B-162387, DECEMBER 11, 1967, 47 COMP. GEN. 336

B-162387: Dec 11, 1967

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THE DETERMINATION THAT THE COST ESTIMATES SUBMITTED WERE UNREALISTIC. WAS IMPROPER AND NOT IN ACCORD WITH 10 U.S.C. 2304 (G). REQUIRING THAT OFFERORS WITHIN A COMPETITIVE RANGE BE INFORMED OF THE AREAS IN WHICH THEIR PROPOSALS ARE DEFICIENT AND BE GIVEN AN OPPORTUNITY TO JUSTIFY THE REASONABLENESS OF THEIR COST ESTIMATES OR TO REVISE THOSE ESTIMATES AND/OR FEE FLOORS TO SATISFY THE GOVERNMENT'S REQUIREMENTS. 1967: REFERENCE IS MADE TO A LETTER AND ENCLOSURES DATED SEPTEMBER 12. ALTHOUGH THE PROTEST WAS SUBMITTED BEFORE AWARD. AWARD WAS MADE. ON THE BASES THAT THE PRIOR CONTRACT WITH PAGE WAS TO EXPIRE ON SEPTEMBER 30. THAT NEGOTIATION OF AN EXTENSION OF THAT CONTRACT WAS NOT FEASIBLE.

B-162387, DECEMBER 11, 1967, 47 COMP. GEN. 336

CONTRACTS - NEGOTIATION - COST-PLUS-INCENTIVE-FEE CONTRACTS - DEFICIENT PROPOSALS UNDER A REQUEST FOR QUOTATIONS CONTEMPLATING A COST-PLUS-INCENTIVE FEE CONTRACT FOR AIRCRAFT MAINTENANCE SERVICES, THE CONTRACT TO CONTAIN AN OPTION FOR THE CONTINUATION OF THE SERVICES, THE DETERMINATION THAT THE COST ESTIMATES SUBMITTED WERE UNREALISTIC, MAKING IT IMPOSSIBLE FOR OFFERORS TO QUALIFY FOR INCENTIVE FEES, AND THE AWARD WITHOUT FURTHER NEGOTIATION OF A FIXED-FEE CONTRACT INSTEAD ON THE BASIS OF FEE FLOORS AND RATES FOR EMPLOYEE INSURANCE BENEFITS, THE ONLY AREAS OF DIFFERENCE BETWEEN OFFERORS WITHIN A COMPETITIVE PRICE RANGE, WAS IMPROPER AND NOT IN ACCORD WITH 10 U.S.C. 2304 (G), REQUIRING THAT OFFERORS WITHIN A COMPETITIVE RANGE BE INFORMED OF THE AREAS IN WHICH THEIR PROPOSALS ARE DEFICIENT AND BE GIVEN AN OPPORTUNITY TO JUSTIFY THE REASONABLENESS OF THEIR COST ESTIMATES OR TO REVISE THOSE ESTIMATES AND/OR FEE FLOORS TO SATISFY THE GOVERNMENT'S REQUIREMENTS. HOWEVER, ALTHOUGH PRACTICAL CONSIDERATIONS MILITATE AGAINST CANCELLATION OF THE CONTRACT, THE CONTRACT OPTION SHOULD NOT BE RENEWED BUT A NEW CONTRACT NEGOTIATED.

TO THE SECRETARY OF THE ARMY, DECEMBER 11, 1967:

REFERENCE IS MADE TO A LETTER AND ENCLOSURES DATED SEPTEMBER 12, 1967, FROM THE DIRECTOR OF MATERIEL ACQUISITION, OFFICE OF THE ASSISTANT SECRETARY, AND TO A SUPPLEMENTAL LETTER DATED OCTOBER 26, 1967, FURNISHING OUR OFFICE WITH A REPORT ON THE PROTEST OF THE HAYES INTERNATIONAL CORPORATION (HAYES) AGAINST THE AWARD OF A CONTRACT TO PAGE AIRCRAFT MAINTENANCE, INC. (PAGE), UNDER REQUEST FOR QUOTATION (RFQ) DABC01-67-R- 0042, ISSUED BY THE UNITED STATES ARMY AVIATION CENTER, FORT RUCKER, ALABAMA. ALTHOUGH THE PROTEST WAS SUBMITTED BEFORE AWARD, AWARD WAS MADE, AFTER NOTICE TO US, ON SEPTEMBER 29, 1967, ON THE BASES THAT THE PRIOR CONTRACT WITH PAGE WAS TO EXPIRE ON SEPTEMBER 30, 1967, AND THAT NEGOTIATION OF AN EXTENSION OF THAT CONTRACT WAS NOT FEASIBLE.

THE SUBJECT RFQ WAS FOR AIRCRAFT MAINTENANCE SERVICES TO BE PERFORMED AT FORT RUCKER, ALABAMA, AND FORT STEWART, GEORGIA, DURING FISCAL YEAR 1968 (JULY 1, 1967, THROUGH JUNE 30, 1968) AND CONTAINED AN OPTION RESERVED TO THE GOVERNMENT TO NEGOTIATE FOR CONTINUATION OF THE CONTRACT SERVICES THROUGH JUNE 30, 1970. THE TYPE OF CONTRACT CONTEMPLATED BY THE RFQ WAS COST-PLUS-INCENTIVE-FEE (CPIF), AND PROSPECTIVE CONTRACTORS WERE REQUIRED TO SUBMIT COMPLETE COST ESTIMATES AND FEE SCHEDULES TO BE USED BY THE GOVERNMENT IN EVALUATING QUOTATIONS. THE RFQ PROVIDED IN PARAGRAPH 6 OF THE SECTION ENTITLED "GENERAL INFORMATION" AND IN PARAGRAPH 1 OF THE SECTION ENTITLED"EVALUATION OF QUOTATIONS" THAT:

"6. QUOTATIONS RECEIVED WILL PROVIDE A BASIS FOR SELECTION OF A PROSPECTIVE CONTRACTOR, AND NEGOTIATION OF A CONTRACTUAL DOCUMENT IN FINAL FORM. NEGOTIATIONS SHALL BE CONDUCTED AS FOLLOWS: (I) WHERE A RESPONSIBLE PROSPECTIVE CONTRACTOR SUBMITS A RESPONSIVE PROPOSAL WHICH, IN THE CONTRACTING OFFICER'S OPINION IS CLEARLY AND SUBSTANTIALLY MORE ADVANTAGEOUS TO THE GOVERNMENT THAN ANY OTHER QUOTATION, NEGOTIATIONS MAY BE CONDUCTED WITH THAT PROSPECTIVE CONTRACTOR ONLY; (II) WHERE SEVERAL RESPONSIBLE PROSPECTIVE CONTRACTORS SUBMIT QUOTATIONS WHICH ARE GROUPED SO THAT A MODERATE CHANGE IN EITHER THE PRICE OR THE TECHNICAL PROPOSAL WOULD MAKE ANY ONE OF THE GROUP THE MOST ADVANTAGEOUS PROSPECTIVE CONTRACTOR TO THE GOVERNMENT, FURTHER NEGOTIATIONS SHALL BE CONDUCTED WITH ALL PROSPECTIVE CONTRACTORS IN THAT GROUP.

"1.ALL QUOTATIONS RECEIVED SHALL BE CAREFULLY CONSIDERED AND EVALUATED BY A CONTRACT EVALUATION BOARD AND THE DEFENSE CONTRACT AUDIT AGENCY, UTILIZING CRITERIA ESTABLISHED FOR THE EXPRESS PURPOSE OF SELECTING A CONTRACTOR FOR A COST-REIMBURSEMENT TYPE CONTRACT. ALL THE FACTORS WILL BE CONSIDERED, EVALUATED, AND GRADED ACCORDING TO AN ESTABLISHED EVALUATION PROCEDURE. * * *"

A DETAILED LIST OF THE FACTORS TO BE CONSIDERED DURING EVALUATION, INCLUDING "REALISM OF COST DATA" AND "REASONABLENESS OF INCENTIVE FEE," WAS ALSO SET OUT IN THE RFQ.

