Contract Types and EVMS

By Steven Norton

Course Outline

Contract Types

Fixed Price

Firm Fixed Price (FFP)

Fixed Price Incentive (FPI)

Cost Type

Cost

Cost Plus Fixed Fee (CPFF)

Cost Plus Incentive Fee (CPIF)

Cost Plus Award Fee (CPAF)

Flexibly Priced

Time and Material (T&M)

Labor Hour (LH)

Cost Plus a Percentage of Cost (Big NO! NO!)

Earned Value Management (EVMS) Overview

Fixed Price Contract Types A fixed price contract is based on a negotiated price prior to the

commencement of work completion and is independent of the actual cost amounts incurred.

Example: An optical lens is negotiated for $75/unit and the supplier incurs $100/unit in actuals. The buyer is only obligated for the $75/unit cost. In this manner, fixed price contracts shift the burden of risk to the supplier.

A Firm Fixed Price contracting arrangement has a defined price that does not change unless formally amended while a Fixed Price Incentive contract provides sharing of underrunning or overrunning pre-set target costs

Economic adjustment clauses can also be included in Fixed Price arrangements to cover uncertainties such as fluctuation in commodity prices (i.e., oil based products, special metals, and copper).

The key take-away is that fixed price arrangements are implemented when there are minimal unknowns and risk can be shifted to the supplier without jeopardizing contract execution.

Production phases in product life cycle = Fixed Price contracting arrangements.

Cost Type Contracts A Cost Type contract reimburses a supplier for costs incurred and are

executed when work scope cannot be clearly defined

Development efforts lend themselves well to Cost Type contracting arrangements and the burden of cost risk shifts to the buyer or customer.

Cost Plus Fixed Fee contracting arrangements reimburse a supplier their incurred costs plus a pre-negotiated FIXED fee in dollars. Percentage fees are not recommended since the contract type then becomes Cost Plus a Percentage of Cost which is not allowed in Government Contracting.

Example: A software package is in development. A target price is projected at $1M and includes $900K target cost and a $100K fixed fee. The effort overruns by $200K. The total price becomes $1.2M which breaks down into $1.1M cost and $100K fixed fee (unchanged).

It should be noted that in the prior example if the target cost was reached and the buyer decided not to continue with the effort the supplier would not be required to incur any additional costs or finish the effort.

Cost Type Contracts (Continued) Cost Type Contracting is where one sees a lot of creativity in fee

structuring.

Incentive and award fees can provide motivation for suppliers to contain cost growth and maintain schedules.

Award fees can be used if pre-set performance goals are attained.

Incentive fee arrangements share cost risk and reward by establishing a share line for over and underruns.

In this example, 60% of all overruns and underruns are shared by the customer while 40% are shared by the supplier. This relation holds between “Max” and “Min” levels in which the agreement converts to a CPFF Arrangement.

Flexibly Priced: T&M and LH Flexibly Priced Contract Types include Time and Material (T&M) as

well as Labor Hour contracts.

Profit/Fee margins are included in the burdened labor rate only. Materials are at cost through G&A (General and Administrative).

Least preferred contracting types since they come very close to a cost plus a percentage of cost contracting arrangement – the more you spend the more you make negating any efficiency incentives!

These contract types should truly be a last resort in support type contracts or consulting arrangements. Performance times should be minimal.

Ceiling prices are negotiated to provide some type of sizing for the effort in order to control costs.

Example: A radar engineer is needed for two man-months at a negotiated rate of $75/hour through profit/fee. The ceiling price would be: 2 MM x 160 hrs/MM = 320 hours x $75/hour = $24,000. Any overruns causing funding extensions would include the billing rate’s fee/profit so the more money spent would equate to additional profits made by the supplier.

Contract Type Payment Methods Fixed Price contract payment methods include delivery, progress and

milestone payments. While progress payments make payments as a percentage of incurred costs, milestone payments are based on pre-defined tangible objectives.

Good milestones include:

Significant objectives that measure actual progress

Missing these milestones is a red flag that performance is at risk

Provide sensible cost risk reduction to the supplier such as payment for high cost materials

Cost Type and Flexibly Priced contracts are typically paid monthly for the costs incurred so there is literally no cost risk assumed by the supplier requiring mitigation. The opposite is in effect – how to ensure that billings and schedule completion coincide.

Earned Value Management (EVMS) What is Earned Value Management (EVMS)?

Simply put: EVMS is an attempt to correlate the incurrence of cost with schedule completion. It’s primary goal is to flag and allow corrective actions to take place when cost and schedule are out of alignment.

Key EVMS Terms:Abbrev Name What Does It Measure?

BCWS Budgeted Cost for Work Scheduled

Resource loaded schedule providing monthly budgets

BCWP Budgeted Cost for Work Performed

Discreet, apportioned, or level of effort completion

ACWP Actual Cost of Work Performed Actual monthly and cumulative costs incurred

BAC Budget At Completion Total sum of the BCWS monthly budgets

EAC Estimate At Completion Actuals incurred plus the Estimate To Complete (ETC)

CV Cost Variance BCWP minus ACWP (>0 = underrun while <0 = overrun)

SV Schedule Variance BCWP minus BCWS (>0 = ahead while <0 = behind)

VAC Variance At Completion BAC minus EAC (>0 = favorable while <0 =unfavorable)

Earned Value Management (EVMS) The key take-away for Earned Value Management is to determine

relevant completion tasks that truly indicate schedule progression when setting up the BCWS. The BCWP becomes the tracking mechanism for their completion.

Poorly set completion tasks result in erroneous data and time wasted writing meaningless variance reports. EVMS at this point becomes another administrative exercise “to do just to do”.

If set up properly, EVMS can provide a very useful management tool for proactive decisions and responses in cost type arrangements.

Summary

When selecting a contract type, consider:

What is the program phase and risk

What fee and payment options improve contract execution

What tasks and milestones measure relevant performance