Advantages & Disadvantages of a Fixed-Price Contract

When you enter into a fixed-price contract, you are agreeing the final cost of a good or service upfront. This price is written into a contract that both parties sign and agree to honor. How long the fixed price lasts depends on the terms of the contract. Weighing the advantages and disadvantages of a fixed-price contract helps a small business decide whether to exercise the option.

Advantage: Certainty of Costs

A fixed-price contract gives both the buyer and seller a predictable scenario, offering stability for both during the length of the contract. A buyer may be concerned about the cost of a good or service suddenly increasing, adversely affecting his business plans. The seller may be concerned about the value of his good or service dropping suddenly, reducing his income with little to no warning. Fixing the price removes these concerns entirely.

A buyer may also benefit from the predictability of a fixed-price contract, since any degree of uncertainty on the final cost of the project exceeding initial estimates shifts entirely to the seller. So, if you are buying supplies or resources, you may favor a fixed-price contract because it gives you a concrete budget to work with, versus a contract where costs may rise indefinitely over time.

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Disadvantage: Certainty Comes at a Higher Cost

While a fixed-price contract gives a buyer more predictability about the future costs of the good or service negotiated in the contract, this predictability may come with a price. The seller may realize the risk that he is taking by fixing a price and so will charge more than he would for a fluid price, or a price that he could negotiate with the seller on a regular basis to account for the greater risk the seller is taking.

Advantage (or Disadvantage): Market Changes

When market forces change the value of a good or service, including any materials or supplies necessary in the production of the good or service, the fixed-price contract can be a benefit or a detriment. If market forces cause the value of the good or service to increase dramatically, the buyer receives a benefit while the seller loses potential profits he could have enjoyed outside of the fixed-price contract arrangement. When the price of the good or service drops suddenly, the buyer sits at a disadvantage and the seller at an advantage.

Advantage: Budgeting and Ability to Pay

Even though a fixed-price contract may cost a buyer more money up front, the buyer has the ability to budget for the costs of the contract and ensure that it has enough funds to fulfill its end of the agreement. When the costs of the good or service increase dramatically, the buyer may no longer have the means to honor the contract, meaning the seller must take a loss and weigh the option of legal action. If the good or service is necessary to a buyer's business process, then the buyer's business may be adversely affected.