[Federal Register Volume 67, Number 81 (Friday, April 26, 2002)]
[Rules and Regulations]
[Pages 20688-20692]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-10096]



48 CFR Part 215

[DFARS Case 2000-D018]

Defense Federal Acquisition Regulation Supplement; Changes to 
Profit Policy

AGENCY: Department of Defense (DoD).

ACTION: Final rule.


SUMMARY: DoD has issued a final rule amending the Defense Federal 
Acquisition Regulation Supplement (DFARS) to make changes to profit 
policy. The changes reduce the emphasis on facilities investment, add 
general and administrative expense to the cost base used in determining 
profit objectives, increase emphasis on performance risk, and encourage 
contractor cost efficiency.

EFFECTIVE DATE: April 26, 2002.

OUSD(AT&L)DP(DAR), IMD 3C132, 3062 Defense Pentagon, Washington, DC 
20301-3062. Telephone (703) 602-0289; facsimile (703) 602-0350. Please 
cite DFARS Case 2000-D018.


A. Background

    This final rule amends the profit policy in DFARS Subpart 215.4. 
The rule--
     Reduces the value assigned to facilities capital employed 
for equipment by 50 percent, and eliminates facilities capital employed 
for buildings in establishing profit objectives on sole source, 
negotiated contracts;
     Offsets these changes by increasing the values for 
performance risk by 1 percentage point; and
     Adds a special factor for cost efficiency to encourage 
cost reduction efforts.
    DoD published a proposed rule at 65 FR 45574 on July 24, 2000. Due 
to the complexity of the issues raised in the comments received, DoD 
published a notice of public meeting at 65 FR 69895 on November 21, 
2000. The public meeting was held on December 12, 2000. After 
considering written comments received in response to the proposed rule, 
and verbal comments provided during the public meeting, DoD published a 
second proposed rule at 66 FR 48649 on September 21, 2001.
    DoD received comments from five respondents on the second proposed 
rule. The comments, grouped into eight major categories, are discussed 
    1. Use of the Cost Efficiency Factor. Several respondents expressed 
concern regarding the measurement and documentation of cost savings. 
One thought metrics should be developed to aid in assessing cost 
efficiency gains. Another thought consideration should be expanded 
beyond ``pending contracts'' and that its use should be mandatory. 
Another wanted an element in the cost efficiency factor that would 
recognize new facilities when they contributed to improved 
productivity. DoD Response: Partially concur. A sentence has been added 
to DFARS 215.404-71-5(b)(4) to suggest how metrics could be used to 
demonstrate cost reduction efforts. The policy requires the contractor 
to demonstrate cost reduction efforts that benefit the pending 
contract. While we believe in a longer-term focus, we believe that the 
longer-term payoff will be on those contract actions that actually 
benefit from the contractor's efforts at cost reduction. Since cost 
efficiency is being added as a special factor, it already must be 
considered; however, we do not concur with mandating its use. We have 
also added a new 215.404-41-5(b)(8) to recognize new facilities when 
such investments contribute to improved productivity.
    2. Reduction of Facilities Capital Employed as a Factor in 
Calculating Profit Objectives. One respondent wanted facilities capital 
completely restored while another wanted only the equipment portion 
restored. A number of respondents believed it was a good idea to 
eliminate facilities capital, while others thought there might be 
circumstances where it would be desirable to reward facilities 
investment. DoD Response: Partially concur. The equipment portion has 
been restored by 50 percent from the policy shown in the first proposed 
rule. DoD remains concerned about overcapacity

