Incentive Contracts

Subpart 16.4—Incentive Contracts

16.401 General.

(a) Incentive contracts as described in this subpart are appropriate when a firm-fixed-price contract is not

appropriate and the required supplies or services can be acquired at lower costs and, in certain instances,

with improved delivery or technical performance, by relating the amount of profit or fee payable under the

contract to the contractor's performance. Incentive contracts are designed to obtain specific acquisition

objectives by—

(1) Establishing reasonable and attainable targets that are clearly communicated to the contractor; and

(2) Including appropriate incentive arrangements designed to (i) motivate contractor efforts that might not

otherwise be emphasized and (ii) discourage contractor inefficiency and waste.

(b) When predetermined, formula-type incentives on technical performance or delivery are included, increases in

profit or fee are provided only for achievement that surpasses the targets, and decreases are provided for to

the extent that such targets are not met. The incentive increases or decreases are applied to performance

targets rather than minimum performance requirements.

cost-reimbursement incentive contracts (see 16.405). Since it is usually to the Government's advantage for the

contractor to assume substantial cost responsibility and an appropriate share of the cost risk, fixed-price

incentive contracts are preferred when contract costs and performance requirements are reasonably certain.

Cost-reimbursement incentive contracts are subject to the overall limitations in 16.301 that apply to all cost-

reimbursement contracts.

(d) A determination and finding, signed by the head of the contracting activity, shall be completed for all

incentive- and award-fee contracts justifying that the use of this type of contract is in the best interest of the

Government. This determination shall be documented in the contract file and, for award-fee contracts, shall

address all of the suitability items in 16.401(e)(1).

(e) Award-fee contracts are a type of incentive contract.

(1) Application. An award-fee contract is suitable for use when—

(i) The work to be performed is such that it is neither feasible nor effective to devise predetermined

objective incentive targets applicable to cost, schedule, and technical performance;

(ii) The likelihood of meeting acquisition objectives will be enhanced by using a contract that

effectively motivates the contractor toward exceptional performance and provides the Government

with the flexibility to evaluate both actual performance and the conditions under which it was

achieved; and

(iii) Any additional administrative effort and cost required to monitor and evaluate performance are

justified by the expected benefits as documented by a risk and cost benefit analysis to be included

in the Determination and Findings referenced in 16.401(e)(5)(iii).

(2) Award-fee amount. The amount of award fee earned shall be commensurate with the contractor's

overall cost, schedule, and technical performance as measured against contract requirements in

accordance with the criteria stated in the award-fee plan. Award fee shall not be earned if the

contractor's overall cost, schedule, and technical performance in the aggregate is below

satisfactory. The basis for all award-fee determinations shall be documented in the contract file to

include, at a minimum, a determination that overall cost, schedule and technical performance in the

aggregate is or is not at a satisfactory level. This determination and the methodology for determining

the award Fee are unilateraldecisions made solely at the discretion of the Government.

(3)Award-fee plan. All contracts providing for award fees shall be supported by an award-fee plan that

establishes the procedures for evaluating award fee and an Award-Fee Board for conducting the

award-fee evaluation. Award-fee plans shall—

(i) Be approved by the FDO unless otherwise authorized by agency procedures;

(ii) Identify the award-fee evaluation criteria and how they are linked to acquisition objectives which

shall be defined in terms of contract cost, schedule, and technical performance. Criteria should

motivate the contractor to enhance performance in the areas rated, but not at the expense of at

least minimum acceptable performance in all other areas;

(iii) Describe how the contractor's performance will be measured against the award-fee evaluation

criteria;

(iv) Utilize the adjectival rating and associated description as well as the award-fee pool earned

percentages shown below in Table 16-1. Contracting officers may supplement the adjectival rating

description. The method used to determine the adjectival rating must be documented in the award-

fee plan;

(v)Prohibit earning any award fee when a contractor's overall cost, schedule, and technical

performance in the aggregate is below satisfactory;

(vi) Provide for evaluation period(s) to be conducted at stated intervals during the contract period of

performance so that the contractor will periodically be informed of the quality of its performance

and the areas in which improvement is expected (e.g. six months, nine months, twelve months, or at

specific milestones); and

(vii) Define the total award-fee pool amount and how this amount is allocated across each evaluation

period.

