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Defense Outsourcing: Better Data Is Needed to Support Overhead Rates for A-76 Studies (Letter Report, 02/27/98, GAO/NSIAD-98-62).

Pursuant to a congressional request, GAO reviewed three provisions
associated with a revision to the Office of Management and Budget (OMB)
Circular A-76 supplemental handbook, focusing on: (1) the basis for
OMB's new requirement that a standardized 12-percent overhead rate be
applied to in-house cost estimates, regardless of the type of commercial
activity or where in the country the activity is to be performed; (2)
whether the Department of Defense (DOD) has developed a separate
overhead rate for military personnel and, if so, the basis for that
rate; and (3) how best-value criteria are expected to be used in A-76
competitions.

GAO noted that: (1) because actual cost data in government agencies have
historically been unavailable and unreliable, OMB told GAO it lacked
meaningful information on which to develop a standard overhead rate or
to differentiate between particular types of activities or regions of
the country; (2) absent this data, OMB selected a single overhead rate
of 12 percent, a rate that was near the midpoint of overhead rates
suggested by government agencies and private sector groups; (3) most
government and private-sector groups GAO contacted agreed that
reasonable levels of overhead should be included in A-76 cost estimates
and, absent anything better, the 12-percent rate is acceptable at this
time; (4) in this respect, the revised handbook allows federal agencies
to develop their own rates, but to date, none have done so; (5) while
the 12-percent rate represents an appropriate move toward including
overhead costs in government cost estimates, until actual overhead costs
are captured, the magnitude of savings expected will be uncertain and
the results of A-76 studies are apt to continue to be controversial; (6)
recent legislation and federal management reforms emphasize the need for
such actual cost data; (7) despite the requirement to develop a separate
rate for military personnel included in government in-house estimates,
DOD officials that manage commercial activity programs have no plans to
develop such a rate; (8) they explained that, by definition, commercial
activities under the A-76 program should not include any
military-essential functions; (9) therefore, when they prepare an
in-house estimate under the A-76 program, they assume that all military
personnel currently working in the activity will be reassigned and the
activity will be staffed with civilians, therefore no overhead costs for
military personnel will be incurred; (10) the use of best-value
procurement is an important development; (11) while not appropriate for
use in all cases, best-value helps ensure that decisions to outsource
are based on a number of important, performance-related factors, not
just cost; (12) recently, only the Air Force has used best-value
criteria, and only in 5 of its 15 competitions completed since March
1996; and (13) in the future, DOD officials expect to use best-value
criteria for activities for which performance standards are particularly
important, but not for more routine tasks often associated with base
support activities.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-98-62
     TITLE:  Defense Outsourcing: Better Data Is Needed to Support 
             Overhead Rates for A-76 Studies
      DATE:  02/27/98
   SUBJECT:  Contract costs
             Privatization
             Cost effectiveness analysis
             Military personnel
             Defense procurement
             Overhead costs
             Cost accounting
IDENTIFIER:  OMB Circular A-76 Program
             
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Cover
================================================================ COVER


Report to the Honorable
Henry Bonilla, House of Representatives

February 1998

DEFENSE OUTSOURCING - BETTER DATA
NEEDED TO SUPPORT OVERHEAD RATES
FOR A-76 STUDIES

GAO/NSIAD-98-62

Defense Outsourcing

(709283)


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

  CFO - Chief Financial Officer
  DOD - Department of Defense
  FASAB - Federal Accounting Standards Advisory Board
  FFMIA - Federal Financial Management Improvement Act
  IFB - invitation for bids
  JFMIP - Joint Financial Management Improvement Program
  MEO - most efficient organization
  OMB - Office of Management and Budget
  RFP - request for proposals

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


B-277898

February 27, 1998

The Honorable Henry Bonilla
House of Representatives

Dear Mr.  Bonilla: 

The Office of Management and Budget's (OMB) Circular A-76 and its
supplemental handbook provide policy guidance and implementation
procedures for government agencies to use in deciding whether to
contract out for commercial goods, services, and activities.  As you
requested, we examined three provisions associated with a March 1996
revision to the A-76 supplemental handbook.  Specifically, this
report addresses (1) what is the basis for OMB's new requirement that
a standardized 12-percent overhead rate be applied to in-house cost
estimates, regardless of the type of commercial activity or where in
the country the activity is to be performed; (2) whether the
Department of Defense (DOD) has developed a separate overhead rate
for military personnel and, if so, the basis for that rate; and (3)
how "best value"\1 criteria are expected to be used in A-76
competitions.  Because your interest focused on A-76 competitions
within DOD, we focused our attention there, while gathering some data
from other agencies. 


--------------------
\1 A government agency can negotiate and select an offer from the
private sector that is most advantageous to the government,
considering prior performance and other noncost factors--not just the
lowest priced, acceptable offer.  This "best value" private sector
offer is then compared to the government's in-house proposal. 


   BACKGROUND
------------------------------------------------------------ Letter :1

Although a subject of increasing emphasis in recent years, federal
agencies have been encouraged, since 1955, to obtain commercially
available goods and services from the private sector through
outsourcing, that is contracting out, whenever they determine such
action is cost-effective.  In 1966, OMB issued Circular A-76, which
established federal policy for the government's performance of
commercial activities.  Later, in 1979, OMB issued a supplemental
handbook to the circular that included the procedures for
competitively determining whether commercial activities should be
performed in-house, by another federal agency through an interservice
support agreement, or by the private sector.  OMB updated this
handbook in 1983 and again in March 1996.  The latest revision was
intended to reduce the administrative burden of performing A-76
studies and to make cost comparisons between private sector proposals
and government estimates more equitable. 

To compare costs of in-house versus contractor performance, OMB's
supplemental handbook requires the government to conduct a management
efficiency study.  In this study, the government reviews its
organizational structure, staffing, and operating procedures to
determine the most efficient and effective way of performing an
activity with in-house staff.  Based on this "most efficient
organization" (MEO), the government prepares an in-house cost
estimate and compares it with the best offer from the private sector. 
OMB's A-76 guidance stipulates that work will remain in-house unless
the private sector offer meets a threshold of savings that is at
least 10 percent of personnel costs or $10 million over the
performance period.  The minimum cost differential was established by
OMB to ensure that the government would not contract out for marginal
estimated savings. 

