Pentagon Acquisition Chief Warns About Misuse of 'Fixed Price' Contracts

Pentagon buyers have been under pressure of late to stop the flow of red ink in Defense Department weapons systems.
One way to keep vendors from running up the tab is to use fixed-price contracts, particularly in purchases of equipment whose cost and complexity is predictable. But fixed-price contracts come in different varieties, and knowing what specific contract type makes the most sense for the government can be a challenge for Pentagon buyers, warns Undersecretary of Defense for Acquisition, Technology and Logistics Frank Kendall.
Kendall's latest policy guidance tells procurement officials to use "appropriate" contract types. "Unfortunately, sorting this out is not always easy," Kendall writes in the March-April 2013 issue of the Defense Acquisition University journal.
Kendall's rulebook, known as Better Buying Power, has been interpreted as a mandate to avoid "cost-plus" arrangements where the government agrees upfront to pay a vendor to design a product before it has determined its final price tag.
In the article, titled, "Use of Fixed-Price Incentive Firm Contracts in Development and Production," Kendall cautions buyers that there is no simple benchmark to select a contract type. "The choice of appropriate contract types is very 'situationally' dependent," he says.
Kendall suggests that even though fixed-price contracts do relieve the government from taking on all the risk in a program, if not used properly, such deals could backfire and lead to unneeded court battles.
"Fixed firm price development tends to create situations where neither the government nor the contractor has the flexibility needed to make adjustments as they learn more about what is feasible and affordable as well as what needs to be done to achieve a design that meets requirements," he says.
A fixed-price contract is basically a government “hands off” contract, he adds. "While we can get reports and track progress, we have very little flexibility to respond to cases where the contract requirements may be particularly difficult to achieve."
Shifting the risk to contractors should not be seen as the antidote to the Defense Department's poor track record in predicting costs, Kendall notes. The average EMD (engineering, manufacturing, development) program for a major defense acquisition over the last 20 years has overrun by nearly 30 percent. "Industry can only bear so much of that risk," he says. "It is unrealistic to believe contractors will simply accept large losses. They will not. ... Industry has a finite capacity to absorb that risk and knows how to hire lawyers to help it avoid large losses."
In most cases, says Kendall, there needs to be a "fair sharing" of the risk and rewards of performance. "For good reasons, I am conservative about the use of fixed-price development, but it is appropriate in some cases."
Kendall’s admonition follows anavalanche of complaints by defense industry about policies that treat contractors as convenient scapegoats for the Pentagon weapons programs’ massive cost overruns.
“The government rarely knows what it wants with sufficient specificity to support reasonable fixed prices for evolving, complex or sophisticated products to be delivered years later,” charges John Chierichella, a government contracting attorney at the law firm of Sheppard, Mullin, Richter & Hampton LLP.
He predicts the “latest federal fascination with fixed prices will end like the others — badly — with delayed fielding of the products, contractors deeply damaged by inadequate cash flow, increased claims and litigation, and focused “bail outs” in which the government decides which of the wounded contractors deserves triage.”
A shift toward fixed-price contract began during the second half of President Obama's first term. Pentagon officials had become increasingly frustrated as too many programs got started and “we find out later on that they were unaffordable,”Kendall says in a February 2012 speech. He cites fixed-price contracting as one of several contracting trends that are embraced and rejected in cycles. In the past two decades, he says, “We have been for-or-against for-or-against fixed price contracting four or five times."
Photo Credit: Defense Dept.

Topics: Defense Contracting, Defense Department, DOD Leadership, DOD Policy, Procurement, Acquisition Reform