Cost Realism Analysis

When negotiating a contract price, the Government's primary concern is the price that it will pay to obtain the required supplies or services from a responsible contractor. The Government's objective is 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.

In a competitive bid situation, the Government is keenly sensitive to unrealistically low offers. Unrealistically low offers generally occur, because the offeror:

• Does 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).
• 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:
• Increase the contract amount after award (e.g., through unnecessary or excessively priced contract modifications), or
• Receive follow-on contracts at unrealistically high prices to recover losses on the buy-in contract.

If there appears to be one or more unrealistically low bids for a given procurement, the Government will perform a cost realism analysis. Cost realism analysis is discussed in FAR 15.101, FAR 15.401 and FAR 15.404-1(d). Cost realism 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:

• Are realistic for the work to be performed;
• Reflect a clear understanding of contract requirements; and
• Are consistent with the unique methods of performances and materials described in the offeror's technical proposal.

Sometimes cost realism analyses are performed in-house by the contracting officers' staff. Sometimes the work is farmed out to auditors or contract administrators. Tomorrow, we will look at some of the specific steps that are performed in a cost realism review.