Cost plus incentive fee

With this structure, the buyer and the seller agree to cover the sellers costs, but beyond that, they will share any cost overruns and under runs according to an agreed upon formula. This might be used when two companies are not familiar with each other, they need to work together to complete the project, and neither is certain that the other has a strong focus on enabling the completion. Perhaps this would be used in the case of a network move, which accompanies a corporate relocation to a new office.

With some types of contracts the onus is on the buyer to ensure that the seller have complete and clear information, plus full access or anything else required to complete the project, whereas with other types the seller is taking the risks. Which type of contract is better for a PM who is managing the development of a service which will allow his company to provide their services electronically, dealing as a buyer with a supplier who is doing the actual service development? Which type for the seller in this project? Why?

With a firm fixed price contract the risk is on the seller to provide the buyer with the required services within the allocated price. The seller needs to cover his direct costs, his overhead and his profit margin within the amount. Of course, the seller should not agree to a price which would be less than his estimate of these costs, but he takes the risk that he can meet the buyers requirements within the agreed to price. In order to ensure that he is covered, the seller will build in some contingency along with his estimate of his costs. If he does not include enough, the loss is his. For very risky cases the buyer might have to agree to a very high price so that the seller can protect himself. However, if there is any competition at all, this will hold the prices as low as the sellers can manage within their risk tolerances.

For cost plus percentage contracts, the risk is completely with the buyer, as the seller is covered no matter how much work he does. But when there is significant risk, sellers may not agree to any other option.

For our electronic service project, the seller would love to have cost plus percentage, but would probably not bid this as there is likely to be a competitor who would bid something more favourable to the buyer. The buyer would prefer a fixed price, and could probably get this. But since the neither the buyer nor the seller would likely know up front the full scale of the project, the sellers would likely insist on some type of cost plus contract.

Cost plus fixed fee would work well in this case, because the seller is covered at least in terms of his costs, and the buyer at least limits his risk by fixing the overhead fee. However, if the buyer does not trust the sellers to agree to a fair fee for the overhead, he may not want to agree to this option. If even one seller offers the cost plus incentives option, the buyer would be attracted to it, because the seller shares in the risk. In fact, if the seller can come in under the anticipated cost level, the buyer benefits from both a lower base cost and a lower overhead fee to be paid. If the seller goes over, he does not receive the margin he wants. Thus the incentives are a strong motivation to the seller to contain the costs. They also motivate the buyer to cooperate in providing any required information and access, to help the supplier complete in less time, and with less effort.

Contract administration - managing the relationship with the dealer

The PMBOK® GUIDE describes the contract administration process as shown in Figure 4

Contract Administration

Figure 4

In this process the team ensures that the contractors performance meets contractual requirements, but also that the buyer meets his contractual requirements. To do this the team should build key millstones into the schedule at reasonable time periods and then manage these milestones. To ensure that the performance is as required, the team might need to inspect (products, installations, reports etc), test (software, networks, etc.), receive material (servers, switchers, fibre, etc.) and check quality. In many situations, particularly when people skills are involve i.e. outsourcing a call center, maintaining a positive relationship is key.


Every contract has warranties, either expressed or implied. Even if they are not explicitly expresses, they still exist, and the seller is bound by them. Therefore the onus is on the seller to ensure that his product or service quality will minimize any need for claims. The team should complete all inspections and testing, and report to the seller the need for any adjustments.


If one party ignores a contract clause, and the other party allows the clause to be ignored, the second party waives their right to enforcement of the clause.

Contract close-out - completion and settlement of the contract, including resolution of any open terms

When the work has been performed and accepted, the parties need to perform the handoff of the product or service, complete all required documentation, and process payment. Contract work does not always go smoothly, and if there is any disagreement about what has been or should have been provided, the parties need to resolve any continuing disputes. Both parties hope that there will be no such problems, because these are time consuming and costly for both parties.

Contract Disputes should be avoided by identifying potential problems early, and having both parties work actively to find a resolution before too much has been spent by either party. Such problems can often be prevented by ensuring strong communications between the buyer and the seller as the work proceeds. It is better for the seller to ask for additional information, and for the buyer to provide this before the work advances too far, to prevent any wasted time and effort. The PM must know the contract and ensure all performing parties are familiar with the details. If, in spite of all of this, there are disputes, there are a number of ways to handle them- listed from the cheapest to the most expensive: Negotiation

■ Mediation Arbitration Disputes Review

■ Litigation

It is recommended that given any choice, the PM use techniques as close to the top of this list as possible, to save time and money. In negotiation, the parties work together to find a solution that meets the needs of both parties. The principles of negotiation mentioned above should be applied. This is the cheapest method of resolution, because it involves the time of only the parties involved. If both parties follow the negotiation principles, it can also lead to some innovative solutions, and should satisfy both parties in the end. This should be abandoned only if it becomes evident that no acceptable solution will be reached.

With mediation, a neutral person works with both parties to find mutually acceptable resolutions. Thus the people who would be involved in negotiation will still be involved, and the cost of one additional person is added to the equation. But this might bring a level of objectivity which cannot be reached in some cases by the parties themselves.

In arbitration, an appointed arbitrator makes a decision which is binding on both parties. Both parties must agree ahead of time to go to arbitration in the case of a dispute, because they will be bound by the decision, even if they do not like it. So not only does this add the cost of an arbitrator, it also raises the risk of dissatisfaction of one of the parties.

In some cases a Disputes Review Board is used. Three people are involved to come to a decision about the issue in question. One of these is chosen by the buyer, one by the seller, and the third by the first two. The review board probably follows the project on an ongoing basis, in order to be informed in case any disputes arise. Or, the board can simply be convened to resolve disputes on demand.

Litigation is most expensive and time consuming option. Sometimes it is the only acceptable option, but it should be avoided unless nothing else can effect a resolution. The time for a case to come to trial can be significant, and once there, the time to resolve can also be significant. There is also the time of both parties, plus their lawyers, to prepare which must be considered. This is not a desired solution in terms of time or money, unless it is really necessary.

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