Prior to awarding a contract, the Contracting Officer must determine that the price is fair and reasonable. A large part of that effort involves price analysis, one or more analysis techniques, and considering multiple cost and price elements. The Federal Acquisition Regulation (FAR) establishes different procedures based on the contracting method, size of contract award, and other factors, but the general procedure is the same: the CO analyzes the proposed price and determines whether it is fair and reasonable.
The critical element of price analysis is market research; the CO simply must understand the market at large, including historical prices, recent trends and developments, alternative sources and products, and general price levels and availability. A lot of the market research can be precluded by adequate competition – if multiple offers are received, this competition sets the baseline for fair and reasonable pricing and shows availability from alternate sources. And provided that full and open competition is sought by the CO in the solicitation, then if only one proposal is received, that condition also frames the market and provides valuable reference data for analysis. Simply put, if only one vendor offers a proposal under the terms of the solicitation, that provides market feedback on the proposed price and the overall effectiveness of the solicitation.
Even so, the CO must still perform price analysis, using one or more of the established techniques. The best technique is analysis of actual cost data, wherein the contractor provides the specific cost information used to develop the proposed price. But this technique takes a long time, involves additional costs in preparation, and is only required for contracts that exceed the thresholds set by the Truth in Negotiations Act (TINA). The cost build-ups include direct cost elements such as labor and materials, and indirect costs such as overhead and facilities, and general and administrative (G&A). In addition, the contractor’s price usually involves markup from supplier prices and pass-throughs of supplier expenses, all intended to increase the price to reduce the prime contractor’s costs and maximize their profit. Profit is the reason that the contractor exists, so it must be understood in the overall context of fair and reasonable pricing. One final factor to consider is that of escalation, which is an index of past price increases over regular time intervals. This escalation (and occasionally de-escalation) is a result of inflation or changing market conditions and is used to project price indices for future years, which is a helpful tool for long-term, multi-year contracts.
The next best price analysis technique is comparison to competing offers, but the government does not always obtain competitive bids, and often has decided to pursue a non-competitive procurement. Therefore, government price analysts rely on less exact but easier and simpler methods. Of these, historical data is a prominent technique, wherein the CO compares the proposed price to past prices to gauge the reasonableness. The second technique is comparison to prices for similar products, in which the comparison focuses on form, fit and function of the different items. A third method is parametric estimate, which is useful when historical or similar product comparisons are limited or incomplete. Parametric estimates involve comparison of measurable quantities or features of the proposed item to a like item; these measurable quantities include such examples as physical dimensions, performance specifications, and such traits. Good examples of parametric estimates include price per pound, price per square foot, price per amount of horsepower, and so on.
There are few other techniques, including technical analysis that incorporates examination of materials, manufacturing, processes, facilities, and the like, and independent estimates developed by market or product experts. These techniques are less desirable, as they involve lengthy and/or costly studies, or are simply not specific enough; hence, these techniques are typically used to support other analyses or when other techniques are not available.
Contractors that understand these various elements and price analysis techniques should be able to better understand the challenges that the CO and government analysts face in determining the proposed prices to be fair and reasonable. Contractors can also use these principles in shaping their pricing effort, not only to provide some rigor to their process, but also to balance the realism of their price objective with the constraints the government must operate under. It may not change their price, but it might help the CO determine the price as fair and reasonable in a faster, easier manner.