Contract Types and
Appropriate Incentives
Contract Types & Appropriate Incentives
Jo Cunningham
Distinguished Member of Laboratory Staff
Sandia National Laboratories
Session #3, 1:00pm - 1:30pm ET
NCMA’s 1st Performance-Based Service Acquisition
Community of Practice - Virtual Conference
Wednesday, March 31, 2010 12:00pm - 4:00pm ET
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Basic Decisions:
• Selecting the contract pricing
arrangement is THE most important
decision you will ever make!
• The Second most important decision is
how to motivate the contractor.
2
What’s Really in it For Me?
Describe how you
saved us
$10 Million AND
reduced our risks!
3
Contract Types
• Two Basic Contract Types:
– Fixed Price
• FFP, FFP/EPA, FP+AF, FP+I, FF Rate, CostShare
– Cost Reimbursement
• CNF, CPFF, CPIF, CPAW, Cost-Share
• T&M, LH
4
Contractor Performance Considerations
• Firm Fixed Price: Failure is not an
option
• Time & Materials: We can’t fail as long
as we show up for work.
• Cost Reimbursable: We will give it our
best try, but failure may be an option
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Cost Risk & Contract Type
Cost Risk:
High
Requirement
Definition
Vague >>>>>>>>>>>>>>>>>>>>>>>>>
Production
Stages
Concept
Studies, &
>>>>>>>>>>>>>>>>>>>>>>>>
Low
Well Defined
Exploratory
Test/
Full scale
Full
Development
Demo
Development
Production
CPFF
CPIF,
CPIF, FPIF,
FFP, FPIF,
FPIF
or FFP
or FPEPA
Basic Research
Contract
Type
Varied
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Firm Fixed Price
Principal Risks: None, Contractor assumes all cost risk
Use When: The requirement is well-defined.
Contractors are experienced in meeting the fixed price.
Market conditions are stable.
Financial risks are otherwise insignificant
Typical Application: Commercial supplies and services,
Generally NOT appropriate for R&D.
Contractor is required to: Provide acceptable deliverable at
the time, place and price specified in the contract
Contractor Incentive: Generally realizes an additional dollar of
profit for every dollar that costs are reduced
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Fixed Price Economic Price Adjustment
Principal Risks: Unstable market prices for labor or material over
life of contract.
Use When: Market prices at risk are severable and significant.
Risks stem from industry-wide contingencies beyond contractor's
control. Dollars at risk outweigh administrative burdens of an
FPEPA.
Typical Application: Long-term contracts for commercial
supplies during a period of high inflation.
Contractor is required to: Provide acceptable deliverable at
the time and place specified in the contract at the adjusted price.
Contractor Incentive: Generally realizes an additional dollar of
profit for every dollar that costs are reduced
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Fixed Price Incentive Fee
Principal Risks: Moderately uncertain contract labor or material
requirements
Use When: Ceiling price can be established that covers most
probable risks inherent in nature of work. Proposed profit sharing
formula would motivate contractor to control costs to & meet other
objectives
Typical Application: Production of a major system based on a
prototype.
Contractor is required to: Provide acceptable deliverable at
time & place specified in contract, at or below ceiling price.
Contractor Incentive: Realizes a higher profit by completing
work below ceiling price and/or by meeting objective performance
targets
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Fixed Price Award Fee
Principal Risks: Risk that the user will not be fully satisfied
because of judgmental acceptance criteria.
Use When: Judgmental standards can be fairly applied by Awardfee panel. The potential fee is large enough to both: (1) Provide
meaningful incentive; (2) Justify related administrative burdens.
Typical Application: Performance-based service contracts.
Contractor is required to: Perform at time, place, and price
fixed in contract.
Contractor Incentive: Generally realizes an additional dollar of
profit for every dollar that costs are reduced; earns an additional fee
for satisfying performance standards
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Fixed Price Prospective
Redetermination
Principal Risks: Costs of performance after the first year because
they cannot be estimated with confidence.
Use When: Buyer needs a firm commitment from contractor to
deliver supplies /services during subsequent years. Dollars at risk
outweigh administrative burdens of FPRP.
Typical Application: Long-term production of spare parts for a
major system.
Contractor is required to: Provide acceptable deliverables at
time & place specified in contract at price established for each
period.
Contractor Incentive: For the period of performance, realizes an
additional dollar of profit for every dollar that costs are reduced.
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Cost Plus Incentive Fee
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other) necessary to perform contract. Buyer
assumes risks; benefiting if actual cost is lower than expected cost; losing
if work can’t be completed within expected cost of performance.
