fixed amount that does not vary even if unexpected costs arise or additional resources are needed.3 min read
If you're wondering, "what is a firm fixed price contract," it's the type of contract in which the person buying a product or service pays the seller a fixed amount that does not vary even if unexpected costs arise or additional resources are needed. This type of contract places the maximum risk on the seller since he or she carries full responsibility for all costs and the profit or loss. A firm-fixed-price (FFP) contract thus gives the contractor incentive to control costs and fulfill the contract efficiently.
In some cases, this type of contract is offered with an award-fee, performance, or delivery incentive that rewards certain goals.
When is an FFP Contract Used?
FFP contracts are most appropriate when purchasing commercial items, supplies, or services that are subject to detailed and definite specifications and offered at a reasonable price. This includes the following situations:
- Adequate price competition exists.
- Reasonable price comparisons can be supported with valid data.
- Available information allows the costs to be realistically estimated.
- The fixed price accounts for identifiable performance uncertainties and their likely costs.
For the seller, the benefit of using this contract is the ability to charge a higher base fee without risking sticker shock. The buyer, on the other hand, benefits from the peace of mind of having a fixed price.
Certain types of price changes can be written into an FFP contract, including economic pricing, contract change, and defective pricing. However, if supplier prices change, the contractor is generally required to absorb these costs under an FFP contract. On the other hand, when prices are significantly reduced, these costs cannot be recouped by the buyer, who is tied to the original quoted price in the contract. As the contractor, you must be prepared to assume full responsibility for maximum risk.
What Are the Hidden Costs of FFP Contracts?
FFP contracts can cause administrative burden and cause the purchasers to miss out on potential savings. However, they work well for routine services such as training, administrative support, and other basic services.
With this type of contract, the contractor must control costs, but he or she cannot do so effectively without also having control of inputs, outputs, and processes. In the case of government contracts, these factors are typically controlled by external government entities and may be subject to delays, false starts, changes in priorities, or lengthy approval processes that make a cost-plus or labor-hour contract more appropriate.
The impact on cost control for contracted services can change significantly when funding is reduced, offices are reorganized, or project requirements are drastically updated. The FFP contract lacks the flexibility to deal with these types of changes; contract modifications and terminations may increase the administrative burden of this contract type.
Constructive changes often cause contractor claims for additional compensation. Because of the lead time delays for contract modification, the contractor may be unable to provide needed support in the case of a requirement surge. This type of surge also places the government at a weaker negotiation position.
What Is a Work Breakdown Structure?
A work breakdown structure (WBS) can effectively reduce the uncertainty associated with FFP contracts by defining and developing specific requirements, including breaking down the project into granular tasks and subtasks. Creating the WBS should be a collaborative effort of the buyer and seller and include input from personnel, teams, and departments that will be supported by the contract. You can review calendars, emails, policies, operating procedures, and other documents to identify tasks, events, and issues that should be accounted for in the contract. These steps will create a more accurate cost estimate.
What Are Hybrid Contracts?
Hybrid contracts can be used to incorporate flexibility in an FFP structure. Update your WBS, denoting each defined task as either a surge or core task. Core tasks, such as daily system operation and sustainment and regular maintenance, are associated with a fixed price. Surge tasks include those that are unexpected or that could change, such as cost, labor hours, time, and materials. Tasks that are subject to price surge can be used and needed, and the contract will then return to the original, lower rates. This would eliminate the need for contract amendment or termination and costly claims.
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