15.404-4 Profit.

(a) General. This subsection prescribes policies for establishing the profit or fee portion of the

Government prenegotiation objective in price negotiations based on cost analysis.

(1) Profit or fee prenegotiation objectives do not necessarily represent net income to contractors.

Rather, they represent that element of the potential total remuneration that contractors may receive

for contract performance over and above allowable costs. This potential remuneration element and

the Government’s estimate of allowable costs to be incurred in contract performance together equal

the Government’s total prenegotiation objective. Just as actual costs may vary from estimated costs,

the contractor’s actual realized profit or fee may vary from negotiated profit or fee, because of such

factors as efficiency of performance, incurrence of costs the Government does not recognize as

allowable, and the contract type.

(2) It is in the Government’s interest to offer contractors opportunities for financial rewards

sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large

and small business concerns to Government contracts, and maintain a viable industrial base.

(3) Both the Government and contractors should be concerned with profit as a motivator of efficient

and effective contract performance. Negotiations aimed merely at reducing prices by reducing

profit, without proper recognition of the function of profit, are not in the Government’s interest.

Negotiation of extremely low profits, use of historical averages, or automatic application of

predetermined percentages to total estimated costs do not provide proper motivation for optimum

contract performance.

(b) Policy.

(1) Structured approaches (see paragraph (d) of this subsection) for determining profit or fee

prenegotiation objectives provide a discipline for ensuring that all relevant factors are considered.

Subject to the authorities in 1.301(c), agencies making noncompetitive contract awards over

$100,000 totaling $50 million or more ayear-

(i) Shall use a structured approach for determining the profit or fee objective in those acquisitions

that require cost analysis; and

(ii) May prescribe specific exemptions for situations in which mandatory use of a structured

approach would be clearly inappropriate.

(2) Agencies may use another agency’s structured approach.

(c) Contracting officer responsibilities.

(1) When the price negotiation is not based on cost analysis, contracting officers are not required to

analyze profit.

(2) When the price negotiation is based on cost analysis, contracting officers in agencies that have a

structured approach shall use it to analyze profit. When not using a structured approach,

contracting officers shall comply with paragraph (d)(1) of this subsection in developing profit or fee

prenegotiation objectives.
(3) Contracting officers shall use the Government prenegotiation cost objective amounts as the basis

for calculating the profit or fee prenegotiation objective. Before applying profit or fee factors, the

contracting officer shall exclude from the pre-negotiation cost objective amounts the purchase cost

of contractor-acquired property that is categorized as equipment, as defined in FAR 45.101, and

where such equipment is to be charged directly to the contract. Before applying profit or fee factors,

the contracting officer shall exclude any facilities capital cost of money included in the cost objective

amounts. If the prospective contractor fails to identify or propose facilities capital cost of money in a

proposal for a contract that will be subject to the cost principles for contracts with commercial

organizations (see subpart 31.2), facilities capital cost of money will not be an allowable cost in any

resulting contract (see 15.408(i)).

(4)

(i) The contracting officer shall not negotiate a price or fee that exceeds the following statutory

limitations, imposed by 10 U.S.C. 3322(b) and 41 U.S.C. 3905:

(A) For experimental, developmental, or research work performed under a cost-plus-fixed-fee

contract, the fee shall not exceed 15 percent of the contract’s estimated cost, excluding fee.

(B) For architect-engineer services for public works or utilities, the contract price or the estimated

cost and fee for production and delivery of designs, plans, drawings, and specifications shall not

exceed 6 percent of the estimated cost of construction of the public work or utility, excluding fees.

(C) For other cost-plus-fixed-fee contracts, the fee shall not exceed 10 percent of the contract’s

estimated cost, excluding fee.

(ii) The contracting officer’s signature on the price negotiation memorandum or other

documentation supporting determination of fair and reasonable price documents the contracting

officer’s determination that the statutory price or fee limitations have not been exceeded.

(5) The contracting officer shall not require any prospective contractor to submit breakouts or

supporting rationale for its profit or fee objective but may consider it, if it is submitted voluntarily.

(6) If a change or modification calls for essentially the same type and mix of work as the basic

contract and is of relatively small dollar value compared to the total contract value, the contracting

officer may use the basic contract’s profit or fee rate as the prenegotiation objective for that change

or modification.

(d) Profit-analysis factors-

(1) Common factors. Unless it is clearly inappropriate or not applicable, each factor outlined in

paragraphs (d)(1)(i) through (vi) of this subsection shall be considered by agencies in developing

their structured approaches and by contracting officers in analyzing profit, whether or not using a

structured approach.

