Details

Under the Defence Reform Act 2014 (the Act), the Single Source Regulations Office (SSRO) is required annually to review the figures used to determine the contract profit rate for pricing qualifying defence contracts (QDCs) and qualifying sub-contracts (QSCs). Section 19(2) of the Act requires us to provide the Secretary of State with an assessment of the appropriate baseline profit rate, SSRO funding adjustment and capital servicing rates for fixed and working capital for that year.

The Secretary of State for Defence announced his determination of the rates that will apply from 1 April 2021 on 15 March 2021 following a recommendation from the SSRO.

We welcome the Secretary of State’s decision to accept our recommendations on the SSRO funding adjustment and capital servicing rates. The Secretary of State’s determination included a second baseline profit rate in addition to the SSRO’s recommended rate. As required by section 19(6) of the Act the Secretary of State has explained the reasons for the difference in the London Gazette notice, which is available at: https://www.thegazette.co.uk/notice/3760612.

The SSRO plans to launch a consultation on Friday 19 March 2021 to explore if any changes are required to its Guidance on the baseline profit rate and its adjustment (“Profit rate guidance”) to facilitate the application of the additional rate. We will also seek views on how the 2022/23 rates recommendation, and beyond, could accommodate an additional net-zero baseline profit rate to apply to wholly owned UK Government companies.

As in previous years, the SSRO has published information on our methodology and its application this year to aid those who may wish to scrutinise or replicate the approach taken for the SSRO’s 2021/22 recommendations. The practical application of the methodology remains unchanged from last year. We are confident that the methodology is correct, and that our stakeholders will consider it to be robust.

In addition, as in previous years the SSRO has published a supporting information pack that sets out details of the SSRO’s recommendation to the Secretary of State alongside analysis of changes to the baseline profit rate since last year and sensitivity analysis around some of the key judgements in the methodology.

Part of the SSRO’s methodology is the categorisation of comparator companies in to four activity types: Develop and Make, Provide and Maintain, Ancillary Services, and Construction. The baseline profit rate combines results from Develop and Make and Provide and Maintain. The SSRO has published separate fact sheets for each group for information.

Under the Defence Reform Act 2014, the SSRO must provide the Secretary of State with its assessment of the appropriate rates used to determine the contract profit rate for pricing qualifying defence contracts and qualifying sub-contracts. For further information on the methodology used to calculate these rates please see the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Baseline Profit Rate

The baseline profit rate is step 1 of the six-step process for determining the contract profit rate for a qualifying defence contract.

2017/18	2018/19	2019/20	2020/21	2021/22
Underlying rate (unadjusted for capital servicing)	8.39%	9.22%	9.85%	9.80%	9.59%
Capital servicing adjustment	-1.95%	-1.28%	-1.35%	-1.57%	-1.40%
Underlying rate	6.44%	7.94%	8.50%	8.23%	8.19%
Baseline profit rate: three-year rolling average of the underlying rate	7.46%	6.81%	7.63%	8.22%	8.31%

Note: The capital servicing adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which step 6 of the contract profit rate applies. The pre-2017/18 underlying rates used for the three-year average were: 2016/17: 6.06%; 2015/16 (calculated using the Review Board’s methodology): 9.88%.

Data sources

For further information on the data selection approach please see section 7 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. A company update search of the Orbis database was carried out on 5 November 2020 on data update number 202001 using software version 202. The financial data for the calculation was extracted from Orbis at the same time.

Median capital servicing adjusted return on cost of production

Proportion of companies by country

Proportion of companies with defence keyword

Supplementary statistics

Number of companies	347
of which profit making	297
Aggregate turnover	£1,142
Total capital employed (CE)	£315
Average company CP:CE ratio	3.24

Source: Orbis (Cash figures shown in GBP Billions) 

Names of companies in the index

A/S Vestfrost *	DEL BO Impianti S.R.L.	Magna International INC	Spirit Aerosystems Holdings, Inc.
Aaon INC	Deutz AG	Makron Oy	SPX Corp
AAR Corp	Douglas Dynamics, Inc.	Manitex International, Inc. *	SPX Flow, Inc.
AB Transitio	Dril-Quip INC *	Manitou BF	Star Refrigeration Limited
AB Volvo	Dublin Aerospace Limited	Manitowoc Company, Inc. (The)	Steerprop Oy *
Advanced Energy Industries INC	Ducommun INC	Marel HF	Sturm Ruger & CO INC
Aerojet Rocketdyne Holdings, Inc.	Duerr AG	Mariani S.R.L.	Sulzer AG
Aerovironment, Inc.	DXP Enterprises INC	Maschinenfabrik Berthold Hermle AG	Sureserve Group PLC
Aertec Solutions SL.	Electromecanica Naval E Industrial SA	MAX Automation SE *	SVI S.P.A.
Aggreko PLC	Elettronica – Societa PER Azioni	Maxar Technologies Inc.	Swede Ship Marine Aktiebolag *
Airbus SE	Energy Recovery, Inc.	Mccoy Global Inc.	Systemair AB
Alamo Group INC	Enerpac Tool Group Corp	Mcgrath Rentcorp	Tacchi Giacomo E Figli S.P.A. *
ALC (Superholdco) Limited	Espey Manufacturing & Electronics Corp	Meggitt PLC	Talgo,S.A.
Alimak Group AB	Eurofighter Jagdflugzeug GmbH	Mercury Systems INC	Talleres Daumar SL
Allied Motion Technologies, Inc.	Europress Group Oy	Mikron Holding AG	Taylor Devices INC
Allison Transmission Holdings, Inc.	EVS Broadcast Equipment SA	Miller Industries INC	Teagle Holdings Limited
Alstom	Faro Technologies INC *	Mino S.P.A.	Team INC *
Altra Industrial Motion Corp.	Fedegari Autoclavi – S.P.A.	MKS Instruments INC	Teledyne Technologies Incorporated
American Axle & Manufacturing Holdings, Inc. *	Federal Signal Corp	Modine Manufacturing CO	Tennant CO
Ametek INC	Filtronic PLC *	Moen-Gruppen AS	Tenneco Inc.
Amtech Systems INC	Finning International INC	Moog INC	Teradyne INC
Applus Services, S.A.	Fisher (James) & Sons PLC	Morgan Advanced Materials PLC	Terex Corp
Aptiv PLC	Flir Systems INC	Motorola Solutions, Inc.	Tesmec SPA
Archrock, Inc.	Flowserve Corp	Mpac Group PLC	Textron INC
Ashtead Group PLC	Fratelli Mazzocchia S.P.A. *	MS International PLC	Thales
Astec Industries INC	Freightcar America, Inc. *	MTS Systems Corp	THE Shyft Group, Inc.
Astronics Corporation	Frigoveneta S.P.A.	MTU Aero Engines AG (J)	Thwaites Limited
Astronova, Inc.	G.H.B. (Holding) Limited	Muehlhan AG	Thyssenkrupp AG *
Atlas AIR Worldwide Holdings, Inc.	Gama Aviation PLC	National Oilwell Varco, Inc. *	Tomra Systems ASA
Atlas Copco AB	GAP Holdings Limited	Natural GAS Services Group, Inc. *	Tornos Holding S.A
ATS Automation Tooling Systems INC	Gatx Corp	Navistar International Corp	Total Energy Services Inc. *
Autoliv, Inc.	Genasys Inc.	NC Engineering (Hamiltonsbawn) Limited	Trakm8 Holdings PLC *
Avant Tecno Oy	Gencor Industries, Inc.	Nicolas Correa S.A.	Trane Technologies PLC
Axcelis Technologies INC	General Dynamics Corp	Nordson Corp	Transdigm Group Incorporated
Axon Enterprise, Inc. *	General Electric Company	Northrop Grumman Corporation	Trinity Industries INC
Azkoyen SA	Gentex Corp	Novanta INC	Triumph Group INC
Babcock & Wilcox Enterprises, Inc.	Gesellschaft fuer Oeltechnik mit beschraenkter Haftung	Nuova Idropress – Societa’ PER Azioni IN Forma Abbreviata NIP S.P.A.	Tronrud Engineering AS *
Babcock International Group PLC *	Glunz & Jensen Holding A/S *	Oceaneering International INC * (J)	Twin Disc INC
BAE Systems PLC	GO Plant Fleet Services LTD	Officine Bieffebi S.P.A.	Ultra Electronics Holdings PLC
Barco NV	Gorman-Rupp Company (The)	Omav S.P.A.	United Rentals INC
Barnes Group INC	Graco INC	Onto Innovation Inc. *	Univer S.P.A. *
Bevan Group LTD	Graham Corp	Oshkosh Corporation	Vaisala OYJ
Bittium OYJ	Gray & Adams (Doncaster) Limited	Oxford Instruments PLC	Varian Medical Systems INC
BK Technologies INC *	Greenbrier Companies, Inc. (The)	P P S Commercials Limited	VEO Oy
Blonder Tongue Laboratories INC *	Grovgaarden AS	Paccar INC	VMS (Holdings) Limited
Boeing Company (The)	Gulf Island Fabrication INC *	Park Aerospace Corp.	VSE Corp
Boston Scientific Corp	H&E Equipment Services, Inc.	Paul Mueller Company	Wabash National Corp
Brieda E C. – S.R.L.	Havyard Group ASA *	PC TEL INC	Wacker Neuson SE
Broadwind, Inc. *	Heico Corp	Pekkaniska Group Oy	Wartsila OYJ
Bruker Corporation	Heidelberger Druckmaschinen AG *	Perceptron INC *	Washtec AG
Brunvoll Holding AS	Heroux-Devtek INC *	Petards Group PLC *	Waters Corp
Burkhalter Holding AG	Hexcel Corp	Pietro Fiorentini S.P.A.	Welbilt INC
BWX Technologies Inc.	Honeywell International INC	Ponsse OYJ	Westinghouse AIR Brake Technologies Corp
Byggesystemer Norge AS	Huntington Ingalls Industries, Inc.	Portsmouth Aviation Holdings Limited *	William Cook Holdings Limited (J)
C.M.A. S.P.A.	Idex Corp	Powell Industries INC	Williams Shipping Holdings Limited
C.S.C. – S.P.A.	Ii-Vi INC	Prima Industrie SPA	Willis Lease Finance Corp
Caci International INC	Imer International SPA	Qinetiq Group PLC	Wilton Universal Group Limited *
CAE INC	Indra Sistemas SA	Radley Engineering Limited	Wireless Telecom Group INC *
CAI International INC	Inficon Holding AG	Raute OYJ	Witt & SON UK Holdings Limited
Calf S.P.A.	Ingenieria Y Tecnicas de Montajes Lointek SL	Raytheon Technologies Corporation	Wood Group (John) PLC
Calpeda S.P.A.	Innovative Solutions & Support INC	Renew Holdings PLC	Woodward, Inc.
Caprari S.P.A.	Insta Group Oy	Renishaw PLC	Worthington Industries INC
Caterpillar INC	Interroll Holding AG	Rheinmetall AG	Xylem Inc.
Ceco Environmental Corp.	Intevac INC	Ricardo PLC	Zambello Riduttori 2 – S.R.L.
Ceotronics AG	Intricon Corporation *	Robor SRL	Zebra Technologies Corp
Chart Industries INC	Istobal SA	Rockwell Automation, Inc.
Chemring Group PLC	Italcab S.P.A.	Rohde & Schwarz GmbH & Co. Kommanditgesellschaft
CMZ Machine Tool Manufacturer Sociedad Limitada.	Jacobs Engineering Group INC	Rolls-Royce Holdings PLC *
CNH Industrial N.V	John Bean Technologies Corp	Roper Technologies, Inc.
Cognex Corp	Judges Scientific PLC	RWG (Repair & Overhauls) Limited
Coherent INC	Kadant INC	Ryder System INC *
Cohort PLC	Kaman Corp	Saab AB
Cohu INC *	Katsa Oy	Saalasti Oy *
Columbus Mckinnon Corp	Kbr, Inc.	Safran
Comerio Ercole S.P.A.	Kesla OYJ	Saltire Energy Limited
Commercial Vehicle Group, Inc.	Keysight Technologies, Inc.	Samp S.P.A.
Comtech Telecommunications Corp	KIS Partners AS	Sandvik AB
Construcciones Y Auxiliar de Ferrocarriles, S.A.	KMG Systems Limited	Schaltbau Holding AG
Continental AG *	Koenig UND Bauer AG	Schlatter Industries AG
Cormach S.R.L.	Komax Holding AG	Schmitt – Elevadores, LDA
Costar Technologies, Inc. *	Konecranes OYJ	Science Applications International Corp
Cowles Holdings Limited	Kongsberg Gruppen ASA (J)	SCM Group S.P.A.
CTA International SAS	Kratos Defense & Security Solutions, Inc.	Sheffield Forgemasters International Limited
CTT Systems AB	Krohne Italia SRL *	Siemens AG
Cubic Corp	KVH Industries INC *	Signature Aviation PLC
Cummins Inc.	L3harris Technologies, Inc.	Skako A/S
Curtiss Wright Corp	LAM Research Corp	Smith & Wesson Brands, Inc.
CVD Equipment Corporation *	Lecitrailer SA	Smith Brothers (Leicester) Limited
Cyberoptics Corp	Leidos Holdings, Inc.	Smiths Group PLC
Dalmec S.P.A.	Leonardo – Finmeccanica S.P.A.	Snc-Lavalin Group INC *
Dana Incorporated	Lillbacka Powerco Oy *	Speedy Hire PLC
Data I/O Corp *	Linamar Corporation	Spirax-Sarco Engineering PLC
Dawsongroup PLC	Lockheed Martin Corp
Deere & CO	Logset Oy
	Macpresse Europa S.R.L.
	Mactaggart Scott (Holdings) Limited

‘*’ Indicates that the company is a loss-maker in the year. The data for loss-makers are not included in the 2021/22 assessment, but the companies will be taken forward for consideration next year.

