MOSS ADAMS LLP

February 7, 2013

Pricing to Win Federal Government Contracts

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The material appearing in this presentation is for informational purposes

only and is not legal or accounting advice. Communication of this

information is not intended to create, and receipt does not constitute, a

legal relationship, including, but not limited to, an accountant-client

relationship. Although these materials may have been prepared by

professionals, they should not be used as a substitute for professional

services. If legal, accounting, or other professional advice is required, the

services of a professional should be sought.

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Presenter

Jeff Witt - CPA, CIA, CFE, MCSE

ManagerJeff Witt is a manager in Moss Adams’ Federal Contracting Risk Management practice. He brings over 17 years of relevant experience. Prior to his current employment with Moss Adams, Jeff was a Controller for a government contractor for two years where he led the implementation and control of compliant systems for government contracting. Jeff also served as a government auditor for the Defense Contract Audit Agency for 10 years. During his time with DCAA, Jeff was stationed at a variety of defense, high tech and university contractors, including Lockheed Martin, Boeing, LSI Logic, SRI International and Stanford University. Jeff served as Lead DCAA Auditor on a variety of engagements including incurred cost, forward pricing, defective pricing, equitable adjustment and delay claim audits.

Since joining Moss Adams, Jeff has led numerous government compliance consulting and attestation engagements. Attestation engagements included auditing or reviewing submitted indirect rates for compliance with applicable regulations and evaluation of internal controls for compliance with specific criteria.

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Presenter

Curtis Matthews - CPA, CPE, CISA, CITP, CGMA

Managing PartnerCurtis leads Moss Adams’ Federal Contracting Risk and Compliance group. He brings over 28 years of federal and state program controls and audit experience. Curtis provided internal control and compliance services for PricewaterhouseCoopers LLP’s government clients, monitored Intel’s Federal Programs Office compliance, prepared submissions and negotiated Federal contracts for a large aerospace and defense contractor. Curtis has served as a full charge Defense Contract Audit Agency (DCAA) auditor and has helped federal contractors comply with Federal Acquisition Regulations (FAR), Federal and State Department Requirements, and Federal Cost Accounting Standards (CAS).

Curtis has performed over 100 government compliance audits and has negotiated over 200 federal contracts. He has helped companies implement federal contracting compliance programs and successfully respond to and address DCAA audits. Curtis has helped his clients improve government compliance controls in a wide variety of contracting environments, including firm fixed price and cost reimbursable federal contracts.

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Agenda• Overview of the need for a well defined and controlled

pricing function• The Government’s preference for commercial pricing• Systems requirements for non-commercial pricing• Summary of pricing risks by type of contract• Common misunderstandings of Government contracting

process• Pitfalls and opportunities associated with pricing

philosophies• Resources available for competitor pricing information• Recommendations for establishing a well defined and

controlled pricing function

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Overview of the need for a well defined and controlled pricing function

• How important is understanding the nuances of pricing? o For many government contractors, it is very important

o Unless you provide a unique product, and the Government is willing to pay regardless of price, then pricing correctly is critical

o Pricing correctly = pricing to win while achieving or exceeding company profitability goals

o Pricing correctly also means understanding the Government regulations that pertain to the type of contract you will be awarded

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Overview of the need for a well defined and controlled pricing function (cont.)

• How important are well defined processes and controls to pricing? o For many government contractors, where price is a significant

factor in the award process, having well defined pricing processes and controls is key.

o Companies often have good controls around their financial systems but lack controls around the pricing function.

o For some companies, the pricing function may be performed by those without all of the financial acumen needed.

o When understanding cost is important to pricing, company financial personnel may need to have a role in establishing processes and controls for pricing.

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The Government’s Preference for Sealed Bid/Commercial Pricing

• The Government has moved to an approach that prefers sealed bid or commercial pricing data rather than contracting by negotiation.

• This means that whenever possible contracting officers will not require certified cost or pricing data.

• In some cases, certified cost or pricing data is still required.

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Sealed Bid?Sealed Bid?Sealed Bid?Sealed Bid?

FAR Part 14 applies – Generally not subject to defective pricing,

commercial pricing or contracting by

negotiation requirements

FAR Part 14 applies – Generally not subject to defective pricing,

commercial pricing or contracting by

negotiation requirements

FAR Part 12 or Part 15 applies - Must then determine if

subject to commercial pricing or

contracting by negotiation

FAR Part 12 or Part 15 applies - Must then determine if

subject to commercial pricing or

contracting by negotiation

FAR 6.401:“…award will be made on

the basis of price…it is not necessary to conduct

discussions…”

FAR 6.401:“…award will be made on

the basis of price…it is not necessary to conduct

discussions…”

Yes No

The Government’s Preference for Sealed Bid/Commercial Pricing (cont.)

