Department of Energy: Challenges to Implementing Contract Reform (Letter
Report, 03/21/94, GAO/RCED-94-150).

This report to the Secretary of Energy summarizes GAO's views on her
Contract Reform Team's 1994 report entitled Making Contracting Work
Better and Cost Less. The Reform Team acknowledges that weaknesses in
the Energy Department's (DOE) "contracting practices are significant and
systemic." In GAO's view, the Team's recommendations--more than 45 in
all--represent a bold step forward for DOE and address many of GAO's
long-standing concerns. These suggestions include using
performance-based measures to evaluate contractors, providing more
incentives to motivate behavior, and reducing strict reliance on cost
contracts. The challenge facing DOE's leadership will be to develop a
strategy for making these reforms a reality. Overcoming workforce and
management information weaknesses--essential prerequisites for
change--is a major hurdle for DOE.

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

 REPORTNUM:  RCED-94-150
     TITLE:  Department of Energy: Challenges to Implementing Contract 
             Reform
      DATE:  03/21/94
   SUBJECT:  Contract administration
             Financial management
             Management information systems
             Contracting procedures
             Financial statement audits
             Financial records
             Accountability
             Contractors
             Contract monitoring
             Procurement regulation

             
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Cover
================================================================ COVER


Report to the Secretary of Energy

March 1994

DEPARTMENT OF ENERGY - CHALLENGES
TO IMPLEMENTING CONTRACT REFORM

GAO/RCED-94-150

DOE Contract Reform


Abbreviations
=============================================================== ABBREV

  DOE - Department of Energy
  GAO - General Accounting Office
  M&O - management and operating

Letter
=============================================================== LETTER


B-256648

March 21, 1994

The Honorable Hazel R.  O'Leary
The Secretary of Energy

Dear Madam Secretary: 

This letter summarizes our views on your Contract Reform Team's
report entitled Making Contracting Work Better and Cost Less,
February 1994.\1 The Reform Team's effort stemmed from your pledge in
early 1993 to evaluate and fundamentally reform the Department of
Energy's (DOE) contracting practices. 

As you know, we participated in several Reform Team meetings,
supplied background information for Team staff, and presented our
views at the DOE meetings on contract reform.  We also briefed you
and your senior managers on a variety of DOE's contracting issues as
well as on the overall management challenges facing the Department. 
We appreciate the opportunity to work with you and your staff on
these important issues.  Our objective in this letter is to present
several issues that your staff may want to consider as they develop a
strategy for implementing contract reform. 


--------------------
\1 Pursuant to the Feb.  17, 1994, notice in the Federal Register
requesting comments on the Contract Reform Team's recommendations. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The Reform Team acknowledges that "weaknesses in DOE's outdated
contracting practices are significant and systemic." The Team's
recommendations--over 45 in total--are a bold step forward for DOE,
address many of the concerns previously raised in our reports,
include an ambitious timetable for implementation, and require action
by many different parts of the organization. 

As DOE moves forward with its contracting changes, a number of issues
confront management as it develops an implementing strategy: 

  DOE staff should be prepared to implement the Team's initiatives
     with stronger contract administration and oversight skills,
     supported by reliable management and financial information
     systems.  Weaknesses in these areas have long plagued DOE's
     contracting activities and have hampered past contracting reform
     efforts. 

  The recommendation to hold nonprofit contractors to the same level
     of accountability as profit-making firms highlights the
     importance of having a skilled workforce and strong systems to
     properly administer new contracting rules. 

  DOE's desire to grant contractors greater freedom to change the
     skill mix of their workforces to meet new mission requirements
     underscores the importance of DOE's having an overall plan for
     restructuring the entire contractor workforce. 

  The recommendations to negotiate performance-based contracts places
     a high premium on developing fee and profit policies that are
     consistent with results- oriented performance measures. 

  Requiring audited financial statements from DOE's contractors
     (under review by the Chief Financial Officer) could lessen the
     need for the Team's other recommendations on voucher accounting
     and contract audits. 

Finally, a key to achieving contracting change will be establishing a
strong institutional entity with the oversight responsibility for
holding DOE managers accountable for implementing the Reform Team's
recommendations. 


