Spare-parts problems threaten commercial buying gains

Dramatic congressional testimony from the Defense Department's inspector general on overpayments in DOD spare-parts purchasing last month made national headlines and the network news. For most of the public, this is DOD conducting "business as usual." Some, though, have noticed that the problem is related to DOD's efforts to buy commercial products and its transition to a new procurement environment.

How did DOD end up paying too much for some spares? Traditionally, when buying sole-source items, DOD received certified cost and pricing data from the contractor, which served as a basis for price negotiations. One of the thrusts of acquisition reform, reflected in the Federal Acquisition Streamlining Act (FASA) and the Clinger-Cohen Act, has been to get rid of government demands for cost data when buying commercial items. The reason was that such demands have significantly inhibited commercial firms from doing business with DOD, depriving DOD of access to less expensive, state-of-the-art technology and limiting DOD to reliance on defense-unique vendors.

In the case of these spares, Sundstrand Corp. informed DOD that the spares were part of Sundstrand's commercial spare-parts catalog sold to commercial customers. The company refused to provide cost data and demanded that DOD pay the catalog price like any commercial customer.

As it turned out, the commercial price was far higher for these spares than the price DOD had traditionally negotiated using cost data. This was partly because commercial aerospace companies traditionally follow a "razor and blade" strategy, keeping prices for the original item low and making money on selling spares. The other reason for the higher commercial price was that embedded in the price was the help that vendors often provide commercial customers in designing equipment to meet customer needs.

Neither of these features of commercial spares pricing applied to DOD's situation. There has been no suggestion that as part of commercial pricing Sundstrand lowered its prices on the underlying equipment, or the "razor." The kind of design help Sundstrand provides commercial customers is not really possible in the federal procurement environment.

Nonetheless, Sundstrand more or less said to DOD that "buying commercial" meant accepting these prices. In some cases, harried DOD buyers either didn't notice that the new prices were much higher because they didn't bother to check the pricing history for the parts, or they accepted Sundstrand's claim that this higher price was a necessary part of "buying commercial." In other cases, DOD buyers protested the costs and accepted Sundstrand's prices only when supplies were about to run out; however, they noted in the contract file that they couldn't vouch that the prices were reasonable.

Sole-source spares buying is a tough game for a customer under the best of circumstances. Overpricing was hardly unknown in the days of cost data. In addition to receiving a hefty refund from Sundstrand, DOD is now training buyers not just to accept catalog prices but to know the difference between what DOD and commercial customers receive from vendors and to leverage DOD's large buying power better.

But these genuine problems should not obscure the big picture, which is that commercial buying has yielded savings to DOD many times the losses caused by these transitional problems.

For example, DOD reduced the price of a lightweight Global Positioning System receiver from $20,000 to $700 a unit by buying commercial while obtaining a unit weighing 2.5 pounds instead of 35 pounds. DOD bought a commercial training simulator for $69,000, although as a developed-for-DOD item, it had been estimated at $l0 million. The agency also reduced its cost on a forklift maintenance contract from $24,600 to $3,900 by going commercial.

National TV news programs that had never run a single story on procurement reform— missing such minor details as the $2 billion savings, or 50 percent price break, on one weapons system that was bid out before acquisition reform and later rebid as a FASA test program; the hundreds of millions of dollars in savings annually generated by the government purchase card; and the lowest long-distance phone rates in the country— rediscovered procurement when the spares story broke.

Ironically, perhaps the good news is that because TV never reported procurement reform in the first place, the public will think the spare-parts pricing problems are just business as usual at DOD, thus reducing any pressure to roll back the reforms. For the rest of us, though, the lesson is this: Take measures to deal with problems that procurement reform creates while realizing that the benefits of reform far, far outweigh the costs.

Kelman was the administrator of the Office of Federal Procurement Policy from 1993 to 1997. He is now Weatherhead Professor of Public Management at Harvard's Kennedy School of Government.