14 Contract Types Explained: How Each Impacts Risk, Pricing, and Profit
If you're navigating the world of contracting, one of the most important concepts to understand is contract type. Each contract type comes with its own balance of risk, pricing structure, and profit potential—and understanding these dynamics can make or break your success.
Whether you're dealing with any contract or managing a growing portfolio, this guide breaks down the 17 most common contract types, what they mean, and how they impact the bottom line.
Breaking into the world of contracting can feel overwhelming—especially when you’re faced with acronyms, complex rules, and an alphabet soup of contract types. But don’t worry—understanding the basics of each contract type can give you a competitive edge and help you make smarter business decisions.
Whether you're a small business entering the marketplace for the first time, a growing contractor looking to diversify your portfolio, or an entrepreneur responding to your first RFP, the type of contract you’re awarded will significantly affect your responsibilities, how you get paid, and what your profit margins will look like.
Why Contract Type Matters
The U.S. government uses 17 primary contract types, each with its own approach to pricing, oversight, risk allocation, and performance evaluation. While we won’t be covering them all today, I always use these as a baseline. After all, no one manages more contracts than the federal government. Some types offer speed and flexibility, while others require strict cost controls and detailed reporting. Understanding which type you've been awarded—or choosing the right one from the start—is critical to successful execution.
Before You Bid: What You Should Be Expected to Know
No matter which contract type you're working with, there are foundational rules and standards that all contractors must understand and comply with:
FAR Compliance: The Federal Acquisition Regulation (FAR) governs all federal contracts. Contractors are expected to understand the specific FAR clauses included in their agreements. This framework helps ensure that contractors meet defined legal and ethical standards, promoting fairness, transparency, and accountability in the procurement process. Whether bidding in the public or private sector, understanding the rules of the game is essential—many of the core principles are surprisingly similar.
Accounting Standards: Certain contract types—especially cost-reimbursement contracts—may require an approved accounting system and compliance with Cost Accounting Standards (CAS). It’s important to thoroughly review the documentation provided by the customer to understand their specific expectations. When drafting terms, clarity is critical to avoid misunderstandings and ensure alignment from the outset.
Cybersecurity & Data Compliance: If your contract involves handling government data—particularly in defense or IT—you may be subject to NIST SP 800-171 or CMMC (Cybersecurity Maturity Model Certification) requirements. Regardless of the contract type, we strongly recommend maintaining a solid cybersecurity posture. Just as important is strict adherence to Mutual Non-Disclosure Agreements (MNDAs). Even if the information isn't classified, it may be highly sensitive to the customer—and protecting it builds trust and credibility.
GSA Schedules for Travel: GSA per diem schedules typically apply only to government contracts and are essential to understand when working in that space. However, I find that referencing them in any contract—government or private—offers a clear, standardized baseline for setting fair and reasonable travel expectations for both parties. You can find the current rates on the GSA website: GSA per diem rates
Fixed-Price Contracts
Fixed-Price Contracts: Fixed-price agreements are among the most common in government contracting, particularly for well-defined products or services. As the name implies, the government agrees to pay a set price for a specific scope of work—regardless of the actual costs incurred by the contractor.
These contracts often carry a reputation for inflated pricing, as contractors may add a buffer to account for unexpected challenges or overly demanding customer expectations. While many prefer Time & Materials (T&M) for their flexibility, understanding the different types of fixed-price arrangements—and building strong relationships with customers upfront—can make fixed-price contracts work well for both sides.
Success with this model depends heavily on clear communication, precise scoping, and mutual trust. If you're unsure about the scope, cost, or timeline, consider exploring more flexible contract types—or ensure the fixed-price contract is broken down in a way that fairly distributes risk. An imbalanced contract often leads to dissatisfaction and, ultimately, subpar results.
1. Firm-Fixed-Price (FFP)
FFP contracts are the simplest type of agreement, providing a single fixed payment for a (hopefully) clearly defined scope of work. Since pricing does not adjust for actual costs, contractors bear the full risk of cost overruns—but they can achieve higher profit margins if the project is completed efficiently. These contracts are best suited for projects with stable requirements and minimal change, and are often preferred by agencies seeking price certainty and reduced administrative oversight.
