Today’s DOD Profit
Approach – Two
Perspectives
Breakout Session # D02
Jim Gill, Acquisition Instructor, Salient Federal Solutions
and Consultant, BTAS
Stan Neves, Manager, Contracts, Pricing & Property
Management Azusa, CA & Boulder, CO Campuses,
Northrop Grumman Systems Corporation Electronic
Systems Sector - ISR & T Systems Division
November 4, 2014
11:15am - 12:30pm
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Agenda
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Introduction to Topic
DOD Perspective – Mr. Jim Gill
Industry Perspective – Mr. Stan Neves
Summary/Conclusion
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Government/Industry Perspective on Profit
• How much profit is reasonable?
– How do we tell?
– FAR & DFARS provide minimal information
– Concept of “Fair” and “Reasonable” very soft
– Weighted Guidelines one technique
• Only a Guideline
• Major Programs use it for comparative purpose
– Who Decides?
• Ultimate Approval Authority varies
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Jim Gill - DOD Perspective
• My background
• History over time
• Profit relationship to Political
Administration
• Definition of “Fair & Reasonable”
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My Background
• Thirty Seven Years of Major Space
Systems Experience
– Ballistic Missiles (Peacekeeper, Minuteman &
Small ICBM)
– Space Systems (SBIRS, DSP, Space Radar,
Launch Systems, Weather, GPS)
• Contracting Officer/ Deputy Chief of
Contracts/ Chief of Contracts/Chairman of
Review Committee/Technical Advisor to
the Director of Contracting
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History Over Time
• 1976-80 Carter Administration
– Investment in Social Programs
– Recession, Stagnation of Defense
– Cold War Ongoing, Soviet Union Arms Buildup
• 1980’s Reagan/Bush Administrations
– DOD Investment in New Programs
– End of Cold War
• 1992-2000 Clinton Administration
– Peace Dividend, Reduction in Defense Budget
– Acquisition Reform, Faster, Better, Cheaper
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History Over Time
• 2000-2008 Bush Administration
– 911 Response to Terror Threat
– Growth in DOD Programs
• 2008-Present Obama Administration
– Recession, Sequestration, Reduction in
Defense Spending on Major Programs
– Affordability Key to BBP Initiative
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ROLE OF POLITICS
• What role does Politics play in
determination of profit? Or does it?
– Is profit a function of affordability, or does an
Administration’s philosophy also dictate what
constitutes “fair and reasonable”?
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FAIRNESS
• There are many variables in policy that goes into
the determination of fairness
• Risk, primarily technical risk often has significant
impact on government’s determination
• Space and Missiles are unique, but they offer
perspective
• Early Development contains greater risk than
Production, often dictating contract type (Cost vs.
Fixed Price)
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• Competition for Development Programs often
dictates profit opportunity, difficult to avoid
Contractor buying-in
• Industry has traditionally expected to realize
greater profit during Production
• For Missile Programs Peacekeeper and Small
ICBM, there were limited production
opportunities
– Profit for Cost Plus was not greater than 8%
– Profit for Fixed Price was limited to 12%
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SPACE PROGRAMS
• Most Space Programs developed after the
Clinton Administration fell into two
categories:
– Programs such as SBIRS, AEHF, GPS IIF & III
that experienced cost growth and delays in
development
– Programs such as Space Radar, TSAT,
NPOESS that were cancelled due to lack of
affordability
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SPACE PROGRAMS
• Profit for Space Programs often exceeded 15%
for Cost Plus Development contracts
– Most were Award Fee contracts
– GAO highly critical of Award Fee paid to contractors
• Several (SBIRS, AEHF) have moved into
Production with initial contracts Cost Plus and
later contracts moved to Fixed Price
– Profit has been reduced during Production even as
contract type has moved to FP
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CURRENT TREND
• Is there a noticeable trend?
– Perspective of reasonableness depends upon subjective factors
– Democratic Administrations tend to view profit somewhat
skeptically while Republican Administrations are more inclined to
reward industry
– Not an exact science
• Clinton over reached with expectation that “Reform” would mitigate
projected cost estimates
• Obama policy suggests not “war on profit” but rather “doing more,
without more”
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CURRENT TREND
• Skeptics suggest that Industry has realized
excessive profits through Defense acquisitions
– DPAP analysis
• Lack of understanding of business issues by Contracting
Officers leads to bad business arrangements
• Inexperience of CO’s contribute to poor profit agreements
• Profit on profit
• Facts seem otherwise:
– If Defense business is highly profitable, why is there a
crisis in the Supply Chain of Space, with many
companies going out of business
– Why are Defense stocks not more in demand?
