Guidance

3. Pricing queries

Updated 6 February 2024

3.1 What Baseline Profit Rate (BPR) should be applied to a Qualifying Defence Contract (QDC) and when will I know the BPR for the upcoming year?

Published April 2023

The Defence Reform Act 2014 requires the Secretary of State to determine and publish the Baseline Profit Rate (BPR) and other rates for a financial year in the London Gazette no later than 15 March in the preceding financial year. This means that the BPR that will apply to qualifying contracts entered into from 1 April to 31 March will typically be published on or before the preceding 15 March. Following the Secretary of State’s publication of the rates, the SSRO publishes guidance on the baseline profit rate and its adjustment in advance of 1 April. The guidance comes into effect on 1 April.

Section 17(2) of the Act, and regulation 11(2), set out the requirement for the baseline profit rate (BPR) as the first step in determining the contract profit rate to be applied in the pricing formula: “Take the baseline profit rate which is in force at the relevant time”.

The “relevant time” is the time of agreement, as defined in regulation 2(1). Broadly, this is:

• the date a QDC or QSC is entered into or the date of a re-determination of the contract price, or;
• for a QDC by amendment, the date of the amendment by which it was agreed the contract was to be a QDC or the date of a re-determination of the contract price.

The SSRO has provided separate guidance that will assist the contracting parties to determine the time of agreement for a particular QDC or QSC, which is set out at paragraphs 3.9 to 3.35 of the SSRO’s contract reporting guidance.

The contract profit rate for a particular QDC or QSC (in respect of which calculation the relevant BPR is step 1) applies to the entire contract and for the life of the contract, unless the parties propose to amend the contract in a way that would affect the original contract price. In that case, regulation 14 (and the Schedule to the Regulations) explains how the parties are to re-determine the contract price, which can involve the application of a different BPR (as part of a new Contract Profit Rate) from the one which previously applied, in relation to all or a component of the particular QDC or QSC.

Link to SSRO guidance on Allowable Costs

Link to SSRO guidance on the baseline profit rate and its adjustment

3.2 Does the SSRO approve company forward bid rates?

Published July 2023

The SSRO does not approve any contract costs, including bid rates, that contractors present to the MOD in relation to QDCs or QSCs. The regulatory framework requires both the MOD and the primary contractor (in the case of a QDC) or sub-contractor (in the case of a QSC) to be satisfied that costs that are included in the price of a qualifying contract meet the requirements of allowable costs (appropriate, attributable to the contract and reasonable in the circumstances – AAR). Rates are agreed by the MOD and the contractor as part of this process. For any cost claim, the Secretary of State may require the contractor to show that the cost is AAR and can be included in the price of a qualifying contract. The SSRO issues statutory guidance about determining whether costs are allowable costs and the Secretary of State and contractors must have regard to that guidance when determining whether costs are allowable.

3.3 Does the Questionnaire: Method and Allocation of Costs (QMAC) determine if a cost is Allowable?

Published July 2023

No. A QMAC is a record of an agreement between the MOD and a contractor regarding the approach to the classification and method of allocating costs within the contractor’s organisation. The agreement of a QMAC does not demonstrate that costs are allowable, however the parties may find its contents informative in applying the SSRO’s statutory guidance on allowable costs. For example, in identifying the type of costs and corresponding cost recovery bases which the parties may agree to recover through the application of cost recovery rates.

3.4 Can more than one regulated pricing method be used when pricing a contract?

Published July 2023

Yes. Regulation 10(3) of the Single Source Contract Regulations 2014 provides that: “The parties to a qualifying defence contract may agree that different regulated pricing methods are to be used for defined components of that contract.” The legislation currently permits only one contract profit rate can be applied to the allowable costs at a particular time of agreement. The MOD plan to amend the legislation in a way that would allow for different contract profit rates to apply to different defined components of allowable cost each using its own regulated pricing method.

3.5 Can a pricing method outside the six regulated pricing methods be used when pricing a contract?

Published July 2023

No. The Defence Reform Act 2014 and Single Source Contract Regulations 2014 do not permit the use of pricing methods other than the six regulated pricing methods described in Regulation 10.

3.6 Does the 5% final price adjustment limit allow a contractor to earn an outturn profit rate equal to the CPR + 5pp before an adjustment may be needed, or is it the CPR + 5%?

