Fixed Price Contracting: Strategies for Success By Michael Smigocki As you may have noticed in the marketplace, there has been a marked increase in the usage of fixed price contracts by contracting officers. This is the result of an initiative by the Obama aministration to move away from the usage of cost-plus and T&M contracts due to the belief that they are expensive and inefficient. This shift however, can create havoc for contracting officers and contractors alike, especially those that have been operating in a cost-plus and T&M environment. This article will identify some of the issues that are prevalent with this shift as well as provide some strategies contractors should consider to aid in this transition. Issues During the Proposal Stage A fixed price contract differs from a cost-plus or T&M contract in that performance risk rests with the contractor. This requires the contractor to deliver whatever is being contracted for at the agreed-upon price, regardless of how much it may internally cost the contractor to perform. 1. Bid higher fee percentages. The assumption of performance risk by the contractor should translate into a higher fee percentage being bid than otherwise would have been in a cost plus or T&M contract. 2. Educate the contracting officer. Many contractors are fearful of bidding these higher fee percentages out of concern to the possible reaction by the C.O. The contractor should educate the C.O. as to the inherent risks it is assuming in this new fixed price contract and how this risk assumption needs to be compensated for accordingly. Utilize the DoD profit guidelines to further educate the C.O. It is important to the success of a fixed price contract that the statement of work and contract deliverables be clearly defined. Failure to do so by the C.O. can lead to contract performance issues and possible losses being incurred by the contractor. 3. Ask questions. If there is any ambiguity or uncertainty in the scope of work, submit written questions and hopefully the answers received will alleviate these issues and allow a proper bid to be submitted. 4. Detail assumptions made in the proposal. If however, uncertainty or ambiguity still exists in the scope of work, detail the assumptions you have made in determining your pricing in both the technical and cost proposal. These assumptions can become the foundation for negotiating change orders/modifications or even the basis for a contract dispute resolution. Issues During Contract Performance Many C.O.’s who have previously operated in a cost-plus and T&M environment are used to directing the contractor’s efforts based on issues/needs that arise during the performance period of the contract. This is easily done with these types of contracts because of the tremendous flexibility they afford. However, with a fixed price contract, it requires a change order to be issued. 5. Negotiate change orders for out-of-scope work. It will be up to the contractor to differentiate between doing a “favor” for the C.O. or when out-of-scope work effort has been requested. At the time of the request, the contractor should be requesting change orders. Failure to do so can result in losses (sometimes significant) or reduced fee percentage being realized by the contractor. 6. Utilize internal budgets and estimates to complete. The best tool a contractor has for identifying out-of-scope work and/or constructive changes is preparation of internal budgets and the utilization of estimates to complete. This type of monthly analysis against actual costs can identify issues promptly and ensure profitability levels are maintained on the contract. Final Thoughts The environment of fixed price contracting can be very different from that of cost-plus and T&M contracts. 7. Create an internal culture of financial accountability. A fixed price contract places significantly more burden on the project manager because pricing estimates and initial budgets to complete the work may have been wrong. Holding project managers and cost proposal personnel accountable for contractual financial performance will lead to better profit margins. 8. Use your job cost system as a management tool. One’s accounting system can be a valuable tool in the development of budgets and monitoring actual contractual performance. In addition, when out-of-scope work is being performed, these costs should be separately identified in the system. Remember that the burden of proof resides with the contractor to support requests for equitable adjustment or contract claims. Contractors need to adapt their culture and their practices to this new environment. Those that are able to adapt will find that this shift to fixed price contracts can lead to significantly higher profit margins than they had previously experienced. Michael Smigocki, CPA, CVA, ABV, is the senior managing director of Federal Strategies Group LLC. He provides government contract and management consulting, M&A advisory, forensic accounting and expert testimony services to the government contracting and technology industries. He can be reached via email at MikeS@FedStrat.com.