DOD Competitive Sourcing: Plan Needed to Mitigate Risks in Army Logistics
Modernization Program (Letter Report, 10/04/1999, GAO/NSIAD-00-19).

Pursuant to a congressional request, GAO reviewed the Army's decision to
contract for its Wholesale Logistics Modernization Program.

GAO noted that: (1) the Army's plans for implementing its Wholesale
Logistics Modernization Program initiative by contracting with the
private sector include actions to respond to the congressional
notification requirements contained in legislation and the guidance
contained in Office of Management and Budget Circular A-76; (2)
significant uncertainties about the Army's abilities to execute its
modernization program as planned, particularly within preset funding
levels, exist; (3) in July 1998, the Army provided advance notification
to Congress, under 10 U.S.C. 2461, concerning its plans to consider
contracting for the operation of its existing system and development of
a modernized system; (4) it subsequently notified Congress in April 1999
concerning approval of a waiver of a detailed cost comparison between
the public and private sector under Circular A-76; (5) while the Army
has not yet provided Congress with cost information and certifications
required under section 2461 and section 8014 of the Department of
Defense Appropriations Act for Fiscal Year 1999 (P.L. 105-262), it
expects to do so prior to entering into a contract for the modernization
effort; (6) to date, the Army has taken actions to comply with
legislative and A-76 requirements for the plan to contract for the
wholesale logistics modernization; (7) however, affected employees have
filed four appeals of the A-76 waiver with the Assistant Secretary of
the Army for Installations and Environment which are pending; (8)
because it was granted an A-76 waiver, the Army did not conduct a
detailed cost comparison, but it did complete a business case analysis
to assess prospective costs of various alternatives and as a basis for
selecting its planned approach; (9) however, various factors suggest
that much uncertainty exists over the Army's ability to achieve its
modernization objectives within preset funding levels and whether a new
system would be put in place as quickly as initially anticipated to
reduce operating costs; (10) thus, the Army could be faced with making
future tradeoffs between Wholesale Logistics Modernization Program
investment costs and its modernization objectives; (11) additionally,
the Army faces uncertainties regarding the number of employees who may
be willing to accept employment with the private sector to maintain the
existing system while a new system is being developed; and (12) limited
system documentation of the existing system increases the importance of
existing employees to continue maintenance of the legacy system while a
new system is being developed.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-00-19
     TITLE:  DOD Competitive Sourcing: Plan Needed to Mitigate Risks in
	     Army Logistics Modernization Program
      DATE:  10/04/1999
   SUBJECT:  Military cost control
	     Privatization
	     Cost effectiveness analysis
	     Logistics
	     Inventory control systems
	     Army procurement
	     Reengineering (management)
IDENTIFIER:  Army Wholesale Logistics Modernization Program

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Report to Congressional Committees

October 1999

DOD Competitive Sourcing

Plan Needed to Mitigate Risks in Army Logistics Modernization
Program
*****************

*****************

GAO/NSIAD-00-19

Letter                                                                     3

Appendixes

Appendix I:Chronology of the Modernization Initiative

                                                                         20

Appendix II:Comments From the Department of Defense

                                                                         21

Appendix III:GAO Contacts and Staff Acknowledgments

                                                                         23

Table 1:  Estimated Cost and Schedule for Wholesale Logistics
Modernization Alternatives11

AMC     Army Materiel Command

DOD     Department of Defense

CECOM   Communications and Electronics Command

OMB     Office of Management and Budget

 The Army has a two-tiered, wholesale and retail logistics support system.
The wholesale system is comprised of the four major commands subordinate
to the Army Materiel Command; these subordinate commands procure supplies
directly from vendors and hold inventories of stocks to meet the demands
of retail customers. Retail customers are
 Financial Audit: 1998 Financial Report of the United States Government
                                                     National Security and 
                                             International Affairs Division

B-283303

October 4, 1999

The Honorable Floyd D. Spence
Chairman
The Honorable Ike Skelton
Ranking Minority Member
Committee on Armed Services
House of Representatives 

The Honorable James M. Inhofe
Chairman, Subcommittee on Readiness
  and Management Support
Committee on Armed Services
United States Senate

The Army is seeking to implement a Wholesale Logistics Modernization
Program to reengineer its processes and modernize the aging computer
information systems it uses to manage its inventories of equipment, parts,
and supplies needed to support combat forces. To accomplish this
modernization, the Army plans to contract with the private sector to
reengineer its business processes and develop and operate a new system.
Until the new system is operational, the contractor will operate the
existing computer information system as well. The Army's goal is to
accomplish these objectives with the same level of resources currently
devoted to the existing system. The contractor selected to perform the
work would be expected to make the capital investment needed to develop
the new system, with the expectation that it would be able to recoup its
investment through future operating efficiencies.

This report responds to the request of the Chairman of the Senate
Subcommittee on Readiness and Management Support, Committee on Armed
Services, that we review the Army's decision to contract for its wholesale
logistics management information system. It also fulfills a requirement of
the House National Security Committee's/Footnote1/ report (Report No. 105-
532) on the Strom Thurmond National Defense Authorization Act for Fiscal
Year 1999, which directed us to analyze and determine whether the
information provided by the Army supports this proposed action.
Specifically, this report discusses (1) the Army's actions to comply with
the requirements of 10 U.S.C. 2461, section 8014 of the Department of
Defense Appropriations Act for Fiscal Year 1999 (P.L. 105-262), and Office
of Management and Budget Circular A-76 and (2) cost uncertainties and
other risks that could impact the future success of the modernization
program.

