FPIF Math

[Guest Vern Edwards]

I understand where you're coming from. But what would you say to a judge who asked:

Why, Mr. Craigmccaa, is adding "the only way" of applying the adjustment? What do you see in the language of (2)(i) that leads you to that conclusion? (2)(i) tells us how to calculate the amount of the adjustment, but it does not tell us how to "apply" the adjustment. In fact, I don't see anything in the clause that tells us how to apply the adjustment. It just says that you must apply it in some way. Your worthy opponent says that subtracting is the only way of applying the adjustment. Why should I believe you instead of him? (I'm going to ask him the same question after you answer.) I don't see anything in the contract or in the description of FPI(F) in FAR Subpart 16.4 that talks about an "effective" ceiling different from the stipulated ceiling. I don't care why the CO did what he did, I only care about what the parties are entitled to believe about the contract based on the language therein.

Just help me with the logic.

[Navy_Contracting_4]

I understand where you're coming from. But what would you say to a judge who asked:

Why, Mr. Craigmccaa, is adding "the only way" of applying the adjustment? What do you see in the language of (2)(i) that leads you to that conclusion? (2)(i) tells us how to calculate the amount of the adjustment, but it does not tell us how to "apply" the adjustment. In fact, I don't see anything in the clause that tells us how to apply the adjustment. It just says that you must apply it in some way. Your worthy opponent says that subtracting is the only way of applying the adjustment. Why should I believe you instead of him? (I'm going to ask him the same question after you answer.) I don't see anything in the contract or in the description of FPI(F) in FAR Subpart 16.4 that talks about an "effective" ceiling different from the stipulated ceiling.

Just help me with the logic.

I would suggest that he apply the same logic to the situation where the actual final negotiated cost equals the target cost and see how he applied the adjustment.

[Guest Vern Edwards]

Suggest away. Why should he do that? Please elaborate.

(I'm going to lunch now, so we'll recess for two hours.)

[Don Mansfield]

Vern,

If the correct formula were "x = a - (b - c)", wouldn't you have a CPPC arrangement for costs in excess of the target price? Think about it. Once c gets bigger than b, an extra dollar of cost results in an extra dollar of profit (i.e., profit would be earned at 100% of contract cost).

[FAR Fetched]

Vern,

If the correct formula were "x = a - (b - c)", wouldn't you have a CPPC arrangement for costs in excess of the target price? Think about it. Once c gets bigger than b, an extra dollar of cost results in an extra dollar of profit (i.e., profit would be earned at 100% of contract cost).

Stand down counselor, we're in recess [gavel sound]

[Guest Vern Edwards]

Thank you, FAR Fetched. You're a first rate bailiff. Court is now back in session.

Don, the contractor's profit would increase up to the ceiling, but I'm not sure that would make the arrangement CPPC. It might. Let's suppose it does. What is your argument?

[joel hoffman]

Judge, the final price is derived 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."

Thus, Total Price = Total Cost + Target Profit

However, in this case, the final negotiated cost exceeded the target cost by $ 8 million dollars..

"(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."

Thus, Total Price = Total Cost + (Target Profit - (100% x (Total Cost - Target Cost))).

TP = 68 + ( 7 - (68 - 60)) = 75 - 8 = 67 ($ million)

[Guest Vern Edwards]

Joel:

Suppose we get the contractor to agree to that calculation. What if anything is the significance of the $ 70 million ceiling price and the fact that the contractor's actual cost was $68 million? What if he argues that he should get his entire incurred cost since it's less than the ceiling price? What would you say to that?

[joel hoffman]

Vern, the 70 million ceiling price is unachievable, with the share ratios given here. The most that the final contract price can be is $ 67 million with no overrun or under run.

The government keeps all underruns and the contractor must absorb all overruns. This is a bum deal for the contractor.

I'm guessing that the government specified at least the ceiling price, then the winning proposer probably proposed the target price and the share ratios. Either the firm desperately needed the work or is not too smart?

As for what to tell the contractor, I'd probably say, "Please read the clause, which is used to establish the final contract price."

Some incentive contract this turned out to be!

[joel hoffman]

Judge, the final price is derived 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."

Thus, Total Price = Total Cost + Target Profit

However, in this case, the final negotiated cost exceeded the target cost by $ 8 million dollars..

"(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."

Thus, Total Price = Total Cost + (Target Profit - (100% x (Total Cost - Target Cost))).

TP = 68 + ( 7 - (68 - 60)) = 75 - 8 = 67 ($ million)

Let's test Don's original assertion that this specific arrangement will yield a final price of $67 million, regardless of actual total cost.

