GAO

United States General Accounting Office

Report to Congressional Requesters

June 1999 CONTRACT 

MANAGEMENT

DOD Pricing of 

Commercial Items 

Needs Continued 

Emphasis

GAO/NSIAD-99-90

Page 1 GAO/NSIAD-99-90 Contract Management

United States General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-280125 Letter

June 24, 1999

The Honorable James Inhofe

Chairman

The Honorable Charles Robb

Ranking Minority Member

Subcommittee on Readiness and Management Support

Committee on Armed Services

United States Senate

The Department of Defense (DOD), with the support of the Congress, is

increasing its purchases of commercially available products and services.

While the current level of commercial purchasing is relatively small and

sole-source commercial purchases even smaller, DOD expects commercial

purchases to increase in the future and believes determining fair and

reasonable prices for commercial sole-source items will continue to be

challenging. The Federal Acquisition Regulation (FAR) cautions DOD

contracting officers not to obtain more information than is necessary for

determining price reasonableness and it emphasizes the need to limit

information requests of the contractor. However, when needed,

contracting officers may ask contractors to provide sales prices for the

same or similar items, an explanation of the contractors discount policy, or

cost data.

The FAR defines price analysis as the process of examining and evaluating

a proposed price without evaluating its separate cost elements or profit.

Price analysis techniques include (1) comparing proposed prices in

response to a competitive solicitation; (2) comparing a currently offered

price to previously paid prices if both the validity of the comparison and

the reasonableness of the previous prices can be established; (3) using

parametric methods such as dollars per pound or other measurement units;

(4) comparing offers to competitive published price lists, published market

prices, and discount or rebate arrangements; (5) comparing proposed

prices with independent government cost estimates; and (6) comparing

proposed prices with prices obtained through market research for the same

or similar items.

As you requested, we (1) determined the extent of price analysis DOD

contracting personnel were performing to arrive at fair and reasonable

prices for commercial sole-source items, (2) evaluated how well contract
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personnel performed price analyses, and (3) determined what guidance

and training was available to assist them in determining price

reasonableness. We reported our preliminary observations during

testimony before the Senate Subcommittee on Acquisition and Technology,

Armed Services Committee, in March 1998. 1 This report supplements the

information presented in that testimony.

Results in Brief In 33 of the 65 commercial sole-source purchases we reviewed, price

analysis consisted of comparing the offered price to an offerors catalog or

price list, and/or to the price(s) the government previously paid for the

same or similar items. Contracting officers accepted the offered price in

30 of the 33 purchases and negotiated lower prices in 3 cases (9 percent).

In the other 32 purchases, contracting personnel used one or more

additional price analysis tools such as obtaining commercial sales cost

information. Contracting officers accepted the offered price in 19 of the

32 purchases and negotiated lower prices in 13 cases (41 percent).

The price analysis performed by contracting personnel were often too

limited to ensure that prices were fair and reasonable. For example, some

contracting personnel believed that when the offered price was the same as

the catalog or list price, it could be considered a fair and reasonable price.

In several cases, contracting personnel did not use pertinent historical

pricing information contained in contract files that should have raised

questions about the reasonableness of offered prices. Further, contracting

officers, generally, were not using a discretionary solicitation clause that

requires offerors to provide information other than certified cost and

pricing data, such as sales data, in support of their offered prices. In

addition, some contracting officers paid prices that included unneeded

services. Finally, many contracting officers were not documenting in the

contract file how they determined that a price previously paid for an item

was fair and reasonable and, therefore, could be relied on in evaluating the

currently offered price.

Reasons given for the limited price analysis included workload burdens

and urgent requirements for items. DOD officials also noted the reduced

negotiation leverage that contracting officers now have when purchasing

commercial items in a sole-source environment.

1Defense Acquisition: Improved Program Outcomes Are Possible (GAO/T-NSIAD-98-123, Mar. 18, 1998).
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DOD continues to provide guidance and training to assist contracting

personnel in contracting for commercial items and in performing sound

price analysis. However, based on our work, DODs efforts have yet to be

fully understood or embraced by all DOD contracting personnel. In time,

the training should improve their price analysis and negotiating skills.

