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Balancing Risk

Contractors shouldn’t bear the burden of cost overruns alone.

Since taking the reins of federal spending, the Obama administration has been clamping down on open-ended cost-reimbursement contracts, saying that limiting their use could save taxpayers billions of dollars. The assumption is the lack of constraints allows contractors to drive up the government's tab through no fault of agencies.

One theory of contracting is the risks inherent in contractual agreements should be borne by the party best able to minimize them. In other words, the one who is best positioned to ensure a project stays on schedule should shoulder any costs if it does not. The question is who should bear the burden, government or industry.

Under fixed-price contracts, companies will get paid a certain amount no matter what. They must eat the costs of a contract gone awry. Under cost-type contracts (cost-plus award fee, for example), contractors can bill agencies for additional costs incurred because of delays, changes or other issues.

In a March 2009 memo, President Obama informed senior executives that dollars obligated under cost-reimbursement contracts nearly doubled between fiscal 2000 and 2008, from $71 billion to $135 billion. Cost-reimbursement contracts were lumped in with sole-source contracts, in which companies face no pressure from competition, as procurements prone to being "misused, resulting in wasted taxpayer resources, poor contractor performance and inadequate accountability."

Peter R. Orszag, then-director of the Office of Management and Budget, told lawmakers at a hearing earlier this year that one reason cost- reimbursement contracts are risky is they require intricate oversight to ensure contractors are working efficiently and controlling costs. "This oversight requires more resources and the involvement of a broader range of disciplines than are typically required to administer a fixed-price contract," he said.

According to Orszag, cost-reimbursement contracts provide no incentive for contractors to keep down expenses. OMB determined such agreements should be used only when circumstances prevent procurement officials from defining requirements in enough detail to use a fixed-price contract.

Contractors might, in fact, be guilty of abusing cost-reimbursement contracts. At the very least, the Government Accountability Office has reported that many companies have inadequate accounting systems for reporting costs and agency oversight is lacking. But are contractors solely responsible for cost and schedule overruns and other cost drivers? Of course not.

Contractors lament that agency delays at every stage of the acquisition process drive up their costs. Lawmakers have joined industry in urging the government to improve its requirements process, citing it as a major cause of overruns. Perhaps more than anything else, attempting to meet a long list of vague or ever-changing requirements for a project can financially doom a contractor. And the government is well aware of its own failings. In a 2007 Acquisition Advisory Panel report, agency and industry officials both said, "The government frequently is unable to define its requirements sufficiently to allow for fixed-price solutions."

According to those who worked with the advisory panel, the inability to nail down requirements stemmed from a culture steeped in the rush to award contracts, budget deadlines, a strained acquisition workforce and a lack of internal expertise.

So why shift the burden to contractors? For starters, they are in competition with one another, and they operate in a commercial market that forces them to maximize profits. Contractors will do everything in their power to avoid a scheduling delay if the agreement they signed says it will eat into their profits. The inducement isn't as cut-and-dried in government. Few can expect an agency to respond as nimbly as a corporation when a struggling acquisition starts running up costs.

In fact, agencies rarely take significant or rapid action to quell contracts when costs escalate. Under the Nunn-McCurdy provision of the 1982 Defense Authorization Act, a contract can grow 15 percent beyond its expected cost before Congress is notified, and 25 percent before termination is recommended, barring a compelling reason to maintain the program.

The Obama administration is trying to hold agencies accountable, or perhaps more accurately, to shame them into watching the bottom line. OMB is compiling and posting contract performance data such as cost and schedule data and ratings online and encouraging citizens to monitor agencies' progress. A number of poor-performing information technology programs have been shuttered as a result.

Industry isn't the only culprit when acquisitions run amok. And minimizing cost-reimbursement contracts isn't the only fix. When government fails to do its part in controlling procurement costs, contractors don't have much incentive to try harder.

Elizabeth Newell covered management, human resources and contracting at Government Executive for three years.