Chapter 14

Preparing the Winning Cost Volume

Stating that cost is important in winning government contracts is equivalent to proclaiming that the Pope is Catholic. Of course cost is important! Sometimes it is the most important ingredient of a winning bid. Occasionally, it is practically the only consideration. Being the low bidder has its advantages regardless of the relative weight of cost in the overall source selection criteria. No matter what you read, hear, or think, cost is always important. Yet there is more to winning the cost war than bidding the lowest number.

Winning means capturing a piece of new business and making money for your organization. Winning is easy if you are willing to lose money. The key is to bid low enough to win, yet high enough to satisfy contract requirements and still book a little profit. Moreover, in many instances, the government is just as interested in how you arrived at your bid as it is in the absolute value. Viewing the preparation of the proposal cost volume as simply a task of deriving cost estimates and plugging numbers into pricing forms could be a fatal mistake.

How well you present cost information and substantiate its basis can have a significant impact on the outcome of the source selection process. This is especially true for best-value procurements. Even government customers willing to award an auditory vigilance contract to the low-bidding deaf person may be concerned about how you arrived at your bid price. They know a low bid that cannot reasonably be executed is no bargain. Contractors that underbid programs likewise tend to underperform. Government customers and users most often bear the brunt of such bids. Consequences come in the form of slipped schedules, cost overruns, and lower-than-expected performance.

Admittedly, the outcome of government source selection often seems to defy reason. Sometimes the government awards contracts to lower-priced and less qualified, or unqualified, offerors. Other times the government picks a more qualified and higher-priced bidder.

Some amount of mystery will always surround government source selection. It is an inherently subjective process administered by fallible and biased humans. Nonetheless, understanding your customer and what it is attempting to achieve when it evaluates your cost proposal is the first step on the journey toward competitive advantage.

Adequately describing the full array of cost-estimating techniques and addressing the intricacies of preparing a cost volume would require a separate book in its own right. Instead, this chapter attempts to shed some light on key variables that shape the cost proposal evaluation process. It also focuses on tips, guidelines, and recommendations that will enable you to step ahead of the competition and prepare a winning cost volume.

COMMON COST PROPOSAL MISTAKES

As you jockey for position in the cost race, it is important to avoid mistakes that could undermine the evaluation of your cost proposal. Just steering clear of these potholes might be sufficient to edge out the competition.

The following list of common cost proposal shortfalls is based on a briefing given by a major government procurement agency. Although dated, the briefing highlights today’s cost volume shortcomings as if it were written yesterday.

• Not responsive to RFP instructions

• Inadequate definition and description of the building blocks of the cost approach

• Failure to provide logical conclusions and illustrate that the cost estimate is realistic and reasonable

• Making good-intention statements such as “we understand,” “we are committed,” “we are capable,” “our experience ensures,” “we comply” instead of showing how experience is applied, showing results and benefits, proving the level of capability, and providing the cost estimate basis and substantiating data

• Not following instructions to complete costing forms provided in the RFP

• Not showing the associated CLIN for each WBS, or a WBS-to-CLIN cross reference

• Not providing cost subtotals for each higher level of WBS

• Failure to separately report prime/subcontractor indirect rates

• Failure to separately break out hardware/software requirements

• Not providing historical cost data for labor hours, staffing levels/labor mix, etc.

• Not providing required data for each major subcontractor (e.g., cost summaries, detailed substantiation, labor/overhead rates)

• Inadequately defining what work is/is not included in task descriptions

• Not providing an adequate trace from the lowest level of detailed substantiation to the cost summaries

• Referencing paragraphs that do not exist

• Failure to ensure accuracy of costs/hours at each higher level of cost summary

• Assuming that cost summaries are adequate substantiation

• Not providing negotiated rates/rate agreements and a trace between calendar year rates and rates used in the proposal

• Not explaining changes from recent historical rates

• Not providing labor category definitions

• Classifying material as commercial off-the-shelf (COTS) or a non-developmental item (NDI) when extensive modifications are required.

In this same briefing, the government presented its recommendations for preparing an adequate cost proposal, as follows:

• Demonstrate that you have a thorough understanding of the requirements and inherent risks, can devote the necessary resources, and have a solution to meet the RFP requirements.

• Support your statements with facts, analysis, and substantiating data to illustrate that your approach is realistic and reasonable.

• Provide clear and concise cost estimate descriptions/justifications.

• Understand the evaluation criteria so you know where to place emphasis in your proposal.

• Ensure traceability throughout the proposal (bill of material to WBS; WBS to CLIN, WBS to statement of work, etc.).

• Ensure that technical and cost proposals are consistent.

• Show support for any proposed improvements to historical cost data (i.e., improved technology).

• The burden of proof for cost credibility rests with the offeror. Please substantiate the cost estimate!

In the words of the customer:

Most of this information represents the view of a single government agency. However, experience suggests that it is representative of most, if not all, government customers. Use it as a general checklist to prepare your cost proposal. Better still, arrange a meeting with your customer’s head of contracts. Ask that person to share with you the common shortcomings of cost proposals the customer receives. Also, ask what actions you can take to ensure that your cost proposals contain the information necessary for cost evaluators to perform their job effectively and efficiently. Use this information to build a checklist to guide the preparation of cost proposals to that customer. Remember, the government “want[s] to accept your estimate.” Make its job easy, and you gain competitive advantage. Make its job difficult, and you forfeit advantage and perhaps the bid opportunity. A poor cost proposal can completely neutralize a superior technical proposal.

Consider this scenario: Two bidders are scored as technically equivalent, and both bid about the same price. One bidder submits a cost proposal that lacks sufficient traceability and does a poor job of substantiating cost estimates. The other bidder provides the necessary cost traceability and does a good job of substantiating cost estimates. With few exceptions, the second bidder will win.

More often than you might imagine, contracts are lost because of an inadequate cost proposal. To reiterate: There is more to preparing a cost volume than developing and presenting cost estimates. It is possible to have the best technical approach, bid the lowest price, and still lose. In such cases, the likely culprit is a cost proposal that fails to convince government evaluators that the proposed price is reasonable, realistic, and complete.

COST VOLUME EVALUATION

Cost proposals, unlike technical proposals, are not scored. They do not receive a color rating or point count, but they are evaluated. Depending on the procuring agency, the cost volume may also receive a risk rating based on past contract cost performance and a cost risk based on your proposed technical approach and the corresponding cost information contained in the cost volume. Even firm-fixed-price contracts can receive a risk rating for cost.

