Focusing on Cost Is Not the Answer

By Scott Trail
For decades, defense acquisition reforms have aimed to reduce the cost of equipping our nation’s defenders. Unfortunately, none of these reforms has produced the kind of reductions envisioned by their originators.

A case could be made that cost-focused acquisition reform has actually increased costs rather than reduced them. Instead of focusing on cost, the acquisition system would be better improved by focusing on incentives, culture and mechanisms.

The counterproductive impact of a cost-focused approach starts at program inception. In order to receive funding for a new program, each service competes with the other. They are incentivized to maintain a competitive appearance against other programs by minimizing cost and maximizing performance. Program baselines are established based on these optimistic assumptions, which lead to overruns.

When faced with a funding shortfall, unplanned and inefficient adjustments are made such as shifting funding between programs, deferring work and associated costs into the future, or cutting procurement quantities. This practice of underestimating costs and compensating with shortsighted adjustments feeds a spiral of ever increasing growth.

The incentive to underestimate cost is further exacerbated during times of decreased funding, as the Defense Department is experiencing now. As funding levels decrease, the competition for funding and the incentive to underestimate program costs increases.

This relationship is supported by a 2014 Institute for Defense Analyses study which found program acquisition unit cost (PAUC) growth was three to five times higher during times of limited funding than during times of plentiful funding.  Interestingly, the study found no correlation between PAUC growth and periods of reform or process changes. This finding suggests that incentives to match cost to the funding available trumps attempts to improve the process.

Another cost-focused method is targeting profit. Targeting profit results in consolidation, selecting companies based on cost alone instead of value, reduced internal research funding and serves as a barrier to leveraging commercial items.

While the perception exists that defense contractors command lucrative profits, a 2012 Deloitte study found otherwise. The study showed the aerospace and defense industry had a profit margin of 10.5 percent compared to 18.2 percent for all other industries. With comparatively low profit margins, defense contractors are forced to consolidate to attract investors. This is exactly what has happened in the defense industry over the past several decades. In 1940 there were 16 fixed-wing aircraft manufacturers, in the 1990s there were eight, today there are three. When F-18, F-15, and F-16 lines cease production, there may be only one U.S. company actively producing advanced fixed-wing fighter aircraft. 

Profit is also a company’s source of internal research-and-development funding. In targeting profit, the department reduces both the amount of IRAD as well as the incentive to invest in defense systems. Even the world’s largest defense contractor, Lockheed Martin, is investing internal research funding in such non-defense enterprises as energy generation and fish farming. These are industry research dollars that could be used to develop defense systems. Instead, the focus on limiting profit has helped compel the Defense Department to bear the costs of research and development alone.

Finally, the cost focus via profit also decreases the quality of goods and services contracted by the Defense Department. In order to reduce cost, programs have turned to selecting contractors based on lowest price, technically acceptable criteria. This approach awards contracts to companies that meet the minimum technical requirement at the lowest cost. Little or no consideration is given to the quality of the company, quality of the service or the value of paying a modestly higher price for higher quality, capability or flexibility.

As a result, high quality contractors choose not to bid, reducing both the quantity and quality of bidders. The products and services provided under such contracts are often inflexible and low value. The focus on cost frequently results in substandard outcomes, rework, delays and ultimately a higher cost to the program.

Beyond profit, the focus on cost has driven a process oriented culture which takes uneven interpretations of existing regulations, often going beyond the law’s implied or stated intent. This focus has created a culture of “no” in which defense acquisition personnel are incentivized to stop the process rather than facilitate the process.

Interpretations of what constitutes a commercial item and ever increasing demands for supplier cost and pricing data prevent the Defense Department from leveraging the commercial market. Conservative interpretations of the more than 2,000 pages in the Federal Acquisition Regulation and Defense Federal Acquisition Regulations System in the name of saving taxpayer dollars incurs a cost in itself, which may more than offset what, if any, savings are gained from focusing on strict compliance.

Focusing on cost also contributes to counterproductive activities when applied to restructuring an organization. In 2013, Defense Secretary Chuck Hagel announced an across-the-board 20 percent budget cut to all military staff headquarters commands. While the Pentagon is ripe for reorganization, a one-size-fits-all approach could exacerbate existing inefficiencies by cutting staff performing critical tasks, while not cutting other, inefficient staff enough. Practices, such as cutting back on support staff and narrowly focusing on contract costs, create increased inefficiencies and poor program outcomes.

Instead, the focus should be on fully understanding the incentives, culture and mechanisms that drive cost. Once those are understood, the department can focus on improving acquisition outcomes. This requires a much different focus than the current practice of reducing personnel or the price of a contract.

