The Advantages and Disadvantages of Price Based Contracting Methods

Comparing the Advantages and Disadvantages of Cost-Based and Price-based DoD Contracting Methods

For several years, the Department of Defence has primarily relied on cost-based proposals for most of its contracting processes. This emphasis has dramatically influenced the imposition of specific accounting systems, lost focus on the best value, and extensive auditing. Commercial markets are increasingly driving the rate of change and adoption of technology.

Hence, the intensity of investment in and the focus on new industrial methods in product design, manufacturing, and development processes is ahead of the defense system producers. The Department of Defence (DoD) uses primarily two contract types to acquire powerful weapons systems. These are the price-based contracts and the cost-based contracts. Price-based contracting methods, commonly referred to as price-based acquisition, is a significant acquisition reform or measure seeking to reduce the costs while enhancing the efficiency of purchase.

The central idea or concept of this reform measure is the procurement of services and goods via a market pricing approach that is commercialized, rather than the commonly used or the traditional cost-based DoD contracting approach that is heavily regulated and uses the pricing data or the certified cost of goods and services (Will, 1999).

On the other hand, in cost-based contracting or cost-based acquisition, the development and production price depends on the cost data or pricing data that the contractor is required to provide by the government. Critics of the CBA approach see it as an imposition of heavy regulatory burdens on the contractor and the government and discourages competition for government contracts by potential non-defense contractors. This reduces the quality and competition and instead increases the cost.

On the contrary, the PBA approach is seen as purchasing goods and services without primarily relying on the contractor or supplier to provide the cost data. It, therefore, results in a firm-fixed-price that is reasonable and fair (Will, 1999).

Presently, many senior officials of the Department of Defence advocate for the PBA contracting approach as the best means of improving schedule, cost, and performance outcomes. It has continuously been viewed as the highest potential and effective acquisition practice best for reduced weapon systems’ costs and schedules and enhanced quality.

Service acquisition officials and other senior DoD officials have in the past advocated for increased adoption of price-based acquisition approach. The DoD has considered using this approach for its major defense acquisitions for years. Because of this, the interest in making the acquisition system more cost-effective has intensified since the late 1980s.

Over the years, the DoD has developed and used the Cost-based approach that mandates the contractors to provide the cost or pricing data for informed decision making regarding the amount to be paid for any weapon system (Euske & Wang, 2012). This creates additional work for the evaluators who analyze what is submitted in every contractor’s proposal and the contractor who needs to provide the pricing or cost data in detail. Proponents of the PBA approach have argued that this approach alleviates such problems by providing an alternative of higher quality, shorter schedules, and reduced costs.

The primarily emphasized benefit of the PBA is reduced cost. It has been proven to reduce the prices for the DoD procurements via mechanisms categorized as enhanced CMI, share in savings, and reduced overhead (Euske & Wang, 2012). In addition, this approach eliminates the cost-premium imposed by the DoD on the industry through certification, cost reporting, and cost accounting, among others necessary when dealing with CBA procurements.

Proponents of the PBA approach have also said that this approach saves government resources such as money since it eliminates the need for price and cost analysts on top of any other expert to conduct audits, assess cost data, and evaluate proposal tasks.

PBA approach is also associated with shorter schedules and higher quality. On top of the reduced costs, this approach has been proposed to enhance more excellent quality of programs and shorten schedules. The shortening of schedules results from removing the burdensome cost reporting by contractors and analysis on the government side, typical of the CBA approach.

Shortened schedules result from the greater efficiencies that arise due to the use of a more commercialized system and exploitation of the NDIs and commercial technologies that exist. Increased access to commercial processes and technologies coupled with the introduction and encouragement of more competitors, both from large and small civilian and commercial competitors, enhance military defense products’ performance and quality (Euske & Wang, 2012).

The critics also ascertain that most civilian commercialized companies that don’t specialize in the DoD procurements are prevented from participating in government contracts because of the disclosure burdens and the cost collection burdens. This is also brought about by the potential legal issues raised by TINA.

The proposers of the PBA further contend that most of such companies are firmly against the ability of the DoD to audit and fix the profit margins received by contractors and find their data to be competition and proprietary sensitive. Such a situation denies the DoD access to the processes and technologies from the commercial sector and reduces competition. The requirements for the CBA are so burdensome that only the most significant and most decisive defense contractors with extensive accounting and legal offices compete for the government contracts.

On the other hand, price-based acquisitions (PBA) mandates the government to provide a fair market price for the items and services whenever possible (Euske & Wang, 2012). This encourages smaller companies to also compete for the government contracts of defense work, and concurrently, there is a reduction of the initial programs’ costs. When smaller commercial companies compete for government contracts, the result would be the government gaining even greater access to higher quality and less expensive commercially developed technologies and items.

Despite the advantages that the PBA approach has over the cost-based approach, it remains controversial. Many individuals within the acquisition community are continuously questioning the scale and the means of the claimed benefits of the PBA contracting approach. As such, numerous significant challenges have been advanced, including potential pitfalls that arise from using the mentioned approach.

