Section 2 Production

2. Section 2 Production • Chapter 3 Analysis of Indirect Costs • Chapter 4 FPIF Contracts Contract Type... Fixed Price Incentive Firm FPIF

3. In 1998 Incentive Contracts accounted for $10 Billion of DoD contract actions over $25K

4. This Could Be You! Aghhh....I've been asked to help put together an FPIF compensation arrangement for the new contract! Aghhh....I've inherited an FPIF contract to manage through close out!

5. Matching Contract Type to Contract Risk • 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…. Contract Type Selection No Increasing Competition 4-3

6. Matching Contract Type to Contract Risk What is Your Objective? • A contract type that will result in reasonable contractor risk with the greatest incentive for efficient and economical contract performance Who is Assuming Risk? CPFF The Govt Contract Type CPIF FPIF The Contractor FFP Low High 4-3 Contract Risk

7. 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

8. 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

9. What Contract Types are Available? FFP…FFP/EPA…FPIF…FPAF…FPRP…CPIF…CPAF…CPFF…C or Cs….T&M Table Comparing Major Contract Types • Principal Risk • Use When… • Elements • Contractor Obligated to… • Contractor Incentive • Typical Application • Principal Limitation • Variants See Table at Pages 4-5 & 4-6 4-5

10. Most Likely . Consider Cost Risk Pessimistic Optimistic • What is the proper allocation of risk between the Govt and the Contractor? • Requiring contractors to accept unknown or uncontrollable risk can endanger performance Point Estimate Variance 4-8

11. Consider Cost Risk • The greater the potential variability between projected and actual cost, the greater the cost risk Most Likely . Most Likely . Point Estimate Pessimistic Pessimistic Optimistic Optimistic Less Variance, Less risk... More Variance, More risk... Fixed Price Type Cost Type 4-9

12. Consider Cost Risk • When assessing cost risk consider… • Contract performance risk • Market risk 4-10

13. 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

14. Market What are the Market Risk Considerations??? • 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 4-11

15. 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

16. Fixed Price Incentive Firm FPIF

17. 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

18. BASIC ELEMENTS • Target Cost • Target Profit • Profit Adjustment Formula • Ceiling Price • Point of Total Assumption 4-15

19. 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

20. Y TGT PROFIT X TGT COST

21. 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

22. Pessimistic profit Pessimistic cost

23. 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

24. Optimistic Profit Point of Total Assumption Ceiling Price Pessimistic Profit Optimistic Cost Pessimistic Cost

25. 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 4-18

26. 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 4-18

27. 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

28. PTA FORMULA • PTA - POINT OF TOTAL ASSUMPTION • Kc = Ceiling Price • Kt = Target Price • Ct = Target Cost • Sg = Government percentage cost share 4-23

29. Profit FPIF Optimistic slope: under target share ratio slope: over target share ratio Target Profit PTA Target Cost Cost Pessimistic Pessimistic Optimistic Ceiling

31. FPIF CONTRACT TYPE QUESTIONS 1,2

32. COMPUTING FINAL PRICE (FPIF) 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

33. FPIF CONTRACT TYPE FINAL CONTRACT PRICE COURT QUESTION 3

34. REVIEW QUESTIONS QUESTIONS 1,2,3

35. That's all folks !!

36. Backup

37. To Do • Check Page References

38. Profit FPIF Optimistic slope: under target share ratio slope: over target share ratio Target Profit PTA Target Cost Cost Pessimistic Pessimistic Optimistic Ceiling

39. FIXED PRICE INCENTIVE FIRM FPIF

40. Optimistic Profit Point of Total Assumption Ceiling Price Pessimistic Profit Optimistic Cost Pessimistic Cost