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22
Unique Pricing And Estimating Challenges Faced In Change Orders, Requests For Equitable Adjustments, And Claims
Breakout Session # 408
Greg Bingham
Date: July 20, 2010
Time: 11:15 am - 12:30 pm
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3
Recognized Claim And Damages Theory “Three Column Approach”
Actual
Less
Would Have Been Equals
Claim
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4
Reasons For Increased Costs
Scope Increases Unit Rate Changes
• Labor And Material Unit Rates
• Inefficiencies (Disruption)
Delays• Time Related Costs
• Inflation
• Cost Of Capital (e.g., Interest)
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Jan Feb March April May June July Aug$0
$20
$40
$60
$80
5
Time-Related Cost
Direct Labor
$1,000
$500
$0
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Activity-Related Cost
6
Jan Feb March April May June July Aug$0
$20
$40
$60
$80 $1,000
$500
$0
Direct Labor
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“Joint” Cost
7
Jan Feb March April May June July Aug$0
$20
$40
$60
$80
Direct Labor
$1,000
$500
$0
Time-Related
Activity-Related
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Claim Methods
8
ContractorOriginal
CostEstimate
ContractorOriginal
CostEstimate
Total Cost Claim (Entire Overrun)
Actual Costs
Change Orders
ContractorOriginal
CostEstimate
Modified TotalCost Claim
Change Orders
Contractor Inefficiencies
ContractorOriginal
CostEstimate
Change Orders
Not Claimed
Build Up Claims
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“Sanity Check”
9
Claimed
ContractorCost
Estimate (with Changes)
Overrun
Not Claimed
Claimed (Entire
Overrun)Claimed
(More ThanEntire
Overrun)
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1010
10
Low High
Cost Of Initial
Preparation
Percentage Of Claim Dollars Recovered
How Do The Methods Compare?
Low
High
Total Cost
ModifiedTotal Cost
DetailedCost
Build-Up
10
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Low High
Total Cost ToResolveClaim
Percentage Of Claim Dollars Recovered
How Do The Methods Compare?
(continued)
Low
High
Total Cost
ModifiedTotal Cost
DetailedCost
Build-Up
11
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Customers And Courts Strongly Prefer Detailed Cost Build-Up Method
Significant Up Front Preparation Effort, But Often The Least Costly Method In The Long Run
Faster Settlement (Less Customer Resistance)
Generally Higher Recovery Percentage Than Total Cost Or Modified Total Cost Methods
Observations On The Detailed Cost Build-Up Method
12
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Modified Total Cost Claims Can Be An Effective Tool For Getting A “Quick And Dirty” Claim On The Table For Customer Consideration• Vulnerable To Customer “Slow Roll”
Should Be Supported By Detailed Cost Build-Ups Or “Benchmark” Support Where And As Soon As Possible• Properly Done, A Modified Total Cost Claim Requires Much
More Effort Than Perceived
Observations On The Modified Total Cost Method
13
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Improving Modified Total Cost Claims
Combine The Modified Total Cost Claim With Some Detailed Cost Build-Up Claims• Example Constructive Changes• Delay Impacts• Labor Disruption Examples
Contractors Can Present Both Types Of Claims And Argue In The Alternative• Different Pricing For Different Legal Arguments• Early Settlement Discussions Or ADR
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Labor Claims
15
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16
Reasons For Increased Costs –Labor Claims
Scope Increases Unit Rate Changes
• Labor And Material Unit Rates
• Inefficiencies (Disruption)
Delays• Time Related Costs
• Inflation
• Cost Of Capital (e.g., Interest)
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Labor Overrun Components
17
$25
Budget
$125,000
5,000Hours
$30
WageVariance$25,000
9,000Hours
QuantityVariance$120,000
10,000Hours
ProductivityVariance$30,000
$
Time
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Labor Overrun Components
18
Time
$
$25
Budget
$125,000
5,000Hours
$30
WageVariance$50,000
9,000Hours
QuantityVariance$100,000
10,000Hours
ProductivityVariance$25,000
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Labor Claims, Generally Should
19
Be Based On Actual Project Experience. Be Based Upon Concurrent, Objective Evidence. Reflect A Reasonable Attempt By The Contractor To
Capture Costs Expended Outside Of Its Control. Reflect Actual Productivity Information, If Available. Consider Actual Labor Rates Vs. Change Order
Rates.
