The Defense Department has taken another stab at changing its 15 year old profit policy in a proposed rule issued in September that seeks to add general and administrative expenses to the base used to determine a profit objective, increase emphasis on performance risk and encourage cost efficiencies.  An earlier proposal submitted in July 2000 attempted to reorient profit incentives from facilities investment to performance risk factors and cost reduction efforts without impacting the overall profit levels.  Specifically, the July proposal tried to (1) add the G&A cost base used to establish the acquisition profit objectives (2) phase out and eventually eliminate facilities investment as a factor (3) offset these changes by increasing the importance of performance risk by increasing this factor by one percentage point and decreasing values for contract-type risk by a half of percentage point and (4) add a special factor of up to 4 percent of the total contract price (excluding cost of money) for cost efficiency to encourage cost reduction efforts.

Numerous comments and meetings resulted in a revised proposal in late September 2001 where the differences with the earlier proposed rule was (1) not to completely phase out facilities investment over four years but retain 50 percent of current values for equipment as an incentive to modernize equipment and (2) to lessen the impact on performance risk and not increase the value for contract type risk since there was less need to offset the reduced emphasis on facilities investment.  Adding the G&A base and emphasizing cost reduction efforts are unchanged.  Specifics of how to demonstrate cost reduction were added that include (1) participation in Single Process Initiatives (2) actual cost reductions on prior contracts (3) elimination or reduction of excess idle facilities (4) contractor’s cost reduction initiatives such as reliance on value engineering, spare parts pricing reform and competition advocacy programs (5) process improvement (6) subcontractor cost reduction efforts and (7) incorporating commercial items and processes.  The new proposal is in the Federal Register No. 48649.

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