(4) Rollover of unearned award fee. The use of rollover of unearned award fee is prohibited.

(5) Limitations. No award-fee contract shall be awarded unless—

(i) All of the limitations in 16.301-3, that are applicable to cost-reimbursement contracts only, are

complied with;

(ii) An award-fee plan is completed in accordance with the requirements in 16.401(e)(3); and

(iii) A determination and finding is completed in accordance with 16.401(d) addressing all of the

suitability items in 16.401(e)(1).

(f) Incentive- and Award-Fee Data Collection and Analysis. Each agency shall collect relevant data on award fee

and incentive fees paid to contractors and include performance measures to evaluate such data on a regular

basis to determine effectiveness of award and incentive fees as a tool for improving contractor performance

and achieving desired program outcomes. This information should be considered as part of the acquisition

planning process (see 7.105) in determining the appropriate type of contract to be utilized for future

acquisitions.

(g) Incentive- and Award-Fee Best Practices. Each agency head shall provide mechanisms for sharing proven

incentive strategies for the acquisition of different types of products and services among contracting and

program management officials.[48 FR 42219, Sept. 19, 1983, as amended at 62 FR 12695, Mar. 17, 1997; 74

FR 52858, Oct. 14, 2009; 75 FR 60263, Sept. 29, 2010]

16.402 Application of predetermined, formula-type incentives.

16.402-1 Cost incentives.

(a) Most incentive contracts include only cost incentives, which take the form of a profit or fee adjustment formula

and are intended to motivate the contractor to effectively manage costs. No incentive contract may provide for

other incentives without also providing a cost incentive (or constraint).

(b) Except for award-fee contracts (see 16.404 and 16.401(e)), incentive contracts include a target cost, a target

profit or fee, and a profit or fee adjustment formula that (within the constraints of a price ceiling or minimum

and maximum fee) provides that—

(1) Actual cost that meets the target will result in the target profit or fee;

(2) Actual cost that exceeds the target will result in downward adjustment of target profit or fee; and

(3) Actual cost that is below the target will result in upward adjustment of target profit or fee.

16.402-2 Performance incentives.

(a) Performance incentives may be considered in connection with specific product characteristics (e.g., a missile

range, an aircraft speed, an engine thrust, or a vehicle maneuverability) or other specific elements of the

contractor’s performance. These incentives should be designed to relate profit or fee to results achieved by the

contractor, compared with specified targets.

(b) To the maximum extent practicable, positive and negative performance incentives shall be considered in

connection with service contracts for performance of objectively measurable tasks when quality of

performance is critical and incentives are likely to motivate the contractor.

development (when performance objectives are known and the fabrication of prototypes for test and

evaluation is required) and in production (if improved performance is attainable and highly desirable to the

Government).

(d) Technical performance incentives may involve a variety of specific characteristics that contribute to the overall

performance of the end item. Accordingly, the incentives on individual technical characteristics must be

balanced so that no one of them is exaggerated to the detriment of the overall performance of the end item.

(e) Performance tests and/or assessments of work performance are generally essential in order to determine the

degree of attainment of performance targets. Therefore, the contract must be as specific as possible in

establishing test criteria (such as testing conditions, instrumentation precision, and data interpretation) and

performance standards (such as the quality levels of services to be provided).

(f) Because performance incentives present complex problems in contract administration, the contracting officer

should negotiate them in full coordination with Government engineering and pricing specialists.

(g) It is essential that the Government and contractor agree explicitly on the effect that contract changes

(e.g., pursuant to the Changes clause) will have on performance incentives.

(h) The contracting officer must exercise care, in establishing performance criteria, to recognize that the

contractor should not be rewarded or penalized for attainments of Government-furnished components.

16.402-3 Delivery Incentives.

(a) Delivery incentives should be considered when improvement from a required delivery schedule is a significant

Government objective. It is important to determine the Government’s primary objectives in a given contract

(e.g., earliest possible delivery or earliest quantity production).

(b) Incentive arrangements on delivery should specify the application of the reward-penalty structure in the event

of Government-caused delays or other delays beyond the control, and without the fault or negligence, of the

contractor or subcontractor.

