The Complete Guide to Government Contract Types

By Kenneth R. Segel

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.

• Language: English
• Publisher: Berrett-Koehler Publishers, Inc.
• Release date: Apr 1, 2016
• ISBN: 9781567264692

Kenneth R. Segel

Kenneth R. Segel has nearly three decades of experience working with government contracts, subcontracts, purchasing, and pricing. In addition, he has worked as an executive at several Fortune 500 corporations and has conducted numerous training seminars on government contracting types. He is the author of The Government Subcontractor's Guide to Terms and Conditions.

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Index

Preface

Government contracting is a highly complex way of procuring goods and services. Over the course of nearly three decades working in government contracts, subcontracts, purchasing, and contract pricing, I have experienced a wide range of situations and encountered a variety of issues. Quite often, I see parties venturing into contracts that are not well-suited for the effort or managing them incorrectly. Many of the errors I come across stem from the parties’ lack of experience. I offer the following examples.

When sequestration took place in January 2013, the fixed-price-incentive-firm-target (FPIF) contract gained favor for its cost-saving features. Many contracting officials were unfamiliar with this complex contract type and therefore used it inappropriately. For example, I was involved in the negotiation of a high-value research and development (R&D) project. The contracting officer was adamant about using an FPIF contract for the effort until I convinced her that the proposed application was inconsistent with the intent of that type of contract—incentivizing a contractor to perform optimally under a fixed-price arrangement.

The appropriate contract type in this case was a cost-plus-fixed-fee (CPFF) contract, under which the government assumes most of the risk in recognition that R&D projects do not have a definitive performance work statement (PWS). Without a detailed description of the work that needs to be completed within the scope of a contract, it is not possible to estimate with any accuracy what it will cost to complete the project. A CPFF contract was appropriate under these circumstances as all allowable cost would be borne by the government because it was hiring my employer to develop a specific product. The incentive my employer received was in the form of a fixed fee.

When I started a new job as director of contracts for a Fortune 500 company, I was informed that one of the company’s contracts was losing nearly $1 million a month. The company had already overextended itself by half the contract value, with no relief in sight, largely because it had mistakenly negotiated a firm-fixed-price (FFP) contract for an R&D effort. When it began to lose money, the company attempted to renegotiate the project as a CPFF contract, which would have been the appropriate contract type for this application in the first place. However, the government was unwilling to renegotiate. Had the parties understood the intended purpose of an FFP contract versus a CPFF contract during the original negotiations, the outcome would undoubtedly have been different. Unfortunately, my company lost nearly $25 million on the project.

Misunderstandings of this nature span all contract types. It is critical that everyone involved in government contracts, both in industry and in government, understand the purpose and use of each contract type. Using the appropriate contract type benefits both the government and the contractor by enhancing performance and establishing an appropriate price for the effort while appropriately assigning risk. This book addresses the distinctions between the contract types, providing detailed explanations of the various aspects of each.

The government customarily divides contracts into fixed-price and cost-reimbursement contract families. Some contract types fall outside these boundaries. For example, an incentive contract is a combination of fixed-price and cost-reimbursement and, therefore, does not fit into either of those categories. For ease of understanding, this book groups contract types into four families: fixed-price, cost-reimbursement, incentive, and other.

When purchasing a commercially available item (such as production parts) that involves little risk, the government generally prefers to use a fixed-price contract. A cost-reimbursement contract, which is typically associated with an indeterminate PWS, is far more complex. This contract type is used primarily for R&D work, where the government assumes significant risk. Incentive contracts can be fixed-price-incentive, cost-plus-award-fee (CPAF), or cost-plus-incentive-fee (CPIF). This contract type is used to incentivize the contractor to perform optimally by offering increased profit/fee for performance beyond expectations or decreased profit/fee when performance objectives are not met. Other contract types that do not fall under the first three categories include time-and-materials and labor-hour contracts.

