Currency Paper Procurement: Additional Analysis Would Help Determine Whether a Second Supplier Is Needed
Published: 2005-04-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: For over 125 years, the Bureau of Engraving and Printing (BEP), within the Department of the Treasury, has relied on a single contractor to supply the paper for U.S. currency. Such a long-term contracting relationship could contribute to higher costs and other risks. Another federal agency that relied on a single contractor, the U.S. Mint, decided to obtain a second supplier for coin metal. In solicitations for currency paper contracts in 1999 and 2003, BEP took steps to address barriers to competition that GAO had identified in 1998 through a survey of paper manufacturers. This report updates GAO's 1998 report using data from a second survey. It addresses (1) the changes BEP made to encourage competition and the results of its efforts, (2) the steps BEP took to ensure that it paid fair and reasonable prices, and (3) the analysis BEP has done of the advantages and disadvantages of obtaining a second supplier.
section_title: What GAO Found
paragraphs: To encourage competition for the 1999 and 2003 contracts, BEP modified its solicitations to, among other things, indicate that it would provide bidders with the security thread that is inserted into most currency paper and extend the time for initial deliveries. For the 1999 contract, one additional supplier submitted an initial proposal but later withdrew it, and for the 2003 contract, only the current supplier submitted a proposal. This company remains the sole supplier of U.S. currency paper. According to paper manufacturers, several barriers to competition remain, including the high capital costs of and technological requirements for producing currency paper. BEP said it has not addressed these barriers because the requirements are either essential to preserve the security of currency paper or they are outside BEP's control (e.g., anticounterfeiting features are recommended by a federal committee). While some of the remaining barriers are outside BEP's control, BEP's outreach to paper manufacturers has been limited. For example, BEP does not meet regularly with them, as the Departments of Defense and Homeland Security meet with potential suppliers of their procurements, to identify additional steps that could be taken to encourage competition. To the extent that BEP has reached out to paper manufacturers, it has generally done so in conjunction with other BEP procurements. For the contracts awarded in 1999 and 2003, BEP took several steps, consistent with the Federal Acquisition Regulation's requirements, to determine that the prices it paid under these contracts were fair and reasonable. For the 1999 contract, it used price analysis (a comparison of two proposals) to determine that the two proposals it initially received were fair and reasonable. This analysis was sufficient because BEP had determined that adequate price competition existed. For the 2003 contract, BEP performed several cost analysis activities to ensure that the final agreed-to price was fair and reasonable, since the current supplier was the only company that submitted a proposal. For example, BEP obtained certified cost and pricing data from the current supplier, requested an audit review of the current supplier's price proposal, and established a technical analysis team to examine steps in the current supplier's manufacturing process that affect price. BEP also arranged for postaward audits of the current supplier. BEP has not analyzed the advantages and disadvantages of obtaining a second supplier of currency paper since 1996. At that time, it concluded that the costs would outweigh the benefits, but it did not analyze the long-term effects. As a result, it does not know how a second supplier would affect the costs, quality, security, and supply of currency paper over time. Analyzing the advantages and disadvantages of obtaining a second supplier would help BEP determine the need for one.

section_title: Letter
paragraphs: For over 125 years, the U.S. government has relied on one contractor to  supply virtually all of the paper for U.S. currency. The Bureau of Engraving  and Printing (BEP), which is responsible for printing U.S. currency, is  currently under a 4-year contract with this supplier and, according to BEP  data, is paying about $115 million a year for currency paper. Although BEP  has historically received a steady, timely supply of paper that meets its  requirements from its current supplier, having one supplier for currency  paper raises a number of concerns. Among these concerns are (1) the lack  of competition for the currency paper contract, (2) the fairness and  reasonableness of price, and (3) the adequacy of the currency paper supply  in the event of an attack or other disruption of the currency supply.
These concerns, combined with the importance of U.S. currency to  domestic and international commerce, have led to reviews of this unique  situation. For example, in a 1996 report, the Department of the Treasury  and BEP concluded that competition was not immediately feasible because  the current supplier was the only domestic source that could supply  currency paper that met BEP’s requirements. At the request of Congress, in  1998 we also completed a review and reported that the optimum situation  for the procurement of currency paper would include an active,  competitive market with several responsible bidders. However, this  situation did not exist because, according to paper manufacturers we  surveyed, there were several barriers to competition. These barriers  included the large initial capital investment required to produce currency  paper and a legislative provision generally precluding foreign-owned  companies from competing for the contract. We also reported that BEP  could not determine a “fair and reasonable” price for some of its paper  contracts—a requirement in negotiating a federal contract that involves the  judgment of the contracting officer based on various defined techniques  and established procedures for analyzing proposed prices. To help BEP  improve its contract oversight and increase competition, we made several  recommendations, most of which BEP has implemented. (See app. I.)
