Currency Paper Procurement: Additional Analysis Would Help	 
Determine Whether a Second Supplier Is Needed (29-APR-05,	 
GAO-05-368).							 
                                                                 
For over 125 years, the Bureau of Engraving and Printing (BEP),  
within the Department of the Treasury, has relied on a single	 
contractor to supply the paper for U.S. currency. Such a	 
long-term contracting relationship could contribute to higher	 
costs and other risks. Another federal agency that relied on a	 
single contractor, the U.S. Mint, decided to obtain a second	 
supplier for coin metal. In solicitations for currency paper	 
contracts in 1999 and 2003, BEP took steps to address barriers to
competition that GAO had identified in 1998 through a survey of  
paper manufacturers. This report updates GAO's 1998 report using 
data from a second survey. It addresses (1) the changes BEP made 
to encourage competition and the results of its efforts, (2) the 
steps BEP took to ensure that it paid fair and reasonable prices,
and (3) the analysis BEP has done of the advantages and 	 
disadvantages of obtaining a second supplier.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-368 					        
    ACCNO:   A22997						        
  TITLE:     Currency Paper Procurement: Additional Analysis Would    
Help Determine Whether a Second Supplier Is Needed		 
     DATE:   04/29/2005 
  SUBJECT:   Competitive advantage				 
	     Competitive procurement				 
	     Cost analysis					 
	     Currency and coinage				 
	     Federal procurement				 
	     Manufacturing contracts				 
	     Prices and pricing 				 
	     Surveys						 

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GAO-05-368

                 United States Government Accountability Office

                     GAO Report to Congressional Requesters

April 2005

CURRENCY PAPER PROCUREMENT

  Additional Analysis Would Help Determine Whether a Second Supplier Is Needed

                                       a

GAO-05-368

[IMG]

April 2005

CURRENCY PAPER PROCUREMENT

Additional Analysis Would Help Determine Whether a Second Supplier Is Needed

  What GAO Found

To encourage competition for the 1999 and 2003 contracts, BEP modified its
solicitations to, among other things, indicate that it would provide
bidders with the security thread that is inserted into most currency paper
and extend the time for initial deliveries. For the 1999 contract, one
additional supplier submitted an initial proposal but later withdrew it,
and for the 2003 contract, only the current supplier submitted a proposal.
This company remains the sole supplier of U.S. currency paper. According
to paper manufacturers, several barriers to competition remain, including
the high capital costs of and technological requirements for producing
currency paper. BEP said it has not addressed these barriers because the
requirements are either essential to preserve the security of currency
paper or they are outside BEP's control (e.g., anticounterfeiting features
are recommended by a federal committee). While some of the remaining
barriers are outside BEP's control, BEP's outreach to paper manufacturers
has been limited. For example, BEP does not meet regularly with them, as
the Departments of Defense and Homeland Security meet with potential
suppliers of their procurements, to identify additional steps that could
be taken to encourage competition. To the extent that BEP has reached out
to paper manufacturers, it has generally done so in conjunction with other
BEP procurements.

For the contracts awarded in 1999 and 2003, BEP took several steps,
consistent with the Federal Acquisition Regulation's requirements, to
determine that the prices it paid under these contracts were fair and
reasonable. For the 1999 contract, it used price analysis (a comparison of
two proposals) to determine that the two proposals it initially received
were fair and reasonable. This analysis was sufficient because BEP had
determined that adequate price competition existed. For the 2003 contract,
BEP performed several cost analysis activities to ensure that the final
agreed-to price was fair and reasonable, since the current supplier was
the only company that submitted a proposal. For example, BEP obtained
certified cost and pricing data from the current supplier, requested an
audit review of the current supplier's price proposal, and established a
technical analysis team to examine steps in the current supplier's
manufacturing process that affect price. BEP also arranged for postaward
audits of the current supplier.

BEP has not analyzed the advantages and disadvantages of obtaining a
second supplier of currency paper since 1996. At that time, it concluded
that the costs would outweigh the benefits, but it did not analyze the
long-term effects. As a result, it does not know how a second supplier
would affect the costs, quality, security, and supply of currency paper
over time. Analyzing the advantages and disadvantages of obtaining a
second supplier would help BEP determine the need for one.

                 United States Government Accountability Office

Contents

Letter                                                                   1 
                                  Results in Brief                          3 
                                     Background                             5 
          BEP Has Modified Its Solicitations for Currency Paper to Address 
                                   Some Barriers                            6 
             BEP Took Several Steps, Consistent with the FAR, to Determine 
                                                                      Fair 
                      and Reasonable Prices for Currency Paper             11 
             BEP Has Not Recently Analyzed Advantages and Disadvantages of 
                            Obtaining a Second Supplier                    16 
                                    Conclusions                            19 
                        Recommendations for Executive Action               20 
                         Agency Comments and Our Evaluation                20 

Appendixes

                                  Appendix I:

                    Appendix II: Appendix III: Appendix IV:

Summary of GAO's Previous Recommendations and Bureau of Engraving and
Printing's Actions 22

Objectives, Scope and Methodology 23

Comments from the Bureau of Engraving and Printing 25

GAO Contacts and Staff Acknowledgments 28 GAO Contacts 28 Staff
Acknowledgments 28

Figure Figure 1:	Estimated and Actual Currency Paper Orders, Fiscal Years
1999 through 2004

Abbreviations

BEP Bureau of Engraving and Printing DCAA Defense Contract Audit Agency
DOD Department of Defense FAR Federal Acquisition Regulation

This is a work of the U.S. government and is not subject to copyright
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separately.

A

United States Government Accountability Office Washington, D.C. 20548

April 29, 2005

The Honorable Carolyn B. Maloney

Ranking Minority Member

Subcommittee on Domestic and International Monetary Policy, Trade, and
Technology Committee on Financial Services House of Representatives

The Honorable Peter T. King House of Representatives

For over 125 years, the U.S. government has relied on one contractor to
supply virtually all of the paper for U.S. currency. The Bureau of
Engraving and Printing (BEP), which is responsible for printing U.S.
currency, is currently under a 4-year contract with this supplier and,
according to BEP data, is paying about $115 million a year for currency
paper. Although BEP has historically received a steady, timely supply of
paper that meets its requirements from its current supplier, having one
supplier for currency paper raises a number of concerns. Among these
concerns are (1) the lack of competition for the currency paper contract,
(2) the fairness and reasonableness of price, and (3) the adequacy of the
currency paper supply in the event of an attack or other disruption of the
currency supply.