THE DATE FIXED FOR RECEIPT OF PROPOSALS WAS MARCH 15, 1967, AND QUOTATIONS WERE RECEIVED AT THAT TIME FROM HAYES, PAGE, AND HAWTHORNE AVIATION. NEGOTIATIONS WERE CONDUCTED WITH ALL THREE OFFERORS DURING APRIL 1967, AND AFTER NEGOTIATION AND SUBMISSION OF FINAL PROPOSALS, EACH OFFEROR WAS EVALUATED ON A POINT EVALUATION BASIS. CONCERNING THE EVALUATION, THE SEPTEMBER 12 REPORT STATES:

"ALL THREE OFFERORS WERE EVALUATED ON ORGANIZATION, MANAGEMENT EXPERIENCE AND CAPABILITY, QUALIFICATIONS OF KEY PERSONNEL, RECORD OF PRESENT AND PAST PERFORMANCE, ACCOUNTING PROCEDURES AND MACHINE ACCOUNTING CAPABILITY. THE MAXIMUM ALLOWABLE POINTS FOR THIS PORTION OF THE EVALUATION WAS 900. IN ADDITION, FINANCIAL ELEMENTS WERE EVALUATED FOR REALISM, AND REASONABLENESS OF THE INCENTIVE FEES. THE MAXIMUM ALLOWABLE POINTS FOR FINANCIAL EVALUATION WAS 700. THE POINTS GIVEN WERE AS FOLLOWS: HAYES, 880, PAGE, 888 AND HAWTHORNE 846 OUT OF THE POSSIBLE 1600 POINTS. THUS THERE WERE ONLY 8 POINTS DIFFERENCE BETWEEN HAYES AND PAGE MEANING THAT FOR ALL PRACTICABLE PURPOSES THEY WERE EQUAL FROM THE STANDPOINT OF CAPABILITY.'

WITH REGARD TO THE PORTION OF THE EVALUATION DEALING WITH THE REASONABLENESS OF ESTIMATED COSTS AND FEES, THE RFQ ON PAGE 6 PROVIDED AS FOLLOWS: "G. REALISM OF COST DATA.

(1) NUMBER OF DIRECT LABOR EMPLOYEES AS COMPARED TO GOVERNMENT ESTIMATE.

(2) RATIO OF INDIRECT TYPE OF PERSONNEL TO DIRECT TYPE.

(3) PAY RATES - SALARY AND HOURLY.

(4) FRINGE BENEFITS.

(5) GENERAL AND ADMINISTRATIVE EXPENSES.

(6) PHASE-IN COSTS. "H. REASONABLENESS OF INCENTIVE FEE (ASPR 3 808).

(1) CONTRACTOR'S INPUT TO TOTAL PERFORMANCE.

(2) CONTRACTOR'S ASSUMPTION OF CONTRACT COST RISK.

(3)RECORD OF CONTRACTOR'S PERFORMANCE.

(4) SOURCE OF RESOURCES.'

THE POINT EVALUATION CONCERNING COSTS AND FEES COVERED SUBSTANTIALLY THESE SAME AREAS AND HAYES AND PAGE WERE APPARENTLY WITHIN THE SAME GENERAL RANGE IN THESE AREAS AS THEY WERE IN THE OVERALL EVALUATION AND WERE ALSO APPARENTLY FAR ENOUGH UP THE POINT SCALE TO BE GENERALLY ACCEPTABLE IN THESE AREAS.

THEREAFTER, HOWEVER, IT WAS DETERMINED THAT THE COST ESTIMATES SUBMITTED BY ALL 3 OFFERORS WERE SUBSTANTIALLY LOWER THAN THE COST ESTIMATE PREPARED BY THE GOVERNMENT. IN THIS REGARD, THE SEPTEMBER 12 REPORT STATES: "* * * THE ABSTRACT OF QUOTATIONS SHOWS THE RELATIVE COST STANDING OF ALL THREE OFFERORS WITH RESPECT TO EACH OTHER, AND WITH RESPECT TO THE GOVERNMENT ESTIMATE. SINCE ALL THREE QUOTATIONS WERE FAR BELOW THE GOVERNMENT ESTIMATE, THE VALIDITY OF THE GOVERNMENT ESTIMATE IMMEDIATELY BECAME A CRITICAL POINT. ACCORDINGLY, THE FISCAL YEAR 1967 CONTRACT WAS EXTENDED FOR 90 DAYS AND THE U.S. ARMY AUDIT AGENCY WAS REQUESTED TO AUDIT THE GOVERNMENT ESTIMATE. THE RESULT OF THIS AUDIT WAS THAT THE GOVERNMENT ESTIMATE WAS VERIFIED AS BEING ACCURATE AND CONSERVATIVE, THUS SUPPORTING THE CONCLUSION THAT THE QUOTATIONS FROM THE THREE OFFERORS WERE UNREALISTICALLY LOW. THE GOVERNMENT ESTIMATE CLEARLY DEMONSTRATED THAT ALL THREE OFFERORS WOULD SO SUBSTANTIALLY OVERRUN THE TARGET COST THAT NO INCENTIVE FEE WOULD BE EARNED, AND THE RESULTING CONTRACT WOULD ACTUALLY BE ON A COST-PLUS FIXED-FEE BASIS RATHER THAN COST-PLUS-INCENTIVE FEE. THUS THE ONLY DISCERNIBLE COST DIFFERENCE BETWEEN THE HAYES INTERNATIONAL CORPORATION AND PAGE AIRCRAFT MAINTENANCE, INC., WAS THE DIFFERENCE IN THE FEE FLOOR OF $127,000 FOR HAYES AND $75,000 FOR PAGE SINCE ALL COSTS WOULD BE REIMBURSED AND NO INCENTIVE FEE WOULD BE EARNED.'

THE ORIGINAL ABSTRACT OF QUOTATIONS WAS ON AN 11 MONTH BASIS AS THE INITIAL MONTH UNDER THE NEW CONTRACT WAS TO BE A "PHASE-IN" MONTH IF THE CONTRACT CHANGED HANDS, WITH THE OLD CONTRACTOR ASSISTING THE NEW CONTRACTOR IN ASSUMING THE CONTRACT DUTIES, AND WITH THE COSTS INCURRED BEING APPORTIONED BETWEEN THE TWO CONTRACTORS. THE 11 MONTH ABSTRACT, WITH THE EXCEPTION OF THE BREAKDOWN OF THE ESTIMATED TARGET COSTS FOR EACH TYPE OF AIRCRAFT TO BE MAINTAINED, IS SET OUT BELOW:

HAYES PAGE HAWTHORNE GOVT. ESTIMATE

---------- ---------- ---------- ---------- --- (1) ESTIMATED 14,227,965 15,148,933 15,508,342 17,089,509 TARGET COST (2) ESTIMATED 5,533,097 5,891,252 6,031,022 6,645,920 EXCLUDED COST (3) TOTAL EST. 19,761,062 21,040,185 21,539,364 23,735,429 OPERATIONAL COST (4) TARGET FEE 396,000 223,189 250,000 (5) TOTAL EST. 20,157,062 21,263,374 21,789,364 CONTRACT PRICE (6) INCENTIVE

70/30 70/30 70/30 SHARING FORMULA (7) FEE CEILING 893,000 370,000 325,000 (8) FEE FLOOR 127,000 75,000 175,000

THE "EXCLUDED COST" PORTION OF THE ABSTRACT REFERS TO THOSE COSTS NOT CONSIDERED DURING EVALUATION BECAUSE OF THE DIFFICULTY OF MAKING ANY ADVANCE DETERMINATIONS OF THEIR AMOUNT. ONE EXAMPLE OF AN "EXCLUDED COST" WOULD BE THE COST OF REMOVING AND REPAIRING CRASH DAMAGED AIRCRAFT.

AFTER EXTENSION OF THE FISCAL YEAR 1967 CONTRACT, THE VARIOUS ABSTRACTED PRICES WERE RECOMPUTED ON A 9 MONTH BASIS, APPARENTLY WITHOUT CONSIDERATION OF POSSIBLE PHASE-IN COSTS, WITH THE RESULTING 9 MONTH ABSTRACT SET OUT BELOW, AGAIN WITHOUT THE TARGET COST BREAKDOWN.

