Section 2 Production Chapter 3 Analysis of Indirect Costs Chapter 4 FPIF Contracts

This Could Be You!

What is the principal method of allocating cost risk? Is there a single contract type that is right for every contracting situation? Selecting the right contract type will make the work more attractive to more potential offerors, thereby…. Matching Contract Type to Contract Risk 4-3

CPFF FFP 4-3 CPIF FPIF Contract Risk Contract Type LowHigh The Govt The Contractor Matching Contract Type to Contract Risk A contract type that will result in reasonable contractor risk with the greatest incentive for efficient and economical contract performance What is Your Objective?

What to Consider When Matching Contract Type to Contract Risk Do you know what contract types are available? What acquisition method should I use? Can the requirement be met with a commercial item or service? What is the cost risk? Should I use performance incentives? Is the accounting system adequate? Document the contract-type decision 4-3

What Contract Types are Available? Fixed Price –Contract risk is relatively low –Contractor agrees to deliver at a price Cost Reimbursement –Contractor agrees to provide best effort –Govt pays allowable incurred costs within estimated total cost and funding limitations Labor-Hour/Time & Material –Generally considered cost-reimbursement –Includes fixed labor rates with estimated hours to complete effort 4-3

What Contract Types are Available? 4-5 See Table at Pages 4-5 & 4-6 Principal Risk Use When… Elements Contractor Obligated to… Contractor Incentive Typical Application Principal Limitation Variants FFP…FFP/EPA…FPIF…FPAF…FPRP…CPIF…CPAF…CPFF…C or Cs….T&M Table Comparing Major Contract Types

Consider Cost Risk What is the proper allocation of risk between the Govt and the Contractor? Requiring contractors to accept unknown or uncontrollable risk can endanger performance 4-8 Point Estimate Variance.

Consider Cost Risk 4-9 Point Estimate.. Fixed Price TypeCost Type The greater the potential variability between projected and actual cost, the greater the cost risk

Consider Cost Risk When assessing cost risk consider… –Contract performance risk –Market risk 4-10

What are the Performance Risk Considerations??? How stable and clear is the requirement? What is the type and complexity of the item or service required? To what extent is historical pricing data available? Does the contractor have prior experience in providing required supplies or services? Is this an urgent requirement? Is the contractor technically capable? Is the contractor financially able? What is the extent and nature of proposed subcontracting? 4-10

What risks are inherent in doing business within this market? –Stability of technology –Probable level of competition –Relative capability and experience –Past Performance records –Probable changes in general level of business over the life of the contract Volatile market increases cost risk in contract pricing, especially with long period of performance Market What are the Market Risk Considerations??? 4-11

Matching Contract Type to Contract Risk Select the contract type that will best motivate contract performance Firm Fixed Price best utilizes profit to motivate efficient contract performance and cost control Risk of using Firm Fixed Price when there is no reasonable basis for firm pricing –May limit competition –Can encourage inflated contract pricing –Inappropriate emphasis of cost control may hamper effective contract performance 4-12

FIXED PRICE INCENTIVE FIRM (FPIF) FPIF contracts are designed to attain specific cost, technical, or delivery incentives by rewarding contractor achievements in exceeding stated targets and negatively rewarding contractors failures to reach stated targets. Profits will increase when targets are surpassed Profits will decrease when they are not met. 4-13

BASIC ELEMENTS Target Cost Target Profit Profit Adjustment Formula Ceiling Price Point of Total Assumption 4-15

PROFIT ADJUSTMENT FORMULA Step 1 - Develop a target cost objective –Should be most likely contract cost –Reach agreement with contractor using using judgment and available facts –This $ amount will be in the FPIF provision Step 2 - Develop a target profit objective –Use your agencys structured approach to develop your profit ($) objective –This $ amount will be in the FPIF provision 4-16

TGT COST TGT PROFIT Y X

PROFIT ADJUSTMENT FORMULA Step 3 - Develop a pessimistic cost –Highest cost you would consider based on information available –Consider high side of confidence curve –High side of prediction interval Step 4 - Develop profit at pessimistic cost –Consider target profit and contractor effort required to limit cost to pessimistic cost estimate 4-16

Pessimistic profit Pessimistic cost

PROFIT ADJUSTMENT FORMULA Step 5 - Set ceiling price –Pessimistic cost estimate plus profit at pessimistic cost Step 6 - Develop optimistic cost –Low side of confidence interval –Low side of prediction interval Step 7 - Develop profit at optimistic cost –Consider contractor effort to reach optimistic cost estimate 4-17

Optimistic Profit Optimistic Cost Pessimistic Profit Pessimistic Cost Ceiling Price Point of Total Assumption

PROFIT ADJUSTMENT FORMULA Step 8 - Calculate under target share ratio –Scu = Contractor share of cost risk –Pt = Target Profit –Po = Profit at optimistic cost –Ct = Target cost –Co = Optimistic cost estimate 4-18

PROFIT ADJUSTMENT FORMULA Step 9 - Calculate over target share ratio –Sco = Contractor percentage share of cost –Pt = Target Profit –Pp = Profit at pessimistic cost –Ct = Target cost –Cp = Pessimistic cost estimate 4-18

POINT OF TOTAL ASSUMPTION (PTA) Cost at which the contractor assumes total responsibility for each additional dollar of contract cost PTA is equal to the pessimistic cost estimate PTA formula can be used to calculate pessimistic cost if unknown Once PTA is approached, surveillance must be increased to ensure completion of contract and quality of remaining items due 4-23

PTA FORMULA PTA - POINT OF TOTAL ASSUMPTION –Kc = Ceiling Price –Kt = Target Price –Ct = Target Cost –Sg = Government percentage cost share 4-23

FPIF Profit Cost slope: under target share ratio slope: over target share ratio Target Cost Target Profit Pessimistic Ceiling Optimistic Pessimistic PTA

FPIF CONTRACT TYPE QUESTIONS 1,2

1. Subtract Final Cost From Target Cost = change in Cost 2. Multiply change in Cost by Ktrs Share = change in Profit 3. Add change in Profit to Target Profit = Computed Profit 4. Add Computed Profit to Final Cost = Computed Price 5. Compare Computed Price to Ceiling Price * If Computed Price < Ceiling Price: Pay Computed Price * If Computed Price > Ceiling Price: Pay Ceiling Price COMPUTING FINAL PRICE (FPIF)

FPIF CONTRACT TYPE QUESTION 3 FINAL CONTRACT PRICE COURT

REVIEW QUESTIONS QUESTIONS 1,2,3

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FPIF Profit Cost slope: under target share ratio slope: over target share ratio Target Cost Target Profit Pessimistic Ceiling Optimistic Pessimistic PTA

Optimistic Profit Optimistic Cost Pessimistic Profit Pessimisti c Cost Ceiling Price Point of Total Assumption