FAR 16.401—General.
Plain-English Summary
FAR 16.401 explains when and how the Government may use incentive contracts, including fixed-price incentive contracts, cost-reimbursement incentive contracts, and award-fee contracts. It states the basic policy for using incentives: they are appropriate when a firm-fixed-price contract is not suitable and when linking profit or fee to performance can lower cost, improve delivery, or improve technical results. The section also explains how incentive targets must be reasonable, attainable, and clearly communicated, and how incentive formulas must reward performance above target and penalize performance below target. It identifies the two basic categories of incentive contracts and notes that fixed-price incentive contracts are preferred when cost and performance are reasonably certain, while cost-reimbursement incentive contracts remain subject to the general cost-reimbursement limitations in FAR 16.301. The section further requires a signed determination and findings (D&F) by the head of the contracting activity for all incentive- and award-fee contracts, documenting why the contract type is in the Government’s best interest. Finally, it lays out the special rules for award-fee contracts, including when they are appropriate, how award-fee amounts are determined, the need for an award-fee plan and Award-Fee Board, approval requirements, evaluation criteria tied to acquisition objectives, and the use of adjectival ratings and award-fee pool percentages.
Key Rules
Use incentives only when justified
Incentive contracts are appropriate when a firm-fixed-price contract is not suitable and when tying profit or fee to performance can reduce cost or improve delivery or technical performance. The contract should be designed to achieve specific acquisition objectives, not simply to add a bonus structure.
Set clear, attainable targets
The Government must establish reasonable targets and communicate them clearly to the contractor. Incentive arrangements should motivate effort that might otherwise be neglected and discourage inefficiency and waste.
Reward performance above target
For formula-type technical or delivery incentives, increases in profit or fee are earned only for performance that exceeds the target, and decreases apply when targets are missed. The incentive applies to performance targets, not to minimum performance requirements.
Know the two incentive contract types
The two basic categories are fixed-price incentive contracts and cost-reimbursement incentive contracts. Fixed-price incentive contracts are preferred when costs and performance requirements are reasonably certain, while cost-reimbursement incentive contracts must also comply with the general limitations in FAR 16.301.
Prepare a signed D&F
A determination and findings signed by the head of the contracting activity is required for all incentive- and award-fee contracts. The D&F must justify that using the contract type is in the Government’s best interest and must be placed in the contract file.
Use award-fee only when objective targets do not work
Award-fee contracts are appropriate only when it is not feasible or effective to set predetermined objective incentive targets for cost, schedule, and technical performance. They are intended for situations where flexible evaluation of both performance and the conditions under which it was achieved will improve the chance of meeting acquisition objectives.
Support award-fee with risk and cost-benefit analysis
The added administrative effort and cost of monitoring and evaluating award-fee performance must be justified by expected benefits. That justification must be documented in a risk and cost-benefit analysis included in the D&F.
Tie award fee to overall satisfactory performance
Award fee must be commensurate with the contractor’s overall cost, schedule, and technical performance against the contract requirements and award-fee plan. No award fee may be earned if overall performance in the aggregate is below satisfactory.
Use an approved award-fee plan
Every award-fee contract must have an award-fee plan that sets evaluation procedures and establishes an Award-Fee Board. The plan must be approved by the FDO unless agency procedures authorize another approval path.
Use required rating structure
The award-fee plan must identify evaluation criteria linked to acquisition objectives and use the prescribed adjectival ratings and award-fee pool percentages. The contracting officer may supplement the adjectival descriptions, but the method for assigning ratings must be documented in the plan.
Responsibilities
Contracting Officer
Select an incentive or award-fee structure only when appropriate, ensure targets and criteria are clearly written, document the basis for award-fee determinations in the contract file, and make sure the award-fee plan and rating methodology are properly incorporated and followed.
Head of the Contracting Activity
Sign the required determination and findings for all incentive- and award-fee contracts, justifying that the contract type is in the Government’s best interest.
