# Cost-plus-incentive fee

A cost-plus-incentive fee (CPIF) 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.

Like a cost-plus contract, the price paid by the buyer to the seller changes in relation to costs, in order to reduce the risks assumed by the contractor (seller). Unlike a cost-plus contract, the cost in excess of the target cost is only partially paid according to a Buyer/Seller ratio, so the seller's profit decreases when exceeding the target cost. Similarly, the seller's profit increases when actual costs are below the target cost defined in the contract.

## Formula and Examples

Incentive contracts allow sharing of the risks between the contractor and the client. The contractor is reimbursed all its justifiable costs in addition to a calculated fee. The basic elements of a CPIF contract are:

• Target Cost: the estimated total contract costs.
• Actual Cost: constitutes the reasonable costs that the contractor can prove he has made.
• Target Fee: the basic fee to be paid if the Target Cost matches the Actual Cost (target profit). The Target Fee varies between the Minimum Fee and the Maximum Fee according to a formula tied to the Actual Cost (e.g. Target Fee could be 10% of the Actual Cost).
• Sharing Ratio: the agreed upon cost sharing proportion, normally expressed in percentage (e.g. 85% for the client / 15% for the contractor). It is often different for cost overruns and cost underruns.

Other components of incentive fee contracting include:

• Maximum Fee: the highest fee that may be earned, usually expressed as a percentage.
• Minimum Fee: the lowest fee that may be earned, usually expressed as a percentage.

The Final Fee (profit of the contractor) is expressed as follows: Final Fee = Target Fee + (Target Cost - Actual Cost) * Contractor Share

The Final Price of the contract is expressed as follows: Final Price = Actual Cost + Final Fee

Note that if Contractor Share = 1, the contract is a Fixed Price Contract; if Contractor Share = 0, the contract is a cost plus fixed fee (CPFF) contract.

For example, assume a CPIF with:

• Target Cost = 1,000
• Target Fee = 100
• Benefit/Cost Sharing Ratio for cost overruns = 80% Client / 20% Contractor
• Benefit/Cost Sharing Ratio for cost underruns = 60% Client / 40% Contractor

If the Actual Cost is higher than the Target Cost, say 1,100, the client will pay: 1,100 + 100 + (1,000 - 1,100) * 0.2 = 1,180 (contractor earns 80).

If the Actual Cost is lower than the Target Cost, say 900, the client will pay: 900 + 100 + (1,000 - 900) * 0.4 = 1,040 (contractor earns 140).