Privatizing Government Scrap

Plans to privatize as many as 71 U.S. government scrap processing facilities in the next 12 months are designed to help the government cut costs and improve net revenue from those operations. Only time will tell, though, how privatizing these facilities will affect the scrap industry.
   The Defense Reutilization & Marketing Service (DRMS), the sales arm of the U.S. Department of Defense’s Defense Logistics Agency, has already begun turning over control of its scrap facilities—called Defense Reutilization & Marketing Offices, or DRMOs—to the private sector through a pilot program that began in June 2000.
   A second initiative, dubbed the scrap venture program, could place the remainder of the government’s annual scrap supply—more than 630 million pounds of metallic and nonmetallic material—in the hands of a few private contractors.
   What’s happened thus far, how is the privatization move working out, and what’s next?

Going Private
The government’s impetus for privatizing its scrap operations is to “reduce overall cost to the taxpayer,” says Roscoe Davis, scrap business unit leader for DRMS. “The way we do that is to look at process improvements while maintaining or improving the Department of Defense’s overall financial position.”
   Both the pilot and scrap venture programs focus on helping the government improve the way its scrap facilities operate. These programs are part of DRMS’s philosophy of enterprise management. The idea is to continuously review business practices to seek improvements and reduce costs wherever possible. Sometimes this means opening certain government operations to outside contractors when it makes good business sense to exploit the private sector’s best business practices and efficiencies for a given operation. Basically, this philosophy recognizes the need to ensure that the government’s current operating methods are based on the latest technology and best business practices. In the case of the scrap pilot program, the process will examine if the skill of the scrap industry’s managers and their past ability to turn a profit carry over to the disposal of government materials.
   “When the pilot program was sanctioned,” Davis notes, “we were looking to improve the effectiveness of the DRMOs involved through enterprise management.”
   Enterprise management is fairly new for DRMS’s scrap operations. In the past, the agency would accumulate just about every kind of metallic and nonmetallic scrap imaginable. DRMS personnel would sort the material and offer it for sale through a sales catalog. Scrap operators then submitted sealed bids for the scrap. A high bidder would be identified, and the material would be sold.
   The process is quite different under the current pilot program.
   In late 1999, DRMS invited scrap companies to submit technical proposals for its pilot program. Those technical proposals requested a host of information, including the bidder’s financial condition and environmental management practices, a plan stating how the bidder would manage a government scrap site, and even the resumes of individuals to be involved in the program.
   Companies gleaned from these technical proposals were later invited to bid for the scrap generated at one or more DRMOs in the pilot program. The term of this program was set at one year, with the possibility of two six-month extensions.
   “The scrap pilot program was developed to test improved DRMS scrap business performance at selected DRMOs,” the agency said in a July 20 release. The selected sites included Vandenberg Air Force Base, March Air Force Base, Camp Pendleton, North Island, Port Hueneme, and DRMO San Diego in California; Yuma Proving Grounds in Arizona; Fort Lewis in Washington; and Hill Air Force Base in Utah.
   Now for the money—in the pilot program, successful bidders had to make an initial payment up front to DRMS to be awarded the scrap generated at the pilot facilities for one year, explains Davis. In addition, each month these successful bidders must pay DRMS a predetermined percentage of the market value of the scrap covered in the program. The percentage that must be paid to DRMS varies depending on the commodity.
   As an example, if one of the pilot program DRMOs generated 100 pounds of a specific grade in December and its published price was 10 cents a pound, the contractor might pay DRMS 35 percent of the material’s market value, or $3.50.
   Three companies agreed to those terms and were the successful bidders in the pilot program:
•  Jerry M. Hyman, doing business as General Commodity Co., or GENCOM, won the rights to DRMO Fort Lewis with a bid of $888.88. Fort Lewis had generated almost 7.7 million pounds of scrap in fiscal year 1999 for which DRMS received $486,186.42;
•  Ekco Metals (Los Angeles) won the right to process scrap from Hill Air Force Base for an initial payment of $10,000. That DRMO generated 4.8 million pounds of metallic and nonmetallic scrap in 1999 with proceeds of $312,502.64, DRMS reports; and
•  Integrity Enterprises L.L.C., whose parent company is Integrity Recycling Inc. (Baltimore), was awarded the right to process more than 13 million pounds of scrap generated annually from the remaining seven pilot facilities for an initial payment of $30,133. Those seven facilities had 1999 proceeds of $684,845.23.
   Besides their initial payments, these firms also have to pay DRMS the predetermined percentage of market value for each commodity sold at their respective sites. They also had to purchase performance bonds of $150,000, $150,000, and $50,000 per site, respectively.

