What are Forward Pricing Rate Agreements?
Forward Pricing Rate Agreements (FPRAs) are contracts between contractors and contracting agencies that set forth a basis to estimate proposed indirect costs and determine the appropriate practical significant noncompliance materiality threshold for the incurred cost audits. Per FAR 42.1701(d), the contracting officer may enter into a forward pricing rate agreement with a contractor pursuant to FAR 15.407-3. Forward pricing rate agreement means a written agreement between the Government and a contractor establishing a predetermined, negotiated indirect cost rate(s) that –
- Will be used for pricing (pending Contracting Officer determination that a pass-through rate is necessary due to uncertainty of subcontractor/direct material/other indirect cost sources) of contract modifications that are not priced on the basis of adequate price competition.
- May be used to establish indirect cost billing rates for services performed in accordance with cost reimbursement contracts. Unless an amortization schedule is specifically requested and approved by the Contracting Officer , the forward pricing rate agreement will not address the issue of how unallowable costs will be treated for billing purposes if included in the agreed to billing rates.
- May be used as a basis for negotiations of subcontract indirect cost rates.
A forwarding pricing rate agreement (FPRA) contains estimates and projections of the contractor’s indirect cost rates. It’s intent is to expedite negotiations for contract modifications that are not priced on the basis of adequate price competition (such as contract changes and task order work). Additionally, the FPRA can be used to establish the indirect cost billing rates for services performed under certain cost type contracts and to establish indirect cost rates for subcontractors.
The Purpose of FPRAs for Government Contracts
The importance of FPRAs in government contracts cannot be overstated. These agreements provide cost predictability, which is one of their most significant benefits. Government contracts often span over a number of years and can involve complex pricing structures. Having a predetermined basis on which to establish the costs of goods and services promotes budgeting and, therefore, governmental efficiency.
FPRAs are beneficial to not only government entities but also contractors. They reduce risk for both parties and allow them to focus on the scope of performance rather than on the disposition of funds. Contractors don’t have to worry about whether all of their costs are reimbursable; if they are within their agreement, they are reimbursable regardless of the actual cost. This certainty also helps contractors budget for and determine competitive billing rates for future contracts.
Negotiating FPRAs with the Government
The negotiation of a Forward Pricing Rate Agreement ("FPRA") between a contractor and the government is not unlike a game of poker. Each party has its breathing pattern, tell, betting strategy, and assessment of probabilities. As the process continues, the game becomes complicated with the addition of different versions leading to new proposals, counterproposals, and rejections. We will attempt to outline some of the factors that come into play in negotiating an FPRA but must leave each contractor to consider its own personal circumstances with respect to the terms of the FPRA.
Typically a contractor will be asked by a contracting officer ("CO") to sign a proposed FPRA and provide it to the CO for review. This provides the contractor with an opportunity to negotiate a different rate or contract term. After receipt of the contractor’s proposed FPRA, the CO will review its adequacy and then send it to Washington for a more extensive review. If Washington believes that the FPRA is both adequate and suitable, it will request the contractor to sign the FPRA and return it to Washington. The FPRA will then be executed by the CO.
If a contractor is unhappy with the terms of an FPRA it should first call the CO and explain its reasons for being dissatisfied with its terms. If the CO and the contractor cannot reach agreement, the contractor will be expected to file a rejection and to submit its own FPRA proposal. Ultimately, if the contractor and the CO can still not reach an agreement, the matter will have to be raised at a contracting officer’s conference. If agreement cannot be achieved at that level the FPRA matter is submitted to the Director of the Cost Negotiation Section (CNS) at the U.S. Navy Office of Naval Research in Arlington, Virginia.
One of the requirements of effective FPRA negotiation planning is the collection of historical data to help justify your FPRA proposal. Additionally, you should prepare a workload estimate of your forward program to support the rates being proposed. In most instances, the FPRA will be forwarded to the Defense Contract Audit Agency ("DCAA") for verification purposes. The cost element as well as the basis of estimate could all be required and reviewed by DCAA.
Key Elements of a Strong FPRA
A well-crafted FPRA should include at minimum: (i) a reference to the underlying contract and any specific contract provisions which relate to the proposed FPRA and its administration, (ii) a description of each element used to determine the Forward Pricing Rates, (iii) an explanation of how the FPRA’s rates will be applied to billings submitted in accordance with the contract, (iv) a method for updating the FPRA’s rates, and (v) the effective period for the FPRA itself. Several of these "required" elements are often addressed on the first page of the FPRA. Careful consideration should be given to very specifically address the cost categories for which rates are being established, the period for which those rates will be established, and the procedure for requesting an update when actual costs increase or decrease from the indirect rate at the start of the contract. The final FPRA will vary in length depending upon the size and complexity of the contract but, at a minimum should only address labor rates, overhead rates and G&A rates. As previously discussed, the purpose of a cost-reimbursement contract is to reimburse the contractor for the costs actually incurred in performing the contract work. In order to establish the overall agreed-to rates in a FPRA, the contracting officer typically performs an analysis of the contractor’s books and records; a review which can take several weeks or even months, especially where the audited rates are not consistent with the claimed rates. The contracting officer’s tentative rate generally represents the maximum rate to be paid by the Government under the contract, unless otherwise provided by FAR. A FPRA is typically drafted by the contractor, and if executed and properly performed, establishes the cost elements (direct and indirect) of a contract as a matter of law.
