How Fair is the Subcontractor Fairness Act?
Introduced in the House of Representatives on November 19, 2009 as the “Subcontractor Fairness Act of 2009,” H.R. 4134 should be a litmus test for certain members of Congress. Hold that thought for a minute.
The Federal Government’s procurement system is marked by bureaucratic complexity and defined by a set of overlapping and interlocking statutes and regulations. Reform effort after reform effort has attempted to address the inefficient and expensive system, with limited success. Congress, the Government Accountability Office, and the military services of the Pentagon have each tried various fixes, but nothing has seemed to work. More recently, the Obama Administration has made several attempts to get tough with Federal contractors; but so far there has been little progress to show for the efforts.
Retired Air Force Lt. General Robert Kadish was recently quoted as saying, “"In an effort to improve the system, we have made it almost unintelligibly complex. And, this complexity is an albatross around our neck."
Very few individuals understand the details of the complex acquisition system. Those that do are valuable subject matter experts who help stakeholders find and exploit the system’s loopholes. Former Defense Comptroller Dr. Dov Zakheim recently described the U.S. government’s acquisition system “as one that is based on end-running the system.” That’s right. To make the system work, one must work around it, not within it—according to one of those few experts who ought to know.
There are many on the outside of the system who complain and posture and bloviate on what ought to be done, from gadflies to bloggers to lawmakers. Even fewer of this group have any understanding about how the system works; they only know that contractors charge too much and deliver too little, too late—without understanding why, let alone what to do about it.
Individuals of this latter group self-identify by clearly incorrect pontifications designed to attract attention rather than to fix any serious problems. Lawmakers of this latter group self-identify by introducing legislation that addresses a problem that doesn’t exist, or addresses the wrong problem, or which will obviously create problems more severe than the “problem” the proposed legislation purports to address.
So when we say H.R. 4134 is a litmus test for certain members of Congress, what we mean to say is that those members who have sponsored the bill are self-identifying themselves into that latter group of cluelessness—dubbed PWACs by certain seasoned acquisition professionals. (PWAC = Persons Without A Clue.)
What makes this bill stand out for its cluelessness?
Simply put: each competitive solicitation issued by the Federal government (both civilian and defense) valued at more than $550,000 ($1,000,000 for construction) must require that each offeror submitting a proposal must:
(a) Identify all of its subcontractors at the time it submits its proposal for evaluation
(b) Negotiate subcontract agreements including prices with each of its subcontractors
(c) Include with its proposal a list of each of its subcontractors, including the subcontract scope of work and the prices to be paid
(d) Agree that, should the offeror be awarded a contract from the government, each subcontracting agreement will become a valid subcontract “upon award of the prime contract.”
See the entire bill here. You can also see those members of Congress who’ve sponsored the legislation, who have thusly self-identified into the PWAC group.
There are so many problems with the proposed bill that we hardly know where to start.
1. This bill, if approved and signed into law, wouldn’t ensure prime contractors treat subcontractors fairly. Instead, primes will enter into long-term agreements with certain subcontractors and the others will be left out in the cold. This is because the process for preparing a competitive proposal to the Federal government doesn’t have sufficient time to negotiate subcontracts. (We’ve written about this before.) So this bill will reduce subcontract awards and hurt small businesses.
2. At the very least, imposition of this requirement would delay the proposals and thus delay contract awards. Consequently, the delivery of goods and services to those that need them will be delayed as well.
3. Speaking of small businesses, since all subcontracts will be identified and negotiated prior to award and become effective on the date of the prime contract award, you can forget socioeconomic reporting or preparation of “small business subcontracting plans.” Subcontracting plans and the reporting thereof are about what happens after award of the prime contract; since nothing will be allowed to happen after award, there will be no need for them.
4. By linking this requirement to the proposal preparation effort as opposed to the contract execution effort, the PWACs have just converted direct labor into B&P labor. I.e., watch contractor’s indirect cost rates climb up and up, making everything more expensive for the buying commands and other Federal stakeholders.