2. Fixed-Price with Economic Price Adjustment (FPEPA)
FPEPA contracts offer a fixed base price with pre-negotiated provisions that allow for adjustments due to economic factors such as inflation, material costs, or labor rates. This structure helps protect contractors from market volatility over the life of the contract while still offering the government pricing stability. Ideal for long-term or resource-sensitive projects, FPEPA contracts balance risk and flexibility for both parties.
3. Fixed-Price Incentive Fee (FPIF)
Fixed-Price Incentive Fee (FPIF) Contracts: FPIF contracts blend a fixed-price structure with performance-based incentives, typically including a target cost, target profit, and a formula for sharing cost savings or overruns. This approach motivates contractors to control costs and stay on schedule by offering additional profit for efficient performance, while still maintaining accountability for budget discipline.
Risk is shared between the client and contractor, making FPIF contracts well-suited for projects with a mostly defined scope but variable performance outcomes. They can also be especially effective for projects with tight timelines or where there’s a risk of scope creep, as the incentive structure encourages proactive management and cost control.
4. Fixed-Price Award Fee (FPAF)
FPAF contracts offer a fixed base payment plus the opportunity to earn additional profit through an award fee and typically only used within government contracts. The award is determined by the government’s subjective evaluation of performance. Profitability depends on how well the contractor meets or exceeds expectations in areas like quality, responsiveness, and innovation. While the base price limits risk, the performance-based fee introduces uncertainty, making this contract type suitable for projects where excellence—not just delivery—is critical.
5. Fixed-Price Level-of-Effort (FP-LOE)
Fixed-Price Level of Effort (FP-LOE) Contracts provide payment for a specified level of effort over a set period, rather than for defined deliverables or outcomes. They are commonly used in research and development or exploratory projects where results cannot be guaranteed. This contract model compensates contractors for their time and expertise rather than specific performance metrics. With relatively low risk and predictable profit, FP-LOE contracts are well-suited when the client values the effort itself more than the final product.
This approach is often applied in early-stage projects aligned with lower Technology Readiness Levels (TRLs), where initial discoveries can generate valuable intellectual property. For more on TRLs, see NASA’s Technology Readiness Level Deskbook. TRLs will be discussed in greater detail in a future article.
Cost-Reimbursement Contracts
Cost-Reimbursement Contracts are used when the scope of work carries uncertainty—like research, development, or complex technical services. Instead of a fixed price, the customers agree to reimburse you for all allowable, allocable, and reasonable costs, plus a fee (profit), which may be fixed or performance-based.
Cost-reimbursement contracts are ideal when the end result isn’t clearly defined or when it’s not possible to estimate costs accurately in advance—like in R&D, pilot programs, or evolving technical requirements.
Cost-reimbursement contracts shift more risk to the customer, but demand a higher level of administrative discipline and compliance from you. If your business is set up for strong cost control and can handle oversight, these contracts can provide stable work with reduced financial exposure.
From both sides, I/we feel these contracts are superior because it prevents the “out of sight out of mind”; whereas clients discover the real cost of a product when they start producing it.
6. Cost-Reimbursement (CR)
Cost-Reimbursement (CR) contracts reimburse contractors for all allowable, allocable, and reasonable costs incurred during a project, placing most of the financial risk on the customer. This model minimizes cost risk for the contractor and is particularly effective for hardware-focused projects, where variables like tariffs or shifting component availability can create unforeseen expenses. However, CR contracts require robust accounting systems and close oversight. They are best suited for complex or evolving efforts where the scope cannot be clearly defined upfront—especially when each iteration may involve different hardware configurations or selection options.
7. Cost-Plus-Incentive Fee (CPIF)
Cost-Plus-Incentive-Fee (CPIF) contracts reimburse contractors for allowable costs and include an incentive fee that adjusts based on performance—typically tied to cost savings, schedule targets, or other measurable objectives. This structure shares risk between the contractor and the customer, encouraging efficient execution while covering actual expenses. As performance improves, so does the contractor’s profit, making CPIF contracts ideal for projects with some uncertainty but where outcomes can still be tracked and rewarded.
That said, CPIF contracts often require longer negotiation periods, as defining success metrics can be challenging—particularly in early-stage efforts with lower Technology Readiness Levels (TRLs), where project goals and benchmarks are still evolving.
8. Cost-Plus-Award Fee (CPAF)
CPAF contracts reimburse all allowable costs and include an award fee determined by a government review panel based on subjective performance evaluations. This model minimizes financial risk for contractors while offering the potential for higher profit depending on how well they meet or exceed performance criteria. It’s well-suited for projects where quality and responsiveness are prioritized but outcomes may be difficult to quantify upfront.