(J) indicates a company that was not in either the D&M or the P&M activity group last year, but has been added this year.

Capital servicing rates

The capital servicing rates are used as part of the Step 6 Capital Servicing Adjustment (CSA) of the six-step process for determining the contract profit rate for a qualifying defence contract. A corresponding adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which Step 6 of the contract profit rate applies.

2017/18	2018/19	2019/20	2020/21	2021/22
Fixed capital servicing rate	4.84%	4.38%	3.98%	3.66%	3.27%
Positive working capital servicing rate	1.37%	1.21%	1.18%	1.22%	1.33%
Negative working capital servicing rate	0.59%	0.53%	0.53%	0.61%	0.65%

Data sources

For further information on the data selection approach please see section 13 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Rate	Description
Fixed capital servicing rate	Seven-year average of ’15-year BBB GBP’ bonds*	C40515Y INDEX
Positive working capital servicing rate	Three-year average of ‘1-year BBB GBP’ bonds	C4051Y INDEX
Negative working capital servicing rate	Three-year average of Monthly average of UK resident monetary financial institutions’ (excl. Central Bank) sterling weighted average interest rate – time deposits with fixed original maturity <=1 year from private non-financial corporations (in percent) not seasonally adjusted	CFMBI32

Sources: Bloomberg or Bank of England

‘*’ Note: Prior to 31 December 2014 the underlying rate is calculated using the Review Board’s methodology, adding 0.5pp to estimate a BBB- yield.

Trends in capital servicing rates

The SSRO funding adjustment

The SSRO funding adjustment is Step 4 of the six-step process for determining the contract profit rate for a qualifying defence contract. The SSRO will be funded equally by the Secretary of State and industry. Industry funding is intended to be equitably shared across contractors based upon the value of their QDCs.

Calculation of SSRO funding adjustment

SSRO funding adjustment = (SSRO costs-Cost of additional tasks requested by SofS) / (Average annual total Allowable Costs of contracts entered into) × 1/2

Financial year	2017/18	2018/19	2019/20
SSRO running costs (£ thousand)	5,916	6,148	6,336
Cost of additional tasks requested by SofS (£ thousand)	–	–	–
Total Allowable Costs of QDCs and QSCs (£ thousand)	2,692,000	4,899,000	8,414,000

Recommendation		2021/22
SSRO running costs (£ thousand) – 3-year average	a	6,133
Cost of additional tasks requested by SofS (£ thousand) – 3-year average	b	–
Total Allowable Costs of QDCs and QSCs (£ thousand) – 3-year average	c	5,355,000
SSRO funding adjustment = (a-b)/c × 50%		0.057%

Data sources:

For further information on the data selection approach please see section 1 of part 2 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. The SSRO costs and the costs of additional tasks requested by the Secretary of State are from the SSRO Annual Report and Accounts. The total value of contracts is as reported in the latest SSRO Qualifying defence contract statistics.

SSRO funding adjustment history

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1. Introduction

Under the Defence Reform Act 2014 (the Act), the Single Source Regulations Office (SSRO) is required annually to review the figures used to determine the contract profit rate for pricing qualifying defence contracts (QDCs) and qualifying sub-contracts (QSCs). Section 19(2) of the Act requires that, for each financial year, the SSRO must provide the Secretary of State with its assessment of the appropriate baseline profit rate, capital servicing rates for fixed capital and working capital, and the SSRO funding adjustment.

The baseline profit rate is step 1 of the six-step process set out at section 17(2) of the Act and regulation 11 of the Single Source Contract Regulations 2014 (the Regulations) for determining the contract profit rate. The Act and Regulations do not set out how the baseline profit rate should be calculated, but the SSRO must aim to ensure that good value for money is obtained in government expenditure on qualifying defence contracts, and that persons (other than the Secretary of State) who are parties to qualifying defence contracts are paid a fair and reasonable price under those contracts.

The capital servicing rates are used in the determination of the baseline profit rate and as part of step 6 of the six-step process set out in the Act and Regulations for determining the contract profit rate. The Act and Regulations do not set out how the capital servicing rates should be calculated, but the purpose of step 6 is to adjust the contract profit rate so as to ensure that the contractor receives an appropriate and reasonable return on the fixed and working capital employed by the contractor for the purposes of enabling it to perform the contract.

The SSRO funding adjustment is step 4 of the six-step process set out in the Act and Regulations for determining the contract profit rate. The Regulations provide that this adjustment shall be a deduction from the price payable under QDCs and QSCs. The explanatory notes to the Act further set out an expectation that the SSRO will be funded equally by the Secretary of State and industry. Industry funding is intended to be equitably shared across contractors based upon the value of their QDCs.

The SSRO’s Guidance on the baseline profit rate and its adjustment explains how parties to a QDC or QSC apply these rates when determining the contract profit rate.

This document sets out the SSRO’s methodology used to calculate the baseline profit rate, capital servicing rates and SSRO funding adjustment for recommendation to the Secretary of State in January 2021.

The rates, together with the reasons for any difference to the SSRO’s recommendation, must be published by the Secretary of State in accordance with sections 19(4)-(6) of the Act.

2. Key terms and definitions

Activity characterisation	A written description of the group of economic activities and the relevant boundaries which define an activity type.
Activity type	A group of economic activities, defined by the SSRO, which correspond to types of activity that contribute to the delivery of QDCs and QSCs. For example ‘Develop and Make’, ‘Provide and Maintain’, ‘Ancillary Services’ or ‘Construction’.
Comparability analysis	Transactions carried out by comparable companies are used as a benchmark.
Comparability principle	The aim of the baseline profit rate is to provide the starting point in the determination of the contract profit rate (totalling steps 1 to 6). It is set with reference to the returns of companies whose economic activities are included in whole or in part in the activity types that contribute to the delivery of QDCs and QSCs.
Comparable company	A company whose economic activities are included, in whole or in part, within an activity type.
Comparator group	A group of comparable companies undertaking one or more of the economic activities which make up an activity type.
Economic activity	An activity that involves the production, distribution and consumption of goods and services.
NACE Rev 2 code	The European Union system of classifying economic activities for the purpose of statistical and other analysis. The SSRO uses NACE codes in conjunction with text search terms to identify comparable companies within the Orbis database.
OECD Guidelines	The OECD transfer pricing guidelines for multinational enterprises and tax administrations (2017). This provides guidance on the application of the “arm’s length principle”, which is the international consensus on transfer pricing.
Orbis	The database of company-specific information and data supplied by Bureau van Dijk, a Moody’s Analytics company. The SSRO uses this to identify comparable companies and as a source of financial data for those comparable companies for use in the calculation of the baseline profit rate .
Text search term	A word or group of words relating to economic activities used to identify comparable companies. For example ‘manufacture’ or ‘production’. The SSRO uses text search terms in conjunction with NACE codes to identify comparable companies within the Orbis database.
Underlying profit rate	The median profit level indicator of the comparator group after deducting allowances for the servicing of capital employed. An unadjusted underlying rate can also be calculated using financial data for the comparator companies that is not adjusted for capital servicing.

3. Baseline profit rate: Key concepts at a glance

4. Approach to the baseline profit rate and capital servicing rates

This section summarises the approach taken in the SSRO’s methodology for calculating the baseline profit rate (BPR) and capital servicing rates (CSRs).

In overview, the methodology identifies companies whose economic activities are included in whole or in part in the activity types that contribute to the delivery of QDCs and QSCs. These comparable companies form the comparator groups for each activity type.

The financial data of the comparable companies that form the comparator groups are combined with capital servicing rates derived from relevant bond yields or interest rates to calculate a single underlying profit rate for each activity type. This process is used to calculate four underlying profit rates based on the following activity types:

• Develop and Make (D&M);
• Provide and Maintain (P&M);
• Ancillary Services; and
• Construction.

Three-year rolling averages of the ‘Develop and Make’ and ‘Provide and Maintain’ underlying profit rates are used as the basis for the composite baseline profit rate that the SSRO recommends to the Secretary of State.

The methodology adopts a comparable company search process that follows transfer pricing principles to identify comparable companies. The planned lifespan of a comparator group is three years, after which a new search is performed. Annual reviews are undertaken to validate the existing group in the intervening years.

Transfer pricing is employed extensively by multinational enterprises and tax authorities globally to ensure that companies operating in a number of territories receive appropriate income and profit in each. The UK’s transfer pricing legislation details how transactions between connected parties are handled and, in common with many other countries, is based on the OECD’s internationally-recognised ‘arm’s length principle’, whereby the profit mark-up on transactions between connected entities are benchmarked against comparable transactions between independent entities to ensure that profits are transferred to, and so are taxed in, the appropriate jurisdiction. The OECD’s guidelines and their related expectations and practices are widely known and understood, and their practical implications have been explored.

The application of the arm’s length principle in international taxation is analogous to the SSRO’s requirement to recommend a baseline profit rate, which simulates the outcome of a market process (for example a competitive tender). Box 1 sets out an overview of the application of the arm’s length principle as it would apply in the context of international taxation.

The principle of the BPR is to ensure that QDC and QSC contractors receive a fair level of profit on contracts, consistent with their functions performed. While this approach is distinct from tax matters, the goal is similar to that of certain transfer pricing methods, which seek to identify an arm’s length profit mark-up by benchmarking returns achieved by comparable companies. Figure 1 illustrates the application of best practice in transfer pricing in the context of the BPR.

The methodology for calculating the BPR from comparator companies selected using this approach involves:

i. calculating a profit level indicator for each company;

ii. calculating a capital servicing adjustment for each company;

iii. adjusting each company profit level indicator for capital servicing;

iv. removing loss makers in the current year;

v. calculating an underlying profit rate; and

vi. calculating the baseline profit rate.

The remainder of this document sets out the details relating to the application of each step taken by the SSRO.

Figure 1: Application of best practice approach to transfer pricing

5. Functional analysis

Steps 3 and 7 in Box 1 are clear that the transactions (or activities) to be tested (in this case QDCs and QSCs) must be understood and the component aspects identified and sought in comparable companies. To do this, the activities to be tested must be characterised.

In developing these activity characterisations, the SSRO considered the nature of the activities involved in QDCs and QSCs. The SSRO invests time and resources to understand the defence industry as well as the contracts which are reported to it. The organisation does this in a number of different ways:

• It undertakes a regular programme of site visits to defence companies to understand their businesses and the nature of the work involved in QDCs.
• It regularly reviews the MOD’s Defence Contracts Bulletin and the wider defence industry media to identify and understand the type of contracts being awarded.
• It logs queries to the SSRO Support Helpdesk so it can understand the areas where contractors may not be clear about the requirements of the regime and how the requirements are applied to individual contracts.
• It provides information on all QDCs to SSRO staff so they can understand at a high level the elements of each contract.
• It attends a range of defence industry events like the DSEI conference, Farnborough Air Show and DPRTE to identify future developments and requirements.
• It has a number of staff who have experience of defence procurement and/or the defence environment. It supplements this through expanding its access to a network of subject matter experts from across the stakeholder community and beyond.
• It speaks with the MOD and industry project teams to understand the complexity involved in defence procurement contracts.
• It attends training courses delivered by the Defence Academy to understand more about defence procurement.
• It reviews the annual reports and other publicly available information about defence companies to understand past performance, industry health and future priorities.
• It reviews individual company details to confirm whether they are a comparator company in the calculation of the baseline profit rate.
• It learns about each individual contract through the statutory reports it receives and the additional information which is provided by contractors through our engagement with them and their responses to consultations.
• It provides statistical bulletins based on what it learns across contracts on a range of topics, such as pricing methods, and sub-contracting.

Descriptions of the activities a company is typically expected to undertake to be considered as comparable are at Appendix A.

These activities are not exclusive to defence contractors. For example, manufacturers of industrial production or agricultural equipment may fall within essentially the same criteria and as such may be considered as potentially comparable manufacturing activities (subject to other considerations such as location).

The OECD acknowledges that a search focused purely on a product can return limited results, particularly in smaller or niche industries. A broader search also negates potential concerns regarding the influence of government contracting under frameworks, such as the Single Source Contract Regulations themselves, which could be viewed as influencing the results.

The SSRO has developed these activity characterisations based on the principle that a comparable company is one that undertakes economic activities that are included in whole or in part in the activity types that contribute to the delivery of QDCs and QSCs.

6. Identifying external and internal comparables

Steps 4 to 7 in Box 1 involve identifying companies that undertake comparable economic activities and transact with enterprises on an independent basis.

‘External comparables’ are where companies perform comparable activities, but not for the MOD. ‘Internal comparables’ are where companies perform comparable activities for the MOD, perhaps alongside other business with independent parties.

Internal comparables will have a close relationship to the transactions involved in a QDC or QSC. However, differences are likely to exist between comparable transactions carried out for the MOD and those with an independent third party due to the characteristics of the UK defence market. Therefore, the SSRO’s approach principally relies on the use of external comparables, which are supplemented by internal comparables.

