Cost Realism: Key Points for Buyers and Sellers

2. Cost Realism: Key Points for Buyers and Sellers Breakout Session # 208 Presented by Tom Tagle & Kristin Torcasi July 19, 2010 Session Schedule: 2:30 – 3:45 1

3. Introduction Definitions and Key Points of Cost Realism Definitions Key points to consider Setting the Stage for Cost Realism Circumstances warranting Factors influencing Who performs? Buyers: What really matters? Sellers: Some unconventional wisdom

4. Defining the Terms “Cost” An expenditure or outlay of cash…identified with good or services acquired (Kohler’s Dictionary for Accountants) “Realism” Concern for fact or reality and rejection of the impractical and visionary (Merriam-Webster)

5. Purpose of Cost Realism Cost Realism aims 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. (FAR 15.404-1(d)) “The purpose of a cost-realism analysis by an agency under a cost reimbursement contract is to determine the extent to which the offeror’s proposed costs are realistic and reasonable.” (GAO: Comptroller General Decision, DCT. Inc., Sept. 28, 1993) Note: A cost realism determination must itself be reasonable

6. “Reasonableness” Defined Dictionary definition of Reasonable: Capable of reasoning; Governed by or being in accord with reason or sound thinking; Being within the bounds of common sense; Not excessive or extreme. (American Heritage Dictionary) (Synonyms: rational, sensible, moderate, plausible) FAR 31.201-3(a) A cost is reasonable if: …in its nature and amount… …it does not exceed… …that which would be incurred by a prudent person… …in the conduct of competitive business.

7. Key Clarification #1 – Price vs. Cost Price: The quantity of one thing that is exchanged or demanded in barter or sale for another; the amount of money given or set as consideration for the sale of a specified thing (Merriam-Webster) Price is what someone is willing to pay for a product or service Cost: Cost is what it takes, in terms of dollars or resources, to produce a particular product or service Price is the overall “cost” to the buyer

8. Key Clarification #2 – Reasonableness vs. Realism Cost Reasonableness: Cost Reasonableness, in an allowable-cost sense, is an evaluation of individual elements of cost and discrete activities giving rise to them (i.e., a particular element of cost is unreasonable) Overall Reasonableness, in a macro sense, is an informed judgment about reasonableness in the aggregate (i.e., proposed costs in the aggregate may be reasonable even if some individual elements of cost are unreasonable) Cost Realism: A top-down analysis to determine if aggregate proposed costs are commensurate with contemplated effort Can a cost be realistic but unreasonable? Can a cost be reasonable but unrealistic? Can certain individual costs be unreasonable but overall costs be reasonable?

9. Key Clarification #3 – Cost Realism vs. Cost Analysis Cost Realism: Cost realism is not about the exact cost estimate. It's about the system of logic, the assumptions about the future, and the reasonableness of the historical basis of the estimate Cost realism is an assessment of the things that make up the foundation of the offeror’s cost estimate Cost Analysis: A bottoms-up evaluation of the cost elements built upon the foundation of an offeror’s cost estimate Required when cost or pricing data are required Used to assess Cost Reasonableness Provides key input to buyer’s negotiation position

10. Circumstances Warranting Cost Realism Analysis Must be performed on cost reimbursement contracts (FAR 15.404-1(d)(2)) Responsibility of Contracting Officer to perform & document May be used on competitive fixed-price incentive contracts May be used on other competitive fixed-price-type contracts when new requirements may not be fully understood by competitors In other words: any circumstance where the primary risk is that proposed costs may be too low placing program success in jeopardy

11. Key Factors Influencing Extent & Complexity of Cost Realism Analysis Maturity of product/service/solution Complexity of product/service/solution Contract performance period/schedule Stakes of contract outcome Relative experience of offerors with same/similar scope of work Past experience with offerors Financial condition of offeror(s)

12. Who Performs Cost Realism Analyses? In general, any buyer in the contracting supply chain Government  Prime  Top-tier Sub  Other Subs In specific proposal analysis, the following disciplines are often involved: Contracting Officer COTR Cost/Price Analyst Other specialized expertise as appropriate Auditor

13. Buyers: What Really Matters(1 of 5) Considering its purpose, the objective of a cost realism analysis must be to: Assess contractor performance risk relative to proposed cost Two extreme scenarios that will likely fail cost realism analysis: High performance risk at low cost Low performance risk at high cost

14. Buyers: What Really Matters(2 of 5) Performance Risk (Realism): Proposed technical approach/solutions compatible with - Contract requirements Performance period Life cycle considerations Cost Risk (Reasonableness): In light of technical approach - Cost elements are logical, complementary and consistent Proposed costs are reasonable in nature and amount

