A cost-plus-incentive fee contract
is a contract
based on a Cost-plus contract
that includes an incentive fee which is awarded if the contractor completes the work under budget. The amount of the incentive fee can be fixed, or proportional to the difference between the actual cost and the total cost agreed to in the contract; this allows for the contractor to earn a greater profit
by beating cost targets.
Like a cost-plus contract, the contractor will make money even if they suffer from cost overruns (cost + profit margin). The contractor will make more money if they surpass the contracted total cost (cost + profit margin + incentive fee).
Assume a cost-plus incentive fee contract is signed with the following characteristics:
- Total cost: $10,000
- Profit margin: $0.15 per dollar
- Incentive fee: $0.45 per dollar
The contractor will make $0.15 for every dollar spent (each dollar of expense is paid for, plus $0.15 profit). If the contractor finishes work with an actual cost under $10,000, then they are awarded $0.45 per dollar saved. The bonus in this example is worth 3 times as much per dollar, thus providing an incentive for the contractor to finish the job under budget.
- If the actual cost is $15,000, the contractor earns a profit of $2,250.
- If the actual cost is $10,000, the contractor earns a profit of $1,500.
- If the actual cost is $5,000, the contractor earns a profit of $3,000. ($750 base profit + $2,250 from the incentive fee).