Starting at the inception of a program, the focus should be on accurate program estimates rather than focusing on making the cost estimate fit into the existing budget. Reasonable cost and schedule estimates with funding available to execute the program, sustainment cost estimates, and technology demonstration are all certification requirements under Title 10 of U.S. law for major acquisition programs.

Yet, the department continues to waive certification requirements for major programs at the start of their development. Adherence to these certification requirements will reduce cost and schedule overruns, but will likely increase the up-front cost of a program. However, providing adequate resources will likely pay long-term dividends as the incentive for engaging in counterproductive, short-sighted and costly program adjustments will recede.

Once a program is started, cost can be reduced by providing incentives in contracts that increase profit rather than focus on minimizing profits.  Contracts constructed to be mutually beneficial to both the Defense Department and industry provide the incentives to improve program outcomes. These include multi-year contracts, performance-based logistics contracts and incentive-type contracts, which provide potential for increased profit margin for lower costs, early delivery or increased performance.

Shifting the focus away from reducing cost via profit and toward contracts constructed around mutually beneficial incentives will improve program performance and consequently reduce program cost.

In addition to providing the right incentives, contracts should also shift focus from cost to value.  While lowest price, technically acceptable contracts may be appropriate when quality is not a primary factor, the majority of defense acquisition contracts do not fall into this category. Shifting the focus from cost alone to value will require taking into account the intangibles, which drive value. Examples include quality of the product, service and company’s past performance as well as performance above the minimum acceptable level. Focusing on the contract that provides the greatest value will result in more bids, better performance for dollars spent and a greater likelihood that the contract will be executed satisfactorily the first time.

Increasing government efficiency would also produce better performance per dollar spent. One way to increase efficiency would be to change the focus from strict regulatory compliance to a solution-focused culture. This culture exists in special operations programs that embrace problem solving rather than strict policy compliance.

Focusing on the best solution within the already complex regulatory structure would encourage exercising the flexibility available in the system, reducing contracting timelines and improving responsiveness to program changes. It would facilitate communication between industry and the Defense Department in the earliest stages of the program, which is critical for gaining a common understanding of program expectations.

Focusing on the solution rather than strict compliance would also lower barriers to leveraging commercial technology, thereby lowering cost and speeding commercial innovations to the war fighter. 

Speed is similarly inhibited by the personnel structure of the military services and the Defense Department. While recent attempts at personnel reductions focused on across-the-board staff cuts, a more effective method of restructuring would be to focus on making the Pentagon more efficient. Consolidating business units, removing communication barriers between program managers and program executive officers, and streamlining the document staffing process would all create efficiencies. Focusing on these strategic goals rather than simply cutting staff would reduce redundancies, shorten the decision making cycle, and accelerate the approval cycle for requirements and funding. 

Fundamentals such as using contract incentives, determining best value, leveraging commercial technology and eliminating unproductive process and bureaucracy are all tenants of Undersecretary of Defense for Acquisition Technology and Logistics Frank Kendall’s Better Buying Power 3.0. Some of its aspects of are being incorporated into defense acquisition, but there remain many that are not being embraced.

Greater incorporation of the Better Buying Power initiatives has the potential to reduce cost by focusing on better practices. This can be achieved by placing greater emphasis on reasonable program estimates and face-to-face communication from senior Pentagon leadership to acquisition personnel.

Title 10 already requires that reasonable program estimates be submitted, but given the nature of the acquisition system, unreasonable estimates are allowed to go forward.

The check against unrealistic program estimates lies with the cost assessment and program evaluation office. Not approving program estimates that are unrealistic would significantly reduce the incentive to underestimate costs and overestimate performance. In the short term, it would likely reduce the number of programs that were started.

In the longer term, once the portfolio of defense programs stabilized at a sustainable level, more programs could be afforded as overruns would be reduced but not eliminated, providing increased funding for additional programs. In this way, a disciplined approach to following the laws and processes already in place would yield positive results.

Communication is another way senior Pentagon leadership can achieve positive results. In order to inculcate the change desired across the enterprise, face-to-face communication with the people executing the defense acquisition process is required.

Unfiltered forums of senior acquisition executives would cut through the morass of staff, enabling an honest discussion about the challenges they face and direction they should take.

Secretary of Defense Ash Carter set a precedent during his first week in office during a PowerPoint free war council meeting in Kuwait. Similarly, Kendall has traveled to conduct town hall meetings with acquisition professionals. Building on this direct communication will help facilitate the culture change needed to improve acquisition outcomes.

Lt. Col. Scott Trail is a Marine Corps helicopter pilot, served two tours as an MV-22 Osprey developmental test pilot and was selected for the Acquisition Management Professional MOS in the V-22 Joint Program Office.  He is a fellow with the Secretary of Defense Corporate Fellows Program assigned to Sikorsky in Connecticut.

Topics: Procurement, Acquisition Reform

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