Guidance

Q&As arising from Session 3: Pricing Teach-In held on 10 April 2024

Published 5 July 2024

This session focused on the changes to existing features of pricing contracts, including:

• the cost risk adjustment; and
• POCO.

Agreement of components

Can a contractor and the MOD agree that something is not a component?

The circumstances in which a component is formed are set out in law. These circumstances are also set out in the introductory section of each piece of SSRO pricing guidance. If the parties agree to price their contract such that those circumstances apply, then components are formed and the parties cannot agree otherwise. The only way for the parties to agree that something is not a component is to agree to price their contract in such a way that the requirements for having formed a component are not met.

Componentisation

Does a pricing amendment force a component to be created?

An amendment which affects the price of a QDC or QSC is a “pricing amendment”. Not all amendments will be pricing amendments.  A pricing amendment could result in the contract meeting one or more of the criteria set out in law for a component having been formed:

• uses a different pricing method from that used in any other part of the contract;
• has a different contract profit rate to that used in any other part of the contract; or
• has its price redetermined in accordance with specific circumstances laid out in the regulations which result in component being formed.

Where the parties agree to amend a contract in such a way that would affect the original contract price and as result any one or more of these three criteria are met, then components are formed.

It is possible to group what would currently be termed as multiple ‘amendments’ into a single component, so long as the relevant criteria apply to each of those grouped amendments. For example, a collection of amendments which apply the same CPR (but which is different to that used in the unamended part of the contract) could be treated as a single component.

Not all pricing amendments will result in a component being formed. For example, several amendments which all attract the same contract profit rate and pricing method as the unamended part of the contract.

The SSRO has stated that the requirements of componentisation are not retrospective, but where existing contracts have parts treated distinctly we are still required to report on these at component level from 1 April. How is this not retrospective?

The new requirements are prospective. Contracts entered into before 1 April are not required to be re-opened to comply with the new regulations and, similarly, contractors are not required to revise or re-submit historic reports.

However, some existing contracts are priced in a way that now means they consist of “components” as defined under the new regulations. Therefore, going forward, contractors with existing contracts must report on these components in accordance with the new regulations. But note that regulation 44 of the Single Source Contract (Amendment) Regulations 2024 contains transitional provisions such that in respect of existing contracts some of the new regulations have delayed or altered effect – see slides 18 & 19.

If we have multiple tasks priced as part of a QDC and some of them have different profit rates, are the tasks separate components?

The parts of the contract that have different profit rates will each be components. If several tasks share the same contract profit rate and pricing method, these will not be components unless the parties agree otherwise.

What if no element of my contract triggers the requirement to componentise but I or the MOD still feel this would be useful?

Creating components other than when the legislation requires it is a matter for the contractor to agree with the MOD. The contractor would need to consider if they wish to agree to treat one or more parts of the contract distinctly for the purpose of pricing, in the absence of any legal requirement to do so. In the absence of an agreement between the parties to price in this way, no new components would be formed.

The four profit rate steps

We have provisionally priced a contract that started before 1 April 2024, however the agreed contract price will be finalised when the contract is signed in June 2024. Does this mean we have to redo the work to price everything again? i.e. the cost audit, or does it still stand?

The Regulations do not allow for provisional pricing. The price prior to 1 April 2024 should have been determined using the regulations in force at the time. If it is to be redetermined on or after 1 April 2024 then the new regulations will apply. The extent of any repricing will depend on the circumstances of the contract and what it is proposed will be changed. If the changes are limited, for example a small change to a defined element of allowable costs, then it should not be necessary to reprice the entire contract.

Componentisation and blended profit rates

The SSRO has made reference to “blended profit rates” in its teach-in materials. It was understood that the SSRO did not consider ‘blended profit rates’ to follow the regulatory requirement. Is this view changing?

No. Prior to 1 April 2024, the price of a QDC was required to be determined only in accordance with the pricing formula and this applied to the entire contract. However, the SSRO observed a limited number of cases where this was not happening – for example, in relation to QDCs by amendment (for the part of a contract relating to the period before the contract came into the regime), or where the parties were agreeing to form the price from several components with different contract profit rates. This results in non-compliant prices, which the SSRO reports in accordance with its compliance methodology. In order for contractors to comply with their reporting obligations in these circumstances, they may have “blended” multiple profit rates across a contract to arrive at a single rate.

Given we are aware of this occurring in practice, we have drawn attention to the consequences for componentisation of using a blended CPR.

Rates agreed on a group basis

Is the option to agree rates on a group basis available for qualifying sub-contracts (QSCs)?

No, this provision of the legislation applies only to Qualifying Defence Contracts (QDCs) and not QSCs.

