What is a Fixed Price Contract in Project Management?

When it comes to charging for services, it can feel like every firm has their own way of doing it. One might charge an hourly rate; others work on a retainer basis offering a specific package of services. But many clients favor one particular type of arrangement: the fixed-price contract.

But what is a fixed-price contract? How do you decide which projects to use them with? What are the benefits – and risks – of utilizing this type of project agreement?

In this article, we will help you navigate the ins and outs of fixed-price contracts in project management.

What is a fixed-price contract?
What are the types of fixed-priced contracts for projects?
What is the advantage of a fixed-price contract?
What are the risks of a fixed-price contract?
When is a fixed-priced contract appropriate for a project?
How can you manage a fixed-price contract project?

What is a fixed-price contract?

Fixed-price contracts are, as the name suggests, contracts where the pricing is fixed. Typically, the client describes what they need from the project in terms of tasks, deliverables, and delivery time, and the supplier then confirms the price of the job. Once agreed between the two parties, the costs for the work described are fixed.

Fixed-price contracts work well for clients because there are no nasty surprises in costs later on. Regardless of the actual costs of the materials, or the number of people you assign to work on the project, the client's invoice will be exactly what they're expecting.

How is fixed-price different from hourly contracts?

Another common type of contract is an hourly basis contract, in which billable hours are tracked and charged to the client. A fixed-price contract, on the other hand, costs the same regardless of how many hours are spent working on it.

Time and materials contracts, based on material costs and labor rates, are another type of contract where the costs add up as the project progresses. Fixed-price contracts consolidate those costs up front into the agreed price.

Another common type of contract, called the cost-plus contract, is based on the service provider being reimbursed for their costs, plus a share of the profits of the project. However, the final price of cost-plus contracts depends on the success and profit generated by the project, while fixed price contracts provide the security of a guaranteed payment.

What are the types of fixed-price contracts for projects?

While the premise of a fixed-price contract is that the value is agreed before the project commences, there are different types of fixed-price contract that offer different levels of flexibility:

Firm fixed price contract

Firm fixed-price contracts, or FFPs, are contracts where the client pays for one agreed amount regardless of the costs incurred during project implementation. A firm-price contract only changes when the scope of the project changes, to reflect the cost of the additional work carried out.

Fixed price with economic price adjustment contract

The fixed price with economic price adjustments contract is based on a fixed-price contract, but allows for the fact that economic factors might have a significant impact on costs as time progresses. At the end of the project, adjustments are made to account for economic factors like inflation, currency rate, and average labor rates.

Fixed ceiling price contract

Another type of fixed-price contract that provides more wiggle room is the ceiling price contract, which sets out a maximum price based on the agreed terms. This kind of contract protects the client from excessive costs, while allowing the service provider to charge for their materials and time within defined parameters.

Fixed price incentive contract

There are two other types of fixed-price contract that include an element of incentive.

Fixed-price incentive contracts are based on a firm-fixed-price contract, but include specific criteria that would qualify for an incentive. Examples of these criteria could be finishing part of the project before a specific date, or achieving certain metrics. If these are achieved, the client pays the incentive as well as the fixed price of the contract.

Another type of incentive contract is the fixed-price award contract. In this contract, the client pays a performance bonus on top of the fixed-price contract, based on their subjective evaluation of the project, rather than achieving specific criteria.

What is the advantage of a fixed-price contract?

They may not be popular among project managers, but there are benefits to having a fixed-contract price. Here are some of the advantages:

Fixed-price projects are usually well-defined. Because both parties know they are setting all the agreements up front, the discussions are usually detailed, on-point and direct, reducing room for misunderstanding. This makes it easier for the project manager to plan and execute the project.
They can attract more customers. Fixed-price contracts are attractive to clients, particularly those who might have been stung by an excessive bill from a previous service provider.
They can improve workflow and reduce costs. When your firm routinely offers specific projects as fixed-price contracts, the whole team knows what to expect and can jump into action once they've got the green light. The familiarity reduces stress on the team, compared to handling projects with ever-changing variables.

What are the risks of a fixed-price contract?

Like any other contract, a fixed-price contract has its own share of risks and exposures. Here are some considerations you should take into account before engaging in a fixed-price contract:

Unexpected costs or delays: However good your planning, you can guarantee there will be some kind of hiccup along the way. With fixed-price agreements, you need to ensure a contingency has been included in your budget, because if the project is not completed on time or requires additional resources, these costs cannot be charged to the client. In some cases, projects may start going over budget, and your organization ends up losing money instead of earning profit.
Client changes: Scope changes need to be handled clearly in fixed-price projects, as you won't be able to charge for the extra work through the existing system. Establish scope change processes with the client early on, and document them appropriately, so that it is clear what is included and what will incur additional costs.
Client communication: Sometimes issues with client communications, such as delayed approvals, repeated revision requests, or miscommunication, can stall a project or increase the work involved. While this can be frustrating in any project, for fixed-price contracts you may find your company footing the bill.

When is a fixed-price contract appropriate for a project?

Fixed-price contracts are great for projects that fit the following criteria:

Well-defined scope with clear outputs, so all parties are clear when the end-point has been reached.
Comprised of tasks or activities that your team is familiar with, so it's easy to budget out and package together.
Short-term, so your costs are unlikely to be subject to economic price swings during the project period.
Independent: no need for the client to supervise closely or have regular input; your team can move along at their own pace.

However, for projects where you're venturing into new territory, your client wants a high degree of creative input, and there is the potential for the project to expand or extend in the future, a fixed-price contract might present more problems than it solves.

How can you manage a fixed-price contract project?

One of the biggest concerns when working with fixed-price contracts is producing high-quality work for the client, whilst staying within the original budget.

The process starts with generating an accurate budget estimate, from which you can calculate the contract price. Using a bottom-up estimating technique can help you work on developing accurate cost estimates needed for each activity, to ensure you don't under-estimate the cost of the work.

During the implementation phase, you will need to employ the same level of project cost management as cost-based projects, with the additional incentive that optimizing your resources can help maintain your profit margin.

You can manage fixed-price contracts using a project management tool that allows you to simultaneously monitor your budget and schedule, like Runn. With Runn's fixed-price setting, you can conveniently control your schedule, allocate and organize your planned resources, and prioritize tasks using the Project Planner and Project Stats.

You can also plot and identify your baseline to keep an eye on the project's scope throughout the project implementation, and ensure changes are managed appropriately.

Runn makes fixed-price contracts profitable

Successfully managing fixed-price contracts can bring a number of benefits to your business, but they can also present several risks. Ultimately, in order for fixed-price contracts to be profitable, you need to keep a handle on your costs.

That's where a tool like Runn can really save your bacon. With clear, real-time reporting, Runn makes it easy to see how the project is progressing against the budget. Runn's project performance report surfaces the key information you need to understand what direction your project is going in - so that you can course-correct before things go off the rails.