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The Complete Guide to Government Contract Types

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Everything You Need to Know About Government Contract Types

As the world's single largest buyer of goods and services, the federal government has many ways to structure its procurements. Different situations and conditions often determine the best vehicle for a particular purchase. Contracting officers must assess a wide range of factors to determine which contract type will provide the government the best value and the least risk.

The Complete Guide to Government Contract Types provides a comprehensive overview of the key government contract vehicles and types: fixed-price, cost-reimbursement, incentive, and other (which includes letter, indefinite-delivery/indefinite-quantity, and time-and-material contracts). The author first explains the selection process for contract vehicles, which is the basis for selecting the appropriate contract type for the work in question. He then presents a comprehensive, in-depth analysis of each contract type, explaining how each works best to meet certain types of requirements and conditions.

This is an essential resource for both contracting officers and contractors seeking to understand and work effectively within the nuances of contract selection and compliance.

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Chapter 1: Firm-Fixed-Price Contract

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Typically used to procure commercial items or other products or services containing an adequately defined specification, the firm-fixed-price (FFP) contract is the most widely used of government contract types. A specification is defined as “a detailed statement … of the measurements, quality, materials, or other items to be provided under a contract.”1 Products may include commercial off-the-shelf (COTS) hardware such as bolts and fasteners, a jet engine that has passed qualification testing, or a building for which the government provides a detailed blueprint or services such as program management support. An FFP contract is uniquely suited for procuring commercial or well-defined items or services.

COs typically administer numerous FFP contracts over the course of their careers. Accordingly, the CO should have a thorough understanding of its definition, use, purpose, applicability, performance requirements, financial elements, and risks.

An FFP contract is part of the family of fixed-price contracts that the government uses to procure supplies and services for a specified price. An FFP contract is not subject to adjustment on the basis of the contractor’s cost increases during contract performance. It can be modified, however, when there is a “constructive” change such as an alteration to the PWS or specification; when an economic price adjustment is in order; and after a defective pricing incident. The contractor assumes all risk under an FFP contract and is therefore incentivized to perform well. An FFP contract places minimal administrative burden on both parties.

 

Chapter 2: Fixed-Price Contract with Economic Price Adjustment

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An FFP contract may not be an appropriate contract type in a volatile marketplace because it can place considerable risk on a supplier. As a safeguard, the government may engage in a fixed-price contract with economic price adjustment (FPEPA). This contract type allows for a price adjustment due to fluctuations in labor or material costs. FAR 16.203-3. As assurance that an adjustment is fair and reasonable to both parties, the price may fluctuate either up or down; an economic price adjustment is negotiated and the contract is modified accordingly.

When price fluctuation is a real possibility over the course of a contract, an FPEPA contract is well-suited. The government and the contractor determine at the onset of the contract which items have a high probability of price fluctuation. At the end of the contract, the contractor provides the government an economic price adjustment, identifying those items that have experienced a price change. This allows the parties to negotiate a fair and equitable agreement. The CO modifies the contract price accordingly.

 

Chapter 3: Fixed-Price Contract with Prospective Price Redetermination

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From solicitation, subcontractor selection, negotiation, and award, a large-dollar, long-term FFP contract requires considerable preparation and forethought to attain best value for a specified effort. Yet, price reasonableness cannot necessarily be assessed at initial award for a number of reasons. For example, the scope of work has yet to be fully defined for follow-on work. It is thus necessary to establish price reasonableness upon the award of each specified effort rather than at the onset of the initial contract. A fixed-price contract with prospective price redetermination (FPRP) is an ideal contract type to accommodate this need. Given the FPRP’s significance and frequent use, it is important to understand its definition, use, application, price, limitations, financing, and risk.

An FPRP contract encompasses an FFP contract for a preliminary period of contract delivery or performance followed by the negotiation of subsequent FFP contract work. The contract identifies the periods for new FFP prices to be negotiated. FAR 16.205-1(b).

 

Chapter 4: Fixed-Ceiling-Price Contract with Retroactive Price Redetermination

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When a noncompetitive, low-value contract is required, but there is no time to justify the price prior to issuance, a fixed-ceiling-price contract with retroactive price redetermination (FPRR) may be the ideal contract type. To ensure an expeditious procurement, the CO must have a comprehensive understanding of this contract type, including its definition, use, application, price, limitations, benefits, constraints, performance requirements, financial elements, and associated risks.