9. Cost-Plus-Fixed-Fee (CPFF)
Cost-Plus-Fixed-Fee (CPFF) contracts reimburse all allowable costs and include a fixed fee that remains constant, regardless of performance. This structure provides contractors with predictable profit and minimal financial risk, making it especially well-suited for research and development efforts where outcomes are uncertain and scope cannot be precisely defined upfront. CPFF contracts are also effective in scenarios involving unknown-cost variables—such as experimental materials or rapid-turnaround manufacturing—where budget flexibility is essential despite unclear deliverables.
Time-Based Contracts
Time-Based Contracts—including Time-and-Materials (T&M) and Labor-Hour (LH) agreements—are used when the exact scope, duration, or deliverables are uncertain. Under these contracts, the customer pays pre-negotiated hourly rates for labor, and in the case of T&M, for materials as well.
These contracts are commonly used for staff augmentation, consulting, or technical support—situations where it’s difficult to define the full scope upfront. They offer flexibility and predictable labor costs, but require strong project management to stay on track and maintain profitability.
Because of the risk of scope creep, many customers hesitate to use time-based contracts—especially when the end goal isn’t clearly defined. However, when combined with a solid delivery framework and a Not-To-Exceed (NTE) clause, T&M contracts can deliver strong results. Just remember the wisdom of Logan Lucky rule #11: don’t get greedy.
10. Time-and-Materials (T&M)
T&M contracts compensate contractors based on hourly labor rates plus the cost of materials, sharing risk between the customer and contractor, but normally pretty heavy on the customer. Project scope may be undefined or evolving, these contracts require careful oversight (may be a vast understatement in many cases) to manage labor hours and control costs.
11. Labor-Hour (LH)
LH contracts pay contractors based solely on hourly labor rates without reimbursing materials, making them a streamlined version of Time-and-Materials agreements. This model offers scalable profit opportunities and is commonly used for staff augmentation or services where labor is the primary cost driver. Risk is moderate, with the need for oversight to ensure hours worked align with project needs.
Indefinite Delivery Contracts
12. Indefinite-Delivery Indefinite-Quantity (IDIQ)
IDIQ (Indefinite Delivery, Indefinite Quantity) contracts offer flexible ordering for recurring or uncertain needs, allowing the government or customers to issue task or delivery orders up to a specified ceiling over a set period. Risk varies with each individual order, as these contracts typically handle increasing volumes of a product or service. IDIQ contracts are ideal when there’s a need for adaptable supply or service support without committing to fixed quantities upfront.
Urgent or Temporary Contracts
These contracts are typically short-term agreements designed to address immediate needs—such as covering for staff on leave, managing workload surges, or completing time-sensitive projects. While not as commonly used as the standard contract types discussed earlier, they’re invaluable to have on hand. They provide flexibility for both organizations and individuals, enabling quick onboarding without long-term commitments. Having a template ready can save critical time and ensures that even short-term work is governed by clear expectations and legal protections.
13. Undefinitized Contract Actions (UCAs)
UCAs allow contractors to begin work immediately when urgent needs arise, even though final contract terms and pricing have yet to be determined. This approach carries high risk due to uncertain pricing and scope. UCAs require flexibility from both parties and are often used to avoid delays on critical projects while contract details are finalized.
14. Letter Contracts
Letter Contracts are preliminary agreements that authorize contractors to begin work before all terms, including pricing, are finalized. This approach enables a rapid project start but carries significant risk and budget uncertainty due to undefined conditions. Like Unilateral Contract Actions (UCAs), Letter Contracts demand careful management to handle potential changes and to negotiate final terms without delay.
The goal is to quickly develop valuable, usable results—not to rush and produce waste.
Final Thoughts
Choosing the right contract type is more than just paperwork—it’s a strategic business decision. It influences how much risk is assumed, how payments are structured, and how project delays are managed.
The most successful projects don’t focus solely on the outcome—the formal “divorce” between parties—but prioritize the communication leading up to that point. They understand that the quality of dialogue, transparency, and mutual understanding before the split often shapes the long-term impact far more than the separation itself. Similarly, thriving business relationships are built on genuine partnerships, not just shared goals. When both sides invest in the relationship—not just the end result—the foundation becomes stronger, more adaptable, and ultimately more successful.