oversight

Contract Management: Commercial Use of Share-in-Savings Contracting

Published by the Government Accountability Office on 2003-01-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to Congressional Requesters




January 2003
               CONTRACT
               MANAGEMENT
               Commercial Use of
               Share-in-Savings
               Contracting




GAO-03-327
                                               January 2003


                                               CONTRACT MANAGEMENT

                                               Commercial Use of Share-in-Savings
Highlights of GAO-03-327, a report to          Contracting
Congressional Requesters, House of
Representatives




The Congress and federal agencies              SIS can be a highly effective contracting technique to motivate contractors to
are increasingly turning to                    generate savings and revenues for their clients. But to be successful, clients and
performance-based contracting                  their contractors need to be specific and in agreement in their goals and
methods to enhance the delivery of
government services. Share-in-                 objectives, as well as how to achieve them. This can be a difficult task for more
Savings (SIS) contracting–in which             complex services, but the companies we spoke with found that pursuing this
the contractor assumes more risk               type of arrangement was worth the extra effort.
by investing upfront costs but also
receives a share in any savings                Conditions that Facilitate Success
generated by its efforts–is one
performance-based technique that
                                               •   An Expected Outcome Is Clearly Specified. By outcomes, we mean such
Congress is trying to promote. We
were asked to examine its use by                   things as generating savings by eliminating inefficient business practices,
industry in terms of whether there                 realizing savings through conservation measures, or identifying new
were any key conditions that                       revenue centers. Because the success of SIS relies heavily on the ability to
needed to be in place to make this                 identify and track savings or revenues, it is critical that a contractor and
technique successful.                              client have a clear understanding of what they are trying to achieve.
                                               •   Incentives are defined. Both the client and the contractor need to strike a
In conducting our review, we found
                                                   balance between the level of risk and reward they are willing to pursue. A
that the form of SIS used in a
commercial contract varied by                      pure SIS arrangement offers attractive benefits, such as no upfront
contract. Some contracts employed                  investment on the part of a client and a bigger return for a contractor. But
a basic SIS approach, in which a                   there are real risks, particularly for a contractor, if savings or revenues are
contractor’s total compensation                    not realized as anticipated. As a result, clients and contractors need to work
was paid entirely through sharing a                through incentives and risks and come to agreement on how far they would
portion of a client’s savings or                   take their SIS arrangement.
increased revenues. And some                   •   Performance measures are established. By its nature, SIS cannot work
employed a tailored approached in                  without having a baseline and good performance measures to gauge exactly
which contractors were paid for at
                                                   what savings or revenues are being achieved. Agreement must be reached
least some portion of their time and
materials costs, even if savings or                on how metrics are linked to contractor intervention. For some services,
increased revenues were not                        such as energy management, they are relatively easy to define. For more
realized. We performed a detailed                  complex services, such as those in the information technology industry, this
analysis on four specific contracts                can be a much more difficult task.
to identify conditions that fostered           •   Top management commitment is secured. This is paramount in any SIS
success.                                           arrangement. A client’s top executives need to provide contractors with the
                                                   authority needed to carry out solutions, since change from the outside is
                                                   often met with resistance. They also need to help sustain a partnership over
We did not make recommendations                    time since relationships between the contractor and client can be tested in
in this report.                                    the face of changing market conditions, legal pitfalls, and other barriers.

                                               To date, federal agencies have made limited use of SIS contracting. Officials
                                               we spoke with noted that these arrangements may be difficult to pursue, given
                                               potential resistance and the lack of good baseline performance data. However,
www.gao.gov/cgi-bin/getrpt?GAO-03-327.
                                               it may be worthwhile for agencies to examine ways to overcome potential
To view the full report, including the scope   problems to achieve better outcomes.
and methodology, click on the link above.
For more information, contact David Cooper
(202) 512-4125, CooperD@gao.gov.
United States General Accounting Office
Washington, DC 20548




                                   January 31, 2003

                                   The Honorable Tom Davis
                                   Chairman
                                   Committee on Government Reform

                                   The Honorable Jim Turner
                                   Ranking Minority Member
                                   Subcommittee on Technology
                                    and Procurement Policy
                                   Committee on Government Reform
                                   House of Representatives

                                   The Congress and federal agencies are increasingly turning to
                                   performance-based contracting methods as a way to enhance the delivery
                                   of government services. You requested that we determine how Share-in-
                                   Savings (SIS) contracting, one performance-based technique, is used in the
                                   commercial sector. This report responds to your request by examining
                                   four commercial SIS contracts and identifying common characteristics
                                   that made them successful. For the purposes of this report, we have
                                   defined SIS contracting as an agreement in which a client compensates a
                                   contractor from the financial benefits derived as a result of contract
                                   performance. Financial benefits can come from either contractor-
                                   generated savings or revenues.


