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Scenario:

Target Cost: $60M

Target Profit: $7M

Target Price: $67M

Ceiling: $70M

Share Ratio, Under and Over: 100/0; 0/100

The issue surrounds interpretation of FAR 52.216-16(d)(2) and the adjustment for loss if the contractor's share of the over target costs exceeds the target profit.

If the actual cost were $68 million, is the final price $67 million or $68 million? In this case, the contractor's share in the adjustment in profit would be $8M, but the target profit is only $7M. Would the calculation of the final price be equal to the actual cost plus a negative $1M of profit or actual cost plus no profit?

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The clause says:

(2) The total final price shall be established by applying to the total final negotiated cost an adjustment for profit or loss, as follows... (ii) If the total final negotiated cost is greater than the total target cost, the adjustment is the total target profit, less ______ (Contracting Officer insert percent) percent of the amount by which the total final negotiated cost exceeds the total target cost.

In your scenario, the contractor pays every dollar of overrun (0/100) up to $7,000,000. The contractor must complete the work, but will get no more than the $70,000,000 ceiling price.

So I think that if the actual cost is $68,000,000, $7,000,000 will come from the contractor's profit and the Government, which is liable up to $70,000,000, must pay $61,000,000. I think.

Is this a real arrangement?

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Scenario:

Target Cost: $60M

Target Profit: $7M

Target Price: $67M

Ceiling: $70M

Share Ratio, Under and Over: 100/0; 0/100

if the cost exceeds the target, this is no different than a firm-fixed-price contract for $67 million. Plug in anything you want into the formula and you will get $67 million. The ceiling is meaningless.

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Don, you can't leave it at that! You've got to do better than that! Your statement, "this is no different than a firm-fixed-price contract for $67 million" is conclusory, as is your statement, "the ceiling is meaningless." Give us your argument in support of those conclusions based on the incentive price revision clause.

The target cost is just that. It does not limit the Government's obligation to the contractor. The government's obligation is limited only by the ceiling price and the share ratio, which is applied to the target profit to determine the contractor's share of a cost overrun.

Under the scenario, If the contractor incurs cost of $68,000,000, then under the incentive price revision clause the share ratio is applied to the target profit of $7,000,000. Once that's gone there is no more sharing of the overrun, but the government is still on the hook up to the ceiling. That's what I would argue as the contractor. Is that wrong? If you think so, then please explain. What would you argue if you were the government?

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The clause says:

In your scenario, the contractor pays every dollar of overrun (0/100) up to $7,000,000. The contractor must complete the work, but will get no more than the $70,000,000 ceiling price.

So I think that if the actual cost is $68,000,000, $7,000,000 will come from the contractor's profit and the Government, which is liable up to $70,000,000, must pay $61,000,000. I think.

Is this a real arrangement?

If the total final price is established by applying to the total final negotiated cost an adjustment for profit or loss, as follows... (ii) If the total final negotiated cost is greater than the total target cost, the adjustment is the total target profit, less 100 percent of the amount by which the total final negotiated cost exceeds the total target cost.

Then:

$ 68M Total final negotiated cost

+ $ 7M Total target profit

- $ 8M Amount by which the total final negotiated cost

______ exceeds the total target cost

$ 67M

So Don is correct, but only so far as $67M will always be the result if there's an overrun. If there's an underrun, the total final price will be the total final negotiated cost plus $7M.

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16.403-1 Fixed-price incentive (firm target) contracts.

(a) Description. A fixed-price incentive (firm target) contract specifies a target cost, a target profit, a price ceiling (but not a profit ceiling or floor), and a profit adjustment formula. These elements are all negotiated at the outset. The price ceiling is the maximum that may be paid to the contractor, except for any adjustment under other contract clauses. When the contractor completes performance, the parties negotiate the final cost, and the final price is established by applying the formula. When the final cost is less than the target cost, application of the formula results in a final profit greater than the target profit; conversely, when final cost is more than target cost, application of the formula results in a final profit less than the target profit, or even a net loss. If the final negotiated cost exceeds the price ceiling, the contractor absorbs the difference as a loss. Because the profit varies inversely with the cost, this contract type provides a positive, calculable profit incentive for the contractor to control costs.

From what's provided in this thread, I would think that the contractor is paid $68M for negotiated Costs and $2M in profit.