The most important critique of this approach lies in its assumption of the market dynamics and the market structure that is non-existent in the defense marketplace for commercial items that are non-civilian, specifically for the primary source of defense-unique materials or items.

In addition, the lack of empirical or systematic data concerning how the PBA approach is implemented makes it extremely difficult for policymakers to know whether it eventually holds the claimed benefits and the truly existing challenges. This cannot be said about the CBA contracting approach since, with this approach, there exists empirical pricing data (Lorell, Graser & Cook, 2005).

The contracting officers rely on certified pricing or cost data with the CBA approach mandated by TINA requirements. The pricing and cost data are usually provided by the contractor and are used in decision-making as far as establishing reasonable and fair prices is concerned. Many critiques of this approach, however, find this as a disadvantage.

Many say that this approach imposes time-consuming and costly regulatory burdens on the contractors and the DoD analysts since they have to collect and assess the data provided and determine if they are reasonable and fair. This will eventually lead to unnecessary cost premiums that lead to the increment of the DoD procurement prices and mandates the contractors and the government to maintain an expensive and extensive support system for the cost collection, analysis, auditing, and reporting, as well as for contract management (Grady, 2016).

On the contrary, many proponents of the PBA approach claim that some procedures and cultures have developed in the Department of Defence that need more cost data than are necessary. They claim that this adds to the workload on contractors and DoD analysts. On the contrary, they find the adoption of the PBA approach as the best method since it reduces cost and increases performance.

Also, the CBA contracting provides few incentives to the defense contractors. This is because the contractor’s profits under this approach are primarily determined as a proportion of the total contracting cost as a percentage. As a result, if a contractor desires increased profits, they must have an incentive to determine why a system or item was expensive instead of reducing costs. This is where the most significant advocate for adopting PBA lies. Proponents of this approach claim that the price-based DoD contracting method motivates contractors to cut costs to share their savings. They claim that with PBA and in the commercial world, the contractor would have to sell material for the pre-determined price by the market and not by the individual buyer or seller. Therefore, there will be higher profits because the contractor will be driving their costs to go below the market price. Based on this, the proponents claim that this approach will continuously motivate contractors to continuously reduce their costs below the pre-determined price, whether determined by a contract or market forces (Grady, 2016).

Using the CBA approach can also lead to wastage of time. This is because the price data and cost data are usually certified according to the “Truth in Negotiations Act (TINA)” requirements. This bill was passed in 1962 by the United States Congress and is the central piece of legislation that provides the legal framework for the contractors providing certified pricing data or cost data in “large sole-source military-unique” procurements.

In addition, the CBA process might take longer because the TINA implementation is a lengthy process with extensive documentation requirements for both the DoD analysts and the contracting officers. According to the TINA requirements, the contracting officers must certify that every cost recorded in the proposals is complete, current, and is accurate.

Legal liabilities that accompany TINA requirements would further arise in a situation where the government (who has extensive auditing rights) later discovers that the certified pricing data or cost data recorded in the proposal were not complete, current, or accurate. Should such a situation occur, the contractor will be liable for any criminal and civil penalties and fines imposed.

Furthermore, using the PBA approach makes it difficult to measure the exact effects on cost or the schedule in most programs of the DoD acquisition reforms. This is primarily because this approach has never been implemented as an individual policy initiative. On the contrary, it is implemented in conjunction with other different policy reforms. This makes it even more challenging to isolate the effects solely attributed to this approach from those of the companion reform measures and other aspects of the same program unrelated to this method.

In addition, the DoD does not provide any direction to track schedule or cost savings from PBA. As a result, neither the DoD nor the contractors collect such data. On particular types of programs that have a long-term pricing agreement, eliminating the TINA requirements for the CBA approach and using the PBA approach have been proven to reduce the workload for both the contractor and the government, even though it is on a small scale. However, this comes as a disadvantage. This is because the scale of such reductions cannot be easily quantified (Lorell, Graser & Cook, 2005).

Moreover, eliminating every cost data requirement does not necessarily save the workload; instead, it brings about significant difficulties for contracting officers who are mandated to determine reasonable and fair pricing and the analysts. It is also difficult to detect the role played by PBA single-handedly in the increment of contractor incentives to reduce cost.

PBA approaches may cause the reduction of prices when combined or integrated with the use of charge (as an independent variable) competition and mechanisms that allow contractors to share savings. Without this integration, PBA approaches alone might be the least important amongst such measures regarding cost reduction. This is because it cannot automatically produce such measures primarily. After all, the military category lacks the competitive market forces possessed by the commercial sector. Furthermore, contractors don’t mainly require the PBA in implementing such cost-saving incentives and measures.

Even though the PBA approach has a high probability of shortening various aspects of the oversight and the contracting process, there has been no clear evidence of it shortening the period of acquisition schedules. Every contract award needs market research. However, the market research done when using the price based acquisition approach puts so much burden on the cost and price analysts of the department of defense and the contracting officers since they must determine a reasonable and fair price without the help of either the estimated or the actual cost data that the contractor provides when using the cost-based acquisition approach.