FAR 16.405-1—Cost-plus-incentive-fee contracts.
Plain-English Summary
FAR 16.405-1 explains what a cost-plus-incentive-fee (CPIF) contract is, when it is appropriate, and what limits apply before it can be used. It covers the basic structure of the contract, including target cost, target fee, minimum and maximum fees, and the fee-adjustment formula that increases or decreases fee based on actual allowable costs compared with target cost. It also addresses when CPIF is suitable for services and development/test work, including situations where a cost-reimbursement contract is necessary and where the parties can negotiate a realistic target cost and incentive formula that will motivate effective management. The section further discusses the optional use of technical performance incentives for major systems and other acquisitions when both cost and technical incentives are practical and desirable. Finally, it emphasizes that the fee-adjustment formula must work across the full range of reasonably foreseeable cost outcomes and that all general cost-reimbursement limitations in FAR 16.301-3 must be satisfied before award. In practice, this section matters because it tells contracting officers how to structure an incentive arrangement that rewards cost control without shifting excessive risk to the contractor, and it helps contractors understand how their fee can rise, fall, or be capped depending on performance.
Key Rules
CPIF is cost-reimbursement
A CPIF contract is a cost-reimbursement contract, not a fixed-price arrangement. The contractor is paid allowable costs, and the fee is later adjusted by formula based on how total allowable costs compare to target cost.
Target cost and fee required
The contract must specify a target cost, target fee, minimum and maximum fees, and a fee-adjustment formula. These terms are negotiated up front and determine the final fee after performance.
Fee moves with cost performance
If actual allowable costs come in below target cost, the contractor can earn more than target fee; if costs exceed target cost, the fee is reduced below target fee. The incentive is intended to encourage effective cost management.
Fee is capped at limits
When actual allowable costs fall outside the range where the formula operates, the contractor is paid allowable costs plus the minimum or maximum fee. This prevents the fee from changing without limit.
Use only when appropriate
CPIF is appropriate for services or development and test programs when a cost-reimbursement contract is necessary and a workable target cost and incentive formula can be negotiated. The formula must be likely to motivate effective contractor management.
Technical incentives may be added
The contract may also include technical performance incentives when major-system development is highly probable and the Government has established performance objectives, at least in general terms. This can also be used in other acquisitions if both cost and technical incentives are practical to administer.
Formula must cover foreseeable range
The fee-adjustment formula should create a meaningful incentive across the full range of reasonably foreseeable cost variation from target cost. If a high maximum fee is used, the contract must also include a low minimum fee, which may be zero or, in rare cases, negative.
General cost-reimbursement limits apply
No CPIF contract may be awarded unless all limitations in FAR 16.301-3 are met. Those baseline restrictions govern when cost-reimbursement contracting is permissible at all.
Responsibilities
Contracting Officer
Determine whether a cost-reimbursement approach is necessary, ensure the CPIF structure is appropriate for the acquisition, negotiate target cost, target fee, minimum and maximum fees, and the fee-adjustment formula, and verify compliance with FAR 16.301-3 before award.
Agency/Program Office
Define the work, performance objectives, and any technical performance incentives; support development of realistic target cost and performance goals; and ensure the acquisition strategy makes sense for services or development/test programs.
Contractor
Propose and negotiate realistic cost and fee terms, manage performance to control allowable costs and meet any technical objectives, and understand that final fee will be adjusted after performance based on the contract formula.
Government Technical/Cost Personnel
Help establish credible cost estimates, assess whether the incentive formula is likely to motivate effective management, and support evaluation of whether technical performance incentives are feasible and administratively practical.
Practical Implications
CPIF is useful when the Government needs a cost-reimbursement contract but still wants a strong cost-control incentive; it is not a substitute for a fixed-price contract when requirements are stable enough for fixed pricing.
The biggest drafting risk is a weak or unrealistic fee formula. If the target cost, fee range, or adjustment slope is poorly designed, the incentive may not actually change contractor behavior.
Contracting officers should make sure the formula works across likely cost outcomes, not just around the target. A formula that stops being meaningful too early can leave the Government overpaying or under-incentivizing.
If maximum fee is set high, the minimum fee must be low enough to preserve balance; otherwise the contract may reward overrun risk too generously.
Before using CPIF, confirm the broader cost-reimbursement prerequisites in FAR 16.301-3 are satisfied, because this section does not override those threshold limitations.
Official Regulatory Text
(a) Description . The cost-plus-incentive-fee contract is a cost-reimbursement contract that provides for the initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs. This contract type specifies a target cost, a target fee, minimum and maximum fees, and a fee adjustment formula. After contract performance, the fee payable to the contractor is determined in accordance with the formula. The formula provides, within limits, for increases in fee above target fee when total allowable costs are less than target costs, and decreases in fee below target fee when total allowable costs exceed target costs. This increase or decrease is intended to provide an incentive for the contractor to manage the contract effectively. When total allowable cost is greater than or less than the range of costs within which the fee-adjustment formula operates, the contractor is paid total allowable costs, plus the minimum or maximum fee. (b) Application. (1) A cost-plus-incentive-fee contract is appropriate for services or development and test programs when- (i) A cost-reimbursement contract is necessary (see 16.301-2 ); and (ii) A target cost and a fee adjustment formula can be negotiated that are likely to motivate the contractor to manage effectively. (2) The contract may include technical performance incentives when it is highly probable that the required development of a major system is feasible and the Government has established its performance objectives, at least in general terms. This approach also may apply to other acquisitions, if the use of both cost and technical performance incentives is desirable and administratively practical. (3) The fee adjustment formula should provide an incentive that will be effective over the full range of reasonably foreseeable variations from target cost. If a high maximum fee is negotiated, the contract shall also provide for a low minimum fee that may be a zero fee or, in rare cases, a negative fee. (c) Limitations . No cost-plus-incentive-fee contract shall be awarded unless all limitations in 16.301-3 are complied with.