Five Types of Government Contracts | Risks, Pros and Cons (2024)

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Government contracts are financial agreements made between government agencies or government branches and private companies. There are many types of government contracts, each with their own rights and restrictions. Government contracts are a great way to do business, as the government is a big client with money to spend.

Most government contracts entail government agencies or government branches detailing exactly what they need, and the company has to make sure they can deliver on these needs. Government contracts are restricted in some ways by government legislation regarding the government’s right for secrecy, their price ceilings and other measures which ensure both efficiency and fairness.

Types of government contracts can vary, so it is important that you understand what each type is, what each entails, what the risks are, and if it is a government contract type you want to get involved with.

There are five main types of government contracts:

1. Cost Plus
2. Fixed Price
3. Time and Material
4. Labor Hour
5. Indefinite-Delivery, Indefinite-Quantity

Let’s look at each government contract type in detail to help you determine if it is one you wish to pursue.

1. Cost Plus Contract

With a Cost Plus Contract, the government essentially pays you back for all expenses that were incurred plus an agreed-upon profit margin, while satisfying the requirements of the government.

This type of contract is less risky for the contractor because they are guaranteed to make a profit on the contract.

Pro: The contractor is guaranteed to make a profit on the government contract, and essentially pay back all of their expenses.

Con: The government sets a maximum amount they will reimburse the contractor for expenses and any costs incurred over this set amount must be paid by the contractor themselves.

2. Fixed Price Contract

Fixed Price Contracts are the most common type of contract that the government uses. With a Fixed Price Contract, the government agrees to pay you a specific pre-determined price for your product or service.

This type of contract is more risky for the contractor as you would be responsible for any cost overruns.

Pro: The contractor benefits for efficiencies as the government sets a pre-determined price.

Con: The government sets a pre-determined price that you are obligated to sell your product or service for, so if market prices change and it becomes more expensive to produce your government contract, you will have to absorb the additional costs.

3. Time and Material Contract

This government contract type is also very common among government contracts, where you are obligated to complete a project in an agreed-upon timeframe and price range and the government pays for the time and materials that it took to finish the job. This type of contract is less risky to the contractor as they are reimbursed for time and materials incurred.

Pro: These are very simple. The government sets a per-hour labor rate and calculates material cost that the contractor is entitled to.

Con: The contractor does not benefit from being more efficient.

4. Labor Hour Contract

Labor Hour Contracts are essentially another form of Time and Material Contracts. In a government contract, with a labor hour contract, the contractor is obligated to complete the contract in a pre-determined timeframe and the government calculates how much it will cost based on your hourly labor rate.

Pro: The government does not hold you responsible for any cost overruns, only paying for the actual hours worked.

Con: You do not benefit from being more efficient.

5. Indefinite-Delivery, Indefinite-Quantity Contract

In situations where the government doesn’t know exactly what they require, it can issue an Indefinite-Delivery government contract. An example of this would be the government issuing you a government contract for “X” number of widgets, but not specifying how many or when they need them.

Pro: This type of government contract is meant to encourage competition and is beneficial to small businesses as it reduces risk.

Con: At the time they are awarded, there is no guarantee of work and the contract is not funded, so it can be hard to plan for.

We have discussed the five main types of government contracts and what each entails. Government contracts can be beneficial for small businesses and there are advantages and disadvantages for each type of contract.

Even though government contracts can be very lucrative, government contract work can also come with a lot of red tape and paperwork involved, which makes them very time-consuming. It is important to be aware of the different contract types when bidding on government contracts and to be prepared if you are awarded one.

If you have any questions about government contracts, reach out to your PBMares representative or the Government Contracting Team.

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The content of this post is accurate as of the date below. Always ensure you are reviewing the most recent information available. Contact your tax advisor if you need clarification.

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