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

DOD contracting officials generally rely on tools in the FAR and DFARS in  assessing the risk of excessive pass-through charges when work is  subcontracted. For the 32 selected contracts we reviewed, when there was  full and open competition, contracting officials assessed contractor value  added based on the technical ability to perform the contract, but did not  need to separately evaluate costs for value added as market forces  generally control the proposed contract cost. We found that  conducting assessments of contractor value added is especially  challenging in unique circumstances, such as when requirements are  urgent in nature and routine contracting practices may be overlooked. Contract pricing is used to determine price reasonableness for the  contract, including subcontracting costs. Presence of Competition and Type of Contract Generally Guide the Use of Assessment Tools

According to DOD contracting officials and based on our review of selected  contracts, assessments of contractor value added are typically driven by  contract risk—the presence of competition and whether the type of contract  requires the government to pay a fixed price or costs incurred by the  contractor. When using noncompetitive contracts, however, the  market forces did not control contract cost and required contracting officers  to consider—in addition to cost—the technical ability to perform the work. For the Air Force’s estimated $3 billion satellite program contract,  DCAA reviewed the certified cost and pricing data that the contractor  was required to provide. In addition, related GAO  work and DOD audits on contracts awarded for Hurricane Katrina  recovery efforts found multiple layers of subcontractors, questionable  value added by contractors, increased costs, and lax oversight. Selected Private Sector Companies Rely on Several Shared Approaches to Minimize The Risk of Excessive Pass- Through Charges

Selected private sector companies we interviewed had several strategies in  common for minimizing the risk to them of excessive pass-through  charges when purchasing goods and services. These companies focus  resources on acquisition planning and knowledge of their supply chains  and costs—challenges DOD continues to face. They also seek to optimize  competition, preferring fixed-price competitive arrangements. According  to several companies, they recognize the financial risks of other types of  contracts, such as time-and-materials, and enter into them with proper  oversight and accountability. As we have previously reported, DOD’s use  of these riskier contracts has not always ensured good acquisition  outcomes and prudent expenditure of taxpayer dollars. Private Sector Companies Focus on Acquisition Planning and Knowledge of Supply Chain

The contracting officials we spoke with at selected private sector  companies told us that to avoid unnecessary pass-through charges when  purchasing goods and services, they devote attention to planning  acquisitions. Contracting Officials Lack The Guidance and Insight Needed to Effectively Implement DOD’s Interim Rule

DOD recently issued an interim rule that allows it to recoup contractor  payments that contracting officers determine to be excessive on all eligible  contracts. The rule requires detailed information from the prime  contractor on value added when subcontracting reaches 70 percent or  more of the total contract. While the rule aims to provide contracting  officers with more information, it will not provide greater insight into  DOD’s supply chain and costs. However, contracting officials indicated the importance for  newer and less experienced staff to involve DCAA and DCMA as appropriate. Appendix I: Scope and Methodology

To determine the Department of Defense’s (DOD) approach to assessing  the risk of excessive pass-through charges when work is subcontracted,  we reviewed and analyzed tools in the Federal Acquisition Regulation  (FAR) and the Defense Federal Acquisition Regulation Supplement  (DFARS). We met with DOD officials from the Office of the Secretary of  Defense, Defense Procurement and Acquisition Policy, Defense Contract  Audit Agency (DCAA), Defense Contract Management Agency (DCMA),  and contracting officials from 11 DOD contracting locations to discuss  these regulations and their approach to assessing the risk of pass-through  charges, evaluating contractor value added, and factors that drive these  assessments.
Why GAO Did This Study

One-third of the Department of Defense's (DOD) fiscal year 2006 spending on goods and services was for subcontracts. Concerns have been raised among DOD auditors and Congress about the potential for excessive pass- through charges by contractors that add little or no value when work is subcontracted. To better understand this risk, Congress mandated that GAO assess the extent to which DOD may be vulnerable to these charges. This report examines (1) DOD's approach to assessing the risk of excessive pass-through charges when work is subcontracted, (2) the strategies selected private sector companies use to minimize risks of excessive pass-through charges when purchasing goods and services, and (3) DOD's interim rule to prevent excessive pass-through charges. GAO's work is based on analysis of 32 fiscal year 2005 DOD contract actions at 10 DOD top contracting locations and discussions with DOD acquisition policy, audit, and contracting officials, including Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA) staff. GAO also interviewed nine selected private sector companies with diverse contracting experience.

What GAO Found

Although no specific criteria exist for evaluating contractor value added, DOD contracting officials generally rely on tools in the Federal Acquisition Regulation (FAR) to assess the risk of excessive pass-through charges when work is subcontracted. For the 32 selected contract actions GAO reviewed, DOD contracting officials generally applied these tools to their assessments. The degree of assessment depended on whether the contract was competed and whether the contract type required the government to pay a fixed price or costs incurred by the contractor. When using full and open competition, contracting officials assessed contractor value added based on the technical ability to perform the contract, but did not separately evaluate cost since market forces generally control contract costs, potentially minimizing the risk of excessive pass-through charges. However, when using noncompetitive contracts, contracting officials were required to evaluate more detailed cost information in assessing value added, as market forces did not determine the contract cost. For example, for a $3 billion noncompetitive contract for an Air Force satellite program, contracting officials assessed detailed cost or pricing data that included subcontractor costs, and received DCAA and DCMA support to negotiate lower overall contract costs. However, assessing contractor value added is especially challenging in unique situations where requirements are urgent in nature and routine contracting practices may be overlooked. Related GAO work and DOD audits on contracts awarded for Hurricane Katrina recovery efforts found multiple layers of subcontractors, questionable contractor value added, increased costs, and lax oversight. The selected private sector companies GAO interviewed rely heavily on acquisition planning, knowledge of supply chain, and managing contractual relationships to minimize risk of excessive pass-through charges when purchasing goods and services. They seek to optimize competition to minimize overall contract costs, and several companies indicated that they prefer fixed-price competitive arrangements. In addition, some form collaborative business relationships with contractors and subcontractors that provide greater insight into their supply chains and costs--a challenge DOD continues to face. When using other than fixed-price contracts, they recognize the financial risks and ensure proper oversight and accountability. As GAO has reported in the past, DOD's use of riskier contracts, such as time-and-materials contracts, has not always ensured good acquisition outcomes. DOD recently issued an interim rule requiring a contract clause in all eligible contracts, which allows it to recoup contractor payments that contracting officers determine to be excessive. The rule also requires detailed information from contractors on their value added when subcontracting costs reach 70 percent or more of total contract cost. However, the rule alone will not provide greater insight into DOD's supply chain and costs--information companies told us they use to mitigate excessive costs. Further, contracting officials indicated the need for guidance to ensure effective implementation and consistent application of tools in the FAR as appropriate.