A-76 competitions provide an important basis for achieving
efficiencies and cost savings.  DOD data on cost comparisons
completed between fiscal year 1978 and 1994 shows that savings
occurred--usually through a reduction in personnel--regardless of
whether the government or a private company was awarded the work.\2
These savings were achieved primarily by closely examining the work
to be done and reengineering the activities to do them with fewer
personnel, whether in-house or outsourced.  Also, our prior work has
shown the potential for significant cost savings where military
incumbency is not mission essential and civilian personnel can be
substituted for military personnel in performing commercial-type
functions.\3 DOD's data showed the government won about half of the
A-76 competitions and private industry won the other half. 

Despite the benefits of competition, the A-76 process has
historically been controversial within and outside the government. 
Government officials have been concerned about the cost and length of
time required to complete the procurement process associated with
A-76 studies, and employees have been concerned about the potential
loss of jobs.  Private sector representatives, on the other hand,
believed that the A-76 process favored the government.  They have
contended that the government did not include all costs of operations
in its A-76 competitions.  In particular, they believed the
government excluded proportional shares of indirect and
administrative costs such as facility maintenance and upkeep,
payroll, and personnel services. 

Consequently, OMB revised its A-76 supplemental handbook in 1996 to
improve the administration of the A-76 process and the way government
cost estimates are developed.  As a result, several standard cost
factors were either changed or established, including the requirement
that government overhead costs be calculated based on a standard rate
of 12 percent of direct labor costs.  Because military personnel have
higher benefits and support costs than their civilian equivalents,
the revised handbook also directed DOD to develop a separate overhead
rate for military personnel to be included in any work proposals. 
Further, it placed increased emphasis on consideration, during the
review of private sector offers, of the best overall value of each
offer to the government. 


--------------------
\2 Base Operations:  Challenges Confronting DOD as It Renews Emphasis
on Outsourcing (GAO/NSIAD-97-86, Mar.  11, 1997). 

\3 DOD Force Mix Issues:  Converting Some Support Officer Positions
to Civilian Status Could Save Money (GAO/NSIAD-97-15, Oct.  23,
1996). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Because actual cost data in government agencies have historically
been unavailable and unreliable, OMB told us it lacked meaningful
information on which to develop a standard overhead rate or to
differentiate between particular types of activities or regions of
the country.  Absent this data, OMB selected a single overhead rate
of 12 percent, a rate that was near the midpoint of overhead rates
suggested by government agencies and private sector groups.  Most
government and private sector groups we contacted agreed that
reasonable levels of overhead should be included in A-76 cost
estimates and, absent anything better, the 12-percent rate is
acceptable at this time.  In this respect, the revised handbook
allows federal agencies to develop their own rates, but to date, none
have done so.  While the 12-percent rate represents an appropriate
move toward including overhead costs in government cost estimates,
until actual overhead costs are captured, the magnitude of savings
expected will be uncertain and the results of A-76 studies are apt to
continue to be controversial.  Recent legislation and federal
management reforms emphasize the need for such actual cost data. 

Despite the requirement to develop a separate rate for military
personnel included in government in-house estimates, DOD officials
that manage commercial activity programs have no plans to develop
such a rate.  They explained that, by definition, commercial
activities under the A-76 program should not include any
military-essential functions.  Therefore, when they prepare an
in-house estimate under the A-76 program, they assume that all
military personnel currently working in the activity will be
reassigned and the activity will be staffed with civilians. 
Therefore, no overhead costs for military personnel will be incurred. 

The use of "best value" procurement is an important development. 
While not appropriate for use in all cases, best value helps ensure
that decisions to outsource are based on a number of important,
performance-related factors, not just cost.  Recently, only the Air
Force has used best-value criteria, and only in 5 of its 15
competitions completed since March 1996.  In the future, DOD
officials expect to use best-value criteria for activities for which
performance standards are particularly important, but not for more
routine tasks often associated with base support activities, such as
providing grass-cutting or dining hall services. 


   NEW CIVILIAN OVERHEAD RATE NOT
   SUPPORTED BY ACTUAL COST DATA
------------------------------------------------------------ Letter :3

OMB required that government agencies include overhead costs in their
in-house A-76 estimates prior to the adoption of a standardized rate
in March 1996.  Overhead was supposed to include two types of cost on
a marginal or proportional basis:  (1) operations overhead, which
includes the costs of managing an organization that are not 100
percent attributable to the activity under study, and (2) general and
administrative costs, which include the salaries, equipment, and work
space related to headquarters management, accounting and finance
support, personnel support, legal support, data processing support,
and other common support activities such as facilities maintenance. 

Despite this guidance, OMB and DOD officials told us that overhead
costs, particularly general and administrative costs, were often not
included in the government's estimates because they were difficult to
quantify and allocate to specific activities.  These officials, as
well as private sector representatives, told us that in the few
instances when agencies did include overhead costs, they generally
ranged from 1 to 3 percent of the direct labor costs.  We found this
to be the case in our own examination of available data from the Air
Force, the defense activity with the greatest number of A-76 studies
in recent years.  We found that only 12 of 109 in-house estimates
over a period of several years included overhead costs.\4 Ten of the
estimates included overhead rates of 3 percent or less; two estimates
had overhead rates of 9 and 12 percent, respectively. 

To respond to private sector concerns that federal agencies were not
properly recognizing overhead in their A-76 proposals and to reduce
the difficulty and burden of this requirement on agencies, OMB sought
to develop a standardized rate.  OMB stated in the revised handbook
that reliable cost data is crucial to conducting A-76 competitions. 
However, the government's accounting processes and commercial
activity data systems\5 did not contain the cost information needed
by OMB to develop a standard rate, or a rate specific to individual
activities and functions or a particular region of the country.  OMB
recognized this condition in the handbook, stating that cost data has
generally been unavailable and has often been found to be unreliable. 

Lacking sound empirical data on which to base an overhead rate, OMB
held discussions with various representatives from government and the
private sector to obtain their views on an appropriate rate. 
Proposed rates ranged from 0 to 30 percent; the higher rates were
proposed by representatives from the private sector.  An OMB official
told us that further discussions with these representatives enabled
them to reach an understanding that the extremes of this range were
not realistic.  For example, zero overhead costs did not recognize
any operations overhead or general and administrative costs.  And 30
percent would likely cover a full allocation of overhead costs rather
than proportionate costs.  After considering the various proposed
rates, OMB decided on the 12-percent rate and included it in a draft
of what would become the March 1996 revision to the A-76 supplemental
handbook. 

