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**Determining Price Reasonableness\
in Federal ESPCs**

**January 2005**

> Contents

[[Executive Summary iii]{.smallcaps}](#executive-summary)

[1. Introduction 1](#introduction)

[1.1 Need for Guidance 1](#need-for-guidance)

[1.2 Importance of Price Reasonableness in ESPCs
2](#importance-of-price-reasonableness-in-espcs)

[1.3 Price Reasonableness Working Group
2](#price-reasonableness-working-group)

[1.4 Overview of Contents 3](#overview-of-contents)

[2. Federal Requirements for Determining Fair and Reasonable Pricing in
ESPCs
3](#federal-requirements-for-determining-fair-and-reasonable-pricing-in-espcs)

[2.1 Executive Order 13123 4](#executive-order-13123)

[2.2 National Energy Conservation Policy Act and DOE Final Rule
4](#national-energy-conservation-policy-act-and-doe-final-rule)

[2.3 FAR 15.404 5](#far-15.404)

[3. Bedrock Guidance --- FAR 15.404-1 5](#bedrock-guidance-far-15.404-1)

[3.1 Applying FAR 15.404-1 to ESPC 5](#applying-far-15.404-1-to-espc)

[3.2 FAR Analysis Techniques 6](#far-analysis-techniques)

[3.2.1 Price Analysis 6](#price-analysis)

[3.2.2 Cost Analysis 8](#cost-analysis)

[3.2.3 Technical Analysis 8](#technical-analysis)

[3.2.4 Summary of Applicable FAR Proposal Analysis Techniques
9](#summary-of-applicable-far-proposal-analysis-techniques)

[4. Recommended Strategies for Cost-Effective Assurance of Fair and
Reasonable Pricing
10](#recommended-strategies-for-cost-effective-assurance-of-fair-and-reasonable-pricing)

[4.1 Introduction 10](#introduction-1)

[4.2 Preliminary Activities 10](#preliminary-activities)

[4.3 Pricing Reviews for Initial and Final Proposals
12](#pricing-reviews-for-initial-and-final-proposals)

[4.3.1 Appropriate Level of Review --- Initial Proposal
12](#appropriate-level-of-review-initial-proposal)

[4.3.2 Appropriate Level of Review --- Final Proposal
12](#appropriate-level-of-review-final-proposal)

[4.3.3 ECM Pricing 13](#ecm-pricing)

[4.3.4 Performance-Period-Services Prices
17](#performance-period-services-prices)

[5. Conclusions 18](#conclusions)

[6. References 18](#references)

[Appendix A --- Charter for Price Reasonableness Working Group
19](#appendix-a-charter-for-price-reasonableness-working-group)

[Appendix B --- Membership of Price Reasonableness Working group
19](#appendix-b-membership-of-price-reasonableness-working-group)

[Appendix C --- FAR 15.404-1 20](#appendix-c-far-15.404-1)

[Appendix D --- Benchmarks: A More Rigorous Approach to Price Analysis
24](#appendix-d-benchmarks-a-more-rigorous-approach-to-price-analysis)

# Executive Summary

This document reports the findings and implementation recommendations of
the Price Reasonableness Working Group to the Federal ESPC Steering
Committee. The working group was formed to address concerns of agencies
and oversight organizations related to pricing and fair and reasonable
price determination in federal energy savings performance contracts
(ESPCs). This report comprises the working group's recommendations and
is the proposed draft of a training curriculum on fair and reasonable
price determination for users of federal ESPCs. The report includes

• A review of federal regulations applicable to determining price
reasonableness of federal ESPCs (section 2),

• Brief descriptions of the techniques described in Federal Acquisition
Regulations (FAR) 15.404-1 and their applicability to ESPCs (section 3),
and

• Recommended strategies and procedures for cost-effectively completing
price reasonableness determinations (sections 4).

Agencies have struggled with fair and reasonable price determinations in
their ESPCs primarily because this alternative financing vehicle is
relatively new and relatively rare in the federal sector. The methods of
determining price reasonableness most familiar to federal contracting
officers (price competition based on the government's design and
specifications, in particular) are generally not applicable to ESPCs.

The regulatory requirements for determining price reasonableness in
federal ESPCs have also been misunderstood, as federal procurement
professionals who are inexperienced with ESPCs are further confused by
multiple directives, including Executive Order 13123, which stresses
life-cycle cost-effectiveness.

Uncertainty about applicable regulations and inconsistent practice and
documentation among agencies have fueled claims that price
reasonableness determinations have not been sufficiently rigorous in
federal ESPCs or that the prices paid in ESPCs are generally higher than
the prices paid for similar goods and services obtained through
conventional procurements. While claims of excessive prices are largely
unsubstantiated and based on anecdotal evidence, the perception that
there is a problem is shared by many in the ESPC community and has been
noted by auditors and oversight organizations.

The Price Reasonableness Working Group determined that a more formal
emphasis on FAR 15.404-1 in the ESPC process could remove much of the
doubt about price reasonableness determinations. The working group's
recommended consensus policy on price reasonableness stresses the price
analysis techniques described in the FAR that are applicable to ESPCs
and includes guidance for agencies' use of these techniques in
determining price reasonableness for their ESPC delivery orders.

The recommended policy and guidance, if communicated to federal ESPC
stakeholders, can ensure that agencies will comply with the FAR in
awarding ESPCs, obtain fair and reasonable prices and best value for the
government, and follow procedures that provide auditable documentation
of due diligence in price reasonableness determinations.

> Determining Price Reasonableness in Federal ESPCs

# 1. Introduction

This document reports the findings and implementation recommendations of
the Price Reasonableness Working Group to the Federal ESPC Steering
Committee. The working group was formed to address concerns of agencies
and oversight organizations related to pricing and fair and reasonable
price determination in federal energy savings performance contracts
(ESPCs).

## 1.1 Need for Guidance

Agencies have struggled with fair and reasonable price determinations in
their ESPCs primarily because this alternative financing vehicle is
relatively new and relatively rare in the federal sector. All branches
of the government have experience in implementing appropriations-funded
contracts, and there are a number of effective methods to assure price
reasonableness in these contracts. Implementing an ESPC, however, is
fundamentally different from the process used in more conventional
contracting mechanisms.

In particular, the methods of determining price reasonableness most
familiar to federal contracting officers are generally not applicable to
ESPCs. Most federal ESPC projects are implemented as delivery orders
under one of the Defense or Energy Department's indefinite-quantity,
indefinite-delivery (IDIQ) ESPCs without a true price competition, so
competition at the contractor selection stage cannot be used to
guarantee price reasonableness. ESPC projects are similar to
design-build contracts, except that the energy services company (ESCO)
generally develops a firm-fixed-price proposal when the ESCO-developed
design is only about 30% complete. Lacking complete cost data, it is
difficult for the government to perform traditional cost analyses or to
develop an independent cost estimate to compare with the ESCO's
proposal. Unable to rely on customary methods, some agencies have
struggled with how to perform timely, cost-effective price review of
ESPC projects.

The regulatory requirements for determining price reasonableness in
federal ESPCs have also been misunderstood, as federal procurement
professionals who are inexperienced with ESPCs are further confused by
multiple directives that appear to provide conflicting guidance.
Executive Order 13123, which is often cited as the impetus for the
Department of Energy (DOE) Federal Energy Management Program's (FEMP's)
Super ESPC program, stresses life-cycle cost-effectiveness, but contrary
to common interpretation, does not supercede or replace overarching
requirements of the Federal Acquisition Regulation (FAR). The federal
requirements for determining price reasonableness in ESPCs are reviewed
in section 2.

Uncertainty about applicable regulations and inconsistent practice and
documentation among agencies have fueled claims that price
reasonableness determinations have not been sufficiently rigorous in
federal ESPCs or that the prices paid in ESPCs are generally higher than
the prices paid for similar goods and services obtained through
conventional procurements.[^1] While claims of excessive prices are
largely unsubstantiated and based on anecdotal evidence, the perception
that there is a problem is shared by many in the ESPC community and has
been noted by auditors and oversight organizations.

## 1.2 Importance of Price Reasonableness in ESPCs

The responsibility to ensure that the government pays fair and
reasonable prices for the goods and services it buys is critical in
ESPCs, where the procurement is financed over time. Figure 1 shows the
distribution of costs over the lifetime of the typical ESPC project
awarded under DOE's Super ESPC program. Implementation price, which is
the installed cost of the energy conservation measures, accounts for the
largest share of the total, 42.8%. Financing-related costs, including
interest, account for another 38.1%, and these depend directly on the
prices of energy conservation measures (ECMs). As the figure shows, when
the ECM prices in the average Super ESPC project are increased by 10%,
the total sum of payments over time increases by 25.5%.

