Halibut Hangar

Originally Published May 15, 2009; Updated and Republished May 26, 2009; Updated and Republished June 09, 2009:

On those rare occasions that the Navy, contractors and their patrons "demand" the use of an FPI (Fixed Price Incentive) defense contract it’s usually in response to exogenous outrage². It would be a gross mistake to assume that this "demand" for an FPI contracting vehicle changes the symbiotic and incestuous dynamics of the Navy, contractor and patron relationship...

In most cases it's just a method of quelling the latest cycle of exogenous outrage, usually over the enormous weapon system costs and under performance (which is always classified) until the latest cycle of outrage subsides—while continuing the relationship and business as usual.

Here is how FPI contracting for major weapon systems "works"¹ in general and Virginia-class submarine is unlikely to be the exception:

The Navy announces outrage at the contractor's continued cost overruns and under performance. The Navy and patrons threaten cancellation if something isn't done to stop the "outrageous cost growth" (they never say overrun). The contractor pleads a thousand reasons why the undefined specification, performance requirements, schedules, late GFE etc. caused the overrun and under performance—warning that an FPI contract is not a suitable vehicle because of the risk.

However, if the Navy and patrons insist on an FPI contract the customer is always right and the contractor will reluctantly convert to or accept an FPI contract—since so much risk has now been shifted to the contractor it will have to price that risk into the new FPI contract...a gigantic estimated risk premium soon follows.

The Navy and patrons publicly scream bloody murder when they see the gigantic number for the "risk premium" and again threaten cancellation of the weapon system—but now both the Navy and patrons have the true cost of using the FPI contracting vehicle—that is the amount the contractor believes is eventually required to restore and maintain the business and relationship as usual.

After the Navy and patrons publicly screaming bloodying murder and express public outrage at the "enormous risk premium” the contractor "capitulates", drops most or all of the risk premium, and accepts an FPI contract at the “required target price”. The "required target price" is defined as the price necessary to quell the exogenous outrage and enable the weapon system to avoid cancellation (the "required target price" is focused on quelling the exogenous outrage not the true or eventual cost of the weapon system).

The Navy, contractor, and patrons promptly announce, promote, and laud the new target price, pronouncing the weapon system affordable...everybody is happy and the exogenous outrage subsides...then the first and subsequent change orders arrive...change orders on a complex weapon system are unavoidable.

The exogenous outrage having been abated the contractor now proceeds to incrementally recoup the previously announced but rejected FPI "risk premium" over the sequence of subsequent change orders.

In effect the contractor has made a long term loan to the Navy and its patrons which is then incrementally recouped and repaid with each change order over the life of the FPI contract—everybody is happy until the next cycle of exogenous outrage.

Sometimes the Navy, contractors, and patrons are challenged by knowledgeable, talented, and aggressive estimator(s), auditor(s) or negotiator(s) who are not “team players”. They will get another “more challenging” assignment and sometimes promotion compatible with their valued knowledge, talent, and skills as estimators, auditors, or negotiators.

If an inspector general (IG) gets involved that usually signals a whistle blower or Qui Tam preceding which the Navy, contractor, and patrons take very seriously. The Navy, contractor and patrons will together individually and jointly attack the whistle blower while temporarily turning their efforts toward damage and fallout assessment should the IG investigation continue and subpoenas begin arriving.

Res:

• UPDATED 06/09/2009 SecDef, Acquisition and Technology

• Defense Acquisition University.

  Wonder what the impact of world-class acquisition training is if an admiral's next career is to use the resources of the defence contractor to "pitch" the gee-whiz value of the latest weapon system to his former colleagues?

  It might also be useful to assess the impact with respect to the stock portfolios for members of entities like the Defence Acquisition Board, too.

Web:

• UPDATED 05/26/2009 Thomas, Weapon Systems Acquisition Reform Act of 2009. President signs act on May 22, 2009.

-----notes-----

1. In the context of quelling public outrage and maintaining existing relationships and business as usual—not the technical aspects of FPI contracting which are quite fascinating and can be extraordinarily complex and challenging when used and structured properly.

One of the "convenient" attributes of switching from a cost plus to a fixed price contract structure is that it enables the contractor (and indirectly the Navy and patrons) to argue that cost disclosure and auditing are now irrelevant. Convenient because it comes at a time when cost (usually greatly overrun costs) are most relevant and at issue.

The logic is the contractor has agreed to deliver the line item (submarine) for a fixed price so what's to disclose or audit. In most cases their argument has limited success, as there are other reasons and methods of reaching the same cost data. However, the logic cannot be completely ignored.

2. UPDATED 05/20/2009 Of course there is plenty of endogenous outrage too.

Decisions on what weapon system(s) to cancel, delay, rescope, or restructure because of an overrun(s) are not pleasant for the Navy, contractors, or patrons, particularly if the overrun(s) have little or no prospect of eventual funding.

However, the endogenous outrage among Navy, contractors, and patrons is independent from quelling the exogenous public outrage—like most "family outrage" the endogenous outrage strains, but rarely fractures a major weapon system relationship.