Comparison And Usage Of Contracting Strategy Business Essay


This paper will illustrate the spectrum of contract vehicles available to project ownership. These range from low owner risk type contracts of the Firm Fixed Price type, to neutral risk Time and Material type contracts, and to the low contractor risk type Cost Reimbursement type contracts. While the Firm Fixed Price contracts are the easiest to understand by the layman, they often are not applicable to more complicated projects, due to uncertainties over methods, means, results desired, timing, funding and other imposed restrictions.

The intent of this paper is to give the layman a general understanding of the differing capabilities of the various contracting vehicles to limit risk to the owner as much as possible, while at the same time reducing contractor risk to the extent needed to stimulate honest bidding for the right to perform the project owner s desired scope, with the needed to incentivization to perform in a timely and cost effective manner. Ideally the descriptions contained in this paper will give the layman the information needed to begin to craft the idea of a better contracting vehicle for his needs. The latter part of the paper contains hypotheticals that will allow the layman to incorporate the various real elements that go into project planning and influence the variations of contract chosen.

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Ideally, this paper will serve as an introduction for the layman s use for the basics of contract type and selection. Future papers would go into the various elements of risk that impact the initiation, performance, and closure of a project, and would analyze in greater detail which of the contracting choices is best suited to deal with those risk elements and their severity.


I chose the topic of contracts and applications by the widening of experience that I encountered as a progressed along my project controls and engineering career path. I initially began my career in the mining and heavy construction fields. In those industries, the typical and indeed overwhelming contract vehicle tended to be the Firm Fixed Price contract, competitively bid. In mining, bids were solicited from vendors and contractors, who were issued plans, blueprints, or scheduled quantities, and bids were received. These bids were examined for competency and realistic methods, and with those requirements satisfied, the low bidder won.

The latter part of my career however, placed me in a cost consultancy and project controls role. In this role, I discovered that not all contracting situations are that simple. Projects I have encountered have ranged from highly investigated and prepared request for proposal situations to projects where the government agency involved has had only a general idea of the total scope involved, and often a poor appreciation of the total risks that might be encountered.

Government projects have a tendency to be unfocused on their ultimate goals, and even in those cases where the goal to be achieved is well understood, the means of accomplishing that goal and the funding to pay for it are often undefined. In this situation if the proposal that is issued is to collect any serious interest, the project owner has to be prepared to take on some of the risk that these undefined elements impose. While the owner can press the usage of the Firm Fixed Price contract vehicle, the result in such a high risk environment would be bidding that incorporates such a high additional cost factor in each bid item as to be unrealistic. This paper serves as an analysis of the contract vehicles available to a project owner, and also applies these vehicles to scenarios whose details require the usage of variations on the main types of contract vehicles.

Chapter One-Contract Concept

Contracts are the glue that holds an economy together. While mutual gain and enlightened self-interest ideally should guide transactions between parties, contracts serve as the guarantees that all parties will perform as they are obligated; that those employed will deliver goods, or perform services as they have promised, and that those employing them will compensate in the time and form as they have promised as well.

In law, a contract is an agreement between two or more parties, that if it contains the elements of a valid legal agreement is enforceable by law or by binding arbitration. [1] For many jurisdictions in the United States, a written contract is a legal requirement for certain transactions; sales of property or contracts of more than one year s duration for example. However for all places and parties, the written contract serves as a record for the conditions, the terms, the work scope, pricing arrangements, and special requirements for the goods or services sold. The benefit of the written contract is most felt when parties involved in a contract have come to a disagreement upon some facet of the terms and conditions. The presence of the written, as opposed to oral, contract allows both parties to cite the disputed area, and if necessary allow a trier of fact (arbitrator, judge, or jury) to determine if either or both parties have a valid dispute. Additionally, the Contract itself should define what a particular contract contains, and what the definition of contract is for this document.

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A contract can include (but is not limited to) the following elements [2]:

1) An invitation to bid or a request for proposal (RFP)

2) Instructions for bidders

3) An agenda issued for the bid period

4) The bid or proposal

5) Contract

6) Bonds

7) General conditions

8) Special or supplemental conditions

9) The scope of work (including plans, drawings, specifications, special provisions, etc.)