The company search process has three stages.

i. The first stage applies tailored search criteria to a database of company information (see section 9). This identifies a range of potential external comparator companies that meet a broad set of comparability criteria.

ii. The second stage is a search for potential internal comparator companies, and to identify those companies also found in the first stage that are internal comparator companies (see section 10).

iii. At the third stage, the potential comparator companies found by the two searches are manually reviewed against detailed activity characterisations to deliver the comparator groups (see section 11).

7. Initial selection and ensuring that data is maintained year-on-year

The potential external comparator companies are initially the result of a full database search carried out in the first year of the multi-year search cycle. Subsequent annual updates pass updated data of the prior year’s final comparator groups through the financial search criteria again but there is no new search against the full database until the next cycle begins.

A full search for external comparator companies is anticipated to be required every three years. However, the SSRO monitors Orbis on a regular basis and may conduct a refresh earlier than planned should it be observed that the comparator groups are no longer sufficiently representative of the population of companies in the database.

The search for potential internal comparator companies is carried out every year.

The detailed review against activity characterisations is carried out every year to ensure that companies remain appropriate comparators to the activities in question. Companies that fail to continue to meet the financial or functional criteria will be removed from the comparator group. Companies that do not have data present in the database at the time of the company search will be retained in the comparator group for consideration in later years.

8. Identify database

To identify comparator companies, comparable transactions between independent parties need to be identified. To achieve this, information from a third-party database is used.

A third-party database serves three functions in this process:

i. Firstly, it provides the functionality to automatically assess a very large pool of companies against a set of tailored search criteria to identify potential external comparator companies.

ii. Secondly, it provides additional information that assists in a detailed manual review against activity characterisations.

iii. Thirdly, it is the source of company financial information used to calculate the underlying profit rates once the comparator groups have been identified.

The SSRO uses historical reported data of companies as the basis for benchmarking contract profits. A lack of available contract-level data and the unreliability of forecasts means there is no feasible alternative but to use historical company data to benchmark contract profits.

A range of publicly-available databases exist which can be used to meet these requirements. The Orbis database provided by Bureau Van Dijk is used by the SSRO. Orbis is a comprehensive, global database containing information on over 385 million public and private companies^{[footnote 1]}.

9. Perform search for potential external comparators

Comparable companies are identified by applying the financial and functional search criteria described in this section using data in the most recent year and the four years prior to that.

The use of multiple-year data is recognised by the OECD guidelines to offer additional insight into factors which may (or should) have influenced the transaction being examined. For example, information on changes in size or loss-making may indicate at what stage a company is in its life cycle.

Financial results reported in other currencies are converted to GBP using the exchange rates reported on Orbis for each year. The exchange rates used on Orbis come by default from the International Monetary Fund (IMF) website and refer to the closing date of the statement.

9.1 Data availability

Companies are required to have data for their most recent year present in Orbis at the time of the company search.

The SSRO defines a company’s ‘most recent year’ as its financial year ending during the period from 1 April to 31 March inclusive immediately prior to when the company search is performed.

9.2 Active companies

Companies are only included in the search if they are active trading companies and are not dormant.

9.3 Legal form

Companies are only included in the search if they take on one of the following legal forms:

• Public limited company (PLC, AG, SA, SPS, NV, OYJ, ASA, KK, etc.)
• Private limited company (Ltd, GmbH, SARL, SRL, BV, OY, AS, YK, etc)

LLPs and partnerships are not included in the search as a result of the potentially incomparable nature of their base costs. For example, payments to partners are classified as “partners’ drawings” or distributions rather than operating costs. As such, costs may be understated compared to the costs of companies that pay and recognise salary costs. The results of LLPs or partnerships could therefore distort the benchmarking results.

9.4 Independence

Companies are only included in the search if they are independent. In order to select only companies that are independent at least one of the following is required:

• The company is classified as ‘A’ independent: has known recorded shareholders, none of which having more than 25 per cent of direct or total ownership; or
• The company is classified as ‘B’ independent: has known recorded shareholders, none of which with an ownership percentage (direct, total or calculated total) over 50 per cent, but having one or more shareholders with an ownership percentage above 25 per cent.

It is important to identify only those companies that are independent and transact solely with third parties rather than related entities.

9.5 Consolidated accounts test

Companies are only included in the search if their accounts do not include intra-group transactions. Consolidated accounts can be considered to give a fair reflection of arm’s length transactions between the group and third parties (subject to the overall independence of the group).

Unconsolidated group accounts cannot be relied upon as there is no guarantee that any intra-group transactions are conducted on an arm’s length basis. An exception to this is in cases where a company has subsidiaries that are dormant since there will be no related party trading to consider. Companies with both unconsolidated accounts and subsidiaries are therefore rejected.

9.6 Geographic location

Companies located in the following geographic regions are included in the search:

• Western Europe: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Malta, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK
• North America: USA and Canada

A company’s location is determined by the country of its incorporation (i.e. the place where a company is established and formally registered). A company’s place of incorporation is typically, but not always, the location of its head office and management function.

9.7 Data quality and company size

Companies are only included in the search if their financial data is of sufficient quality, determined by if that company is of a size that would normally require an independent financial audit. This requires companies to have data that demonstrates they meet the following criteria for all of the last five years:

• an annual turnover of more than £10.2 million; and either one of the following
  • total assets worth more than £5.1 million; or
  • 50 or more employees on average.

9.8 Operating profit (EBIT)

Companies are excluded that report a negative EBIT in all of the five years. This requires companies to have EBIT data for all years subject to this criteria.

The OECD Guidelines recognise that an independent enterprise would not tolerate losses indefinitely, but that an associated enterprise may remain in business under these circumstances if it was beneficial to the group as a whole. The SSRO’s analysis uses independent enterprises therefore persistent loss-makers are excluded.

9.9 Assets and liabilities data

Companies must have data for tangible fixed assets, current assets, cash and cash equivalents, current liabilities and short-term debt for the most recent two years available in Orbis. This is to enable the calculation of the capital servicing adjustment (section 13).

9.10 Tangible fixed assets

Companies must have a tangible fixed assets value greater than nil for the most recent two years. This is to reflect the expectation that companies performing comparable activities will be required to own or control assets for use in their commercial activities.

9.11 Function

The SSRO’s activity characterisations are written descriptions of economic activities which correspond to types of activity that contribute to the delivery of QDCs and QSCs.

Assessment against the activity characterisations is too complex to be solely filtered for automatically. The search criteria are broader than the activity characterisations in order to deliver a pool of potential comparator companies that are manually reviewed in detail (section 11).

Within Orbis, each company is placed within the industry standard classification system Statistical Classification of Economic Activities in the European Community (NACE)^{[footnote 2]}. A company may have more than one NACE code and the search draws on all codes attributed to a company.

Within Orbis, each company is provided with a brief trade description, primary business line description and full overview description which indicate their business activities. Keywords are searched for within these fields. Tables B1, B2, B3 and B4 in Appendix B present the NACE codes and text search terms used in the search strategy for the activity types of ‘Develop and Make’, ‘Provide and Maintain’, ‘Ancillary Services’ and ‘Construction’.

10. Identify potential internal comparators

Comparable companies are identified by inspecting Ministry of Defence (MOD) supplier lists to ensure that the MOD’s actual suppliers are represented in the comparator groups, where they meet the other criteria.

The SSRO inspects statistics published by the MOD and uses the SSRO’s Defence Contract Analysis and Reporting System (DefCARS) data to identify potential additional comparators that are not found through the external comparator’s search process (section 9).

As with external comparators, only companies that are independent and transact solely with third parties rather than related entities are appropriate. Therefore, where relevant, the SSRO identifies the global ultimate owner (GUO) of the contracting company as the potential internal comparator.

The potential internal comparators must meet the Orbis search criteria described in Section 9, excluding the ‘function’ criteria. This ensures that comparators meet the necessary financial criteria, but are included for consideration irrespective of how their activities are recorded in Orbis.

11. Review company information

Information on each potential comparator company resulting from the search for both external comparables (section 9) and for internal comparables (section 10) is reviewed in detail to determine if it can be accepted for entry into a comparator group. This involves assessing if the company’s activities are comparable with those set out in the relevant activity characterisation and if it operates in comparable markets. Descriptions of the activities a company is typically expected to undertake to be considered as comparable are at Appendix A.

The underlying principle is that an ideal comparable company will undertake those activities that are described in the relevant activity characterisation and the market characterisation.

In order for a company to be accepted into a comparator group, positive evidence is required that it undertakes comparable activities. If the company does not perform comparable activities, or the review is inconclusive, that company must be rejected. In line with the OECD Guidelines this review follows an iterative process, refining comparability at each stage.

At the first stage, the Orbis ‘main activity’, ‘primary business line’, ‘full overview’ and ‘main production sites’ are reviewed. This is used as a triage to reject companies that are non-comparable, for example those identified in the D&M activity type search that focused on sales or advertising or where main production sites are located outside of comparable markets. At this stage, companies are only rejected where there is strong positive evidence of non-comparability.

Companies not rejected at the first stage are then reviewed in greater detail. Orbis is interrogated to establish the company’s activities and where these take place. A broad range of information is examined, such as the location and activities of any subsidiaries and segmental data. Internet searches are carried out to locate information about the company. Typically, this involves examining the company website and, if required, the company reports.

Details of the main subsidiaries of the company are also examined where the company is a group or holding company.

Where positive evidence of comparability or non-comparability can be established the decision to accept or reject the company is made. Where the review does not yield sufficient information, or where the website or company reports are not accessible or could not be translated to determine comparability, the company is rejected.

The activities undertaken by group companies as a whole are considered rather than just those of the holding company. For example, the holding company of an airline is deemed to have an aviation-related function irrespective of the specific activities of the holding company.

Decisions are subject to a further round of reviews for quality assurance purposes, including examining the presence or otherwise of the MOD’s suppliers. This entire process is supported by independent transfer pricing experts.

The outcome of the detailed review is a set of comparable companies from which financial indicators are identified to calculate the underlying profit rates.

12. Select profit level indicator

To determine the underlying profit rate for each activity type, an appropriate profit level indicator (PLI) must be used. A PLI refers to the margin or measure used relative to an appropriate base (for example costs, sales or assets) that is realised from a transaction.

The net cost plus margin (also known as return on cost of production) is the PLI used by the SSRO. It is the closest equivalent measure of return on Allowable Costs used to determine the contract profit rate of QDCs and QSCs. The SSRO uses earnings before interest and tax (EBIT) as the measure of the return a company makes on its core operations. It excludes the impact of tax, financing structures, and some other income or expenses. EBIT includes depreciation and amortisation which contractors may be reimbursed for through Allowable Costs on a contract-by-contract basis (where these meet the relevant criteria). This maintains consistency with the approach to Allowable Costs.^{[footnote 3]}

The PLI is calculated as:

13. Adjustments

Section 17(2) of the Act and Regulation 11(7) set out the requirement for the capital servicing adjustment at ‘step 6‘:

Take the amount resulting from step 5 and add to or subtract from it an agreed amount (“the capital servicing adjustment”), so as to ensure that the primary contractor receives an appropriate and reasonable return on the fixed and working capital employed by the primary contractor for the purposes of enabling the primary contractor to perform the contract.

The PLI of each comparator company is adjusted with respect to capital employed to set a baseline upon which ‘step 6’ can be added. The approach of the SSRO is to adjust the PLI in proportion to the ratio of fixed and working capital employed by each comparator company. This is the reverse of the approach taken at ‘step 6’ in calculating the capital servicing adjustment for a contract profit rate set out in Guidance on the baseline profit rate and its adjustment.

The SSRO makes a capital servicing adjustment to take into account the different levels of fixed capital and working capital employed by the companies in the comparator group. This adjustment acts to ameliorate the effects of extreme outliers in the data and is considered by the SSRO to enhance comparability which is consistent with OECD Guidelines.

The capital servicing adjusted profit level indicator is calculated according to the following:

CSR_FC and CSR_WC are the capital serving rates for fixed capital and working capital respectively. The SSRO calculates capital servicing rates for:

• fixed capital;
• positive working capital;
• negative working capital.

The figures for fixed and working capital are the average of the opening and closing balances for the most recent year of the company whose PLI is being adjusted. The definitions of each balance sheet item, the relevant Orbis data fields and a detailed breakdown of the calculation of the capital servicing adjusted PLI is at Appendix C.

The capital servicing rates that apply at this stage are the same as those recommended to the Secretary of State for application at ‘step 6’ in the calculation of the contract profit rate. This ensures that contractors are not disadvantaged should the aggregate credit rating of the comparator groups differ from their own. Bloomberg and the Bank of England are the sources of data for the capital servicing rates.

13.1 Fixed capital servicing rate

The fixed capital servicing rates use the C40515Y Bloomberg index for 15-year BBB rated daily yields of sterling-denominated corporate bonds. The time period is seven years up to and including data available at 30 November in the year immediately prior to that in which the rate being calculated applies.

Prior to the introduction of the SSRO’s methodology, the Review Board for Government Contracts applied the ‘Yellow Book’ methodology, which used a BBB- credit rating, approximated by a BBB interest rate plus an additional 0.5 percentage points applied. To reflect this legacy approach, the 0.5 percentage point adjustment is applied to all data points up to and including 31 December 2014.

The fixed capital servicing rate is calculated as the mean average of the seven years of daily data.

13.2 Positive working capital servicing rate

The positive working capital servicing rate is calculated using Bloomberg data for one-year BBB rated sterling-denominated corporate bonds yields (C4051Y index). The time period is three years up to and including data available at 30 November in the year immediately prior to that in which the rate being calculated applies.

The positive working capital servicing rate is calculated as the mean average of the three years of daily data.

13.3 Negative working capital servicing rate

The negative working capital servicing rate is calculated using Bank of England data on monthly interest for short term deposits (CFMBI32 index^{[footnote 4]}). The time period is three years up to and including data available at 30 November in the year immediately prior to that in which the rate being calculated applies.

The negative working capital servicing rate is calculated as the mean average of the three years of monthly data.

14. Calculating the underlying profit rates and composite baseline profit rate

Companies that made a loss in the most recent year, determined by a negative capital servicing adjusted PLI, are excluded from this calculation. Loss-making companies are removed to reflect the expectation of positive profit on estimated Allowable Costs in QDCs. This maintains consistency with the construct of the profit formula as a mark-up on estimated Allowable Costs and removes the possibility of a negative BPR being produced.

The underlying profit rate of each activity group for the current year is calculated using the median of comparator company data. The choice of average should reflect the specific characteristics of the data set and the median is a superior measure of central tendency compared to the mean or weighted mean, given the SSRO places no upper limit on the profit level or size of comparator companies.

The three-year mean averages of the underlying profit rate for the current year and those of the two immediately preceding years are calculated. The SSRO does not reassess previous year’s underlying rates for the current year.

The mean average of the resulting rates for ‘Develop and Make’ and ‘Provide and Maintain’ is the composite baseline profit rate that the SSRO recommends to the Secretary of State.

15. The SSRO funding adjustment

15.1 The calculation of the SSRO funding adjustment

The method to calculate the funding adjustment calculation is intended to set it at a level that allows the MOD to recover half of the SSRO’s costs through a reduction in the amounts paid on single source contracts, shared across contractors based upon the value of their QDCs and QSCs.

The SSRO funding adjustment is calculated as:

The SSRO’s costs, and the costs of additional tasks requested by the Secretary of State, are the mean averages of the three full financial years immediately prior to the year in which the recommendation is made.

Where the SSRO’s audited financial information is not yet available for three years, the funding adjustment will be based on the latest years that are available.

The average annual total Allowable Costs of contracts entered into will be a mean average of the annual sum of the Total Allowable Costs (including any Risk Contingency Allowance) values reported in latest available report for all QDCs entered into in each of the three preceding financial years. Where contract amendments are made the most recently reported values will be used but each contract will be included only once in the calculation. QDC data will be drawn for the periods which align to that used for SSRO running costs, based on the most recently available published statistics at the time of calculation.

16. Data sources and adjustments

All SSRO costs, including referrals and one-off items, will be included unless specifically incurred as a result of a request for additional work by the Secretary of State. The part-year costs incurred during the set-up year (2014/15) and costs incurred by the MOD in establishing the SSRO were not included.

The SSRO costs and the costs of additional tasks requested by the Secretary of State will be drawn from the audited financial statements in the preceding three financial years. The costs are drawn from the Statement of Comprehensive Net Expenditure – Net Expenditure. This means capital expenditure is accounted for via depreciation rather than in cash terms (the SSRO is funded and pays for capital expenditure as it is incurred).

The QDCs’ data used to calculate the SSRO funding adjustment comes from the latest Quarterly qualifying defence contracts statistics. The total value of QDCs is based on:

• Data for any contract which became a QDC between 1 April and 31 March of a given financial year
• The total Allowable Costs (including any Risk Contingency Allowance) reported in the latest available report as of the date of extraction.

17. Appendix A – Activity characterisations

17.1 Market characterisation

Companies undertaking comparable activities in any activity group are expected to operate in markets that would typically include Western Europe and North America.

Where a company undertakes global operations consideration should be given to the nature of the activities occurring in different geographic areas. The comparable activities of the business are expected to meet the relevant activity characterisation and be undertaken in comparable geographic areas.

The determination of where a company’s activities are undertaken might be by reference to the amount of cost incurred, the number of employees, the value of assets employed, or other measures depending on the nature of the activities undertaken.

It may be acceptable for comparable firms to undertake some activities in non-comparable geographic areas.

However, these activities are not expected to extend beyond what might reasonably be required to deliver the company’s principle business.

The end customers for the outputs generated by comparable companies may be located in any geographic area.

For example, a company that exports goods or services from a comparable market to a non-comparable market is unlikely to be excluded on that basis.

17.2 Develop and make

Companies undertaking comparable activities considered as ‘Develop and Make’ are expected to engage in manufacturing and the design and development contributing to that process. This would therefore not include manufacturing on behalf of a hiring firm that supplies the design, or those solely undertaking research or design work with no associated manufacturing. Where development activities do not seek to result in a novel or differentiated product the company is less likely to be considered comparable.

Comparable activities would typically be of the type that can be likened to those involved in producing equipment used for military or defence purposes. This would include scientific or technical research, design, development or testing activities leading to the production of self-contained sub-systems or finished goods. To the extent that a product is being assembled or constructed then it is likely to represent comparable manufacturing. This could cover a broad range of products such as structural metal goods, machinery, electronic and mechanical sub-systems, vessels, containers, general machinery, ships, aircraft, and wheeled or tracked vehicles or other means of transportation and other items of machinery of an industrial nature. If the product is a commoditised unit or processed raw manufacturing input, for example a generic electrical or mechanical components, sheet metal, shaped plastic, ancillary items such as basic tools, then this may not be sufficiently complex and is likely to be excluded. Electronic or mechanical assemblies or sub-systems that are complex and not of a commoditised nature are more likely to be considered the output of a comparable manufacturing process.

The value added, cost base or profits of the business are expected to principally derive from the manufacturing, design and development activities as described above. For example, comparable firms would not be expected to derive the majority of their value added through the purchase of raw materials, luxury branding, the exploitation of patents and copyrights or distribution activities. It may be acceptable for comparable firms to engage in some loosely associated activities as part of delivering core comparable business (for example the procurement of inputs and the distribution and marketing of final goods). However, these activities are not expected to extend beyond what might reasonably be required to deliver the company’s principal business. Significant involvement in activities that are obviously non-comparable in nature (for example provision of financial services, marketing or food processing) would be cause to reject a company.

The end customers for the outputs generated by comparable companies are expected to be other businesses, institutions or governments. Comparable companies are not expected to maintain marketing models, sales operations, large networks of product outlets or dealerships aimed at the general public.

17.3 Provide and maintain

Companies undertaking comparable activities considered as ‘Provide and Maintain’ are expected to deliver services to ensure the availability of an asset either through repair and servicing to third party equipment, or through hire or lease arrangements that include associated upkeep and maintenance services.

Comparable activities would typically be of the type which can be likened to those involved in the support and provision of equipment used for military or defence purposes. This could cover a broad range of products such as structural metal goods, machinery, electronic and mechanical sub-systems, vessels, containers, general machinery, ships, aircraft, and wheeled or tracked vehicles or other means of transportation and other items of machinery of an industrial nature. Comparable companies may also provide the facilities embodying or integrating the equipment and the training necessary to operate or maintain these assets.

Repair and servicing activities include arrangements where spares and labour are charged for as they are required, or may include these costs as part of a longer term contracting arrangement. Diagnosis, repair and installation activities would be expected to require an in-depth knowledge of the asset being serviced. This would exclude companies whose capabilities are limited to rudimentary work, such as those involving user-serviceable parts or domestic installations (for example domestic white goods). Hire and leasing arrangements should be focused on items of an industrial or commercial nature.

The value added, cost base or profits of the business are expected to principally derive from the asset provision and maintenance activities described above. For example, the provision of aftersales service to products that a company manufactures or sells would be insufficient to consider a company to be comparable. Companies are unlikely to be comparable if they include a significant consumer-targeted sales and marketing model or the sale of associated finance products (for example in the case of consumer automotive sales). It may be acceptable for comparable firms to engage in some loosely comparable activities as part of normal business (for example parts procurement, warehousing, logistics, installation, or the sale of the company’s ex-hire fleet). However, these activities are not expected to extend beyond what might reasonably be required to deliver the company’s principle business. Significant involvement in activities which are obviously non-comparable in nature (for example manufacturing or distribution) is grounds for rejection.

The end customers for the services provided by comparable companies are expected to be businesses, institutions or governments. Comparable companies are not expected to maintain significant marketing models or sales operations in relation to the goods they service, or large networks of service outlets or dealerships aimed at the general public.

17.4 Ancillary services

Companies undertaking comparable activities considered as ‘Ancillary Services’ are expected to deliver either one of administrative, facilities or IT support activities. Companies undertaking these support services are not expected to bear any significant risks other than that of failing to provide the contracted outputs. This captures risk in relation to the delivery of the services, contract risk, procurement risk, staff risk and some quality control risk in respect of these activities.

Administrative support relates to outsourced business services such as payroll processing, call centres, HR, basic book-keeping, routine tax or legal advice and other clerical work. IT support services would include data management, data processing, network hosting, IT repairs and maintenance and IT security services. Facilities support services would include property cleaning, property repairs and maintenance, canteen services, laundry, gardening and general guarding and security services.

The value added, cost base or profits of the business are expected to principally derive from the Ancillary Services activities described above. Companies that engage in support services loosely connected to those described above, but which are of a specialised nature would not typically be considered comparable. Such non-comparable services would include provision of security services in prisons, the design and procurement of IT infrastructure, the services of chartered professionals, or the supply of clinical staff to hospitals. Companies that do not undertake activities akin to ancillary support services (for example recruitment, construction, software development, management consultancy, engineering consultancy) are not considered comparable.

The end customers for the services provided by comparable companies are expected to be other businesses, institutions or governments. Comparable companies are not expected to be entities which solely exist to provide these services to members of their own corporate group. Comparable companies are not expected to primarily serve the general public with, for example, domestic gardening or cleaning services.

17.5 Construction

Companies undertaking comparable activities considered as ‘Construction’ are expected to deliver services in relation to the construction of buildings or other structures at fixed locations. Companies could provide such services either on a contract basis with designs and specifications received or using their own designs.

Comparable companies may be responsible for the management of the construction project, and are likely to bear contract risk, procurement risk, staff risk and some quality control risk in respect of these activities. They are not expected to bear any significant property price risk in respect of these activities.

Buildings would include industrial buildings such as factories, warehouses, plants, and public, commercial or residential buildings of steel-frame or concrete construction (not individual houses) and may include the associated design services. Civil engineering works in the form of the erection of structures in a fixed location, for example in metal and concrete, would also be considered comparable. To the extent that civil engineering works relates to the assembly of a structure at a fixed location then it is more likely to be considered as ‘Construction’. To the extent that companies engage in tunnelling, pipe-laying, highways maintenance or river and coastal work, these activities are not expected to extend beyond what might reasonably be required to support the delivery of a structure. Speciality trade contractors, such as outfit contracting services (plumbing, ventilation, electrical installation and windows) must be demonstrably of an industrial nature and be active in the construction of the building.

The value added, cost base or profits of the business are expected to principally derive from the construction activities described above. Comparable companies are not expected to hold land for long-term appreciation purposes and as such those who engage primarily in real estate development would typically be excluded. It may be acceptable for comparable companies to engage in some loosely comparable activities in the delivery of their core construction work (for example manufacturing or procurement of construction inputs, earthworks, provision of construction labour, building preservation, site clearance and recycling of reclaimed items from demolition).

However, these activities should not be the focus of their business. Significant involvement in activities which are obviously non-comparable in nature (for example toll-road operation, property investment, interior design services) is grounds for rejection.

The end customers for the services provided by comparable companies are expected to be other businesses, institutions or governments. Comparable companies are not expected to primarily serve the general public and as such domestic building services, roofing, flooring and general building maintenance contractors would not be considered comparable.

18. Appendix B – Industry codes and text search terms used in activity type search strategies

18.1 Develop and make

The ‘Develop and Make’ activity type NACE Rev 2 codes were selected as they were considered to be the most appropriate given the activity characterisation.

Companies are selected as potential ‘Develop and Make’ activity type comparators if they have:

• at least one manufacturing sub-activity NACE Rev 2 code AND at least one manufacturing sub-activity text search term in either their trade description or primary business line description or full overview description;

OR

• at least one R&D NACE Rev 2 code AND at least one text search term from each of the two R&D sub-activity text search terms groups in either their trade description or primary business line description or full overview description.

Table B1: The ‘Develop and Make’ activity type NACE Rev 2 codes and text search terms

Sub-activity	NACE Rev 2 code	Description	Text search terms
Manufacturing	2511	Manufacture of metal structures and parts of structures	(manuf, produc, fabric, build, defense, defence, militar*)
	2529	Manufacture of other tanks, reservoirs and containers of metal
	253	Manufacture of steam generators, except central heating hot water boilers
	254	Manufacture of weapons and ammunition
	2599	Manufacture of other fabricated metal products n.e.c.
	2630	Manufacture of communication equipment
	2651	Manufacture of instruments and appliances for measuring, testing and navigation
	28	Manufacture of machinery and equipment nec
	29	Manufacture of motor vehicles, trailers and semi-trailers
	301	Building of ships and boats
	302	Manufacture of railway locomotives and rolling stock
	303	Manufacture of air and spacecraft and related machinery
	304	Manufacture of military fighting vehicles
	3099	Manufacture of other transport equipment n.e.c.
Research and development (R&D)	749	Other professional, scientific and technical activities nec	(research, develop, design) AND (test, equip, machin , militar* , vehic* , defense* , defence*)
	721	Research and experimental development on natural sciences and engineering
	741	Specialised design activities
	712	Technical testing and analysis

’ * ‘ denotes a part word. For example, “develop*” includes “develop”, “develops”, “developed”, “developing”, “developer” and “development”.

