FFP vs Cost-Plus Contracts Compared

What Is a Firm-Fixed-Price Contract?

A Firm-Fixed-Price (FFP) contract, governed by FAR 16.202, establishes a price that is not subject to adjustment based on the contractor's cost experience during performance. The contractor assumes maximum risk because any cost overruns come directly out of profit, while cost underruns increase profit. This creates a strong incentive for efficiency.

FFP is the government's preferred contract type under FAR 16.104 and must be used when the risk involved is minimal or can be predicted with reasonable certainty. The government favors FFP because it shifts cost risk to the contractor and reduces the administrative burden of auditing costs during performance.

What Is a Cost-Plus Contract?

Cost-reimbursement contracts, commonly called "cost-plus" contracts, are governed by FAR 16.3. Under these contracts, the government reimburses the contractor for allowable, allocable, and reasonable costs incurred during performance, plus a fee (profit). The government assumes the majority of cost risk because it pays actual costs regardless of whether they exceed estimates.

There are several variants: Cost-Plus-Fixed-Fee (CPFF), Cost-Plus-Incentive-Fee (CPIF), Cost-Plus-Award-Fee (CPAF), and Cost-Plus-Percentage-of-Cost (prohibited for federal contracts since 1914). CPFF is the most common, providing a fixed dollar fee that does not vary with actual costs. CPIF and CPAF structures tie a portion of the fee to performance metrics or cost targets.

DCAA Audit Requirements

The most significant operational difference between FFP and cost-plus contracts is the audit and accounting infrastructure required. Cost-type contracts demand a Defense Contract Audit Agency (DCAA) adequate accounting system that can segregate costs by contract, track direct and indirect costs separately, and produce compliant incurred cost submissions.

Contractors performing cost-type work must comply with FAR Part 31 (Contract Cost Principles) and, for contracts over $7.5 million, the Cost Accounting Standards (CAS). Indirect rates (overhead, G&A, fringe) must be proposed as provisional rates and then trued up annually through incurred cost audits. This process can take years to close out.

For FFP contracts, the contractor's accounting system need only meet basic commercial standards. The government does not audit individual cost elements — it pays the agreed-upon price for delivered work. This makes FFP contracts far more accessible for small businesses and commercial firms entering the government market.

Profit and Fee Structures

FFP Profit

Under FFP, profit is embedded in the contract price. If a contractor bids $1 million and performs the work for $800K, the $200K difference is profit. Conversely, if costs reach $1.2 million, the contractor absorbs a $200K loss. There is no cap on profit or loss. Government weighted guidelines (FAR 15.404-4) typically analyze profit as 7-15% of estimated costs during negotiations, but the final price is what matters.

Cost-Plus Fee

Under cost-plus contracts, fee is negotiated separately from estimated costs. For CPFF contracts, the fee is a fixed dollar amount that does not change regardless of actual costs — providing limited profit incentive but also limited profit risk. Fee percentages are capped by statute at 10% of estimated cost for R&D and 15% for other work (10 U.S.C. 3322).

CPIF contracts set a target cost and target fee, with a sharing ratio (e.g., 80/20 government/contractor) that adjusts the fee up or down based on actual cost performance. CPAF contracts award a base fee plus an award fee pool evaluated against subjective performance criteria. These incentive structures encourage cost control while still protecting the contractor from catastrophic losses on uncertain work.

When Each Contract Type Is Used

Use FFP When:

• Requirements are well-defined and stable (clear statement of work)
• Historical cost data exists for reliable pricing
• The work involves commercial or near-commercial items
• Both parties can agree on a fair and reasonable price
• You want to maximize profit potential through efficient execution

Use Cost-Plus When:

• Requirements cannot be sufficiently defined to allow FFP pricing
• The work involves research, development, or experimental activities
• Significant technical uncertainty makes cost estimation unreliable
• The government wants visibility into actual costs for future pricing
• The contractor cannot assume the full cost risk without excessive contingency pricing

In practice, many large contracts use a hybrid approach. An IDIQ contract might allow both FFP and cost-plus task orders depending on the nature of specific requirements. The government may also use a Fixed-Price Incentive (FPI) contract as a middle ground, sharing cost risk between the parties with a ceiling price.