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A cost-plus contract, also termed a cost plus contract, is a contract such that a contractor is paid for all of its allowed expenses, ''plus'' additional
payment A payment is the voluntary tender of money or its equivalent or of things of value by one party (such as a person or company) to another in exchange for goods, or services provided by them, or to fulfill a legal obligation. The party making the ...
to allow for a profit.Cost-Plus Contracts
Center for Strategic and International Studies The Center for Strategic and International Studies (CSIS) is an American think tank based in Washington, D.C. CSIS was founded as the Center for Strategic and International Studies of Georgetown University in 1962. The center conducts polic ...
Cost-reimbursement contracts contrast with
fixed-price contract A fixed-price contract is a type of contract such that the payment amount does not depend on resources used or time expended by the contractor. This is opposed to a cost-plus contract, which is intended to cover the costs incurred by the contractor ...
, in which the contractor is paid a negotiated amount regardless of incurred expenses.


History

Frank B. Gilbreth, one of the early developers of industrial engineering, used "cost-plus-a-fixed sum" contracts for his building contracting business. He described this method in an article in ''Industrial Magazine'' in 1907, comparing it to
fixed price A fixed price is a price set for a good or a service that is not subject to bargaining. The price may be fixed because the seller has set it, or because the price is regulated by the authorities under price controls. Bargaining is very common ...
and
guaranteed maximum price A guaranteed maximum price (also known as GMP, not-to-exceed price, NTE, or NTX) contract is a cost-type contract (also known as an open-book contract) such that the contractor is compensated for actual costs incurred plus a fixed fee, limited to a ...
methods. Cost-plus contracts were first used by the government in the United States during the World Wars to encourage wartime production by American businesses. According to Martin Kenney, they "allowed what were then small technology firms like
Hewlett-Packard The Hewlett-Packard Company, commonly shortened to Hewlett-Packard ( ) or HP, was an American multinational information technology company headquartered in Palo Alto, California. HP developed and provided a wide variety of hardware components ...
and
Fairchild Semiconductor Fairchild Semiconductor International, Inc. was an American semiconductor company based in San Jose, California. Founded in 1957 as a division of Fairchild Camera and Instrument, it became a pioneer in the manufacturing of transistors and of int ...
to charge the
Department of Defense Department of Defence or Department of Defense may refer to: Current departments of defence * Department of Defence (Australia) * Department of National Defence (Canada) * Department of Defence (Ireland) * Department of National Defense (Philippi ...
for the price of research and development that none could pay on its own. This enabled the firms to create technology products that eventually created entire new markets and economic sectors".


Types

There are four general types of cost-reimbursement contracts, all of which pay every allowable, allocatable, and reasonable cost incurred by the contractor, plus a fee or profit which differs by contract type. *Cost plus fixed-fee (CPFF) contracts pay costs plus a pre-determined fee that was agreed upon at the time of contract formation. * Cost-plus-incentive fee (CPIF) contracts have a larger fee awarded for contracts which meet or exceed certain performance goals, for example being on schedule and any cost savings. *Cost-plus-award fee (CPAF) contracts pay a fee based upon the contractor's product. An aircraft development contract, for example, may pay award fees if the contractor's product achieves certain speed, range, or payload capacity goals. For some contracts, the award fee is determined subjectively by an awards fee board whereas for others the fee is based upon objective performance metrics. *Cost plus percentage of cost contracts pay a fee that increases as the contractor's cost increases. Because this contract type provides a disincentive for the contractor to control costs it is rarely used by government, although it is prevalent in private industry. The U.S.
Federal Acquisition Regulations The Federal Acquisition Regulation (FAR) is the principal set of rules regarding Government procurement in the United States,. and is codified at Chapter 1 of Title 48 of the Code of Federal Regulations, . It covers many of the contracts issued by ...
specifically prohibit the use of this type for U.S. Federal Government contracting and in federal sub-contracts except firm fixed price ones (FAR Part 16.102). The US
Comptroller General A comptroller (pronounced either the same as ''controller'' or as ) is a management-level position responsible for supervising the quality of accounting and financial reporting of an organization. A financial comptroller is a senior-level executi ...
has also found that where the additional element is not expressed as a percentage but as an additional amount which rises in bandings in line with the contractor's cost increases may effectively constitute a "cost plus percentage of cost" contract and therefore fall within the prohibition.


