by DerekHuether

Psych!

Unfortunately, there is no ONE best type of contract because the risk the vendor and customer share is determined by the contract type.  The best thing you can do is understand who bares the risks or benefits of each.  Being I don’t know if you are a vendor, a customer, or a project manager, this objective description of each contract type should help shed some light on the subject.

There are three categories of contracts: Fixed-Price, Cost-Reimbursable, and Time and Material (T&M).

Fixed-Price is a contract category involving setting a fixed total price for a defined scope of work to be provided.  Fixed-price may also incorporate financial incentives for achieving or exceeding selected project objectives, such as schedule delivery dates, cost and technical performance, or anything that can be quantified and subsequently measured.   Vendors under fixed-price contracts are legally obligated to complete these contracts, with possible financial damages if they do not.  Under the fixed-price arrangement, vendors must precisely specify the products or services being offered.  Changes in scope can be accommodated, but generally at an increase in contact price.  The three common types of fixed-price contracts are Firm Fixed Price Contracts (FFP), Fixed Price Incentive Fee Contracts (FPIF), and Fixed Price with Economic Price Adjustment Contracts (FP-EPA). [risk is on the vendor]

Cost-reimbursable is a contract category involving payments (cost reimbursements) to the vendor for all legitimate actual costs incurred for completed work, plus a fee representing vendor profit.  Cost-reimbursable contracts may also include financial incentive clauses whenever the seller exceeds, or falls below, defined objectives such as costs, schedule, or technical performance targets.  Why would anyone ever use this contract vehicle?  Assume the customer doesn’t know what they want.  By absolving the vendor of risk, they may actually get something delivered.  Three of the more common types of cost-reimbursable contracts in use are Cost Plus Fixed Fee (CPFF), Cost Plus Incentive Fee (CPIF), and Cost Plus Award Fee (CPAF). [risk is on the customer]

Time and Materials (T&M) is a hybrid type of contractual arrangement that contains aspects of both fixed-price and cost-reimbursable contracts.  They are often used for staff changes, acquisition of experts, and any outside support when a precise statement of work cannot be quickly prescribed. [blended risk]

So there you have it, the three categories of contracts.  Some people make it their job to know these inside and out.  I wouldn’t recommend getting too far into the weeds unless this topic really interests you.  If there is one takeaway from this post, I would say remember which party is at risk and which party will benefit. It’s not fun being on the short end of that stick.

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