Project Management

A Strategic Planning Approach

by Paul D.  Gardiner

Chapter 6 material

Website references

Website references from page 149:
  • to see a more detailed comparison of contract types and pricing arrangements.

Comparison of contract payment structures, Chapter 6

FIRM FIXED PRICE/LUMP SUM

Characteristics:

Calls for delivery of supplies and/or services at a specified firm price fixed at inception of the contract and is not subject to adjustment in light of actual cost of performance.

Application:

1. When fair and reasonable pricing can be established at outset.

2. Availability of reasonably definite functional or detailed specifications.

3. Available cost or pricing information permits realistic estimates of the probable costs of performance.

4. Purchase of "Off the Shelf" items, modified commercial items, and items for which sound prices can be developed.

5. Where performance uncertainties can be identified and reasonably estimated as cost variants, and the contractor agrees to a firm-fixed price representing assumption of the risk involved.

Advantages:

1. Easiest and least costly type of contract to administer.

2. Encourages contractor efficiency and economy.

3. Maximum risk for profit or loss borne by contractor.

4. Allows accurate obligation of funds at outset.

Disadvantages:

1. No recovery by client if market prices fall; lacks flexibility.

2. Not appropriate if specs are indefinite.

Limitations:

Must be able to provide specific requirements.

Remarks:

1. Most preferred type contract; however, usually inappropriate for R&D unless extent of work can be precisely defined.

2. May be formally advertised (tender competition) or negotiated.

3. Can be expected to produce the widest range of profits and losses.

FIXED-PRICE WITH ECONOMIC PRICE ADJUSTMENT

Characteristics:

1. Provides for upward and downward revision of the stated contract price upon the occurrence of specified contingencies

2. Price adjustments are cased on established prices; actual cost of labour or material; and cost indexes of labour or material.

Application:

1. Utilised when there is serious doubt concerning the stability of market or labour conditions that will exist during an extended period of contract performance; and when contingencies that would otherwise be included in the contract price can be identified and covered separately in the contract.

2. Price adjustments based on established prices are based on increases and decreases from an agreed upon level in published or otherwise established prices of specific items or the contract end items. Should normally be restricted to industry-wide contingencies.

3. Price adjustments based on labour and material costs should be limited to contingencies beyond the contractor's control.

Advantages:

Provides contingency allowances for increased costs of labour or materials, protecting both the contractor and the Government against significant loss.

Disadvantages:

More costly to administer and less expeditious as compared to a lump sum contract.

Limitations:

1. Not to be used unless the contracting officer determines that it is necessary either to protect the contractor and the client against significant fluctuations in labour or material costs or to provide for contract price adjustment in the event of changes in the contractor's established prices.

Remarks:

FIXED PRICE INCENTIVE

Characteristics:

Applies profit motivation to obtain more economy and efficiency in procurement by offering proportionately high profit for outstanding effective and economical contractor performance; modest profit for mediocre performance and low profit or a loss for below average economy and efficiency in contractor performance.

Application:

1. Appropriate when parties can negotiate at the outset a firm target cost, target profit, and profit adjustment formula that will provide a fair and reasonable incentive and a ceiling that provides for the contractor to assume an appropriate share of the risk.

2. When incorporating incentive provision(s) into the contract will not only be practical, but will likely result in a savings and more satisfactory attainment of a procurement objective.

Limitations:

1. Contractors accounting system must be adequate for price revision purposes and allow satisfactory application of price adjustment formula.

2. Not appropriate for shifting substantially all cost responsibility to the client.

Remarks:

1. Under appropriate individual contract circumstances, performance and delivery incentive provisions may be added to cost incentive. Incentive provisions must be kept in balance as concerns the needs and best interests of the client.

2. Objective is to obtain what is needed for the requirement at the lowest cost to the client by the most practical means; is not designed to replace FFP.

3. Billing price is established at outset as interim basis of payment pending determination of final price, or negotiating of a FFP. This interim price is flexible within ceiling limits and subject to adjustment as appropriate upon request of client or the contractor.

4. Effect of delays and additional costs caused by the client and beyond control of the contractor will normally be treated outside the incentive pattern or be subject to equitable adjustment.

FIRM FIXED PRICE LEVEL OF EFFORT TERM CONTRACT

Characteristics:

1. Customer pays the contractor a fixed dollar amount.

2. Requires the contractor to provide a specified level of effort, over a stated period of time, on work that can only be stated only in general terms, usually calling for investigation or study.

Application:

1. Particularly useful in the research and exploratory development categories when the work cannot be clearly defined and the level of effort desired can be identified and agreed upon in advance.

2. The product of the contract is usually a report showing the results achieved through application of the required level of effort (however, payment is based on the effort expended rather than on the results achieved).

Advantages:

Can be used in situations in which an administratively expensive cost reimbursement contract might otherwise be necessary; e.g., CPFF.

Disadvantages:

Does not guarantee that desired results will be achieved.

Limitations:

1. Should be used only when the work to be performed cannot otherwise be clearly defined.

2. Level of effort desired should be identified and agreed upon in advance of performance.

3. There should be reasonable assurance that the result desired cannot be achieved by expenditure of less than the stipulated effort.

Remarks:

Useful for R&D studies.

COST

Characteristics:

1. Provides for payment to contractor of costs only, no fee or other consideration.

2. Estimated cost ceiling is established for purpose of fund obligation and limitation of reimbursable cost incurrence by contractor.

Application:

1. When magnitude of performance cost uncertainties preclude use of Fixed Price (FP) contract.

2. For R&D work particularly with non-profit educational institute or other non-profit organisation and for facilities contracts.

3. When contractor wants production experience or to keep plant operating.

Advantages:

Economical for customer if contractor is efficient and conscientious in performance.