Agency / Contracting Activity
Maintain procedures for approving award-fee plans, establishing Award-Fee Boards, and ensuring the contract file contains the required documentation and analyses.
FDO
Approve award-fee plans unless agency procedures assign that approval authority elsewhere.
Award-Fee Board
Conduct award-fee evaluations under the approved plan, assess contractor performance against the stated criteria, and support the Government’s award-fee recommendation or determination.
Contractor
Perform to the stated targets and criteria, understand that incentives apply to performance above target rather than minimum requirements, and provide the performance needed to earn fee or profit under the contract structure.
Practical Implications
This section is a gatekeeper for using incentive and award-fee contracts: if the acquisition does not justify the structure, the Government should not use it. Poorly supported incentive choices can create protest risk, audit findings, or weak contract administration.
The biggest drafting risk is vague or unrealistic targets. If the targets are not measurable, attainable, and tied to acquisition objectives, the incentive loses value and may be difficult to administer or defend.
Award-fee contracts require significant administrative discipline. Agencies must be prepared to run evaluations, maintain an Award-Fee Board, document decisions, and support the added overhead with a real cost-benefit rationale.
Award-fee determinations are discretionary and must be based on the approved plan and documented performance record. Contractors should not assume that strong performance in one area will earn fee if overall cost, schedule, and technical performance is below satisfactory.
Contracting officers should be careful not to use award-fee as a substitute for poor requirement definition. If objective performance measures can be set, FAR expects the Government to consider whether a more structured incentive approach is better than award-fee subjectivity.
Official Regulatory Text
(a) Incentive contracts as described in this subpart are appropriate when a firm-fixed-price contract is not appropriate and the required supplies or services can be acquired at lower costs and, in certain instances, with improved delivery or technical performance, by relating the amount of profit or fee payable under the contract to the contractor’s performance. Incentive contracts are designed to obtain specific acquisition objectives by- (1) Establishing reasonable and attainable targets that are clearly communicated to the contractor; and (2) Including appropriate incentive arrangements designed to- (i) motivate contractor efforts that might not otherwise be emphasized; and (ii) discourage contractor inefficiency and waste. (b) When predetermined, formula-type incentives on technical performance or delivery are included, increases in profit or fee are provided only for achievement that surpasses the targets, and decreases are provided for to the extent that such targets are not met. The incentive increases or decreases are applied to performance targets rather than minimum performance requirements. (c) The two basic categories of incentive contracts are fixed-price incentive contracts (see 16.403 and 16.404 ) and cost-reimbursement incentive contracts (see 16.405 ). Since it is usually to the Government’s advantage for the contractor to assume substantial cost responsibility and an appropriate share of the cost risk, fixed-price incentive contracts are preferred when contract costs and performance requirements are reasonably certain. Cost-reimbursement incentive contracts are subject to the overall limitations in 16.301 that apply to all cost-reimbursement contracts. (d) A determination and finding, signed by the head of the contracting activity, shall be completed for all incentive- and award-fee contracts justifying that the use of this type of contract is in the best interest of the Government. This determination shall be documented in the contract file and, for award-fee contracts, shall address all of the suitability items in 16.401 (e)(1). (e) Award-fee contracts are a type of incentive contract. (1) Application . An award-fee contract is suitable for use when- (i) The work to be performed is such that it is neither feasible nor effective to devise predetermined objective incentive targets applicable to cost, schedule, and technical performance; (ii) The likelihood of meeting acquisition objectives will be enhanced by using a contract that effectively motivates the contractor toward exceptional performance and provides the Government with the flexibility to evaluate both actual performance and the conditions under which it was achieved; and (iii) Any additional administrative effort and cost required to monitor and evaluate performance are justified by the expected benefits as documented by a risk and cost benefit analysis to be included in the Determination and Findings referenced in 16.401 (e)(5)(iii). (2) Award-fee amount . The amount of award fee earned shall be commensurate with the contractor’s overall