Going Commercial

Uncle Sam is in the process of a major
transformation. After months of budget battles that caused repeated government shutdowns and employee furloughs, agencies have gone into survival mode. With the help of accounting firms and various consultants, federal organizations have spent the year examining ways of doing more work with fewer people and less money. Recent legislation and White House initiatives such as the National Performance Review have forced them to consider whether they should be doing the work at all.

Current thinking on the subject goes like this: Why should we drain our labor pool doing jobs that the private sector does equally well-or even better-for less money? Why not shift non-mission-critical work to commercial firms and free up resources to focus on core competencies vital to agency objectives?

The Office of Management and Budget reports that agencies already spend $114 billion a year on five categories of services: research and development, construction, automatic data processing, architecture/engineering tasks and miscellaneous work covering everything from janitorial services to consulting. Outsourcing will likely continue to grow as agencies respond to pressures to eliminate more jobs. Austerity will remain the order of the day while Congress and the White House work to cut more than $900 billion in projected government spending over the next seven years to eliminate a federal budget deficit that has lingered over two decades.

"The challenge for public officials today is to provide essential services in a cost-effective manner," says William Eggers, privatization center director at the Reason Foundation, a libertarian think tank in Los Angeles. "Privatization increases competition and competition increases productivity and lowers costs."

Contracting Outlays Flat

Lowering costs is certainly a goal for every federal organization these days. Although overall contracting appears to have increased from $173 billion in fiscal 1994 to $179 billion last year, according to data compiled for Government Executive by Eagle Eye Publishers Inc., actual spending has remained relatively flat. The discrepancy is due to late filing of procurement data by some agencies and improved reporting techniques by others. The Tennessee Valley Authority, for instance, went from $1.7 billion in total purchases in fiscal 1994 to more than $4 billion last year. But the increase is a result of more accurate reporting, not additional buying. (Also, the $179 billion covers only contracts worth $25,000 or more; smaller contracts bring total federal contracting outlays to about $200 billion.)

The year's top 10 government contractors earned $54.2 billion (30 percent of total spending on prime contracts), down almost $1 billion from the previous year. Among the biggest moves in Government Executive's roster of top contracts was made by Tenneco, which jumped from 41st in last year's rankings to 5th place this year. The surge from $508 million to $3.7 billion in sales was due to delivery of a new Nimitz-class aircraft carrier.

Flat agency budgets have prompted more industry consolidation. In the past year, the trend toward mega-mergers and acquisitions among federal contractors continued. The largest deal was Lockheed Martin's $9.1 billion purchase of Loral's defense electronics and systems integration businesses. Northrop Grumman bought Westinghouse's defense electronics unit for $3 billion while Litton Industries picked up PRC, a systems integrator, for $425 million.

Spending at civilian agencies rose 6 percent to $60.6 billion from $57.4 billion in fiscal 1994, with the Energy Department and NASA purchasing a combined total of $28.6 billion (47 percent) of the civilian total. Rankings of civilian agency contractors remained about the same, with the exception of TRW, which catapulted from 19th place in fiscal 1994 ($430 million in contract awards) to 8th place last year ($690 million in awards)-a gain of 61 percent. TRW, which derives about 30 percent of its income from civilian agencies, attributes the gain to a Treasury Department communications contract.

Of the $179.1 billion the government spent on products and services last year, $118.5 billion, or 66 percent, went toward Defense Department procurements. This is a different picture from a decade earlier when, at the height of the Reagan-era defense buildup, DoD procurements accounted for 80 percent of total federal purchases.

President Clinton has worked to cut the defense budget to one of its lowest points since before Pearl Harbor. Reshaping of the military-industrial complex has resulted in increased emphasis on training, simulation and C3I (command, control, communications and intelligence). The Pentagon's goal is to build a smaller but more lethal military with the strategic tactical thrust to go after aggressors in places like Iraq, Syria, North Korea and Libya.

Flexibility seems to be the key to DoD's goals. Future defense procurements will seek weapons systems with open systems architectures that make upgrading easy. But the budget for modernization of weapons systems has declined in real terms by 59 percent since 1985-and has fallen from 43 percent to 29 percent of DoD's budget, according to figures published earlier this year by the Defense Budget Project.

