Cost of Risk

Fixed-price stimulus contracts could create more problems than they solve.

The conventional wisdom in Washington is that fixed-price contracts are the government's best procurement option. Support for other types of acquisition vehicles, such as cost-plus or time-and-materials contracts, has become politically risky because of the potential for waste, fraud and abuse.

The Obama administration has encouraged agencies to use fixed-price contracts for Recovery Act projects, but some have questioned whether a one-size-fits-all approach is the most effective way to spend stimulus dollars. The federal government generally uses fixed-price contracts when requirements and risk are unlikely to change and when a reasonable cost estimate can be established. The initial contracts related to the Recovery Act will involve construction and public works projects, which usually are fixed-price.

Stimulus funds also will go to initiatives in which schedules, requirements and cost are more difficult to estimate, such as broadband, health information technology and advanced research energy-based projects. Contracting observers say fixed-price contracts not only are inappropriate for many of these projects, but also could scare away potential bidders-thereby reducing competition and raising prices.

"There is going to be enormous pressure to use fixed-price contracts even if it's not the best tool, because contracting officers and [agency] leadership are under intense scrutiny," says Jaime Gracia, a senior associate with Vienna, Va.-based Octo Consulting Group and author of a blog on federal acquisition.

President Obama has blamed skyrocketing cost-plus contracts for many of the high-profile acquisition problems in Iraq. In directives to the Office of Management and Budget and in his fiscal 2010 budget proposal Obama has encouraged the use of fixed-price contracts.

Language in the Recovery Act states that "to the maximum extent possible" contracts should be awarded fixed-price and through competitive processes. If either option is not used, contracting officers must provide a public justification for the decision-painting a potential bull's-eye on them if the contract's cost or performance runs into significant problems.

"Fixed-price contracts . . . provide maximum incentive for the contractor to control costs and perform effectively and impose a minimum burden upon the contracting parties," wrote OMB Director Peter R. Orszag in a February memo to agencies. "These contracts expose the government to the least risk."

But that lack of risk comes at a price. Contractors generally adopt a more cautious, and arguably higher, pricing estimate when using a fixed-price contract to cover themselves for potential situations that could arise. Fixed-price contracts also provide less incentive for the contractor to finish ahead of schedule and below pricing estimates than would a cost-plus or performance-based contract. Even so, the administration says bids for many of the first stimulus-funded construction projects are lower than anticipated and work is being performed ahead of schedule.

Richard C. Loeb, adjunct professor of government contract law at the University of Baltimore School of Law, believes fixed-price contracts likely will be the wisest and safest tool for spending stimulus funds. But he argues the administration would be better served by tapping the expertise of its acquisition workforce and allowing those employees the flexibility to choose the vehicle they find most appropriate.

"I am reluctant to say one contract type is better than another. Each contract type is developed for different circumstances," says Loeb, who previously served as OMB's acting deputy administrator of federal procurement policy. "The key is knowing when those circumstances are appropriate for one contract type versus another."

In April, federal agencies reported to Congress that the majority of Recovery Act contracts they would issue would be fixed-price. The Education Department said it would make at least 84 percent of its contracts fixed-price, while Agriculture projected a 93 percent rate. Only the Energy Department-which relies on several complex cost-reimbursement contracts for the management and operations of its laboratories-suggested fixed-price contracts would be out of reach.

So far, agencies have failed to deliver on those estimates. While a majority of recovery-funded agency contracts have been fixed-price, they represent a small percentage of overall procurement spending, according to a June report by INPUT, an industry research firm in Reston, Va. Of the $3.9 billion in stimulus contract actions reported to the government through May 27, only 18 percent have been fixed price.

"A substantial percentage of the dollars awarded are being channeled through cost-plus contract vehicles, which are the very contracting method that President Obama aimed at regulating in his campaign and in early acquisition policy guidance," the report said.

One explanation is 94 percent of the contract spending has been issued against existing awards-generally cost-type contracts-that were in place prior to the Recovery Act's passage, INPUT said.

Others suggest agencies, pressed to spend money quickly, have shied away from fixed-price contracts, which can take longer to execute, are tougher to write, require more staffing and are more likely to generate protests.

"The focus is always on cost, schedule and performance," Gracia says. "What's not considered is the actual procurement costs. It takes more management, oversight and personnel to get a fixed-price contract out on the street . . . which leads to higher procurement costs on the front and back ends."

Time-and-material contracts typically are faster to issue but are considered the third rail of acquisition, ranking dead last among preferable procurement options in the Federal Acquisition Regulation. Cost-plus contracts grew in popularity during the Bush administration but have declined recently. In fiscal 2008, they represented just 25 percent of all contracting dollars, compared with 60 percent for fixed-price, according to OMB data.

"We go through this cycle every decade or so," says Loeb. "We tend to do these types of things because of perceived scandals or misuse, and right now there is a perceived misuse of cost-type contracts." In time, he says, the pendulum will swing back in the opposite direction, "leading us to throttle back to cost-plus contracts."