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compelling importance that, to the ex- realistic estimates of the probable costs tent practical, firms not willing to ne- of performance; gotiate appropriate incentive provisions (4) The uncertainties involved in conmay be excluded from consideration for tract performance can be identified and the award of development contracts. reasonable estimates of their possible im$ 1–3.404 Fixed-price contracts.

pact on costs made, and the contractor is

willing to accept a firm fixed price at a § 1-3.404–1 General.

level which represents assumption of a Fixed-price contracts are of several

reasonable proportion of the risks intypes so designed as to facilitate proper

volved; or pricing under varying circumstances.

(5) Any other reasonable basis for The fixed-price type contracts provide for

pricing can be used consistent with the

pri a firm price. or under appropriate cir- purpose of this type of contract. cumstances may provide for an adjust The firm fixed-price contract is particuable price, for the supplies or services larly suitable in the purchase of standard which are being procured. In providing or modified commerical items, or of any for an adjustable price, the contract may other items for which sound prices can fix a ceiling price, target price (including be developed. target cost), or minimum price. Unless otherwise provided in the contract, any

§ 1-3.404–3 Fixed-price contract with such ceiling, target, or minimum price

escalation. is subject to adjustment only if required (a) Description. The fixed-price conby the operation of any contract clause tract with escalation provides for the which provides for equitable adjustment, upward and downward revision of the escalation, or other revision of the con stated contract price upon the occurtract price upon the occurrence of an rence of certain contingencies which are event or a contingency.

specifically defined in the contract.

The risks in a fixed-price contract are § 1-3.404–2 Firm fixed-price contract.

reduced by the inclusion of escalation (a) Description. The firm fixed-price provisions in which the parties agree to contract provides for a price which is not revise the stated price upon the happensubject to any adjustment by reason of ing of a prescribed contingency. Where the cost experience of the contractor escalation is agreed upon, upward adin the performance of the contract. justments shall be limited by the estabThis type of contract, when appropri lishment of a reasonable ceiling, and proately applied as set forth in this $ 1 visions will be included for downward 3.404–2, places maximum risk upon the adjustments in those instances where the contractor. Because the contractor as- prices or rates fall below the base levels sumes full responsibility, in the form of provided in the contract. In the estabprofits or losses, for all costs under or lishment of the base levels from which over the firm fixed price, he has a max escalation will operate, contingency alimum profit incentive for effective cost lowances shall be eliminated from the control and contract performance. Use base to be set forth in the contract to the of the firm fixed-price contract imposes extent that escalation is provided for any a minimum administrative burden on the particular contingency. Generally, escontracting parties.

calation provisions are of two broad (b) Application. The firm fixed-price types. contract is suitable for use in procure (1) Price escalation provides for adments when reasonably definite design justment of the contract price on the or performance specifications are avail basis of increases or decreases from an able and whenever fair and reasonable agreed upon level in published or estabprices can be established at the outset, lished prices of specific items or in price such as where:

levels of the contract end items. (1) Adequate competition has made (2) Labor and material escalation initial proposals effective;

provides for adjustment of the contract (2) Prior purchases of the same or price on the basis of increases or desimilar supplies or services under com creases from agreed standards or indices petitive conditions or supported by valid in wage rates, specific materials costs, or cost or pricing data provide reasonable both. price comparisons;

(b) Application. Use of this type of (3) Cost or pricing information is contract is appropriate where serious available permitting the development of doubt exists as to the stability of market

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and labor conditions which will exist during an extended period of production and where contingencies which would otherwise be included in a firm fixedprice contract are identifiable and can be covered separately by escalation. Its usefulness is limited by the difficulties inherent in its administration. Escalation should be restricted, to the extent possible, to industry-wide contingencies, and labor and material escalation should be limited to contingencies beyond the normal control of the contractor. § 1-3.40444 Fixed-price incentive con

tract. (a) Description—(1) General. The fixed-price incentive contract is a fixedprice type contract with provision for adjustment of profit and establishment of the final contract price by a formula based on the relationship which final negotiated total cost bears to total target costs.

