Contract Type Selection Don Shannon 1.5 Contract Structures Contract Type Selection Don Shannon

Basic Contract Types Three basic types Fixed Price Cost Reimbursement Time and Materials Each type has characteristics that make it applicable for a type of procurement Risk (Cost, Schedule, Quality) are primary consideration Completeness /detail of specifications will often determine risk Contract Types Fixed Price Firm Fixed Price Fixed Price LOE Fixed Price Economic Price Adjustment Fixed Price Redetermination Prospective Fixed Price Redetermination Retroactive Cost Reimbursement Cost Contract Cost Sharing Cost Plus Fixed Fee Time and Materials Labor Hours

Cost Risk and Contract Type Risk must be viewed from each parties perspective Buyer (Often the Government) Seller Both parties seek to minimize their risk Cost risk Technical risk / Performance risk Contract type is negotiable (FAR 16.103) Selecting the contract type is generally a matter for negotiation and requires the exercise of sound judgment. Negotiating the contract type and negotiating prices are closely related and should be considered together. Contract Risk and Contract Type Cost Risk High Low Requirement Definition Poorly- defined Well Defined Defined Production Stages Concept Studies & Basic Research Exploratory Develop Full-scale Deployment Follow-on Production Contract Type Various types of Cost Reimbursement CPFF CPIF, FFIF, or FFP FFP, FPIF, or FPEA

Risk Elements Buyer Risks Seller Risks Price will exceed established ‘budget’ Work will not meet customer requirements Poor quality Inferior workmanship Substandard materials Late delivery Seller Risks Specifications incomplete or missing Differing Site Conditions Changing business conditions Material Prices Labor concerns Laws / regulations Weather “Force Majeure” .. Unforeseen events Acts of God War Performance failures by failures outside of either parties control

Fixed Price Contracts Buyer and Seller agree to a price Generally the price is not changed (i.e., it is “fixed”) Offers buyer lowest risk by transferring risk to seller Does NOT immunize buyer from all cost risks Differing Site conditions Imperfect specifications Seller agrees to do all work / deliver all goods for one price Seller assumes most risks and has little recourse for cost variations Preferred contract type for most Government agencies.

Firm Fixed Price Price is not subject to adjustments Sometimes called “lump sum” Strong incentive for seller to control costs Buyer must be able to accurately state requirements and estimate costs. Applicable to: Construction Commercial purchases

Fixed Price – Economic Adjustment Allows upward and downward revision of contract price Revisions are keyed one or more factors Established prices Actual cost of labor or material Published indexes

Fixed Price - Redetermination Fixed price for part of the contract with Redetermination of future prices at some point during performance (Prospective) Especially useful if prices are subject to large swings such as oil or currency exchange rates. Retroactive adjustment after completion Fixed ceiling price at start Retroactive adjustments can not exceed ceiling

Fixed Price – Level of Effort Fixed sum paid over time Contractor provides a ‘level of effort’ Can be based on labor hours (e.g., Full Time Equivalent (FTE) Contractor not obligated to continue performance beyond that limit Used when exact requirements can not be accurately stated but buyer wishes to cap total cost. Fixed price is invoiced over time as percentage of Period of Performance (1/12 per month etc.)

Cost Reimbursement Contracts Contractor is paid (reimbursed) for actual costs Ceiling cost is established Contractor may not exceed ceiling except at own risk Contract shall make ‘best efforts’ to complete work within ceiling Types of Cost Reimbursement Contracts Cost Contract Cost Sharing Cost Plus Fixed Fee

Cost Contract Contractor is reimbursed for their costs Must be “allowable” (i.e., not specifically prohibited) Must be allocable to the “final cost objective” Must be “reasonable” Arms-length dealing What would be normally paid by a prudent buyer in the normal course of business No profit or fee is paid Often to non-profit institutes, colleges, universities, etc.

Cost Sharing Contracts Both the buyer ad the seller share in the actual costs Benefits to both parties Often used for developing intellectual property shared by both One gets ownership and sales rights Other benefits from a paid-up license to use the technology

Cost Plus Fixed Fee Contracts Most commonly used form of cost contract Fee is calculated as a fixed value based on estimated costs “Best Effort” of seller to complete work for estimated cost Stop performance when the cost is reached If costs exceed estimate buyer may be provide added funds with or without additional fee No fee if costs are determined to be ‘overrun’

Incentive Contracts Applicable to both Cost and fixed price contracts Provide additional motivation for seller to control a specific risk e.g., cost, schedule, quality. Cost Incentive Permits adjusting final contract price using a formula based on Final negotiated cost Target cost Performance (Quality) Incentive Bonus for exceeding certain performance goals Delivery Incentive Bonus for early completion e.g., the Big I project. Penalty for late completion Liquidated damages

Guidelines for Selecting Contract Type When … Select a … The offeror can actually estimate cost(s) Firm Fixed Price Contract Economic conditions that will likely affect cost significantly and are outside offeror’s control but otherwise offeror can accurately estimate costs Fixed Price Economic Adjustment There are substantial cost uncertainties but it should be possible to estimate/control costs Fixed Price Incentive Fee Cost uncertainties are so great that fixed price would force seller to accept unreasonable risk but reasonable targets and formulas for sharing costs can be negotiated Cost Plus Incentive Fee The Level of Effort is uncertain and it is not feasible to negotiate an adjustment formula but likelihood of meeting objectives can be enhanced by a clear subjective fee plan Cost Plus Award Fee Cost uncertainty is so great the establishment of predetermined targets and incentive arrangements could result in a final fee out of line with the real work Cost Plus Fixed Fee Contracting Officers consider a number of factors when selecting contract type Risk is the primary factor Sellers should be rewarded for accepting increased risk Incentives, adjustments and award fees can be used to share the risk Equity .. What is fair and reasonable for both parties Buyer (Government) should never place itself in a position to make or break a seller (offeror)

Other Contract Devices Basic Agreement – Pre-negotiated agreement. Includes Offer and Acceptance of terms but has no value Basic Ordering Agreement (BOA) – Similar to above except may include pre-negotiated prices for standard items – again no value Letter Contract – Temporary agreement pending negotiation of key terms and conditions – undefinitized contract actions Indefinite Delivery / Indefinite Quantity (ID/IQ) – Establishes ordering framework as with BOA but includes assurance of some minimum value. Items are typically stated but quantity to be delivered and date for delivery need not be stated.