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Selecting the most effective contract type for a purchase is an important element of purchase planning and must be considered along with price, risk, uncertainty, and responsibility for costs. The nature of a purchase will determine the appropriate contract type. The type of contract selected should reflect the appropriate risk and responsibility that will be assumed by the supplier. For example, full cost responsibility is assumed under a firm fixed-price contract, while there is minimal cost responsibility under a cost-reimbursement contract. The selected contract type determines how the supplier will be paid; it drives the supplier’s fee or profit amount. Purchase/SCM teams may decide to use a type of contract not described in this process step subject to the approval of a portfolio manager. Cost plus a percentage of cost contracts may not be used.
The contract is also a driver of supplier performance. An inappropriate contract type (e.g., supplier’s risk is too high) can lead to the supplier delivering sub par work, renegotiations, or a unsuccessful relationship with a supplier. A wide selection of contract types is necessary to provide the flexibility needed for the purchase of a large variety of products and services.
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