What are the three main types of contracts in project management?

The three main types of contracts are: (1) Fixed Price (Lump Sum) — used when scope is clear, most cost risk on seller; (2) Cost Reimbursable — used when scope is unclear, buyer reimburses seller's costs plus a fee; and (3) Time and Material (T&M) — a hybrid of the two, used when scope and duration are uncertain.

What is the difference between Fixed Price and Cost Reimbursable contracts?

In a Fixed Price contract, the seller bears the cost risk because the price is set regardless of actual costs. In a Cost Reimbursable contract, the buyer bears the cost risk because they reimburse the seller's actual costs plus a fee. Fixed Price is preferred when scope is well-defined; Cost Reimbursable when scope is uncertain or for R&D work.

What is the Point of Total Assumption (PTA) in FPIF contracts?

The Point of Total Assumption (PTA) is the cost point on a Fixed Price Incentive Fee (FPIF) contract above which the seller bears all additional cost overruns. Beyond the PTA, every dollar of cost overrun reduces the seller's profit dollar-for-dollar, creating strong incentive for the seller to control costs.

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Study Notes

Procurement

Contract Types

Common types of contracts used in project procurements

There are three main types of contracts used in traditional projects:

Fixed Price or Lump Sum
Cost-Reimbursable
Time and Material (T&M) - hybrid of the above two types

In addition, Indefinite Delivery Indefinite Quantity (IDIQ) contract is also covered in this article. For Agile projects, refer to Agile Contracts.

Fixed Price (FP)

Also known as Lump Sum
Used when scope of work is clear
Buyer doesn't have time to audit invoices
Most cost risk for seller - as the seller's effort increases, the project cost remains constant, but the seller's profit continues to fall
Three sub types:
Firm Fixed Price (FFP)
A type of fixed price contract where the buyer pays the seller a set amount (as defined by the contract), regardless of the seller's costs
Price is firm
Most preferred by buyers around the world
Cost, performance and time are equally important constraints
Fixed Price Incentive Fee (FPIF)
Performance incentives
Cost is measured to determine the incentive fee; therefore, cost is the most important constraint
Performance is the second important constraint
Time is the least important constraint
Sets a ceiling price for the seller
Uses parameters such as ceiling price, total price, award fee and fee criteria
The total cost on a FPIF contract, above which the seller bears all cost overruns is known as the Point of Total Assumption
Fixed Price with Economic Price Adjustment (FP-EPA)
A fixed-price contract, but with a special provision allowing for predefined final adjustments to the contract price due to changed conditions, such as inflation changes, or cost increases (or decreases) for specific commodities.
Adjusts the contract prices for currency fluctuations, inflation, raw material cost, and labor rate changes
Used when contract spans multiple years
Protects both buyer and seller

Cost Reimbursable (CR)

A type of contract where the buyer reimburses the seller for the seller's actual costs, plus a fee representing the seller's profit
Scope of work is not clear
Higher cost risk for buyer
Full value of the contract not defined upfront
Buyer needs to audit invoices
Suitable for:
High-risk work
R&D type work
Three sub types:
Cost Plus Fixed Fee (CPFF)
A type of cost-reimbursable contract where the buyer reimburses the seller for the seller's allowable costs (allowable costs are defined by the contract) plus a fixed amount of profit (fee).
Does not provide any motivation for the seller to control costs - Buyer beware!!!
Although there are no incentives for efficiency in time or performance, there may be penalties for bad performance; therefore, performance is the most important constraint
Time is the second most important constraint
Cost is the least important constraint
Cost Plus Incentive Fee (CPIF)
A type of cost-reimbursable contract where the buyer reimburses the seller for the seller's allowable costs (allowable costs are defined by the contract), and the seller earns its profit if it meets defined performance criteria
The criteria for determining seller fee is defined in objective terms
Cost is the most important constraint
Performance is the second most important constraint
Time is the least important constraint
Most appropriate if the buyer expects the product to be built with the best quality material available, in the shortest possible time
Uses parameters such as target cost, target fee, target price and share ratio
Cost Plus Award Fee (CPAF)
A type of cost-reimbursable contract that involves payments to the seller for all legitimate actual costs incurred for completed work, plus an award fee representing seller profit
The criteria for determining seller fee is defined in subjective terms
Performance is the most important constraint
Time is the second most important constraint
Cost is the least important constraint
Uses parameters such as target cost, target fee, target price, award fee, and fee criteria

Time and Material (T&M)

A type of contract that is a hybrid of cost reimbursable (CR) and fixed price (FP) contracts
Higher cost risk for buyer
Mainly used for staff augmentation
Suitable when work needs to start soon
Cost is the most important constraint
Buyer wants the control
Time is the second most important constraint
Performance is the least important constraint

Indefinite Delivery Indefinite Quantity (IDIQ)

An Indefinite Delivery Indefinite Quantity (IDIQ) contract is a type of contract used by organizations, particularly governments, to procure an unspecified quantity of goods or services over a fixed period. The contract establishes minimum and maximum limits on the deliverables, allowing flexibility in procurement while ensuring the availability of necessary resources. The key characteristics are:

Undefined Quantity – The exact amount of goods or services is not predetermined. Instead, the contract specifies an acceptable range (e.g., a minimum and maximum quantity).
Fixed Timeframe – The contract runs for a set duration, such as one year, five years, or another agreed-upon period.
Task or Delivery Orders – Instead of a single large purchase, the buyer issues individual task orders (for services) or delivery orders (for goods) as needed.
Flexibility in Procurement – The buyer can request only the quantity needed at a given time, reducing waste and unnecessary stockpiling.
Common in Government & Large Enterprises – Widely used in construction, IT, professional services, and defense.

Cost Risk in Contracts

Point of Total Assumption

The total cost on a Fixed Price Incentive Fee (FPIF) contract, above which the seller bears all cost overruns
The point at which a Fixed Price Incentive Fee (FPIF) contract becomes a Firm Fixed Price (FFP) contract

Read the 5-part series on Point of Total Assumption to get a detailed understanding of this topic.

Q&A

What is the difference between Cost Plus Fixed Fee (CPFF) contract and Cost Plus Incentive Fee (CPIF) contract?

In both these contracts, the seller is reimbursed for the allowable costs of project work. However, in CPFF, the seller fee is fixed and is not tied to the seller's performance, whereas in CPIF, the seller fee is tied to the seller's performance.

What is the difference between Cost Plus Incentive Fee (CPIF) contract and Cost Plus Award Fee (CPAF) contract?

In CPIF, the criteria for determining seller fee is defined in objective terms, whereas in CPAF, the criteria is subjective.