The Federal Government has practiced "outsourcing" in one form or another for many years. While not traditionally referring to the practice as outsourcing, government agencies and commercial organizations have long contracted out "blue collar" administrative and maintenance type functions such as equipment and grounds maintenance and custodial, laundry, and food services. These were functions which the outsourcing organization had neither the skill sets nor the internal resources to perform.

In the private sector, the move to make America more competitive in the global markets forced corporations to focus on their own "core competencies." This focus led to the outsourcing of functions that did not directly add value to their competency- and competitive-edge areas. Functions being outsourced evolved to include a number of "white collar" type functions such as the following:

• Business Services (including business support services, electronic imaging and records management)
• Logistics (including import/export services, freight brokers, freight audit services and warehousing)
• Human Resources (including payroll management, tax administration, benefits management, workers compensation, and staffing support)
• Health Care (specialized medical departments in hospitals, support services for hospitals, clinical services, and business services)¹

The commercial Information Technology (IT) world has followed much the same path. Initially, most outsourcing of IT included functions that could be narrowly and easily defined. In the 1970s and most of the 1980s, the majority of outsourced IT work was for low-end services such as tape cleaning and keypunching. More complex tasks were handled by in-house IT shops.

However, outsourcing significantly impacted the IT world in a major way in the late 1980s. At that time, Kodak selected three companies to perform a significant part of its internal information systems activities.² As a result, IT organizations across the country considered outsourcing functions such as facility management and payroll processing.

As with other organizational functions, IT organizations began scrutinizing their competitiveness, including focusing on their own core competencies. Organizational leaders even began to challenge whether or not IT itself is a legitimate core organizational competency. As a result, outsourcing of IT functions now includes work that only a few years ago was considered so critically related to the agency mission that it mandated performance by Government employees.

A 1996 study³ by the Outsourcing Institute found that the following IT activities are currently outsourced or being considered for outsourcing (listed in descending order):

• Applications Development
• Applications Maintenance
• Mainframe Data Center
• Client/Server
• Training
• Local Area Networks (LANs)
• Desktop Systems
• End-User Support
• Wide Area Networks (WANs)

This dramatic increase in outsourcing of IT functions has become big business in both private and government sectors. As an example, Dataquest recently estimated⁴ that the worldwide IT outsourcing market will reach some $54.1 billion by 1998, and $76.6 billion by 2000. IT outsourcing is now being employed by every sector of business and government worldwide. IT functions are being outsourced by American cities, states, and Federal agencies, as well as international agencies, Government, and private sector. Internationally, Canada, Australia, and Britain have all outsourced significant IT functions.

This White Paper provides information, guidance, and recommendations for IT outsourcing decision-makers and discusses steps that should be considered for successful outsourcing implementation. This White Paper does not provide detailed instruction at the level necessary to fully conduct an outsourcing acquisition. Rather, it is intended to provide guidance that will enable agency IT personnel to make suitable decisions regarding outsourcing and to develop acquisition strategies tailored to their specific requirements and circumstances.

The General Services Administration (GSA) developed this White Paper to solicit feedback on the issue of outsourcing. GSA will use the feedback obtained in response to this document to expand areas of interest and provide examples, case studies, and best practices for a governmentwide guide.

Comments on this document should be addressed to the General Services Administration, IT Management Practices Division, 1800 F Street, NW, Washington, D.C. 20405. We will be accepting comments through May 15, 1998. The points of contact for this document are Theresa Noll and Martin Kwapinski; file:///T:/INTERNET/MKM/GSAEPP/sycmtsmk.htm and file:///T:/INTERNET/MKM/GSAEPP/sycmtsmk.htm .

This White Paper is presented to meet the needs of Federal IT program/project managers and supporting technical and contracting staffs.

The following are applicable "working" definitions for the overall White Paper:

Commercial Activity: The term commercial activity is used in the governmental context to identify those activities that the government performs with its employees or resources but could obtain from private-sector sources. Commercial activities are in contrast to "inherently governmental" activities.

Contracting-Out: Contracting out is the hiring of private-sector firms or nonprofit organizations to provide goods or services for the government. Under this approach, the government remains the financier and has management and policy control over the type and quality of goods or services to be provided. Thus, the government can replace contractors that do not perform well.

Franchising of Internal Services: Under the franchising of internal services, government agencies provide administrative services to other government agencies on a reimbursable basis. Franchising gives agencies the opportunity to obtain administrative services from another governmental entity instead of providing them for themselves. In the federal government, these arrangements are often called interservice support agreements (ISSA).

Information Technology (IT): As defined by the Clinger-Cohen Act (ITMRA), IT is any system for the "acquisition, storage, manipulation, management, movement, control, display, switching, interchange, transmission, or reception of data or information" by an executive agency and includes "computers, ancillary equipment, software, firmware and similar procedures, services (including support services), and related resources." (NOTE: Per Federal Acquisition Circular 97-3, IT does not include incidental equipment or equipment which contains embedded IT where the principal purpose of the equipment is not IT.)

Inherently Governmental: An "inherently governmental function" is a function that is so intimately related to the public interest as to mandate performance by Government employees. These functions include activities that require either the exercise of discretion in applying Government authority or the application of value judgments in making decisions for the Government. Governmental functions normally fall into two categories: (1) the act of governing, i.e., the discretionary exercise of Government authority, and (2) monetary transactions and entitlement. (For a full discussion of the definition of "inherently governmental" see OFPP Policy Letter 92-1, Inherently Governmental Functions dated September 23, 1992.)

Most Efficient Organization (MEO): In certain circumstances under OMB Circular A-76, agencies that are considering contracting out an activity must first conduct a cost benefit exercise to identify the MEO. The MEO refers to the government's in-house organization that would most efficiently perform a commercial activity after a managed competition under A-76. It may include a mix of federal employees and contract support and is used as the basis for measuring all government costs (direct and indirect) and performance against competitive contractor or interservice support agreement (ISSA) offers. To determine the MEO, the in-house activity may reinvent, reorganize and restructure itself, including making capital investments, in order to arrive at the agency's most efficient method of performing the commercial activity.

OMB Circular A-76: OMB Circular A-76 sets forth federal policy for determining whether commercial activities associated with conducting the government's business will be performed by federal employees or private contractors. Recent revisions to the A-76 Supplemental Handbook were designed to enhance federal performance through competition and choice, seek the most cost-effective means of obtaining commercial products and support services, and provide new administrative flexibility in agency decisions to convert to or from in-house, contract, or ISSA performance.

Outsourcing: Under outsourcing, a government entity remains fully responsible for the provision of affected services and maintains control over management decisions, while another entity operates the function or performs the service. This approach includes contracting out, the granting of franchises to private firms, and the use of volunteers to deliver public services.

Performance Based Service Contracting (PBSC): PBSC is the process of contracting for services by using mission-related, outcome-oriented statements of work (Performance Work Statements) and quality assurance performance measures. PBSC focuses on the desired outcome and its quality measures rather than on the "how" of providing the required services.

Performance Work Statement (PWS): The basic document used in PBSC that describes the specific requirements the contractor must meet in performance of the contract in terms of "output" and a "measurable standard" for the output.

Privatization: The term privatization has generally been defined as any process aimed at shifting functions and responsibilities, in whole or in part, from the government to the private sector.

Since the mid-1950s the United State’s official policy has been to acquire needed goods and services from commercial sources. In 1955, President Eisenhower stated, [t]he Federal government will not start or carry out any commercial activity to provide a service or product for its own use if such product or service can be procured from private enterprise through ordinary business channels.⁵

OMB Circular A-76 Performance of Commercial Activities, states the national policy as:

Although the policy itself is clear, Circular A-76 has been viewed by proponents of outsourcing as a major impediment. Instead of being a tool to efficiently outsource, it has often appeared to serve as a tool to oppose outsourcing. Outsourcing opponents have used the labyrinth of procedural requirements of Circular A-76 to delay outsourcing decisions.

However, agencies are being required to look at outsourcing in a new light. Congressional support for outsourcing has increased over the past several years. Congress has passed several important laws dealing with implementing business processes within the government, and legislation has been introduced directly aimed at outsourcing. The Administration has set out to implement a series of reforms as a result of its National Performance Review (NPR). In its initial 1993 report, the NPR addressed outsourcing directly when it stated, Globally, with private and public organizations undergoing major upheavals and restructuring, innovation is becoming key to survival. Outsourcing and electronic commerce are emerging as strategic issues.⁷

Congress and the Executive Branch have established significant initiatives to direct Federal agencies to conduct the government’s affairs in a more business like fashion. Federal policy requires Government agencies to perform strategic planning, implement internal and external performance measurements, use capital planning tools in their budget submissions, and implement "earned value" methodologies for their large IT programs.

