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Cover
================================================================ COVER


High-Risk Series

February 1997

DEFENSE CONTRACT MANAGEMENT

GAO/HR-97-4

Defense Contract Management


Abbreviations
=============================================================== ABBREV

  DCAA - Defense Contract Audit Agency
  DCMC - Defense Contract Management Command
  DFAS - Defense Finance and Accounting Service
  DOD - Department of Defense

Letter
=============================================================== LETTER



February 1997

The President of the Senate
The Speaker of the House of Representatives

In 1990, the General Accounting Office began a special effort to
review and report on the federal program areas its work identified as
high risk because of vulnerabilities to waste, fraud, abuse, and
mismanagement.  This effort, which was supported by the Senate
Committee on Governmental Affairs and the House Committee on
Government Reform and Oversight, brought a much-needed focus on
problems that were costing the government billions of dollars. 

In December 1992, GAO issued a series of reports on the fundamental
causes of problems in high-risk areas, and in a second series in
February 1995, it reported on the status of efforts to improve those
areas.  This, GAO's third series of reports, provides the current
status of designated high-risk areas. 

This report discusses the high risks in contract management that the
Department of Defense continues to face, despite improvements in
selected areas. 


Copies of this report series are being sent to the President, the
congressional leadership, all other Members of the Congress, the
Director of the Office of Management and Budget, and the heads of
major departments and agencies. 

James F.  Hinchman
Acting Comptroller General
of the United States


OVERVIEW
============================================================ Chapter 0

Improvement and simplification of the Department of Defense's (DOD)
contract payment system is imperative.  If DOD does not achieve
effective control over its payment process, DOD's Defense Finance and
Accounting Service (DFAS) will continue to risk overpaying
contractors millions of dollars.  Further, failure to reform the
payment system perpetuates other financial management and accounting
control problems and increases the administrative burden of
identifying and correcting erroneous payments and their associated
costs.  DOD is aware of the seriousness of its payment problems and
is taking steps to address them. 

With improved contractor cost-estimating systems, DOD could reduce
the risk of overpricing and manage contracts more efficiently. 
Contractors' cost-estimating systems are a critical control for
ensuring sound price proposals.  Sound price proposals reduce the
risk that the government will pay excessive prices, and they permit
less government oversight and management attention.  DOD has improved
its oversight of contractors' cost-estimating systems, and some
improvement in contractor systems is indicated.  Nevertheless, poor
cost-estimating systems remain an area of concern at some
contractors' locations and require continued attention by contractors
and government contracting officials. 

Maintaining public support for defense programs requires that
potential fraud involving defense contractors be identified and dealt
with swiftly.  DOD has established a voluntary disclosure program to
encourage defense contractors to report potential civil or criminal
procurement fraud to the government.  However, contractors'
participation in the program has been relatively small and the dollar
recoveries modest.  Efforts to improve the administration of the
program, including coordination between DOD and the Department of
Justice, may encourage program participation and improve dollar
recoveries. 

As is the case with many other elements of defense, contract
administration and audit resources have been reduced, and further
reductions are planned.  At the same time, DOD continues to look to
additional outsourcing opportunities, and it plans to increase its
procurement budgets significantly in the coming years.  Both these
actions may increase contracting actions and the need for effective
contract administration and audits.  As DOD seeks to reengineer and
streamline its contracting and acquisition processes, including
contract administration and audit, new business process techniques
will be key to accomplishing effective and efficient oversight in the
future. 

We will continue to monitor DOD's progress in addressing the contract
management issues discussed in this report. 


BACKGROUND
============================================================ Chapter 1

Over the last few years, many changes have been witnessed in the
defense contracting environment--both within DOD and in the private
contractor community.  Between fiscal year 1991 and 1995, the defense
procurement budget was reduced by almost 40 percent.  Many defense
contractors, in response to budgetary changes, substantially
restructured their businesses.  DOD, recognizing that it could no
longer afford to buy weapon systems as it had in the past, began
broad-based changes to its acquisition and contracting processes. 
With these changes, DOD is attempting to significantly improve the
way it relates to its contractors and the rules governing their
relationships.  And the changes are by no means complete. 
Acquisition reform, with its emphasis on widespread reengineering of
fundamental processes, continues to receive attention at the highest
levels in DOD. 

In spite of budget reductions and other changes, DOD's contracting
activity remains substantial, amounting to about $110 billion in
fiscal year 1995.  The risks associated with this level of
contracting activity alone are high.  The risk increases
substantially when this activity is coupled with (1) continuing
fundamental changes in the acquisition and contracting processes that
have yet to be fully implemented or evaluated and (2) a contract
administration and auditing resource base that has already been
substantially reduced.  Therefore, contract management must remain an
area of potential high risk that receives marked DOD management
attention. 


DOD'S CONTRACT PAYMENT PROCESS IS
ERROR PRONE AND COSTLY
============================================================ Chapter 2

The need for DOD to achieve effective control over its payment
process is imperative.  If it does not, it continues to risk
erroneously paying contractors millions of dollars and perpetuating
other financial management and accounting control problems.  In
recent years, we have reported on DOD's numerous problems in making
accurate payments to defense contractors.  These reports identify
millions of dollars in government overpayments, underpayments, and
interest on late payments, in addition to other financial management
problems.  For example, as we reported in our 1995 high-risk report,
during a 6-month period in fiscal year 1993, DFAS in Columbus,
Ohio--a principal DOD contract-paying activity--processed $751
million in checks returned by defense contractors.  Our examination
of $392 million of the $751 million disclosed that about $305
million, or about 78 percent, represented overpayments by the
government.  Later, we found that some contractors had retained
overpayments.  For example, in one case, a contractor was overpaid
$7.5 million due to numerous errors.  The overpayment remained
outstanding for 8 years.  We estimate that the government lost
interest on the overpayment amounting to nearly $5 million.  We
concluded that neither DOD nor the responsible contractors appeared
to be aggressively pursuing resolution of payment discrepancies. 

As of May 1996, DOD reported that its problem disbursements totaled
about $18 billion.  However, our preliminary work on DOD's reporting
of problem disbursement data indicates that reported amounts are
substantially understated.  This understatement raises concerns over
whether DOD has sufficient, reliable information to determine the
extent to which disbursement problems have been reduced.\1

In our most recent review, we concluded that the following factors
have contributed significantly to errors in DOD's payment process: 
(1) nonintegrated computer systems often require data to be entered
manually, and the data are often erroneous or incomplete; (2)
multiple documents must be matched before contractors are paid; and
(3) payments are allocated among numerous accounting classifications. 
In addition to contributing to numerous errors, these factors
increase the cost of paying contract invoices. 

DOD is taking steps to address its payment problems.  Its initiatives
include testing and adopting some best practices.  In the long term,
it is developing procurement and payment systems that are linked by
sharing common data.  This linkage is expected to allow one-time
entry of contract data critical to making correct payments.  DOD
plans to implement the payment system in fiscal year 1999 and to make
both systems fully operational in 2004.  In the meantime, DOD is
enhancing its current technologies to further automate the payment
process.  DOD is also testing streamlined payment practices. 

While DOD's planned procurement and payment systems could improve the
accuracy and reliability of new contract payment data and reduce
processing costs, they will not fully address the factors identified
as contributing to payment problems.  Ongoing contracts may be
transferred to the new system with existing errors, multiple document
matching will still be done, and payments will continue to require
allocation among sometimes numerous accounting classifications. 


--------------------
\1 For a discussion of DOD's inability to resolve problem
disbursements, see our Defense Financial Management high-risk report
(GAO/HR-97-3). 