                                   We found variations in the forms of SIS used in the four commercial
Results in Brief                   contracts we studied. The forms ranged from a basic SIS approach, in
                                   which a contractor’s total compensation was paid entirely through sharing
                                   a portion of a client’s savings or increased revenues, to a tailored approach
                                   in which contractors were paid for at least some portion of their time and
                                   materials costs, even if savings or increased revenues were not realized.

                                   We also found, in the commercial SIS contracts we reviewed, that four key
                                   conditions facilitated the development and execution of the SIS contracts.
                                   First, the client and contractor clearly defined an expected outcome from
                                   the arrangement, such as generating savings by eliminating inefficient
                                   business practices, realizing savings through conservation measures, or
                                   identifying new revenue centers. Second, both client and contractor had
                                   incentives to use this contracting technique. SIS contracting is attractive to



                                   Page 1                                         GAO-03-327 Contract Management
             clients who (a) do not have the funds for, or choose not to pay, some or all
             of the up-front costs of a needed project and (b) are willing to pay the
             premium SIS contractors charge for putting some or all of their
             compensation at risk. Contractors, on the other hand, must have
             confidence that the financial benefits they can produce are sufficient to
             cover their costs and provide a profit that rewards them for the increased
             risk they incur. Third, a baseline and performance metrics could be
             established to define a client’s costs and/or revenue prior to, and after,
             contractor intervention. Fourth, the client’s management contributed to
             success by committing to execute the project and implement contractor
             recommendations.

             Overall, the commercial companies we studied, along with other users of
             SIS, have noted that, even when the right incentives and measures are in
             place, other issues could impact a company’s use of SIS contracting. For
             example, parties may blame each other, when savings or increased
             revenues are lower than expected. As a result, before going into such an
             arrangement, both client and contractor need to carefully consider the
             potential risks and rewards of an SIS arrangement and whether the
             conditions that facilitate success are present–something that may not be
             easily achievable in government, which frequently is unable to calculate a
             baseline. On the other hand, companies have found it worthwhile to
             overcome potential barriers to SIS contracting because successful
             arrangements have generated savings and revenues–in one case
             highlighted in this report, $980,000 in annual energy savings, which
             otherwise would not have been realized.

             This report does not contain a recommendation.


             In its basic form, SIS contracting is a contracting and financing technique
Background   in which a contractor, rather than a client, funds the up-front cost of a
             project, and, in return, receives a percentage of the savings that the
             contractor generates for the federal agency. SIS contracting effectively
             shifts the risk of contract performance to the contractor because, in
             addition to providing the up-front capital, the contractor receives payment
             only after savings are realized. In short, a contractor is paid only for
             results, not just effort. The attraction of this technique to the federal
             government is the ability to capitalize on modern technology, while not
             incurring the up-front expense. Conversely, the attraction to a contractor
             is the potential for a greater return, because of the increased risk, than
             from a traditional contract. Both parties involved in an SIS contract



             Page 2                                        GAO-03-327 Contract Management
                      anticipate that a contractor’s potential to earn more will generate an
                      incentive to save more, thereby creating a win-win situation.

                      The appeal of SIS contracting has generated congressional interest to
                      expand its use within the federal government. For example, the Clinger-
                      Cohen Act of 1996 authorized pilot programs to (1) contract on a
                      competitive basis with a private sector source to provide the federal
                      government with information technology solutions for improving mission-
                      related or administrative processes of the federal government and (2) pay
                      the private-sector source an amount equal to a portion of the savings
                      derived by the federal government from any improvements. The recent E-
                      Government Act of 2002 expands authority to enter SIS contracts in fiscal
                      years 2003 through 2005 and also provides for incentives to federal
                      agencies.1

                      Despite this interest to expand its use, there are few documented
                      examples of SIS contracting in the federal government. One of the best-
                      known examples of federal SIS contracting is in the Department of Energy
                      (DOE). The National Energy Conservation Policy Act, as amended by the
                      Energy Policy Act of 1992, and subsequent executive orders require
                      federal agencies to reduce their consumption of energy in federal
                      buildings. This law provided that federal agencies may enter into SIS
                      contracting as a way of encouraging industry to help achieve this goal and
                      required DOE to establish methods and procedures to implement this
                      authority, which allows federal agencies to realize energy efficiencies with
                      minimal up-front costs to the government. Accordingly, DOE’s Federal
                      Energy Management Program crafted an energy savings contract under
                      which energy service contractors are expected to contribute the up-front
                      costs identifying a federal facility’s energy needs and buying, installing,
                      operating, and maintaining energy-efficient equipment to cut energy bills.
                      In return, the companies get a share of energy savings generated by the
                      improvements.


