Hi there! It’s been a minute. Thanks for coming back here.

I have so much to write about—prominently the recent CAS Board activities. Not to mention, DCAA’s CAS cost impact audit guidance that was clearly written by lawyers instead of, you know, accountants or auditors. I’m going to get to all that stuff when time permits. But today I want to talk about people.

It’s crystal clear (in my mind, at least) that when we are discussing the triumvirate “people, process and technology,” people are the most important component. I know not everyone agrees. In June, at the Deltek/ProPricer Government Contract Pricing Summit (where I spoke on the topic of evaluating and negotiating profit), I heard a very well-known speaker assert that technology was the most important component. He said (paraphrasing) “technology is always moving forward; people and process both struggle to catch up.” Okay. He was a former Assistant Secretary of the Air Force and now CEO of an innovative start-up that has a very cool Lord of the Rings-related name, and I’m just me. Who am I to argue with him?

But he’s wrong.

People are the most important thing. Always and forever.

Corporations look to reduce costs wherever possible. All things being the same, reduced costs leads to greater margins. Investors like increasing margins and the increasing profits that result from cost-cutting. We know that’s not always true in the government contracting market space—especially in developmental efforts—where cost-type contracts mean that (generally speaking and with many exceptions), more costs equal more revenue. All things being equal, more revenue leads to a higher bottom-line profit. But most government contractor executives don’t have a clue about government contract accounting rules so they base decisions on what they’ve been taught in business school, which is that cost-cutting is a good thing.

As a result of that logic, they locate their engineering centers and factories in low-cost states, where employee compensation will be lower than in other states. That’s not the only reason—obviously. Political realities ensure that locating facilities in the states of certain politicians gives contractors a boost during budget time. There’s also the matter of locating facilities in states that are not friendly to unions, or that offer lower corporate taxes, or even full-on tax breaks for the right companies. But we don’t talk about that in the 10-K management discussions. Instead, we talk about cost-cutting.

Employee compensation (among other factors discuss noted) is why Lockheed Martin has so much work in Texas, Florida, and Georgia. (LockMart is in many other states, including California and Colorado, but that’s not the point.) Where does Lockheed Martin make the most money? In its Aeronautics Division. Where is that Aeronautics Division headquartered? Fort Worth, Texas.

Employee compensation is why Boeing builds its 787 Dreamliner in Charleston, South Carolina. From Wikipedia—

Boeing announced in October 2009 that it would build a new 787 Dreamliner final assembly and delivery line in North Charleston. Boeing said that the second production line was necessary to ‘meet the market demand for the airplane,’ but it came amid tense negotiations between the company and the International Association of Machinists and Aerospace Workers (IAM) union representing workers in Everett who had recently gone on strike. South Carolina's unionisation rates, the lowest in the country at 2.7%, were stated by Boeing management as a reason to transfer production to there. IAM said the decision was retaliatory and National Labor Relations Board agreed, filing a lawsuit against the company in April 2011. The lawsuit was dropped in December after IAM withdrew its complaint as part of a new contract with Boeing, clearing the way for production to begin in South Carolina. Since then, Boeing has continued to challenge the rights of unions to organize at the plant, and is alleged to have fired workers for their attempts to unionize.

(Footnotes omitted.)

Companies—particularly those who manufacture MILSPEC products—that have an unhealthy, misplaced focus on people tend to have long-term consequences from that manifest years later, long after the executives who made critical blunders in workforce management have left the companies, taking with them millions of dollars of incentive compensation.

Recently, the NASA Inspector General released report number IG-24-015, discussing the management of the Space Launch System (SLS) Block 1B development. The IG had many criticisms of NASA and its lead contractor, Boeing. The one we are going to focus on is NASA’s blunder to locate SLS core stage manufacturing at the 85-year-old plant in Michaud, Louisiana—located in New Orleans.

The SLS program is under cost pressure. In 2011, Congressional testimony estimated that SLS development costs through 2017 would be roughly $18 billion. As of 2017, $11.9 billion has been spent, of which 40% was spent developing the core stage. As of 2021, development of the core stage was expected to have cost $8.9 billion, twice the initially planned amount. (Source: Wikipedia.) The program is behind schedule and faults have been found in the welding of the core stage.

