Contract Management: Commercial Use of Share-in-Savings 	 
Contracting (31-JAN-03, GAO-03-327).				 
                                                                 
The Congress and federal agencies are increasingly turning to	 
performance-based contracting methods to enhance the delivery of 
government services. Share-in-Savings (SIS) contracting--in which
the contractor assumes more risk by investing upfront costs but  
also receives a share in any savings generated by its efforts--is
one performance-based technique that Congress is trying to	 
promote. We were asked to examine its use by industry in terms of
whether there were any key conditions that needed to be in place 
to make this technique successful. In conducting our review, we  
found that the form of SIS used in a commercial contract varied  
by contract.  Some contracts employed a basic SIS approach, in	 
which a contractor's total compensation was paid entirely through
sharing a portion of a client's savings or increased revenues.	 
And some employed a tailored approached in which contractors were
paid for at least some portion of their time and materials costs,
even if savings or increased revenues were not realized. We	 
performed a detailed analysis on four specific contracts to	 
identify conditions that fostered success.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-327 					        
    ACCNO:   A06018						        
  TITLE:     Contract Management: Commercial Use of Share-in-Savings  
Contracting							 
     DATE:   01/31/2003 
  SUBJECT:   Contract administration				 
	     Program evaluation 				 

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GAO-03-327

Report to Congressional Requesters

United States General Accounting Office

GAO

January 2003 CONTRACT MANAGEMENT

Commercial Use of Share- in- Savings Contracting

GAO- 03- 327

SIS can be a highly effective contracting technique to motivate
contractors to generate savings and revenues for their clients. But to be
successful, clients and their contractors need to be specific and in
agreement in their goals and objectives, as well as how to achieve them.
This can be a difficult task for more complex services, but the companies
we spoke with found that pursuing this type of arrangement was worth the
extra effort.

Conditions that Facilitate Success

An Expected Outcome Is Clearly Specified. By outcomes, we mean such things
as generating savings by eliminating inefficient business practices,
realizing savings through conservation measures, or identifying new
revenue centers. Because the success of SIS relies heavily on the ability
to identify and track savings or revenues, it is critical that a
contractor and client have a clear understanding of what they are trying
to achieve.

Incentives are defined. Both the client and the contractor need to strike
a balance between the level of risk and reward they are willing to pursue.
A pure SIS arrangement offers attractive benefits, such as no upfront
investment on the part of a client and a bigger return for a contractor.
But there are real risks, particularly for a contractor, if savings or
revenues are not realized as anticipated. As a result, clients and
contractors need to work through incentives and risks and come to
agreement on how far they would take their SIS arrangement.

Performance measures are established. By its nature, SIS cannot work
without having a baseline and good performance measures to gauge exactly
what savings or revenues are being achieved. Agreement must be reached

on how metrics are linked to contractor intervention. For some services,
such as energy management, they are relatively easy to define. For more
complex services, such as those in the information technology industry,
this

can be a much more difficult task.

Top management commitment is secured. This is paramount in any SIS
arrangement. A client*s top executives need to provide contractors with
the authority needed to carry out solutions, since change from the outside
is often met with resistance. They also need to help sustain a partnership
over time since relationships between the contractor and client can be
tested in the face of changing market conditions, legal pitfalls, and
other barriers.

To date, federal agencies have made limited use of SIS contracting.
Officials we spoke with noted that these arrangements may be difficult to
pursue, given potential resistance and the lack of good baseline
performance data. However, it may be worthwhile for agencies to examine
ways to overcome potential problems to achieve better outcomes.

CONTRACT MANAGEMENT

Commercial Use of Share- in- Savings Contracting

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 327. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact David Cooper (202) 512- 4125, CooperD@ gao. gov.
Highlights of GAO- 03- 327, a report to

Congressional Requesters, House of Representatives

January 2003

The Congress and federal agencies are increasingly turning to performance-
based contracting methods to enhance the delivery of government services.
Share- inSavings

(SIS) contracting* in which the contractor assumes more risk by investing
upfront costs but also

receives a share in any savings generated by its efforts* is one
performance- based technique that Congress is trying to promote. We were
asked to examine its use by industry in terms of whether there

were any key conditions that needed to be in place to make this technique
successful. In conducting our review, we found that the form of SIS used
in a commercial contract varied by contract. Some contracts employed a
basic SIS approach, in which a contractor*s total compensation was paid
entirely through sharing a portion of a client*s savings or increased
revenues. And some employed a tailored approached in which contractors
were paid for at least some portion of their time and materials costs,
even if savings or

increased revenues were not realized. We performed a detailed analysis on
four specific contracts to identify conditions that fostered success. We
did not make recommendations in this report.

