Pentagon Unveils Tactics to Drive Affordability in Defense Acquisitions
In
May, 2010, Secretary of Defense Gates unveiled his initiative to drive
down the cost of weapon systems and reduce Pentagon bureaucracy. Calling
for long-term savings of nearly $102 billion, he said—
The
goal is to cut our overhead costs and to transfer those savings to
force structure and modernization within the programmed budget. In other
words, to convert sufficient ‘tail’ to ‘tooth’ to provide the
equivalent of the roughly two to three percent real growth – resources
needed to sustain our combat power at a time of war and make investments
to prepare for an uncertain future. Simply taking a few percent off the
top of everything on a one-time basis will not do. These savings must
stem from root-and-branch changes that can be sustained and added to
over time.
Undersecretary
of Defense (Acquisition, Technology & Logistics) Dr. Ashton Carter
quickly responded to his leader’s call for action. On June 28, 2010, he
met with defense industry leaders and called for savings of $66.3
billion over five years, to be found on current programs and activities.
He said—
We
need to restore affordability to our programs and activities … by
identifying and eliminating unproductive or low-value-added overhead; in
effect, doing more without more. … The guidance will focus on getting
better outcomes, not on our bureaucratic structures. … Most of the rest
of the economy exhibits productivity growth, meaning that every year
the buyer gets more for the same amount of money. So it should be in
the defense economy.
At
that time, Dr. Carter issued a Memorandum addressed to Defense
acquisition professionals. Entitled “Better Buying Power: Mandate for
Restoring Affordability and Productivity in Defense Spending,” the Memo
called for “delivering better value to the taxpayer and improving the
way the [Defense] Department does business.”
We wrote about the new initiatives here.
Despite
some initial confusion over terms, what have emerged are two distinct
lines of attack: (1) the drive to reduce waste, bureaucracy, and
inefficiency within the Pentagon, and (2) the drive to reduce the costs
of goods and services by focusing on reducing contract prices. To
clarify, we call them the “efficiency” and the “affordability”
initiatives. We explored the two lines of attack in this article.
The drive for Pentagon efficiency seems to be led by SecDef Gates,
while the drive for contractor affordability seems to be led by USD
(AT&L) Dr. Carter. In our latest article,
we focused on SecDef Gates’ August 9, 2010, press conference and his
“series of initiatives designed to reduce overhead, duplication, and
excess in the Department of Defense, and, over time, instill a culture
of savings and restraint in America’s defense institutions.”
Today’s
article focuses on the other initiative, Dr. Carter’s quest to create
billions of dollars of acquisition savings through driving down the
prices paid by the Pentagon for weapon systems and services. On
September 14, 2010, Dr. Carter unveiled the tactics he will employ in
his attack on acquisition costs. We will discuss two documents: (1) a
single-page “Guidance Roadmap” that provides plans on five specific
areas of attack, and (2) a new “Better Buying Power” Memorandum for
Acquisition Professionals.
Dr. Carter’s Guidance Roadmap listed five specific areas of attack in the drive to reduce Defense acquisition costs. These areas included:
-
Target Affordability and Control Cost Growth
-
Incentivize Productivity & Innovation in Industry
-
Promote Real Competition
-
Improve Tradecraft in Services Acquisition
-
Reduce Non-Productive Processes and Bureaucracy
The
Guidance Roadmap document can be found via the link, above. Note it
included specific sub-bullet points beneath each of the five lines of
attack listed above.
The
accompanying Memo, entitled “Better Buying Power: Guidance for
Obtaining Greater Efficiency and Productivity in Defense Spending,”
provided details on specific tactics Dr. Carter intends for his
acquisition corps to deploy. There are 23 “principal actions to improve
efficiency” linked to the five lines of attack listed above. Here is the
9/14/2010 Memo, and it is definitely worth reviewing in considerable detail.
We
will not go through every word of the 17-page Memo, or review each of
the 23 individual “principal actions”. What we want to do is to
highlight some of the significant (and dare we say controversial?)
tactics the Pentagon has been directed to utilize in the fight against
acquisition costs. Here are some of the interesting aspects of Dr.
