PRODUCT CHARACTERISTICS, MARKET CONDITIONS AND CONTRACT TYPE: U.S. DEPARTMENT OF DEFENSE USE OF FIXED-PRICE AND COST REIMBURSEMENT CONTRACTS

Abstract

This report examines the impact of product characteristics and market conditions on the use of fixed-price and cost reimbursement contracts by the Department of Defense. When the product is easy to specify, easy to produce, and there is a thick market of buyers and sellers, fixed-price contracts are more likely. When the product is difficult to produce, difficult to specify, and a market with few buyers and sellers, cost-reimbursement contracts are more likely. To test these arguments, we draw five years of data (FY 2004-2008) from the Federal Procurement Data System (FPDS), the most comprehensive and largely untapped database on federal contracting practices, to examine the contract type of over 2000 DOD contracts. We use these data to chart contract type (i.e. fixed-price versus cost-reimbursement) across simple and complex products. The results of our analysis results confirm conventional wisdom about public sector procurement practice, at least within the DOD: product characteristics and market conditions drive the use of fixed-price versus cost-reimbursement contracts. We draw three key findings from our analysis. Federal regulatory policy is effective in promoting the use of fixed-price contracts. Following federal regulatory policy, DOD procurement personnel match contract type to product characteristics. Competitive markets promote the use of fixed price contracts. The value of our research is two-fold. First, our analysis lays the foundation for research on contract outcomes by identifying factors that drive the use of different contract types. Second, we produce unique measures of product characteristics that are not currently available in the literature.