Tuesday, May 17, 2011

Arnold, Newt and the ACLU are nothing compared to this outrage!

What to write?

There is so much stupid stuff around today that it is difficult to choose between topics. I could look at Arnold and his decade old love child....but that is way too tabloid like.

Maybe Newt's unfortunate episode that is likely to end his presidential run just days after he bolted from the blocks would make an interesting topic? Nope...again, every tabloid will cover that.

How about the ACLU demands that a NJ school change its venue for graduation services because last year one attendee was offended by the Christian symbols on display at the very historic venue? This would be a perfect case of stupidity, but unfortunately is neither news nor original as the ACLU is always taking this type of action. It is clear that lawyers who can no longer earn a living doing real work attach themselves to the ACLU in the hopes that they can garner a name for themselves by fighting Christianity. No real story there either...just predictable stupidity.

Of course there is always the debt ceiling that we hit at 4pm yesterday. Strange how today there is no noticeable impact from that particular tragedy. Although, we have been told that the government is able to pull a whole range of tricks that keep it solvent for another, what, 11 weeks?  Or at least so says little Timmy Geithner (have you ever noticed how he resembles a leprechaun?). Now, I understand that he doesn't know how to use Quickbooks or Turbo Tax and therefore is incapable of lodging his tax returns, but that is no reason to doubt he understands the economic impact of reaching the debt ceiling. No! That is just crazy stuff. Of course he understands this...I just wonder what tricks he has up his sleeve to avoid a fiscal meltdown? Maybe....nah...well...couldn't do that, could he? Maybe he will just forget to pay some bills? Nah! That is crazy. About as crazy as the government cutting back on some of its spending programs to avoid default on its borrowings.

Which brings me to a new idea. Spending programs.

I am sure you have all guessed by now that I am a small limited government type of guy. I happen to believe that the federal government has a few responsibilities that I expect it to carry out in the most fiscally efficient but yet effective manner possible.

SO today I am going to restrict my musings to the efficiency of government spending in areas where the federal government has a mandate to spend. The most obvious area is the protection of its people and borders. Defense. To the extent that some NASA programs could also be said to be potentially good for defense, I will even include NASA in this discussion, although I do believe that most of what NASA does is better done by the private sector (but that is a discussion for another day!)

The focus of my attention today is government contracting for armaments, materials, vehicles, weapons, aircraft etc etc. Let me say at the outset that I have no problem with the government acquiring these things, no do I have a problem with the government contracting with private companies for research and development, some of which will never result in an end product. It is essential for research and development to be conducted to ensure that the US stays at the forefront technologically . This is all good stuff, by and large.

No.  The problem is in the type of contracts.

For years the government has required cost plus contracts (as opposed to fixed price contracts). For a minute let's ignore all the other inefficiencies in the contracting systems (such as Hubzone preference, women owned preferences, veteran owned preferences etc etc) and simply look at the greates cost increasing vehicle ever devised by Government.

The cost plus contract.

A cost plus contract works very simply. The contractor estimates what it will cost him to fulfill the contract. He then adds a fee or profit of around 7% to come to the estimated contract amount. That becomes the price of the contract. I don't think anybody would argue that a 7% profit is too unreasonable, after all we expect companies to make a profit, right?

So...on the face of it, cost-plus contracts look very efficient. Companies are not able to make "super profits" off the government and everyone is happy.

Not quite. You see, the Government has to determine what is acceptable as part of "cost" so they have thousands of government employees determining what constitutes 'cost" and what the contractor can include in the cost base. This is part of the "hidden cost" of cost plus contracting.

Ok. Once the Government has determined what are allowable expenses for "costs" it must ensure that these definitions are complied with. So another department with thousands of employees is structured to ensure that companies comply with the definition of "cost". These people go into the contractors workplace and audit their books and records to ensure compliance with costs definitions. Another "hidden" cost in government cost plus contracting.

And we haven't even gotten to the contractor yet.

So, lets go there now.

The contractor, in initially preparing the quotation for the contract, is fully aware of the thousands of pages of definitions of cost he must know. So, he creates an entire division within his company that simply examines government requirements and ensures that the company complies with them. This is a huge overhead that not only can not be avoided but is an acceptable cost for a cost plus contract and therefore actually makes the contractor money by the 7% fee that gets applied to it.

Wait...that creates an opportunity to make more money. If every allowable cost provides a 7% profit, if we simply increase our costs, we make more money!! What a thought! so...instead of using stainless steel screws that cost $1 each, we could use titanium screws that cost $4 each and effectively quadruple our profit. Wow! A goldmine that the government is paying for.

Wait a minute. This is just plain crazy talk. The government doesn't just give out no-bid contracts. There is still a competitive bid process right? Yes, with a few exceptions, most contracts have a competitive bid process...but remember, all the people bidding know how the game is played and have all gamed the system in the same way. Whichever company eventually wins the bid, has already built in the most waste it possibly can, because by doing so, it makes more money that you are paying for through your taxes.

If you think this is bad, it actually gets worse.

Most corporations know that if they push too hard on their initial quote, they may lose the contract. So...they underquote to get the job. They bid $3 million when they know it is going to cost them $5 million. Why do they do this, you ask? Why take a loss? The answer may surprise you. 

They will NOT make a loss. IN fact they will make more money. Why? Because when they get 2/3 through the contract they will tell the government that they have had some problems and have run out of budget, and the revised cost will be $5 million. They will say they cannot complete the contract without a revision in price. The government then has to decide whether to cancel the contract, in which case the contractor gets his $3 million (which generates a profit for him because he has not spent that much yet) or the government decides that an incomplete contract is unacceptable and agrees to extend the contract value to $5 million and the game begins again.

So...why does the government insist on cost plus contracts?

There are a number of reasons:_

1. the government does not want to be seen as causing companies to go broke. If they negotiated a fixed price contract and the contractor got it wrong, and ran out of money, the government would be blamed for causing its demise. What? Did I read that right? Yep...sure did.

Of course the thought of renegotiating a fixed price contract as they do with cost plus contracts could never happen. Garbage. I don't believe this line for a minute.

2. the government wants to make sure that it is not paying "super profits" to the contractor. IF it entered a fixed price contract and the contractor made 30% instead of 7%, people would say the government was wasting money.

On the face of it, this makes sense. However, would you rather the government pay $6 million on a contract where the contractor made 30% profit, or $9 million on a contract where the contractor made 7% profit?? For the identical item?

Don't laugh...I have seen these numbers in a real situation, and have seen far worse than that.

3. We don't want to find the company is unable to finance the contract. 

Ok...I can see that. Under a cost plus contract the contractor sends in a monthly bill of costs and fee and gets paid within 30 - 60 days and the cash flow remains fine. Umm...why can't a fixed fee contract be based on fixed monthly payments ,or payments when certain steps are achieved? Of course they can - the problem is that the government contracting officers are either too lazy or two ignorant of the technology to determine what reasonable monthly payments should be. It is way easier for them to wait on the contractor to invoice its costs and fees...no thought required.

So...cost plus contracting is costing us taxpayers hundreds of billions a year. A simple change to compulsory fixed price contracting eliminates government waste, contractor waste...and probably hundreds of lawyers both in government and in the private sector who will need to find new jobs.

Of course they can always go work with the ACLU while they try to find that elusive honest job.

Just my thoughts....


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