Mavericks and Mavens

The Federal Technology Service is struggling with the burdens of its success at driving hard bargains for agencies buying information technology.

i n this era of businesslike government, when legislative reforms have allowed agencies to operate more like corporations and less like bureaucracies, the General Services Administration's Federal Technology Service has pushed the limits of entrepreneurial government farther than most. FTS, an expansive fee-for-service operation that buys information technology and telecommunications goods and services for other agencies, has had sales in the billions of dollars during the past six years. But FTS now risks falling victim to its own success.

Unlike other acquisition organizations that simply craft technology contracts other agencies can use, FTS provides a cradle-to-grave, handholding service for customers that have neither the time nor the inclination to buy technology on their own. FTS writes its own contracts or uses those of other agencies, makes the buys, oversees the installation of the goods or the performance of services and sticks around to provide customer support, freeing agencies to focus on their missions. All that service comes at a high price. Lawmakers are expressing concerns about the size of FTS' service fees and the ways they're set. Congressional ire and investigations could imperil the agency. The General Accounting Office is probing FTS' business practices and separately scrutinizing how other agencies establish fees for their governmentwide contracts. The tandem reviews come as GSA Administrator Stephen Perry is searching for ways to improve management and efficiency at GSA, raising questions about whether FTS' services justify its fees. Observers inside and outside the government agree that the answers to these questions will have a dramatic effect on FTS' ability to continue operating like a business. The results of GAO's reviews and Perry's quest also could have a ripple effect on other fee-for-service agencies in the IT buying business.

FTS operates two business lines-information technology sales and telecommunications sales. The IT side handles everything from small purchases of goods and services to large-scale hardware and software installations and modernization efforts. FTS also operates a number of contracts. The largest, Millennia and Millennia Lite, handle large- to medium-sized IT integration projects. FTS' roster also includes a services contract called ANSWER (Applications 'n Support for Widely-diverse End-user Requirements) and the Small Business Solutions Development Center, which awards contracts to small and disadvantaged businesses. In addition, FTS runs contracts for seat management, information security and other IT services. On the telecommunications side, FTS manages the FTS 2001 contract for nationwide long-distance telephone and data service, and the Metropolitan Area Acquisition Program (MAA), which offers agencies local voice and data service on a city-by-city basis. The IT and telecom contracts are held by prime vendors that are usually free to form partnerships with other corporations to provide services.

FTS is the value-added reseller of information technology and telecom in government, agency officials crow. But FTS also lives and dies by the bottom line because it receives no appropriated funds. To keep the lights on and to pay its more than 1,500 employees, who are scattered throughout 11 regions in more than 400 locations worldwide, FTS charges agencies fees for its services. And while those fees may seem high, in many cases they're not high enough to keep FTS from drowning in the costs of doing business.

Numbers Crunch

At first glance, FTS' financial statistics appear to tell the tale of a business on the fast track to massive growth. In fiscal 1996, FTS sold $2 billion worth of IT and telecom products and services to other agencies. Business more than doubled, to $4 billion, in just three years. Sales hit the $5 billion mark in fiscal 2000, says Chief Financial Officer Anthony Tisone. That's more than 10 percent of the $41 billion budgeted for IT and telecom purchases by all agencies that year. Tisone says FTS continued to boom in fiscal 2001-to the tune of $5.8 billion in sales.

But those numbers can be deceiving. Ninety-five percent of every dollar that came into the agency last year went back out to private industry, leaving FTS a "margin" of $255 million to cover fiscal 2000 costs. The amount was large enough to prompt Rep. Tom Davis, R-Va., chairman of the House Government Reform Subcommittee on Technology and Procurement Policy, and others to ask whether business is too good at FTS. But a closer look at the agency's numbers show that while it has grown tremendously, FTS is now teetering on the brink of financial peril.

Even though the amount of contract dollars handled by FTS has grown almost 500 percent since fiscal 1994, the agency is operating in the red, with a net loss of $82 million predicted for fiscal 2001. The cost of doing business has eclipsed sales, forcing the agency into the hole for the past four years. Salaries, operating costs and the cost of managing contracts totaled $5.1 billion in fiscal 2000. In the next two years, FTS predicts, costs will rise even higher.

