To Cut Defense Costs, In At Least One Area, Pentagon Should Cut Competition

Last week Representatives Thornberry (R-TX) and Smith (D-WA), the Chairman and Ranking Member of the House Armed Services Committee, unveiled a bipartisan proposal to reform the defense acquisition process. This proposal acknowledges the fact that there is no “silver bullet” for acquisition reform and instead proposes a number of relatively small changes to the existing system rather than a complete overhaul. Forbes reports.

One specific change proposed by Thornberry and Smith, however, may seem counterintuitive to many. They propose striking the requirement for DoD to use competitive prototyping in acquisitions. Competitive prototyping is a process by which DoD contracts with two or more companies to build working prototypes of a weapon system before selecting one (or more) for production. Eliminating this requirement will reduce opportunities for competition—which may at first seem counterproductive to cutting costs. But I think they are right.

The requirement to use competitive prototyping was a key provision of the 2009 acquisition reform legislation, known as WSARA (Weapon Systems Acquisition Reform Act). An overall theme in this previous attempt at acquisition reform was to create more opportunities for competition. Not only did WSARA require competitive prototyping, it also required the Department of Defense to use acquisition strategies that “ensure competition, or the option of competition, at both the prime contract level and the subcontract level.” But in my view, WSARA went too far and failed to recognize that a one-size-fits-all approach to competition is not in the best interests of DoD or the taxpayer.

To be clear, I’m not against competition in defense acquisitions. If used appropriately, competition can be a powerful force to drive down costs, spur innovation, and improve the performance of weapon systems. And competition certainly works in many areas, particularly when DoD is buying commercial or commercially-derived systems. But in a blind quest to increase competition, DoD and Congress have, in some instances, attempted to artificially create competition where it does not naturally exist and have driven up acquisition costs in the process.

How can this be true? First, the U.S. defense industry is not a traditional free market with many buyers and sellers and limited regulation. The defense industry can be more accurately characterized as a monopsony, with the U.S. government as the sole customer and chief regulator. There are few (if any) other buyers for many of the major weapon systems DoD procures, such as stealthy aircraft, aircraft carriers, nuclear-powered submarines, and specialized communications and electronics equipment. When other potential customers for these systems exist, such as U.S. allies and partners, sales must still be approved through the U.S. government and tend to be much lower in quantity.

Additionally, in many sectors of the defense industry there are a limited number of vendors capable of producing the weapon systems DoD requires—just one or two primes in some sectors. In these situations, the barriers to entry for competitors can be high, and artificially creating competition requires a large and sustained investment by DoD.

As the only customer for many of the weapon systems it buys, DoD pays the full development cost for these systems through cost reimbursable contracts or higher fees on fixed-priced contracts. When competitive prototyping is used, DoD pays the development costs for two or more contractors to develop similar systems. Once development work is complete, DoD usually selects a single vendor for production, effectively granting the winner a monopoly for future procurements of the same system.

If DoD instead decides to keep competition alive throughout production, it can split the award between competing contractors to keep two production lines running in parallel. A split award, however, means that neither contractor will receive the full order. Thus the cost of each unit will not decline as much as it would if one company were building all of the units.  This effect, known as the learning curve, has long been recognized and empirically observed.

Proponents of competition argue that the additional costs from redundant development work and reduced learning can be offset by the competitive pressure among contractors to drive down prices. But there is scant evidence to support this assumption for defense acquisitions. Historical data for acquisition programs only reveals what happened when dual sourcing was used. To calculate the savings from competition, one also needs to know the counterfactual—what would have happened had dual sourcing not been used in those same programs. Since historical analysis cannot produce data for a counterfactual, analysts often just assume what the costs would have been without competition. Their historical analysis is, therefore, based on nothing more than assumptions about a counterfactual.

In a 2012 paper, I proposed a game theory approach to model how contractors would be incentivized to bid under various forms of competition. Using this approach, I found that the way a competition is structured can be a determining factor in whether competitive pressure is sufficient to produce real savings. More specifically, I identified conditions in which the structure of the competition could actually incentivize contractors to bid higher and drive up costs—a finding I admit is strongly counterintuitive to many.

Without going into the gory details, which you can read here, the ability of competition and competitive prototyping to reduce costs depends on the type of weapon system being procured and the way a competition is structured. If the development costs of a weapon system are a large share of the total acquisition cost, the learning curve is steep, and small procurement quantities are planned, competition tends to be less effective. Therefore, it does not make sense to have a blanket policy requiring competition for all acquisitions by default. Of course acquisition costs are not the only factor to consider; DoD must also consider the effect of competition on long-term operation and maintenance costs, the industrial base, and innovation.

Competition certainly has an intuitive appeal as a way to drive down costs in defense acquisitions, but it is not always the most effective approach. Representatives Thornberry and Smith are on the right track in their acquisition reform efforts. Developing an acquisition strategy tailored to the unique circumstances of each program is critical to keeping costs affordable. And a key part of any acquisition strategy is a thoughtful analysis of if and when to use competition and competitive prototyping. Competition, while useful in many circumstances, is not a silver bullet for acquisition reform. It’s time we stop pretending that it is.