FPIF Math

[Guest Vern Edwards]

Thanks, wvanpup. Don't worry about the mistake. I have done the same thing in haste more than once. In fact, navy caught me at it early in this thread.

If I were the government in our case I would argue that the ambiguity was patent on the grounds that the targets, the 0/100 overrun formula, and the ceiling price are clearly inconsistent with FPI(F) contracting as described in FAR and in other readily available government contracting publications. I don't know if I could win that argument, but if I were the government I'd sure give it a try.

[wvanpup]

In post #7, Vern wrote:

(from earlier post) (2) The total final price (X) shall be established by applying to the total final negotiated cost ($ 68M) an adjustment for profit or loss, as follows...

(ii) If the total final negotiated cost is greater than the total target cost ($ 60M), the adjustment is the total target profit ($ 7M), less 100

percent of the amount by which the total final negotiated cost exceeds the total target cost.

(applying the formula exactly as written) So we adjust the $ 68M by

deducting

$ 7M (total target profit) - $ 8M (the amount by with the total final negotiated cost exceeds the total target cost). Is that right?

The total final negotiated cost is $ 68M. The total target profit ($ 7M) less the amount by which the total final negotiated cost exceeds the total target cost ($ 8M) is how much?

$ 7M - $8 M = - $ 1M.

So the total final price is: $ 68M - (- $ 1M).

How much is that?

In post # 59, Navy wrote:

(quoting me)...The literal language, as Vern has demonstrated, results in subtracting -1, which mathematically means adding 1. I suppose you can take your pick -- apply the literal language or find something else that is not addressed specifically.

(navy's comment) Vern has said no such thing. As a matter of fact, here's a quote from his post #48 - "you

add

the adjusted profit to the total final negotiated cost in order to get the total final price." [emphasis added.]

My response to Navy: Maybe Vern was having fun with numbers and got me. He wrote: "So we adjust the $ 68M by deducting $ 7M (total target profit) - $ 8M (the amount by with the total final negotiated cost exceeds the total target cost). Is that right?" That sounded good at the time, but is "deducting" the right word there? The adjustment actually is adding. If we apply Vern's formula in the case of a final cost of $64M, we get "So we adjust the $ 64M by deducting $ 7M (total target profit) - $ 4M (the amount by with the total final negotiated cost exceeds the total target cost). Is that right?" This results in $64M - $3M, or a price of $61M rather than $67M, which cannot be right.

Regardless of whether I was got or not, I stand behind my conclusion as to how I would apply the clause. I am not going to establish a de facto price ceiling of $67M and ignore the contract price ceiling of $70M.

[wvanpup]

I have enjoyed reading all of the posts. I am glad that I gave everyone something to think about. The share ratios are real.

The share ratios were recommended by an individual at USD AT&L about a year ago. Rather than an incentive, the arrangement was structured to remove the contractor's incentive to limit expenses in order to pocket additional profit which was a concern at the time when the RFP was issued. The CLIN with the applicable arrangement is an interim development (i.e. completion of PDR, CDR, etc.).

Regarding the CPIF math, my personal interpretation had previously matched that of wvanpup because I had believed that the adjustment to the target profit could not be less than zero. Additionally, an FPIF graphing tool from the former chief of our pricing office generated a graph which showed a final cost between target price and ceiling that resulted in the final price equalling the final cost.

Based on the conversations here and recent discussions with my current management, I am inclined to believe that I along with the grahing tool were wrong.

Given these new facts, I add to my previous analysis the probability of giving some form of relief based on mutual mistake. The Government has now admitted that it intended the clause to permit a reduction in profit to zero, but not below. Assuming that was also the contractor's intention, the contract should be reformed to correct the mistake (the clause was not written to reflect the intent of the parties) that frustrates the intention of each party.

It also strikes me that a cost incentive is not appropriate in this situation. "Rather than an incentive, the arrangement was structured to remove the contractor's incentive to limit expenses in order to pocket additional profit which was a concern at the time when the RFP was issued." Isn't the whole purpose of a cost incentive to limit the contractor's expenses while still giving us what we want? Why are we writing an incentive contract if we do not want the contractor to reduce expenses, or if by reducing expenses we will not receive what we want?

[Guest Vern Edwards]

wvanpup:

In re your post #77, i stated what I think the proper formula would be several posts back, and that it's:

68 + (7 - 8)

= 68 + (-1)

= 68.

You add, not deduct, the -1.

I was having fun earlier, but I was also serious. The question that interested me was: How do we know when we are right, and how do we explain our thinking so as to persuade others that we are right? Why can't the answer be 68 - (7 - 8) = 68 - (-1) = 69? Why isn't the ceiling significant to the outcome? In every disagreement, both parties think they are right. The problem is how best to end the disagreement short of litigation? If you do have to litigate, how do you persuade a board or court so that you win? Several solutions have been proposed by various persons, and all have some merit. At this point in my life I am far more interested in those kinds of questions and problems than the actual answer to the questions most frequently posted here, which are usually elementary and very often just silly. Half the questions asked here can be answered with 15 minutes work at Google or Bing. It gets a little wearisome doing other peoples' work for them, but I'm lazy and it saves me from doing what I ought to be doing, which is real work.

I am sympathetic to the contractor in this case. I think the deal was so weird and one-sided that it never should have been offered or approved. I know that contractors have to be held responsible for what they agree to, but the Government usually is far more powerful than contractors during competitive contract formation, and is often unwilling to bargain or listen to reason.

[Whynot]

The formula mathematically comes out to $67M, no way around it. However, I think the 0%/100% renders it meaningless. Just as putting in a percentage equal to the square root of -1. Nothing says you can’t but it doesn’t work - you will get two very different answers every time, with both being equally correct.