Results in Brief

The Army's plans for implementing its Wholesale Logistics Modernization
Program initiative by contracting with the private sector include actions
to respond to the congressional notification requirements contained in
legislation and the guidance contained in Office of Management and Budget
Circular A-76. At the same time, significant uncertainties about the
Army's abilities to execute its modernization program as planned,
particularly within preset funding levels, exist. Specifically, 

o In July 1998, the Army provided advance notification to the Congress,
  under 10 U.S.C. 2461, concerning its plans to consider contracting for
  the operation of its existing system and development of a modernized
  system. It subsequently notified the Congress in April 1999 concerning
  approval of a waiver of a detailed cost comparison between the public
  and private sector under Circular A-76. While the Army has not yet
  provided the Congress with cost information and certifications required
  under section 2461 and section 8014 of the Department of Defense
  Appropriations Act for Fiscal Year 1999 (P.L. 105-262), it expects to
  do so prior to entering into a contract for the modernization effort.
  To date, the Army has taken actions to comply with legislative and A-76
  requirements for the plan to contract for the wholesale logistics
  modernization. However, affected employees have filed four appeals of
  the A-76 waiver with the Assistant Secretary of the Army for
  Installations and Environment which are currently pending.

o   Because it was granted an A-76 waiver, the Army did not conduct a
  detailed cost comparison, but it did complete a business case analysis
  to assess prospective costs of various alternatives and as a basis for
  selecting its planned approach. However, various factors suggest that
  much uncertainty exists over the Army's ability to achieve its
  modernization objectives within preset funding levels and whether a new
  system would be put in place as quickly as initially anticipated to
  reduce operating costs. Thus, the Army could be faced with making
  future tradeoffs between Wholesale Logistics Modernization Program
  investment costs and its modernization objectives. Additionally, the
  Army faces uncertainties regarding the number of employees who may be
  willing to accept employment with the private sector to maintain the
  existing system while a new system is being developed. Limited system
  documentation of the existing system increases the importance of
  existing employees to continue maintenance of the legacy system while a
  new system is being developed.

This report contains a recommendation to the Secretary of Defense
concerning the need to mitigate the risks identified and to closely
monitor this program as it progresses.

Background

In August 1997, in response to a tasking from the Army Materiel Command
(AMC), the Communications and Electronics Command (CECOM) formed a special
project team to gather information and market research to develop
alternatives for modernizing its logistics information system processes.
The approach the Army ultimately selected was to rely on the private
sector to modernize and operate the wholesale/Footnote2/ logistics
management information system. This approach affects existing software
design, development, and operations involving Army employees and
contractors at Army facilities in St. Louis, Missouri, and Chambersburg,
Pennsylvania. Under the plan, functions currently performed by government
employees would be performed by contractor personnel in the future.
Accordingly, the Army must consider legislative provisions and policy
guidance that may be applicable.

Overview of the Modernization Plan
----------------------------------

The Army's wholesale logistics management information system is currently
sustained by the Logistics Systems Support Center in St. Louis, Missouri,
and the Industrial Logistics Systems Center in Chambersburg, Pennsylvania.
These centers report to the Communications and Electronics Command at Fort
Monmouth, New Jersey, a major subordinate command of the Army Materiel
Command. The two centers, referred to as Central Design Activities,
design, develop, and maintain computer software systems and provide
services that manage commodities, such as ammunition, avionics,
communications and electronics, tanks, and missiles. The software systems
integrate all wholesale logistics functions, including cataloging the
inventory of items, processing customer orders, computing requirements for
items and ordering replenishment stocks, and handling the accounting
processes. The budget for the two centers has been about $40 million
annually. The centers support numerous customers besides AMC, such as the
Joint Chiefs of Staff, Defense Logistics Agency, and the Defense Finance
and Accounting Service. In addition to the
$40 million used to sustain the software by the two centers, the Army also
provides funding to have the current software processed by the Defense
Information Systems Agency. This additional funding has been around
$60 million each year./Footnote3/ 

The Wholesale Logistics Modernization Program/Footnote4/ is but one
portion of a larger Army strategy for a future logistics system. The
larger strategy, known as Global Combat Support System--Army, is to
implement a single system to provide a seamless, integrated interactive
communications and an automated information system for the Army's retail
and wholesale logistics support systems, and to support joint and allied
operations. The retail logistics support system is currently undergoing a
modernization effort similar to the wholesale modernization program. The
retail modernization is structured so that federal employees continue to
operate the current system while working with the contractor to develop a
new system, which will be operated and maintained by the contractor.

The software programs associated with the Army's wholesale logistics
management information system are complex, were initially developed about
30 years ago, and widely recognized as being in need of modernization to
avoid system failure in the future. To undertake such a modernization
effort, the Army believes its wholesale logistics modernization program
must include business process reengineering. The goal would be to
eliminate non-value added activities and develop processes that expedite
sound decision making. The change would apply both on the battlefield and
at home, and create a system that will be flexible, adaptable, and
responsive to both a peacetime and a wartime environment. Reduced
operating and support costs and the elimination of data redundancy and
inaccuracy are additional anticipated benefits.

