Profit

Q. Can profit be a fixed percent for construction contracts?

A. As an internal policy a transit agency may determine that for certain categories of construction projects fixed percentages of profit are appropriate. However, when writing the contract, profit may not be stated as a fixed percent of costs. In a firm fixed price contract the profit would not be stated in the contract as a separate amount (% or dollars), but in a cost reimbursement type contract, profit is initially negotiated as a percent of the agreed estimated cost of the project. It is written into the contract as a fixed dollar amount.

Grantees may negotiate a clause (“advance understanding”) in any contract, whether for construction or otherwise, that limits the fee or profit on change orders or additional quantities to a stated maximum percent of estimated costs, and which is negotiable downward only, depending on the complexity of the change, the risk involved, amount of subcontracting, etc. This profit limit should not be stated as a predetermined, guaranteed profit percentage on change order work because the changed work may not warrant the percentage in question and such an agreement could be construed as a cost-plus-percent-of-cost agreement, which is prohibited per FTA Circular 4220.1F. When the cost and profit have been negotiated, the contract amendment will contain a fixed price (cost plus profit) for the changed work in a firm fixed price contract or an adjustment to the fixed fee dollar figure in a cost reimbursement contract. (Revised: October, 2010)

Q.  Is there any limitations on the amount of profit a sole source contractor can charge for his product?  I am interested in individual contracts where award is over $200,000.

A. If the contract is being awarded by a Federal agency to a profit-making company, there are limits on the percentage of fee that can be negotiated if the contract type is Cost Plus Fixed Fee.  The limits are 15% for R&D work and 10% for other than R&D.  There are no limits to profit on fixed price contracts. These limits are set forth in the Federal Acquisition Regulations (FAR) Part 15.404-4.  The FAR does not apply to FTA grantees, so there are no Federal statutory limits on the fees they can negotiate with their contractors. However, FTA requires grantees to conduct a cost or price analysis for every contract award and determine that the price is fair and reasonable.  If the product is a commercial product then price analysis is sufficient - ensuring that the price is competitive with other prices for like items sold to the general public in arms length transactions.  If the item or service is not a commercial item, then the profit must be evaluated for reasonableness together with the elements of estimated cost to arrive at a fair and reasonable price. (Revised: October, 2010)



Q. Will FTA grant an exception to calculating profit as a percentage of cost if this is the most beneficial method?  We are in the process of negotiating a construction management contract in which the consultant will essentially provide construction personnel on an as-needed basis under various tasks. For example, there is a task for providing up to 2 resident engineers and a task for providing up to 6 inspectors. A fix fee for profit would not be appropriate. The profit should be calculated based on an agreed fixed percentage of the cost with a cap but will vary with the actual number of personnel and duration of service required. If we need less personnel and the construction duration is less than expected, then the profit will come in under the cap. If we procure the maximum number of personnel and the construction duration exceeds expectation, then the profit will cap off at the maximum provided under the guaranteed maximum amount of the contract and a change order (including profit, overhead and direct costs) will need to be negotiated for services extending beyond the expected duration's. Using profit as a percentage would be better than burying the profit and overhead costs into an all inclusive labor rate - which is a permissible option with FTA. The problem with this all inclusive labor rate is that we would need to determine the exact labor rate in advance which is difficult because for an as-needed type contract, the labor rate is best determined at the time the consultant personnel is hired because of availability reasons.

A. Your question relates to the structuring of a contract on a cost-plus-percentage of cost (CPPC) basis. This form of contract is prohibited by FTA Circular 4220.1F. But the prohibition goes beyond the FTA Circular and is actually prohibited by Federal statute on Federal contracts and third-party contracts funded with Federal dollars. This means that the FTA has no authority to approve of a CPPC contract arrangement under any circumstances. The basis of the prohibition is that the contractor is not motivated to control costs and is actually incentivized to increase costs and thereby increase profits. A suitable alternative would appear to be a cost-plus-fixed-fee level of effort contract. Under this arrangement you would negotiate for a certain number of labor hours to be priced using the best available estimates of what type and quality of effort the work was likely to require. A fixed fee would also be negotiated for this total level of effort. The contractor would earn the total fee in return for providing the number of labor hours specified in the contract, and not for incurring the estimated costs. If it cost more or less to complete the specified level of effort, the contractor would still be paid the fixed fee. If the job required less than the level of effort specified in the contract, you would be entitled to a credit in the fee. If the job required more labor hours than those stated in the contract, this would require a negotiated contract modification adding both effort (man-hours) and fixed fee. A variation on this structure can also be a range of labor hours: i.e., once the estimated cost and fixed fee are negotiated for the level of effort predicted to be required, the payment of fixed fee clause can be structured to say that the fee will be paid for the furnishing of the level of effort plus or minus a certain percent. So instead of stating the effort as a single number of hours, it is stated as "not less than X hours and not more than Y hours." For any outcome within the range, the contractor will be paid the full fixed fee of the contract. A fee adjustment would only be required if the effort falls outside the range.

It is recognized that this method is not as precise as the CPPC method but all CPFF contracts have some degree of impreciseness; i.e., the fixed fee dollars paid will never equate precisely to the same percentage of the contract costs as that assumed when the contract was negotiated. But the CPFF method protects both the grantee and the contractor in so far as neither party is at risk with respect to the uncertainty in actual labor costs that will be incurred. This CPFF level of effort approach also avoids the Time and Materials type of contract you mentioned (using fixed billing rates with profit included), which is also not preferred by FTA. In fact, FTA Circular 4220.1F states that this type of contract is not to be used unless no other type of contract is suitable. (Revised: October, 2010)



Q. 
Is there a maximum allowable fee or profit that can be billed on top of direct costs plus overhead by an A&E contractor?

