A business venture is a going concern; thus in the course of operations, a firm enters into agreements with suppliers, customers, and other vendors. For this reason, it is imperative for business owners to enter into forms of contracts depending on the nature of engagement and commodities in question. Some of these forms of contracts include fixed price and cost reimbursement contracts. In a fixed price contract, both the buyer and the seller enter into an agreement that outlines the final cost of the end product, which both parties sign and agree to honor. Cost reimbursement contracting, on the other hand, refers to when a buyer pays a contractor all the negotiated expenses to a set point, plus additional payments to cater for profit. Depending on the size and nature-small or large firms- of consumers, for instance, government, businesses have a task of selecting the most appropriate method of contracting.
Keywords: Fixed Cost, Contract, Cost reimbursement, Government
Evaluating Contracts
As an owner of a small business, it is imperative to analyze the advantages and disadvantages that arise from using the forms of contracting and select the most suitable contracting method depending on the situation.
Comparing and Contrasting Fixed Price and Cost Reimbursement Contracting
In fixed-price contracting, as discussed earlier as a service provider my company accepts in a signed agreement to supply or complete a stated project at an agreed fee at the project’s onset (Kim, Roberts & Brown, 2016). For example, while bidding for a road work project, the government asks various companies to submit bids based on fixed prices of the entire work. As such, my company’s estimations factors in all the labor expenses, costs of materials, and profit mark-ups while submitting bids. Fixed price contracting is particularly essential when submitting proposals for government jobs because states mandate suppliers and service providers to provide their requests at a fixed price covering the entire assignment.
Besides private consumers prefer this method of contracting because of its transparency thus enabling them to know the prices up front (Kim et al., 2016). Also, fixed price contracting method simplifies the process of forecasting the sales projection of our company by providing clear and quantifiable goals. Besides, it provides for the least administrative costs and burden between my company and the other parties. However, the method poses a risk of underpricing thus leaving lots of uncompensated labor hours and any other material costs.
Cost Reimbursement Contracting method
A cost reimbursement method is more detailed in that it requires the parties to set up the material costs used in the assignment which a supplier can refund for later (Kim et al., 2016). Cost reimbursement contract stipulates the fees a service provider earns on top of the reimbursed costs of the expenses utilized and agreed on in the course of the project. For instance, a plan might allow for expenses costs plus a fee of $10,000. Hence, if fully reimbursed for the material and labor costs of say $20,000, the total project costs $30,000.
The primary advantage that accrues to my small business by using a cost reimbursement contracting method is the knowledge of the profits to be achieved regardless of the cost of materials used or labor time utilized, thus, minimizing risks. However, the technique might set a center stage for disputes arising from purchasing materials and utilizing labor hours which the buyer might be unwilling to reimburse (Kim et al., 2016). Moreover, individual consumers are most likely reluctant to enter into open-ended contracts whose final costs they do not know. More importantly, regardless of how efficiently my company works with the resources, the service fee is set at a fixed agreed amount.
Advantages of Operating a Small Business
Operating a small business brings in lots of opportunities to owners like me. Even though large firms have advantages such as economies of scale, benefits of running a small firm far outweigh those that arise from operating large companies. First, a small business possesses the agility to make decisions that improve the experiences of consumers without wasting a lot of time spent on consulting several layers of management and company lawyers (Bullough, Renko & Myatt, 2014). Whenever I feel like something is not going the right way, I simply switch without consulting anyone- as long as the decision works in the best interest of the company and the customers.
Besides making timely decisions, a small business will enable me to rebrand more easily to match the evolving customer preference and needs. For instance, if I notice the customers are more receptive to social media marketing (Bullough et al., 2014). I swiftly switch to the marketing technique. Next, small business provides for more personalized consumer service. In my day to day operations, I get to involve directly with customers hence understand their needs and expectations firsthand. The situation is a bit different from owning a large organization where I am limited to the board meetings. More importantly, the mission statement remains a text on the wall with no day to day contact with consumers. Further, working with repeat customers on a daily basis deepens one's understanding within a particular area. However, for large organizations, employees are rotated continuously breaking previous contacts with customers. Lastly, operating a small business enables the establishment of a localized niche thus allowing more specific and more in-depth content development compared to large organizations which serve a diverse range of consumers.