In 1998 we reported that a number of BEP’s actions to encourage  competition were too new for us to assess their impact. Since that time,  BEP has entered into two additional contracts, in 1999 and in 2003, and has  taken further steps to encourage competition. BEP is now scheduled to  award another currency paper contract in the fall of 2006. Moreover, the  U.S. Mint (the Mint), which is responsible for producing coins, has now had  over a decade of experience with having a second supplier for coin metal  after having had a single supplier for decades. Given these developments,  you asked us to update our 1998 report. To do so, we determined  the changes BEP made to encourage competition for the 1999 and 2003  currency paper contracts and the results of its efforts,  the steps BEP took to determine that the prices it paid for currency  paper under these contracts were fair and reasonable, and  the extent to which BEP has analyzed the advantages and disadvantages  of obtaining a second supplier for currency paper.
To determine the changes BEP made to encourage competition for the 1999  and 2003 currency paper contracts and the results of its efforts, we  reviewed the changes that BEP made to its solicitations and contracts. We  also conducted a survey of domestic and foreign paper manufacturers,  using a questionnaire similar to the one we used for our 1998 report. Of the  15 manufacturers we identified as having the potential to compete for the  currency paper contract, 14 responded to our survey, and 8 of these said  they were interested in providing currency paper to BEP. The remaining 6  manufacturers told us that they were not interested in competing for the  currency paper contract. We reviewed economic literature to identify  barriers to competition for the currency paper market, and we reviewed  applicable procurement laws and regulations to identify requirements  affecting the procurement of currency paper. Among these are the Conte  Amendment, a statute that requires that paper for U.S. currency be  manufactured in the United States, and another statute that limits the  procurement of distinctive currency paper to 4-year contracts. To  determine the steps BEP took to determine that the prices it paid for  currency paper under these contracts were fair and reasonable, we  reviewed the Federal Acquisition Regulation (FAR) and compared its  requirements with the steps BEP took. Finally, to determine the potential  advantages and disadvantages of obtaining a second supplier for currency  paper, we reviewed economic literature as well as interviewed former and  current officials from BEP and the U.S. Mint about their efforts to develop a  second supplier. We performed our work in Washington, D.C., from August  2004 through April 2005 in accordance with generally accepted government  auditing standards. Details of our objectives, scope, and methodology are  in appendix II.
subsections: section_title: Background
paragraphs: BEP, a bureau of the Department of the Treasury, buys currency paper from  a private company and prints the nation’s currency at production facilities  in Washington, D.C., and Fort Worth, Texas. According to BEP data, the  currency paper contract amounts to about $115 million per year. Currency  paper is a highly specialized product that includes cotton and linen fibers  as well as anticounterfeiting features to enhance the quality and security of  the paper. Several agencies affect the production of currency paper. The  Department of the Treasury oversees BEP’s production of currency,  including its procurement of currency paper. The U.S. Secret Service, now  within the Department of Homeland Security, is responsible for  anticounterfeiting activities and works with BEP in assessing the security  of BEP’s money production facilities and currency redesign. The Federal  Reserve Board sets monetary policy for the nation, obtains new currency  from BEP, and issues the new currency to the public through depository  institutions. The Advanced Counterfeit Deterrence Steering Committee,  which includes members from BEP, the Department of the Treasury, the  U.S. Secret Service, and the Federal Reserve System recommends to the  Secretary of the Treasury the anticounterfeiting features to be placed in  U.S. currency. If the Secretary of the Treasury accepts these  recommendations, they become part of the specifications or requirements  for the currency paper.
The procurement of currency paper is subject to an appropriations  limitation, called the Conte Amendment, enacted in December 1987. In  effect, the Conte Amendment requires that distinctive paper for U.S.  currency and passports be manufactured in the United States. The  amendment further prohibits the purchase of currency and passport paper  from a supplier owned or controlled by a foreign entity unless the Secretary  of the Treasury determines that no domestic source exists. The  procurement of currency paper is also subject to another statutory  limitation that prohibits the Secretary of the Treasury from entering into a  contract in excess of 4 years for manufacturing distinctive currency paper.
section_title: BEP Has Modified Its Solicitations for Currency Paper to Address Some Barriers
paragraphs: BEP changed the solicitations for the 1999 and 2003 currency paper  contracts and intends to include these changes in the solicitation for the  next contract, which will be awarded in 2006. Some of the changes  addressed barriers we reported in 1998. These changes included the  following:   Switching to a 4-year contract. Previously, BEP negotiated a 1-year  contract with three 1-year options, which meant that manufacturers  were not assured that they would receive the contract from one year to  the next. According to BEP officials, a 4-year contract creates less risk  for manufacturers because the contractor is almost guaranteed to  receive the contract for 4 years when the government no longer has the  option to renew the contract each year.
Allowing multiple awards. Previously, BEP required any bidder to bid  on the entire currency paper contract. BEP divided its total currency  paper requirements into several different lots and allowed companies to  select the parts of the solicitation they would bid on. For example, a  company could choose to bid only on the paper for the $1 and $2 bills.  Thus, the contract could be awarded to two companies. Potential  suppliers told BEP that, in order to begin production, they would need a  long-term commitment for at least 40 percent of the contract.
