Fixed Price Contracts
What are the types of fixed price contracts and what is the role of risk in each?
Contracts in the fixed price family include:
Firm fixed price (FFP). The contractor assumes all risks. This type of contract is the norm when contracting for commercial products and services in price-competitive markets or establishing production contracts for mature hardware.
Contemplate award of an FFP contract when the total cost of performance can be estimated with a high degree of accuracy and confidence.
Fixed price with economic price adjustment (FP/EPA). The government assumes part of the risk of market fluctuations.
Contemplate award of an FP/EPA contract when market prices for critical categories of labor or materials:
- Are likely to be unstable over the life of the contract
- Are at risk because of industry-wide contingencies beyond the contractor's control
- Are significant to the overall price
- Can be severed and covered separately in the contract.
Fixed price incentive (FPI). The government shares part of the cost risk up to the ceiling price (the maximum amount the government will pay), after which the contractor assumes all risks.
Contemplate award of an FPI contract when:
- FAR Part 12 does not apply (i.e., it is not a commercial item contract)
- The expected cost of performance is moderately uncertain
- Actual costs will probably not exceed a specified ceiling price (i.e., the ceiling price covers the most probable risks inherent in the nature of the work)
- The government needs a firm commitment from the contractor to deliver the supplies or services with that ceiling price
- The contract price is high enough to justify the additional costs of administering the FPI terms and conditions.
The FPI contract provides for adjustment of profit and establishment of final price through the use of a formula (or sharing ratio) based on the relationship of final total cost to target cost and profit agreed to by the parties at the time of award. After performance of the contract work is completed, the contractor and the government, using the previously established formula, agree on the final cost of the contract, taking into account any deviation from the target cost. The formula can link price not only to costs, but also to other objective indicators of performance (e.g., performance benchmarks or standards, such as the quality level of services to be provided). Only contemplate such links when:
A mathematical relationship can be established between the price and the indicators of performance
Establishing such relationships is likely to have a meaningful impact on the contractor's management of the work
The expected performance benefits are of sufficient magnitude to justify the additional costs of administering the FPI terms and conditions.
Fixed price award fee (FPAF). This is a type of incentive contract in that an additional amount (award) of fee may be added to the base amount of fee, based on judgmental measures of productivity (i.e., if the contractor performs especially well). Of course, if the contractor does not perform above the established criteria, the award would be smaller, or the contractor might not even receive an additional award. The award amount will be decided by the government based on a subjective evaluation of the contractor's performance against the established performance criteria. Such contracts are especially suitable when contracting for services. See Exhibit 4-1, Sample Award Fee Plan, at the end of this chapter.
Contemplate award of a FPAF contract when:
- FAR Part 12 does not apply (or, if it applies, the award fee would be based solely on factors other than cost)
- Performance indicators (i.e., inspection and acceptance criteria) are inherently judgmental (e.g., what is "clean"?), with a corresponding possibility that the end user will not be fully satisfied
- Judgmental standards can be fairly applied by an award-fee panel
- Expected benefits are likely to exceed the expected costs of conducting award-fee evaluations
- The potential fee is large enough to both provide a meaningful incentive and justify the additional costs of administering the award fee terms and conditions.
Firm fixed price/level of effort (FFP/LOE). Such a contract requires the contractor to demonstrate a specified effort, over a stated period of time, in return for a fixed dollar amount. This contract type is used for investigations or studies for which the government can only explain the work to be performed in general terms.
Contemplate award of an FFP/LOE contract when:
- FAR Part 12 does not apply
- The work required cannot otherwise be clearly defined
- The required level of effort is identified and agreed upon in advance
- There is reasonable assurance that the intended result cannot be achieved by expending less than the stipulated effort
- The contract price is $150,000 or less (unless otherwise approved by the chief of the contracting office).