2  Contract Basics

Keywords

Contracts, Contract Types, PWS, FFP

2.1 Context

This courses introduces the concept of contracts to familiarize students with the context for how they may perform work.

The course will use a performance work statement for a firm fixed price contract to formalize the collaboration between the student and the project sponsor.

This also provides the basis for the student to execute the project management life cycle with their project.

2.2 References

• Government Contracting 101
• Federal Acquistion Regulation (FAR) Part 37 Service contracting is a very, very, very, detailed set of regulations about US government contracting.@usgovernmentFederalAcquisitionRegulation2025

2.3 Fundamentals of a Contract

A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more parties. A contract typically involves consent to transfer of goods, services, money, or promise to transfer any of those at a future date. Wikipedia

Our focus is on business contracts where the agreement is between two parties (organizations) for the procurement by or provision of goods/services from one to the other.

• The organization procuring the goods/services is the client.
• The organization providing the goods/services is the contractor.

Organizations use contracts to mitigate their risk and agree on the allocation of risk between the client and contractor.

Contracts are typically written and formally acknowledged (signed) by individuals empowered to legally obligate their organization.

• A contracting official with special authorities to obligate the organization.

• An “Officer” of a corporation with special authorities to obligate the corporation

• Oral contracts can also be legally enforceable but rare in corporate business interactions.

To be a valid contract, both parties must have reason to believe the other party is capable of fulfilling the terms and conditions of the contract.

Amy changes to the contract, known as modifications, must also be formally acknowledged by the authorized individuals.

Failure to meet contract requirements is known as a “breach” of contract.

• A client can terminate a contract early for a breach of contract and/or impose financial or other penalties.

Contracts are typically awarded after a process of soliciting proposals from potential contractors.

• The client will develop a Request for Proposal (RFP) (or other type of solicitation) where they identify their performance and schedule requirements and any other terms and conditions. The solicitation typically includes a section on how to submit proposals and how the client will evaluate the proposals.
• The client will issues the RFP to one (sole-source award) or more (competitive award) potential contractors who then develop bids/proposals for the contract.
• A bid or proposal typically includes how the contractor will accomplish the performance and schedule requirements and what they plan to charge for the contract, i.e., the price/cost.
• The contract solicitation may require contractors to include additional information in their proposal such as resumes for key personnel, past performance evaluations from other contracts, and any subcontractor relationships.
• Proposals are formal submissions and may be in writing, and require oral presentations, videos, etc..
• The client then evaluates all proposals, chooses a winning contract, and awards the final contract terms with potentially some minor negotiations.
• Thee contract solicitation, proposal, and evaluation and award process is usually limited in the amount of communication between the client and prospective contractors.
  • As an example, there can be no communications about the process with the client organization outside the specific channels, or all questions about the RFP must be submitted in a timely manner and the answers shall be shared with all other potential bidders.

2.4 Elements of Contracts

Contracts have three main elements and then a set of associated terms and conditions (Ts&Cs).

• Performance
• Schedule
• Price/Cost

Performance specifies what the contractor shall deliver.

Schedule specifies what shall be delivered by when.

Price/Cost specifies the structure for the payment of goods and services.

Terms and Conditions specify rules for how the contract may be performed, e.g., requirements for security clearances, data protection, dispute resolution, modifications, etc..

2.4.1 Performance

Service Contracts typically incorporate a document that specifies the scope of work and the requirements for what is to be delivered.

The Scope of Work establishes the boundaries for the work to be performed. As an example a contract may limit the areas of work that can be performed to avoid duplication of effort.

There are three main types of requirements documents that vary in their level of restriction on the solution and the level of detail about the work.

• Statement of Objectives (SOO) - few restrictions
• Performance Work Statement (PWS)
• Statement of Work (SOW) - highly specific and detailed

A Statement of Objectives is used when the client is primarily concerned with solving a problem and not how the problem is solved.

• A SOO is typically short and specifies the current state and the desired “objective” state.
• The contractor is required to create and implement a solution that enables the client to achieve the objective state.

A Performance Work Statement focuses on achieving specific outcomes and they want more say in the structure of a solution.

• A PWS may be long or short as it specifies the current state and desired “performance outcomes” or results and provides more guidance on how the solution shall be achieved, e.g., specify classes of tools or architectures but allows the contractor to choose the specific implementations and follow their own processes.
• The contractor is required to achieve the performance outcomes by following the guidance in the PWS.
• The client focuses on monitoring how well the contractor is meeting the performance requirements, not how they perform individual tasks.

