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entitled 'Use of Legislative Incentive for Performance-Based 
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May 22, 2003:

Congressional Committees:


Subject: Use of Legislative Incentive for Performance-Based Contracting 
Unknown:

The Department of Defense (DOD) spent about $93 billion in fiscal year 
2002 to acquire various types of services, such as base operations, 
logistical support, and information technology. To achieve greater cost 
savings and better outcomes when agencies acquire these and other 
services, Congress and the executive branch have encouraged greater use 
of performance-based contracting. Performance-based contracts specify 
the desired outcomes and allow the contractors to determine how best to 
achieve those outcomes, rather than prescribe the methods contractors 
should use.

In October 2000, Congress sought to provide an incentive for the use of 
performance-based contracts through legislation[Footnote 1] giving DOD 
temporary authority to treat certain performance-based service 
contracts as contracts for commercial items.[Footnote 2] Contracts for 
commercial items may be awarded using streamlined procedures under Part 
12 of the Federal Acquisition Regulation (FAR). This authority is 
scheduled to expire in October 2003.

As required by the October 2000 legislation, we reviewed DOD's 
implementation of the temporary authority, including the interim and 
final implementing regulations, public comments on the interim 
regulation, and other DOD documents. We also discussed with DOD 
officials the extent to which the authority had been used. We conducted 
our review from September 2002 through February 2003 in accordance with 
generally accepted government auditing standards.

Results in Brief:

DOD issued regulations to implement the legislative authority, but 
because there is no tracking mechanism, DOD does know the extent to 
which the authority has been used. DOD officials believe, however, that 
use of the authority has been limited, at best. Although a January 2002 
DOD policy memorandum indicated that additional guidance on reporting 
use of the authority would be forthcoming, no additional guidance has 
been issued to date.

Background:

In October 2000, Congress passed section 821(b) of the National Defense 
Authorization Act for Fiscal Year 2001, which allows DOD to treat 
performance-based service contracts or task orders as contracts for the 
procurement of commercial items under specified conditions. The 
conditions are that the contract or task order must: (1) be valued at 
$5 million or less; (2) define the work in measurable, mission-related 
terms; (3) identify a specific end product or output; (4) contain a 
firm, fixed price; and (4) be awarded to a contractor that provides 
similar services to the general public under terms and conditions 
similar to those offered to the federal government.[Footnote 3]

The use of performance-based contracts to acquire services offers a 
number of potential benefits. Performance-based contracts can encourage 
contractors to be innovative and to find cost-effective ways of 
delivering services. By shifting the focus from process to results, 
they hold the promise of better outcomes and reduced costs. In view of 
the potential benefits, Congress has been encouraging greater use of 
performance-based contracting, and the administration has set a general 
goal that 20 percent of eligible service contracts should be 
performance based.[Footnote 4] DOD has a goal that 50 percent of its 
service contracts will be performance based by 2005.

Congress and the administration also have been encouraging agencies to 
acquire commercial items to the maximum extent practicable to satisfy 
agency needs for goods and services. The objectives are to reduce the 
government's reliance on government specifications and to take 
advantage of technical innovations available in the commercial 
marketplace. Special rules designed to facilitate the acquisition of 
commercial items are contained in Part 12 of the FAR. These rules 
permit greater flexibility in negotiating contract terms and 
conditions. In addition, certain enumerated laws do not apply to 
commercial item acquisitions, such as the requirement that the 
contractor submit cost or pricing data. In general, to be acquired 
using the commercial item procedures of FAR Part 12, services must be 
of a type that are sold competitively in substantial quantities in the 
commercial marketplace based on established catalog or market prices 
for specific tasks performed. Under the authority of section 821(b), a 
service could be acquired as a commercial item even though it would not 
otherwise meet the commercial item definition.

DOD Issued Regulations to Implement Section 821:

On December 6, 2001, DOD issued an interim rule amending the Defense 
Federal Acquisition Regulation Supplement to implement section 821(b). 
The rule listed the legislative conditions for use of the new 
authority, as well as additional conditions that apply generally to the 
use of performance-based contracts. For example, the rule required the 
use of quality assurance surveillance plans. Although there is no 
mention of these plans in section 821(b), other sections of the FAR 
require them whenever performance-based service contracting is used.

DOD also requested comments on the interim rule and received four sets 
of comments from various sources. In some cases DOD agreed with the 
points raised and revised the final rule. Other comments dealt with 
conditions imposed by the legislation. For example, one comment pointed 
out that the requirement that a contract under the section 821(b) 
authority be with an entity that provides similar services to the 
general public precludes use of the authority to contract with an 
entity whose only business activity consists of contracts with the 
government under section 8(a) of the Small Business Act or other 
federal preference programs. DOD agreed with this conclusion, but noted 
that the requirement was contained in the legislation and could not be 
changed through regulation. DOD published the final rule in the Federal 
Register on October 25, 2002.

DOD Does Not Know the Extent to Which Section 821(b) Has Been Used:

Department of Defense officials are not aware of the extent to which 
the new authority contained in section 821(b) has been used to acquire 
services because DOD does not have a reporting system to track the use 
of this authority. At our request, however, DOD officials asked each of 
the military services to query some of their buying commands about 
possible instances of the use of section 821(b) authority. Officials 
from each of the services confirmed that data on the possible use of 
this authority are not collected. In addition, Air Force and Navy 
officials told us that they were unaware of instances in which 
contracting personnel used the authority. Army officials, however, said 
they believed a minimal number of contracting personnel in the Army had 
used the authority to treat certain services as commercial items, such 
as plumbing and electrical motor repair services. Army officials were 
unable to identify the specific contracts on which the authority had 
been used.

