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Debunking Acquisition Reform Myths
Prepared statement of Derek J. Vander Schaaf, deputy DoD inspector general, the House Small Business Committee, Thursday, August 03, 1995

I appreciate the opportunity to appear before you today to discuss what can be done to improve the acquisition system. The Office of the Inspector General, Department of Defense, has been a proactive participant in helping shape acquisition reform policy. We have expressed our views on administration and congressional proposals to reform acquisition policies, and we appreciate that the Department of Defense and the Congress ensured our views were considered as these matters were reviewed.

The challenge facing us is how can the government buy the goods and services that it needs more efficiently in the commercial marketplace. Many reform measures seek to make it easier for the government to participate as any other buyer in the marketplace. In doing so, traditional acquisition rules may no longer apply.

The current emphasis on acquisition reform has the basic objective of simplifying the government contracting and procurement process while reducing costs. These objectives are no different than those sought by many other acquisition reform efforts over the last 30 years. What is unique this time is the degree that this simplification is to be achieved through the use of "standard" commercial practices and procedures. This in turn, at least in theory, will better integrate our commercial and key military industrial base capacity.

There is no doubt in my mind that use of some commercial practices can help to simplify and make the government acquisition process more efficient and user friendly. The major challenge to this effort is obtaining a major portion of military products and services from the commercial sector and merging military and commercial capabilities and facilities to maintain a healthy and responsive industrial base.

Many of the acquisition reform efforts are directed to eliminating the obstacles to the integration of commercial producers and defense products. Many reform measures seek to make it easier for the government to participate as any other buyers in the marketplace. In doing so, traditional acquisition rules may no longer apply. This part of acquisition reform requires a new set of ground rules to state how the government will participate in the commercial marketplace. The objective is to simplify these ground rules.

Unfortunately, the more we try to simplify, the more complex things become. Two weeks ago, at an Acquisition Reform Senior Steering Group meeting, a copy of the Federal Acquisition Regulation provision implementing the rules for commercial acquisition, defining what is a commercial product or service, was handed out. The proposed regulation, with comments from DoD, totaled over 200 pages of small, single-spaced print.

As part of our participation in the reform process, we continue to stress that any acquisition reform measures include new or retain existing statutory language that provide[s] sound managerial and internal controls and protect[s] the government's interest.

Reform can and should result in significant changes to the government acquisition process. However, some underlying principles of government procurement must and will remain. For example, the government will always want to buy its goods and services at the quality and performance levels specified in the contract and at fair and reasonable prices, and the government should provide an opportunity for all qualified suppliers to compete. Our audits of the acquisition system, operating under rules much more stringent than those being proposed for future commercial acquisitions, indicate that DoD procurements present enormous financial risks because of the sheer number of suppliers, diversity of products and large sums being expended.

In the area of product quality alone, the Defense Criminal Investigative Service maintains an active caseload that averages about 400 product substitution cases per year that results in about 100 convictions annually. Past audits of product quality also showed high levels of major nonconformance that made the products unusable or unsafe for intended purposes.

The legal requirement for competition in public contracting is one of the major differences between government contracting and contracts involving private parties. The primary reasons for competition in government contracting are to afford private sector individuals and entities an opportunity to do business with the government, to obtain lower prices and to avoid collusion or fraud, unjust favoritism and abuse in the awarding of contracts.

The Competition in Contracting Act has been an important tool in ensuring fair prices and reducing the scandals from overpriced spare parts and supplies. While we have seen savings of 5 to over 90 percent from competition, typically competition results in price reductions of 15 to 30 percent. The Competition in Contracting Act requires the use of competitive contracting procedures unless use of other than competitive procedures can be justified against one of seven statutory exceptions. It further requires contracting officers to justify the use of other than competitive procedures and obtain approval at increasingly higher levels as the value of the contract increases.

HR 1670, the Federal Acquisition Reform Act of 1995, proposes to change the standard of "full and open" competition to an undefined new standard of "maximum practical" or "open access" competition. This change to a "maximum practical" standard could be used to limit competition to only those "prequalified" or "verified" vendors.

I do not agree with limiting access to government markets, because it can deny firms such as new high-technology companies the opportunity to bid on government contracts and deprive us of the benefits of a broader base of suppliers, both large and small. This proposal seems to be a step backwards from trying to entice additional companies to enter the government market.

