Can Profit Policy And Contract Incentives Improve Defense Contract Outcomes PDF Download

The Defense Department, through the military services, buys equipment and services for which no open market exists. In negotiating the contracts for these acquisitions, the government has policy guidelines to aid the contracting officer in developing a reasonable amount of profit to pay the contractor. The goal of profit policy is a contract price that reimburses the contractor for its costs, provides the necessary incentives to yield beneficial performance, and to provide the contractor with sufficient risk reward. The effect of profit policy on contractor profits is inextricably linked to the type of contract financing policy the government uses in an acquisition. The authors examine the effectiveness of these two policy tools, profit and contract financing, on achieving contract outcomes and contractor financial performance. They also look at how these policies are implemented by the Defense Department. Their methodologies include analyses of profit target setting and actual contract results data in addition to discounted cash flow modeling to value a contract or contract stream to an investor. This study as a whole is concerned with two questions about profit policy. First, in what ways does profit policy provide incentives or disincentives with respect to cost growth, schedule slips, and the performance features of a system eventually provided to the Department of Defense? Specifically, the authors are interested in whether or not profit policy can be reliably manipulated to encourage desirable outcomes on particular contracts. Second, does profit policy provide defense contractors with a profit that is large enough to retain these firms in the defense industry? Each of these questions presents several distinct issues which IDA approached using different methods and data.