Circling back to Director of Defense Pricing and Contracting John Tenaglia’s talk at the Pricing Summit, he mentioned one of the big questions he often gets from media is when progress payments are going to revert back to where they had been.
For a primer on progress payments, check out this blog post. The Covid-19 emergency saw progress payments increase from 80 to 90 percent for medium and large businesses, and from 90 to 95 percent for small. What would happen to industry cash flow if DoD reduced progress payments to the previous rates? Moreover, there was some talk about actually reducing progress payments down to 50 percent and reallocating that to additional warfighter capability. What would that impact be?
Tenaglia said DPC is reviewing that impact right now with DCMA and university partners. Though I personally support DPC on a related project, I have no knowledge of their industry cash flow studies. However, in November 2020, I wrote a report on DoD contracting during Covid-19. I took a quick swag at estimating the cash flow impact of a change in progress payments. This was only possible because of the “natural experiment” offered by the increase in progress payments due to Covid-19, and the reported $2.6 billion impact on industry cash flow. Here’s what I wrote at the time (I’ll forego the indentation):
“The DoD’s reported figures on progress payments can be used to calibrate a crude model that can forecast any change. Presume average monthly DoD progress payments equals the average DoD total obligations ($30B/month) less profit (10 percent) less other-than-fixed price contracts (40 percent). The remaining dollars [i.e., those that possibly have progress payments] are segregated into small business (one-third) and other-than-small (two-thirds). The one-time bump when progress payments increase also depends on the duration the contract, which is 6 months on average for small business and 12 months for all others.
“Calibrating that model to return $2.6B over the first 5 months provides the proportion that actually submit progress payment compared to the total eligible (roughly 25 percent). The model can then be used to give a rough size of the impact to industry from a policy to decrease progress payments, as had been suggested in 2019. A decrease from 80 to 50 percent could decrease relative cash flow by $4.5 billion in the first month and $0.75 billion on a continuing basis. For small businesses, decreasing progress payments from 90 to 70 percent could lower cash flow by $0.68 billion in the first month and $0.5 billion on a continuing basis.”
I remember thinking I could build the model pretty quickly, but then got sucked into a web of complexity. Just as when you increase progress payments, when you reduce them there’s a one-time shock and then a smaller effect that continues as cash flow is pushed into the future. The real question is, what do companies do with their sources of cash flow? Is it reinvested into R&D, plant and equipment, the workforce, or business IT systems? Or is it returned to the shareholders through stock buy-backs and dividends?
From DoD’s perspective, that’s an additional few billion that is pulled forward in time. But it is still stuck in the same program elements. So potentially there is more funding to execute for the same requirements, but there won’t be a windfall to allocate to promising emerging technologies that are stuck in a funding gap across the valley of death.
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