A cost reimbursable contract with an incentive fee is used to encourage performance in areas critical to the project. Often the contract attempts to motivate contractors to save or reduce project costs. The use of the cost reimbursable contract with an incentive fee is one way to motivate cost reduction behaviors.
Incentive Fee for Road Project
A road construction company won a contract to build a small road to the new county courthouse. The estimate to complete the road was $10 million. The contractor received a cost reimbursable contract that would pay all costs plus a 3 percent fee. The contactor could also earn an incentive by performing the work for less than $10 million. The contract might include a fee that would pay the contractor 20 percent of all savings below the estimated $10 million. In this case, the county got the road at a lower cost, and the contractor made more money.
The contract could have focused on schedule and paid a bonus for completing ahead of schedule. This type of contract requires that the project management team has the capability to assure the quality of work performed meets project specifications and the savings was not generated through reducing the quality of the work.
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