I was in a contract negotiations meeting for several hours yesterday. The most notable quote came after the customer was asking for the basis of estimates for the scope of work being proposed.
I think both the vendor and customer could have done a lot better if they had just valued customer collaboration over contract negotiation.
I felt like I was watching a first-time buyer at a used car dealership. When the sticker price is in the Millions of dollars, it becomes a very interesting game of poker. As usual, my job was not to negotiate. It was merely to observe and advise.
Vendor: You’re saying the LOE is too high.
Customer: No, I’m saying I want you to justify your LOE.
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I have to admit, doing a guest post for PMStudent was harder than I thought it would be. I’ve been wanting to do it for a while but haven’t because I couldn’t think of the perfect topic and then wound up posting all of those topics on my own site. What would be good enough for this guest post? Clearly, the answer was whatever is good enough to post on my own site! I’ve done a guest post before, writing about the challenges to task prioritization at the Personal Kanban website. Still, pondering a topic and writing about it are two very different challenges. I finally followed through and completed my guest post. After I let go of my anxiety, it was really quite easy.
I’ve been following Josh Nankivel, and his PMStudent blog, since I first logged onto Twitter and started PM blogging. Josh is an excellent resource for anyone in the PM industry. Particularly, he is passionate about helping new and aspiring project managers succeed. It shows! Since I aspire to do the same thing, you can understand my trepidation in choosing a topic for my guest post on his blog.
My topic of choice was on “Contract type: Here’s the best one…“
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 to do is understand who bares the risks or benefits of each. Being I don’t know if you (the reader) are a vendor, a customer, or a project manager, I offered an objective description of each contract type to help shed some light on the subject.
Please check out Josh’s blog and let me know what you think of the post. Scathing reviews are welcome. OK, that’s a lie. No scathing reviews, please. I hope this is the first of many guest posts I will be doing. If you want me to write something for your site, please send me an email or direct message me on Twitter.
Now that I published some information on the PMStudent site, I think I’m going to add a little more content and provide it for download, as an informative product.
Unfortunately, there is no ONE best type of contract to manage. The risk the vendor and customer share is determined by the contract type. The best thing you can do is understand the risks and benefits of each. There are three categories of contracts: Fixed-Price, Cost-Reimbursable, and Time and Material (T&M). In this 3 part series, I defined the contracts in each category. Hopefully, it will help you on the PMP exam and out in the real world.
Time and Materials (T&M) is a hybrid type of contractual arrangement that contains aspects of both cost-reimbursable and fixed-price contacts. They are often used for staff augmentation, acquisition of experts, and any outside support when a precise statement of work cannot be quickly prescribed.
These types of contracts resemble cost-reimbursable contracts in that they can be left open ended and may be subject to a cost increase for the buyer. The full value of the agreement and the exact quantity of items to be delivered may not be defined by the buyer at the time of the contract award. Thus, T&M contracts can increase in contract value as if they were cost-reimbursable contracts. Many organizations require not-to-exceed values and time limits placed in all T&M contracts to prevent unlimited cost growth. Conversely, T&M contracts can also resemble fixed unit price arrangements when certain parameters are specified in the contract. Unit labor or materials rates can be preset by the buyer and seller, including seller profit, when both parties agree on the values for specific resource categories, such as senior software engineers at specified rates per hour, or categories of materials at specified rates per unit.
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As I mentioned in my previous post, Fixed-Priced Contracts, there is no ONE best type of contract to manage. The risk the vendor and customer share is determined by the contract type. The best thing you can do is understand the risks and benefits of each. There are three categories of contracts: Fixed-Price, Cost-Reimbursable, and Time and Material (T&M). In this second installment of a 3 part series, I will define the contracts in the cost-reimbursable category. It will hopefully help you on the PMP exam and out in the real world.
Cost-reimbursable is a contract category involving payments (cost reimbursements) to the seller for all legitimate actual costs incurred for completed work, pus a fee representing seller 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. 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).
A cost-reimbursable contract gives the project flexibility to redirect a seller whenever the scope of work cannot be precisely known and defined at the start and needs to be altered, or when high risks may exist in the effort. Frankly put, if the buyer doesn’t know what they want, this type of contract allows the project to move forward without the risk to the seller.
- Cost Plus Fixed Fee (CPFF) reimburses the seller for all allowable costs for performing the contract work, and they then receive a fixed fee payment calculated as a percentage of the initial estimated project costs. The fee is paid only for competed work and does not change regardless of seller performance. The fee amounts do not change unless the project scope changes.
- Cost Plus Incentive Fee (CPIF) reimburses the seller for all allowable costs for performing the contact work and receives a predetermined incentive fee based upon achieving certain performance objectives as set forth in the contract. In CPIF contracts, if the final costs are less or greater than the original estimate costs, both the buyer and seller share costs from the departures based upon a prenegotiated cost sharing formula, e.g., an 80/20 split over/under target costs based on the actual performance of the seller.
- Cost Plus Award Fee (CPAF) reimburses the seller for all legitimate costs, but the majority of the fee is earned, based on the satisfaction of certain broad subjective performance criteria. This performance criteria is defined and determined by the buyer and and incorporated into the contact. The determination of the fee is based solely on the subjective determination of seller performance by the buyer, and is generally not subject to appeals.
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Unfortunately, there is no ONE best type of contract to manage. The risk the vendor and customer share is determined by the contract type. The best thing you can do is understand the risks and benefits of each. There are three categories of contracts: Fixed-Price, Cost-Reimbursable, and Time and Material (T&M). In this 3 part series, I will define the contracts in each category. Hopefully, it will help you on the PMP exam and out in the real world.
Fixed-Price is a category of contract 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. Sellers under fixed-price contracts are legally obligated to complete such contracts, with possible financial damages if they do not. Under the fixed-price arrangement, buyers must precisely specify the products or services being procured. Changes in scope can be accommodated, but generally at an increase in contact price.
- Firm Fixed Price Contracts (FFP) are the most commonly used contract type. It is favored by most buying organizations because the price for goods is set at the outset and not subject to change unless the scope of work changes. Any cost increase due to negative performance is the responsibility of the seller, who is obligated to complete the effort.
- Fixed Price Incentive Fee Contracts (FPIF) are arrangements which give the buyer and seller some flexibility whereby allowing for deviation from performance, with financial incentives tied to achieving agreed to metrics. Typically such financial incentives are related to cost, schedule, or technical performance of the seller. Performance targets are established at the outset, and the final contract price is determined after completion of all work, based on the seller’s performance. Under FPIF contracts, a price ceiling is set, and all costs above the price ceiling are the responsibility of the seller, who is obligated to complete the work.
- Fixed Price with Economic Price Adjustment Contracts (FP-EPA) are used whenever the seller’s performance period spans a considerable period of years, as is desired with many long-term relationships. FP-EPA is a fixed-price contract, but with a special provision allowing for predefined final adjustments to the contract price due to changed conditions, such as inflation changes, or cost increases (or decreases) for specific commodities. The EPA clause must relate to some reliable financial index which is used to precisely adjust the final price. The FP-EPA contract is intended to protect both buyer and seller from external conditions beyond their control.
Next in my series on Contracts, I’ll define Cost-Reimbursable and Time and Material Contracts (T&M)
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