CHAPTER 2 Contracting Methods and Contract Types: Pricing Implications

This chapter will briefly review the major contracting methods and the broad categories of contract types used by the government. The subjects will be covered primarily from a pricing standpoint. We will not attempt to cover all aspects of these subjects in this text; however, this chapter should suffice to bring those readers without prior experience to essentially the same level as more experienced readers.

Those readers who desire to learn in more detail about contracting methods should refer to additional texts on basic acquisition or types of contracts. FAR Parts 12, 13, 14, and 15, respectively, provide detail on acquisition of commercial items, simplified acquisition procedures, sealed bidding, and contracting by negotiation. FAR Part 16 covers contract types in detail.

CONTRACTING METHODS

FAR 6.401 identifies two acceptable procedures for obtaining competitive prices:

Sealed Bidding. A process by which government needs are made known by a solicitation called an Invitation for Bids (IFB). The government will use sealed bidding when (1) it feels confident that award can be made to the lowest price offeror who is responsive and responsible and (2) the government’s requirement is reasonably well defined in the form of drawings and specifications. Award by sealed bidding exploits the presumed existence of adequate price competition.

Competitive Proposals. A process by which government needs are made known by a solicitation called a Request for Quotation (RFQ) or a Request for Proposals (RFP). Offerors respond by submitting priced offers for the work, product, or service described in the solicitation. However, FAR 15.304(c)(2) provides that offerors’ responses may—and in some cases, must—provide other relevant information to enable the government to consider such noncost evaluation factors as past performance, compliance with solicitation requirements, technical excellence, management capability, personnel qualifications, and prior experience. The government evaluates the proposals and generally, but not always, holds individual discussions with each offeror. Offerors have an opportunity to change their proposals. Final contract award is made to the offeror or offerors who provide the “best overall deal(s)” to the government. Award may or may not be primarily based on the lowest price, but cost or price must always be a factor in the final choice. This process, normally referred to as contacting by negotiation, is described in FAR Part 15. The processes of competitive proposals, as they apply to acquisition of commercial items, and simplified acquisition procedures are described in FAR Parts 13 and 14, respectively.

Sealed Bidding (FAR Part 14)

Sealed bidding is used when the government contracting officer decides that adequate price competition exists and that the specification or statement of work is well enough defined to enable offerors to bid on a fixed-price basis.

In sealed bidding, the using activity prepares an acquisition request that describes its needs and cites funds for the acquisition. The contracting activity prepares an IFB to inform prospective bidders of the government’s needs. It is made up in accordance with a standard format prescribed in the FAR and contains a description of the supplies or services required, any special inspection and acceptance criteria, certain required bidder certifications, and copies of (or references to) the clauses applicable to the final contract.

The upcoming acquisition is publicized through distribution to prospective bidders. Distribution of the solicitation is usually accomplished electronically through FedBizOpps http://www.fedbizopps.gov.. Notification is not limited to an agency’s past or incumbent suppliers, or the agency’s market research base. This electronic web-based notification system enables any interested firm to download the IFB and decide if it warrants a response. Those firms interested in the work will submit bids. The bids are kept in a secure place until the bid opening time stated in the IFB and are publicly opened at that precise time. (Late bids are not considered unless the bidder can prove, under very stringent criteria, that its bid was delayed through no fault of the bidder, by mail delays, or by mishandling within the government.)

The price that was bid by each offeror becomes publicly known once the bids are opened. The government starts the evaluation of the bids at this point, beginning with the apparent low bidder. To be eligible for award, the bidder must be both responsive and responsible. To be responsive, the bidder must not have taken exception to any material aspect of the specification, work statement, or other terms of the proposed contract. To be responsible, the bidder must be judged capable of performing and meeting the terms stated in the IFB. Both determinations are made by the contracting officer. If the apparent low bidder meets both criteria, that firm gets the contract award as long as the bid price is reasonable. If the criteria are not met, the next low bidder is evaluated. The process continues until the lowest responsive, responsible, and reasonably priced bid is determined. The bidders have agreed, by submission of their bids, to keep their bids open for acceptance during this evaluation period, normally 60 days.

