Trust your vendor, but verify the prices

I have been spending a good deal of my summer interviewing government contracting professionals for research that examines procurement reform at working levels of government organizations. One of the interesting things I've heard is that a number of government folks are worried that some contractors might exploit the government/vendor partnership, which was spurred by procurement reform, to win unilateral advantages.

The good news is that I've heard this concern mostly from folks dealing with Defense contractors and not much from those dealing with information technology. But because of the IT sea change in recent years— from a wall of separation to a world of better communication, fewer protests and more collaboration— these signals are worth noting.

One of the most thoughtful people I interviewed who brought up this subject was Don Utendorf, chief of contracting for the Wright Research Site of the Air Force Research Laboratory, Dayton, Ohio. The lab is one of the premier high-tech research contracting operations in government and an outfit that has aggressively embraced acquisition reform. After stating a number of positive changes that reform had brought, Utendorf told me that the jury is still out on "whether contractors are willing to operate in this area of trust and not see it as an opportunity to take advantage of the government."

Utendorf recounted that in his career, in addition to buying R&D, he had bought commercial planes (Gulfstream jets and Air Force One) and military aircraft. The culture of the commercial companies he dealt with, he said, was more attuned to mutual benefit than the culture of the firms that dealt with the Defense Department. "When I was buying Gulfstreams, the company volunteered they were nearing the end of a production line and that many customers liked to wait for the new model, and that if I was interested in buying the old model, they could give me a really great deal," he said. "I don't think most defense companies think that way." He's worried that some defense firms will try to dictate prices by presenting them as "commercial" and telling the government to take it or leave it.

His solution? He cited former President Reagan's adaptation of a Russian proverb: "Trust but verify."

"It is to our mutual advantage to work very closely with contractors in a trusting environment," Utendorf said. "But we have to make sure that we're comfortable with the prices we're paying and not just giving contractors carte blanche."

Utendorf's perspective tracks the results of social science research about prisoner's dilemma games. The dilemma involves two players who need to decide whether to cooperate with, or to take advantage of, each other. If each player cooperates, both will do well. This is called a "win-win" strategy (the origin of the phrase). Procurement reform seeks to move toward "win-win" government/vendor relationships.

What makes the prisoner's dilemma dicey is that if one of the players seeks to take advantage of the other and the other is a patsy, the player who exploits his counterpart's willingness to cooperate makes off like a bandit, doing better than he would in a win-win approach but at the other player's expense. (This is a "win-lose" strategy.) This creates an incentive for each player to try to achieve a unilateral advantage.

However, an exploitative player can seldom get away with exploiting the relationship for long. Sooner or later, the other player will punish him. However, such punishment produces a situation in which both suffer, although the player who punishes the noncooperator doesn't suffer as much as by being a patsy. This is a "lose-lose" strategy— the kind that dominated government/vendor relationships before procurement reform.

To put it in simplistic terms, a win-win approach might produce a satisfied government customer and an economic return of 10 percent for the vendor, while a lose-lose approach will produce an irate customer and a 5 percent return for the vendor. But the vendor might be tempted to abandon a win-win approach because if it can do so without retaliation, the vendor's return might be 20 percent.

Social science research on the prisoner's dilemma indicates that win-win outcomes are fragile because players are tempted to exploit the kindness of those with whom they have been cooperating. It also indicates that lose-lose outcomes can become stable because, once established, neither player wants to risk being a patsy by becoming the first to resume cooperation. Examples of lose-lose outcomes of the prisoner's dilemma range from the overfishing of lakes to arms races among nations.

In 1984 Robert Axelrod of the University of Michigan published an influential book, The Evolution of Cooperation, demonstrating a simple strategy to create win-win outcomes. Called tit-for-tat, the strategy's rules are simple: Start by cooperating and cooperate in return every time the other player cooperates. When the other player fails to cooperate, retaliate the next time around. But don't hold grudges. As soon as the other player resumes cooperation, cooperate in return.

The bottom line: Partnership between government and industry is one of the most valuable results of procurement reform. It is crucial to getting better results from the government's IT investments. But recent gains also are fragile. Both sides need to be sensitive to the possibility that the partnership can unravel, and they need to avoid seeking to exploit each other. The government also must be ready to punish exploitation of the post-reform climate while returning to partnership if the vendor puts the relationship back on a cooperative track.

-- 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.