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United States Government Accountability Office:
GAO:

Report to Congressional Committees:

January 2008:

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

GAO-08-269: 

GAO Highlights:

Highlights of GAO-08-269, a report to congressional committees. 

Why GAO Did This Study:

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.  

What GAO Found:

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.    

What GAO Recommends: 

GAO is recommending that DOD guidance to implement its interim rule 
requires that assessments of pass-through charges be risk-based and 
involve DCAA and DCMA as appropriate. DOD concurred with the 
recommendations. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.GAO-08-269]. For more information, contact Ann 
Calvaresi Barr at (202) 512-4841 or calvaresibarra@gao.gov

[End of section] 

Contents:

Letter1:

Results in Brief:

Background:

Risks of Excessive Pass-Through Charges Are Assessed through Routine 
Evaluations of Contractor Value:

Selected Private Sector Companies Rely on Several Shared Approaches to 
Minimize The Risk of Excessive Pass-Through Charges:

Contracting Officials Lack the Guidance and Insight Needed to 
Effectively Implement DOD's Interim Rule:

Conclusions:

Recommendations for Executive Action:

Agency Comments:

Appendix IScope and Methodology:

Appendix IIKey Elements for Contracting Officers in Assessing 
Contractor Value Added:

Appendix IIIComments from the Department of Defense:

Tables:

Table 1: Number of Selected Contracts by Competition and Risk:

Table 2: Selected Companies and Operations:

Figures:

Figure 1: Total Subcontract Awards from DOD Contracts, Fiscal Years 
2002 through 2006:

Figure 2: Example of Costs with Subcontract Layers:

Abbreviations:

ANCAlaska Native Corporation DCAADefense Contract Audit Agency 
DCMADefense Contract Management Agency DFARSDefense Federal 
Acquisition Regulation Supplement DODDepartment of Defense FARFederal 
Acquisition Regulation SARAServices Acquisition Reform Act USACEU.S. 
Army Corps of Engineers:

United States Government Accountability Office:

Washington, DC 20548:

January 25, 2008:

Congressional Committees:

In fiscal year 2006, the Department of Defense (DOD) spent over $294 
billion to procure goods and services from prime contractors, with more 
than one-third of this spending for awards to subcontractors. However, 
concerns have been raised among federal auditors and Congress about the 
potential for DOD to overpay contractors that subcontract work and add 
little or no value.[Footnote 1] To help minimize this risk, Congress 
mandated that DOD issue regulations on preventing these pass-through 
charges. It also required GAO to assess the extent to which DOD may be 
vulnerable to excessive pass-through charges.[Footnote 2] 
Specifically, we (1) determined DOD's current approach to assessing the 
risk of excessive pass-through charges when work is subcontracted, (2) 
identified the strategies selected private sector companies use to 
minimize risks of excessive pass-through charges when purchasing goods 
and services, and (3) assessed DOD's interim rule to prevent excessive 
pass-through charges.

To determine DOD's current approach to assessing the risk of excessive 
pass-through charges when work is subcontracted, we reviewed and 
analyzed the Federal Acquisition Regulation (FAR) and the Defense 
Federal Acquisition Regulation Supplement (DFARS). We also discussed 
these regulations with DOD acquisition policy, audit, and contracting 
officials. This included Defense Contract Audit Agency (DCAA) and 
Defense Contract Management Agency (DCMA) staff to discuss their roles 
in reviewing and managing contracts. To obtain a broad perspective on 
the processes in place to determine costs and extent of subcontracting, 
we met with contracting staff from 10 of the top contracting locations 
across DOD. At those locations, we reviewed and analyzed available 
documentation for a nongeneralizable sample of 32 DOD contract actions 
awarded in fiscal year 2005.[Footnote 3] Using DOD's procurement 
information system--DD350 database--we selected actions that had 
subcontracting plans and small business contracts over $10 million. 
While our sample cannot be generalized to all DOD contract actions, it 
represented a range of products and services, levels of competition, 
types of contracts, and dollar value across DOD military services. We 
discussed these contracts with the responsible contracting officials 
and examined the degree to which available tools in acquisition 
regulations were used in assessing the value added of contractors. 
Because no specific criteria exist for assessing value added, we did 
not measure the adequacy of the contracting officials' assessments. To 
understand how DOD approached the assessment for contracts where much 
of the work was subcontracted, we reviewed recent GAO and DOD audits 
and reports on questionable value added and costs as well as discussed 
the reports with responsible DOD audit officials. We also looked at 
practices outside of DOD to identify the strategies nine selected 
companies use to minimize the risk of excessive pass-through charges 
when purchasing a range of goods and services. We also reviewed 
findings and recommendations of the Acquisition Advisory Panel's 2007 
report on commercial practices.[Footnote 4] We reviewed previous GAO 
reports and issues raised in various GAO acquisitions forums and 
interviewed officials from industry groups such as the Professional 
Services Council and the Coalition for Government Procurement. To 
assess DOD's recent efforts to prevent excessive pass-through charges, 
we reviewed its interim rule responding to the congressional mandate 
and discussed it with DOD officials. We conducted this performance 
audit from March 2007 to December 2007 in accordance with generally 
accepted government auditing standards. Those standards require that we 
plan and perform the audit to obtain sufficient, appropriate evidence 
to provide a reasonable basis for our findings and conclusions based on 
our audit objectives. We believe the evidence obtained provides a 
reasonable basis for our findings and conclusions based on our audit 
objectives. A more detailed discussion of our scope and methodology is 
provided in appendix I.

Results in Brief:

DOD assesses the risk of excessive pass-through charges when work is 
subcontracted as part of its routine contracting practices. While no 
specific criteria exist for evaluating contractor value added, DOD 
contracting officials rely on tools in federal and DOD acquisition 
regulations. For the 32 selected contract actions we reviewed, DOD 
contracting officials generally applied these tools to their 
assessments. However, the extent to which these tools were applied 
depended on the contract risk--that is, whether the contract was 
competed and whether the type of contract required the government to 
pay a fixed price or costs incurred by the contractor. According to the 
contracting officers we spoke with, competitive fixed-price contracts 
may reduce the risk of excessive costs to the government. As a result, 
they did not perform the same level of assessment as they did on 
contracts with greater risk--such as those awarded noncompetitively or 
without fixed prices. 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 costs 
for value added since market forces generally control proposed contract 
cost, potentially minimizing the risk of excessive pass-through 
charges. However, when using other than full and open 
competition,[Footnote 5] contracting officials were required to 
evaluate more detailed cost information in assessing value added to 
minimize risk of excessive pass-through charges, as market forces did 
not determine the contract cost. For example, in a $3 billion 
noncompetitive contract for an Air Force satellite program, contracting 
officials required detailed cost and pricing data that included 
subcontractor costs to assess the contractor's value added, and 
received DCAA and DCMA support to negotiate lower overall contract 
costs. In another case--an $863 million cost-reimbursement competitive 
contract for Navy support services--while detailed cost information was 
considered in source selection, the technical capability of the 
contractor to manage multiple tiers of subcontractors was a significant 
factor in assessing its value added. However, conducting assessments of 
the value added by contractors is especially challenging under unique 
situations where requirements are urgent in nature and routine 
contracting practices may be overlooked. For example, related GAO work 
and DOD audits on contracts awarded for Hurricane Katrina recovery 
efforts found multiple layers of subcontractors, questionable value 
added by contractors, increased costs, and lax oversight.

To minimize the risk of excessive pass-through charges when procuring 
goods and services, private sector companies we interviewed indicated 
that they rely heavily on acquisition planning, knowledge of supply 
chain, and managing contractual relationships. As part of their 
acquisition planning, company officials told us that they seek to 
optimize competition to control overall contract costs. Several 
companies indicated that they enter into fixed-price competitive 
arrangements and form collaborative business relationships with 
contractors and subcontractors that provide greater insight into their 
supply chain and costs--a challenge DOD continues to face. According to 
several companies, using other than fixed-price contracts is sometimes 
necessary based on the requirements. When doing so, however, they 
recognize the financial risks and devote resources to ensure proper 
oversight and accountability. As we have reported in the past, DOD's 
use of riskier contracts, such as time-and-materials contracts, has not 
always ensured good acquisition outcomes or a prudent expenditure of 
taxpayer funds.

