Weighted Guidelines Profit Analysis - any basis in reality??

Patrick Mathern said:

I'm looking for anyone that might have knowledge on how the WGL calculations came to be.  For example, WHY is the standard value for performance risk 5%?  Why not 4.72% or 6.39%?  I'm familiar with the regulatory history, but would like to know more about the origins of the calculations themselves.

Anybody have this knowledge or source material tucked away somewhere?

I doubt that anyone alive today could answer your question. But the files may still exist... somewhere.

I suppose you have this already, but in case not...A Google search found a paper with a  partial history and a bibliography reaching as far back as 1968.

https://apps.dtic.mil/sti/pdfs/ADA494735.pdf

Patrick:

I did a google search also.  This study dates the DoD WGL system back to 1964 and offers some interesting footnotes.  Pricing of contracts was a big issue in the early 1960s.  Check the table of contents.

Performed under contract with the Air Force by The Rand Corporation:  The Impact of the Weighted Guidelines Profit System on Defense Contract Fees.

The first official version of the Weighted Guides Method was published in the Federal Register on Nov. 23, 1963, Defense Procurement Circular (DPC) 5, 28 Fed. Reg. 12555 - 12561, which amended 32 CFR 3.808-2.

It's been pointed out to me before that the Weighted Guidelines don't incentivize early delivery. A contractor that can deliver a satisfactory product six months early is not entitled to receive any more profit than a contractor that promises to deliver on time.

So much for "speed of relevance"

here_2_help said:

It's been pointed out to me before that the Weighted Guidelines don't incentivize early delivery. A contractor that can deliver a satisfactory product six months early is not entitled to receive any more profit than a contractor that promises to deliver on time.

So much for "speed of relevance"

Good point - what are some other areas that the WGLs miss the mark, especially in the case where the government is trying to entice new commercial entities to take on CPFFs?

Patrick Mathern said:

what are some other areas that the WGLs miss the mark

I don't think there is a mark to miss. The WGL are just a "structured" analytical device. They are "guidelines." They are only as useful as the user is thoughtful. I've never thought of them as incentivizes.

Vern Edwards said:

They are "guidelines." They are only as useful as the user is thoughtful.

Am I the only one that has mistakenly over-incentivized the use of progress payments by blindly skipping through the DD 1547 form and entering into Block 25's "Costs Financed" the costs the USG is financing?  Adding profit on top of the time value of money is dumb.  It's clearly supposed to be the inverse of the amount the USG is financing (i.e. the amount the contractor has to cover after USG financing), per DFARS and common sense.  Because the output of this Working Capital section is just more profit on that amount.

A lot of the DFARS at this Subsection has always seemed to promote thoughtfulness.  Why it had to be output into a form DD 1547, though, is a mystery to me, and just increases the chance of dumb mistakes like the one I describe above to occur.  A PNM should be required to attach a printout of the DFARS here, documenting where the negotiator walked through and wrote in the margins all of his/her selections for the various factors.  It should not need to be boiled down to spreadsheet data entry nor a one-page form covering the tens of pages of thoughtful decisions made in selecting numbers for each factor.  I wrote a PNM once that included a marked-up copy of this DFARS Subsection as an attachment, and have recommended it be done by the Contract Negotiator/Specialist ever since, because I don't want their data entry brain to activate here.  I want their thoughts.

Anyhow, while we wait for anyone that helped develop the DD Form 1547 to arrive to this thread, I would pose a question to the OP.  Does that Block 25 Cost Financed amount really need a profit motive for the contractor to cover the 10-20% of costs that are not being financed by Uncle Sam?  Or is that just the DFARS being overly generous.  I always thought the FAR was being generous providing financing for cheap (progress payments), which is why I ask.  If a motive is needed here, does the DFARS 215.404-71-3(b)(8) limit of 4 percent make sense from an industry perspective?  Interested to hear your thoughts here @Patrick Mathern, and any basis for a different percent of contract costs.

Quote

(8)  Multiply (5) by (6) by (7).  This is the working capital adjustment.  It shall not exceed 4 percent of the contract costs in Block 20.

DD Form 1547 - Weighted Guidelines Tool (dau.edu)

On 9/24/2021 at 5:33 PM, Vern Edwards said:

I don't think there is a mark to miss. The WGL are just a "structured" analytical device. They are "guidelines." They are only as useful as the user is thoughtful. I've never thought of them as incentivizes.

