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Intermediate Cost and

Price Analysis

November 2017
Learn. Perform. Succeed.
www.dau.mil
CON 270
Intermediate Cost and
Price Analysis

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Student Preparation
Students are expected to read assignments in advance of class and be prepared to discuss the
materials in class. Students are expected and encouraged to actively participate in class
discussions.

Student Grades
In accordance with DAU policy, students must receive an overall 80% or 80 points to
successfully complete the class. Your grade will be composed of the following:

Assessments:

Assessment Grade Assessment


Points Method
Multiple
Exam 1 35 choice
Wesley Integrating Group
Exercise 10 Assessment
Group
Week 2 Integrating Case
10 Assessment
Cost Realism Individual Individual
Exercise 5 Assessment
Multiple
Exam 2 40 choice
Total Available 100

Points needed to
successfully complete
80
CON 270

DAU Remediation Policy

It is DAU policy to not permit remediation. For example, no extra work or credit can be given to
make up or gain additional points on the quizzes or case presentations. Instead, we offer
remediation BEFORE each quiz and the integrating case study. The instructors are available to
meet with students to help the student with anything in the course before the quizzes. The
instructors highly encourage students take advantage of the instructors’ availability.

DAU Policies

Student Academic Polices addresses student Standards of Conduct as well as policies on Course
Enrollment/Disenrollment; Student Evaluations; accommodation for students with disabilities;
and procedures for violations of academic policy.

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Students at DAU are expected to maintain the highest standards of personal, ethical, and moral
conduct. These standards require personal integrity and honesty. The discovery, advancement,
and communication of knowledge will be achieved only with a commitment to these standards.
The policies cited in this directive are intended to establish a minimum standard of conduct,
conducive to attainment of excellence in training and education.

DAU encourages students who have an issue or concern with the learning environment to
discuss it with their instructor. Students who feel their issue is not resolved satisfactorily may
go to the department chair/site manager or Regional Associate Dean for Academics.

The policies can be accessed at the following link:


http://www.dau.mil/studentInfo/Pages/student_info.aspx

Attendance/Absenteeism

The DAU expectation is full-time attendance; however, DAU recognizes that this may not
always be possible. Accordingly:

 Whenever possible, the student shall request permission from the instructor in advance
of the absences, which must be for valid reasons such as illness or family emergencies.
Routine work requirements are not considered a valid excuse.
 Cumulative absences that exceed five percent of instructional time may be grounds for
disenrollment, e.g., for a 40-hour course, students are expected to participate in at least
38 hours. Under extenuating circumstances the student may request an exception to the
disenrollment policy. The faculty member will forward the request and justification and
their recommendation to the Regional Associate Dean for Academics for a decision.
 Some courses require students who receive permission to miss periods of class time to
complete supplemental work before receiving a graduation certificate. If a student does
not complete the prescribed make-up, no credit will be given for any part of the course,
i.e., no completion certificate will be issued.
 When a weather-related absence affects significant segments of the course, the
instructor, in coordination with the Regional Associate Dean for Academics, and/or
other appropriate DAU staff will determine the appropriate course of action which can
range from make-up work to rescheduling of the offering.
 Early plane reservations that require departure before course graduation are not
considered a valid reason to miss class.
 In the rare case where an absence is excused, civilian students are responsible for
reporting leave taken during a course offering to their employing organization. Military
students shall document their leave with the appropriate military personnel office.
 Some courses have required activities

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In-Class Behavior

Students are expected to behave in a professional manner at all times. This includes, but is not
limited to:

 Being attentive and participating in all class activities. Instructors will be sympathetic
and supportive of students who use moderate methods to maintain alertness or relieve
physical discomfort, such as non-alcoholic drinks, snacks, or standing at the rear of the
room.
 Abiding by professional standards and courtesy when interacting with faculty, guests,
and other students.
 Arriving on time, returning promptly from breaks, and staying until the class day ends.
 Being respectful of the facilities and leaving the student areas in the same condition they
were in upon arrival.
 Ensuring cell phones, blackberries and other communicative or electronic devices not
used in support of the instruction are either turned off, set to silent or set to vibrate only.

Student Attire

Unless otherwise noted in the welcome letter or e-mail, civilian and military students are
authorized to wear business casual attire: dress slacks, collared shirts, dress shoes/loafers and the
equivalent attire for women. Shorts; flip flops; strapless, excessively short or sheer garments;
exposed mid-drift; jeans; and athletic wear of any kind are examples of inappropriate attire. The
instructor may specify in advance exceptions to the above in support of a specific class event.
Appropriate cleanliness and grooming is expected of all students. Additionally, students are
requested to be cognizant that the heavy use of colognes and perfumes can be a distracter in class
and cause allergic reactions in other students. In the case of DAU courses conducted at customer
sites, alternative attire, consistent with local command or organization standards, may prevail.

Academic Integrity
Absolute integrity is expected of every DAU student in all academic undertakings. Integrity
entails a firm adherence to a set of values, and the values most essential to an academic
community are grounded on the concept of honesty with respect to the intellectual efforts of
oneself and others. Academic integrity is expected not only in formal coursework situations, but
in all university relationships and interactions connected to the educational process, including
the use of university resources.

 A DAU student's submission of work for academic credit indicates that the work is the
student's own. All outside assistance and citations should be acknowledged, and the
student's academic position truthfully reported at all times. In addition, DAU students
have a right to expect academic integrity from each of their peers. Students shall not:
 Misrepresent their work.
 Fraudulently or unfairly advance their academic position.
 Be a party to another student's failure to maintain academic integrity.
 Violate the principle of academic integrity in any other manner.

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 The following actions are examples of activities that violate the Student Academic
Policy and subject their participants to actions under this policy (this is not a
comprehensive list):
 Knowingly representing the work of others (from any source) as one's own.
 Using, obtaining, or providing unauthorized assistance on examinations, papers,
or any other academic work.
 Fabricating data in support of research or field work.
 Forging a signature to certify completion of a course assignment or a
recommendation.
 Misrepresenting one's academic accomplishments.
 Viewing, removing or copying any examination materials or any portions
thereof by any means, including electronically.

Principles for Computer Use and Network Systems


The use of computers and network systems does not exempt students from the normal
requirements of ethical behavior in the DAU community. Use of a computer and network system
that is shared by many users imposes certain additional obligations. While rules are built into
computer and network systems, such restrictions cannot eliminate the opportunity for perusal of
the work or resources of others. Students are responsible for their actions whether or not rules are
built in, and whether or not they can circumvent them. Standards of behavior include, but are not
limited to respect for the:

 Privacy of other users’ information, even when that information is not securely protected.
 Ownership of proprietary software. For example, making or using unauthorized copies of
such software, even when that software is not protected against copying, is inappropriate
and violates this policy.
 Finite capacity of the system and limitation of use so as not to interfere unreasonably
with the activity of other users.
 Procedures established to manage the use of the system.

Academic Freedom and Non-Attribution

DAU supports a policy of academic freedom with the privilege of discretionary debate on any
subject related to our curricula within the university environment. In order to ensure this
academic freedom, DAU maintains a non-attribution policy. The objective is to enable students,
instructors and guest speakers to express their views freely and without possible attribution or
embarrassment. In keeping with this policy specific statements or remarks shall not be attributed
to specific speakers (by name or other identifying comments) unless specifically allowed by the
speaker.

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SCHEDULE
CON 270 CLASS SCHEDULE WEEK 1

Day Class Time Topic/Assignment Reading Assignments/


Homework

1 Introduction/Orientation Review: Statistics


AM Acme Proposal Modeling Review Wesley Case Material
Monday Exercise Proposal Modeling
Lunch
GPS Modeling
PM Wesley Integrating Case Prep
Special Interest Items (as needed)

2 AM Using Statistics in Contract Pricing Review: Regression


Review Wesley Case Material
Tuesday Lunch

PM Using Statistics in Contract Pricing

AM Cost Estimating Relationship Regression practice problems


3 Regression Analysis Review Improvement Curve
Lunch Review Wesley Case Material
Wednesday
PM Factor Analysis in Contract Pricing

4 AM  Factors (continued as required) Review: VIQ

Improvement Curve
Thursday Lunch Exam preparation

Wesley Integrating Exercise


PM

5 AM Exam I Review: Cost Risk Analysis and


Incentive Contract Student
Guide
Friday Lunch VIQ

WGL Refresher
PM

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CON 270 CLASS SCHEDULE WEEK 2

Day Class Time Topic/Assignment Reading Assignments/


Homework

6 AM Cost Risk Analysis

Monday Lunch
Review Incentive Contract
PM Incentive Contracting Student Guide

7 AM Incentive Contracting

Tuesday Lunch FPIF/CPIF practice problems

PM

8 AM Incentive Contracting

Wednesday Lunch

Integrating Case
PM Review: Cost Realism
Analysis, EA

9 AM Cost Realism Analysis


Cost Realism Exercise
Thursday Lunch

PM Equitable Adjustment

Review: Exam Preparation

10 AM Exam II

Friday MTM/Admin Graduation


Lunch Introduction to CON 280 and CON 290
Pre-course requirements

PM

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CON 270, Intermediate Cost and Price Analysis

Proposal Modeling

CON 270
Intermediate Cost & Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

Defense Acquisition University


DEFENSE ACQUISITION UNIVERSITY

ACME INCORPORATED
Con270 Cost/Price Exercise

Table of Contents
1. ACME Proposal of Record
2. Basic Statistics Application (DL Rates)
3. Regression Application (DL Rates and Program Support CER)
4. Cost Improvement Curve (CIC) Application (Mfg Labor Hours)

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CON 270, Intermediate Cost and Price Analysis

ACME Incorporated
St Louis, Missouri
Today’s Date
Dear PCO,

We are pleased to submit our proposal in response to your RFP No: F12345-08-R-2000. You will find our
cost breakdown summary (CBS) below tabbed with our supporting basis of estimate (BOE) immediately
following.

Element Amount Ref ¶


Material and Subcontracts $1,535,908 (1)
Engineering Labor 1,652,054 (2)
Engineering Overhead 1,683,918 (5)
Manufacturing Labor 285,960 (3)
Manufacturing Overhead 588,062 (5)
Other Direct Cost 8,110 (4)
Subtotal Production Cost $5,754,012
General and Administrative Cost 873,835 (5)
Facilities Capital Cost Money 62,279 (5)
Profit 1,325,569
Total Price $8,015,695

1. Material and Subcontracts – Purchased parts and raw material proposed at $267,849 supported by
priced bill of material (available upon request) and scrap at 4%. AJAX quoted subcontract at
$1,257,345.

2. Engineering Labor – Effort requires two (2) full time equivalent (FTE) Design and Integration
Engineers for year one (1) reduced to one FTE each for years two (2) and three (3). One Test
Engineer FTE support required for years two (2) and three (3). Program Support Engineering
proposed at 5% of engineering labor hours. See Proposal Rates and Factors Table, Attachment 1, for
standard labor hours and direct rates as submitted for DCMA review and negotiation.

3. Manufacturing Labor – Fabrication, assembly and quality assurance are estimated at 3.5, 1.75, and
0.25 hours/unit, respectively, supporting delivery schedule of 300 units in year two (2) and 500 units
in year three (3). See Proposal Rates and Factors Table, Attachment 1, for direct labor rates as
submitted for DCMA review and negotiation.

4. Other Direct Cost – Travel and subsistence for one (1) Design and one (1) Integration Engineer to
support two one-week design reviews – one at the subcontractor AJAX facility in Ft. Worth and one
at your Washington DC office. Round trip airfare from St. Louis (STL) to Dallas Fort Worth (DFW)
and Reagan National (DCA) estimated at $725 and $625, respectively. Estimated Per Diem at $174
and $297, respectively, and rental cars at $350/week.

5. Indirect Cost and Facilities Capital Cost of Money - See Proposal Rates and Factors Table,
Attachment 1, as submitted for DCMA review and negotiation.

Respectfully and sincerely submitted for your consideration

ACME

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CON 270, Intermediate Cost and Price Analysis

ACME Proposal of Record

Proposal Rates and Factors1 Attachment 1


Base Year 1 Year 2. Year 3

Material Scrap CER 4.00%

Engineering - Escalation 9% 9%

Design DL $75.83 $75.83 $82.65 $90.09

Integration DL $65.74 $65.74 $71.66 $78.11

Test DL $68.33 $68.33 $74.48 $81.18


Program Support DL $60.82 $60.82 $66.29 $72.26
FTE Hours/Year 2080
Program Support CER 5%

Manufacturing - Escalation 9% 9%

Fabrication DL $56.90 $56.90 $62.02 $67.60

Assembly DL $55.98 $55.98 $61.02 $66.51

Quality Assurance DL $53.45 $53.45 $58.26 $63.50

Indirect Cost Rates

Engineering OH 101% 103% 102%

Manufacturing OH 204% 205% 206%


General & Admin 15% 15.5% 15.25%

FCCOM Factors

Engineering .0225 .0225 .0225

Manufacturing .0375 .0375 .0375

General & Admin .0025 .0025 .0025

1
Reference FPRP submitted to DCMA ACO, day before yesterday.

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CON 270, Intermediate Cost and Price Analysis

Design Eng. $/Hr. by Emloyee # Fabrication $/Hr. by Emloyee #


Eng # 1 $ 69.07 Fab# 1 $ 47.98
Eng # 2 $ 43.08 Fab# 2 $ 56.95
Eng # 3 $ 52.07 Fab# 3 $ 53.24
ACME
Eng # 4 $ 44.80 Fab# 4 $ 57.38
Incorporated
Eng # 5 $ 125.87 Fab# 5 $ 62.63
Eng # 6 $ 57.37 Fab# 6 $ 65.36
Eng # 7 $ 57.80 Fab# 7 $ 55.17
Eng # 8 $ 205.29 Fab# 8 $ 58.06
Eng # 9 $ 44.53 Fab# 9 $ 67.17
Eng # 10 $ 50.33 Fab# 10 $ 49.01
Eng # 11 $ 53.81 Fab# 11 $ 55.75
Eng # 12 $ 56.29 Fab# 12 $ 46.66
Eng # 13 $ 59.34 Fab# 13 $ 58.57
Eng # 14 $ 149.17 Fab# 14 $ 56.89
Eng # 15 $ 68.63 Fab# 15 $ 64.40
Fab# 16 $ 63.24
Fab# 17 $ 52.83
Fab# 18 $ 52.73
Fab# 19 $ 60.85
Fab# 20 $ 53.13

Mr/Ms PCO,

You requested supporting information for our base design engineering labor rate and fabrication
labor rate. We use the departmental average labor rate which you can see is substantiated by the
actual labor rates of the employees in those departments.

We hope you find this information fully supports our proposal and we look forward to your
acceptance and getting started on this very important program.

Sincerely,

ACME

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CON 270, Intermediate Cost and Price Analysis

DCMA ACME Incorporated


Mr/Ms PCO,

You requested historical median engineering labor rates and mean manufacturing labor rates for
ACME incorporated. As you know, DCAA is still auditing ACME’s forward pricing rate
proposal and we hope to consider their audit findings in our upcoming forward pricing rate
recommendation. In the mean time you will find the data requested below.

2005 2006 2007 2008 2009 2010 2011

Design $ 53.80 $ 55.11 $ 55.44 $ 56.77 $ 57.37 ? ?

Integration $ 55.50 $ 56.83 $ 57.18 $ 58.54 $ 59.17 ? ?

Test $ 57.69 $ 59.06 $ 59.44 $ 60.84 $ 61.50 ? ?

Prog Supt $ 54.19 $ 55.51 $ 55.83 $ 57.18 $ 57.78 ? ?

Fabrication $ 52.32 $ 53.87 $ 54.44 $ 56.03 $ 56.90 ? ?

Assembly $ 51.47 $ 53.00 $ 53.56 $ 55.13 $ 55.98 ? ?

Quality $ 49.13 $ 50.62 $ 51.12 $ 52.65 $ 53.45 ? ?

We hope you find this information responsive and helpful.


Sincerely,

ACO - DCMA, ACME Incorporated

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CON 270, Intermediate Cost and Price Analysis

ACME Incorporated
Mr/Ms PCO,

As we discussed our historical Manufacturing Indirect Cost on the phone yesterday, you can see
that our proposed Manufacturing Overhead rate is based on historical observation. It has been
increasing by one percentage point per year since 2005 and we estimate that trend to continue.

Year: 2005 2006 2007 2008 2009 2010 2011


(actual) (actual) (actual) (actual) (estimated) (estimated) (estimated)
Rate: 200% 201% 202% 203% 204% 205% 206%

You also requested our current business outlook relative to our manufacturing operations. Our
current estimated base manufacturing cost in 2009 is $850,000 and we are expecting that to grow
by $100,000/year as a result of the recent economic stimulus package.

The requested four year history of base manufacturing labor costs and associated support
expenses is also provided as follows:

Year Mfg. Labor $ Support Exp. $


2005 $834,311 $1,665,522
2006 $711,145 $1,426,301
2007 $626,459 $1,268,546
2008 $784,041 $1,594,703

I trust you find this information responsive to your inquiry to fully support our proposal. We
look forward to your acceptance and getting started on this very important program.

Sincerely,

ACME Incorporated

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CON 270, Intermediate Cost and Price Analysis

ACME Incorporated
Mr/Ms PCO,

You requested supporting information for fabrication, assembly and quality assurance hours
proposed at 3.5, 1.75, and .25 hours per unit, respectively. Your requirement will immediately
follow four (4) prior production lots. The historical data from these production lots appears
below substantiating the average hours per unit experienced in these lots and expected to
continue for your requirement.

Lot # Quantity Fabrication Hours Assembly Hours Quality Hours


1 50 250 155 14
2 50 200 100 13
3 100 350 170 25
4 200 600 275 48
Total 400 1400 700 100

Average 3.5 1.75 .25

We hope you find this information fully supports our proposal and we look forward to your
acceptance as we look forward to getting started on this very important program.

Sincerely,

ACME

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

Note Page

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CON 270, Intermediate Cost and Price Analysis

DCAA Proposal Adequacy Checklist


If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
1. FAR 15.408, Is there a properly completed first
Table 15-2, page of the proposal per FAR
Section I 15.408 Table 15-2 I.A or as
Paragraph A specified in the solicitation?

2. FAR 15.408, Does the proposal identify the


Table 15-2, need for Government-furnished
Section I material/tooling/test equipment?
Paragraph A(7) Include the accountable contract
number and contracting officer
contact information if known.

3. FAR 15.408, Does the proposal identify and


Table 15-2, explain notifications of
Section I noncompliance with Cost
Paragraph A(8) Accounting Standards Board or
Cost Accounting Standards (CAS);
any proposal inconsistencies with
your disclosed practices or
applicable CAS; and
inconsistencies with your
established estimating and
accounting principles and
procedures?

4. FAR 15.408, Does the proposal disclose any


Table 15-2, other known activity that could
Section I, materially impact the costs?
Paragraph C(1) This may include, but is not
limited to, such factors as—
FAR 2.101, “Cost (1) Vendor quotations;
or pricing data” (2) Nonrecurring costs;
(3) Information on changes in
production methods and in
production or purchasing volume;
(4) Data supporting projections of
business prospects and objectives
and related operations costs;
(5) Unit-cost trends such as those
associated with labor efficiency;
(6) Make-or-buy decisions;
(7) Estimated resources to attain
business goals; and

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CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
(8) Information on management
decisions that could have a
significant bearing on costs.
FAR 15.408, Is an Index of all certified cost or
Table 15-2, pricing data and information
Section I accompanying or identified in the
proposal provided and
appropriately referenced?

6. FAR 15.403-1(b) Are there any exceptions to


submission of certified cost or
pricing data pursuant to FAR
15.403-1(b)? If so, is supporting
documentation included in the
proposal? (Note questions 18-20.)

7. FAR 15.408, Does the proposal disclose the


Table 15-2, judgmental factors applied and
Section I the mathematical or other
Paragraph methods used in the estimate,
C(2)(i) including those used in projecting
from known data?

8. FAR 15.408, Does the proposal disclose the


Table 15-2, nature and amount of any
Section I contingencies included in the
Paragraph proposed price?
C(2)(ii)

9. FAR 15.408 Table Does the proposal explain the


15-2, Section II, basis of all cost estimating
Paragraph A or B relationships (labor hours or
material) proposed on other than
a discrete basis?

10. FAR 15.408, Is there a summary of total cost by


Table 15-2, element of cost and are the
Section I elements of cost cross-referenced
Paragraphs D to the supporting cost or pricing
and E data? (Breakdowns for each cost
element must be consistent with
your cost accounting system,
including breakdown by year.)

11. FAR 15.408, If more than one Contract Line


Table 15-2, Item Number (CLIN) or sub
Section I Contract Line Item Number (sub-

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CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
Paragraphs D CLIN) is proposed as required by
and E the RFP, are there summary total
amounts covering all line items
f o r each element of cost and is it
cross-referenced to the supporting
cost or pricing data?

12. FAR 15.408, Does the proposal identify any


Table 15-2, incurred costs for work performed
Section I before the submission of the
Paragraph F proposal?

13. FAR 15.408, Is there a Government forward


Table 15-2, pricing rate agreement (FPRA)? If
Section I so, the offeror shall identify the
Paragraph G official submittal of such rate and
factor data. If not, does the
proposal include all rates and
factors by year that are utilized in
the development of the proposal
and the basis for those rates and
factors?
COST ELEMENTS
MATERIALS AND SERVICES
FAR 15.408, Does the proposal include a
Table 15-2, consolidated summary of
Section II individual material and services,
frequently referred to as a
Consolidated Bill of Material
(CBOM), to include the basis for
pricing? The offeror’s
consolidated summary shall
include raw materials, parts,
components, assemblies,
subcontracts and services to be
produced or performed by others,
identifying as a minimum the
item, source, quantity, and price.

SUBCONTRACTS (Purchased materials or services)

15. DFARS 215.404-3 Has the offeror identified in the


proposal those subcontractor
proposals, for which the
contracting officer has initiated
or may need to request field
pricing analysis?

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CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)

16. FAR 15.404-3(c) Per the thresholds of FAR 15.404-


3(c), Subcontract Pricing
FAR 52.244-2 Considerations, does the proposal
include a copy of the applicable
subcontractor’s certified cost or
pricing data?

17. FAR 15.408, Is there a price/cost analysis


Table 15-2, establishing the reasonableness of
Note 1; each of the proposed subcontracts
Section II included with the proposal?
Paragraph A If the offeror’s price/cost analyses
are not provided with the
proposal, does the proposal
include a matrix identifying dates
for receipt of subcontractor
proposal, completion of fact
finding for purposes of price/cost
analysis, and submission of the
price/cost analysis?
EXCEPTIONS TO CERTIFIED COST OR PRICING DATA

18. FAR 52.215-20 Has the offeror submitted an


exception to the submission of
certified cost or pricing data for
FAR 2.101, commercial items proposed either
“commercial at the prime or subcontractor
item” level, in accordance with
provision 52.215-20?
a. Has the offeror specifically
identified the type of commercial
item claim (FAR 2.101 commercial
item definition, paragraphs (1)
through (8)), and the basis on
which the item meets the
definition?
b. For modified commercial
items (FAR 2.101 commercial item
definition paragraph (3)); did the
offeror classify the modification(s)
as either—
i. A modification of a type
customarily available in the
commercial marketplace
(paragraph (3)(i)); or

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CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
ii. A minor modification
(paragraph (3)(ii)) of a type not
customarily available in the
commercial marketplace made to
meet Federal Government
requirements not exceeding the
thresholds in FAR 15.403-
1(c)(3)(iii)(B)?
c. For proposed commercial
items “of a type”, or “evolved” or
modified (FAR 2.101 commercial
item definition paragraphs (1)
through (3)), did the contractor
provide a technical description of
the differences between the
proposed item and the
FAR 15.408, comparison item(s)?
Does the proposal include a price
Table 15-2, analysis for all commercial items
Section II offered that are not available to
Paragraph A the general public?

20. FAR 15.408, Does the proposal support the


Table 15-2, degree of competition and the
Section II basis for establishing the source
Paragraph A(1) and reasonableness of price for
each subcontract or purchase
order priced on a competitive
basis exceeding the threshold for
certified cost or pricing data?
INTERORGANIZATIONAL TRANSFERS

21. FAR 15.408, For inter-organizational transfers


Table 15-2, proposed at cost, does the
Section II proposal include a complete cost
Paragraph A.(2) proposal in compliance with Table
15-2?

22. FAR 15.408, For inter-organizational transfers


Table 15-2, proposed at price in accordance
Section II with FAR 31.205-26(e), does the
Paragraph A(1) proposal provide an analysis by
the prime that supports the
exception from certified cost or
pricing data in accordance with
FAR 15.403-1?

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CON 270, Intermediate Cost and Price Analysis

DIRECT LABOR
If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
FAR 15.408, Does the proposal include a time
Table 15-2, phased (i.e.; monthly, quarterly)
Section II breakdown of labor hours, rates
and costs by category or skill
level? If labor is the allocation
base for indirect costs, the labor
cost must be summarized in order
that the applicable overhead rate
can be applied.

FAR 15.408, For labor Basis of Estimates


Table 15-2, (BOEs), does the proposal include
Section II labor categories, labor hours, and
task descriptions, (e.g.; Statement
of Work reference, applicable
CLIN, Work Breakdown Structure,
rationale for estimate, applicable
history, and time-phasing)?

25. FAR subpart If covered by the Service Contract


22.10 Labor Standards statute (41 U.S.C.
chapter 67), are the rates in the
proposal in compliance with the
minimum rates specified in the
statute?
INDIRECT COSTS
FAR 15.408, Does the proposal indicate the
Table 15-2, basis of estimate for proposed
Section II indirect costs and how they are
applied? (Support for the indirect
rates could consist of cost
breakdowns, trends, and
budgetary data.)

OTHER COSTS
FAR 15.408, Does the proposal include other
Table 15-2, direct costs and the basis for
Section II pricing? If travel is included does
the proposal include number of
trips, number of people, number
of days per trip, locations, and
rates (e.g. airfare, per diem, hotel,
car rental, etc)?

27
CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)
28. FAR 15.408, If royalties exceed $1,500 does
Table 15-2, the proposal provide the
information/data identified by
Section II
Table 15-2?
Paragraph E

29. FAR 15.408, When facilities capital cost of


Table 15-2, money is proposed, does the
Section II proposal include submission of
Paragraph F Form CASB-CMF or reference to
an FPRA/FPRP and show the
calculation of the proposed
amount?
FORMATS FOR SUBMISSION OF LINE ITEM SUMMARIES

30. FAR 15.408, Are all cost element breakdowns


Table 15-2, provided using the applicable
Section III format prescribed in FAR 15.408,
Table 15-2 III? (or alternative
format if specified in the request
for proposal)
FAR 15.408, If the proposal is for a
Table 15-2, modification or change order,
Section III have cost of work deleted (credits)
and cost of work added (debits)
been provided in the format
described in FAR 15.408, Table 15-
2.III.B?

FAR 15.408, For price


Table 15-2, revisions/redeterminations, does
Section III the proposal follow the format in
Paragraph C FAR 15.408, Table 15-2.III.C?

OTHER

33. FAR 16.4 If an incentive contract type, does


the proposal include offeror
proposed target cost, target profit
or fee, share ratio, and, when
applicable, minimum/maximum
fee, ceiling price?

34. FAR 16.203-4 If Economic Price Adjustments are


and FAR being proposed, does the proposal
15.408 Table 15-2, show the rationale and application
Section II, for the economic price adjustment?
Paragraphs A, B,
C, and D

28
CON 270, Intermediate Cost and Price Analysis

If not provided
EXPLAIN (may
SUBMISSION PROPOSAL
REFERENCES use
ITEM PAGE No.
continuation
pages)

35. FAR 52.232-28 If the offeror is proposing


Performance-Based Payments did
the offeror comply with FAR
52.232-28?

36. FAR 15.408(n) Excessive Pass-through Charges–


Identification of Subcontract
FAR 52.215-22 Effort: If the offeror intends to
subcontract more than 70% of the
FAR 52.215-23 total cost of work to be performed,
does the proposal identify: (i) the
amount of the offeror’s indirect
costs and profit applicable to the
work to be performed by the
proposed subcontractor(s); and
(ii) a description of the added
value provided by the offeror as
related to the work to be
performed by the proposed
subcontractor(s)?

DFARS 215.408

29
CON 270, Intermediate Cost and Price Analysis

GPS Modifications

You are negotiating a base contract for year one for modifications to the DAGR GPS receiver
with priced options for years two and three. The schedule calls for 600 units in year one, 725
units in year two, and 575 units in year three.

The tech audit recommended 1.5 hours per unit for assembly and 0.5 hours per unit for
calibration and test. The ACO is currently renegotiating the FPRA for the company wage rates,
but recommends $52.75 for assembly and $65.40 for calibration/test, with a 3% escalation rate
for years two and three on both rates.

Manufacturing overhead (based on assembly, calibration and test) is projected at 175% in year
one, 180% in year two, and 165% in year three.

The vendor quotes of $150 per unit for materials in the current year have been validated. The
escalation on materials has averaged 2% a year over the last three years. The FPRA lists a
material handling rate of 5% on direct materials, which is still current and has remained
relatively unchanged in the last four years.

The current G&A rate on total cost input is 10%. This rate is expected to be stable over the next
three years.

The profit rate on similar efforts has been 12.5%.

Develop your preliminary government objective including both the price by year and the total
price for all three years.

