How a relatively little-known cost estimating tool can help prevent and correct contract overruns when other methods have fallen short.
by Mr. Anthony J. Nicolella
When a contractor regularly overruns the estimated cost of a contract, the solution may lie in a tool that the Federal Acquisition Regulation (FAR) does not require but, when properly implemented, can make all the difference: the most probable cost estimate, known as MPC.
If you needed to buy a new heating, ventilation and air conditioning system for your house, you would get prices on several, then look at future costs in terms of energy and repairs, filters, etc. Should you go for the cheapest model and keep your fingers crossed? Or should you go for a more expensive one that will actually cost less over several years because of lower additional costs? In much the same way, the government has to understand whether costs in a contractor’s cost proposal are realistic for the work to be performed.
The FAR requires the government, before awarding a cost-reimbursement contract, to perform cost realism analysis and develop a probable cost estimate for each offeror. However, neither the FAR nor the Contract Pricing Reference Guide mentions anything about using a probable cost estimate as a contract administration tool or funding baseline.
The MPC is not a cost-control panacea. It requires the proper staff, with the right training and clear lines of accountability, to achieve the desired benefits. Applied with the necessary support processes in place, however, the MPC can succeed in bringing ongoing costs under control, even in a post-award environment.
CASE IN POINT
I saw the difference the MPC can make when I was the commander of the National Training Center (NTC) Acquisition Command at Fort Irwin, California, from June 2002 to May 2005. Faced with spiraling cost overruns on our multimillion-dollar, multiyear, cost-reimbursement base operations contract, we used the MPC and the process of developing it as a contract administration tool and funding baseline and brought the contract costs under control. The experience was a case study of sorts in making the most of the MPC.
The contract in question covered everything from minor construction to crossing guards at the installation. Approximately 80 percent of the work performed on this installation was done by the contractor who held this contract.
The contractor at the time regularly overran the estimated cost of our cost-plus-award-fee contract for base operations and hit the contract price ceiling by the fourth quarter, when fiscal constraints take hold and additional funding is limited. The money for base operations contracts normally comes from operations and maintenance (O&M) funds. DOD’s Financial Management Regulation says that O&M appropriations are considered expenses that cannot cross accounting periods or fiscal years. Thus, O&M funds used to pay for services under a base operations contract are good for one fiscal year, or through Sept. 30. After this date, these funds expire and are no longer available for new awards or new contract actions.
The question was whether the contractor couldn’t manage its costs, or whether there was a problem in the MPC that the command had developed and used as a funding baseline. Even though the FAR and Contract Pricing Reference Guide did not require using the MPC process to create a probable cost estimate after the contract award, doing so was an avenue that we had found worthy of exploration.
If using the MPC before the contract award could help the government determine whether the offeror’s cost proposal was realistic, why not use the MPC after the award to determine if the contractor’s actual cost was still in line with what was proposed? If not, then the government would investigate the circumstances and take the appropriate actions.
We needed to take into consideration the characteristics of the contract, as well as the context surrounding it, when determining how best to address cost overruns.
The FAR calls for the government to “ensure timely notification by the contractor of any anticipated overrun or underrun of the estimated cost under cost-reimbursement contracts.” Depending on whether the contract is funded in a lump sum or paid out in increments, the FAR requires the contractor to notify the government when there’s reason to believe that costs will exceed 75 percent of the estimated cost of the contract. The regulation further says that under cost-reimbursement contracts, the government is not obligated to reimburse the contractor for costs incurred in excess of the estimated cost specified in the schedule.
Unfortunately, the contractor was not notifying us of overruns in a timely fashion, nor were we proactively monitoring the situation to determine the root cause of the overruns. The NTC director of resource management was funding the contract at the MPC amount, as opposed to the estimated contract cost. Since the government awards cost-reimbursement contracts based on an estimated cost with a ceiling (or a not-to-exceed price), the contractor receives reimbursement for its actual, allowable and auditable costs. This difference between the MPC amount and the estimated cost awarded can be significant, and the apparent lack of understanding of this exacerbated an already complex situation.
DIG THE DETAILS
Though the NTC had estimated the most probable cost for one contract, it was only after digging into the information that informed supported the estimate that the Acquisition Command realized the estimate was inaccurate. Part of the problem was that the team needed information from various organizations to make a cost estimate, but those organizations weren’t accountable to the acquisition team for the accuracy of the information they provided. (Image courtesy of Ilyaf/Getty Images)
RETOOLING THE PROCESS
Our first step in rectifying the situation was to examine our MPC process—both the elements internal to Acquisition Command and external information received from our customers, the NTC directorates. The command saw room for improvement in the MPC development process. Namely, it lacked trained cost and price analysts; the MPC was developed by one individual with little or no collaboration.
