Monopsony: monopoly through the looking glass

Government Should Leverage Its Size to Get Better Prices, Senators Say

“When Wal-Mart buys, I guarantee they get the best price, and when Honeywell buys, they get the best price,” said ranking member Sen. Tom Coburn, R-Okla.

Chairman Tom Carper, D-Del., called the Obama administration’s key procurement officers to respond to Government Accountability Office reports showing that the top four purchasing departments -- Defense, Energy, Homeland Security and Veterans Affairs -- were achieving only 5 percent of contracts using strategic sourcing’s careful analysis of spending needs and markets and rigorous monitoring of vendor prices. “Federal agencies appear to behave more like medium-sized, unrelated businesses than the largest purchaser in the world -- which is what the U.S. government is,” Carper said.

A defense of progress to date came from Joe Jordan, administrator of the White House Office of Federal Procurement Policy. The obstacles include “a decentralized process with a lack of visibility into what other agencies do,” Jordan said. But he cited progress in reducing what once was 4,000 separate wireless phone agreements with 800 plans to one contract vehicle, the saving of $600 million through shared contracts for janitorial services, and the General Services Administration’s office supplies contracts that have upped the rate of small business participation from 67 percent to 76 percent.

Dan Tangherlini, newly confirmed as administrator of GSA, said strategic sourcing in 20 agencies has saved $300 million since 2010. “Contractors are required to report transactional data on all program sales,” he said. “For the first time, this level of financial information collection provides us with a clear picture of agency spending behavior. Over the last several months, GSA has used this data to show contractors their pricing item by item, compared with their competitors in an anonymous fashion. This has empowered contractors to understand their competitive position, and in many cases offer better deals.”

I'm reminded of the post from a couple of days ago: Published benchmark costs bring procurement savings.

In the article in chief above, criticism of government procurement uniformly complained that the government did not achieve the market-leveraged savings of private business. Private business, of course, is not burdened with the many so-called "wealth distribution" programs (see, here) of the federal government, such as Buy American. And, WalMart acquires large parts of its product in China and other non-US production centers. Do we want our government to do likewise? We could do it.

America made a great leap forward economically at the start of the 20th century by dismantling the monopoly "trusts", a form of forced "creative destruction" of concentrated capital. The lesson learned is that too much concentrated market power is not good for the larger society or economy.

So, what is a Monopsony? According to Investopedia:

Definition of 'Monopsony': A market similar to a monopoly except that a large buyer not seller controls a large proportion of the market and drives the prices down. Sometimes referred to as the buyer's monopoly.

Investopedia explains 'Monopsony': People have accused Ernest and Julio Gallo (the big wine makers) of being a monopsony. They had such power buying grapes from growers, that sellers had no choice but to agree to their terms.

“The rule is, jam to-morrow and jam yesterday--but never jam to-day.'


'It MUST come sometimes to "jam to-day,"' Alice objected.


'No, it can't,' said the Queen. '

It's jam every OTHER day: to-day isn't any OTHER day, you know.'


'I don't understand you,' said Alice. 'It's dreadfully confusing!'


'That's the effect of living backwards,' the Queen said kindly: 'it always makes one a little giddy at first--'


'Living backwards!' Alice repeated in great astonishment. 'I never heard of such a thing!'


'--but there's one great advantage in it, that one's memory works both ways.'


‘I'm sure MINE only works one way,' Alice remarked. 'I can't remember things before they happen.'


'It's a poor sort of memory that only works backwards,' the Queen remarked.”

― Lewis Carroll, Through the Looking-Glass, and What Alice Found There

http://www.goodreads.com/work/quotes/17240250-through-the-looking-glass-and-what-alice-found-there

One buyer's "fair and reasonable" is another's fair and reasonable -- "maybe"

The US government General Services Administration operates an Amazon-like online catalog service for its agencies, states, territories and certain NGOs and others to purchase routine, or commercially standard, supplies and services.

GSA awards Schedule Contracts to responsible companies that offer Commercial off-the-shelf (COTS) products and services falling within the descriptions of the Schedules. Combined, the GSA Schedules are a comprehensive, categorical offering of almost every product and service available. To date, there are over 11 million commercial products and services available through the GSA Schedules.

Acquisitions through GSA Schedules are issued using full and open competition. Prices have already been deemed fair and reasonable, and Contracts are in compliance with all applicable laws and regulations, reducing evaluation cycles. Purchases can be made directly from a contractor's GSA Schedule Contract, eliminating time-consuming responses to complex RFP’s and lengthy negotiations.

See source.

That's their story and GSA is sticking with it.

Fundamentally, the government is intended to purchase anything only if the price is "fair and reasonable". (See FAR Part 15.402.) And what does that mean; how is fair and reasonable determined?