When funding must be allocated quickly to commence work on a low-value R&D agreement, but it is not possible to negotiate a fair and reasonable price at time of award, FAR 16.206-2 allows the CO to grant an FPRR contract estimated at the simplified acquisition threshold or less. A ceiling price is established up front and the final price is determined at contract completion, as prescribed in FAR 52.216-6.

The simplified acquisition threshold is the maximum dollar value of a procurement that may use simplified acquisition procedures. The dollar threshold is found at 41 U.S.C. § 134 and the simplified procedures prescribed are found in FAR Part 13.

 

Chapter 5: Fixed-Price-Level-of-Effort Contract

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When a budget is limited to $150,000 and it is not possible to develop a clear statement of work or to assess the number of hours required to complete a task, a fixed-price-level-of-effort (FPLOE) contract may be the appropriate contract type. Understanding this contract type’s definition, use, performance requirements, and financial elements will aid the CO in making an informed decision on whether an FPLOE is the appropriate contract type for the proposed work.

“A firm-fixed-price, level-of-effort term contract requires (a) the contractor to provide a specified level of effort, over a stated period of time, on work that can be stated only in general terms and (b) the Government to pay the contractor a fixed dollar amount.” FAR 16.207-1. An FPLOE contract “is suitable for investigation or study in a specific research and development area. The product of the contract is usually a report showing the results achieved through application of the required level of effort. However, payment is based on the effort rather than the results achieved.” FAR 16.207-2.

 

Chapter 6: Cost Contract

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Cost contracts are part of the family of cost-reimbursement contracts designed to enable the government to purchase R&D work at an undeterminable unit price at a particular point in time. FAR 16.302(b). Cost contracts do not involve any fee. FAR 16.302(a). Given that the contractor has little incentive to control costs, these contracts pose high risk to the government.

Cost contracts are quite complicated as they require a projection of costs. If costs are not estimated with some accuracy, the government may be required to expend financial resources in excess of the predetermined ceiling price (the maximum amount of money the government intends to pay under the contract). Although the government is solely responsible for any excess costs under a cost contract, the FAR has established built-in safeguards to assist both parties in meeting their objectives.

Contractors are often willing to forgo fee on a contract when they anticipate they may realize future business or when they are trying to break into a market. Universities and other nonprofit organizations commonly engage in non–fee-bearing contracts for research studies.

 

Chapter 7: Cost-Sharing Contract

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Cost-sharing contracts are excellent tools to offset some of the cost of R&D. This is particularly true for a small business that has limited resources. These contracts offer additional advantages, such as providing increased marketplace exposure, access to technology, reduced procurement expenses through economies of scale, and lower overall costs.

Cost-sharing contracts are quite different from other cost-reimbursement contracts in that both parties participate in the work and share in the cost, in anticipation of mutual benefit. For example, both the government and the contractor may receive employee training, acquire equipment, or gain enhanced technical awareness. Given the dissimilarities of this contract to others, it is necessary for the contracting officer to have a comprehensive grasp of its nuances, including methods of cost sharing, when it is an inappropriate mode of contracting, the percentage of cost sharing between the parties, limitations identified in FAR 16.301-3, ensuring that the contractor has an adequate accounting system, making certain there is appropriate surveillance during the life of the contract, and confirming that all appropriate assessments have been conducted (e.g., making sure the contract type is less expensive than other contract types or that it is infeasible to procure required supplies or services without a cost-sharing contract). 41 U.S.C. 254(b), 257(b), and 257(a).1

 

Chapter 8: Cost-Plus-Fixed-Fee Contract

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The cost-plus-fixed-fee (CPFF) contract is the most widely used of the cost-reimbursement contracts. Like other cost-reimbursement contracts, it enables the government and the contractor to engage in a contract containing an undefinitized performance work statement (PWS). Unlike other cost-reimbursement contracts, however, it allows for payment of fee up to the ceiling cap, at which point any cost overrun is paid to the contractor at cost, minus fee (provided that the added expenditure is formally authorized by the CO in writing).

A CO will likely manage many CPFF contracts. Because this contract type is so common, the CO must have a thorough understanding of its definition, purpose, use, performance requirements, financial elements, incentives, and associated risk to achieve maximum benefits while remaining contractually compliant.

