U.S. federal agencies conduct realism analyses on cost-reimbursable contracts to determine whether costs in a prospective contractor’s proposal are realistic and consistent with the proposed technical solution. Under such contracts, the government must pay contractors all actual and allowable costs, regardless of the proposed costs. Proper realism analysis helps the government determine whether the contractor’s proposed costs are so low that they fail to reflect a clear understanding of the solicitation’s requirements. Since contractors may submit artificially low bids on cost-reimbursable contracts to gain a competitive advantage, cost-realism analysis is necessary to ensure performance under these contracts is not compromised. In recent years, such contractor strategies have also contributed to the government’s shift away from the use of cost-reimbursable contracts. The Federal Acquisition Regulation (FAR) § 15.404-1(d)(2) outlines the requirements of cost realism analysis under such contracts to determine the probable cost of performance. Under FAR § 15.404-1(d)(3), cost realism analysis may also be utilized under limited circumstances in certain fixed-price contracts when new or complex requirements still need to be fully understood. Contractors may challenge the adequacy of the government’s cost realism analysis in a post-award bid protest by alleging that the agency failed to conduct a cost realism analysis or did not conduct such an analysis on a reasonable basis.

In B-420627, the GAO sustained a post-award bid protest alleging a lack of adequate and contemporaneous cost realism analysis of the awardee’s direct labor rates and escalation methodology. In that procurement conducted under the procedures of FAR § 16.505, the Federal Emergency Management Agency (FEMA) contemplated the acquisition of training services under a task order involving both fixed-price and cost-plus-award-fee contract line items. The task order had a base year and four one-year options and was to be awarded on a best-value trade-off basis. The awardee’s total evaluated cost/price of approximately $88 million was significantly lower than the protestor’s evaluated cost/price of approximately $109 million. The protestor challenged FEMA’s evaluation of the awardee’s proposed costs, alleging that the awardee’s proposed direct labor rates for a vast majority of positions were unrealistically low. Additionally, the protestor alleged that the awardee improperly failed to apply escalation to these unrealistically low rates for the four option years. The GAO agreed with the protestor and sustained the protest by determining that FEMA’s cost realism evaluation of the awardee’s proposed costs was inadequate in three key aspects.

• Wage Determination Rates Proposed as Labor Rates for Incumbent Personnel

The awardee was the incumbent contractor and produced letters of commitment from all incumbent personnel performing under the cost-plus-award-fee contract line items. In proposing labor rates, the awardee used the actual salaries of key and certain non-key-named personnel. However, wage determination rates were used as labor rates for the remaining non-key labor categories, which included personnel performing under the cost-plus-award-fee line items. These personnel constituted a vast majority of the proposed incumbent staff. The protestor alleged that the agency failed to adequately evaluate whether the awardee’s proposed wage determination rates were sufficiently realistic to retain the proposed incumbent personnel on the contract. That is, even though the awardee produced letters of commitment for all incumbent personnel, nothing in the record demonstrated that these personnel actually agreed to perform at the proposed wage determination rates instead of their actual salaries. The GAO agreed with the protestor that FEMA’s cost realism evaluation was unreasonable as it did not evaluate whether the awardee’s proposed wage determination rates would be realistic to retain incumbent personnel on the contract.

• Lack of Escalation of Proposed Wage Determination Rates

Additionally, the awardee failed to apply an escalation factor to the proposed wage determination rates labor categories. Notably, both the awardee’s own non-Service Contract Act (SCA) labor rates and the government’s independent cost estimate applied an escalation factor for the option years. FEMA pointed to the inclusion of FAR clause 52.222-43 in the contract to justify why it did not require the awardee to apply an escalation factor to its proposed labor rates. The GAO determined that FEMA’s reliance on this clause was misplaced as the purpose of FAR 52.222-43 is to enable contractors to obtain upward adjustments to their price in case of increased labor costs in an otherwise fixed-price contract. Therefore, the clause was included in the hybrid contract only for its applicability to the solicitation’s fixed-price contract line items.

The GAO further explained that the agency’s reliance on wage determination as a substitute for conducting an adequate cost realism analysis on the awardee’s non-escalated rates was unreasonable. This is because a wage determination demonstrates the minimum wages or fringe benefits to which an employee may be entitled. In comparison, a cost realism analysis determines whether a proposed cost is realistic for the work to be performed. The GAO found FEMA’s cost realism evaluation was unreasonable since no documentation existed to demonstrate that it considered the realism of the awardee’s potential cost increases in retaining incumbent personnel in the option years.

• Cost Realism Evaluation Utilizing an Inadequate Standard Deviation Methodology

Finally, the protestor alleged, and the GAO agreed, that FEMA relied on a flawed standard deviation methodology to partly justify the realism of the awardee’s proposed costs. Under the methodology, FEMA calculated the mean of the proposed costs of the cost-reimbursable contract line items for all contractors. FEMA then calculated a range representing one standard deviation over and below that mean and suggested that since the awardee’s proposed costs for the cost-reimbursable contract line items fell within that range, they were realistic. GAO explained that while the use of such standard deviation methodologies in determining the realism of proposed costs may be acceptable under certain conditions, it is not appropriate where prospective contractors are required to propose unique staffing approaches. In such solicitations, using standard deviation methodologies often disregards the government’s obligation to consider the unique methods of performance described in the prospective contractors’ technical approaches. Since the solicitation at issue required unique staffing approaches, the GAO concluded that FEMA’s reliance on the standard deviation methodology produced unreasonable results, making the cost realism analysis of the awardee’s proposed cost-reimbursable contract line item rates inadequate.

To protest awards based on the government’s inadequate cost realism analysis, contractors should challenge the government's cost evaluation methodologies. The government’s analysis must adequately evaluate whether the awardee’s proposed costs represent the probable cost of performance. Additionally, the government’s analysis must be sufficiently documented to represent that the awardee’s proposed costs demonstrate a clear understanding of the technical requirements. Contractors should be aware that any cost development techniques that reduce proposed costs to levels jeopardizing contract performance, including unbalanced pricing, may be challenged in a post-award bid protest.

This Bid Protests Insight provides a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.