Performance-period services account for the third largest cost component
of the average ESPC project, at about 19% of the total over the life of
the project. Ensuring that prices for these services are fair and
reasonable is also important. While these costs are not financed, they
have an indirect effect on financing costs: Reducing the amount of
guaranteed cost savings available for paying debt service increases the
term of the contract. A 10% increase in the cost of performance-period
services increases total costs over the term of the average Super ESPC
by 5.5%.

## 1.3 Price Reasonableness Working Group 

The Federal ESPC Steering Committee authorized the formation of a Price
Reasonableness Working Group to address this issue. The working group
includes representatives of the four Armed Services, DOE, and the DOE
National Laboratories. The objectives of the working group were to
identify and document the approaches agencies have used for price review
in ESPC projects, including best practices, and to develop consensus
among the federal ESPC programs on implementation recommendations to
users of federal ESPCs for performing price review in future projects.

The working group surveyed its members to determine how their
organizations assure price reasonableness in ESPC contracts and found
that all members were relying on their own interpretation of FAR
15.404-1, Proposal Analysis Techniques. Although FAR 15.404-1 was
intended to apply to conventional multiple-bid, appropriations-funded
contracts, many of the techniques it specifies are also useful for
assuring price reasonableness in ESPCs. For this reason, the working
group decided that a more formal emphasis on FAR 15.404-1 in the ESPC
process could remove much of the doubt about price reasonableness
determinations. Therefore, FAR 15.404-1 forms the basis for the working
group's recommended consensus policy on price reasonableness.

![](media/image2.jpeg){width="4.981944444444444in" height="3.6in"}

**Figure 1. Assuring fair and reasonable pricing in ESPCs is perhaps
more important in financed contracts such as ESPCs than in conventional
contracts. If the implementation price for the average Super ESPC
project increases by 10%, total agency payments over the term of the
contract increase by 25.5%.**

## 1.4 Overview of Contents

The remainder of this report comprises the working group's
implementation recommendations and is the proposed draft of a training
curriculum on fair and reasonable price determination for users of
federal ESPCs. The report includes

• A review of federal regulations applicable to determining price
reasonableness of federal ESPCs (section 2),

• Brief descriptions of the techniques described in FAR 15.404-1 and
their applicability to ESPCs (section 3), and

• Recommended strategies and procedures for cost-effectively completing
price reasonableness determinations (section 4).

# 2. Federal Requirements for Determining Fair and Reasonable Pricing in ESPCs

The requirements for determining fair and reasonable pricing in
federally awarded ESPCs are found in Executive Order 13123, the
legislation that authorized federal ESPCs, and the federal regulations
that implement the ESPC authority. ESPCs, like all government contracts,
must comply with the FAR's solicitation and competition requirements.

## 2.1 Executive Order 13123

E.O. 13123, which is often cited as the impetus for FEMP's Super ESPC
program, directs agencies to consider life-cycle cost in their
deliberations about resource-efficiency investments, which includes
ESPCs:

PART 4 --- PROMOTING FEDERAL LEADERSHIP IN ENERGY MANAGEMENT, Sec. 401.
Life-Cycle Cost Analysis. Agencies shall use life-cycle cost analysis in
making decisions about their investments in products, services,
construction, and other projects to lower the Federal Government's costs
and to reduce energy and water consumption. Where appropriate, agencies
shall consider the life-cycle costs of combinations of projects,
particularly to encourage bundling of energy efficiency projects with
renewable energy projects. Agencies shall also retire inefficient
equipment on an accelerated basis where replacement results in lower
life-cycle costs. Agencies that minimize life-cycle costs with
efficiency measures will be recognized in their scorecard evaluations.

The emphasis on life-cycle cost-effectiveness seems to have led to the
perception in some quarters that price reasonableness is less important,
as long as the project pays from savings. The perception is partially
correct in that the reason life-cycle cost is emphasized is to allow
consideration of advanced energy conservation measures that could
potentially cost more -- but have higher energy and energy cost savings
-- than more conventional conservations measures. However, the
requirement to consider life-cycle cost does not replace or supercede
the requirement to comply with the FAR and to perform fair and
reasonable price determinations with due diligence. The intent is that
the prices paid for the advanced ECMs --- and for all equipment
installed under ESPC --- should be fair and reasonable, and in
accordance with prices paid for similar equipment in the private sector.

## 2.2 National Energy Conservation Policy Act and DOE Final Rule

The National Energy Conservation Policy Act, as modified by the Energy
Policy Act of 1992, established the authority for the government to
enter into the guaranteed savings style of ESPCs. Title VIII, Section
801, directed the Secretary of Energy to "establish appropriate
procedures and methods for use by Federal agencies to select, monitor,
and terminate contracts with energy service contractors in accordance
with laws governing Federal procurement that will achieve the intent of
this section in a cost-effective manner," and in doing so, to "determine
which existing regulations are inconsistent with the intent of this
section and ... formulate substitute regulations consistent with laws
governing Federal procurement."

DOE subsequently determined that requiring ESCOs to submit certified
cost data is inconsistent with the intent of Section 801 of the Act.
Specifically, the Final Rule on Energy Savings Performance Contracts, 10
CFR 436, section 33, paragraph (c) (2), reads:

Pursuant to the authority provided under section 304A(b)(1)(B) of the
Federal Property and Administrative Services Act of 1049, the heads of
procuring activities shall waive the requirement for submission of
certified cost or pricing data. However, this does not exempt offerors
from submitting information (including pricing information) required by
the Federal agency to ensure the impartial and comprehensive evaluation
of proposals.

The supplementary information provided with 10 CFR 436 emphasizes this
point:

It should be noted, however, that the waiver of the requirement for
certified cost or pricing is not intended to preclude contracting
officers from requesting information considered necessary to determine
whether a contractor's prices are fair and reasonable.

To summarize, 10 CFR 436.33 provides some guidance on price
reasonableness in sections (c) (1) and (2). The final rule:

• Waived the requirement for certified pricing,

• Stated that offerors must nevertheless provide information requested
by federal agencies, and

• Did not specify how agencies are to assure price reasonableness.

The fact that ESPCs include finance charges has led to further
uncertainty. However, the working group believes that ESPCs must be
approached in the same way an individual approaches the purchase of a
home or an automobile --- by first seeking a fair price for the item,
and then seeking the best available financing. Seeking a fair price is
the objective of a price reasonableness determination and is the focus
of the remainder of this document.

## 2.3 FAR 15.404

ESPCs must comply with the FAR's solicitation and competition
requirements, but if the FAR conflicts with EPACT or the DOE Final Rule,
the latter take precedence over the FAR. There is no conflict in these
regulations pertaining to price reasonableness determination. ESPC
delivery orders, as government procurements, are required to comply with
FAR Subpart 15.4 -- Contract Pricing.

# 3. Bedrock Guidance --- FAR 15.404-1

## 3.1 Applying FAR 15.404-1 to ESPC 

ESPC delivery orders, as government procurements, are required to comply
with FAR Subpart 15.4, "Contract Pricing." Price reasonableness
determinations are required for all ESPC price components, including
ECMs, performance-period services, and financing. (The Financing Cost
Reduction Working Group's recommendations to the Federal ESPC Steering
Committee, which cover price reasonableness determination for financing
costs, are reported in *Reducing Financing Costs for Federal ESPCs*,
available at www.ornl.gov/sci/femp/wg_financing.shtml.)

The FAR instructs contracting officers to purchase supplies and services
from responsible sources at fair and reasonable prices. Although the FAR
does not define what constitutes a fair and reasonable price, the term
is understood to mean the price that would be paid by a prudent person
considering the current market environment.

FAR 15.404-1, "Proposal Analysis Techniques," describes the techniques
contracting officers are to use to ensure that final agreed-to prices
are fair and reasonable. (FAR 15.404-1 is given in Appendix C.) The main
techniques are

• price analysis,

• cost analysis, and

• technical analysis.

These techniques, discussed in section 3.2, can be used singly or in
combination.

The FAR instructs contracting officers to require offerors to submit the
smallest amount of information necessary to determine price
reasonableness. This tends to favor price analysis. Where price
reasonableness cannot be established through price analysis alone, cost
analysis may be performed. This is a more detailed assessment of the
need for and reasonableness of each of the individual cost elements that
make up the offeror's price proposal, including labor, materials, and
overheads, and tends to be more costly and time-consuming than price
analysis. Although this technique provides a more detailed analysis of a
proposal, the final price reasonableness determination should be made on
the basis of overall price.