Allowing a 24-month mobilization period. Previously, the mobilization  period—the time between the contract award date and the date for  starting deliveries to BEP—was no more than 60 days. In 1998 some  paper manufacturers told us that the start-up period historically allowed  by BEP was not long enough for companies that are not currently  manufacturing currency paper.
Allowing representative rather than identical samples. Previously,  companies had to produce samples during the bidding process using the  same machines they would use to produce currency paper if they  received the contract. BEP required these samples, which are called  identical samples, so that it could determine whether the companies  were capable of manufacturing paper that met its specifications. BEP  now allows for representative samples during the bidding process.  Representative samples are manufactured on equipment that is similar  to what the company would use if it were awarded the contract.  Allowing representative samples enables companies that do not  currently own the required equipment to produce paper samples on  another company’s equipment and avoid purchasing costly equipment  until they have been awarded the contract. Domestic paper companies,  for example, could use the equipment of European paper companies to  produce representative samples and then acquire the appropriate  equipment if they were awarded the contract.
Agreeing to consider innovative financing and acquisition  arrangements. Previously, solicitations did not provide any help to  companies that would have had to make a considerable financial  investment to purchase the equipment needed to compete for the  contract. To facilitate such an investment, the 1999 and 2003  solicitations stated that BEP would “consider innovative financing and  acquisition arrangements” proposed by a potential supplier, but the  solicitations did not specify what these arrangements might be. BEP  officials told us that these arrangements could include having the  government pay for some capital equipment if the contractor repaid the  government at the end of the contract. However, two of eight paper  manufacturers who said they were interested in competing for the  contract told us that the lack of financial assistance continues to make it  difficult for them to compete for the contract.
Furnishing the security thread. Previously, BEP expected potential  paper manufacturers to obtain the security thread used in currency  paper on their own, which some paper manufacturers cited as a barrier  because the sole manufacturer of the security thread is a subsidiary of  the current supplier. As a result, potential manufacturers would have  had to purchase the thread and make royalty payments to that company.  BEP modified the solicitations for the 1999 and 2003 contracts to  indicate that it would provide the security thread that is inserted into  most currency paper to other successful bidders as government- furnished property rather than requiring them to obtain the thread  themselves.
BEP awarded the first contracts with these changes in fiscal years 1999 and  2003. According to documents in BEP’s contract files, one company in  addition to the current supplier submitted a proposal for the 1999 contract,  but ultimately withdrew because, according to this company, it was  unwilling to continue to expend the resources required to produce fully  compliant paper samples without a contract. Four other companies  expressed interest in the 1999 contract, but did not submit proposals. One  company said it did not submit a proposal because it determined that the  estimated capital expenditures exceeded any potential profit that might be  realized over the 4-year contract period. Another company that had  expressed interest in the contract said it did not submit a proposal because  it was unable to obtain a commitment for the large capital investment  required.  Additionally, the company said the contract’s provision for  ordering a wide range of paper quantities made it difficult to calculate a  return on investment. A third interested company did not submit a proposal  because of durability requirements for the currency paper. A fourth  interested company did not give a reason for not submitting a proposal. For  the 2003 contract, the current supplier was the only company to submit a  proposal. Three paper companies other than the current supplier asked to  receive the solicitation, but these companies took no further action. The  next solicitation for the currency paper contract is expected to be issued in  the fall of 2005, and the contract is scheduled to be awarded in 2006. This  solicitation will include all the changes that BEP previously made,  according to BEP officials.
subsections: section_title: BEP Has Not Addressed All Barriers
paragraphs: Despite the changes BEP made to the contract solicitation, paper  manufacturers we surveyed in 2004 told us that significant barriers to  competition remain. Specifically, the eight paper manufacturers we  surveyed who said they would be interested in providing currency paper to  BEP told us that the following barriers, which we reported in 1998, still  exist:  Security requirements for the manufacturing facility. Three of the  eight manufacturers told us that implementing these security  requirements—which include ensuring that all waste is accounted for,  controlling access to sensitive production areas in the paper mill, and  erecting physical barriers around the mill—make it difficult for them to  compete for the currency paper contract because of the high costs to  upgrade their facilities.
Technology required to incorporate anticounterfeiting features. Three  of the eight manufacturers told us that the cost of the equipment and the  technical expertise necessary to insert the security thread into currency  paper make it difficult for them to compete for the currency paper  contract.
Requirement for U.S. ownership. Three manufacturers told us that this  legislative restriction, known as the Conte Amendment, continues to be  a barrier because it mandates that the company that produces U.S.  currency paper be domestically owned—that is, at least 90 percent U.S.- owned, according to the Department of the Treasury.
Lack of financial assistance for capital investment. Although BEP has  indicated that it will consider innovative financing proposals from a  potential supplier, two of the eight manufacturers told us that the lack of  financial assistance for capital investment continues to make it difficult  for them to compete for the contract. According to BEP, under the FAR,  it can make advance payments to manufacturers for capital investment  only if the manufacturer pays the money back to BEP, with interest,  during the life of the contract.