Page 1 GAO- 03- 327 Contract Management January 31, 2003 The Honorable Tom
Davis

Chairman Committee on Government Reform The Honorable Jim Turner

Ranking Minority Member Subcommittee on Technology

and Procurement Policy Committee on Government Reform House of
Representatives

The Congress and federal agencies are increasingly turning to performance-
based contracting methods as a way to enhance the delivery of government
services. You requested that we determine how Share- inSavings (SIS)
contracting, one performance- based technique, is used in the commercial
sector. This report responds to your request by examining four commercial
SIS contracts and identifying common characteristics that made them
successful. For the purposes of this report, we have defined SIS
contracting as an agreement in which a client compensates a contractor
from the financial benefits derived as a result of contract performance.
Financial benefits can come from either contractorgenerated savings or
revenues.

We found variations in the forms of SIS used in the four commercial
contracts we studied. The forms ranged from a basic SIS approach, in which
a contractor*s total compensation was paid entirely through sharing a
portion of a client*s savings or increased revenues, to a tailored
approach in which contractors were paid for at least some portion of their
time and

materials costs, even if savings or increased revenues were not realized.
We also found, in the commercial SIS contracts we reviewed, that four key
conditions facilitated the development and execution of the SIS contracts.
First, the client and contractor clearly defined an expected outcome from
the arrangement, such as generating savings by eliminating inefficient
business practices, realizing savings through conservation measures, or
identifying new revenue centers. Second, both client and contractor had
incentives to use this contracting technique. SIS contracting is
attractive to United States General Accounting Office Washington, DC 20548

Results in Brief

Page 2 GAO- 03- 327 Contract Management clients who (a) do not have the
funds for, or choose not to pay, some or all of the up- front costs of a
needed project and (b) are willing to pay the

premium SIS contractors charge for putting some or all of their
compensation at risk. Contractors, on the other hand, must have confidence
that the financial benefits they can produce are sufficient to cover their
costs and provide a profit that rewards them for the increased risk they
incur. Third, a baseline and performance metrics could be established to
define a client*s costs and/ or revenue prior to, and after, contractor
intervention. Fourth, the client*s management contributed to success by
committing to execute the project and implement contractor
recommendations.

Overall, the commercial companies we studied, along with other users of
SIS, have noted that, even when the right incentives and measures are in
place, other issues could impact a company*s use of SIS contracting. For
example, parties may blame each other, when savings or increased revenues
are lower than expected. As a result, before going into such an
arrangement, both client and contractor need to carefully consider the
potential risks and rewards of an SIS arrangement and whether the
conditions that facilitate success are present* something that may not be
easily achievable in government, which frequently is unable to calculate a
baseline. On the other hand, companies have found it worthwhile to

overcome potential barriers to SIS contracting because successful
arrangements have generated savings and revenues* in one case highlighted
in this report, $980,000 in annual energy savings, which otherwise would
not have been realized.

This report does not contain a recommendation. In its basic form, SIS
contracting is a contracting and financing technique in which a
contractor, rather than a client, funds the up- front cost of a project,
and, in return, receives a percentage of the savings that the contractor
generates for the federal agency. SIS contracting effectively shifts the
risk of contract performance to the contractor because, in addition to
providing the up- front capital, the contractor receives payment only
after savings are realized. In short, a contractor is paid only for

results, not just effort. The attraction of this technique to the federal
government is the ability to capitalize on modern technology, while not
incurring the up- front expense. Conversely, the attraction to a
contractor is the potential for a greater return, because of the increased
risk, than

from a traditional contract. Both parties involved in an SIS contract
Background

Page 3 GAO- 03- 327 Contract Management anticipate that a contractor*s
potential to earn more will generate an incentive to save more, thereby
creating a win- win situation.

