City and County of San Francisco

Transcription

1 City and County of San Francisco Office of the Controller City Services Auditor OFFICE OF CONTRACT ADMINISTRATION: Office Depot Did Not Comply With Its Contract and Has Overcharged the City at Least $5.75 Million December 18, 2009

2 CONTROLLER S OFFICE CITY SERVICES AUDITOR The City Services Auditor was created within the Controller s Office through an amendment to the City Charter that was approved by voters in November Under Appendix F to the City Charter, the City Services Auditor has broad authority for: Reporting on the level and effectiveness of San Francisco s public services and benchmarking the city to other public agencies and jurisdictions. Conducting financial and performance audits of city departments, contractors, and functions to assess efficiency and effectiveness of processes and services. Operating a whistleblower hotline and website and investigating reports of waste, fraud, and abuse of city resources. Ensuring the financial integrity and improving the overall performance and efficiency of city government. The audits unit conducts financial audits, attestation engagements, and performance audits. Financial audits address the financial integrity of both city departments and contractors and provide reasonable assurance about whether financial statements are presented fairly in all material aspects in conformity with generally accepted accounting principles. Attestation engagements examine, review, or perform procedures on a broad range of subjects such as internal controls; compliance with requirements of specified laws, regulations, rules, contracts, or grants; and the reliability of performance measures. Performance audits focus primarily on assessment of city services and processes, providing recommendations to improve department operations. The audits unit conducts the audits in accordance with the Government Auditing Standards published by the U.S. Government Accountability Office (GAO). These standards require: Independence of audit staff and the audit organization. Objectivity of the auditors performing the work. Competent staff, including continuing professional education. Quality control procedures to provide reasonable assurance of compliance with the auditing standards. Audit Team: Paige Alderete, Audit Manager Houman Boussina, Associate Auditor Annie Cheng, Associate Auditor

3 City and County of San Francisco Office of the Controller City Services Auditor Office of Contract Administration: Office Depot Did Not Comply With Its Contract and Has Overcharged the City at Least $5.75 Million December 18, 2009 Purpose of the Audit At the request of the Office of Contract Administration (OCA), the City Services Auditor assessed whether Office Depot has correctly charged the City and County of San Francisco (City) for office supplies and complied with key contract terms, and whether the City s monitoring process should be strengthened and the current office supplies contract improved. Highlights Office Depot did not comply with several terms of its contract with the City for office supplies between January 2005 and July Office Depot s practices undermined some of the City s purchasing controls and resulted in at least $5.75 million in overcharges to the City. The $5.75 million in overcharges were primarily incurred because Office Depot: Did not apply required discounts to half of the City s expenditures for items that were not included in the original approved price lists, resulting in $4.4 million in overcharges. Inappropriately placed limits on discounted prices (known as price floors), resulting in $1.3 million in overcharges. Did not always sell items at the prices quoted to the City in accordance with the contract. Made unauthorized price increases. The audit also found that the terms of the City s office supplies contract were violated because Office Depot: Did not make all contract items available for purchase. Sold restricted items without proper authorization. Inappropriately allowed $1.9 million in purchases to be ordered via phone or fax. Did not appropriately enforce the contract terms for purchases by some City employees or for purchases placed by phone or fax. Did not always deliver items by the next day, as required. Charged the City $26,000 in delivery fees. Recommendations The audit report includes 40 recommendations for OCA regarding Office Depot s contract compliance and how OCA can improve its contract administration. OCA should: Collect at least $5.75 million plus interest from Office Depot for overcharges during the term of the contract. Require Office Depot to remove all price floors, to provide the required notification for price changes, and to properly discount items. Require Office Depot to only sell items that are discounted under the contract. Require Office Depot to properly restrict the sale of items when required by the contract. Require Office Depot to make all contract items available to the City. Copies of the full report may be obtained at: Controller s Office City Hall, Room Dr. Carlton B. Goodlett Place San Francisco, CA or on the Internet at

4 City and County of San Francisco Office of the Controller City Services Auditor Highlights (continued) Overall, OCA did not properly administer and monitor the office supplies contract. OCA needs to improve its office supplies contract and work with other City departments to strengthen monitoring of the contract. Current contract and administration weaknesses include: A contract discount structure that makes it difficult to determine the actual discount received by the City. Several key contract terms that are unclear and inconsistent. Paying for City office supply purchases without sufficient reconciliation or approval procedures. Recommendations (continued) Monitor Office Depot s compliance with all key contract terms. Enforce the requirement to amend the contract when the City s business needs can be better addressed with modified terms. Ensure the contract clearly defines key terms, such as price floors and price changes. Reassess the contract s discount structure. Develop controls to ensure that Office Depot invoices are reconciled with records of purchases, and that they are approved before payment is made. Copies of the full report may be obtained at: Controller s Office City Hall, Room Dr. Carlton B. Goodlett Place San Francisco, CA or on the Internet at

5 CITY AND COUNTY OF SAN FRANCISCO OFFICE OF THE CONTROLLER Ben Rosenfield Controller Monique Zmuda Deputy Controller December 18, 2009 Naomi Kelly, Director and Purchaser Office of Contract Administration 1 Dr. Carlton B. Goodlett Place, Room 430 San Francisco, CA Dear Ms. Kelly: The Controller's Office, City Services Auditor (CSA), presents its audit report on the office supplies contract between the City and County of San Francisco (City) and Office Depot. The objectives of this audit were to determine if Office Depot correctly charged the City for office supplies and complied with key contract terms, and whether the City s monitoring process should be strengthened and the current office supplies contract improved. This audit was conducted at the request of the Office of Contract Administration (OCA). CSA found that Office Depot overcharged the City at least $5.75 million for office supplies and did not comply with some terms of the contract. Office Depot did not provide the contracted discounts because it imposed unauthorized limitations on discounted prices, known as price floors, and inappropriately sold items to the City outside of the contract s discount structure. CSA also established that OCA did not adequately monitor Office Depot s compliance with contract terms. The City makes monthly payments to Office Depot without sufficient verification that items and prices are correct. In addition, the terms and discount structure of the office supplies contract need to be improved. The audit report includes 40 recommendations for OCA regarding Office Depot s contract compliance and how OCA can improve its contract administration process. OCA s response to the audit report is included as Appendix C, and Office Depot s responses are included as Appendices D and F. The Controller s Office, City Services Auditor, will work with OCA to follow up on the status of the recommendations in this report. Respectfully submitted, Tonia Lediju Director of Audits City Hall 1 Dr. Carlton B. Goodlett Place Room 316 San Francisco CA FAX

6 cc: Mayor Board of Supervisors Civil Grand Jury Budget Analyst Public Library

7 TABLE OF CONTENTS Introduction... 1 Chapter 1 Office Depot Overcharged the City at Least $5.75M for Office Supplies... 7 Finding 1.1. Office Depot overcharged the City $1,310,053 for Section B items by incorrectly discounting the items sold... 7 Finding 1.2. Half of the City s expenditures did not receive the required discounts because they were for items not on the approved Section A and B price lists, causing $4,381,019 in overcharges to the City... 9 Finding 1.3. Pricing errors on Section A items resulted in $17,119 overcharged to the City Chapter 2 Office Depot Did Not Comply With All Contract Requirements Finding 2.1. Only 15 percent of the City s expenditures were for items in the highest discount category (Section A), instead of the 46 percent projected in the contract Finding 2.2. Unauthorized price increases violated contract terms Finding 2.3. Office Depot used an incorrect methodology to increase prices for Section B Finding 2.4. Office Depot inappropriately removed some restrictions Finding 2.5. Office Depot violated contract terms by allowing $1,907,528 in purchases to be ordered via phone or fax Finding 2.6. Twenty-two percent of orders placed in March 2009 were delivered later than the next day, in violation of contract terms Finding 2.7. Office Depot charged the City $26,000 in delivery fees... 22

