Download Contract Pricing Options (graded) Assume that you have made the

Contract Pricing Options (graded)
Assume that you have made the final payment on a one-acre residential lot that you purchased
years ago to build your retirement home. You are now ready to build your dream home. This will
be your ongoing project for the next couple of years. Which contract structure (fixed price, unit
price, reimbursable) do you think that you would use to proceed with your project? Explain your
choice.
For building a house, there are different scenarios.
1. Fixed price: This is probably the easiest choice. This house = this cost
2. Unit price: This is is good for cost savings on nicer homes, especially if you have any home
building skills yourself or if you have connections with material stores, appliance suppliers, etc. You
can have the builder build a bigger home but not do a lot of the upgrades or landscaping, as you
could do those yourself. For example, the woodwork or decking,
3. Reimbursable: This is risky. If the builder agrees to upcharge 10% on the supplies plus time, you
don't know where he is buying the materials from and he may not be getting the best deal.
In fixed price contract, the engineer and/or contractor agrees to do a described and specified project
for a fixed price. A Fixed Fee is suitable if the scope and schedule of the project are sufficiently
defined to estimate project costs. Unit Price Contract is based on estimated quantities of items
included in the project and their unit prices. The final price of the project is dependent on the
quantities needed to carry out the work. In general this contract is only suitable for construction and
supplier projects where the different types of items, but not their numbers, can be accurately
identified in the contract documents. Reimbursable Contract provides the initially negotiated fee to
be adjusted later by a formula based on the relationship of total allowable costs to total target costs.
This type of contract specifies a target cost, a target fee, minimum and maximum fees, and a fee
adjustment formula. After project performance, the fee payable to the contractor is determined in
accordance with the formula. With reimbursable contracts, contractors are paid for the work
accomplished. Reimbursable contracts are effective when the scope of work is ill-defined. Under
reimbursable contracts, uncertainty in project scope is born by the agency administering the
contract. Reimbursable contracts are generally the most expensive to administer and offer relatively
less incentive for contractors to be cost-efficient. On the other hand, cost-reimbursable contracts
offer significant flexibility for responding to conditions that are unexpected.
In this case, since I am planning to build a dream home, I might change the layout and basic
architecture of the house as the project execution takes place. Since, I will be monitoring my home
project on daily/weekly basis; it makes more sense for me to go for reimbursable project. I also want
to build my home project at my own pace giving enough attention to minute details and so I will be
personally supervising each and every aspect of this project. So, I would like to keep this project as
much flexible as possible. For this reason, I think that keeping the contract structure "Reimbursable"
would be beneficial for me.
What are the four basic contract pricing options?
Basic Contract pricing options are:
Fixed Price Contract
Unit Price Contract
Cost Plus Contract
Reimbursement Contract
Percentage of Construction Fee Contracts
The four basic contract pricing options are:
Fixed Price – this is where the goods or services have a fixed price
Unit Price - this pricing is priced per unit and is adequately defined
Cost reimbursable - this is paid per cost and reimbursed accordingly and is not well defined.
Time and materials - this is paid for as labor and materials similar to a cost plus and unit plus
contract respectively.
I would say that the fixed rate contract would be the best structure. Once you have your home
spec'd out and the bids in place, you can go to the bank and get a construction loan which is basically
a fixed mortgage but the funds are distributed to vendors as work is completed. For example, if the
total loan amount was $200,000 this money would be put in escrow. When the foundation was
completed, you would pay the contractor's invoice out of the $200,000. This is how we did it
because we had individual contractors. If you have one vendor who does the subcontracting then
you would just pay the one vendor the deliverable amounts as part of the project are finished.
What are five options of cost reimbursable contracts?
The five are as follows...
1. Cost Plus Percentage Fee - Sellers actual cost plus percent of total project cost.
2. Cost plus Fixed Fee - Sellers cost plus fixed fee based project cost estimate
3. Cost Plus Incentive Fee - Sellers cost plus incentive fee if contractor meets bonus criteria
4. Cost plus Sharing Agreement 5. Cost Plus Guaranteed Maximum - Same as above
There are five types of Cost Reimbursable contracts. They are:
Cost Contracts
Cost-Sharing Contracts
Cost-Plus-Incentive-Fee Contracts
Cost-Plus-Award-Fee Contracts
Cost-Plus-Fixed-Fee Contracts.
Cost-reimbursement types of contracts provide for payment of allowable incurred costs, to the
extent prescribed in the contract. These contracts establish an estimate of total cost for the purpose
of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own
risk) without the approval of the contracting officer.
References:
http://www.concompass.com/costreimbursable.htm
In what situation a company is best to use a unit price contract? In what situation, a company is
best to use cost-plus-percentage-fee contract?
A unit price contract is one in which the contractor bills the customer by the unit of work he has
done. Units could be hourly rate, square footage, or any physical quantity of anything agreed to.
