The DoD is starting to run commercial-like procurement processes as opposed to purely cost-plus contracting. In traditional government contracting, the government comes up with a spec that they want somebody to match, they kind of run a bidding process and people say ‘yes, I’m going to build it for you at this price,’ And then once you win the contract, then the price you just quoted is irrelevant at that point. You start to book your cost to the government and you get a 10% margin on it. That’s what’s led to all these overruns, extreme cost, really long delayed schedules, etc., because, as a contractor you’re incentivized to just have costs go over since your total profit dollars increase the more you let things run over because you just get a 10% margin on however much you charge to the government. You’re incentivized to charge obviously as much as possible and let things go on as long as possible.
So around that era [2005-2015] is where we see you had a couple of these early Founder’s Fund backed companies that tried to sue the government into changing how they would award government contracts. That fundamentally shifted both in the world DoD technology via Palantir and SpaceX succeeding, and especially in the world of aerospace where the Air Force had to purchase the best capabilities at the cheapest cost, and when you’re a provider you don’t just get to cost overrun, you get a $400 million contract. If you were able to deliver for $200 million, then great, you just get better margins than your competitor.
… The reason SpaceX succeeded was not because the Shuttle got canceled, the reason SpaceX succeeded was because the Air Force decided to change its contracting process… Now, you’re seeing the acceleration of that shift where the latest iteration of this is a company like Anduril, which is also incubated out of Founder’s Fund, it is explicitly trying to say — now that the stage has shifted, not fully, but has shifted significantly, we’re going to make a next-generation defense contractor that primarily sells products as opposed to just a contractor. Anduril comes up with what they think the government needs, and they say ‘Here are the products we’re selling. We will adjust it slightly for various use cases you want, but no more than a commercial company would for a large enterprise customer. But we’re not going to respond to a contract and custom build whatever the government wants.’
… Varda has benefitted from that shift as well. We’re like, ‘Hey DoD, we’re building space factories, we’re building interesting materials, and we’re also building reentry vehicles back down. If you’re interested in those products let us know and give us contracts for what we’re making, but we’re not going to adjust our path to be a defense contractors.’ If we took that stance a decade ago, we would have been laughed out the room. The only reason it’s possible now is that Palantir, SpaceX sued the government into changing how they work, and Anduril showed that by changing how they work they got a lot of benefits.
That was Delian Asparouhov, co-founder of Varda Space Industries, on a super-interesting episode of the Deep End podcast.
I have a few issues with Delian’s narrative.
First, SpaceX was funded mostly by NASA in the early days using Other Transactions with milestone payments. Between 2008 and 2015, DoD only gave SpaceX $259 million worth of contracts, while NASA had provided nearly 10x that amount ($2.3 billion). Unfortunately, USA Spending data doesn’t go back earlier than 2008, but I don’t think the Air Force was an early backer for SpaceX.
Indeed, Vice Chief of the JCS General Hyten said, “I’ll tell you, what SpaceX had to do to effectively do business with the United States Air Force embarrassed us in public.”
Second, I don’t see Palantir’s role as being particularly important in the acquisition reform efforts. It is true that Palantir sued DoD to win the DCGS program, successfully arguing that it had a commercial product capable of satisfying the requirements at a cheaper price and thus DoD was required to purchase from them under the Federal Acquisition Streamlining Act. But I think that had no bearing on the adoption of the Adaptive Acquisition Framework, Other Transactions, or things like the Defense Innovation Unit as Delian later brings up. I wonder how many regular contracting officers and program office personnel are even aware of the Palantir lawsuit.
Third, it’s almost laughable to say that the dogged efforts of SpaceX and Palantir suing the government made the Air Force, for the first time, have to “purchase the best capabilities at the cheapest cost,” or start using fixed-price contracts. It is the job of many thousands of acquisition professionals’ to purchase the best capabilities at the cheapest cost. It’s not like they knowingly turn down amazing defense products because they just want to funnel money to legacy contractors. What capabilities and price are “best” is of course subjective — though I would agree that DoD processes lead to poor weapon system choices.
And fixed-price contracts have always been emphasized in DoD. They were law for all government contracts until the Armed Services Procurement Regulation in 1947 provided 11 exemptions which made cost-plus pervasive. But fixed price had a resurgence of interest in the 1960s under McNamara, who increased fixed price from 62% of DoD total in 1961 to over 90% four years later. Fixed price contracts became a hot topic again in the 1980s under Carlucci, in the 1990s under Perry, and most recently in the 2010s with the Better Buying Power efforts. Fixed price contracts were used for major development efforts like the KC-46A, and some of these efforts didn’t turn out so well. There’s been a ton of literature and careful thought about this tradeoff between cost plus and fixed price contracts, but I would estimate the impact of contract type on program outcomes is marginal due to the huge number of other important factors.
Bloomberg government data actually finds that in DoD, the share of fixed price contracts fell from 47% in fiscal 2016 to 38% in 2020. So that goes directly against Delian’s narrative. I also worry whether the acquisition reform efforts are starting to swing backwards. There’s a lot more to discuss or push back on, but overall I think that Delian has an interesting view and I hope that there are transformations in acquisition practices as well as the industrial base.
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