Don - I have to disagree with you, the contractor should only absorb the difference as a loss when the ceiling is exceeded, not the target (from my experience with these contract types).

Vern - I'm not sure where your $61M number is coming from in post #2

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(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.

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?

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(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.

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 result it $ 68M - (- $ 1M).

How much is that?

I think the result is $67M, not $68M or "$ 68M - (- $ 1M)."

The total final price (X) shall be established by applying to the total final negotiated cost (A) 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 (B ), less 100 percent of the amount (C ) by which the total final negotiated cost exceeds the total target cost.

So -- X = A + B - C

Thus, for the given case, X = $68M + $7M - ($68M-$60M)

X = $67M.

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You are starting with the number -- 68 + 7 -- that you are supposed to derive from the clause and then deducting the overrun. That's not what the says says to do. The clause does not say to add the total target profit to the total target cost and then deduct the overrun. The clause says, in my own paraphrasing:

Derive the total final price by deducting from the total final negotiated cost an amount that is equal to the total target profit minus 100 percent of the overrun. That latter amount is $ 7M - $ 8M = - $ 1M. That's the plain English of the clause. Have I read the clause wrongly? If so, what's my mistake. If not, then what is $ 68M - (- $ 1M)?

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You are starting with the number -- 68 + 7 -- that you are supposed to derive from the clause and then deducting the overrun. That's not what the says says to do. The clause does not say to add the total target profit to the total target cost and then deduct the overrun. The clause says, in my own paraphrasing:

Derive the total final price by deducting from the total final negotiated cost an amount that is equal to the total target profit minus 100 percent of the overrun. That latter amount is $ 7M - $ 8M = - $ 1M. That's the plain English of the clause. Have I read the clause wrongly? If so, what's my mistake. If not, then what is $ 68M - (- $ 1M)?

You have read the clause wrongly. Nowhere does it say to "deduct" from the total final negotiated cost an amount that is equal to the total target profit minus 100 percent of the overrun. It says to apply an adjustment to the final negotiated cost. When you apply the -$1M adjustment to the final negotiated cost of $68M, you get $67M.

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Vern - I believe Navy's process/calculation is correct. The clause states that you make an adjustment to (not a deduction from) the final negotiated cost. So if the final cost was $ 61M, the adjustment would be the target profit of $ 7M less the percentage (in this case 100%) of the amount by which the final cost exceeded the target cost ($ 1M) which leaves $ 6M. The adjustment in that case adds $ 6M to the $ 61M final cost for a total of $ 67M.

If the final cost exceeds the target cost by an amount that's more than the target profit (which is the OPs scenario) the adjustment becomes a deduction from the final cost.

But I want to re-ask the question you posed in post#2 -- is this a real arrangement? Who negotiates a deal that is, in effect a firm fixed price over the target cost and CPFF below the target cost?

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navy and Craig:

Give me a break. What does "applying to" mean if it does not mean adding or subtracting? Please provide your definition. What would you tell a judge? It's no good telling me I'm wrong if you won't show me how. You start with a result and then work backwards. I can't accept that.

And Craig, can we solve one problem before we take up another?

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ok going to give it a shot. (after reading the NASA incentive guide to freshen up on FPIF contracts)

Target cost $60M

Final negotiated cost $68M

difference ($8M)

target profit $7M

contractor would see a decrease in their profits of 100% of the difference of the target cost and the final negotiated cost. In this case since it is a 0/100 share on the over, the ceiling does not matter as the contractor assumes responsibility for for all costs over the the target cost. ( if there were a different ratio, then I could see where the ceiling would come into play)

so based upon the sharing ratio, my answer would be the final cost would be $67M, with the contractor absorbing a ($1M) loss.

just my two cents.

edited for spelling,

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navy and Craig:

Give me a break. What does "applying to" mean if it does not mean adding or subtracting? Please provide your definition. What would you tell a judge?

And Craig, can we solve one problem before we take up another?

Of course, it means adding or subtracting. I think my example makes it perfectly clear how I interpret/define adjustment, and that's exactly what I would tell a judge. What do you think a judge would say to me in response?