Carter’s affordability initiative—
-
Reward
contractors for successful supply chain and indirect expense
management. This involves rewarding performance through setting
appropriate profit levels. “Higher profit should be awarded to
management of higher-risk subcontracts, and higher profit should be
given when the prime succeeds in driving down subcontractor costs every
year.” The Director of Defense Procurement and Acquisition Policy (DPAP)
will “review the Weighted Guidelines … with the aim of emphasizing the
tie between profit and performance.” Dr. Carter emphasized, however,
that this was not simply an exercise in cost-cutting. He said—
-
It
is important to note that the savings to be expected from this
direction will be in cost, not in profit. Savings are not expected in
profit per se since in some instances profit will increase to reward
risk management and performance. But if profit policy incentivizes
reduction in program cost, the overall price to the taxpayer (cost plus
profit) will be less.
-
Reverse
a decade of practice and restore DOD’s preference for using customary
progress payments based on cost incurred, with other contract financing
options being agreed-upon only with a commensurate reduction in
contractor profit, based on increased cash flow.
-
Use
Forward Pricing Rate Recommendations (FPRRs) in lieu of Forward Pricing
Rate Agreements (FPRAs). In particular, “where DCAA has completed an
audit of a particular contractor’s rates, DCMA shall adopt the DCAA
recommended rates as the Department’s position with regard to those
rates.”
While
some of Dr. Carter’s plans seem like good ideas, others disappoint us
and strike us as counter-productive. For instance, we are disappointed
to see the end of DOD’s regulatory preference for Performance-Based
Payments and the return of customary progress payments. The debacle of
the A-12 program taught many that progress payments had little to do
with actually making progress, and everything to do with the ability to
spend money. It looks to us like that lesson has been forgotten.
The
substitution of DCAA audit findings for DCMA discretion and negotiation
ability strikes us as a spectacularly bad idea, one that further
shrinks the regulatory role of the Contracting Officer in favor of
findings from an agency that has, in recent years, generated audit
reports of poor quality that were, at the same time, dramatically
untimely. We have reported many times on problems with recent DCAA audit
guidance, and we see no indication that Dr. Carter’s direction will do
anything other than cause financial problems for the defense industrial
base.
As always, stay tuned for further developments.
BAE, Boeing & Lockheed Martin React to New Economic Reality in Different Ways
It’s
no secret that the Pentagon has gotten religion. Spurred by the
teachings of Defense Shepherd Gates, the Pentagon’s acquisition flock
has begun to chant the two-tone mantra of “efficiency and
affordability”. We’ve reported on this new (or re-learned) religion before,
and we’ll have more to say about it in the near future. But today’s
article is about how some of the leaders in the defense industrial base
are reacting to pressure from the zealous Pentagon faithful.
The contractors are reorganizing and cutting staff.
But
first we need to be intellectually honest and admit that some
contractors have been making adjustments for many months, and these
changes we report today are but the latest in a series of intricate
steps designed to position the companies for future dances with their
favorite partner, the Department of Defense. For example, we reported here about cutbacks at Northrop Grumman’s Gulf Coast shipbuilding businesses and about cuts to Navistar’s MRAP production staff. Over here,
we reported on a reorganization at BAE Systems and a planned early
retirement buy-out offer for Lockheed Martin executives. And those are
just two of the many stories we’ve posted about how defense contractors
are adapting to the changing economic reality of the post-Bush,
post-Iraq defense acquisition environment. So let’s be clear: today’s
stories are nothing new, nothing out of the ordinary. But they are illustrative of what’s happening in the A&D industry.
Lockheed Martin
As
noted above, we previously reported on LockMart’s early July 2010
announcement of early retirement incentives (the “Voluntary Executive
Separation Program,” or VESP) to be offered to Directors and Vice
Presidents who, if they accepted, would need to exit the company by
February 2011. We reported that LockMart hoped to thin its executive
ranks by about seven percent.
On September 8, 2010, Bloomberg reported
that “about 25 percent” of the company’s executives had accepted their
VESP offers. According to the article, “More than 600 vice presidents
and directors applied for the program … [and] all will have gone by
February.” According to the Bloomberg article—
The
severance program will yield ‘substantial savings’ starting in 2011,
Lockheed said. It also will provide ‘a leaner management structure at a
time when our customers have an urgent need for more affordable
solutions to the global security challenges they face,’ Chief Executive
Officer Bob Stevens said.
