Government contractors need to be familiar with the different types of contracts and the differences between them. This primer was written to help contractors to develop a foundational knowledge of government contracts, as well as the challenges and opportunities for each contract type.
Why contract type matters
- Risk allocation: Who bears the risk of overruns or inefficiency?
- Pricing mechanics: Lump‑sum vs reimbursed costs vs. hourly rates.
- Oversight & audit: How closely your costs, systems, and invoices will be examined.
- Change flexibility: How easy it is to incorporate evolving requirements.
Four primary types of government contracts
- Fixed-price contracts
- Cost-reimbursement contracts
- Time-and-materials contracts
- Indefinite delivery, indefinite quantity contracts
Fixed‑Price (“FP”) Contracts
- What it is: You commit to deliver a defined scope for a set price. If you beat your estimate, you keep the savings; if you miss, you absorb the loss.
- When it’s used: Requirements are well‑defined, technical risk is modest, and market pricing is competitive (production, repeatable services, commercial items).
- Variants
- Firm‑Fixed‑Price (“FFP”): The purest form – no upward adjustment.
- Fixed‑Price with Economic Price Adjustment (“FPEPA”): Allows limited price changes for material or labor inflation indexed to agreed triggers. Helpful for contracts with longer periods of performance.
- Fixed‑Price Incentive (“FPI”): Includes a target cost, target profit, and a share line; underruns raise profit, overruns reduce it, up to a ceiling.
- Fixed‑Price Award Fee (“FPAF”) or Performance Incentives: Additional fee tied to qualitative metrics (e.g., on‑time delivery, quality).
- Benefits
- Predictable cash flow.
- Ability to capture efficiency gains as profit.
- Lower audit intensity on cost build‑up once awarded.
- Risks
- Estimation discipline is critical since you’ll bear the brunt of any cost overruns.
- Changes require formal modifications; vague requirements are dangerous.
- Subcontracts and supply chain risk transfer straight to you. You must price for contingencies accordingly.
Cost‑Reimbursement (“Cost‑Plus”) Contracts
- What it is: The government reimburses allowable, allocable, and reasonable costs up to a ceiling and pays a negotiated fee (profit). You must maintain strong accounting and timekeeping to support provisional billing and year‑end true‑ups.
- When it’s used: Contracts where requirements or technical risks are uncertain, such as R&D, early development, complex services.
- Common forms
- Cost‑Plus‑Fixed‑Fee (“CPFF”): Fee is a fixed dollar amount or a percentage of the actual cost.
- Cost‑Plus‑Incentive‑Fee (“CPIF”): Gainshare on underruns and pain‑share on overruns relative to target cost.
- Cost‑Plus‑Award‑Fee (“CPAF”): A fee is earned based on government evaluation of performance against predefined criteria.
- Cost‑Sharing: Government reimburses a negotiated share of cost; typically no fee (used for some R&D).
- Benefits
- Downside protection on uncertain efforts.
- Flexibility to adapt as requirements evolve.
- Ability to hire talent with less concern for cost.
- Risks
- System maturity: You’ll need DCAA‑ready accounting, indirect rates, and disciplined billing.
- Fee can be modest; inefficiency erodes competitiveness on future proposals.
- Strong surveillance; expect documentation and reviews.
Time‑and‑Materials (“T&M”) / Labor‑Hour (“LH”) Contracts
- What it is: The government pays fixed hourly rates (loaded with indirects and profit) for labor categories plus materials at cost (T&M) or no materials (LH).
- When it’s used: The exact scope/duration can’t be estimated confidently, but the needed skills are known (e.g., surge support, help desks, remediation).
- Benefits
- Straightforward staffing and billing.
- Less estimating risk than FFP for uncertain workloads.
- Risks
- Heightened surveillance of hours authorized and labor categories used.
- Pressure to convert to FFP/CP once the work stabilizes.
- Profit tied to hours; efficiency gains may reduce revenue unless you adjust staffing.
Indefinite‑Delivery/ Indefinite‑Quantity (“IDIQ”) & Ordering Vehicles
- What it is: A vehicle that sets terms and ceiling, with work awarded via task or delivery orders. The order can be FFP, cost‑reimbursement, or T&M depending on the requirement.
- Why it matters:
- Once you’re “on‑ramp’d,” opportunities are competed among a smaller vendor pool, speeding awards.
- Capture shifts to task‑order agility: keep rates competitive and line up your teammates early.