The Most Suitable Form of Contracting for My Small Business
Investment can be a risky venture; the various risks are only worth taking if profit is assured. Since my business is small in size, it is prudent to choose a type of contract that would be beneficial considering the risks associated with small businesses. Small companies are characterized by; a low range of assets and collaterals. Another characteristic of my business based on the fact that it deals with the low range of products covers a relatively small market and has quite limited access to external financing due to minimal collaterals.
Cost reimbursement contract would be efficient for my business. This development can be substantiated by the fact that in cost reimbursement is contracting, the buyer pays the seller the expenses negotiated to a set point and besides the set prices that would cover the profit. Thus, ensuring that in the event when the negotiated price is less than the possible price, then the additional costs are on the shoulder of the buyer (Cibinic et al., 2016). Because my business is small, cost reimbursement type of contract will ensure our safe continuity if the changes in the market pose various contingencies that would cause harm to our profits.
As a small contractor, this particular type of contract will also ensure that we deliver the quality of work because we do not necessarily have to buy low-cost materials in an attempt to cut off costs. Th reason is that in the event a lot more is spent, it will be reimbursed by the owners of the contract (Cibinic et al., 2016). Cost reimbursement contracting also allows us to hire quality personnel and this will ensure that the work done is quality. It also covers various cost changes that may arise as a result of multiple changes within the market.
Suitable Contracting Method Appropriate for Large Companies
Significantly, fixed price type of contract would be more appropriate for large companies. Large companies have a broad capital base that is sufficient to cover various risks when they arise. Boeing for example, being the largest aerospace company and manufacturer of jetliners is capable of estimating costs during contracting which will enable the company deliver its various services the set costs since in fixed-price contracting both the owner and the contractor enter into an agreement that outlines the final price of end product (Hart, 2001), which both parties sign and agree to honor. In most cases, the contracts ventured into by large companies tend to be longer.
Fixed price contracting would be useful as it gives both the parties contracting, the predictability of events to happen as well as the various deliverables within the contracting period. Because large companies are more endowed with multiple resources including machinery, their operational costs become more straightforward to estimate. Hence they can predict the feasible value of contracts that would not lead to pressure on their side if market changes occur that do not favor their budget. It is equally possible for them to have a more quality budget that would facilitate flexibility in costs if the cost of contracting would lead to a rise in contract prices (Hart, 2001). Large companies are also associated with substantial overhead costs, to help cover these costs, they are can charge more for the contracting. This form of contracting will also enable them to cover for various expenses that may arise during the period of the contract and as a result still deliver their multiple products or services within the budget.
Plan to Justify Contract Award from the Government
The possible reasons why the government would want to award a contract to a larger company are based on their ability to honor the various parts and ensure that they deliver on their side of the arrangements. Contracts awarded by the government in most cases tend to be significant; they require a wide range of resources and machinery to deliver (Hart, 2001). Two possible plans would allow my business to reach the standards needed and also be able to provide the various services for the government. One plan is to acquire a capital base that will enable me to hire or purchase the materials needed to deliver these service. The various machinery can be obtained through lease as well as other methods, one of the possible ways is to ensure that my business can contact other industries and build a relationship that will enable me to obtain the capacity required to deliver the contract to the government.
I would also ensure that I have a proper internal control mechanism as well as a budgetary plan that will assure the government of the safety of its resources. One other possible plan will be on the ability to subcontract with other companies which are significantly larger. The companies will take the tender then my business works with them from subcontract. Ultimately, ensuring that the bid is awarded and we still get the contract.
References
Bullough, A., Renko, M., " Myatt, T. (2014). Danger zone entrepreneurs: The importance of resilience and self‐efficacy for entrepreneurial intentions. Entrepreneurship Theory and Practice, 38(3), 473-499.
Cibinic, J., Nash, R., " Knight, S. D. (2016). Cost Reimbursement Contracting. Wolters Kluwer.
Hart, O. (2001). Financial contracting. Journal of economic Literature, 39(4), 1079-1100.
Kim, Y. W., Roberts, A., " Brown, T. (2016). Impact of Product Characteristics and Market Conditions on Contract Type: Use of Fixed-Price Versus Cost-Reimbursement Contracts in the US Department of Defense. Public Performance " Management Review, 39(4), 783-813.
