“Only when the tide goes out do you discover who's been swimming naked.”

--Warren Buffet

The blog involves some musings on the impact of rising inflation on contractor service contract bidding strategies.

When an offeror bids on a US Government fixed price service contract covered by the Service Contract Act (“SCA”), the offeror is supposed to hold the prevailing wages and benefits of SCA covered workers constant over the base year and option years of the contract. The contractor is supposed to wait until the Government exercises the option and then submit a price proposal to the for the out-of-pocket projected cost for the increased wages and benefits. In that way, the fixed priced contractor still gets reimbursed for the wage and benefit escalation in the option years. Indeed, there is a specific “warranty “ provision in FAR 52.222-43(b) whereby the contractor promises that it has not included any contingency in its price proposal for costs which are subject to adjustment under the clause. That promise obviously includes all SCA covered nonexempt employees engaged to work on the contract.

What it does not include, however, is the increased wage and benefits that must be paid to exempt workers. These are executive, administrative, professional, and computer employees who are exempt from both the Fair Labor Standards Act (“FLSA”) and the SCA by virtue of their job duties and method of compensation. Employers are not able to recover any price adjustment in a fixed price contract for escalations paid to such exempt workers. Thus, those anticipated labor escalation costs must be built into the proposed contract price at the onset.

That subject is particularly dicey today since it requires that the contractor guess at the future inflation rate and the anticipated escalation of salaries for these kinds of exempt employees. Do you think the inflation is transitory or endemic? In other words, do you feel lucky punk?

If you had bid on a government service contract back in March 2020, in the midst of the economic downturn arising from the pandemic, you were bidding in a different era than today. The issue of that moment was possible deflation, and projected wage increases were likely trivial. Presumably, those offers had modest escalations built in.

Fast forward to today. The inflation monster is escaping the pen. The inflation rate of the CPI-U index was 0.9 % for October 2021 and 0.8% for November 2021. If that is annualized, it would be 10.2% inflation. And make no mistake about it, in my view that number under reports the inflation rate, because it is held back by a bogus owner’s equivalent rent estimated factor which is being used to underreport the true inflation rate. If , back in the early pandemic days, you only escalated the exempt employee wages by 2% for the next four option years, you may end up being out a lot of money. Ask contractors in Argentina, Venezuela or Zimbabwe what happens when hyper-inflation hits. And you don’t need that kind of Weimar Republic inflation to destroy your business.

The conundrum faced by employers today is what inflation factor to build into their service contract bid or proposal for option year increases for exempt employees. If you underestimate future inflation, you may face ruination. If you fully factor the coming price tsunami into your offer price, you may end up too bidding too high and not get the award of the contract. Afterall, the award often goes to the “greater fool” who underbids.  And one area of foolishness is what kind of escalation to build into your bid.

Another area of foolishness is not including a factor for unabsorbed overhead, G&A and profit on the exempt employee wage and benefit escalations.  The trade-off under the SCA price adjustment clause for nonexempt workers is that the contractor will get an adjustment, but the adjustment is “inequitable”, at least to the extent it squeezes out overhead, G&A and profit.  Thus, a prudent contractor builds the anticipated but unabsorbed OH, G&A and profit into the basic price each option year when bidding, because those costs will not be subject to a price adjustment. 

It is a new era for bidding. This time may indeed be different, at least to anyone who came of age after 1981.