Capitol Hill seen on a cloudy day. (Photo by Anna Moneymaker/Getty Images)
As traditional defense contractors and outsiders alike gather for the Association of the US Army mega-conference this month, the latest Army acquisition policy just reinforces old dysfunctions that keep the most innovative firms away.
Above all, the Army’s March directive on “Enabling Modern Software Development & Acquisition Practices” [PDF] encourages the service to buy custom-built software, developed under arcane cost-plus accounting rules, “to the maximum extent possible,” instead of following best private-sector practices.
Even the official Senate Armed Services Committee report [PDF] warns that the Army directive “appears to deviate from the current law” and requires the service report back by Jan. 15 on how it “will implement the Directive in a manner that supports the participation of small businesses and nontraditional defense contractors.”
The Army’s fumbling is just the latest and most blatant manifestation of the antiquated business model in place across the Department of Defense. It’s an approach that consistently fails to seek out, absorb, and deploy innovative new technologies as fast as the commercial world or our adversaries.
There are pockets of excellence — like DIU, AFWERX, SOFWERX, and SDA — that have entrepreneurial culture baked into their DNA. They are funded by a disorganized hodgepodge of well-meaning, if uncoordinated pots of money — including Hedge Portfolio, APFIT, RDER, RCCTO, and RIF — and deliver cutting-edge products, including software, to the warfighter at the speed of relevance using commercial purchasing methods. But the Army directive appears to be doubling down on the legacy system that everyone else is trying to move away from as quickly as possible.
That current system, resembling the Soviet centralized economy model, notoriously ignores currently available technology and products made by commercial companies, and instead fantasizes impossible-to-make exquisite weapons through the “requirements” process, runs a fiction-writing contest to select from one of the five remaining large prime contractors that can write such proposals, then awards the winner a monopoly for decades for an item they have never made. Because the DoD locks themselves into purchasing that product only from that contractor, no private company would invest out of their own pocket in a superior product, as there is no way for the DoD to switch. The prime contractor is free to burn billions of taxpayer dollars for years, unmolested by competitive pressures from other vendors or adversaries whizzing by us.
The worst part, however, is the way these prime contractors get paid, specifically the so-called “Cost Plus” model — which particularly drew ire in the SASC report. Media reports often liken the Cost-Plus model to an hourly time and materials arrangement. It is not. It is much, much worse.
Imagine you need to replace the heating system in your house. You prefer the plumber bid for the job using a firm fixed price with everything included so there are no nasty surprises at the end. Many plumbers work this way: pad the estimate a little for safety, then perform the work while aggressively keeping expenses in check to maximize the profit left over at the end. Thousands of years of economic evolution have made this the most popular business model as it rewards efficient work by the vendor with higher profits and rewards the customer with certainty of cost.
If the job is too complex for firm fixed price — say, there are unknowns inside the walls — the plumber might say, “It will be $85 per hour for my labor, plus the cost of materials”. This is still a normal commercial practice. The plumber will be rewarded for driving the underlying cost of that hour as far below $85 as possible to maximize the profit on each hour.
This is where the DoD goes off the rails. Imagine then telling your plumber: “OK, inside that $85 per hour, I need to see exactly how much you are paying yourself and your workers in salary, benefits, and all your internal business costs, so I can make sure you’re not making too much profit”. After some very colorful language, the plumber will tell you it’s none of your business.
But a defense contractor can’t tell the US military to go to hell. There’s no commercial market for tanks and submarines. So the hardcore defense industry has had no choice but to implement laborious, bespoke accounting systems — and, in fact, has used them not only as a barrier to entry, keeping competitors from entering the defense business, but as a tool to extract more profit from the Pentagon.
In the Cost-Plus world companies are rewarded for increasing their business expenses. Instead of $85, you get $125, then add all the unnecessary auditing and accounting expenses just to keep track of all this nonsense and you’re up to $150. Then, because you have a locked-in monopoly, the hours spent performing each task magically inflate once the work starts. The customer can’t cut the contractor off and switch to someone else. The excellent article The Law the Department of Defense Loves to Break accurately describes the misguided philosophy that drove DoD to create this dystopian model in the first place. (The article was written by an employee of non-traditional tech contractor Palantir, but is not an official company statement). But needless to say, it is perhaps the worst way to buy anything that one could possibly imagine.
The net result of the Cost Plus incentive structure is to skew the “make or buy?” decision towards “make” wherever possible. Buying a finished off-the-shelf item that could shave years off of deployment to the warfighter, and save billions in the process is anathema to a Cost Plus contractor. It would cost them a boatload of profit they could make reinventing wheels.
Lawmakers are no dummies. In 1994 they passed the Federal Acquisition Streamlining Act, which amongst other things, mandates that before a Cost-Plus custom development contract can be solicited, the DoD must first search the commercial market for something that already exists, and is “close enough” to what is needed, and if it exists, buy it with whatever commercial business model that vendor uses (which is invariably some kind of fixed price arrangement). This is codified in 10 U.S.C 3453.
As the Senate report language spells out, it’s very hard to see how the Army’s March directive does not “deviate” from that law — and even if the service can somehow satisfy the letter of FASA, it very much violates the spirit. And while FASA is far from consistently enforced, it’s not a dead letter, as shown by the Army’s loss to Palantir in a 2017 lawsuit over this very matter. In the future, a new suit over the new policy could cost the Army hundreds of millions and years of delay.
Yet the Army seems to be heading, undaunted, towards the cliff, as shown by this declaration by the service’s acquisition chief, Doug Bush: “If some companies don’t want to bid on a contract, it’s a free country. Don’t bid. Others will. My goal is simply to get the capability for the Army, not to make everybody happy.”
But the very best software companies in the world all work on firm fixed price: By pre-ordaining Cost Plus, the Army effectively excludes the very best in the business right from the get-go. What possible reason could one have to do this? The only beneficiaries of this policy are the incumbent defense contractors, who are rejoicing at the affirmation of business-as-usual, and our adversaries around the world, who will take aid and comfort in this opportunity to surpass the United States’ competitive advantage.
It’s incumbent on Congress to step in, conduct rigorous oversight, and if necessary pass new legislation to hold the Army to both the letter and the spirit of the Federal Acquisition Streamlining Act. It’s clear the Pentagon won’t do it themselves.
Warren Katz is Chairman of The Alliance for Commercial Technology in Government, the industry association representing commercial technology companies that would like to do business with the DoD on commercial terms. He was past Managing Director of The Air Force Accelerator Powered by Techstars, prominent angel investor and startup founder in dual-use companies.