The University of Lahore

Lahore Business School

Assignment
Demand operations and inventory planning
Master of Business Administration

Submitted to: Sir Zia

Submitted by: Maryam Khushbakhat (70073544)
Aqib Latif (70073860)
Raheel Raza (7003861)
Abubakar Makhdoom (70072814)
Abdul Ahad (70073544)

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Write the examples for any three contracts type of your choice and explain the
benefits of choosing that contract type.

1. Firm fixed price

The most basic contractual pricing mechanism is called a firm fixed price. In this type of
purchase contract, the price stated in the agreement does not change, regardless of fluctuations in
general overall economic conditions, industry competition, levels of supply, market prices, or
other environmental changes. This contract price can be obtained through any number of pricing
mechanisms: price quotations, supplier responses to the buying organization’s requests for
proposal, negotiations, or any other method.
Example: Let us assume we called a Building Architect before calling the Electrical Contractor.
The Architect provided us with complete Electrical Layout & Design. The Architect also gave us
Material Specifications of the Wiring to be used. In brief we finalized everything before the
Contractor walked in. We prepared a detailed Statement of Work for the Contractor. The
contractor would study the detailed Statement of Work (finalized designs and material
specifications) to provide a Fixed Cost Estimate.
1. HR Cost – The contractor would look at the whole house and architectural design to
estimate how many Labor units (duration & effort) would be required to complete the
work.
2. Material Cost – The contractor would survey the house and study the Electrical Layout &
Design to make an approximation of how much Wire (quantity of wire) would be
required.
Based on above two estimates, the Contractor can estimate Cost of Labor and Cost of Wire. The
Contractor would total these Estimates and add some profit to provide us with a Fixed Price
Quotation. This Quotation (once finalized and accepted by us) would become part of the
Contract. We will have to pay a Fixed Price to the Contractor for completing the work. Even if
the Contractor overruns his estimates, we would not be liable to pay anything extra.
Salient Features of FP Contracts
1. In FP Contracts Scope is well defined and Price is Fixed.
2. FP Contracts could run into losses for the Seller if the costs are not managed well. FP
Contracts are more risky for Sellers.

2. Fixed-Price Contract with Escalation There are a number of variations on the basic firm
fixed-price contract. If the item being purchased is to be supplied over a longer time period and
there is a high probability that costs will increase, then the parties may choose to negotiate an
escalation clause into the basic contract, resulting in a fixed-price contract with escalation.
Escalation clauses allow either increases or decreases in the base price depending on the
circumstances. A greater degree of price protection is therefore provided for the supplier, while
the purchaser enjoys potential price reductions. All price changes should be keyed to a third-
party price index.
Example: In the event the price of certain materials (e.g. structural steel) increases by more than
10% between the date of this contract and the date of installation (or purchase by the Contractor),
the Contract Sum shall be equitably adjusted by the amount which exceeds a 10% price increase
over the material’s Baseline Price.

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A fixed price contract allows a small business to manage the cost of hiring outside the company
because the business and the contractor determine the total value of the agreement before
signing. The monetary value of the contract is normally not subject to any type of escalator. If
the

contract uses an escalator, it typically has a ceiling that caps the contract's dollar value. This
provides a small business with a clear picture of how much it will cost to hire the independent
contractor without any surprises popping up later in the working relationship.

3. Fixed-Price Contract with Incentives A final type of fixed-price contract is the fixed-price
contract with incentives. This contract is similar to the fixed-price contract with redetermination
except that the terms and conditions of the contract allow cost-savings sharing with the supplier.
As in the redetermination contract, it is difficult for the buying and selling parties to arrive at a
firm price prior to actual production. If the supplier can demonstrate actual cost savings through
production efficiencies or substitution of materials, the resulting savings from the initial price
targets are shared between the supplier and the purchaser at a predetermined rate. This type of
purchase contract is typically utilized under conditions of high unit cost and relatively long lead
times. The sharing of cost savings may be 50/50 (or some other split may be a negotiated part of
the contract).
Example: Using the example of our car manufacturer, a buyer might provide an incentive when
the manufacturer delivers the car early. This early delivery allows the buyer an additional week
of use, which puts the entire project ahead of schedule. Thus, the buyer wants to show
appreciation with an incentive.
There are benefits of this type of contract to both the buyer and the seller. To the seller, it is
beneficial because it typically allows for the seller or provider to charge a reasonable base fee,
yet also allows for exceptional performance to be rewarded further. However, for the buyer that
also provides a very tangible benefit. This type of purchase contract is typically utilized under
conditions of high unit cost and relatively long lead times. The sharing of cost savings may be
50/50 (or some other split may be a negotiated part of the contract).

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