OMB published its draft revision to the supplemental handbook in the
Federal Register in December 1995 and invited comments from
interested parties.  In total, OMB received 27 responses--13 from
government organizations and 14 from the private sector.  In
examining these comments, we found only 4 that commented on the
proposed overhead rate.  Three of the comments were from agencies
that either wanted clarification on how the 12-percent rate was
developed or wanted OMB to allow agencies to use a different rate if
it could be justified.  The fourth comment was from a private sector
association that represents about 275 contractors.  The association
suggested agencies use a higher rate of at least 15 percent.  After
considering these comments, OMB agreed to allow agencies to use a
rate different from 12 percent and included this provision in the
revised handbook.  However, OMB required that before agencies used a
different rate, they would have to explain their methodology for
developing that rate in the Federal Register and subject it to public
review and comment. 

Our discussions with government and industry representatives
indicated that the 12-percent rate was about the midpoint of the
range of rates proposed to OMB.  These discussions, as well as our
review of public comments on the proposed changes to the handbook,
identified no strong opposition to the 12-percent rate.  In general,
government and private sector persons we contacted tended to
acknowledge that overhead costs should be recognized and that while
they might personally opt for a different rate, the rate adopted was
acceptable at that time.  Only one military service, the Air Force,
had considered developing a methodology to determine an overhead rate
for its activities.  However, after considering the cost, time, and
data requirements for such a study, it elected to use the 12-percent
factor rather than develop its own rate. 


--------------------
\4 Forty-seven of the 109 in-house estimates were for MEOs with 10 or
fewer government employees.  Under these circumstances, OMB Circular
A-76 criteria do not require the government's cost estimate to
include an overhead factor. 

\5 DOD and the military services use two primary information systems
to support their commercial activities programs--the Commercial
Activities Management Information System and the Commercial
Activities Inventory data base.  These are not standard DOD systems. 
As a result, the services use a different version of each system. 


      RECENT LEGISLATIVE AND
      MANAGEMENT REFORMS TO
      CAPTURE ACTUAL COSTS
---------------------------------------------------------- Letter :3.1

Recognizing the serious deficiency in financial and other management
information and systems across government, recent legislative and
management reform initiatives have emphasized the need for better
information, including cost data, to support federal decision-making
and measure results of program operations.  Continuing efforts to
implement the Chief Financial Officers (CFO) Act are central for
ensuring that agencies resolve their long-standing problems in
generating vital information for decisionmakers.  In that regard, the
Federal Accounting Standards Advisory Board (FASAB) has developed a
new set of accounting concepts and standards that underpin OMB's
guidance to agencies on the form and content of their agencywide
financial statements.\6 As part of that effort, FASAB developed
managerial cost accounting standards.\7

These managerial cost accounting standards require that federal
agencies provide reliable and timely information on the full cost of
federal programs, their activities, and outputs.  While there are
many different purposes for which this type of cost information may
be used, the standards focus on cost information to improve (1)
federal financial management and (2) managerial decision-making. 
Specifically identified in the standards is the need for information
to help guide decisions involving economic choices such as whether to
do a project in-house or contract it out.  Such information would
allow for the development of appropriate overhead rates for specific
operations.  The cost accounting standards were to take effect in
fiscal year 1997.  However, because of serious agency shortfalls in
cost accounting systems, the CFO Council--an interagency council that
includes CFOs of the major agencies--requested an additional 2 years
before the standard would be effective.  FASAB recommended extending
the date by 1 year, and the standard became effective for fiscal year
1998. 

In addition, in 1996 the Congress passed the Federal Financial
Management Improvement Act (FFMIA) requiring that agency financial
management systems substantially comply with, among other things,
federal accounting standards and federal financial management system
requirements.  The federal financial management system requirements
cited by the FFMIA are developed by the Joint Financial Management
Improvement Program (JFMIP)\8 .  Included are the Managerial Cost
Accounting System Requirements, which were issued in February 1998,
and are intended to guide federal agencies in defining their cost
accounting software requirements. 

Further, the CFO Council developed The Managerial Cost Accounting
Implementation Guide.  This guide, which is intended to aid federal
entities in implementing cost accounting systems, has been issued in
draft and is expected to be finalized this fiscal year. 

These are all positive steps that will eventually lead to better cost
data throughout the federal government.  Unfortunately, cost
accounting systems typically are not now in place and able to provide
reliable cost information to support A-76 competitions.  Federal
agencies must now develop an implementation strategy, determine their
system and software needs, make appropriate modifications to, or buy
new, cost accounting systems, and implement the new standards.  These
actions present a difficult challenge, particularly for an
organization as large and diverse as DOD.  Moreover, as we have
reported in our 1997 high-risk report,\9 our financial statement
audit work has consistently identified significant problems with the
comprehensiveness and accuracy of DOD's cost information.  While
these long-standing problems are being addressed, the solutions will
take some time to implement in DOD. 


--------------------
\6 FASAB was created in October 1990 by the Secretary of the
Treasury, the Director of OMB, and the Comptroller General to
consider and recommend accounting principles for the federal
government.  If accepted by Treasury, OMB, and GAO, the standards are
adopted and issued by OMB and GAO. 

\7 Statement of Federal Financial Accounting Standards No.  4,
Managerial Cost Accounting Standards (July 31, 1995). 

\8 JFMIP is a joint cooperative undertaking of OMB, GAO, the
Department of Treasury, and the Office of Personnel Management, who
work together and with operating agencies to improve financial
management throughout the government.  JFMIP was given statutory
authorization in the Budget and Accounting Procedures Act of 1950. 

\9 High-Risk Series:  Defense Financial Management (GAO/HR-97-3, Feb. 
1997). 


      IMPACT OF NEW OVERHEAD RATE
      ON RECENT A-76 COMPETITIONS
---------------------------------------------------------- Letter :3.2

Prior to establishing the 12-percent overhead rate, winners of A-76
competitions in DOD were generally divided equally between the
government and the private sector.  To determine how this balance
might have been affected by the new overhead rate, we asked the Air
Force to determine how the results of 33 competitions won in-house
would have changed if the 12-percent rate had been applied to its
cost estimates.\10 Its analysis showed that if all other factors
remained constant, 12 of the competitions previously won by the
government would have been won by the private sector. 

We also asked the Air Force to recalculate the in-house estimates for
seven Air Force A-76 competitions completed since the 12-percent
overhead rate went into effect.  Private sector contractors had won
six of the seven competitions.  This analysis showed that in three of
the six competitions won by the private sector, the activity would
have remained in-house if overhead rates of 0.15, 8.0, and 9.0
percent, respectively, had been used.  In the other three
competitions, the in-house organizations would have lost even if they
had not included any overhead costs.  This analysis assumes, once
again, that all other cost factors remained constant.  We point this
out because Air Force and other military officials told us that the
12-percent factor, along with other changes required by the new
handbook, will likely cause in-house organizations to look for new
ways to cut costs in order to remain competitive with private sector
bids. 