The role of cost evaluators is to ensure that the government pays a fair and reasonable price for the work being procured. The government evaluates cost proposals to determine factors like the reasonableness, realism, and completeness of the cost estimate; the most probable cost to the government; and the bidder’s understanding of the required effort. To ensure it receives a proper evaluation, your cost proposal must be accurate, complete, and well documented.

The government contracting officer’s primary concern is the overall price the government will actually pay. Hence, in evaluating cost proposals, two plus two does not necessarily equal four. If the government views your proposed cost as risky, it may increase your bid cost to the “most probable cost to the government.” You might propose the lowest price but be evaluated as the highest-priced bidder based on the type of cost analysis performed.

To illustrate this point, carefully read the following Section M excerpt, which clearly states the government’s intent to adjust the proposed price based on its cost analysis:

Pay close attention to the language contained in Section M concerning how cost will be evaluated. The government is supposed to inform prospective bidders about its intention to perform cost analyses. When in doubt, ask the government contracting officer.

CONTRACT TYPE AND COST

An important role of the customer’s contracting officer is to manage risk to the government. To fulfill this role, contracting officers select a contract type appropriate to the scope and uncertainty of the work being procured. The amount and type of information requested in the cost volume normally reflect the type of contract to be awarded. Other factors include the criticality and sophistication of the work to be performed, local procuring agency policies, and the recent cost performance of contracts managed by the agency.

Contract types fall into two broad categories: fixed price and cost reimbursement. They also vary in terms of how profit is awarded. Profit is either fixed at contract award or based on contract performance. This creates four general contract types; Figure 14-1 lists some general characteristics of each.

Under a fixed-price contract, you are completely responsible for contract cost performance. A fixed cost is bid and reimbursed by the government. If your actual costs exceed the amount bid, you will likely lose money. Only formal contract changes made and approved by the government result in additional monies being allocated to the contract.

Cost-reimbursement contracts provide payment of incurred costs up to the maximum prescribed by the contract. Increases in work scope and government-directed or -approved changes lead to an increase in allowable cost. Under cost-type contracts, cost risk is shared between the government and the contractor.

Under a fixed-fee contract, profit (normally expressed as a percentage) is determined at contract award and does not vary. If you bid a profit of 10 percent, that is the profit you receive for work performed regardless of actual cost required to perform the contract. Alternatively, the government can incentivize contract performance by using an incentive fee or award fee contract.

Incentive fee contracts are used to reward contractors for how well they manage cost, for achieving desired performance characteristics, or for meeting delivery schedules.

Figure 14-1. General Characteristics of Different Government Contract Types

A fixed-price incentive (firm target) contract specifies a target cost, a target profit, a price ceiling, and a profit adjustment formula. The price ceiling is the maximum amount that will be paid to the contractor (except for any adjustment under other contract clauses). The profit adjustment formula determines how the final fee will be determined. For example, a 70/30 formula means you will receive 30 percent of cost underruns below the firm target and the government will share 70 percent of cost overruns up to ceiling price. Therefore, if the final cost is less than the target cost, applying the formula results in a final profit greater than the target profit. However, if final cost is more than target cost, applying the formula results in a final profit less than the target profit or even a net loss if price exceeds the ceiling. Because profit varies inversely with cost, this contract type in-centivizes the contractor to control costs. Figure 14-2 illustrates the CLIN structure for a fixed-price incentive fee contract where cost control is the incentive factor. In this example, if we complete the contract at an actual cost of $900,000, we receive $130,000 in fee (target profit of $100,000 plus 30 percent of the cost underrun).

Other incentive fee contracts reward contractors if they achieve a specified performance or meet a delivery date. For example, a number of years ago we won a contract that required us to assume responsibility for a logistics function previously performed by the government. The contract requirement was to assume responsibility within 90 days after contract award. However, if we assumed responsibility in less than 90 days, we received an incentive of $10,000 per day, up to a maximum of $300,000. We assumed responsibility 59 days after contract award.

Figure 14-2. Sample CLIN Structure for Fixed-Price Incentive Fee Contract

Performance incentives can be used in connection with specific product characteristics (e.g., a missile range, an aircraft speed, an engine thrust, or identifying a target at a specified range) or other specific elements of technical performance. In such cases, a baseline performance requirement must be established and a specific formula for determining the incentive must be clearly specified. Note that in some cases an incentive contract can have both positive and negative incentives.

Award fee contracts are used to reward contractor performance on contracts where specific characteristics cannot be easily defined or where performance cannot be measured objectively. For these contracts, an award fee pool is determined, say 15 percent of contract cost. Contractor performance is reviewed periodically, according to an award fee plan, and the contractor is paid a percentage of the total allowable fee based on contract performance. The award fee plan defines the areas of contract performance that will be evaluated, performance criteria, and how performance will be evaluated, and it establishes an award fee board. Figure 14-3 shows a typical award fee rating system.

Figure 14-3. Typical Award Fee Rating System

The amount of award fee earned is based on periodic evaluations and lasts for the life of the contract. Figure 2-3 in Chapter 2 shows the CLIN structure for an award fee contract.

Contract Type and Cost Risk

Considerations of cost risk, technical uncertainty, and type and complexity of the requirement determine the type of contract selected. Fixed-price contracts place the greatest risk on the contractor. They are appropriate when cost risk and technical uncertainty are low and where competition is adequate. Most service-type contracts fall into this category. Cost-type contracts place the greatest risk on the government. They are appropriate when cost risk or technical uncertainty is high, or where contract requirements are complex. Developmental contracts fall into this category. Incentive profit schemes are used to reward contract performance on both fixed-price and cost-reimbursement contracts.

Generally, the amount of cost information requested by the RFP is related directly to the amount of cost risk assumed by the government and the complexity or criticality of the procurement. A firm-fixed-price contract places all the risk on the contractor. Hence, a formal cost proposal may not be requested for some firm-fixed-price contracts. In these cases, the government assumes that sufficient competition exists to ensure cost reasonableness.

Alternatively, the government assumes the greatest amount of risk on cost-reimbursement contracts. Therefore, more cost information is required for cost-type contracts, and the government conducts a more thorough cost analysis.