In addition, the agency's rapidly shrinking year-to-year margins have sent FTS into a nosedive. Margins fell from 16.8 percent of sales in fiscal 1995 to 6.7 percent in fiscal 1999, and the agency's gross margin in fiscal 2000 was just 5.1 percent. As those percentages have evaporated, so has the amount of cash FTS has on hand. At the end of December 2000, not counting the revolving fund FTS is allowed to carry over year to year to finance contracts, the agency had less than $20 million at its disposal, down from $289 million in fiscal 1995. The dwindling of cash resulted in part from several years of poor margins and the lack of timely collection of payments from customers.

FTS officials stress that they planned to take losses beginning in 1997. FTS intended to stock up on cash in its revolving fund in the mid-1990s in order to offset the costs to customers of major future projects-especially the phone-line-by-phone-line transition from the FTS 2000 contract to the new FTS 2001 contract, which took effect in January 1999. Agencies had no choice but to purchase telecom service under FTS 2000, which was awarded exclusively to AT&T and Sprint. But use of FTS 2001 is voluntary and competition is open to many companies, forcing vendors to bid more aggressively for customers, bringing prices down. As prices on long-distance have dropped, FTS' share from fees has decreased. By stockpiling cash, FTS planned to avoid passing costs on to customers in the form of higher fees. The money held in reserve was supposed to help the agency get through the lean years.

But FTS officials never anticipated that competition would cause prices for long-distance telephone service to plummet as low as they have. Current and former FTS officials ruefully admit that the agency is a victim of its own success in negotiating rock-bottom prices in the FTS 2001 contract. Under FTS 2000, agencies were paying as much as 14 cents per minute for long-distance. With FTS 2001, customers have secured rates of 2 cents per minute on average, and FTS expects rates to continue dropping. Low prices are great for customers but a burden for FTS, as the cost of delivering services soars. Most observers agree that smaller fees stemming from low prices on FTS 2001 are largely to blame for the agency's financial difficulties.

While FTS 2001 is bringing agencies vastly lower prices, the transition from FTS 2000 fell months behind schedule. Critics say inadequate planning by vendors and FTS are to blame, as well as foot-dragging by incumbent contractor AT&T, which lost the bid for FTS 2001 and didn't move its customers to the new contract as quickly as requested. Agencies that were slow to switch contracts didn't reap the benefit of FTS 2001 prices. FTS estimates that the transition was 99 percent complete as of August 2001, but GAO reported in March that the extra time agencies spent buying long-distance at FTS 2000 prices cost the government $74 million in lost savings. Complicating matters even further, FTS has committed to paying $1.5 billion in minimum revenue guarantees to the first two FTS 2001 vendors, Sprint and MCI WorldCom. Those obligations must be met if the companies don't earn enough money through sales under the eight-year contract. Hindsight is 20/20, but Dennis Fischer, FTS commissioner from 1997 to 2000 and now vice president of government services at Visa USA, says he feared from the beginning that revenue guarantees would end up crippling FTS. "We put too much money on the table," Fischer reflects. Agency leaders hoped to meet the commitments in a few years, but prices suddenly dropped. Robert Woods, who preceded Fischer as FTS commissioner, says leaders at FTS had discussed the financial risk of a massive price drop. But they believed the high volume of business they'd land would offset the pinch, added Woods, who now serves as the president of business applications solutions at ACS Government Solutions Group Inc., a Rockville, Md., provider of technology services.

Taking Heat

In the midst of this turmoil, FTS is trying to deflect political heat from its detractors. "We firmly believe that FSS and FTS are collecting more in fees than is needed," Rep. Davis says, also drawing attention to the General Services Administration's Federal Supply Service schedules, a set of standing-order contracts agencies use to buy a range of goods and services. The Federal Supply Service's technology schedules accounted for approximately $10.8 billion in sales in fiscal 2001, 66 percent of total schedule sales as of the end of August, according to FSS officials. The technology schedules also captured 61 percent of all technology sales on governmentwide contracts in fiscal 2000, according to FSI (Federal Sources Inc.), an IT market analysis firm headquartered in McLean, Va. The Federal Supply Service, a fee-for-service operation like FTS, sold $8 billion worth of IT goods and services on its technology schedules in fiscal 2000, 60 percent more than FTS sold in the same year. With the 1 percent fee all agencies pay FSS to use the technology schedules, the agency had racked up more than $108 million in fees on fiscal 2001 technology sales as of August.