Federal agencies, like their private sector counterparts, are focusing on their core competencies so they can perform their missions more efficiently and effectively. In an April 1997 speech, then OMB Deputy Director John Koskinen stated, reinvention is not its own reward – it’s to ensure agencies carry out their mission better" Mr. Koskinen also noted that OMB recognizes outsourcing and privatizing are viable options for effective government.⁸

Implementation of the NPR recommendations continues to streamline and downsize government. As noted in the Vice President's Third Report of the NPR⁹, Americans want to "get their money's worth" and want a Government that is more businesslike and better managed. The report also noted that the reinvention of Government begins by focusing on agencies’ core mission competencies and service requirements. Thus, the reinvention process must consider a wide range of options, including outsourcing.

Additionally, Congress is moving to require the nation’s business be performed in a manner more closely resembling the private sector. The three pieces of legislation that affect outsourcing in general and the methodology of outsourcing specifically are Clinger-Cohen/ITMRA, the Government Performance Results Act (GPRA), and the Federal Acquisition Streamlining Act (FASA). Together these statutes require agencies to make determinations regarding outsourcing and to give guidance on measuring performance.

Congress is considering additional legislation that looks at outsourcing options as a means to improve service and reduce budgets. The Freedom from Government Competition Act was introduced in the 104^th Congress. While it did not pass at the time, it has been reintroduced in the 105^th Congress and is believed to have a greater chance of passage.

This section summarizes key Federal legislation, policy, and regulations that form the basis for the government’s approach to outsourcing.

Government Performance and Results Act (GPRA). GPRA (P.L. 103-62), enacted in 1993, legislates that Federal agencies are to be more responsive and accountable to the public/customers relative to achieving program results. GPRA requires that agencies develop comprehensive strategic, business, and performance plans documenting the organizational objectives, goals, strategies, and measures for determining results. The organizational plans and measures for achieving the goals are key elements in determining an agency’s need for services.

Federal Acquisition Streamlining Act (FASA). FASA (P.L. 103-355), enacted in 1994, applies the principles from the GPRA to all Federal acquisitions. For example, OMB’s FASA implementation instructions for acquisitions (including IT) include the following:

• Require that cost, schedule, and performance goals and measures be established for each "acquisition program" (those exceeding $20 million over the system life cycle)
• Place program success accountability in an "acquisition program manager"
• Require agencies to measure and achieve, on average, 90 percent of the cost and schedule goals established for major and non-major acquisition programs… without reducing the performance or capabilities of the items being acquired
• Take action and report steps taken on non-compliant acquisition programs, to include termination (those with cost overruns, schedule noncompliance, inadequate performance).

Clinger-Cohen/Information Technology Management Reform Act (ITMRA). ITMRA (P.L. 104-106), enacted in 1996, applies a broad definition of IT. With the passage of ITMRA, Congress covered a wide range of functions, requiring agencies to perform the following:

• Determine who will perform the IT functions
• Develop performance-based work statements for contracting purposes
• Benchmark activities against those of the private sector
• Re-evaluate internal processes prior to making significant investments in IT.

ITMRA specifically requires that, prior to making an investment in a new information system, agencies must determine

• "whether the function to be supported by the systems should be performed by the private sector, and if so, whether any component of the executive agency performing that function should be converted from a governmental organization to a private sector organization; or
• whether the function should be performed by the executive agency, and if so, whether the function should be performed by a private sector source under contract or by executive agency personnel."

The driving force behind the government’s redirected focus comes from the NPR (thus leading to outsourcing). The NPR and other pertinent policy directives that should be examined during the outsourcing decision making process are discussed below.

National Performance Review (NPR). The NPR, created and led by Vice President Gore, examined ways in which the Government can become more efficient and responsive to its customers. The NPR’s was chartered to "create a government that works better and costs less by:

1. Putting customers first
2. Empowering Federal employees to put their customers first
3. Cutting the "red tape" that keep employees from putting their customers first, and
4. Cutting back to basic missions."

The NPR has estimated that its recommendations, when implemented, will save approximately $177.4 billion. By September 1996, NPR estimated that savings of about $97.4 billion have been ensured through legislative or administrative action. Additionally, the Federal workforce has shrunk by an estimated 240,000 by January 1996.¹⁰

Certainly, the source of many of these savings came or are coming about in the Federal IT community. As examples:

• Consolidation of 22 Defense Joint Military Pay Systems down to 2
• Restructuring Information Management systems at the Department of Energy
• Cancellation of IT systems suffering from cost or schedule overruns
• Reductions in IT workforce due to investment in, and implementation of, IT systems
• Consolidation, elimination or outsourcing of Data Processing Centers at agencies such as the Department of Agriculture and the General Services Administration.

The government has not published a Federal policy solely on outsourcing (e.g., Executive Order) or regulation (e.g., the Federal Acquisition Regulation (FAR)). However, there are numerous policy documents that must be considered when making the outsourcing decision.

OFPP Policy Letter 91-2 Service Contracting. This policy letter, issued in April 1991, suggests the use of performance-based contracting methods to the maximum extent practicable when acquiring services.

OFPP Policy Letter 92-1 Inherently Governmental Functions. OFPP Policy Letter 92-1, issued in September 1992, acknowledges that contractors provide a wide variety of useful services and provides guidance on determining what constitutes inherently governmental functions.

OFPP Policy Letter 93-1 Management Oversight of Service Contracting. This policy letter, issued in May 1994, provides agencies with a more results-oriented approach to managing and administering service contracts.

OFPP’s Guide to Best Practices for Performance-Based Service Contracting. This guide, published in April 1996, is the result of an OFPP "pledge" initiative to promote implementation of OFPP Policy Letter 91-2 and to encourage the governmentwide use of PBSC. The guide gives a very brief overview of the PBSC process and provides guidance regarding the different phases of the Job Analysis.

Regulatory guidance concerning outsourcing is limited to OMB Circular A-76, Performance of Commercial Activities and to FAR Part 37 Service Contracts. There are no other significant regulatory guidelines that focus on outsourcing.

OMB Circular A-76. OMB Circular No. A-76 was first issued over 30 years ago. It establishes Federal policy for the performance of "recurring commercial activities." The Circular was revised in 1967, 1979, and 1983. The 1983 version was supplemented in 1996. The 1996 supplement provides updated guidance and procedures for determining whether recurring commercial activities should be operated under contract with commercial sources or in-house using Government facilities and personnel.

Circular A-76 conforms to the national policy. It sets forth the policy that:

To implement this policy, Circular A-76 states, The Federal Government shall rely on commercially available sources to provide commercial products and services" A-76 then modifies the policy to state that a function can be retained by the government if it is more cost advantageous to do so. It qualifies the national policy by saying In accordance with the provisions of this Circular, the Government shall not start or carry on any activity to provide a commercial product or service if the product or service can be procured more economically from a commercial source. (Emphasis added.)

The 1996 Supplemental Handbook addresses the conversion of recurring commercial activities to or from in-house or contract performance. Circular A-76 is designed to:

• Balance the interests of the parties to a make or buy cost comparison
• Provide a level playing field between public and private offerors to a competition
• Encourage competition and choice in the management and performance of commercial activities
• Empower Federal managers to make sound and justifiable business decisions.

In summary, Circular A-76 requires that an agency consider outsourcing before the agency commits to using government personnel for either undertaking a new requirement or expanding an existing commercial activity. A new requirement is a newly established need for a commercial product or service. An expansion is the modernization, replacement, upgrading, or enlargement of an in-house commercial activity or capability. An expansion involves a 30 percent increase in the total capital investment or a 30 percent increase in the annual personnel and material costs.

Circular A-76 also requires that all commercial activities performed in-house must be identified on an inventory list. The inventory list must be made available to the public on request. At least once every 5 years, the agency must review whether continuation of the in-house commercial activity can be justified under the Circular. To justify retaining a commercial function (e.g., software development or maintenance) in-house, the agency must substantiate the decision based on one of the following reasons: no satisfactory commercial source is available, national defense, or lower cost.

FAR Part 37 Service Contracts. FAR Part 37 contains sections that give general guidance on service contracting as well as specific advice on management oversight of service contracts. FAR Part 37.6 provides specific guidance on Performance Based Contracting that is used to outsource services and functions. Most of the guidance contained in Part 37.6 repeats the information in OFPP Policy Letter 91-2, and will not be repeated here. However, an additional important piece of guidance is an admonition to avoid combining requirements into a single acquisition that is too broad for the agency or a prospective contractor to manage effectively.

ITMRA required that OMB establish clear and concise direction regarding investments in major information systems, and enforce that direction through the budget process. OMB implemented this requirement by issuing a letter to agencies. That letter, signed by OMB Director Franklin D. Raines on October 25, 1996, was entitled Funding Information Systems Investments. It set forth eight decision criteria (now know as "Raines’ Rules) regarding IT investments. As a result, OMB now requires agencies develop a long-term investment strategy that will act as a roadmap for getting from "where we are today" to "where we want to be" -- achieving the strategic mission goals of the organization in the framework of GPRA.