EFFECTIVE COST-ESTIMATING SYSTEMS
ARE KEY TO SOUND CONTRACT PRICES
============================================================ Chapter 3

Cost-estimating systems that produce accurate price proposals are a
key safeguard for obtaining fair and reasonable contract prices and
minimizing overpricing.  In the past, we found significant problems
with contractors' cost-estimating systems.  In July 1994, we reported
that 11 of 30 DOD contractors had cost-estimating systems containing
significant uncorrected deficiencies that had been outstanding an
average of 3.8 years.  Although DOD administrative contracting
officers are responsible for determining the adequacy of the
contractors' cost-estimating systems and requiring correction if the
systems are deficient, we found that contracting officers were
reluctant to use all available sanctions to encourage contractors to
correct deficiencies.  The failure to correct these deficiencies in a
timely manner, we reported, creates a variety of problems for DOD,
including increased costs and delays in contract award. 

Based on our audit recommendations, DOD took steps to strengthen
oversight of its contractors' estimating systems.  Specifically, it
issued new internal guidance for monitoring contractors'
cost-estimating systems and established positions within Defense
Contract Management Command (DCMC) district offices to serve as focal
points for overseeing the status of contractors' cost-estimating
systems.  DOD now requires a biannual status report from
administrative contracting officers on the status of outstanding
deficiencies in contractors' estimating systems.  According to these
reports, the number of estimating system deficiencies has declined. 
However, DCAA's audits continue to identify proposals that lack
complete, accurate, and current data.  According to DCAA information,
its audits of proposals have saved $5.3 billion over the last 3
fiscal years. 

Despite DOD's changes, some contractors continue to have
long-outstanding deficiencies in their estimating systems.  For
example, one contractor had significant deficiencies dating to at
least June 1992.  According to a June 1992 DCAA audit report, this
contractor had outdated support for its material estimates as well as
other material and subcontractor cost deficiencies.  Additional
audits by DCAA in September 1993, May 1994, and April 1996 continued
to find material estimating weaknesses, such as the use of
undocumented judgmental cost estimates instead of vendor quotes and
the use of outdated vendor quotes.  In July 1996, the administrative
contracting officer reported that the company's corrective action
plan was being monitored by a contractor-government team.  The
contracting officer also said that the risk to the government is
being minimized by more extensive government review during pre-award
activities and increased scrutiny of contractor billings. 

Because of the importance of accurate cost-estimating systems for
producing sound contractor price proposals and the additional
government resources and costs associated with the more extensive
review required when contractors have deficient systems, DOD needs to
continue to encourage contractors to resolve deficiencies in their
estimating systems quickly.  Where necessary to achieve compliance,
government administrative contracting officers need to use the full
range of tools available to them to motivate contractors to address
estimating system deficiencies. 


IMPROVING THE ADMINISTRATION OF
DOD'S VOLUNTARY DISCLOSURE PROGRAM
============================================================ Chapter 4

In 1986, a report to the President on defense management concluded
that the defense industry needed to promote principles of ethical
business conduct, detect acts of procurement fraud through
self-governance, and voluntarily report potential fraud to the
government.  In response to the report, a number of defense
contractors established self-governance programs that included
monitoring compliance with federal procurement laws and voluntarily
disclosing violations to government authorities.  These efforts
became known as the Defense Industry Initiative on Business Ethics
and Conduct. 

To facilitate contractors' self-governance and encourage contractors
to adopt a voluntary disclosure policy, DOD established the Voluntary
Disclosure Program in July 1986.  This program provides general
guidelines, policy, and processes to enable DOD and its contractors
to address matters of wrongdoing that contractors discover.  At the
time, DOD recognized that a process was needed for consistently
handling matters disclosed by contractors.  In return for voluntarily
disclosing potential wrongdoing and cooperating in any government
audit and investigation, the government generally allows contractors
to conduct their own investigations, which the government then
attempts to verify expeditiously. 

