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#1 Ophelia

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Posted 22 March 2012 - 07:09 AM

I've been having discussions at my company about a new product that we have developed for the military on company funds. We have approached the military about this product and they are interested. We fully understand that the Government cannot purchase our products without authorization, etc.

In order to recoup some of our development costs, we want to include an amount in the purchase price. The discussions have centered around royalties. Looking at the FAR (27.202-1 and 52.227-6) indicates that royalties are for patented items. I do not think that our company will seek a patent.

I had mentioned to my management that we should be selling a license for each unit. I was told that it is really a royalty. So, I'm confused.

Anyone have any ideas?

#2 Vern Edwards

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Posted 22 March 2012 - 08:34 AM

What do you want to do -- sell them the product or sell them rights to use the product design and production data as they see fit?

#3 here_2_help

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Posted 22 March 2012 - 08:54 AM

Do you qualify for deferred IR&D treatment under 31.205-18(d)?

#4 Ophelia

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Posted 22 March 2012 - 08:55 AM

Vern, we want to sell them the product. The thought is that the Government avoids overall NRE costs.

#5 Ophelia

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Posted 22 March 2012 - 08:58 AM

here2help: No. We are a large Government contractor.

#6 Vern Edwards

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Posted 22 March 2012 - 09:58 AM

Vern, we want to sell them the product. The thought is that the Government avoids overall NRE costs.


Well, I don;t see how a royalty would be involved. A royalty would be involved if you want to grant a license to manufacture a patented product or use or disclose proprietary intellectual property.

#7 Ophelia

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Posted 22 March 2012 - 10:02 AM

Vern, that 's the discussion. I keep saying it's not a royalty; I'm thinking it's a license. Do you know of any reading materials on royalties?

#8 Vern Edwards

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Posted 22 March 2012 - 10:52 AM

Ophelia:

It does not make sense to speak in terms of a license OR a royalty. A license is something that you sell. A royalty is a payment for something that you sell.

You say you have a new "product" that you have developed and that you want to sell it, but you have not described the product. What is the product? Hardware, software, something else? If it's hardware, then "license" and royalty do not make sense if you don't have a patent.

If it's software, then license does make sense. You may want to sell a license to use the software. But if you want to sell a license, then you may want a royalty instead of or in addition to an upfront payment.

If you don't know what a royalty is, there are literally countless -- literally, countless -- articles on the internet that explain royalties. Google (or Bing or Yahoo) "royalty".

Come on, Ophelia. Join the modern world. You're killing yourself here.

#9 Ophelia

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Posted 22 March 2012 - 12:39 PM

Vern,

It's hardware--a box for aircraft. I don't want to say too much about it re: technical. Inthis environment of smaller DoD budgets, we're trying to offer something to the military with a different acquisition method. I know this question may seem strange, but I'm relaying to you what my management is telling me. I was told to research it.

I already Binged (that doesn't look good) "royalty," but there isn't much out there as it relates to the Government.

Thanks.

#10 Vern Edwards

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Posted 22 March 2012 - 12:45 PM

If you're selling hardware, then I don't understand your use of either license or royalty. If you sell hardware you transfer ownership of the specific deliveries to the buyer. There is no license and no royalty.

As for royalty in government contracting, the concept is the same as it is in the commercial sector.

Anyway, I see you told here_2_help that you work for a large contractor. Your legal office ought to be able to sort this out for you.

#11 Ophelia

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Posted 22 March 2012 - 01:00 PM

Yes, I invited our IP attorney to a meeting today. Hopefully he can explain things. I think we're getting mixed up with semantics/word choice. I think it is IP we want to license, but whatever.

#12 Navy_Contracting_4

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Posted 22 March 2012 - 05:07 PM

here2help: No. We are a large Government contractor.


So would it be correct to infer from this response that you've already allocated the development costs to government contracts during the time the costs were incurred? If so, then haven't you already recouped them, albeit indirectly? If not, how were these costs accounted for?