The first four decision criteria relate specifically to capital planning and are of important consideration in outsourcing. They state that investments in major information systems proposed for funding in the President 's budget should accomplish the following:

1. Support core/priority mission functions that need to be performed by the Federal government;
2. Be undertaken by the requesting agency because no alternative private sector or governmental source can efficiently support the function;
3. Support work processes that have been simplified or otherwise redesigned to reduce costs, improve effectiveness, and make maximum use of commercial, off-the-shelf technology; and
4. Demonstrate a projected return on the investment that is clearly equal to or better than alternative uses of available public resources. Return may include: improved mission performance in accordance with GPRA measures; reduced cost; increased quality, speed, or flexibility; and increased customer and employee satisfaction. Return should be adjusted for such risk factors as the project's technical complexity, the agency's management capacity, the likelihood of cost overruns, and the consequences of under- or non-performance.

(Appendix A contains the Funding Information System Investments memorandum including all eight criteria.)

Successful outsourcing enables organizations to focus on what they do best—accomplish their mission. For the Federal government, it is the core business of governing and government. IT is, in many cases, an important part of an agency’s operation, but it is seldom their core expertise – i.e., it is not what they are in business to do. To redirect this focus, Federal agencies are analyzing the extent to which IT represents a strategic aspect of their operation, and if their internal capability is likely to provide the high quality results necessary for success.

Outsourcing is not an end to itself. It is a management tool and should be approached in that manner. In determining whether to outsource, management will make numerous decisions that have significant consequences. In the course of the outsourcing process, management must address several critical issues in order to achieve success. These issues include identifying potential organizational problems, factoring in human resources and behavior, considering asset transfers and authorities; establishing and negotiating contracts; and overcoming political obstacles. These issues are key reasons that mandate top management’s involvement throughout the entire process.

In determining how to use outsourcing as a management tool, agencies need to make sure their strategic plans and their goals, objectives, and methods for measurement, are prepared in compliance with the GPRA. These decision documents represent agencies’ long range direction and are important management tools. If an IT function is not a distinctly integrated part of an agency’s core processes, then it is a probable candidate for outsourcing. The decision process for outsourcing must be directly interrelated with the long-range, strategic planning process.

There are short-term, tactical reasons for considering certain IT functions as candidates for outsourcing. However, outsourcing should not be used as a means of dealing with personnel issues or inefficient operations. Functions outsourced solely to alleviate an unproductive situation may not be successful. The Outsourcing Institute researched the reasons the private sector outsources and determined that:

When outsourcing IT operations, agencies do not have to outsource all functions at once. Similarly, all IT functions do not need to be outsourced to the same service provider. When determining functions to be outsourced, agencies should consider those functions that can be logically placed together. This enables agencies to take advantage of modular contracting techniques¹² being promoted by ITMRA and Raines Rules.

Finally, management should take into account that agency staff must remain to determine policy, give direction, and perform contract management oversight. This may require either re-training existing staff or acquiring new staff with experience in the new set of skill requirements.

In considering outsourcing as a means of providing IT services, agencies should first determine whether the functions are "inherently governmental." Those that are inherently governmental should not be considered for outsourcing but should be accomplished in-house.

In general, inherently governmental functions are those tasks that are so intimately related to public interest that they need to be performed by government employees. These functions require the government employee to exercise discretion in applying government authority or making value judgments.

Inherently governmental functions involve the exercise of substantial discretion that commits the Federal government to a course of action when two or more alternative courses of action exist. An example might be the actual decision itself regarding which vendor to select in a large, competitive acquisition. However, not every exercise of discretion is indicative of an inherently governmental function.

In exercising judgment, an agency should carefully examine the issue of the exercise of discretion. This is not an easy task nor is it well defined. OFPP advises that the exercise of discretion is normally present in activities such as follows:

• Participating as a voting member on any source selection boards
• Approving any contractual documents, to include documents defining requirements, incentive plans, and evaluation criteria
• Awarding or administering contracts, including ordering changes in contract performance or contract quantities, taking action based on evaluations of contractor performance, and accepting or rejecting contractor products or services.

However, OFPP also advises that activities to be contracted out can include services that involve or relate to the following:

• Analyses, feasibility studies, and strategy options to be used by agency personnel in developing policy
• Development of regulations
• Evaluation of another contractor's performance
• Providing support regarding acquisition planning
• Providing assistance in contract management, such as where the contractor might influence official evaluations of other contractors
• Providing technical evaluations of contract proposals
• Providing assistance in the development of statements of work
• Participating as technical advisors to a source selection board or participating as voting or nonvoting members of a source evaluation board.

Generally speaking, contractors cannot perform activities in which they exercise discretion on the part of the government. However, contractors can gather information for, or provide advice, opinions, recommendations, or ideas to, Government officials; develop options to inform an agency decision maker; and develop or expand decisions already made by Federal officials.

OFPP Policy Letter 92-1 provides guidance on whether a function is "inherently governmental" or not. However, OMB allows agencies to apply discretion in applying the guidance. For example, several agencies have Maintenance and Operations (M&O) contractors, Government Owned-Contractor Operated (GOCO) contractors, or research activities that are provided a great deal of discretion in "subcontracting" goods and services for the agency. Agency oversight is provided through examinations of the contractor’s purchasing system with periodic follow up.

At first, this situation appears to violate the policy against contractors making any contracting or purchasing decisions. Yet, the agencies have applied discretion in giving contractors authority to acquire supplies at prices within specified ranges and subject to other reasonable conditions deemed appropriate by the agency.

The bottom line is that agencies exercise solid judgment in determining what is or is not an inherently governmental function. Each agency has special requirements that affect their own decision. In the future, agencies will likely be forced by budget and political constraints to become more liberal in interpreting this requirement.

Private industry and the Federal government have numerous reasons for outsourcing. J. Collins and R. Millen published the results of an outsourcing survey.¹³ Based on responses to the survey, they deduced the following reasons, in descending order of importance, for outsourcing information systems:

• Focus in-house resources on core functions
• Personnel cost savings
• Improved quality of information systems services
• Increased flexibility
• Increased access to new technology
• Provide alternatives to in-house costs
• Stabilize information systems costs
• Technology cost savings
• Re-engineer process
• Reduce technological obsolescence risk.

Federal managers have similar reasons for outsourcing. These reasons can be combined and categorized as follows:

• Budget Realities
• Cost Reduction
• Access to Skilled Personnel
• Improved IT Responsiveness
• Help with Legacy Systems
• Improved Business and Customer Service
• Implement New Architecture.

Budget Realities/Cost Reduction. Budget realities and reducing costs are clearly a significant concern for both the Federal government and private industry. Four of the ten reasons listed by Collins and Millen dealt with cost savings of one type or another. It is no different in the Federal government sector. Budget restrictions are the controlling factors in the Federal environment and have a key impact on deciding which functions to perform in-house versus which to outsource.

Federal and private sources have determined that outsourcing is an excellent method to produce savings. The Heritage Foundation has estimated potential savings at 10 to 20 percent.¹⁴ The Congressional Budget Office estimated in 1995 that between 20 to 40 percent cost savings could be achieved through outsourcing.¹⁵ The potential savings make it feasible to consider outsourcing as a means of providing IT services.

Access to Skilled Personnel. Agencies need to consider access to skilled personnel. Federal IT organizations are experiencing a shortage of highly skilled and experienced personnel brought about by continued buyouts and early retirements. In addition, hiring freezes, the loss of FTE slots, loss of funding, and/or buy-out and early retirement authorizations have prevented restaffing. Remaining employees may not always have the specialized skills or training to keep pace with the rapidly evolving technology. Additionally, technicians and programmers skilled in the most current technology and languages (e.g., C++) are often hired by commercial firms at salaries significantly higher than the government can offer.

Improved IT Responsiveness/Business and Customer Service. Outsourcing is a means of improving IT responsiveness and business/customer service. As agencies implement GPRA and ITMRA, they are taking a closer look at their core competencies and how these services can be provided to the customer in a more efficient and effective manner. Agencies are focusing their resources on the core functions which they do best--their mission. Outsourcing some functions provides agencies with the flexibility to strategically redirect those resources to mission critical activities.

Outsourcing also enables an agency to potentially improve the quality of information systems services by obtaining those services from an organization whose primary mission is IT. An example is the current industry move to obtain certification using Carnegie Mellon University’s Software Engineering Institute (SEI) Capability Maturity Model (CMM). The SEI CMM rating validates that an agency or company has put repeatable software development and program management processes in place in its projects/programs and in various levels of its organization. Few Federal activities have the resources or funds to obtain the knowledge and skills required, implement the repeatable processes, and go through the certification process. However, these capabilities can be obtained from vendors whose core competency is to provide high quality software development. Agencies are finding that outsourcing gives them access to CMM Levels 3, 4, and 5 capabilities which they otherwise could not afford to develop in-house.

Help with Legacy Systems. Agencies are currently looking to outsource functions related to legacy systems. Many agencies have large systems written in earlier computer languages such as COBOL. These programs are full of "spaghetti code" -- the result of years of modifications to the code, some without adequate documentation. The programming challenges resulting from these undocumented programs are intensified by a lack of programmers skilled in the earlier languages. Although the number of legacy system programmers is limited, private industry has better access to people with these skills.

