|Image: Oregon State University Professional and Continuing Education|
You have worked to establish your federal government contract business contacts. You have developed your company infrastructure and processes to accommodate the Federal Acquisition Regulation. Your company has effectively marketed and teamed on a prospective program. A proposal has been carefully prepared and submitted to the contracting officer. You have been selected as the apparent winner and you are ready for the next phase on the government contracting process - the negotiation. This article assumes that your are in the federal government services contracting business, that you plan to price your services at an hourly rate and sell them by labor categories with professional job descriptions to perform the government's statement of work and bill by the hour. This article also assumes that you are not contracting under FAR Part 12, "Commercial Contracting".
Unlike commercial business, the vast majority of federal government contracts are subject to negotiation. Even in competitive procurements, the government may award a contract based on best value (a combination of technical, cost and other factors) not necessarily to the lowest price bidder. The final price paid by the government is then subject to negotiation. Under General Services Administration (GSA) Schedules and Indefinite Delivery/Indefinate Quantity (IDIQ) Contracts, terms and conditions and labor hour pricing are agreed upon in advance but individual delivery orders are negotiated separately regarding the labor hours, material and travel cost necessary to complete a discrete scope of work. Cost Plus and Time and Material contracts are also negotiated procurements on many occasions. Only small, fixed price purchase orders and items purchased under FAR Part 12, "Commercial Contracting", are awarded solely on the basis of price.
This document will address contract negotiations under three (3) different business scenarios:
Negotiations directly with a government contracting officer pursuant to a federal government contract
Negotiations with a prime contractor for a subcontract under the prime's federal government contract
Negotiations with a subcontractor to establish a price and flow down the terms and conditions of your contract with the federal government.
II. NEGOTIATION TEMPLATE
In federal government contracting each of the above scenarios pass through the following template of negotiation steps:
C. Pre-award Survey
D. Cost Negotiations
E. Final Profit Negotiations
F. Contract Award
The above template is recognized throughout the Federal Acquisition Regulation (FAR) and in the Defense Contract Audit Agency (DCAA) Handbook. All government agencies and contractors utilize it.
III. RULES OF THUMB
Your proposal represents an initial offer to a government agency or a prime contractor. Correspondingly, a subcontractor's proposal represents his initial offer to you. Government contract and subcontract negotiation is an art, not a science. You will find the above negotiation template is applied with various degrees of expertise among government agencies, prime contractors and subcontractors. Like many other aspects of business, the intellect and experience of customer or supplier personnel will vary with the agencies and the companies with whom your are dealing.
Keep in mind that your client or your subcontractor is also developing his/her position against the above template. Confirm with the other party at which step the negotiation is located and the fact that the negotiation is moving from one step to the next. If you are dealing with an agency or company representative who is unfamiliar with the process, take the time at the beginning to convey in a tactful manner your understanding of how the negotiation will proceed. Keep a careful written record of events during each step, to include information provided, offers and counter-offers made and agreements reached.
Develop a negotiation with a "target" position and a "floor" position. Your objective is to conclude the negotiation achieving a price as close to the target position as possible while never going beneath the floor.
Courtesy and politeness are mandatory. Avoid confrontations. Do not reveal your strategy in front of the other party except to objectively explain your position in terms of an incremental offer or a counter offer. Excuse yourself for outside caucuses or adjournments whenever it is necessary to study an offer, assess a situation or develop your next move.
It is always best to look at negotiations from a win/win perspective. Be honest and forthright during the audit, fact-finding and site survey steps. Look for insights into the other party's negotiation position from the questions being asked, the data being requested or the responses being obtained. Defend your cost and performance position as conveyed in your proposal with documented facts. Look for openings in your subcontractor's proposal support documentation. When cost and profit negotiations commence, offer compromises and trade-offs of value to the other party in return for acceptance of your position.
IV. NEGOTIATIONS DIRECTLY WITH A FEDERAL GOVERNMENT CONTRACTING OFFICER
Procurement Contracting Officers (PCO's) hold warrants to represent the federal government. PCO's must have internal approval of a contract within their respective agencies before they can sign a contract. Only a PCO is authorized to officially commit the government. For smaller contracts a PCO may delegate his authority to an Administrative Contracting Officer (ACO). This often occurs in larger industrial plants where the ACO is resident in the facility or in remote locations where the ACO is a member of the Defense Contract Management Area Office (DCMAO) in the city where the contract is being performed.