Agencies pay FTS handsomely for its services. Fees for IT services average 4 percent of the total value of a contract. FTS 2001 fees go as high as 8 percent. But none have more potential for creating sticker shock than the fees for managing local voice and data services under the Metropolitan Area Acquisition program. FTS' fees for MAA services range from 28 percent to more than 80 percent of the cost of each office phone line an agency buys. Recognizing the deal-killing potential of its fees, FTS has not revealed them to customers, which vendors say has forced them to hide the amounts in their bids for agencies' business.

Margaret Binns, assistant commissioner for regional services, who oversees the MAA Program, justifies the high fees by noting, "Local telecom is a very labor-intensive business." It's also very expensive. For a fee, FTS will compile an agency's monthly billing statement, break it down and pay the vendor on the agency's behalf. FTS also will order any new services its customers need. There is no set formula for determining rates in all cities. Rather, FTS officials say they measure the cost of delivering goods and services in each metropolitan area served by an MAA contract.

Former FTS chief Woods offers a simple explanation for how he set per-line fees for local service in Washington in the mid-1990s. "I made it up," he says. Local telecom used to be a "cash cow," Woods says of the days before MAAs. On Woods' watch, when the agency was known as the Office of FTS 2000 and later the Federal Telecommunications Service, FTS was buying phone lines in the Washington area under a different contract at $10 to $12 each, he says. He decided the agency should sell them for $15. "It was educated guesswork," he says. FTS Commissioner Sandra Bates says there's no "hocus-pocus" involved in setting fees for the MAAs or any other FTS contract or service. "We're not here to see how much revenue we can bring in," she says.

FTS officials past and present are frustrated by what they consider to be an inordinate amount of attention and criticism directed at the MAA fees, which pay for many services, from contract management to ordering and billing. Under the MAAs, the agency pays an estimated $3 per phone line, down from the nearly $30 agencies paid without FTS' assistance in the mid-1990s. When FTS tacks on its management fees, the cost to agencies goes up, but the total price per line still is well below what agencies were paying before. But FTS' success in winning lower telecom prices hasn't kept Davis from nipping at the agency's heels. In a memo to the congressman in July, GAO suggested that agencies could save money by handling their own billing and ordering, rather than paying FTS to do it. "Agencies should have the option to choose," Davis says. "Right now, it is not clear that agencies understand that they have a choice in what they purchase from FTS." GAO recommended that FTS disclose its MAA fees to agencies up front. Also, Davis is unconvinced that billing and ordering is as difficult and costly as FTS says it is. "The billing requirements are complex because FTS built those requirements [into the contract]," he contends. "I don't think we know for sure that that is how agencies need to pay for or order services. Shouldn't they purchase these services like the commercial sector does?"

MAA program leader Binns won't yield. "I refuse to be defensive . . . when I'm reducing the cost by half [in some cities]," she says flatly. Binns says the post-deregulation telecom market is in chaos and that FTS provides an important service in navigating those treacherous waters for its customers. Handling their own contracts and billing would pull agencies away from their core missions, Binns points out. As government agencies try to streamline their operations, many don't want to allocate time or people to sorting out monthly phone invoices.

Divide and Conquer

What doesn't appear on the agency's balance sheet, says FTS Deputy Commissioner Charles Self, is the amount of money FTS has saved agencies by spending its own cash. "We are first and foremost a government agency," he says, adding that as a self-funded organization FTS has to show financial success, and if it can't demonstrate that it provides vital services to agencies, it's in trouble. In the area of local telecom, FTS provides a necessary service. "We can't ditch it," Self says.

FTS' success or failure can't be measured solely by its telecom troubles. On the other side of the house, the IT business is strong and continues to grow. IT sales-totaling $4.8 billion in fiscal 2001-account for 85 percent of FTS' total business. Sales rose from $3.1 billion in fiscal 1999 to $4 billion in fiscal 2000. Overall, FTS has maintained fees at an average of 4 percent on its IT contracts, says assistant FTS commissioner for IT integration Robert Suda, who runs the IT side of the business. Regional officials confirm that IT fees have come down over the past several years. In the Mid-Atlantic Region fees were nearly 15 percent just a few years ago. Now they're down to 5 percent.

But while IT sales may be strong, FTS isn't the only agency making a living off the boom in federal technology buying. The Office of Management and Budget reports that the federal IT budget ballooned from $28 billion in fiscal 1996 to $41 billion in fiscal 2000, and a number of agencies' procurement organizations have gone fee-for-service and compete with FTS for all that business. Most recently, GovWorks, the procurement arm of the Interior Department's Minerals Management Service, announced that it plans to make a run at FTS' telecom business this fall.