Certainly,
Lockheed Martin will see a reduction in current compensation costs from
the departures. But at what cost? According to this Washington Post
article, the company’s September 13, 2010 filing with the SEC estimated
that it would record a one-time charge of between $175 and $200 million
for the severance packages. According to the Post’s math, “Based on
that figure, the average cost per employee could be as much as
$333,000.” The article continued—
Lockheed's
filing details how the payments will be made. An individual's lump-sum
payment is broken into three elements: 75 percent to 125 percent of the
executive's annual salary, based on years of service; a payment of
$2,000 per year of service, up to 30 years, meant to defray future
medical costs; and an amount equal to the executive's 2011 vacation pay.
Additionally,
executives who take the buyout will remain eligible for bonuses early
next year based on their 2010 performance. … The severance payment will
be made within 90 days of an executive's departure.
That’s a pretty sweet deal, if you ask us. And very likely 100% allowable, as well. But we haven’t seen any inquiries regarding whether the result of LockMart’s VESP--which were more than 300 percent better than its planned outcome--was a good thing or really just another problem that has been deferred and will surface in a few years? Is the company really saying that it can cut 25 percent of its executive ranks and not miss a beat? Wow, that’s kind of a message right there ....
Boeing
The
No. 1 Aerospace/Defense company in the world also reported some changes
to its Military Aircraft business, so as to “continue to position the
company for growth in the current business environment,” according to
this Boeing press release.
The reported changes include consolidating six divisions into four and
ten percent cuts to the BMA executive ranks. The press release adds
that, “Additional reductions across all levels of the organization are
anticipated in coming months.” The press release included a statement of
BMA’s strategic intent—
In
announcing the changes, Boeing Military Aircraft President Chris
Chadwick said the new organization will allow BMA to meet domestic and
global defense requirements for the next 10 years and beyond.
‘This
new structure supports BMA's progression from a product-based business
to a capabilities-based business, focusing on supporting our customers
in the United States and increasingly important international markets,’
Chadwick said. ‘It is consistent with initiatives under way throughout
the entire Boeing defense business that will allow us to remain
competitive and grow.’
Frankly,
we’re not 100 percent sure what Chadwick’s statement means. But we
think it means that Boeing may be finally admitting that it won’t be
making too many new military aircraft in the foreseeable future. With
the end of the C-17 program in sight, and the F/A-18 program focused on
international sales, and LockMart firmly in the F-35 driver’s seat,
Boeing may be admitting that its military aircraft business is going to
inevitably shink—significantly—in the near future.
In related news, remarks
by Boeing Defense President Dennis Muilenburg fueled rumor and
speculation that the company might make a play to acquire some or all of
Northrop Grumman. Reuters reported—
Defense
analyst Loren Thompson said weapons demand fell by 50 percent during
the last two downturns, spurring earlier consolidation, and the same
could happen again this time. ‘That means that at least one of the big
players will have to exit if we are facing a similar downturn in the
years ahead,’ Thompson told the Reuters Summit.
‘There's
not enough business to go around,’ said one former senior military
official who now works in industry, but who was not authorized to speak
on the record.
Northrop
Grumman Corp would be a good fit with Boeing, although there could be
antitrust concerns about the two companies' space operations, Thompson
said. ‘Boeing has a big revenue shortfall on the defense side that it
needs to cover. Buying part or all of Northrop could fix that problem,
while giving it entry into the Joint Strike Fighter program,’ Thompson
said, referring to the $380 billion Lockheed Martin Corp F-35 fighter
program. Northrop has a large role on the program, which Lockheed beat
out Boeing to win in 2001
On
the other hand, given the Obama Administration’s focus on increasing
competition in the defense marketplace, as well as potential anti-trust
issues, we don’t see this as a likely outcome.
BAE Systems
On September 11, 2011, the Wall Street Journal reported
that BAE Systems was going to put “parts of its North American
commercial aerospace business up for sale in an auction.” The article
asserted that the sale could “fetch up to $2 billion.” The article
stated that—
One
of the units on the block makes aircraft-engine controls for General
Electric Co. The other units include a commercial avionics business and a
division that makes hybrid propulsion systems for buses and trucks,
According to this article at Forbes, “BAE is reportedly looking to focus on its support and maintenance operations.” We’re
not sure what conclusions one can draw from the foregoing news
snippets. But we’ll have more reorganization, layoff, and M&A
activity to report this year—we’re sure of that.