The Year 2000 (Year 2K) is an excellent example of agencies having to make major modifications to legacy systems. Contractors have developed tools and management processes to handle much of this re-programming and re-engineering effort. With the Year 2K coming to the forefront, programmers with skills in the older languages are in high demand. Accordingly, they are demanding and getting higher compensation than the government can provide. Outsourcing Year 2K projects provides Federal agencies access to the specialized tools, management processes, and personnel private industry has available.

Implement New Architectures. Agencies are also looking to outsourcing as a solution and source to keep up with the increasing changes in technology. Contractor organizations are seen to have more leverage to acquire and maintain new computing/telecommunications resources at a significantly reduced cost than can the Federal agency can have directly. Contractors are also seen to be able to implement the new technology better and more quickly because of their focus on continuous technology refreshment.

Most large contractor organizations already have the vendor agreements in place, and the revenue volume necessary to take advantage of them, to provide continuously updated technology. The contractor can spread the cost of this technology over several customers so that one customer does not bear the brunt of the entire technology upgrade.

Private and Federal managers historically have been resistant to the idea of outsourcing, citing concerns for security, control, corporate knowledge, and reversibility once a function has been outsourced. While these are legitimate issues that must be addressed, a well organized and differentiated approach to IT outsourcing can overcome these concerns and ultimately enhance the IT decision maker’s position.

Control. Critics of IT outsourcing argue that an outside vendor can not match the responsiveness and service levels as that done by an in-house IT function because the outsider is not subjected to the same management direction and control as Federal employees.

The major reason for this concern may be that Federal managers historically have not been required to apply success metrics to vendors or to internal operations. The GPRA and ITMRA requirement to apply metrics to the implementation and operation of IT systems have basically re-engineered/structured the Federal manager’s approach to managing IT. Managers will now be required to benchmark the performance of their systems against commercial activities and develop metrics for their internal operations. Once developed, these metrics can easily be used to measure and control a contractor’s performance.

Similarly, there was little pressure to, or knowledge about how to, write performance based statements of work. In addition to becoming more adept at measuring and benchmarking their internal activities, agencies will become more comfortable at managing performance-based contracts instead of simply managing people and activities. As this experience and knowledge grows, "loss of control" will diminish as an objection to outsourcing.

Security. Agency concerns regarding the security and confidentiality of data and other information are important. Both Congress and OMB consider information security to be an overall concern and are working on issues for agency implementation. However, OMB also recognizes that activities that may require access to secure and sensitive information may be contracted out.¹⁶

Outsourcing has been in effect in private industry for a number of years. Commercial organizations such as banks, brokerage houses, insurance companies, and organizations with extensive research and development activities have designed processes by which their most closely held information is often processed in an outsourced environment.

Contractors have long operated in the most secure environments in government and industry. The language in secure environment contracts requires contractors take necessary precautions. In addition, contractors working in such situations are often required to establish and promulgate security procedures with the appropriate Federal agency auditing compliance by the contractor and the contractor’s personnel.

Corporate Knowledge. Another concern of outsourcing critics is that outside vendors’ lack of corporate knowledge will prevent them from performing as well as insiders who are familiar with the agency, its customers, its reporting requirements, and its idiosyncrasies.

Many agencies are facing a loss of corporate knowledge from their workforces. Personnel buyouts and hiring freezes have taken their toll on corporate knowledge as knowledgeable and experienced staff have taken advantage of the many downsizing opportunities offered by the agencies. At the same time, there have been no new staff hired and trained to take their places due to hiring freezes. Thus, agency corporate knowledge is being drained. Agencies increasingly have to rely on the skills of service providers who are new to the arena regardless of whether they reassign internal resources, receive authority for new staff hires, or outsource to contractor personnel.

If corporate knowledge is a specific concern, then agencies can base the evaluation and selection of outsourcing vendors on their past record of working closely with a customer in the customer’s environment. Additionally, close communication and cooperation between the contractor and the agency will facilitate contractors becoming knowledgeable in the critical areas.

Reversibility. Critics of outsourcing express concern that once IT functions have been turned over to a contractor, it will be too costly to reverse the situation and return them in-house. This concern is based on the assumption that once functions have been outsourced, the agency will lose all of its critical skills and resources (e.g., hardware, software, etc.), will become locked-in to a particular vendor’s proprietary hardware or software, or will have difficulty recompeting contracts if problems arise with service quality.

Although these are valid concerns, agencies can use contractual requirements to address many of their concerns. As an example, a key person provision might be included in the contract requiring the contractor to keep certain, specifically named individuals assigned to the project. In other instances, agencies have included language in Request for Proposals (RFPs) that require the successful vendor to provide "knowledge transfer" back to the government. The use of award or incentive fee contracts is a good technique to avoid prematurely recompeting a contract or bringing it back in-house.

Concerns with a vendor’s proprietary hardware or software, or of not having title to, and the use of data generated under the contract should be addressed during the requirement’s analysis phase of the outsourcing effort. Appropriate language can be drafted assuring the agency of interoperability of equipment/software and of the retention of all necessary intellectual property (e.g., escrow of source code, conversion of data to any follow-on system, etc.).

Finally, "big bang" or "grand design" contracts probably work no better for outsourcing situations than they did for large system development projects. If the functions being outsourced are of a critical enough nature to the agency’s mission, then the agency should seriously consider awarding several small contracts for various, severable functions. Likewise, such an incremental or modular¹⁷ approach can be effectively used where the agency lacks outsourcing experience.

A key element of any outsourcing/acquisition effort is cooperation and participation by the HR staff. An organization must get its HR staff on board as part of the outsourcing/acquisition team from the very beginning. With HR’s involvement, the status of any discussions concerning outsourcing should be communicated with the employees and with the union(s). OMB Circular A-76 stresses that communication with employees is vital and should take place continually during the process.

HR helps the outsourcing study team to make sure that all relevant issues have been raised and considered, and that information is prepared and available for employees. The study team needs to have information on issues such as the number of affected employees, transition costs, retraining opportunities and obligations, termination costs, relocation requirements, etc. Employees will want information on issues such as job status, benefits, timing of any outsourcing and how it affects retirement possibilities, potential buyouts, etc.

OMB Circular A-76 requires agencies exert maximum efforts to find available positions for Federal employees adversely affected by conversion decisions, including the following:

• Giving priority consideration for available positions within the agency.
• Establishing a reemployment priority list and an effective placement program.
• Paying reasonable costs for training and relocation that contribute directly to placement.
• Coordinating with the Office of Personnel Management (OPM) to ensure employees have access to placement programs, including the OPM-operated Displaced Employee Program (DEP) and the Interagency Placement Assistance Program (IPAP).

The Circular requires that Federal employees and existing Federal support contract employees adversely affected by a decision to outsource have the Right-of-First-Refusal for jobs for which they are qualified that are created by the award of the conversion. The Right-of-First-Refusal is afforded to all Federal employees adversely affected by the decision to convert to contract performance. (Executive Order 12933, Non-Displacement of Qualified Workers Under Certain Contracts, dated October 20, 1994, also provides the Right-of-First-Refusal to contract employees (see FAR 7.305 (c)); however, OMB believes, as stated in Circular A-76, the Right-of-First-Refusal offered at FAR 52.207-3 is superior.)

Once the decision to pursue outsourcing has been made, management and the outsourcing study team will be faced with numerous challenges.

Political opposition to the potential outsourcing may come from internal sources, unions, community leaders and possibly other contractors, who may be affected by the outsourcing decision. Senior management should communicate with internal or external groups. This communication should begin as early in the process as possible and continue periodically.

Developing the government’s cost proposal can be a challenge. OMB Circular A-76 provides guidance on how to prepare the extensive in-house cost estimate. The outsourcing team will need detailed costs that are not normally readily available such as personnel costs that are adjusted for items such as fringe benefits (workers’ compensation, bonuses, awards, and unemployment), retirement (which may vary by occupation), employee insurance, and Medicare. In addition to personnel costs, all expenses for materials and supplies must be accounted for. A-76 also recognizes "other specifically attributable costs" including depreciation on capital assets, rent on real and personal property, maintenance and repair on real and personal property, utilities, and travel and insurance. Further adjustments must be made for overhead (other than fringe benefits) and general and administrative costs. Finally, inflation adjustments must also be made.

Once an in-house function is identified as a candidate for outsourcing, an outsourcing team is established and an outsourcing study developed (unless a cost estimate is not required as discussed below). The Outsourcing Study will provide the agency with all the material necessary to perform an IT outsourcing acquisition project and ultimately to conduct a cost estimate. The purpose of the Outsource Study and the resulting cost comparison is to determine whether it is "more economical" to award a contract to the most advantageous proposal or to perform the work in-house.

