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When a federal government agency awards a particular contract, it is important that the government pays a price that is deemed to be both fair and reasonable. The government takes risks whenever it enters into a contract.
One of those risks is that it may pay a higher price than is necessary for whatever it is procuring. In an effort to mitigate that risk, the government will do an analysis of the contractor’s price to ensure that the government does not pay too high a price for whatever that contractor is proposing.
I want to share with you 3 approaches that the government uses to ensure that the price it pays for a requirement is fair and reasonable. I also want to point out that this information can be further researched in the Federal Acquisition Regulation (FAR) Part 15.404
Here are the 3 approaches to fair and reasonable price used by the government
1. Price Analysis – A price analysis is when the government compares a contractor’s bottom line price with other prices. It is where the government determines fair and reasonable price without digging into the separate cost elements. This is used when, based on the rules outlined in FAR, the contractor is not required to submit cost or pricing data. The government may look into published price lists, other proposed prices for the same requirement, previously proposed prices for the same requirement, the independent government estimate, or prices obtained through market research. Price analysis is objective.
Example: You decide to buy a 2015 Toyota Camry. You check the price for the same 2015 Toyota Camry at Dealership A, Dealership B, and Dealership C. Your simple comparison of the bottom line price of the 2015 Toyota Camry at all three dealerships represents a simple price analysis. You may also check the other price lists online for the same 2015 Toyota Camry, or do some other market research to see what 2015 Toyota Camry’s sell for. All of this represents a price analysis, because you are only evaluating the bottom line price.
2. Cost Analysis – A cost analysis Is when the government evaluates the individual cost elements separately. It is a more in depth deeper dive into the individual cost elements in order to determine if the price is fair and reasonable. Cost analysis is used when, based on the rules outlined in FAR, the contractor is required to submit cost or pricing data. The typical nomenclature used in federal contracting is that a cost is considered “reasonable” if it’s less than what a prudent person conducting competitive business, would pay for it. Cost analysis is fairly objective.
Example: You again decide to buy a 2015 Toyota Camry. However, this time, instead of simply evaluating the bottom line price at Dealership A, Dealership B, and Dealership C, you decide to evaluate the specific costs of individual elements of the price at each dealership. So you examine the costs of each dealerships markup, the overhead allocation applied to the cost of sales at each dealership, the holding costs per dealership, and the administrative fees at each dealership. So what you’ve done is not just compare the bottom line price, but you’ve actually analyzed the individual cost elements that make up the price at each of the dealerships. Perhaps Dealership A has a $950 cost for administration fees, while Dealership B has a $100 cost for administration fees. And so on.
3. Cost Realism – Cost realism is the process that the government uses to review and evaluate specific elements of a proposal to determine whether or not the proposed costs are realistic. Cost realism is usually used on cost-reimbursement contracts to help determine the probable cost of performance for each contractor. There is a formula the government uses for adjusting costs up and down, during a cost realism analysis, based on probable costs, but I won’t go into that level of detail in this blog post. Cost realism is obviously going to be subjective.
Determining the cost realism of a proposal generally focuses on 3 basic premises regarding a contractor’s proposal:
1. Are the contractor’s costs realistic for what is being performed or procured?
2. Does the contractor’s costs reflect that they have a clear understanding of the requirements?
3. Is the contractor’s costs consistent with the unique methods of performance and materials described in their proposal? Or said another way, does their costs make sense, given the other costs elements in their technical proposal?
As I mentioned above, when a contract is awarded on the basis of competitive proposals, the government agency can establish the reasonableness of prices by comparing the prices proposed by the competing contractors. However, it is very important to note that competition alone, does not mean that the prices are reasonable. The contracting officer MUST COMPARE the prices in order to determine price reasonableness. If the prices are not actually compared, then a contracting officer cannot necessarily deem the price to be reasonable. The mere receipt of multiple proposals does not assure that prices proposed are fair and reasonable. It must be DOCUMENTED that those prices have been compared. This was determined in the recent GAO case entitled Technatomy Corporation. B-414672.5 (Oct. 10, 2018).
For further reading, check out FAR Part 15.404.
I hope this helps.
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