Use When: Objective relationship can be established between fee &
such measures of performance as actual costs, delivery dates,
performance benchmarks, etc.
Typical Application: Research and development of prototype for
major system.
Contractor is required to: Make good faith effort to meet Buyer's
needs within estimated cost in the Schedule.
Contractor Incentive: Realizes a higher fee by completing work at
lower cost and/or by meeting other objective performance targets
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Cost Plus Award Fee
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other things) necessary to perform contract.
Buyer assumes risks inherent in contract; benefiting if actual cost is lower
than expected cost; losing if work cannot be completed within expected
cost of performance.
Use When: Objective incentive targets are not feasible for critical
aspects of performance. Judgmental standards can be fairly applied.
Potential fee would provide a meaningful incentive.
Typical Application: Large scale research study.
Contractor is required to: Make good faith effort to meet Buyer's
needs within estimated cost in the Schedule.
Contractor Incentive: Realizes a higher fee by meeting judgmental
performance standards.
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Cost Plus Fixed Fee
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other things) necessary to perform contract.
Buyer assumes risks inherent in contract; benefiting if actual cost is lower
than expected cost; losing if work cannot be completed within expected
cost of performance.
Use When: Relating fee to performance (e.g., to actual costs) would be
unworkable or of marginal utility.
Typical Application: Research studies.
Contractor is required to: Make good faith effort to meet Buyer's
needs within estimated cost in the Schedule.
Contractor Incentive: Realizes a higher rate of return (i.e., fee
divided by total cost) as total cost decreases.
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Cost Sharing
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other things) necessary to perform contract.
Buyer assumes risks inherent in contract; benefiting if actual cost is lower
than expected cost; losing if work cannot be completed within expected
cost of performance.
Use When: The contractor expects substantial compensating benefits for
absorbing part of the costs and/or foregoing fee.
Typical Application:
Joint research where Contractor expects to
derive long term benefits to his company.
Contractor is required to: Make good faith effort to meet
Buyer's needs within estimated cost in the Schedule.
Contractor Incentive: Shares in the cost of providing a deliverable of
mutual benefit..
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Cost No Fee
Principal Risks: Highly uncertain & speculative labor hours, labor
mix, material requirements (and other things) necessary to perform
contract. Buyer assumes risks inherent in contract; benefiting if
actual cost is lower than expected cost; losing if work cannot be
completed within expected cost of performance.
Use When: The supplier is a not-for-profit entity.
Typical Application: Joint research with an educational
institutions or other not-for-profit entities.
Contractor is required to: Make good faith effort to meet
Buyer's needs within estimated cost in the Schedule.
Contractor Incentive: Providing a deliverable with benefits to both
parties; Contractor expects to derive long term benefits to his firm;
Enhanced reputation.
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Time and Materials
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other things) necessary to perform contract.
Buyer assumes risks inherent in contract; benefiting if actual cost is lower
than expected cost; losing if work cannot be completed within expected
cost of performance.
Use When: No other type of contract is suitable (e.g., labor & materials
can’t be reliably estimated due to inherent uncertainties, and contractor
does not have accounting system to support a job cost accounting
system).
Typical Application: Emergency repairs to heating plants and aircraft
engines; hazardous waste removal; Contractor support for field exercises.
Contractor is required to: Make good faith effort to meet Buyer's
needs within ceiling price.
Contractor Incentive: None, other than enhanced reputation.
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Firm Fixed Rate
Principal Risks: Highly uncertain & speculative labor hours, labor mix,
material requirements (and other things) necessary to perform contract.
Buyer assumes risks inherent in contract; benefiting if actual cost is lower
than expected cost; losing if work cannot be completed within expected
cost of performance. Limit risk by ceiling price of $100,000 or less.
Use When: No other type of contract is suitable (e.g., because
costs are too low to justify an audit of the contractor's indirect
expenses).
Typical Application: Emergency repairs to facilities and
equipment; Contractor support for small efforts <$100,000.
Contractor is required to: Make good faith effort to meet
Buyer's needs within ceiling price.
Contractor Incentive: None, other than enhanced reputation.
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Summary
• Initial steps to remember:
• Discuss requirements with the customer & compare to the SOW,
revising as necessary
• Review the pricing types, and consider the pros & cons of each.
• Pitfalls:
• Avoid cost-type and T&M/LH if contractor has unsophisticated
accounting system.
• Avoid setting up Contractor for failure (e.g. using FFP when not
appropriate)
• Award / Incentive Fees = High Admin costs
• Remember: Choosing Wisely Reduces Risks and may save you
potentially significant costs!
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