Why Contract Types Matter
The contract type determines how you get paid, how risk is distributed, and what financial reporting is required. A firm-fixed-price contract means you bear all cost risk but keep any savings. A cost-reimbursement contract means the government bears cost risk but scrutinizes your expenses. Choosing or competing for the wrong contract type can mean the difference between profit and loss.
The Federal Acquisition Regulation (FAR) Part 16 defines the spectrum of contract types, from the highest contractor risk (firm-fixed-price) to the highest government risk (cost-plus-fixed-fee). Most federal contracts fall somewhere on this spectrum, and the selection depends on the nature of the work, the degree of cost uncertainty, and the level of performance risk.
Firm-Fixed-Price (FFP) Contracts
FFP contracts establish a fixed total price for the work, regardless of your actual costs. If you complete the work for less than the contract price, you keep the difference as additional profit. If costs exceed the price, you absorb the loss. This makes FFP the highest-risk but potentially highest-reward contract type for contractors.
FFP is the government’s preferred contract type and is used whenever the requirement is well-defined and costs are reasonably predictable. Simple services, commercial products, and repeat procurements are almost always FFP. When pricing an FFP bid, you must accurately estimate all costs and build in enough margin to cover contingencies.
Variants include Fixed-Price Incentive (FPI) contracts, which share savings or overruns between you and the government above or below a target cost, and Fixed-Price with Economic Price Adjustment (FPEPA), which adjusts for inflation on long-term contracts.
Time-and-Materials (T&M) and Labor Hour Contracts
T&M contracts pay you based on hourly rates for labor plus the actual cost of materials used. Labor Hour contracts are similar but exclude materials. You’re paid for hours worked at pre-negotiated rates, so your profit is built into each hourly rate rather than the total contract price.
T&M is used when the scope of work can’t be precisely defined upfront — common in IT services, consulting, and professional services. The government usually sets a ceiling (not-to-exceed) amount to limit spending. You’re not guaranteed the ceiling; you’re only paid for hours actually worked.
The key risk for contractors is underutilization. If you staff a T&M contract with personnel who aren’t fully utilized, you still bear the cost of their unproductive time. Conversely, if your labor rates include adequate overhead and profit, T&M contracts provide predictable per-hour profitability.
Cost-Reimbursement Contracts
Cost-reimbursement contracts pay you for all allowable costs incurred in performing the work, plus a negotiated fee. The government bears most of the cost risk, but in exchange, your fee (profit) is typically lower than on an FFP contract, and your accounting system must meet rigorous government standards.
The most common variant is Cost-Plus-Fixed-Fee (CPFF), where you receive a fixed dollar fee regardless of actual costs. Cost-Plus-Incentive-Fee (CPIF) adjusts the fee based on how well you control costs. Cost-Plus-Award-Fee (CPAF) links a portion of your fee to performance evaluations conducted by the government.
To perform cost-reimbursement contracts, your accounting system must be approved by the Defense Contract Audit Agency (DCAA) or meet equivalent standards. This requires separating direct and indirect costs, maintaining adequate timekeeping, and complying with Cost Accounting Standards (CAS). For smaller businesses, the overhead of maintaining a compliant system can be significant.
Indefinite-Delivery Contracts (IDIQ, BPA, BOA)
Indefinite-Delivery/Indefinite-Quantity (IDIQ) contracts establish the terms and pricing for work, but the specific quantity and timing of orders is determined later through individual task orders or delivery orders. IDIQs have a minimum guaranteed amount (often small) and a maximum ceiling.
IDIQ contracts can be single-award (one contractor) or multiple-award (several contractors compete for individual task orders). Major government-wide IDIQs like OASIS, Alliant, and SEWP generate billions in annual task order spending. Winning a position on a major IDIQ vehicle is a significant business development milestone.
Blanket Purchase Agreements (BPAs) and Basic Ordering Agreements (BOAs) serve similar purposes for simpler or more routine procurement needs. BPAs are especially common for recurring services and supply purchases.
Choosing the Right Contract Type
You don’t always get to choose the contract type — the government determines it based on the nature of the requirement. But understanding contract types helps you price accurately, manage risk, and decide which opportunities are a good fit for your business.
FFP contracts reward efficient performers and are ideal when the scope is clear. T&M contracts work well for professional services with variable demand. Cost-reimbursement contracts are appropriate for R&D and complex projects where costs are uncertain. Build your pricing strategy around the contract type, not the other way around.