A company that is looking for the cheapest person to do an hourly job could use the unit price to
easily decide on whom the cheapest will be or the cheapest they will pay. Or, if a company wants a
large amount of anything removed in a certain amount of time that will be billed per unit they could
benefit from unit price contract because contractors tend to do the job faster to complete as many
units as possible for a greater pay. It allows the company to relate the cost of the project to tangible
and measurable results. However the quality of the work may not be so good.
Cost plus percentage fee reimburses for costs, and then adds a percentage of costs on top. This kind
of contract to me personally is totally advantageous to the contractor because he is double dipping
the contract. The more the contract cost, the more is his fee. It is almost impossible to keep the cost
of any contract down in this manner except in fixed situations.
A company may best use cost plus percentage fee contract if their only or main concern is about the
quality of the work being done or when the project involves a certain amount of strict specifications
or accuracy and they want it being done right to the tee.
When using the unit price contract, one situation that comes to mind is my company's situation
where in a bank setting we have to supply branches with supplies. Every month we do not know how
many supplies are needed because we cannot tell how many supplies are used. So the price contract
with our vendors is the ideal contract due to the way we can purchase supplies as needed and only
pay for what each branch needs thus we are not over paying or over ordering.
The situation where a cost-plus contract would work would be were a company would need a
marketing campaign for a new product and the outsourced company would be paid on the amount
of materials and labor used during the duration of the campaign. On top of that the outsourced
company would make a profit in the form of either a percentage of the actual costs or a flat fee at
the end of the project.
A company is best to use a unit price contract is when the probable quantity of units is known but
the total quantities are uncertain. A company is best to use cost-plus-percentage-fee contract when
the scope of the contract is not well defined.
What are the differences among a fixed price contract, a time and materials contract, and a
reimbursable contract in terms of how well defined a BPO contract needs to be relative to price,
scope and schedule prior to the commencement of any work/services?
The difference between fixed price, time and materials, and reimbursable contract with respect to
BPO is that with BPO the outsourcing vendor assumes responsibility for, and manages the contract
on an ongoing basis including all or part of a customer's business processes, along with the
applicable scope, performance requirements, and compensation schedules. Whereas with fixed
price, time and materials, and reimbursable, the full value of the contract is not known at the time
the contract is awarded. Also with fixed price the purchaser pays the seller a fixed total amount;
Time and material both parties agree to predetermined unit rates in advance; Reimbursable does
not rely on the price or scope of the contract.
Fixed price contracts, also known as a "Flat Price" contract, transfers all price risk and opportunity
from the buyer to the seller on the date of the trade. The price is fixed and if the estimated costs
were not correct, the seller will take a loss. For the fixed price contract, the scope and schedule
need to be well defined and fully understood by the seller to get an accurate price. If the buyer
requests any changes, the seller should not accept them without asking for additional funding
and/or a schedule extension. The seller must deliver the services/products that were offered before
he can quit the project.
Example for fixed price contract - you ask a fellow to come to your house to put up a 6-foot chain
link fence around 3 sides of the back yard, measuring a total of 450 feet. You agree on the price for
this work. He puts up the fence and you pay him the fixed fee (just make sure there are no changes
to the type of fence, the length of the area you will be fencing, etc.)
Time and materials can be a way of reimbursing jobs that aren't well defined. Most field service
contracts are time and material contracts. The incentive for making such a contract is for the
customer to lock in usually discounted labor and materials pricing. The incentive for the vendor is to
have a captive customer. The challenge with time and materials is that the customer not only has to
keep its eye on the deliverables, it also has to keep its eye on the vendor's costs.
Example for time and materials contract - A company hire a painter to paint the building at $30 an
hour. The company would buy the paint for the painter. The painter just need to come to the
company, punch the time card, and paint the building. The company will pay the service fee when
the job is done.
Time and materials and reimbursable puts the risk on the buyer. The seller can stop once the ceiling
is reached. Usually the contract requires a 75% or 85% letter to notify the buyer that the seller is
close to the ceiling. The letter will state whether the project can be completed within the remaining
ceiling. The scope needs to be understood by both parties to ensure the price and schedule is
achievable. However, the seller can stop once the ceiling is reached and the buyer will have to come
up with more money if all the product/ services were not delivered.
Example for reimbursable contract - you hire a carpenter to create new cabinets in your kitchen. You
know this guy is really good, and you want to be able to make changes as you go along. So the
carpenter says that he will charge you for all materials and supplies at cost, and then you pay him
$75 per hour for every hour he works. The risk: there is really no motivation on his part to work as
fast as he can, BUT you have the flexibility to make any changes to the scope of the work as you go
along.
Class, do you feel the length of the contract also has some influence on the contract type you
choose? Why or why not?
