The Federal Acquisition Regulation (FAR) is a comprehensive guidebook outlining the different types of government contracts that federal agencies routinely award. Selecting the right contract type isn’t a one-size-fits-all endeavor; it involves various factors, including the nature of supplies and services, the degree of competition, and the associated risks.
Learn here about each type of government contract designed to align with the specific needs of the federal government and the contractor.
Table of Contents
Three Levels of Government of Contracts
Here are the three levels of government contracts—each with specific reach, compliance, and opportunities.
Local government contracts
Local governments, including cities, counties, and school districts, fulfill their operational needs and public services through contracts. Contractors can bid on these contracts on local government websites; for example, the California Department of Transportation for road and rail projects.
Local governments have different ways to make these contracts.
- Personal service contracts: professional or technical services provided to the government (e.g., auto repair services to maintain an agency’s vehicle fleet)
- Interlocal agreements: local government agencies contract with one another to avoid duplicate services for animal control, parks and recreation, and law enforcement
- Mutual aid agreements: for assistance in disasters and emergencies
State government contracts
State government contracts provide services for programs at the state level. These contracts often involve big projects like IT systems, building and zoning, and infrastructure like roads and water systems. Each state has its way of managing contracts, usually involving competitive bidding to get the best value for taxpayers.
For instance, Illinois’ official website contains a live database showing state contracts, spending, and the organizations involved. The Illinois Department of Central Management Services facilitates activities on competitive bidding and cost-effective purchases, while the Illinois Office of the Comptroller shows state tax dollar allocation and vendor engagement.
Meanwhile, California requires that state agencies give at least 25% of their contracts to small businesses certified by the state (Certified SB) and 3% to businesses owned by disabled veterans (DVBE). The California Department of General Services manages these contracts and assists businesses that want to work with the state.
Federal government contracts
Federal contracts are governed by the Federal Acquisition Regulation (FAR), which sets the rules for federal procurement processes. In 2023, federal government contract awards reached $765 billion, mainly due to increased spending in defense, construction, technology, and space programs.
Federal contracts tend to be larger in value and impact compared to state and local contracts. They benefit the U.S. government as a whole, while state and local contracts tend to focus more on local needs.
Read more: What is Government Contracting: A Complete Overview
8 Different Types of Government Contracts
Here are the different types of government contracts, including their examples, advantages, and disadvantages.
1. Fixed-price contracts
A fixed-price contract is when a contractor agrees to do a job for a set price, no matter how much the overall costs set back the contractor. This type of government contract is also called a firm-price or lump-sum contract.
With the nature of this contract type, contractors can’t ask for additional funding if the project ends up costing more than expected. They need to manage their expenses carefully because they’re always at risk of paying extra costs.
Subtypes of fixed price contracts
- Firm fixed-price contracts pay the contractor a set amount for completed work without any cost adjustments. This puts maximum risk on the contractor, responsible for managing all costs and making a profit or loss.
- Fixed-price incentive contracts adjust the contractor’s profit and contract’s final price based on the relationship between the total final negotiated cost and the total target cost. This type of contract is used when a firm-fixed-price contract is unsuitable because of potential technical performances or delivery incentives.
- Fixed-ceiling-price contracts with price redetermination provide a firm fixed price for the initial performance period; the price for subsequent periods is determined at specified times. It’s mainly used for research and development contracts worth up to $100,000 when a fair and reasonable firm fixed price cannot be negotiated at the outset.
- Fixed-price contracts with economic price adjustment are used when there is uncertainty in market or labor conditions during the extended performance period. They are often used when acquiring commercial items.
- Firm fixed-price level-of-effort contracts are suitable for investigations or studies in specific research and development areas. The contractor is paid based on their exerted effort, with a report reflecting the achieved results.
Advantages of fixed-price contracts
Fixed-price contracts offer stability on the project costs for both the government and the contractor. These contracts compel contractors to manage their spending efficiently, reducing the government’s risk of budget overruns.
In addition, fixed-price contracts enable government agencies to compare proposals and select the best value agreements easily. This contract structure encourages contractors to innovate and find cost-effective solutions to maximize their profits.
Disadvantages of fixed-price contracts
Conversely, fixed-price contracts pose several risks and limitations. Contractors bear the financial burden of cost overruns and significant losses. For instance, Boeing experienced over $7 billion in cost overruns on a $4.9 billion fixed-price contract for the KC-46 tanker program.
Additionally, these types of government contracts offer limited flexibility to change project scope or requirements, leading to disputes over contract modifications. Contractors may also cut corners or use lower-quality materials to stay within budget, compromising the project’s quality.
