With a CPFF contract the client pays the contractor a fixed fee and reimburses the contractor for all costs associated with the project: labour, plant, and materials actually consumed are charged at rates that are checked and approved by open book accounting. The cost of overcoming errors, omissions, and other charges is borne by the client.
Advantages for the client include the following: costs are limited to what is actually needed, the contractor cannot earn excessive profits, and the possibility that a potential loss for a contractor will lead to adverse effects is avoided.
However, CPFF contracts have a serious disadvantage as far as most clients are concerned, in that there is an uncertain cost commitment coupled with an absence of any incentive on contractors to control costs. Under a CPFF contract, the contractor's motivation to carry out work efficiently and cost-effectively is considerably weakened. Moreover, contractors may be tempted to pad costs in ways that bring benefits to other work they are undertaking. Examples include expanded purchases of equipment, excessive testing and experimentation, generous arrangements with suppliers, and overmanning to avoid non-reimbursable lay-off costs, a problem that is more pronounced when the fee is based on a percentage of actual project costs.
A further difficulty is that of agreeing and documenting in the contract what are allowable costs on a given project. However, it is important that all project-related costs are correctly identified and included at appropriate charging rates in the contract. Particular areas of difficulty are overhead costs and managerial time. To the extent that costs are not specifically reimbursed, they will be paid for out of the fixed fee and contractors will be motivated to minimize such costs.
The use of a CPFF contract also presents problems in selecting a contractor who can perform the work for the lowest cost. Selecting a contractor on the basis of the lowest fixed fee tendered in a competitive bidding situation does not guarantee a least cost outcome. It could be argued that it encourages a maximum cost outcome.
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What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.