Cost-plus contract
Encyclopedia
A cost-plus contract, also termed a Cost Reimbursement Contract, is a contract
where a contractor is paid for all of its allowed expenses to a set limit plus additional payment
to allow for a profit. Cost-reimbursement contracts contrast with fixed-price contract
, in which the contractor is paid a negotiated amount regardless of incurred expenses. Cost-plus contracts first came into use in the United States during the World Wars to encourage wartime production by large American companies.
of successful contract performance from the contractor to the buyer. It is most commonly used when the item purchased cannot be explicitly defined, as in research and development
, or in cases where there is not enough data to accurately estimate the final cost.
Disadvantages:
The distribution of annual contract values by sector category and award types indicates that cost plus contracts in the past carried the largest importance in research, followed by services and products. In 2004, however, services replaced research as the dominant sector category for cost plus contracts. For all other contract vehicles combined the relative ranking is reversed to the original cost-plus order, meaning that products leads, followed by service and research.
With cost-plus contracting being primarily designed for research and development tasks, the percent share of cost-plus contracting within a contract is expected to be in correlation with the percent share of research undertaken in any given program. However, several programs, such as the F-35, the Trident II, the CVN 68, and the CVN 21 deviate from this pattern by continuing to make extensive usage of cost-plus contracting despite programs progressively moving beyond the research and development state.
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
where a contractor is paid for all of its allowed expenses to a set limit plus additional payment
Payment
A payment is the transfer of wealth from one party to another. A payment is usually made in exchange for the provision of goods, services or both, or to fulfill a legal obligation....
to allow for a profit. Cost-reimbursement contracts contrast with fixed-price contract
Fixed price
The term "fixed price" is a phrase used in the English language to mean that no bargaining is allowed over the price of a good or, less commonly, a service...
, in which the contractor is paid a negotiated amount regardless of incurred expenses. Cost-plus contracts first came into use in the United States during the World Wars to encourage wartime production by large American companies.
Types
There are four general types of cost-reimbursement contracts, all of which pay every allowable, allocatable, and reasonable cost incurred by the contractor, plus a fee or profit which differs by contract type.- Cost Plus Fixed Fee (CPFF) contracts pay a pre-determined fee that was agreed upon at the time of contract formation.
- Cost-Plus-Incentive FeeCost-Plus-Incentive FeeA CPIF Cost-Plus-Incentive-Fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs....
(CPIF) contracts have a larger fee awarded for contracts which meet or exceed performance targets, including any cost savings. - Cost Plus Award Fee (CPAF) contracts pay a fee based upon the contractor's work performance. In some contracts, the fee is determined subjectively by an awards fee board whereas in others the fee is based upon objective performance metrics. An aircraft development contract, for example, may pay award fees if the contractor achieves certain speed, range, or payload capacity goals.
- Cost Plus Percentage of Cost pay a fee that rises as the contractor's cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized. The U.S. Federal Acquisition RegulationsFederal Acquisition RegulationsThe Federal Acquisition Regulation is the principal set of rules in the Federal Acquisition Regulation System. This system consists of sets of regulations issued by agencies of the Federal government of the United States to govern what is called the "acquisition process"; this is the process...
specifically prohibit the use of this type for U.S. Federal Government contracting (FAR Part 16.102).
| Contract Type | US government outlays in FY07 |
|---|---|
| Award-fee contracts | $38B |
| Incentive fee contracts | $8B |
| Fixed-fee contracts | $32B |
Usage
A cost-reimbursement contract is appropriate when it is desirable to shift some riskRisk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
of successful contract performance from the contractor to the buyer. It is most commonly used when the item purchased cannot be explicitly defined, as in research and development
Research and development
The phrase research and development , according to the Organization for Economic Co-operation and Development, refers to "creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of...
, or in cases where there is not enough data to accurately estimate the final cost.
Pros and cons
Advantages:- In contrast to a fixed-price contractFixed priceThe term "fixed price" is a phrase used in the English language to mean that no bargaining is allowed over the price of a good or, less commonly, a service...
, a cost-plus contractor has little incentive to cut corners. - A cost-plus contract is often used when long-term quality is a much higher concern than cost, such as in the United States space programNASAThe National Aeronautics and Space Administration is the agency of the United States government that is responsible for the nation's civilian space program and for aeronautics and aerospace research...
. - Final cost may be less than a fixed price contract because contractors do not have to inflate the price to cover their risk.
Disadvantages:
- There is limited certainty as to what the final cost will be.
- Requires additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls.
- Properly designing award or incentive fees also requires additional oversight and administration.
- There is less incentive to be efficient compared to a fixed-price contract.
Recent trends
Between 1995 and 2001 fixed fee cost-plus contracts constituted the largest sub group of cost-plus contracting in the U.S. defense sector. Starting in 2002 award-fee cost plus contracts took over the lead from fixed fee cost plus contracts.The distribution of annual contract values by sector category and award types indicates that cost plus contracts in the past carried the largest importance in research, followed by services and products. In 2004, however, services replaced research as the dominant sector category for cost plus contracts. For all other contract vehicles combined the relative ranking is reversed to the original cost-plus order, meaning that products leads, followed by service and research.
With cost-plus contracting being primarily designed for research and development tasks, the percent share of cost-plus contracting within a contract is expected to be in correlation with the percent share of research undertaken in any given program. However, several programs, such as the F-35, the Trident II, the CVN 68, and the CVN 21 deviate from this pattern by continuing to make extensive usage of cost-plus contracting despite programs progressively moving beyond the research and development state.
External links
- The Federal Procurement Data System The central repository for U.S. Government contract information.
- Defense Industrial Initiatives Group - Cost-plus Contracting Narrated Slide Show