United States: Adjustments in Agency Cost Realism Analyses Must Be Rational

Last Updated: December 15 2014
Article by Michelle E. Litteken

Editor's note: This is the second post in a series focused on protest allegations related to cost and price analyses. The first post explained the basic principles on price and cost realism. Planned future posts will discuss 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. 

As discussed in the first post in this series, a cost realism analysis is required when an agency evaluates proposals for a cost-reimbursement contract. The analysis is required for cost-reimbursement contracts because under these contracts, an offeror's proposed costs are not controlling–the Government will be bound to pay the contractor its actual, allowable, and reasonable costs. To determine the probable cost of performance, an agency may adjust the amounts an offeror proposed for given elements to reflect what the agency believes is realistic–the most probable cost. When an agency adjusts an offeror's proposed amount and the offeror is not selected for award, those adjustments can become a ground for protest at GAO or the CFC. 

Cost realism analyses are a standard part of an evaluation for the award of a cost-reimbursement contract. When an agency does a cost realism analysis, it reviews and evaluates specific elements of an offeror's proposed cost estimates to determine whether the proposed costs (1) are realistic for the work to be performed, (2) reflect an understanding of the requirements, and (3) are consistent with the method of performance described in the offeror's technical approach. If the proposed costs are inconsistent with these principles, the agency will make adjustments to determine the probable cost of performance.

Anyone who has reviewed a cost/price proposal knows that they can be complicated and detailed, and reasonable minds can disagree over the realism of the proposed cost for a given line item. As reasonable minds can differ about these matters, agencies' assessments regarding proposed costs and needed adjustments can provide fertile ground for bid protest challenges to the agency's realism analysis. To succeed, the disappointed offeror will have to demonstrate that the adjustments lacked a rational basis or that the amount of an adjustment was unreasonable.

The Amount of an Adjustment Must Be Reasonable 

In MPRI, Division of L-3 Services, Inc.; LINC Government Services, the protesters challenged the award of an Army contract for mentoring and program support in Afghanistan. The agency assessed the realism of the offerors' labor rates by comparing them to a range of rates that reflected one standard deviation from the average of the five offerors' proposed rates. MPRI was the incumbent, and in its proposal, it had reduced the direct labor rates from the rates being charged in its incumbent contract. MPRI explained that it had updated salaries based on current market conditions. The Army determined that MPRI "grossly underestimated" its labor costs, adjusted MPRI's evaluated costs upwards to align with the rates under its existing contract, and downgraded its proposal under the capability evaluation factor because it believed that MPRI would experience high turnover and lack qualified personnel if it performed at its proposed rates. After the agency adjusted MPRI's rates, three of the five labor categories were higher than the one standard deviation range. The SSA cited MPRI's rating under the capability factor when he selected a proposal with a higher evaluated cost for award, reasoning that the awardee's superiority under the capability factor outweighed MPRI's lower cost.

MPRI protested, arguing among other things, that the agency unreasonably failed to consider whether MPRI could achieve the proposed rates and that the adjustment unreasonably increased MPRI's rates above the one standard deviation range. GAO determined that the agency was reasonable in rejecting MPRI's proposed labor rates as unrealistic. GAO's opinion explained that although MPRI attributed the reduction in labor rates to market conditions, it did not include any information explaining those market conditions; the adjustments were also reasonable because MPRI's proposed rates were lower than other similar contracts in the region and all of the other offerors' proposed rates.

However, even though GAO that there was a reasonable basis to make an adjustment to MPRI's rates, it found that that the extent of the upward adjustment was unreasonable. GAO explained that the adjusted rates were higher than the average proposed rate for all five labor categories and higher than the one standard deviation range for three of the five categories. Accordingly, GAO sustained MPRI's protest because the magnitude of the agency's adjustments could not be justified.

