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Identify the fundamentals of cost analysis; Distinguish between price analysis, cost analysis, and cost realism analysis; Identify cost analysis terms and techniques used when developing a prenegotiation position; Identify factors to consider in determining when cost analysis should be used.
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Who Performs Cost Analysis? You! Im sure youve heard this before, but back in the day, there used to be contract pricing and cost analysts that were plentiful, immediately available, and whom eagerly awaited to assist you in performing your analyses. Today, these subject matter experts still exist, but they are few and far between. You may have a price or cost analyst sitting in the cubicle right beside you or down the hall. If so, consider yourself fortunate. It is suggested that you be extremely nice to your analyst and show your appreciation from time to time, because your situation is rare. Back to the subject, you, the contracting officer, specialist, negotiator or analyst, are responsible for performing cost analysis. FAR 15.4041(a)(1) states that you are responsible for evaluating the reasonableness of the offered prices.
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Other Direct Cost (ODC) $150,000 Subtotal G & A (15%) Profit (12%) Total Contract Price $650,000 97,500 89,700 $837,200
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Notes
What type of labor category is appropriate for the type of service you are buying? Does your contract requirement call for a marine biologist or an oceanographer or both to conduct the study? What is a reasonable labor rate for the labor category? Are the proposed hours sufficient to do the job?
With input from your technical and other support groups, you will employ sound business judgment in answering these questions. What is Cost Analysis-Part III As you can see, profit/fee is an important element to all parties. Both the Government and contractors should be concerned with profit as a motivator of efficient and effective contract performance. It is not in the Governments best interest to attempt to negotiate a profit/fee that is extremely low or that is based on an historical average or a predetermined percentage of the total estimated costs. Remember, the objective is to provide a profit that will provide proper motivation for maximum contract performance. Reference: (FAR 15.404-4(a)(2).
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Make a necessity and/or reasonable determination of the contractors proposed costs, including allowances for contingencies. Remember, it is your responsibility to make a price or cost reasonableness determination. Project cost trends on the basis of current and historical cost or pricing data. By projecting cost trends, the Government can better budget its resources for current and future spending. Determine reasonableness of estimates generated by appropriately calibrated and validated cost analysis techniques, i.e. parametric models or cost-estimating relationships (CER). Contractors use cost estimating techniques to assist them in developing their proposed costs. The Government must also use cost estimating techniques to calibrate the validity and reliability of the proposed cost. Apply audited or negotiated indirect cost rates, labor rates, material costs, and cost of money or other factors to establish your Government objective.
There have been numerous stories reported by the press about how taxpayer dollars are being misspent. Two examples are the Carnival Cruise debacle and the overcharges associated with Operation Blue Roof. Each of these stories came to light because the government was accused of overpayment of some contracts that were awarded to assist in the hurricane Katrina clean up and recovery of New Orleans in 2005.
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Cost analysis can help you to confirm an offerors proposed cost for each individual element by comparing it with: actual costs previously incurred by the same offeror; previous cost estimates from the offeror or from other offerors for the same or similar items; other cost estimates received in response to the Government's request; independent Government cost estimates by technical personnel; and forecasts of planned expenditures, when well-developed like an Independent Government Estimate(IGE).
Interim Summary of Cost Analysis Fundamentals Your role as the Contracting Officer is multifaceted. As such, you must have adequate knowledge of cost analysis and be able to exude confidence in making decisions about when to perform it and why. Youve learned that cost analysis is the process of examining each element of cost to determine price reasonableness and that there are several benefits to performing it. In the next section, you will learn the differences between price analysis and cost analysis.
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Differences in Analyses
Content Overview With clear understanding of the definition of cost analysis and insight into when and why it should be performed, you are now ready to examine the distinguishing characteristics of price analysis, cost analysis, cost realism analysis, and technical analysis. Remember that the objective of any type of proposal analysis is to ensure that the final agreed-to price between the Government and the contractor is fair and reasonable to both parties. It would not be fair to the Government to pay a price that is unreasonable for a product or service nor would it be fair to inadequately compensate a contractor for work provided. As the contracting officer, you have the responsibility of evaluating the reasonableness of the offered price. There are two basic approaches which may be used to determine whether the contract price is fair and reasonable for the work being performed: price analysis and cost analysis. In addition to these two approaches, there are other forms of analysis referred to as cost realism analysis and technical analysis which may be used to determine which offeror will provide the best value to the Government considering both quality and price. Deciding which approach to use can be complicated. However, the complexity and circumstances of each acquisition will determine the level of detail required for your analysis. In this section, you will address each of the following:
Notes
Identify methods of analysis Identify differences between price analysis, cost analysis, and cost realism analysis, and technical analysis.
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Differences in Analyses
Content Methods of Analysis As an aspiring contracting professional, you want to be familiar with the different types of proposal analysis techniques. Therefore, lets define what they are. Price Analysis "Price analysis" is the process of examining and evaluating a proposed price in order to determine whether it is fair and reasonable, without evaluating its separate cost elements and the proposed profit. The process of performing price analysis involves comparing a proposed price with other prices, i.e., historical prices, competitive prices, Government estimate, etc. Let's say you have a need for a new pair of shoes. You find a pair that you really like at Wal-Mart. How do you determine that the shoe price at Wal-Mart is fair and reasonable? You might compare Wal-Mart's shoe price with the price for the same or similar style shoe from another retailer, such as Target and or a company on the internet (competitive prices). In addition, you might compare Wal-Mart's shoe price with a price that you paid for a similar or same style shoe that you purchased last year (historical price). The more prices you use for your basis of comparison the better you can determine price reasonableness. After you compare the prices you will determine if Wal-Mart's price is too high or too low or within the price comparison range. Congratulations, you just performed price analysis. Cost Analysis "Cost analysis" is the review and evaluation of the separate cost elements and profit in an offerors or contractor's proposal (including cost or pricing data or information other than cost or pricing data), and the application of judgment to determine how well the proposed costs represents what the cost of the contract should be, assuming reasonable economy and efficiency. Cost analysis must be performed when cost or pricing data are required and it can or may be performed when you have information other than cost or pricing data. Okay, let's go back to the Wal-Mart shoe scenario. With the price analysis you performed a moment ago you compared the price of a pair of shoes with other shoe Notes
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Differences in Analyses
Content prices (competitive and historical). In contrast, with cost analysis you examine each separate element of cost, plus profit. If you wanted to perform cost analysis as your basis for determining the reasonableness of the cost of the shoes you saw at Wal-Mart you would need to have detailed information. Such information would include a itemize breakdown of the type of material, i.e., leather, vinyl, dye, thread, glue, rubber, wood, etc.; the quantities of material and costs. Then you would need to know what percentage of the material handling, insurance, and storage costs are chargeable to the material overhead pool. These are costs that are associated with the direct material, but cannot be assigned directly to the production or sales of a particular product. Next, you would need to examine the labor cost. You will do so by analyzing the skill level of the shoemaker, examine the hourly rate and the number of hours required to make the shoes. Next, you will need to examine the labor overhead cost, general and administrative cost and the profit. Lastly, you would make a determination that each element of cost is fair and reasonable based on your analysis. As you can see, this cost analysis process can be quite extensive. Realistically, you would not perform cost analysis to determine reasonableness of the cost of a single pair of shoes that is commercially available in the open market, since: (1) commerciality is an exemption to cost or pricing data, and (2) the bottom line price is the only cost information available. Without itemized cost data, cost analysis cannot be performed. The shoe example is provided to simply give you a quick contrast between price and cost analysis. Reference: FAR 15.404-1(c) Notes