A. Audit - Upon receipt of your proposal the contacting officer will order a Defense Contract Audit Agency (DCAA) audit. The Request for Proposal (RFP) to which you responded may in fact have ordered a copy of your proposal be submitted to the DCAA Office nearest your location. If you are a new supplier to the government, DCAA may ask for a copy of your long-range plan containing your direct and indirect rate structure. They will verify the rates utilized in your proposal against your LRP, evaluate escalation factors utilized for long term projects and check the math. The auditor will ask for copies of major material and travel quotations and insure that government per diem rates are utilized for lodging and meals in the cost proposal. DCAA may also visit your facility and complete a "Pre-award Survey of Prospective Contractor Accounting System" form. The survey checks compliance with Cost Accounting Standards 401 and 402 to insure that the company sets up each new government contract on job cost accounting in the identical manner in which it was proposed; in effect identifying direct labor, direct material and other direct costs to each contract monthly and allocating overhead and G&A utilizing the same numerator and denominator relationships upon which the contract was originally estimated. DCAA is paid by the PCO to perform the audit. The audit does not extend to negotiations and at the audit conclusion the auditor files a report with the PCO. The report will contain information on any errors uncovered and findings on the adequacy of the accounting and long range planning systems. DCAA will not express an opinion on the cost content of the proposal in terms of a value judgment regarding prices for prospective supplies and services. If the auditor does not offer an exit interview, ask for one. Better yet, ask for a copy of the audit report to the PCO. Many DCAA offices will provide a copy to audited contractors. DCAA does not have the authority to direct a proposal revision based on audit findings. An astute contractor will immediately correct any errors found by the auditor in the proposal and examine other audit findings in preparation for negotiations.
B. Fact-finding - Assuming your proposal met the requirements specified in the RFP, fact-finding usually involves the PCO or his ACO requesting additional information. These areas of interest are early indications of where the negotiator is looking for weaknesses in your cost justifications or disconnects between your technical approach and the cost your are estimating to do the job. If you have subcontractors or major material suppliers, the government may ask for copies of your vendor proposal evaluations. The government may wish to examine cost history for the last time you performed similar efforts. Keep in mid that most government agencies put together an independent cost estimate of what they feel the item or service should cost. These s are commonly called "Should Cost Estimates". The additional requests for information during fact finding are feeding the should cost . The PCO typically has an end user for the product or service who will become the Contracting Officer's Technical Representative (COTR) when the contract is awarded. The COTR has a strong influence on the negotiations and will usually be present when negotiations commence. On many occasions, the COTR is the real internal customer at the agency. He has fiscal, technical and schedule responsibilities to his management for the program you are servicing. He simply cannot sign for the government. The PCO has the agency warrant for that function and knows the most about public law and the Federal Acquisition Regulation (FAR) as it is applied to contracts the agency undertakes. It is the COTR who is likely feeding the PCO requests for fact-finding data. Keep in mind that the COTR and the PCO are formulating their assessment of the cost and the risk associated with the program during the fact-finding process. Cost is the first item of negotiation and risk has a direct influence on the government's position on profit.
C. Pre-award Survey - A pre-award survey is an extension of fact finding in the form of a visit to a new supplier's facility. The PCO or the ACO and the COTR usually attend. In some instances the local Defense Contract Management Area Office (DCMAO) is involved. As you become a regular supplier to an agency, site survey visits will normally cease or occur only rarely. The site survey team is interested in establishing the physical presence of a new supplier, the technical capability and the human resources to perform the prospective work and the quality of the environment in which the effort will be performed. A "Pre-award Survey of Prospective Contractor" Form is completed and becomes part of the contract file. Select the person who will meet with the government survey team. This person should be empowered to speak for the company and should be completely familiar with details of the solicitation and of your company's offer. If relevant, make available one or more technicians to answer questions. Identify any disparities that may exist between the solicitation and your company's offer that should be resolved during the initial meeting with the survey team. Think about how you can demonstrate actual technical capability or the development of technical capability on the proposed contract. Make sure your plant facilities and equipment are available and operable. If they are not, be prepared to demonstrate that they can be developed or acquired in time to meet proposed contract requirements. Make sure that your labor resources have the proper skills or that personnel with the needed skills can be hired expeditiously. Gather and make available to the survey team documentation, such as previous government contracts or subcontracts or commercial orders, to demonstrate a past satisfactory performance record with regard to delivery, quality and finances. Gather financial documentation for the team financial analyst, including the company's current profit and loss summary, balance sheet, cash flow chart and other pertinent financial information. Make sure the plans are in place for vendor supplies and materials or subcontracts to assure that the final delivery schedule can be met. Make sure that these plans are verifiable. Review any technical data and publications that may be required under the proposed contract and make sure you understand them. If the contract is a type other than a firm-fixed price or if you have requested progress payments, prepare adequate accounting documentation for review. Review your quality control program and make sure that it is workable and consistent with the quality requirements stated in the contract.
