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Annual Escalation Adjustment Clause

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A couple of years ago I encountered an issue with sole-source contracting for a series of requirements where the offerors each proposed an annual escalation rate of 5% for his / her contract. Try as I might I couldn't get the offerors to budge on the escalation rates, and thus negotiations languished because given the economy there was no chance I would accept 5% escalation. So I offered an alternative. Either reduce the annual escalation rate to 2% or accept the a clause which would automatically set the annual escalation rate tied to the BLS index for the industry code. In all but one case, the offerors accepted the 2%. In no way do I claim that the clause was perfect, but thought I would share because I truly believe that the clause did save the Government money in a fair manner. If anyone has any ideas how to make this type of clause better I welcome your feedback.

H.XX ANNUAL ESCALATION ADJUSTMENT

( a ) This clause applies to the labor category contract line items appearing in the Pricing Schedule. This clause shall be applied unilaterally by the Contracting Officer in order to arrive at the annual escalation rate to be incorporated at the time of option exercise.

( b ) The Contractor warrants that the prices in this contract do not include any allowance for any contingency to cover increased costs for which adjustment is provided under this clause.

( c ) The fixed hourly labor rates will be adjusted to reflect the actual market indicator increase or decrease in the U.S. Department of Labor Bureau of Labor Statistics (BLS) "Architectural, engineering and related services" Industry Index (Industry Code 5413) as it appears in the BLS publication Producer Price Indexes for the Net Output of Selected Industries and Their Products, Not Seasonally Adjusted which is available at http://www.bls.gov/web/ppi/ppitable05.pdf. In the event that the U.S. Department of Labor Bureau of Labor Statistics discontinues publication of this index an appropriate substitute index will be incorporated into the contract by mutual agreement of the parties.

( d ) Any adjustment will be limited to increases or decreases in the index as described in paragraph ( c ) of this clause, but shall not otherwise include any other adjusted amounts for general and administrative costs, overhead, or profit.

( e ) The Contracting Officer will include with the preliminary written intent to exercise the option period, the escalation adjustment rate based upon the percent index change from June of the previous year to June of the current year.

( f ) During any contract period within which an adjustment to the contract line item prices, as either an increase or decrease, will be made under the authority of this clause, the increase or decrease shall not exceed seven (7) percent of the contract unit prices in effect during the preceding contract period.

(End of Clause)

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In my opinion, this clause creates a significant cost and/or administrative impact on contractors. If you have been using it repetitively, it should have been published for comment in the Federal Register in accordance with FAR 1.301( b ).

What agency do you work for (if you don't mind saying)? Your agency supplement probably has some policy on clause control.

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Guest Vern Edwards

What was the contract type? Fixed price? T&M?

With respect to option periods, do you think that the clause allow you to comply with FAR 17.207(f)? If so, in what way?

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Thank you Don and Vern for your replies.

The contract type in each case is a labor hours IDIQ contract where the rates are fixed in the base contract and task orders are issued at a Firm-Fixed-Price to complete the Statement of Work. So this clause is intended to control how the fixed rates escalate each year. Clearly this clause would not translate well to other contract types.

As far as FAR 17.207(f) is concerned, this was considered when crafting the contract language. The contract's option periods are a part of the contract as solicited, as is the clause which affords for the rate determining methodology. In terms of unbiased evaluation and the basis for award to the particular offeror, this was a Brooks-Act selection for a series of A-E contracts. I could see how this could be very problematic if it were used on a contract that was competitively awarded under FAR Part 15's best value continuum, tradeoff process. But for a sole-source contract, which is the negotiating environment that you end up in when negotiating price and rates under an A-E, then really there is no change to the scope in terms of Part 6 and CICA.

This clause was crafted with a focus on FAR 17.207(d) and being able to make a determination that 5% escalation could be fair and reasonable given that the industry only typically encountered 1% - 2% annual PPI increase. edited to add: This could amount to increasing amounts of undue profit each year, reasonably up to 8% if the PPI trajectory is in a straight line in the outyears.

