Let’s say your company wants to redesign your board room. Chances are, your business doesn’t have an in-house interior design or demolition team. You are probably looking to outsource this work to another company or individual.
Your team has specific chairs they want to include, a material they prefer for the board table and they also want a new projector. In addition, you have allocated a specific budget for the whole redesign, including the materials, and a hard deadline you need it finished by.
These are a lot of areas to touch on. Cost and timeliness need to be ensured. This is where procurement contracts come into play. Procurement and contract management go hand-in-hand when ensuring that any outsourced service or product you commit to gives you the results you want, quality-wise and financially.
In this article, we will break down procurement contracts and what you need to know about them.
What is contract procurement exactly?
Wikipedia defines procurement as “the acquisition of goods, services or works from an external source. It is favourable that the goods, services, or works are appropriate and that they are procured at the best possible cost to meet the needs of the purchaser in terms of quality and quantity, time, and location.”
Essentially, it is an agreement between a buyer and seller where the former exchange’s money for a good or service from the latter.
The procurement contract is the written documentation of this agreement that details things like payment list, payment delivery, deadlines, conditions, and other obligations. The contract makes the transaction process as clear as possible.
Types of procurement contracts
There is a multitude of ways procurement contracts are structured in regards to how payment is determined and given.
Firm Fixed-Price Contract (FFP) or lump-sum
Firm fixed-price procurement contracts are quite simple: the contract sets out an agreed-upon amount of money and deadline. If there is any increase in cost (such as damages to the material, hiring more personnel), the seller is responsible for covering those costs. Many businesses prefer firm, fixed-price contracts because the prices usually do not change unless the scope of the work changes. Ergo, there is less unpredictability.
Within fixed-price contracts, there are also Fixed-Price Incentive Fee Contracts (FPIF) and Fixed-Price with Economic Price Adjustment Contracts (FP-EPA).
Fixed-Price Incentive Fee Contracts are the same as your regular fixed-price contract where the price is predetermined, but the seller might receive bonus payment (hence, the incentive) if the buyer sees them performing well. There would be certain incentives set out in the contract with a specific amount of bonus payment attached to it. This incentive can be things like getting things done on time (or early) or performing a certain task above expectations.
Fixed-Price with Economic Price Adjustment Contracts (FP-EPA) are contracts that usually span over a long period of time where the pricing would be adjusted with the changing economic landscape. This type of contract ensures the seller is receiving the appropriate amount by factoring in inflation. For example, the payment may increase by 2% in accordance with your country’s Consumer Price Index.
Another type of contract is the Cost Reimbursable Contract
With Cost Reimbursable Contracts, the seller is reimbursed for the work they completed and given a bonus fee that equals their profits. This type of contract is mainly used when the scope of the work may be unclear at the beginning of the project, or if there are more risks involved. This usually turns out to be more costly for the buyer as they are committing to pay for all the costs of the completed work.
Whereas fixed-price contracts give more certainty for both the buyer and seller, cost-reimbursable contracts are totalled at the end of the project.
Within Cost-Reimbursable contracts, there are a few variations:
Cost Plus Fixed Fee Contract (CPFF)
In cost plus fixed fee contracts, the buyer pays for all the costs of the project and also a fixed fee on top of that. The fee is not dependent on performance, hence it is not an incentive.
Cost Plus Percentage of Cost (CPPC)
In cost plus a percentage of cost contracts, the buyer pays for all the costs plus a percentage of the costs. For example, the contract may state that the buyer will pay the costs plus 15 per cent of the costs on top.
Both these types of contracts pay more to the seller and might be used in high-risk or low-interest projects.