BME/CompE/EE/ME 297 Senior Design Seminar Contracts

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BME/CompE/EE/ME 297 Senior Design Seminar
Contracts Contract Management
Andrew W. Dozier FGH 249
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System Life Cycle

• In order to discuss contracts and contract
  management, it is necessary to understand where
  in the system life cycle contracting is used
• Typically, project engineers get involved at
  various phases of a system development
• Front end studies
• System Engineering
• Development
• Production
• Fielded systems
• Logistics, maintenance and support

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Front End Studies

• Typically, the customer has an existing system
  that they want to advance to current state of the
  art
• A significant amount of work is required to
  define and refine the requirements for the new
  system
• The only deliverable is a paper study, with no
  delivery or performance requirement
• This requires a different contract type from
  later system development phases
• Time and Material

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Later Phases

• As system development proceeds the number of
  unknown unknowns diminishes
• This implies that the risk of performance on the
  contract diminishes with each advancing phase
• As before, the contract type changes
• Cost reimbursable
• Fixed price
• Time and material (again)

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Contract Life Cycle

• Each phase of development typically is competed
  and awarded incrementally
• This allows the customer to deal with differences
  in implementation risk via the contract type used
• Typical phases
• Requirements Development
• Prototype/breadboard development
• First article production
• Low rate initial production
• Production
• Life cycle support
• Each development phase goes through the same
  process

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Contract Development

• Request for Proposal
• Includes contract type, or form
• Proposal development
• Cost/Schedule
• Technical
• Data/deliverables
• Factfinding
• Negotiations
• Best and Final Offer (BAFO)
• Award
• Performance
• Closeout

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Estimating

• Estimating takes place at the time of the
  proposal for each phase, and includes an estimate
  of the following
• Time phased cost
• Direct labor
• Direct material
• Overhead
• General and Administrative Expenses
• The sum of cost and GA equals your cost through
  GA
• The above defines your breakeven point
• Please note that this is based on your cost
  estimate, not what you end up spending on a
  project
• Actual cost can vary significantly from the
  estimate

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Contract Negotiations

• The customer spends a lot of time understanding
  what is contained in the proposal, also known as
  factfinding
• After factfinding, a final iteration of the
  contract cost and fee is generated
• The idea is to define the cost and the fee
  for the entire project
• The price of the contract equals cost plus fee
• Based on the final submittal by all competitors,
  an award is granted
• There are a variety of incentives available to
  the customer based on the type of contract
• Cost reimbursable
• Fixed price
• Time and Material

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Direct Material and Labor

• The term Direct implies that both the labor
  hours expended and the material utilized in
  accomplishing the project is incorporated into
  the deliverable product
• Consider a building/construction project
• Direct Material and Labor do not include the cost
  of the contractors facilities, rent, utilities,
  etc.
• These items are included in the Overhead that
  is applied to the cost of Direct Material and
  Labor
• The cost of direct material and labor does
  include employee benefits, the cost of buyer
  labor to procure material, etc.

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Typical Overhead Items

• Direct Labor would include
• Vacation pay
• Sick pay
• Insurance
• FICA
• Direct Material would include
• Cost of shipping
• Buyers to purchase the material and their overhead

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How are Overhead Rates Calculated?

• By an accounting methodology that conforms to the
  Federal Accounting Standards Board (FASB) for
  government contracts, and generally acceptable
  accounting practices for commercial companies
• The approach may vary from Company to Company
• Overhead does not include Wheat Tax or the cost
  of non-direct labor
• Supervisors, department heads, executives, etc.
• Also referred to as Indirect cost
• Overhead does include the Cost of Doing Business

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Overhead Rate Calculation Example
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Methods for Apportioning Overhead
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Application of O/H, G A, and Profit
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Definition of a Contract

• A bilateral agreement between two business
  entities to do something in the future for
  Consideration
• The giving party is the Customer (or Buyer, or
  Client)
• Receiving party is the Contractor (or Seller)
• The contractor can subcontract work to other
  companies and individuals
• However, the contractor is still responsible for
  contract performance
• Typically, this decision is made by going through
  a make vs. buy analysis
• All contracts are governed by the Uniform
  Commercial Code of the United States
• A body of law

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Contractual Relationships

• Interactions between business entities are based
  on Common Law
• Ultimately, contracts are administered by the
  Federal and State Government if a dispute arises
• Court of Claims
• Settlement of Contract Disputes
• Court of Patent Appeals
• Settlement of Intellectual Property Disputes

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Consideration

• Consideration is provided to the contractor upon
  successful completion of the contract terms
• Consider the following scenario
• Contractor builds a building, pays for all labor,
  subcontractors, and material suppliers
• Contractor delivers the finished building with a
  perfect title.
• Owner gives the contractor money as consideration
• All contracts and changes to contracts have
  consideration
• Consideration can take forms other than money,
  such as schedule relief, technical performance
  relief, etc.

