Commercial Item Determination and Price Reasonableness Presented by

Commercial Item Determination and Price Reasonableness Presented by: Ryan Connell, DCMA CIG Lynne Fandetti, DCMA CIG Joe Bellantuoni, Mercury Systems 8 March 2017

2 Agenda • General Overview ▫ Commercial Acquisition ▫ FAR Commercial Item Definition ▫ The Evolution of Commerciality • DCMA Commercial Item Group (CIG) ▫ Group Overview ▫ Establishing a Common Framework • • • Determining Commerciality Market Research Price Analysis Industry Takeaways Examples: Part and Services

3 Overview- Commercial Acquisition Highlights 3 • Commercial Acquisition is a streamlined AQ process ▫ Reduced acquisition costs, cycle times • Commercial Optimization ▫ Less legacy issues, obsolescence, diminishing manufacturing sources ▫ New innovations in technology ▫ New companies can be introduced to defense procurement without investment in compliant business systems and processes • FAR Clause 52. 244 -6 ▫ To the maximum extent practicable, the Contractor shall incorporate, and require its subcontractors at all tiers to incorporate, commercial items or nondevelopmental items as components of items to be supplied under this contract.

4 Overview - Commercial Item Definition 2. 101 4 • “Customarily” means “usually” FAR Commercial Item Definition CIG Interpretation: • A commercial item is any item…similar to items usually used by the public for commercial purposes and– the item or the similar item has been sold or offered for sale to the general public. • Definition 1 leads into Definition 2, 3, 4, 5 and 7. • Definitions 6 & 8 are the only ones that don’t revert back to Definition 1.

5 Overview – Definition Clarifications • “Of a Type” ▫ “Similar” ▫ “Customarily” used • How to evaluate “Similar” item ▫ Form, Fit, and Function ▫ Essential characteristics that define a product ▫ Technical specifications • Customarily used ▫ “Usually” or “Commonly” ▫ What industries & applications? ▫ Size of the market 5

6 Overview – “Modification” Definition 6 • Modification should be: ▫ “Customarily” available to the public, OR ▫ Required to meet specific Government reqs; but are minor modifications • What constitutes a “minor” modification? ▫ ▫ Are there changes to the essential physical characteristics? Is the non-governmental function significantly altered? Value and size of the modification Certified cost and pricing data may be required �FAR 15. 403 the greater of 5% of total price or the certified cost and pricing threshold ▫ Non-minor, non-commercial modification ▫ Un-modified item may still be commercial and exempt from TINA

7 Commercial Services 7 (5) Installation services, maintenance services, repair services, training services, and other services if-- (i) Such services are procured for support of an item referred to in paragraph (1), (2), (3), or (4) of this definition, regardless of whether such services are provided by the same source or at the same time as the item; and (ii) The source of such services provides similar services contemporaneously to the general public under terms and conditions similar to those offered to the Federal Government; (6) Services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices for specific tasks performed or specific outcomes to be achieved and under standard commercial terms and conditions. For purposes of these services—

8 Overview – Nondevelopmental Item 8 • Nondevelopmental Item (NDI) ▫ Defined in 2. 101 as �(1) Any previously developed item of supply used exclusively for governmental purposes by a Federal agency, a State or local government, or a foreign government with which the United States has a mutual defense cooperation agreement; �(2) Any item described in paragraph (1) of this definition that requires only minor modifications of a type customarily available in the commercial marketplace in order to meet the requirements of the procuring department or agency; or �(3) Any item of supply being produced that does not meet the requirements of paragraph (1) or (2) solely because the item is not yet in use. ▫ Commercial NDI is defined in the commercial item definition �Developed exclusively at private expense, sold in substantial quantities, on a competitive basis, to multiple State and local governments.

9 Evolution of Commercial – Recent NDAAs • NDAA 2013 ▫ Implements Commercial Centers of Excellence (COEs) ▫ Set the mandate for a “Cadre of Experts’ within Do. D ▫ Industry reacts negatively to DFARS changes • NDAA 2016 ▫ Restricts PCO’s ability to change commercial decision; to HCA ▫ Reliance on prior Government prices paid for price reasonableness ▫ Added scrutiny to convert from FAR 12 to FAR 15 • NDAA 2017 ▫ Market research for price analysis ▫ Create a non-public database to collect PCO CIDs ▫ Many Pilot programs for commercial items

