“Should Cost” vs. “Did Cost”: How the Military-Industrial Complex Swindles Billions of Our Dollars

Changing the way we price weapons could cut billions, but will the entrenched Department of Defense bureaucracy allow it?

“Forget about what it does cost or what it will cost, we're talking about what it should cost,” said Shay Assad.

With that bold quote, Department of Defense (DoD) Director of Defense Pricing Shay Assad, claimed in an interview last week to truly change the DoD's traditional way of pricing weapons – historical costs that have allowed weapons to be grossly priced for years.

Last week, I wrote a column about a change in the pricing of weapon systems in the DoD from using historical costs (what it did cost) to determine prices, to using industrial engineering standards to find out what weapons “should cost,” without all the fraud and fat from past weapons. To refresh on what I was talking about, here are the main issues from last week's column:

For decades, the DoD has decided what each new weapon will cost by looking at what historically similar weapons “did cost” in the past. So, if you decide to buy a new fighter plane, you look at what the previous plane cost as the baseline, and then add on more for all the new advances and gadgets you plan to put on the new plane. This has been disastrous because all of the contractor's fraud, waste and fat that were tolerated in the past plane's costs by the ever-appeasing DoD bureaucracy now become the baseline for the new plane. This makes every generation of weapon more and more unaffordable as the waste and fraud from generations before is rolled over to the new weapon. The result is that the bloated costs are expanded exponentially and we have fewer and fewer weapons for more and more money …

More bucks and less bang has been the legacy of this did-cost/will-cost basis of pricing weapons. While I was investigating DoD weapons costs over the years, whenever I found that the DoD had paid excessively for a weapon, the DoD gave me the standard answer that if the Pentagon paid the bill for the weapon, it must have been “reasonable.” The continuing spare parts scandals that I first exposed in the 1980s are a clear example of institutional overpricing – a legacy of historical, “did-cost pricing” – which the public can easily understand. You know that it is too much to pay $435 for a claw hammer, but it is hard to know what a plane, tank or ship should cost, even though they are priced with the same pricing formulas. When the hammer cost was widely publicized and the DoD was forced to investigate, they found that the hammer was “exorbitant but legal” because of institutionalized overpricing.

This why using the industrial engineering method of should-cost is so important in weapons pricing, in a system that is not like the competitive private market, which could naturally drive down costs with true and varied competition.

I ended last week's article with the question: Mr. Assad, are you listening? That is usually a rhetorical question on my part because over the years, top brass or civilian overseers in the DoD were not happy to talk to me or grant an interview because of my reputation of investigating Pentagon fraud and waste and advocating a radical change to the DoD bureaucracy. But I decided to try to contact the newly minted DoD Director of Defense Pricing Assad to find out if he really thought that his new should-cost efforts were similar to the traditional should-cost studies in the past that use to give the generals fits.

To my surprise, he granted the interview on the same day of my request and spent 30 minutes on the phone with me. He was surprisingly frank and not defensive. He openly admitted that the recently finished should-cost study of the F-35, while thorough, was not a true should-cost study, but an effort to start down that path of getting managers to start thinking about what a weapon should cost and to get out of the mindset of historical pricing.

Assad asserts that he has a mandate from Deputy Secretary of Defense, Dr. Ashton Carter, to work to eliminate historical pricing of weapons and to eventually train enough pricing professionals in the DoD to be able to do true should-cost studies on weapon systems. He said that he is interested in establishing should cost, not only for the prime contractors of a weapon system, but also for the large amount of subcontractors on each weapon system. These subcontractors do much of the manufacturing of the weapon system, and the prime contractors try to pass their subcontractors' “did costs” through the system without seeing if the costs were reasonable or true.

Assad said that he has been “breaking a lot of glass” because he has been pushing this on large contractors like Lockheed and Boeing and “getting a lot of contractors mad at him.” In the 30 years of looking at weapons costs, I have rarely heard anyone in the civilian leadership be pleased that a contractor is unhappy with him, especially since these contractors can put a lot of heat on the Congress and the administration to pull zealous cost cutters back from their goals, warehouse them and threaten their jobs. Assad doesn't seem worried about that because he says he has been given a mandate to cut costs.

He also said that he has 12 teams embedded in various contactor plants around the country to examine cost structures of DoD contractors, so that the DoD is in a better position to negotiate costs with the contractors. These teams are looking at overhead costs, indirect costs and general and administrative costs with new should-cost attitudes, even though there aren't enough industrial or mechanical engineers right now to do real should-cost studies. He went through other initiatives to try to change the culture to should cost, including making new data bases; peer reviews of weapon systems (having each service review another service's pricing work, thus using the natural rivalry between services to a good use); and putting all the pricing elements on a weapon system under one umbrella, so that the left hand knows what the right hand is doing in these massively costly weapon systems.

I was most pleased that Assad understands that there are very few people left in the DoD and in the United States who really know how to do the traditional should cost studies that made US manufacturing so effective 40 years ago. The DoD has spent years making sure those types of industrial engineers were purged from the system and all traces of should cost were swept away. Assad vows to train and rebuild a professional corps who can do real should-cost studies on weapons and make it a permanent fixture on how we price weapons. He said that he was “absolutely” going to purge the historical pricing system in the DoD for good.

