Pentagon Weapons Buyer Considers More Fixed-Price ContractsOctober 15, 2009

 

Ashton Carter, the Pentagon’s chief weapons buyer, said he was conducting a detailed analysis of the U.S. military’s troubled weapons programs to bring an end to chronic delays and cost overruns, according to a Reuters report.

Carter, the Under Secretary of Defense for Acquisition, Technology & Logistics, noted that the Pentagon is not repeatedly making one mistake but rather making “lots of different mistakes.”

He said he was directing his acquisition force to improve how programs are first conceived and to increase oversight over the course of a program. He added that the department must terminate programs that run into problems or allow them to run their course and terminate, Reuters reported.

The Pentagon would focus on whether initial costs projections were overly optimistic, according to the article. Carter said that although fixed-price contracts were not appropriate in all situations, his department would turn to more fixed-price type contracts for a wide array of programs, including aerial refueling tankers, and even for logistics contractors in war zones.

That could raise a whole set of other problems, says Morris Cohen, a professor of operations and information management at Wharton.

If all contracts were fixed price, many suppliers would refuse to bid, Cohen notes. Fixed price contracts transfer risk to the supplier and are, therefore, often preferred by the customer, in this case the Pentagon. Cost plus contracts work the other way, transferring risk to the customer.

Wharton research has found that there is no single answer to the question, “What is the best type of contract?” Cohen suggests that terms include performance-based contracting. This model is based on actual performance of the systems. For example, a performance-based contract might be based on the amount of time big-ticket items like jets are in use without requiring repairs.

In an earlier article by the Wharton Aerospace & Defense Report, Cohen noted that this model allows the interests of the government and the contractor to be more closely aligned. "The Defense Department (DoD) doesn't want to be responsible any more for maintaining its weapons systems," said Cohen in the earlier article. "The DoD wants the supplier to maintain them and it wants to pay the supplier for the value that it gets from using those products—not for resources required to maintain them."

More generally, Cohen suggests a mix of contract types. That mix could evolve from heavy on cost plus to heavy on fixed price as programs mature, grow in scale and as uncertainty declines.

Cohen has spent the past several years researching such ideas with Sang-Hyun Kim, a professor at Yale University's School of Management, Wharton operations and information management professor Serguei Netessine, and Wharton doctoral student Jose A. Guajardo. According to the researchers, they now have breakthrough evidence that supports performance-based contracts, which they outline in a forthcoming paper titled, "Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis." A Knowledge@Wharton story on the study can be found by following this link.