5. No mention as to whether this requirement will flow down from the primes to the lower-tier subcontractors. The PWACs apparently don’t understand that the first-tier subcontractors also award subcontracts themselves, and so on. That’s why we call it a “supply chain.” Wouldn’t it be perfect to say that each subcontractor must also identify its subcontracts, and so on, before submitting a competitive proposal? That would be just about the best way to freeze the entire Federal acquisition system we could conceive of.
6. No mention as to what the contracting officers and source selection teams evaluating the offerors are supposed to do with the subcontracting information provided by the prime contractors. Do they read it? If so, what for? Do they throw the paper away?
We could go on. But we think the point’s been made. This is bad legislation and, if signed into law as written, will do much more harm than good. We hope it dies in Committee. And we hope those PWAC members of Congress stay far away from any further legislation that could similarly affect the Federal acquisition system.
Obama Administration Issues Executive Order Getting Tough on Improper Payments
Recently the GAO reported on poor contract management and large amounts of “improper payments” by the Centers for Medicare and Medicaid Services (CMS). Here is a link to an article discussing that report. Nearly simultaneously, the White House announced that the Federal government made $98 billion in improper payments in 2009, an increase of 38 percent compared to the prior year.
So it came as no real surprise that on November 20, 2009 President Obama issued an Executive Order entitled “Reducing Improper Payments and Eliminating Waste in Federal Programs” that announces his administration’s intention to reduce “payment errors” with respect to Federal grants and contracts. The Executive Order, found here, consists of four substantive sections (plus an introductory section as well as a two policy sections). Briefly, the content is as follows:
Section 2
Directs the Office of Management and Budget (OMB) to identify those Federal programs in which the highest-dollar or majority of improper payments occur, designated as “high-priority programs”. Once those high-priority programs are identified for each Federal agency and/or Executive department, the OMB will establish annual targets (in coordination with the affected agency/department) for reducing the amount of improper payments. The OMB will also issue Government-wide guidance for various administrative aspects of the program—including the identification and publication of those entities that have received improper payments.
Also directs that the Secretary of the Treasury, Attorney General, and Director of the OMB “shall publish on the Internet information about improper payments on high-priority programs. Various pieces of information are to be made available to the public—including (as noted above) identification of “entities that have received the greatest amount of outstanding improper payments (or, where improper payments are identified solely on the basis of a sample, the entities that have received the greatest amount of outstanding improper payments in the applicable sample).” Entities that are the subject of referrals to the Department of Justice are not to be identified, according to the Executive Order.
Also directs that the parties named above, in coordination with the Council of Inspectors General on Integrity and Efficiency (CIGIE), will establish a “central Internet-based method to collect from the public information concerning suspected incidents of waste, fraud, and abuse by an entity receiving Federal funds that have led or may lead to improper payments by the Federal Government.”
Section 3
Requires the head of each Federal agency responsible for operating a high-priority program to designate a point of contact/coordinator to be responsible for addressing improper payments and meeting the reduction targets. Requires the affected agencies to report to their respective Inspector General their plans for addressing improper payments and meeting the reduction targets. Among other things, requires the various stakeholders to recommend to the President “actions designed to reduce improper payments by improving information sharing among agencies and programs, and where applicable, State and local governments and other stakeholders. The recommendations shall address the ways in which information sharing may improve eligibility verification and pre-payment scrutiny, shall identify legal or regulatory impediments to effective information sharing….”
Section 4
Requires (among other actions) the various stakeholders to recommend to the President –
… actions designed to enhance contractor accountability for improper payments. The recommendations may include, but are not limited to, subjecting contractors to debarment, suspension, financial penalties, and identification through a public Internet website … for knowingly failing timely to disclose credible evidence of significant overpayments received on Government contracts.
