Federal Contracting: Share-in-Savings Initiative Not Yet Tested
Published: 2005-07-26T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Federal agencies spend billions of dollars every year on information technology and are increasingly using performance-based contracting methods where agencies specify desired outcomes and allow contractors to design the best solutions to achieve those outcomes. Share-in-savings contracting is one such method under which a contractor provides funding for a project, and the agency compensates the contractor from any savings derived as a result of contract performance. The E-Government Act of 2002 authorized the use of share-in-savings contracting for information technology and required implementing regulations by mid-September 2003. The Office of Management and Budget (OMB) reported in December 2004 that no share-in-savings contracts had been awarded. The act's authority expires in September 2005. The act required GAO to assess the effectiveness of share-in-savings contracts. Because no such contracts have been awarded, GAO cannot provide an assessment. Instead, GAO reviewed the status of regulations and tools available to agencies in developing these contracts and identified the reasons agencies have not used the authority provided by the act. OMB and the General Services Administration (GSA) generally agreed with GAO's report.
section_title: What GAO Found
paragraphs: More than 2 years after enactment of the E-Government Act of 2002, implementing regulations and OMB guidance for using share-in-savings contracts for information technology have yet to be issued. OMB officials indicate, however, that implementing regulations and share-in-savings guidance will be issued in the near future. GSA--which the act holds responsible for helping agencies identify share-in-savings opportunities, among other requirements--established a share-in-savings program office in February 2003. A few months later, GSA launched two Web-based tools, one of which is designed to assist agencies in identifying cost-effective uses for the share-in-savings approach and producing business cases for using share-in-savings for information technology projects. As of March 2005, this tool had been used more than 200 times. A total of 15 business cases were deemed potential share-in-savings candidates, however, none of these resulted in a contract award. GSA hired a contractor that developed a 2-day training course for share-in-savings contracting, but only 21 federal acquisition employees have taken the course. And even though GSA prequalified six contractors as viable information technology system solution providers with commercial share-in-savings experience, no agencies have taken advantage of these opportunities to award a share-in-savings contract. Officials from 11 agencies cited a number of reasons that the share-in-savings initiative has not resulted in the award of contracts for information technology projects. Reasons include lack of implementing regulations; difficulty determining baseline costs; a belief that the return on investment using share-in-savings contracts is insufficient; concerns among agency officials that they still would have to obtain funding for cancellation and termination liability, which can be a significant sum; and too few acquisition employees have been trained to use the share-in-savings contracting technique. Since OMB expects the implementing regulations and share-in-savings guidance to be issued soon, at least some of the reasons agencies cited for not using the share-in-savings contracting authority for information technology soon could be addressed. Whether or not other reasons can be overcome may not be known until the authority is tested.

section_title: Letter
paragraphs: Federal agencies spend billions of dollars every year on information  technology to improve mission-related or administrative processes. To try  to maximize the prospects for success of information technology projects,  agencies are increasingly using performance-based contracting methods  where they specify desired outcomes and allow the contractors to design  the best solutions to achieve those outcomes. Share-in-savings contracting  is a performance-based technique, under which a contractor provides the  initial funding for a project and the agency then compensates the  contractor from any financial benefits derived as a result of contract  performance.
The E-Government Act of 2002 authorized the use of share-in-savings  contracting to obtain information technology. This authority is set to  expire at the end of September 2005. The act required that implementing  regulations be issued no later than September 2003. It also required that  the Office of Management and Budget (OMB) report to Congress on the  use of this authority, and that we report on our assessment of the  effectiveness of share-in-savings contracting. In December 2004, OMB  reported that no share-in-savings contracts for information technology  projects had been awarded. We cannot, therefore, provide an assessment  of the effectiveness of this contracting method. As agreed with your  offices, however, we (1) determined the status of regulations, guidance,  and program level support available to agencies in developing share-in- savings contracts for information technology, and (2) identified the  reasons agencies have not used the authority provided by the legislation.
