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plies or services which are being pro- assumption of a reasonable proportion cured. In providing for an adjustable of the risks involved; or price, the contract may fix a ceiling (5) Any other reasonable basis for price, target price (including target pricing can be used consistent with the cost), or minimum price. Unless other purpose of this type of contract. wise provided in the contract, any

The firm fixed-price contract is parsuch ceiling, target, or minimum price

ticularly suitable in the purchase of is subject to adjustment only if re

standard or modified commercial quired by the operation of any con

items, or of any other items for which tract clause which provides for equita

sound prices can be developed. ble adjustment, escalation, or other revision of the contract price upon the § 1-3.404-3 Fixed-price contract with escaoccurrence of an event or a contingen

lation. cy.

(a) Description. The fixed-price con

tract with escalation provides for the § 1-3.404-2 Firm fixed-price contract.

upward and downward revision of the (a) Description. The firm fixed-price stated contract price upon the occurcontract provides for a price which is rence of certain contingencies which not subject to any adjustment by are specifically defined in the conreason of the cost experience of the tract. The risks in a fixed-price concontractor in the performance of the tract are reduced by the inclusion of contract. This type of contract, when

escalation provisions in which the parappropriately applied as set forth in

ties agree to revise the stated price this $ 1-3.404-2, places maximum risk

upon the happening of a prescribed upon the contractor. Because the con

contingency. Where escalation is tractor assumes full responsibility, in

agreed upon, upward adjustments the form of profits or losses, for all

shall be limited by the establishment costs under or over the firm fixed

of a reasonable ceiling, and provisions price, he has a maximum profit incen

will be included for downward adjusttive for effective cost control and con

ments in those instances where the tract performance. Use of the firm

prices or rates fall below the base fixed-price contract imposes a mini

levels provided in the contract. In the mum administrative burden on the

establishment of the base levels from contracting parties.

which escalation will operate, contin

gency allowances shall be eliminated (b) Application. The firm fixed-price

from the base to be set forth in the contract is suitable for use in procure

contract to the extent that escalation ments when reasonably definite design

is provided for any particular continor performance specifications are

gency. Generally, escalation provisions available and whenever fair and rea

are of two broad types. sonable prices can be established at

(1) Price escalation provides for adthe outset, such as where:

justment of the contract price on the (1) Adequate competition has made

basis of increases or decreases from an initial proposals effective;

agreed upon level in published or es(2) Prior purchases of the same or

tablished prices of specific items or in similar supplies or services under com price levels of the contract end items. petitive conditions or supported by (2) Labor and material escalation valid cost or pricing data provide rea provides for adjustment of the consonable price comparisons;

tract price on the basis of increases or (3) Cost or pricing information is decreases from agreed standards or inavailable permitting the development dices in wage rates, specific materials of realistic estimates of the probable costs, or both. costs of performance;

(b) Application. Use of this type of (4) The uncertainties involved in contract is appropriate where serious contract performance can be identified doubt exists as to the stability of and reasonable estimates of their pos- market and labor conditions which sible impact on costs made, and the will exist during an extended period of contractor is willing to accept a firm production and where contingencies fixed price at a level which represents which would otherwise be included in

a firm fixed-price contract are identifi- share of total cost responsibility is asable and can be covered separately by sumed by the contractor, every considescalation. Its usefulness is limited by eration should be given to establishing the difficulties inherent in its adminis- target profits which reflect assumptration. Escalation should be restrict. tion of such responsibility. ed, to the extent possible, to industry. (3) Successive targets. Under the wide contingencies, and labor and ma- successive targets type of incentive terial escalation should be limited to contract, there is negotiated at the contingencies beyond the normal con outset an initial target cost, an initial trol of the contractor.

target profit, a price ceiling, a formula

for fixing the firm target profit, and a § 1-3.404-4 Fixed-price incentive contract.

