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Please join us for an in-depth exploration of past performance management in government contracting. Gain valuable knowledge to leverage your past successes for future growth and competitive advantage.
Past performance management holds significant weight in the success of government contractors. Government agencies now place a premium on a contractor’s ability to deliver on promises, emphasizing the adage that “actions speak louder than words.” Contractors with a strong track record of past performance gain a competitive edge in the government contracting arena.
Nicole Pottroff and Greg Weber, will discuss the essential components of past performance crucial for building a solid foundation for success. Register here.
The post Govology Webinar: Past Performance: A Critical Factor For Success in the Government Marketplace (2024 Update), April 25, 2024, 1:00-2:30pm EDT first appeared on SmallGovCon - Government Contracts Law Blog.- Read more...
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AI remains a critical focus of both the federal government and industry, with multiple efforts in recent weeks to address governance of the development and use of AI in the United States. On February 26, 2024, a U.S. Department of State-commissioned report, titled “Defense in Depth: An Action Plan to Increase the Safety and Security of Advanced AI” (Action Plan), proposed multiple U.S. Government and partner nation lines of effort to address growing national security risks posed by rapidly expanding AI capabilities, including the expectation of achieving artificial general intelligence (AGI). Just days later, on March 5, 2024, House Chairman Comer and Ranking Member Raskin introduced the Federal AI Governance and Transparency Act. This bipartisan bill would focus government resources on increasing transparency, oversight, and responsible use of federal AI systems and centrally codifying federal governance of agency AI systems. Additionally, on March 28, 2024 the Office of Management and Budget released the final guidance on Memorandum M-24-10, Advancing Governance, Innovation, and Risk Management for Agency Use of AI as we address here.
The State Department-commissioned Action Plan broadly warns that the federal government must move “quickly and decisively” to avert substantial national security risks stemming from AI. The Action Plan outlines five lines of effort (LOEs) designed to put the government on a path to stabilize (LOE1), strengthen (LOE2, LOE3), and scale (LOE4, LOE5) advanced AI development safely and securely.
- LOE1, titled “Establish Interim Safeguards to Stabilize Advanced AI Development,” focuses on potential executive branch actions to lower AI risk in the near term (1-3 years), while setting the conditions for successful long-term AI safeguards. Examples in the Action Plan include creating an AI Observatory, mandating an interim set of responsible AI development and adoption (RADA), and creating an interagency AI Safety Task Force (ASTF) to coordinate implementation and oversight of RADA safeguards.
- LOE2, titled “Strengthen Capability and Capacity for Advanced AI,” outlines specific actions that the federal government could take to increase its preparedness for rapidly addressing incidents related to advanced AI development and deployment. For example, the Action Plan recommends coordinating the development of an indications and warnings (I&W) framework for advanced AI and AGI incidents.
- LOE3, titled “Increase National Investment in Technical AI Safety Research and Standards Development,” offers recommendations that the federal government could take to strengthen domestic technical capacity in advanced AI safety and security, AGI alignment, and other technical AI safeguards. These actions include directly funding advanced AI safety and security research and promulgating safety and security standards for responsible AI development and adoption.
- LOE4, titled “Formalize Safeguards for Responsible AI Development and Adoption by Establishing an AI Regulatory Agency and Legal Liability Framework,” focuses on specific actions the legislative branch could take to establish the conditions for long-term (4+ years) domestic AI safety and security such as creating the Frontier AI Systems Administration (FAISA), a regulatory agency that would have rulemaking and licensing powers to oversee AI development and deployment.
- Lastly, LOE5, titled “Enshrine AI Safeguards in International Law and Secure the AI Supply Chain,” suggests near-term diplomatic actions and longer-term measures the federal government could take to establish an effective AI safeguards regime in international law while securing the AI supply chain. Recommendations from the Action Plan include building a domestic and international consensus on catastrophic AI risks and safeguards and establishing an International AI Agency (IAIA) to monitor and verify adherence to those safeguards.
The Action Plan also recommends establishing civil and criminal liability for “dangerous behaviors” by individuals and entities involved in the AI supply chain. For example, the report suggests that failing to accurately report high-performance AI hardware to the FAISA or responding to information requests from the FAISA with misleading data may constitute misdemeanors, and disregarding an emergency order to halt AI development activities or breaching the conditions of a license may constitute a felony.
Similarly, the proposed Federal AI Governance and Transparency Act focuses on creating federal standards, consolidating other existing laws that impact AI, and establishing AI transparency and accountability. Specifically, the bill focuses on the following key objectives:
- defining federal standards for responsible AI use by codifying, in law, key safeguards for the development, acquisition, use, management and oversight of AI used by federal agencies;
- strengthening governmentwide federal AI use policy authority and requirements, by re-codifying and clarifying the role of the Office of Management and Budget in issuing governmentwide policy guidance, in concert with existing federal IT and data policy requirements;
- establishing agency AI governance charters, which would require the publication of governance charters for high-risk AI systems and other AI systems used by federal agencies that interact with sensitive personal records covered by the Privacy Act;
- creating additional public accountability mechanisms by establishing a notification process for any individual or entity that has been substantively and meaningfully affected by an agency determination influenced by AI;
- streamlining and consolidating existing law regarding the government’s use of AI and repealing repetitive provisions in the AI in Government Act of 2020 and the 2022 Advancing American AI Act; and
- updating existing Privacy Act Personally Identifiable Information (PII) record notice requirements and FAR procurement rules.
The House Committee on Oversight and Accountability has considered this bill and voted on a markup. Both the Action Plan and the Federal AI Governance and Transparency Act appear to be in furtherance of Executive Order 14110, Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence.
Government contractors engaged in AI development or use should be aware of the Action Plan and recent bill report because, taken together, both suggest broad changes to the federal government’s and industry’s current approach to AI. Additionally, the bill in particular aims to increase U.S. participation from stakeholders, such as government contractors, in critical AI-based activities.