To determine the status of share-in-savings regulations, guidance, and  program-level support, we obtained documentation from and interviewed  officials with OMB and the General Services Administration (GSA), which  is responsible for identifying potential share-in-savings opportunities and  providing guidance to the agencies. To determine the reasons agencies  have not entered into share-in-savings contracts for information  technology, we interviewed officials at seven agencies with high-dollar  contracting in information technology during fiscal year 2003. We also  interviewed officials at four additional agencies that had expressed  interest in annual budget submissions to OMB in using share-in-savings  contracts for information technology. We conducted our review from  February 2005 through June 2005 in accordance with generally accepted  government auditing standards.
subsections: section_title: Background
paragraphs: Share-in-savings contracts fall under the umbrella of performance-based  contracting, in which a federal agency specifies the outcome or result it  desires and lets the contractor decide how best to achieve the desired  outcome. In theory, share-in-savings contracting can provide a number of  potential benefits to both an agency and its contractor. For example, an  agency can ask a contractor to provide up-front funding, in which case  most of the financial risk of the project shifts from the government to the  contractor. The agency also can leverage the contractor’s stake in the  success of a project since the contractor receives payment only after  demonstrating that the project—a new or upgraded information  technology system, for example—saves the agency money. Unexpected  problems, such as a delay in system installation, could erase some of the  projected savings, so the contractor has an incentive to effectively manage  overall costs, schedule, and performance. In short, the contractor is paid  for results, not just for effort. Because of the increased financial risk a  contractor assumes, a contractor can earn a greater return with a share-in- savings contract compared to the return on a traditional contract.
In 1996, the Clinger-Cohen Act authorized limited pilot programs to test  the feasibility of share-in-savings contracts for information technology. In  2002, the E-Government Act expanded authority to award share-in-savings  contracts in fiscal years 2003 through 2005 to acquire information  technology solutions and provided incentives for agencies to enter into  such contracts. For example, agencies are allowed to retain, in their  information technology accounts, any savings above amounts paid to their  contractors. The act required the OMB to report to Congress on the  number of share-in-savings contracts entered into under this initiative. In  December 2004, the OMB reported that no contracts for information  technology projects had been awarded.
In 2003, we issued two reports related to the use of share-in-savings  contracts. Our January 2003 report, which focused on commercial use of  share-in-savings contracting, found that this approach can be an effective  technique to motivate contractors to generate savings and revenues for  clients. To be successful, though, clients and contractors need to agree on  goals and objectives and how to achieve them. Our March 2003  correspondence to OMB addressed the need for OMB’s Office of Federal  Procurement Policy to ensure that members of the federal acquisition  workforce understand and appropriately apply the authority of the   E-Government Act of 2002.
The Department of Energy has used share-in-savings contracting for  technology solutions to reduce energy consumption. Congress authorized  the department, among other federal agencies, to use a type of share-in- savings contract for private financing of energy-efficiency improvements  in federal facilities. Rather than use up-front appropriations from  Congress, the department asked energy service contractors to contribute  the up-front costs for identifying a federal facility’s energy needs as well as  buying, installing, operating, and maintaining energy-efficient equipment  to reduce energy bills. In return, the contractors get a share of the energy  savings generated by the improvements. We have found that agencies that  have used energy savings performance contracts have reduced their  energy consumption and achieved other goals.
We have raised questions, however, about the use of share-in-savings  contracts for energy-efficiency improvements. For example, a number of  factors may cause third-party financing of long-term capital improvement  projects to be more expensive than the direct use of available  appropriated funds. This is so because the interest rate paid by a  contractor for needed capital typically would be higher than if the  improvements were funded through appropriations. Inevitably, by opting  to use a share-in-savings contract, the federal agency would have to take  into account the contractor’s higher cost of financing than if the agency  had funded the project itself. Another area of concern is how share-in- savings contracts should be reflected in the federal budget, an issue about  which federal budget agencies disagree. On the one hand, OMB believes  that share-in-savings budget authority, contract obligations, and outlays  should be recognized on a year-to-year basis. In other words, only the first  year’s costs, not the cumulative annual costs of energy share-in-savings  contracts, would need to be reflected in the agency’s budget in the year  the contract is awarded. On the other hand, the Congressional Budget  Office believes that the budget should reflect long term share-in-savings  contract commitments as new obligations at the time the contract is  signed, consistent with government accounting principles. In a recent  report, we raised similar concerns. Finally, the extent to which energy  savings cover costs remains uncertain, and we have recommended more  oversight of energy savings performance contracts and other steps to  ensure cost-effectiveness.
section_title: Share-in-Savings Regulations and Guidance Lag Behind Progress in Other Areas
paragraphs: Final regulations to implement the share-in-savings authority in the   E-Government Act of 2002 have yet to be published. Additional guidance  on the use of this method also lags behind the progress made in  establishing a share-in-savings program office and providing agencies with  some share-in-savings tools and related training.