The appeal of SIS contracting has generated congressional interest to
expand its use within the federal government. For example, the
ClingerCohen Act of 1996 authorized pilot programs to (1) contract on a
competitive basis with a private sector source to provide the federal
government with information technology solutions for improving
missionrelated or administrative processes of the federal government and
(2) pay the private- sector source an amount equal to a portion of the
savings derived by the federal government from any improvements. The
recent EGovernment Act of 2002 expands authority to enter SIS contracts in
fiscal years 2003 through 2005 and also provides for incentives to federal

agencies. 1 Despite this interest to expand its use, there are few
documented examples of SIS contracting in the federal government. One of
the bestknown examples of federal SIS contracting is in the Department of
Energy (DOE). The National Energy Conservation Policy Act, as amended by
the Energy Policy Act of 1992, and subsequent executive orders require
federal agencies to reduce their consumption of energy in federal
buildings. This law provided that federal agencies may enter into SIS
contracting as a way of encouraging industry to help achieve this goal and
required DOE to establish methods and procedures to implement this
authority, which allows federal agencies to realize energy efficiencies
with minimal up- front costs to the government. Accordingly, DOE*s Federal
Energy Management Program crafted an energy savings contract under which
energy service contractors are expected to contribute the up- front costs
identifying a federal facility*s energy needs and buying, installing,

operating, and maintaining energy- efficient equipment to cut energy
bills. In return, the companies get a share of energy savings generated by
the improvements.

We found various forms of SIS were used in the four commercial contracts
we studied. The forms ranged from a basic SIS approach, in which a
contractor*s total compensation was paid entirely through sharing a
portion of a client*s savings or increased revenues, to a tailored
approach 1 Public Law 107- 347, December 17, 2002. Forms of SIS Varied

by Contract

Page 4 GAO- 03- 327 Contract Management in which a contractor was paid for
at least some portion of the time and materials costs, even if savings or
increased revenues were not realized.

The difference between the approaches was the level of risk the contractor
assumed and the portion of the contractor*s compensation tied to the
savings and/ or revenue generated.

Of the four situations presented in this report, two used a basic SIS
approach in which the contractors* compensation was entirely at risk*
unless they produced results, and two used a tailored approach. The basic
SIS approach was used by (1) the Massachusetts Institute of Technology
(MIT) and its contractor, Alliant Energy Integrated Services/ Cogenex, to
reduce utility costs in MIT*s 100- building campus and (2) Texas Online
Authority and its contractor, BearingPoint, 2 to create an Internet Web
site to provide state and local government services to Texas businesses
and citizens. The tailored approach was used by (1) Best Buy and its
contractor, Accenture, to identify cost reduction opportunities and
potential new revenue centers and (2) Harley- Davidson and its contractor,
Henkel Chemical Management, to reduce Harley- Davidson*s chemical
management costs.

For the commercial SIS contracts we studied, four conditions emerged as
playing a key role in facilitating the development and execution of the
SIS contracts. As shown below, the client and contractor (1) defined an
outcome, (2) determined whether SIS incentives were appropriate, (3)
established a baseline and performance metrics tied to their desired
outcome, and (4) obtained client commitment to success.

SIS contracting was considered only after the client and contractor
defined an expected outcome, such as realizing savings through energy
conservation measures, identifying new revenue centers, or generating

savings by eliminating inefficient business practices. A clearly defined
outcome was required so that contractors could focus their resources,
knowledge, and expertise on obtaining solutions to their clients* needs
and/ or business problems. To define an outcome, the client and contractor
examined the client*s existing systems and/ or business processes to
determine whether opportunities existed to generate savings and/ or

2 Formerly KPMG Consulting. Certain Conditions

Facilitated the Use of SIS

An Expected Outcome Was Clearly Defined

Page 5 GAO- 03- 327 Contract Management revenues for the client. The
examination process involved an open exchange of information and took, in
one case, 6 months to complete.

