Defense Contracting: Improved Insight and Controls Needed over	 
DOD's Time-and-Materials Contracts (29-JUN-07, GAO-07-273).	 
                                                                 
Under time-and-materials contracts, payments to contractors are  
made based on the number of labor hours billed at hourly rates	 
and, if applicable, other direct costs. Because of the risk they 
pose to the government, their use is supposed to be limited to	 
cases where no other contract type is suitable. GAO was asked to 
identify trends in the Department of Defense's (DOD) obligations 
under time-and-materials contracts; analyze what DOD is buying	 
under these contracts; assess why DOD is using them and whether  
actions are being taken to ensure that they are used only when no
other contract type is suitable; evaluate DOD's monitoring of	 
contractor performance; and determine the differences between the
labor rates prime contractors bill DOD and the rates in their	 
subcontracts. GAO reviewed 82 time-and-materials contracts,	 
agreements, and orders and examined prime contract and		 
subcontract labor rates on 12 additional contracts or agreements.
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-273 					        
    ACCNO:   A71708						        
  TITLE:     Defense Contracting: Improved Insight and Controls Needed
over DOD's Time-and-Materials Contracts 			 
     DATE:   06/29/2007 
  SUBJECT:   Contract administration				 
	     Contract oversight 				 
	     Contract performance				 
	     Contractor payments				 
	     Cost analysis					 
	     Data integrity					 
	     Defense procurement				 
	     Department of Defense contractors			 
	     Federal procurement policy 			 
	     Federal regulations				 
	     Policy evaluation					 
	     Procurement planning				 
	     Requirements definition				 
	     Risk assessment					 
	     Service contracts					 
	     Subcontractors					 
	     Time and materials contracts			 
	     Task orders					 

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GAO-07-273

   

     * [1]Results in Brief
     * [2]Background
     * [3]Overall Trend in Time-and-Materials Obligations Is Incomplet
     * [4]Most of DOD's Time-and-Materials Obligations Are for Three C
     * [5]DOD Frequently Did Not Justify Why Time-and-Materials Contra

          * [6]Lack of Firm Requirements, Funding Uncertainties, and Pressu
          * [7]Contracts and Orders Lacked Justifications or Rationale Show
          * [8]Little Attempt to Change Contract Type for Follow-on Efforts
          * [9]New Rules Implementing Provisions in Services Acquisition Re

     * [10]Contractor Performance Monitoring Often Did Not Reflect Inhe
     * [11]DOD Is Paying More Than Actual Costs for Subcontracted Labor

          * [12]Prime Contract Labor Rates Were Usually Higher Than Subcontr
          * [13]Defense Contract Audit Agency Identified Additional Profits
          * [14]Debate Has Surrounded How Primes Should Be Reimbursed for Su

     * [15]Conclusions
     * [16]Recommendations
     * [17]Agency Comments and Our Evaluation
     * [18]GAO Contact
     * [19]Acknowledgments
     * [20]GAO's Mission
     * [21]Obtaining Copies of GAO Reports and Testimony

          * [22]Order by Mail or Phone

     * [23]To Report Fraud, Waste, and Abuse in Federal Programs
     * [24]Congressional Relations
     * [25]Public Affairs

Report to the Committee on Armed Services, U.S. Senate

United States Government Accountability Office

GAO

June 2007

DEFENSE CONTRACTING

Improved Insight and Controls Needed over DOD's Time-and-Materials
Contracts

GAO-07-273

Contents

Letter 1

Results in Brief 3
Background 6
Overall Trend in Time-and-Materials Obligations Is Incomplete Because of
Missing Data 10
Most of DOD's Time-and-Materials Obligations Are for Three Categories of
Services 13
DOD Frequently Did Not Justify Why Time-and-Materials Contracts Needed but
Used Them for Ease and Flexibility 16
Contractor Performance Monitoring Often Did Not Reflect Inherent Risks of
Time-and-Materials Contract Type 26
DOD Is Paying More Than Actual Costs for Subcontracted Labor on Some
Contracts 28
Conclusions 36
Recommendations 36
Agency Comments and Our Evaluation 37
Appendix I Scope and Methodology 39
Appendix II Comments from the Department of Defense 45
Appendix III GAO Contact and Staff Acknowledgments 49

Tables

Table 1: Categories of Services Acquired Most Using Time-and-Materials
Contracts, Fiscal Year 2005 14
Table 2: Reported Time-and-Materials Obligations by Contract/Order Type
for Service Acquisitions, Fiscal Year 2005 14
Table 3: Contract Types Used for Largest Dollar Value Contracts in Our
Sample 17
Table 4: Selected Examples of Differences in Labor Rates between Prime
Contracts and Subcontracts 33
Table 5: Governmentwide Provisions and Those in DOD's Interim Rule
Regarding Billing for Subcontracted Labor under Time-and-Materials
Contracts 35
Table 6: Characteristics of GAO's Sample of 28 Contracts, Agreements, and
Orders 41

Figures

Figure 1: Contract Types 7
Figure 2: DOD Reported Obligations against Service Contracts 11
Figure 3: Percentage of DOD Reported Obligations, Sorted by Contract Type,
for Service Acquisitions, Fiscal Years 1996 through 2005 12
Figure 4: Percentage Differences between Prime Contract and Subcontract
Labor Rates for 628 Labor Categories on 13 Contracts or Agreements 30
Figure 5: Range of Percentage Differences between Prime Contract and
Subcontract Labor Rates for 628 Labor Categories in 24 Orders 32

Abbreviations

COR Contracting Officer's Representative
DCAA Defense Contract Audit Agency
DCMA Defense Contract Management Agency
DFARS Defense Federal Acquisition Regulation Supplement
DFAS Defense Finance and Accounting Service
DIA Defense Intelligence Agency
DISA Defense Information System Agency
DOD Department of Defense
FAR Federal Acquisition Regulation
FASA Federal Acquisition Streamlining Act of 1994
GSA General Services Administration
NIH National Institutes of Health

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separately.

United States Government Accountability Office
Washington, DC 20548

June 29, 2007

The Honorable Carl Levin
Chairman
The Honorable John McCain
Ranking Member
Committee on Armed Services
United States Senate

The Department of Defense (DOD) uses time-and-materials and labor-hour
contracts to acquire billions of dollars in services annually. Under these
contracts, payments to contractors are based on the number of labor hours
billed at a fixed hourly rate--which includes wages, overhead, general and
administrative expenses, and profit--and the cost of materials if
applicable. Services acquired under time-and-materials and labor-hour
contracts span a breadth of activities--from administrative support and
intelligence analysis to the installation of data and communications
networks and maintenance of multimillion-dollar DOD weapon systems. These
services can be provided by a single individual from a company or by
companies utilizing scores of subcontractors. Time-and-materials and
labor-hour contracts are considered high risk for the government because
they provide no positive profit incentive to the contractor for cost
control or labor efficiency. A contractor operating under a
time-and-materials contract could conceivably work less efficiently so
that more hours could be charged to the government. Thus, the onus is on
the government to prevent wasteful spending by monitoring contractor
performance to ensure that the contractor is efficiently performing the
work and effectively controlling costs. Even with appropriate monitoring,
however, the government is not fully protected because contracting
officers may not reduce payments for hours actually worked when, in their
opinion, the work was performed inefficiently. Finally, federal
regulations require contracting officers to justify in writing that no
other contract type is suitable before using a time-and-materials
contract. The Department of Defense (DOD) uses time-and-materials and
labor-hour contracts to acquire billions of dollars in services annually.
Under these contracts, payments to contractors are based on the number of
labor hours billed at a fixed hourly rate--which includes wages, overhead,
general and administrative expenses, and profit--and the cost of materials
if applicable. Services acquired under time-and-materials and labor-hour
contracts span a breadth of activities--from administrative support and
intelligence analysis to the installation of data and communications
networks and maintenance of multimillion-dollar DOD weapon systems. These
services can be provided by a single individual from a company or by
companies utilizing scores of subcontractors. Time-and-materials and
labor-hour contracts are considered high risk for the government because
they provide no positive profit incentive to the contractor for cost
control or labor efficiency. A contractor operating under a
time-and-materials contract could conceivably work less efficiently so
that more hours could be charged to the government. Thus, the onus is on
the government to prevent wasteful spending by monitoring contractor
performance to ensure that the contractor is efficiently performing the
work and effectively controlling costs. Even with appropriate monitoring,
however, the government is not fully protected because contracting
officers may not reduce payments for hours actually worked when, in their
opinion, the work was performed inefficiently. Finally, federal
regulations require contracting officers to justify in writing that no
other contract type is suitable before using a time-and-materials
contract.

At your request, we reviewed DOD's use of time-and-materials contracts.
Specifically, we (1) identified the overall trends in DOD obligations
under time-and-materials and labor-hour contracts; (2) analyzed what DOD
is buying under these contracts; (3) assessed the factors contributing to
the department's use of time-and-materials and labor-hour contracts and
whether actions are being taken to ensure that they are only used when no
other contract type is suitable; (4) evaluated DOD's monitoring of At your
request, we reviewed DOD's use of time-and-materials contracts.
Specifically, we (1) identified the overall trends in DOD obligations
under time-and-materials and labor-hour contracts; (2) analyzed what DOD
is buying under these contracts; (3) assessed the factors contributing to
the department's use of time-and-materials and labor-hour contracts and
whether actions are being taken to ensure that they are only used when no
other contract type is suitable; (4) evaluated DOD's monitoring of
contractor performance; and (5) for selected contracts, determined the
differences between the labor rates prime contractors charged DOD and the
labor rates in their subcontracts. In this report, we use the term
"time-and-materials contract" to refer to both time-and-materials and
labor-hour contracts and agreements, ^1 unless otherwise noted.

To identify trends in the use of time-and-materials contracts, we analyzed
data on all obligations for fiscal years 1996 through 2005 from DOD's
procurement information system--the DD350 database. The 2005 data was the
most recent available when we performed our analysis. During the course of
our review, we discovered a potentially significant underreporting of
time-and-materials contracts in this database. To address this limitation,
we developed a methodology to estimate the magnitude of the gap. The other
key DD350 contract information that we used to select our contracts for
review was present in the contract files we examined. The system's
information, except for the time-and-materials coding issue, was deemed
sufficiently reliable for our purposes. We also used DD350 data to analyze
what types of services DOD is buying under time-and-materials contracts.
To obtain more detailed information on services procured under specific
contracts, to assess the factors contributing to DOD's use of this
contract type, and to evaluate DOD's monitoring of contractor performance,
we conducted an in-depth review of 28 time-and-materials contracts,
agreements, and orders from among those identified in DOD's database as
active in fiscal years 2004 and/or 2005. Twenty of the 28 were DOD
contracts and the remaining 8 were under other agencies' contracts. None
were coded as commercial acquisitions, but DD350 data for three of the
non-DOD contracts did not indicate whether they were commercial or
non-commercial acquisitions. We made our selection taking into account
dollar value, military organization, location of the buying activity, and
type of contract. For contracts or agreements that allowed DOD to place
individual orders for services (such as the General Services
Administration's (GSA) federal supply schedules or multiple award
schedules),^2 we also selected time-and-materials orders for review. In
many cases, these contracts also permitted orders to be issued using
contract types other than time-and-materials. In all, we reviewed a total
of 82 contracts, agreements, and orders. For each, we reviewed the
contract file and collected documentation related to the choice of
contract type and monitoring of contractor performance. We interviewed the
contracting officer and the individual responsible for the monitoring.
Although our sample size did not allow us to develop statistical estimates
that would enable us to project our results to the entire universe of
DOD's time-and-materials contracts, we identified recurring issues related
to DOD's use and management of time-and-materials contracts, regardless of
the contract dollar value or buying activity.