Weighing the Pros and Cons
These three pioneering companies were the first to sample DRMS’s scrap materials partnership program with private industry. So far, they’re reporting mixed results.
   On the positive side, the contractors praise DRMS personnel. David Van Metre Jr., project director for Integrity Enterprises, says his firm’s working relationship with DRMS has been “surprisingly good,” adding that DRMS “has been very willing to be taught, if you will, about the scrap industry, and its personnel are educating me about government facility management. They want this project to succeed.”
   He gives kudos to the government’s contracting officers, commenting that they’re “quite knowledgeable about scrap.” The government has also been flexible when the circumstances have merited, he says, noting that “in some instances, they have a requirement that the scrap be removed in 30 days, but if I don’t have a truckload, they let me hold it.”
Also, “part of the contract included government-furnished equipment. They were very generous in transferring that to me,” Van Metre says. “That was one area where I was very pleasantly surprised.”
   Despite DRMS’s willingness to work with him, GENCOM’s Hyman points out differences in how government and contractors work. “You have DRMS, and you have me. I’m an entrepreneur,” he says. “This is a challenge—it’s the melding of two cultures.”
   All three contractors also express skepticism about the profit potential of the pilot program.
   “At this point, I’m not sure if it’s going to be profitable or not,” says Ely Keenberg, president of Ekco Metals. “They’re making us take a lot of nonmetallic as well as metallic in some of the sortations they want us to buy. Their sortations aren’t profitable. This is a learning process, so there are pluses and minuses—a lot of minuses.”
   Keenberg’s counterparts were also disappointed with the quality and quantity of material passing through the DRMOs. On a recent drive through DRMO Fort Lewis, Hyman pointed to stacks of old tires and staging areas filled with household items, asserting, “It’s like a garage sale.” He also was concerned that a recently established recycling center on that site was diverting scrap away from his operation.
   There are also other challenges for the pilot program. Van Metre points out that the military doesn’t know what it has in the pipeline, which makes it difficult to plan. “You’re asking your customer—in this case, DRMS—what kind of scrap they’re going to have next year, and they just don’t know.”
   For its part, DRMS is satisfied with the pilot program thus far. “We’ve had a great start,” says Davis. “Over the next couple of months, we’ll be better able to gauge the scrap pilot concept. I’m sure there will be a few problems to be resolved, but overall we’re very pleased.”

