Thursday, October 20, 2016

Losing money on the sure thing– how improper contract administration makes CPFF contracts a looser for contractors…

So, I love cost reimbursable contracts; what’s not to love?  You estimate the total cost based on, most of the time, a very generous scope of work and then bill the Government for all your allowable direct and indirect costs plus a profit for job well done.  Risk = 0, right?

It is what the Pretty Woman would call “a sure thing” for contractors.

And therefore the riskiest for the Government… or is it?

In theory, it should be impossible to lose money on cost reimbursable contracts, unless you never read FAR Part 31 or unless you do your cost accounting for multi million dollar jobs in an excel spreadsheet (or its fancy version - Quick Books) and not in a proper accounting system. In practice, however, it happens way too often and almost always for the same reasons.  So here are the top 6 ways to guarantee losing money on any CPFF contract:

1    1. Do not define what “LOE” means in CPFF Term contracts
      2. Do not define how the Fee is paid in CPFF Completion contracts
      3. Do not accrue your costs in real time accounting system with ability to produce accurate estimates to complete
      4. Do not ask for more fee when adding new work
      5. Do not include estimate to complete including increase in indirects at the time of Limitation of Funds/Cost Notification
      6. Cap your indirect costs for no reason and without the Government asking you to do so (see also my next blog on this subject)

So lets start by examining the 6:

Defining Level of Effort (LOE) on CPFF Term Contracts

CPFF Term contracts administered under FAR Part 16.306 allow for reimbursement of all allowable costs plus a fixed fee paid in proportion to delivered Level of Effort ordered by the Government under the contract.  The basic premise of the CPFF Term Contract is that it is more or less the same as T&M, except the Labor is being purchased at cost and not at a fixed rate, which would ostensibly be less risky for the Government.
So, normally the Government should be providing estimates of such Level of Effort in the labor categories that they would like to purchase in the RFP.  Very often however, USAID asks the contractors to estimate the Level of Effort and Labor Categories that they need to accomplish the scope of work.

This can vary dramatically since without the Government controlling what type of Labor they get in exchange for fixed fee, the contractors often propose All Labor’s Effort as Fee bearing LOE.  This is, of course, silly.  Given that you have no way of knowing, most of the time, how many locals you end up hiring, the contractors estimate way too many days of LOE and collect fee for every driver and secretary that they bill against the LOE in the contract.    The remedy for the Government, which we now see in some of the better equipped Missions, like South Africa and Latin America is to fix the fee against delivery of LOE ONLY by Professional Categories of Labor.

By nature, the scopes of CPFF contracts are not precise or fixed and are instead fluid and illustrative.  So, once the LOE is agreed upon and contract is signed, the fee is then paid in proportion to the successful delivery of the LOE stated in the contract.  Not completing the scope!  Successful Delivery of LOE!  Important to remember that.  Once LOE is delivered, the contract is completed.  If an in-scope or duration change is made, the contractor may continue working, but the Government adds more LOE (and therefore more fee) to allow the contractor to continue.

So the issue is – what is LOE?  The contract often does not define what LOE is at all.  And the budgets or budget notes provided by the Contractor are not incorporated by reference.  This makes for wide interpretations that can result in nasty surprise of overruns for the Government and the contractor. 

As I mentioned before, defining LOE allows you to define how the fee is paid.  So if your LOE is defined as an 8 hour day, then any hours over that would count towards more LOE regardless of whether or not those hours are additionally compensated by the contractor.  

So if your staff are working a 50 hour week (for example) because they have a deadline due and then travel one day of the weekend, and your LOE is defined as 8 hour max per day including travel days, you will be able to bill fee for 58 hours of LOE, i.e. 7.25 fee days vs 5 fee days.

Of course, you will need to make sure your people only work overtime for bona fide reasons and get approval of the COP to do that, in order not to blow through your LOE limits.  Travel days however must be defined as part of LOE in order for you to bill fee for those days.

The most common definition in estimating is an 8 hour basic work day up to 40 hours per week.  Work-days may also include travel days up to 8 hours per day (including weekend travel whether additionally compensated or not).

With this definition, it is up to the contractor to then make sure that all staff, whose LOE is fee bearing, work a basic 40-hour work week and charge their travel time appropriately.  

There should be a procedure for exceptional work over the 40 hour work week (for example work on week end or after hours to meet a client deadline) and those hours should also be recorded towards the LOE – regardless of whether they are paid or unpaid.  Yes, if they are unpaid, the Government is getting labor at cheaper cost that week, but the Government is still paying the fee for those extra labor hours above the 40-hour work week (or 8 hours per calendar day) defined as LOE.

Same with travel days.

Whether or not the travel days during weekends are paid, is up to your company's policy.  Normally, the travel should be arranged during regular business hours, unless there is a compelling reason to do otherwise.  If the travel is required to be outside regular business hours and your company policy is to pay for those travel days at a straight time (no overtime premium) up to 8 hours per day or whatever, then you can pay for those as long as it applies not directly charged staff and indirectly charged staff for ALL program (not just USG) and indirect travel - i.e. policy consistently applied.

Whether the days are paid or not, you have to record time in travel on your time sheet as work time, just like you have to record ALL the hours that you work during regular work days (both exempt and non exempt employees).