(2) Firm target. Under the firm target type of incentive contract there is negotiated at the outset a target cost, a target profit, a price ceiling (but not a profit ceiling or floor), and a formula for establishing final profit and price, After performance of the contract, the final cost is negotiated and the final contract price is then established in accordance with the formula. Where the final cost is less than target cost, application of the formula results in a final profit greater than the target profit; conversely, where final cost is more than target cost, application of the formula results in a final profit less than the target profit, or even a net loss. Thus, within the price ceiling, the formula provides for the Government and the contractor to share the responsibility for costs greater or less than those originally estimated, as determined by a comparison of negotiated final cost with target cost. Because the profit resulting from application of the formula is in inverse relationship to costs, the formula provides the contractor in advance with a calculable profit incentive to control costs. To provide an incentive consistent with the circumstances, the formula should reflect the relative risks involved in contract performance. Thus, it is appropriate in certain procurements to establish a formula which provides for contractor assumption of a considerable or major share of total cost responsibility. In such circumstances, when a major

share of total cost responsibility is assumed by the contractor, every consideration should be given to establishing target profits which reflect assumption of such responsibility.

(3) Successive targets. Under the successive targets type of incentive contract, there is negotiated at the outset an initial target cost, an initial target profit, a price ceiling, a formula for fixing the firm target profit, and a production point at which the formula will be applied. Generally, the production point will be prior to delivery or shop completion of the first item. This formula does not apply for the life of the contract but simply is used to fix the firm target profit for the contract. The initial formula shall also provide for a ceiling and floor on the firm target profit. To provide an incentive consistent with the circumstances, the formula for fixing the firm target profit should reflect the relative risk involved in establishing an incentive arrangement where cost and pricing information were not sufficient to permit the negotiation of firm targets at the outset (see § 1-3.404–4(b) (3)). Thus it normally will not provide for as great a degree of contractor cost responsibility as would a formula for establishing final profit and price. When the production point for applying the formula is reached, the firm target cost is then negotiated, consideration being given to experienced cost and all other pertinent factors, and the firm target profit is automatically determined in accordance with the formula. At this point, two alternatives are possible. First, a firm fixed price may be negotiated using as a guide the firm target cost plus the firm target profit. Second, if use of the firm fixed price is determined to be inappropriate, a formula for establishing final profit and price may be negotiated, using the firm target profit and the firm target cost. As in the firm target type of contract described in § 1-3.404-4(a) (2), the final cost is negotiated at the completion of the contract and the final contract price is then established in accordance with the formula for establishing final profit and price.

(4) Billing price. In either of the types of contract described in (2) and (3) of this § 1-3.404–4(a), a billing price will be established as an interim basis for payment. This billing price may be adjusted within the ceiling limits, upon request of either party to the contract, when it becomes apparent that final

negotiated costs will be substantially ance, or (2) the sole or principal purpose different from the target cost.

is to shift substantially all cost respon(b) Application. (1) Fixed-price in- sibility to the Government. In no case centive contracts are appropriate when shall the firm target profit or the foruse of the firm fixed-price contract is mula for final profit and price be estabinappropriate, and the supplies or sery- lished prior to the negotiation of the firm ices being procured are of such a nature target cost. Neither type of fixed-price that assumption of a degree of cost re- incentive contract shall be used unless sponsibility by the contractor is likely a determination has been made, in acto provide him with a positive profit in- cordance with the requirements of Subcentive for effective cost control and part 1-3.3, that such method of concontract performance. It may also be tracting is likely to be less costly than appropriate to negotiate additional in other methods, or that it is impractical centive provisions covering performance to secure supplies or services of the kind levels and more timely delivery (see or quality required without the use of § 1-3.407-2), Contract performance re- such type of contract. quirements must be such that there is

§ 1-3.404–5
a

Prospective price redeterreasonable opportunity for the incentive

mination at a stated time or times provisions to have a meaningful impact

during performance. on the manner in which the contractor manages the work.

