For about 50 years, the Department of Energy (DOE) and its predecessors have used contracting policies that were developed during the crisis of World War II. Since that time, billions in taxpayer dollars have been spent on contracts where competition was the exception, almost any contractor’s cost was reimbursed, and lax oversight of contractors was the practice. In 1990, DOE began taking initial steps toward improving its contracting. The current Secretary of Energy, after acknowledging that DOE was not in control of its contractors, is continuing to reform DOE’s contracting. DOE is the largest civilian contracting agency in the federal government. In fiscal year 1995, DOE had contract obligations of $17.5 billion, or about 91 percent of the Department’s total fiscal year 1995 obligations. Its contracting practices are rooted in the development of the atomic bomb under the Manhattan Project during World War II. This Project was a unique undertaking to produce atomic capability under emergency conditions and under circumstances of utmost urgency, extreme risk, and unprecedented security. Special contracting arrangements were developed by DOE’s predecessor agencies with participating industry and academic organizations, including the government’s agreement, with few exceptions, to fully reimburse all of the contractors’ costs and completely indemnify contractors against any liability incurred from their involvement on the project. From these roots, DOE’s contracting took two separate paths—(1) the path for management and operating (M&O) contracts, the direct descendants of the Manhattan Project, under which several current contracts were originally awarded during World War II and (2) the path for non-M&O contracts. The M&O contracts, which accounted for 82 percent ($14.3 billion) of DOE’s fiscal year 1995 contract obligations, have been governed in key procurement areas by DOE’s own unique procurement regulations. M&O contracts are for the operation, maintenance, or support of government-owned research, development, production, or testing facilities, both nuclear and nonnuclear. The non-M&O contracts, which account for the remaining 18 percent ($3.2 billion) are governed by the governmentwide Federal Acquisition Regulation (FAR). As a result of the two different paths, these contracts have distinct differences. For example, noncompetitive procurement has been the normal practice for M&O contracts, while competitive contracting has been the norm for non-M&O contracts. In early 1990, we designated DOE’s contract management as one of 16 high-risk areas in the federal government warranting close attention over a period of several years. We did so because we believed that DOE was highly vulnerable to waste, fraud, abuse, and mismanagement as a result of DOE’s extensive reliance on contracting and its history of inadequate oversight of contractors. From this effort, we have issued a series of reports and testimonies on DOE’s contracting practices that have contributed to Congress’s deliberation on DOE’s budget and have provided an important impetus for DOE’s efforts to reform its M&O contracts. (See the end of this report for a list of related GAO products and testimonies.) DOE’s contract reform initiatives encompass a myriad of efforts. This report focuses on important changes being made in the areas of competition, performance goals, and incentives but does not cover all aspects of DOE’s contract reform effort. Reforming M&O contracts has been an elusive and longstanding DOE goal. For the fiscal 1989, 1990, and 1991 Federal Managers’ Financial Integrity Act reports, the Secretary of Energy identified contract management as a material weakness and recommended actions to correct some of the weaknesses. In April 1992, we reported that the Secretary’s recognition of contract management weaknesses, commitment to strengthening contract controls, and actions to address some contracting weaknesses were important first steps for reform. However, we concluded that the weaknesses would not be corrected in the near future because the corrective actions would take several years to implement. In May 1993, the Secretary of Energy told the Congress that DOE was not in control of its M&O contractors and was not in a position to ensure the effective and efficient expenditure of taxpayer dollars. To find solutions to its contracting problems, the Secretary announced the creation of a Contract Reform Team, chaired by the Deputy Secretary of Energy, to do a “top-to-bottom” review of DOE’s contracting mechanisms and practices. In February 1994, the Contract Reform Team published its report, Making Contracting Work Better and Cost Less. In the report, the Reform Team focused its efforts on M&O contracting and identified a number of problems that needed correction, including the following: Loose accountability for contractors’ performance and few controls to ensure that funds are spent on the highest priorities. Few controls over contractors’ costs. Fees that did not properly reflect the quality of the contractor’s performance. Insufficient fee incentives to encourage excellent performance. The reimbursement of costs that the government should not reimburse. Insufficient competition and a strong bias for existing contractors. Insufficient financial accountability. To correct these problems, the Reform Team recommended 47 specific actions to make DOE’s contracting work better and cost less. The Secretary subsequently added another recommendation to the Reform Team’s list regarding diversity among participating contractors and subcontractors. These 48 recommendations included requirements to develop items, such as policy, guidance, and plans to correct identified problems. The policy and guidance provide a framework for reform, but their actual implementation will require a period of years, as the current contracts are either competitively awarded or renewed and the reform provisions incorporated into the contracts. Chief among the Contract Reform Team’s goals, represented by several recommendations, was a new contract form that the Reform Team proposed—the Performance-Based Management Contract. Key elements of this contract included the following: Clearly stated, results-oriented, performance goals and indicators of performance. Incentives for contractors to meet and exceed the performance goals effectively and efficiently. Criteria and incentives for contractors to seek opportunities to subcontract work that could be performed better by firms other than the M&O contractor. Incentives for cost-saving. Improved financial accountability. Concerned about the results of DOE’s undertaking, the Chairman, Subcommittee on Energy and Power, House Committee on Commerce requested, in January 1996, that we review DOE’s contract reform efforts and focus on the key contracting areas of competition and performance goals. Specifically, we (1) determined the status of the Contract Reform Team’s recommendations; (2) evaluated the effect of the initiatives on competition for M&O contracts, which are used to manage and operate DOE’s facilities; (3) evaluated DOE’s initial efforts at inserting performance goals in its M&O contracts; and (4) evaluated DOE’s early use of incentive contracts to control the costs of its M&O contracts. To determine the status of DOE’s actions in response to the Contract Reform Team’s recommendation, we analyzed the Contract Reform Team’s report and identified the actions that the recommendations required. We then reviewed DOE’s documentation supporting the actions to determine if they met each requirement of the individual recommendations. To determine the timeliness of each action, we compared the original and amended deadlines with the actual dates that the actions were completed. We discussed each action with the staff of the Contract Reform Project Office and staff of the DOE organizations that acted on the Reform Team’s recommendations. To evaluate the effect of contract reform on competition for M&O contracts, we reviewed the Contract Reform Team’s report and recommendations and reviewed DOE’s interim and final policy for the award of M&O contracts. We identified each decision to award contracts including those listed in the Secretary of Energy’s July 5, 1994, decision memorandum to those decisions made by the end of August 1996 and obtained information from DOE showing whether these contracts had been competitively awarded previously. We then analyzed the information provided by DOE to determine if the new decisions reflected an increase in competition