Two types of public contracts common in government work are fixed-price and cost-reimbursement contracts. Each have their own advantages and disadvantages when compared to on another. These two types will be discussed in detail below in the context of contracting with the U.S. government.
Fixed Price contracts provide supplies or services at a price not subject to any adjustment on the basis of the contractor’s incurred costs. The fixed price provides less of an administrative burden. FFP Contracts are favored by the government because contractors assume the risk of increase performance costs.
FFP contracts can be risky for contractors. If the cost of materials or other resources is higher than anticipated, the costs would diminish the contractor’s profits. Increased costs could also lead to contractors cutting corners to ensure they get the same, if not more profit from the contract.
The following are three types of fixed-price contracts:
Firm Fixed-Price (FFP) Contract has the government pay a set amount to the contractor regardless of the contractor’s cost to complete the work. The contractor’ profit is included in the price of the contract services. They are commonly used for items or services where there are multiple vendors and little risk of cost increases to the contractor. Examples include production of military equipment like tanks, aircraft, etc.
Fixed-Price-Economic Price Adjustment Contract is a contract where the government pays a set amount to the seller regardless of the contractor’s cost to complete the work. The FP-EPA contract includes the negotiated price and economic price adjustment (EPA) clause. The negotiated price is based on assumptions regarding price of materials or labor needed for the production of goods or services. If the assumptions are incorrect, the contract’s EPA clause becomes active, and the price is adjusted either upward or downward. These contracts are most common in goods or services where there is significant risk of cost increases due to supply or demand fluctuations.
Fixed-Price Incentive- FPIF contracts provide for adjusting profit and establish the final contract price by considering the negotiated total cost and total target cost. The price paid by the government is not fixed. A firm target price is negotiated that includes target cost and target profit. The contract contains a government/contractor share ratio that governs what percentage the contractor and government would share in the costs that exceed the budget. The government is protected because a ceiling price is negotiated that ensures it will not pay over a specific amount.
FFP contracts provide both the contractor and contracting officer assurance over the contract. Both parties are given the comfort of knowing different aspects of the contract will not change. Duration of the contract, cost of goods or services, and value of the goods or services will remain unaffected. Under FFP, both parties have greater understanding and control of their own expenses, allowing the project to remain within the budget.
FFP contracts require contractors to disclose a great amount of detail to the government. Because there is greater understanding as to how the contractor will fulfill its responsibilities under the contract, there is less opportunity for misinterpretation by either party that can expose the contractor to unnecessary litigation and fines.
Fixed-price contracts are often awarded based on price. If the contractor makes a poor estimate on price, the contractor is likely to incur a loss. The challenge for the contractor is to submit a bid price that covers work involved and a reasonable profit, while still bidding lower than the competition. The contractor must plan the bid, so it is considered “responsive” by the client, no requirements are overlooked, necessary qualifications are documented, and accurate date is compiled for pricing.
In cost-reimbursement contracts, the government pays all allowable and reasonable costs incurred in performing the contract work and additional fee for the contractor’s profit. the contractor is required to perform the work. If the work requires more funding than originally estimated, after notifying the government, the contractor may stop work.
Cost-reimbursement contracts are beneficial when uncertainties regarding contract performance make it difficult for costs to be estimated. Two reasons for the inability to accurately estimate costs are the following:
- lack of knowledge of the work needed to meet the requirements of the contract
- and the lack of cost experience in performing work.
Cost-reimbursement allows for payment of incurred costs indicated in the contract. They provide an estimate of total cost for obligating funds and setting a ceiling the contractor may not exceed without approval of the contracting officer. This places greater risk on the government. Cost-reimbursement contracts are used when uncertainties involved in contract performance do not allow costs to be estimated with sufficient accuracy to use any type of fixed-price contract.
According to FAR Section 16.301, cost-reimbursement contracts can be used when factors in Section 16.104 have been considered; a written acquisition plan has been approved by at least one level above the contracting officer; the “contractor’s accounting system is adequate for determining costs applicable to the contract;” adequate Government resources are available to award and manage a contract other than FFP. T
he factors in Section 16.104 of the FAR include price competition, price analysis, cost analysis, type and complexity of the requirement, urgency of the requirement, period of performance or length of production run, and many others.
The three types of cost-reimbursable contracts are described below:
Cost Plus Fixed Fee (CPFF) contract is one which the contractor receives a specific amount for the cost of materials. It contains no incentives. The contractor is reimbursed for all allowable costs and is paid a set fee regardless of quality of performance. This contract provides the least risk for contractors and the most for government.
Cost Plus Award Fee (CPAF) provides for a fee consisting of a base fee and an award fee. The contractor is paid the base fee regardless of performance. The award fee is earned based on the government’s evaluation of the contractor’s performance based on criteria established at the beginning of each award fee period. Examples of criteria include contractor’s cost, technical, schedule, and quality of performance. These contracts are common where the government wishes to incentivize quality of performance and it is difficult to account for targets for cost, technical performance, or schedule in advance of contract award.
Cost Plus Incentive Fee (CPIF) provides a higher fee when the contractor keeps costs down or meets the project deadline without delay. A target price is negotiated that includes a target cost and target fee. The target cost is the best estimate of the cost to be incurred in performing the contract. The target fee is the amount agreed by both parties that should be earned by the contractor if it incurs costs equal to the target cost. The contract contains a share ratio that states the portion the contractor and government would both pay the contract cost exceeds the agreed upon budget.
There is minimal risk for contractors under cost-reimbursement. Unexpected costs/resources contractors incur are paid for by the government. Quality of the contract is as expected. Contractors are not forced to cut corners to complete projects with the added stress of ensuring they do not diminish their profit margin.
The inability to know the cost of completing a cost-reimbursement contract creates uncertainty to the government as to what it pays for. This results in contractors being expected to justify their additional costs.
For more information on the different types of government contracts, contact Whitcomb Selinsky PC at (866) 476-4558 or book a free assessment below.