Magazine article National Defense

Pentagon, Contractors Clash over Profits

Magazine article National Defense

Pentagon, Contractors Clash over Profits

Article excerpt

* The pressure is on at the Pentagon to bring down the cost of military hardware. The dictum from acquisitions chief Frank Kendall is that "unaffordable" programs will be axed.

As expected, the scramble to slash costs is fueling tension and finger pointing between government officials and contractors. In a budget dimate where the future is uncertain, relations between buyers and sellers appear to have hit rock bottom.

A sense of distrust from both sides was on display during a recent industry conference when Air Force Maj. Gen. Wendy Masiello, deputy assistant secretary for contracting, suggested that companies are making too much money on defense work and that some of that wealth should be returned to the taxpayers. After one industry executive asked her to elaborate, Masiello responded: "I'm not looking at taking money out of your pocket. But I have an obligation to make sure that what I'm paying is a fair and reasonable price."

The Air Force is in a fiscal straightjacket. This year alone, it is more than $12 billion short of what it needs to pay its bills. At the same time, as Masiello noted, "Every day we read in the paper that the defense industry is still doing pretty well financially. ... We have to figure out how to get a share of that."

Masiello has ruffled feathers in industry circles for questioning some of the Air Force's long-term contracts for the maintenance of weapon systems. She has challenged contractors to disclose their financial data so the government can see exactly how much money a company earns from a deal. Some firms find that level of scrutiny excessive, as long as they are delivering the products and services the government is seeking at agreed-upon prices.

Kendall and other senior Pentagon leaders have frequently reassured industry CEOs that there is no "war on profits."

But the tension is palpable. In today's contracting world, there is little trust in negotiations, said Lt. Gen. Charles R. Davis, the Air Force's top military acquisitions official. "We are all focused on trying to shift the risk somewhere else," he said. "We are often very suspect of each others' motivations. When money was flowing freely, there was less pressure on government program officers to squeeze industry for a better deal. Things are different now."

Davis clearly gets the irony of being a U.S. military officer who is challenging corporate profits. "These are wonderful elements of capitalism that we [the armed forces] try to defend every day," he said at a conference hosted by Credit Suisse and McAleese & Associates.

Davis suggested there should be a better way to protect the collective interests of government and industry. But nobody has yet come up with a winning strategy for how to do that.

In the face of a shrinking bank account, Defense Department contracting officials are becoming unhappy with contractors who seem to have figured out ways to make more profit than the government thinks they should.

"I need to understand the cost and the resulting profit," Masiello said. "It's a little scary that we've never had that kind of insight. It can be a little threatening that they figured out how to make a lot more money and return on that investment than the government might have been reaping in that process."

As Masiello spoke, she raised eyebrows in the audience. "That is not how free enterprise works," whispered one executive.

Although the idea that a highly regulated defense industry is a free market might be a stretch, companies believe that they should be given incentives to make money, and that corporate efficiencies are ultimately returned to the customer via lower prices. …

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