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Differences in Analyses
Content Cost Realism Analysis "Cost realism analysis" is the process of independently reviewing and evaluating specific elements of each offerors proposed cost estimate to determine whether the estimated proposed cost elements are: realistic for the work to be performed, reflect a clear understanding of the requirements, and are consistent with the unique methods of performance and material described in the offerors technical proposal. The use of cost realism analysis is common when you have adequate competition (two or more offers) and cost and pricing data are not required and are not obtained. You must use cost realism analysis with cost-reimbursement contracts (when cost or pricing data are not required) to determine the probable cost of performance for each offeror. With a fixed-price incentive contract or (in exceptional cases) other fixed-price contract, you may use cost realism analysis to assess offeror responsibility and contract performance risk. Let's look at an example of the use of cost realism analysis. You have a requirement for non-personal services to provide technical and administrative support to the Helicopter Support Squadron. You receive four proposals of which the lowest offer is considerably below its competitors prices. By performing cost realism analysis, you will also evaluate the separate elements of costs that are questionable to determine whether or not the low offeror fully understands the requirement. You might discover that the low offeror plans on using lower skilled laborers, in lieu of the skill level necessary to perform the work, which could result in poor performance or shortfalls. The low offered amount could simply be a mistake or an effort to buy-in based on anticipated future changes to the subsequent contract. On the other hand, the low offer could be the contractors effort to establish business relations with the Government. Your role would be to have the offeror explain how the contract will be performed at the price offered. If the contractor cannot explain the unrealistically low price, you should not make the award. Notes
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Differences in Analyses
Content Technical Analysis "Technical analysis" is another method that may be used to determine the need for and reasonableness of proposed resources, assuming reasonable economy and efficiency. Technical analysis examines the type and quantities of material proposed, the need for the types and quantities of labor hours and the labor mix, and the need for Government furnished material or facilities. Also included in the technical analysis is any other data that may be pertinent to an assessment of the offeror's ability to accomplish the technical requirements or the cost or price analysis of the service or product proposed. Technical analysis is performed by personnel having specialized knowledge, skills, experience, or capability in the areas of the product or service being acquired. This analysis could also require expertise in such areas as manufacturing, engineering, software development, sciences, etc., as well as the management of these disciplines. Reference: FAR 15.404-1(e) Differences Between Analyses Now that you are familiar with the different types of proposal analysis techniques available to assist you in determining price or cost reasonableness and technical capability, this section points out the differences between the types of analysis (price, cost, and cost realism). However, keep in mind that you may use any of the methods of analysis (price, cost, technical and or cost realism), by themselves or in combination, to ensure that the final price is fair and reasonable. What determines the level and detail of the analysis is the complexity and circumstances of the acquisition. We will look at each in detail starting with price analysis. Notes
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5.
6. 7. 8.
Parametric estimating methods and application of rough yardsticks (such as dollars per pound or per horsepower or other units) to highlight significant inconsistencies that warrant additional pricing inquiry. Competitive published price list, published market prices of commodities, similar indexes, and discount or rebate arrangements. Independent Government cost estimates. Prices obtained through market research for the same or similar items. An analysis of pricing information provided by the offeror. Reference: FAR 15.404-1(b)
The first two price analysis techniques listed above are the preferred techniques. However, if you determine that information on competitive proposed prices or previous contract prices is not available or is insufficient to determine price reasonableness, any of the remaining techniques may be used as appropriate to the circumstances applicable to the acquisition. All bases for which recent, reliable, and valid data are available should be used. For instance, the last price paid in addition to current competitive offers should be considered, especially if the prior contract was recently awarded at a reasonable price. Further comparison with commercial catalog, market, or regulated prices can be just as desirable as comparison with competitive offers. After all, the prices of commercial items are defined by market conditions, considering supply and demand. Let's cover the Independent Government Estimate (IGE). Price analysis is a highly judgmental process. For any given procurement, different techniques for price analysis may give a different view of price reasonableness. Even given the same information, different contracting officers might make different decisions about price reasonableness. It is important to document in your contract file the rationale used in making the pricing decision, so that individuals who may review the file later will understand the factors that affected such decisions.
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First, you should rely on information available within the Government. There are numerous sources within the Government who have cost or pricing information. These sources include: fellow coworkers, government auditors, administrative contracting officers, engineers, department of labor, etc. Next, you should gather information from sources other than the offeror. For example, other sources might include: catalog prices, market prices, a price from a previous contract, competitive prices, and data gathered from trade journals, the internet, or other suppliers or vendors. If necessary, as a last resort, obtain information from the offeror.
Remember, it is the Governments responsibility to determine price reasonableness. Therefore, you should explore every means available to assist you in making the determination, before asking the offeror. Format for Submittal If you require the contractor to submit information other than cost or pricing data, it may be submitted in the contractors own format unless you decide that a specific format is essential, and the format has been described in the solicitation. Reference: FAR 15.4033(a)(2)
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limit your requests for sales data relating to commercial items to data for the same or similar items during a relevant time period; limit the scope of the request for information relating to commercial items to include only information that is in the form regularly maintained by the offeror as part of its commercial operations; and not disclose outside the Government information obtained relating to commercial items that is exempt from disclosure or the Freedom of Information Act.
Reference: FAR 15.403-3(c) Failure to Submit You may encounter a situation in which an offeror does not submit information for a contract. In that instance, the offeror is ineligible for award unless the Head of the Contracting Agency (HCA) determines that it is in the best interest of the Government to make the award to that offeror. The HCA bases that decision on:
The effort made to obtain the data. The need for the item or service. Increased cost or significant harm to the Government if the award is not made.
Failure of the contractor to submit information other than cost or pricing data is rare. Most offerors are willing to cooperate with the Government. However, if such a case does occur, consider discussing the matter with your legal office and the auditor. The lack of cooperation may draw suspicion on the contractor's business practices.
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First, you should rely on information available within the Government. There are numerous sources within the Government who have cost or pricing information. These sources include: fellow coworkers, government auditors, administrative contracting officers, engineers, department of labor, etc. Next, you should gather information from sources other than the offeror. For example, other sources might include: catalog prices, market prices, a price from a previous contract, competitive prices, and data gathered from trade journals, the internet, or other suppliers or vendors. If necessary, as a last resort, obtain information from the offeror.
Reference: FAR 15.403-3(a)(4) Remember, it is the Governments responsibility to determine price reasonableness. Therefore, you should explore every means available to assist you in making the determination, before asking the offeror.
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The necessity for, and reasonableness of, proposed costs, including allowances for contingencies; Projection of the offerors cost trends, on the basis of current and historical cost or pricing data; Reasonableness of estimates generated by appropriately calibrated and validated parametric models or cost-estimating relationships; and The application of audited or negotiated indirect cost rates, labor rates, and cost of money or other factors.
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In conducting this evaluation, you shall ensure that the effects of inefficient or uneconomical past practices are not projected into the future. In pricing production of recently developed complex equipment, you should perform a trend analysis of basic labor and materials, even in periods of relative price stability.