10 Evolution of Commercial – NDAA 2017 • Key Item 1: Formally codifies a preference for commercial items and services • Key Item 2: Prior commercial item determination ▫ Commercial determinations for one item are leveraged for future decisions ▫ Application to subcontractors is not addressed • Key Item 3: Price reasonableness factors ▫ Market research ▫ Can include purchases made by commercial or government customers ▫ Can include uncertified cost information (everything but the signature) ▫ Uncertified data can be in the contractor business system format • Key Item 4: Non-Traditional Defense Contractor ▫ Any contractor not performing on a CAS-covered contract in the year prior to an order ▫ Exempt from certified cost data on commercial item sales ▫ Items sold under this header are not categorized as “commercial”, but are not eligible for certification of costs • Key Item 5: Overall added emphasis on unified commercial acquisition process

11 Commercial Item Group (CIG) - Mission MISSION Develop a robust “cadre” of commercial acquisition expertise to support buying commands and DCMA for commercial item recommendations and pricing Commercial@dcma. mil OPERATIONAL 30 JUNE 2016 Imperative: 2013 NDAA, Section 831(b)

12 Commercial Item Group (CIG) - Setup Denver Markets: Space (Spacecraft and Lift), C 4 I (Systems, Cyber and Services), Indianapolis Markets: Automotive, Aeronautics, Aircraft Engines Phoenix Markets: Heavy Machinery, Missiles Currently Being Refined St. Petersburg Group HQ Markets: Special Operations (Vehicles, Weapons, Ammo) Boston Markets: Services (MRO), Chemicals and Materials Philadelphia Markets: Naval Transport & Equipment, Troop Supply (Shelters, Personal Equipment)

13 Commercial Item Group (CIG) – Capabilities & Goals 1. Requests (From ACO/PCO or DCMA internal) – Technical and pricing analysis – Market analysis – Commercial item determination recommendations – Price Reasonableness Analyses – Negotiation Support – Training and Assistance 2. Establish Commercial Item Database 3. Establish a “Common Framework” with industry

14 Common Framework - Commerciality • Identify the specific FAR 2. 101 definition – paragraphs (1) to (8) • Item nomenclature, Description - Pictures • Side-by-side comparison proposed item vs. similar commercial item(s) noting any differences and similarities. – Functionality – of the proposed item and the “similar” commercial – Application – how / what is the item used for (both proposed / “similar”) – Physical characteristics • Evidence of sales or offered for sale – Website, catalog – Sales history • Services -- Compare/contrast key terms & conditions vs. customary commercial terms & conditions – Pricing, Warranty, Test, Inspection, Technical data rights - as applicable;

15 Common Framework - Pricing • Sales data/Invoices; proposed item and “similar” item – Unredacted – All sales data / not a subset of sales data / Govt. and commercial sales – Identification and agreement of specific SAP/ERP reports • Agreement to allow DCMA to review sales data/Invoices – Unredacted, names, dates, item description, quantities – Sales orders (not just invoices – total quantities, terms/conditions) • • • Catalog prices – excerpt applicable catalog pages Price lists – published prices lists Explanation of sales data anomalies Explanation of price differences – proposed vs sales data of “similar” Relevant strategic pricing agreements – i. e. long term agreements

16 Common Framework - MOA • Agreements establish a process for review of commerciality and commercial pricing • Agreement is between DCMA and “Contractor” – Does not bind Contracting Officers – DCMA’s authority is limited to recommending commerciality and recommending price reasonableness • Common framework – – Data DCMA needs to evaluate commerciality – Data DCMA needs to evaluate pricing • Agreement to provide data / access to sales data – Unredacted invoices • Other caveats – communication of preliminary recommendation • Commerciality & Proposal Walkthrough

17 17 Determining Commerciality – FAR 12 and FAR 15 • Step 1. Does a prior PCO CID exist? • Step 2. Market Research ▫ Is this part/service available to the commercial market? ▫ Is it customarily used by non-governmental entities ▫ Are similar parts being used by non-governmental entities �How similar are they? “Of-A-Type” – side by side comparison • Step 3. Review Contractor Supplied information • Step 4. Make a determination, citing which part of the definition the part or service meets, using market research and proposed information

18 Determining Commerciality – Pre. Award Implications Pursue Other Than Commercial Item Procurement Are Commercial Items Available? Yes No Can Commercial items be reasonably modified? Yes Pursue Commercial Item Procurement IAW FAR Part 12 No Can the requirements be modified Yes No

