The profit limitations imposed by FAR 15.404-4 only apply to cost plus "fixed fee" contracts. I remember a time when, I believe, profit limitations were imposed on both cost reimburseable and fixed price contracts. Does someone know the history as to why these limitations have been relaxed?

Are there other regulations (besides 15.404-4) or directives/policies which govern the amount of profit/fee a contractor can earn on contract types other than CPFF; or even combined contract types? For instance, could a CPIF/AF contract provide for a 10% target fee and an additional 15% award fee?

Brad

By Vern Edwards on Wednesday, August 23, 2000 - 05:12 pm:

To the best of my knowledge there has not been any limitation on profit under fixed-price contracts since the demise of the Renegotiation Act.

Before Jan. 1, 1998, FAR 15.903(d)(1) had imposed fee limitations on CPFF, CPIF and CPAF contracts. (It had also imposed a different "fee" limitation on all types of architect-engineer contracts.) The FAR Part 15 Rewrite eliminated the limitations on fee for CPIF and CPAF contracts. The May 14, 1997 proposed rule (62 FR 26640, 26641) explained the change as follows:

"[T]he fee limitations at 15.809-3(d) [sic] have been strictly alighed with statute[.]"

The statute in question is 10 U.S.C. 2306(d) or 41 U.S.C. 254(b), both of which impose fee limitations on CPFF contracts. The FAR Council and its predecessors had extended the limitation to all cost-reimbursement contracts on their own initiative. To the best of my knowledge there has never been a public explanation for the change of heart.

By joel hoffman on Thursday, August 24, 2000 - 09:53 am:

Brad, in response to your question asking if other regulations/directives/policies govern the amount of profit/fee can earn on other types of contracts than CPFF, I would like to discuss a little about FFP construction and A/E "practical limitations."

Our Engineer FAR Supplement prescribed "alternate, weighted-guidelines approach" limits our pre-negotiation objectives to a range of 3-12% for FFP construction and 3-15% for A-E contracts. In practice, it is difficult to make the scoring rubric come up to the upper limits. Anyhow, we have been conditioned to those limits. In fact, in my non-government experience, "10% profit" was the standard rate, expressed in most commercial construction proposals.

Our negotiators have been trained and conditioned through experience to hold that these rates constitute "fair and reasonable" equitable adjustments. In fact, I've seen case law backing up the COE's rate, as being determined to be "reasonable" in litigation. That record is also used as a bargaining point, with an "unreasonable" contractor.

Usually, a contractor's first argument is "I can make more money than your X% by investing my resources elsewhere". Well, at first blush, it sounds like a good argument. I used to wonder why a Contractor would bid 3-4% profit on a 4-5 year, 50 million dollar lock and dam contract, for instance. Then I wondered why they were in the construction business at all, if their argument were true!

I have analyzed a typical construction contractor's probable, investment and cash flow. In truth, a contractor's "return on investment" can be much, much higher than its "return on sales" (the return on sales is what we are actually negotiating). It can be likened to comparing a supermarket's return on sales (almost zilch) with its return on investment (good or great - weekly or daily stock turnover). With the Government's A-E and construction contract prompt pay requirements, monthly (or sometimes twice monthly) invoicing, payment for stored materials prior to payment to the suppliers, etc., a good prime contractor's annual return on investment may be up in the 30-50% range. Most construction contractor's actual investment is a very low percentage of the contract price. Subcontractors' return on investment can also be very good but their cash flow is not as good as the primes', in general.

(So, my first response to their negotiating "argument" is they must be in the wrong line of work. Then, if they are really serious, I mention the difference between the superficial return on sales and return on investment. Then they know I wasn't fooled by their argument.)

Try analyzing a service contractor's actual return on investment sometime...

Yes - I know - there is usually a real risk of loss on a FFP contract for before the fact pricing. In my opinion, this is a primary reason why FFP negotiated fee/profit margins should be higher than that allowed on CP contracts. And yes, I know that CP contracts usually do not assure recovery all of a contractor's legitimate costs (there are unallowable or unallocable costs). But the responsibility and risk to the Contractor is much higher on a FFP contract than on CP.

I have also used provisions for award fees (providing a pre-established, available pool of $$, not a percent of contract amount) on FFP contracts with mixed success, depending upon how well the award fee criteria emphasized superior performance. Happy Sails!