Recent financial problems have caused a renewal of interest in alternative ways to run state government and deliver public services. One often mentioned possibility is to let others, especially private businesses, provide more goods and services. It is argued that market forces and free enterprise can yield equal or better quality goods and services at lower cost than state agencies with their own employees.
It is not easy, however, for state government to purchase goods and services from outside sources. Reliable cost and quality comparisons are often hard to make, and state agencies must comply with numerous rules and procedures to meet the requirements of public accountability. In other words, contracting with outside sources is itself a complex and difficult management challenge.
We were asked by the Legislative Audit Commission to study state contracting. Our study focused on the broad category of professional/technical services rather than commodities. We focused on these key questions:
In general, we found that state agencies are satisfied with contractors' performance, but they sometimes lack information which would allow them to determine the costs and benefits of various alternatives. In addition, we found that contracts are not always managed efficiently and effectively, and the state's regulatory efforts are sometimes uncoordinated. Until such problems are resolved, in our opinion, the effects of increased state reliance on alternative service providers are uncertain and may not be entirely beneficial.
Contracting by State Agencies
The term "contract" refers to written instruments containing the legal elements of offer, acceptance, and consideration to which a state agency is party. Our study focused on 2,922 professional/technical service contracts which the Department of Administration approved during fiscal year 1990. The term "professional/technical" includes various services from consultants, professionals, and technical workers, as well as computer-related services, construction projects, and miscellaneous activities.
Based on contract records for fiscal year 1990, the most recent complete source of data when our study began:
About three-quarters of this amount was for construction projects by the Department of Transportation, but about one-fourth of all professional/technical contracts were estimated at $3,000 or less. The largest contract in fiscal year 1990 was for $68 million, for the intersection of Trunk Highway 100 and Interstate 394, and the smallest was for $80, to provide an artwork.
State law requires the Commissioner of Administration to describe the amount and purpose of professional/technical contracts in monthly and quarterly reports to the Governor and Legislature. However, we found that:
We reviewed several of the monthly listings, each of which is about ten pages long. The only summary information we found was the total estimated cost and the subtotal for each department. But this information could be misleading: the totals and subtotals combine the estimated cost of new contracts with additions and subtractions to old ones.
Types of Contracts
We analyzed a sample of 39 percent of the 2,922 professional/technical contracts and found that 64 percent were for goods and services such as the production of a video program, medical tests, and software maintenance. Twenty-two percent were for research and opinions including a computer needs study, consultation on security, and an evaluation of a grant application. Ten percent of the contracts were for training and instruction, and four percent were for miscellaneous items including live entertainment.
Looking at the contracts by subject, we found that 23 percent were for building operations, real estate, and construction of various types. Nineteen percent were for health care, 10 percent involved the environment, agriculture, and science, 7 percent concerned advertising and communications, and 6 percent each were for computer information systems, management and finance, and architecture and engineering. No other subject captured more than five percent of the total.
Agencies' Use of Contractors
To examine state agencies' use and management of professional/technical contracts, we conducted in-depth interviews and reviewed paperwork for 36 medium-to-large contracts in 18 major departments. In nearly half the cases, program managers were actively working with the contractors and expected to continue. On the average, the contractors had worked for the state for about five years.
In some instances, contractors were so well integrated with agency operations that they were hard to tell apart from state employees. Often, they provided some departments' ongoing tasks and services such as data processing, psychiatric services, magazine production, and debt collection. As shown in the table, most of the remaining contracts were either to start a program or system, or to do a one-time project, event, or report. Examples of these contracts included a study of the care given to Medicaid recipients, landscaping, installation of a computer system, and training sessions.
According to program managers, the most common explanation for professional/technical contracts was that they provided special expertise. Also, in 14 cases, program managers said that the contracts were related to staff shortages. Eleven program managers indicated that their professional/technical contracts were the customary way to get a particular job done. As shown, time constraints and external requirements such as federal, executive, or legislative directives further explained why state agencies hired professional/technical contractors.
We asked the program managers to rate their contractors' performance on a ten-point scale. Most of the program managers gave their contractors a score of at least eight, but others could not make a judgment. On a standard evaluation form which the Department of Administration requires agencies to complete, only one program manager reported that the contractor's services were unsatisfactory.
While they generally maintained positive relationships with state agencies, contractors' work was usually adequately controlled. In cases where individual contract workers performed badly, the state managers could sometimes get replacements.
In general, professional/technical contracts gave state managers a welcome measure of freedom from personnel problems. Also, in light of fluctuations in work flow and uncertainty about budgets, the program managers were glad for the opportunity to contract for services on a time-limited basis although they seldom canceled contracts and often extended them.
Although most program managers were pleased with contractors' performance and reported only minor difficulties managing the work, we found some exceptions and reasons for policymakers to be concerned.
