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Unique Pricing And Estimating Challenges Faced In Change Orders, Requests For Equitable Adjustments, And Claims

Breakout Session # 408

Greg Bingham

Date: July 20, 2010

Time: 11:15 am - 12:30 pm

3

Recognized Claim And Damages Theory “Three Column Approach”

Actual

Less

Would Have Been Equals

Claim

4

Reasons For Increased Costs

Scope Increases Unit Rate Changes

• Labor And Material Unit Rates

• Inefficiencies (Disruption)

Delays• Time Related Costs

• Inflation

• Cost Of Capital (e.g., Interest)

Jan Feb March April May June July Aug$0

$20

$40

$60

$80

5

Time-Related Cost

Direct Labor

$1,000

$500

$0

Activity-Related Cost

6

Jan Feb March April May June July Aug$0

$20

$40

$60

$80 $1,000

$500

$0

Direct Labor

“Joint” Cost

7

Jan Feb March April May June July Aug$0

$20

$40

$60

$80

Direct Labor

$1,000

$500

$0

Time-Related

Activity-Related

Claim Methods

8

ContractorOriginal

CostEstimate

ContractorOriginal

CostEstimate

Total Cost Claim (Entire Overrun)

Actual Costs

Change Orders

ContractorOriginal

CostEstimate

Modified TotalCost Claim

Change Orders

Contractor Inefficiencies

ContractorOriginal

CostEstimate

Change Orders

Not Claimed

Build Up Claims

“Sanity Check”

9

Claimed

ContractorCost

Estimate (with Changes)

Overrun

Not Claimed

Claimed (Entire

Overrun)Claimed

(More ThanEntire

Overrun)

1010

10

Low High

Cost Of Initial

Preparation

Percentage Of Claim Dollars Recovered

How Do The Methods Compare?

Low

High

Total Cost

ModifiedTotal Cost

DetailedCost

Build-Up

10

Low High

Total Cost ToResolveClaim

Percentage Of Claim Dollars Recovered

How Do The Methods Compare?

(continued)

Low

High

Total Cost

ModifiedTotal Cost

DetailedCost

Build-Up

11

Customers And Courts Strongly Prefer Detailed Cost Build-Up Method

Significant Up Front Preparation Effort, But Often The Least Costly Method In The Long Run

Faster Settlement (Less Customer Resistance)

Generally Higher Recovery Percentage Than Total Cost Or Modified Total Cost Methods

Observations On The Detailed Cost Build-Up Method

12

Modified Total Cost Claims Can Be An Effective Tool For Getting A “Quick And Dirty” Claim On The Table For Customer Consideration• Vulnerable To Customer “Slow Roll”

Should Be Supported By Detailed Cost Build-Ups Or “Benchmark” Support Where And As Soon As Possible• Properly Done, A Modified Total Cost Claim Requires Much

More Effort Than Perceived

Observations On The Modified Total Cost Method

13

Improving Modified Total Cost Claims

Combine The Modified Total Cost Claim With Some Detailed Cost Build-Up Claims• Example Constructive Changes• Delay Impacts• Labor Disruption Examples

Contractors Can Present Both Types Of Claims And Argue In The Alternative• Different Pricing For Different Legal Arguments• Early Settlement Discussions Or ADR

14

Labor Claims

15

16

Reasons For Increased Costs –Labor Claims

Scope Increases Unit Rate Changes

• Labor And Material Unit Rates

• Inefficiencies (Disruption)

Delays• Time Related Costs

• Inflation

• Cost Of Capital (e.g., Interest)

Labor Overrun Components

17

$25

Budget

$125,000

5,000Hours

$30

WageVariance$25,000

9,000Hours

QuantityVariance$120,000

10,000Hours

ProductivityVariance$30,000

$

Time

Labor Overrun Components

18

Time

$

$25

Budget

$125,000

5,000Hours

$30

WageVariance$50,000

9,000Hours

QuantityVariance$100,000

10,000Hours

ProductivityVariance$25,000

Labor Claims, Generally Should

19

Be Based On Actual Project Experience. Be Based Upon Concurrent, Objective Evidence. Reflect A Reasonable Attempt By The Contractor To

Capture Costs Expended Outside Of Its Control. Reflect Actual Productivity Information, If Available. Consider Actual Labor Rates Vs. Change Order

Rates.