15. Buyers: What Really Matters(3 of 5) Focus on the order of “so what” TOP – DOWN EVALUATION Acceptability of Product/Service/Solution Appropriateness of Production/ Delivery Process Who/What (Labor/Materials) How Many relative to How Fast How Much (Unit Prices, Indirect Costs & Profit)

16. Buyers: What Really Matters(4 of 5) Product/Service/Solution: Does proposed deliverable or purpose meet contracting need? Quality, Durability, Functionality, Scalability, Adaptability Production/Delivery Process: Will the product/service/solution be produced/provided using methods or approaches that are demonstrable? Empirical proof/Evidence Reason/logic

17. Buyers: What Really Matters(5 of 5) Who/What: Does the proposed process employ: Acceptable labor/talent? Acceptable materials? Acceptable means of production? How many in light of how fast: Are acceptable labor and materials provided in: Acceptable labor mix? Appropriate hours in light of schedule? How much in light of how many: Are unit prices reasonable within a relative range? Labor, materials, subcontracts Component parts Indirect costs (in total, not rates)

18. Sellers: Some Unconventional Wisdom (1 of 5) Establish and maintain a clear and continuous linkage between the technical proposal and the cost proposal Demonstrate cost proposal completeness – that significant processes and tasks are represented in the cost volume Said another way, don’t make the cost analyst guess as to where the cost of some task or process might be represented within the cost proposal

19. Sellers: Some Unconventional Wisdom (2 of 5) Document and clearly explain all assumptions – both technical and cost Persuade technical/cost analyst that assumptions have sound, logical basis Opportunity to avoid risk concerns; poorly explained, unexplained, or inherent assumptions may cast doubt on technical competence Consider identifying selected point estimates with their reasonable ranges of outcomes to enhance perspective of downside risks and upside benefits

20. Sellers: Some Unconventional Wisdom (3 of 5) If asserting benefits of a new or aggressive approach, demonstrate it – don’t ask buyer to assume it Provide tangible evidence that benefits will indeed accrue as proposed Weigh and explain risks relative to benefits Have a Plan B, a key decision point, and a Plan B cost estimate that includes the cost of Plan A failure

21. Sellers: Some Unconventional Wisdom (4 of 5) Provide validation/substantiation of technical approach and cost estimate Establish a high degree of credibility that cost estimate will reflect execution of technical approach Arrive at same cost estimate in alternate way Provide alternate cost estimates for less desirable approaches to demonstrate lower cost may produce higher risk/poorer quality, or lower risk/higher quality will come at higher cost

22. Sellers: Some Unconventional Wisdom (5 of 5) Strive for “confidence inspiring” and avoid overselling Emphasize superiority of proposed approach/methods but avoid overarching impressions of “too good to be true” Call a spade a spade – identify high risk elements of proposal and articulate risk mitigation plans to demonstrate firm understanding of undertaking Under-promise to provide room to over-deliver Oral presentations must demonstrate technical mastery of proposed approach

23. Questions/Comments ?

24. About Baker Tilly Founded in 1931 as a certified public accounting firm Currently operate in six states with over 1,400 professionals Member of Baker Tilly International, the world’s 8th largest network of accounting firms Headquartered in Chicago East Region is located in Washington, D.C. with over 275 professionals East Region provides a range of professional services including: Financial statement audit Tax planning and compliance Consulting services to private and publicly traded companies across many industries Government contract and grant consulting Forensic and litigation services Mergers and acquisitions Technology management

25. Presenters Tom Tagle, Partner Tom has over 15 years of experience in government contract accounting, pricing, business system and internal control oversight, and regulatory and federal contract compliance assisting defense, manufacturing, construction and professional services clients. Tom earned his Bachelor of Science in Business Administration and Accounting from Washington and Lee University. He is a member of the American Institute of Certified Public Accountants, Virginia Society of Certified Public Accountants, and National Contract Management Association. Prior to Baker Tilly, Tom worked for a major international public accounting firm and was at Navigant Consulting for 7 years. Tom is a member of the Baker Tilly Government Contractor Advisory Services practice in Vienna, Virginia. Tel: (703) 923-8312, tom.tagle@bakertilly.com

26. Presenters Kristin Torcasi, Manager Kristin has over 7 years of experience in government contract accounting, pricing, business system and internal control oversight, and regulatory and federal contract compliance assisting defense, manufacturing, engineering, information and communications, higher education, and non-profit clients. Kristin earned her Bachelor of Science in Accounting and Business Management from Elon University. She is a member of the American Institute of Certified Public Accountants, Greater Washington Society of Certified Public Accountants, and National Contract Management Association. Prior to Baker Tilly, Kristin worked for DCAA, KPMG, and Navigant Consulting. Kristin is a member of the Baker Tilly Government Contractor Advisory Services practice in Vienna, Virginia. Tel: (703) 923-8376, kristin.torcasi@bakertilly.com