Defense Contractor Negotiation & Pricing

1. Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D.

2. Source Data summarized from Pricing Manual of the Federal Acquisition Regulations (FAR).

3. Determining Contract Type • By contract type we mean compensation arrangement • There is no best contract type for every occasion • Select contract type that will result in reasonable contractor risk with the greatest incentive for efficient economic performance

4. Three Contract Types • Firm fixed price • Cost reimbursement • Labor hour and time and materials

5. Firm fixed price • Firm fixed price • Fixed price with economic price adjustment • Fixed price incentive fee • Fixed price with successive targets • etc.

6. Cost reimbursement • Cost reimbursement • Cost sharing • Cost plus fixed fee • Cost plus award fee • Cost plus incentive fee

7. Labor hour and time and materials • Both of these include fixed labor rates but only estimates of hours to complete the contract • Neither require the contractor to complete the required work within an agreed upon price

8. Consider Contractor Risk • Having contractors accept unknown or uncontrollable risk can result in • Poor contract performance • Reduced competition • Substantial increase in contract price

9. Two Areas of Risk • Performance Risk • Market risk

10. Performance Risk • Most contract risk is related to contract requirements and the uncertainty surrounding contract performance

11. Performance Risk • Consider • Stability and clarity of contract specification or statement of work • Type and complexity of the item being purchased • Availability of historical pricing data • Prior experience in providing required supplies or services

12. Cost Risk and Contract Type • Exploration and development--cost plus fixed fee • Test/demonstration--cost plus incentive fee or fixed price incentive fee • Full scale development--cost plus incentive fee, fixed price incentive fee, or firm fixed price • Full production--firm fixed price

13. Market risk • Changes in the marketplace will affect contract costs • Changes in prices of labor • Changes in prices of materials • Changes in availability of labor or materials

14. Market Risk • Address through contracts with economic price adjustment clause

15. Pricing • Definition of price • Seller pricing objectives and approaches • Government pricing objective • Government approaches to contract pricing

16. Definition of price • Price is the amount the buyer pays for a product or service • When contract price is less than cost, performance risk increases • If contractor effort to control costs result in unsatisfactory performance, contractor default is a real possibility

17. Seller pricing objectives • Pricing objectives • Cover costs and earn profit • Operational objectives • Short-term/long-term profitability • Market share • Survival • Product quality • Productivity

18. Seller Pricing Approaches • Cost based pricing • Market based pricing

19. Cost based pricing • Mark-up Pricing--price is based on cost plus markup • Margin on Direct Cost--base price on amount necessary to achieve profit margin as a percent of price • Rate of Return Pricing--profit is calculated based on return on investment

20. Market Based Pricing • Profit maximization pricing • Marker share pricing • Market skimming • Current revenue pricing • Promotional pricing • Demand differential pricing • Marketcompetition pricing

21. Market Skimming Pricing • Charge early buyers a premium

22. Promotional Pricing • Products are priced to enhance the sales of the overall product line rather than the profitability of each product

23. Demand Differential Pricing • Products sold in different markets are sold at different prices • Get what the customer will pay

24. Market Competition Pricing • Price is based on what action the competitors have taken or are expected to take • Firms follow this pricing strategy in relatively homogeneous markets

25. Government pricing objective • Pay a fair and reasonable price • What is fair? • Price each contract separately • Don’t try and balance the financial results of one contract against another • Exclude contingencies • Items that cannot reasonably be estimated at the time of award

26. Examples of Contingencies • Results of pending litigation • Cost of volatile market price changes

27. Evaluating the Bid • Evaluate price • Analyze cost

28. Evaluate price • Compare prices in competitive bidding situations • Look at competitive published price lists, rebate agreements etc. • Get independent price estimates

29. Analyze cost • When do you look at bidder’s costs? • When you require offeror to submit cost or pricing data • Why have offeror submit cost data? • To provide support that proposed price is reasonable

30. Contract Costs Include • Direct costs • Indirect costs • Fee

31. Government approaches to contract pricing • Quantitative Techniques for Contract Pricing • Cost Analysis • Negotiation Techniques

32. Quantitative Techniques for Contract Pricing • Round table estimating • Comparison • Detailed analysis

33. Round table estimating • Get various experts around a table, have them come up with their best estimate of what the price will be • Use only where historical costs, detailed drawings, bills of materials, and specifications are not available

34. Comparison • Index numbers can be used to adjust historical costs for inflation • CVP is used • Regression analysis used to determine relationship between independent and dependent cost variables • Improvement curve analysis • Moving averages

35. Detailed analysis • Break costs into tasks, estimate resources required for each task

36. Detailed Analysis Questions • Can the material requirements stated in the bill of materials be tracked directly to the drawings and specifications? • Are scrap rates reasonable? • Are price estimates based on the quantities required by the contract?

37. Detailed Analysis Questions • Are labor requirements based on detailed analysis of the processes and materials required to complete the contract? • Do labor rate estimates consider the time period of the labor requirement? • Do labor rate estimates consider the skill level of the labor required to complete the contract?

38. Detailed Analysis Questions • Do labor rate estimates consider changes in the work force? • Do labor rate estimates consider geographical differences?

39. Cost Analysis • Contract costs are monetary measures of capital and labor required to complete a contract • Cash expenditures • Expense accrual • Inventory draw-down

40. Defective cost or pricing data • Cost or pricing data that is inaccurate, incomplete, or non-current • If the government suspects after the award that there was defective pricing, they can request an audit

41. Defective cost or pricing data • If the audit shows there was defective pricing, the government is entitled to a price adjustment, including fee or profit. • Government can also get interest on over-payment

42. Forward pricing rates • Prepared by contractor • Audited by government • When accepted, used in bidding contracts for that fiscal year

43. Fee or Profit • The fee objective does not necessarily represent net income to the contractors • Some costs are disallowed • Entertainment

44. Profit Analysis Factors • Contractor effort • Material acquisition • Conversion direct labor • General management

45. Profit Analysis Factors • Contractor risk • Cost responsibility and risk the contractor will assume • Fixed price contracts have more risk, will probably have more profit potential

46. Profit Analysis Factors • Federal socioeconomic programs • Capital investment • Cost control and other past accomplishments • Independent development--did contractor do R&D on own?

47. Negotiation • A process of communication in which two parties, each with its own viewpoint and objectives, attempts to reach a mutually satisfactory result on a matter of common concern.

48. Negotiation vs. Sealed Bidding • FAR states that any contract awarded using other than sealed bidding is considered a negotiated contract

49. The best negotiators . . . • Plan carefully • Gain management support • Effectively apply bargaining techniques • Tolerate conflict while searching for agreement • Project honestly • Foster team cooperation • Apply good business judgement

50. Win/win negotiators • Attack the problem, not each other • Focus on long-term satisfaction and common interests • Consider available alternatives • Base results on objective standards whenever possible • Focus on positive tactics to resolve differences