HAYES PAGE HAWTHORNE GOVT. ESTIMATE

---------- ---------- ---------- -------------- (1) EST. TARGET 11,476,135 12,176,259 12,523,313 13,833,678 COST (2) EST. EXCLUDED 4,462,941 4,735,212 4,870,177 5,379,764 COST (3) TOTAL EST. 15,939,076 16,911,471 17,393,490 19,213,442 OPERATIONAL COST (4) TARGET FEE 324,000 182,609 204,545 (5) TOTAL EST. 16,263,076 17,094,080 17,597,935 CONTRACT PRICE (6) INCENTIVE 70/30 70/30 70/30 SHARING FORMULA (7) FEE CEILING 730,600 302,727 265,909 (8) FEE FLOOR 103,900 61,364 143,182

DURING THE 90-DAY EXTENSION OF THE FISCAL YEAR 1967 CONTRACT, THE ARMY, AS A RESULT OF SUGGESTIONS BY HAYES, SECURED A REVISION OF THE DEPARTMENT OF LABOR WAGE DETERMINATIONS WITH REGARD TO HEALTH AND WELFARE BENEFITS. THE SEPTEMBER 12 REPORT SUMMARIZES THIS ASPECT OF THE CASE AS FOLLOWS: "* * * THE THEN EXISTING RULING CALLED FOR HEALTH AND WELFARE BENEFITS IN THE AMOUNT OF $25.35 PER MONTH PER EMPLOYEE AND THE DEPARTMENT OF LABOR HAD RULED THAT EVEN IF A CONTRACTOR COULD OBTAIN THE SAME INSURANCE BENEFITS FOR AN EMPLOYEE FOR LESS THAN $25.35 HE MUST MAKE UP ANY DIFFERENCE BY CASH PAYMENTS TO THE EMPLOYEES IN A TOTAL AMOUNT OF $25.35. ON AUGUST 9, 1967, THE DEPARTMENT OF LABOR AMENDED THE DETERMINATIONS SO THAT THE CONTRACTOR WAS REQUIRED MERELY TO PROVIDE BENEFITS WHICH AT LEAST EQUAL THE MINIMUM BENEFITS SPECIFIED IN THE INCUMBENT CONTRACTOR'S COLLECTIVE BARGAINING AGREEMENT. WITH THIS REVISION THE ARMY WAS IN A POSITION TO REAP FINANCIAL BENEFITS FROM COMPETITIVE INSURANCE QUOTATIONS WHICH PROVIDED THE EMPLOYEES THE MINIMUM REQUIRED INSURANCE PROTECTION BUT AT A PRICE PER EMPLOYEE PER MONTH OF LESS THAN $25.35. SINCE THIS ITEM OF COST COULD BE FIXED IT WAS DECIDED THAT THE REQUEST FOR QUOTATIONS WOULD BE REOPENED AND EACH OFFEROR WOULD BE REQUIRED TO SUBMIT TO THE GOVERNMENT HIS LOWEST COMPETITIVE QUOTATION, AND THIS QUOTATION WOULD BE INCORPORATED INTO AN ADVANCED AGREEMENT OF ALLOWABLE COST AS PROVIDED IN ASPR 15-107. THIS WAS ACCOMPLISHED BY AMENDMENT NO. 4 TO THE SOLICITATION AND RESULTED IN OFFERS FROM HAYES AT $16.84 PER MONTH, PAGE AT $15.97 AND HAWTHORNE AT $25.19. THE PAGE QUOTATION OF $15.97 WAS INCORPORATED INTO AN ADVANCED COST AGREEMENT. * * *"

THE END RESULT OF THE ABOVE-DESCRIBED SEQUENCE OF EVENTS WAS THAT IT WAS DETERMINED THAT THE COST ESTIMATES SUBMITTED BY PAGE AND HAYES WERE SO UNREALISTIC THAT IT WOULD BE IMPOSSIBLE FOR EITHER OFFEROR TO QUALIFY FOR ANY INCENTIVE FEES UNDER A CPIF CONTRACT, AND THAT THE ONLY DIFFERENCE BETWEEN THEM THEREFORE WAS TO BE FOUND IN THEIR OFFERED FEE FLOORS AND RATES FOR EMPLOYEE INSURANCE BENEFITS. ACCORDINGLY, SINCE PAGE WAS LOWER IN BOTH OF THESE AREAS, IT WAS DETERMINED THAT PAGE SHOULD RECEIVE THE AWARD.

HAYES MAINTAINS THAT ANY AWARD TO PAGE ON THE BASIS OUTLINED ABOVE IS ILLEGAL BECAUSE IT IS AN AWARD BASED ON ELEMENTS NOT SET OUT IN THE RFQ, WITH RESPECT TO WHICH NO NOTICE WAS GIVEN TO THE RESPECTIVE OFFERORS. FURTHER, HAYES MAINTAINS THAT NOT ONLY ARE ITS COST ESTIMATES REALISTIC, BUT THAT THEY WERE DETERMINED TO BE SO BY THE FINANCIAL CAPABILITY POINT EVALUATION AS WELL AS BY THE DEFENSE CONTRACT AUDIT AGENCY (DCAA), THE AGENCY CHARGED WITH THE RESPONSIBILITY OF AUDITING COST ESTIMATES OF PROSPECTIVE CONTRACTORS. IN THIS REGARD, IN AN ATTEMPT TO REFUTE THE LEGALITY OF THE ARMY'S LATER USE OF THE ARMY AUDIT AGENCY (AAA) TO VERIFY THE VALIDITY OF THE GOVERNMENT'S COST ESTIMATE, HAYES POINTS OUT THAT DOD DIRECTIVE 7600.2 PLACES ALL CONTRACT AUDIT MATTERS WITHIN THE SCOPE OF DCAA AND RESTRICTS AAA PRIMARILY TO INTERNAL AUDIT MATTERS. FINALLY, HAYES ALLEGES THAT THE ARMY ENGAGED IN A PROHIBITED AUCTION TECHNIQUE IN ITS SOLICITATION OF COMPETITIVE INSURANCE RATES BY ALLOWING PAGE TO ASCERTAIN THE AMOUNTS AND THE SOURCES OF THE RATES QUOTED BY HAYES, THUS ENABLING PAGE TO UNDERBID HAYES IN THIS AREA.

IN SUBSTANTIATION OF ITS AUCTION CLAIM, HAYES HAS SUBMITTED A COPY OF A TELEGRAM FROM PAGE TO PROTECTIVE LIFE OF ALABAMA WHICH REQUESTED PROTECTIVE LIFE TO QUOTE THE SAME RATES TO PAGE WHICH IT HAD QUOTED TO HAYES AND/OR HAWTHORNE, AS WELL AS THE TERM FOR WHICH THE RATES WERE GUARANTEED AND ANY REFUND ARRANGEMENTS MADE WITH HAYES OR HAWTHORNE. THE TELEGRAM ALSO REQUESTED THAT RATES BE QUOTED TO PAGE IN THE EVENT NONE HAD BEEN QUOTED TO EITHER HAYES OR HAWTHORNE. HAYES MAINTAINS THAT SIMILAR TELEGRAMS WERE SENT TO SEVERAL OTHER INSURANCE COMPANIES FROM WHICH IT HAD SOLICITED RATE QUOTES, INDICATING, IN THE OPINION OF HAYES, THAT ITS PROPOSAL INFORMATION IN THIS RESPECT WAS DIVULGED TO PAGE. WHILE PAGE'S INFORMATION REGARDING INSURANCE COULD POSSIBLY HAVE BEEN THE RESULT OF SOMETHING OTHER THAN AN EDUCATED GUESS, WE ARE NOT CONVINCED, ON THE BASIS OF THE PRESENT RECORD, THAT ANY PRIVILEGED INFORMATION WAS DIVULGED TO PAGE BY THE CONTRACTING OFFICIALS OR THAT AUCTION TECHNIQUES WERE OTHERWISE EMPLOYED.