30
CON 270, Intermediate Cost and Price Analysis

Excel Spreadsheet Operations

Formulas

A formula in Excel always begins with an equal sign (=). Following the equal sign are the elements to be
calculated (the operands), which are separated by calculation operators.

Arithmetic Operator Meaning (Example)


+ (plus sign) Addition (3+3)
Subtraction (3–1)
– (minus sign)
Negation (–1)
* (asterisk) Multiplication (3*3)
/ (forward slash) Division (3/3)
% (percent sign) Percent (20%)
^ (caret) Exponentiation (3^2)

Reference (Description) Changes to


$A$1 (absolute column and absolute row) $A$1
A$1 (relative column and absolute row) C$1
$A1 (absolute column and relative row) $A3
A1 (relative column and relative row) C3

Use of parentheses

To change the order of evaluation, enclose in parentheses the part of the formula to be calculated first.
For example, the following formula produces 11 because Excel calculates multiplication before addition.
The formula multiplies 2 by 3 and then adds 5 to the result.
=5+2*3
In contrast, if you use parentheses to change the syntax, Excel adds 5 and 2 together and then multiplies
the result by 3 to produce 21.
=(5+2)*3
In the example below, the parentheses around the first part of the formula force Excel to calculate
B4+25 first and then divide the result by the sum of the values in cells D5, E5, and F5.
=(B4+25)/SUM(D5:F5)

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CON 270, Intermediate Cost and Price Analysis

Auditing Cells in a Spreadsheet

In this example, assume we want to determine the basis for the number 53.92 in the Year 2
column.

“Double-clicking” the cell will display the formula and highlight the associated cells.

“Clicking” the cell and selecting the Formulas tab and Trace Precedents will highlight associated
cells.

“Click” the escalation rate (3%) and select Trace Dependents to identify where a cell is referenced.

34
CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

Statistics

CON 270
Intermediate Cost & Price Analysis

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CON 270, Intermediate Cost and Price Analysis

The Trouble with Numbers

“We decided to total-out your wife’s car” the insurance agent reported, (not surprising as I recalled the
image of the streetlight looming out of the dashboard of the ’92 Caprice) “… and we have assessed the
car’s value at $4000.” Now that one stopped me. The NADA showed $5000 and my brief newspaper
search had resulted in only a ’91 and a ’93, both priced well above $5000. After voicing my concerns to
the agent he replied that they didn’t use NADA, but rather had a company that provided them with
prices on similar cars. I suggested that his listings might represent higher than average mileage (which at
the time was about 89,000 miles), but he assured me that at worst case the cars they priced had average
mileage. At my request he provided me with phone numbers for the cars they used, and surprisingly
there were only three listings. Even more unusual I thought was that two of the cars were located 200
miles away from my local area. However, the most intriguing part was the cars themselves. One car had
131,000 miles. Another car was a police cruiser with 300,000 miles! And yes, this is a true story that
occurred some years ago.

If the above account were an isolated incident there would be no cause for concern. Unfortunately,
misuses of data occur countless times each day. In fact, the era we live in could legitimately be called the
“Misinformation Age”. Years back an article in Consumers’ Research1 stated that while polls and surveys
have greatly increased in number, the accuracy of such studies has actually declined. The media often
sacrifices precision for speed in their eagerness to make statements on public opinion, report trends in
the market place, or draw attention to social and environmental issues. Errors are further compounded
when such studies are taken out of context and are used to make broad generalizations.

Never has the warning “caveat emptor” (let the buyer beware) been more fitting, and how much more
so for those people charged with the responsibility for cost and price analysis. These are the people
known as business managers, financial managers, contracting officers, buyers, pricers, estimators and
various other titles that I will simply refer to as analysts. Adding to the challenges of today’s analysts is
the growing pressure to make faster decisions with less data and yet with more confidence. The only
way to gain this confidence is through a better understanding of the numbers with which we work and
the factors that effect them.

Sampling – A Chip Off The Old Block

The use of samples to make statements or inferences about the populations from which they were
drawn is a common practice. The Gallup Organization2 typically uses a sample size of 1,000 adults to
make inferences about the opinions of a population of over 200,000,000 adults, and generally with an
accuracy of 3 percent. So where did the insurance agent in the opening story go wrong?

1
Consumers’ Research, A Consumer Guide To Opinion Polls, September 2000.
2
The Gallup Organization, How Polls Are Conducted, FAQ.

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CON 270, Intermediate Cost and Price Analysis

Sampling is one area where size really does matter. The larger the sample the more representative it is
of the population. Larger sample sizes allow the analyst to employ a variety of graphical and
computational diagnostic techniques to better understand the nature of the data. Conversely, the small
sample of three cars in my example makes it very difficult to state with any certainty the properties of
the population of ’92 Caprices. Now, while this sounds like we should collect as much data as possible,
judgment is required in balancing between the additional confidence and accuracy that comes with
larger sample sizes and with the resources required to obtain the additional data. For example, let’s say
that you are purchasing toner cartridges for your office printers. Checking prices with three vendors
would probably be sufficient given that a toner cartridge is very well defined and given the small dollar
amount associated with the purchase. Next, let’s consider that you are contracting for roof repair for
your organization. How large is the roof? Are you repairing one building or a number of buildings? Is
there some question as to whether the roof should be patched or replaced? If the roofing needs to be
replaced, do you replace the roofing itself or does structural work need to be accomplished as well? Is
there a fair amount of variation in the price and quality of the materials? Should a life cycle cost and
benefit analysis be done? This situation calls for more data than the toner cartridges because of the
dollar value involved and the uncertainty associated with the actual requirement. It would also call for
more market research and data analysis to include consulting with civil engineering, an independent
consultant, etc. Again, it’s a balancing act between confidence and resources. Remember the old adage,
“There’s strength in numbers”.

Another important principle in sampling is that the sample should be random in nature, meaning that
any observation in the population should have an equal opportunity of being selected. Some market
research on my part revealed that the insurance company’s sample car prices were among the lowest in
the market place, a sample that was anything but random. Although this may sound obvious, a common
oversight is not checking your sample to make sure all of the items came from the population in
question. I think we can conclude that in the case of my insurance claim that a police cruiser did not
belong in a sample of personal vehicles. This may not always be so straightforward. Do HF, UHF, and VHF
all belong to the same population of radios? Are there differences between HF radios installed in
airplanes, helicopters, and tanks? The best advice in constructing or evaluating samples is to consult
with someone who has experience in that particular area. And while it is important to ask why each item
was included in the sample, it is just as important to ask why certain items were excluded. For example,
as part of the proposal for an aircraft acquisition the contractor provided the government with the
prices of similar aircraft to support the fairness of their price. What was absent, however, was the price
of the previous version of the aircraft being procured. A suspicious person might speculate that the price
of the previous version was omitted to avoid drawing attention to the significant disparity in the prices of
the two versions.

3
CON 270, Intermediate Cost and Price Analysis
Why does my apple juice taste like fruit punch?

It would be nice to think that having selected an appropriate sample we would be ready to start
crunching numbers, but we need to first stop and ask ourselves if we are making “apples to apples”
comparisons. Numbers, unfortunately, do not come with a list of ingredients. We need to determine
what the numbers represent. Your car gets 30 miles per gallon. Is that highway, city, or a combination of
the two? The price of the car is $17,000. Does that include warranty, taxes, and tags? Careful attention to
the content that the numbers represent is essential to avoid getting fruit punch when you were trying to
make apple juice.

Some of the problems that Gene Fisher3 identified when it comes to comparing numbers deal with
definitions, formats, matching-up, and temporal factors. Definitional problems occur when terms are
subjective in nature or when terms can be used in various contexts. What are nonrecurring costs, and
should they be considered a development cost, a cost spread between development and the first lot of
production, or should the nonrecurring costs be amortized over the production run? You might think
that there would be little confusion in referring to the weight of an aircraft; however, as it turns out
there are different kinds of weight such as airframe unit weight, empty weight, gross take-off weight,
etc. Using a number should be like following a recipe, pay close attention to the ingredients and how
they should be used.

Have you ever tried to price cars and found some were advertised as $300 a month, some as $18,500,
and yet others as $14,500 with trade-in? Did you want to know the warranty cost, but were told that it
was “not separately priced”. The problem in this case is that the information is not in a format suitable
for making comparisons. Format problems can occur when information is in different types of formats or
when information is in different levels of format. You may want cost reporting on an item, part by part,
but the contractor records cost by manufacturing and engineering categories. It may be difficult to
compare lower level costs like data, spares, logistics support, and warranties across various contractors
because their accounting systems may allocate the costs differently. You may want to know the
software development cost for an electronic component, but find that the software costs were not
segregated from the hardware costs. If you were buying jet engines you might be interested in the price
of turbines, but find that the cost is not broken down to that level of detail. Maybe you’ve collected
prices on some product or service, but find that the prices represent different quantities or levels of
effort or periods of time. In each case a decision must be made as to whether the data can be adjusted
to account for the differences and what level of error, if any, is introduced as part of making the
adjustment. Depending on the level of confidence you are looking for, you may choose not to use
certain data points because you cannot accurately adjust the data into the desired format.

On the “Price is Right” contestants are often called upon to match prices to products, a “matching”
problem we often have to face ourselves. Let’s say that you wanted to develop a cost estimating
relationship between an airframe cost and the airframe unit weight. You find out that the F-16 airframe

3
Cost Considerations in Systems Analysis, Fisher, The Rand Corporation, 1970.

4
CON 270, Intermediate Cost and Price Analysis

cost $14,000,000 and the weight is 12,000 pounds. While this sounds simple enough, there is a problem.
Both the cost and the weight are moving targets. Is the cost associated with the first aircraft built, the
100th, 200th, or the 500th aircraft built? Was there a learning curve where the cost decreased in real
dollars as more units were produced due to improvements during production? Does the cost represent
an average cost for a given production lot? Is the average cost affected by variations in quantity? The
weight is no more static in nature than the cost because over the production life of an aircraft it typically
experiences weight growth. Given the tendency for these values to vary, do we even know if the cost
and weight reflect the appropriate values for the same aircraft? Data analysis is like a Rubik’s Cube,
you’re not done until everything matches.

Temporal problems occur because things change over time. One effect on prices over time is inflation.
Care must be taken to avoid comparing prices from different years without first having adjusted the
prices to a common year through the use of some index. The Department of Defense, Bureau of Labor
Statistics, and other organizations publish indices for the purpose of adjusting prices to the same year;
removing the effects of inflation to see the true trend in real prices; or to project the effects of inflation
into the future. Another temporal problem is that companies themselves change over time. Mergers,
divestures, business base changes, capital investments4, accounting system changes, and varying market
conditions impact prices, costs, rates, and labor standards. Market conditions vary due to competition,
supply, demand, and the life cycle5 of the product or service. Changes in technology likewise change the
cost of goods and services making it problematical to make consistent comparisons except over
relatively short time spans. This has the effect of limiting the size of your data set.

The terms and conditions of contracts can also make price comparisons difficult. Did the contract
include a warranty, technical support, documentation, training, spares, installation, or delivery costs?
What about the contract type? Was it time and materials, cost reimbursable with fixed fee,
reimbursable with incentive fee, fixed price with incentive, firm fixed price, or some other arrangement?
Was it sole source? Was there a prime contractor, contractor teaming, or did the buying office act as the
prime? Did regulatory or environmental considerations impact the contract performance?

The bottom line is this: analysis is more than just crunching numbers; analysis also means understanding
the conditions that caused the numbers to be what they are.

4
Investments in capital may reduce labor and machine hours while resulting in increases in other direct and
indirect costs such as depreciation and maintenance.
5
The life cycle generally involves a development, growth, maturity, and decline phase. Prices may vary over the life
cycle or even within a phase of the life cycle. For example, as a product nears the end of its life cycle the price may
fall due to lack of demand or rise due to shortage of supply.

5
CON 270, Intermediate Cost and Price Analysis

Well, isn’t that just typical!

Have you ever taken your car in for repair and were told that the repair “typically” costs $200, and
wondered, with some concern, exactly what “typically” meant? Words like typically, most likely, usually,
commonly, frequently, regularly and on average tend to be used without discretion or precision, which
is why you need to determine exactly what the person meant by the term. Was the person referring to
the mean or average, which is the sum of the numbers divided by the sample size? Were they describing
the median value, which is the middle value of a set of numbers when the numbers have been ranked
either from high to low or low to high? Perhaps the person was expressing the value that occurs most
often, the mode. Or maybe the answer is none of the above. There is one thing you can know for sure,
given any one of these measures the only thing you are really seeing is the tip of the iceberg and you
have no idea of what lies beneath the surface. If we are to see the true shape and size of the iceberg we
need to understand the amount of dispersion in the data as well as the general shape of the distribution
the data comes from.

Think of the dispersion or variation in the data as the size of the iceberg, for sailors, the larger the
iceberg the greater the risk. The same is true for analysts working with numbers, the more variation in
the data the greater the risk. The range is one way of measuring dispersion. Let’s say that the “typical”
car repair of $200 mentioned earlier is the mode, the most frequently paid price. This might actually
represent the minimum that you will pay, while at times the repair could run as high as $500. We now
know that the range is $300 and that there is a 100 percent probability of the price being $200 or more.
However, this still does not tell us if people almost always pay $200 or if there is a fair amount of
variation in the prices paid.

The standard deviation is one way of expressing the average or typical variation when the data
approximates a normal (bell-shaped) distribution. If the average price of a repair was $300 and the
standard deviation $60, then, depending on the sample size, we could assume that about 60 to 70
percent of the prices would fall in the $240 to $360 range. We can use the standard deviation and the T
distribution to construct a confidence interval to bound the population mean or with a prediction
interval to bound the next observation. If you want to put the standard deviation into perspective,
divide the standard deviation by the sample mean to arrive at an average percent variation. The $60
divided by $300 is 20 percent. This calculation is known as the coefficient of variation or CV. We can now
make the statement that our average price is $300 and it varies on average by $60 or it varies on
average by 20 percent. An alternative measure, which also expresses the average variation in a set of
numbers, is the mean absolute deviation or MAD. One advantage of the MAD is that it can be used
without making any assumptions of the normality of the distribution.

The mean, median, and mode are all measures of central tendency, and in a distribution that is fairly
normal (bell-shaped) they are similar values. However, there are many types of distributions, which is
why it is important to not only know whether a value represents the mean, median, or mode, but also to
know the distribution the value came from. The distribution can give you insight as to the risk inherent
in the cost element as well as the risk associated with using any given value from the distribution.

6
CON 270, Intermediate Cost and Price Analysis

Examples (1), (2), and (3) all have the same mean, median, and mode of $300. However, we can see that
the risk in accepting $300 as our position increases as the variability increases as we move from (1) to (2)
to (3). We can see here the importance of determining the range of possible values for any given
distribution. Asking questions like what are the optimistic, pessimistic, and most likely costs, in addition
to asking what factors drive the costs are essential. Of equal importance is the shape of the distribution
and where on the distribution your point estimate is located.

In example (A) we see a uniform distribution where any value from $200 to $400 has the same
likelihood of occurring. In other words, the price is just as likely to be $225 as it is to be $250 or $350.
The mean and median are $300, but there is no mode. If you were quoted a price of $250 for example,
there would be a 75 percent probability of the price actually being higher than $250. From the triangular
distribution, (B), we would conclude that the most likely price (mode) is around $350, however, there is a
high probability that the price would actually be less than $350. The mean and median in this case are
probably between $300 and $350. Our normal distribution, (C), has a mean, median, and mode of $300.
If the standard deviation were $60, then about 60 to 70 percent of the prices would be between $240
and $360 depending on the sample size. In each case, by understanding the distribution and the
assumptions that are associated with the population from which the sample is drawn the analyst can
make a statement about the probability or risk associated with any value from the distribution.

7
CON 270, Intermediate Cost and Price Analysis

I’ve Got Your Number!

There is an Indian parable about six blind men who were trying to describe an elephant. One touched the
elephant’s side and thought him like a wall; the second held the tusk and described him as a spear; the
third lay hold of the trunk and declared him to be a large snake; the fourth felt his leg and thought
him like a tree; the fifth grasped the ear and stated the elephant was a large fan; and the sixth seized the
tail and described him as a rope. “And so these men of Indostan, disputed loud and long, each in his own
opinion, exceeding stiff and strong, though each was partly in the right, and all were in the wrong!”6

When we ignore differences in definitions, content, format, economic year, market conditions, etc., we
are only grasping a part of the data and we will be prone to misunderstand that about which we are
trying to make a statement or judgment. Normalization, adjusting the data to make it more consistent,
is one of the first steps in data analysis.

The next step is like assembling a jigsaw puzzle; you have to determine what each piece represents and
how it will be used. Does the number represent the mean, median, or mode? What is the range in the
data? How much variation exists? Do I have all of the pieces? What does the distribution look like and
where is a particular value on the distribution?

The final step is to interpret the information you have assembled. Have you ever seen one of those
pictures that appears at first to be just a random pattern of lines and textures, then, after staring
intently at the pattern for a few moments, you suddenly see a three-dimensional picture within the
picture? We must look past the numbers to see the picture within if we are to fully understand the
implications of the data, and properly use the data to support management decisions.

6
The Blind Men and the Elephant, John Godfrey Saxe.

8
CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

10
CON 270, Intermediate Cost and Price Analysis

11
CON 270, Intermediate Cost and Price Analysis

12
CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

25
CON 270, Intermediate Cost and Price Analysis

26
CON 270, Intermediate Cost and Price Analysis

27
CON 270, Intermediate Cost and Price Analysis

Y Y Y- Y

Y- Y

Y Y Y- Y CY - Y)2
2

2 ∑CY - Y) 408
s = n - 1 = 30 - 1 = 14.07

28
CON 270, Intermediate Cost and Price Analysis

Y Y Y- Y CY - Y)2
2

2 ∑CY - Y) 408
s = n - 1 = 30 - 1 = 14.07

s = Js2 = √14.07 = 3.75

∑CY - Y)2

Y Y Y- Y CY - Y)2
2
∑CY - Y) 408
s2 = n - 1 = 30 - 1 = 14.07

s = Js2 = √14.07 = 3.75

29
CON 270, Intermediate Cost and Price Analysis

Y Y Y- Y CY - Y)2
2
2 ∑CY - Y) 408
s = n - 1 = 30 - 1 = 14.07

s = Js2 = √14.07 = 3.75

average error 3.75


= = .030 or 3.05%
average hours 123
s
CV =
Y

30
CON 270, Intermediate Cost and Price Analysis

31
CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

33
CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

50
CON 270, Intermediate Cost and Price Analysis

Contract # W9126G-04-D-00021

Contractor: A

Inspection & Calibration

Job Hour Report

Work Order # Hours


C618 122
C619 124
C620 118
C621 123
C622 123
C623 125
C624 119
C625 118
C626 122
C627 126
C628 129
C629 128
C630 118
C631 127
C632 130
C633 123
C634 120
C635 120
C636 119
C637 126
C638 125
C639 124
C640 122
C641 121
C642 115
C643 121
C644 125
C645 123
C646 124
C647 130

51
Contractor A
CON 270, Intermediate Cost and Price Analysis
STD DEV's
# DATA INPUT
from MEAN
1 122.00 -0.27
2 124.00 0.27
3 118.00 -1.33
4 123.00
5 123.00
6 125.00 0.53
7 119.00 -1.07
8 118.00 -1.33
9 122.00 -0.27
10 126.00 0.80
11 129.00 1.60
12 128.00 1.33
13 118.00 -1.33
14 127.00 1.07
15 130.00 1.87
16 123.00
17 120.00 -0.80
18 120.00 -0.80
19 119.00 -1.07
20 126.00 0.80
21 125.00 0.53
22 124.00 0.27 0
115≤ n ≤118 118< n ≤121 121< n ≤124 124< n ≤127 127< n ≤130 130< n ≤133
23 122.00 -0.27
24 121.00 -0.53 # Obs 4 6 10 6 4 0
25 115.00 -2.13
26 121.00 -0.53
27 125.00 0.53
28 123.00
29 124.00 0.27
30 130.00 1.87 Descriptive Statistics
31
32
33 Count: 30 Mean: 123.00 Enter Confidence Level: 90.0%
34
35 Minimum: 115.00 Median: 123.00 Minimum 121.84
36
37 Maximum: 130.00 Mode: 123.00 Mean 123.00
38
39 Standard Deviation: 3.75 Skewness: 0.06 Maximum 124.16
40
41 Coefficient of Variation: 3.05% Kurtosis: -0.36 Confidence Level (+/-) 1.164
42
43
44
45
46
47
48
49
50

Mean
52
Contractor B
CON 270, Intermediate Cost and Price Analysis
STD DEV's
# DATA INPUT
from MEAN
1 105.00 -1.34
2 124.00 0.07
3 116.00 -0.52
4 123.00
5 123.00
6 123.00
7 102.00 -1.56
8 107.00 -1.19
9 140.00 1.27
10 137.00 1.04
11 131.00 0.60
12 128.00 0.37
13 141.00 1.34
14 115.00 -0.60
15 130.00 0.52
16 116.00 -0.52
17 145.00 1.64
18 120.00 -0.22
19 119.00 -0.30
20 100.00 -1.71
21 106.00 -1.27
22 113.00 -0.75 0
100≤ n ≤109 109< n ≤118 118< n ≤127 127< n ≤136 136< n ≤145 145< n ≤154
23 144.00 1.56
24 103.00 -1.49 # Obs 6 5 6 7 6 0
25 142.00 1.42
26 111.00 -0.89
27 133.00 0.75
28 130.00 0.52
29 135.00 0.89
30 128.00 0.37 Descriptive Statistics
31
32
33 Count: 30 Mean: 123.00 Enter Confidence Level: 90.0%
34
35 Minimum: 100.00 Median: 123.00 Minimum 118.84
36
37 Maximum: 145.00 Mode: 123.00 Mean 123.00
38
39 Standard Deviation: 13.42 Skewness: -0.06 Maximum 127.16
40
41 Coefficient of Variation: 10.91% Kurtosis: -1.04 Confidence Level (+/-) 4.163
42
43
44
45
46
47
48
49
50

Mean
53
Contractor C
CON 270, Intermediate Cost and Price Analysis
STD DEV's
# DATA INPUT
from MEAN
1 132.00 0.48
2 134.00 0.69
3 118.00 -1.05
4 131.00 0.37
5 133.50 0.64
6 125.00 -0.28
7 132.00 0.48
8 133.00 0.59
9 122.00 -0.61
10 135.00 0.80
11 97.00 -3.33
12 128.00 0.04
13 136.00 0.91
14 127.00 -0.07
15 130.00 0.26
16 135.00 0.80
17 120.00 -0.83
18 106.00 -2.35
19 130.00 0.26
20 126.00 -0.18
21 135.00 0.80
22 133.00 0.59 0
97≤ n ≤105 105< n ≤113 113< n ≤121 121< n ≤129 129< n ≤137
23 134.00 0.69
24 118.00 -1.05 # Obs 1 1 4 7 17 0
25 118.00 -1.05
26 134.50 0.75
27 125.00 -0.28
28 136.00 0.91
29 136.50 0.97
30 128.00 0.04 Descriptive Statistics
31
32
33 Count: 30 Mean: 127.62 Enter Confidence Level: 90.0%
34
35 Minimum: 97.00 Median: 130.50 Minimum 124.76
36
37 Maximum: 136.50 Mode: 118.00 Mean 127.62
38
39 Standard Deviation: 9.20 Skewness: -1.78 Maximum 130.47
40
41 Coefficient of Variation: 7.21% Kurtosis: 3.54 Confidence Level (+/-) 2.854
42
43
44
45
46
47
48
49
50

Mean
54
CON 270, Intermediate Cost and Price Analysis

Practical Exercise – Services

Energetics Corp. has submitted a proposal for a Time & Materials support contract for Test &
Evaluation. They stated that their standard rate for engineering is $75 hour. Based on the
following data on similar past contracts for Energetics, determine whether their stated rate is
representative of past projects and whether their use of the term “standard” is consistent with
the CAS definition of a labor standard.

Project Eng. Hrs Eng. $


1 2,580 129,000
2 2,970 222,750
3 4,560 342,000
4 8,500 552,500
5 6,430 546,550
6 2,940 161,700
7 7,845 470,700

CAS 407

1. When a labor-rate standard is set to cover a category of direct labor, determine that the
functions performed within that category are not materially disparate and the
employees involved are interchangeable with respect to the functions performed (CAS
407.50(a)(3)).

2. When a labor-rate standard is set to cover a group of direct labor workers who
perform disparate functions, determine that:
a. The group of workers all work in a single production unit yielding homogeneous
outputs; or
b. The group of workers, in performance of their respective functions, forms an
integral team (CAS 407.50(a)(4)).
55
CON 270, Intermediate Cost and Price Analysis

Practical Exercise – Base Telephone Contracted Maintenance

You are evaluating three proposals to provide maintenance support services for the base
telephone system as follows:

Contractor A has proposed a flat rate of $40,000/month regardless of the number of


service calls.

Contractor B proposes to charge $35,000/month when the number of service calls in a


month does not exceed 1,000; but to charge $45,000 for any month where the number
of service calls exceeds 1,000.

Contractor C proposes to charge $30,000/month when the number of service calls in the
month does not exceed 1,000; $40,000/month when the number of calls exceed 1,000
but does not exceed 2,000; and $50,000/month when the number of service calls in any
month exceeds 2,000.

You have contacted the facilities manager and he says the odds are 50/50 that the number of
service calls will exceed 1,000 in any given month. However, the odds they will exceed 2,000 is
only about one in ten. Construct a decision table below to calculate the average expected
monthly rate for each contractor. Which offer is in the best interest of the Government?

56
CON 270, Intermediate Cost and Price Analysis

Record Time
You are preparing to negotiate a service task for routine maintenance of Government equipment. A
sample of 25 records for similar maintenance tasks was taken to support development of your price
negotiation positions (minimum, objective, maximum). Develop an estimate of the reasonable time
required to complete the task. The results are shown on page 2.

Part A

1. How would you describe the distribution of the data (e.g. normal, skewed)?

2. One of the maintenance tasks in the data set required 722 hours to complete. How would you
characterize this value, and are there any actions you should take with respect to this value?

3. The observation in the previous question would have the most impact on what measure of
central tendency? What measure would you cite as most representative of the hours?

4. The observation in question (2) would impact what measure(s) of dispersion?

Part B

After investigating the maintenance task that required 722 hours you determine that the hours included
nonrecurring tooling which were not separately accounted for. You decide to remove this observation
from the data set and you have the results shown on page 3.

1. How were the measures of central tendency impacted by deleting the data point? The measures
of dispersion?

2. You decided that the data is distributed normally enough such that the use of a confidence
interval would be appropriate. What would be your opening negotiating position on the hours?

57
Maintenance Records Times
STD DEV's
# DATA INPUT
from MEAN
1 400.00 0.00
2 295.00 -1.00
3 490.00 0.85
4 420.00 0.19
5 325.00 -0.72
6 285.00 -1.10
7 501.00 0.96
8 340.00 -0.57
9 550.00 1.42
10 390.00 -0.10
11 490.00 0.85
12 722.00 3.06
13 395.00 -0.05
14 435.00 0.33
15 250.00 -1.43
16 399.00 -0.01
17 326.00 -0.71
18 393.00 -0.07
19 332.00 -0.65
20 370.00 -0.29
21 516.00 1.10
22 240.00 -1.53 0
240≤ n ≤336 336< n ≤432 432< n ≤528 528< n ≤624 624< n ≤720 720< n ≤816
23 433.00 0.31
24 358.00 -0.40 # Obs 7 10 6 1 0 1
25 355.00 -0.43
26
27
28
29
30 Descriptive Statistics
31
32
33 Count: 25 Mean: 400.40 Enter Confidence Level: 90.0%
34
35 Minimum: 240.00 Median: 393.00 Minimum 364.42
36
37 Maximum: 722.00 Mode: 490.00 Mean 400.40
38
39 Standard Deviation: 105.14 Skewness: 1.13 Maximum 436.38
40

CON 270, Intermediate Cost and Price Analysis


41 Coefficient of Variation: 26.26% Kurtosis: 2.36 Confidence Level (+/-) 35.975
42
43
44
45
46
47
48
49
50
58

Mean
Maintenance Records Times
STD DEV's
# DATA INPUT
from MEAN
1 400.00 0.16
2 295.00 -1.11
3 490.00 1.24
4 420.00 0.40
5 325.00 -0.75
6 285.00 -1.23
7 501.00 1.38
8 340.00 -0.57
9 550.00 1.97
10 390.00 0.04
11 490.00 1.24
12
13 395.00 0.10
14 435.00 0.58
15 250.00 -1.66
16 399.00 0.14
17 326.00 -0.74
18 393.00 0.07
19 332.00 -0.66
20 370.00 -0.21
21 516.00 1.56
22 240.00 -1.78 0
240≤ n ≤318 318< n ≤396 396< n ≤474 474< n ≤552
23 433.00 0.56
24 358.00 -0.35 # Obs 4 10 5 5 0 0
25 355.00 -0.39
26
27
28
29
30 Descriptive Statistics
31
32
33 Count: 24 Mean: 387.00 Enter Confidence Level: 90.0%
34
35 Minimum: 240.00 Median: 391.50 Minimum 358.05
36
37 Maximum: 550.00 Mode: 490.00 Mean 387.00
38
39 Standard Deviation: 82.77 Skewness: 0.17 Maximum 415.95
40

CON 270, Intermediate Cost and Price Analysis


41 Coefficient of Variation: 21.39% Kurtosis: -0.51 Confidence Level (+/-) 28.955
42
43
44
45
46
47
48
49
50
59

Mean
CON 270, Intermediate Cost and Price Analysis

Answers
Part A

1. While the majority of the data appears to be normally distributed there appears to be one or
two data points on the higher end that are skewing the data to the right.

