CHAPTER 2 Types of Government Contracts

A flexible selection of contract types is available to the government for acquiring the variety and volume of goods and services it requires. Contract types vary according to the degree and timing of the responsibility assumed by the contractor for the costs of performance, and the amount and nature of the profit incentive offered to the contractor for achieving or exceeding specified standards or goals.

Two factors are significant in the government’s selection of contract type: (1) the government’s ability to state precisely a quantity of goods or services; and (2) the government’s ability to define precisely the work to be performed. When uncertainties are limited, the contracting arrangement will be precise with respect to price and performance. When uncertainties are great, the contractual arrangement will have much more flexibility.

The government uses two major categories of contract type: fixed-price and cost-reimbursement. Numerous variations exist within each of these two categories. Specific contract types range from firm-fixed-price, in which the contractor has full responsibility for the performance costs and the resulting profit or loss, to cost-plus-fixed-fee, in which the contractor has minimal responsibility for the performance costs, and the negotiated fee or profit is fixed. For a fixed-price contract, the contractor is obligated to provide an end product or service at an established price. Thus, the profit or loss on the contract will be directly affected by any difference between the estimated cost and the actual cost of performance.

By comparison, in a cost-reimbursement contract, the contractor is responsible only for whatever product or service evolves as a result of the effort, up to the estimated costs established in the contract. The contractor’s fee or profit is fixed by the contract and, thus, the contractor’s interest in cost performance factors is not as significant as in a fixed-price contract. In between the firm-fixed-price contract and the cost-plus-fixed-fee contract are various incentive contracts, in which the contractor’s responsibility for the performance costs and the profit or fee incentives offered are tailored to the uncertainties involved in contract performance.

The government’s concern in monitoring contractor costs is greatest under cost-reimbursement contracts. The government imposes strict regulations on contractors regarding the accumulation, allowability, and allocation of costs. In addition, the government takes steps to ensure that the accounting systems of contractors with cost-reimbursement contracts are adequate to establish actual costs. The same regulations apply to the negotiation of fixed-price contracts; however, the emphasis on cost monitoring is not as rigid.

Negotiated contracts may be of any contract type that promotes the government’s interest. Contract types not described in the FAR are not to be used without a formal deviation. The cost-plus-a-percentage-of-cost system of contracting is prohibited by legislation. Prime contracts other than firm-fixed-price contracts must prohibit cost-plus-a-percentage-of-cost subcontracts.

During the federal government’s early years, the use of firm-fixed-price contracts was essentially exclusive. Purchased goods and services were rather simple—horses, guns, cannons, etc. World War I temporarily popularized the cost-reimbursement contract type. Because of the contractor risks involved in designing, developing, and producing new items, this contract type was necessary for equitable contracting arrangements. World War II expanded the use of cost-reimbursement contracts, which became institutionalized in regulations shortly thereafter.

The development of cost allowability rules parallels the expanded usage of cost-reimbursement contracts. From World War II through about the 1960s, contracts were either firm-fixed-price or a variation of cost-reimbursement. The next additions to contract types were the variations on the fixed-price contract. These variations permitted more risk to be shifted to a contractor than under a cost-reimbursement contract. However, both fixed-price incentive and cost-reimbursement contracts depended on the determination of actual costs in establishing a final contract price.

In the mid-1990s, a new trend developed to minimize administrative requirements by using other than cost-based pricing of contracts. The definition of commercial items was expanded to allow more purchases under fixed-price contracts without prices being cost-based. The government began to use “other transaction” authority instead of traditional contracting to obtain goods and services. This approach greatly limited the amount of audited cost-based pricing. Initiatives were directed at eliminating or reducing the extent of cost-based pricing throughout the government procurement process.