                      We found various forms of SIS were used in the four commercial contracts
Forms of SIS Varied   we studied. The forms ranged from a basic SIS approach, in which a
by Contract           contractor’s total compensation was paid entirely through sharing a
                      portion of a client’s savings or increased revenues, to a tailored approach



                      1
                          Public Law 107-347, December 17, 2002.




                      Page 3                                        GAO-03-327 Contract Management
                          in which a contractor was paid for at least some portion of the time and
                          materials costs, even if savings or increased revenues were not realized.
                          The difference between the approaches was the level of risk the
                          contractor assumed and the portion of the contractor’s compensation tied
                          to the savings and/or revenue generated.

                          Of the four situations presented in this report, two used a basic SIS
                          approach in which the contractors’ compensation was entirely at risk–
                          unless they produced results, and two used a tailored approach. The basic
                          SIS approach was used by (1) the Massachusetts Institute of Technology
                          (MIT) and its contractor, Alliant Energy Integrated Services/Cogenex, to
                          reduce utility costs in MIT’s 100-building campus and (2) Texas Online
                          Authority and its contractor, BearingPoint,2 to create an Internet Web site
                          to provide state and local government services to Texas businesses and
                          citizens. The tailored approach was used by (1) Best Buy and its
                          contractor, Accenture, to identify cost reduction opportunities and
                          potential new revenue centers and (2) Harley-Davidson and its contractor,
                          Henkel Chemical Management, to reduce Harley-Davidson’s chemical
                          management costs.


                          For the commercial SIS contracts we studied, four conditions emerged as
Certain Conditions        playing a key role in facilitating the development and execution of the SIS
Facilitated the Use of    contracts. As shown below, the client and contractor (1) defined an
                          outcome, (2) determined whether SIS incentives were appropriate, (3)
SIS                       established a baseline and performance metrics tied to their desired
                          outcome, and (4) obtained client commitment to success.


An Expected Outcome Was   SIS contracting was considered only after the client and contractor
Clearly Defined           defined an expected outcome, such as realizing savings through energy
                          conservation measures, identifying new revenue centers, or generating
                          savings by eliminating inefficient business practices. A clearly defined
                          outcome was required so that contractors could focus their resources,
                          knowledge, and expertise on obtaining solutions to their clients’ needs
                          and/or business problems. To define an outcome, the client and contractor
                          examined the client’s existing systems and/or business processes to
                          determine whether opportunities existed to generate savings and/or



                          2
                              Formerly KPMG Consulting.




                          Page 4                                        GAO-03-327 Contract Management
                                       revenues for the client. The examination process involved an open
                                       exchange of information and took, in one case, 6 months to complete.

Table 1: How Clients and Contractors Defined an Expected Outcome

Client/contractor                        How an expected outcome was defined

MIT/Alliant Energy Integrated            Outcome: Reduced utility costs.
Services/Cogenex
                                         In 1987, MIT recognized the need to reduce utility costs by upgrading its inefficient
                                         lighting, heating, and air conditioning systems. Because managing such a project is not
                                         an MIT core competency, MIT solicited the assistance of Alliant/Cogenex.
                                         Alliant/Cogenex is an energy service company whose expertise is to reduce energy
                                         costs by determining whether energy inefficiencies in facilities exist and, if so,
                                         executing the changes needed to eliminate the inefficiencies. Through its energy audit,
                                         Alliant/Cogenex determined that enough energy savings (the amount MIT would have
                                         paid if improvements were not made) could be accomplished over 10 years to pay for
                                         the improvements. In the end, MIT saved $980,000 annually over what it would have
                                         paid had the improvements not been made.

Texas Online Authority/BearingPoint      Outcome: Enable on-line access to government services.

                                         The Texas Online Authority was established to satisfy an unfunded state legislative
                                                                              a
                                         mandate to create an Internet site to provide the services of state agencies, counties,
                                         cities, and institutions of higher learning to Texas businesses and citizens. The intent
                                         of the legislation was to provide a variety of online services such as driver license and
                                         motor vehicle registration renewals, occupational license and permit renewals, and
                                         college tuition payments. BearingPoint responded to a Request for Offer and was
                                         awarded the contract to develop and operate the Web site at no cost to the state.
                                         BearingPoint’s confidence that it could meet the contractual requirements, recover its
                                         costs,b and earn a profit rested on (1) state legislation encouraging/requiring the use of
                                                          c
                                         online services and (2) a Texas Online survey of potential users revealing that
                                         business and citizens were willing to pay the additional fees required to allow
                                         BearingPoint to recover its costs and earn a profit.

