§ Mr. Ronald Brown
asked the Chancellor of the Exchequer whether he has yet received from the Review Board for Government Contracts its Report on the Second General Review of the Profit Formula for Non-Competitive Government Contracts ; and, if so, what decisions the Government have reached.
§ Mr. Joel Barnett:
The Report was submitted to the Government on 15th July 1977 and a copy has been placed in the Library. The Report formed the basis of discussions with the Confederation of British Industry, which have now been completed. Both the Government and the CBI have agreed to accept all the Board's recommendations. The agreement has been formalised by an exchange of letters with the President of the CBI. The texts of the letters are as follows:
From the Chief Secretary to Lord Watkinson, 4 October 1977.
REPORT ON THE SECOND GENERAL REVIEW OF THE PROFIT FORMULA FOR NON- COMPETITIVE GOVERNMENT CONTRACTS
This report by the Review Board for Government Contracts was submitted to us by the 4W Chairman on 15 July 1977, as provided in paragraph 24 of the 1968 Memorandum of Agreement between the Government and the CBI.
Discussions on the report between Government officials and CBI representatives have now been completed. In the light of these, I write to you to propose that the arrangements put forward by the Board for consideration by us both should be accepted as they stand. The main features of the arrangements are set out in the Annex to this letter.
If you agree with the arrangements incorporated in the report, I propose that they be implemented with effect from 1 October 1977. The revised arrangements would then apply to:
- (a) risk contracts where no price arrangement has been agreed by this effective date; and
- (b) non-risk work carried out after the effective date for which no arrangement for profit has been agreed by that date.
The report makes various comments and recommendations which will require full co-operation between Departments placing noncompetitive contracts and the contractors who carry them out. In particular I attach importance to the implementation of the proposals in the document "Working Guidelines for the Pricing of Non-Competitive Risk Contracts" (General Notice to Defence Contractors No. 4 refers); to the increased use of budgeted or forecast information for determining the cost of production to capital employed (CP/CE) ratios relevant to the periods when contract work will be carried out; and to the establishment, wherever practicable, of CP/CE) ratios for relevant units or divisions of companies. Regard should be had to the need to avoid undue delay in pricing contracts as a consequence of implementing these proposals.
I also welcome the Board's recommendation that, where there is genuine difficulty in classifying a contract at the outset as between risk and non-risk, the contract should by agreement be placed on a non-risk basis but with a specific statement of the intention to introduce incentive pricing at an agreed stage. I accept that cases where this arrangement might be appropriate would be exceptional.
I should be grateful for your assurance that the CHI attach the same importance to both sides co-operating in the manner recommended by the Board as I do, and will use its best endeavours to this end.
NON-COMPETITIVE GOVERNMENT CONTRACTS PROFIT FORMULA
New profit formula arrangements will take effect from 1st October 1977 and will then apply to:
- (a)risk contracts where no price arrangement has been agreed by 1st October 197; and
- (b)non-risk work carried out after 1st October 1977 for which no arrangement has been agreed by that date.
The new arrangements will not necessarily apply for a full three-year period. The Review 5W Board for Government Contracts will be invited to carry out an interim review, the date and terms of reference for which shall be determined by agreement between the Government and the CBI, after consultation with the Board.
3. The new arrangements will be as follows:
- (i) The overall target rate of return on capital employed, on an historic cost basis, will be 20 per cent.
- (ii)The proportion of risk to non-risk shall be taken to be three-fifths/two-fifths.
- (iii)The target rates of return on capital employed for risk and non-risk contracts shall be 23 per cent. and 16 per cent. respectively, giving a weighted average of approximately 20 per cent. on the basis that the proportion of risk to non-risk work is assumed to be 175 to1.
- (iv)The average CP/CE ratio is taken to be 2725 to 1.
4. The new profit rates to be used to give effect to 3 above will be:
14 per cent. on capital employed plus 4 per cent. on cost ; on the basis of the CP/CE ratio of 2.25 to 1, this provides an average return on capital employed of 23 per cent.
1175 per cent. on capital employed plus (i)075 per cent. on cost, and (ii) up to a further 3 per cent. on cost for efficiency (1.5 per cent. being the assumed average addition) on the basis of the CP/CE ratio of 2725 to 1, this provides an average return on capital employed of 16 per cent.
5. For target cost contracts which include a minimum profit provision, the target profit rate shall be negotiated between the parties within the range of the risk and non-risk rates.
6. In exceptional cases where it is accepted that there is genuine difficulty in classifying a contract at the outset as between risk and non-risk, the contract shall, by agreement, be placed initially on a non-risk basis but with a specific statement of intention to introduce incentive pricing at an agreed stage of the contract.
7. For contracts and sub-contracts to which the new profit formula rates at 4 above apply and where the CP/CE ratio does not exceed 3 to I, the reference points stated in paragraphs 16 of the Memorandum of Agreement become respectively 3775 per cent. profit on capital employed and 475 per cent. loss on capital employed.
8. For contracts and sub-contracts to which the new profit formula rates at 4 above apply, and where the CP/CE ratio is greater than 3 to 1, the reference points are defined in terms of a return on cost of production, and become, respectively, 1275 per cent. profit on cost and 175 per cent. loss on cost.6W
These arrangements are set out in full in the Review Board's "Report of the Second General Review of the Profit Formula for Non-Competitive Government Contracts" of 15th July 1977, published by Her Majesty's Stationery Office in August.
LORD WATKINSON'S REPLY OF 7TH OCTOBER 1977
Report on the Second Genera! Review of the Profit Formula for Non-competitive Government Contracts
Thank you for your letter of 4th October. I confirm that the CBI is prepared to accept and to recommend to CBI member firms and trade associations the revised arrangements as put forward by the Review Board for Government Contracts in their "Report on the Second General Review of the Profit Formula for Non-Competitive Government Contracts" dated 15th July 1977. The main features of the arrangements are set out in the Annex to your letter.
The revised arrangements will, as indicated in paragraph 3 of your letter, be implemented with effect from 1st October 1977. The CBI accepts the importance of the Board's proposals set out in paragraph 4 of your letter, and the need for full co-operation between the Departments and contractors concerned to implement these proposals. The CBI will use its best endeavours to this end. I agree that your letter of 4th October 1977 and my reply should form an agreement between us.