The total cost of contract service delivery is the sum of: 1) contractor costs; plus 2) contract administration costs; plus 3) an allowance for one-time conversion costs; minus 4) off-setting revenues.

Contractor Cost + Administrative Cost + Conversion Cost (Amortized) — New Revenue
= Total Contracting Cost

A. Contractor Costs

Contractor costs may be the easiest component of contract-service delivery costs to compute. Contractor costs are simply the total costs a contractor proposes to charge for performing the target service. Contractor costs can generally be taken directly from a contractor's bid or proposal.

B. Contract Administration Costs

Contract administration costs may be the most difficult component of contract-service delivery costs to compute. Contract administration can be defined as all those activities that take place from the time a decision is made to contract out until the contract is fully executed and final payment is made.[11] Contract administration costs include: procurement, contract negotiations, contract award, the processing of amendments and change orders, the resolution of disputes, the processing of contractor invoices, and contract monitoring and evaluation.

The two major methods in use for estimating the cost of contract administration are informed judgment and federal Office of Management and Budget (OMB) guidelines.

INFORMED JUDGMENT

Based on state and local government experiences with contracting out, the costs of contract administration have been assessed at between zero and 25 percent of contractor costs. At the low end of the cost range falls the County of Los Angeles, which computes the costs of contract administration at zero.[12] In Los Angeles County, existing staff are assigned contract administration duties in addition to their regular job responsibilities. Consequently, the county maintains that no additional contract administration costs are incurred when a target service is contracted out.

Estimating the cost of contract administration at zero almost certainly underestimates the true cost.[13] Even when existing staff are used to perform the contract monitoring function, government departments such as purchasing and finance still experience workload increases with attendant cost implications. For example, purchasing departments have new bid and proposal packages to develop and issue, and finance departments have new contractor invoices to process and audit.

At the high end of the cost range is the estimate of 25 percent of contractor costs derived from a major study of municipal contracting out in the greater Los Angeles area.[14] Other estimates of contract administration costs fall somewhere between these two values. The City of Cincinnati, Ohio, uses a figure of 4 percent of contractor costs unless more precise cost data are available.[15] E. S. Savas, a nationally recognized expert on contracting, estimates the cost of contract monitoring-exclusive of other contract administration costs-at between 2 and 7 percent of contractor Costs.[16] John Rehfuss, another contracting expert and a former city manager, suggests that the cost of contract monitoring-again exclusive of other contract administration costs-is probably closer to 5 or 10 percent of contractor costs.[17] This cost may depend on what soft of service is contracted, and the ease with which it can be objectively measured and monitored.

Whereas the estimate of zero underestimates monitoring costs, computing the costs of contract administration at 25 percent of contractor costs probably overestimates the true cost. Most state and local governments should conduct at least some monitoring of in-house service delivery, so contract monitoring costs should not represent entirely new costs.

When all contract administration costs—not just monitoring costs—are considered, estimates can increase substantially. For example, the City of Phoenix, Arizona estimates the administration costs of its former sanitation contracts to be 16 percent of contractor costs.[18] A growing body of evidence suggests that on average the true cost of comprehensive contract administration falls between the two extremes of zero and 25 percent.

Based on the judgments and experiences noted above, a reasonable estimate for contract administration costs is between 10 and 20 percent of contractor costs.[19] A general rule of thumb in applying this cost range would be to move toward the higher end of the range for small dollar contracts and the low end of the range for large dollar contracts. In instances where existing staff are assigned contract-monitoring responsibilities, the low end of the range should probably be used.

OMB GUIDELINES

An alternative approach to computing the cost of contract administration is to utilize the staffing formula developed by the federal Office of Management and Budget (OMB). In 1985, OMB revised its Circular A-76, which governs the contracting out of commercial activities, to require the use of a staffing formula to estimate contract administration costs.[20] The OMB staffing formula is derived from a major study of federal contracting out conducted by the accounting firm then known as Peat, Marwick and Mitchell.[21]

The OMB staffing formula assumes that the best indicator of contract-administration requirements is the number of people engaged in providing a service—the larger the staff working on a particular service, the greater the contract-administration requirements. The OMB staffing formula (see Table 1) is based on the number of staff required to provide a target service in-house. The number of in-house staff is then related to the number of full-time-equivalent (FTE's) government personnel needed for contract administration if the target service is contracted out.

Table 1

OMB STAFFING FORMULA FOR COMPUTING THE COSTS OF GOVERNMENT CONTRACT ADMINISTRATION

In-house staffing estimate

Contract administrative staffing requirements in FTE’s

10 or below

0

11-20

1

21-42

2

43-65

3

66-91

4

92-119

5

120-150

6

151-184

7

185-222

8

223-265

9

266-312

10

313-367

11

368-429

12

430-500

13

501-583

14

584-682

15

683-800

16

Above 800

2% of the in-house staffing estimate

Source: U.S. Office of Management and Budget, Supplement to OMB Circular No. A-76 (Revised). Performance of Commercial Activities (Washington, D.C.: U.S. Government Printing Office, 1985), p. IV.37.

Because of the complexity of federal contract procurement laws and regulations, the OMB staffing formula may overestimate the actual cost of contract administration for some state and local governments. The Texas State Auditor's Office, for one, has revised the OMB staffing formula for purposes of computing the costs of Texas state agency contract administration.[22] The revised Texas contract administration staffing formula is shown in Table 2.

Table 2

STATE OF TEXAS CONTRACT ADMINISTRATION REQUIREMENTS

In-House Staffing Requirements

Contract Administration Staff

Less than 20

1

11-20

2

21-42

3

43-65

4

66-91

5

92-119

6

120-150

Use 2-4% of

Source: Office of the Texas State Auditor, Guide to Implement the Competitive Cost Review Program, (Austin, TX: 1984). P.32.

C. One-Time Conversion Costs

One-time costs are sometimes incurred when converting a target service from in-house to contract service delivery. Examples of one-time conversion costs include: 1) personnel-related costs; 2) material-related costs; and 3) other costs. When substantial one-time conversion costs are involved, these costs should be amortized over multiple years. The "front-end-loading" of substantial one-time conversion costs into one year can skew cost comparisons between in-house and contract service delivery in favor of the former.[23]

PERSONNEL-RELATED COSTS

Personnel-related costs include unemployment compensation, accrued annual and sick-leave benefits, and other severance items that must be paid to terminated government employees.

MATERIAL-RELATED COSTS

Material-related costs include costs associated with the preparation and transfer of government property or equipment to be made available to a contractor for use in providing a target service.

OTHER COSTS

Other costs include any other one-time conversion costs, such as penalty fees associated with terminating leases or rental agreements, the costs of unused or underused facilities and equipment until other uses are found or they are sold, and other costs associated with the transition.

D. Off-Setting Revenues

An off-setting revenue is any new or enhanced revenue stream (e.g. state or local income, sales, property or other taxes, user fees, etc.) that will accrue to the government as a result of contracting out a target service. If a revenue stream is already being received by a government and no increase is anticipated, then no entry is required. An item here that is sometimes overlooked is revenue to be derived from the sale or other disposition of facilities or equipment made redundant as a result of contracting out a target service. Any amount included in this section represents a deduction from the cost of contract service delivery.

E. The Total Cost of Contract Service Delivery

When contractor costs, contract administration costs, and one-time conversion costs are combined and reduced by any off-setting revenues, the resulting dollar amount represents the total cost of contract service delivery.