National Academy of Public Administration Presidential Transition Memorandum No. 6

This Memorandum is principally about needed improvements in the contracting process, particularly for service contracts which now account for 43 percent of all federal spending on contracts. But it seeks to place contracting in the context of other means of carrying out the government's business, sometimes called "third party government." Making grants to state and local governments gives rise to some of the same issues as are discussed below, but we make no further comments on grants in this Memorandum.

Before addressing issues affecting the use of contracts, we discuss two other matters: First, the need to conduct a major review and assessment of federal programs; and Second, distinguishing between contracting and the fairly nebulous term "privatization."

Since a major effort has already been launched to contract for the performance of more government activities by the OMB Director's Memorandum of February 14, 2001 (M-01-11) and the Deputy Director's Memorandum of March 9, 2001 (M-01-15), this Memorandum suggests that caution, and perhaps additional steps, are needed in carrying out that effort. Conceptually and ideally, there would first have been a comprehensive review and evaluation of what government agencies are doing, or should be doing, with the objective of identifying activities that should be transferred or terminated.

The Defense Department has used the phrase "strategic sourcing" to describe its approach toward first evaluating what needs to be accomplished, and then considering whether that can best be done through the private sector or in-house. The Navy Department is a leading practitioner of this methodology. Realistically, such a government-wide strategic sourcing review would be time-consuming and labor-intensive, and proposals to deal with any identified cases of unnecessary overlap would encounter formidable political obstacles.

Efforts have often been made to identify programs that are outdated, or that overlap with similar programs being carried out by other agencies. Zero Base Budgeting in the Carter Administration was such an effort. Both the General Accounting Office (GAO) and the Congressional Budget Office (CBO) have produced many analyses of programs that overlap with those in other agencies. For example, GAO stated in a recent report (GAO-01-241) that, "There are over 40 program areas … related to a dozen federal mission areas, where our work suggests that mission fragmentation and program overlap exist." Examples cited by GAO include: § the food safety system with as many as 12 different federal agencies administering over 35 laws regarding food safety; and § federal land management issues where the missions of four major land management agencies in two departments have become more similar over time.

Other cases recently cited by GAO include: § 69 federal programs in 9 different agencies provided support or care for children under age 5 in FY 99 (GAO HEHS-00-78); and § 40 employment and training programs in 7 agencies (GAO-01-71).

Another long-standing case is water resources management, where three departments (the DoD's Corps of Engineers, the Interior Department's Bureau of Reclamation, and the Agriculture Department's Natural Resources Conservation Service), and at least five other agencies have overlapping responsibilities.

Congress has not been very helpful in addressing these issues. Indeed, many of the overlapping programs have resulted from efforts by authorizing committees to get "a piece of the action." And many programs that may have outlived their usefulness are stubbornly protected by those in Congress who oversee them.

The National Performance Review (NPR) early in the Clinton Administration focused on management and administration, rather than program and policy. NPR II was to focus on those matters but not much came of it.

In light of the circumstances outlined above, it would be highly desirable to have a thoroughgoing review of programs and activities at the earliest possible date in order, possibly, to influence decisions about what additional activities should be contracted. This requires discipline, time, and skills that are often lacking.

Such a review across-the-board would likely identify numerous activities that should be discontinued, transferred to other agencies, redesigned, or devolved to state and local governments. If such a review were completed, efforts to expand the use of contracts for the performance of those activities deemed suitable for continuation by the federal government could be carried out with fewer risks. Contracting for performance of government activities may, in fact, reduce their effectiveness and, at the same time, make it harder to terminate or reorganize them because the contractors, through their supporters in Congress, become a force for continuing them.

Dating from colonial days, our government has made wide use of private firms to manufacture and supply products, such as munitions. Supplies and equipment for our armed services in World War II were provided largely by contractors, and that practice has continued to this day. During its formative years, the government even used private firms to perform such government services as tax collection and mail delivery. The U.S. Postal Service still relies heavily on contracts for the provision of many of its services to the public.

