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curement objectives. For example, in an initial product development contract, it may be appropriate to negotiate a cost-plus-incentive-fee contract providing for relatively small increases or decreases in fee tied to the cost incentive feature, balanced by the inclusion of performance incentive provisions providing for significant upward or downward fee adjustment as an incentive for the contractor to meet or surpass negotiated performance targets. Conversely, in subsequent development and test contracts, it may be more appropriate to negotiate an incentive formula where the opportunity to earn additional fee is based primarily on the contractor's success in controlling costs. With regard to the cost incentive provisions of a contract, the minimum and maximum fees, and the fee adjustment formula, should be negotiated so as to provide an incentive which will be effective over variations in costs throughout the full range of reasonably foreseeable variations from target cost. Whenever this type of contract, with or without the inclusion of performance incentives, is negotiated so as to provide incentive up to a high maximum fee, the contract also shall provide for a low minimum fee, which may even be a "zero" fee or, in rare cases, a "negative" fee. (c) Limitations. The maximum fee shall be subject to the limitations stated in § 1-3.405-5(c)(2).

§ 1-3.405-5 Cost-plus-a-fixed-fee contract. (a) Description. The cost-plus-afixed-fee contract is a cost reimbursement type of contract which provides for the payment of a fixed fee to the contractor. The fixed fee once negotiated does not vary with actual cost, but may be adjusted as a result of any subsequent changes in the work or services to be performed under the contract. Because the fixed fee does not vary in relation to the contractor's ability to control costs, the cost-plus-afixed fee contract provides the contractor with only a minimum incentive for effective management control of costs.

(b) Application. The cost-plus-afixed-fee contract is suitable for use when:

(1) A cost-reimbursement type of contract is found necessary in accordance with § 1-3.405-1(b);

(2) The parties agree that the contract should be fee bearing;

(3) The contract is for the performance of research, or preliminary exploration or study, where the level of effort required is unknown; or

(4) The contract is for development and tests where the use of a cost-plusincentive-fee contract is not practical.

(c) Limitations. (1) This type of contract normally should not be used in the development of major weapons and equipment, once preliminary exploration and studies have indicated a high degree of probability that the development is feasible and the Government generally has determined its desired performance objectives and schedule of completion (see § 1-3.4054).

(2) The fixed fees shall not exceed the limitations set forth in the first sentence of section 304(b) of the Act (41 U.S.C. 254(b)), which sentence reads in part as follows:

* in the case of a cost-plus-a-fixed-fee contract the fee shall not exceed 10 per centum of the estimated cost of the contract, exclusive of the fee, as determined by the agency head at the time of entering into such contract (except that a fee not in excess of 15 per centum of such estimated cost is authorized in any such contract for experimental, developmental, or research work and that a fee inclusive of the contractor's costs and not in excess of 6 per centum of the estimated cost, exclusive of fees, as determined by the agency head at the time of entering into the contract, of the project to which such fee is applicable is authorized in contracts for architectural or engineering services relating to any public works or utility project)."

(d) Contractors' investment in workin-process. Contractors having costreinbursement type contracts shall be required to maintain a reasonable investment in the property and facilities acquired and in the services rendered in the performance of such contracts. This investment provides a strong incentive for the contractor to strive for greater efficiency and economy and better management, with resultant lower costs to the Government.

(1) In keeping with this policy, costreimbursement type contracts other

than those set forth below shall provide for interim payment of not to exceed 80 percent of the costs incurred by the contractor in the performance of the contract.

(i) Contracts under which the contractors receive no fee or profit.

(ii) Contracts with educational institutions or nonprofit organizations.

(iii) Contracts solely for the operation of Government-owned plants or vessels.

(iv) Contracts with small business concerns.

(v) Contracts for research and development which do not provide for quantity production.

(vi) Contracts for performance outside the United States, its possessions, and Puerto Rico.

(vii) Contracts having an estimated cost not in excess of $250,000.

(viii) Contracts for construction and architect-engineer services.

(ix) As determined by the agency head concerned, contracts in which the application of the policy would impose undue hardship on the contractor or adversely affect the interests of the Government.

(2) An appropriate clause implementing this policy shall be inserted in all cost-reimbursement type supply contracts.

(3) Application of this policy need not affect the method of payment of the fee, but the extent of the contractor's capital investment in the performance of the contract will be taken into consideration in fixing the amount of fee or profit.

(e) Completion or Term form. The cost-plus-fixed-fee contract can be drawn in one of two basic forms, Completion or Term.

(1) The Completion form is one which describes the scope of work to be done as a clearly-defined task or job with a definite goal or target expressed and with a specific end-product required. This form of contract normally requires the contractor to complete and deliver the specified endproduct (in certain instances, a final report of research accomplishing the goal or target) as a condition for payment of the entire fixed-fee established for the work and within the es timated cost if possible; however, in

the event the work cannot be comple ed within the estimated cost, the Go ernment can elect to require mo work and effort from the contract without increase in fee provided it i creases the estimated cost.

