New Buy American Rule Threatens to Disrupt Existing Supply Chains
Nimble Companies Can Ensure Market Access by Preparing for the New Rule
The sensible idea that one should keep one’s money for oneself isn’t new. And, in government procurement, it has been around in the U.S. since at least 1933. That was the year President Hoover signed the first Buy American Act, declaring a structural preference for domestic goods in U.S. government procurement. The preference has persisted over many years, even while a fulsome implementation has proved to be elusive.
The recent return to a Buy American mantra in government procurement has domestic and foreign contractors expressing concern. U.S. domestic entities worry that their supply chains will be denied the lifeblood of relatively inexpensive foreign components, while non-U.S. contractors worry that they will be squeezed out of the market all together.
While the Neo-protectionist narrative accompanying the new push suggests opportunities for foreign contractors may tighten, the reality is more complicated and will play out over time. Existing protections under current law and treaties, including notably the World Trade Organization Agreement on Government Procurement (WTO GPA), will temper the President’s ambitions. But President Biden has indicated his intent to “modernize international trade rules—including those related to government procurement—to make sure all countries can use their taxpayer dollars to spur investment.” So, what can U.S. and non-domestic contractors do to prepare for a Buy American resurgence?
Nimble contractors can ensure their continuing market access by preparing for a modernized view of what constitutes a domestic end product under a new test being proposed by the Biden Administration.
On January 25, 2021, the President signed an Executive Order (EO) intended to close perceived loopholes and strengthen the Buy American regime. The EO is the Biden Administration’s first attempt to reverse the perceived weakness in the efficacy of existing U.S. domestic preference regulations. “Under the previous administration, federal government contracts awarded directly to foreign companies went up 30%,” Biden has said. “That’s going to change on our watch.”
To promote this change, the EO instructs the Federal Acquisition Regulatory Council (FAR Council) to consider replacing the current Buy American “component test” with a “value” test. And, while the devil will be in the details, the new rule is sure to disrupt existing supply chains, creating new winners and losers.
Currently, qualifying an end product as “domestic” involves a two-part test. First, the end product has to be manufactured in the U.S. Second, the cost of the end product’s components “mined, produced, or manufactured” in the U.S. must exceed 55% of the cost of all its components. The current test invites accounting creativity. So, for example, the established cost of a contractor-produced end product permissibly includes the cost of transportation and allocable overhead, but not profit. Savvy contractors ensure their compliance while also managing supply chain efficiencies.
But that’s all soon to change. And the change is sure to impact existing supply chains.
The new rule seeks to qualify domestic end products by measuring the “value” that is added to the product through “U.S. based production or U.S. job supporting economic activity.” This second element is novel and the term isn’t defined in the EO. It’s up to the FAR Council to give it life. But, at a minimum, the new rule appears to foreshadow a more sophisticated definition of domestic content that takes all allocable (U.S. job supporting) economic activity into account and doesn’t rely myopically on the domestic origin of a product’s constituent components.
While the Biden Administration sees the Buy American push as an opportunity to boost U.S. based manufacturing jobs, it may also promote the administration’s goals relating to innovation, research, and development. The President campaigned on his intent to make a new $300 billion investment in R&D. It would be natural for his new Buy American rule to be fashioned so as to incentivize independent U.S. research investments, too.
Take, for example, Independent Research & Development (IR&D) and Bid and Proposal (B&P) costs. IR&D covers the full spectrum of R&D activities, including expansion of basic knowledge, exploitation of scientific discoveries, improvement of existing technologies, and creation of new ones. Closely linked, B&P costs reflect the burden contractors incur, at their own expense, to develop and support specific technical proposals, solicited and unsolicited, to potential customers. Both IR&D and B&P are components of a company’s overhead expense.
Unambiguously including the IR&D and B&P costs in those costs properly allocable to a product’s final value for Buy American purposes would have two benefits. It would
(1) allow foreign parents of domestic subsidiaries to more fully leverage current U.S.-based activities, and
(2) create a marginal, rational incentive for contractors to relocate qualifying cost centers to America. The government procurement community could re-envision their supply chains; Buy American calculations could reflect the sum of the value of U.S. domestic components and the allocated value of U.S. IR&D and B&P costs, for example.
Industry should consider contributing to the upcoming notice and public comment period to promote an expansive and unambiguous view of what constitutes value under the new test. And, both domestic and non-domestic firms should reassess the compliance posture of their existing supply chain in light of the new rule. By carefully tracking the rule making and assessing their supply chains in parallel with this government activity, nimble contractors may benefit from a modernized view of what constitutes a permissible “American” end product.
The new rule could be less “Made in America” and more “Made or Innovated in America.”
Interested in learning more? Link here to an Aerospace Industries Association of Canada webinar featuring phalanx’s man�ging member, Jim Lay.
