A procurement decision begins as an economic question and ends as a relationship. A contract type settled in a fortnight of sourcing decides who absorbs the surprises for the next two years.
Make or buy has a long tail
The comparison is not the build cost against the purchase price. It is 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.
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. 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.
Three families and who carries the risk
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 rather than in 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 earn their keep.
The variants worth reasoning about
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, whereas 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 |
Plan, conduct, control, close
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, and a vague statement of work written in the first stage becomes a dispute in the third with a delay attached.
The contract signed is the relationship managed
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.
None of that is bad faith. Each is a rational response to incentives somebody wrote down, which is why the contract type is a delivery decision rather than a procurement formality, and why the project manager who will live with it for two years belongs in the room where it is chosen.