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Fixed price contract: What is it and how does it work?
Learn the pros and cons of fixed price contracts and when to use them.
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A fixed-price contract is a type of contract where the agreed payment amount is not subject to adjustment, regardless of any costs incurred or time expended by the contractor. This type of contract is different from a cost-plus contract, a time-and-materials contract, and a labor-hour contract.
What is a fixed price contract?
A fixed price contract (or fixed price agreement contract) outlines a single set price for a project, no matter the time, labor, or resources it takes to complete the job. These types of contracts are often used in construction projects or contracts with the U.S. government because they are straightforward with one bottom line, thus avoiding potential cost overruns. While fixed price development contracts come with higher risks for contractors, they can be an efficient and lucrative way to handle project agreements.
A fixed-price contract is a type of agreement where the buyer and seller agree not only on a predetermined price but also on a specific scope of work or project. The specified scope should help ensure that the price remains unchanged by reducing the probability of fluctuations in labor or unforeseen expenses that may arise during the execution of the contract.
Fixed-price contracts differ from time and materials (T&M) contracts, where clients pay based on the actual time spent and materials used, making costs more flexible but potentially unpredictable. Another alternative is a cost-plus contract, where the client reimburses the contractor for actual costs incurred along with an additional fee or percentage for profit. Unlike these variable-pricing models, a fixed-price contract shifts the financial risk primarily onto the provider, as they must absorb any unexpected expenses while still delivering the agreed-upon results. While this contract type offers stability and simplicity, it requires careful planning and precise cost estimation to ensure profitability and avoid losses.
When to use a firm fixed price contract.
A fixed price contract is a good fit if you are working on a project with a clear scope of work and you can accurately estimate labor and material costs.
For example, some construction contracts may have daily or hourly rates that add to the total project cost straightforwardly. Others, like time and materials contracts or cost-plus contracts, include a fixed fee in addition to a cost reimbursement contract based on the actual cost of the work. And, while very similar to a fixed price, a lump sum contract can fluctuate based on factors such as indirect costs, a subcontractor agreement, or changes in procurement costs. But a fixed price contract is the only type that operates on a single flat fee, which brings simplicity to the paperwork.
Fixed-price contracts are commonly used in industries like construction, consulting, and freelancing, where clearly defined deliverables and timelines make it easier to estimate costs upfront. They provide cost certainty for clients and motivate service providers to manage resources efficiently while staying within budget.
They are particularly useful in transactions where costs can be determined in advance. Some common business scenarios include, but are not limited to:
- Buying inventory or office supplies at a predetermined cost
- Purchasing a vehicle or securing a fixed-price agreement for vehicle repairs
- Contracting an advertising agency to design a logo for an agreed-upon fee
- Paying a web development company a flat rate of $7,000 for website creation
In each of these cases, the price remains unchanged regardless of any unforeseen factors or additional effort required. This is the fundamental principle of a fixed-price contract.
What to include in a fixed price contract.
A fixed-price contract can be tailored to suit specific business needs, ensuring that both parties are aligned on expectations. However, certain key components are typically included to create a clear and legally enforceable agreement. These fundamental elements help define the terms of the contract, establish responsibilities, and protect both the buyer and seller. While the details may vary, incorporating these essential provisions is crucial for maintaining transparency and avoiding disputes:
- Name and contact information of the project owner and the contractor
- Legal description of the property being worked on and a detailed description of the work to be completed
- Completion date and date of final payment
- Terms for contract termination and consequences of breach of contract by either party, and terms for unforeseen accidents
- Change orders or a policy for adjusting the contract
- Hold harmless clause outlining details of warranties, liability, and indemnification
- Required licenses, permits, and insurance, as well as terms for access to the property and other necessary logistics
- Total contract price or terms for calculating construction cost and payment terms
- Right to withhold payment by the contract owner, and any terms for the condition of the property and disposal of items upon completion
- Signatures and date of signatures from both parties
Types of fixed price contracts.
The beauty of the fixed price contract is that there are no special subtypes or nuances to hassle with. However, if a contractor is working for the US government on a federal project, the rules are different.
Under the Federal Acquisition Regulation (FAR), the government may choose from a few special types of fixed price contracts, all of which are designed to let the government control costs, maximize taxpayer dollars, and put more of the risk on the vendor’s side. These special types of fixed price contracts include:
- Firm fixed-price contracts
- Fixed-ceiling-price contracts with price redetermination
- Fixed-price contracts with economic price adjustment
- Fixed-price incentive contracts
- Firm fixed-price level-of-effort contracts
Make and sign digital contracts with Adobe.
Fixed price contracts lend themselves to quick and easy signing, and for fast and simple contracts without the hassle, turn to e-docs. Everyone can view, comment on, and edit drafts in real time so that all parties are on the same page. With Adobe Acrobat for business you can send your contract to be signed in just a click, and the other parties can review and sign right from their phone or laptop.
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Fixed price contract: What is it and how does it work?
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