Government Contract Pricing: A Starter's Guide

Is government contracting profitable? It's an excellent question for the uninitiated, and the answer depends upon a myriad of factors. Among them:  the economy of your costs incurred as a contractor, the reasonableness of your proposed pricing to the government and how successfully you can negotiate your final, awarded price.

In this article, we'll examine these basics, as well as the fundamentals of government contract pricing, executing cost and pricing analyses, pricing services as well as products and knowing your average profit margin for a contract.

In This Article:

• How Do You Price a Contract for Government Work?
• What Are Examples of Labor Categories?
• What is Contract Cost Analysis?
• What is Meant By “Fair and Reasonable” Price?
• What is Price Analysis in Government Contracting?
• How to Price Services in Government Contracting
• What is a GSA Price?
• What is the Average Profit Margin in Government Contracts?

The pricing process in government contracts involves negotiating between submitting a competitive bid and ensuring compliance with federal regulations. It always involves a thorough analysis of both direct and indirect costs associated with fulfilling the contract. 

Cost Estimation is the Foundation

The first step in pricing a government contract is to estimate the total costs involved. Included are direct costs, such as labor, materials and equipment, as well as indirect costs or overhead, made up of administrative expenses, utilities and other costs that support the contract but are not directly tied to it. For example, a construction company bidding on a government project would need to consider the cost of raw materials, the wages of its workers and the expenses associated with operating its offices.

Pricing Strategy is the Innovation

Once cost estimating is done, a contractor has to decide on a pricing strategy that aligns with the contract type they're pursuing and its specific requirements. Cost-plus pricing, where a profit margin is added to the estimated total cost, is popular when the scope of work is not well-defined, allowing for adjustments as the project progresses. Fixed-price contracts, on the other hand, require accurate cost estimation upfront to ensure profitability and compliance, as the agreed-upon price remains the same regardless of actual costs incurred.

Navigating the Regulatory Landscape

Compliance with federal regulations, such as the Federal Acquisition Regulation (FAR) and Cost Accounting Standards (CAS), is mandatory in establishing a firm contract price. These regulations dictate how costs are estimated, allocated and reported; failure to adhere to them can result in severe consequences, including penalties, contract termination or even legal action. Market intelligence tools like Deltek's GovWin IQ platform can help contractors stay informed about the latest regulatory changes and ensure their pricing strategies remain compliant.

Related articles:

• Guide to Government Contracting Compliance
• What is the Federal Acquisition Regulation?
• What are Cost Accounting Standards?

Staying Competitive in the Market

Contractors must continuously monitor the competitive landscape when pricing their services. Ways to do this include analyzing competitors' past and current pricing strategies and continuously grasping government agencies’ budget constraints.

Government contracts almost always include a variety of labor categories that define the roles and qualifications required for different positions within a contracting firm. These categories help agencies and contractors align on expectations and pricing for various types of work.

One standard set of labor categories is found in the OASIS (One Acquisition Solution for Integrated Services) contract vehicle. OASIS uses Junior, Journeyman, and Senior designations based on factors like years of experience, education level and job responsibilities. For example, a Senior Software Developer might need seven or more years of experience and a relevant advanced degree.

Beyond OASIS, many contracts use numbered levels to indicate increasing seniority and independence. Level II roles typically involve contractor staff who work autonomously and make key decisions, while Level III positions often require extensive experience, advanced degrees and specialized certifications.

Agencies may also allow contractors to propose custom labor categories for unique or specialized work. This flexibility can be valuable for emerging technology fields or niche skill sets not covered by standard categories.

Some contracts, like OASIS+, provide a standard set of labor categories that contracting officers can use as a starting point when defining task order requirements. Preset options like these can streamline the procurement process.

It's worth noting that contractors often have some leeway to deviate from strict labor category definitions as long as they clearly explain any differences in their proposals. This allows customization to match a company's specific organizational structure or talent pool.

When bidding on government contracts, contractors must deliver—on time—a detailed cost estimate that demonstrates an understanding of the resources needed to complete the work. This is where cost analysis comes into play. It's the process of evaluating the separate cost elements and profit in a contractor's proposal to determine if the proposed costs are fair, reasonable and realistic.

Cost analysis involves a thorough examination of a contractor's basis of estimate (BOE), which is a comprehensive set of data and narrative information that explains the logic, methodology, calculations and assumptions used to define tasks and determine the costs needed to accomplish the scope of work outlined in the government RFP at hand. A credible BOE is essential for a successful cost analysis, as it tees up the government with the necessary information to verify that the contractor clearly understands the project. 

