Procurement is the work of obtaining goods or services from outside the project, and a contract is the agreement that governs it. PMI treats procurement as four processes running the length of a project and gives the contract types a section of their own, because the examination tests them constantly. A procurement decision begins as an economic question. It ends as a relationship. A contract type settled in a fortnight of sourcing decides who absorbs the surprises for the next two years.
The sections below take the decision in the order it is made. Whether to buy at all, which contract family to use, which variant within it, how the four processes run and why the type chosen shapes the relationship that follows.
The make or buy decision
The comparison is between the total cost of ownership on each side, counting support, licence renewals, integration, the cost of getting out again and the capability the organisation either keeps or gives away. The build cost against the purchase price is the wrong comparison. It is also the one usually made.
Buying converts an uncertain internal effort into an obligation somebody else carries, which is worth a great deal when the work is well understood and peripheral, and worth very little when it is neither, because the obligation then has to be renegotiated every time the understanding changes. It also introduces a party with a commercial interest of its own, a lead time on every change and a dependency nobody can manage directly. Building keeps control and cheap changes of direction, and it leaves the whole of the delivery risk in house. Where the capability is one the organisation competes on, buying it is usually wrong at any price.
The three contract families and who carries the risk
Once the decision is to buy, the contract type is chosen. Every contract type sits somewhere on one spectrum, which runs from the seller absorbing an overrun to the buyer absorbing it. Knowing where a type sits is usually enough to answer a scenario question, because the party carrying the risk is the party whose behaviour the agreement will shape.
Cost risk transfers gradually, with no steps, and the incentive variants exist to sit in the middle of it. Time and materials belongs at the open end because the rates are agreed and the quantity is not, so a programme without a ceiling has handed the buyer an obligation with no stated size.
Fixed price. The seller commits to a price for a defined scope and therefore carries the cost risk, prices it and is paid for it whether or not it materialises. It suits work that can be specified precisely in advance and suits moving requirements badly, because every discovery becomes a commercial negotiation.
Cost reimbursable. The buyer pays allowable costs plus a fee and carries the cost risk, which makes this the sensible family where scope genuinely cannot be pinned down, such as research or a first of its kind integration. The flexibility is paid for in oversight, since the buyer now needs the ability to audit costs and judge whether effort is being spent well.
Time and materials. Agreed unit rates and no agreed total. Rates are fixed as in a fixed price deal and quantity is open as in a cost reimbursable one, which makes it quick to put in place and right for staff augmentation and small urgent pieces. With no ceiling it has no natural end, so a not to exceed figure and a review point are worth writing in.
The incentive and adjustment variants
Within the fixed price family, two variants soften the edges. Fixed price with incentive fee sets a target cost, a target fee and a ceiling price, then shares any underrun or overrun on an agreed ratio up to that ceiling. It exists because a firm fixed price rewards a seller for cutting corners, and here both parties gain from the work going well. Fixed price with economic price adjustment does one narrower job, indexing the price to a published rate so that a long term contract need not price years of inflation guesswork into month one.
On the cost reimbursable side the variants differ only in how the fee is set. Cost plus fixed fee agrees the fee at the outset, so the seller gains nothing from inflating costs and nothing from controlling them either. Cost plus incentive fee ties part of the fee to cost performance against a target. Cost plus award fee ties part of it to a buyer judgement against stated criteria, which suits work whose quality matters more than its price. The fee structure is always where the buyer decides what the seller is being paid to optimise.
| Contract type | Who carries the cost risk | Where it fits |
|---|---|---|
| Firm fixed price | The seller, in full | Scope that can be specified precisely and is unlikely to move |
| Fixed price with economic price adjustment | The seller, apart from movements in a named published index | Long agreements where inflation or a commodity price would otherwise be guessed at in month one |
| Fixed price with incentive fee | Shared on an agreed ratio up to the ceiling price, and the seller alone above it | Well understood scope where the buyer wants the seller to gain from delivering efficiently |
| Cost plus incentive fee | The buyer, with part of the fee tied to cost performance against a target | Uncertain scope that still needs a brake on cost |
| Cost plus award fee | The buyer, with part of the fee tied to a buyer judgement against stated criteria | Work whose quality matters more than its price |
| Cost plus fixed fee | The buyer, in full, since the fee moves for nothing | Research and first of a kind work where the outcome cannot be specified in advance |
| Time and materials | The buyer, since the rates are agreed and the quantity is open | Staff augmentation and small urgent pieces, under a not to exceed figure and a review date |
The four procurement processes
Choosing the type is one step in a longer sequence. Planning decides what to buy, picks the contract type, writes the statement of work and sets the selection criteria. Conducting covers the market approach, the bids, the evaluation and the award. Controlling runs for the life of the agreement and takes in performance, payments, inspection, claims and any changes, which travel through change control like any other. Closing settles final payments, resolves outstanding claims, confirms deliverables against the contract and records how the seller performed for whoever procures next.
Each stage hands something to the next. A vague statement of work written in the first stage becomes a dispute in the third, with a delay attached and a supplier who can point to the words.
How the contract type shapes the relationship
The dispute is rarely bad faith. It is what the contract type asked for. Put a firm fixed price on a requirement nobody could specify and every unforeseen detail arrives as a change request, priced by the one supplier now holding a viable route to delivery. Put a cost reimbursable arrangement on well understood work and the buyer funds inefficiency it has no practical grounds to challenge. Put time and materials on a large programme with no ceiling and nothing in the agreement makes finishing more attractive than continuing.
Each is a rational response to incentives somebody wrote down, which is why the contract type is a delivery decision, and why the project manager who will live with it for two years belongs in the room where it is chosen.