18.2 Provide and maintain

The ‘Provide and Maintain’ activity type NACE Rev 2 codes were selected as they were considered to be the most appropriate given the activity characterisation.

Companies are selected as potential ‘Provide and Maintain’ activity type comparators if they have:

• at least one capacity provisioning sub-activity NACE Rev 2 code;

OR

• at least one text search term from each of the two capacity provisioning sub-activity text search terms groups in either their trade description or primary business line description or full overview description;

OR

• at least one upkeep and maintenance sub-activity NACE Rev 2 code;

OR

• at least one text search term from each of the two upkeep and maintenance sub-activity text search terms groups in either their trade description or primary business line description or full overview description.

Table B2 – The ‘Provide and Maintain’ activity type NACE Rev 2 codes and text search terms

Sub-activity	NACE Rev 2 code	Description	Text search terms
Capacity provisioning	7735	Renting and leasing of air transport equipment	(rent, leas, hir) AND (container, truck, tank, trailer, aircr, aviation, industrial, defence, defense, militar*)
	7739	Renting and leasing of other machinery, equipment and tangible goods nec
	7712	Renting and leasing of trucks
	7732	Renting and leasing of construction and civil engineering machinery and equipment
	7734	Renting and leasing of water transport equipment
Upkeep and maintenance	33	Repair and installation of machinery and equipment	(repair, maint, upkeep, update, training) AND (equip, vehic, aircr, defense, defence, militar*)
	749	Other professional, scientific and technical activities nec

18.3 Ancillary services

The ‘Ancillary Services’ activity type NACE Rev 2 codes were selected as they were considered to be the most appropriate given the activity characterisation.

Companies are selected as potential ‘Ancillary Services’ activity type comparators if they have:

• at least one of the ‘Ancillary Services’ NACE Rev 2 code;

AND

• either their trade description or primary business line description or full overview description contained at least one ‘Ancillary Services’ text search terms from each of the two sets of the text search terms.

Table B3: The ‘Ancillary Services’ activity type NACE Rev 2 codes and text search terms

NACE Rev 2 code	Description	Text search terms
6311	Data processing, hosting and related activities	(outsourc, support, maint) AND (clean, maint’ facil, industr, upkeep) cleric, IT! office, data, admin, defence, defense, militar*)
811	Combined facilities support activities
8121	General cleaning of buildings
8122	Other building and industrial cleaning activities
8129	Other cleaning activities
821	Office administrative and support activities
8299	Other business support service activities n.e.c.
802	Security systems service activities

! denotes where the search is case-sensitive

18.4 Construction

The ‘Construction’ activity NACE Rev 2 codes were selected as they were considered to be the most appropriate given the activity characterisation.

Companies are selected as potential ‘Construction’ activity type comparators if they have:

• at least one ‘Construction’ activity NACE Rev 2 code;

AND

• at least one ‘Construction’ activity text search term in either their trade description or primary business line description or full overview description.

Table B4: The ‘Construction’ activity type NACE Rev 2 codes and text search terms

NACE Rev 2 code	Description	Text search terms
41	Construction of buildings	(construct, build, engineer, architect, defense, defence, militar*)
42	Civil engineering
43	Specialised construction activity

19. Appendix C – Orbis data fields and calculation steps for the underlying profit rates

19.1 Data fields

The following data is downloaded from Orbis to calculate the baseline profit rate:

• OPPL: Operating P/L [=EBIT] – the most recent year
• OPRE: Operating revenue (Turnover) – the most recent year
• TFAS: Tangible Fixed Assets – the two most recent years
• CUAS: Current Assets – the two most recent years
• CULI: Current Liabilities – the two most recent years
• CASH: Cash and Cash Equivalent – the two most recent years
• LOAN: Loans – the two most recent years

19.2 Calculation steps

Step indicator	Financial indicator	Data source/calculation
A	Operating revenue (turnover)	Orbis data [Orbis code OPRE]
B	Operating profit (EBIT)	Orbis data [Orbis code OPPL]
C	Cost of production	A – B
D	Profit level indicator (net cost plus) [percentage]	B / C
E	Fixed capital (the two year average)	Orbis data – ‘Tangible Fixed Assets’ [TFAS]
F	Working capital (the two year average)	Orbis data – current assets [CUAS] – cash [CASH] – current liabilities [CULI] + short-term debt [LOAN]
G	Capital employed (average)	E + F
H	Positive working capital	F (when F is positive)
I	Negative working capital	F (when F is negative)
J	Cost of production: capital employed ratio	C / G
K	Fixed capital ratio	E / G
L	Positive working capital ratio	H / G
M	Negative working capital ratio	I / G
N	Fixed capital servicing rate [percentage]	Bloomberg data – 7-year average of C40515Y INDEX
O	Positive working capital servicing rate [percentage]	Bloomberg data – 3-year daily rates’ average of C4051Y INDEX
P	Negative working capital servicing rate [percentage]	3-year monthly rates’ average of Bank of England statistics on monthly interests for short term deposits [CFMB132]
Q	Fixed capital servicing allowance	K x N
R	Positive working capital servicing allowance	L x O
S	Negative working capital servicing allowance	M x P
T	Capital servicing rate	Q + R + S
U	Capital servicing adjustment [percentage]	T / J
V	Capital servicing adjusted PLI [percentage]	D – U

1. As of December 2020. ↩
2. The current version is revision 2 and was established by Regulation (EC) No 1893/2006 ↩
3. SSRO, Allowable Costs guidance (2020) ↩
4. Monthly average of UK resident monetary financial institutions’ (excl. Central Bank) sterling weighted average interest rate – time deposits with fixed original maturity <=1 year from private non-financial corporations (in percent) not seasonally adjusted. ↩

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This document should be read in conjunction with the SSRO publication Single Source Baseline Profit Rate, Capital Servicing Rates and Funding Adjustment Methodology (March 2021) and Guidance on the Baseline Profit Rate and its Adjustment (March 2021).

1. Terms and definitions

Comparability principle: The aim of the baseline profit rate is to provide the starting point in the determination of the contract profit rate. It is set with reference to the returns of companies whose economic activities are included in whole or in part in the activity types that contribute to the delivery of QDCs and QSCs.

Baseline profit rate: Step 1 of the 6-step process to calculate the contract profit rate of a contract that falls under the Single Source Regulations. The baseline profit rate is the average of the underlying rates for the last three years.

Underlying rate: The median rate of profit (return on cost of production) based on the performance of the companies in a comparator group over a financial year. The SSRO reports this before and after the application of the capital servicing adjustment.

Return on cost of production: The measure of profit used as the basis for the underlying rates and baseline profit rate:

Capital servicing adjustment: An adjustment to the return on cost of production to account for the levels of fixed capital and working capital employed by companies in the comparator groups. A corresponding adjustment is made in the pricing of individual contracts by an adjustment at step 6 of the contract profit rate.

Activity type: A group of economic activities, defined by the SSRO, which correspond to types of activity that contribute to the delivery of QDCs and QSCs.

Comparable companies: A company whose economic activities are included, in whole or in part, within an activity type.

Comparator group: A group of comparable companies undertaking one or more of the economic activities which make up an activity type.

2. The baseline profit rate

2.1 How is the baseline profit rate calculated?

The baseline profit rate (BPR) is an average of the actual profit rates of companies whose activities are comparable to those that contribute to the delivery of MOD single source contracts. The SSRO categorises those activities under the headings ‘Develop and Make’ and ‘Provide and Maintain’ and companies are selected into those comparator groups based on the nature of their activities. The BPR is the rolling average of the underlying rate for the current year and those of the two previous years.

2.2 Why does the baseline profit rate change every year and why has it increased?

The Defence Reform Act 2014 (the Act) requires the SSRO to provide the Secretary of State with an assessment of the appropriate baseline profit rate for each financial year.

The baseline profit rate for 2021/22 is 8.31 per cent (prior year: 8.22 per cent). This year’s composite underlying rate of 8.19 per cent replaces the 2017/18 underlying rate of 7.94 per cent in the calculation of the three-year average which determines the SSRO’s BPR recommendation. The other two underlying rates in the three-year average are 8.50 and 8.23 percent.

The SSRO’s approach is to use the most recent data available at the time of making its assessment in order to ensure its assessment is appropriate. The underlying rate assessment changes year-on-year in response to changes in the comparator group data, as shown in figure 1.

Figure 1: change in the underlying rate

2.3 What steps has the SSRO taken in response to the COVID-19 pandemic when making its assessment?

The financial information used for the 2021/22 recommendation was taken from annual company financial statements for the year ending on or before 31 March 2020.

The SSRO has analysed the period to which the financial data that informs the recommendation relates and 325 (94%) of companies in the composite comparator groups have financial year ends on or before 31 December 2019. The methodology excludes loss-makers in the current year from the calculation and all companies need to meet all other criteria including having data available in Orbis at the relevant time.

Optional extensions to financial reporting deadlines have been made available in many of the countries from which we take data. There was a risk that not enough data would be available at the cut-off date for the analysis. However, we have continuously monitored the availability of data during the year and are satisfied there are enough companies in the comparator groups. In light of the extended reporting deadlines, the methodology now allows previously accepted companies that had not reported data as at our cut-off date to be retained for consideration next year.

2.4 How will the COVID-19 pandemic impact future SSRO recommendations?

Under the current methodology, the financial information used for the 2022/23 recommendation will be extracted from annual company financial statements for the year ending on or before 31 March 2021.

It is too early to say what the financial effect of COVID-19 will be on the comparator groups or the extent to which the effects can be distinguished from other events that have occurred during the year, which is still ongoing at this time. The impact on the data the SSRO will use will start to become known in 2021 as companies publish their financial statements.

The SSRO’s methodology contains a number of stabilising features which mitigate the impact of transient shocks, for example the use of the median and the removal of loss makers. And if there were systematic changes to the underlying rate then the three-year average will phase the impact in a predictable and measured way.

The SSRO will continue to engage with its stakeholders on its approach to delivering its 2022/23 recommendation. As data becomes available the SSRO will be better placed to judge how the methodology will respond to it and what, if any, response is required by the SSRO.

2.5 What is the impact of the new higher baseline profit rate and how much will it cost the taxpayer?

The BPR is the first of six steps that contribute to the Contract Profit Rate (CPR), which supports both value for money in government expenditure and fair and reasonable prices for contractors. The new rate will mean that Step 1 of the CPR will be 0.09 percentage points higher compared to 2020/21, and 0.68 percentage points higher than in 2019/20. The other five steps of the CPR take account of factors such as risk, performance incentives and capital servicing. SSRO data on contract profit rates is shown in the table below.

The implications of an increase in the BPR for MOD will depend on how all six of the steps which determine the contract profit rate are applied. In addition, the performance of the contractor, the pricing method which allocates cost risk between the parties to the contract, specific contract terms and conditions, and any final price adjustment, will come together to determine the final contract price. Prices may therefore decrease or increase alongside a change in the BPR.

Table 1 shows the average contract profit rates of contracts entered into each year and demonstrates that changes in contract profit rates may not always mirror changes in the BPR, as a result of those other factors.

Table 1: Average (mean) estimated contract profit rate by financial year

Financial year in which contract became a QDC/QSC	Baseline profit rate (%) Step 1	Average contract profit rate reported by contractors to the SSRO via statutory reports (%) Steps 1-6	Difference – baseline vs. contract (pp)
2015/16	10.60	11.30	0.70
2016/17	8.95	10.57	1.62
2017/18	7.46	8.32	0.86
2018/19	6.81	8.33	1.52
2019/20	7.63	9.11	1.48
2020/21 Apr to Sep	8.22	9.43	1.22

Source: SSRO (2020) Quarterly Qualifying Defence Contract Statistics: Q2 2020/21, Table 3.

Note: The differences between the baseline profit rate and the observed contract profit rates are due to the application of steps 2-6 in the calculation. For more details see SSRO (2020) Guidance on the Baseline Profit Rate and its Adjustment.

2.6 What are the lowest and highest profit rates achievable under the new BPR?

Table 2 illustrates the range of initial contract profit rates achievable given the adjustments that are possible. The SSRO’s Annual qualifying defence contract statistics includes a summary of actual agreed contract profit rates to date.

Depending on the contract pricing method, it is possible for a contractor to achieve a higher percentage profit than was initially agreed at contract signing by outperforming cost estimates, or to achieve a lower profit rate by underperforming. The final contract profit rate will therefore only be known once the contractor has delivered the contract.

Table 2: Illustration of the six steps and the range of CPRs available before the impact of contractor performance

	Contract profit rate step	Value/Adjustment
	Unadjusted rate	9.75%
	Capital servicing adjustment†	-1.44pp
Step 1	Baseline profit rate	8.31%
Step 2	Cost risk adjustment*	-2.08pp to +2.08pp
Step 3	POCO adjustment**
Step 4	SSRO funding adjustment	-0.057pp
Step 5	Incentive adjustment***	up to +2.00 pp
Step 6	Capital servicing adjustment (CSA) † **	Minimum: 0.0% Lower quartile: 0.6% Upper quartile: 1.6% Maximum: 4.4%

Illustrative minimum CPR, based on: -25% step 2, +0pp step 5 and +0.0pp step 6	6.18%
Illustrative low CPR, based on: -25% step 2, +0pp step 5 and +0.6pp step 6	6.78%
Illustrative high CPR, based on: +25% step 2, +2pp step 5 and +1.6pp step 6	13.93%
Illustrative maximum CPR, based on: +25% step 2, +2pp step 5 and +4.4pp step 6	16.73%

The six-step process is set out in the SSRO’s publication Guidance on the Baseline Profit Rate and its Adjustment.

