Guidance

3. Pricing queries

Updated 31 October 2024

3.1 What Baseline Profit Rate (BPR) should be applied to a Qualifying Defence Contract (QDC) which uses a pricing method applying the pricing formula and when will I know the BPR for the upcoming year?

Published April 2023. Updated May 2024.

The Defence Reform Act 2014 requires the Secretary of State to determine and publish the Baseline Profit Rate (BPR) and other rates for a financial year in the London Gazette no later than 15 March in the preceding financial year. This means that the BPR that will apply to qualifying contracts entered into from 1 April to 31 March will typically be published on or before the preceding 15 March. Following the Secretary of State’s publication of the rates, the SSRO publishes guidance on the baseline profit rate and its adjustment in advance of 1 April. The guidance comes into effect on 1 April.

Section 17(2) of the Act, and regulation 11(2), set out the requirement for the baseline profit rate (BPR) as the first step in determining the contract profit rate to be applied in the pricing formula: “Take the baseline profit rate which is in force at the relevant time”.

The “relevant time” is the time of agreement, as defined in regulation 2(1). Broadly, this is:

(i) the date a QDC or QSC is entered into or the date of a re-determination of the contract price, or;

(ii) for a QDC by amendment, the date of the amendment by which it was agreed the contract was to be a QDC or the date of a re-determination of the contract price.

The SSRO has provided separate guidance that will assist the contracting parties to determine the time of agreement for a particular QDC or QSC, which is set out at paragraphs 3.19 to 3.44 of the SSRO’s contract reporting guidance.

The contract profit rate for a particular QDC or QSC (in respect of which calculation the relevant BPR is step 1) applies to the entire contract (or relevant component) and for the life of the contract or component, unless the parties propose to amend the contract or component in a way that would affect the original contract price of the contract or component. In that case, the Schedule to the Regulations explains how the parties are to re-determine the contract price, which can involve the application of a different BPR (as part of a new Contract Profit Rate) from the one which previously applied, in relation to all or a component of the particular QDC or QSC.

3.2 Does the SSRO approve company forward bid rates?

Published July 2023

The SSRO does not approve any contract costs, including bid rates, that contractors present to the MOD in relation to QDCs or QSCs. The regulatory framework requires both the MOD and the primary contractor (in the case of a QDC) or sub-contractor (in the case of a QSC) to be satisfied that costs that are included in the price of a qualifying contract meet the requirements of allowable costs (appropriate, attributable to the contract and reasonable in the circumstances – AAR). Rates are agreed by the MOD and the contractor as part of this process. For any cost claim, the Secretary of State may require the contractor to show that the cost is AAR and can be included in the price of a qualifying contract. The SSRO issues statutory guidance about determining whether costs are allowable costs and the Secretary of State and contractors must have regard to that guidance when determining whether costs are allowable.

3.3 Does the Questionnaire: Method and Allocation of Costs (QMAC) determine if a cost is Allowable?

Published July 2023

No. A QMAC is a record of an agreement between the MOD and a contractor regarding the approach to the classification and method of allocating costs within the contractor’s organisation. The agreement of a QMAC does not demonstrate that costs are allowable, however the parties may find its contents informative in applying the SSRO’s statutory guidance on allowable costs. For example, in identifying the type of costs and corresponding cost recovery bases which the parties may agree to recover through the application of cost recovery rates.

3.4 Can more than one regulated pricing method be used when pricing a contract?

Published July 2023. Updated May 2024.

Yes. The term “regulated pricing method” has been removed from the legislation. What were previously known as regulated pricing methods are now referred to as “default pricing methods”, although the methods themselves remain broadly unchanged. The reason for the change in terminology is to distinguish these methods from the new “alternative pricing methods”. More than one default or alternative pricing methods can be used when pricing a contract.

3.5 Can a pricing method outside the six regulated pricing methods be used when pricing a contract?

Published July 2023. Updated May 2024.

