Government Contract Types Chart: FAR Fixed-Price, Cost, and IDIQ

Federal procurement uses six main government contract types under Part 16 of the Federal Acquisition Regulation: fixed-price, cost-reimbursement, incentive, indefinite-delivery, time-and-materials or labor-hour, and letter contracts. Each shifts financial risk between the contractor and the government in a different way, which drives how price is set, how profit is calculated, and how tightly the work is audited. The comparison below walks through each family, what it looks like, and where it sits on the risk spectrum.

The Risk Spectrum at a Glance

The clearest way to compare contract types is by who pays when costs run over or come in under estimate. On one end sits firm-fixed-price, where the contractor absorbs every dollar of overrun and keeps every dollar of savings. On the other end sits time-and-materials, where the government pays for every hour billed and the contractor’s revenue actually rises with hours worked. Everything else sits between those poles.

Firm-fixed-price — contractor bears all cost risk.¹
Fixed-price incentive — risk shared by formula, capped by a ceiling price above which the contractor absorbs the loss.²
Cost-plus-incentive-fee — government pays allowable costs; fee rises or falls with cost performance.³
Cost-plus-fixed-fee — government pays allowable costs plus a flat fee that does not move with actual spending.⁴
Time-and-materials — government pays a fixed hourly rate per labor category plus material costs; contractor has no built-in incentive to limit hours.⁵

The FAR expects contracting officers to place the maximum feasible cost risk on the contractor that competitive bidding will still tolerate. When the work is uncertain, the government has to absorb more risk to get anyone to bid.⁶

Fixed-Price Contracts

Fixed-price contracts set a price the government will pay regardless of what the work actually costs the contractor. They work best when requirements are clearly defined and enough pricing information exists to set a fair number up front. There are several variants.¹

Firm-Fixed-Price

The simplest arrangement in federal contracting. The price does not change based on actual costs. Officers use it when there is adequate price competition, when prior purchases of similar items give reliable comparisons, or when cost data supports realistic performance estimates.⁷

Fixed-Price With Economic Price Adjustment

Used on longer contracts when labor or material markets swing. The price can move up or down based on specific triggers written into the contract, such as published catalog price changes, actual labor or material cost increases, or movements in recognized cost indexes. The contracting officer must find the adjustment mechanism necessary before using it.¹

Fixed-Price Incentive

Adds a profit-adjustment formula on top of the fixed price. The parties agree at the start on a target cost, target profit, and ceiling price. After the work is done, they negotiate the final cost. Beating the target increases profit; missing it reduces profit; blowing past the ceiling means the contractor absorbs the difference as a loss.²

Firm-Fixed-Price Level-of-Effort

Pays a fixed amount for an agreed quantity of effort rather than a defined deliverable, such as a set number of engineering hours over a fixed period. Because there is no measurable end product, the FAR caps these at the simplified acquisition threshold unless a senior official approves a higher value.⁸

Cost-Reimbursement Contracts

Cost-reimbursement contracts pay the contractor’s allowable costs up to an estimated ceiling. The government carries most of the cost risk, so these are reserved for work that cannot be priced accurately at the outset — research and development, early testing, or any effort where performance unknowns make a fixed price unreasonable.⁴

Before awarding one, the contracting officer must confirm three things: the contractor’s accounting system can accurately track costs to the contract, a written acquisition plan has been approved at least one level above the contracting officer, and the government has enough personnel to manage and surveil performance. Cost-reimbursement contracts cannot be used to buy commercial products or commercial services.⁹

Cost and Cost-Sharing

A straight cost contract reimburses allowable costs and pays no fee. It shows up most often in research agreements with nonprofits and universities. A cost-sharing contract works the same way except the contractor agrees to absorb a portion of the costs, often because the work produces knowledge or intellectual property the contractor can use commercially.⁴

Cost-Plus-Fixed-Fee

The most common cost-reimbursement arrangement. The government reimburses allowable costs and pays a fee that is locked in at the start. The fee does not move with actual costs, which gives the contractor limited financial incentive to control spending but works when the scope can be described only in general terms.⁴

The Cost Ceiling

Every cost-reimbursement contract has an estimated cost that acts as a ceiling. The contractor must notify the contracting officer as it approaches that number. The contractor is not required to keep working beyond the funded amount, and the government is not obligated to add more. “Limitation of Cost” and “Limitation of Funds” clauses enforce the boundary.⁴

One Type You Will Never See

Cost-plus-percentage-of-cost is flatly prohibited by federal law for both defense and civilian agencies, because tying the contractor’s fee to a percentage of costs creates an incentive to spend more.¹⁰ The FAR extends this to subcontracts: any prime contract other than firm-fixed-price must include a clause barring cost-plus-percentage-of-cost at the subcontract level.¹¹

Incentive and Award-Fee Contracts

Incentive contracts sit between fixed-price and cost-reimbursement on the risk spectrum. They use formulas to reward contractors for beating cost, schedule, or technical performance targets. The structure can be fixed-price incentive (above) or cost-plus-incentive-fee. In both, the mechanism is the same: target cost, target fee, and an adjustment formula that increases profit when costs come in low and decreases it when they run high.³

Cost and Technical Performance Incentives

Most incentive contracts rely on cost incentives alone. No incentive contract can include schedule or technical incentives without also including a cost incentive. Technical performance incentives tie profit adjustments to measurable characteristics like range, speed, or reliability, and show up most often in major weapons systems contracts. When several technical incentives coexist, they must be balanced so that chasing one metric does not degrade overall performance.³