Adjustments Are Likely Reasonable If They Are Consistent with the Solicitation

In FedSys, Inc., GAO rejected a disappointed offeror's contention that the agency made two unreasonable adjustments to its proposed costs. The protested requirement was a contract for counter-improvised explosive device training services, and the training was to be provided at locations within the continental United States (CONUS) and outside the continental United States (OCONUS). The solicitation instructed offerors to propose 40-hour workweeks for CONUS personnel, and 80-hour workweeks, plus a salary adjustment for hazard and hardship pay, for OCONUS personnel. The agency made two adjustments. First, the agency adjusted the protester's labor costs upward because 40-hour workweeks were proposed for CONUS and for OCONUS personnel (of both the prime and subcontractors). Second, the agency increased the protester's proposed costs by approximately $2 million because the protester had not proposed any travel costs for the CONUS portion of the work.

The protester acknowledged that its proposal worksheet listed 40-hour workweeks for OCONUS personnel but argued that the agency should not have made any adjustment because its proposed salaries reflected 80-hour workweeks. GAO rejected this argument, finding that the proposal referred to 40-hour work weeks, and there was nothing to indicate that the higher salaries reflected 80-hour work weeks and hazard and hardship pay. GAO concluded that the agency was required to address the 40-hour shortfall, and the agency's adjustment was reasonable. Likewise, GAO rejected the protester's challenge to the agency's adjustment for travel costs, finding that because the protester failed to propose travel costs, it was reasonable for the agency to plug in the number from the independent government cost estimate.

Adjustments Cannot Be Made for Fixed-Price Elements

It is important to remember that no matter how rational an adjustment may be, an agency cannot make any adjustments when assessing a firm-fixed price offer for realism. In IBM, the agency made four adjustments to the protester's proposed prices in a competition for a contract to upgrade the agency's financial management system. The solicitation allowed offerors to propose how they would be reimbursed, e.g., fixed-price, labor hour, or on a time and materials basis. The agency made four relevant adjustments to IBM's proposed price:

  • Adjusted the proposed fixed price to account for replacement of legacy applications because the agency was concerned that IBM had inadequately explained its approach and costs.
  • Increased price of hosting services because IBM proposed to provide hosting on a time and materials basis but estimated $0 for the effort.
  • Increased the proposed price to account for IBM approach requiring agency personnel to work additional hours (based on the fact that after discussions, IBM reduced the number of hours agency personnel would work in its final proposal but did not increase contractor personnel hours to offset the decrease).
  • Increased IBM's price to reflect additional ongoing maintenance costs based on its determination that IBM would not be able to replace the agency's legacy system as quickly proposed.

The adjustments made IBM's most probable cost approximately $40-56 million higher than its proposed price. When the agency selected a lower-rated technical proposal over IBM's, it cited the cost risks associated with IBM's approach as one of the reasons for its decision. IBM protested, and GAO sustained the protest, finding that three of the agency's adjustments were unreasonable; specifically:

  • The adjustment for the price of work that IBM proposed to perform on a fixed-price basis was improper and not permitted by the FAR. Agencies cannot adjust prices for fixed-price elements. Instead, the agency could account for any perceived risks concerning IBM's understanding of the requirements in the performance risk evaluation–not the cost evaluation.
  • Although it was reasonable to make an adjustment for the work that IBM proposed to perform on a time and materials basis at no cost, the amount of the adjustment (which was the amount IBM had used in its initial proposal) was unreasonable because there was no other support for that amount.
  • It was unreasonable for the agency to assume that agency personnel would be required to perform additional work and make a corresponding price adjustment because IBM specified the amount of work agency personnel would perform and proposed to perform the balance of the work on a fixed-price basis.

On the other hand, GAO determined that the agency's adjustment to reflect additional maintenance costs was proper because the agency reasonably determined that there was risk IBM would not be able to replace the legacy system as quickly as it proposed, and the amount of the adjustment was based on the maintenance costs in IBM's proposal.

* * *

Protests challenging adjustments made during cost realism analyses are increasingly common. Contractors should be aware of when adjustments are permitted and the standard GAO or the court will use to review them.

Tags: Cost Realism, GAO

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