The E-Government Act required that the Federal Acquisition Regulation  (FAR) be revised by mid-September 2003 to implement the share-in- savings authority contained in the act. It was not until July 2004, however,  that a proposed revision to the FAR was published in the Federal Register  for public comment. As of July 2005, the final FAR rule was still awaiting  approval by OMB’s Office of Federal Procurement Policy. The act also  required the OMB to develop guidance for techniques to permit agencies  to retain a portion of resulting financial savings after payment of the  contractor’s share of the savings. OMB officials told us they plan to  develop a broader policy memorandum providing agencies with additional  guidelines to ensure share-in-savings contracting success. As of July 2005,  the policy memorandum had not been issued. OMB officials indicated,  however, that implementing regulations and share-in-savings guidance  would be completed in the near future.
The act assigned GSA responsibility for helping federal agencies identify  information technology projects as potential share-in-savings candidates  and for providing guidance on determining share ratios and baselines from  which savings may be measured. GSA established a share-in-savings  program office in February 2003, and in July of that year launched two  Web-based tools to help agencies identify and evaluate share-in-savings  opportunities. The Business Case Decision Tool is designed to assist  agencies in developing business cases on the basis of realistic baseline  costs to ensure that use of share-in-savings contracts would be cost- effective. The Proposal Evaluation Tool is used to evaluate the merits of  contractor share-in-savings proposals. According to the program office  director, agencies started using the Business Case Decision Tool in  September 2003. As of March 2005, various agencies have used the tool to  conduct 219 analyses, resulting in the identification of 15 information  technology projects as potential share-in-savings candidates. Although  some of these 15 potential projects are still under consideration, various  steps remain to be completed, and none has yet resulted in a share-in- savings contract award.
GSA hired a contractor to train agencies in identifying suitable share-in- savings projects, structuring solicitations, and analyzing proposals. The  training, which has been available to agencies since July 2004, is a 2-day  course and costs $650 per student. As of March 21, 2005, a total of 21  federal acquisition employees from six agencies had taken the training.  The same training is now being offered by the Federal Acquisition  Institute, an entity within OMB charged with developing the curriculum  needed to train the civilian agency workforce. Two classes have been  scheduled, one in June 2005, and the other before the E-Government Act’s  authority expires in September 2005. The Federal Acquisition Institute may  exercise an option to provide five additional share-in-savings training  classes in fiscal year 2006.
Finally, in July 2004, GSA established blanket purchase agreements with  six contractors; each of which is a major information technology solution  provider with commercial share-in-savings contracting experience. A  blanket purchase agreement is a simplified method of filling the  government’s anticipated repetitive needs for supplies or services by  establishing charge accounts with qualified sources of supply. The  agreements may subsequently be used by agencies to procure specific  goods or services. As of June 2005, however, since no share-in-savings  project is ready for the contracting phase, no agencies have used the  blanket purchase agreements.
section_title: Use of Share-in- Savings Authority Hindered by Issues Related to Regulations, Baseline Costs, Up-front Funding, and Training
paragraphs: Officials from 11 agencies cited several reasons the share-in-savings  contracting authority for information technology has not led to the award  of share-in-savings contracts. Reasons include a lack of final implementing  regulations and OMB guidance on how to budget and account for retained  savings and the difficulty of determining baseline costs. Some officials said  contractors are reluctant to get involved in share-in-savings contracts  because the return on investment is believed to be too low. In addition,  officials told us that even though contractors would provide up-front  funding for a share-in-savings contract, some amount of appropriated  funds would still be required. Officials also said that too few acquisition  personnel have been trained to use this innovative contracting technique.
subsections: section_title: Implementing Regulations and OMB Guidance Not Yet Issued
paragraphs: Agency officials told us they are reluctant to use share-in-savings  contracting until the FAR implementing regulations are finalized. Because  share-in-savings contracting is considered innovative within the federal  government, agency officials said they need clear regulations to  understand when and how to use this technique.
We also highlighted the need for guidance in our March 2003  correspondence to OMB’s Office of Federal Procurement Policy. Given  the federal government’s limited experience with share-in-savings  contracting, as well as limited understanding of the conditions that foster  successful implementation in commercial share-in-savings contracts, we  reported that members of the federal acquisition workforce need to  understand and appropriately apply the E-Government Act’s new  authority. Toward that end, we recommended that OMB develop the  necessary guidance. To date, OMB has not responded to our  recommendation. While GSA’s guidance may be helpful in identifying  potential candidates, additional guidance is still needed from OMB on  accounting for savings in excess of amounts paid to the contractor and  developing sound business cases with firm baselines.
