What is the difference between cost-plus and fixed-price defence contracts?

Cost-type (cost-plus) contracts reimburse allowable costs plus a fee: lower margin opportunity, lower cost-growth risk to the contractor. Firm fixed-price contracts set a predetermined price: higher margin opportunity if costs are controlled, higher unanticipated-cost risk if they are not. Northrop Grumman's FY2025 10-K uses this margin/risk framing explicitly.

What share of defence prime revenue is fixed-price?

Approximately half of Northrop Grumman's FY2025 sales came from firm fixed-price contracts ("approximately half" per the 10-K). General Dynamics' US government revenue was 51% fixed-price, 44% cost-reimbursement and 5% time-and-materials. Portfolio mix varies by prime; there is no single industry average in filings.

How does contract type affect segment operating margins?

Contract mix and lifecycle phase drive segment margin dispersion. L3Harris Communication Systems ran 25.2% segment operating margin in FY2025; Northrop Grumman Mission Systems 14.6%; GD Combat Systems 14.4%; LMT Missiles & Fire Control 13.8%; NOC Aeronautics Systems 6.3%; LMT Aeronautics 6.9%. High-volume platform production (F-35 at LMT) tends to run thinner margins than subsystem or comms work at scale.

Why do analysts care about fixed-price exposure?

Fixed-price share sets the earnings risk profile on cost overruns, supply-chain inflation and schedule delays. A prime with heavy fixed-price mix can post strong margins in stable production but face charges when development programmes slip. Cost-type work protects margin percentage but caps upside. Segment margin tables reveal the mix effect faster than a company-wide average.

Cost-Plus vs Fixed-Price Contracts

Educational analysis for professional use. This guide is not investment advice or a recommendation to buy or sell any security, and it is not personalised.

Contract Type Sets the Margin-Risk Trade-Off

Defence primes do not earn a single margin on a single risk profile. Cost-type (cost-plus) contracts reimburse allowable costs plus a fee. Firm fixed-price (FFP) contracts lock in a price upfront. The contractor takes more margin opportunity on FFP when costs stay inside plan, and more downside when they do not.

Northrop Grumman’s FY2025 10-K states the trade-off directly: cost-type carries lower margin and lower cost-growth risk; firm fixed-price carries higher margin opportunity and higher unanticipated-cost risk. That language is the filing anchor for every segment-margin comparison in the peer set.

Cost-Type vs Firm Fixed-Price

Feature	Cost-type (cost-plus)	Firm fixed-price
Price basis	Allowable costs + fee	Predetermined price
Margin opportunity	Lower, fee-based	Higher if costs controlled
Cost overrun risk	Lower (reimbursed)	Higher (contractor absorbs)
Typical phase	Development, R&D-heavy	Production, mature lots
Billing	Tracks allowable costs	Milestone or delivery based

Time-and-materials sits between the two on risk: GD reports 5% of US government revenue on T&M alongside 51% fixed-price and 44% cost-reimbursement.

Neither type is “better.” Development programmes skew cost-type because the government shares technical risk. Serial production (F-35 lots, missile rounds, submarine blocks) shifts toward fixed-price as costs stabilise.

Filed Portfolio Mix

Four filers publish a contract-type split, each on its own basis:

Filer	Fixed-price	Cost-type / cost-reimb	Basis
Northrop Grumman	~50% of FY2025 sales	Balance cost-type	Company sales, rounded filing language
General Dynamics	51%	44% cost-reimbursement (5% T&M)	US government revenue only
L3Harris	75% of FY2025 revenue	Balance	Company revenue
Lockheed Martin	Not stated as its own figure	~40% of 2025 sales	Company sales; fixed-price share is the balance, not stated

NOC’s “approximately half” is rounded filing language. GD’s split is precise on US government revenue only; Gulfstream commercial work sits outside that breakdown. Lockheed Martin states only the cost-reimbursable share, so its fixed-price share is an inference, not a filed number. RTX and BAE do not publish a consolidated fixed-price percentage; for those two, segment margin tables are the practical mix proxy.

Segment Margin Dispersion

Contract type and programme lifecycle show up in segment operating margins, not in a single company-wide ratio:

Company	Segment	FY2025 segment operating margin
L3Harris	Communication Systems	25.2%
RTX	Collins Aerospace	16.3%
NOC	Mission Systems	14.6%
GD	Combat Systems	14.4%
LMT	Missiles & Fire Control	13.8%
RTX	Raytheon	11.5%
BAE	Electronic Systems	15.4% (return on sales)
LMT	Aeronautics	6.9%
NOC	Aeronautics Systems	6.3%
GD	Marine Systems	7.0%
RTX	Pratt & Whitney	7.9%

BAE reports return on sales rather than operating margin; the two measure the same thing, profit as a share of revenue.

The spread from 6.3% (NOC Aeronautics) to 25.2% (LHX Communication Systems) is not noise. Platform production at volume, F-35 in LMT Aeronautics at 6.9%, with F-35 at 27% of consolidated sales, runs thinner than tactical comms or missiles at mature production rates. The comms archetype at the top of the range, L3Harris, links to C4ISR (command, control and sensor systems) and tactical communications revenue (75% US Government). Northrop Grumman’s Mission Systems segment sits in the middle of the table: electronics and sensors on a mix of contract types.

Platform vs Subsystem Economics

Platform primes (LMT, NOC Aeronautics, GD Marine) carry programme lifecycle risk on a few large contracts. F-35 makes up 27% of Lockheed Martin’s consolidated sales and keeps Aeronautics revenue high while margin sits near 7%. General Dynamics’ nuclear-powered submarine work runs a similar shape: $12.6B of revenue, 24% of the consolidated total, at a 7.0% Marine Systems margin.

Systems and electronics names (LHX comms, NOC Mission Systems, RTX Raytheon) earn higher margins on subsystem content but lack that single-programme anchor. RTX does not disclose programme-level revenue percentages; GTF (Pratt & Whitney’s geared turbofan engine) and Patriot are key programmes without a filed share.

The house screen flags single-programme concentration above 25% of consolidated sales. Both F-35 at LMT and the submarine programme at GD sit either side of that line, which is why a platform prime’s earnings quality depends more on the health of one contract than a subsystem supplier’s does.

How Mix Feeds FCF Conversion

Fixed-price production with smooth billing converts cash predictably. Fixed-price development with milestone revenue recognition can bunch earnings and cash in different years. Cost-type work bills against allowable costs, which tends to align OCF with segment profit more closely.

General Dynamics ran 94% FCF conversion in FY2025 with a 51% fixed-price US government mix. Northrop Grumman ran 79% conversion with ~50% fixed-price. The conversion gap is not fully explained by contract type alone (NOC’s 1.10x book-to-bill ties up working capital too), but FFP-heavy development phases are the first place to look when conversion drops. The FCF conversion guide walks the full FY2025 ladder.

Reading Contract Mix in Filings

Pull the contract-type paragraph from the 10-K risk factors (NOC’s wording is the clearest example to work from).
Match segment margins to the programmes named in the segment discussion (Aeronautics vs Mission Systems at NOC; Combat vs Marine at GD).
Flag development-to-production transitions: a programme moving from cost-type to FFP often compresses or expands margin over 2-3 years.
Do not infer company-wide fixed-price % from segment margins alone without a filed split.
Cross-check backlog momentum: a cost-type development award builds backlog without the FFP margin pop until production lots begin.

Northrop Grumman is the contract-language teaching case. General Dynamics supplies the filed 51/44/5 split. L3Harris shows where subsystem mix pushes margins to the top of the peer range.