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CIPS L4M3 - Commercial Contracting > Chapter 3.3 > Flashcards

Chapter 3.3 Flashcards

Recognise types of pricing arrangements in commercial agreements

1
Q

Cost-plus

A

The cost price of an item or service plus am agreed margin

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2
Q

What 2 things must be very clear whether the contract is tendered or negotiated

A
  1. Which pricing model the purchaser envisages using
  2. Whether it is willing to look at other options
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3
Q

What three things must the pricing mechanisms used permit?

A
  1. Variations or changes to the contract to be adequately costed
  2. Price adjustments to be applied correctly
  3. Any recharges or distribution over different cost centres to be accurately produced
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4
Q

What is price

A

The amount expressed in units of currency to be paid by the purchaser to the supplier in order to obtain the goods or services

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5
Q

What is cost

A

The total sum of amounts paid by the supplier in order to produce the goods or provide the services

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6
Q

Name 5 ways in which pricing schedules in commercial contracts can be complex

A
  1. Call off contracts will not have a predetermined total price; it will depend on exactly what is called off, how many orders there are.
  2. Even where the total fee is known, payment might be made in stages as key milestones are reached
  3. The price may need to be broken down into various elements so that any changes to the contract can be accurately priced
  4. The price may have to be broken down for accounting reasons
  5. There may be changes to the scope or duration of the contract which require variation orders
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7
Q

Day rate

A

A pricing method where the contractor charges by the day

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8
Q

Guaranteed maximum price (GMP)

A

A pricing method where the contractor guarantees the maximum price a project will cost

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9
Q

Price schedule

A

Sometimes this is called a ‘fee schedule’ when it applies to professional or consultancy services. It is an appendix to a contract setting out what the prices are

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10
Q

What should the design of the price schedules take into account?

A

How the price information may need to be used, other than for the primary function of invoicing and payment

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11
Q

Schedule of rates

A

A list of prices associated with the products or services to be provided. Note that the rate may be different for different order volumes

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12
Q

Lump-sum

A

A pricing method where a single price is given for the whole project

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13
Q

Do price schedule and schedule of rates mean the same thing?

A

No, however the terms are often used interchangeably

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14
Q

What is the simplest pricing method?

A

Unit price

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15
Q

What is unit pricing commonly used for

A

Goods

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16
Q

What pricing is commonly used for services

A

Hourly or daily rates

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17
Q

Why may there need to be a pricing schedule for hourly or daily rates

A

Because the hourly rate may differ depending on the seniority or expertise of the person providing the service

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18
Q

When may a schedule of rates (combination rates) be produced?

A

Where the service being provided is a mixture of goods and services

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19
Q

Name 3 examples of standard schedules of rates

A
  1. APS (Australian Psychological Society)
  2. NHF (National Housing Federation)
  3. DPSA (Department of Public Service and Administration)
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20
Q

What are standard schedules used for?

A

To give a reasonable estimate of the price for a given product or service

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21
Q

How are pricing schedules properly incorporated into the contract as a contract document?

A

By a simple contract term that states that the goods or services will be charged for at the rates set out in the schedule

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22
Q

Are standard schedules compulsory?

A

Rarely

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23
Q

How may standard schedules be used in tendering and negotiating?

A

Using them as reference points against which prices can be compared

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24
Q

Fixed pricing

A

In most cases, this relates to a set of prices that have been agreed and are fixed in the contract for a period of time

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25
Q

Firm prices

A

Prices which have stability but which can move under some predetermined mechanisms. The UK MoD however reverses this logic with fixed prices being allowed to move in line with some contractual mechanisms

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26
Q

What is an alternative to the schedule of rates approach

A

Fixed-fee pricing or fixed-pricing arrangements

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27
Q

Name 2 circumstances where fixed-pricing arrangements can be used for services or works

A
  1. It is useful for small to medium scope projects, with short timelines, where what is delivered can be adequately specified and the likelihood of changes to the specification, scope and input costs is limited
  2. It can also be used where a service is repeatedly required but the specifics of which vary slightly on each occasion. It may take a shorter or longer period of time, or may need more or fewer resource inputs
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28
Q

Is the cost risk of fixed pricing arrangements shared between the parties?