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DOD Oversight Wars Continue: Inspector General Faces Criticism
DCAA is in the process of publishing new audit guidance that we can’t wait
to share with you. But in the meantime, the Pentagon is facing renewed
criticism, including allegations of oversight failures by the DOD
Inspector General (IG). As readers may recall,
the DOD IG has not hesitated to point a finger at the failings of the
DCAA—so it seems apt justice that they start to feel some of the heat as
well.
DOD Inspector General “Does Less with More”
On September 9, 2010, Robert Brodsky reported at GovExec.com that Senator Charles Grassley (R-Iowa) released a report
that was highly critical of the DOD IG. Mr. Brodsky reported that
Senator Grassley accused the DOD IG of failing to pursue any oversight
reviews of any major weapon system or contractor in FY 2009, “leaving
that mission to the DCAA.” As the GovExec article reported—
‘As
the [Office of Inspector General] has drifted away from its core
mission of conducting contract audits, it chose to move in an
ill-advised direction,’ the 73-page report said. ‘Today, the majority of
audits appear to be nothing more than quasi-academic reviews of DoD
policies and procedures. The DoD OIG has become the department's 'policy
police.' ‘ …
Overall,
the 765-person audit office issued just 113 reports in fiscal 2009, its
lowest total in two decades. In 1995, when the office had 717 auditors,
the IG published 264 reports, the Senate staffers said. …
And
despite conducting less labor-intensive contract audits, the office is
averaging 18 months to issue reports, Grassley's staff found. Some
audits have dragged on longer than three years, and others have taken so
long the IG eventually scrapped them.
Not content with issuing the report, Senator Grassley also sent a letter to Secretary of Defense Gates, calling for “significant audit reforms” to the Office of the IG, according to Brodsky.
We
spent some time looking at the Grassley report. There was plenty of
criticism for all facets of DOD IG operations, ranging from an inability
to audit DOD accounting data because of system limitations, to poor
morale, to looming problems with financial statement audits of DOD
components. But to us, the most interesting portion of the report was
the portion devoted to “Acquisition and Contract Management (ACM).”
The
Grassley report stated, “ACM has 162 auditors assigned to 26 branches
spread across 9 divisions. There are an additional 11 persons assigned
to the Front Office, including one SES executive, three senior auditors,
one contract specialist, and 6 administrative personnel.” In Government
Fiscal Year 2009, ACM’s auditors “produced a total of 28 reports.”
According to Senator Grassley’s staff, that worked out to “an average of
.173 audits per auditor per year.”
The
Grassley report noted that, given the name and mission, one might think
the ACM auditors focused on auditing contract payments. According to
the report, one would be wrong to make that assumption.
ACM
senior management repeatedly stated that ‘we don’t examine contract
payments, and we don’t rely on DCAA to do it, either.’ They also said:
‘it’s impossible to audit contracts … We can’t do it …..It’s too hard to
find transaction-level data, or it just doesn’t exist.’ They can’t do
contracts, they said, because of ‘missing documentation and no audit
trails.’ They indicated that ‘we used to do big weapons contracts but we
lack the right skill sets – or experienced staff – to do it today.’ A
top Audit Office official said they could ‘cobble together such an audit
team to look at one of the big Category I weapons systems,’ but doing
that would ‘deplete resources needed to meet other priorities.’
The
Grassley report opined that, “De-coupling payments from contracts, as
is the ACM practice, greatly reduces the probability of detecting and
reporting fraud. In fact, it just about eliminates that possibility
altogether.”
The
Grassley report focused on one audit performed by the DOD IG ACM staff
in FY 2009 as an example of what worked and didn’t work. The report
(D-2009-108) was entitled ““U.S.