The Contractor Advances Its Position By These Methods
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Labor Claims – Approaches
20
Total Cost / Modified Total Cost
Measured Mile
Industry Factors
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Measured Mile Example
21
1.36 MH/LF
1.0 MH/LF1.13 MH/LF
Period1
Period2
Period3
Budget .75 MH/LF
Impact .23 mh/lf
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Measured Mile Example
22
Claim Calculation:
Linear Feet Installed In Period 3 22,485
"Should Have Been" MH/LF 1.00
"Should Have Been" MHs 22,485
Actual MHs 30,671
Claimed MHs 8,186
Actual Labor Cost Per MH 25.93$
Labor Claimed 212,261$ Markups (7% OH, 5% Fee) 15,601 Claim 227,862$
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Industry Factors
23
Mechanical Contractors Association Of America (MCAA)• Used For Thirty Years• Updated Publication In 2005• Derivation Of Factors Not Known• Most Complete Approach
Corps Of Engineers Modification Impact Evaluation Guide (COE Guide)• July 1979• Curves For Certain Impacts (Trade Stacking, Crew Size, Overtime)• Officially Withdrawn By The Corps
Construction Users Roundtable (CURT)• Recent Empirical Data• Not Published• Deals With Overtime, Weather, Schedule, Planning
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Pitfalls Of Industry Factors Approach
24
Basis Of Data Is Often Unclear Applicability To Your Situation
• Different Industry• Different Impacts
Very Judgmental
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Equipment Costs
25
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Reasons For Increased Costs – Equipment Costs
26
Scope Increases
Unit Rate Changes• Labor And Material Unit Rates
• Inefficiencies (Disruption)
Delays• Time Related Costs
• Inflation
• Cost Of Capital (e.g., Interest)
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Equipment Costs – Issues
27
Construction Equipment Can Be Owner-Supplied, Contractor-Owned, Or Rented.
Very Complex Area Due To Number Of Disparate Views Of “Actual” Costs.
Can Be Complicated By “Related Party” Transactions.
Equipment Is Frequently Priced By “Agreed To” Rates To Avoid Confrontations Over Costs.• Blue Book• Cal Trans
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Equipment Costs –Cost Components
28
Ownership Costs - Charges For Depreciation Of Acquisition Costs, As Well As Overhauling, Insurance, Financing, Taxes, And Storage Of Equipment.
Operating Costs - Expenses The Contractor Faces By Turning The Equipment “On.” Charges Include Routine Equipment Maintenance, Fuel, Lubrication, Tires, Tracks, And Tool Attachment Repair.
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Equipment Cost Issues
29
What Does The Contract Say?
Change Order Rates Vs. Major Claims?
Recording Equipment Hours
Idle Vs. Standby
What Are Actual Costs?
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Home Office Overhead Costs
30
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Reasons For Increased Costs –Home Office Overhead
31
Scope Increases
Unit Rate Changes• Labor And Material Unit Rates
• Inefficiencies (Disruption)
Delays• Time Related Costs
• Inflation
• Cost Of Capital (e.g., Interest)
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Home Office Overhead –Conceptual Issues
32
G&A Expenses0
20
40
60
80
100
120
140
160
5 6 7 8 9 10 11 12 13 14 15YEARS
$ M
ILL
ION
S
Actual Revenue
$10M G&A SupportsUp to $70M in Revenue
$15M G&A Supports$71M-$130M in Revenue
$20M G&A Supports$131M-?M in Revenue
Actual G&A 21%
Year 7G&A 14%
Planned Revenue
Year 10Planned G&A 15%
Year 13G&A 12%
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Home Office Overhead –Example Costs
33
Officers’ Salaries
Rent
Advertising & Promotion
Corporate Accounting
General & Administrative
Estimating
Legal
Insurance
Utilities
Office Supplies
Telephones
Contributions
Medical And Other Benefits
Taxes
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Home Office Overhead
34
Generally Represents The Cost To The Project For Support From A Remote Home Or Division Office, Which Provides Some Services To The Project. Also Called General & Administrative (“G&A”) Costs.
