The Obama Administration yesterday issued a Presidential Memorandum on government contracting that is designed to improve the efficiency and effectiveness of the federal procurement system. The memorandum, which directs the Office of Management and Budget (OMB) to give detailed guidance to federal departments and agencies later this year, is likely to have significant impacts on companies that contract with the government with respect to: (1) the types of contracts awarded, (2) definitions of permissible outsourcing, and (3) the extent of competition in government contracts.

The genesis of the memorandum is growing concern over federal procurement programs—notably, the lack of sufficient government oversight and resulting significant cost growth on major programs. The memorandum notes a recent Government Accountability Office (GAO) study of 95 major defense acquisition projects that found cost overruns of 26%, totaling $295 billion, over the life of such contracts.  

The memorandum cites a number of specific practices of concern, including: (1) the trend away from the use of full and open competition in contracting (using sole-source or no-bid contracts instead); (2) the use of cost-reimbursement rather than fixed-price contracts; and (3) the outsourcing to contractors of functions that may be inherently governmental. The memorandum notes that reversing these trends may allow taxpayers to receive more value for their dollars and reduce the sums spent on government contracts.  

The substance of the memo is not surprising. It is consistent with what then-candidate Obama said during the recent presidential campaign. It also tracks with numerous recent studies highlighting flaws in government contracting as well as pending legislation, recently introduced by Senators Carl Levin and John McCain, respectively the Chairman and Ranking Member of the Senate Armed Services Committee, to reform government contracting rules, policies and practices.  

The legislation (S. 454), known as the “Weapon Systems Acquisition Reform Act of 2009,” is designed to address what its authors called “the unreasonable cost and schedule estimates, unrealistic performance expectations, immature technologies, and repeated program changes that have led to explosive cost growth and costly schedule delays on so many of our major defense acquisition programs,” according to the press statement announcing the bill. While S. 454 contains numerous provisions that parallel the contents of the Obama memorandum, it also goes significantly beyond the memorandum in some areas, covering organizational conflicts of interests, vertical integration and other areas. There undoubtedly will be an interactive relationship between the legislation, as it moves forward, and the guidance provided by OMB.  

Specifically, to address the concerns over the federal procurement system, the memorandum directs OMB to provide guidance on the following:  

1. Review of Existing Programs. The memo notes that the OMB guidance will assist agencies in reviewing and creating processes for ongoing review of existing contracts in order to “identify contracts that are wasteful, inefficient, or not otherwise likely to meet the agency’s needs, and to formulate appropriate corrective action in a timely manner.” It notes that such corrective action may include “modifying or canceling such contracts.” Such reviews, which candidate Obama called for during the campaign, could potentially affect large and significant government contracts.

2. Maximize Use of Full and Open Competition. The memo directs OMB to give guidance on the appropriate use and oversight of sole-source and other types of noncompetitive contracts. While there already is a federal policy embodied in the Federal Acquisition Regulation (FAR) in favor of competition, the new guidance may potentially require more government review and establish more stringent justifications before agencies depart from competitive processes. The memorandum also notes the need to create appropriate safeguards for the use of such noncompetitive contracts to minimize risks to the government (e.g., presumably risks such as sizable cost overruns). The implication is that more rigorous oversight of the initial use of such noncompetitive contracts and the use of better management tools and incentives during the life of such contracts (perhaps some types of cost/pricing standards) will provide better value to the taxpayer.  

3. Preference for Fixed-Price Contracts. While there is today a preference for the use of firm, fixed-price contracts in the FAR, the memorandum would appear to go further and may create rigorous standards governing alternative contracting methods. An open question is whether the guidance will in practice materially affect the use of cost-plus contracting on large development contracts. It has been historically proven hard to use fixed-price arrangements for this work because of the inherent difficulty the Department of Defense and other agencies have had in sufficiently defining requirements for new, yet-to-be-developed systems. Earlier efforts at fixed-price development were not successful. But with changes in rules and practices, it may today be possible, and OMB may try to move toward more price-based acquisitions for these types of contracts.  

4. Assess the Capacity of the Federal Acquisition Workforce. A clear thrust of the memorandum and numerous recent studies is that the federal government today lacks a workforce with sufficient capability—both size and expertise—to oversee federal contracts. Hence, the memo requires OMB to offer guidance in this area to the agencies. Other pending legislation also is directed at requiring the Defense Department and other agencies to conduct such reviews as a first step toward rebuilding the workforce in order to better oversee federal contracts.  

5. Clarify Permissible Outsourcing. The memorandum notes that “the line between inherently governmental activities that should not be outsourced and commercial activities that may be subject to private sector competition has been blurred and inadequately defined.” It therefore directs OMB to give guidance to agencies in this area to establish “clear rules” and avoid situations, which it notes may now exist, where “contractors may be performing inherently governmental functions.” The clear import of the memorandum is to limit outsourcing to private contractors. Thus, this new guidance will have significant consequences for the range of service contractors that have emerged in recent years.  

In sum, this important Obama memorandum is probably just the first, opening effort of a full-fledged drive by the Administration to fulfill its campaign commitment to reform government contracting.