As you explore career options in becoming a DoD contractor there are a few more things you should know, namely the concepts of Firm Fixed Price and Cost Reimbursement contracts. Understanding these concepts will make you a better job candidate and contractor employee.
Now that you are familiar with the definitions of a prime contractor and subcontractor and have a basic understanding of contract durations we are going to review the concepts of Firm Fixed Price and Cost Reimbursement contracts. If you did not read Part I of this series I encourage you to do so before proceeding.
When the government issues a contract for goods and/or services they have several contract types to choose from. These contract types are grouped into two categories: fixed-price contracts and cost-reimbursement contracts. With fixed price contracts the contractor has full responsibility to control costs and achieve a profit (fee) or minimize losses associated with performing the contract. Under cost reimbursement contracts the contractor has minimal responsibility for the costs associated with contract performance and the negotiated profit is fixed.
Within both of these models the government has a variety of incentive models to use to tailor the contract type and incentivize contractors to control cost or achieve performance targets. Key drivers for the type of contract the government issues is risk and cost control. In general Fixed Price contracts are the least risky to the government and cost contracts are more risky.
Within both of these models the government has a variety of incentive models to use to tailor the contract type and incentivize contractors to control cost or achieve performance targets. Key drivers for the type of contract the government issues are risk and cost control. In general Fixed Price contracts are the least risky to the government and cost contracts are more risky.
Knowing about these DoD contract types will provide you a basic understanding of how the government uses them to incentivise contractors to get work done. It will also give you information on how to best support your company maximize profit. With these goals in mind, let’s review a few of the more common fixed price and cost reimbursement contract models.
Firm Fixed Price (FFP) Contracts
The most straight forward and less risky for the government are Fixed Price contracts. A Firm Fixed Price contract provides for a set price that is not subject to any change resulting from a contractor’s cost in performing the contract. 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 contractors to control costs and perform effectively and imposes a minimum administrative burden and oversight responsibilities for the government. 1
The contractors who bid Firm Fixed Price work have to be sure they can provide the goods or services requested for the price negotiated and still make a profit. This type of contract puts the majority of delivery risk on the contractor.
To provide an example, consider if you were in business as a fence builder and you build fences in your county in the summer for homeowners. Your company name is ACME Fence Builders LLC. Under a FFP model when you bid new work, you would do a location survey, calculate your material needs and profit and provide your customers a firm fixed price bid for the work.
Since you have been building fences in your county for years you know the land and soil types, the weather conditions, what permits you need to get, and the cost of labor. As a result you can create a FFP bid and be confident you will come in very close to your estimate and make a profit.
In this situation your company takes on all the risk that your assumptions and bid are valid. If the price of redwood spikes two days after your customer signed your contract then your business would have to cover the price increase out of profit.
This is the same scenario for government contracting. In FFP contracts the DoD contractor takes on all the risk that they can deliver the product or service for the set price.
Cost Reimbursement Contracts
When the government releases a Cost Reimbursement contract, they will release a Request For Proposal (RFP) to industry to bid on using one of several cost contract types (Cost Plus Incentive Fee, Cost Plus Award Fee, Cost Plus Fixed Fee, etc.). Cost-reimbursement contracts provide for payment of all allowable incurred costs as prescribed in the contract.
Cost contracts, result in the government taking a majority of risk as they are obligated to pay all contractor costs related to performing the work and provide fee (profit) as well. Also, cost contracts provide minimum incentives for contractors to control costs and imposes a maximum administrative burden and oversight responsibilities on the government.
Cost contracts are most often used when circumstances do not allow the agency to define its requirements sufficiently to allow for a fixed-price type contract or there are uncertainties involved in contract performance that do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract.2
To continue with our an example, consider your business as a fence builder and you get a request to build a fence in a new state and the customer needs the fence built as soon as possible without giving you the time to do a proper site survey, review local building codes or do a thorough analysis of local labor costs. Let’s say your company really needs the work so you do your best and estimate the work based on your experience building fences in your state and local county and submit a bid. Also, for sake of example let’s say the customer accepts your bid and awards your company a cost reimbursable contract for the fence.
As you began work you discover the soil in the new location is twice as hard as your local location and the drilling of fence post holes takes twice as long and doubles the labor for that part of the job. Under a cost reimbursable contract the customer would cover the additional cost associated with the extra time required to drill the post holes. Thus for cost reimbursable contracts the majority of cost risk falls to the customer.