Don, as far as clause control - the agency is a civilian agency and the policy arm did not seem to take issue with the crafting of clauses out in the field. Although the agency certainly should have an internal control to manage such clauses.

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Guest Vern Edwards

The contract type in each case is a labor hours IDIQ contract where the rates are fixed in the base contract and task orders are issued at a Firm-Fixed-Price to complete the Statement of Work. So this clause is intended to control how the fixed rates escalate each year. Clearly this clause would not translate well to other contract types.

As far as FAR 17.207(f) is concerned, this was considered when crafting the contract language. The contract's option periods are a part of the contract as solicited, as is the clause which affords for the rate determining methodology. In terms of unbiased evaluation and the basis for award to the particular offeror, this was a Brooks-Act selection for a series of A-E contracts. I could see how this could be very problematic if it were used on a contract that was competitively awarded under FAR Part 15's best value continuum, tradeoff process. But for a sole-source contract, which is the negotiating environment that you end up in when negotiating price and rates under an A-E, then really there is no change to the scope in terms of Part 6 and CICA.

Here is 17.207(f), in pertinent part:

(f) … To satisfy requirements of part 6 regarding full and open competition, the option must … be exercisable at an amount specified in or reasonably determinable from the terms of the basic contract, e.g.--

(1) A specific dollar amount;

(2) An amount to be determined by applying provisions (or a formula) provided in the basic contract, but not including renegotiation of the price for work in a fixed-price type contract;

(3) In the case of a cost-type contract, if--

(i) The option contains a fixed or maximum fee; or

(ii) The fixed or maximum fee amount is determinable by applying a formula contained in the basic contract (but see 16.102©);

(4) A specific price that is subject to an economic price adjustment provision; or

(5) A specific price that is subject to change as the result of changes to prevailing labor rates provided by the Secretary of Labor.

Through which of the five methods will you determine the amount at which the option will be exercised?

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Vern,

If Dingoes contract is for A-E services, why should he worry about FAR 17.207(f)? Don't tell me you didn't read the "Scope" section at FAR 17.200 :o

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Guest Vern Edwards

Uhhh... I didn't forget. I was just testing you. Good job.

:wacko:

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In fairness, I did not state until later that the contract was an A-E contract. I actually thought about the question more in terms of how you can make the determination at FAR 17.207(f) with for any IDIQ, notwithstanding the clause that I have put forward.

I guess my question is this: With an IDIQ where the scope is typically defined in terms of the Statement of Work, period of performance (base period plus any option periods), minimum guaranteed ordering amount, and maximum ordering amount, and ordering units with fixed rates, how do any of the listed items which are provided as exempli gratia apply to the exercise of an option period under an IDIQ? In any case, you are exercising the option period according to the terms and conditions of the contract and nothing about the action is undefinitized - the rates are determined using the clause language. Is the clause made better by prescribing an exact formula to be followed?

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Guest Vern Edwards

Okay, we're not talking about A-E now, right?

The question isn't whether the clause would be made better by prescribing an exact formula. The question is whether an exact formula is necessary in order to comply with 17.207(f). I think the answer is yes.

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I interpret DAMB's clause as a variation of a fixed price with economic price adjustment (see Federal Acquisition Regulation (FAR) Subsection 16.203-4(d)):

(d) Adjustments based on cost indexes of labor or material. The contracting officer should consider using an economic price adjustment clause based on cost indexes of labor or material under the circumstances and subject to approval as described in paragraphs (d)(1) and (d)(2) of this section.

(1) A clause providing adjustment based on cost indexes of labor or materials may be appropriate when—

(i) The contract involves an extended period of performance with significant costs to be incurred beyond 1 year after performance begins;

(ii) The contract amount subject to adjustment is substantial; and

(iii) The economic variables for labor and materials are too unstable to permit a reasonable division of risk between the Government and the contractor, without this type of clause.

