Understanding 'commerciality' and why you need to align your pricing strategy with your compliance plan

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The concept of 'commerciality' is a critical requirement contractors must master in the government market to remain in compliance with FAR rules. Here's a guide on what to know and where to start.

How much do you know about the government acquisition concept of “commerciality”? If your company is new to the public sector, you’ll have to understand how to align your pricing to “commerciality” requirements if you want to maintain commercial margins when doing business with government.

Selling to public sector customers is vastly different from selling to the commercial market, even when selling commercial products and services. Public sector customers spend tax dollars and must do so in a way that is fiscally responsible and promotes public policy objectives. That means government customers require disclosure of cost data and then negotiate your profit, called a “fee,” unless an exception applies.

Fees typically range from 8% to 15%, depending upon the risk to the contractor or subcontractor. This pricing process flows through the entire government acquisition supply chain to ensure transparency and fairness to the taxpayer.

Can you imagine this practice in the commercial marketplace – or the next time you go to buy a car? Can you imagine telling your boss that margins are capped, even if you can lower your costs? This approach greatly restricted the market of sellers interested in selling to the government (and the technology the government had access to) until the government embraced the concept of “commerciality,” expanding their access to new, market-tested commercial technologies and increasing acquisition speed.

Commerciality was introduced as an exception to the general rule of cost disclosure. This was to encourage the fast-advancing commercial technology market to do business with the government, and to streamline the process for government acquisition of commercial technology through less onerous requirements, aligned to commercial market practices. Commercial technology is vetted by the open market, which creates less risk to the government, and market prices mean less expensive acquisitions for the government as the cost of technology development is spread across an open commercial market with many users.

Federal regulations addressing commercial technology

Today, government policy is to acquire commercial products and services whenever these offerings are available to meet the needs of the acquiring agency. This preference  is outlined in Federal Acquisition Regulation 12.101 (FAR 12.101), with additional regulations and contract clauses allowing and encouraging the inclusion of commercial technology, into higher level assemblies and deliverables which do not meet the commercial product requirements.

The government established broad definitions of commercial products in FAR 2.101, including services, which allow contractors to assert that the offered technology is either same, similar to, or “of a type” in terms of form, fit and functionality as a commercially available technology for non-government purposes. They also defined “Commercial Off The Shelf” (COTS) products which offered even fewer requirements.

An award for commercial products or services is made after a contracting officer issues a commercial-item determination, upon review of the contractor’s commercial item assertion and price reasonableness justification. This award is issued on SF-1449, commonly called a “FAR 12” contract, and clearly states that it is an award for commercial products or services in the header.

The prime contract will also include FAR 52.212-4 or FAR 52.212-5 as the governing clauses for commercial product contracts and list out any additional requirements applicable to the contract, which are quite short, and balance promoting public policy objectives with commercial practices.

Additionally, a prior contract for commercial products or services issued by a contracting officer serves as a determination of commerciality for subsequent awards. This eliminates the need for constant re-documentation and review (ref. FY 2018 NDAA § 848).

The advantage of selling commercial products/services, and pricing guidance

The greatest advantage in having your technology sold as a commercial product is that you do not have to disclose your cost and negotiate a fee. Rather, pricing of commercial products and services is based on market pricing. Common market pricing techniques include prices established by:

  • Competition,
  • Published catalog, or
  • Historical sales

Having a tight pricing strategy in support of your commerciality argument is crucial to your success in avoiding cost disclosure and expanding your margin. For public sector customers, pricing strategies with multiple price lists (depending upon whether the end user is government or commercial) suggests there’s a difference in technology offerings; it often makes these customers question the commercial nature of the technology.

Leveraging non-government end-use pricing and historical sales is required to establish a commercial market for the technology. The pricing strategy for your public sector customers should be the same as it is for your non-government end-use customers for products or services containing the same commercial technology. Without an aligned strategy, you may undermine your argument that the technology is commercial in nature, thus opening your business up to up to additional compliance requirements, cost disclosures, and increased government oversight.

Securing and preserving commerciality positions decreases financial and compliance risk. It should be a priority when designing, developing and selling to government customers.

Skyler Handl is corporate counsel, public sector for immixGroup, an Arrow Electronics company. She can be reached at skyler.handl@immixgroup.com.