in today's video guys we would be
learning about the different types of
procurement contracts such as firm fixed
price cost reimbursable and time and
material contracts so if you are
struggling to understand the different
types of contracts such as
fpif cpif cpaf in terms of what do they
mean where are they used what are the
key characteristics of such type of
contracts then do watch this video till
the end
so in this video guys we will be solving
some pmp style questions as well so this
will form an important part of your pmp
exam preparation okay so let's get
started okay so when we talk of contract
guys there are primarily three types of
contracts right
firm fixed price time and material and
cost reimbursable now it is very
important to understand the definition
of these types of contracts in context
of two things
initial clarity of project scope and the
risk impact of project cost on the buyer
by initial clarity of project scope
which we have in the x axis
it means how clear or defined is the
scope of the project at the initiation
phase of a project
and this is irrespective of the project
being agile hybrid or predictive okay
and when we talk of the risk impact guys
it is the risk impact we are evaluating
for the buyer or the project itself as a
whole okay in your pmp exam whenever we
talk of procurement management always
evaluate the question as you are the
project manager on the buyer's side okay
unless stated otherwise
now with that
let's understand what each of these
three types of contracts mean
so first is
firm fixed price
in this type of contract guys the vendor
agrees to supply a product or service
for a fixed price
and if there is any extra cost that is
incurred it has to be paid by the seller
this way in firm fixed price contracts
the buyer's risk is very low and as a
result consequently the seller's risk is
very high
the advantages of such type of contracts
are
firstly they provide a high clarity of
scope up front so the seller and the
buyer both needs to be very clear of the
end state of the project and the success
criteria
and secondly as we discussed the buyer
bears a very low risk of getting a cost
hurt further downstream in the project
now talking about the disadvantages of
firm fixed price contract
due to the fear of unknown it is often
noticed that the seller builds a lot of
cost buffer up front in such type of
contract
this may result your overall project
cost look inflated at the onset so you
need to build a solid assumptions log as
well at the beginning of the project
while dealing with such type of
contracts
secondly another major drawback of firm
fixed price contracts are if the project
gets delayed or the supplier suffers a
cost hurt in some other way let's say
some issues in their organization such
as labour strike or downsizing he may
start to sacrifice the safety quality or
the level of execution for your project
to keep his profit margins which is
normal human nature right
so as a pm you also need to be very
careful of this
a typical example where firm fixed price
contracts can be used is let's say
installing an end-of-line case packing
machine in a manufacturing plant
the scope is simple
case packers are generally off-the-shelf
items and installing them is pretty much
straightforward
hence a ffp contract will make perfect
sense in this scenario if you are
looking to solve some high quality pmp
style questions guys check out my mock
exam simulator on udemy which is updated
as per the new format of the pmp exam of
2021 and has questions from the pmbok
seventh edition as well the course
already has over a thousand five star
reviews on udemy and many pmp aspirants
have used this course to pass the exam
on their very first attempt there is a
discount coupon which i'll be providing
on this course for a limited period of
time so check out the description
section of this video to avail the offer
so now back to the different types of
contracts next we move on to cost
reimbursable contracts
in this type of contract guys the scope
is not very clear at the onset this is
typically found in agile or scrum
projects
the scope in these type of projects
keeps on modifying at the end of each
iteration right
so in cr contracts which is the cost
reimbursable contracts the buyer pays
the seller for the actual cost of the
work performed
including the cost of materials
equipment and salaries
plus an additional fee on top which
represents the seller's profit
talking of the advantage of cr contracts
a very big advantage of such type of
contracts is it prevents dummy billing
that means the seller cannot build the
buyer something that is not done because
the buyer verifies each and every hour
and invoice before releasing the payment
it is also a strong audit point for such
type of contracts as a project manager
you should keep strong stewardship and
control while signing off invoices for a
cost reimbursable contracts
secondly as i mentioned earlier there is
plenty of opportunity for agile with
such type of contracts due to its
inherent flexible nature
and thirdly
cost reimbursable contracts are very
good from a seller standpoint because it
protects the seller from any cost risk
further downstream of the project
conversely if we talk of the
disadvantages
cr contracts keep on having very low
clarity of scope all along the project
and hence
carries risks of misinterpretation of
actual work completion
for example the seller may say that he
has completed a specific module and bill
you for the same
but when you check you may find that the
module is not completed as per your
expectations
hence you may need to reject the invoice
this may result in delays right so this
is a disadvantage
also
cr contracts poses high risk for the
buyer from a cost standpoint for the
obvious reasons as we talked earlier an
example where you can use a cr contract
as a project manager is let's say while
developing a new application for android
or ios where the initial scope is very
vague
and the functionalities of the
application
will require a lot of user testing or
user story analysis etc
next
time and material contracts or tnm
contracts
this one is like let's say a midway
between ffp and cr contracts where the
buyer and the seller risks are equally
shared
in time and material contracts the buyer
pays for the materials plus a per day or
a per hour rate for all staff the seller
provides to complete the work
such type of contracts are often seen in
an example where you have hired a few
developers to write a program for you
and they charge you a fixed cost per
month for their office rentals
and maybe a variable cost on a per hour
basis for the number of hours spent in
coding okay
if you need to increase or decrease the
number of developers working for you
such type of contracts provide you the
option to do that very easily
the risks as i mentioned are equally
shared between the buyer and the seller
right as a buyer you always set an upper
limit on the time and material part
of the contract
another example of such type of contract
can be when you hire an external
accounting company for bookkeeping or
accounting purposes