19 Determining Commerciality – Sharing the Decisions • • Spreadsheet retained by CIG – Commercial@dcma. mil Future database will incorporate PCO decisions Helps both Industry and Government Once commercial always commercial ▫ “Once Commercial” refers to a PCO determination ▫ Prime determination of a subcontractor does not count • CIG non-commercial recommendations revisited with additional data or evidence of market changes

20 Determining Commerciality - Responsibilities • Government issues FAR 12 Solicitation � Government performs market research to determine commerciality (FAR 12 or 15 RFP) � Prime contractor needs to support price reasonableness in the sole source proposal � Government PCO should engage experts pricing, engineering & DCMA CIG, for support � Government PCO is required to have a written D&F – CID on any commercial buys over $1 M • FAR 15 Non-Commercial Prime with commercial Subcontracts � Prime Contractor shall perform a Commercial Item Determination, using Market Research and guidelines in FAR Part 10. (244. 402) � Prime contractor submitting a Subcontractor “assertion of commerciality” is not meeting the requirement � Prime Contractor shall perform price analysis on the subcontractor � PCO still has responsibility to make sure prime proposal, including CIDs is adequate and price is fair and reasonable �Decisions, no matter who is responsible, rely heavily on Market Research

21 Market Research �What is Market Research? FAR 2. 101 “Market research” means collecting and analyzing information about capabilities within the market to satisfy agency needs FAR Part 10 - use the results of the market research to determine if commercial items can be used to meet the agency’s needs. �Price Analysis? or Commerciality? �Who’s is responsible? �Importance �Commerciality - Reliance on future CIDs �Pricing – Understanding the delta

22 Market Research 22 • Collect ▫ Market research is a continuous process designed to gather data on products and services, market capabilities and the business practices associated with them. • Organize ▫ Data is used to evaluate trade-offs among the various ways of meeting an organization’s requirements. • Present ▫ Market research is also the documentation of the data collected and its presentation in a way to facilitate acquisition decisions. • Maintain ▫ Keep your market research for future decision makers to understand the products and services and how your decisions were made.

Market Research • • • Is one source good enough? Are two sources good enough? Does 1 commercial sale = Commercial? What about 1 commercial sale 4 years ago? Does 1 quote showing an offered price mean its fair? Is the catalog price fair? Is a % off catalog price fair? 23

24 Commercial Item Pricing 24 • Price Analysis Techniques ▫ ▫ ▫ ▫ Comparison to other prices received from other companies Comparison to historic prices paid Parametric estimating methods Government cost estimates Market research on same or similar items (NDAA 2017 – required) Data other than certified cost or pricing data Value based pricing (NDAA 2017 – allowable)

25 Commercial Item Pricing 25 • Evaluate price, not cost ▫ Cost plus a certain profit is not the F&R way to look at commercial pricing ▫ Peanut butter and jelly sandwich • Be a prudent business person • Understand the competitive market conditions ▫ Direct competition, if commercial, why isn't it being competed ▫ Who makes products/services similar? Who buys besides USG? • Reasonable knowledge of the market ▫ What has the Government paid, what do others pay? ▫ What is the value of the item/service; complexity, risk, difficulty • Negotiate a fair and reasonable price

26 Commercial Item Pricing 26 • Step 1. Evaluate contractor provided information • Step 2. Collect as much information as necessary ▫ What are prices like in the market – on commercial similar-to items �Understand the difference ▫ Has Government bought it before, how much? How long ago? Quantity? ▫ Are there any market standards i. e. price per pound/foot, etc • Step 3. Form a recommendation ▫ Compile as many pricing data points as possible ▫ Use all the points with varying levels of fidelity to recommend a price/range • Step 4. Document your analysis

27 Common Misconceptions • • • 27 A company is a commercial company A facility is commercial Nondevelopmental items are commercial If it is developed at private expense, it is commercial You have no commercial sales, so it’s not commercial It is listed for sale on our website, so it’s commercial Sales data is too old for consideration into commerciality It is commercial so the price is fair and reasonable The price is in our catalog so it’s fair and reasonable

28 Industry Perspective • Practice is sometimes different than policy • Reasons for denial of commerciality ▫ Age of commercial sales ▫ Only one invoice example does not prove a commercial market exists ▫ Difference between “evolved from” price and new item price ▫ Higher dollar sales, if a lower dollar amount would have been “ok” ▫ Individual agency or customer comfort ▫ Catalog price list is seen as not enough to establish commercial item status �Keep in mind: Catalog price does not in itself justify price reasonableness • Why is this? ▫ Contracting officers and prime compliance officers are reluctant to make commerciality decisions ▫ Prime contractors have been hit with estimating and purchasing system deficiencies based on commercial item evaluations ▫ Generic business model discomfort (i. e. if the buyer cannot evaluate the cost, how can they be certain of reasonableness)