2. This data point is an outlier, falling 3.06 standard deviations from the mean. We should
investigate this observation to determine if the content is the same as the other data points,
whether it was recorded incorrectly, or if it represents an unusual event.

3. The mean or average would be impacted by an unusually high or low value. Since the median is
only looking at the middle (or middle two) values, an extreme value is of no consequence. If you
are concerned about an outlier, or that the data may be skewed in some way, then generally the
median is more representative of the typical value.

4. All of the measures (range, variance, standard deviation, CV) would be affected by an outlier
with the range perhaps have the biggest impact.

Part B

1. The mean changed from 400.4 to 387 hours; the median from 393 to 391.5 hours; and there
was no change in the mode. The only reason the median changed was not because of the high
value of the data point being dropped, but because we actually dropped the data point which
shifted the median slightly.

The range changed from [240, 722] to [240, 550] which is a reduction in the range from 482
hours to 310 hours. The standard deviation changed from 105 hours to about 83 hours. The CV
dropped from 26% to 21%.

2. We might consider the lower end of the confidence interval (358 hours) as our opening position.

60
CON 270, Intermediate Cost and Price Analysis

Meals‐On‐Tracks
Contract specifications require that Meals‐On‐Tracks, Inc. deliver 15,000 combat meals with a mean
weight of 8.5 ounces. The COR pulled a random sampling of 15 combat meals taken from today’s
shipment. You entered the weights from your sample into the statistics template and obtained the
results shown on page 2.

Part A

1. What would you characterize as the typical weight, and why?

2. Given the 90% confidence level, what statement would you make concerning the average
weight? Would you accept the shipment?

3. Would a 95% confidence interval be larger or smaller? Why?

4. The contractor contends that the difference between the specified weight and the sample
weight is due to sampling error. What actions might you take?

Part B

You’ve taken a second sample, this time checking the weights on 30 of the combat meals. The results
are shown on page 3.

1. In the histogram, where does the mode occur? Is it representative of the typical weight? Why or
why not?

2. How do the findings of the second sample compare to the earlier sample?

3. Is the confidence interval from the second sample larger or smaller than the first sample? What
are two reasons for the change?

61
Meals-On-Tracks
STD DEV's
# DATA INPUT
from MEAN
1 8.42 1.45
2 8.11 -0.48
3 8.30 0.70
4 8.26 0.46
5 8.15 -0.23
6 8.00 -1.16
7 8.12 -0.41
8 8.25 0.39
9 7.92 -1.65
10 8.45 1.63
11 8.05 -0.85
12 8.03 -0.97
13 8.42 1.45
14 8.18 -0.04
15 8.14 -0.29
16
17
18
19
20
21
22 0
7.92≤ n ≤8.1 8.1< n ≤8.28 8.28< n ≤8.46
23
24 # Obs 4 7 4 0 0 0
25
26
27
28
29
30 Descriptive Statistics
31
32
33 Count: 15 Mean: 8.19 Enter Confidence Level: 90.0%
34
35 Minimum: 7.92 Median: 8.15 Minimum 8.11
36
37 Maximum: 8.45 Mode: 8.42 Mean 8.19
38
39 Standard Deviation: 0.16 Skewness: 0.26 Maximum 8.26
40

CON 270, Intermediate Cost and Price Analysis


41 Coefficient of Variation: 1.97% Kurtosis: -0.80 Confidence Level (+/-) 0.073
42
43
44
45
46
47
48
49
50
62

Mean
Meals-On-Tracks
STD DEV's
# DATA INPUT
from MEAN
1 8.19 -0.11
2 8.11 -0.64
3 8.30 0.60
4 8.23 0.15
5 8.25 0.28
6 8.06 -0.96
7 8.12 -0.57
8 8.00 -1.35
9 7.92 -1.87
10 8.33 0.80
11 8.05 -1.03
12 8.03 -1.16
13 8.20 -0.05
14 8.18 -0.18
15 8.14 -0.44
16 8.50 1.90
17 7.90 -2.00
18 8.13 -0.51
19 8.50 1.90
20 8.27 0.41
21 8.18 -0.18
22 8.50 1.90 0
7.9≤ n ≤8.02 8.02< n ≤8.14 8.14< n ≤8.26 8.26< n ≤8.38 8.38< n ≤8.5 8.5< n ≤8.62
23 8.31 0.67
24 8.20 -0.05 # Obs 3 7 10 7 3 0
25 8.32 0.73
26 8.35 0.93
27 8.36 0.99
28 8.24 0.21
29 8.15 -0.38
30 8.21 0.02 Descriptive Statistics
31
32
33 Count: 30 Mean: 8.21 Enter Confidence Level: 90.0%
34
35 Minimum: 7.90 Median: 8.20 Minimum 8.16
36
37 Maximum: 8.50 Mode: 8.50 Mean 8.21
38
39 Standard Deviation: 0.15 Skewness: 0.10 Maximum 8.26
40

CON 270, Intermediate Cost and Price Analysis


41 Coefficient of Variation: 1.87% Kurtosis: -0.04 Confidence Level (+/-) 0.048
42
43
44
45
46
47
48
49
50
63

Mean
CON 270, Intermediate Cost and Price Analysis

Answers
Part A

1. The mean would be a good choice because: the histogram indicates the data is fairly normally
distributed; the mean and median values are close; there don’t appear to be any outliers
skewing the data.

2. There is a 90% likelihood that the average weight is between 8.11 and 8.26 ounces. Given the
sample data and resulting confidence interval, it is unlikely that the population average weight is
8.5 ounces as called for in the contract.

3. Larger; the more confident you want to be, the wider the interval. Observe the T values from
the T table as the significance level decreases (and confidence level increases) as you move from
left to right in the table.

4. You could take more samples, and samples of larger size.

Part B

You’ve taken a second sample, this time checking the weights on 30 of the combat meals. The results
are shown on page 3.

1. The mode of 8.50 occurs in the last bin. It is not representative of the typical weight because this
value only occurred twice out of 30 observations. It also represents the highest value in the data
set with the remaining 28 observations all being lower than the mode.

2. The second sample is fairly consistent with the first sample in having comparable means and
comparable minimum and maximum values in the data range. The confidence intervals in both
cases do not bound the required weight of 8.5 ounces, again suggesting that the contractor is
not meeting the contract requirements.

3. The second confidence interval is smaller (8.16 – 8.26) than the first (8.11 – 8.26).
 The confidence level (90%) is the same in both cases.
 While the standard deviations are comparable in this case, the standard error of s
the mean gets smaller as the sample size increases (there is less variability in the √n
means of larger samples than smaller samples).
 The sample with 30 observations would have 29 degrees of freedom with respect to
determining the t‐value from the t‐table (1.699 at a 90% level of confidence). The sample
with 15 observations would have 14 degrees of freedom and a corresponding value from
the t‐table of 1.761. The t‐table reflects that the smaller the sample size the greater the
uncertainty.

64
CON 270, Intermediate Cost and Price Analysis

Transmission Overhauls
Suppose that you are preparing a solicitation for an indefinite‐quantity transmission overhaul contract
to support a fleet of 300 light utility trucks. You believe that you can develop an accurate estimate of the
number of transmissions that will require a major overhaul during the contract period, if you can
determine the date of the last major overhaul for each vehicle transmission and estimate the period
between overhauls. You select a simple random sample of 25 vehicle maintenance records from the 300
fleet vehicle maintenance records. The results are shown below in number of months.

Descriptive Statistics

Count: 25 Mean: 37.08 Enter Confidence Level: 90.0%


Minimum: 24.00 Median: 36.00 Minimum 34.76
Maximum: 49.00 Mode: 36.00 Mean 37.08
Standard Deviation: 6.79 Skewness: -0.14 Maximum 39.40
Coefficient of Variation: 18.31% Kurtosis: -0.52 Confidence Level (+/-) 2.323

1. How would you characterize the distribution of the data?

2. Use the standard deviation and CV to make statements about the accuracy of using the mean as
your objective.

3. What statement could you make about the “actual” average months between overhauls?

65
CON 270, Intermediate Cost and Price Analysis

Answers

1. Given the low values for skewness and kurtosis, and given that the mean and median are fairly
close, it would suggest that the data is normally distributed.

2. If we used the average months (37) as our objective, then we could typically expect to be off by
give or take about 7 months (6.79). That would be like being off by about 18% (18.31%). We
would be off by more than that in some cases and less in others, but that would give us a general
idea of the accuracy of using the average hours as the objective.

3. There is a 90% chance that the average months between overhauls are between 34.76 and
39.40 months.

66
CON 270, Intermediate Cost and Price Analysis

Excel Spreadsheet Functions

Functions can be entered by using the equal sign such as: = average(A1:A10)
or can be accessed by selecting fx which brings up a list of functions and function categories as seen in
the examples below.

Math and Trigonometry Functions


Function Description
EXP Returns e raised to the power of a given number (i.e. the antilog of the natural logarithm)
LN Returns the natural logarithm of a number
LOG Returns the logarithm of a number to a specified base
RAND Returns a random number between 0 and 1
SQRT Returns a positive square root
SUM Adds its arguments

Statistical Functions
Function Description
AVERAGE Returns the average of its arguments
MEDIAN Returns the median of the given numbers
MODE Returns the most common value in a data set

67
CON 270, Intermediate Cost and Price Analysis

Adding the Analysis Toolpak (Office 2007)

Start by Selecting the “Office Button”


at the upper left corner of the screen

Select the “Excel Options”


button at the lower right

Select “Add-Ins” Button

Press “Go”

68
CON 270, Intermediate Cost and Price Analysis

Select and check


“Analysis ToolPak”
Click “OK”

Windows acknowledges Excel can’t yet


run this add-in because it is not currently installed.
Select “Yes” to the question
“Would you like to install it now?”

Find the tool under the “Data” tab . . .

. . . in the “Analysis” group.

69
CON 270, Intermediate Cost and Price Analysis

Data Analysis

Running Descriptive Statistics

Select the Data tab. . .

Select Data Analysis…


and then Descriptive Statistics

70
CON 270, Intermediate Cost and Price Analysis

Descriptive Statistics Dialog Box

Descriptive Statistics Output  Mean: mathematical average.


Cost  Median: middle value of ordered data.
Mean 9.642857143  Mode: value which occurred most frequently.
 Range: distance between the high and low value.
Standard Error 2.242326294
Median 8.1

 Variance (s ): measure of squared variability around the mean.


Mode #N/A 2
Standard Deviation 5.932637733

 Standard Deviation (s): measure of variability around the


Sample Variance 35.19619048
Kurtosis -1.41642864
Skewness
Range
0.53941421
15  mean; can be interpreted as the “average” estimating error.

Minimum 3.8 Coefficient of Variation (CV): standard deviation expressed as
Maximum 18.8
a percentage of the mean. It can be interpreted as the average
Sum
Count
67.5
7 
Confidence Level(80.0%) 3.22840217 “percent” error. CV s
Y
s
Standard Error: short for “standard error of the mean”; n .
The term is used in confidence interval and hypothesis test
calculations.
Confidence Level: based on the selected confidence level in
s 
the dialog box, this entry on the output provides the value: t  
n 
The 80% confidence interval for the true population mean

71
CON 270, Intermediate Cost and Price Analysis


Graphical Analysis – Developing a Histogram

Hours Hours
1700
1800 Mean 2012.821429
1850 Standard Error 20.12146013
1904 Median 2052.5
1904 Mode 1904
1904 Standard Deviation 106.472759
1950 Sample Variance 11336.44841
1960 Kurtosis 1.455674766
1970 Skewness -1.374624171
1980 Range 407
2035 Minimum 1700
2040 Maximum 2107  Determine the number of bins
2045 Sum 56359

2050 Count 28 desired. One rule of thumb is or


2055 in this case 28 5 .
2060 Bin Width 81.4  Divide the range by the number
2085
2087 Bins of bins to determine bin width 407 
2089 1781.4 5 = 81.4
2091 1862.8  Add bin width to the minimum
2093 1944.2
value and cumulatively until you have
2095 2025.6
2097 2107 5 bins.
2099  Select the Data Analysis feature
2101 as before and then select Histogram.
2103
2105
2107

 Select the input range for the


data and the bins.
 Select “Labels” if you input range
includes titles in the first row.

72
CON 270, Intermediate Cost and Price Analysis

Bins Frequency
1781.4 1
1862.8 2
1944.2 3
2025.6 4
2107 18
More 0

20

15
Frequency

10

2025.6 2107 More


Bins

Note that the bin labels are displayed to the left of the tick marks (i.e. the first tick mark represents
1781.4, the second tick mark is 1862.8, etc.).

Hours

Mean 2012.821429  Based on the histogram above, the mode of 1904


Standard Error 20.12146013 would fall in the third interval.
Median 2052.5
Mode 1904  The mean of 2012.82 falls in the fourth interval.
Standard Deviation 106.472759
Sample Variance 11336.44841  The median of 2052.5 falls in the fifth or last
Kurtosis 1.455674766 interval. Since most of the data is located in this
Skewness -1.374624171 interval, the median is most representative of the
Range 407
“typical” value that occurred in this sample.
Minimum 1700
Maximum 2107
Sum 56359
Count 28

73
CON 270, Intermediate Cost and Price Analysis

T-DISTRIBUTION TABLE, SELECTED PROBABILITIES

Example: degrees of freedom = 14; significance level = .10

Significance Level (both tails combined)


d.f. .10 .05 .02 .01
1 6.314 12.706 31.821 63.657
2 2.920 4.303 6.965 9.925
3 2.353 3.182 4.541 5.841
4 2.132 2.776 3.747 4.604
5 2.015 2.571 3.365 4.032
6 1.943 2.447 3.143 3.707
7 1.895 2.365 2.998 3.499
8 1.860 2.306 2.896 3.355
9 1.833 2.262 2.821 3.250
10 1.812 2.228 2.764 3.169
11 1.796 2.201 2.718 3.106
12 1.782 2.179 2.681 3.055
13 1.771 2.160 2.650 3.012
14 1.761 2.145 2.624 2.977
15 1.753 2.131 2.602 2.947
16 1.746 2.120 2.583 2.921
17 1.740 2.110 2.567 2.898
18 1.734 2.101 2.552 2.878
19 1.729 2.093 2.539 2.861
20 1.725 2.086 2.528 2.845

74
CON 270, Intermediate Cost and Price Analysis

DISTRIBUTION TABLE, SELECTED PROBABILITIES (continued)

Example: degrees of freedom = 24; significance level = .05

Significance Level (both tails combined)


d.f. .10 .05 .02 .01
21 1.721 2.080 2.518 2.831
22 1.717 2.074 2.508 2.819
23 1.714 2.069 2.500 2.807
24 1.711 2.064 2.492 2.797
25 1.708 2.060 2.485 2.787
26 1.706 2.056 2.479 2.779
27 1.703 2.052 2.473 2.771
28 1.701 2.048 2.467 2.763
29 1.699 2.045 2.462 2.756
30 1.697 2.042 2.457 2.750
40 1.684 2.021 2.423 2.704
60 1.671 2.000 2.390 2.660
120 1.658 1.980 2.358 2.617

75
CON 270, Intermediate Cost and Price Analysis

76
Cost Estimating
Relationships

CON 270
Intermediate Cost & Price Analysis
CON 270, Intermediate Cost and Price Analysis

2
CON 270, Intermediate Cost and Price Analysis

3
CON 270, Intermediate Cost and Price Analysis

4
CON 270, Intermediate Cost and Price Analysis

5
CON 270, Intermediate Cost and Price Analysis

6
CON 270, Intermediate Cost and Price Analysis

7
CON 270, Intermediate Cost and Price Analysis

8
CON 270, Intermediate Cost and Price Analysis

Regression

CON 270
Intermediate Cost & Price Analysis

1
CON 270, Intermediate Cost and Price Analysis

Note Page

2
CON 270, Intermediate Cost and Price Analysis

X, My Search for Significance


(Developing Cost Estimating Relationships)

Hello, my name is turbine inlet temperature, but you can call me X. I’m an independent variable by
trade, and this is the story of my search for significance.

What makes it tick?

I haven’t always been an independent variable. When I first started out I was just one of the many
characteristics of a jet engine. Then one day a cost and price analyst happened along apparently trying to
understand why the cost varied from one jet engine to the next. He began by sitting down with one of
the engineers and tried to get an understanding of how a jet engine worked. After that they discussed
the different factors that effect or drive the cost of a jet engine. These factors can describe things like the
size, performance, or technology of an item. I suppose that if you were interested in trends in wage
rates, prices, or something else over time, you could even use time as an independent variable. The
analyst made a list of the various factors like weight, thrust, by-pass ratios, and other characteristics like
myself because he wanted to develop a parametric or regression model. It seems that the reason the
analysts call it “parametric” estimating is that they are trying to explain why the cost varies from one
engine to the next by associating the changes in cost with the changes in the engine characteristics or
“parameters”. I’m told that cost is considered the “dependent” or “Y” variable, and that a dependent
variable can be cost, price, hours, pounds, or anything else you want to predict.

Apparently not just anybody can become an independent variable; we had to pass several tests. The
analyst didn’t want to waste time and money by investigating and collecting data on all the engine
characteristics, just the major drivers. He also wanted only “significant” variables. As it turned out,
because the by-pass ratios were about the same for all the engines they looked at, the by-pass ratio was
not considered to be significant since it didn’t vary with the cost. He also seemed particular about
knowing with some confidence what the value of the independent variable would be for any engine he
needed to estimate. He said, for example, that with software estimating one of the parameters they like
to use is size, measured in lines of code or function points. The only problem is that before they can use
size to estimate cost, they have to figure some way of estimating the size. The more uncertainty
associated with the independent variable, the more uncertainty in being able to predict the value of the
dependent variable. And, it goes without saying that an independent variable is no good to you if you
can’t get the data on it, so some upfront planning is necessary to come up with a reasonable data
collection plan.

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CON 270, Intermediate Cost and Price Analysis

What’s my line?

The next step, for those of us that made the first cut, was to determine in a general sense how we
related to cost. Did we make the cost increase or decrease? What “specification” or “function” would
best suit us? The analyst said that a function could be linear, curvilinear, or even nonlinear in nature like
some of the examples below.

Y Y Y Y

X X X X

He said that starting out with the right function was important when working with small data sets
because one or two data points could easily lead you to the wrong conclusion, so you had better know
what you were expecting to see.

In God We Trust (all others must bring data)

They also seemed pretty concerned about how many “analogous” data points or other engines they
would be able to find cost and technical data on. The larger the sample of data you have the more the
sample looks like the population that it came from and therefore the more confident you would be in
any inferences or statements that you would make. Sure, you can run regression on two or three data
points, but how much confidence would you have? According to the analyst, when you have a simple
regression equation with one independent variable you will lose two “degrees of freedom” because you
have estimated the Y-intercept and the slope of the independent variable. So if you have two data
points, you have zero degrees of freedom left, with three data points you would have one degree of
freedom, and so on. Just like the sample size, the more degrees of freedom the more confident you are
in your equation. With each additional independent variable in the equation you lose another degree of
freedom. Some analysts1 suggest that in an ideal situation you should have six to ten degrees of
freedom for each independent variable in the equation. Now while that may be desirable, often times
we find ourselves with a limited amount of data and have to be a little more realistic. Perhaps a more
reasonable rule of thumb would be to count the data points, subtract a degree of freedom for the
intercept and one more for each independent variable in the equation, and try to leave yourself with
three to five degrees of freedom. You can see how this would affect the number of data points you need
to collect and the number of independent variables you could have in an equation. If you only have a
few data points you might be better off to find the best one-variable equation rather than using several
independent variables together.

1
Applied Linear Regression Models, Neter, Wasserman, & Kutner, 1989.

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CON 270, Intermediate Cost and Price Analysis

Sometimes, good data is hard to come by because it may be: proprietary; collected in a different format;
defined differently; not collected at all. Data can also be difficult to compare because things like costs,
prices, labor hours, and technology change over time. These things can result in smaller sets of analogous
data points. One piece of advice that the analyst offered was to not overly constrain the term
“analogous”. For instance, you want to determine a reasonable price for a piece of fire-fighting
equipment on a ship. It might be analogous to equipment used at airports, fire departments, and in
industrial settings. Another way that analysts can overly constrain themselves is to look at something
like the F-117 stealth aircraft and say, “There’s nothing else like it”. Well, maybe there’s nothing like the
aircraft as a whole, but there may be a number of aircraft using the same landing gear, avionics, engines,
and material coatings. The same is true with services. Maybe you don’t know what a fair price is for
overhauling a specific truck, but you can find prices for the individual tasks involved in performing an
overhaul. Breaking an item or a task down into lower level components is one way of increasing the
number of possible analogous data points.

Remember, any regression equation is only as good as the data that was used to create it. It’s a lot like
painting a room; most of the time is spent in preparation, and if you skip the spackling they won’t care
how well you rolled the paint on.

85.23567% of all estimates claim a false level of precision

Now, after collecting data on a number of engines, the analyst was going to test myself and some of the
other independent variables statistically, using a spreadsheet like Excel or one of the many statistical
packages available, to see how well we could explain why the cost varied on jet engines.

One of the tests was to determine how much of the variation in the engine cost I could explain. This was
called the R2 or coefficient of determination, and it is a measure of the strength of the relationship
between the dependent variable and myself. I was rated on a scale from 0% to 100%. Scoring 0% would
have meant that I had nothing to offer, where as scoring 100% would have meant that there wasn’t
anything about the change in engine cost that I couldn’t tell you. The analyst offered two cautions, one,
if it sounds too good to be true it probably is; check sample sizes and both the data that was included as
well as the data that was not included. Second, the R2 only represents correlation, not causation; don’t
go on a fishing trip to find correlated variables, start out with variables that you believe are causal, and
then see if there is correlation. Another thing I found out was that as more independent variables are
added to the equation the R2 can only get better, not worse. I was just about to invite some of my
friends to join me in the equation so that we could really max-out the R2 when the analyst warned me
about the adjusted R2. He said that in equations with more than one independent variable he used the
adjusted R2 because it accounted for the loss of the additional degrees of freedom associated with
including additional independent variables. Apparently the adjusted R2 can actually decrease if an
independent variable is included that explains little of the variation.

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CON 270, Intermediate Cost and Price Analysis

Another test that was run on me was the T test, a measure of the significance of the relationship
between the dependent variable and myself. The analyst was concerned that factors such as sample size
and sampling error could create a false impression of my worth. He assumed that I was not related to
engine cost and that it would be up to me to prove otherwise. If I was not significantly related to cost I
would have a slope of zero or thereabouts. The larger the slope value, relatively speaking, the more
confidence the analyst would have in using me. The T statistic represents the number of standard
deviations my slope is from zero, the higher the better. Most applications report a “P” value, which is the
probability of my slope being zero. If the P value is .01 then there is only a 1% probability that my
slope is zero. Roughly translated, the other 99% is the confidence that you can have in using me.
Analysts usually have a pass/fail criterion for using an independent variable based on either an
acceptable P value (the level of significance) or an acceptable level of confidence. If I fail the T test in a
single independent variable model it means that you would actually prefer to use the average engine
cost as your estimate rather than the equation with me. Don’t write me off to soon though because
even if I don’t do well by myself I still might be helpful if paired with one or more other independent
variables.

When more than one of us independent variables are used together, our individual T statistics measure
the marginal contribution we make to the equation. If I fail the T test here you would conclude that you
are better off without me in the equation. After all, I cost you a degree of freedom and I wouldn’t be
giving you anything in return.

One thing you might consider if you decide to use me with another variable is whether the other variable
and I are correlated, and how strong is that correlation. Some applications provide a pairwise correlation
matrix that can show the correlation between all the variables in a particular model or the correlation
between selected variables. This correlation is measured by the R value, which,
appropriately enough, is the square root of R2. The R value can range from a –1 to +1, the plus or minus
driven by whether the slope between any two variables is positive or negative. The closer the R value is
to one 1the stronger the relationship between the two variables. The analyst would actually prefer if
we were not related since then it would be easier to tell us apart. Some analysts would prefer not to use
two independent variables in a model if their R is greater than .7even if they have good T statistics.
Their concern is that the slopes of the independent variables are less accurate in this case and that they
may change from one sample to the next. Other analysts feel that as long as the slopes make sense and
have good T statistics there is no harm in using the equation. Given all that, the real issue is that there
are two characteristics of, let’s say an engine, that are strongly related like the thrust and weight. If the
engines in the data set have a thrust to weight ratio of 25% to 30% then we better not use this data, in
any form, to estimate an engine with a thrust to weight ratio of 45%.

This also brings up a good point about the range of the data which is, stay in the range whenever
possible. Take me for example. If the turbine inlet temperatures for the engines in the data set range
from 2500to 3500then you should not estimate any engine with a value outside this range unless you
have the guidance of a technical expert.

6
CON 270, Intermediate Cost and Price Analysis

Of course, one of the most important considerations is my accuracy; how well do I predict the cost of an
engine. In order to answer this question the analyst will look at my standard error (SE) or what is
sometimes called the standard error of the estimate (SEE). The SE or SEE is the average or typical
estimating error associated with using the equation. If the SE were $50,000, then, on average, the
estimated engine cost would be off by $50,000 from the actual cost. Sometimes we might be off by a
few thousand dollars and at other times by $60,000 or $70,000, but on average we would be off by
about $50,000. Now while a SE of $50,000 is a lot of money, it is difficult to put the SE into perspective
unless we compare it to the average cost of an engine. If the average engine cost $1,000,000 then the SE
of $50,000 would only represent on average a 5% estimating error. This calculation where we divide the
SE by the average or mean value is known as the coefficient of variation or CV and it represents the
average percent estimating error.

Putting it into Perspective

While there are certainly other important issues to explore like the influence and treatment of outliers,
residuals and standardized residuals, and so on, we will leave these for another story. Whether you are
building the model yourself or evaluating a model that someone else has developed, the questions are
the same. What are the cost drivers? What is the nature of the relationship between the dependent and
independent variables? What data points do we include or exclude? What are the statistics and how do
we interpret them? Also consider the use of scatter plots because a picture is truly worth a thousand
statistics. Keep in mind that when evaluating the results of a parametric model, nothing is more
important than the process by which it was built.

7
CON 270, Intermediate Cost and Price Analysis

Notes

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

Price

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CON 270, Intermediate Cost and Price Analysis

Price

Price

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

$2.06.

100%

$530 6.6%.

98%

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

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CON 270, Intermediate Cost and Price Analysis

Note Page

35
CON 270, Intermediate Cost and Price Analysis
Mobile Water Purifier

CON 270 Simple Linear Regression Tool


Enter Variable Labels (blue) and up to 50 pairs of observations (yellow) below left. For your estimate, enter your
independent variable value and desired confidence level below the graph and estimating equation.

Obs Dependent (Y) Independent (X)


# Price GPH
1 12,499.00 5,500.00
2 11,499.00 4,500.00
3 9,475.00 4,000.00
4 8,499.00 3,250.00
5 6,195.00 2,500.00
6 5,185.00 1,500.00
7 2,499.00 600.00
8
9
10
11
12
13
14
15
16
17
18
19
20 Number of observations = 7

21 Estimating Formula: Price = 1559.22659 + ( 2.05659 ) * ( GPH )


22
23 Enter the GPH for which you desire an estimate: 1,800
24 Your estimated Price is: 5,261.08
25

26 Prediction Interval (+/-) Range Low Estimate High


27 Confidence Level: 90.0% 2,380 4,071.31 5,261.08 6,450.85
28
29 Goodness-of-Fit Statistics
30 Standard Error Coefficient
31 Estimate (SEE) Variation (CV) R-Squared
32 529.93231 6.64% 98.161%
33
34 Analysis of Variance (ANOVA) Table
35 Due To: DF Sum of Squares (SS) Mean Squares (SS/DF)

36 Regression 1 74944566.19 (SSR) 74944566.19 (MSR)


37 Residual (Error) 5 1404141.243 (SSE) 280828.2486 (MSE)
38 Total 6 76348707.43 (SST)
39
40 Coefficient Statistics Summary
41
42 Variable Coefficient Std Dev T-Statistic Prob Not Zero
43 Intercept 1559.22659 441.06411 3.53514726 98.34%
44 GPH 2.05659 0.12589 16.33614875
45
46
47
48
49
50

https://www.dau.mil/tools/t/SLR-Tool
36
CON 270, Intermediate Cost and Price Analysis

Note Page

37
CON 270, Intermediate Cost and Price Analysis

NEWTON CORPORATION

You have been asked to review the indirect costs in the firm-fixed price proposal from the
Newton Corporation. The proposed manufacturing overhead is $170,000, which is based on
the number of units being purchased, and an overhead rate of $850 per unit.

You have obtained the following data concerning the company’s actual manufacturing overhead
expenses and four possible bases for the past 4 years.