The 12-percent rate represents a proper move toward including
overhead costs in government cost estimates.  However, the absence of
cost data or a methodology to support this rate leaves unclear how
closely this rate matches actual overhead costs on a site-by-site,
activity-by-activity, or agency-by-agency basis.  Having a sound
overhead rate is particularly important, since DOD has recently
announced plans to conduct A-76 competitions involving over 150,000
positions over the next 5 years.  Because this could involve hundreds
of A-76 competitions, a standard 12-percent rate, particularly one
that is not based on sound cost data, may not be appropriate for the
wide range of commercial activities in DOD.  A rate based on more
realistic data would be key to mitigating concerns over whether the
government or private sector had any undue advantage in the process. 

As discussed previously, no DOD component is planning to develop
rates that are more specific to their activities, even though the
supplemental handbook gives them this opportunity.  Nevertheless, a
few organizations in DOD and elsewhere are beginning to look at how
activity-based costing might help them identify the true costs of
their operations.  Activity-based costing is an analytical tool that
can be used, generally in conjunction with existing accounting
systems, to identify all costs--both direct and indirect--of
providing a service or performing a function.  The city of
Indianapolis, Indiana, for example, recently used this tool to obtain
the cost of its commercial activities, even though its existing
accounting systems could not provide cost data by activity.\11

This tool or similar tools might be useful in helping DOD establish
appropriate overhead rates for commercial activities.  For example,
overhead rates associated with aircraft maintenance may be higher
than rates associated with grass-cutting activities due to issues of
complexity, safety, and quality assurance.  On the other hand, to
reduce the administrative burden of developing a rate for each
commercial activity, DOD could use these tools to develop a
departmentwide rate or rates for each military service and defense
agency.  Over time, extensive reengineering of activities could also
lead to lower overhead costs.  This would be the case particularly
where there are large reductions in direct labor, thus increasing the
potential to significantly impact indirect costs. 


--------------------
\10 These 33 A-76 competitions were completed between January 1990
and October 1996.  We used examples from the Air Force because it was
the only military department that had readily available cost
information on its A-76 studies. 

\11 Privatization:  Lessons Learned by State and Local Governments
(GAO/GGD-97-48, Mar.  14, 1997). 


   DOD HAS NO PLANS TO DEVELOP A
   SEPARATE MILITARY OVERHEAD RATE
------------------------------------------------------------ Letter :4

The March 1996 A-76 supplemental handbook recognized that military
personnel are more costly to the government than civilian
equivalents.  Accordingly, it required DOD activities to cost
military personnel at their respective military pay rates and develop
and apply a separate rate for them, rather than use the 12-percent
rate that was to be applied only to civilian direct labor costs.  The
previous edition of the handbook required that DOD activities convert
military positions to civilian ones and then cost the positions at
the civilian rate when preparing A-76 proposals. 

DOD officials told us they have no plans to develop separate overhead
rates for military personnel.  They explained that, by definition,
commercial activities under the A-76 program should not include any
military-essential functions.  Therefore, when they prepare in-house
estimates under the A-76 program, they assume that all military
personnel working in the affected activities will be reassigned and
the activity will be staffed with civilians.  Given this assumption,
DOD plans to continue what it described as a long-standing policy not
to include military personnel in their in-house estimates.  While DOD
may exclude military personnel from activities being considered for
outsourcing, it is likely that some military personnel will continue
to be used in selected overhead positions associated with the
activity.  Accordingly, some level of military overhead costs are
likely to be incurred, and these costs should be appropriately
reflected in overhead costs. 


   USE OF BEST VALUE CRITERIA IN
   A-76 COMPETITIONS
------------------------------------------------------------ Letter :5

While the supplemental handbook did not preclude the use of best
value criteria under the A-76 process, the March 1996 revision has
resulted in heightened attention to the consideration of "best
overall value to the government" in competitions.  Best value
criteria are considered most appropriate when work to be competed
involves higher levels of complexity, significant technical
expertise, and risk.  In these situations, the government is normally
able to obtain a better value by comparing the private sector's
technical proposals and making tradeoffs between various technical
and nontechnical factors such as past performance and costs. 

Once the best private offer is selected, a comparison is made between
the private offer and the in-house estimate.  To ensure that the cost
comparison is fair, the March 1996 revision specifically requires the
government to submit a technical proposal along with its other
proposal data.  This allows the source selection authority\12 to
determine whether the government's technical proposal is based on the
same scope of work and performance levels as the private sector's
best value contract offer.  If the in-house proposal does not include
the same level of performance, the government is required to change
its technical proposal and cost estimate before the final comparison
is made to determine the winner of the competition. 

According to DOD data, only 5 of 24 studies completed since March
1996 included best value criteria--all by the Air Force's Air
Education and Training Command.  Although different criteria can be
used, each of these studies used the following four evaluation
criteria listed in order of importance to the Command:  (1)
understanding the mission, (2) key personnel, (3) mobilization and
transition plans, and (4) relevant past performance.  According to
Command guidance, understanding the mission was the most important
technical evaluation item.  It addressed the technical capability of
the contractor in terms of how it planned to use manpower to
accomplish the mission along with supporting policies and procedures. 
The contractor's planned use of manpower was the more important
factor.  Key personnel addressed the quality of the offeror's
executive and top supervisory personnel and availability dates of key
management personnel from the senior on-site manager through
supervisory levels.  Mobilization was evaluated based on the
offeror's plan to recruit staff, transfer equipment and facilities to
the work site, and phase in its workforce after the contact start
date.  Finally, relevant past performance evaluated the offeror's
performance on current and completed government contracts. 

To get an indication of how the best value criteria had affected the
A-76 process, we reviewed the outcome of three competitions that were
completed according to the guidelines in the revised A-76 handbook. 
We reviewed documents and discussed the competitions with Air Force
officials involved in the process.  These officials said that because
best value criteria requires the government to submit a technical
proposal, they were better able to compare the contractor's winning
proposal with the government's.  In one of the studies, for example,
the government was required to adjust its proposal to match the same
level of performance as the best private offer.  Although the private
offeror still won the competition, the contracting officer said she
had greater confidence that the competition was fair.  In the other
two studies, the source selection authority determined that the
contractor and government proposed the same levels of performance. 
Consequently, the government did not have to adjust its proposals. 
The government won one of the competitions and the private offeror
won the other. 