The post Recent Developments from the Federal Government Relating to AI appeared first on Government Contracts Legal Forum.
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Husch Blackwell Launches New FCA-Themed Podcast
Last week, we launched False Claims Act Insights, a new podcast devoted to exploring issues relating to False Claims Act (FCA) investigations and litigation. The show is hosted by Jonathan Porter—a partner in our firm’s White Collar, Internal Investigations & Compliance practice group and former Assistant U.S. Attorney for the Southern District of Georgia—and will feature prominent guests who dive into the complexities of FCA enforcement and compliance.
The new show is a timely addition to our lineup of podcasts as FCA enforcement continues to increase. The U.S. Department of Justice recently published its annual release of FCA-related information, boasting that its 2023 results were the “Highest Number of Settlements and Judgements in History.” In sum, the Department achieved settlements and judgments exceeding $2.68 billion during the last fiscal year.
The podcast is sure to be of interest to subscribers of The Contractor’s Perspective and we urge you to give it a listen.
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DFARS Realigns with FAR Buy American Requirements
For the second time in as many years, the Department of Defense (DOD) has issued a final rule that brings its Buy American Act (BAA) requirements into alignment with the Federal Acquisition Regulation (FAR).- Read more...
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Gordon Griffin, Robert C. MacKichan Jr.
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The Fixed-Price Incentive Firm Target Contract: Not As Firm As the Name Suggests
By Robert Antonio
November 2003
At the end of 1976, I met the Director of the Procurement Control and Clearance Division of the Naval Material Command in Arlington, Virginia. The Director was a legend of the contracting community and any significant Navy contract had to be approved by his office prior to award. I was there because of a controversy involving a contract to acquire a new class of nuclear cruisers. The attendees at the meeting surrounded a conference table and waited for the Director to make his appearance. After several minutes, the Director entered the room and placed a chart on the table. "What do you see?" "What do you see?" He demanded. The fellow next to me said, "It says fixed-price incentive." "No, no, look at it," the Director said. It was a chart that depicted a fixed-price incentive (firm target) contract (FPIF). "Look how flat it is," the Director said. I tried to look at the chart but I was more interested in seeing the Director. Out of the corner of my eye, I saw him dressed in a dark suit, vest, watch chain connected to the middle button of his vest and dangling perfectly from one side to the other. He had a paunch and tufts of white hair on his head and he looked like Winston Churchill—the World War II Prime Minister of the United Kingdom. He was Gordon Wade Rule—the highest-ranking civilian in Navy contracting. Years later, I met a colleague of Gordon Rule and told him about my first impressions. The colleague looked at me and laughed, "Gordon not only looked like Churchill, he thought he was Churchill." Since this first meeting with Gordon Rule, I have been interested in the FPIF contract type and how it can be used on government contracts. The Rule Contract
Table 1 is the pricing structure that Gordon Rule was talking about during our meeting. For the purpose of discussion in this article, it will be referred to as the "Rule Contract."
Table 1: FPIF Structure on the Navy Contract Provided by Gordon Rule.
Structure
Description
Target Cost $76,000,000 Target Profit $9,700,000 Target Price $85,700,000 Ceiling Price 133 percent of Target Cost at $101,000,000 Share Ratio 95/5 between $64,600,000 and $87,400,000
90/10 below $64,600,000 and from $87,400,000 to Point of Total AssumptionPoint of Total Assumption $92,366,660 Someone familiar with an FPIF contract will notice what Gordon Rule was talking about. For those who are not, the following discussion explains the mechanics of an FPIF contract pricing structure.
Mechanics of the FPIF Contract
The FPIF contract includes cost and price points, a ratio, and a formula. They include-
Target Cost (TC): The initially negotiated figure for estimated contract costs and the point at which profit pivots.
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Target Profit (TP): The initially negotiated profit at the target cost.
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Target Price: Target cost plus the target profit.
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Ceiling Price (CP): Stated as a percent of the target cost, this is the maximum price the government expects to pay. Once this amount is reached, the contractor pays all remaining costs for the original work.
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Share Ratio (SR): The government/contractor sharing ratio for cost savings or cost overruns that will increase or decrease the actual profit. The government percentage is listed first and the terms used are "government share" and "contractor share." For example, on an 80/20 share ratio, the government's share is 80 percent and the contractor's share is 20 percent.
- Point of Total Assumption (PTA): The point where cost increases that exceed the target cost are no longer shared by the government according to the share ratio. At this point, the contractor’s profit is reduced one dollar for every additional dollar of cost. The PTA is calculated with the following formula.
PTA = (Ceiling Price - Target Price)/Government Share + Target Cost
All of these points and shares have an effect on costs, profit, and price. However, two tools in the structure—the ceiling price and the share ratio—dramatically affect the potential costs, profits, and prices.
For the examples in tables 3, 4, and 5, I use the target cost, target profit, profit rate at target cost, and target price identified in Table 2. The ceiling price and share ratio will vary according to example.
Table 2: FPIF Structure Used for Examples in Tables 3, 4, and 5.
Structure Elements Structure Amounts Target Cost $10,000,000 Target Profit $1,000,000 Profit Rate at Target Cost 10% Target Price $11,000,000 Ceiling Price
At the ceiling price, the government's liability for cost within the terms of the original contract ends and the contractor pays for all costs above the ceiling price. The setting of the ceiling price significantly affects the relationship between the government and the contractor once the target cost has been reached. The example in Table 3 includes 4 different ceiling prices and the same 70/30 share ratio. Remember, the ceiling price is stated as a percentage of the target cost.
Table 3: FPIF Target Costs and Profit with Different Ceiling Prices and Constant 70/30 share ratio.
