At the 2002 Nash & Cibinic Report Roundtable, there was some debate about where T&M contracts fell on the spectrum of compensation arrangements during the "Compensation Arrangements" discussion. The panelists seemed to agree that the FAR's guidance, which implies that T&M contracts are less desirable than cost reimbursement contracts, was not realistic. Instead, the panelists agreed that T&M contracts probably fell in between fixed price and cost reimbursement contracts on the compensation arrangement spectrum. I tend to agree with this. Does anybody know of any writings that would support the panelists' contention? I would be required to execute a D&F stating that no other contract type is suitable before issuing a T&M contract and would like to make a cogent argument. Appreciate any help/comments.

By Vern Edwards on Wednesday, March 19, 2003 - 08:15 am:

Don:

Time-and-materials (T&M) and labor-hour (L-H) contracts combine features of fixed-price and cost-reimbursement contracts in a way that makes them uniquely disadvantageous to the government. On the one hand, they stipulate a fixed unit-price for each labor hour, which includes direct and indirect costs and profit, and the contractor is paid for each labor hour it delivers on the basis of that fixed unit-price, rather than on the basis of its actual cost. See FAR § 52.232-7, paragraph (a). That’s the fixed-price feature. On the other hand, T&M and L-H contracts require only the contractor’s “best efforts”; the contractor does not have to complete any task in order to be entitled to payment. See FAR § 52.232-7, paragraph (c). That’s the cost-reimbursement feature. (I’m going to ignore the reimbursement of the cost of materials under a T&M contract, because such costs are usually relatively minor.)

The consequence of combining these two features is that each labor hour is an independent unit of sale for which the contractor makes a profit, at least in theory, because payment is calculated by multiplying the hours delivered by the unit prices and is not conditioned upon the completion of a task. And it is this combination that makes T&M and L-H contracts riskier for the government than cost-reimbursement contracts. Cost-reimbursement contracts generally do not give a contractor a positive reason to be inefficient, because they do not reward the contractor with additional profit as its costs increase; but T&M and L-H contracts theoretically reward inefficiency in a positive way, because each labor hour is a profit-bearing unit of sale. Moreover, as cost-volume-profit analysis will show, the rate of profit will actually increase if the number of hours sold within a pricing period exceeds the quantity at which the fixed cost component of the price has been fully absorbed.

(I realize that inefficiency under a cost-reimbursement contract can reward the contractor by allowing it to spread some of its indirect costs across a larger allocation base; however, this gain, if any, is at least somewhat offset by the reduction in the contractor’s rate of profit as fixed-fee becomes a smaller percentage of costs or as fee is reduced under an incentive.)

Furthermore, it is often the case that within a labor category actual wages or salaries vary from one employee to another, with the more experienced and skilled employees earning higher wages or salaries. If a contractor priced T&M or L-H labor hours on the basis of weighted averages of labor category salaries or wages, but then uses the lower paid, but less experienced and skilled, workers in a labor category to do the work, its performance may be less efficient, but it will be rewarded, because it can pocket the difference between the actual wages and salaries and the weighted average upon which the hourly labor rates were based and get paid for more hours.

Now, this analysis is theoretical and reality is more complicated than theoretical models; however, the analysis is fundamentally sound.

Some contracting officers foolishly believe T&M and L-H contracts to be advantageous to the government because labor rates are fixed and do not increase on the basis of the contractor’s actual cost experience. However, they are ignoring the fact that each labor rate includes a profit component, and they are ignoring the consequences of combining a unit-price arrangement with a “best efforts” performance obligation. If contract types can be placed along a "spectrum" of risk, then T&M and L-H contracts are riskier for the government than cost-reimbursement contracts.

So -- what is the advantage to the government of T&M or L-H contracts over cost-reimbursement contracts? The advantage is mainly administrative: they do not require incurred cost audits (except for the cost of materials, which are usually minor); they require only verification of labor hours expended. And to a government that finds itself too understaffed to do the things that it needs to do, this may seem to be an advantage.

