Use of Legislative Incentive for Performance-Based Contracting	 
Unknown (22-MAY-03, GAO-03-674R).				 
                                                                 
The Department of Defense (DOD) spent about $93 billion in fiscal
year 2002 to acquire various types of services, such as base	 
operations, logistical support, and information technology. To	 
achieve greater cost savings and better outcomes when agencies	 
acquire these and other services, Congress and the executive	 
branch have encouraged greater use of performance-based 	 
contracting. Performance-based contracts specify the desired	 
outcomes and allow the contractors to determine how best to	 
achieve those outcomes, rather than prescribe the methods	 
contractors should use. In October 2000, Congress sought to	 
provide an incentive for the use of performance-based contracts  
through legislation giving DOD temporary authority to treat	 
certain performance-based service contracts as contracts for	 
commercial items. Contracts for commercial items may be awarded  
using streamlined procedures under Part 12 of the Federal	 
Acquisition Regulation (FAR). This authority is scheduled to	 
expire in October 2003. As required by the October 2000 	 
legislation, we reviewed DOD's implementation of the temporary	 
authority, including the interim and final implementing 	 
regulations, public comments on the interim regulation, and other
DOD documents. We also discussed with DOD officials the extent to
which the authority had been used. We conducted our review from  
September 2002 through February 2003 in accordance with generally
accepted government auditing standards. 			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-674R					        
    ACCNO:   A06969						        
  TITLE:     Use of Legislative Incentive for Performance-Based       
Contracting Unknown						 
     DATE:   05/22/2003 
  SUBJECT:   Service contracts					 
	     Defense cost control				 
	     Defense procurement				 
	     Procurement policy 				 
	     Procurement practices				 

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GAO-03-674R

GAO- 03- 674R Contract Management Page 1

United States General Accounting Office Washington, DC 20548

May 22, 2003 Congressional Committees Subject: Use of Legislative
Incentive for Performance- Based Contracting Unknown The Department of
Defense (DOD) spent about $93 billion in fiscal year 2002 to

acquire various types of services, such as base operations, logistical
support, and information technology. To achieve greater cost savings and
better outcomes when agencies acquire these and other services, Congress
and the executive branch have encouraged greater use of performance- based
contracting. Performance- based contracts specify the desired outcomes and
allow the contractors to determine how best to achieve those outcomes,
rather than prescribe the methods contractors should use.

In October 2000, Congress sought to provide an incentive for the use of
performancebased contracts through legislation 1 giving DOD temporary
authority to treat certain performance- based service contracts as
contracts for commercial items. 2 Contracts for commercial items may be
awarded using streamlined procedures under Part 12 of the Federal
Acquisition Regulation (FAR). This authority is scheduled to expire in
October 2003.

As required by the October 2000 legislation, we reviewed DOD*s
implementation of the temporary authority, including the interim and final
implementing regulations, public comments on the interim regulation, and
other DOD documents. We also discussed with DOD officials the extent to
which the authority had been used. We conducted our review from September
2002 through February 2003 in accordance with generally accepted
government auditing standards.

Results in Brief

DOD issued regulations to implement the legislative authority, but because
there is no tracking mechanism, DOD does not know the extent to which the
authority has been

1 Section 821( b) of the Defense Authorization Act for Fiscal Year 2001,
Pub. L. 106- 398, Oct. 30, 2000. 2 The term *commercial item* is defined
as any item that is of a type customarily used for nongovernmental
purposes that has been sold, leased, or licensed or offered for sale,
lease, or license to the general public. 41 U. S. C. 403 (12). With
respect to services, the statute includes *services

offered and sold competitively, in substantial quantities, in the
commercial marketplace based on established catalog or market prices for
specific tasks performed and under standard commercial terms and
conditions.* Id.

GAO- 03- 674R Contract Management Page 2 used. DOD officials believe,
however, that use of the authority has been limited, at

best. Although a January 2002 DOD policy memorandum indicated that
additional guidance on reporting use of the authority would be
forthcoming, no additional guidance has been issued to date.

