Cost-plus contract
A cost-plus contract, also termed a cost plus contract, is a contract where a contractor is paid for all of its allowed expenses, plus additional payment to allow for a profit. Cost-reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.
History
, one of the founders of industrial engineering, used "cost-plus-a-fixed sum" contracts in his building contracting business. He described this method in an article in Industrial Magazine in 1907, comparing it to fixed price and guaranteed maximum price methods.Cost-plus contracts first came into use by the government in the United States during the World Wars to encourage wartime production by large American companies. According to Martin Kenney, they "allowed what were then small technology firms like Hewlett-Packard and Fairchild Semiconductor to charge the Department of Defense for the price of research and development that none could pay on its own. This enabled the firms to create technology products that eventually created entire new markets and economic sectors".
Types
There are four general types of cost-reimbursement contracts, all of which pay every allowable, allocatable, and reasonable cost incurred by the contractor, plus a fee or profit which differs by contract type.- Cost plus fixed-fee contracts pay a pre-determined fee that was agreed upon at the time of contract formation.
- Cost-plus-incentive fee contracts have a larger fee awarded for contracts which meet or exceed performance targets, including any cost savings.
- Cost-plus-award fee contracts pay a fee based upon the contractor's work 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.
- Cost plus percentage of cost pay a fee that rises as the contractor's cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized. The U.S. Federal Acquisition Regulations specifically prohibit the use of this type for U.S. Federal Government contracting.
| Contract type | U.S. government outlays in FY07 |
| Award-fee contracts | $38 billion |
| Incentive-fee contracts | $8 billion |
| Fixed-fee contracts | $32 billion |
Usage
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.Pros and cons
Advantages:- A cost-plus contract is often used when performance, quality or delivery time 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, especially when the ability to estimate costs is low.
- Final cost may be less than a fixed price contract when there is little market or price competition.
- Allows more oversight and control over the quality of the contractor's work.
- Flexible, allowing for changes in specification.
- 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.
Recent trends
The distribution of annual contract values by sector category and award types indicates that cost plus contracts in the past carried the largest importance in research, followed by services and products. In 2004, however, services replaced research as the dominant sector category for cost-plus contracts. For all other contract vehicles combined the relative ranking is reversed to the original cost-plus order, meaning that products lead, followed by service and research.
With cost-plus contracting being primarily designed for research and development, the percentage of cost-plus contracting within a contract is expected to be correlated to the percentage share of research undertaken in any given program. However, several programs, such as the Lockheed Martin F-35 Lightning II, UGM-133 Trident II, CVN-68, and the CVN-21 deviate from this pattern by continuing to make extensive usage of cost-plus contracting despite programs progressively moving beyond the research and development state.