Dollar Costs Ceiling Prices (Percent of Target Cost)
115 120 125 130 $8,000,000 $1,600,000 $1,600,000 $1,600,000 $1,600,000 9,000,000 1,300,000 1,300,000 1,300,000 1,300,000 10,000,000 1,000,000 1,000,000 1,000,000 1,000,000 10,500,000 850,000 850,000 850,000 850,000 11,000,000 500,000 700,000 700,000 700,000 11,500,000 0 500,000 550,000 550,000 12,000,000 500,000 0 400,000 400,000 12,500,000 1,000,000 500,000 0 250,000 13,000,000 1,500,000 1,000,000 500,000 0 PTA
$10,714,286 $11,428,571 $12,142,857 $12,857,143 As can be seen, there is no difference in profit for any of the examples where costs are less than the target cost. This is because the ceiling price affects the cost and profit structure somewhere after the target cost is exceeded. Since the ceiling price is used to determine the PTA, it also results in different PTAs. Notice the PTAs for each ceiling price. Prior to the PTA, but after the target cost is reached, the 70/30 share ratio is in effect and the government shares 70 percent of all overruns and the contractor shares 30 percent of all overruns. Once the PTA is reached, the contractor’s profit will be reduced on a dollar-for-dollar basis up to the ceiling price. Remember when Gordon Rule said "Look how flat it is?" He was referring to the incentive curve. The incentive curve reflects the amount of potential profit for each cost level throughout the FPIF structure. The smaller the profit increment as costs increase, the flatter the incentive curve becomes. The flatter the curve becomes, the closer it approaches a cost plus fixed-fee (CPFF) contract since the fixed-fee on a CPFF remains constant for all levels of costs. By increasing the ceiling price on an FPIF contract, the government's share in cost overruns and the contractor's opportunity to recover costs is placed at a higher dollar level. The higher the ceiling price, the flatter the FPIF incentive curve is because it is being stretched in length.
Share Ratios
To compare the effect of share ratios on an FPIF structure, Table 4 includes 5 different share ratios ranging from 50/50 to 90/10. As mentioned earlier, the government's share of savings or overruns is the first number in the share ratio. In Table 4, a simple share ratio structure is used—one with the same share ratio throughout the structure— to analyze the effect of different share ratios. Share ratios can be complex and can include more than one share ratio. However, to explain the effects of different share ratios, a simple structure is adequate.
Table 4: FPIF Target Costs and Profits with Different Share Ratios.
Dollar Costs
Share Ratios (Government/Contractor)
50/50 60/40 70/30 80/20 90/10 Contractor's Profit Based on Share Ratios Above and Costs In Left Column
$8,000,000 $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 8,500,000 1,750,000 1,600,000 1,450,000 1,300,000 1,150,000 9,000,000 1,500,000 1,400,000 1,300,000 1,200,000 1,100,000 9,500,000 1,250,000 1,200,000 1,150,000 1,100,000 1,050,000 10,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 10,500,000 750,000 800,000 850,000 900,000 950,000 10,600,000 700,000 760,000 820,000 880,000 900,000 10,700,000 650,000 720,000 790,000 800,000 800,000 10,800,000 600,000 680,000 700,000 700,000 700,000 10,900,000 550,000 600,000 600,000 600,000 600,000 11,000,000 500,000 500,000 500,000 500,000 500,000 11,500,000 0 0 0 0 0 PTA
$11,000,000 $10,833,333 $10,714,286 $10,625,000 $10,555,556 Prior to the target cost, the different share ratios provide profits based on the contractor’s share of saved costs alone. Under the 50/50 share ratio, a contractor can increase its profit by $1 million when costs are $2 million less than the target cost because its share is 50 percent of any savings. On the other hand, with the 90/10 share ratio, a contractor can increase its profit by only $200,000 when costs are $2 million less than the target cost because its share is only 10 percent of any savings. The message is clear—there is less incentive to reduce costs as the government share increases.
Once the target cost is exceeded, a contractor with a 50/50 share ratio has its profit reduced quickly below the PTA because it is sharing in half of the cost overruns above the target cost. On the other hand, the reduction in profit is less dramatic for the 90/10 ratio. In effect, the incentive curve is being flattened below the PTA. Take another look at the overrun structure for the 50/50 and 90/10 share ratios.Ceiling Prices and Share Ratios Working Together
Now that you have seen the basics for different ceiling prices and different share ratios, it is time to see how they can work together. Table 5 illustrates the effect of different share ratios coupled with different ceiling prices. Compare a 50/50 share ratio with a 115 percent ceiling price structure to that of a 90/10 share ratio with a 135 percent ceiling price structure. Quite a difference!
Table 5: FPIF Target Costs and Profits with Different Ceiling Prices and Share Ratios.
Dollar Costs
Share Ratios Combined with Ceiling Prices
50/50
11560/40
12070/30
12580/20
13090/10
135$8,000,000 $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 8,500,000 1,750,000 1,600,000 1,450,000 1,300,000 1,150,000 9,000,000 1,500,000 1,400,000 1,300,000 1,200,000 1,100,000 9,500,000 1,250,000 1,200,000 1,150,000 1,100,000 1,050,000 10,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 10,500,000 750,000 800,000 850,000 900,000 950,000 11,000,000 500,000 600,000 700,000 800,000 900,000 11,500,000 0 400,000 550,000 700,000 850,000 12,000,000 (500,000) 0 400,000 600,000 800,000 12,500,000 (1,000,000) (500,000) 0 500,000 750,000 13,000,000 (1,500,000) (1,000,000) (500,000) 0 500,000 13,500,000 (2,000,000) (1,500,000) (1,000,000) (500,000) 0 PTA
$11,000,000 $11,666,667 $12,142,857 $12,500,000 $12,777,778 The 50/50 share ratio and 115 percent ceiling price structure is referred to as a “tight structure” because it places a good deal of cost control incentive on the contractor. On the other hand, the 90/10 share ratio and 135 percent ceiling price structure is referred to as a “loose structure” because there is less cost control incentive placed on the contractor. With the combination of a high ceiling price and a high government share, we have flattened the incentive curve significantly.
