Many government contractors start with firm-fixed-price contracts and do well, but at some point they are lured by the possibility of being awarded a cost-type fixed-fee contract that is too tempting to pass up. There are significant differences between the two contract types and these differences should be understood before a cost-type contract is accepted.
Accepting a firm-fixed-price contract places 100% of the risk of financial success on the contractor and their ability to accurately estimate and control the cost of contract performance. They are suitable for commercial items or goods and services where pricing can be reasonably determined.
They should not be accepted unless you are familiar with the effort to be performed, have performed the efforts required before or have historical support for the amounts proposed. If the contract is competitively awarded be sure your pricing, in a desire to win, has not been driven down below what you know is realistic.
Minimal administrative infrastructure (i.e., accounting) is required to perform on firm-fixed-price contracts where your customer has only a marginal interest in the cost of performance and your financial ability to perform. Billings are generally the result of product or service delivery, not the incurrence of cost.
Competitively awarded firm-fixed-price contracts are not subject to a government audit. If the contract is sole-source it is subject to post-award audit to make sure that you are complying with the Truthful Cost or Pricing Act (P.L. 87-653) known as TINA. Non-compliance is considered defective pricing and subjects the contract to a price reduction and the contractor to potential criminal and civil penalties.
If the contractor can legitimately reduce the actual cost of contract performance below that proposed through efficiencies and cost reductions they can increase the amount and percentage of profits earned. It is only limited by the reality of potential savings in contract performance.
Cost-Plus Fixed-Fee Contracts:
Cost-plus contracts, because they reimburse the contractor for all allowable costs incurred in contract performance would appear to be extremely desirable, especially to those in need of responsive cash flow to ensure cohesive performance. Their use should be limited to contracts where the cost of performance cannot be estimated with enough certainty to establish a fixed-price contract. Generally, they apply where performance risk is high (i.e., new technology, new process, research, and development.
The risk of contract performance is borne by the government since they are responsible for reimbursing the contractor for all allowable costs incurred in contract performance. Because of this assumption of risk by the government the amount of fee, which is guaranteed, is fixed at a negotiated level that is relatively small (i.e., 4%-6%).
Cost-plus contracts are subject to an increased level of government cost surveillance and needed infrastructure. The contractor is required to have in place and in use an accounting system that is deemed adequate for use on cost-type contracts. The adequacy requirements are defined on Standard Form 1408, Preaward Survey of Prospective Contractor Accounting System. Significant requirements center around identification and segregation of direct and indirect costs, a logical method for the allocation of indirect costs to intermediate and final cost objectives, a labor collection system that identifies employee direct and indirect labor by contract or account, identification and segregation of unallowable costs incurred, and the accumulation of all costs under general ledger control on a monthly basis.
This process culminates in the annual preparation of your total actual direct and indirect costs incurred by contract and the determination of the accuracy of the amounts billed by contract or cost objective. This preparation and submission of these incurred costs is audited by the government annually.
It is extremely important for an organization’s success that they understand the type and complexity of tasks they are proposing and the proper contract vehicle that should be used. FAR Part 16 identifies some fifteen contract types. The contract type that may be right at the beginning of a contract may not be the right one at the end of the day. Be sure you sign-up for the right one.