Here's an example from a more representative type of FPI arrangement:

Target cost --- $60M

Target profit -- $ 7M

Share ratio over and under -- 50/50

Ceiling price -- $70M

So, in the case of an overrun, the final negotiated price (X) would be the final negotiated cost (W) adjusted by the total target profit (Y), less 50% of the of the amount by which the total final negotiated cost (Z) exceeds the total target cost.

Or, X = W + Y - 0.5(Z-W)

Now assume the final negotiated cost was $64M.

X = $64M + $7M - 0.5($64M-$60M)

In this example, X = $69M

Do you agree? If not, where did I go wrong?

If so, apply the formula to the OP's scenario, thusly -- X = $68M + $7M - 1.0($68M-$60M)

The result is X = $67M

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ok going to give it a shot. (after reading the NASA incentive guide to freshen up on FPIF contracts)

Target cost $60M

Final negotiated cost $68M

difference ($8M)

target profit $7M

contractor would see a decrease in their profits of 100% of the difference of the target cost and the final negotiated cost. In this case since it is a 0/100 share on the over, the ceiling does not matter as the contractor assumes responsibility for for all costs over the the target cost. ( if there were a different ratio, then I could see where the ceiling would come into play)

so based upon the sharing ratio, my answer would be the final cost would be $67M, with the contractor absorbing a ($1M) loss.

just my two cents.

edited for spelling,

Can you provide a link to where from this statement is derived?

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FAR 16.403-1 states "when final cost is more than target cost, application of the formula results in a final profit less than the target profit, or even a net loss. "

with the application of the formula (0/100) the contractor sees his profit decremented by his percentage, which in this case is 100%.

Tjhe statement you are questioning is based upon the information given to us and my interpretation of 16.403-1

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my original statement

In this case since it is a 0/100 share on the over, the ceiling does not matter as the contractor assumes responsibility for for all costs over the the target cost. ( if there were a different ratio, then I could see where the ceiling would come into play

so yes in this case .

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Scenario:

Target Cost: $60M

Target Profit: $7M

Target Price: $67M

Ceiling: $70M

Share Ratio, Under and Over: 100/0; 0/100

The issue surrounds interpretation of FAR 52.216-16(d)(2) and the adjustment for loss if the contractor's share of the over target costs exceeds the target profit.

If the actual cost were $68 million, is the final price $67 million or $68 million? In this case, the contractor's share in the adjustment in profit would be $8M, but the target profit is only $7M. Would the calculation of the final price be equal to the actual cost plus a negative $1M of profit or actual cost plus no fee?

Wouldn't the final price be the actual cost of 68 million with an absorption of 100 percent of the fee ($7 million) for the overrun plus absorption of the additional loss of ($7 million - $8 million)? This is because the contractor agrees to absorb 100% of costs in excess of the target price and the government agreed to absorb none of the excess costs. The excess is covered by the fee plus $1 million in cost overrun in excess of the fee.

Thus the final price will be $68 million, minus $1 million, equals $ 67 million.

Contractor is paid all costs less $1 million plus no fee.

The contractor will absorb a $1 million loss and earn no fee.

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I don't think either navy or I started with a result and worked backwards. And calling it adding is OK with me.

If the difference between final negotiated cost and target cost is less than the target profit you're adding a positive number (7 minus some number less than 7) to the final negotiated cost. If the difference is greater than the target profit you're adding a negative number (7 minus some number greater than 7) to the final negotiated cost.

From 52.216-16(d)(2) --

(2) The total final price shall be established by applying to the total final negotiated cost an adjustment for profit or loss, as follows:

(i) If the total final negotiated cost is equal to the total target cost, the adjustment is the total target profit.
[
60 + 7 = 67]

(ii) If the total final negotiated cost is greater than the total target cost, the adjustment is the total target profit, less
100
percent of the amount by which the total final negotiated cost exceeds the total target cost.
[From the original posted scenario ... 68 + (7 - 8) = 67; If the final negotiated cost was 65 the adjustment would show as 65 + (7- 5) = 67]

(iii) If the final negotiated cost is less than the total target cost, the adjustment is the total target profit plus
0
percent of the amount by which the total final negotiated cost is less than the total target cost.
[because of the 100/0 share, this results in adding 7 to whatever the final negotiated cost is]

Because of the pretty unusual share ratio over the target cost (0/100), the adjustment is a 1 for 1 movement, which makes the result static at the target price, or essentially FFP.