Background

In October 2000, Congress passed section 821( b) of the National Defense
Authorization Act for Fiscal Year 2001, which allows DOD to treat
performance- based service contracts or task orders as contracts for the
procurement of commercial items under specified conditions. The conditions
are that the contract or task order must: (1) be valued at $5 million or
less; (2) define the work in measurable, missionrelated terms; (3)
identify a specific end product or output; (4) contain a firm, fixed
price; and (4) be awarded to a contractor that provides similar services
to the general public under terms and conditions similar to those offered
to the federal government. 3 The use of performance- based contracts to
acquire services offers a number of

potential benefits. Performance- based contracts can encourage contractors
to be innovative and to find cost- effective ways of delivering services.
By shifting the focus from process to results, they hold the promise of
better outcomes and reduced costs. In view of the potential benefits,
Congress has been encouraging greater use of performance- based
contracting, and the administration has set a general goal that 20 percent
of eligible service contracts should be performance based. 4 DOD has a
goal that 50 percent of its service contracts will be performance based by
2005.

Congress and the administration also have been encouraging agencies to
acquire commercial items to the maximum extent practicable to satisfy
agency needs for goods and services. The objectives are to reduce the
government*s reliance on government specifications and to take advantage
of technical innovations available in the commercial marketplace. Special
rules designed to facilitate the acquisition of commercial items are
contained in Part 12 of the FAR. These rules permit greater flexibility in
negotiating contract terms and conditions. In addition, certain enumerated
laws do not apply to commercial item acquisitions, such as the requirement
that the contractor submit cost or pricing data. In general, to be
acquired using the commercial item procedures of FAR Part 12, services
must be of a type that are sold competitively in substantial quantities in
the commercial marketplace based on established catalog or market prices
for specific tasks performed. Under the authority of section 821( b), a
service could be acquired as a commercial item even though it would not
otherwise meet the commercial item definition.

3 In addition, the legislation provided that special simplified procedures
previously authorized for acquiring commercial items valued up to $5
million would not apply to acquisitions of services deemed to be
commercial items under section 821( b). 4 For additional information, see
Contract Management: Guidance Needed for Using PerformanceBased Service
Contracting, GAO- 02- 1049 (Washington, D. C. Sept. 23, 2002).

GAO- 03- 674R Contract Management Page 3

DOD Issued Regulations to Implement Section 821

On December 6, 2001, DOD issued an interim rule amending the Defense
Federal Acquisition Regulation Supplement to implement section 821( b).
The rule listed the legislative conditions for use of the new authority,
as well as additional conditions that apply generally to the use of
performance- based contracts. For example, the rule required the use of
quality assurance surveillance plans. Although there is no mention of
these plans in section 821( b), other sections of the FAR require them
whenever performance- based service contracting is used.

DOD also requested comments on the interim rule and received four sets of
comments from various sources. In some cases DOD agreed with the points
raised and revised the final rule. Other comments dealt with conditions
imposed by the legislation. For example, one comment pointed out that the
requirement that a contract under the section 821( b) authority be with an
entity that provides similar services to the general public precludes use
of the authority to contract with an entity whose only business activity
consists of contracts with the government under section 8( a) of the Small
Business Act or other federal preference programs. DOD agreed with this
conclusion, but noted that the requirement was contained in the
legislation and could not be changed through regulation. DOD published the
final rule in the

Federal Register on October 25, 2002.

DOD Does Not Know the Extent to Which Section 821( b) Has Been Used

Department of Defense officials are not aware of the extent to which the
new authority contained in section 821( b) has been used to acquire
services because DOD does not have a reporting system to track the use of
this authority. At our request, however, DOD officials asked each of the
military services to query some of their buying commands about possible
instances of the use of section 821( b) authority. Officials from each of
the services confirmed that data on the possible use of this authority are
not collected. In addition, Air Force and Navy officials told us that they
were unaware of instances in which contracting personnel used the
authority. Army officials, however, said they believed a minimal number of
contracting personnel in the Army had used the authority to treat certain
services as commercial items, such as plumbing and electrical motor repair
services. Army officials were unable to identify the specific contracts on
which the authority had been used.

