Thursday, February 2, 2012

Performance-Based Payments - DoD Implementation

DoD is proposing to require the use of its performance-based payments (PBP) analysis tool whenever contracts are awarded using PBPs as a financing mechanism. The PBP analysis tool is a cash-flow model for evaluating alternative financing arrangements.

As with all contract financing, the purpose of PBP is to assist the contractor in the payment of costs incurred during the performance of the contract. Therefore interim payments should never exceed total cost incurred at any point during the contract. The Government has found itself in many situations where PBP to contractors have exceed their costs. It gets really sticky when there is a contract termination or some other contract dispute.

Under DoD's proposed regulations, prior to using PBPs, the contracting officer must agree with the offeror on a price using customary progress payments before negotiation begins on the use of PBPs. Then the contracting officer must analyze the PBP schedule using the PBP analysis tool. This tool is an Excel-based model and is available on the DPAP website. Contractors contemplating a PBP arrangement should download and become familiar with this tool. Contracting officers will need your help to ensure the accuracy of the data needed to accurately populate the model.

If performance-based payments are desired, the contractor must submit a proposed PBP payment schedule which includes all performance-based payments events, completion criteria, and event values, along with the expected expenditure profile. If PBP are deemed practical, the Government will evaluate, and negotiate the details of the PBP schedule.

Here's the incentive for the Government. If, based on the PBP analysis tool, the payment schedule will be more favorable to the contractor than customary progress payments, the Government will expect some consideration in return. This is typically a reduction in the profit percentage that was negotiated without concern for PBP payments. DoD calls this a "win-win" situation. On its previously linked website, DoD states the following:

PBPs offer a unique opportunity for a real "Win-Win" financial arrangement for the Government and the contractor. This opportunity presents itself due to the Government and the contractor having differing views of the time-vale of money. The "Win" for the contractor is better cash flow resulting in a more favorable financial outcome as measured by the IRR (internal rate of return) and the NPV (net present value) of the cash flows at a reduced contract price.

The "Win" for the Government is a lower contract price that more than offsets the additional financing costs of providing a better cash flow to the contract. The PBP Analysis Tool employs a discounted cash flow analysis to help the contracting officer to determine the Win-Win financial solution for any PBP arrangement. The tool provides a unique and simple to use "what if" feature on the timing of PBP event completin and payment that enables both sides to objectively assess the ptential risk of PBPs in determining the Win-Win solution.

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