Best Buy/Accenture                       Outcome: Higher revenues and reduced costs.

                                         Best Buy wanted to identify cost reduction opportunities and new revenue centers
                                         because, in 1996, Best Buy faced a dilemma: fast, furious growth but sagging profits,
                                         which, if left uncorrected, would result in operational losses that could drive the
                                         company into bankruptcy. Best Buy recognized that it was best served by entering into
                                         a consulting agreement with an organization whose retailing experts could
                                         independently study Best Buy operations and business processes. Accordingly, Best
                                         Buy contracted with Accenture to perform a study of their operations and business
                                         processes. The purpose of the study was to determine if Accenture could (a) identify
                                         inefficiencies contributing to Best Buy’s sagging profits, and, if so, (b) if Accenture,
                                         working in partnership with Best Buy, could eliminate such inefficiencies. As a result of
                                         that study, which lasted 6 months, Accenture determined that there were cost
                                         reduction opportunities and potential new revenue centers not recognized by Best Buy.




                                       Page 5                                                  GAO-03-327 Contract Management
Client/contractor                     How an expected outcome was defined

Harley-Davidson/Henkel Chemical       Outcome: Reduced costs for indirect materials.
Management Group
                                      Harley-Davidson wanted to realize cost savings from the indirect materials and
                                      services needed for the maintenance, repair, and operations of their facilities.
                                      Examples of indirect services and materials include building repair, janitorial services,
                                      vehicle maintenance, plumbing, and chemical management. Through 1998, Harley had
                                      been spending about $85 million annually with more than 3,500 suppliers for such
                                      indirect materials and services. To help realize cost savings, Harley contracted with
                                      Henkel. The Henkel Chemical Management Group has a core competency in chemical
                                      management. Examples of indirect materials and services, which Henkel could help
                                      achieve cost savings over what Harley had been paying, include oils/greases,
                                      coolants, washer/cleaning fluids, adhesives, and paint additives/chemicals to name a
                                      few. After reviewing Harley’s chemical management program, Henkel determined it
                                      could deliver cost savings through improved pricing by leveraging buying power and
                                      the introduction of new usage and disposal efficiencies.

                                  Sources: MIT/Alliant Energy Integrated Services/Cogenex; Texas Online Authority/BearingPoint; Best Buy/Accenture; and Harley-
                                  Davidson/Henkel Chemical Management Group.
                                  a
                                  A high available Internet facility and portal.
                                  b
                                   Forty-three million dollars for capital equipment plus $15 million to $20 million for operations and
                                  variable expenses, as of December 4, 2002.
                                  c
                                   One example is Texas Senate Bill 645 (enacted by the 77th Legislature), which requires 23
                                  occupational licensing entities to use a common Internet licensing system on Texas Online.


Incentives to Use an SIS          Once the outcome had been identified, both the client and the contractor
Contract Were Identified          determined that it was in their individual best interest to engage in an SIS
                                  contracting arrangement and they struck a balance between the level of
                                  risk and reward they were willing to pursue. For a client, SIS contracting is
                                  attractive because it enables a company to initiate a project without
                                  borrowing or investing its own funds. Moreover, it ties contractor
                                  compensation to results rather than just contractor recommendations that
                                  may not translate into the savings or increased earnings a client expects.
                                  But a client may hesitate at pursuing a basic SIS approach because that
                                  would require foregoing savings generated, and instead opt to finance
                                  some up-front costs or to partially compensate the contractor for effort in
                                  order to obtain a greater share in the savings. For contractors, SIS
                                  arrangements provide an opportunity to earn a return on investment that
                                  is higher than a traditional contract. But the contractor faces the risk that
                                  savings or increased revenues will not be realized after investing heavily in
                                  the project or will be realized more slowly than anticipated. To mitigate
                                  that risk, the contractor may also decide not to pursue a basic SIS
                                  arrangement. In each of the cases we examined, the client and contractor
                                  were able to work through these issues and come to agreement on how far
                                  they would take their SIS arrangement.



