Apogee Consulting Inc

More on Blended Rates

Nick Sanders

Executive compensation, the gift that keeps on giving.

Complicated Congress has no trouble with the free market, until and unless that same free market dictates that corporate executives should earn as much as movie stars. Then legislation is drafted and becomes law, and the FAR Councils draft regulatory revisions and they become final rules … and then contractors have to figure out how to comply. At which point, everybody realizes how flawed the original statutory language was, which led to a flawed regulatory regime, which led to a compliance conundrum—wherein it costs contractors more to comply with the flawed requirements than the Federal government saves in price reductions.

What are we talking about?

For background, please start with this article, published more than two years ago, in January, 2014. Or maybe start with this one, an article written about six months prior to the other one. They are but two of several articles we’ve devoted to the topic of calculating allowable executive compensation in accordance with the complex – and flawed – rules.

Those articles formed the backdrop for our November 2014 article on use of “blended rates” to calculate allowable executive compensation. As we wrote in that article—

At this point, the average contractor must handle three separate rules that each establish separate limits on allowable compensation. Some contracts are subject to the “old” executive compensation ceiling of $952,308, as applied to the Top 5 most highly compensated individuals in each segment. Other contracts are subject to the “old” ceiling as applied to all contractor employees (not just the Top 5). Still other (newer) contracts are subject to a lower compensation ceiling of $487,000, as applied to all contractor employees. The ceiling on allowable compensation depends on when the contract was issued and its effective date, because it is the FAR Part 31 cost principle language in effect on that effective date that establishes the applicable ceiling.

The solution to that problem, as we discussed, was the use of “blended rates” to calculate a weighted average allowable executive compensation amount.

But as we noted, at that time DCAA was not on board with the use of blended rates, even though DOD as an agency approved of that methodology. DCAA was going to question the resulting indirect cost rates and questioned costs were going to be found to be expressly unallowable. Thus, the need for an Advance Agreement to create the situation where the contractor and the cognizant ACO agreed in advance that the resulting rates were going to be allowable. The Advance Agreement acted to protect the contractor; any DCAA questioned compensation costs stemming from use of blended rates would not be sustained by the ACO.

(Never mind that Advance Agreements are extremely difficult to obtain these days, as we discussed in yet another article.)

So, anyway. That’s where things stood until recently.

What changed?

Well, one thing that changed was that the OFPP published another executive compensation benchmark and ceiling in March, 2016. The new ceiling, which applies to compensation costs incurred after January 1, 2014 is $1,144,888. We think that ceiling applies to compensation costs incurred by non-DOD contractors (and to compensation costs incurred by DOD contractors prior to June 24, 2014) but, quite honestly, at this point we’re not sure of anything regarding executive compensation. It’s a big confusing mess. The OFPP has a webpage that tries to help people make sense of it all, but we got lost trying to figure it all out.

Another thing that changed was that DCAA issued MRD 16-PSP-005 on February 19, 2016. That MRD transmitted a guidance memo from OUSD (AT&L) signed by Shay Assad, Director of Pricing. The DOD memo noted that the FAR had been revised (via interim rule) to implement some of the legislative interference in the free market we noted above. The DOD memo acknowledges that DOD contractors “may elect, but are not required, to use the blended rate approach.” The DOD memo states –

If a contactor proposes to use the blended rate method to cost and propose, the contractor will initially calculate and use a blended rate for interim billing. Subsequently, for the purpose of establishing final overhead rates, contractors will calculate blended rates reflecting actual proportion of contract costs for the current year for contractors prior to and after June 24, 2014. The contractors’ final overhead submission for the completed fiscal year must include auditable substantiation of the calculation of the actual blended rates.

The DOD memo also stated –

Contract administration office contracting officers and contractors will execute an advance agreement … with each contractor that chooses to employ the blended rate method. The advance agreement will outline the agree-to process, auditable data submission and expiration for the application of the blended rates. Additionally, DCMA will issue implementation guidance in coordination with DCAA on this subject.

The implementing guidance noted in the preceding quoted paragraph was issued January 29, 2016; it was also included in the DCAA MRD. It started by reciting some of the history of the compensation ceiling and how that ceiling applies to contractors. (I.e., it is a summary of the hairball of compliance rules with which contractors must comply.) The implementing guidance memo made it crystal clear that DCAA was to audit the contractor’s calculation of the blended rate ceiling. In other words, DCAA was not to question compensation costs solely from the use of a weighted average compensation ceiling. (Thus the prior DCAA audit guidance was changed by executive fiat.)