^1 Agreements include blanket purchase agreements and basic ordering
agreements.

^2 Under the GSA schedules program, GSA establishes long-term
governmentwide contracts with commercial firms, and agencies place orders
under these contracts.

To determine the differences between the rates prime contractors charged
the government for subcontracted labor and their own prime contract rates,
we selected, in addition to 1 blanket purchase agreement from our sample
of 28 contracts, agreements, and orders that permitted this billing
practice, an additional 12 (6 blanket purchase agreements and 6 large
service contracts) for further review. In all, we analyzed 24 orders and
628 associated labor rates under these 13 contracts and agreements. We
reviewed contract clauses, contractor proposals, subcontracts, and other
documents related to the contracts and contacted prime contractor
representatives to obtain more information on the subcontract labor rates.
We also examined Defense Contract Audit Agency (DCAA) audit reports issued
between December 2004 and November 2006 that are related to DOD's use of
this billing practice.

Appendix I contains additional details on our scope and methodology. We
conducted our review between February 2006 and May 2007 in accordance with
generally accepted government auditing standards.

Results in Brief

DOD's reported obligations under time-and-materials contracts have nearly
doubled, from almost $5 billion in fiscal year 1996 to about $10 billion
in 2005. This increase was at a somewhat greater rate than the overall
rise in DOD's spending on services. But the dollar amount is understated
because the reported dollars did not include DOD's time-and-materials
orders placed under federal schedules, such as GSA's schedules program.
Because DOD spends billions of dollars a year on schedule orders, the
unreported time-and-materials dollars are likely to be substantial. The
data were not available because defense acquisition instructions and
procedures, starting in 1997, directed officials not to specify contract
type--such as time-and-materials--for schedule orders in DOD's procurement
information system. The accuracy of reported time-and-materials dollars
should be improved starting in fiscal year 2007, because that is when DOD
transitioned to the federal government's procurement information system,
under which users are required to code contract type for schedule orders.

Over 75 percent of DOD's time-and-materials obligations, as reported in
DOD's procurement information system, are concentrated in three service
categories: professional, administrative, and management support services;
information technology and communications; and maintenance, repair, and
rebuilding of equipment. Our reviews of contract files and discussions
with DOD officials showed that DOD is also using time-and-materials
contracts to acquire contract services to supplement the government
workforce. Examples included subject matter experts in the intelligence
field, systems engineering support, and advisory and assistance services.
The workforce increasingly reflects a "blend" of government and contractor
personnel. Government personnel are finding themselves working
side-by-side with contractors, often performing similar roles.

Contracting and program officials frequently failed to ensure that
time-and-materials contracts were only used when no other contract type
was suitable. According to DOD officials, the main reasons
time-and-materials contracts are used are the speed with which contracts
can be awarded and the flexibility they provide in adjusting labor hours
or labor categories in light of changing priorities, unclear requirements,
or funding uncertainties. Most of the written determinations we examined
did not include a rationale showing why another contract type could not be
used instead. For some task orders, no determination had been prepared
when required by ordering guidance for the underlying contract. Further,
with a few exceptions--such as a Navy contract for aircraft upgrades that
changed from time-and-materials to fixed-price once sufficient knowledge
about costs was attained--we found that little effort had been made to
convert follow-on work to a less risky contract type when historical
pricing data existed, despite guidance to do so. In February 2007, federal
acquisition regulation revisions implementing the new provisions in the
Services Acquisition Reform Act of 2003 pertaining to the use of
time-and-materials contracts for commercial acquisitions went into effect.
The revisions require more stringent justifications for the use of
time-and-materials contracts, including a requirement to justify their use
at the task order level, but most of the changes apply only to commercial
acquisitions.

Even though time-and-materials contracts call for appropriate government
monitoring of contractor performance, we found inconsistencies in the
rigor with which the monitoring occurred. Most of the contracts and orders
we reviewed did not include documented plans for monitoring, as required.
Such plans are intended to assist program officials and contracting
officers' representatives in knowing what contractor activities they
should be monitoring and how they should monitor them. In general,
contracting officers' representatives performed their monitoring based on
information that contractors provided about the status of ongoing work and
"burn rates," or how quickly the money was being spent. In a few instances
though, we found plans and reporting requirements, designated performance
monitors, or evidence that program officials had actively monitored
spending in labor categories. Some contracting officers obtained
timesheets along with billing submissions, providing program managers with
the necessary information to closely monitor labor hours according to
specific labor categories.

DOD time-and-materials contracts typically allow prime contractors to bill
DOD in one of four ways for subcontracted labor, one of which involves the
prime charging the government for subcontract labor at the prime contract
labor rate. According to DCAA, this practice can result in the prime
contractor earning additional profit. Indeed, our analysis of billing
rates under 13 contracts showed that when the contract allowed the prime
to charge its own hourly rates for subcontracted labor, the differences
between the prime contract rates and those in subcontracts ranged from
negative 40 percent to 192 percent, with most in the 6 to 53 percent
range. In addition, DCAA has questioned costs pertaining to subcontractor
billing. In one case, DCAA found a prime contractor billed DOD for
subcontracted labor at rates that ranged from 20 to 95 percent higher than
the rates the primes paid their subcontractors. An interim rule to DOD's
acquisition regulations supplement effective in February 2007 requires the
prime contractor to propose separate labor rates for itself and its
subcontractors for non-commercial, competitively awarded acquisitions
under time-and-materials contracts, but--like new federal acquisition
regulation provisions that apply governmentwide--does not require separate
rates for commercial acquisitions.

We are recommending that the Secretary of Defense direct the Director of
Defense Procurement and Acquisition Policy to require a similar level of
justification for use of time-and-materials for non-commercial services as
is now required for commercial acquisitions. We are also recommending that
DOD analyze the use of time-and-materials orders under indefinite-quantity
contracts to ensure that it does not become the default contract type when
other types of orders are also allowed. Finally, we recommend that plans
outlining government monitoring of contractor performance under
time-and-materials contracts should include specific activities needed to
ensure adequate oversight under this contract type. In its written
comments on a draft of this report, DOD concurred with the
recommendations. DOD's comments are printed in their entirety in appendix
II of this report.

Background

Federal agencies, including DOD, can choose among different contract types
or pricing arrangements, including time-and-materials contracts, to
acquire products and services. This choice is the principal means that
agencies have for allocating cost risk between the government and the
contractor. Various contract types can be employed to meet the
government's needs. For example, time-and-materials can be used in
conjunction with stand-alone contracts; indefinite-quantity contracts,
including those under GSA schedules; blanket purchase agreements; or basic
ordering agreements. These choices are illustrated in figure 1.

Figure 1: Contract Types

Time-and-materials contracts comprise the highest contract type risk to
the government, according to the organizations who are responsible for
promulgating federal acquisition regulations. Like cost-reimbursable
contracts, they require that the contractor use its best efforts to
provide the goods or services at the stated ceiling price.^3 If the
contractor performs work pursuant to the contract, the contractor is
entitled to be reimbursed for labor at agreed-upon rates, which include
wages, overhead, general and administrative expenses, and profit; and for
materials purchased at cost. If the services delivered do not meet
contract requirements and the government exercises its right to have the
contractor correct the deficiencies, the government pays the additional
labor and material costs to do so, excluding the portion of the labor rate
attributable to profit.^4

Because of the risks involved, the Federal Acquisition Regulation (FAR)
directs that time-and-materials contracts should only be used when it is
not possible at the time of award to estimate accurately the extent or
duration of the work or to anticipate costs with any reasonable degree of
confidence.^5 The regulation also states that this type of contract may
only be used after the contracting officer executes a written
justification, known as a determination and findings, that no other
contract type is suitable. Time-and-materials contracts also must include
a ceiling price that the contractor exceeds at its own risk. In addition,
because these contracts do not include a positive profit incentive for the
contractor, appropriate government monitoring of contractor performance is
required to give reasonable assurance that efficient methods and effective
cost controls are being used. Documentation that the monitoring occurred
is required by the FAR.^6

The question of whether time-and-materials contracts could be used for
commercial acquisitions has been an issue of some contention. During
discussion of proposed provisions in the Services Acquisition Reform Act
of 2003,^7 which explicitly authorized the use of time-and-materials
contracts to purchase commercial services under certain circumstances, a
former Administrator of the Office of Federal Procurement Policy noted
that the issue of whether time-and-materials contracts should be
authorized under the FAR's commercial acquisition procedures appeared to
trigger more public dialogue than any other provision of the act. While
some believed that increased use of time-and-materials contracts would
encourage more commercial firms to compete for government business,
others, such as the DOD Inspector General, opposed the idea of expanding
use of this contract type for commercial item purchases. In fact, although
the FAR explicitly prohibited agencies from purchasing commercial items or
services using time-and-materials contracts until February 2007 when it
implemented the act's provisions, government agencies were doing so under
GSA schedule contracts. According to GSA officials, this practice was
allowed based on the agency's interpretation of the Federal Acquisition
Streamlining Act of 1994 (FASA)^8, which required that fixed-price
contracts be used to the "maximum extent practicable" for commercial
acquisitions and remained silent on whether time-and-materials contracts
were allowed. Viewing the FAR as more restrictive than FASA, in March 1998
GSA executed a FAR deviation to allow for the use of time-and-materials
contracts for commercial services. But this deviation applied only to
Information Technology Schedule 70, one of the many GSA schedules. GSA
officials were unable to provide us with additional FAR deviations that
allowed time-and-materials orders under the other GSA schedules, such as
those with contracts for professional, administrative, and management
services, despite our requests.

^3 We note that time-and-materials contracts also exhibit characteristics
of fixed-price contracts. The labor rates in a time-and-materials contract
are similar to a fixed-price contract in that these rates are fixed,
regardless of the contractor's actual labor costs or indirect expenses.
The contractor assumes the cost risk associated with these labor rates but
can also maximize its profit by finding individuals who meet the
qualifications of a labor category at the lowest possible cost.