The primary elements of the Outsourcing Study are a Job Analysis, a Performance Work Statement, a Quality Assurance Plan, a Management Plan, and a cost estimate. Much of the information contained in the Outsourcing Study documents is required by GPRA, ITMRA, FASA and Raines’ Rules. Therefore, agencies that are in compliance with these Federal policies will have the information readily available for inclusion in the study.

The Outsourcing Study will lead to development of an acquisition project in which the agency will issue an RFP for the work and compare government costs with the costs proposed by vendors. According to OMB Circular A-76, agencies must generally perform a cost comparison if the commercial activity involves more than 10 Full-Time Equivalents (FTEs). However, commercial activities may be converted to contract, without cost comparison, if market surveys or comparisons with similar activities show that fair and reasonable prices can be obtained through competitive award, and if all directly affected Federal employees serving on permanent appointments are reassigned to other comparable Federal positions for which they are qualified.

Additionally, a cost comparison is not required to outsource a commercial activity of any size that is performed by Federal employees if the contract is awarded to a preferential procurement source (e.g., National Institutes for the Severely Handicapped, National Institutes for the Blind, etc.) at a fair market price as determined by market surveys or comparisons with similar activities. This is true even if the outsourcing action results in adverse employee actions. (However, a cost comparison may be conducted at the agency’s discretion). Finally, cost comparisons may be "waived" and the otherwise commercial function retained in-house if certified by the Secretary of Defense or the Director of Central Intelligence or their designees for national security reasons.

An outsourcing study and acquisition, especially in the IT world, can be a complex and lengthy undertaking. It is to the government’s advantage to have the same employees participate in both the outsourcing study and acquisition solicitation and evaluation. Therefore, the team becomes responsible for conducting the outsourcing study, developing outsourcing documents and the acquisition strategy; evaluating the government and vendor proposals, and selecting the best value.

The outsource/acquisition team formed should have a wide range of experience in such skill sets as management analysis, position classification, HR benefits, work measurement, value engineering, industrial engineering, cost analysis, procurement, and the technology aspects of the activity under study.

Team members should be knowledgeable of the activities being studied so that they can properly document mission requirements. It is important that team members understand the functional operations, be able to apply analytical processes, and communicate effectively. During the creation of the PWS and the RFP, as well as during contract evaluation and negotiations, the agency should assure itself that its team members are qualified for, and committed to, the tasks at hand. Team members should be experts in their particular field. As an example, the contracting representative(s) should be experienced in contracting methods such as PBSC, award fee, and incentive fee contracting.

In addition to the team members who prepare the study and other relevant documentation, the agency will need to designate an Independent Review Officer (IRO). The IRO is a qualified person from an impartial activity that is organizationally independent of the commercial activity being studied and the activity preparing the cost comparison. The IRO is responsible for certifying that the cost estimates developed by the Federal activity are in compliance with Circular A-76.

As discussed in Section 2, Congress is requiring Federal agencies to focus on the effective and efficient delivery of services through the passage of legislation. This legislation requires agencies to ask the following:

• What is our mission?
• What are our goals?
• What are our requirements?
• What functions must the government do?
• What can be contracted out?

More specifically:

• GPRA requires that strategic plans containing goals, objectives, measurement plans be implemented. As a result, agencies are becoming more focused on core competencies.
• FASA focuses on the metrics for the actual implementation of large programs – cost, schedule and performance. It requires agencies to question if a program is on schedule and within budget. It also requires agencies to establish implementation goals. Metrics are applied to measure the goals as a way to implement programs on schedule and within cost without affecting the performance or capabilities of the systems being implemented.
• ITMRA focuses on the outcome. Specifically, ITMRA requires the measurement of the system itself in regards to why it was implemented (e.g., did tax form processing increase by the planned X percent, are veteran’s benefits being processed Y percent more accurately, has the new system decreased staffing levels by Z percent, etc.).

The agency will also have developed much of the information required as a result of its compliance with Raines’ Rules. To comply with Raines’ Rules, the agency must perform a Return on Investment analysis. This analysis will provide much of the data required for the Outsourcing Study. As an example, data gathered as a result of the ITMRA/Raines’ Rules analysis will serve as the basis of the job analysis and for inclusion in the resulting PWS and Quality Assurance Plan.

The development of a performance-based statement of work is based on a systematic analysis of the function; therefore, a job analysis is the foundation for, and key to, performance-based service contracting (PBSC). Job analysis consists of a step-by-step review of the requirement to arrive at the specific output services and associated quality standards. This analysis establishes the outcome-based need documented in the PWS and provides an understanding of how the contractor’s work interrelates with that of the government. Finally, team members need to understand how the agency will determine receipt of the desired work and how to measure success.

The job analysis includes:

• An organizational analysis which reviews the agency’s needs and identifies the services and outputs required from the contractor.
• A work analysis which further analyzes the required outputs, breaks down the work into its lowest task level and links tasks in a logical flow of activities.
• Performance analyses and standards which assign a performance requirement to each task, determines how a service can be measured and what performance standards and quality levels apply.
• A directives analysis which screens all potentially relevant directives to determine which should be utilized and to what extent. Care should be taken as part of the analysis to minimize application of government directives to the provisioning of commercial IT goods and services.
• Data gathering which collects and analyzes historical data to determine the appropriate metrics for quantifying or forecasting expected work requirements.
• A cost analysis which baselines costs for each service or output thereby setting the ground work for preparation of the government estimate, evaluation of proposals, and determination of positive and negative performance incentives
• The establishment of positive and/or negative incentives that will induce better quality performance.

The PWS defines what is being requested, the performance standards and measures, and timeframes required. It provides the basis for the technical performance sections of the RFPs. It states the government’s requirements in terms of "what" is to be the required output rather than "how" the work is to be performed. Exhibit 4-1 provides an example of a PWS.

When developing the PWS, agencies should take special care to ensure that it does not limit service options, arbitrarily increase risk, reduce competition, unnecessarily violate industry service or service grouping norms, or omit statutory or regulatory requirements without full justification. The PWS should be performance-oriented, specifying what outputs or measures are desired and limiting directions as to how the results are achieved.

The QAP describes the methods of inspection to be used, the reports required and the resources to be employed with estimated work-hours to allow for the quality assurance review and documentation of the function being performed.

PBSC should simplify the quality assurance process by eliminating many of the traditional inspection requirements because PBSC focuses on the quality of the output products and services rather than on the internal process of how the contractor produced the output. However, it does not totally negate the requirement for quality assurance. The government should still have a plan in place to review and document the contractor’s performance.

Although the QAP accompanies the PWS to the IRO for a cost comparison, it does not need to be included as a part of the solicitation or provided to offerors. In-house and contract offerors should develop their offers based upon the requirements of the PWS alone. The QAP process is supplemented with periodic Post-MEO Performance Reviews.

The Management Plan describes the Government's Most Efficient Organization (MEO) and is the basis of the Government's in-house cost estimates. It reflects the scope of the PWS by documenting the assumptions used in the development of the MEO and in-house cost estimate. In doing so, it identifies the organizational structures, staffing and operating procedures, equipment and other assets, facilities, and transition and inspection plans necessary to ensure that the in-house activity is performed in an efficient and cost effective manner.

The Management Plan is certified as reflecting the Government's MEO. The certifying official may be any technically competent individual who is (a) organizationally independent of the function under study or (b) at least two levels above the most senior official included in the in-house cost estimate. The certifying official must also be able to commit the resources necessary to perform the activity. The certification is made before the review of bids or proposals.

Circular A-76 allows agencies at this point to consider existing management re-invention, consolidation, re-engineering, personnel classification, and market and other analyses in the identification and development of the MEO. However, a post-MEO Performance Review is required when a decision is made to keep a commercial activity in-house. This review, which must be conducted on not less than 20 percent of the functions performed by the Government as a result of the cost comparison, allows some adjustments to be made due to changes in mission or scope. The review may measure workload, responsiveness, quality and cost. Minor deficiencies may be corrected by the agency; however, major deficiencies or failure to correct a series of minor deficiencies may lead to contractual action. This action may either be the "termination" of the work with the government and an award to the next lowest offeror or an immediate re-solicitation to conduct a revised and updated cost comparison.

Preparation of the cost estimate involves many tedious calculations for costs spread out over a minimum 3-year period. Circular A-76 provides detailed instructions on how to prepare the cost estimate. It is important that the Outsourcing study team include specialists from a variety of disciplines (e.g., HR, technical experts, and procurement analysts) so that the computations and requirements can be properly developed, interpreted, and coordinated.

Costs to be considered are as follows:

• Standard Costs. The principal costs to be researched and included in the cost estimate are standard costs. These are the costs incurred by the agency in the performance of the activity being studied. These costs include:
  • Personnel Costs. Personnel costs include the cost of all direct in-house labor and supervision necessary to accomplish the requirements specified in the PWS. Salaries, wages, and fringe benefits should be calculated using the in-house staffing estimate and the proper wage/grade classifications described in the management plan. Special entitlements such as uniform and housing allowances, night differential pay, premium pay, and overtime must be included. Additionally, the cost of labor for the government’s administration and inspection of contracts that are a part of the in-house estimate should be included here.

