Overview

As is typical in the summer months in Washington, regulatory developments slow to a simmer. Thus, there are no notable developments in the procurement or grant space particular to nonprofits. Accordingly, we are taking this opportunity to summarize how nonprofits, which are not necessarily accustomed to calculating profits or fees, might calculate their proposed fees under federal contracts.

Regulatory Framework

OMB Circular A-122 explicitly excludes its applicability to “profit or other increment[s] above cost.” In cost-type contracts, a nonprofit may include profit as an element of its overall price proposal and designate it as a “fee” component or line item. For fixed-price contracts where Circular A-122 does not apply, a nonprofit could include a “profit” component as part of the total contract amount.

“Profit” under the Federal Acquisition Regulation (“FAR”) is not analogous to “profit” as used for accounting purposes, i.e., net income to contractors. The FAR defines profit as the contractor’s compensation under a fixed-price contract, while “fee” is the contractor’s compensation under a cost-reimbursement contract. The FAR imposes only two limitations to profits/fees, both of which arise when a cost-plus-fixed fee ("CPFF") contract is involved. First, fees must not exceed 10% of the contract’s estimated cost, excluding fee. Second, for experimental, developmental, or research work performed under a CPFF contract, the fee cannot exceed 15% of the contract’s estimated cost, excluding fee.

Aside from the two limitations above, the FAR requires contracting officers to procure products and/or services at a “fair and reasonable price,” regardless of the type of contract. This requirement causes contracting officers to drive down prices (and thus profits/fees) through competition and/or negotiation. Generally, the contracting officer will not separately evaluate the profit/fee. To the extent a contractor does not violate the above-mentioned profit limitations and does not inappropriately or unethically manipulate the procurement process, the contractor can seek as much profit/fee as it desires, so long as the contracting officer finds the overall price to be fair and reasonable.

Under the FAR § 15.404-1, price analyses are the preferred method that agencies use for evaluating an offered price. Nonprofits would not be presenting cost components where only a price analysis is performed, e.g., with most fixed-price contracts. However, contracting officers must use cost analyses “to evaluate the reasonableness of individual cost elements when certified cost or pricing data are required” (pursuant to FAR 15.403-4), and may use cost analyses “to evaluate data other than certified cost or pricing data to determine cost reasonableness or cost realism when a fair and reasonable price cannot be determined through price analysis alone." In this situation (i.e., during a cost analysis), the contracting officer will separately analyze the profit/fee. Practically speaking, this will have no bearing on a nonprofit (i.e., it will not alter the application of Circular A-122). Rather, the above are merely the steps a contracting officer may be required to take to ensure fair and reasonable pricing, for instance, with regard to a firm-fixed price (“FFP”) contract where there is not adequate price competition.

If the price negotiation is based on cost analysis, contracting officers that have a structured approach must use it to analyze profit. Structured approachesprovide a discipline for ensuring that all relevant factors are considered” during the profit analysis. An agency may create its own, or use another agency’s, structured approach. Accordingly, profit/fee analyses may differ across agencies. Notwithstanding the differences that may exist across agencies’ approaches to evaluating profit/fee, the FAR stipulates factors that must be considered (unless clearly inappropriate or inapplicable) by federal agencies in developing their structured approaches and by a contracting officer in analyzing profit, whether or not using a structured approach.

Contractor effort

This factor measures the complexity of the work and resources required for the work to be performed. Specifically, a greater profit opportunity exists for contracts requiring a higher degree of professional and managerial skill, and for prospective contractors whose skills, facilities, and technical assets can be expected to lead to efficient and economical contract performance.

Contractor risk

This factor measures the performance and/or cost risk to the contractor. Specifically, a greater profit opportunity exists for contractors assuming a greater degree of cost responsibility and associated risk. Risk considerations include:

  • Contract type:
    • Firm-fixed-price contract with complex undertaking = greatest cost risk
    • Cost-plus-fixed fee level-of-effort contracts = lowest cost risk
    • Time-and-materials, labor-hour, and firm-fixed-price level-of-effort term contracts will be treated as cost-plus-fixed-fee contracts in evaluating this factor, i.e., lowest cost risk
  • Reliability of the cost estimate in relation to the complexity and duration.

Federal socioeconomic programs

This factor provides for greater profit opportunity for contractors displaying an unusual initiative in federal socioeconomic programs, e.g., women- and veteran-owned small business concerns or energy conservation.

Capital investments

This factor examines and considers whether contractors have made investments that will facilitate efficient and economical contract performance.

Cost-control and other past accomplishments

This factor provides for additional profit opportunities for contractors previously demonstrating their ability to perform similar tasks economically and efficiently.

Independent development

This factor provides for additional profit opportunities for contractors who have undertaken independent development without government assistance.

In addition to the above, each agency also “may include additional factors in its structured approach or take them into account in the profit analysis of individual contract actions.”

Conclusion

For practical purposes, in contract negotiations where the agency engages in a cost analysis, a nonprofit may be asked to substantiate any fee or profit that it includes in its proposal based on the factors noted above. Therefore, it would behoove nonprofits to document the process by which they calculate and determine their fee so as to better position themselves in negotiations with the federal agency.