This is the same scenario for government contracting. Under Cost Reimbursement Contracts the Government takes on the majority of risk that the product or service can be delivered for the negotiated price. Keep in mind this is just an example to explain the basics of Cost Reimbursement Contracts and there are rules and regulations associated with allowable increased costs versus unallowable costs.
Now that you have a basic understanding of Cost Reimbursement Contracts let us briefly review the three most common types of Cost Reimbursement Contracts. These include Cost Plus Incentive Fee (CPIF), Cost Plus Award Fee (CPAF) and Cost Plus Fixed Fee (CPFF).
Cost Plus Incentive Fee (CPIF)
Under a Cost Plus Incentive Fee structure the government provides for an initially negotiated fee (profit amount) to be adjusted later by a formula. The formula is usually comprised of performance goals and cost goals. At the end of the incentive fee period a contractors profit is calculated based on the performance target score and the relationship of total incurred costs to total target costs.3
The potential to earn more fee based on performance is intended to incentivize contractors to manage the contract effectively. Cost Plus Incentive Fee contracts provide incentives for contractors to control costs and maximize profit.
Going back to our fence example let’s say as part of the contract the customer indicates they will pay you a flat 3% profit for building of the fence. Also, if you can complete the initial permitting, site survey and get all of the posts dug and set within between 51 and 60 days after contract award you can earn an additional fee of 2%. If you get the posts set after 60 days but before 90 days you get 1% additional fee and if you are greater than 90 days late you 0% additional fee. Likewise, if you complete everything in 50 days or less you get 3% profit. Also, if you can complete the total job at 80% of the negotiated labor cost you can earn an additional 3% percent profit.
Using this example, let’s say your company gets the initial work done in 65 days and completes the work for 79% of the negotiated labor estimate. Using the agreed to incentive fee plan you would earn your flat 3% for the base work, an additional 1% for getting the initial milestone done before 90 days and an additional 3% profit for coming in under total labor costs. Your total profit would be 7%. See table below.
| Incentive Fee | Posts set 61 -90 days 1% fee | Posts set 51-60 days 2% fee | Posts set 30-50 days 3% fee |
So if you get a job as a government contractor and you are working on a CPIF contract then you would want to be sure you knew the basics of the incentive fee plan. By knowing the basics of the plan you can ensure you align and perform your job in a manner to help your company maximize profit.
Cost Plus Award Fee (CPAF)
Cost plus Award Fee contracts are a type of incentive contract. Under this type of contract the government pays the contractor’s costs for providing the services in the contract and allows for a base fee (profit) amount. Then at the end of the performance period the contractor can earn additional “award fee/profit” based on their performance against a preset list of award fee criteria.4
Under a Cost Plus Award Fee structure the government establishes an initial Award Fee plan. This plan outlines the award-fee evaluation criteria and how they are linked to government objectives which are defined in terms of contract cost, schedule, and technical performance objectives. The award fee criteria is designed to motivate contractors to enhance performance in the areas rated, but not at the expense of at least minimum acceptable performance in all other areas. Also, award fee shall not be earned if the contractor’s overall cost, schedule, and technical performance in the aggregate is below satisfactory.5
Returning to our fence example, let’s say the customer awarded your company a cost plus award fee contract to build a fence in four months. Under this model the customer will pay all your company’s costs in building the fence and a set fee of 4% profit. Additionally, your company can achieve upto 6% additional profit if you achieve maximum award fee scores for product quality as defined in the Award Fee Plan. Also, the award fee plan will be assessed in two periods (two months after award and at completion.) Accordingly, if your company finishes the fence and receives max award fee during both of the rating periods you would earn 10% profit, 4% on the base work plus 6% award fee.
The following example uses a modified excerpt from Appendix D – Sample Evaluation Criteria from the Department of the Air Force Award-Fee Guide October 2008. Also, to ensure consistency in product and service quality most government contracts require contractors to follow industry standards. The example below cites ISO 9001 as the governing quality standard.
Sample Award Fee Plan for ACME Fence Builders
Product Quality (PQ): (Specific areas of interest: ISO 9001 (or equivalent) compliance & minimizing material/workmanship defects)
Unsatisfactory: PQ program is not compliant with standards for ISO 9001 (or equivalent) and initial quality of products fails to meet baseline standards. Fee 0%
Satisfactory: PQ program is compliant with standards for ISO 9001 qualification (or equivalent) and initial quality of products meets baseline standards. Fee 3%
Excellent: PQ program significantly exceeds standards for ISO 9001, reducing material/workmanship defects; implements some process improvements. Fee 6%
Using these definitions and our example scenario let’s say the customer assigned 0% additional fee if any part of the fence is rated Unsatisfactory and fails to meet ISO 9001 standards for quality. Accordingly for Satisfactory PQ the customer assigned 3% additional fee and Excellent PC the customer assigned 6% additional fee. Also since the customer stated it would be assessed in two periods you would be able to achieve 1.5% fee for satisfactory and 3% fee for excellent for each assessment period for a total of 3% for satisfactory and 6% for excellent respectively. See table below.
