If you’re studying for the PMP exam, you may have noticed that much of the study guides talk about contracts. Before becoming a PMP, you might expected contracts to be mostly in the realm of stakeholders, but there are a number of contracts PMPs need to acquaint themselves with. After all, as a PMP, you’ll work closely with stakeholders and sellers. You’ll be expected to have an understanding of contracts and what sets each contract apart from the rest not just for your PMP exam, but in your work as a PMP.
The first thing to understand is that not all contracts are the same. In your time as a PMP, you’ll encounter many different types of contracts. The big ones can be divided into fixed price, cost reimbursable, and time and material. But even within those three categories, there are several different types of contracts with which to familiarize yourself.
A fixed price contract is a contract that agrees on a specific price for the whole of the product or service. This is the best kind of contract for experienced sellers who are likely to have a regular relationship with the contractee. It’s set in stone for the most part: for exactly a certain rate, you get exactly a certain product. However, some fixed price contracts allow for a bit of wiggle room.
- Firm fixed price (FFP) – A graphic artist offers to make a logo for a non-profit charity for the cost of $200. Whether the book includes pictures, formatting, or rounds of edits, the price will remain exactly the same. This is the most straightforward fixed rate contract. The seller offers a service and the buyer offers a particular price, and that’s exactly what each party receives. No more, no less.
- Fixed price incentive fee (FPIF) – A graphic artist offers to make a logo for a non-profit charity for the cost of $200, but if they finish the logo over a week before deadline, the organization offers to add $50. FPIFs benefit both parties of the contract, as the organization can reveal the mural sooner and the artist can make a higher profit.
- Fixed price with economic price adjustment (FP-EPA) – A graphic artist offers to make a logo for a non-profit charity for the cost of $200, but raises the cost to $250 due to inflation or the rising cost of their graphic design software. This is allowed under a FP-EPA, because the artist had no way of controlling inflation.
In most fixed price contracts, the vendor is confident that they can finish the work and in a set amount of time. Similarly, the buyer knows for certain what they want. But business is not always so cut and dry as that. An organization might hire a graphic designer to make promotional images for a new ad campaign — but they haven’t quite agreed amongst themselves what demographic they want to reach or how much different promotional imagery they need. Because the scope for this job is a little more changeable, a cost reimbursable contract may be in the best interest of the parties.
- Cost plus fixed fee (CPFF) – A graphic artist bills the charity non-profit for all of their time and other project related expenses, as well as creating a fixed fee (usually a percentage of the cost of the work) to be paid in addition upon completion. This way if the scope changes, the artist can be assured that they’ll make at least so much.
- Cost plus incentive fee (CPIF) – Let’s say the ad campaign is designed to garner interest in the charity non-profit from a younger audience in a way that’s never been tried before. Because there’s a chance the campaign could fail, there’s risk on all sides. The organization who hires the graphic artist might then add an incentive fee in the event that the artist finishes the promotional material a month early.
- Cost plus award fee (CPAF) – This is similar to CPIF except that the award fee is at the buyer’s discretion. A graphic artist agrees to work on an ad campaign for a non-profit charity, who lays out in the contract exactly what they expect. At certain stages of the project, the organization judges the artist’s performance to determine if an award fee will be given at the end of the project.
Time & Material
Both vendors and buyers alike sometimes find T&M contracts to be the perfect compromise. They’re simple and flexible: a graphic artist agrees to create a logo or an ad campaign, and the buyer pays them a certain rate for their time and materials. T&M contracts can be made to look like cost-reimbursable contracts or fixed fee contracts. In the latter case, the buyer need only stipulate a certain limit in the contract: the work must cost no more than $2,000, for instance.
For the PMP exam, you will be expected to have an understanding of each of these PMP contracts differs and how each one will apply in business settings. Which contracts provide the most benefit to which party under what circumstance?
Christine is an assistant for EdWel Programs, a leading provider for PMP Exam Prep and risk management training since 2002.