Clearly, the Executive Order is designed to put pressure on the agencies to better manage their payments, while putting pressure on contractors to promptly report receipt and make timely restitution.
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Will Insider Trading Charges Bring Down EADS?
Airbus’ design and manufacturing problems with its A380 ultra-high capacity airliner are well-known and we need not belabor them here. Suffice to say that in December 2000 Airbus officially started its program, and by June 2005 the company had announced a six month production delay attributed to wiring design problems and configuration control issues. A year later, in June 2006, the company announced a further delay to its production and delivery schedule—causing a 26% drop in the stock price of Airbus’ parent, EADS. After that second delay announcement, the A380 program manager “departed” the company, as did the Airbus CEO as well as the CEO of EADS. Not even three months later (October 3, 2006) the new Airbus CEO announced a third delay to the program. Despite the setbacks, Airbus has begun delivery of its planes and so far has delivered roughly 20 of the 202 on order.
Having surmounted its program execution issues and, indeed, surpassed Boeing as the world’s largest Aerospace/Defense company, EADS now faces a new challenge, this time from French legal authorities, who have put seventeen corporate executives on trial for insider trading, alleging that they had prior knowledge of the second delay announcement and sold stock prior to a steep drop in share price.
After the October 2007 original announcement of an investigation by the French Financial Markets Authority (Autorite des Marches Financiers or AMF), it was reported by Time magazine that as many as “1,200 other shareholders [ ] may have used inside knowledge of troubles with the A380 program to dump millions worth of stock before that bad news was revealed in June 2006.” In addition to Arnaud Lagardère, 20 other EADS executives were targeted by the AMF and French prosecutors. According to the Time article, Lagardère and the others “received a memo from an unidentified source in December 2005, warning EADS would be entering ‘a zone of turbulence.’" The memo to Breton also purportedly urged the French government to lower its 15% stake in the group before flying got rough for EADS, which would allow the state to "profit from the current value of shares, which incorporates only the good news of the last financial year."
According to this report by MSNBC.com, “EADS’ Web site shows that Forgeard and other executives exercised stock options within two weeks following the March 6 [2006] meeting. In fact, La Tribune said, some 85 percent of the company’s 800 top officials exercised options soon after the meeting, despite a March 8 announcement of record profits in 2005.”
Earlier this year, many of the EADS executives were cleared by the AMF, but the Seattle Post-Intelligencer reports that “Antoine Courteault, the AMF's examiner … urged fines totaling more than 12 million euros against the other seven, according to an account in the U.K. Times Online. (See also accounts in The New York Times and The Wall Street Journal.) This includes fines of 5.4 million euros against former EADS joint chairman Noel Forgeard, who was forced out by the scandal, and 3.6 million euros against John Leahy, Airbus' head of sales. Courteault also said EADS should pay 700,000 euros for failing to inform investors of delays to A380 production plans in 2006, according to The Times.”
As this article is being posted, seventeen current and former EADS executives are testifying before the AMF regarding the allegations. Reports indicate that the verdict should be rendered before the end of 2009. If found guilty, the executives could be fined up to ten times the amount of profit they made from their trades. For those who read French, the latest news story from Le Figaro can be found here.
Besides the obvious implications of corporate executives profiting from insider information, this issue raises (in our minds at least) the spectre of program status reporting. In our experience, program managers and their program management teams are reluctant to report potential bad news to management; it is only when all potential corrective actions and workarounds are finally admitted to be ineffective, and when the numbers absolutely permit no other course of action, that the program teams reluctantly inform management of the cost growth, schedule slip, or performance problem. In other words, the traffic light is always green, until it goes red (or even black). Rarely does one see a yellow traffic light indicating caution or potential problems ahead.
This phenomenon, of course, is the exact opposite of what’s supposed to happen—especially in a risk-aware management culture.
