Federal contracts are not all priced and paid the same way. The contract type — defined in FAR Part 16 — determines who bears cost risk if the work costs more than estimated, how billing and payment work during performance, what accounting systems and audit exposure your firm must manage, and how you should approach pricing at proposal stage. Winning a contract on the wrong type without understanding the implications has ended otherwise capable firms.
Every solicitation specifies the contract type. It is usually stated in Section B or in the contract terms. Reading it early changes how you should structure your cost proposal, what your accounting system needs to be able to document, and whether your firm is actually positioned to perform on that vehicle profitably.
Firm Fixed Price
A Firm Fixed Price contract pays you a set amount for the deliverable or service, regardless of what it actually costs you to produce it. You bear all cost risk. If your costs run over your estimate, the overrun comes out of your fee. If your costs come in below estimate, you keep the savings.
FFP is the government’s preferred contract type under FAR 16.103 because it places maximum incentive on the contractor to control costs and transfers cost risk away from the taxpayer. It also requires the least government oversight — there is no need to audit contractor costs when the price is fixed.
For SDVOSB firms, FFP is appropriate when the work is well-defined, the scope is stable, and you have enough historical data to estimate costs accurately. It rewards efficient firms and punishes poor estimating. The proposal pricing discipline that matters most on FFP is understanding your true cost to perform — not just your direct labor and materials, but your indirect rates, your management overhead, and your contingency for scope ambiguity. Underpricing an FFP to win it is one of the most common ways small contractors end up performing work at a loss.
Time and Materials
A Time and Materials contract pays you a negotiated fixed hourly rate for each labor category, plus reimbursement of actual material costs. Your fixed hourly rates include your labor cost, your overhead, your G&A, and your profit — all bundled into a single billing rate per labor category. You bill hours actually worked at those rates.
T&M places cost risk on the government in a different way — the government pays for whatever hours are required to complete the work. This makes T&M appropriate for work where the scope or duration cannot be defined precisely at contract award. The government’s protection is a Not-to-Exceed ceiling on the total contract value; your obligation is to not exceed that ceiling and to notify the contracting officer when you approach it.
Because T&M billing rates are fixed but hours are variable, your profit on a T&M contract depends on how efficiently your team performs. If your estimating was accurate and the work runs on schedule, the fixed rates generate solid margin. If the work takes longer than estimated, you absorb the efficiency loss because you cannot exceed the NTE without a modification.
T&M contracts require careful timekeeping. Each employee must record hours by contract and labor category, and those records must be available for audit. The government does not audit your costs on T&M the way it does on cost-reimbursable contracts — your rates were fixed at award — but it can verify that hours billed correspond to hours actually worked on the contract.
Labor Hour
A Labor Hour contract is T&M without the materials component. You bill fixed hourly rates for labor only. Materials are either not required or are procured by the government directly. LH contracts are common for professional services and IT support where the labor is the deliverable.
The pricing and performance considerations are the same as T&M. The key difference is administrative — there is no materials tracking requirement and no separate materials reimbursement process.
Cost-Reimbursable Contracts
Cost-reimbursable contracts pay you for your actual allowable, allocable, and reasonable costs plus a fee. The government bears cost risk — if the work costs more than estimated, the government pays the actual costs up to the contract ceiling. Your fee is separate and depends on the specific cost-reimbursable variant.
Cost Plus Fixed Fee is the most common variant for small businesses. You receive reimbursement of actual costs plus a fixed fee that does not change based on performance. The fee is negotiated at contract award, typically as a percentage of estimated cost.
Cost Plus Incentive Fee ties a portion of your fee to cost performance — if the actual cost comes in below the target cost, you share in the savings; if it exceeds the target, you absorb a share of the overrun through reduced fee. CPIF requires careful cost estimation to establish a realistic target cost and a fair sharing ratio.
Cost Plus Award Fee contracts split fee into a base fee earned for satisfactory performance and an award fee pool the government distributes based on periodic evaluations against predetermined criteria. Award fee contracts are common on large, long-duration services contracts where continuous performance management is important.
Indirect Rates and Their Significance
On cost-reimbursable and T&M contracts, your indirect rates — fringe benefit rate, overhead rate, and G&A rate — are central to both your cost proposal and your billing. The rates you propose must be defensible. If you are new to cost-type work, you will likely propose provisional rates, which are subject to audit and adjustment at the end of each fiscal year through the incurred cost submission process.
The incurred cost submission is an annual filing with your cognizant audit agency that reconciles your actual indirect costs against the provisional rates you billed throughout the year. If your actual rates exceeded your provisional rates, the government owes you the underbilling. If your actual rates were lower, you owe the government the overbilling. This settlement process adds administrative burden and cash flow unpredictability that FFP contracts do not carry.
Choosing the Right Contract Type for Your Firm
The contract type is usually specified in the solicitation and is not negotiable after solicitation issuance. But you should evaluate it as part of your go/no-go decision. A solicitation on a contract type your accounting system cannot support, or that places more cost risk on you than your estimating confidence justifies, is a solicitation worth declining regardless of how attractive the opportunity looks otherwise.
For firms early in their federal contracting history, FFP and T&M on well-defined services work is the lowest-friction entry point. Your financial exposure is predictable, your audit exposure is limited, and the accounting requirements are manageable without a sophisticated cost accounting system. Cost-reimbursable work, particularly on R&D or long-duration professional services, requires investment in systems and processes before you can pursue it competitively.
Understanding which contract types appear most frequently in your target agencies and NAICS codesis part of market research. If most awards in your space are FFP, your competitive position depends on estimating accuracy and cost efficiency. If most are T&M or cost-plus, your billing rates, indirect rate structure, and accounting system become the infrastructure of your competitiveness.