The term “regulated pricing method” has been removed from the legislation. What were previously known as regulated pricing methods are now referred to as “default pricing methods”, although the six methods remain broadly unchanged. New “alternative pricing methods” have been introduced which in certain circumstances can be used instead of or alongside the default pricing methods.

The price payable under the contract or any component must be determined in accordance with either the default pricing method or an alternative pricing method. The parties may agree to use an alternative pricing method to price a contract or component only where the certain circumstances apply. Each alternative pricing method and when it can apply is described in regulations 19A to 19G and explained in the SSRO Alternative pricing of contracts guidance. Where the circumstances that permit the use of an alternative pricing method do not apply, the price payable must be determined using a default pricing method.

3.6 Does the 5% final price adjustment limit allow a contractor to earn an outturn profit rate equal to the CPR + 5pp before an adjustment may be needed, or is it the CPR + 5%?

Published October 2023. Updated May 2024.

A reduction to the contract price to reflect excess profit may only be applied once the outturn profit rate exceeds the contract profit rate by 5 percentage points. Once the difference between these two rates is known, and the threshold for a final price adjustment is met, whichever of regulations 17(2) to 17(4) are relevant to the circumstances may be applied to determine the adjustment to be made. In the situation described in regulation 17(2), the difference between the contract profit rate and the outturn profit rate would be at least 5 percentage points but less than 10 percentage points. There are other conditions and procedural requirements in relation to the application of a final price adjustment and these are described in regulations 16 and 17.

3.7 Can the costs associated with hedging be considered Allowable Costs?

Published October 2023

Hedging may be used to mitigate the risk of cost variations and involves paying a premium for the protection it provides, which we assume would be the basis upon which any claim of allowability for the premium would be based. Section H.3 of the SSRO’s Allowable Costs guidance covers costs associated with mitigating risk or uncertainty. This sets out the matters to be considered when determining if the cost of risk mitigation meets the requirements of allowable costs. The onus of proof rests with the contractor to demonstrate to the Secretary of State’s satisfaction that the costs meet the requirements of allowable costs. Hedging involves mitigating the impact of financial losses and can be thought of as form of insurance. As part of the agreement of any hedging premium as an allowable cost, the parties should also agree how they are to treat any losses that may arise and that the hedging was intended to offset.

3.8 The anticipated costs of performing my contract are increasing due to economic factors. Can I claim the additional costs as allowable in my QDC?

Published February 2024. Updated May 2024.

A contractor whose costs to perform a QDC are rising should discuss this with the relevant contracting authority. The ability of a contractor to claim any costs as allowable costs to be included in the price of a QDC which uses a contract pricing method applying the profit formula – whether the costs were expected at the time of agreement or arose unexpectedly – depends primarily on the pricing method used for the contract (or relevant contract component).

The pricing methods described in regulation 10 require that allowable costs used to determine the contract price are either:

• the allowable costs as estimated at the time of agreement (which, in some cases, may be adjusted in accordance with changes in specified indices or rates between the time of agreement and a specified time); or
• the actual allowable costs determined during the contract or after contract completion.

If the pricing method requires the allowable costs to be estimated at the time of agreement and this estimate did not include the ‘additional costs’, the additional costs can only be added to the contract price if:

• the parties agree the additional costs meet the requirement of allowable costs; and
• the parties agree to amend the contract in a way that would allow the additional costs to be included in the contract price. This would be achieved through a price re-determination using one of the methods set out in regulation 14 and the Schedule to the Regulations.

Or

• The contract terms provide that the price is to be adjusted in accordance with specified rates and indices which serve to cover some or all of the costs (for example a variation of price clause linked to a relevant price index).

If the pricing method requires the allowable costs to be determined during the contract or after contract completion, the actual ‘additional costs’ may be claimed if the parties are satisfied that the costs meet the requirements of allowable costs.

