Friday, January 4, 2013

Zen and the Art of Can Kicking

The so-called “Fiscal Cliff” was in three parts. First and largest was the expiration of the Bush tax cuts for everyone. Second and next in size was the end of the payroll tax holiday. The last (and the smallest) piece was the sequestration of the budget resulting in equal cuts to Defense and non-Defense budgets for 2013 to the tune of about $55B each.

Congress addressed the Bush tax cuts by making them permanent for families with income less than $450,000 and individuals with income less than $400,000. Those above the thresholds will see income tax rates return to Clinton-era rates. They let the payroll tax holiday expire resulting in about 2% less in each paycheck for all wage earners starting with the first paycheck of 2013.

When it came to the automatic budget cuts known as sequestration, the task appeared just too hard. They simply moved the effective date for the action from January to March. So, the budget cuts that would have taken place on the first working day of January, will now take place on Friday, March first.

Nothing else changed. They tweaked the budget authority numbers on which the cuts are based, but not enough to be noticeable - $2B each for Defense and non-Defense spending. It’s a round off in either budget.

President Obama signed the 157 page bill into law Wednesday, January second, along with the 2013 National Defense Authorization Act, a bill he had earlier threatened to veto.

After all that, sequestration is no more a certainty today than it was a week ago or a month ago, but neither are the budgets for the Federal programs that could potentially be affected. The probability of eventually dodging the sequestration bullet is just as uncertain.

Both sides of the aisles now believe they have greater leverage for what they unanimously describe as the coming battle over the debt ceiling. Failure to come to an agreement by the first of March will belatedly trigger the same Presidential sequestration order that would have happened on January second. And, prospects for a compromise don’t look good at this point.

In a televised address on Tuesday, President Obama said of the debt ceiling: “I will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed.” Meanwhile, on MSNBC Senator Patrick Toomey (R-PA) said “We Republicans need to tolerate a temporary, partial government shutdown. It’s disruptive, but it’s a hell of a lot better than the path we’re on. We absolutely have to have this fight over the debt limit.”

Looks like the lines are drawn and the trenches dug, but never underestimate the ability of Congress to kick the can down the road one more time. They’ve gotten really good at it.

The discussion in the press over the “Fiscal Cliff Deal” has given rise to two intriguing new mental images. The first is a characterization of the Senate as “a bunch of sleep-deprived octogenarians.” Not entirely accurate, but still evocative. The other is of Bill Murray in a thousand-dollar suit addressing a can on a golf tee, chanting “be the can” and then shanking it (think Caddy Shack).

Apologies to Mr. Murray.

Wednesday, June 20, 2012

The Hidden Dangers of Sequestration

As if the ones we can see aren’t bad enough!

The prospect of a sudden, disastrous reduction in Defense spending is daunting. The mechanisms by which the reduction might be effected could make it even worse in certain segments of the GovCon world.

At his confirmation hearing before the Senate Armed Services Committee in March, DoD Deputy Under Secretary for Acquisition and Technology, Frank Kendall, said “We've already taken $50 billion a year out of the Defense budget. If we had to take another $50 billion out, a lot of that would fall onto industry."

He explained that it would fall disproportionately onto industry because the language in the Budget Control Act lets the President exempt military personnel from the additional sequestration cuts, an authority Kendall said President Barack Obama would likely exercise in order to prevent mass layoffs of service members. Doing so wouldn't reduce the overall cuts to the DoD budget. It would just concentrate them elsewhere. "That would just increase the burden on the research and development, and investment accounts," Kendall said. "It would have a devastating impact."

He went on to comment that sequestration might mean that DoD would be unable to pay vendors the amounts it’s agreed to under existing contracts.

Heidi Shyu, nominee for the post of Assistant Secretary of the Army for Acquisition, Logistics and Technology, was even more definitive. She told the committee at that same hearing that personnel programs would be shielded from the effects of sequestration, but industry would not.

"The bulk of the Army's budget is in the manning area. That's not going to go down quickly," she said. "The procurement accounts that impact our prime contractors, our second, third, fourth-tier companies are all going to be significantly impacted. "

Translation: DoD’s sequestration impact will be mostly to contractors, probably services contractors, and will probably involve partial or full Terminations for Convenience (T for C) of existing contracts.