   BACKGROUND
------------------------------------------------------------ Letter :2

DOE's contractors manage the nation's nuclear weapons production
complex and conduct basic research and development in science and
energy for the Department.  In fiscal year 1993, the cost of these
activities totaled about $19 billion.  Newer missions now require
DOE's contractors to manage the largest environmental cleanup effort
in the nation's history and redirect the expansive national
laboratory network into centers of excellence for commercial
technology and economic competitiveness. 

Employing nearly 150,000 contractor employees, DOE is the largest
civilian contracting agency in the federal government.  It has 52
management and operating (M&O) contracts with many private
corporations and nonprofit institutions.  The key feature of DOE's
M&O contracting is that all costs to contractors are generally
reimbursed by DOE.  Historically, DOE has provided little oversight
over its contractors' activities and the resulting costs to DOE.  DOE
has about 20,000 employees, 5,200 of whom are located in field
offices directly responsible for overseeing contractors. 

The urgency and uncertainties associated with building the world's
first atomic bombs led to special arrangements that allowed DOE's
predecessors to rely extensively on the contractors' expertise to
manage and operate a vast network of weapons facilities.  Contractors
have worked under these arrangements for nearly 50 years and have
made extraordinary contributions to the nation's nuclear enterprise. 
However, changing national priorities, recent world events, the
environmental degradation of the DOE's weapons complex, and the
demand for greater accountability by DOE and its contractors call
into question the continuance of these special arrangements. 


   CONTRACTING REFORMS ARE A MAJOR
   STEP FORWARD
------------------------------------------------------------ Letter :3

DOE intends to make significant changes in its 50-year-old
contracting practices.  Over 45 specific "action items" are advanced,
along with other recommendations for changing how DOE conducts it
business through the private sector.  An aggressive time schedule for
completing actions is also presented.  Many recommendations start
immediately and cover a wide range of contracting practices. 

The Reform Team accurately characterizes DOE's basic contracting
weaknesses and boldly calls for fundamental change, a position
consistent with our views articulated in numerous reports to DOE and
the Congress (see the end of this report for a list of related GAO
reports and testimonies). 

The Team's basic premise is that DOE's contracting suffers from an
overreliance on cost contracts, a lack of well-defined performance
criteria and measures, and weaknesses in oversight.  To correct these
conditions, the Team established broad goals calling for

  more flexibility in contracting,

  wider use of incentives for contractors, and

  a willingness to experiment. 

These changes, along with many other measures suggested, should
provide DOE with a stronger basis for selecting and evaluating those
contractor behaviors that are consistent with mission needs. 


   PREPARING DOE FOR CHANGE
------------------------------------------------------------ Letter :4

The Reform Team recognizes that changing DOE's contracting practices
poses "an enormous challenge." We certainly agree and believe that
fundamental change is a long-term process.  As DOE develops its
strategy to implement contract change, we believe closer attention to
several issues can help prepare DOE for contracting reform. 


      IMPROVING DOE'S OVERSIGHT
      SKILLS AND CAPABILITIES
---------------------------------------------------------- Letter :4.1

The Reform Team's report focuses heavily on improving DOE's
contracting vehicles--a substantial need--but gives less attention to
developing ways to improve contract administration and oversight.  We
believe that under any new contracting strategy, DOE's challenge is
to manage its contractors more effectively than it has in the past. 
Although the Reform Team acknowledges the needs in these areas, few
of its recommendations aim to improve workforce skills and systems,
and many actions are scheduled before workforce and systems
corrections are in place.  For example, a recommendation to improve
financial management is a critical action slated for implementation
late in the cycle. 

Poor contract administration and oversight skills are major reasons
why DOE has had difficulty in its past contracting practices. 
Applying new practices will require significant training and perhaps
higher staff levels in some locations--needs acknowledged by the
Reform Team.  Our examination of DOE's implementation of past
contracting reforms illustrates the need for having a technically
skilled and trained workforce with supporting systems to administer
reforms before major changes in contracting practices are attempted. 
Both the accountability rule and task order contracting--two of DOE's
previous contracting initiatives--
encountered many difficulties because field staff were not trained to
administer these programs.\2 As a result, DOE staff were forced to
rely on the contractors for information and systems support.  DOE
staff could not independently evaluate the contractors' costs or
other activities.  Ultimately, under the accountability rule,
contractors received higher fees without a commensurate increase in
risk. 