16.402-4 Structuring multiple-incentive contracts.

A properly structured multiple-incentive arrangement should—

(a) Motivate the contractor to strive for outstanding results in all incentive areas; and

(b) Compel trade-off decisions among the incentive areas, consistent with the Government’s overall objectives for

the acquisition. Because of the interdependency of the Government’s cost, the technical performance, and the

delivery goals, a contract that emphasizes only one of the goals may jeopardize control over the others.

Because outstanding results may not be attainable for each of the incentive areas, all multiple-incentive

contracts must include a cost incentive (or constraint) that operates to preclude rewarding a contractor for

superior technical performance or delivery results when the cost of those results outweighs their value to the

Government.

16.403 Fixed-price incentive contracts.

(a) Description. A fixed-price incentive contract is a fixed-price contract that provides for adjusting profit and

establishing the final contract price by application of a formula based on the relationship of total final

negotiated cost to total target cost. The final price is subject to a price ceiling, negotiated at the outset. The

two forms of fixed-price incentive contracts, firm target and successive targets, are further described in

16.403-1 and 16.403-2 below.

(b) Application. A fixed-price incentive contract is appropriate when—

(1) A firm-fixed-price contract is not suitable;

(2) The nature of the supplies or services being acquired and other circumstances of the acquisition are such

that the contractor’s assumption of a degree of cost responsibility will provide a positive profit incentive

for effective cost control and performance; and

(3) If the contract also includes incentives on technical performance and/or delivery, the performance

requirements provide a reasonable opportunity for the incentives to have a meaningful impact on the

contractor’s management of the work.

payment. These billing prices may be adjusted, within the ceiling limits, upon request of either party to the

contract, when it becomes apparent that final negotiated cost will be substantially different from the target

cost.

16.403-1 Fixed-price incentive (firm target) contracts.

(a) Description. A fixed-price incentive (firm target) contract specifies a target cost, a target profit, a price ceiling

(but not a profit ceiling or floor), and a profit adjustment formula. These elements are all negotiated at the

outset. The price ceiling is the maximum that may be paid to the contractor, except for any adjustment under

other contract clauses. When the contractor completes performance, the parties negotiate the final cost, and

the final price is established by applying the formula. When the final cost is less than the target cost,

application of the formula results in a final profit greater than the target profit; conversely, when final cost is

more than target cost, application of the formula results in a final profit less than the target profit, or even a

net loss. If the final negotiated cost exceeds the price ceiling, the contractor absorbs the difference as a loss.

Because the profit varies inversely with the cost, this contract type provides a positive, calculable profit

incentive for the contractor to control costs.

(b) Application. A fixed-price incentive (firm target) contract is appropriate when the parties can negotiate at the

outset a firm target cost, target profit, and profit adjustment formula that will provide a fair and reasonable

incentive and a ceiling that provides for the contractor to assume an appropriate share of the risk. When the

contractor assumes a considerable or major share of the cost responsibility under the adjustment formula, the

target profit should reflect this responsibility.

(1) The contractor’s accounting system is adequate for providing data to support negotiation of final cost and

incentive price revision; and

(2) Adequate cost or pricing information for establishing reasonable firm targets is available at the time of

initial contract negotiation.

(d) Contract schedule. The contracting officer shall specify in the contract schedule the target cost, target profit,

and target price for each item subject to incentive price revision.

16.403-2 Fixed-price incentive (successive targets) contracts.

a) Description.

(1) A fixed-price incentive (successive targets) contract specifies the following elements, all of which are

negotiated at the outset:

(i) An initial target cost.

(ii) An initial target profit.

(iii) An initial profit adjustment formula to be used for establishing the firm target profit, including a ceiling

and floor for the firm target profit. (This formula normally provides for a lesser degree of contractor cost

responsibility than would a formula for establishing final profit and price.)

(iv) The production point at which the firm target cost and firm target profit will be negotiated (usually before

delivery or shop completion of the first item).

(v) A ceiling price that is the maximum that may be paid to the contractor, except for any adjustment under

other contract clauses providing for equitable adjustment or other revision of the contract price under

stated circumstances.

