Application Approaches

1. Application Approaches An animated Graphic with blocks listing the 12 lessons of the course. The animation will zoom in on the Application approaches block of the graphic Select the links to print the text, formula list and tables required for this lesson. You may also print out practice problems and their corresponding solution sets for this lesson as well. It is recommended that you print out or save all lesson materials to your hard drive before continuing. You may require the formula list and tables to complete the exercises within the lesson.

2. Introduction Welcome to the Acquisition Approaches lesson. After completing this lesson, you will understand some of the general considerations in selecting an acquisition approach, and specifically the considerations in selecting a contracting approach. Located throughout the lesson are Knowledge Reviews, which are not graded but enable you to measure your comprehension of the lesson material. Approximate lesson length: 2 hours. Graphic: use Sparrowhawk or other standard image

3. Objectives • The overall objective of this lesson is: • Assess some of the general considerations in selecting an acquisition approach, and specifically the considerations in selecting a contracting approach. • In this lesson, you will learn to: • Identify some of the general considerations in selecting an acquisition approach, and specifically the considerations in selecting a contracting approach • Contrast cost reimbursement, fixed price, and time and materials contract attributes • Develop share ratios under incentive contracts • Determine the final price under various contract types • Recognize the implications of contract type on the estimate/budget Watermark DoD seal

4. Lesson Topics Select a book title to move to a different part of the lesson. Lesson Introduction: takes you to the first page of the lesson. Topic 1 - Acquisition Approaches: explains the importance of how goods or services are acquired. Topic 2 - Final Price, FPEPA, and CPIF: about the various contract types and how to calculate final prices. Topic 3 - FPIF, Award-Fee Pricing Arrangements, and Cost Estimating Considerations: other types of contracts and the characteristics of contract types. Lesson Summary: summary page for the entire lesson. A stack of books with the bolded areas to the left written on book spines. It is an interactive, graphical hotspot. Student selects where to go by selecting the appropriate book spine.

5. Topic 1 - Acquisition Approaches • It is important that we consider how goods or services will be acquired. Let’s say you have decided on a particular vehicle you would like to drive. In determining the cost of driving that vehicle you might consider new versus used, buying from a retailer versus a private owner, buying versus leasing, purchasing extended warranties, whether there will be a down payment and how large of a down payment, the nature of the financing arrangement, etc. • From a cost estimating perspective, these types of considerations will influence: • How we interpret the historical data used in developing the estimate • Our interpretation of the cost estimating requirement • Our assessment of risk • Our level of confidence in the estimate • Our re-evaluation of the final cost of goods or services as the program is being executed • From a financial management perspective, these types of considerations will impact areas like: • Forecasts of commitment, obligation, and expenditure patterns • Our expectation of contingent liabilities or unfunded requirements • Our understanding of unliquidated obligations Graphic: auto dealer lot full of cars

6. Business Strategy Considerations Rollover the image to read business strategy considerations: What is the source for the goods or services being procured? Government - sources include depots, test centers, other government agencies, and federally funded research and development centers (FFRDC). Contractor - sources range from major contractors to small disadvantaged businesses. International - sources range from imports and off-shore work, to domestic co-production arrangements. Graphic: full page rollover image with box diagram of Source, GFE Vs CFE, and Buy Vs Lease as three business strategies. Buy Vs. Lease rollover Are we buying or leasing the asset? From an estimating perspective, this decision will impact the total cost as well as the time phasing aspect of the cost. GFE Vs. CFE rollover Are provided items government furnished equipment (GFE) or contractor furnished equipment (CFE)? The use of CFE results in additional procurement costs and additional risk to the contractor, which is reflected in higher costs and profit. GFE represents additional risk to the government due to the potential for defects, or for items not being delivered to the contractor in accordance with the contract schedule.

