Federal Business Intelligence Analyst Brian Friel released a study about big MACs which explores the 2009 order by President Obama to favor fixed-price contracts over cost-reimbursement contracts. The impact being, cost-reimbursement orders limit companies’ ability to increase profits by reducing their operating costs.

Friel joined The Federal Drive with Tom Temin and Emily Kopp Wednesday to discuss the study.

Executive Summary: (By Brian Friel)

President Barack Obama in 2009 ordered agencies to favor fixed-price contracts over cost-reimbursement contracts, which leave the government exposed to expensive cost overruns. At the same time, the federal government is seeking to do more work with vendors using multiple-award contracts, or MACs, an arrangement designed to speed decision-making without sacrificing robust competition.

This Bloomberg Government Study explores these and other important developments that are changing the nature of the relationship between government purchasers and their suppliers. The study is intended to help companies better understand how different payment agreements can alter the profitability of their multiple-award contracts with the federal government.

Under fixed-price agreements, agencies and contractors agree upfront to a total price. Under cost-type contracts, agencies agree to pay contractors’ costs as they accrue.1 Profit percentages are capped on cost-type contracts. With fixed-price deals, companies can increase profit by reducing their costs below the amount they originally bid.

Under multiple-award contracts, agencies first select a pool of qualified companies to perform certain kinds of work over a period of years. Those companies then compete against each other for specific task orders placed by the agencies. Having a pre-selected pool of vendors allows agencies to more quickly fill orders than they can by holding full-blown competitions among all comers. Buyers retain the ability to drive down costs through competition among MAC companies.

In fiscal 2011, 53.6 percent of spending on multiple-award contracts went through fixed-price orders, compared with 63 percent of spending on all other federal contracts.

The lower rate of fixed-price orders on multiple-award contracts means contractors that rely on MACs for most of their federal revenue may have less ability to increase profit by reducing their operating costs, although there is the potential for MACs to follow the trend toward fixed-price contracts. Meanwhile, companies that rely on cost-type orders via multiple-award contracts assume less risk that cost overruns will erode profits. Amid declining federal contract spending, many companies are facing pressure from shareholders to increase their profits on existing contracts.

This study’s findings also include:

• Cost-reimbursement orders and a subset of these arrangements called “time-and-materials” are more prevalent on MACs than on other federal contracts. On time-and-materials orders, contractors’ profit is included in the hourly labor rates they charge the government.
• Forty-two percent of multiple-award contract spending went through cost-type orders in fiscal 2011. Such deals accounted for just 34.4 percent of spending on other federal contracts in fiscal 2011. Time-and-materials orders accounted for 8.8 percent of MAC spending in fiscal 2011, compared with 2.5 percent of other contract spending.
• There is a notable shift under way from time-and-materials to cost-plus-fixed-fee orders on MACs. On cost-plus-fixed-fee contracts, agencies agree to cover contractors’ costs and to negotiate a fee that provides for their profit. The percentage of MAC spending through time-and-materials orders fell to 8.8 percent in fiscal 2011 from 12.4 percent in fiscal 2010.

The shift away from time-and-materials orders may threaten MAC companies’ profits. Profit is fixed ahead of time on a cost-plus-fixed-fee contract, meaning extra hours of work don’t translate into more profit. Under time-and-materials orders, companies make more profit when agencies request extra hours of work because profit is included in the hourly rate. Companies also can increase their profit margins on time-and-materials contracts by lowering the other costs included in their hourly rates. Companies cannot control profit margins in the same way on cost-plus-fixed-fee contracts, which separate cost reimbursement from profit payment.

The study builds on three previous Bloomberg Government Studies on MACs including “Big MACs: The Rapid Growth of Multiple Award Contracts,” published Dec. 15, 2011; “Big MACs in 2011: Continued Growth, Tougher Competition,” published March 27, 2012; and “Big MACs: Funding for Information Analysis Centers Transformed,” published April 18, 2012.

(Brian Friel is a federal business analyst for Bloomberg Government. The views expressed are his own.)

To contact the analyst: Brian Friel at bfriel1@bloomberg.net

To contact the editor responsible: Anne Laurent at alaurent7@bloomberg.net

(Read the full Bloomberg Government study, “Big MACs: Fixed-Price Deals Lag.” BGov.com is a paid site and requires a subscription for access.)

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