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December 14, 2022
Major Government Contract Types - What You Need to Know
Written by: Ron Lewis
The federal government issues many different types of contracts. While more than a dozen contract types are described in the Federal Acquisition Regulation (FAR) Part 16 External, the table below highlights the most commonly used contract types. The contract type is a term used to signify differences in contract structure or form, including compensation arrangements and amount of risk (either to the government or to the contractor). Federal government contracts are commonly divided into two main types, fixed-price, and cost-reimbursable.
Other contract types include incentive contracts, time-and-materials, labor-hour contracts, indefinite-delivery contracts, and letter contracts. This wide selection of contract types is available to the government and contractors to provide flexibility in acquiring the large variety and volume of supplies and services required by agencies. Contract types vary according to:
- The degree and timing of the risk assumed by the contractor for the costs of performance
- The amount and nature of the profit incentive offered to the contractor for achieving or exceeding specified standards or goals
|Labor Hour||A variation of the Time and Materials contract type, differing only in that materials are not supplied by the contractor. When acquiring commercial services, a time-and-materials or labor hours contract may be used only when the award of the contract or order is made using competitive procedures.||Used only when it is not possible at the time of placing the contract to estimate the extent or duration of the work or to anticipate costs with any reasonable degree of confidence. Used only when the contracting officer determines that no other contract type is suitable.|
|Time & Material||Acquire supplies or services on the basis of:
||Used only when it is not possible at the time of placing the contract to estimate the extent or duration of the work or to anticipate costs with any reasonable degree of confidence. Used only when the contracting officer determines that no other contract type is suitable. When acquiring commercial services, a time-and-materials or labor hours contract may be used only when the award of the contract or order is made using competitive procedures.|
|Provides for payment of allowable incurred costs, to the extent prescribed in the contract. These contracts establish an estimate of the total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk) without the approval of the contracting officer. This places cost risk on the government.||Used only when circumstances do not allow the agency to define its requirements sufficiently to allow for a fixed-price type contract, OR uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract.|
|A Cost contract reimburses allowable costs up to the specified total awarded amount of the contract in which the contractor receives no fee or profit.||Used for research and development work, particularly with nonprofit educational institutions or other nonprofit organizations.|
|Provides payment to the contractor for a negotiated fee (profit) that is fixed at the inception of the contract. The fixed fee does not vary with the actual cost but may be adjusted as a result of changes in the work to be performed. This permits contracting for efforts that might otherwise present too great a risk to contractors but provides the contractor only a minimum incentive to control costs.||Same as stated for Cost Reimbursement contracts AND for example when the contract is for the performance of research or preliminary/ exploration study, and the level of effort required is unknown.|
|Fixed Price||Acquire supplies or services for a specific price not subject to any adjustment on the basis of the contractor’s incurred costs. This contract type imposes a minimum administrative burden.
||Generally favored by the government because the contractor assumes the risk of increased performance costs. Used for acquiring supplies and services with reasonably definite specifications, and reasonable prices can be established at the outset.|
|IDIQ||IDIQ Acquires supplies or services but does not specify a firm quantity that will be issued and delivered during the period of the contract (as delivery orders or task orders). The basic contract specifies the contract types authorized (e.g. Cost Reimbursement or Firm Fixed Price) and each task order will identify the specific contract type utilized.||Used when the Government cannot predetermine, above a specified minimum, the precise quantities of supplies or services the Government will require during the contract period and it is inadvisable for the Government to commit itself for more than a minimum quantity. Used when a recurring need is anticipated. There are three types of indefinite-delivery contracts: definite quantity, indefinite quantity, and requirements contracts.|
All Types: All contract types contain a set of standard terms and conditions from the federal acquisition regulations (FAR), such as allowable cost, cost accounting standards, accounting, and procurement business systems requirements as well as requirements for audit and record retention. It's important to understand these requirements. You must read your contract carefully.
Labor Hour and Time and Materials: These types of contracts are used when the government just wants to purchase labor and materials. Usually, these contracts specify the labor categories, the number of hours for each, and the billing rates and schedule. Each labor category will also have a total ceiling that controls how much the government will allow contractors to charge. Labor hour contracts do not allow the contractor to purchase materials. When you set up a contract or project your Contracts/PM should allow you to maintain: the awarded and funded amounts, contract labor categories, categories hours, categories billing rates, schedule, and ceilings. This information is used by the billing system to generate an accurate customer invoice.
