Cannot Decide on the Right Type of Contract? The Answer Can Be Found Easier Than You Think
Any process requires your full dedication if you want it to undergo the way you need, and project management is not an exception. Constructing a building, developing an application or a website, building software for educators, or thinking about implementing a delivery management system or a GPS vehicle tracking system – every business solution needs a project or two in order to follow stated objectives. To be a successful PM and not to lead your solution to downfall, you should have outstanding communication skills, be familiar with various project management methodologies, be able to utilize project management software and tools, as well as be aware of the legal aspects and types of contracts.
Having a project in your mind means that sooner or later the time will come when you will need to get help from the third-party vendors or subcontractors. This is why a PM has to learn the differences between the types of contracts in project management and know which one to choose depending on the situation. Let’s look at different types of contracts in software project management, their key features, and the reasons of their popularity.
Contract in Project Management: What Should You Know About It
Before looking at the differences, you need to understand the basics. The contract in the software project management is an agreement between two or more parties that comply with all its parts, including the proposal, procurement state of work, marketing and reporting agreements, and payment terms. All roles and responsibilities, terms and conditions are added as well.
The key features and components are the following:
- There is an offer from one of the sides and acceptance from the others;
- It contains equal exchange of values between all the sides;
- Authorized personnel should sign the contract and approve that the work is legally allowed.
All in all, it should be a win-win solution for all the parties involved to develop the software you need. That is why, if you decide to ask a software development company for help, you will need to pick a cooperation model. It is important to choose the right type to be sure that you will not go over your budget, end up with a rushed product, or will be able to change or replace features in the process. You must think carefully and decide which one will suit your requirements and needs best.
Some of the popular options that you may have heard of are fixed price model and time and materials model. However, there are even more choices that you can make. Therefore, let’s look at them closer.
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Types of Contract in Software Project Management
So, you have a project to maintain, and are now thinking about which type of contract to choose. The available options are the following, and you need to understand their differences to know the outcome of the software development process:
Fixed Price Contract (FP)
Choosing this type requires fully detailed specifications, project scope statements, and checklists from the seller side. Both sides agree on a fixed price. It means that when the project is delayed as well as there are cost overruns, the seller will absorb all the extra expenses. With this option, the buyer is in the least risk category. Thus, while it is useful for controlling the cost, the downside for FP is that deviating from the defined scope can be expensive. Therefore, it is better to opt for this type when the scope of work is already clearly defined and the set requirements are well understood.
This type is also divided into several subtypes:
- Firm Fixed Price (FFP) is the most common one. The price is set from the outset and cannot change unless there is a change in scope;
- Fixed Price Incentive Fee (FPIF) model is usually chosen to offer the seller a performance-based incentive. It can be dependent upon certain project metrics, including development cost, time, and performance;
- Fixed Price Award Fee (FPAF) is used when the expectations from the seller can be exceeded. If the product is finished earlier than expected, an extra payment will be received;
- Fixed Price Economic Price Adjustment (FPEPA) option gives you an opportunity to readjust the fixed price according to the fluctuations in the market. Usually, it is chosen in the case when a project is going to last for multiple years.
Cost Reimbursable Contract (CR)
This type is used when the requirements are uncertain from one side and the development process is not clear from the other. It is used for new research and development and requires immense innovation without a guarantee of predicted outcome. The key idea of this contract is that the seller provides work for a fixed time period and then increases the bill to get profit after finishing the product. The amount of the raise in this case is unknown to the other party, because it is not discussed prior to the agreement.
There are subtypes that you can choose from if you decide to go for this option:
- Cost Plus Percentage of Cost (CPPC) arrangement mainly benefits the seller. Upon completion of the software, they get the total cost they incurred during the software development as well as a defined percentage of the total cost;
- Cost Plus Fixed Fee (CPFF) ensures that, besides the cost incurred on the product, the seller gets an additional fee as well. The profit is set at the beginning of the project;
- Cost Plus Incentive Fee (CPIF) option contains a performance-based fee that is paid on top of the actual expenses;
- Cost Plus Award Fee (CPAF) type provides an award on top of the costs incurred.
Time and Material Contract (T&M)
This is the second popular option after FP, and it is a hybrid of both FP and CR. One of the parties agrees to pay the other the time and materials that are used for the project within a reasonable limit. It can be cost reimbursable when the customer agrees to pay the cost for all the genuine and legitimate expenses. Or, it can be more like a FP type when the customer sets the limit.
In this case, the vendor is selected based on the capabilities and experience, having the required manpower and materials. The cost for supplies is negotiated and is paid according to the quantity of the resources consumed or purchased. The contract is pretty simple and convenient for both parties, and it is possible to establish a not-to-exceed price to avoid massive cost overruns.
Unit Price Contract
This type is less popular than the other three options and is also known as an hourly rate contract. It combines the elements of the FP and CR models, just like T&M. However, this option differs on setting the price per item or unit not per hour rate along with the receipts for all the resources used in the overall process.
If you choose the unit price contract, it will ensure that the party that is engaged in the development process is paid a specified hourly rate for every hour its members spent on the overall software development process. This is the main advantage of this type. That is why it is usually used by freelance workers.
As for this one, it is a specific type that is used only to purchase commodities and goods.
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Most Popular Options: Fixed Price Contract VS Time and Material Contract
So, if going back to software development and project management, the most popular battle is time and material vs fixed price. Therefore, it is likely that you will choose one of these models. Before making your choice, you need to know the advantages and disadvantages of time and material contract and fixed price options.
If both parties are thinking about choosing the fixed price software development agreement, it is important to remember that the price is fixed. The buyer should be ready for higher initial cost, while the seller needs to be ready for the risk of loss. Lack of flexibility is another weak point of the FP agreement.
As for the bright side, it includes no cost overruns for the buyer and well-defined product for the seller. All in all, choosing this type ensures predictability, ease of management, and transparency. Payments are mainly based on the percentage of work performed, and workflow requires little involvement since expectations are predictable.
If talking about the T&M contracts, the advantages are vendor relations for the buyer and no loss for overages for the seller. As for the disadvantages, it is important to mention the risk of exceeding expected costs and the requirement of having a good scope agreement. This is because of the fact that the buyer pays the seller for all time and materials and bears risk. The overall expenses can go far beyond the expected budget, which is why it is vital to be ready for this. Deep involvement is required, which can be considered a disadvantage as well.
Nonetheless, there are many benefits that both sides will get if choosing this model. Flexibility, better timing, and dynamic work scope are the advantages of the option. It gives many opportunities, including the modification of the volume of work, revision of materials or designs, simultaneous evolution of a strategy and development of custom software. It also allows you to see how much time the team spends on each feature.
Project management is all about the management, control, and tracking for successful completion as per the expectation of the customer. That is why it is important to cover all parts of the process, including the choice of a contract. To decide which type to opt for, you need to understand what you and the other party of the agreement want as well as your goals and how they can be merged together to lead both sides to success.
Your choice will surely be on the T&M or FP contract, but which one to go for depends on many factors. The most significant difference between these two models is that you are able to retain more control over the project if you pick time and material and can better control expenses by going for a fixed price. The answer lies in the names of these models, therefore, decide your goals and requirements with the other party, and you will be able to pick the right choice.
Depending on the choice of the contract type, the workflow of your project may differ. If you need to manage it in a simple way and be sure that you are enhancing your business, contact us and get top-notch project management software solutions.