^4 FAR Part 52.246-6(f), Inspection--Time-and-Material and Labor-Hour.
Additional provisions in FAR Parts 52.246-6(g) and (h) describe alternate
actions the government may take if the delivered services do not meet
contract requirements.

^5 FAR Part 16.601(b)(1).

^6 FAR 52.246-6(b), Inspection--Time-and-Material and Labor-Hour and FAR
46.104, Contract Administration Office Responsibilities. The FAR uses the
term "surveillance"; however, for clarity we use the term "monitoring" in
this report.

Commercial companies avoid time-and-materials contracts in most
situations. In a prior review,^9 we surveyed 23 companies--22 of which
used time-and-materials contracts in their commercial practices, either as
a buyer or a seller. The companies represented 18 different industries.
They reported using time-and-materials contracts when they could not
complete a well-defined scope of work and when risk could be managed by
monitoring costs and contractor performance. Company representatives told
us they use this contract type in the early stages of projects, in
situations when work is not easily definable (such as emergency repairs)
or is prone to change because of unforeseen conditions. One representative
response from industry was that they use time-and-materials only when the
risk and cost of the deal is low and/or they truly do not know what they
want.

^7 Services Acquisition Reform Act of 2003, Title XIV of National Defense
Authorization Act for Fiscal Year 2004, Pub. L. No. 108-136 (Nov. 24,
2003).

^8 Federal Acquisition Streamlining Act of 1994, Pub. L. No. 103-355 (Oct.
13, 1994).

^9 We presented a briefing entitled "Time and Materials Contracting:
Survey of Private Sector Practices" to the Office of Federal Procurement
Policy in January 2005.

The Acquisition Advisory Panel, which the Services Acquisition Reform Act
established to review acquisition laws and regulations regarding many
different acquisition issues--including time-and-materials
contracts--issued its draft report to the Office of Federal Procurement
Policy and the Congress in December 2006. The panel expressed concern
about risks associated with the time-and-materials contract type,
particularly in the areas of price and contract management. The panel's
Commercial Practices Working Group noted that commercial buyers who spoke
to the panel provided many sound reasons not to use time-and-materials
contracts, but when they do use this contract type, they "endeavor to
maintain tight controls over the contracting process, costs, and levels of
effort." The panel made several recommendations regarding
time-and-materials contracts, including (1) current policies limiting
their use should be enforced; (2) whenever practicable, procedures should
be established to convert work to a performance-based effort; and (3) the
government should not award time-and-materials contracts unless the
overall scope of the effort, including the objectives, has been
sufficiently defined to allow for efficient practices and effective
government oversight.

Overall Trend in Time-and-Materials Obligations Is Incomplete Because of Missing
Data

From fiscal years 1996 through 2005, DOD's obligations against
time-and-materials contracts rose from almost $5 billion to over $9.6
billion, according to DD350 data. This rate of increase was somewhat
greater than the increase in DOD's overall service spending. Not shown in
DD350 data, however, is DOD's spending through time-and-materials
contracts for orders placed against GSA and other federal schedules. The
data gap is the result of DOD instructions and procedures that directed
users not to code contract type when the action was an order under a
federal schedule. These instructions were in effect from fiscal year 1997
until fiscal year 2007. Reporting should improve starting in fiscal year
2007, with DOD's transition to the government's Federal Procurement Data
System-Next Generation. In that system, a contract type is identified for
all orders, including those under GSA schedule contracts.

Figure 2 illustrates the growth rate of DOD's reported time-and-materials
obligations and the growth rate of DOD's overall service contract
obligations.

Figure 2: DOD Reported Obligations against Service Contracts

When comparing contract types, DOD's reported use of time-and-materials
for service acquisitions has remained relatively steady over the past 10
years. Contracts reported as time-and materials ranged from 5.9 percent to
6.8 percent of service contract dollars. Figure 3 depicts the obligations
coded as time-and-materials as well as those where contract type was not
coded--i.e., schedule orders.

Figure 3: Percentage of DOD Reported Obligations, Sorted by Contract Type,
for Service Acquisitions, Fiscal Years 1996 through 2005

As the use of GSA schedules has grown, so has the size of DOD's knowledge
gap. Reported data on DOD's schedule orders for services show an increase
of almost 200 percent over the past 10 years, from $2.4 billion in fiscal
year 1996 to $6.9 billion in 2005. None of these entries include a
contract type. To shed light on the potential magnitude of the missing
data, we calculated the percentage of obligations with a reported contract
type of time-and-materials for each of the 24 categories of services in
the DD350 database. We then applied this same percentage, for each service
category, to the dollars that were uncoded--i.e., schedule orders. For
example, in fiscal year 2005, contract type was not coded for $3.4 billion
in obligations related to the acquisition of professional, administrative,
and management support services. Of reported obligations in this service
category for which DOD did record a contract type, almost 17 percent was
obligated against time-and-materials contracts. We applied the 17 percent
to the $3.4 billion to estimate that $570 million of obligations in this
service category was likely to be time-and-materials. In looking at a
single year, fiscal year 2005, our conservative estimate is that over $1
billion of the $6.9 billion in services acquired through federal schedules
was obligated against time-and-materials contracts. For fiscal year 2005,
this would represent an over 10 percent increase in the dollars attributed
to time-and-materials contracts. Estimates from others place the amount
higher. The GSA Inspector General in 2003 reported that use of
time-and-materials was prevalent under schedule contracts and that 65
percent of the 1,976 task orders for professional services purchased by
several agencies under the schedules it surveyed were priced on a
time-and-materials basis.^10 In 2005, the GSA Assistant Inspector General
for Auditing told the Acquisition Advisory Panel that recent studies of
523 GSA Federal Technology Service contract awards, valued at over $5.4
billion, found over 60 percent of all orders were awarded on a
time-and-materials basis.

Most of DOD's Time-and-Materials Obligations Are for Three Categories of
Services

Over 75 percent of DOD's reported time-and-materials purchases are for
professional, administrative, and management support services; information
technology and communications; and maintenance, repair, and rebuilding of
equipment. These are three of the largest and among the fastest growing
categories of DOD service acquisitions. Obligations for professional,
administrative, and management support services, for example, increased
161 percent from 1996 to 2005. Table 1 shows the percentage of DOD
contract dollars spent using time-and-materials contracts for these three
categories.

^10 GSA Inspector General, Audit of Procurement of Professional Services
from the Federal Supply Service's Multiple Award Schedules, Report Number
A020243/F/A/V03009 (Arlington, Va.: July 31, 2003).

Table 1: Categories of Services Acquired Most Using Time-and-Materials
Contracts, Fiscal Year 2005

                                      DOD obligations      Time-and-materials 
                              DOD               using        obligations as a 
                      obligations  time-and-materials     percentage of DOD's 
                        in fiscal contracts in fiscal  total fiscal year 2005 
Type of service      year 2005           year 2005             obligations 
Professional,    $28.3 billion        $4.2 billion              15 percent 
administrative,                                                            
and management                                                             
support services                                                           
Information       10.3 billion         1.8 billion              18 percent 
technology and                                                             
communications                                                             
Maintenance,      11.4 billion         1.3 billion              12 percent 
repair, and                                                                
rebuilding of                                                              
equipment                                                                  

Sources: DOD DD350 database (data); GAO (presentation and analysis).

Note: Percentages may not calculate within table due to rounding.

Table 2 shows that DOD is most often making its time-and-materials
purchases by issuing task orders under indefinite-delivery contracts,
according to reported obligations.

Table 2: Reported Time-and-Materials Obligations by Contract/Order Type
for Service Acquisitions, Fiscal Year 2005

Dollars in billions                                                        
                                             DOD obligations in Percentage of 
Contract/order type                         fiscal year 2005   obligations 
Order under an indefinite-delivery                    $7.928            82 
contract                                                                   
Definitive contract                                    0.832             9 
Blanket purchase agreement order under                 0.761             8 
federal schedule                                                           
Order under an agreement                               0.066   less than 1 
All other contracts                                    0.099             1 

Sources: DOD DD350 database (data); GAO (analysis).

Notes: Reported information does not include orders placed off federal
schedules (e.g., GSA schedule contracts). "All other contracts" include
letter contracts, orders from Federal Prison Industries or the
Javits-Wagner-O'Day Program for the blind or severely disabled, and awards
under FAR Part 13 simplified acquisition procedures.

In addition to reported data in DOD's procurement information system, our
analysis of contract files and discussions with DOD officials showed that
the department is using time-and-materials contracts and orders to acquire
contract services to supplement the government's workforce. For example,
under one of the contracts we reviewed, the Defense Intelligence Agency
(DIA) hired subject matter experts in the intelligence field for such
things as assisting in the implementation of defense intelligence
operational planning, including identifying requirements; establishing an
in-theater contract management branch to oversee contractor personnel
acquisitions, performance, and training; research and analysis in support
of human intelligence collection operations; and serving as a security
officer. According to a DIA official, contractor personnel were needed to
backfill the government workforce in light of changing and increased
operational requirements. Many of these contractor personnel were former
DIA employees. In another case, the Air Force signed a 1-year contract to
acquire advisory and assistance services^11--specifically, 27 contract
employees to provide systems engineering and technical assistance--to
support the Air Force Deputy Chief of Staff for Warfighter Integration.
During a pre-award review of the statement of work, the contracting
specialist indicated that it was necessary to use the word "assist" to
describe certain activities, such as acquisition strategy development, so
that the statement of work did not show the contractor performing
inherently governmental functions.

Government personnel are increasingly finding themselves working
side-by-side with contractors, often performing similar roles. The
Acquisition Advisory Panel, in its December 2006 draft report, found that,
as the workforce increasingly reflects a "blend" of government and
contractor personnel, issues have arisen with respect to the proper roles
and relationships of federal employees and contractors. It pointed in
particular to uncertainties about the scope and application of what are
"inherently governmental" functions, the practical difficulties of
enforcing the current FAR prohibition on personal services contracts,^12
and the increasing probability of, and need to protect against,
organizational conflicts of interest. The report also noted that, with the
growth of a workforce in which contractor employees are working alongside
federal employees, performing identical functions, questions have been
raised about whether the contractor employees should be required to comply
with certain ethics rules that apply to government personnel. It made a
number of recommendations pertaining to these issues.

^11 Advisory and assistance services include services provided under
contract to support or improve such things as organizational policy
development, decision making, or management and administration. It can
also mean the furnishing of professional advice or assistance rendered to
improve the effectiveness of federal management processes or procedures.
All advisory and assistance services are classified in one of the
following definitional subdivisions: management and professional support
services; studies, analyses, and evaluations; or engineering and technical
services. FAR 2.101.

^12 The key indicator of a personal services contract is whether the
government exercises relatively continuous supervision and control over
the contractor personnel performing the services. The FAR lists elements
that may indicate whether a personal services contract exists. FAR 37.104.