Vern, I'm going to disagree with you. Reference FAR 15.404-4 (Profit). (Emphasis added.)

Quote

(2) It is in the Government’s interest to offer contractors opportunities for financial rewards sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large and small business concerns to Government contracts, and maintain a viable industrial base.

(3) Both the Government and contractors should be concerned with profit as a motivator of efficient and effective contract performance. Negotiations aimed merely at reducing prices by reducing profit, without proper recognition of the function of profit, are not in the Government’s interest. Negotiation of extremely low profits, use of historical averages, or automatic application of predetermined percentages to total estimated costs do not provide proper motivation for optimum contract performance.

It's true that the word "incentive" does not appear in the above quote. However, I see the words "stimulate" and "motivate" in the regulations. Other possible words that could have been used are: "prompt," and "encourage" -- according to an online list of synonyms. Also note the reference to "optimum contract performance." How is it defined? How can it be achieved if not through incentivizing the contractor through profit on its performance?

I assert that the use of weighted guidelines does very little, if anything at all, towards achieving innovation and performance speed -- both things that DoD Leadership claims are important to national security. Misuse of the guidelines is even worse; misuse is actually detrimental to the Department's stated goals.

Further, you note that they are only "guidelines." However, in practice, they establish policy limits on the amount of profit that a contracting officer is willing to negotiate with a contractor. And they establish exactly how that amount of profit is to be calculated, at least on a prenegotiation basis. Factors that are not listed in the weighted guidelines are not considered. (To be fair, I should say "I've never seen the other factors considered and, when brought up during negotiations, contracting officers consistently have declined to consider them.")

Sure, alternate approaches exist; but they are (in my experience) rarely, if ever, used.

here_2_help said:

I assert that the use of weighted guidelines does very little, if anything at all, towards achieving innovation and performance speed -- both things that DoD Leadership claims are important to national security.

H2H, some years ago, the DoD IG submitted a FAR case to penalize contractors who delivered early.  The theory was that early delivery meant early payment which could affect the amount of money the government had to borrow.

Retreadfed said:

H2H, some years ago, the DoD IG submitted a FAR case to penalize contractors who delivered early.  The theory was that early delivery meant early payment which could affect the amount of money the government had to borrow.

That brings up an interesting question. When are funds actually available to the government agency for payment? At the time of obligation? Or earlier?

@here_2_helpH2H,  you quoted me and say you disagree. In the quote I make five assertions. I'm trying to pinpoint your disagreement.

I have never thought of them as an incentive. I think that is the core of your disagreement. You think they are meant to be and should be but are not.

I think of an incentive as a contingent reward offered in return for something. The idea is to give someone a reason to do something they otherwise would not do. If so, then how do weighted guidelines motivate? They are used to develop a pre-negotiation profit objective when cost analysis must be performed. By what mechanism do they work as an incentive during contract performance?

Or do you think that, as a general proposition, setting high(er) contract prices or fixed-fees during contract negotiation will motivate contractors to do better during contract performance than they otherwise would?

If that's what you think, then I say you can't prove it. But I am open to any evidence you can produce.

I said evidence, not theory. I've read plenty of theory about the role of profit in our kind of economy and in contracting. I will weigh evidence, but I won't debate theory. That's for the young and idealistic. After almost 50 years of reading about profit policy, I won't even discuss theory.

In my experience they are incentives given personally by me, as a CO, to the other side’s negotiator, during negotiations (not during performance), to make him/her personally see to it that the company prices what I request in other negotiation items.  What is a Technology Incentive on a FFP Sustainment contract?  It’s payment for whatever my technical analyst says would be nice to have in the proposal’s CLIN price.  And, in return, it’s a new bullet on that negotiator’s appeal to the boss for a nice bonus/promotion.

The timing of when you hang this carrot out there really matters.  Same concept as the timing of putting a stick on the table upfront (see thread in this Forum about decrementing profit at outset of negotiations for poor/lacking subcontract analyses in proposal). In this carrot case, you may need to hang it out there during fact-finding.

Vern Edwards said:

Or do you think that, as a general proposition, setting high(er) contract prices or fixed-fees during contract negotiation will motivate contractors to do better during contract performance than they otherwise would?

