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Cost-plus contract

Fixed-price contract Fixed price contract Contract

A cost-plus contract, also termed a cost plus contract, is a contract where a contractor is paid for all of its allowed expenses, plus additional payment to allow for a profit.[1] Cost-reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.

History

Frank B. Gilbreth, one of the founders of industrial engineering, used "cost-plus-a-fixed sum" contracts in his building contracting business.[2] He described this method in an article in Industrial Magazine in 1907, comparing it to fixed price and guaranteed maximum price methods.[3]

Cost-plus contracts first came into use by the government in the United States during the World Wars to encourage wartime production by large American companies. According to Martin Kenney, they "allowed what were then small technology firms like Hewlett-Packard and Fairchild Semiconductor to charge the Department of Defense 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".[4]

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.

Contract type U.S. government outlays in FY07[5]
Award-fee contracts $38 billion
Incentive-fee contracts $8 billion
Fixed-fee contracts $32 billion

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 most commonly used when the item purchased cannot be explicitly defined, as in research and development, or in cases where there is not enough data to accurately estimate the final cost.

Pros and cons

Advantages:

Disadvantages:

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 in 2002 award-fee cost plus contracts took over the lead from 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 carried 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 vehicles combined the relative ranking is reversed to the original cost-plus order, meaning that products lead, followed by service and research.

With cost-plus contracting being primarily designed for 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, UGM-133 Trident II, CVN-68, and the CVN-21 deviate from this pattern by continuing to make extensive usage of cost-plus contracting despite programs progressively moving beyond the research and development state.[7]

See also

References

  1. ^ a b Cost-Plus Contracts Center for Strategic and International Studies
  2. ^ Lancaster, Jane (2004). Making Time: Lillian Moller Gilbreth, a Life Beyond "Cheaper by the Dozen". Northeastern University Press. p. 79. ISBN 978-1-55553-612-1.
  3. ^ Gilbreth, Frank B. (1907). "The 'Cost-Plus-a-Fixed-Sum' Contract". Industrial Magazine. 6: 31–37.
  4. ^ Kenney, Martin (2 July 2014). "Silicon Valley's Spy Problem". Project Syndicate.
  5. ^ Defense Industrial Initiative Group – Current Issues: Cost Plus Contracting
  6. ^ a b c d e f g Poole, Walter S. (2013). Adapting to Flexible Response 1960-1968. History of Acquisition in the Department of Defense. Washington, DC: Cambridge University Press. pp. 50–52, 76–85. ISBN 978-0-16-092183-4. OCLC 877851275.
  7. ^ Defense Industrial Initiatives Group – Cost-plus Contracting Narrated Slide Show Archived 2009-04-17 at the Wayback Machine