DOD officials suggested two possible explanations for why the authority
provided by section 821( b) may have seen little, if any, use. First, the
officials cited a perception among some contracting personnel that the
section provided no new authority. In fact, in our discussions with some
DOD personnel it was apparent that they believed section 821( b) could
only be used to acquire services that already met the definition of
commercial item. As indicated by DOD, however, the implementing regulation
*provides additional authority for use of FAR Part 12 to acquire services
that do not meet the definition of commercial item.* 5 Second, numerous
DOD officials cited the

requirement for a firm, fixed- price contract as an impediment to use of
the authority. In this regard, the existing regulatory definition of
commercial item expressly excludes services sold in the commercial
marketplace at hourly rates without an

5 67 Fed. Reg. 65, 512 at 65, 513 (Oct. 25, 2002). (Emphasis in original.)

GAO- 03- 674R Contract Management Page 4 established catalog or market
price for a specific service performed. Although

services priced on an hourly basis-- and thus by definition not considered
to be commercial items-- might be good candidates for use of the new
authority, the requirement of section 821( b) for a fixed- price contract
reportedly made the authority less attractive.

In January 2002, the Under Secretary of Defense, Acquisition and
Technology issued a policy memorandum reemphasizing the department*s
commitment to performancebased contracting and highlighting the temporary
authority provided in section 821( b). The memorandum said it was
*important that we thoroughly test this

authority during the pilot period to demonstrate its value.* In addition,
the memorandum said that DOD would provide additional direction on the
reporting requirements applicable to the pilot authority. To date, DOD has
not provided any additional direction. According to one DOD official, a
reporting system would have been an unnecessary burden on contracting
personnel because they anticipated only limited use of the temporary
authority.

We requested comments from DOD on a draft of this report. On May 16, 2003,
a representative of the Office of the Director of Defense Procurement and
Acquisition Policy stated that the draft report was technically accurate
and that no other comments were needed.

- - - - - - We are sending copies of this report to the Secretary of
Defense; Director, Office of Management and Budget; and interested
congressional committees. We will also make copies available to others on
request. In addition, this report will be available at no charge on the
GAO Web site at http:// www. gao. gov.

If there are any questions concerning this report, please call me at
(202)- 512- 8214. The major contributors to this report were Odi Cuero,
Chris Galvin, Gary Middleton, and Ralph White.

William T. Woods Director Acquisition and Sourcing Management

GAO- 03- 674R Contract Management Page 5

List of Congressional Committees

The Honorable John Warner Chairman Committee on Armed Services United
States Senate

The Honorable Carl Levin Ranking Minority Member Committee on Armed
Services United States Senate

The Honorable Ted Stevens Chairman Subcommittee on Defense Committee on
Appropriations United States Senate

The Honorable Daniel Inouye Ranking Minority Member Subcommittee on
Defense Committee on Appropriations Unites States Senate

The Honorable John Ensign Chairman Subcommittee on Readiness & Management
Support Committee on Armed Services

United States Senate The Honorable Daniel Akaka Ranking Minority Member
Subcommittee on Readiness & Management Support Committee on Armed Services

United States Senate The Honorable Duncan Hunter Chairman Committee on
Armed Services House of Representatives

The Honorable Ike Skelton Ranking Minority Member Committee on Armed
Services House of Representatives

GAO- 03- 674R Contract Management Page 6 The Honorable Jerry Lewis

Chairman Subcommittee on Defense Committee on Appropriations House of
Representatives

The Honorable John Murtha Ranking Minority Member Subcommittee on Defense
Committee on Appropriations House of Representatives

The Honorable Joel Hefley Chairman Subcommittee on Readiness Committee on
Armed Services House of Representatives

The Honorable Solomon Ortiz Ranking Minority Member Subcommittee on
Readiness Committee on Armed Services House of Representatives

(120171)

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