In the commercial marketplace the question of profit usually is not a subject for discussion when buying a product.  As consumers we accept an inherent principle that market place competition drives suppliers to the lowest price.  We don’t care how Amazon can beat Walmart on the price of a toaster oven.  We also don’t care how much the toaster oven “cost’ to make, consumers are concerned about getting the lowest price in the marketplace and accept that competition will provide that lowest price.

There is a bit of confusion out there because people switch back and forth between price and cost.  To many people, it’s the same thing.  We all do it, “how much does it cost?’ or “what’s the price on Amazon?”  However, in government contracting, cost is different from price. Cost is the amount of money spent to manufacture a product or provide a service.  Price is cost plus profit/fee.  Profit/fee being a reasonable expense for a company to add in to cover such things as new product development or to share with stock holders.

Selling to the government is basically the same as in the commercial marketplace.  Since consumers buy on a firm fixed price basis, when the government buys FFP, it lets the marketplace take care of profit through competition.  The government does not want the lowest price it wants a fair price, the same as commercial customers can get from that company.

Cost contracts are different. The statutory limits on profit/fee are for cost-plus-fixed-fee contracts:

Experimental, developmental, or research work performed under a cost-plus-fixed-fee contract – 15% of estimated contract costs.

All other cost-plus-fixed-fee contracts – 10% of estimated contract costs.

How to bid cost contracts and use the proper fee is a topic for another day but all other factors being equal the fee could tip the balance even when cost is not the most important factor.

The government does change the rules when competition doesn’t exist on firm fixed price offers.  Now every CO must make a “price reasonableness determination” as part of his award decision no matter the value.  It is easy when you have competition, and everyone is close to each other in price.  Even if you have competition, it doesn’t necessarily mean you have a fair and reasonable price.  Here are two examples where a CO may have to dig deeper into prices:

(1)  One offer is much lower than all the rest of the offers. The CO must determine if this is an unrealistic price.  In many cases, especially on small purchases, less than “reputable” sellers will bid very low prices to “win” the order (this is called “buying in”).  Since many of these are awarded as purchase orders (where the offeror may not have to sign the document – performance is considered acceptance), if the pricing data can’t be obtained, the CO will ask for a no-cost cancellation.  Government COs have an obligation to ask about unrealistic prices.

(2)  Everybody is higher than what historical pricing shows the government has paid in the past.  Why is the price so much more? Factors that may cause this include quantity, changes in material cost, or other elements of cost. COs may call and inquire as to why the price has changed and even share the historical prices to understand the new price.

In the case of getting only one offer, the government can ask for “supporting data” for a price to make the price reasonableness determination.  Now that can take a couple of different forms. It can be a commercial price list showing that the government is paying the same as commercial industry (must be commercial sales, just not a list of prices). It can be orders that were completed with commercial firms and prices are similar.

The last method is hard for industry to swallow sometimes.  A CO can ask for what we used to call a “price breakdown”.  It really is a cost sheet that shows labor, material, overheads and profit.  It’s not audited or and the offeror does not have to certify the prices. Since I bought a lot of aircraft structural products below the Truth in Negotiation Act (TINA) levels, I did business with many small machine shops and I needed to understand the elements of cost to determine whether a price was fair and reasonable.  Now when I saw 30% profit, that set off alarm bells. Poll a hundred COs and I bet 90% will tell you anything over 15% profit is not fair and reasonable.  While that’s not anywhere in the FAR, most COs where raised on 15% being the max profit on FFP.  So be prepared to have to justify price on an offer where you are the only offeror, no matter the overall value.

Profit analysis changes when you start getting into the TINA level procurements.  If you find your company having to provide a TINA compliant proposal, profit analysis most likely will include the “Weighted Guidelines Method” to determine profit.  I will give you some insight into weighted guidelines in a future blog.

The USG wants contractors to make money and does not want to see any contractor get into a position of losing money on the performance of contract.  However, the government has an obligation to spend tax dollars prudently; and, therefore, does want to make sure the price is fair and reasonable, and profit is part of that analysis.