Analysts: Pentagon Could Save $100 Billion by Changing Business Practices

Only one issue is on the minds of defense leaders and industry executives these days: Looming budget cuts. But widespread panic over the coming spending reductions — known as sequestration — could be turned into an opportunity to tackle the obvious fat in the Pentagon’s budget, analysts suggest.
Based on interviews with 80 defense industry executives, a team of researchers concluded that 25 percent of the cost of what the Pentagon buys is attributed to “transaction” expenses. These include administrative and legal costs, expenses associated with negotiating contracts, monitoring purchases, making changes to documents and resolving disputes.
“Some transaction costs are necessary, but others can be lowered or eliminated,” says a study titled, "Cutting Fat without Cutting Substance,” which was published in theContract Management industry journal in May.
The Defense Department buys more than $400 billion annually in goods and services from the top 100 suppliers. That is $100 billion a year spent on transaction costs alone.
Studies that identify potential savings from procurement reforms are a dime a dozen in Washington, to be sure. Just in the past year, the House Armed Services Committee, the Lexington Institute and others havereleased their own estimates of the price of Pentagon red tape. Intestimony to the HASC last month, EADS North America CEO Sean O’Keefe said the cost of doing business with the government can add more than 20 percent to the price of goods. “The current regulatory load stunts competition and increases the cost of doing business,” O’Keefe said.
An industry executive who did not want to be quoted by name said the current budget crisis means the Pentagon can no longer afford to sweep these studies under the carpet. Even if acquisition transaction costs were conservatively estimated at 10 percent, that could amount to $40 billion in savings. “The sequestration catastrophe could be averted by cleaning up acquisition inefficiency alone,” he said. “It is crazy to be talking about cutting meat when so much low-hanging fruit exists.”
One of the authors of the “Cutting Fat” study, T. Russell Crook, said many of the Pentagon’s transaction costs could be eliminated rather easily if there were sufficient motivation for people to embrace change. “Inertia is a problem,” he said in an interview.
Crook, an associate professor of management at the College of Business Administration at The University of Tennessee, worked on the study under the auspices of the National Defense Business Institute, a Pentagon-funded organization within UT led by David Patterson, a former Defense Department official.
The 25 percent transaction cost estimate was based on insights provide by industry executives, said Crook. They cited four main cost drivers: Vague requirements, inflexible processes for modifying requirements, unnecessary reporting and compliance requirements and adversarial buyer-supplier relationships.
The executives’ recommendations on how to bring down those costs will sound familiar to most people in the government procurement business:
• Use “relational” contracting, where buyers and suppliers make long-term commitments that bolster trust and cooperation, rather than treating each contract as a one-time event.
• Where appropriate, monitor suppliers’ outcomes rather than their behavior. “The buyer focuses on ‘what’ and allows the supplier to decide ‘how,’” said Crook.
• Use “best value” they way it is done in the private sector, instead of just focusing on cost or speed.
• Retain knowledgeable workers who work with suppliers. “Turnover has the potential to create major performance problems within buyer- supplier relationships,” Crook said.
Crook recognized that it would be unrealistic to expect huge savings from these proposed reforms, given the Pentagons' track record.
Budget experts in recent years have cast doubts on projected "efficiencies" that defense officials promise but never materialize.
“Efficiencies historically have yielded only a small fraction of the projected savings,” Andrew Krepinevich, president of the Center for Strategic and Budgetary Assessments, told reporters. CSBA budget analyst Todd Harrison has said he tends to be suspicious of business reforms that promise big savings.
Retired Army Col. Nathaniel H. Sledge Jr., a former acquisition program manager, questioned whether any reforms could overcome the endemic inefficiency that is built into the defense procurement.
"There’s no real catalyst to force change," he wrote in arecent article in National Defense Magazine, unless the defense budget is cut deeply.
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Topics: Business Trends, Doing Business with the Government, Defense Contracting, Defense Department, DOD Budget, Procurement, Acquisition Reform, Defense Department