The Next Venture
   DRMS’s next privatization project—the scrap venture program—could touch all remaining domestic DRMOs. That program will differ considerably from the pilot project, especially on the financial side.
   Though details of the scrap venture program weren’t etched in stone at presstime, the program will likely have a retained-interest feature, says Cyrus Gardner, a principal of Kormendi/Gardner Partners, a Washington D.C.-based consultant that’s helping DRMS institute enterprise management across its operations.
   The retained-interest model, which can take many forms, is basically profit-sharing between the scrap contractors and DRMS. DRMS used a retained-interest model when it initiated its commercial venture last year. That program sold usable goods to a contractor, who in turn sold the items and then returned slightly more than 78 percent of the profit to DRMS.
   In the scrap venture program, one possible arrangement could have scrap companies bidding to pay some percentage of the market value of various grades of scrap—similar to the 35 percent that the pilot program contractors could pay DRMS each month for some commodities.
   Under the scrap venture program, however, contractors would also share their profits with DRMS at some set rate. In one profit-sharing scenario, Gardner says, DRMS would receive 80 percent of the profit while the contractor would get the remaining 20 percent.
   Here’s one example of this possible arrangement: After agreeing to the 80/20 profit split, potential contractors would bid to pay a percentage of market value for the scrap generated at one or more DRMOs. Let’s assume the successful bidder won his or her contract with a bid of 10 percent of market value. If the DRMO generates 100 pounds of a specific grade and the published price is 10 cents a pound, the contractor would pay DRMS $1 for the scrap—10 percent of the material’s market value.
   The contractor then sells that same 100 pounds for, say, $10 and deducts operating costs from the revenue to determine net profit. Assuming the contractor’s operating costs were $4 to process and sell the 100 pounds of scrap, the contractor would then pay DRMS an additional $4.80, or 80 percent of the $6 of net profit. That makes the contractor’s share of distribution after expenses $1.20, giving the contractor 20 cents of profit after you deduct the $1 originally paid to DRMS to purchase the material.
   Other examples of the retained-interest model could have companies offering a bid for both the percentage of market value and the percentage of profit sharing. Yet this approach can make it difficult for DRMS to figure out which contractor is the high bidder.
   Company A, for instance, could offer to pay 60 percent of the market value of a given grade but share only 10 percent of the profit with the government. Company B could offer to pay 1 percent of the market value but give 95 percent of the profit. If both start with 100 pounds of a specific grade that’s sold for 10 cents a pound, company A would pay $6 for the material (60 percent of market value) and share 40 cents of the profit (10 percent of $4 of income), leaving a profit of $3.60. Company B would pay DRMS $1 (10 percent of market value) and share $8.55 (95 percent of $9 of income), leaving a profit for the contractor of 45 cents.
   It’s also possible that the retained-interest model could include an up-front payment. That up-front payment could be a payment from the contractor to DRMS to be awarded the scrap, or it could be a payment from DRMS to the contractor as a sort of retainer. Using the example above, company A—which would only pay $6.40 for the 100 pounds of scrap—might also have to put up $10,000 at the beginning of the contract, while company B would pay $9.55 for the 100 pounds of scrap at the outset.
   Now which is the better deal?
   Some scrap executives find this proposed model not only confusing, but also financially questionable.
   “I don’t think you’d make any money,” says Howard Glick, treasurer of Tri-State Iron & Metal Co. (Texarkana, Ark.). “DRMS wants a service, and typically when you want a service you pay for it. But it wants a service—somebody to manage its scrap yards—and it wants to get paid for it.”
   In Glick’s view, “the way they’re wanting to do it won’t work. There’s just not enough value at some of these locations to make it worthwhile.”
   Gardner, the government’s consultant, disagrees, asserting that the scrap venture program would be profitable for an efficient contractor. “You can’t expect the private sector to do anything without a profit opportunity,” he says.
   A few steps remain before the scrap venture program will fly.
   According to Gardner, DRMS will likely circulate a request for technical proposal and invitation for bid in draft form to ReMA and the scrap industry at large. Next, a bid conference will be scheduled about a month after the drafts are released. At that conference, industry members will be able to comment on the drafts and the retained-interest model.
   Soon after that conference, the final request for technical proposal will be sent, with a deadline set about a month after release. DRMS will then need about a month to review the submissions and communicate with companies that haven’t completely filled out the proposal, explains Gardner.
   Once companies have passed the proposal phase, they’ll be invited to bid, again having about a month to submit their information. Then DRMS will select a winning bidder, possibly by next spring.

Stay Tuned for the Results
Just as the exact shape of the scrap venture program is not yet determined, the effect of DRMS privatization on the U.S. scrap industry is also not yet known.
   One area of concern is the small scrap dealer, who may have depended on scrap from local DRMOs as a primary source of income. Some processors maintain that these small companies won’t survive after privatization, while others—including DRMS—see no such problem.
   “We had a meeting in January with private industry,” Davis states. “We had over 100 people there representing about 80 firms, and potential damage to small operators was not a theme. So, we’re hoping that small businesses will be able to participate in the new scrap programs, either on their own or as local partners with larger firms.”
   Privatization could even be a boon to small processors, Keenberg of Ekco Metals says, noting that they could be able to buy government scrap more economically from private contractors than they could from the government itself.
   Other voices are calling for DRMS to keep doing business as usual. These voices claim that DRMS’s previous approach of soliciting sealed bids for scrap sales gave the best return to the government and offered a fair trading opportunity for scrap companies.
   But DRMS has been set on its course by higher powers than those running the activity. Enterprise management in DRMS is inevitable as it works to achieve the goals of cutting costs and maintaining or increasing its revenue.
   Will the government’s privatization efforts succeed or fall flat? No one has the answer at this point. The best that can be said is that the privatization movement is an ambitious experiment whose outcome is still very much uncertain. •