In one case, a program manager stated that the $280,000 project was overdue, and contract workers at times had almost completely disregarded the department's goals and objectives while submitting work that did not meet requirements. The manager added that state employees had to help the contract workers because they lacked certain technical skills.
In another case, an agency reported that a contractor did not provide help when it was needed. The contractor visited the agency once a month, but the technical nature of the work inhibited good communication with the program manager. The agency questioned whether the contracting firm was adequately staffed and said it was initially difficult to track the contractor's progress.
These situations illustrate the complexities of successfully using professional/technical contracts. In other cases, the issues were simpler.
First, we found that competition for the contracts occurred only about half the time. For example, according to two program managers, their contracts went without publicity, partly because they had bad experiences with previous vendors.
Second, state agencies sometimes exercised weak control over contractors' activities. In one case, an agency originally asked contractors to propose as much work as they could for $2 million. According to the program manager, this way, the selection committee would not have to choose the lowest bidder for any given set of required services.
Third, program managers indicated that the cost of services through contracts, including administration, may have been higher than alternatives in eight cases. However, some pointed out that the extra costs were unavoidable because they could not hire additional state employees to do the work.
Our fourth concern was that some contracts arose because of problems between state agencies. For example, one program manager explained that his agency had to hire computer programmers under contract because it had purchased a particular type of computer which the Department of Administration did not support. Another manager said that the Department of Employee Relations lacked the staff and financial resources to provide quality training classes, so it used a contractor instead.
In five cases, program managers indicated that the quality or quantity of contractors' work had a negative effect on state projects. One such case involved a contractor who operated a messy waste-handling facility, which the agency had to close for two weeks while the contractor cleaned up.
Finally, we were concerned about the potential for conflict of interest in two cases. In one of these, a program manager told us that her department made it very clear to a contractor that future hardware purchases were contingent on getting a good price for a software development contract. The department advertised the contract but received only one proposal, from the hardware manufacturer. The second case involved a former parttime state employee who, while still on the job, had her own consulting business and proposed to work for her department as a consultant.
Most program managers we interviewed (26 of 36) were critical of the state's procedures for contract review and approval. The biggest problem was that:
Despite the law, program managers were convinced that it sometimes made economic sense to let contractors begin before contracts were final. On the other hand, some managers went to great lengths to validate contracts before work began. One told us that he hand-carried half of all his professional/technical contracts to the Department of Administration for review and approval.
Some managers saw little or no value in the work of reviewers from the Departments of Administration and Finance. To more than one agency, they merely seemed to rubber-stamp contracts and shuffle papers.
Review and Approval Procedures
State law says that professional/technical contracts are not valid until approved in writing by the Commissioner of Administration, the Attorney General, and the Commissioner of Finance. The Department of Administration has overall responsibility for contract management and review. The Attorney General's main responsibility is to see that contracts are consistent with legal requirements. The Commissioner of Finance is primarily responsible for seeing that agencies have set aside enough money to cover contract costs.
We found that all of these external reviewers independently followed written, sometimes duplicative, procedures and consulted statutes while carrying out their duties. Overall, we concluded that:
However, we also found that state agencies' own practices sometimes cause significant delays.
Reasons for Delays
Depending on the size, complexity, and specific features of contracts, it takes attorneys about a week to review, approve, and return contracts to state agencies. After that, the Departments of Administration and Finance together take roughly two weeks to review, approve, and return contracts to agencies, usually by inter-office mail. In these two departments, staff usually review the contracts in the same order as they are received, without regard to dollar value or other characteristics. If agency representatives personally walk or rush their contracts through the process, they can possibly get approval in a day or two, not counting attorneys' time.
Records at the Department of Administration indicated that staff returned about ten percent of professional/technical contracts to agencies for corrections or further information, before granting final approval. In addition, the department returned five percent of agencies' requests for prior approval (required before writing larger contracts), and the Department of Finance returned two percent of the contracts it reviewed. However, the return rate varied widely by agency.
Among other reasons, the Departments of Administration and Finance returned contracts because of missing signatures and unclear references. In other cases:
We found that both departments scrutinize the anticipated effective date on professional/technical contracts and demand a written explanation when they see that it has passed. But since contracts do not indicate when or if work actually began, agencies sometimes are innocent of wrongdoing. Moreover, contracts' effective dates sometimes pass because the reviewers take longer to do their work than agencies originally plan.
Another factor that affects the length of the review and approval process is the time of year when contracts are written. Agencies submit a crush of contracts for review and approval in the summer, when one fiscal year ends and the next one begins (July 1). During the high season, the Department of Administration has had a backlog of as many as 15 working days. The Department of Finance told us that its processing can take five to six days in the peak period compared with three to four days at other times.
