Impact of Product Characteristics and Market Conditions on Contract Type: Use of Fixed-Price Versus Cost-Reimbursement Contracts in the U.S. Department of Defense

Abstract

Transaction cost economics is used to produce a conceptual framework that helps explain public-sector contract decisions. When a 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 a product is difficult to produce, difficult to specify, and the market has few buyers and sellers, cost- reimbursement contracts are more likely. These arguments were tested with five years of data (FY 2004–2008) drawn from the Federal Procurement Data System (FPDS), the most comprehensive and largely untapped database on federal contracting practices. Over 2,000 Defense Department contracts were examined, charting contract type (i.e., fixed-price vs. cost-reimbursement) across simple and complex products. The results confirm conventional wisdom about public sector procurement practice, at least within the Defense Department: product characteristics and market conditions drive the use of fixed-price and cost-reimbursement contracts. This research lays the foundation for research on contract outcomes by identifying factors that drive the use of different contract types and producing unique measures of product characteris- tics that are not currently available in the literature.