29 Industry Example– Palantir Technologies • Central theme is around pre-award market research • Palantir claims existence of a commercial offering during the formal RFI process • US Army PCO submitted a solicitation for an IDIQ for developmental services on a cost reimbursable basis • Palantir claimed that the solicitation did not take into account the existence of commercial technology that would have allowed the Army to solicit proposals under FAR 12 terms • Federal Claims Court ruled in favor of Palantir ▫ The Army violated a 1994 law -- the Federal Acquisition Streamlining Act ▫ The Army did not conduct the market research needed to determine if commercially available items could meet its needs with or without modification • Could force USG agencies to first look to commercial marketplace before soliciting developmental solutions to their needs

30 Commercial Service Example Case 30 • Helicopter Blade Repairs ▫ Commercial services for repairs on a military helicopter rotor blades • Review the contractors proposal ▫ Contractor provides data showing that they provide similar services to commercial customers & the rotor blades are considered commercial ▫ Contractor states the proposed services meet FAR 2. 101 definition 5 Are these commercial services? • Definition 5 (ii) ▫ …under similar terms and conditions (T&Cs) as in the commercial marketplace ▫ RFI to get more information regarding T&Cs, as well as market research to see what commercially normal T&Cs.

31 Commercial Service Example Case 31 T&C Government Commercial Pricing FFP per repair category (i. e. Cat 1, Cat 2, Cat 3) Inspect / Propose Firm Fixed Price Scope Multiple repair scopes grouped into Categories (CAT 2 and CAT 3) Scope established post inspection Contract Term 5 years Per repair Materials Furnished by Govt. Included in price Are these commercial services? CIG opinion is no. While the service itself is commercial, it is not being offered in the same/ similar manner as in the commercial market. This could be because of the RFP or because of the proposal.

32 Commercial Part Example 32 • Buying a Valve ▫ Contractor makes custom valves for various military and commercial application • Review the contractors proposal ▫ Contractor provides data showing various part numbers and technical specifications, including price for each valve they made ▫ Never made this specific valve before, but they have sold valves commercially Is the valve commercial? • We are going to review to see if it fits into “of a type” ▫ Compare the Form, Fit and Function of the commercially sold valves, to the one we are buying.

33 Commercial Part Example • Contractor provided sales history of commercial sales • CIG performed mkt research and found other similar for sale • Government-requirements ▫ ▫ 2. 25” diameter 2000 PSI 10” long Max Temp 2, 000 degrees Is the valve commercial? • CIG opinion is yes. This fits into the “of a type” scope. • Inbounds 33

34 Commercial Part Example • What about pricing? ▫ KTR proposed $50 k ▫ Some are higher some are lower Is $50 k reasonable? • Let’s Compare various technical specs to the average price sold/offered for sale 34

35 Commercial Part Example Length 35 Diameter $ 70, 000 R 2 = 0. 0627 $ 60, 000 R 2 = 0. 0627 $ 50, 000 $ 40, 000 Average Price $ 30, 000 Linear(Average Price) $ 20, 000 $ 10, 000 $ - 0 0 5 10 15 20 25 30 30 Temperature PSI R 2 = 0. 827 $ 70, 000 R 2 = 0. 0561 $ 60, 000 $ 50, 000 Average Price $ 40, 000 $ 60, 000 $ 50, 000 $ 40, 000 Average Price Linear(Average Price) $ 30, 000 $ 20, 000 Linear(Average Price) $ 20, 000 $ 10, 000 $ - $ 0 1000 2000 3000 4000 5000

36 Commercial Part Example 36 • Using the model that Temperature is a cost driver ▫ 12. 284(2000) +8975. 3 = $33, 543 Is $50 k reasonable? • RFI to contractor. You haven’t given us supporting data for a $50 k price • Government Requires additional testing, that we don’t do commercially Wait, is this still a commercial valve? • RFI to contractor. Need more information regarding the testing • Tests are all offered/performed commercially, frequency was different • CIG bottoms up estimated the value of the tests, $2, 500; total $36, 043 Is $50 k reasonable? – No, not based off the information provided, plus market research. CIG recommends $36 k

37 Summary • • • 37 NDAAs added emphasis on market research & price analysis Collect as many fact based pieces of information to build story Added emphasis on commercial acquisition Changes affect both Industry and Government CIG is Commercial@dcma. mil ▫ Building database ▫ Agreements with Industry