In April 2007, DOD issued an interim rule that allows it to recoup 
contractor payments that contracting officers determine to be excessive 
on all eligible contracts. The rule specifically requires contracting 
officers to insert a clause in these contracts that allows recovery of 
excessive payments and contractors to report detailed information on 
their value added when subcontracting reaches 70 percent or more of the 
total contract cost. While the rule aims to provide contracting 
officers with more information on contractor value added, it alone will 
not provide greater insight into DOD's supply chain and costs--
information that companies told us they use to mitigate excessive 
costs. In addition, while the rule is not yet final, contracting 
officials we spoke to indicated the need for guidance on how to 
effectively implement the rule since they were not clear what more they 
should be doing beyond applying tools in the FAR and DFARS. This would 
ensure that contracting officers, particularly newer and less 
experienced staff, consistently apply federal acquisition tools in 
conducting their assessments of contractor value added and take into 
account contract risk when determining the degree of assessment needed, 
documenting assessments, and involving DCAA and DCMA as appropriate.

We are recommending that as DOD finalizes its rule on avoiding 
excessive pass-through charges and develops guidance for assessing 
contractor value added, DOD (1) require contracting officials to take 
contract risk into account when determining the level of assessment 
needed, (2) require assessments of contractor value added be 
documented, and (3) involve DCAA and DCMA in facilitating assessments 
as appropriate. In written comments on a draft of this report, DOD 
concurred with the recommendations and noted planned and current 
actions underway that are directly responsive. DOD's comments are 
included in appendix III.

Background:

DOD is increasingly relying on contractors to provide a range of 
mission-critical support from operating information technology systems 
to providing logistics support on the battlefield. These contractors 
are responsible for managing contract performance, including planning, 
placing, and administering subcontracts as necessary to ensure the 
lowest overall cost and technical risk to the government. Although 
total subcontract awards from DOD contracts decreased 15 percent from 
fiscal year 2005 to 2006, total subcontract awards have increased by 27 
percent, from $86.5 billion in fiscal year 2002 to $109.5 billion in 
fiscal year 2006.[Footnote 6] (see fig. 1).

Figure 1: Total Subcontract Awards from DOD Contracts, Fiscal Years 
2002 through 2006:

[See PDF for image]

[End of figure]

Notes: All dollar figures have been converted to fiscal year 2007 
dollars. DOD officials were not able to explain the decrease from 
fiscal year 2005 to fiscal year 2006.

While subcontracting plans submitted by contractors are required for 
most contracts over $550,000,[Footnote 7] this information is reported 
only for first tier subcontracts.[Footnote 8] Historically, DOD has 
limited insight into costs associated with using multiple layers of 
contractors to perform work. Figure 2 depicts how lower tier's costs 
become part of the higher tier's and prime contractor's overall costs.

Figure 2: Example of Costs with Subcontract Layers:

[See PDF for image]

[End of figure]

Risks of Excessive Pass-Through Charges Are Assessed through Routine 
Evaluations of Contractor Value:

DOD contracting officials generally rely on tools in the FAR and DFARS 
in assessing the risk of excessive pass-through charges when work is 
subcontracted. For the 32 selected contracts we reviewed, when there 
was full and open competition, contracting officials assessed 
contractor value added based on the technical ability to perform the 
contract, but did not need to separately evaluate costs for value added 
as market forces generally control the proposed contract cost. However, 
contracts with greater risk--such as those awarded noncompetitively or 
without fixed prices--require contracting officers to consider more 
than the technical ability to perform the work in assessing value 
added. We found that conducting assessments of contractor value added 
is especially challenging in unique circumstances, such as when 
requirements are urgent in nature and routine contracting practices may 
be overlooked.

DOD Generally Relies on Tools in Acquisition Regulations to Assess 
Contractor Value Added:

The FAR and DFARS contain requirements for contracting officials when 
entering into contractual relationships that are intended to help 
ensure the best value for products and services. Contracting officers 
have wide latitude to exercise business judgment when applying these 
regulations. While no specific criteria exist for contracting officers 
to use in evaluating contractor value added, several key elements in 
acquisition regulations, however, provide them with a mix of tools to 
gain insight into how prime contractors intend to do the work and the 
associated costs, including the role and costs of 
subcontracting:[Footnote 9]

* Acquisition planning is key to determining contract requirements, 
level of competition available based on market research, and the 
appropriate contract vehicle to be used based on level of 
risk.[Footnote 10] :

* Solicitation procedures allow contracting officers to select the 
prospective contractor that represents the best value to the 
government.[Footnote 11]

* Contract pricing is used to determine price reasonableness for the 
contract, including subcontracting costs.[Footnote 12]

* Contract administration is intended to obtain a variety of audit and 
administration services to hold contractors accountable for operating 
according to their proposals.[Footnote 13]

Presence of Competition and Type of Contract Generally Guide the Use of 
Assessment Tools:

According to DOD contracting officials and based on our review of 
selected contracts, assessments of contractor value added are typically 
driven by contract risk--the presence of competition and whether the 
type of contract requires the government to pay a fixed price or costs 
incurred by the contractor. When using full and open competition, the 
value added by the prime contractor was determined by its technical 
ability to perform the contract, but generally contracting officers did 
not do a separate detailed evaluation of cost to determine value added. 
DOD contracting officials told us that competitive fixed-price 
contracts allow the market to control overall contract value, which 
provided them with reasonable assurance of the contractor's value added 
and potentially minimizing the risk of excessive pass-through charges. 
When using noncompetitive contracts, however, the market forces did not 
control contract cost and required contracting officers to consider--in 
addition to cost--the technical ability to perform the work. 
Specifically, DOD contracting officials noted that noncompetitive as 
well as other than fixed-price contracts require additional oversight 
and administration, including more detailed information to conduct the 
assessment of contractor value added and minimize the risk of excessive 
pass-through charges. For the 32 selected contracts we reviewed, 16 
were awarded noncompetitively, with 7 of those on a cost-reimbursement 
basis and 2 on a time-and-materials basis. (see table 1) .

Table 1: Number of Selected Contracts by Competition and Risk:

Full and open competition: Fixed-price; (2); Full and open competition: 
Cost-reimbursement; (11); Full and open competition: Time-and-
materials; (3); Noncompetitive: Fixed-price; (7); Noncompetitive: 
Cost-reimbursement; (7); Noncompetitive: Time-and-materials; (2).

Full and open competition: Lower risk; Noncompetitive: Higher risk.

[End of table]

Source: GAO analysis of DOD contract data and the FAR.

DOD contracting officials noted that fixed-price contracts incentivize 
prime contractors to keep overall contract costs low--to include any 
subcontract costs--as they will have to absorb cost overruns under such 
contracts. In reviewing two fixed-price competitive contracts for Air 
Force space systems,[Footnote 14] acquisition planning and market 
research up-front provided insights into reasonable prices as well as 
identified the best-qualified suppliers to do the work. Air Force 
officials stated that because competitive contracts are often proposed 
by a team of contractors--the prime plus the subcontractors--market 
pricing extends to subcontractor costs as well. In discussing the two 
contracts, these officials added that fixed prices lowered the 
government's risk of increased costs. As a result, the contracting 
officials said that in assessing the prime contractor's value added, 
they focused more on the technical capabilities--rather than cost--to 
ensure contractors were responsive in meeting the mission.

Contracting officials told us that contracts awarded noncompetitively 
decrease their assurance of price reasonableness since there is no 
basis of comparison through competition.[Footnote 15] Therefore, they 
rely on other pricing tools contained in the FAR and DFARS. These tools 
assist the contracting officers in obtaining more detailed information 
to provide reasonable assurance of contractor value added and 
potentially minimize the risk of excessive pass-through 
charges.[Footnote 16] Our review of contract files also revealed the 
role that DCAA and DCMA played in reviewing cost information in several 
of the 16 noncompetitive contracts we reviewed and helping to negotiate 
subcontract costs.