A Statement of Work is used when the client is concerned that specific tasks are completed to a given standard.

• A SOW is typically longer than a PWS as it specifies discrete tasks the contractor is to perform and the standards for their performance.
• The contractor is required to perform the tasks to a satisfactory level and the client retains responsibility for achieving their desired outcomes.

The SOW was the document of choice for many years and is still common.

• However, SOWs are best used for well-defined, repetitive tasks where the scope and method are clearly understood.
• A SOW is appropriate when the client has expertise on possible solutions and is confident satisfactory execution of the SOW tasks will lead to the proper results. Otherwise, a SOW can inhibit innovative solutions.
• A SOW can also require the client to spend more resources on monitoring contract compliance as there more tasks to be checked.

The SOO is the other end of the spectrum where the client gives wide latitude to the contractor to develop a solution. Contract monitoring focuses on the objectives instead of the activities.

• This can be challenging as the objective states may be hard to define and measure, especially over time.

A PWS is the seen as a good middle of the road approach where the client provides more guidance about their desired solution but the contractor is incentivized to provide innovative solutions. As a performance-oriented contract, the PWS allows for focused contract monitoring.

• Clients who use a SOO or PWS may require the contractor to develop a SOW to communicate what it will do in developing the solution. This provides the client additional information for monitoring and evaluating performance.

2.4.2 Schedule

The schedule typically includes milestones or dates for the delivery of the goods or services. These may be recurring (e.g., weekly reports), interim/draft deliverables, and final deliverable.

2.4.3 Price/Cost

The price/cost element specifies the terms and conditions for how the clients will pay the contractor for their delivery of goods/services.

The contractor typically proposes a table of price/cost for meeting the PWS/SOW performance and schedule requirements and the client accepts/negotiates the final price/costs incorporated into the contract.

Service contract price/costs typically include four elements:

• Labor
• Direct Costs (Travel)
• Other Direct Costs (ODCs) -
• Indirect Costs

Labor is the price/cost for the worked performed by individuals supporting the contract as either direct support or managerial support.

• Labor costs include the direct labor costs based on the workers wage or salary plus the overhead associated with the direct labor cost, e.g., paying for the fringe benefits for the worker (paid time off (PTO), retirement plan, health care, insurance, …), the corporate portion of the federal taxes for social security and medicare, and other taxes directly attributable to the individual’s labor.

Direct Costs (Travel) is the cost for any travel required by the contract.

• Includes transportation, lodging, meals, and incidentals.
• These costs are typically reimbursed based on actual expenditures or per diem rates agreed upon in the contract.

Other Direct Costs covers all non-labor and travel costs incurred in direct support of the contract, e.g., Purchases of goods or services, e.g., computers or software licenses that might be needed.

• These costs are usually itemized and reimbursed at cost.

Indirect Costs are charges for costs that are incurred that are not traceable directly to a contract. As an example, a contractor may have a pool of administrative contract, purchasing, or legal personnel who allocate their time across many contracts. However, the contractor does not track their time directly to a contract and therefore each contract is charged a portion of the contractors total costs for their support as a “multiple” applied to other costs on the contract.

Each of these cost elements is usually by multiplied by a factor. Common factors include:

• Labor Multiple: covers the fringe benefits and taxes plus other approved costs e.g., marketing and proposal costs.
• General and Administrative (G&A): covers the cost of running a business, e.g., the back office functions such as human resources, legal. contracting, claims, financial management, IT, buildings/services, insurance, ….
• Material Handling (MH): covers costs associated with purchasing goods and supplies.

The cost of a contract are what is actually incurred by the contractor. They are responsible for managing their cost.

The price of a contract is what is charged to the client. This is typically the allowable cost plus profit, typically a percentage of the allowable costs.

The type of contract will determine the planned relationship between cost, price, and risk.

2.5 Types of Contracts

A contract is ultimately a statement about a future that is different than the present.

• Contracts are based on facts and explicit and implicit (unstated) assumptions.
• Thus all contracts involve risk as assumptions may turn out to be incorrect

Contract risks can exist for each element of performance, schedule, and price/cost.

The total risk is shared by both the client and the contractor, however the risks for each element of the contract may not be shared the same.