"Supplies offered on the [GSA]schedule are listed at fixed prices. Services offered on the schedule are priced either at hourly rates, or at a fixed price for performance of a specific task (e.g., installation, maintenance, and repair)." (FAR Part 8.404(d).) Under a fixed price contract, "the contracting officer can establish fair and reasonable prices at the outset, such as when — (a) There is adequate price competition", etc. (FAR Part 16.202-2.) (Also see, for instance, 5 GCA 5232(c) under Guam procurement law (based on the ABA Model Procurement Code), which suggests cost or pricing supporting data is not required "where the contract is based on adequate price competition", etc.)

So, then, is the GSA schedule a list of the lowest priced contractors for each item of supply or service? No. It is, as mentioned, like Amazon, with multiple pre-vetted contractors, each with its own price and contract terms. Each approved contractor posts its own pricelist which contains the pricing and the terms and conditions pertaining to each Special Item Number that is on the contractor's schedule. (See FAR Part 8.402(b).)

Thus, the GSA schedule does not provide the lowest price (nor one necessarily associated with contract terms specified by an agency), but simply a catalog of contractors GSA has determined offer "fair and reasonable" prices. The prices simply reflect "prices associated with volume buying" (Part 8.402(a)). The implication is that each of these prices are fair and reasonable because they have been determined by arm wrestling with the largest monopsony in the US economy; in effect, it is fair and reasonable because it is determined by the same thing as monopoly power. Of course, in a market with a monopoly, or a monopsony, there is no effective competition. Thus, the GSA prices are not based on price competition, but unilateral market power by a party that the market power has determined is -- or should be -- the "most favored customer".

The GSA describes this benevolent rule this way: GSA's goal is to be the best value supplier of choice. GSA Schedule contracts are negotiated with the intent of achieving the contractors' "most favored customer" pricing/discounts under similar conditions. (See GSA FAQ #7 here.)

Critical observers have pointed out, this requirement (to obtain most favored customer pricing) is not based on any explicit mandate of law or regulation, and is problematic as a practical policy decision. For instance:

Most Favored Customer And Price Reductions Clause

The most favored customer (MFC) and price reductions clause (PRC) operate jointly - seldom will you see the MFC clause without the PRC, and the PRC has no meaning without the MFC clause. There simply does not exist a legal basis for these clauses to exist. The FAR standard at 15.4 is "fair and reasonable". Their inclusion in an IFB or RFP is clearly not proper. It is currently in the FTS 2001 RFP improperly.

GSA has imposed these clauses in the schedule program for decades without legal basis. But no one has taken GSA to court. So, the bluff wins. The MFC clause is based on the premise that the government deserves similar or better discounts than the best discount you offer to a particular customer category. When you apply for a GSA schedule, you are required to identify the best discounts you have granted the following customer categories: Dealers/retailers; distributors/wholesalers; educational institutions; state, county, city and local governments; OEMs; and others (national accounts, end users.) Based upon the information you provide, the government will identify the customer that you have granted the largest discount to as your most favored customer, such as the OEM category. It is up to you to negotiate with the government in identifying the category that is most similar to the government customer. This will usually be the end user customer category, which ordinarily receives a lesser discount than offered to other customer categories and is most similar to the government in the way it buys.

We would like to make the case that GSA does not deserve any special price consideration from vendors in schedule negotiations. The rules clearly require procurement from lowest price vendors or justification of higher prices. GSA should be content to let market forces determine price. If Vendor A gives GSA 3% and Vendor B offers 8% for a comparable product, Vendor B will get the business. If this does not occur, this means that the entire schedule program is not workable and should be abandoned. If GSA and GAO cannot enforce this simple concept then we can only conclude that the higher priced product is worth more. - See more at: http://www.captureplanning.com/articles/12118.cfm#sthash.9LJLHicN.dpuf

See also, GSA and Most Favored Customer Pricing and POGO's White Paper on GSA Multiple Award Schedule Pricing, which has a chapter specifically addressing the Most Favored Customer ("FMC") pricing issue.

It is an issue recognized in the GSA Acquisition Manual: "The Government will seek to obtain the offeror’s best price (the best price given to the most favored customer). However, the Government recognizes that the terms and conditions of commercial sales vary and there may be legitimate reasons why the best price is not achieved." (Part 538.270)

The Office of the Undersecretary of Defense has recently released new guidance, under the hand of Richard Ginman, Director of Defense Procurement and Acquisition Policy, directing DOD contracting officers to determine fair and reasonable pricing independent of the GSA scheduled prices:

GSA has determined the prices of supplies and fixed-price services, and rates for services offered at hourly rates, to be fair and reasonable for the purpose of establishing the schedule contract. GSA 's determination does not relieve the ordering activity contracting officer from the responsibility of making a determination of fair and reasonable pricing for individual orders, BP As, and orders under BP As, using the proposal analysis techniques at 15.404-1. The complexity and circumstances of each acquisition should determine the level of detail of the analysis required.

