fixed price 520

The service provider may setup payment terms with the client at periodic intervals or when milestones or intermediate deliveries are achieved. In this case, a fixed percentage of the total cost is paid at each interval through the course of the entire project life cycle.

In this model, the service provider contractor must take extra effort to ensure that they have covered their costs and could make a comfortable profit on the entire transaction. As the service provider assumes all the risks, such as increasing costs, covenants for nonperformance, or other issues, they usually builds in the extra cost of risk management into the contract price.

Fixed price contracts are most suitable for long-term projects and those that have a high value to the outsourcing organization.

2.1 Fixed-Price contract with Economic Price Adjustment (FP EPA)

In this type of fixed-price contract, provisions exist to accommodate adjustments to the stated contract price necessitated by contingencies triggered due to upward or downward movements of some macro-economic indicators. These economic price adjustments are of three types:
1. Adjustments based on established prices
2. Adjustments based on actual costs of labor or material
3. Adjustments based on cost indices of labor or material

2.1.1 Adjustments based on established prices: Price adjustments are based on price divergence i.e. upward or downward price movement of specific items or contract items
2.1.2 Adjustments based on actual costs of labor or material: Price adjustments are based on divergence i.e. upward or downward movement of labor or material costs that arise during project execution
2.1.3 Adjustments based on cost indexes of labor or material: Price adjustments are based on divergence i.e. upward or downward movements in labor or material cost indices identified in the contract

A fixed-price with economic price adjustment contract is used when:
1. Serious doubts regarding market stability or poor labor conditions exist for extended time period during which the project is implemented
2. Contingencies could be clearly identified and covered separately in the contract price

2.2 Fixed price plus Incentive (FPI)

Fixed price plus incentive contracts are another popular form of fixed price contract. The main difference in this model is that the outsourcing organization i.e. the buyer of outsourced products or services includes an incentive or bonus for achieving some metrics important and relevant for the outsourcing organization. These metrics may include performance criteria, such as early completion, delivery that exceeds the scope specified in the contract, etc. Hence, it is mandatory that these metrics are clearly articulated in the contract so both parties understand the terms and conditions.
An FPU contract contains at least the following basic elements, which are negotiated at the outset:
1. Target cost
2. Target profit
3. Price ceiling
4. Profit Adjustment Formula (PAF)

Upon delivery, final costs and contract price are re-negotiated and using the profit adjustment formula. If the total project costs are less than the expected target costs, then the overall profit is greater than the expected target profit. On the other hand, when the total project cost exceeds the expected target cost, the final profit is less than the expected target profit, or may even result in a net loss. If the total project cost exceeds the price ceiling, the service provider absorbs the net difference as loss.

These contract types are most desirable in cases where it is pertinent for the service provider to assume some cost responsibility. It is also suitable when a target cost, target profit, and Profit Adjustment Formula could be negotiated at the outset.

2.3 FPI Successive Target (FPI ST)

An FPI ST model is similar to an FPI contract in most aspects. However, the only difference between these two models is that the FPI ST contract allows one or more adjustments to the target cost and profit values during the course of project execution. Such a contract is used when FPI contract cannot be used because realistic target costs and profits cannot be negotiated during the project kick-off.

An FPI ST contract adjustment could be done upfront or retroactively, giving rise to two further costing models, namely:

1. An FPI ST model with forward price re-determination consists of two components:
• An initial fixed price for a certain initial duration during project start
• This period is followed by a period of prospective price adjustments or re-determination at time intervals identified in the contract

An FPI ST contract is used in situations where it is possible to procure commodity products or services at a fixed price for an initial foreseeable period, but price movements during subsequent periods make it impossible to fix prices upfront.

2. An FPI ST model with backward price redetermination contract consists of two components:
• An initial fixed price for a certain initial duration during project start
• Backward price re-determination within the ceiling after project completion

Price revision, in this model, also takes management effectiveness, innovation and ingenuity into consideration after the project is completed. This contract type is suitable for situations where a fixed price contract cannot be established because of contract size and short project duration that makes the use of any other contract type impractical.

 

> Read here soon in the third part about Cost reimbursable model –

> Missed the first part? No problem – read it here

 

About the author: Mithun Sridharan is a General Manager at BlueOS LLC, an advisory based in Germany, where he is res pons ible for driving the s trategic s ales initiatives and managing cus tomer engagements in Digital transformation & Analytics. Prior to BlueOS, he was an Account Manager with Oracle Corporation, where he drove strategic partnerships with key enterprise accounts and major Independent Software Vendors in Europe and the USA. He brings with him over a decade of International experience in Management Consulting, Business development, Strategic Marketing & Product Management. He holds an MBA from ESMT Berlin and a Master of Science (MSc) from Christian Albrechts University of Kiel. He is a Harvard Manage Mentor Leadership Plus graduate, an SAP certified Business Intelligence Professional, a Project Management Professional (PMP) and a Certifed Information Systems Auditor (CISA). He also served as the Communication Chair for the German Outsourcing Association in 2013 and is based in Heidelberg, Germany.

Contact: Mobile: +49 176 9792 4897 eMail: mithun@gmx.net
LinkedIn: http://de.linkedin.com/in/mithun Twitter: http://twitter.com/jixtacom

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