* For the Air Force's estimated $3 billion satellite program contract, 
DCAA reviewed the certified cost and pricing data that the contractor 
was required to provide. The required data included not only the 
contractor's costs but a detailed description of the efforts and costs 
of each subcontractor, including subsidiary companies. The contracting 
officer judged the proposed costs based on results of audit reports and 
a technical evaluation. Because of the high dollar value and complexity 
of this contract, the program office required the prime contractor to 
submit cost data reports at the conclusion of each effort and cost 
performance reports to provide insight into the prime contractor's and 
subcontractor's cost and schedule data. Additionally, DCAA and DCMA 
helped to negotiate individual subcontracts and, in some cases, achieve 
lower overall costs.

* The Army similarly relied on DCAA and DCMA assistance on a $1 billion 
fixed-price contract for a family of heavy tactical vehicles. The Army 
did not pursue full and open competition, citing the lack of industry 
response, thus requiring contracting officers to gain more insight into 
prime contractor and subcontract costs to assess contractor value added 
and minimize the risk of excessive pass-through charges. The Army used 
a teaming arrangement that allowed the contracting command, DCAA, DCMA, 
and the contractor to evaluate, discuss, and negotiate the costs. Each 
cost element was mutually agreed upon, resulting in a negotiated price 
list. Contracting officials told us that these negotiated prices 
applied to subcontracts for vehicle parts as well, preventing 
overcharges by lower-tier subcontractors.

* For an $11 million Navy contract for fighter aircraft support, DCMA 
provided an evaluation of prime contractor and subcontractor costs for 
certain services. In prenegotiation discussions with the Navy, DCMA 
described the technical evaluation of the contractor's cost proposal, 
providing a cost summary of what was proposed by the contractor and 
what was recommended during the technical evaluation. For one portion 
of the contract, the evaluators questioned the direct labor hours 
proposed by the prime contractor for managing the project because most 
(if not all) the actual work would be done by subcontractors. The DCMA 
technical evaluator found the hours proposed to be excessive, raising 
questions about the prime contractor's value added relative to the 
costs. Documentation in the contract file stated that although the 
prime contractor believed the hours proposed were fair, it agreed to a 
25 percent reduction in the hours.

In addition to the presence of competition, the risk associated with 
contracts in which the government pays based on costs incurred also 
affects the degree to which contracting officers assess contractor 
value added and potentially minimize the risk of excessive pass-through 
charges. These contracts, which include cost-reimbursement and time-
and-materials contracts, increase DOD's need to ensure appropriate 
surveillance during performance to provide reasonable assurance that 
efficient methods and effective cost controls are used. Because of the 
risks involved, the FAR directs that these contracts should be used 
only 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 17] Of the selected 
contracts we reviewed, 18, or 56 percent, were cost-type contracts with 
11 noncompetitively awarded. Contracting officials told us that under 
these arrangements, although competition increases the assurance of 
reasonable prices and controls contract cost, the absence of a fixed 
price requires them to take additional steps to obtain other 
information to assess the roles and costs of prime contractors and 
subcontractors, which assists in evaluating contractor value added.

For example, a task order awarded under a $3 billion Army multiple 
award contract, which reimbursed the contractor based on the cost of 
its time and materials, demonstrated the risk associated with these 
contracts.[Footnote 18] Under this multiple award contract, eight prime 
contractors competed for task orders, with one of the contractors 
identifying over 75 subcontractors in its proposal. On the task order 
we reviewed, for engineering services, most of the work was 
subcontracted. Contracting officers stated that because the contract 
was awarded on a time-and-materials basis, the government was 
particularly vulnerable to the prime contractor charging more than it 
paid for its subcontractor since at this time prime contractors could 
charge for subcontract labor at the prime's rate and keep any 
difference between its rate and the subcontractor's. While the prime 
contractor was not required to submit certified cost or pricing data, 
it was required to provide a task execution plan that described the 
specific duties of both the prime contractor and the subcontractor, 
including the fees they were charging the government to manage the 
subcontractor. The Army evaluated the plan and determined that the 
number of hours and rates proposed by the prime contractor were 
reasonable based on the data provided. We have previously reported that 
for some time-and-materials contracts, DOD paid more than actual costs 
for subcontracted labor.[Footnote 19] To minimize this risk with time-
and-materials contracts, a new DOD regulation set forth different rules 
about how prime contractors are to be reimbursed for subcontracted 
labor to ensure that prime contractors do not charge the government 
higher rates than those charged by subcontractors.[Footnote 20]

In our review of other cost-type contracts, DOD gained insight into 
value provided by the prime contractor in determining price 
reasonableness. The cost or pricing data in some cases provided the 
contracting officer with added insight by breaking out costs of the 
prime contractor and major subcontractors by the work they were to 
perform. Further, in some cases, DCAA questioned the proposed 
subcontractor costs and provided an estimate for the contracting 
officer to use in negotiating a more reasonable price to ensure best 
value. For example, in a $92 million Army contract for the redesign of 
a chemical demilitarization facility, DCAA questioned the surcharges 
applied to certain subcontractor costs and recommended lower rates. The 
contractor accepted the lower rates, reducing the overall cost to the 
Army.

According to several contracting officials, as prime contractors assign 
subcontractors more critical roles to achieve a mission, the increased 
need for detailed cost information is coupled with the need for more 
insight into the technical capabilities of the subcontractors. Because 
cost is not always the primary criterion used to determine best value, 
technical capabilities can also be evaluated to determine the role of 
the prime contractor when work is subcontracted.[Footnote 21] We found 
that cost was not always ranked as the highest factor in reviewing 
source selection criteria for five cost-type contracts. For one 
example--an $863 million Navy contract for support services related to 
a destroyer--the technical evaluation determined the ability of the 
prime contractor and multiple tiers of subcontractors to perform the 
work. While detailed cost information was obtained from the prime 
contractor and considered in the source selection, its ability to 
consolidate and manage efforts that had previously been conducted under 
five separate contracts was a particularly significant factor in 
evaluating the contractor's value added. In another example--a $2.9 
billion Navy contract for a major weapons system--given the size of the 
contract and magnitude and complexity of work involved, the contracting 
officer required greater insight into how the prime contractor intended 
to subcontract. As a result, the contracting officer modified the 
contract to increase requirements for the prime contractor to obtain 
consent to subcontract. The contracting officer told us that although 
prime contractors are ultimately responsible for managing their 
subcontractors, DOD still needed to maintain a certain level of insight 
into subcontracting, given the increased role.

Unique Circumstances Can Drive Contracting Arrangements That Carry 
Greater Risk of Excessive Pass-Through Charges:

Some unique contracting arrangements that are noncompetitive or where 
requirements are urgent in nature carry greater risk of excessive pass-
through charges and pose challenges in conducting assessments of 
contractor value added. This was the case with a contract we reviewed 
that had been awarded to an Alaska Native Corporation (ANC) firm 
through a small business development program. In addition, related GAO 
work and DOD audits on contracts awarded for Hurricane Katrina recovery 
efforts found multiple layers of subcontractors, questionable value 
added by contractors, increased costs, and lax oversight.

Through the Small Business Administration's 8(a) program,[Footnote 22] 
DOD and other federal agencies can award sole-source contracts to ANC 
firms for any dollar value. The Small Business Administration requires 
agencies to monitor the percentage of work performed by the 8(a) firms 
versus the percentage performed by their subcontractors to ensure that 
small businesses do not pass along the benefits of their contracts to 
subcontractors. The "limitations on subcontracting" clause in the FAR 
requires that for 8(a) service contracts with subcontracting, the firm 
must incur at least 50 percent of the personnel costs with its own 
employees (for general construction contracts, the firm must incur at 
least 15 percent of the personnel costs).[Footnote 23] However, for one 
contract we reviewed that was awarded to an ANC firm, contracting 
officials had failed to include the required FAR clause in the contract 
and other contracting officials we spoke to were unsure who should be 
monitoring compliance--findings consistent with our past work on ANC 
8(a) contracts.[Footnote 24]

For an Army logistics support services cost-reimbursement contract for 
$54 million awarded to an ANC noncompetitively, substantial variations 
in workload created too much cost risk to make it a fixed-price 
contract. According to the contracting officer, usually with a scope of 
work this large and varied, the contract lends itself to 
subcontracting. When asked about the level of insight into how the ANC 
would use subcontracted support, the contracting officer responded that 
this was challenging since small businesses are not required to submit 
subcontracting plans. In reviewing the base contract, we found that it 
did not contain the required clause that limits subcontracting. We 
brought this to the attention of the contracting officer, who told us 
that although he was not aware of any subcontracting, the clause should 
have been included and it was an oversight. Several other contracting 
officials we spoke to said they were unsure of whose responsibility it 
is to monitor compliance with the subcontracting limitations under 
these 8(a) contracts. They recognized that they should be doing more to 
monitor compliance. By not ensuring compliance with the limits on 
subcontracting requirement, there is an increased risk that an 
inappropriate degree of the work is being done by large businesses, 
raising questions about the value added by the ANC firm.

