Federal government contractors are getting hit by inflation and may be wondering – does the government even care that my costs have increased oh so very much?
Short Answer: Yes. And there is even evidence that the government cares! The evidence is a Department of Defense Memo to its acquisition teams providing guidance on working with contractors given inflation’s impact on costs. (CLICK HERE FOR THE MEMO)
Long Answer: Although DoD cares, whether that helps your business depends on your contract type and the clauses in your contracts – like the economic price adjustment clause. (EPA)
The Relief, If Any Depends on the Type of Contact
Cost Reimbursement Contracts: Since the government bears the risk of increased costs, even if related to inflation, the FAR clauses already in the contract may allow the government to increase contract funding. But, if so, contractors must let the government know that incurred costs are reaching the funded amount.
Firm Fixed Price Contracts: Contractors bear the risks of increased costs. (Remember though, you also get the benefit if you manage your costs and perform efficiently, no help when hit by inflation but that’s how it works.) BUT – if your fixed price contract happens to have an economic price adjustment clause, DoD will work with you on costs up to any limit set in your EPA.
Fixed Price Incentive Contracts: Although the contractors generally bear the costs of price increases, in incentive contracts, DoD may adjust a contract’s target profit by applying the contract share ratio to the costs over the contract’s target cost.
The GREAT Economic Price Adjustment Clause (EPA)
Arguably the most important clause in all of this, even before DoD’s memo on inflation, is the economic price adjustment clause (EPA). Note that, there is not just one EPA clause; there are a number of different EPA clauses, depending on your contract type. But, no matter the EPA clause in your contracts, they essentially work the same way: allowing for the contract price to be adjusted up or down based on economic factors.
Generally, the EPA is not in fixed price contracts and is generally included in contracts that are cost reimbursement.
However, the DoD Memo explains that using the EPA, even in new fixed price contracts, “may be an appropriate tool to equitably balance the risk of inflation between the Government and contractor”. Why – because as DoD notes, without an EPA clause, contractors making offers to the government for fixed price contracts, may make an offer based on worst-case scenario that is an offer that covers costs for long term, rising inflation.
The DoD Memo suggests that contracting officers should consider using an EPA clause for new contracts that will start while we are facing high inflation – even possibly include an EPA in fixed price contracts.
Considerations When Using the Economic Price Adjustment Clause
The DoD Memo provides contracting officers with ideas on what they should consider when deciding whether to include an EPA clause in a new contract and when adjusting prices in contracts that exist and have an EPA clause. Here are some of the factors contracting officers were advised to consider:
- Is there concern that market and labor conditions will impact the stability of prices, especially in a longer term contract?
- Can the risk of price increases that a contractor faces be identified and limited to costs most likely impacted by economic changes – like inflation?
- Is there an independent, recognized source that can be used as a basis for measuring cost increases as a result of inflation that is related to the goods or services being provided to the government, like the Bureau of Labor Statistics (BLS) Producer Price Index series, for example?
- Is it possible to identify timeframes/events that will trigger a price adjustment?
- Can there be a clear, mechanical method for calculating price adjustments such as a pre-established formula so it’s just not reopening price negotiations?
The DoD memo also makes clear that using the EPA clause must be fair to DoD and to contractors. Here is what DoD says are some things that make the use of the EPA fair:
- Allow for both upward and downward adjustments to the contract price
- Use an established index as a benchmark for establishing price
- Use a ceiling and even a floor for managing adjustments
What You Should Do
- Review your contracts to see if you have an EPA clause – that means all you subcontractors too – review your subcontracts to assess how your subcontract deals with costs increases
- If your contracts have EPA clauses, and your costs are increasing, notify the contracting officer as soon as you know that costs incurred are approaching any cost ceilings in your contract and make a request for a price adjustment
- If your costs are increasing and you have an EPA clause, decide if you are willing and able to continue performing beyond what is possible within the amount funded because you may have the right not to continue performance
- If you are negotiating new contracts, even fixed price contracts, ask the contracting officer to include an EPA clause remembering that you will bear the risks if costs start going down
- Review the list of items the contracting officer should consider and, gather that information for the contracting officer
- If you are a prime contractor, develop plans for managing your subcontractors, to include even being prepared to replace subcontractors who may walk away
- Pushback if the government wants you to hold pricing open for a long time without the right to adjust costs.
Finally, as Warren Buffet said:
“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital.”
So, keeping doing your arithmetic as you run your business and pursue opportunities.