the basics of price analysis presented by edmund kowalski financial services office (fso) updated as...

The Basics of Price Analysis

Presented by Edmund Kowalski

Financial Services Office (FSO)

Updated as of April 19, 2006

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Pricing Wisdom

A cynic is a man who knows the price of everything and the value of nothing.

Oscar Wilde

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Agenda/Briefing Topics

• Price Analysis• GAO Report• Two Types of Cost or Pricing Data• Price Analysis Techniques• Commercial Items • Price Analysis Arithmetic• Price Analysis Documentation• Commercial Versus Government Contracting/Pricing • Price Comparisons Discussion• Price Analysis Techniques: Discussion• Discounts• Discussions with Offerors• Unbalanced Pricing

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Introduction

• This module presents the FAR, DFARS, and AFARS sections related to price analysis:– definitions and concepts discussed in the regulations

– direction and support for pricing evaluations.

• This module is set up to be used as a price analysis reference guide.

• The contractors know the regulations! • YOU should know the regulations too!!

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Disclaimer

• This module and others in the series represent a summary covering the pricing basics. – Not an exhaustive, all inclusive presentation on pricing

• They do not replace attending the series of DAU price and cost courses.

• This module covers many types of pricing situations, not just those pertaining to contracting in Europe.

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Price Analysis

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Price Analysis Defined

• Per FAR 15.404-1(b):

Price Analysis is the process of examining and evaluating a proposed price, without analyzing its separate cost elements and proposed profit.

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In Plain English:What is a Price Analysis?

• It’s a comparison!• A comparison of the proposed price to

– All offered prices– The current contract price– The previous/historic contract price– A similar item’s/service’s price– An IGCE– Others

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Why Perform a Price Analysis?

• A Price Analysis is performed to ensure that the offered/proposed price is fair and reasonable.– FAR 15.402(a): Contracting officers shall

purchase supplies and services from responsible sources at fair and reasonable prices.

– FAR 15.404-1(a)(1): The contracting officer is responsible for evaluating the reasonableness of offered prices.

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What is a Fair and Reasonable Price?

• There is no specific definition for “Price Reasonableness” or “Fair and Reasonable Price” in the FAR.– Suggestion: Substitute price for cost in the FAR

definition below.– Cost Reasonableness: A cost (price) is reasonable if,

in its nature and amount, it does not exceed what a prudent person would pay in the conduct of competitive business [FAR 31.201-3(a)].

• Bottom Line: Price Reasonableness is determined by the results of a price analysis.

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FSO Working Definition of Price Reasonableness

• A price is determined reasonable if it does not exceed what a prudent consumer and/or businessman would pay in the conduct of competitive business, based on the written results of a price/cost analysis for which the contracting officer’s rationale, assumptions, calculations, and final conclusion (reasonableness determination) are verifiable and convincing to a third party.

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When Must a Price Analysis Be Performed?

• A Price Analysis is always performed!– Price analysis shall be used when (certified) cost or pricing data are not

required [FAR 15.404-1(a)(2)].– If a cost analysis is performed when (certified) cost or pricing data are

required, a price analysis should also be used to verify that the overall price is fair & reasonable [FAR 15.404.1(a)(3)].

– At a minimum, the contracting officer must use price analysis to determine whether the price is fair and reasonable whenever acquiring a commercial item [FAR 15.403-3(c)(1)].

• Be prepared: Management always asks how the proposed price compares to the previous contract figure or similar items/services on the market.

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Examples of When a Price Analysis Is Used

• Competitive Procurement: Comparing competing offers.

• Competitive or Sole Source Procurement: Comparing the low or proposed price to a– Historic price (data) for the same or similar item

– Current price (data) for the same or similar item

• Sole Source Procurement: cost analysis performed– Unit/total price is compared to historic or current contract prices for the

same or similar item/service as additional support for the cost analysis

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GAO/DoD IG Reports (Or Why Should You Care?)

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Summary Results of GAO Report, June 1999: DOD Pricing of Commercial Items Needs

Continued Emphasis: (1 of 3)

1. Price Analyses are too limited to ensure that the proposed prices were fair and reasonable.

2. Pertinent historical pricing information was not utilized in price analyses, such as prior contracts or contracts at other agencies.

3. Base comparison prices were not determined to be fair and reasonable; thus, they are not valid for use in price comparisons.

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Continued Emphasis: (2 of 3)4. Buyers are accepting offered prices as fair and

reasonable, when identical to the catalog or list price figures (ignoring discounts, etc.).

5. Some prices included the costs for services that were not requested (paying price premiums).

6. PCOs are not using the discretionary clause (FAR 52.215-20), requiring offerors to provide information other than cost or pricing data, such as sales data, as support for proposed prices.

7. Contract files lacked documentation .

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Continued Emphasis: (3 of 3)• Conclusion?

– Management is looking at the price analyses performed by the contracting community

– Price analysis is an important function and part of the contract specialist’s job

– Documentation is essential

• Opinion: There doesn’t appear to be any negative fallout if it is not done properly

• Report Number: GAO/NSIAD-99-90, June 1999• Study references ODUSDA(AR) Information Guide,

Commercial Pricing

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IG DoD Audit Report

• Contracting Officer Determinations of Price Reasonableness When Cost or Pricing Data Were Not Obtained– Report Number D-2001-129, dated 30 May

2001– Office of the Inspector General Department of

Defense

• Basically, it came to the same conclusions

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Two Types of Cost or Pricing Data

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First Type: (Certified) Cost or Pricing Data [FAR 2.101]

• Definition: All facts that, as of the date of price agreement or, if applicable, an earlier 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.– Are factual, not judgmental, and are verifiable.– Includes data forming bases of judgments.– More than historic accounting data.– All facts contributing to soundness of estimates.

