Use of Cost Realism in Proposal Evaluations

By: Curt Smith, Manager, Government Contractor Services Group

When negotiating a contract price, the primary concern of contracting officers (“CO’s”) should be the price that the government will pay to obtain the required supplies or services from a responsible contractor. Their objective should be to negotiate a contract type and price (or estimated fee and cost) that will result in reasonable contractor risk and provide the contractor with the greatest incentive for efficient and economical contract performance.

To achieve this goal, the Federal Acquisition Regulation (“FAR”) requires agencies to establish a negotiating objective based upon a price or cost analysis. Generally, cost analysis is to be used when certified cost or pricing data, or data other than certified cost or pricing data, is required. Cost realism analysis may be used when certified cost or pricing data are not required. FAR 15.404 defines cost analysis and cost realism analysis.

Cost analysis involves the review of the separate cost elements proposed to determine a fair and reasonable price, and applies judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. The government may verify that cost proposals are in accordance with the contract cost principles in FAR Part 31 and, when applicable, the requirements and procedures in the Cost Accounting Standards.

A cost realism analysis reviews specific elements of proposed cost estimates to determine whether the estimates 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 technical proposal. Cost realism analyses must be performed on cost-reimbursement contracts to determine the probable cost of performance for each offeror.

The probable cost may differ from the proposed cost and should reflect the government’s best estimate of the cost likely to result from a given proposal. The probable cost is determined by adjusting proposed cost to reflect any additions or reductions in cost elements based on the results of the cost realism analysis. The probable cost is used to determine the best value. However, the award is made at the negotiated cost.

Cost realism analyses may, but are not required to, be used on competitive fixed-price incentive contracts or on other competitive fixed-price-type contracts when new requirements may not be fully understood by competing offerors, there are quality concerns, or past experience indicates that contractors’ proposed costs have resulted in quality or service shortfalls.

There are hundreds of Government Accountability Office (“GAO”) bid protest decisions that address cost realism. The following discussion concerning a bid protest demonstrates the use of cost realism analysis in the evaluation of proposals.

In Prism Maritime, LLC B-409267.2; B-409267.3 (April 7, 2014) the Navy was to issue a task order containing cost-plus-incentive-fee (“CPIF”), cost-plus-fixed-fee (“CPFF”) and cost-reimbursement requirements to perform services. The request for proposal (“RFP”) stated that the agency would perform a cost realism evaluation of the offerors’ proposed costs. The Navy received proposals from Prism and Valkyrie.

The source selection authority (“SSA”) found that the proposals were technically equivalent and based on the proposed cost difference between the proposals– $54,429,954 for Prism and $46,106,405 for Valkyrie — awarded the task order to Valkyrie.

In its protest, Prism asserted that the agency failed to perform an adequate cost realism evaluation based on the following claims:

• Valkyrie’s proposed cost was so low that it would be unable to recruit and retain qualified personnel;
• Valkyrie proposed the minimum Service Contract Act wage rates for approximately 40 percent of its proposed staff; and,
• Because Valkyrie’s proposal did not include any identified personnel, it would not be able to recruit personnel at the labor rates proposed.

The GAO agreed that the agency’s cost realism evaluation was inadequate.

The GAO commented that when an agency evaluates proposals for a cost-reimbursement contract, a cost realism analysis must be performed to determine the extent to which an offeror’s proposed costs represent what the contract costs are likely to be under the offeror’s unique technical approach, assuming reasonable economy and efficiency. In addition, where a contract involves a large amount of labor, agencies are required to consider the realism of an offeror’s proposed labor rates.

The GAO noted that the entire cost realism evaluation was comprised of two excel spreadsheets that did not provide meaningful information relating to the agency’s cost evaluation. The Navy did not provide a cost evaluation report or any supporting materials (e.g., Defense Contract Audit Agency reports) that the Navy claimed to have used in its cost evaluation.

The Navy did provide an after-the-fact declaration from its contract specialist describing her cost evaluation activities. However, the GAO had several concerns with the agency’s evaluation. First, nothing in the record showed that the Navy gave meaningful consideration to the offerors’ proposed direct labor rates. Simply checking to determine whether or not an offeror has proposed the minimum Service Contract Act wage rate did not give meaningful consideration to whether the rates proposed were realistic.

Another concern was that the Navy could not have performed a meaningful evaluation of Valkyrie’s proposed wages since Valkyrie did not specify which of its proposed employees were junior, mid-level and senior as required by the RFP to determine the appropriate labor mix. Since the Navy did not know what mix of staffing was being proposed, it could not have meaningfully judged whether the proposed rates were realistic.

In addition, while the Navy performed some kind of cost realism evaluation and made adjustments to proposed costs for evaluation purposes, the source selection decision used the offerors’ proposed, rather than evaluated, costs. This was inherently improper.  The Navy also ignored that the contract was largely a CPIF contract, the central feature of which is a financial risk and reward mechanism to spur cost effective performance where the contractor will be rewarded for reducing costs and penalized for cost overruns. With a CPIF-type contract, once an overrun is so large that the fee has dropped to the minimum the contractor is no longer incentivized to control costs. With other cost reimbursement contracts, calculating a proposal’s most probable cost may be all that is needed to address cost realism; however, a lack of realism in an offeror’s proposed target cost for a CPIF contract can defeat the purpose of the incentive fee. Nothing in the record showed that the Navy gave any thought to these considerations.

In view of the above, the GAO concluded that the agency failed to perform a reasonable cost realism evaluation, and to the extent that it did perform any such evaluation, it did not use the results of that evaluation in its source selection decision. Therefore, the GAO sustained this aspect of Prism’s protest.