Manufacturing Indirect Cost Pool and Potential Bases

20X3 20X4 20X5 20X6 20X7 (Proj)


Indirect Cost Pool $3,574,000 $3,345,000 $2,987,000 $3,537,000 $3,995,000
Units Produced 4,700 4,500 4,495 4,600 4,700
Direct Labor Dollars $1,940,000 $1,875,000 $1,863,000 $1,930,500 $2,034,100
Direct Labor Hours 142,000 150,000 147,000 143,000 143,500
Prod. Machine Hours 82,500 74,000 70,500 80,000 82,000

1. Run a regression between the Indirect Cost Pool and each of the candidate bases.
Begin your evaluation by determining if there is a statistically significant relationship
between the independent and dependent variables at the 90% level of confidence. If
there is a relationship, save the file for further analysis.

2. Of the bases that indicated a relationship in Question 1, which base explains more of the
variation in the Indirect Costs over the past four years?

3. Using Newton’s 20X7 estimate for the base that you identified in Question 2, estimate
Newton’s manufacturing overhead rate for 20X7.

4. Estimate manufacturing overhead for your contract, given your rate estimate and the
following contract information: 200 units; 6,200 direct manufacturing labor hours;
$87,900 for direct manufacturing labor; and 3,500 machine hours.

Base Slope’s Relationship? R-Squared Pool Rate Contract


PNZ* Y/N Estimate Estimate Overhead
(Q1) (Q1) (Q2) (Q3) (Q3) (Q4)
Units Produced
Direct Labor Dollars
Direct Labor Hours
Prod. Machine Hours
*PNZ = Probability Not Zero

38
CON 270, Intermediate Cost and Price Analysis

Note Page

39
Statistics to Regression Transition
Mobile Water Purifiers
AVERAGE (MEAN) PRICE = 7979 PRICE = 1559.22659 + 2.05659 (GPH)
Price
2
Price Y Y Y Y Y Y 2 14000 GPH Y YC Y - YC (Y - YC)
5500 12499 12870 -371
12499 12499 7979 4520 20432983 4500 11499 10814 685 137977
11499 11499 7979 3520 12392412 12000 4000 9475 9786 -311 469409
9475 9475 7979 1496 2238871 3250 8499 8243 256 96455
8499 8499 7979 520 270697 2500 6195 6701 -506 65468
10000
6195 6195 7979 -1784 3181637 1500 5185 4644 541 255725
5185 5185 7979 -2794 7804840 600 2499 2793 -294 292566
8000 0.000
2499 2499 7979 -5480 30027269 86541
0.000 76348707 1404141
6000

4000

2000

0
0 1000 2000 3000 4000 5000 6000

CON 270, Intermediate Cost and Price Analysis


GPH
40
CON 270, Intermediate Cost and Price Analysis

Note Page

41
Statistics to Regression Transition
Mobile Water Purifiers
AVERAGE (MEAN) PRICE = 7979 PRICE = 1559.22659 + 2.05659 (GPH)
Price
2
Price Y Y Y Y Y Y 2 14000 GPH Y YC Y - YC (Y - YC)
5500 12499 12870 -371
12499 12499 7979 4520 20432983 4500 11499 10814 685 137977
11499 11499 7979 3520 12392412 12000 4000 9475 9786 -311 469409
9475 9475 7979 1496 2238871 3250 8499 8243 256 96455
8499 8499 7979 520 270697 2500 6195 6701 -506 65468
10000
6195 6195 7979 -1784 3181637 1500 5185 4644 541 255725
5185 5185 7979 -2794 7804840 600 2499 2793 -294 292566
8000 0.000
2499 2499 7979 -5480 30027269 86541
0.000 76348707 1404141
6000

4000

2000

0
0 1000 2000 3000 4000 5000 6000

CON 270, Intermediate Cost and Price Analysis


GPH
42
CON 270, Intermediate Cost and Price Analysis

Note Page

43
CON 270, Intermediate Cost and Price Analysis

Janitorial Services
You have received one response to your solicitation for janitorial services for your facility of 40,000
square feet. The contracting officer has determined that because of your location and size, there is only
one qualified source for the services. Market research has shown this to be a commercial service, and
the effort will be contracted as firm fixed price. You have requested the contractor provide you with the
prices they charge other customers for similar services at facilities of similar size and location. The
contractor has provided you with the following data and supporting documentation.

Sq Ft Price
24,000 $420,000
28,500 $490,000
30,000 $520,000
32,500 $550,000
34,500 $575,000
36,000 $590,000
37,900 $600,000
39,250 $610,000
41,000 $620,000
42,500 $882,000

1. Determine the estimating equation for the price of janitorial services.


2. How confident are you that there is a relationship between Price and Square Feet?
3. How would you characterize the accuracy of the equation?
4. How much of the variation in Prices has been explained by Square Feet?
5. Using a 90% prediction interval:
a. What would be your opening offer?
b. What would be your objective?
c. How would each change for a 95% prediction interval?

44
CON 270, Intermediate Cost and Price Analysis

Note Page

45
Excel Analysis Toolpak
Water Purifier Output

GPH Price SUMMARY OUTPUT


5500 12499
4500 11499 Regression Statistics
4000 9475 Multiple R 0.990761748
3250 8499 R Square 0.981608841
2500 6195 Adjusted R Square 0.977930609
1500 5185 Standard Error 529.9323057
600 2499 Observations 7

ANOVA
Price
df SS MS F Significance F
14000
Regression 1 74944566.19 74944566.19 266.869756 1.56775E‐05
12000
Residual 5 1404141.243 280828.2486
10000 Total 6 76348707.43
8000
6000 Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%
4000 Intercept 1559.226589 441.0641126 3.53514726 0.016648292 425.4351934 2693.017985

CON 270, Intermediate Cost and Price Analysis


2000 GPH 2.056586447 0.125891756 16.33614875 1.56775E‐05 1.732971387 2.380201508
0
0 1000 2000 3000 4000 6000
46
Note Page

47
Regression Practice Problems
1. You are reviewing the contractor’s proposal for engineering overhead. You decide to look at the
historical trend between the engineering indirect costs and engineering labor dollars. In your
regression, what would be the dependent variable?

2. There are two items you are pricing using regression.


A. The average price of item A is $13,425 and the standard error from the equation is $1,611.
B. The average price of item B is $4,500 and the standard error from the equation is $810.

Relatively speaking, which equation is more accurate, equation A or equation B?

3. The Light Tactical Vehicle (LTV) is going through an armor replacement program. The contractor
has stated that manufacturing hours are a function of piece weight. You have asked for historical
hours and weights for similar efforts, and you created the graph below.

Manufacturing Hours
250
#8
200

150
Hours

100

50

0
0 50 100 150 200 250 300
Weight

A. How would you describe observation #8, and what steps would you take?
B. If the piece weight of the LTV was 250 pounds, how would the inclusion of observation #8 in
the data set affect the estimate for the LTV?
C. What would be the dilemma in simply removing observation #8?

48
4. You are looking at the relationship between base telephone maintenance cost and number of
service calls. The results from the regression are shown below. Should you consider using this
estimating equation? Why or why not?

Goodness-of-Fit Statistics
Standard Error Coefficient
Estimate (SEE) Variation (CV) R-Squared
3685.251 59.79% 12.62%

Analysis of Variance (ANOVA) Table


DF

Coefficient Statistics Summary

Variable Coefficient Std Dev T-Statistic Prob Not Zero


Intercept 2793.995 3848.236 0.726 50.49%
# Users 23.201 24.929 0.931 61.21%

Answers
1. What would be the dependent variable? The indirect costs
2. Relatively speaking, which equation is more accurate, equation A or equation B?

SEE 1611 SEE 810


CV = = = 0.12 or 12% CV = = = 0.18 or 18%
y 13425 y 4500

3. A. How would you describe observation #8, and what steps would you take?

Observation #8 is an outlier and we should investigate whether it represents an unusual event, a


different type of material, a different application, etc.

B. If the piece weight of the LTV was 250 pounds, how would the inclusion of observation #8 in the
data set affect the estimate for the LTV?

Since #8 would be “pulling” the equation towards itself, and since the 250 is in the high end of the
range, then #8 would cause us to have higher estimated hours for our effort.

C. What would be the dilemma in simply removing observation #8?

If we remove #8, then our 250 pound part is outside of the relevant range of the remaining data.

4. Should you consider using this estimating equation? Why or why not?

No. The equation fails any reasonable T‐test, only have a Prob Not Zero of 61.21%

49
IT Support
You are contracting for technical support with the contractor who developed your organization’s new
enterprise management system. They state that technical support hours are a function of the number of
users on the system. You have 185 employees that will be using the system. You have collected data on
price and number of users from other organizations with similar types of systems. The results are below.
Price is in dollars.

Range Low High


90.0%

Goodness-of-Fit Statistics
Standard Error Coefficient
Estimate (SEE) Variation (CV) R-Squared
14724.368 7.04% 92.46%

DF

Variable Coefficient Std Dev T-Statistic Prob Not Zero


Intercept 84918.579 15375.574 5.523 99.85%
# Users 854.347 99.604 8.577 99.99%

1. If we interpret in the general equation YC = A + BX that “A” represents fixed costs, what would
be the fixed costs for IT Support?

2. What would be the marginal cost for each additional user?

3. What does the R-Squared of 92.46% represent?

4. What does the Prob Not Zero for # Users of 99.99% represent?

5. What are two ways in which you could describe the accuracy of the equation? State both.

6. What price would you expect to pay for IT support for 185 employees?

50
Answers

1. If we interpret in the general equation YC = A + BX that “A” represents fixed costs, what would
be the fixed costs for IT Support?

$84,919

2. What would be the marginal cost for each additional user?

$854.35

3. What does the R-Squared of 92.46% represent?

About 92% of the variation in price is being explained or accounted for by # Users.

4. What does the Prob Not Zero for # Users of 99.99% represent?

We are 99.99% confident that there is a relationship between Price and # Users.

5. What are two ways in which you could describe the accuracy of the equation? State both.

The standard error of the estimate (SEE) and the coefficient of variation (CV).

If we used the equation we could typically expect to be off by ± $14,724.

If we used the equation we could typically expect to be off by ± 7%.

6. What price would you expect to pay for IT support for 185 employees?

Price = 84918.58 + 854.35 (185) = $242,973

51
Graphical Analysis – Looking at Trends in the Data

Generating a Scatterplot

Arrange the data in columns in the order (X, Y)…

Highlight the data…

Select the Insert tab

Select the Scatter diagram and then the first chart in the gallery

Resulting graph

52
Customizing the Graph

Clicking anywhere on a chart…will activate the Chart Tools Tab

Allowing you to access the Design, Layout, and Format tabs

53
Adding a Trendline

Right clicking on any data point will activate a menu that allows you to add a Trendline

You can select various types of Trendlines, and you have the
option of displaying the Equation and R-squared on the
chart

54
Linear Regression

Accessing the Regression Function

Select Data…
Data Analysis…
And then Regression

Regression Dialog Box

55
Regression Output

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.980055948
R Square 0.960509662
Adjusted R Square 0.952611594
Standard Error 1.291468687
Observations 7

ANOVA
df SS MS F Significance F
Regression 1 202.837686 202.837686 121.6132475 0.000106741
Residual 5 8.33945685 1.66789137
Total 6 211.1771429

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%


Intercept 0.666083283 0.949148453 0.70176934 0.514134864 -1.773780489 3.105947055
Weight 6.545564273 0.593549097 11.02783966 0.000106741 5.019797746 8.0713308

Regression Equation

Ŷ b  b X Cost = .6661 + 6.5456 (Weight)


X 0 1

Where: ŶX is the estimated or predicted value of Y for any given X


b0 is the Y intercept
b1 is the slope (for a one unit change in Weight, Cost changes by 6.5456)
X is the value of the independent variable

T-Statistic

The “t-Stat” for Weight indicates that the sample slope for Weight is 11.0278 standard deviations from
zero. The likelihood that the slope of the population regression line is zero is expressed as the “P-value”
which is .0001 or .01%. In other words, there is only a .01% chance that the actual population slope is
zero. Since we are confident that the slope is not equal to zero, we are confident that there is a
statistical relationship between Cost and Weight, and we should consider using Weight as an
independent variable.

The P-value is known as the level of significance. Some applications report the value “1 – P”. The value
“1 – P” is known as the level of confidence. The COSTAT application in ACEIT reports this as the “Prob
Not Zero” and EZ Quant refers to it as the “Inclusion Assurance”.

Different sources will vary in their recommendation as to what constitutes an “acceptable” probability,
stating that the level of confidence should be above .80, .90, or .95; or that the level of significance
should be below .20, .10, or .05.

56
Regression Statistics
Multiple R 0.980055948
R Square 0.960509662
Adjusted R Square 0.952611594
Standard Error 1.291468687
Observations 7

ANOVA
df SS MS F Significance F
Regression 1 202.837686 202.837686 121.6132475 0.000106741
Residual 5 8.33945685 1.66789137
Total 6 211.1771429

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%


Intercept 0.666083283 0.949148453 0.70176934 0.514134864 -1.773780489 3.105947055
Weight 6.545564273 0.593549097 11.02783966 0.000106741 5.019797746 8.0713308

R-squared (R2 )

The R2 (Coefficient of Determination) is a measure of the amount of variation around the mean that has
been explained by the regression equation. The R2 in our example of .96 or 96% can be expressed as,
“96% of the variation in the Cost can be explained by the variation in Weight”.

The R2 value can range from .00 to 1.00, with .00 indicating that none of the variation has been
explained and with 1.00 indicating that all of the variation has been explained (in which case all of the
data points would fall on the regression line). Like many statistics, sources will vary on what is a “good”
R2 value, but usually a value above 80% or a value above 90% is considered “good”.

Standard Error (SE) or Standard Error of the Estimate (SEE)

The standard error of 1.29 is a measure of the variability around the regression line. If Cost is in
thousands, then a reasonable interpretation of the SE would be, “If we were to use this equation we
would typically expect to be off by give or take $1.29K” or “The average estimating error would be
$1.29K”. While not a precise definition, it does communicate that the SE is a measure of the accuracy of
the equation. The lower the standard error is, the more accurate the equation.

Coefficient of Variation (CV)

The CV is a means of expressing the standard error (SE) as a relative value. While not displayed on the
Excel output, the CV can easily be calculated by dividing the SE by the mean. In our example the SE is
1.29 and the mean (from the Descriptive Statistics output) was 9.64.

The .13 can be expressed as 13% and stated, “The average estimating error is
SE 1.29
 .13 13%” or “We would typically expect to be off by give or take 13%”. The lower
Y 9.64 the CV, the more accurate the equation.

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T-DISTRIBUTION TABLE, SELECTED PROBABILITIES

Example: degrees of freedom = 14; significance level = .10

Significance Level (both tails combined)


d.f. .10 .05 .02 .01
1 6.314 12.706 31.821 63.657
2 2.920 4.303 6.965 9.925
3 2.353 3.182 4.541 5.841
4 2.132 2.776 3.747 4.604
5 2.015 2.571 3.365 4.032
6 1.943 2.447 3.143 3.707
7 1.895 2.365 2.998 3.499
8 1.860 2.306 2.896 3.355
9 1.833 2.262 2.821 3.250
10 1.812 2.228 2.764 3.169
11 1.796 2.201 2.718 3.106
12 1.782 2.179 2.681 3.055
13 1.771 2.160 2.650 3.012
14 1.761 2.145 2.624 2.977
15 1.753 2.131 2.602 2.947
16 1.746 2.120 2.583 2.921
17 1.740 2.110 2.567 2.898
18 1.734 2.101 2.552 2.878
19 1.729 2.093 2.539 2.861
20 1.725 2.086 2.528 2.845

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DISTRIBUTION TABLE, SELECTED PROBABILITIES (continued)

Example: degrees of freedom = 24; significance level = .05

Significance Level (both tails combined)


d.f. .10 .05 .02 .01
21 1.721 2.080 2.518 2.831
22 1.717 2.074 2.508 2.819
23 1.714 2.069 2.500 2.807
24 1.711 2.064 2.492 2.797
25 1.708 2.060 2.485 2.787
26 1.706 2.056 2.479 2.779
27 1.703 2.052 2.473 2.771
28 1.701 2.048 2.467 2.763
29 1.699 2.045 2.462 2.756
30 1.697 2.042 2.457 2.750
40 1.684 2.021 2.423 2.704
60 1.671 2.000 2.390 2.660
120 1.658 1.980 2.358 2.617

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Notes Page

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Factors

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ACME Support Engineering Factor

As requested, ACME hereby provides the additional information requested in support of our proposed
Support Engineering factor of 5%. This factor was applied to the total DIT hours of 20,800 consisting of
Design (8,320), Integration (8,320), and Test (4,160) engineering hours estimated for your contract. You
can see that this factor averages 5% based on actual history as provided below. We trust you find this
fully supports our proposal and look forward to your prompt acceptance so we can begin this very
important program.

Contract
Program Award DIT Hrs Prg Spt Hrs Prg Spt %
GHI 20X5 12,150 650 5.35%
RST 20X7 18,900 850 4.50%
ABC 20X4 11,320 620 5.48%
XYZ 20X8 21,000 920 4.38%
LMN 20X6 15,000 790 5.27%
Average 5.00%

1. Your engineers find the design, integration, and test hours proposed to be reasonable. DCMA
approves the 5% factor, but notes that Test hours were not actually included when the
contractor developed the factor. What is your objective for Support Engineering?

2. Assume the contractor provides information to show that DCMA was in error, and the
development of the 5% average factor does indeed include Test. What is your revised objective
for Support Engineering?

3. How would your objective change if you were to run a regression using DIT hours and Program
Support hours?

4. What might you use as a negotiating range for the hours and the rate?

5. Does the proposed 5% factor correctly represent the relationship between DIT hours and
program support hours?

6. Under what specific circumstances would the 5% factor be fairly accurate?

7. In the case of our contract, was the factor over or under-applied?

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CON 270 Intermediate Cost and Price Analysis

Factors Practice Problems


1. You are considering the use of a factor for pricing material scrap. The trend in scrap compared
to raw materials is shown in the diagram.

Scrap $
1400
1200
1000
Scrap $

800
600
400
200
0
0 5000 10000 15000 20000 25000 30000
Raw Material $

Is the use of a factor warranted here? Why or why not?

2. You are reviewing the contractor’s overhead rate for manufacturing which uses direct labor
hours as the base. You graphed the historical indirect costs and direct labor hours. The solid line
represents the trend in the historical data. The dashed line represents the contractor’s overhead
rate.
A. Over what range would it be reasonable to use the overhead rate?
B. When would the contractor be over-applying the rate?
C. When would the contractor be likely to want to revise the overhead rate?

Manufacturing Overhead
3000000
Manufacturing Indirect

2500000
2000000
1500000
1000000
500000
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Direct Labor Hours

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CON 270 Intermediate Cost and Price Analysis

Answers
1. Is the use of a factor warranted here? Why or why not?

No, if we fit a trend line through the data we can see that it does not even come close to going
through the origin (as a factor would as a function of its specification).

2.
A. Over what range would it be reasonable to use the overhead rate?

When the actual base is somewhere between 2000 to 2500 hours.

B. When would the contractor be over-applying the rate?

As the base starting exceeding around 3000 hours we would be concerned about the rate.

C. When would the contractor be likely to want to revise the overhead rate?

If the actual base was less than 2000 the contractor would likely want to revise their rate
since they would not be recovering all of their indirect costs.

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Cost Improvement
(Learning Curves)

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Variation in Quantity

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Could this be happening at your depot or supply center?

When it comes to curves - are you being led up a steep? Or, down a flat?

Your organization has observed a historical price normalization process that adjusts previous prices paid for the
same item for current economics and quantities being purchased. Prices are adjusted for economics using inflation
indices from the Bureau of Labor Statistics (for this exercise, we won’t concern ourselves with this adjustment).
Prices are adjusted for quantity with a user defined curve percentage.

Scenario #1 -Let’s say a prior contract paid $1,250 each for 20 items (for a total of $25,000) and now you want to
purchase 40 items. Although you are considering using a 90% curve to estimate the price of the next 40 items, the
contractor suggests that when you do your market research you should find a 95% curve to be more appropriate.
You follow the contractor’s lead and find a range of 90-95% f o r repetitive electronics manufacturing. Your
contractor asserts that in this situation the 95% curve is more appropriate. Should you use the 95% curve, rather
than 90% curve, to normalize your historical price for quantity?

Points to ponder: 1) which is the steeper curve, 90% or 95%?

2) in which direction are we going on the curve, up or down?

3) what is the unit price that will result from each curve?

4) is the higher unit price is associated with the steeper or flatter curve?

Scenario #2 – Let’s say a prior contract paid $1,250 each for 20 items, but now you only want to purchase 10 items.
In this situation the contractor points to an industry standard for these complex machine tools to average between
75% and 90% which you were able to confirm with your own market research. Your contractor asserts that in
this situation they are willing to accept the more aggressive and challenging 75% curve. Should you use the 75% or
the regular 90% curve to normalize your historical price for quantity?

Points to ponder: 1) which is the steeper curve; 75% or 90%?

2) in which direction are we going on the curve; up or down?

3) what is the unit price that will result from each curve?

4) are the higher unit prices associated with the steeper, or flatter, curves?

Which rule of thumb appears to be more robust? (Use the graph paper provided to plot price/quantity points and
label appropriate curves.)

• The steeper the cheaper; the flatter the fatter.


• Buyer beware going up a steep or down a flat.
• Buyer beware going up a flat or down a steep.

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Weighted Guidelines Review
CON 270 presumes that all students have mastered developing profit/fee objectives using the Weighted
Guidelines (WGL) using the DD Form 1547 and the instructions at DFARS 215.404‐71 as covered in CON
170.

This package contains the following:

• A summary of Federal Acquisition and DoD Profit Policy


• A summary of the main sections of the DD Form 1547.
• DD Form 1547 blank reference copies to key with DFARS detailed instructions.
• Two WGL Scenarios.
• For downloaded electronic copy of DFARS 215.404-71, Weighted Guidelines Method, see Student
CD, Incentive Student Folder, Student Reference Guide, Page 5.

Federal Acquisition Regulation Profit/Fee Policy (FAR 15.404)

• Requires structured approach for each agency with common factors.


• Agency’s structured approached required when cost analysis done.
• Agencies may use another agency’s approach.
• Profit shall not be computed using FCCOM in base cost.
• Statutory ceilings on R&D (15%), A&E (6%), and CPFF (10%), with compliance certified by
contracting officer signature on contract or PNM.
• May use basic contract profit/fee percentages on relatively minor modifications of same type
and mix of effort.
• Exemptions from mandatory application permitted if specified.

Department of Defense Profit/Fee Policy (DFARS 215.404‐4, and ‐72 thru ‐75)

• One (1) of three (3) methods on all but CPAF (‐74) and FFRDCs (‐75)
– Weighted Guidelines, or WGL (the default structured approach)
– Modified WGL (nonprofits other than FFRDCs , ‐72)
– Alternate structured approach (< TINA, A&E/Construction, subcontractor material
delivery, terminations, or HCA approval if WGL not reasonable)
• WGL shall be used for formula priced (e.g. CPI, FPI)
• Application MUST be documented in the PNM
WGL, DD Form 1547 and Instructions Overview (DFARS 215.404-71)

Performance risk (215.404-71-2)

• Applied to total cost block 20 including G&A, not FCCOM.


• Tech vs. Mgt/Cost Control Splits (e.g. 60/40, 70/30, etc. considers contribution to total
performance).
• Specified ranges and “normal” values (representing avg. conditions, all DoD acquisitions, not
requiring special explanation in PNM).
• Higher valued “Technology incentive” for new technology innovation.
• Above normal and below normal condition examples provided.

Contract type risk (215.404-71-3(a) thru (d))

• Applied to total cost block 20 including G&A, not FCCOM.


• Higher ranges/normal values for contractors taking riskier K types (e.g. compare CPFF/T&M/FFP-
LOE
• with FFP no financing).
• Higher ranges/normal values with less/no Government financing.
• “Mandatory” assessment of reduced risk for cost incurred under UCAs/ECPs.

Working capital adjustment (215.404-71-3(e) thru (f))

• “NA” unless progress payment financing is used.


• Contractor working capital investment (cost less progress payments), times length of investment,
times current treasury rate.
• Not to exceed (NTE) 4% of block 20.

Facilities capital employed (215.404-71-4)

• Facilities employed from DD1861 computation dividing total cost of money by treasury rate used
by CASB-CMF computation of factors.
• Currently applied only to equipment share (%) of facilities employed.

Cost efficiency factor (215.404-71-5)

• Provided to extent contractor demonstrates benefits to pending contract.


• No “normal” value, consequently normal value is zero.
• NTE 4% of block 20.

Negotiated summary

• Mandatory reporting of profit/fee statistics on actions exceeding TINA threshold within 30 days
after contract award.
• Automated WGL software accomplishes this timely reporting requirement and recommended
by PGI.
Developing the two Profit positions Using ACME data.

Open the WGL tool “DD1547_WGL_Template_Oct_2012” found on the Student CD.

You will be developing 2 profit objectives using the information provided below. Both of the profit
positions developed in this review will be used during the Week 2 Incentive Contracting lesson,
“Constructing FPIF Pricing Positions – The target Centric Approach (ACME Parts I – IV)”. As
such, save each of your profit objectives onto your desktop under the file names “ACME Part I” and
“ACME Part II”.

Information for use in both Scenarios:

• Contract Type: FPI with a 50/50 Share Ratio


• Performance Risk
– 70% Technical
• POP: 30 months Substantive Portion
• Progress Payment Rate = 80%
• Treasury rate (Interest Rate) = 2.5%
• Facilities Capital Employed
– Land: $ 191,052
– Bldg: $ 955,260
– Equip: $ 764,208

Develop a separate profit objective for both scenarios below:

Scenario #1 (see ACME Part I.xls)


• You have no rationale to deviate from normal ranges as described in DFARS 215.404-71

Scenario #2 (see ACME Part II.xls)


• You can support the use of the technology incentive at its “Normal” value
• You think that a 50/50 share ratio places high risk on the contractor (Contract Type Risk)
CON 270, Intermediate Cost and Price Analysis

Cost Risk Analysis

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Intermediate Cost & Price Analysis

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Evaluating the Pricing Position

As I understand it, in the early 90’s the automotive industry was tasked with developing lead-
free paints. My 92’ car was apparently not one of the new painting process success stories given that the
paint on my car began to delaminate in a number of areas. This led me to get an estimate for having my
car repainted from the local auto paint shop. The initial estimate was about $1100 which came as
something of a shock given all of the advertisements you see on TV for auto painting for $199 to $299.
Since I was not familiar with auto painting I asked the painter what the process entailed. He outlined the
hours required to: prep the car (taping, removal of emblems, etc.); strip the paint; apply the primer and
the finishing coats; and replace emblems, pin-striping, rubber strips, etc. Sensing my apprehension
about the price, he suggested that he might be able to get the price down to $800 if he was able to:
reuse the emblems and rubber strips; leave off the pin-striping; cut some time in prep; and if some
other steps went better than expected. I followed up with my mechanic, who was familiar with auto
painting costs, and he stated that it would be reasonable to pay $1100-$1200 for this work.

How did having all of this information help? It provided me a better understanding of the requirements,
some grounds for determining if the initial quote was realistic, and also some insight into the risk
associated with the $800 and $1100 quotes. Two things became apparent from our discussion: the $199
to $299 advertisements could not possibly entail the same level of work as the $1100 effort; and there
was a greater risk and a lower probability of success in performing the work for $800 than for the $1100.

Perhaps in this example you can see some of the concepts we have discussed in the course. There is
market research, information other than certified cost and pricing data, interviewing experts, and from
our statistics block, the idea that with every population (in this case, auto paint prices) there is a
distribution with some degree of dispersion. I would like to suggest that these concepts could assist us in
performing cost realism and price analysis.

Cost realism analysis is the process of independently reviewing and evaluating specific elements of each
offeror's proposed cost estimate 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. Price analysis is the process of examining and evaluating a proposed price without evaluating
its separate cost elements and proposed profit.

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CON 270, Intermediate Cost and Price Analysis

Price Analysis Example: Let’s say that we are using a time and materials contract and that through
further discussions we determine the most optimistic estimate to paint the car is $700, the most
probable is $1100, and the most pessimistic is $1500.
Assuming a triangular distribution, we could conclude
an estimate of $1100 would represent a 50% chance
of over-running and a 50% chance of under-running.
You can see that if we use the $800 estimate we 50% 50%

approach a 100% chance of over-running while


estimates closer to $1500 reduce the risk of over-run. $700 $1100 $1500

Cost Analysis Example #1: We are purchasing the painting services on a time and materials contract for
which the contractor has proposed a price of $935. We have asked some fact-finding questions and have
gained the following insights into the cost elements associated with painting a car. We arrived at these
assumptions through discussions with the contractor much like a government IPT or a
government/contractor IPT might work.

Labor: Most likely it will take 22 man-hours to paint the car. The most pessimistic estimate is 32
hours and most optimistic is 18 hours. The contractor assumed it would require 22 hours.

Fully Burdened Labor Rate: The contractor has a billing rate of $32.50 an hour.

Materials: Depending on reuse of the existing car parts, the material costs could range
anywhere from $150 to $350. Any cost within that range is just as likely to occur. The contractor
believes that it would be reasonable to expect to spend $200 based on an assumption that most
of the parts could be reused.

Material Mark-Up Rate: If the contractor can purchase the materials wholesale the rate is 10%.
If instead the materials have to be purchased through a dealership then the rate is 20%. There is
a 25% probability that the parts can be purchased wholesale. The contractor expects to
purchase the parts wholesale.

