When thinking of Lean principles (which is the common name for the principles of the Toyota Production System), most people think of single-piece manufacturing flow and continuous improvement of manufacturing processes.  Other people realize that Lean can be applied to other back-office processes such as accounting and finance.  Still others are considering how Lean can be applied to program management and supply chain management.  We’ve yet to see Lean applied to proposal preparation, even though everybody agrees that the existing processes take too long and cost too much.  Recent DCAA audit guidance that directs auditors to question (as being unsupported) subcontractor bids for which the higher-tier contractor fails to perform cost and price analysis underscore the need to apply Lean principles to the proposal preparation process—particularly with regard to managing subcontractor bids.

Performing Cost and Price Analysis on Subcontractor Proposals

FAR 15.404-3(b) requires that a prime contractor perform cost or price analysis on proposals received from prospective subcontractors in order to establish that the subcontractors’ proposed prices are reasonable in amount.  Price analysis is the process of examining and evaluating a proposed price without separating evaluating individual cost elements and proposed profit/fee amounts.  There are different price analysis techniques available; however, most involve comparison of the proposed price with another price, generally through obtaining competition.  In contrast, cost analysis is the review and evaluation of separate cost elements and proposed profit/fee in an offeror’s proposed price, and the use of judgment to determine how well the proposed costs represent what the contract costs should be, assuming reasonable economy and efficiency.  It is focused on a single bid.  Generally, this effort involves examination of “cost or pricing data” or “information other than cost or pricing data”.  “Cost or pricing data” is a term of art, defined at FAR 2.101, and indicates that the offeror is under a duty to disclose all relevant facts and verifiable data, as required by the Truth-in-Negotiation Act (TINA).  A prime contractor whose proposal is subject to TINA requirements may also have to submit its analyses of the subcontractors’ cost or pricing data as part of its cost or pricing data submission – meaning that there may be three sets of data to which it is certifying under TINA:  (1) its own cost or pricing data, (2) the subcontractors’ cost or pricing data, and (3) its analyses of the subcontractors’ cost or pricing data.  That’s quite a bit to keep track of. 

It’s also quite a bit to evaluate, assess, and certify to.  As part of the prime’s proposal process, it must determine which aspects of the work will be subcontracted (via a make-or-buy analysis), tell the subcontractors what they should propose on (and either obtain competition for price analysis or obtain sufficient data for cost analysis), determine which subcontractor proposals will be subject to TINA requirements, perform and document the required analyses, and prepare the required submissions to the Government.  That’s a lot to get done in the short proposal preparation timeframe.

Recent DCAA Guidance

On June 30, 2009 the DCAA issued audit guidance entitled “Audit Guidance on Performing Audits of Subcontract Forward Pricing Proposals.”  Much of the guidance focuses on how auditors might review subcontractor proposals before the prime contractor has completed its proposal efforts.  This aspect of the guidance is relatively benign, unless one was to take issue with DCAA’s definition of a subcontractor.  (DCAA uses the FAR Part 44 definition, which is expressly limited solely to activities covered by FAR Part 44 and thus does not apply to activities covered by FAR Part 15.)  Other aspects of the audit guidance are more troublesome.

The guidance instructs auditors to “(1) determine if the prime contractor completed the required cost or price analyses of its subcontractors and (2) review the adequacy of the prime contractor’s analyses.  For those analyses that are not completed, determine the contractor’s completion schedule.”  Importantly, the guidance directs auditors to question as being unsupported any proposed subcontractor costs for which the prime has not completed the required cost or price analysis.  According to the audit guidance,

“The contractor’s estimating system should have policies and procedures in place to conduct the required cost or price analyses and provide it to the Government negotiator prior to negotiation of the prime contract price.  If, due to time or other constraints, the prime contractor cannot complete the required analyses prior to the submission of its prime contract proposal, the prime contractor should have policies and procedures in place to ensure a plan is implemented to complete the analyses prior to the prime contract negotiation. “

In addition to questioning proposed costs, the audit guidance directs that, for those contractors that continually fail to perform cost or price analysis, a “flash” audit report should be generated documenting the estimating system deficiency.  For “major contractors,” this will lead to a “limited scope” audit to confirm the control failure.  If confirmed, the DCAA auditor is to recommend that the contractor’s estimating system should be determined to be inadequate.  Accordingly, contractors will need to focus on obtaining the necessary data from their proposed subcontractors and performing the required cost/price analyses, in order to avoid a significant amount of questioned costs and to maintain the adequacy of their estimating systems.

