What is a Procurement Contract?

A procurement contract serves as a legally binding agreement between a purchaser and a supplier. Within this contract, the supplier commits to providing goods or services to the purchaser according to specific requirements, often at a predetermined price with potential discounts for larger volumes.

In return, the purchaser agrees to either accept delivery of and pay for a designated quantity of the supplier’s goods or reimburse the supplier for the expenses associated with providing the goods or services.

This contract forms the foundation for establishing and overseeing the relationship between the purchaser and the supplier, ensuring clarity and reducing uncertainties. To enhance supplier management practices, we’ve developed a strategic sourcing guide. Access it now to enhance supplier relations and achieve cost efficiencies.

What is included in a procurement contract?

At its core, a procurement contract defines the parameters of the relationship between the buyer and seller. It explicitly outlines the obligations and expectations of both parties, clarifying what each party is required to deliver and what they can anticipate from the other.

Key components typically found within a procurement contract encompass the following:

Monitoring and performance control

Monitoring and performance control encompass overseeing contract efficiency, managing procurement relationships, making necessary adjustments and corrections, and concluding contracts when necessary.

This process ensures that each party derives the intended benefits from the contract, safeguards their respective rights, and ensures compliance with contractual obligations.

Receipt, Inspection, and Acceptance

Upon receiving supplies from the seller, the procurement contract dictates the procedure for inspecting them to ensure compliance with agreed specifications.

Contract Termination

In the event of irreconcilable differences, the procurement contract specifies conditions for terminating the agreement, allowing both parties to part ways amicably.

Alternative Dispute Resolution

Rather than resorting to costly litigation, the procurement contract outlines procedures for resolving disputes, ensuring a structured approach to addressing potential issues.

Financial Management and Payment

The contract stipulates financial matters such as invoicing, payment terms, methods, and preferences, providing clarity on how financial transactions will occur upon meeting contract terms.

Performance Securities

The procurement contract guarantees the quality of performance expected from both buyer and seller throughout their partnership.

Contract Completion and Closeout

Acting as a comprehensive guidebook, the procurement contract details the process for transferring supplies, acceptable behaviors, and the overall conclusion of the contract.

Types of procurement contracts

Different situations and objectives call for various types of procurement contracts, tailored to manage risk effectively for both parties involved. Essentially, a contract serves as a risk management tool, ensuring each party can rely on the expected performance of the other.

Here are the three primary types of procurement contracts, along with their respective variations:

Fixed price contract

A fixed-price contract ensures that a buyer secures specific pricing for products or services, contingent upon ordering a minimum required quantity of inventory.

These contracts are particularly suitable for essential supplies crucial to the buyer’s supply chain, as they lock the buyer into an agreement ensuring a steady supply at reasonable prices, provided the terms of the contract are upheld.

Fixed-price contracts are categorized into three main types:

Firm Fixed Price

In this basic form of fixed-price contract, both buyer and supplier agree to a set minimum order volume at a specified cost.

Fixed Price & Incentive Fee (FPIF)

This type of contract involves the buyer paying a fixed price for a minimum order quantity of supplies, with an additional incentive offered if the supplier meets or exceeds contract terms. Essentially, the buyer guarantees payment for the required supplies, while the supplier commits to delivering a specified volume. The buyer may offer a bonus if the agreed order volume is available at the promised price. FPIF contracts are often used when there’s a scarcity of the desired supply, and the buyer wants to secure a deal for future procurement. 

Fixed Pricing with Economic Price Adjustment (FPEPA)

In an FPEPA contract, the buyer and supplier agree to a fixed price for a certain volume of supplies, with the provision for price adjustments if the supplier’s production costs change. If production costs increase beyond the agreed levels, the supplier can adjust pricing accordingly to maintain their margins.

For instance, if inflation occurs after signing an FPEPA contract, causing the supplier’s costs to rise, they are justified in raising prices for the delivered supplies.

Fixed-price contracts are commonly employed when the buyer seeks to acquire pre-built products at stable, predictable prices over a specified period. The supplier invests in producing the inventory, while the buyer ensures a guaranteed supply based on their anticipated needs.

Cost reimbursement contract

A cost reimbursement contract differs from a fixed-price contract in that it obligates the buyer to reimburse the seller for the capital costs incurred in developing a product, service, or project.

There are three primary types of cost reimbursement contracts:

Cost Plus Fixed Price (CPFF)

In this model, the seller provides a quote for the desired product, service, or project, including specifications for quantity and quality. The seller bears the expenses of undertaking the project, and upon completion, the buyer reimburses these expenses along with a fixed bonus, typically a percentage of the total cost. If the project fails to meet the buyer’s requirements, the seller may bear the costs associated with any unusable product due to deviations from the contract terms.

Cost Plus Incentive Fee (CPIF)

Under this arrangement, the seller covers the costs of fulfilling the buyer’s order. Upon successful completion, meeting all specified contract terms, the buyer reimburses the seller for project costs and provides an agreed-upon incentive fee. Conversely, if the project fails to meet expectations, both parties share the costs of the unsuccessful project.

Cost Plus Award Fee (CPAF)

In a CPAF contract, the seller delivers the agreed goods, services, or project, and upon completion, the buyer reimburses the seller for costs and provides an award fee at their discretion. The award fee can vary in size based on the buyer’s evaluation of the project’s success.

Cost reimbursement contracts shift the burden of capital costs onto the seller, with the buyer committing to reimburse these costs, plus interest, upon meeting contract terms. These contracts are often employed when the buyer seeks customized products or ongoing project work, rather than standard goods. They provide flexibility for sellers to undertake projects without upfront payment, with reimbursement contingent upon meeting specified targets.

Time & material contracts

In a time and material contract, the buyer agrees to compensate for both the labor and materials involved in the desired product or service. However, there’s a mutual understanding that these expenses will not surpass a specified volume, ensuring cost control and preventing potential fraudulent practices.

For instance, in the digital services industry, a freelancer might propose a quote of 100 hours to develop a new website. The client, seeking to manage costs, negotiates for the project not to exceed 80 hours, with an hourly rate set at $100.

Once terms are agreed upon, the project commences. Upon completion of the website, the freelancer submits an invoice detailing the hours worked along with any additional material expenses such as web hosting, premium themes, and SaaS subscriptions (e.g., Cloudflare), among others.

About Zapro Procurement

Zapro Procurement Platform offers a versatile procure-to-pay solution designed to enhance procurement processes for businesses of any scale. With Zapro, organizations can optimize their procurement strategies and boost operational efficiency. Its comprehensive modules cover eProcurement, Punchout Catalogs, AP Automation, Supplier Portal and Management, Inventory Management, Custom Integrations, and more—all seamlessly integrated into a single platform. Whether you’re upgrading from manual procurement methods or consolidating multiple systems, Zapro Procurement Platform is the solution you need.