CHOOSING THE CONTRACT TYPE

Before deciding on the type of SOW you will write (functional, performance, or design), you need to consider the type of contractual pricing arrangement to be used. You must have a general idea of the contract type before beginning to write your SOW so that its contents will support your preference. The contracting officer will make the final decision regarding contract type but will usually follow your preference, as long as it makes sense.

Choosing the most effective contract type involves considering how the contract type will affect the description of your requirement. For each contract type, your SOW must be definitive enough to achieve the intended result.

Fixed-Price Contracts

In a fixed-price contract, the contract price is fixed at the time of contract award. This price cannot be changed unless the scope of work is changed, and the contractor is entitled to payment only if the contract is completed successfully. The contractor makes its profit by completing the work at a cost less than the fixed price.

Fixed-price contracts are used only when the SOW is definitive enough for the contractor to price the cost of contract performance accurately and have a high degree of confidence that the work can be completed within that price. Fixed-price contracts are generally used for commercial or commercial-like equipment or services available in the open market.

In a fixed-price contract the contractor guarantees performance at the fixed or ceiling price. If the contractor cannot complete performance at this price, the contractor must complete the work at its own expense. This puts a significant burden on the author of the SOW to ensure that a fixed-price SOW is definitive enough for the contractor to estimate accurately the costs of performance. For example, the following was taken from a fixed-price solicitation for training services:

3.6 The contractor agrees to undertake new course development as required by the Government pursuant to the terms of this contract. When the Contracting officer determines that such services are required, he will issue an order for such work.

The SOW did not provide any further discussion of new course development. The RFP required a fixed price for each line item. How can a contractor put a fixed-price on such an ill-defined requirement? This is not the way to describe a requirement for a fixed-price contract. Needless to say, this solicitation and the resulting contract had a lot of problems.

When you have a requirement that involves performance uncertainties or risks, a fixed-price contract is usually inappropriate. Performance uncertainties are present when you are uncertain about the final outcome or your requirement cannot be defined except through contract performance, as in a research and development effort. Performance uncertainties are also found in requirements for studies and analytic effort when you are uncertain as to the extent of effort required. Requirements for creative effort, such as the development of computer software, training courses, manuals, or handbooks, also involve performance uncertainties because creative efforts often require flexibility in the extent of effort required.

Fixed-priced contracts are inappropriate for efforts of this nature because the fixed price limits the extent of the contractor’s efforts. If performance proves to be more difficult or extensive than anticipated, and the contractor’s costs are approaching the fixed price, the contractor’s options are limited. The contractor can continue to strive for a quality product, at its own expense, or the contractor can cut corners and do whatever is necessary to finish the contract within the fixed price.

The first option is not popular with contractors—a contractor cannot stay in business for long unless it makes a profit. The second option is not popular with the government—cutting corners and taking other actions designed to “finish the contract” usually have an adverse effect on the quality of the final product. Problems such as these can be avoided by carefully assessing the performance uncertainties of your project and using a fixed-price contract only when performance uncertainties are minimal.

Cost-Reimbursement Contracts

In a cost-reimbursement contract, the contractor is reimbursed for the costs it actually incurs. In addition, the contractor is usually paid a fee for contract performance. This fee may be fixed or variable. The maximum fee amount is fixed at the time of contract award and cannot be changed unless the scope of work is changed.

The contractor is required to expend its best efforts to complete the contract within the funds initially obligated. The contractor is not required—or expected—to complete the work at its own expense as in a fixed-price type contract. The contractor recovers its actual costs incurred regardless of contract performance. When it appears that the obligated funds are not sufficient to complete the contract effort, the contractor should notify the contracting officer and provide an estimate to complete the effort, indicating if, and how much, additional funding will be required. The contracting officer may or may not add the required funds, as appropriate. When the funds are fully expended, the contractor should stop work. Any continued work is at the contractor’s own expense, unless the contracting officer adds funds before all the originally allotted funds are expended.

Cost-reimbursement contracts are designed for efforts that contain performance uncertainties. This type of contract accommodates those uncertainties by basing the price on estimated costs (plus the fixed or variable fee) and permitting additional costs (but not fee) to be funded without the need for a corresponding change in the scope of work. Cost-reimbursement contracts are used when the work cannot be fully defined, the nature of the work is uncertain, or creative effort is required. Cost-reimbursement contracts are typically used in R&D, studies, analytic effort, and software development.

The funding flexibility in cost-reimbursement contracts, however, does not lessen the SOW requirements. An SOW for cost-reimbursement work must be as definitive as possible so that the contractor’s cost estimate is as accurate as possible. Otherwise, you will be creating a cost-overrun situation in your initial SOW. The SOW must be written to minimize overruns, not create them.

Time-and-Materials and Labor-Hour Contracts

In a time-and-materials (T&M) contract, the contractor is paid a fixed hourly rate for each labor category set forth in the contract. The fixed rate includes direct labor, overhead, general and administrative expenses, and profit. Materials used in contract performance are reimbursed at cost. The T&M contract has some characteristics similar to both cost-reimbursement and fixed-price contracts.

The T&M contract is worked on a best-efforts basis like the cost-reimbursement contract, but this is its only resemblance to a cost-reimbursement contract. The T&M contract has a price ceiling, but this is its only resemblance to a fixed-price contract. Payment is for the hours worked, not for the delivery of a specific product. The T&M contract is a fixed-rate contract, and the total amount paid depends on the number of hours worked plus material at cost. The labor-hour contract is exactly the same as a T&M contract, except that no materials are involved.

