The Competitors

By Michael D. Serlin

June 1, 1996

The bracing breeze of competition is about to begin blowing through the halls of the U.S. government, pitting agencies against one another in a race to sell their services to colleagues throughout the federal bureaucracy.

One can envision the day, not far in the future, when an agency might publish an ad like this:

Such a world may seem galaxies away from today's practices, which don't feature much entrepreneurship on the part of federal employees. But under the authority of a 2-year-old law, six agencies are about to start up so-called franchising projects under which they'll be hawking administrative services to other units of government. The projects are full of risks-both for the agencies that will be operating the franchises and for their customers as well. But if they succeed they'll be a model for a government that's less turf-conscious and more willing to consider outsourcing of services, both to other agencies and to the private sector. A franchising conference on the future of competitive reimbursable government services is scheduled for this month in Washington.

The franchising movement builds on an idea as old as 18th century philosopher and economist Adam Smith-that efficiencies can be derived from competition, specialization and intelligent division of labor. It's not a wholly new idea in government circles; for several years a small number of agencies have been providing common support services on a reimbursable basis to other agencies. This so-called "cross-servicing" was encouraged by the Reagan Administration and its most visible example was and is the big payroll record-keeping and accounting operation run by the Agriculture Department's National Finance Center in New Orleans. The NFC services more than 100 federal agencies. Another example is found in the Public Health Service's Federal Occupational Health Services organization, which markets health promotion activities to federal offices throughout the United States.

These kinds of operations have been growing slowly. But the numbers are about to grow exponentially as "franchise funds," authorized by the 1994 Government Management Reform Act (PL 103-356), begin operations this year. The range of franchise services proposed within these six funds runs the gamut of support functions, from payroll and accounting to security, computer services, telecommunications, procurement, facilities management, consulting, travel management, copying and printing, personnel management, health services and specialized training.

The six agencies offering these services can see an obvious benefit. By broadening the market for their services, they'll be able to generate more revenue that can be used to enhance staff and upgrade facilities. At the same time, they will shoulder some risk. If their services do not prove salable, they have no guarantee that their franchise operations will stay in business.

For agencies on the buying end, the promise of reduced cost and reduced headcount is balanced by the risk of signing up for services that might not be delivered as promised. They might have better luck with another provider, but once an agency decided to relinquish its own administrative services capabilities, it could be difficult to reestablish them. For these reasons, among others, managers in many agencies have long been reluctant to allow contracting out of support functions.

The Franchising Movement

"Franchising" was the name used by the National Performance Review's 1993 report to describe a practice for providing administrative services that had at least three key characteristics:

1. The services would be offered on a competitive basis, with providers bidding for the business they wished to secure.

2. The services would be reimbursable by transfers of funds from the contracting agency to the service-providing agency.

3. The service providers would meet basic standards and be self-sufficient, with revenues covering costs of operations without subsidies from parent agencies.

The NPR's goal was to promote efforts to reduce federal overhead by cutting down on the cloning of staff support functions in virtually every agency of government (and often at the subagency or regional level). It proposed to end the staff support operations' monopolies in the agencies by giving managers a choice in finding the best service value for the dollar.

The Office of Management and Budget proposed legislation in support of this NPR recommendation that called for establishing franchise funds in every agency. These revolving funds would provide the working capital needed to allow individual franchises to operate as businesses, giving them start-up money for such functions as planning and marketing. Congress preferred a more cautious approach, approving establishment of six franchise funds on a pilot basis in the Government Management Reform Act (GMRA), signed into law in October 1994. Selection of agencies to establish these funds was left to the executive branch, in consultation with Congress. A five-year pilot phase is expected to run through 1999, with a proposed extension to 2001.

The opportunities and flexibilities permitted by the act, and the process by which the pilot agencies would be selected, were described by officials from an interagency working group and from the Office of Management and Budget at a February 1995 briefing. Then applications were sought from interested agencies.

Briefers described some of the advantages that would accrue to the six pilot agencies. Those that didn't already have a working capital fund would obtain one. The new funds could retain up to 4 percent of their "profits" to fund capital and other investments to improve operations, and to cover temporary lulls in business volume. Agencies needed to determine which functions they felt confident about including in a franchise fund proposal. Applicants were evaluated on seven key criteria:

1. Their ability to meet the intent of franchising by fostering competition among agencies for the provision of services.

2. The support they could demonstrate for franchising within their own agency and among relevant congressional committees.

3. Their ability to overcome any impediments that might be suggested by legislative or regulatory directives.

4. The soundness of the proposed organizational structure and operating procedures.

5. Their ability to help capitalize the operation through transfer of dollars, people and equipment.

6. Their ability to manage resource constraints, including fluctuations based on customer needs; to meet customer service and other performance standards; and to reduce costs and enhance productivity.

7. Their planning for contingencies, including the possibility of ceasing operations if the franchise proved unsuccessful.

