CRITICAL IMPACT OF BLOCK CHANGES TO IMPLEMENT PERFORMANCE SPECIFICATIONS
AND COMMERCIAL STANDARDS ON EXISTING DoD CONTRACTS

We have crafted this Executive Briefing Paper to alert you to the immediate impact of Department of Defense Acquisition Executive, Dr. Paul Kaminski's imminent directive to effect the conversion from Military Specifications, Military Standards, and Business Processes to performance specifications and commercial standards on your existing Department of Defense ("DoD") contracts. We refer to such transition throughout this Executive Briefing Paper as "block changes."

The block changes will most visibly manifest themselves as cost reductions in full-rate production and derivative contracts, since these are generally awarded on a fixed-price basis. Consequently, this Briefing Paper is designed to assist Senior Executives within: (1) contractors which focus on both RDT&E and DoD production; (2) military production houses; (3) mixed commercial and military suppliers; and (4) commercial suppliers which maintain small-scale military production operations. Sophisticated contractors must be prepared to immediately conduct cost-benefit analyses of projected net savings on facility-wide and corporate-wide bases to prepare fully-articulated strategies for negotiation of these block changes.

In June of 1994, Secretary of Defense William Perry signed a Memorandum directing the DoD to transition from Military Specifications ("MilSpec"), Military Standards ("MilStd"), and Business Processes ("BP"), to performance specifications and commercial standards to the maximum extent practicable on future contracts. That Memorandum also directed development of a streamlining protocol for modifying existing DoD contracts from MilSpec/MilStd/BP to contractor proposed performance specifications, commercial standards, and other businesses processes. Secretary Perry's directive creates a unique opportunity for contractors to seek block-change modifications to standardize existing DoD contracts on facility-wide or corporate-wide bases with other Federal product and commercial production lines. These block changes will effect substantial net savings on all contract types, but particularly on fixed-price contracts such as large full-rate production contracts. While savings from standardization on cost-type contracts accrue to the government, there is strong controversy as to whether contractors should share any of the projected net savings with DoD on fixed-price contracts. This is exacerbated by our experience that revenues from fixed-price contracts such as full-rate production and derivative contracts generally exceed cost-type revenues, such as RDT&E, by a ratio of at least six-to-one. Consequently, the projected net savings on fixed-price-type contracts are substantial.

We anticipate that Dr. Kaminski will issue a decision within the next few days authorizing DoD-wide block changes. Many individuals have commented that his decision will continue the Federal government's commercialization of the acquisition process. However, a more critical understanding reveals that Dr. Kaminski's authorization of block changes does not focus as much on commercialization as it does on the standardization of parallel DoD-specific product lines to those of Federal product/ commercial production lines on a facility-wide or corporate-wide basis. The benefit of standardizing existing DoD programs with other production lines on the "shop floor" permits contractors to: (1) focus on their respective core competencies; (2) reduce the number of product lines (e.g., reducing fixed-cost capital expenditures) to improve efficiency without reducing manufacturing output; (3) reduce the learning curves of workers and eliminate duplicative tasks; and (4) reduce inspection costs by eliminating non-value-added or cost prohibitive government-unique MilSpec/MilStd/BP.

The complexity and importance of block changes cannot be overstated. It often takes one to one-and-one-half years, or more, to complete negotiations and execute modifications to major weapons systems programs. Consequently, precision planning and comprehensive facility-wide or corporate-wide strategy is required to capture the benefits to be derived from the contemplated block change authority. Failure to promptly negotiate the conversion of existing contracts from MilSpec/MilStd/BP to performance specifications and commercial practices will compound administrative delays while program managers, ACOs, DCAA, and DCMC struggle to negotiate the surge of expected modification proposals from industry. Failure to properly negotiate that conversion will not only result in loss of bargaining power on net savings from your Federal contract base, but could also trigger civil and criminal repercussions.

I. The Competing Forces/Proposals

There is no question that DoD's Senior Leadership wants to implement these block changes as quickly as possible to take advantage of the potential net savings, both in terms of reduced need for DoD oversight of vendors and reduced vendor direct and indirect costs. However, the methodology for effecting these changes is being hotly debated.

One vehicle for implementing block changes is the use of blanket modifications. The Director of Defense Procurement ("DDP") has asserted that block changes must be negotiated with respective ACOs on contract-by-contract bases. The DDP dispatched a letter in August of 1995 to all contracting agencies, reminding COs of their obligation to obtain consideration on behalf of the government, on contract-by-contract bases, for all modifications where contractors receive benefits resulting in lower costs.