Furthermore, the field office managers reported being overwhelmed by
the demands of new initiatives.  Field managers still report that
they are understaffed in many areas, and other reviews and
observations--
including those by the Reform Team--frequently document and recognize
the need to upgrade staff skills. 

The use of performance-based standards also underscores the need for
a more skilled workforce.  Designing and administering new sets of
performance standards under a new contract form could be quite
complex, particularly at diversified facilities where research and
production activities all exist under a single contractor.  In
addition, the Team's Rocky Flats model is a complex arrangement that
places a high premium on the skills of DOE's local staff.  The model
was designed to blend a variety of fixed-price and cost-reimbursable
contracts under potentially many different contractors; some of the
contracts are to be administered by DOE staff and others by a new
form of management contractor. 

To the extent that DOE's contractors negotiate higher potential fees
to compensate for increased levels of accountability, a danger exists
that under DOE's new contracting environment, contractors could
receive higher profits without a corresponding increase in risk or
performance.  Strengthening DOE's contract administration and
oversight skills as among the highest--and earliest--priorities would
help ensure that new contracting practices achieve their intended
objectives. 


--------------------
\2 The accountability rule holds contractors liable for expenditures
not allowed by regulation or those that could have been avoided by
proper contract performance.  Task order contracting requires DOE to
describe tasks to be performed by the contractor in substantially
more detail than under previous arrangements and requires specific
DOE authorization before work can begin or moneys can be obligated. 


      CHANGING THE CONTRACTOR
      WORKFORCE
---------------------------------------------------------- Letter :4.2

Historically, only a handful of senior managers are replaced when new
contractors arrive to manage and operate DOE's facilities--as few as
a dozen out of 14,000 employees in one changeover.  The contractors
are required by DOE's policy to retain the existing workforce, except
for a small number of "key" officials.  In other words, the
contractor workforce is more or less permanent.  The Reform Team
argues that workforce retention policies restrict a new contractor's
ability to change the skill mix to meet changing mission
requirements. 

The Reform Team's desire to revise DOE's policy requiring a
contractor to retain the previous contractor's workforce could be a
significant change in DOE's practice.  This is a complex issue
involving many considerations, such as union agreements, retraining,
and cost effectiveness.\3 How DOE prepares to allow its contractors
more freedom to change their workforces will be closely watched by
stakeholder groups, including the Congress, states, and regulators. 

Having in place a plan that is based on an analysis of the
contractors' skill needs, consistent with DOE's changing missions,
would be important to the success of new policies. 


--------------------
\3 For example, under section 3161 of the National Defense
Authorization Act for Fiscal Year 1993, the Secretary of Energy must
develop a plan for restructuring the workforce for a defense nuclear
facility, whenever a change in workforce is deemed necessary. 


      PROVIDING MORE CONTRACT
      FINANCIAL INCENTIVES
---------------------------------------------------------- Letter :4.3

The Reform Team recommends using performance-based measures for
evaluating the contractors' activities on a more objective and
results-oriented basis.  The Team also recommends developing
incentives to reward superior and penalize inferior performance. 
Setting an objective to reduce the disincentives in the current
contractors' profit structure would help DOE achieve its new goals. 

For example, historically, DOE has relied extensively on the
cost-plus-award-fee contract by which a for-profit contractor earns a
"base" fee for operating a DOE facility.  The contractor need only
perform at the level of "satisfactory" to earn its base fee.  In
addition, the contractor can earn an additional or "award" fee based
on DOE's evaluation of the contractor's performance.  DOE uses award
fees to influence contractors' behavior, for example, in
environmental, safety and health issues.  Recently, in a rare
occurrence, two DOE contractors were denied award fees because of
poor performance. 

In some contracts, the award fee earned is smaller than the base fee,
and DOE allows unearned award fees to carry over to the next rating
period, thereby creating a second chance for the contractor. 
Consequently, a contractor could receive little or no award fee for
poor performance in one period but then, in the next period, receive
an award fee, plus all or part of its previously unearned fee even if
performance declines.  DOE's carryover provision could limit
contractors' incentive because contractors may be afforded an
opportunity to earn fees that previous performance did not merit. 
This provision could also raise the assumption that little incentive
exists to strive for the award fee, thereby limiting the success of
DOE's new performance-based measures. 