WITH REGARD TO THE BASES RELIED UPON BY THE CONTRACTING OFFICER FOR MAKING AN AWARD TO PAGE, HOWEVER, WE BELIEVE THAT THEY DEVIATED SUBSTANTIALLY FROM THE NEGOTIATION REQUIREMENTS OF 10 U.S.C. 2304 (G) AND THE IMPLEMENTING REGULATIONS. IT IS AXIOMATIC THAT THE CONTRACTING OFFICER ENJOYS THE WIDEST POSSIBLE RANGE OF DISCRETION IN THE EVALUATION OF NEGOTIATED PROPOSALS AND IN DETERMINING WHICH OFFER OR PROPOSAL IS ENTITLED TO BE ACCEPTED AS IN THE GOVERNMENT'S BEST INTEREST AND ADVANTAGE. HOWEVER, IT IS EQUALLY AS AXIOMATIC THAT THE CONTRACTING OFFICER'S ACTIONS IN EXERCISING THAT DISCRETION MUST NOT BE ARBITRARY, CAPRICIOUS OR WITHOUT SUBSTANTIAL BASIS IN FACT. EQUALLY IMPORTANT IS THE REQUIREMENT THAT HIS DECISION BE IN ACCORD WITH THE APPLICABLE STATUTE AND REGULATIONS. IT IS OUR CONCLUSION, FOR REASONS SET OUT BELOW, THAT THE DETERMINATION -- ARRIVED AT WITHOUT THE BENEFIT OF MEANINGFUL COST NEGOTIATIONS -- THAT ALL THREE COST ESTIMATES WERE SO UNREALISTIC AS TO WARRANT NO CONSIDERATION WITH THE RESULT THAT THE OFFERED FEE FLOORS AND THE HEALTH BENEFITS COSTS WERE THE ONLY ELEMENTS OF DIFFERENTIATION AMONG THE VARIOUS OFFERS WAS NOT IN ACCORD WITH THE CONCEPT OF INCENTIVE-FEE NEGOTIATION AS CONTEMPLATED BY THE APPLICABLE STATUTE AND REGULATIONS.

IN ORDER TO ASSURE THAT THE AWARD OF A NEGOTIATED CONTRACT IS IN THE BEST INTEREST OF THE GOVERNMENT, ASPR 3-805.1, IN IMPLEMENTATION OF 10 U.S.C. 2304 (G), REQUIRES THAT NEGOTIATIONS BE CONDUCTED WITH ALL OFFERORS WITHIN A COMPETITIVE RANGE, PRICE AND OTHER FACTORS CONSIDERED. ALSO, ASPR 3- 805.1 (A) (V) STATES,"* * * ANY CASE WHERE THERE IS UNCERTAINTY AS TO THE PRICING OR TECHNICAL ASPECTS OF ANY PROPOSALS, THE CONTRACTING OFFICER SHALL NOT MAKE AWARD WITHOUT FURTHER EXPLORATION AND DISCUSSION PRIOR TO AWARD. * * *" ADDITIONALLY, ASPR 3-804 STATES THAT "COMPLETE AGREEMENT OF THE PARTIES ON ALL BASIC ISSUES SHALL BE THE OBJECTIVE OF THE CONTRACT GOTIATIONS.' ON THE SUBJECT OF EVALUATION OF PROPOSALS LEADING TO THE AWARD OF NEGOTIATED CONTRACTS, OUR OFFICE HAS OBSERVED THAT SOUND PROCUREMENT PRACTICE DICTATES THAT OFFERORS BE INFORMED OF ALL EVALUATION FACTORS AND OF THE RELATIVE WEIGHTS TO BE ATTACHED TO EACH FACTOR. SEE 44 COMP. GEN. 439. WE THINK THAT THE REASONABLE CONCLUSION TO BE DRAWN FROM THESE EXPRESSIONS IS THAT FOR COMPETITIVE NEGOTIATION TO BE MEANINGFUL AND EFFECTIVE, NEGOTIATIONS SHOULD INFORM OFFERORS WITHIN A COMPETITIVE RANGE AS TO THE AREAS IN WHICH THEIR PROPOSALS ARE BELIEVED TO BE DEFICIENT TO THE END THAT COMPETITIVE OFFERORS ARE GIVEN AN OPPORTUNITY TO SUPPORT OR REVISE THEIR PROPOSALS TO SATISFY THE GOVERNMENT'S REQUIREMENTS. THIS IS ESPECIALLY TRUE WHERE, AS HERE, THE PURPORTED DEFICIENCIES RESULTED IN A CHANGE IN THE EVALUATION APPROACH WHICH WAS SO SUBSTANTIAL THAT IT WOULD, IN ALL PROBABILITY, RESULT IN A CONTRACT OTHER THAN THAT CONTEMPLATED BY THE RFQ. THAT IS TO SAY, THE RESULTING CONTRACT WILL SHIFT ALMOST THE ENTIRE RISK OF EFFICIENT CONTRACT MANAGEMENT FROM THE CONTRACTOR TO THE GOVERNMENT AND WILL EFFECTIVELY DENY ANY INCENTIVE TO REDUCE CONTRACT COSTS.

IN THE CASE AT HAND, NEGOTIATIONS WERE CONDUCTED WITH ALL OFFERORS AND DURING THE NEGOTIATIONS THE COST ESTIMATES, AMONG OTHER THINGS, OF THE RESPECTIVE OFFERORS WERE DISCUSSED. AFTER NEGOTIATIONS, FINAL PROPOSALS WERE SUBMITTED, WERE AUDITED BY THE DCAA, AND WERE EVALUATED BY A CONTRACT EVALUATION BOARD ON THE BASIS OF A POINT SYSTEM WHICH CONSIDERED, AMONG OTHER THINGS, THE REALISM OF THE RESPECTIVE COST ESTIMATES, WITH THE RESULT THAT TWO OF THE THREE OFFERORS ACHIEVED SUBSTANTIALLY EQUAL RATINGS. IT WAS AT THIS POINT THAT THE CONTRACTING OFFICER DETERMINED THAT THE COST ESTIMATES WERE UNREALISTIC, NOTWITHSTANDING THE FACT THAT THEY HAD BEEN AUDITED AND FOUND TO BE GENERALLY ACCEPTABLE BY THE DCAA AND CONSEQUENTLY HAD RECEIVED POINT TOTALS IN A GENERALLY ACCEPTABLE RANGE.

IN OUR VIEW, THE DISCREPANCIES BETWEEN THE OFFERORS' COST ESTIMATES AND THE GOVERNMENT ESTIMATE CERTAINLY WERE OR SHOULD HAVE BEEN EVIDENT DURING NEGOTIATIONS AND THEREFORE SHOULD HAVE BEEN DISCUSSED WITH THE OFFERORS. YET A REVIEW OF THE HAYES NEGOTIATION MINUTES SHOWS THAT, WHILE ESTIMATED COSTS, THE NUMBER OF MAINTENANCE HOURS ALLOCATED TO SPECIFIC TASKS, THE NUMBER AND TYPES OF PERSONNEL FOR VARIOUS TASKS, ETC. WERE DISCUSSED, RESULTING IN REVISIONS IN SOME AREAS OF THE HAYES PROPOSAL, AT NO POINT IN THE MINUTES FURNISHED US WAS THERE DISCUSSED THE FACT THAT THE HAYES COST PROPOSAL WAS CONSIDERED TO BE GENERALLY UNREALISTIC. WE ACCORDINGLY FIND IT DIFFICULT TO UNDERSTAND HOW THE UNREALISTIC NATURE OF THE HAYES COST ESTIMATE, AS WELL AS THE UNREALISTIC NATURE OF THE COST ESTIMATES OF THE OTHER TWO OFFERORS, COULD HAVE BEEN LARGELY IGNORED DURING NEGOTIATIONS AND YET COULD BECOME SO PATENTLY OBVIOUS AFTER SUBMISSION OF FINAL PROPOSALS THAT IT WAS NECESSARY TO DISREGARD THE COST ESTIMATES AND MAKE THE AWARD ON A FIXED-FEE BASIS. HOWEVER, ASSUMING THAT THE DETERMINATION OF UNREALISTIC COST ESTIMATES WAS CORRECT AND THAT IT WAS NOT POSSIBLE TO MAKE SUCH DETERMINATION BEFORE THE SUBMISSION OF FINAL OFFERS, IT IS OUR OPINION THAT THE CONTRACTING OFFICER WAS OBLIGED TO INFORM OFFERORS OF HIS DETERMINATION AND TO REOPEN NEGOTIATIONS FOR THE PURPOSE OF ENABLING OFFERORS EITHER TO JUSTIFY THE REASONABLENESS OF THEIR COST ESTIMATES OR TO REVISE THEIR COST ESTIMATES AND/OR FEE FLOORS.