We reviewed DOD's administration of its Voluntary Disclosure Program
and found that contractors' participation in the program has been
relatively small and the dollar recoveries modest.  From its
inception in 1986 through September 1994, DOD reported that of the
thousands of defense contractors, 138 had made 325 voluntary
disclosures of potential procurement fraud.  DOD reported recoveries
from these disclosures to be $290 million, about 17 percent of the
total reported DOD procurement fraud recoveries between fiscal year
1987 and 1994.  However, our review indicated that DOD's reported
recoveries of $290 million were overstated because they included $75
million in premature progress payments and amounts from disclosures
made prior to the program. 

We also found that DOD had accepted some disclosures in the program
that the Justice Department believed were triggered by imminent
government discovery and thus did not meet the criteria for
admission.  Further, contractors' less-than-full cooperation with the
government and DOD's and other investigative agencies' low priority
on managing cases expeditiously may have been problems in some cases. 

Most disclosures did not result in significant dollar recoveries for
the government.  Of 129 closed cases, 81 cases, or about 63 percent,
had reported recoveries of less than $100,000, of which 52 cases, or
40 percent, had no dollar recoveries.  Forty-eight cases had reported
recoveries of $100,000 or more, of which 15 cases had reported
recoveries of $2 million or more. 

To ensure continued public support for defense programs, it is
critical that potential fraud involving defense contractors be
identified quickly and pursued aggressively.  DOD's Voluntary
Disclosure Program has the potential to contribute to that end, but
improvements are needed.  Efforts to improve the administration of
the program, including improving coordination between DOD and the
Department of Justice, could increase both program participation and
dollar recoveries.  Such improvements could also help reduce the risk
to the government from procurement fraud. 


MANAGING FUTURE CONTRACT RISK
============================================================ Chapter 5

DOD's budget declined from about $311 billion in fiscal year 1991 to
about $254 billion in fiscal year 1996.  However, beginning in fiscal
year 1998, DOD projects a steady budget increase to about $270
billion by fiscal year 2001.  While DOD's contracting activity is
related to the size of the defense budget, it is particularly related
to trends in the procurement part of the budget.  In this regard, DOD
plans to increase its procurement budget from $43 billion in fiscal
year 1996 to $60 billion by fiscal year 2001.  As procurement
activity increases, the amount of contracting and the demands for
contract administration and audits are also likely to increase. 

DCMC administers defense contracts, and DCAA audits them.  Consistent
with recent declines in the defense budget, resources for
administering and auditing contracts have been cut significantly. 
However, unlike future defense budgets, contract administration and
audit resources are expected to be cut back further.  By fiscal year
2001, the staff at DCMC and DCAA are expected to be reduced to around
12,650 and 4,200, respectively--a reduction of about 41 and 32
percent from fiscal year 1991 levels. 

DOD is also moving toward outsourcing more government functions. 
This is, perhaps, nowhere more apparent than in recent debates over
privatizing depot maintenance workloads.  DOD's depot maintenance is
a vast undertaking, supporting millions of equipment items.  DOD
annually spends about $15 billion on depot maintenance activities,
and its depot maintenance facilities and equipment are valued at over
$50 billion.  DOD and the Congress are redefining the role of DOD
depots in the post-Cold War era, much in the same way the roles of
U.S.  war-fighting forces are being reshaped.  While the new model
for managing depot maintenance is evolving, there appears to be a
clear shift toward greater reliance on the private sector.  This
shift affects force structure and the public and private activities'
supporting force structure.  It is also likely to affect the degree
of DOD contracting activity. 

If DOD increases procurement budgets, increases outsourcing, and
reduces contract administration and audit resources, DOD will need to
be creative in finding ways to meet an expected increase in demand
for contract oversight and be more efficient in using its existing
resources.  In this regard, recent acquisition reform initiatives may
create opportunities for DOD to redeploy oversight resources. 


