The Chimerical Cost Savings of Outsourcing

08/22/2010 11:56 pm ET | Updated May 25, 2011
  • David Isenberg Author, 'Shadow Force: Private Security Contractors in Iraq'

This year has seen increased rhetoric, if not a lot of action, about the idea that the Obama Administration is suddenly putting back into government all sorts of jobs that previously had been outsourced or privatized. The August 9 announcement by Defense Secretary Robert Gates about the Pentagon relying less on contractors is supposedly a sign that the pendulum is suddenly swing back towards insourcing.

This is a laughable contention, if for no other reason, that the Pentagon doesn't even know how many contractors it has working for it.

As Winslow Wheeler of the Center for Defense Information pointed out, in regard to Gate's call for a 10 percent reduction per year for three years in "support contractors":

The total number of these contractors appears to be unknown. One estimate is that the DOD contractors number 790,000; other numbers in are higher. In any case, the denominator for this 10 percent reduction appears to be unknown. Also, it is unclear if this 10 percent reduction pertains to all contractors or a subset. If the correct number is 790,000, will there actually be three years of reductions of 790,000 of these people?)

More to the point private military contractor advocates have been beating their rhetorical drums for many years that the private sector is usually better than the public sector in achieving results. Sometimes; maybe even many times, it is true but hardly always.

Most people have forgotten the background to this. That is why an article published earlier this year in the Air Force Law Review merits our attention

The article, "Uncontracting: The Move Back to performing In-House" by Major Kevin P. Stiens and Lt. Col. (Ret.) Susan l. Turley recalls that Section 832 of the National Defense Authorization Act for Fiscal Year 2001 required the Comptroller General to convene a panel to study transferring commercial activities from performance by federal employees to performance by contractors. "The Panel was to consider procedures for determining whether functions should continue to be performed by government personnel, and for comparing the cost of performance of functions by government personnel with the cost of the functions by contractors." ...

The section did not mandate insourcing but did require DOD to consider returning to performance by government employees when a contract has been "poorly performed due to excessive costs or inferior quality." ... The GAO also agreed that outsourcing could achieve substantial savings, concluding that "outsourcing is cost-effective because the competitions generate savings--usually through a reduction in personnel--whether the competition is won by the government or the private sector." ...

But, and here is the part that private military advocates rarely mention:

the short-term savings that outsourcing promises evaporate quickly once competitors drop out; contractors who underbid to win a contract are free to raise rates later or in follow on contracts, often leaving government representatives with little choice but to accept." ... But " while some exalt the benefits of the blended workforce, others are concerned about the loss of in-house expertise, lack of ethical standards for contractors, and the 'pirating' of government employees by contractors.

The article argues that "overestimated cost savings and global changes negatively impacted the outsourcing process. Not only did the cost savings fail to materialize, outsourcing caused other tangible losses. The government lost personnel experience and continuity, along with operational control, by moving to contractors."

The authors also write, "Although insourcing will not be a miracle cost-saving tool, performing more functions with federal employees instead of contractors will better equip the government to operate in current global conditions."

Ignore that background noise; it's just the sound of various trade associations gnashing their teeth and sputtering indignantly.

Considering how often advocates claim that PMC are just doing their part to help make the country safer, paragraph is worth considering:

Initially, outsourcing aimed to cut government spending while also decreasing the size of the government, especially the military. Eisenhower worried that big government "would make decisions that suited them best, undermining democracy. In short, they might use the pursuit of making Americans safer as cover for all kinds of ills.

I do not have space here to do justice to the article's detailing of the history of governmental outsourcing so let's just say that in the author's view it is a nice idea, which does not live up to reality. They note:

Despite increased effectiveness, improved capabilities and taxpayer savings, competitive sourcing ultimately fails for a number of reasons. The biggest drawbacks roughly correspond to benefits offered by insourcing. The anticipated cost savings turned out to be inflated at best and non-existent at worst. In some cases, outsourcing has actually cost the government more, in part because of an inability to properly manage the contracts and contractor personnel, and the recurring recompetition requirement. Insourcing, on the other hand, would not only reverse the financial roller-coaster but would allow the government to better control personnel while retaining in-house expertise.

They also note that many of the purported savings claimed by PMC advocates are not backed by evidence; a point I have been making for years.

Additionally, the fact that the government uses a detailed process to determine costs does not guarantee that the private competitor will conduct such an exacting pricing valuation. Contractors' bids should reflect their overhead costs, such as training personnel and providing medical and retirement benefits; their more direct costs, such as wages; and what they plan to charge the government to achieve a reasonable profit. However, contractors have an economic incentive to overestimate their savings and efficiencies: award of the contract. In a fixed-price contract, the contractor bears the risk of underbidding, but if the government commits to reimbursing the contractor's costs, the government may realize no savings. No matter how the results are calculated, they are simply estimates, which may or may not play out as expected.

Most outsourcing savings estimates failed to account for typical growth in contract costs. Admittedly, the government can obtain some simple goods and services more cheaply through contracting out. However, frequently "the short-term savings that [outsourcing] promises evaporate quickly once competitors drop out; contractors who underbid to win a contract are free to raise rates later or in follow on contracts, often leaving government representatives with little choice but to accept." While the GAO recognized that outsourcing can be cost-effective, in a report to Congress it questioned some of the savings projections. The GAO reported doubts that the services would ever achieve the projected 20 to 30 percent savings. In fact, the "GAO found that contracting outside of A-76 can actually cost the government more than doing the work in-house." According to GAO, both DOD and OMB lacked "reliable data" at every stage of the outsourcing effort. Neither agency had the right information at the start "to assess the soundness of savings estimates," and DOD then failed to consistently track and analyze cost data to determine whether the contract achieved the savings. The process takes into account anticipated costs; it does not look at what a contract costs the government in the end.

The authors also note that this is not exactly what you would call breaking news.

As early as 1991, various studies showed that contracts are more expensive than government employees. For example, the GAO concluded that 11 out of 12 contractors in their study were about 25 percent more costly. Studies after years of outsourcing confirmed this early data. In 2007, a Congressional study found that contracts for intelligence support cost, on average, almost twice as much as in-house performance. In 2008, the Office of the Director of National Intelligence reported that the cost of a federal employee--including not just salary but all benefits such as retirement and healthcare--was $125,000, while the direct cost (excluding overhead) for each contractor employee was $207,000.