UNDER 10 U.S.C. 2306 (A) A CONTRACT NEGOTIATED PURSUANT TO 10 U.S.C. 2304 (A) MAY BE OF ANY TYPE WHICH, IN THE OPINION OF THE AGENCY HEAD, WILL PROMOTE THE BEST INTEREST OF THE UNITED STATES. SEE ASPR 3 401 (B). ALSO, ASPR 3-403 PROVIDES THAT IN THE ABSENCE OF "EFFECTIVE PRICE COMPETITION" AND WHERE PRICE ANALYSIS IS NOT SUFFICIENT, THE COST ESTIMATES OF THE OFFEROR AND OF THE GOVERNMENT ARE THE BASES FOR NEGOTIATION OF ANY PRICING AGREEMENT. AND ASPR 3-807.1 (B) (1/A PROVIDES THAT WHETHER THERE IS PRICE COMPETITION FOR A GIVEN PROCUREMENT IS A MATTER OF JUDGMENT TO BE BASED ON THE EVALUATION OF WHETHER THE CONDITIONS SET FORTH THEREIN ARE SATISFIED. HOWEVER, PRICE COMPETITION MAY BE CONSIDERED TO BE INADEQUATE IF THE CONTRACTING OFFICER FINDS THAT THE LOWEST FINAL PRICE IS NOT REASONABLE (ASPR 3 807.1 (B) (1/B/III) ).

THESE PROVISIONS VEST IN THE CONTRACTING OFFICER DISCRETION AS TO THE TYPE OF CONTRACT TO BE AWARDED, AUTHORITY TO USE THE GOVERNMENT'S COST ESTIMATE IN NEGOTIATING A PRICE WITH AN OFFEROR, AND AUTHORITY TO DETERMINE WHETHER OFFERS OR PROPOSALS SUBMITTED TO THE GOVERNMENT ARE REASONABLY PRICED. SINCE EACH OF THE CPIF COST PROPOSALS WAS FOUND BY THE CONTRACTING OFFICER TO BE UNREALISTICALLY LOW, WE BELIEVE THAT A SUBSTANTIAL BASIS EXISTED FOR A DETERMINATION BY THE CONTRACTING OFFICER THAT THE COST PROPOSALS WERE NOT REASONABLY PRICED SO AS TO SUGGEST AN ABSENCE OF "EFFECTIVE PRICE COMPETITION" AND A NEED FOR FURTHER COST NEGOTIATION.

ASPR 3-405.4 (A) DESCRIBES THE CPIF CONTRACT AS A COST-REIMBURSEMENT CONTRACT WITH PROVISION FOR A FEE WHICH IS ADJUSTED BY FORMULA IN ACCORDANCE WITH THE RELATIONSHIP WHICH THE TOTAL ALLOWABLE COSTS BEAR TO THE TARGET COST. ASPR 3-405.4 (B) RELATING TO THE APPLICATION OF SUCH A CONTRACT PROVIDES:

"/B) APPLICATION. THE COST-PLUS-INCENTIVE-FEE CONTRACT IS SUITABLE FOR USE PRIMARILY FOR DEVELOPMENT AND TEST WHEN A COST REIMBURSEMENT TYPE OF CONTRACT IS FOUND NECESSARY IN ACCORDANCE WITH 3 405.1 (B), AND WHEN A TARGET AND A FEE ADJUSTMENT FORMULA CAN BE NEGOTIATED WHICH ARE LIKELY TO PROVIDE THE CONTRACTOR WITH A POSITIVE PROFIT INCENTIVE FOR EFFECTIVE MANAGEMENT. IN PARTICULAR, WHERE IT IS HIGHLY PROBABLE THAT THE DEVELOPMENT IS FEASIBLE AND THE GOVERNMENT GENERALLY HAS DETERMINED ITS DESIRED PERFORMANCE OBJECTIVES, THE COST PLUS-INCENTIVE-FEE CONTRACT SHOULD BE USED IN CONJUNCTION WITH PERFORMANCE INCENTIVES IN THE DEVELOPMENT OF MAJOR SYSTEMS, AND IN OTHER DEVELOPMENT PROGRAMS WHERE USE OF THE COST AND PERFORMANCE INCENTIVE APPROACH IS CONSIDERED BOTH DESIRABLE AND ADMINISTRATIVELY PRACTICAL (SEE 3-403 (C) AND 3-407.2 (B) ). RANGE OF FEE AND THE FEE ADJUSTMENT FORMULA SHOULD BE NEGOTIATED SO AS TO GIVE APPROPRIATE WEIGHT TO BASIC PROCUREMENT OBJECTIVES. FOR EXAMPLE, IN AN INITIAL PRODUCT DEVELOPMENT CONTRACT, IT MAY BE APPROPRIATE TO NEGOTIATE A COST-PLUS-INCENTIVE-FEE CONTRACT PROVIDING FOR RELATIVELY SMALL INCREASES OR DECREASES IN FEE TIED TO THE COST INCENTIVE FEATURE, BALANCED BY THE INCLUSION OF PERFORMANCE INCENTIVE PROVISIONS PROVIDING FOR SIGNIFICANT UPWARD OR DOWNWARD FEE ADJUSTMENT AS AN INCENTIVE FOR THE CONTRACTOR TO MEET OR SURPASS NEGOTIATED PERFORMANCE TARGETS. CONVERSELY, IN SUBSEQUENT DEVELOPMENT AND TEST CONTRACTS, IT MAY BE MORE APPROPRIATE TO NEGOTIATE AN INCENTIVE FORMULA WHERE THE OPPORTUNITY TO EARN ADDITIONAL FEE IS BASED PRIMARILY ON THE CONTRACTOR'S SUCCESS IN CONTROLLING COSTS. WITH REGARD TO THE COST INCENTIVE PROVISIONS OF A CONTRACT, THE MINIMUM AND MAXIMUM FEES, AND THE FEE ADJUSTMENT FORMULA, SHOULD BE NEGOTIATED SO AS TO PROVIDE AN INCENTIVE WHICH WILL BE EFFECTIVE OVER VARIATIONS IN COSTS THROUGHOUT THE FULL RANGE OF REASONABLY FORESEEABLE VARIATIONS FROM TARGET COSTS. WHENEVER THIS TYPE OF CONTRACT, WITH OT WITHOUT THE INCLUSION OF PERFORMANCE INCENTIVES, IS NEGOTIATED SO AS TO PROVIDE INCENTIVE UP TO A HIGH MAXIMUM FEE, THE CONTRACT ALSO SHALL PROVIDE FOR A LOW MINIMUM FEE, WHICH MAY EVEN BE A -ZERO- FEE OR, IN RARE CASES, A NEGATIVE- FEE.'

ASPR 3-807.2 REQUIRES SOME FORM OF PRICE OR COST ANALYSIS IN CONNECTION WITH EVERY NEGOTIATED PROCUREMENT ACTION, THE METHOD AND DEGREE OF ANALYSIS BEING DEPENDENT ON THE FACTS SURROUNDING THE PARTICULAR PROCUREMENT AND PRICING SITUATION. AS NOTED ABOVE, THE COST PROPOSALS HERE WERE SUBJECT TO AUDIT SCRUTINY AND REPORT AND ALSO TO A POINT EVALUATION BY THE CONTRACT EVALUATION BOARD. IN VIEW OF THE CLOSE COMPETITIVE RANGE EXISTING BETWEEN THE OFFERORS, IT WOULD SEEM THAT THE CIRCUMSTANCES SHOULD HAVE DICTATED THE NECESSITY FOR ADDITIONAL TARGET COST NEGOTIATIONS WITH SUCH OFFERORS RATHER THAN A BLANKET DETERMINATION OF "UNREALISTIC COST ESTIMATES" SUBMITTED BY COMPETITIVE OFFERORS.

WE STRONGLY FEEL THAT THE CIRCUMSTANCES REQUIRED, UNDER THE MANDATE OF PUBLIC LAW 87-653, FULL AND MEANINGFUL COST NEGOTIATIONS WITH THE COMPETITIVE OFFERORS AS A PREREQUISITE TO AWARD TO THAT OFFEROR WHO HAD SUBMITTED THE LOWEST PROFIT PROPOSAL WHICH WAS RELATED TO A HIGHER ESTIMATED CONTRACT PRICE DETERMINED TO BE "UNREALISTIC.' THE LEGISLATIVE HISTORY OF PUBLIC LAW 87-653 DISCLOSES THAT ONE OF ITS PRIMARY PURPOSES WAS TO REQUIRE FULL, COMPLETE AND ACCURATE DATA AND DISCLOSURE BY BOTH PARTIES IN PRICING DISCUSSIONS OF INCENTIVE CONTRACTS IN PARTICULAR AND TO REQUIRE THE CONTRACTOR TO CERTIFY TO THE COST FIGURES IN HAND AT THE TIME OF NEGOTIATIONS FOR TARGET PRICE. AS STATED IN HOUSE REPORT NO. 1638, 87TH CONGRESS, 2D SESSION, THE PROVISION DOES TWO THINGS: "IT REQUIRES BY LAW A FULL DISCLOSURE IN NEGOTIATIONS AND IT REQUIRES A READJUSTMENT OF TARGET PRICES, BEFORE FINAL SETTLEMENT AND COST SHARING, SO THAT THE INCENTIVE PROFIT OVER THE NORMAL PROFIT WILL BE THE PRODUCT OF THE CONTRACTOR'S ACTION IN PERFORMANCE RATHER THAN ARTIFICIAL PRICING IN NEGOTIATIONS FOR TARGET PRICE.'

