APPENDIX A

ACQUISITION MANAGEMENT ISSUES

As noted earlier, there has been extensive public and congressional interest over the last two years in the defense acquisition process. The purpose of this study is not to consider all of the issues related to that process. Nevertheless, because of the substantial interest in defense procurement generally, a brief identification of organizational issues related to defense acquisition would be useful. While this appendix will identify problems, questions, and issues, it is not intended to reach conclusions or to present solutions.

1. COST OF WEAPON SYSTEMS

One of the most fundamental concerns about defense procurement is whether weapon systems are being purchased at minimum cost. There are any number of reasons that a system may cost more than it should. First, the military requirement may be excessive. In other words, the Service responsible for establishing the requirement may have specified more capability than that which is necessary to meet the expected threat and defined mission need. Second, the equipment actually procured may exceed the requirement to a greater extent than is desirable. Third, the design selected for a weapon system to meet the requirement may be relatively more costly to build than other possible designs. This may be true either because the design is unduly complex or because the design does not accommodate economic manufacture. Fourth, the production process used by the contractor may not be optimal from a cost standpoint. Fifth, the contractor may simply fail to achieve performance goals in production. Many of the acquisition problems discussed later in this appendix also have an impact on weapon systems cost.

There has been renewed attention to this issue as a result of the recent release of a study by the Contract Management Division of the Air Force Systems Command. The study reported conclusions from a comparison of the actual performance of several defense contractors with the standard work hours of certain manufacturing operations. Though there is some dispute about the methodology of this study, it concludes that the actual hours spent in the production of those weapon systems examined was substantially in excess of the standard hours.

Because the United States has a numerical disadvantage in most weapon systems when compared with the Soviet Union, and because substantial Federal budget deficits may severely constrain defense budget growth in the foreseeable future, acquiring weapons at minimum cost is critically important. Lowering the unit cost of comparable weapon systems is directly translatable into greater

quantities and thus additional military capability. The challenge, therefore, is to define military requirements which are appropriate but not excessive; to meet, but not unnecessarily exceed, the requirement; to select a design which is less costly than competitive alternatives; to optimize the cost of production lines; and to ensure that production workers are encouraged by incentives to meet or exceed production standards.

Of course, there are a number of other factors which affect contractor cost. Does the contractor have sufficient incentive to make capital investments which will lower overall production costs? Is the quantity procured annually generally an economical quantity for production purposes? Does the contract reward the contractor for cost-savings and thus create tangible incentives for efficient operation?

Finally, there has been extensive interest in the last year in overhead costs incurred by contractors and charged against contracts. Specifically, there has been a concern that government regulations on the types of general and administrative costs which the government will pay are too vague and that the system for the submission, audit, and final settlement of such costs is inefficient. Legislation to address these concerns was part of the Defense Procurement Improvement Act of 1985. (At the time this study went to press, the conference report on the fiscal year 1986 defense authorization bill, which included the Defense Procurement Improvement Act of 1985, had been passed by the Senate and was awaiting action in the House.)

2. COST ESTIMATING AND "SHOULD COST" STUDIES

The Department of Defense performs two substantially different types of cost estimating. The first type is the estimate of the likely cost of the weapon system done during its development. This type of cost estimating is essentially for budgetary purposes to facilitate decision-making on the long-term affordability of a particular program. The congressional emphasis on independent cost estimates over the last several years, as well as the work of the Cost Analysis Improvement Group (CAIG), has largely been focused on this type of cost estimating. Such cost estimating efforts try to determine, for example, at the stage of concept exploration and then at subsequent stages into and through full-scale development what the cost of developing, procuring, and supporting a particular system is likely to be.

A different type of cost estimating relates to efforts of the Department to know what a contractor's production cost should be for a particular system that is already in production. These "should cost" studies generally require a very large, multi-skilled team, with substantial technical expertise, to actually go into a contractor facility to independently ascertain whether the manufacturing operation is relatively efficient or can be improved.

The Congress has also had an interest in the second type of independent cost estimating. A provision in the Defense Procurement Improvement Act of 1985 would require the Secretary of Defense to develop an annual plan identifying those major weapon systems for which "should cost" studies are to be performed in any given year.

The need for independent, accurate cost estimates of both types described here is apparent. The challenge is to develop mechanisms that will provide the Department with an enhanced capability to develop accurate estimates both of the long-term budgetary type and of the "should cost" type.

