Federal Contracting: Benefits and Drawbacks of Cost

Federal Contracting: Benefits and Drawbacks of Cost Reimbursement Contracts The objective of this study is to examine the pros and cons of cost-reimbursement contracts from the view of the federal contractor and to discuss which elements of cost-reimbursement contracts tend to produce the biggest troubles for contractors and explain why.

Cost-Reimbursement Compared to Fixed-Price Contract Cost-reimbursement or cost-plus is reported as a contract "where a contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit." (GovWin, 2010, p.1) Cost-reimbursement contracts can be contrasted with fixed-price contracts, which are reported to be such that the contractors "are paid a negotiated amount regardless of incurred expenses." (GovWin, 2010, p.1) Fixed-price contracts make provision of payment of the allowable costs that are incurred in performance of a contract "to the extent prescribed in the contract." (GovWin, 2010, p.1) In the fixed-price contracts, "an estimate of the total cost is established so that the government can obligate funds." (GovWin, 2010, p.1) This estimate is used as well in establishment of a ceiling or limit on the amount of costs that may be incurred by the contractor "without the contracting officer approval and that the contractor exceeds (at his own risk)." (GovWin, 2010, p.1) Cost-reimbursement contracts are such that may only be used when "uncertainties involved in contract performance do not permit costs to be estimate with sufficient accuracy to use any type of fixed-price contract." (GovWin, 2010, p.1) The cost-reimbursement contract involves the contractor agreeing to make provision of its "best effort to complete the required contract effort." (GovWin, 2010, p.1) The cost-reimbursement contract makes provision for a payment of "allowable incurred costs to the extent prescribed in the contract." (GovWin, 2010, p.1) Included in the cost-reimbursement contract is an "estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractor cannot exceed (except at its own risk) without the approval of the contracting officer." (GovWin, 2010, p.1) According to the publication 'Federal Computer Week' there is about $135 billion spent each year in cost-reimbursement contracts.

(GovWin, 2010, p.1) The cost-reimbursement contract represented the "largest subgroup of cost-plus contracting in the U.S. defense sector" between the years 1995 and 2001. II. Agencies that Use Cost-Reimbursement Contracts Agencies that use cost-reimbursement contracts are reported to include those stated as follows: (1) Federal Transit Administration; (2) National Weather Service (NWS); (3) U.S. Department of Defense (DOD); and (4) Other federal agencies. (GovWin, 2010, p.1) III. Advantages of Cost-Reimbursement Contracts There are certain advantages to the use of cost-reimbursement contracts.

For example, when compared to fixed-price contracts a cost-plus contract "has little incentives to cut corners." (GovWin, 2010, p.1) As well, a cost-plus contract is used many times when "long-term quality is a much higher concern than cost, such as in the United States space program." (GovWin, 2010, p.1) Stated third as an advantage to the use of cost-reimbursement contracts is that the "final cost may be less than a fixed price contract because contractors do not have to inflate the price to cover their risk." (GovWin, 2010, p.1) IV.

Disadvantages to the Use of Cost-Reimbursement Contracts There are certain disadvantages to the use of cost-reimbursement contracts and specifically stated is that there is a "…limited certainty as to what the final cost will be." (GovWin, 2010, p.1) As well, cost-reimbursement contracts make a requirement of "…additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls." (GovWin, 2010, p.1) Cost-reimbursement contracts when properly designed in terms of award or incentive fees make a requirement of "additional oversight and administration and there is less incentive for efficiency as compared to fixed-price contracts.

(GovWin, 2010, paraphrased) V. Types of Cost-Reimbursement Contracts There are several types of cost-reimbursement contracts including: (1) Cost-Contracts: These are cost-reimbursement contracts "under which the contractor receives no fee. Only costs incurred in the performance of the contract are paid. This contract type is often used in research and development, particularly with nonprofit organizations, or in facilities contracts." (GovWin, 2010, p.1) (2) Cost-Plus-Fixed-Fee (CPFF) Contracts: These are cost-reimbursement contracts that make provision for a "payment of allowable costs plus a fixed fee.

A CPFF may take one of two basic forms: completion or term." (GovWin, 2010, p.1) (3) CPFF Completion Contracts: This type of cost-reimbursement contract "…describes the scope of work by stating a definite goal or target and specifying an end product. This form of contract normally requires the contractor to complete and deliver the specified end product (e.g., a final report of research accomplishing the goal or target) within the estimated cost, if possible, as a condition for payment of the entire fixed.