Contracts & Legal

Incentive Contract

An Incentive Contract (FAR Subpart 16.4) is appropriate when a Firm-Fixed-Price (FFP) contract is not appropriate and the required supplies or services can be acquired at lower costs and relating the amount of profit or fee payable under the contract to the contractor’s performance.

Purpose of Incentive Contracts

The purpose of an Incentive contract is to motivate the contractor to deliver a better product or service. They are designed to obtain specific acquisition objectives by:

  •  Establishing reasonable and attainable targets that are clearly communicated to the contractor; and
  • Including appropriate incentive arrangements designed to motivate contractor efforts that might not otherwise be emphasized; and
  • Discourage contractor inefficiency and waste.

Types of Incentive Contracts

Application of predetermined, formula-type incentives:

  1. Fixed Price Incentive
  2. Cost Reimbursement Incentive
  3. Performance Incentive
  4. Delivery Incentive
  5. Structuring multiple-incentive contracts

1) Fixed-price Incentive Contracts (FAR 16.403)

A fixed-price incentive contract is a fixed-price contract that provides for adjusting profit and establishing the final contract price by application of a formula based on the relationship of total final negotiated cost to total target cost. The final price is subject to a price ceiling, negotiated at the outset. The two forms of fixed-price incentive contracts, firm target, and successive targets are further described below.

  • Fixed-price incentive (firm target) contracts: A fixed-price incentive (firm target) contract specifies a target cost, a target profit, a price ceiling (but not a profit ceiling or floor), and a profit adjustment formula. These elements are all negotiated at the outset. The price ceiling is the maximum that may be paid to the contractor, except for any adjustment under other contract clauses. When the contractor completes the performance, the parties negotiate the final cost, and the final price is established by applying the formula. When the final cost is less than the target cost, application of the formula results in a final profit greater than the target profit; conversely, when 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. If the final negotiated cost exceeds the price ceiling, the contractor absorbs the difference as a loss. Because the profit varies inversely with the cost, this contract type provides a positive, calculable profit incentive for the contractor to control costs.
  • Fixed-price incentive (successive targets) contracts: A fixed-price incentive (successive targets) contract specifies the following elements, all of which are negotiated at the outset:   Fixed-price contracts with award fees (FPAF) Award-fee provisions may be used in fixed-price contracts when the Government wishes to motivate a contractor and other incentives cannot be used because contractor performance cannot be measured objectively. Such contracts shall establish a fixed price (including normal profit) for the effort. This price will be paid for satisfactory contract performance. Award fee earned (if any) will be paid in addition to that fixed price. See 16.401(e) for the requirements relative to utilizing this contract type.

2a) Cost-plus-incentive-fee Contracts (CPIF) (FAR 16.405)

A Cost-Plus-Incentive-Fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs

2b) Cost-plus-award-fee Contracts (CPAF) (FAR 16.405)

A cost-plus-award-fee contract is a cost-reimbursement contract that provides for a fee consisting of (1) a base amount fixed at the inception of the contract, if applicable and at the discretion of the contracting officer, and (2) an award amount that the contractor may earn in whole or in part during the performance and that is sufficient to provide motivation for excellence in the areas of cost, schedule, and technical performance.

3) Performance Incentive (FAR 16.402-2)

Performance incentives may be considered in connection with specific product characteristics (e.g., a missile range, an aircraft speed, and engine thrust, or vehicle maneuverability) or other specific elements of the contractor’s performance. These incentives should be designed to relate profit or fee to results achieved by the contractor, compared with specified targets

4) Delivery Incentive (FAR 16.402-3)

Delivery incentives should be considered when improvement from a required delivery schedule is a significant Government objective. It is important to determine the Government’s primary objectives in a given contract (e.g., earliest possible delivery or earliest quantity production).

5) Structuring multiple-incentive contracts (FAR 16.402-4)

A properly structured multiple-incentive arrangement should motivate the contractor to strive for outstanding results in all incentive areas.

AcqNotes Tutorials

Other Types of Contracts

– See Firm-Fixed Price Contract
– See Indefinite Delivery Contract
– See Cost-Reimbursement Contract
– See Time and Materials Contract

AcqLinks and References:

Updated: 1/7/2022

Rank: G4.6

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