Are you expecting to sell these items to the government on a sole-source basis, under which you'll be providing certified cost or pricing data?

#13 here_2_help

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Posted 23 March 2012 - 10:29 AM

Ophelia,

Naturally you have to be circumspect in order to protect your company's valuable IP. That being said, it would be helpful if you could address some of the questions your original post generated. In addition, I wonder --

1. What type of company funds were used to develop the product in question? Were they profit dollars or IR&D dollars, or what? (I.e., what Navy_Contracting_4 asked.)
2. Did the company account for the development costs as current period expense costs, or are they sitting on the balance sheet? If on the balance sheet, what is the description?

My take on it is that, unless your development costs are on the balance sheet in some fashion, you have no hope of recovering your company's development costs in the price you would like DOD to pay for your item. That's not to say that you can't request a whopping big profit rate on estimated costs (if you are entering into an other-than CPFF contract type). If you truly invested company profit dollars and risked a lot to develop your innovative technology, I believe you should be able to persuade DOD negotiators to recognize that fact in the negotiated price.

Hope this helps.

#14 Vern Edwards

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Posted 23 March 2012 - 11:20 AM

My take on it is that, unless your development costs are on the balance sheet in some fashion, you have no hope of recovering your company's development costs in the price you would like DOD to pay for your item.


Wait a minute! Why do you say that? She wants to sell a hardware item, presumably for a firm-fixed price. She can ask for any price she can get, enough to recoup her development costs whether they're on the books or not (although I cannot imagine why they wouldn't be). it all depends on how badly DOD wants the item and what they think it's worth.

Please explain.

#15 here_2_help

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Posted 23 March 2012 - 08:51 PM

Wait a minute! Why do you say that? She wants to sell a hardware item, presumably for a firm-fixed price. She can ask for any price she can get, enough to recoup her development costs whether they're on the books or not (although I cannot imagine why they wouldn't be). it all depends on how badly DOD wants the item and what they think it's worth.

Please explain.


Yes, she can ask for any price she can get. The question (as others have alluded to) is how the price is derived. If the price is based on costs incurred, there is a problem. If the development costs are not on the balance sheet, then that means that they have been previously expensed in prior periods. You can't reopen the books to claim prior period expenses as current period contract costs. You can't claim them as allowable pre-contract costs because they won't meet the requirements for allowability. They are now historical costs and not relevant to current contract pricing. There is an opportunity under 31.205-18(d) for deferring R&D costs and amortizing the costs over production units (I raised this possiblity in my first post) but that does not seem to be possible in this case. Plus, you can't defer and amortize if you've already expensed the costs. They're sunk.

Again, one can jack up the profit portion of the proposal under the legitimate theory of risk assumption and innovation. No problem there. But you can't claim costs that are no longer costs. (See CAS 406, if nothing else.) Today they are (likely) as sunk as the Titanic.

Okay?

H2H

#16 Vern Edwards

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Posted 23 March 2012 - 09:42 PM

I understand your answer, but it's not okay.

What if the contractor does not take a cost-based approach to pricing, but takes a market-based approach? It has looked at similar items that perform the function that its item performa and made judgments about the quality value of their item on that basis. It has not added up the cost of development and unit production and then topped it off with a profit, and there is no legal requirement that it do so. The price that they request legally need not be based on any costs incurred and they need not make a "claim" about costs. Instead, they argue for what they want on the basis of market competition and expected demand. DOD has referred to that approach as price-based acquisition.

http://www.nationald...ntagon4425.aspx

http://www.rand.org/.../RAND_MG337.pdf

http://www.dtic.mil/...oc?AD=ADA407709

There are many, many more such references.

If the parties use price-based acquisition, why would the contractor have to "jack up the profit portion"?

#17 here_2_help

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Posted 24 March 2012 - 10:05 AM

I understand your answer, but it's not okay.