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Second Type: Information Other than Cost or Pricing Data

[FAR 2.101]• Definition: Any type of information that is not

required to be certified IAW FAR 15.406-2 and is necessary to determine price reasonableness or cost realism.– Such information may include pricing, sales, or cost

information, and includes cost or pricing data for which certification is determined inapplicable after submission.

• Certification is the difference between the two categories of cost/price data!

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Certification of Cost or Pricing Data [FAR 15.406-2]

• When cost or pricing data are required, the contracting officer shall require the contractor to execute a Certificate of Current Cost or Pricing Data.

• “To the best of my knowledge and belief, the cost or pricing data submitted, either actually or by specific identification in writing, to the Contracting Officer or the Contracting Officer’s representative in support of (the proposal) are accurate, complete, and current as of (date negotiations complete or price agreement reached).”

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Certification Implications for the Contractor

• Emphasis on non-certified data was an Acquisition Streamlining change:– To reduce lead-times and costs to the Government & Contractors– Facilitate evaluations and reduce post award administration

• Certification is expensive to the contractor in terms of time, manpower, and cost.

• Administrative and Legal problems for contractors with certification:– Truth in Negotiations Act (TINA) - 10 U.S.C. 2306a and 41 U.S.C.

254b) – DCAA post award audits– Potential defective pricing

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Exemptions from (Certified) Cost or Pricing Data Requirements

• FAR 15.403-1(b) provides five exemptions– Adequate price competitionAdequate price competition– Prices set by law or regulation– Commercial items– Waivers– Modifying commercial item/service contract or subcontract

• FAR 15.403-2 adds the exercise of options if the price was established at contract award or initial negotiation.

• Also FAR 15.403-1(a): Cost or pricing data shall not be obtained for acquisitions at or below the simplified acquisition threshold.

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Adequate Price Competition [FAR 15.403-1(c)(1)] 1 of 3

1. Two or more responsible offerors, competing independently, submit offers that satisfy the expressed requirement

– Award based on best value where price is a substantial factor in the source selection.

– There is no finding that the price of the otherwise successful offeror is unreasonable.

(A finding that the price is unreasonable must be supported by statement of the facts, approved at the level above the PCO.)

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2. Received only one offer but:– PCO expected competition (two or more responsible

offerors, etc) based on market research or other assessment

– PCO concludes offeror also expected competition

– A written Determination documents that the price• Is based on adequate competition

• Is reasonable

• Is approved at level above PCO

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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.”

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Waivers [FAR 15.403-1(c)(4)] 1 of 2

• The Head of the Contracting Agency (HCA) may waive the requirement for submission of cost or pricing data in exceptional cases.– This authorization must be in writing with supporting rationale.

– The waiver is based on a determination of the price as fair and reasonable without submission of (certified) cost or price data.

• Example: data submitted on previous production buys sufficient for the current one, when combined with updated information,

– Subcontractors are still required to submit certified data unless a separate waiver is obtained.

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Waivers [FAR 15.403-1(c)(4)] 2 of 2

• Per DFARS 215.403-1(c)(4), DOD also waived the requirement for submission of cost and pricing data for:– Canadian Commercial Corporation (CCC) and its

subcontractors.

– Nonprofit organizations, including educational institutions, on cost-reimbursement-no-fee contracts.

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Obtaining Information to Establish Price Reasonableness [FAR 15.402(a)]

• Do not obtain more info than necessary.– Data collection/preparation is expensive

• Order of preference for type of data required.

1. No additional information, if price based on adequate price competition (except as in FAR 15.403-3(b))

2. Information other than cost or pricing data

3. (Certified) cost or pricing data

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Order of Preference for Obtaining Information Other Than Cost or

Pricing Data

• FAR 15.402(a)(2) states– Rely first on information available within the

Government.– Second, on information obtained from sources

other than the offeror.– If necessary, on information obtained from the

offeror.

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Information Other than Cost or Pricing Data General [FAR 15.403-3(a)]

• If the PCO obtains information other than cost or pricing data from the offeror, it must include appropriate information on the prices at which the item or similar items have been sold, adequate for determining price reasonableness.– Example: Prices/sales data from the same/similar items

at comparable quantities.

– See Chapter 2, Volume 3, Contract Pricing Reference Guides

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Price Analysis Techniques

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Proposal Price Analysis Techniques[FAR 15.404-1(b)(2)]• Compare offers received *• Compare proposed prices to price history *

– or system bill of material or current contract

• Parametric methods• Comparison to published (catalog) price lists and published

market prices• Comparison with independent government estimates • Compare proposed prices to market research or pricing data for

same/similar items• Analysis of pricing information provided by the offeror.

* preferred techniques per FAR 15.404-1(b)(3)

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An Aside: FAR 2.101 Definitions

• “Catalog price” – means a price included in a catalog, price list, schedule, or other

form that is regularly maintained by the manufacturer or vendor, is either published or otherwise available for inspection by customers, and states prices at which sales are currently, or were last, made to a significant number of buyers constituting the general public.

• Artifact of the old days • Use/view with caution since price lists are easily produced

• “Market prices” – means current prices that are established in the course of ordinary

trade between buyers and sellers free to bargain and that can be substantiated through competition or from sources independent of the offerors.