We also reviewed two other competitions for which best value criteria
were considered but were not subject to the requirement that the
government submit a technical proposal, since they began prior to
March 1996 (the effective date of the new A-76 handbook).  One of the
competitions--in Altus, Oklahoma--resulted in an in-house win that
required the Air Force to convert a workforce of 1,444 personnel
(1,401 military and 43 civilians) to a workforce of 742 civilians. 
According to Air Force officials, many problems have been associated
with the transition of workload at this location.  We could not
determine, based on limited analysis, whether the new best value
criteria, particularly the requirement for the government to submit a
technical proposal, might have mitigated the problems resulting from
this competition.  However, at the request of the Senate Armed
Services Committee, we are reviewing selected aspects of recently
completed A-76 competitions--one of which is the Altus study--in
greater detail and will provide a report on our review at a later
date. 

As we have previously mentioned, over the next 5 years, DOD plans to
study more than 150,000 in-house positions under A-76.  In the
future, DOD officials expect to use best value criteria when
performance standards are particularly important but not necessarily
for more routine tasks, such as providing grass-cutting or dining
hall services. 


--------------------
\12 The source selection authority is the government official
responsible for selecting the private sector offer that provides the
best overall value to the government and determining whether the
in-house proposal offers the same level of performance as the private
sector offer. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

The adoption of a standard overhead rate represents a proper move
toward including overhead costs in government A-76 cost estimates. 
Nevertheless, the 12-percent rate adopted by OMB lacks an analytical
basis, and its use could lead to understating or overstating overhead
costs and savings.  This could be significant, particularly if DOD
follows through with its plan to subject nearly 150,000 positions to
A-76 studies in the next several years.  A rate that is not
analytically based could unfairly shift the results to either the
government or the private sector.  Given prior DOD overhead
estimates, which usually ranged from 0 to 3 percent, the private
sector will probably be more successful in future competitions from
the use of the new 12-percent rate.  We do not intend to imply,
however, that a rate of 12 percent might not be appropriate in
certain circumstances or is too high.  Depending on the activity that
is being competed under the A-76 process, specific rates might be
higher or lower.  Rather, our point is that overhead rates that
better reflect actual overhead costs are preferable and would promote
fairer competition between the government and private sector. 

As we point out in the report, however, it will likely be many years
before FASAB cost standards are fully implemented in DOD and capable
of producing accurate and reliable cost data.  For this reason, we
believe DOD, with OMB's encouragement and assistance, should develop
a methodology for determining a more appropriate interim overhead
rate or range of rates for use in its A-76 competitions.  This
methodology could make appropriate use of activity based costing or
similar tools to estimate rates on either a departmentwide, military
service, or commercial activity basis, depending on how DOD chooses
to develop its rates.  This process would not require an adjustment
in the most recent A-76 Supplemental Handbook because the Handbook
already gives agencies the option of developing a separate overhead
rate if it better reflects the costs of operations.  By exercising
this option, DOD would be developing interim rates that are more
accurate and that promote fairer competition, regardless of whether
the rate goes up or down.  Over the long-term, the more extensive
reengineering of DOD business activities through the A-76 process
could lead to lower overhead costs.  This would be the case,
particularly where reductions in direct labor are large, thus
increasing the potential for significantly impacting indirect costs. 

Despite the requirement to develop a separate overhead rate for
military personnel included in government in-house proposals, DOD
officials indicated they do not plan to do so.  This is based on
DOD's policy to reassign military personnel and only use civilians in
commercial activities being subjected to A-76 competition.  However,
some military personnel will continue to be used in selected overhead
positions and as such some level of military overhead costs are
likely to be incurred. 

Although the concept and use of best value criteria are not new, the
emphasis on them has increased, primarily because it gives the
government the opportunity to consider other important factors
besides cost.  In particular is the new requirement that the
government submit a technical proposal as part of its in-house
estimate.  To date, best value criteria have received limited use
within DOD under A-76, but their use could grow in the future with
DOD's increased emphasis on outsourcing competitions.  We believe
this is a useful approach to better ensure commonality of work being
proposed between in-house and private sector offerors. 


   RECOMMENDATION
------------------------------------------------------------ Letter :7

We recommend that the Director of the Office of Management and Budget
and the Secretary of Defense work together to develop a methodology
that will determine an appropriate interim overhead rate or range of
rates for DOD commercial activities.  The methodology needs to have
an analytical base and include appropriate indirect overhead costs as
well as general and administrative costs identified in the A-76
supplemental handbook.  The methodology also needs to consider the
cost of military personnel that may be in the various categories of
overhead costs and the unique nature of individual business
activities being assessed.  Once OMB and DOD agree on a methodology,
OMB should consider its applicability to civilian agencies. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

OMB generally agreed with the report's findings.  However, OMB
strongly disagreed with our conclusion that the lack of a detailed
analytical basis leaves open to question the fairness of the A-76
process.  It pointed out that the 12-percent overhead rate
strengthens the cost comparison process by being both
administratively and economically reasonable.  Given this condition,
OMB said it was not clear whether it can or should require the
development of more accurate overhead figures.  Further, OMB said
that the 12-percent overhead factor has always been treated as an
interim solution and asked that we recognize the work that is being
done by the FASAB, the CFOs Council, and others to develop better
data that would eventually be used in government financial statements
and to support A-76 studies. 

While it did not comment on the report's findings, DOD said that it
fully supported OMB's efforts to streamline the A-76 process and that
the development of a standard overhead rate was a key component of
that effort.  Without a standard rate, DOD said it would have to
calculate overhead costs for each A-76 study, which it did not
believe made good management sense.  Consequently, DOD disagreed with
our recommendation and said it has no plans to develop a specific
DOD-only overhead rate or rates.  However, DOD said it is prepared to
work with OMB if OMB decides to make additional revisions to A-76
procedures. 

