What You Don t Know About Procuring Commercial Items Could Hurt You (or Your Suppliers)! BY DORIS HOLLINGSWORTH GRAY

What You Don t Know About Procuring Commercial Items Could Hurt You (or Your Suppliers)! BY DORIS HOLLINGSWORTH GRAY 52 Contract Management April 2008

Knowing precisely what characterizes products or services as commercial items is a key element in the procurement process. Contract Management April 2008 53

The Federal Acquisition Streamlining Act of 1994 (FASA) established such a strong preference for the acquisition of commercial and non-developmental items (NDIs) that the government must now conduct market research to determine if its needs can be met by an item or service that meets the definition of commercial item as defined by the Federal Acquisition Regulation (FAR). If commercial items do not meet agency requirements, or are not available, the agency must re-evaluate its needs to determine whether these needs can be restated so as to permit the use of commercial items. 1 Government requirements must be stated in terms of measurable standards such as functions to be performed, desired performance, or essential physical characteristics in order to promote the use of a commercial item. 2 Once products and services are considered to be commercial items, all agencies must comply with the policies and procedures described in FAR Part 12, Acquisition of Commercial Items. 3 How Do You Determine What is a Commercial Item? Much of the reluctance to effectively use Part 12 of the FAR is attributable to the difficulty in understanding the definition of what makes an item commercial, as defined at FAR 2.101. 4 Failure to understand the proper definition has led many buyers to apply incorrect terms and conditions, which increase the supplier s compliance burden and the government s costs for procuring products and services. Failure to acquire commercial items using Part 12 undermines the congressional mandate of FASA, which establishes a preference for commercial items throughout the supply chain. In order to understand how to properly acquire commercial items, it is important to first understand what products and services fall under the definition as being commercial items. The definition extends beyond government prime contractors to those items acquired by subcontractors at every tier. FAR 2.101 defines commercial item quite broadly. It includes items transferred from a contractor s divisions, affiliates, and subsidiaries, and encompasses eight separate categories of items considered to be commercial. (See Figures 1 and 2 on page 58.) The broadest aspect of both the statutory and regulatory definition of commercial item is the fact that the particular service does not have to be sold to the general public. It need only be of a type sold to the general public in the marketplace in order to qualify as a commercial item. 5 Of a type is used by the government in four of the commercial item categories in the FAR s definition: Commercial-off-the-shelf (COTS) items, Modifications and minor modifications, Stand-alone services, and Any combination of the first three categories of the FAR s definition. The phrase is also used in the definition of modifications to NDIs. The phrase of a type is not intended to allow the use of FAR Part 12 to acquire sole-source, military-unique items that are not closely related to items already in the marketplace. Instead, the phrase broadens the commercial item definition so that qualifying items do not have to be identical to those in the commercial marketplace. The best value offer in a competitive solicitation can be for an item that has previously satisfied the government s needs, but which has not yet been sold, leased, licensed, nor offered for sale, lease, or license, to the general public (an NDI as defined in Title 10 USC 403 [13]). In this scenario, the phrase of a type allows the best value offer to qualify for a Part 12 contract as long as it is sufficiently similar to items that meet the government s requirements and which are sold, leased, licensed, or offered for sale, lease, or license, to the general public. In such instances, of a type broadens the statutory commercial item definition to allow Part 12 acquisitions of government-unique items that compete with commercial items that also meet the government s requirements. This avoids the undesirable result of shutting out otherwise price-competitive, preexisting suppliers of government-unique items from Part 12 solicitations. 6 54 Contract Management April 2008

COTS is a subset of the commercial items definition. COTS items are covered in the first paragraph of the commercial item definition in FAR 2.101. In the Clinger-Cohen Act of 1996 (CCA), COTS is defined as a commercial item (excluding bulk cargo) sold in substantial quantities in the commercial marketplace and offered to the government without modification in the same form in which it is sold in the commercial marketplace. 7 Besides COTS items, the definition includes items that evolved from commercial items which will be available in time to satisfy the government s delivery requirements; certain modifications to commercial items; installation, maintenance, repair, and training services procured for support of a commercial item; stand-alone services; NDIs; and the combination of services and products that meet the definition. Stand-alone services are those services of a type offered and sold competitively in substantial quantities in the commercial marketplace based on established catalog or market prices. The established market price for stand-alone services does not have to be published or written. Market research enables the government to collect data from independent sources in order to substantiate the market price. 8 The government has created a subcategory of NDIs called government-off-the-shelf (GOTS). This is a government-unique item used by a federal agency, state or local government, or a foreign government with which the United States has a mutual defense cooperation agreement. The words of a type facilitate the acceptance of a best-value GOTS/NDI offer in response to a competitive FAR Part 12 solicitation when the offered GOTS/NDI items are sufficiently like similar items sold, leased, or licensed, or offered for sale, lease, or license, to the general public. 9 Modifications and minor modifications to commercial items seem to cause the most confusion to buyers. There are differences in the way the FAR treats these two types of modifications. The inclusion of the phrase modifications of a type customarily available in the commercial marketplace was intended to give the government and its contractors the flexibility to purchase customized products similar to those sold by commercial manufacturers to its non-governmental customers. In some respects, the commercial sector is becoming more like the defense sector. It caters to single customers with unique product requirements in small quantities. The major difference, however, is that they do this economically. 10 To determine whether these modifications are customarily available in the marketplace, buyers should ask themselves: How closely related is the modified product to the other modified products sold in the commercial marketplace? Does the supplier perform similar modifications or customizations for commercial customers? Are there similarities in the manufacturing process and expertise used in Contract Management April 2008 55