To accomplish such dramatic change in the wholesale logistics process,
while containing costs, the Army decided to leverage industry's investment
in commercial logistics practices. CECOM considered the status quo and
three alternatives to accomplish the modernization effort. Specifically,
they included:

Status Quo: Maintain the current systems, supported by the Central
DesignActivities as currently staffed, organized, trained, and funded.

Alternative I: The Central Design Activities perform legacy
sustainment,wholesale logistics modernization, and sustainment of the
modernized system.

Alternative II: The Central Design Activities perform legacy sustainment;
thecontractor performs wholesale logistics modernization andsustainment of
the modernized system.

Alternative III: The contractor performs legacy sustainment, wholesale
logistics modernization, and sustainment of the modernized system.
Inaddition, the contractor will employ displaced Central Design Activities
workers.

The Army selected alternative III, which placed reliance on the private
sector to operate the existing legacy system as it undertook the
modernization effort and would be expected to operate the modernized
system once it was in place.  The alternative selected would have the
potential to eliminate approximately 478 government civilian employees at
the two center locations. AMC wanted to minimize the impact on these
employees and help ensure continuity of operation of the legacy system and
mission. To accomplish that goal, AMC decided to include as a key
requirement in its request for proposals for the private-sector
competition that the winning contractor offer displaced employees jobs
with comparable pay and benefits, in the employees' current geographical
location, for a minimum of 1 year. A chronology of key decisions
associated with the evolution of this program is contained in appendix I.

Policy Guidance and Legislative Reporting Requirements
------------------------------------------------------

Office of Management and Budget (OMB) Circular A-76 as well as two
legislative provisions outline important requirements affecting agencies
when they consider converting functions from performance by government
employees to the private sector.

Since 1955, federal agencies have been encouraged to obtain commercially
available goods and services from the private sector if doing so is
cost-effective. In 1966, OMB issued Circular A-76, which established
federal policy for the government's performance of commercial activities
and set forth the procedures for studying them for potential contracting.
In 1979, OMB issued a supplemental handbook to the circular that included
cost-comparison procedures for determining whether commercial activities
should be performed in-house, by another federal agency through an
interservice support agreement, or by the private sector. OMB updated this
handbook in 1983 and again in March 1996./Footnote5/  The March 1996
Revised Supplemental Handbook describes a wide range of options government
officials must consider as they contemplate reinventing government
operations. They include "the consolidation, restructuring or
reengineering of activities, privatization options, make or buy decisions"
and others. It also explains that the scope of the handbook is limited to
conversion of recurring commercial activities to or from in-house,
contract or interservice support agreement performances./Footnote6/

Where A-76 cost-comparison procedures apply, the initial step is to
develop a performance work statement describing what is needed to perform
the activity, which is used as the technical performance section of a
solicitation for private-sector offers. The government also develops a
management plan that describes the most efficient organization for in-
house performance of the activity described in the performance work
statement. The cost of performance by the government in accordance with
the most efficient organization is compared to the cost proposed by the
private-sector source selected pursuant to the solicitation. The activity
will be converted to performance by the private sector if the private
sector's offer represents a cost differential of at least 10 percent of
direct personnel costs or
$10 million over the performance period when compared to the government's
in-house cost estimate.

The handbook also allows for direct conversions to contractor performance
and cost comparison waivers. In the case of the Department of Defense
(DOD), the authority to issue such a waiver may be delegated to the
cognizant military service Assistant Secretary. A cost-comparison waiver
must be accompanied by a detailed determination that the conversion meets
at least one of the following requirements:

o   the conversion will result in a significant financial or service
  quality improvement and a finding that the conversion will not serve to
  reduce significantly the level or quality of competition in the future
  award or performance of the work or

o   the waiver will establish why in-house offers have no reasonable
  expectation of winning a competition conducted under the cost
  comparison procedures.

Cost-comparison waivers are subject to the administrative appeal
procedures contained in the handbook. An appeal must be in writing and
generally submitted within 20 calendar days of documentation being made
publicly available concerning the outcome of the waiver. A final decision
should be made within 30 days of receipt of the appeal.

In addition to Circular A-76, DOD must consider 10 U.S.C. 2461 and section
8014 of the Department of Defense Appropriations Act for Fiscal Year 1999
(P.L. 105-262). Both contain requirements for congressional notifications
concerning the planned performance of functions by the private sector.

Section 2461, as amended by the Strom Thurmond National Defense
Authorization Act for Fiscal Year 1999 (P.L. 105-261), requires that
before any commercial or industrial type function that as of October 1,
1980, has been performed by DOD civilian employees is changed to private
sector performance, DOD must report to the Congress, conduct an analysis
showing that private-sector performance will result in a savings to the
government over the life of the contract, and certify that
analysis./Footnote7/ Section 8014 of the 1999 Defense Appropriations Act
requires that DOD certify its in-house estimate to congressional
committees before converting any activity performed by more than 10 DOD
civilian employees to contractor performance. While this provision is
applicable to fiscal year 1999 actions only, we expect that next year's
appropriation act will have this same provision as it has been included in
recent years' appropriations acts.

