GAO Finds Downside of Competition
The notion that competition is good is one of the foundational principles of the Federal government’s acquisition system. It’s right there in the FAR Statement of Guiding Principles (FAR 1.102). The Federal Acquisition System will promote competition. It’s like motherhood and apple pie: competition is a good thing and nobody can question it.
Nobody, that is, except for the Government Accountability Office (GAO).
Recently GAO issued a report that discussed the evolving competitive landscape of the Evolved Expendable Launch Vehicle (EELV). Currently, the EELV is provided to the Air Force by the United Launch Alliance (ULA) via a sole-source, cost-reimbursement contract. However, in future acquisitions the Air Force intends to “procure launch as a commercial item using a firm-fixed price contract.” We’ve discussed ULA and its sweet spot with the EELV launches before, and we noted then that the situation was subject to change based on smaller, more nimble, commercial companies looking to capture market share from ULA. So the in-process change in USAF acquisition philosophy is nothing new. And yet, that change in approach has GAO concerned, even though use of competition and firm fixed-price contracting would seem to fit right in line with the acquisition emphases of the current administration.
Haven’t we posted article after article talking about increased use of fixed-price contracting (including fixed-priced development contracting)? Haven’t we posted article after article talking about the general focus on increasing competition? Yes to both questions. Yet GAO is concerned.
Let’s explore GAO’s concerns.
The GAO report takes a reader through the history of the USAF relationships with Boeing, McDonnell Douglas and Lockheed Martin – companies that eventually merged and/or agreed to a joint venture—the joint venture that became ULA. The GAO report discusses the Air Force’s ability to obtain cost or pricing data and the ability to rely on such data from ULA’s “immature” business systems. That data was deemed necessary because of the sole-source award to ULA – since there was no competition, the Air Force needed detailed, reliable, cost data in order to determine that the price being paid was fair and reasonable. ULA and the Air Force struggled with the issues (and were criticized by GAO while they struggled). However, by July 2014, all six DFARS business systems at ULA had been approved.
Now that ULA has its business systems approved, the Air Force is moving to a competitive acquisition strategy, one in which certified cost or pricing data will not be required—because competition will permit the use of price analysis alone to determine that the price being paid is fair and reasonable. This concerns GAO.
As GAO wrote –
Relying on the commercial market reduces the Air Force’s insights into and access to certain types of information that is currently provided under ULA’s Phase 1 contract. For example, under the current ULA contract, the Air Force requires ULA to maintain six major business systems that need to be reviewed and approved by a government oversight organization, and provide insights into ULA’s cost and schedule performance on a continuous basis, among other benefits. Under the revised acquisition strategy, the Air Force will not have access to the same level of detail it currently obtains and the contractors will be allowed to use business systems that are not required to meet DOD standards.
Let’s bottom-line this: GAO is concerned because the Air Force’s new acquisition strategy will rely on competition and commercial market forces to assure price reasonableness.
Really. That’s their concern.
What we see here is the old guard fighting for “the way we’ve always done it” while the new guard implements new and innovative strategies. To be clear: we view GAO’s concerns as a great example of why it is so difficult for the Pentagon to undertake meaningful acquisition reform.
In addition, notice that what the GAO is fighting for is the traditional oversight processes, the kind of stuff that was once estimated to add as much as 17 percent to defense acquisitions. We wrote once that the six DFARS business systems were a big waste of taxpayer funds. We wrote –
Reviewing contractor business systems has become a cottage industry, with consultants and attorneys eager to assist contractors with creating adequate business systems, or remediating those systems that failed DCAA or DCMA audit.
And now we have reenergized DCMA functional specialists and refocused DCAA auditors, with new and improved audit programs to help them evaluate business systems. We have peer reviews of ACO business system adequacy determinations, and at least two levels of Review Boards to help adjudicate disagreements between the ACO and those who performed the reviews. We have process upon process, and guidance upon guidance—all to help focus oversight on the first line of defense against fraud, waste, and abuse.