Contracting is one of the principal activities that are included in the phrase "Third Party Government" that denotes the reliance by the government on third parties to carry out functions that are, or were, its responsibility. Another term that is often used to cover government contracting is "privatization." Upon investigation by GAO and others, most so-called examples of federal or state "privatization" turn out actually to be contracts. For that and other reasons, we think the privatization term undesirably obscures who is responsible for what and that it would be preferable to use that term only when the government transfers functions entirely to the private sector. In fact, such transfers would more accurately be called "divestiture."

Divestiture. A clear distinction should be made between contracting and divestiture. In contracting for operations or for the provision of goods and services, the government continues to bear full responsibility for the outcomes. Divestiture is appropriate when the government can safely depend entirely on the private sector to perform (or not perform) the functions, subject only to whatever federal and state laws apply generally to relevant business enterprises. (We are not referring here to public utilities that may be operated by private companies but that are subject to a regulatory regime not applicable to competitive businesses.)

In this Memorandum, we use the term "contracting" to discuss the engagement of the private sector in the provision of goods or services to or for the government. Further, we avoid the term "contracting out," as the use of the word "out" may undesirably suggest that the government's ultimate responsibility is somehow reduced. In that connection, the term "outsourcing" may be preferable to "contracting out" since the sourcing part of the word better preserves recognition that the contracting agency is using another party to help get its own work done.

With respect to divestiture of federal programs, a wide range of issues ought to be considered before undertaking such a step. Previous efforts have had quite dissimilar results, some not very favorable. For example, in 1992, Congress permitted the transfer of sensitive foreign policy and national security activities to the U.S. Enrichment Corporation (USEC), a U.S. government corporation. Shortly thereafter, USEC was named Executive Agent to carry out the U.S. agreement with Russia for purchase of its modified, nuclear weapons-grade uranium for re-use as nuclear power plant fuel. In 1996, Congress authorized the "privatization" of USEC (effected in 1998), with the U.S. (and taxpayers) retaining ownership of basic assets and liabilities - the gaseous diffusion plants, power supply contracts, and its purchase and sales contracts. The 1998 privatization transferred the Executive Agent status to the private corporation.

Further, as forecast by many critics, USEC proved incapable of becoming financially viable if it abided by the public obligations imposed by Congress. Congress was later moved to appropriate $325 million to keep the agreement with Russia alive, and last year President Clinton announced a $630 million bailout for worker severance and to support new technology. USEC had announced in 1999 that it would abandon its commitment to new technology in which the government had already invested over $1 billion. This technology had been expected to make it possible for USEC to maintain a reliable and economical domestic source of enriched uranium - another of its key responsibilities.

The lesson here is that pursuit of "privatization" may result in overlooking the public's risks and overstating the expected benefits of such a transaction.

Government Sponsored Enterprises. Major issues arise when the government entirely divests a function in which the public has a continuing interest. In such cases, the government sometimes bears an implicit financial risk even when the legislation explicitly disavows any government liability. Examples are such government-sponsored enterprises (GSEs) as Fannie Mae and Freddie Mac. The government has potential liabilities of tens of billions of dollars in connection with such entities.

If the government has a continuing interest in whether the divested activities succeed or fail, that would suggest that divestiture is not the right approach. The government needs to be very careful in proposing or accepting such so-called "divestitures" to assure that it is not left with major liabilities, together with little authority.

If, upon divestiture, some responsibility for related activities remains with the government, the separation between the two types of activity should be made quite clear and the government must have authority commensurate with its responsibility. We do not attempt to address these matters further in this Memorandum, but would be pleased to do so if there is interest.

The reminder of this Memorandum addresses questions that arise with respect to the use of contracts, once the decision has been made to continue the activities in question. The focus is primarily on service contracts (more than $87 billion last year), rather than on procurement of large-scale military, aeronautical or space systems. However, a number of the issues discussed may also arise in those kinds of contracts. It should be noted that the cause of troubled procurements of large systems, whether in civilian or defense/ aerospace agencies, is often not just a procurement problem, but the result of inadequate coordination of information, procurement, and financial management systems and expertise. Even in OMB, these specialized functions are organized in three, distinct statutory offices.