performing the modification for the government and commercial customers? If the modification is of the type customarily available, then the cost of the modification is immaterial to the determination of whether the modified item is considered to be commercial. Buyers need only determine that the price is fair and reasonable. The category of minor modifications of a type not customarily available in the commercial marketplace is the most problematic for buyers and their suppliers. The regulations at FAR 2.101 define minor modifications as modifications that do not significantly alter the non-governmental function or essential physical characteristics of an item or component, or which change the purpose of a process. Factors to be considered include the value and size of the modification and the comparative value and size of the final product. Anyone who has tried to apply this definition and its factors to an actual modification knows how difficult the analysis can be. FAR 2.101 goes on to say that [d]ollar values and percentages may be used as guideposts, but are not conclusive evidence that a modification is minor. For example, a modification could significantly alter the non-governmental function without significantly increasing the cost of the item. On the other hand, even a slight alteration to a commercial item may be a great deal more expensive than the original commercial item if the supplier has to interrupt an entire production run in order to supply the modified item. The approaches that some buyers and suppliers have found to be effective in evaluating minor modifications include: Identifying the changed features; Evaluating the scope of the changes to the features in order to determine whether the changes are, in fact, minor; Comparing the cost of the modification with the value of the final product and documenting the reason for the increase or decrease in the price; and If commercial items do not meet agency requirements, or are not available, the agency must re-evaluate its needs to determine whether these needs can be restated so as to permit the use of commercial items. Comparing the processes, equipment, and skill sets needed to produce the modified item. In one particular case, the U.S. Air Force found that certain electronic modules were of a type customarily used for non-governmental purposes because the electronic modules for the Air Force F-22 Raptor fighter and the U.S. Army RAH-66 Comanche helicopter would be manufactured using the same processes, equipment, and workforce as the commercial products being manufactured by the commercial division of TRW. The Air Force s decision allowed TRW s Avionics Systems Division, which had extensive military contracting experience, to subcontract with its commercial division to produce the modules. 11 Who Makes the Determination that an Item is a Commercial Item? The contracting officer (CO) makes this determination for the government. The person who makes the determination for the subcontractor is the contractor s procurement personnel, and the subcontractor makes the determination for lower tier subcontractors. However, the supplier of the item is often in the best position to determine whether the item being sold is a commercial item. The supplier usually has substantial sales data and other information to support a determination as to whether the item should be classified as such. Buyers should never reject evidence offered by the commercial supplier in this regard. When contractors insist on non-commercial terms and conditions and unnecessary FAR provisions, it puts the supplier at risk due to the inability of a commercial supplier to meet the requirements of many terms and conditions. 14 The Office of the Secretary of Defense states: Contractor determinations are another source of information that acquisition personnel should consider when making their own determinations. If a contractor procured an item commercially, and the government subsequently acquires the same item, acquisition personnel should consider the contractor s determination as part of their own market research efforts. Likewise, if the government determines that an item is commercial, the prime contractor should consider the government s determination as part of its own market research efforts. Evidence that an item is produced in a facility predominantly engaged in producing similar items for the commercial market, or a production line that produces similar items for the commercial market, is one indication that the item being acquired may be a commercial item. Such evidence should be provided by a potential supplier and corroborated through market research. 15 Even though there is now an established preference for commercial items, many products and services are currently being procured as non-commercial items which is contrary to the mandates of FASA and FAR policy requirements at 44.402. Poor training in the acquisition of commercial items, lack of time, and inflexible or outdated procurement systems encourage the over-reliance on standard boilerplates that were designed for the acquisition of non-commercial or military end items. Only after careful review of the commercial item definition and the gathering of significant evidence that the item is not commercial should they consider the item government-unique. 16 56 Contract Management April 2008