D. Cost Negotiations - At the conclusion of audit, fact-finding and pre-award survey steps, the PCO and the COTR complete their should cost and open negotiations. They may make a counter offer to your price proposal at this time. Such a counter-offer reflects the government's initial position on cost and a reasonable profit. Assess how far from your negotiation target the counter-offer is and how close to your floor the government wants to take you. In the vast majority of cases you and the government determine that further negotiations are necessary. The profit issue is set aside and negotiations commence on the elements of cost, comparing the government's position to yours. This is perhaps the most important step in negotiations, since fully loaded cost makes up the vast majority of the prospective contract price. The parties address each direct and indirect cost element and factor in the cost proposal and attempt to come to an agreement on the total cost for the contract. As agreement is reached the government will adjust their cost to reflect the agreed upon amounts. You will do the same. The following discussion will address cost elements least and most likely to undergo negotiation and the associated reasons:
Cost Elements Least
Subject to Negotiation
(1) Direct Labor Rate - The contractor can supply cost history, salary surveys or other documentation to support direct labor rates.
(2) Labor Overhead & Material Handling Rates - DCAA has reviewed the company forward pricing rates
(3) G&A Rates - DCAA has reviewed the company forward pricing rates
(4) Direct Material Cost - The contractor can supply vendor quotations and demonstrate competitive bidding
(5) Travel Costs - The contractor can supply airline and rental car quotes and government per diem rates are used for lodging and meals
(6) Terms and Conditions - All clauses required by the government and public law were contained in the RFP when the solicitation was provided for contractor response. In a competitive environment very few contractors take exception to these requirements. However, if the procurement is a HUB Zone or 8(a) Set aside to your compan there may be certain terms which the government is willing to negotiate. The FAR is written for protection of the contractor as well as the government. During the draft RFP stage when contractors are asked for comments it is wise to highlight any omissions.
Cost Elements Most
Subject to Negotiation
(7) Labor Category - The government may choose to question or have an alternative assessment of the skill level and mix necessary to perform the statement of work. A mutual agreement on the labor skill mix must be achieved.
(8) Labor Hours - The government may choose to question or have an alternative assessment of the quantity of labor hours necessary to perform the statement of
work. A mutual agreement on the labor hours to do the job must be achieved.
(9) Number of Travel Trips - The government may choose to question or have an alternative assessment of the quantity of trips necessary to perform the statement of work. A mutual agreement on the number of trips must be achieved.
(10) Data Items - Some data item requirements are negotiable, such as the level of reporting in the product hierarchy for cost and schedule reporting. Agreement must be reached on these fields. Although data items are normally not quoted separately in the proposal, their preparation cost can be dramatically influenced by content requirements and heavily effect direct labor hours.
(11) Material and Labor Escalation - The government generally recognizes the consumer price index as a reasonable projection of annual labor and material cost
increases. This index has been running plus or minus 3% per year for several years. In the event the contractor proposes escalation values in excess of 3.5% per year compounded for multi-year contracts, the rationale must be supported and agreed upon.
At the conclusion of the cost negotiation, all elements of cost for the base price of the contract have been agreed upon. During the course of the cost negotiations this agreement can be reached by arriving at a fully negotiated amount for each of the above cost elements one by one, or offering and counter-offering at the total cost line until agreement is achieved. Very few contractors are willing to accept negotiated changes in cost elements IV. D. 1-5, above because the nature of these cost elements is fixed across the company for all projects or is firm in quotations by vendors, suppliers and government-mandated per diem rates.
