On October 1st, the Department of War (DOW) issued a memorandum, “Implementation of Supplier Cost and Pricing Transparency” (the Memo), establishing policies and procedures to “secure cost visibility across DOW’s acquisition portfolio, when necessary.” Although transparency is one of the Memo’s key objectives, the guidance may have the opposite effect for government contractors because it leaves individual contracting officers (COs) to determine when such visibility is “necessary.” The Memo intends to implement the DOW’s August 18th “Supplier Cost and Pricing Transparency” and September 14th “Fostering One Strong Industrial Base” memoranda, discussed in our most recent installment of the Warfighting at Warp Speed series. In this Client Alert, we summarize the Memo’s key provisions and identify practical considerations for defense contractors and suppliers.
Reinforcing DOW’s Cost Transparency and Profit Policy Priorities
The Memo, like the two that preceded it, highlights DOW’s purported need for cost information to (1) determine fair and reasonable pricing and (2) generate realistic cost estimates. The Memo contains the following key updates to its plans to implement measures to meet these two goals:
- Determining Fair and Reasonable Pricing
To help ensure fair and reasonable pricing, the Memo authorizes COs to request actual cost information at both prime and supplier levels, even when a contract is not subject to Cost Accounting Standards (CAS), if the CO determines that the information is necessary to establish a fair and reasonable price. Critically, COs remain subject to the limitations imposed by the Truth in Negotiations Act (TINA) at 10 U.S.C. § 3705, as implemented by Federal Acquisition Regulation (FAR) 15.402 and 15.403. Thus, the Memo does not alter the requirement that COs must first attempt to determine whether prices are fair and reasonable through other means, such as adequate price competition, market pricing, sales data, or data obtained from sources other than the contractor, before requesting certified cost or pricing data.
They key takeaway is that even though a CO may request certified data pursuant to this Memo, a contractor may not be legally required to provide it for an acquisition not subject to CAS absent a contractual or statutory requirement to do so.[i] When a contractor is not legally obligated to provide certified data, the Memo instructs COs to request data other than certified cost or pricing data—a practice COs already use.
When an acquisition is subject to TINA—that is, when certified cost or pricing data is statutorily required—the Memo directs a CO whose contractor refuses to provide the requested data to immediately coordinate with the Defense Contract Audit Agency to initiate a TINA Audit.
- Generating Realistic Cost Estimates
The Memo identifies Cost and Software Data Reporting (CSDR)—required only for Acquisition Category II and larger contracts valued at more than $50 million—as essential to DOW’s ability to generate realistic cost estimates and support contract negotiations. If a contractor fails to submit a required CSDR report, the Memo instructs COs to issue a formal demand letter immediately, requiring submission within 30 days. If the contractor still does not submit the CSDR report, COs must, at a minimum, apply withholds when permitted by the contract until the report is received.
Clarifying Cost and Pricing Data Format and Potential Automatic Access
The Memo offers an important point of clarification from the previous memoranda, providing that contractors should not be required to implement new accounting systems or establish special data formats to adhere to DOW’s policies. Rather, requested cost information should be limited to “data immediately available in the form in which the contractor regularly maintains it.” When needed, contractors subject to CAS may continue to provide actual cost data from a CAS compliant system. Contractors not subject to CAS should provide data maintained in accordance with Generally Accepted Accounting Principles (GAAP).
The Memo also addresses the use of Application Programming Interfaces (APIs) integrated with contractors’ Enterprise Resource Planning (ERP) systems to automate push-only access to actual cost data. Contractors who have been tracking these memos will be relieved to know the Memo clarifies that any such initiative would be introduced through formal rulemaking, and participation would be strictly voluntary. Those considering volunteering such access should engage legal counsel before making the decision, as permitting the Government automated access to your organization’s ERP comes with numerous risks that your contract, IT, finance, and legal teams should navigate and mitigate in tandem.
Explaining “Modernized” Profit Policies
Beyond cost and price transparency, the Memo focuses on the DOW’s “Modernized Profit Policy and Commercial Sector Alignment,” which it states is intended to promote fair and reasonable contract profit margins. It directs COs to tailor profit models using sector-specific commercial benchmarks to inform negotiation objectives, while clarifying that those benchmarks are not intended to operate as profit caps. According to the Memo, margins should reward efficiency, speed, and performance. The Memo states that the appropriate approach varies by sector:
- Hardware and Weapon Systems: Profit expectations should align with commercial manufacturing risk-to-reward ratios, including consideration of self-funded facilitization, non-recurring engineering investments, and execution risk.
- Software and IT Services: Margins should reflect commercial Software-as-a-Service margins and R&D investments, as well as company lifecycle and scale, rather than simply importing traditional hardware profit structures.
- Services and Sustainment: Margins should look to commercial logistics and third-party maintenance rates and performance-based metrics.
For sole-source or long-term production programs, the Memo encourages COs to use a “Tiered Profit-Sharing” mechanism. Under this approach, the parties negotiate a realistic base profit margin and then share profits generated by efficiencies realized over time. When this approach is used, prime contractors will be required to flow down similar terms to their key suppliers.
Like the use of APIs, DOW intends to pursue these new profit principles through formal rulemaking. Defense contractors will need to stay engaged in the rulemaking process to see how this profit “modernization” takes shape.
Key Takeaways
- Engage Counsel to Advise on Unexpected Certified Cost and Pricing Data Requests. The Memo does not eliminate statutory thresholds or exceptions governing certified cost or pricing data. Despite DOW’s goal to the contrary, this means that not every contractor will be required to provide such data. Contractors should consult legal counsel if a CO makes an unexpected request for certified cost and pricing data to determine whether they are obligated to comply.
- DOW’s Policy May Require Subcontract Updates. The Memo introduces new requirements affecting lower-tier suppliers. Prime contractors should review the requirements in their contracts and solicitations and ensure that their subcontracts include appropriate enforcement mechanisms and protections addressing these requirements.
- Cost Transparency May Bring Greater Profit Scrutiny. As was the case with the memoranda issued before it, the Memo’s profit “modernization” policy may subject contractors’ proposed profit margins—and profits realized during contract performance—to greater scrutiny.
- Keep an Eye on DOW’s Formal Rulemaking. Several potentially significant concepts in the Memo, including the revised profit policy and possible API integration, expressly contemplate formal rulemaking. Contractors should monitor those developments and consider participating in the industry comment process.
PilieroMazza will continue to monitor DOW’s implementation of these cost and pricing initiatives, including any future rulemaking. If you have questions about how these policies may affect a current or future contract or any questions on DOW procurements in general, please contact Cy Alba, Lauren Brier, Josie Farinelli, Krissy Crallé, or another member of PilieroMazza’s Government Contracts Group.[ii]
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[i] This is not intended as legal advice. A full review of every contract is required prior to determining a contractor’s obligations to the Government. Contractors should engage counsel to determine the requirements of their contract before declining to provide such information to the CO.
[ii] Special thanks to Domenic Allegra, a law clerk in PilieroMazza’s Government Contracts Group, for his assistance with this Client Alert.