Air Forces Central War Reserve Material Contract” and it documented the
audit of a cost-plus-award-fee contract awarded to DynCorp for managing
pre-positioned war reserve materials (WRM) at storage sites in
Southwest Asia. The Grassley report summarizes the DOD IG audit report
as follows—
The most troublesome findings were buried deep in the body of the report. These are as follows:
-
The contract arrangement with DynCorp was prohibited by 10USC2306[a];
-
Once
Operation Enduring Freedom caused a major surge in WRM requirements far
beyond the scope of the existing contract, that contract should have
been terminated in FY 2002-03 and re-competed;
-
Missing
documentation resulted in either no audit trail or one so complex that
accountability was questionable; The lack of internal controls created
an environment with “high risk” for fraud;
-
DynCorp
was authorized to submit vouchers directly to DFAS under the Direct
Billing program; DCAA was required to test and sample those transactions
periodically but failed to do so;
-
$161.1 million was obligated without a written, binding agreement in violation of 31USC1501…
The Grassley report continued—
The
[DOD IG audit] report appears to imply that the vouchers, for the most
part, could not be matched with the contract modification documents
because the language in those documents did not specify what goods and
services had to be delivered. If a payment/contract match-up was not
feasible, this could be a violation of 31 USC § 1501. That law requires
that a financial obligation be supported by a written, binding agreement
(contractual document) that specifies what goods and services are to be
delivered. Without that kind of specificity, a contract would be the
equivalent of a blank check. The report stated: the “government
did not know what it was paying for … The government may have paid for
services DynCorp did not perform. … It may have overpaid for services.”
In other words, the government did not know what it had ordered, what
was delivered, or what it was actually buying or paying for.
To conclude, Grassley’s staffers offered the following summary—
All
of this taken together appears to suggest that DynCorp may have
received $161.1 million in unauthorized and/or improper or even
fraudulent payments. But the report’s findings are inconclusive.
The
OIG recommended that DCAA go back and examine this DynCorp contract.
However, bucking this audit back to DCAA made no sense whatsoever. To
begin with, the report gave DCAA very poor grades for failing to
watchdog DynCorp on this contract from the get-go. The DOD IG should
finish the audit that it started.
Whew. That sounds bad.
What did the DOD Inspector General say in response to such criticism?
On September 13, 2010, DOD Inspector General Gordon S. Heddell issued a response to Senator Grassley’s criticisms. In his letter to Senator Grassley, Mr. Heddell stated—
I
believe that your report presents valid concerns and is an opportunity
to enhance the mission of the Department of Defense Inspector General
(DoD IG) in regard to detecting and reporting fraud. Therefore, I have
directed the Deputy Inspector General for Auditing and her staff to make
concrete and specific proposals on how your report can be used to improve the timeliness, focus, and relevance of audit reports. Furthermore, I
have directed that these proposals, to be completed no later than
October 15, 2010, are supplemented by a detailed plan listing specific
initiatives to be implemented at the earliest
possible date. The recommendations in your report will be an important
tool in the transformation I have initiated since being confirmed as
Inspector General.
The
letter included more detailed responses to each of the 12 criticisms
found in the Grassley report. And by “more detailed responses” we mean
such detailed responses as the following—
As
noted in the response to recommendation 2, "end-to-end" contract
performance and payout audits involve an extensive amount of resources
and time to complete and which, by the very nature of their wide scope,
could exacerbate the very issues the report highlights involving
timeliness. Instead, we provide audit coverage of the contract process
through a series of audits based on the risks associated with the
specific contract segment.
To
further strengthen this approach, the DoD IG focus on finance and
accounting systems has been expanded to include oversight of plans and
programs to acquire new accounting systems and efforts to modernize the
existing systems.
Well, that
response really ought to placate Senator Grassley and his staffers, who
think the DOD IG is failing at its oversight mission. Right?
Settling-Up: Concluding DOJ Enforcement Actions
It’s
hard to go more than a week without reading yet another story about
fraud, waste, abuse—or even outright corruption—in the US public
procurement process. Today we bring you two stories about entities that
have settled their issues by settling-up with the Department of Justice,
and one story about DOJ dropping fraud charges because of judicial
setbacks.