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CON 270, Intermediate Cost and Price Analysis

Contractor’s Estimate:
Labor Hours 22

Billing Rate $32.50

Subtotal Labor $715

Material Cost $200

As it is, this point estimate does not communicate the uncertainty inherent in the estimate nor does it
provide the decision-maker with any measure of the risk associated with the $935 position. Now, what if
we incorporate our assumptions:

Labor Hours: Materials: Material Rate:

75%
PROBABILITY

25%
18 22 32
$150 $350
MH RATE 10 % 20%

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CON 270, Intermediate Cost and Price Analysis

Now if we were to randomly sample from each of these distributions 1000 times, each time generating
an estimate at total price, we would generate a total price distribution something like this:

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CON 270, Intermediate Cost and Price Analysis

Where does the contractor’s position of $935 fall on this distribution?

As you can see from the distribution, the area to the left of $935 is about 13% and the area to the right
of $935 is about 87%. In other words, there is a 87% probability that the price for the effort will actually
be more than $935. In contrast, if we wanted a 50/50 probability of success, a reasonable price would
be somewhere in the neighborhood of $1100. Since with this contracting arrangement, the government
for all intents and purposes, will basically pay the actual cost, there is no risk to the contractor in under-
bidding the effort.

Cost Analysis Example #2: In this case, rather than a time and materials contract, let’s assume that we
have a firm fixed price contract for which the contractor has proposed a price of $1330. Again, we will
review our assumptions.

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CON 270, Intermediate Cost and Price Analysis

Labor: Most likely it will take 22 man-hours to paint the car. The most pessimistic estimate is 32
hours and most optimistic is 18 hours. The contractor assumed it would require 28 hours.

Fully Burdened Labor Rate: The contractor has a billing rate of $32.50 an hour.

Materials: Depending on reuse of the existing car parts, the material costs could range
anywhere from $150 to $350. Any cost within that range is just as likely to occur. The contractor
believes that it would be reasonable to expect to spend $350 based on an assumption that none
of the parts could be reused.

Material Mark-Up Rate: If the contractor can purchase the materials wholesale the rate is 10%.
If instead the materials have to be purchased through a dealership then the rate is 20%. There
is a 25% probability that the parts can be purchased wholesale. The contractor expects to
purchase the parts through a dealership.

Labor Hours 28
Contractor’s Estimate:
Billing Rate $32.50

Subtotal Labor $910

Material Cost $350

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CON 270, Intermediate Cost and Price Analysis

Where does the contractor’s position of $1330 fall on this distribution?

As you can see from the distribution, the area to the left of $1330 is about 95% and the area to the right
of $1330 is about 5%. In other words, there is a 95% probability that the price for the effort would
actually be less than $1330. Again, if we wanted a 50/50 probability of success, a reasonable price would
be somewhere in the neighborhood of $1100. Since this is firm fixed price, if the effort actually came in
at $1100, the delta of $230 between the $1100 and the $1330 price would represent additional profit to
the contractor.

This process of identifying distributions for each of our assumptions provides a number of advantages
over the simple point estimate. One, the variability in the total distribution not only communicates a
sense of risk, but also suggests which contract type might be appropriate – low variability, low risk, firm
fixed price; moderate variability, moderate risk, fixed price incentive; high variability, high risk, cost plus.
Second, the process of identifying the distributions gives us insight into the risk drivers. We can vary our
assumptions, rerun the simulation, and assess the impact on the total distribution (what we might call
sensitivity analysis). Third, the process provides us a better understanding of the requirements and the
statement of work (SOW), regardless of whether it was the contractor or the government that generated
the SOW. It provides us the means of communicating with the contractor to truly determine whether
we have a mutual understanding of the task at hand.

The IPT is an ideal setting for the use of risk analysis since by definition it includes representation from
various functional specialties, not only in the government, but potentially from the contractor as well.
The use of an IPT in risk management is further discussed in the extract from the Risk Management
Guide which is included later in this chapter.

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Radar Modification Risk Analysis Exercise

Your organization has been negotiating with the original manufacturer for a modification to
their radar system. The program manager and her staff have been working the proposal using
an IPT approach. You have been provided with the agreed-to positions for the elements of cost
and are now trying to determine the amount of risk inherent in the effort so that you can assign
the appropriate risk factors on the weighted guidelines.

You have gone back to the government focal points for the various elements of cost and
conducted interviews that yielded the following information:

1. The audit on direct materials indicated a likely range between $42,250 and $47,395.

2. Given the estimates of design engineering labor and the forward pricing rate agreement
(FPRA), the most likely engineering direct labor cost is $175,500. Based on the
assessment, the cost could be as low as $165,250 or as high as $197,500.

3. The engineering overhead rate based on the FPRA is 175% and the distribution for
overhead would correspond to the distribution of direct engineering labor.

4. Your engineer is fairly confident in the estimate of manufacturing hours. The primary
cost driver in manufacturing direct labor costs is the ongoing company-union labor
negotiation. Speaking with company representatives, they believe there is a 3-out-of-4
chance the company will prevail in negotiations, in which case the direct manufacturing
cost would be $225,000. If the union prevails the cost would be $245,125.

5. The manufacturing overhead rate based on the FPRA is 215% and the distribution for
overhead would correspond to the distribution of direct manufacturing labor.

6. The other direct costs (ODCs) are based on the average price of special tooling
equipment. DCMA located eight current prices for this type of tooling: $11,195;
$12,950; $11,750; $12,350; $12,500; $12,450; $12,550; $13,450.

7. Test engineering is treated as a separate department. The test manager said that while
the costs based on the hours and FPRA could range between $25,000 and $37,250 that
he expected it more likely that the hours would be in the lower end of that range. He
said that estimates of test hours tend to be right skewed.

Develop the distributions for each element of cost and estimate the total cost and variance for
subtotal costs.

32
CON 270, Intermediate Cost and Price Analysis

Probability under a Normal Distribution

The area under a normal distribution is equal to 1.0000. Since the


.5000 .5000
curve is symmetrical, there is .5000 in each half.

The distance between the mean of any normal distribution (μ) and
a value of X can be measured in standard deviations (Z). The Z
table indicates the probability or area between 0 and Z standard
deviations. Since “μ” is in the middle, it is at zero (0) standard
deviations. The only thing we need to determine is how many
μ X
Std Devs
standard deviations (Z) that X is from μ.
0 Z X−μ
The Z value is calculated as: Z = σ
After calculating the Z value, we can look-up the probability between 0 and Z standard deviations in a
Z table. In a Z table the numbers down the left hand column, combined with the numbers across the
top, represent standard deviations. The values within the table represent the areas between 0 and Z
standard deviations.

z .00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.00 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
0.10 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.20 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.30 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.40 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.50 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224

Let’s say that the average (μ) age of people in the United States is 40 with a standard deviation (σ) of
10. What percentage of the population is between 40 and 45 years of age?

X−μ 45 − 40 5
Z= = = = .50 standard deviations
σ 10 10

We go down the left hand column to .50 and across to the column of
.00 (the .00 column indicates that the second decimal place in the Z
calculation of .50 is a 0). We locate a probability of .1915. This could
be stated as 19.15% of the population is between 40 and 45 years
of age. Graphically, it is represented by the gray area in the picture. Years
Ye of age
μ x
Std Devs
Z
If we wanted to know the percentage of the population over 45, it 0

would be the area to the right of the gray area. Since the area on the right side of the curve is equal to
.5000, if we subtracted the gray area (.1915) from .5000, it would leave us with the area to the right.

.5000 - .1915 = .3085 This could be stated as 30.85% of the population is over 45 years old.

If we wanted to know the percentage of the population under 45, we would add the gray area (.1915)
to the area in the left half of the curve (.5000).

.5000 + .1915 = .6915 This could be stated as 69.15% of the population is under 45 years old.

33
CON 270, Intermediate Cost and Price Analysis

What if we wanted to know the percentage of the population between


35 and 45 years of age? Graphically the problem would look like this:

In addition to our previous calculations, we would need to determine the probability of people being
between 35 and 40 years of age.

X−μ 35 − 40 -5
Z= = = = - .50 standard deviations
σ 10 10

When referencing probability in a Z table we treat the Z as an absolute value, so we interpret -.50 as
.50 standard deviations. We want to know the probability between 0 and .50 standard deviations.
Once again, referencing .50 standard deviations in the Z table gives us a probability of .1915.

In this case we want to add the two gray areas.

.1915 + .1915 = .3830 Stated as 38.30% of the population is between 35 and 45 years of age.

What if we wanted to know the percentage of the population between


42 and 45 years of age? Graphically the problem would look like this:

Since we already know that the probability between 40 and 45 is .1915, we just need to determine the
probability of people being between 40 and 42 years of age.

X−μ 42 − 40 2
Z= = = = .20 standard deviations
σ 10 10

Referencing .20 standard deviations on the Z table we locate a probability of .0793.

The shaded area in our diagram represents the difference between .50 and .20 standard deviations,
so we subtract the probabilities.

.1915 - .0793 = .1122 Stated as 11.22% of the population is between 42 and 45 years of age.

So, what process should we use to determine probabilities under a Normal Distribution?

1. Draw a diagram of the area you are trying to determine.


X−μ
2. Calculate the Z value(s) Z=
σ

3. Locate the probability in the Z table associated with the Z (standard deviations) you calculated.

4. Determine whether the probability you located in the Z table represents the area in your
diagram, or whether an addition or subtraction will be required.

34
CON 270, Intermediate Cost and Price Analysis

Symmetric Approximation
Step 1 – Identify the areas of uncertainty in your estimate (labor hours, material prices, etc.)

Step 2 – Select a distribution type for each area of uncertainty you are going to quantify

Normal Uniform Triangular

Beta

Alpha = 2 Beta = 3 Alpha = 3 Beta = 3 Alpha = 3 Beta = 2

Step 3 – Calculate the Mean and Variance for each cost element you are analyzing

A B A = minimum
Uniform  
2
B = maximum
2

(B A)
2  12
A B
51

Triangular7 A = minimum
A B C B = maximum

3
C = mode

2 2 2
2 A B C (A B) (A C) (B C)
 
A C B 18

Beta (A) (B) A = minimum


 
  
B = maximum

() (B A)


2 
( 1)()2

Alpha = 2 Beta = 3
35
2

CON 270, Intermediate Cost and Price Analysis


Alpha and Beta
correspond to shape
preference

36
CON 270, Intermediate Cost and Price Analysis

Step 4 – Calculate the Mean and Standard Deviation for the Total Cost (TC)

1) Sum the means of the cost elements to get μTC (mean of the total cost)
2
2) Sum the variances of the cost elements to get σ TC (variance of the total cost)
2
3) Calculate the square root of σ TC to arrive at the σTC (standard deviation of the TC)

Step 5 – (For example) Determine the probability of Over-Running the Gov’t objective

Distribution of Total System Cost


(Normal Distribution centered at μTC) Probability from Z table

+ .5000

Probability of Overrun

POEPOE μ
Gov’t TTS
TSC
POE CC Z standard deviations
Z 0

(Govt ‐ µTC) z .00 .01 .02 .03 .04 .05 .06 .07 .08 .09
Z= 0.00 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
σTC 0.10 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.20 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.30 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.40 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.50 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224

0.60 .2257 .2291 .2324 .2357 .2389 .2422 .2454 .2486 .2517 .2549
0.70 .2580 .2611 .2642 .2673 .2704 .2734 .2764 .2794 .2823 .2852
0.80 .2881 .2910 .2939 .2967 .2995 .3023 .3051 .3078 .3106 .3133
0.90 .3159 .3186 .3212 .3238 .3264 .3289 .3315 .3340 .3365 .3389
1.00 .3413 .3438 .3461 .3485 .3508 .3531 .3554 .3577 .3599 .3621

37
CON 270, Intermediate Cost and Price Analysis

The Standard Normal Distribution (Z Table)

  z 

z .00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.00 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
0.10 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.20 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.30 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.40 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.50 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224

0.60 .2257 .2291 .2324 .2357 .2389 .2422 .2454 .2486 .2517 .2549
0.70 .2580 .2611 .2642 .2673 .2704 .2734 .2764 .2794 .2823 .2852
0.80 .2881 .2910 .2939 .2967 .2995 .3023 .3051 .3078 .3106 .3133
0.90 .3159 .3186 .3212 .3238 .3264 .3289 .3315 .3340 .3365 .3389
1.00 .3413 .3438 .3461 .3485 .3508 .3531 .3554 .3577 .3599 .3621

1.10 .3643 .3665 .3686 .3708 .3729 .3749 .3770 .3790 .3810 .3830
1.20 .3849 .3869 .3888 .3907 .3925 .3944 .3962 .3980 .3997 .4015
1.30 .4032 .4049 .4066 .4082 .4099 .4115 .4131 .4147 .4162 .4177
1.40 .4192 .4207 .4222 .4236 .4251 .4265 .4279 .4292 .4306 .4319
1.50 .4332 .4345 .4357 .4370 .4382 .4394 .4406 .4418 .4429 .4441

1.60 .4452 .4463 .4474 .4484 .4495 .4505 .4515 .4525 .4535 .4545
1.70 .4554 .4564 .4573 .4582 .4591 .4599 .4608 .4616 .4625 .4633
1.80 .4641 .4649 .4656 .4664 .4671 .4678 .4686 .4693 .4699 .4706
1.90 .4713 .4719 .4726 .4732 .4738 .4744 .4750 .4756 .4761 .4767
2.00 .4772 .4778 .4783 .4788 .4793 .4798 .4803 .4808 .4812 .4817

2.10 .4821 .4826 .4830 .4834 .4838 .4842 .4846 .4850 .4854 .4857
2.20 .4861 .4864 .4868 .4871 .4875 .4878 .4881 .4884 .4887 .4890
2.30 .4893 .4896 .4898 .4901 .4904 .4906 .4909 .4911 .4913 .4916
2.40 .4918 .4920 .4922 .4925 .4927 .4929 .4931 .4932 .4934 .4936
2.50 .4938 .4940 .4941 .4943 .4945 .4946 .4948 .4949 .4951 .4952

2.60 .4953 .4955 .4956 .4957 .4959 .4960 .4961 .4962 .4963 .4964
2.70 .4965 .4966 .4967 .4968 .4969 .4970 .4971 .4972 .4973 .4974
2.80 .4974 .4975 .4976 .4977 .4977 .4978 .4979 .4979 .4980 .4981
2.90 .4981 .4982 .4982 .4983 .4984 .4984 .4985 .4985 .4986 .4986
3.00 .4987 .4987 .4987 .4988 .4988 .4989 .4989 .4989 .4990 .4990

38
Incentive Contracting

CON 270
Intermediate Cost & Price Analysis
CON 270, Intermediate Cost and Price Analysis

2
CON 270, Intermediate Cost and Price Analysis

Terminal and Enabling Learning Objectives


The Terminal and Enabling Learning Objectives for this chapter are contained below.

TLO 1: Given an assigned incentive contract, successfully appraise the incentive


provisions.
ELO 1: Calculate appropriate final price determination
ELO 2: Graphically summarize incentive provisions
ELO 3: Detect aberrant FPIF contract geometry
ELO 4: Determine effectiveness of performance and technical incentive valuations
and corollary prohibitive cost incentive tradeoffs under multiple incentive
contracts
ELO 5: Summarize acceptable contract change techniques on incentive contracts
TLO 2: Given a potential incentive acquisition, formulate an effective incentive
contracting strategy.
ELO 1: Summarize pertinent regulatory guidelines
ELO 2: Construct a target-centric incentive contract arrangement integrating
pertinent profit/fee policy and regulatory incentive guidance
ELO 3: Construct a ceiling-centric incentive contract arrangement integrating
pertinent profit/fee policy and regulatory incentive guidance
ELO 4: Illustrate the effects of dollarizing risk for certain cost elements described in
DFARS/PGI 216.403-1(3)
ELO 5: Calculate the probability of contract completion within ceiling using
quantitative risk analysis
ELO 6: Integrate reward pools with quantitative cost risk analysis to determine
appropriate contract type and share ratios
ELO 7: Construct an effective cost limitation provision for multiple incentive CPIF
contracts
ELO 8: Examine competing incentive contract proposals in a source selection
environment

3
CON 270, Intermediate Cost and Price Analysis

Notes Page

4
CON 270, Intermediate Cost and Price Analysis

INCENTIVE CONTRACTING
Contract incentives come in all shapes and sizes, and exist in every business arrangement,
whether a commercial enterprise or DOD contract. Incentives can be monetary or non-monetary.
Incentives should reward contractors for successful performance while meeting desired
acquisition outcomes, but include consequences when targets or objectives are not met. Simply
stated, the objective of any incentive is to motivate the contractor to earn more compensation by
achieving better performance and controlling cost.
Historically, selection of the appropriate contract type has been the primary strategy for
motivating contractor performance. FAR Part 16, Types of Contracts, provides ample guidance
for selecting a contract type appropriate to the circumstances of the acquisition.
For example, a firm-fixed-price (FFP) contract provides for a price that is not subject to any
adjustment on the basis of the contractor’s cost experience in performing the contract. It
provides maximum incentive for the contractor to control costs and perform effectively since the
contractor realizes an additional dollar of profit for every dollar that costs are reduced. The
contractor’s ability to avoid a loss or make a profit under a FFP contract is directly related to
control of the costs of performance. One could make the argument that a FFP contract is the
ultimate incentive contract because all cost savings below price are returned 100 percent to the
contractor. There is no sharing of savings between the contractor and the government. Of
course, the flip side of that argument is that every dollar the contractor has to spend above price
comes 100 percent from the contractor. In effect a FFP contract has a 0/100 share ratio, whereby
the Government has no cost control responsibility and the contractor has 100 percent of the cost
responsibility. In Incentive contracting, the first number in the incentive share ratio is the
percent of cost responsibility being taken by the government and the second is the cost
responsibility being taken by the contractor. So a 0/100 share ratio places 100 percent of the cost
responsibility on the contractor. If the contractor’s final costs of performance are less than the
agreed to contract price, the contractor keeps 100 percent of those savings. If final costs exceed
the agreed to price, the contractor is responsible for covering the entire overrun amount while
still being required to complete performance because it from the fixed price family of contracts
(deliver or default).
Although this chapter is directed primarily at the objective incentive arrangements versus the
subjective incentive arrangements (CPIF/FPIF contracts versus Award Fee contracts), focus on
contract type selection as the sole or primary means of incentivizing a contractor may lead the
acquisition team to discount the effects of other contractual incentives such as contract financing
and profit. Extra-contractual indicators such as return on investment, cash flow, earnings per
share, meeting sales projections, reputation and past performance are just as important, if not
more so, than the figures in the instant contract. For that reason, contract type should be
considered as only one part of the total compensation package that includes financing, profit, and
other contract terms and conditions. Agreement on cost, profit, share ratios, probable cost
outcomes, contract financing, and terms and conditions should result in simultaneous, not
sequential, agreement on all factors.

5
CON 270, Intermediate Cost and Price Analysis

Non-cost based incentives established by clearly defined performance objectives or product


features and functions are another strategy that can be employed. These delivery and
performance incentives may be used on their own or as part of a multiple-incentive arrangement.
We will explore these Multiple-incentive arrangements later in this chapter.
As in any DOD contractual arrangement, any incentive arrangement presupposes conduct of
appropriately thorough market research. This is necessary to establish the appropriate business
arrangement that reflects acceptable risk to both parties, a commitment to economy and
efficiency, and adherence to schedule. This should lead to fair and reasonable prices and greater
overall value to the taxpayer.
Both cost and non-cost based incentives are contractual incentives. Extra-contractual incentives
are also very important to a company. These types of incentives may include:
 Gaining future business
 Increasing profits on other contracts being performed concurrently (through absorption of
a portion of the fixed overhead expense)
 Improving or maintaining a company’s reputation
 Gaining prestige and goodwill
 Retaining and maintaining an engineering and/or production capability
 Exceling for the sake of excellence
These factors should be considered prior to contract award as they may affect short term profit
incentives.
This chapter will be divided into 4 major sections. In the first section after a brief review of the
attributes of the fixed price family and cost plus family of contracts, we’ll delve into the
mechanics and geometry of CPIF and FPIF contracts. We’ll then examine the current policy for
incentive contracts in the second section. Within that examination, we’ll conduct an exercise
that explores the implications of the current policy on structuring an incentive agreement. For
the third section we will conduct a series of exercises that compare using different techniques to
structure an incentive arrangement for a negotiation objective. In this section we will also
discuss how to add a performance or delivery incentive to a CPIF or FPIF contract. Finally, a
group Integrating exercise will be conducted in the fourth section to bring together the concepts,
policies, and mechanics of cost incentive contracts.
Throughout this chapter, we will primarily refer to two guides. Within DOD, in April 2016 the
Undersecretary of Defense for Acquisition, Technology, and Logistics’ Defense Procurement
and Acquisition Policy (DPAP) Directorate released “Guidance on Using Incentive and Other
Contract Types”. This guide has been incorporated into the DFARS PGI at 216.104. The other
primary source document is the 1969 DoD/NASA Incentive Contracting Guide. While
somewhat dated, it is still one of the best resources to use when structuring an incentive
arrangement. Both of these guides are included on your Student Disk. We will also use as a
reference the Student Reference Guide – Incentive Contracting FPI-CPI (SRG) which is also on
the Student Disk.

6
CON 270, Intermediate Cost and Price Analysis

SECTION I – THE BASICS

Contract Type Review

Let’s begin our discussion of Cost Incentive contracts with a brief refresher from CON 170.
Slide 9 below has the basic geometry of a Cost Plus Fixed Fee (CPFF) and a Firm Fixed Price
(FFP) contract. A primary element of CPFF contracts is that the Fee DOLLARS, not percent, is
what is fixed across all actual cost outcomes. You can see by the flat slope (0%) of the fee line
that regardless of final audited cost outcome, the fee dollars will remain unchanged. In contrast,
under FFP contracts it is the PRICE that is fixed across all potential cost outcomes, which remain
the business of the contractor (i.e. it is neither required nor desired that the contractor submit
their costs). Note also that on the CPFF line the government pays 100% of all allowable costs
incurred by the contractor, thus the government has assumed 100% of the cost risk and it could
be said that the effective “share line” is 100/0 (where the first number represents the
government’s share percentage and the second the contractor’s share percentage). On the FFP
line, however, every point on the line represents the same price (combination of cost plus profit).
That is to say that the line drawn is at a 45 degree angle where every dollar increase in cost is
matched by a one dollar decrease in the contractor’s profit, even to the point of having to
potentially incur a loss. Thus the contractor is responsible for 100% of the cost risk which would
equate to a share line of 0/100.

7
CON 270, Intermediate Cost and Price Analysis

Perhaps the most significant area of contrast between a CPFF and FFP contract is the
delivery/completion requirement. Being from the Cost Plus family of contracts, a CPFF contract
requires the best efforts of the contractor in performance of the contract; although strongly
desired, delivery is not an absolute requirement. A FFP contract, being from the Fixed Price
family of contracts, requires delivery or performance completion (commonly referred to as
“Deliver or Default”). Because under a CPFF contract the Government will pay all allowable
incurred costs without guarantee of delivery/full performance, the vast majority of contract risk
is placed upon the Government. Just the opposite situation occurs in FFP: the contractor is
required to deliver/complete performance at an agreed to price, even if the contractor ends up in
a loss position at completion. Therefore contracts from the Cost Plus family are generally
utilized where the work to be done is not well defined leading to uncertain cost and/or
performance risk. In those situations, often in the research and development arena, the
Government will absorb much of that risk by using a cost type contract where all allowable costs
are paid and the fixed fee DOLLAR amount is guaranteed. Whereas contractors might be
willing to propose FFP on a risky effort, they would have to include the pricing for unknown
risks leading to potentially wildly inflated prices. On the other hand, the Fixed Price family of
contracts is used generally where the work is much better defined and the risks of performance
are well known and can be priced accordingly. The ability or inability to clearly define the work
to be done is often the key determinant in selecting from the cost or fixed price family of
contracts.

Slide 10 further outlines the differences between the Cost Plus and Fixed Price family of
contracts.

8
CON 270, Intermediate Cost and Price Analysis

There are incentives for the contractor to perform all types of contracts, even CPFF contracts
where there may not be a cost incentive but other incentives that may vary depending on the
situation. Such extra-contractual incentives are discussed in the 1969 Incentive Contracting
Guide on page 2 – “extra-contractual incentives, such as to (i) gain future business, (ii) increase
profits on other contracts being performed at the same time (by absorbing a portion of the fixed
overhead expense which otherwise would be absorbed by other fixed price or incentive type
contracts and thereby increasing the profit margin under those other contracts), (iii) contribute to
and improve the nation's international reputation, (iv) gain prestige and goodwill, (v) retain and
maintain an engineering and/or production capability, and (vi) excel for the sake of excellence.
These factors should be considered prior to making awards, and when possible while structuring
the incentive sharing provisions, because, with any particular contractor, these factors may
outweigh the short term profit incentives.” On the other hand, unlike the FFP where there is an
absolute contractual incentive to perform regardless of cost because of the 100% cost incentive –
absent these extra-contractual incentives, there is no incentive for the contractor to necessarily
continue to perform the contract once the fee has been disbursed and paid.
As stated previously the key difference between the two families is that of a cost reimbursable
being best efforts while fixed price is deliver or default. In addition, warranties are included with
fixed price but not cost reimbursable. The FAR warranty guidance is provided at FAR 46.7 and
also included in the Student Reference Guide (SRG). Generally with cost type contracts, no
warranties are included beyond what is found in the applicable Inspections clause. For fixed
price contracts, the Government is warranted against latent defects, but often specific warranties
may be included. Additionally, the inspection regime for fixed price is more significant than that
for cost plus. (See FAR 52.246-2 and -3 and SRG.)
Payment on cost type contracts is made in accordance with FAR 52.216-7 the Allowable Cost
and Payment (AC&P) Clause, also in SRG, that goes into all cost reimbursable contracts. This
highlights the need and requirement for an approved contractor accounting system which is not
required for Firm-fixed-price contracts that do not provide progress payments (although an
approved accounting system will be required for a FPIF contract or a FFP contract with progress
payments). The AC&P clause also helps explain why “financing” is really only needed in the
fixed price family. Under the AC&P clause in cost reimbursable contracts the contractor can
claim 100% of their actual costs as often as every two weeks (monthly billing via cost vouchers
is more typical with large businesses).
CON 170 should have covered the issues of funding contracts, as well as making the distinction
of the completion vs. term form of CPFF contracts. Nevertheless, in the area of incentives you
can further incentivize performance, even under a CPFF contract, by exercising the contracting
officer’s ability to tie fee payments to some event called out in the schedule. For example note at
FAR 52.216-8, Fixed Fee (see SRG), deferring to the “Schedule” for the payment of fixed fees.
Quite often the Schedule is silent on the contracting officer’s desires for the payment of the fixed
fee, thus leaving it to the administrative contracting officer to devise a method for the payment of
fees which is often a method involving a proration of some sort or another.

9
CON 270, Intermediate Cost and Price Analysis

To wrap up this quick review, again, perhaps the most important distinction between the cost and
fixed price families of contracts is that because of the promises, warranties, and legal
repercussions associated with the fixed price contract – it MUST have a clear definition of work.
The cost reimbursable contract does not require as firm a definition. This will be perhaps the key
determining factor when deciding between the cost incentive (or formula) forms of contract type
in the cost reimbursable and fixed price families discussed next.
Slide 12 provides a point of reference to compare and contrast the elements of the Cost Plus
Incentive Fee (CPIF) with the Fixed Price Incentive Firm (FPIF) – the two cost formula contracts
that will be the focus of the remaining part of this lesson in CON 270.

Notice that the horizontal axis on both the CPIF and FPIF are now labeled identically. On the
previous slide that graphically compares the CPFF with the FFP there was a very significant
difference in the labeling of the horizontal axis. On the horizontal axis of the FFP the cost is all
internal. Here we see the FPIF, like the CPIF and CPFF, requires an approved accounting
system for the contractor to submit their actual cost of performance for audit and determination
of allowability. Hence the contract types other than FFP such as the CPFF, CPIF, and FPIF are
referred to as “flexibly priced” contracts. The vertical axes for CPFF and CPIF are labeled as
Fee, while on the FFP and FPIF, the axes are labeled Profit. Fee is associated with cost type
contracts and profit is associated with fixed price type contracts. Additionally, note that the
nomenclature for FPIF is Fixed Price Incentive (Firm Target), not fee. The second “f” in FPIF
stands for “Firm”, meaning firm targets for cost, profit, ceiling price and profit adjustment
formula are negotiated up front. This is the Fixed Price Incentive type contract we will focus on

10
CON 270, Intermediate Cost and Price Analysis

in this chapter. There is another type of FPI contract – FPIS, where the “S” stands for
Successive targets. Because this particular type of incentive contract is used much less
frequently than the FPIF incentive contract, this chapter will forgo an expanded discussion of it.
For a more detailed description of FPIS please see FAR 16.403-2.
When comparing the graphical portrayal of the CPFF and FFP contract types on slide 9 with the
CPIF and FPIF graphs of slide 11, anywhere there is a slope to the share line not equal to 0%,
sharing of cost risk is occurring. For example, on the CPIF graph, the CPIF converts to a CPFF
beyond the sloped share line (where the share line goes horizontal, 0% slope) and the FPIF
converts to a FFP at the Point of Total Assumption (PTA) line which has that same characteristic
45 degree slope associated with the FFP. PTA is the point at which the government stops
sharing in overrun costs. At that point the contractor has full contract cost responsibility (0/100
share line, 45 degree slope).
Slide 12 provides a general outline of the differences between CPIF and FPIF contracts. The
basic terms and conditions for CPIF and FPIF are the same as they were for CPFF and FFP,
respectively.

