Defense Department's New Definition of "Commercial Item" Will Save Money

By SCOTT AMEY

The Department of Defense (DoD) is taking a major step in stopping the waste of taxpayer dollars. POGO recently learned that DoD sent a legislative proposal to Congress to narrow the definition of a "commercial item" to mean goods or services that are actually sold to the general public in "like quantities." This proposal is a huge improvement over the current definition, a broadly worded definition open to abuse because it includes good or services “of a type” that are “offered” for sale or lease.

Why does this matter? Once a good or service is considered “commercial,” the government has little to no information about the relative cost of a good or service, and has little ability to audit the numbers behind the cost that the government is paying. If the new definition becomes law, DoD will no longer have to buy C-17s, C-130Js, or billions of dollars of specialized weapons-related subsystems (see pages 8-10) as commercial items. This should yield savings for taxpayers, as it has in the past. In 2006, for example, the conversion of the C-130J from a commercial item, which caused the repricing of 39 aircraft, resulted in “institutional net savings of $168 [million]”—thank you, Senator John McCain (R-AZ, who was credited with the Air Force’s actions).

If this issue sounds vaguely familiar it is because POGO has recommended changing the definition of commercial item as far back as 1999. In 2005, POGO provided written testimony to Senator McCain and the Senate Armed Services Airland Subcommittee, urging that the commercial item designation only be used for goods and services whose price is set by the genuine commercial marketplace. The next year, we asked Congress to look into the upsurge in the number of no-bid commercial item contracts.

Our most recent recommendation to alter the definition of a commercial item came in 2011, when we asked Congress to re-establish the taxpayer-protection checks and balances that have been removed from the contracting system, including requiring contractors to provide cost or pricing data to the government for all contracts except those where the actual goods or services being provided are sold in substantial quantities in the commercial marketplace.

Unfortunately, many government commercial item purchases have been awash in wasteful spending based on the elasticity of the current definition. Items with little or no commercial market availability were easily labeled as commercial, and were purchased on a sole source basis (i.e., non-competitive contracting) with no objections by government acquisition staff or reviews by auditors. The “commercial item” definition was developed by industry and enacted into law in the 1990s (as part of so-called “acquisition reform”) precisely in order to prevent the contracting agencies from obtaining cost or pricing data when adequate price competition—which exists in real commercial markets—does not exist. The law should more accurately have been called the “sole source contracting without cost or pricing data act.”

Not surprisingly, the contracting industry is opposing DoD’s proposal, claiming that competition will suffer as certain companies won’t do business with the federal government because of stricter contracting rules.

The argument that the elimination or scaling back of the “commercial item” definition will inhibit so-called “commercial companies” from doing business with the government is nonsense. Under the law as it existed prior to the development of the “commercial item” definition, the government did not obtain cost or pricing data in most instances unless the item being purchased was being bought on a sole source basis. The benefit of the current definition—for contractors at least—is that it permits sole source without cost or pricing data. This is because once an item or service is labeled as “commercial,” (under an extraordinarily creative definition), the government is legally denied access to certified cost or pricing data which is used to ensure that the items or services being purchased are reasonably priced.

Years ago, a DoD Inspector General (IG) audit report about an $860 million contract for spare parts used on weapon systems found that “higher prices were paid for commercial items” because “there was no competitive commercial market to ensure the reasonableness of prices.” According to the report, the contractor, Hamilton Sundstrand Corporation, “refused to provide [Defense Logistics Agency] contracting officers with ‘uncertified’ cost or pricing data for commercial catalog items, and terminated Government access to the Sundstrand cost history system”; and “guidance on commercial items qualified any item ‘offered for sale … to the general public’ as a commercial item without clearly addressing commercial pricing concerns, particularly when DoD was the primary customer procuring significantly larger quantities than other commercial customers.”

The DoD proposal would put an end to the kinds of disputes highlighted in that report. In fact, DoD’s analysis states:

For example, GAO Report 06-838R dated July 7, 2006, cites “adequate pricing” as one of five key area vulnerabilities of the DoD. In part, the report states that “Also, DoD sometimes uses commercial item procedures to procure items that are misclassified as commercial items and therefore not subject to the forces of a competitive marketplace. While the use of commercial item procedures is an acceptable practice, misclassification of items as commercial can leave DoD vulnerable to accepting prices that are not the best value for the department.”

...

These amendments of the law would prompt commensurate adjustments of the Federal Acquisition Regulation and ensure that commercial goods and services are acquired by the DoD and other Federal agencies only at fair and reasonable prices consistent with comparable sales actually observed in the competitive marketplace.

After many years of ignoring the concerns of POGO, the Government Accountability Office, and the Acquisition Advisory Panel (which recommended that the definition of commercial services be amended to delete the phrase “of a type”), Congress is in a better position to give DoD the tools it needs to eliminate a vulnerability to “pricing deficiencies” that could save taxpayers billions of dollars.

Scott Amey is POGO’s general counsel.

Follow @SAmeyJD

Image via 401K.

Comments

[Dfens]

Scott, you used a lot of words there to say exactly nothing. That must be one of the hazards of living too close to Washington DC. If you were to ask anyone who would give you a straight answer in the defense community where the problems are with COTS, it would be in the procurment of MODIFIED COTS, or MCOTS. That has been a true disaster of epic proportions. In the case of MCOTS, what you say happens with regard to sole sourcing does, in fact, occur. COTS, on the other hand, has been a huge success. The only reason it is being changed is because it has been successful. Yet again you duck the issues with the C-130 AMP. Yet again you side with the big military contractors against the US taxpayer. Forget the spin and hype, the truth about government procurement is plain as your face.