Lastly, contractors may increase their initial bid to cover potential risks, which may heighten the final costs for the government.
2. Time and materials contracts
A time and materials contract is a flexible agreement between the government and contractors. The contractor gets paid for the actual time they spend working and the materials they use.
These types of government contracts are ideal for projects with unpredictable work or materials, such as renovating an old building, developing new software, or providing consulting services.
Federal Acquisition Regulation Subpart 16.6 limits the contractor’s charge of these contractors, giving the government most of the authority to monitor project operations.
Advantages of time and materials contracts
Time and materials contracts offer the government flexibility to adjust the scope of work as the project progresses. This becomes useful when requirements are uncertain or expected to change within the project duration. These contracts reduce the risk of budget overruns as government buyers set the labor rates upfront.
Additionally, T&M contracts provide transparency and control, allowing the government to monitor project progress and costs closely. This enables the government to pay for the actual work done and materials used only.
Disadvantages of time and materials contracts
T&M contracts pose a financial risk to the government, as it must shoulder costs exceeding the initial budget. These types of government contracts also require meticulous tracking of time and materials, requiring more administrative work from the government.
Furthermore, since contractors are paid for the actual hours worked, there may be less incentive to complete the work efficiently.
3. Cost-reimbursement contracts/cost plus fixed fee contracts
Cost-reimbursement contracts are agreements where the contractor gets reimbursed for all the reasonable costs they incur, plus a profit fee, for the completion of the project. The U.S. government uses these contracts for its research and development efforts, which often involve exploring uncertain ideas where the outcomes and costs upfront can be difficult to predict.
Having a clear system to track and report costs is key to managing these types of government contracts. Regular reporting, cost audits, and clear procedures for changes can also help maintain transparency and avoid unexpected costs.
The Department of Defense and the National Institutes of Health use cost-reimbursement contracts for research of new technologies or medical treatments. For example, the Department of Energy awards cost-reimbursement contracts for cleaning up hazardous waste sites where the extent of contamination and the cleanup methods are uncertain.
Subtypes of cost reimbursement contracts
- Cost-plus-fixed-fee (CPFF) pays the contractor a fixed negotiated fee, regardless of the actual costs incurred. However, the fixed fee may be adjusted if there are modifications in the work specified in the contract.
- Cost-plus-incentive-fee (CPIF) sets a fee that can be adjusted based on the relationship between total allowable costs and total target costs. If the contractor meets or exceeds specified performance targets, they may receive additional incentives.
- Cost-plus-award-fee (CPAF) determines the base award amount at the contract’s start date. The government bases the amount on the contractor’s performance and execution.
- Cost-plus-percentage of cost (CPPC) requires the government to reimburse the contractor for all legitimate project costs. Subsequently, the contractor’s profit increases as costs rise.
Advantages of cost-reimbursement contracts
Cost-reimbursement contracts can be more cost-effective than fixed-price contracts because the government reimburses the contractor for the actual cost of materials rather than the estimated cost. It incentivizes contractors to take on projects with uncertain costs and use high-quality labor and materials.
Disadvantages of cost-reimbursement contracts
On the flip side, the final costs for cost-reimbursement contracts are uncertain, leading to budget uncertainty for the government. Contractors may find it less appealing to operate efficiently as they are reimbursed for costs and receive a fixed fee regardless. These types of government contracts also require increased oversight from the government to ensure that only allowable costs are reimbursed.
4. Indefinite delivery, indefinite quantity contracts
Indefinite delivery, indefinite quantity (IDIQ) contracts are flexible contracting agreements the U.S. government uses to buy goods and services. These types of government contracts allow for an indefinite amount of supplies or services to be purchased over a set duration, typically with a base period and renewal options for up to five years.
When purchasing under an IDIQ contract, the government issues task orders for services or delivery orders for supplies. These orders specify the quantity, delivery schedule, and other requirements for that particular purchase.
The federal government frequently relies on IDIQ contracts to acquire all the IT services and products like software, hardware, and support services within the project duration. For example, the GDIT recently secured all initial task orders on a $4.5 billion Air Force security support services IDIQ contract.
Subtypes of indefinite delivery and quantity contracts
- Definite quantity contracts set a specific quantity of goods or services to be delivered over a fixed period. Deliveries are scheduled based on orders the government places at designated locations.
- Requirements contracts are a type of IDIQ contract wherein the contractor agrees to supply all the goods or services that the government needs. In return, the government commits to purchasing exclusively from the contractor, ensuring a steady demand for the seller’s products or services.