The Eichleay Formula Is Often Used As A Means Of Allocating Some Portion Of Home Office Overhead To Projects, Which Have Been Delayed By Owner Caused Interference (Billings To Billings).
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Home Office Overhead –Eichleay Formula
35
x Home Office OverheadFor Actual Contract
Period
= Allocable Home OfficeOverhead
Contract Billings
Total Billings For ContractorIn Contract Period
OverheadAllocable Home Office
=Daily Home Office
Overhead Rate AllocableTo ContractActual Days Of
Contract Performance
x Number Of Days OfCompensable Delay = Claimed Home Office
Overhead
Daily Home OfficeOverhead Allocable To
Contract
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Home Office Overhead –Eichleay Vs. Cost-To-Cost
36
Eichleay Method$480,000 x 10% = 48,000
Cost-To-Cost Method$480,000 x 15% = $72,000
vs.
$140,000
Costs $195,000 $520,000 $585,000 $1,300,000
40% Percentage 15% 45%
$1,400,000$700,000$560,000
Claim Project
Billings
100%
Percentage
Project A
10%
TOTAL
100%
Project B
40%
Project C
50%
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Why Are We So Careful?
37
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38
Daewoo Engineering And Construction Co., Ltd.
V.United States of America
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Background
39
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Background
40
Palau Has A “Compact Of Free Association” With The U.S.
U.S. Was To Build A Road Around Island Of Babeldaop (One Of 300 Islands That Make Up Palau).
Issue Was Compaction Specification For Embankments, Weather.
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Background
41
• Daewoo’s Certified Claim
– $13.4 Million In “Incurred Damages,” Additional Costs Of $50 Million Not Yet Incurred.
– REA Was Ultimately Denied By The CO.– Daewoo Hired Exponent To “Update/Reprice” The
Claim. Resulted In Measured Mile Study Of $42M.
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Court Findings
42
Contracts Disputes Act Fraud Clause:“If a contractor is unable to support any part of his claim and it is determined that such inability is attributable to misrepresentation of fact or fraud on the part of the contractor, he shall be liable to the Government for an amount equal to such unsupported part of the claim in addition to all costs to the Government attributable to the cost of reviewing said part of his claim.”
$50 Million
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Setting The Stage To Claims Analysis And Pricing
Relevance Of Claims
Some “Street - Lore”
Identifying Contract Changes
Challenges Of Claim Preparation
Hypothetical Claim
Possible Reasons Claim Might Be Waived
4343
43
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Why Claims Are Relevant
Management – Claim Knowledge Will Improve Job Performance
Customer – Expects Some Claims
Owners And Creditors• Equity• Security For Financing
444444
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Some “Street - Lore”
100% Avoidance Of Changes
Customer Is Offended By Changed Work Claims
Claim Preparation Is Not “Fun”
NOT!
454545
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Identification Of Contract Changes
Formal Changes• Unilateral Customer Directives• Pricing
Constructive Or Informal Changes• Technical Specifications• Statements Of Work
464646
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Claim Preparation Challenges
Skill - Mix
Sufficiency Of Resources
Scope And Pricing
Timeliness
Organization
474747
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Hypothetical Claim
484848
Original Contract Price 115$ million
Original Contract Costs 100 million
Incurred Costs 120 million
To Go Costs 40 million
Subtotal (160) million
Over-Run 60$ million
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Hypothetical Claim (Continued)
494949
Changed Work Claim 55$ million
Changed Work Claim Settlement 33$ million
Original Contract Price 115$ million
Claim Settlement 33 million
Less: Claim Preparation (3) million
Revenue 145$ million
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Hypothetical Claim (Continued)
Claim Settlement Compared To New Business
Assume Average Before Tax Profit Is 10%
$30 million ÷ 10% = $300 million
505050
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Possible Reasons Claim Might Be Waived
Lack Of Training
Insufficient Cross Checking With Counsel
Lack Of Clarity Regarding The Original Contract Requirements
“Our Fault” Attitude
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Conclusion
Claim Control And Preparation May Be Challenging, But Is Very Important And Beneficial To Your Company.