Disadvantages:

1. Expensive to administer.

2. Little, if any, incentive to contractor to reduce costs.

3. Contractor must have adequate accounting system.

4. Requires appropriate surveillance by client during performance to assure against contractor inefficiency or waste.

Limitations:

1. Ceiling amount not be exceeded by contractor without approval of client, except at contractor's own risk of non-reimbursement.

2. Client pays only allowable costs.

3. Audit of costs before final payment.

Remarks:

Contractor may consider surveillance by client an imposition.

COST SHARING

Characteristics:

Same as Cost contract except contractor is reimbursed only for an agreed-upon portion of its allowable costs.

Application:

1. Used when the contractor agrees to absorb a portion of the costs, in the expectation of substantial compensating benefits.

2. Appropriate of R&D (with other than educational institutions and foreign countries) only when there is a high probability that the contractor will accrue substantial commercial benefits.

3. R&D work with educational institutions or foreign governments.

Advantages:

Mutual benefit to contractor and client.

Disadvantages:

Same as Cost type except there is an incentive to reduce costs.

Limitations:

1. Audit of costs before final payment.

2. Contractor must show conclusive evidence of anticipated commercial benefits to accrue to contractor

Remarks:

9. COST PLUS INCENTIVE FEE

Characteristics:

1. Provides for the initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs.

2. Provides a target cost, a target fee, a minimum and maximum fee, and a fee adjustment formula, all established during initial negotiations.

3. Upon contractor completion, the formula is applied and, subject to the minimum and maximum fee limits, the fee is adjusted; an increase from target for total allowable cost under-run or a decrease from target for allowable cost over-run.

4. Can incorporate delivery, performance and cost incentive provisions, appropriately weighted to basic procurement objective.

Application:

1. For development and test of major systems when operational success of development is highly probable.

2. When an incentive formula can be negotiated which will provide positive incentive for effective management and be effective over the entire range of variations that may reasonably be expected either above or below target cost.

3. For both initial product development of major products where desired performance objectives are known, and in subsequent production run with potential for improvement of performance.

4. Given level of performance is desired and confidence in achieving that performance level is reasonable good, but technical and cost uncertainties are excessive for a FPI contract.

Advantages:

1. Encourages economical, efficient and effective contractor performance when cost-reimbursement type contract necessary.

2. Mutual benefit potential for client and contractor.

Disadvantages:

1. Costly auditing and administrative burden.

2. Contractor must have adequate accounting system for timely and proper cost determination.

Limitations:

1. High maximum fee should be balanced by a low minimum fee which may even be a "zero" or (rarely) a "negative" fee.

Remarks:

1. Delays and costs beyond the control of the contractor will normally be treated outside the incentive pattern or be subject to equitable adjustment.

11. COST PLUS FIXED FEE

Characteristics:

1. Provides for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost, but may be adjusted as a result of changes in the work to be performed under the contract.

2. Permits contracting for efforts that might otherwise present too great a risk to contractors, but it provides the contractor only a minimum incentive to control costs.

3. Contractor is paid allowable and allocable costs subject to limit of estimated cost amount.

Application:

1. Research, preliminary exploration, or studies to determine feasibility of development, and level of effort required is unknown.

2. Development and test when use of CPIF impractical.

3. Client owned plant, facilities.

4. When use of any type fixed-price contractor is inappropriate, and parties agree that a fee is justified.

5. Level of effort is required where high technical and costs uncertainty exists.

Advantages:

May proceed with vague scope and indefinite specs.

Disadvantages:

1. Provides minimum incentive to contractor to control costs.

2. Expensive to administer.

3. Essentially, profit without risk to contractor.

4. Contractor must have adequate accounting system.

5. Least contractor responsibility for cost.

Limitations:

1. Requires a final audit.

2. Normally not used in development of major systems once preliminary exploration, studies and risk reduction have indicated a high degree of probability that the development is achievable and the client has established reasonably firm performance objectives and schedules.

Remarks:

1. In order to more fully encourage and motivate contractors to foster and demonstrate both economy and efficiency in contracting, use of CPFF arrangement has been greatly curtailed within some sectors, e.g. defence.

TIME AND MATERIALS

Characteristics:

1. Provides for acquiring supplies or services on the basis of direct labour hours at specified fixed hourly rates that include wages, overhead, general and administrative expenses, and profit; and materials at cost, including, if appropriate, material handling costs as part of material costs.

2. As a variant, may entail only Labour-Hours when either no material is involved, or material is not supplied by contractor. Other features of T&M contract apply.

3. Requires a price ceiling which contractor may not exceed except at own risk. contractor must document contract file and substantiate any change to price ceiling and to the extent of such change.

Application:

1. When nature of work is known in advance, but not the extent, or duration of the work.

2. When it is not possible at outset to anticipate costs with any degree of confidence.

3. Procurement of engineering and design services; manufacture of production and special machine tools; repair, maintenance or overhaul work; emergency situation work.

Advantages:

Can fulfill a special situation need that no other type contract can suitable serve.

Disadvantages:

1. Requires appropriate surveillance by client during performance to preclude inefficiency or waste by contractor.

2. Danger of contractor running up time to increase profit.

3. Expensive to administer.

4. Contractor must have adequate accounting system.

5. No positive profit incentive to contractor to control costs or to manage labour force efficiently.

Limitations:

1. Contract must include a ceiling price that the contractor exceeds at its own risk.

Remarks:

Rarely used for R&D efforts; however, sometimes used for engineering support services.

Website references from page 150:

Website references from page 151:

Website reference from page 153:

  • to see an example memorandum of understanding used as a statement of goodwill between the University of Alberta and other organisations wishing to form a partnership to generate mutually beneficial activities.
    Click here to view the website


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