Government Contracts (Hansard, 20 March 1975)

§ Mr. Arnold Shaw
asked the Chancellor of the Exchequer whether he has completed his discussions with the Confederation of British Industry on the recommendations made recently by the Review Board for Government Contracts.

§ Mr. Joel Barnett:
Yes. Interim updated arrangements for non-competitive Government contracts have now been agreed. I have exchanged letters with the President of the CBI as follows:
526W
which have been accepted by the Treasury in satisfaction of estate duty during the period since the enactment of the Finance Act 1973 on 25th July of that year, together with the net value in each case after allowing for exemption from estate duty and capital gains tax.

§ Mr. Joel Barnett:
Offers of works of art pre-eminent for aesthetic merit or historical value which have been accepted in lieu of estate duty in the period in question are:
Treasury Chambers,
Parliament Street,
SW1P 3AG.
12th March 1975
Dear Mr. Bateman,
REPORT ON THE GENERAL REVIEW OP THE PROFIT FORMULA FOR NONCOMPETITIVE GOVERNMENT CONTRACTS
The Chairman of the Review Board for Government Contracts submitted to us on 31st October 1974 the Board's Report on the General Review of the Profit Formula for Non-Competititve Government Contracts, in accordance with paragraph 24 of the Memorandum of Agreement between the Government and the CBI dated March 1970 and set out as Appendix A of the Report.
Discussions have been held between Government officials and CBI representatives, on the basis of this Report, concerning the revision of the profit formula arrangements. Following these discussions, I write to propose to you that new arrangements should be adopted. These proposed arrangements are set out in the Annex to this letter. Except where amended by the arrangements in the Annex, I propose that the existing arrangements should continue.
In addition:—
(a) I should like to emphasise the importance of equality of information and the need to fix prices as early as practicable. The Government regard the respect by both sides of these basic features of the 1968 Agreement relating to the pricing of noncompetitive contracts as essential to the satisfactory working of the Agreement. I suggest that by this present exchange we should both re-affirm the intention of 527 the 1968 Agreement that as a result of equality of information the Government and the contractor will be in the same position at the time the price is fixed; and that we should undertake to use our best endeavours to ensure that the obligations in this respect which are recognised in the Agreement should be fully observed by both sides.

The Government for its part accepts, as I understand the CBI equally accepts, the Review Board's comments on the importance of earlier pricing, and I trust that both sides will continue to take all practical steps towards the achievement of this objective. In this context I should welcome your endorsement of the importance of the precepts set out in Appendix D to the Review Board's report; and in particular your agreement that purchasing departments and contractors should take all practical steps to ensure that all information which has a material bearing on the fixing of a fair and reasonable price is taken into account in the pricing.

(b)) The Review Board referred in their report to the primacy to be attached, in policy-making in the area of non-competitive contracts, to the securing of value for money and the efficient use of resources. I agree very much with the Board's view on this point, and I am confident that it commends itself equally to you.

(c) I accept the Board's recommendation that purchasing departments and contractors should give further thought to selecting more relevant units, such as separate divisions of a company, when negotiating CP/CE ratios, and I propose that we should both, consistently with (a) above, agree to give it our full support.
If you are in agreement with the proposed arrangements set out in the Annex, and with what I have said above, I suggest that this letter and your reply in that sense should form an agreement between us.
Yours sincerely,
Joel Barnett.
ANNEX
NON-COMPETITIVE GOVERNMENT
CONTRACTS PROFIT FORMULA
1.New profit formula arrangements will take effect from 1st march 1975 and will them apply to:

(a)risk contracts where no price arrangement has been agreed by 1st March 1975 except that risk contracts completed before 1st January 1974 will be priced in accordance with the arrangements in force prior to this agreement; and

(b)non-risk work carried out after 1st March 1975 for which no arrangement for profit has been agreed by that date.
2.The new arrangements will be of an interim nature, and apply until 29th February 1976 or such later date as may be agreed between the Government and the CBI. As soon as may be practicable after a consensus has been reached in the light of the 528W Report of the Sandilands Committee, or at the end of 1975, if such consensus has not emerged by then, the Review Board should be asked to review the position urgently to consider whether any interim readjustment of the formula is required.
3. The now arrangements will be as follows:—
i. The overall target rate of return on capital employed, on an historic basis, arrived at by reference to the best present estimate available of recently earned company profits, will be 18 per cent.

