This article has been written by Bhumika Saishri Panigrahi pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Dipshi Swara (Senior Associate, Lawsikho).
Table of Contents
Introduction
A contract between a contractor and a client might take a number of different forms. A fixed-price contract is one in which the contractor commits to complete a specific task for a specific price. This indicates that both parties are aware of the amount of money that will be exchanged. The contractor knows how much he or she will be paid, and the client knows how much he or she will be required to pay. A fixed-price contract has various advantages for both parties. When you sign a fixed-price contract, you agree on the final price of a product or service upfront. This pricing is spelled out in a contract that both parties agree to follow. The project budget is set under a fixed price model. To build a product, you (the client) pay a predetermined amount of money, which is determined by two factors: the scope of the project (i.e., the number and complexity of features) and the timeframe you set. You can pay a single amount for everything, including features, materials, and problem fixes, with this form of contract. To work efficiently in the fixed model, the end product must be extremely well-defined, right down to the smallest detail. As a result, the planning step will almost certainly take significantly longer than on previous projects. The duration of the set pricing is determined by the contract’s terms. A small firm can determine whether or not to use a fixed-price contract by weighing the benefits and drawbacks. This article will specifically focus on the advantages and disadvantages of a fixed price contract.
- Requirements of a fixed term contract: : When signing a fixed-price contract, the client and the contractor should agree on clear, specified task requirements as well as a reasonable cost estimate.
- Furthermore, the parties should be able to agree on a delivery schedule for the task as well as a reasonable pricing.
- Finally, before the final pricing agreement, the contractor should offer an estimate or bid.
Advantages of fixed price contracts
This sort of contract provides a predictable scenario for the seller and buyer, as well as stability for both sides over the contract’s duration. Buyers may be concerned that the price of a service or commodity will rise unexpectedly, disrupting their business objectives. As a result, sellers may be apprehensive about the value of their service or commodity plummeting unexpectedly, reducing their income. Buyers profit from the predictability of a fixed-price contract since any uncertainty about the project’s final expenses that exceeds the original estimates is shifted solely to the seller.
Employees of the buying firm may prefer a fixed-price contract since it provides them with a solid budget to present to their superiors for approval, as opposed to a contract with prices that can climb indefinitely over time. Buyers benefit when the market raises the worth of a service or commodity, but sellers lose potential earnings they would have made if they didn’t have a set price contract.
This sort of contract may initially cost the buyer more money; however, it is beneficial since the buyer can budget for the contract’s costs and ensure that there are sufficient finances to complete the agreement. A fixed price contract offers definite parameters for the contract’s overall worth, and as a business owner, there are numerous benefits to employing this type of agreement. The following are some of them:
1. Allowing your business to maintain control over the amount payable.
2. Maintaining control over the contract’s maximum value.
3. Managing the cost of employing outside of the company. Controlling the cost of hiring is advantageous since the contractor and firm will determine the complete agreement value before signing it, ensuring that there are no surprises. The contract’s monetary value will remain unchanged.
- Cost Clarity is an advantage
A fixed-price contract provides a predictable scenario for both the buyer and the seller, as well as stability for both parties throughout the contract’s duration. A buyer may be apprehensive that the price of a good or service will rise unexpectedly, disrupting his business objectives. The seller may be anxious that the value of his product or service will drop unexpectedly, lowering his income with little or no notice. Fixing the price eliminates all of these concerns.
A buyer may also profit from the predictability of a fixed-price contract, because any degree of uncertainty about the project’s final cost surpassing earlier estimates is wholly transferred to the seller. If you’re buying supplies or resources, a fixed-price contract may be preferable to a contract where costs may climb indefinitely over time because it offers you a concrete budget to deal with.
2. Market Change
When market forces alter the value of a product or service, including any materials or supplies required in its creation, a fixed-price contract might be advantageous or disadvantageous. If market forces drive the value of the commodity or service to skyrocket, the buyer benefits, but the seller loses out on potential gains he could have made outside of the fixed-price contract. The buyer is at a disadvantage and the seller is at an advantage when the price of a good or service drops suddenly.
