Cost-plus contract

A cost-plus contract, more accurately 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.

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 contracts pay a pre-determined fee that was agreed upon at the time of contract formation.
• In a Cost-Plus-Incentive Fee contract, a larger fee is awarded for contracts which meet or exceed performance targets including cost savings.
• Cost Plus Award Fee 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 contractors cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized. The U.S. Federal Acquisition Regulations 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 risk 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.

Pros and cons

Advantages:

• In contrast to a fixed-price contract, 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 program.
• Final cost may be less than a fixed price contract because contractors do not have to inflate the price to cover their risk.

Disadvantage:

• 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 no incentive to be efficient, and an explicit economic incentive to be inefficient as profit is tied to total spending.

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 for instance 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 resarch and development state.

See also

• Cost-plus pricing
• Cost-plus-incentive fee

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