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Proposal Price Analysis Techniques

DFARS 215.404-1(a)(i) – (iv)]• For spare parts and support equipment,

perform an analysis– If proposed price exceeds last price paid (in last

12 months) by 25% or more– Comparison of item description and proposed

price indicate potential for overpricing– Significant high-dollar items– Random sample of low dollar items

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Auxiliary Price Analysis Techniques

• These include:– Value Analysis: List the functions required, and

compare to those of alternative products with know prices

– Visual Analysis: Inspect the item or drawings to get a general idea of price, and to prevent oversights

• These techniques cannot be used alone: They provide subjective results that can be used to support traditional techniques.

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Comparing Offers Received

• If you have competition on a fixed-price type contract, comparing offers received will normally satisfy the requirement for price analysis. (FAR 15.305(a)(1))– Generally, when the lower/lowest proposed

prices are in a close range, it is more likely that the prices are fair and reasonable.

– If you find that the price is unreasonable [FAR 15.403-1(c)(1)(i)(B)], a cost analysis may be required.

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Comparing Offers ReceivedSample Problem

• You receive three offers for a widget:

Offeror A proposed $100 per unit.

Offeror B proposed $125 per unit.

Offeror C proposed $130 per unit.

• Trick Question: Is the price based on adequate price competition?

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Answer to Sample Problem on Comparing Offers Received

• There is not enough information.• The problem didn’t state if the offerors are

competing independently– Are they dealers or manufacturers?

• Nor did it state that a price analysis clearly demonstrates that the proposed price is reasonable in comparison with other contracts.

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Commercial Items

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What is a Commercial Item?

• Commercial Pricing Information Guide, Volume 1, ODUSD(AR), provides a working definition:

– A commercial item is any item evolving from, or available in the commercial market place that will be available in time to satisfy the user requirement.

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Commercial Item Defined FAR 2.101

• Any item, other than real property, that is of a type customarily used for non-governmental purposes and that:– Has been sold, leased, or licensed to the general public– Has been offered for sale, lease, or licensed to the general public– Has evolved from a commercial item that is sold or offered for sale

as a result of technological advancement– Requires either modifications or a type that is customarily available

in the commercial market place or minor modifications for unique government purposes or

– Is any of the above

• Also government unique items that are developed exclusively at public expense and sold to multiple state and local governments.

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Commercial Services Defined FAR 2.101

• Installation services, maintenance services, repair services, training services, and other services if--

– Such services are procured for support of a commercial item, regardless of whether such services are provided by the same source or at the same time as the item; and

– The source of such services provides similar services contemporaneously to the general public under terms and conditions similar to those offered to the Federal Government;

• Services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices for specific tasks performed or specific outcomes to be achieved and under standard commercial terms and conditions. This does not include services that are sold based on hourly rates without an established catalog or market price for a specific service performed or a specific outcome to be achieved.

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Commercial Items Are Exempt from Certified Cost or Pricing Data

• Except for certain alterations to the items and contract modifications, commercial items are exempt from the requirement for certified cost/pricing data.

• Requests for offeror’s sales data should be limited to data for the same or similar items during a relevant time period [FAR 15.403-3(c)(2)(I)].

• To the maximum extent practicable, limit any request for info to include only info that is in the form regularly maintained by the offeror [FAR 15.403-3(c)(2)(ii)].

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FAR Part 12 Acquisition of Commercial Items (1 of 2)

• Point to be Made: cross referencing of FAR cites.• Per FAR 12.209 Determination of Price

Reasonableness – established IAW – FAR 13 Part Simplified Acquisition Procedure

• Cites FAR 13.106-3 Award and Documentation

– FAR Part 14 Sealed Bidding • Cites FAR 14.408-2 Responsible Bidder – Reasonableness of

Price– References price analysis techniques in FAR 15.404-1(b)

– FAR Part 15 Contracting by Negotiation• Cites FAR 15.4 Contract Pricing

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FAR Part 12 Acquisition of Commercial Items (2 of 2)

• FAR 13.106-3 Award and Documentation– Before making award, the contracting officer must determine that the

proposed price is fair and reasonable.(1) Whenever possible, base price reasonableness on competitive quotations or

offers.(2) If only one response is received, include a statement of price reasonableness

in the contract file. The contracting officer may base the statement on --(i) Market research;(ii) Comparison of the proposed price with prices found reasonable on previous

purchases;(iii) Current price lists, catalogs, or advertisements. However, inclusion of a price in a

price list, catalog, or advertisement does not, in and of itself, establish fairness and reasonableness of the price;

(iv) A comparison with similar items in a related industry;(v) The contracting officer’s personal knowledge of the item being purchased;(vi) Comparison to an independent Government estimate; or(vii) Any other reasonable basis.

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Price Premiums

• Per FAR 12.209: Commercial item prices are affected by factors as– speed of delivery, length and extent of warranty, limitations of seller’s

liability, quantities ordered, length of the performance period, and specific performance requirements.

• Per FAR 12.209: The contracting officer must ensure that contract terms, conditions, and prices are commensurate with the Government’s need.

– Be aware of “price premiums,” included but not specifically indicated/stated, on catalog/price lists for quick delivery, small or minimum quantity orders, etc.

• Price Premium Example: Boeing’s catalog priced items for quick delivery (within 24 hours).

– The buyer was unaware of this price premium. It was an unnecessary cost; the items were going to a depot for storage, not out to the field.

– Result: the item was over-priced (high).

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Minor Item Modification per FAR 2.101(c)

• A modification that does not significantly alter the non-governmental function or essential physical characteristics of an item or component, or change the purpose of a process– Factors to consider:

• Value and size of the mod versus the comparative value and size of the final product.

