SSRO determination on the extent to which labour costs in a qualifying defence contract are Allowable
The SSRO was asked by the Secretary of State for Defence to determine the extent to which the labour costs in a qualifying defence contract were Allowable.
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This document sets out an anonymised account of the SSRO’s determination, which is intended to aid understanding of how the regulatory framework is being applied without disclosing sensitive information. The process of anonymisation has involved removing some of the detailed facts relied upon in making the determination. As the determination was made having regard to the circumstances of the subject contract, care must be taken when contractors are applying the findings to other contracts.
The contract in question concerned support and maintenance of equipment. The labour costs formed part of a target price for the contract and were estimated by multiplying labour rates for the contractor’s business by the labour hours estimated to deliver the contract.
The determination focused on the labour rates forecast for the contract. The key issue was whether the contractor’s approach to estimating the labour rates would result in allowable costs, having regard to the test of whether the costs are appropriate, attributable to the contract and reasonable in the circumstances (the AAR test).
The labour rates were estimated in circumstances where there was a degree of uncertainty about the amount of labour which would be required from the contractor’s business over the life of the contract. The contractor had previously carried out similar work for the MOD, but the scope of work for the contract was expected to also depend on survey, inspection and testing and there were additionally two elements of the specification that were new. There were also revisions being made to the MOD’s work programmes that would be likely to impact on labour required from the contractor.
The contractor took a top-down approach to estimating the labour rates, which involved taking the rates for a baseline year and rolling them forward for the contract (a period of between four and five years).
The SSRO considered, first, whether the contractor’s top-down approach was suitable in the circumstances that applied at the time of entering into the contract. Secondly, it considered whether appropriate adjustments were made to the baseline rates when applying them to the contract.
The SSRO determined that the top down approach adopted by the contractor was capable of providing a reasonable estimate of the labour rates, provided that relevant adjustments were made to the baseline to address the differences in the contract period. While for this contract, the uncertainty in the MOD’s programmes made it unlikely that a bottom up approach would be more accurate, the SSRO confirmed that this does not mean that a top down approach will always be most appropriate, nor that a bottom up approach will never be appropriate.