3. Comparison of cost proposed by the offeror for individual cost elements with
Actual cost previously incurred by the same offeror; Previous cost estimates from the offeror or from other offerors for the same or similar items; Other cost estimates received in response to the Governments request;
4. Verification that the offerors cost submissions are in accordance with the contract cost principles and procedures in FAR 31 and the cost Accounting Standards, when applicable. 5. Review to determine whether any cost or pricing data necessary to make the contractors proposal accurate, complete, and current have not been either submitted or identified in writing by the contractor. If there are such data, you shall attempt to obtain them and negotiate, using them or making satisfactory allowance for the incomplete data. 6. Analysis of the results of any make-or-buy program reviews, in evaluating subcontracting costs. Reference: FAR 15.404-1(c)(1)(2)
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When deciding the type and quantity of information to obtain from the contractor to conduct cost analysis, the request should be limited to only the information that is needed to conduct the analysis. To require unnecessary submission of cost or pricing data leads to increased proposal preparation costs, generally extends acquisition lead time, and consumes additional contractor and Government resources.
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Are realistic for the work to be performed; Reflect a clear understanding of contract requirements; Are consistent with the unique methods of performances and materials described in the offeror's technical proposal.
The regulation requires that you perform cost realism analysis on costreimbursement contracts to determine the probable cost of performance for each offeror. The probable cost may differ from the proposed cost and should reflect the Government's best estimate of the cost of any contract that is most likely to result from the offeror's proposal. The probable cost shall be used for purposes of evaluation to determine the best value. You may determine probable cost by adjusting each offerors proposed cost, and fee when appropriate, to reflect any additions or reductions in cost elements to realistic levels based on the results of the cost realism analysis. Cost Realism Example The table that follows shows the contractor's proposed cost and the probable cost determined by the Government. As you may notice, the Government has adjusted the contractor's proposed labor hours, hourly rate, and material. The reason for the change is because the Government believes that the proposed labor of 4,000 hours is insufficient to realistically accomplish the work required and the hourly labor rate of $10 is inconsistent with standard labor rates for that type of work. Also, exception is taken on the material cost. Apparently the Government believes that the cost for material is overstated and does not adequately reflect what the cost should be.
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By establishing a probable cost, the Government can determine best value by evaluating the degree and types of risk associated with awarding a contract to the offeror. The Government may conclude that: (1) the contractor's underestimated total cost could be an indication that the contractor misunderstands the requirement; (2) the subsequent contract award could result in a cost overrun, schedule slippage, unskilled or unqualified workers, and improper or and defective material; and (3) that the contractor may be trying to buy-in with a low offer and will later attempt to recoup the difference through a modification to the contract. (Reasons why the proposed cost and the probable cost may differ will be discussed in more detail.) Cost realism analyses may also be used on competitive fixed-price incentive contracts or, in exceptional cases, on other competitive fixedprice-type contracts when new requirements may not be fully understood by competing offerors, there are quality concerns, or past experience indicates that contractors proposed costs have resulted in quality or service shortfalls. Results of the analysis may be used in performance risk assessments and responsibility determinations. However, proposals shall be evaluated using the criteria in the solicitation, and the offered prices shall not be adjusted as a result of the analysis.
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On cost-reimbursement contracts, the contractor may expect to recoup all or most of the costs related to any cost overrun that may occur. On fixed-price contracts, the contractor may hope to: (1) increase the contract amount after award (e.g., through additional and/or excessively priced contract modifications), or (2) receive follow-on contracts at unrealistically high prices to recover losses on the buy-in contract.
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Clear documentation is essential, because it is the documentation that demonstrates to others the basis for your analysis. You can use clear documentation to guide your efforts to resolve offeror disagreement with the results of your analysis, before that disagreement becomes a formal protest. If you are faced with a protest, clear documentation will greatly affect your chances of success in sustaining an award decision. Cost Realism Analysis Process Consider the following process whenever you perform cost realism analysis. Consider Award Criteria Obtain Necessary Information Obtain Acquisition Team Support Identify Understated Costs/Prices Estimate Probable Cost Make Decision
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Notes
Should be limited to the data that you anticipate will be needed for cost realism analysis. For example, if you are primarily concerned about the realism of labor estimates, you may limit the information requirement to the labor skill mix, labor rate, and labor hour estimates. In that situation, you need not require submission of information on material, indirect costs, or profit. Should permit each offeror to determine its submission format unless you need a specific format for efficient and effective analysis. For a commercial item acquisition, limit information requirements, to the maximum extent practicable, to information in the form regularly maintained by the offeror in its commercial operations. Should require each offeror to submit information that is sufficiently current to permit effective cost realism analysis. May include specific information requirements adapted from FAR Table 15-2.
Obtain Government Acquisition Team Support You are ultimately responsible for performing the cost realism analysis, but you cannot be an expert in everything involved in proposal preparation and analysis. Support from both in-house and field members of the Government Acquisition Team can be invaluable. Communicate with team members early in the acquisition process to determine the information already available, extent of assistance required, specific areas where assistance is needed, and information necessary for an efficient and effective review. Ensure that the team supporting the analysis is aware of its responsibility to safeguard sensitive contractor information. During the evaluation process, disclosure of proprietary offeror information must be governed by FAR procedures and applicable agency regulations. Government personnel must not visit any offeror or discuss the proposal with any offeror without proper approval. Only request the support needed to evaluate the offers received. As the number of personnel involved in the evaluation process increases, the chance of unauthorized disclosure of proprietary proposal information also increases.
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Notes
Does the information other than cost or pricing data submitted by the offeror satisfy the solicitation requirements? The information submitted must be adequate for proposal analysis. Inadequate information could indicate a lack of understanding of contract requirements or an attempt to hide weaknesses in proposal development. Does the offeror's cost or price appear realistic based on a comparison with the IGE? A detailed and well documented IGE serves as the initial benchmark against which all proposals are measured.
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Do the proposed costs or prices reflect an accurate understanding of contract requirements? With the assistance of other Government Acquisition Team members, determine if the proposal is consistent with the technical and other solicitation requirements. Inconsistencies need to be identified and clarified. A lack of understanding of the technical requirements can lead to severe contract over or under pricing. Further, a lack of understanding can jeopardize successful contract completion. Are the proposed costs or prices consistent with the various elements of the technical proposal? The cost or price proposal should be a dollars and cents representation of the technical proposal and must be consistent with the technical proposal. Inconsistencies may be identified in any element of the offeror's cost estimate (e.g., direct labor cost, direct material cost, or indirect cost). How has the offerors actual price or contract costs on previous contracts compared with the price proposed? Past performance can be a strong indicator of future performance. However, if records indicate historically poor cost performance, provide the offeror an opportunity to demonstrate that past problems were beyond the firm's control or that improvements have been made in the firm's cost estimating system. Is the contractor likely to satisfactorily meet all contract requirements at the proposed price? Even if the proposal is internally consistent and reflects an accurate understanding of the work, the offeror may still have underestimated the cost of completing the contract. Assess the probability that the offeror can complete the contract on time at the proposed price.
