Buying the unknown, pricing the unknowable

This article will likely confuse most of the procurement staff in local and municipal and probably state governments. It does not fit their typical need. Most things purchased, whether supply, service or work of construction, at local levels are standard commercial products. When you don't have to invent the wheel, there is no need to re-invent it either. Keep it simple and stick to what you know.

But, when developing new products, other acquisition paradigms come into play. No one size fits all and an inflexible means of achieving the acquisition will frustrate the goal. That is my take away from the following article, which I digest below, and which itself is a review by Sandra I. Erwin of a more extensive journal article by Frank Kendall, US Under Secretary of Defense for Acquisition, Technology and Logistics titled "Use of Fixed-Price Incentive Firm (FPIF) Contracts in Development and Production". You have the links, so pick your poison.

Pentagon Acquisition Chief Warns About Misuse of 'Fixed Price' Contracts

Kendall's latest policy guidance tells procurement officials to use "appropriate" contract types. "Unfortunately, sorting this out is not always easy," Kendall writes in the March-April 2013 issue of the Defense Acquisition University journal.

A shift toward fixed-price contract began during the second half of President Obama's first term. Pentagon officials had become increasingly frustrated as too many programs got started and “we find out later on that they were unaffordable,” Kendall says in a February 2012 speech. He cites fixed-price contracting as one of several contracting trends that are embraced and rejected in cycles. In the past two decades, he says, “We have been for-or-against fixed price contracting four or five times."

Kendall's rulebook, known as Better Buying Power, has been interpreted as a mandate to avoid "cost-plus" arrangements where the government agrees upfront to pay a vendor to design a product before it has determined its final price tag.

In the article, titled, "Use of Fixed-Price Incentive Firm Contracts in Development and Production," Kendall cautions buyers that there is no simple benchmark to select a contract type. "The choice of appropriate contract types is very 'situationally' dependent," he says.

Kendall suggests that even though fixed-price contracts do relieve the government from taking on all the risk in a program, if not used properly, such deals could backfire and lead to unneeded court battles.

"Fixed firm price development tends to create situations where neither the government nor the contractor has the flexibility needed to make adjustments as they learn more about what is feasible and affordable as well as what needs to be done to achieve a design that meets requirements," he says.

A fixed-price contract is basically a government “hands off” contract, he adds. "While we can get reports and track progress, we have very little flexibility to respond to cases where the contract requirements may be particularly difficult to achieve."

Shifting the risk to contractors should not be seen as the antidote to the Defense Department's poor track record in predicting costs, Kendall notes. The average EMD (engineering, manufacturing, development) program for a major defense acquisition over the last 20 years has overrun by nearly 30 percent. "Industry can only bear so much of that risk," he says. "It is unrealistic to believe contractors will simply accept large losses. They will not. ... Industry has a finite capacity to absorb that risk and knows how to hire lawyers to help it avoid large losses."

In most cases, says Kendall, there needs to be a "fair sharing" of the risk and rewards of performance. "For good reasons, I am conservative about the use of fixed-price development, but it is appropriate in some cases."

“The government rarely knows what it wants with sufficient specificity to support reasonable fixed prices for evolving, complex or sophisticated products to be delivered years later,” charges John Chierichella, a government contracting attorney at the law firm of Sheppard, Mullin, Richter & Hampton LLP.

He predicts the “latest federal fascination with fixed prices will end like the others — badly — with delayed fielding of the products, contractors deeply damaged by inadequate cash flow, increased claims and litigation, and focused “bail outs” in which the government decides which of the wounded contractors deserves triage.”