And that is what GAO is arguing for. GAO is arguing for bureaucracy. It is afraid of innovation. It is afraid of change. And it is afraid that too many bureaucrats will be out of work if the Air Force decides to acquire launch services via commercial competition.
Proposed DFARS Rule Addresses Market-Based Pricing
 Twenty years or so ago, the FAR definition of “commercial item” was substantially revised in order to make it easier for the Federal government to acquire such items. As the DoD’s Commercial Item Handbook (Version 2.0) states –
Since the passage of the Federal Acquisition Streamlining Act of 1994 (FASA), the preference within the Federal Government has shifted from the acquisition of items developed exclusively for the Government to the acquisition of commercial items. This change was necessary to take full advantage of available and evolving technological innovations in the commercial sector. The Government’s increased reliance on commercial items is essential to provide technology solutions that increase war fighter capabilities.
FASA signaled a dramatic shift in the course of acquisition policy for the Federal Government. It was the most far-reaching acquisition reform in the last fifty years. FASA promoted maximum use of commercial items to meet the government’s needs and streamlined the process to acquire such items following commercial market practices. Commercial practices are overarching and affect every functional area within acquisition. All of acquisition must move to a price-based, market-driven environment from requirements development through property disposal. Source selection must be made on a ‘best value’ not ‘cheapest price’ basis. Agencies must evaluate their business processes, and reengineer those necessary to ensure streamlined acquisition and operating practices. This will be a never-ending process of mission identification, analysis, planning, implementation, measurement and results. Continuous process improvement will become the norm in the Department.
The FASA preference for commercial items is incorporated into the Federal Acquisition Regulation Statement of guiding principles for the Federal Acquisition System in FAR Section 1.102.
The FASA-era reforms were based on laudable goals, no doubt about it. But for the past twenty years certain groups (that seem to be mostly within DCAA and the DoD Pricing Directorate) have been pushing back. Now, a recent proposed revision to the Defense Federal Acquisition Regulation Supplement (DFARS) seems to signal a retreat from FASA-era acquisition reforms and a return to the days in which the commerciality of an item was determined by rigid application of mathematical formulae.
In the pre-FASA days, the commerciality of an item was determined by a strictly prescribed set of criteria that led to a black/white, yes/no decision based on the percentage of sales to non-Governmental entities. Generally, the pre-FASA requirement was that at least 55 percent of an item’s sales had to be proven to be to non-Governmental entities. If the contractor couldn’t establish that at least that percentage of sales, then its item would not be determined to be a commercial item.
The problem with that approach was that the companies who offered commercial items for sale were the same ones who didn’t keep their books and records in the format that the DoD auditors liked to see. Consequently, the commercial companies struggled with the process. The prices of items that could not be certified (by the auditors) as being commercial in nature had to be supported by cost or pricing data—which meant that those commercial entities had to struggle with the process of submitting bids via SF 1411 (which we would now call FAR Table 15-2 requirements). Then they had to support their cost proposals through audit and negotiation. According to a Coopers & Lybrand study at the time, the DoD was paying a premium of at least 17 percent because it refused to acquire goods and services the way the marketplace offered and priced them. In addition, many companies (including leading-edge technology companies) simply refused to sell to DoD because they didn’t want to put up with all the nonsense for a relatively small sales channel. Thus, DoD had trouble availing itself of the latest technology for its warfighters.
The FASA-era reforms were intended to change that paradigm and open the door for DoD to enter the commercial marketplace as just another buyer. The recent proposed DFAR rule revisions seem to signal a walk back to the pre-FASA days. That’s puzzling – at least to us – because why would the DoD be trying to make it harder to acquire goods and services from non-traditional defense contractors at the very same time the Secretary of Defense has publicly proclaimed that the DoD wants to get more of the Silicon Valley cutting-edge technology and innovation?
The proposed rule points to the FY 2013 National Defense Authorization Act (NDAA) as the driver for the proposed rule changes. Left unsaid in the background section of the proposed rulemaking action is the fact that it was the DoD itself that requested Congress take action on the matter. (H/T Project on Government Oversight for the link to the original DoD request.) It seems a bit disingenuous to submit a legislative request to Congress, and then to blame Congress for the unfortunate necessity of having to revise the rules. But maybe that’s just us.
