Key Takeaways
- Fixed-Price contracts place maximum risk on the seller; the buyer knows the total cost upfront if scope is well-defined
- Cost-Reimbursable contracts place maximum risk on the buyer; seller is reimbursed for all allowable costs plus a fee
- FPIF (Fixed Price Incentive Fee) contracts include a ceiling price; costs above the ceiling are 100% seller responsibility
- Point of Total Assumption (PTA) is the cost point where the seller bears all additional costs in an FPIF contract
- Time & Materials (T&M) contracts fix unit rates but leave quantity open, creating a hybrid of fixed and cost-reimbursable characteristics
Procurement & Contracts
Procurement management involves acquiring products, services, or results from outside the project team. Understanding contract types and their risk allocation is essential for PMP exam success.
Procurement Management Processes
| Process | Purpose | Key Output |
|---|---|---|
| Plan Procurement Management | Determine what to procure and approach | Procurement Management Plan |
| Conduct Procurements | Obtain seller responses and select sellers | Agreements (Contracts) |
| Control Procurements | Manage relationships and monitor performance | Closed Procurements |
Make-or-Buy Analysis
Before procurement, organizations decide whether to produce internally or buy externally:
Factors Favoring Make (Insource)
| Factor | Reason |
|---|---|
| Core competency | Strategic capability to maintain |
| Cost advantage | Cheaper to produce internally |
| Control | Need tight control over quality or process |
| Capacity | Available internal resources |
| Intellectual property | Protect proprietary knowledge |
Factors Favoring Buy (Outsource)
| Factor | Reason |
|---|---|
| Specialized expertise | Skills not available internally |
| Cost advantage | Seller has economies of scale |
| Flexibility | Adjust resources as needed |
| Risk transfer | Shift risk to seller |
| Focus | Concentrate on core business |
Contract Types Overview
Contracts are categorized based on how they allocate risk between buyer and seller:
Risk Spectrum
| Contract Type | Buyer Risk | Seller Risk |
|---|---|---|
| Cost Plus (CPFF, CPIF) | Highest | Lowest |
| Time & Materials (T&M) | Moderate | Moderate |
| Fixed Price (FFP, FPIF) | Lowest | Highest |
Fixed-Price Contracts
Fixed-Price contracts establish a firm price for a defined scope of work. The seller bears most of the cost risk.
Firm Fixed Price (FFP)
| Aspect | Description |
|---|---|
| Price | Set at contract signing, does not change |
| Risk | Seller bears all cost risk |
| Best Use | Well-defined scope, low uncertainty |
| Seller Incentive | Complete efficiently to maximize profit |
Example: Contract for $100,000 to build a website with defined specifications.
- If seller's costs are $80,000 → Seller profit = $20,000
- If seller's costs are $120,000 → Seller loss = $20,000
Fixed Price Incentive Fee (FPIF)
| Element | Description |
|---|---|
| Target Cost | Expected cost to complete work |
| Target Profit | Expected seller profit |
| Target Price | Target Cost + Target Profit |
| Ceiling Price | Maximum buyer will pay |
| Share Ratio | How over/under runs are split (e.g., 70/30) |
FPIF Example:
- Target Cost: $100,000
- Target Profit: $15,000
- Target Price: $115,000
- Ceiling Price: $125,000
- Share Ratio: 70% Buyer / 30% Seller
If Actual Cost = $90,000 (Under Target):
- Savings = $100,000 - $90,000 = $10,000
- Seller Share = 30% x $10,000 = $3,000
- Final Price = $90,000 + $15,000 + $3,000 = $108,000
If Actual Cost = $110,000 (Over Target):
- Overrun = $110,000 - $100,000 = $10,000
- Seller Share = 30% x $10,000 = $3,000
- Final Price = $110,000 + $15,000 - $3,000 = $122,000
Point of Total Assumption (PTA)
The PTA is the cost point in an FPIF contract where the seller bears ALL additional costs:
PTA = [(Ceiling Price - Target Price) / Buyer Share Ratio] + Target Cost
Example:
- Ceiling Price: $125,000
- Target Price: $115,000
- Target Cost: $100,000
- Buyer Share: 70%
PTA = [($125,000 - $115,000) / 0.70] + $100,000 = $14,286 + $100,000 = $114,286
Above $114,286 in costs, the seller pays 100% of overruns.