Commentary on the DCAA Audit Guidance

A couple of points on the DCAA audit guidance may help put it into perspective.  First, when DCAA “questions” costs, it does not mean that the costs are unallowable or that the customer will not pay them.  It does provide a strong position from which the customer can negotiate, and it means that negotiations will be harder than they otherwise would be.  It’s not a position to aim for, and it will require hard work to overcome, but it is not fatal.

Second, an inadequate estimating system is not the end of the world.  Although a good Government contractor should have at least ten adequate control systems, estimating is not as important as, say, the accounting or billing systems are.  That said, it will be difficult to be considered to be a “low risk” contractor—particularly when an ID/IQ contract will require multiple task order proposals—if the estimating system cannot be trusted.  As with the questioned costs situation, it’s not a position to aim for, and it will require hard work to overcome, but it is not fatal.

Finally, a word about TINA and the term “cost or pricing data”.  The term “cost or pricing data” is defined at FAR 2.101.  The DCAA audit guidance appears to conflate the terms “cost or price analysis” with “cost or pricing data” but they are not at all the same thing.  TINA is a disclosure requirement.  Contract actions subject to TINA (see FAR 15.403-4 and 15.403-5) need not be based on cost or pricing data; the cost or pricing data need merely to be disclosed in an organized fashion.  Moreover, the proposal itself is not cost or pricing data.  The prime’s cost or price analyses are performed on the proposal(s) submitted by the subcontractor(s), not necessarily on the subcontractors’ cost or pricing data.  It is true, however, that where the prime is subject to TINA, its subcontractor cost or price analyses become part of its cost or pricing data to be disclosed to its customer.

Lean Proposal Preparation

Many prime contractors do not have time to solicit multiple subcontractor bids and evaluate them properly during the proposal preparation process.  There is simply too much happening in to short of a timespan, and B&P budgets rarely permit the kind of robust staffing required to comply with the FAR requirements.  Given the DCAA audit guidance and potential consequences associated with a continued failure to perform subcontractor cost or price analysis, it is more important than ever to establish a process where more can be accomplished in less time and for less money.  The answer, as with most process improvement initiatives, lies with applying Lean principles to the proposal preparation process.

Lean is about avoiding waste.  Waste comes from many sources; commonly, waste in the administration process comes from the repetition of (1) prepare, (2) review, comment and return for rework, and (3) repair and resubmit.  Any time this cycle can be broken will create process efficiencies.  With respect to proposal preparation, it is important to work with subcontractors in the early stages of the proposal process to flesh out objectives, risks, and budgets.  There is no time to return subcontractors’ proposals as being inadequate, or too expensive; the program team must operate as a single team by collaborating from day one in order to get it right the first time.

Another area to address is to avoid treating the subcontract as if it was a transaction.  If viewed as a transaction, then all the process steps need to be performed for each subcontract action or for each proposal.  In contrast, treating the subcontract as part of an alliance or partnership creates opportunities to perform some process steps once and once only, and then leverage from those steps for future activity.  For example, competing precision casting shops once and then awarding a long-term subcontract to the winner, for all precision casting activity over, say, a five-year period, avoids wasteful recompetition and permits the pricing to be evaluated once and then used again and again.  Problem solved.

There is much more to say about applying Lean principles to proposal preparation processes.  The foregoing hopefully gives the reader a taste of what can be done with the right attitude and desire to streamline and improve.  The recent DCAA audit guidance clearly spells out what will happen to those contractors who do not focus on this area.