Can OMB's new centers of excellence really compete?

Designated providers are prevented from retaining and reinvesting earnings, putting them at a disadvantage

Former OMB official

"The COEs in franchise funds have an advantage in competing with the private sector."

Which COEs can keep money?

Center of Excellence/Line of BusinessFranchise Fund?Retain earnings?
Treasury's Bureau of Public Debt/FMYesYes
Defense Finance and Accounting Service/FMNoNo
General Services Administration/FMNoYes*
Health and Human Services/HRNoNo
Interior's National Business Center/FM and HRNoNo
Agriculture's National Finance Center/HRNoNo
Transportation Dept./HRYesYes
Treasury Dept./HRYesYes

FM=financial management, HR=human resources

*GSA uses a revolving fund and can retain earnings.

"If we want COEs to operate like government-owned enterprises and compete like private sector companies, then they need freedoms and incentives." 'Wayne Leiss, former OMB official

The Office of Management and Budget's strategy for moving agencies to consolidated financial and human resources management systems is about to be put to the test. As agencies begin to adopt shared-services providers, federal experts question whether a 74-year-old law that applies to agency balance sheets will prevent some of the service providers from competing on level ground.

At least three major agencies -- the Agriculture and Labor departments and the Environmental Protection Agency -- will turn financial mamagement over to OMB-designated centers of excellence this year.

These follow migrations to Human Resources COEs, started last year when the Homeland Security and Housing and Urban Development departments moved to shared-services providers, that are expected to continue this year, if at a slower pace.

But chief among the concerns is whether COEs have the legal and financial latitude to support and sustain these systems over the long term, providing better and less expensive services. A related concern is how COEs would pay to remedy shortcomings
in service-level agreements. Some experts are concerned that the COEs will not be able to compete with private-sector companies or even some other agency providers, known as franchise funds, that operate under a different set of rules that let them retain earnings for capital investment.

Three civilian COEs, led by the Interior Department's National Business Center, the Health and Human Services Department and Agriculture's National Finance Center, are stuck in a government time warp'unable to act like a private-sector business but being asked to compete like one and against them.

The time warp stems from the Economy Act, a law written in 1932 to govern how agencies procure services from one another. And while Congress updated the act in 1988, the tenets remain basically the same: Shared-services providers can charge customer agencies only for services provided, and cannot spend funds they do not have or extend the availability of their money by transferring it to services for another agency.

Additionally, NBC, NFC and HHS, unlike the other COEs, cannot retain earnings from year to year, meaning they start each Oct. 1 with a zero balance, and cannot easily plan for normal business activities such as marketing, refreshing technology or hiring of personnel to meet customer demands. These COEs also cannot budget revenues below costs, because then they would be in violation of the anti-deficiency act, which states agencies cannot spend money they do not have.

Either ... or

If the COEs cannot retain earnings, they must either convince their customer agencies to pay for technology upgrades or other indirect costs through normal monthly fees, or the COE must go through the arduous appropriations process, government officials said.

'The Economy Act and our ability to retain earnings are competitively affecting us now,' said Doug Bourgeois, director of NBC. 'We are not authorized to set aside reserves, so when an agency puts out a request for proposals and they want a fixed-price contract, we don't have the ability to sign up for the way they intended, and we have to propose our best way to meet their intent. We are constrained, and it is a competitive issue.'

With COEs unable to retain earnings and constrained by an archaic law, some in government wonder whether OMB is setting up the COEs to effectively compete against other service providers, let alone private-sector companies with greater financing flexibility and the ability to underbid their competition to win business.

Some officials wonder whether OMB's vision of consolidating agency financial-management services around a limited number of suppliers'either public or private'will truly save agencies money and provide them better service if certain COEs are retrained in acquiring cutting-edge technology or hiring the best personnel.

'If we want COEs to operate like government-owned enterprises and compete with private-sector companies, then they need freedoms and incentives,' said Wayne Leiss, former systems branch chief for the Office of Federal Financial Management in OMB and now CIO at the Commodity Futures Trading Commission. 'The COEs in franchise funds have an advantage in competing with the private sector.'

Four civilian COEs operate as franchise funds, or as revolving funds, and can retain up to 4 percent of their earnings (see chart). For instance, the Treasury Department's Bureau of the Public Debt brought in $60 million in revenue last year and was legally allowed to retain about $2.4 million for capital investment projects or other essential services that most businesses take for granted.

'Retaining earnings allows us to behave like an actual business, where we are taking on significant risk in taking on customers, bringing up an appropriate infrastructure and bringing on employees to service them,' said Fred Philips, executive director of the Bureau of the Public Debt, a financial-management COE.