3. COMPETITION

There have been few subjects that have received as much congressional and public attention as that of competition for weapon systems and spare parts. In 1984, the Competition in Contracting Act was enacted into law (Public Law 98-369). This measure made substantial changes to federal procurement law in order to limit those circumstances under which non-competitive procurements were permitted. In addition, the Congress passed the Defense Procurement Reform Act of 1984 (Public Law 98-525) and the Small Business and Federal Procurement Competition Enhancement Act of 1984 (Public Law 98-577), both of which included numerous provisions that were intended to permit the government to compete a larger percentage of procurements by DoD and other agencies.

If structured properly, competition offers the opportunity to reduce cost. Concern is sometimes expressed that competition for major weapon systems in DoD may place relatively too great an emphasis on the technical quality of proposals and other non-price factors, while placing insufficient emphasis on the price that is of fered. A properly structured competition should ensure that the government obtains the lowest price for comparable items.

The interest of the Congress in promoting competition has also been evidenced by legislative provisions to establish competition advocates within the Services. The Services have established competition advocates in every buying command. Though there is some concern about the large number of individuals who have been committed to this effort, there is nevertheless preliminary evidence that competition advocates are having a salutary impact in promoting competition in instances where it was not previously being achieved.

There is also substantial concern over the appropriate amount of competition at different stages in the procurement process. For example, at concept exploration it would be desirable to have extensive competition and to permit competitors to submit widely varying proposals for meeting identified mission needs. The number of competitors will usually have to be reduced as the process proceeds through demonstration, validation, and full-scale development. In many cases, only one full-scale development source has been funded, and there is often only one production source funded for major weapon systems.

There has also been a long-standing interest in the question of whether or not competitive prototypes should be produced in development for the purpose of selecting a production source. For example, the Blue Ribbon Defense Panel in 1970 included among its recommendations the greater use of competitive prototypes and less reliance on paper studies. Though there are obvious advantages to competing actual prototypes, it is apparent that this is very costly. Recently substantial emphasis has been placed on trying to obtain dual source procurement of major weapon systems, where it

appears economical to do so. Under dual source procurement, two contractors are maintained throughout the period of time in which the system is acquired, with an annual competition between the two contractors. Some of the benefits of dual source procurement can be obtained even where similar (but not identical) items are purchased, as is the case with the current Air Force aircraft engine competition.

Provisions of the Defense Procurement Improvement Act of 1985 establish a presumption of having two sources in both development and production unless certain criteria for exception are satisfied. It is apparent that significant congressional attention to the need for greater competition continues, and a strong view predominates in the Congress that competition has numerous benefits in addition to the cost-saving opportunities that it provides.

4. SOURCE SELECTION PROCEDURES

The present source selection process involves the establishment by the buying command of evaluation criteria for proposals. Typically, the evaluation criteria will include such elements as the quality of the technical proposal, the management of the proposer, integrated logistical support that can be provided, and cost. The risk of a proposal is also carefully evaluated. These selection factors may be weighted in whatever manner is agreed upon in a buying command.

There are a number of questions that are periodically asked about the source selection process. For example, there is an interest in whether greater emphasis should be placed on the prior performance of contractors in source selection. There is also a concern about whether designs chosen in source selection give appropriate consideration to manufacturing factors, reliability, maintenance, production cost, and life-cycle cost.

There is always a concern in the source selection process about "buy-ins." A buy-in occurs when a contractor bids less than it anticipates its costs are likely to be under the contract, with the expectation that it will make the program profitable either through changes in the initial contract or through subsequent contracts.

Dealing with appropriate trade-offs between technical excellence and cost; ascertaining how to treat prior performance; and preventing buy-ins are all challenges of the source selection process. Source selection procedures should also encourage alternate design proposals during the development of the concept of a new major weapon system.

5. CONTRACTOR PROFIT

There is always interest in the appropriate level of profit which defense contractors earn. Since the defense procurement process is based upon virtually all major weapon systems being developed and produced by private industry, it is necessary to permit contractors to earn a sufficient profit to attract equity capital. At the same time, there is a justifiable concern that profits earned by defense contractors not be excessive.

The Department of Defense has recently released a Defense Finance and Investment Review (DFAIR) study. This study considers