• Dollar values and percentages are guideposts, not conclusive evidence.

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Acquisitions of Modified (altered) Commercial Items

• If the item modifications are of a type customarily available in the commercial marketplace, you should be able to evaluate the item and the modifications/alternations on a commercial basis.

• If you are acquiring an otherwise commercial item with noncommercial alternations, you may need to get certified cost/pricing data (or information other than certified cost/pricing data) to evaluate the alternations, and evaluate the base commercial item on a commercial pricing basis.

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Modifications to Contracts for Commercial Items

• If the contract mod changes the item to a noncommercial item, and no other exception applies, the modification is not exempt from the requirement for (certified) cost or pricing data.

• If the mod does not change the item to a noncommercial item, consider what “information other than cost or pricing data” you may require.– This can range from info on prices to cost data that is

not certified (see restrictions on data for commercial items.

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Price Analysis Arithmetic

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Price Analysis Arithmetic Examples

• Calculating the price difference and percentage change for– a price increase

– a price decrease

• Calculating the annualized percentage change

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Calculating Percent Change:

Two Scenarios• 1st scenario: price increase

– current or proposed price is $150

– previous or comparison price is $110

• 2nd scenario: price decrease.– current or proposed price is $110

– previous or comparison price is $150

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Calculating Percent Change, Scenario One; Price Increase

Current or proposed price $150Less previous/comparison price ($110)Equals price change/difference $ 40Divided by previous/comparison price $110Equals 0.3636Result multiplied by 100Equals percent change/difference 36.36%

There is a $40 or 36.4% difference between the two prices.There is a $40 or 36.4% increase in the price.

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Calculating Percent Change, Scenario One; Price Decrease

Current or proposed price $110Less previous/comparison price ($150)Equals price change/difference ($ 40)Divided by previous/comparison price Divided by previous/comparison price $150$150Equals (0.2667)Result multiplied by 100Equals percent change/difference (26.67%)

There is a $40 or 26.7% difference between the two prices. There is a $40 or 26.7% reduction in the price.

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Calculating the Annualized*Percentage Change (1 of 3)

The Pricing Scenario:• Previous or comparison price.

– Last award date: May 9, 1996– Unit Price: $4,976.59

• Current or proposed price.– Projected award date; November 27, 1997– Unit Price: $6,295.00

* Using TACOM’s method per the old SOP 715-1

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Calculating the AnnualizedPercentage Change (2 of 3)

Steps: 1 Calculate the difference in days between the

previous and projected award dates. 2 Calculate the percentage change in prices. 3 Divide 360 (30 days per month x 12 month) by

resulting figure of step 1. 4 Multiply the result figure of step 3 by the result

of step 2. 5 Multiply result of step 4 by 100.

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Calculating the AnnualizedPercentage Change (3 of 3)

1 From 9 May 96 to 27 Nov 97 is 558 days. 2 From $4,976.59 to $6,295.00 results in a $1,318.41 difference or 26.49% price increase. 3 Divide 360 by 558 = 0.6452 4 Multiply 0.6452 by 0.2649m = 0.1709 5 Multiply 0.1709 by 100 = 17.09% The 26.5% price change represents an annualized increase of approximately 17%.

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Price Analysis Documentation

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Competitive ProcurementPrice analysis (PA) Example

(1 of 4)

• Example Scenario:– Commercial item procurement– Significant quantity– Reasonable delivery schedule– Competition expected

• What type of analysis and documentation are necessary?

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Competitive Procurement PAExample (2 of 4)

• “Suggested” documentation:

– prepare spreadsheet• arrange offers by ascending dollar value• detail dollar and percent differences between offers• detail dollar and percent differences between the low and competing offers

– prepare narrative• indicate low offer • indicate number of offers• discuss price and percentage differences• others (procurement history, etc.)

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Offer

Red

Price

$1000

$ Diff

N/A

% Diff

N/A

$ LO

N/A

% LO

N/A

Blue

Green

White

$1050

$1500

$2050

$50

$450

$550

5%

43%

37%

$50

$500

$1050

5%

50%

105%

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• Documentation:– “Four offers were received. Red is the low

offeror at $1000. With the second low offer at $1050, reflecting an approximate 5% difference, there appears to be adequate price competition.”

– “The low offer compares favorably with the previous contract price.”

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Price Analysis: The Basics

• Use the previous or similar item price as the base for the comparison.– Calculate dollar amount difference– Calculate percentage difference

• Price Change? – Increase or decrease ?

• Materiality: Is the difference significant ?– Explain/discuss the difference.– Action needed to be taken ?

• Document: price analysis (negotiation).

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Price Analysis: More Basics• Extent/depth of the price analysis is determined

by:– Type of contractual action

– Type of item purchased

– Dollar value of contractual action

– Agency/department policy and procedures

– Availability of price/cost data and other information

– Your team leader/supervisor (Dah Boss)

• Not all price differences can be explained away.

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Unit Versus Total Prices

• Question: For price analyses and comparisons, should you use unit or total prices?

• Answer: It depends on the procurement type and management policy.– Unit prices are useful and expected for item

comparisons (trucks, tires, etc.).– Use totals

• to show total procurement price• for comparison purposes if procurement involves various types

of items and services.

– Check for Unbalanced Pricing

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Price Analysis: Documentation

• “There is a $_______ difference between the current proposed and previous (similar item) prices; this resents a (an) ____% difference over a (an) ____ time period.”

• The following factor(s) may explain the price difference: __________ (quantity, economics, etc).