DOD Frequently Did Not Justify Why Time-and-Materials Contracts Needed but Used
Them for Ease and Flexibility

DOD contracting and program officials frequently did not justify why
time-and-materials contracts were the only contract type suitable for the
procurement. The main reasons time-and-materials contracts are used,
according to the officials we interviewed, are the speed with which
contracts can be awarded and the flexibility they provide in adjusting
labor hours or labor categories in light of changing priorities--often as
a result of requirements that are not firm--or funding uncertainties.
Existing management controls, such as contracting officers' written
justifications and acquisition plans, could help decision makers to ensure
that time-and-materials contracts are used only when appropriate. However,
for most of the contracts we reviewed, the justifications did not include
a rationale showing why no other contract type was suitable, nor did the
acquisition plans. With a few exceptions, little attempt was made to
convert follow-on contracts or task orders to a different contract type,
even when historical data existed. Recent revisions to the FAR implement a
number of stricter requirements for contracting officers to justify use of
time-and-materials contracts, but most pertain only to commercial
acquisitions.

Lack of Firm Requirements, Funding Uncertainties, and Pressure to Award
Contracts Drive Use of Time-and-Materials

Contracting and program officials told us that their decisions to use
time-and-materials contracts were driven by the flexibility this contract
type provides to deal with unknowns related to the
acquisition--particularly a lack of firm requirements--and the ability to
award these contracts quickly, not because this contract type was the only
one suitable. The combination of indefinite-quantity contracts and
time-and-materials allows contracting officers to get new work on contract
quickly, because labor rates have been pre-negotiated. In fact, based on
DD350 data, for the five largest contracts we examined--each with
obligations of more than $250 million through fiscal year 2005--that
permitted various contract types,^13 time-and-materials was by far the
predominant type used, as shown in table 3.

^13 Contracts may include various contract types for different line items.

Table 3: Contract Types Used for Largest Dollar Value Contracts in Our
Sample

Dollars          in                                                        
thousands                                                                  
                                           Cost                               
                       Fixed price reimbursable Time-and-materials      Total 
Contract 1                 $456            0         $1,510,146 $1,510,602 
                             0.03%            0             99.97%    100.00% 
Contract 2                2,053            0          1,341,109  1,343,161 
                             0.15%            0             99.85%    100.00% 
Contract 3               43,558       $4,906            612,213    660,677 
                             6.59%        0.74%             92.66%    100.00% 
Contract 4              118,539        3,494            200,360    322,393 
                            36.77%        1.08%             62.15%    100.00% 
Contract 5               24,634       22,493            218,014    265,141 
                             9.29%        8.48%             82.23%    100.00% 

Sources: DOD DD350 database (data); GAO (analysis).

Note: Totals may not add due to rounding.

Use of time-and-materials under indefinite-quantity contracts also allows
contracting officers to keep adding work to the orders, since hours and
funds are only limited by the ceiling price of the contract. For example:

           o The original value of a Defense Information System Agency (DISA)
           task order for installation, de-installation, and maintenance
           services related to the Defense Information System Network was
           $20.7 million for a 1-year period. The value of the order has
           grown to over $386 million and has been in place for over 5 years.
           According to a DISA official, instead of issuing a new task order,
           the task order is "renewed" on a yearly basis.^14

           o The value of a 1-year task order under the Air Force's
           Contractor Field Team contract for the maintenance of aircraft
           deployed to support Operation Iraqi Freedom increased from $23.9
           million to over $221 million.

Contracting and program officials also noted that time-and-materials
contracts provide DOD the flexibility to shift the skill sets being
acquired by adjusting the distribution of hours between labor categories.
However, this type of flexibility is only needed if DOD is unable to
define its requirements in terms of outcomes. The need for improved
requirements definition was also addressed by the Acquisition Advisory
Panel in its December 2006 draft report. The panel found that the
government fails to invest in the acquisition planning phase of
procurement, focusing on rapid awards rather than on defining
requirements. The testimony the panel heard was consistent in identifying
the major contributors to this problem as the cultural and budgetary
pressure to quickly award contracts or orders, combined with a lack of
market expertise in an already-strained acquisition workforce.

^14 According to a DISA official, DISA's legal office concurs that it is
administratively prohibitive to issue new task orders, in part due to
foreign logistics requirements.

The pressure to get to award was evident in several of the contracts we
examined and contributed to the use of time-and-materials contracts over
other contract types. According to the contracting officers, this pressure
was the result of such factors as the need to get supplemental funding on
contract, the expiration of an existing contract, or urgent customer
demands. They told us they turned to time-and-materials contracts or
orders in these situations because they require less up-front effort than
cost-reimbursable contracts to determine that prices, in the form of labor
rates, are fair and reasonable; require less specific requirements than
are needed to support a fixed-price bid; or had been previously used. For
example, the Air Force had been acquiring advisory and assistance services
under a time-and-materials contract when it determined that the work was
out of the contract's scope. It quickly put in place a new contract, again
under a time-and-materials arrangement even though there was historical
data available, because, according to an Air Force official, it was
expedient and the customer was comfortable with this contract type.

According to contracting and program officials, budget pressures are also
driving contracting officers to accept more risk by using
time-and-materials contracts. Army officials told us that
cost-reimbursable and time-and-materials contracts are being chosen over
fixed-price contracts in part because of the way funding is allocated.
They stated that funding is being allocated to Army programs and offices
on a quarterly basis, based on shifting priorities. Without a stable
funding stream with which to fully fund fixed-price contracts, contracting
officers are looking to the flexibility provided by time-and-materials
contracts, which allow them to take actions such as adjusting the number
of hours being purchased. Similarly, Air Force officials told us that when
the military service was directed to cut spending on contractor support
services by 29 percent in 2006, it was easier and less costly to change or
eliminate requirements on time-and-materials contracts than on fixed-price
contracts.

Contracts and Orders Lacked Justifications or Rationale Showing Why
Time-and-Materials Was Needed

When choosing to use time-and-materials contracts, the FAR requires
contracting officers to provide a written justification, known as a
determination and findings, that no other contract type is suitable for
the acquisition.^15 The determination and findings is required to set
forth enough facts and circumstances to clearly and convincingly justify
the determination made.^16 Contract type is also addressed in acquisition
plans, which set forth the overall strategy for managing the
acquisition.^17 These management controls are designed to help decision
makers ensure that a time-and-materials contract is appropriate.^18 In
most cases, however, the justifications and plans we examined did not
include a rationale showing why less risky contract types could not be
used for the procurement. The GSA and DOD Inspectors General have also
reported on a lack of determinations and findings and contract files with
minimal information to support the use of time-and-materials contracts.^19

We found that some contracting officers' justifications for use of
time-and-materials contracts quoted language from the FAR^20--such as
stating that it was not possible at the time of awarding the contract to
estimate accurately the extent or duration of the work or to anticipate
costs with any reasonable degree of confidence and that time-and-materials
was the only suitable contract type--and did not set forth the rationale
for why other contract types could not be used. In several of these cases,
the determinations and findings did not include specifics related to the
acquisition at hand.

^15 FAR 16.601(d)(1) and 1.701. Under the FAR, "contract" is defined to
include all types of commitments that obligate the government to an
expenditure of appropriated funds and that, except as otherwise
authorized, are in writing. In addition to bilateral instruments,
contracts include (but are not limited to) awards and notices of awards;
job orders or task letters issued under basic ordering agreements; letter
contracts; orders, such as purchase orders, under which the contract
becomes effective by written acceptance or performance; and bilateral
contract modifications. FAR 2.101.

^16 FAR 1.704.

^17 FAR 7.102 and 7.105(b)(4).

^18 An October 2, 2006, DOD policy implementing Section 812 of the
National Defense Authorization Act for Fiscal Year 2006 requires senior
DOD officials or their designees to review and approve the acquisitions of
services valued at $250 million or above for non-information technology
service acquisitions and $500 million and above for information technology
services. This review should consider the anticipated pricing arrangement.
We recently reported on DOD's review structure in the context of the
department's overall management of its service acquisitions. See GAO,
Defense Acquisitions: Tailored Approach Needed to Improve Service
Acquisition Outcomes, [26]GAO-07-20 (Washington, D.C.: Nov. 9, 2006).

^19 GSA Inspector General, Compendium of Audits of the Federal Technology
Service Regional Client Support Centers (Washington, D.C.: December 2004);
and DOD Inspector General, Contracts for Professional, Administrative, and
Management Support Services, D-2004-015 (Arlington, Va.: October 2003).

^20 FAR 16.601.

We also found two indefinite-quantity contracts, both of which allowed for
only time-and-materials orders, that completely lacked written
determinations and findings justifying the use of time-and-materials. One
was a Navy contract for ongoing support related to F/A-18s sold through
the foreign military sales program, and the other was a Navy contract for
technical and engineering services regarding the maintenance of aging
aircraft. The contracting officers said they were unaware of the FAR
requirement to prepare a determination and findings.^21

As shown above in table 3, the vast majority of DOD's reported
time-and-materials obligations are against orders under
indefinite-quantity contracts. At the time of our review, the FAR did not
require determinations and findings for task orders issued under
indefinite-quantity contracts. Consequently, many of the
time-and-materials orders we reviewed--even those issued under contracts
that allowed for multiple order types--did not have a determination and
findings showing why no contract type other than time-and-materials was
suitable. On some of the contracts we reviewed, the contracting officers
relied on the initial determination and findings for the
indefinite-quantity contract to justify subsequent time-and-materials
orders, even when the scope of work allowed under the contract was very
broad. For example, the Army's Communications-Electronics Command prepared
a class determination and findings for the use of time-and-materials under
a contract for equipment and engineering services. The document noted that
the statement of work included many tasks, including research and
development, systems integration and engineering, test and evaluation,
studies, logistics support, training, and acquisition support. It stated
that "Due to the complexity and variety of tasks available to Federal
customers, it is impossible to estimate the duration of work or to
anticipate costs with any reasonable degree of certainty."

^21 The FAR specifically required a determination and findings for
time-and-materials contracts, but was not explicit with respect to
indefinite-quantity contracts. The FAR was recently amended for commercial
acquisitions to require a determination and findings for
indefinite-quantity contracts that only provide for the issuance of
time-and-materials orders.

We also found cases where ordering guides for specific contracts required
a determination and findings before time-and-materials orders were used;
in some of these cases, the contracting officers had not complied with the
requirement.

           o The Army placed an order for network and systems engineering
           services under a National Institutes of Health (NIH)
           governmentwide acquisition contract. The Army contracting officer
           did not complete a determination and findings for the order,
           stating that this was the responsibility of the NIH contracting
           officer. The NIH contracting officer told us that executing a
           determination and findings is normally the responsibility of the
           ordering agency. According to NIH's ordering guide for this
           governmentwide acquisition contract, in the event that a
           time-and-materials order was contemplated, the customer (in this
           case, the Army) was required to follow the FAR requirements for
           completing a determination and findings.

           o The DISA ordering guide for one of the indefinite-quantity
           contracts in our sample stated that a time-and-materials contract
           could only be used after the contracting officer executed a
           determination and findings that no other contract type was
           suitable. Such a determination had not been made for all three
           time-and-materials orders we reviewed under the contract.

