Federal Acquisition Regulation (FAR) Part 16 describes types of contracts “… that may be used in Federal government acquisitions.” The phrase “type of contract” is often used to distinguish whether the purpose of a federal government contract is the acquisition of IT services or IT hardware or production of a major weapon system, or construction of a building, or services of many kinds. But in FAR Part 16, and for our purposes here, the type of contract is best thought of as the “business arrangement” between the contractor (supplier) and the government (customer). In other words:
“I’ll provide X to you per your schedule, and
you’ll pay $Y to me for specific achievements (along the way or all at the end).”
In the FAR, the time-and-materials (T&M) contract type and its “kissing cousin” — the labor-hours (LH) type — are officially disfavored since the business arrangement places all the risk of unexpected costs or delays on the government. In fact, the use of T&M/LH type contracts is strictly limited to situations when no other type is “suitable” because it is impossible to “… estimate accurately the extent or duration of the work or to anticipate costs …” with a reasonable degree of confidence before award. AND, this must be approved in writing by a senior agency official.
So, how does this business arrangement really work? What makes it so risky for the customer agency/program? Let’s look at how the T&M/LH business arrangement works:
| Contractor provides labor to perform specific needs that the government may alter — within the general contract scope — during ongoing performance. Contractor measures its labor efforts by the hour expended. | T&M ONLY: Contractor incurs costs for personnel travel if needed to meet requirements OR incurs other costs for materials/hardware, etc. — purchased to meet contract needs. Must be expenditures ONLY required directly to meet contract needs. | Contractor bills (and government pays for) all labor hours performed to meet specified requirements. T&M bills/payments include costs for materials/services purchased. Labor hours are billed at contract-defined hourly rates that include direct labor, overhead and profit. Purchase reimbursements allow purchasing overhead. |
So where is all the risk that makes T&M/LH so disfavored?
Recall that T&M/LH is used when the detailed performance needs/costs cannot be confidently predicted. This upfront uncertainty manifests in the fact that factors, such as external circumstances or early performance outcomes or some re-direction at the government level, will generally change ultimate performance costs. For instance:
- Did some of the labor already expended or purchases already made become unnecessary or have to be re-done? Under T&M/LH, the government must still pay for it all.
- Did an early performance outcome reveal that an unanticipated additional step needs to be performed to ensure ultimate contract success?
Cost (likely + schedule) risk — realized and absorbed by the government.
- Did an unanticipated risk occur, causing ultimate failure to achieve some/all contract objectives?
- Was funding not available to pay for the cost increases in 1 or 2 above?
Performance risk — realized and absorbed by the government.
What can be done about this risk and why is T&M/LH my favorite contract type? Come back for Part 2!
As the Seventh Sense Consulting LLC (SSC) Director of Acquisition Practice, Mr. Patrick Shields has over 45 years of experience as an acquisition/contracting professional and innovative leader. As a Navy Department civilian, he was a major weapons systems contracting officer and manager. Since his civil service retirement, with 2 firms he has provided subject matter expertise support to numerous Federal civilian and DoD organizations, including acquisition strategy/ documentation support for key acquisitions, policy development, and personnel training. He also managed a subscription “ask the expert” response team and authored numerous topical publications for over 25,000 professional employees of subscribing agencies.
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