• Test 1

Pricing Formula - Profit

New contracts outside the scope of the DRA

The extent to which the existing framework and ASG commercial guidance is to be altered for new awards of contracts that fall outside of the scope of regulations and statutory guidance is becoming clearer  e.g. a revised suite of pricing DEFCONs have been issued and these will need to be negotiated on a case by case basis, pricing arrangements for single source changes to new competitive contracts (DEFCONs and arrangements to be incorporated into the contract) is unaddressed.

New Contracts within the scope of the DRA regulations and statutory guidance

The Defence Reform Act replaced the Review Board for Government Contracts with a new body with significantly more extensive powers‘ The Single Source Regulatory Office’ (SSRO).

The Defence Reform Act and supporting regulations introduces significant changes to the pricing and reporting of larger single source contracts and sub-contracts and contractors and group companies undertaking larger single source contracts. Single source contracts affected become ‘qualifying defence contracts’ (QDCs) and, single source sub-contracts affected become 'qualifying sub-contracts' (QSCs), and contractors become 'qualifying defence contractors (QDCs). A QDC (prime single source contract greater than £5m) or a QSC’s (single source sub-contract greater than £25m) is required, by law, to be priced in accordance with the ‘Pricing Formula’. The ‘Pricing Formula’ requires contract prices of single source contracts within the scope of the regulations to always be priced by reference to ‘Allowable Costs’ and ‘Contract Profit Rate’. The SSCRs set out allowable methods (see regulation 10) and they all only comprise ‘Allowable Costs’ and ‘Contract Profit Rate’. A contract may comprise several allowable methods with prices separated by CLIN. Although the ASG continues to state that ‘Fair and reasonable prices for Ministry of Defence (MOD) contracts may be established by effective competitive tendering, by reference to established market prices (e.g. commercial catalogues, price lists) or in the absence of competition by negotiation.’ there is no provision within the act or the regulations for prices on single source contracts to be agreed other than by reference to costs. Unlike the previous arrangements, which were based on a voluntary code of conduct, legislation introduced by the Defence Reform Act provides less flexibility to MOD and contractors. 

The Defence Reform Act can be found here and regulations can be found here and statutory guidance on calculating the profit rate here

Calculating the profit rate applicable

The Act sets out six steps which are as follows:

Step1. The baseline profit rate at the relevant time. The SSRO have concluded that the methodology adopted by the Review Board for Government contracts gave rates higher than were appropriate. SSRO have proposed changes to the method used by them to calculate this value, consequentially the baseline profit rate applicable for new qualifying contracts awarded after 1st April 2016 are significantly lowered. A further significant reduction should be anticipated for contracts awarded after 1st April 2017 and a final significant reduction for contracts awarded after 1st April 2018.

Step 2. Negotiated adjustment for the contractor’s cost risk, range restricted to + or – 25% of the value at Step 1. SSRO has issued new statutory guidance for new qualifying contracts awarded after 23rd March 2016 the starting point for a fixed or firm price is reduced from +25% to 0%; TCIF remains at +0%; and cost plus remains at -25%. SSRO is consulting on proposed amendments to the rush issue statutory guidance.

Step 3. Elimination of profits applied to same costs more than once by businesses under common control; anti fee stacking or POCO

Step 4. Reduction for financing of the SSRO (initially zero)

Step 5. Add any incentive agreed.

Step 6. Fixed and working capital servicing allowance. This is applicable to all business units in the supply chain including those under common control. See below and SSRO's statutory quidance.

Fixed Capital Servicing Allowance

This element of the Government Profit Formula is expressed as a percentage of capital employed and needs to be converted to a by year on cost element of the fee. 

Working Capital Servicing Allowance

This also needs to be converted to an on cost allowance. A lower rate is now applied to net negative working capital

Protection against Excessive Profits or Losses (PEPL)

Firm or Fixed priced CLINs of a contract are subject to sharing of profits or losses if the variation is above the threshold specified in the regulations. Draft 16 sets out the details. A calculator to assess the impact of PEPL share line is available here

A contractor should not assume that it is automatically entitled to additional monies if the loss threshold is exceeded.