Profit on Profit

[kristine]

Is there a DFARs or FAR clause that prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost? I see in the Defense Reauthorization Act where there is a prohiibition on excessive passthroughs, but I can't find a reference that prohibits a primes profit on its subs work. Is the prohibition applicable to contracts for A&E services?

Also what is the definition of profit on profit?

[here_2_help]

Is there a DFARs or FAR clause that prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost? I see in the Defense Reauthorization Act where there is a prohiibition on excessive passthroughs, but I can't find a reference that prohibits a primes profit on its subs work. Is the prohibition applicable to contracts for A&E services?

Also what is the definition of profit on profit?

1. No, except for T&M types.

2. There is no definition of "profit on profit" but profit on inter-organizational transfers between affiliated entities under common control is prohibited by 31.205-26(e), unless an exception applies. You may be thinking about that prohibition, which does not cover subcontractor costs.

Fundamentally, a prime should be entitled to profit on subcontractor work, because it is responsible to the government for the subcontractor's compliance and performance. Any problems are addressed at the prime level. Because it has that risk, it should be entitled to a profit. But perhaps that's just an opinion and not directly responsive to your questions ....

Hope this helps.

[joel hoffman]

Is there a DFARs or FAR clause that prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost? I see in the Defense Reauthorization Act where there is a prohiibition on excessive passthroughs, but I can't find a reference that prohibits a primes profit on its subs work. Is the prohibition applicable to contracts for A&E services?

Also what is the definition of profit on profit?

"Is there a DFARs or FAR clause that prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost?"

No, not in general, assuming that we aren't talking about affiliated entities, as Here discussed or acting as a front for other firms actually performing the design.

Should an A-E not be entitled to profit on a subcontract for specialty design efforts, assuming that the A-E is actually performing design work and not merely acting as a pass-through for other firms performing the design? I'm assuming that you are asking here about an A-E performing a significant portion of the design effort with subcontractors performing some specialized portion of the design.

[Guest Vern Edwards]

Is there a DFARs or FAR clause that prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost? I see in the Defense Reauthorization Act where there is a prohiibition on excessive passthroughs, but I can't find a reference that prohibits a primes profit on its subs work. Is the prohibition applicable to contracts for A&E services?

Also what is the definition of profit on profit?

Yes, there is a rule that prohibits a contractor from earning a profit on subcontract costs, i.e., "profit on profit." The rule applies only in very limited circumstances. See FAR 15.408(n) and 52.215-23, Limitations On Pass-Through Charges (OCT 2009). The clause prohibits an "excessive pass-through charge," which is defined as "a charge to the Government by the Contractor or subcontractor that is for indirect costs or profit/fee on work performed by a subcontractor (other than charges for the costs of managing subcontracts and any applicable indirect costs and associated profit/fee based on such costs)." Emphasis added. See also the solicitation provision at FAR 52.215-22, Limitation On Pass-Through Charges--Identification Of Subcontractor Effort (OCT 2009). A similar provision and clause appear in DFARS at 252.215-7003 and 252.215-7004.

If a prime contractor or a subcontractor proposes profit that is based in part on work done by a subcontractor or lower-tier subcontractor, and adds little of value to the subcontractor's work, then the CO might consider that profit to be an "excessive pass-through charge," in which case he or she may disallow part of the subcontract cost or seek a price reduction. This is not a general prohibition, but one the applies only in very limited circumstances.

There is no official definition of "profit on profit," but as generally used it means that a prime has proposed a price or a fee under a cost-reimbursement contract that is based in part on the amount of a subcontract that includes a provision for profit or fee to the subcontractor.

[kristine]

I must be thickheaded because this has become confusing to me. Is the description below saying essentially the same thing as the responses above for A &E contracts?

FAR 15.404-4 requires the use of a structured approached. The structured

approach is defined by EFARS 15.404-73-101 Alternate Structured Approach for

Architect-Engineer contracts as follows

" (a) The pre-negotiation profit objective for a

firm-fixed-price architect-engineer (including surveying and mapping)

contract, contract modification, or task order will be determined as

described below. The profit objective for all other types of A-E contracts

will be determined in accordance with DFARS 215.404-71.

Profit Objective = Cost x (Technical Complexity Factor +

Length Factor + Support of Socioeconomic Program Factor)

Where:

(1) Cost is the total estimated costs, including general and

administrative costs, of the prime contractor and any subcontractors,

exclusive of any profit. However, normal profit need not be deducted from

the prices for commercial supplies and services (such as airfares,

reproduction, lab tests, express mail and materials) in developing the cost

base.

