Is cost-plus debate off point?


Cost-plus and fixed-price contracts each can take a variety of forms.
They include:
• Cost-plus-award-fee contract: This cost-reimbursement contract provides a fee that consists of a fixed base amount and an award amount based on evaluations by the government.

• Cost-plus-incentive-fee contract: This type of cost-reimbursement contract provides for an initially negotiated fee to be adjusted by a formula based on target costs and actual costs.

• Fixed-price contract: These contracts provide for a set price regardless of cost or performance.

• Fixed-price-award-fee contract: In this variation of fixed-price contracts, the contractor is paid the set price and paid a subjectively determined award fee.

• Fixed-price-incentive-fee contract: This is a fixed-price contract that allows the government to adjust profit and establish the final contract price based on a formula relative to target cost and actual cost.

• Time-and-materials contracts: Under these contracts, the government pays the contractor for the time and materials it spends on reaching the agency’s desired product.

Source: Government Accountability Office

While the presidential candidates talk about plans to cut back or end the use of contracts that provide companies an award for their work, rather than setting a fixed price, Congress has already acted.

Lawmakers clamped down on cost-plus contracts in the fiscal 2009 National Defense Authorization Act (S. 3001), that President Bush signed Oct. 14.

By mid-July 2009, officials must update the Federal Acquisition Regulation with direction on what circumstances warrant an agency turning to cost-plus contracts. The regulatory revision must include the necessary evidence to use those contracts and the resources an acquisition workforce must have to award and manage those contract types well, the law states.

Before the next president and Congress do more to limit the future of those unique contracts, acquisition experts say officials need to understand the real problems underlying the waste and abuse that critics connect to those contracts.

Clay Johnson, deputy director for management at the Office of Management and Budget, said in a recent speech that agencies carry most of the blame for the problems with cost-plus contracts.
“We’re not good at contract management,” he said.

The arcane rules of federal contracting don’t get much attention from the public, but even so, cost-plus contracting came up in the first presidential debate. Republican presidential nominee Sen. John McCain said he would end cost-plus contracts as a way to control defense spending and manage costs.

“We need to have fixed-cost contracts,” he said. “We need very badly to understand that defense spending is very important and vital, particularly in the new challenges we face in the world, but we have to get a lot of the cost overruns under control.”

Under cost-plus contracts, the government carries much of the risk of a project that has many unknowns. The contracts offer agencies the flexibility to maneuver through unclear situations.
But the FAR gives contracting officers several options to make the acquisition process run as smoothly as possible.

For instance, in cases where requirements are initially unclear, a department can pay a company for its time and materials, as it would under a cost-plus contract. But once the requirements are firm, they could modify it to a fixed-price contract. It may be true that cost-plus contracts can heighten the potential for abuse, but experts say that banning them from government use is too broad a solution.

“Why would you want to tie a contracting officer’s arms?” asked Kevin Plexico, executive vice president of information services at Input, a market research firm. Forbidding the use of the contract would bring unintended consequences, such as major project delays, timid companies and higher prices, he said.
“If the government goes only to firm, fixed-price contracts, the contractors have no option but to bid high to cover their risk,” said an executive at a small IT support company. “You know what they say, ‘You get what you pay for.’ ”

Trey Hodgkins, vice president of federal government programs at the Information Technology Association of America, said the most obvious and immediate effect would be program delays as agencies take more time to define their requirements. Because they are bidding a fixed price, companies need to know exactly what they are bidding on.

Experts say there are better ways to avoid the problems of delays and higher prices: Well-defined project requirements and more supervision.

Experts say agencies often provide bidders with incomplete requirements when soliciting or even awarding contracts. In fixed-price procurements, contractors are at risk of having costs escalate after the contract is signed, which eats into their profits.

This is particularly true in projects with large unknown variables, such as research and development programs and urgent procurements.

“It’s not in the government’s best interest to shoehorn a situation that has ill-defined requirements into a fixed-price contract,” Hodgkins said.

However, if the cost-plus contracts are well-managed, the problems should dissipate, Plexico said.
While McCain suggested the end of cost-plus contracts, Democratic presidential nominee Sen. Barack Obama’s position aligns with the language in the defense authorization legislation.

In a policy statement, Obama said he would require audits of a quarter of large contracts each year, focusing in the first year of his presidency on noncompetitive and cost-plus contracts.
Obama said he believes these contracts are vulnerable to waste because they provide no incentive to control costs.

Obama said he would encourage more fixed-price or incentive-based contracts. But when cost-plus contracts are necessary, he would force agencies to use incentives tied to performance goals and cost savings.

Congress seems to be generally leery of cost-plus contracts as well, Plexico said. Rep. Henry Waxman (D-Calif.), chairman of the House Oversight and Government Reform Committee, has pushed for years to reform contracting regulations, including curtailing cost-plus contracts.

Waxman has said cost-plus contracts leave the government vulnerable to wasteful spending. Those reforms found a home in this year’s Defense Authorization bill.

Similarly, Sen. Susan Collins (R-Maine), ranking member of the Senate Homeland Security and Governmental Affairs Committee, introduced contracting reforms to curb cost-plus contracts and add oversight to them.

According to reports by both committees, the House and Senate believe cost-plus contracts have their place in the contracting officers’ toolboxes.

But the contracts are abused because agencies often don’t keep tight reins on the contracts.
For some longtime acquisition experts, hearing presidential nominees and Congress talk about cracking down on contracting brings back memories.

“You know it’s time to retire when you see the same solution to a problem that you remember seeing earlier in your career,” said an Air Force officer who works in acquisition.

In the 1980s, the government was upset about program costs and decided to outlaw cost-plus contracts and allow only fixed-price contracts, which pay companies a fee and no bonus for good work or for other costs.

“Didn’t work then and won’t work now because the type of contract is not the problem,” he said.
Phil Kiviat, partner at the Guerra Kiviat consulting firm, who started working for the government in 1972, said he’s heard that before, too.

“There’s a cycle to everything,” he said. 

About the Author

Matthew Weigelt is a freelance journalist who writes about acquisition and procurement.

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