The Contractor Advances Its Position By These Methods

Labor Claims – Approaches

20

Total Cost / Modified Total Cost

Measured Mile

Industry Factors

Measured Mile Example

21

1.36 MH/LF

1.0 MH/LF1.13 MH/LF

Period1

Period2

Period3

Budget .75 MH/LF

Impact .23 mh/lf

Measured Mile Example

22

Claim Calculation:

Linear Feet Installed In Period 3 22,485

"Should Have Been" MH/LF 1.00

"Should Have Been" MHs 22,485

Actual MHs 30,671

Claimed MHs 8,186

Actual Labor Cost Per MH 25.93$

Labor Claimed 212,261$ Markups (7% OH, 5% Fee) 15,601 Claim 227,862$

Industry Factors

23

Mechanical Contractors Association Of America (MCAA)• Used For Thirty Years• Updated Publication In 2005• Derivation Of Factors Not Known• Most Complete Approach

Corps Of Engineers Modification Impact Evaluation Guide (COE Guide)• July 1979• Curves For Certain Impacts (Trade Stacking, Crew Size, Overtime)• Officially Withdrawn By The Corps

Construction Users Roundtable (CURT)• Recent Empirical Data• Not Published• Deals With Overtime, Weather, Schedule, Planning

Pitfalls Of Industry Factors Approach

24

Basis Of Data Is Often Unclear Applicability To Your Situation

• Different Industry• Different Impacts

Very Judgmental

Equipment Costs

25

Reasons For Increased Costs – Equipment Costs

26

Scope Increases

Unit Rate Changes• Labor And Material Unit Rates

• Inefficiencies (Disruption)

Delays• Time Related Costs

• Inflation

• Cost Of Capital (e.g., Interest)

Equipment Costs – Issues

27

Construction Equipment Can Be Owner-Supplied, Contractor-Owned, Or Rented.

Very Complex Area Due To Number Of Disparate Views Of “Actual” Costs.

Can Be Complicated By “Related Party” Transactions.

Equipment Is Frequently Priced By “Agreed To” Rates To Avoid Confrontations Over Costs.• Blue Book• Cal Trans

Equipment Costs –Cost Components

28

Ownership Costs - Charges For Depreciation Of Acquisition Costs, As Well As Overhauling, Insurance, Financing, Taxes, And Storage Of Equipment.

Operating Costs - Expenses The Contractor Faces By Turning The Equipment “On.” Charges Include Routine Equipment Maintenance, Fuel, Lubrication, Tires, Tracks, And Tool Attachment Repair.

Equipment Cost Issues

29

What Does The Contract Say?

Change Order Rates Vs. Major Claims?

Recording Equipment Hours

Idle Vs. Standby

What Are Actual Costs?

Home Office Overhead Costs

30

Reasons For Increased Costs –Home Office Overhead

31

Scope Increases

Unit Rate Changes• Labor And Material Unit Rates

• Inefficiencies (Disruption)

Delays• Time Related Costs

• Inflation

• Cost Of Capital (e.g., Interest)

Home Office Overhead –Conceptual Issues

32

G&A Expenses0

20

40

60

80

100

120

140

160

5 6 7 8 9 10 11 12 13 14 15YEARS

$ M

ILL

ION

S

Actual Revenue

$10M G&A SupportsUp to $70M in Revenue

$15M G&A Supports$71M-$130M in Revenue

$20M G&A Supports$131M-?M in Revenue

Actual G&A 21%

Year 7G&A 14%

Planned Revenue

Year 10Planned G&A 15%

Year 13G&A 12%

Home Office Overhead –Example Costs

33

Officers’ Salaries

Rent

Advertising & Promotion

Corporate Accounting

General & Administrative

Estimating

Legal

Insurance

Utilities

Office Supplies

Telephones

Contributions

Medical And Other Benefits

Taxes

Home Office Overhead

34

Generally Represents The Cost To The Project For Support From A Remote Home Or Division Office, Which Provides Some Services To The Project. Also Called General & Administrative (“G&A”) Costs.