Finally, we found two cases where agencies had issued time-and-materials
orders under blanket purchase agreements based on GSA schedule contracts,
but had not prepared determinations. GSA's schedule ordering guidance,
under "frequently asked questions" on the agency's Web site, states that
time-and-materials orders under schedule contracts require a determination
that it was not possible at the time of placing the order to estimate
accurately the extent or duration of the work or to anticipate cost with
any reasonable degree of confidence. According to a GSA official, this
guidance was posted in March 2005. Of the nine orders discussed below, six
were issued prior to this guidance; however, three were issued after it
was posted.

           o DIA awarded two blanket purchase agreements against GSA schedule
           contracts, one for three orders totaling $1.6 million for
           administrative operational support in the intelligence area and
           the other for three orders totaling $23 million for information
           technology engineering and intelligence support. A determination
           had not been prepared for any of the orders. 
           o The Defense Contract Management Agency (DCMA) issued a blanket
           purchase agreement and three subsequent task orders under a GSA
           schedule contract for information technology services. The
           contract files did not contain a determination justifying the use
           of the time-and-materials orders. For one order, the price
           negotiation memorandum stated that the decision to use a
           time-and-materials contract was driven by the customer (i.e.,
           program officials). The document did not discuss the customer's
           rationale for why no other contract type was suitable.

Acquisition officials at DCMA and DIA respectively attributed the lack of
documentation to an understaffed acquisition workforce and inadequate
agency acquisition policies.

Little Attempt to Change Contract Type for Follow-on Efforts

One way to decrease the risks inherent in time-and-materials contracts is
to convert to a less risky contract type for follow-on efforts. In fact, a
September 2004, Defense Procurement and Acquisition Policy memorandum
directed that, when preparing the requirements for a follow-on contract to
an existing time-and-materials or cost-reimbursable service contract,
program officials should work with the contracting officer to determine if
any portion can be broken out and ordered on a fixed-price basis.^22 The
memorandum notes that the experience gained on the prior contract may
serve as a basis to reasonably price similar future efforts on a
fixed-price basis. The FAR, too, states that

In the course of an acquisition program, a series of contracts, or a
single long-term contract, changing circumstances may make a different
contract type appropriate in later periods than that used at the outset.
In particular, contracting officers should avoid protracted use of a
cost-reimbursement or time-and-materials contract after experience
provides a basis for firmer pricing.^23

We found little evidence, however, that efforts are being made to convert
time-and-materials to fixed-price for follow-on efforts or recurring
services, even when historical information existed. Examples follow.

^22 The memorandum did not specifically reference orders; however, we note
that DOD is obligating most of its time-and-materials dollars under
orders.

^23 FAR 16.103(c).

           o The Army has continued to use a time-and-materials order under a
           GSA governmentwide acquisition contract to acquire information
           technology services to support an online educational contest for
           middle school students in the areas of science, math, and
           technology. According to the acquisition plan, the original
           directive for the program was neither detailed nor specific. The
           effort has now been ongoing for 4 years and is still priced on a
           time-and-materials basis.

           o In 1998, the Air Force signed a 10-year contract for B-52
           engineering services that was a sole-source follow-on to a
           previously issued time-and-materials contract. Overall, the
           contractor had been providing similar support for the B-52 program
           since 1963. During the development of the acquisition strategy,
           the Assistant Secretary of the Air Force for Acquisition initially
           rejected the program's plan to award a time-and-materials contract
           for this effort, advocating a cost-plus award fee contract
           instead. Eventually it was agreed that the time-and-materials
           portion of the work would be limited to 50 percent. For the first
           year, under monitoring by Air Force headquarters, this target was
           met. In fiscal year 2000, the percentage of time-and-materials
           obligations was 59 percent before decreasing back to 49 percent in
           fiscal year 2001. However, the level of monitoring slackened after
           2001, and for 2006, nearly all of the work was on a
           time-and-materials basis.

           o In 2005, DISA issued a request for proposal for Encore II, a
           follow-on to its Encore I indefinite-quantity contract. Encore I
           offered a variety of information technology services to
           organizations throughout DOD and other federal agencies.^24
           Although orders can be issued using various contract types, the
           contracting officer told us that most of the orders issued have
           been time-and-materials. The DOD Inspector General found that
           Encore II also allows for a significant portion of
           time-and-materials task orders and raised concerns about
           contractors not being motivated to increase efficiency and
           maximize performance. In response, DISA plans to implement goals
           to decrease the time-and-materials orders over the life of the
           contract. However, the Inspector General noted that these goals
           are based on a percentage of total dollars awarded in a calendar
           year. Therefore, DISA will not be able to determine whether it is
           meeting the established goal until the end of the year.

^24 Encore I was a follow-on to DISA's Defense Enterprise Integration
Services I and II multiple-award, indefinite-quantity information
technology contracts.

We found one case in which the Navy specified that a contract for aircraft
structural inspections and repairs could be changed from
time-and-materials to fixed price once sufficient knowledge about costs
was attained. Under this contract, the Navy agreed that the contractor
would perform structural inspection and repairs on one aircraft  and use
the data it collected, along with the cost history for similar efforts, to
better define the extent, costs, and duration of the work so that the
remaining work could be completed on a fixed-price basis. As it turned
out, the Navy was able to use the data from the previous effort to convert
all service and repair work to fixed price shortly after the contract was
signed.

New Rules Implementing Provisions in Services Acquisition Reform Act Strengthen
Justifications for Time-and-Materials Contracts for Commercial Acquisitions

On December 12, 2006, the Civilian Agency Acquisition Council and the
Defense Acquisition Regulations Council (the Councils) agreed on a final
rule amending the FAR to implement section 1432 of the Services
Acquisition Reform Act of 2003.^25 The act authorized the use of
time-and-materials contracts for the following categories of commercial
services: (1) commercial services procured for support of a commercial
item^26 and (2) any other category of commercial services that is
designated by the Administrator of the Office of Federal Procurement
Policy on the basis that

           o the commercial services in such category are of a type of
           commercial services that are commonly sold to the general public
           through use of time-and-materials contracts and
           o it would be in the best interests of the federal government to
           authorize use of time-and-materials contracts for purchase of the
           commercial services in such category.

The final rule includes a number of stricter requirements for contracting
officers that directly address many of the problems we found with the use
of time-and-materials contracts. For example, contracting officers'
written justifications must describe actions planned to maximize the use
of fixed-price contracts on future acquisitions for the same requirements,
and they must be prepared for task orders. However, most of the revisions
pertain to commercial acquisitions only. In responding to public comments
on the proposed regulations, the Councils acknowledged that the rule
contained more requirements for commercial determinations and findings
than for non-commercial. Their rationale was that the additional
requirements were needed to encourage the preference for fixed-price
contracts for commercial items. At the same time, though, the Councils
stated that they believe additional controls are needed to ensure both
commercial and non-commercial time-and-materials contracts are only used
when no other contract type is suitable. The DOD Acquisition Regulations
Council chair at the time this FAR rule was being considered told us that
discussions focused mostly on commercial acquisitions because the belief
was that this was the area where tighter controls were needed. We note
that none of the 28 time-and-materials contracts, agreements, and orders
we selected for review were coded as commercial acquisitions in DOD's
procurement information system.^27

25The changes went into effect in February 2007.

^26 As described in 41 U.S.C. 403(12)(E).

The new provisions pertaining to commercial acquisitions of services on a
time-and-materials basis include the following:

           o The determinations and findings must at a minimum (1) describe
           market research conducted; (2) establish that it is not possible
           at the time of placing the contract or order to accurately
           estimate the extent or duration of work or to anticipate costs
           with any reasonable degree of certainty; (3) establish that the
           requirement has been structured to maximize the use of fixed-price
           contracts on future acquisitions for the same or similar
           requirements (e.g., by limiting the value or length of the
           time-and-materials contract or order or establishing fixed prices
           for portions of the requirement); and (4) describe actions planned
           to maximize the use of fixed-price contracts on future
           acquisitions for the same requirements.

           o Indefinite-delivery contracts must be structured to the maximum
           extent practicable to allow the use of fixed-price orders. For
           these contracts, each time-and-materials order under an
           indefinite-delivery contract must have a separate determination
           and findings.

           o If an indefinite-delivery contract only allows for
           time-and-materials orders, a determination and findings shall be
           executed to support the basic contract and shall also explain why
           providing for a fixed-price alternative is not practicable.
           Further, the determination and findings must be approved one level
           above the contracting officer.

^27 The DD350 data for three non-DOD contracts in our review did not
indicate whether or not they were commercial.

One new provision applies to all time-and-materials
acquisitions--commercial and non-commercial. It requires the
determinations and findings to be signed before the execution of the base
period and any option periods. If the period of performance exceeds 3
years, the determination and findings must be approved by the head of the
contracting activity. According to the Councils, this provision is also
intended to help avoid protracted use of non-commercial time-and-materials
contracts after experience provides a basis for firmer pricing.

Contractor Performance Monitoring Often Did Not Reflect Inherent Risks of
Time-and-Materials Contract Type

The FAR calls out the need for appropriate government oversight on
time-and-materials contracts to give reasonable assurance that efficient
methods and effective cost controls are being used, because this contract
type provides no incentive for the contractor to control costs or be
efficient. In addition, DOD guidance requires adequate monitoring of
contractor performance. This monitoring is to be properly documented,
including a plan setting forth the required activities and, if applicable,
specific performance measures. For time-and-materials contracts, the plans
could include activities such as ensuring that the labor categories and
rates in the contract match those provided by the contractor. Monitoring
of performance is typically performed by a contracting officer's
representative (COR), who is designated as such by the contracting
officer.^28 Duties associated with the monitoring include reviewing
contractor costs to determine if there are variances from the budgeted or
anticipated costs, such as by labor category. The COR is also responsible
for assuring that the contract performance is consistent with the
description and scope of the contract.^29

Although we found that CORs were assigned in most cases, many of the
contract files we reviewed did not include plans setting forth how the
monitoring was to be accomplished, and we found wide discrepancies in the
rigor with which monitoring was performed. For example, on the Army's $17
million Omnibus 2000 logistics support services contract, CORs told us
that no monitoring plans or records were required and that they did not
review invoices.^30 Further, some CORs had a limited background in
acquisition issues or were new to the role. A DIA COR, who was accustomed
to working on contracts for goods and supplies, not services, told us the
COR training received was not adequate and, as a result, it took some time
to learn how to do the job. An Army customer on an Air Force maintenance
contract hired a contractor to perform day-to-day monitoring. The official
stated that between promotions and a lack of experience, the Army lacked
in-house government capability to provide adequate oversight. In general,
on the contracts we reviewed, CORs performed their monitoring role based
on information in monthly progress reports from the contractor that
provided a status of ongoing work and information on how fast money was
being spent, known as "burn rates."

