Federal Contract Types Explained: FFP, T&M, CPFF, CPAF, and When to Use Each

Every federal contract assigns risk somewhere. The contract type determines who bears it — the government, the contractor, or some negotiated split between them. Understanding federal contract types is not an academic exercise for defense contractors and GovCon professionals; it is the foundation of every pricing decision, every bid/no-bid analysis, and every margin forecast you will make across your portfolio. Get it wrong, and you either leave profit on the table or expose your company to losses that no amount of good performance can recover.

The Federal Acquisition Regulation dedicates all of FAR Part 16 to contract types, spanning fixed-price, cost-reimbursement, time-and-materials, and hybrid structures. For contractors focused on winning federal contracts, fluency in these structures is table stakes. Contracting officers select contract types based on the maturity of the requirement, the degree of performance uncertainty, the availability of cost data, and the government's risk appetite. Your job is to understand why a particular type was chosen and build a pricing strategy that maximizes both your competitiveness and your ability to perform profitably.

This guide walks through every major federal contract type, explains the risk allocation logic behind each one, provides a side-by-side comparison, and gives you the pricing strategy playbook for each. Whether you are preparing for your first firm-fixed-price bid or negotiating fee structures on a cost-plus development effort, the sections below give you the practical knowledge to make sound decisions.

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The Risk Spectrum: How Contract Types Allocate Risk

Before diving into individual contract types, it helps to understand the overarching logic. Federal contract types exist on a spectrum from maximum contractor risk (firm-fixed-price) to maximum government risk (cost-plus-fixed-fee). The FAR establishes this spectrum deliberately because different procurement situations call for different risk profiles.

The guiding principle is simple: risk should be borne by the party best positioned to manage it. When the government knows exactly what it wants and the contractor can accurately estimate costs, a fixed-price contract makes sense because the contractor controls execution. When the requirement is exploratory, the technology is immature, or the scope cannot be fully defined, cost-reimbursement shifts financial risk to the government because the contractor cannot reasonably predict what the work will require.

Here is the full spectrum, from highest to lowest contractor cost risk:

Understanding where each contract type sits on this spectrum is essential for revenue forecasting and portfolio risk management. A contractor with 80% of revenue on FFP contracts has a very different risk profile than one with 80% on cost-plus work — and each requires a different financial management approach.

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Firm-Fixed-Price (FFP) Contracts

Firm-fixed-price contracts are the workhorse of federal procurement and the FAR's preferred contract type. Under an FFP contract, the contractor agrees to deliver a defined scope of work for a set price. If actual costs come in below the price, the contractor keeps the difference as additional profit. If actual costs exceed the price, the contractor absorbs the loss. The government pays the agreed amount, period.

When Agencies Use FFP

Contracting officers select FFP when three conditions are met:

1. The requirement is well-defined. Specifications, deliverables, and acceptance criteria are clear enough that the contractor can estimate costs with reasonable confidence.
2. Sufficient cost data exists. Either from prior procurements of similar work, market research, or the contractor's own cost experience.
3. The performance period is bounded. The work has a clear start, execution phase, and completion — not an open-ended research effort.

Common FFP applications include production contracts, commercial-item procurements, facilities maintenance, routine IT services, and construction. In the defense sector, FFP is standard for manufacturing, sustainment, and well-scoped integration work.

Pricing Strategy for FFP

FFP pricing is where your wrap rate matters most. Because the price is fixed, every dollar of indirect cost directly erodes your margin. Successful FFP contractors focus on:

Accurate cost estimation. This is the single most important discipline. Underestimate effort, and you lose money on every hour worked beyond your estimate. Overestimate, and you lose the competition. Build bottom-up cost estimates using work breakdown structures, historical actuals from similar efforts, and parametric models validated against your own data.

Scope discipline. FFP contracts live and die by the statement of work. Ambiguity in the SOW is not your friend — it is a source of unpriced risk. During pre-proposal Q&A periods, push for clarity on every deliverable, acceptance criterion, and government-furnished item. Document assumptions explicitly in your proposal so that any scope creep triggers an equitable adjustment rather than an unfunded cost increase.

Management reserve. Prudent FFP pricing includes a management reserve — typically 3% to 8% of estimated cost — to absorb unforeseen execution risks without consuming profit. The reserve is internal to your pricing model; it does not appear as a separate line item in your proposal to the government.