DOD officials suggested two possible explanations for why the authority 
provided by section 821(b) may have seen little, if any, use. First, 
the officials cited a perception among some contracting personnel that 
the section provided no new authority. In fact, in our discussions with 
some DOD personnel it was apparent that they believed section 821(b) 
could only be used to acquire services that already met the definition 
of commercial item. As indicated by DOD, however, the implementing 
regulation "provides additional authority for use of FAR Part 12 to 
acquire services that do not meet the definition of commercial 
item."[Footnote 5] Second, numerous DOD officials cited the requirement 
for a firm, fixed-price contract as an impediment to use of the 
authority. In this regard, the existing regulatory definition of 
commercial item expressly excludes services sold in the commercial 
marketplace at hourly rates without an established catalog or market 
price for a specific service performed. Although services priced on an 
hourly basis--and thus by definition not considered to be commercial 
items--might be good candidates for use of the new authority, the 
requirement of section 821(b) for a fixed-price contract reportedly 
made the authority less attractive.

In January 2002, the Under Secretary of Defense, Acquisition and 
Technology issued a policy memorandum reemphasizing the department's 
commitment to performance-based contracting and highlighting the 
temporary authority provided in section 821(b). The memorandum said it 
was "important that we thoroughly test this authority during the pilot 
period to demonstrate its value." In addition, the memorandum said that 
DOD would provide additional direction on the reporting requirements 
applicable to the pilot authority. To date, DOD has not provided any 
additional direction. According to one DOD official, a reporting system 
would have been an unnecessary burden on contracting personnel because 
they anticipated only limited use of the temporary authority.

We requested comments from DOD on a draft of this report. On May 16, 
2003, a representative of the Office of the Director of Defense 
Procurement and Acquisition Policy stated that the draft report was 
technically accurate and that no other comments were needed.

- - - - - -:

We are sending copies of this report to the Secretary of Defense; 
Director, Office of Management and Budget; and interested congressional 
committees. We will also make copies available to others on request. In 
addition, this report will be available at no charge on the GAO web 
site at http://www.gao.gov.

If there are any questions concerning this report, please call me at 
(202)-512-8214. The major contributors to this report were Odi Cuero, 
Chris Galvin, Gary Middleton, and Ralph White.

William T. Woods:

Director:

Acquisition and Sourcing Management:

Signed by William T. Woods:

List of Congressional Committees:

The Honorable John Warner:

Chairman:

Committee on Armed Services:

United States Senate:

The Honorable Carl Levin:

Ranking Minority Member:

Committee on Armed Services:

United States Senate:

The Honorable Ted Stevens:

Chairman:

Subcommittee on Defense:

Committee on Appropriations:

United States Senate:

The Honorable Daniel Inouye:

Ranking Minority Member:

Subcommittee on Defense:

Committee on Appropriations:

Unites States Senate:

The Honorable John Ensign:

Chairman:

Subcommittee on Readiness & Management Support:

Committee on Armed Services:

United States Senate:

The Honorable Daniel Akaka:

Ranking Minority Member:

Subcommittee on Readiness & Management Support:

Committee on Armed Services:

United States Senate:

The Honorable Duncan Hunter:

Chairman:

Committee on Armed Services:

House of Representatives:

The Honorable Ike Skelton:

Ranking Minority Member:

Committee on Armed Services:

House of Representatives:

The Honorable Jerry Lewis:

Chairman:

Subcommittee on Defense:

Committee on Appropriations:

House of Representatives:

The Honorable John Murtha:

Ranking Minority Member:

Subcommittee on Defense:

Committee on Appropriations:

House of Representatives:

The Honorable Joel Hefley:

Chairman:

Subcommittee on Readiness:

Committee on Armed Services:

House of Representatives:

The Honorable Solomon Ortiz:

Ranking Minority Member:

Subcommittee on Readiness:

Committee on Armed Services:

House of Representatives:

(120171):

FOOTNOTES

[1] Section 821(b) of the Defense Authorization Act for Fiscal Year 
2001, Pub. L. 106-398, Oct. 30, 2000.

[2] The term "commercial item" is defined as any item that is of a type 
customarily used for nongovernmental purposes that has been sold, 
leased, or licensed or offered for sale, lease, or license to the 
general public. 41 U.S.C. 403 (12). With respect to services, the 
statute includes "services offered and sold competitively, in 
substantial quantities, in the commercial marketplace based on 
established catalog or market prices for specific tasks performed and 
under standard commercial terms and conditions." Id.

[3] In addition, the legislation provided that special simplified 
procedures previously authorized for acquiring commercial items valued 
up to $5 million would not apply to acquisitions of services deemed to 
be commercial items under section 821(b).

[4] For additional information, see Contract Management: Guidance 
Needed for Using Performance-Based Service Contracting, GAO-02-1049 
(Washington, D.C. Sept. 23, 2002).

[5] 67 Fed. Reg. 65,512 at 65,513 (Oct. 25, 2002). (Emphasis in 
original.)