Fixed Price or Lump Sum Contracts

Fixed-price contracts (also referred to as lump-sum contracts) can either set a specific, firm price for the goods or services rendered (known as a firm fixed-price contract, or FFP) or include incentives for meeting or exceeding certain contract deliverables.

Fixed-price contracts can be disastrous for both the buyer and the seller if the scope of the project is not well defined or the scope changes dramatically. It's important to have accurate, well-defined deliverables when you're using this type of contract. Conversely, fixed-price contracts are relatively safe for both buyer and seller when the original scope is well defined and remains unchanged. They typically reap only small profits for the seller and force the contractor to work productively and efficiently. This type of contract also minimizes cost and quality uncertainty. There are three types of fixed-price contracts you should know for the exam:

Firm Fixed-Price (FFP) In the FFP contract, the buyer and seller agree on a well-defined deliverable for a set price. In this kind of contract, the biggest risk is borne by the seller.

The seller—or contractor—must take great strides to assure they've covered their costs and will make a comfortable profit on the transaction. The seller assumes the risks of increasing costs, nonperformance, or other problems. However, to counter these unforeseen risks, the seller builds in the cost of the risk to the contract price.

Fixed-Price Plus Incentive (FPIF) Fixed-price plus incentive (FPIF) contracts are another type of fixed-price contract. The difference here is that the contract includes an incentive— or bonus—for early completion or for some other agreed-upon performance criterion that meets or exceeds contract specifications. The criteria for early completion, or other performance enhancements, are typically related to cost, schedule, or technical performance and must be spelled out in the contract so both parties understand the terms and conditions.

Another aspect of fixed-price plus incentive contracts to consider is that some of the risk is borne by the buyer, unlike the firm fixed-price contract where most of the risk is borne by the seller. The buyer takes some risk, albeit minimal, by offering the incentive to, for example, get the work done earlier. Suppose the buyer really would like the product delivered 30 days prior to when the seller thinks they can deliver. In this case, the buyer assumes the risk for the early delivery via the incentive.

Fixed-Price with Economic Price Adjustment (FP-EPA) There's one more type of fixed-price contract, known as a fixed-price with economic price adjustment contract (FP-EPA). This contract allows for adjustments due to changes in economic conditions like cost increases or decreases, inflation, and so on. These contracts are typically used when the project spans many years. This type of contract protects both the buyer and seller from economic conditions that are outside of their control.

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