11
CON 270, Intermediate Cost and Price Analysis

Among other differences between the CPIF and FPIF, a significant difference is how risk is
viewed. By coming off of a 100/0 share ratio associated with a CPFF contract where the
Government has all of the cost risk, cost risk to the contractor is added by changing the share
ratio (and hence the slope of the line) to 90/10 or 80/20. For FPIF, cost risk to the contractor is
actually reduced from FFP (45 degree slope with 0/100 share ratio) by reducing the share line
(for example, from 60/40 to 70/30). A good portion of this lesson on the cost incentive, or
formula, contract types is devoted to the geometry and share lines. One way to think of the rate
of sharing in cost risk is to look at the contractor share in the share ratio. With a share ratio of
90/10, a contractor is gaining or losing fee or profit at the rate of 10 cents on the dollar (a
relatively flat slope); whereas with a 70/30 share ratio, the contractor is gaining or losing that fee
or profit at a rate of 30 cents on the dollar (a relatively steeper slope). The steeper the slope of
the share line, the faster the contractor share of available fee is being changed. Also it is
important to note that beyond the share line, we need to keep in mind these other important
attributes that stem from their respective contract families, especially in the area of financial
responsibilities for the Government. The Government is only liable up to any self-imposed
funding constraint for CPIF contracts. Money may be added to the effort if the contractor is
showing progress but no fee dollars are added. For FPIF contracts, the Government is liable up
to the Ceiling Price of the contract. Ceiling price is typically negotiated and calculated as a
percentage of target cost, although a discreet dollar value may be used.
So is there a significant difference between an 80/20 CPIF and 80/20 FPIF? YES! The latter,
although having the same cost sharing formula, carries the fixed price terms and conditions (Ts
& Cs) requiring the contractor to deliver or default, etc. CPIF only requires the best efforts of
the contractor.
Another important consideration, as brought out by the 1969 Guide on pages 7 & 8, is that the
technical risk is an absolute determinant in choosing between CPIF and FPIF. As noted on page
8 – “While it is true that the confidence in both technical and cost outcomes should be very high
in firm-fixed-price contracts, generally technical uncertainties should influence the selection
between FPI and CPIF contract. A fixed-price-incentive should be used only when there is a
reasonably high expectation of technical success, without significant likelihood for the need for
extensive technical direction.” On the same page in the Guide it continues: “Technical
uncertainties are far more significant than cost uncertainties in the selection of contract type.
Where there is a high probability of technical failure (and therefore cost uncertainty) any fixed
price contract, other than level of effort type, should be avoided.”
Before we get in depth into the geometry of Incentive arrangements, let’s take a look at the
explosion in use of Cost Incentive contracts since 2010. As you can see from the next two slides
the use of Cost Incentive contracts more than doubled from 2010 to 2014 while the use of Award
fee contracts declined significantly. These simultaneous phenomena are due to Congress’s
dissatisfaction with execution of Award fee contracts by DoD during deployments in the 1990’s
and early 2000’s as well as the beginning of the Better Buying Power tenets in 2010.

12
CON 270, Intermediate Cost and Price Analysis

13
CON 270, Intermediate Cost and Price Analysis

Now that we’ve observed that they are being used more and more, let’s get more familiar with
how we might go about using a CPIF contract.
Cost Plus Incentive Fee (CPIF)
Determining Final Price:
The scenario below provides an example to go through the process of determining final CPIF
price at various final cost outcomes. Guidance in the FAR for this process is found at FAR
52.216-10 - Incentive fee (Jun2011) [in SRG (read subparagraphs a through e)].

CPIF Clause and Application


The Director of Financial Management has mentioned to your boss, the Director of Contracting
(DOC), that she was somewhat concerned about budgeting for your recently awarded CPIF
contract. She wants to know how much funding she should retain (commit) for various
hypothetical final cost outcomes on that contract.

You open your contract and find for the CLIN in Section B a Target Cost of $1,000,000 and a
target fee of $70,000. Turning to Section I and looking at FAR 52.216-10 -- Incentive Fee (see
Student Reference Guide)

Insert in first blank at paragraph (e): 10 (Contractor under-run share = 10%)


Insert in second blank at paragraph (e): 20 (Contractor over-run share = 20%)
Insert in third blank at paragraph (e): 9% (Maximum fee = $90,000, 9% of
$1,000,000)
Insert in fourth blank at paragraph (e): 3% (Minimum fee = $30,000, 3% of
$1,000,000)

Using this information with the clause, calculate the final fees and total funding required at
the following potential final cost: Use the steps listed in below:

When finished filling in the table, graph the Final Cost – Final Fee combination points and
connect each point in sequence from left to right by line segments on the graph provided on
page 18.

14
CON 270, Intermediate Cost and Price Analysis

Target Cost - ; Target Fee - ;


Ktr Share Under – %: Over – %: Max Fee - $ Min Fee - $
1. Final Cost? $750,000 $800,000 $900,000 $1,000,000 $1,200,000 $1,250,000

2. Underrun or $750,000 (F)


Overrun? less than (<)
$1,000,000(T)
UNDERRUN
3. How much $1,000,000
Under/Over? - 750,000
$ 250,000
4. Contractor $ 250,000
Share? X 0.10
$ 25,000
5. Adjusted $ 70,000
Fee? + 25,000
$95,000
6. Adjusted $95,000
fee within exceeds
max/min? $90,000
7. Final Fee? $90,000
8. Final $750,000
Funding? +90,000
$840,000

Final Cost Final Fee Total Funding


$ 750,000 $90,000 $840,000 (This one was done for you)
$ 800,000 ________ ___________
$ 900,000 ________ ___________
$1,000,000 ________ ___________
$1,200,000 ________ ___________
$1,250,000 ________ ___________

15
CON 270, Intermediate Cost and Price Analysis

CPIF Final Cost and Fee Determination Process


Before anything else: List all known information
1. What is the final actual/allowable cost? (add to list)
2. Compare the final cost to target cost
If final cost is less than target, then it is an underrun
If final cost is greater than target, then it is an overrun.
3. How much is the underrun/overrun (add to list)
4. Identify the underrun or the overrun share % (found in the contract clause); multiply the
appropriate share percentage by the amount of the underrun or overrun
5. Identify contract target fee, and adjust it
If an underrun, add the adjustment to the target fee
If an overrun, subtract the adjustment from the target fee
6.&7. Determine the relationship between the adjusted fee and the maximum and minimum fees
If adjusted fee is between the maximum and minimum fee, use the adjusted fee
If adjusted fee is above the max fee, use the max fee
If adjusted fee is below the min fee, use the min fee
8. To determine the final funding amount:
Sum the allowable final cost and the final fee

16
CON 270, Intermediate Cost and Price Analysis

Once all of the blank areas have been filled in, you should notice as you read left to right - the
contractor’s final fee goes down as the final funding amount required of the government goes up.
And the converse is also true as you read from right to left – that as the funding required of the
government goes down, the contractor’s final fee goes up. Thus we see the fundamental nature
of incentive contracting - as the contractor responds to the incentive to control cost they benefit
with getting higher fees and the government benefits by paying an overall lower amount when
considering both cost and fee. Going through the final funding exercise demonstrates how the
cost risk is shared between the Government and the contractor. In this scenario, given a 90/10
underrun share ratio and a final cost of $800,000, the final funding amount ends up being
$890,000 – made up of $800,000 in cost and $90,000 in fee. Because the contractor underran
target cost by $200,000, this entitled the contractor to an additional $20,000 in fee (10% of
$200,000). When adding the $20,000 in incentive fee to the target fee of $70,000, the contractor
has actually earned the max fee amount. The way the sharing works is that given a 90/10
underrun share ratio, every dollar by which the contractor underruns target cost will result in the
Government saving 90 cents of cost and the contractor will gain an additional 10 cents in fee
(subject to the min and max fee restrictions imposed by the arrangement). Given an 80/20
overrun share ratio, every dollar the contractor overruns target cost will result in the Government
having to pay an additional 80 cents of cost and the contractor will forfeit 20 cents in fee (subject
to the min and max fee restrictions imposed by the arrangement).
Once these amounts have been determined, graph the final funding amounts starting with the
final cost of $750,000 and final fee of $90,000 on the graph paper provided (this results in a price
point of $840,000. Once all of the price points have been determined, draw line segments
between each of the points. The graph should have the same general shape as the graph for CPIF
at slide 12.

17
CON 270, Intermediate Cost and Price Analysis

$ in Thousands (CPIF)
Fee
200
150

18
100
50
-0-
700 800 900 1,000 1,100 1,200 1,300

Graph.ppsx
CPIF Initial
Cost
CON 270, Intermediate Cost and Price Analysis

Clicking the icon for the PowerPoint Presentation at the lower left of the slide on the previous
page will open the above slide in a PowerPoint slide show where each element is animated to
build as you go. To see the animated builds you have to click on the slide show icon in the lower
right. This convention will be utilized throughout this chapter, so where you see a hyperlink
with a .ppsx extension, there will a PowerPoint build slide.
One word about these build slides: The intent is not for you to go directly to the builds to see the
answers. The intent is for you to do the work by hand initially. This handiwork reinforces the
learning and is the way many experienced price analysts first lay out an incentive arrangement
when establishing negotiating positions and monitor the impacts of offers and counteroffers
during negotiations. Once you have done the work by hand, you may use the build slide to check
your work. Inclusion of these builds is primarily intended as a study aid and to use as a resource
when you are dealing with incentive contracts as a practitioner.
CPIF Graphing (with the deal elements):
We will now graph a CPIF arrangement with just the deal elements. Although graphing by hand
may seem somewhat tedious in our technology driven world, there are significant advantages to
laying the arrangement out by hand. Immediate payback for you as a student is that graphing
with the elements reinforces concepts you just learned in computing final CPIF prices and
graphing them out. Additionally, graphing in this manner serves as a building block skill which
we will use when we start developing objectives share lines in a contract formation/negotiation
mode later in this lesson. Finally, this skill enables practitioners (Government contract
negotiators/administrators/price analysts) to develop a valuable job aid for any incentive contract
that gets placed in front of them to administer. The old adage that “A picture is worth a thousand
words” is appropriate here. By graphing the elements, you can see what level of sharing is
taking place at various cost points and you can easily estimate from the graph what a projected
final price would be at various final cost points. Not only will this provide the practitioner
insight into potential motivations of the contractor as contract performance is ongoing, it will
also aid in ensuring that the financial manager is aware of any potential additional funding
requirements.
The information on slide 25 contains all of the information that is needed to graph the particular
CPIF arrangement. The instructor will lead you through the exercise. A blank sheet of graph
paper that is already scaled is provided for you to graph the arrangement.

19
CON 270, Intermediate Cost and Price Analysis

20
CON 270, Intermediate Cost and Price Analysis

1,300
(CPIF)

1,200
1,100
1,000

Cost
$ in Thousands

900
800
700
50
100

-0-
200

150
Fee

CPIF Graphing w
Deal Elements (1).ppsx

21
CON 270, Intermediate Cost and Price Analysis

From our CPIF example above: Target Cost - $1,000,000; Target Fee - $70,000; Max Fee -
$90,000; Min Fee - $30,000; 90/10 Under; 80/20 Over.
Using graphical analysis we were able to determine the Range of Incentive Effectiveness (RIE)
that “falls out” from graphing the above contract parameters. Looking at Slide 27 below,
graphically we see that the lower end of the RIE, RIE(lower), is the intersection of the under-target
share line and the maximum fee line. The higher end of the RIE, RIE(higher) , is at the intersection
of the over-target share line and the minimum fee line. These points are referred to as the
“optimistic” and “pessimistic” cost in the Contract Pricing Reference Guide (CPRG). For
negotiation purposes, the practitioner might consider the RIE(lower) as an opening position and the
RIE(higher) as a reservation price.

In our example, the RIE was determined to be between the costs of $800,000 and $1,200,000.
Below $800,000 [RIE(lower)], the contract converts from CPIF to CPFF (100/0 share ratio, 0
slope). Above $1,200,000 [RIE(higher)], the contract again converts from CPIF to CPFF (100/0
share ratio, 0 slope). So the RIE is truly just that - the range in which the contractor is
incentivized to control costs. Outside that range, above or below, there is no motivation for the
contractor to control costs. Should you desire more precision than may be gleaned from visual
inspection, formulas exist for calculating the points that define the RIE.

22
CON 270, Intermediate Cost and Price Analysis

The formulas for calculating the points that define the RIE in every CPIF deal are based upon
those used by the CPRG for “optimistic” and “pessimistic” cost. These formulas are as follows:
RIE(lower) = Target Cost – [ (Max Fee – Target Fee) ÷ Contractor Underrun share ]
RIE(higher) = Target Cost + [ (Target Fee – Min Fee) ÷ Contractor Overrun share ]
Use our CPIF example values above to calculate the RIE below:
RIE(lower) =

RIE(higher) =

Now that we’ve looked more closely at the CPIF arrangement, let’s now examine the FPIF
arrangement, where we would presume there is less contract risk than CPIF, but still too much
risk to use a FFP vehicle.

23
CON 270, Intermediate Cost and Price Analysis

Fixed Price Incentive Firm (FPIF)


Determining Final Price
The scenario below provides an example to go through the process of determining final FPIF
price at various final cost outcomes. Guidance in the FAR for this process is found at FAR
52.216-16 Incentive Price Revision - Firm Target (also, SRG, read subparagraphs a through d).

FPIF Clause and Application


The Director of Financial Management has budgeting and funding concerns for the Fixed Price
Incentive Firm target, or FPIF, contract recently assigned to you. She wants to know how much
funding she should retain (commit) for various hypothetical final cost outcomes on that contract.
You open your contract and find for the CLIN in Section B a Target Cost of $1,000,000 and a
target profit of $110,000. Turning to Section I and looking at FAR 52.216-16 -- Incentive Price
Revision – Firm Target (Oct 1997) (Appendix 1 at the end of this chapter) you see the following:
Insert in blank at paragraph (a): $1,250,000
Insert in blank at paragraph (d)(2)(ii): 30%
Insert in blank at paragraph (d)(2)(iii): 20%
Using this information with the clause, calculate the final profit and price to obtain total
funding required at the potential final costs. Use the steps in the book or see student drive
“FPIF Clause Process”

24
CON 270, Intermediate Cost and Price Analysis

Notes Page

25
CON 270, Intermediate Cost and Price Analysis

Final Cost Final Profit Final Price (Total Funding)


$ 800,000 $150,000 $950,000 (This one was done for you)
$ 900,000 ________ ___________
$ 1,000,000 ________ ___________
$ 1,100,000 ________ ___________
$ 1,200,000 ________ ___________
$ 1,350,000 ________ ___________

26
CON 270, Intermediate Cost and Price Analysis

FPIF Final Cost and Profit Determination Process


Before anything else: List all known information
1. What is the final actual/allowable cost? (add to list)
2. Compare the final cost to target cost
If final cost is less than target, then it is an underrun
If final cost is greater than target, then is is an overrun.
3. How much is the underrun/overrun (add to list)
4. Identify the underrun or the overrun share % (found in the contract clause); multiply the
appropriate share percentage by the amount of the underrun or overrun. This is the adjustment
amount.
5. Adjust the target profit
If an underrun, add the adjustment to the target profit
If an overrun, subtract the adjustment from the target profit
6. Determine the final adjusted price
Add the adjusted profit to the final cost
7. Compare the adjusted final price to the ceiling price
If final price exceeds the ceiling price, use the ceiling price
If final price is less than ceiling price, use the final price
8. To determine final profit:
Subtract the final cost from the final price

27
CON 270, Intermediate Cost and Price Analysis

Once all of the blank areas have been filled in, as you read left to right, the final contract price
goes up as the contractor’s final profit goes down. MORE IMPORTANTLY, the converse is
also true as you read from right to left – that as the final contract price goes down, the
contractor’s final profit goes up. Thus we see the fundamental nature of incentive contracting -
as the contractor responds to the incentive to control cost they benefit with getting higher profits
and the government benefits by paying an overall lower price when considering both cost and
profit.
Also note that in the last scenario the actual cost exceeds the ceiling price, and thus the
contractor incurs a $100,000 loss. Because this is a FPIF contract (from the fixed price family of
contracts), the contractor is required to complete performance while receiving the ceiling price
and absorbing the loss.
In this scenario, given an 80/20 underrun share ratio and a final cost of $800,000, the final price
ends up being $950,000 – made up of $800,000 in cost and $150,000 in profit. Because the
contractor underran target cost by $200,000, this entitled the contractor to an additional $40,000
in profit. When adding the $40,000 in incentive profit to the target profit of $110,000, the
contractor has actually earned a profit rate of 18.75% ($150,000 Profit/$800,000 Final Cost).
The way the sharing works is that given an 80/20 underrun share ratio, every dollar by which the
contractor underruns target cost will result in the Government saving 80 cents of cost and the
contractor will gain an additional 20 cents in profit. Given a 70/30 overrun share ratio, every
dollar the contractor overruns target cost will result in the Government having to pay an
additional 70 cents of cost and the contractor will forfeit 30 cents in profit, up to the point of total
assumption. Once the contractor incurs costs beyond the point of total assumption, the
Government stops sharing in overrun costs.
Your DOC has also asked for a graphical portrayal of the contract’s Cost/Profit relationship.
Once these amounts have been determined, graph the final price amounts starting with the final
cost of $800,000 and final profit of $150,000 on the graph paper provided (this results in a price
point of $950,000. Once all of the price points have been determined, draw line segments
between each of the points. The graph should have the same general shape as the graph for FPIF
at slide 12.

28
Profit $ in Thousands (FPIF)
(Loss)

FPIF Initial
Graph.ppsx
250

200

150

100

29
50

-0-

(50)

(100)

Cost 800 900 1,000 1,100 1,200 1,300 1,400


CON 270, Intermediate Cost and Price Analysis
CON 270, Intermediate Cost and Price Analysis

FPIF Graphing (with the deal elements):


Recall our FPIF example: Target Cost - $1,000,000; Target Profit - $110,000; (Target Price -
$1,110,000); Ceiling Price - $1,250,000; 80/20 Under; 70/30 Over.
We will now graph a FPIF arrangement with just the deal elements. Again, there are multiple
purposes for graphing by hand: reinforces concepts being learned, serves as a building block
when we start building objectives late in the chapter, and the skill enables practitioners to
develop a valuable job aid for any incentive contract that gets placed in front of them to
administer. The slide below contains all of the information that is needed to graph the particular
FPIF arrangement.
Be advised that the values provided in the computation exercises were engineered to
conveniently provide the points of intersections where the final profits shift from the incentive
profit share line to the ceiling price line (shift from sharing to a 45 degree, 0/100 share line).
This point where the share line and the ceiling price line intersect is the PTA. If it is not known
in advance, it may be obtained through graphing. The PTA on FPIF contracts is the upper end of
the Range of Incentive Effectiveness [ RIE(higher) ]. This point is critical to know on FPIF
contracts for several reasons, not the least of which is that the contractor may start to cut corners
in an effort to avoid losing profits, or even worse, operate at a loss. Because of this potential, the
Government needs to increase surveillance on the contractor’s efforts to ensure contract
requirements are fully met. Try to graph the arrangement on your own following the directions
on Slide 41. The instructor will facilitate if necessary.

30
CON 270, Intermediate Cost and Price Analysis

1,400
(FPIF)

1,300
1,200
1,100
1,000
$ in Thousands

900
800
(Loss)

(50)

(100)
150
250

200

100
Profit

-0-
50

Cost

FPIF Point of Total Assumption (PTA) and Range of Cost Sharing (RCS)

FPIF Graphing w
Deal Elements.ppsx

31
CON 270, Intermediate Cost and Price Analysis

Recall our FPIF example: Target Cost - $1,000,000; Target Profit - $110,000; (Target Price -
$1,110,000); Ceiling Price - $1,250,000; 80/20 Under; 70/30 Over.
Using graphical analysis we were able to determine the Point of Total Assumption (PTA) that
“falls out” from graphing the above contract parameters is $1,200,000. Not required as an
element called out by the contract, it is the (cost) point at which the contractor assumes all (or
total, 100%) responsibility for any additional cost growth (the Government ceases sharing in the
overrun).
Graphically we see that the PTA (cost value) occurs at the intersection of the over target share
line and the ceiling price line. This point is also referred to as the “pessimistic” cost in the
CPRG. The contract ceiling price is equal to the contractor’s profit at the PTA (cost value) plus
the PTA (cost value).
The PTA is also the upper limit of the Range of Cost Sharing (RCS). The lower limit of the RCS
will be a point of interest similar to the RIELower in CPIF contracts. The Government will use this
range between the lower and upper limits of the RCS to assist in calculating share ratios. More
on this process later.
The below formulas for calculating PTA (cost value) and profit at the PTA (cost value) are based
upon those used by the CPRG for “pessimistic” cost.
PTA (cost) = Target Cost + [ (Ceiling Price – Target Price) ÷ Government Overrun share ]
Profit at PTA, or PTA (profit) = Ceiling Price - PTA (cost)
Calculate the values below using the incentive information from Slide 41 above:
PTA (cost) =

Profit at PTA, or PTA (profit) =

32
CON 270, Intermediate Cost and Price Analysis

Notes Page

33
CON 270, Intermediate Cost and Price Analysis

Another FPIF Graphing Exercise – Can this be right?


You just finished a sole source, FPIF negotiation. It was a tough one, but you were able to settle
on a Target Cost of $1,000,000 and Target Profit of $110,000. You also settled on the following
FAR 52.216-16 elements:

Insert in blank at paragraph (a): $1,300,000

Insert in blank at paragraph (d)(2)(ii): 50%

Insert in blank at paragraph (d)(2)(iii): 30%

Your boss has asked you to graph the deal, calculate the PTA, and the contractor’s profit at PTA.
Please graph the arrangement on the graph provided on the left. She has also asked what you
think the final price will be should the actual final cost come in at $1,310,000.

Team Exercise: Work individually. Then collaborate together in your teams and be ready to
discuss the answers.

34
Profit $ in Thousands (FPIF)
(Loss)

250

Right.ppsx
Can This Be
200

150

100

35
50

-0-

(50)

(100)

Cost 800 900 1,000 1,100 1,200 1,300 1,400


CON 270, Intermediate Cost and Price Analysis
CON 270, Intermediate Cost and Price Analysis

Fixing the Problem

Where aberrant geometry occurs, the PTA is negative and final price is less than ceiling price
even though final cost is greater than ceiling price. Along with the target cost and target profit,
which when added together equal target price, the incentive elements required to be identified in
the Incentive Price Revision – Firm Target clause at FAR 52.216-16 determine the geometry of
the incentive arrangement. It is in these elements where the solution for aberrant geometry may
be found.
First the target cost and target profit have to be identified to establish target price. Once target
price is plotted graphically, it becomes the pivot point for the under and over target share lines. If
you can raise the pivot (target price) point up (most likely by increasing target profit), you may
be able to raise the PTA, perhaps to a point above the X-axis to where PTA is positive.

36
CON 270, Intermediate Cost and Price Analysis

Another way to correct aberrant geometry is to flatten the over target share line. Because PTA
occurs graphically at the intersection of the over target share line and the ceiling price line
segment, by flattening the over target share line, you may be able to raise that intersection point
(PTA), perhaps to a point above the X-axis to where PTA is positive.

37
CON 270, Intermediate Cost and Price Analysis

The final way to correct aberrant geometry is to decrease the ceiling price (bring back ceiling
price toward the origin along the X-axis). This will also have the effect of raising the
intersection point (PTA), perhaps to a point above the X-axis where PTA is positive.

You can use one of these methods by itself or combine methods to correct the aberrance.
However, note that raising target profit and/or flattening the over target share line provides cost
risk relief to the contractor in the incentive arrangement. Decreasing the ceiling price provides
worst case cost relief to the Government. If you are trying to keep roughly the same cost risk
level in the incentive arrangement while trying to correct an aberrance, you may want to combine
methodologies to perhaps increase target price while reducing ceiling or flattening the share line
while reducing ceiling. While balancing all of these elements, don’t lose sight of the reason why
you chose to go with an FPIF arrangement in the first place – to incentivize the contractor to
control costs.

38
CON 270, Intermediate Cost and Price Analysis

Incentive Contract Modifications


We will conclude our coverage of the basics of incentive contracting with a discussion of how to
modify these contracts when a change is necessary.

For Incentive Contracts, let’s focus in on changes executed under the authority of the Changes
clause. Although other modifications may and do take place under an Incentive Contract, most
affecting any changes to the incentive arrangement will more than likely be done under the
Changes clause.

39
CON 270, Intermediate Cost and Price Analysis

How do we handle pricing contract changes with Incentive Contracts? Do you include the
“changed” effort in the incentive arrangement or keep it outside of the arrangement? It depends.
If the changed work is very similar to what is currently under contract, you very well may want
to include that effort under the current incentive arrangement. If it is something different, yet
still in scope, you may set up a separate incentive arrangement for that effort. However, be
aware that it may be challenging to establish and may require significant effort to administer. If
the change is not related or something you specifically choose not to incentivize, you may want
to leave that effort out of the incentive arrangement and employ the contract type appropriate for
that changed effort.
When the work required by a contract is changed under the Changes clause of an incentive
contract -- either increased or decreased -- or when an equitable adjustment is authorized under
any other clause of the contract, adjustments may be made in the target cost, target fee/profit,
minimum fee, maximum fee, ceiling, or any or all of them as appropriate. This also means that
performance or schedule goals, the sharing rate or rates and the RIE/RCS may be adjusted as
appropriate.

40
CON 270, Intermediate Cost and Price Analysis

Change orders do not have to be subject to undefinitized contract action (UCA) requirements.
DFARS 217.7401(a)(3) specifically excludes engineering change proposals which, by definition
of the changes clause, are to be made within the scope and terms of the contract. But DFARS
217.7402 also states the contracting officer should apply the UCA requirements to changes under
the Changes clause to the maximum extent practicable. The UCA procedures at DFARS
217.7404-6(a) require the consideration of reduced cost risk for cost incurred before
definitization negotiations. The procedure for that application is found in the Weighted
Guidelines instructions at DFARS 215.404‐71‐3(d)(2). Note that the mandatory consideration in
the WGL is not limited to UCAs – it applies to any and all scenarios, including unpriced change
orders, where the accrual of actual costs is recognized before definitization of price.
For example, say you have a $10 million unpriced FPIF changes order that has incurred a large
percentage of the costs of the total effort prior to definitization. Negotiations would be limited to
any remaining effort and incentive elements. You would want to take into consideration the
reduced cost risk for any potential impacts to share lines or ceiling as well as targets for
establishing your negotiation positions.

41
CON 270, Intermediate Cost and Price Analysis

Relevant parts of the DFARS clauses are included below. It’s interesting to note that
consideration of reduced fee/profit for incurred costs is discussed three different times, yet the
GAO has found that Contracting Officers either are not complying and/or documenting their
contract files as to any consideration given.
217.7404-6 Allowable profit.
When the final price of a UCA is negotiated after a substantial portion of the required
performance has been completed, the head of the contracting activity shall ensure the profit
allowed reflects—
(a) Any reduced cost risk to the contractor for costs incurred during contract performance before
negotiation of the final price;
(b) The contractor's reduced cost risk for costs incurred during performance of the remainder of
the contract; and
(c) The requirements at 215.404-71-3(d)(2). The risk assessment shall be documented in the
contract file
215.404-71-3 Contract type risk and working capital adjustment.
(d) Evaluation criteria.
(2) Mandatory. The contracting officer shall assess the extent to which costs have been incurred
prior to definitization of the contract action (also see 217.7404-6(a) and 243.204-70-6). The
assessment shall include any reduced contractor risk on both the contract before definitization
and the remaining portion of the contract. When costs have been incurred prior to definitization,
generally regard the contract type risk to be in the low end of the designated range. If a
substantial portion of the costs have been incurred prior to definitization, the contracting officer
may assign a value as low as 0 percent, regardless of contract type.
243.204-70-6 Allowable profit.
When the final price of an unpriced change order is negotiated after a substantial portion of the
required performance has been completed, the head of the contracting activity shall ensure the
profit allowed reflects—
(a) Any reduced cost risk to the contractor for costs incurred during contract performance before
negotiation of the final price;
(b) The contractor's reduced cost risk for costs incurred during performance of the remainder of
the contract; and
(c) The extent to which costs have been incurred prior to definitization of the contract action (see
215.404-71-3 (d) (2)). The risk assessment shall be documented in the contract file.

42
CON 270, Intermediate Cost and Price Analysis

From the DOD and NASA Incentive Contracting Guide, Chapter IV:
There are many methods and approaches which can and are used in order to arrive at an
equitable adjustment to a contract. However, most changes will be done by either the Individual
Element method or the Severable Change method. While the Guide discusses four of these
techniques, it is suggested that any method which fits the particular situation is appropriate.
Further, while the coverage will indicate that some of the methods have more advantages and
fewer disadvantages than others, each has its particular application and, therefore, is the “most
preferred method” in that instance.”
The Constant-Dollar and Constant-Percentage Methods are used less frequently and are more
advanced in application. For greater detail on these two methods, see the Incentive Guide,
Chapter IV, Paragraph B, Cost Incentive Changes.
The four methods of making equitable adjustments to incentive contracts are:

a. Individual Element Adjustment Method -- i.e., determining the effect of the change on each
element such as target cost, target profit, and ceiling price individually. This method has also
been referred to as the “equitable adjustment” method. However -- and hopefully -- the
objective of any technique should be an equitable adjustment.