[[Page 20689]]

within the defense industry and continues to believe some reduction in 
emphasis on facilities capital employed is warranted. However, we added 
a new 215.404-71-5(b)(8) so that contracting officers could recognize 
new facilities as part of the cost efficiency factor in appropriate 
    3. Adding general and administrative (G&A) expense to the Cost base 
used to develop profit objectives. Some respondents thought putting G&A 
expense back into the cost base was a good idea, while others thought 
it would incentivize contractors to increase their G&A costs. DoD 
Response: Most other agencies include G&A in computing profit 
objectives, and this was the DoD policy until 1986. We believe that 
adding G&A into the cost base results in consistent treatment of all 
allowable costs when computing profit objectives, and that G&A expenses 
should not be subject to less favorable treatment than other types of 
contract costs.
    4. Revenue neutrality. Some respondents believed that the changes 
to the profit policy would increase negotiated profits; one thought 
profits would stay the same; and one thought profits would decrease 
under the proposed policy. DoD Response: DoD's goal was to have the 
policy changes be revenue neutral, excluding the cost efficiency 
factor. We believe the final policy achieves that objective.
    5. Performance risk. One respondent did not agree with the added 
emphasis on performance risk, whereas another respondent stated that 
the high end of the range should be increased to allow the contracting 
officer to provide the statutory limits where the risk merits the 
highest fee. DoD Response: Do not concur. The increase to performance 
risk was to offset the impact of reducing facilities capital employed, 
thereby maintaining revenue neutrality. Any further increase or 
decrease would affect the goal of revenue neutrality. Statutory limits 
of profit apply only to cost-plus-fixed-fee contracts.
    6. Contract type risk. One respondent recommended increasing the 
weights for fixed-price contracts. DoD Response: Do not concur. This 
policy makes no change to contract type risk.
    7. Eliminate structured approach. One respondent recommended 
eliminating the structured approach to profit, determining profit based 
on sound business judgment, and establishing a website with guidance on 
current profit incentivizing techniques used by Government and 
industry. DoD Response: Do not concur. The FAR requires a structured 
approach for establishing profit objectives. The ``Guide to Incentive 
Strategies for Defense Acquisitions'' is available at www.acq.osd.mil/ar/resources.htm.
    8. Other Comments
    a. One respondent indicated that DoD should expressly allow and 
encourage the use of a technology incentive factor for superior life 
cycle support through COTS insertion. DoD Response: Technology 
incentive is not being considered as a part of this case.
    b. One respondent recommended modifying DFARS 215.404-71-3(d)(2) so 
that it is inoperative when contractors furnish funds prior to contract 
award in order to protect schedule, permit efficient material ordering, 
and provide continuity of workflow. Additional profit for management/
cost control should be allowed. DoD Response: Current policy is 
appropriate, which requires the contracting officer to assess the 
extent to which costs have been incurred prior to contract 
definitization, reimburse the contractor for actual costs incurred, and 
reduce contract risk accordingly.
    c. One respondent stated that adjusting a factor or two by a point 
or half a point is not going to provide adequate incentive to change 
contractor operations. DoD Response: Concur. That is why a 4 percent 
factor for cost efficiency was added.
    d. One respondent recommended eliminating cost of money since the 
money at stake is often minimal. DoD Response: Do not concur.
    e. One respondent recommended that the profit percentage should be 
lowered if performance-based payments are used. DoD Response: Concur. 
The DFARS weighted guidelines method already has different weights for 
this type of financing than for the progress payments type of 
financing. In addition, contracts with performance-based payments do 
not receive any working capital adjustment factor.
    This rule was not subject to Office of Management and Budget review 
under Executive Order 12866, dated September 30, 1993.

B. Regulatory Flexibility Act

    DoD certifies that this final rule will not 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.

C. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the rule does 
not impose any information collection 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, 48 CFR Part 215 is amended as follows:
    1. The authority citation for 48 CFR Part 215 continues to read as 

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


    2. Sections 215.404-71-1 and 215.404-71-2 are revised to read as 

215.404-71-1  General.

    (a) The weighted guidelines method focuses on four profit factors--
    (1) Performance risk;
    (2) Contract type risk;
    (3) Facilities capital employed; 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 shall 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) Management/cost control--the degree of management effort 

[[Page 20690]]

    (i) To ensure that contract requirements are met; and
    (ii) To reduce and control costs.
    (b) Determination. The following extract from the DD Form 1547 is 
annotated to describe the process.

                                 Contractor risk     Assigned        Assigned       Base  (item       Profit
             Item                    factors         weighting         value            20)          objective
21............................  Technical.......             (1)             (2)             N/A             N/A
22............................  Management/Cost              (1)             (2)             N/A             N/A
23............................  Reserved.
24............................  Performance Risk             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:

                                     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.

