Block Changes Briefing No. 2

December 8, 1995

This morning, Under Secretary of Defense (Acquisition and Technology), Dr. Paul G. Kaminski, issued the attached memorandum entitled the "Single Process Initiative" (memorandum). We informed you of the impending policy decision in our Briefing Paper, the "Block Change Directive" on October 25, 1995. Dr. Kaminski's memorandum authorizes the conversion of existing DoD contracts, from multiple government-unique management or manufacturing processes, to common business processes on a facility-wide basis. Our assessment is that the memorandum authorizes: (1) consolidation of DoD/agency-specific production lines either into one another or into commercial lines (reducing fixed-cost capital expenditures, and variable-cost learning curves and duplicative tasks), (2) reduction of government-unique quality assurance, inspection, and testing requirements; and, (3) deviation from residual DoD specific "business processes," often categorized as "non-value added." Our Briefing Paper addressed this in its true essence, i.e., net savings, or pure profit, for the contractor.

The memorandum encourages contractors to submit "concept papers" to the administrative contracting officer (ACO) for implementing proposed changes, accompanied by cost-benefit analyses using rough order of magnitude figures. Approval of the concept paper is contingent upon its technical acceptability. The ACO is expressly empowered by the memorandum to execute "class modifications" for those contracts in which no significant decreases in overall net cost of performance accrue on a contract-by-contract basis.

While we applaud DoD's progress, Dr. Kaminski had the opportunity to go much further in authorizing facility-wide changes, by determining that "consideration" to modify contracts on a facility-wide basis is inappropriate. To the contrary, Dr. Kaminski's memorandum requires ACOs to conduct contract-by-contract analyses to determine if there are significant savings resulting from changes to individual contracts. If those savings are significant, ACOs must negotiate monetary consideration. Because the memorandum fails to define "significant savings," it creates the probability that ACOs will minimize risk by compelling contractors to submit proposals and cost or pricing data. The lack of guidance dictates that each contractor develop a fully-articulated corporate-wide strategy to capture the maximum savings possible, and craft a negotiation strategy prior to submitting concept papers to the respective ACOs. Savings in this context shall be reflected in net reduction in overhead costs. The benefit to the contractor is two-fold: (1) greater profits will be realized on high dollar value, firm-fixed-price type contracts; and (2) competitive advantage shall be achieved over competitors in the DoD and commercial marketplaces.

We believe that every corporate strategy must include taking immediate advantage of "low hanging fruit" to maximize 1996 profitability. The low hanging fruit includes those processes in each facility for which non-recurring transition costs are minimal, as compared to the reduction in overhead resulting from their elimination. These changes encompass processes where the government has already provided for no cost changes, and where those changes can be implemented by mid-year 1996 to post actual savings by the close of the fourth quarter. At least two areas are prime for the picking: the first is the conversion from MIL-Q-9858A to ISO-9000, and the second is the modification of existing contracts to bring them under the newly created TINA exceptions. The benefits of converting from article-testing to process-testing are self-evident. Establishing the applicability of one of the TINA exceptions, or obtaining a waiver, eliminates the burden of submitting cost or pricing data on future contract actions. We would be pleased to discuss proprietary strategies for extracting maximum value from the low hanging fruit.

It is absolutely essential that contractors act promptly to post highest profitability in 1996. Contractors' proposals must identify and "front-load" those changes which will have the greatest measurable impact on the bottom-line. We anticipate that there will be a surge in demand on the resources of Defense Contract Management Command (DCMC), and its customers, to review the technical acceptability of the concept 
papers. Given the expected surge of contractor proposals, those submitted immediately will have the highest probability of ACO approval for early to mid-year 1996 execution. Delay in submitting plans will result in transition costs sapping existing profits, without the accrual of offsetting net savings in 1996.

Additionally, contractors must act properly to craft a corporate-wide strategy for negotiations with the respective ACOs. The memorandum, as well as the letter issued earlier this year by the Director of Defense Procurement mandating consideration, compels ACOs to require contractors to relinquish substantial portions of large savings on high dollar value, firm-fixed-price type contracts. The memorandum also authorizes ACOs to execute facility-wide modifications without definitizing cost impact, i.e., profit-sharing ratios of significant savings on high dollar value, firm-fixed-price type contracts. The bulk of the savings are expected to manifest themselves in high dollar value, firm-fixed-price contracts, but only after conversion of entire facilities. However, the memorandum encourages the irrevocable conversion of entire facilities without definitization of profit-sharing on coveted net savings from the high dollar value, firm-fixed-price contracts.

Consequently, each corporate strategy must coordinate the changes in all contracts so that the government does not receive the windfall benefit of reduced costs in cost-type contracts and lower dollar value, firm-fixed-price type contracts; without concurrently negotiating savings to be realized by contractors in high dollar value, firm-fixed-price contracts. This is reinforced by a need to leverage and negotiate high dollar value, firm-fixed-price type contracts (clustered in some facilities) against the government's advantages in cost-type contracts and lower dollar value, firm-fixed-price contracts (predominantly scattered among other facilities). Conducting corporate, group/sector-wide, and facility-specific cost-benefit analyses will maximize shareholder value to the bottom-line, as opposed to facility-specific concessions on existing contracts within each facility on the date of contract modification.

We have prepared a comprehensive strategy which can be readily tailored to your corporate, sector/group, and facility-specific needs to accelerate net savings to the bottom-line in 1996. Since we will be in your vicinity during the next several weeks, we are amenable to providing a proprietary briefing to Senior Management on an uncompensated basis.