The Air Force wants to put downward pressure on the prices of its acquisition programs by asking its contractors to scrub their supply chains for unreasonable costs.
The service thinks its vendors have already made some progress on that front, but that it’s still paying more for its systems than it should.
The cost reduction effort is part of the Air Force’s implementation of the Defense Department’s Better Buying Power initiative, including that initiative’s concept of “should cost” management — the notion that program managers should shepherd their programs through the acquisition process based on what the final product should cost, not what history has shown it will cost.
Job one is figuring out what causes programs to be expensive. Getting a good handle on the cost drivers behind the service’s acquisition programs has become more difficult as increasing layers of subcontracting by its prime vendors have obscured those programs’ cost structures, said Maj. Gen. Wendy Masiello, the Air Force’s deputy assistant secretary for contracting.
“One of the things we’re increasingly recognizing is that the work we pay our prime vendors for is 60 to 70 percent subcontracted. Once upon a time, when we negotiated with the prime, most of the dollars and expense was associated with that prime contractor, and that’s reversed now,” she said. “So we’re spending a lot more time understanding those supplier partnerships. It’s an area of expertise that you would hope the primes are starting to develop in order to manage those costs, but there’s often less motivation to be as stringent in those relationships. It’s often more about maintaining those suppliers as long-term partners. But together, we’ve got to figure out how to do a better job of negotiating.”
Masiello, speaking at an Air Force Association breakfast Wednesday, said the Air Force would like its vendors to reconsider the most costly of those agreements with subcontractors, particularly for projects that are well into the production or sustainment phases, when cost structures should be more predictable.
“As we are trying to find efficiencies and pressure our primes to reduce costs, we need our primes to look at their supply base in the same way,” she said. “There may be opportunities to make sure they’re truly getting the quality of work at the price we should be paying for that work from their suppliers. The long-term relationships with suppliers can be sticky, and I understand that, but as we contemplate new arrangements and follow-on deals, that’s the time to reopen those, so we can improve the pricing, especially if they’re programs that have long-term production lines.”
Defense Department officials have said repeatedly that the Better Buying Power initiative is not intended to cut DoD’s costs at the expense of industry profits.
But Masiello said the Air Force is attempting to do a better job of understanding precisely how much profit industry derives from its contracts. So far, it has found that on many programs, there is a bigger margin between what the service pays vendors and their actual costs than the service previously realized. Those profits, in many cases, exceed DoD’s guidelines for determining profits and fees on contracts.
“Profit is not a dirty word,” she told a separate audience when the National Defense Industrial Association convened later Wednesday. “Profit is absolutely legitimate, but we have some parameters on what that budget should look like, and as we go into negotiations, I’m often surprised that there’s an expectation that industry wants 18 to 20 percent profit on a relatively low-risk program. I think we need to get practical in those negotiation processes. We need to be consistent and transparent with matching risk and profitability.”
To get more insight into the rates its vendors are charging the Air Force for products and services, Masiello said her service has begun working with the Defense Contract Audit Agency to help it understand the cost estimating factors contractors use to build their proposals.
The Air Force’s pressure on pricing is driven by necessity, Masiello said. In an environment in which every military service is scaling back its acquisition ambitions, the programs that have survived cuts up until now simply can’t afford to overrun their budgets, she said.
“To keep our programs alive and viable, we’ve got to make sure they deliver on the promises we’ve made,” she said. “If the programs get behind in schedule or the costs start to overrun, we risk losing that program. There is very little room for mistake in today’s environment.”
Masiello said vendors are clearly aware of DoD’s budget issues, and she credits Air Force contractors for having already taken several steps over the past few years to reduce their costs by, for example, divesting themselves of unneeded infrastructure and unproductive business units.
“They’re lowering their overhead costs. They’re cleaning up their books,” she said. “A lot of the companies are also looking at their systems engineering and program management workforces and asking, ‘Do we still need the standing armies that we’ve had in the past, or is it appropriate to start shrinking those?’ They’re being deliberate about that, depending on where the programs are and making sure the workforce is sufficient so that they don’t put the program at risk. Some of our industry partners are also working really hard to clean up their bid and proposal processes, and that’s something that really works to our advantage. If there’s one thing that can help us shrink our acquisition timelines, it’s making sure those are right in the beginning.”