There is lots of good guidance in the memo regarding exactly how a contractor is to calculate its weighted average compensation ceilings. If you have questions in this area, please see the memo.

But that’s not all that changed.

On June 30, 2016, DCAA published MRD 16-PSP-007, which was an “audit alert” regarding treatment of proposals to establish final billing rates (aka “incurred cost proposals”) when a contractor used blended rates to determine allowable executive compensation. It establishes the novel and utterly unsupportable position that a final billing rate proposal shall not be considered to be adequate for audit until and unless the contractor and government have executed an Advance Agreement.

Now, we’ve already written that such Advance Agreements are good things to have, and we agree that one should be in place. On the other hand, we’ve also written that it’s very difficult to actually obtain an Advance Agreement these days. It may be the case that the contractor and the government cannot come to a meeting of the minds regarding how the contractor will implement the blended rate methodology. It may be the case that the Contracting Officer is waiting for legal review, or the results of a Review Board, or maybe everybody is really busy. The point is, an Advance Agreement may not be in place.

The DCAA audit guidance states: “When the proposal is determined adequate and there is no executed advance agreement, the audit team should return the proposal and require the contractor to resubmit the proposal only after executing an advance agreement with the ACO.” That is insane.

Contract clause 52.216-7 establishes the format of a contractor’s proposal to establish final indirect rates. DCAA rammed through its ICE model approach into the FAR a couple of years ago, and right now that’s what the FAR requires. Nowhere does the language of 52.216-7 require an Advance Agreement to be in place in order for the contractor’s proposal to be audited.

Nowhere in the FAR language of 31.109 does it condition cost allowability on the existence of an Advance Agreement. In fact, the word “should” is found in the regulatory language, which is a far cry form the word “shall” (which denotes the imperative).

In our admittedly biased view, if DCAA refuses to audit a contractor’s incurred cost proposal simply because an Advance Agreement is missing, that decision would be tantamount to a contract breach. If the conditions established in 52.216-7 have been met, then the government must meet its duty of performing an audit and entering into negotiations to establish final billing rates.

We hope somebody, somewhere, takes DCAA to task for this bizarre and unsupportable position.

So there you have it. Executive compensation. Cost allowability. Blended rates. Legislative interference and DCAA interference. A hairball of regulatory complexity that may actually cost more to comply with than any savings generated thereby.

Your government at work.

Innovation Meets Resistance from Entrenched Bureaucrats

Nick Sanders

“When leaders say they want innovation, what they want is spiral development and predictable forward progress. They don’t want disruptive innovation that upsets the status quo and puts jobs at risk.”

We wrote that more than a year ago, in discussing why the Pentagon was never going to get the innovative technology it says it wants. In that same article, we also wrote—

Disruptive innovation is the result of a vision plus hard development work, and the Pentagon doesn’t fund that type of effort much anymore. Disruptive innovation gets in the way of carefully managed, centrally planned, incremental improvements. Nobody wants to sponsor a wild hair idea that may, or may not, end up working out. While innovators seek to ‘fail faster’ the current Pentagon mantra is ‘failure is not an option.’ Thus, disruptive innovation has no patrons and has to fight a difficult battle against the forces that defend the status quo.

Further to those year-old thoughts, let us offer two pieces of evidence in support of our assertions.

First, follow this link to an article on TechWire, written by Jason Shueh, which discusses the problems faced by the 18F group at the GSA. For those readers who may be unfamiliar with the 18F group, it is described as “an office inside the General Services Administration that helps other federal agencies build, buy, and share efficient and easy-to-use digital services.” Started in 2014, after the debacle of healthcare.gov, 18F was supposed to bring disruptive technology solutions to the Federal government. Eleven of the first 15 employees of the group were Presidential Innovation Fellows, staffed from both government and industry.

Back to the TechWire article –

Multiple sources connected to 18F report that the group of former Silicon Valley tech innovators — that helps agencies buy, build and share technology — is grappling with opposition from GSA’s Federal Acquisition Service (FAS), the division managing funding for 18F. Speaking on the condition of anonymity, an authority inside 18F reported that FAS has on multiple occasions sought to defund the program due to some of its private-sector tactics, charging that while 18F strives to improve government purchasing and technology development, the group is also disrupting traditional procedures.

