Government Contract Pricing Structures: FFP, T&M, and Cost-Plus Compared

The contract type you propose — and the contract type the government selects — determines how you get paid, who bears performance risk, and how much administrative overhead you carry. Getting this wrong has direct financial consequences.

This guide explains the major federal contract pricing structures, when each is appropriate, and how to price and perform successfully under each type.

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Why Contract Type Matters

FAR Part 16 requires the government to select a contract type based on the nature of the work and the degree of risk involved. The fundamental principle: place the risk with the party best able to control it.

For well-defined requirements with predictable costs, fixed-price contracts put the risk with the contractor — and the contractor can price for that risk with reasonable confidence. For development work where requirements are uncertain, cost-reimbursement contracts shift risk to the government — but at the cost of government oversight overhead and contractor pricing protection.

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Firm-Fixed-Price (FFP) Contracts

FAR 16.202 — The most common contract type for commercial services, commodity procurement, and well-defined services.

How it works: The contractor agrees to deliver specific deliverables or services at a fixed price. If the work costs more than estimated, the contractor absorbs the loss. If it costs less, the contractor keeps the profit.

When it's appropriate:

• Requirements are clearly defined and stable
• Costs can be estimated with reasonable certainty
• The work is similar to commercial practice

Risk: All on the contractor. Cost overruns reduce margin; scope growth without a contract modification forces loss performance.

Pricing strategy for FFP:

• Estimate all costs thoroughly including risk
• Include contingency (typically 5–15%) for uncertain cost elements
• Understand what you are not getting paid for — scope creep is FFP's greatest threat

Contractor incentive: Maximum efficiency and control — you keep any savings below your estimated cost.

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Fixed-Price Incentive Firm (FPIF) Contracts

FAR 16.403-1 — A fixed-price contract with a profit incentive tied to cost performance.

Key terms:

• Target Cost (TC): Expected total cost
• Target Profit (TP): Expected profit at target cost
• Ceiling Price: Maximum the government will pay (typically 120–130% of target cost)
• Share Ratio: How cost overruns/underruns are split between contractor and government

Example: Target cost $1M, target profit 10%, ceiling price $1.3M, share ratio 80/20 (government/contractor)

• If actual cost is $900K (under target): contractor keeps 20% of the $100K savings → additional $20K profit
• If actual cost is $1.1M (over target): contractor pays 20% of the $100K overrun → profit reduced by $20K

When used: Development contracts where requirements are relatively firm but cost uncertainty exists.

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Time and Materials (T&M) Contracts

FAR 16.601 — The government pays for time (at defined labor rates) plus actual material costs.

How it works:

• Labor is billed at fixed rates per labor category (e.g., Software Engineer Level III: $175/hour)
• Materials are billed at actual cost plus any specified handling fee
• Total not-to-exceed (NTE) ceiling established at contract award

When it's appropriate:

• It is not possible to estimate the extent or duration of the work
• Agile/iterative software development
• Emergency or contingency work
• Work where requirements will evolve with government guidance

Risk profile: Contractor has limited financial risk (you bill hours worked at predetermined rates), but government carries cost risk. FAR requires "appropriate government surveillance" for T&M contracts.

Pricing your T&M labor rates:

• Rates are typically burdened: Direct Labor + Fringe + Overhead + G&A + Profit
• Use the GSA CALC Tool to check market rates for comparable labor categories
• Ensure rates remain competitive through option years; escalation can be included

Contractor incentive: Less incentive for efficiency than FFP — you are paid for hours regardless of how efficiently you work. Government oversight exists to manage this risk.

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Labor-Hour (LH) Contracts

FAR 16.602 — A T&M contract that does not include materials; labor hours only.

Used when the work is exclusively labor (consulting, professional services) with no material procurement.

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Cost-Plus-Fixed-Fee (CPFF) Contracts

FAR 16.306 — The government reimburses all allowable costs plus a fixed dollar amount of fee (profit).

How it works:

• Contractor bills allowable actual costs (direct labor + materials + indirect rates)
• Plus a fixed fee amount that does not change regardless of actual cost
• Fee is typically expressed as a percentage of estimated cost but is a fixed dollar amount at award

Fee limits (FAR 15.404-4):

• Research and development: maximum 15% of estimated cost
• Other cost-plus: maximum 10% of estimated cost

When it's appropriate:

• Exploratory research where work cannot be defined
• Basic research contracts
• Early-stage development

Contractor risk: Very low — you are reimbursed for allowable costs and paid a fixed fee. But if the program takes longer than estimated, you work at a lower effective fee rate.

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Cost-Plus-Incentive-Fee (CPIF) Contracts

FAR 16.304 — Like CPFF but fee varies based on cost performance relative to target.

Key terms:

• Target cost and target fee established
• Minimum and maximum fee bounds
• Share ratio for over/underruns

If you beat target cost, your fee increases up to the maximum. If you exceed target cost, your fee decreases to the minimum.

Incentive: CPIF provides cost control incentive unlike CPFF where fee is fixed regardless of cost efficiency.

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Cost-Plus-Award-Fee (CPAF) Contracts

FAR 16.305 — Costs reimbursed plus a base fee and a discretionary award fee based on the government's subjective assessment of performance.

Award fee evaluation: The government assesses the contractor's performance in areas like technical quality, schedule, responsiveness, and management. The CO (with input from a Fee Determining Official) determines the award fee percentage earned.

Award fee periods: Typically 6-month or annual evaluation periods.

Contractor incentive: Perform well on the government's defined evaluation criteria — technical performance, responsiveness, and meeting schedules directly affect earned fee.

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Hybrid and Indefinite Delivery Structures

Indefinite Delivery/Indefinite Quantity (IDIQ)

Not a pricing type, but a contract ordering structure. IDIQ contracts can place task orders under any of the above pricing types. Each task order specifies its own pricing structure.

BPA (Blanket Purchase Agreement)

Ordering vehicle under GSA Schedule. Each call order establishes the specific T&M, FFP, or LH pricing for that task.

Undefinitized Contract Actions (UCAs)

Contracts awarded before price is definitized — used for urgent requirements. The contractor performs at risk until a definitized price is negotiated. Avoid where possible; if unavoidable, track costs carefully for definitization.

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Choosing What to Propose

When the government allows contractors to propose contract type:

Propose FFP when: Requirements are clear, costs are predictable, and you can reasonably absorb the cost risk.

Propose T&M or LH when: Requirements will evolve, work is iterative, or the government will direct effort in ways that make cost estimation unreliable.

Propose CPFF when: This is exploratory research, early development, or work where failure to perform is inherent to the mission (research that doesn't yield results is not contractor failure).

The government's preferred default is FFP — it shifts cost risk to the contractor. If you believe FFP is inappropriate for a given requirement, explain why in your proposal and propose an alternative structure with justification.

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Key Takeaways

• FFP places all cost risk on the contractor — appropriate when requirements are clear and costs predictable.
• T&M reimburses hours at fixed rates — appropriate for iterative, evolving, or undefined-scope work; requires government surveillance.
• CPFF reimburses all allowable costs plus a fixed fee — appropriate for research and development where requirements cannot be defined.
• CPIF and CPAF add performance incentives to cost-reimbursement structures — CPIF for cost performance, CPAF for subjective performance evaluation.
• Fee limits cap your profit on cost-type contracts — 10% for most work, 15% for R&D (FAR 15.404-4).
• The government prefers FFP — if you propose cost-reimbursement, justify it with specific uncertainty factors that make fixed-price inappropriate.

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