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entitled 'Defense Contracting: Improved Insight and Controls Needed 
over DOD's Time-and-Materials Contracts' which was released on June 29, 
2007.

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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:

DOD Time-and-Materials Contracts:

GAO-07-273:

GAO Highlights:

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

Why GAO Did This Study:

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 Defenseís (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 
DODís 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.

What GAO Found:

DODís 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 
Administrationís schedule contracts). The accuracy of reported time-and-
materials dollars should improve starting with fiscal year 2007 because 
DOD transitioned to the federal governmentís procurement information 
system, which requires contract type to be coded for every order. 

Over 75 percent of DODís 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 officersí 
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 contractorís 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. GAOís 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 primeís 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.

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.

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-273]: 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Katherine V. Schinasi at 
(202) 512-4841 or schinasik@gao.gov.

[End of section]

Contents:

Letter: 

Results in Brief:

Background:

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

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

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

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

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

Conclusions:

Recommendations:

Agency Comments and Our Evaluation:

Appendix I: Scope and Methodology:

Appendix II: Comments from the Department of Defense:

Appendix III: GAO Contact and Staff Acknowledgments:

Tables:

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

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

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

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

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

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

Figures:

Figure 1: Contract Types:

Figure 2: DOD Reported Obligations against Service Contracts:

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

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

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

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:

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.

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,[Footnote 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),[Footnote 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.

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:

[See PDF for image]

Sources: FAR, Defense Federal Acquisition Regulation Supplement, DOD 
Contract Pricing Guide (data); GAO (presentation and analysis): 

[End of figure]

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.[Footnote 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.[Footnote 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.[Footnote 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.[Footnote 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,[Footnote 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)[Footnote 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.

Commercial companies avoid time-and-materials contracts in most 
situations. In a prior review,[Footnote 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.

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:

[See PDF for image]

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

[End of figure]

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:

[See PDF for image]

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

[End of figure]

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.[Footnote 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.

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

Type of service: Professional, administrative, and management support 
services; DOD obligations in fiscal year 2005: $28.3 billion; DOD 
obligations using time-and-materials contracts in fiscal year 2005: 
$4.2 billion; Time-and-materials obligations as a percentage of DOD's 
total fiscal year 2005 obligations: 15 percent.

Type of service: Information technology and communications; DOD 
obligations in fiscal year 2005: 10.3 billion; DOD obligations using 
time-and-materials contracts in fiscal year 2005: 1.8 billion; Time- 
and-materials obligations as a percentage of DOD's total fiscal year 
2005 obligations: 18 percent.

Type of service: Maintenance, repair, and rebuilding of equipment; DOD 
obligations in fiscal year 2005: 11.4 billion; DOD obligations using 
time-and-materials contracts in fiscal year 2005: 1.3 billion; Time- 
and-materials obligations as a percentage of DOD's total fiscal year 
2005 obligations: 12 percent.

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

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

[End of table]

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: Contract/order type: Order under an indefinite- 
delivery contract; DOD obligations in fiscal year 2005: $7.928; 
Percentage of obligations: 82.

Dollars in billions: Contract/order type: Definitive contract; DOD 
obligations in fiscal year 2005: 0.832; Percentage of obligations: 9.

Dollars in billions: Contract/order type: Blanket purchase agreement 
order under federal schedule; DOD obligations in fiscal year 2005: 
0.761; Percentage of obligations: 8.

Dollars in billions: Contract/order type: Order under an agreement; DOD 
obligations in fiscal year 2005: 0.066; Percentage of obligations: less 
than 1.

Dollars in billions: Contract/order type: All other contracts; DOD 
obligations in fiscal year 2005: 0.099; Percentage of obligations: 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.

[End of table] 

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[Footnote 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,[Footnote 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.

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,[Footnote 13] time-and- 
materials was by far the predominant type used, as shown in table 3.

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

Dollars in thousands: Contract 1; Fixed price: $456, 0.03%; Cost 
reimbursable: 0, 0; Time-and-materials: $1,510,146, 99.97%; Total: 
$1,510,602, 100.00%.

Dollars in thousands: Contract 2; Fixed price: 2,053, 0.15%; Cost 
reimbursable: 0, 0; Time-and-materials: 1,341,109, 99.85%; Total: 
1,343,161, 100.00%.