Contract award will not be made by this procedure unless the price of the low responsible bidder is determined to be reasonable. This determination is made by price analysis techniques, since the bid price is the only information available. The bidder is not required to furnish information on cost and profit to support its bid price; the government has depended on adequate price competition to get a fair and reasonable price. There are no individual discussions with any bidder during the process, and no price discussions occur.

Sealed bidding always leads to a firm-fixed-price contract or fixed-price with economic adjustment contract. Once the contract has been awarded, the government is firmly committed to paying the price that was bid and accepted. This practice requires that great care be taken to assure that the price is reasonable. The government cannot later go back and demand a refund or otherwise reduce the contract price on the pretext that it made a mistake in the price reasonableness determination.

Negotiation (FAR Part 15)

In many instances sealed bidding is needlessly time consuming and cumbersome. The government recognized this concern with the passage of The Federal Acquisition Streamlining Act (FASA) of 1994 (Public Law 103-355). FASA established the government’s preference for the acquisition of commercial items by setting out policies more closely resembling those of the commercial marketplace and encouraging the acquisition of commercial items and components. FAR Part 12 prescribes the policies and procedures for the acquisition of commercial items.

The government also recognizes that certain acquisitions of relatively low dollar value do not warrant the time-consuming efforts of sealed bidding. FAR Part 13 prescribes the policies and procedures for the acquisition of supplies and services, the aggregate amount of which does not exceed the “simplified acquisition threshold.” Past editions of the FAR referred to these items as “small purchases.” The designation “small purchases” no longer shows up in the FAR. Indeed the current simplified acquisition threshold is $100,000 for most items, but can be a high as $5 million for certain commercial items. Regardless, to avoid the time-consuming procedures of sealed bidding, the government exploits the existence of multiple sources in the marketplace to obtain competing offers.

In still other instances, the specification or statement of work may not be well-enough defined to enable offerors to bid on a fixed-price basis, the buying activity may find it desirable to hold individual discussions with offerors before making a final source selection, or, in some rare instances, multiple sources may not exist.

Negotiation is the contracting method that may be used when sealed bidding is inappropriate. The using activity states its requirements in an acquisition request, including specifications for needed products and a statement of work for needed services. The contracting activity converts the acquisition request into a solicitation—usually into an RFP. Notification and distribution of the RFP is accomplished electronically through FedBizOpps http://www. fedbizopps.gov —in a manner described for the issuance of an IFB. Offers must be received by the date and time stated in the RFP, but there is no formal public opening of the offers (as in sealed bidding). Offers are then evaluated in light of the solicitation requirements.

In marked contrast to a sealed bid award, a negotiated award:

Need not be made to the lowest priced offeror;

Is not restricted to a firm-fixed-price contract or fixed-price with economic adjustment contract;

May result in any of the wide selection of contract types permitted by FAR Part 16, and

May be preceded by changes to the original offer up to the time of contract award, based on discussions and negotiations.

Also, in contrast to sealed bidding, offers are sometimes subjected to an early screening to qualify for the competitive range. The competitive range consists of those offerors who, based on initial proposal evaluation, are believed to have a reasonable chance of getting the final award. This determination is the result of:

Evaluating technical proposals by systematic procedures to determine their strengths and weaknesses and their relative order of excellence;

Evaluating the pricing proposals by price analysis techniques to determine their reasonableness and the offerors’ apparent understanding of the contract requirements; and

If applicable, evaluating management proposals and any other special requirements which may have been stated in the RFP.

Offerors who are determined to be outside of the competitive range based on evaluation of their initial proposals are notified that they will not be considered further.

The competitive range establishes the list of offerors with whom individual discussions will be held; the discussions may be written or oral, or both. The purpose of these discussions is to advise offerors of deficiencies in their proposals, resolve any uncertainties that exist, and give offerors a reasonable opportunity to revise their proposals in light of the discussions. Obviously, the government must prepare for individual discussions with each offeror by completing a detailed and thorough examination of each proposal. This requirement applies to technical and pricing content of the proposals, and to any other information that sheds light on the offerors’ ability to perform at a reasonable cost or price.

FAR Part 15 prescribes the policies and procedures governing competitive and noncompetitive negotiated acquisitions.

FAR 15.002 distinguishes between two types of negotiated acquisition: competitive and sole source acquisitions.