The article continued –

[Former GSA Administrator] Tangherlini said his worry for 18F, and innovation programs like it, is that the federal government’s risk-averse nature, and proclivity for tradition, will discourage top talent from entering civil service. The roster at 18F — and the U.S. Digital Service, its sister organization, that offers IT consulting in teams at the White House and agencies — boasts expertise from Google, LinkedIn, Facebook, Twitter and a host of other leading tech companies. The allure for these technologists to enter government isn’t a federal salary they could easily surpass in the private sector. The willingness comes from an ambition — as idealistic as it might sound — to enhance and rethink the systems and tools used by government to serve citizens.

Another article about 18F, this time from GovernmentTechnology (also written by Jason Shueh), reported more of the details regarding the “tension” between 18F and the entrenched GSA FAS bureaucracy. It stated—

Externally, 18F is defending itself from IT lobbyists, representing companies like IBM, Deloitte, Cisco Systems and others, that allege 18F is hindering revenues as a competing government tech provider — a message they shared at a recent hearing evaluating 18F's effectiveness. Internally, the group has met resistance from CIOs unsure of its private-sector development practices, and within the General Services Administration (GSA), 18F's parent agency, insiders say that the Federal Acquisition Service (FAS) that funds 18F is actively working to terminate the group. The sources report that 18F’s procurement work to break down IT contracts into smaller pieces has compelled FAS to act. They allege that FAS leadership fears shorter-term IT contracts at more competitive prices would decrease the revenues the organization receives from agencies via contract service fees and other FAS procurement vehicles.

In summary, the entrenched bureaucracy at GSA’s FAS group seems to be afraid of a government that works better and costs less (at least for technology projects) and is doing what it can to stifle disruptive innovation. The bureaucracy seems to be aided and abetted in its efforts by the “traditional” IT consulting firms, who stand to make bank by following the traditional Federal IT project approach of late deliveries, broken budgets, and unmet requirements. (A hat tip to Bob Antonio’s WIFCON site for pointing us to the 18F controversy.)

In related news, our second piece of evidence in support of our assertions concerns a recent report from the DOD Office of Inspector General. The DOD OIG report concerned the Advanced Arresting Gear (AAG) program, a Major Defense Acquisition Program (MDAP) managed by the U.S. Navy. According to the DOD OIG, the program is behind schedule and in an overrun position.

What’s the root cause of the programs problems?

The DOD OIG states the fundamental problem is “the Navy pursued a technological solution for its Ford-class carriers that was not sufficiently mature for the planned use, resulting in hardware failures to mechanical and electrical components, and software modifications to accommodate these failures.”

Yes, you read that correctly. According to the IG, the Navy’s problem was that it tried to innovate with insufficiently mature technology. Apparently, innovation should only be pursued with mature technology, technology that has been proven. The fact that this is a logical impossibility apparently escaped the DOD IG.

So there you have it, folks. Two anecdotes. Two pieces of evidence (plus the recent update article on the Palantir vs. DCGS fight) that support our pessimism regarding the Federal government’s ability to innovate and to facilitate innovation by its contractors.

Oh, how we wish we were wrong about this.

DOE Withdraws Proposed Business System Rule

Nick Sanders

More than two years ago we reported on the Department of Energy’s implementation of a business system administration regime, one that was remarkably similar to (but not a copy of) the DOD’s business system administration regime. Late last year, we collected some of our thoughts on the state of the DOD’s business system administration regime. Since that time we have found no reason to change our mind regarding those thoughts. The current DOD business system administration regime just ain’t working out the way the DAR Council thought it would.

Everybody knows it just ain’t working; but nobody has said so publicly.

Except for Apogee Consulting, Inc. We called for a new approach last November at the ABA Section of Public Contract Law meeting. Not that our call for action resulted in any action being taken ….

Everybody knows DCAA is understaffed to perform its share of the business system reviews. Everybody knows that DCMA is unable to review and issue System adequacy determinations within the timelines established in the applicable DCMA Business Instructions. Everybody knows it takes too long and costs too much money to fulfill the regulatory (and internal) requirements associated with Contractor Business Systems administration and management. They just don’t talk about it.

We all shrug and try to do the best we can with a misguided and obviously flawed approach. What else can be done? There seems to be no appetite for change at the moment. Which is unfortunate ….

Thus, we took it as a very good sign that the DOE withdrew its proposed rule that would have officially implemented its version of Contractor Business System administration on July 6, 2016.

