Paper
Sharing fractions in cost-plus-incentive-fee contracts

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Abstract

A Cost-Plus-Incentive-Fee (CPIF) contract tries to provide a risk sharing approach between owner and contractor. It is between the two extremes of firm fixed price and cost plus contracts. This paper reviews the literature of risks in contracts. It uses utility theory to explain how owners and contractors determine the best sharing fraction from their points of view. Negotiation is discussed as a vehicle for owners and contractors to convince each other regarding the sharing fraction that is acceptable to both of them.

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    These clauses traditionally consist of a cost target (Ct), in combination with an agreed upon sharing of potential cost over- or underruns. The majority of these clauses studied in literature belong to a limited number of archetypes which specify only this target and a cost sharing ratio above and below this target, respectively (Al-Subhi Al-Harbi, 1998; Anvuur & Kumaraswamy, 2010; Arditi & Yasamis, 1998; Bubshait, 2003; Chan, Lam, & Chan, 2012; Chan, Chan, Lam, & Wong, 2010a, 2011a; Chan, Chan, Lam, & Chan, 2011b; Chapman and Ward, 1994; Jaraiedi, Plummer, & Aber, 1995; Lippman et al., 2013; McAfee & McMillan, 1986; Meng & Gallagher, 2012; Mihm, 2010; Perry & Barnes, 2000; Rosandich, 2007; Rose & Manley, 2010, 2011; Rosenfeld & Geltner, 1991; Ryan, Henin, & Gandhi, 1986; Tang, Qiang, Duffield, Young, & Lu, 2008; Turner, 2004). These archetypes can be ranked based on the amount of risk they transfer from the owner to the contractor (Al-Subhi Al-Harbi, 1998) and are commonly denoted as follows: Firm Fixed Price (FFP), Guaranteed Maximum Price (GMP), Fixed Price Incentive (FPI) (or Target Cost (TCC)), Cost Plus Incentive Fee (CPIF), Cost Plus Fixed Fee (CPFF) and Cost Plus Percentage Fee (CPPF) contracts.

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    Moreover, the contracts which are discussed can frequently be categorised as one of six basic contract types [87]: firm fixed price (FFP), guaranteed maximum price (GMP), fixed price incentive (FPI) (or target cost (TCC)), cost plus incentive fee (CPIF), cost plus fixed fee (CPFF) and cost plus percentage fee (CPPF) contracts. This set of cost contract types forms a risk-transfer spectrum, where the FFP contract represents the situation where all the risk is carried by the contractor, and the CPPF is the situation where all the risk is carried by the owner [3]. Variations on these archetypes are also often used to manage cost performance in production environments [85].

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