Contracting officers have flexibility to exercise sound business judgment under the current statute in determining the appropriate acquisition strategy for a procurement. We have not seen any analyses or demonstration of a problem that supports moving away from full and open competition or eliminating the seven exemptions to competition. Further, we see no benefit to adding the words "not feasible" or "not appropriate" to the reasons for not pursuing a competitive strategy.

I am in favor of legislative proposals that would permit the contracting officer[s] to limit the number of offerers in the competitive range or to use a two-step proposal and evaluation process that would limit the number of contractors competing after the first step. Both of these proposals could reduce the time and resources expended on suppliers who have little or no chance of success. These proposals would also help reduce the burden on contracting officers and the time required to award a contract.

For effective competition, potential suppliers must be given enough information to know what are the government's needs and what they are competing for. The present law requires that specifications in contracts permit full and open competition and include restrictive provisions only to the extent necessary to satisfy the needs of the agency or as authorized by law. HR 1670 would repeal this requirement. We are opposed to deleting this requirement, because specifications must clearly state agency minimum needs. Inadequate and ambiguous specifications undermine competition. Excessive requirements are also inappropriate and wasteful.

The Competition in Contracting Act requires that a solicitation identify all factors by which an agency reasonably expects to evaluate proposals and their relative importance. We believe that the solicitation must clearly state what factors and subfactors will be scored so competitors can be treated fairly, but we do not agree with the legislative proposal that the entire source selection plan must be included in the solicitation.

Agency contracting officers have discretion in whether to disclose a source selection plan to competitors, and that discretion should be retained. Source selection plans often contain sensitive information that should not be disclosed prior to contract award, such as the organization, membership and responsibilities of the source selection team.

We also believe that preproposal conference can and should be held with prospective contractors where the procurement involves complicated specifications and requirements. We do not agree that such conferences should be conducted for all procurements, because this would impose a significant administrative burden on contracting officer and increase administrative costs and procurement lead time.

Under the current statutes, contracting officers are required to consider quality of product and contractor performance in addition to price before awarding a contract. DoD is currently working on systems to collect contractor past performance data and regulations to implement the statutory mandate in the Federal Acquisition Streamlining Act that agencies consider past performance in the award of individual contracts.

The proposal in HR 1670 to establish a contractor verification system appears to move away from trying to add new vendors to this lists, particularly small manufacturers, and appears to limit suppliers to the past DoD contractors. Currently, DoD uses qualified bidders lists, qualified manufacturers lists and qualified products lists in lieu of a formal system of awards based on past performance. Until the department is better able to identify and measure past performance, we believe the current system is better than what is proposed in HR 1670.

Section 105 of HR 1670 seeks to eliminate fee limits on cost contracts. This includes the 15 percent limit on cost-plus-fixed-fee contracts for experimental research and development work, the 10 percent limit on any other cost-plus-fixed-fee contract and the 6 percent fee limit on architect and engineering services contracts.

People attempt to justify the change by saying fee limits do not exist in the commercial marketplace and will encourage more bids on contracts. I am unaware of the government not finding adequate numbers of interested suppliers or of any company going broke because they can only earn a 10 or 15 percent fee on a cost-type contract.

The A&E fee limit was enacted to preclude the government from overspending on design and getting ostentatious or grandiose buildings. Our auditors have reviewed thousands of military construction projects. Buildings being erected on military installation are state of the art that have won A&E awards, so there is evidence that we are getting quality A&E work.

Eliminating the fee limit will make more work for contracting officers and will adversely affect the pricing of $17 billion of cost-type contracts with fixed fees.

The elimination of the fee limits on cost-plus-fixed-fee contracts could result in higher fees on other types of cost reimbursable contracts. Contracting officers often use the 10 percent and 15 percent limitations as a basis to determine maximum fees on cost-plus-incentive-fee and cost-plus-award-fee contracts. These other types of cost reimbursable contracts account for about another $30 billion of DoD procurements. Fee limits on government contracts have been with us since the Continental Congress set fee limits to reduce profiteering during the Revolutionary War.

Our office not only supported but pushed for expanded use of commercial products to meet DoD needs for many years. We supported the expanded definition of a commercial item that initially evolved from the acquisition reform process and the use of nondevelopmental items whenever possible.

I am concerned about the attempt in HR 1670 to create a broader definition of a commercial item or service. I am all for buying commercial items and services. However, it appears to me that current acquisition reform proposals are attempting to define government and defense-unique items and services as commercial items in order to exempt them from coverage of the Truth In Negotiations Act and keep government from gaining auditor access to contractor records. This acquisition reform process seems to be dedicated to removing the contracting officer's right to seek cost and pricing data even if he or she cannot establish a fair price by other means.