Importantly, the proposed rulemaking action seems to go far above what Congress directed. This is hardly surprising, given the long history of certain DoD constituencies seizing every opportunity to roll back FASA-era reforms in this area. In fact, according to the proposed rule, the NDAA required DoD to take the following actions – and only the following actions:
Section 831 requires the issuance of guidance on the use of the authority to require the submission of other than cost or pricing data. Specifically, section 831, paragraph (a) provides that the guidance accomplish the following:
1. Include standards for determining whether information on the prices at which the same or similar items have previously been sold is adequate for evaluating the reasonableness of price;Show citation box
2. Include standards for determining the extent of uncertified cost information that should be required in cases in which price information is not adequate for evaluating the reasonableness of price;
3. Ensure that in cases in which such uncertified cost information is required, the information shall be provided in the form in which it is regularly maintained by the offeror in its business operations; and
4. Provide that no additional cost information may be required by the Department of Defense in any case in which there are sufficient nongovernment sales to establish reasonableness of price.
Key to the DAR Council’s implementation of the four Congressional-mandated actions is to define a new term—“market-based pricing”. According to the proposed rule—
Market-based pricing means pricing that results when nongovernmental buyers drive the price in a commercial marketplace. When nongovernmental buyers in a commercial marketplace account for a preponderance (50 percent or more) of sales by volume of a particular item, there is a strong likelihood the pricing is market based.
Gee, does that look familiar to anybody? We guess that 50 percent is better than 55 percent but, really, what’s the difference in philosophy? None. This is simple the return of the pre-FASA application of rigid mathematical formulae to determine commerciality.
Moreover, note the phrase “there is a strong likelihood” in the above definition. To us, that means that the offeror can provide sales data that shows it sells 90 percent of its goods to non-governmental entities, but the Contracting Officer can still determine that the item is not commercial in nature—in the name of being prudent and to protect the Government’s interest, of course.
Another definition in the proposed rule caught our eye. What are we to make of this one?
Sufficient nongovernment sales to establish reasonableness of price (see 215.402(a)(3)) exist when relevant sales data reflects market-based pricing, are made available for the contracting officer to review, and contains enough information to make adjustments covered by FAR 15.404-1(b)(2)(ii)(B).
In other words, in addition to showing that at least 50 percent of its sales have been to non-governmental entities, the offeror must also provide sufficient data to allow the Contracting Officer or pricing analyst to adjust the prior prices “to account for materially differing terms and conditions, quantities and market and economic factors.” How many commercial entities are going to have all that data handy?
The proposed rule also permits the Contracting Officer to request, obtain and review “uncertified cost data” when necessary to determine the price being offered is fair and reasonable. Uncertified cost data is defined (in the proposed rule) to mean uncertified cost or pricing data that relates to the offeror’s costs. In other words, the offeror may be required to submit cost data in support of its proposed prices, even if it sells 90 percent of its goods to non-governmental entities.
In fairness, we have to report that the proposed rule states, “If the contracting officer requires the offeror to provide uncertified cost data, it shall be the form in which it is regularly maintained by the offeror in its business operations.” That would be a bigger relief if we didn’t already know that commercial entities don’t maintain, as a general rule, detailed cost subledgers or detailed timekeeping systems. They do not, as a general rule, know the cost of their individual products. Instead, they know their costs of goods sold, which is a number that encompasses the sales of all products, not just the ones being offered for sale to DoD in response to a particular RFP.
There’s more where that came from. In the interest of time (and typing fatigue) we’re not going to discuss the rest. If your company sells—or would like to sell—commercial items or services to the Department of Defense, then we urge you to follow the link in this article and read the entire proposed rule for yourself.
Comments on the proposed rule should be submitted in writing on or before October 2, 2015. They may be submitted to the DAR Council via one of several means. (See the proposed rule for a list of all communication avenues.) One easy way is to e-mail
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
and include DFARS Case 2013-D034 in the subject line of the message.
