With a fixed-price contract, the customer pays the contractor a set fee irrespective of the actual cost to complete the contract. The contractor bears the risk of loss associated with expenses more significant than anticipated but gains if costs are lower than predicted (Klastorin & Mitchell, 2020). For some causes of uncertainty, such as quantity fluctuation and unpredictable ground conditions, the contractor will be eligible for extra compensation via a claims process. In terms of benefits, a fixed-price contract provides both the buyer and the seller with a stable, predictable situation throughout the contract (Klastorin & Mitchell, 2020). Moreover, even though a fixed-price contract may initially cost the buyer more money, the buyer can budget for the contract’s expenses and guarantee that it has sufficient cash to meet its obligations (Klastorin & Mitchell, 2020). However, the assurance comes at a greater price, as the seller may recognize the risk they are taking by setting a fixed price and so charge more than they would for a variable price.
Cost-plus Contract
In terms of risk distribution, this contract is primarily employed in the construction industry, where the buyer accepts a portion of the risk while simultaneously allowing the contractor some degree of freedom. In such a scenario, the party drafting the contract believes that the contractor will fulfill their obligations and agrees to provide higher compensation so that the contractor may earn a more significant profit upon completion. A Cost-plus contract removes some risk for the contractor by allowing the contractor to receive a specified amount in addition to the amount paid (Klastorin & Mitchell, 2020). It also permits a change in emphasis from the total cost to the service quality. In this instance, the contract covers all costs associated with the decentralized project; thus, there are no unexpected charges (Klastorin & Mitchell, 2020). However, there are drawbacks to this sort of contract since it takes more resources to duplicate and explain all expenditures. Additionally, the contract may result in difficulties when collecting construction-related charges.
Performance-based Contract
With risk allocation in a performance-based contract (PBC), the execution of the task would be compensated at a defined rate. However, extra incentives to a client may be awarded dependent on the result of the service by the contractor. Most PBCs are hybrid schemes, combining fixed and variable payments to a client, and the primary distinction between standard contracts and PBCs is the proportion of payments provided via variable payments (Klastorin & Mitchell, 2020). In terms of risk allocations, PBC have both benefits and drawbacks. For instance, the contract reduces the service provider’s expenses by permitting capacity sharing across different contracts, resulting in increased resource utilization and cost savings. The contract decreases the customer’s investment expenses by preserving their financial resources and decreasing their capital commitment to machinery or equipment (Klastorin & Mitchell, 2020). Concerning the capital costs associated with retaining ownership of the machinery or equipment. However, the performance provider faces the challenge of making available its financial resources for investment in supplied machinery or equipment that can be refinanced only gradually by the service fee.
Incentive Contract
An incentive contract is an agreement between two entities in which one side promises to provide additional compensation for exceptional performance. During risk allocation, the contractor and client debate the contract’s price ceiling and predict the final expenses (Klastorin & Mitchell, 2020). The contractor earns a profit if the initial project costs are less than the end project costs. Similarly, the contractor incurs a loss if the initial cost of the project exceeds the ultimate cost (Klastorin & Mitchell, 2020). Its benefits include fostering more ownership over the finalized work and enhancing communication channels throughout the process. Nonetheless, it creates more administrative revenue for the owners at the cost of the user. Furthermore, extra time is needed since additional negotiating time is used.
Reference
Klastorin, T., & Mitchell, G. (2020). Project management a risk management approach. Sage Publication.