Suppliers should examine all of the products and services that they sell to the government or prime contractors to determine whether their products or services are indeed considered commercial items and, if so, determine which of the eight categories, as defined by the FAR, their products or services fall into. (See the table on page 60.) Suppliers will then have a head start in collecting the information needed to convince buyers that their products and services are commercial. On the other hand, if any of the items fall into the non-commercial category, then the supplier especially a commercial supplier whose government business makes up only a small percentage of its total business can make an informed decision as to whether the non-commercial items it sells are worth the additional risks of having to comply with a host of applicable FAR flowdowns. What Terms and Conditions Apply? The FAR includes the following provisions for the acquisition of commercial items from prime contractors: FAR 52.212-3, Offerors Representations and Certifications Commercial Items; FAR 52.212-4, Contract Terms and Conditions Commercial Items; and FAR 52.212-5, Contract Terms and Conditions Required to Implement Statutes or Executive Orders Commercial Items. FAR 52.212-3 provides a single consolidated list of certifications and representations which are attached to solicitations for offerors to complete and return with the offer. This provision may not be tailored except in accordance with Subpart 1.4, Deviation from the FAR. A list is provided at 52.212-4 of the contract terms and conditions that apply to prime contractors and includes terms and conditions that are, to the maximum extent practicable, consistent with customary commercial practices. The CO may tailor some of these clauses in accordance with 12.302. However, there are several clauses that implement statutory requirements and therefore, shall not be tailored: Assignments, Disputes, Payments (except as provided in Subpart 32.11), Invoices, Other compliances, and Compliance with laws unique to government contracts. In accordance with FAR 12.302, the CO is not permitted to tailor any clause, or otherwise include any additional terms or Contract Management April 2008 57

1 2 PRODUCT OR SUPPLIES Is it an item of a type customarily used by the general public and i) Has been sold to the general public, or ii) Offered for sale to the general public? Is it an item that evolved from advances in technology and that is not yet available in the commercial marketplace but will be available in time to satisfy government requirements? COMMERCIAL ITEM Designate as a commercial item and annotate evidence of actual sale. Designate as a commercial item and annotate evidence that item will be available in time to satisfy government requirements. 3 Is it an item that would satisfy (1) or (2) for: i) Modifications of a type customarily available in the commercial place, or ii) Minor modifications of a type not customarily available in the commercial marketplace made to meet government requirements? Designate as a commercial item and annotate either evidence of customary availability of modification or the technical relationship between modified items in (1) or (2). 4 5 Is Any combination of items meeting (1), (2), and (3) above that are of a type customarily combined and sold in combination to the general public? it a non-developmental item (NDI) that was developed exclusively at private expense and sold in substantial quantities on a competitive basis to multiple state and local governments? Designate as a commercial item and annotate evidence of the customary combination sold to the general public. Designate the NDI as a commercial item and annotate evidence that it was developed exclusively at private expense and sold competitively in substantial quantities to multiple state and local governments. Designate as n-commercial Item FIGURE 1. Commercial Item Determination Flow Chart for Products and Supplies A process that buyers and suppliers can use to determine whether an item falls within the definition of FAR 2.101 for a commercial item. 1 2 3 4 SERVICES Do the services consists of installation services, maintenance services, repair services, training services, and other services in support of a commercial item from the same source regardless of whether the services were provided at the same time? Are the services in (1) from a source that provides similar services to the general public and the government at the same time and under similar terms and conditions? Are the services of a type offered and sold competitively in substantial quantities in the commercial marketplace based upon established catalog or market prices for specific tasks performed under standard commercial terms and conditions? Is any combination of services meeting (1) and (3) above but for being transferred between or among separate divisions, subsidiaries, or affiliates of a contractor? Designate as n-commercial Service COMMERCIAL SERVICES Designate the services as commercial. Designate the services as commercial and annotate information regarding their source. Designate the services as commercial. Designate the services as commercial and annotate how the services would meet (1) and (3) above. FIGURE 2. Commercial Item Determination Flow Chart for Services A process that buyers and suppliers can use to determine whether a service falls within the definition of FAR 2.101 for a commercial service. 58 Contract Management April 2008