cost, schedule, and technical performance as measured against contract requirements in accordance with the criteria stated in the award-fee plan. Award fee shall not be earned if the contractor’s overall cost, schedule, and technical performance in the aggregate is below satisfactory. The basis for all award-fee determinations shall be documented in the contract file to include, at a minimum, a determination that overall cost, schedule and technical performance in the aggregate is or is not at a satisfactory level. This determination and the methodology for determining the award fee are unilateral decisions made solely at the discretion of the Government. (3) Award-fee plan . All contracts providing for award fees shall be supported by an award-fee plan that establishes the procedures for evaluating award fee and an Award-Fee Board for conducting the award-fee evaluation. Award-fee plans shall- (i) Be approved by the FDO unless otherwise authorized by agency procedures; (ii) Identify the award-fee evaluation criteria and how they are linked to acquisition objectives which shall be defined in terms of contract cost, schedule, and technical performance. Criteria should motivate the contractor to enhance performance in the areas rated, but not at the expense of at least minimum acceptable performance in all other areas; (iii) Describe how the contractor’s performance will be measured against the award-fee evaluation criteria; (iv) Utilize the adjectival rating and associated description as well as the award-fee pool earned percentages shown below in Table 16-1. Contracting officers may supplement the adjectival rating description. The method used to determine the adjectival rating must be documented in the award-fee plan; Table 16-1 Award-Fee Adjectival Rating Award-Fee Pool Available To Be Earned Description Excellent 91%-100% Contractor has exceeded almost all of the significant award-fee criteria and has met overall cost, schedule, and technical performance requirements of the contract in the aggregate as defined and measured against the criteria in the award-fee plan for the award-fee evaluation period. Very Good 76%-90% Contractor has exceeded many of the significant award-fee criteria and has met overall cost, schedule, and technical performance requirements of the contract in the aggregate as defined and measured against the criteria in the award-fee plan for the award-fee evaluation period. Good 51%-75% Contractor has exceeded some of the significant award-fee criteria and has met overall cost, schedule, and technical performance requirements of the contract in the aggregate as defined and measured against the criteria in the award-fee plan for the award-fee evaluation period. Satisfactory No Greater Than 50% Contractor has met overall cost, schedule, and technical performance requirements of the contract in the aggregate as defined and measured against the criteria in the award-fee plan for the award-fee evaluation period. Unsatisfactory 0% Contractor has failed to meet overall cost, schedule, and technical performance requirements of the contract in the aggregate as defined and measured against the criteria in the award-fee plan for the award-fee evaluation period. (v) Prohibit earning any award fee when a contractor’s overall cost, schedule, and technical performance in the aggregate is below satisfactory; (vi) Provide for evaluation period(s) to be conducted at stated intervals during the contract period of performance so that the contractor will periodically be informed of the quality of its performance and the areas in which improvement is expected ( e.g. six months, nine months, twelve months, or at specific milestones); and (vii) Define the total award-fee pool amount and how this amount is allocated across each evaluation period. (4) Rollover of unearned award fee . The use of rollover of unearned award fee is prohibited. (5) Limitations . No award-fee contract shall be awarded unless- (i) All of the limitations in 16.301-3 , that are applicable to cost-reimbursement contracts only, are complied with; (ii) An award-fee plan is completed in accordance with the requirements in 16.401 (e)(3); and (iii) A determination and finding is completed in accordance with 16.401 (d) addressing all of the suitability items in 16.401 (e)(1). (f) Incentive- and Award-Fee Data Collection and Analysis . Each agency shall collect relevant data on award fee and incentive fees paid to contractors and include performance measures to evaluate such data on a regular basis to determine effectiveness of award and incentive fees as a tool for improving contractor performance and achieving desired program outcomes. This information should be considered as part of the acquisition planning process (see 7.105 ) in determining the appropriate type of contract to be utilized for future acquisitions. (g) Incentive- and Award-Fee Best Practices . Each agency head shall provide mechanisms for sharing proven incentive strategies for the acquisition of different types of products and services among contracting and program management officials.