New Standards for Should-Cost Reviews

Should-cost reviews are a specialized form of cost analysis. Should-cost reviews differ from traditional evaluation methods because they do not assume that a contractor's historical costs reflect efficient and economical operation. Instead, Should-cost revews evaluate the economy and efficiency of the contractor's existing work force, methods, materials, equipment, real property, operating systems, and management.

Should-cost reviews are performed by a multi-functional team of Government contracting, contract administration, pricing, audit, and engineering representatives. The objective of such reviews is to promote both short and long-range improvements in the contractor's economy and efficiency in order to reduce the cost of performance of Government contracts. Additionally, by providing rationale for any recommendations and quantifying their impact on cost, the Government is in a better position to develop realistic objectives for negotiation.

There are two types of should-cost reviews; program and overhead. Program should-cost reviews are used to evaluate significant elements of direct costs while overhead should-cost reviews are used to evaluate indirect costs, including fringe benefits, shipping and receiving, real property, and equipment depreciation, plant maintenance, security, taxes, and G&A activities.

Under FAR 15.407-4, the Government has a right to perform should-cost reviews but since they are very costly and time-consuming to carry out, such reviews are usually limited to major weapons system acquisitions. From the contractors' perspective, should-cost reviews are also costly to support and sometimes, in the contractors' view, do not offer tangible benefits to either the Government or the contractor.

Under the Fiscal Year 2018 NDAA (National Defense Authorization Act), the Defense Department was required to amend its regulations to ensure that the use of should-cost reviews were performed in a manner that is "transparent, objective, and provides for the efficiency of the systems acquisition process". This week, the Defense Department finally got around to finalizing its regulations accordingly. Under the revised regulations, DoD must consider the following:

1. A thorough review of each contributing element of the program cost and the justification for each cost
2. An analysis of non-valued added overhead and unnecessary reporting requirements.
3. Benchmarking against similar DoD programs, similar commercial programs and other programs by the same contractor at the same facility.
4. An analysis of supply chain management to encourage competition and incentive cost performance at lower tiers.
5. A review of how to restructure the program team in a streamlined manner. The program team in this context include both Government and contractor representatives.
6. Identification of opportunities to break out Government-furnished equipment versus prime contractor-furnished materials.
7. Identification of items or services contracted through third parties that result in unnecessary pass-through costs.
8. Evaluation of ability to use integrated developmental and operational testing and modeling and simulation to reduce overall costs.
9. Identification of alternative technology and materials to reduce developmental or life-cycle costs for a program.
10. Identification and prioritization of cost savings opportunities
11. Establishment of measurable targets and ongoing tracking systems.

Have Contractor's Been Complaining About DCMA's "Should-Cost" Reviews?

Unless you're a very large contractor, you may not have heard of "should-cost" reviews. Should-cost reviews are a specialized form of cost analysis. They differ from traditional evaluation methods in that they don't assume that historical costs reflect efficient and economical operation. Instead, should-cost reviews evaluate the economy and efficiency of the contractor's existing work force, methods, materials, equipment, real property, operating systems, and management.

These reviews are conducted by a multi-functional team of Government contracting, contract administration, pricing, audit and engineering representatives. The objective of should-cost reviews is to promote both short and long-range improvements in the contractor's economy and efficiency in order to reduce the cost of performance of Government contracts.

There are two types of should-cost reviews - program reviews and overhead reviews. A program review focuses on significant elements of direct costs, usually associated with the production of major systems. You can read about should-cost reviews more fully in FAR 15.407-4.

We have not had direct experience with should-cost reviews but we've been around the fringes enough to know that contractor's dread them, not for the potential findings and recommendations but because they require a tremendous amount of contractor resources to support and the "team's" lackadaisical approach to completing the engagement is the exact antitheses to what the Government wants to accomplish - i.e. improvements in economy and efficiency.

Which brings us to the Senate's fiscal year 2018 National Defense Authorization Act (NDAA) and a provision designed to make the Government more accountable in performing should-cost reviews - to use the tool appropriately in a manner that his transparent, objective, and provide for the efficiency of the acquisition process.

The NDAA provision, if passed, will require DoD to amend its FAR Supplement (DFARS) to include the following:

1. A description of the features distinguishing a should-cost review and the analysis of program direct and indirect costs.
2. Establishment of a process for communicating with the contractor the elements of a proposed should-cost review.
3. A method for ensuring that identified should-cost savings opportunities are based on accurate, complete, and current information and are associated with specific engineering or business changes that can be quantified and tracked.
4. A description of the training, skills, and experience, including cross functional experience, that Department of Defense and contractor officials carrying out a should-cost review should possess.
5. A method for ensuring appropriate collaboration with the contractor throughout the review process.
6. Establishment of review process requirements that provide for sufficient analysis and minmize any impact on program schedule.
7. A requirement that any separate audit or review carried out in connection with the should-cost review be provided to the prime contractor under the program.

We think these proposed enhancements to the should-cost program are reasonable and a positive step in ensuring that should-cost reviews are well-planned and staffed with trained and qualified individuals.