I’m making this post so that I don’t have to keep repeating the contents in all of my future posts. It’s intentionally very high level but should be sufficient to understand how the Government contracting world operates. This one is on contract types.
The Government issues contracts of four major types. There are some variants of these, but in thirty-one years, these are the only ones I actually saw in use.
Fixed Price Contracts
Most people are familiar with fixed price contracts from the commercial world. If you’re buying a shirt at Walmart, there’s a fixed price for it. You pay it or you don’t. That price may be negotiable, like when you go to buy a car at a car dealership. It may change after you’ve signed the initial contract, like when you’re buying a house and an inspection turns up termites (thereby leading the buyer to request a price cut).
But the price is known.
Or is it?
Fixed price contracts can be structured with all sorts of clauses that allow the price to change. For example, on one contract, my company negotiated a late delivery fee for some hardware the customer was providing us. Every day the customer was late, they had to pay us $10,000 to compensate us for the personnel and facilities that were sitting idle waiting for their hardware to arrive.
Well, the customer was so late that we made more profit off that late fee than we did off the original contract.
The challenge of fixed price contracting is being adequately specific. If the contract says that you are buying a “red car” and you’re thinking cherry red, but I deliver blood red, you’re stuck. I fulfilled the contract and you have to either accept what I delivered, pay me to repaint the car, or take me to court (where, even if you don’t lose, you’ll spend more money than if you’d just paid me to repaint it).
This can work against me as well. If you refuse to pay me because it wasn’t the red you wanted, then what? I have to either sell the car to someone else (which could be tricky—where are the buyers of blood red cars?) or take you to court to get my payment. Either way, I’ve got an unhappy customer and all the game theoretics about having unhappy customers come into play.
Good fixed price contracts are either “as is” for something already built or are very carefully negotiated with as much ambiguity driven out as possible.
Most people suck badly at avoiding ambiguity in communications. Just look at all the miscommunications you have with your loved ones who know you well. Now put a few million dollars on the line with strangers and imagine the result.
Thus, negotiating good fixed price contracts for things that haven’t been built is an huge challenge.
Which leads to the second major contract type…
Cost Plus Contracts
Imagine you want to buy something that’s never been done, like a rocket that will take men to the moon (1960s), or a system that can shoot down missiles (1980s), or a telescope capable of looking into the far reaches of the universe (the James Webb Space Telescope, 2000’s). It may be theoretically possible and there may be technology demonstrations, but going from the lab to space is still a huge step.
Getting the requirements right for a fixed price contract will be very difficult if not impossible. As a contractor, I would either turn down the business or bid a *very* high price. That price up front might be too high to swallow. I would have to do this because the risk of losing my shirt with something that’s never been done is too high.
So how does the customer get something like this built?
They could turn to a Cost Plus contract.
In a Cost Plus contract, the customer pays all the contractor’s costs plus a fee (usually a percentage fee). The contractor can’t lose money and thus is willing to do the work. The customer then gets a lot of oversight and involvement in the contract execution. If the contractor starts to pain the car blood red, the customer can jump in immediately and say, “No! Cherry Red!” Developments are corrected before it’s too late.
Imagine hiring a general contractor to build you a house. You sign a contract that gives the general scope, but then you say that you’ll meet every Monday so you can make more detailed changes as needed. If you decide to add a hot tub—the contractor’s fine with it. He adds it to your bill along with his 10% fee on top for getting it ordered and installed. The final cost of the house might not be anywhere close to the original bid price, but you didn’t have to spend all that time arguing about whether it was in the contract or not. Especially since you may not have known you wanted a hot tub when the original contract was signed.
So a cost plus contract is a trade—the buyer (the Government) accepts that they can’t specify everything to the level of detail needed for a Fixed Price contract. The contractor accepts greater oversight and involvement by the customer in exchange for eliminating the risk of losing money.
The major advantage to the Government is it may be the only way to get some things built.
The major advantages to the bureaucracy are that it eases conflicts and lets them be personally involved.
For easing conflicts, I once said to NASA: “Imagine there’s an ambiguously worded requirement and the difference in interpretations is $100,000. If it’s a Fixed Price contract, I’m arguing with you about $100,000. If it’s a Cost Plus contract, I’m arguing with you about the fee on $100,000, at most. How hard do you think I’m going to argue in each case?”
For personal involvement, if it’s a Fixed Price contract, the customer gets only what’s delivered. When you buy a car, you don’t get to go to the paint factory and learn how they paint cars. You don’t get to tell them how to paint the car, even if your way is better.
But for Cost Plus contracts, you get to be involved in almost any step you want to be involved in.
That sure beats sitting at a desk auditing reports.
Once you’ve moved into the Cost Plus contracting world, there’s a lot of nuance at play that I’ll describe in future posts.
Now… sometimes the Government procures services instead of hardware or reports. This leads to the third contracting category, Time and Materials.
Time and Materials Contracts
A Time and Materials contract in Government contracting is basically the same as consultant contracts in industry. The customer pays for the time of the employees at a specified rate plus any directly applicable expenses. If I hire a lawyer or a Private Investigator, I’m doing it on a Time and Materials contract.
The challenge in Time and Materials contracts is the same as any consulting contract. What are you actually getting? Was it worth it to have McKinsey employees spend a week interviewing your staff? Could they have done it in a day? Would the resulting advice have been better or worse?
It’s really hard to evaluate and the costs can get out of hand quickly.
The advantage of Time and Materials contracts is that you’re not buying physical stuff. Your contracts are simpler, clearer, and easier to manage.
Indefinite Delivery, Indefinite Quantity (IDIQ)
Now there’s a fourth type of contract that I’ve seen used frequently in Government contracting called Indefinite Delivery, Indefinite Quantity (IDIQ) [https://en.wikipedia.org/wiki/IDIQ] A company “wins” an IDIQ contract without specific tasks to do. Then when the customer wants them to do something, they write a Task Order for the work in question.
The industry equivalent is a retainer. If I issue a retainer to a lawyer, I’m basically setting up a contract that lets me call him or her later and have them do billable work then.
The major advantage of IDIQ contracts is they separate the bid and task order process. The process of awarding a Government contract takes a long time (why will be a future post). A typical contract takes 6-12 months or more to be awarded. A task order can be turned on in a week. So if the Government awards a 5 year IDIQ contract, that gives them 5 years of being able to start work quickly.
To go back to the lawyer retainer—by having a contract already in place, the lawyer can start work immediately without us having to get something set up first. That may be worth it. On the other hand, lawyers don’t need a year to get a contract in place.
The disadvantage of IDIQ contracts to contractors is that you do all this work to “win” a contract and there’s no guarantee you’ll actually get any work. My company was on multiple teams that “won” and we spent money helping writing the proposals, but never saw a dime in actual work.
The advantage and disadvantage to the Government of IDIQ contracts is… well… the task order process is not held to the same rigor as the contract award process. So, on the one hand, you can be more sane about how you issue task orders (advantage!). On the other hand, you can be more corrupt about how you issue task orders (disadvantage!).
Summary
These four contract types form the majority of Government contracts. Two of them are pretty common to the world outside Government contracting but two aren’t. The differences are significant.