Sunday, October 4, 2015

Pushing squishy scope and risk around with contracts


Is your scope understanding squishy? How about your understanding of risk? Squishy also?

Here's the question of the day: Can you contract for 'squishy'?

Answer: yes, cost reimbursable contracts are for the squishy among us.

Default to CPFF
The usual answer, if no incentives are involved, is  CPFF (cost plus fixed fee). But, CPFF often gets confused with just paying all the costs and paying a fee on all the costs.

Noooo! paying all the costs and paying a fee on all the costs is CPPC (cost + percentage of costs). In federal contracting, which is my experience base, CPPC is a prohibited contracting procedure.
Obviously, there is no incentive for the contractor to control costs ... as the cost goes up, the contractor makes more, so the latent incentive is actually to drive (or allow) costs to go up.

It's shocking! to think a contractor would contrive to drive costs up to make money, but there you are ... no CPPC in federal contracting

CPFF is different: the fee is fixed at the time of award. (See excerpt below from the federal acquisition regulations [FAR])  If costs go up, the %-return goes down because the denominator, cost, is going up, but the numerator, fee, is not.
The CPFF contractor has some incentive, admittedly modest, to control costs so that a %-return business objective is achieved. 

Change management
The project office always anticipates change orders in CPFF because, if the scope and risk were not squishy, then FFP (firm fixed price) would have been the contracting vehicle. 
When there is new scope which requires a change order, then that scope change would carry its own CPFF estimate.

The issue always is: what is "new scope" which justifies a change order, and what is simply under-estimated on "old scope" which does not justify a change order?
CPFF is always in tension between project office and contractor about justifiable change orders that bring new fee to the contractor.

Cost control mitigation:

Now, as a practical matter, setting aside how change orders might be handled, CPPC and FPLOE (estimated level of effort [LOE] with estimated labor mix, supported by fixed price labor rates) are not materially different re cost-control incentives. As the cost goes up, the contractor makes more in either case.

As in all cost reimbursable contracts, sans specific cost-control incentives, there is no incentive in a FPLOE  to control costs (other than not to be so irritating to the project office that the contract is terminated for project office convenience).

Mitigations:
  • Ceiling cost, with contractor assumption of cost-over-ceiling. Ok, but there's no free lunch. The contractor will build risk mitigation reserves into the FP labor rates. Only competition will hold down the rates, but all competitors will cover the risk somehow
  • Job orders. Actually, I like this one. It's zero-base in effect, and agile in its outlook on evolving scope and risk. You estimate the immediate future and put that estimate in a JO. Then, when the horizon arrives and the first JO completes, you zero-base the next JO. (Zero base does not ignore history, but it does re-baseline with every JO. Thus, variances are reset with every JO). If you don't like where things are going, you've got time to react.

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FAR 16.306 Cost-plus-fixed-fee contracts.

"A cost-plus-fixed-fee contract is a cost-reimbursement contract that provides for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost, but may be adjusted as a result of changes in the work to be performed under the contract.
This contract type permits contracting for efforts that might otherwise present too great a risk to contractors, but it provides the contractor only a minimum incentive to control costs."

16.601 Time-and-materials contracts.

"A time-and-materials contract may be used only when it is not possible at the time of placing the contract to estimate accurately the extent or duration of the work or to anticipate costs with any reasonable degree of confidence.
A time-and-materials contract provides no positive profit incentive to the contractor for cost control or labor efficiency. Therefore, appropriate .... surveillance of contractor performance is required to give reasonable assurance that efficient methods and effective cost controls are being used."


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