iollowing are some of the considerations which may influence the estimate and hence, the selection of contract type:

(i) Type and complexity of the item; (ii) Stability of design, which in turn may influence such subordinate considerations as the adequacy and firmness of specifications, and the availability of relevant historical pricing data and prior production experience;

(iii) Prospective period of contract performance and length of production run at the time of negotiation;

(iv) Extent and nature of subcontracting contemplated;

(v) Adequacy of the contractor's estimating system; and

(3) Urgency of the requirement. In certain procurements the best interests of the Government may dictate that the urgency of the requirement be a primary consideration in selection of contract

type.

(4) Technical capability and financial responsibility of the contractor.

(5) Adequacy of the contractor's accounting system. Before reaching agreement on price and contract type, determination should be made that the contractor's accounting system will permit timely development of all necessary cost data in the form required by the specific contract type contemplated. This may be particularly critical where the contract type requires revision of price while performance is in progress, or where a cost-reimbursement type of contract is being considered and all current or past experience with the contractor has been on a fixed-price basis (see §3.809).

If

(6) Other concurrent contracts. performance under a proposed procurement involves operations which concurrently are required in performance of other work, the nature of the pricing arrangements on the other work may be important in selecting the contract type for the proposed procurement. This factor may not be so important where close controls exist that will assure proper allocation of costs.

(b) Research. In the majority of research programs, including preliminary explorations and studies, the work to be performed cannot be described precisely. Hence, the negotiation of cost-plus-afixed-fee or cost-sharing contracts frequently is necessary. However, where the level of contractor effort desired can be identified and agreed upon in ad

vance of performance, negotiation of a firm fixed-price contract should be considered.

(c) Development and test. Where possible, a final commitment to undertake specific product development and test should be avoided until 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. As a result, the Government should be able to make such desired objectives known to prospective contractors in advance of source selection. In all major system developments, and in other development programs where use of cost and performance incentives are considered desirable and administratively practicable, the request for proposals should describe the Government's desired performance and schedule completion objectives and the type of contract contemplated. The request for proposals should also include the relative weights which the Government attaches to these objectives, and to cost factors. Where such relative weights are included in the request, proposals should be required to include proposed targets for the accomplishment of the Government's desired performance and schedule completion objectives, together with an estimate of the cost of doing so. Then, to the extent practical, performance and schedule completion targets proposed by each prospective contractor in meeting the Government's desired objectives, together with the estimated cost thereof, should be considered by the Government in the competitive contractor selection process. Where this approach to contractor selection has been used, the resulting development program should be performed under an incentive contract which includes performance, schedule completion, and cost targets, the requisite test procedures against which attainment of performance targets will be measured, and provisions for varying profits to the extent targets are or are not met. In order to provide the maximum incentive, the range of profit variation should, in each case, be as wide as practical (see § 3.405-4(b)). The introduction of incentives into development is of such compelling importance that, to the extent practicable, firms not willing to

Fixed-price contracts are of several types so designed as to facilitate proper pricing under varying circumstances. The fixed-price type contracts provide for a firm price, or under appropriate circumstances may provide for an adjustable price, for the supplies or services which are being procured. In providing for an adjustable price, the contract may fix a ceiling price, target price (including target cost), or minimum price. Unless otherwise provided in the contract, any such ceiling, target, or minimum price is subject to adjustment only if required by the operation of any contract clause which provides for equitable adjustment, escalation, or other revision of the contract price upon the occurrence of an event or a contingency. § 3.404-2

Firm fixed-price contract.

(a) Description. The firm fixed-price contract provides for a price which is not subject to any adjustment by reason of the cost experience of the contractor, in the performance of the contract. This type of contract, when appropriately applied as set forth below, places maximum risk upon the contractor. Because the contractor assumes full responsibility, in the form of profits or losses, for all costs under or over the firm fixed-price, he has a maximum profit incentive for effective cost control and contract performance. Use of the firm fixed-price contract imposes a minimum administrative burden on the contracting parties.