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Requirements for the Creation of a Contract

• In order to establish a contract, a mutual
  understanding as to what each business entity
  will give and receive must be defined
• Consideration
• Cost and fee
• Deliverable items and data
• Technical performance of deliverables
• Schedule
• Tasks (work) to be performed
• If you dont have all of the above items defined,
  you do not have an executable contract

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Requirements for the Creation of a Contract
(contd)

• The contractor makes an offer to the customer
  (Proposal)
• Can be a written or verbal offer, or an offer
  created by other acts of communication by
  responsible officers of the seller
• Fax, email?
• Contractor defines the period within which the
  proposal will be honored
• Customer enters into negotiations by issuing a
  letter of acceptance
• The offer must be revoked in writing if something
  happens that requires withdrawal of the offer
  prior to expiration
• The offer defines all cost, schedule, and
  technical requirements
• Factfinding then takes place with the customer
  team
• Negotiations are then held to clarify items in
  the proposal, and to state the customers
  perception of the should cost

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Requirements for the Creation of a Contract
(contd)

• The customer then counteroffers to the seller to
  converge differences in understanding
• This can take multiple iterations
• Customer then generates a Best and Final Offer,
  or BAFO
• This is then either accepted by the performer
  (seller) or the seller takes a hike
• If the offer is accepted, a contract is generated
  which incorporates all of the final changes, and
  everyone signs it
• The signators must be able to legally obligate
  the business
• Typically, signators would be officers of the
  company with a delegated signature authority
  greater than the value of the contract
• This could be many 100 Million

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Requirements for the Creation of a Contract
(contd)

• Upon everyones signature, the project starts
• The seller is under contract to perform in
  accordance with the final negotiated document

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Contract Changes

• Things happen during the course of the project
  that change either the amount of work (), or
  the schedule
• A formal change process is incorporated into all
  contracts
• Unilateral Change
• Imposed by the Customer on the Contractor without
  concurrance
• Constructive Change
• Failure by the Customer to meet contractual
  requirement, ie. Breach of Contract
• Bilateral Change
• Mutually agreed to change between the Customer
  and Contractor
• Unilateral and Constructive Changes generally
  result in a Dispute

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Disputes and Breaches

• Unilateral changes are typically not acceptable
  to the Contractor
• Consideration is insufficient
• Need more money to do the additional work
• Impossible to perform to changed schedule,
  performance, etc.
• A breach of contract occurs when the Customer or
  the Contractor fail to meet the requirements of
  the contract
• Failure to provide Customer Furnished Equipment,
  Facilities, etc.
• Failure to deliver on time

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Dispute Resolution

• Negotiations are required by all parties to
  resolve disputes
• Contract letters and supporting documentation are
  very important in order to document the situation
  and position of both parties
• Getting ready to go to trial
• Lawyers get involved
• Generally very unproductive and expensive
• Not worth the effort for less than 10K on a
  large job
• Disputes must eventually adjudicated by the Court
  of Claims, which requires a legal trial
• This is a very expensive process

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Termination

• Contract Termination is possible under certain
  pre-negotiated conditions
• Termination for Convenience of the Government
• Termination is also possible for failure to meet
  Contract requirements
• Cost, Schedule, or Technical Performance
• Termination for Cause
• Termination for Default
• Termination clauses are always included as a part
  of the original Contract

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Termination (contd)

• Termination for cause allows the customer to
  re-procure the item at the expense of the
  original contractor!
• This is extremely serious and can bankrupt a
  company
• Termination for convenience requires a
  Termination Proposal, which is then negotiated
  like a new contract
• Material purchased is packaged and turned over to
  the customer
• Subcontracts must also be terminated
• Costs associated with early termination of
  employees are included
• Layoff notification, etc.

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Contract Concepts

• Different contract types are available
• The contract type selected must be based upon a
  mutual understanding of the risk of success of
  the project
• If the customer is incorrect with regard to their
  perception of risk, than there should be no
  bidders on the contract
• Success is defined as the achievement of all
  contract objectives Cost, Schedule, Performance
• Improper utilization of a contract type can, and
  does frequently result in project failure
• All contracts provide a concept of Profit or
  Fee
• Related to consideration
• Generally, the fee equals funds left over at
  contract completion, and after closeout

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Contract Concepts (contd)

• Residual materials or equipment are not included
  in the final profit
• Sold as surplus and credited to overhead
• Delivered to Customer
• Profit percentage varies with the type of
  contract, ie. cost reimbursable or fixed price

The residual funds can be negative!!
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Types of Contracts

• Fixed Price
• Cost Reimburseable
• Time and Material

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Fixed Price Contracts

• Highest risk to Seller. Used for low risk
  procurements.
• Three Types
• Fixed Fee (FFP)
• Incentive Fee (FPIF)
• Fixed Price with Redertimination (FPR)

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Firm Fixed Price Contracts (FFP)

• Fixed profit, no ceiling price
• Exceptions
• Constructive Changes
• Unilateral Changes
• Definition of Change subject to interpretation
• Generally used as negotiating tool
• Customer has upper hand by withholding of funds
• Can overrun! Can also have costs disallowed.

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Fixed Price Incentive Fee (FPIF)

• Lower Risk to Seller, fee determined by targets
• Ceiling Price
• Cost/Profit Sharing
• Incentive Curve
• 30/70 Share for Underrunns
• 70/30 Share for Overruns
• Still subject to Changes Clause
• Can receive minimal or no profit and overrun!
• Customer can also disallow costs.

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Fixed Price with Redetermination (FPR)

• Two types Prospective and Retroactive
• Prospective FPR negotiates prices to be paid in a
  prospective period
• Similar to two FFP arrangements negotiated at
  stated times during contract performance period
• Retroactive FPR provides for adjusting price
  after performance
• Essentially like FPIF
• Maximizes Project Managers attention on happines
  of Customer

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Cost Reimbursable Contracts

• Lower Risk to Seller than Fixed Price Contracts
• Used for higher risk procurements
• Uncertainty of performance goals, etc.
• Three Types
• Fixed Fee (CPFF)
• Incentive Fee (CPIF)
• Award Fee (CPAF)

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Cost Plus Fixed Fee (CPFF)

• Fixed profit, no renegotiation of contract
  allowed
• No ceiling price
• Exceptions
• Constructive Changes
• Unilateral Changes
• Definition of Change subject to interpretation
• Generally used as negotiating tool
• Customer has upper hand by withholding of funds
• All Costs are paid
• Subject to interpretation as to Allowable cost

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Cost Plus Fixed Fee (contd)

• If project overruns at cost, no increase in fee
  (lower profit margin)
• If project underruns at cost, higher profit
  margin achieved
• Can overrun, but will always make a profit

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Cost Plus Incentive Fee (CPIF)

• Lower Risk to Seller
• Established Targets (Cost, Schedule, Performance)
• Cost/Profit Sharing
• Incentive Curve
• 30/70 Share for Underrunns
• 70/30 Share for Overruns
• Still subject to Changes Clause
• Can overrun and still make a profit subject to
  the Incentive Curve

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Cost Plus Award Fee (CPAF)

• Fee determined by Customer via award criteria
• No rules regarding Award Criteria
• Typical targets established
• Responsiveness to Customer
• Cost/Schedule Controls, etc.
• Completely dependent on Grade of Customer.
• Can receive 0 profit, but will always be
  reimbursed for costs
• Maximizes Project Managers attention on
  happiness of Customer

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Time and Material Contracts

• Lowest risk to Seller. Generally used for
  studies with indeterminate outcome, or support,
  operational or maintenance contracts.
• Not to Exceed Contract for labor and material
• Task orders from Customer are negotiated with
  Seller
• Defines effort for small tasks
• Minimizes any cost uncertainty

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Cost/Fee Examples

• FFP
• FPIF
• CPFF
• CPIF

Note In the following slides, the price to
the customer equals the sum of the profit and
cost.
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Firm Fixed Price (FFP)
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Fixed Price Incentive Firm Target (FPIF)
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Cost Plus Fixed Fee (CPFF)
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Cost Plus Incentive Fee (CPIF)
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Elements of a Contract

• Contract Form
• Schedule
• Statement of Work (SOW)
• Deliverables
• Contract Data Requirements
• Contract Data Requirements List
• Specifications

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Contract Form

• Document which provides all contractual details
• Type of Contract
• Total Cost
• Deliverables/Services and Prices
• Packaging and Marking
• Inspection and Acceptance
• Contract Clauses and Administration Data
• List of Documents, Exhibits
• Representations and Certifications

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Contract Form (contd)

• Technically, Schedule and SOW are part of
  Contract
• Generally referenced in body of Contract Form
• No Schedule or Technical Information. Cost only!

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Schedule

• Time phased tasks and deliverables which are
  detailed in SOW, Supplies List, and CDRL
• Generally identical to the proposed schedule,
  with modifications resulting from negotiations
• No Cost or Technical Information. Schedule only!

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Statement of Work

• Details all tasks and activities to be
  accomplished on Contract
• References the following documents
• Contract Data Requirements
• Contract Data Requirements List (CDRL)
• Deliverable Items
• Specifications
• Defines all design activities, documentation,
  etc.
• No Cost or Schedule Information. Technical Only!

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Other Topics of Interest

• Government Acquisition Regulations
• DARS/FARS
• Government Contracting vs. Commercial Contracting
• Estimating/Scheduling Methodology
• Work Planning
• Specification Development and System Engineering