8 Chapter 3 OCA and City Departments Need to Better Monitor Compliance With the Office Supplies Contract Finding 3.1. OCA did not adequately monitor Office Depot s compliance with its contract, and it did not properly administer the office supplies contract Finding 3.2. The City pays Office Depot invoices without ensuring that payments are for items actually ordered and received Finding 3.3. Some department employees with online purchasing authority are not subject to contract purchasing controls Chapter 4 OCA Needs to Improve the City s Office Supplies Contract Finding 4.1. The contract s discount structure makes it difficult to determine the actual discount received by the City Finding 4.2. Unclear and inconsistent contract terms make it difficult to ensure contract compliance Appendix A Office Depot Communications With OCA... A-1 Appendix B Office Depot s Section B Bid... B-1 Appendix C OCA s Response to the Draft Audit Report... C-1 Appendix D Office Depot s October 27, 2009, Initial Response to the Draft Audit Report... D-1 Appendix E City Attorney and CSA Communications to Office Depot... E-1 Appendix F Office Depot s December 4, 2009, Subsequent Response to the Draft Audit Report...F-1 Appendix G CSA Notification of Revisions Made to the Draft Audit Report... G-1 Appendix H CSA Rebuttal to Office Depot s Responses Dated October 27, 2009, and December 4, H-1

9 LIST OF ACRONYMS AND DEFINITIONS CSA GSA OCA CPI Section A City Services Auditor General Services Agency Office of Contract Administration Western Region Consumer Price Index Contract section referring to a list of items to be provided to the City at a fixed price. Section B Contract section referring to items, allocated into one of 16 categories, with fixed discount levels. Miscategorized Item Refers to items sold to the City that were not on the approved original lists of Section A and B items, and which, as a group, did not receive contracted discounts.

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11 INTRODUCTION Audit Authority Background OCA awarded the office supplies contract to Office Depot in January 2005 for 30 months, through July 2007 OCA extended the contract through November 30, 2009 The contract projected the proportion of expenditures for Section A and B items to be 46 percent and 54 percent, respectively This audit was conducted under the authority of the Charter of the City and County of San Francisco (City), which requires that the Office of the Controller, City Services Auditor (CSA), conduct periodic, comprehensive financial and performance audits of City departments, services, and activities. The Office of Contract Administration (OCA) purchasing division provides contracting and procurement services to support the operations of City departments. On January 26, 2005, OCA accepted a bid from Office Depot under contract proposal number to furnish office supplies and related services to all City departments at discounted prices. The contract allows office products to be purchased and delivered for use by the City s approximately 27,000 employees located in 65 departments, and was solicited to reduce the City s cost to buy office supplies, manage customer relations and satisfaction, provide electronic ordering of office supplies for the City, and facilitate timely acquisition of office supplies. The contract requires Office Depot to provide items at fixed prices or discount levels. The original contract term was for a period of 30 months, January 26, 2005, through July 25, 2007, or to a maximum total expenditure amount of $10 million, whichever occurred first. There were eight contract modifications, the last of which extended the contract to November 30, 2009, 1 or to a maximum total expenditure of $19,345,441. As required by the bidding process, Office Depot submitted unit prices and category discounts in bid sheets known as Section A and Section B. Sections A and B represent the solicited discount structure of the contract. Section A consists of Office Depot s fixed unit prices for 591 of the City s most commonly used office supply items. Section B consists of Office Depot s fixed discounts, off of list price, for 16 categories of office supplies that cover items not 1 As of December 1, 2009, the City is using a different vendor. According to an OCA supervising purchaser, the City has signed onto a piggy-back contract with Staples, originally put out to competitive bid by the County of San Diego in 2007, and used by over 400 public and nonprofit entities. The contract is effective as of December 1, 2009, for a period of six months with the option to extend. The City s intent is to put the office supplies contract out to bid at the appropriate time. 1

12 discounted under Section A. Based on the City s 2003 office supplies purchases, the contract projected that 46 percent of expenditures would be for Section A items while 54 percent would be for Section B items. Other key contract terms Beyond the discount structure, other key contract terms 2 include: The City is not required to reimburse Office Depot for items or prices that are not within the scope of the contract. Section A unit prices and Section B discounts are fixed for the duration of the contract. Office Depot must provide OCA with 30 days notice prior to making any quarterly changes to the Section B list prices. All Section A items need to be available and carried by Office Depot at stocking levels of 95 percent. In the event of discontinuance or unavailability of items, Office Depot must find an acceptable and equal substitute for delivery at the contract price. Items shall be ordered through the Office Depot online ordering system, which has the capability of restricting items. Purchases will be delivered by the next day, at no additional cost to the City. The contract cannot be modified, nor can compliance with any of its terms be waived, except through a formal and legal amendment process. As of June 2009, the City expended $18.3 million under the Office Depot contract. Exhibit 1 shows the total payment amount by year. 2 All contract terms were extended through November 30,

13 EXHIBIT 1 City Payments to Office Depot Period Payment January 26, 2005, through December 31, 2005 $ 3,047,762 January 1, 2006, through December 31, ,832,405 January 1, 2007, through December 31, ,778,957 January 1, 2008, through December 31, ,622,125 January 1, 2009, through June 30, ,007,059 Total: $ 18,288,308 Source: General Services Agency, City Administrator s spreadsheet of Office Depot billings under the City s office supplies contract. Other jurisdictions have audited their contracts with Office Depot and have found overcharges and instances of noncompliance Other jurisdictions, including the states of California, Georgia, North Carolina, and Nebraska, have audited their office supplies contracts with Office Depot and found overcharges and compliance issues. For example: Items were sold under a discount category not specified in the contract. Negotiated contract prices were not honored. Contracted items were not available for purchase. Multiple prices were charged for the same items. Items that were blocked and restricted from sale under the contract were inappropriately sold. In response to other jurisdictions findings, OCA requested CSA to audit the City s contract with Office Depot and to identify areas in which the City s administration of the contract could be improved. Objectives The objectives of the audit were to determine whether: 1. Office Depot correctly charged the City for office supplies. 2. Office Depot complied with the contract. 3. The City s monitoring process can be strengthened to better ensure contract compliance. 4. The City s current office supplies contract can be improved. 3

14 Scope and Methodology The audit period was January 1, 2005, through June 30, The auditors extended the testing period to use Office Depot s billing data received through July 31, To conduct the audit, the CSA audit team: Reviewed the terms of the City s contract with Office Depot and subsequent modifications. Interviewed OCA, Office Depot, City Attorney, City Administrator, and Controller s Office staff. Used the audit analytic software Audit Command Language (ACL) to conduct comprehensive, transaction-level testing of Office Depot s billing data for compliance with approved contract prices and discounts. 3 Applied the average Section B discount to items that were not on the approved lists of Section A and B items and did not receive the required contract discounts. 4 While the contract states that the City is not required to reimburse Office Depot for items outside the scope of the contract, auditors treated these purchases as valid, but recalculated prices based on Section B discounts. Tested Office Depot s billing data for sale of restricted items and for unauthorized price increases. Used a sample of transactions to test Office Depot s website for availability of contracted items and restricted items. Used a sample of transactions to test for compliance with next-day delivery terms. 5 Scope Limitation One percent of sales ($185,759) made during the audit period were reviewed subsequent to the release of the draft audit report because these records were not made available by Office Depot until after audit fieldwork was complete. The additional overcharges calculated based on 3 The testing accounted for all transactions, including: overcharges, undercharges, purchases, and returns. The test results represent the net overcharges. 4 Because these items were not included in the original approved price lists, to test accuracy of prices charged, the auditors used the reported manufacturer s list prices for these items. 5 The auditors interpreted next day to mean next business day. 4

15 these records, totaling $44,657, have been included in the total overcharges due to the City of $5.75 million. However, the graphs and charts included in this report do not include the additional overcharges calculated after fieldwork. This performance audit was conducted in accordance with generally accepted government auditing standards. These standards require planning and performing the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for the findings and conclusions based on the audit objectives. We believe that the evidence obtained provides a reasonable basis for the findings and conclusions based on the audit objectives. However, these standards require we disclose that CSA may not be considered organizationally independent for this audit because it is part of the Controller s Office, which performs the accounting functions of the City. Due to some delays, this report is being issued subsequent to the termination of the contract with Office Depot on November 30, Therefore, some of the recommendations addressing the administration of the contract may no longer apply, but have been retained for completeness. 5