from past procurements. Since DOE did not provide specific justification for each of its noncompetitive decisions in the July 5, 1994, decision memorandum, we could not evaluate whether these decisions were appropriate. To evaluate DOE’s use of performance goals for M&O contracts, we reviewed the requirements of the Government Performance and Results Act of 1993, DOE’s strategic plan, and the Secretary’s performance agreements with the President for fiscal years 1995 and 1996. Additionally, we reviewed the performance goals and indicators contained in the contracts for the Rocky Flats Environmental Technology Site, the Nevada Operations Office’s Support, the Argonne National Laboratory, and the Thomas Jefferson National Accelerator Facility (formerly called the Continuous Electron Beam Accelerator Facility). We compared the performance goals from these contracts with the goals identified in DOE’s strategic plan and annual performance agreements. We also discussed the goals and plans with DOE’s strategic planning staff, contract reform staff, and contracting staff involved with the contracts we reviewed. To evaluate the use of cost incentives on incentive contracts, we reviewed DOE’s M&O procurement regulations and the FAR for the negotiation of contract prices. To evaluate two alternative ways in which DOE applied cost incentives to its M&O contracts, we reviewed the two contracts that used contract types that typically are used to control costs. These included contracts for the Oak Ridge facility and the Waste Isolation Pilot Plant. These two contracts used incentive contracts that are typically used to provide a cost incentive in their pricing arrangement. We discussed the contracts with DOE contracting staff involved in the setting of incentives for these contracts and with cognizant contracting officials at DOE’s headquarters. We provided DOE with a draft of this report for its review and comment. The Department provided us with written comments on the draft report, which are presented and evaluated in chapters 2 through 5 and are reprinted in appendix II. We performed our review from March 1996 through November 1996 in accordance with generally accepted government auditing standards. DOE is making headway in developing policies, procedures, and guidelines in response to the Contract Reform Team’s report. Together, these reform actions, among others, should serve as the framework for contract reform. At the end of August 1996, DOE reported completing 47 of the 48 actions needed to respond to the Reform Team’s recommendations. Our analysis indicates, however, that DOE has not completed nine actions in accordance with the Reform Team’s recommendations. Moreover, DOE is well behind its original schedule for completing reform actions, which will add to the time that is needed to fully and properly implement contract reform for its contracts. Furthermore, DOE staff that developed reform actions have reported potential problems with implementation. In subsequent chapters in this report, we identify examples of problems that DOE has encountered as it begins to implement contract reform. As a result of its review of DOE’s contracting practices, DOE’s Contract Reform Team made 47 recommendations in its February 1994 report to make DOE’s contracting work better and cost less. Shortly after the Reform Team’s report was published, the Secretary of Energy added a 48th recommendation concerning diversity. For the most part, the Reform Team’s recommendations dealt with the development of policies, procedures, guidance, or plans involving such key contracting issues as competitive procurement, performance goals, and performance and cost-reduction incentives. or each recommendation, the Reform Team prescribed a specific reform action to be taken, established a specific deadline for the action, and assigned a specific DOE organization with the responsibility for developing the reform action. (See app. I for a list of the specific reform actions and their status.) In March 1994, the Secretary established an executive committee to oversee the implementation of contract reform, and in June 1994, the committee established the Contract Reform Project Office within the Office of the Deputy Secretary. The purpose of the Project Office is to provide DOE organizations having responsibility for completing actions with guidance as well as to shepherd completed reform actions through the approval process. Among its other duties, the Project Office ensures that (1) recommendations have been assigned to the proper departmental organizations for action, (2) desired reform goals have been clarified, and (3) systems have been established to track reform efforts. The Project Office considers a reform action complete when the action has been officially approved by the executive committee. DOE states that it has completed action on 47 recommendations. However, nine of DOE’s actions were not performed in accordance with the Reform Team’s requirements. DOE’s Contract Reform Project Office staff explained that all of their completed actions complied with the intent of the Reform Team. We reviewed the documentation for each of DOE’s completed actions performed in response to the Reform Team’s recommendations and found that nine actions did not meet the specific requirements of the Reform Team’s recommendations. For example, to operate DOE’s facilities in a more efficient and cost-effective manner, the Reform Team recommended that DOE establish a preference for its M&O contractors to subcontract various functions, such as laundry and cafeteria services, unless the M&O contractor could perform these functions at a lower cost. The Reform Team further recommended that contractors be provided with incentives to encourage the contractors to subcontract these services. However, DOE’s proposed regulation, published in the Federal Register in June 1996, did not include provisions for the incentives that were recommended by the Reform Team. According to Project Office officials, the incentives were unnecessary because the proposed regulation would require contractors to subcontract for these services where appropriate. However, the Project Office officials stated that several DOE field offices are currently providing their contractors with incentives to subcontract these services. Furthermore, in an effort to implement performance-based contracting methods for support service contracts, the Reform Team recommended that DOE develop a plan for converting cost-reimbursement support service contracts to performance-based contracts, when applicable. Although DOE provided illustrations of potential application of performance-based methods to support services and identified specific program and field offices that are now planning to convert some of their support service requirements to performance-based support, DOE did not develop an actual plan with targets and milestones for converting these possible support services as required by the Reform Team. Project Office officials and program office officials who were assigned to develop actions in response to recommendations stated that while actions may not have strictly adhered to the requirements of the Reform Team’s report, these actions, nevertheless, achieved their intended goals. For example, the Reform Team recommended that DOE reduce its current audit backlog in order to improve the ability of DOE managers to administer financial operations. In doing so, the Reform Team advised DOE to identify ways to provide the Defense Contract Audit Agency with sufficient funding to permit additional resources to be assigned to DOE’s non-M&O contracts. Before providing the Defense Contract Audit Agency with funds, however, the Reform Team recommended that the costs and benefits of obtaining such additional resources as well as any plausible alternatives be assessed. In response, DOE provided the Defense Contract Audit Agency with funding in fiscal year 1995 to reduce DOE’s current audit backlog with plans to continue funding until the current backlog is eliminated. However, DOE neither performed a cost-benefit analysis nor suggested any viable alternatives as recommended in the contract reform report. Although DOE has made progress in its efforts to write new policy, guidelines, and plans, it has substantially exceeded its deadlines for 45 of 47 completed reform actions. DOE exceeded its deadlines by an average of 11 months, and 13 actions were from 18 months to 26 months late.Moreover, many of the original deadlines had been subsequently