Tuesday, April 4, 2017

Negotiated Profit or Fee Percentages Should Be Applied to Total Negotiated Cost

The Government wants its contractors to be profitable and it is the Government's policy to negotiate a fair profit on each contract. We have written several articles on profit over the years to help contractors understand how the Government develops its negotiation objectives for profit. Consider the following.

To summarize some of the key points in those articles, 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 (FAR 15.404-4(a)(2)).

Both the Government and contractors should be concerned with profit as a motivator of efficient and effective contract performance. Negotiations aimed merely at reducing prices by reducing profit, without proper recognition of the function of profit, are not in the Government's interest. Negotiation of extremely low profits, use of historical averages, or automatic application of predetermined percentages to total estimated costs do not provide proper motivation for optimum contract performance (FAR 15.404-4(a)(3)).

FAR requires a "structured approach" for determining profit or fee. A structured approach provides discipline for ensuring that all relevant factors are considered. FAR leaves the development of structured approaches up to individual agencies. For DOD, the structured approach is commonly referred to as the "Weighted Guidelines Method". Agencies are allowed to use another agency's structured approach (see FAR 15.404-4(b)(2)) and as a result, many agencies have adopted the DOD model or slight variations thereof. The DOD weighted guidelines model is described in DFARS (DOD FAR Supplement) 215.404-4.

We recently became aware of a situation where a Government negotiator refused to apply profit to a contractor's negotiated G&A (General and Administrative Costs) because he had "learned" that to do so was inappropriate. We don't know where he "learned" this but his learning does show a lack of understanding of applicable FAR considerations.

For example, one of several common factors that require consideration in determining a profit percentage is "General Management" (see FAR 15.404-4(d)(1)(i)(D)). General Management ... measures the prospective contractor's other indirect costs and general and administrative (G&A) expense, their composition, and how much they contribute to contract performance. There it is, G&A specifically called out in the procurement regulations.

We always recommend that contractors perform their own structured approach to determining reasonable profit rates prior to negotiation and to ask the Government for their analysis as well. There is a lot of subjective elements to developing a profit objective but reviewing the Government's "weighted guidelines" analysis or another agency's structure approach could lend some clarity on what the Government considers important. Perhaps its not the same as what the prospective contractor believes to be important and resolving these differences could facilitate negotiations and result in a profit percentage that is more "reasonable".

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