Length of contract. One of the eight manufacturers, who said it plans to  submit a proposal for the 2006 contract, told us that the length of the  contract, which is restricted by statute to 4 years, makes it difficult to  compete for the currency paper contract. This manufacturer said that,  to make a profit during this contract, it would need a 5-year contract and  at least 40 percent of the contract.
According to BEP, these five barriers continue to exist because they either  are outside of BEP’s control or are essential components of producing  currency paper. For example, the restriction against foreign ownership and  the length of the currency paper contract are both legislative provisions  that would require congressional action to change. In addition, U.S. Secret  Service officials told us that there are tremendous benefits to producing  U.S. currency paper inside the United States because, according to the  Secret Service, it does not have the authority to oversee the security of  personnel or plant facilities in a foreign country. The Secret Service further  stated that, although it may be able to make agreements allowing for such  oversight, it can be difficult to take quick, decisive action in a foreign  country. The Secret Service also pointed out that the logistics of moving  currency paper across great distances and borders would pose additional  security risks. However, Secret Service officials indicated that, in their  view, foreign ownership would not pose a security problem as long as the  paper was produced in the United States and the employees who produced  the paper had undergone background checks. BEP officials also believe  that providing financial assistance for capital investment is outside of their  control because, as previously mentioned, under the FAR, BEP can make  advance payments to manufacturers for capital investment only if the  manufacturer pays the money back to BEP, with interest, during the life of  the contract.
Two of the barriers to competition that paper manufacturers identified are  within BEP’s control, but these barriers—the security requirements for the  manufacturing facility and the technology required to insert  anticounterfeiting features, such as the security thread—remain because  they are essential for currency paper. Officials from BEP, the Federal  Reserve Board, and the Secret Service noted that currency paper is a  valuable asset that must be guarded and protected from counterfeiting.  Potential security features for U.S. currency are reviewed by the Advanced  Counterfeit Deterrence Steering Committee, which is made up of  representatives from BEP, the Department of the Treasury, the Federal  Reserve System, and the U.S. Secret Service. This committee recommends  which security features should be in U.S. currency, and the Secretary of the  Treasury decides which features to incorporate. These security features  require that manufacturers of currency paper use advanced technology to  insert anticounterfeiting features into paper. Furthermore, to ensure the  security of the paper and of the anticounterfeiting features, manufacturing  facilities must have greater physical security than paper mills generally.
We agree with BEP that some of the remaining barriers are outside its  control; however, we found that BEP’s outreach to paper manufacturers is  limited and is generally done in conjunction with its other procurements.  For example, BEP does not conduct industry briefings for its potential  suppliers. We found that the Departments of Defense and Homeland  Security hold industry briefings as frequently as possible to provide  potential contractors with information and an opportunity to comment on  future solicitations and procurements. BEP's outreach to potential paper  manufacturers generally consists of publishing its draft currency paper  solicitation in Federal Business Opportunities and waiting for the paper  manufacturers to contact them. One paper manufacturer we surveyed  commented that it was unaware of the solicitation for the 2003 contract. In  commenting on a draft of this report, BEP stated that, in addition to the  outreach efforts we describe, it is pursuing other outreach efforts. For  example, BEP stated that it attends fairs and banknote conferences where  potential suppliers are consulted to determine if their company has an  interest in contracting with BEP for various currency materials, primarily  currency paper, inks, and counterfeit deterrent features.
section_title: BEP Took Several Steps, Consistent with the FAR, to Determine Fair and Reasonable Prices for Currency Paper
paragraphs: The FAR states that an agency’s contracting officer is responsible for  evaluating the reasonableness of the offered prices to ensure that the final  price is fair and reasonable. The FAR does not define “fair and reasonable,”  but establishes various techniques and procedures for a contracting officer  to use in evaluating prices. Furthermore, the contract pricing reference  guidance available from the Department of Defense (DOD) discusses the  application of these requirements. For a price to be fair to the buyer, it must  be in line with either the fair market value of the product or the total  allowable cost of providing the product that would  be incurred by a well- managed, responsible firm using reasonably efficient and economical  methods of performance, plus a reasonable profit. To be fair to the seller, a  price must be realistic in terms of the seller's ability to satisfy the terms and  conditions of the contract. A reasonable price, according to the DOD  guidance, is a price that a prudent and competent buyer would be willing to  pay, given available data on market conditions, such as supply and demand,  general economic conditions, and competition. For the currency paper  contract, there is currently only one buyer and one seller, domestically. As  a result, pricing is established through negotiation.
The FAR further states that the contracting officer may use any of several  analysis techniques to ensure that the final price is fair and reasonable. The  techniques the officer uses depends on whether adequate price  competition exists. For the 1999 contract, BEP determined that adequate  price competition existed because of the expectation that at least one  additional meaningful proposal would be submitted. Consequently, BEP  used price analysis—a comparison of the two proposals—as a basis for  determining that the 1999 contract prices, which totaled $207 million, were  fair and reasonable. BEP also compared the proposed prices with an  independent government cost estimate, which BEP prepared for the  contract.