extended by the executive committee at the request of cognizant departmental organizations. However, even the extended deadlines have been exceeded as well. According to Project Office officials, unanticipated circumstances often caused delays in the processing of actions. For example, some of these delays were caused by the review process. Moreover, Project Office officials said that a considerable amount of time was consumed in an attempt to achieve greater participation from departmental organizations in reviewing and commenting on actions. Delays were also encountered in the assigning of actions to specific departmental organizations. For example, Project Office officials mentioned that the Office of Procurement and Assistance Management opposed being assigned responsibility for six action items because these actions were inherently field related, which the officials believed, could best be handled by the Office of the Associate Deputy Secretary for Field Management. Project Office officials further pointed out that the reform actions were done by staff on a part-time basis because the reform action work was in addition to their normal duties. Moreover, because many of the actions were new approaches that crossed lines of responsibility, they often required considerable internal coordination among the offices that shared such responsibility. According to the officials, other factors such as newly established initiatives, downsizing, and retirements also caused delays in completing actions. Although it is too soon to assess the overall effectiveness of the reform actions on achieving DOE’s contract reform goals, early indications suggest that delays, limited available resources, and overly broad guidance may inhibit implementation. The deadlines for the vast majority of the reform actions were missed. Of those reform actions that are now reported as complete, many have been completed recently. For example, 49 percent were completed during fiscal year 1996. Because of these delays in setting the framework of contract reform, successful implementation of the new policies will be pushed further into the future. Several task teams have expressed concerns about whether available resources can adequately support the reform actions they developed. For example, the task team with responsibility for developing specific performance goals and indicators for real and personal property reported that numerous stakeholders expressed concerns that implementation may be problematic “because of the lack of resources and baselines to be measured against.” We raised similar concerns in a 1995 report on property management at DOE’s Rocky Flats site. In the report, we concluded that without accurate data on property, neither DOE nor its contractor can determine how much property is present at the site and how much has been lost or stolen. Furthermore, the task team charged with developing generic and specific performance goals and indicators for business management as well as environment, safety, and health expressed similar concerns. The task team recommended that “prior to commencing implementation, detailed planning, including an assessment of the impact on staffing and infrastructure and the ability to adjust to such impact, must be done.” The team further reported that the performance goals and indicators were developed “at a high level and may not directly apply to an individual contract being incentivized.” The team finally added that many of the examples contained in its report were based on site-specific goals that would need to be replaced with goals that are relevant to each contractor. Project Office officials reiterated that it may take years to determine whether many of these actions will make DOE contracting work better and cost less. However, the Project Office expects to issue its own report on the impact of the contract reform actions in late 1996. Project Office officials stated that they will not assess each action individually but will assess the cumulative impact of the actions on such things as competition, performance goals, and incentives. Although, DOE has made significant progress in setting a framework for contract reform through the issuance of new policies, guidance, and plans, the real test of contract reform will be in the implementation of these reforms in contracts. These changes will take time to come to fruition because (1) it will take time for DOE’s existing contracts to be replaced by new ones incorporating reform measures, (2) some reform actions are still works-in-progress and will continue to evolve, and (3) DOE was late in completing almost all of its reform actions. Because of the magnitude of DOE’s reforms, some of which are directly opposed to its previous contracting policy, we believe that implementation problems are to be expected. These problems must be identified and corrected during implementation for contract reform to succeed. For this reason, we believe it is vital for the continued monitoring of contract reform implementation by the Secretary of Energy and other top DOE officials. Since contract reform has been a high priority of the Secretary, we are not making any recommendations along this line. While we recognize that having new policies in place is an important step toward ensuring that reform occurs, the actual implementation of contract reform and these policies should not lose momentum nor priority. DOE believes that our draft report did not provide a comprehensive overview of their reform efforts and failed to address the extent to which contract reform has made contracting work better and cost less. We believe that DOE has taken some very important steps in reforming its contracting problems. DOE has (1) changed its policy and adopted competitive awards as its new contracting standard, (2) included performance goals in its contacts, and (3) moved quickly to implement the use of incentive contracts to control costs. In our opinion, the broad strategy presented by DOE is inextricably linked with contract reform and, more particularly, the 48 action items. Furthermore, the completion of the policies, procedures, and guidance developed under the action items is the backbone of sustained contract reform. Therefore, the status of these action items provides a reasonable assessment of DOE’s progress and the framework for future assessments as DOE’s overall effort evolves. Furthermore, DOE’s new contacts are not based on final policy, and they had been in effect for only about 1 year. Thus, it will take years to determine the extent to which DOE has met its goal of making contracting work better and cost less. DOE believes that our report does not address what the Department has done to make each of the 48 action items a reality, and it attached specific comments relating to these items. Our detailed responses addressing the specific items that DOE questioned is discussed in appendix II. In response to one of the most significant recommendations of the Contract Reform Team, DOE has changed its policy from one of making noncompetitive M&O contract awards to one that adopts full and open competition as the norm for M&O contract awards. For various reasons, however, the majority of M&O contracts continue to be extended on a noncompetitive basis. Of the 24 decisions made between July 1994 and August 1996, DOE decided to extend 16 on a noncompetitive basis while competitively awarding 8. Furthermore, for three University of California contracts, DOE made the decision to extend the contracts prior to completing negotiations despite the Contract Reform Team’s recommendation to the contrary. As a result, DOE has placed itself in the same weak negotiating position that it has maintained for years and that contract reform was designed to prevent. The Contract Reform Team recommended, and DOE put in place, a policy to overturn years of noncompetitive contracting with M&O contractors. Prior to contract reform, DOE’s procurement regulation authorized competition for M&O contracts when it appeared likely that the government’s position might be meaningfully improved in terms of cost or performance unless it was determined that to change contractors would be contrary to the best interests of the government. As a result of this policy and practice, the Contract Reform Team concluded that noncompetitive contracting had become the norm in M&O contracting. The Contract Reform Team was critical of this noncompetitive policy stating that because, in part, of the close working relationships with particular contractors, contracts