Pentagon Moves to Price-Based Procurement to Attract Vendors

The Defense Department's acquisition chief, Jacques S. Gansler, wants to lure the world's top-notch commercial companies. The Pentagon should establish closer business ties with these companies, he says, because it needs them to develop and produce the technologies of the future battlefield.

Another reason for seeking a strong commercial vendor base is the need to cut costs. The Pentagon is confronting a $30 billion a year gap between its spending plan and its acquisition wish list. Unless prices come down, that wish list may never come to fruition.

Gansler believes the answer partly lies in what he calls a "civilian/military industrial integration." He wants the state-of-the-art technologies from commercial industries without having to pay the premium the Pentagon currently incurs as a result of the elaborate oversight and cost-accounting system imposed on defense contractors.

Commercial Industry
"We seek a greatly expanded partnership with a revived and prospering commercial industry-not a partnership in which we become simply the pawns of commercial products and processes, but a dynamic and vigorous engagement that, through research and development, creates technically advanced products and systems with common applications that, through use of flexible manufacturing, allows production of defense-unique items on the same lines with high-volume commercial items," Gansler explained to a congressional panel.

He cites TRW's production of military-unique circuit boards for the Air Force's F-22 fighter aircraft and the Army's Comanche helicopter on the same production line as its high volume commercial electronics products. "This has resulted in 30-50 percent savings and a product that actually exceeds our requirement for operating in a high temperature environment," relates Gansler.

The largest obstacle in the way of the civilian/military integration are the "antiquated defense-unique requirements that discourage world-class companies from doing business with the Department of Defense," he told an industry and government audience at a conference sponsored by the Center for Naval Analysis CNA), Alexandria, Virginia.

The accounting paperwork requirements and layers of oversight bureaucracy were instituted to prevent fraud and abuse by contractors. But the Pentagon is now feeling the weight of its own regulatory machine because it is adding million of dollars to the price tags of its weapon systems.

As long as the Defense Department is required to reimburse contractors for their costs, massive auditing will be needed to ensure the government is not being over-charged. But Gansler believes that many items could be purchased under commercial arrangements whereby the customer and supplier agree on a price in advance. This would save the expenses associated with the cost accounting and the inspections of contractor facilities.

"Price-based acquisition must become the norm, with cost-based acquisition the rare exception," Gansler asserted at the CNA gathering.

Price-Based Acquisition
Last October, Gansler directed a study group to "analyze implementation of a price-based acquisition system on a department-wide basis." He expects a final report from the group by March 1.

Price-based acquisition is the "establishment of contractual relationships using price instead of cost. Price may be established by comparisons to prices of other offers, market prices, competitive alternatives ... Price-based acquisition is a well established approach in the commercial world," Gansler wrote in a memorandum to the study group.

As the group probes various approaches to price-based acquisition, it will aim for cost savings but, more importantly, for "access to markets that are now unavailable to us," said William Stussie, the group's leader, who also is the Navy's deputy assistant secretary for air programs.

Many of the companies the Pentagon wants to buy from only sell under commercial arrangements, based on price only, and refuse to conform to the Defense Department's demands for internal cost data, Stussie told National Defense.

He conceded, however, that price-based acquisition often conjures memories of the 1980s fiascoes involving fixed-price defense contracts-the most famous of which was the Navy's failed A-12 aircraft development program.

The study group, however, has not made any judgments as to whether price-based contracting necessarily equals fixed-price deals. The solution could be "somewhere in between," Stussie said, but cautioned that it's still too early to jump to conclusions.

Because the Defense Department buys military-unique items that have no market in the civilian world, Gansler wants also to establish alternative procurement strategies-which would particularly apply to high-risk advanced technology projects. An example would be an "incremental acquisition," where the contractor would use off-the-shelf components as much as possible, but a price would be negotiated for the military-unique components.

The customer and the supplier would not only negotiate a price but also incentive fees or awards based on performance.

Hybrid Contracts
Stussie's group has discussed options such as hybrid contracts with both cost-based and price-based segments. Only the military-unique add-ons would be cost-based contracts.

The reforms proposed by Gansler seek, on the one hand, to bolster cost-cutting efforts. On the other hand, they are aimed at expanding the Pentagon's base of industrial suppliers, many of which are exiting the defense market because it burdens contractors with regulations.

"More companies will walk away from defense if there are not commercial practices being adopted," said John W. Douglass, president of the Aerospace Industries Association, Washington, D.C. In a recent briefing to reporters, he said he worries that the government is alienating commercial industries.

"We are worried about the relationship between the government and industry ... We want a partnership that is friendly to industry," Douglass said.

Companies often don't want to do business with the Defense Department because of excessive oversight and the risk of being prosecuted under the federal False Claims Act if they fail to provide the required cost data, explains an industry source who requested anonymity. As far as industry is concerned, said the source, "we don't know what it [price-based acquisition] means yet."

Gansler envisions a supplier base founded on "modern, flexible manufacturing-of differing products on a common production line." To achieve this, he told a congressional panel, "We must reduce or eliminate, where practical, those unique terms and conditions (including unique cost-accounting systems) we previously established for doing business with the government. This will not only improve the Department's ability to get goods and services faster, better, and cheaper, but will also help our domestic industrial market compete in the global arena.

"He offered examples of how shifting to commercial practices saves money. The Defense Logistics Agency (DLA) has used commercial buying practices and purchased high-quality commercial items-instead of military-standard items-which, from a sample of more than $190 million worth of items, resulted in savings of more than 20 percent in medical supplies, and 22 percent in clothing and textiles, Gansler explained.

Using commercial business practices during the past five years, the DLA wholesale inventory alone was reduced $721 million; a 30 percent savings. According to Gansler, "This shows the dramatic savings that can result when we adapt commercial practices to our military requirements. These practices must become widespread."

On the government side, less oversight on contractors would mean fewer employees on the payroll-a boon for agencies that must downsize to meet mandated work force cuts.

"Gansler wants the Motorolas of the world" to bring the cutting-edge technology to the Pentagon, says the industry source. "He wants to buy commercial commodities and tap into someone else's assembly line."ND

Topics: Budget, Procurement