Download Fair and Reasonable Price Justification: Judgment

Fair and Reasonable
Price Justification:
Judgment- or
Market-Based?
BY JOHNNY J. BATTLE JR.
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Contract Management | January 2008
Employing innovative techniques to ensure fair and reasonable
pricing should become the rule rather than the exception to help
minimize risk to the government by using available market and
historical contract data.
Contract Management | January 2008
63
Fair and Reasonable Price Justification
Determining fair
and reasonable
pricing is one of the
more difficult tasks
that contracting
professionals face if
ally work very well in a competitive pricing environment; however,
in a sole source environment, you sometimes do not have the
aforementioned elements to depend on. We normally have to rely
on cost analysis in making a determination that the price is fair and
reasonable, but even after we have negotiated what we determine
to be a fair and reasonable price in sole source procurements, the
bottom line is still based on our best business judgment.
One of the more difficult determinations of fair and reasonable
pricing involves the design and fabrication of a product. It becomes
very difficult when the design is done in-house and the bidders fabricate the product from our in-house designs. Even in a competitive
environment, the bids you receive inevitably will be in a wide range.
This may occur even if our design is complete and flawless. What are
the approaches that we can take to ensure that we are awarding a
contract that is indeed fair and reasonable?
ƒƒ
The Independent Government Estimate (IGE), if prepared using
a value analysis estimate, is probably the most worthwhile
because it actually involves creating an estimate based on the
function of the product—taking it apart and determining how
it is made. When employing this method of estimating, there
should be an associated estimate for every part of the product.
Although this method can be very time consuming in its preparation, the results should allow a determination of whether the
bidders are in the competitive range.
ƒƒ
Often visual inspection of a product design is used in determining the IGE. Although this method is useful in making a determination of fair and reasonable pricing, it can sometimes lead
to a lower IGE. Because unknowns and various decisions by the
bidders (such as G&A and profit, labor rates, and market conditions), each bidder’s price can easily exceed the IGE. Certain
factors cannot be predicted and will not be recognized until the
bids are received and evaluated.
there are no clear-cut
comparisons to make
a definitive fair and
reasonable price
determination.
Our hope is that through competition we can award a contract
based on no more than a five, 10, or 20 percent difference between
the apparent low bidder and the other competitive participants. If
we use 20 percent as the rule of thumb, we generally can expect
that we have obtained a fair and reasonable price. The difference
in prices can be attributed to bidder profit and overhead and other
factors, such as manufacturer-to-supplier pricing. There may also
be a relationship between the bidder and sub-tiers who are actually
doing the procurement for the bidder. If the percentage difference
starts increasing beyond 20 percent, then we have the dilemma of
making a decision that the apparent low bidder’s price is determined
to be fair and reasonable. How do we make a sound decision and a
determination that the price is fair and reasonable in a competitive
environment?
Fair and reasonable prices can be determined by comparison to
other proposed prices, commercial prices, previously proposed
prices and contract prices, parametric and rough yardstick estimates,
and independent government estimates. These comparisons gener64
Contract Management | January 2008
Whenever we compare pricing we must evaluate using the same
criteria for each bidder in making the correct determination of
price—factors such as whether the bidders are using the same technology in fabricating the product, or whether their location from
the final place of delivery affects their price. Market conditions are
another factor in the determination of fair and reasonable pricing.
Being unaware of trends in the market can certainly be a detriment
in our determination of fair and reasonable pricing. The question is
whether the trend in the market leans more toward quality or are
we asking the bidders to sacrifice quality for other trends such as
quantity because of urgent needs for certain products?
We must be aware of all of the factors that can affect price comparison when evaluating competitive bids, and we must take into
account all issues including cost realism if the low bid can eventually
put the government or the bidder at risk. However, we must remember that some low bids are not necessarily unfair to bidders, but are
a business judgment that bidders must ultimately be responsible for
in the performance of the agreement.
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Fair and Reasonable Price Justification
Contracting professionals must be mindful of all of the conditions
that can affect pricing, such as supply and demand and general
economic conditions. Because of the volatile price of many products
or the component parts of products, we have to be cognizant of
the inelasticity of demand for these products. This force can have
an effect on historical price comparison—the price of a product can
drastically change from purchase to purchase because of changes
that can affect the marketplace in a short period of time because of
increasing or decreasing supply. If we are not paying close attention
to what is happening in the marketplace for the products we are
buying, we may think that the prices being proposed are unreasonable, or conversely, reasonable when in fact they are not.
When price reasonableness is not apparent even through competition, it might be worthwhile to make a determination that
discussions are needed—even though it was clearly stated in the
solicitation that award would be made without discussions. Discussions can be held once we document the file with the reasons
why it became necessary to hold discussions. It is at this point
that we can discuss all of the pertinent economic and market
conditions that may have affected a bidder's price. By doing this,
Contracting professionals
must be mindful of all of the
conditions that can affect pricing,
such as supply and demand and
general economic conditions.
we can then extrapolate all of the pricing and cost information
necessary to determine price reasonableness of bidders in the
competitive range. This cannot be emphasized enough in today’s
ever-changing markets and the volatility of commodities.
After we hold discussions we have a clearer picture of what is
included in a bidder’s price, even in a competitive environment.
Comparing prices alone is not always the best determinant of fair
and reasonable pricing, even if it appears clear to us that we have
a low bidder that is both technically acceptable and responsible.
There are factors that may have contributed to their low bid, such
as product quality, untimely deliveries, a possible technological
advantage the low bidder may have over the other bidders, and how
their mark-up pricing applied. Is their mark-up pricing on direct costs
or total costs? The way that a bidder marks up their pricing certainly
can cause the differences we see in pricing when all bidders have
equality in the factors previously mentioned.
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Contract Management | January 2008
Determining fair and reasonable pricing must involve, in many
cases, discussions with the bidders in order to get a clearer picture
of the market conditions that caused the bidders to price products
at varying sums in a competitive environment. We should be able
to obtain enough information from each bidder without employing cost analysis to make the determination for fair and reasonable pricing. By holding meaningful discussions with each bidder
determined to be in the competitive range, we should be able to
discern which bidder might be buying in, transportation cost, lifecycle cost, Buy American Act factors, requirement understanding,
and other factors that can affect price. By engaging in discussions when necessary, we can eliminate the decisions based on
judgment, and be assured of our ability to determine that the low
bidder’s price has been determined to be fair and reasonable based
on market forces.
Emphasis should always be placed on minimizing the risk to the government when making a determination of fair and reasonable prices.
Taking into account all business practices from bidders that help to
formulate their pricing is a daunting task that has to be approached
with a thorough understanding of what went into a bidder’s price.
Because of necessity, schedules, and urgency, we don’t always perform due diligence in ensuring that the prices we paid for products
were indeed fair and reasonable.
The Government Accountability Office (GAO) has determined as far
back as 1999 that the price analysis was oftentimes too limited to
determine that pricing was fair and reasonable. The use of catalog
or list prices causes some confusion because we mistakenly believe
that these prices are considered to be fair and reasonable without
taking into account historical pricing that might be in contract
files of previous purchases. As it becomes more difficult to ascertain fair and reasonable pricing in a competitive environment, our
solicitations have to become more comprehensive in requesting
additional supporting data from the bidders (such as sales data) to
support their pricing.
Another obstacle in price determination is not substantiating whether
previous paid prices were determined to be fair and reasonable; thus
not allowing for adequate comparison for evaluation of current pricing. The most common reasons given for inadequate price analysis
are urgency and heavy workload, but as we become more cognizant
of what we can ask for in our solicitations, bearing down on fair and
reasonable pricing becomes an integral part of our commercial evaluation, and helps to limit the time spent justifying prices to be fair and
reasonable when we don’t have adequate comparisons.
In the face of a dwindling contracting workforce, we must be prepared
to request additional support data in our solicitations to make better
decisions about fair and reasonable pricing during the commercial
evaluation process. We have proven that doing more with less does
not work, so we must either step up our recruiting efforts or come
up with more efficient ways to make pricing determinations with the
workforce that we have. In the short term, there is no quick fix to the
problem of underemployment in the contracting career field.
Fair and Reasonable Price Justification
The most valuable and most recent lesson learned was the test
of fair and reasonable determination after Hurricane Katrina. The
GSA inspector general reviewed the contracts involving ambulance
services, base camps, catering, and showers, which represented
about $218 million of the contracts issued by GSA; the prices for
the services varied widely. The prices paid by GSA were compared to
similar standing contracts awarded by the U.S. Forest Service (USFS).
For instance:
their awarded contracts to the Internet, their database repository
of contracts remains current and up-to-date as well. This is one way
to approach the problem of being able to compare prices, especially
in an emergency situation when time is of the essence, but we
still want to maintain the integrity of the acquisition process. We
must continue to be vigilant to reduce the risk to the government
of spending more for goods and services than we should without
ƒƒ
Hourly prices for ambulance services (advanced life support)
ranged from $124 to $160, with an average price of $147;
Factors that contribute to paying
ƒƒ
Pricing for basic base camp services (lodging, meal, and showers) ranged from $109 to $499 per person per day; and
more than a fair and reasonable
ƒƒ
Catering service contract prices (which include breakfast, lunch,
and dinner) ranged from$25.41 to $70.95 per day. The range for
comparable services from 16 U.S. Department of Agriculture
(USDA) national mobile food services contracts reviewed was
$37.24 to $48.33.
It was noted that the pricing for the mobile shower facility contracts
by GSA was unreasonable, and the pricing was determined to be
significantly higher than the standing contract by the USFS. Because
of the way that the GSA contract was structured, with line items for
the different equipment necessary to operate a mobile shower facility, they ended up paying $5,285 a day more than the USFS, whose
contract was all-inclusive of the different equipment items. Over 30
days, this was a $158,460 cost difference.
Because of the urgency of the quality-of-life requirements after such
a catastrophic event, and the fact that the contracting personnel
that were tasked to provide these products and services lacked the
knowledge of many of the products and services being purchased,
unreasonable pricing was obtained. The inspector general recommended that contracting officers have the ability to order from
pre-existing contracts, such as the Forest Services contracts. The
problem with this scenario is the mass integration of a database
that would encompass all possible types of contracts that would be
needed in an emergency situation.
One possibility might be the uploading of awarded government
contracts on the Internet by agency. The contracts don’t have to be
maintained in the same place, but by searching the Web, any contracting professional in need of price comparison data for equivalent
type contracts would have easy accessibility. Currently, there are
very few government contracts available on the Internet. Obviously,
no classified contracts would be uploaded, nor if certain redactions
are needed prior to the upload of contracts for goods and services
that should be accomplished prior to the upload.
A scenario such as this would not burden any one agency for having
the responsibility of researching and developing a huge database of
contracts, plus they would not be responsible for maintaining this
database. When individual agencies are responsible for uploading
price for products and services
can be attributed to the shortage
of qualified contracting personnel,
urgency of requirements by
customers, and not being aware of
market factors that affect prices in
the commercial sector.
using all of the tools available to us, such as the Internet. Not only
will this be a good tool to use during urgent events, but also in our
normal course of contracting business when accomplishing market
research and searching for historical pricing data.
We must use the authority granted to us by FAR 1.102-4(e), and
realize that the FAR does not prohibit contracting professionals from
using innovative contracting methods and techniques. FAR 1.102-4(e)
states that the FAR outlines procurement policies and procedures
that are used by members of the acquisition team. If a policy or
procedure, or a particular strategy or practice, is in the best interest
of the government and is not specifically addressed in the FAR, nor
prohibited by law (statute or case law), executive order, or other
regulation, government members of the team should not assume it
is prohibited. Rather, absence of direction should be interpreted as
permitting the team to innovate and use sound business judgment
that is otherwise consistent with law and within the limits of their
authority. Contracting officers should take the lead in encouraging
business process innovations and ensuring that business decisions
are sound.
Contract Management | January 2008
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Fair and Reasonable Price Justification
Reverse auctioning should be one of those innovative contracting
tools that should become the primary tool for competitive procurements. Not only can we realize huge savings from using reverse
auctioning, but it forces the bidders to do their own form of market
research to determine the price for which others in the market are
selling similar products or services. The test is not to have bidders
lose money, but to fairly price the product or service.
The use of this tool is only worthwhile if three or more bidders
participate. Finding bidders to participate should not be hard—
the fairness of this system should become obvious to participants
regardless of their business size status. If the proper criteria are
included in the solicitation prior to the actual reverse auctioning
event, there should be no degradation in the quality of the products
or services that are being acquired in this process. Again, we must
be innovative and thoughtful of all pertinent factors that will affect
the procurement, such as Buy America Act provisions and a welldefined scope.
Training in price analysis techniques of government contracting
personnel should be revised to place major emphasis on the market
research skills necessary to acquire government-required products
and services from commercial firms. It would be worthwhile to develop a course that instructs contracting personnel on factors that
affect pricing in a particular market, rather than awarding contracts
based on judgment that the lowest priced offer is fair and reasonable. Government contracting personnel do receive an enormous
amount of training, but we need to provide more instruction in the
area of commercial practices so that our effort at determining fair
and reasonable pricing is an actual determination that we have been
good stewards of the public funds entrusted to us.
Buying commercial items should rely on market forces to ensure that
the government is receiving a fair and reasonable price. However,
when the government requires unique products and services that
are considered to be commercial items, then we are approaching an
area that causes a problem in attempting to do business within the
commercial industry. The more we retrofit our scope of work and
specifications to meet certain requirements in the government, the
more difficult it becomes to make fair and reasonable pricing determinations, thus requiring the contracting professional to obtain
enough market information during the solicitation phase in order to
make a fair and reasonable pricing decision.
If we attempt to merely use a pencil and calculator to make this fair
and reasonable determination, we will most certainly fall short of
making a clear assessment for the commercial products and services
that have nonstandard specifications included in the requirement.
We must remember that most commercial companies survive as
business enterprises without considering the government as their
preferred customer. In addition, because of the cultural differences
between the commercial market and the government, we need to
ensure that the prices we are receiving are in indeed fair and reasonable. Commercial firms are aware that doing business with the
government has some intrinsic conditions, such as penalties for not
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Contract Management | January 2008
complying with government regulations, possible protest, funding
issues, and the government’s right to terminate contracts.
Therefore, it becomes very important that judgmental decisions of
price reasonableness takes a back seat to identifying market factors
that affect prices to avoid inflated prices because of perceptions by
commercial suppliers. Because the government doesn’t face the risk
of bankruptcy and other penalties that might be fatal within the commercial sector because of an inefficient procurement system, our objective should be to find ways to control cost and make purchases that
have been adequately analyzed for price reasonableness. We must try
very hard to change the mindset that because the government is not
a for-profit entity, we are at liberty to make purchases that are less
than fair and reasonable because of need, and in many cases, urgency
of the requesting organization—who, in most cases, hasn’t planned
the acquisition of the product or service in advance of submitting the
request to the contracting organization for purchase to allow for time
to adequately analyze the prices received.
The statement “we have to do more with less” will make more sense
as we streamline our commercial requirements so that they are less
cumbersome and intimidating to prospective bidders. This is a huge
problem that needs to be addressed by the contracting community
so that we can tailor our requirements more toward what commercial suppliers are used to seeing in the marketplace from their other
customers. Once we streamline this process, we will probably see
huge differences in price for those items that are sold in substantial
quantities in the marketplace.
However, when we add mountains of documents in the form of
specifications and the scope of work, we are unknowingly setting
ourselves up for failure because of the risk associated with the
number of specifications for what we determine to be a commercial
item. With this risk comes the inevitable inflation of pricing because
of the fear from bidders that they may have missed something in
the specifications and the scope of work because of the enormous
amount of documents required of them.
Furthermore, there is the business cost to any commercial firm
to provide resources to read the specifications and scope of work
before they can estimate the cost for the product or service. None of
this cost might be captured in a competitive environment without specific instructions to provide certain data with their bid or
through negotiations. The reasonable approach to this dilemma is
to streamline our specifications and scopes of work when targeting
commercially available products and services from the commercial
sector. While developing our specifications and scopes of work
where certain components of a product might require nonstandard
material, we must re-think our procurement approach. We must
enlist the assistance of experts for the particular product to be able
to narrow down the specification and scopes of work as to limit the
risk to the commercial firms when they are invited to submit bids.
The alternative is to pre-qualify the bidders by asking specific questions that might allow a dialogue between the potential bidders and
the contracting professional, and to hold pre-bid conferences that
Fair and Reasonable Price Justification
will generate questions that might help to eliminate portions of the
specifications and scopes of work that add no value to the requirement for commercial products or services. While these tools are
being used we must make them more efficient to better streamline
our commercial requirements.
Conclusion
We must become more aware that our task is to define requirements within the marketplace in an effort to make rational business
decisions. We cannot depend on subjective judgments by contracting professionals that may not pass the scrutiny of audits, and newspaper articles that may not give all of the information necessary to
show that there were underlying reasons why prices were paid for
government-acquired products or services in the commercial marketplace. Making the appropriate determination of fair and reasonable
pricing, if based on judgment, should have all of the characteristics
necessary to be able to pass any litmus test by those who review our
acquisitions for reasonableness.
The factors that contribute to paying more than a fair and
reasonable price for products and services can be attributed to
the shortage of qualified contracting personnel, the urgency of
requirements by customers, and not being aware of market factors
that affect prices in the commercial sector. These can all be offset
by not only making the contracting professional more cognizant of
how we can better conduct business, but by informing everyone
in the acquisition process of how important it is for all of us to be
good stewards of the public funds entrusted to us. Customers have
to realize the impact of poor planning on the procurement process
and where they fit within the process. Contracting professionals
must continue to educate our customers by involving them in corrective actions after inspections and audits where the results are
less than lackluster. CM
Endnotes
1.
FAR 1.102-4(e)
2.
FAR 15.404-1(a)
3.
FAR 15.404-1(b)(2)
About the Author
JOHNNY J. BATTLE JR., is a procurement representative for Bechtel National, Inc. (BNI), and is currently part of the Bechtel Parsons
Blue Grass Project, which was selected by the Department of Defense
Assembled Chemical Weapons Alternatives Program to design, build,
systemize, test, operate, and close a facility to destroy the chemical
weapons stockpile stored at the Blue Grass Army Depot in Kentucky.
Send comments about this article to [email protected].
Contract Management | January 2008
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