These concerns, combined with the importance of U.S. currency to domestic
and international commerce, have led to reviews of this unique situation.
For example, in a 1996 report, the Department of the Treasury and BEP
concluded that competition was not immediately feasible because the
current supplier was the only domestic source that could supply currency
paper that met BEP's requirements. At the request of Congress, in 1998 we
also completed a review and reported that the optimum situation for the
procurement of currency paper would include an active, competitive market
with several responsible bidders.1 However, this situation did not exist
because, according to paper manufacturers we surveyed, there were several
barriers to competition. These barriers included the large initial capital
investment required to produce currency paper and a legislative provision
generally precluding foreign-owned companies from competing for the
contract. We also reported that BEP

1GAO, Currency Paper Procurement: Meaningful Competition Unlikely Under
Current Conditions, GAO/GGD-98-181 (Washington, D.C.: Aug. 28, 1998).

could not determine a "fair and reasonable" price for some of its paper
contracts-a requirement in negotiating a federal contract that involves
the judgment of the contracting officer based on various defined
techniques and established procedures for analyzing proposed prices. To
help BEP improve its contract oversight and increase competition, we made
several recommendations, most of which BEP has implemented. (See app. I.)

In 1998 we reported that a number of BEP's actions to encourage
competition were too new for us to assess their impact. Since that time,
BEP has entered into two additional contracts, in 1999 and in 2003, and
has taken further steps to encourage competition. BEP is now scheduled to
award another currency paper contract in the fall of 2006. Moreover, the
U.S. Mint (the Mint), which is responsible for producing coins, has now
had over a decade of experience with having a second supplier for coin
metal after having had a single supplier for decades. Given these
developments, you asked us to update our 1998 report. To do so, we
determined

o 	the changes BEP made to encourage competition for the 1999 and 2003
currency paper contracts and the results of its efforts,

o 	the steps BEP took to determine that the prices it paid for currency
paper under these contracts were fair and reasonable, and

o 	the extent to which BEP has analyzed the advantages and disadvantages
of obtaining a second supplier for currency paper.

To determine the changes BEP made to encourage competition for the 1999
and 2003 currency paper contracts and the results of its efforts, we
reviewed the changes that BEP made to its solicitations and contracts. We
also conducted a survey of domestic and foreign paper manufacturers, using
a questionnaire similar to the one we used for our 1998 report. Of the 15
manufacturers we identified as having the potential to compete for the
currency paper contract, 14 responded to our survey, and 8 of these said
they were interested in providing currency paper to BEP. The remaining 6
manufacturers told us that they were not interested in competing for the
currency paper contract. We reviewed economic literature to identify
barriers to competition for the currency paper market, and we reviewed
applicable procurement laws and regulations to identify requirements
affecting the procurement of currency paper. Among these are the Conte
Amendment, a statute that requires that paper for U.S. currency be
manufactured in the United States, and another statute that limits the
procurement of distinctive currency paper to 4-year contracts. To

determine the steps BEP took to determine that the prices it paid for
currency paper under these contracts were fair and reasonable, we reviewed
the Federal Acquisition Regulation (FAR) and compared its requirements
with the steps BEP took. Finally, to determine the potential advantages
and disadvantages of obtaining a second supplier for currency paper, we
reviewed economic literature as well as interviewed former and current
officials from BEP and the U.S. Mint about their efforts to develop a
second supplier. We performed our work in Washington, D.C., from August
2004 through April 2005 in accordance with generally accepted government
auditing standards. Details of our objectives, scope, and methodology are
in appendix II.

Results in Brief	To encourage competition for the 1999 and 2003 contracts,
BEP made a number of changes to its contract solicitations to address some
of the barriers that paper manufacturers we surveyed had identified. For
example, BEP modified the solicitations to indicate that it would provide
the security thread that is inserted into most currency paper to other
successful bidders as government-furnished property rather than requiring
them to obtain the thread themselves. In addition, BEP increased the
mobilization period-the time between the contract award and the start of
deliveries to BEP-to 24 months. This period had previously been limited to
60 days. In response to the solicitation for the 1999 contract, one
additional supplier submitted an initial proposal, but later withdrew it,
and for the 2003 contract, only the current supplier submitted a proposal.
This company remains the sole supplier of U.S. currency paper today.
Although BEP addressed a number of barriers, several other barriers, such
as the high costs and the technological difficulties of producing currency
paper, still exist, according to paper manufacturers we surveyed for this
report. According to BEP, it has not addressed these barriers because they
are due to requirements that are outside its control or they are essential
to preserve the quality and security of currency paper. For example, the
anticounterfeiting features in currency paper are recommended by the
Advanced Counterfeit Deterrence Steering Committee, which consists of
members from BEP, the U.S. Secret Service, the Federal Reserve System, and
the Department of the Treasury. We agree with BEP that some of the
remaining barriers are outside its control; however, we found that BEP's
outreach to paper manufacturers is limited and is generally done in
conjunction with its other procurements. For example, BEP does not conduct
industry briefings for potential suppliers. We found that the Departments
of Defense and Homeland Security hold industry briefings as frequently as
possible to provide potential contractors with information

and an opportunity to comment on future solicitations and procurements.
Before BEP issues solicitations for currency paper contracts in the
future, we recommend that the Secretary of the Treasury direct the
Director of BEP to increase outreach activities with paper manufacturers
to allow them to provide their views on the barriers to competition,
suggest what steps BEP should take to address these barriers, and comment
on future solicitations.