According to contracting officials we spoke with, assessing the value 
added by a prime contractor is especially challenging in emergency 
situations, where requirements are critical and urgent in nature, such 
as those for recovery from Hurricane Katrina. We have similarly 
reported that the circumstances created by these situations can make it 
difficult to balance the need to deliver goods and services quickly 
with the need for appropriate controls. Our past work has cautioned, 
however, that limited predictability must not be an excuse for poor 
contracting practices. In some cases, the response to Hurricane Katrina 
suffered from inadequate planning and preparation to anticipate 
requirements for needed goods and services.[Footnote 25] The scale of 
operations and the government's stated inability to provide program 
management after Katrina drove the decision to award contracts with 
large scopes of work that, in certain cases, led to multiple layers of 
subcontractors and increased costs.

GAO's past work in reviewing orders and contracts for the Katrina 
recovery effort found that the U.S. Army Corps of Engineers (USACE) 
disclosed increased costs associated with multiple supplier layers. In 
reviewing orders and contracts for portable public buildings in 
Mississippi, which were awarded in 2005, we found that USACE ordered 88 
buildings that were purchased and sold through two to three layers of 
suppliers, resulting in prices 63 percent to 133 percent higher than 
manufacturers' sales prices. In one example, 45 of the 88 portable 
public buildings were purchased from a contractor who in turn purchased 
the buildings from a distributor, who in turn purchased them from 
another distributor, who had purchased the 45 buildings from the 
manufacturer. Each layer added an additional fee, resulting in USACE 
agreeing to a price that was 63 percent higher than the manufacturer's 
price.

DOD auditors have noted additional concerns in some Katrina contracts 
they reviewed. For example, a November 2006 Army Audit report stated 
that unclear requirements for four post-Katrina debris removal 
contracts awarded by USACE--for $500 million each with an option for an 
additional $500 million--resulted in prices renegotiated in unfavorable 
circumstances.[Footnote 26] According to the report, the urgency to 
award contracts quickly did not give USACE contracting personnel 
sufficient time to develop a well-defined acquisition strategy--one 
that defined desired outcomes and risks related to the acquisition to 
ensure contracts were structured in the government's best interest. 
Contracting officials were less diligent about complying with 
acquisition regulations regarding best value contracts and reasonable 
pricing. Fixed-price contracts were renegotiated at higher prices 
without the benefit of a DCAA review. USACE's decision to use four 
large contracts also resulted in multiple tiers of subcontractors to 
accomplish the work, with each tier adding costs. Post-award audits 
performed by DCAA found substantial overcharges by the debris 
contractors.

USACE officials we spoke with noted that they have revised the 
acquisition strategy to structure the size and scope of contracts to 
maximize competition and minimize subcontractor tiers. New contracts 
will have reduced performance periods to ensure that prices reflect the 
existing conditions. While USACE previously set production rates in its 
contracts, it did not measure them during the performance of the 
contract. USACE officials further stated that under the revised 
strategy, they will negotiate the production rate and measure the 
contractor's ability to maintain it. To ensure price reasonableness of 
proposed prices, USACE plans to request DCAA to assist the contracting 
officer in reviews of competitive proposals and in negotiations. 
According to the officials, these revisions to USACE's acquisition 
strategy were designed to address concerns related to prime contractors 
passing work on to subcontractors and increasing costs to the 
government without adding value.

Selected Private Sector Companies Rely on Several Shared Approaches to 
Minimize The Risk of Excessive Pass-Through Charges:

Selected private sector companies we interviewed had several strategies 
in common for minimizing the risk to them of excessive pass-through 
charges when purchasing goods and services. These companies focus 
resources on acquisition planning and knowledge of their supply chains 
and costs--challenges DOD continues to face. They also seek to optimize 
competition, preferring fixed-price competitive arrangements. 
According to several companies, they recognize the financial risks of 
other types of contracts, such as time-and-materials, and enter into 
them with proper oversight and accountability. As we have previously 
reported, DOD's use of these riskier contracts has not always ensured 
good acquisition outcomes and prudent expenditure of taxpayer dollars. 
In addition, company officials we interviewed told us that continuous 
and close management of the contractual relationship is critical to 
minimizing risks of excessive costs.

Private Sector Companies Focus on Acquisition Planning and Knowledge of 
Supply Chain:

The contracting officials we spoke with at selected private sector 
companies told us that to avoid unnecessary pass-through charges when 
purchasing goods and services, they devote attention to planning 
acquisitions. Some companies told us that they invest in teams of 
experts and consultants to define contract requirements and then 
structure contracts based on the complexity of the acquisition. For 
example, one company described the use of cross-functional teams to 
obtain input on information technology, purchasing, quality, and other 
internal expertise. Having such information assists in developing 
comprehensive project acquisition plans and clear and stable 
requirements. One company seeks input from its engineers to develop a 
set of criteria based on the product or service acquisition. Officials 
from another company told us they will determine the optimum number of 
subcontracts required to procure a particular product or service and 
group them based on the requirements and need to subcontract. One 
company contracting official told us that it is an "expensive fishing 
expedition" when the requirements are not clearly defined, as it limits 
the company's ability to enter into fixed-price competitive contracts 
and can increase its vulnerability to excessive costs. Private sector 
firms that spoke before the Acquisition Advisory Panel--established to 
review federal acquisition laws and regulations on a number of issues-
-also described a vigorous acquisition planning phase when buying 
services. These firms invest time and resources necessary to clearly 
define requirements first, allowing them to achieve the benefits of 
competition.

According to some company contracting officials, they use rigorous 
market research and requests for information to develop a range of 
potential suppliers and cost and pricing data. Having this information 
on their supply chain allows these companies to minimize the risk of 
excessive pass-through charges. To gain additional information into 
costs, some companies work in a collaborative environment with 
contractors and subcontractors. However, they indicated that in these 
types of arrangements, companies have to be willing to share 
information openly and communicate their concerns and needs to achieve 
best value from the contractual relationship.

Company officials told us that clearly defined requirements contribute 
to their ability when purchasing goods and services to enter into 
fixed-price contracts that lower costs and mitigate the risks of 
unnecessary charges relative to value added by the prime contractor. 
While the vast majority of their contracts are competitive fixed-price 
type contracts, some companies noted that the use of other contracts is 
sometimes necessary. Companies we met with recognize the financial 
risks involved and enter into them only with proper oversight and 
accountability. Buyers from companies who spoke before the Acquisition 
Advisory Panel also noted that when they enter into time-and-materials 
contracts, for example, they "endeavor to maintain tight controls over 
the contracting process, costs, and levels of effort.":

Prior GAO work has found that DOD has been challenged in adequately 
planning many of its major acquisitions. In 1992, GAO identified DOD 
contract management as high-risk due to long-standing concerns in 
planning, execution, and overseeing acquisition processes.[Footnote 
27] We have reported that to produce desired outcomes, DOD and its 
contractors need to clearly understand acquisition objectives and how 
they translate into a contract's terms and conditions. Likewise, we 
have reported that obtaining reasonable prices depends on the benefits 
of a competitive environment, yet we have found cases where DOD failed 
to adequately define contract requirements, making it difficult to hold 
DOD and contractors accountable for poor acquisition outcomes. 
Moreover, participants at a October 2005 GAO forum related to Managing 
the Supplier Base noted that DOD faces challenges in maintaining 
insight into its supply chain and recognized the importance of 
promoting competition in managing multiple tiers of suppliers.[Footnote 
28] In addition, our recent work on DOD's use of time-and-materials 
contracts noted that contracting and program officials frequently 
failed to ensure that these contracts were used only when no other 
contract type was suitable. DOD officials cited speed and flexibility 
as the main reasons these contracts were used, and we reported 
inconsistencies in the rigor with which DOD monitored contractor 
performance, as called for in time-and-materials contracts.[Footnote 
29]