A

Yes but it may not be shared equally

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29
Q

What is the main advantage of fixed pricing arrangements

A

Planning advantage. The purchaser has budget certainty, the supplier has income certainty

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30
Q

Will fixed-fee pricing cover the whole of the contract?

A

It might not

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31
Q

Name 2 advantages of fixed-pricing arrangements

A
  1. Budget/income certainty - prices are fixed up front and should not change
  2. The impact of changes to the supplier’s cost base is not fed through to the purchaser. If costs diminish, the supplier will benefit from this, and if costs rise, the purchaser will benefit
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32
Q

Name 4 disadvantages of fixed-pricing arrangements

A
  1. Time needed to fully specify exactly what is included and excluded in the price
  2. The impact of changes to the suppliers cost base is not fed through to the purchaser. If costs diminish, the supplier will benefit from this, and if costs rise, the purchaser will benefit
  3. Assumptions could lead to disputes
  4. Potential for quality issues if the fixed price is too low - supplier will deliver down to price
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33
Q

Why may fixed pricing and schedule of rates be combined within a single contract?

A

To cover different aspects of supply

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34
Q

Are cost plus and cost-reinbursable used interchangably?

A

Yes

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35
Q

Fixed costs

A

Business costs that remain the same irrespective of the volume of activity of a business

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36
Q

Variable costs

A

Costs that change in proportion to the output of business. They increase as the volume of the service or product produced is increased. As sales increase, variable costs increase. As sales go down, variable costs go down. For example, the amount of materials that are used or the cost of hours worked

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37
Q

How will a contract be sustainable

A

By at least breaking even

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38
Q

How do you make a profit

A

Income must exceed costs

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39
Q

What has happened once the breakeven point has been reached?

A

Fixed costs are covered

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40
Q

What can help purchasers determine whether they are getting a reasonable deal?

A

Understanding supplier mark ups and margins

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41
Q

Whats the difference between costs and income

A

Profit

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42
Q

What is mark up?

A

Profit as a percentage of total costs

43
Q

What is profit margin

A

Profit as a percentage of total sales value

44
Q

Where is a supplier’s overall profit margin reported?

A

In its income statement

45
Q

What happens to the mark up if costs go up?

A

It shrinks

46
Q

Name 3 things that may happen if a supplier starts to make a loss

A
  1. It will become disputatious
  2. It will become claim happy
  3. It will cut corners on quality
47
Q

What is the formula for cost plus pricing

A

Cost + (cost x % mark-up) = price

48
Q

What is the cost plus pricing model set on the basis of?

A

Cost, plus an agreed profit mark-up

49
Q

What 4 things must the supplier demonstrate to reach an agreed cost figure in cost plus pricing model

A
  1. Exactly what the input costs are
  2. Whether they are fixed or variable
  3. How the variables normally move
  4. How much control the supplier has over them and that they are exercising that control
50
Q

Name 2 advantages to the purchaser of cost plus pricing

A
  1. Value for money demonstrated by fixed profit mark up
  2. Risk of supplier collapse is reduced
51
Q

Name 3 advantages to the supplier of cost plus pricing

A
  1. All costs are covered
  2. Guaranteed profit levels aid forward planning and may assist small companies in accessing cheaper credit
  3. Easy to justify price increases
52
Q

Name 3 disadvantages to the purchaser of cost plus pricing

A
  1. Lack of certainty over supplier cost base
  2. Changes in the supplier cost base feed directly into the price paid, with no room for negotiation
  3. Supplier has no incentive to manage costs
53
Q

Name 4 disadvantages to the supplier of cost plus pricing

A
  1. Profit is limited, cannot gain from cost efficiencies
  2. Cannot leverage market advantage to charge a higher price
  3. Cannot refuse price reductions in response to input cost reduction
  4. No incentive for supplier to reduce costs
54
Q