IT IS QUITE EVIDENT THAT THE CPIF SYSTEM OF CONTRACTING REQUIRES FULL AND MEANINGFUL NEGOTIATION OF PROPOSED CONTRACT TARGET COSTS AS A PREREQUISITE TO A PROPER AWARD. IN A PRESENTATION AT HEARINGS HELD BEFORE THE PROCUREMENT SUBCOMMITTEE OF THE COMMITTEE ON ARMED SERVICES, UNITED STATES SENATE, ON FEBRUARY 8 AND 9, 1960, A FORMER ASSISTANT SECRETARY OF DEFENSE STATED: "* * * THE WEAKNESS OF THE COST-PLUS FIXED-FEE CONTRACT IS ITS COMPARATIVE LACK OF INCENTIVE TO THE CONTRACTOR TO REDUCE HIS COST OF PERFORMING THE CONTRACT. TO COUNTER THIS WEAKNESS, THE COST-PLUS- INCENTIVE-FEE CONTRACT WAS DEVELOPED. IT ASSURES THE CONTRACTOR A MINIMUM FIXED FEE BUT PERMITS THE FEE TO BE INCREASED WITHIN SPECIFIED LIMITS, IF THE CONTRACTOR PERFORMS THE CONTRACT FOR LESS THAN THE ESTIMATED COST. "UNDER THIS TYPE OF CONTRACT, THE GOVERNMENT AND THE CONTRACTOR AGREE AT THE TIME OF NEGOTIATION OF THE CONTRACT UPON THE TARGET COST OF PERFORMANCE. THE TARGET FEE IS THEN DETERMINED, AS IN THE CASE OF THE COST-PLUS-FIXED FEE CONTRACT, IN RELATION TO THE TARGET COST. ALSO ESTABLISHED ARE MINIMUM AND MAXIMUM FEES AND FINALLY A FEE ADJUSTMENT FORMULA SIMILAR TO WHAT IS DONE IN A FIXED-PRICE INCENTIVE CONTRACT. ,AFTER PERFORMANCE OF A CONTRACT, THE FEE PAYABLE TO THE CONTRACTOR IS DETERMINED IN ACCORDANCE WITH THE FORMULA. THE FORMULA PROVIDES, WITHIN LIMITS, FOR AN INCREASE IN FEE ABOVE TARGET FEE WHEN THE TOTAL ALLOWABLE COSTS ARE LESS THAN TARGET COSTS. CONVERSELY, IT PROVIDES FOR DECREASES IN THE FEE BELOW THE TARGET FEE WHEN THE TOTAL ALLOWABLE COSTS EXCEED THE TARGET COSTS. THUS, WE BUILD IN AN INCENTIVE TO THE CONTRACTOR TO INCREASE THE EFFICIENCY OF PERFORMANCE. "WE USE THE INCENTIVE-FEE CONTRACT WHERE A COST-REIMBURSEMENT TYPE CONTRACT IS NECESSARY AND WHERE THERE IS A PROBABILITY THAT ITS USE WILL RESULT IN LOWER COSTS TO THE GOVERNMENT THAN OTHER FORMS OF COST-REIMBURSEMENT TYPE CONTRACTS THROUGH COST REDUCTION INCENTIVE TO THE CONTRACTOR. TARGET AND MAXIMUM FEES ARE SUBJECT TO THE SAME ADMINISTRATIVE PERCENTAGE LIMITATIONS PREVIOUSLY MENTIONED UNDER OUR DISCUSSION OF COST-PLUS-FIXED-FEE CONTRACTS.' IN 22 FEDERAL BAR JOURNAL 195-197, THE FOLLOWING PERTINENT OBSERVATIONS WERE MADE CONCERNING INCENTIVE-TYPE CONTRACTING:"* * * ONE WAY TO LOOK AT INCENTIVE CONTRACTING IS AS A SUBSTITUTE FOR COMPETITIVE PROCUREMENT. THAT IS TO SAY THAT INCENTIVE PROVISIONS IN CONTRACTS ARE AN ARTIFICIAL METHOD OF INDUCING A CONTRACTOR TO BE EFFICIENT IN HIS USE OF THE BASIC RESOURCES NEEDED TO DO THE JOB. THE PRIMARY METHOD FOR ACCOMPLISHING THIS UNDER OUR ECONOMIC SYSTEM IS COMPETITION. IN TERMS OF GOVERNMENT CONTRACTS, THIS MEANS COMPETITION AT THE TIME OF AWARD OF THE CONTRACT WITH THE ACCOMPANYING USE OF A FIXED PRICE CONTRACT. THEN, IF ADEQUATE COMPETITION HAS BEEN OBTAINED, THE PRICE SHOULD BE SET AT A LEVEL WHICH WILL REQUIRE THE CONTRACTOR TO USE ALL OF HIS ABILITY AND INGENUITY TO MAKE A GOOD PROFIT ON THE CONTRACT. IT IS ONLY WHEN THE CONDITIONS DO NOT PERMIT THE USE OF COMPETITIVE PROCUREMENT TECHNIQUES THAT INCENTIVE CONTRACTING TECHNIQUES COME INTO PLAY. AND THEY ARE, AT BEST, AN IMPERFECT SUBSTITUTE FOR THE COMPETITIVE PROCESS. BUT THEY ARE BEST CONCEIVED OF AS A SUBSTITUTE-NOT AN ALTERNATIVE BUT A SUBSTITUTE-FOR COMPETITION WHEN IT CANNOT BE USED.

* * * * * * * "THE MOST ESSENTIAL ELEMENT OF ANY INCENTIVE CONTRACT IS THE TARGET-THE NORM WHICH THE CONTRACTOR IS EXPECTED TO ACHIEVE. THIS TARGET, WHETHER IT BE COST, PERFORMANCE CHARACTERISTICS OR DELIVERY, MUST BE NEGOTIATED AT A REALISTIC LEVEL. IT MUST NOT BE SO DIFFICULT AN ACHIEVEMENT THAT THE CONTRACTOR HAS NO CHANCE OF BETTERING IT AND IT MUST NOT BE SO EASY AN ACHIEVEMENT THAT IT CAN BE BETTERED WITH NORMAL EFFORT.

* * * * * * * "WHEN THE COST, PERFORMANCE AND DELIVERY TARGETS, AS THE CASE MAY BE, ARE ESTABLISHED, THE PARTIES TO THE CONTRACT MUST NEGOTIATE THE TARGET PROFIT. THIS IS THE AMOUNT OF PROFIT WHICH THE CONTRACTOR WILL BE PAID IF THE ACTUAL RESULTS UNDER THE CONTRACT ARE IDENTICAL TO THE TARGETS. IT IS NORMALLY NEGOTIATED IN AN AMOUNT WHICH REFLECTS THE RISK ASSUMED BY THE CONTRACTOR, THE DIFFICULTY OF THE CONTRACT EFFORT, THE INVESTMENT OF THE CONTRACTOR, AND OTHER PERTINENT FACTORS. IT IS THEREFORE CLOSELY RELATED TO THE COST, PERFORMANCE AND DELIVERY TARGETS WHICH HAVE BEEN ESTABLISHED SINCE THESE TARGETS REFLECT THE RISK AND DIFFICULTY OF THE TASK TO A LARGE EXTENT. THUS, IF THE TARGETS ARE DIFFICULT OF ACHIEVEMENT, THE CONTRACTOR WOULD BE JUSTIFIED IN INSISTING ON A HIGH RATE OF TARGET PROFIT AND CONVERSELY, IF THE TARGETS ARE RELATIVELY EASY TO ACHIEVE, THE GOVERNMENT NEGOTIATOR WOULD BE EXPECTED TO OBTAIN A LOWER RATE OF TARGET PROFIT. IN GENERAL, IT CAN ALSO BE SAID THAT THE RATES OF PROFIT IN INCENTIVE CONTRACTS SHOULD FALL BETWEEN THOSE USED FOR FIRM FIXED PRICE CONTRACTS AND THOSE USED FOR COST-PLUS-FIXED-FEE CONTRACTS WITH THE RATES FOR FIXED PRICE INCENTIVES BEING HIGHER THAN THOSE ON COST-PLUS-INCENTIVE FEE CONTRACTS. THIS IS SO BECAUSE THE ELEMENT OF RISK OF FINANCIAL LOSS IS GREATEST IN THE FIRM FIXED PRICE CONTRACT AND LEAST IN THE COST-PLUS-FIXED-FEE CONTRACT.'