^28 CORs are typically responsible for such things as verifying that the
contractor performs the technical requirements of the contract in
accordance with contract terms, monitoring the contractor's performance,
notifying the contractor of deficiencies, and directing appropriate action
to effect correction. They are not authorized to modify the contract terms
or conditions or to obligate the payment of any money by the government.

^29 According to Defense Procurement and Acquisition Policy and DCAA
officials, oversight of contractor payment requests on time-and-materials
contracts is conducted by DCAA. The officials noted that CORs are not
responsible for certifying costs or performing cost verifications, such as
reconciling contractor labor cost records or material cost invoices to
amounts included on public vouchers.

On the other hand, we found a case in which DOD generated regular reports
of contractor performance, based on a documented monitoring plan. An Air
Force contract to meet surge requirements for field maintenance used a
management plan that outlined monitoring responsibilities for contracting
staff, required formal delegation of these responsibilities, and provided
a standard government form for monthly reporting on all task orders. We
also found a number of cases in which contracting officers obtained
timesheets and other supporting documentation along with billing
submissions. Doing so meant the program managers had the necessary
information to closely monitor contractor performance using labor hours
according to specific labor categories. On one DIA task order, the program
manager used the information from invoices to monitor the charges in
program management labor categories for the contractor. The program
manager stated that if these costs exceeded 5 percent of the value of the
hours billed during the period, the contractor would be questioned about
the reasons for those charges.

^30 Some of the contracting officials said that monitoring under the
follow-on contract is more substantial.

DOD Is Paying More Than Actual Costs for Subcontracted Labor on Some Contracts

We found that contracts specified various ways prime contractors can be
reimbursed for subcontracted labor. Some required the prime contractor to
be reimbursed for the actual costs it paid for the subcontracted labor,
others set forth separate rates for subcontractors, some contained
"blended" prime and subcontract rates, and some permitted the prime
contractor to be reimbursed for subcontracted labor at the prime's own
rates. The last category in particular has caused some concern within DOD.
For example, DCAA audit reports have questioned costs under this billing
arrangement, claiming the differential to be additional profit to the
prime contractor. On the contracts we reviewed that allowed the prime
contractor to bill DOD for subcontractor labor using its own prime
rates,^31 we found a wide range of differences between prime contract and
subcontract labor rates. New FAR provisions and a Defense Federal
Acquisition Regulation Supplement (DFARS) interim rule set forth different
rules about how prime contractors are to be reimbursed for subcontracted
labor under competitive versus non-competitive, and commercial versus
non-commercial, procurements.

^31 Among the 28 time-and-materials contracts, agreements, and orders that
we examined in depth, we reviewed one blanket purchase agreement that
demonstrated this billing practice. We collected information on the
difference between the prime and subcontract labor rates under this
agreement. Subsequently, we identified an additional 12 contracts and
agreements that allowed the prime contractor to bill the government for
subcontract labor using the prime contract labor rates.

Prime Contract Labor Rates Were Usually Higher Than Subcontract Rates on
Contracts We Reviewed

We analyzed the differential between 628 prime and subcontract labor rates
within 13 contracts or agreements we reviewed that allowed the prime
contractor to bill DOD for subcontracted labor using prime contract rates.
The differential ranged from negative 40 percent to 192 percent, with most
falling in the 6 to 53 percent range. Figure 4 shows these differences
under the 628 different labor rates. Each rate is associated with a labor
category (e.g., program manager, systems engineer, or senior analyst) that
includes a description of the position, along with minimum education and
experience requirements.

Figure 4: Percentage Differences between Prime Contract and Subcontract
Labor Rates for 628 Labor Categories on 13 Contracts or Agreements

Note: The figure reflects a break in percentage ranges between 111% and
170% because there were no instances of rate differentials within these
ranges.

In most of these cases, the prime contract's labor rates were higher than
the rates in subcontracts; therefore, the prime contractor could realize
additional profit by using these subcontractors. One contractor
representative told us that the rate differential for his company, which
ranged from 2 to 14 percent, consisted of overhead, material handling
costs, and subcontract administration costs, as well as profit. In another
case, a contractor representative told us that the labor rate in the prime
contract for a systems engineer was 108 percent more than the subcontract
rate because the subcontractor provides temporary labor with a lower
benefits package.

The prime contract's labor rates did not exceed the subcontract rate in
all instances. In limited circumstances, we found that the subcontract
rate for a given labor category was lower than the rate in the prime
contract. For example, under one task order, the prime contractor was
billing the government 38 to 40 percent less for one labor category than
it was paying its subcontractors. In this instance, subcontract labor
hours represented less than 6 percent of total labor hours associated with
the task order. Most of the contractor representatives told us that the
subcontract rates were established by negotiating with the subcontractors
or after accepting bids. However, one representative told us that some
larger subcontractors are unwilling to accept lower labor rates.

Of the 13 contracts and agreements we reviewed, all allowed task orders to
be issued under them. In total, we reviewed 24 task orders associated with
these contracts and agreements. While prime contract labor rates were
almost always higher than subcontract rates, the magnitude of this
difference varied, even within the same task order. Figure 5 shows the
range of labor rate differentials within each of the 24 orders we
reviewed.

Figure 5: Range of Percentage Differences between Prime Contract and
Subcontract Labor Rates for 628 Labor Categories in 24 Orders

Note: The range for each order is shown as a solid line, but is made up of
multiple observations. So even though 7 of the 24 orders show instances in
which the prime contract rate was less than the subcontract rate, these
instances are still rare among the 628 labor categories for which we
collected this information.

In some cases, the subcontract rates showed wide differences when compared
to the prime contract rate, even within the same labor category. Table 4
provides examples of variations within and among labor categories.

Table 4: Selected Examples of Differences in Labor Rates between Prime
Contracts and Subcontracts

Contract Labor category                 Rate difference Percent difference
A        Senior Analyst (Subcontractor           $11.23              16.48
            1)                                                      
            Senior Analyst (Subcontractor           -10.43   -11.61 
            2)                                                      
            Senior Analyst (Subcontractor            12.73    19.10 
            3)                                                      
B        Technician                               -7.92             -15.70
            Technical Editor                         19.34    75.19 
            Engineer/Analyst                         10.17    20.16 
C        Program Manager Level 4                  16.16              14.70
            Systems Engineer Level 4                  5.39     6.30 
            Systems Engineer Level 3                  1.11     1.59 
            Systems Engineer Level 2                  2.55     4.41 
            (Subcontractor 1)                                       
            Systems Engineer Level 2                 31.39   108.24 
            (Subcontractor 2)                                       

Sources: Contractors and DOD (data); GAO (analysis).

Defense Contract Audit Agency Identified Additional Profits Related to
Subcontracted Labor

At our request, DCAA queried its field offices to identify reports on
questioned costs pertaining to the subcontractor billing issue. The query
generated 11 audit reports that questioned over $4 million in billings
based on the rates subcontractors billed to prime contractors under DOD
contracts.^32 The audit reports, issued between December 2004 and November
2006, contain varying levels of detail and reflect audits of incurred
costs, final vouchers, and customer requested evaluations of billed
amounts. They cover five different prime contractors. The audit agency, in
accordance with the FAR payments clause for time-and-materials
contracts^33 in effect at that time, considers as unallowable costs the
amount that the prime contractor bills DOD in excess of the amount the
subcontractor bills the prime contractor. In one case, DCAA found that a
prime contractor realized profits ranging from 20 to 95 percent based on
differences between billed amounts and the actual costs of subcontract
labor.

^32 DCAA provided two additional audit assignments that raised the issue
of prime contractor billing for subcontracted labor without specifically
questioning costs. According to DCAA, one audit is in process and the
questioned costs will be reported when the report is issued. The second
assignment was cancelled at the customer's request.

^33 FAR 52.232-7(b)(4).

Debate Has Surrounded How Primes Should Be Reimbursed for Subcontracted Labor,
but New Regulations Enumerate Acceptable Billing Practices

The issue of how the government should reimburse prime contractors for
subcontracted labor has been a matter of debate. For example, as noted
above, DCAA has questioned contractors' proposed costs or billings for
subcontracted labor at amounts other than the actual costs when the
standard time-and-materials payments clause was included in the contract.
In instances in which the contract specifically permitted the prime to
bill for subcontracted labor at the prime contract rates, DCAA did not
question those costs. In its official comments on proposed FAR cases
pertaining to time-and-materials contracts,^34 DCAA stated that such a
practice places the government at a greater risk of paying costs higher
than what prime contractors actually pay without receiving any additional
benefits. DCAA noted that this practice will incentivize prime contractors
to maximize profits by subcontracting out more work and that the
government will have to expend additional resources to monitor the quality
and efficiency of the subcontracted labor to ensure that it is receiving
the level of service for which it had contracted. DCAA has held that, if
the FAR payments clause is in the contract, it applies. Until recently,
the payments clause stated that

the Government will limit reimbursable costs in connection with
subcontracts to the amounts paid for supplies and services purchased
directly for the contract when the Contractor has made or will make
payments determined due of cash, checks, or other forms of payment to the
subcontractor....^35

GSA has taken the position that prime contractors should bill for
subcontracted labor at their own prime GSA schedule rates, posting this
instruction on the agency's Web site. Industry associations have argued
that only reimbursing the prime contractors for the actual costs of
subcontracted labor (without profit) fails to recognize the risk that
prime contractors assume when they subcontract. These associations have
also indicated that requiring separate subcontract rates would be
administratively burdensome for the government and the contractor and
limit the ability to quickly bring on subcontractors.

^34 FAR Cases 2004-015 "Payments under Time-and-Materials and Labor-Hour
Contracts" (70 Fed. Reg. 56,314 (Sept. 26, 2005)) and 2003-027 "Additional
Contract Types" (70 Fed. Reg. 56,318 (Sept. 26, 2005)). These FAR cases
resulted in FAR amendments effective February 12, 2007 (71 Fed. Reg.
74,656 (Dec. 12, 2006) and 71 Fed. Reg. 74,667 (Dec. 12, 2006)),
respectively.

^35 FAR 52.232-7 (3)(B)(4)(ii).

Effective February 12, 2007, FAR provisions clarified under what
circumstances prime contractors can bill the government for subcontractor
labor at the prime contract's labor rates. This billing practice is
permitted now if the time-and-materials contract or order was
competitively awarded or for a commercial service, but separate prime and
subcontract rates are required if the contract was not competitively
awarded.^36 An interim rule to DOD's supplement to the FAR is stricter,
requiring prime contractors to charge at separate prime and subcontractor
rates for all non-commercial, competitively-awarded contracts as well.^37
Table 5 summarizes the new FAR rule^38 and DOD's interim rule.