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Commercial Item?

Commercial Item?

FAR Part 12 applies - (Acquisition of

Commercial items)

FAR Part 12 applies - (Acquisition of

Commercial items)

FAR Part 15 applies - (Contracting by Negotiations)

FAR Part 15 applies - (Contracting by Negotiations)

FAR 2.101:“…of a type customarily

used by the general public…”

FAR 2.101:“…of a type customarily

used by the general public…”

Yes No

The Government’s Preference for Sealed Bid/Commercial Pricing (cont.)

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Non-Commercial Pricing Regulations (FAR Part 15.403)•In those instances when FAR Part 15 applies (non-commercial item) and the procurement will be over $700,000, certified cost or pricing data will be required.•In this scenario, the company will be required to have compliant estimating, accounting and billing systems.•This is a high hurdle and many companies find that their systems are deemed to be noncompliant by the government.

Systems Requirements for Non-Commercial Pricing

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Systems Requirements for Non-Commercial Pricing (cont.)

15.407-1  Defective cost or pricing data (FAR 15.407-1)

•“(a) If, before agreement on price, the contracting officer learns that any cost or pricing data submitted are inaccurate, incomplete, or noncurrent...”

•“(b)(1) If, after award, cost or pricing data are found to be inaccurate, incomplete, or noncurrent as of the date of final agreement on price or an earlier date agreed upon by the parties given on the contractor’s or subcontractor’s Certificate of Current Cost or Pricing Data, the Government is entitled to a price adjustment…”

•This entitlement is ensured by including in the contract one of the clauses prescribed in 15.408(b) and (c) and is set forth in the clauses at 52.215-10, Price Reduction for Defective Cost or Pricing Data, and 52.215-11, Price Reduction for Defective Cost or Pricing Data—Modifications.

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Common Mistakes Related to Government Contract Pricing

• Misunderstanding government regulations related to pricing:o Applying the wrong set of regulations to the proposed procuremento Mis-pricing so as to comply with misunderstood “cost realism”

requirements

• Not fully understanding the companies indirect cost structure in the areas of:o Fixed versus variable costo The impact of contract volume on indirect rateso The impact to company bottom line instead of contract bottom line

Note: The above represent real examples of contractors that we have worked with.

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Common Mistakes Related to Government Contract Pricing (cont.)

Type of Contract Under Pricing Risk Over Pricing RiskSealed Bid Impact to company

profitabilityLoss of contract award

Commercial Item N/A - must use commercial price

N/A - must use commercial price

Non Commercial Item - FFP Impact to company profitability

Defective pricing risk and potential loss of contract award

Non Commercial Item - T&M Impact to company profitability

Defective pricing risk and potential loss of contract award

Non Commercial Item - Cost Type Subject to "cost realism" determination

Defective pricing risk (profit only) and potential loss of contract award

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Common Mistakes Related to Government Contract Pricing (cont.)

Cost Element Variable Cost Examples Fixed Cost ExamplesLabor Direct labor, Supervisors of direct

personnelCompany Executives, Accounting, IT, IR&D, B&P, Selling & Marketing

Benefits Benefits associated with personnel classified as variable labor

Benefits associated with personnel classified as fixed labor

Materials Any direct materials N/ASubcontracts Any direct subcontracts N/ABldg Depreciation/Rent Generally not variable Generally fixedEquipment Rented equipment Owned equipmentUtilities Utilities billed based on consumption Basic utilities for home offi ce

Other costs Avoidable costs within company "relevant range"

Non-avoidable costs within company "relevant range"

• Depending on company indirect cost structure, it may be important to be able to differentiate fixed from variable costs, since this can significantly impact pricing decisions. Some companies are unable to do this with their present accounting structure.

• The definition of fixed depends on the companies proclivity for reducing or increasing a cost as volume changes. The definition is different for every company.

Possible Mistake: Not accumulating fixed and variable costs

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Pitfalls and Opportunities

• Pitfall – Not complying with government regulations when pricing:o Defective pricing risko Loss of potential awardo Loss of ability to win future work

• Pitfall – Not pricing with an understanding of the competitive environment (i.e., assuming that pricing at cost plus 10 percent will be successful in every case):o Loss of potential awardo Loss of qualifications that could lead to future work

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Pitfalls and Opportunities (cont.)Example: Pricing using a “silo” approach

IndirectDescription Amount Rate Fixed/Variable

Net Revenue 100,000,000$ VariableDirect Labor 22,000,000 VariableMatls/Subs/ODC 20,000,000 VariableGross Margin 58,000,000$ Overhead 1 15,000,000 68% VariableOverhead 2 22,000,000 100% FixedSG&A 16,000,000 73% FixedNet Income 5,000,000$

Note: This slide represents a contractor’s budget for 2013 prior to consideration of an opportunity

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Opportunity IndirectDescription Amount Rate Fixed/Variable

Net Revenue 20,000,000$ VariableDirect Labor 8,000,000 VariableMatls/Subs/ODC 2,000,000 VariableGross Margin 10,000,000$ Overhead 1 5,454,545 68% VariableOverhead 2 5,866,667 73% FixedSG&A 4,266,667 53% FixedNet Income (5,587,879)$

Note: This slide represents the FFP opportunity that the contractor is considering. They believe if they price at this level, they will win, but if they increase the price, they will likely lose.

