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Barry McVay's FEDERAL CONTRACTS DISPATCH

DATE: July 24, 2000

FROM: Barry McVay, CPCM

SUBJECT: Defense Federal Acquisition Regulation Supplement (DFARS); Profit Policy

SOURCE: Federal Register, July 24, 2000, Vol. 65, No. 142, page 45574

AGENCIES: Department of Defense (DOD)

ACTION: Proposed Rule

SYNOPSIS: DOD is proposing to amend DFARS Subpart 215.4, Contract Pricing, to change DOD profit policy to reduce and eventually eliminate emphasis on facilities investment, increase emphasis on performance risk, and encourage contractor cost efficiency.

EDITOR'S NOTE: For more on the earlier proposed rule to revise the profit policy in DFARS 215.4 to encourage contractors to develop and produce complex and innovative new technologies, see the May 22, 2000, FEDERAL CONTRACTS DISPATCH "Defense Federal Acquisition Regulation Supplement (DFARS); Profit Incentives to Produce Innovative New Technologies."

For more on the advanced notice of proposed rulemaking that led to the May 22, 2000, proposed rule, see the February 10, 2000, FEDERAL CONTRACTS DISPATCH "Defense Federal Acquisition Regulation Supplement (DFARS); Profit Policy."

DATES: Comments on the proposed rule must be submitted by September 22, 2000.

ADDRESSES: Submit comments on the proposed rule to Defense Acquisition Regulations Council, Attn: Ms. Amy Williams, OUSD (AT&L) DP (DAR), IMD 3D139, 3062 Defense Pentagon, Washington, DC 20301-3062; fax: 703-602-0350; e-mail: dfars@acq.osd.mil. Cite DFARS Case 2000-D018 in all correspondence related to this proposed rule.

FOR FURTHER INFORMATION CONTACT: Ms. Amy Williams, 703-602-0288.

SUPPLEMENTAL INFORMATION: The basis of the existing DOD profit policy in DFARS 215.404-71, Weighted Guidelines Method, was a report published in 1985 on the Defense Financial and Investment Review (DFAIR). One of the key DFAIR objectives was to encourage defense contractors to invest in productivity-enhancing facilities. However, since 1985, the defense industry has downsized and consolidated in response to substantial reductions in the defense budget, and the defense industry now has excess capacity and underutilized facilities. In this environment, rewarding contractors for investing in facilities is counterproductive. So the primary purpose of this proposed rule is to reduce and eventually eliminate facilities investment as a factor in establishing profit objectives on sole-source, negotiated contracts. However, this proposed rule includes the changes in the May 22, 2000, proposed rule that encourage contractors to develop and produce complex and innovative new technologies.

The following are the changes that would be made by this proposed rule:

• Paragraph (c)(2)(C)(1)(i) of DFARS 215.404-4, Profit, would be removed. The paragraph authorizes the contracting officer to use an alternate structured approach described in DFARS 215.404-73, Alternate Structured Approaches, in contracts under $500,000.
  
  
• To paragraph (a) of DFARS 215.404-71-1, General, would be added a fourth profit factor to be considered: cost efficiency. Paragraph (b) would be revised to add the following two sentences: "The cost efficiency special factor has no normal value. The contracting officer must exercise sound business judgment in selecting a value when this special factor is used (see 215.404-71-5)."
  
  
• The following changes would be made to DFARS 215.404-71-2, Performance Risk:
  
  
  • The "cost control" factor would be combined with the "management" factor to become the "management/cost control" factor. (EDITOR'S NOTE: This was part of the May 22, 2000, proposed rule.)
    
    
  • In the table in paragraph (b)(3), the assigned weighting for the technical factor would be increased from 30% to 60% (with the assigned value of 5%, the weighted value becomes 3.0%), and the assigned weighting for the management/cost control factor would be increased from 30% to 40% (with the assigned value of 4.0%, the weighted value becomes 1.6%. As a result, the composite weighted value would increase from 4.5% to 4.6% (3.0% + 1.6%). (EDITOR'S NOTE: This was part of the May 22, 2000, proposed rule.) Also, in (b)(4), the statement that "total costs" excludes general and administrative expenses, contractor independent research and development and bid and proposal expenses (IR&D/B&P), and facilities capital cost of money, would be revised to state that total costs excludes only facilities capital cost of money.
    
    
  • The table in paragraph (c) would be revised to eliminate the alternate designated range in two years; to add a "technology incentive" for "acquisitions that include development or production of innovative new technologies" (the "technology incentive" was part of the May 22, 2000, proposed rule); to increase the values between October 1, 2002, and September 20, 2004, by 1% to offset the elimination of buildings as a factor and the reduction in the value of equipment by 50%; and to increase the values after September 30, 2004, by an additional 1% to offset the elimination of facilities capital employed as a factor. The following would be the new values:
    
    

    	Normal value (percent)	Designated range (percent)
    Through September 30, 2002:
    Standard	5	3 to 7
    Alternate	6	4 to 8
    Technology Incentive	9	7 to 11
    October 1, 2002 to September 30, 2004:
    Standard	6	4 to 8
    Technology Incentive	10	8 to 12
    After September 30, 2004:
    Standard	7	5 to 9
    Technology Incentive	11	9 to 13

    
    
  • Paragraph (d)(4) would address the technology incentive. It would state, "The contracting officer may assign values within the technology incentive range when contract performance includes the introduction of new, significant technological innovation. Use the technology incentive range only for the most innovative contract efforts...When selecting a value within the technology incentive range, the contracting officer should consider the relative value of the proposed innovation to the acquisition as a whole."
    