(2) Any clause using this method shall be prepared and approved under agency procedures. Because of the variations in circumstances and clause wording that may arise, no standard clause is prescribed.

Therefore, FAR Section 17.207(f)(4) would apply, as this was "[a] specific price that is subject to an economic price adjustment provision [sic]." Therefore, a specific formula under FAR Section 17.207(f)(2) would NOT be necessary.

In regards to DAMB's clause, I do not necessarily agree with the language because of the 7-percent cap. If economic conditions changed significantly, it would result in the contractor taking a loss on its labor services. Ultimately, this could result in performance issues. When the intent of the clause is to share the risk of future price fluctuations, limiting that risk to an arbitrary amount seems unproductive and could potentially have unintended consequences. However, I appreciate DAMB's negotiation tactic as I see firms with unprecidented escalation rates, especially in sole source environments.

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Guest Vern Edwards

By variation, do you mean deviation? See FAR 1.401(a), ( c), and (d).

Dingoes's contract appears to be L-H, not fixed price.

Which of the FAR EPA clauses for fixed-price contracts is Dingoes's clause a variation of?

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Not a deviation, but a variation. FAR Subsection 16.203-4 (a) through (d) includes four variations of fixed price with economic price adjustment:

( a ) Adjustment based on established prices - standard supplies;

( b ) Adjustment based on established prices - semistandard supplies;

( c ) Adjustments based on actual cost of labor or material; and

( d ) Adjustments based on cost indexes of labor or material.

DAMB's clause is an "economic price adjustment clause based on cost indexes of labor or material... prepared and approved [hopefully] under agency procedures" (see FAR Subsection 16.203-4(d)(2)).

DAMB said that the contract type was... "a labor hours IDIQ contract where the rates are fixed in the base contract and task orders are issued at a Firm-Fixed-Price to complete the Statement of Work."

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Guest Vern Edwards

Forgive me for saying this, but "variation" is nonsense. You're just trying to work your way around the regulation. It's a deviation, and it is probably an unauthorized deviation.

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Vern,

When I say “variation,” I am referring specifically to FAR 16.203-4 (a) through (d), where (a) through (d) are variations/flavors/types of fixed price with economic adjustment contract types.

Further, I believe you are mistaken in claiming the clause is deviation. A deviation implies noncompliance with a mandatory procurement regulation. In this case, FAR 16.203-4(d)(2) states, “[a]ny clause using this method shall be prepared and approved under agency procedures. Because of the variations in circumstances and clause wording that may arise, no standard clause is prescribed.” This regulation explicitly directs agencies to develop their own clause(s) for a fixed price contract with equitable adjustments based on cost indexes of labor or material. I do not understand how you could argue here that creation of a new clause would not be consonant with the plain language of the regulation. Therefore, creating a new agency supplemental clause under FAR 16.203-4(d) would fall under the purview of an “additional… contract clauses that supplement the FAR to satisfy the specific needs of the agency…” per FAR 1.302(b ), not a deviation under FAR 1.401.

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Guest Vern Edwards

FAR 16.203-4 prescribes clauses for use in EPA contracts and rules for developing a clause where one is needed, but not prescribed. The clause written by Dingoes isn't one of them. He said nothing about his clause being approved under agency procedures.

Paragraph ( b ) and ( c) of Dingoes's clause prescribe the method of adjustment. FAR 16.203-4(d)(1) requires the use of a "cost index of labor" when developing a clause. But Dingoes's clause does not use a cost index of labor, e.g., one of the BLS employment cost indexes.

The Employment Cost Index (ECI) measures the change in the cost of labor, free from the influence of employment shifts among occupations and industries.

See http://www.bls.gov/news.release/eci.tn.htm.

Instead, Dingoes's clause uses one of BLS's producer price indexes, which are indexes of seller prices, not labor costs.

The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.