The Eichleay Formula Is Often Used As A Means Of Allocating Some Portion Of Home Office Overhead To Projects, Which Have Been Delayed By Owner Caused Interference (Billings To Billings).

Home Office Overhead –Eichleay Formula

35

x Home Office OverheadFor Actual Contract

Period

= Allocable Home OfficeOverhead

Contract Billings

Total Billings For ContractorIn Contract Period

OverheadAllocable Home Office

=Daily Home Office

Overhead Rate AllocableTo ContractActual Days Of

Contract Performance

x Number Of Days OfCompensable Delay = Claimed Home Office

Overhead

Daily Home OfficeOverhead Allocable To

Contract

Home Office Overhead –Eichleay Vs. Cost-To-Cost

36

Eichleay Method$480,000 x 10% = 48,000

Cost-To-Cost Method$480,000 x 15% = $72,000

vs.

$140,000

Costs $195,000 $520,000 $585,000 $1,300,000

40% Percentage 15% 45%

$1,400,000$700,000$560,000

Claim Project

Billings

100%

Percentage

Project A

10%

TOTAL

100%

Project B

40%

Project C

50%

Why Are We So Careful?

37

38

Daewoo Engineering And Construction Co., Ltd.

V.United States of America

Background

39

Background

40

Palau Has A “Compact Of Free Association” With The U.S.

U.S. Was To Build A Road Around Island Of Babeldaop (One Of 300 Islands That Make Up Palau).

Issue Was Compaction Specification For Embankments, Weather.

Background

41

• Daewoo’s Certified Claim

– $13.4 Million In “Incurred Damages,” Additional Costs Of $50 Million Not Yet Incurred.

– REA Was Ultimately Denied By The CO.– Daewoo Hired Exponent To “Update/Reprice” The

Claim. Resulted In Measured Mile Study Of $42M.

Court Findings

42

Contracts Disputes Act Fraud Clause:“If a contractor is unable to support any part of his claim and it is determined that such inability is attributable to misrepresentation of fact or fraud on the part of the contractor, he shall be liable to the Government for an amount equal to such unsupported part of the claim in addition to all costs to the Government attributable to the cost of reviewing said part of his claim.”

$50 Million

Setting The Stage To Claims Analysis And Pricing

Relevance Of Claims

Some “Street - Lore”

Identifying Contract Changes

Challenges Of Claim Preparation

Hypothetical Claim

Possible Reasons Claim Might Be Waived

4343

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Why Claims Are Relevant

Management – Claim Knowledge Will Improve Job Performance

Customer – Expects Some Claims

Owners And Creditors• Equity• Security For Financing

444444

Some “Street - Lore”

100% Avoidance Of Changes

Customer Is Offended By Changed Work Claims

Claim Preparation Is Not “Fun”

NOT!

454545

Identification Of Contract Changes

Formal Changes• Unilateral Customer Directives• Pricing

Constructive Or Informal Changes• Technical Specifications• Statements Of Work

464646

Claim Preparation Challenges

Skill - Mix

Sufficiency Of Resources

Scope And Pricing

Timeliness

Organization

474747

Hypothetical Claim

484848

Original Contract Price 115$ million

Original Contract Costs 100 million

Incurred Costs 120 million

To Go Costs 40 million

Subtotal (160) million

Over-Run 60$ million

Hypothetical Claim (Continued)

494949

Changed Work Claim 55$ million

Changed Work Claim Settlement 33$ million

Original Contract Price 115$ million

Claim Settlement 33 million

Less: Claim Preparation (3) million

Revenue 145$ million

Hypothetical Claim (Continued)

Claim Settlement Compared To New Business

Assume Average Before Tax Profit Is 10%

$30 million ÷ 10% = $300 million

505050

Possible Reasons Claim Might Be Waived

Lack Of Training

Insufficient Cross Checking With Counsel

Lack Of Clarity Regarding The Original Contract Requirements

“Our Fault” Attitude

515151

Conclusion

Claim Control And Preparation May Be Challenging, But Is Very Important And Beneficial To Your Company.

