Fixed-price contracting makes unwelcome return

It's a depressing sign of getting old: You witness the discrediting of a bad idea, then, after a period of dormancy, its resurrection as the new best thing. It's happened with fondue, leggings, open classrooms and now, in the procurement arena, fixed-price development contracting.

Section 818 of the 2007 Defense Authorization Act repeals the 18-year-old prohibition against fixed-price development contracts. In its place, the new law creates a de facto preference for fixed-price contracts, unless the agency can justify in writing that because of complexity and technical challenges, program risk is so high that only a cost-based contract would be practicable.

The Bush administration, in conjunction with industry groups, opposed the return to a fixed-price preference and worked successfully to modify the Senate bill before passage. Nonetheless, Section 818 encourages use of fixed-price development contracts, despite the fact that they have been thoroughly discredited in the past.

The false allure of fixed-price development contracting has twice led to acquisition policies that resulted in spectacular contracting failures. The first incarnation of this approach occurred in the 1960s in the Total Package Procurement.

TPP typically involved a fixed-price, multiyear contract for research, development and initial procurement, followed by fixed-price options for full-scale production and implementation. The contractor was required to look into the future and estimate the costs to be incurred, and then was held to that price after award.

Not surprisingly, TPP was generally acknowledged as a failure. Instead of creating more successful projects, the approach resulted in "bet-the-company" risk, major technical problems and delays, and large-scale, protracted claims litigation.

This failure was perhaps best illustrated in the development of the C-5A Galaxy aircraft, which required a costly $250 million restructuring. In 1971, after similar failures in other large projects, the government abandoned TPP and returned to a more equitable, balanced allocation of contract risk.

Unfortunately, this mistake was repeated in the mid-1980s when the Defense Department again flexed its superior buying power and?with good intentions, but disastrous effect?transferred undue risk to its contractors. Again, the mechanism was fixed-price development contracts.

The 1980s reincarnation of the concept is most notoriously reflected in the Navy's failed development of the A-12 Avenger II aircraft. When the A-12 contract ultimately was terminated for default, the disputes between DOD and the contractors, played out over more than 10 years of litigation, became the source of the largest claim ever brought against the United States.

By the late 1980s, the concept of fixed-price contracting was thoroughly discredited, and Congress in 1989 changed the law to prohibit such contracts except in limited circumstances.

So why, in 2006, did Congress reverse its position and pass a law that likely will lead to the same mistakes being made all over again?

Arguably, it's just the triumph of politics over policy. The popular idea of being tough on contractors simply trumped the knowledge that transferring too much risk to contractors is a demonstrably bad idea.

But that's not the whole story. Passage of the law also was motivated by a genuine concern about cost and schedule growth on cost-type contracts, as well as the frustrating inability of DOD and contractors to consistently manage those contracts to original expectations.

It's a complex problem and one that demands honest dialogue from both sides, particularly concerning whether expectations are being realistically set in the first place. But simply shifting the risk associated with the problem to contractors, as Congress has encouraged DOD to do, is not a reasoned solution.

History tells us that fixed-price development contracting is an approach that is doomed to failure. Let's hope that, in applying the new law, reasonable minds in DOD remember the lessons of the past and use the approach sparingly.

Richard Rector is chairman of the Government Contracts practice at DLA Piper US LLP. He can be reached at richard.rector@dlapiper.com.