By: Paul Emanuelli
This article is an excerpt from the 2022 edition of The Art of Tendering: A Global Due Diligence Guide.
Recent case studies highlight how flawed pricing strategies can undermine the defensibility of bid evaluations and undermine value-for-money objectives by removing incentives for efficient performance. This article analyses some of these recent cases and provides recommendations on how to develop appropriate pricing strategies.
Flawed pricing structures can have a significant adverse impact on the tendering process. For example, in its December 2020 decision in Cross Construction Services, Inc. v Department of Transportation, Florida’s Division of Administrative Hearings dealt with a dispute over a flawed pricing form that resulted in the cancellation of a tendering process. The case involved two tender calls for asbestos abatement, removal, and demolition services. The Department rejected all bids and decided to re-tender the requirement. That decision was challenged by two bidders. While the court ultimately decided that the ambiguity in the pricing form caused bid compliance issues and justified the cancellation of the process, this case serves as a useful reminder of the importance of using clear pricing forms in a tendering process to avoid downstream irregularities that may be fatal to the evaluation process and trigger legal challenges.
Similarly, in its October 2020 decision in Vectrus Mission Solutions Corporation, the U.S. Government Accountability Office (GAO) ordered the government to award a contract to the complainant after finding flaws in the original price evaluation process. The dispute dealt with a Request for Proposals (RFP) for the Department of the Army for logistics support services at Fort Benning, Georgia. The complainant challenged the evaluation process since its bid included a price cap, but the evaluators failed to take that cap into account in their analysis of pricing. As the GAO summarized, during the cost realism analysis, the government evaluators made “two upward cost adjustments to the Vectrus cost/price proposal for a total amount of $19,719,898.”
The complainant took issue with these price adjustments since its bid included a legally binding promise in its cost proposal to limit the cost to the agency over the course of contract performance. The complainant argued that the cost-capping was permitted under the RFP rules and that it was therefore “improper for the agency to have applied the upward cost adjustments to its proposal for evaluation and source selection purposes.” The GAO agreed, finding that the price calculations were flawed and that the evaluation flaws cost the complainant the contract award. The GAO therefore ordered the government to rescind the award to a competing bidder and to award the contract to the complainant instead.
Furthermore, in its January 2021 decision in Crowley Government Services, Inc., the GAO directed the government to either conduct a re-evaluation of pricing or cancel, amend, and reissue its solicitation to clearly disclose its price calculation rules. The dispute dealt with a Request for Proposals for the Defense Logistics Agency for various petroleum products. The evaluation was challenged by two complainants who argued that the agency misevaluated their prices. As the GAO explained, due to the market volatility of prices for the solicited products, the RFP included an economic price adjustment (EPA) clause that permitted price adjustments throughout the contract period. More specifically, the EPA clause provided for daily price adjustments Monday through Friday, with prices for Saturday and Sunday based on prices established on the preceding Friday. Those prices would be based on published Government Preferred Base Reference Indexes.
However, after posting the RFP, the government released an addendum that allowed bidders to opt out of the government price escalators and instead propose their own price escalators, which were referred to in the addendum as “uncommon escalators”. The addendum stated that those uncommon escalators would be subject to additional price calculation procedures. However, the addendum failed to specify that bids that were based on the government price escalators would also be subject to those additional price calculation procedures.
Rather than limiting those additional calculations to uncommon bidder-proposed escalators as contemplated in the addendum, the evaluators applied those calculations to all proposed pricing, including bids that were based on government price escalators. Two bidders who submitted pricing based on the government price escalators challenged the application of those calculations to their price evaluations. The GAO sustained the protests, finding that the government failed to clearly define its price evaluation rules. As this case illustrates, public institutions need to be precise in defining their price evaluations and should ensure that their calculations are in line with the rules established in their solicitation documents.
In fact, overly complicated price evaluation methods raise the risk of evaluation irregularities and resulting legal challenges. For example, in its October 2020 decision In the Matter of Appeal by Mid-State Communications & Electronics Inc. with respect to the procurement of Tower and Communications Facility Maintenance Services conducted by the New York State Police, New York’s Office of the State Comptroller struck down a contract award after finding that the price evaluation method arbitrarily awarded more points to bidders who bid on more lots even if those additional bids were non-competitive. The dispute dealt with a Request for Proposal (RFP) for public safety communications equipment and services throughout New York State. The RFP sought bids for 12 individual lots and permitted bidders to submit bids for one, several, or all lots.
