Generally, contracts are divided into the following broad classifications:

  1. Contracts for items to be delivered or services to be performed
  2. Research and development contracts
  3. Construction contracts
  4. Facilities contracts for the acquisition, construction, or operation of plant and production equipment

Within those broad classifications, the specific contract type is defined by the pricing arrangement selected. Selecting the appropriate pricing arrangement is a critical step in the government procurement process because the contract type determines the amount of risk each individual party is willing to accept. It is important to recognize that the federal procurement system is based on the premise that the greater the risk assumed by the contractor, the greater the earnings potential. Therefore, selection of the appropriate contract type for a given procurement is important to achieve a proper balance between risk and profit.

Federal contracts are generally classified as either fixed-price or cost-reimbursement. Contracts awarded by sealed bids are firm-fixed-price. The type of contract selected for negotiated procurements is generally a matter for negotiation and generally requires the exercise of sound judgment. The objective is to negotiate a contract type that represents a reasonable sharing of risk, considering the nature of the work to be performed, the scope of the effort, and the performance schedule. Under the fixed-price arrangement, the company is obligated to deliver the product or service at the established price without regard to the actual cost to perform. The contractor assumes less risk under a cost-reimbursement contract, because the contract typically provides for reimbursement of allowable costs incurred plus a fee (profit). Unlike fixed-price contracts, cost-reimbursement contracts obligate the contractor only to use its best efforts to accomplish the scope of work within a specified time and stated dollar limitation; the contractor can legally stop work when all of the contract funds are spent.

Fixed-Price Contracts

Firm fixed-price contract. A contract under which the contractor is paid a predetermined fixed amount for a specified scope of work and has full responsibility for the performance costs and resulting profit or loss. This contract type is used primarily when (a) the scope of work is known with relative certainty and (b) a fair and reasonable price can be established based either on adequate price competition or on a reasonable price comparison with prior purchases or available cost or pricing data that permits realistic estimates of the probable costs of performance.

Fixed-price contract with economic price adjustment. This contract provides for revision of the contract price based on the occurrence of specifically defined economic contingencies, for example, increases or decreases in either material prices or labor wage rates.

Fixed-price incentive contract. This contract establishes the initial firm target cost, firm target profit, price ceiling (but not a profit ceiling or floor), and formula for establishing final profit and price based on the relationship that the final negotiated total cost bears to total target cost. The formula is typically based on the contractor and the customer sharing the benefits of cost underruns or the burden of cost overruns.

Fixed-price contracts with prospective price redetermination. This contract establishes a firm fixed price for an initial number of units or for an initial period of performance, with prospective price redeterminations at stated intervals during the remaining period of performance.

Fixed-ceiling-price contracts with retroactive price redetermination. These contracts establish a ceiling price and retroactive price redetermination (within the ceiling price) after the completion of the contract, based on costs incurred, with consideration given to management ingenuity and effectiveness.

Firm fixed-price level-of-effort term contracts. These contracts usually call for investigation or study in a specific research and development area. It obligates the contractor to devote a specified level of effort over a stated period of time for a fixed dollar amount.

Cost-Reimbursement Contracts

Cost contracts. These contracts provide for the contractor to be reimbursed for allowable incurred costs with no provision to give the contractor any profit or fee.

Cost-sharing contracts. These contracts specify that the contractor is reimbursed only for an agreed portion of costs incurred to perform with no provision for a contractor fee.

Cost-plus-award-fee contracts. 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 sufficient to provide motivation for excellence in contract performance.

Cost-plus-incentive-fee contracts. 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-fixed-fee contracts. 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.

Other Types of Contracts and Arrangements

Indefinite delivery contracts. These types of contracts are used when the exact time of delivery or the quantities to be delivered are unknown at the time the contract is executed.

Time and materials (T&M) and labor hour contracts. Under a T&M contract, the contractor is paid fixed hourly rates for direct-labor hours expended under specified labor categories. The labor rates include direct-labor costs, indirect expenses, and profit. Materials or other specified costs are usually reimbursed at actual costs plus allocable indirect costs. A labor hour contract is similar to a T&M contract except that materials are not supplied by the contractor.

                                                                                                                            June 2012