were routinely extended every 5 years, thus resulting “in many contractors continuing to perform for decades.” The Reform Team further said that this practice created a bias that favored the incumbent contractor and that a new policy favoring competition would improve DOE’s contracting by encouraging new contractors to participate in M&O awards because they would understand that DOE and the incumbent contractor would no longer have perpetual relationships. Finally, the Reform Team noted that DOE’s decisions to extend individual M&O contracts were made before negotiations were held with the contractors. As a result, DOE’s negotiating position with its contractors was weakened. DOE established an interim policy on September 28, 1994, that changed its M&O contract award policy to one favoring full and open competition. As recommended by the Contract Reform Team, the policy provided that competitively awarded M&O contracts would include a basic contract term of 5 years or less and may include an option to extend the term of the contract for 5 additional years or less and a maximum term limit of 10 years. As recommended, the policy also provided for noncompetitive extensions of M&O contracts, in exceptional circumstances, where competition was “incompatible with the effective and efficient discharge of Departmental programs or is otherwise incompatible with the paramount interest of the United States.” In these instances, the Secretary of Energy was to authorize the use of noncompetitive procedures to extend an existing contract, and the extension of the contract was to be conditioned upon the successful negotiation of DOE’s objectives. DOE’s final policy, which became effective on August 23, 1996, adopted a standard of full and open competition in the award of M&O contracts, including performance-based management contracts. The policy further states that an M&O contract may be awarded or extended without providing for full and open competition only when justified under one of the exceptions provided under the Competition in Contracting Act of 1984. The seven exceptions provided by the act include identified and specific circumstances such as where only one source can perform the work or when an agency’s need for an item is of unusual and compelling urgency.The policy states that noncompetitive extensions shall be considered conditional upon the successful negotiation of the contract. Additionally, the Secretary must authorize all awards that do not use full and open competition. From July 5, 1994 to August 31, 1996, DOE made 24 decisions to competitively award or noncompetitively extend M&O contracts. Of these 24 decisions, 16 were to noncompetitively extend contracts and 8 were to competitively award contracts. Additionally, decisions were made on four other former M&O contracts that either brought them to an end or converted them to cooperative agreements. The 16 contracts that DOE noncompetitively extended or plans to noncompetitively extend include 12 contracts that, according to DOE, have never been competitively awarded. The average age of these 16 contracts is about 35 years. Table 3.1 lists contracts that DOE either noncompetitively extended or plans to noncompetitively extend. The eight contracts that DOE has competitively awarded or is planning to competitively award include four prior contracts that were competitively awarded in the late 1980s, according to DOE. These include the contracts for the Savannah River, Hanford Reservation, Hanford Environmental Health Center, and Mound facilities. However, the Oak Ridge contracts, which DOE plans to competitively award, will replace contracts that were noncompetitively awarded. On the other hand, the new competitively awarded contracts for the Idaho, Nevada, and Rocky Flats facilities each replaced several contracts that were both competitively and noncompetitively awarded. Table 3.2 presents a list of the competitively awarded procurements or procurements that are planned for competition. In reaching its decisions on whether to competitively award or noncompetitively extend a contract, DOE considered such things as the transition of its facilities to environmental restoration facilities; the long-standing relationships with its incumbent contractors at research and development laboratories and the need to make special arrangements with contractors on whose property the facilities were situated (some of DOE’s laboratories are located on the campuses of universities); and the need to maintain core competencies in nuclear weapons design, production, and dismantlement during the transition to a post-Cold War society. We discussed the results for the 24 contract decisions with the Deputy Assistant Secretary for Procurement and Assistance Management, the Director of the Contract Reform Project Office, the Deputy Associate Deputy Secretary for Field Management, and other DOE staff. They explained that the new noncompetitive contracts are really new contracts that include new clauses and new requirements. In addition, they stated that there is increased competition for former M&O work, which is being competitively awarded through DOE’s privatization efforts. For example, at the Hanford facility, the procurement for the Tank Waste Remediation System, which in the past would have been done noncompetitively by the current M&O contractor, is now being competitively awarded as a separate procurement. Finally, the procurements for sites that had a change in their missions or were in transition from one mission to another were competitively awarded and the contracts were noncompetitively extended for those where there was a significant amount of continuity with the contractor. Although contrary to a recommendation by the Contract Reform Team, DOE may have weakened its bargaining position with the University of California when it conditionally decided to extend the contracts prior to their negotiation. “Under these circumstances, it would be unrealistic to consider the introduction of an unknown and untested management team to these critical scientific and technical endeavors.” “The loss of such resources by transferring to a different contractor is equally incompatible with our program requirements.” At the end of the decision, the Secretary explained that any award to the University is contingent on improvements in the terms of the current contracts. We discussed this decision with the Deputy Assistant Secretary for Procurement and Assistance Management, the Director of the Contract Reform Project Office, and the Deputy Associate Deputy Secretary for Field Management and were told that regardless of the statements, DOE has the resolve to competitively award these contracts if it does not obtain the contract reforms that it is seeking from the university. Additionally, the officials explained that they were very careful in the wording of the decision and that the comments about the university only reflected its scientific capabilities and not its business management, which must be improved. DOE’s new policy on competition became effective on August 23, 1996. As a result, the timing of our work did not give us the opportunity to review DOE’s justifications for noncompetitive procurement under the new policy. However, we note that the new policy adopts a standard of full and open competition. DOE’s policy also adopts the provision of the Competition in Contracting Act, as implemented by the FAR, that provides specific exceptions to the act’s requirements for full and open competition. Under these exceptions, DOE can continue to justify its noncompetitive procurements and not fulfill the intent of its own competition policy. The Competition in Contracting Act was enacted in 1984 to increase the use of competitive procurement in the federal government. Although the act requires full and open competition, it provides seven exceptions to full and open competition that can permit noncompetitive procurement. One exception that DOE could use to justify noncompetitive procurements for many of its M&O contracts is the exception that authorizes noncompetitive procurements to maintain an essential engineering, research, or development capability to be provided by a federally funded research and development center. Although this exception is available to DOE, in the past, DOE has successfully awarded M&O contracts competitively to operate its research centers at the Sandia National Laboratory and the Idaho National Engineering Laboratory. Additionally, within the last few months, DOE has decided to