Competitive Acquisition

As the name implies, competitive acquisitions rely on market forces to obtain the best value to the government. FAR 15.002(b) states that procedures for competitive acquisitions should “minimize the complexity of the solicitation, the evaluation, and the source selection decision, while maintaining a process designed to foster an impartial and comprehensive evaluation of offerors’ proposals, leading to selection of the proposal representing the best value to the Government.”

RFPs for competitive acquisitions exploit the competitive marketplace to obtain the best overall deal to the government. The issuance of an RFP to multiple suppliers, in and of itself, shows that the buying agency is trying to promote adequate price competition.

FAR Subpart 15.1—Source Selection Processes and Techniques, provides considerable flexibility to the buying activity in evaluating competitive proposals. An agency can obtain best value in negotiated acquisitions by using any one or a combination of source selection approaches. In different types of acquisitions, the relative importance of cost or price may vary. For example, in acquisitions where the requirement is clearly definable and the risk of unsuccessful contract performance is minimal, cost or price may play a dominant role in source selection. The less definitive the requirement, the more development work required, or the greater the performance risk, the more that technical or past performance considerations may play a dominant role in source selection.

A tradeoff process may be appropriate when it is in the best interest of the government to consider awarding to other than the lowest priced offeror or other than the highest technically rated offeror. However, when using a tradeoff process:

All evaluation factors and significant subfactors that will affect contract award and their relative importance shall be clearly stated in the solicitation; and

The solicitation shall state whether all evaluation factors other than cost or price, when combined, are significantly more important than, approximately equal to, or significantly less important than cost or price.

This process permits tradeoffs among cost or price and noncost factors and allows the government to accept other than the lowest priced proposal. The perceived benefits of the higher priced proposal shall merit the additional cost, and the rationale for tradeoffs must be documented in the file

Final award is made to vendors who remain in the competitive range. The final source selection is made either: (1) after discussions or (2) without discussions.

Award after discussions. Should the government exercise this option, discussions must be conducted with all vendors in the competitive range. Offerors are given the opportunity to revise their proposals. Proposal revisions must be made by a final proposal revision date established by the contracting officer. Offeror may—but need not revise their offers. Offers not revised are evaluated as originally proposed. Final proposal revisions replace the original offer. The government makes a final source selection based on the content of the latest offer.

Award without discussions. Final source selection is based on the content of the originally submitted offer. Making an award without discussions encourages vendors to give it their best shot on the first go round. Under these circumstances, the government believes that the offeror(s) proposal(s) have enough information to make a final source selection, and that the additional resources in time and effort are not compensatory.

Sole Source Acquisition

When contracting in a sole source environment, the RFP should be tailored to remove unnecessary information and requirements—e.g., evaluation criteria and voluminous proposal preparation instructions.

Contrary to popular opinion, awards for sole source acquisitions may be based on price analysis. Indeed, FAR 15.403-1 forbids the contracting officer from even requesting cost and pricing data for acquisitions below the simplified acquisition threshold or for the acquisition of commercial items. Nor can the contracting officer request cost and pricing data if the sole source supplier’s price is set by law or regulation. And as we learned in Chapter 1, FAR 15.403-1(c) acknowledges that reasonableness of a proposed price can be judged by comparison with current or recent prices for the same or similar items purchased in comparable quantities, under comparable terms and conditions under contracts that resulted from adequate price competition.

As we will see in Chapter 5, the requirement for the submission of cost and pricing data is to be the exception rather than the rule. Nevertheless, in some unusual circumstances, the RFP for sole source acquisitions may require that offerors submit detailed cost and pricing data in their pricing proposal. Or in some instances, the contracting officer may require limited information other than cost and pricing data to support a determination of price reasonableness or cost realism. This requirement means that the offerors will provide detailed estimates of the expected costs of performance and the expected profit or fee. This detailed cost and profit information enables the application of cost analysis principles. We will cover cost and pricing data in detail in Chapter 5.

This text covers the detailed procedures needed to perform an adequate cost, profit, and price analysis. Failure to do this job thoroughly and properly may well result in the payment of excessive prices, or in awarding a contract to an offeror who cannot do the work. Be aware, however, that issues related to proposal evaluation other than cost, such as offerors’ technical competency and understanding of the solicitation requirements, are also essential to proper discussions and to source selection. You may wish to refer to other texts on source selection and technical evaluation of proposals.

