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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.

Contract Selection Factors

Numerous factors guide the selection of the best contract type for a given purchase. Factors to be considered when determining the contract type include:

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)

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Contract Types

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 considered.

Firm-Fixed-Price Contract

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.

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Fixed-Price Incentive Contract

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 specifies:

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.

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Fixed-Price Contract with Economic Price Adjustment

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).

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Cost-Reimbursement Contracts

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 contract.

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 nonprofit organizations.

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.

Cost-Plus-Incentive-Fee Contract

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).

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Cost-Plus-Fixed-Fee Contract

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 costs.

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 increased.

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 new purchase.

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.

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Cost-Plus-Award-Fee Contract

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 development).

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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 - No Fee.

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.

Time-and-Materials Contracts

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).

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Indefinite-Delivery 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 investment.

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 time-and-materials rate).

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: Requirements.

All delivery-order, task-order, and definite-order contracts must include Clause 2-39: Ordering and Clause 2-40: Delivery-Order Limitations.

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Performance-Based Contracts

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: Evaluate Sources.

Letter Contracts

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 is impossible

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, including a:

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 date

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 and Disputes.

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)

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Ordering Agreements

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.

Other Topics Considered

Consider Performance-Based Contracting Arrangements topic, Develop Sourcing Strategy task, Process Step 2: Evaluate Sources

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