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

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Cross-posted on POGO's blog.

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

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

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

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

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

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

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

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

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

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

...

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

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

Scott Amey is POGO's general counsel.