16.402-1
Cost incentives
All incentive contracts must include a cost incentive with a clear profit or fee adjustment formula to motivate effective cost management.
Overview
FAR 16.402-1 outlines the requirements for cost incentives in incentive contracts. These incentives are designed to motivate contractors to control and reduce costs by adjusting profit or fee based on actual performance against target costs. The regulation mandates that any incentive contract must include a cost incentive (or constraint) if other incentives are present. Typically, such contracts specify a target cost, a target profit or fee, and a formula for adjusting the profit or fee depending on whether actual costs are above, at, or below the target. The adjustment is subject to any price ceilings or minimum/maximum fee limits. Award-fee contracts are excluded from these requirements and are governed by separate provisions.
Key Rules
- Mandatory Cost Incentive
- All incentive contracts must include a cost incentive if any other incentive is present.
- Profit/Fee Adjustment Formula
- Contracts must specify a target cost, target profit/fee, and a formula for adjusting profit/fee based on actual costs.
- Adjustment Outcomes
- Meeting the target cost yields the target profit/fee; exceeding the target reduces profit/fee; underrunning the target increases profit/fee, within set limits.
- Exclusion of Award-Fee Contracts
- Award-fee contracts are not subject to these cost incentive requirements.
Responsibilities
- Contracting Officers: Ensure incentive contracts include required cost incentive structures and adjustment formulas.
- Contractors: Manage costs effectively to maximize profit/fee under the contract's incentive structure.
- Agencies: Oversee contract compliance and ensure incentive structures are properly implemented.
Practical Implications
- This section ensures contractors are financially motivated to control costs, aligning their interests with the government's. Failure to include proper cost incentives can result in noncompliance. Contractors must understand how their performance impacts profit/fee and manage projects accordingly. Common pitfalls include misunderstanding the adjustment formula or failing to monitor costs closely.