Damage Claim

525252

Simple Example Of Dispute Process Involving The Government

FAR, Part 33: Protests, Disputes And Appeals

Contractor Notifies Contracting Officer And Prepares Claim Claim Summary Requirements Of The Original Contract Describe Change (Entitlement) Describe Impact (What Changed) Quantify Increased Costs And Increased Schedule

Audit And Technical Evaluation Performed At Contracting Officer’s Request

Contracting Officer Negotiates With Contractor Representative

Final Decision By Contracting Officer

5353

Contractor Can Accept Or Appeal Final Decision• Boards Of Contract Appeals• U.S. Court Of Federal Claims

Contractor And Government Prepare For Trial• Claim Brought Current• Document Production• Depositions• Other Preparation

Trial Or Hearing

Simple Example Of Dispute Process Involving The Government

(Continued)

545454

Claims Pricing “How To’s”

Types Of Increased Costs

Some Recommendations For Identifying And Pricing Claims

Claim Pricing Challenges

5555

Developing The Claim

Determine The “Rough” Cost Baseline• Cost Baseline Is Generally The BAFO + Formal

Changes, Or The Budget • Develop Overruns By Task, Functional Area Or Both

• Cost Analysis Helps You Avoid Missing The 800 lb. Gorilla

Determine The Technical Baseline - Know The “Hard Legal Requirements” Of The Contract

5656

Changed Work Claim Identification

Technical And Legal Review

Change 1 Change 2 Contractor Delay Disruption

Engineering

Manufacturing

Quality

Management

Cost Growth Review

575757

Typical Changed Work Claim Elements

Direct Cost Claims For Changed Work• Labor• Material• Subcontracts

Delay-Related Costs• Sustaining Personnel (i.e., Fixed Direct

Charging Personnel)• Escalation (Both Material And Labor)• Unabsorbed Overhead

5858

Typical Changed Work Claim Elements

(continued)

Disruption, Acceleration And Inefficiencies Other

• Profit• Claim Preparation Costs (Internal & External)• Legal Fees• Interest

5959

Some Challenges In Developing The Claim

Claim Development Is Resource Intensive• Requires Input Of Key Program Personnel

Throughout The Process

Perspective Of Program Personnel

Waivers And Other Legal Issues• Waivers Not Fully Considered Or Too Broadly

Interpreted• Schedule Slippage

6060

Avoid Common Pricing Challenges

Double Counting Between Claim Elements

Improper Baseline• Overstated Claims• Understated Claims

No Linkage Between Entitlement And Pricing (Cause And Effect)

6161

Summary And Recommendations

Generally Avoid Use Of Total Cost Method

Use Modified Total Cost For Settlement Discussions, ADR And Trial Where Appropriate• Consider Combination Of Modified Total Cost And

Detailed Cost Build-Up Methods• When Using Modified Total Cost, Still Demonstrate

And Prove Costs Claimed

6262

Detailed Cost Build-Up (Change By Change) Generally Results In Fastest And Best Settlement• Perform Thorough Technical And Legal

Evaluation To Determine The “Hard Legal Requirements Of The Contract”

• Coordinate Cost, Technical And Legal Claim Efforts To Maximize “Hardcore” Claim Pricing

Avoid The Common Claim Pricing Pitfalls

Summary And Recommendations

(continued)

6363

Delay-Related Cost “How To’s”

Sustaining Personnel Material And Labor Escalation Fixed Overhead Costs

Claim

6464

Schedule Analysis Goals

Quantify Actual Program Delays Identify Actions, Inactions Or Events Which Caused

Delays Determine Party(ies) Responsible Identify Impact On Costs

=

6565

As-Planned Vs. As-Built

AssemblyDesign

Hardware Procurement

Software Development

Start Finish

As-Planned

4 Months

5 Months

3 Months

4 Months

Start

Design ModsDesign

Software Development

Finish

4 Months

5 Months

6 Months

3 Months 4 Months

Assembly

DelayDelay4 months4 months

Hardware Procurement

As-Built

6666

Sustaining Personnel

Certain Direct Charge Personnel Perform Work As A Function Of Time

Program Extension Can Cause A Direct Increase In The Cost Of Time-Related Efforts

