# Presentation: 702454

## 
Cost Realism – A Critical Factor in Contract Award 

Barbara S. Kinosky, Esq.

bkinosky@centreconsult.com

Centre Consulting, Inc.
1953 Gallows Road, Suite 650
Vienna, VA 22182
(703) 288-2800

© 2008 Centre Consulting, Inc.
   All Rights Reserved

**Cost Realism – A Critical Factor in Contract Award **
*Barbara S. Kinosky, Esq.*
- bkinosky@centreconsult.com
- Centre Consulting, Inc.
- 1953 Gallows Road, Suite 650
- Vienna, VA 22182
- (703) 288-2800
- © 2008 Centre Consulting, Inc.
-    All Rights Reserved

## Objectives

Understand cost realism
Understand the unique challenges of cost contracting
Know when a cost realism analysis is required
Learn best value contracting principles
Critical mistakes to avoid

- Understand cost realism
- Understand the unique challenges of cost contracting
- Know when a cost realism analysis is required
- Learn best value contracting principles
- Critical mistakes to avoid

## 
Part 1

In The Beginning...

Price vs. Cost

**Part 1**
**In The Beginning...**
**Price vs. Cost**

## Price vs. Cost 

Price – An agreed amount to perform required tasks.     May or may not include profit in addition to costs.

Cost – The amount incurred by a contractor to perform required tasks.  Includes direct and indirect costs.

Price = Costs +/- Profit 
(Note that a loss is possible)

**Price** – An agreed amount to perform required tasks.     May or may not include *profit* in addition to *costs.*
**Cost** – The amount incurred by a contractor to perform required tasks.  Includes *direct* and *indirect* costs.
**Price = Costs +/- Profit **
**(Note that a loss is possible)**

## Fixed Price Contracts

Performance risk is on contractor: no performance no payment!
Contractor may make or lose money!
Contractor’s profit or loss is not regulated (unless award is non-competitive).

- Performance risk is on contractor: no performance no payment!
- Contractor may make or lose money!
- Contractor’s profit or loss is _not_ regulated (unless award is non-competitive).

## Cost Type Contracts

Performance risk is on government: contractor paid its costs plus fee regardless of contract outcome.

Profit/fee is negotiated/regulated!

Losing money is not really a possibility for contractor.

- Performance risk is on government: contractor paid its costs plus fee regardless of contract outcome.
- Profit/fee is negotiated/regulated!
- Losing money is not really a possibility for contractor.

## A Word About Profit/Fee

As long as contract award was competitive, there is no limit on the amount of profit or loss earned by prime on firm fixed price contracts.

On cost plus fixed fee contract: a fixed fee is negotiated and paid regardless of actual costs.  

On cost plus award/incentive fee contract: fee is established in whole or in part based on fulfillment of performance objectives and/or post award negotiations with the Government.

- As long as contract award was competitive, there is _no_ limit on the amount of profit or loss earned by prime on _firm fixed price contracts._
- _On cost plus fixed fee contract_: a fixed fee is negotiated and paid regardless of actual costs.
- _On cost plus award/incentive fee contract_: fee is established in whole or in part based on fulfillment of performance objectives and/or post award negotiations with the Government.

## Cost/Price Reasonableness

FFP Contract:  Price is deemed reasonable if two or more bidders compete for the same requirements.

Cost Based Contracts:  The Government is obligated to verify cost reasonableness/realism.

- _FFP Contract_:  Price is deemed reasonable if two or more bidders compete for the same requirements.
- _Cost Based Contracts_:  The Government is obligated to verify cost reasonableness/realism.

## Why? 

- Why?

## Cost Realism Evaluation

	“When contracting on a cost-reimbursement basis, evaluations shall include a cost realism analysis to determine what the Government should realistically pay for the proposed effort, the offeror’s understanding of the work, and the offeror’s ability to perform the work.”

FAR 15.305(a)(1)

- 	“When contracting on a cost-reimbursement basis, evaluations shall include a **cost realism analysis** to determine what the Government should realistically pay for the proposed effort, the offeror’s understanding of the work, and the offeror’s ability to perform the work.”
- FAR 15.305(a)(1)

## FAR Part 15 Requirements for Negotiated Procurements

Contracting Officers must do the following:
Evaluate cost as part of the source selection decision.
Determine that the proposed costs are reasonable.

- Contracting Officers must do the following:
- Evaluate cost as part of the source selection decision.
- Determine that the proposed costs are reasonable.

## Cost As An Evaluation Factor

Costs to the Government must be evaluated as part of the source selection.
But cost need not be the most important evaluation factor!
See FAR 15.304

- Costs to the Government must be evaluated as part of the source selection.
- But cost need not be the most important evaluation factor!
- See FAR 15.304

## 

Objective?

**Objective?**

## Cost Realism – Determine If:

Overall costs proposed are realistic
Costs reflect offeror’s understanding of requirements
Costs are consistent with technical approach

- Overall costs proposed are realistic
- Costs reflect offeror’s understanding of requirements
- Costs are consistent with technical approach

- Cost realism analysis is required on cost-reimbursement contracts to determine **the probable cost of performance** that will be used as an evaluation factor.
*KPMG*, B-259479

## Impact on Source Selection Decisions
FAR 15.404-1(a)

Competitive Procurements:  Use each offeror’s probable cost as the basis for evaluating the cost evaluation factor against other evaluation factors.  

Non-Competitive Procurements: The Contracting Officer must find that the offeror’s proposed cost is reasonable!

- FAR 15.404-1(a)
- _Competitive Procurements_:  Use each offeror’s probable cost as the basis for evaluating the cost evaluation factor against other evaluation factors.
- _Non-Competitive Procurements_: The Contracting Officer must find that the offeror’s proposed cost is reasonable!

## Cost or Pricing Data Not Required:

Adequate price competition
Commercial item
Prices set by law or regulation

- Adequate price competition
- Commercial item
- Prices set by law or regulation

## 
What is a Cost Realism Analysis?

FAR 15.404-1(d)(1)

**What is a Cost Realism Analysis?**
- FAR 15.404-1(d)(1)

## Cost Realism Analysis

	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.

- 	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.

**Key Elements of Cost Evaluations**
- Direct labor
- Direct materials
- Other direct costs
- Overhead and G&A
- Profit/fee

## 	
	“An agency is not required to conduct an in-depth cost analysis or to verify each and every item in assessing cost realism.”

NHIC Corp., B-310801, Feb. 12, 2008

**	**“An agency is not required to conduct an in-depth cost analysis or to verify each and every item in assessing cost realism.”
- NHIC Corp., B-310801, Feb. 12, 2008

## 

What Do I Need to Evaluate?

**What Do I Need to Evaluate?**

**Cost Analysis**
- Verify cost or pricing data.
- Evaluate offeror’s current practices on future costs.
- Compare proposed costs with actual costs on previous cost estimates.
- Verify that the offerors comply with FAR Part 31 and CAS if applicable.

## T

- The analysis should include:
- Probable cost including additions/deletions
- Differences in business methods as they may impact cost

## Key Cost Estimate Elements – 
Direct Costs - Labor

Are the bidder’s staffing levels and proposed labor hours reasonable/realistic? 
Typically measured against a Work Breakdown Structure (WBS) tied to all contract tasks/requirements.

**Direct Costs - Labor**
- Are the bidder’s staffing levels and proposed labor hours reasonable/realistic?
- Typically measured against a _Work Breakdown Structure (WBS_) tied to all contract tasks/requirements.

## 
Cost Realism

Some Critical Mistakes

**Cost Realism**
**Some Critical Mistakes**

## 
Mistake #1

Normalization

**Mistake #1**
**Normalization**

## 
	“An agency may not award a cost-reimbursement contract to an offeror whose cost proposal evidenced a different technical approach than presented in the proposal, without resolving the discrepancy.”

Earl Indust, LLC, B-309996, Dec. 12, 2007

- 	“An agency may not award a cost-reimbursement contract to an offeror whose cost proposal evidenced a different technical approach than presented in the proposal, without resolving the discrepancy.”
*Earl Indust*, LLC, B-309996, Dec. 12, 2007

## 
	“After more than doubling an awardee’s proposed staffing hours under sample tasks as part of a cost realism analysis, the Navy should have looked again at the awardee’s technical proposal and its understanding of contract requirements before making the award.”

Serco Inc., B-298266, Sept. 9, 2006

- 	“After more than doubling an awardee’s proposed staffing hours under sample tasks as part of a _cost realism analysis_, the Navy should have looked again at the awardee’s technical proposal and its understanding of contract requirements before making the award.”
*Serco Inc*., B-298266, Sept. 9, 2006

## 

Uneven Treatment of Offerors

**Uneven Treatment of Offerors**

- In order to be rational, the cost realism analysis has to be performed on a contractor by contractor basis.  A mechanical approach that applies the same factors to all offerors is likely to fail the test of rationality.
*Jonathan Corp*, B-251698

## 
	“CDC failed to reconcile contradictory cost and technical evaluations of offeror’s proposed staffing levels and unreasonably raised both offeror’s labor hours to the same level under its cost realism analysis.”

Information Ventures Inc., B-297276, March 1, 2006

- 	“CDC failed to reconcile contradictory cost and technical evaluations of offeror’s proposed staffing levels and unreasonably raised both offeror’s labor hours to the same level under its cost realism analysis.”
*Information Ventures Inc*., B-297276, March 1, 2006

## 

Failure to Look at Historical Trends

**Failure to Look at Historical Trends**

## 
	“Agency’s cost realism evaluation is deemed unreasonable where the agency simply referred to the awardee’s proposed costs instead of its own analysis of awardee’s costs and failed to adjust awardee’s proposed labor rates based on information it received rewarding awardee’s direct labor rates.”

Magellan Health Services, B-298912, Jan. 5, 2007

- 	“Agency’s cost realism evaluation is deemed unreasonable where the agency simply referred to the awardee’s proposed costs instead of its own analysis of awardee’s costs and failed to adjust awardee’s proposed labor rates based on information it received rewarding awardee’s direct labor rates.”
*Magellan Health Services*, B-298912, Jan. 5, 2007

- Advice to Avoid Protests:
- Compare labor hours in cost proposal with the labor hours in the technical proposal.
- Consider each  offeror’s individual approach instead of mechanically adjusting costs.
- Question unrealistic labor rates.

- Question low overhead rates that differ from prior years.
- Low costs may also indicate an offeror’s lack of understanding of the SOW.
- Rely on auditors for their expertise.
- Remember – you have substantial discretion but the analysis must be rational.

**Questions?**

**Thank You**
- bkinosky@centreconsult.com