E. Final Profit Negotiations - During the offer/counter-offer process the preliminary profit positions which may have been conveyed from one party to the other must be finalized. Under Federal Acquisition Regulations (FAR) a PCO must place in the negotiation file a memorandum on the derivation of the profit rate awarded to the contractor in the final price. The general rule of thumb from the government perspective is that once the costs for a contract have been agreed upon the profit rate is determined by the amount of risk to the contractor in the deal. In government contracting profit is rarely proposed at a higher rate than 25% and only at that level on firm, fixed price contracts where the risk to the contractor is the highest. In some time and material contracts, profit cannot be calculated on a cost base containing material, travel or subcontractor cost elements. Profit in these cases is only awarded on fully burdened labor through G&A. The following broad profit ranges apply in general to the various types of government contracts :
Firm, Fixed Price (FFP) - 15% to 20% profit on total cost
Time and Materials (T&M) - 5% to 15% profit on fully burdened labor cost
Cost Plus (CP) - 5% to 15% profit on fully burdened cost
The Federal Acquisition Regulation (FAR) prohibits profit awards above certain levels for certain types of contracts where the government is bearing virtually all the risk. The PCO has the authority to negotiate the profit rate with the contractor but his profit memorandum to the file must specify the logic he utilized. PCO's must therefor justify the profit by discussing risk and certain other factors in the memorandum. To assist PCO's the government has provided the "Weighted Guidelines Method" of profit determination for use by government representatives in developing a position on profit. Ask for a copy of the government's weighted guideline analysis. It lends structure to the profit negotiation process. As you will see when you analyze it the government assesses risk and certain other factors such as management/cost control, contract type, working capital and cost efficiency factors in determining the profit to award on the contact. Your job is to influence the government with regard to risk and other factors and obtain the highest possible profit considering the nature of the prospective contract and the risk involved in performing it. Remember that the PCO's opinion of the risk in the contract is being regularly influenced during all steps of the negotiation process.
Certain cost plus incentive fee and cost plus award fee arrangements are available to the government and are usually specified in the RFP. Contractors are required to provide proposal input to these arrangements. A base fee is negotiated and then an incentive fee range or an award fee pool is also negotiated. The contract requires regular awards of additional increments of fee based on the performance achievements negotiated in advance with the contractor. A "Best Value" performance fee arrangement proposed by a contractor may be a key discriminator in winning a competitive procurement.
F. Contract Award -. Agreement on a final price for the contract is determined by the total negotiated cost plus the negotiated profit. The negotiation result is documented by the contractor in the form of a letter to the PCO specifying the date negotiations were concluded and the agreed upon price. A Certificate of Current Cost and Pricing may be required if the RFP contains the FAR clause for Certified Cost and Pricing Data. The clause has serious implications with regard to avoiding defective pricing and should be carefully researched before a company or an individual signs the document.
Upon receipt of negotiation confirmation from the contractor and the Certificate of Current Cost and Pricing, if required, the PCO and his staff prepare the contract document. The document is forwarded to the contractor for review, approval and signature. The PCO then signs the contract and returns a copy of the fully executed document to the contractor. You are now authorized to commence work. The government is obligated for the full amount of the contract and will pay invoices up to the incremental funding level. Many contracts are fully funded at award. Other contracts, particularly multi-year programs, are incrementally funded by year.
You are obligated for delivery of the supplies and services specified in the negotiated and signed contract in accordance with the delivery schedule and terms and conditions contained therein.
V. NEGOTIATIONS WITH A PRIME CONTRACTOR FOR A SUBCONTRACT
You signed a teaming agreement with a prime contractor during the RFP stage of a solicitation. You prepared your proposal and submitted it to the prime contractor who incorporated it into the submission to the government. Your submission contained flowdown versions of terms and conditions from the prime's federal contract as well as a technical description of the effort you intend to perform. Your cost proposal contained fully loaded rates for the labor categories and material as well as the travel you will perform on the subcontract. The government has awarded the prime contract to our team member. You are now undertaking negotiations with the prime to convert your teaming agreement to a subcontract. The subcontract will replace the teaming agreement between you and your prime.
