Though the PCO has stated that the requirements are still needed, PCO and ACO feel shipping in delinquent is alright to show performance. How is this fair and reasonable to the government that the items (whether surplus or not) are over 2-3yrs late? Further aren't the pre-award teams suppose to go back to review the performance prior to issuance of new orders? In a situation like this wouldn't it be advantageous to utilize Market Research to determine a new supplier? Lastly is there any other course of action?
Contracts with sole source providers can give rise to contract performance issues that are not amenable to easy solutions. As long as the item still is necessary to the mission, termination for default (or termination for cause in commercial situations) is often not a suitable solution. Working with the contractor may be the best option in a bad situation. Modifying the contract (with consideration on both sides) is often called for. In your situation it seems as though a review is underway to verify the rationale for a modification.
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You also asked whether Market Research should be utilized. The FAR requires market research appropriate to the circumstances (FAR 10.001(a)(2)). In sole source circumstances ongoing market research helps early identification of new entrants offering competition and/or new products that can substitute for the item provide solely by one source.
It sounds as though there is communication among the team on a regular basis and that the necessary people are aware of the situation. The FAR speaks to the requirement for the team to exercise good business judgment (FAR 1.102-4) and a sole-source scenario such as you are describing can require the type of time-consuming assessment of the facts and potential courses of action in order to work with the contractor to deliver the necessary supplies in order to meet the mission.