We agree with OMB that a standard overhead rate reduces the
administrative burden associated with conducting cost comparisons,
which was one of OMB's goals in revising the A-76 handbook.  We have
no basis to judge, however, the economic reasonableness of the
12-percent rate adopted by OMB.  As we point out in the report, the
rate lacks an analytical basis and may or may not reflect actual
overhead costs.  Because this could unfairly shift the results of the
competition to either the government or the private sector, we think
it is important for OMB and DOD to develop a methodology to determine
an overhead rate(s) more appropriate for DOD.  Contrary to DOD's
view, this methodology does not have to be burdensome or costly to
implement, nor does it have to reflect the overhead rates of every
activity being assessed under the A-76 process.  Such a methodology
could be developed on a military service, defense agency, or DOD-wide
basis.  As we point out in the report, using a rate that better
reflects actual overhead costs is important because DOD has announced
plans to use the A-76 process to study about 150,000 positions over
the next 5 years. 

As suggested by OMB, we included a section in the report to reflect
the work that has been done by FASAB, the JFMIP, and the CFO Council
to develop management cost accounting standards, system requirements,
and implementing guidance that, once fully implemented by DOD and
others, will enable agencies to identify reasonable overhead rates
for their A-76 studies.  The Managerial Cost Accounting Standards,
which became effective at the beginning of fiscal year 1998, are
aimed at providing reliable and timely information on the full cost
of federal programs, their activities, and outputs and should help
agencies begin to make tangible progress toward developing improved
cost accounting systems.  The adoption of these standards, however,
is only the first step in a potentially long process at DOD.  Because
of the poor condition of DOD's financial systems, it will likely be
many years before DOD can fully implement and take full advantage of
more reliable cost data.  For this reason, and considering the large
number of A-76 studies that DOD may conduct before the cost standards
are fully implemented, we continue to believe that OMB and the
Secretary of Defense should work together to develop a methodology
for an overhead rate or range of rates for DOD--one having an
analytical underpinning that can be further refined as more reliable
cost data becomes available. 

Our scope and methodology are discussed in appendix I.  Appendix II
provides a detailed description of the A-76 process.  DOD's and OMB's
comments are reprinted in their entirety in appendix III and IV,
respectively, as well as our comments on specific points. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Chairmen of the Senate
Committees on Armed Services and on Appropriations and the House
Committees on National Security and on Appropriations; the
Secretaries of Defense, the Air Force, the Army, and the Navy; and
the Director of OMB.  We will make copies available to others on
request. 

Please contact me at (202) 512-8412 if you or your staff have any
questions concerning this report.  Major contributors to this report
were Barry Holman, James Hatcher, James Fuquay, and Cheryl Andrew. 

Sincerely yours,

David R.  Warren, Director
Defense Management Issues


OBJECTIVES, SCOPE, AND METHODOLOGY
=========================================================== Appendix I

As requested, we examined three provisions associated with a March
1996 update to the A-76 supplemental handbook.  Specifically, we
examined (1) what is the basis for a new A-76 requirement that a
standardized 12-percent overhead rate be applied to in-house
estimates, regardless of the type of commercial activity being
studied or where in the country that activity is to be performed; (2)
whether the Department of Defense (DOD) has developed a separate
overhead rate for military personnel and, if so, the basis for that
rate; and (3) how "best value" criteria are expected to be used in
A-76 competitions. 

To determine the basis for how the Office of Management and Budget
(OMB) developed the civilian overhead rate of 12-percent of direct
labor costs, we held discussions with OMB officials in charge of
rewriting the supplemental handbook.  We initially asked for
empirical data that would provide an analysis and support for the
development of a rate.  We were advised that the government did not
have enough useful data for OMB to develop the rate.  Therefore, OMB
considered the views of various private sector and government
representatives before setting the rate.  Because OMB had not
retained any records supporting discussions with these
representatives, we contacted the following government and private
sector organizations to verify that they had discussions with OMB
regarding an appropriate civilian overhead rate and to discuss their
views about the 12-percent overhead rate: 

<head4x>GOVERNMENT SECTOR

  -- Office of Secretary of Defense, Arlington, Virginia

  -- Department of the Air Force, Arlington, Virginia

  -- Department of the Army, Arlington, Virginia

  -- Department of the Navy, Arlington, Virginia

  -- U.S.  Marine Corps, Arlington, Virginia

  -- Defense Logistics Agency, Fort Belvoir, Virginia

  -- Center for Naval Analysis, Arlington, Virginia

  -- Defense Finance and Accounting Service, Arlington, Virginia

  -- Defense Information Systems Agency, Arlington, Virginia

<head4x>PRIVATE SECTOR

  -- Contract Services Association, Washington, D.C. 

  -- American Operations Corporation, Tysons Corner, Virginia

  -- American Federation of Government Employees, Washington, D.C. 

In government sector organizations, we met with the organizational
component responsible for the commercial activities program.  We also
reviewed the public comments OMB received after publishing a draft
version of the revised supplemental handbook in the Federal Register. 
In total, we reviewed 27 comments--13 from government organizations
and 14 from private industry.  Only one association recommended a
rate different from 12 percent.  We met with representatives of that
group and found that they did not have any support for the higher
rate. 

We also surveyed the military services, selected DOD agencies, and
selected civilian agencies of the federal government to determine the
number of A-76 studies that have been completed or initiated since
the March 1996 handbook revisions were issued.  Where agencies had
completed or had ongoing studies, we identified those that used best
value criteria to evaluate contractor proposals.  We did not attempt,
however, to validate the accuracy of this survey information.  In
addition to the DOD components identified above, we contacted the

  -- Agency for International Development

  -- Department of Agriculture

  -- Department of Commerce

  -- Department of Education

  -- Department of Energy

  -- Department of Health and Human Services

  -- Department of Housing and Urban Development

  -- Department of Interior

  -- Department of Justice

  -- Department of Labor

  -- Department of Transportation

  -- Department of the Treasury

  -- Environmental Protection Agency

  -- General Services Administration

  -- National Aeronautics and Space Administration

  -- Office of Personnel Management

  -- Social Security Administration

  -- United States Information Agency

Within DOD, the Air Force has, by far, conducted the preponderance of
A-76 studies during the last several years.  Also, the Air Force is
the only military service that captures overhead costs related to the
in-house estimates in its Commercial Activities Management
Information System.  We found limited efforts underway in the
civilian agencies to initiate new A-76 studies--only two studies were
ongoing.  These studies are underway at the Department of Agriculture
and the Department of Commerce.  Among the civilian agencies we
contacted, we identified only two A-76 competitions that had been
completed since the handbook revisions were implemented; both were
best value competitions.  Therefore, our analysis of completed
studies focused almost entirely on DOD and the Air Force. 

