SPEAKING OUT
A War on Profit in DOD Contracting?
It’s All in the Eye of the Beholder
BY JAMES GILL
There is a good deal
of discussion as to
whether there is a
current war on profit
by the Department of
Defense (DOD). Much of
the discussion depends
on your perspective, and
the same goes for many
issues currently in vogue.
The head of DOD pricing
(Shay Assad) would have
you believe that there
is no such thing; rather
there is a new attitude
toward what constitutes
a fair and reasonable
price for DOD to pay
for development and
production of its major
weapon systems.
Industry, on the other hand, while reticent to
get into a war of words with the head of DOD
pricing, recognizes that profit is an area that
has changed with regard to how negotiations
are proceeding with DOD. They perceive that
profit is often placed in a negative context
when negotiations for sole-source systems
have been held with DOD negotiators.
So who is right? Is there a war on profit, or
not? The Defense Systems Management
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Contract Management | December 2014
ing Manufacturing Development contract
from one that had been negotiated as cost
plus, to one for fixed price. The level of
ignorance on the part of some congressmen
was that it should be easy, because once
you had negotiated the target cost, all you
had to do was negotiate a revised profit rate
in exchange for adding a cost ceiling.
College program manager’s course would
have its students believe that the correct
answer to this type of question should always be that “it depends,” and I agree with
them regarding the “war on profit.”
It depends on where your starting point
is. Was the profit rate received during the
Bush administration a fair one to continue
through the Obama administration, or not?
Historical profit rates for space systems had
been in the 12–15 percent area for cost-plus
(usually award or incentive fee) contracts
during the turn of the century (2000) and on.
Before answering the question on the
profit war, let me provide some historical
context. During the 1980s, a good example
of U.S. Air Force profit policy could be found
in the ICBM development and production
programs. The contracts that were awarded
for the Peacekeeper Production Program
(using the associate contractor approach)
were mostly for cost-plus-award-fee contracts. These were pretty standard, and
leadership was hesitant to go much above
the 8–9 percent limit if they hoped to get
their acquisition planning documentation
approved by headquarters. In the mid-80s,
Congress fixated upon fixed-price contracts
for development and the Air Force had to
change the Peacekeeper Stage III Engineer-
As hard to believe as that was in the 1980s,
we have seen a revision of some of that
thinking in acquisition leaders in the current
administration who seem to believe that
there is one target cost for either cost-plus
or fixed-price contracts, so all you have to
do is increase the profit when changing
from cost-plus to fixed-price contracts (kind
of a one-size-fits-all approach to negotiating). This approach may be somewhat
sensible in the 15th or 20th production buy
for a jeep (where the idea of a cost-type
contract is ludicrous), but it defies logic
when negotiating the second or third buy of
a highly complex system such as a satellite.
Satellites often take from five to 10 years to
build, and thus make it difficult to project
costs for third/fourth units until they are
almost complete.
The projected savings that should be
obtained due to “efficiencies” are extremely
difficult to project and any “should cost” savings are truly high risk to the contractor. The
concept of “should cost” in the Better Buying Power (BBP) Initiatives is also a peripheral issue in the alleged war on profit, since
it relies upon hypothetical savings, that
have never been demonstrated, to reduce
target cost. Since target cost is the basis
upon which contract profit is based, asking
contractors to accept this challenge with no
accompanying increase in target profit for
accepting the associated risk seems unfair
and unreasonable to most contractors.
SPEAKING OUT
There is also no interest in DOD leadership
to authorize an increase in the ceiling price
for fixed-price incentive fee contracts in recognition of the acceptance of an aggressive
target cost by the contractor. This reflects a
philosophical shift in profit theory, as seen
by the contractor community as a part of
the “war on profit.”
This is consistent with the history of acquisition of weapons by DOD and goes with
changes in political administrations. Going
from the Carter administration to the present, DOD profit expectation is reflective of
the democrat and republican vision of the
DOD acquisition process and the corresponding views on profit.