For the contracts awarded in 1999 and 2003, BEP took several steps
consistent with the FAR's requirements to determine that the prices it
paid under these contracts were fair and reasonable. Since BEP initially
received two proposals for the 1999 contract, it used price analysis-a
comparison of the two proposals-to determine that the prices were fair and
reasonable. This analysis was sufficient because BEP determined that
adequate price competition existed. For the 2003 contract, BEP performed
several cost analysis activities to ensure that the final agreed-to price
was fair and reasonable, since the current supplier was the only company
that submitted a proposal. For example, BEP obtained certified cost and
pricing data from the current supplier, requested an audit review of the
current supplier's price proposal, and established a technical analysis
team to examine steps in the current supplier's manufacturing process that
affect price. BEP also arranged for a postaward audit of the current
supplier, as we recommended in 1998, to ensure that the price negotiated
for the contract was based on adequate data. In 1998, we reported that BEP
had engaged in two procurement practices that could contribute to a
higherthan-necessary price for currency paper. For example, BEP did not
obtain royalty-free data rights to, or fund the development of, the
security thread used in currency paper. Consequently, under the current
4-year contract, BEP is paying about $650,000 in royalties related to
obtaining the security thread. Although royalty payments are an allowable
expense under FAR, according to the current supplier, these payments will
end in December 2006. In addition, to prevent this situation from
recurring, BEP plans to purchase royalty-free data rights to new
anticounterfeiting features that it obtains in the future from any sources
for a cost to be determined. Such an arrangement could enable BEP to use
the technology at its discretion, including allowing currency paper
contractors to use the technology without having to pay royalty fees.

Although BEP has stated that it favors competition for currency paper and
has taken some steps to encourage competition, it has not recently
analyzed the advantages and disadvantages of obtaining a second supplier,
including the impact on the cost, security, quality, and adequacy of the

supply of currency paper. In its August 1996 currency paper report, BEP
concluded that competition was not immediately feasible because the
current supplier was the only domestic source that could furnish currency
paper that met BEP's requirements. Moreover, BEP estimated that it would
pay an additional $21 million to $37 million per year for currency paper
if it purchased the paper from more than one supplier, primarily because
the new supplier would have high capital costs. However, BEP's 1996 report
did not analyze the long-term advantages and disadvantages of obtaining a
second supplier. Such an analysis would help BEP determine if obtaining a
second supplier would be cost effective over the long term, decide whether
the benefits of obtaining a second supplier outweigh the potential
security and quality concerns associated with a second supplier, and
ensure that BEP can maintain an adequate supply of currency paper. We are
recommending that the Secretary of the Treasury direct the Director of BEP
to determine if there is a need to obtain a second supplier for currency
paper by preparing an analysis of the advantages and disadvantages of a
second supplier, including the impact on the cost, security, quality, and
adequacy of the supply of currency paper. If the analysis determines that
there is a need to obtain a second supplier, the Secretary should then
determine what steps are necessary to obtain a second supplier for
currency paper. We provided BEP, the Mint, and the Federal Reserve Board
with draft copies of this report for their review and comment. They agreed
with the draft report's findings and provided some technical comments
which we incorporated where appropriate. BEP also agreed with our
recommendations and described its plans to implement them. See appendix
III for BEP's comments.

Background	BEP, a bureau of the Department of the Treasury, buys currency
paper from a private company and prints the nation's currency at
production facilities in Washington, D.C., and Fort Worth, Texas.
According to BEP data, the currency paper contract amounts to about $115
million per year. Currency paper is a highly specialized product that
includes cotton and linen fibers as well as anticounterfeiting features to
enhance the quality and security of the paper. Several agencies affect the
production of currency paper. The Department of the Treasury oversees
BEP's production of currency, including its procurement of currency paper.
The U.S. Secret Service, now within the Department of Homeland Security,
is responsible for anticounterfeiting activities and works with BEP in
assessing the security of BEP's money production facilities and currency
redesign. The Federal Reserve Board sets monetary policy for the nation,
obtains new currency from BEP, and issues the new currency to the public
through depository

institutions. The Advanced Counterfeit Deterrence Steering Committee,
which includes members from BEP, the Department of the Treasury, the U.S.
Secret Service, and the Federal Reserve System recommends to the Secretary
of the Treasury the anticounterfeiting features to be placed in U.S.
currency. If the Secretary of the Treasury accepts these recommendations,
they become part of the specifications or requirements for the currency
paper.

The procurement of currency paper is subject to an appropriations
limitation, called the Conte Amendment, enacted in December 1987.2 In
effect, the Conte Amendment requires that distinctive paper for U.S.
currency and passports be manufactured in the United States. The amendment
further prohibits the purchase of currency and passport paper from a
supplier owned or controlled by a foreign entity unless the Secretary of
the Treasury determines that no domestic source exists. The procurement of
currency paper is also subject to another statutory limitation that
prohibits the Secretary of the Treasury from entering into a contract in
excess of 4 years for manufacturing distinctive currency paper.3

BEP Has Modified Its Solicitations for Currency Paper to Address Some
Barriers

BEP changed the solicitations for the 1999 and 2003 currency paper
contracts and intends to include these changes in the solicitation for the
next contract, which will be awarded in 2006. Some of the changes
addressed barriers we reported in 1998. These changes included the
following:

o 	Switching to a 4-year contract. Previously, BEP negotiated a 1-year
contract with three 1-year options, which meant that manufacturers were
not assured that they would receive the contract from one year to the
next. According to BEP officials, a 4-year contract creates less risk for
manufacturers because the contractor is almost guaranteed to receive the
contract for 4 years when the government no longer has the option to renew
the contract each year.

o 	Allowing multiple awards. Previously, BEP required any bidder to bid on
the entire currency paper contract. BEP divided its total currency paper
requirements into several different lots and allowed companies to

231 U.S.C. S: 5114 note. 331 U.S.C. S: 5114.

select the parts of the solicitation they would bid on. For example, a
company could choose to bid only on the paper for the $1 and $2 bills.
Thus, the contract could be awarded to two companies. Potential suppliers
told BEP that, in order to begin production, they would need a long-term
commitment for at least 40 percent of the contract.

o 	Allowing a 24-month mobilization period. Previously, the mobilization
period-the time between the contract award date and the date for starting
deliveries to BEP-was no more than 60 days. In 1998 some paper
manufacturers told us that the start-up period historically allowed by BEP
was not long enough for companies that are not currently manufacturing
currency paper.

o 	Allowing representative rather than identical samples. Previously,
companies had to produce samples during the bidding process using the same
machines they would use to produce currency paper if they received the
contract. BEP required these samples, which are called identical samples,
so that it could determine whether the companies were capable of
manufacturing paper that met its specifications. BEP now allows for
representative samples during the bidding process. Representative samples
are manufactured on equipment that is similar to what the company would
use if it were awarded the contract. Allowing representative samples
enables companies that do not currently own the required equipment to
produce paper samples on another company's equipment and avoid purchasing
costly equipment until they have been awarded the contract. Domestic paper
companies, for example, could use the equipment of European paper
companies to produce representative samples and then acquire the
appropriate equipment if they were awarded the contract.