Review by technical experts and individuals familiar with the equipment
and services being procured is another valuable technique for
establishing price reasonableness.

## 3.2 FAR Analysis Techniques 

### 3.2.1 Price Analysis

Price analysis is defined as "the process of examining and evaluating a
proposed price without evaluating its separate cost elements and
proposed profit." This encompasses a number of different techniques.
Many of these are directly applicable to ESPC, although not all are. The
techniques described in the FAR are the following.

#### 3.2.1.1 Price competition

The FAR considers the market forces inherent in the competitive bidding
process to be adequate to establish price reasonableness, and the FAR
lists price competition \[FAR 15.404-1 (b)(2)(i)\] as the preferred
method of price analysis in traditional government contracting. Because
in ESPCs the ESCO is selected before the project is defined sufficiently
to support a true price competition, ESCO selection through price
competition and hence use of competition for establishing price
reasonableness is rarely used in ESPC. Agencies can, however, obtain
competitive pricing by requiring ESCOs to solicit competitive bids from
subcontractors.

#### 3.2.1.2 Comparison with previously proposed prices 

*Comparison of previously proposed prices and previous Government and
commercial contract prices with current proposed prices for the same or
similar items, if both the validity of the comparison and the
reasonableness of the previous price(s) can be established. --- FAR
15.404-1 (b)(2)(ii)*

For the most part, the equipment installed and the services provided
under ESPC involve systems that provide electrical service, lighting,
heating, air conditioning, and ventilation for buildings. Similar ECMs
have usually been installed in the past at the same installation or at
other installations, either in previously awarded ESPCs or in
appropriations-funded energy conservation programs. Prices paid in the
past can be used to determine whether the prices offered for similar
equipment and services are fair and reasonable.

The project team often has access to a great deal of information on past
pricing for similar ECMs from its own site or from agency-level service
organizations. FEMP maintains a database of prices for all of the ECMs
installed under its Super ESPCs and makes the information available as
requested to project teams installing similar ECMs in other projects.

For comparisons to be valid, adjustments in the data are usually
required. No two construction projects are identical --- prices are
affected by site-specific factors such as safety and security
requirements and the cost of labor in the local economy. Likewise, no
two contracting mechanisms are identical. Caution should be exercised
when comparing prices offered in ESPCs, which are design-build
contracts, to prices received for previous projects in which the site
may have received funding for partial design from an agency energy
conservation program. Adjustments for general inflation must be made as
well.

#### 3.2.1.3 Parametric estimating methods 

*Use of parametric estimating methods/application of rough yardsticks
(such as dollars per pound or per horsepower, or other units) to
highlight significant inconsistencies that warrant additional pricing
inquiry. --- FAR 15.404-1 (b)(2)(iii)*

Other terms for such yardsticks are cost estimating relationship (CER)
and price benchmarks. CERs and benchmarks are mathematical
relationships, usually based on statistical analysis, between price as
the dependent variable and one or more physical characteristics of the
item or system purchased as independent variables. CERs can be used to
extend the technique of comparing proposed prices with previously
proposed prices described above.

As a simple example, suppose a site wishes to replace a 500-ton
centrifugal chiller. The site recently paid \$162,000 to replace a
200-ton centrifugal chiller and \$366,000 to replace an 800-ton chiller,
but because there is no recent pricing information available for
replacement of 500-ton chillers, strict reliance on past pricing would
not provide enough information to establish price reasonableness. A
simple price benchmark would be to assume a straight-line relationship
between installed price and equipment size. Based on the two previous
chiller replacements, the benchmark relationship is Price = \$94,000 +
340 × tons, so a reasonable price for replacement of a 500-ton chiller
would be \$94,000 + 340 × 500 = \$264,000.

Most benchmarks or CERs are based on much more data than this and
require corrections for project scope, general price inflation, and
geographical location, as well as statistical analysis to determine the
relationship itself. However, information on past pricing from the site,
the agency, or other sources can be used by acquisition teams to develop
their own CERs.

FEMP has developed CERs for some of the more commonly installed ECMs
based on data from past Super ESPC projects and appropriations-funded
projects and makes this information available to project teams.

#### 3.2.1.4 Comparison with published prices 

*Comparison with competitive published price lists, published market
prices of commodities, similar indexes, and discount or rebate
arrangements.\
--- FAR 15.404-1 (b)(2)(iv)*

This refers to catalog prices and GSA schedules, as well as
cost-estimating guides published by firms such as R. S. Means, Marshall
and Swift, and Craftsman. These lists and guides provide pricing for
specific commercial items such as boilers and chillers. ESPC projects
often involve demolition of existing equipment as well as installation
of new equipment, and so the ECM price will include more than just the
commercial cost. For this reason, price lists and guides find more use
in cost analysis than in price analysis.

#### 3.2.1.5 Market research 

*Comparison of proposed prices with prices obtained through market
research for the same or similar items.* --- *FAR 15.404-1 (b)(2)(vi)*

In some cases useful pricing information can be obtained through market
research. An example would be the solicitation of price quotes from
other suppliers. However, as with the use of price lists and guides, the
information obtained usually applies to specific commercial items.
Again, because ESPC projects often involve demolition and construction,
information obtained through market research tends to be more useful in
cost analysis than in price analysis.

#### 3.2.1.6 Analysis of pricing information provided by the offeror

Prices proposed by the offeror to other customers can also be used to
establish price reasonableness \[FAR 15.404-1 (b)(2)(vii)\], although
15.402 (a)(2)(i) lists the preferred source of information to be that
which is available within the government, followed by that which is
available from sources other than the offeror. Information provided by
the offeror is only to be used if necessary.

#### 3.2.1.7 Comparison of proposed prices with independent Government cost estimates

While usually associated with more traditional contracting methods, an
independent government estimate (IGE) can also be used to establish
price reasonableness in ESPCs if the necessary resources are available
to develop one \[FAR 15.404-1 (b)(2)(v)\]. The IGE is the government's
estimate of the resources needed and the estimated cost of those
resources that a prudent contractor would incur in the performance of a
contract. The estimate includes both direct costs (e.g., labor,
supplies, equipment, and transportation) and indirect costs (e.g., labor
burden, overhead, general and administrative expense, and profit or
fee). Development of an IGE typically requires designs to be at the 95%
stage. This limits their usefulness in ESPC programs where contracts are
signed at the 30% design stage, but some programs do postpone ESPC
project award until 95% designs are available.

### 3.2.2 Cost Analysis

If price reasonableness cannot be established by the price analysis
techniques described above, contracting officers may use cost analysis,
defined in FAR §15.404-1(c)(1) as

> > *"the review and evaluation of the separate cost elements and profit
> > in an offeror's 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
> > represent what the cost of the contract should be, assuming
> > reasonable economy and efficiency."*

For a cost analysis, the contracting officer needs a detailed breakdown
of the offeror's price into material, labor, and overhead costs. While
several different cost analysis techniques are listed in FAR 15.404-1
(c), the process basically comes down to verifying the necessity for and
reasonableness of each of the elements in the offeror's cost proposal.
Many price analysis techniques are applicable in cost analysis as well
to assess the reasonableness of individual cost elements. For example,
proposed costs of individual pieces of capital equipment can be compared
with previously proposed prices for similarly sized equipment. Price
benchmarks can also be used at the level of individual costs. Price
lists, catalogs, and cost estimating guides are generally most useful in
cost analysis.

It should be noted that the more detailed, in-depth review carried out
in a cost analysis does not necessarily assure price reasonableness. For
example, consider the procurement of a computer. An offeror could submit
a detailed price proposal including all of the materials and labor
required to fabricate each individual electronic component and combine
them together on circuit boards. While cost analysis might judge each
individual cost to be fair and reasonable, the overall price of building
a computer from scratch would be much higher than purchasing one on the
open market. For this reason, the FAR specifies that even where cost
analysis is used, price analysis should also be used to verify that the
overall price is fair and reasonable.

### 3.2.3 Technical Analysis

In technical analysis, the contracting officer seeks the opinion of
individuals with specialized knowledge of the equipment or services
being procured \[FAR 15.404-1 (e)\]. These individuals would generally
be professional cost estimators who would examine, at a minimum, the
types and quantities of materials proposed and the need for the types
and quantities of labor hours and the labor mix. Also, agency or
site-level engineering staff are usually integral members of the ESPC
project team, and their analysis of cost proposals is carried out as a
normal part of the review process. Less common ECMs such as geothermal
heat pumps or combined heat and power equipment may require review by
independent experts such as DOE National Laboratory personnel.