Private Sector Companies Closely Manage Contractual Relationships to 
Control Costs:

Company officials we interviewed told us that continuous management of 
the contractual relationship is critical to minimizing risks of 
excessive costs. The specific management practices used by companies 
generally include establishing clear contract terms and periodic 
evaluations to monitor performance. Subcontractor management practices 
include the use of clear contract terms to guide the relationship and 
ensure both parties understand each other's needs. Some companies told 
us that the type of contract arrangement depends on the product or 
service and some contract terms may include more detail than others. 
According to one company, the level of detail of information requested 
also depends on the product or service procured, size of the 
procurement, and complexity of the work to be performed. This company 
told us that in such cases it has requested information on all parties 
who would be performing the work, down to the fifth level. In other 
cases it may retain the right to renegotiate the contract to ensure it 
is receiving the best price throughout the contractual agreement. 
Typically, both parties agree to renew the contract as long as the 
performance and benefit goals are being met.

Company officials stressed the importance of having performance 
monitoring systems to ensure that the prime contractor's value added 
relative to subcontractor costs is being met. For example, one company 
we interviewed told us that it periodically checks prices in the 
marketplace against cost information provided by the supplier. 
Similarly, another company emphasized the need to continuously check 
prices against the market, since similar to DOD, it does not have 
insight below the first-tier subcontractors. Some companies we 
interviewed also emphasized the importance of periodically evaluating 
and assessing the contractor's value added relative to the costs and 
the need for continuing, changing, or ending the contract relationship.

Contracting Officials Lack The Guidance and Insight Needed to 
Effectively Implement DOD's Interim Rule:

DOD recently issued an interim rule that allows it to recoup contractor 
payments that contracting officers determine to be excessive on all 
eligible contracts. The rule requires detailed information from the 
prime contractor on value added when subcontracting reaches 70 percent 
or more of the total contract. While the rule aims to provide 
contracting officers with more information, it will not provide greater 
insight into DOD's supply chain and costs. Further, while the rule is 
not yet final, contracting officials indicated to us that guidance is 
needed to ensure effective and consistent implementation in assessing 
contractor value added, particularly for newer and less experienced 
contracting staff.

Congress required DOD in the Fiscal Year 2007 National Defense 
Authorization Act to prescribe regulations on excessive pass-through 
charges, which are defined in the act as charges (overhead and profit) 
for work performed by a contractor or subcontractor that adds no, or 
negligible, value. In April 2007, DOD issued an interim rule to require 
a contract clause that provides audit rights and cost recovery should 
these excessive pass-through charges occur.[Footnote 30] The rule also 
requires specific disclosure by a contractor that intends, or 
subsequently decides, to subcontract most of the work. Specifically, 
the contractor is to identify in its proposal the percentage of effort 
it intends to perform, and the percentage expected to be performed by 
each subcontractor under the contract, task order, or delivery order, 
or if a decision to subcontract comes after award, the contractor must 
notify the contracting officer in writing. Under the interim rule, 
prime contractors are required to inform a contracting officer of the 
value added that they are providing when subcontract costs exceed 70 
percent of the total contract value.[Footnote 31] While the rule may 
enhance insight into contractor value added under these circumstances, 
it will not address DOD's challenges in obtaining insight into its 
supply chain and costs--key information needed to mitigate risk of 
excessive pass-through charges according to companies we interviewed.

In addition, DOD has not developed guidance for contracting officers to 
use in implementing the rule. Specifically, it lacks guidance that 
addresses contract risk associated with presence of competition, 
contract type, and unique circumstances where requirements are urgent 
in nature. As we found during our contract review, these are key risk 
factors to take into account when determining the degree of assessment 
needed, not necessarily the percentage of subcontracting alone. 
However, contracting officers have wide latitude in exercising judgment 
on how to apply these tools. While contracting officers we met with 
were generally applying these tools in conducting their assessments of 
contractor value added for the selected contract actions we reviewed, 
they indicated that guidance--particularly for newer and less 
experienced staff--would help ensure the tools are consistently applied 
and that assessments are properly documented in the contract files. We 
brought this to the attention of DOD procurement policy officials, who 
told us that as they develop implementing guidance, they will emphasize 
that contracting officers need to include contract risk in conducting 
their contractor value added assessments and document the results.

While the regulation allows contracting officers to recoup charges that 
they determine to be excessive, it does not specify the roles of DCAA 
and DCMA in this process. As we found in our contract review and in 
discussions with contracting officials, these organizations played a 
key role in assessing cost information. However, contracting officials 
indicated the importance for newer and less experienced staff to 
involve DCAA and DCMA as appropriate. We spoke with officials from both 
of these agencies, who also indicated that they would play a role in 
implementing this regulation and in assisting contracting officers in 
determining whether costs are excessive, but they said they had not 
fully considered the extent or the resources needed. We brought this to 
the attention of DOD procurement policy officials, who agreed these 
organizations need to be involved in assisting contracting officers in 
their assessments of whether pass-through charges are excessive, and as 
they develop implementing guidance, they will emphasize the involvement 
of DCAA and DCMA in facilitating the assessments as appropriate.

Conclusions:

Assessing contractor value added and minimizing the risk of excessive 
pass-through charges have taken on heightened importance given the 
increasing role of subcontractors in providing DOD with critical goods 
and services--especially for emergency situations, where routine 
contracting practices may be overlooked in an effort to meet urgent 
requirements. Historically, DOD has lacked insight into subcontractor 
costs, raising questions about the value added when multiple layers of 
contractors perform the work. Optimizing competition--an acquisition 
strategy the private sector companies we interviewed emphasized when 
purchasing goods and services for their own operations--can minimize 
DOD's risk of paying excessive payments since market forces generally 
control contract cost. However, without insight into the supply chain 
and associated costs, it is difficult to assess the risk of excessive 
pass-through charges. While DOD's new interim rule is a step in the 
right direction, it by itself will not help contracting officials gain 
this insight. Further, although we found that contracting officers were 
generally applying tools in the FAR in conducting assessments of 
contractor value added for selected contracts we reviewed, implementing 
guidance for the new rule would help ensure these tools are 
consistently applied in determining the degree of assessment needed, 
documenting the assessments, and appropriately involving DCAA and DCMA.

Recommendations for Executive Action:

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, we recommend that 
the Secretary of Defense direct the Director of Defense Procurement and 
Acquisition Policy to take the following actions:

* 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.

* Require contracting officials to document their assessments of 
contractor value added in the contract files.

* Involve DCAA and DCMA in facilitating assessments as appropriate.

Agency Comments:

We provided a draft of this report to DOD for comment. In written 
comments, DOD concurred with our recommendations and noted actions 
planned and underway that are directly responsive. Specifically, DOD 
anticipates issuing a second interim rule in February 2008 and expects 
a final rule in August 2008. Once the rule is finalized, DOD intends to 
provide extensive guidance to supplement the regulation that will cover 
a range of issues, including those GAO recommended. DOD's comments are 
reproduced in appendix III.

We are sending copies of this report to the Secretary of Defense and 
will make other copies 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 
calvaresibarra@gao.gov. Contact points for our Offices of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. Key contributors to this report were John Neumann, Assistant 
Director; Barry DeWeese; Yvette Gutierrez-Thomas; Kevin Heinz; Maurice 
Kent; Julia Kennon; John Krump; and Karen Sloan.