Hidden Danger #1
The largest impact of sequestration cuts in procurement may be to services contracts. The mechanisms of the sequestration cuts appear to require pro ratarata cuts with no ability to shift or “reprogram” funds to spare one program at the expense of another.

In DoD, a budget line is usually a weapon system. In the early stages of a program, a system could have both an R&D budget line and a Procurement budget line in the same year, but usually it’s one or the other. From that budget line, the Program Office will fund both support contracts and weapon system procurements.

Even if a Program Office elects to cut both services contracts and production contracts, it will be tempting to cut “a million off each contract” even though that may be two percent of the hardware contract and half of the services contract.

Hidden Danger #2
The immediate impact of sequestration reductions may be to existing contracts. The reality is that many services contracts will be funded for FY 2013 in October or November. Many of those actions will be option exercises, delivery order placements, or contract awards. Few, if any, of those will take anticipated sequestration reductions into account. When the mandated reductions occur, the buying offices will have few alternatives and among the few will be full or partial termination of those contracts.

Hidden Danger #3
Large prime contractors facing a partial termination of ten or fifteen percent of a contract may choose to (fully) terminate a subcontractor rather than lay off employees. It is unlikely that the prospect of failing to meet subcontracting goals will provide the subcontractor any protection. A prime contractor facing a partial T for C would probably invoke the “sovereign act” defense and demand to renegotiate the subcontracting plan as part of the termination settlement. In fact, a full T for C of a subcontractor might very well cost the Government less in the prime’s termination claim than a partial layoff of prime contractor employees.

Hidden Danger #4
The administrative effort necessary to carry out the reductions may completely consume the bandwidth of DoD’s acquisition workforce. Procurements not yet solicited will need to be restructured and the statements of work rewritten. Procurements in process will need to be amended, reproposed, reaudited and renegotiated. Contracts already in force will need to be modified or partially (or even fully) terminated and the termination claims prepared, audited and negotiated. In spite of DCAA’s claims that the newly formed incurred cost audit teams are inviolate, watch them evaporate in the face of this new workload. And, forget anything like a new procurement or something as mundane as a disclosure statement or system review.

Hidden Danger #5
The impact to new procurements initiated after “sequestration day” may be greater than the impact to existing contracts. DoD consistently underestimates the amount of termination claims. Under normal circumstances, there’s no real penalty for this since termination claims, by the time they are negotiated, are often paid from prior year funds. In this case, it is likely that funds will have to be committed for the termination claims at the time of the T for C in order to account for the sequestration reductions. In reality, an eleven or twelve percent reduction in an existing contract, effected via a T for C, could net only seven or eight percent (or even less) after the termination claim is taken into account. The buying office could increase the amount of the reduction to the existing contract to take this into account or it could reduce the funds available for future procurements even further. Either way, a mandated “12% sequestration reduction” could translate to a real loss of 15% or more of available future funding.

Hidden Danger #6
The longer it takes, the larger the current year effect will be. Sequestration cuts will happen automatically on January 2nd, 2013 unless Congress intervenes and that just doesn’t seem likely. By that time, one full fiscal quarter of spending will already have occurred at current levels. In order to effect an across the board cut of 12% (for example) in spending for the (entire) fiscal year over the (remaining) nine months, current spending levels would have to be cut by 16%. And, that’s assuming that all the decisions are made, the paperwork completed and the stop work or T for C notices are delivered promptly on the 2nd of January. If those processes take another month, the effective cut percentage required rises to 18%. If it takes two months, it’s almost 21%. By the end of March, it’s 24%.
Services contracts are easier to cut and yield more savings than reductions in hardware quantities. Much of the cost associated with production overhead is fixed in the form of assembly lines, jigs and fixtures, test equipment and tooling whereas much of the overhead of a services contractor is variable. In my experience, a small or even a moderate reduction in a high volume production line may produce little or no savings.

Do you see other "Hidden Dangers?" Post a comment and tell the GovCon community your views.