The preceding discussion has presented a general sequence of events for negotiated procurements; however, negotiation is a flexible process and may be modified, within reason, to meet special requirements.

GOVERNMENT CONTRACT TYPES (FAR PART 16)

FAR Part 16 lists five categories of contract types used by the government.

This text will review the major characteristics of the first two contract types from a pricing standpoint. The other types listed are special modifications of either fixed-price or cost-reimbursement contracts.

Impact of Cost or Price Evaluation on Contract Type (FAR 15.305(a)(1))

Normally, competition establishes price reasonableness. Therefore, when contracting on a firm-fixed-price or fixed-price with economic price adjustment basis, comparison of the proposed prices will usually satisfy the requirement to perform a price analysis, and a cost analysis need not be performed. In limited situations, a cost analysis may be appropriate to establish reasonableness of the otherwise successful offeror’s price. When contracting on a cost-reimbursement basis, evaluations shall include a cost realism analysis to determine what the government should realistically expect to pay for the proposed effort, the offeror’s understanding of the work, and the offeror’s ability to perform the contract.

Fixed-Price Contracts (FAR Subpart 16.2)

This contract category includes firm-fixed-price contracts and fixed-price with economic adjustment contracts. These fixed-type contracts can result from either sealed bidding or negotiation.

The basic criterion for use of a firm-fixed-price type contract is that the costs of performance can be predicted with great accuracy. We must understand from the outset that no one can predict exactly what it will cost in the future to do anything. Material and labor costs may change, or unexpected problems may arise to increase costs. FAR 16.202-2 states that a firm-fixed-price type contract is suitable for use when we are buying commercial or commercial-type products and other products and services on the basis of reasonably definite functional or detailed specifications. This statement can be better understood if we define the key words and phrases as follows:

Commercial products: The manufacturers and suppliers of these items already have a lot of experience in making and selling these products on the open market. When any customer, including the government, requests a price for future delivery (a bid or proposal), it is possible to use past experience to project a very close estimate of the costs of supplying the order.

Commercial-type products: Commercial-type products are items on which some changes have been made to a purely commercial item to adapt it to government-peculiar uses. For example, standard vehicles may be painted with a particular color paint and a few decals added for use by the National Park Service or the Marine Corps. The added costs to make these changes can be closely estimated for future delivery.

Acquiring products or services on the basis of reasonably definite functional or detailed specifications: Functional specifications describe what a product is to do. Detailed specifications state exactly how to make the product. Work statements define the work to be done to render services. In all such cases, there is some level of uncertainty about what it will actually cost to provide the work. A competent offeror takes that uncertainty into consideration when preparing its proposed price. The government can afford to take the risk when the built-in cost to cover the uncertain aspects is comparatively low.

Firm-fixed-price contracts place the total cost risk on the contractor. The offeror who bids or proposes a firm fixed price to do work is guaranteeing to deliver the work to meet requirements for that amount of money. When the government accepts the offer, it is obligated to pay that amount of money and the contractor is similarly obligated to deliver or perform the work for that fixed price. If unexpected costs arise, the contractor’s profit decreases. In some cases, the contractor’s profits may disappear or the contractor may even sustain a loss to meet the contract requirements. On the other hand, the contractor may be able to get the required work done for less than originally estimated costs. If so, the contractor keeps the extra profit earned. It is unlawful to give the contractor extra money simply because the costs have unexpectedly exceeded the contractor’s original estimate. We cannot increase the contract price unless we get something special in return; more money to deliver what was already promised does not meet the test. On the other side, the contractor is very unlikely to give the government a refund if the actual profit is higher than expected because of decreased cost.

From the above discussion, you can see that we must do our cost and price analysis as accurately as possible before committing the government to paying a firm-fixed price. Once the contract is signed, the government can almost never recover if it belatedly discovers that the price was too high. (The possible exception will be covered in more detail in Chapter 5. If the government relied on noncurrent, incomplete, or inaccurate cost and pricing data at the time of price agreement, the government may effect a recovery of the amount by which the contractor unjustifiably enriched itself. Public Law 87-653, the Truth in Negotiations Act (TINA), enables the government to negotiate a recovery of the overpricing. This exception applies only to negotiated fixed-price contracts when detailed cost data was provided by the offeror and certified.)