I appreciate this perspective, but I think there’s a different incentive that the DoD is currently concerned with that this comment doesn’t consider: Current profit levels attract current offerors. Raising profit levels could inspire new entrants to the DoD marketplace (specifically in R&D scenarios). I don’t have hard evidence to support this, Vern, but basic economic theory holds that if you offer more money to do a job, it will be more interesting to a larger group of potential workers.

On 9/25/2021 at 9:52 AM, WifWaf said:

If a motive is needed here, does the DFARS 215.404-71-3(b)(8) limit of 4 percent make sense from an industry perspective?  Interested to hear your thoughts here @Patrick Mathern, and any basis for a different percent of contract costs.

I can’t speak for “Industry” as a whole at this point. This is exactly what we hope to ascertain in the near future. We are designing a survey that hopes to get some insight into this and other considerations regarding profit that results from WGL.   

“Alternate approaches” to the WGL have been mentioned a few times in this thread, but I’ve yet to see specific examples presented that meet FAR/DFARS requirements.  Anybody have one they could share?

Vern Edwards said:

@here_2_helpH2H,  you quoted me and say you disagree. In the quote I make five assertions. I'm trying to pinpoint your disagreement.

I have never thought of them as an incentive. I think that is the core of your disagreement. You think they are meant to be and should be but are not.

I think of an incentive as a contingent reward offered in return for something. The idea is to give someone a reason to do something they otherwise would not do. If so, then how do weighted guidelines motivate? They are used to develop a pre-negotiation profit objective when cost analysis must be performed. By what mechanism do they work as an incentive during contract performance?

Or do you think that, as a general proposition, setting high(er) contract prices or fixed-fees during contract negotiation will motivate contractors to do better during contract performance than they otherwise would?

If that's what you think, then I say you can't prove it. But I am open to any evidence you can produce.

I said evidence, not theory. I've read plenty of theory about the role of profit in our kind of economy and in contracting. I will weigh evidence, but I won't debate theory. That's for the young and idealistic. After almost 50 years of reading about profit policy, I won't even discuss theory.

Vern,

Yes, the core of my disagreement is your theoretical position that the amount profit does not provide a contractor with incentive. I believe that it does. I do believe that establishing higher contract prices or fixed-fees during contract negotiation will motivate contractors to do better during contract performance.

You ask for evidence, and all I can offer is anecdotal data. One such anecdote is the (true) story of a prime contractor who entered into a FFP subcontract where the margins were so tight, the only way the subcontractor could make any money was to assign only its most junior technical folks to the project. Unsurprisingly, the junior folks made a lot of junior-folks-type errors along the way, resulting in a Level III CAR from DCMA--assessed against the prime, of course.

That's all I've got.

here_2_help,

Did the prime still get 100% of the fixed fee?

Patrick Mathern said:

Raising profit levels could inspire new entrants to the DoD marketplace (specifically in R&D scenarios).

@Patrick MathernPatrick, is DOD short of firms wanting its contracts? Anyway, my understanding is that firms that do not want to do business with the government are put off primarily for other reasons, like government intrusiveness and data rights policy.

here_2_help said:

Yes, the core of my disagreement is your theoretical position that the amount profit does not provide a contractor with incentive.

@here_2_helpI have posited no theory in that regard, and I have not said thatprofit is not an incentive. Do you need to be taught what a theory is? I can recommend some explanatory text books.

I said I have never thought that the WGL were an incentive. I still don't. And I have explained what I think an incentive is and how it is supposed to work. I can recommend some theoretical explanations of them. You have not explained the mechanism  by which a higher pre-negotiation profit objective affects post-award performance. As for your anecdote, my thought is that the subcontractor either underestimated its costs or accepted a below-cost price, not that the price did not include enough profit.

You're welcome to believe what you like. I know that studies of incentive contracts by Dr. Fisher of Rand, Prof. Kennedy of Notre Dame, and the GAO have concluded that there is no proof that post-award profit  incentives work as advertised.

Some people, like you and Patrick, think that profits on government contracts are too low, and that all  would be better if they were higher. Well, you two are industry advocates. Some think that profits are too high. They are industry critics. Profits on defense contracts have been studied and debated for decades. I think I have a copy of every single study and congressional hearing  in which defense profits were discussed, and I don't know whether they are too high, too low, or just right.

But I know that you are not going to persuade anyone to set a policy calling for higher profits on government contracts with ridiculous anecdotes like the one you related in your last post.

Vern Edwards said:

As for your anecdote, my thought is that the subcontractor either underestimated its costs or accepted a below-cost price, not that the price did not include enough profit.