competitively award the future contract for the Oak Ridge National Laboratory—another research center. We believe that DOE should continue its efforts to competitively award its research centers whenever feasible. In the event that DOE does need to use this exception to justify a noncompetitive procurement, we believe that, whenever feasible, DOE should use noncompetitive procedures only after segregating the research work from other activities of its M&O contractors. For example, in 1995, we reported that about 50 percent of the funds spent by M&O contractors in fiscal year 1994 under 19 contracts for research centers was for research and development activities. The remaining funds were spent on such things as the environmental restoration of facilities contaminated with hazardous and nuclear waste. Thus, about 50 percent of the M&O contractors’ funds were not directly associated with research activities. DOE could maximize its competitive awards by separating the nonresearch work from that of the research center and competitively awarding the nonresearch work. We discussed the new competition policy and its potential use in regard to the research centers with the Deputy Assistant Secretary for Procurement and Assistance Management, the Director of the Contract Reform Project Office, and the Deputy Associate Deputy Secretary for Field Management. They told us that DOE shares our concern about the granting of exceptions from competition for all of the work done at research facilities. Furthermore, they told us that DOE is also concerned with the number of its federally funded research and development centers and is considering a reduction in the number of research centers it now operates. Bringing competition into DOE’s contracting could be the single most significant aspect of the contract reform initiative. However, DOE’s new policy is only as good as its implementation. After nearly 2 years of experience under contract reform and after 24 decisions, DOE’s actions show that it has a long way to go before it realizes the benefits of competition. Although DOE officials told us that DOE is improving its existing contracts through noncompetitive negotiations, it is doing just that—negotiating in a noncompetitive environment. This does not identify new potential contractors as contract reform intended. Only competition will do that. DOE believes that our draft report did not adequately acknowledge the impact of the Department’s new competition policy. Specifically, DOE believes that real changes have occurred in its contract competition culture and practices and that the proposed extension of the three laboratory contracts conforms to its policy. First, DOE states that in all cases where noncompetitive extensions have been sought, the Department subjected each decision to a rigorous examination of the facts and circumstances. Also, DOE states that rather than using the existing contract as a basis for negotiation, the Department developed administrative mechanisms to ensure that contract reform terms and conditions were the basis for negotiation. While we agree that DOE has changed its competition policy, the Department decided in two-thirds of its decisions to noncompetitively extend M&O contracts. Furthermore, the Contract Reform Team’s report concluded that contracts should be competitively awarded except for unusual circumstances. We believe that such a large proportion of noncompetitively extended contracts suggests that DOE still has a long way to go before realizing the benefits of competitive contracting. Although DOE believes that it is improving its existing contracts by negotiating in a noncompetitive environment, it is not obtaining the benefits of competition. Second, DOE states that extending the three laboratory contracts was contingent on incorporating contract reform provisions and achieving other negotiation objectives. As noted in our draft report, the Secretary’s decision to extend these contracts stated that considering other contractors was unrealistic and incompatible with program requirements. Once DOE stated that only one contractor could do this work, DOE effectively weakened its negotiation position. Even though the Secretary also noted that any resulting contract was contingent on the incorporation of reform measures, we believe that DOE’s actions to date, give the appearance that the decision to extend these contracts was made prior to the completion of successful negotiations and therefore is inconsistent with the intent of contract reform. One of the key elements of DOE’s new Performance-Based Management Contracts is their inclusion of clearly stated, results-oriented performance goals and indicators to determine if the performance was achieved.However, as DOE seeks to implement its new contracting approach together with its strategic planning initiative, contract weaknesses are becoming apparent. DOE’s new contracts do not always contain a clear linkage between the contract goals and those of the Department. In addition, some contract provisions allow contractors to dispute either the total amount of the contract incentive or the amount of the incentive provided for a specific goal. Because DOE relies heavily on its contractors to carry out its missions, it is essential that the goals in DOE’s contracts be aligned with DOE’s strategic goals. Additionally, DOE’s contracts should not harm the Department’s authority to allocate incentives to the performance of contract goals. DOE officials agree that their efforts to put reforms and initiatives in place quickly resulted in inconsistencies. They see these early stages of implementing contract reform and strategic planning as a learning process. Two DOE initiatives—contract reform and strategic planning—are closely aligned. The conversion of M&O contracts into Performance-Based Contracts is a major goal of the Contract Reform Team’s report and DOE has been converting its management and operating contracts to Performance-Based Contracts. The Reform Team concluded that earlier M&O contracts included loose accountability for performance with few quantitative controls to ensure that funds were spent on the highest priorities. While DOE was incorporating performance goals in its new contracts, it also was working on its strategic planning initiative. During its strategic planning efforts, DOE developed a strategic plan that includes performance goals to be achieved and performance indicators to determine if the goals were achieved. Considering that DOE’s M&O contractors were provided with about 74 percent of DOE’s total fiscal year 1995 obligations, it is clear that DOE cannot fulfill its strategic goals without directing the work of its M&O contractors. Therefore, DOE’s contract reform and strategic planning initiatives are closely linked. In February 1995, DOE developed contract reform guidance for the use of performance goals, indicators, and incentives in M&O contracts. Among other things, the guidance stated that (1) a top-down approach should be used to link DOE’s strategic plan to subordinate strategic plans and ultimately into specific goals and indicators in contracts and (2) performance goals and indicators should be traceable to the successive levels of strategic plans. Additionally, the guidance indicated that goals and indicators must be derived from the site where the contract work is to be performed. Under the Government Performance and Results Act of 1993 (GPRA), most federal agencies, including DOE, will be required to set strategic goals, measure performance, and report on the degree to which their goals are met. Specifically, by September 30, 1997, they will be required to prepare a strategic plan covering at least a 5-year period that describes, among other things, (1) general goals and objectives for the major functions and operations of the agency, (2) how the agency intends to achieve these goals and objectives, and (3) how the goals of the strategic plan are related to those to be used in annual performance plans. In later years, agencies will be required to prepare annual performance plans with goals that are related to those of the strategic plans and program evaluation reports that show the success at accomplishing their goals. Finally, the GPRA identifies the drafting of strategic plans, annual performance plans, and program performance reports as inherently governmental functions that must be performed by federal employees. DOE is ahead of the deadlines imposed by GPRA’s requirements and published its first departmental strategic plan in