Table 1: How Clients and Contractors Defined an Expected Outcome Client/
contractor How an expected outcome was defined MIT/ Alliant Energy
Integrated

Services/ Cogenex Outcome: Reduced utility costs. In 1987, MIT recognized
the need to reduce utility costs by upgrading its inefficient lighting,
heating, and air conditioning systems. Because managing such a project is
not an MIT core competency, MIT solicited the assistance of Alliant/
Cogenex. Alliant/ Cogenex is an energy service company whose expertise is
to reduce energy costs by determining whether energy inefficiencies in
facilities exist and, if so, executing the changes needed to eliminate the
inefficiencies. Through its energy audit, Alliant/ Cogenex determined that
enough energy savings (the amount MIT would have paid if improvements were
not made) could be accomplished over 10 years to pay for the improvements.
In the end, MIT saved $980,000 annually over what it would have paid had
the improvements not been made. Texas Online Authority/ BearingPoint
Outcome: Enable on- line access to government services. The Texas Online
Authority was established to satisfy an unfunded state legislative

mandate to create an Internet site a to provide the services of state
agencies, counties, cities, and institutions of higher learning to Texas
businesses and citizens. The intent of the legislation was to provide a
variety of online services such as driver license and motor vehicle
registration renewals, occupational license and permit renewals, and
college tuition payments. BearingPoint responded to a Request for Offer
and was awarded the contract to develop and operate the Web site at no
cost to the state. BearingPoint*s confidence that it could meet the
contractual requirements, recover its costs, b and earn a profit rested on
(1) state legislation encouraging/ requiring the use of online services c
and (2) a Texas Online survey of potential users revealing that business
and citizens were willing to pay the additional fees required to allow
BearingPoint to recover its costs and earn a profit.

Best Buy/ Accenture Outcome: Higher revenues and reduced costs. Best Buy
wanted to identify cost reduction opportunities and new revenue centers
because, in 1996, Best Buy faced a dilemma: fast, furious growth but
sagging profits, which, if left uncorrected, would result in operational
losses that could drive the company into bankruptcy. Best Buy recognized
that it was best served by entering into a consulting agreement with an
organization whose retailing experts could independently study Best Buy
operations and business processes. Accordingly, Best Buy contracted with
Accenture to perform a study of their operations and business processes.
The purpose of the study was to determine if Accenture could (a) identify
inefficiencies contributing to Best Buy*s sagging profits, and, if so, (b)
if Accenture, working in partnership with Best Buy, could eliminate such
inefficiencies. As a result of that study, which lasted 6 months,
Accenture determined that there were cost reduction opportunities and
potential new revenue centers not recognized by Best Buy.

Page 6 GAO- 03- 327 Contract Management Client/ contractor How an expected
outcome was defined Harley- Davidson/ Henkel Chemical Management Group
Outcome: Reduced costs for indirect materials.

Harley- Davidson wanted to realize cost savings from the indirect
materials and services needed for the maintenance, repair, and operations
of their facilities. Examples of indirect services and materials include
building repair, janitorial services, vehicle maintenance, plumbing, and
chemical management. Through 1998, Harley had been spending about $85
million annually with more than 3,500 suppliers for such indirect
materials and services. To help realize cost savings, Harley contracted
with Henkel. The Henkel Chemical Management Group has a core competency in
chemical management. Examples of indirect materials and services, which
Henkel could help achieve cost savings over what Harley had been paying,
include oils/ greases, coolants, washer/ cleaning fluids, adhesives, and
paint additives/ chemicals to name a few. After reviewing Harley*s
chemical management program, Henkel determined it could deliver cost
savings through improved pricing by leveraging buying power and the
introduction of new usage and disposal efficiencies.

Sources: MIT/ Alliant Energy Integrated Services/ Cogenex; Texas Online
Authority/ BearingPoint; Best Buy/ Accenture; and HarleyDavidson/ Henkel
Chemical Management Group.

a A high available Internet facility and portal. b Forty- three million
dollars for capital equipment plus $15 million to $20 million for
operations and variable expenses, as of December 4, 2002.

c One example is Texas Senate Bill 645 (enacted by the 77th Legislature),
which requires 23 occupational licensing entities to use a common Internet
licensing system on Texas Online.

Once the outcome had been identified, both the client and the contractor
determined that it was in their individual best interest to engage in an
SIS contracting arrangement and they struck a balance between the level of
risk and reward they were willing to pursue. For a client, SIS contracting
is attractive because it enables a company to initiate a project without

borrowing or investing its own funds. Moreover, it ties contractor
compensation to results rather than just contractor recommendations that
may not translate into the savings or increased earnings a client expects.
But a client may hesitate at pursuing a basic SIS approach because that
would require foregoing savings generated, and instead opt to finance some
up- front costs or to partially compensate the contractor for effort in
order to obtain a greater share in the savings. For contractors, SIS
arrangements provide an opportunity to earn a return on investment that is
higher than a traditional contract. But the contractor faces the risk that
savings or increased revenues will not be realized after investing heavily
in the project or will be realized more slowly than anticipated. To
mitigate that risk, the contractor may also decide not to pursue a basic
SIS arrangement. In each of the cases we examined, the client and
contractor were able to work through these issues and come to agreement on
how far

they would take their SIS arrangement. Incentives to Use an SIS

Contract Were Identified

Page 7 GAO- 03- 327 Contract Management Table 2: How Clients and
Contractors Determined Incentives Were Appropriate Client/ contractor How
incentives were determined to be appropriate

