Tackling 3 Myths Around Cost-Plus Contracting
From our CEO and Master Collaborator, Richard Crespin:
I’ve worked in government contracting on-and-off for nearly three decades, supporting federal defense, intel, and civilian agencies. And in all that time, I thought of Cost Plus Fixed Fee (CPFF) contracts like dinosaurs: something I’d read about in books or visited in a museum but never actually seen one in the flesh. Until, that is, I started consulting to USAID. Turns out, these terrible lizards still roam the earth. I call them terrible lizards because they are bulky and unwieldy for both the government and its suppliers and they unnecessarily limit competition.
In a recent conversation with a now former USAID official, I said, “Please stop with all the CPFF.” To which s/he responded, “But why? It’s so much easier!” For whom? For the small retinue of oligopolists that regularly top the leader boards of USAID contract and grant recipients? Sure. It helps them maintain their barriers to entry and defend their fiefs. For the rest of us, no way. If USAID really wants to expand the implementing partner pool — and I sincerely believe it does — that starts with severely limiting the use of CPFF. To understand why it should and how it can, let’s start by debunking a few myths.
Myth #1: Working in international development requires CPFF. In a market economy, the intersection of demand and supply sets the price (see Diagram 1). The US government (USG) invented CPFF contracting to create markets for services where no market existed; for things like going to the moon. With only one customer (the USG) and one or two suppliers, how do you establish a fair price? You can’t. Hence, CPFF.
I will grant you, in international development, there remain cases where USAID is the only buyer and where there are only a few competitors. Rebuilding infrastructure in the aftermath of armed conflict or natural disaster comes to mind. But USAID uses CPFF for way more than these outliers and for many services with very well established commercial markets, for everything from knowledge management to training and from financial analysis to workshops.
On the surface, many of USAID’s objectives sound complex but a seasoned professional can break them down into their individual parts composed of quite basic and relatively easily priced elements. As an example, we worked on a multi-year project to establish a multi-sector collaboration platform for managing a set of vital natural resources in multiple countries. Sounds complicated. But in reality, we broke our piece of this work into bite-sized projects that consisted of predictable elements like literature reviews, primary research, interviews, workshops, focus groups, needs assessments, and report writing. With a bit of manageable risk, we provided the USG with a firm fixed price for each element.
Myth #2: Working with USAID requires lots of costly administration. In a recent survey of non-traditional USAID partners (i.e., those organizations that don’t normally work with USAID), the #1 reason cited for not pursuing work with USAID: paperwork. What generates all that paperwork? There are three main models of managing cost and risk in a government contract or grant:
- CPFF. The contractor or grant recipient (to save time and space from here on out I’ll call both a “service provider” or just “provider”) shares all the details of their underlying costs and the donor/agency (hereinafter the “payor”) agrees to cover the costs plus a fixed fee (aka profit). This model requires a lot of disclosure (and therefore paperwork and administrative expense) on the part of the provider as they have to document and share salaries, operating costs, overhead costs, and a lot of other accounting and human resources information — and they have to keep updating it all the time.
- Time and materials (T&M). The provider proposes a set of fully loaded (i.e., inclusive of salary, benefits, overhead, plus profit) hourly or daily rates for different labor categories, usually based on levels of education and experience along with an estimate for the number of hours required by labor category. The payor agrees to pay based on hours used plus any other direct costs (ODCs) which may include travel, office supplies, consumables, etc.
- Firm fixed price (FFP). The provider proposes a set fee that covers everything: fully loaded labor, risk, profit, ODCs, etc.
Yes, CPFF requires lots of paperwork. But the other two models, do not. They require some, especially the first time establishing labor rates, but not nearly the same amount as CPFF. But when most providers or prospective providers think of working with USAID, they think about CPFF because CPFF remains the go-to for most USAID contracts.
To further debunk both of these myths, take as an example, a recent tender released by USAID to contract knowledge management and learning services. USAID received dozens of responses, which debunks the idea of a limited number of providers. Moreover, not only are these services regularly provided by multiple USAID service providers, vast commercial markets exist for them. Knowledge management and learning services are, in fact, simply a form of HR outsourcing and immediately prior to my current role, I used to help run a set of trade associations and trade magazines dedicated to HR outsourcing services, including learning and knowledge management. In the commercial world, not only are these services not contracted using CPFF, they’re often not contracted T&M or FFP either. Instead, many forward-thinking firms provide them on a shared-benefits basis, meaning the provider agrees to manage and reduce costs to the payor and receives a portion of the savings. This is a level of sophistication, risk reduction, and quality improvement USAID has locked itself out of due to its infatuation with CPFF.
Myth #3: CPFF is effective at controlling cost and risk. Take a look at Diagrams 2, 3, and 4. Each diagram compares the relative assigned risk and administration born by each party under the different models. I use the term “assigned risk” to distinguish from actual risk because while, as an example, in FFP the provider bears the majority of the assigned risk, its actual risk depends on how good it is at a) estimating cost and risk when writing a proposal, and b) managing cost and risk during execution. Contrary to this myth, the payor‘s (e.g., the USG’s) ability to manage risk and cost lies in FFP or T&M, not CPFF. Under CPFF, the payor bears all the assigned risk.
All the administrative burden that accompanies CPFF gives the illusion of cost containment and risk management but in fact does no such thing. First and foremost, if a market exists, the market sets the price, not the cost. Second, by reducing the administrative burden, USAID would find more providers, increasing competition and reducing cost. Lastly, and perhaps most importantly, the more USAID can engage in FFP the better, as it transfers the assigned risk and attracts skilled operational professionals who can effectively manage projects.
For USAID: I may have been too quick to relegate CPFF to the dustbin of history. I’ve seen where it has a place, especially in extreme situations like conflict zones, areas recovering from natural disaster, or countering violent extremism. BUT, if I were the head of the Office of Acquisition and Assistance (OAA – the office responsible for overseeing how USAID provides grants and buys stuff), I would immediately require all Missions and Offices not in those areas to provide a CPFF justification to explain why a given activity can’t be handled T&M or better yet FFP or even better still, on a shared-benefits basis. If USAID can transfer risk and responsibility for cost containment to a provider, it should.
For Service Providers: If you are a small or medium-sized business looking to expand your work with USAID, two recommendations:
- The next time you respond to an RFI from USAID, ask if they would consider making the award FFP or T&M. If you know multiple vendors exist to provide the service, tell them.
- Join the Small Business Association for International Companies (SBAIC) and the Professional Services Council (PSC). These associations are your voice. Once you join, show up at their meetings and advocate for more T&M and FFP contracting. Reducing the administrative burden will break the oligopoly and open up more business for you.
With these actions as part of the Agency’s overall Effective Partnership and Procurement Reform initiative we can end the oligopoly, reduce USAID’s overall cost and risk, while accelerating impact.