Wednesday, June 13, 2012

DoD to Conduct Study on Contractor Profits

The Federal Acquisition Regulations (FAR) expressly recognizes the importance of a contractor's ability to earn a reasonable profit. FAR 15.404-4(a)(2) states that it is in the Government's interest to offer contractors opportunities for financial rewards sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large and small business concerns to Government contracts and maintain a viable industrial base."

The DoD has consistently maintained that contractor profits are not a target. At a Aerospace and Defense conference last fall, Shay Assad, DoD's Director of Procurement, told participants that the Pentagon is concerned with cost reduction, not margin reduction. "It wouldn't bother us at all if operating margins go up, so long as we're paying less".

Recent acquisition trends and policies, however seem to suggest otherwise. There have been elimination of fee on certain cost elements and reductions in fee as part of Government negotiation strategies. Policy changes regarding business systems are threatening to disrupt contractor cash flows. Additionally, the trend in research and development are favoring cost-share or cost-no-fee arrangements.

One of the provisions in the Senate version of the Fiscal Year 2013 National Defense Authorization Act (NDAA) requires DoD to review the DFARS (DoD FAR Supplement) profit guidelines to identify any modifications to such guidelines that are necessary to ensure an appropriate link between contractor profit and contractor performance (sounds very subjective to us).

Matters to be considered in this study include:

  1. Appropriate levels of profit needed to sustain competition in the defense industry, taking into account contractor investment and cash flow,
  2. Appropriate adjustments to address contract and performance risk assumed by the contractor, taking into account the extent to which such risk is passed on to subcontractors,
  3. Appropriate incentives for superior performance in delivering quality products and services in a timely and cost-effective manner, taking into account such factors as prime contractor cost reduction, control of overhead costs, subcontractor cost reduction, subcontractor management, and effective competition at the subcontract level (applies to incentive fee and award fee contracts).

Assuming this provision is enacted, DoD gets 180 days to modify the DFARS profit guidelines.

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