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Contract Types

A wide selection of contract types exist to provide flexibility in acquiring the large variety and volume of supplies and services required by agencies. Contract types vary according to-

1. The degree and timing of the responsibility (risk) assumed by the contractor for the costs of performance; and
2. The amount and nature of the profit incentive offered to the contractor for achieving or exceeding specified standards or goals.

The contract types are grouped into two broad categories:

• Fixed-price contracts and
• Cost-reimbursement contracts

The specific contract types range from firm-fixed-price, in which the contractor has full responsibility for the performance costs and resulting profit (or loss), to cost-plus-fixed-fee, in which the contractor has minimal responsibility for the performance costs and the negotiated fee (profit) is fixed. In between are the various incentive contracts, in which the contractor's responsibility for the performance costs and the profit or fee incentives offered are tailored to the uncertainties involved in contract performance.

Factors in Selecting Contract Types

There are many factors to consider when selecting and negotiating the contract type. They include but are not limited to the following:

1. Price competition.
2. Type and complexity of the requirement.
3. Urgency of the requirement.
4. Period of performance or length of production run.
5. Adequacy of the contractor's accounting system.
6. Acquisition history.

Firm Fixed-Price Contracts

A firm-fixed-price contract is the preferred contracting method because it provides for a price that is not subject to any adjustment on the basis of the contractor's costs during contract performance. This contract type places maximum risk and full responsibility for all costs and resulting profit or loss on the contractor. It provides maximum incentive for the contractor to control costs and perform effectively. In addition, the Government's administrative burden for this contract type is usually very low.

Application

A firm-fixed-price contract is suitable for acquiring commercial items or for acquiring other supplies or services on the basis of a reasonably well defined statement of work and functional or detailed specifications. Pricing can be determined fair and reasonable at the outset.

Fixed-Price Incentive Contracts

A fixed-price incentive contract is a fixed-price contract that spreads risk and provides for adjusting profit and establishing the final contract price by a formula based on the relationship of final negotiated total cost to total target cost. The Government's administrative burden for this contract type is usually higher than fixed-price but less than cost-type contracts.

Application

A fixed-price incentive contract is appropriate when-

1. A firm-fixed-price contract is not suitable;
2. The nature of the supplies or services being acquired and other circumstances of the acquisition are such that the contractor's assumption of a degree of cost responsibility will provide a positive profit incentive for effective cost control and performance; and
3. If the contract also includes incentives on technical performance and/or delivery, the performance requirements provide a reasonable opportunity for the incentives to have a meaningful impact on the contractor's management of the work.

Firm-fixed-price, level-of-effort term contracts

A firm-fixed-price, level-of-effort term contract requires-

1. The contractor to provide a specified level of effort, over a stated period of time, on work that can be stated only in general terms; and
2. The Government to pay the contractor a fixed dollar amount.

Application

A firm-fixed-price, level-of-effort term contract is suitable for investigation or study in a specific research and development area. The product of the contract is usually a report showing the results achieved through application of the required level of effort. However, payment is based on the effort expended rather than on the results achieved.

Limitations

This contract type may be used only when-

1. The work required cannot otherwise be clearly defined;
2. The required level of effort is identified and agreed upon in advance;
3. There is reasonable assurance that the intended result cannot be achieved by expending less than the stipulated effort; and
4. The contract price is $100,000 or less, unless approved by the chief of the contracting office.

Cost-reimbursement

Cost-reimbursement type contracts provide for payment of allowable incurred costs, to the extent prescribed in the contract. These contracts establish an estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk) without the approval of the contracting officer. One disadvantage of cost-reimbursement contracts is that there is little or no motivation for the contractor to control or reduce costs. These contracts are a high risk for the Government (cost overrun, schedule and technical risks) and a low risk for the contractor. The Government's administrative burden for cost-reimbursement contracts is high.

Application

Cost-reimbursement contracts are suitable for use only when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract.

Limitations

A cost-reimbursement contract may be used only when-

1. The contractor's accounting system is adequate for determining costs applicable to the contract; and
2. Appropriate Government surveillance during performance will provide reasonable assurance that efficient methods and effective cost controls are used.

NOTE: The use of cost-reimbursement contracts is prohibited for commercial item acquisition.

Cost contracts: A cost contract is a cost-reimbursement contract in which the contractor receives no fee. These may be appropriate for research and development work, particularly with nonprofit educational institutions or other nonprofit organizations, and for facilities contracts.

Cost-sharing contracts: A cost-sharing contract is a cost-reimbursement contract in which the contractor receives no fee and is reimbursed only for an agreed-upon portion of its allowable costs.

Cost-plus-incentive-fee contracts: A cost-plus-incentive-fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs.

Cost-plus-award-fee contracts: A cost-plus-award-fee contract is a cost-reimbursement contract that provides for a fee consisting of (a) a base amount (which may be zero) fixed at inception of the contract and (b) an award amount, based upon a judgmental evaluation by the Government, sufficient to provide motivation for excellence in contract performance.

Cost-plus-fixed-fee contracts: A cost-plus-fixed-fee contract is a cost-reimbursement contract that provides for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost, but may be adjusted as a result of changes in the work to be performed under the contract. This contract type permits contracting for efforts that might otherwise present too great a risk to contractors, but it provides the contractor only a minimum incentive to control costs.

Incentive Contracts

Incentive contracts are appropriate when a firm-fixed-price contract is not appropriate and the required supplies or services can be acquired at lower costs and, in certain instances, with improved delivery or technical performance, by relating the amount of profit or fee payable under the contract to the contractor's performance.

Incentive contracts are designed to obtain specific acquisition objectives by-

1. Establishing reasonable and attainable targets that are clearly communicated to the contractor; and
2. Including appropriate incentive arrangements designed to-
1. motivate contractor efforts; and
2. discourage contractor inefficiency and waste.

The two basic categories of incentive contracts are fixed-price incentive contracts and cost-reimbursement incentive contracts. Since it is usually to the Government's advantage for the contractor to assume substantial cost responsibility and an appropriate share of the cost risk, fixed-price incentive contracts are preferred when contract costs and performance requirements are reasonably certain.