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Column: Maximizing bid profits in negotiated procurements
by Michael Smigocki, CPA/ABV, CVA
Senior managing director, Federal Strategies Group LLC
I am often asked by clients who are bidding on various government contracts what profit percentages they should be proposing.
Obviously, in competitive procurements, the market forces will dictate your overall pricing, including profits.
However in negotiated procurements, where the government will have insight into your costing and pricing information, there are steps that you can take to help maximize the negotiated profit percentage.
This article will discuss some of these bidding and positioning strategies.
Government’s view of profit
The first place to start is to gain an understanding of how the government views profit and the concept of risk versus reward.
There are different types of risk the government considers when evaluating a proposed profit percentage including performance risk, contract type risk, and facilities employed.
In contracts where the contractor is assuming the highest degree of risk, this fact should be rewarded with the highest level of profitability allowed. The inverse of this is also true: when the government is assuming more of the risk, then a lower level of profitability would be expected.
Performance Risk
Performance risk covers both the technical complexity of the procurement as well as the risks inherent in a particular contract type.
Factors considered when evaluating performance risk of a particular procurement include:
- Technology being applied or developed
- Technical complexity
- Program maturity
- Performance specifications and tolerances
- Delivery schedule
- Extent of warranty coverage or guarantees provided.
The government also will look at management and its cost control abilities including:
- Internal control systems
- Extent of management’s involvement and approach
- Socioeconomic programs
- Reliability of cost estimates
- Cost reduction initiatives
- Budgeting systems and ability to meet cost targets
Type of contract
The performance risk also will vary depending on the type of contract being awarded. There are three predominant types of contract that the Government utilizes – fixed price, cost-type and time & materials.
Fixed price contracts carry the highest degree of performance risk. Under a fixed price contract, the contractor is required to provide the product or service that was contracted for at the price/s that were negotiated. If the contractor incurs more costs than budgeted, and there have been no modifications or scope changes, then those extra costs have to be absorbed by the contractor. Because of this “performance risk,” bid profit percentages are the highest with fixed price contracts.
A time and materials contract sets forth fixed hourly rates for the life of the contract. There is not the same deliverable issue as under fixed price contracts. However, there is still risk because of the fixed hourly rates. It is possible the contractor will not be able to find qualified personnel at the budgeted compensation rates, or operate within the indirect rates assumed at the time of bid. These price risks should be taken into consideration when bidding the profit percentage.
Cost-type contracts carry the least amount of risk and thus the lowest profit percentage results. In a cost-type contract, the government will reimburse the actual costs incurred as long as the cost is allowable and allocable pursuant to the Federal Acquisition Regulation.
The government is bearing the risk of increased costs. The best way to think of a cost-type contract is to consider it a best-efforts contract. For the negotiated price of the contract, the contractor will do their best effort to deliver the product/service contracted for. Thus, there is no deliverable risk associated with this contract type.
The government does have ceilings for profit percentages that can be awarded in cost-type contracts. For experimental, developmental or other type of research work, a cap of 15% of estimated contract costs applies. For all other cost-type contracts, a cap of 10% of estimated contract costs applies.
Convey all your risks
When negotiating a profit percentage in a negotiated award, you should convey all of the risks you are assuming with this contract. The government does have weighted guidelines it follows in assigning profit percentages to each of the elements of risk described above.
Contractors should familiarize themselves with these guidelines at DFARS Section 215.404. Understanding how the government views profit and the factors they consider in negotiating an acceptable profit percentage will enable a contractor to maximize the final negotiated profit rate.
Michael Smigocki, CPA/ABV, CVA is the Senior Managing Director of Federal Strategies Group LLC. He provides government contract and management consulting, M&A advisory, litigation support and expert testimony to the government contracting industry. He can be reached via email at MikeS@FedStrat.com.
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