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      Rising defence spending and new technological requirements are making the defence sector an attractive prospect for an increasing number of companies. Alongside established industry players, technology firms, start-ups and medium-sized industrial companies in particular are looking to enter the sector – for example, in the fields of software, AI, drones, cybersecurity or communications. However, any company wishing to secure contracts from the Bundeswehr faces a specific regulatory framework. Alongside public procurement law, export controls and security clearance, this includes the often underestimated public pricing law. 

      The Federal Office for Equipment, Information Technology and Use of the Bundeswehr (BAAINBw) now intends to reform the pricing structure for Bundeswehr procurement. A working group is to draw up proposals by the end of 2026 on how this can be made more innovation-friendly. The focus will be in particular on digital and software-based products, as well as on young technology companies whose development and financing models are only to a limited extent comparable with traditional industrial cost structures. 

      What do public procurement law and pricing law cover?

      Public pricing law is regarded as a separate field of law alongside public procurement law. Put simply, public procurement law governs how a contractor is selected. Pricing law determines the maximum price permitted for a public contract. Even following a proper procurement procedure, an additional review under public pricing law may therefore be necessary.

      Of particular relevance are Regulation PR No. 30/53 on prices for public contracts and the Guidelines for Price Determination Based on Cost Price (LSP). However, this regulatory framework – which has been in place since the 1950s and has been modernised in a piecemeal fashion since then – only reflects today’s digital and innovation-driven business models to a limited extent.

      Its core principle is: market price takes precedence over cost price. If a company can demonstrate that it has repeatedly sold a comparable service at a certain price under functioning competitive conditions, this market price is, in principle, the determining factor. Only where no reliable market price can be established or competition is significantly restricted are cost-based prices taken into consideration.

      In this context, pricing law distinguishes primarily between

      • the fixed cost price, which is determined prior to the conclusion of the contract on the basis of the expected costs,
      • the indicative cost price, which is initially agreed on a provisional basis and is subsequently converted into a fixed price where possible,
      • and the cost-recovery price, under which the proven, reasonable actual costs are reimbursed once the contract has been completed, up to an agreed ceiling where applicable.

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      What does ‘cost price’ mean in the context of defence contracts – and what does it not mean?

      Cost prices are particularly relevant for defence contracts. Complex weapon systems, bespoke military developments or highly specialised IT solutions are often offered by only a handful of companies. Technologies and systems that can only be supplied, maintained or further developed by the respective manufacturer make it even more difficult to establish a reliable market price.

      For companies, however, a cost price does not mean that all internal expenses can simply be passed on to the client and supplemented by a profit margin set at the company’s discretion. Only those costs that are permissible under the LSP and reasonable in the context of sound business management may be included in the calculation. This concerns, amongst other things, the allocation of material and labour costs, overheads, depreciation, imputed interest, individual risks, and provided equipment or services. The imputed profit must also be determined in accordance with pricing regulations or agreed contractually. 

      The practical challenge therefore lies less in a single calculation formula than in the verifiable representation of the entire costing model. In particular, companies must be able to demonstrate that,

      • what costs are incurred as a result of the contract,
      • the allocation bases used for overheads,
      • whether planned or actual costs were used as a basis,
      • how risks, work in progress and development costs are treated,
      • and whether the costs are consistent with sound business management.

      In particular, companies whose accounting systems have so far been geared towards financial statements prepared in accordance with commercial law, investor management or project-based contribution margin accounting do not automatically have a cost accounting system that complies with LSP. Pricing calculations therefore typically involve Finance, Controlling, Sales, Legal and Contract Management simultaneously.

      Why the reform has implications beyond the payout ratio

      The debate on reform does not merely concern the calculation of imputed profit (in the context of the Bundeswehr, in particular the application of the so-called ‘Bonn formula’). At its core, the question is whether cost-based pricing legislation still adequately reflects the value of modern technologies. Whilst the price of traditional industrial products is largely determined by the cost of materials and manufacturing, software, AI and data-driven solutions are often based on pre-funded research, specialised expertise and intellectual property. Their military utility can be considerable, even if the direct production costs are comparatively low.

      This is particularly evident in the case of start-up technology companies. These often finance their development and growth from their own resources or venture capital even before securing their first public contract. The working group set up by the BAAINBw is therefore also tasked with examining how innovations, development risks and intangible value contributions can be better taken into account in future. Discussions will also focus on more functional specifications, greater competition during development phases and closer integration of development and procurement.

      Price reviews can have an immediate impact on turnover and profit margins

      Contractors must, upon request, provide evidence of how their prices are calculated. The competent price review authorities may inspect documents and electronic data, as well as carry out site visits. In the defence sector, additional contractual rights of inspection are frequently agreed.

      If an audit reveals that the agreed price exceeds the maximum price permitted under price regulation law, the price agreement may be invalid to that extent; any overpaid amounts may be reclaimed.  

      Even invoking a market price requires preparation: price lists or internal sales calculations are often insufficient. Comparable transactions, the scope of services, prices actually charged and discounts granted must be documented in a transparent manner.

      What businesses should bear in mind when entering a market

      • Until any reform is implemented, the existing pricing legislation remains in force.

        Companies should therefore assess at an early stage which pricing model is suitable for their services and whether their cost accounting, contract drafting and documentation will stand up to scrutiny in the event of a subsequent price review. Clear lines of responsibility and robust interfaces between Sales, Finance, Controlling and Legal are essential.

      • Pricing regulations may be indirectly relevant

        They may also have an indirect impact on companies that are involved in Bundeswehr programmes via systems integrators or Tier 1 suppliers, for example where relevant costing and documentation requirements are passed on contractually.

      • Pricing law is just one of several issues to consider when entering the defence sector

        However, it serves as a prime example of how public defence contracts cannot be calculated and negotiated solely on the basis of standard commercial criteria. In further articles in this series, we will therefore examine additional requirements – including security clearance – in greater detail.

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