Evaluating Contracts
What are the benefits and drawbacks of fixed-price contracts from the perspective of a contractor?
A fixed price contract is one that the government pays a fixed amount without any adjustments. It does not consider the actual costs that the contractor will incur in completing the contract. This contract is appropriate when reasonable market prices are easily determinable in advance. This type of contract is also applicable when supplying standard issue goods such as military contingencies. The prices of such items are determinable and fixed at the beginning to the end of the contact.
The contract has the following characteristics, maximum risk on the contractor, minimal supervision and monitoring on both parties to the contract, the desire of the contractor to minimize and control the level of expenditure and overall costs, and finally, the contract is payable based on the amount of effort applied rather than the quality and results of the job. In this contract, the contractor may deliver poor quality job due to non-emphasis on the quality of work. The contractor will purchase cheap materials and labor in a bid to control and manage the cost of the contract. The maximum risks that the contractor bears have an impact to the quality of the final product.
Advantages of such a contract to the contractor include the payment made based on the efforts applied rather than the quality and results. This is an advantage to the contractor since he can concentrate on applying a certain amount of effort paid at the end of a specified period. The contractor is able to control costs and faces minimal supervision and interference from the client. The drawback in this type of contract is that the contractor faces maximum risk. In case of adverse changes in the price level, the contractor bears the loss since there will be no adjustments to the amount receivable to cater for the price changes.
What are the benefits and drawbacks of cost-reimbursement contracts from the perspective of the federal government?
In this type of contract, the government incurs the extra costs that are reasonable, allowable, determinable, and allocable that the contractor will face due to changes in the estimated contractual price. There is an up or downward adjustment in the economic price of the contract upon the happening of a certain contingent. The government makes the adjustments based on contingencies beyond the control of the contractor. The contingency must affect the whole industry and not the individual contractor. The government will determine the most suitable formula for calculating the reimbursements. It will place a lot of emphasis on the target costs, estimated fees, minimum and maximum fees in the contract.
The benefit with this type of contract is that price adjustments cushion the government from unforeseen contingency. If the government estimates are high and during the contract execution, the contractor incurs lower costs, then adjustments will occur to lower the contractual price. In the contract, the government will focus on the excellence of the work; therefore, it is likely to end up with quality work. The contractor will have to work hard so that to achieve better payments and fees. It can also control the expenditure by the contractor through determination of the maximum and minimum cost figures. The major drawback for the federal government in this type of contract is that it faces a high risk of bearing the loss due to price changes. Contractors tend to care less in spending since there are reimbursements at the end of the day.
Which element(s) of cost-reimbursement contracts tends to produce the biggest troubles for contractors and explain why?
The determination of allocable costs is a difficult task for contractors. In trying to estimate, the contract cost the contractor must be able to distinguish allocable costs from no-allocable costs. Allocable costs are those costs, which the contractor can identify with the contract. Contractors tend to include non- allocable costs in the estimations.
Another problem that contractors face in determination of cost reimbursement contracts is the determination of reasonable costs, allowable costs, and grouping of costs. Contractors tend to inflate the costs beyond reasonableness due to reimbursement from the government. Grouping of costs into specific cost centers such as overheads, direct and indirect costs tend to present a difficulty to contractors. Some contractors will include non- allowable costs such as fines and penalties, interest and other financing costs, organizational costs, alcoholic drinks, entertainment costs, organizational charity costs and organizational ruinous debts as part of the contractual costs. This is not the practice, and it presents problems when it comes to payments from the federal government.
Calculating the contractual costs and rates is also difficult to the contractors. Lack of understanding of the contractual rates such as the overhead rates and the G&A rates leads to wrong determination and calculation of the contract cost. This may lead to losses on either parties of the contract due to misrepresentation of the cost. The calculation of profits and fees presents a challenge to the contractors. It may bring a conflict with the government in that while the contractor considers high profits, the government may advocate for reasonableness.
Select one other contract type (neither fixed-price nor cost-reimbursement) and explain its pros and cons from the perspective of the federal government.
Indefinite delivery contract is one that the government agrees with the client to supply either a definite or indefinite quantity of the contractual items. The government uses this type of contract to place orders for goods and services it requires over a long period. Once the contract is agreed, the client will supply the goods over the specified period.
Under indefinite quantity, the government orders a minimum amount of items and a subsequent supply of the same for an indefinite period. Under the definite contract, the government contracts the supply of a specified quantity of items for a specified period. This type of contract is applicable in situations where the government is unable to determine the specific price of the items during a definite period. The price under this type of contract is fixed. It contractor also faces a fixed redemption price. The contractor will supply the goods at the specified fixed price regardless of changes in cost. The loss transfers to the supplier in case an increase in costs occurs.
The contract offers the government a financial benefit in case it is difficult to determine the amount it requires and the item prices during a definite period. Entering into a contract with a fixed price will cushion the government in case unforeseen contingencies occur. The government is also gets an assurance of a continuous supply of contractual items under this type of contract. Once the contractor agrees to supply the goods then there is an obligation to him to make clear his promise; otherwise, he will pay a fee for a contract default. The major drawback with this type of contract is that the government may enter into a long-term contract and later realize to its loss that it no longer requires the items.
References
Anderson, R. A. (1958, August). Cost reimbursement contracts - More profit through cost
control. NAA
Bulletine , pp. 57-71.
Murphy, J. E. (2009). Guide to contract pricing : cost and price analysis for contractors,
subcontractors, and government agencies. Virginia: Management Concepts, 2009.
Stanberry, S. A. (2008). Federal Contracting Made Easy. Vienna: Management Concepts, Inc.,
©2009.