In order for a cost to be allowable, it must be reasonable. You would think that incurring a poorly controlled cost (a cost above target cost on a contract that you have 100% responsibility) would not be reasonable and therefore unallowable. It certainly does not seem to pass the requirement at FAR 31.201-3(a). However, if the Government also has some responsibility for cost above target cost then it would seem that these costs are more reasonable and therefore allowable.

If we consider that there is no other distinction to a given cost element than whether it is either under or over the target cost, then an over-run cost is as reasonable as an under-run cost. For example, what caused the contract over-run, the first hours worked or the last hours worked or some hours worked in between? You cannot tell. So we end up with a single cost element that could be arbitrarily sometimes reasonable and sometimes unreasonable. It would make a certain amount of sense that all allowable costs are billable (up to the contract ceiling) and it is the profit (which is not a cost) that becomes not payable. In this thread this would result in a final price of $68M.

The incentive contract places an incentive for a company to increase profit and profit percentage at the expense of revenue. If you look at today’s stock market, and how investor’s react to earnings, you will find that many investors put more value on revenue (total price) and growth then on profit and profit percentage – up to a point of course. You would like to think that the lower cost is the result of increased efficiencies and that these now available (and unused) resources are available to do additional work. It would be a shame if these past incentivized resources sit idle and unproductive in the future – driving up overhead cost, putting the increased profit that was earned at risk of being quickly lost. It seems a better incentive would be one that also includes the award of additional work (more revenue) to the vendor.

[joel hoffman]

We dont know all the facts regarding the establishment of this task order or contract but it would have to have been bilateral. Whether the contractor knew what the terms were is also unknown.

Service contractors might be adverse to a Guaranteed Maximum Price (GMP) contract type with assumption of total risk for overruns on a completion type contract. Many construction and design-build firms apparently aren't.

The contract format is quite common in the construction industry, where firms will guarantee their top price to complete a project, either with or without a separate fee.

However, these type contracts also often have share ratios to incentivize and reward cost savings. There is usually a limited range. Say, for example, "70/30 owner/contractor savings up to $5 million in total cost savings". Construction firms seem to like such arrangements, regardless of the apparent drawbacks cited in the previous post.

I've also read that, because it is a pain for both parties to administer contracts on an actual cost basis, many such contracts contain provisions to definitize the contract price o a FFP as soon as possible during performance.

[Guest Vern Edwards]

The formula mathematically comes out to $67M, no way around it. However, I think the 0%/100% renders it meaningless. Just as putting in a percentage equal to the square root of -1. Nothing says you can’t but it doesn’t work - you will get two very different answers every time, with both being equally correct.

In order for a cost to be allowable, it must be reasonable. You would think that incurring a poorly controlled cost (a cost above target cost on a contract that you have 100% responsibility) would not be reasonable and therefore unallowable. It certainly does not seem to pass the requirement at FAR 31.201-3(a). However, if the Government also has some responsibility for cost above target cost then it would seem that these costs are more reasonable and therefore allowable.

If we consider that there is no other distinction to a given cost element than whether it is either under or over the target cost, then an over-run cost is as reasonable as an under-run cost. For example, what caused the contract over-run, the first hours worked or the last hours worked or some hours worked in between? You cannot tell. So we end up with a single cost element that could be arbitrarily sometimes reasonable and sometimes unreasonable. It would make a certain amount of sense that all allowable costs are billable (up to the contract ceiling) and it is the profit (which is not a cost) that becomes not payable. In this thread this would result in a final price of $68M.

The incentive contract places an incentive for a company to increase profit and profit percentage at the expense of revenue. If you look at today’s stock market, and how investor’s react to earnings, you will find that many investors put more value on revenue (total price) and growth then on profit and profit percentage – up to a point of course. You would like to think that the lower cost is the result of increased efficiencies and that these now available (and unused) resources are available to do additional work. It would be a shame if these past incentivized resources sit idle and unproductive in the future – driving up overhead cost, putting the increased profit that was earned at risk of being quickly lost. It seems a better incentive would be one that also includes the award of additional work (more revenue) to the vendor.

Gobbledegook.

[Guest Vern Edwards]

We dont know all the facts regarding the establishment of this task order or contract but it would have to have been bilateral. Whether the contractor knew what the terms were is also unknown.

Why wouldn't the contractor know the terms of the contract?

[Retreadfed]

Vern, I will let Joel speak for himself, but from personal experience I can give you two reasons why the contractor would not reasonsably know what the terms of a contract are. First, when the contract was awarded, it had different terms and conditions from what were included in the RFP. Second, the government provided the contractor with one version of the contract and retained a different version.

[Guest Vern Edwards]

Thanks, Retread.

That's scary. In your experience, did the contractor ever discover the disconnect and, if so, was it able to sort things out? Did it cause serious problems?

[joel hoffman]

Why wouldn't the contractor know the terms of the contract?

Let me rephrase. We dont know all the facts regarding the establishment of this FPIF task order or contract. It must have have been bilaterally agreed to. We don't know if the contractor understood the terms either. Whoever established the formulas and the cost ceiling does not seem to have understood that the cost ceiling is unacheivable using the stated cost share ratios.

[Guest Vern Edwards]

Thanks.

[Retreadfed]

Vern, in regard to your post #85, there were major problems in each instance with the government withholding payment from the contractor in each instance because of disagreements over what the contract required. I do not know if the contractor ever got things worked out in regard to the terms of the RFP being changed when the contract was issued as I was no longer associated with that company. In regard to the situation where there were two different versions of the contract, the contractor made a business decision not to fight the government's contention that its version of the contract was the "official" version that the contractor was required to follow. This required a lot of rework and lost revenue which the contractor was willing to accept to put everything behind it and get paid for work it had done.