Module01 CostAnalysisBasics

Con 217- Cost Analysis & Negotiation Techniques
Cost Analysis Basics
Cost Analysis Basics Introduction

Content Introduction Why is cost analysis important? Whats in it for me, you may ask? Well, lets say you are tasked by your supervisor to determine if cost analysis should be used to evaluate a contractors proposal. What will be your opinion? Will you be confident enough to make the decision? Although you are extremely intelligent, the concept of performing cost analysis and the approach to use can be difficult to understand. For instance, you want to learn some cost analysis techniques, but you arent sure which ones to use. Maybe you have never performed cost analysis and you want to gain insight into the subject area; or you have performed cost analysis, but you need to refresh your memory of the applicable terms. Perhaps you are not quite clear on the differences between price analysis, cost analysis, and cost realism. Whichever situation applies, this module will meet your learning needs. You will find that there is some redundancy in terms and definitions throughout this module. This is by design to emphasize the importance of the term or definition and to promote understanding. Objectives At the end of this module, you will be able to determine when cost analysis should be used. In order to get you to that point, you will:

Notes
Identify the fundamentals of cost analysis; Distinguish between price analysis, cost analysis, and cost realism analysis; Identify cost analysis terms and techniques used when developing a prenegotiation position; Identify factors to consider in determining when cost analysis should be used.
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Fundamentals of Cost Analysis

Content Disclaimer - The content of this module is for learning purposes and merely represents the writers interpretation of regulation, policy and guides, and shall not in anyway supersede or take precedence over regulatory guidance, policy, and or directives. Readers are strongly encouraged to refer any question about procurement law, regulation or policy with their agencys legal counsel. Overview Contracting officers must purchase supplies and services from responsible sources at a price that is fair and reasonable. In establishing the reasonableness of an offered price, you, as the contracting officer, must be clear on the fundamentals of cost analysis. For example, you will learn that price analysis is the evaluation of an offered price using a comparative method for your analysis; and cost analysis is the evaluation of individual cost elements using sound judgment. In this section on cost analysis fundamentals, we will answer these questions: Who performs cost analysis? What is cost analysis? Why perform cost analysis? When to use cost analysis? Notes
Who Performs Cost Analysis? You! Im sure youve heard this before, but back in the day, there used to be contract pricing and cost analysts that were plentiful, immediately available, and whom eagerly awaited to assist you in performing your analyses. Today, these subject matter experts still exist, but they are few and far between. You may have a price or cost analyst sitting in the cubicle right beside you or down the hall. If so, consider yourself fortunate. It is suggested that you be extremely nice to your analyst and show your appreciation from time to time, because your situation is rare. Back to the subject, you, the contracting officer, specialist, negotiator or analyst, are responsible for performing cost analysis. FAR 15.4041(a)(1) states that you are responsible for evaluating the reasonableness of the offered prices.
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Content What is Cost Analysis--An Overview Cost analysis is the systematic review and evaluation of the separate cost elements, judgmental factors, and profit and/or fee that, when added together, constitute contract price. It can be used to evaluate an offerors or contractors proposal (including cost or pricing data or information other than cost or pricing data) to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. (Refer to FAR Part 15.404-1(c) (1). ) Cost analysis entails the examination of the basic cost building blocks: direct and indirect cost, facilities capital cost of money (FCCM), and profit. (These will be discussed in more detail later.) At this point you might ask the question, "What does this mean?" What is Cost Analysis-Part I In order to better understand the process of performing cost analysis, we need to break down the cost analysis definition. Lets refer to the thesaurus to help us understand the term systematic. The thesaurus provides a listing of synonyms such as orderly, organized, or logical. Therefore, a systematic review and evaluation means to arrange each cost element into a logical or organized manner in order to review and evaluate them separately. Notice that each element of cost in the following example is separately listed in an organized fashion, i.e. direct labor, labor overhead, and so on. This itemized format is consistent with Table 15-2 of FAR 15.408, which provides instructions to the contractor for submitting cost/price proposals when cost or pricing data are required. The table provides instructions to contractors on the standard format for identifying costs in their proposals. The table is also useful to the government because it lays out an organized format for performing your cost analysis. Notes
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Content Cost Element Example--Sonar For example, if you are purchasing services for a research and development (R&D) effort to study the impact of sonar on marine mammals, you might see that the contractor proposes costs for direct labor, labor overhead, other direct costs (ODC), General and Administrative (G&A) expense, and profit. These proposed costs are referred to as cost elements. Although the value of each of these elements differ, they are equally important to the Government with no one element having greater importance than another. In performing your cost analysis, you might itemize the cost elements as shown in the table. We'll refer back to this table as we continue our discussion. Cost Elements Direct Labor Labor Overhead (25%) Cost $400,000 $100,000 Notes
Other Direct Cost (ODC) $150,000 Subtotal G & A (15%) Profit (12%) Total Contract Price $650,000 97,500 89,700 $837,200
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Content What is Cost Analysis-Part II The second part of the cost analysis definition refers to judgmental factors. This means that you must apply sound judgment in conducting your review and analysis of each of the proposed cost elements. For example, you are evaluating the proposed labor cost for the contract to study sonar impact on marine mammals. You might consider factors such as the type of labor, the hourly rate, and the number of hours.

Notes
What type of labor category is appropriate for the type of service you are buying? Does your contract requirement call for a marine biologist or an oceanographer or both to conduct the study? What is a reasonable labor rate for the labor category? Are the proposed hours sufficient to do the job?
With input from your technical and other support groups, you will employ sound business judgment in answering these questions. What is Cost Analysis-Part III As you can see, profit/fee is an important element to all parties. Both the Government and contractors should be concerned with profit as a motivator of efficient and effective contract performance. It is not in the Governments best interest to attempt to negotiate a profit/fee that is extremely low or that is based on an historical average or a predetermined percentage of the total estimated costs. Remember, the objective is to provide a profit that will provide proper motivation for maximum contract performance. Reference: (FAR 15.404-4(a)(2).
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Content What is Cost Analysis-Part IV The last part of the cost analysis definition refers to adding all of the cost elements together (direct labor, labor overhead, ODC, etc.), to constitute the final bottom line price. At this point, you are to evaluate the total price. The process of evaluating the total price (inclusive of all the elements) is called price analysis. To clarify why price analysis must be performed in conjunction with cost analysis, lets refer to the regulation. The FAR provides two reasons to evaluate the final price. The first reason is to ensure that the final price is fair and reasonable (FAR 15.404-1(a)(1)). What this means is that in addition to reviewing and evaluating each of the cost elements that make up total cost, when cost or pricing data are required, you are responsible for evaluating the reasonableness of the offered price to ensure that it is fair and reasonable for the intended procurement. Price analysis should be performed on all purchases, whether or not cost analysis is required. Remember, with the sonar example a breakdown was provided that identified each element of cost (direct labor, direct material, ODC, G&A, and Profit) which made up the final price of $837,200. Although each cost element may be deemed fair and reasonable, the final price may in fact not be reasonable when compared to competitive prices for the same or similar service. For example, Sonars R Us is an architect and engineering firm that hires local college students to work part-time documenting study results. The firm offered a competitive price of $730,000 for the sonar study. While conducting a comparison of the two competitive prices, you notice that the price offered by Happy Sonar is considerably lower. You may determine that the offered price of $837,200 is too high, even after you initially determined that the cost elements were deemed fair and reasonable based on the quality and volume of effort proposed. For this reason, FAR requires that you evaluate both the cost elements, when cost or pricing data are required, and the final price. Notes
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Content Final Price Example Another example demonstrating differences associated with analyzing cost elements and the final price is if you were to purchase a brand new bicycle from a bike shop. It might cost you $350.00. When you compare the final price of the bike with prices from other retailers for the same or similar bike, you might find that the price is fair and reasonable. However, let's say that you have a friend who builds bikes, and you decide to have the same or similar bike custom built instead of purchasing it from a retailer. You purchase the bike parts separately (handlebar, pedals, gear sprocket, gear shifter, chain, seat, bike frame, brake calibers, brake cables, brake controls, brake pads, wheels, rims, hand grips, etc.) at costs that are fair and reasonable and you're willing to pay for the cost of labor, which you've also determined to be reasonable. But when you total the cost of material and labor, you might discover that the final price of having the bike custom built far exceeds the cost of the commercial price of $350.00. The second reason for performing price analysis is because FAR 15.404-1(a)(2) says that price analysis shall be used when cost or pricing data are not required. This means that the bottom line price should be whether we do or do not have cost or pricing data (data received in accordance with FAR 15.403-4, which is a a certified breakdown of each of the elements of cost). Therefore, if cost or pricing data are not required, evaluate the price only or perform cost realism analysis. The guidance that FAR 15.404-1(a) (3) provides is that cost analysis shall be used to evaluate the reasonableness of individual cost elements when cost or pricing data are required; and price analysis should be used to verify that the overall price offered is fair and reasonable. Notes
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Content Why Perform Cost Analysis? Why? Because sometimes you are required to (by regulations) and sometimes you are permitted to perform cost analysis in order to assist you in making a fair and reasonable determination. You must perform cost analysis when the dollar threshold of your procurement is expected to exceed the cost or pricing data threshold of $650,000 and none of the exceptions apply. Later, you will learn more about the Truth in Negotiations Act (TINA) and the exceptions to acquiring cost or pricing data. Now that cost analysis is clearly defined and you are aware that it is your responsibility, lets review some of the benefits of performing cost analysis. Benefits of Performing Cost Analysis First, by using good business sense when it comes to determining whether or not to perform cost analysis on a proposed price for products or services could save valuable tax dollars. Further, the use of cost analysis could potentially preclude you from being the topic of discussion on improper government spending in the media. For example, reflect back on the R&D services effort to study the impact of sonar on marine mammals that you looked at earlier. The contractor proposed a price of $837,200. How well do the proposed cost elements and price represent what the values should be? Do you take the word of the contractor that the proposed amount is reasonable considering economy and efficiency? Should the Government ensure that the amount is fair and reasonable to both parties? One might argue that the Government should not waste time reviewing and evaluating the contractors proposed cost, especially when the contractor knows best what it should cost to do the job. Notes
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Content Another reason to perform cost analysis is to assist you in making the determination of whether or not the contractor clearly understands the contract requirement. This determination can be made with a simple comparison between the position you developed with your cost analysis and the contractors proposed cost. For example, if the contractors proposed costs for labor or material do not resemble your estimate for these elements, there is good indication that the contractor has misinterpreted what the government wants. It is better to discover this unfortunate error prior to contract award and be able to correct it, than to discover it at the end of the contract, when it is too late. More specifically, you may use cost analysis to verify cost or pricing data and to evaluate cost elements to:
Notes
Make a necessity and/or reasonable determination of the contractors proposed costs, including allowances for contingencies. Remember, it is your responsibility to make a price or cost reasonableness determination. Project cost trends on the basis of current and historical cost or pricing data. By projecting cost trends, the Government can better budget its resources for current and future spending. Determine reasonableness of estimates generated by appropriately calibrated and validated cost analysis techniques, i.e. parametric models or cost-estimating relationships (CER). Contractors use cost estimating techniques to assist them in developing their proposed costs. The Government must also use cost estimating techniques to calibrate the validity and reliability of the proposed cost. Apply audited or negotiated indirect cost rates, labor rates, material costs, and cost of money or other factors to establish your Government objective.
There have been numerous stories reported by the press about how taxpayer dollars are being misspent. Two examples are the Carnival Cruise debacle and the overcharges associated with Operation Blue Roof. Each of these stories came to light because the government was accused of overpayment of some contracts that were awarded to assist in the hurricane Katrina clean up and recovery of New Orleans in 2005.
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Content Carnival Cruise Example The government awarded Carnival Cruise a $236 million deal to provide temporary housing on the Mississippi River and off of the Gulf Coast. According to Congressional investigators, the cost per person was $1,275 a week. That amount was nearly twice the typical cost of a weeklong cruise for a typical passenger. Operation Blue Roof Example Highly criticized after the wake of Hurricane Katrina were some of the contracts awarded under Operation Blue Roof. This operation hired contractors to nail down large blue tarpaulins on top of wind-damaged roofs of the Gulf Coast residents in order to prevent further weather damage. These contractors were paid an average of $2,480 for less than two hours of work to cover each damaged roof with government provided supplies. It was later reported that the cost should have been closer to $300 to tarp a 2,000-square-foot roof - a fraction of what the government paid. Although the Operation Blue Roof and the Carnival Cruise examples are unique situations that were the result of urgent requirements which may not have allowed for sufficient time to conduct cost analysis, they demonstrate the importance of why cost analysis should be performed. As a contracting officer you are personally involved. As such, you must make wise business decisions that protect the best interest of the government and your tax dollars. When to Use Cost Analysis Earlier in the module, cost analysis was defined as the review and evaluation of the separate cost elements and profit in an offerors or contractors proposal, and the application of judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. FAR 15.404-1(a) offers the following two situations when you may use cost analysis: it shall be used to evaluate individual cost elements when cost or pricing data are required in accordance with the Truth in Negotiations Act (TINA); AND Notes
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Content it may also be used to evaluate information other than cost or pricing data to determine cost reasonableness or cost realism. With the former situation, you are required to use cost analysis. With the latter situation, you may use cost analysis only to the extent needed to determine price reasonableness. Cost or pricing data are broadly defined to include all facts that prudent buyers and sellers would reasonably expect to affect price negotiations significantly. While such data does not include information that is judgmental, it does include the factual information from which a judgment was derived. By requiring the offeror to provide factual supportive data, the Government seeks to place its negotiators on equal footing with the contractor and thus ensure that the price negotiated by the parties is fair and reasonable. When a contractor submits cost or pricing data, it must certify that such data is "current, accurate and complete" as of the date on which the parties agreed upon a price. If the Government later determines that the contractor's data was not current, accurate or complete, it may assert a defective pricing claim against the contractor demanding a reduction in the contract's price to compensate for the effect of the undisclosed or inaccurate data. The Government must establish three elements in order to prevail on such a claim: it must show that the information at issue fits the definition of "cost or pricing data"; it must further show that this information was not meaningfully disclosed to the Government; and it must show that its negotiators relied upon the contractor's defective data, leading to an overstatement in the final price agreed to by the Government. Notes
Reference: (FAR 15.403-4(b)(2)).
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Content You may use cost analysis to evaluate the effect of an offeror's current practices on future costs. For example, once the sonar contract is awarded, you could perform a trend analysis of labor, even in periods of relative price stability. By conducting a trend analysis you can forecast potential impact on the cost of labor, such as, increases or decreases in the cost of labor due to changing skilled labor market or labor shortages. If your trend analysis shows that the cost of labor is steadily increasing, this information is valuable for developing future cost objectives. Cost analysis can be used to verify that an offeror's proposed costs are allowable, allocable, and reasonable. FAR 31.205 identifies 52 types of cost, and distinguishes whether they are allowable, unallowable or allowable with restrictions under a Government contract. In some cases determining if a cost is allowable is cut and dried; yes or no - the cost is or is not allowed. However, in many cases determining whether a cost is allowable depends upon the contract situation. For example, the sonar contract may require the use of test equipment to study sound patterns. Your evaluation of each of the cost elements will reveal that the offerors proposal does not contain a cost element for direct material. You must then ask the question why. If the test equipment is necessary to conduct the study and it is an allowable expense according to the FAR, then the cost of the equipment is an allowable charge under the contract. In addition, the cost of the test equipment should be allocated under the cost element of direct material. Notes
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Content A cost analysis review can be used to help you determine if the potential offeror or contractor used accurate, complete, and current information in developing their proposal. This information is generally made available to a government auditor for review but can be submitted as part of a proposal.
Notes
Cost analysis can help you to confirm an offerors proposed cost for each individual element by comparing it with: actual costs previously incurred by the same offeror; previous cost estimates from the offeror or from other offerors for the same or similar items; other cost estimates received in response to the Government's request; independent Government cost estimates by technical personnel; and forecasts of planned expenditures, when well-developed like an Independent Government Estimate(IGE).
Interim Summary of Cost Analysis Fundamentals Your role as the Contracting Officer is multifaceted. As such, you must have adequate knowledge of cost analysis and be able to exude confidence in making decisions about when to perform it and why. Youve learned that cost analysis is the process of examining each element of cost to determine price reasonableness and that there are several benefits to performing it. In the next section, you will learn the differences between price analysis and cost analysis.
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Differences in Analyses
Content Overview With clear understanding of the definition of cost analysis and insight into when and why it should be performed, you are now ready to examine the distinguishing characteristics of price analysis, cost analysis, cost realism analysis, and technical analysis. Remember that the objective of any type of proposal analysis is to ensure that the final agreed-to price between the Government and the contractor is fair and reasonable to both parties. It would not be fair to the Government to pay a price that is unreasonable for a product or service nor would it be fair to inadequately compensate a contractor for work provided. As the contracting officer, you have the responsibility of evaluating the reasonableness of the offered price. There are two basic approaches which may be used to determine whether the contract price is fair and reasonable for the work being performed: price analysis and cost analysis. In addition to these two approaches, there are other forms of analysis referred to as cost realism analysis and technical analysis which may be used to determine which offeror will provide the best value to the Government considering both quality and price. Deciding which approach to use can be complicated. However, the complexity and circumstances of each acquisition will determine the level of detail required for your analysis. In this section, you will address each of the following:

Notes
Identify methods of analysis Identify differences between price analysis, cost analysis, and cost realism analysis, and technical analysis.
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Content Methods of Analysis As an aspiring contracting professional, you want to be familiar with the different types of proposal analysis techniques. Therefore, lets define what they are. Price Analysis "Price analysis" is the process of examining and evaluating a proposed price in order to determine whether it is fair and reasonable, without evaluating its separate cost elements and the proposed profit. The process of performing price analysis involves comparing a proposed price with other prices, i.e., historical prices, competitive prices, Government estimate, etc. Let's say you have a need for a new pair of shoes. You find a pair that you really like at Wal-Mart. How do you determine that the shoe price at Wal-Mart is fair and reasonable? You might compare Wal-Mart's shoe price with the price for the same or similar style shoe from another retailer, such as Target and or a company on the internet (competitive prices). In addition, you might compare Wal-Mart's shoe price with a price that you paid for a similar or same style shoe that you purchased last year (historical price). The more prices you use for your basis of comparison the better you can determine price reasonableness. After you compare the prices you will determine if Wal-Mart's price is too high or too low or within the price comparison range. Congratulations, you just performed price analysis. Cost Analysis "Cost analysis" is the review and evaluation of the separate cost elements and profit in an offerors or contractor's proposal (including cost or pricing data or information other than cost or pricing data), and the application of judgment to determine how well the proposed costs represents what the cost of the contract should be, assuming reasonable economy and efficiency. Cost analysis must be performed when cost or pricing data are required and it can or may be performed when you have information other than cost or pricing data. Okay, let's go back to the Wal-Mart shoe scenario. With the price analysis you performed a moment ago you compared the price of a pair of shoes with other shoe Notes
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Content prices (competitive and historical). In contrast, with cost analysis you examine each separate element of cost, plus profit. If you wanted to perform cost analysis as your basis for determining the reasonableness of the cost of the shoes you saw at Wal-Mart you would need to have detailed information. Such information would include a itemize breakdown of the type of material, i.e., leather, vinyl, dye, thread, glue, rubber, wood, etc.; the quantities of material and costs. Then you would need to know what percentage of the material handling, insurance, and storage costs are chargeable to the material overhead pool. These are costs that are associated with the direct material, but cannot be assigned directly to the production or sales of a particular product. Next, you would need to examine the labor cost. You will do so by analyzing the skill level of the shoemaker, examine the hourly rate and the number of hours required to make the shoes. Next, you will need to examine the labor overhead cost, general and administrative cost and the profit. Lastly, you would make a determination that each element of cost is fair and reasonable based on your analysis. As you can see, this cost analysis process can be quite extensive. Realistically, you would not perform cost analysis to determine reasonableness of the cost of a single pair of shoes that is commercially available in the open market, since: (1) commerciality is an exemption to cost or pricing data, and (2) the bottom line price is the only cost information available. Without itemized cost data, cost analysis cannot be performed. The shoe example is provided to simply give you a quick contrast between price and cost analysis. Reference: FAR 15.404-1(c) Notes
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Content Cost Realism Analysis "Cost realism analysis" is the process of independently reviewing and evaluating specific elements of each offerors proposed cost estimate to determine whether the estimated proposed cost elements are: realistic for the work to be performed, reflect a clear understanding of the requirements, and are consistent with the unique methods of performance and material described in the offerors technical proposal. The use of cost realism analysis is common when you have adequate competition (two or more offers) and cost and pricing data are not required and are not obtained. You must use cost realism analysis with cost-reimbursement contracts (when cost or pricing data are not required) to determine the probable cost of performance for each offeror. With a fixed-price incentive contract or (in exceptional cases) other fixed-price contract, you may use cost realism analysis to assess offeror responsibility and contract performance risk. Let's look at an example of the use of cost realism analysis. You have a requirement for non-personal services to provide technical and administrative support to the Helicopter Support Squadron. You receive four proposals of which the lowest offer is considerably below its competitors prices. By performing cost realism analysis, you will also evaluate the separate elements of costs that are questionable to determine whether or not the low offeror fully understands the requirement. You might discover that the low offeror plans on using lower skilled laborers, in lieu of the skill level necessary to perform the work, which could result in poor performance or shortfalls. The low offered amount could simply be a mistake or an effort to buy-in based on anticipated future changes to the subsequent contract. On the other hand, the low offer could be the contractors effort to establish business relations with the Government. Your role would be to have the offeror explain how the contract will be performed at the price offered. If the contractor cannot explain the unrealistically low price, you should not make the award. Notes
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Content Technical Analysis "Technical analysis" is another method that may be used to determine the need for and reasonableness of proposed resources, assuming reasonable economy and efficiency. Technical analysis examines the type and quantities of material proposed, the need for the types and quantities of labor hours and the labor mix, and the need for Government furnished material or facilities. Also included in the technical analysis is any other data that may be pertinent to an assessment of the offeror's ability to accomplish the technical requirements or the cost or price analysis of the service or product proposed. Technical analysis is performed by personnel having specialized knowledge, skills, experience, or capability in the areas of the product or service being acquired. This analysis could also require expertise in such areas as manufacturing, engineering, software development, sciences, etc., as well as the management of these disciplines. Reference: FAR 15.404-1(e) Differences Between Analyses Now that you are familiar with the different types of proposal analysis techniques available to assist you in determining price or cost reasonableness and technical capability, this section points out the differences between the types of analysis (price, cost, and cost realism). However, keep in mind that you may use any of the methods of analysis (price, cost, technical and or cost realism), by themselves or in combination, to ensure that the final price is fair and reasonable. What determines the level and detail of the analysis is the complexity and circumstances of the acquisition. We will look at each in detail starting with price analysis. Notes
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Differences in Analyses: Price Analysis

Content Identifying Differences - Price Analysis As previously stated price analysis is the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit. It is used to determine that an offered price is fair and reasonable when cost or pricing data are not required. It is also used to verify that the overall price offered is fair and reasonable when cost analysis is performed. The depth of the price analysis depends on the size of the purchase. This is done by considering the potential cost of overpricing and the administrative cost of performing the price analysis. For example, if you suspect an offerors proposal is overpriced in the amount of $100 and the administrative cost to perform an extensive price analysis is $300, then the degree of the analysis should be less in depth. On the other hand, if the cost of the potential contract is estimated at three million dollars, a more in depth price analysis is justified, because there is greater potential of overpricing with the larger dollar contract versus the smaller dollar one. Price AnalysisTechniques Price analysis always involves some form of comparison with other prices. You as the Contracting Officer, are responsible for selecting the basis for comparison. As such, you may use various price analysis techniques and procedures to conduct the comparison. For example, you may compare a current proposed price with: Other proposed prices received in response to the same solicitation. Normally, adequate price competition establishes price reasonableness. 2. Previously proposed prices for the same or similar items, if both the validity of the comparison and the reasonableness of the previous price(s) can be established. 3. Previous Government and commercial contract prices for the same or similar items, if both the validity of the comparison and the reasonableness of the previous price(s) can be established.
1.
Notes
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Content
4.
Notes
5.
6. 7. 8.
Parametric estimating methods and application of rough yardsticks (such as dollars per pound or per horsepower or other units) to highlight significant inconsistencies that warrant additional pricing inquiry. Competitive published price list, published market prices of commodities, similar indexes, and discount or rebate arrangements. Independent Government cost estimates. Prices obtained through market research for the same or similar items. An analysis of pricing information provided by the offeror. Reference: FAR 15.404-1(b)
The first two price analysis techniques listed above are the preferred techniques. However, if you determine that information on competitive proposed prices or previous contract prices is not available or is insufficient to determine price reasonableness, any of the remaining techniques may be used as appropriate to the circumstances applicable to the acquisition. All bases for which recent, reliable, and valid data are available should be used. For instance, the last price paid in addition to current competitive offers should be considered, especially if the prior contract was recently awarded at a reasonable price. Further comparison with commercial catalog, market, or regulated prices can be just as desirable as comparison with competitive offers. After all, the prices of commercial items are defined by market conditions, considering supply and demand. Let's cover the Independent Government Estimate (IGE). Price analysis is a highly judgmental process. For any given procurement, different techniques for price analysis may give a different view of price reasonableness. Even given the same information, different contracting officers might make different decisions about price reasonableness. It is important to document in your contract file the rationale used in making the pricing decision, so that individuals who may review the file later will understand the factors that affected such decisions.
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Content Price Analysis: Requiring Information Other Than Cost or Pricing Data The contracting officer needs to make a determination that an offerors price is fair and reasonable prior to making an award. If the contracting officer cannot obtain adequate information from sources other than the offeror, the contracting must require submission of information other than cost or pricing data from the offeror that is adequate to determine a fair and reasonable price. (FAR 15.403-3(a)(1)). The data are any type of information required to determine price reasonableness or cost realism, for example, pricing, sales, or cost information. Unlike FAR 15.403-4(a)(1), which has a threshold of $650,000 for obtaining cost or pricing data, there is no threshold for other than cost or pricing data. Order of Preference As the contracting officer, you are responsible for obtaining information that is adequate for evaluating the reasonableness of the price or determining cost realism. However, the regulation states that "in establishing the reasonableness of the offered price, the contracting officer must not obtain more information than is necessary." What this means is that if you need to obtain information from an offeror to determine whether or not a proposed cost or price is reasonable, you may ask the offeror for only the information that will assist you in making the determination. But first consider other resources before asking the offeror. FAR 15.402(a)(2) identifies the order of preference for acquiring information other than cost or pricing data: Notes
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Content
Notes
First, you should rely on information available within the Government. There are numerous sources within the Government who have cost or pricing information. These sources include: fellow coworkers, government auditors, administrative contracting officers, engineers, department of labor, etc. Next, you should gather information from sources other than the offeror. For example, other sources might include: catalog prices, market prices, a price from a previous contract, competitive prices, and data gathered from trade journals, the internet, or other suppliers or vendors. If necessary, as a last resort, obtain information from the offeror.
Remember, it is the Governments responsibility to determine price reasonableness. Therefore, you should explore every means available to assist you in making the determination, before asking the offeror. Format for Submittal If you require the contractor to submit information other than cost or pricing data, it may be submitted in the contractors own format unless you decide that a specific format is essential, and the format has been described in the solicitation. Reference: FAR 15.4033(a)(2)
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Content The contracting officer must ensure that information used to support price negotiations is sufficiently current to permit negotiation of a fair and reasonable price. Requests for updated offeror information should be limited to information that affects the adequacy of the proposal for negotiations, such as changes in price lists. Reference: FAR 15.403-3(a)(3) Adequate Price Competition When adequate price competition exists, generally no additional information is necessary to determine the reasonableness of price. However, if there are unusual circumstances where it is concluded that additional information is necessary to determine the reasonableness of price, you shall, to the maximum extent practicable, get the additional information from sources other than the offeror. In addition, you may request information to determine the cost realism or to evaluate competing approaches. Reference: FAR 15.403-3(b) Commercial Items As a minimum, you must use price analysis to determine whether the price is fair and reasonable whenever the contracting officer acquires a commercial item. The fact that a price is included in a catalog does not, in and of itself, make it fair and reasonable. If you cannot determine whether an offered price is fair and reasonable, even after obtaining additional information from sources other than the offeror, then the contracting officer must require the offeror to submit information other than cost or pricing data to support further analysis. Notes
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Content Limitations relating to commercial items As Contracting Officer, you are required to:

Notes
limit your requests for sales data relating to commercial items to data for the same or similar items during a relevant time period; limit the scope of the request for information relating to commercial items to include only information that is in the form regularly maintained by the offeror as part of its commercial operations; and not disclose outside the Government information obtained relating to commercial items that is exempt from disclosure or the Freedom of Information Act.
Reference: FAR 15.403-3(c) Failure to Submit You may encounter a situation in which an offeror does not submit information for a contract. In that instance, the offeror is ineligible for award unless the Head of the Contracting Agency (HCA) determines that it is in the best interest of the Government to make the award to that offeror. The HCA bases that decision on:

The effort made to obtain the data. The need for the item or service. Increased cost or significant harm to the Government if the award is not made.
Failure of the contractor to submit information other than cost or pricing data is rare. Most offerors are willing to cooperate with the Government. However, if such a case does occur, consider discussing the matter with your legal office and the auditor. The lack of cooperation may draw suspicion on the contractor's business practices.
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Content FAR 15.402(a)(2) identifies the order of preference for acquiring information other than cost or pricing data:
Notes
First, you should rely on information available within the Government. There are numerous sources within the Government who have cost or pricing information. These sources include: fellow coworkers, government auditors, administrative contracting officers, engineers, department of labor, etc. Next, you should gather information from sources other than the offeror. For example, other sources might include: catalog prices, market prices, a price from a previous contract, competitive prices, and data gathered from trade journals, the internet, or other suppliers or vendors. If necessary, as a last resort, obtain information from the offeror.
Reference: FAR 15.403-3(a)(4) Remember, it is the Governments responsibility to determine price reasonableness. Therefore, you should explore every means available to assist you in making the determination, before asking the offeror.
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Differences in Analyses: Cost Analysis

Content Cost Analysis Techniques As stated earlier, cost analysis is used to evaluate the reasonableness of individual cost elements when cost or pricing data are required. Cost analysis may also be used to evaluate information other than cost or pricing data to determine cost reasonableness or cost realism. The purpose of cost evaluation is to form an opinion regarding the degree to which the proposed costs represent what the cost of the contract will be, assuming reasonable efficiency and economy. Cost analysis is necessary when the offeror is required to submit certified cost or pricing data in accordance with FAR 15.406-2. Cost Analysis Techniques As a Government representative, you may use various cost analysis techniques and procedures to ensure a fair and reasonable price, given the circumstances of the acquisition. These techniques and procedures will be discussed here and on the next three screens. 1. Verification of cost and pricing data and evaluation of cost elements, including:

Notes
The necessity for, and reasonableness of, proposed costs, including allowances for contingencies; Projection of the offerors cost trends, on the basis of current and historical cost or pricing data; Reasonableness of estimates generated by appropriately calibrated and validated parametric models or cost-estimating relationships; and The application of audited or negotiated indirect cost rates, labor rates, and cost of money or other factors.
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Content 2. Evaluating the effect of the offerors current practices on future costs.
Notes
In conducting this evaluation, you shall ensure that the effects of inefficient or uneconomical past practices are not projected into the future. In pricing production of recently developed complex equipment, you should perform a trend analysis of basic labor and materials, even in periods of relative price stability.
3. Comparison of cost proposed by the offeror for individual cost elements with

Actual cost previously incurred by the same offeror; Previous cost estimates from the offeror or from other offerors for the same or similar items; Other cost estimates received in response to the Governments request;
4. Verification that the offerors cost submissions are in accordance with the contract cost principles and procedures in FAR 31 and the cost Accounting Standards, when applicable. 5. Review to determine whether any cost or pricing data necessary to make the contractors proposal accurate, complete, and current have not been either submitted or identified in writing by the contractor. If there are such data, you shall attempt to obtain them and negotiate, using them or making satisfactory allowance for the incomplete data. 6. Analysis of the results of any make-or-buy program reviews, in evaluating subcontracting costs. Reference: FAR 15.404-1(c)(1)(2)
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Content Cost Analysis: Cost or Pricing Data Categories While cost or pricing data do not indicate the accuracy of the prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment. Cost or pricing data are more than historical accounting data; they are all facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of determinations of costs already incurred. Cost or pricing data require certification as accurate, complete, and current; are factual, not judgmental, and are verifiable; and include the data that form the basis for the prospective offerors judgment about future cost projections. Cost or pricing data include such items as: Vendor quotations Nonrecurring costs Information on changes in production methods and in production or purchasing volume Data supporting projections of business prospects and objectives and related operations costs Unit-cost trends such as those associated with labor efficiency Make-or-buy decisions Estimated resources to attain business goals Information on management decisions that could have a significant bearing on costs Notes
When deciding the type and quantity of information to obtain from the contractor to conduct cost analysis, the request should be limited to only the information that is needed to conduct the analysis. To require unnecessary submission of cost or pricing data leads to increased proposal preparation costs, generally extends acquisition lead time, and consumes additional contractor and Government resources.
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Content Cost Analysis: Threshold The threshold for obtaining cost or pricing data is $650,000. You are required to obtain cost or pricing data when the price is expected to exceed the applicable cost or pricing threshold and only if you can conclude that none of the exceptions apply. Unless an exception applies, cost or pricing data are required before The award of any negotiated contract (except for undefinitized actions such as letter contracts). The award of a subcontract at any tier, if the contractor and each higher-tier subcontractor have been required to furnish cost or pricing data. The modification of any sealed bid or negotiated contract (whether or not cost or pricing data were initially required) or subcontract. When calculating the amount of the contract price adjustment, consider both increases and decreases. This requirement does not apply when unrelated and separately priced changes for which cost or pricing data would not otherwise be required are included for administrative convenience in the same contract modification. (Example: A total net modification of $300,000 resulting from a reduction of $500,000 and an increase of $200,000 ($500,000 - $200,000 = $300,000) is a pricing adjustment of $700,000. ($500,000 + $200,000) This exceeds the current cost or pricing data threshold of $650,000.) Negotiated final pricing actions (such as termination settlements and total final price agreements for fixed-price incentive and redeterminable contracts). (These are contract modifications requiring cost or pricing data if The total final price agreement for such settlements or agreements exceeds the pertinent threshold; or The partial termination settlement plus the estimate to complete the continued portion of the contract exceeds the pertinent threshold.) Notes
Reference: FAR 15.403-4(a)(1)(iii)
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Content Special Circumstance to Acquiring Cost or Pricing Data Below the Threshold Unless an exception applies, the HCA, without power of delegation, may provide authorization to obtain cost or pricing data for pricing actions below the pertinent threshold of $650,000, provided the action exceeds the simplified acquisition threshold. The HCA shall justify the requirement for cost or pricing data. The documentation shall include a written finding that cost or pricing data are necessary to determine whether the price is fair and reasonable and the facts supporting that finding. Reference: FAR 15.403-4(a)(2) Cost Analysis: Cost or Pricing Data Prohibitions This section of the lesson is extremely important, because the regulation expressly identifies two situations when you are prohibited from requiring an offeror to submit cost or pricing data: if the acquisition is at or below the Simplified Acquisition Threshold (SAT); or if any of the exceptions apply. The regulation states that cost or pricing data shall not be obtained for acquisitions at or below the SAT. Furthermore, as the contracting officer, you are prohibited from requiring submission of cost or pricing data to support any action, whether for a new contract award, subcontract, or a modification to an existing contract, when any of the exceptions apply. FAR 15.403-1(b) provides a list of exceptions to cost and pricing data and FAR 15.403-1(c) provides the standards for each exception. You can view this list in Appendix A at the end of this lesson. Reference: FAR 15.403-4(a)(2) Notes
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Differences in Analyses: Cost Realism Analysis

Content Cost Realism Analysis Cost realism analysis is the process of independently reviewing and evaluating specific elements of each offeror's proposed cost estimate to determine whether the estimated proposed cost elements:

Notes
Are realistic for the work to be performed; Reflect a clear understanding of contract requirements; Are consistent with the unique methods of performances and materials described in the offeror's technical proposal.
The regulation requires that you perform cost realism analysis on costreimbursement contracts to determine the probable cost of performance for each offeror. The probable cost may differ from the proposed cost and should reflect the Government's best estimate of the cost of any contract that is most likely to result from the offeror's proposal. The probable cost shall be used for purposes of evaluation to determine the best value. You may determine probable cost by adjusting each offerors proposed cost, and fee when appropriate, to reflect any additions or reductions in cost elements to realistic levels based on the results of the cost realism analysis. Cost Realism Example The table that follows shows the contractor's proposed cost and the probable cost determined by the Government. As you may notice, the Government has adjusted the contractor's proposed labor hours, hourly rate, and material. The reason for the change is because the Government believes that the proposed labor of 4,000 hours is insufficient to realistically accomplish the work required and the hourly labor rate of $10 is inconsistent with standard labor rates for that type of work. Also, exception is taken on the material cost. Apparently the Government believes that the cost for material is overstated and does not adequately reflect what the cost should be.
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Content Contractor's Proposed Cost Labor (4000 hrs @ $10) Material Subtotal Profit (12%) Total $40,000 Government's Probable Cost Labor (4160 hrs @ $12) $49,920 14,000 $63,920 7,670 $71,590 Notes
20,000 Material $60,000 Subtotal 7,200 Profit (12%) $67,200 Total
By establishing a probable cost, the Government can determine best value by evaluating the degree and types of risk associated with awarding a contract to the offeror. The Government may conclude that: (1) the contractor's underestimated total cost could be an indication that the contractor misunderstands the requirement; (2) the subsequent contract award could result in a cost overrun, schedule slippage, unskilled or unqualified workers, and improper or and defective material; and (3) that the contractor may be trying to buy-in with a low offer and will later attempt to recoup the difference through a modification to the contract. (Reasons why the proposed cost and the probable cost may differ will be discussed in more detail.) Cost realism analyses may also be used on competitive fixed-price incentive contracts or, in exceptional cases, on other competitive fixedprice-type contracts when new requirements may not be fully understood by competing offerors, there are quality concerns, or past experience indicates that contractors proposed costs have resulted in quality or service shortfalls. Results of the analysis may be used in performance risk assessments and responsibility determinations. However, proposals shall be evaluated using the criteria in the solicitation, and the offered prices shall not be adjusted as a result of the analysis.
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Content When negotiating a contract price, your primary concern should be the price that the Government will pay to obtain the required supplies or services from a responsible contractor. Your objective should be to negotiate a contract type and price (or estimated fee and cost) that will result in reasonable contractor risk and provide the contractor with the greatest incentive for efficient and economical contract performance. Cost Realism Analysis: Proposed Cost vs. Probable Cost A comparison of your probable cost established from your cost realism analysis can help you to determine if a proposed cost is unrealistically low. An unrealistically low offer generally occurs, because the offeror: Did Not Understand Contract Requirements. Government requirements may not be clearly stated or the offeror may be unfamiliar with common product terminology. If the offeror underestimates the magnitude or complexity of a proposed task, the estimated costs could be far below the probable cost of successful contract performance. Did Not Properly Coordinate Proposal Preparation. The cost proposal may not be consistent with the offeror's technical proposal. The inconsistency may occur as the result of inadequate coordination between the team preparing the technical proposal and the team preparing the cost proposal. Consciously Understated The Proposed Cost/Price. In the face of competitive pressure, an offeror may submit an unrealistically low price in order to win a contract (i.e., use a buy-in pricing strategy). Buying-in refers to a contractor submitting an offer below anticipated costs
o
Notes
On cost-reimbursement contracts, the contractor may expect to recoup all or most of the costs related to any cost overrun that may occur. On fixed-price contracts, the contractor may hope to: (1) increase the contract amount after award (e.g., through additional and/or excessively priced contract modifications), or (2) receive follow-on contracts at unrealistically high prices to recover losses on the buy-in contract.
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Content Cost Realism Analysis: Protests Page 25 of 32 Many protests to the Comptroller General (CGEN) have challenged Government cost realism analyses. The CGEN has generally sustained the contracting officer's judgment on cost realism -- as long as that judgment is: Informed Accurate Sufficiently thorough for the acquisition situation Reasonable (not arbitrary) In accordance with evaluation criteria stated in the solicitation. Notes
Clear documentation is essential, because it is the documentation that demonstrates to others the basis for your analysis. You can use clear documentation to guide your efforts to resolve offeror disagreement with the results of your analysis, before that disagreement becomes a formal protest. If you are faced with a protest, clear documentation will greatly affect your chances of success in sustaining an award decision. Cost Realism Analysis Process Consider the following process whenever you perform cost realism analysis. Consider Award Criteria Obtain Necessary Information Obtain Acquisition Team Support Identify Understated Costs/Prices Estimate Probable Cost Make Decision
Each part of the process is discussed in greater detail.
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Content Award Criteria and Cost Realism Analysis If you plan to consider cost realism in evaluating offers for contract award, your solicitation must define how it will be considered. FAR 15.404-1(d)(2) states that cost realism shall be performed on all costreimbursement type contracts to determine the probable cost of performance for each offeror. Normally, you should make this decision during acquisition planning. However, you may decide that cost realism analysis is necessary after evaluating the offers received. At that point, you may issue an amendment revising offer evaluation criteria for contract award and requiring each offeror to submit the information required for analysis. However, remember that changing award criteria after receipt of proposals is likely to raise questions about the fairness of the proposal evaluation process. Obtain Necessary Information Other Than Cost or Pricing Data Once you decide to use cost realism analysis, you must decide what information other than cost or pricing data you will need to complete your analysis. In particular, you must decide what information to require from offerors. Normally, you should make this decision during acquisition planning and identify necessary cost information requirements in the solicitation. You may establish the requirement after receipt of offers, but the acquisition will be delayed while offerors gather and submit the information required. Notes
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Content During the solicitation phase the requirement for information other than cost or pricing data:
Notes
Should be limited to the data that you anticipate will be needed for cost realism analysis. For example, if you are primarily concerned about the realism of labor estimates, you may limit the information requirement to the labor skill mix, labor rate, and labor hour estimates. In that situation, you need not require submission of information on material, indirect costs, or profit. Should permit each offeror to determine its submission format unless you need a specific format for efficient and effective analysis. For a commercial item acquisition, limit information requirements, to the maximum extent practicable, to information in the form regularly maintained by the offeror in its commercial operations. Should require each offeror to submit information that is sufficiently current to permit effective cost realism analysis. May include specific information requirements adapted from FAR Table 15-2.
Obtain Government Acquisition Team Support You are ultimately responsible for performing the cost realism analysis, but you cannot be an expert in everything involved in proposal preparation and analysis. Support from both in-house and field members of the Government Acquisition Team can be invaluable. Communicate with team members early in the acquisition process to determine the information already available, extent of assistance required, specific areas where assistance is needed, and information necessary for an efficient and effective review. Ensure that the team supporting the analysis is aware of its responsibility to safeguard sensitive contractor information. During the evaluation process, disclosure of proprietary offeror information must be governed by FAR procedures and applicable agency regulations. Government personnel must not visit any offeror or discuss the proposal with any offeror without proper approval. Only request the support needed to evaluate the offers received. As the number of personnel involved in the evaluation process increases, the chance of unauthorized disclosure of proprietary proposal information also increases.
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Content In-House Support: Technical specialists and others familiar with specific contract requirements are typically the Government personnel best qualified to evaluate technical proposals. They can also raise key questions about apparent inconsistencies between offeror's technical and pricing proposals. Audit Support: Their familiarity with offeror cost accounting information puts auditors in a unique position to question inconsistencies in proposed costs. Field Support: The contract administration team can include administrative contracting officers, price analysts, quality assurance personnel, engineers, plus small business and legal specialists. These specialists can use their unique understanding of offeror operations to raise questions about the proposal or help answer questions raised by in-house personnel. Identify Any Understated Costs or Prices Ask the following questions to determine whether proposed costs/prices are significantly understated for the required contract effort.
Notes
Does the information other than cost or pricing data submitted by the offeror satisfy the solicitation requirements? The information submitted must be adequate for proposal analysis. Inadequate information could indicate a lack of understanding of contract requirements or an attempt to hide weaknesses in proposal development. Does the offeror's cost or price appear realistic based on a comparison with the IGE? A detailed and well documented IGE serves as the initial benchmark against which all proposals are measured.
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Content
Notes
Do the proposed costs or prices reflect an accurate understanding of contract requirements? With the assistance of other Government Acquisition Team members, determine if the proposal is consistent with the technical and other solicitation requirements. Inconsistencies need to be identified and clarified. A lack of understanding of the technical requirements can lead to severe contract over or under pricing. Further, a lack of understanding can jeopardize successful contract completion. Are the proposed costs or prices consistent with the various elements of the technical proposal? The cost or price proposal should be a dollars and cents representation of the technical proposal and must be consistent with the technical proposal. Inconsistencies may be identified in any element of the offeror's cost estimate (e.g., direct labor cost, direct material cost, or indirect cost). How has the offerors actual price or contract costs on previous contracts compared with the price proposed? Past performance can be a strong indicator of future performance. However, if records indicate historically poor cost performance, provide the offeror an opportunity to demonstrate that past problems were beyond the firm's control or that improvements have been made in the firm's cost estimating system. Is the contractor likely to satisfactorily meet all contract requirements at the proposed price? Even if the proposal is internally consistent and reflects an accurate understanding of the work, the offeror may still have underestimated the cost of completing the contract. Assess the probability that the offeror can complete the contract on time at the proposed price.
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Content Estimate Probable Costs The probable cost is the Government's estimate of what it will cost for the offeror to complete the contract based on the Government's evaluation of the offeror's technical proposal and proposed costs.
Notes
Decide if a probable cost estimate is necessary. Depending on the solicitation award criteria and the offeror's proposal, you may or may not need to develop a probable cost estimate. o If you are performing a cost realism analysis of a proposal for a cost-reimbursement contract, you must develop a probable cost estimate to support your analysis of best value. o If you are performing a cost realism analysis of a proposal for a fixed-price contract, you may develop a probable cost estimate to assess contract performance risk or contractor responsibility. However, you may be able to analyze key areas of performance risk without a probable cost estimate. Consider general points for probable cost development. Whenever you develop a probable cost estimate, consider the following points: o As you collect the information required to evaluate the realism of the offeror's cost/price estimate, you are also collecting the information required to develop your own estimate of the most probable contract cost. o In developing your estimate, adopt the portion of the offeror's estimate that appears realistic and modify the portion of the estimate that you believe is unrealistic. For example, you may accept proposed labor hours and adjust the labor rate based on an audit recommendation. Adjustments may increase or decrease cost estimates o Use relevant estimating tools and techniques. o As you complete your estimate, assure that you clearly document your rationale for any adjustment.
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Content
Notes
Assure that assessment is reasonable. The Comptroller General has repeatedly found that cost realism analysis is a judgmental process and review should be limited to assuring that the analysis is reasonable and not arbitrary. Develop a probable cost estimate for each offer. Each probable cost estimate must consider the unique characteristics of the offeror and the technical proposal. For example, in 1993, the Comptroller General rejected a cost-plus-fixed-fee contract award decision based on probable cost, because the agency failed to consider each offeror's individualized approach and instead mechanically adjusted proposed labor hours and material costs. In that case, the Comptroller General found that: o The agency's cost analyst entered into a computer each offeror's labor hours and material cost estimate for the 100 work items in a work package. o The computer was programmed to compare the offeror's proposed labor hours and material costs with the Government's labor hours and material cost estimates for each work item. o The computer automatically accepted those offeror estimates that were within a predefined percentage of the Government's estimate. For all offeror estimates outside the predefined percentage range, the computer adjusted the offeror's estimate by means of a mathematical formula which approximately split the difference between the contractor estimate and the Government estimate.
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Content Notes
Make Decision Use your cost realism analysis in offer evaluation. Consider the results of your cost realism analysis in offer evaluation, in accordance with the contract award criteria identified in the solicitation. Once you decide to use cost realism analysis, you must decide what information other than cost or pricing data you will need to complete your analysis. In particular, you must decide what information to require from offerors. Normally, you should make this decision during acquisition planning and identify necessary cost information requirements in the solicitation. You may establish the requirement after receipt of offers, but the acquisition will be delayed while offerors gather and submit the information required.
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Content During the solicitation phase the requirement for information other than cost or pricing data:
Notes
Should be limited to the data that you anticipate will be needed for cost realism analysis. For example, if you are primarily concerned about the realism of labor estimates, you may limit the information requirement to the labor skill mix, labor rate, and labor hour estimates. In that situation, you need not require submission of information on material, indirect costs, or profit. Should permit each offeror to determine its submission format unless you need a specific format for efficient and effective analysis. For a commercial item acquisition, limit information requirements, to the maximum extent practicable, to information in the form regularly maintained by the offeror in its commercial operations. Should require each offeror to submit information that is sufficiently current to permit effective cost realism analysis. May include specific information requirements adapted from FAR 15.408, Table 15-2 .
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Content Summary In this lesson you learned about the four methods of analysis (price, cost, cost realism, and technical). Price analysis is the process of evaluating the final price when cost or pricing data are not required. Not to confuse the two, cost analysis is required when cost or pricing data are required and none of the exceptions apply. Or you may perform cost analysis using information other than cost or pricing data to evaluate cost reasonableness or cost realism. Technical analysis is the process of evaluating the offeror technical capability and approach to carrying out the contract requirement. You learned that cost realism analysis is the process of reviewing and evaluating specific elements of each offeror's proposed cost estimate when cost or pricing data are not required to determine if the cost is realistic. Furthermore, you learned about the following re: when cost or pricing data are required: 1) the exceptions to obtaining cost or pricing data (competition, prices set by law, commercial, waiver or modification of a commercial contract or subcontract); 2) when information other than cost or pricing data may be obtained; and 3) when cost realism analysis may be performed. Distinguishing the differences can be confusing to someone new to contracting, but with the information you read and with the support of your peers, you should easily identify the difference in any situation. To assist you in making the determination of which method of analysis is most appropriate you may apply the knowledge gained from this lesson; you may also acquire the advice and assistance of other acquisition team experts, i.e. other contracting officers, government auditors, pricing analysts, legal counsel, and or an Administrative Contracting Officers (ACO). Furthermore, there are several written guides referred to as the Contract Pricing Reference Guides. These documents serve as useful guides to pricing and negotiation personnel and contain detailed discussion and examples applying pricing policies to pricing problems. They may be used for instruction and professional guidance. However, they are not directives and should be considered as informational only. Notes
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Cost Analysis Terms and Techniques

Content Introduction Developing a prenegotiation position requires you to perform cost or price analysis. As you already know, cost analysis involves reviewing and evaluating separate elements of direct and indirect costs, plus profit. In essence, you analyze each element of cost to determine its reasonableness. Your analysis might reveal that the cost associated with the element is too high, too low or just right. Whatever the case, you will use the information as your basis for the negotiation. For example, you may determine from your analysis that the cost element for labor is unrealistically low to support the performance requirement and should be increased by 15%. You may then use this information to establish your prenegotiation position with the intent of persuading the offeror to revise the proposed labor to more adequately reflect your position or to one that both parties can agree to. There are several applicable terms and cost estimating techniques that you should be familiar with to assist you in performing cost analysis and developing a price or cost objective. The terms identified are commonly used by contracting professionals to effectively express their prenegotiation positions. In addition to being an effective communicator, you should be aware of some of the techniques that are frequently used to perform cost analysis, i.e., cost-estimating relations, regression, learning curve, statistics, and understand when to use them. The cost analysis terms are presented first in alphabetical order, followed by cost analysis techniques. Cost analysis terms are in Appendix B. Cost analysis techniques are in Appendix C. Take time now to review these two appendices and then come back here. These terms are the most common phrases that you will use to express your prenegotiation position. Several examples are provided to help you grasp sound knowledge of the concepts. In addition, you should have comprehended some of the techniques that are frequently used in performing cost and or price analysis and examined situations when they may be used. These techniques include cost-estimating relations, regression, learning curve, statistics, and price index numbers Notes
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Factors to Consider When Conducting Cost Analysis

