Top Tips: Government Contract Pricing During Inflationary Periods

It’s been over 40 years since we’ve seen inflation rates like today’s. And inflation will continue as long as there’s a demand for limited services and supplies. If the government institutes tariffs on incoming goods and price controls, these certainly won’t aid existing product shortages and could potentially magnify them.

According to the U.S. Bureau of Labor Statistics, the consumer price index (CPI)—one measure of inflation—rose 8.3% from January 2021 to January 2022. Though the year-to-year rate has leveled off to 2.6% since then, prices are still significantly higher in the U.S. than they were pre-COVID. That means contractors’ costs have ballooned. But has profitability? Not so much. This blog offers tips to correct that.

The Criticality of Cost Modeling

Now more than ever, government contracting requires crystal-ball predictions to address every dimension of cost and pricing, otherwise known as cost modeling. Accurate cost modeling can be the difference between a profitable contract and a financial burden.

Contractors: Consider developing detailed cost models that account for various inflationary scenarios. You might want to create best-case, worst-case and most-likely projections for key cost drivers such as labor, materials and overhead. Doing this will better prepare you to negotiate contracts that protect your interests. 

For example, let's say you're bidding on a multi-year IT services contract. Your cost model might consider factors like projected salary increases for IT professionals, potential rises in software licensing costs and changes in hardware prices. This detailed approach allows you to build more accurate pricing proposals and helps you identify areas where you might need to negotiate for economic price adjustments.

But choose the model you do submit wisely. If you significantly overestimate inflation, your offer will likely be higher than your competitors’, resulting in failure to win an award. But if you underestimate inflation, you may end up underwater – performing a contract at a significant loss. That said, there are certain cases where agencies will provide guardrails for inflation adjustment. 

What is Inflation Adjustment in a Government Contract?

Inflation adjustment, also known as economic price adjustment (EPA), is a crucial mechanism in some government contracts that helps balance the financial risks between contractors and the government.

It allows for periodic adjustments to contract prices based on changes in specific economic indicators, such as material costs.

It's important to note that inflation adjustments aren't automatic. As a contractor, you typically must ask for them during the proposal process.

Which Types of Contracts Allow for Inflation Adjustment?

Cost-reimbursement Contracts

In a cost-reimbursement contract, your partner agency will pay actual and reasonable costs you’ve incurred. However, any fee you suggest to compensate your team for the risks of delivering on that commitment—in other words, a margin increase— will be very low.

For cost-reimbursement contracts that include Limitation of Cost or Limitation of Funding clauses, you’re obligated to notify your agency Contracting Officer (CO) as you approach the limits of the contract’s funding. As a contractor, the upside is that you don’t have to continue performance beyond what you can accomplish under that funding ceiling. The onus, then, is on your agency’s CO to seek more funding to continue your performance.

Fixed-Price Contracts

How and when can COs offer inflation-related adjustments to contractors in fixed-price contracts? The short answer is that concessions can’t be solely related to inflation.

Though many would argue that inflation-rated costs should be shared by the contractor and the government, the reality of this perspective hasn’t fully taken hold. Concessions are also generally dependent upon the CO making an additional request in contract delivery that’s new to the contractor and not included in the original RFP. 

In this respect, agencies seem quick to adopt an idealistic perspective—at least for the government— under the Changes Clause in the Federal Acquisition Regulation (FAR) section that speaks to fixed-price contracts.

But that doesn’t completely rule out more realistic pricing for contractors and the potential for profit.

Fixed-price contracts that already contain an adjustments clause—language designed to balance the risk between the government and a contractor in situations where there is significant uncertainty about future economic conditions—have the best hope for contractor profitability, and many COs are now adding that clause to new acquisition solicitations.

Ways to Handle Inflationary Scenarios for Fixed-Price Contracts

Let’s take a look at how you can approach each of the inflation-related setups currently in play for fixed-price contracts at the Department of Defense (DoD) and other agencies:

Figure Out How to Negotiate Adjustments for Existing Contracts

Currently, COs can make a good-faith adjustment to a fixed-price contract in cases covered by the standard Changes Clause in FAR 52.243-1. The DoD and other agencies are trying to find other ways to help contractors address unanticipated inflation, which is the state we live and work in now.

The government still has a somewhat limited view of the standard Changes Clause. The clause allows for adjustments only when there is a CO-directed change within the scope of the contract, which means you can’t receive pricing adjustment permission unless your CO partner has shifted something within the proposal process that warrants more funds. In other words, the government’s recent guidance discourages COs from granting equitable adjustments based purely on inflation.

Still, the guidance leaves open the possibility of inflation-related claims when a CO has directed changes within the scope of the clause. This could include situations where a CO administers a different method of performance because of changed economic conditions (e.g., directions to use an alternative services method from the one specified in the original proposal). 

Yes, if you’re experiencing increased costs, you should think broadly about potential changes caused by the CO, which could open the door to adjustments.

Your proactive next steps: Study the contents of your current fixed-price proposal versions carefully, and look for language indicating that a CO requested a change or changes. Bring these passages up to your agency CO and ask that an adjustment be made based on 1.) increased contractor costs due to change orders in the contract, combined with  2.) more equitable inflationary measures. 

Look for Contracts that Already Include Economic Adjustment Clauses

Fortunately, agencies developing RFPs are usually now willing to include economic adjustment clauses, provided they don’t establish pricing expectations based on worst-case projections of market conditions. (The government expects COs to watch their agencies’ backs, first and foremost.)

Also, COs must be mindful that inflation’s impacts vary widely, depending on the nature of certain costs and where they fall within their appropriate price indexes.

Sadly, any clause placed in a contract can’t apply to the profit portion of the contract. So your expected cost adjustments should map to just that—your costs.

Your proactive next steps: Seek out contract RFPs with an economic adjustment clause. Some include it, especially those posted from 2022 onward. A little research can save you a world of headaches and many lost dollars.

Request Concessions for New, Fixed-Price Solicitations and Contracts

Any fixed-price RFP currently in development can include EPA clauses, specified by the FAR and Defense Federal Acquisition Regulation Supplement (DFARS). 

Realistic COs can and do insert these clauses into draft and finished RFPs. In the former situation, if you’re not seeing the language you need upon review, ask your agency partner CO to include it. (COs can reference these document sections for appropriate clauses: FAR 52.216-4; DFARS 252.216-7000.)

Clauses allow pricing to adjust both ways: They enable upward and downward revision of contract pricing if it meets contingencies. Adjustments are based on established prices and actual costs or index costs of labor and materials. 

There are a few prerequisites in place on the government’s end: 

• Clauses have to benefit both the government and the contractor in some way.
• The contract length is a primary consideration; ideally, clauses are included in more extended contracts.
• The total contract price must exceed the simplified acquisition threshold, currently $250K.
• COs should exclude costs that don’t vary with inflation.

Your proactive next steps: Whenever you can, submit pre-RFP questions to your CO and encourage the inclusion of EPA clauses in new solicitations, especially in draft RFPs you’re asked to edit. Note: The term “Economic Price Adjustment” doesn’t necessarily have to appear in a contract, as any clause that addresses pricing changes due to economic conditions is effectively an EPA clause. But again, when in doubt, ask.

Predict Pricing More Accurately with an Automated Platform

Get closer to your ideal profit potential in every contract by using Deltek ProPricer, the same pricing adjustment platform many DoD agencies use. Experience speed and efficiency in contract negotiations that can help make a win/win proposal a reality—even during inflation.