Report: Navy outsourcing decision leads to higher costs

A Navy contract awarded two years ago with a creative performance-based pricing structure was poorly written and implemented, leading the government to pay too much for services and potentially making the contract more expensive than if the work had stayed in-house, according to a recent audit report.

In early 2005, the Navy completed a public-private job competition, resulting in a contract with Shaw Infrastructure Inc. to provide environmental services such as laboratory testing, waste water treatment and site remediation at the Public Works Center in San Diego. The contract uses firm fixed-price agreements for recurring work and task orders for one-time projects, and is performance-based. The Defense Department has backed performance-based arrangements as part of an effort to enhance accountability.

But in a Defense inspector general review, investigators found that poor implementation of performance-based clauses has left Navy officials unable to effectively monitor and manage the contractor's work.

Inspectors also found that the contractor's fixed payment structure is not aligned with variable reimbursements to the center based on actual services delivered. When the contractor workload in some areas turned out to be about half of what was expected, vague language left officials unable to negotiate better terms.

In addition, under task orders, the Navy paid labor rates higher than those originally negotiated, overpaying by about $1.4 million for the first 18 months. If the agency continues to accept the higher labor rates, the Navy will pay about $6.6 million more than was negotiated over the remaining three years of the contract, reviewers wrote, wiping out the cost advantage of using the private company rather than government employees.

The IG office made numerous recommendations to improve contract management and control payments, with which the Navy agreed.

Procurement experts are divided on the use of performance-based contracting. A panel of government and industry specialists, convened under the Services Acquisition Reform Act, found that in a sampling of contracts that were designated as performance-based, only 38 percent implemented the strategy well, while about 23 percent used some aspects of it and 40 percent did not use it at all. (The figures do not add up to 100 percent due to rounding.)

Based in part on that finding, the panel recommended that the Office of Management and Budget drop a quota that 40 percent of contract dollars be covered by performance-based agreements.

The IG's findings also raise questions for the review of other public-private competitions carried out under OMB's Circular A-76 rulebook. In an April memorandum, OMB directed agencies to validate the savings achieved from a sampling of competitive sourcing decisions. Those analyses could support critics' arguments that many work agreements, like this one, end up with unexpectedly high costs that eat into projected savings.