WE MAY STATE, THEREFORE, THAT SINCE COSTS CONSTITUTE A LARGE PART OF THE PRICES PAID BY THE GOVERNMENT UNDER THIS TYPE OF CONTRACTING, AN EXCESSIVE CONCERN OVER PROFITS, TO THE EXCLUSION OF COST CONSIDERATIONS, MAY LEAD TO UNSOUND DECISIONS IN SELECTING THE SUCCESSFUL OFFEROR. THAT IS TO SAY, EXCESSIVE CONCERN OVER THE ACCURACY OF ESTIMATED TARGET COSTS COULD BE COSTLY TO THE GOVERNMENT IF IT RESULTS IN A CONTRACT WHICH DOES NOT ENCOURAGE CONTRACTOR EFFICIENCY. A FURTHER EXTENSION OF THE FOREGOING MAY BE FOUND IN ASPR 3-402 (A) (1) AND 3-806 (B) AS FOLLOWS:

"/1) PROFIT, GENERALLY, IS THE BASIC MOTIVE OF BUSINESS ENTERPRISE. BOTH THE GOVERNMENT AND ITS DEFENSE CONTRACTORS SHOULD BE CONCERNED WITH HARNESSING THIS MOTIVE TO WORK FOR THE TRULY EFFECTIVE AND ECONOMICAL CONTRACT PERFORMANCE REQUIRED IN THE INTEREST OF NATIONAL DEFENSE. THIS END, THE PARTIES SHOULD SEEK TO NEGOTIATE AND USE THE CONTRACT TYPE BEST CALCULATED TO STIMULATE OUTSTANDING PERFORMANCE. THE OBJECTIVE SHOULD BE TO INSURE THAT OUTSTANDINGLY EFFECTIVE AND ECONOMICAL PERFORMANCE IS MET BY HIGH PROFITS, MEDIOCRE PERFORMANCE BY MEDIOCRE PROFITS, AND POOR PERFORMANCE BY LOW PROFITS OR LOSSES. THE PROPER APPLICATION OF THESE OBJECTIVES ON A CONTRACT BY CONTRACT BASIS SHOULD NORMALLY RESULT IN A RANGE OF PROFIT RATES.

"/B) PROFIT OR FEE IS ONLY ONE ELEMENT OF PRICE AND NORMALLY REPRESENTS A SMALLER PROPORTION OF THE TOTAL PRICE THAN DO SUCH OTHER ESTIMATED ELEMENTS AS LABOR AND MATERIAL. WHILE THE PUBLIC INTEREST REQUIRES THAT EXCESSIVE PROFITS BE AVOIDED, THE CONTRACTING OFFICER SHOULD NOT BECOME SO PREOCCUPIED WITH PARTICULAR ELEMENTS OF A CONTRACTOR'S ESTIMATE OF COST AND PROFIT THAT THE MOST IMPORTANT CONSIDERATION, THE TOTAL PRICE ITSELF, IS DISTORTED OR DIMINISHED IN ITS SIGNIFICANCE. GOVERNMENT PROCUREMENT IS CONCERNED PRIMARILY WITH THE REASONABLENESS OF THE PRICE WHICH THE GOVERNMENT ULTIMATELY PAYS, AND ONLY SECONDARILY WITH THE EVENTUAL COST AND PROFIT TO THE CONTRACTOR.'

THE GUIDELINES CONTAINED IN THE ARMED SERVICES PROCUREMENT REGULATION MAKE IT ABUNDANTLY CLEAR THAT EFFECTIVE AND MEANINGFUL NEGOTIATION WITH COMPETITIVE OFFERORS IS A NECESSARY INGREDIENT OF A PROPER AWARD OF A CPIF CONTRACT. NEGOTIATION OF THE TARGET COST, TARGET FEE, MINIMUM AND MAXIMUM FEE AND FEE ADJUSTMENT FORMULA IS PROVIDED FOR IN ASPR 3-405.4. MOREOVER, SUBPARAGRAPH (B) OF THAT SECTION CLEARLY CONTEMPLATES SUCH NEGOTIATION OF TARGETS, ETC., TO PROVIDE AN INCENTIVE TO THE CONTRACTOR TO EARN UP TO THE MAXIMUM FEE THROUGH HIS INGENUITY AND EFFECTIVE MANAGEMENT. WE QUOTE BELOW THE APPLICABLE PROVISION OF THE SUBSECTION:

"* * * WITH REGARD TO THE COST INCENTIVE PROVISIONS OF A CONTRACT, THE MINIMUM AND MAXIMUM FEES, AND THE FEE ADJUSTMENT FORMULA, SHOULD BE NEGOTIATED SO AS TO PROVIDE AN INCENTIVE WHICH WILL BE EFFECTIVE OVER VARIATIONS IN COSTS THROUGHOUT THE FULL RANGE OF REASONABLY FORESEEABLE VARIATIONS FROM TARGET COST. WHENEVER THIS TYPE OF CONTRACT, WITH OR WITHOUT THE INCLUSION OF PERFORMANCE INCENTIVES, IS NEGOTIATED SO AS TO PROVIDE INCENTIVE UP TO A HIGH MAXIMUM FEE, THE CONTRACT ALSO SHALL PROVIDE FOR A LOW MINIMUM FEE, WHICH MAY EVEN BE A -ZERO- FEE OR, IN RARE CASES, A -NEGATIVE- FEE.' IF REALISTIC COST ESTIMATES ARE INCAPABLE OF BEING ACHIEVED THROUGH NEGOTIATION AND IT APPEARS THAT ANY CONTRACT AWARDED WOULD BECOME, IN EFFECT, IF NOT IN NAME, A CPFF CONTRACT, WE FEEL THAT IT IS INCUMBENT UPON THE CONTRACTING OFFICER TO CONDUCT NEGOTIATIONS LEADING UP TO AN AWARD OF SUCH A CONTRACT. HOWEVER, THE AWARD OF A CPIF CONTRACT BASED ON COST ESTIMATES DETERMINED TO BE UNREALISTIC WHERE NO EFFORT IS MADE TO BRING THE COST ESTIMATES UP TO A REALISTIC LEVEL BY MEANS OF FURTHER NEGOTIATION TO ASSURE CONTRACT MANAGEMENT EFFICIENCIES THROUGH INCENTIVES IS PATENTLY IMPROPER AND AT VARIANCE WITH THE SOLICITATION AND THE RESPONSES THERETO.

ALTHOUGH ASPR 3-805.2 CAUTIONS AGAINST UNDUE RELIANCE ON COST ESTIMATES IN THE AWARD OF COST-REIMBURSEMENT TYPE CONTRACTS AND PROVIDES THAT THE PRIMARY CONSIDERATION IN DETERMINING TO WHOM AWARD SHALL BE MADE IS WHICH PROSPECTIVE CONTRACTOR CAN PERFORM IN A MANNER MOST ADVANTAGEOUS TO THE GOVERNMENT, IT DOES NOT COUNTENANCE A FAILURE TO NEGOTIATE REALISTIC TARGET COSTS AND AN AWARD BASED ON A PREDETERMINED "UNREALISTIC" COST PROPOSAL WHICH WAS SOLICITED ON AN INCENTIVE-FEE BASIS WHEREUNDER COST ESTIMATES ASSUME PRIMARY IMPORTANCE AS THE PARAMOUNT EVALUATION FACTOR IN DECIDING, AFTER NEGOTIATION, WHICH OFFEROR CAN PERFORM IN A MANNER MOST ADVANTAGEOUS TO THE GOVERNMENT.

