Value Analysis
Value analysis is an important technique to establish price reasonableness of commercial products and services. It is very useful when used in combination with other price analysis techniques to establish the value of a commercial item compared to, for example, what costs the government would incur to develop such an item. Value analysis is used to understand what features or characteristics of a given product or service, or offered terms and conditions warrant consideration as having legitimate value to the Government. For example, answering questions such as: What is a five year warranty worth? How do you value sustaining engineering that is included with the product? What portion of research and development costs is the vendor entitled to recover? Is the Government obtaining the same terms and conditions as other buyers? Why or why not? These are difficult questions which require critical thinking, collaboration, and judgment that go into a value analysis.
Other relevant definitions: Pricing data. Pricing data are all facts that prudent buyers and sellers would reasonably expect to affect price negotiations significantly of an item or service. Examples of pricing data include established catalog or market prices, or any form of data on sales to commercial and Government customers. Cost data. Cost data are any facts, other than prices, that prudent buyers and sellers would reasonably expect to affect price negotiations significantly. Cost data should help you understand what the item did cost, will cost, or should cost. “Did cost”, “will cost” and “should cost” data should be available from the offeror and may be available from sources other than the offeror.
Conducting a cost analysis and requesting cost information from the offeror should be the last resort when performing fair and reasonable price analysis for commercial goods and services. Per 10 USC 3703 (formerly 2306a(b)), submission of certified cost or pricing data shall not be required for any contract, subcontract, or modification of a contract or subcontract involving (for example):
- Price agreed upon is based on adequate price competition or prices set by law or regulations; or
- Acquisition of a commercial product or a commercial service.
When data other than certified cost or pricing data is required, contracting officers must follow the order of preference in FAR 15.402 which looks first to price-related data and, secondarily, to cost data. With the order of preference in mind, you should start with Government resources, move to public resources, and only obtain information from the offeror as the last resort.
Commercial items are not subject to the Truth in Negotiations Act because the commercial marketplace is presumed to be a competitive environment and should drive a fair and reasonable price. When determining a fair and reasonable price, market research should be conducted in order to compare the proposed price to comparable market pricing. Determining a fair and reasonable price is easy when acquiring commercially available off-the-shelf (COTS) items as typically a catalog price is available and there are many buyers in the marketplace. In general, when firms compete for business there is a competitive pressure for a firm to put forth their best price to ensure they make the sale or win the award. Determining a fair and reasonable price is challenging when the commercial market does not exist for a specific item or service, or when market price data is not readily available. This is the case when buying “of a type” items on a sole source basis. Because a commercial item determination “of a type” has been made, we are prohibited from getting certified cost or pricing data. Ultimately, the effectiveness of price analysis will depend on what meaningful data the Government successfully obtains to conduct the pricing analysis.
When considering the “value” of an item, consider that a fair and reasonable price is a price that a prudent businessperson would pay for an item under competitive market conditions, given a reasonable knowledge of the marketplace. Below are some general guidelines that will assist you in the concept of value analysis.
1. Evaluate price, not cost
The difference between an offeror’s cost and the selling price is profit. This may lead you to think cost plus a certain profit rate drives fair and reasonable pricing in the commercial marketplace. This is not completely accurate. Using value analysis, our determination of a fair and reasonable price, however, should be based on our assessment of the value to the Government. In a commercial marketplace, some companies will charge the highest price the market will bear irrespective of the damage it may cause to their long term business prospects. Understanding who is in the market is an important factor when evaluating price as it relates to value.
2. Be a prudent businessperson
A reasonably prudent person is a concept or standard in the law entailing a hypothetical person that acts in a manner society might expect of a normal, reasonable person under the same or similar circumstances. The key is to understand the circumstances surrounding your acquisition (Step 2 of the 7-Step Services Acquisition Process). In addition, negotiation of terms, conditions and relevant factors need to be taken into consideration when determining what a prudent businessperson is willing to pay for an item.
3. Understand the competitive market conditions
Adequate price competition is the preference for commercial acquisitions. Understand that the competitive market conditions reinforce the importance competition plays in fair and reasonable pricing especially in the commercial environment since cost data may not be available. The following are things to consider when understanding the competitive market conditions:
• Who makes the products/provides the service? Who are the sellers and who are the buyers?
• What supplies/services are available? If the supplies/services are similar, can the item(s) be competed?
• If supplies/services are similar but not exact, can they be combined with other supplies or services to meet the Government need at a fair and reasonable price?
• What stage is the marketplace in? Is the market emerging, maturing, saturated with competition, or controlled by one company? In a sole source acquisition, it may difficult to determine the impact, if any, of a competitive marketplace.
4. Reasonable knowledge of the marketplace
Conduct market research to know what buyers are paying in the marketplace. Always try to gather as much relevant pricing data as possible from multiple sources to compare to the proposed price. A contracting officer can always consider weighting the data based on relevance. When developing a negotiation position, consider developing a range of reasonableness. Also, utilize functional specialist such as Defense Contract Management Agency Commercial Item Group (DCMA CIG) to gain insight into specific industries. Knowing the industry will allow you to access what value buyers and sellers place on industry specific terms and conditions.
Value analysis should foster an understanding of the Government’s acquisition need and help align the requirements with the industry capabilities. For an effective acquisition, market research should provide information on the value of the item/service in comparison with possible substitutes in the industry.
Consider the guidance from the Contract Pricing Reference Guide (CPRG) when conducting value analysis:
1. Determine acquisition costs based on current proposal or other estimates.
2. Assure Government requirement documents reflect the minimum needs of the Government.
3. Identify alternative products or methods meeting the minimum needs of the Government. This is typically the key step in the analysis. The following are examples of questions you should consider:
a. Can any part of the product be eliminated?
b. Can a standard part replace a special part?
c. Can a lower cost material or method be used?
d. Can paperwork requirements be reduced?
e. Can the product be packaged more economically?
4. Estimate the costs associated with alternative products or methods that would meet the minimum needs of the Government.
5. Document the reasonableness of the current prices or recommend appropriate changes. Ensure that the process and results of the value analysis are clearly documented and include a copy of the documentation in the contract file. When you are satisfied that the value to be received supports the offered price, use the information obtained to support your determination of price reasonableness. When you are not satisfied, use the information to document efforts to bring the price in line with the perceived value.