1. Contract Type Selection Don Shannon
1.5 Contract Structures
Contract Type Selection Don Shannon

2. Basic Contract Types Three basic types Fixed Price Cost Reimbursement
Time and Materials
Each type has characteristics that make it applicable for a type of procurement
Risk (Cost, Schedule, Quality) are primary consideration
Completeness /detail of specifications will often determine risk
Contract Types
Fixed Price
Firm Fixed Price
Fixed Price LOE
Fixed Price Economic Price Adjustment
Fixed Price Redetermination Prospective
Fixed Price Redetermination Retroactive
Cost Reimbursement
Cost Contract
Cost Sharing
Cost Plus Fixed Fee
Time and Materials
Labor Hours

3. Cost Risk and Contract Type
Risk must be viewed from each parties perspective
Buyer (Often the Government)
Seller
Both parties seek to minimize their risk
Cost risk
Technical risk / Performance risk
Contract type is negotiable (FAR )
Selecting the contract type is generally a matter for negotiation and requires the exercise of sound judgment.
Negotiating the contract type and negotiating prices are closely related and should be considered together.
Contract Risk and Contract Type
Cost Risk
High Low
Requirement Definition
Poorly- defined Well Defined Defined
Production Stages
Concept Studies & Basic Research
Exploratory Develop
Full-scale Deployment
Follow-on Production
Contract Type
Various types of Cost Reimbursement
CPFF
CPIF, FFIF, or FFP
FFP, FPIF, or FPEA

4. Risk Elements Buyer Risks Seller Risks
Price will exceed established ‘budget’
Work will not meet customer requirements
Poor quality
Inferior workmanship
Substandard materials
Late delivery
Seller Risks
Specifications incomplete or missing
Differing Site Conditions
Changing business conditions
Material Prices
Labor concerns
Laws / regulations
Weather
“Force Majeure” .. Unforeseen events
Acts of God
War
Performance failures by failures outside of either parties control

5. Fixed Price Contracts Buyer and Seller agree to a price
Generally the price is not changed (i.e., it is “fixed”)
Offers buyer lowest risk by transferring risk to seller
Does NOT immunize buyer from all cost risks
Differing Site conditions
Imperfect specifications
Seller agrees to do all work / deliver all goods for one price
Seller assumes most risks and has little recourse for cost variations
Preferred contract type for most Government agencies.

6. Firm Fixed Price Price is not subject to adjustments
Sometimes called “lump sum”
Strong incentive for seller to control costs
Buyer must be able to accurately state requirements and estimate costs.
Applicable to:
Construction
Commercial purchases

7. Fixed Price – Economic Adjustment
Allows upward and downward revision of contract price
Revisions are keyed one or more factors
Established prices
Actual cost of labor or material
Published indexes

8. Fixed Price - Redetermination
Fixed price for part of the contract with
Redetermination of future prices at some point during performance (Prospective)
Especially useful if prices are subject to large swings such as oil or currency exchange rates.
Retroactive adjustment after completion
Fixed ceiling price at start
Retroactive adjustments can not exceed ceiling

9. Fixed Price – Level of Effort
Fixed sum paid over time
Contractor provides a ‘level of effort’
Can be based on labor hours (e.g., Full Time Equivalent (FTE)
Contractor not obligated to continue performance beyond that limit
Used when exact requirements can not be accurately stated but buyer wishes to cap total cost.
Fixed price is invoiced over time as percentage of Period of Performance (1/12 per month etc.)

10. Cost Reimbursement Contracts
Contractor is paid (reimbursed) for actual costs
Ceiling cost is established
Contractor may not exceed ceiling except at own risk
Contract shall make ‘best efforts’ to complete work within ceiling
Types of Cost Reimbursement Contracts
Cost Contract
Cost Sharing
Cost Plus Fixed Fee

11. Cost Contract Contractor is reimbursed for their costs
Must be “allowable” (i.e., not specifically prohibited)
Must be allocable to the “final cost objective”
Must be “reasonable”
Arms-length dealing
What would be normally paid by a prudent buyer in the normal course of business
No profit or fee is paid
Often to non-profit institutes, colleges, universities, etc.

12. Cost Sharing Contracts
Both the buyer ad the seller share in the actual costs
Benefits to both parties
Often used for developing intellectual property shared by both
One gets ownership and sales rights
Other benefits from a paid-up license to use the technology

13. Cost Plus Fixed Fee Contracts
Most commonly used form of cost contract
Fee is calculated as a fixed value based on estimated costs
“Best Effort” of seller to complete work for estimated cost
Stop performance when the cost is reached
If costs exceed estimate buyer may be provide added funds with or without additional fee
No fee if costs are determined to be ‘overrun’

14. Incentive Contracts Applicable to both Cost and fixed price contracts
Provide additional motivation for seller to control a specific risk e.g., cost, schedule, quality.
Cost Incentive
Permits adjusting final contract price using a formula based on
Final negotiated cost
Target cost
Performance (Quality) Incentive
Bonus for exceeding certain performance goals
Delivery Incentive
Bonus for early completion e.g., the Big I project.
Penalty for late completion
Liquidated damages

15. Guidelines for Selecting Contract Type
When …
Select a …
The offeror can actually estimate cost(s)
Firm Fixed Price Contract
Economic conditions that will likely affect cost significantly and are outside offeror’s control but otherwise offeror can accurately estimate costs
Fixed Price Economic Adjustment
There are substantial cost uncertainties but it should be possible to estimate/control costs
Fixed Price Incentive Fee
Cost uncertainties are so great that fixed price would force seller to accept unreasonable risk but reasonable targets and formulas for sharing costs can be negotiated
Cost Plus Incentive Fee
The Level of Effort is uncertain and it is not feasible to negotiate an adjustment formula but likelihood of meeting objectives can be enhanced by a clear subjective fee plan
Cost Plus Award Fee
Cost uncertainty is so great the establishment of predetermined targets and incentive arrangements could result in a final fee out of line with the real work
Cost Plus Fixed Fee
Contracting Officers consider a number of factors when selecting contract type
Risk is the primary factor
Sellers should be rewarded for accepting increased risk
Incentives, adjustments and award fees can be used to share the risk
Equity .. What is fair and reasonable for both parties
Buyer (Government) should never place itself in a position to make or break a seller (offeror)

16. Other Contract Devices
Basic Agreement – Pre-negotiated agreement. Includes Offer and Acceptance of terms but has no value
Basic Ordering Agreement (BOA) – Similar to above except may include pre-negotiated prices for standard items – again no value
Letter Contract – Temporary agreement pending negotiation of key terms and conditions – undefinitized contract actions
Indefinite Delivery / Indefinite Quantity (ID/IQ) – Establishes ordering framework as with BOA but includes assurance of some minimum value. Items are typically stated but quantity to be delivered and date for delivery need not be stated.