Bill Greenwalt and Mackenzie Eaglen advocate for greater use of multiyear contracting to help solve supply chain troubles and pricing in an inflationary environment. Here’s a slice from Multiyear contracts could solve plenty of Pentagon problems.
Multiyear contracts last two to five years, potentially saving taxpayers anywhere from 5% to more than 15%. The reason is simple: With this authority, contractors have a steady funding source, signaling that their product is going to be purchased for years and creating an incentive to invest in their own company workforce, research and development, and facilities.
Take the Block IV Tomahawk missile, for example. A multiyear procurement contract contained in appropriations legislation for FY04 resulted in an output of around 357 missiles per year, with an average price tag of $1.4 million per missile in FY22 dollars. Fast forward 16 years and the Pentagon is again procuring the same Tomahawk missile, but this time without a multiyear contract. From FY20 to FY22, the DoD bought about 94 missiles per year at an average price of $2.9 million per missile — a 107% price increase.
I love the authors and ultimately agree with them, but I did not appreciate their example because it doesn’t necessarily say anything about multiyears.
First, the time period between the events is some 15 years. Inflation alone would have been about 35 percent by FY 2020, and baseline military escalation of 1% per year above inflation would have meant price escalation by at least 50%. For example, defense contractors had to make their pension plans whole again in 2009 and led to a giant increase in fringe rates.
Then there are rate effects and learning effects. Where were they on learning? Did the contractor restart the production line and resert learning? Rate effects on materials, like bulk buy discounts, also makes a big difference. Not just over the MYP, but the FY 2004 buy alone was more than three times the FY 2020 buy.
More multiyears is certainly what a contractor wants right now. They can take today’s 8% or greater inflation and forecast long into the future. 8% growth over 5 years is 47%. So DoD needs economic price adjustment clauses to protect itself, in case the Fed is too successful. DoD couldn’t renegotiate price for five years.
Commercial purchasers do not tend to use 5+ year contracts often, and when they do it is borne out in more of a relational contract rather than arms-length FAR contract.
Shorter contracts are a hedge against uncertainty and risk on the customer side. Leasing is better than owning. But for things you know you need and can’t get enough of, like munitions, those should be on multiyear commitments.
But instead of commiting to a particular product, contractor, and price, DoD could instead commit a certain budget to munitions portfolios (e.g., ammo, long-range strike) to guarantee the total addressable market. Now, current producers would likely keep winning because they have the capital investment, but the structure injects competition and potentially new suppliers over longer timeframes.
Finding a really good example isolating the MYP effect is hard because it relies on a counterfactual, or an interesting natural experiment like the same contracting officer signing an MYP and single year for the same product, T&Cs, etc.. I haven’t seen good analysis on that, but I’m sure the research exists.
Using learning and rate effects, cost estimators are supposed to certify (an estimate) that an MYP would decrease costs by 10% or more. Those are just parameters in a model.
In the end, I agree that longer periods of commitment for known requirements is smart and helps companies better manage supply chains. But DoD could benefit from rethinking the way it goes about that.
I’ll leave you with an interesting insight from the authors on why Congress may not like multiyears:
Why are multiyear procurement contracts rarely approved by Congress? Appropriations staff do not want to relinquish any power to question expenditures in subsequent years, and members opt not to overrule the powerful staff. As a result, everyone pays more.
But that is not the only cost to skipping multiyear deals. Forced into year-by-year planning, the defense industry is likely not to make necessary capital investments beyond a one-year horizon. The Pentagon doesn’t incentivize companies to improve capacity and drive down costs.
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