Growth in the Contractor Workforce. For several decades now, there has been a growing reliance on contractors to assist in the performance of government functions. A major impetus for this development has been the desire in the Executive Branch and Congress to reduce federal employment. Only recently has significant attention been drawn to the large number of federal contract employees that ought to be considered along with the direct federal workforce in evaluating the size of government. (See, especially, The True Size of Government, a 1999 book authored by Paul Light of the Brookings Institution.) We commend the recent effort by the Department of the Army to learn more about its contractor workforce, including such matters as how much they get paid and how many hours they work, as this will enhance understanding of the total workforce supported by federal appropriations.

OMB Circular A-76 has long provided the ground rules with respect to how the private sector competes to take over the performance of activities being conducted by government personnel. A number of other OMB circulars, bulletins and policies also govern the contracting process. The Congress recently enacted the Federal Activities Inventory Reform Act (FAIR) in order to increase the government's use of contractors by establishing a presumption in favor of performance of federal activities by the private sector. By direction of Congress, both A-76 and FAIR are currently being reviewed by a panel appointed and chaired by the Comptroller General.

As noted above, the Administration has already taken steps to expand the use of contracts. The OMB Deputy Director's Memorandum of April 3, 2001 (M-01-016) specifically addresses expansion of A-76 competition and a more accurate FAIR inventory analysis. But significant questions have been raised as to whether many agencies have the special skills or processes in place that are required to let contracts efficiently and to manage effectively the work to be done by contractors. Following are some of the key issues.

1. Deciding what needs to be done. As already noted, an agency, as well as OMB, should carefully assess whether the activities being considered for contracting are still appropriate and needed, or whether the program should be terminated or redesigned. OMB ought to consider asking the agencies to make an affirmative finding that an activity earmarked for contracting has been evaluated as to its current relevance and its relation to similar activities being conducted elsewhere.

2. Inappropriate Contracting. Under pressure from both Congress and successive administrations through personnel ceilings or appropriations restrictions for Salaries and Expenses, agencies have let many contracts which cause the contractors to serve essentially as agency staff. They sometimes perform such functions as making policy, developing budgets, program planning, writing and enforcing rules, program management, and even supervision of other prime contractors. An egregious case arose a few years ago in congressional hearings on the possibly-excessive reliance on contractors when it was revealed that the Secretary's testimony had been written by a contractor.

The phrase "inherently governmental functions" refers to functions that ought always to be performed by persons fully responsible and accountable to public officials under the body of law that governs public agencies. Although there may be agreement on broad subjects that are inherently governmental, such as national defense, law enforcement and representing the United States at international organizations or in official contacts with other nations, even these examples are subject to exceptions. In short, the inherently governmental concept has never been adequately defined or developed. Absent that, there is growing use of another undefined term and concept, i.e., "core functions" of the government that appear to relate to functions that are, for one reason or another, essential to being performed by government personnel.

In a November 1991 report (GAO/GGD-92-11), "…GAO found that DOT, DOE, and EPA contracted out for some activities that may have involved [inherently] governmental functions." In the absence of any clear definitions or principles, however, GAO was not able to definitively conclude that these activities involved such inherently governmental functions.

Accordingly, a review of contracts already in place to identify any that may be inappropriate should accompany any expansion of contracting.

Once determining that activities ought to be continued and that they could appropriately be contracted, it is not an easy task to assess whether it would be more cost-effective to contract for their performance or to perform them in-house. For example, a decision to contract for performance of certain activities may have substantial costs associated with the process, which are not usually taken into account, such as dealing with bid protests and the resulting delays related to the process of solicitation and selection of contractors. Here too, while processes have been in place for many years, the needed analytical skills are frequently lacking. A GAO report in 1994 (GGD-94-95) concluded that it was possible that a number of contracts for the performance of services were more costly than if the agencies had performed those services in-house.

