Bid and proposal expert Bob Lohfeld offers a warning and advice about how the government applies price reasonableness and cost realism rules, and how often a low price can just get lower.
With so many IT and professional services contracts being awarded to the lowest priced offeror, you have to wonder if the government is worried about awarding contracts to firms whose prices are unreasonably low.
As it turns out, in many procurements the government does not look for unreasonably low prices, and in some instances, is prohibited from doing so. In these procurements, low price has no floor.
The rules for examining price reasonableness and cost realism are complex and generally not well understood by capture and proposal professionals, so I thought I would point out some of the more interesting aspects of these rules about how low you can go.
Price reasonableness has nothing to do with low prices. Instead, it focuses on prices being too high. The government can assess price reasonableness by several methods—the most popular is comparing your bid prices to the prices of other bidders or comparing your prices to an independent government cost estimate (IGCE).
In both methods, the government looks at how high your bid is compared to the other bidders or the IGCE, and the amount of acceptable deviation is up to the government contracting officer’s discretion. In practice, the government tosses out very few bids for unreasonably high pricing because it is much easier in best value procurements to show that the high priced offeror simply didn’t provide the best value for the government when the source selection authority trades off cost and non-cost factors.
The question of price reasonableness being reasonable is really an inappropriate question since it only looks at the high side of pricing and doesn’t examine the question of pricing being so low that it jeopardizes contract performance. Looking at the low side of pricing is the realm of cost realism.
Cost realism in proposals for cost plus contracts
In cost reimbursable contracts, it is well established that the government is obligated to pay a contractor for actual and allowable costs incurred in the performance of the contract, not costs proposed by the contractor during the bidding process.
Because contractors tend to understate their costs when bidding, FAR 15.305(a)(1) and 15.404-1(d), require the government to review detailed cost information to determine whether the proposed costs are realistic and represent the costs that are likely to be incurred under the contractor’s proposed technical approach.
This additional cost information can include a detailed breakout of direct labor rates, estimated hours, indirect rates, other direct costs, and profit. The government analyzes this information to determine whether the offeror’s proposed costs demonstrate a reasonable understanding of the work to be done, are realistic, and are consistent with the technical approached proposed by the offeror. The contracting officer determines the level of analysis conducted; however, there is a requirement that this analysis must be done and the results documented in the contract file.
If the bid price is determined to be too low, the contracting officer has considerable discretion in what is done next.
Normally the bid price is adjusted upward to offset the unrealistic pricing, and in some cases, the technical score of the offeror can be lowered by showing that their unrealistic pricing demonstrates a lack of understanding of the work to be performed. The probable cost adjustment and the ability to down score the technical proposal act as a safety net to prevent awards from going to offerors with unrealistically low proposed costs on cost reimbursable contracts.
Cost realism in proposals for fixed price and time and materials contacts
FAR rules for cost realism analysis of price proposals for fixed price and time and materials (T&M) contracts are simple. There aren’t any. The logic here is that performance risk is borne by the contractor, not the government, and the contractor is obligated to perform the contracted work whether it underestimated its cost or not. Concerns over low price really become matters of offeror responsibility.
Smart buyers clearly see that the risk of poor performance is not entirely borne by the contractor since no government agency wants to be the recipient of impaired services provided by a contractor who can’t pay prevailing wages or offer competitive benefits.
In these instances, the contracting officer must include language in the RFP that price proposals will be evaluated for cost realism to demonstrate that the contractor understands the work to be performed, the elements of costs are realistic, and the price is consistent with the offeror’s proposed technical approach. With this language in the RFP, the government must conduct a cost realism analysis and document the results in the contract file.
Without language in the RFP specifically stating that the government will do a cost realism analysis, the government is prohibited from evaluating price proposals on the basis of cost realism, and to do so would be to evaluate a proposal using evaluation criteria that are not stated in the RFP. Clearly in this instance, fixed price and time and material contracts have no price floor, and it is impossible to disqualify a bidder based on lower, unrealistic pricing.
This has proven to be a fertile area for procurement protests since in many cases the government fails to do a reasonable cost realism analysis when it is required by the RFP or fails to document the results in the contract file. GAO reviews the government’s records, and if the government did not document the cost realism analysis, the protest will be sustained.
Going a step further to prevent awards to unrealistically low-priced proposals
In addition to providing language in the RFP committing the government to conduct a cost realism analysis, the government can provide an extra measure of protection against unrealistically low-priced offers by requiring that the contractor submit a Professional Employee Compensation Plan with its proposal.
This requires the offeror to provide detailed analysis of its direct labor rates with details to substantiate that these rates are reasonable. Similarly, employee benefit details are examined to make sure pricing is sufficient to recover the cost of these benefits.
For non-exempt employees not covered by the Professional Employee Compensation Plan, the Service Contract Act can provide wage protection to prevent companies from proposing wage and benefits that are less than those determined by the Department of Labor in its Area Wage Determinations.
Including these additional requirements can help the government sidestep the pitfalls of awarding contracts to unrealistically low-priced offers, but many government executives don’t understand these rules or the consequences of awarding to an unrealistically low-priced offeror.
Price reasonableness and cost realism are very different concepts. The price analysis techniques under FAR 15.404-1(b) are for the purpose of establishing that the price is not too high—a fair and reasonable price—whereas the techniques for cost realism under FAR 15.404-1(d) are for the purpose of determining whether costs are too low.
Make sure you read your next RFP carefully to understand which tests the government intends to apply. You may be surprised to find that low price has no floor.
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