FURTHER ACTION NEEDED
============================================================ Chapter 6

The need for DOD to achieve effective control over its payment
process is imperative.  If it does not, it continues to risk
erroneously paying contractors millions of dollars and perpetuating
other financial management and accounting control problems.  While
DOD is taking steps to improve its payment process and controls,
other actions are needed to better ensure that payments are
effectively monitored.  Because of the effect of acquisition
decisions on the payment system, it is most critical that the DOD
Comptroller and the Under Secretary of Defense for Acquisition and
Technology work together to ensure that changes in the acquisition
process and systems do not place undue burdens on the payment system. 
The focus of changes should be to optimize the use of technology and
simplify the payment process. 

While the level of overpricing of defense contracts varies from year
to year, overpricing remains an area that must continually be
watched.  Contractors may be deterred from overpricing if they know
that the government will identify and deal with it aggressively.  DOD
must ensure that adequate systems and resources are available to
protect government interests.  Particularly important is the need to
ensure that contractors' cost-estimating systems are sound and that
estimating deficiencies are quickly corrected.  While DOD records
indicate improvement, some contractors' systems still contain
long-standing deficiencies.  They must continue to be the focus of
DOD's attention.  Where appropriate, DOD contracting officials need
to use the full range of tools to achieve contractors' compliance
with requirements. 

DOD's Voluntary Disclosure Program is intended to encourage defense
contractors to report potential civil or criminal fraud to the
government.  To realize the maximum benefits from the program,
increase program participation, and improve dollar recoveries, DOD
needs to strengthen the administration of the program, including
improving coordination between DOD and the Department of Justice. 

DOD is facing uncertainty and potential risk in defense contracting
in the future, given projected increases in procurement spending
beginning in fiscal year 1998, increases in outsourcing, and further
reductions in resources for administering and auditing contracts. 
Over the last few years, DOD has placed a high priority on
streamlining and reengineering its contracting and acquisition
processes, including contract administration and audit.  These
efforts are designed to reduce oversight requirements where little
value can be gained and increase the efficiency of the acquisition
process.  DOD deserves much credit for these efforts.  However,
continued high-level management attention will be required to ensure
success of the efforts underway.  Furthermore, DOD will be challenged
to find more efficient ways to meet contract administration and audit
requirements with fewer resources.  We will continue to monitor DOD's
progress in addressing the contract management issues discussed in
this report. 


RELATED GAO PRODUCTS
=========================================================== Appendix 7

Defense Depot Maintenance:  Privatization and the Debate Over the
Public-Private Mix (GAO/T-NSIAD-96-146, Apr.  16, 1996). 

DOD Procurement:  Use and Administration of DOD's Voluntary
Disclosure Program (GAO/NSIAD-96-21, Feb.  6, 1996). 

DOD Procurement:  Millions in Contract Payment Errors Not Detected
and Resolved Promptly (GAO/NSIAD-96-8, Oct.  6, 1995). 

High-Risk Series:  Defense Contract Management (GAO/HR-95-3, Feb. 
1995). 

DOD Procurement:  Overpayments and Underpayments at Selected
Contractors Show Major Problem (GAO/NSIAD-94-245, Aug.  5, 1994). 

DOD Procurement:  Millions in Overpayments Returned by DOD
Contractors (GAO/NSIAD-94-106, Mar.  14, 1994). 


1997 HIGH-RISK SERIES
=========================================================== Appendix 8

An Overview (GAO/HR-97-1)

Quick Reference Guide (GAO/HR-97-2)

Defense Financial Management (GAO/HR-97-3)

Defense Contract Management (GAO/HR-97-4)

Defense Inventory Management (GAO/HR-97-5)

Defense Weapon Systems Acquisition (GAO/HR-97-6)

Defense Infrastructure (GAO/HR-97-7)

IRS Management (GAO/HR-97-8)

Information Management and Technology (GAO/HR-97-9)

Medicare (GAO/HR-97-10)

Student Financial Aid (GAO/HR-97-11)

Department of Housing and Urban Development (GAO/HR-97-12)

Department of Energy Contract Management (GAO/HR-97-13)

Superfund Program Management (GAO/HR-97-14)

























The entire series of 14 high-risk reports can be ordered using the
order number GAO/HR-97-20SET.