43
CON 270, Intermediate Cost and Price Analysis

b. The Constant-Dollar Method -- where the same dollar adjustment is applied to target,
maximum and minimum fee or profit and ceiling price.

c. The Constant-Percentage Method -- where the percentage of minimum and maximum fee or
the percentage of ceiling price over target cost is held constant.

d. The Severable Change Method -- where the change is isolated from the incentive provisions.
In effect, a separate agreement is reached on the change portion.

The Individual Element Adjustment

There are many circumstances where all of the elements of the incentive package should be
negotiated separately on their respective merits in arriving at the equitable adjustment for the
impact of the change in the procurement. This seems to apply especially where a high degree of
technical and/or cost uncertainty exists, a major change is involved, or where the degree of
uncertainty varies significantly from either the original contract or the changed portion. Even the
timing of the definitization of the change can have a direct impact upon the amount of “risk” or

44
CON 270, Intermediate Cost and Price Analysis

uncertainty involved, which would suggest that the equitable adjustment for ceiling price be
something other than the exact figure -- or percentages thereof -- negotiated at target cost or
where the adjustment to maximum and minimum fee should always be to the same dollar or the
same percentage adjustment. The effect of the change on ceiling price may be either greater or
less than the predicted effect of the portion of the original contract deleted. To the degree to
which this can be determined, it should be reflected in the equitable adjustment. The Individual
Element Adjustment Method is appropriate for these circumstances. Its greatest advantage is in
this flexibility to tailor the compensation to the effect of the change on each element of the
arrangement. It does require, however, greater effort to evaluate the effect of the change on each
element and may involve more negotiation time as a result.

The Severable Change Method


This method is appropriate in those unusual situations where the changed effort can be separated
from the incentive structure and treated as a separate arrangement. The primary prerequisite for
the use of this method is the Government’s ability to assure that the costs can be isolated from
the incentive contract (e.g. through a subcontract or a separate cost or profit center).

The practical application of this technique is where the changed effort dictates a completely
different pricing provision from the basic incentive contract. For example, where the basic
contract is CPIF but the change can be priced on an FFP basis. Or the basic contract is FPI and

45
CON 270, Intermediate Cost and Price Analysis

the uncertainties of the changed effort strongly suggest a CPFF arrangement. Under these
circumstances, taking the change “outside” of the incentive structure can protect the integrity of
the original agreement and facilitate the negotiation of a meaningful and equitable adjustment for
the change.

It appears that the severable change method is most appropriate where the uncertainties
introduced by the change would substantially alter the original contract cost/performance (trade-
off) ratio.

Again, it is vitally important that the cost incurred for the effort be traceable if the technique is to
be used.

You may certainly make other changes to an Incentive contract that might affect the incentive
elements. Guidance is provided at FAR 52.216-16 -- Incentive Price Revision -- Firm Target,
Subpart (k), Equitable adjustment under other clauses. “If an equitable adjustment in the
contract price is made under any other clause of this contract before the total final price is
established, the adjustment shall be made in the total target cost and may be made in the
maximum dollar limit on the total final price, the total target profit, or both. If the adjustment is
made after the total final price is established, only the total final price shall be adjusted.”

46
CON 270, Intermediate Cost and Price Analysis

SECTION II – POLICY AND DEEPER EXPLORATION

Policy/Guidance
Let’s begin our survey of policy by reading Dr Carter’s (at that time USD/AT&L) Sep 14, 2010
memo on Better Buying Power with respect to increased use of FPIF contracts and complete the
following questions. The memo may be found in the Student Reference Guide and provides
answers to the below questions:
Read Dr. Carter’s SEP 14 2010 memo with respect to Increase the use of FPIF and complete the
following:
Dr. Carter has mandated the use of FPIF contracts - true or false?
Dr. Carter has suggested the use of the FPIF contract when program managers might have
historically chosen between what two “extreme” contract types? ______ _____ and _____ _____
_______ _____
What specific types of acquisition has Dr. Carter suggested consideration of the FPIF contract
type? _____ ________ and _____ - _____ _________
When considering contract type, Dr. Carter states that one size ______ _______ fit all.
What does Dr. Carter state shall be used as the metric for success of this measure? ______
________ ____ _______ ____ ____ ______

So the general policy does not mandate the use of any type of contract, the policy just wants the
practitioner to consider the use of incentives where it makes sense.

Now read the regulatory guidance in the Student Reference Guide found at FAR 16.103(d),
DFARS 216.403-1 and associated PGI and answer the following questions:

Considering the requirements of FAR 16.103(d), what would you consider to be the preferred
contract type implied by FAR? _______ - ______-_______.
With DFARS PGI 216.403-1, PCO’s shall give particular consideration to _____, especially for
______ _____ __________ __ _________.

Under DFARS 216.403-1(b)(2), PCO’s shall pay attention to _____ ____ and ______. Though
not a default as stated in the interim rule, a ___/___ share ratio and _____ % ceiling are a _____
___ ________.

47
CON 270, Intermediate Cost and Price Analysis

Per the above PGI, FPI should also be considered on production programs where actual costs on
prior FFP contracts have varied by more than __ % from considered negotiated.

The PGI reminds COs that actual costs on prior contracts for the same item are obtainable under
TINA, ___________ of contract type.

According to the PGI – risk is too often evaluated only in _______ _______ without attempting
to _________ the risk.
Per the PGI, equally important to the 50/50 share is determining that there is a _____
__________ of the contractor being able to accomplish the effort within the ceiling price.

The reference to FAR 16 is brought up here to highlight that, notwithstanding the current focus
on FPIF, the FAR would still seem to consider a Firm Fixed Price contract to be desirable as it
would require less justification to use than other contract types, including the so called incentive
types.
The relevant PGI provides some additional insight that the FPIF can/should be considered in
other situations other than those specifically mentioned in Dr Carter’s original initiative memo.
The initiative memo specifically mentions using the 50/50, 120% FPIF when moving from
development to initial production, but the PGI notes that it apparently is being used perhaps on
more mature programs when, for whatever reason, an FFP didn’t work out so well. Thus we see
a suggestion that if costs varied by more than 4% under an FFP then you should consider a
50/50, 120% FPIF in this situation as well.
It may be that negotiators of FFP contracts have not been leveraging their access to contractor’s
cost data using the TINA statute to obtain better deals. This might explain the reference that this
data is available to the government regardless of the predecessor contract type. Indeed, some
might consider the FPIF as an intermediate contract type to get access to cost data so that it can
be used on a follow-on negotiation of a FFP contract. The fact of the matter is that you need not
have an FPIF contract to get access to the contractor’s cost performance data. Under TINA, the
government’s buyers have access to the contractor’s cost in performing any predecessor contract
in the negotiation of the current pending contract – even if that predecessor contract is FFP.
The last two fill-ins above serve to draw the connection between this lesson on incentive
contracts with the prior lesson on quantitative risk analysis. Indeed, this PGI is extremely
important in dispelling a popular idea that all one needs to do is take any point estimated
objective to establish target cost, do a Weighted Guidelines (WGL) to determine target profit,
draw a 50/50 through that point and extend it to a ceiling price line determined by taking 120%
of target cost. We will see how this works out in a future exercise. However, the PGI clearly
mandates that a quantitative, not subjective, risk analysis be performed because - equally
important to the 50/50 is the determination that there is a “high probability” of the
contractor being able to accomplish the effort within the ceiling price.

48
CON 270, Intermediate Cost and Price Analysis

The original 14 September 2010 BBPi memo stated: “A 50/50 share line should represent a point
where the estimate is deemed equally likely to be too low or too high.”
The associated PGI explained the point or estimate being referred to in the BBPi memo is a
reference to the target cost. Thus it even further appeared to try and link the establishment of the
target at the 50th percentile cost probability - point where the estimate is deemed equally likely to
be too low or too high. But the PGI also continues to go on to say, for all intents and purposes -
that it then also necessarily follows that the share line would/should also be 50/50.
See, for example, the PGI provides - “(3) Analyzing risk. (i) Quantification of risk. (A) The
first step is establishing a target cost for which the probability of an underrun and overrun are
considered equal and therefore, the risks and rewards are shared equally, hence the 50/50 share is
the point of departure .” [PGI 216.403-1(3)(i)(A)]
As you will see later in this lesson, the approach taken in this course to determine the share line
is to follow the lead of Chapter III, Cost Incentives, in the 1969 Incentive Contracting Guide.
There the share line is simply the ratio between the Profit or Fee Pool to the Range of Incentive
Effectiveness (RIE) to generate the Contractor Share (KS). The RIE/RCS will come from the
Risk Analysis mandated by the PGI, and the Profit or Fee Pool will come from the mandatory

49
CON 270, Intermediate Cost and Price Analysis

consideration of the Weighted Guidelines [DFARS 215.404-4(c)(2)(D)] combined with other


considerations (judgment) regarding rewards - considering desired policy and/or other program
outcomes. Consequently, as is also being noted in the current policy pronouncements, these will
be determined on a case by case basis.
Thus, to introduce the concept of “Why 50/50”, we return to Dr Carter’s Memo. The original
BBPi pronouncement encouraging consideration of the FPI made note of the conditions
responsible for the suggestion of using 50/50 – that there is another alternative to only using
either CPFF/CPAF or FFP when you get into production. Since the CPFF represents a 100/0
share, and the FFP a 0/100 share, the treatment here suggests that the 50/50 share line should be
a good point of departure since it would evenly split the risk between the government and
contractor when compared to the CPFF and FFP alternatives.
Beyond just presenting the 50/50 as a fair compromise between a CPFF and FFP across the
entire range of cost outcomes both below and above target, the slide also shows the buyer and
seller preferences which can lead to split share lines. Split share lines are when the arrangement
has one share ratio below target and another above target.
A Little More on Risk
Continuing with DFARS PGI 216.403-3(i), “Quantification of risk”, the techniques described in
-3(ii) – 3(iv), go more toward “dollarizing” risk than statistically quantifying it. We will discuss
these immediately below. Employing these techniques satisfies the imperative in the PGI that
risk analysis be performed. However, we will be demonstrating later in this chapter how to
determine probabilities of underrunning certain price positions by statistically quantifying the
risk and using the results in our incentive arrangement analysis.

50
CON 270, Intermediate Cost and Price Analysis

“(A) In many prime contractors’ contracts, a substantial amount of risk is borne by


subcontractors, not the prime contractor, via negotiated firm-fixed-price (FFP) subcontracts. In
the case of FFP subcontracts, the subcontractor is obligated to deliver at the negotiated price. The
risk to the prime contractor is the supplier’s failure to perform or perform on time. Generally,
that risk is considered to be low by both the prime and the subcontractor as evidenced by the FFP
contract type. In addition, the prime contractor will normally have priced effort for material
management or subcontract administration to ensure timely performance on the part of the
suppliers. This effort may be bid directly or indirectly (e.g., as part of an overhead expense)
depending on the contractor’s accounting practices.
“(B) The impact of negotiated FFP subcontracts on the prime contractor’s risk can be significant.
A prime contract with a 120 percent ceiling price provides overrun protection to the prime
contractor equal to 20 percent of the target cost on the contract. However, if FFP subcontracts
represent half of the total contract cost, then half of the target cost is subject to little or no cost
risk on the part of the prime contractor. Therefore, the overrun protection provided by 20 percent
of the target cost is really closer to 40 percent protection of the prime’s cost that is truly at risk to
the prime contractor, which likely is significantly overstated. Thus, a ceiling price less than 120
percent in this risk situation would be more appropriate.
“(C) For subcontracts that have not yet been negotiated between the prime and subcontractor at
the time of negotiation of the prime contract, the degree of risk is essentially limited to the
difference between the price proposed by the subcontractor and the subcontract value included in
the prime contractor’s proposal.“(D) For subcontracts that are not FFP, the risk to the prime is
based on the risk represented by the subcontractors’ contractual relationship with the prime. If
the subcontract is FPIF and has a 50/50 share ratio and 120 percent ceiling, the prime’s risk is 50
percent of each dollar of overrun up to the ceiling amount. An analysis of the subcontractor’s
risk would be necessary to determine the probability of reaching the ceiling price.”
“(D) For subcontracts that are not FFP, the risk to the prime is based on the risk represented by
the subcontractors’ contractual relationship with the prime. If the subcontract is FPIF and has a
50/50 share ratio and 120 percent ceiling, the prime’s risk is 50 percent of each dollar of overrun
up to the ceiling amount. An analysis of the subcontractor’s risk would be necessary to determine
the probability of reaching the ceiling price.”

51
CON 270, Intermediate Cost and Price Analysis

DFARS PGI 216.403-3(iii) Direct labor cost and risk.


“(A) The risk in direct labor is in the hours needed to perform the effort and the risk in the labor
rates paid to employees. There is generally little risk in the direct labor rates. However, there are
various levels of risk in the direct labor hours needed by the prime contractor to accomplish the
contract requirements. This risk can be driven by a number of factors including technical
complexity, schedule constraints, or availability of personnel, parts, or tooling. Risks vary by
task and the key is to identify the major tasks and assess the “what if” impact at the total contract
cost level.

“(B) Schedule is often correctly cited as a risk factor, but it is important to understand and
quantify the probability and impact of a potential schedule slip. Generally, any schedule slip can
only affect the prime contractor’s in-house cost. Therefore, any schedule impact should be
assessed on the impact it would have on the prime contractor’s performance of its tasks.

“(C) However, it is wrong to assume the worst-case scenario that a schedule delay results in an
extension of the entire prime contractor workforce for the period of the delay. A responsible
contractor will take steps to minimize both the delay and the impact of that delay. For instance, a
production schedule assumes an optimal sequencing of tasks which presumes the timely arrival
and availability of parts from suppliers or other in-house sources. A delay in receiving parts as
planned could require a resequencing of tasks and could adversely affect the efficiency of
performing a number of tasks, but it will not cause the entire workforce to be idle during the
delay.”

52
CON 270, Intermediate Cost and Price Analysis

DFARS PGI 216.403-3(iv) Indirect (e.g., overhead) cost and risk.


“Overhead and other indirect costs (e.g., general and administrative expense) can represent a
significant portion of the prime contractor’s in-house cost. Indirect expense (hereafter referred to
as overhead) poses potential cost growth risk or the opportunity for cost reduction from the
following two perspectives:
“(A) Actual overhead rate. (1) First, the actual overhead rate could be different than that
proposed. Proposed overhead rates, even those covered by a forward pricing rate agreement, are
based on forecasts of overhead expenses and the bases to which they are applied. The final
overhead rate that is actually applied (charged) to a contract will be based on the actual overhead
expenses and the actual base, each of which could be considerably different than estimated. The
net effect could be a higher or lower overhead rate than estimated.
“(2) In general, the risk in an overhead rate tends to be driven more by fluctuations in the base
than in the expenses. This is because overhead expenses are made up of expenses that consist of
“fixed” (e.g., depreciation) and variable (e.g., fringe benefits) in nature. When the actual base
turns out to be lower than the estimated base, the fixed costs are spread over a smaller base
resulting in a higher overhead rate. In general, if the actual base is greater than estimated, a lower
overhead rate will result.
“(3) In assessing this risk, the contracting officer should consider the contractor’s ability to
predict overhead rates based on comparing proposed versus actual rates for prior years. In
making this comparison, it is important to do so in a manner consistent with the proposal being
reviewed. For instance, if the majority of overhead costs on the proposal being reviewed occur
two years in the future, the comparison should look at the contractor’s accuracy in predicting
overhead rates two years in advance. For example, in looking at the 2009 actual overhead rate,
what did the contractor propose for 2009 in its 2007 forward pricing rate proposal?
“(B) Actual base cost. If the actual base cost on the contract (e.g., direct labor dollars) is different
than that proposed, the contract will be charged overhead costs according to the actual base costs
on that contract. If the contractor overruns direct labor, even if the actual labor overhead rate was
the same as proposed, that rate would be applied to a higher base resulting in increased overhead
dollars on that contract. The opposite would be true if the contractor underruns direct labor on
the contract. Since this aspect of risk is tied to the base cost on the contract, the risk is the same
as it is for those base costs (e.g., direct labor, material).”

53
CON 270, Intermediate Cost and Price Analysis

Implications of Overly Generous Share Lines


At this junction we draw attention to Robert Antonio’s article appearing at the end of the Student
Reference Guide. Mr Antonio provided permission to use his article provided we note he is the
owner of the website Where in Federal Contracting.
The article describes FPIF contracts with share lines that, when graphed, were so flat that they
might be confused with a CPFF contract. If you combine the flat share line with a very generous
ceiling line, perhaps also consider a special billing arrangement such as fully burdened labor rate
paid for hours incurred as found on T&M or labor hour contracts, you may have a situation
where there is no real need to “finalize” the contract. Thus it would be very much more like a
T&M or labor hour contract even though the term Fixed Price Incentive Firm Target would
appear on its cover.

54
CON 270, Intermediate Cost and Price Analysis

Thus we might also consider the suggestion that we consider more aggressive share lines, such as
a 50/50 share line, to perhaps be a reaction to move away from the flat share line incentive
contracts observed by Gordon Rule or those described above. The share line shown above with
the FPIF contract would perhaps be a 90/10 or even flatter 95/5.

55
CON 270, Intermediate Cost and Price Analysis

Incentive Share Line Concepts


Realism - Some lower level of costs below which a cost outcome is just unrealistic, or
perhaps even undesirable.
For example, under a competitive cost reimbursable acquisition the Government is guarded
about a proposed cost being too low and thus requires a Cost Realism Analysis [FAR 15.404-
1(d)].
This is equivalent to the “Optimistic Cost” estimate used in the Contract Pricing Reference
Guides (CPRG).
Reasonableness - Some higher level of costs beyond which a cost outcome is just
unreasonable when considering some measure of reasonable efficiency and economy.
For example, when competition is not present and the value exceeds the TINA threshold to
require certified cost and pricing data, the Government mandates a Cost Analysis be performed
[FAR 15.404-1(c)].
At even higher levels of (reasonable) costs, this is equivalent to the “Pessimistic Cost” used in
the CPRG.
Range of Incentive Effectiveness (RIE) or Range of Cost Sharing (RCS) - Some
range of Realistic/Reasonable cost outcomes.
As described in the CPRG – the difference between Optimistic and Pessimistic Cost.
The range of cost outcomes over which the contract contemplates the sharing of some pool of
profit or fee.
Incentive Profit/Fee Reward Pool - The amount of profit or fee available to the
contractor depending upon potential cost outcomes over the RIE.
As described in the CPRG – the difference in profit/fee available at the Optimistic and
Pessimistic Cost.
Share Lines - Represents the change in contractor profit or fee based on variations in
performance cost over the RIE.
Slope (profit/fee reward pool ÷ RIE) is “Contractor’s Share” of increase or decrease in
performance cost.
Represented where first number is the Government Share and second the Contractor’s Share –
e.g. 70/30 where Government Share is 70% and Contractor is 30%. Values are complementary;
70%+30%=100%.

56
CON 270, Intermediate Cost and Price Analysis

The following series of graphs and fill in the blanks help demonstrate the relationship between
RIE/RCS and Fee/Profit (Award Pool) and how that relationship determines share line. You will
see that the Contractor Share will be equal to Award Pool divided by RIE/RCS. Once you have
the contractor share, the government share is simply 1 – contractor share.

57
CON 270, Intermediate Cost and Price Analysis

58
CON 270, Intermediate Cost and Price Analysis

59
CON 270, Intermediate Cost and Price Analysis

5
4
3
2
1
0
1
5
4
3
2
1
0
1

5
4
3
2
1
0
1

5
4
3
2
1
0
1

60
CON 270, Intermediate Cost and Price Analysis

Essentially, one size does not fit all. It starts with a risk analysis determining the range of
incentive effectiveness or the range of (rational) cost sharing. Wider ranges indicate more cost
risk which will necessarily tend to flatten the share line unless a conscious decision is made to
put greater rewards out there to reduce cost.
But one of the reasons there might be high variability in the cost analysis showing more cost risk
is that there may very well be a high degree of technical uncertainty. In that case, as suggested
by the 1969 Guide, one should not be considering an FPIF, but a CPIF. Of course one could
make even a CPIF share line steeper simply by adding more rewards to reduce costs. But with
high technical uncertainty, is cost reduction really what you want to motivate the contractor to
pursue? If one places higher rewards to reduce costs, other program objectives might take a back
seat. This cost/performance incentive trade off will be explored more when we add performance
incentives later in this lesson.

61
CON 270, Intermediate Cost and Price Analysis

SECTION III - COMPARATIVE ANALYSIS

Practical Exercise
The next few slides will take us through a four part exercise that demonstrates certain
implications of the DOD Incentive policy. We will be utilizing a “Target Centric” approach
known at Structuring Technique #2 in the DoD/NASA Incentive Contracting Guide. With this
technique, we negotiate target cost, target profit, ceiling price and share ratio individually but
base final negotiation upon simultaneous agreement of all elements of the price. We will use the
objective ACME proposal numbers from last week for the exercise. The ACME objective will
be used as the target cost.

62
CON 270, Intermediate Cost and Price Analysis

63
CON 270, Intermediate Cost and Price Analysis

Power Point build slides are available at the end of the exercise on page 68.

64
Part 1

Profit $ in Thousands (FPIF)


(Loss)

800

600

400

65
200

-0-

(200)

(400)

Cost 5,000 5,400 5,800 6,200 6,600 7,000


5,200 5,600 6,000 6,400 6,800
CON 270, Intermediate Cost and Price Analysis
CON 270, Intermediate Cost and Price Analysis

66
Part 2

Profit $ in Thousands (FPIF)


(Loss)

800

600

400

67
200

-0-

(200)

(400)

Cost 5,000 5,400 5,800 6,200 6,600 7,000


5,200 5,600 6,000 6,400 6,800
CON 270, Intermediate Cost and Price Analysis
CON 270, Intermediate Cost and Price Analysis

A Z Table and Notes Page follow to solve Parts III and IV of the exercise.

01-ACME PART 02_ACME PART 03_ACME Ceiling


1.ppsx 2.ppsx Test_PTA.ppsx

04_ACME Ceiling 05-ACME


Test_PTA_cont.ppsx Ceiling.ppsx

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CON 270, Intermediate Cost and Price Analysis

The Standard Normal Distribution (Z Table)

The Standard Normal Distribution (Z Table)


z .00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.00 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
0.10 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.20 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.30 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.40 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.50 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224

0.60 .2257 .2291 .2324 .2357 .2389 .2422 .2454 .2486 .2517 .2549
0.70 .2580 .2611 .2642 .2673 .2704 .2734 .2764 .2794 .2823 .2852
0.80 .2881 .2910 .2939 .2967 .2995 .3023 .3051 .3078 .3106 .3133
0.90 .3159 .3186 .3212 .3238 .3264 .3289 .3315 .3340 .3365 .3389
1.00 .3413 .3438 .3461 .3485 .3508 .3531 .3554 .3577 .3599 .3621

1.10 .3643 .3665 .3686 .3708 .3729 .3749 .3770 .3790 .3810 .3830
1.20 .3849 .3869 .3888 .3907 .3925 .3944 .3962 .3980 .3997 .4015
1.30 .4032 .4049 .4066 .4082 .4099 .4115 .4131 .4147 .4162 .4177
1.40 .4192 .4207 .4222 .4236 .4251 .4265 .4279 .4292 .4306 .4319
1.50 .4332 .4345 .4357 .4370 .4382 .4394 .4406 .4418 .4429 .4441

1.60 .4452 .4463 .4474 .4484 .4495 .4505 .4515 .4525 .4535 .4545
1.70 .4554 .4564 .4573 .4582 .4591 .4599 .4608 .4616 .4625 .4633
1.80 .4641 .4649 .4656 .4664 .4671 .4678 .4686 .4693 .4699 .4706
1.90 .4713 .4719 .4726 .4732 .4738 .4744 .4750 .4756 .4761 .4767
2.00 .4772 .4778 .4783 .4788 .4793 .4798 .4803 .4808 .4812 .4817

2.10 .4821 .4826 .4830 .4834 .4838 .4842 .4846 .4850 .4854 .4857
2.20 .4861 .4864 .4868 .4871 .4875 .4878 .4881 .4884 .4887 .4890
2.30 .4893 .4896 .4898 .4901 .4904 .4906 .4909 .4911 .4913 .4916
2.40 .4918 .4920 .4922 .4925 .4927 .4929 .4931 .4932 .4934 .4936
2.50 .4938 .4940 .4941 .4943 .4945 .4946 .4948 .4949 .4951 .4952

2.60 .4953 .4955 .4956 .4957 .4959 .4960 .4961 .4962 .4963 .4964
2.70 .4965 .4966 .4967 .4968 .4969 .4970 .4971 .4972 .4973 .4974
2.80 .4974 .4975 .4976 .4977 .4977 .4978 .4979 .4979 .4980 .4981
2.90 .4981 .4982 .4982 .4983 .4984 .4984 .4985 .4985 .4986 .4986
3.00 .4987 .4987 .4987 .4988 .4988 .4989 .4989 .4989 .4990 .4990

Use the following Notes Pages for work area.

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Notes Page

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Integration of Cost Risk and Reward Pool (Profit/Fee)

Building upon our share line concepts, we see that share lines are simply communicating the
results of our Cost Risk and Rewards analysis where the contractor’s share percentage (KS) is
the Reward Pool (RP) divided by the Range of Incentive Effectiveness (RIE)/Range of Cost
Sharing (RCS).

RP
𝐾𝑆 =
RIE or RCS

The RP decision involves determining how much incentive (emphasis) the Government wants to
put on cost versus other desirable (perhaps competing) outcomes. The larger the pool considered
appropriate, the more reward is provided for the contractor to control cost. This gets
communicated in the share line. For any given RCS, a larger RP will result in higher KS
percentages in the share line.
The RIE/RCS decision, while involving a subjective decision of how much risk the Government
should share with the contractor, is primarily a function of the risk distribution which will be
detected with a quantitative risk analysis. Suppose it is considered that the Government should
share 80% of the cost risk from the 10th to the 90th percentile. When applied to riskier programs
having a wider cost distribution, this will result in a wider RCS, and lower KS, than it would for
a less risky program. Thus riskier programs will have flatter share lines than those with less risk.
If the greater risk is due to technical risk, then the contract type should perhaps be changed from
FPIF to CPIF.
Let’s take a look at Structuring Technique #1 from the DOD/NASA Guide which utilizes the
above method of determining contractor share (KS) and hence contract share ratio(s). This
technique also focuses on the relationship of Ceiling to Target instead of focusing primarily on
the Target Cost as in Structuring Technique #2.

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We will now explore the methodology to construct a “Ceiling Centric” FPIF arrangement using
the DOD/NASA Guide Structuring Technique #1 information that starts on Page 71 of that
Guide.

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Notes Page

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The steps on the following slides above are coordinated with the linked PowerPoint slide that
builds in step by step fashion.
In Step 1, we are establishing our “pessimistic” cost using the “High” value from a traditional 3-
point “Low, Most Likely, High” risk analysis; or perhaps from a more robust risk analysis
employing a symmetric approximation or Monte Carlo risk analysis. In this example, we are
using $130M as the “High” cost point/Pessimistic cost.
In Step 2, we want to determine a profit percentage/amount at that Pessimistic cost. This
“nominal” or “pessimistic” profit may be determined by a discussion between you and your
customer, i.e. program manager as to what profit seems reasonable at that level of cost risk
(considered a best practice), or you might simply use 2% or 3% of target cost using the standard
profit amounts used on CPAF contracts (we’ll use approximately 3% in our example). Once the
pessimistic profit is determined and added to the pessimistic cost, the ceiling price is established.
In Step 3, we use the 120% ceiling criteria to determine the target cost at $110.8M (Ceiling price
of $133M divided by 120%).
In Step 4, we establish the target profit of $12.2 million at 11% of target cost. This profit
percentage, used for demonstration purposes only, is reasonable based on using reasonable risk
factors from the weighted guidelines form for a fixed-price incentive contract.
In Step 5, we establish the range of cost sharing (RCS) by subtracting our target cost from our
pessimistic cost leaving $19.2M. As you can see in the build slide, we can now draw our share
line by connecting the target price point with the PTA
In Step 6, to precisely calculate the Contractor Share (KS), you will take Reward Pool (RP)
divided by RCS. To determine the RP, take the total target profit of $12.2M and subtract the
$3M nominal profit amount. This leaves a reward pool of $9.2M. You have to subtract the
nominal profit from the target cost to leave $3M available as the pessimistic profit when
and if the pessimistic cost point is reached.
In Step 7, the RCS has already been determined to be $19.2M. The quotient of 9.2/19.2 is .48 or
48% for the KS. This yields a share ratio of 52/48. Although this does not meet the 50/50
recommended point of departure for share lines, we have limited the liability of the Government
to the ceiling price at 120% of target cost and at 11% profit are pretty close to the 50/50.
To make the share line 50/50, you could increase target profit by $400K to $9.6M. But do you
want to give them an additional $400K to pursue at that 50/50 share line? That’s a decision best
discussed between you and your customer, but you now have the right information to give your
customer to aid them in making an informed decision.
Instead of adding to target profit, could you reduce nominal (pessimistic) profit by $400K to
$2.6M and get the same share ratio? The answer is no and the explanation is best understood by
analyzing the geometry of the arrangement. If you reduce nominal profit aren’t you also
reducing the ceiling of 120% and the PTA? (Remember that ceiling price is equal to pessimistic
cost plus pessimistic (nominal) profit. Will this not also affect your overrun share line by
steepening it, perhaps well past 50/50?