The client and contractor can use the contract type to formalize how the risks for performance, schedule and costs are allocated and who is responsible for managing those risks.

There are three main types of contracts:

• Firm Fixed price (FFP)
• Time and Materials (T&M)
• Cost Plus Fixed Fee (CPFF)

2.5.1 Firm Fixed Price

Firm Fixed Price contracts identify deliverables and for each deliverable a set of acceptance criteria.

• The client is responsible for ensuring their acceptance criteria are clear and measurable and will actually meet their performance objectives.
  • The contractor proposes a price for each deliverable and is responsible for clearly understanding and meeting the acceptance criteria for each deliverable.
  • The contractor is responsible for most of the risk for performance, schedule and price cost.
• The price is typically based on the projected labor costs for their proposed solution plus their profit.
  • If the actual labor costs are less than the projected costs, the price remains the same and the contractor receives a larger than projected profit.
  • If the actual labor costs are greater than the projected costs, the price remains the same and the contractor gets a smaller than projected profit or may lose money.
    • Some contracts may allow the price to include all costs. not just labor, as part of the FFP.
• The contractor is responsible for managing the effort to achieve the acceptance criteria on or before the scheduled delivery date.
• If the client does not agree one or more deliverables meets their acceptance criteria, they can withhold the entire payment for the deficient deliverables.
  • In this case, the contractor typically chooses to incur more cost (less profit) to “fix” the deliverable.

2.5.2 Time and Materials

Time and Materials contracts, sometimes called labor-hour contracts, identify a scope of work and desired outcomes and RFP requests the contractor to propose a workforce the meet those outcomes along with a table of labor categories and a level of effort for each labor category.

• A labor category establishes an hourly price rate for a worker who meets specified criteria.
  • Criteria may include level of education, field of education, years of experience at a certain level, security clearance level, …
  • The price includes all direct and indirect labor costs.
• The client may include the table of labor categories in the RFP with specifications and ask the contractor to propose the hourly price rate for each category or they may ask the contractor to propose the entire table of labor categories with specifications and price.

The client price for a given period, say a month, is the sum of the number of hours worked by individuals in each labor category times the rate for that category.

• Performance and schedule is risk is shared
  • The client is responsible for managing performance and schedule as they direct/approve the workforce assigned to the contract and their level of effort.
    • If they direct a change to the proposed workforce, they may not meet their objectives.
    • The redirect the workforce from the proposed tasks, they may not meet their objectives.
  • The contractor is responsible for providing the proposed workforce and level of effort under the specifications of the contract.
    • If they fail to provide an adequate workforce, they may be considered in default.
• Price Cost risk is also shared.
  • The client is responsible for meeting their objectives within the awarded funding. If they burn too many hours too quickly, or shift to higher labor categories, they may run out of money before the end of the period of performance or they meet their objectives.
  • The contractor is responsible staffing the labor categories with qualified personnel, regardless of their cost.
    • If the actual workforce has higher than projected costs, the contractor will generate less profit than projected, or may incur a loss.
    • If the actual workforce has lower than projected costs, the contractor will generate higher profit.
    • If the contractor consumes the budget faster than projected, they may run out of money prior to the end of the period of performance and have to stop work unexpectedly - could result in unhappy clients.
  • The contractor is typically responsible for reporting the actual burn rate and projecting the “burn rate” for the remaining period of performance to the client so both can make informed decisions about the work and the workforce.

2.5.3 Cost Plus Fixed Fee

Cost Plus Fixed Fee contracts typically have the client agree to reimburse the contractor for all their allowable costs at a fixed level of fee or profit.

• CPFF contracts shift most of the risk to the client. The RFP typically requests a proposed workforce based on labor categories and level of effort, but the labor category rates are not included in the final contract.
• The client price for a given period is the sum of all the labor hours for each person on the contract times that person’s hour cost rate for the period plus the percent fee. Note: the hourly cost rate can change each period depending upon how many hours the individual actually works.
• The client approves the workforce and directs their effort so are responsible for performance, schedule, and cost.
• The contractor is responsible for providing the proposed/directed workforce at the agreed upon level of effort and ensuring the workforce perform their individual tasks to a satisfactory level.
• The contractor typically has to report and project the “burn rate” but the client is obligated to pay for all incurred costs plus their profit % is guaranteed based on the contract.

