Part 13: General Schedule 10: Single source defence contracts Contract profit rate
Section 17(1) and (2) of the DRA provides that SSCRs must make provision for determining the contract profit rate (CPR) for a QDC, and that such a determination must be made by taking six sequential steps.  In broad terms, those six steps are as follows:
Step 1: take the baseline profit rate set by the Secretary of State which is in force at the time the QDC is entered into;
Step 2: adjust that rate by an agreed amount within parameters specified in the SSCRs above or below the baseline profit rate to reflect the risk that the contractor’s actual allowable costs will differ from those estimated when the contract was agreed;
Step 3: deduct from the amount resulting from step 2 an agreed amount so as to ensure that profit arises only once in relation to those allowable costs that relate to the price payable under certain sub-contracts (this is referred to as the "profit on cost once" ("POCO") adjustment);
Step 4: deduct from the amount resulting from step 3 the SSRO funding adjustment which is in force at the time the QDC is entered into (the purpose of the SSRO funding adjustment is to allow the MOD to recoup some of the SSRO’s running costs);
Step 5: increase the amount resulting from step 4 by such amount specified by the Secretary of State, not exceeding an amount specified in the SSCRs, as it considers appropriate to give the contractor a particular financial incentive in relation to specified provisions of the contract; and
Step 6: increase or decrease the amount resulting from step 5 an agreed amount to ensure that the contractor receives an appropriate and reasonable return on the fixed and working capital employed by it to perform the QDC (regulation 11(7) to (9)).
	Step 2 only allows for "the risks of the primary contractor’s actual allowable costs under the contract differing from its estimated allowable costs". This limited definition of risk excludes financial risks that would not be allowable as costs of the contract, such as the risk of incurring a liability to pay liquidated damages, or reputational risks, for which the contractor’s shareholders could legitimately expect to be compensated. It also does not specify that the adjustment should be made specifically for risks borne by the contractor. While it is reasonable to infer that this is the case, it needs to be made explicit.
	The risk to the contractor (and hence the expected reward by way of profit) associated with a particular contract differs substantially for different activity types. For example, contracts to develop and make equipment are considered to be riskier than contracts for works. Therefore, the type of activity to which the contract relates needs to be taken into account when assessing risk.
	Paragraph 9(3)(a) amends section 17 of the DRA to widen the definition of "risk" described in Step 2 in section 17(2) to include financial risks that would not be allowable as costs of the contract, for which the contractor’s shareholders could legitimately expect to be compensated.  The amendment also clarifies the definition of "risk" to provide that activity type may be taken into account when assessing financial risk to reflect that some activities are financially riskier for contractors than others.
	Paragraph 9(3)(b) also amends section 17(2) of the DRA to remove step 3, the profits on cost once (POCO) adjustment and step 4 the SSRO funding adjustment from the profit setting process.  Paragraph 9 also makes consequential amendments to renumber the steps in what is now a four-step process where reference is made to other steps. Both of these steps are intended to speed up and simplify the agreement of profit rates for individual contracts.
	Paragraph 9(3)(e) amends section 17(2) of the DRA to provide the Secretary of State with a power to make SSCRs to set out how and when the incentive fee in new step 3 would be applied.
	Paragraph 10(5) amends section 18 of the DRA by substituting subsection (3)(a) to provide the Secretary of State with a power to make SSCRs that permit, on the application of either party to a QDC or an authorised person, the SSRO to make a determination in relation to all the contract profit steps set out in section 17(2) as amended.  In relation to step 1, whilst the Baseline Profit Rate (BPR) is fixed for a particular year, disputes arise as to which BPR should be applied, particularly to amendments.  Disputes may also arise over the correct application of new step 3, the incentive adjustment.