7. Contract Types The basic contract types are described below: Fixed-Price.Under a fixed-price contract, the contractor agrees to deliver the product or service required at a price not in excess of the agreed-to maximum. Fixed-price contracts should be used when the contract risk is relatively low, or defined within acceptable limits, and the contractor and the government can reasonably agree on a maximum price. Cost-Reimbursement.Under a cost-reimbursement contract, the contractor agrees to provide its best effort to complete the required contract effort. Cost-reimbursement contracts provide for payment of allowable incurred costs, to the extent prescribed in the contract. These contracts include an estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractor cannot exceed (except at its own risk) without the approval of the contracting officer. Labor-Hour and Time-and-Materials. There are two other types of compensation arrangements that do not completely fit the mold of either fixed-price or cost-reimbursement contracts. Labor-hour and time-and-materials contracts both include fixed labor rates but only estimates of the hours required to complete the contract. Graphic of a close up of a hand holding a pen and the titles of the contract types

8. Objective: Identify some of the general considerations in selecting an acquisition approach, and specifically the considerations in selecting a contracting approach • Knowledge Review • This is a multiple choice exercise. Select the best answer, then select the Submit button. • The three general sources from which goods or services are acquired are: • International, local, and government • Government, contractor, and international • Contractor, local, and international • Government, contractor, and private Graphic of person sitting at desk with question mark, shades of blue

9. Objective: Contrast cost reimbursement, fixed price, and time and materials contract attributes • Knowledge Review • This is a matching exercise. Match the numbers on the right to the answers on the left, then select the Submit button. • One of the interns in your office asks why there are so many contract types. You explain that one factor is the amount of risk associated with the effort to be performed. Match the contract types with the relative amount of performance risk they represent. • Low • Moderate • High Graphic of person sitting at desk with question mark, shades of blue 1. FPIF 2. FFP 3. CPFF

10. Topic 2 - Final Price Some may believe that the estimating task culminates with contract award. However, only in the case of a firm fixed price contract can we assert with some degree of confidence that the final price is known because: 1. The government will pay the agreed upon price regardless of the final cost 2. The contractor is required to perform a defined task 3. FFP contracts are generally used when the requirement is mature, well-defined, and contract changes are less likely to occur The final price on other fixed price contracts such as the incentive or EPA contracts, the cost reimbursement family of contracts, and the time-and-material and labor-hour contracts are prone to change based on contract performance, final cost, market conditions, and requirements uncertainty. The remainder of the lesson will focus on some of these contract types for which the final price is more likely to vary over the life of the contract. Graph of firm fixed price as a function of the cost of the project Vs. the price of the contact

11. Show-Me: Fixed-Price with Economic Price Adjustment (FPEPA) An EPA clause is included in a contract awarded in December 20X1, for deliveries during calendar year 20X2. An estimated 25% of the contract price is related to the market price of silver, and fluctuations in the market make it extremely difficult to estimate costs over the next year. The contract states that price adjustments will be made using the Producer Price Index (PPI) for “silver bar, refined, .999 fine” (Index #1022-0272). The calculation below is for units scheduled for delivery during the second quarter of 20X2 using the April 20X2 index as specified in the contract. The base period for adjustment purposes is December 20X1 and the unadjusted contract price is $1,000,000. Graphic: show-me animation demonstrating FPEPA example as seen on the left. Where: I1 = Index for Base Period = 45.0 in December 20X1 I2 = Index for Adjustment Period = 67.5 in April 20X2 S = Percentage of Price Subject to Adjustment = 25% P = Contract Price = $1,000,000

12. Show-Me: Cost Plus Incentive Fee (CPIF) You and the contractor agree that the final cost on a CPIF contract is $1,100,000. Contract target cost is $1,000,000; target fee is $70,000; minimum fee is $20,000; maximum fee is $120,000; the over-target share ratio is 87.5/12.5; and the under-target share ratio is 75/25. Determine final allowable contract cost for fee calculation purposes. In this contract, no costs are excluded for fee calculation purposes, so the final contract cost is $1,100,000. Compare the final allowable cost to the target cost. Since the final cost ($1,100,000) is greater than the target cost ($1,000,000), the contractor is in an overrun position and we will need to adjust the target fee. We will use the contractor’s over-target share of 12.5% (or .125) in the next step. Graphic: show-me animation demonstrating CPIF example shown on the left.

