The now infamous NIH Guidance (NOT-OD-25-068) and Executive Order 14222 started us thinking. Is the Department of Defense (DoD) possibly the next domino to fall? After all, the DoD has a very large contract spend of $431.4 billion based on the Defense Spending by State, FY 2023 — Executive Summary. We looked to see if we could find data on how much of that spend is going to indirect costs (i.e., overhead). Surprisingly, the only data we could find is very dated. The data comes from the DoD Indirect-Cost Management Guide from October 2001 posted on the Defense Acquisition University (DAU) website. The guide states, “estimates made by the Defense Contract Management Command (DCMA), in conjunction with discussions with defense contractor top management on their DCMA Overhead Initiative, indicate[s] that indirect costs constitute approximately $90 billion of the $170 billion total DoD work in process at all defense contractor[s].” While not clear, our assumption is that this represents the 2000 or 2001 timeframe. Based on this, DoD is spending 53% of its appropriated funding on indirect costs. This means the average defense contractor has an approximate 100% indirect cost rate, covering overhead and general & administrative (G&A) costs. Based on recent experiences with our clients, we believe this is still a reasonable estimate of indirect cost on DoD contracts, if not a little higher.
A Little Perspective
We found an article by Anastasia Belyh of Keevee titled “Average Overhead Costs by Industry,” dated February 10, 2025. While this article covered several industries, we selected the following as being the most likely for defense contractors to fall into:
|
Industry |
Overhead as % of Revenue |
Key Cost Drivers |
|
Manufacturing |
15% - 25% |
Equipment maintenance, utilities |
|
Professional Services |
10% - 15% |
Office rent, software tools |
While the data we have for DoD is dated, we believe it is representative of the current situation. We do need to make the percentages consistent. So, here we go. To get the revenue, we took the $170 billion total cost and added $10 billion for profit to get $180 billion in revenue. Using the $90 billion in overhead costs divided by the $180 billion in revenue, we get 50% of revenue.
Based on this very high-level analysis, it appears the average defense contractor is running way above the average commercial company when it comes to indirect costs. We hate to say it, but if our numbers are even close, DoD could easily cut and paste the NIH memo and push out an initiative to cut, or dare we say, cap indirect cost to no more than 25% to 30% of direct costs on future contracts.
What We Believe Drives the Higher Indirect Costs
There are numerous additional requirements placed on defense contractors that do not impact most commercial companies. These include:
- Managing and storing extensive amounts of Government property;
- Additional information technology (IT) requirements for assessments and certifications regarding the handling of classified, control unclassified, and federal contract information;
- Extensive project-level accounting (i.e., cost accounting) requirements; and
- Security requirements.
Granted, these are just a few examples. However, when you are asked to do cost-cutting with a chainsaw, bringing up individual examples is not likely to get much traction.
Our Thoughts on the Matter
Here are just a few of the areas we are seeing impact indirect costs:
- When IT moved to server/laptop-based computing, allocating IT costs on headcount into indirect pools became the common practice, and data centers went the way of the dodo bird. With IT costs ever increasing, this needs to be reevaluated.
- Many support functions (e.g., program management, contract management, etc.) became easier to include in an indirect pool rather than have these employees charge direct and open them up to labor testing (i.e., floor checks) by Defense Contract Audit Agency (DCAA) auditors. This may not be the best practice anymore.
- Fringe benefits are another area of cost that continues to increase. Including the fringe for direct charging employees in the indirect pool may need to change.
- Independent Research and Development (IR&D) and Bid and Proposal (B&P) efforts to support Government expectations add additional costs to G&A. It may be time to push back on some of these Government expectations.
Do not think that you will not be impacted because you do a significant amount of competitive effort with the Federal Government. It is very likely that even in competitions, the contracting officer is going to ask to look at how much indirect costs there are. After all, “other than certified cost or pricing data” is all the rage.
Key Takeaway
Investing in analyzing your costs to get necessary contract costs out of indirect and into direct costs, as well as implementing reasonable cost cutting efforts today will likely make tomorrow’s contract negotiations much easier.
Preparing for What's Next in Indirect Cost Scrutiny
At Redstone GCI, we specialize in helping government contractors navigate the complex landscape of cost accounting and compliance. Our team works closely with contractors to assess their current cost structure, identify opportunities to appropriately reclassify costs, and implement strategies that improve visibility and defensibility in future audits or negotiations. Whether you need to evaluate your indirect cost rates, align with evolving Government expectations, or ensure your accounting system supports compliant cost segregation, we’re here to help. With decades of experience supporting contractors of all sizes, Redstone GCI can provide the insight and practical solutions you need to stay ahead of potential policy shifts—and avoid becoming the next target of indirect cost scrutiny.