Common Issues and Mistakes in FPRAs
While force growth rates can be an incredibly useful pricing tool, there are a number of challenges that may arise when working with FPRAs. First, it is important to calibrate on what it means to "have an FPR" for your particular contract. Just because you do not technically have to negotiate and obtain a forward pricing rate agreement does not mean that you still should not. Because unlike actual FPR rates from government contractors, the CPAF rates in a basic contract clause will likely not be "locked in" for the duration of the contract. As discussed above, for CPAF contracts, the Government’s financial risk rises and falls based on whether their share of cost exceeds their share of profit. So, as the Government’s profits on the contract increase, so too will their share of cost. Conversely, if the contractor performs well and saves the Government money on any given task order , the contractor’s share of profit will also rise.
These shifting risk allocation dynamics can result in sometimes significant price increases on new task orders or funding modifications on a previously awarded task order as the rate of profit is always initially set above the FPR rate. Under a CPAF contract, if the FPR rate is not locked in, the Government may require a new and higher price for the same work – creating a common pitfall for both the Government and the contractor. Further, the Government will presumably want to share more risk on future task orders.
Additionally, if a contractor has not had an audited rate established for a given year, they will either need to provide their prior actual costs to the Government before being able to receive a task order against that FPR, or alternatively, those task order costs may need to be "locked in" at the higher CPAF rates until such time as the new FPR can be negotiated. Similarly, for contractors just entering the space, they may not yet be accustomed to the true nature of "actual costs" and how they are required to track them for purposes of FPRs.
The Advantages of Using the Right FPRAs
The benefits of properly implemented FPRAs apply to both parties. First and foremost, these agreements improve cost control. For the government, the FPRAs provide a mechanism to ensure that its spending caps are met and respected. For contractors, it provides a structure to avoid any contract budget shortfalls. When adhered to, these agreements also enhance financial planning. This is particularly true for contractors, who have to plan and forecast every year without any unexpected federal budgetary cutbacks short of the August or September continuing resolution. Finally, properly implemented FPRAs enhances and strengthens partner relationships – when one agrees to the plan and specific numbers (and it gets reflected in the contract), that partner has to live by those figures and complete the work within that budget cap.
Examples of How FPRAs Impact Business
Before delving into a couple of case studies on the application of FPRAs, it is important to note that there are generally two different types of FPRAs. A forward pricing rate proposal is generated with costs that are known with better precision as compared to costs that are estimated under conditions of uncertainty. Uses of the former generally includes many contract negotiations such as those for long-term weapons systems development and production. The latter, which comes from an analysis of the overall cost structure of a contractor’s business operations, is often a prerequisite for use in the DCAA audit process. The DCAA and contractors must collaborate to establish rates that will comprise the FPRA.
Schedule 1 of the FAR 15.407-3-2 shows the negotiated indirect cost rate (NICR) submission and approval requirements. Schedule 3 of the FAR 15.407-3-2 shows the price negotiation memorandum (PNM) and transmittal of final agreement packages (FOGP) requirements. The PNM includes contractor and government agreement on the proposed NICR. It is prepared and delivered by the price analyst when it is predicted that the prospective contract will exceed the simplified acquisition threshold (SAT). The PNM documents that there are no agreement terms and $1 , 000,000 is the threshold for final review and approval.
Three case studies of the FPRA analysis include the following: John Smith & Company, JSC received defense contracts and subcontracts from the U.S. government to design new weapon systems, including planes and ships. The FPRA analysis allowed JSC to use cost estimates from 1,200 individual plans for its various products. This allowed JSC to keep costs down at $3,000 per square foot.
General Dynamics Corporation, GDC was awarded contracts from the U.S. government and other government agencies for weapons development. The FPRA analysis required GDC to provide indirect costs for the weapons industry and deploy multiple indirect cost rate pools. This provided GDC with a 2% reduction in its overhead costs, giving it a competitive edge over other weapons providers.
Lockheed Martin Corporation, LMC secured contracts for aerospace and defense projects. The FPRA analysis identified 25 indirect cost rate pools and 37 distinct government and commercial contracts. The resulting cost savings were 8% for LMC.