### 3.2.4 Summary of Applicable FAR Proposal Analysis Techniques

The recommended techniques and their application to federal ESPCs are
summarized below.

  ----------------------------------- -----------------------------------
  **FAR Technique**                   **Application to Federal ESPCs**

  1\. Price analysis --- Analyze      Is preferred over and requires less
  price of each ECM, each             information than cost analysis
  performance-period service, and     
  financing individually.             

  a\. Price competition               First preference, but not generally
                                      done in ESPCs. ESCO could compete
                                      subcontracts and document results.

  b\. Comparison with previously      Can be applicable if data is
  proposed prices and previous        available.
  government and commercial contract  
  prices                              

  c\. Parametric estimating methods   Use FEMP Benchmarking Tool, ECM
  --- An extension of comparing       Locator, site- and/or agency-level
  proposed and past prices --- cost   info on past pricing
  estimating relationships (e.g.,     
  dollars per ton of chiller          
  capacity) calculated from past      
  pricing data                        

  d\. Comparison with published       More applicable to cost analysis.
  prices                              

  e\. Market research                 More applicable to cost analysis.

  f\. Analysis of pricing information Using information from within
  provided by offeror                 government is preferable to using
                                      information from offeror.

  g\. Comparison of proposed prices   Can be used in ESPC, but cost
  with independent government cost    estimators require near-complete
  estimates                           designs.

  2\. Cost analysis --- Analyze price More costly and time-consuming than
  of each ECM, each                   price analysis. Price analysis
  performance-period service, and     still needed for final
  financing individually              reasonableness determination.

  3\. Technical analysis ---          Depending on the type of expertise
  Consultation with individuals with  needed, could be provided by site
  specialized knowledge of equipment  or agency engineering staff,
  or services being procured, who     independent experts (e.g., DOE
  examine, at minimum, types and      National Labs), or others, but
  quantities of materials and labor   would generally be professional
  requirements and costs              cost estimators.
  ----------------------------------- -----------------------------------

# 4. Recommended Strategies for Cost-Effective Assurance of Fair and Reasonable Pricing

## 4.1 Introduction

The recommended process for determining price reasonableness in federal
ESPCs complies with the FAR's guidance on proposal analysis and relies
on the techniques described in FAR 15.404-1. Undoubtedly, many of these
activities are already being carried out by agencies in some form, but
until now they have not been formally spelled out.

The key elements of FAR guidance that apply to federal ESPCs are as
follows:

• Price reasonableness determinations are required for all ESPC price
components, including ECMs, performance-period services, and financing
costs. Pricing of each ECM and each service should be considered
individually.

• Contracting officers are directed to require offerors to submit the
smallest amount of information necessary to determine price
reasonableness. This tends to favor price analysis over cost analysis.

• Where price reasonableness cannot be established through price
analysis alone, cost analysis may be used.

• Even when cost analysis is used, price analysis should also be used to
verify that the overall price is fair and reasonable.

• The main techniques recommended for price reasonableness determination
that are applicable to federal ESPCs, in order of preference, are the
following:

--- Price analysis

--- Comparison with previously proposed prices

--- Parametric estimating methods

--- Technical analysis

--- Cost analysis

There are several ESPC vehicles available to agencies, and the
implementation process is slightly different for each one, but all
follow the same basic outline. In the following sections we use DOE's
Super ESPC as an example, but these recommendations are generally
applicable to any of the federal IDIQ ESPCs.

Activities related to price reasonableness determination fall into three
areas and correspond roughly to Phases 1, 2, and 3 of the process of
developing an ESPC delivery order, respectively:

> • Preliminary activities --- Phase 1: Project planning
>
> • Review of initial proposal --- Phase 2: Initial project development
>
> • Review of final proposal --- Phase 3: Negotiation and award of final
> delivery order

## 4.2 Preliminary Activities

The project planning phase encompasses initial exploration of the
feasibility of a pay-from-savings project and preliminary communications
between the site and one or more ESCOs. The agency acquisition team,
which guides the project to its completion, is formed at this time. The
acquisition team should establish early on that one of its key
objectives is to obtain fair and reasonable prices for the equipment and
services that are being contracted for.

The two key members of the acquisition team are the Contracting Officer
(CO) and the Site Technical Representative (STR). It is the CO's
responsibility to make the team aware that the prices for ECMs and
performance-period services received in the ESPC must be fair and
reasonable according to the FAR. Because the focus in developing ESPCs
is often on the requirement for the project to pay for itself out of the
savings it generates, this concept may be unclear to some individuals,
so it is worth emphasizing. Discussions with ESCOs should make this
clear as well.

Although nothing is finalized at this stage, sites usually begin with
some specific ECMs in mind, and the team should begin to consider how
price reasonableness determinations will be performed for each one. Some
questions to consider are:

• Are there any available price benchmarks or cost estimating
relationships for these ECMs?

• Have similar ECMs been installed at this site in the past?

• If so, who at the site is familiar with the work?

• Can the total installation price (including feasibility/initial
design) of these previously installed ECMs be established?

• Are there conditions/regulations at the site that could make these
ECMs more expensive (or less expensive) to install than at other sites?

• What type of information can the project facilitator provide?

• Is there a need for assistance from outside sources (agency support
organizations, DOE, private subcontractors)?

• Who are some likely candidates to provide the information required?

• What is the cost of using these sources?

• What kind of lead time is involved in obtaining them?

• What other information sources are available to make the price
reasonableness determination?

• Are there any agency-specific policies on price reasonableness that
must be followed?

In addition to ECM prices, the acquisition team must ensure that fair
and reasonable prices are received for performance-period services such
as operations and maintenance (O&M), repair and replacement (R&R), and
measurement and verification (M&V) of savings. The team should begin
considering how the price reasonableness determinations will be made for
these services. Some questions to consider include the following:

• Who will be performing O&M and R&R on the installed equipment --- the
ESCO or the site?

• If similar ECMs have been installed at the site in the past, is there
information available on their O&M costs?

• What M&V options and methods are typically used for ECMs like these?

• What cost information is available for these M&V activities?

• What type of information can the project facilitator provide?

• Is there a need for assistance from outside sources?

• Who are some likely candidates to provide the information required?

• What is the cost of using these sources?

• What kind of lead time is needed in order to obtain them?

• What other information sources are available?

In the project planning stage, the main concern is to put these
questions on the table so that the acquisition team recognizes the
importance of price reasonableness and can begin considering how to
address it.

## 4.3 Pricing Reviews for Initial and Final Proposals 

The recommended process for reviewing pricing is basically the same for
both initial and final proposals, as charted in Figure 2. However, the
goals of the two reviews and expected levels of effort for each are very
different.

Review of pricing in the initial proposal is a quick once-through to
ensure that the proposed prices are realistic, as part of the effort to
determine whether the proposed project is feasible and adequately
addresses the agency's needs and priorities.

The final proposal requires more intensive price review. The final
proposal contains the financial schedules that define the deal the
agency will live with for the duration of the ESPC term and is the true
object of the FAR's requirements for contracting officers to establish
that prices in government contracts are fair and reasonable.

### 4.3.1 Appropriate Level of Review --- Initial Proposal 

The initial proposal is intended to give the agency enough information
to make a confident decision on whether to proceed with the project, but
is not expected to reflect a complete understanding of agency- and
site-specific requirements. The initial proposal is a vehicle for
establishing the viability of an ESPC project at the facility, for
reaching general agreement on the scope of a feasible project, and for
making the go or no-go decision.

The initial proposal includes general ECM descriptions and preliminary
estimates of prices and savings based on assumptions and engineering
calculations, but no system design or engineering will have been done,
and no subcontractors' quotes will have been obtained. Prices in the
initial proposal are estimates based on the ESCO's own benchmarks, cost
estimating relationships, and prices the ESCO and its subcontractors
have charged for previous work. Review of pricing in the initial
proposal should be commensurate with the preliminary nature of those
price estimates and should correspond to the overall goal at this stage
of reaching general agreements about the scope and shape of the project.

Price review that seeks a level of precision greater than that in the
estimated prices in the initial proposal is not needed and is not
cost-effective. However, the agency must ensure that preliminary prices
are realistic in order to shape the scope of the project to meet the
government's needs as completely as possible. If pricing is
unrealistically high, ECMs that the agency needs may not appear to be
feasible. If pricing is unrealistically low, the agency may be
disappointed later to find that high-priority ECMs must be dropped to
make the project pay from savings.

