Fixed price and T&M contracts: when should they be used?

Contracts form the backbone of professional business. A contract represents an agreement between two parties outlining the specific circumstances of their dealings. For example, a basic client contract might certify risk and pricing, scope of work, timing of payments and timely review of deliverables. The tighter the contract, the more certain both parties are of their responsibilities and legal accountabilities. A contract represents a legal document that can be referenced and cited in a court of law when disputes are raised.

It is also true that there are many varieties of contracts, depending on the businesses involved and the nature of their interaction. Different contracts follow different style models specific to their function. It is the responsibility of the individual managing the business deal to ensure that the right contract is used, for maximum relevance and appropriate emphasis on terms and conditions.

In many cases, this will come down to whether a fixed-price contract or a T&M contract is offered. But what are these, and when should they be used?

Fixed-Price Contract

A fixed-price contract is defined as a contract where the payment is set, and not dependent on the time taken or amount of materials used. Of the two contract types outlined here, this is the simpler because the price does not need to be worked out on a running basis. It is set from the out, leaving both parties clear of the financial transactions involved.

The advantages of a fixed-price contract include:

  • A clearly defined scope of work.
  • An established job spec.
  • Peace of mind for both parties.
  • Business confidence for both parties.
  • A higher initial cost to cover the guarantee of the set price for the customer.

T&M Contract

By contrast, a T&M (Time and Materials) contract refers to an agreement in which a contractor (or subcontractor) is paid on a rolling basis in accordance with time and resources expended. If the project takes longer than expected to complete, payment increases. Similarly, the volume and quality of materials used will influence the final price.

The advantages of a T&M contract include:

  • Versatility on behalf of both parties to review and alter the job spec as necessary.
  • The ability to adapt design, material and timing elements as the project unfolds.
  • The fast speed at which work can begin, as opposed to lengthy discussions and bidding wars for fixed-price contracts.
  • The option to use a guaranteed maximum price, placing a potential cap on contractor fees.

The importance of choosing the right contract

A contract is of critical importance when entering into a business relationship. This is something MD2MD speaker Tiffany Kemp realised early on in her career when negotiating contracts in her sales role.

Whether you are agreeing to long-term employment, or merely offering/accepting contracted work, a contract is the rock to which you will cling should anything go wrong. In an ideal business interaction, agreed work will be completed on time, to quality standards, according to the outlined spec. Correct payment will be received by the employee and both parties walk away happy.

But in business, as in life, any number of things can and do go wrong. Sometimes this is through manual error. Other times they cannot be helped. Mistakes happen. Accidents occur. Take the time to stop and consider what could potentially go wrong before deciding on which kind of contract to use.

  • What would happen if you went bust? How is the other party left?
  • What would you do if the other party became unable or unwilling to complete the work? Are you protected and how will you complete your project?
  • What are the consequences for a failure to meet standards, or missing fees? Does your contract cover you or have you left important details ambiguous?

Getting it right

Any one of these instances can lead to expensive court battles and damaged business reputations. Neither is desirable, and both can be avoided by the simple process of creating an accurate, air-tight contract.

Not everyone is an expert in legal documents and contractual jargon, but every company will have had their fair share of experiences navigating this challenging territory. Networking with other managers and MDs is the simplest and most inexpensive way of learning from their past experiences and growing your own skillsets and understanding in this area.

Written by Bob Bradley, founder of MD2MD.