U.S. Government Contract Types 101

Key Takeaways:

• There are three common U.S. government contract types: Firm Fixed-Price, Cost-Plus, and Time and Materials contracts.
• From a contractor’s perspective:
  • Firm Fixed-Price contracts are high financial risk, low compliance risk, and have a low administrative burden.
  •  Cost-Plus contracts are low financial risk, high compliance risk, and have a high administrative burden.
  • Time and Materials contracts are moderate financial risk, moderate compliance risk, and have a moderate administrative burden.
• Beyond these three contract types, there are multiple other contract structures, all with unique requirements that contractors must take into consideration when bidding.

U.S. government contracts represent a significant opportunity for companies across various industries, offering access to stable revenue streams and the chance to work on impactful projects. However, the world of government contracting is complex, including the various contract types that can be awarded. 

Understanding these differences, and the challenges and the opportunities each type carries, is essential for existing contractors and those seeking to enter this competitive space. Three of the most common contract types are Firm Fixed-Price (FFP), Cost-Plus (or Cost-Reimbursable), and Time and Materials (T&M) contracts. Each type carries distinct implications for risk, compliance, and profitability, and requires a unique approach to bidding and performing the work.

Firm Fixed-Price Contracts

In a Firm Fixed-Price contract, the contractor and government agree to a set price, including profit, regardless of how much the contract costs to perform. This is typically used for contracts whose product or service is at relatively low financial or operational risk. For example, production contracts are often FFP contracts because they have historical costs which can be used to inform an accurate estimated contract value. 

Who bears the financial risk?

The financial risk is almost entirely borne by the contractor, who must manage their expenses closely and is responsible for covering any overruns, even if that means eroding profit margins. 

Advantages:

• Encourages contractors to manage spending efficiently, innovate, and find cost-effective solutions to protect profits, which ultimately reduces the government’s risk of budget overruns.
• Lower administrative burden on the contractor, as these contract types tend to have fewer regulatory requirements and less regulatory oversight, given that the government does not bear substantial risk. 

Disadvantages:

• Contractors bear the complete financial burden of cost overruns.
• Less flexibility to change project scope or requirements while executing on the contract.

Considerations for Contractors:

When deciding whether to take on an FFP contract, federal contractors should carefully assess the accuracy and maturity of their cost estimates to determine whether they can perform within the agreed-upon price. They must also evaluate potential performance risks (such as technical complexity, subcontractor dependencies, and market volatility) since the contractor bears full financial responsibility to complete the scoped work regardless of cost fluctuations over the initially agreed-upon price.

Cost-Plus or Cost-Reimbursable Contracts

Cost-Plus or Cost-Reimbursable contracts are subject to the most regulatory oversight. While contractors may experience extensive scrutiny from the awarding agency, they often benefit from a fixed fee that does not change based on performance. These contracts are common for research and development (R&D) activities, where costs are difficult to determine upfront due to uncertainties. 

Who bears the financial risk?

The government largely bears the financial risk, since all allowable costs are reimbursed (subject to contract funding limitations). Contractors have relatively minimal risk and are usually guaranteed a profit. 

Advantages:

• Can be more cost-effective, as payment is based on actual costs rather than initial estimates.
• Allows contractors to take on projects with uncertain costs and use high-quality labor and materials.
• Gives contractors the right to stop work if the government does not continue funding past the initial estimate. 

Disadvantages:

• Final costs are uncertain, leading to unpredictable budgets and forecasts.
• Since the government bears most of the risk, they significantly increase regulatory requirements and oversight on contractors.

Considerations for Contractors:

When pursuing a Cost-Plus/Cost-Reimbursable type contract, federal contractors must understand the regulatory requirements and internal infrastructure required to maintain compliance. For example, contractors need to have strong accounting systems and controls in place to accurately track allowable, allocable, and reasonable costs. 

Time and Materials Contracts

Time and Materials contracts land somewhere in the middle between FFP and Cost-Type contracts. Contractors are paid for direct labor hours at negotiated fixed rates and for materials at actual cost. Indirect costs like general and administrative expenses (G&A) may be applied to materials if negotiated; otherwise, they may not be recoverable. This contract type still requires federal contractors to have sophisticated timekeeping systems and can present an administrative burden in terms of billing management. T&M type contracts are typically used for shorter term projects or specialized services where most of the work will be labor (IT, repair and maintenance, consulting, etc.). 

Who bears the financial risk?

The financial risk is relatively shared between the government and the contractor. The government bears much of the financial risk because it pays for the actual resources used, regardless of overruns or inefficiencies. The contractor’s risks tend to lean more operational or administrative, as they must track and document all resources used.  

Advantages:

• Can be more cost-effective, as payment is based on negotiated fixed rates for labor and at actual costs for materials.
• Allows contractors to take on projects with uncertain costs and use high-quality labor and materials.
• Gives contractors the right to stop work if the government does not continue funding past the initial estimate. 

Disadvantages:

• Final costs are uncertain, leading to unpredictable budgets and forecasts.
• Since the government bears some risk, there are substantial regulatory requirements and oversight on contractors. However, there are fewer regulations than for Cost-Type contracts, meaning that audit risk from the government is lower and the burden on contractors isn’t as high.

Considerations for Contractors:

When accepting a T&M contract, federal contractors should ensure they have reliable timekeeping, billing, and material-tracking systems to support compliance with this level of government oversight. They should also evaluate how to increase efficiency and control costs, since profitability often depends on the amount of labor in scope. Contractors must also ensure effective utilization within the government’s ceiling price and approved labor categories.