      INCREASING THE
      ACCOUNTABILITY OF NONPROFIT
      CONTRACTORS
---------------------------------------------------------- Letter :4.4

The Reform Team makes a recommendation to hold nonprofit contractors
to the same controls on cost reimbursement as profit-making
contractors.  In general, DOE has not subjected nonprofits to the
same level of cost controls as for-profit contractors.  To compensate
for the increased risk, the Reform Team intends to pay nonprofits a
management fee, subject to certain limitations. 

Holding nonprofits to a higher level of accountability underscores
the need to be able to competently administer the new cost-control
provisions.  We have consistently reported on DOE's weaknesses in the
administrative oversight of its national laboratories, and we fear
that providing additional fees could lead to the same results that
DOE experienced with the accountability rule as applied to for-profit
contractors--higher fees without the increased risk.  The burden of
proof will be on DOE to ensure that only allowable costs are claimed
and reimbursed. 


      STRENGTHENING FINANCIAL
      MANAGEMENT
---------------------------------------------------------- Letter :4.5

The Reform Team recommends a number of actions to improve financial
management, such as "explore alternatives to the use of the Voucher
Accounting for Net Expenditures Accrued" and "evaluate increasing
Departmental capability for review and audit of contracts and
contractors." In addition, the Team noted that DOE is considering the
costs and benefits of requiring audited financial statements from
contractors. 

We believe that audited financial statements, if properly planned and
conducted, could achieve the objectives of the Team's other financial
improvement recommendations.  Combining all three actions into a
single audit strategy could be an efficient and effective
implementing approach. 

Finally, the Team recommends benchmarking various indirect- cost
categories against the "best in class" of public and private
businesses with the goal of reducing indirect costs.  As these
benchmarking techniques are developed, in order to achieve
cost-reduction goals, it is important that DOE closely monitor
progress to ensure that the artificial transfer of indirect costs to
direct-cost categories does not occur. 


      DESIGNATING AN OVERSIGHT
      ENTITY FOR CONTRACTING
      REFORM
---------------------------------------------------------- Letter :4.6

The Team acknowledges the importance of contracting to DOE's mission
and notes that effecting change of this magnitude will be "an
enormous challenge." We agree.  Reforming DOE's contracting practices
will be an ongoing and long-term process.  Meeting this challenge
will also mean designing and implementing an effective strategy that
sets realistic goals for executing actions, allows for gauging
success, and then makes the necessary adjustments. 

Perhaps the most important feature of an implementing strategy is
holding responsible officials accountable for action.  The Team
intends to establish a committee of senior managers to oversee the
reform's implementation.  This committee will certainly serve an
important leadership role.  However, overseeing the progress of
contracting reform will require an ongoing presence by a central
source with the authority to oversee progress and make adjustments as
necessary. 


   CONCLUSIONS
------------------------------------------------------------ Letter :5

The Contract Reform Team has made many important recommendations to
change the way DOE conducts its business through contractors.  Its
many recommendations, including using performance-based measures to
evaluate contractors, providing more incentives to motivate behavior,
and reducing strict reliance on cost contracts, are major steps for
DOE.  The challenge facing DOE's leadership will be developing a
strategy for implementing these reforms so that real change takes
place.  Overcoming workforce and management information
weaknesses--necessary prerequisites for change--is a major hurdle for
DOE. 


---------------------------------------------------------- Letter :5.1

We are sending copies of this report to interested congressional
committees and subcommittees and to the Director, Office of
Management and Budget.  We will also make copies available to others
upon request. 

If you or your staff have any questions about the information
provided in this report, please contact me at (202) 512-3841.  Other
major contributors to this report are listed in appendix II. 

Sincerely yours,

Victor S.  Rezendes
Director, Energy and Science Issues


OBJECTIVES, SCOPE, AND METHODOLOGY
=========================================================== Appendix I

The purpose of our review was to evaluate DOE's contracting reform
efforts under way to improve contracting practices.  This is one of a
series of GAO reports that assess the Department's management and
organizational performance. 

We examined the Contract Reform Team's report and the documentation
used to prepare the report.  We also attended several meetings of the
Contract Reform Team and discussed aspects of the Team's findings
with several DOE officials. 

