Every contractor needs a margin to stay in business, and the government’s own regulations recognize that profit is a legitimate part of a contract price. But how margin is viewed, negotiated and limited varies with the contract type and with how the price is evaluated. In the fourth quarter, when firms price several bids at once, understanding those differences helps keep margin decisions deliberate rather than accidental. This is general information; talk to an accountant experienced in government contracting about your rates and pricing.
Profit in competitive fixed-price work
In most competitive fixed-price acquisitions, the government evaluates the total price, not its components. Your profit is embedded in the price, and competition, rather than the contracting officer’s analysis of your margin, determines whether the price is acceptable. The FAR’s profit guidance applies when a price is negotiated on the basis of cost analysis, and it states that contracting officers are not required to analyze profit when the negotiation is not based on cost analysis. Contracting officers also may not require a prospective contractor to submit a breakdown or rationale for its profit objective, though they may consider one offered voluntarily.
The practical result is that fixed-price margin is a business judgment about risk and competition. Price too thin and you may not cover the risks you are accepting; price too rich and you may lose.
Profit when the price is negotiated on cost
When a contracting officer negotiates using cost analysis, as on many sole-source awards and modifications, the FAR calls for a structured approach to developing the government’s profit or fee objective. Factors the FAR lists include the contractor’s effort, contract cost risk, federal socioeconomic programs, capital investments, cost control and other past accomplishments, and independent development. The Department of Defense uses a weighted guidelines method for this purpose. Higher risk to the contractor generally supports a higher profit objective, which is one reason fixed-price arrangements tend to carry more margin than cost-reimbursement ones.
Fee on cost-reimbursement contracts
On cost-reimbursement contracts, profit is called fee and takes several forms. A fixed fee is set at award and does not vary with actual cost. Incentive fees adjust according to a formula tied to cost or performance outcomes. Award fees are earned based on the government’s evaluation of performance against stated criteria. Statute and the FAR cap fixed fees on cost-plus-fixed-fee contracts: generally 10 percent of estimated cost, or 15 percent for experimental, developmental or research work, with a separate limit of 6 percent of the estimated construction cost for certain architect-engineer design services.
Profit in hourly rates
On time-and-materials and labor-hour contracts, and on many schedule and task order arrangements priced by the hour, profit is built into the fully burdened labor rates, along with wages, indirect costs and general and administrative expense. That means every hour billed carries margin, and a rate that omits profit, or applies it inconsistently, cannot easily be fixed later.
- Decide your margin deliberately for each bid, based on risk and competition.
- Keep profit separate from costs in your own build-up, even when the government sees only the total.
- Know when fee limits apply before you price cost-type work.
The FAR’s profit guidance is in Part 15 and its contract type rules are in Part 16, both at acquisition.gov.