Damage Claim
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Simple Example Of Dispute Process Involving The Government
FAR, Part 33: Protests, Disputes And Appeals
Contractor Notifies Contracting Officer And Prepares Claim Claim Summary Requirements Of The Original Contract Describe Change (Entitlement) Describe Impact (What Changed) Quantify Increased Costs And Increased Schedule
Audit And Technical Evaluation Performed At Contracting Officer’s Request
Contracting Officer Negotiates With Contractor Representative
Final Decision By Contracting Officer
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Contractor Can Accept Or Appeal Final Decision• Boards Of Contract Appeals• U.S. Court Of Federal Claims
Contractor And Government Prepare For Trial• Claim Brought Current• Document Production• Depositions• Other Preparation
Trial Or Hearing
Simple Example Of Dispute Process Involving The Government
(Continued)
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Claims Pricing “How To’s”
Types Of Increased Costs
Some Recommendations For Identifying And Pricing Claims
Claim Pricing Challenges
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Developing The Claim
Determine The “Rough” Cost Baseline• Cost Baseline Is Generally The BAFO + Formal
Changes, Or The Budget • Develop Overruns By Task, Functional Area Or Both
• Cost Analysis Helps You Avoid Missing The 800 lb. Gorilla
Determine The Technical Baseline - Know The “Hard Legal Requirements” Of The Contract
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Changed Work Claim Identification
Technical And Legal Review
Change 1 Change 2 Contractor Delay Disruption
Engineering
Manufacturing
Quality
Management
Cost Growth Review
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Typical Changed Work Claim Elements
Direct Cost Claims For Changed Work• Labor• Material• Subcontracts
Delay-Related Costs• Sustaining Personnel (i.e., Fixed Direct
Charging Personnel)• Escalation (Both Material And Labor)• Unabsorbed Overhead
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Typical Changed Work Claim Elements
(continued)
Disruption, Acceleration And Inefficiencies Other
• Profit• Claim Preparation Costs (Internal & External)• Legal Fees• Interest
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Some Challenges In Developing The Claim
Claim Development Is Resource Intensive• Requires Input Of Key Program Personnel
Throughout The Process
Perspective Of Program Personnel
Waivers And Other Legal Issues• Waivers Not Fully Considered Or Too Broadly
Interpreted• Schedule Slippage
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Avoid Common Pricing Challenges
Double Counting Between Claim Elements
Improper Baseline• Overstated Claims• Understated Claims
No Linkage Between Entitlement And Pricing (Cause And Effect)
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Summary And Recommendations
Generally Avoid Use Of Total Cost Method
Use Modified Total Cost For Settlement Discussions, ADR And Trial Where Appropriate• Consider Combination Of Modified Total Cost And
Detailed Cost Build-Up Methods• When Using Modified Total Cost, Still Demonstrate
And Prove Costs Claimed
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Detailed Cost Build-Up (Change By Change) Generally Results In Fastest And Best Settlement• Perform Thorough Technical And Legal
Evaluation To Determine The “Hard Legal Requirements Of The Contract”
• Coordinate Cost, Technical And Legal Claim Efforts To Maximize “Hardcore” Claim Pricing
Avoid The Common Claim Pricing Pitfalls
Summary And Recommendations
(continued)
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Delay-Related Cost “How To’s”
Sustaining Personnel Material And Labor Escalation Fixed Overhead Costs
Claim
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Schedule Analysis Goals
Quantify Actual Program Delays Identify Actions, Inactions Or Events Which Caused
Delays Determine Party(ies) Responsible Identify Impact On Costs
=
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As-Planned Vs. As-Built
AssemblyDesign
Hardware Procurement
Software Development
Start Finish
As-Planned
4 Months
5 Months
3 Months
4 Months
Start
Design ModsDesign
Software Development
Finish
4 Months
5 Months
6 Months
3 Months 4 Months
Assembly
DelayDelay4 months4 months
Hardware Procurement
As-Built
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Sustaining Personnel
Certain Direct Charge Personnel Perform Work As A Function Of Time