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Decide if a probable cost estimate is necessary. Depending on the solicitation award criteria and the offeror's proposal, you may or may not need to develop a probable cost estimate. o If you are performing a cost realism analysis of a proposal for a cost-reimbursement contract, you must develop a probable cost estimate to support your analysis of best value. o If you are performing a cost realism analysis of a proposal for a fixed-price contract, you may develop a probable cost estimate to assess contract performance risk or contractor responsibility. However, you may be able to analyze key areas of performance risk without a probable cost estimate. Consider general points for probable cost development. Whenever you develop a probable cost estimate, consider the following points: o As you collect the information required to evaluate the realism of the offeror's cost/price estimate, you are also collecting the information required to develop your own estimate of the most probable contract cost. o In developing your estimate, adopt the portion of the offeror's estimate that appears realistic and modify the portion of the estimate that you believe is unrealistic. For example, you may accept proposed labor hours and adjust the labor rate based on an audit recommendation. Adjustments may increase or decrease cost estimates o Use relevant estimating tools and techniques. o As you complete your estimate, assure that you clearly document your rationale for any adjustment.
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Assure that assessment is reasonable. The Comptroller General has repeatedly found that cost realism analysis is a judgmental process and review should be limited to assuring that the analysis is reasonable and not arbitrary. Develop a probable cost estimate for each offer. Each probable cost estimate must consider the unique characteristics of the offeror and the technical proposal. For example, in 1993, the Comptroller General rejected a cost-plus-fixed-fee contract award decision based on probable cost, because the agency failed to consider each offeror's individualized approach and instead mechanically adjusted proposed labor hours and material costs. In that case, the Comptroller General found that: o The agency's cost analyst entered into a computer each offeror's labor hours and material cost estimate for the 100 work items in a work package. o The computer was programmed to compare the offeror's proposed labor hours and material costs with the Government's labor hours and material cost estimates for each work item. o The computer automatically accepted those offeror estimates that were within a predefined percentage of the Government's estimate. For all offeror estimates outside the predefined percentage range, the computer adjusted the offeror's estimate by means of a mathematical formula which approximately split the difference between the contractor estimate and the Government estimate.
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Make Decision Use your cost realism analysis in offer evaluation. Consider the results of your cost realism analysis in offer evaluation, in accordance with the contract award criteria identified in the solicitation. Once you decide to use cost realism analysis, you must decide what information other than cost or pricing data you will need to complete your analysis. In particular, you must decide what information to require from offerors. Normally, you should make this decision during acquisition planning and identify necessary cost information requirements in the solicitation. You may establish the requirement after receipt of offers, but the acquisition will be delayed while offerors gather and submit the information required.
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Notes
Should be limited to the data that you anticipate will be needed for cost realism analysis. For example, if you are primarily concerned about the realism of labor estimates, you may limit the information requirement to the labor skill mix, labor rate, and labor hour estimates. In that situation, you need not require submission of information on material, indirect costs, or profit. Should permit each offeror to determine its submission format unless you need a specific format for efficient and effective analysis. For a commercial item acquisition, limit information requirements, to the maximum extent practicable, to information in the form regularly maintained by the offeror in its commercial operations. Should require each offeror to submit information that is sufficiently current to permit effective cost realism analysis. May include specific information requirements adapted from FAR 15.408, Table 15-2 .
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Differences in Analyses
Content Summary In this lesson you learned about the four methods of analysis (price, cost, cost realism, and technical). Price analysis is the process of evaluating the final price when cost or pricing data are not required. Not to confuse the two, cost analysis is required when cost or pricing data are required and none of the exceptions apply. Or you may perform cost analysis using information other than cost or pricing data to evaluate cost reasonableness or cost realism. Technical analysis is the process of evaluating the offeror technical capability and approach to carrying out the contract requirement. You learned that cost realism analysis is the process of reviewing and evaluating specific elements of each offeror's proposed cost estimate when cost or pricing data are not required to determine if the cost is realistic. Furthermore, you learned about the following re: when cost or pricing data are required: 1) the exceptions to obtaining cost or pricing data (competition, prices set by law, commercial, waiver or modification of a commercial contract or subcontract); 2) when information other than cost or pricing data may be obtained; and 3) when cost realism analysis may be performed. Distinguishing the differences can be confusing to someone new to contracting, but with the information you read and with the support of your peers, you should easily identify the difference in any situation. To assist you in making the determination of which method of analysis is most appropriate you may apply the knowledge gained from this lesson; you may also acquire the advice and assistance of other acquisition team experts, i.e. other contracting officers, government auditors, pricing analysts, legal counsel, and or an Administrative Contracting Officers (ACO). Furthermore, there are several written guides referred to as the Contract Pricing Reference Guides. These documents serve as useful guides to pricing and negotiation personnel and contain detailed discussion and examples applying pricing policies to pricing problems. They may be used for instruction and professional guidance. However, they are not directives and should be considered as informational only. Notes
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An offeror's or contractor's cost or pricing data or information other than cost or pricing data and The judgmental factors applied in projecting from the data to the estimated costs.
The purpose of the evaluation is to form an opinion on the degree to which the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. Reference: FAR 15.404-1(c)(1)
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When you require an offeror to submit cost or pricing data. In this situation, the offeror must provide complete, accurate, and current data to support all proposed costs and profit/fee. When you require an offeror to submit cost information other than cost or pricing data to support your decision on price reasonableness or cost realism. In this situation, require only the information necessary to determine price reasonableness or cost realism.
References: FAR 15.404-1(a)(3) and 15.404-1(a)(4) What is the offered price? The offered price is the amount that the contractor says is required to perform the contract. The offered amount must be compared with the cost or pricing data threshold. The threshold for obtaining cost or pricing data is $650,000. Unless an exception applies, cost or pricing data are required before accomplishing any of the following actions expected to exceed the current threshold: The award of any negotiated contract (except for undefinitized actions such as letter contracts). The award of a subcontract at any tier, if the contractor and each higher-tier subcontractor were required to furnish cost or pricing.
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Unless an exception applies, the HCA, without power of delegation, may authorize you to obtain cost or pricing data for pricing actions below the pertinent threshold of $650,000, provided the action exceeds the simplified acquisition threshold. The HCA shall justify the requirement for cost or pricing data. The documentation shall include a written finding that cost or pricing data as necessary to determine whether the price is fair and reasonable and the facts supporting that finding. You should never require an offeror to submit cost or pricing data below the simplified acquisition threshold. Examples: Situation 1, Offered price exceeds the threshold. If the offered price is $650,000 or greater and none of the exceptions apply, you must ask for cost or pricing data and perform cost analysis. If the offered amount is less than $650,000, but greater than the SAT, none of the exceptions apply, and the HCA authorizes you to acquire cost or pricing data, you must ask the offeror to submit cost or pricing data and perform cost analysis.
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Award will be made to the offeror whose proposal represents the best value where price is a substantial factor in source selection; and There is no finding that the price of the otherwise successful offeror is unreasonable. Any finding that the price is unreasonable must be supported by a statement of the facts and approved at a level above the contracting officer.
Reference: FAR 15.403-1(c)(1) 2. There was a reasonable expectation, based on market research or other assessment, that two or more responsible offerors, competing independently, would submit priced offers in response to the solicitation's expressed requirement, even though only one offer is received from a responsible offeror and if
Based on the offer received, the contracting officer can reasonably conclude that the offer was submitted with the expectation of competition, e.g., circumstances indicate that o The offeror believed that at least one other offeror was capable of submitting a meaningful offer; and o The offeror had no reason to believe that other potential offerors did not intend to submit an offer; and The determination that the proposed price is based on adequate price competition, is reasonable, and is approved at a level above the contracting officer.