Award-Fee Contracts

Award-fee contracts drop the objective formula. Instead, the government subjectively evaluates performance against criteria laid out in an award-fee plan. A Fee Determining Official decides how much of the available award-fee pool the contractor has earned, using ratings that range from “Unsatisfactory” (zero award fee) through “Excellent.” If overall cost, schedule, and technical performance falls below satisfactory, the contractor earns nothing from the pool. The determination is not subject to the disputes process.¹²

These make sense when work is too complex or qualitative for objective formulas. The tradeoff is administrative burden: an Award-Fee Board, an evaluation plan, and periodic reviews. The contracting officer must document through risk and cost-benefit analysis that the overhead is justified before using the structure.¹²

Indefinite-Delivery Contracts

These are ordering vehicles rather than a single deal. They let the government buy supplies or services over time. Three variants cover different levels of certainty about what will be needed.

Definite-quantity. The government knows how much it needs but not when. The contract locks in a specific quantity, and delivery orders schedule shipments or performance at designated locations.¹³
Requirements. The government commits to buying all of its actual needs for a supply or service from one contractor during the contract period. The estimate of volume in the contract is not a guarantee.¹³
Indefinite-quantity (IDIQ). The contract sets a minimum and maximum quantity, in units or dollars, and the government places task or delivery orders as needs arise. The minimum has to be more than token, so the contract is binding, but should not exceed what the government is fairly certain to order.¹⁴

The FAR generally prefers awarding IDIQ contracts to multiple vendors. Once multiple vendors hold contracts, each must get a fair opportunity to compete for individual task orders, subject to narrow exceptions for urgency, logical follow-ons, minimum-guarantee obligations, and statutory sole-source requirements.¹⁵

Time-and-Materials and Labor-Hour Contracts

A time-and-materials contract pays fixed hourly rates for labor plus the actual cost of materials. Each hourly rate bundles wages, overhead, general and administrative expenses, and profit into a single number per labor category. A labor-hour contract is identical except the contractor supplies no materials.⁵¹⁶

The government treats these as least preferred. More hours billed means more revenue for the contractor, so there is no built-in cost discipline. Before using one, the contracting officer must prepare a written Determination and Findings explaining why no other type will work. Every such contract must include a ceiling price the contractor exceeds at its own risk. If the base period plus options runs past three years, the head of the contracting activity must personally approve the Determination and Findings.¹⁷

Contractors on these vehicles should expect close government surveillance of timekeeping. Labor hours get tracked by contract, task, and labor category, with contemporaneous time entry and supervisor review of timesheets as standard audit expectations.¹⁷

Letter Contracts

A letter contract is a preliminary written agreement that lets the contractor start work before all terms are settled. It fills the gap when the government needs performance to begin immediately but does not yet have enough information for a full contract. It has to be converted into a definitive contract type as quickly as possible.

The FAR imposes tight controls. The head of the contracting activity must determine in writing that no other type is suitable. A letter contract cannot commit the government beyond currently available funds, cannot bypass competition, and cannot be amended for new requirements unless those requirements are inseparable from the original work.¹⁸

Every letter contract must include a definitization schedule. The deadline is 180 days after the letter contract date or before the contractor completes 40 percent of the work, whichever comes first. If the parties cannot agree on price, the contracting officer can unilaterally set a reasonable price, subject to the disputes clause.¹⁹

How Contracting Officers Choose

The FAR gives contracting officers a set of factors to weigh: how much price competition exists, how complex the requirement is, how much cost and pricing data is available, and how urgent the need is. Strong competition and a well-defined scope point to firm-fixed-price. Uncertainty or complexity pushes toward cost-reimbursement or incentive arrangements. If only part of the work can be priced with confidence, the officer can split the contract so the well-defined portion is firm-fixed-price while the uncertain portion uses a different type.⁶

As requirements mature and cost data accumulates over successive procurements, the expectation is that follow-on contracts move toward fixed-price. The direction of travel is always to place more risk on the contractor, as far as the market for the work will bear.⁶

1
Acquisition.GOV. FAR Subpart 16.2 – Fixed-Price Contracts
2
Acquisition.GOV. Fixed-Price Incentive (Firm Target) Contracts
3
Acquisition.GOV. 48 CFR 16.402-1 – Cost Incentives
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Acquisition.GOV. FAR Subpart 16.3 – Cost-Reimbursement Contracts
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Acquisition.GOV. 48 CFR 16.601 – Time-and-Materials Contracts
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eCFR. 48 CFR 16.104 – Factors in Selecting Contract Types
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eCFR. 48 CFR 16.202-2 – Application
8
Acquisition.GOV. FAR 16.207-3 – Limitations
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Acquisition.GOV. FAR 16.301-3 – Limitations
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Office of the Law Revision Counsel. 10 USC 3322 – Cost-Plus-a-Percentage-of-Cost Contracts
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Acquisition.GOV. FAR Part 16 – Types of Contracts
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Acquisition.GOV. FAR 16.401 – General
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Acquisition.GOV. FAR Subpart 16.5 – Indefinite-Delivery Contracts
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Acquisition.GOV. FAR 16.504 – Indefinite-Quantity Contracts
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Acquisition.GOV. FAR 16.505 – Ordering
16
Acquisition.GOV. FAR 16.602 – Labor-Hour Contracts
17
Acquisition.GOV. FAR Subpart 16.6 – Time-and-Materials, Labor-Hour, and Letter Contracts
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Acquisition.GOV. FAR 16.603-3 – Limitations
19
Acquisition.GOV. FAR 16.603-2 – Application