Let’s talk about the welding. The SLS core stage uses a brand-new welding method: friction stir welding. We don’t know that FSW is. All we know is what Wikipedia tells us; we are told that the new process can create unique risks, which can be mitigated by the quality of the tool design.

Okay. NASA decided to build a new core stage for a new rocket at an 85-year-old plant, and to do it with a new welding technology where attention to detail and tooling design is critical for success. What could go wrong?

The NASA IG answered the question in its report.

According to Safety and Mission Assurance officials at NASA and DCMA officials at Michaud, Boeing’s quality control issues are largely caused by its workforce having insufficient aerospace production experience. Michaud officials stated that it has been difficult to attract and retain a contractor workforce with aerospace manufacturing experience in part due to Michoud’s geographical location in New Orleans, Louisiana, and lower employee compensation relative to other aerospace competitors. Safety and Mission Assurance officials advised that Boeing provides training and work orders to its employees in an attempt to mitigate the challenges associated with an inexperienced workforce and help ensure that its workers comply with quality control standards. However, given the significant quality control deficiencies discussed above and our observations during a site visit to Michoud, we found both these efforts to be inadequate.

The NASA IG report added a footnote to the above. The footnote referenced AS9100D, Section 7.2, Competence. The inference is clear: Boeing’s Michoud assembly workforce management does not comply with the requirements of AS9100D. Our research indicates that Boeing has never been certified to be compliant with the requirements of AS9100—even though it requires its suppliers to hold that certification. Only in the past two months has the aerospace giant indicated that obtaining AS9100 certification is something its leadership wants to pursue. Ya think? (Source: Sean Broderick’s article in Aviation Week, 28 June 2024.)

So … you get what you pay for. If you want low-cost employees then don’t ask them to participate in innovative things. If you want to attract and retain a skilled workforce, then be prepared to pay for it. Don’t cheap-out on the hired help. It you want the best, then pay for the best. Learn to accept and to work with a unionized workforce. Your employees are not your enemy.

This issue is not confined to US aerospace/defense contractors. It is global.

Last week, I received an email from Kevin Craven, Chief Executive of ADS, the industry group that represents aerospace and defense companies in the United Kingdom. (Why am I part of a UK industry group? Long story but it’s also why my picture is on file at the MoD.) Mr. Craven had a simple topic he wanted to discuss, “everyone’s favourite subject: skills.”

We are all acutely aware of the difficulties we have as businesses to recruit the right talent, at the right time. Our industries employ - at last calculation - some 427,500 people throughout the country into well-paid, highly skilled, manufacturing, engineering and digital services jobs. Our success in recruiting, however, is mixed.

We know that there are 10,000 vacancies in our industries, as a minimum. We hear from our larger members that they can be oversubscribed in some roles - a fantastic achievement - while our smaller businesses, no less pivotal to our economy, can struggle. To address this imbalance, we’re actively seeking practical solutions to increase engagement across the board - to get those roles filled, capability delivered, and to secure the UK’s advanced manufacturing advantage.

… at ADS we are actively seeking partnerships - whether that’s through STEM events, widening participation schemes, mentoring programmes, policy agendas, practical job finding support, or partnerships with organisations who are leading the way in this area.

Back in the States, Huntington Ingalls Industries announced July 6 that it plans to add 2,000 heads to its current Pascagoula, Mississippi, workforce of 11,300. That’s about a 20 percent increase. On May 24, the VP of Human Resources (Xavier Biele) at HII’s Newport News Shipbuilding site in Hampton Roads, Virgina, announced that the shipbuilder needs to find more employees. Magan Eckstein’s article at Defense News reported:

The yard plans to hire 3,000 skilled tradespeople this year, but it needs to bring in 19,000 over the next decade, Beale said, adding that the existing training pipelines in the Hampton Roads region is unable to funnel enough new employees toward Newport News.

Beale said volume is only one issue when it comes to recruiting. When the COVID-19 pandemic struck the United States in 2020, a wave of highly experienced workers retired. Replacing those master tradespeople with recent high school graduates has affected productivity.