                                  Page 6                                                                         GAO-03-327 Contract Management
Table 2: How Clients and Contractors Determined Incentives Were Appropriate

Client/contractor                       How incentives were determined to be appropriate

MIT/Alliant Energy Integrated           MIT entered into an SIS contract because it (1) allowed MIT to reduce utility costs
Services/Cogenex                        without having to lay out any cash for needed upgrades and (2) provided that
                                        Alliant/Cogenex compensation be made entirely through sharing a portion of the savings
                                        realized. Alliant/Cogenex installed and maintained energy efficient equipment and
                                        assumed the risk that enough savings would be realized to compensate for the up-front
                                              a
                                        costs incurred and provide a profit commensurate to the risk undertaken.
                                        Alliant/Cogenex’s confidence that the SIS contract would be profitable rested on its MIT
                                        energy audit and its experience in providing energy-savings measures in over 3,200
                                        customer buildings. Those energy-saving measures included the installation of energy
                                        efficient lighting, motors, chillers, boilers, building automation systems, and air
                                        conditioning systems. In the end, MIT saved $980,000 annually over what it would have
                                        paid had the improvements not been made.

Texas Online Authority/BearingPoint     The State of Texas, through Texas Online, found a vehicle to offer Internet-based
                                        services to its businesses and citizens from state agencies and local governments,
                                        without spending general revenue funds. BearingPoint agreed to provide the equipment,
                                        setup, and ongoing operation of the Web site–including hardware, software, and
                                        staffing–at no cost to the state. In addition, once operational, Texas Online was designed
                                        to be self-supporting through the use of fees to use the service. BearingPoint determined
                                        that it could recover its investment by 2006 and would achieve the returns that would
                                        reward it for the risks it took in funding the project. The investment recovery projection
                                        was based on (1) the commitment made by the state (see table 4) and (2) numerous
                                        assumptions, including those pertaining to the continued growth in using the Internet as
                                        a medium to acquire government services.

Best Buy/Accenture                      Best Buy entered into a gain-sharing contract with Accenture because, with their
                                        operational losses, Best Buy did not want to risk entering into a typical fee-for-service
                                        contract which could have resulted in paying for a consultant’s advice that may not have
                                        led to improved profits. To reduce that risk, Best Buy wanted to partner with a consultant
                                        committed to success through the sharing of project risks and benefits by being paid, at
                                        least in part, for results achieved. Accenture, through its Best Buy business process
                                        study, was confident it could help deliver needed change in areas such as supplier
                                        consolidations, price negotiation strategies, advertising, inventory levels and in-stock
                                        performance, and buyer support and tools. Further, Accenture convinced Best Buy’s top
                                        management that it had the resources, knowledge, and experience to deliver the needed
                                        change. Finally, Accenture was willing to share risk by reducing its standard consulting
                                        fee in consideration for receiving 20 percent of the Accenture-caused earnings growth,
                                        up to a contractual cap.




                                       Page 7                                                  GAO-03-327 Contract Management
Client/contractor                     How incentives were determined to be appropriate

Harley-Davidson/Henkel Chemical       Harley entered into an SIS agreement with Henkel because Henkel committed to provide
Management Group                      a cumulative savings of 68 percent over a 5-year period, compared to what Harley had
                                      been spending for the products and services, which Henkel now provides. After the total
                                      savings commitments for the contract term are achieved, Harley and Henkel will share in
                                      Henkel-caused savings on a 50/50 basis. In addition, to the cost savings, the SIS
                                      agreement allows Harley to concentrate on its own core competency of manufacturing
                                      motorcycles, while simultaneously benefiting by having Henkel be the single source for
                                      chemical management to include products/services, technical support, and
                                      environmental compliance. Henkel’s confidence that the SIS agreement would be
                                      profitable for them was based on their (1) study of Harley’s chemical acquisition, usage,
                                      and disposal programs; and (2) experience with other manufacturing clients. Henkel
                                      officials said additional incentives include continued growth in their core competency of
                                      chemical management and the goodwill generated by having Harley-Davidson as a
                                      client.
                                  Sources: MIT/Alliant Energy Integrated Services/Cogenex; Texas Online Authority/BearingPoint; Best Buy/Accenture; and Harley-
                                  Davidson/Henkel Chemical Management Group.
                                  a
                                  Alliant/Cogenex borrowed $8 million to finance the project’s up-front costs.


A Baseline and                    Because contractor payment was derived directly from savings and/or
Performance Metrics Were          revenues generated, the ability to link the financial benefits generated for
Established                       the client back to contractor-implemented recommendations was critical.
                                  Accordingly, both the client and the contractor agreed on (1) a
                                  performance baseline to determine the performance the client would have
                                  experienced without contractor intervention and (2) metrics to measure
                                  how contractor-implemented recommendations generate savings and/or
                                  revenue. When required, the baseline took into account market factors
                                  outside of the client and contractor’s control. For example, energy savings
                                  are impacted by weather and energy prices, neither of which a client or
                                  contractor can influence.