What do cost plus contracts do in relation to risks

A

Place all of the risks of increased cost on the purchaser and so there is no motivation for the supplier to control cost

55
Q

Name 5 possible approaches to a desire on the part of either the purchaser or the supplier to change the prices during the life of a contract

A
  1. The contract could unequivocally state that prices are fixed for the duration and there are no possible grounds for adjustment
  2. The contract could remain silent on the matter, not providing any grounds or mechanisms for ajustments but not ruling it out altogether
  3. The contract could state circumstances in which price adjustment will be considered, but leave the nature of the adjustment open for free negotiation between the parties
  4. The contract could state circumstances in which price adjustment will be permitted and describe how such adjustment will be calculated
  5. The contract could allow for automatic periodic adjustment of pricing by linking to a specified price index
56
Q

Indexation

A

The linking of a payment (be it a price, a salary or some other due payment) to an index and the adjustment of the payment in line with the movements of the index

57
Q

Price Index

A

A way of showing the percentage change in prices over a given period, based on the starting year (the base) which is taken to be equivalent to 100%. Indices above 100 indicate a rise; indices below 100 indicate a fall

58
Q

Name the 2 most widely used indices in the UK

A
  1. Retail Price Index (RPI)
  2. Consumer Price Index (CPI)
59
Q

What do RPI and CPI look at?

A

The movement in the total price of a metaphorical basket of goods commonly purchased by UK citizens

60
Q

What is the percentage shift in the overall basket of goods commonly called?

A

The change in the cost of living

61
Q

What does the change in the cost of living provide?

A

A simple measure of the rate of inflation

62
Q

Are RPI increases greater than CPI increases?

A

Yes

63
Q

How often are the price movements of most commodities published?

A

They are published on a regular basis

64
Q

When is inflation negative?

A

When prices fall

65
Q

Name an advantage of no price adjustment being permitted

A

Fixed price gives budget certainty to purchaser, income certainty to supplier

66
Q

Name 5 disadvantages of no price adjustment being permitted

A
  1. Inflexible
  2. One party will gain and the other party will lose from a change in the cost base, no facility share benefits
  3. May lead to claims and disputes
  4. Could undermine sustainability of the contract
  5. Supplier likely to quote higher initial price to cover expected costs
67
Q

When is it suitable to not permit a price adjustment

A

Short-term contracts which can be closely specified and will have limited or no variations

68
Q

Name an advantage of the contract silent approach to price adjustment

A

There is an implication that no adjustments will be permitted and this may discourage the weaker party from seeking them, which is an advantage for the stronger party

69
Q

Name 2 disadvantage of the contract silent approach to price adjustment

A
  1. Claims can quickly escalate into disputes as the contract offers no guidance on how to proceed
  2. The lack of a specified route to seeking adjustment can result in quality being ‘managed down to price’ rather than price being ‘managed up to quality’
70
Q

When is it suitable to use the contract silent approach to price adjustment

A

Never recommended

71
Q

Name the 2 advantages to the circumstances outlined, but no calculation mechanism quoted approach to price adjustment

A
  1. Clearly limits the circumstances in which discussions are possible avoiding time wasted on those where no change will be considered
  2. Flexibility in calculating the change could provide a greater gain for the party with more bargaining power or better negotiations
72
Q

Name the 2 disadvantages to the circumstances outlined, but no calculation mechanism quoted approach to price adjustment

A
  1. Time may be wasted debating appropriate bases for the calculation, prior to the substantive discussion on what adjustment is actually sought
  2. Weaker negotiators will lose out
73
Q

When is it suitable for the circumstances outlined, but no calculation mechanism quoted approach to price adjustment

A

A partially inequitable approach that might suit a party confident of their ability to influence future negotiations, while willing to give some ground to the other party in order to maintain the relationship

74
Q

Name the 5 advantages to the circumstances and mechanisms described approach to price adjustment

A
  1. Clearly limits when the adjustment will be considered
  2. Clearly states how such adjustment should be calculated
  3. Contractual and legal certainty for both parties
  4. Can be linked to contract specific indices or general economy indices depending on the nature of the contract
  5. Supplier may quote lower initial price knowing that some of the risk of cost increases is covered
75
Q