Although it may be possible for the parties to agree a pricing amendment related to the additional costs, there may be no obligation on a contracting authority to make such an amendment. Where additional costs cannot be claimed as allowable and this results in the contractor making a loss, a final price adjustment may apply to mitigate those losses.

The SSRO provides guidance to help contracting parties to determine whether costs in QDCs are allowable. Part H of our Allowable Costs guidance deals with risk and uncertainty. We have also published guidance which aims to assist the MOD and contractors in agreeing how to reflect inflation in the pricing of qualifying contracts.

3.9 The costs of delivering my contract have increased and I am making less profit. Does a final price adjustment apply?

Published February 2024

A final price adjustment will not necessarily apply simply because a contractor is making less profit than expected due to increased costs. Regulation 16 describes the circumstances in which a final price adjustment may be made to the price of a qualifying contract (or component thereof) that uses the firm, fixed or volume-driven pricing method, and these include where either:

• the outturn profit rate exceeds the agreed contract profit rate; or
• the contractor’s outturn costs (its actual costs under the contract which meet the requirements of allowable costs) exceed the contract price.

Where a contractor’s costs have increased, a final price adjustment can only be made when the increase in costs which meet the requirements of allowable costs is such that the contract becomes loss making, i.e., no profit is being made at all.

3.10 Under the regulatory framework, can excess profit earned on one contract be used to deliver activities as Allowable Costs on another contract?

Published July 2024

The regulatory framework provides for a “final price adjustment” in the event that the actual profit earned by a contractor under a QDC or QSC exceeds certain predefined thresholds, or if a loss is made. This protects the contracting parties from excessive profits or losses. The final price adjustment can only be applied after contract or component completion and therefore any excess profit returned to the MOD can only be redirected to fund other activities at that point. However, if during the life of the contract the parties foresee excessive profit being earned, they could agree to amend the contract to either reduce its price, thereby freeing up funds to direct to another contract, or to add more goods, works or services to the contract, thereby incurring additional costs and consuming the forecast excess profit while keeping the price unchanged. Whilst permissible under the regulations, there can be some complexity and risk with either of these approaches and we therefore suggest seeking advice from the SSRO via the SSRO helpdesk if considering either of these options.

3.11 How does the single source regulatory framework apply to NEC contracts?

Published July 2024

New Engineering Contracts (NEC) are a family of standard contracts often used for civil engineering, construction and maintenance projects. ​The single source regulatory framework applies to all qualifying contracts, including NEC contracts. This means that the terms of any NEC contract which is a QDC or QSC should be constructed in a way that does not conflict with the requirements of the Act or Regulations. For example, the price of the contract must be determined in such a way that is consistent with the contract pricing methods specified the Regulations. There are a range of pricing methods available under the Regulations, which should enable alignment between the standard NEC pricing options and a method which is compliant with the regulatory framework.

Similar to the NEC documents, the Single Source Contract Regulations (and the associated SSRO statutory guidance) use specific terminology. Care should always be taken to avoid conflicts of terminology or, where this cannot be avoided, ensuring the Regulations are applied in accordance with the terminology defined therein. ​

If parties are unsure whether aspects of an NEC contract can be accommodated under the single source framework, advice can be sought from the SSRO helpdesk. ​However, in the event of an unresolvable conflict, the single source legislation will prevail over the terms of the NEC (or any other) contract provision. 

3.12 What does the regulatory framework have to say about how overhead costs should be treated when pricing a contract?

Published July 2024

The Act and the Regulations require that for a cost to be allowable under a QDC or QSC it must be appropriate, attributable to the contract and reasonable in the circumstance (AAR). This applies equally to overhead costs as it does to any other costs contractors may seek to claim as allowable.  