MIT/ Alliant Energy Integrated Services/ Cogenex MIT entered into an SIS
contract because it (1) allowed MIT to reduce utility costs

without having to lay out any cash for needed upgrades and (2) provided
that Alliant/ Cogenex compensation be made entirely through sharing a
portion of the savings realized. Alliant/ Cogenex installed and maintained
energy efficient equipment and assumed the risk that enough savings would
be realized to compensate for the up- front costs a incurred and provide a
profit commensurate to the risk undertaken. Alliant/ Cogenex*s confidence
that the SIS contract would be profitable rested on its MIT

energy audit and its experience in providing energy- savings measures in
over 3,200 customer buildings. Those energy- saving measures included the
installation of energy efficient lighting, motors, chillers, boilers,
building automation systems, and air conditioning systems. In the end, MIT
saved $980,000 annually over what it would have paid had the improvements
not been made. Texas Online Authority/ BearingPoint The State of Texas,
through Texas Online, found a vehicle to offer Internet- based services to
its businesses and citizens from state agencies and local governments,

without spending general revenue funds. BearingPoint agreed to provide the
equipment, setup, and ongoing operation of the Web site* including
hardware, software, and staffing* at no cost to the state. In addition,
once operational, Texas Online was designed to be self- supporting through
the use of fees to use the service. BearingPoint determined that it could
recover its investment by 2006 and would achieve the returns that would
reward it for the risks it took in funding the project. The investment
recovery projection was based on (1) the commitment made by the state (see
table 4) and (2) numerous assumptions, including those pertaining to the
continued growth in using the Internet as a medium to acquire government
services. Best Buy/ Accenture Best Buy entered into a gain- sharing
contract with Accenture because, with their

operational losses, Best Buy did not want to risk entering into a typical
fee- for- service contract which could have resulted in paying for a
consultant*s advice that may not have led to improved profits. To reduce
that risk, Best Buy wanted to partner with a consultant committed to
success through the sharing of project risks and benefits by being paid,
at

least in part, for results achieved. Accenture, through its Best Buy
business process study, was confident it could help deliver needed change
in areas such as supplier consolidations, price negotiation strategies,
advertising, inventory levels and in- stock performance, and buyer support
and tools. Further, Accenture convinced Best Buy*s top management that it
had the resources, knowledge, and experience to deliver the needed change.
Finally, Accenture was willing to share risk by reducing its standard
consulting

fee in consideration for receiving 20 percent of the Accenture- caused
earnings growth, up to a contractual cap.

Page 8 GAO- 03- 327 Contract Management Client/ contractor How incentives
were determined to be appropriate Harley- Davidson/ Henkel Chemical
Management Group Harley entered into an SIS agreement with Henkel because
Henkel committed to provide

a cumulative savings of 68 percent over a 5- year period, compared to what
Harley had been spending for the products and services, which Henkel now
provides. After the total savings commitments for the contract term are
achieved, Harley and Henkel will share in Henkel- caused savings on a 50/
50 basis. In addition, to the cost savings, the SIS

agreement allows Harley to concentrate on its own core competency of
manufacturing motorcycles, while simultaneously benefiting by having
Henkel be the single source for chemical management to include products/
services, technical support, and environmental compliance. Henkel*s
confidence that the SIS agreement would be

profitable for them was based on their (1) study of Harley*s chemical
acquisition, usage, and disposal programs; and (2) experience with other
manufacturing clients. Henkel officials said additional incentives include
continued growth in their core competency of chemical management and the
goodwill generated by having Harley- Davidson as a client. Sources: MIT/
Alliant Energy Integrated Services/ Cogenex; Texas Online Authority/
BearingPoint; Best Buy/ Accenture; and HarleyDavidson/ Henkel Chemical
Management Group.

a Alliant/ Cogenex borrowed $8 million to finance the project*s up- front
costs. Because contractor payment was derived directly from savings and/
or revenues generated, the ability to link the financial benefits
generated for the client back to contractor- implemented recommendations
was critical. Accordingly, both the client and the contractor agreed on
(1) a performance baseline to determine the performance the client would
have experienced without contractor intervention and (2) metrics to
measure how contractor- implemented recommendations generate savings and/
or revenue. When required, the baseline took into account market factors
outside of the client and contractor*s control. For example, energy
savings are impacted by weather and energy prices, neither of which a
client or contractor can influence.

