By Geoff Fein
As the Navy and Congress discuss the potential for moving defense contractors to fixed price contracts, all sides need to really examine the risks associated with programs to make procurement efforts more cost effective, according to a Northrop Grumman [NOC] official.
The current environment considers any sort of cost increase an overrun and bad performance, Mike Petters, president of Northrop Grumman Shipbuilding, told Defense Daily last week.
To stop that from happening, the Navy says it is going to make the effort a fixed price type contract, thus preventing industry from coming back later if they are overwhelmed, he said.
“That, at the surface, is what is going on. What really happens, though, is that you come through these contract types, and contract types are secondary to the discussion about how we are going to allocate risk on a program,” Petters said.
“If you have a program that is very mature in series production, you know what you’re doing, the customer knows what you’re doing, you have a mature team and a mature product, you can go to fixed price and that’s good for the customer and good for the company, too,” he said. “I am not afraid of fixed price contracts.”
But if the program is a developmental project with unknown risks and there is an attempt to make it a fixed price contract, no one can blame the contractor if he says it is going to be expensive, Petters said.
“If you are going to put all the risk on me for a product I do not understand the risk register on, you can’t blame me if I tell you the price is pretty high,” he added. “That’s the nature of the beast.”
What the Navy and industry really ought to be discussing is not what the contract type is, Petters said, but how mature is the product, how well is the risk understood. “If we really understand the risk register, then we can move to a fixed price environment.
“If we don’t understand the risk register, then it might be more cost effective to keep it in a cost type [environment] because I can guarantee you, if you put me in an environment where the risk register is undefined and you are going to force me to take a fixed price [type contract], I guarantee you, you will spend more money,” he added. “Because I would push that [cost] all the way up on the front end.”
If the Navy and industry do a cost type contract and share that risk, at the end of the day, the customer is only going to pay for what is done, Petters said. “So the discussion of the risk is what we really ought to be talking about.”
The real challenge, he noted, is that there is a budget process that feels fixed price.
“If you go through this process, it’s all about how much budget is there and what are the expenses against that budget,” Petters said. “But we look at our business from an investment return perspective. How much am I going to invest in this product and how much return am I going to get out of it?”
The acquisition community has to bridge having a fixed price budget environment and a risk sharing, investment return, acquisition environment, Petters said. “I think one of the things that is missing is that we–all of us–don’t do a very good job of communicating back to the taxpayers what risks there are.
“We take on a project that’s fraught with technological risk and both the company and the government decided that because there is so much risk in this project we are going to go down a cost type contract. So we sign a cost contract for the budget,” Petters said. “When we have done that, we’ve said here is how much risk we have got and if we retire all that risk, we will come in under budget.”
So now industry begins working on the project and is able to retire 80 percent, 90 percent of the risk, he said. “We invent stuff to get us to the finish line there. We retire 90 percent of the risk. We [then] have to go back to the taxpayers and say ‘you know what, we have to share the other 10 percent…’ and we are bums.”
That’s why industry and the customer have to do a better job of explaining how much risk there is in this program as it goes forward, Petters added.
“Now the challenge is, in our environment today, if you say you have a program that’s got a little bit of risk in it, suddenly the desire to participate in that program diminishes,” he said. “There has to be a level of maturity that says, ‘we can have a mature conversation about here is where we think the risks are, here is where we think the challenges are.’ We need to communicate that, so when the taxpayers agree to commit national resources to this project they understand there is a risk sharing element to it.”
The contract type, whether cost plus or fixed price, will come out of those discussions, Petters added.
“But the real discussion has to be, ‘what are we really signing up for, how many things do we have to accomplish to get this done; is it okay if you get eight out of 10?’ The environment we’ve been in with all the lead ships we have under construction, the environment we have been in is, if you don’t retire 100 percent of your risk, 100 [percent] successfully, you guys are bums.”