When the government conducts a contractor purchasing system review (CPSR), “subcontract price analysis” is typically at the top of the list of its findings. This is as it should be; after all, it’s taxpayer money we’re talking about.
That’s probably why news stories involving the Government Accountability Office (GAO) uncovering yet another case of overspending land particularly hard on the public’s ear. Why does this happen? I’ll argue that, in large part, there is a fundamental misunderstanding of the cost of—and a general lack of focus on—price analysis.
In general, price analysis is being overlooked as a source of cost savings and increased productivity.
Price analysis, as defined in Federal Acquisition Regulation (FAR) 15.404-1, “is the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit.” This analysis of price occurs in two distinct places in the value chain: first between prime contractors and subcontractors; and second, between the government and the prime.
In a general sense, both the government and prime contractors rely on FAR 15-404 as the authority on adequate price analysis. While the FAR and its related supplements were written for federal agencies, contractors often adopt may of the same standards either because they make good business sense or to simplify transactions with government customers.
Ask a procurement agent the objective of price analysis and you’ll likely get some form of the following answer: “We conduct price analysis to show that the price we paid is fair and reasonable.” Taken on the surface, it’s not egregiously inaccurate. You could even support that statement using the very first sentence of FAR 15.404-1: “The objective of proposal analysis is to ensure that the final agreed-to price is fair and reasonable.”
There’s an important difference between “justifying a price as fair and reasonable” and “determining a fair and reasonable price.” The objectives of these two statements are in conflict. The first focuses on documenting a given price as justified. The second focuses on the open-ended analysis of price reasonableness that results in a value that is unknown at the outset.
It probably seems obvious that simply justifying a known price isn’t productive. So why are so many companies doing it?
The answer to this question varies from organization to organization. However, there are a few basic principles that seem to apply across the board, both in government and private applications. It has to do with a lack of commitment that stretches from the bottom of the ranks to the top; the greenest of rookies all the way through executive leadership.
The people responsible for conducting and documenting price analysis sit at the end of an open spigot that never shuts off. Price analysis, then, becomes just another task in a long list of requirements that causes their backlog to grow.
For the owner of a company, there’s an obvious tie between determining the “right” price to pay and the effect on compensation. For employees, it’s far less clear. Most organizations’ main measurement of productivity is related to throughput, backlog, or both. While this may shine light on efficiency, it leaves “effectiveness” out in the cold.
For companies that have spent time and committed resources to the price analysis process, quality control measures typically mean that a compliance or management review is required. Great! But all too often, the standard of review is not written down, so employees are left to figure out what works. Their efforts then change from documenting a proper analysis to saying what the reviewer wants to hear.
Unless there’s a significant finding in a CPSR (contractor purchasing system review), a negative GAO report, or companies are losing competitions based on price, it’s unlikely that anybody’s going to raise price analysis as an issue…never mind that there’s money being left on the table!
The Contracts (sales) team wants to win deals. The Program (production) team wants goods on-dock so they can be delivered on time. Quality wants delivery standards to be met. Compliance wants to avoid audit findings. Finance wants everything cheaper. Price analysis improvements benefit everybody in the organization, but finding the budget and commitment to pay for it is typically viewed as “somebody else’s” problem. Once a team steps up, the others often try to force their needs and any progress gained is lost to bureaucracy and in-fighting.
If you’re cranking up compliance work, make sure to find an offsetting productivity benefit. The reality of the situation is that if price analysis reports are insufficient, bringing them up to par is going to mean more work. The good news is that this area of the business is often forgotten when it comes to process improvement, so there’s likely a gain to be had if you look closely. A great way to figure it out: Ask the people doing the work!
If your company is committed to improving price analysis, make sure that employees’ annual goals and objectives are in alignment. Your systems should be capable of automatically tracking progress against these goals.
All too often, price analysis is conducted using spreadsheets, word processors, calculators, and multiple internal and external websites. Switching between these results in loss of productivity and frustration. Furthermore, updating reports for follow-on procurements often leads to mistakes. Price analysis tools can help by streamlining the entire process.
Set measurable objective standards, communicate them to employees, and apply them evenly in all situations. Industry best practice is for the compliance review team to publish the checklist they’ll use when reviewing reports and to implement peer reviews prior to the official compliance review.
Remind people that the point of price analysis is to determine a price something should cost and sets an objective for negotiations. The work they put into the analysis becomes the information they need to be successful in closing the deal. Using a logic-based approach that relies on verifiable data opens the door to win-win agreements that grow the pie for everyone.
We live in the social media age and are more connected than ever…unless you’re looking at life at work. If your employees can’t quickly and easily access, copy, and modify the work of their peers, then your company isn’t keeping pace. Embrace collaboration!
If a company’s buying team doesn’t regard price analysis as ranking among the most critical parts of placing a purchase order, they’re leaving money on the table and don’t even know it. Furthermore, without the proper tools and top-down communication, expecting excellence in material pricing and negotiation is unreasonable on the part of leadership. Put the tools in place, communicate the expectation, and then measure and communicate the results. You may be surprised to find that rather than carrying a cost, improving price analysis in your organization becomes a source of net incremental savings. CM