With the new Infrastructure Bill and the CHIPS Act, the U.S. government is more invested than ever in the American market, providing opportunities for significant growth.
The Infrastructure Bill aims to funnel billions of dollars to states and local governments to upgrade outdated roads, bridges, transit systems and more. The CHIPS Act is an industrial strategy to revitalize domestic manufacturing, create good-paying American jobs, strengthen American supply chains, and accelerate the industries of the future. These efforts will lead to more goods manufactured on U.S. soil, and increased investment in government contracts and grants, which means new players are entering and existing providers are growing within the government contracting market.
So, how do organizations that directly or indirectly support these government initiatives gain a competitive edge or build a unique advantage, especially given current economic conditions? To achieve organizational goals and improve profitability at the project and financial reporting level, maintain compliance, and remain competitive in the marketplace, several foundational principles can be leveraged.
When analyzing pricing strategies and developing options to optimize structure and strategy, we recommend considering the following three aspects:
1) The Indirect Cost Rate Structure
While the U.S. government provides guidance on creating a compliant indirect cost rate structure, contractors have the flexibility to design rate pools and related allocation bases within these requirements to optimize cost recoverability for their organization. An effective strategy for the design process is comparing the company’s key differentiators (e.g., services, capabilities, products) within the market to the company’s key cost elements and cost drivers.
We recommend evaluating whether the indirect rate structure supports and aligns with the organization’s key differentiators. For example, if an organization has operations in various locations, they should evaluate whether the overhead rate structure reflects the various locations and its uniqueness in the marketplace to ensure only contracts performed in a certain location absorb overhead costs associated with that location. This is especially important if the contractor operates across a diverse geography with disparities in costs of real estate, talent and other areas. Additionally, if the contractor has employees who work from home, they should evaluate how overhead costs are associated with these employees’ time. Employees should be educated on which location codes to utilize when working from home to help prevent site-specific overhead from being applied to their time.
Understanding the true overhead costs incurred by individual and by contract can increase precision of contract cost accounting and provide more detailed data for pricing future work. While this may seem like a simple concept, organizations need to perform a detailed analysis to improve the accuracy of cost allocation. This will help prevent contracts with lower rates or fees from experiencing reduced margins due to absorbing higher general and overhead costs associated with other contract activities.
2) The Utilization of Commerciality
When evaluating a company’s key differentiators, the leaders should determine if an organization’s offerings are customized for government customers or if they are more commercial in nature. To qualify this, ask if the services or products could be offered to commercial customers as is. FAR part 12 outlines processes by which the U.S. government can purchase commercial products or services. In addition, the guidance includes thresholds for requiring cost or pricing data for procuring goods or services.
Marketing products or services as commercial to the government provides contractors with increased flexibility in improving margins on products or services. For example, when selling as a commercial item, pricing is agreed up-front and is constant. Therefore, any cost savings applicable to these products or services can increase the margin.
If the contractor did not apply commerciality for the same item on a cost-reimbursement contract, this would reduce direct costs or burdens and it would not increase operating margin. By way of contrast, when selling items as commercial, contractors can take advantage of increases in market prices, which increase margins if costs are kept constant or reduced.
Not all products and services offered to the government will qualify as commercial items. Services that require specialized skill sets and products that require customizations to fit unique government customer needs may not qualify. However, it can be advantageous for contractors to thoughtfully evaluate their offerings and identify any that can qualify as commercial items.
3) Frequently Monitoring Market Pricing
Market pricing is relevant to the government sector in addition to commercial products and services. For time and material contracts, contractors must develop proposed rates for various categories of labor. For example, for a contract requiring engineering, a contractor may propose several engineering labor rates based on the level of experience and skill sets required. Contractors can gain advantages by considering the type of services performed by those labor categories in addition to the skill sets required for each labor category. For example, an experienced engineer may provide routine review of engineering designs, and may also provide strategic planning and design services. The strategic services could have a separate and higher rate than the review services since the strategic services are less routine and require an increased level of effort. When developing rates, contractors should perform a market analysis to understand competitors’ rates for similar services and to potentially charge the most profitable and competitive rates possible.
With rising inflation and increased competition, contractors need to review their cost and pricing strategies to help ensure they are best supporting their organization. Careful consideration of the organization’s contract mix, industry, geography and goals is necessary to develop and maintain the optimal cost and pricing strategy.
The principles described herein are foundations for building tailored cost and pricing strategies that best support an organization’s short- and long-term needs. A well-designed indirect cost rate structure, the utilization of commercial item determination and frequent monitoring of market pricing can support the achievement of organizational goals, improve project and overall profitability and make the company more competitive in the marketplace.
Authored by: Asela Wijesiri, Jose Soto, and Cassidy Cunningham