the time here can be number of hours
spent by their team in doing the
accounts for you and the material could
be their office rentals stationery and
licenses they use to do your bookkeeping
in a correct and legal way
clear
now let's move on to understand a bit
more details about each type of these
contracts
so these three type of contracts guys
can be broken down further into subtypes
the first category is the types of fixed
price contracts which is firm fixed
price as we talked earlier
fixed price with an incentive fee
and fixed price with economic
adjustments
i have made a study guide for you which
can be downloaded from the link in the
description box okay
study the details of these contracts
from this document while you are
watching this video but here what is
very important is how they are placed
along this matrix of scope
and risk okay if you see here
firm fixed price contract is with the
least cost risk for the buyer
but needs a very high clarity of initial
scope
on the other hand guys fpif and fpepa
contracts can handle a bit of scope
flexibility but increases the buyers
cost risk and consequently decreases the
seller's cost risk
also note that between fpif and fpepa
contracts
fpepa contracts poses a higher cost risk
for the buyer
i have explained the exact reason for
the same in the study guide so read it
very carefully
moving on let's see the subcategories of
cr contracts so these are some of the
most important types of cr contracts
okay
again refer to the study guide to learn
the details for each one of them
but what is important is to study the
relative distribution across this matrix
of scope clarity and cost risk and as
you see from a cost standpoint the most
risky cr contract is the cppc type
a bit better than that is the cpff
both can handle low clarity of scope
equally the study guide explains why the
fixed fee type is better than the
percentage cost type the other two types
are cpif and cpaf and as you see from
this matrix again from a buyer's
standpoint the cpaf is a better contract
than the cpif the study guide explains
that as well
finally there is this time and material
contract and
the indefinite delivery and indefinite
quantity contract or id iq contract
this id iq contract and time and
material contract falls midway between
the buyer and the seller risk okay
the idiq contract however is a new type
of contract which is introduced in pmbok
7th edition hence i suggest you read the
details for this type of contract from
my study guide which can be downloaded
from the link given in the video
description below so remember guys for
the pmp exam it is very important not
only to understand what each type of
contract means but also to understand
how they are placed in this matrix of
buyers cost risk and scope clarity
this is what will help you to eliminate
the wrong answer when you will get stuck
between two close answer choices in the
exam
we will see this in a moment now when we
solve a few pmp style questions
but before moving on to the questions
some quick takeaways from what we have
learnt till now first always interpret
procurement management or contracting
questions in the pmp exam from a buyer's
standpoint
so always think that you are a project
manager from the buyers side not from
the seller's side the question will tell
you very specifically if you are a
project manager from the seller's side
next
no project works only on a single type
of contract okay
it is always hybrid as different scope
items call for different contracting
types
so for example in a construction project
the overall project may have a ffb
contract or let's say a turnkey contract
but the building material and
construction sub scope may have a time
and material contract
another example for a web application
development may be the design and
development part follow a cr contract
but the deployment and rollout part may
follow a firm fixed price approach next
very important there is nothing called a
good contract or a bad contract guys
okay there is a common misconception
between pmp and capm candidates
that ffp contracts are better than cr
contracts no remember each type of
contract has its own pros and cons and
hence suitable for specific project
scopes
always choose a contract based on the
scenario and the context okay
finally keep my study guide as a ready
reckoner during your exam preparation
and always evaluate every contract in
the matrix of cost risk
and scope clarity as we discussed right
now
let's solve some pmp style questions
so the first question guys
pause the video read the question
carefully and try to answer it before
moving forward
okay so we'll start solving this
question
if you see carefully guys it is
mentioned that the project is delayed
and you are under a cost pressure
that rules out
time and material contract and
cost reimbursable contracts right
because if you see in this matrix
these type of contracts does increase
the cost risk from a buyer's standpoint
hence the only options left are ffp and
fpif
now since in the question it is
mentioned that your project is delayed
it would be a very good decision to go
for a fpif contract here
and incentivize the supplier to complete
the project within schedule or maybe
ahead of schedule
even if it marginally will increase your
costs overall you will be in a very
advantageous position because you will
save cost due to the project delays okay
hence the correct answer to this
question is fpif or fixed price
incentive fee contracts let's move on to
the second question guys
pause the video here read the question
very well and try to answer it before
moving forward
okay so we'll start solving the question
see that
there are two important points here to
note
firstly it's a agile project following
progressive elaboration right so there
is no scope for having a fixed price
contract here so that
rules out option number four
also it is very important to note here
that altus is a long-standing partner
and alex should maintain a good business
equation with them
and for that very reason he has to
choose a procurement contract which is a
win-win for both the organizations
now if you see the matrix as we have
discussed and if you study my reference
guide you will see the exact reason why
a cpif contract is the most optimized
contract from the list of the cost
reimbursable contracts and for that very
reason the cppc and the cpff contracts
will not make any sense here because
alex needs to maintain a good
relationship with altus and also develop
a contract which makes perfect business
sense
hence the correct answer to this
question is cost plus incentive fee
contract i hope today's video was useful
guys and you have learned about the
different types of contracts the details
of each one of them and you will not
have any problems whatsoever in solving
questions now in your pmp exam from this
topic let me know in the comment section
below what other topics of the pmp exam
you would like me to cover in this
channel i wish you all the best for your
pmp exam preparation and i'll see you
again soon in another awesome video like
this on this channel bye bye and have a
nice day