o 	Agreeing to consider innovative financing and acquisition arrangements.
Previously, solicitations did not provide any help to companies that would
have had to make a considerable financial investment to purchase the
equipment needed to compete for the contract. To facilitate such an
investment, the 1999 and 2003 solicitations stated that BEP would
"consider innovative financing and acquisition arrangements" proposed by a
potential supplier, but the solicitations did not specify what these
arrangements might be. BEP officials told us that these arrangements could
include having the government pay for some capital equipment if the
contractor repaid the government at the end of the contract. However, two
of eight paper manufacturers who said they were interested in competing
for the

contract told us that the lack of financial assistance continues to make
it difficult for them to compete for the contract.

o 	Furnishing the security thread. Previously, BEP expected potential
paper manufacturers to obtain the security thread used in currency paper
on their own, which some paper manufacturers cited as a barrier because
the sole manufacturer of the security thread is a subsidiary of the
current supplier. As a result, potential manufacturers would have had to
purchase the thread and make royalty payments to that company. BEP
modified the solicitations for the 1999 and 2003 contracts to indicate
that it would provide the security thread that is inserted into most
currency paper to other successful bidders as governmentfurnished property
rather than requiring them to obtain the thread themselves.

BEP awarded the first contracts with these changes in fiscal years 1999
and 2003. According to documents in BEP's contract files, one company in
addition to the current supplier submitted a proposal for the 1999
contract, but ultimately withdrew because, according to this company, it
was unwilling to continue to expend the resources required to produce
fully compliant paper samples without a contract. Four other companies
expressed interest in the 1999 contract, but did not submit proposals. One
company said it did not submit a proposal because it determined that the
estimated capital expenditures exceeded any potential profit that might be
realized over the 4-year contract period. Another company that had
expressed interest in the contract said it did not submit a proposal
because it was unable to obtain a commitment for the large capital
investment required. Additionally, the company said the contract's
provision for ordering a wide range of paper quantities made it difficult
to calculate a return on investment. A third interested company did not
submit a proposal because of durability requirements for the currency
paper. A fourth interested company did not give a reason for not
submitting a proposal. For the 2003 contract, the current supplier was the
only company to submit a proposal. Three paper companies other than the
current supplier asked to receive the solicitation, but these companies
took no further action. The next solicitation for the currency paper
contract is expected to be issued in the fall of 2005, and the contract is
scheduled to be awarded in 2006. This solicitation will include all the
changes that BEP previously made, according to BEP officials.

BEP Has Not Addressed All Barriers

Despite the changes BEP made to the contract solicitation, paper
manufacturers we surveyed in 2004 told us that significant barriers to
competition remain.4 Specifically, the eight paper manufacturers we
surveyed who said they would be interested in providing currency paper to
BEP told us that the following barriers, which we reported in 1998, still
exist:

o 	Security requirements for the manufacturing facility. Three of the
eight manufacturers told us that implementing these security
requirements-which include ensuring that all waste is accounted for,
controlling access to sensitive production areas in the paper mill, and
erecting physical barriers around the mill-make it difficult for them to
compete for the currency paper contract because of the high costs to
upgrade their facilities.

o 	Technology required to incorporate anticounterfeiting features. Three
of the eight manufacturers told us that the cost of the equipment and the
technical expertise necessary to insert the security thread into currency
paper make it difficult for them to compete for the currency paper
contract.

o 	Requirement for U.S. ownership. Three manufacturers told us that this
legislative restriction, known as the Conte Amendment, continues to be a
barrier because it mandates that the company that produces U.S. currency
paper be domestically owned-that is, at least 90 percent U.S.owned,
according to the Department of the Treasury.

o 	Lack of financial assistance for capital investment. Although BEP has
indicated that it will consider innovative financing proposals from a
potential supplier, two of the eight manufacturers told us that the lack
of financial assistance for capital investment continues to make it
difficult for them to compete for the contract. According to BEP, under
the FAR, it can make advance payments to manufacturers for capital
investment

4In the economics literature, these barriers to competition are referred
to as "barriers to entry." Barriers to entry include conditions or
circumstances that make it very difficult or unacceptably costly for
outside firms to enter a particular market and compete with established
firms. Entry barriers generally listed in the economics literature include
economies of scale, product differentiation, and capital requirements.
Barriers to entry are important in a market because they can ultimately
determine how much market power, or influence over price, established
firms have in the market.

only if the manufacturer pays the money back to BEP, with interest, during
the life of the contract.

o 	Length of contract. One of the eight manufacturers, who said it plans
to submit a proposal for the 2006 contract, told us that the length of the
contract, which is restricted by statute to 4 years, makes it difficult to
compete for the currency paper contract. This manufacturer said that, to
make a profit during this contract, it would need a 5-year contract and at
least 40 percent of the contract.

According to BEP, these five barriers continue to exist because they
either are outside of BEP's control or are essential components of
producing currency paper. For example, the restriction against foreign
ownership and the length of the currency paper contract are both
legislative provisions that would require congressional action to change.
In addition, U.S. Secret Service officials told us that there are
tremendous benefits to producing U.S. currency paper inside the United
States because, according to the Secret Service, it does not have the
authority to oversee the security of personnel or plant facilities in a
foreign country. The Secret Service further stated that, although it may
be able to make agreements allowing for such oversight, it can be
difficult to take quick, decisive action in a foreign country. The Secret
Service also pointed out that the logistics of moving currency paper
across great distances and borders would pose additional security risks.
However, Secret Service officials indicated that, in their view, foreign
ownership would not pose a security problem as long as the paper was
produced in the United States and the employees who produced the paper had
undergone background checks. BEP officials also believe that providing
financial assistance for capital investment is outside of their control
because, as previously mentioned, under the FAR, BEP can make advance
payments to manufacturers for capital investment only if the manufacturer
pays the money back to BEP, with interest, during the life of the
contract.