While it’s difficult to find talent with decades of shipbuilding experience, the next best thing might be finding talent with years of experience as welders or electricians outside of the shipbuilding-industrial base, Beale said.

Where I live in San Diego, we have trouble recruiting employees because of the insanely high cost of living. Everybody knows about California housing prices. And utility prices. And high state taxes. What fewer people know is that salaries tend to be commensurate with the cost of living, and the property taxes are relatively low in comparison to other states. (Hello, Texas: I’m looking at you.)

Aerospace and defense companies need to get over the notion that employee compensation cuts lead to lower prices. Maybe they do; but they also lead to production inefficiencies and delays, and potentially to serious quality issues. The US government can help by removing the “ceiling” on allowable employee compensation (FAR 31.205-6(p))—though almost no direct-charging employee is ever going to come close to that limit; it impacts executives, which may not be a bad thing if they keep on blundering around trying to increase shareholder value by attacking their own employees.

We need to get serious about attracting and retaining good people. If that means paying the rank-and-file more, then so be it. You can cover the costs of wage increases by cutting multi-million-dollar executive bonuses. (Ha! Like that’s ever going to happen.)

In addition, we need to reevaluate certain employee labor classes based on the true value they add in the 21^st century. As noted above, skilled tradespeople are in high demand. It is absolutely viable to skip college (and student debt) in order to join an apprenticeship program that leads to a career in the trades. Touch labor is critical.

And what about our supply chain specialists, our buyers and source inspectors? Given the importance of the supply chain to program success, wouldn’t you think you would want to hire the best, train them, and keep them around for a long time? Sure. But if that’s true, why do you keep hiring former buyers from Sears, thinking they will make already trained supply chain specialists with deep FAR expertise. Let’s not be silly.

Think of a workforce as an inverted pyramid, with the direct-charging touch labor folks on the top and the executives on the bottom. There’s your true value-added illustration.

Why don’t we start managing that way?

Item One: The Government cannot unilaterally impose an arbitrary decrement factor on a contractor that fails to submit its annual proposal to establish final billing rates, even if DCAA recommends that factor, unless it can support that factor. The Government has the burden of proof to show why any decrement factor is reasonably related to its risks that the contractor has overbilled its indirect cost rates.

Item Two: When dealing with Time & Materials (T&M) contract types, any DCAA-recommended decrement factor—no matter how calculated or supported—can only apply to indirect cost rates. Those indirect cost rates are applied to the reimbursable (“M”) side of the T&M contract costs. That factor simply cannot apply to the contractor’s fixed labor billings, the “T” side of contract costs. Nope. Can’t do it—those rates are fixed by contract terms and are simply not affected by any changes to allowable indirect cost rates.

Item Three: The Allowable Cost and Payment clause (52.216-7) applies to T&M contracts whether or not the clause is found in the contract at hand. Yes, readers: the clause will be read into the contract by operation of the Christian Doctrine.

Now, how do we know the foregoing?

We know about this stuff because Allard Nazarian Group, Inc., dba Granite State Manufacturing, appealed a contracting officer’s final decision to the ASBCA and Judge Stinson (writing for the Board) made those determinations in July, 2023.

A short history:

Scandia Manufacturing Company, Inc. (Scandia), had several government contracts—including three ID/IQ contracts that permitted issuance of only T&M task orders. In 2008, Allard purchased Scandia and all its contracts. A Novation Agreement was prepared and signed by an Administrative Contracting Officer. So far, so good.

In 2009, Allard was awarded a fourth contract of a similar nature: ID/IQ with T&M task orders. Unlike the other three, this contract incorporated clause 52.216-7 (“Allowable Cost and Payment”). Because T&M Task Orders were contemplated by the parties, all four contracts contained clause 52.232-7 (“Payments under Time-and-Material and Labor-Hour Contracts”). Okay so far?

Now it gets weird.

Apparently, Allard never submitted the annual proposals to establish final indirect billing rates (popularly but incorrectly called an “incurred cost submission”). Did it have to? Arguably, nothing in the three contracts it acquired from Scandia required the contractor to do so. With respect to the fourth contract—the one it entered into on its own—yes. Absolutely. 52.216-7 requires submission of a proposal to establish final billing rates.

