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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. This mechanism provides an incentive to the seller to reach
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 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) 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)
To protect the buyer, it is common to set a ceiling price. This is the maximal price the buyer will required to pay the seller, regardless of how high the costs are. When the costs exceed a Point of Total Assumption, the ceiling price is paid by the buyer, and beyond that point, the seller pays for 100% of any additional costs.