Eight applications were completed by departments or independent agencies. Several others with existing revolving funds and reimbursable authority did not apply. Ultimately, the CFO Council, an interagency group that promotes management reforms, proposed OMB approve the plans of six agencies: The departments of Commerce, Health and Human Services, Interior, Treasury and Veterans Affairs, and the Environmental Protection Agency.

After additional discussion with OMB review staff, five were approved and consultation with Congress began. The sixth application, from HHS, was limited to a single franchise, the fully functioning Federal Occupational Health organization. The amend-ed HHS proposal was cleared in April by OMB, and the congressional consultation process started.

The six funds will offer a broad array of services. It's clear that agencies will frequently compete with one another. Payroll services, for example, will soon be offered by at least seven agencies, some with and some without franchise funds: the Veterans Affairs Department, the Commerce Department's National Oceanic and Atmospheric Administration, two units of the Interior Department, the Transportation Department's Federal Aviation Administration, the General Services Administration and the Agriculture Department's venerable National Finance Center.

While the franchise funds will be managed in Washington, many individual franchise operations will be run in field installations. The Treasury Department previously had lead responsibility for Cooperative Administrative Support Units (CASUs) in Los Angeles, Baltimore, Cincinnati and Seattle. Now the CASUs will operate as franchises, reporting to the Bureau of Public Debt while using the Financial Management Service's Center for Applied Financial Management to administer the franchise fund. Both the Veterans Affairs Automation Center and its Finance Center in Austin, Texas, are among the franchises, as is Interior's Denver Administrative Service Center. Most of the franchises, other than the CASUs, offer services nationwide.

The Federal Aviation Agency's Aeronautical Center in Oklahoma City is not a GMRA pilot, but plans to operate in similar fashion. The center proposes to offer international training, accounting, payroll, travel, duplicating, multimedia (visuals and TV production), and information technology services. FAA's proposal was examined by the franchising working group, and was deemed to have a strong potential to succeed. As a result, OMB and the Transportation Department have been working with Congress to establish an administrative services fund, with the same characteristics as the GMRA franchise funds. Other agencies continue to offer entrepreneurial administrative services under existing authorities, either through their own working capital funds or under the 1932 Economy and Efficiency Act.

Taking a leaf from the success of the CASUs, and in compliance with the philosophy of the GMRA legislation, customer representatives sit on franchise fund advisory boards and boards of directors.

Prospects for the Funds

Risk-taking entrepreneurial activities clearly counter traditional organization and methods in large bureaucracies. So what has caused the increased interest in federal franchising? And what is the likely impact?

Though there's long been talk of cutting overhead costs so that agencies can concentrate their resources on their primary missions, there was little action so long as budgets were stable or growing. Now, steep cuts in appropriations have forced many agencies to consider sharp downsizing of their staff support offices.

The choices have been to consolidate and eliminate staffing, purchasing the services from other agencies or private industry, or to retain and enhance staff capabilities by offering reimbursable services to other agencies. Closing down the weaker staffs and purchasing services from more efficient, customer-oriented ones can bring an agency a better, cheaper product. Conversely, letting a truly effective staff provide reimbursable service to other agencies can retain a talented workforce.

While it has taken a downsizing crisis to force many agencies to look for alternative ways to reduce their overhead budgets, one benefit from the many innovative entrepreneurial efforts has been to increase pressure on all support staffs to become more customer-oriented. This includes agency staffs, operating in the traditional appropriated structure, who know that their clients now have choices to exercise.

S. Anthony McCann, staff director of the House Appropriations Subcommittee on Labor, Health and Human Services, and Education, points out that "revolving or franchise funds provide powerful incentives to administrative and support functions to become more efficient, reduce costs, and improve services they provide to customers." McCann, previously the first chief financial officer at Veterans Affairs, adds, "They provide models of how administrative support activities can maintain and refresh technology and assure adequate training of employees to keep their skills current."

Formidable Obstacles

Franchising faces formidable obstacles. The people who advise senior line managers are the key support staffers, and few willingly seek to reduce their own staffs in order to obtain services elsewhere. While on a governmentwide basis there can be significant reductions in the number of people providing staff support, in individual agencies there is strong staff self-interest in letting those reductions take place elsewhere. Even though there may be four or five franchises competitively offering a particular staff service, some agencies may require their managers to use the in-house staff. Agencies that continue to mandate use only of internal staff will come under increasing pressure to change.

In a bureaucracy, preservers of the status quo seldom oppose change by direct confrontation. Slow strangulation with red tape is the weapon of choice. Several impediments to the growth of franchising were identified early by the working group and CFO Council. They were confronted and efforts were made to mitigate them.

One significant obstacle was the full time equivalent (FTE) control system. Agencies were concerned about letting their franchises hire people based solely on reimbursable income and customer demand when this hiring would affect agency efforts to meet reduced FTE ceilings. The CFO Council developed a system under which business-like entrepreneurial organizations can receive increased FTE ceilings for which they have the requisite funding.

