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Comparison of Major Contract TypesFirm FixedPrice ks areotherwiseinsignificantdollars at riskoutweigh theadministrativeburdens of anFP/EPA.ElementsA firm fixedprice for eachline item orone or moregroupings ofline items.A fixed-price,ceiling onupwardadjustment,and a formulafor adjustingthe price up ordown basedon: Establishedprices. Actual laboror materialcosts. Labor ormaterialindices.Contractoris Obligedto:Provide anacceptabledeliverable atthe time,place andprice specifiedin thecontract.ContractorIncentive(other thanmaximizinggoodwill) 1Generallyrealizes anadditionaldollar of profitfor everydollar thatcosts arereducedFixed-PriceIncentive FirmTarget(FPIF)Fixed-Pricewith AwardFees(FPAF)Fixed-PriceContract withProspective PriceRedetermination(FPPR)to control coststo and meetotherobjectives. Justify relatedadministrativeburdens.A ceiling priceTarget costTarget profitDelivery,quality, and/orotherperformancetargets(optional) Profit sharingformula A firm fixedprice. Standards forevaluatingperformance. Proceduresfor calculatinga fee basedonperformanceagainst thestandards Fixed-price forthe first period. Proposedsubsequentperiods (at least12 months apart). Timetable forpricing the nextperiod(s).Provide anacceptabledeliverable atthe time andplacespecified inthe contract atthe adjustedprice.Provide anacceptabledeliverable atthe time andplace specifiedin the contractat or below theceiling price.Perform at thetime, place,and the pricefixed in thecontract.Provide acceptabledeliverables at thetime and placespecified in thecontract at theprice establishedfor each period.Generallyrealizes anadditionaldollar of profitfor everydollar thatcosts arereduced.Realizes ahigher profit bycompleting thework below theceiling priceand/or izes anadditionaldollar of profitfor every dollarthat costs arereduced; earnsan additionalfee forsatisfying theperformancestandards.For the period ofperformance,realizes anadditional dollar ofprofit for everydollar that costsare reduced. 6

Comparison of Major Contract TypesFirm FixedPrice icalCommercialsupplies andservices.Long-termcontracts forcommercialsuppliesduring aperiod of highinflationPrincipalGenerallyNOTappropriatefor R&D.Must bejustified.ApplicationLimitationsin FARparts 16,32, 35, and52Variants1Firm Fixedprice Level ofEffort.Fixed-Pricewith AwardFees(FPAF)Fixed-PriceContract withProspective PriceRedetermination(FPPR)Production of amajor systembased on aprototypePerformancebased servicecontracts.Long-termproduction of spareparts for a majorsystem.Must bejustified. Mustbe negotiated.Contractormust have anadequateaccountingsystem. Costdata mustsupporttargets.Must benegotiated.MUST benegotiated.Contractor musthave an adequateaccounting systemthat supports thepricing e rminationGoodwill is the value of the name, reputation, location, and intangible assets of the firm.Comparison of Major Contract TypesCost-PlusIncentive-Fee(CPIF)PrincipalRisk to beMitigatedUse F)Cost (C) orCost-Sharing(CS)Time &Materials(T&M)Highly uncertain and speculative labor hours, labor mix, and/or material requirements (and otherthings) necessary to perform the contract. The Government assumes the risks inherent in thecontract -benefiting if the actual cost is lower than the expected cost-losing if the work cannot becompleted within the expected cost of performance.An objectiverelationship canbe establishedbetween the feeand suchmeasures ofperformance asactual costs,delivery dates,Objectiveincentive targetsare not feasiblefor critical aspectsof performance.Judgmentalstandards can befairly applied.Potential feeRelating fee toperformance(e.g., to actualcosts) wouldbe unworkableor of marginalutility.7 The contractorexpectssubstantialcompensatingbenefits forabsorbing partof the costsand/orforegoing feeNo other typeof contract issuitable (e.g.,because costsare too low tojustify an auditof thecontractor'sindirect