For the 2003 contract, BEP determined that adequate price competition did  not exist because, although several companies requested copies of the  solicitation, only the current supplier submitted a proposal. Under such  circumstances, the FAR requires agencies to use one or more of several  proposal analysis techniques to ensure that the final price is fair and  reasonable. BEP took the following steps to determine its prenegotiation  pricing objective:    Obtaining certified cost data from the current supplier, as required by  FAR 15.403-4.
Requesting that the Defense Contract Audit Agency (DCAA) audit the  current supplier’s price proposal. DCAA found that the current  supplier’s proposal was acceptable as a basis for negotiating a fair and  reasonable price. To perform its audit, DCAA used the applicable  requirements contained in the FAR, the Treasury’s Acquisition  Procurement Regulations, and the Cost Accounting Standards. BEP  officials said they also independently reviewed and assessed the current  supplier’s proposed costs and did not rely solely on DCAA’s findings.
Establishing a technical analysis team to examine various aspects of the  current supplier’s manufacturing process that affect price. The technical  analysis concentrated on production yield factors, paper machine  speeds and capacity, and labor requirements, among other things.  According to BEP, these areas have a major impact on cost and are an  essential part of a cost analysis.
Performing a price analysis using comparison with previous contract  prices for currency paper to verify that the overall price offered was fair  and reasonable.
In 1998, we recommended that BEP arrange for postaward audits of the  current supplier’s costs and ensure that the supplier maintains acceptable  cost accounting and estimating systems for future contracts. The purpose  of a postaward audit is to determine if the price, including the profit,  negotiated for the contract was increased by a significant amount because  the contractor furnished cost or pricing data that were not accurate,  complete, or current. For the 1999 contract, a postaward audit was not  required because the supplier was not required to submit cost or pricing  data. Following the award of the 2003 contract, BEP requested that DCAA  perform a postaward audit of the current supplier. DCAA found that the  current supplier’s certified cost or pricing data were accurate, complete,  and current. DCAA also performed a postaward audit of the subcontractor  that provides the security thread for U.S. currency and found that the  subcontractor’s data were accurate, complete, and current. Finally, DCAA  reviewed the current supplier’s estimating system and found it to be  adequate to provide estimated costs that are reasonable, compliant with  applicable laws and regulations, and subject to applicable financial control  systems.
subsections: section_title: BEP Has Taken Some Action to Address Uneconomical Contracting Practices Identified in 1998
paragraphs: In 1998 we reported that two BEP procurement practices contributed, or  could contribute, to higher-than-necessary currency paper costs. These  practices included not obtaining royalty-free data rights for the security  thread used in currency paper and ordering inconsistent quantities of  paper. We found that BEP continues to make royalty payments for the use  of the security thread and will have to do so until December 2006. We also  found that BEP continues to have difficulty in accurately estimating the  amount of paper it will require, but inconsistent order sizes have not yet  adversely affected the prices it pays.
We previously reported that a subsidiary of the current supplier holds  patents for manufacturing the security thread used to deter counterfeiting.  This thread is inserted into all U.S. currency denominations greater than $2.  According to a BEP official, the current supplier approached BEP with the  idea for the security thread in the mid-1980s, and BEP encouraged this  company to develop the thread, but BEP neither entered into a research  and development contract to help fund the effort, nor did it attempt to  negotiate rights to that technology or technical data, according to another  BEP official. Because the government did not obtain royalty-free data  rights to, or fund the development of the security thread, it does not have  any rights to the associated technical data and must pay for any use of the  thread. The price BEP currently pays for currency paper includes the cost  of royalty payments, which are generally allowable under the FAR. For the  2003 contract, these payments totaled $663,000 over 4 years. According to  the current supplier, these royalty payments will end in December 2006. As  a result, beginning with the next currency paper contract—which BEP  expects to award at the end of 2006—BEP will not have to pay royalties for  the use of the current security thread or negotiate a license to provide the  thread to a second supplier. In addition, to avoid a recurrence of this  situation, BEP plans to purchase, for an undetermined price, royalty-free  rights to any new anticounterfeiting features that it obtains in the future  from any sources. Properly written, such an agreement could enable BEP  to incorporate new technology at its discretion and allow currency paper  contractors to use that technology in manufacturing paper to meet the  government's requirements. In addition, BEP included a special provision  in the 2003 currency paper contract stating that BEP will not incorporate  any new anticounterfeiting feature into U.S. currency paper unless it has  negotiated an exclusive license to the feature.
We also reported in 1998 that BEP actually ordered more paper than it  estimated during some years. As a result, BEP paid a higher unit cost for  the paper, because the price was based on the estimated amount, and  therefore the contractor’s fixed costs were spread over fewer units than  BEP purchased. If BEP had accurately estimated the quantity of paper it  ordered, the contractor’s fixed costs would have been spread over more  units, resulting in a lower per-unit price. We recommended that BEP ensure  that its paper estimates more closely reflect the expected amounts needed.  BEP responded that its estimates are based on the best available estimate  from the Federal Reserve Board.
