Defense Contracting:

Contract Risk a Key Factor in Assessing Excessive Pass-Through Charges

GAO-08-269: Published: Jan 25, 2008. Publicly Released: Jan 25, 2008.

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One-third of the Department of Defense's (DOD) fiscal year 2006 spending on goods and services was for subcontracts. Concerns have been raised among DOD auditors and Congress about the potential for excessive pass- through charges by contractors that add little or no value when work is subcontracted. To better understand this risk, Congress mandated that GAO assess the extent to which DOD may be vulnerable to these charges. This report examines (1) DOD's approach to assessing the risk of excessive pass-through charges when work is subcontracted, (2) the strategies selected private sector companies use to minimize risks of excessive pass-through charges when purchasing goods and services, and (3) DOD's interim rule to prevent excessive pass-through charges. GAO's work is based on analysis of 32 fiscal year 2005 DOD contract actions at 10 DOD top contracting locations and discussions with DOD acquisition policy, audit, and contracting officials, including Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA) staff. GAO also interviewed nine selected private sector companies with diverse contracting experience.

Although no specific criteria exist for evaluating contractor value added, DOD contracting officials generally rely on tools in the Federal Acquisition Regulation (FAR) to assess the risk of excessive pass-through charges when work is subcontracted. For the 32 selected contract actions GAO reviewed, DOD contracting officials generally applied these tools to their assessments. The degree of assessment depended on whether the contract was competed and whether the contract type required the government to pay a fixed price or costs incurred by the contractor. When using full and open competition, contracting officials assessed contractor value added based on the technical ability to perform the contract, but did not separately evaluate cost since market forces generally control contract costs, potentially minimizing the risk of excessive pass-through charges. However, when using noncompetitive contracts, contracting officials were required to evaluate more detailed cost information in assessing value added, as market forces did not determine the contract cost. For example, for a $3 billion noncompetitive contract for an Air Force satellite program, contracting officials assessed detailed cost or pricing data that included subcontractor costs, and received DCAA and DCMA support to negotiate lower overall contract costs. However, assessing contractor value added is especially challenging in unique situations where requirements are urgent in nature and routine contracting practices may be overlooked. Related GAO work and DOD audits on contracts awarded for Hurricane Katrina recovery efforts found multiple layers of subcontractors, questionable contractor value added, increased costs, and lax oversight. The selected private sector companies GAO interviewed rely heavily on acquisition planning, knowledge of supply chain, and managing contractual relationships to minimize risk of excessive pass-through charges when purchasing goods and services. They seek to optimize competition to minimize overall contract costs, and several companies indicated that they prefer fixed-price competitive arrangements. In addition, some form collaborative business relationships with contractors and subcontractors that provide greater insight into their supply chains and costs--a challenge DOD continues to face. When using other than fixed-price contracts, they recognize the financial risks and ensure proper oversight and accountability. As GAO has reported in the past, DOD's use of riskier contracts, such as time-and-materials contracts, has not always ensured good acquisition outcomes. DOD recently issued an interim rule requiring a contract clause in all eligible contracts, which allows it to recoup contractor payments that contracting officers determine to be excessive. The rule also requires detailed information from contractors on their value added when subcontracting costs reach 70 percent or more of total contract cost. However, the rule alone will not provide greater insight into DOD's supply chain and costs--information companies told us they use to mitigate excessive costs. Further, contracting officials indicated the need for guidance to ensure effective implementation and consistent application of tools in the FAR as appropriate.

Recommendations for Executive Action

  1. Status: Open

    Comments: In May 2008, DOD issued an interim rule in the Defense Federal Acquisition Regulation Supplement (DFARS) on preventing excessive pass through charges. Prior to final implementation of the DFARS change, however, Section 802 of the National Defense Authorization Act for Fiscal Year 2013 included an additional requirement related to preventing pass through charges, altering any potential changes to the DFARS. Specifically, Section 802 requires the Secretary of Defense, the Secretary of State, and the Administrator of the United States Agency for International Development to issue guidance and regulations for situations where the offeror intends to award subcontracts for more than 70 percent of the total cost of work to be performed under the contract, task order, or delivery order. The contracting officer must (1) consider the availability of alternative contract vehicles and the feasibility of contracting directly with a subcontractor or subcontractors; (2) make a written determination that the contracting approach selected is in the best interest of the government; and (3) document the basis for such determination. This legislation is currently being incorporated into the Federal Acquisition Regulation through FAR Case 2013-012. The proposed rule was published in the Federal Register in July 2014 and public comments are due by September 2014. GAO will continue to monitor the status of any new guidance or changes to regulation to determine the extent to which it may address this recommendation.