One section of HR 1670 eliminates the words "catalog," which may have the effect of defining any service as commercial. I disagree with this proposal. The DoD spends more on services than we do on hardware. Exceptions to providing cost or pricing data for commercial services are currently limited to installation, maintenance, training and repair services and where "catalog" prices are available for other services.

The proposal would make engineering services, consulting, technical support and just about any type of technical labor a commercial service. This will restrict a contracting officer's ability to obtain certified pricing information and our ability to audit these awards. The pricing of technical, scientific and engineering services is where the auditors and contracting officers spend a lot of time reviewing prices and negotiating concessions from contractors on prices for various labor categories.

What is a little frightening is that this proposed change will allow an estimated $61 billion of service contracts in the DoD ($103 billion in the government), much of which is awarded without competition would be exempted from audit. The government would give up all rights to cost and price information and all audit rights, except audits that are carried out in direct support of a criminal investigation by examining records that are subpoenaed.

I am opposed to the section of HR 1670 that proposes further changes to the TINA. As presently written, TINA allows an exception to the requirement for providing cost or pricing data when the agreed upon price is based on established catalog or market prices of commercial items that are sold in substantial quantities to the general public. The proposed legislation would eliminate that exception and apparently replace it with another exception that is a great deal broader.

The proposed exception would include all commercial items, not just those for which the agreed upon price is based on established catalog or market prices. This is obviously a much broader exception and leaves the contracting officer in a much more difficult position to determine whether the price is fair and reasonable. If the contractor declares that the item is a commercial item, the contracting officer will be unable to request cost or pricing data even when he or she cannot establish that the price is fair and reasonable through price analysis.

I am also opposed to the proposed change in the section to provide a blanket waiver of cost accounting standards for any commercial acquisition. The cost accounting standards ensure consistency of accounting among contractors, as well as require that unallowable costs, such as lobbying, entertainment, etc., not be billed to the government. In order to receive government financing, the contractor must demonstrate that his accounting practices adequately assign costs to contracts. Therefore, I see no reason why contracts that provide for government financing (progress payment) should not include the provisions of the cost accounting standards.

We disagree with the changes, which create loopholes to the TINA. The Federal Acquisition Streamlining Act changes enacted last year to TINA have not yet been implemented, and thus, their effect cannot be judged. I suggest that we wait and gain more experience using the recent revision to the TINA before additional changes are enacted.

The prevailing attitude this year seems to be to eliminate use of the TINA and the auditors. The companies and even some DoD officials state that if you eliminate TINA and auditor oversight, then the DoD can buy their DoD-unique items from contractors at lower prices. Well, if you believe that you will generally receive a better price by eliminating the right to ask for cost and pricing data or the opportunity for auditors to look at a contractor's records, then I have a bridge you will be interested in.

The truth is that requesting cost and pricing data is a common commercial practice. Large companies that have purchasing leverage will generally make their suppliers provide cost and pricing data. Contractors who do business with the government gripe about TINA, yet they will make their own suppliers show them exactly what a product costs to make before they buy it. If the large company detects they overpaid that supplier, the supplier will probably never get another contract. The government cannot exercise a similar option to simply exclude a supplier.

A recent Coopers and Lybrand study estimated that unique government requirements added about 18 percent to the cost of a defense contract vs. a truly commercial contract. The study costs are not applicable to the competition discussion and mainly relate to postaward or contract administration requirements, such as quality assurance and use of military standards and military specifications.

I also caution against the overall use of the 18 percent, because the study was limited to only 10 companies, and the study has other limitations and cautions on use of the data. However, let's assume the study is correct when it concludes that TINA typically adds 1.3 percent to the cost of a contract.

For FY [fiscal year] 1994, the DoD contract reporting system showed that 55,764 contract actions, valued at $51.1 billion, were subject to TINA and certified as to cost and price data provided the government. The DCAA [Defense Contract Audit Agency] reports $2 billion in benefits during FY 1994 from contract price reductions and collections related to TINA. In addition, the criminal investigators recovered about $100 million related to defective pricing investigations.

Thus, the direct quantifiable benefits of TINA are about $2.1 billion. Using the Coopers and Lybrand cost drivers for TINA of 1.3 percent times the total applicable purchases of $51.1 billion yields a cost for TINA of $664 million. The benefits outweigh the costs by a ratio of 3 to 1 ($2.1 billion vs. $664 million), or net dollar benefits of $1.5 billion.

