Breakout Session # 303

2. Afraid of Heights – Government Reluctance to Embrace Commercial Contracting Breakout Session # 303 Philip G. Bail, Jr., CPCM, Fellow, Manager,U.S. Government Contract Management, Small Business Liaison Officer (SBLO) Derco Aerospace, Inc. Milwaukee, WI Date April 23, 2007 Time 1450-1550 hours

3. Premise Conflicts between existing policy, current practice and new developments may destroy the move to commercial item acquisition. Issues are primarily tied to (1) is a product or service “commercial”, and (2) what data a contractor must provide to support proposed price so contracting officers can determine price reasonableness

4. Outline ” Commercial Item - Product • Flat Panel TV Purchase • History of Commercial Item Acquisition • Current Rules - Existing Acquisition Process • Definition of a Commercial Item • Commercial Item Pricing • Misconceptions • Real Life Example of Commercial Item Futility Commercial Item - Services” • Myths • Price Reasonableness New Developments Bottom Line

5. Flat Panel TV Sale – December 2006 • Situation • Best Buy Price for 42-inch plasma HDTV $999.00 • Circuit City Price for 42-inch plasma HDTV $1,049 • If the Government bought the Best Buy Flat Panel, any problem justifying the price as being fair and reasonable? BUT...

6. Wall Street Journal Article onWednesday, January 3, 2007 • WSJ identified margin for Best Buy between 30-40% on these Flat Panel Televisions • Any after the fact issue from the government contracting officer about the fairness of the price paid?

7. C-130 Aircraft Actuator • Sole Source • Item justified as meeting “Commercial Item” definition – similar to same part on commercial aircraft • Manufacturer price includes margin of 40% • Is this price fair and reasonable?

8. Background • Federal Acquisition Streamlining Act (FASA) passed in late 1994; followed by Clinger-Cohen Act (CCA) • FAR Part 12, Commercial Item Acquisition, published in early 1995 • Legislative and regulatory objectives included process streamlining, access to current technologies/products, attracting more bidders/suppliers, and reducing overall acquisition cost • FASA, CCA, and FAR Part 12 establish Commercial Item Acquisition as the PREFERRED method of contracting for prime contracts and subcontracts – FAR Part 12 takes precedence over other FAR Parts • Adoption of FAR Part 12 driven by perception and reality of necessity – traditional system is broken and USG industrial base is declining

9. Definition of Commercial Item • FAR 2.101 – establishes categories of Commercial Items ranging from identical to “of a type” to combinations – products and services – pick one category for each purchase • Intent is for the USG/Buyer to do market research (FAR Part 10) to “determine” if a commercial market exists for the item or type of item to be purchased • Definition to be interpreted and applied broadly – preference for Commercial Items • Determination not primarily a technical or engineering analysis – business judgment IAW FASA, CCA, FAR Part 12, DOD Handbook • Determination of “commerciality” has nothing to do with pricing – apples and oranges – common point of confusion/contention • Determination not driven by quantities/sizes of USG & commercial markets – no “majority customer” test

10. Commercial Item Pricing • FAR Subpart 15.4 contains pricing rules and guidance • FAR emphasis is on “price analysis” vs. “cost analysis” for Commercial Items and getting pricing information from sources other than the contractor • Commercial Item contracts and subcontracts are NOT subject to CAS, TINA, or Cost Principles – no certifications – reduced risk for prime contractors and subcontractors – same for contract modifications that do not change the item to a “noncommercial” item • If provided, pricing information is identified as uncertified “information other than cost or pricing data” • Always remember the False Claims Act (FCA) still applies – no false or misleading information to be provided – good rule for all facets of all USG transactions

11. Commercial Item Contracting Process • Typical proposal/negotiation process should consist of the following 3 steps in the order presented: 1. Does the item (product or service) meet the Commercial Item definition at FAR 2.101? 2. What are the appropriate terms and conditions of the Commercial Item contract/subcontract? 3. What is the price for the Commercial Item and the appropriate pricing method? IMPORTANT from a contractors perspective to distinguish these three steps and try to get the government buyer to follow them in the listed sequence