These are DCAA rules, which are currently subject to much audit.  This means that if you do not get paid extra for “overtime” or weekend travel days, your time for that month becomes cheaper to the contract/Government:

Example:  You get paid $4,000 per week and work 40 hour week.  In one week, your time to the Government costs $100 per hour.   Now you work 10 hours per day, of which 8 hours per day you work for the contract and the other two hours you work on BD stuff plus travel on one day of the week end for the contract.  You must record 58 hours for that week.  Your cost per hour is now $4,000/58= $68.96 per hour.   Since the Government is only getting the 8 hours plus maybe travel day 8 hours (see below), your total cost to the Government under the contract for that week is $68.96 x 48=$3,310.  The rest of your pay (i.e. $690) must be allocated to indirect BD cost.  

Defining how the Fee is paid on CPFF Completion Contracts

CPFF Completion contracts, also administered under FAR Part 16.306 allow for payment of all allowable costs plus a fixed fee for successful delivery of certain deliverables.

The main issue with this one is not defining how the fee is paid.  At best the contracts that I see say nothing except for the Fee is paid in accordance with FAR 52.216-8, i.e. “(a) The Government shall pay the Contractor for performing this contract the fixed fee specified in the Schedule;(b) Payment of the fixed fee shall be made as specified in the Schedule[….]”   The Schedule then specifies nothing…

At worst the contracts will say that the Fee will be paid proportionate to the work delivered under the contract as decided by the Contracts Officer (or even worse as a percentage of cost – prohibited by the FAR). 

The main issue for the contractor is that the Contracting Officer is unlikely to interpret payment of fee in favor of the contractor.  Mostly because it is their job to save for the Government.  And since the fee is not specified in the Schedule, the Government is free to interpret away.  This is not so much an issue if you believe that you have a precise scope with specific deliverables lined up, which you will absolutely deliver as written.  The reality is that most scopes are not written that way and things happen during performance.  The reality is also that if the contract is terminated for convenience, the CO gets to interpret how much of the promised scope you have delivered and what an appropriate fee should be. Disputes ensue…

The best and most appropriate solution for this problem is establishing a Fee Schedule and writing it into the contract.  The Fee Schedule should define deliverable, timing and standards and a proportionate allocation of fee, i.e. Deliverable 1 = 20% of fee etc.

Capturing the Costs for Reimbursement

This one is sort of self-explanatory.  We operate in multiple locations and making sure that all the costs are accrued properly at all times guarantee that we do not blow LOE or Cost Ceilings without the possibility of being reimbursed.   

The solution is having an adequate accounting system like CostPoint or SAP which can capture and upload your home office and field commitments in real time and give you the most precise picture of expenditure rate on the project.

Asking for More Fee
This relates to both types of CPFF.  As described above, the Government agrees to pay the fixed fee for delivery of certain number of LOE days in certain categories (CPFF Term) and certain deliverables (CPFF Completion) while paying all the allowable costs. 

If the contractor runs out of cost it can stop working.  The fee is then paid in proportion of delivered LOE or proportion of accepted deliverables as described above.   Under CPFF Term, the contractor can also stop working once all the LOE is delivered regardless of whether the cost ceiling has been reached. 

If the contractor runs out of cost, the Government may add more cost for contractor to continue working, but no more fee.   If the Contractor has run out of LOE, however, the Government may add more LOE to continue the work, more money or more time or all three but adding more fee is now on the table.  The contractor completed the previous contract by delivering all of the ordered LOE and Government accepted it.  More LOE is the new order, which allows more fee.

Limitation of Fund Notices and Danger of Overruns

Most CPFF contracts are incrementally funded and require the contractors to give notice 60 days BEFORE THEY REACH 75% of the allotted funding EXCLUDING FEE.  This is a whole different discussion, but the Government is supposed to reserve the whole fee to prevent Anti-Deficiency violations, so the notice is supposed to provide the Government the cost estimate to complete the contract without worrying about the final decision on how much the contractor will end up earning in fee. 

The contractors often do not care to include the estimates to complete with their notice, which is simply a poor management trait.  Or if they do, the estimates do not include accruals for commitments with subs or leases, demobilization costs or indirect cost adjustments.

The best way to prevent overruns, and to get paid is making sure your Notice of Funds Limitations includes the following:

1. Costs and Commitments Accrued to Date. You can separate commitments into cancellable and non-cancellable (mostly commercial items), in which case, include the cost of cancellation if Government does not provide additional funding.
2.     Projected Cost to Complete including demobilization and excluding Fee
3.     Projected Final Indirect Costs at current rates
4.     Anticipated Fee Earned To Date
5.     Anticipated Fee to Complete

Capping Indirect Costs

The final way to lose money is a topic onto itself so my next post will be dedicated to this subject.  To make the long story short though, if the Government believes that you should cap your rates, because of your volatile rate history, you should consider this request seriously, but you can still say “no”.    Offering to cap your rates without any request from the Government is simply odd.  It gives you no competitive advantage since indirects are not evaluated against total $$ and,  at best,  only gives you a neutral rating on risk if the Government has reason to believe you were high risk in first place.  The downside is that unless you have a crystal ball to predict your business base, the caps may be a difference between full recovery and eating your whole fee.  If that is not a problem, you should consider assistance instruments….

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