Negotiating Profit & Fee
Breakout Session #304
Fred Schlich
Date July 19, 2010
Time 4:00pm - 5:15pm
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Negotiating Profit & Fee
• Session Objective
– Broad Discussion About of Concepts
– Analytical Examination of a Number of
Considerations for Negotiating Profit & Fee
– Recognition of the Abstract Nature of Profit
- No Formula that Guarantees Success
• Session Outcome
– Negotiators Enthusiastic About Tackling
Profit and Fee
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Negotiating Profit & Fee
Working Definitions
• Negotiation - Where There is Some
Discussion of the Cost Elements
– Competitive negotiations
– Sole source
– Contract changes
• Profit - Part of the Price
• Fee - In addition to Actual Costs
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Profit & Fee
Different Viewpoints
• Economists - profit is the cost of utilizing industry
investment and is necessary to attract industry into
the transaction
• Financial Analysts - seek a return on investment
favorably compared to other potential investments
• Accounting/Bookkeeping - revenue less cost equals
the bottom line
• FAR - potential enumeration over and above
allowable costs
– Motivate efficient and effective performance
– Attract the best capabilities of qualified businesses
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Profit
Pricing Viewpoint
• Direct Costs
– Labor
– Material
– Other
D irec t L abor
M aterial
I ndirec t C os t
O ther D irec t C os ts
• Indirect Costs
G &A
– Overhead
– G&A
P rofit
• Profit
5
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Negotiating Profit & Fee
“The Dilemma”
• Negotiators are “uncomfortable” or “uncertain” with Profit
– Buyers compelled to minimize expense, profit takes the hit
• Statutory Limits exert downward pressure
– Sellers often are at a loss to fully explain proposed profit levels
• Guidance is Vague, General, and Limited
– or Overly Restrictive (Weighted Guidelines, etc.)
• Industry is Reluctant to Disclose Actual Profit Information
– Market Research is Speculative in Many Cases
• Profit Reasonableness is Virtually Un-Auditable
– Auditors can’t contribute much help
• Profit is Almost Always Expressed as a Rate
– Rates are less tangible than actual amounts
• Negotiation of Profit and Fee is Done Last
– Necessity to close the deal rushes meaningful discussion
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Negotiating Profit & Fee
“The Solution”
• As With Cost Analysis, Break Profit Into Elements for Analysis
– The FAR Describes a Structured Approach
• Utilize the Market to Set Profit
– Historical Data can be of Great Value
•
Think of Profit in Terms of the Total Amount
–
“How Much Will it Take to Attract and Motivate Industry into the
Transaction”
• Negotiate Profit or Fee First
– Validate the assumptions that formed the basis for the profit agreement
during cost analysis
– Verify the profit agreement at the conclusion of negotiations against
constraints or external limits
• Profit is Always Negotiable
– Don’t automatically default to a precedent
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Profit Analysis
Common Factors
Other Factors
Contractor Effort
Material Acquisition
Conversion of Direct Labor
Conversion of Related Indirect Costs
General Management
Contract Cost Risk
Federal Socio-Economic Programs
Capital Investments
Cost Control and Other Past Performance
Independent Development
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Far 15.404-4
Describes a
Structured
Approach to
Profit Analysis
Profit Analysis
- Common Factors
Contractor Effort
– Material Acquisition - effort necessary to obtain parts,
material, subcontracted items; consider the complexity of
the items, number of purchase orders required, and
complexity of subcontracts
– Conversion of Direct Labor - direct contribution of labor
to convert material, data, and subcontractor effort into
contract requirements; consider diversity of the labor skills
and supervision/coordination needed
– Conversion of Related Indirect Costs - contribution of
indirect effort; consider the extent and complexity of this
contribution
– General Management - contribution of Other Direct Costs
and G&A expense; consider the extent and complexity of
this contribution
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Profit Analysis
- Common Factors
Contract Cost Risk - No Direct Correlation
Between Contract Type and Appropriate Profit
• FFP doesn’t equate to higher profit - cost risk is not always
present
• CPFF may deserve more profit due to the nature of the effort
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Profit Analysis
- Common Factors
Federal Socio-Economic Programs
– Greater profit opportunity should be provided contractors that
have displayed unusual initiative in these programs
Capital Investments
– This factor takes into account the contribution of contractor
investments to efficient and economical contract
Cost-control and Other Past Accomplishments
– Additional profit opportunities if a contractor has previously
performed similar tasks effectively and economically. In addition,
consideration should be given to productivity improvements, and
other cost-reduction accomplishments that will benefit the
Government in follow-on contracts
Independent Development - relevant to contract end item
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Profit Analysis
- Weighted Guidelines Application
DoD Developed
• Weapons System
Perspective
Analysis
• Performance risk
– Technical
– Management
• Contract type risk
• Facilities capital employed
• Cost efficiency
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Negotiating Award Fee Pool
• Award Fee - Should Not Be Subject to Ordinary Profit
Analysis
– Ultimately the result of subjectively evaluated performance
– Size of pool not influenced by anticipated contractor effort,
contract cost risk, etc.
• Pool is Based on What Potential Fee Will Motivate
Exceptional Performance
– Base verses Award Portion of Pool
– Consistency and predictability effect how much influence will
award fee will provide
• Award Fee Should be Used in Highly Specialized
Situations
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Negotiating Profit
Time and Material or Labor Hours
• Each Unit or Hour Contains All Cost Elements
–
–
–
–
–
Labor
Indirect Costs
Profit
Material – Treatment Varies
ODCs and Travel – Treatment Vaires
• T&M Profit Varies Directly with Cost
– Conceptually very close to Cost Plus Percentage of Cost
• Profit Negotiation
– By Task, Project, or Effort
– By Labor Category
– Variable Profit?
• Negotiation Could Include Concepts Considered in
Any Profit Discussion
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Negotiating Profit & Fee
Breakout Session #304
Fred Schlich
Date July 19, 2010
Time 4:00pm - 5:15pm
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