Key Takeaways

  • A fixed price incentive fee (FPIF) contract sets a target cost, target profit, and ceiling price, with a formula to adjust profit based on cost performance.
  • The Point of Total Assumption (PTA) marks when the contractor assumes full responsibility for cost overruns.
  • Profit adjustment formulas (share ratios) dictate how cost savings or overruns are shared between the government and contractor.
  • After completion, the final price is determined by actual costs and the agreed formula, with the ceiling price as the maximum payable.
  • These contracts balance risk and incentive, encouraging cost control while protecting the government from excessive overpayment.

A fixed price incentive fee contract provides contractors with an additional financial incentive upon completing a project. However, this incentive fee is fixed and under normal circumstances, it cannot be increased or decreased once the fee has been agreed upon and the contract is signed.

Fixed Price Incentive Firm Target (FPIF) Contract Type

Contracting officers are now being encouraged to consider the increased usage of the fixed price incentive firm target, or FPIF contract This is due to 

  • DFARS 216.403-1, and
  • DFARS PGI 216.403-1.

This type of contract is able to offer contractors significant incentives when they take steps to control the costs of a project. However, this is one of the most complex types of contracts in terms of negotiation and execution.

16.403-1 states that a fixed price incentive firm target contract should specify the following:  

  • Target cost  
  • Target profit  
  • Target price.   

The target price is the sum of the target costs and the profits. A contract of this nature should also specify the maximum price, but no maximum or minimum in terms of profit. This is the maximum amount the contractor will receive upon project completion. It excludes any allowable adjustments that may be outlined in other clauses in the contract.

A fixed price incentive firm target contract also outlines a specific formula for calculating profit adjustments. This formula is also sometimes referred to as:  

  • Share ratio  
  • Sharing arrangement  
  • Share line.  

Profit adjustment formulas are usually represented in terms of ratios with the following splits:  

  • The numerator is called the "government share"  
  • The denominator is called the "contractor share."

Core Elements of an FPIF Contract

Under FAR 16.403-1, an FPIF contract must clearly define its structural components to ensure transparency and enforceability:

  • Target Cost: The anticipated total cost for completing the work.
  • Target Profit: The contractor’s expected profit at target cost.
  • Target Price: The sum of target cost and target profit.
  • Ceiling Price: The maximum the government will pay, regardless of overruns (excluding adjustments allowed under other clauses).
  • Profit Adjustment Formula (Share Ratio): Determines how cost variances are split between government and contractor, expressed as a government share over a contractor share (e.g., 60/40).

This structure creates a measurable framework for performance incentives while capping the government’s financial risk.

The Point of Total Assumption

Fixed price incentive firm target contracts should also include a "Point of Total Assumption," or PTA. This contract element will outline the point at which the contractor is expected to assume complete risk related to cost overrun. 

In this clause, the prices calculated using the price adjustment formula outlined earlier in the contract should be equal to the ceiling price. Moving beyond the Point of Total Assumption, the share line price is greater than the maximum price. For this reason, the maximum price should supersede the share line.

Calculating the Point of Total Assumption (PTA)

The Point of Total Assumption (PTA) is calculated by subtracting the target price from the ceiling price, dividing the result by the government’s share ratio, and then adding the target cost. At the PTA, any additional costs are absorbed entirely by the contractor, reducing profit on a dollar-for-dollar basis. Understanding the PTA before bidding or negotiating helps the contractor know the maximum cost they can incur before their profits begin to decrease.

After the Job Completion

All elements of the contract should be negotiated ahead of time before the contract is actually awarded. Upon completion of the job, both parties should assess the following:  

  • Incurred direct costs  
  • Incurred indirect costs  
  • Negotiate the final cost.  

Once this has been done, both involved parties should:

  • Apply the established profit adjustment formula
  • Agree upon the final price of the job. 

In some situations, the contractor can potentially earn all of the target profit, as well as the "contractor share" when a project is underrun according to the requirements outlined in the price adjustment formula. In situations that run up to the Point of Total Assumption, the contractor may be required to subtract the "contractor share" portion of his or her earnings from the project's total target profit.

Performance-Based Outcomes

Upon project completion, the profit adjustment formula directly rewards cost efficiency:

  • Cost Underrun: If actual costs are below the target, the contractor gains additional profit through their share of the savings.
  • Cost Overrun: If actual costs exceed the target but remain below the PTA, the contractor’s profit decreases according to the share ratio.
  • Beyond PTA: The contractor’s profit reduction accelerates, effectively assuming full overrun costs until the ceiling price is reached.

This structure aligns financial incentives with cost control and efficient performance.

The Established Ceiling Price

Moving beyond the Point of Total Assumption, the share line price will exceed the established maximum price. When this happens, maximum price overrules the PTA. The contractor's total profit is reduced by one dollar for every dollar that the project is overrun. This essentially converts the contract into a firm fixed price contract. 

Unless other terms in the contract specify to the contrary, the government will never pay more than the established ceiling price.

Moving beyond the established ceiling price, the contractor is usually obligated to complete the project to remain in compliance with the contract. FPI(F) are part of the "fixed price" family of contracts. This means it should include what is known as a "default clause," according to FAR 52.249-8 through FAR 52.249-10. Because this clause exists in these contracts, the contractor is subject to certain remedies, including contract termination for default.

Risk Allocation in FPIF Contracts

FPIF contracts shift risk progressively from the government to the contractor. Initially, both parties share in cost variances per the share ratio. However:

  • Once actual costs reach the PTA, the contractor bears all further overruns.
  • The ceiling price provides a hard cap on government expenditure, preventing budget overruns.
  • Contractors are still obligated to complete the work, with failure potentially triggering default clauses under FAR 52.249-8 to 52.249-10.

This allocation promotes fiscal discipline while maintaining contractual accountability.

The Total Estimated Cost

In contrast, a default clause is not typically included in contracts related to cost-reimbursement. Under these contracts, the contractor is only required to give his or her "best effort" to perform within the established Total Estimated Cost, otherwise known as the Limitation of Cost Clause as outlined in FAR 52.216-20. 

In these cases, if the contractor is unable to reach job completion within the established Total Estimated Cost, he or she is usually allowed to revise the Total Estimated Cost to assist with the contractor's efforts to complete the work. In this case, the government then decides whether it is willing to provide more funding for the contractor to complete his or her efforts.

Frequently Asked Questions

  1. What is the main advantage of a fixed price incentive fee contract?
    It motivates contractors to control costs while guaranteeing the government won’t exceed a set ceiling price.
  2. How is the contractor’s final profit determined?
    By applying the agreed share ratio to the difference between actual and target costs, subject to the ceiling price limit.
  3. Can the ceiling price be changed after contract award?
    Generally no, unless specific contract clauses allow for adjustments.
  4. What happens if costs exceed the PTA?
    The contractor absorbs all additional costs beyond the PTA until reaching the ceiling price.
  5. How does an FPIF differ from a firm fixed price contract?
    An FPIF adjusts profit based on cost performance, while a firm fixed price contract pays a set amount regardless of actual costs.

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