Overview
Fixed-price incentive contracts provide a mechanism to adjust contractor profit and establish a final price based on a formula comparing final negotiated costs to initial target costs. All such contracts must include a negotiated price ceiling that represents the maximum liability of the government.
Key Rules
- Mandatory Elements: At the outset, the parties must negotiate a target cost, a target profit, and a price ceiling.
- Price Ceiling: The contractor is responsible for all costs incurred above the established price ceiling; the government will not pay more than this amount regardless of the contractor's actual costs.
- Profit Adjustment Formula: Profit varies inversely with cost; if the final cost is below the target, the contractor earns more profit, whereas if the cost exceeds the target, profit is reduced.
- Two Primary Forms:
- Firm Target (FPIF): All incentive elements are fixed at the time of contract award.
- Successive Targets (FPIS): Initial targets are set at award, with a specific production point identified to negotiate firm targets once more cost data becomes available.
- Statutory Limitations: These contracts may only be used if the contractor’s accounting system is adequate for providing data to support cost negotiations and if sufficient cost/pricing information is available to establish reasonable targets.
- Billing Prices: Payments are made based on interim billing prices, which can be adjusted during performance if it becomes clear that the final negotiated cost will differ substantially from the target cost.
Practical Implications
- Risk Sharing: These contracts serve as a middle ground between Firm-Fixed-Price and Cost-Reimbursement contracts, allowing the government to cap its total obligation while incentivizing the contractor to control costs through a profit-sharing arrangement.
- Administrative Burden: FPI contracts require significant administrative oversight, as the government must audit and negotiate final costs after performance is complete to determine the final price.