T&M contracts are used when it is not possible to estimate the extent or duration of the work or to anticipate the total costs, and the use of a cost-reimbursement contract is not feasible. T&M contracts are used for repair, maintenance, or emergency services requirements, or for service contracts with small businesses or individuals who lack an accounting systems sophisticated enough to use a cost-reimbursement contract.

The SOW for a T&M contract must be as definitive as possible. The overall effort is restricted by the ceiling price, which is usually the sum of the total estimated hours at the fixed rates plus materials at cost. The work requirements must be described in sufficient detail for the contractor to estimate accurately the extent of effort and the amount of materials required.

Indefinite-Delivery Contracts

Indefinite-delivery contracts are used when the exact time of delivery or the quantities of supplies or services to be delivered are not known at the time of award. In effect, the government uses the contractor as a warehouse, drawing the necessary supplies or services as the specific requirements develop. There are three types of indefinite-delivery contracts: definite-quantity, requirements, and indefinite-quantity contracts. Requirements contracts and indefinite-quantity contracts are also known as delivery-order contracts (for supplies) and task-order contracts (for services).

Definite-quantity contracts. This arrangement provides for the delivery of a definite quantity of specific supplies or services for a fixed period, with deliveries or performance to be scheduled at designated locations upon order. Definite-quantity contracts are used when a definitive quantity of the supplies or services will be required during the contract period and are regularly available or will be available after a short lead time. Orders are placed for delivery or performance at the designated locations as the requirements develop during the contract term.

Requirements contracts. This arrangement provides for the delivery of all actual requirements of specific supplies or services by designated government activities during a fixed period. Generally, the contract will state the maximum amount the contractor is required to deliver and, within that amount, that the government is required to purchase all of its actual requirements for the specified supplies or services from the contractor. Deliveries are ordered by issuing delivery or task orders when the supplies or services are needed. Under a requirements contract, the contractor is the sole source of supply during the term of the contract.

Indefinite-quantity contracts. This arrangement provides for the delivery of an indefinite quantity, within stated limits, of supplies or services during a fixed period. Deliveries are ordered by issuing a delivery or task order when the supplies or services are needed. Under this arrangement, the government is required to order the minimum quantity stated in the contract, and the contractor is required to provide the maximum quantity stated in the contract, if ordered, at the stated price.

The basic difference between a requirements contract and an indefinite-quantity contract is that while the government must order all of its actual requirements from the contractor under a requirements contract, once the minimum quantity has been ordered under an indefinite-quantity contract, the government is not obligated to place further orders with the contractor and could, for example, place any further orders with another contractor offering lower prices. Once the maximum quantity has been ordered, the contractor may renegotiate the prices for any further orders.

The FAR states a preference for making multiple awards of indefinite-quantity contracts under a single solicitation for the same or similar supplies or services to two or more sources, but does permit single awards under certain circumstances. The decision whether or not to use multiple awards must be documented in the contract file. Generally, when multiple awards are made, the individual delivery or task orders must be competed among the awardees, but the FAR does allow orders to be placed on a sole-source basis under certain circumstances.

The FAR also states that performance-based work statements must be used to the maximum extent practicable when procuring services (see Chapter 3).

The primary characteristics of indefinite-delivery contracts are that government funds are obligated upon issuance of each delivery or task order rather than at contract award, and the government does not have to order the supplies or services until the actual requirement materializes.

While any appropriate cost or pricing arrangement under FAR Part 16 may be used for indefinite-delivery contracts, delivery-order contracts (for supplies) are usually priced on the basis of a fixed price per line item, and task-order contracts (for services) are usually priced on a cost-reimbursement or time-and-materials basis. However, commercially available services with established pricing may be priced on a fixed-price basis.

When using a delivery-order contract, the SOW for the basic contract describes the specific supplies required. The delivery orders simply cite the contract line item numbers and the nomenclature of the supply item. Another complete SOW is not required.

Under a task-order contract, multiple SOWs are usually required. An SOW is required for the basic contract, and another SOW is required for each task order issued. The contract SOW describes the general nature of each task but not the specific work requirements (which are not usually known at the time of contracting). The contract SOW describes the general nature of the tasks required, describes the required resources and facilities, and provides an estimate of the required level-of-effort for each general task. The contract SOW must describe the tasks sufficiently for the contractor to estimate the extent of effort required and provide an overall price estimate. The basic contract is negotiated and priced based on the contractor’s response to the contract SOW.

As each specific work requirement is known, a task-order SOW is required. Each task-order SOW must describe the specific work requirement in sufficient detail for the contractor to submit a priced proposal. This must be a complete SOW, as though it were the SOW for a contract. Keep in mind that the contract SOW is very general in nature. If you want to hold the contractor to your work requirements, the task-order SOW must adequately express these requirements.

Inadequate task-order SOWs are a common problem. Task-order SOWs are often written with the assumption that the basic contract SOW adequately covers the work. This is not the case. The basic contract SOW provides only a general description; it is the task-order SOW that provides the details. If the task-order SOW is not complete, it is likely that the work will also be incomplete or otherwise unsatisfactory. The contractor is required to submit a priced proposal in response to the task-order SOW. Once the price and technical details are negotiated, the task order is issued.

When writing an indefinite-quantity contract, you must explain how the delivery or task orders will be handled. The FAR clauses that are used are general in nature and must be supported by either language in the SOW or a locally developed clause that provides the specific details. Addressing these details in the SOW permits you to tailor the ordering procedures to your specific needs. Locally developed clauses tend to get out of date and are often too generalized for specific needs, so they must be examined in each instance and tailored as required.