In fact, procuring agencies are required to perform a cost realism analysis on cost-reimbursement contracts. To assess cost realism, government evaluators assess specific elements of each bidder’s proposed cost estimate to determine:

• Whether the estimated cost elements are realistic for the work to be performed

• Whether costs reflect a clear understanding of the requirements

• Whether proposed costs are consistent with the technical proposal.

Based on this analysis, the government may then adjust your proposal price to arrive at the most probable cost to the government. This is the price that is used during source selection to determine the winner. Theoretically, you could propose the lowest price and be evaluated as the highest-priced bidder. Clearly, the outcome of such cost analyses can have a profound effect on the evaluation of your cost proposal. You may lose the contract or be eliminated from the competition if the government views your proposed cost as risky, if your cost estimates are poorly substantiated, or if the government has difficulty understanding your proposed cost. The primary information evaluators use to determine the cost realism of your bid is the information contained in your cost proposal, especially basis of estimate. Do a good job here, and you gain competitive advantage. Fail here, and you might lose the contract.

Although cost analyses are required for cost-reimbursement contracts, evaluators may elect to perform similar analyses for fixed-price contracts if requirements are complex or when successful contract performance is critical. In fact, contracts that incentivize cost control often require the same level of cost detail in the proposal cost volume as cost-reimbursement-type contracts. They also undergo the same level of cost evaluation during source selection. The major difference is the government is permitted to adjust your bid costs as part of the cost realism analysis required of cost-reimbursement contracts, but the government is prohibited to adjust fixed-price bids. Nonetheless, the government can still assign risk to your cost proposal based on its contents. This is even true for firm-fixed-price bids.

Therefore, do not assume that the cost volume is less important, or that the low bid price automatically wins, even for fixed-price contracts. Pay close attention to information being requested by the RFP and the corresponding cost evaluation factors contained in Section M. Be especially sensitive to the fact that it is your job to convince evaluators that your proposed price is reasonable, realistic, and complete. Give them the information they need to manage cost risk and give your cost proposal high marks.

You will be required to regularly report cost and program performance using earned-value principles if contract value exceeds a threshold value for a cost-reimbursement contract. This may require you to either have a government-approved earned value management system or put together a plan to implement such a system. The government may levy similar requirements on fixed-price incentive fee contracts.

Contract Type and Profit

Contract type also influences how much profit you bid. A general rule of thumb: The more risk you assume, the higher the allowable profit. This translates into higher allowable profit on fixed-price versus cost-reimbursement contracts. Similarly, higher potential profit is allowed on incentive-type contracts because profit is at risk, based on contract performance. However, things are not always this simple. The government may expect you to bid a lower profit margin on a fixed-price contract if contract requirements are well defined and uncertainty is low. This is especially true of service-type contracts that are fixed price.

Do not assume that the government just looks at the bottom-line price and ignores profit. The government often scrutinizes your direct and indirect costs and profit in evaluating price. Two bidders might propose the same overall price but differ in the proposed amount of direct effort or profit.

Within the constraints of the Federal Acquisition Regulation, selecting profit margin should be the outcome of careful deliberation. Bidding a standard profit margin for fixed-price contracts and another for cost-type contracts is the essence of simplicity. It is, however, an approach that occasionally yields competitive advantage to a more astute bidder. Weigh factors like contract type, customer expectations, perceived contract risk, competitors, and your own organization’s profit goals to arrive at a reasonable and competitive profit margin for each bid.

Cost Strategy

A host of variables go into developing a cost strategy. Understanding the different contract types and the rationale for each is an important consideration for the cost strategy. The risk-reward equation is different for each type and needs to be factored into your final decision about how to approach cost and profit. Moreover, how the government determines evaluated price differs for different contract types. For example, ceiling price is often used to determine probable cost for fixed-price incentive contracts. For award fee contracts, the maximum award fee is similarly used. Likewise, the government expects the amount of profit bid to reflect how much risk the contractor is assuming. As previously indicated, the type and amount of information requested in the cost volume are closely tied to contract type. The amount of effort required to collect and report cost after contract award is also directly related to contract type.

Failing to take preparation of the cost volume seriously can easily lead to a losing effort. More times than I can count, I hear people say things like, “cost is cost,” implying that the numbers you put in Section B of your proposal are the only thing that counts. Except for firm-fixed-price bids that do not require a formal cost volume, this is absolutely and positively wrong! Sometimes the narrative information and detail contained in the cost volume actually supersedes the numbers in Section B. At a minimum, this information can significantly affect how the government views your proposed price.

Seize this often neglected aspect of proposal preparation to gain competitive advantage in terms of both how you formulate your cost strategy and the attention you give to cost volume preparation.

MAJOR COST COMPONENTS

Three components are necessary to arrive at a bid price for government procurements: direct costs, indirect costs, and profit or fee.

Direct costs consist of both labor and material. Direct labor is the salaries of the people who will charge their time directly to the contract. Direct material is the cost of parts, equipment, raw materials, etc., that will be purchased to perform the contract. Another part of direct costs is referred to as “other direct costs,” or ODCs. These are costs that are directly charged to the contract but do not fit easily into either the direct labor or direct material category. For example, travel cost charged to the contract is a typical ODC. So is the cost to lease or rent equipment or acquire special services that will be used on the contract.

Indirect costs are not charged directly to the contract. However, they are added to direct costs to determine the cost of your bid before profit is added. Indirect costs include overhead and general and administrative (G&A) components. Overhead costs include items like employee benefits, payroll taxes, paid time off, facility costs, salaries and benefits of indirect employees whose time is not charged directly to a specific contract, and other miscellaneous costs. G&A costs typically include salaries and benefits for accounting and finance personnel, marketing expenses (including B&P costs), and salaries and benefits for senior management. Many organizations also have a material burden, which is an indirect cost added to all direct material purchases.

Indirect costs are expressed as percentages. They are calculated separately for overhead, G&A, and material burden. Indirect costs are added to direct costs to calculate total cost. For example, an overhead rate of 150 percent means that you will add 150 percent of the cost of direct labor to calculate your total labor cost.

Profit, expressed as a percentage, is then added to the total cost to arrive at your bid price:

Total price, based on $1 million of direct labor, an indirect rate of 150 percent, and a profit of 10 percent, is:

Determining which personnel are classified as direct versus indirect is part of an organization’s business model. It can vary enormously between companies. In addition, companies may vary regarding which costs they allocate to overhead and which they capture as part of G&A. Within reason, you can allocate costs as you choose as long as you are consistent and follow government cost accounting standards.