Wednesday, June 6, 2012

The Continuing Saga of the Ceiling on Government Contractor Compensation

Congress first "capped" Executive Compensation for Defense Contractors in 1995 using a Benchmark set by the Office of Federal Procurement Policy (OFPP). The Benchmark is calculated each Fiscal Year and represents the median of total compensation paid to the top five employees at each home office and segment of all U. S. public companies with more than $50 million in revenues.

The 1995 cap was $250,000 and applied only to the top five executives in each company and only limited allowability on Defense contracts. In 1998, Congress broadened the cap to limit allowability on all Federal contracts, not just those of DoD, but it still applied only to the top five executives.

The provision was problematic almost from the beginning. The Benchmark (or simply "the cap") rose much faster than inflation and by 2010 was almost $700k. In addition, the sixth highest paid executive in a company was often paid considerably more than the cap and, in many cases, comparison to salary survey data showed it was reasonable. This situation persisted until 2012.

The 2012 version of the National Defense Authorization Act (NDAA) modified 10 U.S.C. section 2324(e)(1)(P), the section of the US Code in which the Executive Compensation cap is implemented, to broaden the cap to apply to any contractor employee. The cap continues, however, to be tied to the OFPP Executive Compensation Benchmark which is now more than $763k.

On May 18th, the House of Representatives soundly rejected an amendment to HR 4310, the House version of the 2013 NDAA, that would have limited allowability of Government contractor employee compensation to $400k (the nominal amount of the President's salary).

On June 4th, the Senate Armed Services Committee (SASC) released their markup of the S 3254, the 2013 National Defense Authorization Act and it was placed on the Senate Legislative Calendar. Section 842 of S 3254 would further modify 10 U.S.C. section 2324(e)(1)(P), regarding the maximum allowable compensation of (any) contractor employee.

Currently, the section makes unallowable...

(P) Costs of compensation of any contractor employee for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds the benchmark compensation amount determined applicable for the fiscal year by the Administrator for Federal Procurement Policy under section 1127 of title 41... (currently $763,029)

The new language would make unallowable...

(P) Costs of compensation of any contractor employee for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds the annual amount payable under the aggregate limitation on pay as established by the Office of Management and Budget... (currently $230,700)...

(Emphasis added.)

So, is this new cap provision just election year posturing or is it real? Even if the Senate passes S3254 with it in, will the conference committee take it out right back out?

Stay Tuned.

Monday, February 13, 2012

White House Wants Tighter Contractor Pay Cap

The White House claims the cap on executive salaries allowable on government contracts “has soared to unreasonable heights.” Indeed, the benchmark has risen from $250,000 in 1995 (the first year the cap was effective) to just shy of $694,000 in 2010. OMB did not update the benchmark in 2011 even though it’s a requirement of the OFPP Act (41 U.S.C. 435) which imposed the cap.

Actually, it took significant research to discover that the current cap is really $693,951. Apparently, $694,000 is just so much more impressive in print.

As originally enacted, the law imposed the cap only on the top five contractor executives. Over time, the Government has interpreted this to mean the top five executives in each business unit of a multi-segment contractor. This introduced an interesting situation in very large corporations where the compensation of the number six person (and others) might significantly exceed the cap, but be completely allowable – or at least not capped by law.

Fiscal 2012 saw a number of proposed changes to this provision including one by the White House as part of the President’s deficit reduction proposal to drop the cap to $200,000. This is the amount earned by the most senior federal executives (cabinet secretaries). That proposal never went anywhere, but the Senate did include a provision in its version of the National Defense Authorization Act (NDAA) to drop the cap to $400,000, an amount equal to the President’s salary. The House included a provision in its version that left the current benchmark in place, but extended it to all contractor employees instead of just the top five.

In the end, the NDAA bill the President signed on December 31st included the House language. So, the cap remains at the benchmark set each year by OMB, but is now effective for all contractor employees.

And, the saga is not over yet. Senior Government officials are concerned the overdue OMB update of the benchmark may push it over $750,000 and the White House is once again calling for a dramatically lower cap. On January 31st, the acting head of the Office of Federal Procurement Policy (OFPP) posted an entry to the OMB Blog entitled “Ending the Overpayment of Federal Contractor Executives.” In it he called the current executive compensation benchmark “far in excess of what can be justified” and called on Congress to “abolish the outdated statutory formula” and tie the cap to the top salary of the Government executive pay schedule - $200,000.