Part of the family of cost-reimbursement contracts, a CPFF contract is used when the PWS contains uncertainties. The fixed fee does not vary with actual cost, regardless of whether or not the work is completed at contract conclusion; however, the fee may be adjusted with changes in the scope of work or the services to be performed.

 

Chapter 9: Cost-Plus-a-Percentage-of-Cost Contract

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A cost-plus-a-percentage-of-cost contract rewards a contractor for raising the cost of goods by giving it a percentage of the total cost. In other words, profit grows correspondingly with cost. This type contract is prohibited in government contracting, as established by the 1945 case of Muschany v. United States.

The provision of § 1 of the Act of July 2, 1940, Public Law 703, 54 Stat. 712, prohibiting use of the cost-plus-a-percentage-of-cost system of contracting, was upheld in Muschany v. United States. The court clarified that Congress must protect the government against the misuse of appropriated funds by disengaging in the practice of issuing cost-plus-a-percentage-of-cost contracts under which the government must pay undetermined cost escalations plus a commission based on a percentage of future costs. The court stated that the problem with cost-plus-a-percentage-of-cost contracts is that profit increases in proportion to the greater costs expended during performance. As a result of the ruling, the cost-plus-a-percentage-of-cost form of contracting is prohibited by 10 U.S.C. § 2306(a) and 41 U.S.C. § 254(b). The prohibition applies to both cost-reimbursement contracts and fixed-price contracts where a contractor reaps rewards when additional compensation is paid as a percentage of total cost.

 

Chapter 10: Cost-Plus-Award-Fee Contract

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Cost-plus-award-fee (CPAF) contracts are ideal for driving down costs and improving performance because they incentivize the contractor to perform to its maximum capability and efficiency. Before engaging in a CPAF contract, however, the CO should determine if another contract type is better suited for the effort, as surveillance of a CPAF contract is administratively burdensome and expensive. The CO should perform a cost-benefit analysis to ensure the benefits (e.g., tighter cost control, enhanced technical capability) outweigh the costs. If that is determined to be the case, a CPAF contract is an excellent vehicle for motivating the contractor to perform.

A CPAF contract is “a cost-reimbursement contract that provides for a fee consisting of (1) a base amount fixed at inception of the contract, if applicable and at the discretion of the contracting officer, and (2) an award amount that the contractor may earn in whole or in part during performance and that is sufficient to provide motivation for excellence in the areas of cost, schedule, and technical performance.” FAR 16.405-2.

 

Chapter 11: Fixed-Price-Award-Fee Contract

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The fixed-price-award-fee (FPAF) contract is a viable contractual vehicle when the government seeks to incentivize a contractor’s performance and an FFP contract is inappropriate for the effort. The government must consider the following factors when deciding whether to enter into an FPAF contract: cost to administer, contract complexity, program criticality, and the availability of government personnel to monitor and evaluate performance. If, after careful deliberation, the anticipated benefits outweigh the time and cost needed to administer the effort, an FPAF contract may be an excellent tool to motivate a contractor to perform above and beyond its usual standards.

Aside from the cost-plus-a-percentage-of-cost contract type, which is prohibited from federal contracting per 10 U.S.C. § 2306(a) and 41 U.S.C. § 254(b), the FPAF contract type is the least used of all the contract types. This is likely because the government may issue a simple FFP contract and pay the contractor additional money to incentivize delivery, quality, etc., without engaging in the added expense and additional manpower associated with the evaluation process involved in an FPAF contract.

 

Chapter 12: Fixed-Price-Incentive Contract

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Fixed-price-incentive (FPI) contracts have experienced a resurgence in the past several years as a result of government budget cuts. This contract type can be used to drive down costs while securing high-quality products or services by incentivizing the contractor to perform optimally and to control costs. In large efforts where the product or service is achievable within a specified budget, FPI is an excellent contract type; however, considerable time and costs are involved in its administration.

An FPI contract includes profit rather than fee, which is specific to cost-type contracts. Profit is the amount of money a contractor realizes once the cost of performance is deducted from the amount to be paid under the terms of the contract.

An FPI contract encourages a contractor to control costs and improve technical performance or delivery. It provides a target cost, target profit, price ceiling, and profit adjustment formula. Instead of a profit ceiling or floor, the profit adjustment formula provides incentive to the contractor. FAR 16.403-1 states: “When the final cost is less than the target cost, application of the formula results in a final profit greater than the target profit; conversely, when final cost is more than target cost, application of the formula results in a final profit less than the target profit, or even a net loss.” Because profit fluctuates inversely with cost, an FPI contract offers both a positive and a negative quantifiable incentive to control costs.