                                  We found that it is easier to establish a baseline and performance metrics
                                  in the energy industry than in other industries because it is easy to
                                  measure energy usage, through the use of metering devices. In the
                                  information technology industry, on the other hand, calculating the
                                  baseline can be more complicated. It can be difficult, for example, to
                                  isolate the direct savings from a reduction in the time an employee spends
                                  on a new task that replaces one or more old tasks. Also, the information
                                  necessary to calculate the baseline may simply not be available.




                                  Page 8                                                                         GAO-03-327 Contract Management
Table 3: How Clients and Contractors Established a Baseline and Performance Metrics

Client/contractor                      How a baseline and performance metrics were established

MIT/Alliant Energy Integrated          MIT and Alliant/Cogenex agreed that energy reduction would be defined as the difference
Services/Cogenex                       between energy consumed prior to Alliant/Cogenex’s intervention (the baseline)
                                       compared to energy consumed after Alliant/Cogenex installed energy efficient equipment.
                                       Energy measurement was based on metering, which is the direct tracking of energy
                                       according to engineering protocols. The advantage of metering is its accuracy. In addition
                                       to metering, MIT and Alliant/Cogenex agreed to adjust the baseline due to changes
                                       outside of either party’s control, such as unanticipated changes in operating hours,
                                       electrical loads, user participation, equipment performance, operation, maintenance and
                                       repair, and equipment replacement.

Texas Online Authority/BearingPoint    The established and agreed upon performance measures are based on providing online
                                       services in exchange for fees to use the service. Because this service is new, all
                                       transaction revenue is attributed to the contractor. How contractor-implemented
                                       recommendations generate revenue from a typical user fee transaction follows. A user
                                       inputs information. After user identity is authenticated, appropriate parties validate
                                       electronic charges made either by credit card or electronic check. The services are
                                       fulfilled and payments are distributed. Of the gross revenues generated, the state
                                       receives 10 percent and BearingPoint receives 90 percent, until its initial costs are
                                       recovered. After BearingPoint’s initial costs are recovered, revenue sharing will be made
                                       on an equal 50/50 basis.

Best Buy/Accenture                     Best Buy and Accenture agreed on a baseline defined as the 12-month historical
                                       performance of net sales, cost of goods sold, profit margins, and appropriate variable
                                       expenses. The historical performance was adjusted by existing growth/decline trends and
                                       inflation. For example, if audio had historically experienced an annual sales growth rate of
                                                   a
                                       8 percent, then the audio baseline (net sales, cost of goods sold, profit margins, and
                                       appropriate variable expenses) for the following year would include the 8 percent growth
                                       rate. With implemented Accenture recommendations in place, improvement over that
                                       baseline would be attributed to Accenture. After adjusting for factors outside of Accenture
                                       control, such as inflation, a joint Best Buy/Accenture team computed benefits on a
                                       monthly basis. For example, because increasing inventory turns increases revenue,
                                       Accenture introduced an optimized in-stock management model to receive merchandise
                                       based on rate-of-sale and out-of-stock risk versus the previous method of pushing
                                       inventory into stores. Success was measured by the increased in inventory turns over the
                                       established baseline, as determined by the Best Buy/Accenture team.

Harley-Davidson/Henkel Chemical        The baseline against which cost savings are measured is Harley’s 1998 cost of
Management Group                       chemicals, or the last price paid, whichever is higher. The information sources are paid
                                       invoices. For new items, the average of three viable quotations established the baseline.
                                       Henkel cost savings and calculations are submitted to Harley on a monthly basis,
                                       reviewed by a management team composed of managers from both Harley and Henkel,
                                       and approved when a reduction in the total cost of conducting business can be
                                       documented. Cost savings projects can occur in several areas, such as item/transaction
                                       cost reduction, product substitution, inventory reduction, waste reduction/elimination, and
                                       machine wear improvement.
                                        Sources: MIT/Alliant Energy Integrated Services/Cogenex; Texas Online Authority/BearingPoint; Best Buy/Accenture; and Harley-
                                        Davidson/Henkel Chemical Management Group.
                                        a
                                        Data based on information contained in Best Buy’s annual audited financial statements filed with the
                                        Securities and Exchange Commission.




