Response to the review of Canada’s contract cost principles and profit policy

In 2015, PricewaterhouseCoopers provided a review of how we currently determine contract price for defence procurement. Learn how their recommendations are helping us to improve our price policies and practices.

How prices are set

The Government of Canada makes every effort to ensure that the price of goods and services is determined by the market through competition. But sometimes the price is determined by adding the actual cost to do the work with a fair and reasonable profit, especially in defence contracts. This situation occurs:

• when non-competitive contracts are issued
• following a competitive process, because price negotiations with the successful bidder or amendments are required

The Canadian pricing framework is composed of Canada’s contract cost principles and Public Services and Procurement Canada’s profit policy. The intent of the framework is to apply a consistent approach to all contracts and for all contractors to calculate a price that best represents a fair market price.

Partners around the world have a similar approach to pricing and audit. Canada works with them to share information and performs contract audits of Canadian suppliers on behalf of its partners. This is increasingly important given the globalization of military business and the involvement of Canada’s defence sector internationally.

Opportunity to improve our price policies and practices

In November 2013, the Canadian Association of Defence and Security Industries (CADSI) published a report on government policies. The report highlighted the need to more broadly examine issues around how to price non-competitive contracts and to consider alternative approaches to contracting.

At the same time, the sustainment initiative was created to pilot innovative approaches to contracting. It involved Public Services and Procurement Canada, National Defence, and Innovation, Science and Economic Development Canada. The objective was to improve defence procurement by enhancing the relationship with contractors, introducing incentives for contract performance and examining best practices from our partners.

In 2015, we asked PricewaterhouseCoopers (PwC) to review how we determine the price for goods and services in defence contracts. We had concerns that the pricing framework had not kept pace with innovative procurement practices in Canada and abroad.

The review was conducted as part of the sustainment initiative and completed in December 2015. It made several recommendations on how to update our interpretation of the pricing framework (the guidance).

The renewal of the pricing framework will be strengthened by the contract review project. The contract review project recently initiated by Public Services and Procurement Canada’s procurement policy group aims at:

• simplifying contractual clauses
• standardizing contractual clauses and templates

As we are updating our policies, we will apply plain language and remove duplicate and outdated information from contract clauses. This will make it easier for businesses to sell to government and simplify training and policy documents.

Read our responses to each of the PwC report recommendations and learn about our plan of action.

Main findings of the review

• The principles used to determine costs are comparable with costing standards applied in other nations and only require minor changes to clarify their interpretation
• Some federal government and industry stakeholders see the way we calculate and apply profit rate as too rigid
• Canada’s pricing framework is not applied consistently to military contracts by Public Services and Procurement Canada procurement officers
• There is not enough technical expertise, such as that of military industrial specialists, to validate the production process or other technical matters that determine cost and risk
• Canada’s pricing framework is neither adapted to current contracting practices nor updated for best practices
• There are significant differences in how we manage pricing compared to other nations:
  • these differences include organizational structure, depth of guidance, capacity and technical capabilities

Recommendations and our responses

We respond to each of the seven recommendations provided in the review. Four of the recommendations refer to the interpretation of the pricing framework (the guidance) we currently use to determine contract prices:

• Canada’s contract cost principles, section 3.1031-2 of the Standard Acquisition Clauses and Conditions Manual
• Public Services and Procurement Canada’s profit policy, Chapter 10 of the Supply Manual

Three of the recommendations refer to the management of the pricing framework, which governs how the guidance is applied.

Recommendation 1

Some specific terms in section 3.1031-2 of the Standard Acquisition Clauses and Conditions Manual should be changed, and more instructions on application given.

Our response for recommendation 1

We will:

• research and identify cost elements that require a common understanding, which may result in changes to section 3.1031-2
• develop guidance material and tools to explain how we intend to apply cost-based pricing to ensure it is consistently applied

Recommendation 2

The Supply Manual requires substantive changes to overcome significant shortcomings.

Our response for recommendation 2

We will:

• research, identify and update guidance material to better recognize and reward risk transfer in cost-based pricing:
  • this project will involve comparing international practices
• consider adjustments as an interim measure to determine profit

Recommendation 3

An application manual should be created to assist government procurement practitioners.

Our response for recommendation 3

We will:

• develop guidance material, such as a practitioner’s guide, to aid in consistently applying cost-based pricing and alternatives:
  • the guidance material will include a formal protocol for managing exceptions
• create training material and provide training to staff to reinforce the intended application of the guidance
• incorporate new guidance into training material, such as complex project management

Recommendation 4

The government needs to improve its access to support from military industrial specialists.

Our response for recommendation 4

We will:

• work with National Defence to determine the steps needed to develop this capacity, including when recourse to independent experts should be considered

For example, Public Services and Procurement Canada has hired an independent expert to provide advice on the National Shipbuilding Strategy.

Recommendation 5

Practitioners need to recognize the limitations of the guidance and consider contracting alternatives.

Our response for recommendation 5

We will:

• develop guidance on adopting alternative approaches, such as the use of incentives, and include discussion of suggested use, associated risks and stewardship practices

Recommendation 6

A protocol for enhanced coordination between the departments should be developed.

Our response for recommendation 6

Public Services and Procurement Canada and National Defence will:

• negotiate the protocol through the departmental client service level agreements:
  • these negotiations are underway between Public Services and Procurement Canada and National Defence

Recommendation 7

A management framework for sole-sourced contracting is required, which may include a regulator.

Our response for recommendation 7

We will:

• conduct a study on the feasibility of adopting the following for Canada:
  • the Single Source Regulations Office in the United Kingdom
  • dispute resolution processes in the United States and the United Kingdom
• establish a structure to manage pricing, one that gives a holistic and impartial view of how we apply guidance and coordinate input from stakeholders, other departments and industry, to ensure Canada continues to use best practices

Our plan of action

Fall 2016

We will:

• put in place an interdepartmental working group that includes industry representatives who will be consulted throughout the research and implementation process

Fall 2016 and winter 2017

We will:

• hire consultants, with clear timelines and deliverables
• start updating the contract cost principles, the profit policy and guidance material

Winter and spring 2017

We will:

• issue a policy notification to address the immediate concern with the profit policy as an interim solution
• sign a departmental client service level agreement between Public Services and Procurement Canada and National Defence

2017 to 2018

For all the recommendations, we will:

• research and analyze options
• consult on proposed options to get feedback from key stakeholders
• select the best solution

March 2018

We will:

• complete policy updates and publish guidance
• communicate with stakeholders