Content Introduction When pricing or analyzing a proposal, you learned that three basic approaches may be used to help you determine whether the proposed costs are fair and reasonable: Price analysis, cost analysis, and cost realism analysis. This section of the lesson will address the factors that you should consider when tasked with performing cost analysis. Some of these factors were discussed in previous lessons and serve as a review. The policies described for obtaining and evaluating cost or pricing data or information other than cost or pricing data from offerors apply only to negotiated acquisitions. As a contracting officer, the method that you use to make a price or cost reasonableness determination will depend upon various factors. There is no simple question or a single answer that will guide you through your fair and reasonableness determination. Instead, you might find that you have a combination of questions. For example, when your supervisor hands you a contractor's proposal and asks you to conduct an analysis to determine price reasonableness, you might first ask, "Why me?" Next you might ask, "How did I get stuck with this?" Well, consider yourself fortunate. An opportunity has been bestowed upon you to be a major contributor in this acquisition process. You should recognize that you possess the knowledge and confidence to execute the task at hand. Getting Started Before you get started on your analysis, you should determine if performing cost analysis is required or if another method of analysis is more appropriate. If the contracting situation requires that the offeror submit cost or pricing data, you shall perform cost analysis. If the offeror is not required to submit cost or pricing data, you may perform cost realism analysis and/or price analysis. These questions will help identify factors to consider in your cost analysis decision making. Notes
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Content Each of these questions will be discussed in further detail. 1. What is cost analysis? 2. What are cost or pricing data? 3. When are cost or pricing data required? 4. When should I use cost analysis? 5. What is the offered price? 6. Is there adequate price competition? 7. Is the offered price based on a price set by law or regulation? 8. Is a commercial item being acquired? 9. Is it likely that a waiver will be granted by the HCA? 10. Are there any other circumstances where cost or pricing data are not required? 11. How do I determine price reasonableness? 12. Where can I get help? 13. Do I have to request assistance? 14. How do I request assistance? 15. What type of information is available? 16. When requesting field pricing assistance, are there any restrictions? 17. What should I expect to receive? 18. Is audit assistance available for prime contracts or subcontracts? What is cost analysis? Cost analysis is the review and evaluation of the separate cost elements and proposed profit/fee of:

Notes
An offeror's or contractor's cost or pricing data or information other than cost or pricing data and The judgmental factors applied in projecting from the data to the estimated costs.
The purpose of the evaluation is to form an opinion on the degree to which the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. Reference: FAR 15.404-1(c)(1)
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Content What are cost or pricing data? The term cost or pricing data refers to a category of information broadly defined as including all facts that . . . prudent buyers and sellers would reasonably expect to affect price negotiations significantly. In other words, cost or pricing data are factual information that an offeror provides to the government that would affect price negotiations significantly. Cost or pricing data requires that the offeror certify that the data are current, accurate, and complete, as of the date on which the parties agreed upon a price. Cost or pricing data are not certified by an offeror when a proposal is submitted. Cost or pricing data are certified by the successful offeror when the parties (government and offeror) have agreed to a price. Remember, cost or pricing data are factual, not judgmental, and are verifiable. While they do not indicate the accuracy of the prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment. Cost or pricing data are all the facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of costs determinations already incurred. List of factors included in cost or pricing data include: vendor quotations; nonrecurring costs; data supporting projections; and any information used to support the cost reasonableness. Contract Reference Pricing Guide Volume III Chapter 2 When are cost or pricing data required? The Truth in Negotiation Act (TINA) requires that you obtain cost or pricing data in specific contracting situations. However, the Act also provides exceptions to that requirement. Exceptions are: adequate price competition; prices set by law or regulation; commercial item; waiver; and modification of a contract or subcontract for commercial item. Notes
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Content Never require an offeror to submit cost or pricing data unless you can conclude that none of the exceptions to the cost or pricing data requirement are appropriate. Because you must consider the exceptions before requiring cost or pricing data, the decision to require cost or pricing data is the last determination in the process. You are required to obtain cost or pricing data when the price is expected to exceed the applicable cost or pricing threshold and only if you can conclude that none of the exceptions apply. Cost or pricing data are required before awarding any negotiated contracts or subcontracts, if the prime contractor is required to furnish cost or pricing data. It is also required for any modifications of any sealed bid or negotiated contracts, and any negotiated final pricing actions. Here are some examples of cost data situations. Situation 1, Offeror request for exception. Suppose you are using negotiation procedures and received only one offer. That offer exceeded the cost or pricing data threshold. The offeror requested an exception from the requirements for cost or pricing data on the basis of commerciality. You determined that the offer did not qualify for the exception requested or any other exception. In such situations, you must require the offer to submit cost or pricing data. Situation 2, Single offer over the cost or pricing data threshold. Suppose you expected adequate competition, but received only one offer. That offer exceeded the cost or pricing data threshold. After further market research, you determined that you were wrong to expect price competition, because only one firm makes and sells an item that meets Government requirements. If you determine that no other exception applies, you must require submission of cost or pricing data. However, if any exception does apply, you must not require cost or pricing data. Situation 3, Competition. Suppose you are using negotiation procedures for an acquisition with an estimated price in excess of the cost or pricing threshold. You receive two proposals but you are not convinced that the price of apparent successful offer is fair and reasonable. Price comparisons between the competitive offers are not very useful because the two offerors submitted such different technical proposals in response to the contract performance requirements. After comparing the price of the apparent successful Notes
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Content offer with historical data and commercial prices, you are not convinced that it is reasonable In such situations, you can require the offeror(s) to submit information other than cost or pricing data to support your pricing decision. You could not require cost or pricing data because the competition exception applies. Situation 4, Offeror provided cost or pricing data. If cost or pricing data are requested by the Government and submitted by an offeror, but an exception is later found to apply. The data submitted must not be considered cost or pricing data and must not be certified. Instead file it as information other than cost or pricing data. Situation 5, Single offer in simplified acquisition. Suppose you are using simplified acquisition procedures and the only offeror submitted a proposal with a price that appears unreasonable, based on comparison with commercial prices and the item price history. In such situations, you could require the offeror to submit cost information other than cost or pricing data. You could not require cost or pricing data because the anticipated acquisition price is less than the simplified acquisition threshold. Situation 6, Single offer below the cost or pricing threshold. Suppose you did not require the offeror to submit cost or pricing data because the estimated acquisition price did not exceed the cost or pricing data threshold. Now the offeror has submitted a proposal with a price that (while below the threshold) appears unreasonable, based on comparison with commercial prices and the item price history. In such situations, you could require the offeror to submit cost information other than cost or pricing data. Alternatively, you might require cost or pricing data if the proposal exceeds the simplified acquisition threshold and the requirement is authorized by the head of the contracting activity. Reference: FAR 15.403-4 Notes
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Content When to use cost analysis? According to regulation, you should perform cost analysis in either of the following situations:
Notes
When you require an offeror to submit cost or pricing data. In this situation, the offeror must provide complete, accurate, and current data to support all proposed costs and profit/fee. When you require an offeror to submit cost information other than cost or pricing data to support your decision on price reasonableness or cost realism. In this situation, require only the information necessary to determine price reasonableness or cost realism.
References: FAR 15.404-1(a)(3) and 15.404-1(a)(4) What is the offered price? The offered price is the amount that the contractor says is required to perform the contract. The offered amount must be compared with the cost or pricing data threshold. The threshold for obtaining cost or pricing data is $650,000. Unless an exception applies, cost or pricing data are required before accomplishing any of the following actions expected to exceed the current threshold: The award of any negotiated contract (except for undefinitized actions such as letter contracts). The award of a subcontract at any tier, if the contractor and each higher-tier subcontractor were required to furnish cost or pricing.
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Content The modification of any sealed bid or negotiated contract (whether or not cost or pricing data were initially required) or any subcontract. Price adjustment amounts must consider both increases and decreases (e.g., a net $200,000 modification resulting from a reduction of $500,000 and an increase of $300,000 ($300,000 - $500,000 = -$200,000) is an aggregate pricing adjustment exceeding $650,000 ($500,000 + $300,000 = $800,000)). This requirement does not apply when unrelated and separately priced changes for which cost or pricing data would not otherwise be required are included for administrative convenience in the same modification. Negotiated final pricing actions (such as termination settlements and total final price agreements for fixed-price incentive and redeterminable contracts) are contract modifications requiring cost or pricing data if o The total final price agreement for such settlements or agreements exceeds the pertinent threshold, or o The partial termination settlement plus the estimate to complete the continued portion of the contract exceeds the pertinent threshold. Notes
Unless an exception applies, the HCA, without power of delegation, may authorize you to obtain cost or pricing data for pricing actions below the pertinent threshold of $650,000, provided the action exceeds the simplified acquisition threshold. The HCA shall justify the requirement for cost or pricing data. The documentation shall include a written finding that cost or pricing data as necessary to determine whether the price is fair and reasonable and the facts supporting that finding. You should never require an offeror to submit cost or pricing data below the simplified acquisition threshold. Examples: Situation 1, Offered price exceeds the threshold. If the offered price is $650,000 or greater and none of the exceptions apply, you must ask for cost or pricing data and perform cost analysis. If the offered amount is less than $650,000, but greater than the SAT, none of the exceptions apply, and the HCA authorizes you to acquire cost or pricing data, you must ask the offeror to submit cost or pricing data and perform cost analysis.
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Content Situation 2, Offered price is less than the threshold. If the offered price is less than $650,000, do not ask the offeror to certify the cost or pricing information. Instead, require only the information necessary to determine price reasonableness or cost realism. If the offered amount is less than $650,000 but greater than the SAT, none of the exceptions apply, and the HCA authorizes you to acquire cost or pricing data, you must ask the offeror to submit cost or pricing data and perform cost analysis. Is the offered price based on a price set by law or regulation? Pronouncements in the form of periodic rulings, reviews, or similar actions of a governmental body, or embodied in the laws are sufficient to set a price. Examples of prices that are set by law or regulation are: utilities, labor, and produce. Examples: Situation 3, Price set by law or regulation. If the offered price is based on a price that is set by law or regulation, do not ask for cost or pricing data. Instead, consider acquiring information other than cost or pricing data, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Situation 4, Price not set by law or regulation. If you can conclude that the offered price exceeds the cost or pricing data threshold, the price was not determined by law or regulation, and none of the other exceptions apply, you must require the offeror to submit cost or pricing data. In such case, you shall perform cost analysis. Is there adequate price competition? This is an important question, because FAR 15.403-1 prohibits submission of cost or pricing data to support any action (contract, subcontracts, or modifications) when you determine that prices agreed upon are based on adequate price competition. However, you may require information other than cost or pricing data to support a determination of price reasonableness or cost realism when there is price competition. Notes
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Content Price competition exists if: 1. Two or more responsible offerors, competing independently, submit priced offers that satisfy the Government's expressed requirement and if:
Notes
Award will be made to the offeror whose proposal represents the best value where price is a substantial factor in source selection; and There is no finding that the price of the otherwise successful offeror is unreasonable. Any finding that the price is unreasonable must be supported by a statement of the facts and approved at a level above the contracting officer.
Reference: FAR 15.403-1(c)(1) 2. There was a reasonable expectation, based on market research or other assessment, that two or more responsible offerors, competing independently, would submit priced offers in response to the solicitation's expressed requirement, even though only one offer is received from a responsible offeror and if
Based on the offer received, the contracting officer can reasonably conclude that the offer was submitted with the expectation of competition, e.g., circumstances indicate that o The offeror believed that at least one other offeror was capable of submitting a meaningful offer; and o The offeror had no reason to believe that other potential offerors did not intend to submit an offer; and The determination that the proposed price is based on adequate price competition, is reasonable, and is approved at a level above the contracting officer.
Reference: FAR 15.403-1(c)(1)(ii)(A)(1)(B)
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Content 3. Price analysis clearly demonstrates the following: that the proposed price is reasonable in comparison with current or recent prices for the same or similar items, and adjusted to reflect changes in market conditions, economic conditions, quantities, or terms and conditions under contracts that resulted from adequate price competition. Notes
Examples: Situation 1, Adequate price competition exists. If your procurement situation meets the definition of having adequate price competition, you shall not require the offeror to submit cost or pricing data. Instead, consider acquiring information other than cost or pricing data, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Situation 2, No adequate price competition. If you can conclude that adequate price competition did not exist (sole source), the price is over the cost or pricing data threshold, the HCA did not waive the requirement, and none of the other exceptions apply, you must require the offeror to submit cost or pricing data. In such case, you shall perform cost analysis.
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Content Is a commercial item being acquired? Any acquisition of an item that meets the commercial item definition in FAR 2.101, or any modification, as defined therein, that does not change the item from a commercial item to a noncommercial item, is exempt from the requirement for cost or pricing data. Any acquisition for noncommercial supplies or services treated as commercial items at FAR 12.102(f)(1), exempt from the requirements for cost or pricing data, except sole source contracts greater then $16,000,000. Examples: Situation 1, Meets the definition of a commercial item. If you determine that an item claimed to be commercial is, in fact commercial, do not require submission of cost or pricing data. Consider acquiring information other than cost or pricing data, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Situation 2, Does not meet the definition of a commercial item. If you determine that an item claimed to be commercial is, in fact, not commercial and that no other exception or waiver applies, you must require submission of cost or pricing data and perform cost analysis. Is it likely that a waiver will be granted by the HCA? The HCA may, without power of delegation, waive the requirement for submission of cost or pricing data in exceptional cases. The authorization for the waiver and the supporting rationale shall be in writing. The HCA may consider waiving the requirement if the price can be determined to be fair and reasonable without submission of cost or pricing data. For example, if cost or pricing data were furnished on previous production buys and the contracting officer determines such data are sufficient when combined with updated information, a waiver may be granted. If the HCA has waived the requirement for submission of cost or pricing data, the contractor or higher-tier subcontractor to whom the waiver relates shall be considered as having been required to provide cost or pricing data. Consequently, award of any lower-tier Notes
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Content subcontractor to whom the waiver relates shall be considered as having been required to provide cost or pricing data. Consequently, award of any lower-tier subcontract expected to exceed the cost or pricing data threshold requires the submission of cost or pricing data unless (1) an exception otherwise applies to the subcontract or (2) the waiver specifically includes that subcontract and the rationale supporting the waiver for that subcontract. Examples: Situation 1, HCA waived the requirement. If the HCA waived the requirement to acquire cost or pricing data, you are to accept the exception and not require the offeror to provide cost or pricing data. In this case, acquire information other than cost or pricing data from the offeror, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Be certain to adequately document your file with the justification and waiver authorization. Situation 2, HCA does not waive the requirement. In order for this exception to apply, you must have waiver authority. If the HCA does not provide waiver authority, the estimated dollar value exceeds the cost or pricing data threshold, and no other exception applies, you must acquire cost or pricing data from the offeror and perform cost analysis. Are there any other circumstances where cost or pricing data are not required? Acquiring cost or pricing data from an offeror is not required if you exercise an option at the price established at contract award or the initial negotiation does not require submission of cost or pricing data. In addition, cost or pricing data are not required for proposals used solely for overrun funding or interim billing price adjustments. If either of these situations applies, do not ask for cost or pricing data. You may acquire information other than cost or pricing data, only to the extent to determine price reasonableness in your cost realism analysis and/or price analysis. Notes
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Content How do I determine price reasonableness? According to regulation a cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by you, the contracting officer or the contracting officers representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable. Reference: FAR 15.31.201-3 Where can I get help? Excellent question! When you need help to make a price reasonableness determination, take notice that there are many people in the acquisition community that are available to assist you. For example, there is both in-house support (technical and pricing) and field pricing assistance available. You work side-by-side with experts who are very knowledgeable and can assist you in your analysis. Just ask for help. In addition, there are numerous agencies within the Government that provide support: Defense Contract Audit Agency (DCAA), Defense Contract Management Agency (DCMA), Government Accountability Office (GAO), and Department of Labor are a few. When field pricing assistance is requested, you are encouraged to team with appropriate field experts throughout the acquisition process, including negotiations. Early communication with these experts will assist in determining the extent of assistance required, the specific areas for which assistance is needed, a realistic review schedule, and the information necessary to perform the review. Notes
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Content Do I need to request assistance? If current and reliable technical or audit information is already available, you may not need assistance or you may be able to limit your assistance request to an informal verification that available information is still current. For example: If there is already information available from an existing audit (completed within the last 12 months), never request a separate pre-award audit of indirect costs unless you consider the available information inadequate for determining the reasonableness of proposed indirect costs. If there was an indirect cost audit within the last 12 months but no forward pricing rate agreement, contact the cognizant auditor/ACO to obtain information on the current Government rate recommendations. If you have a reliable record of the offeror's current forward pricing rate agreement for direct labor rates, there is no reason to request a direct labor rate analysis from the cognizant auditor or ACO. If the offeror's proposal states that the firm has proposed indirect cost forward pricing rates in accordance with an established forward pricing rate agreement, verify that statement with the responsible ACO. If the ACO verifies that the proposed rates are part of a forward pricing rate agreement, no further indirect cost rate analysis is required. However, you should advise the ACO if you believe that rates for all contracts will be affected by your proposed contract. Notes
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Content If current and reliable technical or audit information is already available, you may not need assistance or you may be able to limit your assistance request to an informal verification that available information is still current. For example: If you have a reliable record of recent production costs for an identical item, do not request an audit of production cost history. If the Government and the contractor have established pricing formulas, determine whether changes in production methods or market conditions will affect those formulas. If not, further technical or audit analysis should not be necessary. If conditions have changed, request analyses to consider the effect of those changes. If the offeror uses standard component prices, determine whether changes in production methods or market conditions will affect those prices. If not, further audit analysis of material prices for those components should not be necessary. If conditions have changed, request an audit to consider the effect of those changes. Notes
How do I request assistance? Identify analysis needs before requesting analysis assistance. Remember that early communication with Government Acquisition Team members will assist you in determining the specific areas for which assistance is needed, the extent of assistance required, a realistic analysis schedule, and information requirements for cost analysis. Your request must be tailored to reflect the minimum essential supplementary information needed to conduct a technical or cost or pricing analysis. You must tailor the type of information and the level of detail requested in accordance with the specialized resources available at the buying activity and the magnitude and complexity of the required analysis.
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Factors to consider When Conducting Cost Analysis