38 Questions

39 BACKUP

40 Commercial Item Definition 2. 101 “Commercial item” means -(1) Any item, other than real property, that is of a type customarily used by the general public or by non-governmental entities for purposes other than governmental purposes, and-(i) Has been sold, leased, or licensed to the general public; or, (ii) Has been offered for sale, lease, or license to the general public; (2) Any item that evolved from an item described in paragraph (1) of this definition through advances in technology or performance and that is not yet available in the commercial marketplace, but will be available in the commercial marketplace in time to satisfy the delivery requirements under a Government solicitation; (3) Any item that would satisfy a criterion expressed in paragraphs (1) or (2) of this definition, but for -(i) Modifications of a type customarily available in the commercial marketplace; or (ii) Minor modifications of a type not customarily available in the commercial marketplace made to meet Federal Government requirements. Minor modifications means modifications that do not significantly alter the nongovernmental function or essential physical characteristics of an item or component, or change the purpose of a process. Factors to be considered in determining whether a modification is minor include the value and size of the modification and the comparative value and size of the final product. Dollar values and percentages may be used as guideposts, but are not conclusive evidence that a modification is minor; (4) Any combination of items meeting the requirements of paragraphs (1), (2), (3), or (5) of this definition that are of a type customarily combined and sold in combination to the general public; (5) Installation services, maintenance services, repair services, training services, and other services if-- (i) Such services are procured for support of an item referred to in paragraph (1), (2), (3), or (4) of this definition, regardless of whether such services are provided by the same source or at the same time as the item; and (ii) The source of such services provides similar services contemporaneously to the general public under terms and conditions similar to those offered to the Federal Government; (6) Services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices for specific tasks performed or specific outcomes to be achieved and under standard commercial terms and conditions. For purposes of these services— (i) “Catalog price” means a price included in a catalog, price list, schedule, or other form that is regularly maintained by the manufacturer or vendor, is either published or otherwise available for inspection by customers, and states prices at which sales are currently, or were last, made to a significant number of buyers constituting the general public; and (ii) “Market prices” means 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 of the offerors. (7) Any item, combination of items, or service referred to in paragraphs (1) through (6) of this definition, notwithstanding the fact that the item, combination of items, or service is transferred between or among separate divisions, subsidiaries, or affiliates of a contractor; or (8) A nondevelopmental item, if the procuring agency determines the item was developed exclusively at private expense and sold in substantial quantities, on a competitive basis, to multiple State and local governments. Definition 1 leads into Definition 2, 3(i), 4, 5 and 7. Definitions 3(ii), 6 & 8 are the only ones that don’t revert back to Definition 1.

41 Evolution of Commercial – NDAAs and DCMA • • DCMA identified as implementing agency DCMA Pilot program began in earnest with only 9 personnel Oct 2014 – DCMA Pilot Team was recognized Jan 2016 - pilot ended & full fledge Commercial Item Group came into existence • Operational on 30 June 2016

42 Commercial Item Group (CIG) - Capabilities • Types of Requests (From ACO/PCO or DCMA internal) ▫ ▫ ▫ Commerciality of a part or service Price Analysis Market Research Negotiations Support Other/Inquiries • Types of Requests (From Prime Contractor – for subcontractor) ▫ Request needs to come from PCO/ACO ▫ Request needs to have denial of access letter ▫ Request will be returned if Prime does not perform market research

Market Research – Early Engagement 43 Market Research is everyone’s responsibility Market Research performed during acquisition strategy, requirements definition, solicitation, pre-award, & ongoing

Pricing Example • Proposal Came in, $55 M to buy Green Aircraft • New Aircraft, no sales on this model (2013) Listing Price for the A/C is $65 M, Interior Value estimated at $6 M Prior Model A/C is in 2012 Blue Book for $60 M Bluebook shows a 2009 prior model for $50 M Government previously bought 2007 used ones for $35 M Aircraft Digest article- 10 A/Cs for average $58 M each Another carrier sales to USAF for $45 M, 10% less list price 44

45 Determining Commerciality of a Part Does a prior CID Exist Yes Is the Existing CID adequate and supported Yes No Unknown/No Market Research Does the item exist in the commercial market 45 Gov’t needs HCA approval to overturn Yes Document your findings; It is commercial No Does part have similar capabilities, size and shape? Does it have the same function as an item in the commercial market Yes No Document your findings; Non commercial