The benefits of TINA are really far greater than this because none of the intangible benefits -- "the cop on the block" benefit -- can be measured. Just imagine what prices will be on some of our contracts if the government loses all audit rights to look into contractor costs or the right to require contractors to reveal their costs when selling what are really noncommercial items on a noncompetitive basis to the government.

It has been my position that if the government really wants to go commercial and for the government to fully benefit from simplified acquisition procedures and commercial practices, you have to go a lot further in terms of exemptions from existing statutes, regulations and dollar thresholds.

One area where this could be easily done is in the area of what is often referred to as "fungible commercial commodities." I am talking about such things as steel and other metals, such as aluminum, coal, oil, lumber products.

For the DoD to fully benefit from simplified procedures for the acquisition of fungible commercial commodities, you need to eliminate all domestic source restrictions, government-unique ethics restrictions, socioeconomic requirements (including some small business restrictions) and other miscellaneous restrictions. We identified a list of 37 laws that commercial acquisitions should be exempted from.

One of the problems we have identified is that the laws and regulations that government imposes on the purchase of commercial items discourage major commercial companies from selling to the DoD. As a result, there are other companies that learn the government's acquisition rules and procedures and then specialize in selling to the government. The sales to the government or just DoD usually represents the majority, if not all, of these firms' sales. Under these circumstances, the government does not get the benefits from being just another purchaser in a commercial market. We have performed research on the purchases of various commercial commodities, such as wood products, meat, seafood, textiles, where the top 10 suppliers to DoD do not include any of the top 10 sellers of those commodities.

For these fungible commercial commodities, the new $100,000 simplified threshold serves no purpose other than to create bureaucracy. If you are buying steel, the simplified acquisition procedures should be the same whether you want to purchase $100,000 or $5 million.

The current rules allow use of simplified procedures for commercial purchases under $100,000 and reserves these contracts for small business. We support the section of HR 1670 that proposes to allow use of simplified acquisition procedures for commercial items at any dollar value. However, expanded use of simplified acquisition procedures should only apply to truly commercial items and not the proposed definition of commercial that industry wants to use. I also do not think purchases of commercial items and services at any dollar value should be reserved for small business.

One thing to keep in mind while working on acquisition reform is that there are cost reductions or cost increases for every piece of legislation that results in reduced or additional time to perform a procurement. I have heard there have been discussions about increasing the amount of time a procurement must be announced in synopsized form. The time has been shortened for items procured under the simplified acquisition threshold.

We have recently completed extensive work on the amount of time it takes the different DoD buying centers from recognition that an item needs to be purchased until the contract is awarded. This is called procurement administrative lead time. For example, for purchases under $25,000, the old small purchase threshold, the lead time ranged from 49 days to 278 days for 16 buying centers. Our work was oriented to helping the DoD reduce administrative lead time through use of performance measures and sharing of streamlining practices. However, it has application here because any new acquisition legislation has the potential to increase or decrease acquisition lead time.

Longer administrative lead time requires more items to be purchased and greater holding costs. The factors involved include the cost of money, handling, storage space, obsolescence, safety levels and pilferage. The average cost per day of lead time in the department was $9.8 million for materiel contracts regardless of the contract value -- $3 million for contracts under $25,000, and $6.8 million for contracts over $25,000. These types of figures are useful when weighing the risks and benefits of legislation that affect the length of time to perform a procurement.

We also need to eliminate the Small Business Administration right to overrule a contracting officer's determination that a small business should not be awarded a contract because it lacks certain elements of responsibility, such as competency, capability and capacity.

There are plenty of examples where the SBA overruled a contracting officer's initial determination of nonresponsibility. Contracts with these small or disadvantaged businesses often had to be terminated for default or, only after a great deal of technical assistance and delivery schedule extensions, marginal performance was achieved.

Therefore, we suggest that the SBA Certificate of Competency Program be eliminated. We believe that DoD contracting officers make determinations of nonresponsibility with good reason. In this time of streamlining, it is not proper placement of accountability to give another agency of the federal government the authority to force a contracting officer to award a contract to any offerer that has quoted an unreasonable low price or for other reasons has failed a preaward survey.

If a review of the contracting officer's actions is needed, we could come in and do this on a case-by-case basis. The current procedures violate the principles of accountability, best-value contracting and performance-based contracting.

In fiscal year 1994, there were 762 referrals from the DoD to the SBA for a Certificate of Competency on contracts valued at $1.3 billion. Only 227 certifications were issued for contracts valued at $190 million. Thus, over $1 billion of contracts were delayed an average of 15 days.