(2) The Term form is one which d scribes the scope of work to be done i general terms and which obligates th contractor to devote a specified lev of effort for a stated period of time fo the conduct of research and develop ment. Under this form, the fixed-fee payable at the termination of th agreed period of time on certificatio of the contractor that he has exerte the level of effort specified in the con tract in performing the work calle for, and such performance is consid ered satisfactory by the Government Renewals for further periods of per formance are new procurement and in volve new fee and cost arrangements.

(3) The Completion form of con tract, because of differences in obliga tion assumed by the contractor, is to be preferred over the Term form whenever the work itself or specific milestones can be defined with suffi cient precision to permit the develop ment of estimates within which pros pective contractors can reasonably be expected to complete the work, as is usually the case in advanced development and engineering development. A milestone is a definable point in a program when certain objectives can be said to have been accomplished.

(4) In the case of research and exploratory development work, it is rarely possible to define the scope of work with the degree of precision necessary for contracting on a Completion basis because of the nature of the work to be performed. Hence in such cases, the Term form of contract may be considered preferable in that it provides more flexibility for effective conduct of the research effort.

(5) In no event should the Term form of contract be used unless the contractor is obligated by the contract to provide a specific level-of-effort within a definite period of time.

[29 FR 10155, July 24, 1964, as amended at 43 FR 46303, Oct. 6, 1978]

§ 1-3.406 Other types of contracts.

§ 1-3.406-1 Time and materials contract.

(a) Description. The time and materials type of contract provides for the procurement of property or services on the basis of (1) direct labor hours at specified fixed hourly rates (which rates include direct and indirect labor, overhead, and profit) and (2) material at cost. Material handling costs may be included in the charge for "material at cost," to the extent they are clearly excluded from any factor of the charge computed against direct labor hours. This type of contract does not afford the contractor with any positive profit incentive to control the cost of materials or to manage his labor force effectively.

(b) Application. The time and materials contract is used only where it is not possible at the time of placing the contract to estimate the extent or duration of the work or to anticipate costs with any reasonable degree of confidence. Particular care should be exercised in the use of this type of contract since its nature does not encourage effective management control. Thus it is essential that this type of contract be used only where provision is made for adequate controls, including appropriate surveillance by Government personnel during performance, to give reasonable assurance that inefficient or wasteful methods are not being used. This type of contract may be used in the procurement of (1) engineering and design services in connection with the production of supplies; (2) the engineering, design and manufacture of dies, jigs, fixtures, gauges, and special machine tools; (3) repair, maintenance, or overhaul work; and (4) work to be performed in emergency situations.

(c) Limitation. Because this type of contract does not encourage effective cost control and requires almost constant Government surveillance, it may be used only after determination that no other type of contract will suitably serve. This type of contract shall establish a ceiling price which the contractor exceeds at his own risk. The contracting officer shall document the contract file to show valid reasons for

any change in the ceiling and to support the amount of such change.

(d) Optional method of pricing material. When the nature of the work to be performed requires the contractor to furnish material which is regularly sold to the general public in the normal course of business by the contractor, the contract may provide for charging material on a basis other than at cost if:

(1) The total

estimated contract price does not exceed $25,000 or the estimated price of material so charged does not exceed twenty percent of the estimated contract price.

(2) The material to be so charged is identified in the contract;

(3) No element of profit on material so charged is included in the profit in the fixed hourly labor rates; and

(4) The contract provides that the price to be paid for such material shall be on the basis of an established catalog or list price, in effect when material is furnished, less all applicable discounts to the Government, but in no event shall such price be in excess of the contractor's sales price to his most favored customer for the same item in like quantity, or the current market price, whichever is lower.

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§ 1-3.407-2 Contracts with performance incentives.

(a) Description. A contract with a performance incentive is one which incorporates an incentive to the contractor to surpass stated performance targets by providing for increases in the fee or profit to the extent that such targets are surpassed and for decreases to the extent that such targets are not met. Salient features and considerations in the use of this type of contract are as follows:

(1) “Performance”, as used in this § 1-3.407-2, refers not only to the performance of the article being procured, but to the performance of the contractor as well. Performance which is the minimum which the Government will accept shall be mandatory under the terms of the Completion form contract and shall warrant only the minimum profit or fee related thereto. Performance which meets the stated targets will warrant the "target" profit or fee. Performance which surpasses these targets will be rewarded by additional profit or fee. The incentive feature (providing for increases or decreases, as appropriate) is applied to performance targets rather than performance require

ments.

