[Federal Register Volume 65, Number 142 (Monday, July 24, 2000)]
[Proposed Rules]
[Pages 45574-45579]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18510]


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DEPARTMENT OF DEFENSE

48 CFR Part 215

[DFARS Case 2000-D018]


Defense Federal Acquisition Regulation Supplement; Changes to 
Profit Policy

AGENCY: Department of Defense (DoD).

ACTION: Proposed rule with request for comments.

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SUMMARY: The Director of Defense Procurement is proposing to amend the 
Defense Federal Acquisition Regulation Supplement (DFARS) to make 
changes to DoD profit policy that would reduce and eventually eliminate 
emphasis on facilities investment, increase emphasis on performance 
risk, and encourage contractor cost efficiency.

DATES: Comments on the proposed rule should be submitted in writing to 
the address shown below on or before September 22, 2000, to be 
considered in the formation of the final rule.

ADDRESSES: Interested parties should submit written comments on the 
proposed rule to: Defense Acquisition Regulations Council, Attn: Ms. 
Amy Williams, OUSD (AT&L) DP (DAR), IMD 3D139, 3062 Defense Pentagon, 
Washington, DC 20301-3062. Telefax (703) 602-0350.
    E-mail comments submitted via the Internet should be addressed to: 
[email protected]
    Please cite DFARS Case 2000-D018 in all correspondence related to 
this proposed rule. E-mail correspondense should cite DFARS Case 2000-
D018 in the subject line.

FOR FURTHER INFORMATION CONTACT: Ms. Amy Williams, (703) 602-0288.

SUPPLEMENTARY INFORMATION:

A. Background

    This rule proposes amendments to the profit policy in DFARS Subpart 
215.4. The existing structure of DoD profit policy was established as a 
result of the report published in 1985 on the Defense Financial and 
Investment Review (DFAIR). Since 1985, the defense industry has 
downsized and consolidated due to substantial reductions in the defense 
budget. While a key DFAIR objective was to encourage defense 
contractors to invest in productivity-enhancing facilities, the defense 
industry now has excess capacity and under-utilized facilities. In this 
environment, rewarding contractors for investing is counter-productive 
and acts as a disincentive to the further rationalization of the 
defense industry.
    The primary purpose of this rule is to reduce and, over time, 
eliminate facilities invesment as a factor in establishing profit 
objectives on sole-source, negotiated contracts. The changes in the 
rule include--
     Adding general and administrative expense to the cost base 
used to establish profit objectives.
     Reducing the values assigned to facilties capital 
investment by 50 percent.
     Offsetting these changes by increasing the values for 
performance risk by 1 percentage point and decreasing the values for 
contract type risk by 0.5 percentage point.

[[Page 45575]]

     Adding a special factor for cost efficiency to encourage 
cost reduction efforts.
    Two years after the date this rule becomes effective, DoD will 
eliminate buildings as a factor used to establish profit objectves and 
will reduce the value of equipment by 50 percnet. This will be offset 
by an increase to performance risk values of 1 percentage point.
    Four years after the date this rule becomes effective, DoD will 
eliminate facilities capital employed as a factor used to establish 
profit objectives and will offset this elimination with another 1 
percentage point increase to performance risk values.
    Excluding the addition of the special cost efficiency factor, these 
changes have been developed with the objective of reorienting profit 
incentives from facilities investment to contract performance risk 
factors without causing a significant impact to overall profit levels 
on DoD contracts. However, contracting officers will be able to use the 
special cost efficiency factor to reward companies that undertake 
meaningful efforts to reduce contract costs with additional profit not 
available under the current profit guidelines.
    In addition to these changes, the rule proposes a number of other 
clarifying and editorial amendments and includes changes proposed under 
DFARS Case 2000-D300, Profit Incentives to Produce Innovative New 
Technologies, published at 65 FR 32066 on May 22, 2000.
    This rule was not subject to Office of Management and Budget review 
under Executive order 12866, dated September 30, 1993.

