Blog Post

Six R's for Justifying Higher Profit on Your Next Contract

  • By Mike Gallo
  • 04 May, 2020

Years back, I recalled a DOE Contracting Officer for a “M&O” cost reimbursable type contract commenting to the prime that the two percent fee they were earning was very generous and that the contractor should be grateful. I was appalled and could remember saying to myself, “Who in their right mind would think 2 percent profit is acceptable?”. Was my opinion reasonable? Let’s look at six reasons “six R’s” for justifying higher profit on your next contract.

1.      Risk. Government work is NOT risk-free work. Contract award delays can disrupt a contractor’s business plans. Changes in U.S. Administration can create policy shifts and a re-sort of priorities that can lead to program cuts, recissions, and cancellations. Contract direct and indirect ceiling rates and fixed hour labor rates shift inflation and cost growth risk onto the contractor. Higher profit reflects the ‘consideration’ for contractors absorbing such risks. Lastly, prime contractors assume responsibility and risk for the performance of their subcontractors. It is entirely reasonable for a prime to earn profit on the deliverables and efforts of their subcontractors as 1) compensation for taking such risks, 2) a motivator for executing make vs. buy efficiencies, and 3) for the value the prime adds helping the Government avoid administrative hassle when the Government bundles multiple requirements into large contract vehicles that require large contractor teams.

2.      Reserve. Think rainy-day fund. Who would have thought the recent COVID-19 outbreak could have wreaked such havoc on businesses? The pandemic is a good example of unknown risks that can strike a business. Profits are an important source of funds that build up reserves to pay for unanticipated expenses or cushion the blow of unexpected revenue shortfalls.

3.      Recoupment. Profit helps government contractors recover unallowable costs, such as interest expense, that are nevertheless legitimate business costs. Government contractors pursuing aggressive growth goals rely on lines of credit to ensure access to adequate working capital to fund larger payrolls and subcontractor costs. They subsequently incur interest expense when they tap those credit lines. Since the FAR considers interest expense as an unallowable (and therefore a non-reimbursable) cost, profit is the only means by which these contractors can offset these types of legitimate business costs.

4.      Retained Earnings. Profits retained in the business (i.e., not distributed as dividends, owner draws, or profit sharing) nourishes future growth and investment in improved products and services. Insufficient profit starves companies of an important source of capital and forces them to use (more expensive) debt and equity financing to fund that growth and investment.

5.      Reward. Profit sharing is an excellent way to reward employees for both a job well done and for helping the Company operate with economy and efficiency. Also, since profit sharing isn’t technically a cost, it doesn’t get entrenched as an entitlement into the Company’s cost structure. So, it’s an effective way to ensure indirect rates stay low while also motivating continued high performance.

6.      Return. Business owners endure enormous risks to start and grow a business. Unless there’s an adequate return on that investment and risk, business owners won’t be incentivized to take such risks. That ultimately would mean fewer business ventures started and ultimately reduced innovation and price competition in the market.

Final thought. In every single case above, higher profit not only benefits the contractor, it ultimately benefits the Government - either through better products and services or through a financially strong contractor that can weather disruptions. As a matter of policy, the Federal Acquisition Regulation recognizes the importance of profit – “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). Don't deprive your business of an important source of capital. Think about these six R's of profit in your next pricing proposal.
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After months of wondering what happened to your proposal submission, the Government has responded with pages of pricing questions. Now what? Here’s three tips to help you answer pricing questions.

Common Issues

 Generally, cost and pricing questions fall into four broad issue areas:

  • Omission  The Government believes something is missing from your price proposal. It could be something as simple as a sub-total calculation error or something more serious such as unpriced tasks that are identified in your technical volume, but not included in your price.
  • Necessity  The Government believes something priced into the proposal is not relevant or ‘in-scope’. Sometimes a lack of a clear explanation of how costs were derived and or calculated can also lead the Government to question certain costs. Lump sum costs, without underlying details and explanation, are a great example of this.
  • Consistency  The Government believes something in your pricing doesn’t align with your technical volume. This can occur when last minute pricing drills shave costs (such as staff hours), but the change is not reflected in the technical volume (or vice versa).
  • Reasonableness/Realism  If the Government says a particular cost appears ‘unreasonable’, they’re saying they think it’s too high. Conversely, if the Government says a particular cost appears 'unrealistic', they’re concerned it's too low.

Three Helpful Tips

How should companies respond to these questions?

1.     Don't fight the Fed.

Even if you disagree with the evaluator's question, keep in mind there’s something unclear in your proposal that created ambiguity and doubt in the evaluator’s mind. Don’t take it personally. Avoid argumentative language in your responses that just serves to aggravate the evaluators and doesn’t help you to address the issues raised. The fact that the Government may think a proposed cost might be too high (or too low) doesn’t necessarily mean you should revise your price. Often the Government uses terms such as ‘Justify’, ‘Substantiate’, ‘Clarify’, ‘Explain’, etc. to describe their need for additional information.

2.    Fortify answers with facts and data, not more unsubstantiated assertions.

The four main issues: Omission, Necessity, Consistency, and Reasonableness/Realism almost always boil down to a lack of adequate documentation and substantiation as a root cause. Provide corroborating evidence to justify unit costs and rates. Clearly explain how costs were derived and/or calculated.

3.     Make it Easy for the Evaluator.

If you elect to revise your pricing, clearly track those changes in your pricing model. This is especially important when there are numerous and significant changes to price. The Government needs to understand how and why your price changed. Highlight cost elements that were added to your proposal. Identify unit cost and rates that were revised. Flag items that were removed from your revised proposal. Also ensure to provide a brief narrative summarizing what has changed in your revised proposal pricing.

 Conclusion

Breathe a little sigh of relief. Your firm has progressed through 1st cut. While your firm hasn’t won the contract (yet), the Government believes your proposal has enough merit and deems it worthy enough for additional consideration.

Remember, the Government is evaluating MANY proposals in addition to your proposal. Contracting officers want to progress to contract award, now ! Help them by clearly, accurately, comprehensively responding to evaluator pricing questions. Give the evaluators the missing pricing facts and data they need so they can demonstrate they evaluated your winning proposal objectively, fairly, and consistently.


About the author:  Mike Gallo is Partner and Principal Consultant at Federal Pricing Group, a consulting firm focused on providing expert contracts pricing to small and mid-sized federal government contractors and cost-related acquisition support services to federal agencies. Learn more at https://www.federalpricinggroup.com/.

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