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Raytheon … Again
 We can’t help reporting on Raytheon’s litigation because the decisions in its cases are important. Plus, you know, Raytheon actually litigates—unlike the other major defense contractors who report settlement after settlement in the contract dispute fora. As we’ve noted before, we suspect one reason that Raytheon keeps litigating is because it seems to win more than its fair share of disputes.
And here we are again, reporting on another decision at the ASBCA. This decision addressed ASBCA Nos. 57576, 57579, and 58290. As Judge Delman noted in his decision, he had previously dismissed three other appeals that covered many of the same issues because the claims had been issued “untimely” by the government—i.e., the Statute of Limitations associated with the Contract Disputes Act had expired. Thus, Raytheon had already started with a victory for its Fiscal Years 2002, 2003, and 2004.
The three appeals at issue concern alleged violations of both CAS and FAR. In one dispute (No. 57576) “the government contends that Raytheon failed to identify and exclude from its cost submissions the costs of bonus and incentive compensation (BAIC) for those persons engaged in activities that generate unallowable costs under the following cost principles: FAR 31.205-1, -22, -27, and -47, and that are ‘expressly unallowable’ under these principles.” In other words, the government asserted that the bonus and incentive compensation (BAIC) was a directly associated unallowable cost and, accordingly, it should have been treated as being expressly unallowable.
In the other two disputes (Nos. 57579 and 58290), “the government contends that Raytheon failed to identify and exclude from its cost submissions the costs of certain stock awards to employees under its long-term performance plan (LTPP) that are ‘expressly unallowable’ under FAR 31.205-6(i).”
Obviously, the definition of “expressly unallowable” played a key role in Judge Delman’s decision. We’ve addressed the controversy over that definition before. The decision would also turn on the requirements of Cost Accounting Standard (CAS) 405. In fact, the Judge took about 11 pages to establish the pertinent statutes, CAS rules, and FAR requirements before turning to the Statements of Facts for each appeal.
Getting back to No. 57576, Judge Delman found that Raytheon had briefed DCAA on its various incentive compensation plans as early as 2000. In September, 2002, a DCAA audit report on Raytheon’s incentive compensation concluded that the audit agency “took no exception” to Raytheon’s incentive compensation. A year later, another DCAA audit report concluded that Raytheon’s FY 2002 incentive compensation costs were allowable costs pursuant to the requirements of FAR 31.205-6(f). A year after that, another DCAA audits report reached the same conclusion. In 2006, another DCAA audit report reached the same conclusion. There were other DCAA audit reports discussed by Judge Delman; they also reached similar conclusions. Perhaps our readers are sensing a pattern here.
Regardless of the foregoing litany of audits and audit conclusions, in September, 2007, a DCAA audit alleged a Raytheon noncompliance with CAS 405, stemming from its failure to “withdraw from its incurred cost submissions a proportionate share of its costs of bonuses, restricted stock, and other compensation costs paid to employees engaged in ‘expressly unallowable activities’ as defined by various FAR cost principles. The alleged CAS noncompliance pertained to Raytheon’s Fiscal Years 2002 through 2005. The Corporate Administrative Contracting Officer (CACO) agreed with DCAA, and told Raytheon –
Raytheon Company, Corporate Home Office, withdraws labor and a portion of fringe expenses for employees engaged in expressly unallowable advertising, lobbying, organization, and legal activities. However, they do not withdraw the applicable portion of bonus, restricted stock, and other incentive compensation in connection with these expressly unallowable activities.
Subsequently, DCAA and DCMA added Raytheon’s FY 2006 claimed costs to the alleged CAS noncompliance. Meanwhile, Raytheon was busy calculating GDM cost impacts related to the alleged noncompliance. There was a “fringe delta” cost impact, which was rejected by the government. Then Raytheon prepared a “discrete” impact calculation. Importantly, although the government’s alleged CAS noncompliance covered only four (4) areas of unallowable activity, Raytheon’s cost impact included a fifth area (“Contributions”). Raytheon argued that inclusion of the fifth area was inadvertent. However, the government used Raytheon’s calculation (which included all five areas) to arrive at a quantum of $20,012,578. (That amount included penalties and interest as well.)