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Examples: Situation 1, Adequate price competition exists. If your procurement situation meets the definition of having adequate price competition, you shall not require the offeror to submit cost or pricing data. Instead, consider acquiring information other than cost or pricing data, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Situation 2, No adequate price competition. If you can conclude that adequate price competition did not exist (sole source), the price is over the cost or pricing data threshold, the HCA did not waive the requirement, and none of the other exceptions apply, you must require the offeror to submit cost or pricing data. In such case, you shall perform cost analysis.
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How do I request assistance? Identify analysis needs before requesting analysis assistance. Remember that early communication with Government Acquisition Team members will assist you in determining the specific areas for which assistance is needed, the extent of assistance required, a realistic analysis schedule, and information requirements for cost analysis. Your request must be tailored to reflect the minimum essential supplementary information needed to conduct a technical or cost or pricing analysis. You must tailor the type of information and the level of detail requested in accordance with the specialized resources available at the buying activity and the magnitude and complexity of the required analysis.
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Reference: FAR 15.404-2(a)(2) & FAR 15.404-2(c) When requesting field pricing assistance, are there any restrictions? Field pricing information and other reports may include proprietary or source selection information. If this is the case, the information must be appropriately identified and protected accordingly. Only allow those that have a need to know access to the information.
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Notes
The business relationship between the prime contractor and the subcontractor is not conducive to independence and objectivity; The prime contractor is a sole source and the subcontract cost represents a substantial part of the proposed contract cost; The prime contractor has been denied access to the prospective records; The contracting officer determines that factors (e.g., proposed subcontract dollar value) make audit or field pricing assistance critical to a fully detailed prime contract proposal analysis; The contractor or higher-tier subcontractor has been cited for having significant estimating system deficiencies in the area of subcontract pricing, especially a failure to perform: o adequate subcontract cost analyses or o timely subcontract analyses prior to negotiation of the prime contract with the Government; or A lower-tier subcontractor has been cited as having significant estimating system deficiencies.
When you request analysis of a subcontract proposal, your request should include a copy of the following (when available):
Any review prepared by the prime contractor or higher-tier subcontractor; Relevant parts of the subcontractor's proposal; Cost or pricing data or information other than cost or pricing data provided by the subcontractor; and The results of the prime contractor's cost or price analysis.
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Appendix A Page 1
must require submission of cost or pricing data. The following responsibilities apply to minor modifications of a commercial item that do not change the item from a commercial item to a noncommercial item: For acquisitions funded by any agency other than DoD, NASA, or Coast Guard, the modifications are exempt from the requirement for submission of cost or pricing data. For acquisitions funded by DoD, NASA, or Coast Guard, the modifications are exempt from the requirement for submission of cost or pricing data provided the total cost of the modifications does not exceed the greater of $500,000 or 5 percent of the total price of the contract. For acquisitions funded by DoD, NASA, or Coast Guard where the total cost of the modifications exceeds the greater of $500,000 or 5 percent of the total price of the contract and no other exception or waiver applies, the contracting officer must require submission of cost or pricing data. 2. Any acquisition for noncommercial supplies or services treated as commercial items, at FAR 12.102(f)(1),except sole source contracts greater than $16,000,000, is exempt from the requirements for cost or pricing data (41 U.S.C. 428a). D. Waiver If sufficient information is available to determine price reasonableness, you should consider requesting a waiver. The HCA may, without power of delegation, waive the requirement for submission of cost or pricing data in exceptional cases. The authorization for the waiver and the supporting rationale shall be in writing. The HCA may consider waiving the requirement if the price can be determined to be fair and reasonable without submission of cost or pricing data. An example of a case when the HCA may waive a requirement is if cost or pricing data were furnished on previous production buys and the contracting officer determines such data are sufficient, when combined with updated information. If the HCA has waived the requirement for submission of cost or pricing data, the contractor or higher-tier subcontractor to whom the waiver relates shall be considered as having been required to provide cost or pricing data. Consequently, award of any lower-tier subcontract expected to exceed the cost or pricing data threshold requires the submission of cost or pricing data unless an exception otherwise applies to the subcontract; or the waiver specifically includes the subcontract and the rationale supporting the waiver for that subcontract. E. Other circumstances where cost or pricing data are not required are: When exercising an option at the price established at contract award or initial negotiation does not require submission of cost or pricing data; and When cost or pricing data are not required for proposals used solely for overrun funding or interim billing price adjustments.
Appendix A Page 2
Appendix B Page 1
Cost Elements are the individual items which make up the offerors proposed price or the governments prenegotiation objective. While developing your prenegotiation objective you will evaluate each element and sub-element of cost. The diagram is an illustration of an offerors proposal for engineering services containing several cost elements, including single elements, e.g., direct labor, labor overhead, with numerous sub-elements. COST ELEMENTS DIRECT LABOR (Hours by labor category) Program Manager (Engineer) Mechanical Engineering Manufacturing TOTAL DIRECT LABOR LABOR OVERHEAD Engineering Overhead Manufacturing Overhead TOTAL LABOR OVERHEAD MATERIAL COST MATERIAL OVERHEAD SUBTOTAL COST PROFIT TOTAL COST $140,477.20 35% $3,000.00 35% BASE $52,000.00 $27.040.00 HOURS 520 1040 1040 2600 RATE 75% 68% RATE $35.00 $32.50 $26.00 AMOUNT $18,200.00 $33,800.00 $27,040.00 $79,040.00 AMOUNT $39,000.00 $18,387.00 $57,387.00 $3,000.00 $1,050.00 $140,477.20 $14,047.72 $154,524.92
The number of elements listed in an offerors proposal is dependent upon the type of contract, i.e., services, supply, production; the level of complexity of the work to be performed; and the contractors accounting practices. In fact, there could be differences in the cost elements and sub-elements of two offerors proposal competing independently for the same contract. A competing contractor may propose a single cost element combining engineering and manufacturing overhead, in lieu of two separate cost elements. The governments role is to verify the cost as fair and reasonable and ensure that the proposal is consistent with cost accounting practices and standards. The Government does not tell the contractor the number of cost elements or sub-elements they must use. However, contractors who need assistance in developing or improving their accounting systems and procedures may request information from the Defense Contract Audit Agency via the Internet at http://www.dcaa.mil.
Appendix B Page 2
Cost Input. Cost input refers to the subtotal of all of the cost elements, except general and administrative (G&A) and profit expenses, which for contract costing purposes is allocable to the production of goods and services during a cost accounting period. It may also be referred to as Total Cost Input (TCI) or cost of goods manufactured and is the bases by which the G&A rate is applied. In the example, the Subtotal cost of $14,000 represents the cost input.