WE ALSO QUESTION THE REASONABLENESS OF THE CONTRACTING OFFICER'S DETERMINATION THAT THE OFFERORS' COST ESTIMATES WERE UNREALISTIC. ASPR 3- 405.1 (B) STATES,"THE COST-REIMBURSEMENT TYPE CONTRACT IS SUITABLE FOR USE ONLY WHEN THE UNCERTAINTIES INVOLVED IN CONTRACT PERFORMANCE ARE OF SUCH MAGNITUDE THAT COST OF PERFORMANCE CANNOT BE ESTIMATED WITH SUFFICIENT REASONABLENESS TO PERMIT USE OF ANY TYPE OF FIXED PRICE CONTRACT.' WHILE WE DO NOT CONTEND THAT THE PERFORMANCE UNCERTAINTIES IN THIS INSTANCE WERE NOT OF SUFFICIENT MAGNITUDE TO JUSTIFY THE USE OF A COST-REIMBURSEMENT TYPE CONTRACT, WE DO STRONGLY QUESTION THE ABSOLUTE RELIANCE ON THE VALIDITY OF THE GOVERNMENT ESTIMATE AND WE ARE OF THE OPINION THAT IT IS AT LEAST INCONSISTENT TO USE A COST-REIMBURSEMENT METHOD OF CONTRACTING ON THE ONE HAND WHILE MAINTAINING ON THE OTHER HAND THAT ESTIMATED COSTS ARE CAPABLE OF BEING DETERMINED TO SUCH A DEGREE OF CERTAINTY THAT ANY OFFERED ESTIMATED COSTS OTHER THAN THOSE STATED BY THE GOVERNMENT ARE UNREALISTIC.

ADDITIONALLY, THE FISCAL YEAR 1968 CONTRACT WAS THE FIRST TO BE LET ON A CPIF AS OPPOSED TO A CPFF BASIS. IN THIS REGARD ASPR 3-405.4 AND 3-405.5 POINT OUT THAT THE CPFF TYPE CONTRACT PROVIDES LITTLE IF ANY INCENTIVE FOR COST CONTROL WHILE THE CPIF TYPE CONTRACT, BY ALLOWING THE CONTRACTOR TO SHARE IN COST SAVINGS, PROVIDES A GREATER INCENTIVE FOR EFFICIENT CONTRACT MANAGEMENT. IN VIEW OF THIS AND IN VIEW OF THE FACT THAT THE GOVERNMENT ESTIMATE WAS OF NECESSITY BASED ON AN ANALYSIS OF THE PAST CPFF CONTRACTS, IT WOULD APPEAR THAT COSTS LOWER THAN THOSE ESTIMATED BY THE GOVERNMENT REASONABLY MAY HAVE BEEN ANTICIPATED AS WELL AS COST SAVINGS WHICH WOULD HAVE BEEN REFLECTED IN THE LOWER COST ESTIMATES SUBMITTED BY THE OFFERORS.

FURTHER, IN ADDITION TO THE DCAA AUDIT OF THE RESPECTIVE COST ESTIMATES, ALL THREE ESTIMATES WERE ALSO AUDITED BY THE AVIATION MATERIEL COMMAND, A DEPARTMENT OF THE ARMY ORGANIZATION, BEFORE THE EXTENSION OF THE FISCAL YEAR 1967 CONTRACT FOR THE PURPOSE OF THE AAA AUDIT. THE RESULT OF BOTH OF THESE AUDITS, WITH REGARD TO HAYES AT LEAST, WAS THAT, WITH THE EXCEPTION OF SOME RATHER MINOR DEFICIENCIES, THE HAYES PROPOSAL WAS FOUND TO BE GENERALLY REALISTIC. IN FACT, THE AVIATION MATERIEL COMMAND AUDIT IN FINDING THE HAYES PROPOSAL TO BE GENERALLY REALISTIC ACKNOWLEDGED THE CONSERVATIVE NATURE OF THE GOVERNMENT ESTIMATE. CONCERNING THE DIFFERING RESULTS OF THE DCAA AUDIT AND THE LATER AAA AUDIT, THE OCTOBER 26 REPORT STATES:

"THE THIRD ALLEGATION, THAT THE DEFENSE CONTRACT AUDIT AGENCY AND THE ARMY AUDIT AGENCY REACHED DIFFERENT CONCLUSIONS WITH RESPECT TO THE REALISM OF THE COST ESTIMATES, INDICATES A LACK OF UNDERSTANDING OF PRECISELY WHAT WAS AUDITED. IN THE DCAA AUDIT THE OFFEROR'S PROJECTED LABOR RATES WERE COMPARED WITH ACTUAL LABOR RATES, THE QUOTED OVERHEAD RATES WERE COMPARED WITH OVERHEAD RATES HISTORICALLY UTILIZED BY EACH OFFEROR, ETC. IN OTHER WORDS, THE QUOTATIONS FROM EACH OFFEROR WERE EVALUATED BY COMPARING EXPERIENCED RATES TO QUOTED RATES, BUT NO ATTEMPT WAS MADE BY DCAA TO QUANTIFY THE NUMBER OF LABOR HOURS OF MAINTENANCE EFFORT WHICH WOULD BE REQUIRED FOR EACH AIRCRAFT FLIGHT HOUR. THE ARMY AUDIT AGENCY AUDIT, ON THE OTHER HAND, DID COMPARE THE QUOTED ESTIMATED COST (LABOR, OVERHEAD, ETC.) PER AIRCRAFT PER FLIGHT HOUR WITH HISTORIC COST DATA AVAILABLE FROM PREVIOUS YEARS CONTRACT EFFORT, AND ALSO COMPARED THE QUOTED ESTIMATED COSTS PER FLIGHT HOUR WITH THE ARMY DEVELOPED AVERAGE WORLD-WIDE TABLE OF MAINTENANCE HOURS PER FLIGHT HOUR. * * *"

SINCE WE WERE NOT FURNISHED WITH COPIES OF THE DCAA AUDIT REPORTS, WE MUST ACKNOWLEDGE THE FACTUAL ACCURACY OF THE ABOVE-QUOTED STATEMENT. HOWEVER, DOD DIRECTIVE 7600.2 STATES UNEQUIVOCALLY THAT,"* * * ALL CONTRACT AUDIT FUNCTIONS, WORLDWIDE, FOR ALL DOD COMPONENTS WILL BE THE RESPONSIBILITY OF THE DEFENSE CONTRACT AUDIT AGENCY. * * * OTHER DOD COMPONENTS ARE NOT AUTHORIZED A CONTRACT AUDIT CAPABILITY OR ORGANIZATION.' IT WOULD SEEM THEREFORE THAT DCAA UNIQUELY POSSESSED THE CAPABILITY TO "QUANTIFY THE NUMBER OF LABOR HOURS OF MAINTENANCE EFFORT WHICH WOULD BE REQUIRED FOR EACH AIRCRAFT FLIGHT HOUR" AND IT IS DIFFICULT TO UNDERSTAND HOW THE CONTRACTING OFFICER, MERELY ON THE STRENGTH OF THE AAA DETERMINATION THAT THE GOVERNMENT ESTIMATE WAS CONSERVATIVE, COULD DETERMINE THAT ALL THREE COST ESTIMATES WERE UNREALISTIC WHEN ALL THREE ESTIMATES HAD BEEN FOUND TO BE REALISTIC BY THE DCAA, THE AVIATION MATERIEL COMMAND AND THE CONTRACT EVALUATION BOARD.

WE THEREFORE CONCLUDE THAT THE AWARD TO PAGE WAS IMPROPER IN THAT IT REPRESENTED SERIOUS AND SUBSTANTIAL DEVIATIONS FROM THE STATUTORY AND REGULATORY REQUIREMENTS RESPECTING THE NEGOTIATION OF COST-PLUS INCENTIVE- FEE CONTRACTS. ALTHOUGH WE FURTHER CONCLUDE THAT PRACTICAL CONSIDERATIONS MILITATE AGAINST CANCELLATION OF THE CONTRACT, IT IS OUR DECISION THAT THE GOVERNMENT SHOULD FOREGO ITS OPTION TO RENEW THIS CONTRACT BEYOND JUNE 30, 1968, AND THAT A NEW CONTRACT SHOULD BE NEGOTIATED UNDER PROCEDURES CONSISTENT WITH THE REQUIREMENTS OF LAW AND REGULATION.