Two of the barriers to competition that paper manufacturers identified are
within BEP's control, but these barriers-the security requirements for the
manufacturing facility and the technology required to insert
anticounterfeiting features, such as the security thread-remain because
they are essential for currency paper. Officials from BEP, the Federal
Reserve Board, and the Secret Service noted that currency paper is a
valuable asset that must be guarded and protected from counterfeiting.
Potential security features for U.S. currency are reviewed by the Advanced
Counterfeit Deterrence Steering Committee, which is made up of

representatives from BEP, the Department of the Treasury, the Federal
Reserve System, and the U.S. Secret Service. This committee recommends
which security features should be in U.S. currency, and the Secretary of
the Treasury decides which features to incorporate. These security
features require that manufacturers of currency paper use advanced
technology to insert anticounterfeiting features into paper. Furthermore,
to ensure the security of the paper and of the anticounterfeiting
features, manufacturing facilities must have greater physical security
than paper mills generally.

We agree with BEP that some of the remaining barriers are outside its
control; however, we found that BEP's outreach to paper manufacturers is
limited and is generally done in conjunction with its other procurements.
For example, BEP does not conduct industry briefings for its potential
suppliers. We found that the Departments of Defense and Homeland Security
hold industry briefings as frequently as possible to provide potential
contractors with information and an opportunity to comment on future
solicitations and procurements. BEP's outreach to potential paper
manufacturers generally consists of publishing its draft currency paper
solicitation in Federal Business Opportunities and waiting for the paper
manufacturers to contact them.5 One paper manufacturer we surveyed
commented that it was unaware of the solicitation for the 2003 contract.
In commenting on a draft of this report, BEP stated that, in addition to
the outreach efforts we describe, it is pursuing other outreach efforts.
For example, BEP stated that it attends fairs and banknote conferences
where potential suppliers are consulted to determine if their company has
an interest in contracting with BEP for various currency materials,
primarily currency paper, inks, and counterfeit deterrent features.

BEP Took Several Steps, Consistent with the FAR, to Determine Fair and
Reasonable Prices for Currency Paper

The FAR states that an agency's contracting officer is responsible for
evaluating the reasonableness of the offered prices to ensure that the
final price is fair and reasonable. The FAR does not define "fair and
reasonable," but establishes various techniques and procedures for a
contracting officer to use in evaluating prices. Furthermore, the contract
pricing reference guidance available from the Department of Defense (DOD)
discusses the application of these requirements. For a price to be fair to
the buyer, it must be in line with either the fair market value of the
product or the total allowable cost of providing the product that would be
incurred by a well

5Federal Business Opportunities is a government Web site designed to
publicize procurements over $25,000.

managed, responsible firm using reasonably efficient and economical
methods of performance, plus a reasonable profit. To be fair to the
seller, a price must be realistic in terms of the seller's ability to
satisfy the terms and conditions of the contract. A reasonable price,
according to the DOD guidance, is a price that a prudent and competent
buyer would be willing to pay, given available data on market conditions,
such as supply and demand, general economic conditions, and competition.
For the currency paper contract, there is currently only one buyer and one
seller, domestically. As a result, pricing is established through
negotiation.

The FAR further states that the contracting officer may use any of several
analysis techniques to ensure that the final price is fair and reasonable.
The techniques the officer uses depends on whether adequate price
competition exists. For the 1999 contract, BEP determined that adequate
price competition existed because of the expectation that at least one
additional meaningful proposal would be submitted. Consequently, BEP used
price analysis-a comparison of the two proposals-as a basis for
determining that the 1999 contract prices, which totaled $207 million,
were fair and reasonable. BEP also compared the proposed prices with an
independent government cost estimate, which BEP prepared for the contract.

For the 2003 contract, BEP determined that adequate price competition did
not exist because, although several companies requested copies of the
solicitation, only the current supplier submitted a proposal. Under such
circumstances, the FAR requires agencies to use one or more of several
proposal analysis techniques to ensure that the final price is fair and
reasonable. BEP took the following steps to determine its prenegotiation
pricing objective:

o 	Obtaining certified cost data from the current supplier, as required by
FAR 15.403-4.

o 	Requesting that the Defense Contract Audit Agency (DCAA) audit the
current supplier's price proposal. DCAA found that the current supplier's
proposal was acceptable as a basis for negotiating a fair and reasonable
price. To perform its audit, DCAA used the applicable requirements
contained in the FAR, the Treasury's Acquisition Procurement Regulations,
and the Cost Accounting Standards. BEP officials said they also
independently reviewed and assessed the current supplier's proposed costs
and did not rely solely on DCAA's findings.

o 	Establishing a technical analysis team to examine various aspects of
the current supplier's manufacturing process that affect price. The
technical analysis concentrated on production yield factors, paper machine
speeds and capacity, and labor requirements, among other things. According
to BEP, these areas have a major impact on cost and are an essential part
of a cost analysis.

o 	Performing a price analysis using comparison with previous contract
prices for currency paper to verify that the overall price offered was
fair and reasonable.

In 1998, we recommended that BEP arrange for postaward audits of the
current supplier's costs and ensure that the supplier maintains acceptable
cost accounting and estimating systems for future contracts. The purpose
of a postaward audit is to determine if the price, including the profit,
negotiated for the contract was increased by a significant amount because
the contractor furnished cost or pricing data that were not accurate,
complete, or current. For the 1999 contract, a postaward audit was not
required because the supplier was not required to submit cost or pricing
data. Following the award of the 2003 contract, BEP requested that DCAA
perform a postaward audit of the current supplier. DCAA found that the
current supplier's certified cost or pricing data were accurate, complete,
and current. DCAA also performed a postaward audit of the subcontractor
that provides the security thread for U.S. currency and found that the
subcontractor's data were accurate, complete, and current. Finally, DCAA
reviewed the current supplier's estimating system and found it to be
adequate to provide estimated costs that are reasonable, compliant with
applicable laws and regulations, and subject to applicable financial
control systems.6

BEP Has Taken Some Action to Address Uneconomical Contracting Practices
Identified in 1998

In 1998 we reported that two BEP procurement practices contributed, or
could contribute, to higher-than-necessary currency paper costs. These
practices included not obtaining royalty-free data rights for the security
thread used in currency paper and ordering inconsistent quantities of
paper. We found that BEP continues to make royalty payments for the use

6In addition, for the 2003 contract, BEP included a standard FAR clause on
defective cost or pricing data, which would provide the government with a
refund if it were later determined that the current supplier submitted
inaccurate, incomplete, or out-of-date cost or pricing data and that these
data resulted in a higher price to the government.

of the security thread and will have to do so until December 2006. We also
found that BEP continues to have difficulty in accurately estimating the
amount of paper it will require, but inconsistent order sizes have not yet
adversely affected the prices it pays.