After completing review of pricing in the initial proposal, the
acquisition team should submit written comments to the ESCO (concerning
both technical review and pricing review) and require written replies.
The written documentation can help avoid misunderstandings and provides
backup for auditors and others who may be interested in the development
of the project.

### 4.3.2 Appropriate Level of Review --- Final Proposal 

The final proposal is the precursor of a contract that obligates the
government to make payments over a period of years, so it is critical to
ensure that the prices proposed for ECMs and performance-period services
are fair and reasonable. When the final proposal is submitted,
engineering designs will be about 30% complete, and the proposal should
include backup information supporting the proposed pricing. The
acquisition team will be able to use this information in addition to
pricing benchmarks and other comparative prices to evaluate price
reasonableness.

If any of the checks raise questions about the proposed pricing, the
questions should be put to the ESCO and resolved during final contract
negotiations. All information generated during the price reasonableness
determination should be placed in a file for reference.

![](media/image3.jpeg){width="6.029861111111111in"
height="5.009722222222222in"}

**Figure 2. Flow chart showing the process recommended for the
acquisition team to use in reviewing pricing of the initial and final
proposals.**

### 4.3.3 ECM Pricing

#### 4.3.3.1 Competition

Competition is the FAR's first preference for establishing price
reasonableness. Although price competition is not applicable at the
initial proposal stage and has not been widely used in federal ESPCs, it
would be possible to require the ESCO to compete the subcontracted
portions of the project. Subcontract competition could take place before
the award of the delivery order. Alternatively, all ECM subcontracts, or
just disputed ECMs, could be competed after award and the contract
modified to accommodate price changes.

#### 4.3.3.2 Price Analysis --- Comparison with previously proposed prices and benchmarks

After competition, the preferred methods of determining price
reasonableness are price analysis techniques that compare proposed
prices with previously obtained prices for similar goods and services
obtained by the government, along with parametric estimating methods
using price benchmarks, cost-estimating relationships, or rules of thumb
\[FAR 15.404-1 (b)(2)(ii-iii)\].

Parametric estimating methods are closely related to and sometimes
overlapping with price comparison techniques, and both are well suited
for price review for initial and final ESPC proposals. Comparable
information on previously proposed prices can come from several sources:

• The facility's data on its own past energy projects

• Data on past energy projects compiled by the agency

• FEMP's ECM Benchmarking Tool

• FEMP's ECM Locator

Acquisition team members may be able to use price information from past
energy projects at their own facility, or pricing or benchmarking
information maintained at the agency level. If existing data can be
normalized or adjusted to make valid comparisons possible, these are the
most cost-effective ways to establish price reasonableness. The
following discussions of FEMP's ECM Benchmarking and ECM Locator tools
and an example of reviewing ECM prices from an initial proposal
illustrate how this information is used to make valid price comparisons.

Appendix D describes how price benchmarks are derived from pricing data.

#### ECM Benchmarking Tool

FEMP's ECM Benchmarking Tool incorporates data from all the awarded
Super ESPC projects, plus some appropriations-funded energy projects.
Benchmarks are established for four ECMs that are common in Super ESPCs
--- lighting, chiller replacements, variable-frequency drives, and
geothermal heat pumps. The data include ECM price (including markup),
date, location, and size. The benchmarking tool converts past prices to
current dollars and adjusts them for regional differences for comparison
to proposed prices.

Although these benchmarks alone may not be able to definitively,
precisely determine price reasonableness, they are a cost-effective way
to check whether prices are "in the ballpark." The benchmarks can be
used to focus effort by eliminating prices that appear to be reasonable
from further scrutiny. The FEMP team can use the benchmarks to show
where the proposed price for a particular ECM fits into the array of
past prices for similar ECMs. If the price falls near the middle or in
the middle-lower end of the price range, the agency may assume that the
price is "in the ballpark." Reviewers can then move on to check other
prices.

If the price is at either extreme, the agency should pursue more
information, either through additional price analysis, by consulting
with technical experts, or by obtaining more information from the ESCO.

#### ECM Locator

For ECMs other than lighting, variable-frequency drives, chiller
replacements, and geothermal heat pumps, FEMP's ECM Locator can be used
to compare previous and proposed prices. Data on all ECMs ever awarded
under the Super ESPCs, plus some appropriations-funded projects, is
accessible through ECM Locator. The tool contains pricing information on
the selected ECM, allowing simple comparisons with the proposed ECM.
There is no automatic adjustment of past ECM prices for data and
location, and size variables are not as accurate in Locator as in the
ECM Benchmarking Tool.

ECM Locator can be an effective means of finding additional information
on ECMs of interest. The FEMP team can in some cases check the ECM
descriptions in the final proposals from which the data came and adjust
the prices for closer comparison. The ECM Locator can also provide leads
to the facility or energy managers who implemented the ECM in question,
who can often provide more detailed information.

#### Example of Reviewing ECM Prices from Super ESPC Initial Proposal

The following is an example of applying the recommended process in
review of an initial proposal. ECM implementation prices are found in
column (c) on schedule DO-2. Figure 3 is a DO-2 schedule from a
hypothetical initial proposal with four ECMs. Note that ECMs 1, 2, and 3
include nominal sizing information. DOE requires this information to be
included on the DO schedule to facilitate price reasonableness
determination.[^2]

For ECM No. 2, the acquisition team must determine if the proposed price
is fair and reasonable for replacing 1125 tons of chiller capacity.
First, to calculate the total proposed cost, a share of survey costs
must be added to the implementation price. The DO-2 schedule breaks out
"Proposal Development Energy Surveys" as a separate cost, as required by
DOE, which makes it convenient to determine the percentage of the total
these costs represent --- about 3% in this case. (The FEMP ESPC team can
provide Super ESPC program averages of overall survey costs to help the
project team decide whether the proposed costs are reasonable.) The cost
of the energy surveys must be added in to determine the true ECM cost.
Survey costs vary by ECM, but typically represent less than 5% of the
total implementation price, and we recommend apportioning the survey
costs to each ECM according to the percentage of the total that the ECM
cost represents.

The total of the marked-up costs for the ECMs in Figure 3 is \$3,558,257
(\$3,668,563 -- \$110,306 survey costs), and the marked-up cost of the
chiller replacement ECM represents about 17.5% of this total
(\$622,319/\$3,558,257). The total cost of the chiller replacement is
then the marked-up price from column (c), plus 17.5% of the "Proposal
Development Energy Surveys" cost. The total is \$622,319 + 0.175 ×
\$105,758 = \$640,827. This is the cost that should be compared to the
pricing benchmark to determine whether it is reasonable for the
installation of 1125 tons of chiller capacity.

If a price benchmark formula or price estimating relationship is
available for the ECM, the acquisition team should calculate the
expected price given the ECM size listed in schedule DO-2, and compare
that to the proposed price.

#### Pricing from previous contracts

Not all ECMs lend themselves to the development of pricing benchmarks or
rules of thumb. However, contracting officers usually have access to
pricing from previous contracts for installation or repair of similar
equipment that can prove useful. For example, ECM No. 4 in Figure 3 is
water system repairs. If repairs to the water system have been made in
the past, the acquisition team can compare that pricing with the offered
price of \$461,494 (plus the portion of the survey costs that apply to
it). To determine whether the price is reasonable the team must consider
the scope of the proposed project compared to the scope of past projects
and normalize prices for regional cost differences and price inflation
over time. This may require consultation with experts on the technology
being proposed.

![](media/image4.wmf){width="5.997916666666667in"
height="4.913194444444445in"}

**Figure 3. DO-2 Schedule for an ESPC project with four ECMs.**

#### 4.3.3.3 Technical Analysis

If valid price comparisons cannot be done or are inconclusive, the
contracting officer may seek the opinions of individuals with
specialized knowledge of the equipment or services being procured, or
"technical experts." Technical experts here are understood to mean
professional cost estimators or any technical specialists who support
the acquisition team. In federal ESPCs, technical analysis might be
provided by any of the following:

• Site-level engineering staff

• Agency-level experts (e.g., the Army Corps of Engineers, Naval
Facilities Engineering Support Center, GSA's Energy Center of Expertise,
etc.)

• FEMP ESPC team members

• Independent experts with particular technologies (geothermal heat
pumps, wind, solar, combined heat and power) from DOE National
Laboratories or contractors

• Professional cost estimators

It will be most cost-effective for the technical specialists who are
already supporting the acquisition team to review the information in the
proposal and provide opinions on the reasonableness of the proposed
costs as well as the technical merit of the design. These technical
experts may use their own pricing benchmarks and rules of thumb to
determine what is a fair price for a project of the requested size.

