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.