    Recommendation: As DOD finalizes its rule on preventing excessive pass-through charges and develops implementing guidance to ensure consistency in how contracting officials assess contractor value added, the Secretary of Defense should direct the Director of Defense Procurement and Acquisition Policy to require contracting officials to take risk into account when determining the degree of assessment needed. Risk factors to consider include whether (1) the contract is competed; (2) the contract type requires the government to pay a fixed price or costs incurred by the contractor; and (3) any unique circumstances exist, such as requirements that are urgent in nature.

    Agency Affected: Department of Defense

  2. Status: Open

    Comments: In May 2008, DOD issued an interim rule in the Defense Federal Acquisition Regulation Supplement (DFARS) on preventing excessive pass through charges. Prior to final implementation of the DFARS change, however, Section 802 of the National Defense Authorization Act for Fiscal Year 2013 included an additional requirement related to preventing pass through charges, altering any potential changes to the DFARS. Specifically, Section 802 requires the Secretary of Defense, the Secretary of State, and the Administrator of the United States Agency for International Development to issue guidance and regulations for situations where the offeror intends to award subcontracts for more than 70 percent of the total cost of work to be performed under the contract, task order, or delivery order. The contracting officer must (1) consider the availability of alternative contract vehicles and the feasibility of contracting directly with a subcontractor or subcontractors; (2) make a written determination that the contracting approach selected is in the best interest of the government; and (3) document the basis for such determination. This legislation is currently being incorporated into the Federal Acquisition Regulation through FAR Case 2013-012. The proposed rule was published in the Federal Register in July 2014 and public comments are due by September 2014. GAO will continue to monitor the status of any new guidance or changes to regulation to determine the extent to which it may address this recommendation.

    Recommendation: As DOD finalizes its rule on preventing excessive pass-through charges and develops implementing guidance to ensure consistency in how contracting officials assess contractor value added, the Secretary of Defense should direct the Director of Defense Procurement and Acquisition Policy to require contracting officials to document their assessments of contractor value added in the contract files.

    Agency Affected: Department of Defense

  3. Status: Open

    Comments: In May 2008, DOD issued an interim rule in the Defense Federal Acquisition Regulation Supplement (DFARS) on preventing excessive pass through charges. Prior to final implementation of the DFARS change, however, Section 802 of the National Defense Authorization Act for Fiscal Year 2013 included an additional requirement related to preventing pass through charges, altering any potential changes to the DFARS. Specifically, Section 802 requires the Secretary of Defense, the Secretary of State, and the Administrator of the United States Agency for International Development to issue guidance and regulations for situations where the offeror intends to award subcontracts for more than 70 percent of the total cost of work to be performed under the contract, task order, or delivery order. The contracting officer must (1) consider the availability of alternative contract vehicles and the feasibility of contracting directly with a subcontractor or subcontractors; (2) make a written determination that the contracting approach selected is in the best interest of the government; and (3) document the basis for such determination. This legislation is currently being incorporated into the Federal Acquisition Regulation through FAR Case 2013-012. The proposed rule was published in the Federal Register in July 2014 and public comments are due by September 2014. GAO will continue to monitor the status of any new guidance or changes to regulation to determine the extent to which it may address this recommendation.

    Recommendation: As DOD finalizes its rule on preventing excessive pass-through charges and develops implementing guidance to ensure consistency in how contracting officials assess contractor value added, the Secretary of Defense should direct the Director of Defense Procurement and Acquisition Policy to involve DCAA and DCMA in facilitating assessments as appropriate.

    Agency Affected: Department of Defense

 

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