Regulatory revisions over the last few years might have imposed a requirement for actual sales, despite the FAR’s language to the contrary.

BY SUSAN L. TURLEY

           

The essence of a commercial item is that its price is set by competition in a healthy marketplace in which buyers have many choices.[1]

Commercial items are not subject to the Truthful Cost or Pricing Data Act…because the commercial marketplace is presumed to be a competitive environment and should drive a fair and reasonable price.[2]

If a buyer is purchasing a cell phone, an automobile, or standard janitorial services, these assertions from the Department of Defense (DOD) hold true. However, what if the desired product is available from only one seller? Or, what if no one has ever actually purchased the item? It seems unlikely, if not impossible, that the competitive marketplace could set prices for those products—yet under the Federal Acquisition Regulation (FAR), both transactions could be considered “commercial.”

This article will discuss some of the challenges of commercial item pricing in government contracting. After reviewing the basic definition of a “commercial item,” it will then address how changes to acquisition regulations have impacted the reality of commercial price analysis.

What Is a Commercial Item?

First of all, it’s an obsolete label. The National Defense Authorization Act (NDAA) for Fiscal Year 2019[3] jettisoned the term “commercial item” and supplanted it with separate definitions of commercial products and commercial services.[4] Because the FAR Part 2 definitions have yet to incorporate the changes, this article will continue to refer to commercial items.

While the actual application is much more nuanced, the basic premise of commerciality holds that an item is “commercial” if some version of the item is sold or offered for sale to and customarily used by the general public.[5] A commercial item determination (CID) is a two-step process, with assessing the item’s commercial nature as the first step. In most cases, the finding that a product or service is in fact commercial need only be done once. The FAR requires that the item be of a type that is customarily used by the general public for nongovernmental purposes and that has been sold or offered for sale to the general public. Once that first sale or offering for sale occurs, it satisfies the requirement—without expiration. If the product ceases to be widely sold (think buggy whips, eight-track tape players, or rotary landline phones), it still has been sold.

Defense FAR Supplement (DFARS) 212.102(a)(ii) explicitly states that a contracting officer may rely on previous CIDs for subsequent procurements of the same item. (Of course, a changed product will require a new commerciality evaluation.) DFARS 212.7001 goes even further and prohibits switching to noncommercial acquisition procedures for an item previously purchased as commercial unless the head of the contracting activity determines that—

• The previous commerciality determination “was in error or based on inadequate information,” and
• A noncommercial acquisition will save money.[6]

The second step is analyzing “price reasonableness”—an evaluation that can expire. On top of that, the somewhat inherently contradictory rules governing commercial procurements complicate the analysis.

Why Is Commercial Item Price Analysis Difficult?

FAR Part 12 mandates government agencies to “[a]cquire commercial items…when they are available to meet the needs of the agency.”[7] To implement that mandate, FAR Subpart 12.6 allows streamlined procedures both in soliciting offers and evaluating proposals for commercial items. A significant contributor to this streamlining—and a frequent motivation for contractors to assert commerciality—is the exemption from both the Cost Accounting Standards[8] and the requirement for certified cost or pricing data.[9]

Additionally, commercial-item contract types are restricted to firm-fixed-price or fixed-price contracts with economic adjustment, except for a limited exception for time-and-materials or labor-hour contracts.[10] The prohibition against cost-type contracts aligns with the factors to be considered in selecting contract, especially the “type and complexity of the requirement.”[11] A commercial item should carry few, in any, “performance uncertainties or the likelihood of changes” in requirements that would complicate estimating costs in advance.[12]

Consequently, commercial item procurements will almost never involve cost data, removing that avenue for price analysis. As with noncommercial item procurements, competition remains the preferred method of price analysis. In theory, the government or prime contractors should seldom, if ever, purchase sole-source commercial products or services, but the reality is often quite different.[13]

In February 2019, the DOD Inspector General (IG) issued a report blasting TransDigm Group for charging $16.1 million in excess profit—as much as 4,451%—on $26.2 million in contracts from the U.S. Army and the Defense Logistics Agency.[14] The IG attributed the overcharging, in part, to the FAR’s “less stringent requirements” for commercial contracts that permit sole-source suppliers to sidestep providing even uncertified cost data—a situation the IG called a “flaw” in the federal acquisition system.[15] The IG also pointed to “the general lack of available data in the commercial marketplace that would be relevant to determine both similarity and prices” for sole-source commercial military parts.[16]

