LONDON — Defense companies are facing a 15 percent cut in the having baseline profit rates they can earn on contracts awarded without competition by the UK Ministry of Defence. reduced by 15 percent in the next financial year.
"I have set the baseline profit rate for single-source defense contracts at 8.95 percent in line with the rate recommended by the Single Source Regulations Office [SSRO]," Defence Secretary Michael Fallon told Parliament Monday.Mar 14.
The new rate compares with 10.6 percent available to industry in fiscal the financial year 2015-16 and 10.7 percent the year before that.
Fixed and working capital servicing rates are also being cut on contracts awarded in 2016/17.
The MoD said in a statement that the new rate brings Britain in line with defense suppliers in Western Europe and North America.
Fallon told Parliament the profit rate "provides a fair return to industry while delivering savings that will be reinvested in defense."
Consultant Howard Wheeldon of Wheeldon Strategic disagreed, saying he said the rate was a disincentive for contractors to do business with the British MoD.
"I think that this is unworkable and unwarranted. It is almost bound to make a number of companies, including those that are foreign owned, reconsider the worth of bidding for MoD contracts," he said.
The baseline profit rate acts as the starting point for agreeing to profit rates set for individual contracts, taking into account factors such as risk and performance incentives and capital servicing rates.
SSRO's intention to recommend doing away with the one-size-fits-all baseline profit margin and replace it with a number of rates depending on the actual nature of the business involved was blocked by Fallon.
The defense secretary said in his statement to Parliament that he had asked the SSRO to further develop the methodology used to calculate the profit rate over the next 12 months.
Single-source profit rates are of major importance to contractors here. In the 2014/15 financial year, they accounted for about 53 percent of new contracts with the MoD, spending around £8.3 billion (US $11.9 billion).
That figure is likely to grow if, as expected, the Conservative government secures the approval of Parliament to go ahead with the next phase of the £31 billion Successor program to build four nuclear missile submarine.
Programs like the single-source purchase of Boeing P-8 maritime patrol aircraft under the US government Foreign Military Sales arrangements and other government-to-government deals arrangements are not subject to SSRO scrutiny.
The SSRO was set up in 2014 to rewrite the terms and conditions under which the MoD did business on single-source contracts.
Defense ministers have previously said they hope to save more than £200 million by introducing the new rules.
Aside from the annual recommendations on profit margins, the SSRO has also toughened up the allowable costs that industry is able to offset against single-source contracts.
In an interview with Defense News last year, the then-SSRO chairman, Jeremy Newman, said the profit rate was more visible but over the long term the tightening of allowable costs would likely have the biggest impact.
"Profit is a smaller element of the total contract value than the allowable costs, but it's also more visible. Some of our guidance on cost may have a substantial impact, but it's likely to be hidden because people won't necessarily know what would have been charged in different circumstances. ... The cost guidance in the long run will have the biggest impact; it is potentially quite far-reaching," he said.
Email: achuter@defensenews.com
Andrew Chuter is the United Kingdom correspondent for Defense News.
