New method for calculating profit rate on single source defence contracts announced by SSRO - GOV.UK

Single source procurement represented around 53 per cent of new MOD contracts in 2014/15 and the MOD spent approximately £8.3 billion on single source contracts that year.

The baseline profit rate itself is due to be announced by the Secretary of State for Defence by mid-March and will apply to new qualifying contracts signed from 1 April 2016.

The main change is that the rate will be determined by considering the profit rates achieved by a more international and a more appropriate range of companies. Previously only companies

headquartered in the UK were considered, including some with little or no relevance to defence.

The SSRO was intending to recommend a number of baseline profit rates for 2016/17, including two main activity types, ‘develop and make’ and ‘provide and maintain’. It was also considering

rates for specific categories of work that would not fall into these two broad categories, such as ancillary services, and a composite rate for ‘develop and make’ and ‘provide and maintain’,

to address contracts that had significant elements of both activity types.

However, before the finalisation of the SSRO’s proposals, the Secretary of State issued an instruction that the methodology used to calculate profit rates for UK single source contracts

should result in setting a single baseline profit rate in 2016/17.

Explaining the changes, Jeremy Newman, Chair of the SSRO, said:

The new methodology identifies comparable companies in two categories of activity: ‘develop and make’ and ‘provide and maintain’. A three-year rolling average of the profit range for each

set of categories is then determined, and the baseline profit rate is the average of the two. As in previous years, the profit level indicator used will be net cost plus (also known as

return on total cost).

Capital servicing is not accounted for in the baseline rate but will be included in calculations for the actual rate for individual contracts. Three rates will be set for calculating capital

servicing: for fixed capital, positive working capital and negative working capital. The methodology which will be used to calculate these remains largely unchanged, but includes the use of

more appropriate corporate bonds.