Which statement best differentiates fixed-price and cost-reimbursement contracts, with a scenario for each?

• A. Fixed-price uses hourly rates; cost-reimbursement uses milestones.
• B. Fixed-price is always better; cost-reimbursement is only used for small projects.
• C. Fixed-price sets price and is appropriate when scope is well-defined; cost-reimbursement pays allowed costs plus fee and is suitable when scope uncertain or high risk.
• D. Fixed-price cannot be modified; cost-reimbursement guarantees maximum cost.

Answer: (C)

The important distinction is how risk and scope certainty drive the contract type. A fixed-price contract locks in a firm price before work starts, so the seller bears the risk for cost overruns and the buyer gains price certainty and predictable deliverables. This approach fits when the scope is well-defined, requirements are stable, and changes are unlikely. For example, manufacturing a component with exact specifications and tolerances where the manufacturer can precisely estimate the effort and cost upfront; once set, any changes typically require a formal change order with price adjustments.

A cost-reimbursement contract pays the actual allowable costs incurred plus an agreed fee. The buyer assumes more of the cost risk, but the arrangement provides flexibility to accommodate uncertain or evolving work where estimating costs upfront is difficult. This is suitable when the scope is uncertain or high-risk, such as research and development for a new software platform where requirements may change as understanding grows; the vendor is reimbursed for legitimate costs and earns a fee, with oversight to manage expenses and potential scope shifts.

In short, fixed price offers price certainty and risk on the provider when the scope is clear, while cost reimbursement accommodates uncertainty and higher risk with costs reimbursed plus a fee.