My Lords, this amendment seeks to remove Clause 16 of the Bill.
The clause is essential to ensure the consistent and widespread application of the new framework to all types of contracts used by the Government in single-source procurement. The purpose of Clause 16 is to allow for qualifying defence contracts that use a target price rather than a fixed price. These target-price contracts include sharing arrangements in the event of cost overruns or underruns. The benefits of any cost reductions are shared by the MoD and the supplier, as are the risks of costs being greater than anticipated. They are usually referred to as target-price incentive fee contracts, as the noble Lord has said. This kind of contracting approach is a model often used in high- value single-source MoD procurements where there is insufficient pricing certainty to make a firm or fixed-price contract a sensible option. In the past they have accounted for approximately 40% of our single-source contracts by value.
The Typhoon-availability contract, which provides support to the RAF’s Typhoon fleet, is one such contract. We want to retain the ability to use these target-cost contracts. We also do not want these contracts to be excluded from all the protections offered to both parties by Part 2. Clause 16 ensures that such target-cost incentive fee contracts, or indeed any other pain/gain share models based on a target price, can benefit from all the protections of the new regime.
Target-cost contracts are typically used when it is not reasonable for either party to take the risk of a firm price at the outset of the contract. This risk may be so great that in order to accept it a supplier would have to price in a very large contingency. This does not represent value for money. In this case, the price at the outset is deemed to be a target price. The final price is determined by comparing actual incurred allowable costs with those used to set the target price. Contractually agreed terms specify the share each party takes, whether 50:50 or some other split. Clause 16 ensures that the allowable costs included in the target price, and the allowable costs later agreed as the actual costs, must conform to all the pricing rules within the Bill. It is possible that there might be a disagreement at the end of a contract over what the actual costs were. In this case Clause 16 allows one or both of the contracting parties to ask the independent SSRO to make an expert determination. This helps ensure that disagreements are not overly prolonged.
Clause 16 also specifies that Clause 21—“Final price adjustment”—does not apply to target-cost incentive fee contracts. This requires a little explanation. The purpose of Clause 21 is to deal with any excessive
profits or losses that might apply to firm- and fixed-price contracts. Most of our single-source contracts—approximately 60% by value—are such firm- or fixed-price contracts. A fixed price is typically used for contracts that are not risky enough to justify the use of a target-cost approach. They provide suppliers with the strongest incentive to become more efficient, as any cost reduction will improve their bottom line. This, in turn, will create better value for money for the taxpayer in lower follow-on prices.
However, when profits become excessively high, we do not want to have to wait until we engage in a follow-on contract. Indeed, it is possible that there will not be any follow-on contract at all. That is why we want to ensure that we get a share of these profits even if we have agreed a fixed price. Equally, we do not want to force a supplier to be subject to potentially crippling losses simply because they agreed to a fixed-price contract. For cutting-edge defence equipment, a contract that did not appear risky at first may turn out to be just that, which is why Clause 21 also provides a minimum protection for suppliers in the event of excessive losses. Because Clauses 16 and 21 both include profit-sharing arrangements, they cannot run simultaneously. That is why Clause 21 is excluded from target-price contracts.
Turning back to the amendment, we would like to maintain both options: the option to agree a fixed- or firm-price contract, with suitable protections for excessive profits and losses, as set out in Clause 21; and the option to agree target-price contracts if the contract is clearly high-risk and a fixed-price contract would not give us value for money. Clause 16 is what allows us to do this. The clauses have clearly distinct purposes and will be used in different cases.
Target-price contracts typically account for more than £2 billion worth of contracts per annum. This clause is therefore essential to the overall functioning of the new framework and must remain within the Bill if the substantial financial benefits expected under Part 2 are to be realised. I hope that this explains our position, and I therefore urge the noble Lord to withdraw his amendment.