Content What type of information is available? The type of information that is generally available through field pricing assistance consists of: Technical, audit, and special reports associated with the cost elements of a proposal, including subcontracts; Information on related pricing practices and history; Information to help you determine commerciality and price reasonableness: Verifying sales history to source documents Identifying special terms and conditions Identifying customarily granted or offered discounts for the item Verifying the item to an existing catalog or price list Verifying historical data for an item previously not determined commercial that the offeror is now trying to qualify as a commercial item Identifying general market conditions affecting determinations of commerciality and price reasonableness Information relative to the business, technical, production, or other capabilities and practices of an offeror. Audit assistance for prime contracts or subcontracts. Notes
Reference: FAR 15.404-2(a)(2) & FAR 15.404-2(c) When requesting field pricing assistance, are there any restrictions? Field pricing information and other reports may include proprietary or source selection information. If this is the case, the information must be appropriately identified and protected accordingly. Only allow those that have a need to know access to the information.
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Content What should I expect to receive? Depending upon the extent and complexity of the field pricing review, results, including supporting rationale, may be reported directly in writing, orally or by any other method acceptable to you. Whenever circumstances permit, you and the field pricing experts are encouraged to use telephonic and/or electronic means to request and transmit pricing information. When written technical and audit reports are necessary, you shall request that the audit agency concurrently forward the audit report to you and the ACO. The completed field pricing assistance results may reference audit information, but need not reconcile the audit recommendations and technical recommendations. A copy of the information submitted to you by field pricing personnel shall be provided to the audit agency. Audit and field pricing information, whether written or reported telephonically or electronically, shall be made a part of the official contract file. Reference: FAR 15.404-2(b) Is audit assistance available for subcontracts? Yes. But keep in mind that it is the responsibility of the prime contractor or higher-tier subcontractor for conducting appropriate cost or price analyses to establish the reasonableness of proposed subcontract prices and to include the results of those analyses in the prime contract price proposal. Notes
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Content You should only request audit or technical field pricing assistance to analyze a subcontract proposal if you believe that such assistance will serve a valid Government interest (e.g., determining total price reasonableness). Give special consideration to requesting subcontract audit or field pricing assistance when one or more of the following situations exist:

Notes
The business relationship between the prime contractor and the subcontractor is not conducive to independence and objectivity; The prime contractor is a sole source and the subcontract cost represents a substantial part of the proposed contract cost; The prime contractor has been denied access to the prospective records; The contracting officer determines that factors (e.g., proposed subcontract dollar value) make audit or field pricing assistance critical to a fully detailed prime contract proposal analysis; The contractor or higher-tier subcontractor has been cited for having significant estimating system deficiencies in the area of subcontract pricing, especially a failure to perform: o adequate subcontract cost analyses or o timely subcontract analyses prior to negotiation of the prime contract with the Government; or A lower-tier subcontractor has been cited as having significant estimating system deficiencies.
When you request analysis of a subcontract proposal, your request should include a copy of the following (when available):

Any review prepared by the prime contractor or higher-tier subcontractor; Relevant parts of the subcontractor's proposal; Cost or pricing data or information other than cost or pricing data provided by the subcontractor; and The results of the prime contractor's cost or price analysis.
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Content Assure that you follow agency procedures in requesting any subcontract analysis. For example, DoD contracting officers should notify the appropriate contract administration activities when extensive, special, or expedited field pricing assistance will be needed to review and evaluate a subcontractor's proposal. As you prepare your request, assure that all personnel involved understand that you must obtain the subcontractor's consent before the Government can provide the results of a Government analysis of a subcontract proposal to the prime contractor or higher-tier subcontractor. If the subcontractor withholds consent, you can only provide information on a range of unacceptable costs for each cost element, and you must provide that range in a way that prevents disclosure of subcontractor proprietary information. Module Summary Our goal for this module was to provide you with a brief look into the realm of cost analysis. We identified the relative policy and guidance provided in FAR 31 & 15, as well as, discussed the grading criteria and requirements for completing this module. And lastly, we examined the overall content of the module and the terms applicable to cost analysis. At this point, you should be more confident in your ability to conduct cost analysis or make a determination whether cost analysis should be performed. This module is the precursor to more advance cost analysis modules. It provides you with the basic information to answer the questions of what, when, and how regarding the rules of cost analysis. This module is introductory and is not a comprehensive guide to all issues related to cost analysis. It will, however, provide a base upon which to build your acquisition knowledge, and to assist you in performing proper cost analysis as prescribed in the FAR. Cost analysis is a necessary procedure for contracting for supplies and services. Under the proper conditions, it may apply for acquisitions utilizing FAR 12, 13, 14, and 15 procedures. The knowledge obtained should have provided you with insight into the process of analyzing individual elements of cost. Notes
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APPENDIX A Exceptions from Cost or Pricing Data Requirements

A. Adequate price competition A price is based on adequate price competition if: 1. Two or more responsible offerors, competing independently, submit priced offers that satisfy the Governments expressed requirement and if Award will be made to the offeror whose proposal represents the best value where price is a substantial factor in source selection; and There is no finding that the price of the otherwise successful offeror is unreasonable. Any finding that the price is unreasonable must be supported by a statement of the facts and approved at a level above the contracting officer; 2. There was a reasonable expectation, based on market research or other assessment, that two or more responsible offerors, competing independently, would submit priced offers in response to the solicitations expressed requirement, even though only one offer is received from a responsible offeror and if Based on the offer received, you can reasonably conclude that the offer was submitted with the expectation of competition, e.g., circumstances indicate that o The offeror believed that at least one other offeror was capable of submitting a meaningful offer; and o The offeror had no reason to believe that other potential offerors did not intend to submit an offer; and The determination that the proposed price is based on adequate price competition, is reasonable, and is approved at a level above the contracting officer; or 3. Price analysis clearly demonstrates that the proposed price is reasonable in comparison with current or recent prices for the same or similar items, adjusted to reflect changes in market conditions, economic conditions, quantities, or terms and conditions under contracts that resulted from adequate price competition. B. Prices set by law or regulation Pronouncements in the form of periodic rulings, reviews, or similar actions of a governmental body, or embodied in the laws, are sufficient to set a price. C. Commercial items 1. Any acquisition of an item that meets the commercial item definition or any modification that does not change the item from a commercial item to a noncommercial item is exempt from the requirement for cost or pricing data. If you determine that an item claimed to be commercial is, in fact, not commercial and that no other exception or waiver applies, you
Appendix A Page 1
must require submission of cost or pricing data. The following responsibilities apply to minor modifications of a commercial item that do not change the item from a commercial item to a noncommercial item: For acquisitions funded by any agency other than DoD, NASA, or Coast Guard, the modifications are exempt from the requirement for submission of cost or pricing data. For acquisitions funded by DoD, NASA, or Coast Guard, the modifications are exempt from the requirement for submission of cost or pricing data provided the total cost of the modifications does not exceed the greater of $500,000 or 5 percent of the total price of the contract. For acquisitions funded by DoD, NASA, or Coast Guard where the total cost of the modifications exceeds the greater of $500,000 or 5 percent of the total price of the contract and no other exception or waiver applies, the contracting officer must require submission of cost or pricing data. 2. Any acquisition for noncommercial supplies or services treated as commercial items, at FAR 12.102(f)(1),except sole source contracts greater than $16,000,000, is exempt from the requirements for cost or pricing data (41 U.S.C. 428a). D. Waiver If sufficient information is available to determine price reasonableness, you should consider requesting a waiver. The HCA may, without power of delegation, waive the requirement for submission of cost or pricing data in exceptional cases. The authorization for the waiver and the supporting rationale shall be in writing. The HCA may consider waiving the requirement if the price can be determined to be fair and reasonable without submission of cost or pricing data. An example of a case when the HCA may waive a requirement is if cost or pricing data were furnished on previous production buys and the contracting officer determines such data are sufficient, when combined with updated information. If the HCA has waived the requirement for submission of cost or pricing data, the contractor or higher-tier subcontractor to whom the waiver relates shall be considered as having been required to provide cost or pricing data. Consequently, award of any lower-tier subcontract expected to exceed the cost or pricing data threshold requires the submission of cost or pricing data unless an exception otherwise applies to the subcontract; or the waiver specifically includes the subcontract and the rationale supporting the waiver for that subcontract. E. Other circumstances where cost or pricing data are not required are: When exercising an option at the price established at contract award or initial negotiation does not require submission of cost or pricing data; and When cost or pricing data are not required for proposals used solely for overrun funding or interim billing price adjustments.
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APPENDIX B Cost Analysis Terms