(i) Contractor effort. This factor measures the complexity of the work and the resources required of

the prospective contractor for contract performance. Greater profit opportunity should be provided

under contracts requiring a high degree of professional and managerial skill and to prospective

contractors whose skills, facilities, and technical assets can be expected to lead to efficient and

economical contract performance. The subfactors in paragraphs (d)(1)(i)(A) through (D) of this

subsection shall be considered in determining contractor effort, but they may be modified in specific
situations to accommodate differences in the categories used by prospective contractors for listing

costs-

(A) Material acquisition. This subfactor measures the managerial and technical effort needed to

obtain the required purchased parts and material, subcontracted items, and special tooling.

Considerations include the complexity of the items required, the number of purchase orders and

subcontracts to be awarded and administered, whether established sources are available or new or

second sources must be developed, and whether material will be obtained through routine purchase

orders or through complex subcontracts requiring detailed specifications. Profit consideration

should correspond to the managerial and technical effort involved.

(B) Conversion direct labor. This subfactor measures the contribution of direct engineering,

manufacturing, and other labor to converting the raw materials, data, and subcontracted items into

the contract items. Considerations include the diversity of engineering, scientific, and manufacturing

labor skills required and the amount and quality of supervision and coordination needed to perform

the contract task.

(C) Conversion-related indirect costs. This subfactor measures how much the indirect costs

contribute to contract performance. The labor elements in the allocable indirect costs should be

given the profit consideration they would receive if treated as direct labor. The other elements of

indirect costs should be evaluated to determine whether they merit only limited profit consideration

because of their routine nature, or are elements that contribute significantly to the proposed

contract.

(D) General management. This subfactor measures the prospective contractor’s other indirect costs

and general and administrative (G&A) expense, their composition, and how much they contribute to

contract performance. Considerations include how labor in the overhead pools would be treated if it

were direct labor, whether elements within the pools are routine expenses or instead are elements

that contribute significantly to the proposed contract, and whether the elements require routine as

opposed to unusual managerial effort and attention.

(ii) Contract cost risk.

(A) This factor measures the degree of cost responsibility and associated risk that the prospective

contractor will assume as a result of the contract type contemplated and considering the reliability

of the cost estimate in relation to the complexity and duration of the contract task. Determination of

contract type should be closely related to the risks involved in timely, cost-effective, and efficient

performance. This factor should compensate contractors proportionately for assuming greater cost

risks.

(B) The contractor assumes the greatest cost risk in a closely priced firm-fixed-price contract under

which it agrees to perform a complex undertaking on time and at a predetermined price. Some firmfixed-price contracts may entail substantially less cost risk than others because, for example, the

contract task is less complex or many of the contractor’s costs are known at the time of price

agreement, in which case the risk factor should be reduced accordingly. The contractor assumes the

least cost risk in a cost-plus-fixed-fee level-of-effort contract, under which it is reimbursed those

costs determined to be allocable and allowable, plus the fixed fee.

(C) In evaluating assumption of cost risk, contracting officers shall, except in unusual circumstances,

treat time-and-materials, labor-hour, and firm-fixed-price, level-of-effort term contracts as cost-plusfixed-fee contracts.
(iii) Federal socioeconomic programs. This factor measures the degree of support given by the

prospective contractor to Federal socioeconomic programs, such as those involving small business

concerns, small business concerns owned and controlled by socially and economically disadvantaged

individuals, women-owned small business concerns, veteran-owned, HUBZone, service-disabled

veteran-owned small business concerns, sheltered workshops for workers with disabilities, and

energy conservation. Greater profit opportunity should be provided contractors that have displayed

unusual initiative in these programs.

(iv) Capital investments. This factor takes into account the contribution of contractor investments to

efficient and economical contract performance.

(v) Cost-control and other past accomplishments. This factor allows additional profit opportunities to

a prospective contractor that has previously demonstrated its ability to perform similar tasks

effectively and economically. In addition, consideration should be given to measures taken by the

prospective contractor that result in productivity improvements, and other cost-reduction

accomplishments that will benefit the Government in follow-on contracts.

(vi) Independent development. Under this factor, the contractor may be provided additional profit

opportunities in recognition of independent development efforts relevant to the contract end item

without Government assistance. The contracting officer should consider whether the development

cost was recovered directly or indirectly from Government sources.

(2) Additional factors. In order to foster achievement of program objectives, each agency may

include additional factors in its structured approach or take them into account in the profit analysis

of individual contract actions.

Parent topic: 15.404 Proposal analysis.