Select Contract Type
Selecting the most effective contract type for a purchase is an important
element of purchase planning and must be considered along with price, risk,
uncertainty, and responsibility for costs. The nature of a purchase will
determine the appropriate contract type. The type of contract selected should
reflect the appropriate risk and responsibility that will be assumed by the
Supplier. For example, full cost responsibility is assumed under a
firm-fixed-price contract, while there is minimal cost responsibility under a
cost-reimbursement contract. The selected contract type determines how the
Supplier will be paid; it drives the Supplier's fee or profit amount.
Purchase/SCM Teams may decide to use a type of contract not described in
this Process Step subject to the approval of a Portfolio manager.
Cost-plus-a-percentage-of-cost contracts may not be used.
The contract is also a driver of supplier performance. An inappropriate
contract type (e.g., supplier's risk is too high) can lead to the supplier
delivering sub par work, renegotiations, or a unsuccessful relationship with a
supplier. A wide selection of contract types is necessary to provide the
flexibility needed for the purchase of a large variety of products and services.
Numerous factors guide the selection of the best contract type for a given
purchase. Factors to be considered when determining the contract type
• Realism of cost estimate (either through price or cost analysis)
• Extent of competition (results in realistic pricing)
• Risks and uncertainties
• Type and complexity of the requirement(s)
• Adequacy and firmness of specifications
• Likelihood of changes
• Past experience with industry, suppliers, and requirements
• Extent of subcontracting
• Adequacy of the supplier's estimating and accounting system
• Urgency of the requirement
• Volatility of cost factors (e.g., unstable labor or market conditions)
• Period of performance or length of production run
• Business practices in industries, trades, or professions
• Concurrent contracts (if performance under the proposed contract
involves concurrent operations under other contracts, the impact
of those contracts should be considered)
The contract types below are frequently used for purchasing by the Postal
Service. Provision 4-1: Standard Solicitation Provision (paragraph F, type of
contract) and Clause B-3: Contract Type state which type of contract is
issued. The Contracting Officer, working with the Purchase/SCM Team, may
decide to use other types of contracts, or hybrids/variations of the existing
contract types. Traditional types of contracts include:
• Fixed-Price Incentive
• Fixed-Price with Economic Price Adjustment
The Purchase/SCM Team chooses the contract type in accordance with
Provision 4-1: Standard Solicitation Provisions. Once determined, potential
suppliers must be informed of the contract type, and proposals must be
submitted on this basis. The Postal Service must inform potential suppliers if
alternate proposals based on other contract types will or will not be
A firm-fixed-price (FFP) contract obligates the supplier to deliver the product
or service specified by the contract for a fixed price; the amount of profit the
supplier receives will depend on the actual cost outcome. Clause 2-26:
Payment - Fixed Price stipulates payment terms for suppliers when this
contract type is used and is to be included in all FFP contracts.
An FFP contract places full responsibility on the supplier for all costs and the
resulting profit or loss. It maximizes suppliers' incentive to control costs and
perform effectively. The FFP is the least burdensome type of contract for the
Postal Service to administer if the requirements are stable; if frequent
changes are made, administration becomes difficult.
FFP contracts are appropriate when specifications are definite, there is little
cost or no scheduled risk, and competition has established best value. There
are also mechanisms built into an FFP contract to anticipate instances when
the supplier can request additional funds. For example, if the Postal Service
does not deliver a specification to a supplier by the agreed-upon date, this
may cause the supplier's schedule to slip, which may result in higher costs.
A fixed-price incentive (FPI) contract provides for adjusting profit and
establishing the final price by applying a formula based on the relationship
between the total final negotiated cost and total target cost. An FPI contract
• Target cost
• Target profit
• Target price
• Price ceiling
• Share ratio
The price ceiling is the maximum that may be paid to the supplier, excluding
adjustments specifically provided for under contract clauses. When
performance is completed, the final cost is redetermined by applying the final
negotiated rates to the incurred costs. When the final cost is less than the
target cost, applying the formula results in a profit greater than the target
profit; when the final cost is more than the target cost, applying the formula
results in a profit less than the target profit. If the final redetermined cost
exceeds the ceiling, the supplier absorbs the difference. The profit varies
inversely with the cost, so this type of contract provides a positive, calculable
profit incentive for the supplier to control costs.