GSA Pricing Disclosure Failures Lead to Large Settlements
In 2004 two “former employees of U.S. contractors” filed a qui tam
suit under the False Claims Act in the Eastern District of Arkansas. In
their suit, whistleblowers Normal Rille and Neal Roberts “accused
several IT companies of paying kickbacks to systems integrators in
exchange for preferential treatment on government contracts the system
integrators were working on …” according to this article. We previously reported settlements by Hewlett-Packard and EMC.
Reportedly, IBM, CSC, and PricewaterhouseCoopers have also settled
similar suits filed by the two “private attorneys general.” Now Cisco
and its distributor Westcon Group North America have settled their
issues with the DOJ, by agreeing to pay $48 million.
Still preparing for litigation—or still negotiating with the DOJ—are Accenture and Sun Microsystems.
Former U.S. Army Contracting Officer Pleads Guilty
On September 10, 2010, the DOJ announced
that William Armstrong “pleaded guilty to submitting a false statement
to the U.S. Army” Contracting Agency. According to the press release,
Mr. Armstrong was “former chief of the construction division of the Fort
Carson Directorate of Contracting” for the Army. While serving in that
capacity, Mr. Armstrong was required to submit an “annual confidential
financial disclosure report. Apparently, he failed to disclose
“reportable gifts” on the form. As the press release notes—
Armstrong
indicated on the form that he had not received any reportable gifts in
the previous year when, in fact, Armstrong had received several thousand
dollars worth of gifts from a construction contractor that had
substantial business with the Fort Carson Directorate of Contracting,
the department said.
The DOJ made sure to report—
Armstrong
faces a maximum sentence of five years in prison and a $250,000 fine.
The maximum fine may be increased to twice the gain derived from the
crime or twice the loss suffered by the victims of the crime, if either
of those amounts is greater than the statutory maximum fine.
Finally,
it was noted that Mr. Armstrong’s plea bargain “is the first to arise
from an ongoing investigation related to the award of construction
contracts at Fort Carson.” Tellingly, the DOJ’s Antitrust Division is
leading the investigation.
Agility Sees Fraud Charges Dropped
We
have reported on the problems faced by Kuwait-based Agility (formerly
Public Warehousing Company) several times. Perhaps the most
comprehensive article is this one.
Suffice to say, Agility has been dealing with numerous audit issues and
fraud charges. We noted the back-and-forth between the company and
Federal prosecutors, reporting—
Several
court hearings have been delayed as the company worked to reach a
settlement with prosecutors. And the firm’s lawyers have argued that
prosecutors failed to properly serve the company because it sent the
indictment to the company’s U.S. subsidiaries instead of through
diplomatic channels in Kuwait.
On September 3, 2010, the Associated Press reported that a judge had “blocked” fraud charges against the Kuwait parent corporation, reporting—
U.S.
Magistrate Judge Alan Baverman recommended that fraud charges against
the Public Warehousing Co. not go forward because the indictment had not
been properly served. A federal judge must now sign off on the move.
Prosecutors
then asked Friday to have remaining charges dropped against the
company's U.S.-based subsidiary, Agility DGS Holdings. Prosecutor
Barbara Nelan said she didn't want the subsidiary to be a ‘straw man’
that took the fall for its parent company's wrongdoing.
The
Judge’s 91-page opinion concluded that efforts to serve the parent
company had been “insufficient.” Although the action looks like a
victory for Agility, it is not likely to be the end of the battle. As
the AP article noted—
The
moves aren't likely to be the end of the case. Nelan said that
investigators are still gathering details on the company's contracts and
she did not rule out a new indictment for the companies.
‘This investigation is broadening every day,’ she said.
The
food supplier's attorneys, too, are bracing for new charges. Tom Bever,
who represents Agility DGS Holdings, urged the judge to order
prosecutors to hand over more than 15 million pages of discovery, even
if the case is dismissed, so they can prepare for a new round of
charges.
To
wrap-up, the legal Kabuki dance involved with prosecuting fraud, waste,
and abuse continues. Large U.S.-based corporations settle to avoid the
risk of even larger fines and potential penalties such as debarment.
Individuals settle for pleading guilty to relative minor charges in
order to avoid more perilous ones. And Agility continues to nimbly dance
with the DOJ, protesting its innocence while paying big bucks for
high-priced attorneys.
We would say, “stay tuned for further updates”—but that really doesn’t need to be said, does it?
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