Consider the following exchange between two people:

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Speaker 1 (asking Speaker 2): What type of car do you drive, foreign or domestic?

Speaker 2: I drive a red car.

Obviously, Speaker 2's answer is not responsive to Speaker 1's question. Speaker 1 wanted to know about a particular aspect of Speaker 2's car:  its origin. Speaker 2 described a different aspect of his car:  its color. While Speaker 2's statement about the color of his car may be true, it doesn't tell us anything about the origin of his car.

Easy enough, right? Ok, let's try another one. Consider the following exchange between two contract specialists:

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Contract Specialist 1: Is Contract X a fixed-price or cost-reimbursement contract?

Contract Specialist 2: Contract X is an indefinite delivery contract.

Is Contract Specialist 2's answer responsive to Contract Specialist 1's question? No, the answer is no more responsive to the question than Speaker 2's answer was to the question of whether his car was foreign or domestic. Why? In this exchange, Contract Specialist 1 wanted to know about a particular aspect of Contract X:  ts compensation arrangement. Contract Specialist 2 described a different aspect of Contract X:  its delivery arrangement. While Contract Specialist 2's statement about the delivery arrangement of Contract X may be true, it doesn't tell us anything about the compensation arrangement of Contract X.

Make sense? If so, see if you can spot anything wrong with the following passage of an article on contract types that recently appeared in the December 2010 issue of Contract Management (see Government Contract Types: The U.S. Government?s Use of Different Contract Vehicles to Acquire Goods, Services, and Construction by Brian A. Darst and Mark K. Roberts):

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FAR Subparts 16.2 through 16.6 describe 11 different permissible contract vehicles. These vehicles can be subdivided into three different families:

• Fixed-price contracts,
• Cost-reimbursement contracts, and
• Other contract vehicles that can be used when the quantity of supplies or services cannot be determined at the time of award (i.e., indefinite delivery, time-and-materials (T&M), labor-hour (LH), and level-of-effort contracts) or where it is necessary for the contractor to begin performance before the terms and conditions of the contracts can be negotiated (i.e., letter contracts).

Do you see anything wrong?  Notice that the first two "families" are categorized by compensation arrangement. However, the third family contains a mix of terms used to describe compensation arrangement (T&M/LH), delivery arrangement (indefinite delivery), the extent of contractor commitment (level-of-effort), and a unique term used to describe a contract that is not definitive (letter contract). The way this passage is written implies that an indefinite delivery contract, a level-of-effort contract, and a letter contract are necessarily different (belong to a different "family") from a fixed-price or cost reimbursement contract. However, an indefinite delivery contract or a level-of-effort contract will have a compensation arrangement. The compensation arrangement can be fixed-price, cost-reimbursement, T&M/LH, or some combination thereof. A letter contract may or may not have a compensation arrangement when it is issued. You could conceivably have a letter contract that had a cost-reimbursement compensation arrangement, an indefinite delivery arrangement, and that provided for level-of-effort orders. As such, the authors? categorization of contract types makes as much sense as categorizing cars into three families?foreign, domestic, and red.

Incentive Contracts? Not What You Think They Are

Consider the following simplified description of a compensation arrangement:

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The buyer agrees to pay the seller $100,000 to provide a specified quantity of medical transcription services. If the accuracy of the transcriptions exceeds 99%, the buyer agrees to pay the seller an additional $5,000.

Does the preceding describe an incentive contract? Many would say yes, because the arrangement provides for an incentive--specifically, a performance incentive. However, that would be incorrect. Just because a contract contains an incentive does not mean that it is an incentive contract. FAR 16.202-1 contains the following statements in a description of firm-fixed-price contracts (similar statements pertaining to fixed-price contracts with economic price adjustment can be found at FAR 16.203-1.

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The contracting officer may use a firm-fixed-price contract in conjunction with an award-fee incentive (see 16.404) and performance or delivery incentives (see 16.402-2 and 16.402-3) when the award fee or incentive is based solely on factors other than cost. The contract type remains firm-fixed-price when used with these incentives.

[bold added].

Further, FAR 16.402-1(a) states:

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Most incentive contracts include only cost incentives, which take the form of a profit or fee adjustment formula and are intended to motivate the contractor to effectively manage costs. No incentive contract may provide for other incentives without also providing a cost incentive (or constraint).

Thus, it's not enough for a contract to contain an incentive to be an incentive contract. It must contain a cost incentive (or constraint).

In the aforementioned Contract Management article, an endnote references FAR 37.601(3) and misinterprets this paragraph as--encouraging the use of incentive-type contracts where appropriate.  Here's what FAR 37.601(3) actually says:

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Performance-based contracts for services shall include-

(3) Performance incentives where appropriate. When used, the performance incentives shall correspond to the performance standards set forth in the contract (see 16.402-2).

The authors have made the mistake of assuming that a contract that contained a performance incentive was necessarily an incentive contract. In fact, when acquiring services FAR 37.102(a)(2) states the following order of precedence:

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(i) A firm-fixed price performance-based contract or task order.

(ii) A performance-based contract or task order that is not firm-fixed price.

(iii) A contract or task order that is not performance-based.

As shown above, a firm-fixed-price contract would take precedence over an incentive contract.

A Genuine Misunderstanding

In a discussion of additional contract types and agreements, the Contract Management article contained the following statement (which caused me to stop reading and start writing):

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T&M and LH contracts are varieties of indefinite-delivery contracts and provide procuring agencies with the flexibility to acquire recurring services or when the amount of the effort required to deliver an end-item is uncertain.

Huh? T&M/LH is a type of indefinite delivery contract? I'll let you readers ponder that one.

The article concludes with a plug for the authors-two-day course in, you guessed it, types of contracts. I will pass.