New source of tension emerges between contractors and DoD

If Congress ever passes the 2024 Defense authorization bill, keep your eye on Section 804. It’s now in the Senate version, and it is aimed at granting the Defense Department the rights to increasing amounts contractors’ data more than it appears DoD needs for maintenance and operation of what it buys. Section 804 seems innocuous at first glance. To discuss beyond-the-glance, the Federal Drive with Tom Temin spoke with Haynes-Boone procurement attorney Zach Prince.

Interview Transcript: 

Zach Prince Sure Tom. So Section 804, it’s only in the Senate version of the NDAA for now, though it could always appear in the House bill, assuming there is actually, ultimately a House bill and a continuing resolution and the government is funded and continues. But if that all happens, the section 804 is proposing a pilot program for use of innovative intellectual property strategies intended to acquire the necessary technical data rights required for operations and maintenance. It sounds innocuous. It might be innocuous in practice, but what raises concerns is that DoD already obtains data necessary for operations and maintenance. It’s called OMIT data. Operations, maintenance, installation and training. The government gets unlimited rights in OMIT data. What they don’t get right now under the current statute is detailed manufacturing and process data, which is essentially the secret sauce that contractors have that makes their IP valuable. That’s the technical data that describes step sequences, conditions for manufacturing. And it’s not just in the context of actual manufacturing. They use the same terms roughly in the context of software, too. So it’s what you need in order to take what you’re running and reproduce it. Contractors have spent a lot of money on getting to that stage.

Tom Temin Yes. Well, there’s two issues that have come up recently, one in recent years, I should say. One is too often the maintenance contracts for complicated and expensive platforms remain with contractors. And DoD would like to say, well, I don’t want to fly a Lockheed technician 10,000 miles to install the X, Y, Z actuate or somewhere. And the other issue is they want to get into 3D printing and on board types of manufacturing for replacement parts. So it could be a gambit to give them that capability.

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Zach Prince It could be. And if that’s what they’re looking for, they should be paying for it. Because the contractors spend a lot of money developing this technology and the know how that is their competitive edge. So I think contractors have two concerns. One is making sure that they can recoup the costs that they sink into investment. And that’s how you continue to foster innovation. And two is to make sure that their competitors don’t get what they just spent a lot of time and money investing into without having to put in anything on the front end.

Tom Temin Well, do we know from those that put that provision in there what their intention is, what the senators were listening to?

Zach Prince I suspect that this is all part of the complaints that you hear from some of the DoD components about the need to get replacement parts, particularly for platforms that are around for a long time, and pretty much every major airframe is at cost that DoD considers reasonable. But that’s the thing. DoD’s analysis of reasonableness is extremely myopic. They’re looking at your cost, allowable costs right now. They’re not looking at the CapEx that you’re making in order to continue producing apart. They’re not looking really at all the costs that went in on the front end, the failed parts, the loans that you’ve needed to take out since a lot of that is on allowable. And they’re getting this distorted picture of what your profits are that a commercial company, a real commercial company like an apple, would never abide by. The price is the price the market sets the price. And it does that based on, I think, reasonable metrics. DoD’s metrics are not quite the same.

Tom Temin In other words, if you are making the analogy with Apple, the first iPhone cost a billion dollars for Apple to develop. Something like that, I don’t know what it cost back in 2007, but it was years in development, thousands of people working on it, all of this manufacturing set up, blah, blah, blah. So the first one probably cost them a billion. They’re selling it for 400 at the time or something. So you got to sell a lot of them. So maybe DoD is paying not a volume price, but maybe they have, in some cases, they’re paying the development cost to some degree in that price. And then it goes down as more copies are made. And what they would like to do maybe is accelerate the learning curve as expressed in pricing. Sounds like.

Zach Prince Yeah, that’s about right. And they don’t really recognize that they’re an inconsistent customer. A company when they’re selling a spare part, you’ve got OEM that is pricing a certain way, assuming certain sales going down the road. But you have no idea how many times DoD is going to replace this flange on this piece of this platform. You’re making certain assumptions and then DoD wants to come back and say, hey, restart this manufacturing line. I know you’ve sold four of these in the last ten years. We need another two. And why are you charging us more?

Tom Temin Right. We’re speaking with procurement attorney Zach Prince. He’s a partner at Haynes-Boone. That issue of the irregularity of demand has large and small implications, including the maintenance of the existence of the defense industrial base itself. And so this would seem to mitigate against suppliers staying around if the DoD has the property data that they need to go somewhere else or make it themselves. Which brings up another point. Sometimes you’re talking about a bolt. Well, you can make a bolt on a ship with the right machine. But a lot of these high end parts of high end systems, it doesn’t have to be a platform. It could be a gyroscopic box or something are made of exotic materials, very specialized materials where you look like you could fabricated from the exterior. It would be the same shape and fit, but it wouldn’t operate or stand up properly because it’s not made of the exact alloy. And so this is the type of information DoD would get. What is the alloy and how is it made?

Zach Prince Yeah, that’s right. And it’s always an interesting question of whether anybody can really do anything with that technical data. If you’ve got a super complicated process and know how you’ve developed over decades and you’ve got the equipment to manufacture it, is somebody really going to take that data and be able to stand up an operation to compete with you within a reasonable time frame? Maybe, maybe not. But companies don’t want to take that risk.

Tom Temin I guess the other danger here is, yes, another company would probably not do that, would not be incentivized to do that. But China might be.

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Zach Prince That’s right. And that’s a much broader question about who’s going to end up with access to your data and security of different systems and export controls. And those are all real concerns.

Tom Temin But getting back to 804 as it’s in the Senate NDAA draft, at this point, it’s only a limited program, an experiment or a pilot program. And how would it actually work? Do we know?

Zach Prince It is way too vaguely stated at this point? I sort of suspect that this is not going to make it into a final bill. We’ll see what a final bill actually looks like if hopefully there is one and soon. Similar types of proposals come about in the NDAA almost every year. Some dramatic shifts being proposed in the way that DoD buys IP. It doesn’t usually get much traction, but it keeps being reasserted because there are stakeholders at DoD that care quite a lot about this, and I think their concerns are real. They do want to make sure they can have the operations and maintenance that they need at prices that they need and they don’t like being blackmailed by OEMs. I sometimes fear that they perceive business negotiations that are totally standard commercial practices as blackmail and they’re really nothing of the sort.

Tom Temin And by the way, when it comes to these detailed specifications and so forth, what do the regulations, as they stand now say?

Zach Prince So the regulations are a little vague, and that is an issue that comes up time and time again in these negotiations. The DoD acquires, OMIT data with unlimited rights, assuming that it’s actually a contract deliverable. But where the line lies between information necessary for operations, maintenance, installation training and where it then becomes a detailed process and manufacturing process data is challenging to assess. There is a Section 813 panel that was impaneled by Congress a couple of years ago that looked at this issue. They didn’t recommend any statutory changes. They recommended instead that the DoD put out some really good guidance, an IP acquisition guidebook. GAO looked at this and they roughly said the same thing. They were a little bit cagey about whether they thought a statutory change was needed. But the IP guidebook is going to be really critical and that is supposedly around the corner. So everybody’s paying attention to see what that’s going to look like.

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