Dollars in thousands: Contract 3; Fixed price: 43,558, 6.59%; Cost 
reimbursable: $4,906, 0.74%; Time-and-materials: 612,213, 92.66%; 
Total: 660,677, 100.00%.

Dollars in thousands: Contract 4; Fixed price: 118,539, 36.77%; Cost 
reimbursable: 3,494, 1.08%; Time-and-materials: 200,360, 62,15%; Total: 
322,393, 100.00%.

Dollars in thousands: Contract 5; Fixed price: 24,634, 9.29%; Cost 
reimbursable: 22,493, 8.48%; Time-and-materials: 218,014, 82.23%; 
Total: 265,141, 100.00%.

Note: Totals may not add due to rounding.

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

[End of table]

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:

* 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.[Footnote 14]

* 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.

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.[Footnote 15] The determination and findings is 
required to set forth enough facts and circumstances to clearly and 
convincingly justify the determination made.[Footnote 16] Contract type 
is also addressed in acquisition plans, which set forth the overall 
strategy for managing the acquisition.[Footnote 17] These management 
controls are designed to help decision makers ensure that a time-and- 
materials contract is appropriate.[Footnote 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.[Footnote 19]

We found that some contracting officers' justifications for use of time-
and-materials contracts quoted language from the FAR[Footnote 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.

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.[Footnote 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."

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.

* 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.

* 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.

* 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.

* 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.[Footnote 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.[Footnote 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.

* 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.

* 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.

* 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.[Footnote 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.

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.[Footnote 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[Footnote 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:

* 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:

* 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.[Footnote 27]

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

* 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.

* 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.

* 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.

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.[Footnote 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.[Footnote 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.[Footnote 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."

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.

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[Footnote 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.

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:

[See PDF for image]

Sources: Prime contracts, proposals, and subcontracts (data); GAO 
(analysis and presentation).

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

[End of figure]

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:

[See PDF for image]

Sources: Prime contracts, proposals, and subcontracts (data); GAO 
(analysis and presentation). 

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.

[End of figure]

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: A; Labor category: Senior Analyst (Subcontractor 1); Rate 
difference: $11.23; Percent difference: 16.48.

Contract: A; Labor category: Senior Analyst (Subcontractor 2); Rate 
difference: - 10.43; Percent difference: -11.61.

Contract: A; Labor category: Senior Analyst (Subcontractor 3); Rate 
difference: 12.73; Percent difference: 19.10.

Contract: B; Labor category: Technician; Rate difference: -7.92; 
Percent difference: -15.70.

Contract: B; Labor category: Technical Editor; Rate difference: 19.34; 
Percent difference: 75.19.

Contract: B; Labor category: Engineer/Analyst; Rate difference: 10.17; 
Percent difference: 20.16.

Contract: C; Labor category: Program Manager Level 4; Rate difference: 
16.16; Percent difference: 14.70.

Contract: C; Labor category: Systems Engineer Level 4; Rate difference: 
5.39; Percent difference: 6.30.

Contract: C; Labor category: Systems Engineer Level 3; Rate difference: 
1.11; Percent difference: 1.59.

Contract: C; Labor category: Systems Engineer Level 2 (Subcontractor 
1); Rate difference: 2.55; Percent difference: 4.41.

Contract: C; Labor category: Systems Engineer Level 2 (Subcontractor 
2); Rate difference: 31.39; Percent difference: 108.24.

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

[End of table]

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.[Footnote 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[Footnote 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.

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,[Footnote 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....[Footnote 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.

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.[Footnote 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.[Footnote 37] Table 5 
summarizes the new FAR rule[Footnote 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:

Commercial contracts (governmentwide): Prime contractor is not required 
to propose separate rates for prime and subcontractor labor[A].

Noncommercial contracts: Noncompetitive award: Governmentwide: Prime 
contractor is required to propose separate rates for prime and 
subcontractor labor; 

Noncommercial contracts: Competitive award: Non-DOD: Prime contractor 
is not required to propose separate rates for prime and subcontractor 
labor[B]; 

Noncommercial contracts: Competitive award: DOD interim rule: Prime 
contractor is required to propose separate rates for prime and 
subcontractor 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.

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

[B] However, 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.

[End of table]

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.

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:

* contain sufficient facts and rationale to justify that no other 
contract type authorized is suitable;

* address the specific characteristics of the acquisition that prevent 
the use of either a cost-reimbursable or fixed-price contract;

* 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:

* 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 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 
schinasik@gao.gov. 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.