The Federal Acquisition Regulation (FAR) governs the government acquisition system, regulating how government contracts are selected, negotiated, and managed. The FAR is codified in Title 48, Chapter 1, of the United States Code of Federal Regulations (CFR). The FAR served as the primary source for this book. The CFR, FAR, and agency FAR supplements referenced in this book are all current as of March 2016.

This book presents and describes each contract type within its contract family:

Part I. Fixed-price contracts

Chapter 1. Firm-fixed-price

Chapter 2. Fixed-price with economic price adjustment

Chapter 3. Fixed-price with prospective price redetermination

Chapter 4. Fixed-ceiling-price with retroactive price redetermination

Chapter 5. Fixed-price-level-of-effort

Part II. Cost-reimbursement contracts

Chapter 6. Cost

Chapter 7. Cost-sharing

Chapter 8. Cost-plus-fixed-fee

Chapter 9. Cost-plus-a-percentage-of-cost

Part III. Incentive contracts

Chapter 10. Cost-plus-award-fee

Chapter 11. Fixed-price-award-fee

Chapter 12. Fixed-price-incentive

Chapter 13. Cost-plus-incentive-fee

Part IV. Other

Chapter 14. Time-and-materials and labor-hour

Chapter 15. Indefinite-delivery

Chapter 16. Letter.

To ensure the appropriate contract family and type are selected for a particular effort, each chapter first presents a definition of the contract type and then addresses applications, financial provisions, associated risks, and limitations, along with other factors specific to particular contract families and their respective contract types. Certain chapters repeat significant details to ensure readers a thorough understanding and to provide all relevant information about a particular contract type in one readily accessible place.

—Kenneth Segel

Introduction

Contracts management is a dynamic field entailing virtually every aspect of business and public administration. Despite common misconceptions, the job of a contracting officer (CO) involves much more than understanding, negotiating, and ensuring compliance with contractual terms and conditions. Some liken the CO to a police officer who ensures that the government and the contractor remain contractually compliant. This is true to an extent, but the role involves much more than simply policing for compliance.

The CO is the lead in the negotiation process and the caretaker of the contract from inception to closeout. As the interface with the government customer, the CO must know what is taking place at all times, ensure that deliverable schedules are met, act as a compliance manager, address legal and technical issues, make certain that the work remains within scope, address modifications when appropriate, pay close attention to the financials, fund the contract when appropriations are made available, and play politician, along with a host of day-to-day roles and responsibilities.

The CO’s job requires a near-fanatical understanding of the contract in its totality to administer it properly. This means having a strong background in contracts, understanding pricing, and having at least a rudimentary comprehension of the PWS and a broad understanding of the Code of Federal Regulations (CFR), the Federal Acquisition Regulation (FAR), and the relevant agency FAR supplement. This also holds true for the contractor, which must adhere to many of the same rules and regulations as the government contracting officer.

The federal government customarily divides contracts into two main contract families—fixed-price and cost-reimbursement—depending on the level of performance risk the government and the contractor will assume. Fixed-price contracts provide for either a firm price or an adjustable price. Adjustable-price contracts typically include a ceiling price, a target price, or both.

Cost-reimbursement contracts, on the other hand, provide for payment to the contractor of allowable incurred costs to the extent prescribed in the contract. FAR 16.301. The contractor is entitled to payment for all allowable costs in performing certain work up to the total funded amount; the financial risk shifts to the government when performance costs exceed the anticipated ceiling amount. Consequently, cost-reimbursement contracts require only that the contractor perform its best effort to complete the work. Best effort is defined as diligent attempts to carry out an obligation… measured by the measures that a reasonable person in the same circumstances and of the same nature as the acting party would take.¹

In essence, the contractor is not obligated to finish the work until additional funds are appropriated on the contract. This understanding is based on the condition that the contractor made a diligent attempt to carry out its obligation. The government must continue to fund the effort (without fee once the contract ceiling is reached; with fee if it has not been reached) to complete the assigned task

Although risk factors play a significant role in the contract type a CO chooses, contract type is also a question of law. Specifically, the CO does not have authority to choose the contract type in three circumstances: (1) cost-plus-a-percentage-of-cost contracts are strictly prohibited [FAR 16.102(c)], (2) commercial items may not be procured on a cost-reimbursement contract [FAR 16.301-3(b)], and (3) sealed bidding is limited to firm-fixed-price (FFP) or fixed-price-with-economic-price-adjustment (FPEPA) contracts [FAR 16.102(a)].