While the per-lot bid prices were evaluated based on a conventional relative pricing formula, with the lowest total cost receiving the full number of available points in the 75-point price category and the higher bids receiving a proportionately lower score out of 75, the Comptroller found that bidders were arbitrarily awarded up to an additional 25 points in the remaining “technical score” category based on the number of total bids they submitted across all lots. This had the effect of distorting the price evaluation since higher-cost bidders could earn bonus points based on the number of total bids submitted across all lots even if their pricing was not competitive.
In fact, the Comptroller found that a bidder that submitted the highest cost in a specific lot was awarded the contract based on the bonus points earned by having submitted a high number of bids for other lots. As the Comptroller concluded, “awarding additional points to an offerer with respect to one Lot simply because that offerer submits a proposal on another Lot, no matter how high-cost that other proposal might be, bears no reasonable relationship to the application of best value, i.e., the optimization of quality, cost and efficiency.” Since the unnecessarily complicated and flawed price evaluation scheme led to obvious distortions in the evaluation of prices, the contract award for the lot in question was struck down as legally invalid.
Purchasing institutions are also under a duty to protect pricing information from inadvertent disclosures since those disclosures can compromise a bidder’s future competitive position. For example, in its May 2021 decision in Inmarsat Government, Inc., the GAO found that the government improperly disclosed the incumbent’s pricing during pre-bid market consultations. It therefore ordered the government to cancel, re-scope, and re-tender the solicitation to address the prejudice caused to the incumbent. The dispute dealt with a Request for Proposals (RFP) issued by the Defense Information Systems Agency (DISA) to procure worldwide commercial broadband satellite services for the Department of the Navy, Military Sealift Command.
As the GAO summarized, the contract included two pricing categories, one for bandwidth services, and the other for non-bandwidth services. The government inadvertently disclosed the incumbent’s non-bandwidth pricing in a draft RFP that was released to the market. The incumbent challenged the resulting final RFP since the government did not take adequate steps to mitigate the prejudice caused by the disclosure by re-scoping the solicitation. The government argued that there was no prejudice to the incumbent since the disclosed pricing was from a prior contract and was now stale information. However, the incumbent countered by asserting that its pricing remained the same as the prior contract due to the competitive nature of the marketplace. The GAO therefore ordered the government to cancel, re-scope, and re-tender its requirements to mitigate the prejudice to the incumbent. As this case illustrates, government institutions must be careful to protect competitor pricing to preserve the integrity of future competitive bidding processes.
Flawed pricing structures can also adversely impact value-for-money in the administration of contracts. For example, in its February 2021 report entitled Getting to the Root of the Issues, the City of Toronto’s Auditor General found ongoing issues in the management of the City’s tree maintenance contracts. The report, which was a follow-up audit to a 2019 report entitled Review of Urban Forestry – Ensuring Value for Money for Tree Maintenance Services, found persistent problems relating to the hourly billing practices of tree maintenance contractors. More specifically, the report, which was based on field surveillance of contractor activities, found that work crews “were actively working on trees for, on average, less than half of the eight-hour standard paid work day.”
In fact, the audit found that “vendor crews were actively working on trees for, on average, only about 3.5 hours (44 per cent of the day).” The report defined “actively working on trees” as including setting up a job site, preparing for work through on-site discussions, directly performing tree maintenance and site clean-up, and performing other related activities including paperwork. However, the report found that for “over a quarter of the day crews were taking breaks, idle, or otherwise not observed to be productive and actively working on trees”. Furthermore, the Auditor General found that “during periods of time where crews reported on their daily logs that they were working on trees, crewpersons were observed eating, drinking, chatting with others, smoking, using their phones, sitting in the truck / on the curb / on the grass or just standing around.”
The Auditor General determined that an increase of 30 minutes per day in productivity would translate to $1 million worth of additional tree maintenance work per year” and noted that, moving forward, the City planned to pay for some of the services under unit price contract structures, rather than time-based payment schemes. As this report illustrates, adopting stipulated sum or fixed-unit-price payment structures, as opposed to hourly rate payment structures, can help shift the risk of unproductive contractor staff time back onto contractors. This adjustment will likely increase the incentives to efficient performance without increasing the cost of contract management that would be incurred by the City if it had to deploy more staff to properly oversee the current time-based contracting arrangements.
The failure to establish consistent pricing structures can create significant barriers to comparing value-for-money between different contracts in the same portfolio. For example, in a July 2021 data bulletin entitled An Examination of County Jail Communication Services and Equipment Contracts, Kentucky’s Auditor of Public Accounts raised concerns over the award of non-competed communication services contracts in county jails. The contracts in question were not subject to procurement open tendering rules since they did not involve the expenditure of public funds. Rather, they were revenue-generating contracts since inmates paid for the services directly to the service providers, who then remitted a percentage of that payment back to the jails.