In some cases, the site may require a professional cost estimator to
develop an independent estimate of project costs without reference to
the cost information the ESCO provides. This requires the ESCO to
develop a fairly complete design before the contract is awarded. The
cost estimator should submit a written opinion as to whether the
proposed ECM cost is fair and reasonable. The use of technical experts
to perform cost analysis is a combination of FAR 15.404-1 paragraphs (e)
and (c) (2) (i).

### 4.3.4 Performance-Period-Services Prices 

Establishing that prices for performance-period services (O&M, R&R, M&V)
are fair and reasonable is similar to determining price reasonableness
for ECMs.

Responsibility for performance-period services is negotiable, and the
proposal should reflect the site's decision as to who will perform these
activities. (In Super ESPCs, assignments are shown in the
Risk/Responsibility Matrix, which is part of the contract, and Schedule
DO-3 contains proposed pricing for performance-period services.)

The proposal should include supporting information describing the
activities to be carried out and the level of effort expected. Prices
for performance-period services cover mainly labor hours. Preventive
maintenance and R&R prices also include replacement parts.

A primary standard for comparison will be the cost of previous O&M and
R&R contracts at the site for similar equipment, or agency support
organizations may be able to provide prices for similar contracts at
other sites. Benchmark prices may also exists for some common
maintenance activities.

Technical experts who review ECM designs may also need to review
proposed O&M and/or R&R services to determine whether they are necessary
and whether their pricing is reasonable for the level of effort
proposed. The experts should provide written documentation of their
opinions.

FEMP's data on Super ESPC projects does include average annual costs for
O&M, R&R, and M&V as a percentage of guaranteed savings, which may be
useful as general rules of thumb.

M&V is a requirement in federal ESPCs, but there is a wide range of
options depending on the site's requirements, the particular ECM, and
the perceived level of risk. Proposed prices for M&V can be compared
with the price of M&V on similar ECMs at the same or other sites, if
such information is available.

Performance-period services are a recurring cost throughout the life of
the contract, and the proposals will include inflation factors that
escalate the prices from year to year. These inflation factors should be
no higher than the inflation rate published each April by NIST in the
Annual Supplement to Handbook 135, "Energy Price Indices and Discount
Factors for Life-Cycle Cost Analysis."

# 5. Conclusions

Making price reasonableness determinations in ESPCs has been problematic
for a number of reasons. First, ESPCs represent a new way of doing
business that is very different from the traditional government
procurement process. In an ESPC, a single ESCO obtains financing to
purchase and install equipment at a government site. In most cases the
government pays nothing up front, but agrees to make regular payments to
the ESCO out of the energy cost savings generated by the equipment.
Long-term contracts are signed on the basis of firm-fixed-price
proposals prepared at about the 30% design stage. In most cases there is
no opportunity for price competition facilitated by multiple bids, and
insufficient design information is available for the development of
independent government estimates, though some agencies have developed a
process whereby 95% designs must be completed before contracts are
awarded.

An ESPC is simply a procurement in which the government is purchasing
equipment and services and paying for them over time out of the
project's guaranteed savings to energy and related O&M budgets. As in
any government procurement, the FAR does apply, and FAR §15.404-1
provides a detailed description of the techniques to be used to ensure
that the prices paid are fair and reasonable.

This document provides concrete recommendations for using the proposal
analysis techniques of FAR 15.404-1 in ESPCs. A procedure is outlined
for integrating price reasonableness considerations during review of the
initial and final proposals. The procedure refers specifically to FEMP's
Super ESPC process, but is generally applicable to all federal ESPCs.

The recommended policy and guidance, if communicated to federal ESPC
stakeholders, can ensure that agencies will comply with the FAR in
awarding ESPCs, obtain fair and reasonable prices and best value for the
government, and follow procedures that provide auditable documentation
of due diligence in price reasonableness determinations.

# 6. References

Hughes, P. J., Shonder, J. A., Sharp, T., and Madgett, M. 2003.
*Evaluation of Federal Energy Savings Performance
Contracting---Methodology for Comparing Processes and Costs of ESPC and
Appropriations-Funded Energy Projects*. Oak Ridge National Laboratory,
ORNL/TM-2002/150.

R.S. Means. *Mechanical Cost Data, 28^th^ Annual Edition: HVAC and
Controls*. Kingston, Mass., 2005.

R.S. Means. *Facilities Maintenance & Repair Cost Data*. Kingston,
Mass., 2005.

# Appendix A --- Charter for Price Reasonableness Working Group {#appendix-a-charter-for-price-reasonableness-working-group .appx-head}

[Background]{.underline}

In conventional bid-to-spec contracts implemented with appropriated
funds, federal agencies receive construction bids from multiple
competing offerors based on a completed design. In some cases the agency
may develop its own independent cost estimate as well. The price
competition between offerors and the independent government estimate
provide assurance that the prices received are fair and reasonable. A
major difference with energy savings performance contracts (ESPC) is
that a single energy services company (ESCO) develops a firm-fixed-price
bid based on a design that is only about 30% complete. Because of this
difference, some agencies have struggled with how to perform timely,
cost-effective price review of ESPC projects. There is a need to pool
the experience of the various federal agencies, and to use that
experience to develop consensus recommendations that agencies can use
for price review in ESPC projects.

[Objectives]{.underline}

• Identify the approaches agencies have used for price review in ESPC
projects and the lessons learned.

• Document the options and the "best practices" in implementing those
options.

• Develop consensus across the various federal ESPC IDIQ programs on how
price review will be performed by all going forward.

[Final Deliverables]{.underline}

Report on federal best practices for price review in ESPC projects, with
recommended procedures to ensure fair and reasonable pricing.

# Appendix B --- Membership of Price Reasonableness Working group {#appendix-b-membership-of-price-reasonableness-working-group .appx-head}

> John Shonder, Chair, Oak Ridge National Laboratory
>
> Kelly Dowd, Defense Energy Support Center
>
> John Lloyd, U.S. Navy
>
> Pat Mumme, U.S. Air Force
>
> Linda Sisk, U.S. Air Force
>
> Tatiana Strajnic, U.S. DOE/FEMP
>
> David Williams, U.S. Army
>
> Carl Zeigler, U.S. Marines

# Appendix C --- FAR 15.404-1

**15.404 Proposal analysis**

**15.404-1 Proposal analysis techniques**

\(a\) *General.* The objective of proposal analysis is to ensure that
the final agreed-to price is fair and reasonable.

> \(1\) The contracting officer is responsible for evaluating the
> reasonableness of the offered prices. The analytical techniques and
> procedures described in this subsection may be used, singly or in
> combination with others, to ensure that the final price is fair and
> reasonable. The complexity and circumstances of each acquisition
> should determine the level of detail of the analysis required.
>
> \(2\) Price analysis shall be used when cost or pricing data are not
> required (see paragraph (b) of this subsection and 15.404-3).
>
> \(3\) Cost analysis shall be used to evaluate the reasonableness of
> individual cost elements when cost or pricing data are required. Price
> analysis should be used to verify that the overall price offered is
> fair and reasonable.
>
> \(4\) Cost analysis may also be used to evaluate information other
> than cost or pricing data to determine cost reasonableness or cost
> realism.
>
> \(5\) The contracting officer may request the advice and assistance of
> other experts to ensure that an appropriate analysis is performed.
>
> \(6\) Recommendations or conclusions regarding the Government\'s
> review or analysis of an offeror's or contractor\'s proposal shall not
> be disclosed to the offeror or contractor without the concurrence of
> the contracting officer. Any discrepancy or mistake of fact (such as
> duplications, omissions, and errors in computation) contained in the
> cost or pricing data or information other than cost or pricing data
> submitted in support of a proposal shall be brought to the contracting
> officer\'s attention for appropriate action.
>
> \(7\) The Air Force Institute of Technology (AFIT) and the Federal
> Acquisition Institute (FAI) jointly prepared a five-volume set of
> Contract Pricing Reference Guides to guide pricing and negotiation
> personnel. The five guides are: I Price Analysis, II Quantitative
> Techniques for Contract Pricing, III Cost Analysis, IV Advanced Issues
> in Contract Pricing, and V Federal Contract Negotiation Techniques.
> These references provide detailed discussion and examples applying
> pricing policies to pricing problems. They are to be used for
> instruction and professional guidance. However, they are not directive
> and should be considered informational only. They are available via
> the internet at http://www.acq.osd.mil/dp/cpf.

