1. Cost Plus Incentive
2. What Should a Cost Plus Incentive Fee Contract Include?
3. Negotiating the Terms of a Cost Plus Incentive Fee Contract
4. Cost Plus Fixed Fee

A cost plus incentive fee contract is a special type of fixed-price contract that provides contractors and sellers with additional financial incentives for keeping the cost of the project as low as they can. A contract of this nature may also offer incentives when the seller meets other criteria that are laid out in the contract agreement before work begins.

Cost Plus Incentive

Cost plus incentive fees are reimbursement methods that are built into certain fixed-price contracts, specifically the cost plus incentive fee contract. These provide contractors with special incentives to keep the cost of a project under certain thresholds. A cost plus incentive fee contract provides a way to apply any savings, whether financial or by completing work ahead of schedule, that the contractor is able to secure to the pay that he or she will receive for the contracted work.

What Should a Cost Plus Incentive Fee Contract Include?

Contracts of this nature include incentives that are negotiated and agreed upon ahead of time. The incentive fee comes into play when the actual cost of the project comes in below the originally agreed upon cost in the contract. A cost plus incentive fee contract should include the following components:  

Additional items that should be covered in the contract include:  

  • Target fees  
  • Minimum fees  
  • Maximum fees  
  • A method to calculate fee adjustments.

Once a project has been completed, the fee the contractor is entitled to receive should be calculated using the methods built into the contract. Cost plus incentive fee contracts are used in an attempt to share the financial risk of a project between the project's owner and the contractor.

Contracts of this nature can be considered a hybrid between the firm fixed price and cost plus contract types. These contracts utilize special theories to lay out how the project owner and the contractor will determine the best way to divide this risk. This is based on each party's respective point of view.

Negotiating the Terms of a Cost Plus Incentive Fee Contract

During the negotiation phase of the contract, both parties will have the opportunity to discuss their point of view and reach an agreement that is optimal for everybody involved. This formula allows for fee increases that can potentially exceed the target fee within reason. However, this should only be allowed when actual costs are below the target costs. 

Additionally, the contract should allow for decreases in the target fee if actual costs rise above the target cost laid out in the contract. These potential fluctuations are built into the contract as a method for providing the contractor with additional incentives to manage the project as efficiently as possible.

When the total actual cost is higher or lower than the total target cost laid out in the contract, the contractor will be paid the total allowable cost with one of two possible adjustments, based on the specific situation:  

  • Minimum incentive fee is applied if total actual costs are higher than the total target cost.  
  • Maximum incentive fee is applied if total actual costs are lower than the total target cost.

Cost Plus Fixed Fee

In a cost plus fixed fee contract, the fee that was agreed upon during contract negotiations remains the same. This is regardless of the actual total cost of the project upon completion. However, if the project's scope changes, this contract does allow for adjustments to be made to the fee. The contractor must submit a separate set of invoices to be reimbursed for the cost of things, such as labor and materials.

A cost plus fixed fee contract is typically used when the costs of a project are hard to estimate. This could possibly create a potential financial risk for contractors vying for a winning bid on the project. Contracts of this nature are primarily awarded based on the contractor's proposed fees. It is important to note that cost plus fixed fee contracts don't provide any form of incentives for contractors to manage the costs associated with the project effectively.

A cost plus incentive fee contract should never be awarded to a contractor unless all the limitations outlined in 16.301-3 are fully and completely complied with.

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