(b) Application. The firm fixed-price contract is suitable for use in procurements when reasonably definite design or performance specifications are available and whenever fair and reasonable prices can be established at the outset, such as where:

(1) Adequate competition has made initial proposals effective;

(2) Prior purchases of the same or similar supplies or services under competitive conditions or supported by valid

cost or pricing data provide reasonable price comparisons;

(3) Cost or pricing information is available permitting the development of realistic estimates of the probable costs of performance;

(4) The uncertainties involved in contract performance can be identified and reasonable estimates of their possible impact on costs made, and the contractor is willing to accept a firm fixed price at a level which represents assumption of a reasonable proportion of the risks involved; or

(5) Any other reasonable basis for pricing can be used consistent with the purpose of this type of contract.

The firm fixed-price contract is particularly suitable in the purchase of standard or modified commercial items, or military items for which sound prices can be developed.

§ 3.404-3 Fixed-price contract with escalation.

(a) Description. The fixed-price contract with escalation provides for the upward and downward revision of the stated contract price upon the occurrence of certain contingencies which are specifically defined in the contract. The risks in a fixed-price contract are reduced by the inclusion of escalation provisions in which the parties agree to revise the stated price upon the happening of a prescribed contingency. Where escalation is agreed upon, upward adjustments shall be limited by the establishment of a reasonable ceiling, and provisions will be included for downward adjustments in those instances where the prices or rates fall below the base levels provided in the contract. In the establishment of the base levels from which escalation will operate, contingency allowances shall be eliminated from the base to be set forth in the contract to the extent that escalation is provided for any particular contingency. Generally, escalation provisions are of two broad types:

(1) Price escalation provides for adjustment of the contract price on the basis of increases or decreases from an agreed upon level in published or established prices of specific items or in price levels of the contract end items.

(2) Labor and material escalation provides for adjustment of the contract price on the basis of increases or decreases from agreed standards or indices

in wage rates, specific material costs, or both.

(b) Application. Use of this type of contract is appropriate where serious doubt exists as to the stability of market and labor conditions which will exist during an extended period of production and where contingencies which would otherwise be included in a firm fixed-price contract are identifiable and can be covered separately by escalation. Its usefulness is limited by the difficulties inherent in its administration. To the extent possible, escalation should be restricted to industrywide contingencies and labor and material escalation should be limited to contingencies beyond the normal control of the contractor.

§ 3.404-4 Fixed-price incentive con

tracts.

(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 this 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 will be given to establishing target profits which reflect assumption of such responsibility.

(3) Successive targets. Under this 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 paragraph (b) (3) of this section). 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 subparagraph (2) of this paragraph, 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 above types of contract, 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 different from the target cost.

(b) Application. (1) Fixed-price incentive contracts are appropriate when use of the firm fixed-price contract is inappropriate, and the supplies or services being procured are of such a nature that assumption of a degree of cost responsibility by the contractor is likely to provide him with a positive profit incentive for effective cost control and contract performance. It may also be appropriate to negotiate additional incentive provisions covering performance levels and more timely delivery (see § 3.407-2). Contract performance requirements must be such that there is reasonable opportunity for the incentive provisions to have a meaningful impact on the manner in which the contractor manages the work.

(2) The firm target type of incentive contract, described in paragraph (a) (2) of this section, is appropriate for use whenever a firm target and a formula for establishing final profit and price can be negotiated at the outset which will provide a fair and reasonable incentive.

(3) The successive targets type of incentive contract, described in paragraph (a) (3) of this section, is appropriate for use whenever available cost and pricing information is not sufficient to permit the negotiation of realistic firm targets at the outset. However, enough information should be available to permit negotiation of initial targets, and there should be reasonable assurance that additional reliable information will be available at an early point in the performance of the contract so as to permit negotiation of either a firm fixed price, or firm targets and a formula for establishing final profit and price, which will provide a fair and reasonable incentive. The additional information need not in all cases come from experience under the contract itself, but may be drawn from experience on any other contracts for the same or similar items.