Subcontractor lock-in. If your FFP proposal relies on subcontractors, get fixed-price quotes from them before you commit your price. A cost-reimbursable subcontract under an FFP prime exposes you to the subcontractor's cost growth. For guidance on structuring these relationships, see our teaming agreement guide.

FFP Pitfalls

The most common FFP failure mode is bidding aggressively to win, then discovering that the actual work exceeds estimates. This is especially dangerous on:

• Multi-year performance periods where labor costs escalate but the price does not.
• Technology integration contracts where government-furnished systems have undisclosed integration challenges.
• Contracts with poorly defined data rights or security requirements — compliance costs for CMMC and CUI handling can be substantial if not scoped at proposal time.

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Fixed-Price Incentive (Firm Target) — FPI(F) Contracts

Fixed-price incentive contracts add a sharing mechanism to the fixed-price structure. The government and contractor negotiate four key parameters:

1. Target cost — the estimated cost of performing the work.
2. Target profit — the profit the contractor earns if actual costs equal the target cost.
3. Ceiling price — the maximum price the government will pay (typically 120% to 140% of target cost).
4. Share ratio — how cost overruns and underruns are split between the parties (e.g., 60/40, 70/30).

If the contractor performs below target cost, both parties benefit: the contractor earns additional profit based on the share ratio, and the government pays less than the ceiling. If costs exceed the target but remain below the ceiling, the contractor's profit decreases based on the share ratio. If costs exceed the ceiling, the contractor bears 100% of the overrun — the ceiling is absolute.

When Agencies Use FPI(F)

FPI(F) is common on defense development and production contracts where costs are reasonably estimable but carry enough uncertainty that a pure FFP would either result in excessive risk premiums or deter qualified contractors. Major weapon system production lots, complex IT system development, and large-scale integration efforts frequently use FPI(F).

Pricing Strategy for FPI(F)

The share ratio is the critical negotiation point. A 60/40 government/contractor share means the contractor absorbs 40 cents of every dollar of cost overrun (below the ceiling) and retains 40 cents of every dollar of cost savings. Aggressive share ratios incentivize performance but increase risk. Conservative share ratios reduce risk but limit upside.

Smart contractors negotiate the target cost carefully. An artificially low target cost combined with a generous share ratio can create a structure where the contractor earns strong margins even with moderate cost overruns — as long as costs stay below the ceiling. Conversely, an unrealistically high target cost may win the negotiation but raise red flags during source selection.

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Time-and-Materials (T&M) and Labor-Hour (LH) Contracts

Time-and-materials contracts pay the contractor at negotiated hourly rates for labor plus actual material costs. Labor-hour contracts are identical except they exclude materials — the government either provides materials directly or they are not part of the requirement. The hourly rates include direct labor, indirect costs, and profit, making them fully loaded billing rates.

When Agencies Use T&M

FAR 16.601 explicitly states that T&M contracts may be used "only when it is not possible at the time of placing the contract to estimate accurately the extent or duration of the work or to anticipate costs with any reasonable degree of confidence." The contracting officer must prepare a written determination and findings (D&F) justifying why no other contract type is suitable, and must establish a ceiling price that the contractor may not exceed without authorization.

Common T&M applications include:

• Engineering and technical services where task complexity varies unpredictably.
• Maintenance and repair of complex systems where the scope of each repair cannot be determined until inspection.
• Advisory and assistance services where the level of effort depends on emerging agency needs.
• Staff augmentation under large IDIQ vehicles like OASIS+ where agencies issue task orders for personnel at pre-competed rates.

T&M is widespread on many of the major contract vehicles, particularly for IT and professional services.

Pricing Strategy for T&M

T&M pricing revolves around your labor category rate structure. Each labor category (e.g., Senior Systems Engineer, Program Manager, Cybersecurity Analyst) has a fully loaded hourly rate that must cover:

• Direct labor cost for that category
• Fringe benefits
• Overhead
• G&A expense
• Profit

This is where your wrap rate directly translates into competitive positioning. A contractor with a 2.0x wrap rate bidding a Senior Systems Engineer at $70/hour direct labor proposes a billing rate of $140/hour. A competitor with a 2.4x wrap rate on the same direct labor rate proposes $168/hour. That $28/hour difference, multiplied across thousands of hours, is decisive in evaluations.