(2) Technical complexity factor will vary from 0.05 for low

complexity (design of simple road repaving or routine boundary survey

verification) to 0.10 for high complexity (design of nuclear chemistry

laboratory or the design of the remediation of a very unusual and complex

hazardous waste site). Consider the nature of the work, degree of management

involvement required, schedule constraints, amount of Government assistance,

and availability of design criteria.

(3) Length factor is .02 for a contract action of 1 month or

less, and increases proportionately to 0.04 for a contract action of 21

months or longer. Consider the time necessary to complete the substantive

portion of work, including option periods.

(4) Support of socioeconomic programs factor will vary from

0.0 for a prime contractor (including a small business prime contractor) who

plans no subcontracting, to 0.02 for a contractor who demonstrates

exceptional program support. Consider the contractor's past record as well

as the instant contract with regard to mentoring and subcontracting with

small businesses, small disadvantaged businesses, and historically black

colleges and universities and minority institutions. "

A relevant question regarding subcontractor profit can be found on the DAU

ask a professor website. The entire question and answer can be found at

https://akss.dau.mil/askaprof-akss/qdetail2...13&cgiQuest

ionID=12857 The relevant part of the answer follows.

"...I spoke with the author and proponent of the A-E method, which was

developed circa 1995. The construction contract approach has been basically

unchanged since the 1970's or earlier, as was the previous A-E method. You

will note that one of the criteria for calculating the construction profit

objective is the "amount of subcontracting." Thus, the construction prime's

profit objective percentage should decrease as the amount of subcontracting

increases. By not including sub's profits in the multiplier, the A-E profit

objective method is different, but achieves similar results for evaluating

overall profit. The A-E method provides an overall profit objective for the

contract to be distributed any way the A-E team prefers. The author says that

it doesn't matter how the A-E proposal calculates or distributes profit

between the prime and its subconsultants; what is important for analysis and

negotiations objectives is the overall amount of proposed profit. .."

So, to reiterate, if the subcontractor's proposed cost do NOT include profit

they would go above the profit line, however; if the proposed subcontractor's

cost do include profit they would go below the profit line.

[here_2_help]

(1) Cost is the total estimated costs, including general and

administrative costs, of the prime contractor and any subcontractors,

exclusive of any profit. However, normal profit need not be deducted from

the prices for commercial supplies and services (such as airfares,

reproduction, lab tests, express mail and materials) in developing the cost

base.

"...I spoke with the author and proponent of the A-E method, which was

developed circa 1995. The construction contract approach has been basically

unchanged since the 1970's or earlier, as was the previous A-E method. You

will note that one of the criteria for calculating the construction profit

objective is the "amount of subcontracting." Thus, the construction prime's

profit objective percentage should decrease as the amount of subcontracting

increases. By not including sub's profits in the multiplier, the A-E profit

objective method is different, but achieves similar results for evaluating

overall profit. The A-E method provides an overall profit objective for the

contract to be distributed any way the A-E team prefers. The author says that

it doesn't matter how the A-E proposal calculates or distributes profit

between the prime and its subconsultants; what is important for analysis and

negotiations objectives is the overall amount of proposed profit. .."

So, to reiterate, if the subcontractor's proposed cost do NOT include profit

they would go above the profit line, however; if the proposed subcontractor's

cost do include profit they would go below the profit line.

I defer to Joel on construction and A/E type questions. But it seems to me that there is a difference between the formula used to calculate a pre-negotation objective for profit, and "allowing" or "prohibiting" subcontractor profit to be billed/included in contract prices. The original question was whether there was a clause that "prohibits the Government from allowing a prime contractor to earn a profit on its subcontractor's cost?" I stick with my original answer--NO, except for T&M contract types.

I also want to add that the subcontractor's price is the prime contractor's allowable cost. The prime normally doesn't share in the subK's profit, and bears the risk of subcontractor non-performance. Thus, the focus on "profit on profit" seems much ado about very little, in my view.

Finally, Vern correctly noted a limitation on subcontractor profit. He noted it only applies in very limited circumstances. Just to elaborate, the limitation only applies when (a) the prime subcontracts 70% or more of total program cost, and ( adds little or no value to the subcontracted work (as determined by the C.O.) If the prime doesn't subcontract at least 70% of the total program cost, the limitation is not applicable.

H2H

[Guest Vern Edwards]

Finally, Vern correctly noted a limitation on subcontractor profit. He noted it only applies in very limited circumstances. Just to elaborate, the limitation only applies when (a) the prime subcontracts 70% or more of total program cost, and ( adds little or no value to the subcontracted work (as determined by the C.O.) If the prime doesn't subcontract at least 70% of the total program cost, the limitation is not applicable.