Allowable Cost. This term refers to those charges that are expressly identified as allowable in the Cost Principles (FAR 31.205), and meets the relevant test of: 1. reasonableness; 2. allocability; 3. proper application of accounting principles, practices, and standards; 4. terms of the contract; and or 5. is not addressed in the cost principles but meets the requirements of the other four tests. While developing your prenegotiation position, you will need to determine whether a cost is allowable based on meeting the relevant test and cost principles. If the proposed cost is determined allowable, it should be included in your prenegotiation position. Allowable Cost with Restrictions. These are costs that are identified in the cost principles as cost that are allowable, but have restrictions and conditions on the amount that can be considered reasonable and the circumstance in which the cost may be charged. In developing your prenegotiation position, you must ensure that the conditions and circumstances are met before allowing the cost. If the circumstances have been met the cost should be included in the prenegotiation position. For example, the cost for contingencies are generally unallowable for historical costing purposes because such costing deals with costs incurred and recorded on the contractors books. However, in some cases, such as terminations, a contingency factor may be recognized when it is applicable to a past period to give recognition to minor unsettled factors in the interest of expediting settlement. Cost Analysis. The term means the review and evaluation of the separate cost elements and proposed profit of (a) an offeror's or contractor's cost or pricing data or information other than cost or pricing data and (b) the judgmental factors applied in projecting from the data to the estimated costs in order to form an opinion on the degree to which the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency. While developing your prenegotiation objective, you will evaluate each of the separate cost elements using sound judgment.
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Cost Elements are the individual items which make up the offerors proposed price or the governments prenegotiation objective. While developing your prenegotiation objective you will evaluate each element and sub-element of cost. The diagram is an illustration of an offerors proposal for engineering services containing several cost elements, including single elements, e.g., direct labor, labor overhead, with numerous sub-elements. COST ELEMENTS DIRECT LABOR (Hours by labor category) Program Manager (Engineer) Mechanical Engineering Manufacturing TOTAL DIRECT LABOR LABOR OVERHEAD Engineering Overhead Manufacturing Overhead TOTAL LABOR OVERHEAD MATERIAL COST MATERIAL OVERHEAD SUBTOTAL COST PROFIT TOTAL COST $140,477.20 35% $3,000.00 35% BASE $52,000.00 $27.040.00 HOURS 520 1040 1040 2600 RATE 75% 68% RATE $35.00 $32.50 $26.00 AMOUNT $18,200.00 $33,800.00 $27,040.00 $79,040.00 AMOUNT $39,000.00 $18,387.00 $57,387.00 $3,000.00 $1,050.00 $140,477.20 $14,047.72 $154,524.92
The number of elements listed in an offerors proposal is dependent upon the type of contract, i.e., services, supply, production; the level of complexity of the work to be performed; and the contractors accounting practices. In fact, there could be differences in the cost elements and sub-elements of two offerors proposal competing independently for the same contract. A competing contractor may propose a single cost element combining engineering and manufacturing overhead, in lieu of two separate cost elements. The governments role is to verify the cost as fair and reasonable and ensure that the proposal is consistent with cost accounting practices and standards. The Government does not tell the contractor the number of cost elements or sub-elements they must use. However, contractors who need assistance in developing or improving their accounting systems and procedures may request information from the Defense Contract Audit Agency via the Internet at http://www.dcaa.mil.
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Cost Input. Cost input refers to the subtotal of all of the cost elements, except general and administrative (G&A) and profit expenses, which for contract costing purposes is allocable to the production of goods and services during a cost accounting period. It may also be referred to as Total Cost Input (TCI) or cost of goods manufactured and is the bases by which the G&A rate is applied. In the example, the Subtotal cost of $14,000 represents the cost input.
Cost Elements Direct Labor Labor Overhead Material Material Overhead Subtotal G & A (22%) Profit Total Cost Amount $10,000 2,000 1,000 1,000 $14,000 3,080 1,500 $18,580
Cost Objective is a function, organizational subdivision, contract, or other work unit for which cost data are desired and for which provision is made to accumulate and measure the cost of processes, products, jobs, capitalized projects, etc. While developing your prenegotiation position, you are in essence analyzing cost and establishing your cost objective. Cost or Pricing Data means all facts that, as of the date of price agreement or, if applicable, another date agreed upon between the parties that is as close as practicable to the date of agreement on price, prudent buyers and sellers would reasonably expect to affect price negotiations significantly. Cost or pricing data are data requiring certification in accordance with FAR 5.804-4. Cost or pricing data are factual, not judgmental, and are therefore verifiable. While they do not indicate the accuracy of the prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment. Cost or pricing data are more than historical accounting data; they are all the facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of determinations of costs already incurred. They also include such factors as: vendor quotations; nonrecurring costs; information on changes in production methods and in production or purchasing volume; data supporting projections of business prospects and objectives and related operations costs; unit-cost trends such as those associated with labor efficiency; make-or-buy decisions; estimated resources to attain business goals; and information on management decisions that could have a significant bearing on costs. Defective Pricing. This exists when any price, including profit or fee, for any purchase action covered by a Certificate of Current Cost or Pricing Data, is increased by any significant amount because the data were not accurate, complete, or current. Direct Cost is any cost that can be identified specifically with a final cost objective. These costs, for the most part, are easily identified as direct labor, direct material, or other direct costs. For example, in a construction or manufacturing contract, the direct labor cost may be identified in the contractors proposal as engineering, manufacturer, laborer, etc. The direct material element may identify types of material, such as, heating, ventilation, and air conditioning system
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(HVAC), brick, plywood, etc. These costs are tied to the end item (building or manufactured unit) and are not chargeable to any other cost objective. Direct Labor are those labor costs that are directly associated with the end item and or can be tied to a single cost objective. For example, a construction contract to renovate the office building to add a gym may call for a plumber, plasterer, electrician and design/civil engineer, to name a few. Each of these laborers will work directly on completing the end item. The direct labor cost associated consists of each laborers hourly rate applied to the number of hours it takes to do the job. Laborer Plumber Plasterer Electrician Design/Civil Engineer Total Direct Labor cost Rate x Hours $18.00 x 40 $16.00 x 80 $28.00 x 40 $37.00 x 120 Cost $720.00 1,280.00 1,120.00 4,440.00 $7,560.00
Seven thousand, five hundred, sixty dollars is the amount the contractor would apply to the cost element of direct labor. Direct Material are those material costs that are directly associated with the end item and/or are chargeable to a single cost objective, such as, wood, metal, subassemblies or components. For example, a construction contract to renovate the office building to add a gym may call for copper tubing, paint, lumber, and drywall, to name a few. Each of these items will go directly into the finished product. The cost associated consists of the price for each of the items applied to the estimated quantity of material to do the job. Material Copper Tubing; dimensions; 1/16" ID, 1/8" OD, 1/32" wall; max PSI, 3100; 50 ft/roll Interior Wall & trim paint; 5 gal size; Item # 15787; Model # 72102A/05 UPS Lumber Bundles 8/4, white pine (F.G.) Drywall 5/8, 2.6 lbs/sq ft Total Direct Material Cost Cost x Quantity $25.50 (USD) x 100 Cost $2,525.00
$85.00 (USD) x 20
$1,700.00
$72.00 x 40 $6.00 x 768 sq ft
$2,880.00 $4,608.00 $11,713.00
Eleven thousand, seven hundred and thirteen dollars is the amount the contractor would apply to the cost element of direct material.
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Estimating Costs means the process of forecasting a future result in terms of cost, based upon information available at the time. Expert Judgment Techniques involves consulting with one or more experts who use their experience and understanding of the proposed project to arrive at an estimate of its cost. Facilities Capital Cost of Money (FCCOM) means cost of money as an element of the cost of facilities capital. Contractors are encouraged to invest in land, buildings and equipment that are efficient, economical, and state-of-the art and that will be used in support of Government contracts. In turn, the Government is willing to allow the contractor to allocate a percentage of the cost of these investments (buildings and equipment) to Government contracts. The cost is referred to as imputed costs and represents the cost above the actual cost of the buildings and equipment. Imputed costs are indirectly rather than directly charged to the contract. For example, the annual recurring cost of a lease alternative includes costs such as insurance, real estate taxes, land, and other services. The construction alternative should account for similar costs and services. To ascribe these indirect costs to the construction alternative is known as imputing. Final Indirect Cost Rate means the indirect cost rate established and agreed upon by the Government and the contractor as not subject to change. It is usually established after the close of the contractors fiscal year (unless the parties decide upon a different period) to which it applies. For cost-reimbursement research and development contracts with educational institutions, it may be predetermined; that is, established for a future period on the basis of cost experience with similar contracts, together with supporting data. Forward Pricing Rate Agreement (FPRA) is a written agreement negotiated between a contractor and the Government to make certain rates available during a specified period for use in pricing contracts or modifications. These rates represent reasonable projections of specific costs that are not easily estimated for, identified with, or generated by a specific contract, contract end item, or task. These projections may include rates for such things as labor, indirect costs, material obsolescence and usage, spare parts provisioning, and material handling. Forward Pricing Rate Recommendation (FPRR) is a rate set unilaterally by the Administrative Contracting Officer (ACO) for use by the Government in negotiations or other contract actions when forward pricing rate agreement negotiations have not been completed or when the contractor will not agree to a forward pricing rate agreement. Fringe Benefits are an indirect cost that some companies charge in addition to salaries that provide their employees with a variety of benefits. Fringe benefits include costs such as health and life insurance, sick leave, vacation leave, and other employee benefits. Although some contractors group these costs into a fringe-benefit pool, some firms include the costs in the overhead or G&A cost pools.
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General and Administrative (G&A) expense is any management, financial, and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost objectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period. In other words, if the cost is related to a direct base, such as direct labor or direct material, it should be charged to the appropriate indirect pool, i.e., labor overhead, or material overhead, respectively. For example, an indirect cost that would be related to labor are benefits, such as, sick leave or vacation pay for the laborer working on the project. An indirect cost associated with direct material could include the cost of transporting and handling the material or the cost of insurance. On the other hand, if the indirect costs are not associated with a direct cost objective (labor, material or other direct cost), the cost must be charged to the total cost input (TCI) base. Examples of costs included in the G&A pool are executive salaries and benefits, legal and accounting salaries and benefits, and other salaries and benefits of the firms administration. Indirect Costs are those costs that are necessary to operate a business, but are not directly tied to a single cost objective or contract. An example of an indirect cost is General and Administrative (G&A) expense. Indirect costs may be referred to as overhead or burden cost. There can be as many as two hundred different overhead pools depending on a contractors accounting system and how their costs are allocated. The most common indirect cost pools are Material Overhead, Labor Overhead, Engineering Overhead, Facilities Capital Cost of Money, Fringe Benefits, and G&A. Although these costs are necessary for the sake of conducting business, they cannot be charged to a single cost objective or contract and must be spread among the companys total volume of business. If you would like more detail information on indirect costs, DAU offers a residential course (CON 232) entitled Overhead Management of Defense Contracts. Indirect Cost Pools is the grouping of incurred costs identified with two or more cost objectives but not identified specifically with any final cost objective. Examples of indirect cost pools are secretarial or typing pools. The costs associated are chargeable to several cost objectives in lieu of a single objective. Indirect Cost Rate is the percentage or dollar factor that expresses the ratio of indirect expense incurred in a given period to direct labor cost, manufacturing cost, or another appropriate base for the same period. Information Other Than Cost or Pricing Data is any type of information required to determine price reasonableness or cost realism, which does not require offeror certification as accurate, complete, and current. It is information related to prices, sales or cost information, such as, established catalog or market prices or previous contract prices. It includes cost or pricing data for which certification is determined inapplicable after submission. Labor Cost at Standard is a pre-established measure of the labor element of cost, computed by multiplying labor-rate standard by labor-time standard.
Appendix B Page 6
Labor Hours. When performing cost analysis or cost realism analysis, labor hours represent the estimated quantity of labor required to perform a task. The hours identified in an offerors proposal should be reviewed by the technical support to determine whether or not the quantities of hours adequately reflect the time required to meet the performance requirement. A normal person year represents 2080 labor hours, with a half year of 1040 labor hours. Labor Rate represents the wage, earnings, and benefits expressed in monetary terms that a direct laborer would receive for the work performed. The U.S. Department of Labor provides wage estimates for over 800 occupations. Check out its website at http://www.bls.gov. Four general factors have a significant impact on direct labor wage rates: variations in geographical locations, skill levels, conditions in the contractors work force, and the time period of the contract. Labor-rate Standard is a pre-established measure, expressed in monetary terms, of the price of labor. Labor-rate standards are set by industry and are influenced by supply and demand. For example, when you take your car to a mechanic for general maintenance, there may be a sign posted that says, Our standard labor-rate is $40 per hour. Or when you call the plumber to fix a leaky sink, you may be informed that the standard labor-rate is $25 per half hour for service. The Fair Labor Standards Act of 1938 (FLSA), as amended dictates minimum wage and overtime pay standards as well as child labor standards and record keeping in both the private and public sectors, including work conducted in the home. The Wage and Hour Division of the Employment Standards Administration (ESA) administers this Act, which is estimated to affect more than 100 million workers, both full-time and part-time. Labor-time Standard is a pre-established measure, expressed in temporal terms, of the quantity of labor. The concept dates back to the early 1920s, when empirical observations, techniques, moral value, and premises concerning economics were connected, which resulted in the scientific management movement. Pioneered by Frederick Taylor, the Father of Scientific Management, he believed that each and every task, regardless of its size, could be performed in the most efficient and economical way. Hence, both private industry and the public sector have developed labor-time standards for almost every task that exists today. For example, the standard time for processing a contract modification is 30 days. Time standards are based on average time an average worker, under average conditions, takes to perform a particular task or operation without interruption. For the purpose of estimating the number of hours for a proposal, standard times are typically factored upwards or downwards to account for unknown events. Labor Overhead, also referred to as indirect labor or labor burden, includes labor costs and benefits that are not tied directly to a single cost objective or contract, but chargeable to many contracts. An example of a labor overhead expense is the cost of a supervisors salary who oversees the work of several employees working on several contracts or employee related expenses (shift & overtime premiums, employee taxes). This cost should be charged consistently to all of the contracts based on the amount of benefit accrued by the each contract. Other costs included in labor overhead pool are: sick leave, vacation, group insurance, pension fund, FICA/Medicare, training.
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Material-cost at Standard is a pre-established measure of the material elements of cost, computed by multiplying material-price standard by material-quantity standard. Material cost standards are common with the purchase of commercial items. An example of a material-cost at standard is the purchase of a tow hitch package to be installed on a fleet of trucks. The tow hitch package may include the material elements listed. Standard Quantity Unit Item Number Description Standard Material Price 157.00 6.50 25.00 5.80 36.45 7.50 $238.25
1 Each 1 Each 1 Each 2 Each 1 Each 1 Each Standard Material Cost
HH87778 HH19247 HH12256 BUHP6243WC BT18176 EL42813
Hidden Hitch bracket Hitch Ball Crome 2 X 1 X 1 Ball Mount, 2 inch Pin and Clip Class 3 Modulite w/Circuit Protector Connectors, Wire, Breakers, etc.
The standard price of each item represents an average cost of the particular part multiplied by the standard quantity of items required for the tow hitch package. A supplier may quote a standard material cost of $238.25 per tow hitch package. The standard cost normally does not fluctuate, unless there is a change in the material quantity or a major increase of decrease in the material cost elements. Material-price Standard is a pre-established measure, expressed in monetary terms, of the price of material. The example shown under the material cost at standard identifies several items of material at standard price. Standard material prices usually represent the average manufacturers price for a particular item. The suppliers buy items from different manufacturers and because the costs vary, the supplier will quote a standard price for items of material. For example, lets say that your washing machine needs repairing. You call a local supplier of washing machine parts to inquire about the cost of a replacement agitator, the supplier quotes a price of $39.89 for part number AG8821 that will fit your particular washing machine. This price represents a material price at standard. Material-quantity Standard is a pre-established measure, expressed in physical terms, of the quantity of material. The example shown under the material cost at standard identifies the quantity of several items that are included in a tow kit package. The material quantity represents the standard items that are needed for the installation of the package. Material Overhead is the cost associated with the direct material, but cannot be assigned directly to the production or sales of a particular product. Some examples of cost that may be charged to material overhead pool are material handling and storage, inbound transportation, receiving and inspection, inventory adjustment, and vendor quality assurance. In some cases, direct material of minor dollar amount such as nails, screws, washers, etc. may be charged to material overhead.
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Other Direct Cost (ODC) are costs that are directly related to the end item, but are not chargeable to another direct cost objective, such as, direct labor or direct material. ODC are chargeable to a single cost objective. Examples of ODC are patent/data rights, license, travel, consultant, miscellaneous material, special test equipment. Price means cost plus any fee or profit applicable to the contract type. Price Analysis is the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit. Price Objective (Maximum) Position is the highest price that you can reasonably accept, given the information you have. The position is based on your Governments maximum should-pay estimate. Price Objective (Minimum) Position is the Governments position that represents the minimum price to acquire the product or service. This is also the starting point for the negotiation. Price Objective (Target) Position should be the price that you think is most reasonable based on your analysis of the reliability of different price estimates. It is the most reasonable price you think the Government should pay. Profit/Fee. The terms profit and fee are often used interchangeably because they both refer to the amount of money paid above the cost of doing business. However, more specifically the term profit normally refers to fixed price (FP) type contracts, with the exception of a fixed-price award fee (FPAF) contract. The term fee usually refers to cost reimbursement type contracts. Should-Pay Price is an estimated price that, in your best judgment, the Government should reasonably expect to pay for the deliverable based on available information concerning competitive offers, historical prices, commercial prices, Independent Government Estimate (IGE), etc. Unallowable Cost, sometimes referred to as expressly unallowable cost, means any costs that, under the provisions of any pertinent law regulation, or contract, cannot be included in prices, cost-reimbursements, or settlements under a Government contract to which it is allocable. When performing a cost analysis or developing a prenegotiation position, you must not allow any proposed or actual cost identified by the cost principles as unallowable. Any costs that are expressly unallowable according to FAR 31.205 must be excluded from any billing, claim, or proposal applicable to a government contract. Bad debt and goodwill are two examples of unallowable costs as stated in the regulations.
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APPENDIX C Cost Analysis Techniques