Ann Calvaresi Barr Director, Acquisition and Sourcing Management:

List of Committees:

The Honorable Carl Levin Chairman The Honorable John McCain Ranking 
Member Committee on Armed Services United States Senate:

The Honorable Daniel K. Inouye Chairman The Honorable Ted Stevens 
Ranking Member Subcommittee on Defense Committee on Appropriations 
United States Senate:

The Honorable Ike Skelton Chairman The Honorable Duncan L. Hunter 
Ranking Member Committee on Armed Services House of Representatives:

[End of section]

The Honorable John P. Murtha, Jr. Chairman The Honorable C. W. (Bill) 
Young Ranking Member Subcommittee on Defense Committee on 
Appropriations House of Representatives:

[End of section]

Appendix I Scope and Methodology:

* To determine the Department of Defense's (DOD) approach to assessing 
the risk of excessive pass-through charges when work is subcontracted, 
we reviewed and analyzed tools in the Federal Acquisition Regulation 
(FAR) and the Defense Federal Acquisition Regulation Supplement 
(DFARS). We met with DOD officials from the Office of the Secretary of 
Defense, Defense Procurement and Acquisition Policy, Defense Contract 
Audit Agency (DCAA), Defense Contract Management Agency (DCMA), and 
contracting officials from 11 DOD contracting locations to discuss 
these regulations and their approach to assessing the risk of pass-
through charges, evaluating contractor value added, and factors that 
drive these assessments. We selected 10 of these locations, which had 
some of the highest spending in fiscal year 2005, to visit and discuss 
specific contracts, policies, and processes related to evaluating 
contractor value added when work is subcontracted. In addition, while 
we did not visit the Army Tank and Automotive Command in Warren, 
Michigan, we obtained contract documents from it for review. While our 
selection of locations cannot be generalized to the population of all 
DOD contracting locations, those selected represented each of the 
military services and represented a variety of goods and services 
procured. The specific military locations we visited were:

U.S. Air Force:

* Air Force Space Command, Colorado Springs, Colorado:

* Air Force 21st Space Wing, Peterson Air Force Base, Colorado Springs, 
Colorado:

* Air Force 50th Space Wing, Schriever Air Force Base, Colorado 
Springs, Colorado:

* Air Force Space and Missile Command, El Segundo, California:

U.S. Army:

* U.S. Army Space and Missile Defense Command, Peterson Air Force Base, 
Colorado Springs, Colorado:

* Army Contracting Agency, Fort Carson, Colorado Springs, Colorado:

* Army Communications and Electronics Command, Fort Monmouth, New 
Jersey:

* Army Sustainment Command, Rock Island, Illinois:

U.S. Navy:

* Naval Sea Systems Command, Washington Navy Yard, District of 
Columbia:

* Naval Air Systems Command, Patuxent River, Maryland.

At the locations we visited, and to provide a broad perspective on 
extent to which contracting officials apply existing tools in 
acquisition regulations in assessing risk of excessive pass-through 
charges and contractor value added, we analyzed and discussed 32 
selected contract actions awarded in fiscal year 2005. These selected 
actions included base contracts, task orders under contracts, and 
modifications to contracts. Since DOD's procurement information system-
-DD350 database--does not contain a specific field for percentage of 
subcontracting, of all DOD contract actions over $10 million and had 
reported submitting a subcontracting plan, we selected a 
nongeneralizable sample of actions that provided a mix of contract 
types, levels of competition, dollar values, and goods and services 
procured. Moreover, we also selected small business contracts over $10 
million. While small businesses are not required to submit 
subcontracting plans, the dollar value of these actions would have 
otherwise required them. We relied on data provided in the DD350 
database and verified the reliability of the information where 
practical with contracting officers, contract files at contract 
locations visited, and through review of contract documents in DOD's 
Electronic Data Access Web-based system. On the basis of this 
assessment, we found the DD350 database to be sufficiently reliable for 
our purposes.

We reviewed and analyzed available documentation for the selected DOD 
contract actions and discussed these actions with the responsible 
contracting officials. While our selection of contract actions cannot 
be generalized to all DOD contracts, those selected represent each of 
the military services and a number of different contract actions, 
allowing us to obtain a variety of perspectives from DOD contracting 
officials. In reviewing and discussing contract files with contracting 
officials at these locations, we examined factors that drove the need 
to assess prime contractor and subcontractor costs, guidance and tools 
available to conduct assessments, and level of insight into 
subcontracting activity. Included in the contract files and also 
reviewed were documents from DCAA and DCMA that were used to support 
the decisions of contracting officials. We met with both of these 
agencies to discuss their roles in assisting contracting officials. 
Because no criteria exist for assessing value added relative to costs, 
our review does not include a determination of whether the DOD 
contracting officer adequately assessed the value added and costs, but 
rather the extent to which the contracting officer applied existing 
tools in the FAR and DFARS. In addition, to obtain additional 
information on contracts that had been identified as having 
questionable costs, we also interviewed the Army Corps of Engineers, 
the Army Audit Agency, and the DOD Office of Inspector General. We 
reviewed and analyzed documents from these agencies as well as past GAO 
work to determine how tools in acquisition regulations were applied in 
contracts with questionable costs. We also discussed strategies being 
explored to help mitigate risks of excessive costs on future contracts.

To identify the strategies selected private sector companies use to 
minimize risk of excessive pass-through charges when purchasing goods 
and services, we selected nine companies to interview. Our selection of 
companies was based on diversity in commercial and public sector 
contracting and a range of goods and services. In the company 
interviews, we discussed the perspectives and practices for managing 
and assessing value added relative to prime and subcontractor costs. In 
addition to the interviews, we reviewed findings and recommendations of 
the Acquisition Advisory Panel's 2007 report on commercial practices. 
We also reviewed previous GAO reports and issues raised in various GAO 
acquisition forums and met with industry associations, such as the 
Professional Services Council and Coalition for Government Procurement. 
Table 2 provides a list and description of the companies we 
interviewed.

Table 2: Selected Companies and Operations:

Company: Accenture; Description: A consulting firm providing management 
consulting and technical assistance, and outsourcing services to 
government and commercial clients..

Company: ALCOA; Description: The world's leading producer and manager 
of primary aluminum, fabricated aluminum, and aluminum facilities..

Company: IBM; Description: A global leader in business services and 
computer hardware and software..

Company: John Deere; Description: A leading manufacturer of 
agricultural equipment, construction and forestry equipment, 
commercial and consumer equipment..

Company: Miratek; Description: An information technology solution and 
environmental engineering services small business company with mostly 
government clients..

Company: Northrop Grumman; Description: A global defense and technology 
company providing innovative systems, products, and solutions in 
information and services, electronics, aerospace, and shipbuilding to 
government and commercial customers worldwide.[A].

Company: Raytheon; Description: A technology leader specializing in 
defense, homeland security, and other government markets, that provides 
mission systems integration, and other capabilities in communications 
and intelligence systems, as well as a broad range of mission support 
services..

Company: Science Applications International Corporation; Description: 
Specializes in scientific, technical, and engineering work. Develops 
technical solutions and provides systems integration and mission-
critical support services to federal, state, local, and foreign 
governments and private sector customers..

Company: Vangent; Description: The company's markets as well as 
services include consulting, systems integration, business process 
outsourcing, and human capital management..

[End of table]

Source: GAO analysis:

[A] GAO also met with the Northrop Grumman Information Technology 
division that provides commercial information technology services and 
solutions.

To assess DOD's interim rule to prevent excessive pass-through charges, 
we reviewed the specific mandate for DOD in Section 852 of the Fiscal 
Year 2007 Defense Authorization Act. We discussed this requirement with 
DOD procurement policy officials and reviewed the interim DOD rule on 
excessive pass-through charges in response to the mandate as well as 
any changes made based on public comments received. We also spoke to 
DCAA and DCMA regarding their role in implementing the rule and 
obtained perspectives from contracting officials we interviewed at the 
military locations we visited on potential challenges in implementing 
the rule.

[End of section]

Appendix II Key Elements for Contracting Officers in Assessing 
Contractor Value Added:

[End of section]

Element of framework: Acquisition planning; Description: Acquisition 
planning determines the requirements of the contract, the level of 
competition available based on market research, and the appropriate 
contract vehicle to be used..

