Kendall: Pentagon Struggles to Determine ‘Fair’ Prices for Commercial Items

By Sandra I. Erwin

Defense procurement chief Frank Kendall is caught between a rock and a hard place. He faces pressures to ease contracting rules that discourage commercial tech firms from doing business with the Pentagon. At the same time, he must placate lawmakers’ and regulators’ concerns about contractor price gouging.

“We try to strike the right balance,” Kendall said.

The challenge for Kendall is to ensure the government is being charged fair market prices for commercial products without necessarily subjecting vendors to intrusive audits and costly red tape.

“Commercial practices and purchasing are a continuing subject of discussion,” Kendall said Sept. 2 during a lunch meeting hosted by the Professional Services Council.

The issue of how to balance the Pentagon’s desire to attract innovative commercial suppliers against the need to exert proper oversight of contractors is a tough one for Kendall, he recognized. “The DoD inspector general expects me to ensure fair pricing,” he said.Defense contractors, meanwhile, for years have complained to Pentagon officials and members of Congress that they are being asked to provide sensitive internal company data to the government to substantiate prices they charge for products that are sold commercially and for which price data already exists. Among the most disputed items have been aircraft spare parts.

“I get pulled by the Hill in both directions,” said Kendall. “I get pulled internally in both directions.”

For standard commercial items that are widely sold in the open market, determining a fair price is easy, he said. For defense-unique technologies and weapons whose development is entirely funded by the government, the Pentagon requires “certified cost or pricing data.”

The problem is the gray area between those extremes, such as products developed with private funds that a vendor considers to be commercial, although there may be no competition for setting the price. Some companies contend the Pentagon consistently demands certified cost and pricing data for commercial items.

Establishing the “commerciality” of a product will continue to be a source of friction between defense buyers and contractors, Kendall said. He has directed the Defense Contract Management Agency to study better ways to make “determinations of commerciality, to make the system more predictable and more expeditious,” Kendall said.

“Fair and reasonable price is what this is all about,” he added. “It’s always going to be contentious. We’re always going to have difficulties. We will occasionally make a mistake. … But we don’t want commercial suppliers driven away from the defense market.”

Kendall addressed the issue in the latest edition of the Defense Acquisition University Journal. “I’m afraid that we will never be perfect at this, given the vast number of items the DoD procures and our limited resources.”

In most defense acquisitions, he noted, “We need to proactively look for ways to embed or insert the most current commercial technologies. … It is clear that in many areas of technology the commercial market place is moving faster than the normal acquisition timeline for complex weapon systems.”

The Pentagon last month published a proposed rule to amend the Defense Federal Acquisition Regulation Supplement to provide guidance for evaluating the reasonableness of prices using data other than certified cost or pricing data. The proposed rule seeks to clarify the data an agency can use to establish reasonable prices in situations when there is no market competition.

Contracting experts and analysts have raised eyebrows following the publication of the rule Aug. 3 because it seems to add complexity to an already complicated discussion.

“The proposed rule falls short of its goal, instead increasing confusion in the determination of price reasonableness for commercial goods that have been ‘offered for sale’ but not sold,'" wrote Covington & Burling government contracting attorneys Jason N. Workmaster and Kevin T. Barnett. The rule has “open-ended data provisions that arguably permit the agency to request almost unlimited information to substantiate the reasonableness of prices,” they noted in a Law360 article. It is the “latest example of the government considering increasing the burdens and compliance obligations on its commercial contractors while expecting the results to be lower prices.”

Contractors have been invited to comment on the proposed rule by Oct. 2.

Workmaster observed that the Pentagon appears to take the position that market based pricing may not be an appropriate means of determining price reasonableness. “And it passes the buck to the contracting officer, empowering him or her to collect what the proposed rule refers to as ‘relevant sales data.’”

Industry analyst Byron Callan, managing director of Capital Alpha Partners, criticized the rule as a “step that runs counter to greater commercial outreach. That could be a disincentive for broader commercial enterprise engagement with DoD but also may bear on avionics and military engine spare parts pricing.” The regulation would “more rigorously and quantitatively define when DoD could rely on ‘market based’ pricing of commercial items," Callan wrote in a research note. Market based pricing typically is presumed to exist when non-government buyers in a commercial marketplace account for a preponderance — 50 percent or more — of sales of a particular item.

Topics: Defense Contracting, Procurement, Acquisition Reform, Defense Department

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