Background
Acquisition Planning in the United
States of America
The United States Government awarded approximately $438
billion in contracts for supplies and services in fiscal year 2015
.
The Federal Acquisition Regulation governs
the acquisition process of the U.S. Federal Government as defined by the Code
of Federal Regulations. FAR 7.104(a) states that the acquisition planning
process should begin as soon as an agency identifies a need for supplies for
services. During the planning process, the Government will commonly develop an
IGE. An IGE allows the Government to estimate the costs a contractor is likely
to incur while providing the supplies or performing the services to fulfill the
requirement
and is the basis for reserving budgetary funding.
The Independent Government Estimate
(IGE)
The Department of Defense Contingency COR Handbook states
that an IGE is generally developed for commercial items, equipment, supplies
and simple services routinely available on the open market with competitive
pricing.
The IGE does not include breakouts of the
various cost elements. IGE’s are “bottom-line prices paid or availability in
the marketplace.”
On the other hand, the Handbook defines the Independent
Government Cost Estimate (IGCE) as generally used for services, construction,
and non-commercial supplies.
Unlike the IGE, the IGCE attempts to capture the
projected costs a contractor will likely incur during the performance of the
contract. The IGCE also “provides the basis for comparing cost or prices
proposed by contractors/applicants; and… serves as an objective basis for
determining price reasonableness in cases in which one Contractor/Applicant
responds to solicitation”.
Another
important reason that these types of Government estimates are used is to ensure
that the contractors understand the requirement
.
IGCE’s are not meant to be the lowest or highest possible estimate of the cost
and/or price for performance; IGCE’s are meant to be a projection of program
costs
.
The distinction between the IGE and an IGCE is unclear and inconsistent
throughout most U.S. Federal Guidance.
The
Security Classification of the IGE
Most U.S. federal, state and local procurement guidance states that the Government should ensure the IGE remains confidential and only disclose it during negotiations or debriefings, when the Contracting Officer (CO) deems it appropriate.
[8] The USAID IGE Guide indicates that the IGE is a procurement sensitive document and access should only be permitted on a “need-to-know” basis. IGE’s are subject to safeguards as required by 12 FAM 544, which describes information which warrants a degree of protection and administrative control that meets the criteria for exemption from public disclosure set forth under Sections 552 and 552a of Title 5, United States Code: the Freedom of Information Act and the Privacy Act.
[9]
Developing the IGE
The U.S. Army Training and Doctrine Command’s IGE
Preparation Guide
defines the IGE as “the Government’s estimate of the resources and the estimated
cost of resources a prudent contractor will incur in the performance of a
contract.” The TRADOC IGE Preparation Guide explains the importance of the
analysis of variations between the contractor’s proposal and the IGE,
especially in regards to the increased uncertainty for first time procurements.
The Air Force Contracting Construction Guide explains that
the IGE is developed to be unbiased and “based upon the specifications and
without the influence of potential contractor’s marketing effort or input.”
The design engineer or estimator is generally responsible for preparing the
IGE. FAR 36.203 requires IGE’s be used when the anticipated award of a contract
is $100,000 or more and must be prepared with the same amount of detail that
would be required if the Government were also competing for the award. Federal
regulations explain that the IGE should be developed using the same approach
that a prospective contractor would. The IGE should include direct cost
incidents and allowance for overhead costs, indirect costs and a reasonable
amount of profit.
Preferred
Cost Sources
There are three preferred sources for obtaining the
necessary details to support the IGE. The first source is to utilize previous
similar contracts. The competitive prices of the contractors on the previous
similar contracts are used as the basis of each similar line item. The second
source is the Architect-Engineers (A-E) estimate. A-E firms are required to use
the most current computerized estimating programs, technology and commercial
pricing guides in order to provide comprehensive, accurate and up-to-date
estimates. A-E estimates account for changing trends in cost building and
include any relative economics of various types of structures and materials.
The third source is commercial pricing sources
such as RSMeans®
Construction Cost Data and WinEstimator®. These programs can provide the most
accurate estimates because they allow adjustments for local labor rates, site
conditions and material prices.