.... and yes, I can wait until we're done with this before moving to another question.

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my original statement

In this case since it is a 0/100 share on the over, the ceiling does not matter as the contractor assumes responsibility for for all costs over the the target cost. ( if there were a different ratio, then I could see where the ceiling would come into play

so yes in this case .

i agree in this case. The ceiling must have been established before the fee and share ratios were established. The overrun share ratios make the ceiling cost irrelevant here.

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This is the most wonderful problem we've had at Wifcon for a long, long time. Don Mansfield and I just spent an hour talking about it.

Here's where I am coming from:

These days I'm fascinated by the challenge of explaining things to people and making persuasive arguments. It's not enough to just assert that something or other is so, you have to be able to explain to others why it is so and persuade them to believe it.

I like the $67 million answer, but the question is how to persuade a contractor and/or a judge to accept it. The boards and courts say they will rely on the plain language of the contract, unless the contract is clearly ambiguous.

Looking at the incentive price revision clause, paragraph (d)(2)(ii), the issue is which of the following two formulas is correct in the event of a cost overrun on an FPI(F) contract:

(1) x = a - (b - c) or

(2) x = a + (b - c), where:

x is the total final price,

a is the total final negotiated cost,

b is the target profit, and

c is the contractor's share of the cost overrun.

Using the numbers we have been provided, formula (1) gives you $ 69M (the contractor makes $1M in profit) and formula (2) gives you $ 67M (the contractor loses $1M).

x = 68 - (7 - 8)

= 68 - (-1)

= 69, or

x = 68 + (7 - 8)

= 68 + (-1)

= 67.

What interests me is how to determine which of those is formulas is correct and how to prove it to a judge based on the language of FAR 52.216-16(d)(2)?

Since I last read the responses here (it's been a few moments) it seems that most of you think that $ 67M is the right number and you've used all kinds of calculations to show me how you got to your numbers, but you have not justified your choice of calculation based on the language of the clause. E.g., Craigmccaa. You've just plugged your choice of numbers into the right places to produce your result.

I know you think you're right, but if I'm the contractor or a judge, then why should I believe that your method of calculation is the right one? How does th language of the clause justify your choice of calculation? My own thinking is that you cannot establish which of the above formulas is correct based on the language of the clause, and neither can I. So we're going to have to resort to extrinsic arguments.

But speaking of extrinsic arguments, think of this:

Your honor, the government would have you believe that we should take a $1M loss even though we have not exceeded the ceiling price. I have perused all of the government's publications about fixed-price incentive contracts with firm targets, and all indicate that the contractor does not take a loss until its costs exceed the ceiling price. See e.g. FAR 16.403-1, "Fixed-price incentive (firm target) contracts," paragraph (a), sixth sentence, which states, "If the final negotiated cost exceeds the price ceiling, the contractor absorbs the difference as a loss." Well, your honor, we have not exceeded the price ceiling. At $68 million we are $2 million below it. We have lost the profit in the incentive pool, and that's fair, but we are still entitled to be compensated for our allowable costs incurred up to the ceiling price. We are not obligated to take a loss.

By the way, it's no good saying that the ceiling doesn't matter. It matters if for no other reason than the fact that it's in the contract. You cannot just read it out of the contract.

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Vern -

I vote for your formula 2.

Take a look at post #22. I think FAR 52.216-16(d)(2)(i) sets the stage for "applying to the total final negotiated cost an adjustment for profit or loss". The only way "applying" the "adjustment" can be interpreted from (2)(i) is by adding the adjustment to the final negotiated cost. In the examples I included in the clause text, that all works out to $67M. If the "adjustment" is a positive number (target profit greater than the overrun amount) the contractor has a profit which is reduced in this case (because of the 0/100 share ratio) dollar for dollar by the amount of the overrun. If the target profit is less than the overrun the adjustment is a negative number which when added to the final negotiated cost results in a loss.

And I agree that we shouldn't say the ceiling doesn't matter. We should, however, be questioning why the CO would establish a ceiling that mathematically exceeds the amount the contractor could be paid under the formula. While the stated ceiling is $70M, the effective ceiling is $67M. If I were Government counsel during the appeal my best argument might be that the CO was incompetent ... but that doesn't mean the contractor receives more than $67M

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