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.
Cost Reimbursement Contracts
a. Provides for payment
of allowable incurred costs, to the extent prescribed in the contract.
Establishes an estimate of total costs for the purpose of obligating
funds and establishes a ceiling that the contractor may not exceed,
except as his own risk.
b. Cost reimbursement contracts place the least cost and performance risk on the contractor.
c.
Cost reimbursement contracts are suitable for use only when
uncertainties involved in contract performance do not permit costs to be
estimated with sufficient accuracy to use and type of fixed price
contract.
d. Used for research and development contracts.
Cost Plus Fixed Fee contracts pay a predetermined fee that was agreed upon at the time of contract formation.
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.
Advantages:
- 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.
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.
Buyer agrees to pay the seller as compensation for his servics a General contractor's fees as follows:
All cost incurred over the total project lenght in full.
Plus a fixed FEE of $xx,xxx.xx.
What is a “Cost Plus Fixed Fee Contract”?
A cost-plus fixed fee contract is a specific type of
contract
wherein the contractor is paid for the normal expenses for a project,
plus an additional fixed fee for their services. A Cost plus Fixed Fee
(CPFF) contract is a contract type that reimburses you for fair and
reasonable expenses up to a certain amount (a ceiling of some sort) and
then pays you a prenegotiated fixed fee above any beyond your expenses.
So, for example, if your cost ceiling is 90,000 and your fixed fee is
$9,000 for a total contract value of $99,000, you will be reimbursed for
your cost incurred up to, but not exceeding, $90,000 and you will
receive $9,000 as a fee. If you spend more than $90,000 (and this
doesn't get you in hot water with your sponsor - i.e. a default
situation) you may not be reimbursed for the amount that you go over
$90,000 but you will get your $9,000 fee. If you only spend $80,000 you
will be reimbursed for $80,000 and you will still receive $9,000 since
your fee is, you got it… fixed!
When is a Cost Plus Fixed Fee Contract Used?
Cost plus fixed fee contracts can be used when both the contractor and
the owner agree that the contractor is entitled to a fee in addition to
the project expenses. There may be various reasons for this agreement,
but cost-plus contracts should also spell out the basic reasons that the
contractor is entitled to the fee. There should also be provisions
addressing what legal consequences should follow if the fee provisions
aren’t upheld.
What are Some Pros and Cons of Cost Plus Fixed-Fee Contracts?
Depending on the parties’ needs, there may be different pros and cons to
using a cost-plus fixed fee contract arrangement. In order to avoid a
breach of contract, both parties should consider these aspects of cost-plus contracts.
Some advantages of a CPFF contract can include:
- The final cost may be lower than in a normal contract, as the contractor usually will not “inflate” prices to cover risks
- The contractor also has less incentive to control the project costs
(in contrast to other types of contracts, such as a fixed-price
contract)
- They can often ensure higher-quality output than normal contracts
Disadvantages of cost-plus fixed-fee contracts may include:
- The final, overall cost may not be very clear at the beginning of negotiations
- May require additional administration or oversight of the project to
ensure that the contractor is factoring in the various cost factors
- May be less incentive to complete the project in an efficient manner, compared with fixed-price contracts
Cost-Plus-Incentive Fee contract, the fee paid to the contractor is determined using a mathematical formula which provides for a specific fee to be paid if the contractor final cost comes in equal to the negotiated target cost. The fee is raised or lowered in the event of a cost underrun or overrun, respectively.
A cost-plus-incentive fee contract is a contract based on a Cost-plus contract that includes an incentive fee which is awarded if the contractor completes the work under budget. The amount of the incentive fee can be fixed, or proportional to the difference between the actual cost and the total cost agreed to in the contract; this allows for the contractor to earn a greater profit by beating cost targets.
Like a cost-plus contract, the contractor will make money even if they suffer from cost overruns
Actual Cost + Fee (i.e.profit margin).
The contractor will make more money if they surpass the contracted total cost
Actual Cost + Fee (i.e. profit margin) + Incentive fee.
Incentive fee can be fixed, or proportional to the
difference between the actual cost and the total cost agreed to in the
contract; this allows for the contractor to earn a greater profit by
beating cost targets.
If actual cost is less than expected cost, the buyer and seller share in the savings, based on a predetermined formula. This type is used predominantly for contracts with long performance periods and substantial hardware development and test requirements.
The following example shows the general model for cost reimbursable contracts.
Actual Cost + Fee + ((Estimated Cost - Actual Cost) * Share Ratio)
Cost Plus Award Fee
A CPAF contract is a cost-reimbursement contract that provides an estimated cost plus a fee consisting of a base amount (which may be zero) fixed at inception of the contract and an award amount. The award amount is a pool of dollars available to the contractor to earn through excellent contract performance. The award fee determination is made unilaterally by the buyer based upon periodic subjective evaluations of contractor performance.
Cost + Fee (i.e.base amount of profit margin). At the outset this Fee could be even zero.
Cost + Fee +/- Award amount (generally based on contract performance)
Award amount is usually a fixed pool of dollars.
One important aspect to remember, the award fee amount must be sufficient to provide motivation to the Contractor for excellence in contract 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.
Under a CPAF contract, an available award fee pool is negotiated and included in the contract. However, the actual award fee earned by the contractor is determined by the Buyer's assessment of the contractor's performance. Criteria for contract performance are included in the contract, and the contractor is then judged on how well it performs in relation to those criteria. While the contractor can comment on the Buyer's evaluation, it cannot dispute the score and the resulting fee. The contractor can earn any amount of award fee, from all of the award fee pool to none of it. A contractor will not be paid any award fee or base fee for less than satisfactory overall performance.
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.
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.
