For any deal that’s done between two organisations, a contract needs to be drawn up. In the case of one organisation buying goods or services from another, a procurement contract is required. So, what is a procurement contract?
Put simply, a procurement contract is a document that details the legally binding agreement between a buyer and seller. The purpose of a procurement contract is to delineate the rights and duties of each party. Upon signing a procurement contract, the supplier will be contractually obligated to fulfil its terms – usually with regards to quantities, quality of goods and timeframes for delivery. The buyer, in return, is obligated to acknowledge receipt of goods or services and pay for them.
If only things were so simple.
Though the overarching purpose is the same, there are in fact multiple types of procurement contract to choose from when thrashing out a deal with a vendor.
Generally, these can be broken down into three categories:
- Fixed price contracts
- Cost reimbursable contracts
- Time and materials contracts
There are, however, subtypes of each main type of contract. It’s crucial that project managers and procurement professionals understand the differences as using the right procurement contract is crucial to the success of any given project. Ultimately, the onus is on procurement management to select the contract that satisfies the organisation’s requirements.
Let’s look at the different types of procurement contract and consider when it’s best to use each of them.
Fixed Price Contracts
With a fixed price contract, the vendor agrees to supply a product or service for a fixed price. This means that the seller bears most of the risk – once the contract is signed, the seller must produce the goods. If costs end up exceeding the agreed-upon amount, it is the seller that must shoulder them.
As such, fixed price contracts have the least risk for the buyer. That said, what can sometimes happen is that the seller ups the price to allow for any risks, which may mean you end up paying more for your goods. Nonetheless, this type of contract is best used when you know exactly what the project scope is – since the cost cannot change, this contract is ideal for controlling price.
Let’s briefly consider the subtypes of the fixed price contract:
- Firm Fixed Price (FFP): The seller must complete the job or supply the product or service within an agreed amount of time and at a set price.
- Fixed Price Incentive Fee (FPIF): Identical to a FFP contract except that the seller may receive an additional monetary incentive if they perform well – for example, completing the project ahead of schedule.
- Fixed Price with Economic Price Adjustment (FP-EPA): Used in multi-year agreements to protect the seller from inflation – for example, costs will increase 3% after a certain amount of time.
Cost Reimbursable Contracts
Cost reimbursable contracts are best suited to projects when the scope of work is not fully known or will likely change by the end of the project. With this type of procurement contract, the buyer pays the seller for the actual cost of the work performed – including the costs of materials, equipment and salaries – plus an additional fee on top, which represents the seller’s profit.
Again, there are subtypes of cost reimbursable contracts:
- Cost Plus Fixed Fee (CPFF): The buyer pays the seller for all incurred costs plus a pre-negotiated fee, which is paid regardless of the seller’s performance.
- Cost Plus Incentive Fee (CPIF): The same as CPFF, the difference being the fee is based on achieving certain performance objectives outlined in the contract – for example, if the project is completed under budget, the seller receives X% of the savings.
- Cost Plus Percentage of Cost (CPPC): The buyer pays all of the seller’s costs, plus a percentage of those costs as a fee. Considered risky for the buyer as sellers may artificially increase their costs to get a higher profit.
Time and Materials Contracts
With this type of contract, both the buyer and the seller share the risk. It is used in industries such as construction when the seller provides labour as well as materials. The buyer pays for the materials plus a per day or per hour rate for all staff the seller provides to complete the work. When negotiating a time and materials contract, it’s crucial that you set an upper limit for billable hours to prevent the project from going over budget.
Digitising Procurement Contract Management
Selecting the right procurement contract is crucial for any project – but it is only one part of the procurement process. For all deals in place, it’s important for project managers to monitor contract performance to ensure all suppliers fulfil their obligations laid out in the agreement. It’s also essential for managers to regularly update and document any price adjustments or amendments to the contract during its lifecycle.
With multiple contracts to monitor and manage, organisations must establish suitable processes for optimising procurement contract management, utilising appropriate digital tools.
One of the most effective technologies in this regard is rebate management software. From selecting the right type of procurement contract through to contract creation, execution and analysis, rebate management software serves as a complete contract management system. The software captures all details throughout contract negotiations, providing a full audit trail between buyers and suppliers and enabling easy, centralised access for all.
Of course, rebate management software also manages complex rebate agreements that make up a significant part of procurement contracts. Indeed, when procuring goods and services from vendors, contract terms and conditions often include tiered pricing structures based on values, volumes, percentages, growth and other factors.
Rebate management software keeps track of them all, with all sales and purchases automatically calculated in real-time against agreements throughout the entire lifecycle of the procurement contract.To learn more about how rebate management software can help you optimise your procurement contracts, talk to our experts at e-bate today or request a software demo of our intelligent rebate management solution.