We found that it is easier to establish a baseline and performance metrics
in the energy industry than in other industries because it is easy to
measure energy usage, through the use of metering devices. In the
information technology industry, on the other hand, calculating the
baseline can be more complicated. It can be difficult, for example, to
isolate the direct savings from a reduction in the time an employee spends
on a new task that replaces one or more old tasks. Also, the information

necessary to calculate the baseline may simply not be available. A
Baseline and

Performance Metrics Were Established

Page 9 GAO- 03- 327 Contract Management Table 3: How Clients and
Contractors Established a Baseline and Performance Metrics Client/
contractor How a baseline and performance metrics were established

MIT/ Alliant Energy Integrated Services/ Cogenex MIT and Alliant/ Cogenex
agreed that energy reduction would be defined as the difference

between energy consumed prior to Alliant/ Cogenex*s intervention (the
baseline) compared to energy consumed after Alliant/ Cogenex installed
energy efficient equipment. Energy measurement was based on metering,
which is the direct tracking of energy according to engineering protocols.
The advantage of metering is its accuracy. In addition to metering, MIT
and Alliant/ Cogenex agreed to adjust the baseline due to changes

outside of either party*s control, such as unanticipated changes in
operating hours, electrical loads, user participation, equipment
performance, operation, maintenance and repair, and equipment replacement.

Texas Online Authority/ BearingPoint The established and agreed upon
performance measures are based on providing online services in exchange
for fees to use the service. Because this service is new, all transaction
revenue is attributed to the contractor. How contractor- implemented
recommendations generate revenue from a typical user fee transaction
follows. A user inputs information. After user identity is authenticated,
appropriate parties validate electronic charges made either by credit card
or electronic check. The services are fulfilled and payments are
distributed. Of the gross revenues generated, the state receives 10
percent and BearingPoint receives 90 percent, until its initial costs are
recovered. After BearingPoint*s initial costs are recovered, revenue
sharing will be made on an equal 50/ 50 basis.

Best Buy/ Accenture Best Buy and Accenture agreed on a baseline defined as
the 12- month historical performance of net sales, cost of goods sold,
profit margins, and appropriate variable expenses. The historical
performance was adjusted by existing growth/ decline trends and inflation.
For example, if audio had historically experienced an annual sales growth
rate of 8 percent, a then the audio baseline (net sales, cost of goods
sold, profit margins, and

appropriate variable expenses) for the following year would include the 8
percent growth rate. With implemented Accenture recommendations in place,
improvement over that baseline would be attributed to Accenture. After
adjusting for factors outside of Accenture control, such as inflation, a
joint Best Buy/ Accenture team computed benefits on a monthly basis. For
example, because increasing inventory turns increases revenue, Accenture
introduced an optimized in- stock management model to receive merchandise
based on rate- of- sale and out- of- stock risk versus the previous method
of pushing

inventory into stores. Success was measured by the increased in inventory
turns over the established baseline, as determined by the Best Buy/
Accenture team.

Harley- Davidson/ Henkel Chemical Management Group The baseline against
which cost savings are measured is Harley*s 1998 cost of

chemicals, or the last price paid, whichever is higher. The information
sources are paid invoices. For new items, the average of three viable
quotations established the baseline. Henkel cost savings and calculations
are submitted to Harley on a monthly basis, reviewed by a management team
composed of managers from both Harley and Henkel, and approved when a
reduction in the total cost of conducting business can be documented. Cost
savings projects can occur in several areas, such as item/ transaction
cost reduction, product substitution, inventory reduction, waste
reduction/ elimination, and machine wear improvement. Sources: MIT/
Alliant Energy Integrated Services/ Cogenex; Texas Online Authority/
BearingPoint; Best Buy/ Accenture; and HarleyDavidson/ Henkel Chemical
Management Group.

a Data based on information contained in Best Buy*s annual audited
financial statements filed with the Securities and Exchange Commission.

