Many government contracts are fixed-price — i.e., the price quoted in the proposal is final and includes all expenses. In some cases, however, it's difficult if not impossible to predict exactly how much certain items or services are going to cost over the life of the contract. In these situations, the government agency will usually agree to a cost-reimbursement contract, in which the agency assumes some level of risk for the final costs.
In a cost-reimbursement contract, the final pricing will be determined when the contract is completed, or at some other previously established date in the contracting period. A total cost estimate will be determined before contract work commences, which allows the agency to set a budget for the project and to establish a maximum amount for reimbursement. The prime contractor cannot exceed that maximum without the contracting officer's permission, but is allowed to stop work if that maximum is reached (for government regulations on cost-reimbursement contracts, see subpart 16.3 of the FAR). Cost-reimbursement contracts come in several different forms:
Only the actual costs of completing the contract are covered; the contractor receives no additional fee. Cost contracts are typically used for research and nonprofit work.
The contractor agrees to assume part of the contract expenses. The agency will reimburse the contractor for an agreed-upon portion of those expenses. As with a cost contract, the contractor receives no additional fee. A contractor should enter into a cost-sharing contract only if the work will benefit the company in ways sufficient to offset the shared expenditures.
Cost-Plus-Fixed-Fee (CPFF) Contracts
The contractor receives reimbursement plus a predetermined fee that is negotiated when the contract is finalized and will not change based on the actual contract cost. However, the fee may be revised if the work required to complete the contract also changes. This type of contract is useful in situations where the risk to the contractor might otherwise outweigh any non-financial benefits. There are two types of CPFF contracts:
- Completion: A goal or product is identified and the contractor must deliver the product in order to receive the fee. If the costs exceed the original estimate, the government will continue to reimburse for cost but won't increase the fixed fee.
- Term: The scope of work is less specific, but the contract states a time period and level of effort expected of the contractor. When that time period expires, the fee is paid after the agency approves the work completed and level of effort. Any further work that's necessary will require a new agreement.
Cost-Plus-Incentive-Fee (CPIF) Contracts
The contractor receives reimbursement plus an adjustable fee. The initial contract will establish targets for cost and fee, as well as a minimum and maximum fee and a formula for fee adjustment. Once the contract is completed, the contractor will be paid based on this formula. In essence, the fee will be increased if the contract was completed at less than the target cost, and will be decreased if the contract exceeded the target cost. With a CPIF contract, it's definitely in the contractor's best interest to keep costs as low as possible — the less money spent, the more money the contractor receives, up to the maximum.
Cost-Plus-Award-Fee (CPAF) Contracts
The contractor receives reimbursement and a fixed fee, with the potential to earn all or part of an additional fee. The agency will decide the amount of the award based on an assessment of the contractor's performance. Both CPAF and CPIF contracts are intended to motivate contractors to complete the contract as thoroughly and cost-efficiently as possible.