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17 CHAPTER 1 Office Depot Overcharged the City at Least $5.75M for Office Supplies Summary From January 2005 through July 2009, Office Depot overcharged the City at least $5.75 million for office supplies because Office Depot: Inappropriately lowered contracted discount rates on some items by applying limits on discounted prices, known as price floors, resulting in $1.3 million in overcharges. Sold items that were not discounted under the contract, resulting in $4.4 million in overcharges. Charged incorrect unit prices for some Section A items, resulting in $17,119 in overcharges. Did not provide all records during the fieldwork phase of the audit. When the records were later provided, the auditors identified $44,657 in additional overcharges owed from the transactions. Recommendation 3 has been revised accordingly. Upon consultation with the City Attorney s Office, the auditors concluded that OCA should assess interest charges on these amounts. Finding 1.1 Office Depot overcharged the City $1,310,053 for Section B items by incorrectly discounting the items sold. Contract prices for office supplies are determined by a fixed price list in Section A and fixed discount levels for 16 categories of items in Section B. Items that do not fall into Section A are grouped in one of the 16 office supply categories listed in Section B. Based on the City s 2003 expenditures, the contract projected 54 percent of total purchases to fall under Section B. However, instead of the projected 54 percent, Section B purchases represented 35 percent or $6,041,185 of the 7

18 City s total office supply expenditures. 6 Detailed, transaction-level testing of Section B purchases found that Office Depot did not correctly price all items, based on the authorized price list and discount levels, which resulted in overcharges of $1,310,053. The average discount Office Depot gave to the City was 62 percent for Section B items. Office Depot inappropriately imposed price floors, which reduced discount levels Section B purchases did not receive the contracted discounts because Office Depot inappropriately placed limits on discounted prices, known as price floors, beginning around February According to an Office Depot senior district sales manager, new account representatives imposed price floors under the assumption that price floors had not been applied due to a modeling error. The City s bid sheet did allow for price floors to be included in vendors bids. However, the Section B bid submitted by Office Depot did not provide for price floors, and in November 2004, as part of the contract acceptance process, Office Depot clarified in a letter to OCA that it had not used price floors in its bid (see Attachment A). Documents related to contract acceptance take precedence in resolving conflicts regarding contract terms. According to the Office Depot senior district sales manager, the account representatives were unaware of the letter to OCA when they imposed the price floors. The analysis of the City s monthly expenditures under the contract, shown in Exhibit 2, reflects a substantial increase in expenditures starting in March 2007, which is consistent with price floors being implemented around February Average monthly expenditures increased by 29 percent during the period March 2007 to June 2009, in comparison to the period before Office Depot inappropriately applied price floors. The City s average monthly expenditure for office supplies for the period February 2005 through February 2007 was $299,750, while the average monthly expenditure for the period March 2007 through June 2009 was $385, Auditors consider items to be Section B purchases if part numbers (SKU numbers) are included in the original approved Section B price list. 7 According to an Office Depot senior district sales manager, price floors ensure that unit prices do not fall below Office Depot s cost. 8

19 EXHIBIT 2 Citywide Total Expenditures Between February 2005 and June 2009 $500,000 Average monthly expenditures between 3/07 and 6/09: $385,330 $400,000 Average monthly expenditures between 2/05 and 2/07: $299,750 $300,000 $200,000 $100,000 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Source: General Services Agency, City Administrator s spreadsheet of Office Depot billings. Recommendations OCA should: 1. Collect $1,310,053 plus interest from Office Depot for overcharges due to Section B items being incorrectly discounted. 2. Require that Office Depot remove all price floors immediately. 3. Calculate and collect additional overcharges for the missing transaction data and for billing data after July 31, (Note: Subsequent to audit fieldwork, Office Depot provided the missing records for the audit period and the auditors calculated an additional $44,657 in overcharges owed to the City.) Finding 1.2 Half of the City s expenditures did not receive the required discounts because they were for items not on the approved Section A and B price lists, causing $4,381,019 in overcharges to the City. 9

20 Miscategorized items sold to the City were discounted only 46 percent on average, instead of the contracted 70 percent The auditors found that 50 percent of the City s expenditures were for items that were not in the authorized Section A or B price lists. The average discount received by the City for these miscategorized items was only 46 percent off of list price. The contract states that the City is not required to reimburse Office Depot for materials sold beyond the scope of the contract. Thus, since the miscategorized items were not included in the fixed Section A list, the items should have been discounted under one of the 16 supply categories in Section B or otherwise restricted from purchase. 8 Based on a sample of the miscategorized items purchased during one month, the auditors concluded that the items could have been categorized and sold under Section B of the contract. If all miscategorized items had been correctly discounted under Section B, receiving an average of 70 percent off of list price, the City would have received additional discounts amounting to $4,381, Office Depot sold items not discounted under contract terms without proper authorization According to Office Depot representatives, miscategorized items were sold because: Office Depot regularly publishes new office supply catalogs that include the latest products in the market and any price changes. If the City purchases these new items before the City s Section B list has been updated, the items may not receive the expected Section B discounts. City purchasers regularly requested that items not included in the contract be unrestricted and sold through the use of waivers or requisitions. In October 2006, an from a recycling coordinator at the City s Department of the Environment requested that all restrictions be removed with three exceptions. Subsequently Office Depot removed all restrictions from the account, with the exception of a $250 per unit price limit. 8 The contract states that items not sold under Section A are covered under Section B. 9 Attempting to classify miscategorized items into applicable Section B categories is impractical. The auditors refer to the 70 percent average discount for Section B items in determining expected discounts for miscategorized items. 10

21 Certain users, known as super-users, have the ability to override contract restrictions. Office Depot allowed departments to place phone and fax orders, which are not subject to the same purchasing controls as web orders. Upon consultation with the City Attorney s office, the auditors concluded that the from the recycling coordinator does not request that all restrictions be removed, just some environmental restrictions, and that the does not constitute a formal contract amendment. Therefore, its contents do not override or change the contract s terms. Miscategorized items identified by the auditors should have been discounted at an average of 70 percent off list price rather than 46 percent. If items not discounted under Section A had received the required Section B discounts, the City would have saved $4,381,019. Recommendations OCA should: 4. Collect $4,381,019 in lost discounts, plus interest, for miscategorized items sold to the City from Office Depot. 5. Require Office Depot to only sell items that are discounted under the contract (Section A or B). 6. Monitor Office Depot s invoices to ensure that only items approved and specified in the contract are sold to the City, and that the City received the correct discount rate. Finding 1.3 Pricing errors on Section A items resulted in $17,119 overcharged to the City. Office Depot did not charge the correct unit price for some Section A items Some Section A items sold to the City had unit prices that differ from the Section A price list and authorized amendments. The contract specifies that all prices in Section A are fixed for the duration of the contract. The auditors found overcharges of $17,119 for Section A items. The majority of these overcharges, $13,976, were incurred because an often-purchased package of four storage boxes (SKU number ) was sold for $2.20, except for 22 11

22 instances in which it was sold for $2.96, instead of the contracted, fixed price of $0.55. The auditors concluded that the bid price Office Depot submitted for the package of boxes may not have accounted for the number of boxes included in each package. Regardless, Office Depot is required to use contracted prices for Section A items, and in this case the contracted price was not charged. Recommendation OCA should: 7. Collect $17,119 plus interest from Office Depot for overcharges on Section A items. 12

23 CHAPTER 2 Office Depot Did Not Comply With All Contract Requirements Summary Office Depot did not comply with several key terms of the City s office supplies contract, which undermined some of the City s purchasing controls and made it difficult to monitor the contract. For example, Office Depot: Did not have all contracted items available for purchase through its online ordering system. Increased Section B prices without submitting the required notification to the City. Allowed restricted items to be purchased. Did not deliver all items by the next day and billed questionable shipping charges to the City. While Office Depot may have followed some of these practices to better serve the needs of the City, they were done without the required formal contract modification. Finding 2.1 The contract expected purchases from Office Depot to mirror the City s prior purchasing patterns Only 15 percent of the City s expenditures were for items in the highest discount category (Section A), instead of the 46 percent projected in the contract. Based on the City s 2003 purchasing patterns, Office Depot s contract projected that 46 percent of all office supply expenditures would be categorized under Section A, and 54 percent would be for Section B. Exhibit 3 shows that the City s purchases did not mirror the expected purchases. Only 15 percent of the City s total expenditures were for the highly discounted Section A items, 35 percent were for Section B items, and 50 percent were for miscategorized items (items that were not on the approved Section A and B lists). Exhibit 4 shows that under the contract, Section B items should have received a higher discount than the average of 62 percent received off of list price, and miscategorized items should have received a higher discount than the average of 46 percent received. 13

