Defense Department’s Contracting Regulation Needs Improvement

In the realm of federal government contracting, a key question hangs over nearly every contract award – is the public good fulfilled more by the actual product or services acquired by the government, or by the procurement process itself? While a perfect world would suggest a pairing of such interests, that is certainly more rare than common.

Case and point is a recently proposed Department of Defense regulation which would fundamentally restructure the way contractors are compensated for work performance. The proposed regulation would reduce defense contract progress payments as much as 30% below current standards, in addition to imposing subjective program management review criteria for contractor performance.

As an echo from the distant past, DOD’s underlying presumption is the private sector is bilking the government to the tune of hundreds of millions of dollars. The reality is the opposite – in fact, DOD is the benefactor of an amazingly efficient and productive defense industrial base in spite of the challenges in abiding by government-unique and often byzantine compliance requirements.

Of the key contracting variables, namely cost, schedule, and performance, the government is historically bad at choosing between them. Frankly, program requirements regularly exceed their budgetary constraints and program managers are faced with pressure to ensure unrealistic contract metrics, all under the suspicious watch of various oversight authorities including Congress. Thus, if performance, schedule, nor cost can be guaranteed, contracting officers will embrace acquisition processes as the sole measure of effectiveness. Ironically, even a poorly executed program can still receive high marks for acquisition management.

At a time when the average profit margin for defense companies is half the margin for S&P 500 companies, DOD’s proposed regulation would remove cash flow stability for major weapon systems manufacturers which, in turn, could trigger a potential downgrade to the entire industrial sector. Because of the pre-existing operating limitations faced by defense contractors in participating in an artificially controlled market, the contrast with related commercial sectors – namely aerospace and technology – grows even wider.

At the peak of the Cold War, DOD dominated global research and development by the sheer amount of funding dedicated to long range programs. However, even as DOD R&D funding declined, independent commercial investment increased. In 1960, U.S. defense-related R&D represented 36% of worldwide expenditures as compared to 4% by 2013. Not surprisingly, the defense industrial base scaled down and consolidated commensurate with the market. The prospective low margins and reduced cash flow envisioned by this proposed regulation will introduce additional uncertainty and serve as yet another disincentive for non-traditional companies to considering bidding on U.S. military contracts.

While the current defense industrial base has restructured to compensate for ever-increasing compliance demands and funding instability, this regulatory proposal would undercut prime contractor competitiveness in the growing commercial technology sector. Despite the zealous advocacy by the late Sen. John McCain (R-AZ) as Chairman of the Senate Armed Services Committee to push the military to use more commercial item acquisition contracts, DOD has firmly resisted the opportunity to take advantage of this robust economic era to align its own processes and reduce its acquisition barriers and associated costs.

So the key question persists – is the acquisition objective the actual end-use item or the mere observance of governmental processes? At least with regard to DOD’s latest proposed regulation, the answer is the latter.