See http://www.bls.gov/ppi/ppiover.htm. Sellers can raise their prices even if their labor costs have not increased. Nothing in FAR 16.203 provides for an economic price adjustment based on changes in service prices. It provides only for adjustments based on changes in the actual cost of labor and material or in cost indexes of labor and material. See 16.203-1 and 16.203-3.


That's how I can argue here that the creation of Dingoes's clause was not consistent with the plain language of the regulation, and was thus a deviation.

Finally, 16.203-4 prescribes clauses for fixed-price contracts. Dingoes described his contract as labor-hour. I'm not sure he was correct, but that's what he said. In any case, the contract does not state a fixed--price, just hourly rates. In order to have a price you have to have rates and quantities. The fact that orders will be fixed-price may be irrelevant, since he is exercising a contract option, not an order option. But that's debatable.

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Thanks for the explanation, Vern. I understand the distinction you made between the cost and price indexes. If DAMB used the ECI instead of the PPI, the argument that the clause was not a deviation would be stronger.

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Okay, we're not talking about A-E now, right?

The question isn't whether the clause would be made better by prescribing an exact formula. The question is whether an exact formula is necessary in order to comply with 17.207(f). I think the answer is yes.

Vern,

The contract is an A-E contract.

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I interpret DAMB's clause as a variation of a fixed price with economic price adjustment (see Federal Acquisition Regulation (FAR) Subsection 16.203-4(d)):

(d) Adjustments based on cost indexes of labor or material. The contracting officer should consider using an economic price adjustment clause based on cost indexes of labor or material under the circumstances and subject to approval as described in paragraphs (d)(1) and (d)(2) of this section.

(1) A clause providing adjustment based on cost indexes of labor or materials may be appropriate when—

(i) The contract involves an extended period of performance with significant costs to be incurred beyond 1 year after performance begins;

(ii) The contract amount subject to adjustment is substantial; and

(iii) The economic variables for labor and materials are too unstable to permit a reasonable division of risk between the Government and the contractor, without this type of clause.

(2) Any clause using this method shall be prepared and approved under agency procedures. Because of the variations in circumstances and clause wording that may arise, no standard clause is prescribed.

Therefore, FAR Section 17.207(f)(4) would apply, as this was "[a] specific price that is subject to an economic price adjustment provision [sic]." Therefore, a specific formula under FAR Section 17.207(f)(2) would NOT be necessary.

In regards to DAMB's clause, I do not necessarily agree with the language because of the 7-percent cap. If economic conditions changed significantly, it would result in the contractor taking a loss on its labor services. Ultimately, this could result in performance issues. When the intent of the clause is to share the risk of future price fluctuations, limiting that risk to an arbitrary amount seems unproductive and could potentially have unintended consequences. However, I appreciate DAMB's negotiation tactic as I see firms with unprecidented escalation rates, especially in sole source environments.

metteec,

When you say "fixed price with economic price adjustment" I understand I think your reasoning; however, your focus is on the costs of the various components building the fixed labor rate; whereas my methodology (which I now know should be a formula) ignores the costs going into the rate and focuses on the price change over the past year. I believe that this is a better way to measure the value of the labor hour from a price analysis perspective.

The 7 percent cap may be arbitrary, but if it is term and condition that the Contractor agrees to, then they have made a business judgement. Business judgements are inherently risky.

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Vern,

The contract is an A-E contract.

Dingoes, you said in post #8 that you were looking in more general terms than an A-E contract and specifically with application of "the determination at FAR 17.207(f) with for any IDIQ, notwithstanding the clause that [you] have put forward."

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metteec,

When you say "fixed price with economic price adjustment" I understand I think your reasoning; however, your focus is on the costs of the various components building the fixed labor rate; whereas my methodology (which I now know should be a formula) ignores the costs going into the rate and focuses on the price change over the past year. I believe that this is a better way to measure the value of the labor hour from a price analysis perspective.

The 7 percent cap may be arbitrary, but if it is term and condition that the Contractor agrees to, then they have made a business judgement. Business judgements are inherently risky.

