Cost-Plus-Incentive Fee
Encyclopedia
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.
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.
For example, assume a CPIF with:
If the final costs are higher than the target, say 1100, the Buyer will pay 1000 + 100 + 0.8*(1100-1000)=1180 (seller earns 80 which is less than if he had reached the target cost). 1180 (final payout) - 1100 (actual cost) = 80 profit.
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). 1020 (final payout) - 900 (actual cost) = 120 profit.
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.
See also Point of Total Assumption
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Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
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.
Like a cost-plus contract
Cost-plus contract
A cost-plus contract, also termed a Cost Reimbursement Contract, is a contract where a contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit. Cost-reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a...
, 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 (seller earns 80 which is less than if he had reached the target cost). 1180 (final payout) - 1100 (actual cost) = 80 profit.
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). 1020 (final payout) - 900 (actual cost) = 120 profit.
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.
See also Point of Total Assumption
Point of total assumption
The point of total assumption is a point on the cost line of the Profit-cost curve determined by the contract elements associated with a fixed price plus incentive-Firm Target contract above which the seller effectively bears all the costs of a cost overrun...
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