Most prime contractors prefer to negotiate subcontracts with their team members before they negotiate the final prime contract with the government. Therefore, you will likely be approached by your prime with a certain element of urgency to finalize your subcontract and enable him to negotiate his deal. Keep in mind that your prime contractor is preparing his cost for negotiations with the government and may be seeking to obtain cost benefits at your level which will offset elements of his proposal which he may have bid ambitiously.
A. Audit - Prime contractors do not have a right to your direct and indirect rate information. Subcontractors propose fully loaded labor and material through profit and do not disclose their rates to primes. Your teaming agreement may specify the profit rate your team member and you have agreed to apply. Other than profit, your prime does not know the make-up of your direct labor, overhead, material handling and G&A rates. Your proposal disclosed labor hours at a fully loaded rate and burdened material and travel cost. If your prime wants to audit any other cost element of your proposal he must request an assist audit through his PCO. If an assist audit is requested it will be identical to paragraph IV.A., above, except that the PCO will get a copy of the audit report but the prime contractor will get only a general statement regarding the adequacy of our rates and systems. Thus, the PCO on the procurement is in possession of more information than the prime contractor in terms of the cost elements in your proposal. This may seem a disadvantage, but it is the only way the federal government and its contractors have been able to protect proprietary information in an environment where a contractor is teaming with a company today and competing against the same company tomorrow in a different program.
B. Fact-Finding - Prime contractors have similar limitations to subcontractor proprietary data during fact-finding as they do during audit. However, as the government’s buying agent for the subcontractor supplies and services, the prime is expected by the government to conduct a thorough source selection, to include market surveys, competition, technical qualification and contract negotiation. However, prime contractors cannot demand access to what subcontractors deem proprietary data without first signing a non-disclosure agreement with that subcontractor during the teaming agreement phase. Even then, most subcontractors will not disclose closely held process information, software source code and market sensitive data to a prime. When such data are disclosed they are clearly marked company proprietary. Therefore, for fact-finding the prime will utilize end items specifications for products, warranty details, personnel resumes for labor, financial performance information from Dunn and Bradstreet and customer satisfaction information from other clients. The prime may also request a tour of your facility if you are a first time supplier. The business relationship with a prime contractor is formed during the teaming agreement stage when the parties determine that they have complimentary capabilities. Keep in mind that the teaming agreement is replaced with a subcontract when the program is awarded by the government.
C. Pre-Award Survey - Same remarks as IV.C., above. The government PCO may request the Defense Contract Management Area Office (DCMAO) to complete the survey of a major subcontractor on a program where the subcontractor has a major portion of the effort and in cases where the subcontractor is new to the defense business. The PCO will always work through the prime contractor in arranging for the survey and the prime will receive a general statement when the survey is completed that the government either concurs or does not concur with your selection as a supplier. Once again, the relationship formed with your prime contractor during the teaming agreement stage is key in determining your selection as a source.
D. Cost Negotiations - Same remarks as IV.D., above, except that you will be negotiating with a representative of the prime contractor, deemed a "Subcontract Administrator" or a "Subcontracts Manager" instead of the government. Only this person is authorized to commit the company and care should be taken not to undertake matters of negotiation with other members of the prime contractor organization without an authorized contracts representative present. The prime will not have access to your direct or indirect rates [(IV.D. (1) through IV. D. (3)], or the DCAA Audit Report or DCMA Fact-Finding Report. The other party will be viewing your labor, material and travel cost from a fully loaded standpoint and will likely focus on items IV. D. 7 through IV. D. 11, above in pursuing his negotiation target.
E. Final Profit Negotiations - The profit rate will be agreed upon with the prime as either a function of the teaming agreement or as a function of subcontract negotiations identical to IV. E. above except that you will be negotiating profit with your prime contractor instead of the government. Make use of weighted guidelines to support your proposed profit.
F. Contract Award - Identical to IV. F, above, except that you will receive your subcontract from the prime contractor and the prime's subcontract manager instead of the government and the PCO.
