Defeating the cost plus paradigm in defense projects
Charles Fletcher, PMP
Those of us who grew up in the government contracts business during the 70s and 80s should have a good understanding of the Cost Plus concept in pricing a contract. This phenomenon had its beginnings back in the late ‘50s.
The Russians are Coming!
The situation promulgated at the time was that the world was in imminent danger of destruction. First, up jumps Sputnik and the Russians had beaten us to space! Then there was the alleged Cuban Missile Crisis. We were certainly doomed. So the word went out, build missiles, build spaceships, at any cost! Just get the technology. We had to not only catch up with the Russians, but surpass them. Thus was born the boom of cost plus contracts.
For those youngsters who missed out on this concept: you develop the product, you bill the government whatever it cost you to produce it, and you earn a percentage of that cost for your efforts. The fallacy of this type contract is obvious to all but the most naive. The incentive—higher cost. Profits, productivity, and risk were of small concern.
This method of development became a way of life in the high-tech world of rocket science. We had to beat the bad guys to the target, whatever it was, whatever it cost. Engineers did not worry about cost; the emphasis was on the schedule. Whoever got there first won! If more resources were needed to satisfy the project, get them. If more incentive was needed to cause the creative juices of the engineers to flow, double their salaries. After all, the more we spend, the more we make. What a life! And who better to be a project manager in a cost plus environment than the engineer who knows how to develop the product. With the emphasis primarily on technology, and a time schedule the only control ever asked for, the chief engineer was the natural selection for project leader.
Well, folks, times have changed! No more lucrative cost plus contracts; now the emphasis is on cost and schedule. Specifications are given and are expected to be met within a fixed price. But let's back up just a little bit. This change did not come all at once.
The government buyers, who were also used to those cost plus contracts, were not really ready for a complete shift to fixed price. They understood the concept, but they had a problem with being able to ensure that correct and sufficient specifications were written in the Request For Proposal, and that the bids submitted in response to the RFP covered all the specifications. So an intermediate phase developed between the cost plus era and the current fixed price era. This was the era of Engineer Change Proposals: contracts were let at a fixed price, but both contractor and customer knew there would be changes coming. The beauty was that contractors basically had a free hand to set prices on the changes because the contract was already locked in. There were of course a few minor controls, but very few. Still, cost was not a worry. It was common to intentionally bid a contract low, knowing that Engineer Change Proposals would be forthcoming and profits would be good. (Sometimes this was referred to as a buy-in. There are several types of buy-in. The two most prominent are low bids in hopes of sufficient Engineer Change Proposals to create a profit, or low bids in hopes of getting follow-up work.) Again, an engineer's dream. In fact, at times the government would even let the bidder redefine the specifications after the contract was awarded, allowing the end product to be widely different from the item requested. And the price would soar. Again, no worry.
Forget the Russians—What's the Cost?
Now we come to today's environment—that is, to reality. True fixed price contracts! An absolute nightmare for an engineer, for several reasons.
First of all, if left to an engineer, a product would never be finished because an engineer would never stop improving it. It is understandably difficult for a person trained and experienced in state-of-the-art development to say “okay, the product is finished.”
Secondly, many times engineers are on the leading edge of technology—in Captain Kirk's words, going “where no man has gone before.” One of the favorite expressions of engineers is that “you cannot legislate, schedule, or restrict creativity.” Engineers want time to think about what has to be done and then a free hand to do it.
In the cost plus and change order eras, project management left in the hands of engineers was understandable. But things have changed, and most engineers have not kept up with the times. Few engineers are trained for any type of profit-producing management. Few are knowledgeable in performance techniques, and few are schedulers in the strictest sense. Too many of them consider project controls an unnecessary burden. I have heard dozens of engineers who were asked to go to cost account management classes make statements like: I don't have time for this, leave this stuff to the bean counters. Yet these are the people we find as project managers and in project controls.
Thus, the cost plus paradigm persists throughout much of the industry and is being passed on to the next generation of engineers. The people who are currently lead supervisors and managers in many cases grew up with this paradoxical management theory of “don't worry about cost.” With only this type experience behind them, what can we expect except cost plus management? The attitude prevails that things will work out, we will either get a great Engineer Change Proposal or we will convince the customer to lower the specifications.
It's time to look at project management as a profession and a specialty management field. Project management is too important to be left to anyone not formally trained in its techniques or who is inexperienced as a scheduler and a cost account manager. The paradigm of cost plus management must be eliminated!
In today's environment, emphasis is on profits. Even the government agrees that the delivery schedule and the technical specifications are in many cases secondary to cost. The only way to control cost and schedules is by using some form of performance measurement system, having a meaningful and related basis of estimate, and having and maintaining a reasonable and defined schedule (preferably Critical Path Method) from the initial bid proposal all the way through project shutdown—in short, by using project management.
The people who are expected to provide project management and project controls must be trained in modern project management. With the reduction of management layers throughout industry and the reduction of budget from the Department of Defense, modern-day controls must be used to succeed in defense contracting. Training can come from public sources, colleges, and universities, or it can come from organizations such as PMI or the Performance Management Association, or it can be developed and taught from within the organization. The source is not as important as making a serious effort to ensure that project management training is conducted and that the principles of project controls are adhered to. This is the only way to defeat the cost plus paradigm.
Charles Fletcher, PMP, is a retired military officer and owner of Project Management Consulting Associates in San Antonio, Texas. He is an active member of the Austin PMI Chapter and the Performance Measurement Association.
PM Network • May 1996