Page 10 GAO- 03- 327 Contract Management Although commitment by management
is necessary for a successful relationship with any contractor, it was
particularly critical with the SIS

contractors. Top managers needed to commit to change the way the company
did business. Moreover, because SIS arrangements can be long- term, top
managers needed to help sustain the business relationship.

In the cases we looked at, managers helped facilitate success through
frequent meetings with their contractors, backing contractor
recommendations, and investing staff with the authority needed to carry

out contractor recommendations.

Table 4: How Client Management Committed to Success Client/ contractor How
client management committed to success MIT/ Alliant Energy Integrated
Services/ Cogenex MIT*s president was committed to energy efficiency and
decided to give control of

executing an energy savings SIS project to Alliant/ Cogenex. MIT was
focused on outcomes and wanted to create an incentive for Alliant/ Cogenex
to develop optimized energy efficient improvements by linking their
compensation to the savings achieved through their work. MIT recognized,
through its commitment to let Alliant/ Cogenex decide project details,
that it was depending on the capabilities and experience of Alliant/
Cogenex for success and believed that Alliant/ Cogenex was in the best
position to execute the project.

Texas Online Authority/ BearingPoint The commitment of Texas Online
Authority management is reflected in state legislation that encourages/
requires online services. One example is Texas Senate Bill 645 (enacted by
the 77th Legislature), which requires 23 occupational licensing

entities to use the common Internet licensing system on Texas Online. In
addition, in January 2002, the State of Texas Web site was merged into
Texas Online, providing *one- stop shopping* for government information
and services. Further, each participating government agency is charged to
inform potential users about Texas Online as a new service channel and to
encourage its use. Best Buy/ Accenture Accenture required, and Best Buy
agreed to, the active participation of its top

management to include the chief executive officer, the chief operating
officer, and the chief financial officer. These officers, with Accenture
support, provided the direction and commitment by reviewing monthly
overall progress in areas such as supplier consolidations, price
negotiation strategies, innovative advertising, optimal inventory levels,
and buyer support. Best Buy top management also empowered their staff to
implement the recommended changes. Best Buy top management agreed to
partner with Accenture because it recognized that implementing Accenture
initiatives would require changing behaviors, standard practices, supplier
performance, and cultural norms. Best Buy also recognized that such
changes are difficult because they can run afoul of existing behaviors,
practices, and procedures.

Client Management Committed to Success

Page 11 GAO- 03- 327 Contract Management Client/ contractor How client
management committed to success Harley- Davidson/ Henkel Chemical

Management Group Management commitment, by both Harley and Henkel, is
manifested in a two- tiered organizational structure to ensure SIS
contract success. The first tier is a steering team managed by Harley*s
Director of Operations for Purchasing and Logistics and the Henkel
Chemical Management Group*s Operations Director. The purpose of the
steering committee, which meets monthly, is to develop an overall
strategy/ business plan to meet operational goals and make financial
commitments, sign contracts, and dedicate appropriate personnel to ensure
success. The second tier is a site team consisting of Harley plant
management and a Henkel site representative. The site team*s role is to
realize the steering team*s operational goals by managing individual
savings efforts. Sources: MIT/ Alliant Energy Integrated Services/
Cogenex; Texas Online Authority/ BearingPoint; Best Buy/ Accenture; and
HarleyDavidson/ Henkel Chemical Management Group.

Officials from companies we contacted, and others knowledgeable about SIS
contracting, noted that other issues could pose challenges to, or promote
SIS use. One issue identified was that SIS contracts could put a strain on
a business relationship when savings or increased revenues are lower than
expected. Further, when contractor- generated savings and revenues are
greater than originally anticipated, some clients may want to re-
negotiate because, they believe, the contract*s sharing agreement turned
out to be inequitable, allowing the contractor to reap too large a
windfall. Also, legal issues can affect the use and structure of SIS
contracts. For example, in the health care industry, due to the potential
conflict of interest between providing high- quality hospital care and
reducing costs, civil monetary penalty and anti- kickback legislation 3
was enacted that restricts the use of SIS arrangements 4 by hospitals and
physicians.