With respect to No. 57576, Judge Delman dismissed the part of the government’s claim relating to Raytheon’s inadvertent inclusion of the Charitable Contributions cost center in its cost impact calculation. Because the government had never specifically asserted a claim for a violation of that FAR cost principle, it could not include that amount in the damages it sought from Raytheon. With respect to the rest of No. 57576 and the other two appeals, the Judge had more work in front of him.
Judge Delman reminded the litigants that “An ‘expressly unallowable’ cost, by the plain terms of the definition, must be an item of cost or a type of cost that is specifically named and stated as unallowable by law, regulation or contract.” He then explored the various FAR cost principles to determine whether or not “BAIC” was expressly unallowable under each. He concluded as follows:
31.205-1 – BAIC was not specifically named and stated as being unallowable. Victory to Raytheon. However, Judge Delman did not rule on whether BAIC was merely unallowable, or whether it was a directly associated unallowable cost. The parties will have to proceed to trial on those issues.
31.205-22 – BAIC was not specifically named and stated as being unallowable. Victory to Raytheon. However, Judge Delman ruled that the BAIC paid to individuals engaged in such activities was unallowable (but not expressly unallowable), so the Government won on that issue.
31.205-27 – BAIC was not specifically named and stated as being unallowable. Victory to Raytheon.
31.205-47 – Because the cost principle made “all elements of compensation” unallowable, and “it is unreasonable under all circumstances to conclude that [Raytheon’s] BAIC costs with respect to the defined proceedings are allowable,” the BAIC was found to be expressly unallowable. Victory to the Government.
With respect to Nos. 57679 and 58290, Judge Delman found that certain aspects of Raytheon’s Long-Term Performance Plan (LTTP) were expressly unallowable under 31.205-6(i). That was a victory for the Government.
To the extent that the Government “won” a victory with respect to Raytheon’s claimed costs, Raytheon argued that the Government should be precluded from recovering any damages, under the “retroactive disallowance” principle. Judge Delman wrote—
According to [Raytheon], given the government's consistent approval of and/or acquiescence to the subject BAIC and TSR metric costs, it was barred from disallowing those costs prior to the issuance of an authoritative notice that such costs were no longer allowable. [Raytheon] posits that the government's 2011 final decisions on the BAIC costs and TSR costs were the first such government notices, and hence any costs incurred prior to these dates are not recoverable.
(Internal citations omitted.)
Judge Delman found that there were material facts in dispute on that affirmative defense, and declined to issue summary judgment to either party. Thus, the matter will proceed to trial.
What is one to make of this Raytheon decision? First, there will be a trial and there will be another decision. And that decision may well be appealed by either party (or both parties). Therefore, it’s not clear at this point how big a victory Raytheon won. That said, it’s fairly clear that the amount of damages sought by the government was whittled down significantly by summary judgment.
Other commenters, more learned that we, offered the opinion that Judge Delman’s rulings in favor of the government were flawed. For example, one set of legal practitioners wrote –
Unfortunately, the Raytheon decision does nothing to resolve the long-standing dispute between contractors and the government regarding the proper application of expressly unallowable penalties. Specifically, while the Board acknowledged that a cost is only subject to penalty if it is ‘specifically named and stated to be unallowable,’ the Board then found that certain bonus and incentive costs where an employee billed time to unallowable legal activity and long term compensation costs that include a Total Shareholder Return (TSR) element, both which are not expressly referenced anywhere in the FAR, are expressly unallowable. Thus, contractors will be left guessing at whether the government will consider particular costs to be expressly unallowable even if they are not specifically named in the FAR.
Thus, it appears that to the extent Raytheon lost an aspect of its appeals, legal commenters believe that Judge’s logic was flawed. That might give some hope to Raytheon, as it considers whether or not to appeal the ASBCA decision.
GE Rethinks Its HR Management Approach
 We were recently notified, courtesy of an article at GovExec.com, that the bluest of the blue chip corporations—General Electric Company—has decided to reassess and fundamentally change its employee performance management approach.
