Afterthoughts: Evaluating Cost & Price Realism

By Nicole R. Best

On February 23, 2017, Professor Ralph Nash and Tim Sullivan hosted a virtual classroom on the topic of Evaluating Cost and Price Realism. Following the virtual classroom, I interviewed Professor Nash to ask questions related to the discussion during the training.

Why does the government, as a buyer, care about cost and price realism?

Those are two different things.

Cost realism is important because when we are running a competition for cost reimbursement contracts, we don’t want companies to win by proposing an estimate that is unreasonably low. If the government awards at an estimate that is low and the contractor runs out of money on the contract but hasn’t finished the job, either (1) you won’t be able get money to complete the project or (2) you would be able to find more money to get the work completed but would use up money you may have wanted for some other work. So the proper evaluation is probable cost, not the offeror’s estimate. It is curious that when an agency bumps the contractor’s costs up to probable cost during cost realism analysis, they still generally award at the low estimate. It seems irrational but it appears to be standard practice.

Price realism is optional. The FAR doesn’t use the term. And you don’t adjust prices. But the concern is if I award at this low fixed price (1) is price low because the contractor doesn’t understand the work or (2) is the price low because the contractor wants to win the competition. Then the contracting officer needs to ask the question of what will happen when they run out of money. Are they rich enough to complete the job at a loss?

Should contractors prepare their proposals differently when the source selection will involve price realism analysis?

The contractor generally ought to put enough money in the price they are proposing to make sure they can complete the job and hopefully make a little profit. This is true whether or not price realism analysis will occur. The problem is if a company is hurting for work, they can get desperate and they can put in a bid for just variable costs to keep the business afloat while they look for more work. But if the RFP calls for price realism analysis, you have to address how you will be able to manage to do the work with a price that is not covering all costs and gives no profit. Be open. Tell the agency that that is what you are doing and that you have enough money to not recover your fixed costs. Show the government you have enough money to cover the fixed costs. The problem with not telling, is that the contracting officer may find you are such a high risk that they don’t want to deal with you and throw you out of the competition. And if you protest that, you won’t win.

What is the effect on the award decision of a contracting officer’s determination that a price is low under a price realism analysis?

It’s discretionary. The contracting officer has to make a decision based on the facts at hand. He or she has to determine whether the low price is a risk that the agency doesn’t want to bear or if they are willing to live with the risk. Part 3 of the FAR discusses “buying in” – winning a competition by submitting a below cost price. It doesn’t say you can’t award to an offeror who is buying in, but you have to think about it. Will the contractor have an opportunity to recover more of its costs during performance?

A good example is the air tanker. They are going to lose over $1 billion. The government knows this. It is widely publicized. So what does the government say? Don’t issue any changes under the contract that could reopen the contract to negotiate a higher price. If the government can do that, they have a great deal and they have a company that can afford to eat the billion. But if the offeror was a small company that would be foolhardy. The contracting officer would have to conclude that something bad would occur before completion of the work.

During the webinar, we didn’t discuss the details of how contracting officers do this analysis and how they have to look at each cost element and make an assessment of if that element is low; that is what the regulation calls for. The hard thing is that the regulation discusses various reasons that cost could be low. One reason is that the contractor has a unique way to do the job which is why the low cost. There is a line of cases dealing with the scenario where the contracting officer assumes the cost is low because the offeror doesn’t have enough labor hours and then adjusts the hours to match other offerors (called normalization). The offeror protests and says “I had a unique way, it wasn’t low at all.” And they can win a protest on that basis. I tell contracting officers that they have to be careful when doing probable cost adjustments. You almost always have to go into discussions. What I say to companies is that if you have a unique way to do the job, tell the government in the proposal even if they don’t ask for it so you don’t end up in a protest.

During the webinar, there was a discussion about the fact that contracting officers seem to share a similar viewpoint that the government does not want a contractor to bid a loss contract (we don’t want contractors bidding so low that they will be unable to perform without incurring significant financial losses). And that in part is why the government could be concerned about bad results in price realism analysis. Is there any similar viewpoint or concern when it comes to structuring IDIQ base contracts? For example, imagine an IDIQ base contract with a guaranteed order of $50,000 but a maximum possible order of $50 million. The poles are essentially two different contracts in terms of unit costs, and start up and mobilization costs. Is there any similar interest in structuring base IDIQ contracts so as to not lead the offeror into a loss scenario?

The case law says that you get no relief if the government gives estimates that lead to low unit prices but then all you get is the minimum. That is a risk from the contractor point of view. The contractor has to base unit prices on an independent assessment of the market. That creates a pretty unlevel playing field. A competition will have one or more contractors that know how the agency has bought in the past and has some pretty good information on likely orders. Other bidders don’t have that knowledge and are making wild guesses. It should be obvious that you can’t propose based on the minimum quantity because that is not a rational way to price. You would never win. You have to figure out what the market is and where you sit in the market, especially where there are going to be multiple awards. There is more of a problem in the supply area. If dealing with supplies, price will be the controlling factor. And remember the maximum is for all orders not just you. So if they award to five offerors you could get 20% of that maximum or 50% or just the minimum order amount. For most IDIQs for services, all you are proposing is fixed labor rates. They are not as tough.

It would be interesting to go out to industry and ask them how they do these prices. But my guess is people who win are people in the market who have more information than what is given in the RFP.

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