Kelman: Rethinking fixed-price contracting

Agencies are under pressure from the Obama administration and Congress to increase the use of fixed-price rather than cost-based contracts. Many contracting professionals have pushed back. However, in my view, we should see the new push not just as a threat but also as an opportunity to re-examine standard practices.

The argument for fixed-price is straightforward. Contractors have little incentive under cost-based contracts to keep costs under control, because costs — or labor rates under time-and-materials work — are passed on to the customer. To be sure, government keeps a more watchful eye on costs in cost-based contracts. But in practice, this doesn’t occur as much as it should because of workforce shortages. Even with larger staffs, it is really difficult to know whether contractor personnel could have worked more diligently or with fewer people than they did. But contracting folks worry there will be pressure to make contracts — particularly service contracts — fixed-priced even when it doesn’t make sense.

There are two potential problems, distinct though often mixed together. One is a situation in which the government knows what it wants, but it’s unclear how much effort it will take a contractor to meet the requirement. An example would be a requirement to develop technology to save 20 percent of fuel costs for a fighter plane, for a maximum cost of x dollars per plane, without sacrificing any performance specifications. If the requirement is research intensive, forcing contractors to bid a fixed price will lead many not to bid and others will inflate bids radically to compensate for the risk. Classic examples of this problem are the late 1980s’ policies that encouraged fixed-price weapons development contracts, which then produced a series of fiascoes.

A second kind of problem is where government isn’t, or can’t be, specific about what it wants. In such situations, a fixed-priced contract is meaningless, because it is unclear what the customer will get for the price. A poorly specified requirement will produce a poorly delivered service. Requirements changes, which are common, then require negotiating change orders in a sole-source environment, potentially vitiating benefits of a fixed price.

I believe there are opportunities for increasing fixed-price contracting. For example, some requirements get competed and re-competed without changing dramatically. It should be possible to convert these projects to fixed-price. Of course, sometimes requirements are genuinely almost impossible to specify, but other times government could do a better job if agencies had the inclination — and the resources, which workforce deficits often mean we don’t — to spend the time necessary to analyze and specify the requirements. That would bring performance benefits beyond simply making the contract fixed-price. And agencies should develop a past-performance sub-factor that rates the extent to which contractors respect the government’s interests when negotiating change orders.

The administration and Congress need to understand that more fixed-price contracting requires more acquisition professionals to develop requirements. Contracting folks need to step up to the plate and agree that, if given the resources, we will use some of them to improve requirements, allowing more work to be fixed price.