Also, recent legislation requires increased guidance for contracting

personnel on price analysis tools, the appropriate use of information other

than cost or pricing data, and the role of support agencies. The guidance

should also help government contracting personnel become smarter buyers

in the commercial marketplace. As of May 1999, regulations to implement

the act had not been published.

We are making recommendations to the Secretary of Defense to improve

the price analysis performed by DOD contracting personnel.

Price Analysis

Performed by

Contracting Personnel

While the FAR grants DOD contracting officers wide latitude on the type

and extent of price analysis techniques they can use, contracting officers

are required to perform sufficient price analysis to determine whether

offered prices are fair and reasonable. The more knowledgeable

contracting personnel are about the basis and makeup of commercially

offered prices, the better the position they will be in to evaluate the

reasonableness of offered prices. Our review of 65 commercial sole-source

purchases showed that for 33 purchases, price analysis consisted of

comparing the price offered to a catalog or price list, and/or to the price(s)

previously paid for the same or similar items by the government.

Contracting officers accepted the offered price in 30 of these 33 purchases

and negotiated lower prices in 3 (9 percent).

For the other 32 purchases, contracting personnel used one or more

additional price analysis tools. For 21 of these purchases, some

commercial sales information was obtained. Depending on the

circumstances, sales information can be useful in comparing the

reasonableness of prices offered by contractors to prices paid by

commercial customers for the same or similar items sold in comparable

quantities. However, in many of the 21 cases, the quantities the

government required were significantly larger than the quantities reflected

in the commercial sales information. Contracting officers accepted the

offered price in 13 of these 21 cases and negotiated lower prices in 8 cases

(38 percent). With regard to sales information, contracting personnel have

another tool available to them. A 1998 Defense Contract Audit Agency

(DCAA) memorandum emphasized its availability to review sales and other
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data provided by contractors in support of their offered prices for

commercial items. However, contracting personnel requested this support

for only one of the purchases we reviewed. A number of contracting

personnel told us they were unaware that this DCAA support was available.

For the remaining 11 purchases, contracting personnel used other pricing

tools such as obtaining cost information. Contracting officers accepted the

offered price in 6 of these 11 purchases, and negotiated lower prices for

5 purchases. In total, contracting officers accepted the offered price in 49

of the 65 purchases (75 percent) and negotiated a price reduction in 16

cases (25 percent).

Price Analysis Often

Limited

We found that price analysis being performed by contracting personnel

were often too limited to ensure fair and reasonable prices. For example,

some contracting personnel believed that when the offered price was the

same as the catalog or list price, it could be considered a fair and

reasonable price. In several instances the price analysis performed by

contracting personnel did not address pertinent historical pricing

information. In addition, some contracting officers paid prices that

included unneeded services. Further, contracting personnel, generally,

were not using a discretionary solicitation clause that requires offerors to

provide information other than certified cost and pricing data, such as sales

data, in support of their offered prices. Finally, many contracting officers

were not documenting in the contract file how they determined that a price

previously paid for an item was fair and reasonable and, therefore, could be

relied on in evaluating the currently offered price. While we believe some

price analyses were often too limited, we cannot say whether the prices

would have been different had better price analysis been performed.

Comparing Price Offered to

Catalog or List Price

FAR and service guidance make it clear that contracting personnel cannot

simply rely on catalog or list prices in making a price reasonableness

determination. While catalog prices are an appropriate source of pricing

information, contracting personnel must evaluate catalog prices while

considering such things as quantities to be purchased, delivery times,

market conditions, and sales to other customers. Contracting personnel

must do sufficient price analysis to enable them to determine the

reasonableness of an offered price and to document the results of their

price analysis.
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In our review, we found 22 purchases where the price analysis was based

only on catalog prices. For eight of these purchases, the price analysis

consisted of simply comparing the offered price to a current catalog or list

price less whatever discount was offered. For 14 additional purchases, the

offered price was also compared to previous prices that were the same as

the catalog or list price less whatever discount was offered. In all 22 cases,

the contracting officer accepted the offered price. In our discussions with

contracting personnel, some believed that catalog or list prices could be

accepted as fair and reasonable because they assumed that these are the

prices paid by commercial customers.

Not Using Pertinent

Contract File Information

In several cases, contracting personnel did not use pertinent historical

pricing information contained in contract files that should have raised

questions about the reasonableness of offered prices. For example, in June

1998, a DOD contracting officer paid $7,320 each for 31 generator adapter

kits, in part, based on a comparison to prior government purchases since

April 1995 at the same price and other small quantity commercial sales in

1998 at $9,727 each. The price analysis for this purchase referred to an

August 1997 management directive cautioning that historical prices should

only be used if they were prior to 1993 because more recent purchases

from this contractor were overpriced by about 300 percent. Nevertheless,

the 1995 price was used to support a price reasonableness determination

for the 1998 price of $7,320. According to information in the files, DOD had

purchased eight of these items in 1989 for $1,129 per unit. The price analyst

told us that because of her workload she did not have time to research the

price reasonableness of the 1989 purchase made by another DOD buying

office.

In a second case, in October 1996, using a commercial contract, an Air

Force contracting officer paid $1,307 each for 81 aircraft engine vanes for

the KC-135 aircraft. The commercial price was based on the catalog price

less a 7.5-percent discount. This part is also used on the F-16 engine and

was bought by the Air Force in September 1995 under a separate

noncommercial contract for $300 each. The contracting officer was aware

of lower prices for common parts but did not believe that it was

appropriate to use another contract to purchase the vanes. In discussing

this situation with Air Force contracting personnel, they advised us that the

noncommercial contract could have been used to purchase the vanes.

In a third case, in November 1996, a parts distributor offered a price of

$453 per unit for 381 wiring harnesses used on C-130 aircraft. The Defense
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Logistics Agency (DLA) contracting officer accepted this price based on a

comparison to commercial sales prices, with the largest purchase being for

seven units at $495 each. According to information in the contract files,

DOD purchased 461 wiring harnesses directly from the manufacturer in

1993 for $103 each and 194 units in 1994 at $91 each. Subsequently, the

manufacturer declined to sell the item directly to the government but

instead referred DLA to its authorized distributor. The contracting officer

did not use the historical pricing information to attempt to negotiate a

lower price with the distributor for the 1996 purchase. A DLA official told

us it has initiated a review of the price paid for this purchase.

In another case, an Air Force contracting officer determined that an offered

unit price of $2,718 for 83 B-1B hydraulic-cylinder blocks was fair and

reasonable when compared to a 1996 unit price of $2,535, a 7-percent

increase over 17 months. However, the contracting officer told us she did

not consider other information in the contract file showing that the unit

price paid for this item had increased from $441 in 1989 to $2,535 in 1996, a

475-percent increase. She said she was only required to compare the

currently offered price to the last price paid.

Not Using Solicitation

Clause for Obtaining

Information

We found that contracting officers, generally, were not using a

discretionary solicitation clause requiring offerors to provide information

other than certified cost and pricing data, such as sales data, in support of

their offered prices. The FAR allows contracting officers to insert this

clause in solicitations when they determine that such data will likely be

needed to evaluate price reasonableness. 2 For a commercial item, this

clause requires offerors to submit, at a minimum, information on the prices

at which the same or similar items have been sold in the commercial

market that is adequate for evaluating the reasonableness of prices offered

the government. For commercial items where the price is listed in a

catalog, the clause also requires offerors to explain the basis of each

offered price, its relationship to the established catalog price, and an

explanation of how the proposed price relates to the price of recent sales in

quantities similar to those requested by the government. DLA guidance

recommends this clause in all solicitations and contracts for sole-source

commercial items.

2FAR clause 52.215-20 or its predecessor FAR clause 52.215-41.
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We found that some contracting personnel were unfamiliar with this clause

while others did not have a clear understanding about when it should be

used for commercial purchases. Some contracting supervisors believe that

because this clause is also applicable to noncommercial contracts, there

may be some confusion among contracting personnel about its

applicability to commercial contracts.

Paying Prices That Included

Unneeded Services

The FAR and military service guidance emphasize that in determining price

reasonableness, contracting personnel must understand the basis for an

offered price. Accepting offered prices without considering such things as

quantities to be purchased, delivery times, market conditions, or sales to

other customers can result in prices that are not fair and reasonable. For

example, the catalog prices of commercial aircraft parts are often based on

small quantities delivered rapidly; in contrast, government requirements

may be for larger quantities to be placed in inventory and delivered over

much longer periods of time.

We identified two instances where contracting officers paid commercial

catalog-based prices to restock inventories rather than to meet urgent

requirements requiring rapid delivery. In the first instance, the contracting

officer purchased 11 wing components in December 1996 for $38,693 each,

which was the contractors published catalog price. The catalog prices

were based on a 10-day delivery period. However, the governments

required delivery was July 1998--19 months later--for routine restocking of

spare parts. In the second instance, in March 1997, the Air Force placed an

order for 404 engine acoustical panels at the commercial catalog-based

price of $588 each based on a 10-day delivery period. However, because of

the large quantity ordered, the contractor indicated that delivery could not

start until the end of August 1997 and would not be completed until April

1998, over a year after the order was placed. Nevertheless, the order was

placed at a price based on 10-day delivery. In both cases, we found no

indication that contracting personnel inquired about the possibility of

lower prices for extended delivery times.

In contrast to these two situations, we found another buying activity that

negotiated a large discount for items not requiring rapid delivery. The

contracting officer negotiated a 61-percent discount off the offerors

commercial catalog prices for about 8,000 engine spare parts. Delivery

would be based on the time required to manufacture the items ordered

rather than the short delivery times provided for in the catalog. The

government would, however, be required to pay the premium prices paid by
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commercial customers if the shorter catalog delivery times were required

to meet urgent needs.

Not Documenting the

Reasonableness of Prior

Prices

The FAR provides that a contracting officer can compare currently offered

prices to prior prices, if both the validity of the comparison and the

reasonableness of the previous price(s) can be established. However, we

found that many contract files did not show how contracting officers

determined that a price previously paid for an item was fair and reasonable

and, therefore, could be relied on in evaluating the currently offered price.

This issue has been previously recognized as a potential problem. For

example, an Air Force Institute of Technology and Federal Acquisition

Institute Contract Pricing Resource Guide, referenced in the FAR, cautions

that, It is not uncommon to review an item purchase history and find that

no basis other than the last price paid has been used for years to determine

price reasonableness.

Reasons Given for Limited

Price Analysis

Contracting personnel offered a number of reasons why they did not

perform more extensive price analysis. Some said that given their

workload, the most they could do was to compare the offered price to the

catalog price or to the last price paid by the government. They said they

did not have enough time to obtain commercial sales information or

develop detailed independent cost or parametric estimates. At two

activities, managers acknowledged that workforce downsizing had

increased the workload of contracting personnel. At one activity, they said

managements priority had been to clear a large backlog of purchase

orders, which made price a secondary consideration.

In some cases, contracting personnel said pressures from their customers

to meet urgent requirements prevented more extensive price analysis and

negotiations over price. In these instances, customers told contracting

personnel that they were less concerned about price than meeting mission

requirements or keeping to overhaul and repair schedules. In a few cases,

contracting personnel said that additional price analysis was not needed

because the offered prices compared favorably to prices previously paid.

DOD officials noted that one difficulty facing contracting officers is that

some contractors take advantage of their position as sole-source

commercial item providers. Further, one official stated that some

contractors refuse to negotiate what the government would consider fair

and reasonable prices. DOD officials noted that in these situations
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contracting officers do not have enough leverage. For example,

negotiations by DLA with one sole-source supplier resulted in a price that

DLA did not believe was fair and reasonable because it was almost double

the cost of the item. In this instance, the negotiated price was about three

times the price previously paid. Nevertheless, DLA decided to purchase the

item at a price it considered excessive, but limited the quantity to the

amount needed until an alternative source could be developed from among

manufacturers who make similar items.

Efforts to Improve

Price Analysis

DOD continues to add to the training and guidance it offers contracting

personnel to assist them in performing price analysis in a commercial

contracting environment. Between June and August 1997, each of the

military services and DLA issued additional guidance on the pricing of

commercial items. The guidance recognizes the challenges that

contracting officers face in determining whether prices for commercial

items are fair and reasonable, especially when there is no competition. The

guidance also stresses the importance of negotiating prices when buying

commercial items, and reemphasized FAR guidance regarding the pricing

of commercial items and the contracting officers responsibility to ensure

that prices paid by the government are fair and reasonable. The guidance

cautioned contracting officers about the need to fully understand the basis

of commercial catalog prices and not to assume that they are fair and

reasonable just because they are in a published commercial catalog.

Further, the guidance reminded contracting personnel that for commercial

acquisitions, the FAR allows them to request information other than

certified cost and pricing data to the extent necessary to determine price

reasonableness.

In fiscal year 1998, the Office of the Deputy Under Secretary of Defense

(Acquisition Reform) sponsored a series of satellite broadcasts to provide

training on acquisition reform, including the pricing of commercial items.

Specific subjects covered included commercial pricing practices;

performing market research; and the use of historical, comparative, and

parametric pricing techniques. A June 1998 session was devoted entirely to

the pricing of commercial spare parts in a sole-source environment. In

addition, during calendar year 1998, both DLA and the Air Force provided

contracting personnel with 1-day training courses on commercial

acquisition and pricing. The topics covered by this training were similar to

DODs satellite broadcasts.
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Also, in February 1998, the Deputy Under Secretary of Defense (Acquisition

Reform) issued a Commercial Pricing Information Guide. The guide

emphasizes the link between good market research and the ability of

contracting officers to negotiate fair and reasonable prices for commercial

items. In June 1998, the Air Force Materiel Command issued its own

supplementary Commercial Acquisition Guide. In addition to discussing

price analysis techniques that can be used for commercial purchases, the

guide emphasizes the importance of sound market research in determining

price reasonableness and the need for contracting personnel to adequately

document the results of their research in the contract files. Further, DOD,

DLA, and military services have established Internet Web sites with

additional guidance and tools to assist contracting personnel in performing

market research and in acquiring and pricing commercial items.

Other opportunities to obtain training on pricing commercial items

included presentations by DOD and DLA officials during DODs 1998

Acquisition Reform Week Activities, and classes sponsored by DODs

Defense Acquisition University. DOD is continuing its efforts to develop

additional training on commercial pricing, including computer-based

training.

Recent Legislation The Fiscal Year 1999 Strom Thurmond National Defense Authorization Act

required clarification of the procedures and methods used by government

contracting personnel to determine the reasonableness of commercial

prices. This act requires FAR revisions to provide specific guidance on

(1) the application and precedence of specified price analysis tools; (2) the

circumstances under which contracting officers should require contractors

to provide prior sales prices for the same or similar items, or other

information, other than certified cost and pricing data, in support of their

commercially offered prices; and (3) the roles and responsibilities of DOD

support organizations, such as the DCAA, in procedures for determining

price reasonableness. The act also requires DOD to track price trends for

commercial items, and to take appropriate action to address any

unreasonable escalation in prices identified by the price trend analysis.

The same act also directed that the FAR be revised to require offerors, as a

condition for entering into a contract, to provide sales and other

information, other than certified cost and pricing data, in support of their

offered prices when such information is requested by the contracting

officer. This requirement would be subject to any exceptions that the
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Federal Acquisition Regulatory Council determines appropriate. As of May

1999, regulations to implement the act had not been published.

Conclusions The current contracting environment for sole-source commercial items

presents negotiating challenges for DOD contracting personnel. Based on

our work, DODs efforts to improve the quality of price analysis have yet to

be fully understood or embraced by all DOD contracting personnel.

However, it is important to recognize that DOD is in the midst of training its

contracting personnel on commercial pricing. In time, effective training

should improve their price analysis and negotiating skills. Recent

legislation requiring increased guidance for contracting personnel on price

analysis tools, the appropriate use of information other than cost or pricing

data, and the role of support agencies should also help government

contracting personnel become smarter buyers in the commercial

marketplace.

Beyond these actions, we believe that two areas deserve additional

attention. One is the lack of awareness or understanding by contracting

personnel concerning the use of a solicitation clause that requires

contractors to provide information other than certified cost and pricing

data in support of their offered prices. The second is the failure of

contracting personnel to use pertinent historical pricing information

contained in contract files that should have raised questions about the

reasonableness of offered prices. Recent commercial prices paid by some

DOD contracting officers may reflect insufficient training or a lack of

understanding of what constitutes good price analysis in a sole-source

environment.

Recommendations We recommend that the Secretary of Defense direct the Under Secretary of

Defense for Acquisition and Technology to

 include, as part of DODs efforts to implement recent legislation,

clarification of the circumstances when it is appropriate to use the FAR

clause (52.215-20) requiring an offeror to provide information on the

prices at which the same or similar items have been sold in the

commercial market and

 issue a memorandum to contracting personnel emphasizing the

importance of understanding and using historical pricing information

for sole-source commercial item purchases.
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Agency Comments In commenting on a draft of this report, DOD concurred with our

recommendations. DOD said it would issue the guidance recommended by

the draft report as part of its implementation of the requirements of the

Strom Thurmond National Defense Authorization Act for Fiscal Year 1999.

Scope and

Methodology

To determine and evaluate the price analysis DOD contracting personnel

were performing to arrive at fair and reasonable prices for commercial

sole-source items, we focused on the purchase of aircraft parts. We did this

because aircraft parts and related end items represented the largest

category of commercial sole-source purchases DOD made during fiscal

year 1997. Within aircraft spare parts, we selected those DOD buying

activities that were major purchasers of commercial sole-source items. We

obtained this information by analyzing DODs DD350 database, which

contains all contract transactions over $25,000. Based on our analysis, we

selected the following DOD buying activities for review:

 Air Forces Air Logistics Center, San Antonio, Texas;

 Air Forces Air Logistics Center, Oklahoma City, Oklahoma;

 U.S. Special Operations Command, Fort Eustis, Virginia;

 Defense Supply Center, Columbus, Ohio;

 Defense Industrial Supply Center, Philadelphia, Pennsylvania; and

 Defense Supply Center, Richmond, Virginia.

In addition, we selected the Naval Inventory Control Point, Philadelphia,

Pennsylvania, because it was located at the same address as the Defense

Industrial Supply Center in Philadelphia.

For each of these buying activities, we obtained additional information

from the activity on commercial sole-source purchases. From this

information, we further narrowed the universe down to those sole-source

commercial purchases over $100,000 where the price was negotiated

during fiscal years 1997-98. Finally, we judgmentally selected a total of 65

contract actions amounting to about $79 million for review. For each

contract action, we reviewed the information in the contract file, including

the price analysis and negotiation memorandums, and identified the price

analysis tools contracting personnel used to determine fair and reasonable

prices. We also discussed this information with selected contracting

personnel who conducted the price analyses. Based on these reviews and

discussions, we evaluated how well contract personnel performed their

price analyses.
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To identify the guidance and training available to contracting personnel to

assist them in determining a fair and reasonable price, we asked DOD,

DLA, and military service representatives to provide us with available

guidance and training on commercial purchases. We reviewed this

information and discussed it with selected contracting personnel and

management at DOD buying offices.

Our work was performed in accordance with generally accepted auditing

standards.

We are sending copies of this report to the Honorable William Cohen,

Secretary of Defense; the Honorable Jacob J. Lew, Director, Office of

Management and Budget; and Lieutenant General Henry T. Glisson,

Director, Defense Logistics Agency. Copies will also be made available to

others on request.

Please contact me at (202) 512-4587 if you or your staff have any questions

concerning this report. Major contributors to this report are listed in

appendix II.

David E. Cooper

Associate Director

Defense Acquisitions Issues
Page 14 GAO/NSIAD-99-90 Contract Management

Contents

Letter 1

Appendix I

Comments From the

Department of Defense

16

Appendix II

Major Contributors to

This Report

20

Abbreviations

DCAA Defense Contract Audit Agency

DLA Defense Logistics Agency

DOD Department of Defense

FAR Federal Acquisition Regulation
Page 15 GAO/NSIAD-99-90 Contract Management
Page 16 GAO/NSIAD-90-99 Contract Management

Appendix I

Comments From the Department of Defense ApIenxdi
Appendix I

Comments From the Department of Defense

Page 17 GAO/NSIAD-90-99 Contract Management
Appendix I

Comments From the Department of Defense

Page 18 GAO/NSIAD-90-99 Contract Management
Appendix I

Comments From the Department of Defense

Page 19 GAO/NSIAD-90-99 Contract Management
Page 20 GAO/NSIAD-99-90 Contract Management

Appendix II

Major Contributors to This Report ApxIendi

National Security and

International Affairs

Division, Washington,

D.C.

Paula J. Haurilesko

Thomas W. Hopp

Julia M. Kennon

Leslie E. Schafer

Charles W. Thompson

Boston Field Office Paul M. Greeley

Los Angeles Field

Office

Carlos M. Garcia

Noel J. Lance

(707321) Letr
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