(a) Description. This type of con(2) The firm target type of incentive

tract provides for a firm fixed price for contract, described in § 1-3.404-4(a) (2), an initial period of contract deliveries is appropriate for use whenever a firm or performance and for prospective price target and a formula for establishing

redetermination either upward or downfinal profit and price can be negotiated

ward at a stated time or times during the at the outset which will provide a fair performance of the contract. It also and reasonable incentive.

may provide for a price ceiling, where (3) The successive targets type of in

appropriate. Once established, ceiling centive contract, described in § 1-3.404-4

prices are subject to adjustment only (a) (3), is appropriate for use whenever

by reason of the operation of other conavailable cost and pricing information

tract clauses (see § 1-3.404–1). is not sufficient to permit the negotia

(b) Application. This type of contion of realistic firm targets at the out

tract is appropriate in procurements set. However, enough information

calling for quantity production or seryshould be available to permit negotiation

ices where it is possible to negotiate of initial targets, and there should be

fair and reasonable firm fixed prices for reasonable assurance that additional re

an initial period, but not for subsequent liable information will be available at an

periods of contract performance. This early point in the performance of the

initial period should be the longest contract so as to permit negotiation of

period for which it is possible to estabeither a firm fixed price, or firm targets

lish fair and reasonable firm fixed prices and a formula for establishing final

at the time of original negotiation. The profit and price, which will provide a

length of the prospective pricing periods fair and reasonable incentive. The addi

should depend on the circumstances of tional information need not in all cases each case and should generally be at come from experience under the con

least twelve months each. Ceiling prices, tract itself, but may be drawn from ex where appropriate, should be based on perience on any other contracts for the the evaluation of the uncertainties insame or similar items.

volved in contract performance, and (c) Limitations. Fixed-price incen their possible impact on cost, and should tive contracts shall not be used unless be negotiated at a level which reprethe contractor's accounting system is sents contractor assumption of a reaadequate for price revision purposes and sonable degree of risk. permits satisfactory application of the (c) Limitations. This type of conprofit and price adjustment formulas. tract shall not be used unless: In no case should such contracts be used (1) It has been established through where (1) cost or pricing information negotiations that a firm fixed-price conadequate for firm targets is not available tract does not fulfill the requirements at the time of initial contract negotia- established by the conditions surroundtion or at a very early point in perform ing the procurement;

(2) The contractor's accounting sys- (2) Reasonable assurance exists that tem is adequate for price redetermina- price redetermination action will be tion purposes;

taken promptly at the time specified; (3) The prospective pricing period can (3) A ceiling price is established; and be made to conform with the operation (4) Written approval has been received of the contractor's accounting system; from the head of the procuring activity, and

unless approval at a higher level is re(4) Reasonable assurance exists that quired by the agency. price redetermination action will be

§ 1-3.405 Cost-reimbursement type contaken promptly at the time or times

tracts. specified.

§ 1-3.405–) General. § 1-3.404–6 [Reserved]

(a) Description. The cost-reimburse§ 1–3.404–7 Retroactive price redeter

ment type of contract provides for paymination after completion.

ment to the contractor of allowable costs (a) Description. This type of contract incurred in the performance of the conprovides for a ceiling price and retro tract, to the extent prescribed in the active price redetermination after com contract. This type of contract estabpletion of the contract. The redeter lishes an estimate of total cost for the mined price should be negotiated so as to purpose of obligation of funds, and a give weight to the management effective ceiling which the contractor may not ness and ingenuity exhibited by the con exceed (except at his own risk) without tractor during performance, and the prior approval or subsequent ratification basis for such negotiation should be fully of the contracting officer. discussed with the contractor when this (b) Application. The cost-reimbursetype of contract is negotiated. Because ment type contract is suitable for use the price is redetermined on a completely only when the uncertainties involved in retroactive basis, this contract type (ex contract performance are of such magnicept for the price ceiling) does not pro tude that cost of performance cannot be vide the contractor with a calculable estimated with sufficient reasonableness incentive for effective cost control. Once

to permit use of any type of fixed-price established, the ceiling price is subject to contract. In addition, it is essential that adjustment only if required by the opera

(1) the contractor's cost accounting systion of other contract clauses (see $ 1 tem is adequate for the determination of 3.404_1).

costs applicable to the contract, and (2) (b) Application. This type of contract appropriate surveillance by Government is appropriate in procurements where it personnel during performance will give is established at the time of negotiation reasonable assurance that inefficient or that a fair and reasonable firm fixed wasteful methods are not being used. price cannot be negotiated and the

(c) Limitations. The cost-reimburseamount involved is so small or the time ment type contract may be used only for performance so short that use of any

rmance so short that use of any after a determination, in accordance other type of contract is impracticable. with Subpart 1-3.3, that: Even in these situations, however, it (1) Such method of contracting is should be used only after negotiation of likely to be less costly than other metha billing price as fair and reasonable as

ble as ods; or the circumstances of the particular pro (2) It is impractical to secure property curement permit. Based on an evalua

or services of the kind or quality required tion of the circumstances involved in without the use of such type of contract. contract performance, and their possible