For example, let's say a government agency is seeking proposals to develop a new software system. The RFP outlines the technical deliverables and timeline for the project. In response, a contractor submits a proposal with a detailed BOE that breaks down the estimated costs for labor, materials, travel, outside services and other direct costs. The BOE also includes information on the estimating methodology used, such as the Cost Estimating Relationship (CER) methodology, which relies on historical data from similar projects to establish statistically valid cost estimates. 

During the cost analysis process, a government Contracting Officer (CO) reviews the contractor's BOE to confirm the proposed costs are “fair and reasonable.” Their review may involve evaluating the effect of current practices on future costs and verifying that the contractor has complied with the applicable contract cost principles.

Another example of government contract cost analysis might involve a construction project for a new government facility. In this case, the contractor's BOE would likely include detailed estimates for labor, materials, equipment, subcontractors and other direct costs, as well as information on the estimating methodology used, such as the Task-Based or Bottoms-Up methods, which rely on a library of performance standards to calculate labor hours for comparable tasks. 

Throughout the cost analysis process, the CO might ask for additional information from the contractor to make sure the proposed costs are complete. Both parties usually look upon this as a collaboration. It ensures the government is getting the best value for its money and that the contractor is well-positioned to successfully complete the project—within the agreed-upon budget and timeline. 

The overarching lens through which the costing process is viewed is spending taxpayer dollars wisely. 

In government contracting, a "fair and reasonable price" refers to one considered equitable to both the government and the contractor, reflecting the market value of the goods or services under procurement. It's also not excessively high compared to a prudent commercial buyer's pay under similar market conditions. Essentially, it means the price is not too low for the contractor to operate sustainably, nor too high for the government to pay more than necessary. 

Key points about "fair and reasonable price": 

• Market-based Assessment: The price is determined by considering current market prices for similar goods or services, considering factors like quality, delivery time and competition. 
• Government Responsibility: A CO is responsible for evaluating whether a proposed price is "fair and reasonable" before awarding a contract. 
• Price Analysis Techniques: To determine fairness, a CO might use various price analysis techniques, such as cost breakdowns, market research and comparisons to similar contracts. Read on for more about this. 

Like cost analysis, price analysis is a catalyst in the contracting process, helping ensure fair pricing for goods or services to the government. COs use various techniques to evaluate proposed prices, this time without delving into individual cost elements or profit margins:

One common approach involves examining pricing history. COs might review past proposals for similar items or services, adjusting for changes in market conditions, quantities or specifications. For example, when evaluating bids for office furniture, a contracting officer might look at prices various government agencies paid for comparable items in recent years, factoring in any shifts in material costs or manufacturing processes.

Another key aspect of price analysis is assessing special requirements and quality standards. Unique packaging specifications or stringent certification requirements can significantly impact costs. For example, a contractor bidding on a project to supply specialized medical equipment might need to account for additional expenses related to sterilization processes or FDA compliance.

COs also consider market conditions when conducting price analysis. They may compare proposed prices to published price lists or independent government estimates. For instance, when evaluating proposals for IT services, a contracting officer might benchmark against commercial industry salary surveys and prevailing rates for similar work.

Tools like Deltek's ProPricer can provide automation and insights to support price analysis efforts and offer price-centric views into contract data.

Product Pricing Formula

Material cost + labor costs + overhead expenses / # of items produced = Cost per item:

• Material Costs: Figure the total cost of the raw materials used to make up a single item or divide the material cost of a batch of items by the number of items produced.
• Labor Costs: Determine what you pay employees to produce the item—whether or not you have employees. Assign a wage figure even if only you produce the item. Take the weekly salary you pay someone to produce the weekly volume of items and divide it by the number of items.
• Overhead Expenses: Include rent, gas, electricity, business telephone calls, cleaning, insurance, office supplies, postage, repairs, maintenance, delivery charges and packaging and shipping supplies. If you work from home, calculate a portion of your total rent or mortgage payment in proportion to your workspace. List all overhead expense items and total them. Divide the total overhead figure by the number of items per month. This will give you your overhead per item.
• Profit: Add an amount to the cost of each item; check your competition's pricing. This establishes your profit margin. Add Profit to the Cost per Item for the Total Price per Item.