Legislators from Senator Charles Grassley (R-IO) to Senator Barbara Boxer (D-CA) have echoed this call and in the current Congressional environment, it could actually happen!

As they say in the advertising biz, “Watch this space.”

Monday, February 6, 2012

So – What’s that Contract Worth, Anyway?

I keep seeing “news stories” announcing that nine Government contractors have been awarded “contracts worth $476 million.” Every time I think to myself “Not really.”

Just last week, the Government awarded nine Indefinite Delivery, Indefinite Quantity (IDIQ) contracts under the Omnibus Network Enterprise (ONE) program, each with a ceiling of $476 million. For those not familiar with IDIQ contracts, they don’t really have a “value.” They have a “ceiling” – a limit on how much the Government can buy under the contract. You see, IDIQ means “we don’t really know how much we want or when we want it, but we’re pretty sure we’ll buy something from you.”

It’s an empty bag.

The “winner” of an IDIQ contract has to compete again for each order the Government places under the program and (theoretically, at least) one contractor could win them all. So, the Government sets the ceiling for each of the contracts at the theoretical maximum it could possibly order. And, of course, it really doesn’t know what that maximum might be with any certainty, so it takes the “official program estimate” and adds a little something to it to account for that uncertainly. Sometimes it doubles or even triples it.

Add to that the fact that most such programs usually span five to eight years, and suddenly each “winner’s” likely annual revenue on that contract isn't quite as impressive.

Let’s take the ONE program as an example. The contract ceilings were set at $476 million. That’s probably 2 or 3 times the real estimate of program expenditures. Let’s be generous and call the real number half of that or $238 million. Still not too shabby!

Of course, that’s spread over a five year program. So, that’s really about $48 million a year. That’s still respectable! That could employ as many as 500 people.

Oh wait. There were nine “winners.” So, that has to be split nine ways! That makes the probable annual revenue for each contractor in this program just over $5 million – call that 50 jobs, more or less.

And, of course, there are subcontractor team members that expect their share of the pie. Even the most permissive small business subcontracting plans require more than 20% of that to be flowed down to subs. In most cases it’s more than 30%. In this case, it’s likely that at least $1.5 million of that very theoretical $5 million will be passed through to someone else.

One awardee stated in the press release that there were nineteen members (the prime contractor and 18 subcontractors) on the team. For those subcontractors, that $1.5 million could be split 18 ways. That computes to about $88k per subcontractor – maybe one person.

That’s why for a lot of companies the phrase most often heard from the CEO following “Congratulations” is “You spent how much on that proposal?”

The point here is not just to pop anyone’s balloon. There’s a very real problem with news stories that create the perception the Government has just spent $476 million nine times when the reality is more like $48 million once – split nine ways. Ditto for the press releases issued by the winners.

To all the winners and their team members on the award of the ONE contracts, congratulations!

But, don’t spend it all in one place.

Sunday, February 5, 2012

Three New Bills Could Impact Small Business

On February 2nd, Representative Mick Mulvaney (R-SC) introduced a bill titled as the Subcontracting Transparency and Reliability (STAR) Act (HR 3893).

Under the bill, agencies would be required to solicit public comment on procedures used to bring in-house any work previously performed by a small business. The procedures would also have to be reviewed by the department Office of Small and Disadvantaged Business Utilization (SADBU).

Further, the bill would also give small businesses access to the courts to challenge insourcing decisions.

In order to assure that small businesses are actually benefiting from the contacts they win, the bill would prohibit subcontracting of more than 50 percent of a contract’s total value the specifies penalties for violation including suspensions, fines and even jail time.

Just two days before, Rep. Sam Graves (R-MO) introduced bills to provide incentives for agencies to meet small business contracting goals and to elevate the position of agencies’ SADBU directors.

The first bill, introduced on the last day of January and titled the Government Efficiency through Small Business Contacting Act (HR 3850), would take bonuses from agency officials when the agency did not make its small business contracting goals and also raise the government-wide small business contracting goal from 23 percent to 25 percent.