Cost Models
& The Elements of Cost
The cost model that is utilized
in the development of the IGE performs the calculations of price based on cost
elements such as labor hours and rates.
The more elementary cost models only require simple pencil and paper
calculations, while more complex cost models often require extensive computer
models. The type of cost model that the estimate uses would provide any
potential contractors with insight into how important each individual cost
element is to the overall procurement. A lump-sum estimate provides the
acquisition costs based of the bottom-line. Detailed estimates serve as the
basis for determining the type of contract the proposal evaluation criteria.
Detailed estimates identify eight elements of cost.
Classification
of Employees, Direct Hours Required and Wage Rates
This
cost category includes the type of employees required to execute the services
needed to fulfill the requirement. The direct labor hours account for the
number of hours required by each employee to complete the service. These
estimates can be derived from historical workload.
Wage rates are the amounts paid to the
different classifications of employees required to perform the contract. U.S.
law requires, in accordance with the provisions of 29 CFR Part 1 and Part 5,
the applicable Davis-Bacon wage determination set the minimum paid by
contractors to laborers. The Department
of Labor establishes these rates and they are available to the contractor
anytime online. Providing these at the beginning of the solicitation would
allow the contractors to easily reference and be put on notice to the lowest
wages acceptable by law for the positions they are providing. They can then add
justifications for any wages that are significantly higher than those provided.
Labor
Burden
The
labor burden cost category contains the costs for direct labor associated with
employee benefits. The components of labor burden include payroll taxes,
workmen’s compensation insurance, health and welfare, vacation, and holidays.
TRADOC’s IGE Preparation Guide advises a 30% straight-line method be used for
the preparation of the IGE.
Overhead
The
overhead category includes all of the cost elements that are not already
included in direct labor, labor burden, and other direct costs. The components
of overhead are indirect labor, costs associated with labor and indirect
supplies. TRADOC’s IGE Preparation Guide recommends a 15% overhead rate be used
for general estimating purposes.
Other
Direct Costs
An
accurate estimate of the contractors other direct cost elements can be provided
by reviewing the statement of work, determining necessary equipment, materials,
and travel required to perform the contract.
What equipment and materials will and will not be furnished by the Government
should be included in the initial solicitation. Because the Government already
has this information, the estimate of costs for materials furnished, and not
furnished by the Government can be developed. Allowing the contractors to see
what the Government believes the direct cost to be should not provide any
unfair advantage to the contractor because all of the information was
previously available.
General
and Administrative (G&A) Expenses
G&A
costs are incurred by the company and cannot be associated with one specific
project. The TRADOC IGE Preparation Guide states that that G&A rate in
competitive acquisitions will usually not exceed 15%. Government’s could
provide an IGE with its maximum allowable G&A rate, and advise the
contractors that the rate they propose will determine how competitive their
offer will be.
Profit/Fee
The
Public Works and Government Services of Canada explain that profit levels
recognize “the cost of money associated with the capital employed by the
contractor” as well
as the business and contractual risks that are assumed by the contractor in the
performance of the contract. The amount of profit that can be attributed to
each area must be made in accordance with Canadian guidelines, which greatly
eliminate the potential for biased in the selection decision. The total profit the lesser of the sum of
supportable amounts by factor and 20% of total costs. Providing these
calculations to the contractor up front would allow them to know the exact
mechanics behind what profit they should be proposing and for what reason. It
would also allow them the opportunity to dispute any of the determinations in
the first round of negotiations and the procurement process would benefit from
the efficiencies of not having to decipher how and why the contractor is
proposing profit they way they think that they should be. Various examples of
the calculations implemented by the Canadian procurement system are provided in
Appendix I.
Benefits of Disclosing the IGE to Contractors
The
U.S. Air Force (2006) states that one of the reason the Government needs an
estimate is to ensure the contractors understands the requirement that the
Government has. With a full understanding of the requirement, the case can be
made that the contractor can then propose more accurately and/or propose a
better way to technically execute the requirement. If the contractor knows
exactly what the Government is looking to obtain, and how they think it is best
to obtain it, they would be put in a better position to propose a technically
acceptable performance plan that provides better value to the Government.