† See Question 3.12 for an explanation of these two capital servicing adjustments.

‘*’ An adjustment of between +/- 25 per cent of the BPR.

‘**’ A POCO adjustment may be applied to ensure that profit arises only once in relation to some intra-group sub-contracts. The adjustment is nil for the majority of contracts, as shown here.

*** A positive adjustment of up to two percentage points may apply to incentivise the achievement of enhanced performance.

** Estimated using actual values for contracts priced in 2019/20. The actual adjustment may be higher, lower or negative.

Source: SSRO (2020) Annual Qualifying Defence Contract Statistics: 2019/20

2.7 How do the profits of the companies who make up the BPR and the range of contract profit rates compare to those of the MOD’s main suppliers?

The table below shows the range of profits (5 year median of return on cost of production) exhibited by the top 20 listed companies by value of non-competitive spend in 2019/20, as reported by the MOD^{[footnote 1]}. The 5-year median profit rate of the D&M and P&M comparator companies is included for reference. The rates shown for the suppliers are the median over the last five years to illustrate what might be considered typical for each.

Company name	Return on cost of production: median 2015/16 – 2019/20*
Safran	22.61%
CGI	16.17%
Raytheon Technologies	15.57%
Lockheed Martin	14.66%
Northrop Grumman	14.36%
QinetiQ	14.28%
General Dynamics	14.04%
Vinci	12.84%
Ultra Electronics	12.03%
BAE Systems	10.37%
Babcock	10.06%
Thales	8.40%
Boeing	8.06%
Leonardo	5.43%
Airbus	4.50%
Jacobs Engineering	4.01%
Fujitsu	3.52%
DXC Technology	0.94%
Serco	0.88%
Rolls Royce	0.29%

Provide & Maintain median† 9.72%

Develop & Make median† 9.29%

The suppliers’ 5 year median actual profit rates ranged from 0.29 per cent to 22.61 per cent; note the actual profit rate of the company as a whole is also a product of any non-single source work it carries out. The illustrative range of available CPRs at time of agreement (see Q2.4 above) is 6.18 per cent to 16.73 per cent. The actual CPR achieved may be a higher percentage profit by outperforming cost estimates, or a lower profit rate by underperforming.

Source: Orbis and SSRO calculations

‘*’ Return on cost of production, unadjusted for capital servicing

†Median of the underlying rate, unadjusted for capital servicing, of the current year comparator group over the last 5 years

3. The methodology and the comparator groups

3.1 What is the basis of the SSRO’s methodology and how does this provide a fair and reasonable return to industry?

The SSRO is confident that the baseline profit rate is a fair and reasonable starting point for the contract profit rate calculation because it is set with reference to the actual returns of comparable companies. The methodology takes steps to remove loss-making companies and to only incorporate companies that perform comparable economic activities in comparable countries.

The comparable company search process follows the transfer pricing ‘arm’s length principle’ set out in the OECD transfer pricing guidelines. Transfer pricing is a concept which seeks to ensure that companies operating in a number of territories receive appropriate income and profit in each, as if each territory were operating at arm’s length from the other(s), as a third party would do. Transfer pricing is employed extensively by multinational enterprises and tax authorities globally, including the UK,^{[footnote 2]} and as such the guidelines, and their related expectations and practices, are widely known and understood and their practical implications have been explored.

For transparency, the SSRO publishes the list of criteria used to select comparable companies in the methodology and publishes the resulting list of comparable companies used in the comparator groups.

3.2 How representative are the activity type comparator groups of the UK defence industry?

It is not the SSRO’s intention that the comparator groups contain only companies from the defence industry. To produce a robust, open-market benchmark, the BPR methodology includes companies operating in the defence sector as well as companies operating in non-defence sectors and outside of the single source regime. Companies that either have the words ‘defence’, ‘defense’, or ‘militar*’ included in their activities description in the Orbis database account for 32 per cent of the companies used in the calculation of the composite rate for this year.

The methodology identifies companies whose economic activities are of the type which contribute in whole or in part to the delivery of QDCs and QSCs. The result of the process is a robust comparator group that is relevant to the activities which contribute in whole or in part to the delivery of QDCs and QSCs. The range of contract profit rates achievable given this year’s BPR give us confidence an appropriate group of companies has been selected (see questions 2.4 and 2.7).

3.3 Why does the SSRO recommend a composite rate based on the Develop and Make and Provide and Maintain activity types? Why are rates also published for Ancillary Services and Construction?

The composite rate is derived from two activity types: Develop and Make (D&M) and Provide and Maintain (P&M). Together, these types of work represent the vast majority of single-source procurement.

Given Ancillary Services and Construction account for a small minority of single-source contract spend they are not included in the composite rate as doing so would not be consistent with the principle of comparability. The approach taken for the 2021/22 recommendation is the same as for the 2020/21 BPR recommendation.

The data on all four activity types is provided so that the Secretary of State can understand the basis on which the composite rate had been calculated and why it was considered appropriate.

3.4 Why have some companies left the comparator group and some joined?

In accordance with the SSRO’s methodology, the set of comparator companies was fully refreshed for the previous (2020/21) recommendation. This means that this year we carried forward the prior year’s group and reviewed all those companies against our activity descriptions. This group is anticipated to last for another year before a full search of the Orbis data is carried out to refresh the groups. We have the option to retain companies for next year who have been excluded from this assessment due to delayed financial reporting.

To confirm that the companies selected continue to undertake comparable activities, the SSRO has systematically reviewed each company that met the Orbis selection criteria. Assessments drew on detailed information from Orbis, on company websites, and other reputable information sources such as Bloomberg. This process was carried out independently of any consideration of the companies’ profit data. This review contained some subjective elements, but every effort is made to assess these aspects consistently.

Companies may also be added through the annual review of contractors with QDCs or QSCs (or their ultimate parent undertakings) and the latest data on the MOD’s spending with suppliers. Inclusion of additional companies is subject to the companies’ activities being comparable to the SSRO’s activity types and their meeting the relevant selection criteria such as turnover, independence and profitability. The overwhelming majority of the MOD’s main suppliers in recent years are included in the comparator groups.

Our process ensures that, as in previous years, companies are included or excluded based on the most up-to-date and robust evidence available to the SSRO.

3.5 What is the source of company data for the SSRO’s assessment?

The Orbis database supplied by Bureau van Dijk is used to search for comparable companies and as a source of financial information; the calculation uses publicly-reported financial data that is prepared in accordance with accounting standards and aggregated in to the Orbis database. The SSRO publishes its methodology on its website containing detailed information on the data fields it uses.

For a number of the MOD’s major suppliers we have verified the financial data in Orbis against published financial statements. The SSRO is satisfied that the data contained in the Orbis database accurately reflects the financial statements of the comparator companies.

3.6 What are the size criteria for companies to be included in the assessment?

Companies are only included in the search if their financial data is of sufficient quality, determined by if that company is of a size that would normally require an independent financial audit. This requires companies to have data that demonstrates they meet the following criteria for all of the last five years:

• an annual turnover of more than £10.2 million; and either one of the following:
  • total assets worth more than £5.1 million; or
  • 50 or more employees on average.

This threshold is set with reference to standardised thresholds used in the UK, and the EU, for determining if a company is small. The threshold in the methodology therefore ensures that there are no small companies in the comparator groups.

3.7 Why is the BPR set at the median average with loss-making companies excluded from the comparator groups?

The methodology is carefully calibrated to ensure that it represents a reasonable starting point for the application of the six steps. The SSRO has published analysis which supports the exclusion of loss makers and using the median as an analytically robust approach.

The choice of average should reflect the specific characteristics of the data set and the median is a superior measure of central tendency compared to the mean or weighted mean given the skewed nature of the data set. The skew is due to the fact that:

• the SSRO excludes loss-makers but does not place an upper limit on the profit measure, resulting in a small number of companies with very high profit rates in the comparator group. The mean is unduly affected by the presence of such outliers; and
• the SSRO excludes small companies but does not place an upper limit on company size, resulting in a small number of very large companies in the comparator group. Using the weighted mean would result in the BPR being heavily influenced by this small group of companies resulting in volatility and uncertainty about the result.

The median is robust to these features of the data set and is the most appropriate choice of average.

Loss-making companies are removed to reflect the expectation of positive profit on estimated Allowable Costs in QDCs. This maintains consistency with the construct of the profit formula as a mark-up on estimated Allowable Costs and removes the possibility of a negative BPR being produced. Incorporating loss-makers this year would have resulted in a decrease in the BPR of less than one per cent.

3.8 What adjustments has the SSRO made to the data?

In line with the OECD guidelines^{[footnote 3]}, adjustments are made to the company data where they can be performed accurately and are expected to enhance reliability of the results. The SSRO’s calculation of the BPR is based on publicly-reported financial data that is prepared in accordance with accounting standards, is audited by companies’ external auditors, and which is subsequently aggregated by Bureau van Dijk.

As contemplated by the OECD transfer pricing guidelines , the SSRO makes a capital servicing adjustment to take into account the different levels of fixed capital and working capital employed by the companies in the comparator group. (see question 3.11). The SSRO’s view is that no further adjustment should be made.

The SSRO does not make any adjustments to the comparable company data to take into account costs that do not meet the requirement of being Allowable Costs. We do not consider it possible to reliably make an assessment of the costs of comparator companies, or to make corresponding adjustments to their other financial results (such as revenue) to reflect the company’s position as if the “disallowed” cost had not been incurred. The SSRO assumes the cost of production for each comparator company to be appropriate, attributable and reasonable in the circumstances in relation to the revenue each comparator company receives.

The SSRO does not make any adjustments to the comparable company data to take into account costs that relate to the purchase of one company by another. When a comparator company has subsidiaries the data we use is derived from the consolidated group financial statements. This data reflects that when an acquisition occurs the assets acquired and the revenues and costs associated with it become an integral part of the acquirer’s business and activities. Amortisation and impairment of acquired assets are a cost and are recognised in an accounting period in accordance with accounting standards. These costs are therefore treated as costs in both the baseline profit rate methodology and the SSRO’s Allowable Costs guidance. An uplift to the baseline profit rate for such costs would circumvent the requirements for contractors to demonstrate such costs were AAR.

We understand that companies might use alternative performance measures in their annual report and accounts. These might, for example, highlight exceptional items in the income statement or include additional subtotals to show profit before amortisation or impairment of some assets. There are a number of reasons why we do not use these measures:

1. In order to do so we would need to apply them consistently across the whole comparator group and:
   a. detailed information may be available for some companies, but we look at a wide range of companies that have different reporting requirements.
   b. where detailed information is available, our observation is that there are no consistent rules or principles we could apply to determine what is or is not ‘exceptional’.
2. Despite their separate disclosure, such items remain part of the total operational costs of a company. Individual companies may like to provide additional context to help investors understand their underlying results, but we have a different objective, which is to produce comparable measure of return on total operational expenses of a large group of companies.

3.9 Why does the SSRO not adjust for significant one-off events that affect the results of comparator companies?

We understand that companies can be affected by significant one-off events or that companies might be subject to significant one-off adjustments in a current year to reflect past events they were not previously aware of.

As explained in Question 15, we do not think we could reliably adjust for these items. However, the methodology is designed to mitigate the potential impact of these events, in particular:

• whilst some companies might have one-off costs others may have one-off income. The underlying rate is assessed using the financial information of a large pool of companies and so reflects all such one-off events;
• the averaging approaches taken, both the use of the median and the use of a 3-year rolling average, mitigate the impact that a particular one-off event in a particular company can have on the total result; and
• loss-making companies are excluded from the calculation to reflect the expectation of positive profit on estimated Allowable Costs in QDCs. This maintains consistency with the construct of the profit formula as a mark-up on estimated Allowable Costs and removes the possibility of a negative BPR being produced.

3.10 What is the impact on the assessment if a company restates their financial information and will the SSRO reassess a previous year’s rate if financial data has changed?

The financial information we draw from Orbis to calculate the underlying rate reflects the latest set of financial statements issued by a company. This means that if a company were to restate their prior financial results due to adopting a new accounting standard the information used to calculate the current year capital servicing adjustment would be those restated figures.

The SSRO calculates each underlying rate once and we do not re-assess previous years’ underlying rates. Calculating an underlying rate requires two full years of data and so it would not be possible for us to recalculate previous underlying rates because when companies restate financial information it is usually only presented in detail for the current and prior year.

If a material change in the underlying rate were to occur due to market-wide accounting change, or for any other reason, the three-year averaging helps mitigate short-term volatility in the baseline profit rate assessment and incorporates changes in a phased and predictable way. We consider this to be beneficial to contractors and the MOD. Restating past underlying rates would undermine this process.

3.11 Why does the SSRO make a capital servicing adjustment in calculating the BPR?

Regulation 11(6) of the Single Source Contract Regulations 2011 and section 17(2) of Defence Reform Act 2014 provide for an adjustment to the contract profit rate (step 6) so as to ensure that the contractor receives an appropriate and reasonable return on capital employed to perform the contract.

An adjustment made by the SSRO in the calculation of the baseline profit rate to normalise the data in respect of the capital servicing of each company. This is to ensure the BPR is an appropriate baseline upon which to apply step 6.