12. Commercial Item Top 10” Misperceptions • The end item is “noncommercial” so nothing in or on the item can be a Commercial Item – e.g., F-16 • The spec/SOW calls out military specs/standards therefore the item cannot be a Commercial Item • The USG item must be identical to commercially sold items to be a Commercial Item • If the USG is the “majority buyer” the item cannot be a Commercial Item • Any noncompetitive purchase must or should be supported by detailed cost information – price vs. cost analysis

13. Commercial Item“Top 10” Misperceptions • A detailed drawing/engineering/bill of material analysis is required to determine “commerciality” • All “commerciality” determinations for subcontracts must be made or approved by the USG PCO • Prior determinations of “commerciality” can be disregarded for subsequent purchases, especially if not made by the USG • An item requiring nonrecurring engineering (NRE) or more than “minor modifications” cannot be a Commercial Item • An item originally designed or developed for the USG cannot be a Commercial Item – “chicken and egg argument”

14. U.S. Army Commercial Item Determination Scenario • Contractor Quoted M1 tank voltage regulator spares to US Army • Fit FAR definition @ 2.101 (3)(i): (3) Any item that would satisfy a criterion expressed in paragraphs (1) or (2) of this definition, but for – (i) Modifications of a type customarily available in the commercial marketplace; or • Initially, with minimal market research data provided, Army approved contractor’s commercial item assertion • Submitted price proposal; price higher than last buy • Contracting Officer asked DCMA to get involved with pricing, Contractor declined – because of commercial item determination

15. U.S. Army Commercial Item Determination Scenario - (cont’d) • Contracting Officer then reversed decision and said item didn’t meet commercial item designation • Contractor provided more detailed technical information on voltage regulator; Army denied commercial item designation • Contractor elevated to agency commercial item advocate; Army still disagreed • “Comparing ground application to Aerospace stretches “of a type”definition” • “Specific circuit cards for the voltage regulator are not listed in the catalog” • Contractor requested face-to-face meeting, Army still disagreed • Finally…Contractor agreed to the quote as FAR 15

16. Commercial Item - Services (FAR 2.101) Commercial Services are – (5) Installation services, maintenance services, repair services, training services and other services – if (1) the services are in support of a Commercial Item; and (2) your company provides similar services to the general public under the same terms and conditions. (6) Services “of a type” offered and sold competitively in substantial quantities in the commercial marketplace – based on established catalog or market prices. This does not include services based on an hourly rate without a catalog or market price.

17. Award Determination When determining whether to purchase services proposed as commercial, the Government must ask two questions: • Are the proposed services commercial in nature? • Is the price reasonable?

18. “Commercial in Nature” Contractors oftentimes have commercial contracts with: • Private corporations. • U.S. Government agencies, who recognize certain services as commercial in nature (contract on a Standard For 1449). • Aviation Services, i.e., Supply Chain Management, PBL or CLS orHazardous Waste Disposal • Prime Contractors, when the services are recognized as commercial.

19. Common Myths 1. The service must be in support of a commercial item. FALSE. The Department of Defense, Commercial Item Handbook clarifies: • A service is considered a commercial item when it is provided in support of a commercial item as previously defined. • A service is ALSO considered a commercial item when it is of a type offered and sold competitively in substantial quantities in the commercial market on the basis of established catalog or market prices for specific tasks performed under standard commercial terms and conditions. (Handbook, pg. 9)

20. Common Myths 2. The service proposed to the U.S. Government must be the exact same type of service offered and sold in the commercial marketplace. FALSE. The Department of Defense, Commercial Item Handbook clarifies: “The latter, stand-alone definition [subparagraph (6)] does not preclude the inclusion of Government-unique requirements or terms and conditions, as long as there are sufficient ‘common characteristics’ between the commercially available service and the service being acquired.” (Handbook, pg. C-2)

21. Common Myths 3. Contractor must have offered and sold the service in substantial quantities in the commercial marketplace. FALSE. The FAR requires only that the service be offered and sold in the commercial marketplace in general, regardless of who is offering and selling the service. The Department of Defense, Commercial Item Handbook clarifies: “An item is commercial because of the supply or service itself, not because of who provides the item. For example, a Government source such as NIB/NISH can be governed by a FAR Part 12 contract for janitorial services even if it does not provide those services in a commercial market.” (Handbook, pg. 10)

22. Price Reasonableness Issue One issue that has been raised in the past is a concern about the tiering of profit between a contractor and its subsidiaries under common control. Such concern is unwarranted. For commercial services, the FAR explicitly permits the contractor to include a subsidiary’s total price, rather than merely the cost, when the services are procured on a commercial basis. (FAR 31.205-26 (e)) The key question is whether or not “the price is reasonable”.