Element of framework: Defining requirements; Description: Requirements 
and logistics personnel should avoid issuing requirements on an urgent 
basis or with unrealistic delivery or performance schedules, since it 
generally restricts competition and increases prices. Early in the 
planning process, the planner should consult with requirements and 
logistics personnel who determine type, quality, quantity, and delivery 
requirements. (FAR 7.104(b)).

Element of framework: Market research; Description: Market research is 
conducted to determine if commercial items are available to meet the 
government's needs or could be modified to meet the government's needs. 
The extent of market research will vary, depending on such factors as 
urgency, estimated dollar value, complexity, and past experience. 
Market research involves obtaining information specific to the item 
being acquired using a variety of resources. The availability or 
unavailability of items in commercial markets drives the contracting 
procedures used. (FAR 10.001 and 10.002).

Element of framework: Competition; Description: Contracting officers 
shall provide for full and open competition through use of competitive 
procedures that are best suited to the circumstances of the contract 
action and consistent with the need to fulfill the government's 
requirements efficiently. (FAR Part 6.101) When adequate price 
competition exists, generally no additional information is necessary to 
determine the reasonableness of price. (FAR 15.403-3) Acquisition plans 
should address when subcontract competition is both feasible and 
desirable and describe how it will be sought, promoted, and sustained 
throughout the course of the acquisition. (FAR 7.105(b)(2)(iv)).

Element of framework: Type of contract; Description: A wide selection 
of contract types is available to the government and contractors in 
order to provide needed flexibility in acquiring goods and services. 
The objective is to negotiate a contract type and price that will 
result in reasonable contractor risk and provide the contractor with 
the greatest incentive for efficient and economical performance. A 
firm-fixed-price contract, which best utilizes the basic profit motive 
of business enterprise, shall be used when the risk involved is minimal 
or can be predicted with an acceptable degree of certainty. However, 
when a reasonable basis for firm pricing does not exist, other contract 
types should be considered, and negotiations should be directed toward 
selecting a contract type that will appropriately tie profit to 
contractor performance. If the contractor proposes extensive 
subcontracting, a contract type reflecting the actual risks to the 
prime contractor should be selected. (FAR 16.1).

Element of framework: Cost or price evaluation; Description: Normally, 
competition establishes price reasonableness. Therefore, when 
contracting on a firm-fixed-price or fixed-price with economic price 
adjustment basis, comparison of the proposed prices will usually 
satisfy the requirement to perform a price analysis, and a cost 
analysis need not be performed. In limited situations, a cost analysis 
may be appropriate to establish reasonableness of the otherwise 
successful offeror's price. When contracting on a cost-reimbursement 
basis, evaluations shall include a cost realism analysis to determine 
what the government should realistically expect to pay for the proposed 
effort, the offeror's understanding of the work, and the offeror's 
ability to perform the contract. The contracting officer shall document 
the cost or price evaluation. (FAR 15.305(a)(1)).

Element of framework: Technical and past performance analysis; 
Description: The source selection records shall include an assessment 
of each offeror's ability to accomplish the technical requirements; and 
a summary, matrix, or quantitative ranking, along with appropriate 
supporting narrative, of each technical proposal using the evaluation 
factors. Cost information may be provided to members of the technical 
evaluation team in accordance with agency procedures. Additionally, the 
evaluation should take into account past performance information 
regarding predecessor companies, key personnel who have relevant 
experience, or subcontractors that will perform major or critical 
aspects of the requirement when such information is relevant to the 
instant acquisition. (FAR Part 15.305(a)(2)).

Element of framework: Subcontracting plans; Description: In negotiated 
acquisitions, each solicitation that is expected to exceed $550,000 
($1,000,000 for construction) and that has subcontracting 
possibilities, shall require a subcontracting plan. If the offeror 
fails to negotiate a subcontracting plan acceptable to the contracting 
officer within the time limit prescribed by the contracting officer, 
the offeror will be ineligible for award. (FAR 19.702(a)(1)&(2)). Each 
subcontracting plan must include percentage goals for using different 
types of small businesses, a statement of the total dollars planned to 
be subcontracted, a statement of the total dollars planned to be 
subcontracted to small businesses, and a description of the principal 
types of supplies and services to be subcontracted.(FAR 19.704(a)).

Element of framework: Cost accounting; Description: When required, a 
disclosure statement must be submitted as a part of the offeror's 
proposal unless they have already submitted a statement disclosing the 
practices used in connection with the pricing of the proposal. (FAR 
52.230-1(b)). Prime contractors or higher tiered subcontractors can be 
required to include subcontractor accounting practices in their 
disclosure statements (FAR 30.202-8(a)). DCAA provides audit services 
in assuring compliance with Cost Accounting Standards..

Element of framework: Cost and pricing data; Description: The 
contracting officer shall require the prime contractor to submit cost 
and pricing data and a certificate that states that the data are 
accurate, complete, and current. Any subcontractor or prospective 
subcontractor should submit similar data and certification to the prime 
contractor or appropriate subcontractor tier. (FAR 15.403-4).

Element of framework: Information other than cost and pricing data; 
Description: The contracting officer is responsible for obtaining 
information that is adequate for evaluating the reasonableness of the 
price or determining cost realism. The contracting officer may request 
other information to use in this evaluation, including, the prices at 
which the same item or similar items have previously been sold. (FAR 
15.403-3).

Element of framework: Subcontract pricing; Description: The contracting 
officer is responsible for the determination of price reasonableness 
for the prime contract, including subcontracting costs. The contracting 
officer should consider whether a contractor or subcontractor has an 
approved purchasing system, has performed cost or price analysis of 
proposed subcontractor prices, or has negotiated the subcontract prices 
before negotiation of the prime contract, in determining the 
reasonableness of the prime contract price. This does not relieve the 
contracting officer from the responsibility to analyze the contractor's 
submission, including subcontractor's cost or pricing data. (FAR 
15.404-3).

Element of framework: DCAA; Description: The contracting officer should 
request field pricing assistance when the information available at the 
buying activity is inadequate to determine a fair and reasonable price. 
The contracting officer must tailor requests to reflect the minimum 
essential supplementary information needed to conduct a technical or 
cost or pricing analysis. (FAR 15.404-2). DCAA's Financial Liaison 
Advisors provide financial advisory service support at customer sites 
to assist contracting officers in determining fair and reasonable 
contract prices. These services include market research and analysis of 
certified cost and pricing data and other information..

Element of framework: DCMA; Description: DCMA can also provide 
requested assistance through technical analysis (i.e., engineering 
evaluation of proposed labor hours or material requirements) and 
special analyses (i.e., evaluations of specific cost elements, rates 
and factors, or, in some cases, estimating methodologies)..

Element of framework: Audit services; Description: DCAA, as the 
responsible audit agency, submits information and advice to the 
requesting activity based on the auditor's analysis of the contractor's 
financial and accounting records or other related data as to the 
acceptability of the contractor's incurred and estimated costs. DCAA 
may also perform other analyses and reviews that require access to the 
contractor's financial and accounting records supporting proposed and 
incurred costs. (FAR 42.101).

Element of framework: Contract administration; Description: The 
contracting officer delegates many functions to a contract 
administration office. This office can be DCMA or another agency that 
offers a wide variety of administrative services. However, since the 
prime contractor is responsible for managing its subcontracts, this 
office's review of subcontracts is normally limited to evaluating the 
prime contractor's management of the subcontracts. Therefore, 
supporting contract administration shall not be used for subcontracts 
unless the Government otherwise would incur undue cost or successful 
completion of the prime contract is threatened. For major system 
acquisitions, the contracting officer may designate certain high-risk 
or critical subsystems or components for special surveillance in 
addition to requesting supporting contract administration. (FAR 42.201 
and 42.202)..

Element of framework: Consent to subcontract; Description: The 
contracting officer may require consent for subcontracts to protect the 
government because of the subcontract type, complexity, or value, or 
because the subcontract needs special surveillance. These can be 
subcontracts for critical systems, components, or services. (FAR 
44.201-1(a)). Notification submitted to the contracting officer should 
include a description of the supplies or services to be subcontracted, 
the type of subcontract to be used, the proposed subcontractor and 
proposed price, the subcontractor's current cost or pricing data, 
certificate of cost and pricing data, and the subcontractor's 
Disclosure Statement or Certificate to Cost. (FAR 52.244-2 (f)(1))..

