Eric McCameyCEO, Managing Consultant

Business Insight andTransformation Group, LLC

© 2015

An Approach for Costing, Pricing, and Managing Firm Fixed Price Projects for Profitable Results

• To present a framework for managing risk and maximizing returns on Firm Fixed Price (FFP) projects in client companies.

• To Educate on the risks and potential rewards of FFP

• To present a proposed process for costing and pricing FFP

• To present a proposed process for profitably managing FFP once awarded

Objectives

• Cash and Earnings are paramount to well managed companies.

• Revenue growth apart from earnings growth has limited rewards.

• If the current base for a Government contractor consists primarily Cost-Plus type contracts, there is little potential for more than 7% return on costs for most projects – only modestly better for Time & Materials.

• Learning to propose and profitably manage FFP is a key to meeting earnings goals.

Why Firm Fixed Price?

• In Cost Plus type contracts, the customer bears 100% of the risk of cost growth. The only incentive over contractors is potentially through the use of award and incentive fees in some cases.

• By definition, an FFP contract has a fixed price associated with a given scope of work. The contractor must perform to the scope of work regardless of what it costs once an agreement is reached.

• Many of the services based FFP contracts are priced more like T&M and carry little risk if the LOE was estimated well.

• FFP contracts that require a more complex technical solution carry greater risk as the likelihood of underestimating costs, experiencing unpriced changes, schedule risks, and customer acceptance issues run high.

The Risks of Firm Fixed Price Contracts

• What is the key to FFP profitability beyond the obvious of keeping costs low and sell prices high?

• The key to FFP profitability is in effectively managing risk.

• Costs required to fulfill the scope of work will occur whether those costs were factored into the selling price or not. Honestly estimating costs and challenging estimates minimizes future surprises and profit erosions.

• A less obvious source of profitability is to translate reserves into profit. FFP contracts should almost always have some level of reserves in the costs. When these risk reserves are quantified and actively mitigated and managed, the potential for translating unused reserves into profit increases.

• FLAWLESS EXECUTION = LOW USE OF RESERVES = HIGHER PROFIT MARGINS

The Key to Fixed Price Profits

A proposed process

Estimating, Costing, and Pricing FFP

FFP Estimating, Costing, and Pricing Process

• Similar to the Technical Red Team, a “Cost/Schedule Red Team” should aim to ensure that ALL work in the WBS has been estimated.

• This team’s job is NOT to determine the winning sell price, but that the cost of execution and the schedule for execution is realistic.

• Determining the selling price is a function of management based on desired profit margins or even willingness to absorb loss if the smaller FFP’s are deemed to be an investment.

• The Cost/Schedule Red Team should ensure that:

• All WBS elements were costed

• A reasonable Basis of Estimate (BOE) was used

• The schedule has a logical network of tasks

• Resources in the schedule are balanced (not over/underloaded)

• Risks are adequately documented in the Risk Register.

Cost/Schedule Red Team Review

• Once it has been determined that an RFP is FFP, the level of execution risk must be determined.

• Does something have to work at the end?

• Are the requirements well defined or are they vague or ambiguous?

• Are there risks to meeting imposed schedule milestones?

• What re the risks of non-acceptance or expensive rework?

• Determining and baselining the technical solution before estimating is essential. The risk of over or under costing increases when the technical solution is changing while estimating and costing is taking place iteratively.

Identifying Technical/Execution Risk

• One way to mitigate risk and baseline the technical approach is to perform a “Technical Red Team” review.

• The Technical Red Team should be a group of independent SMEs from within the company or partner teammates that will “beat up” on the solution to identify weaknesses.

• The goal of this team is not to help the team win, but to identify risk. Other gate reviews worry about winning. This team is to ensure that management is aware of risks and that risks are fed into the costing process.

• A formal report should be issued to executive management, the proposal/project team, and the costing/pricing leads.

Technical Red Team Review

• The Work Breakdown Structure (or WBS) is the basis of estimating, scheduling, and managing project execution.

• It is more than a task listing just to cost in relatively large “buckets” like CLINs or SLINs imposed by the customer.

• The WBS should be a detailed hierarchical breakdown (usually product oriented) that decomposes the SOW into elements that will form the basis of estimates, scheduling of the work, assignment of work once awarded, reporting, and managing risk.

• Without a solid WBS, the rest of the project is doomed before ever starting. A good WBS minimizes the “I forgots” which later cost time and money.

Developing the Work Breakdown Structure

• A Resource Loaded Schedule is developed by

• Representing the WBS in a tool like MS Project, Primavera, Open Plan, etc.

• Adding hourly labor rates, ODCs, and materials as resources in the tool.

• Assigning these resources and task durations to the lowest level WBS elements where work is done.

• Scheduling lowest level tasks by establishing a network of logical dependencies from the start and determining the Critical Path of activities.

• The benefits of using a Resource Loaded Schedule are:

• The ability to test the validity of estimates in the context of a realistic model of schedule and resource constraints. (i.e. Five key resources are overloaded by 300% in January requiring either extension of the schedule, shifting of work, or adding of resources …at a cost.)

• A cost profile can be exported showing the expected costs by month. This allows for better planning of payment milestones and modeling DSO.

Using a Resource Loaded Schedule

• Project reserves are used to add additional costs to the bid to prepare for possible contingencies.

• Reserves are usually documented in a “risk register” that identifies the risk, the maximum impact in dollars, the probability of occurrence, and likely impact (prob x max impact).

• Sometimes these matrices identify mitigation actions, the cost of the mitigations, and the post mitigation impact.

• The first source of risk should be the report issued by the Technical Red Team. However, risk can come from contractual, schedule, or other programmatic sources.

• These risks should be translated into dollars regardless of the target price. The sell price (the FFP paid by the customer) is a management decision. Costing and estimating should be what it is independent of price. Management has to determine how much profit (or lack thereof) it is willing to tolerate.

Identifying Risks and Reserves

• A cash flow model should forecast when:

• Costs will be incurred (including payments to suppliers)

• When bills will be sent

• When cash (payments) will be received.

• A cash flow model will allow management to see in advance what the Days Sales Outstanding (DSO) metric is likely to look like.

• If there is a lot of outflow of cash before the payments come in, it will hurt DSO.

• Perhaps there are materials and other expenditures that could adopt a Just-In-Time approach to improve cash flow and DSO.

• Perhaps the customer is willing to negotiate more favorable billing milestones in exchange for some other want. (i.e. like a reduced price in exchange for being able to bill more frequently and sooner based on progress).

Cash Flow Modeling

A proposed process

Managing FFP Projects for High Returns

• Elements of successful FFP Project Management include:

• Clearing up any vague or ambiguous requirements before baselining the project plan.

• A strong change control process. (Avoiding “Requirements Creep”)

• Linking cost expenditures to work accomplishment ( EVM lite or similar)

• Managing project risks through the life of the project.

• An actively statused Resource Loaded Schedule / Basline schedule control

• Executive review by management with defined criteria beyond the normal PMR process. Should review the items updated above.

Elements of Effective FFP Management

If you think you would like to learn more about this process for your organization, please send email correspondence to info@BITGconsulting.com or call us at (301) 658-BITG (2484).

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