B. Regulatory Flexibility Act

    The proposed rule is not expected to have a significant economic 
impact on a substantial number of small entities within the meaning of 
the Regulatory Flexibility Act, 5 U.S.C. 601, et seq., because most 
contracts awarded to small entities are below $500,000, are based on 
adequate price competition, or are for commercial items, and do not 
require submission of cost or pricing data. Therefore, an initial 
regulatory flexibility analysis has not been performed. Comments are 
invited from small businesses and other interested parties. Comments 
from small entities concerning the affected DFARS subpart also will be 
considered in accordance with 5 U.S.C. 610. Such comments should be 
submitted separately and should cite DFARS Case 2000-D018.

C. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the rule does 
not impose any information colelction requirements that require the 
approval of the Office of Management and Budget under 44 U.S.C. 3501, 
et seq.

List of Subjects in 48 CFR Part 215

    Government procurement.

Michele P. Peterson,
Executive Editor, Defense Acquisition Regulations Council.
    Therefore, DoD proposes to amend 48 CFR Part 215 as follows:
    1. The authority citation for 48 CFR Part 215 continues to read as 
follows:

    Authority: 41 U.S.C. 421 and 48 CFR Chapter 1.

PART 215--CONTRACTING BY NEGOTIATION


215.404-4  [Amended]

    2. Section 215.404-4 is amended by removing paragraph 
(c)(2)(C)(1)(i) and redesignating paragraphs (c)(2)(C)(1)(ii) through 
(iv) as paragraphs (c)(2)(C)(1)(i) through (iii), respectively.
    3. Sections 215.404-71-1 and 215.404-71-2 are revised to read as 
follows:


215.404-71-1  General.

    (a) The weighted guidelines method focuses on the following profit 
factors:
    (1) Performance risk;
    (2) Contract type risk;
    (3) Facilities capital employed (through September 30, 2004); and
    (4) Cost efficiency.
    (b) The contracting officer assigns values to each profit factor; 
the value multiplied by the base results in the profit objective for 
that factor. Except for the cost efficiency special factor, each profit 
factor has a normal value and a designated range of values. The normal 
value is representative of average conditions on the prospective 
contract when compared to all goods and services acquired by DoD. The 
designated range provides values based on above normal or below normal 
conditions. In the price negotiation documentation, the contracting 
officer need not explain assignment of the normal value, but should 
address conditions that justify assignment of other than the normal 
value. The cost efficiency special factor has no normal value. The 
contracting officer must exercise sound business judgment in selecting 
a value when this special factor is used (see 215.404-71-5).


215.404-71-2  Performance risk.

    (a) Description. This profit factor addresses the contractor's 
degree of risk in fulfilling the contract requirements. The factor 
consists of two parts:
    (1) Technical--the technical uncertainties of performance.
    (2) Mangement/cost control--the degree of management effort 
necessary to--
    (i) Ensure that contract requirements are met; and
    (ii) Reduce and control costs.
    (b) Determination. The following extract from the DD Form 1547 is 
annotated to describe the process.

----------------------------------------------------------------------------------------------------------------
                                                            Assigned      Assigned     Base (item      Profit
            Item and contractor risk factors                weighting       value          20)        objective
----------------------------------------------------------------------------------------------------------------
21. Technical...........................................          (1)           (2)           N/A           N/A
22. Management/Cost Control.............................          (1)           (2)           N/A           N/A
23. Reserved............................................
24. Performance Risk (Composite)........................          N/A           (3)           (4)           (5)
----------------------------------------------------------------------------------------------------------------

    (1) Assign a weight (percentage) to each element according to its 
input to the total performance risk. The total of the two weights 
equals 100 percent.
    (2) Select a value for each element from the list in paragraph (c) 
of this subsection using the evaluation criteria in paragraphs (d) and 
(e) of this subsection.
    (3) Compute the composite as shown in the following example:

[[Page 45576]]



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                                                                          Assigned      Assigned      Weighted
                                                                          weighting       value         value
                                                                          (percent)     (percent)     (percent)
----------------------------------------------------------------------------------------------------------------
Technical.............................................................        60              5.0           3.0
Management/Cost Control...............................................        40              4.0           1.6
Composite Value.......................................................       100      ............          4.6
----------------------------------------------------------------------------------------------------------------

    (4) Insert the amount from Block 20 of the DD Form 1547. Block 20 
is total contract costs, excluding facilities capital cost of money.
    (5) Multiply (3) by (4).
    (c) Values: Normal and designated ranges.