section_title: Baseline Costs Difficult to Determine
paragraphs: Another reason agency officials say they have not used share-in-savings  contracting is the difficulty in determining a baseline cost. A baseline cost  is the cost of current operations. Without an accurate baseline, agreed to  by the agency as well as the contractor, savings cannot be correctly  measured, leaving both the agency and the contractor at risk of not  receiving their fair share of savings, if any are generated. The contractor  cannot determine with any certainty that the savings would cover its costs,  let alone result in a profit. Our past work on commercial use of share-in- savings contracts suggests that the business process and administrative  cost information necessary to calculate a baseline may not be available in  some cases. Agency officials told us that in the information technology  area, calculating a baseline can be very complicated. It can be difficult, for  example, to isolate the direct savings from a reduction in the time an  employee spends on a new task as a result of a new, automated  information system replacing one or more old tasks. Further, in our past  financial reporting, we have described the type of systemic challenges  agencies face in accurately determining the baseline costs of programs,  which could impede agencies’ use of share-in-savings contracting. For  example, we reported in the 2004 Financial Report of the United States  Government that the federal government’s ability to reliably measure the  full costs of certain programs is hampered by a significant number of  material weaknesses related to financial systems, fundamental  recordkeeping, financial reporting, and incomplete documentation.
section_title: Return on Investment Believed to Be Too Low
paragraphs: Even if a baseline could be established, most agency officials we  interviewed said an obstacle to using share-in-savings contracting would  be not having a potential savings pool large enough to provide contractors  an appealing return on investment. The GSA share-in-savings program  office and the Office of the Secretary of Defense’s Business Initiative  Council determined that a successful share-in-savings business case  requires a savings-to-investment ratio of at least 3 to 1. However, a  business case review in 2004 by the Defense Commissary Agency  illustrates the potential difficulty in meeting that target. Last year, that  agency determined that an inadequate return on investment was a primary  reason a share-in-savings contract would not be used to buy a replacement  retail transaction system for its hundreds of commissaries. On two  occasions, the agency requested information from contractors on  installing a replacement retail transaction system under a share-in-savings  contract. Concerns about fewer commissaries in the future, as a result of  anticipated military base closures, and other cost uncertainties led  contractors to request a guaranteed minimum number of system  replacements to protect profit margins associated with their initial  investments. The agency did not provide minimum guarantees, and a  share-in-savings contract was not awarded.
section_title: Appropriations Still Necessary
paragraphs: Another reason, according to officials, agencies may not have used share- in-savings contracting to acquire information technology solutions is that  the E-Government Act requires funds to be available for the first year of  the contract. Even though the contractor pays the up-front costs, the  agency still needs appropriated funds to cover cancellation and  termination liability, in the event the government ends the project.  However, agency officials advised that these funds can represent a  significant share of the total cost of an information technology project.  Accordingly, so that any savings would stay with the government, agency  officials said they are motivated to use appropriated funds for information  technology projects and to award traditional contracts. This is the reason  that the Internal Revenue Service decided not to award a share-in-savings  contract to modernize its taxpayer identification system for non-U.S.  citizens.
In the past, when we interviewed Department of Energy officials about  using share-in-savings contracts for energy-efficiency improvements, they  said this contracting technique is best used to finance projects when  federal funding is thought to be unavailable. According to Department of  Energy officials, they would prefer the agency pay for the entire project,  because all of the savings would stay with the government.
section_title: Few Acquisition Personnel Have Been Trained
paragraphs: We have previously reported that training on the E-Government Act’s  share-in-savings acquisition initiative would be essential to its effective  implementation. However, few acquisition personnel have been trained  on when and how to use share-in-savings contracting. As of March 21,  2005, only 21 federal acquisition employees had received share-in-savings  training from GSA’s share-in-savings training contractor. The training  developed by the contractor addresses the technical and organizational  share-in-savings issues needed to be understood for successful contracts.  For example, negotiating a share-in-savings contract can be a highly  technical and time-consuming process and requires a certain level of  business acumen. As covered in the training, the use of share-in-savings  contracting demands a good understanding of requirements; agreement on  baseline costs, use of metrics to measure savings, confidence in savings- share ratios; and the identification and mitigation of risks.
section_title: Conclusions
paragraphs: With only a few months remaining before authority for the initiative is due  to expire, no federal agencies have used the share-in-savings authority  provided by the E-Government Act to award contracts. Therefore, neither  OMB nor we has a basis for assessing the effectiveness of share-in-savings  contracts for information technology to improve agencies’ mission-related  or administrative processes. Agencies’ limited exposure to share-in-savings  contracting for information technology has not extended much beyond the  initial steps of analyzing potential business cases. As a result, the act’s  authority has not actually been tested.