VI. NEGOTIATIONS WITH A SUBCONTRACTOR UNDER YOUR FEDERAL GOVERNMENT CONTRACT
You signed a teaming agreement with a subcontractor during the RFP stage of a solicitation. Your subcontractor prepared a proposal and submitted it to you. You incorporated it into the prime contract proposal to the government. You have negotiated flowdown versions of terms and conditions from your federal contract to the subcontractor as well as a technical description of the effort the subcontractor will perform. The subcontractor's cost proposal contained fully loaded rates for the labor categories and material as well as the travel he intends to perform on the subcontract. The government has awarded the prime contract to you. You are now undertaking negotiations with the subcontractor to convert your teaming agreement to a subcontract. The subcontract will replace the teaming agreement between you and your subcontractor.
It is preferable to negotiate subcontracts with team members before you negotiate your final contract with the government. Going into negotiations with the government having definitized your subcontracts reduces your risk in terms of unknowns contractually at the supplier level. It also eliminates the subcontractor wanting to know the result of your prime contract negotiations so that he can use it as a frame of reference for his negotiation position with you. The baseline when you go to the table with your subcontractor is your teaming agreement specifying his statement of work and your collective proposal to the government containing the prospective cost and price for his effort as part of the total proposal.
A. Audit - You do not have a right to subcontractor direct and indirect rate information. Subcontractors propose fully loaded labor and material though profit and do not disclose their rates to primes. Your teaming agreement may specify the profit rate you and your team member have agreed to apply. Other than profit, you do not know the specific make-up of your subcontractors direct labor, overhead, material handling and G&A rates. The subcontractors proposal has disclosed the labor hours at a fully loaded rate and burdened material and travel cost. If you wish to audit any other cost element of his proposal you must request an assist audit from DCAA through your PCO. If an assist audit is conducted, it will be held at the subcontractor identical to paragraph IV. A., above, except that the PCO will get a copy of the audit report and you will get a general statement regarding the adequacy of the subcontractor's rates and systems. Thus, the PCO on the procurement is in possession of more information than you are in terms of the cost elements in our subcontractor's proposal. This may seem a disadvantage, but it is the only way the federal government and its contractors have been able to protect proprietary information in an environment where a firm is teaming with a company today and competing against the same company tomorrow in a different program.
B. Fact-Finding - You have similar limitations to access subcontractor proprietary data during fact-finding as you do during the audit. However, as the government's buying agent for the subcontractor's supplies and services, you are expected by the government to conduct a thorough source selection, to include market surveys, competition, technical qualification and contact negotiation. However, you cannot demand access to what subcontractors deem proprietary data without first signing a non-disclosure agreement with the subcontractor during the teaming agreement phase. Even then, most subcontractors will not disclose closely held process information, software source code and market sensitive data to a prime. When such data are disclosed they are clearly marked company proprietary. Therefore, for fact finding you will utilize end item specifications for products, warranty details, personnel resumes for labor, financial performance information from Dunn and Bradstreet and customer satisfaction information from other clients. You may also request a tour of the subcontractor's facility, especially if he is a first time supplier. The business relationship with a subcontractor is formed during the teaming agreement stage when the companies determine that they have complimentary capabilities. Keep in mind the teaming agreement is replaced with the subcontract you are negotiating.
C. Pre-Award Survey - Same remarks as IV. B., above. The pre-award survey will be completed by the government and results will be supplied to the PCO. You will get a general statement that the government either concurs or does not concur with your subcontractor selection.
D. Cost Negotiations - Same remarks as IV.D., above, except that you will be negotiating with a representative of the subcontractor, deemed a "Contract Administrator" or a "Contracts Manager" instead of the government. Only this person is authorized to commit his company and care should be taken not to undertake matters of negotiation with other members of the subcontractor's organization without an authorized contracts representative present. You do not have access the subcontractor's direct or indirect rates [(IV.D. (1) through IV. D. (3)], or the DCAA Audit Report or DCMA Fact-Finding Report. You will be viewing your subcontractor's labor, material and travel cost from a fully loaded standpoint. Focus on items IV. D. 7 through IV. D. 11, above in pursuing your negotiation target. Remember you are acting in the role of the government in this negotiation.
E. Final Profit Negotiations - The profit rate will be agreed upon with the subcontractor as either a function of the teaming agreement or as a function of subcontract negotiations identical to IV. E., above except that you will be in the contracting role instead of the government. Make use of weighted guidelines to support your proposed profit.
F. Contract Award - Identical to IV. F., above, except that you will issue a subcontract to your partner.