Some formal process for evaluating the costs and benefits of contracts should be carried out before such contracts are extended or re-bid.

3. Designing Effective Requests for Proposals. There is a wide range of procurement methods. Some can be quite specific as to the description of the products or services required, while others must be more general or open-ended. Many contracts are individually competed. Others can be negotiated with one or more pre-qualified vendors who have competed for listing on a government-wide, or agency-wide schedule.

There sometimes is a wide gulf between program managers and procurement officers when it comes to choosing procurement methods, or designing solicitations. Agency management needs to oversee carefully (or referee) differences between these two elements. Further, more and more effective training of both procurement officers and program managers in their inter-dependent roles and responsibilities should help to mitigate the conflicts that often arise between them.

It is consistent with the new emphasis on results pursuant to the Government Performance and Results Act (GPRA) to call for greater use of performance-based service contracts (PBSCs), as was done in the OMB Deputy Director's Memorandum of March 9, 2001, cited above. There is both a need and an opportunity to make contractors' performance count and, where feasible, to develop business relationships that share risk and reward more equally between the agency and its contractors. One of the most successful uses of such contracts was in the rapid rebuilding of the freeways devastated by the 1989 earthquake in San Francisco. Well before that, extensive reconstruction of essential facilities in Alaska after the 1964 earthquake was accomplished in large measure through performance-based contracts from the federal government. However, the state of the art is still rather primitive in many federal agencies.

What is needed is some leadership and some formal methods for cross-fertilization between agencies that have used or are using such contracts, and others that need to learn how to do so. Examples of the former are: IRS, NASA, Army, Defense Logistics Agency, Navy-Marine Corps for Internet contracting, Air Force, and Energy.

It should be noted that there is a steep learning curve with respect to PBSCs. Initial efforts at the federal level have not often gotten to the point of building in financial rewards or penalties. But there is much to be gained by emphasizing performance and results as more experience is gained on the way to sharing risk and rewards more directly. For example, contractors could receive recognition for prompt or superior performance, and such recognition could be entered into a contractor data base accessible to other agencies.

OMB's Office of Federal Procurement Policy (OFPP) could play a leading role in achieving the sharing of best practices in PBSCs and in assuring that agencies do not "depreciate the currency," simply by calling contracts PBSCs without any meaningful change in their character.

4. Procurement Reforms. Two sweeping procurement reform laws have been enacted by recent Congresses, but the potential benefits have not been achieved in many agencies. Indeed, in some agencies, there is not much evidence of genuine reform or simplification. The relationship between program managers and procurement officers is often more adversarial than cooperative, with the latter zealously defending their authority, even if it does not redound to the benefit of the agency or the program. Of course, there are cases where procurement officers see a need to prevent program managers' attempts to "cut corners" in seeking expedition of the work. And it must be noted that procurement officers also have IGs looking over their shoulders.

There are cases where procurement offices have, in fact, regressed by failing to use more efficient practices at all, or by loading them down with extra steps that are not needed and that cost the government money. For example, beginning about ten years ago, the General Services Administration (GSA) expanded the scope of Federal Supply Schedule (FSS) contracts to cover services. It developed through competition an FSS roster of approved contractors for management consulting services. The current FSS contract is called Management, Organization and Business Improvement Service (MOBIS). Several hundred contractors have been pre-qualified through a competitive process and their labor rates have been negotiated and are published in the contractors' schedules.

Under the Federal Acquisition Regulation (FAR), agencies are allowed to review the offerings of several pre-qualified vendors and to choose one or more with which to negotiate. This process can legitimately be concluded in one or a few days. However, many procurement offices appear to prefer the old ways of doing business and, increasingly, are demanding that contracts not be let to such pre-qualified vendors without another round or two of full-blown competition among a sub-set of those on the FSS. The cost of serial competition is rarely, if ever, measured.