                                        Page 9                                                                         GAO-03-327 Contract Management
Client Management                     Although commitment by management is necessary for a successful
Committed to Success                  relationship with any contractor, it was particularly critical with the SIS
                                      contractors. Top managers needed to commit to change the way the
                                      company did business. Moreover, because SIS arrangements can be
                                      long-term, top managers needed to help sustain the business relationship.
                                      In the cases we looked at, managers helped facilitate success through
                                      frequent meetings with their contractors, backing contractor
                                      recommendations, and investing staff with the authority needed to carry
                                      out contractor recommendations.

Table 4: How Client Management Committed to Success

Client/contractor                       How client management committed to success

MIT/Alliant Energy Integrated           MIT’s president was committed to energy efficiency and decided to give control of
Services/Cogenex                        executing an energy savings SIS project to Alliant/Cogenex. MIT was focused on
                                        outcomes and wanted to create an incentive for Alliant/Cogenex to develop optimized
                                        energy efficient improvements by linking their compensation to the savings achieved
                                        through their work. MIT recognized, through its commitment to let Alliant/Cogenex
                                        decide project details, that it was depending on the capabilities and experience of
                                        Alliant/Cogenex for success and believed that Alliant/Cogenex was in the best position
                                        to execute the project.

Texas Online Authority/BearingPoint     The commitment of Texas Online Authority management is reflected in state
                                        legislation that encourages/requires online services. One example is Texas Senate Bill
                                        645 (enacted by the 77th Legislature), which requires 23 occupational licensing
                                        entities to use the common Internet licensing system on Texas Online. In addition, in
                                        January 2002, the State of Texas Web site was merged into Texas Online, providing
                                        “one-stop shopping” for government information and services. Further, each
                                        participating government agency is charged to inform potential users about Texas
                                        Online as a new service channel and to encourage its use.

Best Buy/Accenture                      Accenture required, and Best Buy agreed to, the active participation of its top
                                        management to include the chief executive officer, the chief operating officer, and the
                                        chief financial officer. These officers, with Accenture support, provided the direction
                                        and commitment by reviewing monthly overall progress in areas such as supplier
                                        consolidations, price negotiation strategies, innovative advertising, optimal inventory
                                        levels, and buyer support. Best Buy top management also empowered their staff to
                                        implement the recommended changes. Best Buy top management agreed to partner
                                        with Accenture because it recognized that implementing Accenture initiatives would
                                        require changing behaviors, standard practices, supplier performance, and cultural
                                        norms. Best Buy also recognized that such changes are difficult because they can run
                                        afoul of existing behaviors, practices, and procedures.




                                      Page 10                                               GAO-03-327 Contract Management
Client/contractor                      How client management committed to success

Harley-Davidson/Henkel Chemical        Management commitment, by both Harley and Henkel, is manifested in a two-tiered
Management Group                       organizational structure to ensure SIS contract success. The first tier is a steering
                                       team managed by Harley’s Director of Operations for Purchasing and Logistics and
                                       the Henkel Chemical Management Group’s Operations Director. The purpose of the
                                       steering committee, which meets monthly, is to develop an overall strategy/business
                                       plan to meet operational goals and make financial commitments, sign contracts, and
                                       dedicate appropriate personnel to ensure success. The second tier is a site team
                                       consisting of Harley plant management and a Henkel site representative. The site
                                       team’s role is to realize the steering team’s operational goals by managing individual
                                       savings efforts.
                                  Sources: MIT/Alliant Energy Integrated Services/Cogenex; Texas Online Authority/BearingPoint; Best Buy/Accenture; and Harley-
                                  Davidson/Henkel Chemical Management Group.




                                  Officials from companies we contacted, and others knowledgeable about
Other Issues Can                  SIS contracting, noted that other issues could pose challenges to, or
Impact SIS                        promote SIS use. One issue identified was that SIS contracts could put a
                                  strain on a business relationship when savings or increased revenues are
Opportunities                     lower than expected. Further, when contractor-generated savings and
                                  revenues are greater than originally anticipated, some clients may want to
                                  re-negotiate because, they believe, the contract’s sharing agreement turned
                                  out to be inequitable, allowing the contractor to reap too large a windfall.
                                  Also, legal issues can affect the use and structure of SIS contracts. For
                                  example, in the health care industry, due to the potential conflict of
                                  interest between providing high-quality hospital care and reducing costs,
                                  civil monetary penalty and anti-kickback legislation3 was enacted that
                                  restricts the use of SIS arrangements4 by hospitals and physicians.

                                  Within the federal government, there may be additional barriers to using
                                  SIS contracting. For example, according to GSA officials, federal agencies
                                  have difficulty in measuring baseline costs. Without a baseline agreed to
                                  by contractor and client, savings cannot be measured, leaving a contractor
                                  in a risky position with no confidence that the savings needed to cover
                                  costs and provide a profit will be realized.




