National Defense > Blog > Posts > Shift to fixed-price weapons contracts: Smart acquisition reform or recipe for more failure?

1/5/2010

Shift to fixed-price weapons contracts: Smart  acquisition reform or recipe for more failure?
One of the Obama administration’s linchpin initiatives to rein in the cost of weapons systems is coming under heavy criticism by industry experts who claim these new measures are ignoring lessons from past failed military programs. Industry consultants and lawyers specifically object to new federal guidelines that require agencies to covert research-and-development contracts from cost-reimbursement to fixed-price contracts.

Under a cost-reimbursement contract, also known as “cost-plus,” a contractor is paid for allowed expenses to a set limit plus an additional payment to cover a profit margin. In a fixed-price contract, the government pays a negotiated amount regardless of incurred expenses.
A torrent of “haven’t we learned the lessons of history?” proclamations followed the release of new procurement guidelines by the Office of Management and Budget last year. OMB called for all federal agencies to reduce “high risk” contracting, which implies that the government should shift the risk to industry by opting for fixed-price contracts. That is the theory. But in practice, military fixed-price R&D contracts have resulted in notorious flops and ultimately have led to billions of wasted taxpayer dollars, critics contend.

A case in point is Europe’s A400M cargo aircraft -- purchased by seven NATO countries from the European Aeronautic Defense & Space Co. under a fixed price contract. EADS agreed to build 180 aircraft for about $30 billion. The company would swallow any cost overruns.
Now the project is several billion over budget and EADS wants the seven governments to share the burden, reports the Wall Street Journal. The two sides are trying to work out a compromise and the project’s future is up in the air.

The administration’s directive to shift to fixed-price contracts seeks to protect the government from excessive billing by contractors and from bearing the financial brunt when high-tech projects fail. The policy, however, “ignores history,” says former Pentagon acquisition chief Jacques Gansler. He believes this is a shortsighted move that only creates incentives for contractors to bid low and after winning, try to maximize changes in the program as technology or threats evolve.
A veteran defense industry lawyer who requested anonymity put it bluntly: “The administration seems bent on repeating the idiotic attempts to convert highly risky RDT&E to fixed price -- an effort that has failed distinctly on at least five occasions in the 50 years of my experience.” The “change-to-fixed-price-contracts canard has been proposed by every administration since the McNamara era.”
He cites as a “shining example” of why fixed-price contracts usually are a bad idea the Navy’s A-12 bomber, which is entering its 19th year of litigation over who should bear financial responsibility after the Pentagon canceled it in 1991. Insiders will recall that following the A-12 fiasco, the pendulum began to swing in favor of cost-plus contracts.

Robert Burton, an industry consultant and former deputy administrator for procurement policy at OMB, also cites the Air Force C-17 cargo aircraft as proof that fixed-price contracts tend to go awry when used in programs that require significant R&D customization. The C-17 price went from $125 million to $250 million. “That doesn’t sound like fixed price,” Burton says. “Moving to fixed price contracts to address current problems is not the way to go.”

The Air Force is asking for similar troubles by acquiring up to 179 new KC-X tankers under a fixed-price deal, Burton says. The premise in this $40 billion program is that the tanker is a technically low-risk system that is derived from commercially available aircraft. The Air Force is de-emphasizing the complex technology that would be required to turn a commercial jetliner into a sophisticated military refueling tanker and instead is more interested in seeking a low-cost bid, Burton says. “The emphasis is clearly on low cost,” he says. “The whole effort was to modernize the fleet. What we have on the table is a draft RFP (request for proposals) that could arguably result in a tanker that is less capable than the current one,” says Burton.

“Contractors have a tendency to minimize risk. And this is a fixed-price contract for 18 years. Contractors will want to protect themselves against unknown risks for 18 years” so they will likely avoid using advanced technology that might expose them to higher costs, he says. “I think the RFP suggests we’re not making much progress in acquisition reform in the Defense Department.” Some analysts have suggested that an 18-year fixed price deal favors Boeing, which would explain why its competitor, Northrop Grumman, has objected to the way the RFP was written. Northrop CEO Wes Bush wrote in a letter to Pentagon acquisition chief Ashton Carter that the terms of the RFP would create “contractual and financial burdens on the company that we simply cannot accept.”

Defense industry analyst James Hasik says that he cannot think of another example of a similarly durable fixed-price contract. “It’s almost inconceivable,” he writes in his blog.

Gansler says there are ways to achieve a “middle ground” between fixed price and cost-plus by awarding “incentive fees” with pre-established ceilings to incentivize contractors to take technical risks without fearing financial losses. “The award fee works if used properly,” says Gansler. “But we haven’t been using it properly. We reward people who overrun and run late.” The Navy’s littoral combat ship is another case where fixed-price development may backfire, says Gansler. “LCS has 75 changes a week. … With 75 changes a week, who’s going to take the risk? A contractor will bid high under those conditions. But you can’t mandate that no changes be made. The world changes; the budget changes. What’s the meaning of fixed price with 75 changes a week?”

Brett Lambert, the Defense Department’s director of industrial policy, says that there is much misconception and confusion about how the Pentagon will implement fixed-price contracts. “Fixed-price contracting is only going to be applied in a rare number of instances when we have locked in requirements, we understand the requirements, and we know we’re not going to change them,” he says. “It’s really about risk sharing. Industry is on board when it’s described that way. They’re good at doing what we tell them to do … We want to reach an acceptable level where we can accept some risk.”
 
In addition to the KC-X tanker, the Air Force “small diameter bomb” has also been converted to a fixed price development.
Posted at 9:30 AM by Sandra Erwin | Permalink | Email this Post | Comments (0)

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