Aside from these legal limitations, the CO’s discretionary powers to choose the contract type are virtually unlimited. Among the selection factors a CO uses to determine the contract of choice is how much contract risk is involved in the procurement.

THE CONTRACTING OFFICER

FAR 2.101 defines a contracting officer as a person with the authority to enter into, administer, or terminate contracts and make related determinations and findings. One of the CO’s primary responsibilities is to determine what type of contract to use when procuring materials or services. The CO relies on FAR 16.1, Selecting Contract Types, as a guide in selecting the appropriate contract type.

The CO’s primary responsibility during the award phase of procurement (i.e., source selection) is to make an informed determination on the type of contract to award the contractor. The proper contract type ensures that risk is apportioned appropriately between the government and the contractor and simultaneously incentivizes the contractor to perform at or above contract expectations. The CO may perform 12 types of analysis to achieve this goal. Using the guide at FAR 16.104, the CO determines the contract family, the most appropriate contract vehicle depending on the circumstances, and the eventual contract type by conducting one or more of the following analyses:

1. Degree of price competition in the procurement

2. Cost analysis

3. Price analysis

4. Type and complexity of the requirements

5. Combining contract types

6. Urgency of the requirements

7. Period of performance or length of the production run

8. History of the acquisition

9. Contractor’s technical capability and financial responsibility

10. Adequacy of the contractor’s accounting system

11. Concurrent contracts

12. Extent and nature of proposed subcontracting and acquisition history.

Addressing each of these 12 areas of analysis also helps identify the risks associated with a contract type and establish the length of time required to complete the task.

CONTRACT RISK

Contract risk is the potential for monetary loss or gain on a contract that is attributable to the work to be completed. FAR 16.104 notes risk as one of the factors the CO must consider in selecting a contract type. The intent is to establish a fair and equitable distribution of risk between the government and the contractor. Figure I-1 illustrates how much risk the contractor and the government assume, respectively, for each contract type.

FIGURE I-1. Risk by Contract Type

The cost-plus-fixed-fee (CPFF) contract poses the greatest risk to the government: The contractor is reimbursed for all costs and is awarded a fixed fee for its effort. In contrast, the contractor assumes the majority of risk on an FFP contract, where it can make a considerable amount of profit if it performs well and will lose money if it fails to meet the contract objectives. Fixed-price contracts offer contractors the ability to maximize profit. The government benefits because the contractor assumes the majority of risk. As a result, fixed-price contracts should be used whenever possible. An understanding of where risk falls within the spectrum provides the CO a key element to consider in making an informed decision on which contract type to use for any given effort.

AREAS OF ANALYSIS

To make an informed decision on what contract type to use for a particular procurement, the CO performs analyses in 12 areas.

Degree of Price Competition in the Procurement

The 1984 Competition in Contracting Act (CICA) requires full and open competition whenever possible. This holds true for all contract types. Theoretically, increased competition will reduce costs and improve opportunities for small businesses to win contracts. This legal mandate is implemented in FAR Part 6, which establishes three standards:

1. Full and open competition

2. Full and open competition after exclusion of sources

3. Other than full and open competition.

Full and open competition enables the government to drive down costs and potentially heighten performance, innovation, and overall value. In cases when it is either infeasible or impractical to use full and open competition, the contracting office may exclude some sources of supply from bidding or award a contract to a single supplier.

