Types of Contracts in Project Management

Contracts are the foundation of every organisation, transforming plans into action through legally binding commitments. Selecting the right contract type is essential to meet your project’s specific needs. Whether it’s fixed-price, cost-reimbursable, or another option, understanding these contracts can be the difference between success and failure.

As the Contract Management market is set to reach £9 billion by 2032, mastering contract types is more crucial than ever. Explore this blog to discover the different Types of Contracts in Project Management and make strategic decisions that propel your projects forward. 

Table of Contents 

1) What is Managing Contracts in Project Management? 

2) What are the Types of Contracts in Project Management? 

   a) Fixed-Price (FP) Contracts 

   b) Time and Material (T&M) Contracts 

   c) Cost Reimbursable (CR) Contracts 

   d) Other Types of Contracts 

3) Conclusion 

What is Managing Contracts in Project Management? 

In the domain of Project Management, a contract outlines an agreement made by a buyer and a seller or supplier. A contract is a formal agreement between two or more parties that creates legally binding obligations. This agreement  specifies the obligations as well as the actions that can be taken if those obligations are not met. 

Contract Management is vital for Project Managers and is of paramount importance to most contracts.  The Project Manager must ensure that certain key principles guide the selection and management of contractors and suppliers.  Once a contract between the Project Manager and the client is agreed upon and awarded, project professionals are responsible for monitoring and managing the supplier’s performance in line with the contract. 

Additionally, having a proper contract in place for a project provides a legal framework that eliminates uncertainty regarding timelines and payment details.

The terms of the contract dictate what work is required, who is responsible for completing the specified tasks, the project deadline, and how payment will be received. A legally binding agreement helps ensure a positive relationship between the buyer and supplier by establishing trust that the tasks will be completed, and payment will be received on time. 
 

What are the Types of Contracts in Project Management?

In Project Management, there are generally three primary types of contracts. While the specific type depends on the nature of the project and the payment structure, the types mentioned here serve as the best starting point for establishing a legal framework for the working relationship. 

The three primary types of Contracts in Project Management are detailed as follows:

Fixed Price (FP) Contracts 

Fixed price (FP) Contracts, also known as Lump Sum Contracts, have straightforward terms and conditions. This type of contract is typically used when the scope of the project is well-defined and there is a necessary understanding of the requirements. Once the scope of a project is established, it is common for the seller to provide a fixed price quotation for the agreed-upon scope of work. 

The seller must fully understand the requirements and the associated risks that may occur during the project while providing a fixed-price quotation. Hence, for a Fixed-Price Contract, the seller also needs to be highly experienced and capable of managing the project within the agreed terms.

Once both sides agree to the contract, they both benefit. While the buyer is assured of a fixed price that is to be paid once the scope of work is completed by the seller, the seller assumes all the cost-related risks once agreed. The buyer makes the payment based on the delivered well-defined outcomes by the seller. Though the seller is at risk of losing money on this kind of contract, they may also achieve maximum profit if they can complete the scope of the project at a lesser cost. 

It requires a significant level of maturity and clarity on both the buyers' and sellers’ parts to come up with a fixed-price contract, as Negotiation can be time-consuming. Once the fixed-price contract is finalised, any changes in scope or other terms and conditions must be handled through formal change requests for any kind of changes that are to be made either in the scope or any other terms and conditions. 

There are three different types of fixed-price Contracts, namely Firm Fixed-Price Contract (FFP), Fixed Price with Incentive (FPIP), and Fixed Price with Economic Price Adjustment (FP-EPA). 

Time and Material (T&M) Contracts 

These items may include increasing temporary manpower for the project with specific skills and expertise. These items may also include standard materials necessary for project consumption. 

In a T&M Contract, an organisation will select some favoured suppliers of manpower and materials. The vendors for the projects will be selected based on capability and performance. There will be a negotiated rate for all such supplies, and the final price paid will be for the quantity of all such resources consumed or purchased. Several types of cost-reimbursable contracts are discussed below, as a T&M Contract uses both the elements of Fixed Price and Cost Reimbursable Contracts based on consumption. 

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Cost Reimbursable (CR) Contracts 

A Cost Reimbursable Contract involves payment based on the seller’s actual costs, along with fees and incentives for meeting or exceeding objectives. In a Cost Reimbursable (CR) contract, the buyer pays the actual costs incurred by the seller plus an additional profit. 

This type of contract includes two components: the contract is reimbursed for the actual costs of completing the project, and a predetermined fee is also paid. This type of Contract is used in situations where the project requirements are not well-defined, as it allows for flexibility in the scope and direction of the project. 

A Cost Reimbursable Contract is often preferred when there is a high degree of uncertainty or limited information about the project requirements, and when the development team lacks clarity about how the product will be developed. 

In the absence of clarity in all accounts, a Cost Reimbursable Contract becomes the best possible arrangement. There are several types of cost reimbursable Contracts, all of which are briefly discussed as follows: 

a) Cost Plus a Percentage of the Cost (CPPC) or Cost-Plus Fixed Fee (CPFF): This kind of contract means that the buyer will pay the seller for the costs that are involved in doing the project work, along with an additional fixed fee that the seller has to pay. If this fixed fee is calculated as a percentage of the estimated project costs in the beginning, it is called a CPPC type of Contract. 

b) Cost Plus Incentive Fee (CPIF): This type of contract means that the buyer will reimburse the project costs and pay a pre-determined fee if the seller meets certain performance goals or any other specific target mentioned in the contract. 

c) Cost Plus Award Fee (CPAF): This type of contract is similar to the CPFF Contract, except for the fact that instead of paying a fee on top of the costs, the buyer evaluates the seller’s performance and pays a fee based on that evaluation. 

Cost Plus Contracts shift significant financial risk to the buyer, as the seller is guaranteed reimbursement for all costs, potentially reducing their incentive to control expenses.

Other Types of Contracts 

In addition to these, there are other types of contracts worth exploring. These additional contracts, outlined below, offer various approaches to meet specific project needs.

a) Comprehensive Contract: The simplest contract arrangement, where a single supplier is responsible for all project requirements. 

b) Parallel Contract: A contract where similar scopes of work are assigned to two or more suppliers working in parallel to deliver the entire project. For example, a Renovation Contract for a three-story office block where one contractor oversees the ground floor, while two other suppliers are tasked with the responsibilities of the other floors. 

c) Sequential Contract: This type of contract involves engaging two or more contractors at different stages of a project.  An organisation may be employed to help design a project, and another organisation may be employed for the construction of the project. The second contract in such arrangements can act as a comprehensive commitment to help supply all the goods and services needed to complete the project. 

d) Sub Contract: This is a type of contract where the main contractor signs a contractual agreement and then sub-contracts parts of the work to other contractors. 

e)  Partnering or Joint Ventures: Collaborative and transparent relationships between contractors and suppliers are key to successfully completing large-scale projects. By coming together to form a partnership, suppliers can maximise resource usage, achieve project deliverables, and effectively manage costs. 

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Conclusion 

Grasping the types of contracts in Project Management is like unlocking a treasure chest of tools for success. This blog has shed light on fixed-price, cost-reimbursable, and time and materials contracts, each with its own perks. Armed with this knowledge, you can confidently choose the right contract, paving the way for smoother projects and better results.

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