– Turbulence in budgeting (sequestration for example)
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• The GAO Report of 2005 significantly changed
the DOD’s reputation on profit
– Award Fee contracts disappearing from use
• FFP Contracts Initially a Focus for the Obama
Administration
– March 2009 Memo
• FFP contracts are somewhat frowned upon by
DOD Leadership with a skepticism that excess
profit is often a factor of poor cost estimating
– In spite of “Should Cost” requirements under the BBP
Initiative)
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• Profit for Space Systems, with their technical
complexity is a difficult construct with few
companies capable of providing the expertise
required to push boundaries of state of the art
systems
• Competition can force companies to overpromise and under-perform in order to win
source selections
• The number of companies capable of providing
this aerospace expertise has been reduced with
mergers, acquisitions and consolidations
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• Over the past several years it seems that there has been
a “re-evaluation” into the nature of a “fair and reasonable
profit” for major DOD systems
• Some have categorized this re-evaluation as a “War on
Profit” but it seems to be more a reflection of the impact
of political ideology, along with the realities of a financial
crisis in Government
• Democrats often seem to be offended by the perception
of “windfall profits” especially as it relates to National
Security Industries
• Most of the evidence is “anecdotal” but seems consistent
with a pattern of behavior captured by the respective
parties’ platforms
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• Optics are often a problem
– In order to fight for lower TC, BBP seems to
offer the possibility of higher profit
– Higher profit was unsettling to Leadership
– Trade off was to use lower profit with
aggressive TC
– Cost-type contracts especially vulnerable
• Some leadership view 10% as cap for CP contracts
- informal
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• Type of Contracts also hostage to profit
optics
– Award Fee contracts informally prohibited
– FPIF Ceilings are also suspect as back door
attempt to avoid risk
– May impact profitability and add risk
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Clearance/Peer Review Process
• Process for Approval of Government
Team’s Negotiation Authority often creates
difficulties
– Clearances and “Peer Review” seem to push
program team to lower Profit and TC
– Competition between respective Organizations
(Air Force and DOD) to demonstrate
commitment to hold costs and profit down
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View to the Future of Profit
• Profit will continue to be aggressively negotiated
by DOD for major systems
• “Affordability” a function of total contract cost
(including Profit)
• “Fair and Reasonable” is a subjective term,
subject to interpretation through a prism of
politics
• Financial Quagmire of Federal Budget will
continue to drive need to reduce major systems
costs
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Stan Neves - Industry Perspective
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My background
Conclusions of Past Profit Policy Studies
Recent DOD Better Buying Power Approaches
What Industry Evaluates to make a Bid Decision
What we may consider “misapplication of policy”
“”Views/Opinions expressed by Mr. Neves verbally and/or contained
herein are not formally sanctioned by Northrop Grumman Corporation””
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My Background
• Thirty Five+ Years of Major Systems Contract
Management Experience
– 10 years with the Government (DOD Ballistic Missiles:
Peacekeeper, Rail Garrison, & Small ICBM)
– 25+ years with Industry (Aerojet & Northrop Grumman:
SBIRS, DSP, DMSP, ATMS/JPSS, JTAGS, numerous
Ground Processing Systems)
• USAF Contracting Officer / Aerojet Director of
Contracts / Northrop Grumman Functional
Manager of Contracts
• NCMA CPCM (86) and Fellow (96)
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Conclusions of Past Profit Policy Studies
• Several Studies were conducted & Profit
Polices Initiatives enacted since mid 1960’s
– Most findings do not support Incentive Theory
predictions
• GAO (1987) - no significant relationship exists
between share ratios and cost overruns/overruns
– Meeting the Target Price is no guarantee that
the Government paid the appropriate price
• GAO (1987) – without complete price and cost
analysis at the time of negotiations, no way to
determine reasonableness
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Recent DOD Profit Policy Approaches
• Better Buying Power 1 (6/2010 & 11/2010)
– Increase use of Fixed-Price Incentive Firm Target
(FPIF) contract type using a 50/50 share line and 120
percent ceiling as a point of departure for all programs
– Align policy on profit and fee to circumstance
– Adjust progress payments to incentivize performance
• Better Buying Power 2 (11/2012)
– Align profitability more tightly with Department goals
– Employ appropriate contract types
– Align use to FPIF with Low Rate Initial Production only
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Recent DOD Profit Policy Approaches (2)
• Better Buying Power 3 (interim 9/2014)
– Align profitability more tightly with Department goals
• Profit is the reason the firms we rely upon exist, industry
should expect reasonable profit
• We should not use profit as a cost cutting measure
• Profit should not be excessive, however, and higher profit
should be tied to better performance and lower levels to
poorer performance
– Employ appropriate contract types
• Increase the use of incentive-type contracts. Studies show a
high correlation with better cost and schedule performance
• “We do NOT want exclusive use of these types of contracts,”
use whenever appropriate over other contract types
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What Industry Analyzes to make a Bid
Decision
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• Program Financials
Company Strategy
Business Case
Customer Budgets
Competition
Customer Influence
Funding Profiles
Cost Targets
Schedules
Proposal Analysis
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Margin/ROS
“S” Curve Analysis
Payment Structure
Contract Type Parameters
• Technical Approach
– Basis of Estimate/TRL
– Extent Subcontracted
– Risk & Opportunities
• Contract Terms
– Standard/Special
– Liabilities
– Delivery Requirements
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What We May Consider Misapplication
• FPIF Type Contract for on Contract Logistics
Support Level-of-Effort program
• Performance/Schedule Incentives included within
Incentive percentage of CPIF/FPIF
• Arbitrary Fee/Profit rate caps without
consideration of WGL guidance
• Profit Percent Decrement for Incorporation of a
Performance Based Payment Plan
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• Questions? Comments?
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Contact Information
• James G. Gill
• Stanley J. Neves
Manager, Contracts, Pricing, & Property Management
(909) 593-6150
– e-mail: [email protected]
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