Program Extension Can Cause A Direct Increase In The Cost Of Time-Related Efforts
In Order To Identify Time-Related Personnel:• Focus On Program Roles Not Individuals
• Critically Evaluate Which Roles Must Continue In Order To Maintain The Program
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Sustaining Personnel
Examples Of Time-Related Personnel:• Program Manager• Certain Program Control Personnel• Departmental Managers, Supervisors, And
Liaisons• Direct Charge Clerks Or Administrative
Personnel• Some Engineering Personnel• Certain Personnel In Quality And Product
Assurance
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Sustaining Personnel
To Fully Support This Area Of Claim:• Provide Accounting Records For All Hours
Incurred On Time-Related Efforts
• Prepare Exhibit Depicting How Each Time-Related Effort Transitioned To Different Personnel Throughout The Program
• Prepare A Graph Of Total Time-Related Work Throughout The Program To Show Consistency Over Time
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Sustaining Personnel
Time-Related Personnel Direct Labor
Planned Performance Period Extension Period
Total Direct Labor
Direct LaborHours Impact Of
Extended Manning Of Time-Related
Personnel
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Sustaining Personnel
Impact For This Claim Area Can Be Calculated As Follows:• Months Of Compensable Delay• Multiplied By: Average Monthly Hours• Multiplied By: Labor And Overhead Rates
To Try To Simplify Pricing, Consider Estimating The Impact Of Each Department Separately
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Labor And Material Escalation
When A Program Is Delayed, The Performance Of Certain Activities And The Procurement Of Certain Material May Occur In A Later Time Period Than Otherwise Would Have Been The Case
The Increased Cost Which Is Caused By Direct Labor Rate Or Material Unit Cost Increases Are Typically The Subject Of Escalation Claims
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Labor And Material Escalation
Compensable Labor And Material Escalation From Customer Delay Can Occur From:• Normal Economic Inflation• Negotiated Union Contracts
• Purchase Agreements
• Labor Or Skill Mix Variance$
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Labor And Material Escalation
To Prove This Claim Area:• Emphasize The Difference Between The Actual
Rates And The Rates That Should Have Occurred Had There Been No Delay
• Avoid Relying On Overly Simplistic Comparisons Of Bid Vs. Actual Rates Or Unit Costs
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Recap Of Delay-Related Damages
Recovery Of Damages Is Dependent On Proof Of Delay
Sustaining Personnel Material And Labor
Escalation Fixed Indirect Costs
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Disruption Pricing “How To’s”
Definition Of Disruption
Some Example Causes Of Disruption
Entitlement, Causation, And Increased Cost
Some Pricing Approaches
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What Is Disruption?
Loss Of Productivity On Original Scope Of Work
Change In Working Conditions, Resources Or Manner Of Performing Work
Change Orders Can Affect Work Not Otherwise Thought Of As Changed
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Example Causes Of Disruption
Changed Work• Rescheduling Of Planned Work• Excessive Overtime To Avoid Schedule Slippage• Less Than Optimal Work
Sequencing• Changes In Manufacturing
Or Design Work Methods• Excessive Rework• Loss Of Learning
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Example Causes Of Disruption(Continued)
Customer Delays• Unnecessary Starts And Stops To Contract Activity• More Loss Of Learning• Underutilization Of Work Force• Loss Of Economies Of Scale
Acceleration• Excessive Overtime• Congestion In The Work Place • Resequencing Of Work
Performance
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Entitlement, Causation And Increased Cost
Entitlement: Often The Same As For Discrete Claims
Causation: Demonstrate The Effects Of Changed Work On The Original Scope Of Work, i.e. The Unchanged Work
Increased Cost: Quantify Increased Cost Of Performing Original Scope Of Work, Plus Profit
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Simple Example
In Millions
Estimated Cost-At-Completion $500
Less: Original Budget <200>
Cost Growth 300
Less: Discrete Changes <110>
Unexplained Cost Growth $190
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Disruption Pricing Approaches