Army Plans Include Compliance With Circular A-76 and Legislative Reporting
Requirements

The Army has provided notifications to the Congress under 10 U.S.C. 2461
concerning its intent to contract for its modernization effort. The Army
plans to provide the Congress with relevant cost information and
certifications required under section 2461 and the applicable
appropriation act provision prior to awarding any contract for the
program. Further, the Army has executed a waiver of the cost comparison
provision under the terms of the supplemental handbook.

The Army's notification to the Congress in July 1998 stated that the Army
was considering an initiative to rely on private industry to reengineer
its wholesale logistics business processes and to provide information
management support for these processes. The notification stated that the
Army would provide the Congress a summary of its cost comparison and other
reports and certifications pursuant to section 2461 prior to entering into
a modernization contract. 

At the time of its initial congressional notification, the Army believed
that its planned action was not subject to OMB Circular A-76.
Subsequently, the Army changed its view and decided that A-76 did apply.
The Army concluded that in-house performance of the reengineering was not
feasible or cost-effective, and Army officials decided to seek a waiver to
A-76
cost-comparison requirements from the Assistant Secretary. 

On April 27, 1999, the Army submitted a notification to the Congress that
a waiver of the A-76 cost comparison process had been approved. The waiver
was approved by the Assistant Secretary of the Army (Installations and
Environment) pursuant to section E of chapter 1 of the supplemental
handbook. Specifically, the waiver stated that the modernization
initiative will result in significant service quality improvement beyond
that which could be reasonably expected from a reorganization of the
current approach, that the modernization effort will not serve to reduce
significantly the level or quality of competition in the future award of
work, and that the functions involved are not inherently governmental.
However, pursuant to the waiver appeal process provided for in A-76, four
appeals have been filed by affected employees with the Assistant Secretary
of the Army for Installations and Environment and are currently pending.
This latest congressional notification reiterated that section 2461 cost
information would be provided prior to entering into a contract for the
performance of the modernization effort. DOD likewise is expected to
provide the 1999 Defense Appropriations Act certification prior to
entering into a contract for the modernization project.

Cost and Personnel Uncertainties Could Adversely Impact Modernization
Efforts

Because it was granted an A-76 waiver, the Army did not conduct a detailed
cost comparison between the public and private sectors for its wholesale
logistics modernization program. Nevertheless, it did complete a business
case analysis in formulating its logistics modernization strategy. The
Army's business case analysis outlined the modernization program
alternatives being considered and analyzed each alternative's estimated
costs, benefits, and risks.  While numerous criteria were considered in
developing alternative strategies, emphasis was placed on cost containment
and a transition approach for affected government employees in selecting
the preferred alternative. Table 1 summarizes the estimated cost and
schedule for the three alternatives. (The Army determined that the status
quo was not a viable option because it could not meet the design,
implementation, and timeliness of future requirements. The Army concluded
that the risk of doing nothing was unacceptable.)

Table****Helvetica:x11****1:    Estimated Cost and Schedule for Wholesale
                                Logistics Modernization Alternatives

------------------------------------------------------------------------
| Current dollars in millions                                          |
|----------------------------------------------------------------------|
|                 :   Estimated cost to government^   :                |
|----------------------------------------------------------------------|
| Alternative     :    Program cost :      New system : Time to deploy |
|                 :    over the 10- :     development :                |
|                 :   year period^a :          cost^b :    new system  |
|----------------------------------------------------------------------|
| I               :          $581.7 :          $562.5 :       8 years  |
|                 :                 :                 :                |
| (All work done  :                 :                 :                |
| in-house)       :                 :                 :                |
|----------------------------------------------------------------------|
| II              :           425.2 :           329.8 :       6 years  |
|                 :                 :                 :                |
| (In-            :                 :                 :                |
| house/contracto :                 :                 :                |
| r mix of work)  :                 :                 :                |
|----------------------------------------------------------------------|
| III             :           420.9 :           253.5 :       5 years  |
|                 :                 :                 :                |
| (All work done  :                 :                 :                |
| by contractor)  :                 :                 :                |
------------------------------------------------------------------------

Note:  We did not attempt to validate the figures in the table.

^aCost of performing the legacy sustainment and modernization to a common
end-state over a 10-year period.

^bThis cost is included in the 10-year program cost. The cost of new
system development includes sustaining the legacy system until the new
system is deployed.

Source: The Business Case, Wholesale Logistics Modernization Program,
February 12, 1999.

According to the Army, its analysis showed that alternative III, which
called for contractor operation of the legacy system while developing the
modernized system, was the alternative expected to require the least time
to develop a new system, the smallest estimated investment costs, and the
lowest estimated operational costs over a 10-year period. It was also
considered the option most likely to be able to meet the Army's goal of a
solution that was executable within the program's existing operating
budget./Footnote8/ However, available Army data show a range of
uncertainty about the cost estimates that could make it difficult to
achieve this objective. Also, uncertainties associated with the transfer
of the work to the private sector could affect program stability during
the transition period.

Cost Uncertainties
------------------

The Army's request for proposals provides for an expenditure limit on the
planned contract, with certain exceptions,/Footnote9/ of under $40 million
a year, the approximate current funding level of the two centers. The
request for proposals further provides that up to an additional $30.5
million per contract year would be available for the data processing of
the modernized services. The amount allowed for processing is to be based
directly on the percentage of data processing performed by the contractor,
with the Defense Information Systems Agency performing the residual
processing. However, various factors suggest much uncertainty as to
whether the modernized system may be achievable within the projected
funding level.