There are multiple variations of the CPFF contract to include setting a limit on the fee pool (which makes it more like T&M) or using a tiered award fee based on evaluations of contractor performance - higher fee for better performance.

2.5.4 Contract Type Use Cases

Clients match contract type to their use case. What are their performance, schedule and cost requirements, and how much flexibility do they want, how much effort do they want to spend on monitoring performance, and how would they prefer to allocate and manage the risks.

• FFP contracts are used when:
  • The solution may be higher than normal risk but the outcomes can be well defined and the client wants the contractor to own the risk of performance, especially if an innovative technical approach under a PWS.
  • The client does not want to manage the day-to-day workforce or work and instead focus on the outcomes being achieved.
• T&M contracts are used when:
  • The solution seems low to moderate risk and the client wants to have flexibility in changing their requirements over the period of performance.
  • The client wants to retain responsibility for ultimate performance against the objectives.
  • The clients wants flexibility to adjust the workforce and level of effort using a table of labor categories.
• CPFF contracts are used for low-risk work, typically focused on repetitive services that are well understood.
  • The client is comfortable that an adequate and skilled work force performing the tasks as directed will accomplish the objective.
  • The client is comfortable with maintaining a stable and highly predictable burn rate.

From a contractor’s perspective, they do not get a choice of contract, but they do get a choice of the work they bid for.

More contractor risk means more potential profit.

• FFP: high risk means higher potential profit, both as a baseline and as a possibility if their solution truly is better, faster and cheaper than projected.
• T&M: medium risk for an acceptable but stable profit assuming a stable available workforce at lower salaries.
• CPFF: low risk work at lower but guaranteed profit assuming stable available workforce at competitive salaries

Table 2.1 summarizes how the different contract types exist to provide clients flexibility in meeting their performance, schedule and cost requirements while managing their risk.

Table 2.1: Different contracts types serve different client use cases

Criterion	FFP	T&M	CPFF
Risk Allocation	Contractor bears most risk.	Shared between client/contractor.	Client bears most risk.
Scope Definition	Well-defined deliverables.	Broad or evolving requirements.	Repetitive and well-understood tasks.
Management Effort	Minimal client involvement.	High client involvement.	High client involvement.
Profit Potential	High (but tied to efficiency).	Moderate,steady.	Low but guaranteed.
Use Case	Innovation-focused solutions.	Flexible workforce adjustments.	Predictable and stable tasks.

More contractor risk may also reduce competitive price pressure when bidding.

2.6 Competitive Contracting

When clients releases RFPs for competitive bidding, they have to specify how they will evaluate the bids.

Two common approaches are:

• Lowest-Price Technically Acceptable (LPTA)
• Best Value

An LPTA evaluation approach is commonly used for low-risk work.

• There are multiple competitors who could deliver the work with a qualified work force.
• Evaluate each competitor for being technically acceptable - a binary decision.
• Pick the lowest price (even if just a little lower).
• Evaluations are typically faster and cheaper for the client.
• If they make a bad choice, terminate for default and run another competition.

A Best Value evaluation approach is commonly used for higher-risk work, especially where the client seeks innovative solutions to a complicated set of requirements and is willing to pay a bit more than the lowest cost.

• There are at least two contractors who could deliver the work with a qualified work force.
• Specify multiple evaluation criteria and their respective weights.
• Make a technical evaluation rating (multiple levels)
• Compare the technical ratings to the proposed prices.
• Chose the one that offers a “best value” solution - yes that is ambiguous
• Evaluations can take a lot of time, especially if close.
• More subject to protests.

Regardless of evaluation approach though, most contract awards go to the lowest price bidder with an acceptable proposal, but a best value approach tends to limit the bidding pool.

Given the discussion above, what do you think about the following:

Gary Larson Cartoon

2.7 Contract Concepts for this Course

You shall develop a PWS for an FFP project to formalize the requirements for your project from the sponsor.

• You shall meet with the client sponsor to develop the objectives and deliverables and establish the acceptance criteria for all deliverables.

• You shall develop a high-level schedule e.g., phases, for the project, to describe the flow of the project across the data science life cycle over the weeks in the semster.

• Once the deliverables are finalized then you shall develop a schedule for them subject to the course constraints.

• You shall also refine all terms and conditions in the PWS to align with the sponsor’s preferences.

Once the PWS is complete, you shall collaborate with the client for their approval.

The PWS forms the basis for your solution development and project management activities for the rest of the course.