A contract profit rate therefore incorporates two adjustments to take into account the different levels of fixed capital and working capital employed by the companies in the comparator group and the performance of a contract; one in the calculation of the BPR and a corresponding adjustment agreed between the contracting parties at step 6 to reflect the circumstances of the particular QDC or QSC. The making of adjustments for capital is contemplated by the OECD transfer pricing guidelines.^{[footnote 4]}

The definitions of “capital employed” used for adjustments at each stage are intended to be similar, to the extent possible. However, “capital employed” for the purposes of these adjustments is not intended to represent all capital employed by the comparator company or all capital employed in the performance of the contract, nor is step 6 representative of the return on capital employed for the contract. The process is one of normalising the comparator company data and then readjusting the BPR at step 6 to ensure that the overall effect of the CPR (taking account of steps 1-6) is that a contractor receives an appropriate and reasonable return on the fixed and working capital employed by the contractor for the purpose of enabling the contractor to perform the contract.

3.12 Is the SSRO consistent in its treatment of intangible assets in its calculation of the baseline profit rate?

Yes. The approach the SSRO takes ensures the aspects of the BPR calculation which relate to intangible assets are treated appropriately in respect of both cost and profit.

There are two circumstances where intangible assets might affect the calculation:

1. amortisation costs of intangible assets; and
2. the inclusion or otherwise of intangible assets in “capital employed” for the purpose of the capital servicing adjustment (see Q3.12).

The capital servicing adjustment in the calculation of the BPR does not remove any element of profit in respect of intangible assets because these are not included in the definition of “capital employed”. If an item is not included in the definition of capital employed used for the adjustment in the BPR calculation then the contract will receive an average return that is present within the baseline profit rate for that item, plus any additional amount as a result of the application of the other 6 steps.

Amortisation is the spreading out of the cost of acquiring intangible assets over a specific duration and is therefore rightly treated as a cost-related matter. Such costs may be Allowable Costs. Failing to recognise amortisation as a cost in the BPR calculation (for example by using EBITA as the profit level indicator) would result in contractors being reimbursed for these items at a flat rate, irrespective of whether they are incurred and in what amount. This would not be consistent with the requirements of Allowable Costs and would double-count the return on intangible assets already included in the contract profit rate.

3.13 How does the baseline profit rate compare to the MOD suppliers’ weighted average costs of capital (WACC)?

The WACC describes the expected return required by investors on the money they put in to a business. This is a very different measure to the BPR which is based on return on cost of production (also known as a mark-up on cost, or a profit mark-up).

The relationship between investment in a company and cost incurred is complex. For an individual contract, a return on cost of production could be lower, higher or the same as the WACC and meet the requirements of investors. The required contract profit rate will depend on the individual circumstances of each contract and company, and there are few conclusions to be drawn from a direct comparison of the WACC to the BPR.

Measure	Definition	Key similarities and differences
Profit margin or net margin	(Profit (£))/(Revenue (£))	Uses the same inputs as return on cost but is the return on revenue
Return on capital employed	(Profit (£))/(Capital Employed (£))	The return is measured against the assets that are used as part of operations
Return on invested capital	(Profit (£))/(Invested Capital (£))	The return is measured against the capital that has been invested in operations

4. Capital servicing rates

4.1 How does the SSRO calculate the capital servicing adjustments and how are these used in the calculation of the baseline profit rate?

Each year the SSRO calculates the following three capital servicing rates based on averages of interest rate data published by Bloomberg or the Bank of England:

• Fixed capital
• Positive working capital
• Negative working capital

The profit rate of each comparator company is adjusted in proportion to the ratio of fixed and working capital employed to costs of production, a measure of the capital intensity of the company. A corresponding adjustment is made in the pricing of individual contracts by an adjustment at step 6 of the contract profit rate to reflect the capital intensity of the contract (see question 3.11).

This process ensures that the contract profit rate reflects an appropriate and reasonable return on the fixed and working capital employed by the contractor for the purposes of enabling the contractor to perform the contract.

5. SSRO Funding Adjustment

5.1 How does the SSRO funding adjustment fund the SSRO’s activities and why does it change year-on-year?

The SSRO is an executive non-departmental public body sponsored by the Ministry of Defence, which provides a grant-in-aid for the SSRO’s running costs. The funding adjustment calculation is intended to set the adjustment at a level that allows the MOD to recover half of the SSRO’s grant-in-aid through a reduction in the amounts paid on single source contracts, shared across contractors based upon the value of their QDCs.

The funding adjustment is calculated with reference to the average annual total Allowable Costs of contracts entered into, which may change year on year. The adjustment may change accordingly while still delivering a similar reduction in costs to the MOD. The increase in the 2021/22 recommendation compared to 2020/21 is primarily caused by a decrease in the average annual total Allowable Costs of contracts entered into compared to the previous year.

1. Ministry of Defence (2019) MOD Trade, Industry and Contracts: 2019, Table 4 Annex. ↩
2. Part 4 Taxation (International and Other Provisions) Act 2010. ↩
3. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations Chapter III para 3.48 (2017), OECD ↩
4. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations Chapter III para 3.48 (2017), OECD ↩

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Under the Defence Reform Act 2014, the SSRO must provide the Secretary of State with its assessment of the appropriate rates used to determine the contract profit rate for pricing qualifying defence contracts and qualifying sub-contracts. Part of the methodology is the categorisation of comparator companies in to four activity types.

• Develop and Make
• Provide and Maintain
• Ancillary Services
• Construction

The results of these groups are separately analysed and this fact sheet describes the Develop and Make group. The baseline profit rate combines results from “Develop and Make” and “Provide and Maintain”, as set out in the Recommendation Factsheet. For further information on the methodology used to calculate these rates please see the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Develop and make

Profit on cost of production

	2017/18	2018/19	2019/20	2020/21	2021/22
Underlying rate (unadjusted for capital servicing)	8.00%	8.70%	8.78%	9.67%	9.28%
Capital servicing adjustment	-1.23%	-1.03%	-0.92%	-0.98%	-1.15%
Underlying rate	6.77%	7.67%	7.86%	8.69%	8.13%
Three-year rolling average	7.39%	6.65%	7.43%	8.07%	8.23%

Note: The capital servicing adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which step 6 of the contract profit rate applies.

The pre-2017/18 underlying rates used for the three-year average were: 2016/17: 5.51%; 2015/16 (calculated using the Review Board’s methodology): 9.88%.

Data sources

For further information on the data selection approach please see section 7 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. A company update search of the Orbis database was carried out on 5 November 2020 on data update number 202001 using software version 202. The financial data for the calculation was extracted from Orbis at the same time.

Median capital servicing adjusted return on cost of production

Proportion of Companies by country

Proportion of companies with defence keyword

Supplementary statistics

Number of companies	290
of which profit making	247
Aggregate turnover	£1,056
Total capital employed (CE)	£272
Average company CP:CE ratio	3.47

Source: Orbis (Cash figures shown in GBP Billions)

Names of companies in the index

A/S Vestfrost *	Deere & CO	Lockheed Martin Corp	Skako A/S
Aaon INC	DEL BO Impianti S.R.L.	Logset Oy	Smith & Wesson Brands, Inc.
AB Volvo	Deutz AG	Macpresse Europa S.R.L.	Smith Brothers (Leicester) Limited
Advanced Energy Industries INC	Douglas Dynamics, Inc.	Mactaggart Scott (Holdings) Limited	Smiths Group PLC
Aerojet Rocketdyne Holdings, Inc.	Dril-Quip INC *	Magna International INC	Spirax-Sarco Engineering PLC
Aerovironment, Inc.	Ducommun INC	Makron Oy	Spirit Aerosystems Holdings, Inc.
Aertec Solutions SL.	Duerr AG	Manitex International, Inc. *	SPX Corp
Airbus SE	Elettronica – Societa PER Azioni	Manitou BF	SPX Flow, Inc.
Alamo Group INC	Energy Recovery, Inc.	Manitowoc Company, Inc. (The)	Star Refrigeration Limited
Alimak Group AB	Enerpac Tool Group Corp	Marel HF	Steerprop Oy *
Allied Motion Technologies, Inc.	Espey Manufacturing & Electronics Corp	Mariani S.R.L.	Sturm Ruger & CO INC
Allison Transmission Holdings, Inc.	Eurofighter Jagdflugzeug GmbH	Maschinenfabrik Berthold Hermle AG	Sulzer AG
Alstom	Europress Group Oy	MAX Automation SE *	SVI S.P.A.
Altra Industrial Motion Corp.	EVS Broadcast Equipment SA	Maxar Technologies Inc.	Swede Ship Marine Aktiebolag *
American Axle & Manufacturing Holdings, Inc. *	Faro Technologies INC *	Mccoy Global Inc.	Systemair AB
Ametek INC	Fedegari Autoclavi – S.P.A.	Meggitt PLC	Tacchi Giacomo E Figli S.P.A. *
Amtech Systems INC	Federal Signal Corp	Mercury Systems INC	Talgo,S.A.
Aptiv PLC	Filtronic PLC *	Mikron Holding AG	Talleres Daumar SL
Astec Industries INC	Flir Systems INC	Miller Industries INC	Taylor Devices INC
Astronics Corporation	Flowserve Corp	Mino S.P.A.	Teagle Holdings Limited
Astronova, Inc.	Fratelli Mazzocchia S.P.A. *	MKS Instruments INC	Teledyne Technologies Incorporated
Atlas Copco AB	Freightcar America, Inc. *	Modine Manufacturing CO	Tennant CO
ATS Automation Tooling Systems INC	Frigoveneta S.P.A.	Moog INC	Tenneco Inc.
Autoliv, Inc.	G.H.B. (Holding) Limited	Morgan Advanced Materials PLC	Teradyne INC
Avant Tecno Oy	Genasys Inc.	Motorola Solutions, Inc.	Terex Corp
Axcelis Technologies INC	Gencor Industries, Inc.	Mpac Group PLC	Tesmec SPA
Axon Enterprise, Inc. *	General Dynamics Corp	MS International PLC	Textron INC
Azkoyen SA	General Electric Company	MTS Systems Corp	Thales
BAE Systems PLC	Gentex Corp	National Oilwell Varco, Inc. *	THE Shyft Group, Inc.
Barco NV	Gesellschaft fuer Oeltechnik mit beschraenkter Haftung	Navistar International Corp	Thwaites Limited
Barnes Group INC	Glunz & Jensen Holding A/S *	NC Engineering (Hamiltonsbawn) Limited	Thyssenkrupp AG *
Bevan Group LTD	Gorman-Rupp Company (The)	Nicolas Correa S.A.	Tomra Systems ASA
Bittium OYJ	Graco INC	Nordson Corp	Tornos Holding S.A
BK Technologies INC *	Graham Corp	Northrop Grumman Corporation	Trakm8 Holdings PLC *
Blonder Tongue Laboratories INC *	Gray & Adams (Doncaster) Limited	Novanta INC	Trane Technologies PLC
Boeing Company (The)	Greenbrier Companies, Inc. (The)	Nuova Idropress – Societa’ PER Azioni IN Forma Abbreviata NIP S.P.A.	Transdigm Group Incorporated
Boston Scientific Corp	Grovgaarden AS	Officine Bieffebi S.P.A.	Trinity Industries INC
Brieda E C. – S.R.L.	Gulf Island Fabrication INC *	Omav S.P.A.	Triumph Group INC
Broadwind, Inc. *	Havyard Group ASA *	Onto Innovation Inc. *	Tronrud Engineering AS *
Bruker Corporation	Heico Corp	Oshkosh Corporation	Twin Disc INC
Brunvoll Holding AS	Heidelberger Druckmaschinen AG *	Oxford Instruments PLC	Ultra Electronics Holdings PLC
BWX Technologies Inc.	Heroux-Devtek INC *	P P S Commercials Limited	Univer S.P.A. *
C.M.A. S.P.A.	Hexcel Corp	Paccar INC	Vaisala OYJ
C.S.C. – S.P.A.	Honeywell International INC	Park Aerospace Corp.	Varian Medical Systems INC
Caci International INC	Huntington Ingalls Industries, Inc.	Paul Mueller Company	VEO Oy
Calf S.P.A.	Idex Corp	PC TEL INC	Wabash National Corp
Calpeda S.P.A.	Ii-Vi INC	Perceptron INC *	Wacker Neuson SE
Caprari S.P.A.	Imer International SPA	Petards Group PLC *	Wartsila OYJ
Caterpillar INC	Inficon Holding AG	Pietro Fiorentini S.P.A.	Washtec AG
Ceco Environmental Corp.	Ingenieria Y Tecnicas de Montajes Lointek SL	Ponsse OYJ	Waters Corp
Ceotronics AG	Innovative Solutions & Support INC	Portsmouth Aviation Holdings Limited *	Welbilt INC
Chart Industries INC	Interroll Holding AG	Powell Industries INC	William Cook Holdings Limited (J)
Chemring Group PLC	Intevac INC	Prima Industrie SPA	Wilton Universal Group Limited *
CMZ Machine Tool Manufacturer Sociedad Limitada.	Intricon Corporation *	Qinetiq Group PLC	Wireless Telecom Group INC *
CNH Industrial N.V	Istobal SA	Radley Engineering Limited	Witt & SON UK Holdings Limited
Cognex Corp	Italcab S.P.A.	Raute OYJ	Woodward, Inc.
Coherent INC	John Bean Technologies Corp	Raytheon Technologies Corporation	Worthington Industries INC
Cohort PLC	Judges Scientific PLC	Renishaw PLC	Xylem Inc.
Cohu INC *	Kadant INC	Rheinmetall AG	Zambello Riduttori 2 – S.R.L.
Columbus Mckinnon Corp	Kaman Corp	Ricardo PLC	Zebra Technologies Corp
Comerio Ercole S.P.A.	Katsa Oy	Robor SRL
Commercial Vehicle Group, Inc.	Kesla OYJ	Rockwell Automation, Inc.
Comtech Telecommunications Corp	Keysight Technologies, Inc.	Rohde & Schwarz GmbH & Co. Kommanditgesellschaft
Construcciones Y Auxiliar de Ferrocarriles, S.A.	KMG Systems Limited	Rolls-Royce Holdings PLC *
Continental AG *	Koenig UND Bauer AG	Roper Technologies, Inc.
Cormach S.R.L.	Komax Holding AG	Saab AB
Costar Technologies, Inc. *	Konecranes OYJ	Saalasti Oy *
CTA International SAS	Kongsberg Gruppen ASA (J)	Safran
CTT Systems AB	Kratos Defense & Security Solutions, Inc.	Samp S.P.A.
Cubic Corp	Krohne Italia SRL *	Sandvik AB
Cummins Inc.	KVH Industries INC *	Schaltbau Holding AG
Curtiss Wright Corp	L3harris Technologies, Inc.	Schlatter Industries AG
CVD Equipment Corporation *	LAM Research Corp	Schmitt – Elevadores, LDA
Cyberoptics Corp	Lecitrailer SA	SCM Group S.P.A.
Dalmec S.P.A.	Leonardo – Finmeccanica S.P.A.	Sheffield Forgemasters International Limited
Dana Incorporated	Lillbacka Powerco Oy *	Siemens AG
Data I/O Corp *	Linamar Corporation

‘*’ Indicates that the company is a loss-maker in the year. The data for loss-makers are not included in the 2021/22 assessment, but the companies will be taken forward for consideration next year.