- Indefinite quantity contracts allow the delivery of an unspecified quantity of goods or services within set limits over a fixed period. The government places orders based on its needs; quantity limits are specified in units or dollar values.
IDIQ contracts classification based on the number of awardees
- Single-award IDIQ contracts are awarded to a single contractor who receives all task or delivery orders. It simplifies pricing for products and services but limits the government’s flexibility as it relies solely on one vendor.
- Multiple-award IDIQ contracts are awarded to multiple contractors, creating a pool of qualified vendors. Task or delivery orders are then competed among these contractors, providing the government with more options and better value.
Advantages of IDIQ contracts
IDIQ contracts streamline government procurement by consolidating the contract process into a single, multi-year agreement. Reducing the number of small contracts prevents the government from going through lengthy procurement processes, saving its valuable time and resources.
Moreover, the flexibility in the scope of work and pricing structure of IDIQ contracts allows the government to adjust the quantity and scope of work to meet its changing requirements. They facilitate longer-term planning and more effective budget management for its contracting needs.
Disadvantages of IDIQ contracts
A major disadvantage of IDIQ contracts is that the government may only order the minimum required quantity. It leaves contractors with a surplus of work and materials than initially expected.
Multiple-award IDIQs also have higher administrative costs and complexity because of the fair opportunity requirement. In line with this, competition for these types of government contracts can be intense, making it challenging for smaller contractors to secure orders.
5. Labor-hour contracts
Labor-hour contracts are used when the required work scope isn’t clearly defined, such as professional or consultant services. They work similarly to time-and-materials (T&M) contracts, but the key difference lies in the government paying based on the hourly rate of labor. This payment covers all qualified labor categories specified in the contract, including wages, indirect costs, administrative expenses, and profit.
However, unlike T&M contracts, labor-hour contracts don’t cover the cost of materials. These costs are either provided by the government or paid for separately.
For example, Ernst and Young and KPMG were awarded labor-hour contracts for audit services for the Department of Defense Office of Inspector General and the Army General Fund and Working Capital Fund, respectively.
Advantages of labor-hour contracts
Under labor-hour contracts, billing is simple: payments are based on the number of labor hours worked at agreed-upon rates. This straightforward process makes invoicing and payments easier for the government and contractors.
Disadvantages of labor-hour contracts
Contractors face profit uncertainty with labor-hour contracts because their earnings depend directly on the hours worked. If a project requires fewer hours, the contractor’s profit may be lower than anticipated.
6. GSA schedule contracts
GSA schedule contracts, also referred to as multiple award schedules (MAS) contracts, are long-term purchasing agreements between the government and commercial firms. They give federal, state, and local government buyers access to over 12 million products and services at discounted prices, including food service and hospitality, healthcare and medical, and office supplies.
In fiscal year 2023, the GSA reported over $46 billion in sales under their GSA MAS Contracts. Companies awarded with a GSA schedule contract can last for up to 20 years, providing a long-term partnership with government agencies.
To become a MAS holder, businesses must submit an offer and be awarded a MAS contract. However, being awarded these types of government contracts doesn’t guarantee purchases; companies must still pursue opportunities, market their business, and compete against other contractors.
One example is the GSA’s contracts for 2022 light-duty vehicles, including both fossil fuel-powered vehicles and zero-emission vehicles (ZEVs). Automotive companies were chosen to support the electrification of federal fleets in response to President Biden’s Executive Order on climate change.
Advantages of GSA schedule contracts
Vendors on a GSA schedule negotiate their terms and pricing upfront. This process simplifies federal contracting, entitles them as an approved government contractor, reduces competition, and provides access to exclusive opportunities through platforms like GSA Advantage and GSA eLibrary.
At the same time, government buyers benefit from lower administrative costs, more savings through competitive market-based pricing, better flexibility in customizing terms and conditions, and increased time savings due to quicker access to the right industry partners.
Disadvantages of GSA schedule contracts
Conversely, GSA schedule contracts come with strict compliance requirements and regulations. For example, Trade Agreement Act (TAA) compliance requires products to be manufactured or substantially transformed in the United States and designated countries. Failure to comply with TAA can result in the contract being voided.
Pricing restrictions are also a concern, as companies must charge at or below their most favored customer (MFC) pricing to government buyers. It limits them from offering lower prices to commercial customers, compelling them to monitor pricing across customer classes.
Additionally, businesses cannot freely use discounts for marketing once they start contracting with the government. Offering discounts on the commercial market obligates them to offer similar or even lower prices to the government, potentially affecting their profitability.