Published October 2023

A reduction to the contract price to reflect excess profit may only begin once the outturn profit rate exceeds the contract profit rate by 5 percentage points. Once the difference between these two rates is known, and the threshold for a final price adjustment is met, whichever of regulations 17(2) to 17(4) are relevant to the circumstances may be applied to determine the adjustment to be made. In the regulation 17(2) situation, the difference between the contract profit rate and the outturn profit rate would be at least 5% but less than 10%.

The SSRO made a recommendation to the Secretary of State in 2021 to amend Regulation 17 to clarify that reference to “%” in regulations 17(2) - 17(4) ought to instead refer to percentage points. This recommendation was accepted in the “Defence and Security Industrial Strategy: reform of the Single Source Contract Regulations”, which is currently being implemented.

There are other conditions and procedural requirements in relation to the application of a final price adjustment and these are described in regulations 16 and 17.

3.7 Can the costs associated with hedging be considered Allowable Costs?

Published October 2023

Hedging may be used to mitigate the risk of cost variations and involves paying a premium for the protection it provides, which we assume would be the basis upon which any claim of allowability for the premium would be based. Section H.3 of the SSRO’s Allowable Costs guidance covers costs associated with mitigating risk or uncertainty. This sets out the matters to be considered when determining if the cost of risk mitigation meets the requirements of allowable costs. The onus of proof rests with the contractor to demonstrate to the Secretary of State’s satisfaction that the costs meet the requirements of allowable costs. Hedging involves mitigating the impact of financial losses and can be thought of as form of insurance. As part of the agreement of any hedging premium as an allowable cost, the parties should also agree how they are to treat any losses that may arise and that the hedging was intended to offset.

3.8 The anticipated costs of performing my contract are increasing due to economic factors. Can I claim the additional costs as allowable in my QDC?

Published February 2024

A contractor whose costs to perform a QDC are rising should discuss this with the relevant contracting authority. The ability of a contractor to claim any costs as allowable costs to be included in the price of a QDC – whether the costs were expected at the time of agreement or arose unexpectedly – depends primarily on the pricing method used for the contract (or relevant contract component).

The pricing methods described in regulation 10 require that allowable costs used to determine the contract price are either:

• the allowable costs as estimated at the time of agreement (which, in some cases, may be adjusted in accordance with changes in specified indices or rates between the time of agreement and a specified time); or
• the actual allowable costs determined during the contract or after contract completion.

If the pricing method requires the allowable costs to be estimated at the time of agreement and this estimate did not include the ‘additional costs’, the additional costs can only be added to the contract price if:

• the parties agree the additional costs meet the requirement of allowable costs; and
• the parties agree to amend the contract in a way that would allow the additional costs to be included in the contract price. This would be achieved through a price re-determination using one of the methods set out in regulation 14 and the Schedule to the Regulations.

Or

• The contract terms provide that the price is to be adjusted in accordance with specified rates and indices which serve to cover some or all of the costs (for example a variation of price clause linked to a relevant price index).

If the pricing method requires the allowable costs to be determined during the contract or after contract completion, the actual ‘additional costs’ may be claimed if the parties are satisfied that the costs meet the requirements of allowable costs.

Although it may be possible for the parties to agree a pricing amendment related to the additional costs, there may be no obligation on a contracting authority to make such an amendment. Where additional costs cannot be claimed as allowable and this results in the contractor making a loss, a final price adjustment may apply to mitigate those losses.

The SSRO provides guidance to help contracting parties to determine whether costs in QDCs are allowable. Part H of our Allowable Costs guidance deals with risk and uncertainty. We have also published guidance which aims to assist the MOD and contractors in agreeing how to reflect inflation in the pricing of qualifying contracts.

3.9 The costs of delivering my contract have increased and I am making less profit. Does a final price adjustment apply?

Published February 2024

A final price adjustment will not necessarily apply simply because a contractor is making less profit than expected due to increased costs. Regulation 16 describes the circumstances in which a final price adjustment may be made to the price of a qualifying contract (or component thereof) that uses the firm, fixed or volume-driven pricing method, and these include where either:

• the outturn profit rate exceeds the agreed contract profit rate; or
• the contractor’s outturn costs (its actual costs under the contract which meet the requirements of allowable costs) exceed the contract price.

Where a contractor’s costs have increased, a final price adjustment can only be made when the increase in costs which meet the requirements of allowable costs is such that the contract becomes loss making, i.e., no profit is being made at all.