Pricing Matters – Percentage of Profit?

By Ronald Marta, University of Houston PTAC

What profit percentage should I use for my bids for government contracts?

It is well to begin by recalling the government’s position on profit. Federal Acquisition Regulation (FAR) 15.404-4 states: “It is in the Government’s interest to offer contractors opportunities for financial rewards sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large and small business concerns to Government contracts, and maintain a viable industrial base.” ‘Sufficient financial rewards’ is usually interpreted as ‘reasonable profit.’ We can say then that not only are small (and large) businesses entitled to a reasonable profit, but it is in the Government’s interest that they receive a reasonable profit because they then have an incentive to perform efficiently and effectively on their Government contracts.

For the discussion of profit, we note that U.S.C. 2306(d) and 41 U.S.C. 254 (b) impose certain statutory limitations with respect to profit: Under a cost-plus-fixed-fee contract, the cap is 15 percent for fee for experimental, developmental, or research work, 6 percent for fee for architect-engineer services for public works or utilities, and 10 percent for other cost-plus-fixed-fee contracts.

The Federal Acquisition Regulation (FAR) addresses the subject of profit in Part 15. FAR 15.404-4 establishes six factors for the analysis of profit. They are:

  1. Contractor Effort. Measures the complexity of the work and the resources required. There are four subfactors that are to be considered in determining contractor effort. They are:
    a. Material acquisition. Measures the managerial and technical effort needed to obtain the required purchased parts and material, subcontracted items, and special tooling.
    b. Conversion direct labor. Measures the contribution of direct engineering, manufacturing, and other labor to convert the raw materials, data, and subcontracted items into the contract items.
    c. Conversion-related indirect costs. Measures the contribution of the contractor’s indirect costs to contract performance.
    d. General management. Measures the composition of the contractor’s other indirect costs and general and administrative (G & A) expense, their composition, and their contribution to contract performance.
  2. Contract Cost Risk. Measures the degree of cost responsibility and associated risk that the contractor will assume as a result of the contract type contemplated and considering the reliability of the cost estimate in relation to the complexity and duration of the contract risk.
  3. Federal Socioeconomic Programs. Measures the contractor’s support to Federal socioeconomic programs, such as small disadvantaged businesses, women-owned businesses, veteran-owned businesses, etc.
  4. Capital Investments. Takes into account the contribution of contractor investments to efficient and economical contract performance.
  5. Cost-Control and Other Past Accomplishments. Considers the ability of the contractor to perform similar tasks effectively and economically.
  6. Independent Development. Recognizes independent development efforts by the contractor that are relevant to the contract end item without Government assistance.

In addition to the preceding factors, each agency may include ‘Additional Factors’ in its structured approach or take them into account for profit analysis. It is to be noted that each of the factors may provide additional profit opportunities for the contractor.

The U.S. Department of Defense has a method to calculate profit. The method is called Weighted Guidelines. It is contained in DD Form 1547. The Weighted Guidelines method is based on the following contractor risk factors: technical, management cost control, performance risk, and contract type risk. In addition, working capital, facilities capital, and cost efficiency are important components of the method. The Defense Acquisition University (DAU) course CLC 104 Analyzing Profit or Fee provides excellent practice with the DoD Weighted Guidelines method.

In the final analysis, there is no magic answer for determining the profit percentages to be used in proposals for government contracts. The profit percentages should be based on the FAR factors identified and described above. At the same time, it should be remembered that profit percentages exist in the market place where competitive forces are usually in play. The profit analysis factors, as well as the interplay between competition and profit, will make for situations and outcomes that are continuously fascinating and exciting for both participants and observers.

Pricing Matters is a regular feature by Ronald Marta.  Watch for future posts on a wide range of pricing issues.

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Ron Marta Headshot
Ronald S. Marta has been a Senior Procurement Counselor with the University of Houston PTAC since 2008.  Prior to that, he served as an auditor for 15 years with the Defense Contract Audit Agency (DCAA) and 7 years with the NASA Office of Inspector General at Johnson Space Center. His special areas of interest include accounting systems, proposal preparation, cost analysis, and audit preparation.  Ron is a Certified Public Accountant and holds Master’s degrees in Business Administration and in Professional Accounting.

The UH PTAC is a specialty center of the University of Houston Small Business Development Center Network.  UH PTAC provides government procurement consulting and training to 43 counties in Southeast Texas.


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