We previously reported that a subsidiary of the current supplier holds
patents for manufacturing the security thread used to deter
counterfeiting. This thread is inserted into all U.S. currency
denominations greater than $2. According to a BEP official, the current
supplier approached BEP with the idea for the security thread in the
mid-1980s, and BEP encouraged this company to develop the thread, but BEP
neither entered into a research and development contract to help fund the
effort, nor did it attempt to negotiate rights to that technology or
technical data, according to another BEP official. Because the government
did not obtain royalty-free data rights to, or fund the development of the
security thread, it does not have any rights to the associated technical
data and must pay for any use of the thread. The price BEP currently pays
for currency paper includes the cost of royalty payments, which are
generally allowable under the FAR. For the 2003 contract, these payments
totaled $663,000 over 4 years. According to the current supplier, these
royalty payments will end in December 2006. As a result, beginning with
the next currency paper contract-which BEP expects to award at the end of
2006-BEP will not have to pay royalties for the use of the current
security thread or negotiate a license to provide the thread to a second
supplier. In addition, to avoid a recurrence of this situation, BEP plans
to purchase, for an undetermined price, royalty-free rights to any new
anticounterfeiting features that it obtains in the future from any
sources. Properly written, such an agreement could enable BEP to
incorporate new technology at its discretion and allow currency paper
contractors to use that technology in manufacturing paper to meet the
government's requirements. In addition, BEP included a special provision
in the 2003 currency paper contract stating that BEP will not incorporate
any new anticounterfeiting feature into U.S. currency paper unless it has
negotiated an exclusive license to the feature.

We also reported in 1998 that BEP actually ordered more paper than it
estimated during some years.7 As a result, BEP paid a higher unit cost for
the paper, because the price was based on the estimated amount, and
therefore the contractor's fixed costs were spread over fewer units than
BEP purchased. If BEP had accurately estimated the quantity of paper it
ordered, the contractor's fixed costs would have been spread over more
units, resulting in a lower per-unit price. We recommended that BEP ensure
that its paper estimates more closely reflect the expected amounts needed.
BEP responded that its estimates are based on the best available estimate
from the Federal Reserve Board.

Since 1999, BEP's currency paper orders have remained inconsistent, but
this inconsistency has not yet adversely affected BEP's prices.
Specifically, for 4 of the last 6 years, BEP's orders were at or below the
estimates the contractor used in setting its price, and therefore the
orders should not have resulted in a higher price for currency paper. (See
fig. 1.) However, in fiscal years 2003 and 2004, BEP's actual orders were
considerably higher than the minimum quantities estimated in the contract.
In fiscal year 2003, the minimum quantity was 151 million sheets, and BEP
ordered almost 280 million sheets; and in fiscal year 2004, the minimum
quantity was 203 million sheets, and BEP ordered 296 million sheets.
Although BEP's order amounts exceeded the minimum quantities, the price
BEP paid for currency paper was not adversely affected because of the
pricing approach used by the contractor in the current contract.8

7For every currency paper contract, BEP provides minimum and maximum order
quantities, which the contractor uses in setting prices. Because currency
paper manufacturing has high fixed costs, a higher quantity of paper
equates to a lower unit cost because the fixed costs can be spread over
more units.

8We are not disclosing the contractor's pricing approach because it has
been designated as source selection information.

Figure 1: Estimated and Actual Currency Paper Orders, Fiscal Years 1999
through 2004

Number of sheets in millions

                                      400

                                      350

                                      300

                                      250

                                      200

                                      150

                                      100

                    50 0 1999 2000 2001 2002 2003 2004 Year

Estimated quantity Actual quantity ordered

                       Source: GAO analysis of BEP data.

BEP Has Not Recently Analyzed Advantages and Disadvantages of Obtaining a
Second Supplier

In its August 1996 currency paper report, BEP concluded that competition
was not immediately feasible because the current supplier was the only
domestic source that could supply currency paper that met BEP's
requirements. In addition, BEP estimated that it would pay $21 million to
$37 million more per year for currency paper if it purchased paper from
more than one supplier. These increased costs would result from, among
other things, high capital equipment costs for a new supplier, according
to BEP. BEP also made several recommendations, including that it continue
to improve its relationship with the current supplier by working to
resolve problems before they arise; continue to try to identify
alternative sources for currency paper, and if a viable source of currency
paper is identified, analyze the costs and economic feasibility of having
two sources; and review the possible catastrophic occurrences that could
interrupt currency paper supplies, and if necessary, increase the
inventory of currency paper to mitigate the effects of such an occurrence.
Analyzing the advantages and

disadvantages of obtaining a second supplier would help BEP determine if a
second supplier would be cost effective over the long term, weigh the
benefits of obtaining a second supplier against the potential security and
quality concerns associated with a second supplier, and ensure that BEP
can maintain an adequate supply of currency paper.

Obtaining a second supplier could have advantages. Economic literature
shows that a key advantage of obtaining a second supplier is that it can
generate competition, which helps to ensure that the buyer receives the
best price possible. In general, with more competition, each individual
firm has less control over the final price in the market. In contrast, a
single supplier has the potential to restrict output and set market prices
above competitive levels. In addition, some economic studies have found
that the entry of additional firms into a market lowers prices.9 An
additional advantage of obtaining a second supplier is that new entrants
can stimulate innovation in certain markets, whereas some researchers have
found that a single supplier may not be particularly innovative.10 Another
key advantage of obtaining a second supplier could be greater assurance of
a steady supply of currency paper. With more than one supplier and more
than one production site, the buyer would have greater assurance of a
steady supply of goods even if one site were disrupted by, for example, a
strike, natural disaster, bankruptcy, or terrorist attack. This would be
an important advantage for BEP, because currency paper is essential to
U.S. and world commerce, and an adequate supply must be assured. Some
actions have already been taken to avoid these potential problems. To
mitigate a disruption to the currency paper supply, the current supplier
says it could produce currency paper at two separate locations. In
addition, BEP keeps about a 3-month supply of currency paper in reserve.