Full and open competition after exclusion of sources is addressed in FAR Subpart 6.202. This approach is used to meet the following objectives:

1. To increase or maintain competition while simultaneously reducing program cost

2. To maintain a facility that can expeditiously provide supplies and services during a national emergency

3. To retain research and development capability by a nonprofit institution such as a university or other federally funded research and development operation

4. To maintain a reliable source of supply and services

5. To provide the government’s projected needs predicated on the history of high demand

6. To meet a dire need for medical, safety, or emergency provisions.

Occasionally, only one supplier can satisfy an agency’s requirement. In such instances, the CO will engage in other than full and open competition as prescribed in FAR Subpart 6.3. The CO must follow 41 U.S.C. § 3304 when engaging in noncompetitive procedures:

1. Only one source of supply is available and nothing else will work.

2. There is compelling urgency. In this instance, the government is authorized to limit the number of sources of supply that will bid on the effort.

3. There is convincing rationale to support awarding the procurement to a single source of supply. This includes the following:

a. Retain a supplier to ensure that property or services are available in the event of an emergency or so that the government can achieve industrial mobilization

b. Retain essential engineering, research, or development capability by a nonprofit organization such as a university

c. Purchase the services of a professional or neutral party when addressing an alternative dispute resolution or rulemaking process

4. When an agreement or treaty is established between the federal government and a foreign government or other international organization or when a foreign government will pay for the purchase

5. If a senior member of a government agency determines it is in the public interest to engage in a procurement without going through the competitive process

6. The CO has apprised Congress of this determination 30 days prior to contract award.

The Federal Acquisition Reform Act of 1996 (P.L. 104–106) moderated some of the requirements established in 1984, including the elimination or simplification of certain contracting procedures (e.g., raising the dollar thresholds for contracts that use other than competitive procedures, limiting the competitive range to the largest number of contractors permitting an efficient competition). Nonetheless, competition continues to be an important aspect in the CO’s arsenal when determining contract type. For example, the CO is required to solicit competitive quotes when procuring commercial off-the-shelf (COTS) items that may be purchased from a number of different sources. If numerous suppliers are vying for the effort, a sealed bid may be in order. A sealed bid is a method of contracting whereby the government solicits the submission of competitive proposals by inviting suppliers to bid on the effort.

Cost Analysis

Cost analysis is defined in FAR 15.404-1(c)(1) as follows:

Cost analysis is the review and evaluation of any separate cost elements and profit or fee in an offeror’s or contractor’s proposal, as needed to determine a fair and reasonable price or to determine cost realism, and the application of judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency.

Cost analysis is performed by conducting an audit or review of records and other documentation to confirm that the contractor’s proposed prices are current, accurate, and complete and that the contract type places a reasonable amount of responsibility on the contractor. Cost is generally defined as financial rates minus profit. Cost includes overhead, general and administrative (G&A), fringe benefits, material handling, and travel. FAR 15.401 defines price as cost plus any fee or profit applicable to the contract type. Any disparity between the findings and the contractor’s proposal are subject to negotiation. It is during this stage when the CO and the contractor’s representative either agree to the contract type the CO has chosen for the effort or negotiate a different contract type.

Price Analysis

FAR 15.404-1(b) defines price analysis as the process of examining and evaluating a prospective price without performing cost analysis; that is, without evaluating the separate cost elements and profit of the offeror included in that price. In other words, the CO determines price reasonableness by (1) comparing offers, (2) matching offers with competitive published price lists, and (3) associating a proposed price with a price independently developed by government estimates.

FAR 15.404-1(b) provides a more extensive list of factors involved in determining price reasonableness. For example, comparing offers with competitive published price lists may tell the CO that this is a COTS item (an item that is sold commercially to the general public and is not unique to government applications), which calls for an FFP contract. In contrast, associating a proposed price with one independently developed by government estimates may necessitate a CPFF contract for an R&D effort.