Cost Elements Direct Labor Labor Overhead Material Material Overhead Subtotal G & A (22%) Profit Total Cost Amount $10,000 2,000 1,000 1,000 $14,000 3,080 1,500 $18,580
Cost Objective is a function, organizational subdivision, contract, or other work unit for which cost data are desired and for which provision is made to accumulate and measure the cost of processes, products, jobs, capitalized projects, etc. While developing your prenegotiation position, you are in essence analyzing cost and establishing your cost objective. Cost or Pricing Data means all facts that, as of the date of price agreement or, if applicable, another date agreed upon between the parties that is as close as practicable to the date of agreement on price, prudent buyers and sellers would reasonably expect to affect price negotiations significantly. Cost or pricing data are data requiring certification in accordance with FAR 5.804-4. Cost or pricing data are factual, not judgmental, and are therefore verifiable. While they do not indicate the accuracy of the prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment. Cost or pricing data are more than historical accounting data; they are all the facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of determinations of costs already incurred. They also include such factors as: vendor quotations; nonrecurring costs; information on changes in production methods and in production or purchasing volume; data supporting projections of business prospects and objectives and related operations costs; unit-cost trends such as those associated with labor efficiency; make-or-buy decisions; estimated resources to attain business goals; and information on management decisions that could have a significant bearing on costs. Defective Pricing. This exists when any price, including profit or fee, for any purchase action covered by a Certificate of Current Cost or Pricing Data, is increased by any significant amount because the data were not accurate, complete, or current. Direct Cost is any cost that can be identified specifically with a final cost objective. These costs, for the most part, are easily identified as direct labor, direct material, or other direct costs. For example, in a construction or manufacturing contract, the direct labor cost may be identified in the contractors proposal as engineering, manufacturer, laborer, etc. The direct material element may identify types of material, such as, heating, ventilation, and air conditioning system
Appendix B Page 3
(HVAC), brick, plywood, etc. These costs are tied to the end item (building or manufactured unit) and are not chargeable to any other cost objective. Direct Labor are those labor costs that are directly associated with the end item and or can be tied to a single cost objective. For example, a construction contract to renovate the office building to add a gym may call for a plumber, plasterer, electrician and design/civil engineer, to name a few. Each of these laborers will work directly on completing the end item. The direct labor cost associated consists of each laborers hourly rate applied to the number of hours it takes to do the job. Laborer Plumber Plasterer Electrician Design/Civil Engineer Total Direct Labor cost Rate x Hours $18.00 x 40 $16.00 x 80 $28.00 x 40 $37.00 x 120 Cost $720.00 1,280.00 1,120.00 4,440.00 $7,560.00
Seven thousand, five hundred, sixty dollars is the amount the contractor would apply to the cost element of direct labor. Direct Material are those material costs that are directly associated with the end item and/or are chargeable to a single cost objective, such as, wood, metal, subassemblies or components. For example, a construction contract to renovate the office building to add a gym may call for copper tubing, paint, lumber, and drywall, to name a few. Each of these items will go directly into the finished product. The cost associated consists of the price for each of the items applied to the estimated quantity of material to do the job. Material Copper Tubing; dimensions; 1/16" ID, 1/8" OD, 1/32" wall; max PSI, 3100; 50 ft/roll Interior Wall & trim paint; 5 gal size; Item # 15787; Model # 72102A/05 UPS Lumber Bundles 8/4, white pine (F.G.) Drywall 5/8, 2.6 lbs/sq ft Total Direct Material Cost Cost x Quantity $25.50 (USD) x 100 Cost $2,525.00
$85.00 (USD) x 20
$1,700.00
Eleven thousand, seven hundred and thirteen dollars is the amount the contractor would apply to the cost element of direct material.
Appendix B Page 4
Estimating Costs means the process of forecasting a future result in terms of cost, based upon information available at the time. Expert Judgment Techniques involves consulting with one or more experts who use their experience and understanding of the proposed project to arrive at an estimate of its cost. Facilities Capital Cost of Money (FCCOM) means cost of money as an element of the cost of facilities capital. Contractors are encouraged to invest in land, buildings and equipment that are efficient, economical, and state-of-the art and that will be used in support of Government contracts. In turn, the Government is willing to allow the contractor to allocate a percentage of the cost of these investments (buildings and equipment) to Government contracts. The cost is referred to as imputed costs and represents the cost above the actual cost of the buildings and equipment. Imputed costs are indirectly rather than directly charged to the contract. For example, the annual recurring cost of a lease alternative includes costs such as insurance, real estate taxes, land, and other services. The construction alternative should account for similar costs and services. To ascribe these indirect costs to the construction alternative is known as imputing. Final Indirect Cost Rate means the indirect cost rate established and agreed upon by the Government and the contractor as not subject to change. It is usually established after the close of the contractors fiscal year (unless the parties decide upon a different period) to which it applies. For cost-reimbursement research and development contracts with educational institutions, it may be predetermined; that is, established for a future period on the basis of cost experience with similar contracts, together with supporting data. Forward Pricing Rate Agreement (FPRA) is a written agreement negotiated between a contractor and the Government to make certain rates available during a specified period for use in pricing contracts or modifications. These rates represent reasonable projections of specific costs that are not easily estimated for, identified with, or generated by a specific contract, contract end item, or task. These projections may include rates for such things as labor, indirect costs, material obsolescence and usage, spare parts provisioning, and material handling. Forward Pricing Rate Recommendation (FPRR) is a rate set unilaterally by the Administrative Contracting Officer (ACO) for use by the Government in negotiations or other contract actions when forward pricing rate agreement negotiations have not been completed or when the contractor will not agree to a forward pricing rate agreement. Fringe Benefits are an indirect cost that some companies charge in addition to salaries that provide their employees with a variety of benefits. Fringe benefits include costs such as health and life insurance, sick leave, vacation leave, and other employee benefits. Although some contractors group these costs into a fringe-benefit pool, some firms include the costs in the overhead or G&A cost pools.
Appendix B Page 5
General and Administrative (G&A) expense is any management, financial, and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost objectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period. In other words, if the cost is related to a direct base, such as direct labor or direct material, it should be charged to the appropriate indirect pool, i.e., labor overhead, or material overhead, respectively. For example, an indirect cost that would be related to labor are benefits, such as, sick leave or vacation pay for the laborer working on the project. An indirect cost associated with direct material could include the cost of transporting and handling the material or the cost of insurance. On the other hand, if the indirect costs are not associated with a direct cost objective (labor, material or other direct cost), the cost must be charged to the total cost input (TCI) base. Examples of costs included in the G&A pool are executive salaries and benefits, legal and accounting salaries and benefits, and other salaries and benefits of the firms administration. Indirect Costs are those costs that are necessary to operate a business, but are not directly tied to a single cost objective or contract. An example of an indirect cost is General and Administrative (G&A) expense. Indirect costs may be referred to as overhead or burden cost. There can be as many as two hundred different overhead pools depending on a contractors accounting system and how their costs are allocated. The most common indirect cost pools are Material Overhead, Labor Overhead, Engineering Overhead, Facilities Capital Cost of Money, Fringe Benefits, and G&A. Although these costs are necessary for the sake of conducting business, they cannot be charged to a single cost objective or contract and must be spread among the companys total volume of business. If you would like more detail information on indirect costs, DAU offers a residential course (CON 232) entitled Overhead Management of Defense Contracts. Indirect Cost Pools is the grouping of incurred costs identified with two or more cost objectives but not identified specifically with any final cost objective. Examples of indirect cost pools are secretarial or typing pools. The costs associated are chargeable to several cost objectives in lieu of a single objective. Indirect Cost Rate is the percentage or dollar factor that expresses the ratio of indirect expense incurred in a given period to direct labor cost, manufacturing cost, or another appropriate base for the same period. Information Other Than Cost or Pricing Data is any type of information required to determine price reasonableness or cost realism, which does not require offeror certification as accurate, complete, and current. It is information related to prices, sales or cost information, such as, established catalog or market prices or previous contract prices. It includes cost or pricing data for which certification is determined inapplicable after submission. Labor Cost at Standard is a pre-established measure of the labor element of cost, computed by multiplying labor-rate standard by labor-time standard.