Comparison of Major Contract Award-Fee(CPAF)performancebenchmarks, andthe like.would provide ameaningfulincentive. Target cost Performancetargets(optional) A minimum,maximum, andtarget fee A formula foradjusting feebased on actualcosts and/orperformance Target cost Standards forevaluatingperformance A base andmaximum fee Procedures foradjusting fee,based onperformanceagainst thestandardsCost-PlusFixed-Fee(CPFF)Cost (C) orCost-Sharing(CS)or The vendor isa non-profitentity Target cost Fixed fee Target cost If CS, anagreement ontheGovernment'sshare of thecost. No feeContractoris Obligedto:Make a good faith effort to meet the Government's needs within the estimatedcost in the Schedule.ContractorIncentive(other thanmaximizinggoodwill)1Realizes a higherfee by completingthe work at alower cost and/orby meeting otherobjectiveperformancetargets.Realizes a higherfee by meetingjudgmentalperformancestandards.Realizes ahigher rate ofreturn (i.e.,fee divided bytotal cost) astotal costdecreases.If CS, shares inthe cost ofproviding adeliverable ofmutual benefitTypicalApplicationResearch anddevelopment ofthe prototype fora major system.Large scaleresearch study.ResearchstudyJoint researchwith educationalinstitutions.PrincipalLimitationsin FARparts 16,32, 35, 52The contractor must have an adequate accounting system. The Governmentmust exercise surveillance during performance to ensure use of efficientmethods and cost controls. Must be negotiated. Must be justified. Statutoryand regulatory limits on the fees that may be negotiated. Must include theapplicable Limitation of Cost clause at FAR 52.232-20 through FAR 52.232-23.8Time &Materials(T&M)expenses). A ceiling price A per-hourlabor rate thatalso coversoverhead andprofit Provisions forreimbursingdirect materialcostsMake a goodfaith effort tomeet theGovernment'sneeds withinthe ceilingprice.Emergencyrepairs toheating plantsand aircraftengines.Labor ratesmust benegotiated.MUST bejustified. TheGovernmentMUST

Comparison of Major Contract e(CPAF)Cost-PlusFixed-Fee(CPFF)Cost (C) orCost-Sharing(CS)Time &Materials(T&M)exerciseappropriatesurveillance toensure efficientperformance.VariantsCompletion orTerm.Labor Hour(LH)Consider Acquisition Method (FAR 14.104 and FAR 16.102,). The acquisition method selected for aparticular acquisition may limit the available choice of contract type: Simplified Acquisition. When using simplified acquisition procedures purchase orders arenormally firm fixed-price. You may use an unpriced order in certain situations when it isimpossible to obtain firm pricing prior to issuing the purchase order. Whenever you use anunpriced order, the order must include a dollar limit on the Government's obligation and thecontracting officer must follow-up to assure timely pricing. Sealed Bidding. When using sealed bidding procedures: oYou will normally use a firm fixed-price contract.oYou may use a fixed-price contract with economic price adjustment if the contractingofficer determines (in writing) what type of contract is necessary to protect the contractorand the Government against significant fluctuations in labor or material costs or toprovide for contract price adjustments in the event of changes in the contractor'sestablished prices.oYou must not use any other contract type.Negotiation. When using the negotiation procedures prescribed in FAR Part 15:oYou may use any contract type or combination of contract types that will promote the bestinterests of the Government, as long as you meet the specific limitations in FAR Part 16.oYou must not use any contract type not prescribed in the FAR unless authorized byagency regulation or a FAR deviation.Consider Commerciality of the Requirement (FAR 12.207). When acquiring a commercial item: You normally should use a firm fixed-price contract. You may use a fixed-price contract with economic price adjustment if the contracting officerdetermines (in writing) what type of contract is necessary to protect the contractor and theGovernment against significant fluctuations in labor or material costs or to provide for contractprice adjustments in the event of changes in the contractor's established prices. You must not use any other contract type in acquiring commercial items.Consider Cost Risk . Encourage contractors to accept reasonable cost risks of contract performance.However, requiring contractors to accept unknown or uncontrollable cost risk can endanger contractperformance, substantially reduce competition, and/or substantially increase contract price. To realisticallychoose the proper contract type to meet a specific contract situation, you must consider the properallocation of cost risk.9