(J) indicates a company which was not in the group last year but has been added this year.

---

Under the Defence Reform Act 2014, the SSRO must provide the Secretary of State with its assessment of the appropriate rates used to determine the contract profit rate for pricing qualifying defence contracts and qualifying sub-contracts. Part of the methodology is the categorisation of comparator companies in to four activity types.

• Develop and Make
• Provide and Maintain
• Ancillary Services
• Construction

The results of these groups are separately analysed and this fact sheet describes the Provide and Maintain group. The baseline profit rate combines results from “Develop and Make” and “Provide and Maintain”, as set out in the Recommendation Factsheet. For further information on the methodology used to calculate these rates please see the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Provide and maintain

Profit on cost of production

	2017/18	2018/19	2019/20	2020/21	2021/22
Underlying rate (unadjusted for capital servicing)	8.78%	9.75%	10.93%	9.92%	9.90%
Capital servicing adjustment	-2.67%	-1.55%	-1.79%	-2.15%	-1.65%
Underlying rate	6.11%	8.20%	9.14%	7.77%	8.25%
Three-year rolling average	7.53%	6.97%	7.82%	8.37%	8.39%

Note: The capital servicing adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which step 6 of the contract profit rate applies. The pre-2017/18 underlying rates used for the three-year average were: 2016/17: 6.60%; 2015/16 (calculated using the Review Board’s methodology): 9.88%.

Data sources

For further information on the data selection approach please see section 7 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. A company update search of the Orbis database was carried out on 5 November 2020 on data update number 202001 using software version 202. The financial data for the calculation was extracted from Orbis at the same time.

Median capital servicing adjusted return on cost of production

Proportion of Companies by country

Proportion of companies with defence keyword

Supplementary statistics

Number of companies	57
of which profit making	50
Aggregate turnover	£86
Total capital employed (CE)	£43
Average company CP:CE ratio	1.79

Source: Orbis (Cash figures shown in GBP Billions)

Names of companies in the index

AAR Corp	Gama Aviation PLC	Saltire Energy Limited
AB Transitio	GAP Holdings Limited	Science Applications International Corp
Aggreko PLC	Gatx Corp	Signature Aviation PLC
ALC (Superholdco) Limited	GO Plant Fleet Services LTD	Snc-Lavalin Group INC *
Applus Services, S.A.	H&E Equipment Services, Inc.	Speedy Hire PLC
Archrock, Inc.	Indra Sistemas SA	Sureserve Group PLC
Ashtead Group PLC	Insta Group Oy	Team INC *
Atlas AIR Worldwide Holdings, Inc.	Jacobs Engineering Group INC	Total Energy Services Inc. *
Babcock & Wilcox Enterprises, Inc.	Kbr, Inc.	United Rentals INC
Babcock International Group PLC *	KIS Partners AS	VMS (Holdings) Limited
Burkhalter Holding AG	Leidos Holdings, Inc.	VSE Corp
Byggesystemer Norge AS	Mcgrath Rentcorp	Westinghouse AIR Brake Technologies Corp
CAE INC	Moen-Gruppen AS	Williams Shipping Holdings Limited
CAI International INC	MTU Aero Engines AG (J)	Willis Lease Finance Corp
Cowles Holdings Limited	Muehlhan AG	Wood Group (John) PLC
Dawsongroup PLC	Natural GAS Services Group, Inc. *
Dublin Aerospace Limited	Oceaneering International INC * (J)
DXP Enterprises INC	Pekkaniska Group Oy
Electromecanica Naval E Industrial SA	Renew Holdings PLC
Finning International INC	RWG (Repair & Overhauls) Limited
Fisher (James) & Sons PLC	Ryder System INC *

‘*’ Indicates that the company is a loss-maker in the year. The data for loss-makers are not included in the 2021/22 assessment, but the companies will be taken forward for consideration next year.

(J) indicates a company which was not in the activity group last year, but has been added this year.

---

Under the Defence Reform Act 2014, the SSRO must provide the Secretary of State with its assessment of the appropriate rates used to determine the contract profit rate for pricing qualifying defence contracts and qualifying sub-contracts. Part of the methodology is the categorisation of comparator companies in to four activity types.

• Develop and Make
• Provide and Maintain
• Ancillary Services
• Construction

The results of these groups are separately analysed and this fact sheet describes the Ancillary Services group. The baseline profit rate combines results from “Develop and Make” and “Provide and Maintain”, as set out in the Recommendation Factsheet. For further information on the methodology used to calculate these rates please see the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Ancillary services

Profit on cost of production

	2017/18	2018/19	2019/20	2020/21	2021/22
Underlying rate (unadjusted for capital servicing)	4.31%	4.49%	5.86%	4.19%	5.86%
Capital servicing adjustment	-0.36%	-0.14%	-0.32%	-0.37%	-0.63%
Underlying rate	3.95%	4.35%	5.54%	3.82%	5.23%
Three-year rolling average	6.11%	4.27%	4.61%	4.57%	4.86%

Note: The capital servicing adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which step 6 of the contract profit rate applies.

The pre-2017/18 underlying rates used for the three-year average were: 2016/17: 4.50%; 2015/16 (calculated using the Review Board’s methodology): 9.88%.

Data sources

For further information on the data selection approach please see section 7 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. A company update search of the Orbis database was carried out on 5 November 2020 on data update number 202001 using software version 202. The financial data for the calculation was extracted from Orbis at the same time.

Median capital servicing adjusted return on cost of production

Proportion of Companies by country

Proportion of companies with defence keyword

Supplementary statistics

Number of companies	38
of which profit making	35
Aggregate turnover	£106
Total capital employed (CE)	£0.37
Average company CP:CE ratio	258.53

Source: Orbis (Cash figures shown in GBP Billions)

Names of companies in the index

ABM Industries INC	DOC Cleaning Limited	Paychex INC
Aramark	Elior Group	prego services GmbH
Atlas FM Limited	Endurance International Group Holdings, Inc.	Puligest S.R.L.
Automatic Data Processing INC	Firstservice Corporation *	Rentokil Initial PLC
AUX Nettoyeurs Encaustiqueurs Reunis	Fiserv INC	Restore PLC
Bilby PLC	Healthcare Services Group INC	Serco Group PLC
Blueglade Limited	ISS A/S	Softcat PLC (J)
Bulloughs Cleaning Services Limited	Lacera Servicios Y Mantenimiento SA	Sykes Enterprises INC
City Facilities Management Holdings Limited	Limpieza Y Mantenimiento Impacto Sociedad Limitada	Trinet Group, Inc.
Cliner SA	Mears Group PLC *	Tyler Technologies INC
Compass Group PLC	Mitie Group PLC
Conduent Incorporated *	Netapp, Inc.
Coor Service Management Holding AB	O.C.S. Group Limited
CSG Systems International INC	OCO Limited

‘*’ Indicates that the company is a loss-maker in the year. The data for loss-makers are not included in the 2021/22 assessment, but the companies will be taken forward for consideration next year.

(J) Indicates a company which was not in the activity group last year, but had been added this year.

---

Under the Defence Reform Act 2014, the SSRO must provide the Secretary of State with its assessment of the appropriate rates used to determine the contract profit rate for pricing qualifying defence contracts and qualifying sub-contracts. Part of the methodology is the categorisation of comparator companies in to four activity types.

• Develop and Make
• Provide and Maintain
• Ancillary Services
• Construction

The results of these groups are separately analysed and this fact sheet describes the Construction group. The baseline profit rate combines results from “Develop and Make” and “Provide and Maintain”, as set out in the Recommendation Factsheet. For further information on the methodology used to calculate these rates please see the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology.

Construction

Profit on cost of production

	2017/18	2018/19	2019/20	2020/21	2021/22
Underlying rate (unadjusted for capital servicing)	4.00%	3.92%	4.02%	3.34%	3.18%
Capital servicing adjustment	-0.39%	-0.43%	-0.52%	-0.27%	-0.17%
Underlying rate	3.61%	3.49%	3.50%	3.07%	3.01%
Three-year rolling average	5.88%	3.75%	3.53%	3.35%	3.19%

Note: The capital servicing adjustment accounts, at an aggregate level, for different levels of capital employed across the companies in the index and so sets a baseline upon which step 6 of the contract profit rate applies.

The pre-2017/18 underlying rates used for the three-year average were: 2016/17: 4.15%; 2015/16 (calculated using the Review Board’s methodology): 9.88%.

Data sources

For further information on the data selection approach please see section 7 of the Single Source baseline profit rate, capital servicing rates and funding adjustment methodology. A company update search of the Orbis database was carried out on 5 November 2020 on data update number 202001 using software version 202. The financial data for the calculation was extracted from Orbis at the same time.

Median capital servicing adjusted return on cost of production

Proportion of Companies by country

Proportion of companies with defence keyword

Supplementary statistics

Number of companies	88
of which profit making	79
Aggregate turnover	£118
Total capital employed (CE)	£2.37
Average company CP:CE ratio	46.71

Source: Orbis (Cash figures shown in GBP Billions)

Names of companies in the index

3B Construction LTD	Glasgiven Contracts Limited	Modebest Group Holdings Limited
Aasen & Oevrelid AS	Goldfoster Limited	Morgan Sindall Group PLC
ADF Group INC *	Groep VAN Roey	Oliver Connell and SON Limited
Aecom	Grupo Empresarial SAN Jose S.A.	Peab AB
Aecon Group INC	H. G. Construction (Holdings) Limited	Putkiwuorio Oy
AF Gruppen ASA	Haandverkskompaniet AS	Severfield PLC
Andrew Scott Ltd.	Haley Securities Limited	Skanska AB
Ashe Group Holdings Limited	Hallmaker Group AS *	Skorve Gruppen AS
B & R – Bouw en Renovatie	Hardwicke Investments Limited	Societe Groupe 1000
Barnwood Group Limited	Highgrove Group PLC	Spritestore Limited
Bird Construction Inc.	Hollingsworth Bros. (UK) Limited	STEINER BAU Gesellschaft m.b.H. *
Blenheim House Construction Limited	Implenia AG	Steve Hoskin Construction Limited
Bowmer and Kirkland Limited	J P Dunn Construction Limited	Stuart Olson Inc. *
Bravida Holding AB	J. & P. Avax S.A.	Tclarke PLC
Brims Building Group Limited	J.Wareing & SON (Wrea Green) Limited	Tolent PLC *
Buckingham Group Contracting Limited	Jarvis Group Limited	Tonroe Group Limited
Byggpartner I Dalarna Holding AB	Jerram Group Limited	Tutor Perini Corporation *
Cara Holdings Limited	Kier Group PLC * (J)	Vanoncini S.P.A.
Champion Groundworks Limited	Koninklijke BAM Groep NV	Veidekke ASA
Clegg Holdings Limited	Kvia Entreprenoer AS *	Vinci
CMF Structures	Lapin Teollisuusrakennus Oy	Vopi 4 SA
Conlon Holdings Limited	LES Macons Parisiens	Wates Group Limited
Coulson Group Limited	Lindum Group Limited	William Hare Group Limited
Darke & Taylor (Holdings) Limited	Lonsdale Holdings Limited	Williams Industrial Services Group INC (J)
Drange Maskin AS	Lowe Holdings Limited	Winvic Group Limited
Elektro AS	M.P.B. Structures LTD	WYN Construction Limited
Emcor Group INC	Magnus M Thunestvedt AS
Evadx Limited	Martifer Sgps S.A.
Feltham Group Limited	Masterson Holdings Limited
Fira Group Oy	Mitchellson Formwork & Civil Engineering Limited
Fluor Corp *
Gaiger Brothers Limited

‘*’ Indicates that the company is a loss-maker in the year. The data for loss-makers are not included in the 2021/22 assessment, but the companies will be taken forward for consideration next year.

(J) Indicates a company which was not in the activity group last year, but has been added this year.