COST ESTIMATING RELATIONS (CER) (Price/Cost Analysis Technique) A cost estimating relationship (CER) is a technique used to estimate a particular cost or price by using an established relationship with an independent variable. It is a framework for using appropriate quantitative techniques to quantify this relationship. If you can identify an independent variable (driver) that demonstrates a measurable relationship with contract cost or prices (dependent variable) exist, you can develop a CER. A CER may be mathematically simple in nature (e.g., a simple ratio) or it may involve a complex equation. You can use a cost estimating relationship (CER) in any situation where you quantify one of the following: A relationship between one or more product characteristics and contract cost or price. A product-to-cost relationship uses product physical or performance characteristics to estimate cost or product price. The characteristic or characteristics selected for CER development are usually not the only ones driving cost, but the movement of cost has been found to be related to changes in these characteristics. A relationship between one or more elements of contract cost and another element of contract cost or price. A cost-to-cost relationship uses one or more elements of contract cost to estimate cost or product price. If you can establish a relationship between different elements of cost (e.g., between senior engineering labor hours and engineering technician hours), you can use a CER to reduce your estimating or analysis effort while increasing accuracy. If you can establish a relationship between an element of cost and total price (e.g., between direct labor cost and total price), you can use that information to supplement price analysis, without requiring extensive cost information.
Cost Estimating Relationship Example. Due to a major reorganization, the contracting department is going to relocate to a new facility. You have been tasked to locate and lease office space large enough to accommodate all the personnel. You are not familiar with the cost of office space so you gather several estimates and develop a CER. You examine the product-tocost relationship between the dependent variable (cost of the office space) and the independent variable (square footage). Using a rule of thumb in pricing similar office space, you can estimate the cost of the new office facility.
Appendix C Page 1
LEARNING CURVE (Price/Cost Analysis Technique) Learning curve, also known as improvement curve, cost-quantity curve, and experience curve, is a quantitative technique used to estimate the cost or price of a unit. The general concept is that the resources (labor and or material) required to produce each additional unit declines as the total number of units produced over the items entire production history increases. The concept further holds that decline in unit cost can be predicted mathematically. As a result, learning curves can be used to estimate contract price, direct labor-hours, direct material cost, or any other recurring cost. To understand the learning curve concept, imagine the first time you accomplished a difficult task like changing the oil in your car or laying wallpaper. It probably took quite a bit of time and effort the first time you attempted the task. Subsequently, each time you performed that same task the more proficient you became at doing it. Now you probably can change the oil in a matter of minutes without bruising your knuckles or spilling oil all over the driveway or lay wallpaper in half the time that it took to do it the first time you did it. Use of the learning curve should be considered in situations where there is a high proportion of manual labor and uninterrupted production. Other situations when the learning curve can be used include complex tasks and item production; minor technological changes; or continuous pressure to improve. Learning Curve Example. You need to determine price reasonableness for the cost of a single unit of production. The manufacturer offers a unit price that is 30% higher than the independent Government estimated (IGE) price. He/she contends that although the company has manufactured several of the units, the production procedure is still relatively new and as a result the price of the unit has not decreased. By collecting information other than cost or pricing data from the manufacturer, such as, the number of units already produced and the number of labor hours used to produce each unit, you can determine the rate of improvement and use it to estimate the price for your cost, price or cost realism analysis.
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PRICE INDEX NUMBERS (Price Analysis Technique) Price index is considered the most commonly used quantitative technique in contract pricing. It measures the percentage changes in price for one or several related items or services over a period of time. There are two types of indexes, simple and aggregate. Simple index numbers calculate price changes for a single item over time; and aggregate index numbers calculate price changes for a group of related items, such as such as farm products or lumber and wood products, over time. Price index numbers can be used to: Inflate or deflate price or costs for direct comparison; Inflate or deflate prices or costs to facilitate trend analysis; Estimate project price or cost over the period of contract performance; and Adjust contract price or cost for inflation and or deflation. Price Index Number Example 1. You have a four year contract for the purchase of fuel which includes an economic price adjustment (EPA) clause. Fuel prices are too unstable to permit reasonable division of risk between the contractor and the Government. The terms of the contract state that if the price of fuel increases or decreases by 15%, the contract price will be adjusted to reflect the change. You may use price index numbers to adjust the price between the delivery dates of the fuel. Price Index Number Example 2. You purchased a desk top computer in 2003 for $1,200. The price of computers has decreased significantly. Now in 2006, you are buying new computers, and you have an offered price of $1,150 for a desk top computer with the same amount of memory and features as the one you previously purchased. Since you knew the price of the computer in 2003, using a price index number can help you estimate the price of the new purchase.
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REGRESSION ANALYSIS (Price/Cost Analysis) Regression is a quantitative tool used in both price and cost analysis. It is primarily used to develop cost estimating relationships and to project economic trends. The use of regression analysis allows you to develop predictive relationships between dependent and independent variables. Most commonly used is simple regression (two-variable linear regression) in which a single independent variable (X) is used to predict the value of a single dependent variable (Y). The dependent variable will normally be either price or cost (e.g., dollars or labor rate). The independent variable will be a measure related to the product (supply or service) being acquired. It may be a physical characteristic of the product, a performance characteristic of the product, or an element of cost to provide the product. Regression analysis can be used to analyze an indirect cost rate; and to conduct time series analysis to forecast future wage rates, material costs, and production prices. Regression Example 1. You are involved in analyzing a firms direct labor cost. The offeror has proposed hourly labor rates for FY07, 08 and 09. Your technical support indicates that the number of hours proposed are sufficient to perform the task, but questions the proposed hourly rate. You can not determine price reasonableness of the proposed labor rates. As a result, you collect quarterly labor rate data for the same labor category dating back two years. Using the information, you can develop a predictive relationship between the dependent and independent variables of time and hourly labor rate, respectively, to estimate the hourly labor rate for each of the proposed periods. Regression Example 2. You are considering retiring in 20 years. You are not quite certain if you can live off on the amount of money you will receive after retirement. You estimate that your annual retirement income will be 50% of the average salary of your last three years of employment. Using historical salary information for the last 5 years where time is the independent variable and the annual salary for each year is the dependent variable, you can estimate what your salary will be for the last 3 years of service. Once the average 3 year salary is determined, you divide the amount in half. As long as the rate of inflation remains the same, your information will be relatively accurate. Regression Example 3. You have a requirement for the construction of a gym. The contractor proposed a price of $845,000 for a 4,500 square foot facility. With regression analysis you can determine cost reasonableness by collecting historical data for the cost of other facilities recently constructed. By developing an estimating equation using the size of the facility as the independent variable and the cost as the dependent, you can develop cost probability for the 4,500 square foot facility. For more detail information on Regression and how to establish an estimating equation, refer to the Regression Continuous Learning Module (CLM).
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STATISTICS (Cost Analysis Technique) Statistics is a science that involves collecting, organizing, summarizing, analyzing, and interpreting data in order to facilitate the decision-making process. These data can be facts, measurements, or observation. For example, the inflation rate for various commodity groups is a statistic which is very important in contract pricing. Statistics can be classified into two broad categories: Descriptive Statistics--include a large variety of methods for summarizing or describing a set of numbers. These methods may involve computational or graphical analysis. Inferential or Inductive Statistics--are methods of using a sample data taken from a statistical population to make actual decisions, predictions, and generalizations related to the problem of interest.
Statistical analysis can be invaluable to you in: Developing government objectives for contract prices based on historical values. Developing minimum and maximum price positions for negotiations. Developing an estimate of risk for consideration in contract type selection. Developing and estimate of risk for consideration in profit/fee analysis. Streamlining the evaluation of a large quantity of data without sacrificing quality.
Statistics Example 1. An offeror has submitted a proposal on a contract that is part of a complex on-going research program to develop and test a state-of-the-art analysis system. The offeror proposed a mean hourly labor rate o$39.00 for engineering. You can not determine price reasonableness for the proposed labor rate. Your market research indicates that the hourly rate for the type of engineering service required usually range from $26.00 to $50.00 per hour for the geographical location. To determine price reasonableness of the proposed engineering labor rate, you may consider using statistics. Simply by collecting sample data extracted from a statistical population of engineering labor rates, you can calculate a mean labor rate that may be used for your cost or cost realism analysis. Statistics Example 2. You are preparing a solicitation for a 5 year indefinite delivery, indefinite quantity (IDIQ) contact for the service of recharging replacement batteries. The batteries where placed in stock last year. You are not sure how often the service will be required. Your customer has informed you that a sample of 50 batteries extracted from the base storage facility indicates that a fully charged battery has an average shelf life of 1 year and 8 months, with a standard deviation of 3 months. You can use this statistical information to develop a confidence interval to determine when the batteries will require recharging. With more precise information you can establish the Governments prenegotiation position. For more detail information on how to use statistics, refer to the Statistics Continuous Learning Module (CLM).
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Cost Analysis Basics Introduction

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Reference: (FAR 15.403-4(b)(2)).

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