Since OMB expects the implementing regulations and share-in-savings  guidance to be issued soon, at least some of the reasons agencies cited for  not using the share-in-savings contracting authority for information  technology soon could be addressed. Although it is too early to know  whether or not other reasons can be overcome, the issuance of  implementing regulations and OMB guidance may soon create better  conditions under which to test the share-in-savings initiative. If Congress  wants to test the effectiveness of share-in-savings contracts for  information technology, Congress would need to extend the authority  beyond the scheduled September 2005 expiration.
section_title: Agency Comments and Our Evaluation
paragraphs: We received comments on a draft of this report from OMB and GSA. Both  agencies concurred with the report.
In oral comments, OMB officials acknowledged that issuance of the share- in-savings implementing regulations and OMB guidance has been delayed  longer than anticipated. The officials cited the need to ensure that the  regulations and OMB guidance are clear on how to successfully manage  share-in-savings complexities, such as establishing a baseline, determining  a reasonable return on investment, and ultimately developing a sound  business case. OMB officials commented that shortly after enactment of  the E-Government Act, the agency started efforts to develop the share-in- savings regulations and guidance and noted the October 2003 advanced  notice of proposed rulemaking and the July 2004 publication of the  proposed rule as examples of the results of such efforts. OMB officials  also noted that the final rule was drafted in February 2005. However, OMB  officials told us they continue to work with other agencies to ensure that  the final policy is clear on how to successfully handle the complexities of  the share-in-savings planning and budgeting processes. Although OMB  officials could not tell us precisely when, they anticipate that the final rule  and OMB guidance will be published in the near future.
In e-mailed comments, GSA generally agreed with our report but believed  the title of the report did not accurately describe the efforts taken to test  share-in-savings. GSA commented that the report’s title implies that  nothing has been done, despite the agency’s efforts in promoting the use of  share-in-savings and that certain portions of the concept have been tested,  although outside of the E-Government Act’s authority. We recognize that  the government has used share-in-savings contracts under other  authorities. However, the government has not awarded any share-in- savings contracts under the E-Government Act’s authority, and therefore,  the authority has not been tested. We also recognize in the report the work  GSA did to promote the use of share-in-savings contracting.
section_title: Scope and Methodology
paragraphs: To determine the regulations, guidance, and program-level support that  exist to assist agencies in developing share-in-savings contracts, we  interviewed officials and obtained documentation from OMB and GSA. We  participated in a 1-day course adapted from GSA’s 2-day training course,  which was led by the contractor, Beacon Associates Inc. of Bel Air,  Maryland.
To determine the reasons agencies have not entered into share-in-savings  contracts, we interviewed officials from seven defense and civilian  agencies that used contracting vehicles other than share-in-savings to  award high dollar-value contracts for information technology in fiscal year  2003. We identified the agencies with high-dollar information technology  spending by reviewing contract actions reported in the Federal  Procurement Data System, the government’s repository for contracting  data. Though that system has recognized limitations, it was sufficient for  purposes of identifying a mix of defense and civilian agencies with high  levels of spending on information technology.
We interviewed agency officials who had shown an interest in using share- in-savings contracts to buy information technology. We identified these  officials by reviewing their agencies’ Exhibit 300, an OMB budget  justification and reporting requirements document that is required for the  procurement of major information technology systems. We also contacted  the GSA for help in identifying agencies that explored share-in-savings  opportunities. Finally, we interviewed and obtained information from the  Department of Defense’s Business Initiatives Council. The Department of  Defense established the council to improve business operations by  identifying and implementing business reforms, such as share-in-savings  contracting for information technology. The agencies we obtained  information from as to why they opted not to use the E-Government Act’s  share-in-savings contracting authority are the Army, Navy, Air Force, and  the Defense Commissary Agency in the Department of Defense; the  Departments of Agriculture, Health and Human Services, Interior, and  Justice; GSA; the Internal Revenue Service; and the Office of Personnel  Management.
We are sending copies of this report to interested congressional  committees, the Director of OMB, the Administrator of General Services,  and the chief acquisition officers at the 11 agencies from which we  obtained information. We will also make copies available to others upon  request. In addition, the report will be available at no charge on the GAO  Web site at http://www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-4841 or woodsw@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Major contributors to this report were Carolyn Kirby,  Assistant Director; Daniel Hauser; Noah Bleicher; Lily Chin; Johnetta  Gatlin-Brown; and Russell Reiter.