• Adjusting the comparison price for the factors results in the following amount $______.

• “The adjusted figure does/does not compare favorably with the proposed price.”

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Commercial Versus Government Contracting/Pricing

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Commercial VersusGovernment (1 of 3)

• Government and Commercial buyers are from Venus and Mars, respectively.

• They have different objectives, procedures, and modes of operation.

• This difference is recognized in the business world as evidenced by comments in Purchasing magazine.

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Commercial VersusGovernment (2 of 3)

• Commercial – Bottom line/profit driven– Price is important– Price targets determine the buyer’s bonus and

impact evaluations– Partnering leading to more cost analysis– Less rule driven

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Commercial Versus Government (3 of 3)

• Government– NOT bottom line/profit driven, the budget is the

constraint– Fair and reasonable price rather than the lowest (or

best) price obtainable– Partnering with the contractor less intensive than the

commercial world– Buyer rated on making the award and reducing lead-

time– Despite Acquisition Reform, government purchasing is

still rule driven

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Basis of Contractor’s Price:Cost Plus Profit Pricing

(1 of 2)

• Cost plus profit price (cost based)– Used by Government in cost analysis– Also used by the commercial world– Cost element build-up– Profit based on structured criteria– Pro: all costs recovered with acceptable profit– Con: resulting price may not be competitive

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Basis of Contractor’s Price:Cost Plus Profit Pricing

(2 of 2)

• Selling price = cost + markup

• Percent Markup = (markup + cost or selling price) x 100

• Note: the markup can be calculated using either cost or selling price. The resulting percentage figures will differ between cost and sales price as a base in the calculation.

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Basis of Contractor’s Price:Market Based Pricing

• Market based price (price based)– Demand oriented pricing: price set at level buyers

are willing to pay for an item/service and/or level of performance.

– Price set with competition in mind (also called parallel pricing); price increases are limited; cost containment important.

• Differentiate one’s product through advertising, high quality, delivery, and/or customer service.

– Price Leader Pricing. Seller sets prices & price changes followed by others.

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Basis of Contractor’s Price:Price Strategy (1 of 3)

• Buy-in. Price set with low profit, at cost, or below cost to obtain the business; profit recouped with follow-on business, spares etc.

• Idle Capacity.– Low price offered (low or no profit, at or below cost) to

keep shop open, continue to employ key personnel & avoiding layoffs, covering fixed costs, etc.

– Legitimate business strategy

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• Product Life Cycle. Price set depending on life cycle stage (introduction, growth, maturity, saturation, and decline)– new product/price skimming – high price to attract status

conscious customers– growth – market penetration through low prices and high

sales volume

• Rate of Return Pricing. Price set to obtain desired return of investment.

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• Price Bundling. Practice of offering two or more products or services for sale at one price.

• Perceived Value. Seller sets price at the level the intended buyers value the product.

• Loss Leader. Item priced low or at cost to attract buyers to seller’s place of business.

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Price Comparisons Discussion

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Base Price/Comparison Price Reasonableness (1 of 2)

• The comparison price must be reasonable (and supported as reasonable) to be used as a base in any price analysis.– Competitive? Number of quotes & the price

range(s). – Obvious/not so obvious competitive advantage?

Awarded previous contracts?• Amortized tooling, special tooling/equipment,

proprietary item/data, etc.

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Base Price/Comparison Price Reasonableness (2 of 2)

• Sole source? Basis of award.– Price analysis performed/Results.

– Cost analysis performed? Results.

• Independent (Government) Cost Estimate?– Customer

– Industrial Price Analysts

– Cost Analysis Section/Group/Directorate

– PMO/PEO Engineers

– DCMA

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Price Comparisons:Introduction

• When performing a price analysis, it is important to have an “apples to apples” comparison.

• This is not always possible; there are many variables differentiating purchases.

• The analyst will have to adjust the base or previous price to allow for a valid comparison.

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Compare Proposed Prices to Current Prices and/or Price History

• The previous or comparison price used as the base must be reasonable for the “same or similar” contract terms.

• For the comparison to be valid your analysis should adjust the price for:– Economics (price escalation/de-escalation)– Quantity variations (use learning curve)– Technical/configuration changes– Startup tooling/pre-production costs– Packaging differences– FOB: origin or destination

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Price Analysis: Caveat

• Even in price analysis, the individual cost elements are important.

• Though not visible as in cost analysis, these elements influence the final price; a general knowledge of them is necessary.

• They are approached and discussed in general terms as percentages, round number estimates, etc.

• They may be addressed in the price analysis document.

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Price Comparison Example(1 of 2)

• Proposed unit price is $150, FOB: origin, and commercial pack/packaging.

• Comparison unit price of $136 is approximately two years old, quantity is approximately 50% more than the current buy, FOB: destination, and special military pack/packaging.

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Price Comparison Example(2 of 2)

• Current price $150• Comparison Price $136

Differences/Adjustments: Quantity + 15 Transportation/FOB - 5 Packaging - 3 Economics + 4 Adjusted Comparison Price $147

• The $147 adjusted comparison price is approximately 2% less than that proposed. This difference could represent estimating error.

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Price Comparison:Same Contractor? (1 of 3)

• Different contractor means different cost structure.

• Different contractor may mean different price/cost objectives (price strategy).

• Basis of the contractor’s price?– Cost plus profit price (cost based)– Market based price (price based)

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• Foreign or domestic?– Foreign currency (FX) impact on price?

– Customs/Duty/Tariff included in the price?

