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Procurement Contract Types

 Risk and Contract Type

The exam may ask questions that connect risk with the different types of contracts. The diagram below shows the amount of risk the buyer has with each contract type. Use it to better understand the different contract types, and also to answer questions such as:

Who has the risk in a cost reimbursable contract, the buyer or seller?

Answer Buyer. If the costs increase, the buyer pays the added costs.

Who has the cost risk in a fixed price contract, the buyer or seller?

Answer Seller! If costs increase, the seller pays the costs and makes less profit.

Incentives Allows an incentive (or bonus) on top of the agreed upon price for exceeding time or cost as specified in the contract. An incentive helps bring the seller’s objectives in line with those of the buyer. With an incentive, both buyer and seller work toward the same objective, for instance, completing the project on time.
You should have some experience calculating the revised fee and total costs associated with this type of contract (see the next exercise). Such questions occasionally appear on the exam.

Exercise In this cost reimbursable contract, the cost is estimated at $210,000 and the fee at $25,000. If the seller beats that cost they will share the savings; 80 percent to the buyer and 20 percent to the seller. If the actual costs come in at $200,000, what is the final fee and final price?

Types of Contract Statements of Work

Based on the project scope statement, the contract statement of work describes what work is to be completed under the contract. It must be as clear, complete and concise as possible, and describe all the work and activities the seller is required to complete.

Let’s say that again, you read it too fast! The contract statement of work must be as clear, complete and concise as possible and describe all the work and activities the seller is required to complete. Yes, all the work. This should include all meetings, all reports, all communications. If not included, the cost of adding them later can be more than adding them now.

This should also lead you to think of the amount of work required to create a complete contract statement of work. Remember that a contract is a document used to manage a contracted activity. It does not sit in a drawer. Therefore, both parties to the contract should always be asking, “What does the contract say?” Contract problems are not easy to resolve. The trick is to prevent the problems. Having a complete contract statement of work is important.

What does the word “complete” mean? It depends on what you are buying. If you are buying expertise (such as software design or legal services), your contract statement of work (in addition to meetings, reports and communications required) will just include your functional and/or performance requirements.

If you are buying the construction of a building, your requirements will be extremely specific, outlining things like the type of wood to be used, the process that must be followed and even a work schedule. If you are hiring staff that you will direct (a programmer to be added to the team), your contract statement of work will likely contain more details of what you want.

The contract statement of work may be revised during the procurement process, but should become finalized (excluding changes) by the time the contract is signed. There are many types of contract statements of work. Your choice should depend on the nature of the work and the type of industry.

  • Performance Conveys what the final product should be able to accomplish, rather than how it should be built or what its design characteristics should be (e.g., “I want a car that will go zero to 120 kilometers per hour in 4.2 seconds.”)
  • Functional Conveys the end purpose or result, rather than specific procedures, etc.  It is to be used in the performance of the work and may also include a statement of the minimum essential characteristics of the product (e.g., “I want a car with 23 cup holders.” [OK, why can’t I try to be funny?])
  • Design Conveys precisely what work is to be done (e.g., “Build it exactly as shown on these drawings.”)

Performance and functional contract statements of work are commonly used for information systems, information technology, high-tech, research and development and projects that have never been done before. Design is most commonly used in construction, equipment purchasing and other types of projects.

Components of a contract statement of work can include drawings, specifications, technical and descriptive wording, etc. No matter what it contains, you should realize that the contract statement of work becomes part of the contract.

Exercise Complete the following to describe how detailed the contract statement of work must be for each type of contract.

Answer

For a CR
Contract?
In this case, the contract statement of work describes only the performance or requirements because we are buying the expertise of “how to do the work.” We may not be able to say exactly what to do or when.
For a T&M
Contract?
The contract statement of work can be any of the choices (performance, functional or design), but it will be brief, describing limited performance, functional, or design requirements.
For a FP
Contract?
The contract statement of work must be extraordinarily complete because we are buying “do it,” not “how to do it.” In order for the seller to fix the price they need to know, in advance, ALL the work they are required to do.

Be careful, this is a general approach. There are many reasons to handle contracts differently. However, using an inappropriate contract form can result in increased risk, conflict and project failure.

Procurement Management Plan

Like all management plans, the procurement management plan will describe how the procurement process will be planned, managed and executed. Think about how different this might be from your real world and get your mind around the concept of management plans. They have been in almost every lesson. Do you understand them now?

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