What is a risk-aware management culture? It is a management culture that has embedded risk identification, monitoring, and mitigation planning into its project/program management processes. It is a management culture that has integrated risk awareness into its supporting processes. For example, the risk-aware management culture has linked Earned Value Management (EVM) metrics with risk management processes, so that variance analyses, at-completion estimates, and management reserve balances are linked to risk and opportunity registers. Such a culture has made risk management a cross-functional discipline, breaking down silos that traditionally keep risk information from those who can act on it.
As the PricewaterhouseCoopers study on aerospace/defense supply chain risk management explains—
Silos and poor communication within the walls of the prime’s organization can lead to difficulties with supplier management. Recently, a prime contractor faced the collapse of a key component supplier due to an unexpected shortage of a rare metal. After an internal investigation, the company found that one of its own engineering procurement groups had predicted the shortage, but had not shared the prediction with the affected program team.
The Department of Defense Risk Management Guide clarifies that risk management is the alternative to “issue management,” saying, “A common misconception, and program office practice, concerning risk management is to identify and track issues (vice risks), and then manage the consequences (vice the root causes). This practice tends to mask true risks, and it serves to track rather than resolve or mitigate risks.”
So what does risk management have to do with EADS and management’s knowledge of the A380 program difficulties? In a risk-aware management culture, EADS and Airbus executives wouldn’t need an email to tell them that turbulent times were ahead for the program; they would already know it because they would be aware of current program status. They would be actively monitoring program risks and would clearly see inflection points in risk probabilities. Their management “radar screens” would clearly show trouble ahead.
Although it’s probably fair to say that, had EADS and Airbus had the necessary risk-aware management culture, they may have be able to avoid some or even most of the turbulence experienced by the A380 program.
Note to Our Visitors: By our count, this article marks our 100th post. As always, we trust our posts add value and spark some thoughts.
What does it take to Succeed in U.S. Defense Contracting? A European Perspective
At Apogee Consulting, Inc. we are focused on driving excellence into all aspects of program performance—from proposal preparation to invoicing, and from program management to supply chain management. We view the entire series of program execution steps as being integrated and interdependent, as opposed to many who see independent silos and “fiefdoms” that only grudgingly work and share information with each other. Lean principles focus on elimination of muda (waste) from processes, and our belief is that muda exists in all business processes, and that all processes are fit subjects for continuous improvement.
So when we report, over and over, that program execution is of paramount importance, we mean it. But we also acknowledge that program execution is dependent on myriad business processes that, like the cylinders in a combustion engine, all need to be working at maximum efficiency to ensure that the program execution team is positioned for success.
This is especially true when one is a contractor supporting the U.S. Defense Department. To succeed in that complex and difficult environment, a company must surmount many obstacles, from achieving expected “contract outcomes” (i.e., cost, schedule, and performance/quality requirements), to successfully passing audits by the Defense Contract Audit Agency (DCAA), to managing changing customer requirements. The U.S. defense environment is (generally) poorly understood by those entities outside the country’s borders, and consequently the acquisition environment is (generally) viewed as a barrier to entry by those entities who want to sell goods and services to the U.S. Department of Defense (DOD).
One European company, however, claims to have found the secret to succeeding as a DOD Prime Contractor, and this article in FlightGlobal.com discusses the lesions it learned along the way. The article reports on AleniaAeronautica’s experience in manufacturing 18 G222s light transport planes for delivery to the Afghan Army Air Corps., performing as Prime under a US $287 million contract awarded by the U.S. Air Force.
AleniaAeronautica is a subsidiary of Finmeccanica, a global A&D company with 2008 revenues of € $15.billion (roughly US $22 billion at today’s conversion rates). Alenia was part of a team (that included L-3 Communications) who was awarded the contract in 2007. As Prime Contractor, Alenia was responsible all aspects of the program, from change and configuration control to quality assurance, including (most especially) supply chain management. It was a daunting challenge, yet the article reports that Alenia saw the G222s program as a critical part of its “strategic push” into the lucrative U.S. defense market (whose annual value is equal to the aggregate defense spending of the rest of the world combined). As the old cliché goes, failure was not an option. The FlightGlobal article reported, “Finmeccanica executives knew they could not afford a cost overrun or a major schedule delay on its first prime contract. The US military records how contractors perform, and poor marks damage future bids.”