We asked the Air Force's Innovation Center located at Randolph Air
Force Base, Texas, to analyze all studies completed between 1990 and
March 1996 to determine what would have happened to the outcome of
all competitions won by Air Force units if an overhead rate of 12
percent of direct labor costs had been applied in their in-house
estimates.  This analysis involved 33 Air Force competitions that
were conducted from the beginning of fiscal year 1990 until the
12-percent rate was implemented in March 1996.  We also looked at the
results of seven studies that had been completed since the 12-percent
rate was implemented and asked the Innovation Center to determine the
outcome of those competitions if the 12-percent rate had not been
used.  We documented the methodology used by the Innovation Center to
conduct these analyses.  However, we did not verify the Center's
calculations. 

To determine the status of the military services' development of a
military overhead rate to be used in A-76 competitions, we contacted
each military service's office in charge of commercial activities. 
In each instance, we were told that no overhead was being developed. 
We requested DOD's policy statement on this issue but found that DOD
has no written policy addressing the elimination of military
personnel from government proposals during A-76 competitions. 

To determine how best value criteria are expected to be used in A-76
competitions, we held discussions with officials from each military
service's commercial activities office to find out the types of
activities to which best value criteria might be applied and visited
the Air Force Materiel Command at Wright-Patterson Air Force Base,
Ohio, and the Air Education and Training Command at Randolph Air
Force Base, Texas.  We also asked each of the military services to
provide documentation on the number of competitions they had
completed since 1996.  In addition, we asked them to identify the
number of these competitions that used the negotiated, best value
method.  We were able to identify five studies that involved the use
of best value criteria.  Two of the studies were completed prior to
the issuance of the revised supplemental handbook.  The other three
studies were competed under the rules of the revised supplemental
handbook, which required the government to submit a technical
proposal with its estimates. 

We held discussions with the contracting officers and reviewed
documentation for each of the best value contracts to determine the
evaluation criteria used to select the best private offer, the number
of offers received from private industry, the process used to
evaluate the offers, the rationale for selecting other than the low
cost offeror, the rationale for any adjustments to the in-house
proposal, the winner of the competition, and the savings expected
from the competition.  Since these studies had just been completed in
the last 6 months, it was too soon for us to determine whether the
estimated savings would be achieved. 

We performed our work from July to December 1997 in accordance with
generally accepted government auditing standards. 


THE A-76 PROCESS
========================================================== Appendix II

In general, the A-76 process consists of six key activities.  They
are (1) developing a performance work statement and quality assurance
plan; (2) conducting a management study to determine the government's
most efficient organization (MEO); (3) developing an in-house
government cost estimate for the MEO; (4) issuing a request for
proposals (RFP) or invitation for bid (IFB); (5) evaluating the
proposals and comparing the in-house estimate with a proposed
contract or interservice support agreement and selecting the best
proposal; and (6) addressing any appeals submitted under the
administrative appeals process, which is designed to ensure that all
costs are fair, accurate, and calculated in the manner prescribed by
the A-76 handbook. 

Figure II.1 shows an overview of the process.  The solid lines
indicate the process used when the government issues an IFB,
requesting firm bids on the cost of performing a commercial activity. 
This type of process is normally used for more routine commercial
activities, such as grass-cutting or cafeteria operations, where the
work process and requirements are well defined and enough potential
contractors are available to support a competitive procurement.  The
dotted lines indicate the additional steps that take place when the
government wants to pursue a negotiated, best value procurement. 
This type of process is used when competition is limited and/or the
commercial activity involves higher levels of complexity, expertise,
and risk. 

   Figure II.1:  Overview of the
   A-76 Process

   (See figure in printed
   edition.)

Source:  Air Force Air Education and Training Command documents. 

As with all A-76 competitions, the circular requires the government
to develop a performance work statement.  This statement, which is
incorporated into either the IFB or RFP, serves as the basis for both
government estimates and private sector offers.  If the IFB process
is used, each private sector company develops and submits a bid,
giving its firm price for performing the commercial activity.  While
this process is taking place, the government activity performs a
management study to determine the most efficient and effective way of
performing the activity with in-house staff.  Based on this most
efficient organization, the government develops a cost estimate and
submits it to the selecting authority.  The selecting authority
concurrently opens the government's estimate along with the bids of
all firms that are judged to be technically qualified to perform the
statement of work.  According to OMB's A-76 guidance, the
government's in-house estimate wins the competition unless the
private sector's offer meets a threshold of savings that is at least
10 percent of direct personnel costs or $10 million over the
performance period.  This minimum cost differential was established
by OMB to ensure that the government would not contract out for
marginal estimated savings. 

If the RFP--best value process--is used, federal procurement
regulations and the A-76 supplemental handbook require several
additional steps.  The government and private sector offerors submit
proposals that include a management plan, technical performance
proposal, and cost estimate.  While the government's proposal must be
based strictly on the performance work statement, private sector
proposals can be based on a higher level of performance or service. 

The government's selection authority reviews the private sector
proposals to determine which one represents the best overall value to
the government based on such considerations as (1) higher performance
levels, (2) lower proposal risk, (3) better past performance, and (4)
cost to do the work.  After the completion of this analysis, the
selection authority prepares a written justification supporting its
decision.  This includes the basis for selecting a contractor other
than the one that offered the lowest price to the government.  Next,
the authority evaluates the government's technical proposal and
determines whether it can achieve the same level of performance as
the selected private sector proposal.  If not, the government must
then make changes to meet the performance standards accepted by the
authority.  This ensures that the in-house cost estimate is based
upon the same scope of work and performance levels as the best value
contract offer.  After determining that the offers are based on the
same level of performance, the cost estimates are compared.  As with
the IFB process, the work will remain in-house unless the private
offer is
(1) 10 percent less in direct personnel costs or (2) $10 million less
over the performance period.  Participants in the process--for either
the IFB or RFP process--may appeal the selection authority's decision
if they believe the costs submitted by one or more of the
participants were not fair, accurate, or calculated in the manner
prescribed by the A-76 handbook.  Appeals must be submitted in
writing within 30 days of the decision and are supposed to be
adjudicated within 30 days after they are received. 


      RECENT EXAMPLES OF BEST
      VALUE TYPE A-76 COMPETITIONS
------------------------------------------------------ Appendix II:0.1

Following is information on the three recent best value competitions,
all of which were conducted by the Air Education and Training Command
using the best value guidelines established in the revised
supplemental handbook: 

At Tyndall Air Force Base, Florida, aircraft maintenance, civil
engineering, and supply/fuels activities were included in the A-76
study.  Four private sector firms submitted a total of 10 proposals. 
(Contractors were allowed to submit offers on one or more of the
activities).  After reviewing the proposals, the source selection
authority selected the low-cost offer as the best overall value to
the government.  The authority then reviewed the in-house management
plan and determined that the government proposal needed to be
adjusted to the same level of performance as the private sector
offer.  After the adjustment was made, the cost estimates were
reviewed, and a contractor won the competition.  Air Force officials
estimate that this competition will allow it to eliminate 1,017
personnel authorizations. 

