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PM Essence

Point of Total Assumption

S.S.V. Raghavan, PMP

Recently, my attention has been drawn to this topic encountered in Project Procurement Management (often featured in the PMP Certification Examination, but never covered in PMBoK, either in the current or any of its previous editions). Invariably, all the references I have made on the subject state that it is a feature of 'Fixed Price Plus Incentive Fee' (FPIF) type of contract. To cite an example, a learned article I came across recently defines the Point of Total Assumption (PTA) thus:

“The Point of Total Assumption (PTA) is a point on the cost line of the Profit-Cost curve determined by the contract elements associated with a fixed price plus incentive-Firm Target (FPI) contract above which the seller effectively bears all the costs of a cost overrun. The seller bears all of the cost risk at PTA and beyond, due to a dollar for dollar decrease in profit beyond the costs at the PTA. In addition, once the costs on an FPI contract reach PTA, the maximum amount the buyer will pay is the ceiling price.”

The article also seeks to illustrate the principle graphically thus :
The Article further states: “For cost reimbursable contract, the Point of Total Assumption does not exist, since the buyer agrees to cover all costs. However, a similar incentive arrangement with similar components, called a Cost-Plus- Incentive Fee (CPIF) contract sometimes is used. The CPIF includes both a minimum fee and a maximum fee.”

The Article also gives a formula for calculating the PTA:
PTA = (Ceiling Price - Target Price) / Buyer's Share Ratio) + Target Cost
PTA

I have no issues either with the graph or with the formula given above. However, it is the inclusion of PTA under FPIF that I find myself unable to agree

with. At the risk of taking on the learned pundits, and exposing my limited knowledge on the subject, I would venture to pose certain questions:

1. If we are talking of cost “over-runs” and “under-runs”, and making payment to the Vendor depending on the cost incurred, what is “fixed” about the price, for PTA to be included as an aspect of FPIP type of contract?


2.
How are “target” and “actual” costs relevant in a “Fixed” Price contract?

3. Is the graph given above which shows a CONSTANT gap (upto PTA) between the Cost Curve (Blue) and Price Curve (Red) not indicative of a Cost Plus Fixed Fee (CPFF) contract, or rather, (taking into account also the fact that a Sharing Ratio is in operation), can it not be said that it represents a CPIF type?

One may argue then: How else do you explain the “incentive” in a FPIF contract? I would guess that the incentive in a FPIF contract would for the most part be for the SAVING IN TIME, rather than a saving in costs in procurement. A Price Ceiling in a FPIF contract would consequently mean a ceiling on the incentive.


I feel that as long as payments are made to the Vendor according to the costs incurred, the positive and negative risks inherent in cost savings and over-runs respectively being partly transferred according to a mutually agreed Sharing Ratio to the Vendor / Contractor, the deal would have to be considered a Cost Reimbursable Contract only, and it would be erroneous to group it under the FP type.

It is also my contention that it is not quite correct to make a sweeping statement that “For cost reimbursable contract, the Point of Total Assumption does not exist, since the buyer agrees to cover all costs”. I would say that this statement would hold good only for CPFF contracts. CPIF and CPAF (Cost Plus Award Fee) contracts tend to mitigate the risk incurred by the Buyer.


The former fixes the incentive according to a Sharing Ratio when cost savings occur, and transfers part of the risk to the Vendor in case of overruns, while the latter releases the fee in accordance with a subjective assessment by Buyer of milestone achievements by Vendor. (Fortunately PMBoK in its Fourth Edition has seen the absurdity of the proposition inherent in yet another variant CPPF - Cost Plus Percentage Fee - mentioned in the previous editions, and thought it wise to delete it).


My submission therefore is as follows :

1. PTA is a feature of CPIF, not FPIF contract.
2. It is relevant only in case of a cost over-run.
3. It occurs at the point of the price ceiling.
4. The Sharing Ratio ceases to be applicable beyond it.
5. Beyond PTA (i.e. the Price Ceiling), the Vendor TOTALLY ASSUMES all further risks associated with the over-run.

To illustrate, consider this problem :
Target Cost : ` 12000.
Target Fee : ` 1000.
Sharing Ratio : 80/20.
Ceiling Price : `14000.

Calculate actual cost and the Vendor's fee at PTA.

Solution : Since PTA is relevant only in case of over-runs (Pt. 2 above), let us assume that the over- run is ` x. It follows that the actual cost is `(12000 + x). The fee payable to the Vendor would be ` (1000 – 0.2x), because, for over-runs, a sum equivalent to the Vendor's share of the risk associated with the over-run would be deducted from the target fee. Price being Cost + Fee, and at PTA, the Price is the Ceiling Price (See Pt. 3 above), we have, at the Point of Total Assumption, the equation : (12000 + x ) + (1000 – 0.2x) = 14000. which gives x = 1250. Therefore Cost = ` (12000 + 1250) = ` 13250 and the Fee, which can be calculated either as (14000 - 13250 ) or as (1000 - 0.2 *1250), is ` 750. I was at first wary of taking on all available literature, and going against them, and hence tried to pick the brains of a couple of friends for whom I have a great respect for their knowledge of the subject.

One of them says:
“Notwithstanding what the textbooks say, ………... I have not encountered a Fixed Price contract where the client is concerned about the actual cost incurred by the contractor because of his decisions/competence, and adjusts the final sum payable, as you rightly said, what is the sanctity of “Fixed Price” then?” The other also concurs with me by stating: “Many links we see here refer to PTA being applied to FPIF contracts, while every element of the computation points to this being a CPIF contract.”

I too admit that all the literature I have referred to on the subject state that PTA is a feature of FPIF contract, but since I have not yet found any convincing argument as to why it should be part of a Fixed Price, and not a Cost Reimbursable Contract, I would be content to hold on to my view for the nonce.