Budget Crunch Spurs Contracting Reforms in Air Force Programs

FORT WALTON BEACH, Fla. — U.S. Air Force weapon buyers are asking suppliers to be more “transparent” in how they price weapons systems and to reduce overhead expenses that are billed to the government.
Recent audits of Air Force programs have revealed that “sometimes we were paying more than we should have,” said Maj. Gen. Wendy M. Masiello, Air Force deputy assistant secretary for contracting.
One of the reasons why some projects have drawn attention is excessive contractor profits, Masiello said Oct. 4 at the 37th Air Armaments Symposium here, hosted by the Gulf Coast Chapter of the National Defense Industrial Association. In several programs, said Masiello, “Our industry partners in fact were paid a lot more profit than we had anticipated.”
She cautioned that these are isolated cases, and that the problem is not widespread across Air Force programs. But the discovery of “small pockets” of contracts where companies were paid double-digit profit margins have stirred enough concern to cause “us to keep digging in” and “keep asking questions,” she said.
During flush times, contractor profits are less scrutinized, but now that funding for weapons programs is expected to decline, there will be less tolerance for high profits and for questionable expenses billed to the U.S. government, Masiello said.
New methods are now in place to estimate “performance-based payments,” she said. Some contractors may see reduced profits and less cash flow. “In some cases we were floating cash to contractors before we got anything delivered … in some cases, before our contractors had paid anything out,” said Masiello. “There is lots of attention on that.”
Air Force acquisitions managers also are expected to use more fixed-price incentive contracts to keep prices down. That is easier said than done, however, Masiello said. Most program officials are more comfortable issuing cost-plus awards, in which contractors are reimbursed for expenses plus a pre-negotiated fee. As part of a broader effort to cut costs, the Defense Department is now requiring military program managers to use  fixed-price contracts for projects that use mature technologies.
“Cost plus award fee, that’s what everybody does. that’s what we know,” said Masiello. “We are being challenged now to look at every one of our acquisitions in a way that makes sense,” she said. “We need to truly use different contract types. Not only is it a challenge for the contracting team to create these new contracting documents” but it is also a challenge for industry, she noted. “Let’s use the right contract type for the right circumstance in our acquisition programs.”
In addition to adopting new contracting methods, military procurement officials, too, are expected to more closely oversee their suppliers. “We have some additional contractor review responsibilities,” Masiello said. All contracts exceeding $500 million now require “new sets of eyes,” she said. The extra oversight, Masiello acknowledged, has stretched out the length of some programs.
As government officials heave stepped up oversight, they have noticed that one of the biggest contributors to rising price tags for weapon systems are the large staffs associated with programs, Masiello said. Both industry and government will have to be more judicious, she added. “As we dig into the cost of some of our contractors, we found that there’s a tendency to have a standing army of people waiting around, just in case,” she said. “That’s not just contractors. We as a government are also taking a look at that.”
Masiello also warned suppliers that frivolous spending will be frowned upon. “We need our contractors to look at their overhead. When we were cost-plus award fee, there was a tendency to make everything really nice. I remember times when I would go in to visit our industry partners, and they'd have very nice places. Guess what? I’m paying for that.”
Companies need to rethink whether they should be furnishing their offices with plush carpeting and leather couches if those amenities end up driving up the price of a weapon system, Masiello said. “This is the time when we have to tighten up, and clean up our overhead structures. I can’t keep buying stuff at the prices I paid in the past.”
A decade of rising Pentagon budgets has created a “culture of excess,” she said. “We’ve been very comfortable. We’ve been very fortunate to get the dollars we have [for our programs].. But we need to clean up all the excess cost.”
Several industry executives attending the Air Armaments Symposium said that they want to help the Air Force bring costs down, but they worry about growing mistrust and frayed relations between customers and suppliers. Military officials often refer to their suppliers as “partners,” but increasingly,  that partnership has deteriorated, said one industry representative during a question-and-answer session. “From an industry standpoint, we don’t feel like partners right now. We don’t feel as if we’re being treated as partners,” the executive told Masiello. “We feel as if we’ve got a target on our chest” and are being blamed for the bloat in military programs. “How can we get back to the way it was 10 or 15 years ago when we used to work issues together?” he asked.
Masiello responded that the best way to repair the relationship is for vendors to be “more transparent in the way you do business.” When companies have long-term contracts, for instance, they “get smart very quickly” and find ways to charge more money, she said. “ In today’s environment, we can’t do that.” She insisted that the government still wants industry to make a profit. “I believe you’re entitled to a fair profit. But on occasion we run across profit numbers in the double digits that start with a two, and sometimes a three,” she said. “You need to help me. I can’t pay 20 to 30 percent profit. If we can work together to enable a reasonable profit, let’s talk about it.”
Air Force Maj. Gen. Kenneth D. Merchant, commander of the Air Armaments Center at Eglin Air Force Base and program executive officer for weapons, struck a similar note in an earlier speech. In the face of budget cuts, he said, contractors should consider laying off employees to help lower program costs. “If there is an opportunity for you to shed some work force, let’s approach that,” he said. “If we need to make a contract adjustment, we can make an adjustment.”
The goal, he said, is not only to trim cost out of programs but also to help contractors weather the coming downturn, he said. “I want us both to be successful.” If profits are squeezed, industry will cease to invest in research and development, said Merchant. “We need that IRAD [independent research and development] to keep bringing us new ideas,” he said. “We need you to make money.”
In remarks at the conference Oct. 5, Lt. Gen. Herbert J. "Hawk" Carlisle, Air Force deputy chief of staff for operations, plans and requirements, told industry representatives that coping with the coming budget crunch demands team play. “We have to figure out how to work through the uncertainty,” he said. “We’re in this together, we cannot do this without you.”
Some military equipment buyers worry that declining budgets will hurt technological innovation. It shouldn’t be so, said James F. Geurts, deputy director of the Special Operations Research, Development and Acquisition Center at U.S. Special Operations Command, MacDill Air Force Base, Fla.
In a presentation at the conference, Geurts suggested that frugality can be a good thing. “I kind of like this ‘getting back to basics’ with the budget,” he said. “It’s forcing us to go back and really focus on what the priorities are, and to get more effective.” SOCOM typically keeps weapon costs down by working with small businesses, which generally charge lower overhead costs than large companies, he said. “I love small businesses,” Geurts said. “They do great stuff for us.”
He cautioned that in times of spending downturns, the temptation is to hunker down and avoid taking chances on new technology. “I’m worried that as we get into this budget crunch, the reaction is to be to get risk averse, get more process centralization, push up decision making,” he said. “That’s probably the worst thing you can do for innovation and getting stuff to the battlefield faster.”

Topics: Business Trends, Doing Business with the Government, Partnering, Defense Contracting