1.0 Compare and contrast fixed-price contracts and cost-reimbursement contracts in terms of the benefits and drawbacks of each for your business.
Fixed- price contract is one whereby the price of the goods, works or services to be provided is agreed upfront so that the contractor gets paid the amount agreed upon after successfully supplying or providing the contract service. This type of contract is appropriate for goods and services that can be adequately described so that both parties are able to understand the requirements and at the same time asses any risk that may be involved in discharging the contract. This aspect is important in arriving at the contract price objectively rather than arbitrary.
Cost-reimbursement contracts on the other hand are contracts that provides for payment of all costs incurred within a pre-determined reasonable ceiling as agreed by the client and the contractor at the beginning of the contract for supply of goods or services. This type of contract is appropriate in cases where uncertainties involved may not permit estimation of a fixed price accurately. This type of contract helps management of high contingency provisions associated with fixed-price contracts to cover the contractor in case of any unforeseen price changes and high cost of prices.
Comparison based on Benefits and drawbacks
- Inflationary effects
Fixed-price contracts
Since the contract price is fixed, our business is likely to suffer the negative effects of inflation which often leads to high production cost due to high prices and increase in interest rates on borrowed capital.
Cost-reimbursement contracts
Our business is cushioned from effects of inflation since the final payment is based on the actual cost. This means that even if prices hike due to inflation, the client will meet the cost of the price increase as long as it is within the agreed limits.
- Controlling of costs
Fixed-price contracts
Our business will ensure measures are put in place to control production costs given that the contract price is fixed and our profits will be determined by the production overhead. This scenario will promote adoption of efficient methods of running our operations so as to produce more with less but of high quality.
Cost-reimbursement contracts
Our business will be covered by the client incase of cost escalation. This is because the client will be paying for the actual cost at the time of production including any price increase or cost of production. The risk of cost escalation under this type of contract is low
- Flexibility in contract implementation
Fixed-price contracts
This type of contract has specific items at a specified price and therefore little room for exploring other options. However, the specific items and price is good for us because what is expected is known form the start of the contract and planning on production resources is done smoothly.
Cost-reimbursement contracts
This type of contract provided for flexibility because the requirements are not very specifics and the client can come up with changes in specifications depending on what suits them. This however is likely to take much of our time as we shall be required to make changes as requested by the client.
- Continuous cash flows
Fixed-price contracts
Payments for this type of contracts are predetermined and therefore our business can plan on how to have a continuous cash flow necessary to run the operations of the business. This will spare our business from high borrowing interest rates whenever emergency borrowings are made.
Cost-reimbursement contracts
This type of contract on the other hand does not have predictable payment patterns. There challenge this has is that we may lose out on a business opportunity due to lack of cash and end up paying more interest rates on credit facilities.
2.0 Analyze at least three (3) opportunities your small business will have compared to large businesses in general.
The opportunities our small business will have compared to large businesses are as follows:
2.1 Lean Organizational Structure
Our small business has fewer levels of management and this therefore makes decision making much quicker. There is also flexibility and adaptability to any changes in the external environment presenting opportunities for the benefit of our firm. This is unlike in large businesses where a decision has to go in various stages before being approved. The delays in decision making can easily make a firm lose on a business opportunity that required a quick decision or way of operation.
2.2 Close contact with customers
Customer relationship is very important for sustainability of any business today. This is because, today’s customer has access to information and their expectations keep changing. Being a small business, we are able to develop and maintain a close relationship with customers, give customers prompt responses to issues raised by customers, and develop new products that meet the current needs of customers. This is not the case in large businesses which often outsource customer care services and therefore lacks direct contact with customers.
2.3 Flexibility in adapting to changes
Today’s business environment is very dynamic and businesses must be in a position to adapt to the new changes to ensure survival and sustainability. A small business like ours is more flexible to adapt to changes in the business environment that come with opportunities more than the large organization. This includes customization of products depending on the prevailing customer needs due to the few people involved in decision making. Any business opportunity that requires fast adaptability is taken advantage of by our small business more than it could be the case in a large business.
3.0 Discuss which element(s) of cost-reimbursement contracts tend to produce the biggest troubles for your small business. Provide a rationale for your choice(s).
The one element in cost-reimbursement contract that tend to produce the biggest troubles for our small business is scope definition. The following items if not well defined results to big trouble during contract implementation.
3.1 Reimbursement compensation structure.
3.2 Owner-contractor decision making roles and scope.
3.3 Procedural controls.
4.0 Determine which form of contracting would benefit your business the most among all the forms of contracting. Support your response.