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                                                           Normal value
                                                            (percent)           Designated range (percent)
----------------------------------------------------------------------------------------------------------------
Through September 30, 2002:
    Standard...........................................         5         3 to 7.
    Alternate..........................................         6         4 to 8.
    Technology Incentive...............................         9         7 to 11.
October 1, 2002--September 30, 2004:
    Standard...........................................         6         4 to 8.
    Technology Incentive...............................        10         8 to 12.
After September 30, 2004:
    Standard...........................................         7         5 to 9.
    Technology Incentive...............................        11         9 to 13.
----------------------------------------------------------------------------------------------------------------

    (1) Standard. The standard designated range should apply to most 
contracts.
    (2) Alternate. Through September 30, 2002, contracting officers may 
use the alternate designated range for research and development and 
service contractors when these contractors require relatively low 
capital investment in buildings and equipment when compared to the 
defense industry overall. If the alternate designated range is used, do 
not give any profit for facilities capital employed (see 215.404-71-
4(c)(3)).
    (3) Technology incentive. For the technical factor only, 
contracting officers may use the technology incentive range for 
acquisitions that include development or production of innovative new 
technologies.
    (d) Evaluation criteria for technical.
    (1) Review the contract requirements and focus on the critical 
performance elements in the statement of work or specifications. 
Factors to consider include--
    (i) Technology being applied or developed by the contractor;
    (ii) Technical complexity;
    (iii) Program maturity;
    (iv) Performance specifications and tolerances;
    (v) Delivery schedule; and
    (vi) Extent of a warranty or guarantee.
    (2) Above normal conditions.
    (i) The contracting officer may assign a higher than normal value 
in those cases where there is a substantial technical risk. Indicators 
are--
    (A) Items are being manufactured using specifications with 
stringent tolerance limits;
    (B) The efforts require highly skilled personnel or require the use 
of state-of-the-art machinery;
    (C) The services and analytical efforts are extremely important to 
the Government and must be performed to exacting standards;
    (D) The contractor's independent development and investment has 
reduced the Government's risk or cost;
    (E) The contractor has accepted an accelerated delivery schedule to 
meet DoD requirements; or
    (F) The contractor has assumed additional risk through warranty 
provisions.
    (ii) Extremely complex, vital efforts to overcome difficult 
technical obstacles that require personnel with exceptional abilities, 
experience, and professional credentials may justify a value 
significantly above normal.
    (iii) The following may justify a maximum value:
    (A) Development or initial production of a new item, particularly 
if performance or quality specifications are tight; or
    (B) A high degree of development or production concurrency.
    (3) Below normal conditions.
    (i) The contracting officer may assign a lower than normal value in 
those cases where the technical risk is low.
    Indicators are--
    (A) Requirements are relatively simple;
    (B) Technology is not complex;
    (C) Efforts do not require highly skilled personnel;
    (D) Efforts are routine;
    (E) Programs are mature; or
    (F) Acquisition is a follow-on effort or a repetitive type 
acquisition.
    (ii) The contracting officer may assign a value significantly below 
normal for--
    (A) Routine services;
    (B) Production of simple items;
    (C) Rote entry or routine integration of Government-furnished 
information; or
    (D) Simple operations with Government-furnished property.
    (4) Technology incentive range.
    (i) The contracting officer may assign values within the technology 
incentive range when contract performance includes the introduction of 
new, significant technological innovation. Use the technology incentive 
range only for the most innovative contract efforts. Innovation may be 
in the form of--
    (A) Development or application of new technology that fundamentally 
changes the characteristics of an existing product or system and that 
results in increased technical performance, improved reliability, or 
reduced costs; or
    (B) New products or systems that contain significant technological 
advances over the products or systems they are replacing.
    (ii) When selecting a value within the technology incentive range, 
the contracting officer should consider the relative value of the 
proposed innovation to the acquisition as a whole. When the innovation 
represents a minor benefit, the contracting officer should consider 
using values less than the norm. For innovative efforts that will have 
a major positive impact on the product or program, the contracting 
officer may use values above the norm.
    (e) Evaluation criteria for management/cost control.