Even though Alenia suffered setbacks in program execution, it absorbed them (instead of passing them onto its customer), because of the strategic importance of performing well on its first DOD prime contract. The article reports—
· The G222s arrived at Alenia's factory in Capodichino requiring far more work than the company's engineers had predicted. Alenia absorbed the financial impact of a 150% increase in contract work scope. (It is unclear if this was based on a decision by executive management, or because of the contract type.)
· After the DCAA refused to accept Alenia’s financial statements (which, like all European companies are based on International Financial Reporting Standards (IFRS) not U.S.-based Generally Accepted Accounting Principles (GAAP)) and declared Alenia’s accounting system inadequate, the company found itself ineligible for progress payments or submission of cost-reimbursement vouchers. Thus, according to the article, “Alenia officials agreed to internally finance the programme for nearly nine months, a big departure from Finmeccanica's corporate practice.”
To us, one important lesson that stands out from the foregoing is the involvement of Alenia and Finmeccanica’s executive management in sponsoring the program. When the program plan met the reality of execution, the executives bent the corporate rules in order to help the program succeed. Key to the flexibility was the context: the executives didn’t measure success based solely on the results of this particular program, but instead saw it as a part of a strategic portfolio of programs they were attempting to build. Thus, they understood that losing money on this particular program (as they almost certainly did) was not as important as it would be on another program, because of its strategic importance.
When we work with program management teams, one of the most important questions we ask is, “What is the definition of success?” As Aaron Shenhar writes in the November 16, 2009 edition of Aviation Week & Space Technology, “not all programs are equal.” In Alenia’s case, it was important to its customer that the program finish on time and on budget; however, it was important to the company that its customers were satisfied, even if that meant losing money in the process. (Obviously that logic would not hold true in all instances; otherwise the company would go out of business.)
Did the company succeed in meeting customer expectations? According to the article, Col Tim Freeman, commander of the USAF's 330th aircraft sustainment wing, said “I am very impressed. They did exactly what they said they were going to do." Clearly, that is the kind of customer feedback Alenia and Finmeccanica were looking for.
More prosaically, with hindsight we can see how AleniaAeronautica might have better positioned its program to succeed with its U.S. Government customer. First of all, it is surprising that DCAA would refuse to “accept [Alenia’s] financial statements [because] Alenia’s accounting system was based on European standards.” While IFRS and U.S. GAAP differ, the differences are not so pervasive or overwhelming that adjustments couldn’t have been made. (See this brochure by Ernst & Young, or this brochure by PricewaterhouseCoopers, explaining key differences between the two. Importantly, most commenters believe the two sets of financial reporting standards are converging.) One suspects that DCAA may have had other issues with the AleniaAeronautica accounting system, such as the company’s timekeeping and labor reporting practices. Additional investments by the company in this (and other) areas may avoid the future need to forego interim contract payments, thus boosting cash flow. It is possible that the time-value of the money saved may have paid for the efforts.
Second, had Alenia negotiated Performance-Based Payments, it could have received interim contract payments without the need for DCAA to agree that its accounting system was adequate. Performance-Based Payments (PBPs) are a relatively new form of DOD contract financing, not even entirely well-understood by experienced US-based defense contractors. Those companies that have taken advantage of them, however, generally have reported being quite pleased. (See our articles on PBPs here and here.)
Consequently, we conclude that international companies who want to do business with the U.S. DOD should consider investing in preparing their management internal control “business systems” to meet DCAA standards, and in understanding what options may be available to them if they run into difficulties with their Government oversight officials. Thus, the story of AleniaAeronautica’s success with its first U.S. Air Force prime contract has several good lessons within it.
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