The Laughlin Air Force Base, Texas, A-76 study dealt with
regionalizing jet engine repairs.  We found that three private sector
offers were considered by the source selection authority to compete
against the in-house proposal.  The authority chose a private offer
that was not the low cost offer.  In the justification for selecting
this offer, the authority stated, among other things, that the
winning contractor offered a "sound organizational structure and a
solid understanding of the mission at a very reasonable price." After
reviewing the in-house management plan, the authority did not believe
the in-house performance proposal needed to be adjusted because it
satisfied the requirements of the solicitation at the same level of
performance as the selected private offeror.  The cost estimates were
then reviewed, and the private offeror won the competition.  As a
result, Air Force officials estimate that 48 personnel authorizations
will be eliminated. 

Another study was completed at Columbus Air Force Base, Mississippi,
for civil engineering, supply, and transportation activities.  Six
private sector organizations submitted a total of 14 proposals.  The
source selection authority selected two of these proposals, each of
which were deemed the best value for a portion of the work, as
finalists in the competition.\1 Next, the source selection authority
reviewed the government's technical proposal and decided that it
provided the same level of performance as the best private proposals. 
Finally, the cost estimates were reviewed, and the function was
retained in-house.  We reviewed a formal protest from one of the
private sector competitors and upheld the Air Force's decision to
retain the activity in-house.\2 Air Force officials expect this
competition to yield a 34-percent reduction in personnel by
eliminating 114 positions. 



(See figure in printed edition.)Appendix III

--------------------
\1 In this competition, two private sector organizations competed
against the in-house offer.  Unlike the private sector, however, the
in-house organization had to include all activities collectively. 
Either the in-house organization retains all of the activities or
they are contracted out to one or more private sector organizations. 

\2 Madison Servs., Inc., B-277614, Nov.  3, 1997, 97-2 CPD__


COMMENTS FROM THE OFFICE OF
MANAGEMENT AND BUDGET
========================================================== Appendix II

See comment 1. 

See comment 2. 

See comment 3. 



(See figure in printed edition.)

Now on p.  8. 

See comment 4. 

Now on p.  12. 

See comment 5. 

See comment 6. 

See comment 3. 


The following are GAO's comments on the OMB's letter dated January
13, 1998. 

GAO COMMENTS

1.  We agree that the A-76 cost comparison process was designed to
enhance competition, not just to study whether an activity should be
contracted out.  As we point out on page 2, the A-76 supplemental
handbook includes "procedures for competitively determining whether
commercial activities should be performed in-house, by another
federal agency through an interservice support agreement, or by the
private sector".  Nevertheless, in most cases, the A-76 process is
used by federal agencies to determine whether a commercial activity
currently performed by the government can be performed more
cost-effectively by the private sector.  This creates a competitive
environment that has traditionally driven down the cost of performing
the activity, whether it is retained in-house or contracted-out to
the private sector.  This is how we have described the A-76 process
in the report. 

2.  We agree with OMB that savings from A-76 studies result from a
wide range of factors and modified the report accordingly.  Our work
has consistently shown, however, that A-76 studies are
cost-effective, primarily because they result in a reduction in
personnel.  In addition, DOD captures only personnel-related savings. 
DOD generally knows, for example, how many people performed the
activity before and after the A-76 competition.  They do not always
know other historical costs and consequently are unable to calculate
savings associated with other types of improvements. 

3.  The agency comments section in the report addresses this issue. 
Also, on page 6 of the report, we have added a section that
recognizes the work of the FASAB and CFO Council. 

4.  Our intent in including this analysis in the report was to give
the reader some perspective on how the 12-percent standard rate might
have affected A-76 competitions, both before and after the rate
became a requirement.  We believe this is a logical question most
people would want to know.  We agree with OMB that the results of the
analysis is not surprising--it is logical that more private sector
organizations would have won the competitions if the government used
a 12-percent overhead rate since little or no overhead costs were
included in most studies.  The analysis shows the extent to which
this might happen, if all other factors were to remain constant. 
However, considering the subjective nature of the 12-percent rate, we
have no basis to determine if it "improves the playing field," as OMB
suggests.  Logically, it improves the competitive position of private
sector offerors and, as OMB points out, could encourage more of them
to participate in the process. 

5.  The report does not conclude that the 12-percent overhead rate is
both reasonable and appropriate.  Rather the report concludes that
the development of a standard rate is a proper move toward making
sure that overhead costs are included in the government's A-76 cost
estimates.  It is clear throughout the report, however, that our view
is that the 12-percent rate, which lacks an analytical basis, could
understate or overstate overhead costs and unfairly shift the
competition results to either the government or private sector. 

6.  We do not believe the report understates the importance of good
data or the need to ensure fairness in the process.  Rather, it is a
desire to see a more fair process that led to our conclusions and
recommendation.  Likewise, because good data is obviously important
to the A-76 process, our recommendation encourages OMB to work with
DOD and other agencies to develop a more data-based methodology for
calculating overhead rates.  While it is true that DOD lacks
standardized financial systems and cost data, it nonetheless has
large amounts of financial data that it uses regularly to manage
programs, estimate costs, and develop budgets.  Developing some type
of methodology to use this information, even with its limitations, is
preferable, in our view, to relying on one standard rate that is
applied across the government regardless of the agency or type of
activity being studied.  Moreover, we believe that a sound
methodology will further enhance public and private offerors'
perceptions that the A-76 process is fair and reasonable. 




(See figure in printed edition.)Appendix IV
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
========================================================== Appendix II

See comment 1. 

See comment 2. 


The following are GAO's comments on DOD's letter dated January 29,
1998. 

GAO COMMENTS

1.  The agency comments section in the report addresses this issue. 

2.  As we point out in the report, we believe military personnel
costs should be recognized in DOD overhead rates because military
personnel generally cost more than their civilian counterparts. 
While some military personnel assigned to overhead functions may
deploy to support mobilization requirements, many do not.  Therefore,
we believe military personnel costs need to be a component of DOD
overhead rates. 

*** End of document. ***




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