Jump to content
The Wifcon Forums and Blogs

higleykm

Cost plus fixed fee vs Time and Material - profit

Recommended Posts

I have a client that is pushing us to use a cost plus fixed fee vs a time and material for our subcontractor. They believe with a fixed fee of 7% that is all the profit they would receive but my understanding is that is on top of what is built into their rates (let's say 10% in their rates) so they would be making 17% with rate build up and fixed fee.  

However with a Time and material you would just get the rate build up which is 10%. 

Any thoughts on this would be appreciated. 

Share this post


Link to post
Share on other sites

In addition to what Vern said, your financial analysis is not correct, or at least not in accordance with the FAR (you may be operating under a different regime).

In a cost-type contract the subcontractor receives reimbursement for all allowable costs (up to funding) including all allowable and allocable indirect costs. In addition, the contractor receives a fee on estimated costs (NOT actual costs). The amount of the fee is negotiated but may not exceed a certain percentage of estimated costs in certain circumstances.

In a T&M contract the subcontractor proposes hourly billing rates, which should include all indirect cost burdens allocated to its direct labor dollars. In addition the subcontractor proposed a profit on the fully burdened labor costs. If the prime and subcontractor do not negotiate hourly billing rates, then the subcontractor's costs show up on the "M" side of the T&M equation and the prime contractor cannot bill fee on the subcontractor's costs (see 52.232-7). But the subcontractor can certainly bill fee/profit to the prime.

So with respect to the financial analysis, it is possible to make the subcontractor project margins come out the same, regardless of subcontract type chosen.

To my mind, it is the compliance risks that propel the parties toward cost-type subcontracts instead of T&M. In my view, the T&M subcontract is more risky for both parties, but especially for the prime. What steps is the prime taking to ensure that the subcontractor is working the hours it is billing--is it obtaining certified payroll data to support each invoice? What steps are being taken to ensure that the subcontractor personnel have the qualifications to bill at the labor categories the parties have defined? If a security clearance is required, what steps are being taken to ensure that the subcontractor personnel have the requisite clearances? Failure to address those risks by other prime contractors has resulted in allegations of violations of the False Claims Act. Finally, recent litigation indicates that the DCAA is more interested in auditing T&M subcontracts (and doing a poor job of it according to the ASBCA) than they are in auditing cost-type subcontracts. This is because it's easier to catch issues (see my list) and question costs with respect to T&M subcontracts than it is for cost-type subcontracts.

Share this post


Link to post
Share on other sites

I thank you both for your input. It's interesting the thoughts on Time and Material. I would be interested in hearing more on the type of contracts you would use for labor and material support.  

Wouldn't you have the same risk with cost when I can bill any cost to the contract? Plus I can negotiate my fee every time my scope changes which in the long run could potentially have the same issues. Just curious. Especially if FFP is not possible. 

Im trying to find a good option. 

Share this post


Link to post
Share on other sites
4 hours ago, higleykm said:

Wouldn't you have the same risk with cost when I can bill any cost to the contract? Plus I can negotiate my fee every time my scope changes which in the long run could potentially have the same issues.

I disagree that "any" cost can be charged to a cost type contract. The rules for charging contracts don't change depending on contract type. The same labor hours/dollars that would be charged to a T&M contract would also be charged to a cost-type contract.

With respect to your comment about fee, I may not be understanding your point. To my way of thinking. if you add scope to a T&M contract then you have to raise the NTE value, which permits more hours to be billed. Those hours contain a profit component. More hours = more profit. On a cost-type contract you (generally) have a fixed fee; if you add scope then you may need to add more fee (or not, depending on what's negotiated). I must be missing your point because the two situations seem generally equivalent to me.

Share this post


Link to post
Share on other sites
14 hours ago, higleykm said:

Im trying to find a good option.

In order for you to find a good pricing option you must understand the features and terms of each of the various types of contracts and the obligations and risks that they impose on the parties. Coming to that understanding entails extensive study and deep thinking. The labels given to contracts, such as firm-fixed-price, do not describe how they work. Do these things:

Read FAR Part 16.

Read the key FAR clauses for each of the contract types, especially the payment clauses and the inspection clauses.

Read the Contract Pricing Reference Guides, Vol 4, Ch. 1.

Read Contract Pricing Arrangements: A Primer, Parts I and II, in Briefing Papers 09-11 and 09-12. Part I says, among other things:

Quote

The general descriptions of the various pricing arrangements that appear in FAR Part 16 are incomplete and somewhat misleading. For instance, strictly speaking, the price of a “firm-fixed-price” contract is neither firm nor fixed, and a “cost-reimbursement” contract does not reimburse a contractor for all of its costs. The best way to understand how each of the various pricing arrangements really works is to study the terms in the contract clauses prescribed for use with each arrangement.

If you don't do those things you will never really understand the contract types.