FPI contracts should be used when:
• The Postal Service wishes to incentivize performance
• A firm-fixed-price contract is not suitable
• The parties can establish an initial target cost, target profit, and
profit-adjustment formula that will provide a fair and reasonable
incentive, as well as a ceiling that provides for the supplier to
assume an appropriate share of the risk
• The supplier's accounting system is adequate for providing data
to support negotiation of final cost and incentive price revision
All FPI contracts must include Clause 2-27: Incentive Price Revision.
A fixed-price contract with economic price adjustment provides for upward
and downward revision of the stated contract price upon the occurrence of
specified contingencies. This type of contract establishes a basis for
measuring fluctuations so that price adjustments are limited to contingencies
beyond the supplier's control and reflect actual market fluctuations. Upward
adjustments are limited by establishing a reasonable ceiling, and provisions
are included for downward adjustments when prices or rates fall below base
levels established in the contract.
There are two types of economic price adjustments:
• Adjustments based on actual costs of labor or materials - price
adjustments based on actual increases or decreases in the costs
of specified labor or materials during performance
• Adjustments based on cost indexes of labor or materials - price
adjustments based on increases or decreases in labor or material
cost standards or indexes specifically identified in the contract
Fixed-price contracts with economic price adjustment are appropriate when
there is serious doubt about the stability of market or labor conditions during
an extended period of performance and when contingencies that would
otherwise be included in a firm-fixed-price contract are identifiable and can be
covered separately in the contract. Their usefulness is limited by the
difficulties of administering them.
Fixed-price contracts providing for an economic price adjustment based on
actual costs of labor or materials must include Clause 2-28: Economic Price
Adjustment - Labor and Materials, and fixed-price contracts providing for an
economic price adjustment based on cost indexes of labor or materials must
include Clause 2-29: Economic Price Adjustment (Index Method).
Cost-reimbursement contracts provide for paying allowable, incurred costs.
They establish an estimate of total cost so that funds may be committed, and
they establish a ceiling that the supplier may not exceed (except at its own
risk) without the approval of the Contracting Officer. Cost-reimbursement
contracts are suitable when uncertainties about contract performance do not
permit costs to be estimated with sufficient accuracy to use a fixed-price
Limitations. A cost-reimbursement contract may be used only when:
• The supplier's accounting system can determine the costs that
apply to the contract and
• Postal Service monitoring during performance will assure that
efficient methods and effective cost controls are used.
Cost Contract. A cost contract is a cost-reimbursement contract under which
the supplier receives no fee. A cost contract may be appropriate for research
and development, particularly with nonprofit educational institutions or other
Cost-Sharing Contract. A cost-sharing contract is a cost-reimbursement
contract under which the Supplier receives no fee and is reimbursed only a
portion of its allowable costs, as stated in the contract. It is suitable when
there is a high probability that the Supplier will receive substantial commercial
benefits as a result of performance.
A cost-plus-incentive-fee contract is a cost-reimbursement contract that
provides for the fee initially negotiated to be adjusted later by a formula
based on the relationship of total allowable costs to target cost. This type of
contract specifies a target cost, a target fee, minimum and maximum fees,
and a fee-adjustment formula. After performance, the fee is determined by
the formula. The formula provides, within limits, for increases in the fee above
the target when total allowable costs are less than target cost and for
decreases in the fee below the target when total allowable costs exceed the
target cost. This increase or decrease provides an incentive for the supplier
to manage the contract effectively. When total allowable costs are greater
than or less than the range of costs in the fee-adjustment formula, the
Supplier is paid total allowable costs, plus the minimum or maximum fee.
A cost-plus-incentive-fee contract is suitable when a cost-reimbursement
contract is appropriate and a target cost and fee-adjustment formula can be
negotiated that will motivate the supplier to manage the contract effectively.
The fee-adjustment formula should provide an incentive that covers the full
range of reasonably foreseeable variations from the target cost. The
supplier's share of the difference between target cost and actual cost will
usually be in the range of 15-30 percent. If a high maximum fee is
negotiated, the contract must provide for a low minimum fee-or even a zero
or negative fee. The maximum fee will usually not exceed 10 percent of the
contract's target cost (or 15 percent for research and development).
