Contract types for the PMP: fixed price, cost plus and T&M
The pricing type decides who carries the risk. Fixed and firm prices move delivery risk to the supplier and need a fixed, clear scope; cost plus and time and materials leave most risk with the buyer, who keeps control over how the work is done.
Fixed and firm price
In the UK government's guidance, a fixed price agrees base prices at the outset and uplifts them by an agreed price index. A firm price is the same but with no indexation; at most an escalation factor agreed at tender, such as 2 percent a year. Other sources use these words differently, so read whether the price can move.
Both need a fixed scope and a clear specification. An ambiguous specification gives the supplier room to argue that some work is outside the price, so tighten the wording before tender. Firm pricing suits short contracts, generally up to three years. For longer contracts or uncertain inflation, the guidance calls fixed pricing with indexation commercial best practice.
Fixed pricing is not suitable where base prices cannot be estimated, such as an innovative design never costed before. There, cost plus may be the only option.
Cost plus and time and materials
Under cost plus the supplier is paid its directly incurred costs plus an agreed margin or fixed fee. Costs are tested as allowable or disallowable, so the arrangement is open book and the buyer audits what is claimed. It suits novel or first-generation contracts and pilots. It gives the buyer no price certainty and little supplier incentive to cut cost. As requirements become clear, parts of the contract can move to other pricing.
The Sourcing Playbook says that if the buyer wants to control how the services are delivered, it should use an input-based pricing model, normally cost plus or time and materials, and transfer little or no risk to the supplier. There should be no risk premium in the price.
Other approaches
Volume-based pricing pays a rate per unit used and suits a defined schedule of rates with variable demand. Payment by results ties payment to specified outcomes and transfers a lot of risk to suppliers, which can raise their prices. A guaranteed maximum price with target cost shares savings below the target, splits overruns above it equally, and caps what the buyer pays.
Where the exam catches people
Believing a fixed price works with a vague scope: fixed and firm pricing need a fixed, clearly specified scope.
Believing cost plus gives the buyer price certainty: the buyer carries the cost risk and cannot be sure of total spend.
Believing time and materials hands risk to the supplier: it is input-based, so the buyer keeps control and most of the risk.
Believing cost plus needs little oversight: it is open book, and the buyer must check that only allowable costs are paid.
Believing payment by results is low risk for suppliers: it transfers significant risk and can bring high risk premiums.