24 EXHIBIT 3 Expected Versus Actual Percentage of Total Expenditures January 2005 to July 2009 Percentage (%) of Total Expenditures 60% 50% 40% 30% 20% 10% 0% Expected Expected Actual Actual Actual Expected Section A Section B Miscategorized Section A Section B Miscategorized Expected 46% 54% 0% Actual 15% 35% 50% Sources: Office Depot contract and Office Depot billing data. EXHIBIT 4 Contracted Versus Actual Discounts Received January 2005 to July 2009 Average Discount (%) 80% 60% 40% 20% 0% Contracted Actual Contracted Actual Contracted Actual Section A Section B Miscategorized Section A Section B Miscategorized Total Overcharges Contracted 74.9% 69% 70% 1 N/A Actual 74.7% 62% 46% 2 N/A Amount Overcharged $17,119 3 $1,310,053 $4,381,019 $5,708, Items not in Section A should have been grouped in Section B and received an average discount of 70 percent. This represents the average discount in reference to list prices stated in billing data. The average discount given, with reference to the lowest stated list price for each miscategorized item, is 42 percent. Section A overcharges were determined based on the contracted prices. Sources: Office Depot contract and Office Depot billing data. According to an Office Depot senior district sales manager, purchases of Section A items may decrease over time because items can become obsolete as the market evolves and spending trends change. The auditors concluded that it is improbable that only spending trends resulted in such a 14

25 large variance (31 percentage points) between expected (46 percent) and actual (15 percent) Section A purchases. Some Section A items were unavailable for purchase Further testing revealed that another cause for reduced Section A purchases is that not all Section A items were available for purchase. In a sample of 25 Section A items tested, 60 percent were unavailable for purchase and could not be added to the online shopping cart. 10 In addition, keyword searches for Section A products proved generally ineffective as they returned alternate items. The contract stipulates that Office Depot must maintain stocking levels of 95 percent on all Section A items. In its contract bid, Office Depot agreed to comply with this term and stated that because 97 percent of the items the City would purchase come directly from factories, the chance of a backorder is almost completely eliminated. According to an Office Depot senior district manager, some Section A items may not be available because they were phasing into or out of stock, and some Section A items, such as calendars, may have been specific to a certain past period. The City did not receive the expected benefit of having 46 percent of its office supply expenditures discounted at the highest rate because only 15 percent of the City s expenditures were for Section A items, as shown in Exhibits 3 and 4. It is beyond the scope of this audit to estimate losses incurred by the City because Section A items were not always available. Recommendations OCA should: 8. Require Office Depot to comply with the contract term stating that all Section A items be available for purchase. 9. Require Office Depot to inform the City of changes affecting the availability of inventory under Section A. 10. Clarify the contract language to ensure that items are not sold outside of the scope of the contract. 11. Use the contract s Section A and B projections as the basis for monitoring the City s expenditures. 10 Sample was selected from a list of Section A items that were not purchased by the City in March

26 Finding 2.2 Office Depot changed Section B price lists multiple times without giving notice to the City Unauthorized price increases violated contract terms. In September 2005, the contract was amended to allow quarterly price updates to Section B based on increases in the Western Region Consumer Price Index (CPI) and upon 30 days notification to the City. Upon consultation with the City Attorney s office, the auditors concluded that any changes made without 30 days notice violate the contract. Office Depot provided the auditors with five revised price lists for Section B. However, OCA has only one record of a price change notice, and neither OCA nor Office Depot has the corresponding, revised price list. No other change notifications were provided to the auditors. According to an Office Depot senior district sales manager, Office Depot was not aware of the contract amendment requiring 30 days notice for price changes. Prices were changed up to 10 times for some items An audit test found that over the span of four and a half years, many items unit prices were changed more than eight times. In one instance, 10 different prices were charged, with the unit price ranging from $1.96 to $10.48, a 435 percent price increase. 11 Unit prices increased by more than 100 percent for over 5,000 items, out of approximately 24,000 items reviewed. According to Office Depot representatives, the large price variances noted by auditors may be explained by: Multiple price increases implemented by Office Depot. Items provided to the City at nominal amounts (i.e., $.01), because they were samples. Price floors imposed starting February Quantity discounts given at the purchaser s request. Discounts given to match competitor s prices. The contract does not explicitly allow any of the above practices to increase or decrease prices. According to an Office Depot senior district sales manager, OCA asked Office Depot to stop making price overrides in Additionally, an Office Depot analyst indicated that there may have been an error in uploading one of Office Depot s Section B price lists to the City s account. 11 The item is a notebook with SKU number

27 Recommendations OCA should: 12. Ensure that any quarterly price changes made by Office Depot are in accordance with the contract and that appropriate notice is provided. 13. Ensure that the contract explicitly states the terms for allowable price changes, if any, for each of the negotiated discount structures (Section A and B). This includes price change frequency, escalation methods, notification, and approval requirements. 14. Verify that Office Depot has controls in place to ensure the integrity of prices used in billing the City, including controls for uploading authorized price lists. Finding 2.3 Office Depot used an incorrect methodology to increase prices for Section B. According to an Office Depot senior district sales manager, Section B price increases were based on manufacturer s list prices and did not always consider the CPI. This is not the approved methodology for increasing Section B prices. The approved methodology, noted in the first contract modification, states that Section B manufacturer s list prices will be revised quarterly based on increases in the CPI for the previous quarter, but if the CPI does not change or decreases, no changes will be made to pricing. Since price increases were not authorized, auditors referenced the approved Section B price list in determining correct prices and overcharges to the City. In addition, for items sold to the City not included in the approved Section A and B price lists (miscategorized items), auditors determined correct prices and overcharges to the City by referencing the lowest list price stated for each item in billing statements during the audit period. The total overcharges of $5.75 million calculated by auditors account for unauthorized price increases (see Chapter 1). Recommendation OCA should: 15. Require Office Depot to use the approved methodology governing price changes. 17

28 Finding 2.4 Office Depot sold items to the City that were restricted and not discounted at contracted rates Office Depot inappropriately removed some restrictions. The City purchased at least $1,194,860 in restricted items. In October 2006, Office Depot removed contract restrictions based on an sent from a City recycling coordinator. All restrictions were removed except for three environmental restrictions and the $250 per unit limit. The contract specifies that Office Depot is to restrict certain items from being purchased by the City and that changes to the contract must be made through a formal amendment. The following are categories of items classified as restricted under the contract: Furniture 12 Janitorial supplies 12 Computers and computer peripheral devices Copiers and copier supplies Items with unit values over $250 Exhibit 5 provides some examples of purchases for Office Depot product classes that were specifically restricted, and the average discount Office Depot provided on these items. The City spent $472,612 in the following restricted categories: copiers, copier supplies, computer accessories, and wireless notebooks (computers). In all cases, discount levels received were lower than the expected average discount of 70 percent for items sold under Section B. EXHIBIT 5 Examples of City Expenditures for Restricted Items Office Depot Product Class City Expenditures Average Discount Received Copiers $ 2,400 46% Copier Supplies 42,840 16% Computer Accessories/Storage 414,630 39% Wireless Notebooks (computers) 12,742 42% Total of City Expenditures Examples $ 472,612 N/A Sources: Office Depot contract and Office Depot billing data. 12 As noted in Chapter 4 of this report, the contract restrictions concerning furniture and janitorial supplies are not clear because these item categories appear in the contract s Section B discount categories. 18