The DDP's letter calls for modifications of each contract to be negotiated individually. Individual negotiation of each and every existing DoD contract creates an unduly burdensome system, increases the complexities of the processes, and thwarts the immediate implementation of block changes. Contracting officers have always had the authority to determine acceptable consideration, i.e., short-term contractor windfall on existing fixed-price contracts in exchange for long-term DoD savings on future contracts. Requiring consideration from the contractor for each individual contract modification infringes on the contracting officer's and program manager's authority. However, we recognize the DDP's potential concern as to public perception that contractors will be the recipients of windfall savings, as the result of block changes without contract-by-contract consideration.

Another alternative limited to the area of quality assurance would use the existing MILQ 9858A provision, which permits a contractor to change its quality system without consideration. This approach would allow all contracts to be modified to use the ISO 9000 standard for quality control. The benefit of this approach allows for the potential combination of parallel DoD product and Federal product/commercial production lines. The elimination of multiple requirements on either sole or multiple product lines could result in significant cost reductions.

An extremely simple and direct approach is the use of Public Law 85-804, which allows the Secretary, under these circumstances, to determine that consideration is waived in the interest of national security. Such an approach enables contractors to convert current MilSpec/MilStd/BP-based contracts to performance specifications and commercial standards without reduction in price. This does not affect cost-type contracts, where savings naturally accrue to the government. Use of Public Law 85-804 is justified by the risk to national security from the inability to accomplish DoD's mission critical objectives absent the maintenance of a viable industrial base. The Secretary would determine that any windfall to the contractor is offset by reduction in DoD's costs. However, it is unlikely that such "windfalls" will occur when non-recurring contractor transition costs are considered. Under this measure, all modifications are carried out through the normal contract administration process.

Alternatively, members of industry have suggested use of the Value Engineering Clause in existing DoD contracts as a vehicle for implementing block changes. The government retains all savings resulting from concurrent contracts with other vendors, future contracts, and collateral savings. In exchange, the contractor retains all savings on the instant contract and its concurrent contracts with DoD. This approach enables block changes to be made quickly and efficiently.

There are several anticipated difficulties with using VECPs to facilitate block changes to standardize existing DoD contracts. Specifically, even if a contractor waives any savings on its instant and concurrent contracts, the government will still conduct a cost-benefit analysis (calculated perhaps via an expedited rough-order-of-magnitude "ROM" formula). Consequently, DoD would likely approve a VECP Proposal only if projected to "come out ahead" in the cost-benefit tradeoff, i.e., if government savings on concurrent contracts with other vendors, future contracts, and collateral savings is greater than, or at least equal to, the windfall received by the proposing contractor. Given that the block change conversion from MilSpec/MilStd/BP to performance specifications and commercial standards is facility-wide or corporate-wide to a specific contractor, the government is unlikely to recognize any projected net savings on concurrent DoD contracts with other vendors, or on future contracts. The government is also unlikely to accept a VECP Proposal that fails to project greater net savings to DoD than those projected to accrue to the contractor. Hence, the government must likely be accorded substantial benefit (e.g., reduced cost or significant net savings) to agree to the VECP.

II. Projections and Analysis

The Department of Defense has not yet made a final decision on the vehicle to implement block changes to its existing contracts. However, we expect one shortly. Both DoD and industry want to effectuate block changes in as timely and efficient a manner as possible. Yet some within DoD fear that the appearance of "windfall" concessions to contractors will result in criticism from Congress over lost opportunities for DoD to recover potential net savings. Whichever approach Dr. Kaminski ultimately elects, careful preparation and attention to detail must be an integral part of a contractor's strategy to seize the benefits of block changes. If Dr. Kaminski's final determination requires consideration for individual or blanket contract modifications, DoD will want the projected savings immediately, placing contractors at risk if the projected savings do not fully materialize, and/or implementation costs exceed anticipated levels. This is in addition to the unsavory potential for fraud allegations if projected costs and savings do not materialize. We warn you of this element only to demonstrate the critical need to properly prepare for block change negotiations with the government. We are available to work with you in preparing your modification proposals, based upon the new FASA exceptions to requirements for certified cost or pricing data under TINA.

IV. Conclusion

It is our opinion that block changes will likely be implemented on a more ad hoc basis by ACOs as opposed to any of the other alternatives discussed above. If this is the case, then it is critical that contractors prepare now to negotiate those strategic contract modifications to capture the associated benefits. We welcome the opportunity to tailor a proprietary on-site Briefing to achieve your corporate objectives regarding these block changes.