Cost-Reimbursement Contracts (FAR Subpart 16.3)

Cost-reimbursement contracts are always awarded as the result of negotiations, never as the result of sealed bidding. Cost-reimbursement contracts provide for payment of the contractor’s allowable incurred costs to the extent prescribed in the contract. There are several types of basic cost-reimbursement contracts. The cost-plus fixed-fee contract reimburses the contractor for allowable incurred costs and pays a fixed fee (profit) for doing the work. The cost (no fee) contract reimburses the contractor for allowable costs but has no fee. The cost-sharing contract reimburses the contractor for an agreed-upon share of its allowable costs. (FAR Subpart 16.4, Incentive Contracts, covers several types of incentive cost-reimbursement contracts in which the fee is adjusted based on the contractor’s actual costs or on how well the work is performed.)

Cost-reimbursement contracts are used when the costs of performing the contract work cannot be predicted with high accuracy at the time of signing the contract. For example, it is rarely possible at the time of contracting for goal-directed R&D work (developing an advanced state-of-the-art space vehicle or a cure for lung cancer) to estimate costs with enough accuracy for fixed-price contracting to be practical. Certain types of services, including maintenance, may fall into the same category. If the government insisted on a fixed-price contract in such situations, offerors would have no choice except to pad costs and prices heavily just to protect themselves.

A cost-reimbursement contract establishes an estimate of total costs for purposes of obligating funds and stating a ceiling that the contractor must not exceed except at its own risk. The contractor is obligated to provide a best effort to get the required work done within the estimated cost. If the contractor gets the work done for less than the estimated cost, the government has funds left for other purposes. If the contractor fails to finish the work within the estimated cost, the government’s choices are (1) modify the contract to increase the estimated cost, or (2) settle out the contract and take whatever work has been completed.

The government is carrying all, or essentially all, the cost risk in a cost-reimbursement contract. If the contract calls for a fixed-fee, the government must pay that fee. The fee is the contractor’s reward (profit) for taking on the work or engagement. Note that in a cost-plus-fixed-fee contract, the contractor cannot increase its profits no matter how efficiently the work is performed. (It is true that the contractor’s profit as a percent of costs increases if the actual cost is less than the estimated cost; however, that fact is of little practical importance to a company interested in earning more profits.) The cost-plus-incentive-fee contract (an incentive contract described in FAR 16.405-1) does, within limits, allow for increase or decrease of the fee based on the contractor’s actual costs compared to a target cost.

People inexperienced in the proper use of cost-reimbursement contracts often view them with general distrust or even as a license to steal. Generally these people are most experienced in situations where firm-fixed-price contracts are the usual type because their agency purchases well-defined products and services. Properly used and managed cost-reimbursement contracts are a perfectly acceptable contract form. We can draw an analogy in a government installation where in-house personnel perform work of very uncertain and changing content. For example, a government facility would probably budget a set amount each year for exterior building maintenance, including lawn care and clearing snow. That budgeted amount is an estimate. In a given year it may be necessary to remove far more snow than expected, and building maintenance costs may soar because of several storms (both result in an unexpected volume of work). The fact that the budgeted amount (estimated cost) is exceeded does not in itself say that the in-house workforce is wasteful or improperly motivated. It merely means that the cost forecast was wrong.

It is sometimes helpful to readers who do not have experience in using cost-reimbursement contracts to regard them as a way to pay a contractor “by the day” to do government work, and also to pay for the material that the contractor uses. The government must closely administer the work to ensure that it is for proper purposes and is done in an effective and efficient manner. The government will reimburse the contractor for its allowable costs in doing the work required; the contractor is paid only for that work. If work is unnecessary, it should not be done and there should be no reimbursement. In this sense, it is similar to doing work in-house. Here too, the government pays only for the work actually done.

The briefing package (Appendix A: Cost-Reimbursement Contracts—How They Work) has been used to orient contractors—particularly contractors with limited or no experience with cost-reimbursement contracts or other “flexibly priced” contracts. Contracting officers and others should consider this briefing package. The constituent “Instructions” and “Frequently Asked Questions” (FAQs) are a good start. Improve them or add to them as your situation demands.