A cost-plus-fixed-fee contract is a cost-reimbursement contract that provides
for paying the supplier a negotiated, fixed fee. The fixed fee does not vary
with actual costs, but may be adjusted as a result of changes to the contract.
This type of contract gives the Supplier only a minimal incentive to control
A cost-plus-fixed-fee contract is suitable when a cost-reimbursement contract
is necessary, but the uncertainties and risks for the supplier are too great to
permit negotiating a reasonable cost-plus-incentive-fee arrangement.
There are two forms of cost-plus-fixed-fee contracts
Completion form. A completion form describes the scope of work by stating a
definite goal or target and specifying an end product. This form generally
requires the supplier to complete and deliver the end product within the
estimated cost, if possible, as a condition for paying the entire fixed fee. If the
work cannot be completed within the estimated cost, the Postal Service may
require more effort without increasing the fee, but the estimated cost must be
Level-of-effort form. A level-of-effort form describes the scope of work in
general terms and requires the supplier to devote a specified level of effort for
a stated period. Under this form, if performance is satisfactory, the fixed fee is
payable when the period ends and the supplier certifies that the level of effort
specified in the contract has been expended. Renewal for further periods of
performance requires new cost and fee arrangements and is treated as a
Because of the greater obligation assumed by the Supplier, the completion
form is preferred over the level-of-effort form whenever the work can be
defined well enough to permit a reasonable cost estimate within which the
Supplier can complete the work.
A cost-plus-award-fee contract is a cost-reimbursement contract that
provides for a fee consisting of a base amount fixed at the beginning of the
contract and an award amount that the Supplier may earn in whole or in part
during performance. The award amount must be sufficient to motivate
excellence in areas such as quality, timeliness, technical ingenuity, and
cost-effective management. The amount of the award fee is determined by
the Postal Service's evaluation of the Supplier's performance according to
criteria stated in the contract. This determination is made unilaterally by the
Postal Service and is not subject to Clause B-9: Claims and Disputes.
The cost-plus-award-fee contract is particularly suitable for buying services.
The likelihood of meeting purchasing objectives and achieving exceptional
performance is enhanced under this type of contract. It provides the flexibility
to evaluate subjectively, at defined intervals, both actual performance and the
conditions under which performance was achieved. The additional
administrative effort, contract amount, performance period, and cost required
to monitor and evaluate performance must be justified by the expected
benefits to warrant using this type of contract.
Cost-plus-award-fee contracts provide for evaluation at stated intervals
during performance, so that the Supplier is periodically informed of the quality
of performance and areas for improvement. Evaluation criteria and a rating
plan should be prepared for each purchase to motivate the Supplier to
improve in areas important enough to be rated, but not to the detriment of
overall performance. Requirements will vary widely among contracts, so
Contracting Officers must customize evaluation criteria, rating plan, and even
Clause 2-37: Award Fee, seeking advice from the Purchase/SCM Team and
Legal Counsel, as needed. The partial payment of the award fee will usually
correspond to the evaluation periods to provide incentive. If a high award fee
is negotiated, the contract may provide for a low base fee (or even a zero
base). The maximum fee, comprising the base fee plus the highest potential
award fee, will usually not exceed 10 percent (or 15 percent for research and
All solicitations for cost-reimbursement contracts-the estimated value of
which is $100,000 or more-must contain Provision 2-9: Accounting System
Guidelines - Cost Type Contracts. This provision requires preaward review
and approval of the potential supplier's cost accounting system by the
Inspector General or a representative and delineates the elements required
in such accounting systems.
All cost-reimbursement contracts must include the following clauses:
• Clause 2-30: Allowable Cost and Payment
• Either Clause 2-31: Limitation of Cost (if the contract is fully
funded) or Clause 2-32: Limitation of Funds (if the contract is
funded in increments)
Cost contracts must include Clause 2-33: Cost Contract - No Fee.
Cost-sharing contracts must include Clause 2-34: Cost-Sharing Contract -
Cost-plus-incentive-fee contracts must include Clause 2-35: Incentive Fee.