\(b\) *Price analysis.*

> \(1\) Price analysis is the process of examining and evaluating a
> proposed price without evaluating its separate cost elements and
> proposed profit.
>
> \(2\) The Government may use various price analysis techniques and
> procedures to ensure a fair and reasonable price. Examples of such
> techniques include, but are not limited to, the following:
>
> \(i\) Comparison of proposed prices received in response to the
> solicitation. Normally, adequate price competition establishes price
> reasonableness (see 15.403-1(c)(1)).
>
> \(ii\) Comparison of previously proposed prices and previous
> Government and commercial contract prices with current proposed prices
> for the same or similar items, if both the validity of the comparison
> and the reasonableness of the previous price(s) can be established.
>
> \(iii\) Use of parametric estimating methods/application of rough
> yardsticks (such as dollars per pound or per horsepower, or other
> units) to highlight significant inconsistencies that warrant
> additional pricing inquiry.
>
> \(iv\) Comparison with competitive published price lists, published
> market prices of commodities, similar indexes, and discount or rebate
> arrangements.
>
> \(v\) Comparison of proposed prices with independent Government cost
> estimates.
>
> \(vi\) Comparison of proposed prices with prices obtained through
> market research for the same or similar items.
>
> \(vii\) Analysis of pricing information provided by the offeror.
>
> \(3\) The first two techniques at 15.404-1(b)(2) are the preferred
> techniques. However, if the contracting officer determines that
> information on competitive proposed prices or previous contract prices
> is not available or is insufficient to determine that the price is
> fair and reasonable, the contracting officer may use any of the
> remaining techniques as appropriate to the circumstances applicable to
> the acquisition.
>
> \(4\) Value analysis can give insight into the relative worth of a
> product and the Government may use it in conjunction with the price
> analysis techniques listed in paragraph (b)(2) of this section.

\(c\) *Cost analysis*.

> \(1\) Cost analysis is the review and evaluation of the separate cost
> elements and profit in an offeror's 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 represent what the cost of the contract should be,
> assuming reasonable economy and efficiency.
>
> \(2\) The Government may use various cost analysis techniques and
> procedures to ensure a fair and reasonable price, given the
> circumstances of the acquisition. Such techniques and procedures
> include the following:
>
> \(i\) Verification of cost or pricing data and evaluation of cost
> elements, including-
>
> \(A\) The necessity for, and reasonableness of, proposed costs,
> including allowances for contingencies;
>
> \(B\) Projection of the offeror's cost trends, on the basis of current
> and historical cost or pricing data;
>
> \(C\) Reasonableness of estimates generated by appropriately
> calibrated and validated parametric models or cost-estimating
> relationships; and
>
> \(D\) The application of audited or negotiated indirect cost rates,
> labor rates, and cost of money or other factors.
>
> \(ii\) Evaluating the effect of the offeror's current practices on
> future costs. In conducting this evaluation, the contracting officer
> 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, the contracting officer should
> perform a trend analysis of basic labor and materials, even in periods
> of relative price stability.
>
> \(iii\) Comparison of costs proposed by the offeror for individual
> cost elements with-
>
> \(A\) Actual costs previously incurred by the same offeror;
>
> \(B\) Previous cost estimates from the offeror or from other offerors
> for the same or similar items;
>
> \(C\) Other cost estimates received in response to the Government's
> request;
>
> \(D\) Independent Government cost estimates by technical personnel;
> and
>
> \(E\) Forecasts of planned expenditures.
>
> \(iv\) Verification that the offeror's cost submissions are in
> accordance with the contract cost principles and procedures in Part 31
> and, when applicable, the requirements and procedures in 48 CFR
> Chapter 99 (Appendix to the FAR loose-leaf edition), Cost Accounting
> Standards.
>
> \(v\) Review to determine whether any cost or pricing data necessary
> to make the contractor\'s proposal accurate, complete, and current
> have not been either submitted or identified in writing by the
> contractor. If there are such data, the contracting officer shall
> attempt to obtain them and negotiate, using them or making
> satisfactory allowance for the incomplete data.
>
> \(vi\) Analysis of the results of any make-or-buy program reviews, in
> evaluating subcontract costs (see 15.407-2).

\(d\) *Cost realism analysis*.

> \(1\) Cost realism analysis is the process of independently reviewing
> and evaluating specific elements of each offeror's 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 materials described in the offeror's technical
> proposal.
>
> \(2\) Cost realism analyses shall be performed on cost-reimbursement
> contracts to determine the probable cost of performance for each
> offeror.
>
> \(i\) 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.
>
> \(ii\) The probable cost is determined by adjusting each offeror's
> 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.
>
> \(3\) Cost realism analyses may also be used on competitive
> fixed-price incentive contracts or, in exceptional cases, on other
> competitive fixed-price-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.

\(e\) *Technical analysis*.

> \(1\) The contracting officer may request that personnel having
> specialized knowledge, skills, experience, or capability in
> engineering, science, or management perform a technical analysis of
> the proposed types and quantities of materials, labor, processes,
> special tooling, facilities, the reasonableness of scrap and spoilage,
> and other associated factors set forth in the proposal(s) in order to
> determine the need for and reasonableness of the proposed resources,
> assuming reasonable economy and efficiency.
>
> \(2\) At a minimum, the technical analysis should examine the types
> and quantities of material proposed and the need for the types and
> quantities of labor hours and the labor mix. Any other data that may
> be pertinent to an assessment of the offeror's ability to accomplish
> the technical requirements or to the cost or price analysis of the
> service or product being proposed should also be included in the
> analysis.

\(f\) *Unit prices*.

> \(1\) Except when pricing an item on the basis of adequate price
> competition or catalog or market price, unit prices shall reflect the
> intrinsic value of an item or service and shall be in proportion to an
> item\'s base cost (e.g., manufacturing or acquisition costs). Any
> method of distributing costs to line items that distorts the unit
> prices shall not be used. For example, distributing costs equally
> among line items is not acceptable except when there is little or no
> variation in base cost.
>
> \(2\) Except for the acquisition of commercial items, contracting
> officers shall require that offerors identify in their proposals those
> items of supply that they will not manufacture or to which they will
> not contribute significant value, unless adequate price competition is
> expected (10 U.S.C. 2304 and 41 U.S.C. 254(d)(5)(A)(i)). Such
> information shall be used to determine whether the intrinsic value of
> an item has been distorted through application of overhead and whether
> such items should be considered for breakout. The contracting officer
> may require such information in all other negotiated contracts when
> appropriate.

\(g\) *Unbalanced pricing*.

> \(1\) Unbalanced pricing may increase performance risk and could
> result in payment of unreasonably high prices. Unbalanced pricing
> exists when, despite an acceptable total evaluated price, the price of
> one or more contract line items is significantly over or understated
> as indicated by the application of cost or price analysis techniques.
> The greatest risks associated with unbalanced pricing occur when-
>
> \(i\) Startup work, mobilization, first articles, or first article
> testing are separate line items;
>
> \(ii\) Base quantities and option quantities are separate line items;
> or
>
> \(iii\) The evaluated price is the aggregate of estimated quantities
> to be ordered under separate line items of an indefinite-delivery
> contract.
>
> \(2\) All offers with separately priced line items or subline items
> shall be analyzed to determine if the prices are unbalanced. If cost
> or price analysis techniques indicate that an offer is unbalanced, the
> contracting officer shall-
>
> \(i\) Consider the risks to the Government associated with the
> unbalanced pricing in determining the competitive range and in making
> the source selection decision; and
>
> \(ii\) Consider whether award of the contract will result in paying
> unreasonably high prices for contract performance.
>
> \(3\) An offer may be rejected if the contracting officer determines
> that the lack of balance poses an unacceptable risk to the Government.

# Appendix D --- Benchmarks: A More Rigorous Approach to Price Analysis {#appendix-d-benchmarks-a-more-rigorous-approach-to-price-analysis .appx-head}

Price benchmarks are cost estimating relationships that consider the
price of a good or service to be a function of one or more dependent
variables related to the size, level of effort, or some other measurable
characteristic of the good or service in question. An example would be
the cost of constructing office space, expressed in dollars per square
foot. While such a benchmark is not accurate enough for a contractor to
make a bid based on it, it would be of use to a potential building
owner, to determine whether a bid was comparable to the price of other
commercial office space. In ESPC, price benchmarks are useful in
reviewing price proposals, to eliminate from scrutiny prices that are in
the expected range and focus attention on other prices.