Share this post


Link to post
Share on other sites
10 hours ago, here_2_help said:

I disagree that "any" cost can be charged to a cost type contract. The rules for charging contracts don't change depending on contract type. The same labor hours/dollars that would be charged to a T&M contract would also be charged to a cost-type contract.

With respect to your comment about fee, I may not be understanding your point. To my way of thinking. if you add scope to a T&M contract then you have to raise the NTE value, which permits more hours to be billed. Those hours contain a profit component. More hours = more profit. On a cost-type contract you (generally) have a fixed fee; if you add scope then you may need to add more fee (or not, depending on what's negotiated). I must be missing your point because the two situations seem generally equivalent to me.

I agree. That is why I'm trying to find why one is better than the other. I'm trying to better understand the issues with each to make the best decision. I'm confused on why cost would be better than T&M.

Share this post


Link to post
Share on other sites
22 minutes ago, Vern Edwards said:

In order for you to find a good pricing option you must understand the features and terms of each of the various types of contracts and the obligations and risks that they impose on the parties. Coming to that understanding entails extensive study and deep thinking. The labels given to contracts, such as firm-fixed-price, do not describe how they work. Do these things:

Read FAR Part 16.

Read the key FAR clauses for each of the contract types, especially the payment clauses and the inspection clauses.

Read the Contract Pricing Reference Guides, Vol 4, Ch. 1.

Read Contract Pricing Arrangements: A Primer, Parts I and II, in Briefing Papers 09-11 and 09-12. Part I says, among other things:

If you don't do those things you will never really understand the contract types.

Thank you Vern! I will read these.

Share this post


Link to post
Share on other sites
1 hour ago, higleykm said:

I'm confused on why cost would be better than T&M.

Then you need to reread the Wifcon article again, because it should eliminate your confusion.

In short:

T&M, like cost-reimbursement, requires only that the contractor make its best effort to perform. Successful completion is not a condition of payment. As long as the contractor makes a best effort, the contractor is paid, whether it finishes the work or not.

But, unlike cost-reimbursement, T&M pays profit for each additional hour of labor. Thus, in addition to not penalizing the contractor for failure, it rewards the contractor for inefficiency, because the more labor it uses the more profit it makes. Moreover, the fixed labor rates in a T&M contract do not necessarily reflect the contractor's cost of performance. Unless the contractor is proposing rates for specific persons, the contractor is free to use any person who meets a set of labor category criteria. There may be more than one employee in any given labor category, but not all in that category are necessarily paid the same. (Just like not all GS-1102-12s are paid the same.) The contractor can increase its profits by using a less experienced but qualified worker to perform a task at a lower rate of pay than included in the fixed labor rate. Even more profit can be made by fully absorbing the fixed costs in the labor rates before performance is complete. Once that happens, every dollar included in the rate for the fixed cost is potentially additional profit.

THAT is why, from the standpoint of performance cost, cost-reimbursement is better than T&M. However, as explained in the article, there may be administrative advantages to T&M that offset the performance cost disadvantage.

Share this post


Link to post
Share on other sites

Adding to what Vern said, it is not necessary for the contractor to "pay" an employee for every hour worked before it can charge the government for an hour of labor at the hourly rate.  For example, if an employee who is exempt from the overtime provisions of the FLSA works on a T&M contract for more than 40 hours in a week, the contractor is not necessarily required to pay the employee anything extra for the hours in excess of 40 resulting in uncompensated overtime.  However, it can bill the government at the hourly rate for those excess hours. 

Under a T&M contract if the contractor will overrun the contract (incur costs in excess of the ceiling price), and the government wants the contractor to continue to perform, the contractor receives profit on each additional hour.  In contract, under a cost reimbursement contract, if the contractor incurs an overrun, the estimated cost of the contract may be increased, but the contractor receives no additional fee.

Share this post


Link to post
Share on other sites

Tomahawk,

I recommend you ask the contracting officer for clarification on which parts of the work are FFP and which parts of the work are T&M. Hopefully, the answer will be on a CLIN basis, where certain CLINs are wholly FFP and other CLINs are wholly T&M -- that is generally easier than having blended CLINs.  

A prospective offeror never has much time before proposals are due, so I suggest you hurry.

Share this post


Link to post
Share on other sites

Under the new FAR rules, which are based on the long-standing DFARS rules, "blended CLINs" are impermissible. See FAR 4.1003(e).

Share this post


Link to post
Share on other sites
7 hours ago, ji20874 said:

Tomahawk,

I recommend you ask the contracting officer for clarification on which parts of the work are FFP and which parts of the work are T&M. Hopefully, the answer will be on a CLIN basis, where certain CLINs are wholly FFP and other CLINs are wholly T&M -- that is generally easier than having blended CLINs.  

A prospective offeror never has much time before proposals are due, so I suggest you hurry.

The CLIN clearly states FFP.

 

 

Share this post


Link to post
Share on other sites

Tomahawk,

So everything is clear?  And there is no problem?  That's good!

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now

×