Table 5: Governmentwide Provisions and Those in DOD's Interim Rule
Regarding Billing for Subcontracted Labor under Time-and-Materials
Contracts

                               Noncommercial contracts
                        Noncompetitive        
Commercial contracts award                      Competitive award
(governmentwide)     Governmentwide    Non-DOD       DOD interim rule
Prime contractor is  Prime contractor      Prime           Prime          
not required to      is required to        contractor is   contractor is  
propose separate     propose separate      not required to required to    
rates for prime and  rates for prime       propose         propose        
subcontractor        and subcontractor     separate rates  separate rates 
labor^a              labor.                for prime and   for prime and  
                                              subcontractor   subcontractor  
                                              labor^b         labor.         

Sources: FAR and Federal Register (data); GAO (presentation and analysis).

Note: Orders issued under GSA schedule contracts or associated blanket
purchase agreements will fall into the commercial category.

aHowever, the prime contractor must specify whether the fixed hourly rate
for each labor category applies to labor performed by the prime and/or
subcontractors.

bHowever, for each category of labor, the prime contractor must establish
fixed hourly rates using one of three options: separate rates for prime
and subcontracted labor, blended rates, or a combination of separate and
blended; and the prime must specify whether the fixed hourly rate for each
labor category applies to labor performed by the prime and/or
subcontractors.

Prior to these changes, we found that the Defense Finance and Accounting
Service (DFAS) had acted proactively to limit the rate at which prime
contractors bill for subcontracted labor. On one blanket purchase
agreement under a GSA schedule contract, DFAS officials were concerned
that they were paying too much for subcontracted labor that was billed at
the prime contractor's labor rates. According to the DFAS division chief
for contract services, to mitigate this risk on other blanket purchase
agreements, DFAS now includes language in the terms and conditions of the
agreements specifying that the subcontractor's actual costs shall be
billed and that the labor rates in the blanket purchase agreement shall be
used for prime contractor labor only.

^36 71 Fed. Reg. 74,656 (Dec. 12, 2006) and 71 Fed. Reg. 74,667 (Dec. 12,
2006). The revised FAR payments clause for time-and-materials contracts
conditions payment on hourly rates that meet the labor qualifications as
specified in the contract (FAR 52.212-4 and 52.232-7).

^37 71 Fed. Reg. 74,469 (Dec. 12, 2006) (to be codified at 48 C.F.R. parts
216 and 252).

^38 A DCAA official said that, despite the concerns it expressed in
official comments on the proposed changes, DCAA concurred with the new
rules.

Conclusions

While time-and-materials contracts are appropriate when specific
circumstances justify the risks, our findings indicate that they are often
used as a default for a variety of reasons--ease, speed, and
flexibility--and that the risk posed to the government is not fully taken
to heart by contracting and program officials. In our view, these reasons
can also be seen as symptomatic of broader problems related to
requirements and a focus on awarding contracts quickly. Heightened
management controls are needed, including thorough justifications specific
to the individual procurements that provide insight to management about
why time-and-materials contracts are being used and continue to be used
for recurring efforts, even when adequate information is available to
convert to a less risky contract type. The FAR Council has recognized the
need for more controls to address risks. While we understand that the
focus of the new rules was commercial acquisitions, the conditions that
called for the stricter controls also apply to non-commercial
acquisitions, based on our findings. In addition, without appropriate
monitoring of contractor performance when time-and-materials contracts are
used, the risk of wasted government dollars is increased.

Recommendations

To help ensure that all time-and-materials acquisitions receive the
appropriate level of oversight, we recommend that the Secretary of Defense
direct the Director of Defense Procurement and Acquisition Policy to amend
the DFARS to require a similar level of justification for using
time-and-materials for non-commercial services as that in the FAR for
commercial services by taking the following four actions with regard to
non-commercial acquisitions:

           1. Require the contracting officer to execute written
           justifications for each time-and-materials task order issued under
           an indefinite-quantity contract.
           2. Require that written justifications be prepared for
           indefinite-quantity contracts that allow only for
           time-and-materials orders.
           3. Require that written justifications for the use of
           time-and-materials contracts and task orders

                        o contain sufficient facts and rationale to justify
                        that no other contract type authorized is suitable;
                        o address the specific characteristics of the
                        acquisition that prevent the use of either a
                        cost-reimbursable or fixed-price contract;
                        o establish that the requirement has been structured
                        to maximize the use of fixed price contract type on
                        future acquisitions for the same or similar
                        requirements; and
                        o describe actions planned to maximize the use of
                        fixed-price contracts on future acquisitions for the
                        same requirements.

           4. Require that contracting officers, to the maximum extent
           practicable, structure indefinite-quantity contracts to allow
           issuance of fixed-price or cost-reimbursable orders, so that
           time-and-materials is not the only option.

To monitor and minimize DOD's use of time-and-materials contracts, we
recommend that the Secretary of Defense direct the Director of Defense
Procurement and Acquisition Policy to take the following two actions:

           1. For indefinite-quantity contracts that permit
           time-and-materials orders, require heads of contracting activities
           to analyze on an annual basis whether time-and-materials is being
           used as a default contract type when other pricing arrangements
           may be appropriate. The Secretary will need to determine
           appropriate risk-based criteria to select the contracts for such
           analysis.
           2. Direct that monitoring plans for time-and-materials contracts
           recognize the risks inherent in this contract type and set forth
           specific activities to address these risks to the extent feasible.

Agency Comments and Our Evaluation

DOD's Office of Defense Procurement and Acquisition Policy provided
written comments on a draft of this report. These comments are reprinted
in appendix II.

DOD concurred with all six recommendations and has initiated two DFARS
cases to consider changes to DOD's acquisition regulations. DOD also
stated that it will require military departments and defense agencies to
develop plans for analyzing whether time-and-materials contracts are being
used as a default contract type. In its response to the recommendations on
amending its acquisition regulations to require a similar level of
justification as is contained in federal acquisition regulations for
commercial services, DOD stated that it would evaluate or consider our
recommendations during the defense acquisition regulation rulemaking
process. While we understand DOD cannot commit to implementing our
recommendations in advance of the public comment process, we would expect
that the recommendations would be used as the basis for any proposed rules
it offers.

We are sending copies of this report to interested congressional
committees; the Secretary of Defense; the Secretaries of the Air Force,
the Army, and the Navy; the Administrators of the General Services
Administration and Office of Federal Procurement Policy; and the Directors
of the Defense Contract Audit Agency, Defense Contract Management Agency,
Defense Information Systems Agency, Defense Intelligence Agency, and
Office of Management and Budget. We will provide copies to others on
request. This report will also be available at no charge on GAO's Web site
at [27]http://www.gao.gov .

If you or your staff have any questions about this report or need
additional information, please contact me at (202) 512-4841 or
[28][email protected] . Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this report.
Staff acknowledgments are listed in appendix III.

Katherine V. Schinasi
Managing
Director Acquisition and Sourcing
Management

Appendix I: Scope and Methodology

Our objectives were to (1) identify the overall trends in Department of
Defense (DOD) obligations under time-and-materials contracts; (2) analyze
what DOD is buying under time-and-materials contracts; (3) assess the
factors leading to DOD's use of this contract type and whether actions are
being taken to use it only when no other contract type is suitable; (4)
evaluate DOD's monitoring of contractor performance under
time-and-materials contracts; and (5) determine the differences between
the labor rates prime contractors used to bill DOD and the labor rates in
their subcontracts, for selected contracts.

To identify trends in the use of time-and-materials contracts, we analyzed
obligation data from DOD's DD350 database for service contracts that were
identified as either time-and-materials or labor hour contracts between
fiscal year 1996 and 2005. The 2005 data was the most recent available.
For this period, we examined trends in the contract types used for service
acquisitions overall and for specific types of services. During our
initial review of the DD350 data, we found that orders under federal
schedules did not designate a contract type--a potentially significant
limitation for this objective. To address this limitation, we developed an
approach to estimate the percentage of these uncoded federal schedule
orders that were time-and-materials and labor hour actions. We applied the
proportion of obligations reported as time-and-materials for each of the
24 service categories in the DD350 database to the obligations that were
missing a contract type (i.e., federal schedule orders). We believe this
methodology is conservative because it is likely to underestimate the
obligations associated with time-and-materials contracts. Orders for
services under federal schedules must be priced on a fixed-price or
time-and-materials basis. However, cost-reimbursable contracts comprise 16
percent and 57 percent, respectively, (adjusted to exclude contract
dollars in these categories with a missing contract type) of the two
service categories--professional services and information technology
services--that account for the large majority of contract dollars (78
percent or $5.4 billion) where contract type is not coded. In developing
our estimate, we did not adjust the percentages to account for the fact
that cost-reimbursable contracts cannot be used for schedule orders.

To determine the major categories of services where DOD has obligated
time-and-materials dollars and the growth in these categories of services
over time, we analyzed data from the DD350 database from fiscal year 1996
through fiscal year 2005. We also used information from the DD350 database
for fiscal year 2005 to determine the extent to which DOD is obligating
time-and-materials dollars under various types of contracts (such as
indefinite-quantity contracts). To provide examples of types of services
DOD is procuring under time-and-materials contracts, apart from that
reported in the DD350 system, we analyzed documents in the contract files,
such as statements of work and contractor proposals, for the contracts and
orders in our review. We also interviewed contracting and program
officials.

We derived our sample of 28 contracts, agreements, and orders, analysis of
which was used in developing the third and fourth objectives, as follows.
During the design phase of our review, we extracted information from the
DD350 database on all DOD actions in fiscal years 2004 and 2005 with
obligations coded as time-and-materials or labor-hour. This analysis
yielded a total of 4,785 actions. We selected seven contracts from this
group, taking into account the location of the buying activity and type of
contract (e.g., stand-alone, indefinite-quantity, or blanket purchase
agreement). We subsequently selected 21 additional contracts and
agreements for further detailed review in two steps. First, we selected
the three time-and-materials contracts with the most reported obligations
in fiscal year 2005. Each of these had over $300 million in fiscal year
2005 obligations. Second, we selected an additional 18 contracts and
agreements from a smaller population of 559 contracts that were coded as
time-and-materials and had over $1 million in cumulative obligations for
fiscal year 2005. We made these selections randomly within groups based on
type of contract/order, origin of contract, location of buying activity,
and military service or "other DOD" organization.

Of the 28 contracts and agreements in our sample, 21 used orders as the
mechanism for putting work on contract.^1 For 18 of the 19, we chose 3
orders to analyze as well. For the other, we examined the one order with
time-and-materials obligations recorded in fiscal years 2004 and 2005. To
further verify the DD350 data for the contracts we reviewed, we compared
the reported information with documents in the contract files and found
one order that had been miscoded as time-and-materials. We removed this
order from the sample. Cumulatively, we reviewed a total of 82 contracts,
agreements, and orders.