Another complicating factor is the ability to deem an item commercial without any actual sales. Only a few types of items must have been sold before they can be labeled commercial, including:

• The commercially available off-the-shelf (COTS) subset. To be a COTS product, an item must be sold in substantial qualities in the commercial marketplace and offered to the government without modification in the same form in which it’s sold in the commercial marketplace.[17]
• Nondevelopmental items “developed exclusively at private expense and sold in substantial quantities, on a competitive basis, to multiple state and local governments or to multiple foreign governments.”[18]
• “Services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices.”[19]

To fall into any one of these three subsets, an item must not only have actual sales (rather than just being offered for sale), but those sales must also be substantial. For the last two, the sales must also have been made on a competitive basis. Therefore, a buyer should have more than enough market data to determine whether the seller’s asking price is fair and reasonable.

However, for all other commercial items, no actual sales are required—only that the product has been “offered” for sale. In fact, “the ratio of government to non-government sales is irrelevant when determining commerciality.”[20] For commercial items that involve “minor modifications of a type not customarily available in the commercial marketplace made to meet federal government requirements,”[21] by definition, these modifications aren’t offered to the general public (and thus no sales data will exist).

Finally, even if there is available sales data, government contractors might find themselves unable to get it. The Defense Contract Management Agency (DCMA) Commercial Item Group (CIG) used to have a CID repository available to contractors, but that public access ended when market research and pricing information were added to the database a few years ago.[22] Similarly, subcontractors may refuse to provide sales data to higher-level contractors because they consider it proprietary.

Using Catalog or Website Pricing

One of the most common pieces of evidence used to support commerciality is a website or catalog advertising the item for sale. Shouldn’t that be enough to prove both that the item is commercial and the price is reasonable? Unfortunately, no:

Placing a product or service on the website for sale does not confirm it is commercial. Unless there is clear indication that the supplier is selling their product or service to the public, evidence needs to be provided that the item or service is actually available for purchase to the general public.[23]

Similarly, the commercial pricing guidance in FAR 15.403-3(c)(1) states that a price published in a commercial catalog is not automatically “fair and reasonable,” and directs the contracting officer to obtain additional data. If necessary, the data may include “history of sales to nongovernmental and governmental entities” and shall include “at a minimum, appropriate data on the prices at which the same item or similar items have previously been sold, adequate for determining the reasonableness of the price.”

The fact that a price is included in a hard copy catalog or online price list does not automatically make it fair and reasonable. Market prices mean 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 from the offeror. It is possible that an item listed in a supplier’s catalog has never been actually sold at that price or has only been sold for government end-use. You may need to confirm that catalog prices are consistent with relevant actual sales data ([e.g.], prices in commercial invoices, [or] prices in commercial contracts…).[24]

So, the regulations lead buyers back to sales history—but again, what if none exists?

So Long to Simply “Offered for Sale”?

This FAR provision is relatively open-ended, as are most of the price analysis clauses, leaving it up to the procurement professional to determine what data is appropriate. Theoretically, that means a buyer could determine commercial price reasonableness without any sales data.

However, today’s practical reality is that while an item may be deemed commercial without sales data, it’s unlikely to get past the price analysis step without the information. In other words, the price reasonableness requirements have written in a necessity for actual sales, rather than simply an offer to sell.

In January 2018, DOD published a final rule amending the DFARS to require additional information to support price reasonableness. Since then, DFARS 252.215-7010(b)(1)(ii) has required suppliers claiming commerciality to submit, “at a minimum, information that is adequate for evaluating the reasonableness of the price for this acquisition, including prices at which the same item or similar items have been sold” commercially—not just offered for sale.

The DFARS focuses on two types of information:

• Catalog pricing, and
• Market pricing.

For pricing based on a catalog, the contractor must provide a copy or identification of the catalog showing the product’s price. (A “catalog” can be a website, but it must be a publicly available website.) If the proposed pricing is not consistent with the relevant sales data, then the supplier must also explain, in detail, the differences or inconsistencies between the sales data, proposed price, and catalog price including any related discounts, refunds, rebates, offsets, or other adjustments.[25]

For commercial pricing based on market pricing, the supplier must describe the commercial market, explain the “methodology used to establish a market price,” and provide, again, “all relevant sales data.”[26] The DFARS defines relevant sales data as “information provided by an offeror on sales of the same or similar items that can be used to establish price reasonableness taking into consideration the age, volume, and nature of the transactions (including any related discounts, refunds, rebates, offsets, or other adjustments).”[27] Sales data includes records of sales for both the proposed item and similar items where the record should include order data, such as customer name, product number, serial number, product description, sales order number, date of sale, quantity sold, and price.

