“What Happened To My Profit?” - ReliAscent Featured Partner Blog (Part III)
The following blog is the third in a series of special guest and ReliAscent partner blogs, contributed by Richard Busch of the Busch Law Firm, and Mike Anderson, of ReliAscent. This series covers important topics ranging from an introduction to government contracting, to requests for equitable adjustments, risk management, contract change orders, and scope creep. Additionally, our series will cover government financial assistance efforts, and how defense contractors--both small and large business (along with subcontractors)--can increase profits, improve their ability to strategically plan for the future and remain profitable.
By combining DCAA compliance and accounting expertise with defense contracting and FAR compliance legal representation and consultation, ReliAscent and Busch Law can help position contractors for financial success…
“Even if you’re on the right track, you’ll get run over if you just sit there.” - Will Rogers.
Unmanaged “Creep?”…Make Informed Decisions and Manage the Work Effort
The meaning of Mr. Roger’s quote is especially important to a contract administrator for many reasons. The administration of a government contract, as a prime or subcontractor, is a difficult balancing act between strict compliance of your contract obligations, pleasing the government client, balancing the budget, and timely performance—to name a few. Even if you think you are “on the right track”---you must always be performance vigilant. As Mr. Rogers inferred---being proactive in the administration of the work effort is of paramount importance. Successful performance, no matter what type of contract, Fixed Price or Cost Reimbursement, requires keen oversight of performance and cost control.
The concern is NOT just with Government attempts to increase the level of effort; but the contractor MUST police its own actions. Contractors may unknowingly degrade their profits or adversely affect the Government’s budget by not controlling their own performance through unilateral contractor actions that increase the cost of performance that may not be reimbursed. Simply, being on the “right track” can still negatively affect profit if the contract performance contains unmanaged task “creep” cause by either contract party.
No Such Thing as a Perfect Contract---“Position Determines Perspective”
Whenever two or more people with separate interests are involved, there is a strong likelihood there may be different goals for the successful accomplishment of the contract work effort. Real time changes thought to be needed to obtain the desired results; the cost of performance may “creep” beyond the initial understandings of the parties. Take the time to proactively discuss and agree, as much as possible, on what is successful contract performance AND what the cost of performance should be expected.
Complete Understanding the Statement of Work
When creating a cost of performance management system, you must start with the “scope” of the contract. If the initial contract “scope” is poorly defined, performance creep and increased costs will most likely result in subtle changes. Not all scope “creep” is readily apparent. You may not recognize the change or fail to give it any thought; just like recording your daily expenses normally “shock” most people when they learn how their money is spent. A “vague” SOW hurts cost control by opening the door to work scope creep. Simply, you must determine what you are contractually bound to do and what the parties agree is success? Comparing reality to the contractual performance baseline determines the profit on the work effort.
Type of Contract is NOT Always a Factor for Profit
The parties must determine whether the “scope” of the Statement of Work can be completed or is only a “level of effort” expected for successful contract performance? In addition, is the Statement of Work based upon a firm government design or is the final product described through only performance criteria with little design? Obligations and the allocations of risk defined by the Type of Contract must be understood and appreciated before the work effort is agreed upon. Those understandings create the foundation to perform the SOW and achieve the profit expected. While these factors seem premature when discussing “profit,” these factors are the basis for your profit.
Assumption of Risk
Fixed Price contracts always obligate the contractor to accept the risk for the cost of performance and any resulting profit. It is imperative to clearly understand the work effort, the risks of completion, contingencies, and the overall performance baseline. To avoid “scope” creep and the increased costs of performance in time or effort, the contract must be administered in a deliberate fashion. Increased work effort, delays, uncalled for inspections, etc. must be identified and documented as soon as possible and a decision made whether you will accept its impact on the cost of performance or whether a change order is appropriate.
Cost Reimbursement contract performance can also affect the profit factor. It is incorrect to think that just because all allowable costs are reimbursement, the fee cannot be adversely affected. The amount of fee recovered is still measured by contract work effort. Fee is NOT profit. In reality, the “fee” may be proportionally decreased by the increases in time of performance, costs, and work effort that result from scope “creep” and its increased effort/time for performance. The contractor receives less profit from scope “creep.” A contractor is mistaken if they think the risk allocation in a cost reimbursement contract does not impact profit due to its failure to manage the costs of performance.
Who is Responsible for the Cost Growth and Its Effect on Profit?
The Government has the obligation to control costs; but still conduct business with integrity, fairness, and openness. The Contractor must help the Government with those obligations. In the recovery for scope ‘creep” to the performance baseline, the Contractor must not only prove “entitlement” but also “quantum.” Managing risk through sound cost accounting and performance oversight, along with documented contract administration, is the focal point for successful contract performance. As William Arthur Ward stated, “The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” The Contractor must recognize the difference in and balance the need for “risk avoidance” verses “risk management.”
So, what does all this mean for the contractor that is trying to make a profit? It means that managing a Federal Government contract is not just as simple as controlling one aspect, but rather, knowing what your contractual obligations are and managing all the elements of the performance baseline agreed upon by the parties. How can the contractor insure that they make money, especially when the government or the contractor can unwittingly affect the profit margin on contracts? The answer is experience. Experience in how the “game” is played, as well as many years’ experience in playing the game within the rules. Many businesses don’t have this expertise readily available within their organization. It is always cost effective to consult the experts (like ReliAscent and The Busch Law Firm) that deal in the successful administration of government contracts in conjunction with the successful completion of the technical performance. Corporate Management, contract administration, cost control consultants, legal considerations, and technical supervision, are integral parts of understanding how to successfully perform a government contract; especially on how to maintain your profit goals.
- Richard Busch
Managing Partner, Busch Law Firm LLC
Coming up: in part IV, “Request For Equitable Adjustment,” Rich discuss how contractors can make a money-losing contract profitable again. This piece is a must-read for small and large federal contractors alike.