One other aspect of the differences between
the Bush and Obama administrations is that
of the perception of the nature of contractor
risk/reward. Under the Bush administration, in the context of a War on Terror, cost
and profit became secondary to national
security considerations. It was generally
recognized that saving costs at the expense
of mission success could result in potentially
catastrophic consequences to the warfighter. Pushing the state of the art often
required a contractor to accept high risk
that needed recognition in profit and cost
estimates. Under the Obama administration,
there is a perception that contractors are
using this risk excuse to negotiate unreasonably high profit and are highly motivated to
drive cost and profit down.
A somewhat over-the-top summary of
views would have that democrats see
defense business, for the most part, as
greedy war profiteers who expect to have
no-risk contracts, with high profit margins.
Republicans, on the other hand, see defense
business as merely one critical sector of
the overall economy, no more, nor no less
profit-oriented than other businesses in a
capitalist society, but a critical element in
the primary purpose of government—that of
providing for the nation’s security.
How do we see this new perception
translated into the current administration’s
reflection on profit? Obviously, the BBP
Initiatives reflect current thinking on profit,
so it would be a good starting place. Leaders say that they have no war on profit, and
point to the language in the BBP Initiatives
that states that DOD should relentlessly
attack program costs in an attempt to use
these reductions to fund new programs
(“doing more without more”).
Philosophically, the two administrations
have a substantially different perception of
the defense industrial base and how to deal
with it. Many times during the past several
years, in internal sessions, DOD leaders have
claimed that the defense industry wants to
have cost-plus-percentage-of-cost arrangeIn the Clinton administration, under their
ments (although they are illegal). Essentially, Acquisition Reform Initiative program (called
these leaders appear to be stating that con“Lightning Bolts” in the Air Force), this affordtractors are totally risk averse and therefore
ability initiative was called “doing less with
unwilling to have any “skin in the game.”
less.” While the current administration has
done much to attempt to stay away from
So, if you were a part of the previous admina perception of the BBP Initiatives becomistration leadership, or if you consider the
ing an “Acquisition Reform 2.0,” both are
profit that you received during the previous
reflective of a reduction of defense dollars
administration to be “fair and reasonable,”
to their budgets, and the need to use affordyou may agree that there has been a recent
ability to finance necessary replenishment
“war on profit” due to the perception that
programs for DOD.
previous contracts were both fair and reasonable and changing them by reducing profit
The leadership in the Obama administration
and cost does constitute a “war.” On the
believe that they have a certain reasonableother hand, if you are a part of the current
ness behind their contention that industry
administration leadership, you may deny that
was making an unfair profit rate in the perthere is any war, but rather state that there is
formance of their contracts. In their minds,
a movement toward a more fair and reasoncost-plus contracting offers an unreasonable
able price (including profit) for product.
opportunity to gouge the American public.
The fundamental flaw in their logic is that
there is no move by industry into the DOD
business opportunities—rather, since the
years of acquisition reform into the BBP
Initiatives, we do not see contractors entering the defense business base, either at the
prime or subcontractor/supplier level. Rather,
there has been an evolving trend away from
defense business throughout all sectors of
DOD. It seems intuitive that if the contention that DOD contractors are making such
outrageous profits, then the market would
be growing, rather than shrinking, with more
contractors entering the market than leaving.
As with most generalizations, the “war on
profit” can be denied or supported by data,
and most contractors would not like to “bite
the hand that feeds them.” However, the
mere perception that such a thing as a “war
on profit” could exist will likely contribute
to the downward slide away from the
defense sector within the general business
community. This cannot be a good thing
for those who support the acquisition of
weapons needed by the troops, both today
and in the future.
Ultimately it is the responsibility of those in
DOD acquisition to provide the best-quality
systems to protect those in the service who
must protect us with the systems that we
buy. In order to be able to accomplish this,
DOD leadership must find a way to incentivize other contractors to enter the DOD
market. Unfortunately, having the perception (real or not) that there is a “war on
profit” is certainly not a very effective way
to accomplish this. CM
ABOUT THE AUTHOR
JAMES GILL is an acquisition instructor
for Salient Federal Solutions and a consultant
for BTAS.
Contract Management | December 2014
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