First, as part of its economic analysis, AMC performed a limited
sensitivity analysis on alternative III/Footnote10/ by assessing how
underlying assumptions could affect cost estimates. The analysis showed
that for this alternative, developmental costs, an element of investment
cost, ranged from a low of $107.3 million to a high of $232.7 million. For
purposes of its comparison of alternatives, the Army adopted an estimate
at the mid-point of this range; nevertheless, the analysis underscored the
uncertainty associated with development cost estimates. Further,
concerning the issue of additional requirements in the future, the
economic analysis states that "the cost of system growth, adding new
functions during the ten year contract, has not been addressed by the
estimate and could be a significant area of cost considering the number of
related logistic process improvement plans." Underestimating the effects
of changing requirements can significantly affect software development
schedule and costs. History shows that the average project experiences
about a 25-percent increase in requirements over its lifetime. Such a
change can produce at least a 25-percent addition to the software schedule
and increase cost. Also, projects that skimp on initial system development
activities, such as requirement definition, must have the same work
performed later at anywhere from 10 to 100 times the cost of doing it
properly in the first place.

Second, cost uncertainties also exist because of the uncertain nature of
the requirements. The request for proposals/Footnote11/ provides for a
contract that contains a requirements portion and indefinite delivery
portion. The work is to be performed pursuant to task orders issued on
both a firm fixed price and time and materials basis. The cost of the work
is not known in advance for any of the task orders. The cost estimates of
those task orders to be issued on a time and materials basis are
particularly uncertain, even though the hourly rates would be fixed in the
contract, because the number of labor hours and the cost of materials are
not. 

A third risk area that could affect costs relates to the Army's tentative
plans for developing and implementing a modernized information system
under an incremental approach. Under the incremental approach, changes
affecting the legacy system would be made on a graduated basis. This would
allow a gradual transition from the legacy system to the modernized
system, requiring less sustainment of the legacy system as the functions
are transferred from the old to the new systems. Should this prove
feasible, the government would likely begin to realize the benefits of a
modernized system sooner, and the contractor might be able to achieve
operating efficiencies much sooner--and realize additional revenues by
assuming responsibilities for processing the new software code as it comes
online. Until that occurs, the processing of the existing software will
continue to be performed by the Defense Information Systems Agency.
However, an Office of Secretary of Defense official providing oversight
for the modernization effort has expressed concern that a modular,
incremental approach of transferring functions from the legacy system to a
new, modernized system will not work. He indicated that since the new
system is expected to be predicated upon reengineered processes, and new
software code tied to the new processes, this would likely preclude a
one-for-one modular replacement between old and new systems. An Army
official responsible for oversight of information systems issues agreed
that such an incremental approach is likely not to be feasible.

Fourth, known problems with DOD data--particularly "cost" data--undermine
confidence in the reliability of the cost estimates. DOD has acknowledged
fundamental problems with its ability to accumulate reliable cost
information. Continuing problems in this area were confirmed by our most
recent audit of the federal government's 1998 consolidated financial
statements./Footnote12/ For example, we reported that DOD is unable to
provide data on the costs associated with functions to be considered for A-
76 outsourcing competitions. Our audit also revealed a material deficiency
in DOD's ability to report budget information. Given the severity of these
deficiencies, the estimated cost of the modernization effort must be
considered uncertain.

Each of the above factors has the potential to affect the timing and costs
associated with developing and implementing the Army's modernized
wholesale logistics information management system. This could put the Army
in the difficult position of having to revisit issues of cost, timing, or
making tradeoffs in terms of modernization objectives. Close program
monitoring against specific program objectives and milestones will be
important to ensuring the program meets the requirements of relevant
legislation and policy guidance, including the Clinger-Cohen Act of 1996,
which requires federal agencies to have processes and information to help
ensure that technology projects (1) are implemented at acceptable costs,
within reasonable and expected time frames and (2) contribute to tangible,
observable improvements in mission performance. Such monitoring or
tracking of progress should be facilitated by the use of a performance
plan establishing specific goals and indicators to measure performance as
provided for in the Government Performance and Results Act of 1993.
Without performance measures, managers often have great difficulty getting
results from information systems because they cannot define their needs
precisely.

Uncertainty Over Employees' Receptivity to "Soft-Landing" Package
-----------------------------------------------------------------

As the Army contemplates relying upon a contractor to operate the legacy
system while developing a modernized system, uncertainties exist regarding
the extent to which government employees will be willing to accept the
"soft-landing" approach of employment with the winning contractor. Given
the limited amount of documentation on the legacy system, the continued
support of the existing workforce could be important to continuing
maintenance of the system during the transition period. While experience
in other DOD cases suggests that significant numbers of government
employees in other circumstances have accepted similar employment
opportunities with the private sector, the large number of center
employees nearing retirement eligibility under the Civil Service
Retirement System could limit the number of acceptances depending on the
availability of opportunities for other government positions.