Often, acquisition professionals and program management personnel struggle to
determine how much a contract should cost accurately and confidently.
Disclosing all of the information that the estimate developed by the Government
was based on would allow the contractor to feel more at ease with the basis of
their proposed price.
Game Theory
Game Theory is the scientific study of strategy.
Economists use Game Theory to explain and predict people’s behavior in
strategic situations such as bargaining, auctions, and merger pricing.
Each player in any competitive market must consider the impact of their actions
before deciding what they will do and how they will do it. The outcome for each
participant depends on the strategies of not only themselves, but everyone else
playing the game as well.
Auction Theory: The Winner’s Curse
In game theory, has the freedom to formulate the rules of
the game. Auction theory provides one of the most useful test-beds for game
theory because it has well-defined rules that yield clearer theoretical
predictions. In
auction theory, the Winner’s Curse describes how in certain situations, the
winner of an action will tend to overpay. Scholar Paul Milgrom of Stanford
University defines the winner’s curse as traditionally referring to the
selection bias that arises because a bidder tends to win more often when his
value estimate is too high as opposed to when it is too low.
Because the auction winner always tends to be the bidder that overestimates the
value, they are thought to be cursed for winning. The result of the award is
usually the deterioration of the contractor’s financial stability and a bad
quality service due to the contractor being forced to adopt opportunistic
cost-reducing actions because they aren’t receiving enough finding to perform
on the contract. In the worst cases, the contractor is forced into bankruptcy
and is unable to perform on the contract all together.
If the competing firms are aware of the Winner’s Curse,
they tend to become crippled with the fear they may suffer losses. To mitigate
the risk of loss, the contractor adopts an overly cautious bidding strategy,
generating higher award prices. The winner’s curse is recognized in several
court opinions such as Chicago Pacific Corp. v. Canada Life Assur. Co. 850 F.2d 334 (1988) and
Flamm v. Eberstadt. 814 F.2d 1169 (1987).
Common Value
Auctions that place a common value on the winning prize
are highly susceptible to the Winner’s Curse. The source selection criteria are
provided to all bidders in the auction. The auction winner will be whoever bids
the highest. The key characteristic in this situation is that the auction is
worth the same thing to every bidder. The bidders have a common value, which is
equal to the amount of revenue winning the auction will generate. Different
bidders will estimate the revenue using different strategies, potentially
resulting in the winning bidder paying too much.
Intrinsic Value
Auction theory also identifies a solution that makes
bidders immune to the winner’s curse. Each individual bidder in the auction
must have their own intrinsic value for winning the auction. When the basis of
winning the award is the individual bidders underlying perception of value,
derives from its own independent analysis, there is no longer a common value
shared amongst all bidders. The value becomes specific to the individual
bidder, dependent only on the personal preferences of the company. In this
situation, it becomes easy for bidders to avoid overpaying because they limit
their maximum bid to their individual estimation of worth. Consequently, the
winner can always be a company that has bid below their individual value and
the winner’s curse does not occur.
Application to Federal Procurements
To apply auction theory to the current negotiated
procurement environment, the contractors must propose a contract amount based
on its individual analysis of expected award value. Another solution to the
winner’s curse is to design more comprehensive acquisition procedures that ease
the contractors concern in regards to the inaccuracy of cost estimation while
still raising good revenue. Allowing contractors access to more precise sources
of information about the common cost components of the cost function of a
contract (like the IGE) will result in less risk being prices into the
proposals and a better value being offered to the Government. Several
studies find that making the engineer’s cost estimate publicly available before
the bid decreased the average bid level in Oklahoma
.
The Navy was found not to be violating procurement regulations by providing
significantly overstated line items to the bidder permitting them to lower the
bid price and win the award in Academy Facilities Management v. United States,
87 Fed.Cl. 441 (2009). They also provided the variances from the IGE to both
bidders, who both raised prices accordingly
The Risk of Disclosing the IGE to
Contractors
FAR 36.203(c) permits the disclosure of
the IGE during contract negotiations in order to identify specific specialized
tasks and the cost breakdown figures associated with them. Guidance warns
acquisition professionals that the disclosure of the IGE “may put the
government at a disadvantage in dealing with contractors. Moreover, it gives
contractors an unfair advantage over other contractors competing for the same
requirement.”