Signed by: 

Katherine V. Schinasi: 
Managing Director: 
Acquisition and Sourcing Management:

[End of section]

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.[Footnote 39] 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.

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

Organizations; Air Force: Number in our sample; 7: 
Organizations; Army: Number in our sample; 8: 
Organizations; Defense Contract Management Agency: Number in our 
sample; 1: 
Organizations; Defense Information Systems Agency: Number in our 
sample; 2:
Organizations; Defense Intelligence Agency: Number in our sample; 2:  
Organizations; Navy: Number in our sample; 8. 

Obligated dollars through fiscal year 2005; Over $1 billion: Number in 
our sample 2:
Obligated dollars through fiscal year 2005; $1 billion to $500 million: 
Number in our sample; 1:
Obligated dollars through fiscal year 2005; $500 million to $100 
million: Number in our sample; 3: 
Obligated dollars through fiscal year 2005; $100 million to $50 
million: Number in our sample; 5: 
Obligated dollars through fiscal year 2005; $50 million to $10 million: 
Number in our sample; 8: 
Obligated dollars through fiscal year 2005; Less than $10 million: 
Number in our sample; 9. 

Types of services; Engineering and technical support: Number in our 
sample; 12: 
Types of services; Information technology: Number in our sample; 11:  
Types of services; Maintenance of equipment: Number in our sample; 3:
Types of services; Miscellaneous professional, administrative, and 
management support: Number in our sample; 2. 

Types of contract vehicles; Indefinite-quantity contract: Number in our 
sample; 13: 
Types of contract vehicles; Standalone contract; Number in our sample; 
5:
Types of contract vehicles; Order off a schedule or governmentwide 
acquisition contract: Number in our sample; 4: 
Types of contract vehicles; Blanket purchase agreement: Number in our 
sample; 4: 
Types of contract vehicles; Basic ordering agreement; Number in our 
sample; 1: 
Types of contract vehicles; Requirements contract; Number in our 
sample: 1. 

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

[End of table]

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.

[End of section]

Appendix II: Comments from the Department of Defense:

[See PDF for image]

[End of figure]

Acquisition, Technology And Logistics: 

Office Of The Under Secretary Of Defense: 
3000 Defense Pentagon:
Washington, Dc 20301-3000:

JUN 29 2007:

Ms. Katherine V. Schinasi:
Managing Director, Acquisition and Sourcing Management: 
U.S. Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

Dear Ms. Schinasi:

This is the Department of Defense (DoD) response to the GAO draft 
report, GAO-07-273, "DEFENSE CONTRACTING: Improved Insight and Controls 
Needed over DoD's Time-and-Materials Contracts," dated June 1, 2007, 
(GAO Code 120512).

I appreciate the opportunity to comment on the draft report. I concur 
with the GAO recommendations as discussed in the enclosure. I have 
opened two Defense Federal Acquisition Regulation Supplement (DFARS) 
cases to develop necessary changes to the DFARS and any additional 
supplemental guidance that may be appropriate for procedures, guidance, 
and information. I anticipate issuance of the proposed rules and/or 
supplemental guidance within 180 days.

Additionally, I will issue direction within the next 60 days to require 
the military departments and other defense agencies to develop plans 
for analyzing whether time-and-materials contracts are being used as a 
default contract type when other pricing arrangements may be 
appropriate.

If you have any questions or require additional information, please 
contact Ms. Robin Schulze, 703-602-0326, robin.schulze@osd.mil,.

Sincerely,

Signed by: 

Shay D. Assad: 
Director, Defense Procurement: 
and Acquisition Policy:

Attachments: 
As stated:

GAO Draft Report Dated June 1, 2007: 
GAO-07-273 (GAO CODE 120512):

"Defense Contracting: Improved Insight And Controls: 
Needed Over Dod's Time-And-Materials Contracts"

Department Of Defense Comments: 
To The Gao Recommendations:

Recommendation 1: The GAO recommends 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 requiring the contracting officer to execute 
written justifications for each time-and-materials task order issued 
under an indefinite-quantity contract.

Dod Response: Concur. The Department has opened a DFARS case to 
evaluate, for T&M contracts for non-commercial services, whether the 
DFARS should be amended to require a written determination and finding 
(D&F) for each time-and-materials task order issued under an 
indefinite-quantity contract that provides for orders priced on both a 
time-and-materials basis and orders priced on another contract type 
basis, i.e., fixed-price, cost reimbursement, and incentive contracts. 
DPAP will keep the GAO apprised of the progress of this case as it 
moves thru the regulatory process.

