CONTRACT TYPE AND POTENTIAL FINANCIAL REWARD

The fixed-price contract offers the greatest opportunity for profit or loss and the cost-plus-fixed-fee contract offers the least potential variability in profit. The term “profit” is used here in terms of the difference between the contract price and allowable costs. Potential profit must be further reduced by any unallowable costs, including federal income taxes.

Figure 18 displays the relative profit at various levels of cost incurrence for: (1) firm-fixed-price contracts; (2) fixed-price-incentive contracts; (3) cost-plus-incentive-fee contracts; and (4) cost-plus-fixed-fee contracts. The vertical scale is profit or loss, with the breakeven point noted. The horizontal scale is the allowable cost. As allowable costs increase, the profit decreases in all instances. However, the pattern is different for each contract type. The figure incorporates the differences in profit levels associated with the various contract types as well as the relationship to allowable cost.

The firm-fixed-price contract profit has a constant relationship to allowable costs, i.e., a dollar for dollar correlation. The fixed-price-incentive contract involves a 30 percent sharing of any allowable cost variance from the estimate up to a maximum price. The cost-plus-incentive-fee contract provides for a similar sharing; however, both a minimum and maximum profit are established. The cost-plus-fixed-fee contract maintains a constant profit regardless of allowable costs.

Figure 18 COMPARISON OF ALLOWABLE COST TO PROFIT ON VARIOUS CONTRACT TYPES