The Pentagon plans to limit its use of fixed-price development contracts because they require contractors to bear too much financial risk in that phase of a weapons program, the defense acquisitions chief said.
Officials led by Undersecretary of Defense for Acquisition Frank Kendall said in a draft proposal that they want to revise 2010 guidelines that backed wide use of fixed-price incentive contracts. These contracts require companies to bear increasing shares of an overrun until they are paying 100 percent. They make money if a contract comes in at less than the fixed target cost.
The draft, called “Better Buying Power 2.0,” is intended to take effect in January. The approach may be criticized in Congress, which has expressed a preference for awarding more fixed-price contracts as a way to pressure companies to curb cost overruns.
“We are refining our guidance to emphasize the use of the appropriate contract vehicle for the product or services required,” Kendall said in a memo yesterday to the Pentagon workforce. Weapons-buying regulations provide for a “range of contract types for a reason: one size does not fit all,” he said.
Fixed-price incentive contracts are appropriate for production jobs such as the Boeing Co. (BA:US) KC-46 tanker or Lockheed Martin Corp.’s (LMT:US) F-35 fighter, Kendall said in a press briefing yesterday.
“The place where I’m nervous about fixed price is in development” of a weapons system, with all its uncertainties, he said at the briefing.
The new approach was questioned by Scott Amey, general counsel for the Project on Government Oversight, a nonprofit watchdog group based in Washington.
“This change will shift the risk, and costs, from the contractors to the Pentagon, which is another attempt by the contractors to protect the bottom line,” Amey said today in an e-mail.
Moving to fewer fixed-price incentive contracts will require greater vigilance by the Pentagon “to make sure that projects don’t veer too far afield with a large bill being passed along to taxpayers,” he said.
Kendall said that entering into a fixed-price contract locks the Pentagon and a contractor into a situation where “it’s hard to make an adjustment,” he said.
If costs increase during development, a contractor is “supposed to keep putting money in until they can deliver that product,” Kendall said. Companies can take an adversarial stance and file claims against the Pentagon “or just stop” work, he said.
A cost-plus contract that reimburses a company for its documented expenses is more appropriate so that the Pentagon and a contractor work together during development.
A fixed-priced contract “certainly shifts risks to industry,” Kendall said. “But there’s inherent risk in most development programs, and I think we need to balance that.”
Kendall told an audience today at the Center for Strategic and International Studies in Washington that he wants “to back off a little bit” from fixed-price incentive contracts. He said his message to defense program managers is: “Use the right type of contracts. Think about what you are doing.”
Senate Armed Services Committee lawmakers, including Chairman Carl Levin, a Michigan Democrat, and ranking Republican John McCain of Arizona, said in 2009 in introducing the Weapon Systems Acquisition Reform Act, which became law, that it was intended to increase the use of fixed-price contracts.
Asked if he anticipated resistance from Congress and the Senate panel in particular, Kendall said, “I don’t think we are very far apart at the end of the day. As long as we are left some flexibility, we’re OK.”
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