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

ContractType

Low High

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

Small

Variance

Lower Cost Risk

Point Estimate Variance

.

Consider Cost Risk

4-9

Point Estimate. .

Fixed Price Type Cost 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

MarketWhat 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)Compensation Arrangement

Profit($)

Target Cost

Cost($)

CeilingPrice

PTAPessimistic Cost

10-24

Target Profit at Target (Most Likely) Cost

Profit at Pessimistic Cost (PTA)

OptimisticCost

Profit at Optimistic Cost

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 contractor’s 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 agency’s 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

TGT COST

TGTPROFIT

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

TGT COST

TGTPROFIT

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

)100(

CCPPS

OT

OTCU

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

)100(

CCPPS

PT

PTCO

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

CSKK

TG

TcPTA

4-23

FPIFProfit

Cost

slope:

under targetshare ratio

slope:

overtarget share ratio

Target Cost

Tar

get

Pro

fit

Pessimistic Ceiling Optimistic

Op

tim

isti

cP

essi

mis

tic

PTA

Target Cost $110,000Target Profit % 13.00%Ceiling % 130.00%

Contractor's Share %30.00%30.00%

FinalCost Profit Calc.80000 2330081000 2300082000 2270083000 2240084000 2210085000 2180086000 2150087000 2120088000 2090089000 2060090000 2030091000 2000092000 1970093000 1940094000 1910095000 1880096000 1850097000 1820098000 1790099000 17600

100000 17300101000 17000102000 16700103000 16400104000 16100105000 15800106000 15500107000 15200108000 14900109000 14600110000 14300111000 14000112000 13700113000 13400114000 13100115000 12800116000 12500117000 12200118000 11900119000 11600120000 11300121000 11000122000 10700123000 10400124000 10100125000 9800126000 9500127000 9200128000 8900129000 8600130000 8300131000 8000132000 7700133000 7400134000 7100135000 6800136000 6500137000 6200138000 5900139000 5600

Under-TargetOver-Target

23300Final Profit

2300022700224002210021800215002120020900206002030020000197001940019100188001850018200179001760017300170001670016400161001580015500152001490014600143001400013700134001310012800125001220011900116001130011000107001040010100980095009200890086008300800077007400710068006500600050004000

-10000

0

10000

20000

30000

80000 100000 120000 140000

Profit Calc.

FPIF CONTRACT TYPE

QUESTIONS

1,2

1. Subtract Final Cost From Target Cost = change in Cost

2. Multiply change in Cost by Ktr’s 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

Backup

To Do

• Check Page References

FPIFProfit

Cost

slope:

under targetshare ratio

slope:

overtarget share ratio

Target Cost

Tar

get

Pro

fit

Pessimistic Ceiling Optimistic

Op

tim

isti

cP

essi

mis

tic

PTA

TGT COST

TGTPROFIT

Optimistic Profit

Optimistic Cost

Pessimistic Profit

Pessimistic Cost

Ceiling Price

Point of Total Assumption