Fair and Reasonable Markup (FaRM) Pricing Model

Abstract

The Fair and Reasonable Markup (FaRM) is the smallest markup that satisfies the Required Rate of Return (RRR) of the contractor for the particular (or at least the general risk‐class of) project at hand. The model is based on reasonable and easily‐accessible information, and will result in a Minimum Acceptable Price (MAP). The firm cannot accept the project at a price below this MAP without diminishing the “equityholders' wealth.” A modified version of the FaRM Pricing Model for certain contracts under which home‐office overhead expenses must be recovered through FaRM is also presented. Once the FaRM Pricing Model has been implemented, contractors can make more intelligent pricing decisions. Instead of using a subjective markup, which may ignore the cash‐flow differences of various jobs, contractors using FaRM Pricing Model can bid lower on projects which are more attractive and become more competitive while satisfying their RRR. This should result in lower costs to owners. Conversely, by bidding higher on the less‐attractive jobs, contractors will still maintain their RRR should they obtain the contract.