Element of framework: Contractor purchasing system review; Description: 
The objective of a contractor purchasing system review is to evaluate 
the efficiency and effectiveness with which the contractor spends 
government funds and complies with government policy when 
subcontracting. The review provides the administrative contracting 
officer a basis for granting, withholding, or withdrawing approval of 
the contractor's purchasing system. (FAR 44.301). Evaluation of the 
purchasing system pays special attention to items such as the degree of 
price competition obtained, methods of obtaining accurate cost or 
pricing data, and methods of evaluating subcontractor responsibility. 
(FAR 44.303)..

[End of table]

Source: GAO analysis of the FAR.

[End of section]

Appendix III Comments from the Department of Defense:

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FOOTNOTES

[1] Pass-through charges are contractor charges for the costs 
associated with subcontracting work.

[2] Section 852 of the John Warner National Defense Authorization Act 
Fiscal Year 2007, Public Law No. 109-364.

[3] Contract actions consisted of base contracts, task orders placed 
against existing contracts, and contract modifications.

[4] This panel was authorized by Section 1423 of the Services 
Acquisition Reform Act of 2003 (commonly known as the SARA panel). 
Pub.L.No. 108-136. The panel's statutory charter was to review and 
recommend any necessary changes to acquisition laws and regulations as 
well as governmentwide acquisition policies with a view toward ensuring 
effective and appropriate use of commercial practices and performance-
based contracting. Some topics examined included the use of commercial 
practices in federal contracting, performance-based contracting, 
performance of acquisition functions across agency lines of 
responsibility, and governmentwide contracts.

[5] For purposes of this report, we refer to other than full and open 
competitive procedures as noncompetitive. 

[6] The annual subcontracting data were obtained from the Office of the 
Under Secretary of Defense, Office of Small and Disadvantaged Business 
Utilization, for fiscal years 2002 through 2006. We did not 
independently test the reliability of the data obtained from this 
office, which relies on DOD contractors to report this subcontract 
information semiannually on Standard Form 295 (SF295). 

[7] Subcontracting plans are required for most contracts over $550,000 
or $1 million for construction contracts. FAR 19.702(a)(1)&(2); 13 CFR 
§ 125.3(a). Subcontracting plans are not required (1) from small 
businesses; (2) for personal service contracts; (3) for contracts or 
contract modifications performed outside any state, territory, or 
possession of the United States, the District of Columbia, and the 
Commonwealth of Puerto Rico; or (4) for modifications of contracts 
within the general scope of the contract that do not contain the clause 
FAR 52.219-8, Utilization of Small Business Concerns. FAR 19.702(b) 

[8] For purposes of this report, we refer to each level of 
subcontracting as a layer or tier.

[9] Appendix II provides more detail on these key elements.

[10] FAR 16.103 (b). A firm-fixed-price contract is ordinarily used 
when the risk involved is minimal or can be predicted with an 
acceptable degree of certainty. When a reasonable basis for firm 
pricing does not exist, other contract types should be considered. FAR 
16.104(j). If the contractor proposes extensive subcontracting, a 
contract type reflecting the actual risks to the prime contractor 
should be selected. 

[11] FAR 15.101. In different types of acquisitions, the relative 
importance of cost or price may vary. In acquisitions where the 
requirement is clearly definable and the risk of unsuccessful contract 
performance is minimal, cost or price may play a dominant role in 
source selection. The less definitive the requirement, the more 
development work required, or the greater the performance risk, the 
more technical or past performance considerations may play a dominant 
role in source selection. 

[12] When prices are based on adequate price competition, no other 
information is generally needed. In other cases, more information may 
be needed from the prime contractor as well as any subcontractors. See 
FAR 15.403-3, Subcontract Pricing Considerations. 

[13] Contracting officers can request further assistance in contract 
administration from DCMA reviews and DCAA cost audits, which include 
evaluation and surveillance of contractor management systems that 
relate to subcontractors.

[14] Contracting officials estimated that over 90 percent of the 
contracts at two Air Force commands we visited are competitive. 

[15] In fiscal year 2006, DOD reported that 37 percent of its contracts 
were awarded as other than full and open competition.

[16] FAR Subpart 15.4.

[17] FAR 16.301-2 and FAR 16.301-3 describe limitations on the use of 
cost-reimbursement contracts. FAR Part 16.601(c) describes the 
application of time-and-materials contracts. 

[18] A multiple award indefinite delivery, indefinite quantity contract 
occurs when an agency enters into a contract with two or more sources 
under the same solicitation. These contracts provide for an indefinite 
quantity, within stated limits, of products or services during a fixed 
period. Agencies place orders for individual requirements under these 
contracts. 

[19] GAO, Defense Contracting: Improved Insight and Controls Needed 
over DOD's Time-and-Materials Contracts, GAO-07-273 (Washington, D.C.: 
June 29, 2007). 

[20] DFARS 216.601(e).

[21] FAR 15.1--Source Selection Processes and Techniques--provides 
considerable flexibility to the buying activity in evaluating 
competitive proposals. An agency can obtain best value in negotiated 
acquisitions by using any one or a combination of source selection 
approaches. The process permits trade-offs among cost or price and 
noncost factors, such as technical capabilities, when it is in the best 
interest of the government to consider awarding to other than the 
lowest-priced offeror. 



[22] The Small Business Administration's 8(a) program is one of the 
federal government's primary means for developing small businesses 
owned by socially and economically disadvantaged individuals. This 
program allows the government to award contracts to participating small 
businesses without competition below certain thresholds. 

[23] FAR 52.219-14, Limitations on Subcontracting. In the case of a 
contract for supplies (other than procurement from a nonmanufacturer in 
such supplies), the concern will perform at least 50 percent of the 
cost of manufacturing the supplies, not including the cost of 
materials.

[24] While representing a small amount of total federal procurement 
spending, obligations for 8(a) contracts to ANC firms increased from 
$265 million in fiscal year 2000 to $1.1 billion in 2004. GAO, Contract 
Management: Increased Use of Alaska Native Corporations' Special 8(a) 
Provisions Calls for Tailored Oversight, GAO-06-399 (Washington, D.C.: 
Apr. 27, 2006); GAO, Alaska Native Corporations: Increased Use of 
Special 8(a) Provisions Calls for Tailored Oversight, GAO-07-1251T 
(Washington, D.C.: Sept. 19, 2007).

[25] GAO, Agency Management of Contractors Responding to Hurricanes 
Katrina and Rita, GAO-06-461R (Washington, D.C.: March 2006). 

[26] U.S. Army Audit Agency, Debris Removal Contracts: U.S. Army Corps 
of Engineers, Audit Report: A-2007-0016-FFD (Washington, D.C.: Nov. 9, 
2006). 

[27] GAO's high-risk designation is given to major programs and 
operations that need urgent attention and transformation in order to 
ensure that our national government functions in the most economical, 
efficient, and effective manner possible. It also emphasizes programs 
that are at high risk because of their great vulnerability to fraud, 
waste, abuse, and mismanagement. 

[28] GAO, Highlights of a GAO Forum: Managing the Supplier Base in the 
21st Century, GAO-06-533SP (Washington, D.C.: Mar. 31, 2006).

[29] GAO, Defense Contracting: Improved Insight and Controls Needed 
over DOD's Time-and-Materials Contracts, GAO-07-273 (Washington, D.C.: 
June 29, 2007). 

[30] 72 Fed. Reg. 20758 (April 26, 2007). Excessive Pass-through 
Charges. As of December 2007, DOD was in the process of responding to 
public comments and revising its interim rule. 

[31] The rule excludes (1) firm-fixed-price contracts awarded on the 
basis of competition, (2) fixed-price contracts with economic price 
adjustment awarded on the basis of adequate price competition, (3) 
firm-fixed-price contracts for the acquisition of a commercial item, or 
(4) fixed-price contracts with economic price adjustment for the 
acquisition of a commercial item. 

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