23. New Developments: Section 1423 Advisory Panel Report to OFPP/Congress – Commercial Practices Recommendations (December 2006) • Commercial Practices Report contains 11 findings and 10 recommendations • Revise FAR provisions that permit the government to require “other than cost or pricing data” to be more like commercial practice – emphasize price reasonableness by competition, market research, and analysis of prices for similar commercial sales. • Move provisions for determining price reasonableness for commercial items to FAR Part 12 instead of being tied to FAR Part 15 • Establish clear preference for market-based price analysis. Require limited additional information if price reasonableness can’t be determined • Prices paid for same or similar commercial items • Information regarding price or limited cost related information to support price offered, I.e., subcontracts, material costs, wages. • No detailed cost breakdowns or profit. Reliance must be on price analysis • No certification of data or post award audit

24. DoD Inspector General Report D-2006-115, September 29, 2006 • Report Recommendation: Only those commercial items “sold in substantial quantities to the general public” should be exempt from certified cost and pricing data requirements • Rationale: Only goods sold in substantial quantities have an appropriate basis to establish a fair and reasonable price”

25. Bottom Line • Government Panels, GAO and IG have to get on the same page in determining when a product or service is commercial • Contractors have to provide “sufficient” data to justify price • Government has to be staffed to be able to perform adequate market research • Profit on commercial items, if discussed during negotiations, have to more closely approximate the commercial market

26. Definition of a Commercial Item • “Commercial item”means -- • (1) Any item, other than real property, that is of a type customarily used by the general public or by non-governmental entities for purposes other than governmental purposes, and-- • (i) Has been sold, leased, or licensed to the general public; or, • (ii) Has been offered for sale, lease, or license to the general public; • (2) Any item that evolved from an item described in paragraph (1) of this definition through advances in technology or performance and that is not yet available in the commercial marketplace, but will be available in the commercial marketplace in time to satisfy the delivery requirements under a Government solicitation; • (3) Any item that would satisfy a criterion expressed in paragraphs (1) or (2) of this definition, but for -- • (i) Modifications of a type customarily available in the commercial marketplace; or • (ii) Minor modifications of a type not customarily available in the commercial marketplace made to meet Federal Government requirements. Minor modifications means modifications that do not significantly alter the nongovernmental function or essential physical characteristics of an item or component, or change the purpose of a process. Factors to be considered in determining whether a modification is minor include the value and size of the modification and the comparative value and size of the final product. Dollar values and percentages may be used as guideposts, but are not conclusive evidence that a modification is minor; • (4) Any combination of items meeting the requirements of paragraphs (1), (2), (3), or (5) of this definition that are of a type customarily combined and sold in combination to the general public;

27. Definition of a Commercial Item (continued) • (5) Installation services, maintenance services, repair services, training services, and other services if-- • (i) Such services are procured for support of an item referred to in paragraph (1), (2), (3), or (4) of this definition, regardless of whether such services are provided by the same source or at the same time as the item; and • (ii) The source of such services provides similar services contemporaneously to the general public under terms and conditions similar to those offered to the Federal Government; • (6) Services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices for specific tasks performed or specific outcomes to be achieved and under standard commercial terms and conditions. For purposes of these services— • (i) “Catalog price” means a price included in a catalog, price list, schedule, or other form that is regularly maintained by the manufacturer or vendor, is either published or otherwise available for inspection by customers, and states prices at which sales are currently, or were last, made to a significant number of buyers constituting the general public; and • (ii) “Market prices” means current prices that are established in the course of ordinary trade between buyers and sellers free to bargain and that can be substantiated through competition or from sources independent of the offerors. • (7) Any item, combination of items, or service referred to in paragraphs (1) through (6) of this definition, notwithstanding the fact that the item, combination of items, or service is transferred between or among separate divisions, subsidiaries, or affiliates of a contractor; or • (8) A nondevelopmental item, if the procuring agency determines the item was developed exclusively at private expense and sold in substantial quantities, on a competitive basis, to multiple State and local governments.