Cost-Reimbursable: These contracts allow the government to reimburse contractors for all allowable costs. There are a few variations of cost -reimbursable contracts including:
- Cost-Sharing - where the government is covering a portion of the contractor's cost
- Cost Plus Fixed Fee - where the government is covering the contractor's cost and providing a fixed fee based on the total cost incurred
- Cost Plus Award Fee - where the government is covering the contractor's cost and providing a fixed fee (usually small... can be ZERO) and an award fee based on performance
- Cost Plus Incentive Fee - where the government is covering the contractor's cost and offering an incentive based on performance
When two parties agree on a cost-reimbursement contract, they agree that the price is to be determined based on the actual cost incurred. This means that the government is taking on some risk because they don't have a set price. Usually, the final price for the contracted product or service is determined once the product is produced and delivered or the service is complete. Sometimes, cost-reimbursement contracts will determine the price at a set time that isn't necessarily the end of the contract, but probably close to it.
When it comes to cost contracts, you see them most often for research and development projects and for nonprofits. In a cost contract, allowable costs are reimbursed up to the specified total amount of the contract. In a cost-plus fixed fee contract, the level of effort required is not known so the contractor's fee is negotiated and fixed. Payments are made based on the cost incurred. If the type of work the contractor is doing changes, then, adjustments to the fixed fee can be made. However, in this type of contract, there is very little incentive for the contractor to try to control costs. You can see why a fixed-price contract is much more attractive to the federal government than a cost contract.
To effectively manage cost contracts, you must have a good handle on your indirect cost, i.e., all the costs that are not directly traceable to the project's performance. For example, rent, utilities, professional services charges, etc. The integration of your PM and accounting system should allow you to monitor your indirect rates and understand their impact on your overall project cost.
Fixed Price: These contract types allow the government to purchase goods or services at a fixed price. Usually, the government can describe what the contractor must deliver and the price it will pay. To effectively manage FFP contracts you must establish a process that allows you to track burn rates. This means tracking your actual cost and comparing it against your planned cost at various stages in the projects. Establishing a good system for tracking actual cost that can support your ability to determine estimates at complete (EACs) are essential. The PM system can provide the data needed to allow your PM to build an accurate EAC.
The IDIQ contract is included in this table to illustrate that this is not a contract type but a mechanism that the government uses to allow it to have a contractual relationship with suppliers. The IDIQ allows the government to place orders for goods or services with suppliers. It works much like a master service agreement for those of you who are familiar with commercial contracts. The actual order will be awarded using one of the contract types listed.
All contract types come with risks. However, fixed-price contracts have the greatest risks. When developing a risk mitigation plan, you should ask a few questions: Does the client already have a favorable business relationship with your company? How well do you understand the customer's requirements? Are the budget and timeframe reasonable? How confident are you in your ability to deliver the goods or products? Are there technical risks that need to be resolved? It may be worth it to conduct additional peer and management reviews before writing the proposal and finalizing your cost estimate. In the proposal development stage, it may be wise to create a contingency reserve at a major task level. It's also prudent to deliver milestones incrementally to ensure that progress is realized, and the customer is happy. Consider building a project plan that diligently documents roles, responsibilities, and assumptions when creating a detailed scope definition.
The table below summarizes the contract types and the potential risks associated with each. As the table illustrates, the government will include terms and conditions in their contracts to assist them in mitigating their risks.
|Contract Types||Risks||Mitigation Strategy|
|Time & Material||
Throughout the contracting life cycle, there are many ways you can mitigate your risks. If your cost estimates are incorrect, you stand to lose money. One key factor in mitigating risks is having the corporate track record and capabilities to estimate the project scope correctly. A good estimating system can go a long way in controlling risks in a fixed-price arrangement. Perhaps part of the decision to bid or not on a fixed-price contract should have included weighing your capabilities, experience performing on similar projects, and confidence regarding your company's ability to deliver for a fixed price. Putting in place a project management (PM) system allows you to build a library of estimates and use them to plan and execute your projects. When you build an estimate, you will establish a baseline budget or the planned cost. When you execute a project based on the estimate the PM system will track the actual cost. The actual cost can be used to improve your estimate for similar projects. Over time as you plan and execute many projects you can utilize the library of past projects to manage risks.
When negotiating the contract, include risk mitigation strategies and include them in the Statement of Work. If you bring on subcontractors, make sure they are in a fixed-price contract with you. Be wary of bringing on subcontractors when you don't have a prior relationship with them. Those are just a few possibilities, there are many more.
If you would like to learn more about the different federal acquisition contract types or anything else as it relates to government contracting and how to road map your success, reach out to our team today!