An important feature of the Army's approach to the modernization program
is a so-called soft landing for displaced government
employees,/Footnote13/ ensuring them of employment with the winning
contractor. The Army believes such an approach also has important benefits
to both the government and the contractor since these employees may be
essential to maintaining the Army's existing legacy system as a modernized
system is being developed. The current system, as it has evolved over
time, consists of over 560 program applications, 3,000 major subordinate
command bridging programs, 260 databases, and over 20 million lines of
computer software code.  Available information suggests that the
institutional knowledge of the current employees may be essential to
maintaining the system given extensive system modifications that have been
made over the years, but with limited documentation. Based on analyses of
the Central Design Activities completed in 1994 and 1997, employing
criteria developed by the Software Engineering Institute, both centers
ranked very low in written technical documentation needed to replicate
operation and maintenance of their systems./Footnote14/ This means that
much of the institutional knowledge concerning the existing system resides
with the individual employees who have been responsible for maintaining
and modifying the system over time.

The Army currently plans for the wholesale logistics modernization program
contractor to assume operation and maintenance of the existing legacy
system about 90 days after contract award. The contractor is expected to
maintain and operate the legacy system, in full or in part, until the
modernized system becomes fully operational in an estimated 5 years.
Whether a contractor can sustain a system as complex as the Army's without
adequate documentation and staff experienced with that system remains
uncertain. In its business case analysis, the Army acknowledged the
potential for "interruption of wholesale logistics services to the war
fighter due to the transfer of expertise, workload, software, and
documentation of its legacy system to the contractor." The mitigation
proposed by the Army, however, does not fully address the risk. The Army's
mitigation strategy was that "the government would retain control of the
wholesale logistics processing at the Defense Information Systems Agency
Megacenters." However, the risk is in the contractor's ability to sustain
the legacy software, not process it.

While the Army's request for proposals requires that displaced government
employees be given positions with the winning contractor for a period of
at least 1 year, the number of employees who would be willing to accept
such positions, if offered, is unknown. About 85 percent of the current
center employees are participants in the government's Civil Service
Retirement System, and 83 percent will be eligible for either regular or
early retirement within 5 years/Footnote15/--reportedly making them
reluctant to leave Federal service before becoming eligible for
retirement.  

The number of persons willing to accept the soft-landing package could be
significantly affected by the availability of other federal opportunities
for employment. During on-site interviews, staff indicated to us that they
would prefer to continue working for the federal government rather than
join the contractor. A 1997 study sponsored by the Office of the Secretary
of Defense and conducted in RAND's National Defense Research Institute,
Outsourcing of DOD Commercial Activities: Impacts on Civil Service
Employees, addresses this issue. The report states, "Civil service workers
are averse to leaving civil service and accepting employment with
private-sector contractors. Reasons cited are nonportability of some
federal retirement benefits, better civil service wages and benefits, and
better job security." 

Officials from CECOM's personnel office told us that the current employees
expressed an overwhelming preference to remain in government service.
CECOM does not plan to conduct a formal survey to determine the number of
staff by functionality that would actually go to work for the winning
contractor, since many staff do not make decisions until the action is
imminent. 

At the same time, we found that some employees are already beginning to
seek other federal employment and that existing shortages of information
technology personnel within the government could provide other options for
the affected employees. As of May 31, 1999, the CECOM personnel office
told us its estimate of displaced employees who would be required to be
offered jobs by the contractor has been reduced from 350 to 335. However,
it believes the number may be further reduced since there already has been
more attrition than expected because of uncertainty about the program's
future. An official in the Office of Secretary of Defense has expressed
concern that continuing program uncertainties could endanger the
capability of the Army to maintain its existing wholesale logistics
functionality. 

Conclusions

To date, the Army has taken actions to comply with legislative and A-76
requirements for the plan to contract for the wholesale logistics
modernization. While we agree that there is a need to modernize and
improve operating efficiencies, we believe the modernization initiative
has significant uncertainties and risks. We expect some of these
uncertainties will be addressed during the contract negotiation process.
Even then, the uncertainties over cost and implementation schedule for the
modernized system are likely to remain for some time. Also, performance
measures have not been established for measuring whether the modernization
program is achieving observed results.

Recommendation

We recommend that the Secretary of Defense require the Secretary of the
Army to develop a transition plan based on an assessment of the
quantitative and qualitative risks associated with this project and what
actions are planned to mitigate those risks. We also recommend that the
Secretary of Defense require the Secretary of the Army provide for
sufficient oversight with quantifiable performance measures to track the
success of the modernization program.

Agency Comments and Our Evaluation

The Deputy Under Secretary of Defense (Logistics) provided written
comments on a draft of this report. The Department of Defense concurred
with the report's recommendations to develop a strategy to ensure actions
are in place to mitigate the risks associated with the Wholesale Logistics
Modernization Program. It indicated the Army will develop a transition
plan that will be put in place before contract award. The department also
stated that the Army plans to negotiate performance metrics as part of the
contract award. We are encouraged that DOD is starting to address the
risks and uncertainties that have been identified for this major
modernization effort. However, as we previously noted, we expect that the
uncertainties over cost and implementation schedule for the modernized
system will continue for some time and, as indicated in our
recommendation, will require high level oversight to track the success of
the modernization program.

DOD also provided technical comments, which have been incorporated as
appropriate. The department's written comments on a draft of this report
are included in appendix II.

