A Firm Fixed Price (FFP) contract is a commonly used one by the government because the price is fixed and not subject to change unless the scope changes. The government assumes very little risk while the contractor assumes the majority of the risk. But if you want to play in the sand box and the RFP (request for quote) requires an FFP contract then the contractor has to bid it that way and hopefully has included adequate risk budget in the price. This is a story about an FFP contract that did not work out well for my company resulting in serious consequences.
Background
A large defense company I worked for was awarded an FFP contract for delivery of hundreds of HMMWV (high mobile multi-purpose wheeled vehicle) advanced state of the art communications systems over a period of 5 years. Each system included: 3 different frequencies; 35 telephones; state of the art communications electronics; encrypted electronics components; and other electrical and mechanical parts and components. There were 3 models with variations of communications capability and equipment. The average material costs per vehicle was approximately 67% of the total cost per system.
The base contract included design, development and delivery of 20 LRIP (low rate initial production) units. The LRIP units were dedicated to qualification testing and certification of the system. The period of performance was 2 years, a very ambitious schedule. The contract also included 3 multi-year options. Each option was for delivery of 200 production units.
Problem
The LRIP phase of the program went well. All of the qualification tests passed without incident. The customer authorized option number 1. At this point, my company discovered that the cost of the electronics increased significantly above the proposed price. The company was on a path to lose approximately $500K per unit which was unacceptable. The customer refused to negotiate a new price and insisted the option part of the contract be executed per contract. My company was forced to put in a claim against the customer.
The claim was not well received by the customer. Lawyers got involved. After a long litigation process, the customer terminated the contract with my company as a matter of convenience. Later on, the customer awarded a contract to one of our competitors to complete delivery of the production units. It took several years for my company to gain the respect and confidence of this customer.
Lessons Learned
There are several lessons learned:
- Do not bid an FFP contract that includes fixed priced options that involving a long period of performance without an escape clause that mitigates excessive material cost growth or some unforeseen cost risk.
- Do not ruin a good relationship with an important customer over one contract. If negotiations with the customer fails, consider other options including absorbing the loss before pursuing litigation. Consider the loss of future contracts against the loss on this one contract.
- Preform a rigorous risk assessment during the proposal phase especially on an FFP multi-year contract for a new system development. I would guess, if my company did perform a good risk assessment (which they did not), then chances are someone may have thought of this risk and took actions to mitigate it before the proposal was submitted.
Summary
It is not unusual that on a new advanced technology development program, the cost of the production product as envisioned or estimated during the proposal phase may increase significantly resulting in a much higher unit cost than proposed. In the case above, this risk was not identified but should have been a no-brainer due to the high material content, state of the art electronics, and new development. A company does not have control over the material costs and since the content was high in this case, it should have raised a red flag. But it did not and my company suffered serious consequences.
In addition to losing a significant amount of money on the contract, my company also lost a very good relation with the sponsor government agency. Prior to this contract, my company had a very good track record of performance on multiple contracts with this agency. It took a number of years for my company to gain the respect and good relationship with them which cost my company several large contracts.
Remember, there is no more funding coming to you on an FFP contract. For this reason, it is imperative to conduct a very thorough and complete assessment during the proposal phase and include adequate schedule time and budget in the price to mitigate the identified risks.
Bio:
John earned a BS in Mechanical Engineering and MS in Engineering Management from Northeastern University. He has a total of 44 years’ experience, 30 years with DOD Companies. He is a member of PMI (project Management Institute). John has managed numerous firm fixed price and cost plus large high technical development programs worth in excessive of $100M. He has extensive subcontract management experience domestically and foreign. John has held a number of positions over his career including: Director of Programs; Director of Operations; Program Manager; Project Engineer; Engineering Manager; and Design Engineer.His technical design areas of experience include: radar; mobile tactical communication systems; cryogenics; electronic packaging; material handling; antennas; x-ray technology; underwater vehicles; welding; structural analysis; and thermal analysis. He has experience in the following areas: design; manufacturing; test; integration; selloff; subcontract management; contracts; risk and opportunity management; and quality control. John is a certified six sigma specialist, certified level 2 EVM (earned value management) specialist; certified CAM (cost control manager).