Time & Material Contracts

April 15, 2010
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Introduction

These contracts are a kind of hybrid between a fixed price and the cost plus models. The model is to agree on some cost rates and use that to calculate total costs over a period such resources are used. Some legitimate expenses of material used in the contractual process are also payable. Hence the name time and material. The payment being for the use by the time of resources of the seller and the expense on material these resources use to deliver the contracted product, services or an item. Consultancy engagements, staff augmentation, and outside support can be built on such models. These will apply when the services needed are well known and thus fits the model well. For example if you were to engage a call center of a known size, you could be paying for the service by the hour, by the day etc. Similarly when the exact deliverables are not known and thus precise statement of work can be made. This may be the situation when you engage consultants for a broad goal and need to pay him on the time the consultant uses on your project.

Time & material contracts

A strict definition of this kind of contracts from Answers.com is as follows. “A contract providing for the procurement of supplies or services based on direct labor hours at specified fixed hourly rates (which rates include direct and indirect labor, overhead, and profit), and material at cost”. These contracts resemble the cost reimbursable model as the buyer agrees to pay for the costs associated with the use of resources of the seller and associated expenses on materials. Additionally, the total cost of acquisition remains somewhat open ended. The contracts can have the characteristics of a fixed price contract as well. Buyer and seller may agree on a pre-determined rate of the use of a resource ( a senior consultant, for example) or the cost of a unit of material used, etc. To prevent run away escalation on costs due to such open ended contracts many organizations tags along a not to exceed a figure with the contract. Similarly, a time limit also can be added and is favored by many organizations.

A labor hour contract, which is variation on the theme of T&M, allows the seller to charge only for the labor hours. The costs of material used are borne by the seller. Time and Material (T&M) contracts are needed when it is not possible to estimate accurately the extent or time needed for the item to be procured; and/or the total cost of acquisition is also difficult to gauge with any degree of confidence.

Many organizations also insist that T&M contracts should only be used only when no other contract models meet the need. The organizations also insist on keeping the not to exceed or the ceiling price documented prior to the contracting is done Like the cost reimbursable contracts, there are several surveillance measures necessary with the T&M contracts. Realize that, in this model too there are no incentives for a contractor to maximize efficiency/ productivity or cost efficiency. Thus these surveillance measures are required with each such time and material contracts being administered. The surveillance measure needs to cover the following areas. What needs to be audited periodically is that the seller is performing efficiently and undertaking cost control measures. The actual surveillance plan should include the specific audits that are to be carried out and the periodicity, etc.

There are some negotiation strategies that could be used by the buying organization to get away from the feeling of issuing a blank check to the seller. These include imposing controls on labor rate, maximum number of labor hours, mark up on materials and the not to exceed total discussed already. You need to determine very carefully if the seller is going to charge you a standard rate for each category of resources. When you are going to parcel out a large value contract, you could insist on a fairer and lower labor rate. Sellers, particularly the experienced ones should be able to determine closely how many labor hours are going to be used for the job. This can be used as a cap on payments so that if these hours are exceeded it is the seller who pays. That can help you get around the problem of T&M where less efficiency is more money for the seller. Mark up on materials that can be 15 to 35% more on the actual money spent by the supplier is another cost inefficiency you need to watch out for. It should be possible to negotiate this margin down with larger contracts. The not –to-exceed limit imposed will tend to keep labor as well as materials cost within limits as the seller will have to assume any excess that is incurred in the procurement activity.

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