ii. Whilst adhering to the principle of an overall target rate of return on capital employed, the structure of the profit formula is changed so as to increase the proportion of the profit which is related directely to cost of production.

iii. The target rates of return on capital employed for risk and non-risk contracts are 19.8 per cent. and 14.4 per cent. respectively, giving a weighted average of 18 per cent. on the basis that the proportion of risk to non-risk work is two to one. In this context target cost contracts not subject to a maximum price are classified as risk or non-risk contracts according to the basis of the profit rate at the target.

iv. The average CP/CE ratio is taken to be 1.67:1.
4. The new profit rates to be used to give effect to 3 above will be:—
Risk Work
10.8 per cent. on capital employed plus 5.4 per cent. on cost; on the basis of the CP/CE ratio of 1.67:1 this provides an average return on capital employed of 19.8 per cent.
Non-risk Work
9.9 per cent. on capital employed plus (i) 0.7 per cent. on cost, and (ii) up to a further 4 per cent. on cost for efficiency (2 per cent, being the assumed average addition); on the basis of the CP/CE ratio of 1.67 to I, this provides an average return on capital employed of 14.4 per cent.
5. For contracts and sub-contracts to which the new profit rates at 4 above apply and where the CP/CE ratio does not exceed 2.5 to 1, the reference points stated in paragraph 16 of the Memorandum of Agreement become, respectively, 33.75 per cent. profit on capital employed and 4.5 per cent. loss on capital employed.
6. For contracts and sub-contracts to which the new profit rates at 4 above apply, and where the CP/CE ratio exceeds 2.5 to 1, the reference points are defined in terms of a return on cost of production, and become, respectively, 13.5 per cent. profit on cost and 1.8 per cent. loss on cost.
7. With regard to the efficiency allowance in non-risk contracts, it is open to a contractor to make a claim for a higher than average allowance, and a contractor is entitled to be supplied on request with a reasoned statement of why a particular efficiency allowance is considered to be appropriate (except that a con- 529W tractor is not so entitled where the allowance offered or claimed is acceptable to the other party).
R. M. Bateman, Esq.,
President,
Confederation of British Industry,
21 Tothill Street,
London, SW1H 9LP.
CONFEDERATION OF BRITISH
INDUSTRY
21, Tothill Street,
London SW1H 9LP.
12th March 1975.
From the President: R. M. Bateman.
DEAR CHIEF SECRETARY,
Report on the General Review of the Profit Formula for Non-Competitive Government Contracts
Thank you for your letter of 12th March following the discussions held between Government officials and CBI representatives on the basis of the Review Board's Report on the General Review submitted to us on 31st October 1974 by the Chairman of the Board.
I would now like to confirm to you that the CBI is prepared to accept and to recommend to CBI member firms and trade associations the new interim arrangements as set out in the Annex to your letter, which will apply until 29th February 1976 or such later date as may be agreed between the Government and the CBI. I agree that, except where amended by the arrangements set out in the Annex to your letter, the existing arrangements should continue.
In addition:
(a) The CBI reaffirms the intention of the 1968 Agreement that as a result of equality of information the Government and the Contractor will be in the same position at the time the price is fixed; the CBI undertakes to use its best endeavours to ensure that the obligations in this respect which are recognised in the Agreement should be fully observed by both sides.

The CBI accepts the Review Board's comments on the importance of earlier pricing and trusts that both sides will continue to take all practical steps towards the achievement of this objective. In this context the CBI endorses the importance of the precepts set out in Appendix D to the Review Board's Report and accepts that purchasing departments and Contractors should take all practical steps to ensure that all information which has a material bearing on the fixing of a fair and reasonable price is taken into account in the pricing.

(b) The CBI fully supports the Review Board's reference in their Report to the primacy to be attached, in policy making in the area of non-competitive contracts, to the securing of value for money and the efficient use of resources. The CBI welcomes the Government's endorsement of this point.

(c) The CBI accepts and joins with the Government in supporting the Board's recommendation that purchasing departments and Contractors should give further thought 530 to selecting more relevant units, such as separate divisions of a company, when negotiating CP/CE ratios, consistently with (a) above.
I agree that your letter of 12th March and my reply should form an agreement between US.
Yours sincerely,
RALPH BATEMAN.
The Rt. Hon. Joel Barnett, MP,
Chief Secretary to the Treasury,
Parliament Street,
London, SW1P 3AG.