The other bill, also introduced on January 31st and styled as the Small Business Advocacy Act (HR 3851), would make the SADBU director of each agency a Senior Executive Service (SES) position and directs specifically that it would “report directly and exclusively” to the head of the agency.

All of these bills have been referred to the House Small Business and House Oversight and Government Reform committees. The hyperlinked bill numbers following the title of each bill will take you directly to the Bill Summary and Status page for that bill on the Library of Congress’ Thomas Project site. The Thomas site is updated in near real time and provides information from the full text of the bill to actions, status and cosponsors.

Wednesday, November 10, 2010

What Happens to Subcontracting Plans after the Gates Funding Cuts?

I’ve been on three different GovCon Acquisition panels in as many weeks.

On each of these panels, there was a prominent attorney specializing in Federal acquisition law. I asked them all the same question: “If a prime contractor experiences a de-scope of an existing contract as a result of Secretary Gates funding cuts and decides to terminate a subcontractor to achieve the savings, can he use the ‘act of a sovereign power’ defense for his failure to achieve his subcontract plan targets?”

By the way, not one of them could answer the question on the spot. But, they all got that “hmmmmm” look on their faces.

It’s a serious question.

We are already seeing requests by contracting officers to de-scope existing contracts or options to cut the funding. In many cases, the actions are tantamount to a partial termination for convenience (T for C). Astute contractors will probably insist that the Government characterize the action that way. It gives the prime contractor some very specific rights that probably would not accrue under just a negotiated change in scope.

For one thing, under a T for C action (even a partial), the prime can terminate subcontractors under the T for C clause that “flowed down” from the prime contract terms and conditions. There are several reasons this may be preferable to other cost-cutting measures.

Cutting personnel has adverse effects ranging from increases in indirect rates to higher unemployment insurance premiums and everything in between. Terminating a subcontractor, on the other hand, is not only within the rights of the prime, it has almost no adverse effects beyond the obvious loss of resources except for that pesky subcontracting plan.

So… If the Government “causes” a prime to terminate a sub as a result of funding cuts (obviously beyond the prime’s control), does that give the prime a “get out of jail free card” for the subcontracting plan?

If I were a prime, I would argue yes and terminate subs before even thinking about touching my own workforce. Most large primes use subs to manage workforce fluctuations anyway. As a subcontractor, I would scream bloody murder and my position would be an emphatic NO! The Government will end up arbitrating the situation, of course, but they’re not the only ones with an interest in the outcome.

Jeff White, founder of govWin, blogged on that very issue just this week. He says that the American Small Business league is very carefully monitoring the performance of large primes under their subcontracting plans and they’re doing it with lawsuits to force release of subcontracting reports by the Government. Click here for Jeff’s post.

This promises to be a VERY interesting situation and one with real consequences for small businesses.

Stay tuned.

Friday, November 5, 2010

POGO Slams DCAA for Change in Proposal Review Thresholds

The Project on Government Oversight (POGO) issued a press release last week titled “Pentagon Radically Reducing Oversight of Contracts Worth Tens of Billions.” As usual, they got it mostly wrong. Frankly they’ve done worse in the past, but not by much.

The Defense Contract Audit Agency (DCAA) has, in fact, changed their thresholds for review of contractor pricing proposals from an informal rule of $700K for fixed price contracts(the threshold for submission of certified cost and pricing data) to formal guidance of $10M and from $10M to $100M for cost-type proposals − proposals, not contracts. Proposals below that threshold would still be reviewed, just by the pricing and estimating specialists at the Defense Contract Management Agency (DCMA), not DCAA. Last I checked, DCMA was still part of the Pentagon. The “D” does stand for Defense, you know.

And, by the way, there is a lot to be said for proposal pricing reviews being performed by PRICING and ESTIMATING specialists and NOT auditors.

POGO somehow managed to jump directly from a change in the thresholds used to determine WHO would review proposals to the idea that DOD would abandon all oversight of the resulting contracts. POGO’s director of investigations, Nick Schwellenbach, is quoted in an 11/1 article in Government Executive as saying “"POGO has long feared contractors and their government allies would block DCAA from exposing contractor rip-offs."