This directive is discussed in an Lexology-posted article written by Attorney J. Catherine Kunz of the law firm Crowell & Moring LLP:

GSA schedule contracting: has selling to DoD just gotten harder?

This memorandum directs DoD contracting officers to make their own determination of fair and reasonable pricing when using Federal Supply Schedules (also known as GSA or VA Schedule contracts), rather than rely on the fair and reasonable price determination made by GSA when GSA awards Schedule contracts. Specifically, the memorandum establishes a class deviation to FAR 8.404(d) that will be applicable to DoD entities buying off Schedule contracts.

The direction to use proposal analysis techniques at FAR 15.404-1 could mean that DoD contracting officers will (a) compare proposed prices received in response to an RFQ; (b) compare proposed prices to historical prices paid for the same or similar items; (c) use parametric estimating methods/application of rough yardsticks (e.g., dollars per pound); (d) compare proposed prices with competitive published price lists; (e) compare proposed prices with independent government cost estimates; (f) compare proposed prices with prices obtained through market research for the same or similar items; or (g) request and analyze “data other than certified cost or pricing data.”

Because “data other than certified cost or pricing data” is defined at FAR 2.101 as “pricing data, cost data, and judgmental information” and can include “the identical types of data as certified cost or pricing data [required pursuant to the Truth in Negotiations Act] . . . but without the certification,” it is possible that Schedule contractors will need to disclose their cost information in order to perform work for DoD.

The author suggests "This adds complexity and risk to Schedule contract performance and moves Schedule buys even further from the intent that the Schedule program mirror commercial buying practices." (Read the whole article for context I have left out.)  

But, if, as I suggest, the GSA Schedule is simply an Amazon for government buyers, wouldn't a commercial buyer also want independent assessment that the prices offered do, indeed, reflect fair and reasonable ones and not blindly take the first one to pop up on the screen?

Before leaving this topic, to follow up from the observation made above that the Schedules do not offer up the lowest price, rather a catalog of contractors at various prices, I note that the GSA Schedules program has evolved to now both offer and in circumstances require that any authorized government buyers ("ordering activities") to poll the list of contractors with an RFQ (Request for Quotes). The parameters of the e-Buy RFQ program are in FAR Part 8.402(d)

"E-Buy allows ordering activities to post requirements, obtain quotes, and issue orders electronically. Posting an RFQ on e-Buy — (i) Is one medium for providing fair notice to all schedule contractors offering such supplies and services as required by 8.405-1, 8.405-2, and 8.405-3; and (ii) Is required when an order contains brand-name specifications (see 8.405-6)".

See the GSA's Buyer's Guidance here. 

When ordering activities have been authorized to access the GSA Schedule, but are required to use the local source selection method competitive sealed bid to do so, as is the case with Guam agencies under 5 GCA 5122, it would not take a lot of tweaking of the system (laws or regulations) to allow a bid by the lowest contractor on the Schedule, determined by the e-Buy RFQ process, to be qualified for consideration under a local IFB, assuming the contract terms of the GSA Schedule contractor are consistent with the contract terms in the IFB.

Standardizing commercial goods and services but not contract terms

How often do you read the terms of your, say, phone contract, or equipment rental agreement? Are they even negotiable? Your standard commercial purchases come with industry standard terms, and you usually have the choice of taking it or leaving it.

Not so if you are a monopsony. The federal government is one, but small government entities most often are not. I am amazed at the way large manufacturers jam their own contract terms down the throat of our local government.

Lawyers Michael D. McGill and C. Peter Dungan from the firm Hogan Lovells have provided a note on the federal government's start to pushback on this idea. You should read the whole article at the link below.

New procurement rule is intended to limit the Government’s acceptance of standard commercial terms of service for social media applications

The interim rule, which is effective immediately, is specifically aimed to curb the practice of contracting officials agreeing to open-ended indemnification provisions in standard contracts for web-based social media applications. The Government will not agree to certain contract terms that are standard in the commercial space, and even when its officials agree to those terms, some of them may be unenforceable.

The impetus for this rulemaking can be traced back to a June 2011 letter from the Department of Commerce (Commerce) to the Department of Justice (DOJ) seeking the DOJ’s views on the application of the Anti-Deficiency Act to terms of service (TOS} agreements for social media applications.The Anti-Deficiency Act generally prohibits agencies from entering into contracts or other obligations in advance of or beyond the scope of appropriated funding.

