Cost overruns for weapons systems are aggravating for politicians, the Department of Defense, and the taxpayer. When weapons systems run over budget, it reduces trust between the DoD and its contractors, between the public and government, and in the reputation of the United States military abroad. That said, many aspects of cost overruns are misunderstood. Senator McCain’s current opposition to the use of a particular type of contract (cost plus) for the Long Range Strike Bomber (LRSB) ties into several of these aspects.
A cost-plus contract pays for all of the developer’s costs, within set limits, with an additional agreed profit. First, it should be noted that the cost-plus contract applies to the development stage of the program. The production of the aircraft will be covered by a fixed-cost contract. That aside, there have been cost overruns on numerous contract types.
There is a question of whether the DoD would be able to get development done on any long-term weapons programs without underwriting the costs of development. When the needed research is technologically cutting edge, it is reasonable to worry that private firms won’t want to do the work without strong incentives. Underfunding development leads to increased production costs, and discourages contractors from participating. A House Armed Services Committee hearing in October of 2015 highlighted the importance of ensuring adequate funding at the development stage. The costs and length of production balloon when problems aren’t discovered until production has already begun.
Senator McCain has argued against cost-plus contracts by noting that some have led to cost overruns. But there are overruns on every type of contract. It’s true that cost-plus contracts have historically had the second highest average percentage overrun. But their absolute average cost overruns were on par with fixed-cost contracts and dwarfed by unspecified contracts. This would seem to indicate that contractors, when faced with fixed cost contracts, increase bid price to compensate for having to underwrite cost-growth risk. The senator, having said which contracts he is against, must then specify which contracts he prefers.
It’s hard to argue that contract type is a main driver of cost overruns. A study by the Institute of Defense Analysis found that cost overruns tend to reflect the larger budget environment. When the budget shrinks, proposed program cost estimates shrink, making overruns more likely and more likely to be large. When the budget increases, proposed program cost estimates also increase, and programs come in closer to budget. This indicates that the estimated costs of programs rise and fall with budgets, to maintain support for the programs.
In the study, cost overruns were not statistically tied to changes made in the acquisition process. This indicates that the drivers of cost overruns can be found in how the programs are shaped before entering the pipeline.
Cost overruns are a poor measure of the success or failure of a weapons system program. There is evidence that overrun problems begin with overly optimistic estimates for programs, both in the DOD and Congress. If the problem is misdiagnosed, the treatment won’t be right. When policymakers focus on costs overruns, they tend to highlight procedural issues (such as contract types) as the problem, because they assume the problem occurs after the program has been approved. But if implausible initial estimates are the real issue, it means that faulty decisions about costs, strategy, and technology are being made before the process even begins. Instead of worrying about what sort of contract to use, policymakers need to push for greater accuracy and clarity about the cost and strategic necessity of weapons programs.
The Air Force says it has used rigorous independent evaluations to good effect for the Long Range Strike Bomber. Cost overruns remain likely, however, because the platform will rest on new, untested technologies. But overruns will not be caused mainly by contract type. To make sure that the overruns are not shocking, nor prohibitive, Congress should focus on making sure the Air Force’s independent evaluations are properly implemented, that it is properly briefed on how the technology will be developed before beginning production, and that it remains ready to cancel and restructure programs before it is too late.
If Senator McCain really wants to save taxpayer money, he ought to push for deeper Congressional deliberation about strategy, weapons systems, and associated trade-offs. During a hearing last year, Dr. David Chu, the president of the Institute for Defense Analysis, argued that Congress needed to take its role in the process more seriously. Congress should not simply provide an “angry yes” for programs it thinks are too expensive or unworkable.