• The government’s complete share of the weighted CSRS/FERS retirement costs
• Federal employee insurance and health benefits
• Medicare
• Workmen’s compensation, bonuses and awards, and unemployment programs
• Material and Supply Costs. Material and supply costs consist of items such as raw materials, parts, subassemblies, components, and office supplies. These costs are for items that are to be used by the activity and will not be provided to the contractor. These costs, as with all other costs, should adequately reflect the requirements of the PWS. They should include related costs such as transport, handling, and availability/delay costs as well as reflect allowances for normal scrap, spoilage, overruns, and defective work.
• Other Specifically Attributable Costs. These costs include the following:
  • Depreciation
  • Cost of Capital
  • Rent
  • Normal Facility Maintenance and Repair
  • Utilities
  • Insurance
  • Travel
  • MEO Subcontracts
  • Other Costs
    

• Overhead Costs. There are two main parts to overhead – operations overhead and general and administrative overhead. Operations overhead is the cost of functions not 100 percent attributable to the activity under study but which are generally associated with the recurring management or support of the activity. General and administrative overhead is the cost (including salaries, equipment, space, and other activities) related to headquarters management and similar common services performed outside of, but in support of, the activity. Circular A-76 provides guidance on calculating overhead.
• Additional Costs. This cost category reflects costs that result from unusual or special circumstances. Examples include office and plant rearrangements; transport; and employee recruitment, training, relocation or other expenses.
• Other Considerations. Except as otherwise directed by Circular A-76, the above costs should be adjusted during each of the periods for inflation using the annual inflation guidance presented in the President’s Budget.

In preparing the cost estimate, agencies should be aware that common costs (costs that would be the same for in-house or contract performance) are considered a "wash" and should not be included in the estimate. Retained and save pay are also not included in the in-house cost estimates so that agencies are not penalized for historical organizational decisions. Finally, the cost of conducting a cost comparison is not added to the in-house cost estimate. This cost is considered an administrative expense associated with good management practices and, therefore, irrelevant to the cost of performance.

Once the decision to pursue an outsourcing project has been made, the acquisition strategy becomes key. Success in outsourcing is dependent on creating a win-win situation that requires clearly defined expectations and flexibility on the part of both parties. In addition, it requires use of an appropriate contract type that provides an incentive to the vendor to continually improve service and to work with the outsourcing organization as a team. It also requires the use of a PWS that contains benchmarked metrics that both parties understand and on which they agree.

Many agencies are quietly outsourcing services. As budgets and FTE authorizations continue to shrink, agencies are searching for ways to continue to provide quality service to their customers. One way to do this has been to write labor hour/time and material contracts, purchase orders or delivery orders for a small number of positions. By contracting for small, additional amounts of work each time, agencies can meet their needs without formal or complex outsourcing studies. The rapid expansion and increased availability of Government Wide Acquisition Contracts (GWACs) has accelerated this trend.

While this is one method of obtaining services quickly, and by-passing the often frustrating process set in place to conduct formal cost comparisons, it does present problems. As an example, agencies often use the most convenient contracting vehicle regardless of contract type. This leads to contractual arrangements that have poorly designed scopes of work, i.e., the agency utilizes a time and material contract arrangement to buy "hours" of a contractor’s time. Instead of pursuing this "quick fix," the agency needs to prepare a proper PWS and make decisions regarding the proper contract type(s).

OMB Circular A-76 counsels that all competitive methods of procurement may be appropriate for use in outsourcing. This includes sealed bids, two step, and competitively negotiated procurement techniques including best value source selections. Due to the complexity and/or criticality of most IT functions, it is recommended that IT organizations consider the source selection/best value methodology when making outsourcing decisions. Of course, the decision should be based on the requirements being outsourced and their complexity.

FAR guidance on selecting the contract type (Part 16) stresses that the selection of contract type requires the exercise of sound judgment. The objective is to negotiate a contract type and price (or estimated cost and fee) that will result in reasonable contractor risk and provide the contractor with the greatest incentive for efficient and economical performance.

The overall acquisition plan or strategy may affect the choice of contract type. As an example, work may be separated into discrete, readily identifiable work packages by using modular contracting techniques or by placing orders under an Indefinite Delivery Indefinite Quantity (IDIQ) type contract. This may reduce the risk of performance for both the government and the contractor to a point where a contract type (e.g., fixed price) can be used which places more risk on the contractor.

The PWS developed for the Outsourcing Study is used as the basis for the Statement of Work for the outsourcing RFP. Special care should be taken when developing the PWS to ensure that it does not limit service options, arbitrarily increase risk, reduce competition, unnecessarily violate industry service or service grouping norms, or omit statutory or regulatory requirements without full justification. The PWS defines the Government's requirements in terms of the objective and measurable outputs. It should be performance-oriented, specifying what outputs or measures are desired and limiting directions as to how the results are achieved. It should provide the vendor with answers to five basic questions: what, when, where, how many, and how well. It is important to accurately answer these questions in order to allow the vendor the opportunity to accurately assess resources required and risks involved. Requirements that are included in the PWS that place limitations on, or limit the options of, contractors will result in increased cost estimates.

Performance requirements should express the outputs in clear, concise, commonly used easily understood, measurable terms. They should not include detailed procedures that dictate how the work is to be accomplished. Examples of such requirements are: interfaces must contain compatibility among system components in the operational environment; newly developed software shall not adversely affect system performance; and for conversion projects of mission critical systems, provide parallel processing and/or system validation of the old and new systems prior to implementation

For each requirement, there should be a corresponding standard(s), a statement of the maximum allowable degree of deviation from the standard, and the method of surveillance to determine whether the standard is met. The surveillance methodology should be set forth in the quality assurance plan. The quality assurance plan gives the Government flexibility in measuring performance and serves as a tool to assure consistent and uniform assessment of the contractor's performance. This plan is primarily focused on what the Government must do to ensure that the contractor has performed in accordance with the performance standards. It defines how the performance standards will be applied, the frequency of surveillance, the maximum acceptable defect rate(s), and the value of each performance requirement as a percentage of the overall contract. A good quality assurance plan should include a surveillance schedule and clearly state the surveillance methods to be used in monitoring the contractor's performance.

As a part of its Guide to Best Practices for Performance-based Service Contracting¹⁸, OFPP has released model PWSs for a limited number of IT functions (maintenance, software development, and telephone call support). These PWSs were developed by representatives from various agencies and are an excellent source of reference.

Agencies have wide discretion on which selection/evaluation criteria to employ. If there is a government function involved in the bidding process, agencies should follow the guidelines set forth in A-76 as a part of the cost comparison/analysis. However, agencies are not limited to employing strictly a one-dimensional evaluation strategy, i.e., relying solely on a cost comparison. It is clear from recent procurement reforms that agencies should rely on a "best value" evaluation scenario. (Exhibit 5-1 shows one agency’s approach to implementing a best value strategy for outsourcing.) Therefore, agencies should rely on those factors, in addition to the Circular A-76 cost comparison, that will most likely result in a satisfactory contract. Factors may include the following:

• Past Performance. Past performance and core competency should be the paramount technical evaluation factors. Does the evaluated organization have as its core competency the functions to be outsourced, or is the organization merely looking for an opportunity to get in the business or expand its business base? How does the evaluated organization size up in terms of past performance.¹⁹
• Technical Capability. By establishing and evaluating technical criteria, the agency can address questions such as: Does the evaluated organization understand the requirements? Does its response to the PWS (or its submission of a PWS for those organizations which have the vendor submit a PWS) show an understanding of the goods or services to be provided? Has there been a clear agreement as to the expectations of both parties? Failure to agree on expectations is the single leading cause of failure of any contracting situation. Also, does the evaluated organization’s proposal provide evidence that it can meet the measurement criteria set forth in the PWS? Has the vendor performed on performance-based contracts before?
• Management Capabilities. In applying this criteria, the agency should determine if the vendor has the necessary program management processes in place to assure that the metrics are met? Does the vendor have the flexibility to change as the organization makes changes? In the rapidly evolving IT world, this is an especially important item.
• The Cost Comparison. In comparing the government proposals to those from the private sector, certain adjustments must be made. Generally, the private sector proposals involve relatively few adjustments. Perhaps the most significant adjustment is adding the cost of contract administration. A-76 provides a conversion scale for contract administration. Another adjustment that can be made to the private sector offers is the one-time, labor-related expenses to the government regarding displaced Federal employees. These expenses might include severance pay, relocation expenses, and retraining expenses.

Creation of a win-win scenario between the government and the contractor is perhaps the most significant factor leading to the successful implementation of an outsourcing strategy. Flexibility is the key to creating the win-win scenario. The PWS and other contractual documents should recognize that both the government and the contractor require a "living" document. This is especially true in the IT world. How many times have RFPs been released only to have requirements change while the RFP is still on the street? The probability of change occurring over a 3 to 5 year (or longer) life cycle is even more assured. Thus the contracting officer should be prepared to accept and negotiate change through the contract life rather than insisting that nothing in the contract can change.