| Award Fee Plan Criteria | 2 Month Inspection | 4 Month Inspection | Total |
| Unsatisfactory PQ | 0% | 0% | 0% |
| Satisfactory PQ | 1.5% | 1.5% | 3% |
| Excellent PQ | 3% | 3% | 6% |
Under most CPAF contracts there are multiple Award Fee Assessment periods and multiple categories are used. I only used one here to keep the example straight forward. As with the CPIF example, if you are working on a CPAF contract you would want to have knowledge of the Award Fee Plan and what the criteria are so you can align your work to support helping your company achieve excellent scores and maximum profit.
Cost Plus Fixed Fee (CPFF)
Under a Cost Plus Fixed Fee structure the government pays a contractor’s allowable cost for providing services and 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.6
Going back to our fence example, under a CPFF contract the customer would pay your fence building company all costs associated with building the fence and fixed fixed fee of 8%. This would be a guaranteed profit provided you completed the fence per the requirements of the contract. Also, you get no additional fee for finishing early. Likewise, the fee is the same if you get the job done but it is late.
Time and Materials (T&M)
Under a Time and Material structure the government pays a contractor’s allowable costs for all “Time and Materials” supplied in the performance of the contract. “Materials” means those materials that enter directly into the end product, or that are used or consumed directly in connection with the furnishing of the end product or service.
A time-and-materials contract provides for acquiring supplies or services on the basis of (1) Direct labor hours at specified fixed hourly rates that include wages, overhead, general and administrative expenses, and profit; and (2) Actual cost for materials.
A time-and-materials contract may be used only when it is not possible at the time of placing the contract to estimate accurately the extent or duration of the work or to anticipate costs with any reasonable degree of confidence.7
Going back to our fence example, under a T&M contract the customer would pay your fence building company all costs associated with building the fence based on a fixed hourly rate for your companies labor costs and the actual cost of materials. To be successful at T&M contracting your company would need to ensure your labor rates were competitive to allow you to win work, but also high enough to provide you profit. Under this scenario your company is not incentivized to finish early as you would get less fee. Likewise, to protect the customers bottom line they usually stipulate a not to exceed (NTE) clause in the contract to preclude unscrupulous fence builders from stretching out the work to make more money.
Summary
In summary, you now have a general understanding of fixed price and cost reimbursable government contracts. You also have a broad understanding of Cost Plus Incentive Fee, Cost Plus Award Fee, Cost Plus Fixed Fee and T&M contracting models. When you land an interview with a defense contractor you can inquire if the position you are interviewing for is on a fixed price contract or cost reimbursable contract or if the contract supports a mix of contract types. Likewise, if the contract is a cost reimbursable contract you can ask if the contract is an Incentive Fee or Award Fee contract and if the position you are interviewing for has any areas that allow you to directly or indirectly contribute to maximizing profit for your company.
This concludes part II of this series stay tuned for future articles. If you have any questions or comments feel free to message me or comment on the article. To learn more about DoD Contracting job and career opportunities visit my website Defense Careers HQ.
1 Author, United States General Services Administration. 16.202-1 Description. Retrieved from https://www.acquisition.gov/content/16202-1-description
2 Author, United States General Services Administration. 16.301-1 General. Retrieved from https://www.acquisition.gov/content/16301-general
3 Author, United States General Services Administration. 16.405-1 Cost-plus-incentive-fee contracts. Retrieved from https://www.acquisition.gov/content/16405-1-cost-plus-incentive-fee-contracts#i1104535
4 Author, United States General Services Administration. 16.405-2 Cost-plus-award-fee contracts. Retrieved from https://www.acquisition.gov/content/16405-2-cost-plus-award-fee-contracts
5 Author, United States General Services Administration. 16.401 General. Retrieved from https://www.acquisition.gov/content/16401-general#i1104345
6 Author, United States General Services Administration. 16.306 Cost-plus-fixed-fee contracts. Retrieved from https://www.acquisition.gov/content/16306-cost-plus-fixed-fee-contracts#i1104719
7 Author, United States General Services Administration. 16.601 Time-and-materials contracts. Retrieved from https://www.acquisition.gov/content/16601-time-and-materials-contracts
