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BME/CompE/EE/ME 297 Senior Design Seminar Contracts & Contract Management . Andrew W. Dozier FGH 249. 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
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BME/CompE/EE/ME 297 Senior Design Seminar Contracts & Contract Management Andrew W. Dozier FGH 249
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
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
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)
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
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
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 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
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
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 donot include the cost of the contractor’s 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.
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
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”
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
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
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.
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 don’t have all of the above items defined, you do not have an executable contract
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”
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
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
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”
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
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
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
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.
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
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!!
Types of Contracts • Fixed Price • Cost Reimburseable • Time and Material
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)
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.
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.
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
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)
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
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
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
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
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
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.
Elements of a Contract • Contract Form • Schedule • Statement of Work (SOW) • Deliverables • Contract Data Requirements • Contract Data Requirements List • Specifications
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
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!
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!
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!
Other Topics of Interest • Government Acquisition Regulations • DARS/FARS • Government Contracting vs. Commercial Contracting • Estimating/Scheduling Methodology • Work Planning • Specification Development and System Engineering