If the final cost is $ 78 million, then we are looking at:

TP = 78 + (7 - (78 - 60)). = 85 - 18 = 67

But if there is an under run, the govt keeps it all and i think the contractor is paid the total cost plus target profit or fee. So, with a total cost of 59 million plus 7 million fee, the TP = $66 million. I have a low battery, so will verify that later.

[joel hoffman]

But if there is an underrun, the govt keeps it all and I believe that the contractor is paid the total cost plus target profit or fee.

52.216-16 -- Incentive Price Revision -- Firm Target.

" ...(d) (2) (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."

So, with a total cost of $ 59 million plus $ 7 million target profit, the TP = $66 million.

[Guest Vern Edwards]

The math is unassailable, but I always try to come up with a counterargument or two. It's good practice, and you never know. I have seen some pretty goofy court decisions. And you never know how a judge might react when he or she thinks that the government has taken advantage of a contractor. Tell me, Ms CO, what's up with that ceiling price? Whose idea was that?

[joel hoffman]

The math is unassailable, but I always try to come up with a counterargument or two. It's good practice, and you never know. I have seen some pretty goofy court decisions. And you never know how a judge might react when he or she thinks that the government has taken advantage of a contractor. Tell me, Ms CO, what's up with that ceiling price? Whose idea was that?

I agree.

[FAR Fetched]

Your honor

The Government is arguing the ceiling does not matter "now", with their way of applying the formula for this contract. This is the same entity that established the ceiling higher than the Target Price knowing, apparently, that it could never be reached with their way of applying the formula. Clearly, the ceiling was meant as a cap on cost overruns during performance. The cost was higher than the target yet $2M lower than the ceiling established by the same entity whose position is now that the ceiling doesn’t matter.

Can the Government come up with a reason or a 100/0:0/100 scenario applying the formula "their way" where the ceiling is higher than the target price for a reason?

[Guest Vern Edwards]

Ultimately, the contractor's best argument for getting more than $ 67M is the ceiling price. Few judges know much about FPI(F) contracts, and if the issue at hand were to be litigated the contractor would certainly argue that the contract must be read as a whole and the ceiling price is meaningful in that regard. The government would have to acknowledge the weirdness of the arrangement and explain the concept of formula incentives and the structure of FPI(F).

No one mentioned it during the discussion (unless I missed it), but the Contract Pricing Reference Guides explain how to calculate the adjustment in the event of an overrun. See Vol. 4, Section 1.3.1, under the heading "FPIF Contract Final Pricing." It specifically refers to the clause and describes the use of formula (2) from my Post #24, although it uses different symbols. https://acc.dau.mil/...id=379603#1.3.1 Don Mansfield discovered that during our telephone conversation yesterday morning.

If I were the government and trying to deal with the contractor's argument I would admit that the ceiling price doesn't make sense, but point out that it was a patent ambiguity at the time of contract formation and that the contractor should have brought it to the contracting officer's attention before signing. I would argue for using formula (2) to calculate the price revision by showing that formula (1) is inconsistent with the objectives of FPI(F) as described in 16.402-1((2) and as have been well and widely known and described for decades, including my own monograph published by Thomson Reuters in November 2009, 09-12 Briefing Papers. I would not use Don's CPPC argument, because I think it's too complicated, but others might.

I think it's possible that a board of contract appeals or the Court of Federal Claims might give the contractor $ 68M on the ground that the contractor should not take a loss at a dollar amount less than the ceiling price. I very much doubt that the contractor could get $ 69M.

I enjoyed the discussion.

[Craigmccaa]

I understand where you're coming from. But what would you say to a judge who asked:

Why, Mr. Craigmccaa, is adding "the only way" of applying the adjustment? What do you see in the language of (2)(i) that leads you to that conclusion? (2)(i) tells us how to calculate the amount of the adjustment, but it does not tell us how to "apply" the adjustment. In fact, I don't see anything in the clause that tells us how to apply the adjustment. It just says that you must apply it in some way. Your worthy opponent says that subtracting is the only way of applying the adjustment. Why should I believe you instead of him? (I'm going to ask him the same question after you answer.) I don't see anything in the contract or in the description of FPI(F) in FAR Subpart 16.4 that talks about an "effective" ceiling different from the stipulated ceiling. I don't care why the CO did what he did, I only care about what the parties are entitled to believe about the contract based on the language therein.

Just help me with the logic.

I agree that the clause doesn't expressly indicate whether "applying" means to add or subtract.