Key T&M strategies include:

Tiered labor categories. Structure your labor categories to allow staffing flexibility. A single "Engineer" category priced at a senior rate limits your ability to staff junior engineers profitably. Propose multiple tiers (Junior, Mid, Senior, Principal) with appropriate rate differentials.

Ceiling management. Monitor burn rates against the contract ceiling diligently. Exceeding the ceiling without prior government authorization means the contractor works for free — the government has no obligation to pay beyond the authorized ceiling.

Uncompensated overtime risk. On T&M contracts, you are paid for hours worked at the loaded rate. If your people work uncompensated overtime (common in defense environments), those hours are not billed but still generate indirect costs. Factor this into your rate development.

T&M vs. Cost-Plus: A Common Misconception

Many contractors assume T&M contracts are similar to cost-plus because the government pays based on actual effort. The key difference is risk allocation for labor rates. Under T&M, the contractor bears rate risk: if actual indirect rates exceed what was baked into the fixed hourly rates, the contractor absorbs the difference. Under cost-plus, the government reimburses actual indirect costs (subject to allowability), so rate risk stays with the government.

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Cost-Plus-Fixed-Fee (CPFF) Contracts

Cost-plus-fixed-fee contracts represent the maximum cost risk transfer to the government. The government reimburses the contractor for all allowable, allocable, and reasonable costs incurred in performing the work, plus pays a fixed fee (profit) that does not vary with actual costs. If the work costs more than estimated, the government pays the additional cost — but the fee stays the same. If it costs less, the government saves money, but again, the fee stays the same.

When Agencies Use CPFF

CPFF is the go-to contract type when:

• The scope involves significant technical uncertainty — research and development, prototyping, first-of-a-kind engineering.
• No reliable cost data exists for the specific requirement.
• The level of effort cannot be predicted at contract award.
• The government explicitly wants to shift cost risk off the contractor to attract qualified performers or avoid unreasonable risk premiums in fixed-price proposals.

Defense R&D programs, early-stage technology development, complex studies and analyses, and advisory services for emerging threats commonly use CPFF.

Fee Determination

CPFF fee rates are constrained by statute. For R&D work, the fee cannot exceed 15% of the estimated cost (excluding fee). For all other CPFF work, the fee is capped at 10% of estimated cost. In practice, negotiated fees typically range from 6% to 10% depending on the complexity and risk of the work.

The fee is "fixed" at contract award based on the estimated cost. It does not change if actual costs diverge from the estimate — upward or downward. However, if the government formally increases the scope of work through a contract modification, the fee is typically renegotiated to reflect the additional effort.

CPFF Variants

CPFF Completion form requires the contractor to deliver a defined end product and obligates the contractor to continue performance until the deliverable is complete or the estimated cost is exceeded (at which point the government can either provide additional funding or terminate). This is the more common form.

CPFF Term form requires the contractor to devote a specified level of effort over a defined period. The contractor is obligated only to provide the agreed-upon effort, not to achieve a specific result. This form is common for research and advisory services.

Administrative Requirements

CPFF contracts carry substantial administrative overhead. Contractors must maintain:

• A DCAA-auditable accounting system that tracks direct and indirect costs by contract, cost element, and organizational unit.
• CAS compliance — Cost Accounting Standards Disclosure Statements and consistent application of cost accounting practices across all CAS-covered contracts.
• Incurred cost submissions — annual filings detailing all costs charged to government contracts for audit.
• Timekeeping systems, purchasing systems, and estimating systems that meet DCAA adequacy standards.

For contractors building this infrastructure, the investment is significant but necessary for accessing the large pool of cost-reimbursable defense work. Maintaining secure operations for these financial systems is particularly important given the sensitivity of cost data.

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Cost-Plus-Award-Fee (CPAF) Contracts

CPAF contracts reimburse costs (like CPFF) but split the fee into two components:

1. Base fee — a fixed amount (often 0% to 3%) paid regardless of performance.
2. Award fee — an additional amount (typically 3% to 7%) that the contractor earns based on periodic performance evaluations against subjective criteria.

An Award Fee Determination Official (AFDO), advised by an Award Fee Evaluation Board, assesses the contractor's performance at defined evaluation periods (typically semi-annually or annually) and assigns a rating that determines what percentage of the available award fee pool the contractor receives.

When Agencies Use CPAF

CPAF is the government's tool for incentivizing exceptional performance on contracts where outcomes cannot be measured with objective metrics. It is common on:

• Large program management and systems engineering contracts where quality of advice, responsiveness, and leadership are more important than widget counts.
• Operations and maintenance of complex systems where the government wants to reward proactive problem-solving, not just adequate performance.
• Advisory and assistance services supporting acquisition programs, where the value of the work is inherently subjective.

The Award Fee Game

Earning top award fee ratings requires a deliberate strategy that extends well beyond technical performance:

Understand the evaluation criteria. The award fee plan is usually attached to the contract and specifies the criteria, weighting, and rating scale. Some plans evaluate technical, management, and cost control as separate categories with different weights. Know what the evaluation board cares about most.

Maintain continuous communication. Do not wait for the evaluation period to learn how the government perceives your performance. Schedule regular meetings with the Contracting Officer's Representative (COR) and program manager to solicit informal feedback and address concerns proactively.

Document everything. Award fee evaluations are inherently subjective, which means your narrative matters. Maintain an award fee self-assessment library that tracks accomplishments, cost savings initiatives, innovations, and challenges overcome. Submit a well-organized self-assessment before each evaluation period.

Cost control is part of the evaluation. Even on cost-reimbursement contracts, agencies expect contractors to manage costs efficiently. A CPAF contractor that consistently overruns cost estimates will receive lower ratings even if technical performance is satisfactory. Accurate revenue forecasting and cost-at-completion tracking are essential.

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Cost-Plus-Incentive-Fee (CPIF) Contracts

CPIF contracts combine cost reimbursement with an incentive fee structure similar to FPI(F) but applied to cost-type work. The parties negotiate:

1. Target cost — the estimated cost of performing the work.
2. Target fee — the fee earned if actual costs equal the target cost.
3. Minimum and maximum fee — the floor and ceiling for fee adjustment.
4. Share ratio — how cost savings and overruns affect fee (e.g., 70/30 government/contractor).

If the contractor delivers below target cost, the fee increases based on the share ratio (up to the maximum). If costs exceed the target, the fee decreases (down to the minimum). Unlike FPI(F), there is no absolute ceiling price — the government continues to reimburse allowable costs even if the minimum fee is reached.

When Agencies Use CPIF

CPIF is appropriate when the government wants to incentivize cost control on work that is too uncertain for fixed-price treatment but too well-defined for CPFF. Production of complex defense systems with moderate cost uncertainty, large-scale IT system development where prior cost data is limited, and multi-year sustainment programs often use CPIF.

CPIF vs. CPAF: Objective vs. Subjective Incentives

The key distinction is the nature of the incentive. CPIF incentives are purely mathematical — actual cost against target cost, applied through the share formula. CPAF incentives are subjective — a human evaluation board judges performance quality. Some contracts combine both (CPAF with cost incentives), creating a structure where objective cost performance and subjective quality assessment both influence total fee.

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Hybrid and Less Common Contract Types

Fixed-Price with Economic Price Adjustment (FP-EPA)

FP-EPA contracts are firm-fixed-price contracts with a built-in mechanism for adjusting the price based on defined economic variables — typically labor cost indices, material price indices, or established catalog prices. They are used when the performance period is long enough that fixed pricing would require excessive contingency to cover economic uncertainty, but the requirement itself is well-defined.

For multi-year defense production contracts where material costs (steel, semiconductors, rare earth elements) can swing dramatically, FP-EPA protects both parties. The contractor does not need to pad pricing for worst-case material escalation, and the government does not overpay if costs stabilize.

Indefinite-Delivery Contract Types

IDIQ contracts, described in our contract vehicles guide, are ordering frameworks — not standalone contract types. Each task order issued under an IDIQ has its own contract type. A single IDIQ vehicle might include task orders that are FFP, T&M, CPFF, or any other authorized type. Understanding how to price across multiple contract types within a single vehicle is essential for vehicle holders.

Hybrid Task Orders

Increasingly, agencies issue task orders that blend contract types within a single order. A common pattern is:

• FFP for defined deliverables (reports, system builds, training events).
• T&M for ongoing advisory or support services where hours are unpredictable.
• Cost-reimbursable for travel, materials, and other direct costs where actual expenses are more appropriate than fixed estimates.

Hybrid structures require sophisticated cost accounting because different portions of the same contract may have different billing mechanisms, fee structures, and audit requirements. Your accounting system must be able to segregate costs and revenue by contract line item number (CLIN) and contract type.

Letter Contracts and Undefinitized Contract Actions (UCAs)

When agencies need to start work before a definitive contract can be negotiated, they may issue a letter contract or UCA. These authorize work to begin — usually under cost-reimbursement terms — while the parties negotiate the definitive contract type and price. UCAs are common on urgent defense requirements but carry significant risk for contractors because the definitive contract type may not be what the contractor expected, and cost recovery during the undefinitized period may be limited.

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Contract Type Comparison: The Complete Matrix

The following table compares all major federal contract types across the dimensions that matter most for pricing and risk management:

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LPTA vs. Best Value: How Evaluation Method Intersects With Contract Type

The contract type tells you how you will be paid. The evaluation method tells you how your proposal will be judged. These two dimensions interact in ways that directly affect your pricing strategy.

Lowest Price Technically Acceptable (LPTA)

In LPTA evaluations, the government establishes minimum technical requirements and awards to the lowest-priced offeror that meets them. Technical proposals are rated as either "acceptable" or "unacceptable" — there is no credit for exceeding requirements.

LPTA is most common on FFP and T&M contracts for well-defined, commodity-like services. When you see an LPTA evaluation paired with an FFP contract type, the pricing message is clear: optimize your wrap rate, minimize indirect costs, and price to the floor of what allows sustainable performance. There is no margin for premium pricing based on technical superiority.

Best Value Tradeoff

Best-value evaluations allow the government to pay more for higher-quality proposals. The source selection authority can select a higher-priced offeror if the technical, management, or past performance advantages justify the price premium.

Best-value is common across all contract types and is the standard evaluation method for complex services and development work. On cost-reimbursement contracts, the government evaluates your proposed cost for realism (not just low price), meaning that an unrealistically low cost estimate can actually hurt your evaluation.

Practical Implications

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Pricing Strategy by Contract Type: A Practical Playbook

FFP Pricing Playbook

1. Build bottom-up cost estimates from work breakdown structures.
2. Validate estimates against historical actuals from similar contracts.
3. Apply 3%–8% management reserve for execution risk.
4. Optimize your wrap rate — every 0.1x reduction in overhead translates to direct price competitiveness.
5. Lock subcontractor prices before committing your total price.
6. Price escalation into multi-year efforts explicitly.
7. Document assumptions for equitable adjustment leverage.

T&M Pricing Playbook

1. Develop labor category rate tables from your actual compensation data.
2. Apply your fully loaded wrap rate to each category.
3. Benchmark rates against GSA Schedule pricing and incumbent contract rates.
4. Build rate escalation into option-year pricing (typically 2%–4% per year).
5. Structure labor categories to provide staffing flexibility across experience levels.
6. Plan ceiling management and burn rate tracking from day one.

Cost-Plus Pricing Playbook

1. Develop realistic cost estimates — contracting officers evaluate for realism, not just low price.
2. Ensure your accounting system and indirect rate structure are DCAA-adequate.
3. Propose fee rates within the statutory caps and competitive norms (6%–10% for CPFF; calibrate base/award fee split for CPAF).
4. Build a cost control narrative showing how you will manage actual costs against estimates.
5. For CPIF, model the fee adjustment formula across cost scenarios to understand your risk/reward profile.
6. Prepare for rigorous cost monitoring and reporting throughout performance.

FPI(F) Pricing Playbook

1. Negotiate target cost based on your best estimate — not an inflated cushion.
2. Model the share ratio across multiple cost scenarios (optimistic, most likely, pessimistic).
3. Ensure the ceiling price provides adequate headroom for worst-case execution.
4. Build incentive structures that motivate your team to beat the target cost.
5. Track actual costs against the target continuously during performance.