This soon changed for the better when we did the following:
- Filled our vacant cost and price analyst positions with motivated, detail-oriented and highly trainable contract specialists.
- Made the internal MPC process more of a collaborative effort. Having the right people (chief, contract administration personnel, procurement analyst, deputy and commander) participate in the contract review added value by providing much-needed leadership, direction, technical expertise and a wealth of contracting knowledge and experience.
Externally, each directorate (Information Management, Provost Marshal, Public Works, etc.) had a contracting officer’s representative (COR), who provided their cost estimate (or directorate’s MPC) to Acquisition Command. The command then used these MPCs and other data, such as technical reviews and evaluations, wage determinations and results from cost estimating reviews, to develop a single comprehensive MPC.
We soon discovered that some of the directorates’ MPCs were of poor quality, including, for example, undocumented, additional costs not in the original MPC. As with many large contracts, ours was experiencing changes that were expanding the actual costs. Another factor that contributed to the poor quality of the directorates’ MPCs was the fact that the CORs developing them faced minimal quality checks. They worked for and reported to either the commanding general, the chief of staff or the garrison commander, not the contracting officer.
Of particular note, the chief of staff was responsible for acquisitions and funding for the NTC and Fort Irwin. This served as a platform by which Acquisition Command leadership could partner with the chief of staff to achieve a desired end state that motivated all parties involved. This teaming resulted in a recommendation for a revised version of the MPC process, which included quarterly reviews with all key stakeholders (chief of staff, garrison commander, directors, CORs, Acquisition Command personnel and contracting officer). Now, instead of the CORs explaining cost overruns to the contracting officer at the Acquisition Command organization, they and their directors would have to explain them to the chief of staff (who in many cases was the directors’ senior rater), in the presence of the garrison commander (who in many cases was the directors’ rater), in a headquarters conference room. We determined that if we could minimize mission creep and implement this revised MPC process, the quality of our MPC would improve.
Once we put the plan into action, this transformation yielded significant benefits. The chief of staff, the Acquisition Command, the director of resource management and the contracting officer compared the original directorates’ MPCs with current actual costs, and the directors were asked to explain any overruns in detail. We discovered that in some cases, the directorates were asking the contractor to exceed the scope of the contract, resulting in changes, mission creep and overruns.
After the first session, some one-time adjustments to contract funding were made, and the chief of staff and the garrison commander told the directors that they would be responsible for any future cost overruns for their respective organizations. The end result was a tighter MPC process, a higher-quality MPC and significantly fewer cost overruns.
CONCLUSION
The experience at NTC Acquisition Command yielded a number of valuable lessons in how to apply the MPC for maximum benefit:
- When using the MPC as a post-award tool and funding baseline, ensure that your MPC process is robust and flexible enough to incorporate changes that impact contract costs.
- Contractors must notify the contracting officer in a timely manner when they anticipate overrunning their cost on a cost-reimbursement contract.
- Leadership at all levels, not just in the Acquisition Command, needs to be involved in the MPC process. Everyone who contributes to the MPC and its process is a stakeholder.
- Government leaders and the contractor need to be held accountable for controlling their organizations’ respective costs.
- Keep lines of communication open within the government and between the government and the contractor.
- Ensure that MPC quarterly reviews are rigorous, fair and transparent.
- Finally, continually educate acquisition team members on the MPC and its process.
Taken together, these principles can determine whether and how the MPC can help an organization get a grip on its contract costs.
For more information, contact the author at anthony.j.nicolella.civ@mail.mil.
ANTHONY J. NICOLELLA, a retired U.S. Army officer who held numerous pre- and post-award contracting positions, is a professor of contract management at Defense Acquisition University (DAU) – South in Huntsville, Alabama. He holds an M.S.A. in general administration from Central Michigan University and a B.S. in logistics management from Penn State. Nicolella is Level III certified in contracting and is a member of the Army Acquisition Corps. Before joining DAU, he was a senior buyer and planner for NV Energy Inc. and a supervisory contract administrator for the University of Nevada, Las Vegas.
This article is published in the April – June 2018 issue of Army AL&T magazine.
Subscribe to Army AL&T News, the premier online news source for the Acquisition, Logistics, and Technology (AL&T) Workforce.
