Weapons Spending: Much of the Logic Behind Acquisition Reform is Flawed

The Department of Defense has embarked on another crusade to reform the weapons acquisition process. It’s a worthwhile effort, because the department wastes billions of dollars every year on poorly managed programs and processes. But the ranks of military reformers seem to be populated with people who all share the same, flawed convictions about how to make the system work. After watching so many campaigns to fix the acquisition system falter, isn’t it time that policymakers re-examined their assumptions? Here are four contrarian views they might want to consider.

1. Competition reduces efficiency. In classical economics, the free interplay of self-interest in a competitive marketplace is the “invisible hand” disciplining price and performance. But defense isn’t anyone’s idea of a classic market. There is only one customer — the government — whose behavior is often driven by non-economic influences. And there are only two or three qualified suppliers for most major military systems, each of them almost entirely dependent upon the government for revenues. The notion that normal rules of competition can be made to work in a system of monopsony buyers and oligopolistic sellers is nonsensical, because the market is too distorted to function normally. If there are to be two suppliers, then the sole customer must pay for two sets of everything — design teams, production facilities, spare parts, etc. That’s precisely what proponents of the F-35 alternate engine want Washington to do, even though many experts doubt that benefits resulting from competition between two sources will ever justify the cost. When the government is a smart buyer, it can forego the cost of a second source and still motivate primary sources to continuously improve performance. You don’t need a second source to motivate supplier efficiency, just a suitable structure of incentives and a competent buyer. Secretary Gates seems to favor the latter approach, but many acquisition reformers wrongly believe there is no substitute for competition.

2. Fixed pricing raises costs. Conventional wisdom has it that the only way to discipline the pricing behavior of defense contractors once they have won an award is to insist on a fixed price. That way, the contractors know that they will have to absorb any cost overruns, and they work hard to stay within budgets. The problem with this reasoning, though, is that the future is largely unknowable and the government always insists on tinkering with programs after awards have been made. What if a hurricane hits the shipyard where a contract is being executed? What if the cost of production inputs goes up after a multiyear award is made? What if the government increases performance requirements for the system it is buying? The logical way to deal with such unpredictable developments in a fixed-price environment is to bid high at the outset, thereby mitigating any unanticipated cost risks. But incentivizing offerors to bid high at the outset defeats the whole purpose of requiring fixed prices in the first place. Is it really so hard to fashion a cost-plus approach to weapons development where the contractor is rewarded for holding down costs rather than encouraged to bid high from day one?

3. Cost realism is never rewarded. Bidding conservatively in the defense business is a prescription for going out of business. The top tier of system integrators has consolidated into half a dozen military conglomerates that all have similar skills and similar levels of proficiency. What that means in practical terms is that cost becomes the key discriminator in most competitions, so if one side bids optimistically and the other bids pessimistically, the optimists will usually prevail. What source-selection authority is going to pick the system that costs a billion dollars more when all of the competing solutions meet performance requirements? The latest installment in this long-running story came last week, when the Army decided to award a $3 billion truck contract to a challenger that bid 30% below what the incumbent is currently charging for identical trucks; the contractor projects a one-percent profit margin on the work that will only be achieved if it receives financial aid from state and local governments. That’s a very risky pricing profile, but the Army had already decided that cost was the sole discriminator between competing bids, so it picked the lowest cost proposal. This is why incumbents almost never win competitions for next-generation spacecraft — they know too much to make the optimistic assumptions of challengers, and so they don’t get selected.

4. More professionals compound the problem. The Obama Administration thinks the acquisition system can be improved by adding 20,000 more acquisition professionals to the ranks of the civil service. Let’s set aside the fact that the acquisition workforce is being expanded right after the department canceled a slew of weapons programs, and consider a more basic issue: what magnitude of savings would be required to justify all these new hires? Roughly half of them will occupy new positions, and half will take the place of contract personnel. But as civil servants rather than contractors, the new hires are likely to stay with the government until retirement, absorbing healthcare and other benefits in addition to their pay for decades to come. The fully loaded annual cost of an acquisition professional is about $100,000, so the compensation for 20,000 new personnel will run about $2 billion per year. But they will also have to be trained, equipped, housed and otherwise supported, and provision must be made for their retirement once they depart government service. When you add up all these costs, the long-term burden of taking on 20,000 new acquisition professionals will be over $80 billion — which just happens to be the projected cost of buying a replacement for the Trident ballistic-missile sub. Of course, some of this burden is diminished through cost avoidance on contract personnel no longer needed. But there’s the rub: you can get rid of contractors whenever their services are no longer required, you seldom can get rid of civil servants. So as procurement activity wanes with the drawdown in Iraq and cutbacks in big-ticket weapons programs, will the new acquisition personnel generate savings commensurate with the vast burden they impose on future defense budgets? Don’t count on it.