Obtaining a second supplier could also have disadvantages. First, even
though it could create competition, it might not lower prices initially
because each new supplier would have expensive start-up costs (such as the
capital costs of specialized paper-making equipment) and would therefore
need to charge a high price for currency paper. Second, the risk

9Timothy F. Bresnahan and Peter C. Reiss, "Entry and Competition in
Concentrated Markets," The Journal of Political Economy, vol. 99, no. 5
(October 1991), 977-1009. Diana

L. Strassman, "Potential Competition in the Deregulated Airlines," The
Review of Economics and Statistics, vol. 72, no. 4 (November 1990),
696-702.

10P.A. Geroski, "Innovation, Technological Opportunity, and Market
Structure," Oxford Economic Papers, New Series, vol. 42, no. 3 (July
1990), 586-602.

of changes in product quality and design would increase with more than one
supplier in more than one location. For instance, according to a physicist
who specializes in paper production, two companies, given the same
specifications, could produce paper of consistent strength, but would have
much more difficulty adjusting for the texture of the paper, and slight
differences could exist within the same specifications. Even slight
changes can adversely affect a buyer such as BEP, which requires adherence
to very specific technical standards. Federal Reserve Board officials told
us that they are concerned that minor differences in the quality of
currency paper could diminish the reputation of U.S. currency. Secret
Service officials, who are responsible for protecting U.S. currency from
counterfeiting, said they would need to be assured that a second supplier
had proved that it could produce paper of consistent quality over a period
of time because even slight variations between the papers produced by the
two manufacturers could hamper their anticounterfeiting efforts and lower
confidence in U.S. currency. Finally, increasing the number of suppliers,
production locations, or both would increase the potential for security
breaches because more people would know about the classified
anticounterfeiting features incorporated in currency paper, and more sites
could be vulnerable to intrusion. Federal Reserve Board officials, who are
responsible for issuing U.S. currency, maintained that awarding the
contract to several different suppliers could compromise the secrecy of
the paper's anticounterfeiting features because more people would have
access to and could potentially disclose information about them.

Finding itself relying on a single supplier in the early 1990s for the
clad metal it uses to make coins, the U.S. Mint weighed the advantages and
disadvantages of obtaining a second supplier and decided that the
advantages outweighed the disadvantages. To obtain a second supplier, the
Mint worked closely with a new company and allowed it to begin producing a
small amount of material. Initially, the Mint's second supplier had some
difficulty producing a product of consistent quality, and the unit costs
of the material were higher than the original supplier's unit costs
because the second supplier was producing smaller quantities. But as the
quality of the material improved, the company began to increase its
production for the Mint, and it now produces 55 percent of the metal that
the Mint uses to make coins. According to Mint officials, the use of a
second supplier enabled the Mint to maintain a steady supply of material
when the demand for coins spiked in 1999 and 2000 (because coins were
collected for the new millennium) and when each supplier experienced labor
strikes. Mint officials also told us that they believe that obtaining a
second supplier for clad material initially increased the Mint's costs,
but they were not able to

quantify the amount of the increase. Nonetheless, according to Mint
officials, the price for clad metal has decreased since the Mint began
using a second supplier. In commenting on a draft of this report, the
Federal Reserve Board noted that, regardless of price issues, the issues
of security and quality are not the same for clad metal and currency
paper.

Conclusions	Obtaining effective competition for the currency paper
contract continues to be a challenge for BEP, despite the changes it has
made and plans to continue making to its contract solicitations. Barriers
to competition remain, and the current supplier continues to be the sole
supplier of currency paper. We agree with BEP that some of the remaining
barriers are outside its control or are essential for security purposes,
and we recognize that the current supplier has generally provided BEP with
a steady, timely supply of paper that has met its requirements for the
past 125 years. However, we believe the uniqueness of the currency paper
procurement and the disadvantages of having a single supplier are
sufficient to warrant a regular effort on BEP's part to reach out to paper
manufacturers before issuing solicitations to help BEP determine what
additional steps should be taken to encourage competition for the currency
paper contract.

Although BEP concluded in its August 1996 currency paper study that
competition was not immediately feasible because the current supplier was
the only domestic source of currency paper that could meet its
requirements, BEP has not weighed the advantages and disadvantages of
obtaining a second supplier-including the impact on the cost, security,
quality, and adequacy of the currency paper supply-since 1996.
Consequently, while BEP can demonstrate that it is receiving a fair and
reasonable price for currency paper, it is unclear if that price is higher
or lower than the price BEP would pay if there were a second supplier. But
cost is not the only factor in deciding whether or not to use a second
supplier. The security and integrity of the paper, and of U.S. currency,
are also important. A second supplier must be able to demonstrate that it
can produce paper that contains the same security features and technical
specifications as the current paper. Slight changes to the quality and
makeup of currency paper have the potential to hamper anticounterfeiting
efforts and could result in an overall loss of confidence in U.S.
currency. Analyzing the advantages and disadvantages of obtaining a second
supplier would help BEP assess whether a second supplier of currency paper
is needed to ensure an adequate supply of quality currency paper at a fair
and reasonable price.

Recommendations for Executive Action

To obtain the views of paper manufacturers on barriers to competition and
to determine if there is a need for a second supplier of currency paper,
we are recommending that the Secretary of the Treasury direct the Director
of BEP to take the following two actions:

o 	Before issuing solicitations for currency paper contracts in the
future, increase outreach activities with paper manufacturers to allow
them to provide their views on the barriers to competition, identify the
steps BEP should take to address these barriers, and comment on the
solicitations.

o 	Determine if there is a need to obtain a second supplier for currency
paper by preparing an analysis of the advantages and disadvantages of
obtaining a second supplier of currency paper, including the impact on the
cost, security, quality, and adequacy of the currency paper supply. If the
analysis determines that there is a need to obtain a second supplier, the
Secretary should then determine what steps are necessary to obtain a
second supplier for currency paper.

Agency Comments and Our Evaluation

We provided the BEP, the Mint, and the Federal Reserve Board with drafts
of this report for their review and comment. These agencies generally
agreed with our findings and provided technical comments, which we
incorporated as appropriate. In written comments, BEP commented that our
draft report does not recognize all of its outreach efforts to paper
manufacturers and that the royalty payments associated with purchasing
currency paper are an allowable expense under FAR. We incorporated this
additional information in our report as appropriate. BEP also agreed with
our recommendations and described its plans to implement them. BEP's
comments are provided in appendix III.