What if the contractor does not take a cost-based approach to pricing, but takes a market-based approach? It has looked at similar items that perform the function that its item performa and made judgments about the quality value of their item on that basis. It has not added up the cost of development and unit production and then topped it off with a profit, and there is no legal requirement that it do so. The price that they request legally need not be based on any costs incurred and they need not make a "claim" about costs. Instead, they argue for what they want on the basis of market competition and expected demand. DOD has referred to that approach as price-based acquisition.

http://www.nationald...ntagon4425.aspx

http://www.rand.org/.../RAND_MG337.pdf

http://www.dtic.mil/...oc?AD=ADA407709

There are many, many more such references.

If the parties use price-based acquisition, why would the contractor have to "jack up the profit portion"?


Vern, I have no problem with your post, except that it does not answer the question posed by the original poster, which specifically asked about recoupment of development costs. That's the question I answered.

#18 Vern Edwards

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Posted 24 March 2012 - 12:27 PM

Help:

I'm not picking a fight with you, just exploring an idea. The question in the original post seemed to ask about the difference between a license and a royalty as the way to recoup development costs. The actual question was:

Anyone have any ideas?


That was vague, at best. But let's forget about licenses and royalties, a matter about which Ophelia seems fatally confused. Let's assume that the question was: How do we recoup our development costs through sale of our product to the government? You answered with reference to incurred cost and profit, cost principles, and CAS, which is why I asked you to explain.

My response to Ophelia is that one way to do it is to charge a market-based price that will let the company recover its development costs in time through the sale of an expected quantity of units. Using that approach, the parties would not discuss incurred and estimated costs and profit and what is on the company's books, but bottom line price reasonableness.

DOD has sought to use price-based contracting as a way to avoid cost or pricing data, CAS, cost principles, DCAA proposal audits, etc. Dr. Jacques Gansler, former Under Secretary of Defense for Acquisition, Technology, and Logistics (1997 - 2001), advocated that approach as a way to reduce the high costs of doing business, a matter he discusses in his newest book, Democracy's Arsenal: Creating A Twenty-First Century Defense Industry, 140 - 143, (MIT Press, 2011). Today, DOD mignt say that it is a way to get "better buying power."

I don't know if the government personnel that would be involved would be sophisticated enough to understand price-based contracting, would find it acceptable, and would be competent to apply it, My point is that there are other ways to think about price and cost recovery than cost-based pricing (estimated/incurred cost plus profit) and that DOD has shown official interest in that approach in the past. Price-based contracting is one way to recover development costs without ever discussing them with the customer, which it the way that commercial firms do it.

On a different topic: Did you get my message about The Nash & Cibinic Report article about the definition of subcontract? It has been published, and I can send you a copy of the issue. Contact me through the Wifcon message center.

#19 here_2_help

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Posted 25 March 2012 - 11:13 PM

Vern,

I completely agree with your logic, but unfortunately the idea appears to be diametrically opposed to where DOD is now. DCMA and the new DOD Pricing Center want more cost information, not less. I've grown tired of explaining to various DOD officials, who really ought to know better, why they cannot have cost information and EAC information and profit information for FFP contracts, especially those awarded under adequate competition. Everybody is data hungry, though they will admit (off the record) that they don't know what they will do with the data they are collecting.

Dr. Gansler is one of my heroes but I don't think he is in a position to make the kind of fundamental changes that are necessary.

Also, I send you a message on the article --thanks!

H2H

#20 dcarver

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Posted 26 March 2012 - 09:17 AM

Since you guys are focused on how to price the item, I'll throw out the idea for the contractor to sell it to the Government. How exactly have you pitched your idea to the DOD and they are interested? Did you just simply ask someone in the field if they were interested, or perhaps just ask a PM and they said "oh that looks good?"

It seems that you are focused on keeping the Intellectual Property of this item, which is of increasing value in the time of shrinking budgets so you can continue to receive revenues. Perhaps an Unsolicited Proposal should be thought of? It appears your item is unique, since you have developed it completely at your own expense and not at the direction of the Government. It may get a bit muddy since you have contacted somebody and they are interested, but nonetheless an avenue worth exploring if you want to be able to re-coup costs.




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