                                  3
                                      Social Security Act, as amended, 42 U.S.C. sec. 1320a-7b(b)(1)-(2).
                                  4
                                   SIS arrangements are referred to as gainsharing arrangements in the health care industry.
                                  Gainsharing arrangements are designed to align incentives by offering physicians a portion
                                  of a hospital’s cost savings in exchange for implementing cost-saving strategies.




                                  Page 11                                                                        GAO-03-327 Contract Management
                      Also, our previous work on energy-savings SIS contracting,5 together with
                      our work on this audit, revealed that DOE headquarters officials believe
                      such contracts are a viable option only when federal funding is
                      unavailable. The DOE considers direct appropriations as the first option to
                      pay for capital energy renewal projects, since all of the savings would then
                      accrue to the government.


                      In the contracts we studied, an SIS contract was a highly effective
Conclusions           contracting technique to generate savings and revenues. But to be
                      successful, clients and their contractors had to be specific, and in
                      agreement in their goals and objectives, as well as how to achieve them.
                      Moreover, top management commitment was paramount—not only to
                      provide the authority needed to carry out solutions, but to help overcome
                      additional barriers and problems that can arise and to sustain the
                      partnership. Federal agencies may find it even more difficult to engage in
                      these arrangements given the lack of good baseline performance data.
                      However, it may be worthwhile to examine ways to overcome potential
                      problems in order to achieve the benefits possible through SIS contracting.


                      In December 2002, we requested comments on a draft of this report from
Agency Comments       the Director of OMB. In official oral comments on the report, staff from
                      the Office of Federal Procurement Policy, an office within OMB, stated
                      that

                  •   The report’s findings will be taken into account in structuring future policy
                      on the use of share-in-savings contracting, including implementation of
                      section 210 of the E-Government Act.
                  •   Agencies need to heed the lessons learned by industry to achieve success
                      with this technique. Namely, there must be thorough and deliberative
                      planning, as well as management commitment, to identify clear outcomes
                      and measures that are agreed upon by both parties to a share-in-savings
                      contract.




                      5
                      Energy Conservation: Contractors’ Efforts at Federally Owned Sites (GAO/RCED-94-96,
                      Apr. 29, 1994).




                      Page 12                                            GAO-03-327 Contract Management
              To find information regarding commercial sector use of SIS contracting
Scope and     and identify companies that use or have used SIS contracting, we searched
Methodology   numerous electronic databases and queried several professional
              organizations. Although these queries identified thousands of references,
              most were unrelated to the share-in-savings contracting concept.
              Excluding the energy industry, we found a limited number of references to
              companies or state agencies that use or have used the SIS concept.
              Because our focus was on the commercial sector, we contacted
              companies identified and asked them about their SIS contracting
              experiences.

              We then developed case studies on four SIS arrangements, which
              represent different industries, and were determined to be successful by
              the SIS clients and their respective contractors. For each case study
              presented in this report, we interviewed the clients and their contractors
              to obtain their views on when this type of contracting method is best used,
              the risks associated with SIS contracting and how such risks are mitigated,
              the importance of developing baselines and performance measures, and
              other characteristics that distinguish SIS contracting from traditional
              contracting methods.

              For information regarding the use of SIS in the federal government, we
              used our previous work on SIS contracting, searched government web
              sites, including those belonging to the General Services Administration
              (GSA) and the Office of Federal Procurement Policy (OFPP), and had
              discussions with GSA and OFPP officials.

              We conducted our review from November 2001 to January 2003, in
              accordance with generally accepted government auditing standards.


              As agreed with your offices, unless you announce the contents of this
              report earlier, we will not distribute this report until 30 days from its date.
              At that time, we will send copies of this report to other interested
              congressional committees, the Secretaries of Education and Energy, and
              the Administrators of the GSA and OFPP. We will also make copies
              available to others upon request. In addition, the report will available at no
              charge on the GAO Web site at http://www.gao.gov.




              Page 13                                         GAO-03-327 Contract Management
           Please contact me at (202) 512-4125, or Ralph Dawn at (202) 512-4544, if
           you have any questions regarding this report. Major contributors to this
           report were Marie Ahearn, Cristina Chaplain, Daniel Hauser, Mary Jo
           Lewnard, and Russell Reiter.




           David E. Cooper
           Director
           Acquisition and Sourcing Management




(120110)
           Page 14                                      GAO-03-327 Contract Management
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