Since 1999, BEP’s currency paper orders have remained inconsistent, but  this inconsistency has not yet adversely affected BEP’s prices. Specifically,  for 4 of the last 6 years, BEP’s orders were at or below the estimates the  contractor used in setting its price, and therefore the orders should not  have resulted in a higher price for currency paper. (See fig. 1.) However, in  fiscal years 2003 and 2004, BEP’s actual orders were considerably higher  than the minimum quantities estimated in the contract. In fiscal year 2003,  the minimum quantity was 151 million sheets, and BEP ordered almost 280  million sheets; and in fiscal year 2004, the minimum quantity was 203  million sheets, and BEP ordered 296 million sheets. Although BEP’s order  amounts exceeded the minimum quantities, the price BEP paid for  currency paper was not adversely affected because of the pricing approach  used by the contractor in the current contract.
section_title: BEP Has Not Recently Analyzed Advantages and Disadvantages of Obtaining a Second Supplier
paragraphs: In its August 1996 currency paper report, BEP concluded that competition  was not immediately feasible because the current supplier was the only  domestic source that could supply currency paper that met BEP’s  requirements. In addition, BEP estimated that it would pay $21 million to  $37 million more per year for currency paper if it purchased paper from  more than one supplier. These increased costs would result from, among  other things, high capital equipment costs for a new supplier, according to  BEP. BEP also made several recommendations, including that it continue  to improve its relationship with the current supplier by working to resolve  problems before they arise; continue to try to identify alternative sources  for currency paper, and if a viable source of currency paper is identified,  analyze the costs and economic feasibility of having two sources; and  review the possible catastrophic occurrences that could interrupt currency  paper supplies, and if necessary, increase the inventory of currency paper  to mitigate the effects of such an occurrence. Analyzing the advantages and  disadvantages of obtaining a second supplier would help BEP determine if  a second supplier would be cost effective over the long term, weigh the  benefits of obtaining a second supplier against the potential security and  quality concerns associated with a second supplier, and ensure that BEP  can maintain an adequate supply of currency paper.
Obtaining a second supplier could have advantages. Economic literature  shows that a key advantage of obtaining a second supplier is that it can  generate competition, which helps to ensure that the buyer receives the  best price possible. In general, with more competition, each individual firm  has less control over the final price in the market. In contrast, a single  supplier has the potential to restrict output and set market prices above  competitive levels. In addition, some economic studies have found that the  entry of additional firms into a market lowers prices. An additional  advantage of obtaining a second supplier is that new entrants can stimulate  innovation in certain markets, whereas some researchers have found that a  single supplier may not be particularly innovative. Another key advantage  of obtaining a second supplier could be greater assurance of a steady  supply of currency paper. With more than one supplier and more than one  production site, the buyer would have greater assurance of a steady supply  of goods even if one site were disrupted by, for example, a strike, natural  disaster, bankruptcy, or terrorist attack. This would be an important  advantage for BEP, because currency paper is essential to U.S. and world  commerce, and an adequate supply must be assured. Some actions have  already been taken to avoid these potential problems. To mitigate a  disruption to the currency paper supply, the current supplier says it could  produce currency paper at two separate locations. In addition, BEP keeps  about a 3-month supply of currency paper in reserve.
Obtaining a second supplier could also have disadvantages. First, even  though it could create competition, it might not lower prices initially  because each new supplier would have expensive start-up costs (such as  the capital costs of specialized paper-making equipment) and would  therefore need to charge a high price for currency paper. Second, the risk  of changes in product quality and design would increase with more than  one supplier in more than one location. For instance, according to a  physicist who specializes in paper production, two companies, given the  same specifications, could produce paper of consistent strength, but would  have much more difficulty adjusting for the texture of the paper, and slight  differences could exist within the same specifications. Even slight changes  can adversely affect a buyer such as BEP, which requires adherence to very  specific technical standards. Federal Reserve Board officials told us that  they are concerned that minor differences in the quality of currency paper  could diminish the reputation of U.S. currency. Secret Service officials,  who are responsible for protecting U.S. currency from counterfeiting, said  they would need to be assured that a second supplier had proved that it  could produce paper of consistent quality over a period of time because  even slight variations between the papers produced by the two  manufacturers could hamper their anticounterfeiting efforts and lower  confidence in U.S. currency. Finally, increasing the number of suppliers,  production locations, or both would increase the potential for security  breaches because more people would know about the classified  anticounterfeiting features incorporated in currency paper, and more sites  could be vulnerable to intrusion. Federal Reserve Board officials, who are  responsible for issuing U.S. currency, maintained that awarding the  contract to several different suppliers could compromise the secrecy of the  paper’s anticounterfeiting features because more people would have access  to and could potentially disclose information about them.
