Procurement Contract Types

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Sollish et al (2011) states that the decision over what contract type to use is one of the most important strategic decisions; because the type of contract has an influence on how the contractor is paid and the risk allocation between the contracting parties. In making such a decision the goal should be to get the optimum project objective attainment likelihood.

According to Sollish et al (2011), there are two major types of contracts: * Price-based contracts: give the supplier the incentive to work efficiently, controlling costs while maximising profits. In general, the supplier only provides services and goods that meet the absolute minimum specification requirements. The supplier bears a comparatively higher risk level. From the buyer’s perspective, this type of contract presents a contract structure that is relatively inflexible. * Cost-based contracts: tend to be more collaborative though they present a lower control degree on the supplier thus demanding more managerial effort on the buyer’s part. The risk borne by the contractor is reduced whereas that of the buyer is increased. There is relatively high flexibility and therefore can accommodate high change levels.

Turner and Simister (in Sollish et al 2011) recommend that the uncertainly of the final product and not necessarily the risk should determine the appropriate contract type to be used in transaction cost analysis. They authors goes on to suggest that goal alignment is more important when the objective is develop a project organisation based on cooperation and not conflict. Consideration should be given to incentivize all contract parties. Given that the project involves specifications that are likely to change during the project life, a cost-based contract would be most appropriate in this case. This is supported by Sollish et al (2011) in their recommendation that time...
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