The key to flexibility is communication. Agencies and contractors must enter into an arrangement where constant dialogue is the norm. Agencies that look upon a contract as an inflexible and unchangeable document do themselves as well as the contractor a disservice. Good communication between the parties to the contract (these include the "end user", the program management staff [if different than the end user], the contracting staff, and the contractor) can be facilitated by the use of an Integrated Process Team (IPT) or a Customer Process Improvement Working Group. These groups would meet regularly to identify and solve problems, propose innovative management and technical approaches, improve processes, and implement commercial practices.

Another way to implement a win-win situation is to find methods of compensating contractors who produce big savings to the agency. These savings can be achieved through various means such as the introduction of new technology, the re-engineering of certain time consuming but key processes, the introduction of program and risk management methodologies, etc. Agencies can provide incentives to contractors through incentive or award fee contracts. Under such arrangements, agencies should set the additional fees to be gained by the contractor at a level that truly will incentivize the contractor to risk its own funds to achieve a high quality of service. In addition, the agency will want to make sure that contractor management is aware of the incentive or award fees and the importance the government places on the service received. (Award/incentive fee contracts tend to be complex. It is important that agency have staff experienced in these contract types prior to entering into them.)

An innovative method of creating a win-win situation is the share-in-savings arrangement (a type of value engineering arrangement). In this type of arrangement, the government gives the contractor the rights to savings realized as a result of investments and changes implemented by the contractor. While this type of arrangement is new to the IT field, it has been used by agencies for other requirements where good metrics are available. An example is energy savings. In this example, agencies have data available regarding energy usage (e.g., electric, heat, etc.). The contractor implements energy saving measures at its own expense. Its compensation is a portion of the savings realized in reduced energy costs to the agency. The Air Force has implemented share-in-savings type arrangements for some of its energy management requirements. In these cases, capital funds are supplied by the contractor who implements facility improvements. Savings from these improvements are shared with the contractor for a specified period of time after which the government then owns the facilities. The Department of Energy has also begun to enter into these type arrangements for its energy management requirements. These arrangements are in their relative infancy; however, as pressure on budgets increases and as agencies become more comfortable with writing outsourcing agreements containing adequate metrics, etc., these type arrangements will increase as well.

There will always be some situations which do not lead to satisfactory results. Information Week²⁰ cited a Deloitte & Touche survey of 488 which companies found that over half the companies responding had re-negotiated their contracts and that of those who had renegotiated, 8 percent had brought the IT function back in-house. Even successful contracts will have to be recompeted periodically, usually as the result of an expiring contract term. The agency may have developed better information, metrics, etc., with which they can enhance the recompeted solicitation.

What should an agency do to be in a position to either bring an outsourced function back in-house or to recompete it without destroying the agency’s ability to meet its fundamental mission? As discussed in Chapter 3, an agency can protect its ability to provide continual services through several means. One method is to employ modular contracting in which large projects or functions can be divided into logical segments. Agencies, especially those first entering into outsourcing arrangements, may want to consider outsourcing the different pieces of the IT function to different vendors rather than having a single vendor assume the total responsibility. Likewise, an agency should not enter into a long-term contract as its first outsourcing venture. As the agency gains experience over a period of time, it can identify those things that work and change those that do not.

Other ways of building successful strategies are available. Agencies may require the contractor to keep certain individuals on the contract as "key" employees. They may even go so far as to give the government right of first refusal to rehire those employees. Additionally, the agency should definitely require the contractor(s) to provide a transition plan that they are contractually obligated to meet in the case of a re-competition. The agency can even make sure it has the contractual right to acquire from the contractor any assets, licenses, etc., which may be needed to assure continuity of service.

Lastly, the agency should retain an appropriate number of staff with the appropriate skills not only to oversee the contractor but also to perform the acquisition/program functions required to plan and execute the re-competition.

These strategies will help to ensure that the government can successfully continue to provide IT services whether through another vendor or bringing the function back in house.

Presented below is a brief description of some of industry’s major concerns and perceived risks in the outsourcing environment. Understanding these concerns can assist the Government agency in crafting an acquisition strategy which removes some of the risk, resulting in an improved selection and operational environment.

As a general comment, industry is elated that Federal agencies are outsourcing and contracting out greater portions of their IT work. The elation, however, is tempered with concerns over the fairness of the competitive process and the realization that many Federal managers have developed an entrepreneurial spirit and are competing directly with the private sector for certain commercial type activities.

Industry’s primary concern is its ability to compete on a fair and level playing field with Federal agencies especially as it relates to cost. This perception of an uneven playing field is brought about because government organizations are not required to account for costs in the same manner as commercial organizations. OMB Circular A-76 does recognize the problem and proposes some adjustments to offset these costs; however, these offsets do not go far enough to satisfy the contractor community. As an example, Federal agencies are not required to compute all high level general and administrative costs.

In recent years, the government has taken steps to make its operations more businesslike. Chief Financial Officer positions have been created by legislation. OMB has recognized the need for Activity Based Costing for Federal agencies, and executive agencies are working together to develop a Managerial Cost Accounting Implementation Guide. Industry recognizes the government efforts over the last several years and is appreciative of the more open communications with financial policy makers.

The IT industry is also concerned with the quality and application of comprehensive PWSs. Industry is prepared to propose to, and operate under, PWSs that contain realistic and achievable performance metrics.

Industry often believes that government agencies receive more favorable treatment during the RFP evaluation, as well as during contract performance, regarding application of performance metrics and other terms and conditions. Of particular concern is an industry perception that agencies will not be held to the same degree of responsibility (e.g., performance standards, negative incentive criteria, terminations for default, etc.) that contractors are even though OMB Circular A-76 does provide remedies for government non-performance.

While it is true that industry’s main focus is on making a profit, the quality firms understand that they must satisfy the goals and objectives of the customer in order to make an acceptable profit. These firms that are successful in this environment look to establish win-win situations in which they enter into partnerships with their customers. This includes establishing a contract structure whereby quality performance in excess of the minimum is rewarded with increased profitability.

Outsourcing will grow to be an accepted way of doing business as both the private sector and government agencies focus more directly on customer service and cost/budget reductions. As the concept becomes more accepted and outsourcing opportunities expand, the process will be more clearly outlined. Federal agencies will accept outsourcing as another tool to improve services and reduce costs. Properly used, along with modular contracting, past performance initiatives, GWACs, etc., outsourcing will provide agencies with the means to achieve excellence.

Agencies are becoming more adept at dealing with the changes brought about by legislative initiatives. The use of strategic planning to identify goals and objectives is instrumental in agencies’ determination of their core competencies. The use of the various IT Investment Boards, along with the Capital Planning requirements laid out by ITMRA and OMB, will aid agencies in making decisions on which goods and services to retain in-house and which to outsource. The use of Performance Measurements and Performance Work Statements, as required by GPRA and ITMRA, will allow agencies to accurately measure the outputs and outcomes of their own internal efforts as well as those of contractors.

Finally, agencies will become comfortable with the entire process. They will approach outsourcing as a management tool that solves long term, strategic problems rather than short term, tactical problems. In doing so, agencies will work with the private sector as a team to realize successful outsourcing efforts. This cooperation is critical as both parties agree on the expectations to be gained from the outsourcing arrangement.

To paraphrase the Department of Energy’s Report on Privatization²¹, when wisely considered and carefully implemented, outsourcing is a powerful strategic management tool that can remove the Federal government from activities that are not inherently governmental functions or core business lines; improve the management of remaining activities; reduce the costs of doing business; and shift greater performance and financial risk to the private sector. However, it must be remembered that privatization is only a management tool, not a substitute for good management.