Finding itself relying on a single supplier in the early 1990s for the clad  metal it uses to make coins, the U.S. Mint weighed the advantages and  disadvantages of obtaining a second supplier and decided that the  advantages outweighed the disadvantages. To obtain a second supplier, the  Mint worked closely with a new company and allowed it to begin producing  a small amount of material. Initially, the Mint’s second supplier had some  difficulty producing a product of consistent quality, and the unit costs of  the material were higher than the original supplier’s unit costs because the  second supplier was producing smaller quantities. But as the quality of the  material improved, the company began to increase its production for the  Mint, and it now produces 55 percent of the metal that the Mint uses to  make coins. According to Mint officials, the use of a second supplier  enabled the Mint to maintain a steady supply of material when the demand  for coins spiked in 1999 and 2000 (because coins were collected for the  new millennium) and when each supplier experienced labor strikes. Mint  officials also told us that they believe that obtaining a second supplier for  clad material initially increased the Mint’s costs, but they were not able to  quantify the amount of the increase. Nonetheless, according to Mint  officials, the price for clad metal has decreased since the Mint began using  a second supplier. In commenting on a draft of this report, the Federal  Reserve Board noted that, regardless of price issues, the issues of security  and quality are not the same for clad metal and currency paper.
section_title: Conclusions
paragraphs: Obtaining effective competition for the currency paper contract continues  to be a challenge for BEP, despite the changes it has made and plans to  continue making to its contract solicitations. Barriers to competition  remain, and the current supplier continues to be the sole supplier of  currency paper. We agree with BEP that some of the remaining barriers are  outside its control or are essential for security purposes, and we recognize  that the current supplier has generally provided BEP with a steady, timely  supply of paper that has met its requirements for the past 125 years.  However, we believe the uniqueness of the currency paper procurement  and the disadvantages of having a single supplier are sufficient to warrant a  regular effort on BEP’s part to reach out to paper manufacturers before  issuing solicitations to help BEP determine what additional steps should be  taken to encourage competition for the currency paper contract.
Although BEP concluded in its August 1996 currency paper study that  competition was not immediately feasible because the current supplier was  the only domestic source of currency paper that could meet its  requirements, BEP has not weighed the advantages and disadvantages of  obtaining a second supplier—including the impact on the cost, security,  quality, and adequacy of the currency paper supply—since 1996.  Consequently, while BEP can demonstrate that it is receiving a fair and  reasonable price for currency paper, it is unclear if that price is higher or  lower than the price BEP would pay if there were a second supplier. But  cost is not the only factor in deciding whether or not to use a second  supplier. The security and integrity of the paper, and of U.S. currency, are  also important. A second supplier must be able to demonstrate that it can  produce paper that contains the same security features and technical  specifications as the current paper. Slight changes to the quality and make- up of currency paper have the potential to hamper anticounterfeiting  efforts and could result in an overall loss of confidence in U.S. currency.  Analyzing the advantages and disadvantages of obtaining a second supplier  would help BEP assess whether a second supplier of currency paper is  needed to ensure an adequate supply of quality currency paper at a fair and  reasonable price.
section_title: Recommendations for Executive Action
paragraphs: To obtain the views of paper manufacturers on barriers to competition and  to determine if there is a need for a second supplier of currency paper, we  are recommending that the Secretary of the Treasury direct the Director of  BEP to take the following two actions:  Before issuing solicitations for currency paper contracts in the future,  increase outreach activities with paper manufacturers to allow them to  provide their views on the barriers to competition, identify the steps  BEP should take to address these barriers, and comment on the  solicitations.
Determine if there is a need to obtain a second supplier for currency  paper by preparing an analysis of the advantages and disadvantages of  obtaining a second supplier of currency paper, including the impact on  the cost, security, quality, and adequacy of the currency paper supply. If  the analysis determines that there is a need to obtain a second supplier,  the Secretary should then determine what steps are necessary to obtain  a second supplier for currency paper.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided the BEP, the Mint, and the Federal Reserve Board with drafts  of this report for their review and comment. These agencies generally  agreed with our findings and provided technical comments, which we  incorporated as appropriate. In written comments, BEP commented that  our draft report does not recognize all of its outreach efforts to paper  manufacturers and that the royalty payments associated with purchasing  currency paper are an allowable expense under FAR. We incorporated this  additional information in our report as appropriate. BEP also agreed with  our recommendations and described its plans to implement them. BEP’s  comments are provided in appendix III.
We are sending copies of this report to the cognizant congressional  committees; the Chairman of the Board of Governors of the Federal  Reserve System; the Secretary of the Treasury; the Directors of BEP and  the Mint; the Director, Office of Management and Budget; and other  interested parties. 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 siggerudk@gao.gov or Tammy Conquest at conquestt@gao.gov.  Alternatively, I can be reached at (202) 512-2834. Major contributors to this  report are listed in appendix IV.
section_title: Summary of GAO’s Previous Recommendations and Bureau of Engraving and Printing’s Actions
subsections: section_title: Ensure that the current supplier maintains acceptable cost accounting and estimating systems for future contracts and that they are periodically audited.
paragraphs: As appropriate, the Bureau of Engraving and Printing (BEP) has the Defense  Contract Audit Agency (DCAA) perform audits.
