Redstone_-_The_Inherently_Evil_Cost-Type_Contracts

Although there is a “time to every purpose under heaven” (lyrics to the song Turn, Turn, Turn, by the Byrds) including a time and purpose for Cost-Type Contracts (FAR 16.3 Cost-Reimbursement Contracts), do not try to sing this song to Senator John McCain (Chairman of the Senate Armed Services Committee or SASC). In application to cost-reimbursement contracts, Senator McCain recently referred to cost-plus contracting as “an evil that has grown and grown and grown over the years, and I will not stand for it on any weapons system”.   In support of his statement, there is a long history of significant cost overruns on major weapons systems which all started with cost-reimbursable developmental contracts. Unfortunately, comparing original cost estimates with final program costs, i.e., computing the percentage of cost growth, is a very simplistic and incomplete statistic noting that developmental contracts are just that, conceptual and lacking anything approaching a well-defined statement-of-work. As such, these agreements are not exactly candidates for a firm-fixed price contract (FAR 16.2), unless the prime contractor is naïve and/or reasonably sure that its risk will be mitigated by an endless series of change orders and requests for equitable adjustment for each and every change to the statement of work.   As a point of reference explaining why a contractor should not be overly optimistic in terms of accepting a fixed-price contract with an ill-defined statement of work, one only needs to read the decision in US CoFC Nos. 13-55C, 13-97C, filed August 18, 2015.  In particular, the judge rejected the contractor claim for increased costs noting that the contractor voluntarily assumed the risk of a firm-fixed price contract, albeit with an “unusually high risk” attributed to the ill-defined statement of work.

Long Range Strike Bomber 

The impetus for Senator McCain’s most recent anti-cost-type contracts comments is the Air Force announcement of the contractor selection for the new Long-Range Strike Bomber (LRS-B or now the B-21) along with the fact that the $58.4 billion program will involve an initial cost-reimbursable developmental contract (a contract type prone to cost overruns).

Senator McCain is on point with his observation that a competitively awarded cost-reimbursable contract doesn’t really serve the intended purpose of competition (to reduce the price to the Government). As demonstrated by a number of bid protests involving government cost realism evaluations, competitively awarded cost-reimbursement contracts actually increase the risk of understated cost estimates.   In fact, contractors who intentionally understate cost estimates run the risk of a government assertion that such actions violate the False Claims Act.   The fundamental issue, a cost-reimbursable contract may have an initial cost estimate, but the contractor is only compelled to perform up to the Limitation of Costs or Limitations of Funds (FAR 16.306(d)(1)). Thus, the Government is, theoretically, at risk of spending significant funds to obtain nothing in return and/or the more likely scenario of continuously adding funding to obtain the desired product.

Although Senator McCain and any others objecting to cost-reimbursable contracting have some validity to their expressed concerns, it is unlikely that there will ever be a time when he/they block the use of cost-reimbursable contracts on any/all weapons systems. The more likely outcome will be increased internal reviews, higher levels of approvals and after-the-fact compliance reviews by the DOD-IG or the GAO. In 2013, the DOD-IG issued two reports citing Air Force and Army contracting personnel, respectively, for failing to comply with the documentation requirements before issuing cost-type contracts as required by the 2009 National Defense Authorization Act. The DOD-IG recommended: (i) more training; (ii), the use of more hybrid contracts; (iii) transitioning to fixed-price contracts earlier in the process; and (iv) administrative recommendations—specifically requiring contracting officers to document a contractor accounting system adequacy determination (or more accurately, better document that determination) and the contracting officer/agency’s ability to improve monitoring of contract performance.

Fact or Fiction: Government Risk under Cost versus Fixed Price Contracts

Although cost-reimbursable contracts shift risks to the Government (in comparison to fixed-price contracts), the fact is that cost type contracts are anything but risk-free to contractors.   A cost incurred is not automatically a cost recovered, thanks in part to the ever-expanding list of unallowable costs in FAR Part 31, coupled with more aggressive DCAA after-the-fact audits. Reference is invited to the DOD-IG Semi-Annual Reports, Appendix H, Audit Reports with Significant Findings.  

Lastly, when attempting to differentiate fact from fiction, or pre-conceptions from reality, one might consider empirical data. In the context of controlling costs and cost growth on DOD weapons systems, in June 2013, a DOD Study on Major Weapons Systems concluded that there was little or no difference among contract types.   Stated differently, in and of themselves, cost-reimbursable contracts do not result in a higher risk of cost growth in comparison to fixed-price contracts. Obviously, one can selectively identify individual programs which support a hypothesis that cost-reimbursable contracts are high risk in terms of cost growth, thus evil, thus unacceptable. However, doing so requires one to ignore empirical data.   Nothing unique about that in application to statements by elected officials or those seeking office.    

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Written by Michael Steen

Mike Steen is a Senior Advisor with Redstone Government Consulting, Inc. and a specialist in complex compliance issues to include major contractor cost accounting & business system regulations, financial compliance, resolution of DCAA audit issues, Cost Accounting Standards application, litigation support, and claims preparation. Prior to joining Redstone Government Consulting, Mike served in a number of capacities with DCAA for over thirty years, and upon his retirement, he was one of the top seven senior executives with DCAA. Mike Served as a Regional Director for two DCAA regions, and during that time was responsible for audits of approximately $25B and 800 employees. In October 2001, he was selected for the Senior Executive Service and in 2006 he received the Presidential Rank Award. During Mike’s tenure with DCAA, he was involved in conducting or managing a variety of compliance audits, to include cost proposals, billing systems, Cost Accounting Standards, claims, defective pricing, and then-evolving programs such as restructuring, financial capability and agreed-upon procedures. He directly supported the government litigation team on significant contract disputes and has prepared and presented various lectures and seminars to DCAA staff and business community leaders. Since joining Redstone Government Consulting in June 2007, Mike has developed and presented training and seminars on Government Contracts Compliance to NCMA, Federal Publications Seminars and various clients. Mike also is a prolific contributor of written articles to government contracting publications, as well as to our own Government Insights Newsletter. Mike also serves as the director of our training service offerings, with responsibilities for preparing and developing course content as well as instructing our seminars to clients and general audiences throughout the U.S. Mike also serves as a faculty instructor for the Federal Publications Seminars organization. Education Mike has a BS Degree in Business Administration from Wichita State University. He is also a graduate of the DCAA Director’s Fellowship Program in Management, and has a Masters Degree in Administration from Central Michigan University. Mr. Steen also completed a number of OPM’s management and executive development courses.

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Topics: Contracts Administration, Defense Contractors