Overview
FAR Subpart 16.4 outlines the policies and procedures for incentive contracts, which are designed to motivate contractor performance by linking profit or fees to specific acquisition objectives. These contracts are utilized when a firm-fixed-price contract is inappropriate, allowing the government to drive improvements in cost control, technical performance, and delivery schedules.
Key Rules
- Mandatory Cost Incentives: No incentive contract may provide for performance or delivery incentives without also including a cost incentive or a cost constraint to prevent lopsided focus at the expense of budget.
- Determination and Findings (D&F): A D&F signed by the Head of the Contracting Activity (HCA) is mandatory for all incentive and award-fee contracts to justify that the contract type is in the government's best interest.
- Price Ceilings: Fixed-price incentive contracts must include a negotiated price ceiling, which is the maximum amount the government will pay; the contractor absorbs all costs exceeding this ceiling.
- Award-Fee Limitations:
- No Rollover: The practice of "rolling over" unearned award fees from one evaluation period to another is strictly prohibited.
- Performance Floor: No award fee can be earned if the contractor’s aggregate performance is below "Satisfactory."
- Subjectivity: Award-fee determinations are unilateral decisions made solely at the discretion of the government.
- Formula-Type Incentives: These must apply to performance targets (surpassing requirements) rather than minimum performance requirements. Profit/fee increases for exceeding targets and decreases for failing to meet them.
- Accounting System Adequacy: Incentive contracts (specifically fixed-price incentive types) can only be used if the contractor’s accounting system is adequate to provide the necessary data for negotiating final costs.
Responsibilities
- Head of the Contracting Activity (HCA): Responsible for signing the D&F justifying the use of incentive or award-fee contract types.
- Contracting Officer (CO):
- Negotiates target costs, profits/fees, and adjustment formulas.
- Coordinates with engineering and pricing specialists to develop complex performance criteria.
- Ensures the contract file contains documentation of award-fee determinations and methodology.
- Specifies target costs and prices in the contract schedule.
- Fee Determining Official (FDO): Approves the award-fee plan (unless agency procedures dictate otherwise).
- Award-Fee Board: Responsible for conducting evaluations of contractor performance based on the criteria in the award-fee plan.
- Government Agencies: Required to collect and analyze data on the effectiveness of incentive fees and share best practices for different types of acquisitions.
Practical Implications
- Risk Allocation: Fixed-price incentive (FPI) contracts are a "middle ground" that shifts significant cost risk to the contractor via the price ceiling while providing an opportunity for higher profit through efficiency. This is ideal for production where costs are somewhat predictable.
- Administrative Heavy-Lift: Award-fee contracts (CPAF/FPAF) require substantial government resources to manage. Agencies must balance the benefit of subjective motivation against the administrative cost of running Award-Fee Boards and documenting periodic evaluations.
- Trade-off Management: Multiple-incentive contracts force contractors to make strategic trade-offs. For example, a contractor might have to decide whether to spend more (reducing their cost incentive) to achieve a technical breakthrough (increasing their performance incentive).
- Contractor Motivation: Unlike firm-fixed-price contracts where the contractor keeps every dollar saved, incentive formulas share those savings between the government and the contractor, aligning their interests toward cost-effective delivery.