Recommendation 2: The GAO recommends 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 requiring that written justifications be 
prepared for indefinite-quantity contracts that allow only for time-
and-materials orders.

Dod Response: Concur. As part of the DFARS case referenced in our 
response to Recommendation 1, the Department will evaluate, for T&M 
contracts for non-commercial services, whether the DFARS should be 
amended to require D&Fs supporting basic indefinite-delivery contracts 
that only provide for time-and-material orders to explain why it is not 
practicable for the contract to also provide for orders on a fixed-
price, cost reimbursement, and/or incentive contract basis. The case 
will also consider whether the DFARS should be amended to require that 
the D&F to be approved one level above the contracting officer, for the 
D&F to document why other pricing structures are not practicable, and 
to require higher level approval to increase the emphasis on selecting 
the appropriate contract type that results in reasonable contractor 
risk and provides the contractor with the greatest incentive for 
efficient and economical performance. DPAP will keep the GAO apprised 
of the progress of this case as it moves thru the regulatory process.

Recommendation 3: The GAO recommends 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 requiring that written justifications for the 
use of time-and-materials contracts and task orders:

a) Contain sufficient facts and rationale to justify that no other 
contract authorized is suitable;

b) Address the specific characteristics of the acquisition that prevent 
the use of either a cost-reimbursable or fixed-price contract;

c) 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: 

d) Describe actions planned to maximize the use of fixed-price 
contracts on future acquisitions for the same requirements.

Dod Response: Concur. As part of the DFARS case referenced in our 
response to Recommendation 1, the Department will consider, for T&M 
contracts for non-commercial services, whether to amend the DFARS to 
require D&Fs for time-and-materials contracts and task orders to:

a) Contain sufficient facts and rationale to justify that no other 
contract type is suitable;

b) Establish that it is not possible at the time of placing the 
contract or order to accurately estimate the extent or duration of the 
work or to anticipate costs with any reasonable degree of certainty;

c) Establish that the requirement has been structured to maximize the 
use of firmer pricing (i.e., cost-reimbursement, incentive, and fixed-
price contracts) on future acquisitions for the same or similar 
requirements; and:

d) Describe actions planned to maximize the use of firmer pricing on 
future acquisitions for the same requirements.

Recommendation 4: The GAO recommends 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 requiring the contracting officer, 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.

Dod Response: Concur. As part of the DFARS case referenced in our 
response to Recommendation 1, the Department will consider, for T&M 
contracts for non-commercial services, amending the DFARS to require 
indefinite-quantity contracts to be structured, to the maximum extent 
practicable, to also provide for issuance of other contract types. The 
Department agrees it may be appropriate to provide for multiple 
contract types on indefinite-delivery contracts to ensure use of the 
appropriate contract type for the unique circumstances of the 
acquisition.

Recommendation 5: The GAO recommends that the Secretary of Defense 
direct the Director of Defense Procurement and Acquisition Policy to 
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 appropriate.

Dod Response: Concur. The Department will require the military 
departments and other defense agencies to establish review plans for 
analyzing whether time-and-materials contracts are being used as a 
default contract type when other pricing arrangements may appropriate.

Recommendation 6: The GAO recommends that the Secretary of Defense 
direct the Director of Defense Procurement and Acquisition Policy to 
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 risk to the extent feasible.

Dod Response: Concur. The Department has opened a DFARS case to (a) 
describe the roles and responsibilities of contracting officers 
technical representatives (COTRs) for managing risks on time-and-
materials and other cost reimbursement contracts and (b) ensure 
Government surveillance on time-and-materials contracts provides the 
Government reasonable assurance that efficient methods and effective 
costs controls are being used.	DPAP will keep the GAO apprised of the 
progress of this case as it moves thru the regulatory process.

[End of section]

Appendix III: GAO Contact and Staff Acknowledgments:

GAO Contact:

Katherine V. Schinasi (202) 512-4841 or schinasik@gao.gov:

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.

FOOTNOTES

[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.

[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.

[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.

[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).

[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.

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

[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.

[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, 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.

[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.

[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).

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

[25] The changes went into effect in February 2007. 

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

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

[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.

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

[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.

[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).

[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). 

[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. 

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

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