• Manufacturer or Dealer?– Dealer expected to offer higher price

• New Contractor?– Production Start-up costs included?

– Other Nonrecurring costs: tooling, certification, etc.

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• Contractor’s size and expertise are important factors.– Large firms may have higher overhead, enjoy

economies of scale, and/or have wider expertise.– Small firms may be more flexible, have more expertise

in a niche area, and/or lower overhead.

• A contractor’s past performance is also an important price consideration.– If a contractor is late, cannot deliver, or was terminated,

how good is his price?

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Price Comparison:Same Item?

• Purchased complete or partial?• ECP or VECP incorporated?• New or old model?• Special treatment, manufacturing process, or

material (special bolts)?• Quality differences?

– Example: “ruggedized” items such as computers, other electronics.

• Are these differences material?

91

Price Comparison:Packaging

• Level of packaging similar?

• Packaged in bulk or is each item packed/packaged separately?

• Commercial or Military?

• Any special instructions?

92

Price Comparison:Transportation

• Vendor’s Geographic Location impacts the item’s price and his competitive position.

• F.O.B. (Free on Board) Point?– Destination. Transportation cost, insurance,

etc., included in the price.– Origin. Transportation cost not in the price;

buyer pays/arranges for transportation, insurance, etc.

93

Price Comparison:Economics/Time Period

• When was the previous or similar item contract awarded and/or completed?

• Cost change over time:– Material costs increase or decrease– Wages (usually) increase

• Most contractors propose rising prices.• Does the comparison price include a

contingency for economics, price in effect, and/or is it ceiling priced?

94

Economics/Escalation:Price Indexes

• Governments measure the change in the prices and costs of goods and services– U.S. Depart of Labor, Bureau of Labor Statistics (BLS)– Federal Statistical Office Germany

• Common indexes– Consumer Price Index (CPI)

• Measure of what consumers pay

– Producer Price Index (PPI)• Measure of what businesses pay

– Average Hourly Earnings (AHE)– Employment Cost Index (ECI)

95

Example: Applying Escalation Using Price Indexes Problem

• Item: Ball Bearings– Nov 1996 price: $350– Aug 200X price: ? – Proposed price is $375

• PPI # 1149 05 Ball Bearings– Nov 1996: 158.7– Aug 200X: 171.8

• What is the expected/adjusted price for Aug 200X?

96

Example: Applying Escalation Using Price Indexes Solution

• PPI # 1149 05 Ball Bearings– Nov 1996: 158.7– Aug 200X: 171.8

• Calculation:171.8 / 158.7 = 1.0825$350 * 1.0825 = $378.88

• Solution:– Expected/adjusted price is $378.88 in Aug 200X

• Proposed price of $375 is a bargain.

97

Price Comparison:Quantities/Deliveries

• Same Quantity ?– Is there a significant

difference ?– Learning curve

adjustment needed ?

• Delivery Schedule ?– Same, shorter, or

longer

• Delivery Rate ?– Monthly/quarterly ?

– Same quantity per delivery ?

– Lot buy ?– Periodic deliveries ?– Advanced delivery ?– Options ?– Multi-year ?– Price bundling ?– Economic order

quantities ?

98

Price Comparison:Significant Material/Component?• Is Material a major cost driver ?

– Batteries: lead is the cost driver.• Check BLS PPI or American Metals Market for

historic prices/price trends

– Others: aluminum, steel, copper etc.

• Foreign source components ?– Change in foreign exchange rate may impact

the price.

99

Price Comparison:Other Considerations

• Surplus or excess item ?• Contract Terms and Conditions.• Administrative Costs: none versus extensive

customer relations/contact.• Warranty included ?• Prompt Payment (Cash) or other types of Discounts

taken into account ?• Buyer (Government) furnished information, property,

or personnel ?• State of Market/Economy.

100

Price Analysis Techniques:Discussion

101

Parametric Methods

• Using rough yardsticks (ratios) such as dollars per pound or per horsepower, etc.

• Be very careful when applying this technique. You need a large sample size and an appropriate one.

• Often this technique can be used to highlight significant inconsistencies that warrant additional pricing inquiry.

102

Parametric Price Analysis: Sample Problem

• Pricing information indicates engines with– 300 horsepower costs $9,000– 425 horsepower costs $14,000

• Your requirement: 500 horsepower engine with technical features similar to the above two engines.

• Using parametric analysis, estimate a “ball park” price for your engine?

103

Possible Answer to Sample Problem on Parametric Price Analysis

• The pricing information indicated similar engines cost about $30 to $33 per horsepower (hp)– $9,000/300hp = $30 per hp

– $14,000/425hp = $33 per hp

• A “ball Park” estimate for a technically similar 500hp engine might be between $15,000 and $16,500.– $30hp x 500hp = $15,000

– $33/hp x 500hp = $16,500

104

Comparison Price Sources (1 of 2)

• Previous contract.• Current or previous contract for similar

item.• Current or previous proposals.• Vehicle Bill of Material (BOM).• Spare Parts/Contractor Support Lists.• Program Office (PMO or PEO).

– Engineers, logisticians, material managers.

105

Comparison Price Sources (2 of 2)

• Commercial retail outlets, distributors, dealers, etc.

• Company web sites (Market Research)

• Independent (Government) Cost Estimates (ICE or IGCE)– PM/PEO Engineers– DCMA

106

Comparison Price Sources:Suggested Publications & Web Sites

• Purchasing• American Metal

Market• Modern Materials

Handling• Government Product

News• Thomas Register• Yellow Pages

• Heavy Duty Trucking• McMaster-Carr

Supply Company• Rock & Dirt, The

Equipment Marketplace

• Monthly Labor Review/Employment & Earnings – BLS

107

Price Analysis Technique – Compare to Market Research Data

• Search the Internet. A popular site is: www.imart.org

• Contact other commands and/or agencies that may have purchased similar items.