(c) Limitations. Fixed-price incentive contracts shall not be used unless the contractor's accounting system is adequate for price revision purposes and permits satisfactory application of the profit and price adjustment formulas. In no case should such contracts be used

where cost or pricing information adequate for firm targets is not available at the time of initial contract negotiation or at a very early point in performance, or the sole or principal purpose is to shift substantially all cost responsibility to the Government. In no case shall the firm target profit or the formula for final profit and price be established prior to the negotiation of the firm target cost. Neither type of fixed-price incentive contract shall be used unless a determination has been made, in accordance with the requirements of Subpart C of this part, that:

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

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

§ 3.404-5 Prospective price redetermination at a stated time or times during performance.

(a) Description. This type of contract provides for a firm fixed price for an initial period of contract deliveries or performance and for prospective price redetermination either upward or downward at a stated time or times during the performance of the contract. It also may provide for a price ceiling, where appropriate. Once established, ceiling prices are subject to adjustment only by reason of the operation of other contract clauses (see § 3.404-1).

(b) Application. This type of contract is appropriate in procurements calling for quantity production or services where it is possible to negotiate fair and reasonable firm fixed prices for an initial period, but not for subsequent periods of contract performance. This initial period should be the longest period for which it is possible to establish fair and reasonable firm fixed prices at the time of original negotiation. The length of the prospective pricing periods should depend on the circumstances of each case and should generally be at least twelve months each. Ceiling prices,

where appropriate, should be based on an 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 negotiation 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. § 3.404-6 Retroactive and prospective price redetermination at a stated time during performance.

(a) Description. This type of contract provides for a price ceiling and for retroactive and prospective redetermination of prices either (1) upward or downward, or (2) downward only, at a designated time early in the contract performance. The designated time for redetermination may be expressed in terms of delivery, shop completion, percentage of total contract performance on a cost incurred basis or any other reasonable basis. Under a followon contract, it may be timed to coincide with price revision under a preceding contract if both contracts together cover continuing production of similar supplies. In any event, the time designated as the cutoff point for price redetermination should be as early as practicable. The redetermination price may apply to all supplies or services delivered under the contract. Once established, ceiling prices are subject to adjustment only by reason of the operation of other contract clauses (see § 3.404-1).

(b) Application. This type of contract is appropriate in procurements where it is established at the time of negotiation that a fair and reasonable firm fixed price cannot be negotiated, but the contracting parties are reasonably certain that a fair and reasonable firm fixed price can be negotiated prior to the performance of forty percent (40%) of the contract on a cost incurred basis. Based on an evaluation of the uncertainties involved in contract performance, and their possible impact on cost, ceiling prices should be negotiated at a level which represents contractor assumption of a reasonable degree of risk. Additional cost or pricing information neces

sary to redetermination early in contract performance need not in all cases come from experience under the contract itself, and should be drawn from experience under any earlier contracts for the same or similar items.

(c) Limitations. This contract type may be used only until January 1, 1963, and until then, only when:

[Introductory text amended, 28 F.R. 4883, May 16, 1963]

Prior Amendments 1962: 27 F.R. 6123, June 29.

(1) It has been determined through negotiation that use of a fixed-price incentive contract, of either the firm or successive targets type, or a fixed-price contract providing for prospective redetermination only, is impracticable;

(2) The estimated value of the procurement is in excess of $500,000;

(3) The initial negotiated price is a reasonable estimate sufficient to establish a billing price;

(4) There is sufficient time of contract performance to accomplish the price redetermination prior to completion of forty percent (40%) of the contract on a cost incurred basis;

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

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

(7) A ceiling price is established; and (8) Written approval has been received from the Heads of Procuring Activities, for the Army; Office of Naval Material, for the Navy; Headquarters, Air Force Systems Command or Headquarters, Air Force Logistics Command, for the Air Force; and the Executive Director, Procurement and Production, for the Defense Supply Agency.

[Subparagraph (8) amended, 28 F.R. 4883, May 16, 1963]