81–3.405-2 Cost contract. impact on cost, the ceiling price should be negotiated at a level which represents

(a) Description. The cost contract is contractor assumption of a reasonable a cost-reimbursement type contract degree of risk.

under which the contractor receives no (c) Limitations. This type of contract fee. shall not be used unless the procurement

(b) Application. The following are is for research and development at an illustrative situations in which the use estimated cost of $100,000 or less, and of this type of contract may be appro

(1) The contractor's accounting sys priate: tem is adequate for price redetermina (1) Research and development work, tion purposes;

particularly with nonprofit educational institutions or other non-profit organic primarily for development and test when zations.

a cost-reimbursement type of contract (2) Facilities contracts.

is found necessary in accordance with (3) Initial small quantity procure § 1-3.405–1(b), and when a target and a ments of new items with anticipated sub fee adjustment formula can be negotisequent large production runs.

ated which are likely to provide the con§ 1-3.405–3 Cost-sharing contract.

tractor with a positive profit incentive

for effective management. In particu(a) Description. A cost-sharing con lar, where it is highly probable that the tract is a cost-reimbursement type con development is feasible and the Govtract under which the contractor receives ernment generally has determined its no fee but is reimbursed only for an desired performance objectives, the costagreed portion of its allowable costs. plus-incentive-fee contract should be

(b) Application. A cost-sharing con used in conjunction with performance tract is suitable for those procurements incentives in the development of major which cover production or research proj systems, and in other development proects which are jointly sponsored by the grams where use of the cost and perGovernment and the contractor with formance incentive approach is considbenefit to the contractor in lieu of full ered both desirable and administratively monetary reimbursement of costs. In practical (see $$ 1-3.403(c) and 1-3.407consideration of this benefit, the contrac 2(b)). Range of fee and the fee adjusttor agrees to absorb a portion of the ment formula should be negotiated so as costs of performance. The following are to give appropriate weight to basic proillustrative situations in which this type

curement objectives. For example, in of contract is generally desirable:

an initial product development contract, (1) Jointly sponsored research and de

it may be appropriate to negotiate a costvelopment work with nonprofit educa

plus-incentive-fee contract providing for tional institutions or other nonprofit

relatively small increases or decreases organizations. (2) Other research and development

in fee tied to the cost incentive feature, work where the results of the contract

balanced by the inclusion of perforinmay have commercial benefit to the

ance incentive provisions providing for contractor.

significant upward or downward fee ad

justment as an incentive for the con$ 1–3.405-4 Cost-plus-incentive-fee con

tractor to meet or surpass negotiated tract.

performance targets. Conversely, in sub(a) Description. The cost-plus-in

sequent development and test contracts, centive-fee contract is a cost-reimburse

it may be more appropriate to negotiate ment type contract with provision for

an incentive formula where the opportua fee which is adjusted by formula in accordance with the relationship which

nity to earn additional fee is based pritotal allowable costs bear to target costs.

marily on the contractor's success in conUnder this type of contract, there is

trolling costs. With regard to the cost negotiated initially a target cost, a target incentive provisions of a contract, the fee, a minimum and maximum fee, and minimum and maximum fees, and the a fee adjustment formula. After per fee adjustment formula, should be neformance of the contract, the fee pay gotiated so as to provide an incentive able to the contractor is determined in which will be effective over variations in accordance with the formula. The for- costs throughout the full range of reamula provides, within limits, for in sonably foreseeable variations from tarcreases in fee above target fee when total get cost. Whenever this type of conallowable costs are less than target costs, tract, with or without the inclusion of and decreases in fee below target fee performance incentives, is negotiated so when total allowable costs exceed target as to provide incentive up to a high maxcosts. The provision for increase or de imum fee, the contract also shall provide crease in the fee is designed to provide for a low minimum fee, which may even an incentive for maximum effort on the be a "zero" fee or, in rare cases, a "negapart of the contractor to manage the tive” fee. contract effectively.

(c) Limitations. The maximum fee (b) Application. The cost-plus-in- shall be subject to the limitations stated centive-fee contract is suitable for use in § 1-3.405–5(c) (2).

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