29 Office Depot sold $722,248 in items exceeding the $250 per unit restriction Items were restricted from purchase under the Office Depot contract to ensure that the City s contracts with other vendors were honored Purchases of items with unit prices more than $250, which are restricted under the contract, totaled $722,248. Examples of items with unit prices greater than $250 include GPS units, projectors, air conditioners, refrigerators, digital cameras, and printers. The average discount received on these items was 38 percent off of list price, which is substantially lower than the average contract discount of 70 percent expected for Section B items. Upon consultation with the City Attorney s Office, the auditors concluded that Office Depot should not have removed the contract restrictions without a formal contract modification. Certain items were restricted from purchase under the contract to ensure that items included in the City s contracts with other vendors were not purchased from Office Depot. Moreover, computers and electronic equipment were restricted because the City should purchase these items through the approved vendors to whom the City s Committee on Information Technology (COIT) has awarded contracts, not through Office Depot. Among other advantages, technology supply contracts help COIT achieve its goal of greater standardization of technologies among the various City departments to facilitate interaction among the departments, particularly in emergencies. Lastly, Office Depot s removal of the restrictions on furniture purchases may have caused the City to incur $26,000 in shipping costs. Recommendations OCA should: 16. Require Office Depot to properly restrict the sale of items, as stated in its contract with the City. 17. Ensure that the contract accurately reflects the City s desired restrictions. If not, OCA should amend the contract. 18. Develop and implement monitoring controls to prevent and detect the purchase of blocked and restricted items. 19

30 Finding 2.5 Office Depot inappropriately accepted phone and fax orders, which have fewer purchasing controls Office Depot violated contract terms by allowing $1,907,528 in purchases to be ordered via phone or fax. The contract requires that all office supply purchases be ordered through Office Depot s online ordering system. However, 10 percent of all office supply expenditures ($1,907,528) were placed by phone or fax. Local Office Depot representatives who administered the contract described to the auditors controls governing phone or fax orders that are less stringent, and rely on Office Depot representatives to manually ensure compliance with the contract. While Office Depot representatives do receive a pop-up warning when placing a phone order, the alert does not prevent the order from being placed. This control weakness creates an opportunity for department purchasers to mistakenly or purposefully circumvent contract restrictions. This method of purchasing is unauthorized and may cause items not to receive the contracted discounts. According to OCA, some City departments are not equipped to access the online ordering system, so they place orders by phone and fax. While the City s phone and fax orders accounted for 10 percent of total sales, the freight charges incurred from these orders accounted for 20 percent of the total freight charged. A higher percentage of freight charged to phone and fax orders may be the result of Office Depot having less stringent controls over these types of orders. Questionable shipping costs may have been incurred because Office Depot did not properly enforce the contract s restrictions. The allowance of phone and fax orders by Office Depot may have, in appearance, better served the needs of the City; however, it constitutes an unauthorized change to the contract. Recommendation OCA should: 19. Require Office Depot not to accept phone and fax orders. Finding 2.6 Twenty-two percent of orders placed in March 2009 were delivered later than the next day, in violation of 20

31 contract terms. Not all shipments were timely, with 15 percent taking three or more days to deliver Next-day delivery is required for all orders made under the Office Depot contract. Office Depot executive representatives indicated that the auditors initial calculation of delivery delays did not take into consideration of the time it takes for the approval process because orders are not always approved and released by the City on the same day they are placed. Subsequent to the audit fieldwork phase, Office Depot provided a data file that included order approval dates and times. Exhibit 6 illustrates that, in a test of one sample month, only 78 percent of orders were delivered the day after the order was placed. 13 Seven percent of orders were delivered on the second day. Fifteen percent of orders were delivered after three or more days, with 4 percent of orders taking six days or more for delivery. The auditors were unable to review 789 records made during the sample month in this test because the data provided by Office Depot subsequent to audit fieldwork phase was incomplete and missing records were not provided. Of those missing records, 569 were previously found to be late during the initial testing. EXHIBIT 6 Delivery Delays in March 2009 Source: Office Depot s records of City orders placed or delivered in March This test adjusted for orders placed on Friday by providing a two-day grace period and orders placed after 5 p.m. by providing a one-day grace period. 21

32 Although the contract does not offer any exceptions to the next day delivery requirement, Office Depot stated that some special orders, and delivery to the City s remote locations, 14 may require more time to deliver. Recommendations OCA should: 20. Require Office Depot to comply with the contract s nextday delivery term. 21. Work with Office Depot to determine if there should be any exceptions to the next-day delivery requirement. Any agreed-upon changes should be reflected in a contract amendment. Finding 2.7 Office Depot charged the City $26,000 in delivery fees. The contract proposal states that the City shall pay no additional shipping, delivery, or handling charges. Office Depot s contract bid noted that it agreed to comply with the requirement, but that it would charge for delivering furniture and special orders. Office Depot charged the City $26,000 for the delivery of goods during the audit period. These charges were primarily for furniture. Furniture is a category of items restricted under the contract. However, the terms of restrictions are unclear because furniture is also an approved category under Section B. Recommendations OCA should: 22. Consult with the City Attorney to determine if Office Depot should reimburse the City for delivery charges on the restricted items that were sold. 23. Ensure that all contractual documents are consistent. OCA should record its explicit approval of the vendor s bid terms that conflict with the intent of the contract proposal. 14 Remote locations include the Public Utilities Commission (PUC) facilities near the Hetch Hetchy Reservoir. 22

33 CHAPTER 3 OCA and City Departments Need to Better Monitor Compliance With the Office Supplies Contract Summary Inadequate monitoring controls and procedures have caused OCA to not detect overcharges and other instances of noncompliance with the office supplies contract, resulting in a total of at least $5.75 million in lost discounts and incorrect charges. The contract with Office Depot expired in November Chapters 3 and 4 of this audit report address the shortcomings in the current contract and contract administration. The findings noted in these chapters should be used to inform and improve the new contract and the City s monitoring process. Finding 3.1 OCA did not adequately monitor office supply expenditures OCA did not adequately monitor Office Depot s compliance with its contract, and it did not properly administer the office supplies contract. Contract compliance is the primary responsibility of the vendor. However, OCA did not proactively monitor Office Depot s compliance with the contract to adequately ensure that the City was receiving the full benefits of the contract. For example, OCA did not: Take steps to amend the contract when changes, such as the removal of restrictions on certain purchases, may have been preferred. Ensure that it continued to receive quarterly summary reports on expenditures from Office Depot. If it had, OCA might have found that only 15 percent of the City s purchases were discounted under Section A when the contract expectation was 46 percent. Monitor user access to the online purchasing system to determine if unauthorized individuals have access to the City s account. Monitor the discrepancies between contract prices and prices billed by Office Depot. 23

34 Lack of segregation of duties and personnel turnover also affected OCA s monitoring of the contract Adequately segregate the duties of contracting staff, potentially resulting in compromised monitoring of Office Depot s compliance with the contract. According to the OCA director, the same OCA representative prepared, approved, executed, and monitored the contract. Monitoring of the office supplies contract was further compromised because the OCA employee assigned to the task changed at least three times in four and a half years. According to the OCA director, OCA has been aware of issues with the contract and previously requested and received documentation from Office Depot, but was unable to perform the appropriate analysis. OCA has since improved its contract administration procedures by: OCA has taken steps to improve its contract administration procedures Restructuring its procedures to ensure that proper segregation of duties and effective controls exist around its contracting process. For example, the purchaser who develops a contract cannot approve the contract. Requiring formal approval from the assistant director of purchasing for contract modifications. Recommendations OCA should: 24. Require vendors to provide periodic reports on spending trends, compliance with key contract terms, and authorized user lists. 25. Establish a comprehensive process to regularly monitor vendor compliance with key terms of the office supplies contract. Finding 3.2 The City makes average monthly payments of $385,330 without verifying the accuracy of invoices The City pays Office Depot invoices without ensuring that payments are for items actually ordered and received. Office Depot bills the City monthly on its purchases. After the General Services Agency (GSA) uploads the billing data into the City s financial system, the Controller s Office releases payment to Office Depot. Neither GSA nor City departments reconcile the billing data to the City s purchases. OCA confirmed that the City does not have procedures to match Office Depot invoices with departments records of purchases or their records of receipt. In addition, the City does not have procedures to 24