April 1994. The plan identifies five programmatic business lines and four critical success factors. The plan includes performance goals and indicators to determine if the goals for the business lines and success factors have been achieved. Additionally, the Secretary of Energy developed performance agreements between herself and the President for fiscal years 1995 and 1996. DOE considers these performance agreements to be similar to the annual performance plans that will be required by GPRA in future years. Although DOE cannot fulfill its strategic goals without the work of its M&O contractors, it is difficult to find a connection between DOE’s overall strategic plan goals, its performance agreement goals, and its M&O contracts. Without a clear connection, DOE is not assured that its contractors are focused on the Department’s identified goals. Additionally, it will be difficult for DOE to quantify, in the performance reports required by GPRA, its success in meeting goals. DOE’s strategic plan and annual performance agreements identify its five departmental lines of business and its four critical success factors. The performance goals and indicators are then listed together with the lines of business and the success factors. We reviewed four contracts that were awarded after the development of DOE’s strategic plan in 1994 to determine if the contracts’ performance goals could be traced to the strategic plan’s goals. We also compared contract goals with the performance agreement goals using the fiscal year performance agreement that was in effect when the contract was awarded. In some cases, a contract goal could be clearly linked to the strategic plan goal. For example, a goal of the departmental strategic plan under the business line “science and technology” is to “Provide new insights into the nature of matter and energy, address challenging problems, and create a climate in which breakthroughs occur.” The contract for the Argonne National Laboratory under its “science and technology” area included a corresponding contract goal to “Provide new insights the nature of matter and energy.” Although, through experience, DOE may find a need for more specific goals in the individual contracts, such clear linkage to the strategic plan’s business lines and goals can help DOE’s contract efforts and contract results focus on the identified goals of the Department. In other cases, contract goals were difficult to link to the strategic plan or the current fiscal year’s performance agreement. For example, the M&O contract that supports the Nevada Operations Office included goals grouped under seven categories. However, the seven contract categories were not the same as the nine departmental business lines and key success factors. As a result, we could not link the contract goals to those of the strategic plan. A DOE Nevada operations office official explained that specific goals were in the contract even though the Nevada office’s mission was uncertain. Additionally, the office noted a lack of direction from DOE headquarters during the negotiation of performance goals for the contract. Some contract provisions give the contractors the right to legally dispute DOE’s determination of the total amount of contract incentives available or the amount of incentives that can be applied to specific contract goals. Such provisions can compromise DOE’s ability to place priorities on its contract work because these incentives are used to motivate contract performance. The setting of the goals by DOE is clearly important because DOE needs to maintain its authority to direct the work. However, the setting of incentives is also important. Incentives are used to motivate contractors’ efforts that might not otherwise be emphasized. Without the authority to identify the amount of incentives necessary to motivate the contractor, DOE loses an important contracting tool that helps it direct the contract work. DOE’s procurement regulation for its award-fee contracts, a type of contract providing an incentive for contractor performance, likewise emphasizes that the government has the unilateral right to identify the criteria to evaluate the contractor’s performance and the percentage of award fee to be allocated to the individual criterion. However, for the four new M&O contracts identified in table 4.1, we found that the contract language in each contract was different for determining how goals would be determined and how incentives would be allocated to the goals. For example, under the Rocky Flats contract, the contractor can propose goals to add to the contract, but if there is a disagreement between the contractor and DOE, the contractor may legally dispute the amount of an incentive to be applied to a goal. On the other hand, the Hanford contract specifically states that the final determination of goals and the distribution of incentives will be made solely by DOE and the contractor cannot dispute DOE’s decision. DOE’s field offices gave us different reasons for using these provisions. For example, contracting staff at Rocky Flats and Nevada told us they included the provisions because they considered these provisions as typical standard provisions in DOE contracts; contracting staff at Idaho said they incorporated language prohibiting disputes on goal setting to protect the government’s interests and to minimize disputes; and the chief counsel at DOE’s Richland office, which manages the Hanford contract, stated that Richland incorporated language prohibiting disputes on goal setting and the amount of incentives applied to each goal because Richland considered the setting of goals and incentives to be basic to DOE’s ability to direct the work of the contractor in fulfilling the government’s requirements. Language permitting contractors to dispute how DOE will apply incentives to goals can compromise DOE’s ability to place priorities on the work that it deems necessary at its facilities. DOE personnel are in the early stages of implementing contract reform and strategic planning and are still learning about the processes. Although DOE officials agree that the linkage should exist, they cite their attempts to put things in place quickly as reasons for the differences in actual practice. With changes occurring simultaneously and different offices initiating different actions, inconsistencies are occurring in implementation. DOE’s strategic planning staff and contract reform staff agreed with us that there should be a clear linkage of departmental strategic plan goals to those of the M&O contracts. They explained that at present, this clear linkage does not exist, in part, because of DOE’s changing mission and the learning process involved in these new initiatives. They also explained that DOE focused on moving forward with changes and that at times, policy and guidance did not precede the actual implementation of the contract reform and strategic-planning implementation. Because of the concurrent development of guidance and its actual implementation, several different strategies have been followed in DOE’s contracts. A clear linkage of goals in M&O contracts, annual performance agreements, and strategic plans is needed to manage DOE’s complex and varied missions. Such linkage should help DOE in directing the performance of its missions and reporting on its success in accomplishing mission goals. Additionally, contracts that contain provisions that impinge on DOE’s authority to set incentives have the potential to detrimentally affect DOE’s ability to perform its missions. We recommend that the Secretary of Energy require that the goals written into the M&O contracts be clearly linked to DOE’s strategic plan and annual performance goals and a mandatory standard contract clause be included in all M&O contracts that gives DOE the exclusive authority to set contract goals and incentives that support the strategic plans and missions of the Department. Although DOE generally agrees with our two recommendations, it was concerned over two issue related to the linkage of contract performance goals and departmental goals. Specifically, DOE believes that (1) our analysis did not consider subordinate goals, such as program goals, that would better link departmental goals with contract goals and (2) we should have taken a larger sample of contracts in our analysis of performance goals. In analyzing DOE’s goals, we considered the provisions of GPRA and did not find the linkage between agency and contract goals. We reviewed DOE’s strategic plan, annual performance agreements, strategic