Now, with what we have seen so far, let's go back to the contract that Gordon Rule was complaining about in 1976. To do this, we will compare a moderate FPIF structure with a 70/30 share ratio and 125 percent ceiling price to the Rule contract.
Table 6: Moderate FPIF Structure Compared to the Rule Contract.
Dollar Costs
Profit Dollars
Profit Rate
70/30
125Rule Contract
70/30
125Rule Contract
$60,000,000 $14,500,000 $10,730,000 24,17% 17.88% 65,000,000 13,000,000 10,250,000 20.00% 15.77% 70,000,000 11,500,000 10,000,000 16.43% 14.29% 75,000,000 10,000,000 9,750,000 13.33% 13.00% 76,000,000 9,700,000 9,700,000 12.76% 12.76% 80,000,000 8,500,000 9,500,000 10.63% 11.88% 85,000,000 7,000,000 9,250,000 8.24% 10.88% 90,000,000 5,000,000 8,870,000 5.56% 9.86% 95,000,000 0 6,000,000 0% 6.32% 100,000,000 5,000,000 1,000,000 Loss 1.00% 101,000,000 6,000,000 0 Loss 0% As Table 6 shows, there is quite a difference between our moderate FPIF structure and the Rule contract. Look at the $95 million dollar cost level. Here the moderate FPIF results in no profit while the Rule Contract provides a 6.32 percent profit rate and a dollar profit of $6 million. This difference is caused by the higher ceiling price and the higher government share of overruns on the Rule Contract. Take a look at the profit rate on costs before the target cost is reached. It increases more slowly on the Rule contract as costs are reduced below the target cost of $76 million. Here, the flattening effect of the higher government share on any cost savings is evident.
What Was Gordon Rule Saying?
With the basic mechanics of an FPIF contract under your belt, we can go back to that day in 1976 when Gordon Rule said "What do you see?" "What do you see?” "Look how flat it is." Well, a CPFF is a flat curve. For example, on a CPFF contract, the share ratio is 100/0 because the government shares all of the cost savings and overruns within the original contract terms. Additionally, the ceiling price could be infinite if the government wishes. So, a CPFF contract has a 100/0 share ratio and whatever ceiling price the government is willing to accept. Gordon Rule was claiming that the FPIF example in the "Rule Contract" was, in fact, a CPFF contract. Was he right? In Table 7, a CPFF contract structure is compared to the structure of the Rule Contract.Table 7: CPFF Contract Structure Compared with the Rule Contract Structure
Dollar Costs
Profit Comparison (Dollars) Profit Comparison (Profit Rate) CPFF Rule Contract CPFF Rule Contract $60,000,000 $9,700,000 $10,730,000 16.17% 17.88% 65,000,000 9,700,000 10,250,000 14.92% 15.77% 70,000,000 9,700,000 10,000,000 13.86% 14.29% 75,000,000 9,700,000 9,750,000 12.93% 13.00% 76,000,000 9,700,000 9,700,000 12.76% 12.76% 80,000,000 9,700,000 9,500,000 12.13% 11.88% 85,000,000 9,700,000 9,250,000 11.41% 10.88% 90,000,000 9,700,000 8,870,000 10.78% 9.86% 95,000,000 9,700,000 6,000,000 10.21% 6.32% 100,000,000 9,700,000 1,000,000 9.70% 1.00% 101,000,000 9,700,000 0 9.60% 0% For the CPFF contract in Table 7, the fixed-fee is set at the same rate as the target profit on the Rule contract—$9.7 million at a cost of $76 million. Remember that between $64,600,000 and $87,400,000, the share ratio on the Rule contract was 95/5. So, the CPFF share ratio of 100/0 is quite close to that of the Rule contract at 95/5 between $64.6 million and $87.4 million. After $87.4 million, the Rule contract converts to a 90/10 share ratio until the PTA which is between $92 and $93 million. Notice how the percent of fee on costs closely parallels the percent of profit on the Rule contract. As Gordon Rule emphasized, it is flat—it is nearly a CPFF contract.
Abuses of the FPIFThe Federal Acquisition Regulation (FAR) at 16.403-1 (b) explains that an FPIF contract is appropriate when a fair and reasonable incentive and a ceiling can be negotiated that provides the contractor with an appropriate share of the risk and the target profit should reflect this assumption of responsibility. The FAR further points out that an FPIF is to be used only when there is adequate cost or pricing information for establishing reasonable firm targets at the time of initial contract negotiation. Further, FAR 16.401 explains that incentives are designed to motivate contractors to meet government goals and objectives.
The guidance in the FAR, although general, appears sound. However, what happens when people and the survival of their programs or their organizations are involved? Unfortunately, the FPIF can be manipulated and abused by government and/or industry. It can be used to submit below anticipated cost offers, to hide huge anticipated overruns, or to deceive the uninitiated who only recognize the phrase "fixed-price."
One Industry’s Experience with the FPIF
In the 1970s, 1980s, and into the 1990s, a series of General Accounting Office (GAO) reports discussed cost overruns on shipbuilding contracts. For the most part, these reports discussed FPIF contracts. Table 8 provides a summary of the anticipated cost overruns on most shipbuilding contracts during this period.
Table 8: Anticipated Cost Overruns and Savings Reported on Shipbuilding FPIF Contracts.