In the 1980s, there were legislative efforts to make contractors keep data on any should cost they did and make it available to the DoD, but those standards, especially Military Standard 1567A were finally vaporized by 1995 with the historical cost advocates winning full control of the pricing in the DoD. As I mentioned in last week's article, this has lead to paying more for less and less weapons – more bucks for less bang. Assad claims that no contractor will be allowed to refuse giving the necessary data to the DoD that is needed to start moving to a should-cost system.

So, I am impressed with Mr. Assad's gumption to try to change this pricing system though others have failed to do this since the 1960s. Assad told me that he is not naïve and knows what he is up against. He said that he has spent the last few months since he has taken this position to “change the mindset” of the bureaucracy to start thinking about should cost and start to permanently retire historical pricing of weapons. I have seen many cost-cutter shipwrecks on the shoals of historical pricing, including my past efforts, and am surprised and pleased that anyone in the DoD would ever attempt this again.

Assad says that this monumental change has to be done in steps, and he is open to ideas from anyone in or out of the DoD who is sincere about permanently cutting costs of weapons. I have been invited to meet with Assad to go over what else can be done to start to change these pricing practices. I will take him up on that offer soon, but here are some steps that should help change this system:

  • A whole new training system is needed to reintroduce true should-cost methods to a corps of pricing professionals. Most of them are too young to have been exposed to what true should-cost pricing is. The Japanese still have some should-cost methodology left and they should be used as a template. The DoD should go into its archives of the work of DoD whistleblower Ernest Fitzgerald, who worked his whole career to establish should cost. His past should-cost studies on various weapons would also be an important template for future genuine should-cost studies.
  • The contractors generally don't do these types of studies anymore and thrive on keeping their records on pricing, audits and payments in chaos so they can't be closely monitored either by the DoD or by government lawsuits. In the 1980s, Senator Grassley and then-Representative Boxer passed a bill requiring that contractors give the DoD the necessary data to do should-cost studies and to scrub costs. The Military Standard 1567A, which required compliance, was killed in 1995. Contractors don't cooperate, so there needs to be a similar law passed reflecting the new problems of getting data. And payments should be held up until the contractors comply. The contractors will continue to roll the pricing corps in the DoD unless the government contract managers have the right to hold up the money. That is one of the few tools that can get the attention of a contractor and the DoD personnel have to have the guts to use it.
  • Once a pricing corps is established that can truly do should-cost pricing, all historical pricing for new weapons should be stopped. For current weapons, there should be cost studies done and prices and progress payments should be lower to reflect what the weapon should cost based on the studies. Tolerating and sharing in the costs in burgeoning overruns of weapons budgets is just encouraging contractors to continue their tricks to keep the prices high. Once again, withholding money will speak volumes to contractors who are counting on the compliant bureaucracy to just pay the bills.
  • In 1983, Fitzgerald made some suggestions in a book I edited on how to set up should-cost pricing so it would be the most effective tool to lower costs. “If it becomes necessary to negotiate contract terms, negotiated prices should be based on what the work should cost if done by a competitively efficient, competitive commercial producer. This approach to cost estimating, know as should-cost estimating is not new. However, it is extremely controversial in the Pentagon because it lays out avoidable costs numerically, and by doing so, often shows that the Pentagon procurement community just might not be doing the best possible job for the taxpayers…. The should-cost estimates, that is, contract and program cost estimates with the fat and waste squeezed out, should be developed by organizations independent of the buying offices. Should-cost estimates should be maintained as standards against which the job performance of the government buyers and program managers can be measured.” That separation of tasks may be vital to the success of should cost because the contract managers have much to lose and could influence or warp a should-cost effort.

Mr. Assad needs to be ready for some serious blowback by the contractors and his own entrenched DoD procurement bureaucracy. There is already great bellowing by the contractors and their friends in Congress about proposed DoD budget cuts based on the work of the supercommittee in Congress, but they will be even more hysterical if should-cost pricing would become the norm and permanently lower the costs of weapons. Both Dr. Carter and Mr. Assad should not underestimate the money power that they are up against and the severe reaction to the threat of changing bloated pricing that has keep up DoD contractor profits for years.

Fitzgerald was brought into the Pentagon as a civil servant in 1964 to bring should-cost and other efficiency practices into the DoD. He tried to establish it and got blowback from the generals and the civilian bureaucracy at every turn. Nixon illegally fired him for speaking truth to the Congress about a two billion dollar overrun on the C-5A cargo plane. He sued, and after four years was given a job back, but continued to sue for ten more years to get his original job back so he could once again look at contract pricing and attempt to inject should cost back into the pricing formula. He was successful for a short time in the mid 1980s until his should-cost work and the Congressionally mandated should-cost studies began to bite into the costs of weapons. He was then pushed out again and watched as should cost was once again unraveled and then killed in 1995.

Mr. Assad has his work cut out for him, but if he can establish should-cost pricing in the Pentagon and eliminate bloated historical pricing permanently from the DoD, he will have done a great deed for the country. We'll see if the DoD and the Congress will let him. I will be watching the progress with great interest.

It would be a giant solution to the problem of overpriced weapons and bloated defense budgets. Maybe this reform's time has come because the country is growing weary of a defense budget that has doubled in the last decade and is above the amounts being spent for the cold war.