The following table presents basic information about the 28 contracts,
agreements, and orders in our sample.

^1 Nineteen were DOD contracts, one was a General Services Administration
governmentwide acquisition contract, and one was a National Institutes of
Health governmentwide acquisition contract.

Table 6: Characteristics of GAO's Sample of 28 Contracts, Agreements, and
Orders

                            Number in   Obligated dollars through  Number in  
Organizations            our sample  fiscal year 2005           our sample 
Air Force                    7       Over $1 billion                2      
Army                         8       $1 billion to $500 million     1      
Defense Contract             1       $500 million to $100           3      
Management Agency                    million                               
Defense Information                  $100 million to $50            5      
Systems Agency               2       million                               
Defense Intelligence                 $50 million to $10 million     8      
Agency                       2                                             
Navy                         8       Less than $10 million          9      
                            Number in                              Number in  
Types of services        our sample  Types of contract vehicles our sample 
Engineering and              12      Indefinite-quantity                13 
technical support                    contract                              
Information technology       11      Standalone contract                 5 
Maintenance of equipment     3       Order off a schedule or             4 
                                        governmentwide acquisition            
                                        contract                              
Miscellaneous                2       Blanket purchase agreement          4 
professional,                                                              
administrative, and                                                        
management support                                                         
                                        Basic ordering agreement            1 
                                        Requirements contract               1 

Sources: Contract file documentation and DOD DD350 database (data); GAO
(analysis).

To assess the actions DOD officials have taken to ensure
time-and-materials contracts are only used when no other contract type is
suitable, we reviewed applicable acquisition policies and regulations to
identify governmentwide and DOD-specific criteria on when and how they
should be used. We also held discussions with acquisition policy officials
at the Air Force, Army, Navy, Defense Information Systems Agency, Defense
Intelligence Agency, and Defense Contract Management Agency to determine
how each organization commonly utilized time-and-materials contracts and
how they monitored the extent of their use. In addition, for each of the
contracts in our sample, we reviewed acquisition documentation including
the determination and findings, if available; acquisition plans; and
business clearance memorandums to assess what factors were considered to
determine and justify the use of the contract type. We also interviewed
contracting officers and, in some cases, program officials to discuss the
rationale used to support the decision to use a time-and-materials
contract and the reasons this contract type was eventually chosen.

To evaluate the government's monitoring of contractor performance, we
reviewed documentation of contract monitoring for each of our sample
contracts. This documentation included monitoring plans,
contractor-generated monthly status reports, government-generated
contractor performance reports, and sample invoices. We used these
documents to assess what measures were taken to monitor contractor
performance and to what extent those measures were executed and documented
in the contract file. We also interviewed the designated contracting
officer's representative and/or other individuals responsible for
monitoring to corroborate and supplement the information in the contract
file.

To collect contract file documents and conduct interviews related to the
use and monitoring of the time-and-materials contracts in our sample (our
third and fourth objectives), we visited the following locations:

Air Force:

Air Force 11th Contracting Wing, Bolling Air Force Base, Washington, D.C.

Air Force 554th Electronic Systems Group, Wright-Patterson Air Force Base,
Dayton, Ohio

Air Force 951st Electronic Systems Group, Hanscom Air Force Base, Mass.

Air Force Aeronautical Systems Center, Wright-Patterson Air Force Base,
Dayton, Ohio

Air Force Air Logistics Center, Tinker Air Force Base, Oklahoma City,
Okla.

Air Force Cost Analysis Agency, Arlington, Va.

National Air and Space Intelligence Center, Wright-Patterson Air Force
Base, Dayton, Ohio

Army:

Army Aviation and Missile Command, Redstone Arsenal, Huntsville, Ala.

Army Communications-Electronic Command, Fort Monmouth, N.J.

Army Communications-Electronics Research, Development and Engineering
Center, Fort Belvoir, Va.

Army Contracting Center of Excellence, Washington, D.C.

Army Information Technology, E-Commerce and Commercial Contracting Center,
Alexandria, Va.

Department of the Army, G-8 Programs and Priorities, Washington, D.C.

Navy:

Naval Air Systems Command, Patuxent River, Md.

Naval Sea Systems Command, Washington Navy Yard, D.C.

Naval Surface Warfare Center Carderock Division, West Bethesda, Md.

Other DOD:

Defense Contract Management Agency, Springfield, Va.

Defense Intelligence Agency, Washington, D.C., and Arlington, Va.

We were able to obtain contract files from the Defense Information Systems
Agency electronically. We conducted additional interviews by video
conference or telephone.

For the final objective on prime contract labor rates billed for
subcontracted labor, we first analyzed the 28 contracts, agreements, and
orders in our sample to determine which permitted prime contractors to
charge the government for subcontracted labor using their own, prime
contract rates. We collected information on the difference between the
prime and subcontract labor rates for one of the blanket purchase
agreements in our sample. We then selected an additional 12 contracts and
agreements for further, detailed review of the labor rates, based on
congressional interest, for a total of 13 contracts and agreements to
address this objective. We identified these additional 12 contracts and
agreements from two sources. First, since the Defense Contract Audit
Agency had identified this billing practice as an issue primarily with
orders under General Services Administration schedule contracts, we
examined DOD's blanket purchase agreements under schedule contracts as
reported in the DD350 database and selected six for further analysis.
Second, we analyzed contracts that had been reviewed by DOD as a result of
Sections 801 and 802 of the National Defense Authorization Act for Fiscal
Year 2002 to identify those that had reported time-and-materials
obligations, and selected six of these for further analysis. Because all
13 contracts and agreements we reviewed under this objective were
structured to allow task orders to be issued under them, we selected
orders from each to analyze. In all, we assessed the differential between
the prime and subcontract labor rates for 24 task orders and 628 different
labor categories within those orders. We analyzed contract documentation
and interviewed prime contractors about the labor rates used to bill DOD
for subcontracted labor. We queried Defense Contract Audit Agency about
audit assignments it has conducted where it found this billing practice.
We also reviewed recent revisions to the Federal Acquisition Regulation
and DOD's supplement pertaining to how prime contractors can bill the
government for subcontracted labor and discussed these revisions with
officials from DOD's Procurement and Acquisition Policy office.

We performed our review from February 2006 to May 2007 in accordance with
generally accepted government auditing standards.

Appendix II: Comments from the Department of Defense

Appendix III: GAOA Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Katherine V. Schinasi (202) 512-4841 or [29][email protected]

Acknowledgments

In addition to the contact listed above, Michele Mackin, Assistant
Director; Ron Schwenn; Marie Ahearn; Nicholas Alexander; Elaine Boudreau;
Lily J. Chin; Paula J. Haurilesko; Art James; Matt Keeler; Julia Kennon,
and Patrick Peterson made key contributions to this report.

(120512)

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[36]www.gao.gov/cgi-bin/getrpt?GAO-07-273 .

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Highlights of [37]GAO-07-273 , a report to the Committee on Armed
Services, U.S. Senate

June 2007

DEFENSE CONTRACTING

Improved Insight and Controls Needed over DOD's Time-and-Materials
Contracts

Under time-and-materials contracts, payments to contractors are made based
on the number of labor hours billed at hourly rates and, if applicable,
other direct costs. Because of the risk they pose to the government, their
use is supposed to be limited to cases where no other contract type is
suitable. GAO was asked to identify trends in the Department of Defense's
(DOD) obligations under time-and-materials contracts; analyze what DOD is
buying under these contracts; assess why DOD is using them and whether
actions are being taken to ensure that they are used only when no other
contract type is suitable; evaluate DOD's monitoring of contractor
performance; and determine the differences between the labor rates prime
contractors bill DOD and the rates in their subcontracts. GAO reviewed 82
time-and-materials contracts, agreements, and orders and examined prime
contract and subcontract labor rates on 12 additional contracts or
agreements.

[38]What GAO Recommends

GAO is recommending that DOD require more diligence in justifying the use
of certain types of time-and-materials contracts, analyze the use of
time-and-materials on indefinite-quantity contracts to ensure that it does
not become the default contract type, and require monitoring plans to
reflect the risks inherent in this contract type. In written comments on a
draft of this report, DOD concurred with the recommendations.

DOD's reported obligations under time-and-materials contracts increased
from almost $5 billion in 1996 to about $10 billion in 2005. But this
dollar amount is understated because DOD has not been coding contract type
for orders placed under federal schedules (e.g., General Services
Administration's schedule contracts). The accuracy of reported
time-and-materials dollars should improve starting with fiscal year 2007
because DOD transitioned to the federal government's procurement
information system, which requires contract type to be coded for every
order.

Over 75 percent of DOD's reported time-and-materials obligations are
concentrated in three service categories: professional, administrative,
and management support services; information technology and
communications; and equipment maintenance and repair. Over 80 percent of
these obligations are against task orders. DOD is also using
time-and-materials contracts to acquire contract services to supplement
the government workforce. Examples include intelligence support, advisory
and assistance services, and systems engineering.

DOD is turning to time-and-materials contracts because they can be awarded
quickly and labor hours or categories can be adjusted if requirements are
unclear or funding uncertain. Contracting officers' written determinations
almost never included a rationale as to why a less risky contract type
could not be used, and little attempt was made to convert follow-on work
to a different contract type. Recent changes to federal acquisition
regulations to allow for commercial services to be procured on a
time-and-materials basis impose more stringent justification requirements,
but most of the revisions do not apply to non-commercial procurements.

Even though time-and-materials contracts call for appropriate government
monitoring of contractor performance, there were wide discrepancies in the
rigor with which monitoring was performed and most of the contracts and
orders GAO reviewed did not include documented monitoring plans. In
general, monitoring was based on contractor-provided monthly status
reports showing the contractor's activities and amount of funds expended.

Under some time-and-materials contracts, the prime contractor charged DOD
at prime contract hourly rates for subcontracted labor. According to the
Defense Contract Audit Agency, this practice can result in the prime
contractor earning additional profits. GAO's analysis of billing rates
under 13 contracts and agreements showed that when the prime contractor
charged prime contract hourly rates for subcontracted labor, the
difference between the prime's rates and those in their subcontracts
ranged from negative 40 percent to 192 percent, with most in the 6 to 53
percent range. Recent revisions to federal acquisition regulations will
mitigate this practice for certain types of acquisitions.

References

Visible links
  26. http://www.gao.gov/cgi-bin/getrpt?GAO-07-20
  27. http://www.gao.gov/
  28. mailto:[email protected]
  29. mailto:[email protected]
  30. http://www.gao.gov/
  31. http://www.gao.gov/
  32. http://www.gao.gov/fraudnet/fraudnet.htm
  33. mailto:[email protected]
  34. mailto:[email protected]
  35. mailto:[email protected]
  36. http://www.gao.gov/cgi-bin/getrpt?GAO-07-273
  37. http://www.gao.gov/cgi-bin/getrpt?GAO-07-273
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