• Contact trade groups/professional organizations.

• Become the expert on the marketplace for the type of items or services you purchase.

http://www.imart.org/

108

Commercial Items: Published Market Prices and Price Lists

• Be sure to understand available quantity and other discounts available from the published price. Also the terms/conditions the price is based on.

• Again: The price isn’t necessarily reasonable just because an item is in a published price list.

109

Price Analysis:Catalog/Market Prices

• Catalog: published or on computer? Is it available for inspection ?– What are the quantity/price breaks?

– What are the price discounts?

– Catalog date. Updated: when/how often?

• Support documentation available?– Invoices of actual sales for the same or similar items

with comparable quantities and/or prices. Same terms & conditions?

110

Evaluating Prices on Commercial Items

• A price listed in, or discounted from a catalog, doesn’t make it reasonable.

• Use business/common sense.• Use market research to really evaluate

whether the price is good.• Use techniques similar to those you use

when you make important purchases for yourself.

111

Potential Questions on a Catalog Price

• What is the discount policy?• What quantity levels are needed to get price breaks?• What is the included level of packaging?• Are prices based on faster delivery than needed?• Is a warranty included?• What FOB point is the price based on?• How often is the catalog revised?• Examples/proof of other customers paying same price,

with similar terms & quantity. (Ask the contractor to provide sales invoices.)

112

Percent of Sales Test

• Previously used to define commercial sales, it is still a valid technique for reasonableness determination– The item’s total sales for a specified time period (one

year) are divided between commercial customers and the government

– If there is a reasonable distribution between the Government and the general public, usually market pricing pressure adequately controls prices.

– If the government become the only or majority buyer, the proposed price should be closely scrutinized for reasonableness.

113

Independent Government Cost Estimate (IGCE)

• Obtain an IGCE from the requiring activity/customer– FSO can assist them in the preparation

• You can compare offered prices to the estimate that came with a PRON.– Consider investigating how the requiring office came

up with the estimate.

• An alternative is to obtain an estimate from industrial price/cost analyst or DCMA, especially if you have a TDP.

114

Seeking Pricing Info Over the Phone/Internet (1 of 2)

• May involve speaking to sales or trade organization representatives to obtain data.

• Be prepared ! Have as much information as possible. Be polite. Don’t waste the rep’s time. Cultivate the rep as a source of info.

• Explain: “From Government. Doing price study.”

115

Seeking Pricing Info Over the Phone/Internet (2 of 2)

• Have basic information ready:– Known source. Manufacturer’s name, item

nomenclature/description, and serial/model/part number.

– Similar item. Same info as above. If not available, product specs, its function, etc.

– Basic/minimum information. Quantity, delivery period, packaging.

116

Discounts

117

Types of Discounts

• Trade or functional discount

• Promotional discount

• Cash (prompt payment) discount

• Quantity discount– Cumulative– Non-cumulative

• Mom’s price (most favored customer)

118

Trade/Functional DiscountsDefined

• Trade or functional. Price reduction allowed to a class of customers (manufacturing, wholesalers, retailers) on a list price before credit terms consideration; applies to allowance granted w/o reference to payment date.

• Promotional. Price reduction given to retailers and/or wholesalers in return for product promotion.

119

Cash (Prompt Payment)Discounts Defined

• Definition. Price reduction for payment of invoice or account made within a specified period of time.– Seller’s rationale:

• To encourage prompt payment of invoices.• To reduce his credit risks & cost of collecting

overdue accounts.• To follow industry or historical practice.

120

Cash Discounts:Seller’s Considerations

• Amount of cash discount

• Length of credit period

• Customers offered credit terms

• Other (credit line magnitude or amount to spend on collecting overdue accounts).

121

Cash Discounts:Application/Accounting

Practice• (In both price and cost analysis) Credit

applied directly to the item’s price• (In cost analysis) Factor, calculated from

actual data, directly applied to the total material rather than a single item

• (In cost analysis) An indirect expense item in the overhead pool applied through the overhead rate

122

Cash Discounts: Example

• Discount offered: 2/10 net 30 (or 2% - 10, Net 30 days).

• 2% discount of the price if paid within 10 days of the invoice date; if not taken, full price payment due within 30 days.

• Price @ $100 total. Pay $98 within 10 days ($100*[100% - 2%]) or $100 within 30 days.

123

Quantity Discount Defined

• Price reduction for volume purchases. Two types:

– Cumulative. Price reduction for purchases that exceed a given volume level over a specified time period. Also called deferred or patronage discount.

– Non-cumulative. Price reduction for volume purchases in a single point of time.

(Volume level refers to dollar value, quantity, or

both).

124

Quantity Discount:Know the Specifics

• Seller’s consideration/buyer’s inquiry – Minimum quantity purchased to qualify for a

discount– Number of price breaks or additional discounts

for larger quantities– Maximum quantity qualifying for any

additional discount – Amount of discount offered at each quantity

level

125

Quantity Discount: Rationale(1 of 2)

• Larger orders reduce seller’s costs; savings passed on to customer.– Fewer orders processed/shipped & fewer sales calls to

generate the larger orders

– Longer production runs:• Material quantity discounts for manufacturer

• Fewer production line and/or equipment set-ups

• Other non-recurring costs amortized over the larger quantity

• Effect of the learning curve on labor hours

126

Quantity Discount: Rationale(2 of 2)

• Rationale (continued)– Operations costs reduced by shifting finished

goods carrying costs to buyer– Extra funds reinvested sooner– Subtitle form of profit sharing among channel

members leading to channel cooperation– Tradition/industry practice.