Understanding the Relationships among Cost Categories

Understanding the relationships among cost categories is a vital prerequisite to preparing a competitive cost proposal. Of the three price components, two (direct cost and profit) are variable and one (indirect cost) is fixed.

Direct costs reflect your proposed technical solution and cost to perform the contract. They vary based on your approach. Profit likewise can vary within the range allowed by the government and what it takes to be cost-competitive.

Indirect costs are set. Normally, they do not vary from proposal to proposal. They are based on an organization’s total direct revenue generated by all existing contracts compared to its total indirect costs. (Overhead, G&A, and material burdens are calculated separately.) Indirect rates are recalculated periodically to reflect changes in revenues and indirect costs. However, the government must approve your indirect rates. The government conducts audits to ensure that you comply with generally acceptable cost accounting standards and to verify your indirect rates.

If you want to reduce bid price for a specific proposal, you must reduce direct costs, profit, or both. Part of gaining cost advantage is developing creative solutions that minimize direct cost while meeting RFP requirements, as well as understanding how to set profit margins.

As noted, the government is generally willing to allow higher profit margins for contracts where you assume more risk. Within this context, you must still know what the customer expects. A 10 percent profit margin may be allowable for a cost-plus-fixed-fee contract, but the customer may be expecting the winner to bid a 7 percent fee. You must also be aware of what your competitors are likely to bid and what is competitive for the market niche within which you are competing. For example, firm-fixed-price contracts allow the greatest potential profit margin. Yet many large service contracts are won with bid profits of 5 percent or less.

Managing Indirect Costs Effectively

Another part of gaining cost advantage involves managing indirect costs. These costs routinely account for more than half of your bid price. Normally, you cannot arbitrarily change indirect rates for a specific bid. But you can and should actively manage indirect costs to minimize their impact over the long haul.

The best way to reduce indirect costs is to increase the amount of direct revenue generated while holding total indirect costs constant or allowing indirect costs to grow at a slower pace than direct revenue. Another way is to reduce indirect costs while maintaining direct revenue constant. These are easier said than done. Nevertheless, I heartily recommend that you initiate a program to review indirect costs periodically and look for ways to improve the cost-effectiveness of indirect functions. Few activities have the potential to contribute more to the cost-competitiveness of your organization.

Concurrently, use the information provided in this book and your organization’s creative talents to improve your percentage of winning bids. B&P costs are among an organization’s largest manageable indirect expense. Reducing your unit B&P costs per bid contract—by winning more often—will reduce your indirect cost. It will also increase your direct revenue and improve your cost-competitiveness. Becoming more cost-competitive means either winning more bids or making more profit—or both. Nothing begets success like success.

Here is an example of the impact of indirect bid rates. Two bidders propose the same direct cost and profit margin. Bidder A’s total indirect rate is 100 percent, while Bidder B’s indirect rate is 120 percent.

	Bidder A	Bidder B
Direct Cost	$10,000,000	$10,000,000
Indirect Cost	$10,000,000	$12,000,000
Profit (10%)	2,000,000	2,200,000
Price	$22,000,000	$24,200,000

This causes Bidder B’s price to be higher than Bidder A’s price by $2.2 million, or about 10 percent. If total proposed price is key to winning this procurement, Bidder A is the hands-down winner. Even under a best-value procurement, a 10 percent price differential may be difficult to overcome. To bid the same price, Bidder B must either reduce direct cost by $2.2 million (22 percent) or bid zero profit. Reducing direct cost by 22 percent, while proposing a technical solution equivalent to that of other competitors, is not a likely scenario. Clearly, bidding zero profit (with few rare exceptions) is not an acceptable alternative.

Under most circumstances, differences in competitor indirect rates are less than those shown in this example, but the point remains. Everything else being even, maintaining lower indirect rates than your competitors affords a significant competitive advantage.

STARTING POINT

The starting point in any cost competition is to know your customer. You must be knowledgeable about how your customer evaluates cost and the role cost plays in contract award. If your customer always, under every circumstance, awards to the low bidder, then you know the rules of the game. The second piece of information for this part of the equation is knowledge about the cost-competitiveness of other bidders.

Given these two bits of data, can you reasonably expect to win? If cost is king, can you be the low bidder? If not, will you be able to overcome any cost disadvantage? These considerations should have been part of your bid/no-bid decision and integrated into your bid strategy. Even so, it is worth reviewing them before going too far down the road of developing a proposal. Better to cut your losses while you can.

You should also know how much money the customer has. Some RFPs provide funding information, including a spending profile for each contract year and category of funds. If this information is not available in the RFP, you must make every effort to determine the customer’s budget. The easiest way in the world to lose is to bid more than the customer has to spend—or to overbid the funding profile for any given year. Sometimes getting your bid to fit within the customer’s funding profile requires some near superhuman costing gymnastics.

PREPARING COST ESTIMATES

The work effort necessary to prepare a cost volume comprises two major activities. The first is deriving cost estimates. The second involves preparing any required cost narrative, filling out customer-required pricing forms, and organizing the cost volume according to the Section L instructions and your proposal outline.

The cost volume manager is responsible for preparing the cost volume and overseeing the development of cost estimates. The program manager should work closely with the cost volume manager to oversee costing efforts and to ensure they match the proposed technical approach.

Work Breakdown Structure

The first step in preparing an initial cost estimate is to create a work breakdown structure (WBS). The WBS is a hierarchical division of the work effort into manageable parts. To illustrate, Figure 14-4 shows a customer-provided WBS based on a contract to build a military flight simulator and provide one year of contractor logistics support. (MIL HDBK 881A describes how to develop a WBS.)

Figure 14-4. Sample Work Breakdown Structure

Assign cost-estimating responsibility for each WBS element to an individual person. If a WBS element requires multiple inputs, pick a lead person to be responsible. Use this information to create a cost-estimating responsibility matrix. Then develop a completion schedule for each WBS element that coincides with the Tier 1 and Tier 2 proposal schedules (see Chapter 11).

If provided, use the WBS in the RFP as a starting point. Expand it as necessary to support your pricing efforts, but do not change the upper-level structure. Otherwise, you might confuse government cost evaluators. Figure 14-5 demonstrates how you might expand WBS elements 1.1.8.1 and 1.1.8.2 from Figure 14-4. If the RFP does not provide a WBS, create one yourself.

