Incentive Contracts US Federal Acauisition Regulation FAR 16'4

1
Principles of Project Management

• Incentive ContractsUS Federal Acauisition
  Regulation (FAR) 16.4
• Point of TotalAssumption

2
Incentive Contracts Overview

• It has been reported that the PMP examination
  contains questions regarding Point of Total
  Assumption. That is a component of US FAR 16.4
  related to Fixed-Price Incentive Fee Contracts.
  The FAR covers a variety of incentive contracts,
  presented here only to provide perspective.
• General Definition
• Types of Incentives
• Cost
• Performance
• Delivery
• Mixed
• Categories of Incentives
• Fixed Price Incentive (The one of interest here.)
• Cost Plus Incentive

3
What is an Incentive Contract?

• An Incentive Contract is such that the fee is
  structured on the basis of the contractor meeting
  targets in the performance of the contract
• Incentive Contracts
• motivate contractor efforts that might not
  otherwise be emphasized and
• discourage contractor inefficiency and waste
• Incentive Contracts incentivize efficiency!

4
Cost Incentives

• The majority of Incentive Contracts include only
  cost incentives
• Contractor motivated to effectively manage costs
• Cost Incentives include the following targets
• Cost
• Profit / Fee
• Profit / Fee Adjustment Formula (in lieu of an
  award fee)
• The Profit / Fee Adjustment Formula is structured
  so that
• Actual cost that meets the target will result in
  the target profit or fee ?
• Actual cost that exceeds the target will result
  in downward adjustment of target profit or fee ?
• Actual cost that is below the target will result
  in upward adjustment of target profit or fee ? ?

5
Performance Incentives

• Performance incentives may be related to product
  characteristics (e.g. missile range, aircraft
  speed, target accuracy) OR
• Other elements of the contractors technical
  performance (e.g. quality)
• Key is for contractor and the Governments
  Contracting Officer to establish clear criteria
  for meeting performance targets. Include
  engineering and pricing specialists in criteria
  negotiations.
• The attainment of targets will be measured via
  performance tests and / or evaluations.

6
Delivery Incentives

• Consider delivery incentives when contract
  schedule is Government priority
• Remember to address Government caused delays or
  delays due to events outside contractor control

7
Mixed Incentives

• Any combination of Cost, Performance, or Delivery
• Structure contracts so that no one incentive
  unduly takes priority over others (e.g. focusing
  on cost targets and letting technical performance
  slip as a result)

8
Fixed Price Incentive Contracts (1)

• Definition Contract such that all allowable cost
  is paid and final price is based on total final
  cost relative to total target cost final price
  subject to a ceiling price which is negotiated at
  the outset
• Elements of FPI Contracts (negotiated at outset)
• Target Cost
• Fee / Profit
• Price
• Ceiling Price
• Government / Contractor share ratio

9
Fixed Price Incentive Contracts (2)

• Three types of FPI
• Firm Target
• Successive Target
• Fixed Price with Award Fee
• Application Circumstances are such that
  contractor can assume some cost responsibility
  and effective cost control can provide profit
  incentive - e.g. initial production lots where
  Scope is well defined but cost history does not
  support a FFP contract.

10
Fixed Price Incentive Example - Firm Target

• Contract terms proposed, negotiated, and awarded
• Target Cost 100.0M
• Target Profit 15.0M
• Target Price 115.0M
• Ceiling Price 130.0M
• Share Ratios (Government / Contractor share
  variance of cost, affects Contractor profit in
  the following ratios)
• Overrun 85 / 15
• Under run 50 / 50

11
Fixed Price Incentive Example (cont.)
Total price cannot exceed ceiling of 130.
12
Fixed Price Incentive ExamplePoint of Total
Assumption

• Point of Total Assumption (PTA)
• Point at which the share ratio ceases to operate
  and 1 of added cost results in 1 of decreased
  payment to the contractor.
• Formula to compute PTA
• 117.6M 130.0M - 115.0M 100.0M
  .85
• Note As shown by the foregoing example, one need
  not be concerned with the PTA to determine the
  payment the maximum price is all that is needed.