[[Page 45577]]

    (1) The contracting officer should evaluate--
    (i) The contractor's management and internal control systems using 
contracting office information and reviews made by field contract 
administration offices or other DoD field offices;
    (ii) The management involvement expected on the prospective 
contract action;
    (iii) The value added by the contractor;
    (iv) The contractor's support of Federal socioeconomic programs;
    (v) The expected reliability of the contractor's cost estimates 
(including the contractor's cost estimating system);
    (vi) The adequacy of the contractor's management approach to 
controlling cost and schedule; and
    (vii) Any other factors that affect the contractor's ability to 
meet the cost targets (e.g., foreign currency exchange rates and 
inflation rates).
    (2) Above normal conditions.
    (i) The contracting officer may assign a higher than normal value 
when there is a high degree of management effort. Indicators of this 
are--
    (A) The contractor's value added is both considerable and 
reasonably difficult;
    (B) The effort involves a high degree of integration or 
coordination;
    (C) The contractor has a good record of past performance;
    (D) The contractor has a substantial record of active participation 
in Federal socioeconomic programs;
    (E) The contractor provides fully documented and reliable cost 
estimates;
    (F) The contractor makes appropriate make-or-buy decisions; or
    (G) The contractor has a proven record of cost tracking and 
control.
    (ii) The contracting officer may justify a maximum value when the 
effort--
    (A) Requires large scale integration of the most complex nature;
    (B) Involves major international activities with significant 
management coordination (e.g., offsets with foreign vendors); or
    (C) Has critically important milestones.
    (3) Below normal conditions.
    (i) The contracting officer may assign a lower than normal value 
when the management effort is minimal. Indicators of this are--
    (A) The program is mature and many end item deliveries have been 
made;
    (B) The contractor adds minimal value to an item;
    (C) The efforts are routine and require minimal supervision;
    (D) The contractor provides poor quality, untimely proposals;
    (E) The contractor fails to provide an adequate analysis of 
subcontractor costs;
    (F) The contractor does not cooperate in the evaluation and 
negotiation of the proposal;
    (G) The contractor's cost estimating system is marginal;
    (H) The contractor has made minimal effort to initiate cost 
reduction programs;
    (I) The contractor's cost proposal is inadequate;
    (J) The contractor has a record of cost overruns or another 
indication of unreliable cost estimates and lack of cost control; or
    (K) The contractor has a poor record of past performance.
    (ii) The following may justify a value significantly below normal:
    (A) Reviews performed by the field contract administration offices 
disclose unsatisfactory management and internal control systems (e.g., 
quality assurance, property control, safety, security); or
    (B) The effort requires an unusually low degree of management 
involvement.
    4. Section 215.404-71-3 is amended as follows:
    a. In paragraph (b), in the table, by removing the heading ``Base 
(Item 18)'' and adding in its place ``Base (Item 20)'';
    b. By revising paragraph (b)(2);
    c. In paragraph (c) by revising the table; and
    d. By revising paragraph (e)(2) introductory text to read as 
follows:


215.404-71-3   Contract type risk and working capital adjustment.

