Cost-Based Pricing Principles

Cost-Based Pricing Principles are the principles the Government of Canada uses to negotiate a fair and reasonable contract price. The buyer establishes a cost base from accepted incurred costs, cost estimates, or both. Profit is then determined under established profit principles, and contractual incentives are applied where appropriate. CanadaBuys describes cost-based pricing as the most common form of negotiated pricing.

The term belongs to the pricing framework of Public Services and Procurement Canada (PSPC). Its Practitioner's Guide for procurement pricing sets out two main categories of pricing principles: Cost-Based Pricing Principles and Alternative Pricing Principles. The cost-based category rests on Canada's Contract Cost Principles 1031-2 and on PSPC's profit policy.

The three components of a cost-based price

CanadaBuys identifies three components of a fair and reasonable negotiated price: a cost base, profit, and, where appropriate, contract incentives. The getting started guidance presents these as the building blocks of the negotiation.

The Supply Manual glossary defines a cost-based price as one based on incurred costs, cost estimates or actuals, or a combination of those factors. A profit margin calculated under the Profit Principles may be added to that base.

How costs are tested: attributable, appropriate and reasonable

The Contract Cost Principles require total contract cost to comprise the applicable direct and indirect costs incurred or allocated in performing the contract, less applicable credits. Costs must be attributable, appropriate and reasonable. The guidance on analyzing and negotiating costs adds that contract costs must be determined according to the contractor's cost-accounting practices, as accepted by Canada and applied consistently over time.

PSPC states that the framework, made up of the contract cost principles and its profit policy, is meant to give contracts a consistent approach and to calculate a fair market price. Its defence and marine procurement page describes this intent.

When the principles apply and when they do not

The principles for establishing a cost base apply to negotiated contracts, subject to the applicability rules and exceptions in the Practitioner's Guide. CanadaBuys treats cost-based pricing as the usual approach when a price must be negotiated and competition does not establish a reliable price.

Several exceptions exist:

• Cost-based pricing principles are generally not required for commercial goods priced through catalogues, price lists or fee schedules where only discounts are negotiated.
• The profit principles for cost-based pricing do not apply to contracts valued under $50,000, to commercial-price arrangements where only discounts are negotiated, or to contracts using alternative pricing strategies, according to the guidance on analyzing and negotiating profit.
• A contracting officer who uses an alternative pricing strategy must justify why it is appropriate and obtain approval. The alternative should provide better value than applying cost-based pricing principles, as set out in the alternative pricing strategies guidance.

What it means for a supplier bidding on Canadian public contracts

A supplier in a cost-based negotiation must provide the information needed to establish and assess the cost base and the profit. Suppliers should be ready to show that each cost is attributable, appropriate and reasonable. They should also be ready to show that their cost-accounting practices are applied consistently over time and can be accepted by Canada.

Before pricing, check whether the work is a negotiated contract or a commercial catalogue purchase, because the principles generally do not govern the latter. Keep cost records organized by direct and indirect cost, and identify applicable credits, so that your proposed price can be reconciled to the cost base during negotiation.