In the face of persistent inflation, government contractors are grappling with a complex set of challenges that impact their pricing strategies, contract negotiations, and ultimately, the efficiency of delivering products and services to the warfighter. At this year’s 2023 Government Contract Pricing Summit, a panel discussion shed light on these pressing issues, offering insights into the risks associated with inflation and the difficulties of pushing those risks down the supply chain. Here are some excerpts from that discussion:
Understanding the Risk Transfer Dilemma
Contractors often attempt to transfer inflation-related risks to their suppliers, especially smaller businesses. However, it is vital to recognize that, ultimately, the prime contractor bears the ultimate risk. Smaller subcontractors, faced with the prospect of financial distress or even bankruptcy due to contract performance at agreed-upon costs, are increasingly refusing to accept these terms. When a contract is sole-sourced, and there are no alternative suppliers, the prime contractor is left with little choice but to absorb the higher costs.
In some cases, history has shown that even the largest prime contractors must assume these risks to keep crucial projects on track. Airbus, for example, had to renegotiate firm-fixed-price supplier contracts during the global financial meltdown in 2008. The misconception that firm-fixed-price contracts guarantee stable costs proved to be irrelevant in the face of such economic turmoil. Similar situations are unfolding today with other manufacturers.
The Warfighter Suffers
A critical concern arising from this risk transfer dilemma is that the ultimate sufferers are the warfighters who rely on the timely delivery of equipment, products, and services. When subcontractors are unable or unwilling to perform at agreed-upon prices, the prime contractor is left with limited options. In such cases, terminating contracts or defaulting on them can lead to significant delays in critical projects, potentially compromising national security.
The Need for Flexibility in Contracting
One solution to address these challenges lies in adopting more flexible contracting practices. Government agencies and contractors alike should be open to different contract types and more adaptable contract structures. While cost-reimbursable contracts may come with additional requirements, such as adequate accounting systems and reporting, they can shift some of the risk from the contractor to the government. This shift can make negotiations more manageable in the face of inflation.
However, the challenge is not solely about contract type flexibility. It also involves fostering a competitive environment, even in sole-source contracts. Primes and government agencies must continually seek out potential alternative suppliers, especially when dealing with critical projects with long lifecycles. This approach ensures that competition remains a driving force, preventing sole-source suppliers from having disproportionate power in negotiations.
The Role of Government Guidance
Recent Department of Defense (DOD) memos have attempted to address some of these issues, emphasizing the need for flexibility in contracts and suggesting the use of economic price adjustment clauses in new contract awards. However, the panel highlighted that while these memos provided some guidance, the industry has yet to fully implement the flexibility offered by Congress and leadership.
Anticipating and Managing Inflation-Related Costs
While these challenges are significant, the panel also recognized the importance of contractors taking proactive measures. Contractors should factor inflation-related risks into their pricing strategies, offering supportable proposals that consider the anticipated cost increases. This approach minimizes the need for post-award requests for equitable adjustments (REAs) and helps maintain contract stability.
To summarize, addressing inflation risks in government contracting requires a multi-faceted approach. The challenges of risk transfer down the supply chain must be managed carefully, recognizing that the prime contractor bears the ultimate responsibility. Flexibility in contracting, including the use of different contract types, competitive sourcing, and a proactive approach to pricing strategies, is essential in navigating these turbulent economic times.
While government guidance offers some direction, it is crucial for both government agencies and contractors to take proactive steps to adapt to the new economic reality. By doing so, they can better serve the warfighter and ensure the successful and timely completion of critical projects.
We know what you’re thinking: I would love to be a part of discussions like these and to interact with my colleagues in the industry, all with the goal of helping to shape the future of government contract pricing. Come join other contract pricing professionals who gather each June and become part of this fast-growing community!
Save the 2024 GCP Summit date: June 11-13, 2024, in beautiful San Diego, CA.