127

Quantity Discount & theLearning Curve

• Quantity discounts may be estimated using the learning (experience) curve.– Simple definition: costs (hours) decline by a

predictable amount (percentage) each time accumulated volume doubles.

• In many cases, the quantity discount price schedule will reflect a logarithmic function (the mathematical term for the learning curve).

128

Price History & Quantity Impacts-Use of Learning Curve

• Although normally used for production labor hour analysis, learning curve can sometimes be applied in price analysis.

• Consider learning curve when:– Percentage-wise, the quantities you require vary significantly from

the price history, and– Contractors produce the previous and current quantities on a stand-

alone basis, with fairly significant production breaks in-between

• This is evident in many vendor quotes, where vendors detail different quantity price breaks.

• To calculate learning curve impacts, consult someone with experience doing this. We have an Excel file that does the calculation.

129

Discussions With Offerors

130

Discussions with Offerors

• Congressional criticism that buyers were not getting the “best price” for the government.– Damned if you do, damned if you don’t situation

• Bargaining allowed?• Unfair to contractors?• Time consuming

• When do you have discussions? – In Negotiated Procurements

• If multiple offerors, competitive range must first be established.

131

Reasons to Conduct Price-Related Discussions

• Price has increased significantly from last contract, or deviates from government estimate.

• You need the offeror to support their price and/or provide additional data.

• Offeror proposes a catalog price. – Ask what terms the price is based on.

• Changed conditions.

132

Benefits of Conducting Price Discussions

• Minimizes chances of misunderstanding• Allows us to bargain• Often you can obtain cost/price savings not

included in the initial proposal (“Is this your best price, Mr. Contractor?”)

• Secretary of Defense supports award without discussions, to reduce lead time, only in appropriate circumstances.

133

Example of Changed Conditions

• On a negotiated procurement, if conditions change consider obtaining revised quotes.

• For example, on an Indefinite Delivery Indefinite Quantity (ID/IQ) solicitation, if the minimum (or Initial) order quantity will be 3,000 units instead of the original 500 units stated in the solicitation, get revised quotes.

134

Unbalanced Pricing

135

Unbalanced Pricing• Per FAR 15.404-1(g)(1), Unbalanced pricing exists when,

despite an acceptable total evaluated price, the price for one or more contract line items is significantly over or understated as indicated by the application of cost or price analysis techniques.

• Per FAR 15.404-1(g)(2), All offers with separately priced line items or subline items shall be analyzed to determine if the prices are unbalanced.

• No standard but “rules of thumb”– Trend analysis

• “Large” percentage variation: 20% +/-» Compare base to option prices » Compare CLINs/SLINs to those of IGCE» Comparison of competing offerors’ prices

136

Unbalanced Pricing: Example 1

CLIN Service/Description Offeror A Offeror B Offeror C Offeror D0001 Task 1 100 110 120 130 0002 Task 2 200 210 220 230 0003 Task 3 100 310 330 340 0004 Task 4 450 410 440 450

Total 850 1,040 1,110 1,150

137

Unbalanced Pricing: Sustained Protest

• Al Ghanim Combined Group Gen. Trad. & Cont.– Improper price comparisons

• Low price offer won based on the total proposed cost.

• But price analysis not conducted on separate line items.

• Question of whether winning offeror understands SOW.

– Claims Court: • Violated FAR 15.404-1(g) Unbalanced Pricing.

• Government failed to adequately compare bidder prices.

• Government did not compare its IGCE to offerors’ line item prices.

138

Unbalanced Pricing: Example 2

CLIN Service/Description Base Option 1 Option 2 Option 30001 Task 1 100 110 120 130 0002 Task 2 200 190 220 230 0003 Task 3 300 310 320 340 0004 Task 4 400 410 420 450

Total 1,000 1,020 1,080 1,150

139

Price Analysis and Documentation Reference Books• U.S. Army Contracting Agency (ACA) homepage

– Resource Library• ACA Procedures

– ACA Cost & Price Analysis Handbook– Prenegotiation Objective Memorandum & Price Negotiation

Memorandum Guide– ACA Market Research Guide

• AT&L Knowledge Sharing System homepage (DAU)– Guidebooks & Handbooks

• Contract Pricing Reference Guides, Volumes 1- 5

140

Conclusion (1 of 2): General

• Ask questions of and/or discuss with the offeror:– Mr. Contractor: What is the basis of the price ?– From the User/customer: Ask for requirements

clarification when necessary.

• Pricing arithmetic:– Use round numbers– Accuracy has its place but…– Be consistent in your analysis

• Remember: Many factors such as schedule, quantity, transportation, etc., affect the price.

• Document your price analysis.

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Conclusion (2 of 2): Documentation

• Should be a concise, succinct narrative explanation.– What was proposed by the contractor?– Nature and extent of the government evaluation?– Basis of reasonableness determination?

• Use Microsoft Excel spreadsheets for comparing offers/prices rather than incorporating them into a Word document.– Professional appearance counts, lends credibility to presentation.– Basic Microsoft Excel training available if demand sufficient.

• The FSO can review your price/cost document, recommend an optimal format, and/or prepare the final document.

the basics of price analysis presented by edmund kowalski financial services office (fso) updated as...

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