    
  • Paragraph (e), which had addressed the management factor, and paragraph (f), which had addressed the cost control factor, would be combined into a new paragraph (e) that addresses the management/cost control factor.
    
    
• In DFARS 215.404-71-3, Contract Type Risk and Working Capital Adjustment, the following changes would be made:
  
  • Paragraphs (b)(2) and (e)(2) would be revised to require the entry of total allowable costs in Block 20 of DD Form 1547, Record of Weighted Guidelines Method Application, excluding facilities capital cost of money. (EDITOR'S NOTE: DD Form 1547 would be revised to reflect the changes in this rule; current Block 18 would become Block 20.)
    
    
  • In paragraph (c), the contract types values would be as follows (the values are reduced by .5% to offset the increases for performance risk in DFARS 215.404-71-2 (see above)):
    
    

    Contract type	Normal Value (percent)	Designated range (percent)
    Firm-fixed-price, no financing	4.5	3.5 to 5.5
    Firm-fixed-price, with performance-based payments	3.5	2 to 5
    Firm-fixed-price, with progress payments	2.5	1.5 to 3.5
    Fixed-price incentive, no financing	2.5	1.5 to 3.5
    Fixed-price incentive, with performance-based payments	1.5	0 to 3
    Fixed-price with redetermination provision	(treat as fixed-price-incentive with below normal conditions)
    Fixed-price incentive, with progress payments	.5	0 to 1.5
    Cost-plus-incentive-fee	.5	0 to 1.5
    Cost-plus-fixed-fee	0	0 to 0.5
    Time-and-materials (including overhaul contracts priced on time-and-materials basis)	0	0 to 0.5
    Labor-hour	0	0 to 0.5
    Firm-fixed-price, level-of-effort	0	0 to 0.5

    
    
• In DFARS 215.404-71-4, Facilities Capital Employed, the asset types values would be revised as follows (after September 30, 2000, buildings would be eliminated as a factor and the value of equipment would be reduced by 50%; after September 30, 2004, the value of equipment would be totally eliminated):
  
  

  Asset type	Normal Value (percent)	Designated range (percent)
  Through September 30, 2002:
  Land	0	N/A
  Buildings	5	0 to 10
  Equipment	20	15 to 25
  Between October 1, 2002, and September 30, 2004:
  Land	0	N/A
  Buildings	0	N/A
  Equipment	10	7.5 to 12.5
  After October 1, 2004:
  Land	0	N/A
  Buildings	0	0
  Equipment	0	0

  
  
• DFARS 215.404-71-5, Cost Efficiency Factor, would be added. It would state, "To the extent that the contractor can demonstrate cost reduction efforts that benefit the pending contract, the contracting officer may increase the prenegotiation profit objective by an amount not to exceed 4 percent of total objective cost (Block 20 of the DD Form 1547) to recognize these efforts." Contracting officers would be given "maximum flexibility" in determining the effect the contractor's cost reduction efforts will have on the contract, but criteria such as the the following would have to be considered:
  
  
  • The contractor's participation in Single Process Initiative improvements.
    
    
  • Actual cost reductions achieved on prior contracts.
    
    
  • Reduction or elimination of excess or idle facilities.
    
    
  • The contractor's cost reduction initiatives (for example, competition advocacy programs, technical insertion programs, obsolete parts control programs, spare parts pricing reform, value engineering, and the use of metrics to drive down key costs).
    
    
  • The contractor's adoption of process improvements to reduce costs.
    
    
  • Subcontractor cost reduction efforts.
    
    
  • The contractor's effective incorporation of commercial items and processes.
    
    
• DFARS 215.404-72, Modified Weighted Guidelines Method for Nonprofit Organizations Other Than FFRDCs [Federally Funded Research and Development Centers], would be revised to add a paragraph (b)(1)(iii), which would state "do not assign a value from the technology incentive designated range" when making modifications to performance risk.
  
  
• In DFARS 215.404-73, Alternate Structured Approaches, paragraph (b)(1) would be revised to state that the alternate structure must include "performance risk, contract type risk (including working capital), facilities capital employed (through September 30, 2004), and cost efficiency." Also, paragraph (b)(2)(i) would be revised to replace "the contracting officer shall reduce the overall prenegotiation profit objective by the lesser of 1 percent of total cost or the amount of facilities capital cost of money" with "the contracting officer shall reduce the overall prenegotiation profit objective by the amount of facilities capital cost of money." The same change would be made to the discussion of base fee in paragraph (c) of DFARS 215.404-74, Fee Requirements for Cost-Plus-Award-Fee Contracts.

FOR FURTHER INFORMATION CONTACT: Barry McVay at 703-451-5953 or by e-mail to BarryMcVay@FedGovContracts.com.

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