Cost Realism: Agency Must Evaluate Employee Compensation Rates

When an agency performs a cost realism evaluation under a solicitation involving significant labor costs, the agency must evaluate offerors’ proposed rates of employee compensation, not just offerors’ fully burdened labor rates.

In a recent bid protest decision, the GAO held that an agency erred by basing its realism evaluation on offerors’ fully burdened labor rates, without considering whether the direct rates of compensation were sufficient to recruit and retain qualified personnel.

The GAO’s decision in CALNET, Inc., B-413386.2, B-413386.3 (Oct. 28, 2016) involved a Navy task order solicitation for a range of technical services to be provided to the Naval Sea Systems Command Pacific Enterprise Data Center.  The solicitation was issued to holders of the Navy’s Seaport-e IDIQ contract, and contemplated the award of a cost-plus-fixed-fee task order.

Under the solicitation, offerors were to propose personnel in 13 labor categories.  For each labor category, offerors were to provide information on their direct labor rates, as well as the indirect rates to be applied to those direct rates.

In its cost evaluation, the Navy collected information about identical labor categories under 22 other contracts, including the incumbent contract.  Using this information, the Navy created a “range” of realistic fully-burdened hourly rates.  These ranges were, in some cases, quite broad.  For example, the Program Manager category ranged from a low of $69.44 per hour to a high of $228.93 per hour.

The Navy only found a rate to be unrealistic if it fell below the established ranges.  Of the 186 rates examined by the agency, only three fell below the ranges.  Unsurprisingly, the Navy made few cost adjustments to offerors’ proposals.  The Navy awarded the task order to Universal Consulting Services, Inc., which had the lowest evaluated cost.

CALNET, Inc., an unsuccessful competitor, filed a GAO bid protest.  CALNET argued, in part, that the Navy’s cost realism evaluation was inadequate.

The GAO wrote that “[w]here, as here, an agency evaluates proposals for the award of a cost-reimbursement type contract, the agency is required to perform a cost realism evaluation to determine the extent to which each offeror’s proposed costs represent what the contract costs are likely to be.”  Such an evaluation ordinarily involves consideration of “the realism of the various elements of each offeror’s proposed cost,” as well as whether each offeror’s proposal “reflects a clear understanding of the requirements to be performed.”

In this case, although “the cost of the contract is driven almost entirely by the cost of labor,” the Navy’s cost evaluation “was confined entirely to consideration of fully burdened hourly rates.”  However, “where, as here, a cost-reimbursement contract’s cost is driven in significant measure by labor costs, agencies are required to evaluate the offerors’ direct labor rates to ensure that they are realistic.”  The policy behind this requirement is logical: “unless an agency evaluates the realism of the offerors’ proposed direct rates of compensation (as opposed to its fully-burdened rates), the agency has no basis to determine whether or not those rates are realistic to attract and retain the types of personnel to be hired.”

The GAO found that the Navy “has no basis to conclude whether or not the offerors’ proposed direct rates of compensation are realistic because no analysis of those rates was ever performed.”  The GAO sustained CALNET’s protest.

The underlying purpose of a cost realism evaluation is–as its name suggests–to determine whether an offeror’s proposed costs are realistic in light of the solicitation’s requirements.  As the CALNET protest demonstrates, where a cost-reimbursement solicitation includes significant labor costs, it is insufficient for an agency to limit its cost evaluation to fully-burdened labor rates.  Instead, the agency must evaluate each offeror’s direct rates of compensation for realism.