If you're preparing for the Project Management Professional (PMP®) exam, understanding contract types is essential—not just for passing the test but for real-world project execution too. Contracts are the backbone of procurement management. They define the relationship between buyers and sellers, outline obligations, assign risks, and protect both parties legally.
In the PMBOK® Guide, contract types fall under the Project Procurement Management knowledge area. This blog provides you with a detailed breakdown of the three main types of contracts, their variations, when to use each, and how to tackle related PMP exam questions confidently.
Why Are Contracts Important in Project Management?
Contracts are legally binding agreements that:
• Define scope, time, and cost expectations
• Allocate risk between buyer and seller
• Protect parties if something goes wrong
• Provide a framework for conflict resolution
In PMP terms, contracts directly influence cost, schedule, and quality management and can determine project success or failure.
PMP Contract Types: An Overview
The three broad categories of contract types are:
- Fixed-Price Contracts (Lump Sum)
- Cost-Reimbursable Contracts
- Time and Material (T&M) Contracts Let’s break each one down with examples, pros, cons, and when to use them.
- Fixed-Price Contracts (Lump Sum) A Fixed-Price Contract means the seller agrees to deliver a defined product or service for a pre-agreed price, regardless of the cost they incur. Subtypes: • Firm Fixed Price (FFP) – No adjustments. Most commonly used. • Fixed Price Incentive Fee (FPIF) – Incentives tied to performance metrics (e.g., finishing early). • Fixed Price with Economic Price Adjustment (FPEPA) – Adjusted for inflation or currency fluctuation, useful in long-term projects. Advantages: • Predictable costs for the buyer • Shifts risk to the seller • Simple to manage and budget Disadvantages: • Seller may cut corners to stay profitable • Changes require formal change orders • Less flexibility once signed Example: A company hires a software firm to build an app for $80,000, regardless of actual development hours. Best For: • Clearly defined scope and deliverables • Minimal changes expected • Projects with mature technologies or repeatable tasks
- Cost-Reimbursable Contracts Also known as Cost-Plus contracts, here the buyer agrees to cover all actual costs incurred by the seller plus a fee or incentive. These are used when scope is not clearly defined. Subtypes: • Cost Plus Fixed Fee (CPFF) – Seller is reimbursed plus a fixed fee. • Cost Plus Incentive Fee (CPIF) – Seller is reimbursed plus an incentive for meeting performance targets. • Cost Plus Award Fee (CPAF) – Seller is reimbursed plus an award based on subjective buyer judgment. Advantages: • Encourages innovation and flexibility • Suitable for complex or evolving projects • Can incentivize performance Disadvantages: • Less cost control • Buyer assumes risk of overrun • Requires close monitoring and auditing Example: A research firm is hired to develop a new prototype. The buyer pays all expenses plus a 10% fixed fee. Best For: • R&D, prototypes, or innovation-heavy work • Unclear or evolving requirements • Projects where the buyer wants more control or quality
- Time and Material (T&M) Contracts A hybrid between fixed-price and cost-reimbursable. The buyer pays the seller based on actual time spent (hourly/daily rate) and materials used. Advantages: • Simple to start and scale • Good for short-term or agile work • Flexibility in scope Disadvantages: • Hard to predict final cost • Risk of misuse or inefficiency • Requires constant oversight Example: A client hires a freelance designer at ₹2,000/day for 15 days, and agrees to reimburse any tool subscriptions or stock photos. Best For: • Staff augmentation • Agile/scrum projects • Short-term needs with evolving scope Contract Type Comparison Table Feature Fixed-Price Cost-Reimbursable Time & Material Cost Certainty High Low Medium Buyer Risk Low High Medium Seller Risk High Low Medium Flexibility for Changes Low High Medium-High Admin Overhead Low High Medium
How PMP Exam Tests You on Contracts
The PMP exam tests your judgment in selecting the right contract type based on project conditions.
Sample Question:
A buyer wants to outsource part of a project. The scope is well-defined and there’s no room for changes. What contract type should the buyer choose?
Correct Answer: Firm Fixed Price (FFP)
Tip:
Memorize which party carries the risk in each contract type. PMP often tests this understanding in scenario-based questions.
Real-World Contract Decision Scenarios
• New Technology or R&D ➝ Cost-Reimbursable
• Construction with a clear blueprint ➝ Fixed-Price
• Short-term developer hire with unknown timeline ➝ T&M
Always consider:
• How well is the scope defined?
• Who should bear the risk?
• How much flexibility is needed?
PMP Study Strategy for Contracts
- Master the Terminology Use flashcards for terms like CPIF, FPIF, FPEPA, etc.
- Understand Risk Allocation Who takes the cost overrun? Who gains in performance?
- Practice with Scenarios Use situational PMP questions to strengthen decision-making.
- Draw Mind Maps or Tables Visuals help with quick recall during exams.
- Link to Procurement Processes Understand how contracts integrate with Plan Procurement Management, Conduct Procurement, and Control Procurement. Conclusion: Contracts = Control + Clarity Contracts are not just legal documents—they are project control tools that define scope, cost, time, and risk. Understanding the three major contract types and their subtypes can help you succeed both in the PMP exam and in your project management career. Always think like a project manager: What’s the best contract type for this scope, this risk level, and these project constraints? Website: https://www.icertglobal.com
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