35 verify if Office Depot correctly charged contract prices. Exhibit 7 illustrates the missing controls in the City s office supply procurement process, which includes: 1) The City Department places an order. 2) Office Depot ships the order to the department. 3) Office Depot invoices the City. 4) GSA uploads the billing data into City s financial system without reconciliation of the invoice to the goods received. 5) The Controller s Office pays the invoice. While the City s financial system has controls to ensure that duplicate payments are not made, these controls are not designed to ensure that invoices are accurate. EXHIBIT 7 The City s Office Supply Procurement Process Source: Auditor s review of the City s current procurement process for office supplies. Over the last couple of years, the City s monthly Office Depot expenditures averaged $385,330. The City is at risk of significant monetary loss without adequate controls to verify invoices before payment is made. Recommendations OCA should: 26. Ensure that departments are reconciling the items received with the items ordered. 25

36 27. Ensure that the City s monthly office supply invoices are reconciled with departments records before payment is issued. 28. Establish procedures to verify the accuracy of prices charged for office supplies at least on a quarterly basis. Finding 3.3 Some department employees with online purchasing authority are not subject to contract purchasing controls. There are two apparent exemptions from some contract purchasing controls: Some employees can place orders without approval Some employees can override contract restrictions Approvers: Each department has employees who purchase office supplies and others who approve the orders (approvers). This is an effective segregation of duties to ensure that purchases are appropriate and authorized. However, department approvers also have the ability to place office supply orders, which are not subject to review or approval. Super-users: According to Office Depot, super-users are employees who can override contract restrictions and place orders without approval. Allowing some employees to override contract restrictions and place orders without approval compromises the City s purchasing controls, and increases the opportunity for employees to hide inappropriate expenditures from management and commit fraud. Recommendations OCA should: 29. Ensure that Office Depot s systems reflect the correct levels of purchasing authority for all City employees and that orders cannot be placed without approval. 30. Consult with the Controller s Office to determine if permitting super-users to bypass contract restrictions is an acceptable practice. If so, work with the Controller s Office to ensure that mitigating controls exist to protect the City s interests. 26

37 31. Include in the contract the access rights and restrictions for each class of purchasers using the online ordering system. 27

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39 CHAPTER 4 OCA Needs to Improve the City s Office Supplies Contract Summary Finding 4.1 OCA should reevaluate the discount structure for the City s office supplies contract The office supplies contract has significant weaknesses that may have limited OCA s ability to monitor and administer the contract. Improving the terms of the contract will help ensure compliance by the City, Office Depot, and future office supply vendors. The contract s discount structure makes it difficult to determine the actual discount received by the City. The office supplies contract requires fixed unit prices for Section A and fixed discount levels for categories of items in Section B. This method of categorizing City purchases and discounts has the following weaknesses and disadvantages: The use of a fixed list of items (Section A) is not advantageous because it is likely that the City s purchasing needs will change during the course of the contract and some products on the list may become obsolete. If Section A items fall out of use for any reason, purchases of like items in Section B, which are not as highly discounted, may increase. In turn, the City will not receive the contract savings it anticipated. It is difficult to monitor the accuracy of prices charged, and the actual discount provided under Section B, because Section B allows the bidder to use undisclosed, manufacturer s list prices. Without the manufacturer s price list to compare to, the City is forced to accept that the prices and discounts provided on Office Depot s invoices are true and correct. OCA is currently reviewing the costs and benefits of other discount structure options, including the use of a third-party price list that would reflect changing purchasing needs. Recommendations OCA should: 32. Reassess the costs and benefits of having a fixed list of items and prices. 29

40 33. Require vendors to disclose the manufacturer s price list they reference for the bidding process and for any subsequent Section B revisions. 34. Regularly conduct sample tests to ensure that the list prices discounted on the vendor s invoices accurately correspond to the manufacturer s price list previously disclosed by the vendor. 35. Consider the costs and benefits of requiring bidders to reference a third-party price list in the bidding process. Finding 4.2 Unclear and inconsistent contract terms make it difficult to ensure contract compliance. Some terms in the current office supplies contract are unclear and may impede the transparency of the bidding process, contract compliance, and the City s ability to ensure it is receiving the appropriate prices and discounts for its office supply purchases. The auditors identified several contract deficiencies and grouped them into three categories: 1) unclear terms, 2) inconsistencies, and 3) terms not addressed in the contract. Unclear contract terms The contract terms regarding price floors should be made more explicit. The contract does not instruct vendors to submit a list of their price floors during the bidding process, which makes it difficult to adequately compare vendor bids. As a result, OCA had to clarify with Office Depot during the contract award process whether Office Depot s bid included price floors or not. It is unclear whether new catalog items should be automatically included as part of the Section B list. It was Office Depot s practice to treat Section B as a fixed list of items similar to Section A, and Office Depot was required to provide 30 days notification to the City for any changes to the list. According to an Office Depot senior district sales manager, Office Depot manually updated the Section B list to include new items. List prices are defined as the current suggested manufacturer s list price. It is not clear whether the referenced list prices are the ones current as of the date the bid is placed, or are to be updated, indicating a dynamic Section B list. 30

41 The contract requires the vendor to have a system that can restrict items not authorized under the contract, and provides examples of some restrictions or restricted categories. However, the contract should define more clearly how items are to be restricted. The contract should explicitly state if the items should not be sold at all or if there is a limit on the quantity purchased. Inconsistent contract terms The contract restricts furniture and janitorial supplies, yet these same categories are included in Section B, making the City s intention unclear. There were other errors and inconsistencies, such as terms that address the same requirement using different wording in different places. In one clause, the contract uses a double negative making the intent of the term difficult to interpret. Terms not addressed in the contract The contract does not address setting a maximum order amount which no order can exceed, to help reduce the City s liability in case of fraud. The contract does not address volume discounts that the City may take advantage of. Contract terms should be clear, consistent, and concise to adequately convey the City s intent, allow the City to easily compare and evaluate bids across vendors, and to monitor compliance with the contract. Recommendations OCA should: 36. Determine whether allowing price floors is in the City s best interest. If allowed, include a contract clause addressing criteria, frequency, and reporting requirements for price floors, and require all vendors to disclose their price floors during the bidding process so that OCA can accurately compare bids. 37. Clarify the intent of the contract s Section B discount structure. Specifically, make clear whether Section B lists can be changed without notifying OCA. 38. Clearly and consistently define key terms such as list prices, restrictions, and price changes. 31

42 39. Evaluate the benefits of including additional provisions in the office supplies contract, such as restrictions on order amounts and requesting vendors to include volume discounts in their bids. 40. Establish policies and procedures to ensure that all contracts are reviewed for clear, consistent, and accurate terms. 32

43 APPENDIX A: Office Depot Communications With OCA A-1

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47 APPENDIX B: Office Depot s Section B Bid B-1

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49 APPENDIX C: OCA s Response to the Draft Audit Report C-1

50 Recommendation 1. Collect $1,310,053 plus interest from Office Depot for overcharges due to Section B items being incorrectly discounted. 2. Require that Office Depot remove all price floors immediately. 3. Calculate and collect additional overcharges for the missing transaction data and for billing data after July 31, (Note: Subsequent to audit fieldwork, Office Depot provided the missing records for the audit period and the auditors calculated an additional $44,657 in overcharges owed to the City.) 4. Collect $4,381,019 in lost discounts, plus interest, for miscategorized items sold to the City from Office Depot. 5. Require Office Depot to only sell items that are discounted under the contract (Section A or B). Responsible Agency OCA OCA OCA OCA OCA Response OCA has been consulting with the City Attorney s Office regarding the City s rights and options to pursue reimbursement of improper charges. Concur. OCA sent a letter to Office Depot directing the company to delete all floors immediately. OCA has been consulting with the City Attorney s Office regarding the City s rights and options to pursue reimbursement of improper charges. OCA has been consulting with the City Attorney s Office regarding the City s rights and options to pursue reimbursement of improper charges. Concur. OCA has sent a letter to Office Depot requiring that all items sold to the City be priced with an appropriate discount. C-2