10) Change orders and contract modifications;

Additionally there may be:

11) Permits

12) Operating licenses

13) Environmental Agreements

14) Codes

15) Geotechnical or subsurface condition reports, and

16) Other technical requirements incorporated by reference

Chapter Two-Contract Types

The type of work being performed, as well as the conditions under which the work is to be performed, can influence the type of contract vehicle that is chosen in the Invitation to Bid or RFP. There are seven types of common contracts: Cost Reimbursable (time and materials), Cost Reimbursable with Percentage Fee, Cost Reimbursable with Fixed Fee, Cost Reimbursable plus Cost/Schedule Bonus/Penalties, Measured Unit Price, Guaranteed Maximum Price, and Lump-Sum/Fixed Price. [3]

Cost Reimbursable contracts are favorable for projects that have incompletely defined scope, or are based upon evolving technology, whereas Lump-Sum/Fixed Price contracts are favorable to situations where the project scope is well defined, and the means of accomplishment are based upon tried technologies. Firm Fixed Price contracts are defined as: Contract that provides for a price which normally is not subject to any adjustment unless certain provisions (such as contract change, economic pricing, or defective pricing) are included in the agreement. These contracts are negotiated usually where reasonably definite specifications are available, and costs can be estimated with reasonable accuracy. A fixed price contract places minimum administrative burden on the contracting parties, but subjects the contractor to the maximum risk arising from full responsibility for all cost escalations. [4] Cost Reimbursable contracts however are defined as a: Contract under which allowable and reasonable costs incurred by a contractor in the performance of a contract are reimbursed in accordance with the terms of the contract. [5] From a risk standpoint, these represent the extremes of the contract vehicle. The Firm Fixed price contract places all risks upon the party performing the work or delivering the goods. The Cost Reimbursable contract places the risk upon the project owner, as he will reimburse all costs incurred in performance of the project.

The attributes of the various vehicles can be seen in the table below:

Table 1 Major Contract Vehicles

Chapter Three-Contract Applications

The spectrum of contract vehicle types is to a large degree analogous to the risk involved in a given project, be it risk to the project owner, or risk to the performing contractor. In many cases the risk is a development from the maturity of the scope of the project.

This maturity is derived from multiple sources. One source can be from design: buildings, machinery, materials to be used. Site investigation and characterization can be another source of risk: confirmation of contamination, extent of contamination, depth and area affected.

Governmental, and to a lesser degree private contracts can also carry a substantial risk to all involved due to the maturity of the funding of the project. In governmental projects, funding can vary from year to year and projects may gain or lose funding, or even be frozen in place for one to several years. Another possible risk from funding is that the total scope and funding may not change, but the time scale for the project to be funded may be dilated, whereas a project that was originally scheduled to be performed over a seven year period may be extended to ten years and annual funding reduced accordingly. For this kind of funding scenario and others where the final parameters of the project cannot be finalized, the various cost plus models are a preferred method of performance. The original costs of the project are still paid for by the owner, the additional costs incurred by the delay in stand-by of crews and equipment, as well as maintenance costs to work already performed are itemized and are covered by the owner as well. Due to the lack of impact by these uncertainties on the contractor, these contract vehicles are ideal for those projects that need to be started immediately, despite unresolved issues, but still need to have competitive contractor interest

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Alternatively however, the Firm Fixed Price contract variant can be used. This is preferable to situations where the site conditions are pre-investigated and are well known and documented. This information has been collected and organized and is ready to be handed to all interested bidders for the project. Further a project of this sort would preferably use proven technology in a conventional manner. Funding in this case would be either cash in hand, or approved and dedicated funding that has been set aside for this purpose. Bonds, line item appropriations, approved loans, and Congressional earmarks are all funding mechanisms friendly to the FFP contact.

Time and Material contracts are useful in simple situations where a quantified (either by scope or by funding) quantity can be applied to the goods or services needed. For services these are often staff augmentation contracts where a certain number of people are used to assist an owner s staff for a certain pre-defined amount of time, or for open ended jobs where a supplied staff is focused on a need, and is set a fixed time or spending quantity to solve the requirement.

Chapter Four-Contract Vehicle Scenarios

The following chapter describes three hypothetical scenarios where the three above mentioned contract types could be applied. The first considers the situation at the clean up of an Environmental Protection Agency (EPA) job site. The second considers the reclamation of a closed Army and Air Force bombing range. The last situation considers the hiring of a subcontractor to resolve the scheduling issues of a growing trucking fleet.

The EPA has been tasked under Superfund legislation to clean up the remains of a pesticide production and storage facility. The site has been under investigation for over 15 years, and has had several prior contracts let to provide for site investigation, permit processing, geotechnical investigation and initial site preparation for future work. At this point, the EPA can confidently prepare a well developed package for all interested contractors when the RFP is issued. The RFP will ask for a FFP response. This response will include a schedule with milestones for stated goals and interim achievements by the contractor during performance, a proposed schedule of values that will determine the Earned Value structure for the contractor s interim payments as the project progresses, and a baseline to show how the stated costs and schedule can be achieved. Due to the politically sensitive nature of this project, it is in the best interests of the EPA to have this project completed as quickly as possible. Due to this the RFP states that the maximum time to achieve the defined scope of the project is eight years. Further, as the local community wishes to improve the site upon completion to an industrial park, any time saved in performance of the project scope enables the community to more quickly develop revenue generating business on the site. Therefore the EPA wishes to incentivize the contractor chosen to perform as quickly as possible. The EPA has been received a $40,000,000 block grant to achieve the clean-up.