Cost-plus-fixed-fee contracts must include Clause 2-36: Fixed Fee.
Cost-plus-award-fee contracts must include Clause 2-37: Award Fee.
In a time-and-materials (T&M) contract, the Postal Service and supplier agree
on an hourly fixed rate for each labor category which includes overhead and
profit. Materials are supplied at cost, if appropriate, and material-handling
costs may be included with the material costs.
A T&M contract is most commonly used when the exact work to be done
cannot be predicted in advance, such as in repair or warranty work or in the
case of a long-term services contract.
T&M contracts may be used only if no other type of contract will do. The
contract must establish a ceiling price that the supplier exceeds at its own
risk. The Contracting Officer must document the contract file to show the
basis for any change in the ceiling.
A labor-hour contract is a variant of the time-and-materials contract, differing
only in that materials are not supplied by the Supplier. Time-and-materials
and labor-hour contracts must include Clause 2-38: Payment
(Time-and-Materials and Labor-Hour Contracts).
Indefinite-delivery contracts are used when the desired period of performance
is known, but the exact time of delivery is unknown at the time of award.
These contracts establish:
• Supplies or scope of services that can be ordered
• Terms and conditions
• Maximum liability of the Postal Service
Indefinite-delivery contracts typically apply to contracts for products. For
example, if the Postal Service purchases a high-resolution printer, it may
establish an indefinite-delivery contract for future toner purchases for the
printer from the Supplier to reduce administrative lead time and inventory
Indefinite-delivery contracts may provide for delivery of a definite quantity, an
indefinite quantity within a minimum and maximum, or the Postal Service's
requirements. During the contract term, delivery orders are issued by
purchasing organizations or orderors.
The pricing structure of any normal contract type can be used for orders
against indefinite-delivery contracts. Fixed-price orders are preferred unless
the orders cannot be accurately priced before issuing each order. In that
case, time-and-materials or labor-hour orders are preferred. The pricing
mechanism may be the judgment of the Contracting Officer at the time of
issuing each order. The Contracting Officer, in that case, must ensure that the
contract clearly provides for each type of pricing. In addition, if so desired by
the Purchase/SCM Team, the contract may provide for alternative pricing for
each order (e.g., an order may be placed at a fixed price or at a
Definite-quantity contract. A definite-quantity contract provides for a definite
quantity of specific supplies or services during the contract period, with
deliveries to designated locations when ordered. All definite-quantity
contracts must include Clause 2-41: Definite Quantity.
Indefinite-quantity contract. An indefinite-quantity contract provides for an
indefinite quantity of specific supplies or services, within a stated minimum
(must not exceed known requirements) and maximum (must be realistic)
quantity, to be delivered during the contract period to designated locations
when ordered. It is used when precise requirements for supplies or services
ordered over the term of the contract, above known minimums, cannot be
determined. The minimum and maximum are provided to limit the pricing risk
to the supplier. Contract maximums may be exceeded upon the mutual
agreement of the Postal Service and the supplier. All indefinite-quantity
contracts must include Clause 2-42: Indefinite-Quantity.
Requirements contract. A requirements contract provides for filling all (or
specified portions) of actual purchase requirements of designated activities
for specific supplies and services to be delivered as ordered over the term of
the contract. It is used:
• For recurring requirements anticipated during the contract period,
where precise quantities cannot be determined
• To obtain supplies and services in excess of quantities that
activities themselves can furnish within their own capabilities
A requirements contract is preferred when the Purchase/SCM Team decides
to award a requirements contract to only one source and requirements can
be estimated with reasonable accuracy. The solicitation and contract must
state an estimated total quantity and, if feasible, the maximum limit of the
supplier's obligation to deliver and the Postal Service's obligation to order.
The total-quantity estimate must be as realistic as possible, based on records
of previous requirements and current information. The contract may specify
minimum or maximum quantities for individual delivery orders and a
maximum that may be ordered during a specified time.
When a requirements contract is for repair, modification, or overhaul of Postal
Service property, the solicitation must state that failure of the Postal Service
to furnish such items in the amounts described as "estimated" or "maximum"
will not entitle the Supplier to any price adjustment under the Postal Service
Property clause. All requirements contracts must include Clause 2-43:
All delivery-order, task-order, and definite-order contracts must include
Clause 2-39: Ordering and Clause 2-40: Delivery-Order Limitations.