Again, unlike the initial determination, commercial price analysis is never a “one and done.” Instead, just like every other price analysis, determining commercial price reasonableness will depend on the specific facts and circumstances of the acquisition. Both the DFARS and the underlying U.S. Code allow contracting officers to consider recent prices paid in establishing commercial price reasonableness—if “the contracting officer is satisfied that the prices previously paid remain a valid reference for comparison after considering the totality of other relevant factors such as the time elapsed since the prior purchase and any differences in the quantities purchased or applicable terms and conditions.”[28]

What’s “recent?” Again, it depends. The FAR doesn’t really address the issue; the DFARS does, but only in general terms: “Whether data is too old to be relevant depends on the industry (e.g., rapidly evolving technologies), product maturity (e.g., stable), economic factors (e.g., new sellers in the marketplace), and various other considerations.”[29] As DOD has pointed out, “cell phone sales data could be outdated in less than 6 months.”[30] Although I’ve not found anything definitive, three years is probably the outside range for “recency,” and two years is probably the safest time frame.[31]

This guidance again emphasizes the bifurcated nature of a commerciality assessment: While an invoice from five years ago (or even older) can demonstrate that a product has been sold in the commercial market, it probably can’t establish price reasonableness. Consider this question asked to the DCMA CIG:

Question: The government sometimes uses products longer than commercial customers. If a product or service initially started out as commercial, how can a supplier justify its current price is reasonable if the government is now the only customer?

Response: The prime contractor is responsible for performing a price analysis on its subcontract. There are generally similar items to compare in the marketplace even if the government is the only buyer for the specific proposed part number. [32]

Will there always be similar items for sale in the commercial marketplace? Hopefully. Just remember that if you’re using “similar-to” pricing, then you will need to understand and evaluate the differences between the commercial item being purchased and the comparison item. (Refer to SIDEBAR.)

Dealing with Recalcitrant Suppliers

This relatively recent emphasis on the two-step assessment can come as a surprise to contractors that garnered a commerciality determination some years ago and are now expected to provide not only updated information but pricing data that was never required before. Some balk, arguing that we shouldn’t be revisiting the CID. The key is to help them understand that we’re not questioning the commercial nature of their products but performing our due diligence when it comes to pricing. Consequently, suppliers can’t claim the benefits of a CID without fulfilling their duty to provide the required evidence. In other words, a contractor may not assert a commerciality exemption from providing certified cost or pricing data and then refuse to demonstrate the actual prices at which the item or service was sold.

At the end of the day, we should not be buying items or services at prices that we do not consider to be fair and reasonable. While it is our responsibility to perform adequate price analysis of commercial items, that responsibility does not relieve the offeror of its obligation to support the reasonableness of its proposed prices if it chooses to supply goods and services to DOD.[33]

What if a commercial contractor wants to redact the prices at which the item was sold? That might be adequate to provide evidence of commerciality but won’t support price reasonableness. What if the contractor is willing to provide invoices with pricing but insists on redacting the customers’ identities? If you have adequate independent evidence that the product or service is commercial, that might be enough—or it might not. Again, it depends on all the facts and circumstances. Why won’t the contractor provide unredacted invoices? What other evidence can you find of pricing? How significantly does the price you’re paying differ from those on the invoices?

Another alternative that government contractors can use is the equivalent of a government “assist audit” when a subcontractor refuses to provide certified cost or pricing data. A supplier might be unwilling to provide the prime with proprietary sales information but will agree to allow the invoices to “be validated by a government agency at the subcontractor.”[34]

The commercial item two-step can be a delicate dance, and sometimes both buyers and sellers might step on a few toes or make a few missteps. Ultimately, just as with any other dance, it requires cooperation and coordination between both partners to make it work. 

Susan L. Turley

• Currently working in strategic sourcing for a large defense contractor.
• Retired U.S. Air Force Judge Advocate and former DOD government contracting attorney.

 

Endnotes