13. Show-Me: Cost Plus Incentive Fee (CPIF), Cont. Calculate the adjusted fee. In an overrun, the adjusted fee is the target fee less the contractor share of the overrun: Adjusted Fee = Target Fee – Contractor Overrun Share x (Final Cost – Target Cost) Adjusted Fee = $70,000 – [.125 x ($1,100,000 – $1,000,000)] = $70,000 – (.125 x $100,000) = $70,000 – $12,500 = $57,500 Since the Adjusted Fee ($57,500) is more than the minimum fee ($20,000), the adjusted fee is the final fee. Add the final fee to the final allowable cost to determine the final contract amount. Final Amount = Final Allowable Cost + Final Fee = $1,100,000 + $57,500 = $1,157,500 Modify the contract to reflect final contract amount and obtain a final voucher. Modify the contract to reflect a final contract amount of $1,157,500 and obtain a final voucher. Show-Me animation demonstrating the calculations to the left. Including a graphic of a Pile of money with words: Final amount = $1,157,500

14. Objective: Develop share ratios under incentive contracts • Knowledge Review • This is a multiple choice exercise. Select the best answer, then select the Submit button. • Given that the following values were used to develop the over-target share ratio, what would be the contractor’s share percentage of a target cost over-run? • 12% • 14% • 16% • 18% Graphic of person sitting at desk with question mark, shades of blue

15. Objective: Determine the final price under various contract types • Knowledge Review • This is a multiple choice exercise. Select the best answer, then select the Submit button. • You have the following information regarding the CPIF contract for intermediate level support equipment. • What would be the final price if the final allowable cost was $2,300,000? • $2,465,000 • $2,475,000 • $2,482,500 • $2,600,000 Graphic of person sitting at desk with question mark, shades of blue

16. Topic 3 - FPIF, Award-Fee Pricing Arrangements, and Cost Estimating Considerations Computation of the final price under an FPIF contract is very similar to computation of final amount under a CPIF contract. The major difference is that in a FPIF arrangement the total price cannot exceed the contract ceiling price. Graphic: use Sparrowhawk or other standard image

17. Try-It: Fixed Price Incentive Firm (FPIF) You and the contractor agree that the final allowable cost on a FPIF contract is $1,310,000. Contract target cost is $1,000,000; target profit is $100,000; ceiling price is $1,325,000; and the over-target share ratio is 75/25. Review the contractor's final cost proposal to develop a position on final allowable contract cost – negotiate the final cost. The contractor proposed a final contract cost of $1,310,000. Government review and your analysis did not identify any deficiencies. Compare the final allowable cost to the target cost. Since the final allowable cost ($1,310,000) is greater than the target cost ($1,000,000), the contractor is in an overrun position and we will need to adjust the profit. We will use the contractor’s over-target share ratio of 25% (or .25) in the next step. Graphic: try-it FPIF animation. Interactive animation solving for the problem on the left.

18. Try-It: Fixed Price Incentive Firm (FPIF), Cont. Calculate the adjusted profit. In an overrun, the adjusted profit is the target profit less the contractor share of the overrun: Adjusted Profit = Target Profit – Contractor Overrun Share x (Final Cost – Target Cost) Adjusted Profit = $100,000 – [.25 x ($1,310,000 – $1,000,000)] = $100,000 – (.25 x $310,000) = $100,000 – $77,500 = $22,500 Add the adjusted profit to the final allowable cost to determine the final contract price. Final Price = Final Allowable Cost + Adjusted Profit = $1,310,000 + $22,500 = $1,332,500 Since the calculated contract price ($1,332,500) is more than the ceiling price ($1,325,000), the ceiling price is the final contract price. Obtain a final invoice. Obtain a final invoice and process it for final payment. Pile of money with words Final amount = $1,325,000

19. Award-Fee Pricing Arrangements Award-Fee Contract. An award-fee contract is a form of incentive contract. Unlike the FPIF or CPIF contract, the award-fee contract does not include predetermined targets and automatic fee adjustment formulas. Contractor performance is motivated by fee adjustments based on a subjective evaluation of contractor performance in areas such as quality, timeliness, technical ingenuity, and cost-effective management. Cost-Plus-Award-Fee (CPAF) Contract. The most common award-fee contract is the CPAF contract. A CPAF contract provides for a fee consisting of a base fee that is fixed at the time of contract award, and an award-fee that the contractor may earn in whole or in part during contract performance. The award-fee must be large enough to motivate the contractor to excel in such areas as quality, timeliness, technical ingenuity, and cost effective management. Fixed-Price-Award-Fee (FPAF) Contract. You may use award-fee provisions in fixed-price contracts when the Government wishes to motivate a contractor and other incentives cannot be used because contractor performance cannot be measured objectively. Such contracts must establish a fixed price (including normal profit) for the effort and provide for periodic evaluation of the contractor's performance against an award-fee plan. Graphic: image of military and contractor personnel discussing contracts

