Contract Types for PMP Exam

3 Different Contract Types for PMP Exam

contract types for pmp

Have you studied and understood Contract Types for PMP Exam? You can expect a few questions on Contract Types for PMP Exam. The questions on Contract Types for PMP Exam are relatively easy to answer. You should have a compete understanding of the Contract Types.

PMBOK® Guide describes 3 different Contract Types in Procurement Management Knowledge Area. A few years ago I had written an article on Contract Types. The old article was written to explain 3 different Contract Types using a small example. The article has been very well appreciated by the readers. It is extremely good for understanding different Contract Types. But recently some of my students suggested to write an article on Contract Types for PMP Exam. They said (and I agree with them) that a more formal explanation of Contract Types for PMP Exam would be useful. The Exam questions can be better answered after having a formal understanding of the topic.

So let me pen my thought in a different manner.

The old article explained Contract Types with the help of a small example. This article has a formal treatise and a deeper explanation of Contract Types for PMP Exam. I think you should read both the articles to get a complete understanding of Contract Types. Together, these articles will help you in solving PMP Exam questions. You should also read another article that discusses Formulas for different Contract Types.

Let us formally understand 3 different Contract Types for PMP Exam by looking at simple but formal explanations.

  • Fixed Price (FP) Contracts
  • Cost Reimbursable (CR) Contracts – This is also called Cost Plus (CP) Contracts
  • Time and Material (T&M) Contracts

Fixed Price Contracts

In Fixed Price Contracts a Fixed Amount of consideration is required to be paid by the Buyer to the Seller for the Specified Work. The Specified Work could be Deliverables, a Service or a Result or anything else as defined in the Contract. This Contract Type is also called Lump-sum Contract.

Salient Features

General Buyer Seller
Scope of Work is well defined. Buyer has a legal obligation to provide acceptance against the Scope of Work. Seller has a legal obligation to complete the Scope of Work.
Change in Scope of Work is usually allowed. Buyer usually has to pay extra (over & above the Fixed Price) for the agreed upon change. Seller has to complete extra work as defined in the agreed upon change.
Price is Fixed.
Buyer has a legal obligation to pay agreed upon Fixed Price to the Seller. Seller can legally claim full payment after completing the work.
Cost Risk is in favor of the Buyer. Buyer has minimal Cost Risk. Seller has a Risk of losing money. Conversely the Seller can maximize her/his profits.

 

3 categories Fixed Price Contract Type

Cost Reimbursable Contracts

In Cost Reimbursable Contracts, the Buyer is required to reimburse Actual Cost of Work and an Agreed Upon Fee to the Seller for the Specified Work. The Specified Work is usually loosely defined in the Contract. This Contract Type is also called Cost Plus Contract.

Salient Features

General Buyer Seller
Scope of Work is either undefined or loosely defined. Buyer provides acceptance when work is satisfactorily completed. Seller has a legal obligation to complete the Work as defined by the Buyer.
Change in Scope of Work is usually allowed. Buyer has a legal obligation to pay for the extra cost arising out of changes. Seller can legally claim extra cost arising out of changes.
Price is not fixed.
Buyer has a legal obligation to reimburse the Actual Cost incurred by the Seller. Seller can legally claim Reimbursements after delivering the best effort.
Contract Fee is well defined. Buyer has a legal obligation to pay the agreed upon Fee to the Seller. Seller can legally claim Fee after delivering the best effort.
Cost Risk is in favor of the Seller. Buyer has maximum Cost Risk.
Seller has almost no Risk of losing money.
When is this Contract Type Required? Buyer is unable to define Scope of Work due to lack of information or for some other reason. Seller cannot estimate Cost due to absence of well defined Scope of Work.

 

4 categories Cost Plus Contract Type

  • Cost Plus Fixed Fee (CPFF) Contracts
  • Cost Plus Percentage Fee (CPPF) Contracts
  • Cost Plus Incentive Fee (CPIF) Contracts
  • Cost Plus Award Fee (CPAF) Contracts

Time & Material Contracts

In Time & Material Contracts, a Fixed Rate is required to be paid by the Buyer to the Seller for the Specified Unit. The Specified Unit could be Labor Duration Unit or a Material Unit as mutually decided between the Buyer and the Seller. The Quantity of Labor or Material is not specified at the beginning. The Quantity is take as per the actual consumption.

It is a hybrid of the FP and CP Contract Type. It resembles FP Contract Type as there is a Fixed Rate. It resembles CP Contract Type as Quantity is not specified. It is also called Rate Contract or Unit Price Contract.

Salient Features

General Buyer Seller
Scope of Work is broadly defined. Quantity is undefined.
Buyer provides acceptance when work is satisfactorily completed. Seller has a legal obligation to complete the Work as defined by the Buyer.
Change in Scope of Work is usually allowed. Buyer has a legal obligation to pay for the extra units arising out of changes. Seller can legally claim payment for extra units arising out of changes.
Rate is fixed.
Buyer has a legal obligation to make payment for each unit delivered by the Seller at the predefined rate. Seller can legally claim payments at predefined rate after delivering the units.
Buyer and Seller share the Cost Risk. Buyer has to pay predefined rate even if Seller’s Costs escalate. Seller can claim payment for each unit delivered  even if they are not useful for the Buyer.
When is this Contract Type Required? Buyer is unable to estimate the quantity due to uncertainty of requirements or for some other reason. Seller cannot estimate Cost due to absence of well defined Scope of Work.

 

You can refer to Max Wideman Glossary to read some standard definitions on Contract Types.

Image courtesy of fantasista at FreeDigitalPhotos.net

Praveen Malik, PMP is a certified Project Management Professional (PMP®) with a rich 20+ years of experience. He is a leading Project Management Instructor and Consultant. He regularly conducts Project Management workshops in India & abroad.

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