June 2000


Closing the gap

Overhead shortfall measures offer insight into the new management team’s approach

It wasn’t the kind of first all-staff message Bill Madia envisioned delivering as ORNL’s new director, but that’s the way the cards fell. The Lab, he said on May 3, was facing an overhead budget shortfall of $9 million for the fiscal year.

The leadership team immediately enacted a series of deliberate moves meant to close the gap without raising the Lab’s overhead rate. Lab managers also wanted to avoid any short-term staff reductions.

Toward that goal, rates for space and materials handling were raised, reserve funds for Laboratory Directed R&D and program development were reduced, and overhead costs reductions for support organizations were sought, among other measures.

Jeff Smith, the Lab’s deputy director for Operations, explains the Lab’s reluctance to raise the overhead rate.

“A staff concern we hear over and over again is that the overhead rate is too high,” he says. “There are several different rates, but the one most visible to our science and technology staff is the ‘overhead composite rate.’ It is currently at 41.7 percent.”

And that cost of doing business, say Smith and Chief Financial Officer Greg Turner, is considered too high. In the long term, fixing the $9 million shortfall by simply raising the rate could hurt the Lab more than the strong medicine it’s currently having to swallow.

What caused the shortfall?
Several singular events played a role. The largest was a miscalculation of the loss of labor base because of workers transferred to the management and integration contractor for Environmental Management. Those losses to the recovery base historically have been hard to estimate. The impact was a $15 to $20 million loss of recovery base, depending on which rate is cited.

Second were several unexpected cost increases. Among them were contract transition costs, higher costs associated with the protective services contract and a larger than expected bill for vacating space at the Y-12 Plant. UT-Battelle arrived April 1 to find that, like with many things in life, everything costs more these days.

Third, and compounding the problem, was a depleted central reserve fund, which is traditionally used to fill in budget gaps. In fact, it was overcommitted by about half a million dollars. No wiggle room there.

With activities as complex as contract transitions, the unexpected often looms large. Part of the $2.5 million increase in the protective services contract, for instance, is an unanticipated result of the transition. In addition to some cost increases driven by the new security contract, a portion of security costs for Lockheed Martin Energy Research were previously subsidized by Lockheed Martin Energy Systems. “We have to pay the full burden cost, whereas LMER didn’t,” Smith says.

Likewise, Y-12 deactivation costs were budgeted at $1.5 million. The actual cost is expected to be $3.3 million.

“Getting out of Y-12 is the right thing to do, and we were about two-thirds of the way there. But it’s going to cost us more to finish the job,” says Smith.

Says CFO Turner, “If we hadn’t missed the base, or hadn’t had this barrage of singular events—if we had one or the other, we might have been able to recover. But with all these factors, along with the lack of reserves, we had to take these rather drastic actions.”

Prospects of flat or lower budgets also exacerbate the overhead situation, says Smith. “When budgets are growing, you can bet on growing the Lab as well. Our intent is to eventually do that, but at this point we’re simply not ready to resolve this problem on projected growth.”

Says Turner, “In the past we could do that, plus use our reserves to keep things in balance. We just didn’t have those options this time.”

The overhead rate
Some asked, why not just raise the overhead rate? As Smith and Turner cited previously, because that’s what the science and technology staff members decidedly do not want the Lab to do.

“Staff are concerned about the lack of stability in overhead rates,” Turner says. “The R&D staff should be able to depend on overhead rate stability. No one likes to come to the end of the fiscal year and get hit with a retroactive rate increase. This leadership team takes pride in having stable rates that you can depend on. That requires good, high-quality input on the front end of the budget process.”

The UT-Battelle team intends to zero in on the Lab’s cost of doing business, which Turner characterized as being on the “wrong end of the scale.” As an example, the average hourly rate for a mid-level researcher at ORNL is $117, whereas at other DOE labs it is less than $100. That approximately amounts to the 20 percent overhead reduction over three years that UT-Battelle has pledged for ORNL.

“We need a systematic review of our cost structure and cost drivers, and that’s when we get to the organization burdens and lab-level overheads,” Turner says. “That’s still a work in progress on our part, and we will draw upon staff input. It is critical that tech organizations be involved.”

In fact, Smith and Turner cite that while many overhead reduction efforts have in the past fallen on support organizations, overhead in research divisions has risen, not dropped. Division managers counter that’s because costs have been shifted rather than reduced, which is true to some degree.

Nevertheless, those organizational burden figures will be looked at closely. Smith points to a move away from services imbedded within divisions, which he says over time tend to swell the payroll. The preferred model, he says, is support organizations that fill the needs of research organizations and have the flexibility to move resources to where they are needed.

“We’re really going after ‘hard’ cost savings versus ‘soft’ savings,” Smith states, alluding to cost “avoidances” that haven’t materialized in the bottom line. “We’ll have to solve this as a team, and what won’t be tolerated is turf protection.”

The frontiers of space
Smith estimates the net increase on space and materials rates will amount to about $2 million for space and $900,000 for materials handling.

"We could probably do our work in a million less square feet."
“The procurement dollar won’t go as far, and the space issue is tough,” he says. “But in truth, the space charge is artificially low now. We’d like for the space charge rate to reflect what it really costs to manage space.”

The reason, Smith says, is that changes in how we think about space are coming. Whereas divisions now have little incentive to vacate space and tend to hold on to it for future needs, the future dictates a more compact environment.

“ORNL has about 4.7 million square feet of space,” Smith says. “For this size of business, in research volume, we could probably do our work in a million less square feet. This extra space is old and expensive to maintain.”

That’s where ORNL’s facilities upgrade plans can pay off.

“The sooner we can get out of these old, expensive facilities, the sooner we can put those research dollars toward supporting new facilities and new programs,” Smith says. “In the meantime, people should re-assess the space they need.”

Turner says another plan for stretching research dollars entails simplifying ORNL’s business rules. Many current rules stem from the legacy of the single contractor, which has saddled the Lab with production-oriented business rules. Lab managers have complained about that for years.

“We hope to simplify the rules,” Turner says, “and that will require feedback from both our S&T staff and from DOE. We have an opportunity here to deviate from that production focus to a set of business rules more attuned to an R&D organization.”

Acknowledging that the drastic steps will immediately result in less research for the dollar, Madia closed a talk to staff members on May 3 with a warning that the tough steps only solved the problem for the rest of the year. He could not rule out future staff reductions, and said “all options” would have to be considered.

On the other hand, the shortfall can serve as an opportunity to put new ideas on operating and growing ORNL on the fast track. With plans to build new facilities, reduce the cost of doing business and rebuild the Lab’s business structure to more closely resemble an R&D organization, the leadership team’s plans for ORNL go way beyond a balanced book on September 30.—B.C.