Fixed Price with Economic Price Adjustment (FP-EPA)
| Aspect | Description |
|---|---|
| Use | Long-term contracts with inflation risk |
| Adjustment | Price adjusted based on economic indices |
| Protection | Seller protected from uncontrollable cost increases |
Cost-Reimbursable Contracts
Cost-Reimbursable contracts reimburse the seller for allowable costs plus a fee. The buyer bears most of the cost risk.
Cost Plus Fixed Fee (CPFF)
| Aspect | Description |
|---|---|
| Reimbursement | All allowable costs |
| Fee | Fixed amount (does not change with costs) |
| Best Use | Undefined scope, high uncertainty |
| Seller Incentive | Limited (fee is fixed) |
Example: Reimbursable costs plus $10,000 fixed fee.
- If costs = $100,000 → Buyer pays $110,000
- If costs = $150,000 → Buyer pays $160,000
Cost Plus Incentive Fee (CPIF)
| Element | Description |
|---|---|
| Cost Reimbursement | All allowable costs |
| Base Fee | Minimum fee seller receives |
| Incentive Fee | Additional fee based on performance |
| Share Ratio | How savings/overruns affect fee |
CPIF Example:
- Target Cost: $200,000
- Base Fee: $20,000
- Max Fee: $30,000
- Share Ratio: 80/20 (Buyer/Seller)
If Actual Cost = $180,000:
- Savings = $200,000 - $180,000 = $20,000
- Seller Incentive = 20% x $20,000 = $4,000
- Total Fee = $20,000 + $4,000 = $24,000
- Buyer Pays = $180,000 + $24,000 = $204,000
Cost Plus Award Fee (CPAF)
| Aspect | Description |
|---|---|
| Reimbursement | All allowable costs |
| Base Fee | Guaranteed minimum fee |
| Award Fee | Subjective evaluation by buyer |
| Criteria | Broad performance criteria |
Time and Materials (T&M) Contracts
T&M contracts are a hybrid of fixed-price and cost-reimbursable:
| Element | Fixed or Variable |
|---|---|
| Unit Rates | Fixed (e.g., $100/hour) |
| Quantity | Variable (open-ended) |
| Materials | Cost plus markup |
T&M Characteristics
| Aspect | Description |
|---|---|
| Best Use | Staff augmentation, undefined quantity of work |
| Risk | Shared; buyer controls quality, seller controls quantity |
| Duration | Often include "not to exceed" clauses |
| Management | Requires close oversight by buyer |
Contract Selection Criteria
Choosing the Right Contract Type
| Situation | Recommended Contract |
|---|---|
| Well-defined scope, low risk | FFP |
| Defined scope, incentive needed | FPIF |
| Undefined scope, R&D | CPFF or CPIF |
| Need quick start, scope evolving | T&M |
| Long-term, inflation concern | FP-EPA |
Procurement Documents
Key Documents
| Document | Purpose |
|---|---|
| RFI (Request for Information) | Gather information about seller capabilities |
| RFQ (Request for Quote) | Request pricing when scope is clear |
| RFP (Request for Proposal) | Request detailed proposals for complex work |
| IFB (Invitation for Bid) | Formal competitive bidding (government) |
Source Selection Criteria
| Criterion | Considerations |
|---|---|
| Technical Capability | Can seller perform the work? |
| Price/Cost | Total cost of ownership |
| Past Performance | Track record on similar work |
| Management Approach | How seller plans to manage work |
| Financial Stability | Will seller remain in business? |
Key Takeaways
- Fixed-Price contracts place maximum risk on seller; use when scope is well-defined
- Cost-Reimbursable contracts place maximum risk on buyer; use when scope is uncertain
- T&M contracts fix unit rates but leave quantity open; use for staff augmentation
- PTA is the point where seller bears 100% of additional costs in FPIF contracts
- FPIF includes ceiling price that caps buyer's maximum payment
- Select contract type based on scope clarity, risk tolerance, and desired incentives
In a Firm Fixed Price (FFP) contract, who bears the cost risk if actual costs exceed the contract price?
An FPIF contract has: Target Cost = $100,000, Target Profit = $10,000, Ceiling Price = $120,000, Share Ratio = 80/20. Calculate the Point of Total Assumption (PTA).
Which contract type is MOST appropriate when the scope of work is not well-defined and significant research and development is required?