production point at which the formula (a) Description-(1) General. The will be applied. Generally, the producfixed-price incentive contract is a tion point will be prior to delivery or fixed-price type contract with provi shop completion of the first item. This sion for adjustment of profit and es formula does not apply for the life of tablishment of the final contract price the contract but simply is used to fix by a formula based on the relationship the firm target profit for the contract. which final negotiated total cost bears The initial formula shall also provide to total target costs.

for a ceiling and floor on the firm (2) Firm target. Under the firm target profit. To provide an incentive target type of incentive contract there consistent with the circumstances, the is negotiated at the outset a target formula for fixing the firm target cost, a target profit, a price ceiling profit should reflect the relative risk (but not a profit ceiling or floor), and involved in establishing an incentive a formula for establishing final profit arrangement where cost and pricing and price. After performance of the information were not sufficient to contract, the final cost is negotiated permit the negotiation of firm targets and the final contract price is then es at the outset (see § 1-3.404-4(b)(3)). tablished in accordance with the for- Thus it normally will not provide for mula. Where the final cost is less than as great a degree of contractor cost retarget cost, application of the formula sponsibility as would a formula for esresults in a final profit greater than tablishing final profit and price. When the target profit; conversely, where the production point for applying the final cost is more than target cost, ap- formula is reached, the firm target plication of the formula results in a cost is then negotiated, consideration final profit less than the target profit, being given to experienced cost and all or even a net loss. Thus, within the other pertinent factors, and the firm price ceiling, the formula provides for target profit is automatically deterthe Government and the contractor to mined in accordance with the formula. share the responsibility for costs At this point, two alternatives are posgreater or less than those originally sible. First, a firm fixed price may be estimated, as determined by a com negotiated using as a guide the firm parison of negotiated final cost with target cost plus the firm target profit. target cost. Because the profit result. Second, if use of the firm fixed price is ing from application of the formula is determined to be inappropriate, a forin inverse relationship to costs, the mula for establishing final profit and formula provides the contractor in ad- price may be negotiated, using the vance with a calculable profit incen firm target profit and the firm target tive to control costs. To provide an in- cost. As in the firm target type of concentive consistent with the circum- tract described in § 1-3.404-4(a)(2), the stances, the formula should reflect the final cost is negotiated at the complerelative risks involved in contract per- tion of the contract and the final conformance. Thus, it is appropriate in tract price is then established in accertain procurements to establish a cordance with the formula for estabformula which provides for contractor lishing final profit and price. assumption of a considerable or major (4) Billing price. In either of the share of total cost responsibility. In types of contract described in (2) and such circumstances, when a major (3) of this § 1-3.404-4(a), a billing price will be established as an interim basis (c) Limitations. Fixed-price incel for payment. This billing price may be tive contracts shall not be used unle: adjusted within the ceiling limits, the contractor's accounting system upon request of either party to the adequate for price revision purpose contract, when it becomes apparent and permits satisfactory application ( that final negotiated costs will be sub the profit and price adjustment for stantially different from the target mulas. In no case should such cor cost.

tracts be used where (1) cost or pricin (b) Application. (1) Fixed-price in

information adequate for firm target centive contracts are appropriate

is not available at the time of initia when use of the firm fixed-price con

contract negotiation or at a very earl tract is inappropriate, and the supplies

point in performance, or (2) the sole a

principal purpose is to shift substar or services being procured are of such

tially all cost responsibility to th a nature that assumption of a degree

Government. In no case shall the firr of cost responsibility by the contractor is likely to provide him with a positive

target profit or the formula for fina profit incentive for effective cost con

profit and price be established prior ti

the negotiation of the firm target cost trol and contract performance. It may

Neither type of fixed-price incentiv also be appropriate to negotiate addi

contract shall be used unless a deter tional incentive provisions covering

mination has been made, in accord performance levels and more timely

ance with the requirements of Subpar delivery (see § 1-3.407-2). Contract per

1-3.3, that such method of contractin formance requirements must be such

is likely to be less costly than othe that there is reasonable opportunity

methods, or that it is impractical ti for the incentive provisions to have a

secure supplies or services of the kind meaningful impact on the manner in

or quality required without the use o which the contractor manages the

such type of contract. work.