A third reason why state agencies wait so long for contracts to be reviewed and approved is that the Department of Administration has assigned only one contract administrator and one documents assistant to handle about 3,000 professional/technical contracts annually, along with approximately 9,000 other important documents. The administrator answers many questions by telephone and provides agencies with written policies and procedures but, unfortunately, the department's manual is out of date, incomplete, and sometimes inaccurate. Neither has the department conducted regular training sessions nor used its computerized data to manage its workload more effectively.
Procedures and Guidelines
According to the Department of Administration's manual of policies and procedures, agencies can write an "annual plan" memo to justify their need for minor professional/technical services. The anticipated contractors need not be listed, but, according to the manual, they can each receive a maximum of only $500 during the entire fiscal year.
During fiscal year 1990, annual plan memos accounted for nearly $11 million in services. We also found that, despite the $500 cap which is indicated by the manual:
Staff explained that they overrode the manual with a memo which states that the department's policy is actually to determine the maximum allowable amount case by case. Some other discrepancies in the department's manual also have been corrected by staff memos, but these may not reach the program managers who need current information.
The manual provides some useful guidance concerning activities that would be inappropriate for government contractors. The U.S. General Accounting Office recently said Minnesota was the only state to provide such guidance to its agencies, although we think the Department of Administration should review the guidelines and offer more helpful advice on the conditions that make contracting desirable.
We identified several areas of state government where contractors have replaced or supplemented the work of state employees, or where the potential or desire for greater use of nonstate workers exists. In light of program managers' general satisfaction with contractors, we asked why state employees would provide some services when alternatives are available. Specifically, we analyzed the major monetary and nonmonetary costs and benefits of the state providing a range of six different services which are available on the open market: nursing homes, tree nurseries, computer programming and systems analysis, printing, fish rearing, and motor vehicle registration.
We would have preferred to analyze additional services, but often the state had too little information about its own activities to compare the costs and benefits of others providing public services. For example, the Department of Transportation has yet to determine its actual costs for highway maintenance despite running several satisfactory pilot projects with private contractors in 1982-83.
In the six cases where we were able to directly compare the costs and benefits of state employees versus others providing similar services, the results generally indicated that:
For example, we studied nursing homes which are operated by the state as well as nonprofit, for-profit, and city/county governments and found that:
Our study suggested that most residents of the state's major nursing home (Ah-Gwah-Ching, near Walker) needed about the same type of care which is available in the state's many nonstate nursing homes. However, median nonstate salaries were 20 to 40 percent lower than in the state's major nursing home, and the state used more staff per resident. Another reason for the state's high costs at Ah-Gwah-Ching is the facility's age and 219-acre campus.
When we studied the price of tree seedlings from the Department of Natural Resources compared with private growers, the results showed that:
The Legislature appropriated funds to the nursery account during fiscal year 1984 to help establish a working capital base. However, since fiscal year 1985, the fund's operating cash balance has dropped by almost $700,000. In a 1989 financial audit, our office recommended that the department change its pricing structure to: (1) incorporate various depreciation factors, (2) use fiscal rather than calendar year costs to ensure the most current cost data, and (3) build in anticipated wage increases. Now, the department is trying to reduce operating costs and is considering hiring contract workers rather than seasonal state employees.
In a third case, we compared hourly prices for routine computer programming and systems analysis by state employees versus private firms which provide similar services to various state agencies through contracts. The data indicated that:
The department itself calculated that the state employees' rates should have been 13 to 40 percent higher to cover all indirect costs that year, but managers got approval to charge less than the full amount. One reason for the disparity is that the department's indirect costs are inflated and subject to internal dispute. According to the KPMG Peat Marwick accounting firm, which the department called in as a consultant, similar public and private data centers across the nation have 37 percent fewer staff than Minnesota and spend 18 percent less. Another reason for the disparity is that the department selects contractors partly on the basis of their low prices. Recently, the department has been diligently reviewing its activities and is planning major changes.
Fourth, we examined state and private printing prices for four specific documents. The results showed:
When the department compared its printing rates to actual costs for fiscal year 1991, 14 of the 21 rates were underestimated. Overall, the rates should have been about one percent higher. However, the state's fiscal condition makes it difficult for the department to make accurate projections of printing volume, and we recognize that the department has since adjusted the rates and reduced personnel in hopes of better results during the 1992 fiscal year.
In our fifth and sixth case comparisons, we learned that the state sometimes saves or makes money even though it duplicates services which are available elsewhere. For example, a recent study by KPMG Peat Marwick compared the cost to raise fish through the Department of Natural Resources versus private sources. Its findings were that:
The department's costs were lower than private sector prices for seven varieties of fish, higher for five, and about the same for two. Moreover, the department's lower prices applied disproportionately to the species which it stocks most heavily in state waters. The Department of Natural Resources now purchases two species which were costly for it to produce but continues to raise fish such as walleye which it stocks heavily and produces cheaply.
