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Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D.

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Presentation on theme: "Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D."— Presentation transcript:

1 Defense Contractor Negotiation & Pricing Accounting 6310 Fall 2002 Richard E. McDermott, Ph.D.

2 Source Data summarized from Pricing Manual of the Federal Acquisition Regulations (FAR).

3 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

4 Three Contract Types Firm fixed price Cost reimbursement Labor hour and time and materials

5 Firm fixed price Fixed price with economic price adjustment Fixed price incentive fee Fixed price with successive targets etc.

6 Cost reimbursement Cost sharing Cost plus fixed fee Cost plus award fee Cost plus incentive fee

7 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

8 Consider Contractor Risk Having contractors accept unknown or uncontrollable risk can result in –Poor contract performance –Reduced competition –Substantial increase in contract price

9 Two Areas of Risk Performance Risk Market risk

10 Performance Risk Most contract risk is related to contract requirements and the uncertainty surrounding contract performance

11 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

12 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

13 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

14 Market Risk Address through contracts with economic price adjustment clause

15 Pricing Definition of price Seller pricing objectives and approaches Government pricing objective Government approaches to contract pricing

16 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

17 Seller pricing objectives Pricing objectives –Cover costs and earn profit Operational objectives –Short-term/long-term profitability –Market share –Survival –Product quality –Productivity

18 Seller Pricing Approaches Cost based pricing Market based pricing

19 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

20 Market Based Pricing Profit maximization pricing Marker share pricing Market skimming Current revenue pricing Promotional pricing Demand differential pricing Market competition pricing

21 Market Skimming Pricing Charge early buyers a premium

22 Promotional Pricing Products are priced to enhance the sales of the overall product line rather than the profitability of each product

23 Demand Differential Pricing Products sold in different markets are sold at different prices –Get what the customer will pay

24 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

25 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

26 Examples of Contingencies Results of pending litigation Cost of volatile market price changes

27 Evaluating the Bid Evaluate price Analyze cost

28 Evaluate price Compare prices in competitive bidding situations Look at competitive published price lists, rebate agreements etc. Get independent price estimates

29 Analyze cost When do you look at bidders costs? –When you require offeror to submit cost or pricing data –Why have offeror submit cost data? To provide support that proposed price is reasonable

30 Contract Costs Include Direct costs Indirect costs Fee

31 Government approaches to contract pricing Quantitative Techniques for Contract Pricing Cost Analysis Negotiation Techniques

32 Quantitative Techniques for Contract Pricing Round table estimating Comparison Detailed analysis

33 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

34 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

35 Detailed analysis Break costs into tasks, estimate resources required for each task

36 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?

37 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?

38 Detailed Analysis Questions Do labor rate estimates consider changes in the work force? Do labor rate estimates consider geographical differences?

39 Cost Analysis Contract costs are monetary measures of capital and labor required to complete a contract –Cash expenditures –Expense accrual –Inventory draw-down

40 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

41 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

42 Forward pricing rates Prepared by contractor Audited by government When accepted, used in bidding contracts for that fiscal year

43 Fee or Profit The fee objective does not necessarily represent net income to the contractors –Some costs are disallowed Entertainment

44 Profit Analysis Factors Contractor effort –Material acquisition –Conversion direct labor –General management

45 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

46 Profit Analysis Factors Federal socioeconomic programs Capital investment Cost control and other past accomplishments Independent development--did contractor do R&D on own?

47 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.

48 Negotiation vs. Sealed Bidding FAR states that any contract awarded using other than sealed bidding is considered a negotiated contract

49 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

50 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

51 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

52 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.

53 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

54 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

55 Noncompetitive Negotiations Occur in sole-source situations –Example: Only one contractor has the technical expertise to perform a contract

56 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

57 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

58 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

59 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

60 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

61 The End

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