Contract Cost Considerations - Research Paper Example

Running head: CONTRACT COST CONSIDERATIONS Contract Cost Considerations Insert Insert Insert 10 August Abstract Contracting in both government and private sector has been carried out by adopting different contract pricing system. In each case, the adopted system normally reflects the needs, capability and sustainability of the organization and also of the project to be involved in. As a result there exist two broad categories of contract pricing: firm-fixed-price and the cost-based pricing. Below these broad categories lie numerous sub-level contract pricing systems that each firm may adopt. Nevertheless, in this paper it s identified that three major contract pricing systems have frequently been used by many organizations in collaboration with their clients. The three are firm-fixed price, cost-plus-fixed fee and cost-plus-incentive fee. Therefore, this paper will look at the advantages and disadvantages of these three contract pricing systems before outlining and discussing them in a specific NAICS case-study. Contract Cost Considerations Firms seeking contracts in different spheres of operations as classified by NAICS adopt different contracting or pricing schemes that are in line with their needs and capabilities and also by putting into considerations the needs of clients. In this way, it can be deduced that numerous factors, either in single or in multiple, influence the selection of the appropriate and most efficient pricing mechanisms in contract projects. However, in adopting an appropriate contract mechanism to employ, firms are always advised to take into account the responsibility of certain and specific risks that the projects might have. Three major contract pricing systems are used by contracting firms. The three include fixed price system, cost-plus-fixed-fee, and cost-plus-incentive fee. Therefore, discussion in this research paper will involve looking at the three contract pricing systems in terms of advantages and disadvantages and how they apply to a specific NAICS firm. Contract Pricing Systems The first contract pricing mechanism is the firm-fixed-price contract. This type of contract provides a price that in most cases is not subject to any change or adjustment (Stewart, Wyskida and Johannes, 1995). Favor for this type of contract has usually been based on the contractor’s experience in performing the contract. This type of contract provides maximum incentive for the contractor to have control over the costs and also be able to perform effectively. In such arrangement, there is always minimization of administrative burden on both the contracting parties. It has been found firm-fixed-price (FFP) contract is most favored by contractors keen on acquiring and supplying commercial products and the related commercial-type products (Stewart, Wyskida and Johannes, 1995). Further, this pricing mechanism has been adopted by contractors’ keen on supplying services on the basis of reasonably definite functional or detailed specifications when the there is that ability to establish fair and appropriate prices at the outset (Stewart, Wyskida and Johannes, 1995). Firms that have favored firm-fixed-price system have done so after the following conditions have been established. Firm-fixed-price is appropriate when there is adequate price competition; also it is favored when there is either adequate and reasonably price comparisons before purchases are made, or based on competitive basis and finally when supported by valid cost or pricing data (Stewart, Wyskida and Johannes, 1995). Further, firm-fixed-price mechanism is appropriate when the costs are available and also pricing information allows for realistic estimates of the probable costs of performance. Lastly, this pricing mechanism become appropriate when performance uncertainties can be identified and their estimates costs and more so, the contractor is willing to accept the firm’s fixed price that represent the risks involved (Stewart, Wyskida and Johannes, 1995). On its part cost-plus-fixed fee (CPFF) contract is characterized by the following aspects. First, this is a contract that largely provides for payment on the part of contractor in terms of a negotiated fee that is generally fixed at the conception of the contract (Oyer, 2005). This is kind of contract that permits for efforts that might in one way or the other pose great risk to the contractor and in most cases it provides for the contractor only a minimum incentive to control costs. In many instances, contractors have favored the ‘completion cost-plus-fixed-fee’ contract over the ‘term cost-plus-fixed-fee’ contract (Oyer, 2005). The major reason for this is that the completion type normally describes the scope for work by exactly and concisely stating the goals or targets and more so, specifying an end product. In this type of contract the contractor is supposed to finish and submit the specified product within the estimated cost and where possible as a condition for payment of the entire fixed fee (Oyer, 2005). In cases where the contractor is unable to complete the work within the estimated costs, the client may agree to increase the estimated costs without increasing the fee. Further completion type has become most used especially with prior to well and clear definition of the milestone of the work. In this way, it becomes possible for contractors to develop estimates within which it becomes possible for contractors to work with and complete the work. The third contracting system is the cost-plus-incentive-fee (CPIF) whereby this type of contracting is based on agreed percentage on the total negotiated costs and in addition to this percentage there is an incentive payment that is based on performance (Oyer, 2005). The incentive has the tendency to increase the effective fee percentage to that of CPFF contract. In most cases, cost-incentive contracts are based on the ability of the contractor to meet key delivery dates, ability to reach certain performance goals and the ability to keep overall contract costs within a certain limit (Oyer, 2005). This system has two major advantages: it is the appropriate for the contractor in that the contractor working within the ceiling price, the contractor is unlikely to lose money even if the cost of the project was to go up. Second, on the part of