The eight categories encompassed by the FAR's definition of "commercial item" include: 1Any 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 2 3 45 6 7 8 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; Any item that evolved from [a commercial item] 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 [g]overnment solicitation; Any item that would satisfy [the definition of commercial item] 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 [f]ederal [g]overnment requirements... Any combination of items [as expressed in the criterion above] that are of a type customarily combined and sold in combination to the general public; Installation services, maintenance services, repair services, training services, and other services if i. Such services are procured for support of [a commercial item], 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 comtemporaneously to the general public under terms and conditions similar to those offered to the [f]ederal [g]overnment; 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... Any item, combination of items, or service [that meet the criterion for commercial items], 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 A non-developmental 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 [s]tate and local governments. Source: FAR 2.101. conditions that [are] inconsistent with customary commercial practice for the item being acquired unless a waiver is approved in accordance with agency procedures. The clause at 52.212-5 is required to be attached to solicitations or contracts for the acquisition of commercial items by using the appropriate clause prescription and by indicating which, if any, of the additional clauses cited in paragraphs (b) or (c) of the clause are applicable to the specific acquisition. This clause, also, may not be tailored. 17 The FAR also includes provisions that are even more streamlined for the acquisition of commercial items from subcontractors: FAR 52.244-6, Subcontracts for Commercial Items; and FAR 52.212-5, Contract Terms and Conditions Required to Implement Statutes or Executive Orders Commercial Items. FAR 52.244-6, which imposes only six clauses on subcontractors, implements the FAR policy that contractors and subcontractors at all tiers shall not be required to apply any clause except those required to implement provisions of law or executive orders applicable to subcontractors furnishing commercial items or determined to be consistent with customary practices for the item being procured. 18 The effect of 52.212-5 is to impose only one additional clause on subcontractors, FAR 52.222-41, Service Contract Act of 1965, which is not contained in 52.244-6. 19 Finally, the Department of Defense s (DOD) Defense Federal Acquisition Regulation Supplement (DFARS) requires that DFARS 252.244-7000, Subcontracts for Commercial Items and Commercial Components, be included in all DOD subcontracts for the acquisition of commercial items. Agencies and contractors must use firmfixed-price (FFP) or FFP with economic price adjustment contracts and subcontracts for the acquisition of commercial items unless the requirements of FAR 12.207(b) are met. 20 Subparagraph (b) permits the use of time and materials (T&M) contracts and labor hour contracts for the acquisition of com- 60 Contract Management April 2008

mercial services when certain conditions are met. 21 Indefinite-delivery/indefinite-quantity (IDIQ) contracts may be used when the prices are established based upon an FFP with economic price adjustment, or rates are established for commercial services acquired on a T&M or labor hour basis. 22 The CCA exempted the acquisition of commercial items from the Truth In Negotiations Act. 23 Contractors and subcontractors are not required to submit certified cost or pricing data in support of a contract or subcontract, or for a modification to a contract or subcontract, for commercial items. 24 When adequate price competition exists, it is not necessary to determine price reasonableness. Procurement of commercial items should be conducted on a competitive basis to the maximum extent practicable. If sole-source procurement of a commercial item cannot be avoided, and the procurement is not covered by another exception to cost or pricing data, then the buyers must use price analysis to determine if the price is fair and reasonable. The buyers can use information on prices at which the same or similar items have been sold in the commercial market in order to evaluate the reasonableness of the contract or subcontract. If the buyers cannot determine whether a contract or subcontract price is fair and reasonable from sources other than the contractor or subcontractor, then the contractor or subcontractor must submit information other than cost or pricing data to support price analysis. 25 Any modification to a contract or subcontract for a commercial item that does not change the item from being considered as a commercial item to being considered as a non-commercial item is also exempt from cost or pricing data. 26 Cost Accounting Standards (CAS) do not apply to contracts or subcontracts for the acquisition of commercial items when acquired on the basis of FFP or FFP with economic price adjustment. 27 However, FAR Part 12 is not independent of the other parts of the FAR. The CO must use the policies in Part 12 in conjunction with the policies and procedures cited in Part 12. For example: For solicitation, evaluation, and award as prescribed in FAR Part 13; Sealed bidding as prescribed in Part 14; Contracting by negotiations (as appropriate for the particular acquisition) as prescribed in Part 15; Placement of orders for IDIQ contracts as prescribed by Subpart 8.4 or 16.5, as applicable; and Market research regarding identification and availability of specifications, standards, and commercial item descriptions as prescribed in Part 11. 28 The CCA also permitted commercial item purchases to be made under the simplified Contract Management April 2008 61

