Pentagon acquisition chief Ashton Carter is continuing his drive to improve the efficiency of buying weapons systems and services. On November 3 he published a memorandum to provide specific implementation guidance directed at achieving better buying power through greater efficiency and productivity in defense spending. This implementing memorandum orders the Department of Defense to take a number of bold, even radical, steps to make defense acquisitions more affordable, reduce acquisition costs, incentivize productivity and innovation, improve competition, enhance the way the Pentagon contracts for services and reduce bureaucracy. Fully implementing this guidance across the thousands of contracts, and hundreds of acquisition programs is the basis for a revolution in defense acquisition.
One of the most important proposed changes is to establish an affordability target as a key performance parameter for every program at Acquisition Milestone A. At Acquisition Milestone B an affordability requirement will be established not only for production costs but operating and support, as well. In addition, a “should cost” target will be established for all ACAT I programs. The Under Secretary’s memorandum directs that the notional should-cost figure will be based on “sound estimating techniques that are based on bottom-up assessments of what programs should cost, if reasonable efficiency and productivity enhancing efforts are undertaken.” The memorandum also orders the military services to establish and hold to economical production rates. The importance of these measures is that they force the services to address their unending appetite for capabilities and the tendency (mirrored by the Congress) to continually alter production quantities while feigning surprise at the resulting program cost growth.
The memorandum seeks to fundamentally change the nature of defense contracting. For example, it directs the expanded use of so-called Fixed-Price Incentive Firm Target (FPIF) contracts. A fixed-price incentive contract contains a target cost, a target profit, a price ceiling, and a formula by which the contractor and the defense department will share any differences between target costs and actual final costs, as negotiated. The formula rewards you with more profit if final costs are less than the target cost, and it takes profit away if final costs exceed the target. Initially, the Under Secretary calls for a 50/50 sharing of savings and cost overruns and a target ceiling for cost growth of 120 percent.
The problem with the fixed price approach is that the defense industry is subject to unique market forces that make projecting expected costs a very dicey business. If Congress implements Buy America provisions for defense contracts, the cost of specialty metals can skyrocket, imposing unacceptable costs on contractors. Moreover, while the government has deep pockets with which to cover unanticipated cost growth, most defense companies do not. A single major spike in a program cost could drive a company into bankruptcy.
Elsewhere in the same memorandum the services are directed to increase competition by aggressively seeking out prospective bidders and encouraging small businesses to participate in larger contract efforts, conducting more frequent re-competes for knowledge-based service contracts (and limiting the term of such contracts to three years) and restricting the use of time and material or award fee contract in favor of Cost-Plus contracts.
These measures are likely to add to the costs of doing business with the government without producing any significant improvement in efficiency or expenditures. Increasing the frequency of re-competes does not mean improvements in performance or costs, except to increase the costs to contractors. Many defense contracts, particularly in logistics, sustainment and support can be highly varied in demands, tempo and costs. Their costs depend greatly on the demands imposed by the military, often in the midst of hostilities.
The Under Secretary should be applauded for his efforts to establish a more rational basis for acquiring defense systems and services. At the same time, however, he must recognize that the defense industrial base is unlike any other, primarily because of its relationship to the customer and its commitment to do whatever is required — short of bankruptcy — to support that customer. This industry is unlike the computer or commercial electronics industrial bases. So ideas like “should costs” and FPIF contracting should be approached with great care.
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