The sweet scent of government reform is in the air in Washington. The problem of health care has been solved. A new financial reform scheme will prevent future market fluctuations and the scourge of downturns in the economy. On the agenda are saving the environment and solving the illegal immigration problem.
The enthusiasm for reform threatens to sweep over the Department of Defense. DoD uses basically two types of contracts when it procures goods, services or new weapons systems. One is firm, fixed price in which the government and the contractor agree on the price (depending on the duration of the effort there may be built in cost escalators) and on an award fee on top of that price. The other approach is called cost-plus contracts in which the contractor charges the government for the costs incurred, primarily material and labor — again with a fee on top of those costs. In fact DoD uses both kinds of contracts extensively. Fixed-price contracts are generally used when a fair and reasonable price can be established at the outset. The government pays the negotiated amount regardless of the contractor’s real cost. Cost-plus contracts are commonly used when there are enough uncertainties involved in contract performance to preclude using a fixed-price contract.
There is a push in Congress to require that all future contracts to develop new weapon systems be firm, fixed price. Advocates of this policy point to the rising costs associated with the second type of contract, cost plus. They claim that the contractors have no incentive to control costs when they are guaranteed to be reimbursed. They point to a long list of programs that have far exceeded their estimated costs and been delayed by years. The drive to reform the system has already affected near-term procurements. The Air Force will require the winner of the bid to build its new tanker aircraft to bid it as a firm, fixed price.
As is often the case with zealotry, advocates of reform could do harm both to their objective and to the object of their efforts — in this case the U.S. military. DoD has experience with firm, fixed-price contracts to develop new weapons systems. The now infamous A-12 Avenger carrier strike aircraft development contract was a fixed-price incentive contract. The program was cancelled after its costs spiraled and years were added to its duration. Litigation over the contract’s termination costs is still in federal court, nineteen years after the A-12 was cancelled. For a more recent example, how about the European A400 transport, being developed under a firm, fixed-price contract. It is years behind schedule and way over cost.
The reality is that firm, fixed price is the wrong way to go when DoD undertakes innovative new projects with untested or undeveloped technologies. Given the length of time between major procurements for weapon systems and the desire to incorporate the most advanced technologies, virtually all of them are highly risky. The idea of a firm, fixed-price contract might sound like a good idea, but it can lead to all-but inevitable failure or enormous cost escalation.
Find Archived Articles: