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Contracts EECE 295. Estimating. Estimating takes place at proposal time, and includes an estimate of: Time phased cost: Direct labor Direct material Overhead, G & A The sum of cost and G&A equals your cost through G&A The above defines your “breakeven point”

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Contracts eece 295 l.jpg
Contracts EECE 295

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  • Estimating takes place at proposal time, and includes an estimate of:

    • Time phased cost:

      • Direct labor

      • Direct material

    • Overhead, G & A

    • The sum of cost and G&A equals your cost through G&A

  • 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

  • A final iteration of contract cost and fee is accomplished at a negotiation after the contract award

  • The idea is to define the “cost” and the “fee” for the entire project

  • The “price” of the contract equals cost plus fee

  • There are a variety of incentives available 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 is incorporated into the deliverable product

  • Direct Material and Labor do not include the cost of the contractor’s facilities, rent, utilities, etc.

    • 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?

  • 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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Definition of a Contract

  • A “bilateral” agreement between two business entities to do something in the future for “Consideration”

    • 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

  • Governed by the Uniform Commercial Code

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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 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 in return must be defined

    • Consideration, ie. cost and fee

    • Deliverable items and data

    • Technical performance of deliverables

    • Schedule

    • Tasks (work) to be performed

  • If you don’t 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 (cont’d)

  • 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 customer’s perception of the “should cost”

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Requirements for the Creation of a Contract (cont’d)

  • 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 (cont’d)

  • Upon everyone’s 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 Contractor

    • Consideration is insufficient

      • Need more money to do the additional work

    • Impossible to perform to changed schedule, performance, etc.

  • Breach of contract occurs when the Customer or Contractor fail to meet the requirements of the contract

    • Failure to provide Customer Furnished Equipment, Facilities, etc.

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Dispute Resolution

  • Negotiations are required by all parties to resolve dispute

  • 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

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  • 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 (cont’d)

  • 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 (cont’d)

  • 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 (cont’d)

  • 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 Manager’s 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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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 (cont’d)

  • 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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  • 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


  • Government Contracting vs. Commercial Contracting

  • Estimating/Scheduling Methodology

  • Work Planning

  • Specification Development and System Engineering