plans for DOE’s five business lines and key success factors, and site-strategic plans. We discussed our results with staff of DOE’s Office of Strategic Planning, Budget and Program Evaluation and the Contract Reform Project Office and explained to them that we could not track the goals from the Departmental Strategic Plan, through the subordinate program plans, and into the M&O contracts. In selecting the contracts for detailed review, we chose from 11 contracts that were awarded at the time of our selection. From these, we selected four because they had the most thorough provisions for performance goals. On the basis of this selection process, we believe our detailed analysis was sufficient to suggest that as DOE moves forward with contract reform and strategic planning, it needs to ensure that contract goals are clearly identified with departmental goals. Another key element of the Contract Reform Team’s new Performance-Based Management Contract is the inclusion of incentives to control contract costs. As DOE begins to use incentive contracts to control costs, its M&O procurement regulations are not providing the necessary direction for the placement of these incentives in contracts by DOE’s contracting officers. For a cost incentive to be effective, the contracting officer must establish a reasonable target price to motivate the contractor to effectively manage costs. Although the FAR provides considerable direction on the pricing of contracts, DOE’s M&O regulations do not. Since DOE’s contracting officers are not required to follow the FAR for pricing M&O contracts, they are largely left on their own to determine how best to accomplish this task. Our analysis of two DOE contracts—where one contracting officer used important aspects of the FAR requirements and the other did not—show that when the FAR requirements were used, DOE was able to affect the contractor’s performance. Incentive contracts can be used to effectively reduce costs. However, to be effective, incentives need to be properly set within the pricing structure of the contract. Although the FAR provides direction and procedures for the pricing of contracts, DOE’s M&O procurement regulation only provides guidance for the setting of fees. Two basic incentive contracts used by government contracting officers to control costs are the fixed-price-incentive and cost-plus-incentive contracts. Under each of these contracts, the contracting officer’s goal is to negotiate a target cost and a profit or fee that motivates the contractor to effectively manage costs. The incentive should provide the contractor with an incentive to reduce costs and a disincentive to overrun costs. Typically, incentives are expressed as a sharing ratio between the government and the contractor. For example, a sharing ratio of 50/50 indicates that for each dollar of cost reduction below the target cost, the government saves 50 cents and the contractor increases its profit by 50 cents, while for each dollar over the target cost, the government’s costs increase by 50 cents and the contractor’s profit or fee is reduced by 50 cents. These contracts provide the contractor with a clear understanding of how its cost performance will affect its profits or fee and can be effective tools to control costs. However, in order for them to be effective, the contracting officer needs to properly negotiate the target cost of the contract. Under the FAR, a key responsibility of the government contracting officer is to obtain supplies and services at fair and reasonable prices. In the negotiation of contract prices, the contracting officer must determine a fair and reasonable price through an analysis of proposed costs and/or prices. This analysis may include the review and evaluation of individual cost elements, such as materials, labor, and subcontract prices that support the contractor’s overall proposed price. For contracts expected to cost $500,000 or more, the contractor may be required to submit cost or pricing data that include all the facts that prudent buyers and sellers would reasonably expect will affect price negotiations significantly. These data are then certified by the contractor as being accurate, current, and complete as of the date of agreement on the contract price or another date agreed to by the contracting officer and the contractor. For a cost analysis, contracting officers generally are to request a technical analysis of the contractor’s proposed costs. This technical analysis is done by specialists who advise the contracting officer on costs for such things as material and labor. In addition, the contracting officer may have the proposal reviewed by an auditor. DOE’s M&O procurement regulations do not require contracting officers to negotiate costs and prices, determine fair and reasonable prices, obtain cost or pricing data, nor analyze proposed costs. Instead, contract costs are determined by the M&O contractors, who then submit this information to DOE as the basis for the Department’s annual budget process. This process reflects DOE’s historical long-term relationship with its M&O contractors and not the typical arm’s-length relationship between buyers and sellers. As part of the budget process, M&O contractors prepare their own budget requests for the upcoming fiscal year in accordance with DOE’s policy. The budget requests are reviewed by DOE personnel in accordance with DOE’s budget formulation process. M&O contract funding is then determined by the amount of funds appropriated by the Congress and the amount of funds that DOE obligates to the M&O contracts. DOE is including various different cost reduction and cost incentive clauses in its contracts as a contract reform. However, as discussed in the two case studies below, DOE’s process did not provide its contracting officers with the needed direction to price their incentive contracts. As DOE begins to implement contract reform and adopt cost incentive contracts the need for cost guidance becomes important. Therefore we reviewed DOE’s two incentive contracts used under contract reform to determine the possible impact of the absence of guidance for price negotiations. One of these contracts included both a fixed-price-incentive provision and cost-plus-incentive provision and the other contract included only a cost-plus-incentive provision. The experiences of DOE’s contracting officers at the Oak Ridge Facility and the Waste Isolation Pilot Plant, who used these contracts, demonstrates how contracting officers developed cost incentives in the absence of procedures. The Oak Ridge Facility Contract involves work for DOE’s national security and the environmental management and uranium enrichment facilities programs at Oak Ridge, Tennessee; Paducah, Kentucky; and Piketon, Ohio. The contract is structured as a cost-plus-award-fee contract and it includes a base fee. The award fee includes three parts: (1) performance fee, (2) cost reduction fee, and (3) remaining award fee. In addition, the contract established a cost-plus-incentive-fee arrangement for performing work assigned for specific task orders. We reviewed Oak Ridge’s efforts at negotiating a cost-plus-incentive-fee arrangement on one of the task orders that included this incentive arrangement. We selected the first task order negotiated under the contract—for a demolition project—because it had a large dollar value and the work performed on the task order was nearing completion. As of March 31, 1996, DOE had issued 17 task orders estimated to cost $144 million under the contract with a total available fee of $13 million for these task orders. Table 5.1 shows the amounts negotiated between the contracting officer and the M&O contractor for the one task order and the amount that DOE expects the completed work will actually cost. On the surface, the task order pricing arrangement appears to have been successful. However, as explained below, the contractor received the incentive because DOE accepted the contractor’s unsubstantiated target costs (which were significantly higher than actual costs) as part of the contract. A major cost element of the task order was the M&O contractor’s proposed subcontract cost, which the contractor estimated at $10.9 million without obtaining actual bids from any subcontractors. Although DOE’s contracting officer requested a technical analysis of the estimated subcontract costs from an independent engineering firm, the contracting officer did not require the contractor to support its subcontract cost estimate with actual bids from prospective