Government contracting principles and practices

¶ … Government Contracts

Federal contractors are faced with a number of alternatives concerning the type of contract they use for a given project. Different types of contracts, of course, have their respective benefits and weaknesses for any given project, though. To determine optimal contractual approaches, this paper explores the pros and cons of different types of contracts from both the contractor's perspective as well as that of the federal government. A summary of the research and important findings are presented in the conclusion.

Benefits and drawbacks of fixed-price contracts from the perspective of a contractor

There are as many as 20 different types of defense contracts currently in use, and identifying the respective risks that are associated with cost overruns allows them to be categorized into two general groups: (a) fixed price contracts and (b) cost reimbursement (Diltz, 1999). According to Diltz, "By far the most common among the fixed price formats is the firm fixed price contract. The price (award) is fixed for the duration of the contract, and it is not subject to any adjustment. These contracts are used in situations in which costs are reasonably predictable and specifications are well defined" (1999, p. 4). According to Black's Law Dictionary, in contracts, "prices are fixed when they are mutually agreed upon" (1999, p. 637). With fixed-price contracts, suppliers mutually agree to provide a certain quantity of materials and services at a preset price (Weber, 2001). Fixed-price contracts have significant benefits for contractors because they provide a firm monetary amount for the costs that are involved in a federal contract as well as eliminating much of the risk that may be involved if material prices unexpectedly increase. For instance, Abele, Elliott, O'Hara and Roegner (2002) report that, "[One] tactic is to shift risk to the supplier by using fixed-price contracts, which force it to absorb unexpected price hikes for raw materials" (p. 118).

The main drawback for fixed-price contracts from the perspective of contractors relates to the increased pressure on timely performance. In this regard, Kautz (2009) reports that, "When the suppliers work under a fixed price contract, time pressure is often a consequence. If, in contrast, a time and material contract is used, the risk moves to the customer and the price level increases with risk supplements, which reflect the risks that the suppliers perceive" (p. 25). As to potential benefits of using fixed-price contracting for the federal government, the U.S. Department of Defense director for industrial policy, Brett Lambert, emphasizes that, "Fixed-price contracting is only going to be applied in a rare number of instances when we have locked in requirements, we understand the requirements, and we know we're not going to change them'" (quoted in Erwin, 2010 at p. 8).

Benefits and drawbacks of cost-reimbursement contracts from the perspective of the federal government

The primary drawback to the federal government in using cost-reimbursement contracts is the potential for being forced to absorb any cost overruns or losses that are incurred during the duration of the contract project. For example, according to Erwin (2010), "The administration's directive to shift to fixed-price contracts [to cost-reimbursement contracts] seeks to protect the government from excessive billing by contractors and from bearing the financial brunt when projects fail" (p. 8). Conversely, though, Weber (2001) also points out that, "In cost-reimbursement contracts, contractors are paid for the costs they incur -- plus a negotiated amount of profit. This is a way of shifting the risks involved in uncertainty from the contractor to the state" (p. 50).

Discussion concerning which element(s) of cost-reimbursement contracts tend to produce the biggest troubles for contractors and why

According to Erwin (2010), "Industry consultants and lawyers specifically object to new federal guidelines that require agencies to convert contracts from cost-reimbursement to fixed-price contracts" (p. 8). The federal government's recent decision to shift to fixed-price contracts is intended to protect the government from overcharging by contractors and from assuming the potentially enormous losses that are involved when projects, especially high-tech defense initiatives, fail. As Erwin points out, though, "The policy ignores history. This is a shortsighted move that only creates incentives for contractors to bid low and after winning, try to maximize changes in the program as technology or threats evolve" (Erwin, 2010, p. 8).

Another contract type (neither fixed-price nor cost-reimbursement) and an explanation concerning its pros and cons from the perspective of the federal government

Cost-plus pricing contracts can be used to avoid the uncertainty and vagaries that are involved in fixed-price and cost-reimbursement contracts. Cost-plus pricing in a negotiated contract that contains elements of both fixed-price contracts as well as cost-reimbursement contracts (Weber, 2001). In this regard, Weber reports that, "Even most fixed-price defense contracts come with price adjustment mechanisms -- such as change proposals -- that allow principals and agents room to redefine the project specifications and adjust for additional compensation. Because prices are negotiated, not set by the market, there are additional incentives for contractor opportunism. Negotiated contracts give the contractor few reasons to control costs, and they require that both parties devote more resources to monitoring and oversight" (p. 50).