Usage

A cost-reimbursement contract is appropriate when it is desirable to shift some risk of successful contract performance from the contractor to the buyer. It is used most commonly when the item purchased cannot be defined explicitly, as for
research and development Research and development (R&D or R+D), known in Europe as research and technological development (RTD), is the set of innovative activities undertaken by corporations or governments in developing new services or products, and improving exist ...
, or for cases where there is not enough data to estimate the final cost accurately.


Pros and cons

Advantages: * A cost-type contract is often used for research and development efforts where technical requirements and specifications are very general, vague, uncertain or unknown, or circumstances do not allow the requiring organization to define its requirements sufficiently to allow for a fixed-price type contract, or uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract. Cost plus contracting was expanded to include services such as engineering, consulting, and a variety of other such efforts. in the 1980's. * A cost-plus contract is often used when performance, quality or delivery time is a much greater concern than cost, such as in the
United States space program The United States has developed many space programs since the beginning of the spaceflight era in the mid-20th century. The United States Government delivers space program solutions from three primary agencies: NASA for civil space; DoD for Mil ...
. * Final cost may be less than for a fixed price contract because contractors do not have to increase the price to cover their risk, especially when the ability to estimate costs is low. However, because of the aspect of the government withholding final payment until closeout of the contract in question, this can increase the ultimate cost of a contract effort because of the ability of a provider to bill for increased overhead and general and administrative costs, increased wages, and many other costs which can be passed on to the government after the contract has been performed. There is also the cost to the government of conducting audits of the providers to ensure that costs being claimed are consistent with the cost accounting rules of doing business with the government. * Final cost may be less than for a fixed price contract when there is little market or price competition. * Allows more oversight and control of the quality of the contractor's work while increasing the cost of oversight by either the government or by outside consultants. * Flexible, allowing for changes of specification within the contractual scope of work. Disadvantages: * There is limited certainty as to what the final cost will be. * Requires additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls. * Providers to the government will, on occasion, attempt to provide lower prices to the government by proposing a Fixed Price contract. This is done to eliminate the withholding of funds which is required under the rules governing cost plus contracting.


Recent trends

Between 1995 and 2001 fixed fee cost-plus contracts constituted the largest subgroup of cost-plus contracting in the U.S. defense sector. Starting during 2002 award-fee cost plus contracts became more numerous than fixed fee cost plus contracts. The distribution of annual contract values by sector category and award types indicates that cost plus contracts in the past had the largest importance in research, followed by services and products. In 2004, however, services replaced research as the dominant sector category for cost-plus contracts. For all other contract types combined the relative ranking is reversed to the original cost-plus order, meaning that products are most numerous, followed by service and research. With cost-plus contracting being designed primarily for research and development, cost plus contracts were used in many different efforts unrelated to research and development. The percentage of cost-plus contracting within a contract is expected to be correlated to the percentage share of research undertaken in any given program. However, several programs, such as the
Lockheed Martin F-35 Lightning II The Lockheed Martin F-35 Lightning II is an American family of single-seat, single-engine, all-weather stealth multirole combat aircraft that is intended to perform both air superiority and strike missions. It is also able to provide ele ...
,
UGM-133 Trident II The UGM-133A Trident II, or Trident D5 is a submarine-launched ballistic missile (SLBM), built by Lockheed Martin Space in Sunnyvale, California, and deployed with the American and British navies. It was first deployed in March 1990, and rema ...
, CVN-68, and the CVN-21 deviate from this pattern by continuing to make extensive usage of cost-plus contracting despite the programs being subsequent to the research and development state.Defense Industrial Initiatives Group – Cost-plus Contracting Narrated Slide Show


See also

*
Cost engineering Cost engineering is "the engineering practice devoted to the management of project cost, involving such activities as estimating, cost control, cost forecasting, investment appraisal and risk analysis". "Cost Engineers budget, plan and monitor inve ...
* Cost-plus pricing


References


External links


The Federal Procurement Data System
The central repository for U.S. Government contract information.

{{Contract types Business terms Contract law Pricing Procurement