Since future DoD budgets are expected to decline, funding for modernization efforts will have to come from savings in support operations such as depot maintenance, base services and health care-areas defined by some as ideal for privatization. The Electronic Industries Association recently predicted that DoD's procurement budget actually will actually increase in the next decade while the overall defense budget continues to fall. EIA attributes the predicted rise to privatization of support operations.

The Defense Department has spent the past year examining which areas could be privatized without compromising military readiness. A Coopers & Lybrand study commissioned by the Pentagon showed how DoD could save $1 billion alone by farming out data-processing operations during the next 10 years. That and other research has created high-level support for privatization within certain DoD sectors.

"Outsourcing and privatization can provide a critical means of obtaining increased funding for the modernization of the DoD's military equipment and systems," Deputy Defense Secretary John White said at a briefing earlier this year.

Bipartisan Crusade

Federal outsourcing initiatives began as far back as Revolutionary War days when the Navy needed help building the USS Constitution. With the project behind schedule, the government summoned shipbuilding companies to Boston from as far away as Georgia. Work was done in such haste that oak and pine used on the vessel's hull and masts was still green, thus causing cannonballs to bounce off and earning the frigate the nickname "Old Ironsides."

Modern-day outsourcing reached a peak in the 1980s during the Reagan defense buildup. But a flurry of scandals, coupled with audits revealing cost inefficiencies, prompted many agencies to think twice about contracting out work to the private sector. Congressional hearings and subsequent newspaper headlines made outsourcing a dirty word during much of the 1980s.

Then several events turned the tide. The private sector got outsourcing fever. Xerox farmed out all its information-technology operations to Electronic Data Systems in a $3.2 billion contract. Hughes Aircraft gave Computer Sciences Corp. its data-processing business for $1.5 billion. And IBM's Integrated Systems Solutions Corp. struck a 10-year, $3 billion outsourcing deal with McDonnell Douglas.

State and local governments soon jumped onto the bandwagon, privatizing everything from prisons to road systems. Before long, outsourcing pilot projects began to spring up in the federal government as well. These have been fueled by the second part of Vice President Gore's National Performance Review, which urges agencies to evaluate all programs and determine whether work should be performed by the government.

Before making a decision to farm out services, agencies are required to perform lengthy cost-comparison studies to see if it is economically advantageous. OMB recently revised its A-76 Circular-the federal rulebook on contracting out-to ease administrative burdens and encourage competition between agencies and the private sector.

Recent legislation also has helped to boost support for privatization efforts. Many lawmakers on both sides of the aisle see outsourcing as a way to reduce employment while cutting costs and improving government services. Laws such as the Chief Financial Officers Act and the Government Performance and Results Act have forced agencies to tie strategic plans to budgets and to set up qualitative performance measures for those investments.

Procurement-reform initiatives such as the Federal Acquisition Streamlining Act, the Federal Acquisition Reform Act and the Information Technology Management Reform Act also have forced agency managers to rationalize investments. Contracting officers are being encouraged to take prudent risks and to base procurement decisions on what delivers the best value to the agencies.

"The only way for the contracting profession to survive is to reinvent our own image," said Steven Kelman, administrator of OMB's Office of Federal Procurement Policy, at a recent acquisition-reform conference organized by Government Executive and the Council for Excellence in Government and sponsored by BDM, Informix and Northrop Grumman. "We have to show that we can add value to the process. Acquisition reform is not simply an issue of streamlining but freeing resources so we can put our energy into how to obtain results for our missions."

Saving Money, Gaining Flexibility

Outsourcing is simply the only way to go for some cash-strapped organizations. By contracting out work that they otherwise would do themselves, agencies can save time and money while gaining flexibility to deal with future growth or decline. New projects can be added without increasing employment or retraining workers and others can be scrapped without worrying about where to reassign workers.

