50. In many instances, the contractor may seek to charge a management fee, or "margin" on top of its underlying sub-contractor's costs. Research suggests that the approach to these costs varies widely from Project to Project, in terms of whether margins are applied and, if so, what percentage fee is proposed.23
51. Generally speaking, the level of margin should reflect the value added by the contractor. If it is taking an increased risk as a result of the Change or is likely to incur increased costs in managing sub-contractors' input, then a management fee may be appropriate. PUK's guidance on this point states that: "It is unlikely that low value or medium value changes will justify this type of mark-up and where these are asked for on high value changes, [contractors] should demonstrate why these mark-ups are justified and where they were agreed to in the procurement."24
52. Appendix A sets out some examples of where contractors may suggest adding a margin to the costs of a Change, together with a recommended approach in each case. This information has been provided by the FsAST acquisition team and has been tested with some industry partners in that sector and is acceptable to them.
53. Where the MOD has asked the contractor to obtain additional funding for a Change, no separate mark-up should be included in the costs of the Change in respect of sub-contractor performance risk, because this will already have been factored-in to the costs of the additional finance25.
54. If best practice were being applied during procurement, the MOD's statement of requirement should include an obligation on the contractor to process changes. That way, the service of processing Changes would be included by the contractor in the original Project costs and make claims for management fees less justifiable. It could also form part of the payment mechanism, which would allow the MOD to incentivise the contractor to process Changes efficiently. As mentioned earlier in this guidance in many existing contracts, there is no direct incentive on the contractor to do so. This principle may be considered by acquisition team members seeking to re-negotiate existing Change drafting or to put in place informal Change protocols, as described at paragraph 14, above. However, a careful approach is necessary to ensure that any price increases proposed by the contractor to meet such an obligation represents value for money.
55. As a matter of policy, a margin should not be charged where shareholders of the contractor are also affiliates (i.e. holding companies or subsidiaries) of the sub-contractors involved in the Change. To do so would allow the companies involved to obtain "profit on profit". This position would not be acceptable to the MOD.26
56. Experience has shown that contractors take different approaches to charging mark-up on Small Works Changes. These Changes are often carried out by sub-contractors, rather than the contractor and do not increase the level of risk borne by the contractor. Therefore, mark-up on Small Works Changes is "very often not justified"27 and should be rejected. The contractor should be asked to verify any project management fee for Small/Medium Changes.
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23 See the report by the Comptroller and Auditor General HC 205 Session 2007-2008, dated 14 January 2008, page 17, paras. 2.18-2.22: "Management fees have ranged from 2 per cent to as much as 25 per cent of the value of the changes, adding up to an estimated £6 million paid in SPV fees for changes made in 2006."
24 See Partnerships UK's Operational Taskforce Note 3: "Variations Protocol for Operational Projects (entered into prior to Standardisation of PFI Contracts version 4)" dated March 2008, Section 2.29.
25 See Partnerships UK's Operational Taskforce Note 3: "Variations Protocol for Operational Projects (entered into prior to Standardisation of PFI Contracts version 4)" dated March 2008, Section 2.22, bullet point 5.
26 In addition, Partnerships UK's Operational Taskforce Note 3: "Variations Protocol for Operational Projects (entered into prior to Standardisation of PFI Contracts version 4)" dated March 2008, Section 2.27 states that "Contractors and SPVs should not be charging mark-ups on mark-ups for example".
27 Report by the Comptroller and Auditor General HC 205 Session 2007-2008, dated 14 January 2008, page 5, para. c iv.