In response, the DOJ Office of Legal Counsel (OLC) issued an opinion indicating that the Anti-Deficiency Act is violated when a contracting official or other employee with authority to bind the Government agrees, without statutory authorization or an applicable exception, to an open-ended, unrestricted indemnification provision. The OLC opinion, and the Commerce letter that prompted it, focused specifically on web-based TOS agreements, such as “clickwrap” and “browsewrap” agreements. The Opinion describes a situation in which a Government official holding a purchase card consents to an online TOS agreement containing an open-ended indemnification clause in the course of registering for an account with a commercial social media service, and the Government, under the TOS, holds the service provider harmless for damages caused to a third party when the Government uses the application. The contracting officer’s agreement to such TOS creates an immediate Anti-Deficiency Act violation insofar as the agency, upon agreement to the indemnification provision, is legally liable—or at least potentially legally liable8—for an amount in excess of appropriations.

I think there is plenty of scope to expand this concept to other one-sided contract terms, many of which are found in the "standard" contract terms found in the GSA Schedule contracts. Certainly smaller governments may want this kind of protection by law, because they will rarely if ever get it by negotiation. 

 UPDATE: This subject has reached final regulation status. See articles below:

•  GSA Issues Final Rule Governing Negotiations of Common Commercial Terms 

•  GSA Regulation, Unenforceable Commercial Supplier Agreement Terms 

• Final GSA Rule on Commercial License Terms that Conflict with Federal Law

Procurement controversy -- District of Columbia streetcar deal

Note: As I am wont, the following procurement controversy case study for today was cut, rearranged, and otherwise "edited". You are strongly urged to click the link to read the article in its original form if this subject tickles your interest.

The District’s streetcar deal leaves taxpayers holding the bag

IN THE market for streetcars for a planned trolley line, the District of Columbia undertook a lengthy procurement process in 2010.  Inekon, a Czech company that had built the District’s first two streetcars, a company with a proven track record in designing and manufacturing streetcars got the highest ranking in the year-long open competition. But the $8.7 million contract went to Portland, Ore.-based United Streetcar, a firm that had never produced an operational streetcar, had major problems delivering the vehicles and today no longer makes them.

When the contract was awarded to United Streetcar, Inekon protested to the Contract Appeals Board. The case was dismissed after the city acknowledged missteps and agreed to a series of corrective steps.

But instead of continuing that process, it used a provision in procurement law to buy the cars from United Streetcar through the existing contract of another jurisdiction.

I have not been a big fan of the so-called "coop purchasing" method. In my view, it is too often used as a cop out purchasing method. It outsources one jurisdiction's responsibility to another jurisdiction, leading to a large funneling of government funds to one centralized procurement agent who has no accountability back to the purchasing jurisdiction, and makes it problematic for the purchasing jurisdiction to to administer the contract. This case appears to be an example of that.

The theory behind cooperative purchasing is that bulk buying gets the lowest price possible. For instance, the federal supply schedule purchases allow any federal department to purchase from the schedule, as well as states, territories and some NGOs. The schedule acts like a cross between a catalog house, like the old Montgomery Wards or Sears Catalogs, and Amazon.

The theory is good for increasing buying power at the expense of increasing the pool of competition. We encourage competition over monopoly, but we turn around and diminish competition by monopsony.  As Steven Schooner has shown us, here and here, even a fundamental principle of procurement must be balanced against other competing procurement principles. 

Sometimes, the crush to make government contracting as convenient as private contract crowds out the governance principles. Government contracting without governance principles, like fairness and application of principles such as encouraging small or local businesses, does not create an ideal procurement system that satisfies the needs and aspirations of the political base of the purchasing government.

Somewhat related recent articles:

MPs warn over new train contracts

Taxpayers have been left with all the risk over two multibillion-pound contracts for new trains, a report by MPs has said.

The Department for Transport (DfT) decided to lead on procurements of new trains for the Intercity Express programme and for the Thameslink project "despite having no previous experience of doing so", the House of Commons Public Accounts Committee said.

The report continued: "These two major projects also demonstrate yet again that the department has limited capacity and capability to manage large-scale procurements, and that it remains overly reliant on consultants."

The committee's chairman, Margaret Hodge (Lab: Barking), said: "The department decision to buy the new trains itself has left the taxpayer bearing all the risk.

$1.2 billion contract OKd for new Muni Metro light-rail cars

When Muni bought its current fleet of light-rail cars from Italian manufacturer Breda in 1996, Haley said, it didn't buy enough cars and tinkered too much with customizing the design. Its reliability requirements also were too lax and it didn't take maintenance costs into account.

"We tried to learn the lessons from the previous procurement," he said. So the MTA plans to buy more rail cars this time, let the manufacturer handle most of the design, require better performance from the vehicles and consider the costs and time requirements of maintenance.