Privatization's most vocal defenders believe outsourcing efforts could trim federal spending by as much as 40 percent. The Reason Foundation argues that an aggressive, governmentwide privatization campaign could produce more than $350 billion in one-time proceeds from the sale of federal assets. The Defense Department reported to Congress that in programs it managed to outsource last year, operating costs were cut by an average of 31 percent.

Civilian organizations also are reporting big savings from outsourcing. Amtrak, for instance, says that a data-center outsourcing contract will enable it to save $170 million in operating costs and capital expenditures. And the Federal Aviation Administration estimates its Computer Resources Nucleus contract with Electronic Data Systems will save the agency more than $100 million-despite a workload increase of 900 percent.

"In-house support staffs have little incentive to improve productivity levels," says management consultant Peter Drucker. "But an outside contractor knows that it will be tossed out and replaced by a better performing competitor unless quality is improved and costs are cut."

Types of Privatization

True privatization means transferring organizations or projects from the public to the private sector, whereas outsourcing implies that work is contracted out but that the government maintains an oversight role. NASA is transferring all space-shuttle operations to the United Space Alliance, a Rockwell/Lockheed Martin joint venture. In addition, NASA will pay Lockheed Martin almost $1 billion to develop a prototype of the new generation of re-useable spacecraft. The X-33 rocket will be owned and operated by Lockheed and leased to NASA.

"More managerial responsibilities will be transferred to the private sector as NASA consolidates its technical and bureaucratic processes," says NASA Administrator Daniel Goldin, a former TRW executive who believes privatization is key to cutting the cost of space travel. "Contractors will be leading the way with future projects as the agency continues to downsize."

Divestiture is the cleanest form of privatization, of course. Examples are rare so far, although the Energy Department is actively seeking to sell the Alaska Power Administration, the Elk Hills Naval Petroleum Reserve in California, part of the Strategic Petroleum Reserve and the National Institute of Petroleum and Energy. The Office of Management and Budget has concluded that federal entities are candidates for divestiture if it can be proven that they no longer serve a public purpose and are able to compete in the private sector.

A kind of half-way, perhaps even half-hearted, means of moving toward privatization is the so-called "privatization in-place" scheme in which the government says it is closing a facility but then farms work out to many of the same workers now employees of the private entity to which the facility is transferred. This is what's been happening with Pentagon efforts to privatize major maintenance depots in California and Texas.

Government work also can be transferred to an employee stock ownership plan (ESOP). The Office of Personnel Management recently converted its investigative services branch into an ESOP. Work at the newly created private company, known as the U.S. Investigations Services, will be performed by 700 workers from OPM's Office of Federal Investigations.

"This will move us toward the smaller, flatter, more efficient, more market-driven government of the future," OPM Director James King told a House subcommittee earlier this year. "We expect to save about $25 million over the next five years."

GSA, the government's central purchasing agency and real estate owner, also is considering an ESOP structure. The agency has asked Arthur Anderson & Co. to examine its holdings and devise a strategy for selling off buildings it can lease back for federal use.

Clearing Hurdles

Outsourcing initiatives can be difficult to implement in the public sector because of the government's security concerns and unique agency requirements, such as DoD's limitation on contracting out depot maintenance and repair work. Before proceeding down the privatization path, agencies are advised to conduct due-diligence reviews that can determine compliance with applicable regulations and eliminate any hurdles.

One of the most anticipated obstacles-union opposition-has not materialized as predicted. With the exception of a suit recently filed by the American Federation of Government Employees to stop privatization efforts at Kelly, McClellan and Newark Air Force bases, opposition to on the part of federal unions has been muted. ESOP schemes and other privatization initiatives are seen as plausible alternatives to layoffs.

Another potential problem, corruption, is being guarded against with the help of close monitoring. New outsourcing contracts are carrying shorter terms that make them easier to manage than the mega-deals of the 1980s. And more agencies are expected to follow the trend of selective outsourcing, whereby separate companies each handle small components of an operation, instead of one company doing an entire program.

"Contract management is more important than ever now that more of the private sector is delivering services," says Allan Burman, who was administrator of the Office of Federal Procurement Policy during the Bush Administration. "With the right amount of oversight, commercial ventures can pay off handsomely."

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