(2) The incentive, when applied to the product, should relate to specific performance characteristics, such as range of a missile, speed of an aircraft or ship, thrust of an engine, maneuverability of a vehicle, and fuel economy. However, high overall performance of the end item is the primary objective of such contracts. Accordingly, the incentive feature should reflect a balancing of the various characteristics which together account for overall performance, so that no one characteristic will be exaggerated to the detriment of the end item as a whole. When applied to the performance of the contractor, the incentive should relate to specific performance areas or milestones, such as delivery or test schedules, quality controls, maintenance requirements, and reliability standards.

(3) Since performance tests generally are essential in order to determine the degree of attainment of performance targets, the contract must be as

specific as possible in establishing test criteria, such as conditions of testing, precision of instrumentation, and interpretation of test data.

(4) It is essential that there be explicit agreement between the Government and the contractor as to the effect on performance of contract changes (e.g., pursuant to the Changes clause).

(5) Care must be exercised, in establishing performance criteria, to give recognition to the fact that the contractor should not be rewarded or penalized for attainments of Government-furnished components.

(6) In establishing incentives in connection with delivery schedules, it is important to determine the Government's primary objectives in a given contract. In some instances, earliest possible delivery is of paramount importance. In others, early quantity production is essential. On the other hand, it may be that maintaining an established delivery schedule is all that is desired, and that a bettering of such schedule may distrupt continuity of production or run counter to funding limitations.

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(b) Application. Contracts with performance incentives are suitable for use in procurements where it is desired to provide the contractor with an incentive in the form of financial reward for surpassing stated performance targets, counterbalance by a penalty in the form of decreased profit or fee for failure to achieve such targets. Performance incentives are particularly appropriate for inclusion in contracts for major weapons and equipment, both in development when desired performance objectives known and the fabrication of prototypes for test and evaluation is required, and in production where there is potential for improved performance that would be highly desirable to the Government. Effort always should be made in these procurement situations to include a performance incentive in the contract. Performance incentives present complex problems in contract administration and should be negotiated and administered by contracting officers with the full cooperation of Government engineering and pricing specialists.

(c) Limitations. (1) Performance incentives, when related to the performance of the product, may result in increased costs and shall always be coupled with a balancing of range of fee or profit on the cost and performance aspects, negotiated so as to give appropriate weight to basic procurement objectives. Where incentives relating to the performance of the product are included in a contract, and earliest possible delivery is of considerable importance to the Government, the contract normally should include a performance incentive relating to time of performance or for expedited delivery schedules.

(2) In the case of cost-reimbursement type contracts involving a fee, the maximum fee shall be subject to the limitations stated in § 1-3.4055(c)(2).

$1-3.408 Letter contract.

(a) Definition. A letter contract is a written preliminary contractual instrument which authorizes immediate commencement of manufacture of property, or performance of services, including, but not limited to, preproduction planning, and the procurement of necessary materials.

(b) Application. A letter contract may be entered into when (1) the interests of the Government demand that the contractor be given a binding commitment so that work can be commenced immediately, and (2) negotiation of a definitive contract in sufficient time to meet the procurement need is not possible, as, for example, when the nature of the work involved prevents the preparation of definitive requirements, specifications, or cost data.

(c) Limitations. (1) A letter contract shall be used only after a determination in accordance with agency procedures that no other type of contract is suitable.

(2) A letter contract shall not be entered into without competition when competition is practicable. Where a letter contract award is based on price competition, an overall price ceiling shall be included in the letter contract.

(3) A letter contract shall be superseded by a definitive contract at the

earliest practicable date. Executive agencies shall prescribe the limitations as to the period of effectiveness of letter contracts.

(4) The maximum liability of the Government stated in the letter contract generally shall not exceed fifty percent of the total estimated cost of the procurement, but this liability may be increased in accordance with agency procedures.

(d) Content. Letter contracts shall be specifically negotiated and, as a minimum, shall include agreement as to the following:

(1) The immediate commencement of performance of the contract by the contractor, including procurement of necessary materials;

(2) The extent and method of payments in the event of termination either for the convenience of the Government or for default;

(3) That the contractor is not authorized to expend moneys or incur obligations in excess of the maximum liability of the Government as stated in the letter contract;

(4) The type of definitive contract anticipated;

(5) As many definitive contract provisions as possible;

(6) The contractor's obligation to provide such price and cost information as may reasonably be required by the contracting officer; and

(7) The prompt entry into good faith negotiations by the contractor and the Government to reach agreement upon and execute a definitive contract.

§ 1-3.409 Indefinite delivery type contracts.

One of the following indefinite delivery type contracts may be used for procurements where the exact time of delivery is not known at time of contracting.

(a) Definite quantity contract-(1) Description. This type of contract provides for a definite quantity of specified property or for the performance of specified services for a fixed period, with deliveries or performance at designated locations upon order. Depending on the situation, the contract may provide for (i) firm fixed-prices, (ii) price escalation, or (iii) price redetermination.

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