(2) The firm target type of incentive $ 1-3.404-5 Prospective price redetermina contract, described in § 1-3.404-4(a)(2), tion at a stated time or times durini is appropriate for use whenever a firm

performance. target and a formula for establishing

(a) Description. This type of con final profit and price can be negotiat

tract provides for a firm fixed price ed at the outset which will provide a

for an initial period of contract deliv fair and reasonable incentive.

eries or performance and for prospec (3) The successive targets type of in

tive price redetermination either centive contract, described in $ 1

upward or downward at a stated time 3.404-4(a)(3), is appropriate for use

or times during the performance of whenever available cost and pricing in the contract. It also may provide for a formation is not sufficient to permit price ceiling, where appropriate. Once the negotiation of realistic firm tar

established, ceiling prices are subject gets at the outset. However, enough to adjustment only by reason of the information should be available to operation of other contract clauses permit negotiation of initial targets, (see § 1-3.404-1). and there should be reasonable assur (b) Application. This type of conance that additional reliable informa- tract is appropriate in procurements tion will be available at an early point calling for quantity production or in the performance of the contract so services where it is possible to negotias to permit negotiation of either a ate fair and reasonable firm fixed firm fixed price, or firm targets and a prices for an initial period, but not for formula for establishing final profit subsequent periods of contract perand price, which will provide a fair formance. This initial period should be and reasonable incentive. The addi the longest period for which it is possitional information need not in all ble to establish fair and reasonable cases come from experience under the firm fixed prices at the time of origi. contract itself, but may be drawn from nal negotiation. The length of the experience on any other contracts for prospective pricing periods should the same or similar items.

depend on the circumstances of each

rase and should generally be at least twelve months each. Ceiling prices, where appropriate, should be based on the evaluation of the uncertainties involved in contract performance, and their possible impact on cost, and should be negotiated at a level which represents contractor assumption of a reasonable degree of risk.

(c) Limitations. This type of contract shall not be used unless:

(1) It has been established through negotiations that a firm fixed-price contract does not fulfill the requirements established by the conditions surrounding the procurement;

(2) The contractor's accounting system is adequate for price redetermination purposes;

(3) The prospective pricing period can be made to conform with the operation of the contractor's accounting system; and

(4) Reasonable assurance exists that price redetermination action will be taken promptly at the time or times specified

the time for performance so short that use of any other type of contract is impracticable. Even in these situations, however, it should be used only after negotiation of a billing price as fair and reasonable as the circumstances of the particular procurement permit. Based on an evaluation of the circumstances involved in contract performance, and their possible impact on cost, the ceiling price should be negotiated at a level which represents contractor assumption of a reasonable degree of risk.

(c) Limitations. This type of contract shall not be used unless the procurement is for research and development at an estimated cost of $100,000 or less, and

(1) The contractor's accounting system is adequate for price redetermination purposes;

(2) Reasonable assurance exists that price redetermination action will be taken promptly at the time specified;

(3) A ceiling price is established; and

(4) Written approval has been received from the head of the procuring activity, unless approval at a higher level is required by the agency. § 1-3.405 Cost-reimbursement type con

tracts.

{ 1-3.404-6 (Reserved]

$1-3.404-7 Retroactive price redetermina

tion after completion. (a) Description. This type of contract provides for a ceiling price and retroactive price redetermination after completion of the contract. The redetermined price should be negotiated so as to give weight to the management effectiveness and ingenuity exhibited by the contractor during performance, and the basis for such negotiation should be fully discussed with the con tractor when this type of contract is negotiated. Because the price is redetermined on a completely retroactive basis, this contract type (except for the price ceiling) does not provide the contractor with a calculable incentive for effective cost control. Once established, the ceiling price is subject to adjustment only if required by the operation of other contract clauses (see $1-3.404-1).

