Understanding Defense Department Contracts

Motley Fool Staff
Updated

Each business day, the Department of Defense posts information about contracts valued at $6.5 million or more. Investors can find links to the Department's releases by clicking here. The language can be a bit dense and jargon-filled. We've put together the following for Foolish investors who want more insight on some of the terms governing those contracts.

A good place to start is the Federal Acquisition Regulation (FAR), which can be found on this page www.acquisition.gov/far. Part 16 goes over the types of contracts the Department of Defense issues and can be found by clicking here [in HTML].

Here is some selected information from the FAR that may help investors understand the contracts their companies are getting.


Contract types are grouped into two broad categories: fixed-price contracts (see Subpart 16.2) and cost-reimbursement contracts (see Subpart 16.3). The specific contract types range from firm-fixed-price, in which the contractor has full responsibility for the performance costs and resulting profit (or loss), to cost-plus-fixed-fee, in which the contractor has minimal responsibility for the performance costs and the negotiated fee (profit) is fixed. In between are various incentive contracts (see Subpart 16.4), in which the contractor's responsibility for the performance costs and the profit or fee incentives offered are tailored to the uncertainties involved in contract performance.

Fixed-price contracts include:

  • Firm-fixed-price: Provides for a price that is not subject to any adjustment on the basis of the contractor's cost experience in performing the contract. (16.202)

  • Fixed-price contract with economic price adjustment: Provides for upward and downward revision of the stated contract price upon the occurrence of specified contingencies including adjustments in the costs of labor or materials. (16.203)

  • Fixed-price incentive contract: Provides for adjusting profit and establishing the final contract price by a formula based on the relationship of final negotiated total cost to total target cost. (16.204)

Cost-reimbursement contracts establish an estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk) without the approval of the contracting officer. These types of contract include:

  • Cost contract: The contractor receives no fee. (16:302)

  • Cost-sharing contract: The contractor receives no fee and is reimbursed only for an agreed-upon portion of its allowable costs. (16.303)

  • Cost-plus-incentive-fee contract: Provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs. (16.304)

  • Cost-plus-award-fee contract: Provides for a fee consisting of (a) a base amount (which may be zero) and (b) an award amount, based upon a judgmental evaluation by the government, sufficient to provide motivation for excellence in contract performance. (16.305)

  • Cost-plus-fixed-fee contract: Provides for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost, but may be adjusted as a result of changes in the work to be performed under the contract. This contract type permits contracting for efforts that might otherwise present too great a risk to contractors, but it provides the contractor only a minimum incentive to control costs. (16.306)

The FAR provides for several types of incentive contracts that can be based on cost, performance, delivery, or other targets. (16.401) Incentives can be combined with fixed-price and cost-reimbursement contracts.

A delivery-order contract is a contract for supplies that does not specify a firm quantity (other than a minimum or maximum quantity) and that provides for the issuance of orders for the delivery of supplies during the period of the contract. A task-order contract is the same thing, but for services, rather than supplies. (16.501-1)

There are three types of indefinite-delivery contracts:

  • Definite-quantity contract: Provides for delivery of a definite quantity of specific supplies or services for a fixed period. (16.502)

  • Requirements contract: Provides for filling all actual purchase requirements of designated government activities for supplies or services during a specified contract period (from one contractor). (16.503)

  • Indefinite-quantity contract: Provides for an indefinite quantity, within stated limits, of supplies or services during a fixed period. The government places orders for individual requirements. Quantity limits may be stated as number of units or as dollar values. The Pentagon often awards indefinite delivery, indefinite quantity (IDIQ) contracts. They are used when the Pentagon is not sure how much of a given good or service it's going to need, but wants to put a contractor "on retainer." An IDIQ award can be thought of as a sort of umbrella contract -- awarded initially for a certain amount, the contract gets filled in gradually as multiple awards are issued, up until the ceiling value has been reached. (16.504)

The article Understanding Defense Department Contracts originally appeared on Fool.com.

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