Cost estimates, whether they are the offeror's proposed or the Government's recommended, are pointestimates. In all contracts involving forward pricing, the point estimate is a projection of what the estimatorbelieves is most likely to happen. Since things rarely happen exactly as predicted, there is usually somevariation between projected and actual cost. The greater the potential variability between the projectedand actual cost, the greater the cost risk.Cost ReimbursementFixed PriceQuantitative analysis techniques can provide invaluable information about the distribution of valuesaround the most likely future cost. For example, consider the confidence interval when your estimate isbased on sampling analysis and the prediction interval when your estimate is based on regressionanalysis. However, use this information wisely. If the variance is large, attempt to determine why theinterval is so large and what can be done to narrow it, before you select a contract type to share the risk.As a minimum, your appraisal of cost risk should consider two areas of particular concern, contractperformance risk and market risk. Performance Risk. Most contract cost risk is related to contract requirements and the uncertaintysurrounding contract performance. The lower the uncertainty the lower the risk. Therefore, yourappraisal of cost risk should begin with an appraisal of performance risk. For larger more complexcontracts, you will likely need assistance from other members of the Government AcquisitionTeam (e.g., representatives from the requiring activity, engineering staff, contracting, andprogram/project management). Areas that you consider should include:oStability and clarity of the contract specifications or statement of work;oType and complexity of the item or service being purchased;oAvailability of historical pricing data;oPrior experience in providing required supplies or services;oUrgency of the requirement;oContractor technical capability and financial responsibility; andoExtent and nature of proposed subcontracting.oThe figure below depicts what happens as the contract requirement becomes betterdefined.10

COST RISK AND CONTRACT TYPECost ConceptStudies oductionContractTypeVariedCPFFCPIF, FPIFCPIF, FPIF, orFFPFFP, FPIF,or FPEPAFFP, FPIF,or FPEPA LowWell-definedPerformance risk should be reduced from a high to a relatively low level, as the requirementprogresses from vague to well-defined and experience with the product increases.oResearch and development contracts generally have a rather high performance risk. This isdue to the factor of ill-defined requirements that arise from the necessity to deal beyond, orat least very near, the upper limits of current technology (i.e., "the state of the art").oFollow-on production contracts generally have a relatively low performance risk.Requirements are well known, there is a cost history to draw on, contractors haveexperience producing the product, etc. As performance risk changes, so should contract type. Note that cost-reimbursement, time &materials, or labor-hour contracts are generally associated with higher-risk requirements andfixed-price contracts are generally associated with lower-risk requirements. Market Risk. Changes in the marketplace will also affect contract costs. Preferred acquisitionpractice calls for forward pricing of contract efforts, because forward pricing provides a baselinewhich you and the contractor can use to measure cost or price performance against contract effort.oForward pricing requires the contracting parties to make assumptions about futurechanges in the marketplace. A volatile market will increase the cost risk involved incontract pricing, particularly when the contract period will extend several years. What willmaterial and labor cost two years from now? Will material shortages occur two years fromnow? In cases where these unknown costs are significant, contract period risk becomesan important consideration in selection of contract type.oFixed-price contracts with economic price adjustment, for example, are designedspecifically to reduce this risk for contractors.Consider Appropriate Performance Incentives (FAR 16.103(b)). Select the contract type (or combinationof types) that will appropriately motivate contract performance. When the risk involved is minimal or can be predicted with an acceptable degree of certainty, usea firm fixed-price contract, because it best utilizes profit to motivate efficient contract performanceand cost control. When

Fixed-price contracts should be used when the contract risk is relatively low, or defined within acceptable limits, and the contractor and the Government can reasonably agree on a maximum price. Contract types in this category include: o Firm fixed-price (FFP) o Fixed-price contracts with economic price adjustment (FP/EPA)