Appendix B Page 6
Labor Hours. When performing cost analysis or cost realism analysis, labor hours represent the estimated quantity of labor required to perform a task. The hours identified in an offerors proposal should be reviewed by the technical support to determine whether or not the quantities of hours adequately reflect the time required to meet the performance requirement. A normal person year represents 2080 labor hours, with a half year of 1040 labor hours. Labor Rate represents the wage, earnings, and benefits expressed in monetary terms that a direct laborer would receive for the work performed. The U.S. Department of Labor provides wage estimates for over 800 occupations. Check out its website at http://www.bls.gov. Four general factors have a significant impact on direct labor wage rates: variations in geographical locations, skill levels, conditions in the contractors work force, and the time period of the contract. Labor-rate Standard is a pre-established measure, expressed in monetary terms, of the price of labor. Labor-rate standards are set by industry and are influenced by supply and demand. For example, when you take your car to a mechanic for general maintenance, there may be a sign posted that says, Our standard labor-rate is $40 per hour. Or when you call the plumber to fix a leaky sink, you may be informed that the standard labor-rate is $25 per half hour for service. The Fair Labor Standards Act of 1938 (FLSA), as amended dictates minimum wage and overtime pay standards as well as child labor standards and record keeping in both the private and public sectors, including work conducted in the home. The Wage and Hour Division of the Employment Standards Administration (ESA) administers this Act, which is estimated to affect more than 100 million workers, both full-time and part-time. Labor-time Standard is a pre-established measure, expressed in temporal terms, of the quantity of labor. The concept dates back to the early 1920s, when empirical observations, techniques, moral value, and premises concerning economics were connected, which resulted in the scientific management movement. Pioneered by Frederick Taylor, the Father of Scientific Management, he believed that each and every task, regardless of its size, could be performed in the most efficient and economical way. Hence, both private industry and the public sector have developed labor-time standards for almost every task that exists today. For example, the standard time for processing a contract modification is 30 days. Time standards are based on average time an average worker, under average conditions, takes to perform a particular task or operation without interruption. For the purpose of estimating the number of hours for a proposal, standard times are typically factored upwards or downwards to account for unknown events. Labor Overhead, also referred to as indirect labor or labor burden, includes labor costs and benefits that are not tied directly to a single cost objective or contract, but chargeable to many contracts. An example of a labor overhead expense is the cost of a supervisors salary who oversees the work of several employees working on several contracts or employee related expenses (shift & overtime premiums, employee taxes). This cost should be charged consistently to all of the contracts based on the amount of benefit accrued by the each contract. Other costs included in labor overhead pool are: sick leave, vacation, group insurance, pension fund, FICA/Medicare, training.
Appendix B Page 7
Material-cost at Standard is a pre-established measure of the material elements of cost, computed by multiplying material-price standard by material-quantity standard. Material cost standards are common with the purchase of commercial items. An example of a material-cost at standard is the purchase of a tow hitch package to be installed on a fleet of trucks. The tow hitch package may include the material elements listed. Standard Quantity Unit Item Number Description Standard Material Price 157.00 6.50 25.00 5.80 36.45 7.50 $238.25
Hidden Hitch bracket Hitch Ball Crome 2 X 1 X 1 Ball Mount, 2 inch Pin and Clip Class 3 Modulite w/Circuit Protector Connectors, Wire, Breakers, etc.
The standard price of each item represents an average cost of the particular part multiplied by the standard quantity of items required for the tow hitch package. A supplier may quote a standard material cost of $238.25 per tow hitch package. The standard cost normally does not fluctuate, unless there is a change in the material quantity or a major increase of decrease in the material cost elements. Material-price Standard is a pre-established measure, expressed in monetary terms, of the price of material. The example shown under the material cost at standard identifies several items of material at standard price. Standard material prices usually represent the average manufacturers price for a particular item. The suppliers buy items from different manufacturers and because the costs vary, the supplier will quote a standard price for items of material. For example, lets say that your washing machine needs repairing. You call a local supplier of washing machine parts to inquire about the cost of a replacement agitator, the supplier quotes a price of $39.89 for part number AG8821 that will fit your particular washing machine. This price represents a material price at standard. Material-quantity Standard is a pre-established measure, expressed in physical terms, of the quantity of material. The example shown under the material cost at standard identifies the quantity of several items that are included in a tow kit package. The material quantity represents the standard items that are needed for the installation of the package. Material Overhead is the cost associated with the direct material, but cannot be assigned directly to the production or sales of a particular product. Some examples of cost that may be charged to material overhead pool are material handling and storage, inbound transportation, receiving and inspection, inventory adjustment, and vendor quality assurance. In some cases, direct material of minor dollar amount such as nails, screws, washers, etc. may be charged to material overhead.
Appendix B Page 8
Other Direct Cost (ODC) are costs that are directly related to the end item, but are not chargeable to another direct cost objective, such as, direct labor or direct material. ODC are chargeable to a single cost objective. Examples of ODC are patent/data rights, license, travel, consultant, miscellaneous material, special test equipment. Price means cost plus any fee or profit applicable to the contract type. Price Analysis is the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit. Price Objective (Maximum) Position is the highest price that you can reasonably accept, given the information you have. The position is based on your Governments maximum should-pay estimate. Price Objective (Minimum) Position is the Governments position that represents the minimum price to acquire the product or service. This is also the starting point for the negotiation. Price Objective (Target) Position should be the price that you think is most reasonable based on your analysis of the reliability of different price estimates. It is the most reasonable price you think the Government should pay. Profit/Fee. The terms profit and fee are often used interchangeably because they both refer to the amount of money paid above the cost of doing business. However, more specifically the term profit normally refers to fixed price (FP) type contracts, with the exception of a fixed-price award fee (FPAF) contract. The term fee usually refers to cost reimbursement type contracts. Should-Pay Price is an estimated price that, in your best judgment, the Government should reasonably expect to pay for the deliverable based on available information concerning competitive offers, historical prices, commercial prices, Independent Government Estimate (IGE), etc. Unallowable Cost, sometimes referred to as expressly unallowable cost, means any costs that, under the provisions of any pertinent law regulation, or contract, cannot be included in prices, cost-reimbursements, or settlements under a Government contract to which it is allocable. When performing a cost analysis or developing a prenegotiation position, you must not allow any proposed or actual cost identified by the cost principles as unallowable. Any costs that are expressly unallowable according to FAR 31.205 must be excluded from any billing, claim, or proposal applicable to a government contract. Bad debt and goodwill are two examples of unallowable costs as stated in the regulations.
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Cost Estimating Relationship Example. Due to a major reorganization, the contracting department is going to relocate to a new facility. You have been tasked to locate and lease office space large enough to accommodate all the personnel. You are not familiar with the cost of office space so you gather several estimates and develop a CER. You examine the product-tocost relationship between the dependent variable (cost of the office space) and the independent variable (square footage). Using a rule of thumb in pricing similar office space, you can estimate the cost of the new office facility.