Report Date Number of FPIF Contracts Expected Costs Above Target Costs Expected Savings Below Target Costs Number of Contracts Expected to Finish at Target Number Dollars Number Dollars 1987a 22 19 $1,413,000,0000 3 $25,900,000 N/A 1989b 46 25 3,297,000,000 6 315,000,000 15 1990c 44 24 3,784,100,000 6 230,800,000 14 1992d 45 32 4,400,000,000 3 102,000,000 10 a Navy Contracting: Cost Overruns and Claims Potential on Navy Shipbuilding Contracts, GAO/NSIAD-88-15, October 16, 1987, p. 7
b Navy Contracting: Status of Cost Growth and Claims on Shipbuilding Contracts, GAO/NSIAD-89-189, August 4, 1989, p. 2
c Navy Contracting: Ship Construction Contracts Could Cost Billions Over Initial Target Costs, GAO/NSIAD-91-18, October 5, 1990, p. 12
d Navy Contracting: Cost Growth Continues on Ship Construction Contracts, GAO/NSIAD-92-218, August 31, 1992, p. 11As we can see from the table, the majority of the contracts had cost estimates for completion that exceeded the original target costs. Additionally, the amount of estimated cost overruns dwarfed the amount of estimated savings in each GAO report. These numbers defy the law of averages. If we simply look at these results without asking questions, we would declare the FPIF contract type as ineffective. However, there is more to it than that.
During the 1970s and 1980s, the commercial shipbuilding market was shrinking for U. S. shipbuilders and the U. S. Navy became the “sole-customer” for their work. At the same time, the Navy emphasized competition on its contracts and placed more emphasis on price in making decisions for contract awards. Price became more important because of tight budgets. The industry, recognizing that its commercial market had dried-up, placed survival above profit and cut prices in a frenzy of low-ball offers. Since the government was the sole customer, it had pricing power over its contractors. According to the GAOOne shipbuilder said the Navy has sent a message that ship contracts will be awarded based on price and the response has been to bid aggressively. 1
How aggressive was the bidding? Here is one example.
Navy analyses indicate that both contracts were awarded at a substantial cost risk to the government based on comparisons of the proposed prices with the Navy's estimates. In both of these awards, the Navy believes that there is a strong possibility that the contractors will exceed ceiling prices. 2
Yes, under these two contracts target cost was not the issue. The Navy concluded that the contractors offered to work at a loss somewhere beyond the ceiling price.
Beware of the Hidden Target Cost
If an industry or a contractor is trying to survive in a competitive environment, how might it approach the FPIF. As we have seen, contractors will bid below cost when they believe it is in their interest. Does the FPIF provide an opportunity for a contractor to offer a very low price, expect a very large overrun, and hope for a small profit? Yes, it does. Table 9 provides a theoretical example that includes an FPIF with a 95/5 share ratio and a 135 percent ceiling price. Included in the table is a "proposed target cost" which is the official offer amount that the contractor submits to the government. In the second column, there are a range of the contractor's real goals for its target cost.
Table 9: Example of a Potential Contractor's View of a FPIF.
Contractor's Proposed Target Cost Contractor's Actual Goals Target Cost Cost Overrun Overrun Rate Dollar Profit Profit Rate $100,000,000 $100,000,000 $0 0.00% $10,000,000 10.00% 100,000,000 105,000,000 5,000,000 5.00% 9,750,000 9.29% 100,000,000 110,000,000 10,000,000 10.00% 9,500,000 8.64% 100,000,000 115,000,000 15,000,000 15.00% 9,250,000 8.04% 100,000,000 120,000,000 20,000,000 20.00% 9,000,000 7.50% 100,000,000 125,000,000 25,000,000 25.00% 8,750,000 7.00% 100,000,000 126,315,789 26,315,789 26.32% 8,684,211 6.88% 100,000,000 129,807,000 29,807,000 29.81% 5,193,000 4.00% 100,000,000 130,000,000 30,000,000 30.00% 5,000,000 3.85% 100,000,000 135,000,000 35,000,000 35.00% 0 0 100,000,000 140,000,000 40,000,000 40.00% 5,000,000 Loss Assume that the contractor sets a goal of a 4 percent profit on costs. From past experience, the contractor expects that the government will be willing to negotiate a 95/5 share ratio, a 135 percent ceiling price, and a 10 percent profit rate at target cost. The contractor proposes a target cost of $100,000,000 but is really focusing on the 4 percent profit amount. At that profit rate, the contractor's actual target cost goal is $129,807,000. The government determines that the offer is fair and reasonable and negotiations are completed. At the time of agreement on the pricing structure, $100,000,000 is the contractual target cost and the contractor's actual goal is $129,807,000 for a target cost. In effect, the contract is negotiated with nearly a 30 percent cost overrun and a 4 percent profit.
A Government Incentive to Underestimate Costs
Does a government organization ever have an interest in understating the cost of an item? The President's Blue Ribbon Commission on Defense Procurement, popularly known as the Packard Commission, gave us the following answer.
Once military requirements are defined, the next step is to assemble a small team whose job is to define a weapon system to meet these requirements, and "market" the system within the government, in order to get funding authorized for its development. Such marketing takes place in a highly competitive environment, which is desirable because we want only the best ideas to survive and be funded. It is quite clear, however, that this competitive environment for program approval does not encourage realistic estimates of cost and schedule. So, all too often, when a program finally receives budget approval, it embodies not only overstated requirements but also understated costs. 3
If the government has an interest in underestimating the cost of a system, it can use an FPIF to its advantage by simply loosening the pricing structure of the FPIF contract. Let's look at an actual example—the original contract for the Trident submarine awarded in 1974.