Within the federal government, there may be additional barriers to using
SIS contracting. For example, according to GSA officials, federal agencies
have difficulty in measuring baseline costs. Without a baseline agreed to
by contractor and client, savings cannot be measured, leaving a contractor

in a risky position with no confidence that the savings needed to cover
costs and provide a profit will be realized.

3 Social Security Act, as amended, 42 U. S. C. sec. 1320a- 7b( b)( 1)-(
2). 4 SIS arrangements are referred to as gainsharing arrangements in the
health care industry. Gainsharing arrangements are designed to align
incentives by offering physicians a portion of a hospital*s cost savings
in exchange for implementing cost- saving strategies. Other Issues Can

Impact SIS Opportunities

Page 12 GAO- 03- 327 Contract Management Also, our previous work on
energy- savings SIS contracting, 5 together with our work on this audit,
revealed that DOE headquarters officials believe

such contracts are a viable option only when federal funding is
unavailable. The DOE considers direct appropriations as the first option
to pay for capital energy renewal projects, since all of the savings would
then accrue to the government.

In the contracts we studied, an SIS contract was a highly effective
contracting technique to generate savings and revenues. But to be
successful, clients and their contractors had to be specific, and in
agreement in their goals and objectives, as well as how to achieve them.
Moreover, top management commitment was paramount* not only to provide the
authority needed to carry out solutions, but to help overcome additional
barriers and problems that can arise and to sustain the partnership.
Federal agencies may find it even more difficult to engage in these
arrangements given the lack of good baseline performance data. However, it
may be worthwhile to examine ways to overcome potential problems in order
to achieve the benefits possible through SIS contracting.

In December 2002, we requested comments on a draft of this report from the
Director of OMB. In official oral comments on the report, staff from the
Office of Federal Procurement Policy, an office within OMB, stated that

 The report*s findings will be taken into account in structuring future
policy on the use of share- in- savings contracting, including
implementation of section 210 of the E- Government Act.  Agencies need to
heed the lessons learned by industry to achieve success

with this technique. Namely, there must be thorough and deliberative
planning, as well as management commitment, to identify clear outcomes and
measures that are agreed upon by both parties to a share- in- savings
contract.

5 Energy Conservation: Contractors* Efforts at Federally Owned Sites (GAO/
RCED- 94- 96, Apr. 29, 1994). Conclusions

Agency Comments

Page 13 GAO- 03- 327 Contract Management To find information regarding
commercial sector use of SIS contracting and identify companies that use
or have used SIS contracting, we searched

numerous electronic databases and queried several professional
organizations. Although these queries identified thousands of references,
most were unrelated to the share- in- savings contracting concept.
Excluding the energy industry, we found a limited number of references to
companies or state agencies that use or have used the SIS concept. Because
our focus was on the commercial sector, we contacted companies identified
and asked them about their SIS contracting experiences.

We then developed case studies on four SIS arrangements, which represent
different industries, and were determined to be successful by the SIS
clients and their respective contractors. For each case study presented in
this report, we interviewed the clients and their contractors to obtain
their views on when this type of contracting method is best used, the
risks associated with SIS contracting and how such risks are mitigated,
the importance of developing baselines and performance measures, and other
characteristics that distinguish SIS contracting from traditional
contracting methods.

For information regarding the use of SIS in the federal government, we
used our previous work on SIS contracting, searched government web sites,
including those belonging to the General Services Administration (GSA) and
the Office of Federal Procurement Policy (OFPP), and had discussions with
GSA and OFPP officials.

We conducted our review from November 2001 to January 2003, in accordance
with generally accepted government auditing standards. As agreed with your
offices, unless you announce the contents of this report earlier, we will
not distribute this report until 30 days from its date. At that time, we
will send copies of this report to other interested congressional
committees, the Secretaries of Education and Energy, and the
Administrators of the GSA and OFPP. We will also make copies available to
others upon request. In addition, the report will available at no charge
on the GAO Web site at http:// www. gao. gov. Scope and

Methodology

Page 14 GAO- 03- 327 Contract Management Please contact me at (202) 512-
4125, or Ralph Dawn at (202) 512- 4544, if you have any questions
regarding this report. Major contributors to this

report were Marie Ahearn, Cristina Chaplain, Daniel Hauser, Mary Jo
Lewnard, and Russell Reiter.

David E. Cooper Director Acquisition and Sourcing Management

(120110)

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