As the audit found, most of these contracts were directly awarded with only 32 of the 116 contracts reviewed having been put to tender. This raised value-for-money concerns since the rates charged to the inmates were well above prevailing market rates. The audit also raised concerns over a lack of consistency in the contract payment structures, where payments from the service providers to the jails came in various forms including commissions, in-kind technology grants, signing bonuses, incentive payments, line of credit loan arrangements, and other free services.
These varied arrangements also raised significant transparency concerns since the revenues were not always accurately reported by the jails, particularly when payments were made in the form of other benefits not directly connected to the communication services. In fact, the report found that many of the long-standing contracts were never formalized in writing and were instead verbal arrangements between the jail administrators and the service providers. The report also noted that “verbal contracts for a year or more are not enforceable in court under Kentucky’s statute of frauds, KRS 371.010, a situation which may make the legal risk unacceptable.” Further, the report stated that “verbal contracts present an internal control issue that may trigger an adverse audit finding.” To better address these transparency concerns, the report recommended that Kentucky’s procurement legislation be amended to regulate the award of jail communication contracts under the open tendering rules that applied to other government contracts. This would better promote consistent and transparent contracting practices.
Establishing appropriate pricing strategies lies at the heart of obtaining value-for-money and avoiding contract cost overruns. In its December 2020 Practitioner’s Guide for Procurement Pricing, Public Services and Procurement Canada highlighted a series of considerations for how to properly structure contract pricing. As the guide states, “pricing is a fundamental enabler to the achievement of best possible value in a procurement.” In fact, the guide notes that “effective pricing begins with the development of a pricing strategy that closely aligns with the overall procurement strategy to ensure pricing decisions are in accordance with the procurement’s objectives and priorities.” To achieve this alignment, the guide notes that it is “essential that a pricing strategy is developed early on in the procurement process.”
Furthermore, the guide notes that the pricing strategy should be well documented since “it is essential to have a transparent approach to documenting the pricing strategy, the pricing approach and the decisions with respect to the pricing principles” and that this documentation “be thorough and comprehensive enough to enable others to understand how the pricing strategy was intended to function.”
Since the creation of appropriate pricing structures cannot be reduced to pre-prescribed, one-size-fits-all formats, the guide provides recommendations to assist contracting officers in the exercise of professional judgment in developing a pricing strategy. The guide notes that it may be possible to establish a fixed-fee pricing structure for simple short- and-medium-term contracts, and it may also be possible to extend the duration of those contracts by applying price adjustment formulas for longer-term contracts.
However, as the guide warns, not all contracts can be scoped with sufficient certainty to allow for fixed prices and shifting too much price risk onto contractors can create incentives to cut corners during contract performance. The guide therefore identifies other pricing options, including hourly rate or unit rate contracts, as well as cost-plus contracts. However, while setting hourly rates may be an alternative to fixed price contracts, the guide notes that this approach can undermine a contractor’s incentive to perform more quickly. The guide states that in some instances, unit price contracts, where contractors are paid for predefined units of work or products, may be a more viable alternative. Furthermore, the guide also notes that “a contract need not be confined to a single basis of payment” since it may be possible to set a fixed price for the more predictable aspects of a contract while carving out different pricing structures based on hourly rates, unit costs, or cost-plus arrangements for the less predictable aspects of that same contract.
The guide identifies the cost-plus model as the best solution for contracts that involve a high degree of uncertainty but warns that these pricing structures create additional risks that must be effectively managed in the procurement process. As the guide notes, the use of cost-plus contracts requires a careful definition of the cost base, along with clarity around how the “plus” aspect of the contract will be managed to pay the contractor a profit for performing the work. The guide provides different options for paying the “plus” portion of the cost-plus contract, including fixed fees, hourly rates, or a percentage of the total contract price. However, it recommends against that last option since determining payments based on a percentage of the total contract price “provides little or no control over contractor costs and actually encourages contractors to increase costs as a way to increase profit.”
In summary, the guide underscores the need to develop a customized pricing strategy tailored to the unique challenges of the specific contracting situation while also highlighting the need to clearly document for future record-keeping purposes. As recent case studies show, flawed pricing strategies can undermine the defensibility of bid evaluations and undermine value-for-money objectives by removing incentives to efficient contractor performance. Taking the time to develop an effective pricing strategy, particularly for complex projects, is therefore time well spent.
