Presentation on theme: "Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D."— Presentation transcript:
Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D.
Source Data summarized from Pricing Manual of the Federal Acquisition Regulations (FAR).
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
Three Contract Types Firm fixed price Cost reimbursement Labor hour and time and materials
Firm fixed price Fixed price with economic price adjustment Fixed price incentive fee Fixed price with successive targets etc.
Cost reimbursement Cost sharing Cost plus fixed fee Cost plus award fee Cost plus incentive fee
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
Consider Contractor Risk Having contractors accept unknown or uncontrollable risk can result in –Poor contract performance –Reduced competition –Substantial increase in contract price
Performance Risk Most contract risk is related to contract requirements and the uncertainty surrounding contract performance
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
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
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
Market Risk Address through contracts with economic price adjustment clause
Pricing Definition of price Seller pricing objectives and approaches Government pricing objective Government approaches to contract pricing
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
Seller Pricing Approaches Cost based pricing Market based pricing
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
Market Skimming Pricing Charge early buyers a premium
Promotional Pricing Products are priced to enhance the sales of the overall product line rather than the profitability of each product
Demand Differential Pricing Products sold in different markets are sold at different prices –Get what the customer will pay
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
Government pricing objective Pay a fair and reasonable price –What is fair? Price each contract separately –Dont try and balance the financial results of one contract against another Exclude contingencies –Items that cannot reasonably be estimated at the time of award
Examples of Contingencies Results of pending litigation Cost of volatile market price changes
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
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
Detailed analysis Break costs into tasks, estimate resources required for each task
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?
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?
Detailed Analysis Questions Do labor rate estimates consider changes in the work force? Do labor rate estimates consider geographical differences?
Cost Analysis Contract costs are monetary measures of capital and labor required to complete a contract –Cash expenditures –Expense accrual –Inventory draw-down
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
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
Forward pricing rates Prepared by contractor Audited by government When accepted, used in bidding contracts for that fiscal year
Fee or Profit The fee objective does not necessarily represent net income to the contractors –Some costs are disallowed Entertainment
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
Profit Analysis Factors Federal socioeconomic programs Capital investment Cost control and other past accomplishments Independent development--did contractor do R&D on own?
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.
Negotiation vs. Sealed Bidding FAR states that any contract awarded using other than sealed bidding is considered a negotiated contract
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
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
Win/lose negotiators... Are deceptive Focus on negotiating positions rather than long term satisfaction Are argumentative Show reluctance to make any meaningful concessions Are highly competitive and mistrustful of others
Negotiating Strategies Plan the order for addressing issues –One approach: Start with least important issues first, concessions on several less important issues may limit or eliminate the need for concession on more important issues –Another approach: Address issues according to ease of reaching agreement.
Negotiating Strategies Building block approach –Basic requirements are addressed before price is addressed –Tradeoffs between contract requirements and contract price are addressed after resolution of other issues –Contract price is not finally resolved until all other issues are settled
Draft a negotiating plan Background (contract, contractor, negotiation situation) Major and minor negotiation issues and objectives Negotiation priorities and positions on key issues Negotiation approach
Noncompetitive Negotiations Occur in sole-source situations –Example: Only one contractor has the technical expertise to perform a contract
Ten Rules for Bargaining Success Be prepared Aim high Give yourself room to compromise Put pressure on the contractor Do not volunteer weaknesses Use concessions wisely Say it right Satisfy non-price issues Use the power of patience Be willing to walk away from negotiations
Put pressure on the contractor Refer to potential alternatives such as: –Canceling and resoliciting –Changing product requirements to encourage competition –Investing in new source development –Performing the contract with in-house Government resources
Use concessions wisely Dont rush to make concessions, concede slowly and in small amounts. Concessions too large or given too quickly: –Raise the expectations of the other negotiator –Give the impression the concessions were not important to you –Leave little room for further maneuvering –Be more than necessary to get a mutually satisfactory result
Use the power of patience Use patience to: –Increase the stress on the contractors negotiator –Display resolve or firmness by showing you are not overly anxious for a settlement –Dissipate emotional feelings surrounding certain issues by showing a willingness to proceed through negotiations
Be willing to walk away from negotiations There is some risk to this tactic--it is difficult to get the negotiations started again if this is your eventual intent