Cost-Based vs. Price-Based DoD Contracting: Pros and Cons

Introduction to DoD Contracting Approaches

For several years, the Department of Defense (DoD) 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 best value, and led to extensive auditing. Commercial markets are increasingly driving the rate of change and adoption of technology.

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

The central concept of this reform is the procurement of services and goods via a commercialized market pricing approach, rather than the traditional cost-based DoD contracting approach, which is heavily regulated and relies on certified pricing data or certified cost data for goods and services (Will, 1999).

In cost-based contracting, or cost-based acquisition (CBA), the development and production price depends on the cost data or pricing data that the contractor is required to provide to the government. Critics of the CBA approach see it as imposing heavy regulatory burdens on both the contractor and the government, and argue it discourages competition for government contracts by potential non-defense contractors. This dynamic reduces both quality and competition while increasing cost.

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

Presently, many senior DoD officials 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 acquisition practice for reducing weapon systems costs and schedules while enhancing quality.

Advantages of Price-Based Acquisition

Service acquisition officials and other senior DoD officials have in the past advocated for increased adoption of price-based acquisition. The DoD has considered using this approach for its major defense acquisitions for years, and 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, which mandates contractors to provide cost or pricing data to support 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 each contractor's proposal and for contractors who must provide detailed pricing or cost data. Proponents of the PBA approach have argued that it alleviates such problems by offering an alternative characterized by higher quality, shorter schedules, and reduced costs.

The primarily emphasized benefit of PBA is reduced cost. It has been shown to reduce prices for DoD procurements through mechanisms categorized as enhanced commercial-military integration (CMI), shared savings, and reduced overhead (Euske & Wang, 2012). In addition, this approach eliminates the cost premium imposed by the DoD on industry through certification, cost reporting, and cost accounting requirements that are necessary under CBA procurements.

Proponents of the PBA approach have also argued that it saves government resources, including money, since it eliminates the need for price and cost analysts—as well as other experts—to conduct audits, assess cost data, and evaluate proposal tasks.

PBA is also associated with shorter schedules and higher quality. Beyond reduced costs, this approach has been proposed to enhance program quality and shorten schedules. Schedule shortening results from removing the burdensome cost reporting by contractors and analysis on the government side that is typical of the CBA approach.

Encouraging Competition and Commercial Participation

Shortened schedules also result from the greater efficiencies that arise through the use of a more commercialized system and the exploitation of non-developmental items (NDIs) and commercial technologies. Increased access to commercial processes and technologies, combined with the introduction of more competitors—both large and small, civilian and commercial—enhances the performance and quality of military defense products (Euske & Wang, 2012).

Critics of the CBA approach also assert that most civilian commercial companies that do not specialize in DoD procurements are prevented from participating in government contracts because of the disclosure and cost collection burdens involved. This barrier is compounded by the potential legal issues raised by the Truth in Negotiations Act (TINA).

Proponents of PBA further contend that many such companies strongly object to the DoD's ability to audit and fix profit margins and view their proprietary data as competitively sensitive. This situation denies the DoD access to processes and technologies from the commercial sector while reducing competition overall. The requirements of the CBA are so burdensome that only the largest and most established defense contractors—those with extensive accounting and legal offices—typically compete for government contracts.

Price-based acquisition, by contrast, mandates the government to provide a fair market price for items and services whenever possible (Euske & Wang, 2012). This encourages smaller companies to compete for defense contract work and concurrently reduces initial program costs. When smaller commercial companies compete for government contracts, the government gains greater access to higher-quality and less expensive commercially developed technologies and items.

Conclusion

Many PBA contracting approaches for complicated military non-commercial items or materials require some degree of contractor cost data. This is especially true for items purchased in a sole-source environment. Many commercial companies find it useful to analyze cost data provided by their subcontractors and contractors, as it helps ensure appropriate item pricing and encourages cost-saving measures. The significant difficulty faced by the military sector lies in the requirement to collect certified cost data and report on it as mandated by TINA. Numerous options can be employed to provide the government with contractor cost data short of full CBA. Many of these options do not place as heavy a burden on contractors and can yield the advantages associated with PBA.