[Scott Amey]

DFENS, you are confusing the “Commercially available off the shelf” (COTS) definition with the definition of a commercial item. These are two different things (see FAR 2.101). The definition of COTS is essentially the same as the old pre-FASA definition of a “commercial item.” At POGO, we call COTS “real commercial items.” In contrast, “commercial items” as defined in the FAR (as differentiated from COTS), are faux-commercial items for the most part. The definition of a “commercial item” was largely developed to permit sole source contract awards to be made without obtaining certified cost or pricing data. With respect to “commercial items” and not COTS, you are ignoring the fact that several government contracting offices and expert panels have recommended changing the commercial item definition. DoD, the Department of Defense Panel on Contracting Integrity (see p. 22), and the Acquisition Advisory Panel (see p. 31) have recommended that the “of a type” and “offered” for sale should be removed from the definition. Additionally, DOD has acknowledged that because “commercial item” contracts are awarded without certified cost or pricing data (frequently on a sole source basis), the government is vulnerable to overpricing.

POGO's frustration is that the commercial item designation has been abused for years and it's disturbing that agencies are not correcting the problem. Why should it take the involvement of Senator McCain before the AF made the conversion?

Truly commercial items, such as COTS, will continue to operate under the status quo, but goods or services that are not sold in substantial quantities in the commercial marketplace should be awarded under FAR Part 15, not FAR Part 12. DoD commercial item expenditures were more than $75 billion in 2011 -- that amount will be lower under DoD’s legislative fix, but I guarantee that increased access to cost or pricing data will also significantly drive down the price tags on those buys, too.

In response to Prof. Yukins, luring in non-traditional contractors was the basis for commercial item and other transaction authority, but there have been questions about whether non-traditional contractors were coming to the table. From one subsequent comment and some data related to awards via those contracting vehicles, it doesn’t look like those vehicles worked as promised in terms of opening up a larger commercial market after all of the defense mergers in the 1990s. When the top 100 contractors still receive the majority of federal contract award dollars, there are problems in the system. What commercial contractor is going to spend the time and resources to go up against the heavy hitters, especially when there are so many bundled requirements that bar competition? Our view is that contractors have attempted to gut TINA for many years prior to the creation of FARA and FASA, and commercial items were a vehicle to conceal data from the government.

[Dru Stevenson]

This is a great development and VERY helpful analysis by POGO! Congrats on your effective advocacy over the years on this point - your efforts are coming to fruition. I directed my readers at the Privatization Blog over here to get the scoop. Much better than the coverage in the Federal Times.

http://www.privatizationblog.com/2012/05/mechanics-of-government-make-or-buy.html

[Dfens]

Sometimes I wonder who will save us from POGO. I mean, you seriously consider a tightening of the rules regarding what is considered to be Commercial Off the Shelf (COTS) to be a victory for the US taxpayer? Excuse me, but that is the stupidist thing I've ever heard of. If the government buys something as COTS, it means they don't have to reimburse the vendor for development costs. What the hell are you saving us from, the only good thing to happen in government contracting in the last 4 decades? The C-130J is a classic example of how POGO continues to sell out the best interests of the taxpayers in favor of the interests of the government contractors.

The C-130J was developed by Lockheed at their own expense. POGO advocated the military not buy these aircraft and was instead an advocate for the US taxpayer funded C-130 AMP modification of earlier model (read that as "worn out") C-130 aircraft the military already owned. The AMP program was initially to cost $4 billion over 10 years with $1 billion allocated to development of the new avionics. Instead it took 10 years of development and cost $6 billion.

Boeing "won" the program by buying the services of the Air Force's top procurement official, Darlene Druyun, who subsequently spent a year in jail for this little favor. Boeing stretched their earnings to nearly a billion dollars off this contract through their judicious application of sloth and stupidity, and managed to get the program cancelled before a single modified aircraft had been made operational (another thing POGO seems always to be in favor of), but not once in that entire process has POGO had anything negative to say about the affair. POGO advocated for a program that spent $6 billion and delivered nothing, but wants you to do the happy dance over $168 million they claim to have helped you save.

Meanwhile the entire $168 million POGO claims their champion John McCain saved you was entirly due to the fact that the new contract for C-130Js absolved Lockheed of any liability for aircraft that were lemons. That is to say, they saved you money by not buying the extended warrantee.

Seriously, POGO, do you people not have any pride in what you do? Who is going to save us from POGO, the right arm of government contractors everywhere?

[Jaime Gracia]

This is real reform that has benefit and meaning to the taxpayer. I would argue that altering this definition would in fact lower the barriers to entry to many companies who actually do sell "commercial items", which would now have a more clear definition of the market and their products. This can only help small businesses, and I think this is smart, sensible reform.

Now if procurement personnel would use FAR Parts 12 and 13 properly, this too could go along way to lowering overall costs for both industry, and the government by lowering acquisition lead times, streamlining processes, and providing better products and services to the government.

A powerful one-two combination.

[Christopher Yukins]

Thanks to Scott Amey, and POGO, for tracking this important subject. As a professor, I don't necessarily disagree with Scott's concerns, but I would caution that there is a bigger issue here. The federal procurement community tends to see the "commercial item" revolution of the 1990s as an attempt to lure commercial vendors into the federal marketplace -- and tends to be frustrated when those commercial vendors are not subject to the same disclosure requirements that cover traditional contractors. I would argue that's looking at the problem backwards. The "commercial item" revolution was, at least arguably, a first step in better integrating the federal government's procurement system into the broader economy. Since federal procurement ($500 billion) equals over 3 percent of the U.S. GDP ($14.5 trillion), there is no excuse -- over the long term -- for holding the federal procurement system as a separate island, isolated from the mainstream U.S. economy. The commercial item revolution arguably was not an attempt to shield contractors, but rather a first step in integrating federal procurement into the broader economy, much as public procurement is integrated with mainstream economic policy in other industrialized nations.