(2) When the production point specified in the contract is reached, the parties negotiate the firm target cost,

giving consideration to cost experience under the contract and other pertinent factors. The firm target profit

is established by the formula. At this point, the parties have two alternatives, as follows:

(i) They may negotiate a firm fixed price, using the firm target cost plus the firm target profit as a guide.

(ii) If negotiation of a firm fixed price is inappropriate, they may negotiate a formula for establishing the final

price using the firm target cost and firm target profit. The final cost is then negotiated at completion, and

the final profit is established by formula, as under the fixed-price incentive (firm target) contract (see

16.403-1 above).

(b) Application. A fixed-price incentive (successive targets) contract is appropriate when—

(1) Available cost or pricing information is not sufficient to permit the negotiation of a realistic firm target cost

and profit before award;

(2) Sufficient information is available to permit negotiation of initial targets; and

(3) There is reasonable assurance that additional reliable information will be available at an early point in the

contract performance so as to permit negotiation of either (i) a firm fixed price or (ii) firm targets and a

formula for establishing final profit and price that will provide a fair and reasonable incentive. This

additional information is not limited to experience under the contract, itself, but may be drawn from other

contracts for the same or similar items.

(1) The contractor’s accounting system is adequate for providing data for negotiating firm targets and a realistic

profit adjustment formula, as well as later negotiation of final costs; and

(2) Cost or pricing information adequate for establishing a reasonable firm target cost is reasonably expected to

be available at an early point in contract performance.

(d) Contract schedule.

The contracting officer shall specify in the contract schedule the initial target cost, initial target profit, and initial target price for each item subject to incentive price revision.

16.404 Fixed-price contracts with award fees.

Award-fee provisions may be used in fixed-price contracts when the Government wishes to motivate a contractor and other incentives cannot be used because contractor performance cannot be measured objectively. Such contracts shall establish a fixed price (including normal profit) for the effort. This price will be paid for satisfactory contract performance. Award fee earned (if any) will be paid in addition to that fixed price. See 16.401(e) for the requirements relative to utilizing this contract type.

16.405 Cost-reimbursement incentive contracts.

See 16.301 for requirements applicable to all cost-reimbursement contracts, for use in conjunction with the following subsections.

16.405-1 Cost-plus-incentive-fee contracts.

(a) Description. The cost-plus-incentive-fee contract is a cost-reimbursement contract that provides for the

initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to

total target costs. This contract type specifies a target cost, a target fee, minimum and maximum fees, and a

fee adjustment formula. After contract performance, the fee payable to the contractor is determined in

accordance with the formula. The formula provides, within limits, for increases in fee above target fee when

total allowable costs are less than target costs, and decreases in fee below target fee when total allowable

costs exceed target costs. This increase or decrease is intended to provide an incentive for the contractor to

manage the contract effectively. When total allowable cost is greater than or less than the range of costs

within which the fee-adjustment formula operates, the contractor is paid total allowable costs, plus the

minimum or maximum fee.

(b) Application.

(1) A cost-plus-incentive-fee contract is appropriate for services or development and test programs when—

(i) A cost-reimbursement contract is necessary (see 16.301-2); and

(ii) A target cost and a fee adjustment formula can be negotiated that are likely to motivate the contractor to

manage effectively.

(2) The contract may include technical performance incentives when it is highly probable that the required

development of a major system is feasible and the Government has established its performance objectives,

at least in general terms. This approach also may apply to other acquisitions, if the use of both cost and

technical performance incentives is desirable and administratively practical.

(3) The fee adjustment formula should provide an incentive that will be effective over the full range of

reasonably foreseeable variations from target cost. If a high maximum fee is negotiated, the contract shall

also provide for a low minimum fee that may be a zero fee or, in rare cases, a negative fee.

complied with.

16.405-2 Cost-plus-award-fee contracts.

A cost-plus-award-fee contract is a cost-reimbursement contract that provides for a fee consisting of (1) a base amount fixed at inception of the contract, if applicable and at the discretion of the contracting officer, and (2) an award amount that the contractor may earn in whole or in part during performance and that is sufficient to provide motivation for excellence in the areas of cost, schedule, and technical performance. See 16.401(e) for the requirements relative to utilizing this contract type.

Providing a Transformational Bridge to Excellence