How a Service Company Bids

Introduction

A number of years ago, I was working at a local Air Force Base. The defense contractor for whom I worked, although small in comparison with the large defense contactors (in those days, CSC, SAIC, Mitre, etc.), was one of the few major players at this particular military installation.

As usual, in most defense contractor organizations, there was an on-site Program Manager who headed up the entire on-site organization. Under him were a number of department managers and, beneath them, section managers.

The Program Manager was a highly experienced manager with whom I had formed a personal bond. We were both about the same age. We both shared many of the same experiences. Almost every evening, at the close of work, I would wander into his office and share some past experiences over a cup of coffee.

One day, he told me that a young programmer, I'll call her Debbie, had quit. I was surprised. I knew Debbie as a budding junior programmer who had shown her talents on a number of occasions. I asked what reason she had given for her sudden departure. My manager friend smiled and said "Over salary." I was confused by his response. All members of the program had been recruited and had agreed to an offered salary. So I asked him to explain and he responded "Somehow she had found out how much the Air Force was paying us for her services and she felt that she was owed a significantly larger salary."

Of course my friend had tried to explain how service companies charged their customers for their employee's services, but to no avail. Debbie walked out, fuming that she had been defrauded.

In this short note, I'll explain why Debbie was wrong.

The Bid

Most defense contractors go through a bidding process to obtain work under a Government contract. The real sticky issue is the estimate of how much the contractor's employees will cost. This is true of a Fixed-price contract [^] as well as Time and materials [^] contracts.

What Debbie wasn't aware of was that an employer will inflate an employee's salary to arrive at what that employee's services will cost the Government. This process is governed by Federal Regulation [^] primarily the Federal Acquisition Regulation (FAR) [^].

The items that inflate an employee's salary include, but are not limited to:

• Employee Benefits [^]
• Overhead [^]
• General And Administrative Expense (G&A) [^]
• Profit [^]

Application of the Cost Factors

Obviously, an employee's salary is the first cost, and so

bid = employee's salary

Employee benefits might include

1. Health Insurance
2. Retirement Savings Plans
3. Paid Maternity and Paternity Leave
4. Paid Time Off
5. Paid Volunteer Time Off
6. Family Planning Options
7. Fridays Off
8. Travel Stipend
9. Student Loan Reimbursement
10. Parental Support
11. "Snow Days"
12. Kindle Perks
13. Professional Development

Employee benefits (fringe) are usually applied as a percentage. I will use 37% for the purposes of this calculation. Thus

bid += 0.37 * bid

Overhead costs vary widely. An estimate of 40% will be used here. The actual overhead cost is continuously calculated by the company's financial organization.

bid += 0.40 * bid

For the General And Administrative cost we will use a value of 4%. Thus

bid += 0.04 * bid

Lastly comes profit. When I worked for CSC, the profit was 6%. Some companies sought a profit of as high as 50%. I point out that those firms seldom won Government contracts. I will use a value of 10%.

bid += 0.1 * bid

So as an example, let's take Debbie, who, for the sake of example, had a base salary of $25,000. The computations then become

bid = 25000                        // Base
bid = 25000 + 0.37 * 25000 = 34250 // Fringe
bid = 34250 + 0.40 * 34250 = 47950 // Overhead
bid = 47950 + 0.04 * 47950 = 49868 // G&A
bid = 49868 + 0.10 * 49868 = 54855 // Profit

So Debbie will be bid at $54,855. Not understanding how the amount charged the Air Force was calculated led Debbie to leave the employ of a company that was perfectly honest.

Postscript

To insure that I didn't misrepresent the process, I sent a draft of this note to my first manager at CSC, asking for his review. He responded

The work is not exactly what we had used at that time, but is a plausible accounting system and the numbers are also well within the probable range. If I were you I'd go with it as is!

You might mention that if she had wanted to go without all the fringe items (such as in a third world country) it would be a lot less costly.

Harry Kline

Conclusion

I hope this note has provided an understanding of how the bidding process occurs. In general, most contractors will multiply an employee's salary by between 2 and 2.5 to obtain a bidding value.