Moreover, while oral proposals are specifically authorized, the procurement offices often insist on elaborate written proposals, thus duplicating the process already used to place vendors on the Schedule. Then, typically, they demand oral presentations from some or all of those who have submitted worthy written proposals. So, instead of one-stage competition, we have two and three stages (and sometimes more) of competition.

There clearly is a problem with respect to the "culture" of some of those in the procurement community. Their orientation is often how to keep the agency from being criticized for taking full advantage of the congressionally-authorized streamlined procurement methods, rather than how to get the work done most efficiently and effectively.

This kind of behavior suggests that some procurement officers think that unnecessarily-broad and repetitive competitions are free of cost to the government. However, there are substantial, added costs, not just for the time of agency personnel in evaluating multiple proposals but, more importantly, to the vendor community. Vendors must in the long run recover all of their costs of preparing proposals to compete for contracts. These costs are ultimately reflected in their audited overhead rates and paid for by whatever agencies eventually contract with them. It should be self-evident that, if they don't recover all of their costs in the long run, they will go out of business. It is not in the interest of the government either to run up the costs of contractors, and ultimately of contracts, or to drive qualified, potential vendors out of business.

Another manifestation of this "control" mentality in the procurement community is that they have launched in many agencies new Requests for Proposals (RFPs) for Basic Ordering Agreements (BOAs) or Indefinite Delivery, Indefinite Quantity Contracts (IDIQCs) that essentially duplicate the FSS MOBIS contract. Recent examples are HHS, VA and ED. We have estimated a cost of $3 million to the vendor community alone (based upon an average cost of $30,000 per vendor and 100 proposals) for making proposals to a single agency for contracts to cover work that could readily have been contracted for under the existing MOBIS contract with GSA.

It is often hard to discern what possible advantage there is to program managers in having such agency-based procurement vehicles that are redundant with the FSS contract. Indeed, procurement of services through these new vehicles that could otherwise be obtained under the FSS MOBIS contract typically adds a number of months to the procurement cycle. Clearly, this seems at odds with the spirit of the OMB Director's February 14, 2001 Memorandum (cited above), calling for expanding the application of on-line procurement. Moreover, when an agency makes multiple awards for such redundant contracts, it is likely to make them to, perhaps, 50 to 100 contractors, when there are already about 300 available to it under the GSA contract.

Imbedded culture and time-honored practices are notoriously difficult to change. One method of fostering such change is to authorize program managers to "shop around" for procurement services from those agencies that have demonstrated their ability to respond effectively and flexibly to programmatic needs. If confronted with the loss of business, it is highly likely that the out-of-date procurement offices will adapt to the congressionally-encouraged streamlining of procurement.

5. Contract Management and Oversight. Supervision of contract performance to assure that the government receives both quality and value requires skills that are often not well developed. Further, the NPR caused a drastic reduction in the ranks of the middle managers who are the very ones who must oversee contract execution. Efforts to flatten hierarchies should be pursued with recognition of the need to preserve agencies' capacities to hold contractors accountable. Moreover, it must be realized that the body of law that affects the performance of private companies doing contract work for the government is fundamentally different from the body of law that governs direct government activities. The latter body of law includes such matters as pay caps, Freedom of Information Act requirements, and ethics laws and regulations. Finally, the skills required for contract management and oversight are not necessarily the same ones needed for direct program execution.

There is a significant need to address the ability of agencies, in numbers and skills, to assure that the government gets its money's worth for contracted activities.

Many practitioners and academics believe a comprehensive review of how and when contractors should be used is long overdue. Ideally, a broad assessment of programs should precede decisions to contract for services. The statutory framework for contracting has been streamlined, but the practices of many government agencies have not been. OMB should lead a major effort to evaluate what programs need to be dropped or redesigned, and to see to it that the benefits of simplified and more performance-oriented procurement methods are widely shared with respect to those activities that are to be continued through contracts.