In Order To Identify Time-Related Personnel:• Focus On Program Roles Not Individuals

• Critically Evaluate Which Roles Must Continue In Order To Maintain The Program

6767

Sustaining Personnel

Examples Of Time-Related Personnel:• Program Manager• Certain Program Control Personnel• Departmental Managers, Supervisors, And

Liaisons• Direct Charge Clerks Or Administrative

Personnel• Some Engineering Personnel• Certain Personnel In Quality And Product

Assurance

6868

Sustaining Personnel

To Fully Support This Area Of Claim:• Provide Accounting Records For All Hours

Incurred On Time-Related Efforts

• Prepare Exhibit Depicting How Each Time-Related Effort Transitioned To Different Personnel Throughout The Program

• Prepare A Graph Of Total Time-Related Work Throughout The Program To Show Consistency Over Time

6969

Sustaining Personnel

Time-Related Personnel Direct Labor

Planned Performance Period Extension Period

Total Direct Labor

Direct LaborHours Impact Of

Extended Manning Of Time-Related

Personnel

7070

Sustaining Personnel

Impact For This Claim Area Can Be Calculated As Follows:• Months Of Compensable Delay• Multiplied By: Average Monthly Hours• Multiplied By: Labor And Overhead Rates

To Try To Simplify Pricing, Consider Estimating The Impact Of Each Department Separately

7171

Labor And Material Escalation

When A Program Is Delayed, The Performance Of Certain Activities And The Procurement Of Certain Material May Occur In A Later Time Period Than Otherwise Would Have Been The Case

The Increased Cost Which Is Caused By Direct Labor Rate Or Material Unit Cost Increases Are Typically The Subject Of Escalation Claims

7272

Labor And Material Escalation

Compensable Labor And Material Escalation From Customer Delay Can Occur From:• Normal Economic Inflation• Negotiated Union Contracts

• Purchase Agreements

• Labor Or Skill Mix Variance$

7373

Labor And Material Escalation

To Prove This Claim Area:• Emphasize The Difference Between The Actual

Rates And The Rates That Should Have Occurred Had There Been No Delay

• Avoid Relying On Overly Simplistic Comparisons Of Bid Vs. Actual Rates Or Unit Costs

7474

Recap Of Delay-Related Damages

Recovery Of Damages Is Dependent On Proof Of Delay

Sustaining Personnel Material And Labor

Escalation Fixed Indirect Costs

7575

Disruption Pricing “How To’s”

Definition Of Disruption

Some Example Causes Of Disruption

Entitlement, Causation, And Increased Cost

Some Pricing Approaches

767676

What Is Disruption?

Loss Of Productivity On Original Scope Of Work

Change In Working Conditions, Resources Or Manner Of Performing Work

Change Orders Can Affect Work Not Otherwise Thought Of As Changed

7777

Example Causes Of Disruption

Changed Work• Rescheduling Of Planned Work• Excessive Overtime To Avoid Schedule Slippage• Less Than Optimal Work

Sequencing• Changes In Manufacturing

Or Design Work Methods• Excessive Rework• Loss Of Learning

787878

Example Causes Of Disruption(Continued)

Customer Delays• Unnecessary Starts And Stops To Contract Activity• More Loss Of Learning• Underutilization Of Work Force• Loss Of Economies Of Scale

Acceleration• Excessive Overtime• Congestion In The Work Place • Resequencing Of Work

Performance

7979

Entitlement, Causation And Increased Cost

Entitlement: Often The Same As For Discrete Claims

Causation: Demonstrate The Effects Of Changed Work On The Original Scope Of Work, i.e. The Unchanged Work

Increased Cost: Quantify Increased Cost Of Performing Original Scope Of Work, Plus Profit

8080

Simple Example

In Millions

Estimated Cost-At-Completion $500

Less: Original Budget <200>

Cost Growth 300

Less: Discrete Changes <110>

Unexplained Cost Growth $190

818181

Disruption Pricing Approaches

“Should Cost” Approach - Compare Actual Productivity To Productivity On:

• Unaffected Portions Of Work• Similar Work• Productivity Contemplated

In The Original Bid

Learning Curve Analysis

8282

Regression Analysis

Method Of Using One Or More Independent Variables To Quantify A Dependent Variable

Applying Regression Analysis To Disruption• Independent Variable - Increased Costs Of

Changed Work• Dependent Variable - Increased Costs Of

Unchanged Work • Regression Calculates The Mathematical

Relationships Between The Variables

Least Squares Regression Analysis

8383

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Cost Recovery Issues on ClaimsDisclosing Cost Information

Cost Information Under CAS And / Or FAR Part 31 Cost Information Assuming CAS And FAR Part 31 Do Not

Apply• Direct Costs Only• Disclosure Of Indirect Cost Rates• Disclosure Of Typical Profit Rates• Inclusion Of Expressly Unallowable Costs

Establishing That Contractors Books And Records Should Be Relied Upon• Prior Government Audits (e.g., DCAA, DCMA, IRS, EPA, DHS,

Etc.)• Audited Financial Statements• Lending Covenants• Special Purpose Audits Of Claimed Costs• Reliance On The Work Of Others• Work Papers

85

Termination For Convenience Equitable Adjustment After Partial Termination

Contractor May Request An Equitable Adjustment On Continued Work (FAR 49.208)

Contracting Officer Has Authority, Unless Delegated To The TCO

Follow Cost/Pricing Proposal Format (FAR 15.408)

Costs Included In A Request For Equitable Adjustment Shall Not Also Be Included In The Termination Settlement Proposal

Contractor Shall Complete TINA Certification

86

Termination For Convenience Pricing Unsettled Contract Changes

Resolve All Unsettled Contract Changes As Part Of Negotiating The Final Termination Settlement Proposal (FAR 49.114)

Incorporate Resulting Changes In Contract Price Into The Profit/Loss Analysis (FAR 49.203)

87

Reference Materials

1. “BACK TO BASICS: As The Pendulum Shifts To More Fixed Price Contracts, Be Prepared For More Contract Changes and Know How To Price Them,” By Greg Bingham, Cheryl LeeVan And David Hall, American Bar Association Annual Meeting Of The Public Contract Section, August 2010.

2. “Administering Subcontracts After A Termination For Convenience,” By Greg Bingham and Patricia Meagher, Briefing Papers, March 2004, Thomson West Publishers.

3. “DCAA Contract Audit Manual Chapter 12 -- Auditing Contract Termination, Delay/Disruption, And Other Price Adjustment Proposals Or Claims”

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Greg Bingham

Greg Bingham is a Vice President with The Kenrich Group, LLC. He has over 22 years of experience in the fields of business and litigation consulting including investigation of allegations of fraud or overbilling.

Professional Experience

Mr. Bingham has assisted clients on Government Contract matters including: 1) regulatory consulting on allowable costs issues arising from the Cost Principles found at Part 31 of the Federal Acquisition Regulation (“FAR”) as well as allocation of cost issues associated with the Cost Accounting Standards (“CAS”), 2) consulting on matters involving allegations of defective pricing, false claims, mischarges and other improper billings to the Government, 3) the Earned Value Management Systems requirements of Department of Defense regulation 5000.2-R, 4) financial statement and special purpose auditing, 5) management consulting and 6) Foreign Military Sales issues and foreign sales issues. This experience has provided him with substantial knowledge of the program management, financial and accounting records and systems maintained by companies who sell to the Federal Government.

Greg’s work has included the quantification of cost impacts and negotiation with Government auditors and oversight personnel. Greg has planned and performed reviews of various defense contractors’ systems including Internal Controls, Accounting, Billing and Estimating as well as policies and procedures.

Contact Information:1250 Connecticut Avenue NW, Suite 650Washington, DC 20036Tel: (202) 420-7680Fax: (202) 429-5673gbingham@kenrichgroup.com

Masters of Business AdministrationUniversity of Texas at Austin

Bachelor of Science in Electrical EngineeringUniversity of Kentucky