Appendix C Page 1
LEARNING CURVE (Price/Cost Analysis Technique) Learning curve, also known as improvement curve, cost-quantity curve, and experience curve, is a quantitative technique used to estimate the cost or price of a unit. The general concept is that the resources (labor and or material) required to produce each additional unit declines as the total number of units produced over the items entire production history increases. The concept further holds that decline in unit cost can be predicted mathematically. As a result, learning curves can be used to estimate contract price, direct labor-hours, direct material cost, or any other recurring cost. To understand the learning curve concept, imagine the first time you accomplished a difficult task like changing the oil in your car or laying wallpaper. It probably took quite a bit of time and effort the first time you attempted the task. Subsequently, each time you performed that same task the more proficient you became at doing it. Now you probably can change the oil in a matter of minutes without bruising your knuckles or spilling oil all over the driveway or lay wallpaper in half the time that it took to do it the first time you did it. Use of the learning curve should be considered in situations where there is a high proportion of manual labor and uninterrupted production. Other situations when the learning curve can be used include complex tasks and item production; minor technological changes; or continuous pressure to improve. Learning Curve Example. You need to determine price reasonableness for the cost of a single unit of production. The manufacturer offers a unit price that is 30% higher than the independent Government estimated (IGE) price. He/she contends that although the company has manufactured several of the units, the production procedure is still relatively new and as a result the price of the unit has not decreased. By collecting information other than cost or pricing data from the manufacturer, such as, the number of units already produced and the number of labor hours used to produce each unit, you can determine the rate of improvement and use it to estimate the price for your cost, price or cost realism analysis.
Appendix C Page 2
PRICE INDEX NUMBERS (Price Analysis Technique) Price index is considered the most commonly used quantitative technique in contract pricing. It measures the percentage changes in price for one or several related items or services over a period of time. There are two types of indexes, simple and aggregate. Simple index numbers calculate price changes for a single item over time; and aggregate index numbers calculate price changes for a group of related items, such as such as farm products or lumber and wood products, over time. Price index numbers can be used to: Inflate or deflate price or costs for direct comparison; Inflate or deflate prices or costs to facilitate trend analysis; Estimate project price or cost over the period of contract performance; and Adjust contract price or cost for inflation and or deflation. Price Index Number Example 1. You have a four year contract for the purchase of fuel which includes an economic price adjustment (EPA) clause. Fuel prices are too unstable to permit reasonable division of risk between the contractor and the Government. The terms of the contract state that if the price of fuel increases or decreases by 15%, the contract price will be adjusted to reflect the change. You may use price index numbers to adjust the price between the delivery dates of the fuel. Price Index Number Example 2. You purchased a desk top computer in 2003 for $1,200. The price of computers has decreased significantly. Now in 2006, you are buying new computers, and you have an offered price of $1,150 for a desk top computer with the same amount of memory and features as the one you previously purchased. Since you knew the price of the computer in 2003, using a price index number can help you estimate the price of the new purchase.
Appendix C Page 3
REGRESSION ANALYSIS (Price/Cost Analysis) Regression is a quantitative tool used in both price and cost analysis. It is primarily used to develop cost estimating relationships and to project economic trends. The use of regression analysis allows you to develop predictive relationships between dependent and independent variables. Most commonly used is simple regression (two-variable linear regression) in which a single independent variable (X) is used to predict the value of a single dependent variable (Y). The dependent variable will normally be either price or cost (e.g., dollars or labor rate). The independent variable will be a measure related to the product (supply or service) being acquired. It may be a physical characteristic of the product, a performance characteristic of the product, or an element of cost to provide the product. Regression analysis can be used to analyze an indirect cost rate; and to conduct time series analysis to forecast future wage rates, material costs, and production prices. Regression Example 1. You are involved in analyzing a firms direct labor cost. The offeror has proposed hourly labor rates for FY07, 08 and 09. Your technical support indicates that the number of hours proposed are sufficient to perform the task, but questions the proposed hourly rate. You can not determine price reasonableness of the proposed labor rates. As a result, you collect quarterly labor rate data for the same labor category dating back two years. Using the information, you can develop a predictive relationship between the dependent and independent variables of time and hourly labor rate, respectively, to estimate the hourly labor rate for each of the proposed periods. Regression Example 2. You are considering retiring in 20 years. You are not quite certain if you can live off on the amount of money you will receive after retirement. You estimate that your annual retirement income will be 50% of the average salary of your last three years of employment. Using historical salary information for the last 5 years where time is the independent variable and the annual salary for each year is the dependent variable, you can estimate what your salary will be for the last 3 years of service. Once the average 3 year salary is determined, you divide the amount in half. As long as the rate of inflation remains the same, your information will be relatively accurate. Regression Example 3. You have a requirement for the construction of a gym. The contractor proposed a price of $845,000 for a 4,500 square foot facility. With regression analysis you can determine cost reasonableness by collecting historical data for the cost of other facilities recently constructed. By developing an estimating equation using the size of the facility as the independent variable and the cost as the dependent, you can develop cost probability for the 4,500 square foot facility. For more detail information on Regression and how to establish an estimating equation, refer to the Regression Continuous Learning Module (CLM).
Appendix C Page 4
STATISTICS (Cost Analysis Technique) Statistics is a science that involves collecting, organizing, summarizing, analyzing, and interpreting data in order to facilitate the decision-making process. These data can be facts, measurements, or observation. For example, the inflation rate for various commodity groups is a statistic which is very important in contract pricing. Statistics can be classified into two broad categories: Descriptive Statistics--include a large variety of methods for summarizing or describing a set of numbers. These methods may involve computational or graphical analysis. Inferential or Inductive Statistics--are methods of using a sample data taken from a statistical population to make actual decisions, predictions, and generalizations related to the problem of interest.
Statistical analysis can be invaluable to you in: Developing government objectives for contract prices based on historical values. Developing minimum and maximum price positions for negotiations. Developing an estimate of risk for consideration in contract type selection. Developing and estimate of risk for consideration in profit/fee analysis. Streamlining the evaluation of a large quantity of data without sacrificing quality.
Statistics Example 1. An offeror has submitted a proposal on a contract that is part of a complex on-going research program to develop and test a state-of-the-art analysis system. The offeror proposed a mean hourly labor rate o$39.00 for engineering. You can not determine price reasonableness for the proposed labor rate. Your market research indicates that the hourly rate for the type of engineering service required usually range from $26.00 to $50.00 per hour for the geographical location. To determine price reasonableness of the proposed engineering labor rate, you may consider using statistics. Simply by collecting sample data extracted from a statistical population of engineering labor rates, you can calculate a mean labor rate that may be used for your cost or cost realism analysis. Statistics Example 2. You are preparing a solicitation for a 5 year indefinite delivery, indefinite quantity (IDIQ) contact for the service of recharging replacement batteries. The batteries where placed in stock last year. You are not sure how often the service will be required. Your customer has informed you that a sample of 50 batteries extracted from the base storage facility indicates that a fully charged battery has an average shelf life of 1 year and 8 months, with a standard deviation of 3 months. You can use this statistical information to develop a confidence interval to determine when the batteries will require recharging. With more precise information you can establish the Governments prenegotiation position. For more detail information on how to use statistics, refer to the Statistics Continuous Learning Module (CLM).
Appendix C Page 5