Cost risk adjustment (CRA)

Are we required to consider the type of activities performed in the contract or component when negotiating a CRA?

In agreeing the CRA at Step 2, the particular type of activities to be carried out under the contract or component are to be taken into account. However, for the vast majority of contracts, application of the BPR at Step 1 alone will fulfil this requirement. An activity-based adjustment should only be made where there is clear evidence that not making such an adjustment would result in an unfairly high or low rate of profit on the contract or component. 

See paragraphs 4.16 - 4.18 of the SSRO’s Guidance on the baseline profit rate and its adjustment for further information.

Components and amendments

Would the parties need to agree taking a separate BPR against a differing contract scope being added as an amendment?

If a pricing amendment is being made which uses a default pricing method then a contract profit rate for the amended part of the contract would need to be determined using the four-step process. Step 1 involves taking the BPR in force at the “time of agreement” (in this case being the date the contract price is re-determined), which may be a different BPR to that for the unamended part.

Costs incurred when pursing enhanced performance for an incentive adjustment

What happens where parties have not had a ‘conversation’ regarding costs incurred in pursuing enhanced performance linked to a step 3 incentive adjustment? Should there be a referral to the SSRO?

The SSRO’s guidance on the baseline profit rate and its adjustment now states that the treatment of any costs incurred by the contractor associated with the activities or enhanced performance delivery should be agreed by the parties prior to an agreement to an incentive adjustment. It is a legal requirement to have regard to this guidance.

It would be up to the parties to decide whether to pursue a referral in respect of such cost, if those had not been discussed or agreed. The allowability of any costs should be fully discussed between the MOD and the contractor before any referral is made and the SSRO would likely wish to establish as part of its investigations the reason that the guidance had not been followed.

POCO

Will POCO have an impact on amendments to group sub-contracts?

The POCO adjustment affects the price of the QDCs, and does not impact the original or amended price of the group subcontracts.

However, the converse is not true, and a pricing amendment to a group subcontract could affect the POCO adjustment for the prime.

For example, if the QDC was priced on the basis of actual allowable costs, then an amendment to a group subcontract price that increased the amount of profit under that contract, may result in a higher POCO adjustment to the allowable costs of the QDC.

For an amendment which has been priced before 1 April which includes a POCO adjustment, but which has not yet been incorporated into the main contract, would the price need to be re-calculated to adjust the POCO adjustment to reflect the new costs associated with group profits adjustment?

The pricing of amendments entered into from 1 April 2024 must comply with the new regulations. Therefore, the contract profit rate for an amendment entered into on or after 1 April 2024 cannot have a POCO adjustment as part of the contract profit rate, which must instead be applied to the allowable costs of the amendment.

Transitional provisions

The new regulations apply prospectively to existing contracts in the same way that they apply to new contracts in their entirety, except that in a limited number of cases the new regulations have delayed or altered effect for existing contracts. These cases are listed in Regulation 44 of the Single Source Contract (Amendment) Regulations 2024 and referred to as the “transitional provisions”. The transitional provisions are:

Reporting

Contract Pricing Statement and Contract Reporting Plan:

For contracts entered into (or any amendment agreed) before 1 April 2024, the amendments made to regulation 23 (the Contract Pricing Statement) and regulation 24 (the Contract Reporting Plan) do not apply. Instead, contractors are required to report in accordance with the earlier regulations, meaning those reports need not cover the amendments relating to components or alternative pricing.

Quarterly Contract Report:

For contracts entered into before 1 April 2024, the amendments made to regulation 26 (the Quarterly Contract Report) do not apply until 1 April 2025. Until that time, contractors are instead required to report in accordance with the earlier regulations, meaning the report need not cover the amendments relating to components or alternative pricing. 

Interim Contract Report:

For contracts entered into before 1 April 2024, the requirement to report cost recovery base information under regulation 27(4A)(e) and (g)(ii) within the Interim Contract Report does not apply.

Pricing amendments

Schedule to the Regulations:

For contracts in which the price had been determined under Part 3 of the Schedule to the previous Regulations (i.e. where there were multiple pricing amendments), from 1 April 2024 the price is instead to be treated as though it had been determined under Part 2 of the Schedule to the new Regulations (i.e. re-determining the price using a default pricing method).

Referrals

Matters in relation to which the SSRO must make a determination:

For contracts entered into (or any amendment agreed) before 1 April 2024, regulations 52(7) (pre-conditions to the Secretary of State seeking a determination on certain matters) and 52(8) (matters to which the SSRO must have regard in making a determination under Regulation 52) of the new Regulations, which broadly reflect amendments relating to componentisation, do not apply.