Yesterday, the Single Source Regulations Office (SSRO) published its methodology for calculating the profit that contractors will be allowed to make in single source defence contracts. The publication comes following a public consultation on the matter in late 2015.
Using this methodology, the SSRO will make its recommendation on the level of the baseline profit rate and capital servicing rates for qualifying defence contracts (QDCs) for 2016/17 to the Secretary of State for Defence before 31 January 2016. The Secretary of State is expected to publish the rates for 2016/17 by 15 March 2016 and these will apply to new QDCs signed from 1 April 2016. The SSRO will publish the guidance on the adjustments to the baseline profit rate prior to the introduction of the 2016/17 rates.
The SSRO’s initial proposal was to recommend a number of baseline profit rates for 2016/17 but the Secretary of State issued an instruction on 20 January 2016 that the methodology used to calculate profit rates for UK single source contracts should be such that it results in setting a single baseline profit rate in 2016/17.
Key Points on SSRO Methodology
- The rate will be determined by considering the profit rates achieved by a more international and a wider range of companies.
- The SSRO is recommending one baseline profit rate which will be the average rate for ‘develop and make’ and ‘provide and maintain’.
- A three-year rolling average of the profit range for each set of categories is determined, and the baseline profit rate is the average of the two. As in previous years, the profit level indicator used will be net cost plus (also known as return on total cost).
- Capital servicing is not accounted for in the baseline rate but will be included in calculations for the actual rate for individual contracts.
- Three rates will be set for calculating capital servicing: for fixed capital, positive working capital and negative working capital.
- The methodology which used to calculate these rates remains largely unchanged, but includes the use of more appropriate corporate bonds.
- Although the SSRO will recommend only one baseline profit rate this year, it will work towards having multiple profit rates in future, for adoption first in 2017/18.
For further information, the full documents relating to the SSRO’s consultation response and methodology can be viewed at:
ADS is pleased that industry’s concerns regarding the complexity and appropriateness of the SSRO’s initial proposal to have six categories of contract type have been taken into account for the year 2016/17 and that work will continue in this area. Industry hope to continue to work with the SSRO as it prepares to publish the rates for 2016/17 and seeks to develop multiple profit rates for future years. Going forward, it will be important that any multiple profit rates are representative of the work undertaken by industry and that they deliver a fair and reasonable return for companies.