More than a dozen other agencies' procurement shops operate governmentwide acquisition contracts (GWACs). According to a recent FSI study of 60 different GWACs, those contracts accounted for $13.3 billion in IT spending in fiscal 2000-more than 30 percent of the $41 billion spent by federal agencies on IT that year.

FTS officials claim their agency is the single largest user of the Federal Supply Service's technology schedules, the largest GWAC. FSS officials refute that, identifying the Defense Department as their biggest customer.

Regardless of which agency is the top customer, the technology schedules keep the rest of FSS' program afloat, and it's clear to all parties that Federal Technology Service is a major user. Donna Bennett, commissioner of Federal Supply Service, says the two agencies complement one another, but each provides a distinct service.

Sibling Rivalry

In fact, the Federal Technology Service likes FSS' technology schedules so much it would like to run them. No one is willing to say so on the record for fear of igniting internecine warfare within GSA. But many within FTS believe that their technology acquisition expertise makes their agency a far better home for the technology schedules. Cheryl Ward, FTS chief of staff, offers the agency's official position, that "FSS is very adept at establishing and managing schedules." FTS, on the other hand, is good at managing contracts from beginning to end and dealing directly with industry at the point of sale, she adds.

Former FTS chief Woods agrees that the agency is the home of the technology mavens, so it only makes sense that it should own the contracts. The Federal Supply Service's players sell "technology, but they don't get involved in the solution," he says. But Woods' successor, Fischer, says merging the Federal Technology Service and the Federal Supply Service or giving FTS the technology schedules are nonsensical ideas. Combining all of GSA's IT contracts at one agency would reduce competition, Fischer says, since FTS is largely responsible for helping to foster a competitive environment in government technology purchasing. He adds that some IT companies would prefer to see FTS dismantled, making FSS' technology schedules the only game in town and thereby reducing competition and pressure to lower prices. Several large telecom companies favor creating a schedule for telecom services, an idea that appeals to Davis and one that would undercut FTS' ability to compete.

GSA Administrator Perry has said he is not considering restructuring GSA. But a former GSA official who asked to remain anonymous believes the administrator should consider combining FTS and FSS. The former official believes that merging the two would do some good and that behind closed doors neither side would truly object. The Federal Supply Service would bring financial stability and significant back-office accounting technologies that would be of great use to FTS' business, the former official says. "It's probably time to blend the two divisions."

"Gold Projects"

As FTS struggles with the costs of success, it appears to be following in the footsteps of large corporations in attempting to compensate for customers whose smaller purchases are less lucrative. IT contracting chief Suda says FTS is making an effort to capture more "gold projects," large-scale IT deals such as system implementations and modernizations, whose large price tags mean bigger sales and more fees for the agency.

FTS sold about $1 billion in IT goods and services in fiscal 2001 to upper-echelon customers at the Defense Department and sold hundreds of millions more through contracts with the FBI, the Securities and Exchange Commission and the Defense Information Systems Agency, Suda says. FTS' technology hardware sales are dwindling as profit margins on those products shrink industrywide and IT services become the new hot ticket in government. FSI estimates that services accounted for more than 65 percent of all FSS technology schedule sales in fiscal 2001, worth about $9 billion. Corporate mergers also are thinning contractor ranks. So FTS plans to zero in on the burgeoning market for services in partnership with a core of vendors with which it has done business for years.

Woods cautions that this course may be a rocky one. "Moving to bigger deals is much easier to say than do," he says. What's more, FSI predicts that federal IT budgets will grow by only 1 percent in fiscal 2002, down from 7 percent two years before, so there's no guarantee that enough large deals will materialize to support FTS' strategy.

For all its calculated maneuvering and its Pyrrhic victories in driving hard deals, in the end, FTS suffers most from an image problem. Agency leaders are the first to admit that. "Our biggest problem is educating agencies on what our value-added is," says Suda. While rival organizations like the Federal Supply Service and GovWorks have mounted aggressive marketing campaigns to raise awareness of their services, FTS has chosen to fly below the radar.

Many observers say the solution to the furor over FTS' fees, its financial woes and its future role within GSA lies in better public relations. Woods believes FTS is hurt by its lack of flesh-pressing in the power circles of Washington.

In a town where face-time is priceless and decisions often are based more on impressions than facts, FTS is in a fight to prove its true worth, beyond what the numbers show. If the agency loses that battle, says Woods, it will be for lack of trying. "It won't be reality that kills them," he says. "It'll be the perception of reality."

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