* * * * *
    (b) * * *
    (2) Insert the amount from Block 20, i.e., the total allowable 
costs excluding facilities capital cost of money.
* * * * *
    (c) * * *

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                                                            Normal value
               Contract type                     Notes       (percent)          Designated range  (percent)
----------------------------------------------------------------------------------------------------------------
Firm-fixed-price, no financing.............          (1)         4.5      3.5 to 5.5.
      Firm-fixed-price, with performance-            (6)         3.5      2 to 5.
       based payments.
Firm-fixed-price, with progress payments...          (2)         2.5      1.5 to 3.5.
Fixed-price incentive, no financing........          (1)         2.5      1.5 to 3.5.
Fixed-price incentive, with performance-             (6)         1.5      0 to 3.
 based payments.
Fixed-price with redetermination provision.          (3)
Fixed-price incentive, with progress                 (2)          .5      0 to 1.5.
 payments.
Cost-plus-incentive-fee....................          (4)          .5      0 to 1.5.
Cost-plus-fixed-fee........................          (4)         0        0 to .5.
Time-and-materials (including overhaul               (5)         0        0 to .5.
 contracts priced on time-and-materials
 basis).
Labor-hour.................................          (5)         0        0 to .5.
Firm-fixed-price, level-of-effort..........          (5)         0        0 to .5.
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* * * * *
     (e) *  *  *
    (2) Total costs equal Block 20 (i.e., all allowable costs excluding 
facilities capital cost of money), reduced as appropriate when--
* * * * *
    5. Section 215.404-71-4 is amended as follows:
    a. In paragraph (b)(2)(ii), in the first and last sentences, by 
removing ``Block 18'' and adding in its place ``Block 20''; and
    b. By revising paragraphs (c) and (d) to read as follows:


215.404-71-4  Facilities capital employed.

* * * * *
    (c) Values: Normal and designated ranges.

------------------------------------------------------------------------
                                  Normal value      Designated range
  Notes         Asset type         (percent)            (percent)
------------------------------------------------------------------------
    (1)   Land.................        0        N/A.
    (1)   Buildings............        5        0 to 10.

[[Page 45578]]

 
    (1)   Equipment............       20        15 to 25.
    (2)   Land.................        0        N/A.
    (2)   Buildings............        0        N/A.
    (2)   Equipment............       10        7.5 to 12.5.
    (3)   Land.................        0        N/A.
    (3)   Buildings............        0        0.
    (3)   Equipment............        0        0.
------------------------------------------------------------------------

    (1) These are the normal values and ranges through September 30, 
2002. They apply to all situations except as noted in paragraph 
(c)(3)(i) of this subsection.
    (2) These are the normal values and ranges from October 1, 2002, 
through September 30, 2004.
    (3) Do not allow profit on facilities capital employed--
    (i) Through September 30, 2002, when using a value from the 
alternate designated range for the performance risk factor (see 
215.404-71-2(c)(2)); or
    (ii) After September 30, 2004.
    (d) Evaluation criteria.
    (1) In evaluating facilities capital employed, the contracting 
officer--
    (i) Should relate the usefulness of the facilities capital to the 
goods or services being acquired under the prospective contract;
    (ii) Should analyze the productivity improvements and other 
anticipated industrial base enhancing benefits resulting from the 
facilities capital investment, including--
    (A) the economic value of the facilities capital, such as physical 
age, undepreciated value, idleness, and expected contribution to future 
defense needs; and
    (B) The contractor's level of investment in defense related 
facilities as compare with the portion of the contractor's total 
business that is derived from DoD; and
    (iii) Should consider any contractual provisions that reduce the 
contractor's risk of investment recovery, such as termination 
protection clauses and capital investment indemnification.
    (2) Above normal conditions.
    (i) The contracting officer may assign a higher than normal value 
if the facilities capital investment has direct, identifiable, and 
exceptional benefits. Indicators are--
    (A) New investments in state-of-the-art technology that reduce 
acquisition cost or yield other tangible benefits such as improved 
product quality or accelerated deliveries; or
    (B) Investments in new equipment or research and development 
applications.
    (ii) The contracting officer may assign a value significantly above 
normal when there are direct and measurable benefits in efficiency and 
significantly reduced acquisitions costs on the effort being priced. 
Maximum values apply only to those cases where the benefits of the 
facilities capital investment are substantially above normal.
    (3) Below normal conditions.
    (i) The contracting officer may assign a lower than normal value if 
the facilities capital investment has little benefit to DoD. Indicators 
are--
    (A) Allocations of capital apply predominantly to commercial item 
lines:
    (B) Investments are for such things as furniture and fixtures, home 
or group level administrative offices, corporate aircraft and hangars, 
gymnasiums; or
    (C) Facilities are old or extensively idle.
    (ii) The contracting officer may assign a value significantly below 
normal when a significant portion of defense manufacturing is done in 
an environment characterized by outdated, inefficient, excessive, and 
labor-intensive capital equipment.
    6. Section 215.404-71-5 is added to read as follows:


