Procurement, Management, and Administration of Engineering and Design Related Services - Questions and Answers
IV. Compensation (Payment) Methods
1. What compensation methods are allowed for FAHP funded engineering and design related services contracts? (Posted 7-20-11)
Lump sum, cost plus fixed-fee, cost per unit of work, and specific rates of compensation payment methods may be used. A single contract may contain different payment methods as appropriate for compensation of different elements of work. The payment method(s) used to compensate the consulting engineering firm for all work required should be specified in the original contract and any subsequent contract modifications.
Compensation based on a "cost plus a percentage of cost" payment method whereby fee/profit increases with actual costs incurred or a "percentage of construction cost" payment method whereby compensation increases with the cost of project construction shall not be used (as specified in 23 CFR 172.5(c)). These payment methods provide no incentive for effective cost control by the consulting engineering firm.
2. What are the differences between the "specific rates of compensation" payment method and the prohibited "cost plus a percentage of cost" payment method? (Posted 7-20-11)
The "specific rates of compensation" payment method provides for reimbursement for consultant services on the basis of direct labor hours at specified fixed hourly rates (including direct labor costs, indirect costs, and fee (profit)) plus any other direct expenses/costs, subject to an agreement maximum amount. The "specific rates of compensation" payment method should only be used when it is not possible at the time of procurement to estimate the extent or duration of the work or to estimate costs with any reasonable degree of accuracy. Use of this payment method requires close monitoring by the contracting agency to ensure efficient methods and cost controls are employed by the consultant.
While the inclusion of fee (profit) in the loaded hourly rate(s) established for a contract allows the fee earned to be based on the labor hours worked on the project, this is not considered a "cost plus a percentage of cost" payment method. A key distinction for the "specific rates of compensation" payment method is that indirect costs and fee must be recovered as a component of the established, fixed hourly billing rates for labor hours worked. Payment of fee as a separate percentage based on actual labor and indirect costs incurred creates a "cost plus a percentage of cost" arrangement whereby the consultant's fee is increased automatically with increases in either direct labor or overhead costs.
Both the "specific rates of compensation" and "cost plus a percentage of cost" payment methods could in theory render the same total compensation for services performed, however the prohibited "cost plus a percentage of cost" method allows the fee earned by the consultant to increase over the performance period of the contract with increases in the cost of direct labor and/or overhead. The "specific rates of compensation" method establishes a loaded, fixed hourly rate up front which will not change for the duration of the contract and provides reimbursement to the consultant based on the labor hours worked. The "cost plus a percentage of cost" method establishes fee percentages up front which are then applied to actual labor and indirect costs incurred by the consultant over the life of the project.
For example, should a consultant's direct salary rates increase during the performance period of a contract, compensation under the "specific rates of compensation" payment method would not change. Whereas under the "cost plus a percentage of cost" method, as the actual direct labor or indirect cost rates increase, so does the associated fee recovered by the consultant. Under both methods, the more labor hours a consultant works, the more fee that is earned by the consultant, subject to an established total contract maximum amount. However, only under the "cost plus a percentage of cost" method, does the fee earned increase with increases in the cost of the labor hours worked.
Since the cost plus a percentage of cost method provides no incentive for cost control, it is prohibited from use on engineering and design related services funded with FAHP funding (as specified in 23 CFR 172.5(c)).
While the establishment of fixed hourly rate(s) and a maximum contract amount provide some cost control for the contracting agency under the "specific rates of compensation" payment method, consultants still have minimal incentive for efficiency. As such, this payment method is the least preferred allowable payment method and its use on contracts or for components of contracts generally should be limited to only smaller, basic tasks where it is difficult at the time of procurement to estimate the extent or duration of the work. If the scope of work and/or level of effort for the desired services become better defined, a more traditional "lump sum" or "cost plus fixed-fee" payment method should be employed.
Federal laws and regulations for use and application of cognizant approved indirect cost rates still apply in the development of the fixed hourly rate(s) for the "specific rates of compensation" method. Additionally, since financial risk to the consultant is minimal under the "specific rates of compensation" payment method, the fee component of the fixed hourly rate(s) should be commensurate with that limited risk. As with other payment methods, the fee should be based on the anticipated scope and complexity at the time of contract negotiation. (See Contract Negotiation Question & Answer No. 2)