Given the above parameters, a Firm Fixed Price contract is a practical solution to the conditions. The scope of the project has been thoroughly investigated and quantified. Site conditions have been prepared for work to begin, requiring very little infrastructure development by the bidding contractor. All permits have been acquired or are in process, allowing work to launch as scheduled. Given the urgency of project completion, a Firm Fixed Price plus Incentive Fee contract would probably be the best contract vehicle available. There is adequate information for the contractor to reasonably sure of his total costs, and the incentive fee can offset any complications requiring more manpower or materials to make the stated goal completion date. Ideally, if planned well by the contractor, this can be a profit making venture for him in both the main bid items, as well, as the incentive; alternatively, if he is confident of his completion, and wishes to be more competitive in his bidding, he can bid the scope below actual costs and make up the difference in the incentive award.

The Army and Air Force have had a bombing and gunnery range in central Oregon, which was active from 1942 through 1974. The site was idled, and then closed, first by the Army and then by the Air Force. The site however was put into a stand by mode, with a minimum of caretaker personnel until 1983, when it was completely shut down. Today, the site has been deeded to the state of Oregon who wishes to turn it into a state recreation facility, with an Off Road Vehicle park, as well as horseback and bicycling trails.

An initial investigation by the state revealed issues with the facility and range. During the period of disuse and abandonment, the site facilities were left in an unmaintained state. The facility power and water systems are currently dysfunctional, the site buildings condition ranges from obsolete to dangerously deteriorated. Further, many of the buildings contain asbestiform materials, lead paints, mercury vapor lighting and switches and underground water contamination. The bomb range outside the facility is assumed to have large quantities of unexploded ordinance as well. Many of the ordinance drop sites are unrecorded from the earlier and days of the installation, and the latter day drop site records are incomplete due to either poor records storage, incomplete filing, or negligence.

While the state would like to be able to place this facility into public usage, state parks funding is currently constrained for new development, so time is not really a critical factor in this case. The legislature has initially agreed to fund the clean up over a ten year period, with a series of single year appropriations, and acknowledges that further appropriations may be needed.

Under conditions such as these the best contract vehicle that could be chosen would probably be the Cost Plus Percentage of Cost type of contract. The contractor on this project will be exposed to overwhelming risks on the site, ranging from disposal of hazardous wastes, unexploded ordinance detection and removal, and extensive site work required to begin the process of clean up. Further complicating the risk picture is uncertain timeline that the state will have for final clean up, as well as the uncertain funding profile the state has formed. The CPPC contract will make these risks a non-factor. As the state of Oregon has assumed all costs will be reimbursed all risks, even if they should turn out to be true, will be taken care of by the site contractor, and the costs of those remediated risks, will be compensated for by the state. The fixed percentage profit of the contractor is tied to the total costs, so therefore, a proliferation of realized risks could actually increase the total profits generated by the site contractor. As a safety mechanism for the state, a cap on total fees generated would be a wise contract addition in this case.

Quantum Transport is a small trucking company founded by the Walsh family in 1978. The company until recently has never had a fleet of more than 10 medium trucks, and 5 large long haul trucks. However, at the start of the current year Quantum received a contract to transport frozen chickens from the local processing plant to various supermarkets along the east coast of the United States. This in turn has led to a sizeable increase in the truck fleet. The paper and ink scheduling system of the company was not adequate for the increased logistical demand, and the family needed an outside contractor to install and instruct in the use of more sophisticated scheduling software. The invitation to bid requires the company chosen to investigate what system would work best for Quantum s current and anticipated future needs, and to gauge the computer competency of the various Quantum staff members, and devise an instructional program to teach the use of the chosen system to all staff members.

A Time and Materials contract would possibly be the best solution for this situation. While the two goals and their general costs are recognized (software and training), the actual total cost to get to them is somewhat uncertain. The winning contractor will detail the costs of the software he feels is best, and gives a general total of the labor costs to install and educate the Quantum staff. The rates quoted include his profit, and the general total helps the project owner to set a not to exceed project total cost.


Risk to contractor and preparation by the project owner are the two sides to the coin for the selection of a proper contract vehicle.

Risk to the contractor can take the form of project unknowns such as site conditions or contamination levels. It can also take the form of other factors, such as under developed work site infrastructure, undeveloped client expectations, or unstable project funding. While a project owner may have no desire to transfer some of the at contractor s risk upon himself, to generate interest in a request for proposals, and to encourage honest, non-padded bids, he must accept some risk in the form of Cost Reimbursable contracts, or in extensive site preparation.

The ideal is to balance the current project situation with the goals the contractor will have to meet and the incentives to accomplish that.