FAR 16.403-2—Fixed-price incentive (successive targets) contracts.
Plain-English Summary
FAR 16.403-2 explains how a fixed-price incentive (successive targets) contract works, when it may be used, and what must be negotiated and stated in the contract. It covers the required initial elements of the arrangement: initial target cost, initial target profit, the initial profit adjustment formula, the production point for later negotiation of firm targets, and the ceiling price. It also explains the two-step process for moving from initial targets to either a firm fixed price or a final pricing formula once enough performance information is available. The section sets out when this contract type is appropriate, including the need for incomplete cost or pricing information at award but a reasonable expectation that better information will become available early in performance. It also imposes limitations tied to the contractor’s accounting system and the expected availability of reliable cost data. In practice, this section is meant to give the Government and contractor a structured way to start work before final pricing can be fully established, while still preserving incentives and controlling risk through negotiated targets and a ceiling price.
Key Rules
Initial targets required
The contract must be negotiated at the outset with an initial target cost, initial target profit, an initial profit adjustment formula, a production point for later negotiation, and a ceiling price. These are not optional features; they define the successive-target structure.
Profit formula must be set early
The initial profit adjustment formula must include a ceiling and floor for the firm target profit. The formula normally gives the contractor less cost responsibility than a formula used to establish final profit and price.
Firm targets negotiated later
When the specified production point is reached, the parties negotiate the firm target cost based on actual cost experience and other relevant factors. The firm target profit is then established by the formula already agreed to in the contract.
Two options after firm targets
After firm target cost and firm target profit are set, the parties may either negotiate a firm fixed price using those figures as a guide, or negotiate a formula for the final price if a firm fixed price is not appropriate. If a final formula is used, final cost is negotiated at completion and final profit is determined by formula.
Appropriate only with limited initial data
This contract type is appropriate only when available cost or pricing information is not enough to set a realistic firm target cost and profit at award, but enough information exists to set initial targets and there is a reasonable expectation that better information will be available early in performance.
Additional information may come from other work
The later information needed to set firm targets does not have to come only from the contract itself. It may also come from other contracts for the same or similar items.
Accounting system and data availability limits
The contract type may be used only if the contractor’s accounting system can provide data needed to negotiate firm targets, a realistic profit adjustment formula, and later final costs, and if cost or pricing information adequate for a reasonable firm target cost is expected early in performance.
Schedule must state initial pricing data
The contracting officer must put the initial target cost, initial target profit, and initial target price for each item subject to incentive price revision into the contract schedule.
Responsibilities
Contracting Officer
Determine whether this contract type is appropriate, ensure the required initial targets, formula, production point, and ceiling price are negotiated and included, and place the initial target cost, target profit, and target price in the contract schedule. The contracting officer must also manage the later transition to firm targets and, if appropriate, a firm fixed price or final pricing formula.
Contractor
Provide sufficient cost or pricing information available at award, maintain an accounting system capable of supporting later target and final cost negotiations, and participate in negotiations when the production point is reached. The contractor must also support the later establishment of firm targets and final pricing with reliable performance data.
Agency
Use this contract type only when the acquisition circumstances fit the rule’s requirements and when there is a reasonable expectation that better pricing information will become available early enough to support later negotiations. The agency must ensure the contract structure preserves a fair and reasonable incentive and controls risk.
Practical Implications
This contract type is useful when the Government needs to award before it has enough data for a fully realistic firm price, but it is not a shortcut for poor planning; the initial targets still must be negotiated carefully.
The biggest risk is setting initial targets or the profit formula too loosely or too aggressively, which can distort incentives and lead to later disputes when firm targets are negotiated.
Contractors should expect a second major negotiation point during performance, so they need accounting systems and internal cost tracking strong enough to support later pricing discussions.
The production point matters operationally because it triggers the shift from initial targets to firm targets; if it is poorly chosen, the parties may negotiate too early, too late, or without enough reliable data.
The ceiling price is a hard risk-control feature, so both sides should understand that cost growth above the ceiling generally is not recoverable absent another contract clause allowing adjustment.
Official Regulatory Text
(a) Description. (1) A fixed-price incentive (successive targets) contract specifies the following elements, all of which are negotiated at the outset: (i) An initial target cost. (ii) An initial target profit. (iii) An initial profit adjustment formula to be used for establishing the firm target profit, including a ceiling and floor for the firm target profit. (This formula normally provides for a lesser degree of contractor cost responsibility than would a formula for establishing final profit and price.) (iv) The production point at which the firm target cost and firm target profit will be negotiated (usually before delivery or shop completion of the first item). (v) A ceiling price that is the maximum that may be paid to the contractor, except for any adjustment under other contract clauses providing for equitable adjustment or other revision of the contract price under stated circumstances. (2) When the production point specified in the contract is reached, the parties negotiate the firm target cost, giving consideration to cost experience under the contract and other pertinent factors. The firm target profit is established by the formula. At this point, the parties have two alternatives, as follows: (i) They may negotiate a firm fixed price, using the firm target cost plus the firm target profit as a guide. (ii) If negotiation of a firm fixed price is inappropriate, they may negotiate a formula for establishing the final price using the firm target cost and firm target profit. The final cost is then negotiated at completion, and the final profit is established by formula, as under the fixed-price incentive (firm target) contract (see 16.403-1 above). (b) Application . A fixed-price incentive (successive targets) contract is appropriate when- (1) Available cost or pricing information is not sufficient to permit the negotiation of a realistic firm target cost and profit before award; (2) Sufficient information is available to permit negotiation of initial targets; and (3) There is reasonable assurance that additional reliable information will be available at an early point in the contract performance so as to permit negotiation of either (i)a firm fixed price or (ii) firm targets and a formula for establishing final profit and price that will provide a fair and reasonable incentive. This additional information is not limited to experience under the contract, itself, but may be drawn from other contracts for the same or similar items. (c) Limitations . This contract type may be used only when- (1) The contractor’s accounting system is adequate for providing data for negotiating firm targets and a realistic profit adjustment formula, as well as later negotiation of final costs; and (2) Cost or pricing information adequate for establishing a reasonable firm target cost is reasonably expected to be available at an early point in contract performance. (d) Contract schedule . The contracting officer shall specify in the contract schedule the initial target cost, initial target profit, and initial target price for each item subject to incentive price revision.