Investment required

'Without retained earnings, our life would be very complicated, because bringing up an agency like EPA is a multiyear event that requires significant investment in hardware and software,' Phillips said. 'And not being able to do that and being confined by fiscal-year constraints would put you in a pretty big disadvantage.'

Congress granted six franchise fund pilots in 1994 under the Government Management and Reform Act, and OMB assigned them to agencies, many of which became COEs.

The Economy Act's restrictions on retaining earnings is not a new problem for agencies, experts said.

Mike Serlin, who led the financial-management team under President Clinton's National Performance Review program, said his group tried to solve the problem more than 10 years ago.

'No company operates without a reserve, and we shouldn't ask the government cross-services providers to do the same thing,' said Serlin, who retired in 1994 as Treasury's assistant commissioner for the Financial Management Service. 'There is great value in competition, but the competition must be for everyone and not just for some of the group. There needs to be a level playing field. And the Economy Act and the inability to retain earnings' do not provide one.

Federal officials said OMB is aware of the problem and is mulling how to deal with it.

'I would hope OMB would move forward with a consistent retained-earnings policy for all COEs,' NBC's Bourgeois said.

An OMB official, who requested anonymity, would say only that the
E-Government and IT Office is working through the retained-earnings issue.
'OMB is currently reviewing the options available,' the official said.
To become a franchise fund, agencies need congressional approval, federal officials said.

That leaves NBC, NFC and HHS scrambling to put their best foot forward to answer the three RFPs on the street now and future ones.

'We do very little marketing and have no bid and proposal money; we take it out of hide,' said NFC director Jerry Lohfink. 'I try to leverage my travel expenses for other official meetings to meet with potential customers.'

Both NFC and NBC have tried to become franchise funds over the past few years, but Congress has rejected their attempts.

Try, try again

Lohfink and Bourgeois said their organizations will try again this year, hoping to lift the constraints.

'Retained earnings seems to be a controversial issue at times,' Lohfink said. 'I guess we haven't done a good enough job explaining the challenges and opportunities.'

But some say retained earnings is not the answer.

Mark Forman, former OMB administrator for e-government and IT and principal for KPMG LLP of New York, said COEs should work with customer agencies to develop a joint business case to pay for technology upgrades.

'The Government Management Reform Act should have addressed most of these issues,' Forman said. 'Retained earnings is one way to finance investment, but it is not the only way. The onus is on the initiative leader to show the opportunities to save money. Each agency can chip in, share the risk and benefit from the lower cost.'

But Lohfink said that while Forman's idea works in theory, in reality it falls short.

'We tried to replace our personnel system in 1998 or 1999. We developed a business case and got our customers excited about it,' Lohfink said. 'But when you have 132 customers and so many line-item appropriations, we didn't control enough of our destiny to make this work. About 40 percent of our customers gave a verbal commitment to financially support it.'

Instead, COEs must pay technology upgrades by going through the annual appropriation cycle, which is neither easy nor guaranteed. Officials said they must convince both agency management and the Hill to pay for something that will benefit other agencies.

Besides finding money for capital investment, COEs without the ability to retain earnings also cannot bid on RFPs using firm, fixed-price contracts, federal officials said.

Bourgeois said under a firm, fixed-price contract, NBC's estimate of what it will cost them to do the work has to be perfect, and that doesn't happen for any business very often.

'It doesn't matter if the customer changes their requirements and the cost exceeds the firm, fixed price or if we underestimate the costs. When that happens, we have two choices: We can charge the customer or we can violate the law by paying for the cost overrun ourselves'which, of course, we would not do,' he said. 'When an agency is evaluating a proposal, they will give more points to a franchise fund COE or private-sector COE who can tap into reserves to meet the fixed-cost contract requirements.'

Leiss, the former Office of Federal Financial Management official, said a third issue is ensuring that COEs meet service level agreements.

OMB has said if the customer is not happy with the provider, the COE will have to pay for the customer to switch. COEs without retained earnings do not have the ability to pay for that, and so there is no way to ensure SLAs are met, Leiss said.
'If COEs retained earnings, they could pay bonuses to employees for meeting SLAs or penalties back to the customer for not meeting them,' he added.

Most federal officials said making all COEs franchise funds or developing some type of governmentwide working capital fund would go a long way toward solving the problem.

'A franchise fund would solve the serious constraints that are problematic, especially when you talk about our ability to sustain long-term performance and efficiency,' Bourgeois said. 'How long can we survive until we need to scale up? There is a limit.'


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