A. If the contract is being awarded by a Federal agency to a profit-making company, there are limits on the percentage of fee that can be negotiated if the contract type is CPFF. The limits are 15 percent for research and development (R&D) work and 10 percent for other than R&D. There are no limits to profit on fixed priced contracts. These limits are set forth in the Federal Acquisition Regulations (FAR) Part 15.404-4. The FAR does not apply to FTA grantees, so there are no Federal statutory limits on the fees they can negotiate with their contractors. However, FTA requires grantees to conduct a cost or price analysis for every contract award and determine that the price is fair and reasonable. If the product is a commercial product then price analysis is sufficient—ensuring that the price is competitive with other prices for like items sold to the general public in arms length transactions. If the item or service is not a commercial item, then the profit must be evaluated for reasonableness together with the elements of estimated cost to arrive at a fair and reasonable price. (Reviewed: October, 2010)




Q.
Is there a best practice or rule for the methodology used to calculate the fixed fee (profit) for an AE Contract? A question has been raised as to whether the fixed fee should be calculated on an estimate of direct labor cost escalated for multiple years. One argument is that the fixed fee should be calculated on present day value of the estimated cost; another argument states that the fixed fee should be calculated as a percentage of the escalated direct labor over multiple years.
 
A. We are not aware of negotiating fixed fee on a CPFF contract based on present value of future years' direct labor costs. The standard practice in the Federal Government has been to use the total estimated costs of all contract years as one of the factors in establishing a fee negotiation position. The FAR gives guidance for contracting officers regarding the negotiation of fee or profit in FAR 15.404-4.
 The DOD Pricing Guide in Chapter 11 provides more detailed guidance for developing a fee position based on the FAR principles, but also using the structured DOD-weighted guidelines methodology. (Reviewed: October, 2010)



 
Q.
We received a time and materials cost proposal from an engineering company where profit was calculated off of total cost (i.e., off of subcontractor costs as well as prime costs) as opposed to just the costs to their company. It is our belief that profit should only be calculated off of their company costs only—is this correct?

A. We would agree with you that profit should not be multiplied when the prime contractor must subcontract part of the work to other firms. The prime's management of the subcontractor will be compensated with normal profit factors as the prime bills you for its subcontract management labor costs with profit in the hourly billing rates. To add another profit factor to the subcontract prices, which already include the subcontractor's profit, results (in our opinion) is an unwarranted duplication of profit for the prime contractor. (Reviewed: October, 2010)



Q. 
Are sub consultant markups allowed? If so, is there a maximum percentage limit? (This would be in addition to the profit negotiated.) Background: we are going to be negotiating with a Consultant and they show a proposed profit and an additional sub consultant markup.

A. There are no profit limitations imposed by FTA on grantee third party contracts or subcontracts.  Both the prime and the subcontractor would be expected to realize a profit on their contracts but the amount of the profit is subject to negotiation.   As far as the prime contractor adding a "markup" (additional profit) to the cost of the subcontract, that also is subject to negotiation.  We would suggest you question the prime contractor as to his reasons for requesting additional profit on the cost of the subcontract, and if you are not convinced that there is a legitimate reason for the markup, then you should not allow it. If you are awarding a cost plus fixed fee contract and you are willing to allow additional prime contractor profit on the cost of the subcontract work, be sure you state the total fee for the prime contract in dollar terms (including the additional markup for the subcontract cost), and not as a percent of actual subcontract cost incurred by the prime.  The latter would constitute an unallowable cost plus percent of cost contract. (Posted: February, 2011)


Q.
I am working on a billing for a Cost Plus Fixed Fee contract. The contract states that there is no fee allowable on Travel. I understand that I cannot bill fee on travel but what about the G&A on travel? Is that non-fee bearing or can that be included in my "other fee bearing" costs. I would think that the G&A on travel is non-fee bearing but I can't find that anywhere. I don't want to overbill and get dinged in an audit for billing fee on the G&A portion of travel.

A. We would suggest you settle this issue with the Contracting Officer for the contract in question. It appears that it was the agency's intent to pay you a fixed amount of fee dollars (profit) for effort/ work accomplished, and not for travel. If this is the case then you should bill the fee in proportion to work accomplished, not necessarily as a percent of costs incurred. (Posted: January, 2012)


Q. On federally funded A&E contracts, is it permissible to compensate prime consultants a set percentage amount of compensation (e.g. 3% of Task Order amount) for utilizing small sub-consultant firms?

A. It is permissible to negotiate a fee for the prime A&E contractor for its management of subcontractors. Typically the prime contractor’s direct labor hours will include effort for managing the subcontractors. This labor effort is usually fee-bearing at a rate of between 7% - 10%. You may also decide to add a fee on the cost of the subcontract itself, as you note in your question. If you do, be sure that the contractor's compensation is structured on the basis of a fixed amount of fee dollars (CPFF) and not on a cost plus percent of cost basis (CPPC), which is illegal on federal contracts. This means that when the contract is negotiated, the fee is negotiated as a fixed amount of dollars to be paid for managing the subcontractor, and the fee remains fixed in dollar terms regardless of the actual cost of the subcontract. The fee payable to the prime contractor will not vary because the actual cost of the subcontract varies. (Posted: June, 2012)