As a prime contractor incorporating the services and products of a subcontractor – or as a subcontractor incorporating a lower-tier subcontract – you justify the cost of that purchase in your proposal to your customer.
You can gather evidence of competitive pricing, among potential subcontractors, for the same (or similar) services and products. You can research and reference market pricing, based on published list prices, professional association reports, commercial websites, or other relevant sources. Sometimes these avenues are not available – especially when the purchased services and products are unique or scarce.
The best way to demonstrate that the subcontractor’s pricing is fair and reasonable might be a cost analysis of the subcontractor’s proposed costs, by element. The subcontractor proposes and you evaluate:
- Direct Labor by labor category
- Direct Material with a cost-by-item Bill of Material
- Direct (lower-tier) Subcontracts (of your subcontractor)
- Direct Travel by trip with all related calculations
- Other Direct Costs by item
- Fringe Benefits using a proposed rate times Direct (subcontractor employee) Labor, supported by accounts and amounts in the pool and in the base for the (subcontractor) company as a whole
- General and Administrative using a proposed rate times Total Cost Input, or other consistently-applied base, supported by accounts and amounts in the pool and in the base for the (subcontractor) company as a whole
- Any additional indirect expenses, supported by (subcontractor) company-wide rates and their (pools by account and bases by account) calculations
Profit (for a Fixed Price subcontract) or Fee (for a Cost-reimbursable subcontract) are shown separately, but need not be addressed in the cost analysis report. This is a negotiable amount, which may be, but need not be, adequately supported by the proposer.
A technical evaluation by your company reviews:
- The number of proposed Labor hours by labor category, by time period (if applicable)
- The inclusion and exclusion of specific labor categories
- The quantity of units in each item of the Bill of Material
- The type of Materials proposed in the Bill of Material
- The number and destinations of Travel trips
- The number of travelers for each trip
- Each component of Other Direct Costs
Focus! This is a complex topic.
The cost analysis reviews subcontractor support for hourly rates, unit costs, and other component (such as airfare or per diem) costs proposed. Work papers show which (sampled) amounts were evaluated. One of three results are reported for significant findings:
- The subcontractor’s supporting documentation is not adequate to support the proposed cost; also, adequate supporting documentation is not readily available to the reviewer; the costs are Unsupported. Recommended costs are reported at zero for future negotiation.
- The subcontractor’s supporting documentation – or, if inadequate, supporting documentation readily available to the reviewer – shows a fair and reasonable amount that significantly differs from that proposed; the difference is Questioned. Recommended costs are reported at the increased or decreased amount, with reference to the reason(s). Note that inaccurate calculations in the subcontractor’s proposal, also, result in Questioned costs.
- The subcontractor’s supporting documentation supports the proposed cost as fair and reasonable. Recommended costs are reported at the proposed amounts.
The resulting report from the cost analysis shows:
- Proposed amounts by cost element
- Unsupported costs by cost element (if any)
- Questioned costs by cost element
- Recommended costs by cost element
Reasons for Unsupported and Questioned costs are explained in the report. These might require a detailed breakout, especially if more than one amount is questioned within one cost element. For example, Direct Travel might be proposed using first class, non-stop airfare and also (anticipated) actual lodging instead of per diem (maximums). Each questioned amount with its reason is reported.
The cost analysis (report) is, typically, the basis for negotiation. The negotiator – who need not be the cost analyst – considers the cost analysis and the technical evaluation (if any) before deciding on an initial offer (amount) and, separately, a target amount. These amounts are included in the negotiation memo written by your company. Each offer, counter-offer, the reasons for each (if known) and the final agreed-to amounts are all included in the negotiation memo. The negotiation memo supports the Direct Subcontract cost in the proposal to your customer. Because the negotiation memo indicates whether the negotiator relied on the cost analysis and the technical evaluation, these reports accompany the negotiation memo as support for the proposed Direct Subcontract cost.
Well-considered and well-documented costs, negotiated between two arm’s-length parties, are usually accepted as fair and reasonable.
* If the subcontractor has approved Forward Pricing Rates, these need not be analyzed further, but accepted as proposed. Just compare indirect rates in the approval memo (or letter) from the Government to those proposed. Analyze difference, if any.