3 Different Types of Contracts in Project Management

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by StarAgile

December 01, 2020
Category Project Management


Types of Contracts in Project Management

Project management is a topic in which the projects are managed, controlled, and tracked for successful completion as per the expectation of the customer. The customer first releases the Request for proposal or request for information or the tender to the top companies he believes will help him complete the projects. 

The vendors or the suppliers apply for the RFP o RFI or the tender in the form of a proposal which details every minute details on how he will be able to complete the project, the cost, the quality, the time frame, materials, and resources to the customer. The customer chooses the best three proposals by analyzing the received proposals. There are lots of criteria that the customer considers on the best three proposals. To know more about the contracts take up the PMP Certification Online training with StarAgile institute.

Then the vendor is asked to provide the proof of concept or the demo on the proposal on how he will accomplish the project. Finally, based on all the factors the customer chooses the best proposal for signing the contracts. This will take a lot of time and it is not an easy task for the customer to choose the best vendor in the market. Once he decides on the vendor the contract is signed. The contract signing is the last stage for the initial phase of the vendor-customer relationship. After that based on the contract, the project is executed by the suppliers. All these take a lot of time and effort. 

What is a Contract in Project Management? 

The contract in the project management is an agreement between the customer and the vendor for the project to be executed by the vendor following the requirements of the customer. 

The contract consists of the agreement between 2 or more parties in which the parties agree to payment terms, marketing and reporting agreements, proposal, and procurement state of work. 

The contract consists of roles and responsibilities that both parties are responsible for and share, also consists of terms and conditions as defined in the agreement which both parties abide by. 

If there are any changes to the contract then both the parties must sit together and solve it and agree to the changes. 

The contract needs to be wetted by the legal experts from both parties so that the language and communication are all agreed upon and mention what it meant to be. 

The legal contract consists of the offer and acceptance of the offer, the consideration and legal purpose, and legal capacity. The contract is written in a legal language so that there is no violation of any clause in the agreement. It consists of a statement of work, penalties for violation, security and privacy clauses, roles and responsibilities, insurance requirements, and confidentiality agreements, etc. 

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3 Different Types of Contracts in Project Management

1. Contract Types PMP – Fixed Price 

There is various type of contracts and what we are going to discuss in this paragraph is the fixed price contract. It is also called a lump sum contract. This type of contract is signed when the scope of work is fixed. The vendor is supposed to complete the work within the stipulated time and price. Therefore the vendors bear all the risks. There is no price negotiation unless there are changes in the scope. Learn by registering for the Project Manager Certificate Online at StarAgile institute.

Typically all the turnkey and outsourcing projects are fixed-price contracts. The contract is beneficial when the scope of work is fixed and does not change.

This contract is useful for controlling the cost. Typically the suppliers make the bidding with the lowest possible price and get extra revenue when there are changes in the scope.

Here the scope must be detailed and well defined. In general know about project scope here. 

The fixed-price contracts are of three categories, they are as follows,

  1. Firm Fixed price contract - Here in this contract the price is fixed and vendors need to complete the task within the stipulated time and price. Any increase in cost is a risk to the vendor. Generally, the government and semi-government contracts come in this category. For example Painting of the building to be done in Rupees 75,000 etc
  2. Fixed-Price Incentive Fee contract (FPIF) - Here even though the cost is fixed the vendors will receive the incentive if they perform well based on meeting the requirements such as quality, scope, time, and cost. For example: If the vendor delivers the first deliverable on time then he will receive the incentive of Rupees 15,000 etc
  3. Fixed-Price with Economic Price Adjustment Contracts (FP-EPA) - This is done when the fixed price contract is for a multi-year or more than a year. The inflation is adjusted and vendors will have less risk. For example, the cost of the project will increase by 3% after the year.

2. PMI Contract Types –  Time and Material Contract 

The second type of contract is the Time and Material contracts. This type is the contract that is in-between fixed price and cost-reimbursable. The customer agrees to pay the vendor all the time and materials used for the project within a reasonable limit. It can be cost-reimbursable when the customer agrees to pay the cost for all the genuine and legitimate expenses. It can be more like a fixed price when the customer sets the limit. For example, The project is awarded for Rupees 5 million and any escalation in the cost needs to be bear by the vendor. Register for PMP Course Online at StarAgile to learn more about project management and types of project management contracts.

3. PMP Types Of Contracts – Cost reimbursable contracts

The cost-reimbursement contracts are the contracts that are agreed by the buyer or the customer to reimburse all the actual costs for the project incurred by the vendor. The customer also provides a fee for the vendor’s profit. There are 2 types of costs incurred by the vendors; those are direct cost and indirect cost. The direct cost is the cost such as resources salaries and equipment purchased for the use of the project. The indirect costs are the costs that are administrative and general overhead costs. This also contains the incentive option when the vendor provides the deliverables based on the scope, quality, and cost and within time, etc. Take up the Online PMP Training at StarAgile to explore more on project management.

Learn about project deliverables 

Final Thoughts

Here each of the contract types has its benefits. Time and Materials is good when hiring consultants or for outsourcing support. The fixed-price contract is fine when the scope is well defined is not likely to change. The cost-reimbursable contracts are good when there is a change in the scope and the scope is not fixed.

The vendor-customer relationship is very important for any contract to be successful. The vendor needs to select the contracts which have fewer risks and good for providing the best value for time and money and efforts invested.

StarAgile provides PMP Training Online for all aspiring professionals in the field of project management.