The WBS creates a cost structure for collecting and organizing your cost estimates. It is also the basis for allocating, monitoring, and reporting cost expenditures after contract award. As such, it is a critical component of program management. Every cost proposal should be based on a WBS, regardless of whether or not it is required by the RFP.

Figure 14-5. Sample Expansion of WBS Elements 1.1.8.1 and 1.1.8.2

Also, plan to prepare a WBS dictionary. A dictionary defines which costs are contained in each WBS element. It helps cost evaluators understand your cost proposal, and it can be an invaluable asset after contract award. Cost allocations and adjustments performed during the heat of battle are often forgotten by the time the contract is awarded. Maintaining an up-to-date WBS dictionary helps overcome this potential problem.

Pricing for service contracts typically does not lend itself to a WBS format. Instead consider pricing by labor category and cost element and by site if you must support multiple sites. Whatever approach you use, make sure cost-estimating responsibility is assigned for every required cost element.

Quick-Look Cost Estimate

Use your knowledge of the customer’s budget to perform a “quick-look” cost estimate. The purpose of this estimate is to determine whether you can meet all RFP requirements and still make money while remaining within the customer’s budget constraints. This is vital information you need early in the proposal development phase. It might cause you not to bid the program. Or, it might highlight the need to drastically alter your technical approach. The following scenario illustrates the value of performing a quick-look estimate.

You know the customer’s budget but allow cost estimates to be developed using a bottom-up technique. Cost estimates are made by functional organizations starting at the lowest WBS level. Once all costs are summed to arrive at a total price, you discover that your total is three times greater than the customer’s budget. Unfortunately, completing the bottom-up estimate has consumed most of the time available to prepare a cost proposal. Initially, you struggle trying to trim your estimates, but eventually you realize that the only way to stay within budget is to radically alter your technical approach. This results in major revisions to your technical proposal and a frantic scramble to prepare a cost proposal for the new approach.

The clock is ticking. Insufficient time remains to develop a reliable cost estimate. Consequently, the technical and cost proposals do not match, and internal cost reviews to verify a reasonable bid are skipped. The most probable outcome in such a situation is a losing proposal or a bid that cannot be executed.

Conducting a quick-look cost estimate offers an opportunity to avoid this scenario. It can also be a key weapon in your arsenal to capture competitive advantage by preparing a winning cost proposal.

One way to accomplish a quick-look estimate is to perform a top-down cost analysis. Using the customer’s budget, allocate a percentage of the total to each major part of the work effort as defined by the WBS. Then further allocate the budget of each major WBS to its component parts in a top-down fashion. Continue this process until you have allocated the total budget to a manageable size, but keep things at a fairly high level. Then ask functional managers (or the responsible person) to review the cost estimate for each area and determine if they can perform the contract within these costs. This is a rough order of magnitude (ROM) estimate, so do not try to carry it out to four decimal points. Its purpose is to decide whether you can accomplish your proposed technical approach within the customer’s budget constraints.

At this point, you are probably okay if you are close to the customer’s budget. Subsequent cost trimming will normally allow you to achieve a reasonable cost target that fits within the customer’s budget. However, a prudent cost bid will be something less than what the customer has to spend.

If the quick-look estimates show a huge discrepancy between what it will take to execute your proposed technical approach and the customer’s budget, you have two options: overhaul your approach to match the budget or pull the plug on the bid effort. Conducting a quick-look cost estimate maximizes the time remaining to adjust your technical approach if an adjustment is required.

Price to Win Cost Approach

Price to win (PTW) is an approach in which you determine beforehand what you estimate the required winning price will be. PTW requires a rigorous estimate of what you expect competitors to bid. You then estimate the price required to beat the competition. If you have a PTW, you can use it as a top-down cost-estimating approach to establish cost targets for functional organizations and subcontractors responsible for developing cost estimates. Initial cost estimates are adjusted wherever necessary to finally arrive at the price to win.

PTW requires in-depth knowledge of competitors and their cost structure, along with a good estimate of their likely technical approach. Although PTW can be an effective cost strategy, most organizations lack sufficient information about competitors, or the internal expertise, to use it effectively. However, a number of companies specialize in PTW analyses and offer their services for hire. Because such services tend to be fairly expensive, they are normally used only for significant or must-win bids. Even when outside services are used, you must still have someone on your cost team who understands PTW. That person will need to “calibrate” the PTW information you receive from an outside service and decide how to use that information, both to arrive at a final PTW and to ensure the cost volume supports the final number. If you are bidding a cost-reimbursement contract, getting your bases of estimates to fit PTW cost targets can be especially challenging.

Personally, I am a fan of PTW analysis. It forces a serious evaluation of competitors and a level of analysis normally lacking in most costing exercises. Using PTW to set cost targets for cost estimates helps focus cost estimates, and it sets boundaries that limit “extravagant” bids. On the other hand, it requires significant time, effort, and expertise. It also poses serious consequences if you are wrong. If you elect to use PTW, you must start early and ensure you have the expertise to direct the effort, regardless of whether you use outside services.

Initial Cost Estimates

Starting early is a cardinal rule for all proposals. Nowhere is this rule more important than for the cost proposal. Cost estimates lag the development of the technical approach on which they are based. Hence, they tend to be shoved to the end of the proposal development cycle and often get shortchanged. To the extent practical, avoid this potentially disastrous scenario. Hastily prepared cost proposals rarely have a happy ending.

Many costing activities can be performed ahead of or in parallel with the technical proposal effort. At the earliest time possible, build the cost structure required to fulfill RFP costing requirements and meet your organization’s plan to allocate, track, and report costs after contract award. Identify potential labor categories, direct labor rates, any known direct material costs, applicable indirect rates, escalation factors, required travel, and anything else required to develop your cost estimates. Determine the likely start dates and time spans for each WBS. Start preparing any required subcontractor statements of work. Begin assembling historical cost data and structure from past contracts comparable to the one you are bidding. This information may save time later, and it will be required to develop your bases of estimates. If applicable, start preparing a bill of material to support subsequent material cost estimates.