subcontractors. The engineering firm advised the contracting officer that the subcontract should cost about $4.9 million. However, the contracting officer did not use the engineering firm’s advice because the project manager believed that the engineering firm’s estimates were too low. The task order’s target cost was then negotiated with a final subcontract amount of $10 million. After the cost and fees were agreed to on the task order, the M&O contractor obtained competitive bids for the subcontract work that were much less than the negotiated amount. According to the contracting officer and the project manager, the winning bid was about $3.5 million—or about $6.5 million below the task order cost of $10 million. Under the incentive agreement, the M&O contractor will receive a target fee of $935,000 if the project cost comes within the target range of $18.7 million to $19.7 million and could earn an additional incentive fee of up to $654,500 for underrunning the target cost to as low as $17 million. Additionally, the incentive fee was based on a sharing ratio in which the contractor receives 40 percent of the cost underrun. For example, if the target cost was underrun by $1 million, the contractor would receive 40 percent of the underrun, or $400,000. Since the total potential incentive was limited to $654,500, the contractor is limited to that amount even though its costs were expected to be much lower than the $18.7 million to $19.7 million target. On this task order, the M&O contractor earned the entire incentive fee simply by obtaining competitive subcontract bids and not through any effort associated with the work. DOE’s Oak Ridge officials acknowledged the problem that this situation created and to counter it, adopted a “capping” policy on fee amounts that could be paid to the M&O contractor for cost reductions resulting from subcontract costs that are lower than the negotiated cost. The capping policy limits the fee amount that the contractor can receive to a prenegotiated amount. Although this policy limits the incentive fee that the M&O contractor can earn by shopping for bids after task order prices are negotiated, it is only a partial solution. We believe that additional guidance is needed. The Waste Isolation Pilot Plant contract is for a repository for the disposal of transuranic wastes resulting from defense activities and programs. The contract is a multiple incentive contract including both a fixed-price-incentive and a cost-plus-award fee that acts much like a cost-plus-incentive to control contract costs. In addition to the cost incentives, this contract also included performance incentives. In pricing the contract, the contracting officer started with the M&O contractor’s budget request for fiscal year 1995. The budget request had been reviewed and approved by DOE during the budget process. In addition, the contracting officer requested that DOE specialists evaluate the budget amounts. After the budget request was approved by DOE, the M&O contractor identified two work items that could be performed at less cost by a subcontractor. These new amounts were then negotiated into the contract and represented a decrease from the amount that had been submitted in the budget request and earlier approved by DOE. Although not required by DOE’s M&O procurement regulations, the contracting officer obtained a certificate of current cost or pricing data from the contractor in accordance with the FAR because she did not believe that the DOE M&O procurement regulations were adequate for contract pricing of incentive contracts. Table 5.2 shows the negotiated costs for the incentive parts of the contract, the actual costs incurred, and the fees earned. The contracting officer believed that the cost incentive provision served as the catalyst for the substantial cost reduction under the cost-plus-award-fee part of the contract. Although we did not evaluate the incurred costs to determine the reasons for the reduction in cost, both the contractor and the contracting officer said that the contractor’s efficiencies and improved performance contributed to the reduction in the estimated cost of the work. For the fiscal year 1996 price negotiations, the contracting officer went a step further toward the FAR requirements, again on her own initiative, by (1) requesting that the contractor submit cost or pricing data and (2) analyzing the contractor’s documentation that supported about 48 percent of the proposed costs for the contract. We discussed our findings regarding DOE’s incentives under these two contracts with the Deputy Assistant Secretary for Procurement and Assistance Management, the Director of the Contract Reform Project Office, and the Deputy Associate Deputy Secretary for Field Management. They acknowledged that DOE’s regulations are inadequate for the pricing of contracts and the use of incentives tied to the contract pricing. Specifically, they noted that the basic problem is that DOE’s M&O costs are budget based and not cost based. They explained that incentives should not be based on the budgeted amounts but should be based on negotiated contract costs. Under contract reform, DOE planned to increase the use of incentive contracts. However, in the absence of M&O procurement regulations governing the negotiation of contract prices, DOE’s ability to control costs under this type of contract is limited. When the FAR was used, DOE was able to reduce its contract costs. To continue DOE’s reforms that are aimed at placing more cost risk on its contractors through the use of cost incentives and in a further effort to bring M&O contracting into the mainstream of federal contracting, we recommend that the Secretary of Energy adopt federal contract pricing policies such as those contained in the FAR. DOE agrees with our recommendation regarding the inclusion of cost incentives based on those included in the FAR. Furthermore, DOE has a draft fee policy that contains a requirement that contracts (cost plus incentive fee, fixed price incentive fee, and firm fixed price) in the future will be developed pursuant to FAR Part 16. However, FAR Subpart 15.8 provides specific guidance on the analysis of prices and costs and the documentation of price negotiations. DOE’s draft policy should include provisions from this part of the FAR that are appropriate for the pricing of M&O contracts. DOE also believes that our discussion of cost incentives is limited by the number of contracts that we reviewed. However, our primary purpose was to determine the impact of the lack of DOE regulations on how to set these incentives. We looked at two contracts because one case demonstrated the benefits of applying the FAR to this process and the other case showed the impact of not having a regulation. In addition, DOE’s comments questioned our reference to Oak Ridge’s capping policy on fee amounts. DOE officials acknowledged problems with cost incentives at Oak Ridge and adopted a capping policy to limit the fees that could be earned and to provide a check on potential errors in estimating unique projects. Although this policy may have some benefits, it does not fully resolve the identified contract pricing problems.

Summary: Pursuant to a congressional request, GAO reviewed certain aspects of the Department of Energy's (DOE) contract reform initiative. GAO found that: (1) DOE has completed action on 47 of the 48 contract reform recommendations, but 9 of the completed actions did not meet the requirements of the Contract Reform Team; (2) DOE also missed its deadlines for completing the required new policies, guidance, and plans that serve as the framework for contract reform by an average of 11 months; (3) the missed deadlines have added to the time needed to implement contract reform; (4) while DOE has changed its policy and adopted competitive contract awards as the new standard for management and operating (M&O) contracts, in practice, DOE continues to make noncompetitive awards for these contracts; (5) DOE's contracting offices are including performance goals in their M&O contracts, but the contract goals are not always clearly linked to those of the Department; (6) DOE's contracting offices have moved quickly to implement another important reform by using incentive contracts, but the negotiation of these incentives did not always prove effective; and (7) since DOE is authorized to use its own procurement regulation for M&O contracts, the contracting officers have been left to use their own judgment and have achieved different results with the use of these incentives.