Contract Types: An Exposition of Cost - Price Relationships in a New Paradigm

Abstract

Abstract Key decisions in procurement are contractor selection, price, and contract type. Resource managers should be deliberate in considering contract type because contracts by nature allocate risks and rewards and influence contractor performance and final price. Choice of contract type is particularly important in today's collaborative procurement environment wherein the contractor base is reduced, negotiation tends to replace market competition in pricing, and contractor management is critical. This article facilitates better procurement strategy and cost management with regard to contract selection by introducing a general contract equation and a mathematical exposition of cost-price relationships and incentive implications, in the context of a new paradigm of contract types. The paradigm portrays contracts in three general categories: fixed-price contracts, cost-reimbursable contracts, and risk-sharing contracts. Narrative, mathematical, and graphic depictions of these contract types provide important implications for risk allocation, incentives, and cost management.