51 Recommendation 6. Monitor Office Depot s invoices to ensure that only items approved and specified in the contract are sold to the City, and that the City received the correct discount rate. 7. OCA should collect $17,119 plus interest from Office Depot for overcharges on Section A items. 8. Require Office Depot to comply with the contract term stating that all Section A items be available for purchase. 9. Require Office Depot to inform the City of changes affecting the availability of inventory under Section A. 10. Clarify the contract language to ensure that items are not sold outside of the scope of the contract. 11. Use the contract s Section A and B projections as the basis for monitoring the City s expenditures. 12. Ensure that any quarterly price changes made by Office Depot are in accordance with the contract and that appropriate notice is provided. Responsible Agency OCA OCA OCA OCA OCA OCA OCA Response Concur. OCA is working with the Controller on payment and auditing procedures for the remainder of the Office Depot contract, and for the new contract. OCA has been consulting with the City Attorney s Office regarding the City s rights and options to pursue reimbursement of improper charges. Concur. OCA has sent a letter to Office Depot requiring that the company replace any item deleted from Section A with an item of comparable quality and price. Concur. OCA has sent a letter to Office Depot requiring that the company replace any item deleted from Section A with an item of comparable quality and price. Partially concur. It was not the contract language that resulted in items sold outside the scope of the contract, but Office Depot s administration of the contract. Partially concur. Because the current contract ends Nov 30, 2009, projections would not be useful for the remaining time on the contract with Office Depot. OCA will develop projections for the new contract and monitor actual spending against them. Concur. OCA will monitor the remainder of the contract with Office Depot and will develop procedures for the new contract that will monitor price changes. C-3

52 Recommendation 13. Ensure that the contract explicitly states the terms for allowable price changes, if any, for each of the negotiated discount structures (Section A and B). This includes price change frequency, escalation methods, notification, and approval requirements. 14. Verify that Office Depot has controls in place to ensure the integrity of prices used in billing the City, including controls for uploading authorized price lists. 15. Require Office Depot to use the approved methodology governing price changes. 16. Require Office Depot to properly restrict the sale of items, as stated in its contract with the City. 17. Ensure that the contract accurately reflects the City s desired restrictions. If not, OCA should amend the contract. 18. Develop and implement monitoring controls to prevent and detect the purchase of blocked and restricted items. 19. Require Office Depot not to accept phone and fax orders. Responsible Agency OCA OCA OCA OCA OCA OCA OCA Response Concur. OCA addressed this issue in Contract Modification #1 submitted to Office Depot in September This will also be reflected in new contracts. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA is working with the Controller on monitoring procedures. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. C-4

53 Recommendation 20. Require Office Depot to comply with the contract s next-day delivery term. 21. Work with Office Depot to determine if there should be any exceptions to the next-day delivery requirement. Any agreed-upon changes should be reflected in a contract amendment. 22. Consult with the City Attorney to determine if Office Depot should reimburse the City for delivery charges on the restricted items that were sold. 23. Ensure that all contractual documents are consistent. OCA should record its explicit approval of the vendor s bid terms that conflict with the intent of the contract proposal. 24. Require vendors to provide periodic reports on spending trends, compliance with key contract terms, and authorized user lists. 25. Establish a comprehensive process to regularly monitor vendor compliance with key terms of the office supplies contract. 26. Ensure that departments are reconciling the items received with the items ordered. Responsible Agency OCA OCA OCA OCA OCA OCA OCA Response Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA addressed this issue in our letter to Office Depot. This will also be addressed in future contracts. Concur. OCA is in discussions with the City Attorney. Concur. OCA will address this issue in future contracts. Concur. OCA will implement additional reporting in future contracts. Concur. OCA will implement appropriate processes and procedures for future contracts. Partially concur. OCA and the Controller are developing auditing and invoice procedures for departments to follow under the new contract. Enforcement of the procedures will be part of post-audits. C-5

54 Recommendation 27. Ensure that the City s monthly office supply invoices are reconciled with departments records before payment is issued. 28. Establish procedures to verify the accuracy of prices charged for office supplies at least on a quarterly basis. 29. Ensure that Office Depot s systems reflect the correct levels of purchasing authority for all City employees and that orders cannot be placed without approval. 30. Consult with the Controller s Office to determine if permitting super-users to bypass contract restrictions is an acceptable practice. If so, work with the Controller s Office to ensure that mitigating controls exist to protect the City s interests. 31. Include in the contract the access rights and restrictions for each class of purchasers using the online ordering system. 32. Reassess the costs and benefits of having a fixed list of items and prices. Responsible Agency OCA OCA OCA OCA OCA OCA Response Partially concur. OCA and the Controller are developing auditing and invoice procedures for departments to follow under the new contract. Enforcement of the procedures will be part of post-audits. Concur. OCA will have quarterly business review meetings with the vendor of new contracts, where accuracy of prices charged for office supplies will be scrutinized in great detail. Partially concur. OCA s letter to Office Depot directed them to change super users to regular users. In the new contract, orders must be initiated by one person (the initiator) and approved by another (the approver). And those roles cannot be combined in one person. Concur. OCA and the Controller agree that super users should not be permitted to bypass contract restrictions. OCA s letter to Office Depot directed them to change super users to regular users. In future contracts all orders must be initiated by one person (the initiator) and approved by another (the approver). Those roles will not be combined in one person. Partially concur. OCA s letter to Office Depot directed them to change super users to regular users. In future contracts all orders must be initiated by one person (the initiator) and approved by another (the approver). Those roles will not be combined in one person. This will be addressed in future contracts. Concur. OCA will reassess before a new bid is issued. C-6

55 Recommendation 33. Require vendors to disclose the manufacturer s price list they reference for the bidding process and for any subsequent Section B revisions. 34. Regularly conduct sample tests to ensure that the list prices discounted on the vendor s invoices accurately correspond to the manufacturer s price list previously disclosed by the vendor. 35. Consider the costs and benefits of requiring bidders to reference a thirdparty price list in the bidding process. 36. Determine whether allowing price floors is in the City s best interest. If allowed, include a contract clause addressing criteria, frequency and reporting requirements for price floors, and require all vendors to disclose their price floors during the bidding process so that OCA can accurately compare bids. 37. Clarify the intent of the contract s Section B discount structure. Specifically, make clear whether Section B lists can be changed without notifying OCA. 38. Clearly and consistently define key terms such as list prices, restrictions, and price changes. Responsible Agency OCA OCA OCA OCA OCA OCA Response Concur. OCA will reassess before a new bid is issued. Concur. OCA will implement for future contracts. Concur. OCA will reassess before a new bid is issued. Concur. OCA will reassess before a new bid is issued. Concur. OCA addressed this issue in the Contract Modification #1 submitted to Office Depot in September This will also be addressed in future contracts. Concur. This will be part of the new contract. C-7

56 Recommendation 39. Evaluate the benefits of including additional provisions in the office supplies contract, such as restrictions on order amounts and requesting vendors to include volume discounts in their bids. 40. Establish policies and procedures to ensure that all contracts are reviewed for clear, consistent, and accurate terms. Responsible Agency OCA OCA Response Concur. OCA will reassess before a new bid is issued. Concur. Although OCA has a review system in place, we will provide more guidance and additional training to staff. C-8

57 APPENDIX D: Office Depot s October 27, 2009, Initial Response to the Draft Audit Report D-1

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61 D-5

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67 APPENDIX E: City Attorney and CSA Communications to Office Depot E-1

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69 E-3

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71 E-5

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75 APPENDIX F: Office Depot s December 4, 2009, Subsequent Response to the Draft Audit Report F-1

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78 F-4

79 APPENDIX G: CSA Notification of Revisions Made to the Draft Audit Report G-1

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81 APPENDIX H: CSA Rebuttal to Office Depot s Responses Dated October 27, 2009, and December 4, 2009 To provide clarity and perspective, the Controller s Office, City Services Auditor (CSA), is commenting on Office Depot s responses to the audit report concerning its contract with the City and County of San Francisco (City). After the release of the draft report, Office Depot provided additional information, including the 1 percent of the missing sales data that was not made available during fieldwork, which the auditors considered. The auditors maintain that the audit report findings and conclusion are accurate, and that Office Depot has overcharged the City at least $5.75 million. This is approximately $50,000 more than the total overcharges stated in the original draft report submitted to Office Depot and the Office of Contract Administration (OCA). The additional overcharges were calculated in the review of the missing records. Also, minor changes and edits have been made to some findings. CSA s Audit Processes To increase understanding of CSA s compliance with generally accepted government auditing standards (GAGAS), the chart below describes some of the steps taken to ensure the accuracy of facts, conclusions, and the reasonableness of contract interpretations, in the audit report: GAGAS Standard (Summary) Audit findings and conclusions must be impartial and supported by an objective evaluation of the information available to the auditors. See GAGAS 1.03, 2.05, 2.08, 2.10, 3.03, 3.33, 7.80(c). CSA s Compliance With GAGAS CSA s audit findings are based on transaction-level testing of Office Depot s billing data, the terms of the office supplies contract and amendments, and other appropriate and reliable documentation that was provided to the auditors by Office Depot, OCA, and other sources. During the course of the audit, the auditors communicated with the local Office Depot representatives who administered the City s contract, 1 in person, by , and by telephone to ensure that all documents, such as price lists, notifications, and other evidence pertinent to the audit were considered and reviewed. The audit report references pertinent statements made by the local Office Depot representatives who administered the City s contract. 1 Office Depot s local representatives who administered the City s office supplies contract include a San Francisco account manager II, a San Francisco senior district sales manager, the Northern California regional sales director, and a San Francisco global account manager. H-1