                                         value       Designated  range
Standard............................            5  3% to 7%
Technology Incentive................            9  7% to 11%

    (1) Standard. The standard designated range should apply to most 
    (2) Technology incentive. For the technical factor only, 
contracting officers may use the technology incentive range for 
acquisitions that include development, production, or application of 
innovative new technologies. The technology incentive range does not 
apply to efforts restricted to studies, analyses, or demonstrations 
that have a technical report as their primary deliverable.
    (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 
    (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 
    (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 
    (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

[[Page 20691]]

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.
    (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 degree of cost mix as an indication of the types of 
resources applied and 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 
    (A) The contractor's value added is both considerable and 
reasonably difficult;
    (B) The effort involves a high degree of integration or 
    (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 
    (F) The contractor makes appropriate make-or-buy decisions; or
    (G) The contractor has a proven record of cost tracking and 
    (ii) The contracting officer may justify a maximum value when the 
    (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 
    (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 

    3. 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)''; and
    b. By revising paragraph (b)(2) and the introductory text of 
paragraph (e)(2) 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.
* * * * *
    (e) * * *
    (2) Total costs equal Block 20 (i.e., all allowable costs excluding 
facilities capital cost of money), reduced as appropriate when--
* * * * *

    4. Section 215.404-71-4 is amended as follows:
    a. In paragraph (a), in the first sentence, by removing the word 
    b. In paragraph (b)(2)(ii), in the first and last sentences, by 
removing ``Block 18'' and adding in its place ``Block 20'; and
    c. By revising paragraphs (c) and (d) to read as follows:

215.404-71-4  Facilities capital employed.

* * * * *
    (c) Values: Normal and designated ranges. These are the normal 
values and ranges. They apply to all situations.

             Asset type                  value       Designated  range
Land................................            0  N/A
Buildings...........................            0  N/A
Equipment...........................         17.5  10 to 25

    (d) Evaluation criteria.
    (1) In evaluating facilities capital employed, the contracting 
    (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 compared 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 for research and development 
    (ii) The contracting officer may assign a value significantly above 
normal when there are direct and measurable benefits in efficiency and 
significantly reduced acquisition 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 

[[Page 20692]]

    (A) Allocations of capital apply predominantly to commercial item 
    (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, and labor-
intensive capital equipment.

    5. 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 
Form 1547) to recognize these efforts.
    (b) To determine if using this factor is appropriate, the 
contracting officer shall 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 
    (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, outsourcing of 
functions such as information technology). Metrics developed by the 
contractor such as fully loaded labor hours (i.e., cost per labor hour, 
including all direct and indirect costs) or other productivity measures 
may provide the basis for assessing the effectiveness of the 
contractor's cost reduction initiatives over time;
    (5) The contractor's adoption of process improvements to reduce 
    (6) Subcontractor cost reduction efforts;
    (7) The contractor's effective incorporation of commercial items 
and processes; or
    (8) The contractor's investment in new facilities when such 
investments contribute to better asset utilization or improved 
    (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 
shall consider the impact that quantity differences, learning, changes 
in scope, and economic factors such as inflation and deflation will 
have on cost reduction.

215.404-72  [Amended]

    6. Section 215.404-72 is amended as follows:
    a. In paragraph (b)(1)(i), in the first sentence, by removing 
``Block 18'' and adding in its place ``Block 20'';
    b. By removing paragraph (b)(1)(ii); and
    c. By redesignating paragraph (b)(1)(iii) as paragraph (b)(1)(ii).

    7. Section 215.404-73 is amended by revising the first sentence of 
paragraph (b)(2)(i) to read as follows:

215.404-73  Alternate structured approaches.

* * * * *
    (b) * * *
    (2) * * *
    (i) The contracting officer shall reduce the overall prenegotiation 
profit objective by the amount of facilities capital cost of money. * * 
* * * * *

    8. 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. 02-10096 Filed 4-25-02; 8:45 am]