Name the 4 disadvantages to the circumstances and mechanisms described approach to price adjustment

A
  1. Relies on good market knowledge to be able to predict relevant circumstances and plan for them
  2. Failure to capture key influence could lead to a dispute
  3. Can distort prices if the index chosen suggests an impact that is not actually felt by the contracting party
  4. Reduces incentive for supplier control
76
Q

When is it suitable to use the circumstances and mechanisms described approach to price adjustment

A

Despite the limitations this is the best option

77
Q

Name an advantage of the automatic periodic adjustment approach to price adjustment

A

Budgetary certainty for the purchaser. Income certainty for the supplier

78
Q

Name 2 disadvantages of the automatic periodic adjustment approach to price adjustment

A
  1. As normally linked to broad based indices such as the retail price index or consumer price index it can result in unwarranted price rises
  2. No incentive for the supplier to reduce or control costs
79
Q

When is it suitable to use the automatic periodic adjustment approach to price adjustment

A

Not recommended - does not deliver value for money

80
Q

What is a useful way of predetermining price adjustments?

A

Indexation

81
Q

Target costs

A

The expected cost of making a product or delivering a service

82
Q

Target fee

A

In a cost-plus incentive contract, the fee or profit element which will be paid if actual costs equal target costs

83
Q

Sharing ratio

A

Within a cost-plus incentive contract, the proportion of the cost/benefit which is allocated to the purchaser and supplier

84
Q

What is an incentive in the context of a contract?

A

An extra payment to encourage better performance

85
Q

Name 3 ways that you can address the issue of the supplier having no motivation to control costs in a cost-plus contract

A
  1. Target cost
  2. Target fee
  3. Sharing ratios
86
Q

Define fee

A

The amount payable by the purchaser over and above the cost element

87
Q

What is the formula for final fee?

A

Target fee + ((target cost - actual cost) x supplier share) = final fee

88
Q

What is the formula for final price

A

Actual cost + final fee = final price

89
Q

What can you do to ensure that the focus on cost reduction does not harm quality aspects

A

Set a maximum fee

90
Q

Define maximum fee

A

Once costs had reduced to a given point, any further reduction would not change the fee payable

91
Q

Why may the supplier wish to seek a minimum fee?

A

To ensure that some base level of profit is achieved

92
Q

What is another way of ensuring that costs are not permitted to be uncontrolled?

A

To set a ceiling price

93
Q

Ceiling price

A

A maximum that will be paid by the purchaser irrespective of cost

94
Q

Stage payments

A

A payment of part of the total fee following the completion of set ‘work stages’ or ‘project milestones’

95
Q

Whats a benefit of stage payments

A

It can help to ensure momentum on a project as it relates directly to the supplier’s cash flow

96
Q

Name 2 contract incentives

A
  1. For contracts to be extended
  2. For better payment terms
97
Q

When should incentives be used?

A

Where the improvement sought is of financial benefit to the purchaser

98
Q

What do payment term clauses look at?

A

When and how payment is to be made

99
Q

Name 6 things payment term clauses include

A
  1. Documentation required
  2. VAT and other taxes
  3. Payment period and how it is calculated
  4. Disputed invoices and pay-less notices
  5. Treatment of retentions
  6. Remedies for late payment
100
Q

Name 6 things to consider in respect of payment terms

A
  1. Documentation required
  2. VAT and other taxes
  3. Payment period
  4. Disputed invoices and pay-less notices
  5. retentions
  6. Remedies for late payment
101
Q

Commercial Queries (CQ)

A

These are queries, administrative omissions or minor disputes that have arisen in the contractual operation

102
Q

Pay-less notice

A

A formal notice under a contract stating that an invoice will only be paid in part and giving the reasons why the lower amount is being paid

103
Q

Retention

A

A sum of money withheld from payment for a fixed period of time to be used to cover any costs associated with remedying defects that are not corrected by the supplier

CIPS L4M3 - Commercial Contracting (8 decks)

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