If one contract requires submission, then that pretty much means you have to prepare a submission for the entire business entity. You’ve got to calculate final pools and bases; you’ve got claim (and certify) indirect costs. You’ve got to fill out the myriad Schedules we’ve all come to know and love. You signed the contract and so you have to submit the proposal and support it through audit.

But Allard never did.

Finally, the government lost patience.

By letter dated November 27, 2019, the Defense Contract Management Agency (DCMA) issued a contracting officer’s final decision and demand for payment of debt ‘resulting from Allard’s/Scandia’s failure to submit indirect cost rate proposals for Fiscal Years 2007-2009,’ stating that the ‘[d]ecision is applicable to all flexibly-priced contracts and subcontracts performed by Scandia/Allard during Fiscal Years 2007-2009’. According to the contracting officer ‘all reasonable efforts have been exhausted to obtain the subject matter final indirect cost rate proposals,’ and, therefore, the government had ‘unilaterally established . . . final indirect rates for Allard/Scandia fiscal years ending 31 December 2007, 31 December 2008, and 31 December 2009’.

(Internal citations omitted.)

In unilaterally establishing the Scandia/Allard final billing rates for FYs 2007, 2008, and 2009, the contracting officer applied a 20% decrement factor, as recommended by DCAA-Baltimore. With respect to the more current years (FYs 2010 through 2014), the contracting officer applied a decrement factor of 16.4%.

Importantly, the contracting officer’s unilateral rate determination did not limit application of the decrement to just appellant’s indirect costs, but rather applied the decrement factor against all invoiced amounts, including appellant’s direct, fixed rate labor costs.

Yeah, that’s gonna hurt.

Allard appealed. The company didn’t try to claim that it had actually submitted the required proposals; instead, it argued that the application of the unilateral decrement factor was flawed. That was the case in front of the Board, the case on which it ruled in a Partial Summary Judgment.

As part of pre-trial motion practice, the parties agreed to drop FYs 2007 and 2008 from the appeal. We’re thinking that was done because, to be honest, nothing in any Scandia/Allard contract required submission of a proposal to establish final billing rates. Whatever the parties intended, you couldn’t find it in the contract terms. So, at the end, the Board’s decision only covered FYs 2009 through 2014.

What did the Board rule?

• When a government contracting officer unilaterally establishes a contractor’s final indirect billing rates (which, to be clear, is a thing that can be done), then those rate determinations are considered to be a government claim. Because they are a government claim against the contractor, the government has the burden of proof—and it must show its decrement factor is reasonable. “FAR 42.703-2 allows the government to set a unilateral rate aimed at ensuring the government does not reimburse a contractor for unallowable costs. Specifically, FAR 42.703-2(c) provides that any unilateral rate ‘should be - (i) [b]ased on audited historical data or other available data as long as unallowable costs are excluded; and (ii) [s]et low enough to ensure that unallowable costs will not be reimbursed.’ FAR 42.703-2(c)(2).

• “… the government applied a decrement to appellant’s direct labor rate costs based upon appellant’s alleged failure to submit auditable indirect cost rate proposals. FAR 52.216-7(g) does not provide a proper justification, or regulatory authority, for the government’s actions taken here.” (Emphasis in original.) “The government’s imposition of an indirect cost rate decrement upon appellant’s fixed labor costs is unreasonable as not supported by the regulatory authorities cited by the government and contrary to the traditional demarcation between direct and indirect costs and the separate treatment of those costs.”

• “… pursuant to the Christian doctrine, FAR 52.216-7 - as a mandatory time and materials contract clause specified in FAR 16.307(a) - is considered inserted into the contract by operation of law.”

• “The express language of FAR 16.307(a)(1) dictates that FAR 52.216-7 applies ‘only to the portion of the contract that provides for reimbursement of materials (as defined in the clause at 52.232-7) at actual cost’.”

The Board also noted that submission of a proposal to establish final billing rates was not needed to evaluate the propriety of Allard’s direct labor billings. The contract clause 52.232-7 already gave the government audit rights in that area. It did not appear that the government availed itself of its contractual rights before deciding to apply its decrement factors.

So, readers, that’s how we know what we know.