WHAT ARE THE TYPES OF CONTRACTS?
Table 1 lists the various types of contracts and comments as to the salient features of them. The type of contract awarded is based on a number of factors including considerations such as: complexity of project requirements; uncertainty of scope; party assuming unexpected cost risk; need for predictable project costs; and period of performance.
FIRM FIXED PRICE (FFP) CONTRACTS
An FFP type of contract results in the contractor assuming most of the risk. Because there is no additional funding coming to the contractor, the cost and schedule time for risks must be included in the price with some margin resulting in higher prices. From the customer’s viewpoint, the cost of the contract is fixed which results in a more reliable budget, and less risk to the customer. Typically, the fee for an FFP contract is between 12-15%.
COST PLUS (CP) CONTRACTS
For a CP contract, the customer assumes the majority of the risk. The contractor gets reimbursed for all expenses even if there are large overruns on the project. For example, for a CPFF (Cost plus Fixed Fee) the contractor receives the total fee independent of the cost.
The contractor has little risk with these types of contracts. Because of this, the proposal does not usually carry a lot of cost and schedule for risks especially in a competitive environment. The contractor wants to keep the price low to win the job and then look for added fee with contract added scope items. The fee for this type of contract is typically around 7-8% for this type of contract because there is little risk for the contractor.
Table 1 Types of Contracts
| Type | Comment
|
| FFP CONTRACTS | -No additional funds to execute contract. |
| Firm Fixed Price (FFP). | -No adjustment to cost unless scope changes.
-Contractor has maximum risk. -Customer caps their costs. |
| Fixed Price Incentive Fee (FPIF). | -Provides for adjusting final contract price based on achieving agreed to metrics.
– Typically, metrics are related to cost, schedule, and technical performance. |
| Firm Fixed Price with Economic Price Adjustments (FFPEPA). | -No adjustment to price unless scope changes.
-Contractor assumes maximum risk. -Customer caps their costs. |
| CP CONTRACTS | Contractor gets reimbursed from all of their costs plus the agreed upon fee. |
| Cost Plus Fixed Fee (CPFF). | -Contractor is reimbursed for all expenses and receives a fixed fee.
-Fee does not change unless scope changes. -Customer assumes all of the risks. |
| Cost Plus Incentive Fee. | – Contractor is reimbursed for all expenses and receives a fixed fee.
-Contractor receives additional fee based on. achieving predetermined performance goals. |
| Cost Plus Award Fee (CPAF). | -Contractor is reimbursed for all allowable costs but the majority of the fee is based on the satisfaction of certain broad-based objectives.
-Typically, the award fee can range from 70-95% of the maximum fee possible. -Usually, the customer and contractor agree on the fee assessment. |
RISK STORY
An FFP contract is attractive to the customer because the price is fixed and not subject to change unless the scope changes. The exception to this statement is for a new large development project in which case a CP would be used. For the FFP contract, the customer assumes very little risk while the contractor assumes the majority of the risk. If you want to play in the sand box and the RFP requires an FFP contract, then the contractor must bid it that way and hopefully has included adequate risk budget in the price. This is a story about an FFP contract that did not work out well for my company resulting in serious consequences.
BACKGROUND
A large defense company I worked for was awarded an FFP contract for delivery of hundreds of HMMWV (High Mobile Multi-Purpose Wheeled Vehicle) with advanced state of the art communications systems over a period of five years. There were three models with variations of communications capability and equipment. The average material costs per vehicle was approximately 67% of the total cost per system.
The base contract included design, development and delivery of twenty Low Rate Initial Production (LRIP) units. The LRIP units were dedicated to validating the manufacturing procedures, qualification testing, and certification of the system. The period of performance was two years, a very ambitious schedule. The contract also included three multi-year options. Each option was for delivery of two hundred production units.
PROBLEM
The LRIP phase of the program went well. All the qualification tests passed without incident. The customer authorized option number 1. At this point, my company discovered that the cost of the electronics increased significantly above the proposed price. The company was on a path to lose substantial cost per unit which was unacceptable. The customer refused to negotiate a new price and insisted the option part of the contract be executed per contract. My company was forced to put in a claim against the customer.
The claim was not well received, and Lawyers got involved. After a long litigation process, the customer terminated the contract with my company’s contract as a matter of convenience. Later, the customer awarded a contract to one of our competitors to complete delivery of the production units. It took several years for my company to regain the respect and confidence of this customer.
LESSON LEARNED
There are several lessons learned:
- Do not bid an FFP contract that includes fixed priced options involving a long period of performance without an escape clause to mitigates excessive material cost growth or some unforeseen cost risk.
- Do not ruin a good relationship with an important customer over one contract. If negotiations with the customer fails, consider other options including absorbing the loss before pursuing litigation. Consider the loss of future contracts against the loss on this one contract.
- Preform a rigorous risk assessment during the proposal phase especially on an FFP multi-year contract for a new system development. My guess is if the company performed a good risk assessment during the proposal phase, then chances are they may have thought the risk of electronic costs overtime and took actions to mitigate it before the proposal was submitted.
BIO:
Currently John is an author, writer and consultant. He authored a book entitled ‘Project Risk Management. He has written numerous risk papers and articles. He writes a risk column for CERM.
John earned a BS in Mechanical Engineering and MS in Engineering Management from Northeastern University. He has extensive experience with commercial and DOD companies. He is a member of PMI (Project Management Institute). John has managed numerous large high technical development programs worth in excessive of $100M. He has extensive subcontract management experience domestically and foreign. John has held a number of positions over his career including: Director of Programs; Director of Operations; Program Manager; Project Engineer; Engineering Manager; and Design Engineer. He has experience with: design; manufacturing; test; integration; subcontract management; contracts; project management; risk management; and quality control. John is a certified six sigma specialist, and certified to level 2 EVM (earned value management).https://projectriskmanagement.info/
If you want to be a successful project manager, you may want to review the framework and cornerstones in my book. The book is innovative and includes unique knowledge, explanations and examples of the four cornerstones of project risk management. It explains how the four cornerstones are integrated together to effectively manage the known and unknown risks on your project.