Piecemeal this information to your cost team so they can get timely vendor quotes. Build cross-reference matrices to relate individual WBS elements to CLINs, lots, or any other RFP pricing requirement. Verify that you have a place in your cost model for every RFP requirement. Test your initial cost structure to ensure that it accurately sums individual WBS costs and that costs are allocated and collected at the right level. If the government has provided a spreadsheet for you to populate with costs, make sure you test it to ensure any embedded formulas work properly.

Look for every conceivable opportunity to jump-start your cost-estimating effort. Collect estimates for costs that are not likely to change. For example, travel required to attend customer reviews and meetings, or other travel required by the contract, can be estimated early. Recognize that some early costing efforts will need to be discarded or altered due to subsequent decisions or changes. The gains in competitive advantage by starting early will more than compensate for any effort “wasted” by starting the process before the technical effort is perfectly defined.

Your proposed technical solution will ultimately be used to populate the cost structure to derive initial cost estimates for each WBS, CLIN, and lot and for the entire program.

Scrubbing Initial Cost Estimates

Plan to “scrub” initial cost estimates to arrive at the best bid price. The “best” price is the lowest amount necessary to fulfill program requirements, comply with your cost bid strategy, cover program risks, and achieve target profit goals. Arriving at the best price is a serious and difficult balancing act. On one side, you must identify and adjust cases where costs are underestimated. On the other side, you must strive to trim every possible cost element.

Most initial estimates are too high, often by a large margin. This is especially true if you use a bottom-up cost-estimating approach, which tends to include the same cost in multiple WBS elements and include a massive amount of “risk insurance.”

Start by identifying the major cost drivers. These are cost elements that make up a significant percentage of the entire program cost. Then search for ways to reduce cost without affecting your proposed technical solution or diluting your bid strategy.

Every program is different. Be innovative. Look for functions or tasks that can be combined. Can one person perform two jobs or functions? Can one long trip replace three individual trips? Are there cases where equipment commonality could reduce development or logistics support costs? Find tasks or functions where a qualified subcontractor is cheaper. Look for opportunities to substitute a less expensive solution that offers nearly the same performance. Minimize management and oversight costs. Remove any double-counted costs.

Apart from major cost drivers, review all remaining cost elements to complete the cost-scrubbing exercise. Trimming a few dollars here and a few dollars there might amount to enough cost savings to win a close competition. Throughout the entire process, ask yourself if you are taking a reasonable amount of risk. Every cost estimate entails an element of risk. Being too conservative improves the comfort level of those charged with program execution but may take you outside the competitive range. Assuming too much risk may enhance your cost-competitiveness but will probably undermine successful program performance. It might even cause you to be eliminated from the competition if the customer believes your bid is too low. Again, the key is balance.

PREPARING THE COST VOLUME

Section L of the RFP provides instructions about the content and organization of the cost volume or section. Follow these instructions absolutely. However, cost volume instructions do not always specify all the information that cost evaluators require to perform their job effectively. In fact, cost volume instructions are often sparse, bordering on deficient. The guiding rule in such cases is to include whatever information you deem necessary to fully substantiate the realism and reasonableness of your proposed cost. If you must err, then err on the side of providing more information than requested. Just be sure to explain the information and its relevance to your bid.

Remember, one of your goals, in addition to presenting your cost estimates, is to satisfy the government’s need to manage risk. I therefore also recommend that you include the following information:

• Executive summary

• Work breakdown structure and dictionary

• Explanation of costing approach

• Cost summaries

• Basis of estimate (normally not required on fixed-price contracts)

• Risk management

• Ground rules and assumptions.

If you provide information beyond what is requested by the RFP, make sure you integrate it into the proposal outline and the list of topics specified by Section L. Otherwise, you might confuse the evaluators and make it difficult for them to find what they are looking for. Do not bury evaluators in a pile of meaningless costing information. Include only the data necessary to explain clearly and substantiate your cost estimates.

Executive Summary

Cost evaluators do not read the technical volume of your proposal. They might also be relatively unaware of the RFP technical requirements. Therefore, plan to include a brief (two- to four-page) executive summary of your approach to meet RFP requirements. Include major highlights of your technical approach and any relevant experience on which your cost estimates are based. If this is a best-value procurement, showcase what you are proposing that provides “best value” to the government.

WBS and WBS Dictionary

Always include a WBS and a WBS dictionary with your cost proposal. Use the customer-provided WBS included with the RFP, expanded as necessary to meet RFP costing requirements, or your own plan to manage the program. Develop your own WBS if none is included with the RFP.

If the work effort is divided into CLINs or lots, prepare a WBS-to-CLIN matrix and include it with the cost proposal. If it makes sense, also include a WBS-to-SOW matrix.

Explanation of Costing Approach

Provide a high-level explanation of your approach to developing cost estimates. At a minimum, explain your overall approach to estimating direct labor, direct material, and other direct costs; provide a brief explanation of your indirect cost categories and how they are applied to determine cost; and specify the number of hours contained in a person-year of labor. If applicable, include an explanation of how you determined the proposed labor categories and skill mix, how you escalated costs for multiyear contracts, or how you applied any forward-pricing rate agreements you have negotiated with the government. The key is to provide and briefly explain data that allow cost evaluators to understand how you prepared your cost proposal and the major ingredients of your bid.

The following sample illustrates the level of detail for topics in this section:

Cost Summaries

Section L typically specifies how to present cost estimates and the level of cost information that should be provided. Within these instructions, plan to present cost information from general to specific. That is, present cost information at the higher levels first, followed by a more detailed breakout for each major cost (WBS) division.

Figure 14-6 is an example of a cost summary at the CLIN level, which also provides insight into the division of cost for each major cost category.

Figure 14-6. Cost Summary at the CLIN and Program Level for Each Major Cost Category

Figure 14-7 provides another example. It displays total program price presented by major WBS but does not segregate cost into separate categories. At the total program level, you could easily include both types of cost summaries. Each provides a different view of the same cost information.

Figure 14-7. Cost Summary at the Program and Major WBS Level

The subsequent presentation of cost information should be a more detailed breakout for each major WBS. For example, Figure 14-8 shows subordinate prices for WBS 1.1.1 from Figure 14-7. Whether you present prices below this level depends on several factors: pricing instructions provided in the RFP (which often specify the WBS level for pricing), how much visibility you want to provide evaluators, and whether the next level of pricing provides any meaningful insights into your price buildup.