the client advantage is premised on the fact that total cost for a project is unlikely to increase above the ceiling price and in when the contractor/client ratio appear to be fair, the client is likely to benefit through quality work. Conclusion Contract pricing method in the modern world is becoming a challenge to many contractors. This is largely contributed by the increasing changing business environment in which majority of contractors have to carry out their activities. Nevertheless, with this increasing uncertainty, contractors are advisable to observe the following elements in determining the right contract pricing system. The key elements to put in consideration include: clear identification of tasks; ensuring that there is broad participation in preparing estimates and ensuring there are valid data to make estimates on (Garrett, 2008). Other aspects include: adopting a clear and efficient standardized structure for the estimates; ensure there is adequate provision for program uncertainties; recognition of inflation; and the recognition of excluded costs (Garrett, 2008). Case-study: Advanced Tank Technologies (ATT) Adoption of any contract pricing system by any firm will depend largely on the key elements that have been highlighted above. In modern world, the nature and environment of doing business is changing making it requisite for contracting firms to put into consideration various factors before a particular type of contracting system can be adopted. Advanced Tank Technologies (ATT) has officially and legally operationalized its activities in Maryland as from 1985. As One of the contracting firms in the state, ATT has specifically specialized in research and development in engineering with special interest on feasibility studies and surface vehicle design (). In contracting its services, ATT has mainly conducted business with major DoD contractors largely using the firm-fixed-price (FFP) contracting system (Advanced Tank Technologies, n.d). Further looking and analyzing ATT proposal cover sheet, the following key aspects are identified. First, with regard to the aspects of Cost Accounting Standards (CAS) and the Estimating and Accounting Compliance standards, it is clear that ATT is not subjected to these standards (Advanced Tank Technologies, n.d). The company has expressively stated that it is exempted from these standards under the Small Business Exemption. At the same time, the company contract proposal is developed under the company’s established estimating and accounting practices and procedures as per the guidance of FAR Part 31, Cost Principles (Advanced Tank Technologies, n.d). Given the above facts about ATT Company, it can be deduced that firm-fixed-price (FFP) contracting system is appropriate for the company based on the following advantages. In the first place looking at the nature of ATT in conducting business with its DoD contractors it become clear that little regulation and administration is required. As such FFP system accomplishes this need (USA Department of Defense, n.d). Compared with cost-based systems discussed above, it is clear that FFP system does not require government approved accounting system. This can be evidenced from ATT’s lack of compliance to the CAS and Estimating and Accounting Compliance standards. It must be noted that developing accounting systems constitute a big task that a company in nature of ATT would want to avoid if possible, thus FFP system provides for this leeway. Next, it has been noted that government contracts such as the DoD contracts, there is always tendency on the part of the government to reduce administrative costs. Thus FFP system become the appropriate system in that fewer financial and costs reports are required and this may also benefit ATT (USA Department of Defense, n.d). At the same time, FFP system appears to be the most appropriate in the case of ATT in that the company is keen on supplying services on the basis of reasonably definite functional or detailed specifications. In this circumstance, FFP system will guarantee ATT opportunity and ability to establish fair and appropriate prices at the outset of the project unlike with cost-based systems. Further with FFP system and the kind of job ATT is involved in, there is possibility of payments being made as soon as the project is completed. On the other hand, cost-reimbursement contracting systems, there is likelihood of payments being delayed since there has to be a detailed audit of indirect rates involved in the projects and this may affect the operations of the company especially on the pending projects (USA Department of Defense, n.d). In summary, it can be stated that FFP system is appropriate for ATT as compared to the cost-based pricing systems as supported by the above stated advantages. References Advanced Tank Technologies. (N.d). Model Proposal-Advanced Tank Technologies (ATT). Retrieved 10 August 2011, from http://www.sandia.gov/bus-ops/scm/forms/policy/model.pdf. Garrett, G. A. (2008). Cost Estimating and Contract Pricing: Tools Techniques and Best Practices. IL: CCH Incorporated. Retrieved 10 August 2011, from http://books.google.com/books?id=fPrqULWYzEAC&printsec=frontcover&dq=contract+pricing+system&hl=en&ei=rZNCTpqVIcbKsgaiveTpBw&sa=X&oi=book_result&ct=result&resnum=3&ved=0CDwQ6AEwAg#v=onepage&q=contract%20pricing%20system&f=false. Oyer, D. (2005). Pricing and Cost Accounting: A Handbook for Government Contractors. VI: Management Concepts. Retrieved 10 August 2011, from http://books.google.com/books?id=hS78TFSZUQAC&pg=PR17&dq=fixed-price-incentive-fee+contracting&hl=en&ei=Pm5CTvTvDciHhQekzPCgCQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDAQ6AEwAA#v=onepage&q=fixed-price-incentive-fee%20contracting&f=false. Stewart, R. D., Wyskida, R. M. and Johannes, J. D. (1995). Cost estimators reference manual. NY: John Wiley and Sons. Retrieved 10 August 2011, from http://books.google.com/books?id=hS78TFSZUQAC&pg=PR17&dq=fixed-price-incentive-fee+contracting&hl=en&ei=Pm5CTvTvDciHhQekzPCgCQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDAQ6AEwAA#v=onepage&q=fixed-price-incentive-fee%20contracting&f=true. USA Department of Defense. (N.d). “Small Business Innovation Research: SBIR Contracting & Payment Desk Reference”. Retrieved 10 August 2011, from http://www.acq.osd.mil/osbp/sbir/deskreference/05_contr.htm. Read More