“Should Cost” Approach - Compare Actual Productivity To Productivity On:
• Unaffected Portions Of Work• Similar Work• Productivity Contemplated
In The Original Bid
Learning Curve Analysis
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Regression Analysis
Method Of Using One Or More Independent Variables To Quantify A Dependent Variable
Applying Regression Analysis To Disruption• Independent Variable - Increased Costs Of
Changed Work• Dependent Variable - Increased Costs Of
Unchanged Work • Regression Calculates The Mathematical
Relationships Between The Variables
Least Squares Regression Analysis
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Cost Recovery Issues on ClaimsDisclosing Cost Information
Cost Information Under CAS And / Or FAR Part 31 Cost Information Assuming CAS And FAR Part 31 Do Not
Apply• Direct Costs Only• Disclosure Of Indirect Cost Rates• Disclosure Of Typical Profit Rates• Inclusion Of Expressly Unallowable Costs
Establishing That Contractors Books And Records Should Be Relied Upon• Prior Government Audits (e.g., DCAA, DCMA, IRS, EPA, DHS,
Etc.)• Audited Financial Statements• Lending Covenants• Special Purpose Audits Of Claimed Costs• Reliance On The Work Of Others• Work Papers
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Termination For Convenience Equitable Adjustment After Partial Termination
Contractor May Request An Equitable Adjustment On Continued Work (FAR 49.208)
Contracting Officer Has Authority, Unless Delegated To The TCO
Follow Cost/Pricing Proposal Format (FAR 15.408)
Costs Included In A Request For Equitable Adjustment Shall Not Also Be Included In The Termination Settlement Proposal
Contractor Shall Complete TINA Certification
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Termination For Convenience Pricing Unsettled Contract Changes
Resolve All Unsettled Contract Changes As Part Of Negotiating The Final Termination Settlement Proposal (FAR 49.114)
Incorporate Resulting Changes In Contract Price Into The Profit/Loss Analysis (FAR 49.203)
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Reference Materials
1. “BACK TO BASICS: As The Pendulum Shifts To More Fixed Price Contracts, Be Prepared For More Contract Changes and Know How To Price Them,” By Greg Bingham, Cheryl LeeVan And David Hall, American Bar Association Annual Meeting Of The Public Contract Section, August 2010.
2. “Administering Subcontracts After A Termination For Convenience,” By Greg Bingham and Patricia Meagher, Briefing Papers, March 2004, Thomson West Publishers.
3. “DCAA Contract Audit Manual Chapter 12 -- Auditing Contract Termination, Delay/Disruption, And Other Price Adjustment Proposals Or Claims”
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Greg Bingham
Greg Bingham is a Vice President with The Kenrich Group, LLC. He has over 22 years of experience in the fields of business and litigation consulting including investigation of allegations of fraud or overbilling.
Professional Experience
Mr. Bingham has assisted clients on Government Contract matters including: 1) regulatory consulting on allowable costs issues arising from the Cost Principles found at Part 31 of the Federal Acquisition Regulation (“FAR”) as well as allocation of cost issues associated with the Cost Accounting Standards (“CAS”), 2) consulting on matters involving allegations of defective pricing, false claims, mischarges and other improper billings to the Government, 3) the Earned Value Management Systems requirements of Department of Defense regulation 5000.2-R, 4) financial statement and special purpose auditing, 5) management consulting and 6) Foreign Military Sales issues and foreign sales issues. This experience has provided him with substantial knowledge of the program management, financial and accounting records and systems maintained by companies who sell to the Federal Government.
Greg’s work has included the quantification of cost impacts and negotiation with Government auditors and oversight personnel. Greg has planned and performed reviews of various defense contractors’ systems including Internal Controls, Accounting, Billing and Estimating as well as policies and procedures.
Contact Information:1250 Connecticut Avenue NW, Suite 650Washington, DC 20036Tel: (202) 420-7680Fax: (202) [email protected]
Masters of Business AdministrationUniversity of Texas at Austin
Bachelor of Science in Electrical EngineeringUniversity of Kentucky