Procurement questions on the PMP often come down to one idea: who carries the cost risk? Once you can answer that for each contract type, most of these questions answer themselves.
The three families
| Contract type | How the seller is paid | Who carries most risk | Best when |
|---|---|---|---|
| Fixed price | One agreed price for a defined scope | The seller | Scope is clear and stable |
| Cost-reimbursable | Actual costs plus a fee | The buyer | Scope is uncertain or likely to change |
| Time and materials (T&M) | A rate per hour or day, plus materials | Shared, leaning to the buyer | Small jobs, staff augmentation, or work that must start before scope is clear |
Fixed-price variations
- Firm fixed price (FFP): one price, no adjustments. The seller absorbs any overrun.
- Fixed price incentive fee (FPIF): a target price, with a bonus or penalty depending on performance against targets, up to a ceiling.
- Fixed price with economic price adjustment (FP-EPA): used for long contracts, with adjustments tied to something like inflation or a commodity index.
Cost-reimbursable variations
- Cost plus fixed fee (CPFF): costs are reimbursed and the fee stays the same whatever the final cost.
- Cost plus incentive fee (CPIF): the fee rises or falls depending on how actual costs compare with a target, often with a sharing ratio.
- Cost plus award fee (CPAF): the buyer decides the award fee based on agreed performance criteria. It's largely at the buyer's discretion.
A worked example (incentive fee)
A buyer agrees a CPIF contract: target cost $432,000, target fee $36,000, and a 70/30 sharing ratio (buyer/seller). The seller finishes for $396,000, which is $36,000 under target.
- The seller's share of the saving is 30% of $36,000 = $10,800.
- Final fee = $36,000 + $10,800 = $46,800.
- The buyer pays the actual cost plus the fee: $396,000 + $46,800 = $442,800.
If the seller had overrun by $36,000 instead, the fee would drop by $10,800 to $25,200. That's the point of an incentive: both sides gain from keeping costs down.
How the exam tests it
Example: A company needs a new system, but its requirements are still evolving and will be refined with the vendor over several months. Which contract type is most appropriate? A cost-reimbursable contract, because scope isn't stable enough for a fixed price. A vendor asked for a firm fixed price here would either add a large risk margin or refuse.
Flip it: the scope is detailed, signed off and unlikely to change. Now firm fixed price is usually best, because it moves the cost risk to the seller.
Practise procurement questions
Read the PMP chapter on planning and managing procurement, try the PMP formula sheet for the cost calculations, then test yourself in the free PMP mock exam.