Arrange for postaward audits of the current supplier’s  costs.
When required, BEP has DCAA conduct postaward audits of the current  contractor’s costs.
Include data and analyses in the currency paper  procurement record that demonstrate the benefits the  government is to receive when it approves profit levels  that are aimed at recognizing or providing an incentive  for capital investments.
When required, BEP plans to comply with the FAR.
To the extent possible, make more extensive use of  price analysis to determine the fairness and  reasonableness of prices, including the collection of  data from foreign countries on their currency prices  and data on similar supplies purchased by other  agencies, such as paper for passports and money  orders.
BEP stated that a comparison of the price of U.S. currency paper with the price  of foreign currency paper or money order and passport paper would not be a  valid comparison because of technical differences.
Ensure that all future currency paper procurements  reflect the expected amounts of paper needed and  that orders against contracts are for consistent  amounts.
BEP bases the amount of paper needed on the best available estimate provided  by the Federal Reserve System.
Ensure that the government obtains royalty-free data  rights to any future security measures incorporated  into currency paper.
BEP plans to obtain royalty-free data rights to all future security measures that it  incorporates into currency paper.
section_title: Objectives, Scope and Methodology
paragraphs: To determine the steps the Bureau of Engraving and Printing (BEP) took to  encourage competition for the 1999 and 2003 currency paper contracts, we  interviewed BEP officials and reviewed the changes BEP made to the  contract solicitations.  To determine the results of these efforts, we  reviewed the solicitations for the 1999 and 2003 contracts and sent a  questionnaire to 15 domestic and foreign manufacturers of cotton-based  security paper to determine the factors that have made it difficult for them  to compete for the currency paper contract. We used a questionnaire that  was similar to the questionnaire used for our 1998 report, allowing us to  compare responses for the two time periods. Our survey universe consisted  of manufacturers we had surveyed for our 1998 report, manufacturers  identified by the American Forest and Paper Association, manufacturers  identified by BEP as having expressed interest in the currency paper  contract, and the current supplier. We received responses from 14 of the 15  manufacturers and made several attempts to obtain a response from the  one manufacturer who did not respond to our survey. We also performed  structured telephone interviews with all 14 manufacturers to clarify their  survey responses. Our primary variable for analysis was interest in  providing currency paper to BEP. We considered the eight manufacturers  who responded that they were “very interested” or “somewhat interested”  in providing currency paper to BEP as our most important group for the  purposes of this study because they have a stated interest in supplying  paper to BEP. We reviewed economics literature and interviewed several  academic experts to determine the relevant barriers to competition.  Finally, we analyzed the Conte Amendment, the statute limiting the  procurement of distinctive currency paper to a 4-year contract, and other  applicable procurement laws and regulations to identify requirements  affecting the procurement of currency paper.
To determine the steps BEP took to determine that the prices it paid for  currency paper under the 1999 and 2003 contracts were fair and  reasonable, we reviewed documents in BEP’s contract files for the 1999  and 2003 contracts. We reviewed the process BEP must follow to  determine fair and reasonable pricing. We reviewed the prenegotiation  memorandums and negotiation summaries from the contract files and  interviewed BEP procurement officials to determine what cost and price  analysis activities BEP undertook to establish a fair and reasonable price.  We then compared these actions with the requirements for cost and price  analysis techniques under FAR part 15.404-1. We also obtained and  reviewed audits of the current supplier that BEP requested from the  Defense Contract Audit Agency and that have been issued since 1998.
To determine the extent to which BEP has analyzed the advantages and  disadvantages of obtaining a second supplier for currency paper, we  reviewed BEP’s most recent currency paper study, which was issued in  1996. We also interviewed several industry analysts and academic experts,  and reviewed relevant economics literature. Although economic research  on competition in government contracting is abundant, it has never been  applied to the currency paper market. Therefore, we reviewed economic  studies of other markets to determine the advantages and disadvantages of  obtaining a second supplier. We also interviewed officials from BEP, the  U.S. Secret Service, and the Federal Reserve System to obtain their views  on the implications of obtaining multiple suppliers for currency paper. To  gain additional perspective on the potential effects of obtaining a second  supplier for currency paper, we interviewed former and current officials  from the U.S. Mint about their experiences with a second supplier. The  Mint was not able to provide us with financial data to demonstrate whether  the price it paid for clad material changed after it began using a second  supplier.
We performed our work in Washington, D.C., from August 2004 through  April 2005 in accordance with generally accepted government auditing  standards.
section_title: Comments from the Bureau of Engraving and Printing
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Robert Ackley, Tim DiNapoli,  Elizabeth Eisenstadt, Barbara El Osta, Heather Halliwell, Susan Michal- Smith, Terry Richardson, and John W. Shumann made key contributions to  this report.