Performance-based contracting arrangements and partnerships should also
be considered when selecting a contract type. Performance-based
contracting is focused on the results instead of the process. The supplier
provides the Postal Service with specific benefits, such as cost reductions or
revenue generation, and in return the supplier shares in the value created.
Performance-based contracting creates an incentive for the supplier to
control its costs. Partnering allows the Postal Service and supplier to control
costs, resolve differences through negotiations, and transform into a
professional relationship built on trust and cooperation. The partnership will
develop throughout the process of the contract. This will lead to payment or
other issues being resolved economically and efficiently. Additional
information can be found in the Consider Performance-Based Contracting
Arrangements topic of the Develop Sourcing Strategy task of Process Step 2:
A letter contract is a written preliminary contractual instrument that authorizes
the supplier to begin work immediately, before a definitive contract is
negotiated. Each letter contract must be as complete and definitive as
possible under the circumstances. The maximum liability of the Postal
Service must be stated (this is the amount estimated to be needed to cover
performance before definitization).
A letter contract is used when:
• The requirement demands that the supplier be given a binding
commitment so that work can begin immediately
• Negotiating a definitive contract in time to satisfy the requirement
• No other type of contract is suitable
The use of a letter contract must be approved by a Portfolio manager.
Each letter contract must contain a negotiated definitization schedule,
• Date for submission of the Supplier's price proposal
• Date for the start of negotiation
• Target date for definitization, which must be the earliest practical
The definitization schedule must provide for definitizing the contract. Because
an undefinitized letter contract is, in effect, a cost-reimbursement contract, it
is not in the Postal Service's interest to allow it to continue longer than
necessary. Therefore, if after exhausting all reasonable efforts, the
Contracting Officer and the Supplier fail to reach an agreement on price or
fee, Clause 2-44: Contract Definitization requires the Supplier to proceed
with the work and provides that the Contracting Officer may determine a
reasonable price or fee, subject to appeal as provided in Clause B-9: Claims
A letter contract must not:
• Commit the Postal Service to a definitive contract in excess of the
funds available at the time the letter contract is executed
• Be modified to add work unless the added work is inseparable
from the work being performed under the letter contract
A letter contract must include clauses required for the type of definitive
contract contemplated, as well as any additional clauses known to be
appropriate. All letter contracts must include the following clauses:
• Clause 2-44: Contract Definitization
• Clause 2-45: Execution and Commencement of Work
• Clause 2-46: Limitation of Postal Service Liability (the maximum
liability, the amount necessary to cover the Supplier's
performance before definitization)
• Clause 2-47: Payment of Allowable Costs Before Definitization
(used if a cost-reimbursement definitive contract is contemplated)
An agreement that may be used between the Postal Service and a supplier
that is not a contract is an ordering agreement. It is a negotiated written
agreement that contains terms and conditions applying to future contracts
between the parties. A contract comes into being between the parties to an
ordering agreement only when orders are issued and accepted by the
parties. Ordering agreements include basic pricing agreements (BPAs), which
are ordering agreements that permit individuals designated by name or title to
place orders by telephone, over the counter, or in writing. Although there may
be a price ceiling for individual orders, there is no limit on the aggregate value
of orders and no commitment to purchase.
An ordering agreement is useful for expediting contracting for uncertain
requirements of supplies or services when specific quantities and prices are
not known at the time the agreement is signed, but substantial quantities of
the supplies or services are expected to be purchased. Ordering agreements
reduce administrative lead time and inventory investment. Ordering
agreements typically apply to contracts for services.
Task orders are principally placed against an ordering agreement. It is the
responsibility of the Contracting Officer to issue the task order; the Client will
issue task descriptions, as its needs arise; and the Supplier will estimate the
cost, based on the labor rates and other applicable costs that are established
in the ordering agreement. The Contracting Officer may accept the estimate
of costs and schedule or negotiate with the supplier to reach agreement.
Consider Performance-Based Contracting Arrangements topic, Develop
Sourcing Strategy task, Process Step 2: Evaluate Sources