How does a 'time-and-materials' (T&M) contract work and when is it appropriate?

A time-and-materials (T&M) contract pays for direct labor hours at fixed hourly rates that include wages, overhead, general and administrative expenses, and profit, plus the actual cost for materials. The government uses T&M contracts when it is not possible to estimate the extent or duration of the work with reasonable confidence, as stated in FAR 16.601(b) and (c). This contract type places less risk on the contractor compared to a firm fixed price (FFP) contract because the government covers the actual hours worked and materials used, up to a ceiling. However, as a prime, you still bear the risk of managing your labor force efficiently and controlling material costs within the contract's estimated ceiling. You also need to maintain meticulous records for invoicing. The fixed hourly rates for each labor category are a critical component, and these rates are negotiated upfront. My firm has bid on T&M contracts for professional services, and the key is to clearly define the labor categories and justify your proposed rates. These contracts typically include a ceiling price that the contractor may not exceed without the contracting officer's approval, which protects the government from unlimited spending.