7. Modification contracts
Contract modifications are changes made to an existing contract’s terms and conditions. These modifications can include adjusting the price to account for scope changes or market conditions, adding or removing tasks, changing the delivery schedule, or making specific alterations to the contract terms.
Types of contract modifications
- A bilateral modification, also known as a supplemental agreement, is a contract change that both the contractor and the contracting officer sign. It can be used to add more work, revise existing terms, or change the contract price, delivery schedule, quantity, or specific terms.
- A unilateral modification, on the other hand, is signed only by the contracting officer. It is used for administrative changes like updating information, correcting typographical mistakes, issuing change orders within the contract’s scope, making changes authorized by specific contract clauses (like Property, Options, or Suspension of Work), or issuing termination notices.
The main difference between unilateral and bilateral modifications lies in the consent and participation of the parties involved in the contract modification process. However, not all changes can be made through contractor modifications, as major changes outside the original contract’s scope may require a new procurement process.
Advantages of contract modifications
Modifications are useful for adjusting contract terms to fit changing requirements, conditions, or unexpected situations. These changes ensure the contract stays relevant over time and manage risks related to contract performance.
Disadvantages of contract modifications
Modifications, especially unilateral ones, can lead to disputes if there are disagreements over the change’s terms. These changes can increase costs for the contractor, especially if the modification involves extra work or extends the performance period without adequate compensation.
8. Set-aside contracts
Set-aside contracts are a key part of the U.S. government’s procurement strategy to give small businesses a shot at winning federal contracts. These types of government contracts are exclusively for businesses that meet certain criteria to promote diversity, innovation, and growth.
Reserving a portion of federal contracts for small businesses helps the government prevent larger companies from monopolizing the market and offers opportunities to socio-economically disadvantaged groups.
Types of set-aside contracts
- Competitive set-asides give qualified small businesses a chance to win contracts worth under $150,000. This process happens when the contracting officer expects at least two responsible small businesses to bid at set fair prices.
- Sole-source contracts are non-competitive contracts, primarily used when there’s only one known source of the specific solution, or when no other option meets the agency’s requirements. They come with strict rules and conditions, with most states needing a written justification for why they’re the only option.
Small business set-aside programs
8(A) business development program promotes small businesses owned by black Americans, Hispanic Americans, Native Americans, Pacific Americans, and other ethnic groups. This program sets aside at least 5% of federal contracts for these businesses.
Women-owned small business (WOSB) program allocates 5% of the federal contracting dollars for women-owned businesses. To qualify, the business must be at least 51% owned and controlled by women who are U.S. citizens, managing day-to-day operations and making long-term decisions.
Service-disabled veteran-owned program is for veterans who’ve served and become disabled during their military service. This program sets aside 3% of federal contracting dollars for businesses owned by service-disabled veterans, with at least 51% ownership and control by these veterans.
Historically underutilized business zone (HUBZone) program boosts businesses in HUBZone areas. To qualify, a business must be small, at least 51% owned and controlled by U.S. citizens. Their main office should be in a HUBZone, and at least 35% of their employees live in a HUBZone for at least 180 days after certification.
Advantages of set-aside contracts
Set-aside contracts help small businesses soar in economic development and job creation. These types of government contracts are crafted to simplify procedures and speed up payments, a huge plus for small businesses that may find larger procurement processes a bit daunting.
Plus, the federal government provides opportunities for small businesses to subcontract on prime contracts through small business subcontracting plans. This opportunity paves the way for them to compete for and eventually win prime contracts.
Disadvantages of set-aside contracts
Some businesses try to cheat the system by misrepresenting their size or eligibility. This kind of fraud messes with the program’s integrity and takes opportunities away from small businesses that deserve them.
Moreover, small businesses often pay more for their inputs because they can’t buy in bulk like big companies can. In the end, government contracts awarded to small businesses may end up costing more.
FAQs
What is the best type of contract?
The concept of the “best” type of government contract is subjective. It depends on various factors, including the nature of the work, the level of risk involved, the contractor’s capabilities, and the government’s needs. There is no one-size-fits-all answer to this question, as the most appropriate contract type varies significantly based on the specific procurement circumstances.
For instance, fixed-price contracts are best for projects with a set price for the work scope, while time and materials contracts are best for projects with unclear timeframes.
What are the most common government contracts?
The most common types of government contracts are fixed-price, cost-reimbursement, and indefinite delivery/indefinite quantity (IDIQ) contracts due to their distinct characteristics that cater to government procurement’s various needs and risk profiles.
They are also frequently awarded by major government agencies, such as the Department of Defense, the Department of Energy, the National Aeronautics and Space Administration, and the Department of Health and Human Services.