T&M and L-H contracts are fine for relatively small jobs performed at a single location where the government can keep an eye on the contractor to make sure that it performs as efficiently as possible. It is foolish to use them for large projects for which the government has insufficient surveillance resources to protect itself. See FAR § 16.601(b)(1).

By Don Acquisition on Wednesday, March 19, 2003 - 12:39 pm:

Vern,

I very much appreciate your response. I was hoping my post would get your attention.

First, I agree with your argument. However, I may have misclassified the type of compensation arrangement that I had in mind. In fact, I'm not sure how to classify it. Allow me to explain.

I am interested in issuing multiple award IDIQ contracts for services that contain a maximum hourly rate for the service (proposed by the offeror), a labor hour ceiling (stated by the Government), and a contract ceiling in the basic contract. The offeror's evaluated price for the basic contract would be their proposed maximum hourly rate multiplied by the stated labor hour ceiling.

When competing task orders, the Government would provide a statement of work and an estimated number of labor hours to complete the work. Contractors would be free to propose a different number of labor hours if it disagreed with the Government estimate. However, contractors would not be able to propose a higher hourly rate for services than the maximum rate they proposed for the basic contract. Based on their proposed labor hours and labor rate, contractors' proposals would have to contain a fixed price to complete the work (not "best effort").

Do you see a problem with this approach? Is the basic contract a T&M contract? If not, what is it?

The only problem that I see is that it doesn't seem to fit nicely into the contract types described in the FAR. While it has some traits of T&M (fully loaded hourly rates), it doesn't have all of them (task orders would be completion, not level-of-effort).

I would appreciate any comments you could offer. Thanks again for your interest.

By Anonymous on Wednesday, March 19, 2003 - 12:44 pm:

Don,

You are using your category rates as a FFPR (Forward Pricing Rate Agreement).

Makes sense to me.

By Anonymous on Wednesday, March 19, 2003 - 02:09 pm:

I used to know this as a BOA (Basic Ordering Agreement). Contract is made between the Government and private firms that includes the rate for each labor type. These rates include OH, G&A, and Fee. When the government needs to make an order, the Kr(s) bidding on the job do so by stating the type and number of labor hours required to complete the work. The pre-set labor hour rates are then mutiplied by the number of hours required.

By Vern Edwards on Wednesday, March 19, 2003 - 02:16 pm:

Don:

I don't think that what you have described is a T&M contract. A T&M contract is a "best efforts" contract. Based on your lastest post, it sounds like each task order is to be fixed-price, with payment conditioned upon successful performance. If so, then the "basic contract" is IDIQ fixed-price.

I don't see any unique or significant problems with what you plan to do, other than the workload associated with issuing each order.

Vern

By Don Acquisition on Wednesday, March 19, 2003 - 03:18 pm:

Vern,

Thanks again for your input. That's one less D&F I'll have to do.

Anonymous 2:09,

Thank you for your input. I think the difference between what I described and a BOA is that, according to FAR 16.703(a), a BOA is not a contract:

"(a) Description. A basic ordering agreement is a written instrument of understanding, negotiated between an agency, contracting activity, or contracting office and a contractor, that contains (1) terms and clauses applying to future contracts (orders) between the parties during its term, (2) a description, as specific as practicable, of supplies or services to be provided, and (3) methods for pricing, issuing, and delivering future orders under the basic ordering agreement. A basic ordering agreement is not a contract."

By Anonymous on Wednesday, March 19, 2003 - 04:58 pm:

Thanks Don for enticing Vern into another good discussion of the workings of T&M. I believe it has been some years since these discussion boards dealt directly with the reasons T&M contracting are out there on the spectrum.

I believe, from casual observation, that there has been an increased inclination to use these in less than effective situations. That is probably for the reasons Vern mentioned. We need reminding. Perhaps some will reconsider thanks to Vern's response. There is certainly a point at which trading fewer government work hours and dollars for less efficient contract effort is counterproductive and not excusable.

By Yankee Fan on Wednesday, April 09, 2003 - 02:54 pm: