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Fair and Reasonable Price Justification: Judgment- or Market-Based? BY JOHNNY J. BATTLE JR. 62 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? 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. 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. NATION AL CONTRACT MANAGEM EN T ASSOC IATION E-COURSES We are proud to offer you virtual courses to support the NCMA Certification Program. Online learning is a flexible, affordable, and effective way to meet your continuing education needs! 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Completion of these courses earns Continuing Education Units (CEUs), which can be used toward satisfying the continuing professional education requirements for certification or re-certification. Visit us online at www.vcampus.com/ncma/index.html for further information and registration. 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. 66 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 Hourly prices for ambulance services (advanced life support) ranged from $124 to $160, with an average price of $147; Factors that contribute to paying 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 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 67 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 68 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 69