A second problem, now temporarily resolved, involved the potential application to the franchising movement of OMB Circular A-76, issued years ago to govern contracting out of services to the private sector. A-76 was developed to foster private sector competition for government services while offering protection for federal employees who could provide these services as cost effectively. The A-76 process requires a detailed study comparing governmental entity and private sector bids. The agency staff retains the work if the private sector cannot accomplish it for at least 10 percent less. When GMRA was signed into law, A-76 required agencies considering purchasing support services (whether from the private sector or another agency) to go through this time-consuming, paper-intensive process .

The franchising effort encourages competition among federal entities, not lengthy procurement studies. Since one of the purported benefits of franchising is that agencies could swiftly purchase services from other agencies, imposing A-76 on internal competition among agencies would defeat the purpose. So OMB has exempted franchises started before October 1997 from A-76. Some franchises have begun marketing themselves by stressing the relative ease with which agencies can purchase their services. Materials circulated by the Commerce Department's Office of Computer Services, for instance, say "the center has streamlined the procurement process to a simple memorandum of agreement."

One irony of the temporary A-76 exemption is that most federal franchises make significant use of private contractors. They hire them to cover workload surges and specialized skill areas. Another irony is that the exemption vitiates a key objective of the franchising program: ensuring that agencies get services at the lowest cost. Industry surely will not be pleased by the A-76 exemption, but at the moment there is no consensus on the best way to assure a level playing field while achieving the lowest total cost to the taxpayer.

A third obstacle to franchising can be found in the relationships between individual franchises within a fund and their parent agency. History suggests that when some agencies began cross-servicing others in exchange for reimbursement, management in the service-providing agency used the revolving reimbursement fund to pay for agency overhead functions instead of supporting the cross-servicing business. By adding substantial overhead charges onto reimbursable pricing, parent agencies have priced their entrepreneurial offerings out of the market. This was one of the factors contributing to the business decline suffered by the Office of Personnel Management's training function, which has now been shifted to the USDA Graduate School, a more entrepreneurial setting. Parent agencies also fear losing control of their franchises.

Adopting Business Practices

This leads to a final problem likely to cause much debate over the next several years. As Schuyler Lesher, Deputy CFO at Interior points out, "Equitably addressing full cost accounting for franchises and for any federal agency providing support services to others is essential if the benefits are to be achieved." Susan Spurling, project leader for the Veterans Affairs franchise fund, agrees. "One of the biggest challenges facing the franchises is defining their services in terms of products they can identify and the customer can recognize," she says. Full pricing of those products and services will be critical to achieving the level playing field needed to assure agencies can obtain the best overhead services for the fewest dollars.

As Government Executive was going to press in early May, congressional concurrence was imminent for five initial franchise funds, those at Commerce, Interior, Treasury, VA and EPA. This was to be followed immediately by a letter from OMB permitting them to establish franchise funds under GMRA. The flexibilities these revolving funds will provide, including the authority to retain earned funds for reinvestment in capital equipment and to cover temporary lulls in business, should permit them to operate in a businesslike environment. Individual franchises will then stand and grow (or fall) based upon the quality of the services they provide, the price at which they provide them, and their marketing ability. They will be dealing with customers who have alternatives, so none will be able to avoid the hard work of continually striving to improve.

Dr. Ernest Hardaway, a Public Health Service Captain who is vice president for employee assistance of the Federal Occupational Health program, spent 14 years in the Public Health Service, when it was a traditional appropriated activity. He has spent the past 10 years in the entrepreneurial Federal Occupational Health program. "The primary satisfying difference is that when you have good ideas for greater effectiveness, you have fewer constraints in actually getting them implemented," he says. "It is an operational laboratory, with customers rather than hierarchy determining your ultimate performance measures."

Even in the world of the Internet, communication in the vast federal government is uneven and often slow. One reason people are often frustrated with staff support organizations in their agencies is that the staffs are frequently unaware of the latest flexibility offered in a presidential directive or General Accounting Office opinion. Franchising competition puts the pressure on agencies to keep up to date.

Many agencies are only beginning to learn about the opportunities provided by franchising. Efforts to spread the word began a year ago at a franchising workshop at George Mason University in the Washington suburbs. The 1996 Franchising Workshop is scheduled for June 19 and 20 at the Bureau of Labor Statistics training center near Union Station in Washington. Sponsors are the National Performance Review, the National CASU Project and the CFO Council. There are plans to have ready by that time an updated directory of reimbursable services, in effect a Yellow Pages of government entrepreneurial staff support organizations, as well as an operating guide for franchises.

Change does not come easily, even when accelerated by a crisis, but competition in support services can clearly help managers cope in an era of diminishing resources.


By Michael D. Serlin

June 1, 1996

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