Pricing services in government contracting calls for a nuanced approach that differs significantly from pricing products. Unlike tangible goods, services are often customized, making their valuation more complex. Their pricing strategy has to consider the unique challenges of the government sector, including compliance requirements and competitive bidding.

When determining service prices for government contracts, contractors should consider a formula that incorporates hourly overhead expenses, wages and profit. Overhead costs encompass operational expenses, which can be calculated by dividing monthly business costs by average work hours. The hourly salary should reflect the contractor's expertise and industry standards. Finally, a profit factor has to appear to make the effort equitable.

To arrive at a competitive yet profitable rate, contractors must balance these elements while also considering market demand. Of course, the price of “supply” increases when demand does the same. 

Service pricing formula

Hourly overhead expense + hourly wage + profit = Total price per hour

• Overhead Expenses: Calculate all the costs related to operating your business, either from home or from your own office, and arrive at a total cost per month. Divide this by the average monthly hours worked to calculate your hourly expenses.
• Hourly Wage: Decide on a wage to pay yourself or your staff members, considering background, training and expertise. Compare this to industry averages in both the commercial and government realms. 
• Hourly Profit: Add a factor to your hourly wage to indicate a profit margin. Check your competition and, again, market demand.

The Ultimate Guide to Government Proposal Pricing

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The General Services Administration (GSA) is the federal government's procurement arm. It streamlines the purchasing process for agencies nationwide and creates a window for long-term relationships with its awarded contractors. Pricing a contract through the GSA, an option if a contractor has been in business for at least two years and is financially stable, presents unique challenges compared to standard bid processes.

GSA pricing differs significantly from traditional bidding because it involves pre-negotiated rates for goods and services. This approach benefits the government and contractors by expediting transactions. However, it also requires consideration of various factors to ensure profitability while meeting the GSA's stringent "fair and reasonable" pricing standards—which can be even more demanding than in a non-GSA contract.

Contractors must navigate required pricing considerations, including market research, commercial sales practices, and potential price reduction clauses. For instance, a software company offering cybersecurity solutions through a GSA Schedule would need to analyze competitor pricing, evaluate its own commercial discounting practices and potentially adjust its rates to remain competitive in the GSA federal marketplace.

The GSA offers programs like Transactional Data Reporting (TDR), which can provide contractors with greater pricing flexibility in exchange for more detailed sales reporting. This option may be particularly attractive for companies with variable pricing structures or those seeking to avoid disclosing sensitive commercial pricing information.

Crafting an honorable yet profitable proposal for government contracts requires a delicate balance between presenting as both an excellent agency value and a thriving business. While it may seem counterintuitive, the government actually benefits when contractors receive fair profit margins. How? Contractors will demand optimal performance from their teams yet also require the necessary resources to deliver effectively.

Understanding Profit Limitations

Savvy contractors can familiarize themselves with FAR 15, Chapter 11, which outlines factors affecting profit in various scenarios. For cost-plus-fixed-fee contracts, specific profit limitations apply:

• 15% maximum for experimental, developmental, or research work
• 6% maximum for architect-engineering contracts related to public works or utilities
• 10% maximum for all other cost-plus-fixed-fee contracts

Fixed-price contracts, however, have no set profit limit. Contractors can aim for 18% to 25% profit margins while still winning bids, though it's crucial to remain competitive.

Factors Influencing Profit

• Contractor Effort: The complexity of the contract significantly impacts profit calculations. For instance, a contractor working with a small agency office may involve routine tasks, while a Pentagon contract could require specialized expertise and higher stakes.
• Agency Reputation: When dealing with particularly demanding agencies, contractors should adjust their profit calculations to account for the extra attention required.
• Cost Risk: Firm-fixed-price contracts generally carry more risk than cost-reimbursement contracts, warranting higher profit percentages to cover potential risks.
• Investment: Contracts requiring upfront capital investment may justify slightly higher prices. However, if the agency offers frequent payments, it's often better to maintain standard pricing to encourage consistent cash flow. 
• Quality Control: Contractors facing deadlines or quality control challenges should consider lowering profit percentages to remain competitive.
• Special Situations: In some cases, contract work may lead to the development of intellectual property or new product offerings for contractors. In these situations, contractors might consider slightly reducing profit percentages, viewing this gesture as an investment in future opportunities.

Deltek ProPricer: Government Proposal & Pricing Software

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