Mettec, if you are negotiating with an A-E firm to price labor rates downstream years, then you should be looking at the firm's professional labor costs in addition to having visibility of trends of selling prices, in my opinion. Yes, a price analysis of trends will be a good thing, but simply raising prices without regard for proposed or actual cost or cost changes - or lack thereof - in a sole source A-E negotiation is unwise.

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FAR 16.203-4 prescribes clauses for use in EPA contracts and rules for developing a clause where one is needed, but not prescribed. The clause written by Dingoes isn't one of them. He said nothing about his clause being approved under agency procedures.

Paragraph ( b ) and ( c) of Dingoes's clause prescribe the method of adjustment. FAR 16.203-4(d)(1) requires the use of a "cost index of labor" when developing a clause. But Dingoes's clause does not use a cost index of labor, e.g., one of the BLS employment cost indexes.

See http://www.bls.gov/news.release/eci.tn.htm.

Instead, Dingoes's clause uses one of BLS's producer price indexes, which are indexes of seller prices, not labor costs.

See http://www.bls.gov/ppi/ppiover.htm. Sellers can raise their prices even if their labor costs have not increased. Nothing in FAR 16.203 provides for an economic price adjustment based on changes in service prices. It provides only for adjustments based on changes in the actual cost of labor and material or in cost indexes of labor and material. See 16.203-1 and 16.203-3.

That's how I can argue here that the creation of Dingoes's clause was not consistent with the plain language of the regulation, and was thus a deviation.

Finally, 16.203-4 prescribes clauses for fixed-price contracts. Dingoes described his contract as labor-hour. I'm not sure he was correct, but that's what he said. In any case, the contract does not state a fixed--price, just hourly rates. In order to have a price you have to have rates and quantities. The fact that orders will be fixed-price may be irrelevant, since he is exercising a contract option, not an order option. But that's debatable.

Vern,

The contract was certainly a Labor Hours contract with fixed labor rates. Task orders were issued against the contract as a labor hours contract type using the fixed rates in the contract as the basis for the price to the Government for the Contractor to meet the requirements of the statement of work.

I cannot tell what your opinion is of the clause's technique for adjusting the labor rates according to the BLS' PPI. This technique does ignore the costs as the basis for the labor rate and focuses instead on the price in the realm of the PPI. Is that a good method for measuring price fair and reasonableness? To me it should be, regardless of changes to the costs. If the the market for that particular NAICS is consuming the service at a higher price then that is an important metric to consider when making a determination of price fair and reasonableness (see FAR 15.404-1( b )(2)(iv) where comparison with published market price indices is inferred). Which was one of the fundamental goals of the clause.

Maybe it was too ambitious or simplistic. It should have been officially approved by the agency.

Bottom line, is this a viable clause? It sounds like with some adjustment it could be, but then I'm not sure that it would have the desired effect of tying the fixed rate to the price of the service as it is consumed in the market.

Maybe this is just interesting reading, but BLS' guidance at http://www.bls.gov/ppi/ppiescalation.htm was the basis for 'how to' for the formation of the clause.

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Mettec, if you are negotiating with an A-E firm to price labor rates downstream years, then you should be looking at the firm's professional labor costs in addition to having visibility of trends of selling prices, in my opinion. Yes, a price analysis of trends will be a good thing, but simply raising prices without regard for proposed or actual cost or cost changes - or lack thereof - in a sole source A-E negotiation is unwise.

So when I am thinking in an obtuse manner I generally know that I am, but not necessarily why. So can you elaborate on why this is unwise. Especially given that at the time of the negotiation I was being faced with the possibility of having to live with 5% escalation which was completely unsupported by historical data or the outlook of the economy. To me, at worst, the index was capped at 7%; so even if the PPI exploded it would be contained, and the net increase over the course of the option periods would never rise to more than the market price for such services.

I'm not being a wise guy here, I really need to know why it's unwise so that I can learn from this and I have the utmost of respect for your opinions.

