CPM/U2 Topic 9 Fixed Price Level Contracts
A fixed price level contract is a type of contract where the payment amount does not depend on resources used or time expended. This is opposed to a cost-plus contract, which is intended to cover the costs with additional profit made. Such a scheme is often used by military and government contractors to put the risk on the side of the vendor, and control costs. However, historically when such contracts are used for innovative new projects with untested or undeveloped technologies, such as new military transports or stealth attack planes, it can and often results in a failure if costs greatly exceed the ability of the contractor to absorb unforeseen cost overruns.
Fixed prices can require more time, in advance, for sellers to determine the price of each item. However, the fixed-price items can each be purchased faster, but bargaining could set the price for an entire set of items being purchased, reducing the time for such bulk purchases treated as a whole batch. Also, fixed-price items can help in pre-determining the value of the entire inventory, such as for insurance estimates.
However, such contracts continue to be popular despite a history of failed or troubled projects, though they tend to work when costs are well known in advance. Some laws have been written which prefer fixed-price contracts, however, many maintain that such contracts are actually the most expensive, especially when the risks or costs are unknown.
Airbus’s German chief executive Tom Enders has noted the fixed-price contract for the A400M transport aircraft was a disaster rooted in naivety, excessive enthusiasm and arrogance, stating, “If you had offered it to an American defence contractor like Northrop, they would have run a mile from it”. He stated that unless the contract was renegotiated, the project must be abandoned.
A Fixed Price Level Contracts contract is suitable for acquiring commercial items or for acquiring other supplies or services on the basis of reasonably definite functional or detailed specifications when the contracting officer can establish fair and reasonable prices at the outset, such as when:
- There is adequate price competition;
- There are reasonable price comparisons with prior purchases of the same or similar supplies or services made on a competitive basis or supported by valid cost or pricing data;
- Available cost or pricing information permits realistic estimates of the probable costs of performance; or
- Performance uncertainties can be identified and reasonable estimates of their cost impact can be made, and the contractor is willing to accept a firm fixed price representing assumption of the risks involved.