1. Outsourcing Institute, Selected Industry Studies, www.outsourcing.com/library/stats.html, January 29, 1998.
2. Meador, C. Lawrence, "IT Outsourcing: Operational Improvement or Strategic Imperative?", www.mstnet.com/mstnet/articles/wp_outsrc/wp_outsrc.html, January 29, 1998.
3. Corbett, Michael, "The Emergence of Applications Development and Maintenance Outsourcing as a Tool for Maximizing IT Value," The Outsourcing Institute, 1996.
4. Caldwell, Bruce and Marianne Kolbasuk McGee, "Outsourcing Backlash," Information Week, September 29, 1997.
5. Dobkin, James A, "Federal Privatization and Outsourcing of Information Technology Functions: A Practitioner’s Perspective," Federal Contracts Report, Vol.66, No. 19, November 18, 1996.
6. Stockman, David A., Office of Management and Budget, OMB Circular A-76 (Revised) "Performance of Commercial Activities", August 4, 1983.
7. National Performance Review, "Reinventing Federal Procurement", September 14, 1993.
8. Kemper, Carrie, "Report on the Reinvention Revolution Conference April 7-9, 1997", www.npr.gov/cgi-bin/print_hit_bold.pl/library/misc/revolutn.html, January 29, 1998.
9. National Performance Review, "Common Sense Government," September 1995.
10. National Performance Review, "Common Sense Government", September 1995.
11. Outsourcing Institute, "The Top Ten Reasons Companies Outsource," www.outsourcing.com//getstart/topten.html, January 29, 1998.
12. General Services Administration, Strategic Information Technology Analysis Division, "White Paper: Modular Contracting", July 1997.
13. Gabig, Jerome S., Jr., "Privatization: A Coming Wave for Federal Information Technology Requirements, National Contract Management Journal, Volume 27, Issue 1, 1996, quoting J. Collins and R. Millen, "Information Systems Outsourcing By Large American Firms: Choices and Impacts", Information Resources Management Journal, Winter 1995.
14. Dobkin, James A, "Federal Privatization and Outsourcing of Information Technology Functions: A Practitioner’s Perspective", Federal Contracts Report, November 18, 1995 quoting "Rolling Back Government: Budget Plan to Rebuild America", The Heritage Foundation, Scott A. Hodge ed., 1995.
15. Gabig, Jerome S., Jr., "Privatization: A Coming Wave for Federal Information Technology Requirements, National Contract Management Journal, Volume 27, Issue 1, 1996, referencing "Public and Private Roles in Maintaining Military Equipment at the Depot Level", Congressional Budget Office, July 1995.
16. Office of Federal Procurement Policy, "OFPP Circular 92-1 Inherently Governmental Functions", September 1992.
17. General Services Administration, Strategic Information Technology Analysis Division, "White Paper: Modular Contracting", July 1997.
18. Office of Federal Procurement Policy, "OFPP Guide to Best Practices for Performance-based Service Contracting", April 1996.
19. General Services Administration, Strategic Information Technology Analysis Division, "White Paper: Past Performance", 1997.
20. Caldwell, Bruce and Marianne Kolbasuk McGee, "Outsourcing Backlash," Information Week, September 29, 1997.
21. Department of Energy, "Report on Privatization", www.doe.gov/ privatization/report/ message.htm, January 29, 1998.

October 25,1996

THE DIRECTOR

MEMORANDUM FOR HEADS OF EXECUTIVE DEPARTMENTS AND AGENCIES

FROM: Franklin O. Raines

SUBJECT: Funding Information Systems Investments

The Information Technology Management Reform Act (ITMRA) of 1995 (40 USC 1401 et. seg.) directs the Office of Management and Budget to establish clear and concise direction regarding investments in major information systems, and to enforce that direction through the budget process. Accordingly, the decision criteria set out below are established with respect to the evaluation of major information system investments proposed for funding in the FY 1998 President's budget.

The most effective long-term investment strategy is guided by a multiyear plan. The plan is a roadmap for getting from "where we are today. to "where we want to be" -- achieving the strategic mission goals of the organization in the framework of the Government Performance and Results Act (GPRA). Thus the first four decision criteria relate specifically to capital planning. The fifth criterion establishes the critical link between planning and implementation -- information architecture -- which aligns technology with mission goals. Under the ITMRA, the Chief Information Officer is responsible for that architecture. The last three criteria establish risk management principles to assure a high level of confidence that the proposed investment will succeed.

Policy

Investments in major information systems proposed for funding in the President 's budget should:

1. support core/priority mission functions that need to be performed by the Federal government;

2. be undertaken by the requesting agency because no alternative private sector or governmental source can efficiently support the function;

3. support work processes that have been simplified or otherwise redesigned to reduce costs, improve effectiveness, and make maximum use of commercial, off-the-shelf technology;

4. demonstrate a projected return on the investment that is clearly equal to or better than alternative uses of available public resources. Return may include: improved mission performance in accordance with GPRA measures; reduced cost; increased quality, speed, or flexibility; and increased customer and employee satisfaction. Return should be adjusted for such risk factors as the project's technical complexity, the agency's management capacity, the likelihood of cost overruns, and the consequences of under- or non-performance;

5. be consistent with Federal, agency, and bureau information architectures which: integrate agency work processes and information flows with technology to achieve the agency's strategic goals; reflect the agency's technology vision and year 2000 compliance plan; and specify standards that enable information exchange and resource sharing, while retaining flexibility in the choice of suppliers and in the design of local work processes;

6. reduce risk by: avoiding or isolating custom-designed components to minimize the potential adverse consequences on the overall project; using fully tested pilots, simulations, or prototype implementations before going to production; establishing clear measures and accountability for project progress; and, securing substantial involvement and buy-in throughout the project from the program officials who will use the system;

7. be implemented in phased, successive chunks as narrow in scope and brief in duration as practicable, each of which solves a specific part of an overall mission problem and delivers a measurable net benefit independent of future chunks; and,

8. employ an acquisition strategy that appropriately allocates risk between government and contractor, effectively uses competition, ties contract payments to accomplishments, and takes maximum advantage of commercial technology.

As a general presumption, OMB will recommend new or continued funding only for those major system investments that satisfy these criteria. Funding for those systems will be recommended on a phased basis. (For more information on phases, see the discussion of "economically and programmatically separable" modules, in OMB Circular A11, Part 3, "Planning, Budgeting and Acquisition of Fixed Assets," July 1996.)

A "major information system" is a system that requires special management attention because of its importance to an agency mission; its high development operating, or maintenance costs; or its significant role in the administration of agency programs, finances, property, or other resources. Large infrastructure investments (e.g., major purchases of personal computers or local area network improvements) should also be evaluated against these criteria.

OMB recognizes that many agencies are in the middle of ongoing projects initiated prior to enactment of the ITMRA, and may not be able immediately to satisfy the criteria. For those systems that do not satisfy the criteria, OMB will consider requests to use FY 1997 and 1998 funds to support the redesign of work processes, the evaluation of investment alternatives, the development of information architectures, and the use and evaluation of prototypes.

The policies in this memorandum apply to all agencies. The 28 major agencies listed in Section 3 of Executive Order No. 13011, "Federal Information Technology," should provide, by November 12, 1996, a statement listing the major information systems investments for which new or continued funding is requested in the agency's FY 1998 budget, and an evaluation of the extent to which each investment satisfies the decision criteria. For national security systems as defined in Section 10 of the Executive order, only the list need be provided. OMB will work with the agencies to ensure that national security systems satisfy the criteria to the extent practicable.

Because OMB considers this information essential to agencies' long-term success, OMB will use this information both in preparing the FY 1998 President's budget and, in conjunction with cost, schedule, and performance data, as apportionments are made. Agencies are encouraged to work with their OMB representative to arrive at a mutually satisfactory process, format, and timetable for providing the requested information.

In July, 1996, J.P. Morgan signed a contract with a prime contractor and 3 subcontractors to outsource approximately 30 percent of J. P. Morgan’s IT functions. The value was estimated at $2.1 billion over 7 years. The scope of the outsource activities included J. P Morgan’s IT infrastructure (mainframe data centers, midrange computing, client/server, desktops, voice and data networks), plus about 20 percent of their software application base. Approximately 900 employees were transferred from J.P. Morgan.

• Costs in general have fallen and fixed costs have been reduced,
• Company managers are beginning to focus on strategy rather than on day-to-day operations, and
• The company has gained access to IT skills it could never have developed internally.

Keys to success: Teamwork and communication between all parties.

Source - Integration Management, "Ten Deals That Shook the Globe," Mark Mehler, (http://www.integrationmanagement.com/sub_sections/ten_deals.html, January 29, 1998)

In August, 1977, the National Air and Space Administration (NASA) outsourced IT operations at its Jet Propulsion Laboratories (JPL) to a Prime contractor. The contract was estimated at over $200 Million over a 5 year time period. The contractor will provide personnel, computer hardware and software as well as equipment and support services for over 7,000 PCs. The fixed-price, performance-based contract covers help-desk services, systems administration, software acquisitions and upgrades, computer hardware maintenance, and hardware replenishment.

Key Objective: Focus on core competencies.

Source – NASA Press Release c97-k, August 26, 1997

In 1996, the City of Indianapolis awarded a contract to a prime contractor to provide IT services to the City and the surrounding Marion County. The scope of the effort included all IT services not involved with Public Safety. The contract was estimated at $81 Million over 7 years.

• Reduced costs
• Improved quality
• Access to better talent
• Enhanced public access to records.

In May 1994, Britain’s Inland Revenue (comparable to the Internal Revenue Service in the United States) signed an outsourcing contract with a prime contractor to provide computer services previously provided by Inland Revenue’s in-house Information Technology Office. The contract was a 10 year "strategic partnership" estimated at over $1.6 billion. Approximately 1,900 employees from Inland Revenue were transferred to the contractor.

• Substantial improvements in cost-effectiveness
• Significantly improved speed of response in the development and enhancement of systems
• Rapid access to the latest information technology skills and technologies
• Optimized career opportunities for Information Technology Office staff.

Source – National Audit Office, Report by the Comptroller and Auditor General, "Inland Revenue: Market Testing the Information Technology Office", March 8, 1995.