# Cost-plus-incentive fee

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Cost-plus-incentive fee

A CPIF Cost-Plus-Incentive-Fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs.[1]

Like a cost-plus contract, the price paid by the buyer to the seller changes in relation to costs, in order to reduce the risks assumed by the contractor (seller). Unlike a cost-plus contract, the cost in excess of the target cost is only partially paid according to a Buyer/Seller ratio, so the seller's profit decreases when exceeding the target cost. Similarly, the seller's profit increases when actual costs are below the target cost defined in the contract.

## Cost formula and examples

To achieve this incentive, in CPIF contracts, the seller is paid his target cost plus an initially negotiated fee plus a variable amount that is determined by subtracting the target cost from the actual costs, and multiplying the difference by the buyer ratio.

For example, assume a CPIF with:

• target costs = 1000,
• fixed fee = 100 (also called Target Profit),
• benefit/cost sharing = 80% Buyer / 20% Seller,

If the final costs are higher than the target, say 1100, the Buyer will pay 1000 + 100 + 0.8*(1100-1000)=1180[2] (seller earns 80 which is less than if he had reached the target cost). If the final costs are lower than the target, say 900, the buyer will pay 1000 + 100 + 0.8*(900-1000) = 1020 (seller earns 120 which is more than if he had reached the target cost).

Final payout = Target cost + Fixed fee + Buyer share ratio * (Actual Cost - Target Cost). If there is a ceiling price involved and actual cost is more than the ceiling Final payout = Target cost + Fixed fee + Buyer share ratio * (ceiling price - Target Cost).

To protect the buyer, it is occasionally agreed to set a ceiling price. This is the maximal price the buyer will required to pay the seller, regardless of how high the costs have become. It is also occasionally agreed that a bonus be paid if costs are below the Target cost.

## References

1. ^ "Subpart 16.3—Cost-Reimbursement Contracts", U.S. Federal Acquisition Regulations, July 2010, webpage: F3.
2. ^ In the formula, an asterisk ("*") is used for multiplication.

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