20. Cost Estimating Considerations Understanding the characteristics of the contract type used to acquire a product or service gives us an insight as to the nature of the product or service and as to the likelihood of the negotiated price varying during the execution of the contract. This insight is useful in understanding historical costs and in predicting future costs. Rollover the image to view contract characteristics under ideal conditions. • Graphic: rollover with the five categories of contracts: • Firm fixed price • Firm fixed price level of effort • Fixed price incentive • Cost plus incentive • Cost plus fixed fee Firm fixed price contracts are generally used when the requirement is mature and well-defined, and contract changes are unlikely. Firm fixed price level of effort, time-and-material, and labor- hour contracts have fixed rates, but the material costs and the amount of labor required may vary over the performance of the contract, so these efforts may entail a low to moderate amount of risk. Cost plus incentive arrangements only require a contractor’s best effort, but are well-enough defined to establish a target cost, a cost sharing arrangement to provide an incentive to the contractor, and minimum and maximum fees. Fixed price incentive contracts are used when the requirement is well-enough defined to require the contractor to deliver, but also indeterminate enough to suggest a cost sharing arrangement to recognize a moderate amount of risk and to provide a performance incentive for the contractor. Cost plus fixed fee contracts are used for uncertain or speculative efforts (high risk), and only require a contractor’s best effort. They have a target cost for the purpose of obligating funds and establishing a limit of government liability.

21. Objective: Develop share ratios under incentive contracts Knowledge Review This is a drag-and-drop exercise. Drag the lettered boxes to their proper places on the image, then select the Submit button. The first lot of training drones for the Sparrowhawk program is being procured under a FPIF contract. You’ve drawn a diagram of a FPIF arrangement to show one of your co-workers the relationships between the various elements. Complete the diagram.

22. Objective: Determine the final price under various contract types • Knowledge Review • This is a multiple choice exercise. Select the best answer, then select the Submit button. • The contractor just completed the training drone effort at a final cost of $4,750,000. The target cost was $4,500,000 with a target profit of $540,000. There was an under target share ratio of 80/20 and an over target share ratio of 90/10. The ceiling price was $5,450,000. What is the final price that you will report to your financial manager? • $4,632,500 • $4,910,000 • $5,040,000 • $5,265,000 Graphic of person sitting at desk with question mark, shades of blue

23. Objective: Recognize the implications of contract type on the estimate/budget • Knowledge Review • This is a multiple choice exercise. Select the best answer, then select the Submit button. • Which type of contract is generally used when requirements are mature and well-defined, and contract changes are unlikely? • Firm fixed price • Fixed price incentive • Cost plus incentive • Cost plus fixed fee Graphic of person sitting at desk with question mark, shades of blue

24. Lesson Summary • In this lesson, you learned that: • Business strategy considerations when acquiring goods or services are: • What is the source for the goods or services being procured? • Are we buying or leasing the asset? • Are provided items government furnished equipment (GFE) or contractor furnished equipment (CFE)? • The basic contract types are: • Fixed-price - the contractor agrees to deliver the product or service required at a price not in excess of the agreed-to maximum • Cost-reimbursement - the contractor agrees to provide its best effort to complete the required contract effort • Labor-hour and time-and materials - include fixed labor rates but only estimates of the hours required to complete the contract • Firm fixed price contracts are generally used when the requirement is mature and well-defined, and contract changes are unlikely • Firm fixed price level of effort, time-and-material, and labor-hour contracts have fixed rates, but the material costs and the amount of labor required may vary over the performance of the contract, so these efforts may entail a low to moderate amount of risk • Fixed price incentive contracts are used when the requirement is well-enough defined to require the contractor to deliver, but also indeterminate enough to suggest a cost sharing arrangement to recognize a moderate amount of risk and to provide a performance incentive for the contractor • Cost plus incentive arrangements only require a contractor’s best effort, but are well-enough defined to establish a target cost, a cost sharing arrangement to provide an incentive to the contractor, and minimum and maximum fees • Cost plus fixed fee contracts are used for uncertain or speculative efforts (high risk), and only require a contractor’s best effort • Select another topic from the Table of Contents to proceed. Watermark DoD seal