I used (2)(i) as the basis from which to extrapolate the meaning of "applying" to the other cases because (2)(i) involves numbers that are original elements of the agreement (target cost and target profit) and don't require intermediate calculations. The only reasonable way to apply the adjustment in that situation is by adding it to the final negotiated cost , because subtracting the adjustment would mean in the case of the initally posed scenario the contractor is reimbursed $53M on a contract where it incurred the target cost of $60M. The contractor loses the amount of the target profit as a reward for performing right at the target cost, a result that makes my concern about the "effective ceiling" and "who would agree to this arrangement?" seem trivial by comparison.

And just to review the math operation, in post #35 Joel laid out the calculation for an overrun scenario with an incurred cost of $78M as: TP = 78 + (7 - (78 - 60)). = 85 - 18 = 67. In fact, the calculation is TP=78+(7-(78-60))=78+(7-18)=78+(-11)=78-11=67.

[Guest Vern Edwards]

I agree that the clause doesn't expressly indicate whether "applying" means to add or subtract.

I used (2)(i) as the basis from which to extrapolate the meaning of "applying" to the other cases because (2)(i) involves numbers that are original elements of the agreement (target cost and target profit) and don't require intermediate calculations. The only reasonable way to apply the adjustment in that situation is by adding it to the final negotiated cost , because subtracting the adjustment would mean in the case of the initally posed scenario the contractor is reimbursed $53M on a contract where it incurred the target cost of $60M. The contractor loses the amount of the target profit as a reward for performing right at the target cost, a result that makes my concern about the "effective ceiling" and "who would agree to this arrangement?" seem trivial by comparison.

And just to review the math operation, in post #35 Joel laid out the calculation for an overrun scenario with an incurred cost of $78M as: TP = 78 + (7 - (78 - 60)). = 85 - 18 = 67. In fact, the calculation is TP=78+(7-(78-60))=78+(7-18)=78+(-11)=78-11=67.

Your calculation, TP = 78 + (7 - (78 - 60)) simply cannot be gotten from the language of (2)(ii) of the clause. Period. The proper method of calculation, based on the language of FAR 52.216-16(d)(2)(ii) is:

TP_F = TC_FN + (TP - CS(TC_FN – TC))

TP_F = 68 + (7 - 1.00(68 – 60))

TP_F = 68 + (7 - 8)

TP_F = 68 + (-1)

TP_F = 67

where:

TP_F is the Total Final Price,

TC_FN is the Total Final Negotiated Cost,

TP is the Target Profit

CS is the Contractor’s Share of an overrun

TC is the Target Cost

It is important that the CO get this right in his or her final decision, because the explanation should be bulletproof and invulnerable to distracting challenges (Your honor, that's not what the clause says!).

Also, rather than talk about extrapolating I would just point out to the judge that TP_F = 68 + (-1) is consistent with the method of "applying" used in (d)(2)(i) and (d)(2)(iii) and consistent with the way the incentive is supposed to work, rather than say that I was extrapolating (d)(2)(i) to (d)(2)(ii). Someone might argue that consistency proves nothing, but I think it's intuitively persuasive.

[joel hoffman]

"And just to review the math operation, in post #35 Joel laid out the calculation for an overrun scenario with an incurred cost of $78M as: TP = 78 + (7 - (78 - 60)). = 85 - 18 = 67. In fact, the calculation is TP=78+(7-(78-60))=78+(7-18)=78+(-11)=78-11=67. "

Craig: I won't argue that. In hating this iPad I took a shortcut in my typing.

Vern, Craig was responding to my test last night of Don's statement that the result is $ 67 million, regardless of the amount of overrun.

Your calculation, based upon a TC of $68, is correct, of course.

As to whether a contractor should not accept any loss below a cost ceiling, did you mean net loss or any loss of profit?

On the outside, guaranteed maximum price contracts are quite common in the construction and desigN-build industry. They normally include a shared savings formula and may or may not include a separate, non-variable fixed fee.

[Guest Vern Edwards]

As to whether a contractor should not accept any loss below a cost ceiling, did you mean net loss or any loss of profit?

I meant net loss, but in the case we've been dealing with it's fun to argue for the $1 M in profit the contractor would get using formula (1). I mean, when the government enters into an arrangement as apparently screwy as the one at hand, anything goes short of lying and fraud. Why not argue for it? Who knows... ?

[wvanpup]

Kind of late to the party here - maybe this will teach me not to ignore WIFCON for a day or two.

We still don't know if the situation is real or some diabolical plot, with the original poster LHAO. The question reminds me of my rabbi, who when asked how many angels could dance on the head of a pin wanted to know what kind of pin.