Varying time frames would definitely provide the need for different types of contracts; realistically
some contract type provides a different set of characteristics. Typically longer contract have much
more complicated project management /contract management aspects, while those involving
shorter time frames could be much more simple.
The length of the contract does have influence on the contract type. If you have a well-defined
scope, with a very long contract period, you can use a fixed fee contract. However, if you don't have
a well-defined scope which means your contract could end up with a very long contract period, then
you should probably use time and materials and reimbursable contracts that do not require welldefined scope of work and contract terms at the time of bidding.
What are the challenges for an owner in tracking a reimbursable contract?
The biggest challenge would be tracking labor for the projects and the materials used. You will need
to know who is doing what and how long it is taking in each project. Since you are paying for time,
the longer it takes to complete the more it will cost he buyer, the same will apply to the materials
purchased. You need to track if the correct amount is being purchased or is there too much material
on hand.
Some of the challenges in tracking reimbursable contract:
·
The cost of the contract are too uncertain and risky for the buyer
·
Seller is less motivated to keep the cost low
·
the buyer is able to change the scope easily
·
The contractor can legally stop the work when all the contract money is spent
Gives the seller an advantage by protecting their profits
The biggest challenge that the customer encountered is the validity of the expenses that are being
billed for reimbursement. Some of the contracts have allowed for reimbursement all expenses for
most staff members and that can range from breakfast at Burger King to dry cleaning. It makes you
wonder how much of them are really project or work related.
When does a contract manager prefer a fixed fee contract over a reimbursable contract (or vice
versa)?
Fixed fee contracts require greater detail to project scope and requirements. The budgeting is set so
there are no real risks in overspending. On the other hand, in the reimbursable type contracts, you
need to worry about both budget and controlling scope. The reimbursable contract is attractive
because it is flexible. When a project scope is creeping, you don’t need to re-write a new contract.
However, as a manager, you need to ensure you control the scope so that you are not paying for
requirements that do not add value to the project.
How many companies do you think go through outlining their business objectives, and then use
these to guide the selection of a contract structure, rather than letting financial objectives and risk
factors alone determine the decision?
A great company will thoroughly outline its business objectives and its business practices before
outsourcing. A good company realizes that, by outsourcing, it can often increase the number of jobs
it is hiring for domestically or locally. There was a great article in Business Week about when to
outsource, when not, and the pros and cons of doing so. The trick is to know what you're
outsourcing, why you're outsourcing it, and what you expect to gain from it. In many cases the
savings in general labor and other production costs are high but still not what you should do if the
hit to your customer service means lost or non-returning sales.
If your company decided to make you a manager for your division, but began outsourcing all the
personnel that work beneath you, which contract type would you recommend they implement?
Time and materials contract and reimbursable contract would be better in this situation. Time and
materials contract and reimbursable contract are the least defined and are set as a pay as you go
type of contract. In these, the client can make changes as the project develops. This leaves more
freedom for the client but can be a hassle for the vendor. The hassles the vendor could experience is
the maintaining the proper manpower on the job site that have the necessary skills to perform the
job on-hand. There are times when the vendor may have multiple jobs going on and have a specific
skilled individual at another job site. In order to adhere to the client's changes in job scope, the
vendor may have to pull that individual off of another job to suffice the client. This could turn the
vendor against the client especially if there are many changes.
What are the key contract issues? Pick one of them and elaborate on it.
Pricing is one of the key contract issues. All business endeavors are centered on making the most
profit for a product or service. Most of the time, contracts are awarded to the proposed lowest
bidder. This does not necessarily save money if the lowest bidder has problems and need additional
funds to complete a project or for fill the obligations of a contract.
Measuring of performance is another key contract issue. This is how the customer ensures that the
vendor is performing up to the contracted goals. Some of the key issues of measuring performance
are: response times, delivery requirements, document requirements, customer satisfaction,
performance improvement, cost control, etc.
The fixed fee contract requires that you have a well-defined scope of work and detailed out contract
terms prior to issuing the RFP, otherwise there is no basis for vendors/bidders to submit
bids/proposals. The benefit of having a well defined scope and contract terms becomes evident as
you are administering the contract. Typically, there are less stringent contract management
requirements (I said less stringent, I did not say that it avoids the need for good contract
management). Invoices are paid on a percent complete basis, and at the end of the day, the scope
clearly states what needs to be delivered for the vendor/bidder to receive his/her full compensation.
The time and materials and reimbursable contracts do not require scope of work and contract terms
at the time of bidding. In addition, much greater flexibility relative to the fixed-fee structure is
provided to the Owner should he/she want to adjust, revise, amend or create the scope of work as
the project matures. In this type of contract, you pay the vendor for the goods and services he/she
provides as they are provided. However, you as the Owner need to be abreast on what goods and
services he/she provides as they are provided, when, and how much of these were provided. You
also need to verify that the cost being invoiced is adequate and reasonable. A lot of contract
management oversight is required.