acquisition procedures implemented in FAR Part 13. 29 Subpart 13.5, Test Program for Certain Commercial Items, authorizes the use of simplified procedures for the acquisition of supplies and services in amounts greater than the simplified acquisition threshold, but not exceeding $5.5 million, including options. This test program can be used if the CO reasonably expects, based upon the nature of the supplies or services being acquired and on the market research, that offers will consist of only commercial items. The requirements of Part 12 apply, including the clauses in Subpart 12.3 and the order of precedence at 12.102(c), when acquiring commercial items using simplified acquisition procedures. 30 Subpart 12.102(c) states: Contracts for acquisition of commercial items are subject to the policies in other parts of this chapter. When a policy in another part of this chapter is inconsistent with a policy in this part, Part 12 shall take precedence for the acquisition of commercial items. The reluctance to use FAR Part 12, or the ignorance of its content, can be overcome through training and the sharing of success stories. By working together, buyers and suppliers can ensure that the intent of FASA (i.e., the preference for commercial items at every tier of the supply chain) can be met. In a 1998 article published in Contract Management, Michael E. Herberling and Mary E. Kinsella said it best: The implications from this achievement are far reaching. Defense primes now have the ability (if they choose to exercise it) to more easily and affordably take advantage of the capabilities, technologies, and products of purely commercial firms as subcontractors. For world-class commercial firms, defense work is more inviting. Defense work no longer means changing internal accounting and management practices to accommodate a single customer. More important, this change will help expand the defense industrial base into a national industrial base. 31 In order to take advantage of the benefits offered by FASA and CCA, contractors will have to change their paradigm. Like TRW s Avionics Systems Division, those contractors who undertake this challenge will definitely have the competitive advantages of lower prices, the latest and best technologies, and shorter lead times. CM About the Author DORIS HOLLINGSWORTH GRAY, JD, FELLOW, is a senior contracts manager for Avnet Inc., one of the world s largest distributors of electronic components and computers. Gray has more than 20 years of experience in commercial, international, and government (federal, state, and local) contracts and subcontracts, and is an active member of the Phoenix Thunderbird Chapter of NCMA. Send comments about this article to cm@ncmahq.org. Endnotes 1. Office of the Secretary of Defense, Acquisition, Technology, and Logistics (Acquisition Initiatives), Commercial Item Handbook (Version 1.0), vember 2001, 4. 2. Federal Acquisition Streamlining Act of 1994, Public Law 103-355, Section 8104. 3. FAR 12.102. 4. Ralph C. Nash and John Cibinic, Buying Commercial Items: Signs of Progress, 13. 5, Nash & Cibinic Report 27, 1. 5. Letter, Robert E. Lloyd, U.S. Department of State, reprinted by Ralph C. Nash and John Cibinic, 12, Nash & Cibinic Report 62 (December 1997), 1. 6. Commercial Handbook, A-3. 7. Clinger-Cohen Act of 1996, Public Law 104-106, Section 4203. The Clinger-Cohen Act refers to COTS as commercially-available-off-the-shelf items. 8. Commercial Handbook, C-2. 9. Commercial Handbook, J-1 to J-2. 10. Michael E. Heberling and Tracy J. Houpt, What Is and Is t a Commercial Item, Contract Management, August 1995. 11. Michael E. Herberling and Mary E. Kinsella, Commercial Item Definition Facilitates Affordable Military Products, Contract Management, vember 1998. 12. Derived from Appendix D, Sample Commercial Item Checklist, Commercial Handbook, D-1. 13. Ibid. 14. Subcontractors can be liable under both the False Claims Act, 31 USC 3729, and the False Statements Act, 18 USC 1001, for making false certifications and submitting invoices for payment after falsely certifying. 15. Commercial Handbook, K-2 and K-3. 16. Commercial Handbook, iv. 17. FAR 12.301. 18. FAR 44.402(b). 19. FAR.212-5 states that the contractor is not required to flow down any FAR clause other than those in paragraphs (i) through (vii) of the provision. 20. FAR 12.207(a). 21. FAR 12.207(b). 22. FAR 12.207(c)(1)(i) and (ii). 23. Clinger-Cohen Act of 1996, Public Law 104-106, Section 4201(a)(1). 24. Clinger-Cohen Act of 1996, Public Law 104-106, Section 4201(a)(2)(B). 25. FAR 15.403-3(4)(c). 26. FAR 15.403-1(3). 27. Clinger-Cohen Act of 1996, Public Law 104-106, Section 4205. 28. FAR 12.102, 12.202, and 12.207. 29. Clinger-Cohen Act of 1996, Public Law 104-106, Section 4202. 30. FAR 13.500(c). 31. Michael E. Herberling and Mary E. Kinsella, Commercial Item Definition Facilitates Affordable Military Products, Contract Management, vember 1998. 62 Contract Management April 2008