Table 10: Fixed-Price Incentive Pricing Structure for the Trident Submarine.4
Pricing Elements Pricing Structure Target Cost $253,000,000 Target Profit $32,400,000 (12.8% of Target Cost) Target Price $285,400,000 Ceiling Price $384,000,000 (152% of target cost) Share Ratio 95/5 from target cost to $279,600,000
85/15 from $279,600,000 to PTA
70/30 below target costAs can be seen, the contract had a 95/5 share ratio and an incredible ceiling price of 152 percent of target cost. Here is what Gordon Rule had to say about this pricing structure
When the Navy negotiates a 95/5 share above target cost for the first 26 million of overrun of target, the target cost figure is patently phoney. Moreover, when the Navy negotiates a 95/5 share and then also a 152% ceiling, the target cost figure is patently ridiculous. First priority for the future must be the negotiation of more reasonable target costs for our FPI shipbuilding contracts and if the budget has to be changed, then change it. 5
Once a system receives budget approval with an understated cost, the government must find a way to contract for it at that underestimated cost. The FPIF provides the opportunity in two ways. First, it allows the government to hide expected overruns at the time the contract is awarded. Or, in Gordon Rule's words, it allows the government to include "an obvious overrun of target cost built in." 6 Second, the term "fixed-price" can be used to disguise a cost-reimbursement contract. For example, in regard to the Trident contract, the Commander of the Naval Ship Systems Command, explained 7
People said, "That's a CPFF [cost-plus-fixed-fee] contract under another name," and I said, "Right. You want to call it that, do what you like. Call it what you please." ... I suppose it's a matter for some slight chagrin that what really ought to have been a CPFF contract turned out to be something else, or to have a different label on it, but I don't feel bad about it. 8
Some Final Thoughts
Does the FPIF contract have a place in federal contracting? I think it does when it is used as it is intended. However, it can and has been abused. In testing an FPIF structure, there are a number of things I ask. Here are several.
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Is the government's share of savings significantly lower below the target cost than its share of losses above the target cost. For example, is there a 50/50 share ratio below the target cost while a 95/5 share ratio exists above target cost. This alerts me to the possibility that the real target cost exceeds the negotiated target cost in the contract.
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Is the ceiling price above 135 percent of target cost? Although a 135 percent ceiling price is generous, anything above it is excessive.
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Does the share ratio flatten out around the target cost for an extended period? For example, is there a share ratio of 95/5 or 100/0 from 10 percent below target cost to 10 percent above target cost? This effectively converts the extended part of the FPIF structure to a cost plus fixed-fee contract.
If I do identify a suspicious FPIF structure, I turn to the facts surrounding the negotiation of the target cost. For example,
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Is the government's budget for the item unrealistically low?
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Does the government have pricing power over the contractor? In short, can the government dictate the contractor's price because of market conditions?
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Is the contractor in survival mode or is the contractor trying to gain a foothold in a program area?
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If there was a final proposal revision, did the contractor's price drop substantially?
1 Navy Contracting: Cost Overruns and Claims Potential on Navy Shipbuilding Contracts, GAO/NSIAD-88-15, October 16, 1987, p. 9
2 Ibid
3 President's Blue Ribbon Commission on Defense Procurement, Final Report, June 30, 1986, p. 45.
4 J. Ronald Fox and Mary Schumacher, "Trident Contracting (C): Negotiating the Contract," John F. Kennedy School of Government, 1988, pps 6 and 7.
5 Hearings before the Committee on Armed Services, United States Senate, 94th Congress, Second Session, Part 8, Shipbuilding Cost Growth and Escalation, p. 4658.
6 Fox and Schumacher, p. 8.
7 In 1976, the Naval Ship Systems Command was renamed the Naval Sea Systems Command.Copyright © 2023 by Robert Antonio
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Target Cost (TC): The initially negotiated figure for estimated contract costs and the point at which profit pivots.
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NITAAC Blazing the Trail in Environmental Efforts
Joint Proposal Calls for Amendment of the FAR to Support Environmental Concerns.
A joint proposal requesting to amend the current Federal Acquisition Regulation (FAR) to focus on the environment and sustainability and to implement a requirement for agencies to procure sustainable products and services to the maximum extent practicable was issued on August 3, 2023, by the Defense Department (DoD), General Services Administration (GSA), and National Aeronautics and Space Administration (NASA).
This proposal is on the heels of the Catalyzing Clean Energy Industries and Jobs through Federal Sustainability Executive Order (EO 14057). In this EO, President Biden challenged agencies to meet the following targets:
- Achieve 100 percent carbon pollution-free electricity by 2030, including 50 percent on a 24/7 basis.
- Reach 100 percent zero-emission vehicle acquisition by 2035, including 100 percent light-duty acquisitions by 2027.
- Achieve net-zero building emissions by 2045, including a 50 percent reduction by 2032.
- Reduce Scope 1 and 2 greenhouse gas emissions by 65 percent from 2008 levels by 2030.
- Establish targets to reduce energy and potable water use intensity by 2030.
- Reduce procurement emissions to net-zero by 2050.
- Have climate resilient infrastructure and operations.
- Develop a climate- and sustainability-focused workforce.
- Advance environmental justice and equity-focused operations.
- Accelerate progress through domestic and international partnerships.
More importantly to NITAAC, the EO also directs agencies to purchase sustainable products and services in accordance with relevant statutory requirements, and, to the maximum extent practicable, purchase sustainable products and services identified or recommended by the Environmental Protection Agency (EPA).
At NITAAC, protecting our environment is at the forefront of our procurement strategy. In fact, our environmental best practices have been lauded for four consecutive years by the Global Electronics Council, which owns and manages the EPEAT Purchaser Awards. The awards recognize excellence in sustainable procurement of EPEAT-registered products.
NITAAC is one of a few Government-Wide Acquisition Contracts (GWACs) to receive this global award and has been recognized for excellence in multiple categories, including computers, displays and servers.