We are sending copies of this report to the cognizant congressional
committees; the Chairman of the Board of Governors of the Federal Reserve
System; the Secretary of the Treasury; the Directors of BEP and the Mint;
the Director, Office of Management and Budget; and other interested
parties. We will also make copies available to others upon request. In
addition, the report will be available at no charge on the GAO Web site at
http://www.gao.gov.

If you or your staff have any questions about this report, please contact
me at [email protected] or Tammy Conquest at [email protected].
Alternatively, I can be reached at (202) 512-2834. Major contributors to
this report are listed in appendix IV.

Katherine A. Siggerud Director, Physical Infrastructure Issues

Appendix I

Summary of GAO's Previous Recommendations and Bureau of Engraving and
Printing's Actions

                      GAO's recommendations BEP's actions

Ensure that the current supplier maintains acceptable As appropriate, the
Bureau of Engraving and Printing (BEP) has the Defense
cost accounting and estimating systems for future Contract Audit Agency
(DCAA) perform audits.
contracts and that they are periodically audited.

Arrange for postaward audits of the current supplier's When required, BEP
has DCAA conduct postaward audits of the current costs. contractor's
costs.

Include data and analyses in the currency paper When required, BEP plans
to comply with the FAR.
procurement record that demonstrate the benefits the
government is to receive when it approves profit levels
that are aimed at recognizing or providing an incentive
for capital investments.

To the extent possible, make more extensive use of BEP stated that a
comparison of the price of U.S. currency paper with the price
price analysis to determine the fairness and of foreign currency paper or
money order and passport paper would not be a
reasonableness of prices, including the collection of valid comparison
because of technical differences.
data from foreign countries on their currency prices
and data on similar supplies purchased by other
agencies, such as paper for passports and money
orders.

Ensure that all future currency paper procurements BEP bases the amount of
paper needed on the best available estimate provided
reflect the expected amounts of paper needed and by the Federal Reserve
System.
that orders against contracts are for consistent
amounts.

Ensure that the government obtains royalty-free data BEP plans to obtain
royalty-free data rights to all future security measures that it
rights to any future security measures incorporated incorporates into
currency paper.
into currency paper.

                                  Source: GAO.

Appendix II

                       Objectives, Scope and Methodology

To determine the steps the Bureau of Engraving and Printing (BEP) took to
encourage competition for the 1999 and 2003 currency paper contracts, we
interviewed BEP officials and reviewed the changes BEP made to the
contract solicitations. To determine the results of these efforts, we
reviewed the solicitations for the 1999 and 2003 contracts and sent a
questionnaire to 15 domestic and foreign manufacturers of cotton-based
security paper to determine the factors that have made it difficult for
them to compete for the currency paper contract. We used a questionnaire
that was similar to the questionnaire used for our 1998 report, allowing
us to compare responses for the two time periods. Our survey universe
consisted of manufacturers we had surveyed for our 1998 report,
manufacturers identified by the American Forest and Paper Association,
manufacturers identified by BEP as having expressed interest in the
currency paper contract, and the current supplier. We received responses
from 14 of the 15 manufacturers and made several attempts to obtain a
response from the one manufacturer who did not respond to our survey. We
also performed structured telephone interviews with all 14 manufacturers
to clarify their survey responses. Our primary variable for analysis was
interest in providing currency paper to BEP. We considered the eight
manufacturers who responded that they were "very interested" or "somewhat
interested" in providing currency paper to BEP as our most important group
for the purposes of this study because they have a stated interest in
supplying paper to BEP. We reviewed economics literature and interviewed
several academic experts to determine the relevant barriers to
competition. Finally, we analyzed the Conte Amendment, the statute
limiting the procurement of distinctive currency paper to a 4-year
contract, and other applicable procurement laws and regulations to
identify requirements affecting the procurement of currency paper.

To determine the steps BEP took to determine that the prices it paid for
currency paper under the 1999 and 2003 contracts were fair and reasonable,
we reviewed documents in BEP's contract files for the 1999 and 2003
contracts. We reviewed the process BEP must follow to determine fair and
reasonable pricing. We reviewed the prenegotiation memorandums and
negotiation summaries from the contract files and interviewed BEP
procurement officials to determine what cost and price analysis activities
BEP undertook to establish a fair and reasonable price. We then compared
these actions with the requirements for cost and price analysis techniques
under FAR part 15.404-1. We also obtained and reviewed audits of the
current supplier that BEP requested from the Defense Contract Audit Agency
and that have been issued since 1998.

Appendix II Objectives, Scope and Methodology

To determine the extent to which BEP has analyzed the advantages and
disadvantages of obtaining a second supplier for currency paper, we
reviewed BEP's most recent currency paper study, which was issued in 1996.
We also interviewed several industry analysts and academic experts, and
reviewed relevant economics literature. Although economic research on
competition in government contracting is abundant, it has never been
applied to the currency paper market. Therefore, we reviewed economic
studies of other markets to determine the advantages and disadvantages of
obtaining a second supplier. We also interviewed officials from BEP, the
U.S. Secret Service, and the Federal Reserve System to obtain their views
on the implications of obtaining multiple suppliers for currency paper. To
gain additional perspective on the potential effects of obtaining a second
supplier for currency paper, we interviewed former and current officials
from the U.S. Mint about their experiences with a second supplier. The
Mint was not able to provide us with financial data to demonstrate whether
the price it paid for clad material changed after it began using a second
supplier.

We performed our work in Washington, D.C., from August 2004 through April
2005 in accordance with generally accepted government auditing standards.

Appendix III

Comments from the Bureau of Engraving and Printing

Appendix III Comments from the Bureau of Engraving and Printing Appendix
III Comments from the Bureau of Engraving and Printing

Appendix IV

                     GAO Contacts and Staff Acknowledgments

GAO Contacts	Katherine Siggerud, (202) 512-2834 or [email protected] Tammy
Conquest, (202) 512-5234 or [email protected]

Staff 	In addition to the individuals named above, Robert Ackley, Tim
DiNapoli, Elizabeth Eisenstadt, Barbara El Osta, Heather Halliwell, Susan
Michal-

Acknowledgments	Smith, Terry Richardson, and John W. Shumann made key
contributions to this report.

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