Thursday, October 20, 2016

Indirect Rate Ceilings on CPFF contracts = #winning?

I googled “caps on indirects” before writing this and found very little in the area of any other agency but USAID. The chief reason for that is the fact that establishing indirect ceilings in cost type contracts is not widely used by any other Government procurement agency. The reason why they don’t is simple - if they desire to fix costs, they use Fixed Price or T&M type instead.

When the Government insists on caps or ceilings on anything, it increases the risk for the contractor, which almost always results in profit/fee increase. Cost type contracts are inherently risky and should not be used for any work which can be purchased through Fixed Price or T&M types of contract.

But here we are.

The reason for this post is the increased occurrence of certain language being included in USAID RFPs and RFAs “encouraging” the offerors to propose ceilings on their indirects without stating any of the reasons for such “encouragement” pursuant to FAR 42.707. For example:

  • Cost Sharing 
  • New contractors with no indirect rate history
  • Record of volatility of rates from year to year or recently
  • "Low balling" cost estimates by contractors trying to “buy” the contract
So lets discuss:

Why would Government Ask?
FAR allows the Government to try and limit the indirect cost risk on cost type contracts by asking the contractor to agree to ceilings on indirect rates for the duration of the contract.

There are good reasons for this. Some contractors, especially start-up contractors, have highly volatile indirect rates. This makes it very difficult for the Government, when contemplating a cost-reimbursable contract, to accurately forecast contract costs and reserve funding.

To protect against such situations, the Government will sometimes propose to cap contractor's indirect rates and incorporate those capped rates into the contract.

Sometimes the contract auditor will make such a recommendation, sometimes it is the contracting officer who makes it during contract negotiations.

The contractor can say “no”, but if they do, the Government could assign a higher risk rating to such offeror based on the circumstances justified in FAR 42.707.

The Government may also ask the contractor to offer ceilings on indirect rates if it sees that the contractor is offering much lower indirect rates than it has historically experienced, in order to enhance its competitive position. This signals the risk of overrun to the Government, therefore prompting the ceiling discussion. If the contractor says “no” to this discussion, it risks to be assigned a “fail” during the cost realism evaluation - based on the Government’s knowledge of the historical data.

Why would a contractor offer ceilings without being asked?
I don’t really know why a contractor would offer ceilings voluntarily without the Government’s specifying the reasons of why it should.

Maybe, if the offeror knows of some huge addition to their base coming their way, which will in turn lower their indirects well below the provisional NICRA or existing rates, then with the explanation, it would make sense. Everything else is iffy….

I understand trying to “enhance” your competitive position, but unless you have a good reason - like proposing to cost-share the contract because it will enhance your commercial offering - the artificial lowering of your indirects just smacks of trying to “buy” the contract, and, will likely result in some cost realism implications.

Plus, the competitive advantage would unlikely be a deal maker, unless the evaluation criteria specifically includes cost-sharing options or creative cost risk solutions as extra points.

When the Government should not ask?
The recent slew of RFPs and RFAs asking ALL OFFERORS to offer ceilings is a new phenomenon that makes no sense under the regulations and exposes the Government and the contractors/recipients to more risks than necessary.

Without knowing which company will bid, the Government is restricting the possibility of risk…. Why?

Most bidders already have approved NICRAs, so the Government can evaluate the cost risk based on the historical data before singling out the ones that meet the criteria in FAR 42.707 – most likely at BAFO stage.

If USAID wants to control its cost, they should consider fixed price instruments or T&M. There is no point in issuing a cost type contract if you do not understand the risks it entails.

How many points does it add to your evaluated proposal?
It should add none, unless the evaluation criteria specifically list such risk mitigating techniques being worth extra points. If it does, though, the Government opens the door to all sorts of issues, including restricting small business participation and using incorrect type of contract instrument.

Cost Proposals for cost type contracts and awards are not evaluated for “price”, since they only represent a cost estimate and the price is not known until after the contract/award is complete. The cost proposals are evaluated for allowbility, cost realism and risk factors, as well as understanding of technical requirements.

Mitigating the risk of overrun in just one of the cost line items does not make the offeror significantly less risky than others or a great manager. Indirect costs or ceilings therefore should not be evaluated for purposes of award. At best, ceilings should only render the more risky offerors neutral for evaluation purposes as described in FAR 42.707.

Don’t take my word for it, here is the Best Practices for Indirect Costing – Mandatory Help Document of USAID ADS 300 (Best Practices for Indirect Costing USAID ADS 300 ):

“Indirect costs should not be reviewed as part of any cost effective evaluation criteria
Indirect cost rates should not be considered in award decisions or negotiations since indirect cost rates are approved by the Government for standard application on all federal awards and by their nature do not compare across organizations, given the diverse accounting practices and methods for determining rates.

The practice of direct or indirect charging is not an indicator of best value. The ratio of indirect cost to direct cost or total cost varies and depends on many factors. It will be difficult if not impossible to get a definitive or measurable indicator for cost reasonableness since each organization has a different accounting/allocation methodology. That is to say there are numerous differences in both workforce and accounting classifications as to direct or indirect costs, as well as other variables such as the extent to which subcontractors are used, the structure of an organization, the expanding and declining business base for individual organizations, and the differing accounting methodology of one organization verses that of another. For example: one company may have a large labor overhead ratio to direct labor because it includes vacation and sick leave along with other types of overhead costs directly related to labor,  while another organization will have a lower ratio because they direct charge vacation and sick leave. Neither practice is preferred over the other and both are equally acceptable. They are merely different.”

What happens if you won’t get the total contract value?
Well, lets say you have offered or accepted ceilings on indirects in your cost type contract with USAID.

The estimated indirects are based on the projected amount of base of allocation, which presumably includes this new contract, which you have just signed with indirect cost ceilings. Let’s say this contract promises to add $50 MIL per year to your base of allocation and is incrementally funded, as are most CPFF contracts issued by USAID.

Let’s imagine for a second that USAID does not fully fund your contract, so instead of $50MIL per year, you are only adding $20MIL to your base of allocation. What do you think happens to your indirects? That’s right they go way up. With the ceilings and no conditions, you are now out millions of unrecoverable indirects (unless you quickly fire half of your work force).

The moral of the story is this:

If you agree to indirect cost ceilings, you have to write a good clause in your contract that guarantees such ceilings only if the contract is fully funded and not terminated for convenience. If one of the two occurs, the ceilings would not apply.

Get someone who knows what they are doing to write such clause before you sign your contract.

Contractors and Grantees that agree to capped rates need to understand the risks and consequences.

Missing the mark on indirect rates can easily and quickly eat up whatever profit is going to be earned. Costs beyond the profit amount will have to be paid by some other funds and contractors need to determine the amount of resources it can afford to use to defray unreimbursed costs. Many companies have suffered long-lasting negative financial impact from agreeing to capped rates.

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