Question: Assuming they have capacity to do the work, and they don’t have a better opportunity, should they submit a proposal using the price and cost structure shown above?

Pitfalls and Opportunities (cont.)

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Answer: The answer may be Yes!

Original Add: Including IndirectDescription Amount Opportunity Opportunity Rate Fixed/Variable

Net Revenue 100,000,000$ 20,000,000$ 120,000,000$ VariableDirect Labor 22,000,000 8,000,000 30,000,000 VariableMatls/Subs/ODC 20,000,000 2,000,000 22,000,000 VariableGross Margin 58,000,000$ 10,000,000$ 68,000,000$ Overhead 1 15,000,000 5,454,545 20,454,545 68% VariableOverhead 2 22,000,000 - 22,000,000 73% FixedSG&A 16,000,000 - 16,000,000 53% FixedNet Income 5,000,000$ 4,545,455$ 9,545,455$

Pitfalls and Opportunities (cont.)

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Pitfalls and Opportunities (cont.)

Lessons learned by the contractor:o This company, like many other companies, did not have just one

product line and thus should not have one way of pricing.o Each product line needed to be evaluated in terms of market

competition and cost structure to determine the optimal price for that product.

o It was important that the actual indirect costs for the product line were known in order to correctly evaluate the cost structure for the product line. This requires systems capable of accumulating indirect costs by product line.

o It was also important that fixed indirect costs were determinable so that the analysis could be performed.

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Pitfalls and Opportunities (cont.)

• The example shows that:oThose responsible for pricing can reach erroneous

decisions if they are pricing in a vacuum without adequate consideration for the impacts of: Fixed and variable costs Changes to allocation bases and therefore to rates The impact of an opportunity on company bottom

line instead of opportunity bottom line

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Competitor Pricing Information

• Good competitor pricing information is extremely hard to come by

• It is not found in 10Ks or other publicly available information for most companies

• In many cases, when you lose because of price, you can’t obtain visibility to the details behind the winning price

• Even if you cannot obtain the details on the winning bid, it is worth obtaining the total contract value that was awarded. This can be found on https://www.fbo.gov

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• One good source is the General Services Administration’s (GSA) Schedule. You may be able to find fully loaded Time & Materials (T&M) rates for many of your competitors.

• www.GSAAdvantage.gov provides a way to quickly and easily obtain competitor fully loaded rates

• These rates represent the lowest rates these companies charge for the listed services. This provides a good benchmark for how low your competitor may be willing to go to win.

Resources Available for Competitor Pricing Information

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Recommendations for a Robust Pricing Function

• Recommendations for development of a robust pricing function:o Ensure your company understands government procurement

rules and how they impact your options during pricingo Consider using competitor GSA rate data as a factor in

establishing the “floor” for pricing.o Develop a robust market intelligence capability within your

organization that helps inform regarding when an opportunity will require “floor” pricing and when you can price higher than the floor and still win the work.

o Develop clear understanding of the competitive advantages that your company has. Consider these advantages in establishing a pricing structure.

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Recommendations for a Robust Pricing Function (cont.)

• Recommendations for pricing controls:o Establish policies and procedures that consider the relevant

government regulations to ensure compliance when pricing.o Establish clear policies and procedures that assign roles and

responsibilities for pricing.o Do not place all the burden on the Sales and Marketing function

to establish controls over financial aspects of pricing.o Involve financial personnel in control activities for pricing to

ensure pricing rates are kept up to date and align with the company’s strategy and structure.

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Recommendations for a Robust Pricing Function (cont.)

• Recommendations for pricing controls:o Implement controls that ensure that each significant

opportunity is priced with consideration for factors such as: Applicable government regulations Absorption of indirect costs Competitive advantages Degree to which price will be a factor in the award Competition

The objective should be to give the company the best opportunity to win while pricing in ways that are compliant with regulations and enable the company to meet or exceed profitability goals.

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Thank you for attending

Curtis Matthewscurtis.matthews@mossadams.com(503) 704-6943

Jeff Wittjeff.witt@mossadams.com(503) 478-2282