Procurement 101: More on Cost-Reimbursable Contracts

 

Last time I looked at the three general types of contract that you often find on projects: fixed price, cost-reimbursable and time and materials. That’s the overview, but as you’d expect with all things budget related, there’s a lot more to it when you start to dig into the detail.

Let’s look in a bit more detail at cost-reimbursable contracts. Personally, this is the type that I find the most confusing. Fixed price (you pay what both parties agree) and time and materials (you pay for the work done at the vendor’s agreed rates) are pretty straightforward, but cost-reimbursable contracts are harder to get your head around in my opinion.

There are four types. You’ll find the most common three in A Guide To The Project Management Body of Knowledge (PMBOK Guide) – Fifth Edition, each with a snazzy acronym:

Cost Plus Fixed Fee (CPFF)

All allowable costs (that’s whatever you’ve defined in the contract) get reimbursed. Then on top of that the vendor gets a fixed fee extra payment. This is determined at the beginning of the project, normally calculated as a percentage of the project cost. Note that this means it will be based on the estimated overall project cost, so if your costs go up significantly they won’t get any more (although they will probably ask for this to be renegotiated).

Cost Plus Incentive Fee (CPIF)

All allowable costs get reimbursed. Then there’s an incentive paid based on whether the vendor has hit certain performance targets. The theory behind this is that the vendor will try extra hard to meet your needs to earn that performance bonus. The risk is that you set the performance targets against things that are too easy to achieve or too difficult to measure and you end up paying the maximum when you don’t feel as if they have really earned it.

The other twist with this type of contract is that if the project goes over the original agreed budget then you will split the extra charges with the vendor. You’ll agree the amount of the split in the contract (it’s unlikely to be 50/50). This works both ways, so if the project is under budget, you’ll give some extra back to the vendor as you’ll split the saving with them as well. It’s another incentive to do well and to keep costs within budget.

Cost Plus Award Fee (CPAF)

Again, all allowable costs get reimbursed. Then there’s an extra payment, but it isn’t as clearly worked out as in the other two cases. There are performance criteria for the vendor to achieve, and these are documented in the contract, but they are more subjective. The total fee available as an award is negotiated and documented in the contract so the vendor knows the maximum that can be achieved. Then the project team determines how good a job the vendor has done against set criteria and then determines how much of that available fee the vendor will actually get. They can’t dispute the award, so if it is lower than they would have hoped, that’s tough, and they may actually get nothing if the project team consider that their work has not been satisfactory.

These types of contract are used extensively by NASA. As they say in their contracting guidelines, you can’t standardise the performance factors. What’s important on one project is not important on another: early delivery of a weather satellite might be good to help monitor natural disasters more quickly, but early delivery of a planetary probe means nothing because the window to launch it only occurs every couple of years. Therefore in that case early delivery may actually cost money as the probe would have to be stored somewhere. Performance measures should be tailored to the contract and project and, as the NASA guidelines recommend, based on outcomes not outputs.

The final cost-reimbursable contract doesn’t get used much according to Wikipedia. It’s:

Cost Plus Percentage of Cost

In this contract, the allowable costs are covered as you would expect, and the vendor also gets a payment based on those costs. This is calculated as a percentage of their overall cost. So, as they spend more, their fee goes up. See the problem? There’s no incentive to keep costs low. It’s also not that attractive to project teams who have to pay the increasing costs, plus the increasing contractor fee. It’s not surprising that this type of contract is specifically prohibited for U.S. government procurements (its banned in 16.102, the section on Policies if you want to confirm this for yourself, on page 403 of a 1889-page Federal Acquisition Regulation document, or you could just trust me!).

So those are the 4 types of cost-reimbursable contracts. You probably won’t come across all of them, but it’s good to know that they are out there in case you ever do need to use them or a supplier tries to get you to go for one and you aren’t convinced it is the right thing for your project. As with all procurement matters, get specialist help if you are dealing with contracts and legalities: it is very easy to tie yourself and your company into a contract that isn’t clear and that doesn’t serve your best interests so if in doubt, get your in-house counsel to look it over.