No rationale was provided. The Federal Register notice said simply: “the Department has determined that it will not proceed with the rulemaking and, as such, is withdrawing the proposed rule.”

We are left only with speculation regarding the motivation(s) for withdrawing the proposed rule.

Was it a belated recognition that five years of evidence has shown the flaws inherent in the DOD’s implementation?

Was it an acknowledgement that DOE lacks the necessary resources to effectively implement the proposed rule—especially because (for the moment) DCAA is prohibited from performing any business system reviews on behalf of DOE?

Was it recognition of the resources and costs associated with contractor business system administration and management—costs which would have to be borne by DOE? Did somebody do the math and calculate the impacts to DOE’s budget?

Obviously we don’t know why DOE withdrew the rule after more than two years of consideration. But we are glad the Department did so.

Good move, DOE.

Another Lesson for Silicon Valley: The U.S. Army Doesn’t Want You

Nick Sanders

We have written and opined extensively about the DOD’s attempts to woo Silicon Valley and obtain more commercially developed technology for warfighters. We have been skeptical about the entire initiative. We even devoted an entire article to the fight between the data management platform developed by Palantir and the data management platform developed by traditional defense contractors, called Distributed Common Ground Systems (DCGS).

In that article, written about 18 months ago, we summarized the situation thusly—

… a concrete example of innovative technology that works better and costs less than the traditional product that was designed, developed, and delivered by the traditional defense establishment. The only problem is that it’s disruptive and upsets the status quo. The Pentagon has gotten the innovative technology it said it wanted; but it won’t use it, even if that means soldiers’ lives may be at risk.

Now here we are again, 18 months later, and Palantir has just filed suit at the Court of Federal Claims seeking to have the Army’s entire acquisition strategy overturned. Palantir filed a pre-award bid protest, meaning that it believes the solicitation itself will lead to a flawed source selection decision.

According to this article at DefenseNews—

Palantir’s lawyers call the Army acquisition efforts for the Distributed Common Ground System-Army Increment 1 and Increment 2 both illegal and irrational. … Palantir is arguing the way the Army wrote its requirements in a request for proposals to industry would shut out Silicon Valley companies that provide commercially available products. The company contended that the Army’s plan to award just one contract to a lead systems integrator means commercially available solutions would have to be excluded. … A successful lawsuit, according to the court document, could result in breaking down walls the Army has historically built up between its ‘failed procurement approach and the innovations of the private sector.’

There’s more to the DefenseNews article and you should read it in its entirety. In essence, Palantir has asserted that the Army’s failure to adopt its lower-cost, better functioning product has cost casualties. If that’s true, this is more than a procurement story; it’s a story about failed leadership.

More to come on this, we are sure.

Northrop Grumman’s Subcontractor Management Puts $10 Billion Program at Risk

Nick Sanders

From time to time we bloviate about the importance of subcontractor management to effective program execution. Here’s a link to a recent story about Northrop Grumman’s management of a Triton program subcontractor. Corrective Action Requests (CARs) that date back to 2013 are jeopardizing the program’s ability to obtain Milestone C approval. Milestone C would move the program from development to Low-Rate Initial Production (LRIP). The LRIP phase of the program has been estimated to be worth $4 Billion to NOC. Moving from LRIP to FRP would add perhaps another $6 Billion to the pot, bringing the Triton’s program value (excluding development) to about $10 Billion, according to the article.

How much would you pay to ensure your $10 Billion program received Milestone Decision Authority approval? We bet you’d pay quite a bit. We bet you’d bring in engineers and quality assurance experts and experts in composite manufacturing, and you’d drop them into that supplier and have them camp there until all the problems had been fixed. We bet anybody who tried to argue about budget overruns and cost/schedule variances would be told to STFU because there was $10 freakin’ BILLION dollars at stake. But that’s at your company.

Apparently at Northrop Grumman, subcontractor management is handled a bit differently.

That’s a shame, really, especially if you are a NOC shareholder.

Finally, anytime you think we’re full of hot air, and that we are making too much noise about the importance of subcontractor management, feel free to review this article.

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More on Blended Rates

Innovation Meets Resistance from Entrenched Bureaucrats

DOE Withdraws Proposed Business System Rule

Another Lesson for Silicon Valley: The U.S. Army Doesn’t Want You

Northrop Grumman’s Subcontractor Management Puts $10 Billion Program at Risk

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