Exploring Different Types of Government Contracts: Part Three
In the last part of our contract type blog series (Part One, Part Two), we are going to summarize what we have learned and apply it to a real-world example. As a recap, below are the three (3) most common contract types and their risks:
- Firm-fixed-price (FFP): Contract price does not change during execution and is contingent on contractor providing deliverables. Highest risk to a contractor.
- Labor Hour (LH): Time-and-materials (T&M) contract type without any materials. Hourly rates are negotiated, and contractor is paid at these rates for hours performed. Medium risk to a contractor.
- Cost-plus-fixed-fee (CPFF): Contractor is paid based on actual, allowable, reasonable costs, while fee is fixed at contract inception. Lowest risk to a contractor.
To expand on the above and see the impact in action, let’s look at a scenario you could encounter during performance. As a government contract, you have received a request for quotation (RFQ) from the government for some work to be performed. To simplify the math, we are going to assume that you anticipate costs (direct and indirect) at $100/hour for our labor category, it is estimated that it might take 50 hours, and the goal is a 10% profit/fee. Based on this, you are looking at the below total price:
| Cost Per Hour | $ 100.00 |
| Hours | 50.00 |
| Total Cost | $ 5,000.00 |
| Profit/Fee (10%) | $ 500.00 |
| Total Price | $ 5,500.00 |
During performance, costs have gone up 10% more than planned inflation. The work also takes 10 hours longer than expected, maybe due to the requirements being poorly defined when proposed. Based on these two (2) changes, how would each of the main contract types be affected?
Firm-fixed-price (FFP): Under a FFP type contract, the total price you are reimbursed does not change and as the prime government contractor, you are on the hook for all deliverables. Based on the increase to costs and hours, you now have lost $1,600 and will not be able to recoup those costs. One way this could have been mitigated was by reviewing the requirements more thoroughly during the solicitation phase, asking the government to define requirements, and even proposing a higher profit to account for the higher risk in a FFP environment.
| Proposed | Actuals Incurred | Paid under FFP | |
| Cost Per Hour | $ 100.00 | $ 110.00 | $ 110.00 |
| Hours | 50.00 | 60.00 | 60.00 |
| Total Cost | $ 5,000.00 | $ 6,600.00 | $ 6,600.00 |
| Profit | $ 500.00 | $ | $ (1,600.00) |
| Total Price | $ 5,500.00 | $ 6,600.00 | $ 5,500.00 |
Labor hour (LH): For a LH contract, which as a reminder is similar to a T&M contract without any materials, we are now showing the fully burdened rate (FBR) which includes all costs plus any profit since a LH contract is billed on an hourly basis. As a LH effort, your rates have not changed, but you are able to charge the additional hours consumed if funding is authorized and sufficient to cover them. If the government does not authorize additional funding, then you would stop the work even if the requirements were not complete. This results in more revenue than a FFP contract, but less than a CPFF.
| Proposed | Actuals Incurred | Paid under LH | |
| Cost Per Hour | $ 100.00 | $ 110.00 | $ 110.00 |
| Profit Per Hour | $ 10.00 | $ – | $ – |
| Total FBR | $ 110.00 | $ 110.00 | $ 110.00 |
| Hours | 50.00 | 60.00 | 60.00 |
| Total Price | $ 5,500.00 | $ 6,600.00 | $ 6,600.00 |
Cost-plus-fixed-fee (CPFF): Using our example, recall that costs have increased and the work also took longer than expected now in a cost-reimbursement environment. However, as a CPFF effort, your fee has remained unchanged, and all costs have been paid that are allowable under the contract. It is important to note that we are assuming the government authorized more funding to complete the work; if they do not, it is possible the government could reduce your fixed fee amount. Although anticipating the additional hours and costs in your proposal may have led to negotiating a higher fee, the risk of not knowing these elements is the lowest in this scenario and a profit is still likely to be incurred.
Important Note: A common misconception for a CPFF is that you bill based on the fixed-fee percentage for all costs incurred. This is not true, and would constitute a cost-plus percentage of cost contract, the only prohibited contract type. The Federal Acquisition Regulation (FAR) has prohibited this type since there would be a lack of incentive to spend less money.
| Proposed | Actuals Incurred | Paid under CPFF | |
| Cost Per Hour | $ 100.00 | $ 110.00 | $ 110.00 |
| Hours | 50.00 | 60.00 | 60.00 |
| Total Cost | $ 5,000.00 | $ 6,600.00 | $ 6,600.00 |
| Fee | $ 500.00 | $ 500.00 | $ 500.00 |
| Total Price | $ 5,500.00 | $ 7,100.00 | $ 7,100.00 |
So, what can you do to lower these risks during performance and ensure profitability? The first thing is to recognize the contract type from the beginning. If the effort is fixed-price, engage your technical subject matter experts and ask them if the requirements are defined enough to truly estimate the amount of work requirement. And if not, ask questions.
During the request for information (RFI) and request for proposal (RFP) or request for quotations (RFQ) stages, GovCons are encouraged to ask clarifying questions, especially if the solicitation prohibits assumptions. If there is still ambiguity after initial questions are answered, ask the government to consider a different contract type.
Once you have solidified the requirements and understand the scope of work, you can ensure your proposal is as clear and well-defined as possible. For example, if the statement of work does not quantify deliverables, quantify them; articulate assumptions for number of reviews and review turnaround times as long as assumptions are allowable under the RFQ or RFP.
On the pricing side, review both historic and projected prices to ensure rates bid are not too low. Review the solicitation documents to ensure there are no provisions that disallow or cap certain costs.
Conclusion: In this simple example we showed how easily a change in contract type could impact how you might approach an effort and the profit you could incur. However, contract type is only one of the many nuances in federal government contracting. The BOOST LLC contracts, subcontracts, purchasing, and pricing team has the extensive experience necessary to provide a complete range government contracting services. Our highly skilled experts can help decode what are the implications with any contract type during all phases of the contract lifecycle.
If you’d like to learn more about contract types and their variations to determine your best strategy to minimize risk and maximize profit, contact our professionals at BOOST today for specialized assistance.
About The Author, Megan Hand Sr. Contracts & Pricing Consultant
As a former government Contracting Officer and Cost & Pricing Analyst, Megan has the unique insight of understanding contracts and pricing from both the government and contractor perspective. She has not only written evaluation criteria and instructions but has first-hand knowledge of what the government typically deems fair and reasonable. As a consultant at BOOST, Megan has led and assisted with numerous proposals from varying agencies and of different complexities and values. These experiences combined have enabled her to provide a unique, strategic approach to pricing and the creation of a compelling and reasonable price proposal.