Environmentally Responsible Spending
NITAAC takes considerable pride in doing our part to ensure the federal government has access to sustainable products. As agencies look to purchasing commodities, such as laptops and desktops, NITAAC can help. We are committed to providing EPEAT certified laptops, desktops, printers, monitors and servers to meet every federal agencies’ information technology (IT) needs.
With almost 4000 EPEAT certified products to choose from, the ordering process is as easy as the click of a button. To start your order, download a copy of the NextGen GSS Ordering Guide here, then click the log in to e-GOS button in the upper right hand corner of any NITAAC web page.
NITAAC not only offers the standard configurations of the GSS program, we also can handle more complex requirements through our CIO-CS Government-Wide Acquisition Contract for IT Commodities/Solutions. NITAAC offers training in use of our GWACs and is happy to provide customized training for any federal office or organization.
Together, we can achieve the President’s vision for a more sustainable future. We strongly believe it is not only our job to provide a first-class acquisition experience but to also do our part to create a healthier planet. To learn more about how NITAAC can help you meet your end of year laptop and desktop buying needs, and meet the President’s directive in EO 14057, visit https://nitaac.nih.gov/services/government-wide-strategic-solutions.
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Late last year, the United States Office of Management and Budget (OMB) published a memorandum, M-22-18, that required federal agencies to comply with the guidelines regarding ensuring the safety and integrity of third-party software on federal information technology systems. This memorandum applied to the use of firmware, operating systems, applications, cloud-based software and general software.
The memo requires federal agencies to comply with the National Institute of Standards and Technology (NIST) guidance, as detailed in President Biden’s cybersecurity Executive Order 14028, and stipulated that agencies “only use software provided by software producers who can attest to complying with the Government-specified secure software development practices, as described in the NIST Guidance.”
The memo instructed agencies to collect a standardized self-attestation form from all software contractors before deploying their products. Initially, each agency will identify the software and collect the self-attestations forms. The end goal is to create a government-wide central repository of all software-related information, to shore up any cybersecurity vulnerabilities.
I wanted to provide you with a brief update on where the NIH Information Technology Acquisition and Assessment Center (NITAAC) is in the self-attestation process and make you aware of some key dates that will impact your company.
NITAAC is working with the OMB to determine the formal agency posture on this matter. We also are working to finetune the process for our communications requirements, as it relates to collecting the self-attestation forms.
In the meantime, contractors should be aware of the following key dates:
- June 11, 2023: NITAAC deadline to collect self-attestation forms from critical software providers.
- September 14, 2023: NITAAC deadline to collect the forms from all software providers on the NITAAC networks.
- TBD: If needed, NITAAC will request a software bill of materials or other artifact(s) that demonstrate conformance with secure software development practices.
You will hear more from NITAAC as we get additional clarity, however, I wanted you to know you are not in this alone. I understand that this request presents several challenges on your end, in terms of staffing and the additional labor required to conduct and submit the self-attestations.
We face those same challenges at NITAAC. One of the biggest obstacles being faced on the federal level is that of time. The reality is that the government likely will not be able to produce and distribute the attestation forms in a timely manner. Unfortunately, if we cannot do so, this administrative burden will fall upon our contract holders, as you will then need to develop your own forms.
I can’t promise that this process will be smooth, as there are several variables at play, but what I can promise is that we will be as transparent as possible and will make it our business to provide you with timely and relevant updates.
I value our partnership and look forward to attesting the safety, integrity and security of all the software our contract holders provide to the federal government. This will become just one more example of the high-quality, best in class service agencies can expect from the NITAAC Contract Holders.
We will discuss this further on our next Contact Holders’ call.
To read the Executive Order, visit https://www.nist.gov/itl/executive-order-14028-improving-nations-cybersecurity. To learn more about the OMB Memo, visit https://www.whitehouse.gov/wp-content/uploads/2022/09/M-22-18.pdf.
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Describing Contract Type: Watch What You Say
Consider the following exchange between two people:
QuoteSpeaker 1 (asking Speaker 2): What type of car do you drive, foreign or domestic?Speaker 2: I drive a red car.
Obviously, Speaker 2's answer is not responsive to Speaker 1's question. Speaker 1 wanted to know about a particular aspect of Speaker 2's car: its origin. Speaker 2 described a different aspect of his car: its color. While Speaker 2's statement about the color of his car may be true, it doesn't tell us anything about the origin of his car.
Easy enough, right? Ok, let's try another one. Consider the following exchange between two contract specialists:
QuoteContract Specialist 1: Is Contract X a fixed-price or cost-reimbursement contract?Contract Specialist 2: Contract X is an indefinite delivery contract.
Is Contract Specialist 2's answer responsive to Contract Specialist 1's question? No, the answer is no more responsive to the question than Speaker 2's answer was to the question of whether his car was foreign or domestic. Why? In this exchange, Contract Specialist 1 wanted to know about a particular aspect of Contract X: ts compensation arrangement. Contract Specialist 2 described a different aspect of Contract X: its delivery arrangement. While Contract Specialist 2's statement about the delivery arrangement of Contract X may be true, it doesn't tell us anything about the compensation arrangement of Contract X.
Make sense? If so, see if you can spot anything wrong with the following passage of an article on contract types that recently appeared in the December 2010 issue of Contract Management (see Government Contract Types: The U.S. Government?s Use of Different Contract Vehicles to Acquire Goods, Services, and Construction by Brian A. Darst and Mark K. Roberts):
QuoteFAR Subparts 16.2 through 16.6 describe 11 different permissible contract vehicles. These vehicles can be subdivided into three different families:- Fixed-price contracts,
- Cost-reimbursement contracts, and
- Other contract vehicles that can be used when the quantity of supplies or services cannot be determined at the time of award (i.e., indefinite delivery, time-and-materials (T&M), labor-hour (LH), and level-of-effort contracts) or where it is necessary for the contractor to begin performance before the terms and conditions of the contracts can be negotiated (i.e., letter contracts).
