United States: Cost & Price Realism—What Are They and When Are They Required?

Last Updated: November 14 2014
Article by Michelle E. Litteken

Editor's note: This is the first post in a series focused on protest allegations related to cost and price analyses. Planned future posts will discuss limits on the adjustments an agency can make, benchmarks an agency may use in a realism analysis, the role of an offeror's technical approach in a price/cost realism analysis, price reasonableness, and recent protest decisions involving cost/price analysis issues.  

Disappointed offerors often challenge an agency's price or cost realism analysis in a bid protest. Contractors should be familiar with the differences between cost and price realism, when each analysis is required, and the relevant FAR provisions. Understanding these foundational concepts is essential when considering or litigating a protest that raises cost or price realism analysis issues; it can be helpful when responding to a solicitation that anticipates a price or cost realism analysis.

FAR 15.404-1(d) defines cost realism as:

The process of independently reviewing and evaluating specific elements of each offeror's 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 materials described in the offeror's technical proposal.

Agencies are directed to perform a cost realism analysis when evaluating proposals for cost-reimbursement contracts. The requirement is logical because irrespective of the costs proposed, the Government will be bound to pay the contractor its actual and allowable costs.

The FAR does not define "price realism," but the CFC has stated that it is essentially the same as cost realism. However, a price realism analysis is used for fixed-price contracts, and the focus is on whether the offeror's proposed prices are too low or otherwise indicate a misunderstanding of the agency's requirements. Agencies are not required to conduct a price realism analysis unless specified in the solicitation. And, unlike in a cost realism analysis, an agency cannot adjust an offeror's proposed prices for evaluation purposes in a price realism analysis. The nature and extent of a price realism analysis are within an agency's discretion.

Although this brief summary of the law makes it appear that the rules governing cost and price realism analyses are clear and well defined, the regularity of protests arguing that an agency should (or should not) have performed a given analysis suggests that application of the rules by agencies raises serious questions—and can be a fertile ground for litigation.

For example, inOptex Systems, Inc., the solicitation for a fixed unit price, indefinite-delivery, indefinite-quantity contract stated that the agency would evaluate prices to ensure consistency with proposed performance and balanced pricing, and the agency reserved the right to reject any proposal that reflected a lack of technical competence or understanding of the complexity and risks involved. The protester argued that the agency failed to perform an adequate price realism analysis and claimed that if the agency had done the analysis, it would have determined that the awardee's proposed prices were unrealistically low. The agency argued that it was not required to perform a realism analysis because the procurement was for a fixed-price contract. GAO sustained the protest, stating that even if a solicitation does not expressly require a price realism analysis, the analysis is required if "(1) the RFP expressly states that the agency will review prices to determine whether they are so low that they reflect a lack of technical understanding, and (2) the RFP states that a proposal can be rejected for offering low prices."

Similarly, in Iron Vine Security, LLC, the protester argued that the agency failed to evaluate the realism of the offerors' labor rates when the solicitation for the fixed-price contract stated that the cost/price volume would be evaluated to determine realism and/or reasonableness, degree of risk presented, and if it reflected understanding of the Government's requirements. In its price analysis, the agency compared the offerors' proposed labor rates to their rates for a General Services Administration schedule contract and determined that the proposed rates were reasonable; the agency did not compare the proposed labor rates to the offerors' technical proposals or to the requirements in the statement of work. GAO determined that the agency did not assess whether the proposed labor rates posed a risk to successful performance of the tasks described statement of work—a realism analysis concerning performance of the contract. Instead, the agency evaluated the labor rates for reasonableness by comparing them to other offered rates—an analysis not connected to the statement of work. In reaching its decision, GAO rejected the agency's argument that a price realism analysis was not required for the fixed-price contract because the solicitation clearly advised offerors that the evaluation would include such an assessment.

GAO also sustained a protest when an agency failed to perform the proper analysis in Triad International Maintenance Corp. In that case, when evaluating proposals for a fixed-price contract, the agency identified a moderate risk with respect to one of the offeror's proposals because its pricing was 26% lower than the Independent Government Cost Estimate (IGCE). The agency selected a higher-priced offeror for award, and the unsuccessful offeror protested, arguing (among other grounds) that it was unreasonable for the agency to conduct a price realism analysis for a fixed-price contract. The solicitation provided for a price reasonableness determination, and the agency argued that it did just that–not a price realism analysis. GAO sustained the protest, stating that the agency conducted a price realism analysis when it "assessed whether the protester's price was too low for its proposed technical approach"; GAO also made clear that, for fixed-price contracts, an agency "may not conduct a price realism analysis without first advising offerors that the agency intends to do so."

From these decisions, it is apparent that although the FAR provisions on when to conduct a realism analysis seem clear, agencies can encounter difficulty carrying out realism analyses during a procurement—and that parties to a protest may struggle with these concepts. These are fundamental procurement principles of which contractors should be aware.

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