Figure 14-8. Pricing Data for WBS 1.1.1

The WBS level you use to develop cost estimates is determined by both RFP requirements and the level at which you plan to track and report actual program costs. Some RFPs require that costs be presented in the cost proposal at one level but specify a lower level for cost reporting. In addition, you may plan the program at a much lower WBS level than the level you present in your cost proposal.

For illustration purposes, the examples used here are fairly simple. Many procuring agencies require elaborate cost breakouts, such as segregating recurring and nonrecurring costs, and presenting cost data for each major cost category and labor division for every WBS element. Regardless, the key in all instances is to ensure traceability between different cost-estimate levels and to supply the cost information that government evaluators need to perform cost analyses.

Basis of Estimate

The basis of estimate, if requested, is perhaps the most critical portion of the cost volume narrative. It is where you explain the method you used to develop your cost estimate and the source information on which it is based. This is where you must convince evaluators you have a sound basis for your cost estimates. Otherwise, they may assign risk to your estimates or add cost to your bid to arrive at a “most probable cost to the government.”

The government recognizes three general cost-estimating methods: parametric, analogous systems, and detailed (grassroots) engineering estimates.

Parametric Estimates

Parametric estimates are based on cost-estimating relationships (CERs). CERs are equations that relate one or more characteristics of an item to some element of its cost. They can consist of complex formulas based on extensive statistical analysis, or they may simply be a relationship between two variables. In addition, CERs can be established for major systems or subsystems or for specific program components. For example, a CER might relate avionics unit cost to the weight of the avionics system, or a CER could relate the cost per mile for a paved highway of specified dimensions over defined terrain.

The value of a CER depends on its specificity and historical validation. Typically, CERs are derived from historical data. Here are two examples:

1. Number of hours, by labor category, to produce one hour of run-time computer-based training based on the required level of lesson interactivity

2. Number of labor hours to perform systems integration based on the total number of engineering hours required to design and develop the system.

Formal estimating models, like those available to estimate the number of hours required to produce a line of software code, qualify as parametric models. These models consist of a series of CERs. For a model to be accepted as a reliable basis of estimate, you must demonstrate that you have used it previously to estimate cost accurately. In the absence of valid historical cost data, a formal model is still better than no model at all. In such cases, carefully and thoroughly explain how you derived inputs for the model.

Government evaluators tend to like parametric cost-estimating methods because they potentially remove human bias from the process and produce precise estimates. However, to be believable, such estimates must be validated by historical data that attest to their accuracy. One way to achieve this is to show initial cost estimates for past programs and the actual values achieved after contract award. This is easily done in a table that can be included as part of your basis of estimate. However, it does require that you collect and maintain actual cost performance data.

Analogous System Estimates

With this technique, cost estimates are based on your experience developing a comparable system or performing analogous requirements on other past or current programs. The estimated cost of the proposed system is determined by comparing it to the cost of comparable systems previously developed and adjusting the estimate to account for any differences between the systems.

Three elements are required to use this technique. First, you must have historical cost data based on your actual experience with the system or requirements you plan to use as a baseline. Second, you must carefully demonstrate that the system being proposed is comparable to the baseline system. Third, you must convince evaluators that the method you used to determine system differences (the basis of your adjustment) is rational and reliable.

The “value” of an analogous cost estimate is directly related to the amount of relevant experience you can present and the believability of how you determined the difference between the proposed and baseline systems. Believability is determined by the narrative in your basis of estimate.

Engineering Estimates

This method uses estimates of cost or labor hours based on the experience and expertise of your technical staff. It is based on a specification of the work effort and schedule typically associated with a bottom-up cost-estimating approach. Cost estimators may use factors like equipment reliability, maintainability, and component cost characteristics to develop estimates from the bottom up for each cost category.

Engineering estimates are viewed as the most subjective. Hence, they carry the highest risk. To offset this potential negative, you must carefully explain the cost-estimating process and the data you used to derive the estimate. You should also reference any previous and successful cost performance based on engineering estimates and emphasize the experience and expertise of the people performing the cost estimate.

Different cost-estimating methods carry more or less weight with cost evaluators. The more precise and objective your estimation methodology, the better. In addition, cost estimates tied to historical data for comparable requirements are viewed favorably. Some key characteristics of an effective and believable basis of estimate include the following:

• Uses a systematic and repeatable process

• Is based on objective characteristics of the task or product being estimated

• Is related to historical data for comparable requirements

• Is related to successful past cost and schedule performance

• Is clearly and thoroughly explained.

For hardware estimates, include a bill of material, where practical, and use actual vendor quotes as your basis of estimate for those costs. Likewise, for ODCs such as travel, use actual airfare and hotel room rate quotes. If you have any undefined travel destinations, make an assumption or select a baseline destination city on which to base quotes. Then include this information in your basis of estimate and in the ground rules and assumptions section of your cost proposal (see below).

Cost estimates are developed according to the WBS. For consistency, also present your basis of estimate according to the WBS. Rarely are basis-of-estimate formats specified by the RFP. So, you are free to build your own. Just make sure you include enough information to convince evaluators that you know what you are doing and to enable them to follow the logic you applied to derive the cost estimate. The following is a sample basis of estimate for WBS 1.2.3 (from Figure 14-7; dollar values are for illustration purposes only):

Risk Management

Risk management is an important part of your technical approach. It is also a valuable component of your cost proposal. If you have taken measures to mitigate risk, which includes cost, include this information in the cost proposal. If possible, quantify the dollar value of potential risks, both before and after you have applied your risk mitigation strategy. Also, include an explanation and the dollar amount of any risk management funds included in your cost proposal.

Explaining your risk management approach and identifying any contingent risk funds contained in your cost estimates may offset the potential of evaluators to assign an unfavorable risk rating to your cost volume. Doing so might also highlight a potential shortcoming of one of your competitors that does not include a risk management explanation in its cost proposal.

Ground Rules and Assumptions

Ground rules and assumptions are another important part of your cost proposal. Some elements of your cost estimate are conditional upon each of the ground rules and assumptions being true. Therefore, they must be documented in the cost proposal as completely as practicable.

Ground rules are the basic parameters you used to prepare cost estimates. They include things like whether costs are presented in “now” (current) year dollars or “then” year dollars or whether you used a constant escalation rate for cost beyond the first year of the contract. Ground rules are provided so that cost evaluators can better understand your cost proposal.

