Question

Please state the advantages and disadvantages of each of these types of contracts utilized in the construction industry.

Cost plus fixed fee:

Cost plus award fee:

Cost plus incentive fee:

Quote or price in effect:

Fixed price with redetermination:

Fixed price incentive:

Time and Material:

Productive labor rates:

Unit price:

Firm fixed price:

Answer 1

Cost Plus Fixed Fee: - Depending on the parties’ need, there are different advantages and disadvantages of using a cost-plus fixed fee contract arrangement. In order to avoid breach of contract, both parties should consider below aspects of cost-plus contracts.

Some advantages of a CPFF contract can include:

• The final cost may be lower than in a normal contract, as the contractor usually does not “inflate” prices to cover risks
• The contractor has less incentive to control the project costs (in contrast to other types of contracts, such as a fixed-price contract)
• They can often ensure higher-quality output than normal contracts

Disadvantages:

• The final, overall cost may not be very clear at the beginning of negotiations
• This may require additional administration or oversight of the project to ensure that the contractor is factoring in the various cost factors
• Provides less incentive to complete the project in an efficient manner, compared with fixed-price contracts

Cost plus award fee: - This type of contract involves reimbursing the seller for all the legal costs that he or she has incurred with the construction industry. However, majority of the fee earned is based on satisfying the subjective performance criteria stipulated in the contract. The fee is determined based on the buyer’s subjective assessment of the seller’s performance. The fee earned in the cost plus award free contracts (CPAF) will be commensurate with the buyer’s overall schedule, cost, and technical performance. This means that the buyer will not be paid if the performance is below satisfactory. Cost plus award fee type of contractual agreement is very flexible and the contractor usually delivers better product and service. It also promotes a positive relationship between the buyer and seller as good performance is rewarded. On the other hand, this is not a preferred contracting method when regulating organization. It has higher cost as well as increases the liability compared to traditional fixed-price contract.

Cost plus incentive fee: - A cost-plus-incentive fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs. Like a cost-plus contract, the price paid by the buyer to the seller changes in relation to costs, in order to reduce the risks assumed by the contractor (seller). Unlike a cost-plus contract, the cost in excess of the target cost is only partially paid according to a buyer/seller ratio. Hence the seller's profit decreases when exceeding the target cost. Similarly, the seller's profit increases when actual costs are below the target cost defined in the contract. Incentive contracts allow sharing of the risks between the contractor and the client. The contractor is reimbursed of all its justifiable costs in addition to a calculated fee. The basic elements of this contract are:

• Target Cost: the estimated total contract costs.
• Actual Cost: this constitutes the reasonable costs that the contractor can prove he has made.
• Target Fee: the basic fee to be paid if the Target Cost matches the Actual Cost (target profit). The Target Fee varies between the Minimum Fee and the Maximum Fee according to a formula tied to the Actual Cost (e.g. Target Fee could be 10% of the Actual Cost).
• Sharing Ratio: the agreed upon cost sharing proportion, normally expressed in percentage (e.g. 85% for the client / 15% for the contractor). It is often different for cost overruns and cost underruns.

Other components of incentive fee contracting include:

• Maximum Fee: the highest fee that may be earned, usually expressed as a percentage.
• Minimum Fee: the lowest fee that may be earned, usually expressed as a percentage.

Quote or price in effect: Here the contractor shall carry out and complete the supply of all item of goods and perform services in accordance with the contract. Unless otherwise stated in the Contract, all Goods shall be new and unused. The contractor shall deliver the goods and perform the services by the delivery/performance date and in the manner specified in the contract. The contractor shall obtain a receipt therefore from the Government for the same. The Warranty Period shall start on the date of receipt of the goods and on the date of acceptance of the services (as the case may be). The length of the warranty period shall be twelve (12) months or such period as agreed in writing. Within thirty (30) days from the date of invoice or date of receipt of invoice of any goods must be delivered and services performed. If there is delay in the delivery of any item of goods or services under the contract due to any of the following circumstances, namely, Actt of God, force majeure, riots and civil commotion, strikes, lock-outs or other causes or perils that is beyond the contractor’s control, or any event which seriously disrupts public safety, peace or good order, then in any such case the Government shall have the right to suspend performance of the contract after giving the contractor seven (7) days’ written notice.