82 GAGAS Standard (Summary) CSA s Compliance With GAGAS The auditors considered all additional supporting evidence provided by Office Depot executive representatives 2 in response to the draft audit report. The auditors communicated with OCA regarding all evidence pertinent to the audit and the audit findings. The audit report documents where contract inconsistencies exist and that OCA did a poor job of monitoring the City s office supplies contract with Office Depot. OCA s weak administration of the contract does not relieve Office Depot of the responsibility to comply with the terms of the contract. The content of this report and all underlying supporting documentation underwent CSA s stringent review process to ensure that work performed supports the findings, conclusions, and recommendations. The audit report should contain a summary of the views of responsible officials. When the audited entity s comments are inconsistent or in conflict with the findings, the auditors should evaluate the validity of the comments and they should modify their report as necessary if the comments are valid and supported with sufficient and appropriate evidence. If the auditors disagree with the comments, they should explain in the report their reasons for disagreement. See GAGAS 8.08, 8.14, 8.32, 8.33, The draft report was sent to OCA and Office Depot on October 13, The auditors granted an additional 25 business days to Office Depot beyond the standard two-week response time and provided ample opportunity for Office Depot to present additional information supporting its response to the audit report. On November 23, 2009, the auditors met with Office Depot executive representatives to discuss Office Depot s concerns with the draft audit report. The auditors considered all comments and additional information provided by Office Depot executive representatives, and determined whether the additional information presented was sufficient and appropriate to change the report findings. The auditors changed the report findings when the evidence provided was sufficient and appropriate. Where the auditors determined the additional information provided was not sufficient and appropriate, the auditors noted their disagreement in this rebuttal. Office Depot s responses are included in the report as Appendices D and F. 2 Office Depot s executive representatives include the senior vice president of Office Depot in the Business Solutions Division, the senior director of finance in the Business Solutions Division, and a senior litigation counsel. H-2

83 GAGAS Standard (Summary) Auditors must obtain sufficient, appropriate evidence to provide a reasonable basis for their findings and conclusions. This can involve testing the reliability of the evidence, obtaining corroborating evidence to support testimonial evidence, and using professional judgment to determine the sufficiency and appropriateness of the evidence taken as a whole. See GAGAS , A7.03. CSA s Compliance With GAGAS The auditor s considered the comments made by Office Depot executive representatives in relation to the comments made during fieldwork by the local Office Depot representatives who administered the contract. In instances where the statements conflicted, the auditors considered if the Office Depot executive representatives provided sufficient, appropriate evidence to support their statements. In some instances, Office Depot executive representatives provided no evidence to support its statements, and in other instances they provided evidence which CSA determined not to be sufficient. In compliance with GAGAS 7.70b, the auditors did not change the majority of the report content because the additional information submitted by Office Depot failed to provide an adequate basis for modifying the report. Office Depot has expressed a concern that the City may have provided information about the contents of the Draft Report to third parties. It is CSA s policy not to disclose any information pertaining to an audit prior to publication. CSA has not publicly released any information regarding CSA s audit of the City s office supplies contract at any point during this audit. Below are CSA s responses to Office Depot s detailed comments. Missing Billing Records Based on the additional sales records provided by Office Depot after fieldwork ($185,759 in missing records), the auditors analyzed all records provided and conclude that an additional $44,657 in overcharges is due to the City. 3 The auditors have accordingly revised the report. See pages 4 and 7 of the report, and recommendation 3 on page 9. The total amount of overcharges has been changed to reflect the overcharges identified in the additional sales records. Total expenditures for the period from January 2005 through June 2009 were $18.3 million. The revised total amount owed to the City as a result of these additional overcharges is at least $5.75 million. Price Floors During the November 23, 2009, meeting with the auditors and in written responses, Office Depot executive representatives stated that Office Depot properly implemented price floors, as allowed by the contract. The auditors maintain that Office Depot inappropriately imposed price floors for Section B items and overcharged the City $1,310,053. To provide clarity, 3 The total of $44,657 is net additional overcharges (including the $12,000 in credits noted by Office Depot in its October 27, 2009, response). H-3

84 CSA has added a sentence to report finding 1.1 noting that the City s bid sheet did allow for price floors to be included in vendors bids (see page 8 of the report). The following points summarize why Office Depot s application of price floors was inappropriate: The contract bid instructions do allow for price floors to be included as part of the bid. As noted in report finding 4.2, the bid term regarding price floors is vague. Had Office Depot intended to use price floors, it should have included them as part of its bid and should have disclosed its use of price floors or its intent to apply them. At least one vendor who bid on the contract disclosed its intent to impose price floors. In response to a bid protest alleging that Office Depot won the contract because it had not disclosed its intended price floors, OCA requested that Office Depot clarify whether it included price floors or not. In response to OCA s inquiry, an Office Depot regional sales director confirmed that it had not used price floors in its bid (see Appendix A). The contract states that the Section B discounts shall remain in effect for the term of the contract. Price floors would effectively reduce the discount levels for Section B. Therefore, the auditors conclude that if vendors could implement undisclosed price floors after the bidding process, this practice would render the City s bidding process ineffective: vendors could state unreasonable discount levels during the bidding process to appear as the low bidder, and then, after being awarded the contract, reduce the discounts by imposing previously undisclosed price floors. The only communication OCA received from Office Depot regarding its application of price floors occurred in mid-2008, approximately three years after the contract began and one and a half years after Office Depot implemented the price floors. This consisted of Office Depot s response to a competitor s audit finding that Office Depot was overcharging the City. This was the same vendor that filed the bid protest against Office Depot in November 2004, claiming that Office Depot won the contract because it had not disclosed its intended price floors. During the audit fieldwork, the Office Depot local representatives who administered the City s contract informed CSA that price floors were imposed because new account representatives had assumed that floors had not been previously applied due to a modeling error. Office Depot s local representatives also told CSA that they applied the floors without having knowledge of the November 23, 2004, Office Depot letter clarifying that Office Depot did not utilize price floors in the price offering it submitted in its bid. After consultation with the City Attorney s Office, the auditors concluded, given the lack of formal notification of price floors from Office Depot during the bidding process or afterwards, price floors should not have been imposed. H-4

85 To gauge the effect of the price floors used by Office Depot, the auditors performed additional analysis using the price floor information provided by Office Depot s executive representatives on December 4, Exhibit 2 of the audit report shows the financial impact of the floors. o o Office Depot applied price floors to 74 percent of all Section B items included in the highest discount categories (70 percent, 71 percent, and 72 percent off list price). The highest discount categories account for 13 of the 16 Section B categories. Exhibit A shows that, according to the catalog data, Office Depot began applying price floors in July 2007 and that the majority of items sold to the City were subject to price floors after that date. A sample test 4 matching items with price floors to the original Section B bid items found that almost all (92 percent) bid items appeared to have been priced below Office Depot s cost. EXHIBIT A Catalog Items Listed and the Number of Items With Price Floors January 2005 to August 2009* *Note: The Office Depot catalogs cover the period through August 1, Source: Office Depot catalogs submitted by Office Depot executive representatives on December 4, The auditors used the approved Section B bid and Office Depot s price floors stated in the July 2007 catalog, adjusting for inflation. A total of 3,955 items with price floors matched items included in the approved Section B bid. Out of those 3,955 items, 92 percent appeared to have been bid below Office Depot s cost. H-5