We examined the progress that DOE had made on implementing four major
initiatives that were the major contracting changes DOE made over the
past several years:  the accountability rule, task order contracting,
incentive contracting, and environmental restoration management
contracting.  In reviewing these initiatives, we interviewed DOE
headquarters and field officials, examined DOE's internal reports
relevant to the implementation and success of these initiatives, and
discussed their implementation with field managers.  We performed our
audit work at DOE headquarters in Washington, D.C., and at the
following DOE field offices:  Albuquerque, in Albuquerque, New
Mexico; Nevada, in Las Vegas, Nevada; and the Rocky Flats Plant, near
Denver, Colorado. 

We also examined relevant criteria in the Federal Acquisition
Regulation and the Department of Energy Acquisition Regulation to
determine how the new contracting initiatives are consistent with
these regulations. 

Also, we interviewed contractors to obtain their perspective on the
impact of DOE's new contract initiatives and the status of the
implementation efforts. 

We conducted our review from June 1993 through February 1994 in
accordance with generally accepted government auditing standards. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II


   RESOURCES, COMMUNITY, AND
   ECONOMIC DEVELOPMENT DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Jim Wells, Associate Director
Gary R.  Boss, Assistant Director
John Yakaitis, Assignment Manager


   DENVER REGIONAL OFFICE
-------------------------------------------------------- Appendix II:2

Julia DuBois, Evaluator-in-Charge
Ernie Limon, Staff Evaluator





RELATED GAO PRODUCTS
=========================================================== Appendix 0

Financial Management:  Energy's Material Financial Management
Weaknesses Require Corrective Action (GAO/AIMD-93-29, September 30,
1993). 

Department of Energy:  DOE Management Problems Require A Long-Term
Commitment To Change (GAO/RCED-93-72, Aug.  31, 1993). 

Energy Management:  High Risk Area Requires Fundamental Change
(GAO/T-RCED-93-7, Feb.  17, 1993). 

High Risk Series:  Department of Energy Contract Management
(GAO/HR-93-9, Dec.  1992). 

Department of Energy:  Better Information Resources Management Needed
To Accomplish Mission (GAO/IMTEC-92-53, Sept.  29, 1992). 

DOE Management:  Impediments to Environmental Restoration Management
Contracting (GAO/RCED-92-244, Aug.  14, 1992). 

Nuclear Health and Safety:  More Can Be Done to Better Control
Environmental Restoration Costs (GAO/RCED-92-71, Apr.  20, 1992). 

Energy Management:  Vulnerability of DOE's Contracting to Waste,
Fraud, Abuse, and Mismanagement (GAO/RCED-92-101, Apr.  10, 1992). 

Nuclear Health And Safety:  Increased Rating Results in Award Fee to
Rocky Flats Contractor (GAO/RCED-92-162, Mar.  24, 1992). 

Energy Management:  Systematic Analysis of DOE's Uncosted Obligations
Is Needed (GAO/T-RCED-92-41, Mar.24, 1992). 

Energy Management:  DOE Has an Opportunity to Improve Its University
of California Contracts (GAO/RCED-92-75, Dec.  26, 1991). 

Energy Management:  Tightening Fee Process and Contractor
Accountability Will Challenge DOE (GAO/RCED-92-9, Oct.  30, 1991). 

Energy Management:  Contract Audit Problems Create the Potential for
Fraud, Waste, and Abuse (GAO/RCED-92-41, Oct.  11, 1991). 

Energy Management:  DOE Actions to Improve Oversight of Contractors'
Subcontracting Practices (GAO/RCED-92-28, Oct.  7, 1991). 

Energy Management:  Using DOE Employees Can Reduce Costs for Some
Support Services (GAO/RCED-91-186, Aug.  16, 1991). 

Nuclear Security:  Property Control Problems at DOE's Livermore
Laboratory Continue (GAO/RCED-91-141, May 16, 1991). 

Nuclear Security:  DOE Oversight of Livermore Property Management
System Is Inadequate (GAO/RCED-90-122, Apr.  18, 1990). 

Nuclear Health And Safety:  DOE's Award Fees at Rocky Flats Do Not
Adequately Reflect ES&H Problems (GAO/RCED-90-47, Oct.  23, 1989). 