Do you see anything wrong? Notice that the first two "families" are categorized by compensation arrangement. However, the third family contains a mix of terms used to describe compensation arrangement (T&M/LH), delivery arrangement (indefinite delivery), the extent of contractor commitment (level-of-effort), and a unique term used to describe a contract that is not definitive (letter contract). The way this passage is written implies that an indefinite delivery contract, a level-of-effort contract, and a letter contract are necessarily different (belong to a different "family") from a fixed-price or cost reimbursement contract. However, an indefinite delivery contract or a level-of-effort contract will have a compensation arrangement. The compensation arrangement can be fixed-price, cost-reimbursement, T&M/LH, or some combination thereof. A letter contract may or may not have a compensation arrangement when it is issued. You could conceivably have a letter contract that had a cost-reimbursement compensation arrangement, an indefinite delivery arrangement, and that provided for level-of-effort orders. As such, the authors? categorization of contract types makes as much sense as categorizing cars into three families?foreign, domestic, and red.
Incentive Contracts? Not What You Think They Are
Consider the following simplified description of a compensation arrangement:
QuoteThe buyer agrees to pay the seller $100,000 to provide a specified quantity of medical transcription services. If the accuracy of the transcriptions exceeds 99%, the buyer agrees to pay the seller an additional $5,000.Does the preceding describe an incentive contract? Many would say yes, because the arrangement provides for an incentive--specifically, a performance incentive. However, that would be incorrect. Just because a contract contains an incentive does not mean that it is an incentive contract. FAR 16.202-1 contains the following statements in a description of firm-fixed-price contracts (similar statements pertaining to fixed-price contracts with economic price adjustment can be found at FAR 16.203-1.
QuoteThe contracting officer may use a firm-fixed-price contract in conjunction with an award-fee incentive (see 16.404) and performance or delivery incentives (see 16.402-2 and 16.402-3) when the award fee or incentive is based solely on factors other than cost. The contract type remains firm-fixed-price when used with these incentives.[bold added].
Further, FAR 16.402-1(a) states:
QuoteMost incentive contracts include only cost incentives, which take the form of a profit or fee adjustment formula and are intended to motivate the contractor to effectively manage costs. No incentive contract may provide for other incentives without also providing a cost incentive (or constraint).Thus, it's not enough for a contract to contain an incentive to be an incentive contract. It must contain a cost incentive (or constraint).
In the aforementioned Contract Management article, an endnote references FAR 37.601(3) and misinterprets this paragraph as--encouraging the use of incentive-type contracts where appropriate. Here's what FAR 37.601(3) actually says:
QuotePerformance-based contracts for services shall include-(3) Performance incentives where appropriate. When used, the performance incentives shall correspond to the performance standards set forth in the contract (see 16.402-2).
The authors have made the mistake of assuming that a contract that contained a performance incentive was necessarily an incentive contract. In fact, when acquiring services FAR 37.102(a)(2) states the following order of precedence:
Quote(i) A firm-fixed price performance-based contract or task order.(ii) A performance-based contract or task order that is not firm-fixed price.
(iii) A contract or task order that is not performance-based.
As shown above, a firm-fixed-price contract would take precedence over an incentive contract.
A Genuine Misunderstanding
In a discussion of additional contract types and agreements, the Contract Management article contained the following statement (which caused me to stop reading and start writing):
QuoteT&M and LH contracts are varieties of indefinite-delivery contracts and provide procuring agencies with the flexibility to acquire recurring services or when the amount of the effort required to deliver an end-item is uncertain.Huh? T&M/LH is a type of indefinite delivery contract? I'll let you readers ponder that one.
The article concludes with a plug for the authors-two-day course in, you guessed it, types of contracts. I will pass.
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At the beginning of Fiscal Year 2008 John Krieger and John Pritchard, two professors at the Defense Systems Management College, Defense Acquisition University, were kicking around the topic of Acquisition Reform. They reflected on what Jim Nagle wrote in the Epilogue to A History of Government Contracting, "If someone were asked to devise a contracting system for the federal government, it is inconceivable that one reasonable person or a committee of reasonable people could come up with our current system. That system is the result of thousands of decisions made by thousands of individuals, both in and out of government. It reflects the collision and collaboration of special interests, the impact of innumerable scandals and successes, and the tensions imposed by conflicting ideologies and personalities."
They reflected that those thousands of decisions were like putting bandages on the acquisition, contracting and procurement processes. Every time a piece of legislation is passed to “fix” the acquisition process, it’s another bandage. Every time a change is made to the Federal Acquisition Regulation (FAR), it’s another bandage. Every time a change is made to the Defense Federal Acquisition Regulation Supplement (DFARS), it’s another bandage. Every time a procurement or contracting policy memorandum is issued, it’s another bandage.
They joked about that being a great visual aid for the classroom. (Remember classrooms, the places you went to learn before COVID-19?) And the joking became reality. They started with a golf ball, and added a bandage for each new law, executive order, regulation, guide handbook, etc. And it would grow, and grow, and grow. “Acquisition Reform and the Golf Ball” was born that day.
The story of the golf ball was chronicled each fiscal year, and reported in the National Contract Management Association’s Contract Management (CM) after the end of each fiscal year. That is each year up until the report on the results for Fiscal Year 2020, when CM declined the latest installment in the series. Although John and John sought publication elsewhere, there didn’t appear to be a good fit, which brings the latest iteration, “Acquisition Reform and the Golf Ball—A Baker’s Dozen,” to Wifcon.com. (See attachment.)
Acquisition_Reform_and_the_Golf_Ball_Bakers_Dozen_-FY2021-_Wifcon.com_v2.docx
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