(b) Application. This type of con tract is appropriate in procurements where it is established at the time of negotiation that a fair and reasonable firm fixed price cannot be negotiated and the amount involved is so small or

$ 1-3.405-1 General.

(a) Description. The cost-reimbursement type of contract provides for payment to the contractor of allowable costs incurred in the performance of the contract, to the extent prescribed in the contract. This type of contract establishes an estimate of total cost for the purpose of obligation of funds, and a ceiling which the contractor may not exceed (except at his own risk) without prior approval or subsequent ratification of the contracting officer.

(b) Application. The cost-reimbursement type contract is suitable for use only when the uncertainties involved in contract performance are of such magnitude that cost of performance cannot be estimated with sufficient reasonableness to permit use of any type of fixed-price contract. In addition, it is essential that (1) the contractor's cost accounting system is adequate for the determination of costs applicable to the contract, and (2) appropriate surveillance by Government personnel during performance will give reasonable assurance that inefficient or wasteful methods are not being used.

(c) Limitations. The cost-reimbursement type contract may be used only after a determination, in accordance with Subpart 1-3.3, that:

(1) Such method of contracting is likely to be less costly than other methods; or

(2) It is impractical to secure property or services of the kind or quality required without the use of such type of contract.

$ 1-3.405-2 Cost contract.

(a) Description. The cost contract is a cost-reimbursement type contract under which the contractor receives no fee.

(b) Application. The following are illustrative situations in which the use of this type of contract may be appropriate:

(1) Research and development work, particularly with nonprofit educational institutions or other non-profit organizations.

(2) Facilities contracts.

(3) Initial small quantity procurements of new items with anticipated subsequent large production runs.

cational institutions or other nonpri it organizations.

(2) Other research and developme work where the results of the contra may have commercial benefit to ti contractor. § 1-3.405-4 Cost-plus-incentive-fee co

tract. (a) Description. The cost-plus-ince tive-fee contract is a cost-reimburs ment type contract with provision f a fee which is adjusted by formula i accordance with the relationsh which total allowable costs bear target costs. Under this type of coi tract, there is negotiated initially target cost, a target fee, a minimui and maximum fee, and a fee adjus ment formula. After performance the contract, the fee payable to th contractor is determined in accordanc with the formula. The formula pri vides, within limits, for increases in fe above target fee when total allowabl costs are less than target costs, and de creases in fee below target fee whe total allowable costs exceed targe costs. The provision for increase or de crease in the fee is designed to provid an incentive for maximum efforto the part of the contractor to manag the contract effectively.

(b) Application. The cost-plus-incer tive-fee contract is suitable for use pri marily for development and test whe a cost-reimbursement type of contrac is found necessary in accordance witi § 1-3.405-1(b), and when a target and fee adjustment formula can be negot ated which are likely to provide th contractor with a positive profit incen tive for effective management. In par ticular, where it is highly probabl that the development is feasible ani the Government generally has deter mined its desired performance objec tives, the cost-plus-incentive-fee con tract should be used in conjunctioi with performance incentives in the de velopment of major systems, and in other development programs wher use of the cost and performance incen tive approach is considered both desir able and administratively practica (see $$ 1-3.403(c) and 1-3.407-2(b) Range of fee and the fee adjustmen formula should be negotiated so as to give appropriate weight to basic pro

§ 1-3.405-3 Cost-sharing contract.

(a) Description. A cost-sharing contract is a cost-reimbursement type con tract under which the contractor receives no fee but is reimbursed only for an agreed portion of its allowable costs.

(b) Application. A cost-sharing contract is suitable for those procurements which cover production or research projects which are jointly sponsored by the Government and the contractor with benefit to the contractor in lieu of full monetary reimbursement of costs. In consideration of this benefit, the contractor agrees to absorb a portion of the costs of performance. The following are illustrative situations in which this type of contract is generally desirable:

(1) Jointly sponsored research and development work with nonprofit edu

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