The Department of Defense issued guidance yesterday reminding its contracting officers to pay attention to the DFARS (DoD FAR Supplement) guidelines for determining profit or fee on negotiated contracts (see Guidance on Evaluation of Risk in Negotiating Contract Profit or Fee).
There is certainly nothing wrong with earning profit. In fact, the Government's official contracting policy is to pay companies a fair profit for the work performed. But what is a fair profit? DoD has developed a methodology called the Weighted Guidelines Method to developing a range of what is fair and reasonable. After developing the range, the final percentage is determined in negotiations.
The Weighted Guidelines Method (WGM) is, at its core, a risk based approach to determining profit or fee. Fixed price contracts are more risky than cost-type contracts so the profit percentage attributable to fixed price work will be higher than the fee percentage for cost type work.
Investments in property, plant, and equipment will also play a role in fee calculations. Manufacturers having invested considerable sums into equipment will earn a higher rate than say, a grass cutter on a military installation.
Progress payments (and interim billings on cost-type work) will also have a bearing on profit/fee calculations. Getting paid as you go reduces the overall risk of contract performance - it certainly reduces cash flow requirements.
The new guidance offered anew example. If a contractor, required to utilize DoD staffing in performing the work has a contract clause allowing it to submit an equitable adjustment in the event the DoD workforce is not performing up to par (i.e. a work stoppage), that clause reduces the risk to the contractor and should result in a lower profit rate.
The DoD issued the guidance because IG (Inspector General) audits have uncovered numerous cases where the profit paid to contractors were not based on a full understanding of the risks involved in the specific work being performed.
Contractors should familiarize themselves with DoD's weighted guidelines methodologies at DFARS 215.404-71. Although required for DoD contracts, we are aware that other Governmental agencies use the DoD methodologies for their own profit/fee negotiations.