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Guest Vern Edwards

Dingoes:

It's been almost a month since the last posts in this thread before today. I'm afraid that I cannot remember what the thread was about and don't have time to review and recall. Good luck with your inquiry.

Vern

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Dingoes, I don't know the size or volume of your A-E, IDC contracts or whether or not they are subject to the requirement for cost or pricing data, which would require COST analysis, in addition to PRICE analysis. However, our organization uses Engineer Pamphlet 715-1-7, ARCHITECT-ENGINEER CONTRACTING IN USACE (US Army Corps of Engineers) , updated in February 2012, to negotiate prices for A-E contracts, including option periods. Chapter 4 generally covers the process and calls for cost analysis in addition to price analysis for significant pricing actions and for establishing unit prices and for option year adjustments to unit prices. Chapter 4 also states that the firm must provide the basis for adjustments to unit prices for IDC option years. Here is one specific excerpt, which refers to using labor COST indexes (indices), not producer PRICE indexes for establishing option year pricing.

Chapter 4...
4-14. Negotiation of Indefinite Delivery Contracts (IDC)

.

a. Labor and Overhead Rates

(2 ) ...Rates or a method for determining rates, such as reference to Engineering News-Recordcost indices or the Department of Labor Employment Cost Index (website inAppendix F**), for all contract option periods must also be negotiated. Further, for contract periods longer than one year,consider including a pre-determined method foradjusting the rates periodically to account for inflation.

** see: http://www.bls.gov/ncs/ect/home.htm

Dingoes, as you noted in your post #21 above, Vern also made such distinction between using cost and price indexes in his post number 15 and generally cautioned against such practice when unrelated to labor cost increases or decreases.

I believe that you also mentioned above that A-E firms were insisting upon nothing less than 5% escalation rates without any type of justification, which would simply be unacceptable to me as a negotiator.

In addition to Chapter 4, Appendices X, Y, Z and AA of EP 715-17 generally cover the A-E price negotiation process. for our organization.

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Dingoes, I don't know the size or volume of your A-E, IDC contracts or whether or not they are subject to the requirement for cost or pricing data, which would require COST analysis, in addition to PRICE analysis. However, our organization uses Engineer Pamphlet 715-1-7, ARCHITECT-ENGINEER CONTRACTING IN USACE (US Army Corps of Engineers) , updated in February 2012, to negotiate prices for A-E contracts, including option periods. Chapter 4 generally covers the process and calls for cost analysis in addition to price analysis for significant pricing actions and for establishing unit prices and for option year adjustments to unit prices. Chapter 4 also states that the firm must provide the basis for adjustments to unit prices for IDC option years. Here is one specific excerpt, which refers to using labor COST indexes (indices), not producer PRICE indexes for establishing option year pricing.

Chapter 4...
4-14. Negotiation of Indefinite Delivery Contracts (IDC)

.

a. Labor and Overhead Rates

(2 ) ...Rates or a method for determining rates, such as reference to Engineering News-Recordcost indices or the Department of Labor Employment Cost Index (website inAppendix F**), for all contract option periods must also be negotiated. Further, for contract periods longer than one year,consider including a pre-determined method foradjusting the rates periodically to account for inflation.

** see: http://www.bls.gov/ncs/ect/home.htm

Dingoes, as you noted in your post #21 above, Vern also made such distinction between using cost and price indexes in his post number 15 and generally cautioned against such practice when unrelated to labor cost increases or decreases.

I believe that you also mentioned above that A-E firms were insisting upon nothing less than 5% escalation rates without any type of justification, which would simply be unacceptable to me as a negotiator.

In addition to Chapter 4, Appendices X, Y, Z and AA of EP 715-17 generally cover the A-E price negotiation process. for our organization.

Thank you Joel. I went back and re-read FAR 36.606, A-E Contracts Negotiations, and some of the emphasis that I seemed to remember on price was not really there, and more an emphasis on negotiations per Part 15. I will have to reflect on that.

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