February 4, 1986

Mr. Maurice C. Christiansen 
Auditor General 
435 South Chappelle 
Pierre, South Dakota 57501-3292

OFFICIAL OPINION NO. 86-01

Total Cost Bidding

Dear Mr. Christiansen:

You have requested an official opinion from this office in regard to the following factual situation:

FACTS: 

The Auditor General's Office has encountered numerous situations during the past year where local governmental entities have been implementing a 'total cost' bidding procedure for the purchase of heavy equipment.  Using this total cost bidding procedure, the local government entity is requesting bids which are evaluated by netting at face value:  (1) the initial purchase price of the equipment, plus; (2) the guaranteed maximum repair cost for a period specified by the government entity, less; (3) a guaranteed minimum repurchase price at the end of the specified time period. 

With the above factual statement, the Auditor General's office has also enclosed several recent sets of bid specifications used by local government entities attempting to implement a total cost bidding procedure.  Some of the specifications submitted did not require a performance bond or allowed a 'corporate guarantee' in lieu of the performance bond, and establishes a procedure where only the face value of the bid items addressed above were to be considered.

Based upon the above facts, you have asked the following question:

QUESTION: 

Does the total cost bidding procedure as currently being used by local governmental entities violate the competitive bidding provisions of SDCL Ch. 5-18 or SDCL Ch. 5-21?

Total cost bidding describes a bidding procedure whereby a public entity seeks bids from a potential seller, based upon the total costs of ownership, in addition to the initial purchase price.  This is the sole cost basis for governmental purchases under traditional bidding procedures.  One of my predecessors in AGR 1965-1966, page 211, using the term 'guaranteed bidding,' determined that the concept of total cost bidding did not violate the competitive bidding provisions of SDCL Ch. 5-18.  I concur with my predecessor's determination that total cost bidding, if properly implemented by the public entity, does not violate the competitive provisions of SDCL Ch. 5-18 or Ch. 5-21.  It is my opinion, however, upon review of 'total cost bidding procedures' currently used by the local government entities, that the principles of competitive bidding are being violated.

The South Dakota Supreme Court in Gridley v. Engelhart, 322 N.W.2d 3, 7 (S.D. 1982), stated: 

Bid specifications as they pertain to public contracts must be sufficiently definite and precise so as to afford a basis for bids and they must be free of restrictions the effect of which would stifle competition.  Such specifications must be sufficiently detailed upon all essential elements so  as to afford a basis for full and fair competitive bidding upon a common standard.

The flaw in the local government entities current total cost specifications is that these specifications totally ignore the time value of money which, in my opinion, is an essential element in total cost bidding.  It does not take an expert financial analyst to determine that a dollar today is not the same as a dollar three or seven years in the future.  The reason for this is that a dollar today can be invested so that it is worth more at a future date.  A total cost bidding procedure that takes present dollars and future dollars and nets them at face value to determine the low bid compares dollars of different present value.  This netting of face values has the effect of mixing apples and oranges which, in my opinion, makes it impossible for a local government entity as well as potential bidders, to determine what is the 'lowest responsible bid.'

This netting of dollars at face value also could result in potential abuses where the actual value of the equipment at the date of purchase is no longer relevant.

For purposes of illustration, I present the following example: A local government entity is seeking the purchase of a flatbed truck. The local government entity uses a total cost bidding procedure and wants guaranteed repairs for five years with a guaranteed repurchase price.  Suppliers 'A,' 'B'  and 'C' have products that meet the county's general specifications for the flatbed truck and all are responsible bidders.  Bids are received and opened with the following results:

Dollars Bid        

The local government entity could currently invest money in C.D.'s at an investment rate of 8%.  If the value of money was included in the specifications and the bids were reviewed in present value terms the bid results would be as follows:

Under a traditional bidding procedure where only the initial price is considered, the truck from Supplier 'A' would have been purchased by the local government entity.  Under a 'total cost' bidding procedure using dollars at face value as currently used by the local governments, Supplier 'C' would be awarded the bid although Supplier 'C's' initial purchase price was the greatest, the total cost at face value was less than either Supplier 'A' or 'B.' But, once the value of the dollar is added, Supplier 'B' would now become the lowest responsible bidder.  When one looks at all costs of the local government entity, Supplier 'B' provides the best total value if the entity wishes to use the total cost approach.

It is, therefore, my opinion, that if a local government entity decides to use a total cost bidding procedure to comply with the competitive bidding provisions of SDCL Ch. 5-18, the local government entity must include in the bid specifications the current investment rate which the local government  entity could invest funds.  This ensures that the potential bidders and the local government entity have a uniform basis to compare the bid proposals submitted by the various potential suppliers.

In addition, though it is not a violation of SDCL Ch. 5-18, it is my opinion that a prudent local government entity, in order to guarantee future performance of the total cost contract, should require a potential bidder to submit a performance bond in accordance with SDCL Ch. 5-21.  When a supplier enters into a contract based upon a total cost bid, that supplier has a contingent liability to the local government entity for the costs of repairs for the term of the contract and the guaranteed repurchase price. Without a performance bond, the local government entity has no guarantee that the terms of the contract will be fully performed. Currently, some government entities are requiring a performance bond with their total cost bid while other local government entities are not requiring a performance bond or allowing that a 'corporate guarantee' be submitted in lieu of performance bond.  A corporate guarantee adds no additional security to future performance of the contract. Any corporation that enters into a contract with a local government entity for future services or products is getting that corporation's guarantee.  Only a performance bond or submission of actual collateral or security to the local government entity will provide additional security in case the bidder is awarded a contract and is financially incapable of performing all of its terms.

Total cost bidding, if used properly, can reduce the amount of monies a local governmental entity needs to expend for the purchase and use of equipment. Unless properly implemented, however, the total cost bid procedures may result in the county needlessly expending additional funds for goods and services without added benefits.

Respectfully submitted,

Mark V. Meierhenry
Attorney General

[1] 3.993--Present value of an annuity of $1.00 per year for 5 years discounted at 8% and assumes repairs of equal amounts each year.