Scope and Methodology

To determine if the Army's actions complied with the requirements of
applicable legislation and policy guidance, we reviewed Circular A-76 and
relevant legislation; the Army's programming and implementation plans; and
the A-76 waiver package, including the business case and economic
analysis, although we did not establish the reliability of the data. We
interviewed senior officials at the Logistics Systems Support Center, St.
Louis, Missouri; the Industrial Logistics Systems Center, Chambersburg,
Pennsylvania; CECOM, Fort Monmouth, New Jersey; and AMC, the Army's Office
of General Counsel, and the Office of Management and Budget, Washington,
D.C. We met and talked with many of the employees of both Central Design
Activities in St. Louis and Chambersburg. We also made use of our prior
work regarding A-76 issues.

To assess the risks associated with this proposal, we reviewed the A-76
waiver package, which included the business case, economic analysis, and
risk analysis of proposed alternatives, although we did not independently
verify the data. We also reviewed the request for proposals and the
solicitation package. We interviewed officials at the Office of the
Assistant Secretary of Defense, Command, Control, Communications, and
Intelligence and the Army Office of the Director of Information Systems
for Command, Control, Communication, and Computers charged with monitoring
the program and officials at AMC, CECOM, the Central Design Activities,
and the Defense Information Systems Agency. We also made use of our prior
work in the outsourcing area. 

We conducted our review from May 1998 through August 1999 in accordance
with generally accepted government auditing standards. 

We are providing copies of this report to the Honorable Charles S. Robb,
Ranking Minority Member of the Subcommittee on Readiness and Management
Support, Senate Armed Services Committee; the Honorable Ted Stevens,
Chairman of the Senate Committee on Appropriations; the Honorable Robert
C. Byrd, Ranking Minority Member of the Senate Committee on
Appropriations; the Honorable C.W. Bill Young, Chairman of the House
Committee on Appropriations; the Honorable David R. Obey, Ranking Minority
Member of the House Committee on Appropriations; the Honorable James M.
Talent, House Armed Services Committee; the Honorable William S. Cohen,
Secretary of Defense; the Honorable Louis Caldera, Secretary of the Army;
and the Honorable Jacob J. Lew, Director of OMB. We will make copies
available to others upon request.

If you have any questions regarding this report, please contact me on
(202) 512-8412.  Other GAO contacts and other key contributors to this
assignment are listed in appendix III.

*****************

*****************

David R. Warren, Director
Defense Management Issue

--------------------------------------
/Footnote1/-^ Now known as the House Armed Services Committee.
/Footnote2/-^field-operating commands, which receive support from the
  wholesale level.
/Footnote3/-^ This figure includes some costs for data processing that are
  outside the scope of the modernization effort. 
/Footnote4/-^ This program is also referred to as logistics modernization,
  or LOGMOD.
/Footnote5/-^ The Handbook was revised again in June 1999 to issue
  guidance for implementing the Federal Activities Inventory Reform Act of
  1998 (P.L. 105-270).
/Footnote6/-^ While A-76 addresses conversions in both directions, for
  purposes of this report, we will focus on conversion from performance by
  government employees to the private sector.
/Footnote7/-^ The Army notified the Congress prior to the effective date
  for last year's amendments. The prior version of section 2461 contains
  similar notification, certification, and cost comparison requirements.
/Footnote8/-^ The Army's approach is predicated on the assumption that a
  contractor will be willing to provide a sizable investment in the first
  few years with the anticipation that those costs, and a profit, will be
  forthcoming in the later years of the contract.
/Footnote9/-^ Exceptions include additional functionality and in-
  processing changes, data processing for transferred systems, data
  processing for modernized services, related logistics services, and
  expanded services.
/Footnote10/-^ Documentation of the Army's economic analysis states that a
  sensitivity analysis was conducted only for alternative III because it
  was the most favorable option.
/Footnote11/-^ The Army issued its request for proposals on April 29,
  1999; contractor proposals were submitted June 28, 1999.
/Footnote12/-^(GAO/AIMD-99-130, Mar. 31, 1999.)
/Footnote13/-^ Specifically, the "soft landing" requires the contractor to
  offer displaced employees jobs with comparable pay and benefits, in the
  employees' current geographical location, for a minimum of 1 year.
  Displaced employees are those who are on the Central Design Activities'
  rolls on the date immediately preceding the transfer and who are
  involuntarily separated from federal service as a result of the
  contracting action.
/Footnote14/-^ The Industrial Logistics Systems Center was determined to
  be level 2 by the Software Production Consortium in October 1997 and the
  Logistics System Support Center was ranked as level 1 by itself and the
  Software Engineering Institute in 1994. The scale goes from 1 to 5, with
  1 being the lowest ranking.
/Footnote15/-^ Regular voluntary retirement occurs when an employee wants
  to retire and meets the full age and service eligibility requirements.
  Early voluntary retirement occurs when an employee meets lesser age
  and/or service requirements than for regular voluntary retirement.
  Authority to grant early voluntary retirement must be approved by the
  Office of Personnel Management.