FAR 16.301-3(a) provides that a cost-reimbursement contract may be used only when, “The contractor’s accounting system is adequate for determining costs applicable to the contract.” Often contracting officers will ascertain if the contractor’s accounting system meets this requirement by commissioning a Preaward Survey of Prospective Contractor Accounting System using the standards articulated in SF 1408, a survey often performed by an audit activity such as the Defense Contract Audit Agency (DCAA).

In anticipation of such a review some contractors commission their own self-assessment, in order to convince the contracting officer—and themselves—that their accounting systems meet the FAR 16.301-3(a) standards.

Appendix B provides a facsimile in both print and electronic form of a Self-Assessment Accounting System Review, Pursuant to Standards in Preaward Survey of Prospective Contractor Accounting System (SF 1408).

Contracting officers may use this file to provide guidance to contractors who require an accounting system meeting the requirements of FAR 16.301-3(a).

Contractors can use this file as a memory jog and template for a self-assessment of their cost accounting system. Knowing what a government representative (e.g., a Defense Contract Audit Agency auditor is looking for will enable the contractor to:

1.Improve their current system;

2.Identify and correct any deficiencies in their current system;

3.Assert, in a response to any solicitation for a cost-reimbursement or other flexibly priced contract that your accounting system meets the requirement of FAR 16.301-3(a); and

4.Be confidently prepared for any preaward review of their cost accounting system.

A few cautionary notes—particularly to contractors—are appropriate, before using this file.

First, don’t use the electronic files blindly. Download the files and save them on your hard drive making the necessary changes to meet your firm’s unique needs. Start making the obvious and easy changes—such as substituting your firm’s name for M&M, or your accounting system’s software package for QuickBooks Premier 2008.

Second, if you can make your responses even more convincing than the self-assessment responses, by all means do so. But don’t copy the self-assessment responses blindly. Make sure the responses apply to your firm. And if they don’t—find out why.

Third, the self-assessment is primarily for a contractor who must convince a contracting officer that their system meets the requirement of FAR 16.301-3(a). Consider including your completed self-assessment in the business section of a response to a solicitation. For those contractors already performing under a cost-reimbursement contract, your existing cost accounting system has been implicitly approved. Don’t abandon it. Only assert the presumed adequacy of their cost accounting system. But you might want to examine the features of our self-assessment that might improve your version.

Fourth, should a government agent decide to review your cost accounting system, show them the results of your self-assessment. Make their job easy and non-intrusive but if any government agent discloses a deficiency in your cost accounting system, correct it.

Finally, don’t expect perfection in our self-assessment. You may be able to improve our version. Indeed we urge you to improve upon our version. And by all means let us know so that we can consider them for a future edition.

SIMPLIFIED ACQUISITION PROCEDURES (FAR PART 13)

Price analysis, covered in detail in Chapter 3, is always used in simplified acquisition procedures because the benefits—if any—from obtaining more than a bottom line price is not commensurate with the effort.

The FAR Part 13 procedures emphasize simplicity and minimal administrative costs. Oral solicitations are normally used, although very simple written quotations may be used under certain circumstances. These procedures apply to relatively low risk acquisitions such as low-dollar-value acquisitions (the present threshold is set in most cases at $100,000 or less), low risk commercial item purchases, and limited (not to exceed $3 million) sole source acquisitions to meet social-economic goals.

PRICE ANALYSIS FOR PURCHASES BELOW $100,000

FAR 13.106 covers the procedures used for determining price reasonableness for purchases under the simplified acquisition threshold (currently $100,000).

For acquisitions below the simplified acquisition threshold, the contracting officer has broad discretion in determining the price reasonableness. But the contracting officer’s determination can only be based on some form of price analysis. FAR 13.106-3 provides that whenever possible, price reasonableness be based on competitive quotations or offers.

If only one response is received, the contracting officer must include a statement of price reasonableness. The contracting officer may base the statement on: market research; comparison of the proposed price with prices found reasonable on previous purchases; current price lists, catalogs, or advertisements; a comparison with similar items in a related industry; personal knowledge of the item being purchased; comparison to an independent Government estimate; or any other reasonable basis.

In those few instances when supplies can be obtained only from a supplier that quotes a minimum order price or quantity that either unreasonably exceeds stated quantity requirements or results in an unreasonable price for the quantity required, the contracting officer should inform the requiring activity of all facts regarding the quotation or offer and ask it to confirm or alter its requirement.