government contracting system known as "cost plus"

From: Dickey, Michael F (
Date: Tue Jan 15 2002 - 11:23:54 MST

Thought people might find this interesting....



Cost plus

"Beyond These considerations stands the government contracting system, known
as "cost plus," which has been in place for some time now in the United
States. According to the people who invented the system, it is essential
that corporations be prevented from earning excessive profits on government
contracts. Therefore, rather than negotiate a fixed price for a piece of
hardware and allow the company to make a large profit or loss on the job
depending on what its internal costs might be, regulators have demanded that
the company document its internal costs in detail and then be allowed to
charge a small fixed percentage fee (genarlly in the 10 percent range) above
those costs as profit. This system has served to multiple the costs of
government contracting tremendously, so much so that it has produced public
scandals when news leaks out thabout the military paying $700 for a hammer
or a toilet seat cover.

To see how this works, consider the case of the Lockheed Martin corporation,
the largest aerospace contractor in the world. I was employed as a senoir,
and later staff, engineer at the prime facility of this company for seven
years. Lockheed Martin almost never accepts hardware contracts on a fixed
cost basis. That is, the company rarely says to the U.S. government, "We
will produce the ABC vehicle for you at a price of $X. If it costs us less
than $X to make it, we will make a profit. If it costs us more, we will take
a loss." Instead, most important contracts are negotiated along the
following lines: "We will produce ABC vehicle for you at a cost of about $X.
We will then add a 10 percent for to whatever it actually costs us to
produce to provide the company with a modest profit." In other words, the
more the ABC vehicle costs to produce, the more money the company makes.
Hence, in addition to the vast numbers of accounting personnel that the
cost-plus contracting sytstemn necessarily entails, the company is saturated
with "planners" "marketeers" and "matrix managers" among swarms of other
overhead personnel. Of the 9,000 people employed at the Lockheed Martin main
plant in Denver (where the Atlas and Titan launch vehicles are made) only
about 1,000 actually work in the factory. The fact that Lockheed Martin is
keenly competitive with other aerospace giants indicates that thier overhead
structures are similar.

In the context of this regime, government willingess to give such
corporations cost-plus contracts for product improvement can acutally serve
as disincentive for company investment in innovation. A number of years ago,
I was part of a team that proposed a new upper stage for the Titan rocket,
which would have increased the vehicle's performance by 50 percent. Creating
the new upper stage would have required a company investment of abou $150
million. (Asingle Tital launch sells for between $200 million and $400
million.) The coporation's management declined, saying, in effect, "If the
Air Force wants us to improve the Titan, they will pay us to do it." As a
result, the Titan was not improved and the company's commercial Titan line
was shut down when all of its private-market business was taken by the
slightly less obsolescent French Ariane. The company didn't mind much,
however, as all of its cost-plus U.S. government launch contracts are
protected by law from foreign competition, and it faces no U.S. competitors
in the Titan's payload class."

Robert Zubrin - Entering Space - page 24

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