Cost-Plus Percentage of Cost (CPPC)

Cost-Plus Percentage of Cost (CPPC) is a contract type that compensates contractors with a fee calculated as a percentage of actual costs incurred, creating a perverse incentive to increase costs, and is explicitly prohibited by the FAR and federal statute.

What is Cost-Plus Percentage of Cost?

CPPC is expressly prohibited by FAR 16.102(c) and 10 U.S.C. § 3321. Under a CPPC structure, the contractor would receive a fee equal to a fixed percentage of whatever costs they actually incur. As costs go up, the fee goes up proportionally, meaning the contractor has a direct financial incentive to spend more, not less.

This is the fundamental problem with CPPC:

• In a CPFF contract, fee is fixed in dollars, the contractor earns the same $1M fee whether they spend $10M or $12M. There is still some incentive to control costs (no direct reward for overruns, and overruns can hurt CPARS ratings).
• In a CPPC contract (if it were legal), the contractor earns more for spending more: 10% × $10M = $1M fee, but 10% × $12M = $1.2M fee. Spending $2M more earns $200K more. The incentive is entirely inverted.

The prohibition on CPPC reflects one of the earliest lessons in government contracting, that tying compensation directly to spending without caps or incentives for efficiency leads to explosive cost growth. Congress first prohibited CPPC in 1962 based on experience from World War II-era contracts.

Despite the prohibition, contracting officers must be vigilant about arrangements that create CPPC-like incentives through indirect means, for example, fee structures in subcontracts or teaming arrangements that effectively reward total spending rather than performance.

Why CPPC matters for government contractors

Understanding that CPPC is prohibited helps contractors recognize when a proposed arrangement might inadvertently create a similar structure, which could be challenged or voided. More practically, the history of why CPPC was prohibited illustrates why all other cost-plus contract types include mechanisms to avoid this incentive problem: CPFF fixes the fee in dollars, CPIF ties fee adjustment to cost savings (not spending), and CPAF ties fee to subjective performance rather than cost levels.

Example

In the 1950s, some defense contracts inadvertently created CPPC-like arrangements through percentage markups on material costs. A contractor supplying materials at cost plus 8% had direct financial incentive to buy more expensive materials, even when cheaper equivalents existed, because higher material costs meant higher fees. Congress recognized this pattern and enacted statutory prohibitions. Today, cost-plus contracts use fixed fees or incentive structures that specifically avoid creating this backward incentive.

Frequently Asked Questions

Is CPPC prohibited for all government contracts?

Yes. FAR 16.102(c) prohibits CPPC for all federal government contracts. There are no exceptions. Any contract clause or fee arrangement that creates a fee directly proportional to actual costs incurred, where higher costs mean higher fee, violates this prohibition.

Can a contractor use a CPPC structure in a subcontract under a government prime contract?

No. Prohibitions on contract types in prime contracts flow to subcontracts. A prime contractor who sets up a subcontract on CPPC terms violates the prohibition and is exposed to government audit findings and potential contract termination.

Are there any legitimate uses for percentage-based fees in government contracting?

Percentage-based fees on fixed quantities (e.g., a 2% fee on a fixed contract value) are different from CPPC. CPPC is specifically about fee percentages applied to actual costs incurred, which creates the backward incentive. Fixed percentage fees on known, bounded values do not create the same problem.

How do contracting officers detect CPPC arrangements?

DCAA auditors are trained to look for CPPC-like structures in subcontract arrangements, cost-sharing agreements, and consortium arrangements. Audit findings that reveal CPPC-like arrangements result in disallowance of the fee component above what would be proper under an allowable cost-plus structure.