3. Budgeting and Financial Capacity
Even though a fixed-price contract may cost a buyer more money up front, the buyer can budget for the contract’s expenditures and ensure that it has adequate funds to meet its obligations. When the price of a commodity or service rises drastically, the buyer may no longer be able to fulfil the contract, forcing the seller to accept a loss and consider legal action. If the goods or services are required for the buyer’s business to function, the buyer’s business may suffer.
4. There is a set deadline.
The development team can better predict the project’s timeline with a final scope and specified features. They can then create a clear plan with specific deadlines based on this information.
5. A development timetable that is simple to follow.
At any point during the project, you’ll know which features will be implemented. You’ll also be able to detect if the delivery is running late.
6. The client does not need to manage anything.
You can delegate project management to the developer team now that the project details have been finalised. You don’t need to keep an eye on things all the time, so you can keep your involvement to a minimal.
Shortcoming of a fixed term contract
A fixed pricing contract gives a buyer more certainty about future service or goods costs, but it does come at a cost. Because sellers may recognise that they’re taking a risk by having a fixed price, they may charge more than they would for a variable price. The seller is at a disadvantage and the customer is at an advantage if the price of a service or good reduces suddenly.
The buyer will be unable to honour the contract if the cost of the service or items significantly increases. This means the seller must treat the transaction as a loss and determine their legal options.
- Comes at a higher price
A disadvantage is that certainty comes at a higher price.
A fixed-price contract provides a buyer with more certainty regarding the future expenses of the commodity or service specified in the contract, but this certainty may come at a cost. The seller may recognise the risk he is taking by fixing a price and charge more than he would for fluid pricing, or a price he could negotiate with the seller on a regular basis, to pay for the higher risk the seller is incurring.
- Planning takes a long time
This contract type is not for you if you have a tight deadline for delivering your goods. To be able to estimate accurately, the software company must first specify features in great detail, which can take weeks or months.
- Process that is rigid
There is no way to change or add features after you sign the contract. Let’s imagine the market demand shifts, and a feature becomes obsolete or a new feature is required. You won’t be able to change the project’s scope without negotiating each new feature and restarting the planning process. This could cause a significant delay in the product’s delivery.
4. Not recommended for large-scale projects
The fixed price strategy works effectively for smaller projects. The fixed approach, on the other hand, will be overly stiff if your product is more sophisticated, such as an e-commerce website or a multi-platform mobile app. Complex functions, dependencies, and long implementations necessitate ongoing examination, modification, and adaptability.
5. There is a chance of miscommunication
Clear and transparent communication is required to perform efficiently in a fixed price business. If you overlook a detail or the project specifications are unclear, you can end up with something that isn’t exactly what you expected.
Conclusion
There are various methods for obtaining a fixed pricing, but they all serve the same purpose. This is done by having a risk premium that covers uncertainties and contingencies to fairly balance the risk between the customer and the consultant. It calculates the number of resources and time required to complete the job. A risk premium also guards against any unexpected surprises that may arise over the course of a project. Estimates should not be given lightly because they tend to stay in the memory of the client for a long period. In this circumstance, you should follow the guidelines. Without a project task list, it’s practically impossible to make an accurate estimate unless the project has been completed before and there are no risk factors. Estimates must be accurate since they are made by those who will deliver the project. Before the project’s estimate becomes part of the fixed price, any disagreements must be resolved. With each project, you’ll need to assess and score the risk elements so that the appropriate premium may be applied.
References
- https://www.upcounsel.com/advantages-of-fixed-price-contract-in-construction
- https://smallbusiness.chron.com/advantages-disadvantages-fixedprice-contract-21066.html
- https://www.netsuite.com/portal/resource/articles/accounting/fixed-price-contract.shtml
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