Type and Complexity of the Requirement

The type and complexity of the requirement can help determine the appropriate contract type. The more complicated the effort, the more associated risk; the less complex, the less associated risk. For example, R&D projects typically involve many uncertainties and likely changes in scope, making it difficult to assess their performance costs in advance. As a result, a CPFF contract is generally the vehicle of choice as it shifts the majority of the risk to the government. In contrast, a simpler requirement, such as a full-production run, will typically use an FFP contract, under which the contractor assumes all the financial risk and any associated benefits. Presumably, the product has already been developed and passed testing prior to engaging in the manufacturing process.

Combining Contract Types

The American Recovery and Reinvestment Act of 2009 mandates that the government use a fixed-price contract whenever possible. When this is not possible, the CO should consider drafting a multiple-award contract in which different contract types are combined with a fixed-price contract. This will drive down costs by ensuring that the contractor assumes its appropriate share of the risk while meeting the government’s needs.

Suppose, for example, the government awards a supplier a contract for a new-concept six-wheeled armored vehicle, which must meet weight, height, width, and length specifications to accommodate the space and weight limitations of a specific military aircraft transport carrier. Given that it is a new-concept vehicle, R&D activity must take place. Once the product has been developed, the effort moves into the low rate initial production (LRIP) phase. LRIP is defined as production of the minimum number of a weapon system required to (1) provide production-configured or representative articles for operational test [and evaluation], (2) to establish an initial production base for the system, and (3) to permit an orderly increase in the production rate for the system sufficient to lead to full-rate production upon successful completion of operational testing. 10 U.S.C. § 2400(b). Once the prototype passes qualification testing, full-scale production can begin. Under circumstances when a product is conceived, developed, and commences into full production, and one specific contract type cannot accommodate this multifaceted effort, the CO may consider splitting the contract into three separate contract types: a CPFF for the developmental stage, an FPIF for LRIP, and an FFP for the production run.

In this manner, the government assumes the majority of the risk during the developmental stages, the government and the contractor share the risk during LRIP, and the contractor accepts full risk during the production phase. Thus, both parties assume and share in the risk during the appropriate times over the course of the contract.

Urgency of Requirements

The urgency of the product or service needed affects the contract type awarded. For instance, in an emergency situation where a COTS item is required poste-haste, tying an incentive to delivery on a fixed-price contract may encourage the contractor to deliver the product at an earlier date than the standard lead time. On the other hand, if the need for the product is not urgent, an FFP contract may be in order.

For example, envision that boots are on the ground and the Army is in immediate need of smaller radios with better transpondence than the aging radios currently in use, and that the smaller radio requested has already been developed and has recently entered LRIP. Given that development of the new radio has been determined to be feasible and the government has established its performance objectives, a CPIF contract may be appropriate. Part of the criteria for receiving the incentive fee may be quick turnaround time, given the urgent need for the radios.

Period of Performance or Length of the Production Run

Time frame can influence a CO’s decision on contract type. The period of performance, commonly referred to as the length of the production run, is the time frame in which the contractor must complete a specified task under the contract. Unless the item the government is seeking to purchase is readily available, the specified lead time must be taken into consideration. In other words, there is a waiting period between the date of purchase and receipt of the product. A short production run may necessitate an FFP contract, given that it is a simple matter of ordering the material and waiting for it to arrive. By contrast, to expedite delivery, the CO may choose to award a fixed-price-incentive-firm-target (FPIF) contract using early delivery as the criterion for the contractor to earn extra compensation.

History of the Acquisition

FAR Part 16.104(l) states: Contractor risk usually decreases as the requirement is repetitively acquired. Also, product descriptions or descriptions of services to be performed can be defined more clearly. When the same service has been rendered many times, contractor risk may be lower. In such a case, a labor-hour contract, whereby the contractor bills at a specified labor rate on an hourly basis, can be awarded as an FFP contract. An FFP contract is used when the product or