Please. If POGO really doesn’t know the difference between a contract and a proposal, maybe they should let someone else “protect the public.”

According to the same article, DCAA performed more than 30,000 proposal reviews in FY2008, but only about 21,000 in FY2009. Also, in 2008 the average time for DCAA to complete a pricing review was 28 days compared to 72 days in 2010. DCAA claims it’s because they are being so much more thorough. Maybe, but I think that pendulum has swung just a bit too far. Would anyone like to wager that the number of pricing reviews completed in 2010 will be even less than 2009?

The fact is, without management of the thresholds to ensure that the highest risk proposals get the most attention, things will slip through the cracks. It’s the difference in “triage,” which is reactive, and management, which is (or at least should be) proactive.

Emergency rooms practice triage. Good theory. In practice, a heart attack victim in really busy ER may not survive. Across town, in a quiet ER, the medics may be treating splinters and skinned knees. That’s triage. And, that’s probably just about what happened at DCAA last year.

If you could “load balance” all the ER’s in the city, transferring victims and resources at will, heart attacks and car crashes would all get treated and splinters and skinned knees wouldn’t. Ever. And that would probably be a good thing.

You can’t do that with doctors, nurses and victims, but you CAN with proposals and auditors – more so today than ever before. And, that’s exactly what DCAA set out to accomplish. I, for one, think resetting the thresholds to manage the workload was pretty close to exactly the right thing to do.

And, I think we ought to give it a chance to work – without the histrionics.

ANCs Not Out of the Woods Yet

I blogged earlier this week that the Alaska Native Corporations (ANCs) might have dodged a bullet if Lisa Murkowski’s bid to retain her Senate seat is successful (as it appears it might be). The premise of my post was that her win would allow Alaska to retain its representation on the Senate Appropriations Committee and therefore continue to protect the special dispensations afforded the ANCs in Federal procurement.

I may have spoken too soon.

This week, at the annual conference of the Coalition for Government Procurement, Senator Clair McCaskill (D, MO) publically announced her intent to introduce legislation to revoke the special status of the ANCs. Such a legislative initiative might be introduced as an amendment to the 2011 Defense Authorization Bill which has not yet passed the Senate. The following is an excerpt from the Coalition’s weekly newsletter dated today:

This week The Coalition for Government Procurement held its annual Fall Conference in McLean, Virginia. The event kicked off in the morning with comments from Steve Kempf, GSA Federal Acquisition Service Commissioner, and Senator Claire McCaskill (D, MO). …The Senator will be introducing legislation in November that will address Alaska Native Corporations and the special regulatory allowances they receive. The Senator plans to end those special rules when Congress reconvenes this year…
The success of an initiative to repeal the special procurement rules associated with ANCs is not assured. But, there are pockets of strong anti-ANC sentiment both in the Congress and in the (non-ANC) 8(a) community.

It appears there may be more than one bullet.

Oh, by the way… Under Alaska law, EVERY write-in vote must be examined to confirm the spelling of the candidate’s name and discarded if the spelling is not correct. Senator Murkowski’s success is also not assured and it may be weeks before we know.

The saga continues.

Wednesday, November 3, 2010

ANCs May Have Dodged a Bullet Yesterday

I blogged in September, right after the Primary Elections, about the potentially damaging effects on the Alaska Native Corporations (ANCs) associated with the loss of all seniority in the Alaskan Senate delegation. (Click here for that post.) First Senator Ted Stevens lost his election and then died in a plane crash. Then Lisa Murkowski lost her Republican primary bid for reelection to the US Senate.

Having two freshman Senators in the Alaska delegation would almost certainly mean losing the critical seat on the Senate Appropriations Committee currently held by Senator Murkowski. And, that could very well mean losing some or all of the special dispensations ANCs receive in the Federal procurement regulations.

But they may have dodged the bullet.

In yesterday’s General Election, Lisa Murkowski may have actually pulled off a win as a WRITE-IN CANDIDATE for her own Senate seat. It will be weeks (or longer) before all of Alaska’s votes are counted, but her lead is impressive and may represent an insurmountable challenge for her opponents.

More to come…