Selecting the appropriate type of contract that will be beneficial to one’s business is essential in successful implementation of any particular contract and business as a whole. This is because the type of contract determines the risks involved as well as the cost and profits to be realized after completion of the contract.
The most appropriate form of contract that may benefit our business is cost-reimbursement contracts because of the following reasons:
4.1provision for cost-plus-fixed-fee clause in the contract.
This clause provides for payment of all costs incurred within a predetermined ceiling and on top of that, an agreed fixed amount which does not change. This provision is good for our business because it will enable us minimize losses occasioned with unforeseen increase in prices and production cost that may eat into our profits if we were to go for a fixed price form of contract.
4.2 Payment of all costs incurred.
This form of contract ensures that the client pays for all costs incurred. The risk of price uncertainties and changes is therefore passed on to the client while our business is left with the responsibility of sourcing for the materials at competitive prices.
4.3 Minimize cases of wrong estimates.
Wrong estimates in a fixed price contract may be costly. Incase of an under estimation, the business will end up a lot of uncompensated overheads leading to huge losses. In Cost –reimbursement contract however , our business will be paid the entire cost and be able to make its profit from the fixed fee payable after paying for the cost.5.0 Choose the most significant form of contracting that would support large companies (e.g., Boeing) among all the forms of contracting Support your response.
The most significant form of contracting that would support large companies such as Boeing is Fixed-price contracts because of the following reasons:
5.1 Less administrative burden
Fixed-price contracts unlike the cost-reimbursement contracts have less administrative activities. This is because the price of the contract is fixed and the contractor is only required to deliver the specified item for payment to be effected. Large companies usually have many contracts with various clients and this form of contract gives them less administrative burden.
5.2 Transparency
The source of business opportunities for large businesses is governments. Given that governments use taxpayer’s money in procurement, transparency is a key factor in any contract awards. Fixed-price contracts are considered more transparent because the cost of any procurement is known from the start and does not change until the contract is successfully implemented. Large businesses therefore stand to gain much if they adopt fixed-price contracts.
5.3 complexities of materials and technologies used
Large businesses source materials and technologies from various suppliers some of whom they are in contracts with. The prices at which they obtain their materials therefore may vary from time to time. a fixed-price form of contract is favorable because this firms can estimate with accuracy how much the cost an item will be because of the fixed price contracts they have with their suppliers.
5.4 Potential to get more business from government
With fixed-price contracts, large firms can submit as many bids as possible and as long as their quoted prices is lower than that of other bidders, they are likely to get more business from government if their proposals are considered more competitive.
5.5 Economies of Scale
Large businesses operate on large scale in terms of the materials they purchase and the production capacity in place. This provides them with an opportunity to achieve economies of scale in their operations. Fixed-price contracts are favorable for such large firms because they are able to protect themselves against the risk of cost overruns which are absorbed by the economies of scale and therefore able to achieve their target profits.
6.0 Develop a plan on how your company would justify the government to award your company the contract when the form of this contracting supports larger companies.
Our company’s justification to be awarded the contract is based on our strengths which will translate to the government getting value for its money once they award us the contract as illustrated below:
6.1 Sound financial management
We pride our self for having a strong financial base due to our reliable cash flows, growing profitability and turnover. Getting credit facilities is equally easy because of our strong credit rating records with our lending institutions.
6.2 Strong marketing base
We have strengthened our marketing base by broadening our customer base, currently we have a contract with DoD worth $600,000. We have also invested in research and development to come up with innovative products that meet our customer needs. Given that we are a small firm, our after sale service is prompt and satisfactory. We have also registered our designs and they are protected under intellectual property and therefore you can only get the kind of product you need from us alone.
6.3 Resourceful manpower
Our staff establishment is composed of skilled individuals who are competitively hired and very efficient in administration of contracts. The lean structure equally makes our decision making process quick for the benefit of our customers.
6.4 Efficiency in production
Our firm has invested in modern low cost production facilities with extra production capacity. Further, we have entered into strategic partnerships with our suppliers for materials and sub-assemblies. These arrangements have enabled us to achieve efficiency in production so as to get quality products, at the least cost and to the satisfaction of our customers
Given the above strengths, we are able to deliver successfully any contract awarded to us by government irrespective of the form it will take.
References
Cronk, Thomas & Hill, Charles. Global Business Today. McGraw-Hill Australia, 2008 Peterson, Pamela. Analysis of Financial Statements. New York: John Wiley & Sons, 1999
Rapp, Birger. Understanding Competitive Advantage: The Importance of Strategic Congruence and Integrated Control. New York: Springer. 2005