H2H

H2H: I think you have misread the clause. The limitation is not just on subcontractor profit. Next, please explain why the limit applies only when the prime subcontracts 70 percent or more of total program costs. I don't see that in FAR 15.408(n) or in 52.215-23. The only mention that I see of 70 percent is in the reporting subparagraph and it deals with changes after award. What am I missing?

[here_2_help]

H2H: I think you have misread the clause. The limitation is not just on subcontractor profit. Next, please explain why the limit applies only when the prime subcontracts 70 percent or more of total program costs. I don't see that in FAR 15.408(n) or in 52.215-23. The only mention that I see of 70 percent is in the reporting subparagraph and it deals with changes after award. What am I missing?

Vern,

You are looking only at the clause. You also need to look at the provision (below) and FAR 15.408(n)(1).

52.215-22 Limitations on Pass-Through Charges?Identification of Subcontract Effort.

As prescribed in 15.408(n)(1), use the following provision:

Limitations On Pass-Through Charges?Identification Of Subcontract Effort (Oct 2009)

(a) Definitions. Added value, excessive pass-through charge, subcontract, and subcontractor, as used in this provision, are defined in the clause of this solicitation entitled ?Limitations on Pass-Through Charges? (FAR 52.215-23).

( General. The offeror?s proposal shall exclude excessive pass-through charges.

© Performance of work by the Contractor or a subcontractor.

(1) The offeror shall identify in its proposal the total cost of the work to be performed by the offeror, and the total cost of the work to be performed by each subcontractor, under the contract, task order, or delivery order.

(2) If the offeror intends to subcontract more than 70 percent of the total cost of work to be performed under the contract, task order, or delivery order, the offeror shall identify in its proposal?

(i) The amount of the offeror?s indirect costs and profit/fee applicable to the work to be performed by the subcontractor(s); and

(ii) A description of the added value provided by the offeror as related to the work to be performed by the subcontractor(s).

(3) If any subcontractor proposed under the contract, task order, or delivery order intends to subcontract to a lower-tier subcontractor more than 70 percent of the total cost of work to be performed under its subcontract, the offeror shall identify in its proposal?

(i) The amount of the subcontractor?s indirect costs and profit/fee applicable to the work to be performed by the lower-tier subcontractor(s); and

(ii) A description of the added value provided by the subcontractor as related to the work to be performed by the lower-tier subcontractor(s).

(End of provision)

The excessive pass-thru limitation applies only when the contractor / subcontractor intends to award more than 70% of the program cost in subcontracts. If there is no pre-award intent, but actual awards end up exceeding 70% post-award, then the contractor / subcontractor must report to the C.O. for a determination.

That's how it works.

H2H

[joel hoffman]

I must be thickheaded because this has become confusing to me. Is the description below saying essentially the same thing as the responses above for A &E contracts?

FAR 15.404-4 requires the use of a structured approached. The structured

approach is defined by EFARS 15.404-73-101 Alternate Structured Approach for

Architect-Engineer contracts as follows

" (a) The pre-negotiation profit objective for a

firm-fixed-price architect-engineer (including surveying and mapping)

contract, contract modification, or task order will be determined as

described below. The profit objective for all other types of A-E contracts

will be determined in accordance with DFARS 215.404-71.

Profit Objective = Cost x (Technical Complexity Factor +

Length Factor + Support of Socioeconomic Program Factor)

Where:

(1) Cost is the total estimated costs, including general and

administrative costs, of the prime contractor and any subcontractors,

exclusive of any profit. However, normal profit need not be deducted from

the prices for commercial supplies and services (such as airfares,

reproduction, lab tests, express mail and materials) in developing the cost

base.

(2) Technical complexity factor will vary from 0.05 for low

complexity (design of simple road repaving or routine boundary survey

verification) to 0.10 for high complexity (design of nuclear chemistry

laboratory or the design of the remediation of a very unusual and complex

hazardous waste site). Consider the nature of the work, degree of management

involvement required, schedule constraints, amount of Government assistance,

and availability of design criteria.

(3) Length factor is .02 for a contract action of 1 month or

less, and increases proportionately to 0.04 for a contract action of 21

months or longer. Consider the time necessary to complete the substantive

portion of work, including option periods.

(4) Support of socioeconomic programs factor will vary from

0.0 for a prime contractor (including a small business prime contractor) who

plans no subcontracting, to 0.02 for a contractor who demonstrates

exceptional program support. Consider the contractor's past record as well

as the instant contract with regard to mentoring and subcontracting with

small businesses, small disadvantaged businesses, and historically black

colleges and universities and minority institutions. "

A relevant question regarding subcontractor profit can be found on the DAU

ask a professor website. The entire question and answer can be found at

https://akss.dau.mil/askaprof-akss/qdetail2...13&cgiQuest

ionID=12857 The relevant part of the answer follows.