Assumptions generally need to be made in cases where RFP guidance is absent or vague concerning some program aspect on which your cost estimate is based. Some simple examples may involve assumptions about undefined schedule events, such as the start date of the contract, the start date of contract options, or the timing of government-provided assets (e.g., people, data, and equipment). Because your cost estimate is based on these assumptions, failing to meet them could jeopardize your ability to perform the contract for the amount proposed.

Include any assumption you made to estimate cost. In addition, if you have interpreted an RFP requirement to your advantage, you must include this assumption in your cost proposal.

Chapter 9 describes a case in which computer installation costs could be interpreted as being part of development, which was covered under a cost-type contract, or as part of operations, which were covered under a fixed-price contract. To avoid risk, we interpreted installation as a development task and bid it as part of the cost-type contract. Then we clearly explained this as an assumption in our cost proposal and included it as part of our WBS dictionary.

Here is another example of the prudent use of a documented cost-estimate assumption. We were bidding for a service contract being performed by another contractor. Employees at one of the work sites were covered by a collective bargaining agreement that was scheduled to expire between the time we submitted our proposal and the expected contract award date. We were afraid that the incumbent would renegotiate the collective bargaining agreement at higher salaries than those being paid when the contract was bid, which were the basis of our labor cost estimate. To protect ourselves, we included an assumption in our cost proposal that our proposed labor rates were based on salaries in effect when we submitted our proposal and that the same salaries would be in effect at contract award. We won the contract, and in fact higher salaries had been negotiated after we submitted our proposal. The information we put in our assumptions enabled us to be paid at the higher salaries versus the lower salaries contained in our fixed-price bid.

In essence, assumptions serve as insurance against those cases, after contract award, where your cost estimates are no longer valid because the assumptions on which they were based have not proven true. However, your assumptions may not contradict RFP guidance or requirements. Also, do not include every conceivable assumption. Limit assumptions to events that could have a meaningful impact on your actual incurred cost.

MAINTAINING GOOD COST PERFORMANCE RECORDS

Few activities will pay a higher return on investment than maintaining good records concerning your cost performance on past and current contracts and the method you used originally to estimate those costs. Creating and maintaining a database of past bases of estimates and the actual costs incurred on the subsequent contracts pays dividends in several areas.

First, past basis of estimates can be used to reduce the effort of preparing future cost proposals. They will probably need to be amended to fit the specific requirements of each bid, but this is still far more efficient than starting from scratch. Second, you can use actual contract cost data to adjust your basis of estimate. Over time, this should enable you to make more efficient and accurate cost estimates.

Finally, correlating your basis of estimate with actual contract cost performance is just the type of data the government is looking for in your cost proposal. Historically validated bases of estimates are worth far more than you will spend collecting and maintaining the data necessary to derive them.

Keeping good cost performance records, along with bases of estimates, potentially will enable you to reduce B&P costs, improve subsequent program cost performance, and enhance the customer’s evaluation of your cost proposal. These are all ingredients of gaining competitive advantage.

BEST-VALUE PROCUREMENTS

Many government agencies make a concerted effort to award contracts based on best value rather than low price. The application of such initiatives, however, is uneven across agencies. Some agencies have done a good job of making awards based on value. Others pay lip service to value yet remain fixated on cost.

Despite considerable cynicism among contractors, best-value awards are real. Government customers really do award contracts based on best value. However, you must fulfill several prerequisites if you plan to prance into the winner’s circle based on a best-value solution.

First, you must know your customer well enough to discern whether it will actually award to other than the lowest bidder. Second, you must have a sense of the “cost bandwidth” within which a best-value award will be made. This bandwidth is the percentage difference between the cost of the best-value solution and the cost of the next lower qualified bidder. My experience suggests that the bandwidth in most cases is a cost difference of no more than about 10 percent. Cost differences greater than this become very difficult for the customer to defend.

Third, value is in the eyes of the beholder. Therefore, you must ensure that the customer values the features of your technical solution enough to pay for them. Otherwise, the customer will pick a less expensive technically compliant solution. Fourth, your technical proposal must clearly and effectively communicate the value of your technical solution and its benefit to the customer.

Finally, I recommend that you include a best-value section in your cost proposal. Highlight those aspects or characteristics of your technical solution that provide value to the customer. To the extent possible, show the dollar value of your solution compared to a lesser, but technically compliant, solution. Oftentimes, value comes in the form of future cost savings or the ease with which a system can be modified to accommodate new requirements. In such cases, provide an estimate of the cost savings the customer can expect to achieve, or illustrate the “value” of an easily modifiable system. This is exactly the type of information source selection teams need to justify making a best-value award.

One of the chief reasons contracts are awarded on the basis of cost is that there is no discernible difference in the technical solutions proposed by competing bidders. If you hope to win based on value, you must convince evaluators that your solution has “value” and supply them with the ammunition necessary to support a best-value award.

Being the lowest-priced qualified bidder affords an inherent advantage. For procurements where cost is the primary consideration, it is an advantage not easily overcome. Even for procurements where cost is the least important factor, being the low bidder is still an enviable position. Nonetheless, in many instances, being the low bidder is not enough.

Sometimes the government is as interested in the basis of your cost estimates as it is in their absolute value. At other times the government weighs the value of your proposed technical solution against its cost. Hence, how you prepare and present cost information can have a significant impact on the evaluation of your cost proposal and ultimately on whether you win the contract.

Gain competitive advantage by recognizing there is often more to winning than bidding the lowest cost. Avoid common cost-proposal mistakes. Know your customer and the true role cost will play in the overall source selection process. Formulate your cost strategy accordingly, and make sure your technical solution fits within the customer’s budget. Understand the role that risk plays in the selection of contract type and the type and amount of cost information required to support government cost analyses.

Prepare and present your cost proposal in a way that enables evaluators to easily understand how you derived your cost estimates. Provide a strong basis of estimate based on historical data and previously completed contracts where you successfully fulfilled comparable contract requirements. Maintain good cost performance and basis of estimate records to support future proposal efforts. Ensure that each level of your cost estimate is traceable to higher-level WBS elements (e.g., CLINs, lots, SOW).

Avoid having evaluators assign high-risk ratings to your cost proposal or increase your proposed cost to determine most probable cost to the government. Make sure your cost proposal is thorough, complete, and accurate, and that estimated costs correspond with the solution and effort described in your technical proposal. If you undertake to win on value, then understand and be able to meet the key prerequisites necessary to capture a best-value procurement.