FWIW, my vote (absent my "judicial" assessment below) is $68 because (1) incentive contracts do not permit adjusting profit to less than zero, and (2) the permitting the profit adjustment to be less than zero renders the price ceiling meaningless, and we are required to interpret a clause in a way that gives meaning to all its terms.

If I were the judge, my ruling would probably depend on who drafted the pricing arrangement. Applying the rule concerning ambiguities, I would find the clause is subject to two or more reasonable interpretations (I am sure no one here would want to call Vern unreasonable) and therefore ambiguous. The ambiguity would be latent. If, as is normal, the Govenment drafted the pricing arrangement, I would hold for the contractor and rule that there is a price ceiling of $70M and applying the share ratio to the overrun merely establishes $67M as the point of total assumption. If the pricing arrangement was drafted by the contractor I would probably hold that it created the ambiguity and rule in favor of the Government. If, as may be the case, the pricing arrangement was a give and take, I would rule that neither side drafted the ambiguous term, and would therefore interpret the contract in a way that gives meaning to all its provisions, and rule that decreasing the final price to $67M would not give meaning to the price ceiling included in the contract.

To bring another quirk into the equation, what would the price be if the final cost was $72M? For me it is easy, the price would be the price ceiling of $70. But if you think the price ceiling does not really apply because of how the share ratios work, would the final price be $67M ( $72M - ($12M - $7M)) or would it be $65M by deducting from the $70M price ceiling rather than the $72M final costs?

[Guest Vern Edwards]

Thought provoking.

Why do you say the ambiguity would be latent?

As for being unreasonable, I do it here all the time just for the fun of it.

[Navy_Contracting_4]

Kind of late to the party here - maybe this will teach me not to ignore WIFCON for a day or two.

We still don't know if the situation is real or some diabolical plot, with the original poster LHAO. The question reminds me of my rabbi, who when asked how many angels could dance on the head of a pin wanted to know what kind of pin.

FWIW, my vote (absent my "judicial" assessment below) is $68 because (1) incentive contracts do not permit adjusting profit to less than zero, and (2) the permitting the profit adjustment to be less than zero renders the price ceiling meaningless, and we are required to interpret a clause in a way that gives meaning to all its terms.

If I were the judge, my ruling would probably depend on who drafted the pricing arrangement. Applying the rule concerning ambiguities, I would find the clause is subject to two or more reasonable interpretations (I am sure no one here would want to call Vern unreasonable) and therefore ambiguous. The ambiguity would be latent. If, as is normal, the Govenment drafted the pricing arrangement, I would hold for the contractor and rule that there is a price ceiling of $70M and applying the share ratio to the overrun merely establishes $67M as the point of total assumption. If the pricing arrangement was drafted by the contractor I would probably hold that it created the ambiguity and rule in favor of the Government. If, as may be the case, the pricing arrangement was a give and take, I would rule that neither side drafted the ambiguous term, and would therefore interpret the contract in a way that gives meaning to all its provisions, and rule that decreasing the final price to $67M would not give meaning to the price ceiling included in the contract.

To bring another quirk into the equation, what would the price be if the final cost was $72M? For me it is easy, the price would be the price ceiling of $70. But if you think the price ceiling does not really apply because of how the share ratios work, would the final price be $67M ( $72M - ($12M - $7M)) or would it be $65M by deducting from the $70M price ceiling rather than the $72M final costs?

What source can you cite for the statement that "incentive contracts do not permit adjusting profit to less than zero"? The clause doesn't even discuss "adjusting profit." It talks about applying an adjustment to the total final negotiated cost. Profit isn't being adjusted; profit ("or loss") is what constitutes the adjustment.

[Guest Vern Edwards]

What source can you cite for the statement that "incentive contracts do not permit adjusting profit to less than zero"? The clause doesn't even discuss "adjusting profit."

The heck it doesn't! The total final price is the total final negotiated cost plus the adjusted profit . The wording of the clause seems to suggest that the total final negotiated cost is adjusted, but it's not. You adjust profit based on the difference between the total final negotiated cost and the target cost. You either add to or deduct from the target profit based on the contractor's share, Then you add the adjusted profit to the total final negotiated cost in order to get the total final price. You don't change the total final negotiated cost.

That doesn't mean that wvanpup's statement about not adjusting profit to less than zero is true.

[airborne373]

FWIW, my vote (absent my "judicial" assessment below) is $68 because (1) incentive contracts do not permit adjusting profit to less than zero, and (2) the permitting the profit adjustment to be less than zero renders the price ceiling meaningless, and we are required to interpret a clause in a way that gives meaning to all its terms.

how do you reconcile your statement with FAR 16.403-1(a) which states ...."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."

[joel hoffman]

Where the heck is contract price analyst?