According to the article (written by Max Nisen), GE is in the process of “abandoning formal annual reviews and its legacy performance system for its 300,000-strong workforce” and, instead, will implement “a less regimented system of more frequent feedback via an app.” The article noted that GE “got rid of its formal, forced ranking around 10 years ago.” In other words, GE – the company that made employee “racking and stacking” (or, as it was known at GE: “rank and yank”) popular – has decided that that particular approach no longer works for it. Mr. Nisen wrote: “With the decision, GE joins other high-profile companies—like Microsoft, Accenture, and Adobe—that have started dumping or have already gotten rid of formal annual reviews.”
We have railed before on this blog against such knuckle-headed HR strategies. For example, three years ago in this article we wrote –
Recently, we have come across articles and discussions which assert that ‘stack ranking’ is a fairly terrible approach to workforce management—especially when implemented on a routine basis and especially when a pre-selected ‘grading curve’ is issued by upper management. The pre-selected approach was made famous by Jack Welch and the General Electric Company, where the lower 10% of the workforce is identified annually—and then fired—came in for special criticism.
Getting back to Mr. Nisen’s article, why did GE finally abandon the Welch employee management philosophy? Nisen wrote –
But [Welch’s] style and focus on the annual performance review simply doesn’t work for the company or its younger workforce any more, say GE human resources executives. ‘The world isn’t really on an annual cycle anymore for anything. … I think some of it to be really honest is millennial based. It’s the way millennials are used to working and getting feedback, which is more frequent, faster, mobile-enabled, so there were multiple drivers that said it’s time to make this big change.’ She’s not the only one who thinks so. There’s a growing realization that the annual review just isn’t a particularly good way to manage people or to boost performance. It leads to a tendency for HR to focus excessively on process over outcomes.
(Emphasis added.)
Adobe HR head Donna Morris, who led that company’s transition away from annual reviews and ratings [said] ‘It’s a process that looks in the rear view mirror, that’s focused on what you’ve done a year ago. That just isn’t current with how I think we’re working and how many of the employees that we’re looking to attract or grow have been raised.’
And that’s really the thing, isn’t it? The annual performance review and the ranking of employees and the doling-out of the merit increase pool aren’t about boosting (or even rewarding) employee performance. Instead, it’s about HR working its HR process to the detriment of employee morale and employee performance.
Nisen wrote –
The move by more and larger companies away from annual reviews and ratings is well past due, say management theorists. Years of research, from both business school professors and neuroscientists, has found that the practice is ineffective at boosting performance, actively alienates employees, is based on a flawed understanding of human motivation, and is often arbitrary and biased. People simply don’t fit neatly on a bell curve. It ends up being an exercise in paperwork and bureaucracy instead of an agent of change.
Despite its proven flaws, there are many companies in the Aerospace & Defense (A&D) sector that continue to perpetuate that HR management approach. Those are many of the same companies that are seeing the focus of Pentagon R&D funding shift to the more nimble and creative Silicon Valley companies. Those companies include Netflix. We’ve written admiringly about Netflix’s HR philosophy before (as have many others). It’s been called the most important innovation to ever come out of Silicon Valley.
While Silicon Valley focuses on employee freedom and “talent density,” and while dinosaurs like GE abandon their previous HR management philosophies in favor of a more 21st century approach, your company keeps perpetuating the status quo. You still have annual performance reviews that are used to rack and stack employees, and to dole out the paltry merit increase pool. You still receive direction that no more than a certain percentage of employees can receive the highest ratings, and that a certain percentage of employees must receive the lowest ratings—simply because nobody has yet challenged HR to defend the antiquated and fundamentally flawed approach.
If you want the best and brightest employees, we suggest you start pushing back, and tell HR that they need to rethink the employee performance management process. Because if you don’t start to evolve away from the “rack and stack” approach, you may find yourself out of talented employees—and out of business soon thereafter.
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It is a widely accepted fact that the U.S. Navy brews the best coffee of all the military services. For example, see this article by Chief Journalist Earl Smith (USN, of course). In it he wrote—