 

Chapter 13: Cost-Plus-Incentive-Fee Contract

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In response to government budget cuts over the past decade, FPI and CPIF contracts have once again become popular. CPIF contracts enable the government to drive down costs while securing high-quality products or services. These contracts offer contractors financial incentives that fluctuate depending on the quality of performance and cost control achieved.

A CPIF contract is a cost-reimbursement contract that offers a negotiated target fee that adjusts up or down depending on how well the contractor performs. These fee adjustments are computed using a formula based on an association between target cost and total allowable costs, provided in FAR 16.304. The CPIF contract type involves a target cost, actual cost, target fee, minimum fee, maximum fee, and fee adjustment formula (sharing ratio). Under FAR 16.404-1, the target fee increases when the allowable cost is less than the target cost and decreases when the allowable cost exceeds the target cost. The contractor’s risk is minimized by a fixed minimum fee, although a negative fee can be negotiated. The government pays all allocable, allowable, and reasonable costs incurred on the contract, including costs associated with overruns.

 

Chapter 14: Time-and-Materials and Labor-Hour Contracts

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The time-and-materials (T&M) and labor-hour (LH) contract types combine characteristics of the cost-reimbursement and fixed-price contract types. LH contracts are similar to fixed-price contracts in that the government pays a fixed price for labor. The hourly rate includes wages, overhead, fringe, G&A, and profit. An LH contract is identical to a T&M contract, with the exception that the contractor does not procure the material. The contract ends when specific conditions identified in the contract’s PWS are met.

Similarly, a T&M contract is a combination of a labor-hour contract and a cost-reimbursement contract. As in an LH contract, the hourly rate includes wages, overhead, fringe, G&A, and profit. A T&M contract is similar to a cost-reimbursement contract in that costs for material are reimbursed by the government. However, material handling costs are segregated in a separate indirect cost pool and are not included as part of the labor billing rate. The contractor is reimbursed for all expenses and receives profit on all labor hours worked, regardless of whether the work is completed to the government’s satisfaction.

 

Chapter 15: Indefinite-Delivery Contracts

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Established by DOD in 1981, indefinite-delivery (ID) contracting is designed to streamline the bidding process, generally for maintenance, repair, and construction projects. Sometimes also referred to as term contracts, ID contracts take the form of either a task order (TO) or a delivery order (DO), defined as follows in FAR 16.501:

1. “‘Delivery-order contract’ means a contract for supplies that does not procure or specify a firm quantity of supplies (other than a minimum or maximum quantity) and that provides for the issuance of orders for the delivery of supplies during the period of the contract.”

2. “‘Task-order contract’ means a contract for services that does not procure or specify a firm quantity of services (other than a minimum or maximum quantity) and that provides for the issuance of orders for the performance of tasks during the period of the contract.”

ID contracts are used to drive down costs by bundling products in a single contract vehicle. For example, a contractor with high fixed production costs is able to achieve economies of scale by spreading those fixed costs over a large volume, driving down average operating costs. Finding ways to reduce cost in a manner that is advantageous to the government wherever possible not only makes good financial sense, but is a requirement under the 1984 Federal Procurement Competition Enhancement Act. As stated in FAR 16.5, when the government will be purchasing products repeatedly over a course of a year, an ID contract should be considered.

 

Chapter 16: Letter Contract

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A letter contract is a useful preliminary contractual instrument when time is of the essence. It enables the CO to authorize a contractor to start work immediately and to negotiate a fair and equitable contract or purchase order while the work is underway.

A letter contract is defined as “a written preliminary contractual instrument that authorizes the contractor to begin immediately manufacturing supplies or performing services.” FAR 16.603-1.

FAR 16.603-2 provides the following guidelines for drafting and implementing letter contracts:

1. A letter contract is used to bind the parties in a contractual arrangement when it is in the government’s best interest to have the contractor start work immediately.

2. The contracting officer will use this contract type when there is insufficient time to negotiate an alternate contract type to meet the requirements.

3. The letter contract should be as complete and definitive as possible.

4. A price ceiling will be addressed in the letter contract when it is awarded based on competition.

 

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