"...I spoke with the author and proponent of the A-E method, which was

developed circa 1995. The construction contract approach has been basically

unchanged since the 1970's or earlier, as was the previous A-E method. You

will note that one of the criteria for calculating the construction profit

objective is the "amount of subcontracting." Thus, the construction prime's

profit objective percentage should decrease as the amount of subcontracting

increases. By not including sub's profits in the multiplier, the A-E profit

objective method is different, but achieves similar results for evaluating

overall profit. The A-E method provides an overall profit objective for the

contract to be distributed any way the A-E team prefers. The author says that

it doesn't matter how the A-E proposal calculates or distributes profit

between the prime and its subconsultants; what is important for analysis and

negotiations objectives is the overall amount of proposed profit. .."

So, to reiterate, if the subcontractor's proposed cost do NOT include profit

they would go above the profit line, however; if the proposed subcontractor's

cost do include profit they would go below the profit line.

Kristine, if you are with the Corps, you should be familiar with EP 715-1-7, Architect-Engineer Contracting.

Appendix X provides the methodology for preparing the government estimate , including the profit objective.

"e. Profit. Profit rates will be determined in accordance with EFARS 15.404-73-101.

The profit rate will be applied to all costs (direct labor, overhead on direct labor, general and

administrative overhead, travel, reproduction and other direct costs) to estimate the dollar

amount of profit. An IGE will not be structured with redundant levels of profit (no profit on

profit)40. Hence, if an IGE is structured with subcontractors, the estimated costs (without

profit) for the prime contractor and the subcontractors will be added to give the total cost

base for applying the profit rate. However, it is not necessary to deduct reasonable profit

embedded in the prices of commercial supplies and services, such as travel, lab tests, printing

and express mail."

(NOTE 40 "The EFARS alternate structured approach to the weighted guidelines method (WGM)

for A-E contracts yields profits that are substantially greater than the WGM in DFARS

215.404-71. Hence, estimating additional profit for layering of subcontractors is not

warranted.")

You tickled my memory. I was the "Professor" at the time and wrote that response to the AAP question.

[Guest Vern Edwards]

Vern,

The excessive pass-thru limitation applies only when the contractor / subcontractor intends to award more than 70% of the program cost in subcontracts. If there is no pre-award intent, but actual awards end up exceeding 70% post-award, then the contractor / subcontractor must report to the C.O. for a determination.

That's how it works.

H2H

No, that's not how it works.

Seventy percent is a "reporting threshold," not a limit on the prohibition against excessive pass-through charges. See the background statement for the interim rule in FAR 2005-37, 74 FR 52853, at 52854. The statute, Public Law 109-364, Sec. 852(, makes no mention of any 70 percent limitation. The FAR councils said they choose 70 percent as the "reporting threshold" for requiring the contractor to report certain information to the CO "because that represents a substantial amount of subcontracting."

The provision and the clause say that a proposal may not include excessive pass-through charges. Period. They do not say that a proposal may not include excessive pass-through charges only when subcontracting will exceed 70 percent. If a CO is aware of excessive pass-through charges when subcontracting is less than 70 percent, he or she should exclude them during negotiations.

And the rules are the same for architect-engineer contracts.

[kristine]

Thanks all, this has been really very helpful, including the discussion on excessive pass throughs.

Joel do you know where I can get a copy of Foster Construction Company DOTCAB 71-16 73-1 BCA?

[joel hoffman]

Thanks all, this has been really very helpful, including the discussion on excessive pass throughs.

Joel do you know where I can get a copy of Foster Construction Company DOTCAB 71-16 73-1 BCA?

Kristine, if you work with the Corps, just call or visit Office of Counsel. They will have it available. If they haven't thrown away their hard copies, it is in the Law Library, plus they have electronic access. If you are near a Federal Courthouse, they probably also have it in their library. There is some discussion of it in "Calculating Construction Damages", a 2001 publication in the "Construction Law Library" Series by Aspen Law and Business. I GOOGLED it under the search words "Foster Construction Company DOTCAB 71-16 73-1 BCA". I believe that it concerned pricing of equipment costs, back in the days when we used the AGC Equipment rates to calculate rates for contractor owned construction equipment. That is really OBE. I remember all the debates over the AGC rates and which version of their manual was acceptable and which one wasn't. The Corps subsequently developed its own equipment ownerhip and operating rates rates manual.

The URL is http://books.google.com/books?id=B6XDVL3Ep...p;q&f=false

As an aside, there aren't very many general contractors in the construction industry that routinely self-perform 30% or more of the work on general building projects these days, especially small business GC's. To do that requires a lot of capital investment in facilities, equipment and human resources that small firms don't often have.

[joel hoffman]

I edited my above response while some of you were viewing the Thread. sorry.