At some states level, the cost
estimate developed by the engineer’s for construction procurement is made
available the day of bidding, while in other states, it is not available until
after the bids are opened. Many states are involved with organizations
used to detect collusion such as the American Association of State Highway and
Transportation Officials Transport System. They compare bid to the engineer’s
estimate, the other bid received, and analyze past bidding behavior, price
differences, and market prices according to various parameters. The
Interdepartmental Bid Rigging Investigations Coordinating Committee developed
guidance in 1983 that is still referenced today. They recommend that, though
some state agencies include their engineer’s cost estimate for a project among
the initial materials furnished to prospective bidders, a state engineer’s
estimate should not be disclosed prior to the award of a contract. They go on
to suggest that all estimates remain confidential because early release of this
information encourages and/or facilitates bid rigging by permitting prospective
bidders to gauge what the state agency would consider to be a reasonable price
for the project and to decide how far a rigged bid may exceed the estimate
without jeopardizing the award.
“We
are not aware of any compelling business reason for making the state engineer's
estimate available to prospective bidders. It is not necessary to help them
estimate the cost of materials, since bidders are intimately familiar with
these costs. Relying on past experience, bidders can readily determine their own
mobilization and labor costs. We are advised that state engineers in some cases
obtain the data on which their estimates are based from the same contractors
who later bid on the job. We are persuaded, therefore, that the bidding process
would not be impaired if the state engineer's estimates were withheld from
prospective bidders prior to the letting of construction contracts.”
Disclosing the IGE could also lead to
higher prices by serving as a focal point for tacitly collusive price setting.
Thomas Schelling pioneered focal point theory in the 1960’s, noting that in
simply games with many equilibria, agents can frequently identify a focal point
and use it to coordinate. Tacit collusion occurs when firms agree to bid set
amounts without explicitly saying so. If firms bid the amount provided in the
IGE, even though they may be able to provide individual line items at a price
that is more advantageous to the government, higher bids would be received. Knittel
and Stango (2003) analyze tacit collusion in credit card issuer’s rates
charged. They find that regulation created a focal point that allowed tacit
collusion that disappeared with deregulation. If disclosure of the IGE
facilitated collusion, it would not be in the government’s best interest. Morrison-Knudsen Co. v. Dept.
of the Army of US, 595 F. Supp. 352 (D.D.C. 1984) held that the IGE being
released before contract award would have an adverse effect on the procurement
and any benefits expected from the competitive process. Federal Open Market Committee v.
Merrill, 443 U.S. 340, 360, 99 S. Ct. 2800, 2812, 61 L. Ed. 2d 587 (1979) held
that disclosing information in the IGE may place the Government at a
competitive disadvantage or endanger the consummation of the contract. The M-K
case also noted that disclosure of the IGE might discourage commercial firms
from taking the initiative to come up with more innovative techniques for
cutting costs in the hopes of underbidding. Quarles
v. Department of Navy, 893 F.2d 390 (C.A.D.C., 1990) held that cost estimates
are derived from complex set of judgments and thus are not merely fixed facts,
and there is possibility of harm to the decision-making process from disclosure
of estimates by discouraging candid opinions and by unleashing forces which
could preclude alternatives other than one supported by cost projections.
Disclosing the IGE can also result in firms deliberately underbidding jobs, a
practice known as “buying in.” FAR 3.501-2 defines buying-in as an improper
business practice of submitting an offer below anticipated costs, expecting to
increase the contract amount after award or receive follow-on contracts at
artificially high prices to recover losses. Buying-in often decreases
competition and results in poor contract performance. United States ex rel. Hooper v.
Lockheed Martin Corp., No. 11-55278 (9th. Cir. 2012), Lockheed was found to have knowingly
underestimated its costs when submitting its bid, which can be a source of
liability under the False Claims Act.
Conclusion
