Regulations spelling out how much defense contractors can make on non-competitive contracts with the Ministry of Defence are set for a radical shake-up with different types of work attracting different profit levels instead of the current one-size-fits-all approach, the chief executive of the new Single Source Regulations Office (SSRO) will say Sept 15.
“We will propose that there should be different baseline profit rates for different types of work. The current approach provides a single baseline profit rate for every type of defense work. However, defense contracts are increasingly varied in nature, complexity and risk,” SSRO CEO Marcine Waterman will tell a conference at the DSEI defense show.
Setting profit rates depending on the type of work is one of a number of proposals the SSRO will be putting out for an eight-week public consultation period starting Sept 25.
Waterman is also expected to outline how the SSRO intends to update the basket of companies used to arrive at an annual baseline profit rate for the defense industry.
Under the old Yellow Book regime a review panel recommended a profit margin based on the average profit made by a basket of UK companies weighted by their market capitalization. A number of sectors, like finance, natural resources and foreign companies, were excluded.
That’s set to change. Waterman is expected to tell the conference that while the SSRO’s intention is to retain a system that uses a basket of different companies to arrive at a profit rate, the make-up of the industries it uses will change.
“We intend to make sure those companies operate in comparable sectors. We will also look internationally, not just at companies headquartered in the UK, as at present,” she will say.
The SSRO was set up by the government last year to set new rules and regulate a scheme for contractors looking to secure a slice of Britain’s single source defense business. Around £5.4 billion (US $8.3 billion) of non-competitive contracts were placed by the MoD last year.
MoD spending on existing and new single source contracts last year totaled £8.3 billion, over 40 percent of the total procurement and support budget.
That figure is set to rise steeply if the Successor program replacing Britain’s nuclear missile submarine fleet is approved by Parliament next year. The Type 26 frigate program is expected to get a production go-ahead in 2016. Both programs are led by Britain’s biggest defense contractor, BAE Systems.
Waterman will tell business leaders and others at DSEI that the new regime lowers the “risk of moving the goalposts in contracts and delivers greater certainty to suppliers, including clarity of what costs the MoD will meet,” she will say.
The CEO will say the SSRO wants to “foster a regime that enables the British defense industry to prosper and remain competitive in national and international markets."
The SSRO, which is independent of the MoD, replaces what was known as the Yellow Book, a set of contractor rules largely unchanged since the scheme was set up at the end of the 1960s. Scrapping the outdated Yellow Book regulations is part of a series of procurement reforms implemented by the previous government to get better value for money out of the defense budget.
Eventually, all single source contracts over £5 million will be subject to the new rules. That excludes US Foreign Military Sales and government-to-government deals where the SSRO rules have no jurisdiction — a ruling that irks some executives here.
The SSRO rules are expected to be in place for the start of the next financial year.
The proposals come just months after the SSRO shook up the regulations governing the costs industry is allowed to charge the MoD.
Taken together, the changes could have a substantial impact on contractor profits earned from non-competitive contracts in the UK, SSRO Chairman Jeremy Newman says in an interview with Defense News.
Newman reckons that the shake-up in allowable costs for industry has the potential to be a bigger issue than the profit margin.
“Profit is a smaller element of the total contract value than the allowable costs but it's also more visible. Some of our guidance on cost may have a substantial impact but it’s likely to be hidden because people won’t necessarily know what would have been charged in different circumstances," he told Defense News.
“There is, though, a potential profit impact in our allowable cost guidance. We are preventing contractors passing items up through the food chain and adding a profit margin each time. Now we are saying you can only take a profit on that once. The cost guidance in the long run will have the biggest impact, it is potentially quite far reaching,” said Newman.
Few dispute that the rules governing single source contracts were in need of an overhaul. Defence Procurement Minister Philip Dunne told members of Parliament during committee hearings into the Defence Reform Bill in 2013, which resulted in the creation of the SSRO, that some contractors were making between £100 million and £200 million from inappropriate charges a year.
Dunne listed £24,000 for ceremonial mugs and £2,000 for a children’s party as among inappropriate costs being charged to the taxpayers. The government reckons the SSRO regulations could save it £200 million.