Where overhead costs are considered allowable and not identified as arising from performing a single qualifying contract, these must be assessed against the SSRO guidance on the application of the AAR test. If the overhead costs are to be applied to the contract using cost recovery rates using a suitable cost recovery base, the parties must be satisfied that the result is AAR. The parties must have regard to part 4 of the SSRO’s allowable costs guidance on cost accounting, direct costs, indirect costs and overheads when making this assessment.

The regulatory framework is not prescriptive as to the format of overhead cost recovery rates and it is for the parties to agree. However, the SSRO understands that most of the MOD’s processes involving rates are based on hourly rates, and this may be the most practical format for most contractors.

3.13 The updated Regulations make clear that the price of estimate-based fee contracts can be adjusted by agreed rates and indices. How does this work in practice?

Published July 2024

An estimate-based fee price is made up of two parts:

1. The allowable costs which are the actual allowable costs Price = AC + (CPR x AC). These are based on the actual costs incurred by the contractor and are not subject to any adjustment.  

2. A fee added on top which is calculated by multiplying the contract profit rate by the allowable costs estimated at the time of agreement Price = AC + (CPR x AC). These estimated allowable costs upon which the fee is based can be adjusted, meaning the fee will change in line with that adjustment to costs.

The adjustment to the estimated allowable costs used in calculating the fee must be done in accordance with changes in rates or indices between the time of agreement and another specified time. For example, the change in a price index over the life of the contract which captures the inflation which is relevant to those costs. The parties will need to agree at the outset the indices or rates they propose to use, how the adjustment will be made and the relevant timings – it is possible to agree several of these in a single contract if the contracting parties wish. For example, different adjustments for the parts of the fee could be linked to different elements of allowable costs.  

It is not a requirement to include such an adjustment when using this pricing method unless the parties wish, and care should be taken not to double count if an allowance for specific inflation is already included in the estimated allowable costs. The SSRO has published guidance on inflation which those considering this method will find helpful.

3.14 Can I claim additional Allowable Costs if my contract uses any of the alternative pricing methods?

Published July 2024

Allowable costs are only used to determine the price of a contract or component that uses the pricing formula. Some alternative pricing methods also apply the pricing formula. These alternative pricing methods are:

• Prices determined in accordance with law method (where the pricing formula is used)
• Previously agreed price method (where a repricing using the pricing formula is agreed or obligations are transferred between QDCs)
• Novated contract price method (where the pricing formula was used on the original contract before novation)
• Agreed changes to the contract profit rate method.

The ability to claim additional allowable costs will depend on whether the allowable costs have been determined based on an estimate or the actual costs incurred, and any relevant terms of the contract. The answer to question 3.8 addresses this in greater detail.

Where the parties wish to incorporate additional costs into the price where the contract or component does not use the pricing formula (for example, commercially priced items), the parties would need to agree a pricing amendment (the effect of which would be to create an additional component which uses the pricing formula). Any additional allowable costs, and associated profit may be added to this component if the parties agree to it. However, there is no obligation on either party to enter into such a pricing amendment.

3.15 Is rework an Allowable Cost?

Published October 2024

The cost of rework can be an Allowable Cost under a qualifying contract if the parties to the contract are satisfied that the cost is appropriate, attributable to the contract and reasonable is the circumstances. In coming to an agreement on the treatment of rework costs, the contracting parties must have regard to the SSRO’s Allowable Costs guidance. The guidance provides specific consideration of rework, wastage and faulty workmanship to assist the parties in agreeing their position. The guidance recognises that no production or manufacturing process is likely to be completely effective and that attempts to achieve zero rework or wastage may be uneconomical. It also explains the typical characteristics of costs that meet the requirements of allowable costs, including that a cost is reasonable in the circumstances if, among other conditions, it is of an amount that demonstrates due regard for economy and efficiency in the use of resources which is of relevance to rework. The burden of proof rests with contractors to demonstrate that costs are allowable, and in this regard, are expected to keep relevant records which are sufficiently up to date and accurate (see paragraph 1.25 of the Allowable Costs guidance).