You're welcome to believe what you like. I know that studies of incentive contracts by Dr. Fisher of Rand, Prof. Kennedy of Notre Dame, and the GAO have concluded that there is no proof that post-award profit  incentives work as advertised.

Some people, like you and Patrick, think that profits on government contracts are too low, and that all  would be better if they were higher. Well, you two are industry advocates. Some think that profits are too high. They are industry critics. Profits on defense contracts have been studied and debated for decades. I think I have a copy of every single study and congressional hearing  in which defense profits were discussed, and I don't know whether they are too high, too low, or just right.

But I know that you are not going to persuade anyone to set a policy calling for higher profits on government contracts with ridiculous anecdotes like the one you related in your last post.

Agree to disagree. The basis of our disagreement seems to be a misunderstanding of the difference between negotiated profit and realized gross margin.

here_2_help said:

Agree to disagree. The basis of our disagreement seems to be a misunderstanding of the difference between negotiated profit and realized gross margin.

If you say so.

Vern Edwards said:

Some people, like you and Patrick, think that profits on government contracts are too low, and that all  would be better if they were higher.

To take a step back and clarify, I'm specifically talking about profit as a tool to increase interest in DoD R&D efforts.  Increasing profit is likely to increase that interest, but I'm not saying it's the only lever or that it's the even most impactful lever.  You mentioned data rights, Vern, and I agree that this is a big factor in whether a firm decides to work with the government or not.  There are other factors as well.

Where the WGL comes into play is how contractors and contracting officers view it as being directly related to the effort required.  Does it ask the right questions and produce the answer expected given the situation?  Small businesses surely don't believe that to be the case.  Who else might feel slighted and why?  That's where I would like to go.

Have thoughts on this?  This group absolutely has the depth of knowledge to shed light on this.

DOD scheduled a series of public hearings in 2019 following a 2019 GAO report regarding contractor financing and profit policies. See https://www.gao.gov/assets/gao-19-406.pdf

Patrick Mathern said:

To take a step back and clarify, I'm specifically talking about profit as a tool to increase interest in DoD R&D efforts.  Increasing profit is likely to increase that interest, but I'm not saying it's the only lever or that it's the even most impactful lever.  You mentioned data rights, Vern, and I agree that this is a big factor in whether a firm decides to work with the government or not.  There are other factors as well.

Organizations engaged in R&D might pursue government work as a way to fund their enterprise. Profit may not be a primary concern.

I started out in R&D, and many firms large and small were happy for a chance to pursue a line of investigation at government expense.

Vern Edwards said:

Organizations engaged in R&D might pursue government work as a way to fund their enterprise. Profit may not be a primary concern.

Agree.  I worked for ONR for a few years and many contracts were cost sharing or cost no fee contracts.

@Retreadfed and @Vern Edwards:  Thanks for that input - are you saying that firms were open to R&D contracts as a way to bring in revenue in lean times?  Or what did the contractors get out of the deal that made it attractive?  Were these firms in question new to government contracting, or was having ongoing government work part of their strategy?

Patrick Mathern said:

what did the contractors get out of the deal that made it attractive?

As I recall, many of the contractors had commercial operations that would benefit from government funded research.  Although they could claim tax deductions for self funded R&D, that was not the same as actually having the government pay for research they could exploit commercially.  This was particularly true for companies in the pharmaceutical, computing and materials fields.

On 9/27/2021 at 12:35 PM, Neil Roberts said:

DOD scheduled a series of public hearings in 2019 following a 2019 GAO report regarding contractor financing and profit policies. See https://www.gao.gov/assets/gao-19-406.pdf

I remember the latest change to working capital policies went over like a lead balloon.  From the report:

“In August 2018, DOD introduced a proposed rule that was intended to use contract financing rates to help incentivize contractor performance and to implement Section 831. The proposed rule would have set a base progress payment rate for large businesses (specifically, for other than small businesses) at 50 percent and small businesses at 90 percent. At the same time, however, the proposed rule provided opportunities to increase the rate if the contractor achieved certain enterprise-wide priorities such as meeting contract delivery dates.”

Was the rule-maker too aware of the linkage between USG financing and internal rate of return?  Was this perhaps just feigned outrage by industry advocates?  Regardless of the optics at this enterprise level, we at the working level could all learn a thing or two by understanding the buying power of IRR.