Finally, we examined the reasons why the Department of Public Safety processes motor vehicle registrations at a public counter when cities, counties, corporations, and private individuals routinely handle most transactions. Our analysis disclosed that:
Like all other registrars, the department collects a fixed fee of $3.50 for each motor vehicle registration. We found that legislation has increased the reimbursement rate beyond inflation in Minneapolis-St. Paul since 1978.
We think that Minnesota state officials should exercise caution as they consider extending the state's reliance on contractors. Contracting is already common in state government, but contracts are not always processed and managed efficiently and effectively. Also, contracting is not often used today as a cost-saving measure, and sometimes it can cost more to use contractors than state employees.
Overall, five general problems help to explain why state contracting so far has been inefficient. These are:
Our specific recommendations could yield better information and smooth the way for managers to improve the state's process for reviewing and approving professional/technical contracts. But, because such contracts so often are project-specific, it is difficult to say precisely how agencies could better manage.
Concerning the state's strategy for contracting, state agencies' use of state employees to provide services might be justified despite the availability of alternatives in these types of situations:
For example, we found that state tree nurseries are closely related to the state's responsibility for forest management, and low-cost seedlings may encourage public reforestation efforts which are ultimately good for the state and its economy. Likewise, seasonally raising fish is only a small part of the state's responsibility for fish management, while fishing is vital to tourism. And there are financial and technical justifications for state sales of motor vehicle registrations and state print shop operations.
On the other hand, we found little justification for state employees to provide nursing home care or routine computer programming and systems analysis. Neither type of service is in short supply, both are costly, and the state employees have no major role in fulfilling their departments' other goals.
In general, we think that all agencies should pay more attention to the costs and benefits of their programs and services and use objective information to make decisions about the best, most efficient delivery methods. We recognize that it may be difficult to make necessary changes, but it can also be costly to pursue the same objectives regardless of technology, the marketplace, and public preferences.
As noted, the state's process for reviewing and approving professional/technical contracts is inefficient. It wastes reviewers' time and encourages state managers to break the law by allowing work to begin before contracts are legally valid. During our study, the program managers suggested two major ways to improve the process. First, they favored training for themselves, along with better written instructions. Second, they wished for exceptions and increased autonomy. Basically, we endorse these ideas.
To improve the process, we recommend that:
In addition, we think that the Department of Employee Relations, which has recently begun to review some agencies' plans to hire consultants for training sessions, should consult with the primary contract reviewers to avoid further duplication. Ultimately, the shared data base could inform all agencies of the status of specific contracts while providing better information in the future.
We also recommend that:
Although the 1990 Legislature only recently raised the dollar limit from $2,000 to $5,000, the change was not based on data such as we developed for this study. If the law were changed so that agencies obtained prior approval before writing contracts over the $10,000 median, we think that the review and approval process would be more efficient and better focused. The Department of Administration would process approval requests only for the larger half of all professional/technical contracts, yet in fiscal year 1990 this would have covered 99 percent of the total estimated costs.
We also recommend some technical changes in the same statute, also concerning prior approval for larger contracts. For example, the language should clearly state that agencies must demonstrate that they tried but could not obtain needed services from existing state employees or previous contracts. Further, in requesting prior approval before writing larger contracts, state agencies should certify that they will not allow contractors to begin work before funds are officially encumbered. Such an addition could help to reduce the number of delays due to reviewers' unfounded suspicions that work could have begun already. Also, it might discourage agencies from allowing early starts as they do now on occasion.
In our opinion, the problem of delayed approval could also be reduced by changes in the Department of Administration's operating procedures. First:
Top priority would go to costly contracts for complex professional/technical services, especially where services must be delivered according to strict deadlines.
We also recommend that:
The Attorney General's Office already has delegated some of its responsibility to selected individuals, up to specified dollar limits, and the Department of Finance is planning similar actions. To make this type of limited, specific delegation successful, the Department of Administration would need to use its data to analyze agencies' performance, but we think this could be accomplished without significant investment of resources.
In addition, the department should use its annual plan policy more effectively.
This could reduce the number of contracts to be reviewed by about a third, and the $5,000 limit already is an approved practice for one agency. We see little need for the full review and approval process for so many small contracts, provided that agencies follow the same procedures as contract reviewers would enforce, and the Department of Administration carefully reviews the annual plans before granting approval.
We also recommend that:
Although the department has assigned half of one fulltime equivalent employee to answer specific questions, some of this time could be used to provide group instruction and improve the department's written manual of policies and procedures. At the same time, in updating the current manual, we think that:
Finally, we think that agencies should keep track of what their services or programs cost. If they did, they could routinely compare the monetary and nonmonetary costs and benefits of obtaining services through various mechanisms, which could lead to greater efficiency in state operations. However, without such basic information, we see little reason to expect that increased reliance on contracts or other alternatives alone could transform state government.