Wednesday, September 19, 2012

Forward Pricing Rates

One of the major problems faced by contractors and the Government alike when establishing and negotiating  forward pricing rates (indirect rates used to price future work) is the inability to accurately forecast workload beyond the next year. Many contracts have periods of performance that extends three to five years and contractors must try to forecast what their indirect rates will be out in those years. If the contract is fixed price, failure to accurately estimate rates can lead to significant losses or windfall profit. If the contract is cost-type, failure to accurate estimate indirect rates can lead to funding issues or earlier than desired contract completion.

One certainty in Government contracting is the uncertainty over which programs will continue to receive funding. Will the Government buy 12 aircraft per year, or 20, or 25? That makes a big difference for contractors and their supply chains. Or, what about decisions to in-source work that is being contracted. How does one account for that possibility in their indirect rate build-ups? How about the looming potential of sequestration where, if it happens, significant cuts will be made to existing contracts? Was that information known a year ago? Those questions and concerns makes a big difference to a contractor's estimate of the business base used to allocate indirect costs.

Contractors' inclination is to be conservative in estimating future workload. The risk in missing workload estimates has a huge downside; monetary loss. The Government's inclination is that contractors are deliberately understating future workload in order to increase its indirect rates thereby enhancing corporate profits. The reality is that if the Government could be more accurate and certain and provide more assurance to contractors of its purchasing plans, contractors could provide better estimates of their forward pricing indirect rates and feel more comfortable in doing so.

Tomorrow we will discuss one step that DoD is taking to help contractors and its contracting officers to get a better handle on future DoD workload.

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