The Defense Department plans to set up centers of excellence that will specialize in commercial item costs in hopes that the department will not have to rely on pricing data to establish fair and reasonable prices.
The centers of excellence will train DoD employees in commercial pricing practices. Those pricing experts would look at similar products and use other techniques of verifying price without having to resort to unverified cost/price data, said DoD Director of Procurement and Acquisition Policy Claire Grady, during an Oct. 6 event hosted by Defense One in Arlington, Virginia.
“It’s difficult to price commercial products and our workforce is not necessarily well-skilled to do that. We are trying to give them additional tools to do that successfully to get to a fair and reasonable price without having to resort to cost or pricing data,” Grady said. “The goal is to not go to cost or pricing data to find some other mechanism to establish that fair and reasonable price. The real problem is when you no longer have market forces that are establishing a fair price that the market is willing to pay.”
DoD is required by law to buy items at a “fair and reasonable price,” and verifying that price has proven to be complicated.
The current process asks vendors to provide data on their underlying costs, which in turn affect prices.
The thinking goes that if a company already is building and manufacturing a product, then there is no sense in the department reinventing the wheel when it can just buy from industry.
DoD has been trying to reach out to commercial sellers through its reformationist Better Buying Power acquisition policy.
Critics of that policy say that since the product is commercial, the price has already been determined by market forces and therefore providing data is an unnecessary burden on industry.
“Commercial companies frequently don’t compile or retain pricing information and it is almost never in a format used by the government. Even asking for the data is outside of the norm of commercial transaction practices and is only supposed to happen when other means are not available to validate a price,” IT Alliance for Public Sector senior vice president for public sector Trey Hodgkins said in an email.
In August, DoD proposed a rule to ease that burden, but it still requires unverified cost data. Verified cost and price data is provided by an independent department-approved auditor or the Defense Contract Audit Agency.
Frank Kendall, DoD’s undersecretary for acquisition, technology and logistics, said at the event that the Pentagon mostly buys parts from commercial companies and regulates price because it wants to avoid fiascos such as a $17,000 helicopter oil pan that was bought commercially and actually cost $1,000.
“At the extremes there is industry who would like us to just pay whatever they ask and there are people, the [inspector general] in particular who think we should never pay higher than a certain margin for any particular thing we buy. We’ve got to meet somewhere in the middle,” Kendall said.
Subcontractors more profitable
As DoD is watching its back against industry overpricing, a new DoD report says first-tier subcontractors have made higher profit margins than prime contractors since 2001.
“It’s been conventional wisdom for a long time that you can make more money as a subcontractor than as a prime contractor,” Kendall said.
The study shows that in production there is about a 7 percent difference between sub and prime contractor margins and a 2 percent difference in development.
Kendall said he is trying to tie profit with productivity. He said he met with some of the primes and showed them the data and some primes are doing much better than others.
“Ultimately it’s the primes’ responsibility to work with their subcontractors to make sure they get good business deals,” Kendall said. He added that in some cases the primes were surprised by the data.
Prime contractor consolidations concerning
Even though subcontractors are winning in the profit margins, Kendall said he was worried about the consolidation of defense companies and their impact on DoD and the acquisition system.
“Size does confer a certain degree of power. That’s not a judgment that’s just a fact. Corporations are expected to — and should for their shareholders — operate in ways that enhance shareholder value, so I expect that,” Kendall said. “The government on the other hand has an interest in maintaining a good competitive environment and maintaining a range of suppliers.”
Kendall said the tools DoD has to handle that are inadequate. Last week and again on Oct. 6 he said he will ask Congress for their help on the issue, and will change DoD policy around national security and mergers and acquisitions.
In the past few decades larger defense companies have swallowed up the smaller primes, the most recent being Lockheed Martin buying Sikorsky Aircraft.
“If this trend continues we will end up at a point where we have two or maybe three primes who are essentially the sources for all the commodities we buy, and it’s just a fact with size comes the ability to have influence over things like the budget or how acquisitions go,” Kendall said.
Defense Authorization bill acquisition reforms
While Kendall is sifting through contractor issues, Congress is trying to push through the fiscal 2016 Defense authorization act.
Though President Barack Obama has said he plans on vetoing the bill, Kendall said he thinks the final bill will look similar to the current legislation when it comes to acquisition reform.
The bill takes some authority from Kendall’s office and gives the service chiefs and secretaries overall responsibility for acquisition programs within their services. The bill also includes penalties for cost overruns in older programs and in new start programs. If a program that was started after 2009 runs over cost, then 3 percent of the total cost overrun will be put in a fund controlled by Kendall’s office to invest in risk reduction and prototyping.
Kendall said he worried the 3 percent penalty would come too long after the decision that caused the cost overrun.
He added that he wasn’t sure how his office could access the money in the account, since it cannot arbitrarily take money from an account. Kendall said he may need to reprogram the money in order to use it.
“I understand the intent behind it, I’m just not sure as a practical matter it’s going to be all that effective,” Kendall said.
But Kendall said he was comfortable giving the service chiefs acquisition power.
“It encourages the chiefs to do things they could be doing now more than they are. That’s never been a real issue for us,” he said.
Kendall has warned Congress in the past, however, that giving too much authority to the service chiefs would cut out an important civilian oversight role over military acquisition responsibilities.