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How Agencies Decide Which Contract Type to Use

Understanding the contracting officer's decision process helps you anticipate what contract type to expect and how to influence the selection during pre-solicitation engagement.

The FAR Part 16 Decision Framework

FAR 16.103 requires contracting officers to select contract types that result in "reasonable contractor risk and the greatest incentive for efficient and economical performance." The regulation establishes a hierarchy:

1. Start with FFP — it places maximum risk on the contractor and requires the least government oversight.
2. Move toward cost-reimbursement only when the requirement involves sufficient uncertainty that fixed-price treatment would be unreasonable.
3. Use T&M/LH only when neither fixed-price nor cost-reimbursement is feasible, and document why.

Factors Contracting Officers Evaluate

• Requirement maturity. Is the statement of work complete and unambiguous? Mature requirements favor FFP. Evolving requirements favor cost-type.
• Cost estimating confidence. Does sufficient historical cost data exist? High confidence favors FFP. Low confidence favors cost-type.
• Performance risk. Is the technology proven? Proven technology favors FFP. Emerging technology favors cost-type.
• Contract value and duration. Higher-value, longer-duration contracts may warrant incentive structures (FPI, CPIF) to align interests over time.
• Market conditions. In competitive markets with many qualified vendors, FFP is more feasible because competition validates pricing. In thin markets with few qualified performers, cost-type contracts may be necessary to attract bidders.
• Government oversight capacity. Cost-reimbursement contracts require more government surveillance. Agencies with limited contracting workforce may prefer FFP to reduce oversight burden.

How Contractors Can Influence Contract Type Selection

During pre-solicitation engagement — industry days, requests for information (RFIs), and one-on-one meetings with program offices — contractors can shape the contract type discussion:

• If a draft solicitation proposes FFP for work that involves genuine technical uncertainty, provide data showing why cost-type or FPI would be more appropriate and would yield more competitive pricing.
• If an RFI asks about contract type preferences, articulate your rationale clearly — do not simply state a preference without explaining the risk logic.
• If an agency proposes T&M for work that could be defined as FFP deliverables, offer a hybrid approach that may be more competitive.

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Common Mistakes Contractors Make With Contract Types

Mistake 1: Treating All FFP Contracts the Same

An FFP services contract and an FFP production contract have fundamentally different risk profiles. Services contracts typically involve labor cost risk, where staff availability and productivity drive cost variance. Production contracts involve material, manufacturing, and supply chain risk. Your cost estimation methodology must reflect these differences.

Mistake 2: Underbidding Cost-Plus Estimates

On cost-reimbursement contracts, proposing unrealistically low costs to appear competitive is counterproductive. The government evaluates cost proposals for realism — if your estimate is 30% below competitors, the evaluation team will either adjust your estimate upward (eliminating the perceived advantage) or question your understanding of the work.

Mistake 3: Ignoring the CAS and DCAA Infrastructure Required for Cost-Type Work

Winning your first cost-reimbursement contract is a milestone, but if your accounting system is not DCAA-adequate, you cannot bill costs — and you certainly cannot pass an incurred cost audit. Build the infrastructure before you bid.

Mistake 4: Failing to Manage T&M Ceilings

T&M contracts have funded ceilings. Exceeding the ceiling without prior authorization means you work for free. Implement burn rate tracking from contract start, and initiate ceiling increase requests 60 to 90 days before projected ceiling breach.

Mistake 5: Ignoring Contract Type When Building Teaming Arrangements

When structuring teaming agreements, the contract type should dictate the subcontract type. An FFP subcontract under an FFP prime locks in the prime's risk exposure. A T&M subcontract under an FFP prime creates open-ended risk for the prime. Align subcontract structures with the prime contract type.

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Frequently Asked Questions

What is the most common federal contract type?

Firm-fixed-price (FFP) is the most common federal contract type by both number of awards and total obligations. According to federal procurement data, FFP contracts account for approximately 45% to 50% of total federal contract spending in most fiscal years. This dominance reflects the FAR's explicit preference for FFP whenever the requirement is sufficiently defined. However, the distribution varies by agency — the Department of Defense uses more cost-reimbursement contracts (particularly for R&D and weapon system development) than civilian agencies. For contractors focused on winning federal contracts, building competence in FFP pricing is the foundational skill.

What is the difference between FFP and T&M contracts?

Under an FFP contract, the contractor agrees to deliver a defined scope for a fixed price — if costs exceed that price, the contractor absorbs the loss. Under a T&M contract, the government pays negotiated hourly rates for labor plus actual material costs, with a ceiling that cannot be exceeded without authorization. The core difference is in risk allocation: FFP places all cost risk on the contractor, while T&M splits it — the contractor bears rate risk (if actual indirect rates exceed what was built into the hourly rates) and the government bears volume risk (total hours required). FFP is preferred for well-defined work; T&M is reserved for situations where effort and duration cannot be predicted.

When should a contractor prefer cost-plus over fixed-price?

Contractors should prefer cost-reimbursement contracts when the technical scope involves genuine uncertainty that makes accurate cost estimation impractical. Specific indicators include: first-of-a-kind engineering or prototyping, research where the scope of investigation may expand based on findings, requirements that reference emerging technologies with no established cost history, and programs where the government acknowledges scope will evolve significantly. The tradeoff is real — cost-plus contracts carry lower fee rates (capped at 10% to 15%) and require expensive DCAA-auditable accounting infrastructure. But they also eliminate the risk of losses from cost overruns, which protects the contractor's financial stability on uncertain work.

How do incentive-fee contracts work?

Incentive-fee contracts — both FPI(F) on the fixed-price side and CPIF on the cost-reimbursement side — establish a target cost and a formula for sharing cost savings or overruns between the government and contractor. If actual costs come in below the target, the contractor's fee increases by the contractor's share percentage of the savings. If costs exceed the target, the fee decreases by the contractor's share of the overrun. FPI(F) contracts also have an absolute ceiling price that the contractor cannot exceed — above the ceiling, the contractor bears 100% of overrun costs. CPIF contracts have minimum and maximum fee limits but no ceiling on cost reimbursement. The share ratio (e.g., 60/40, 70/30) is the critical negotiation point — it determines how strongly the contractor is incentivized to control costs.

Can the contract type change during performance?

In general, the contract type is established at award and does not change during performance. However, there are limited circumstances where conversion occurs. Undefinitized contract actions (UCAs) and letter contracts start under interim terms (usually cost-reimbursable) and must be definitized into a final contract type. Some contracts include provisions for converting from cost-plus to fixed-price once the requirement matures — this is common on programs that transition from development (cost-type) to production (fixed-price). Any change in contract type requires a formal contract modification signed by both parties. The contractor can negotiate but cannot be compelled to accept a contract type change unilaterally.

What contract type is best for small businesses entering GovCon?

For small businesses entering the federal market, FFP and T&M contracts are typically the most accessible starting points. FFP is manageable because it does not require a DCAA-auditable accounting system — you agree to a price and deliver. T&M is common on small business set-aside task orders under IDIQ vehicles and allows new contractors to build revenue and past performance while learning the government contracting environment. Cost-reimbursement contracts are generally not advisable for early-stage small businesses because the accounting system requirements and audit exposure represent a disproportionate administrative burden. As your company grows and you invest in CMMC compliance and financial infrastructure, cost-type work becomes accessible and strategically valuable.

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Ready to Optimize Your Contract Pricing Strategy?

Choosing the right approach for each contract type — and building the internal infrastructure to execute profitably across FFP, T&M, and cost-plus work — is a challenge that grows with your portfolio. Whether you are navigating your first fixed-price bid, building a DCAA-auditable rate structure for cost-reimbursable work, or optimizing wrap rates across a blended portfolio, having the right tools and advisory support makes the difference between sustainable growth and margin erosion.

Need help with contract pricing strategy? [Contact Cabrillo Club](/contact) to learn how our platform helps defense contractors build compliant, competitive pricing across every federal contract type.

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This guide is part of our [Winning Federal Contracts](/insights/winning-federal-contracts) resource hub. For related strategies on pricing, compliance, and growth, explore our guides on [federal contract wrap rates](/insights/federal-contract-wrap-rate-calculator), [contract vehicles](/insights/federal-contract-vehicles-guide), [revenue forecasting for GovCon](/insights/erp-connected-revenue-forecasting-govcon), and [structuring teaming agreements](/insights/govcon-teaming-agreement-guide).