In a Cost Plus Incentive Fee (CPIF) contract, the cost incurred by the seller is directly reimbursed by the buyer. The seller is offered incentive to finish early for good project performance. It is a type of cost-reimbursable contract where the seller is reimbursed for costs that are defined in the contract.
The main types of contracts to be leveraged during a project are:
- Fixed price contract (FP)
- Firm fixed price (FFP)
- Fixed price incentive fee (FPIF) contract
- Fixed price with economic price adjustment (FP-EPA)
- Cost Reimbursable
- Cost Plus Incentive Fee (CPIF)
- Cost Plus Award Fee (CPAF)
- Time and Materials (T&M)
Dummies.com has a good summary of each type: https://www.dummies.com/careers/project-management/pmp-certification/what-you-should-know-about-fixed-price-contracts-for-the-pmp-certification-exam/
Fixed Price Contract. A type of contract that sets a fixed total price for a defined product or service to be provided. Fixed price contracts may also incorporate financial incentives for achieving or exceeding project objectives, like schedule delivery dates, cost and technical performance, or any other measurement the buyer wishes to define.
Firm Fixed Price (FFP) Contract. A fixed price contract where the buyer pays the seller a set amount regardless of the seller’s costs. In an Invitation for Bid scenario, there is no price negotation, the bid goes to the lowest bidder, and the contract vehicle is an FFP contract. In Fixed Price contracts, the Scope should be very clear. Also beware that in a Fixed Price contract or Fixed Price Incentive Fee contract, sellers may cut corners to keep cost low, sacrificing Quality in the process.
Fixed Price Incentive Fee (FPIF) contract. The buyer pays the seller a set amount defined in the contract, and the seller earns additional dollars if the seller meets the performance criteria. If the share ratio is 80/20 the seller’s percentage is always the 2nd number; 20% in this case. There is always a ceiling price in FPIF contracts. In Fixed Price contracts, the Scope should be very clear. Also beware that in a Fixed Price contract or Fixed Price Incentive Fee contract, sellers may cut corners to keep cost low, sacrificing Quality in the process.
The Point of Total Assumption in an FPIF contract is where anything above the total cost agreed to on a Fixed Price Incentive Fee contract whereby any overruns above that cost are paid by the seller.
Given these numbers: Target Cost = $1,000, Actual Cost = $1,100, Ceiling Price = $1200, Target Profit = $300, and the share ratio = 80/20, the way to figure out the Total Price of the project is: 1) Figure out the seller’s % of the overrun – 20% of $100 overrun is $20. 2) Subtract their share of the overrun from their Target Profit – $100 – $20 = $80. Add $80 to the Actual Cost of $1,100 = $1,180.
Fixed Price With Economic Price Adjustment (FP-EPA) contract. This Contract Type spans a long time, typically years. It is a fixed price contract, but has a provision for final adjustments to price due to changing conditions, such as cost increases. The Economic Price Adjustment clause for cost increase must be tied to a reliable index that is used to adjust the final price, i.e. inflation.
Cost Reimbursable contract (CR) – The buyer pays the seller a reimbursement for the seller’s actual costs.
Cost Plus Award Fee (CPAF) – The seller is reimbursed for all legitimate costs incurred during the project, plus an award fee representing seller profit.
Cost Plus Fixed Fee (CPFF) – Cost reimbursement contract where the fee is predetermined by contract. The fee is not a % of the cost, so there’s no incentive to keep costs low by the seller.
Cost-Plus-Fixed-Fee (CPFF) cost reimbursable contract in which the buyer provides reimbursement to the selling party for the allowable costs that have been accrued by the seller in the commission of the service, the creation, manufacture, delivery of the product, or in any other performance of the contracted work. However, unlike a standard cost-plus-fee contract, the additional fee is not intended to be calculated as a percentage measure of the total costs, in which the fee in these situations would vary based on the actual costs. Instead, the cost-plus-fixed fee contract provides for a pre-determined fixed fee reimbursement. Cost-plus-fixed-fee tends to me more advantageous to the buyer as opposed to the seller as it caps the fee and the fee will not swell or grow based on the future expansion or fluctuations of the budget. However, it also can protect the seller because, in the event the budget tightens, it provides a fixed fee.
T&M – Time & Materials. These contracts are frequently used on staff augmentation,product development, and construction contracts. Employer pays contractor based upon the time spent by the contractor’s employees and subcontracted employees as well as the materials used in the project (plus any additional markup).
Other important terms to know for contracts are:
- Target Fee – the seller’s fee or profit
- Sharing Ratio – The ratio at which buyer and seller share cost overruns or cost savings.
- Target Cost – It is the cost to which the seller aims not to exceed. The seller’s profit is not included in this figure.