Defense Contractor Negotiation

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Defense Contractor Negotiation Pricing

• Accounting 6310
• Fall 2002
• Richard E. McDermott, Ph.D.

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

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Three Contract Types

• Firm fixed price
• Cost reimbursement
• Labor hour and time and materials

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Firm fixed price

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

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Cost reimbursement

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

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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

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Consider Contractor Risk

• Having contractors accept unknown or
  uncontrollable risk can result in
• Poor contract performance
• Reduced competition
• Substantial increase in contract price

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Two Areas of Risk

• Performance Risk
• Market risk

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Performance Risk

• Most contract risk is related to contract
  requirements and the uncertainty surrounding
  contract performance

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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

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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

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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

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Market Risk

• Address through contracts with economic price
  adjustment clause

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Pricing

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

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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

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Seller pricing objectives

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

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Seller Pricing Approaches

• Cost based pricing
• Market based pricing

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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

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Market Based Pricing

• Profit maximization pricing
• Marker share pricing
• Market skimming
• Current revenue pricing
• Promotional pricing
• Demand differential pricing
• Market competition pricing

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Market Skimming Pricing

• Charge early buyers a premium

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Promotional Pricing

• Products are priced to enhance the sales of the
  overall product line rather than the
  profitability of each product

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Demand Differential Pricing

• Products sold in different markets are sold at
  different prices
• Get what the customer will pay

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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

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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

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Examples of Contingencies

• Results of pending litigation
• Cost of volatile market price changes

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Evaluating the Bid

• Evaluate price
• Analyze cost

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Evaluate price

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

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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

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Contract Costs Include

• Direct costs
• Indirect costs
• Fee

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Government approaches to contract pricing

• Quantitative Techniques for Contract Pricing
• Cost Analysis
• Negotiation Techniques

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Quantitative Techniques for Contract Pricing

• Round table estimating
• Comparison
• Detailed analysis

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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

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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

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Detailed analysis

• Break costs into tasks, estimate resources
  required for each task

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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?

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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?

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Detailed Analysis Questions

• Do labor rate estimates consider changes in the
  work force?
• Do labor rate estimates consider geographical
  differences?

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Cost Analysis

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

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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

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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

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Forward pricing rates

• Prepared by contractor
• Audited by government
• When accepted, used in bidding contracts for that
  fiscal year

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Fee or Profit

• The fee objective does not necessarily represent
  net income to the contractors
• Some costs are disallowed
• Entertainment

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Profit Analysis Factors

• Contractor effort
• Material acquisition
• Conversion direct labor
• General management

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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

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Profit Analysis Factors

• Federal socioeconomic programs
• Capital investment
• Cost control and other past accomplishments
• Independent development--did contractor do RD on
  own?

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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.

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Negotiation vs. Sealed Bidding

• FAR states that any contract awarded using other
  than sealed bidding is considered a negotiated
  contract

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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

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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

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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

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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.

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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

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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

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Noncompetitive Negotiations

• Occur in sole-source situations
• Example Only one contractor has the technical
  expertise to perform a contract

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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

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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

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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

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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

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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

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The End