215.404-71-5  Cost efficiency factor.

    (a) This special factor provides an incentive for contractors to 
reduce costs. To the extent that the contractor can demonstrate cost 
reduction efforts that benefit the pending contract, the contracting 
officer may increase the prenegotiation profit objective by an amount 
not to exceed 4 percent of total objective cost (Block 20 of the DD 
1547) to recognize these efforts.
    (b) To determine if using this factor is appropriate, the 
contracting officer must consider criteria, such as the following, to 
evaluate the benefit the contractor's cost reduction efforts will have 
on the pending contract:
    (1) The contractor's participation in Single Process Initiative 
improvements;
    (2) Actual cost reductions achieved on prior contracts;
    (3) Reduction or elimination of excess or idle facilities;
    (4) The contractor's cost reduction initiatives (e.g., competition 
advocacy programs, technical insertion programs, obsolete parts control 
programs, spare parts pricing reform, value engineering, the use of 
metrics to drive down key costs);
    (5) The contractor's adoption of process improvements to reduce 
costs;
    (6) Subcontractor cost reduction efforts; or
    (7) The contractor's effective incorporation of commercial items 
and processes.
    (c) When selecting the percentage to use for this special factor, 
the contracting officer has maximum flexibility in determining the best 
way to evaluate the benefit the contractor's cost reduction efforts 
will have on the pending contract. However, the contracting officer 
must consider the impact that quantity differences, learning, changes 
in scope, and economic factors such as inflation and deflation will 
have on cost reduction.
    7. Section 215.404-72 is amended as follows:
    a. In the first sentence of paragraph (b) (1) (i) and the first 
sentence of paragraph (b) (1) (ii) by removing ``Block 18'' and adding 
in its place ``Block 20''; and
    b. By adding paragraph (b) (1) (iii) to read as follows:


215.404-72  Modified weighted guidelines method for nonprofit 
organizations other than FFRDCs.

* * * * *
    (b) * * *
    (1) * * *
    (iii) Do not assign a value from the technology incentive 
designated range.
* * * * *
    8. Section 215.404-73 is amended by revising paragraphs (b) (1) and 
(b) (2) (i) to read as follows:


215.404-73  Alternate structured approaches.

* * * * *
    (b) * * *
    (1) Consideration of the basic components of profit--performance 
risk, contract type risk (including working capital), facilities 
capital employed (through September 30, 2004), and cost efficiency. 
However, the contracting officer is not required to complete Blocks 21 
through 30 of the DD Form 1547.

[[Page 45579]]

    (2) * * *
    (i) The contracting officer shall reduce the overall prenegotiation 
profit objective by the amount of facilities capital cost of money. The 
profit amount in the negotiation summary of the DD Form 1547 must be 
net of the offset.
* * * * *
    9. Section 215.404-74 is amended by revising paragraph (c) to read 
as follows:


215.404-74  Fee requirements for cost-plus-award-fee contracts.

* * * * *
    (c) Apply the offset policy in 215.404-73 (b) (2) for facilities 
capital cost of money, i.e., reduce the base fee by the amount of 
facilities capital cost of money; and
* * * * *
[FR Doc. 00-18510 Filed 7-21-00; 8:45 am]
BILLING CODE 5000-04-M