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Key Learning Point: The geometry of an FPIF arrangement has interdependencies. The share
lines, target price, and ceiling are all interrelated. The target price becomes a pivot point about
which the share lines can change slopes to reflect sharing of risk between the government and
contractor in both an overrun and underrun. The flatter the slope, the greater the cost risk being
borne by the government; the steeper the slope, the greater cost risk is being borne by the
contractor. The ceiling price in our geometry acts as an anchor to limit the government’s cost
liability. However, if you reduce ceiling, by definition you are reducing either pessimistic cost or
pessimistic (nominal) profit (or perhaps some combination of both). This will have the effect of
steepening the overrun share line. When you negotiate an FPIF arrangement you have to be
aware of these interdependencies - one more reason to graph these arrangements. Although
current policy recommends using a 50/50 share line and 120% ceiling as a “point of departure”,
the overall strategy is to develop an incentive arrangement that has equitability in the sharing of
risks while providing the greatest incentive for containing costs.

A Ceiling Centric
Approach.ppsx

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$ In Millions A Ceiling Centric Approach Steps #1 thru #5


30
Profit
(Loss)
20

78
10
-0-
(10)
Cost 80 90 100 110 120 130 140
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This is quoted from Page 72 of the DOD/NASA Incentive Guide. Although we did blend in the
120% ceiling to try to comply with the recommended point of departure, we have determined the
share lines based upon the PTA and Target price, not arbitrary percentage factors. Reliance on
arbitrary percentage factors is a potential drawback of Structuring Technique #2.

Let’s now turn to an Acquisition Planning exercise that utilizes quantitative risk analysis to help
determine the incentive geometry of that acquisition.

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01_ACQUISITION 02_ACQUISITION
PLANNING EXERCISE.ppsx
PLANNING EXERCISE.ppsx

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When planning for a new contract, it’s necessary give consideration to contract types and special
terms and conditions.
During this planning stage, we should be asking ourselves –
- Will the contract type and standard clauses satisfy our requirements?
- Okay, we have established our minimum requirements (such as the delivery dates) but is
there a desire (not necessarily a need) to obtain earlier deliveries?
-- Is there a potential savings to the Gov’t if the contractor could deliver six months early?
It is prudent on our part to give consideration to what’s important to the Government, what’s
important to the contractor, and is it possible to satisfy both in a win-win outcome?
We need to keep in mind, particularly with Fixed Price contracts, what is being required by the
contract. The cost to perform the requirements of the contract must be included in the target
cost.

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Gift incentives are those where there is already a basic requirement to accomplish the task being
incentivized. These costs/compensation are, or should, already be included in the target cost and
ceiling price.
The following slides go to answering the idea that the incentive (or what we would call the
reward or bounty) must be large enough to motivate the contractor to perform the incentive. We
will attempt to evaluate or determine that minimum amount to motivate the contractor in the face
of the cost incentive expressed in the share line for which they will have to make trade off
decisions.
The slides will also go to the idea of what the total cost to the government is when placing the
incentive on the contract – considering not just the reward or bounty price specifically placed in
the contract for the behavior being incentivized, but also the governments sharing of the
contractor’s cost to pursue that incentive under the share line on the contract.

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The key formula in determining the incentive value is:


Incentive Value ≥ Cost to Pursue × Contractor Share (KS)
For the greater than/equals term, the equals part of the formula would strictly be an estimated
“break even” for the contractor. The Government in all likelihood would have to increase the
value to motivate the contractor to pursue accomplishment of the incentive. Coming up with the
“cost to pursue”, how much in dollars it would take to achieve the incentive, tends to be the
difficult part of this effort. One would/could get this figure through the assistance of the
technical or program office evaluation. Indeed, this would/could have been considered when the
market research was performed to help shape the requirement to begin with during the
acquisition planning process. Also, these values may have been requested from the contractor as
rough order of magnitude or “ROM” estimates as the program officer engineers and/or users
were/are perhaps continuing to work out the final, firm contract requirements.

Multiple
Incentive_1.ppsx

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Multiple
Incentive_2.ppsx

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This slide represents a situation where the contract is awarded up front with a split share ratio
where performance incentives were intentionally valued in the contract with rewards, or
bounties, that exceeded the minimum value to pursue under the flat share 80/20 line but below
the minimum value to pursue under the steep 50/50 share line. Such a structure might be crafted
to have the contractor pursue the performance incentive only if they would be under running the
contract.
The contractor WOULD PURSUE the performance incentive if they are currently underruning
they would see a net GAIN of $100,000
 They would receive the $500,000 performance incentive, but,
 The $2M additional cost to achieve the incentive, a cost that they otherwise would not
have incurred, would cause them to lose $400,000 in profit . . . . $2M X 20% (the KS on
the 80/20 under target share line)
The contractor WOULD NOT PURSUE the performance incentive if they are currently
overrunning – they would see a net LOSS $500,000
 They would receive the $500,000 performance incentive, but . . .
 The $2M additional cost to achieve the incentive, a cost that they otherwise would not
have incurred, would cause them to lose $1,000,000 in profit . . . .
$2M X 50% (the KS on the 50/50 over target share line)

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The $2M additional cost to achieve the incentive, a cost that they otherwise would not have
incurred, would cause them to lose $1,000,000 in profit . . . . $2M X 50% (the KS on the 50/50
over target share line)

In the above example it would be rational for a contractor to pursue this incentive if they are
operating under the basic contract at or just above the RIE (lower). The net gain for them pursuing
the performance incentive would be $100,000 after considering the fee they would lose,
$400,000, while spending the $2M in cost to win the incentive prize of $500,000.
On the other hand, if they were operating at or about target cost performing the basic contract
requirement, it would be irrational for them to pursue the performance incentive. If they did,
they would suffer a net loss in pursuing that incentive. The $500,000 prize for performing the
incentive would be more than offset by the $1,000,000 in lost fee, their 50% share of the $2M
spent in additional cost to pursue the incentive. The Net Loss in pursuing the incentive would be
$500,000 which would be an irrational decision in this range of cost under the basic cost
incentive.
But if the contractor was already at the RIE (higher) level of cost in performing the basic contract
requirement, they would be at the Minimum Fee, and there would be no fee to loose in pursuing
the incentive. They could spend as much as they wanted in additional cost and the Government

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would reimburse them 100% for those incurred costs. And as long as they were successful in
achieving the performance incentive, they would get the entire prize of $500,000 without taking
a reduction in their fee as a result of the overrun beyond the RIE (higher).
In the situation described immediately above where the contractor is operating beyond the RIE
(higher) to keep spending the Government’s money to chase the incentive without consequence to
decrease their own fee, we are clearly outside the Range of Incentive Effectiveness with respect
to cost control. Thus the restrictions of FAR 16.402-1(a) need to be applied – “No incentive
contract may provide for other incentives without also providing a cost incentive (or constraint).”
As a result, one should consider “cost limitation” language with these other incentives
(performance, schedule, etc.) placed on a CPIF contract that pays the incentive only if the
contractor performs the underlying CPIF contract within the RIE. Let’s say, for example, the
point at which the contractor reaches minimum fee [RIE(higher)], when expressed as a percentage
of Target Cost [i.e. RIE(higher) ÷ Target Cost], were to be 107%. One should consider limitation,
or constraint, language that would essentially provide that the incentive becomes null and void
(or otherwise not payable, even if the contractor successfully achieves the incentive) should the
contractor overrun target cost by 7% or more.

The following slide takes us through the process of establishing a performance incentive with a
cost limitation provision.
The FPI/CPI grapher may also be used to identify the overrun percentage where the cost
limitation needs to be established.

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You will now be guided through a series of 5 graphing exercises that will demonstrate what
happens to the incentive geometry (and the evaluation of offers) when various elements of the
geometry, such as share ratios, targets, and ceilings are either dictated or allowed to be proposed
by the competing contractors. In the first exercise, you will be evaluating three competing
offerors where the share ratio was dictated in the solicitation. Award will based upon (primarily)
target price. You will graph this first exercise to evaluate the offers. In the following four
exercises, for ease of demonstration, we will be comparing two competing offerors while
changing or dictating various elements of the incentive geometry and award criteria. You will
graph Part 2 but not be required to graph the three remaining exercises. The instructor will guide
you through these exercises while comparing and contrasting the offers based upon their
geometry. Powerpoint builds are provided for all of exercises.

Let’s consider that the acquisition planning team considered a 70/30 share line to appropriately
consider the cost risk analysis and balance the cost reward pool with other program objectives.
In response to stipulating the 70/30 share line in the solicitation, consider these three contractors
whose offers coincidentally quoted the same ceiling price, but different target prices. Highly
unlikely? Absolutely – at least in some respects.

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CON 270, Intermediate Cost and Price Analysis

Many solicitations are indeed specifying a share line in the solicitation. Could/should they let
the contractors be free to propose their own share lines? Of course they can, but many find
specifying the share line makes for a simpler and sustainable evaluation process.
Cost realism, which is a later lesson in CON 270, will be discussed to note that doing one on an
FPIF contract is not exactly addressed as a black and white issue in the FAR and the question is
not exactly “settled.” Discussions with some practitioners have found that if they could pursue a
more robust cost realism analysis, then perhaps they would consider allowing the contractors to
be free to bid their own share lines.
What is highly unlikely is that all three of these contractors would quote the exact same ceiling
price. Some acquisition locations will evaluate the cost to the government factor in source
selection by comparing the ceiling prices; others may evaluate the target prices which, in this
example are indeed different.
For this exercise, you may calculate final prices and profit using the process charts or you may
use the FPI/CPI Grapher. Then graph all three final price arrangements on the scaled graph
paper provided. Graph all three arrangements on the same graph.

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Three
Competing_Final Prices.ppsx

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Three Competing
Offers.ppsx

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CON 270, Intermediate Cost and Price Analysis

Even though each contractor proposed different targets, the punch line in this exercise is that all
three of these contractual arrangements are the same. Each one will result in exactly the same
final price, regardless of the actual final cost incurred.

But the
contractor who understands the DoD need only fund, at least at the onset, the target price as the
“most likely” price is motivated to bid the target cost, profit, and therefore target price very low
in an attempt to secure the award, particularly if the target price is stated to be the price that will
be used to evaluate the cost to the government factor.

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140
130
120
110
100
$ in Millions

Cost 80
(10)
20

10
(Loss)
Profit

Evaluating
Competing Offers_2.ppsx

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Evaluating
Competing Offers_3.ppsx

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Evaluating
Competing Offers_4.ppsx

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Evaluating
Competing Offers_5.ppsx

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Evaluating
Competing Offers_TakeAways.ppsx

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CON 270, Intermediate Cost and Price Analysis

PART IV – INTEGRATING CASE

Provided Under Separate Cover

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Conducting
Cost Realism

CON 270
Intermediate Cost & Price Analysis

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Note Page

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A Cost Realism Exercise


Aircraft Maintenance Repair and Overhaul (MRO)

You are being asked to put together an acquisition strategy and solicitation for the overhaul of
aircraft. Your project manager has already done market research to find there are a large
number of commercial, independent contractors in the maintenance, repair and overhaul (MRO)
industry that are willing to bid competitively on a firm fixed price basis on a schedule of aircraft
type and hours between overhauls.
Under the current administration there is a renewed emphasis on the use of fixed price
contracting in defense acquisition and, of course FASA legislation continues to provide a
preference to go commercial. While identifying multiple potential commercial sources, the
market research is somewhat light on commercial business practices other than to note there is
existing FAA oversight in this industry.

It just so happens you were watching a Frontline special on “Flying Cheaper” on PBS (that takes
18 minutes to watch) and now have some safety concerns should any competitor try to buy-in.
(http://www.pbs.org/wgbh/pages/frontline/flying-cheaper/) Your project manager has assured
you that the FAA certifications would/should satisfy your concerns. In addition, your contracting
officer has shared that a cost realism could be performed to normalize offers using a
Government Most Probable Cost (MPC) analysis so as to prevent any contractor from trying to
buy in. Evaluate these assurances within the context of what the FAR has to say about “cost
realism.”

Questions:

1. Can you plan to use “cost realism” as a routine evaluation at your local level?
2. On what basis might you be authorized to conduct a cost realism analysis on an
exceptional case on this acquisition?
3. Will you be able to normalize (adjust) any offer upwards to prevent awarding to a buy-in?
4. Assuming you receive permission to conduct cost realism as an exceptional case, how
might the results from the analysis be used?
5. What type of analysis will be required to sustain an assessment that any one offeror
submitting a very low price presents excessive performance risk?
6. What would be your assessment of a contractor being able to successfully overturn your
assessment of excessive performance risk based on a technical evaluation and cost
realism before the GAO should they otherwise be able to show current and complete
FAA certifications?
7. What type of analysis will be required to sustain an assessment that any one offeror
submitting a very low price is a responsibility risk?
8. Can you (or your group as result of brainstorming) think of any better alternatives than
relying on “cost realism” in this situation?

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CON 270, Intermediate Cost and Price Analysis

Most Probable Cost Estimate/Uncompensated Overtime Exercise


1. Performing a probable cost estimate is required by the FAR for which type of contract?
a. Cost-reimbursement.
b. Firm Fixed Price.
c. Time and Materials.
d. All of the above.
2. You have issued a RFP in anticipation of awarding a R&D services contract. The RFP
contemplates awarding a single cost-reimbursement contract. Three proposals were
received: Offeror 1 for $2.95M; Offeror 2 for $2.70M, and Offeror 3 for $2.85M The
Government’s MPC amount for Offeror 1 is $2.8M; Offeror 2 is $2.65M; and Offeror 3
is $2.72M. All proposals have been deemed technically acceptable. Based on the
information provided which Offeror would you award the contract to and why?
a. Offeror 1, since it had the highest proposal costs its technical proposal must be the
best.
b. None of the offerors because none of the proposals were exactly the same
as the Government’s MPC.
c. Offeror 2 because its proposal was technically acceptable, correlation between
its cost proposal and MPC was high, and it had the lowest most probable cost.
d. Instead of doing a separate MPC for each offeror, use one average MPC (of
$2.72M) in order to make a multi-award to all three offerors since all would now
be within range of the average MPC.
3. You are performing your proposal review and evaluation and discover that the
contractor has significant unrecorded uncompensated overtime. You can do all of the
following EXCEPT for:
a. Inform contractor representative and contracting officer of your findings.
b. Have DCAA review time records and conduct employee interviews.
c. If it is determined that indirect costs are not being equitably allocated
then cite contractor for non-compliance with FAR 31.201-4 and CAS 418.
d. Issue Stop-Work Order since it is obvious contractor is doing something criminal.
4. When it comes to considering the uncompensated overtime effect on cost realism,
the Fair Labor Standards Act (FLSA) exempts numerous labor categories such as:
a. Blue collar employees like welders, machine operators, assemblers, etc.
b. Managers and non-managers alike.
c. Administrative personnel only like secretaries and other office workers.
d. Executives, administrative, and professional workers to include accountants,
lawyers, etc.

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CON 270, Intermediate Cost and Price Analysis

COST REALISM
INDIVIDUAL ASSESSMENTS

PALE MAIL

5 Points (Questions 2 and 3 are worth two points and Question 1 is worth one
point)

Pale Laboratories issued a request for proposal (RFP) for “furnishing the necessary
management, personnel, facilities, and equipment, to provide mail distribution and
support services” for the laboratory complex. The RFP solicited offers on a cost-plus
incentive-fee contract, and offerors were informed that technical competence and cost
realism would be the primary factors considered in selecting the contractor.

Three proposals were received and found to be within the competitive range. Oral
discussions were held with all offerors during which pertinent technical and cost
questions were reviewed. Offerors were requested to furnish written responses to the
questions discussed. The total cost from each “Final Proposal Revision” for the basic
and option contract years is shown below:

Offeror Proposed Cost


United Mail $865,000
Northern, Inc. $841,000
Moka Services $891,000

The proposed costs do not appear to be realistic in all cases.

The Moka Services proposal contains $1,000 in contingencies for material that the RFP
clearly states will be furnished by the Government.

The Northern, Inc. proposal also appears to be unrealistic:

 Most wage classes required in the contract are covered by Service Contract Act
wage determinations. In four classes that are not covered (10 of 37 employees
on the contract), Northern proposed wages lower than those being paid by the
incumbent contractor, United Mail. Given the labor shortage in the area, it seems
unreasonable to expect employees to continue to work on the same job for lower
wages. Northern’s technical proposal stated that 80 percent of United’s
employees would continue to work on the contract. Wages appear to be
understated by $6,300.

 Northern’s proposal included NO premium for shift work because they contend
none is required under the contract. Government mail specialists, based on years

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CON 270, Intermediate Cost and Price Analysis

of experience, feel that shift work will be required. The necessary premium is estimated
at $1,000.

 No overtime premium was proposed for the senior clerk as required by the RFP.
Required overtime premium is estimated at $500.

 Northern proposed the same wage rates for the option years as for the basic
contract. Projected wage increases for employees not covered by the Service
Contract Act are estimated to be $29,700.

The United Mail proposal appears to be realistic in relation to its technical proposal.

1. How should you consider cost realism in evaluation of these proposals?

2. Assuming that the technical proposals are relatively equal, which firm would you
select for award? Note: Use all costs (large and small) provided when developing your
MPC. Show your math.

3. Document your decision by providing a short, written justification for your selection
from question 2.

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CON 270, Intermediate Cost and Price Analysis

Dream Home
5 Points (Questions 1 and 2 are worth two points and Question 3 is worth one
point)

You have decided to build your dream home. You have had an architect draw the plans
and you are now ready to solicit offers from builders. Since this is your dream home you
want the latitude to make changes during construction, however, you still want to
motivate the contractor to control costs so you have decide to negotiate a fixed-price
incentive contract.

After sending out the drawings you have received the following offers:

Builder Target Costs


Kentucky Homes $245,500
Ohio Cabins $235,000
Indiana Construction $205,000
American Concepts $150,000

Your estimate to build your dream house is $220,000.

All offers meet the technical specifications provided with the plans. The obvious low
offeror is American Concepts. Unfortunately, the proposed price appears totally
unrealistic.

1. Based only on the information presented above, what could lead American Concepts
to submit a proposal of $150,000?

2. What steps would you take in your proposal cost realism analysis?

3. Under what circumstances, would you consider an award to American Concepts?

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CON 270, Intermediate Cost and Price Analysis

SMYTHE ENTERPRISES
5 Points (Each question is worth 1.25 points)

Your organization issued a request for proposals (RFP) for a cost-plus-fixed-fee level of
effort contract to provide clerical support services. The RFP advised offerors that the
contract will be awarded to the offeror which submitted a technically acceptable offer that
provides the lowest evaluated cost for the total of the base year and four 1-year options.

To support your evaluation of contractor cost realism, the RFP required offerors to
submit cost or pricing data including: direct labor rates, other direct rates, indirect costs,
and escalation rates for proposed labor costs. The evaluation criteria specifically advised
offerors that the cost realism analysis of direct labor rates would consider the anticipated
changes in the direct labor rate over the four option years.

Seven proposals, including proposals from Smythe Enterprises and Ajax Associates,
were determined to be technically acceptable and were evaluated for cost realism. You
found that several offerors did not provide for escalation of labor costs during the option
years as required by the RFP. The low offeror, Smythe Enterprises, is one of the firms
that did not provide for inflation. The second low offeror, Ajax Associates, provided
approximately four percent escalation each year.

1. If you were going to adjust the Smythe proposal to consider increased labor costs,
how would you determine the amount of escalation that you should use?

2. Assume that you developed an estimate of most probable cost by increasing the
base-year wage rate by 3.5 percent per year and applying the contractor proposed
indirect rates to the increased bases. The results would be:

Smythe Enterprises Smythe Enterprises


Without Escalation With Escalation Ajax Associates

Base Year $500,000 $500,000 $480,000


Option 1 $500,000 $517,500 $499,200
Option 2 $500,000 $535,613 $519,168
Option 3 $500,000 $554,359 $539,935
Option 4 $500,000 $573,762 $561,532
Total $2,500,000 $2,681,234 $2,599,835

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CON 270, Intermediate Cost and Price Analysis

Smythe objects for two reasons:

A. Smythe claims that given today’s labor market, wage increases are
unnecessary. Your reply?

B. Smythe further claims that the escalation of wages rates was unreasonably
compounded by the unnecessary escalation of indirect costs. Labor overhead
rates are based on direct labor costs. The G&A Expense is based on total cost
input. Smythe claims that, if direct labor rates did increase, the rate bases
would increase and the rates would decline. Your reply?

3. What if anything could you have done to avoid these problems?

4. To which firm would you award the contract, if the Ajax and Smythe technical
proposals are comparable?

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CON 270, Intermediate Cost and Price Analysis

Notes Page

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CON 270, Intermediate Cost and Price Analysis

Pricing Equitable
Adjustments

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Intermediate Cost & Price Analysis

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CONRAD CORPORATION
The Conrad Corporation is a clothing manufacturer that won a sealed-bid contract to
produce uniforms for the Government. Now several months later, Conrad has
submitted a claim related to the Government’s failure to provide Government Furnished
Material (GFM). The following paragraphs outline contract events related to the claim:
October 20, 1998. A contract was awarded for production for 101,400 uniform coats.
The contract specifies that the Government will furnish the material required to produce
the outer shell of the required coats. GFM consumption was estimated at 2.4 yards per
coat for a total material usage of 243,360 yards. The contract called for the
Government to release GFM in quantities no larger than 50,000 yards to limit contractor
storage space requirements at the Conrad plant.
October 5, 1999. Government Depot personnel notified the contracting officer that the
Depot was unable to fill Conrad GFM requisitions because of a stock outage. Depot
computer records indicated that there were 100,000 yards of material available but a
physical inventory failed to locate any of the required material or an acceptable
substitute.
November 5, 1999. The contracting officer notified Conrad that the required GFM was
not available and that the Government planned to convert the balance of the contract to
Contractor-Furnished Material (CFM). At that time, Conrad estimated that 95,000 yards
of material would be required to complete balance of contract (39,584 units).
November 10, 1999. The contracting officer issued a unilateral change converting the
outer shell material from GFM to CFM. At that time, Conrad indicated that 3-4 weeks of
uncut GFM inventory remained and projected a 5 to 6-week lead time for receipt of the
CFM.
January 5, 2000. Conrad submitted a request for equitable adjustment:

PROPOSED EQUITABLE ADJUSTMENT


Material 95,000 yards @ $10/yard $950,000
Material Overhead 5% of Material Cost $47,500
Other Direct Cost Estimation of cost impact of the change $500
Total Manufacturing Cost $998,000
G&A Expense 10% of Total Manufacturing Cost $
Total Cost 99,800
Profit 15% of Total Cost $1,097,800
Requested Adjustment
$164,670
$1,262,470
February 1, 2000. The Contracting Officer requested assistance from the ACO,
cognizant auditor, and technical personnel.

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CON 270, Intermediate Cost and Price Analysis

CONRAD CORPORATION (cont)

February 28, 2000. Technical personnel found that:

 Conrad purchased a reasonable amount of material.


 The proposed Material Overhead was excessive for the effort involved, issuing
and administering a single purchase order. Estimated actual cost was $250.

February 28, 2000. The cognizant auditor did not question any of the proposed cost.
The auditor did comment that the proposed indirect rates complied with the current
Forward Pricing Rate Agreement (FPRA).

March 5, 2000. The contracting officer developed a negotiation position based on the
audit and technical reports.

EQUITABLE ADJUSTMENT NEGOTIATION OBJECTIVE


Material Accepted Conrad proposed amount. $950,000
Material Overhead Accepted Technical recommendation. $250
Other Direct Cost Accepted Conrad proposed amount. $500
Total Manufacturing Cost $950,750
G&A Expense Accepted proposed 10% rate. $ 95,075
Total Cost $1,045,825
Profit 5% of Total Cost because costs all $52,291
Adjustment Objective incurred $1,098,116

March 31, 2000. After weeks of negotiation, the contracting officer and the contractor
could not reach agreement on an equitable adjustment. The major areas of difference
were Material Overhead and Profit. As a result, the contractor submitted a claim
seeking payment under the Disputes clause of the contract.

CONRAD CLAIM
Material 95,000 yards @ $10/yard $950,000
Material Overhead 5% of Material Cost $47,500
Other Direct Cost Estimation of cost impact of the change $500
Claim preparation cost $1,000
Total Manufacturing Cost $999,000
G&A Expense 10% of Total Manufacturing Cost $ 99,900
Total Cost $1,098,900
Profit 15% of Total Cost $164,835
Requested Adjustment $1,263,735

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CON 270, Intermediate Cost and Price Analysis

CONRAD CORPORATION (cont)

April 5, 2000. The contracting officer received a Claim Certification signed by the
Contract Manager and dated April 2, 2000.

April 15, 2000. The contracting officer received a Claim Certification signed by the
Plant Manager and dated April 10, 2000. The second Certification was identical to the
first, except for the signature.

1. Does the proposed material cost appear reasonable?

2. Whose position on Material Overhead appears most reasonable?

3. Is the cost of preparing the request for equitable adjustment allowable?

4. Is the cost of preparing the claim allowable?

5. Is the proposed G&A Expense reasonable?

6. How should the profit rate be determined?

7. If the contractor is to be paid interest, what should be the first day for interest
calculation? (Assume that the claim was submitted after October 29, 1995.)

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CON 270, Intermediate Cost and Price Analysis

REVIEW QUESTIONS

1. Identify four approaches to establishing an equitable adjustment. a.

b.

c.

d.

2. Which of the approaches to pricing an equitable adjustment is normally


considered best?

3. Identify the types of cost that you should consider in making an equitable
adjustment.

4. In pricing work deleted from a contract, should you use the proposed price or current
estimated price to perform the work?

5. When is a claim certification required?

6. What two requirements establish the maximum period for letter contract
definitization?

7. From what point in time is the Government responsible for paying interest on a
contract claim?

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CON 270, Intermediate Cost and Price Analysis

ABC Construction Company


Equitable Adjustment Request
ABC Construction Company entered into a Design-Bid-Build type of contract with the Army Corps of
Engineers to build a new runway at Vandenberg AFB CA to accommodate a new mission as a result of
the Base Realignment and Closure committee recommendations.

(1) Detailed drawings were provided to ABC Construction as part of the competitive solicitation and
subsequent award.

In the beginning, construction proceeded according to schedule, but subsequently, they began
experiencing problems on the project.

(a) Among other things, the contract drawings required the installation of an underground fuel
pipeline and certification that the system confirmed to specified requirements before testing.

(b) The contract also required the contractor to repair any leaks or other deficiencies that resulted
from faulty workmanship or materials.

(c) Before it buried the pipeline, ABC Construction was informed by the Government that they
would be making changes to the testing requirements for the pipeline to address new
environmental regulations issued by Santa Barbara County. Nevertheless, the contractor buried
the pipeline anyway.
(d) Shortly thereafter, the Corps of Engineers and ABC Construction agreed to a bilateral
modification at no additional increase in contract price that required ABC Construction Company
to conduct hydrostatic testing of the pipeline at 225 pounds per square inch. The modification
indicated that this was a “complete and equitable adjustment” and an “accord and satisfaction,”
releasing the Government from further liability for any and all costs arising out of or incidental
to the work.

(e) The pipeline failed to meet the new standards when tested. ABC Construction made additional
repairs, and the Government allowed it to test the piping at only 100 psi. The piping passed the
new, less stringent test; however, ABC Construction discovered that the tests had significantly
damaged the containment pipe. Since locating the leaks was difficult, ABC Contractors had to
dig up approximately eighty percent of the underground pipe system, much of which had been
paved over. After spending a considerable amount of time and money, ABC Construction was
able to repair the pipeline.

(f) Several months later, ABC Construction submitted a claim to the Government seeking an
equitable adjustment of $250,000.

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CON 270, Intermediate Cost and Price Analysis

Should the contractor’s $250,000 claim be granted?

 Yes. The Corps ordered a change to the contract drawings by requiring the pipeline to undergo
additional testing. Under the Changes Clause, the contractor is entitled to an equitable
adjustment for all costs caused by this damage.

 Yes. The Corps did not formally issue a modification until after the pipeline was buried. The
Changes Clause requires that all changes be made before the work is installed.

 Yes, but only in part. A change to the specifications occurred, but the Corps should deny any
and all costs related to ABC’s re-excavation of the pipeline. ABC Construction Company knew
that additional testing would be required, but assumed the risk when it decided to bury the
pipeline.

 No. The parties entered into a bilateral modification agreeing to a complete and final
adjustment to the contract. Once the modification was signed, ABC waived its right to seek any
and all equitable adjustment resulting from the change.

 Yes. Although ABC executed a no-cost modification, it should not be forced to assume the costs
for repairing additional damages to the pipeline caused by the Government’s test requirements,
which, in hindsight were clearly unnecessary and unreasonable

Justification for your position and/or conditions under which this would apply
(FAIR model =Facts, Assumptions, Issues and Resolution or Recommendation)

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CON 270, Intermediate Cost and Price Analysis
Notes Page

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