This problem is not as bad as before, because the number of DoD requests for a SBA Certificate of Competency has decreased by 65 percent from 2,157 in FY 1992. The decrease in the number of requests and the very few certificates issued in FY 1994 may indicate the program is no longer required. There is a cost to the DoD while awaiting the SBA to make a determination. The cost is part of the overall procurement administrative lead time.

One part of HR 1670 would allow a DoD contracting officer to directly contract with a Section 8(a) company. This would eliminate DoD having to go to the SBA to award the Section 8(a) contracts. This is a good reform, because it will reduce the administrative lead time for contracts, eliminates a layer of bureaucracy, reduces contract administration costs and does not harm companies.

In fiscal year 1994, the DoD had 42,295 contracts, valued at $2.7 billion, awarded to Section 8(a) companies that were delayed an average of 25 days because the SBA had to make the award. Because of the cost of administrative lead time, we believe that millions of DoD funds can be put to better use if the department could directly contract with Section 8(a) companies and eliminate the 25 days.

Much has been written about simplifying protests and consolidating the different boards for contract appeals. This is an area where we have not seen studies or data that show efficiency or cost savings from the proposed legislation. We are all for anything that will make the contracting process easier and less costly for the parties involved. However, we have not done enough work in the contract protests area to form an opinion as to the best way for the federal government to structure its contract appeals or bid protest process.

Acquisition reform has appropriately pursued changes which can be cost drivers to defense contractors, but, in my opinion, has not gone after even more significant cost drivers to the government with the same vigor. In this category, I would place small business set-asides, Buy American Act and domestic content requirements that are applied to many products DoD buys, as well as Davis Bacon, the Service Contract Act and some of the other socioeconomic laws. Certain of these procedures should not apply to those acquisitions below the $100,000 level (the simplified acquisition threshold) or where commercial practices are being used. Application of these laws to commercial practice is a contradiction in terms.

This is probably a good time to add a few thoughts on some of the concerns I have with the acquisition reform process to date. I happen to believe that the process has been focused to a major extent on those cost drivers that the defense industry does not like.

These cost drivers can, in fact, be burdensome and inappropriately used, and even when properly applied, they can cost the contractor a lot of time and money while they help to assure the government gets a quality product at a fair price. I am referring to such things as Competition in Contracting Act and the Truth in Negotiations Act, which help add suppliers and reduce prices. These safeguards and other safeguards have been built into the procurement process in response to past abuse and snafus.

Acquisition reform, especially much of what is being proposed in this second round, is carrying out a longstanding industrial or supplier agenda to curtail or eliminate many of these key safeguards which have been built into the United States procurement process over the past 200 years. I broadly categorize these as disclosure requirements, certifications, price-reduction requirements and audit rights. Certain of these safeguards help ensure cost (fair price) and quality, both of which become greater risks as we rely more on commercial products and practices.

While industry strenuously argues that such safeguards are incompatible with commercial sales practices, it is our experience and that of the inspectors general at the General Services Administration and the Department of Veterans Affairs that large private-sector purchasers consistently require these same types of safeguards in their own dealing with suppliers, as does the federal government.

One of the rallying cries of the current reform initiatives is that the federal government should conduct purchases the way an individual does in a discount retail establishment, such as Office Depot or Wal-Mart. However, I believe that the government, as the nation's largest single potential purchaser, spending about $200 billion annually buying goods and services, is often in the position of being able to obtain much more favorable pricing and conditions than an individual making small, one-time purchases at a local store.

I contend that large corporate purchasers also try to take maximum advantage of their potential purchasing power. The key is balancing the cost of retaining a large acquisition work force and the costs of running a special quality control and supply and logistics systems against any savings that can be achieved through volume purchases.

Too many procurement reform proposals related to commercial products are based on the faulty assumption that the government imposes special requirements on the provider community that are different from those that these very same providers impose in turn on their commercial suppliers.

In fact, in the key areas of most-favored customer, special-price reductions and audit access, government practices are very much the same as those found in the commercial arena. In the competitive marketplace, large-volume purchasers can and do set conditions because it is in their economic interest to do so. ...

 

 

Published for internal information use by the American Forces Information Service, a field activity of the Office of the Assistant to the Secretary of Defense (Public Affairs), Washington, D.C. Parenthetical entries are speaker/author notes; bracketed entries are editorial notes. This material is in the public domain and may be reprinted without permission. Defense Issues is available on the Internet via the World Wide Web at http://www.defenselink.mil/speeches/index.html