A simple method of developing a price benchmark is to assume a linear
relationship between cost and some measure of the item's size. For
example, for a chiller replacement project, the variable would likely be
total chiller capacity, and one might assume a relationship of the form

*C = a + bx* (D.1)

where *C* is total cost, *x* is chiller capacity, *b* is the cost per
unit capacity, and *a* is a constant.

As a simple example, consider Table D.1, which provides information on
three (fictitious) chiller projects. The first four columns contain the
location of the project, the date the equipment was installed, the total
capacity replaced, and the total contract cost. We will assume that the
same types of chillers were installed in each case, and the scope of
each project is roughly the same, involving only the replacement of one
or more chillers, and associated auxiliary equipment.

Table D.1. Chiller replacement projects

  --------------- --------- ---------- ------------- --------- -------------
  Location        Date      Capacity   Cost          CCI       Adjusted
                            (tons)                             price

  Atlanta, GA     9/30/99   1950       \$1,271,078   102.90    \$1,854,118

  Los Angeles, CA 1/23/01   1125       \$724,032     132.40    \$820,825

  Detroit, MI     9/30/03   1000       \$682,169     138.70    \$738,237
  --------------- --------- ---------- ------------- --------- -------------

In order to compare the prices, we must correct for general price
inflation and differences in pricing that are due to the local economy.
One way of doing this is to use Means Construction Cost Index (CCI).
Published annually, the CCI contains historical data on construction
costs in 316 cities in the United States and Canada. For example, for
Atlanta in 1999 the CCI is 102.9. These values are also provided in
Table D.1.

Suppose we wish to compare these prices to a proposal received for a
1500-ton chiller replacement ECM in Minneapolis. The current CCI for
Minneapolis is 150.1. So, to correct each of the prices in Table 1 to
Minneapolis in 2004, we multiply each price by 150.1 and divide by the
project's CCI. So, for example, the cost of the Atlanta project is
multiplied by 150.1/102.9 to approximate what it would cost in
Minneapolis in 2004. The last column of Table D.2 contains the adjusted
price for each project.

Now that we have adjusted all of the prices to the current date and the
location of the ESPC project, we can correlate price to chiller
capacity. Linear regression of the data gives

C = -499,952 + 1203*x* (D.2)

where C is cost and *x* is total chiller capacity. Then based on the
three past contracts, a reasonable estimate of the price to replace 1500
tons of chiller capacity in Minneapolis in 2004 is \$1,304,548.

It is important not to assign any physical significance to the terms of
the price benchmark equation. For example, the fact that the constant
term is negative does not mean that there is a negative setup cost for
each project; nor, in general, does the 1203 represent an accurate cost
per ton. The equation simply represents the best fit to the data
available.

For some ECMs, pricing data may be available over a wide range of ECM
sizes. This could be the case for chiller replacements, since such
projects could range from the replacement of a single small chiller,
with say 15 tons of capacity, up to large projects involving thousands
of tons of capacity. In these cases it is more convenient to assume a
cost model of the form:

$C = e^{\varepsilon}\text{ax}^{b}$ (D.3)

where C is cost, *a* is cost per unit, and *x* is the size. The variable
*b* is included to account for changes in cost per unit over different
size ranges. If the cost per unit is constant over all sizes, then *b*
= 1. If cost per unit increases with size, then b will be greater
than 1. If cost per unit size decreases with size, then b will be less
than 1.

The term *e*^ε^ accounts for variations in pricing, which are assumed to
be random. Here *e* is the base of natural logarithms, and *ε* is a
normally distributed random variable, assumed to have a mean of zero.
Now suppose the standard deviation of this random variable is small, on
the order of 0.10. According to standard probability theory, about 95%
of the values of *ε* will be within two standard deviations of the mean;
in other words, 95% of the values will lie between -0.20 and 0.20. In
Eq. D.3 above the variation in pricing is the exponential of these
values, so 95% of the variations will lie between 0.82 and 1.22. This
means that prices vary by ±20% from the benchmark, approximately.

Taking the natural logarithm of both sides of Eq. D.3 gives:

$\text{ln}C = \text{ln}a + b\text{ln}x + \varepsilon$ , (D.4)

which is standard form for a linear equation with random errors. Thus in
order to develop a pricing benchmark, we correlate the logarithm of cost
with the logarithm of size using standard linear regression techniques.
Of course, past pricing must be adjusted as above to account for
inflation and differences in pricing in different cities across the
country.

The usefulness and accuracy of pricing benchmarks depends on the
quantity of data available to develop them. Even if an ECM can be
categorized by a readily identifiable size variable, it may be that
prices depend heavily on local conditions encountered at the site. In
such cases, the variation in pricing may make it difficult to develop
useful benchmarks.

DOE FEMP has developed pricing benchmarks based on measures of size for
four of the more popular ECMs: chiller replacements, lighting, variable
frequency drives for motors, and geothermal heat pumps. The FEMP ESPC
team can make information from these pricing benchmarks available to
acquisition teams developing ESPC projects with similar ECMs.

An example of the use of the lighting benchmarks is presented in Figure
D.1. The figure, which is on a log-log scale, is based on a database
that contains pricing data from 65 lighting ECMs carried out under ESPC
plus 10 carried out as part of appropriations-funded energy conservation
programs. All of the ECMs were centered on conversion of office lighting
to T-8 fixtures and tubes, and included other subsidiary measures such
as installation of occupancy sensors, fixture delamping, installation of
tandem wiring, and conversion to compact fluorescent lighting

![](media/image5.wmf){width="5.992361111111111in"
height="4.100694444444445in"}

Figure D.1. An example of the use of lighting benchmarks.

The axes have been removed to protect procurement-sensitive information,
but note that there is a well-defined linear relationship between the
log of annual savings and log of implementation cost. The gray circle is
intended to represent a "new" ECM, whose implementation price is being
compared with the implementation prices of previous projects. The ECM
cost database contains the location of each ECM and the date on which it
was installed. To develop Figure D.1, each of the 65 prices were
adjusted to one specific city on the same date using Means Construction
Cost Index, and the adjusted prices plotted against the annual kWh
savings from the project. If this ECM were being installed in, say,
Phoenix, Arizona, the prices of each of the 65 prices would be adjusted
according to Phoenix.

[^1]: The perception that prices are higher in ESPCs than in
    appropriations-funded projects is understandable, because direct
    comparison could indicate that they are. However, direct comparisons
    of the prices of ESPCs and appropriations-funded energy conservation
    projects are invalid comparisons. Most agency-level
    appropriations-funded energy conservation programs are carried out
    in two stages: Funding is first provided for detailed surveys and
    studies of a broad range of competing projects at different
    facilities. Program managers then select the projects with the best
    economics and provide funds for design completion and equipment
    installation until the available appropriated funds are all
    allocated. Although the expense of the cost-benefit analyses for all
    the conservation measures that were not cost-effective or were not
    funded for other reasons is very real, it is not included in the
    price of the winning projects. In ESPCs, on the other hand, it is
    the ESCO that performs cost-benefit studies, eventually proposing
    the conservation measures that are the most economically viable, and
    all of the survey and study costs are included in the price of the
    project. Because the costs of feasibility studies and project
    development are included in ESPCs but excluded from the prices of
    these agency-funded projects, the conservation measures installed
    under ESPCs appear to be more expensive.

    Another misperception is that ESPCs are always less cost-effective
    than appropriations-funded energy projects because private-sector
    financing is more expensive than what can be obtained by the U.S.
    Treasury. In fact, careful comparisons of the costs of projects
    implemented through ESPCs and appropriations-funded programs with
    the two-stage process described in the preceding paragraph show that
    ESPCs are in many cases the better value. Often
    appropriations-funded projects must wait literally years to be
    implemented, resulting in lost energy and cost savings and inflated
    prices, and these costs can quickly exceed the cost that interest
    payments add to the ESPC project (Hughes, Shonder, Sharp, and
    Madgett, 2003).

[^2]: The accuracy and usefulness of benchmarks is directly related to
    the quantity of past pricing information available. Price benchmarks
    can only be developed for ECMs having similar technical scopes and
    for which a significant amount of data is available, which means
    that effective benchmarks can generally only be developed at the
    agency level. Obviously, FEMP's benchmarks presently do not cover
    all ECMs that will be implemented in federal ESPCs. The usefulness
    and applicability of these benchmarks (and ECM Locator) could be
    significantly improved by adding data from other agencies. Much data
    could be obtained with a very small investment of effort. For
    example, data on projects funded by the Department of Defense's
    Energy Conservation Investment Program would be easily accessible if
    size information were added to the cover sheets of the feasibility
    studies for the program's projects.