CHRONOLOGY OF THE MODERNIZATION INITIATIVE
==========================================

                                                                   
                ^aNow known as the Assistant Secretary of the Army
(Installations and Environment).
------------------------------------------------------------------------
| August 1997: In response to tasking from the Army Materiel Command   |
|            : (AMC), the Communications and Electronics Command       |
|            : formed a Special Project Team to gather information     |
|            : and market research to develop alternatives for         |
|            : modernizing its logistics processes.                    |
|----------------------------------------------------------------------|
| October    : Contractors were invited to present their approach to   |
| 1997       : performing the function.                                |
|----------------------------------------------------------------------|
| February   : AMC approved the team's approach, which proposed to     |
| 1998       : contract for development and sustainment of the         |
|            : wholesale logistics system, provide a "soft landing"    |
|            : for affected government employees, and provide for      |
|            : contractor operation of legacy systems until total      |
|            : implementation of a modernized system could be          |
|            : completed.                                              |
|----------------------------------------------------------------------|
| April 28,  : Concerned that the proposed approach would place        |
| 1998       : "national security at risk" by contracting for          |
|            : "mission essential support to the warfighter," the      |
|            : Chairman of the Military Readiness Subcommittee,        |
|            : House Committee on National Security, requested that    |
|            : the Office of the Assistant Secretary of the Army       |
|            : (Manpower and Reserve Affairs) and the Army Audit       |
|            : Agency answer specific questions about the proposed     |
|            : action. The Army considered its planned action was      |
|            : not subject to A-76 requirements.                       |
|----------------------------------------------------------------------|
| July 15,   : Pursuant to 10 U.S.C. 2461, the Army notified the       |
| 1998       : Congress of its intent to rely on private industry to   |
|            : modernize its information management system for         |
|            : wholesale logistics. The notification stated the Army   |
|            : would provide the Congress a summary of its cost        |
|            : comparison and other reports and certification          |
|            : required under 2461 prior to contract award.            |
|----------------------------------------------------------------------|
| August     : The Army Audit Agency published its report.             |
| 17, 1998   :                                                         |
|----------------------------------------------------------------------|
| October    : Because the Army changed its view and decided that A-   |
| 22, 1998   : 76 should apply, the Commander of AMC sent an A-76      |
|            : waiver package to the Assistant Secretary of the Army   |
|            : for Installations, Logistics and Environment,^a         |
|            : recommending that a cost-comparison waiver be           |
|            : granted. AMC recommended an alternative that would      |
|            : transfer responsibility of software support services    |
|            : to a private contractor, reengineer the business        |
|            : processes and recommend changes, and replace the        |
|            : legacy system with commercial software applications.    |
|----------------------------------------------------------------------|
| March 3,   : The original waiver package was revised, based on       |
| 1999       : input from cognizant Army organizations, and            |
|            : resubmitted to the Assistant Secretary. This package    |
|            : included a revised business case analysis, an           |
|            : economic analysis, an acquisition strategy, a           |
|            : logistics integration agency study, background          |
|            : research of industry's achievements in supply chain     |
|            : management, and a risk analysis of proposed             |
|            : alternatives. A draft request for proposals was also    |
|            : sent forward.                                           |
|            :                                                         |
|            : The memorandum supporting the waiver request            |
|            : emphasized the need to modernize the Army's logistics   |
|            : support system and proposed to leverage industry's      |
|            : investments and technology in the logistics field.      |
|            : The basis for the waiver request was threefold: (1)     |
|            : the conversion would result in significant service      |
|            : quality improvement, (2) the conversion would not       |
|            : serve to reduce significantly the level or quality of   |
|            : competition in the future award or performance of       |
|            : work, and (3) the functions to be converted are not     |
|            : inherently governmental.                                |
|----------------------------------------------------------------------|
| April 20,  : The Assistant Secretary approved the A-76 waiver        |
| 1999       : request--the first A-76 waiver approved by the Army.    |
|----------------------------------------------------------------------|
| April 27,  : The Army informed the Congress that it had approved a   |
| 1999       : waiver of the cost comparison requirements of A-76.     |
|            : The notice also reconfirmed the Army's intent to        |
|            : provide a detailed summary of its cost comparison and   |
|            : other reports and certifications pursuant to section    |
|            : 2461 prior to entering into any contract for            |
|            : wholesale logistics modernization.                      |
|----------------------------------------------------------------------|
| April 29,  : Employees and union are officially notified.            |
| 1999       : Final request for proposals is issued.                  |
|----------------------------------------------------------------------|
| May 13-    : A total of four appeals are filed with the Assistant    |
| 28, 1999   : Secretary of the Army for Installations and             |
|            : Environment by both the Industrial Logistics Systems    |
|            : Center and the Logistics System Support Center and      |
|            : are currently pending. The appeals are from             |
|            : individuals, a group of individuals, and the Local      |
|            : 1763 union, representing employees at the St. Louis     |
|            : Central Design Activity.                                |
|----------------------------------------------------------------------|
| June 17,   : Appellants are notified that the Secretary of the       |
| 1999       : Army will resolve the appeals after he has received a   |
|            : recommendation from an independent panel of senior      |
|            : civilian officials after July 30, 1999.                 |
------------------------------------------------------------------------

COMMENTS FROM THE DEPARTMENT OF DEFENSE
=======================================

*****************

*****************

*****************

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GAO CONTACTS AND STAFF ACKNOWLEDGMENTS
======================================

GAO Contacts

Barry Holman,  (202) 512-5581
Marilyn Wasleski, (202) 512-8436

Acknowledgments 

In addition to those named above, John Brosnan, Stephanie May,
J. T. "Mickey" McDermott, Debra McKinney, and Bonita Page made key
contributions to this report.

(709391)

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