‘New Era’ of Performance-based Reimbursements Begins at Defense DepartmentNovember 24, 2009

 

Lockheed Martin, the biggest defense contractor in the United States, last month tapped Christopher Kubasik to head the new position of president and COO. His chief responsibility will be to improve oversight in the company's far flung divisions, including aerospace, information systems, missile defense and the space and commercial satellites divisions.

Kubasik, 48, was Lockheed's executive vice president of electronic systems, but is taking on the new role to address the Pentagon's demand for greater efficiency and performance from its defense contractors as it struggles with shrinking budgets, the company's chief executive officer, Robert J. Stevens, told The Washington Post.

"We are listening to our customers," Stevens said. "We're listening to the leadership in Congress. They are uniformly recognizing that the global security environment is getting more complicated.... They're going to need to do more with less. As their partner, we want to step up and make sure we're focused on execution," he told the Post. "We're happy to add resources where we can make a difference. We want better efficiency to reduce costs and give them better value for the money they spend."

This new position is consistent with the recent focus of the Defense Department (DoD) on operating performance and outcomes, rather than on how much a company spends building the weaponry, says Serguei Netessine, a Wharton operations and information management professor. This procurement process, commonly known as performance-based contracting, is now mandated for acquisition of all new military equipment and services under the DoD Directive 5000.1.

Defense contractors for decades have seen their programs beset by delays and cost overruns -- from the proposed new presidential helicopter fleet to new ships. Directive 5000.1 calls for the DoD to pay suppliers based on operating performance (reliability, availability and response time) rather than on time and materials, the dominant method for years.

Netessine, who has worked with the F-35 Joint Strike Fighter program sourced through Lockheed Martin under the performance-based agreement, said the new reimbursement approach opens a new era for DoD contracting. It also posed unique challenges to contractors that now become directly responsible for equipment performance and must take on a large portion of potential non-performance risk.

This forces suppliers to "develop new approaches to link operating performance to financial outcomes," said Netessine, adding that it also is a "monumental shift for many companies, which for many years essentially submitted expense reports to DoD for reimbursements without much responsibility for the outcomes."