“THE
NATIONAL INTEREST” By
Julia Gledhill
“The
distillation of the defense industry as the number of prime military
contractors shrank from
over fifty to just five, bodes poorly for both the military and
taxpayer because it produces waste, not to mention a strong profit
incentive for war”
__________________________________________________________________________________________________
“As
a matter of practice, military contractors have overcharged the
Pentagon for years—at the expense of both taxpayers and the
military.
However,
several members of Congress are working to end the practice. Last
year, Senators Warren (D-MA), Braun (R-IN), and Grassley (R-IA)
teamed up with Reps. Garamendi (D-CA) and Deluzio (D-PA) to introduce
legislation that will address the legal loopholes that enable
military price gouging.
Acquisition
experts understand these loopholes well, but unfortunately, most
lawmakers are still unaware of how common it is for contractors to
overcharge the military. Without a better understanding of the true
scale of military price gouging, Congress is unlikely to pass
legislation to prevent it.
That’s
why Congress should include in the final FY 2025 defense policy bill
Rep. Doggett’s (D-TX) provision to investigate potential
overcharging by sole-source suppliers of military products and
services. Due to unchallenged market power, sole-source contractors
are well positioned to profiteer. Doggett’s provision would
establish a panel to review sole-source military contracts and
“determine whether the Department of Defense paid fair and
reasonable prices.” By focusing on sole-source contracts, the panel
would shine much-needed light on the issue of military price gouging
writ large, the scale of which is near impossible to discern because
so much of it is legal.
Over
the course of decades, military contractors have consolidated and
harnessed market power to slowly obscure military price gouging.
Industry consolidation began when the Cold War ended, and the Clinton
administration slashed defense spending. However, as Richard
Loeb—former Executive Secretary and Counsel of the Cost Accounting
Standards Board in the Office of Management and Budget—has pointed
out, the administration simultaneously catalyzed an era of
“acquisition reform” to protect contractor profits even as
defense spending plummeted and the number of prime military
contractors shrank from over fifty to just five. Merger mania has
continued, further concentrating market power among the few. Military
contractors wield that power on Capitol Hill, lobbying Congress to
gradually chip away at acquisition laws designed to protect the
government from unfair pricing schemes on military contracts. In so
doing, lawmakers have left the Pentagon in the dark about contract
negotiations with the defense industry.
Acquisition
reform and industry consolidation have helped contractors overbill
the military in pursuit of excess profits. As a result, military
contractors have overcharged the Pentagon to the tune of hundreds of
millions of dollars on a single program, generating nearly 40 percent
in excess profits. Indeed, a CBS investigation last year revealed
that the Pentagon saved $550 million on the Patriot PAC-3 missile
after conducting a 2015 cost review of Lockheed Martin and Boeing’s
previous work on the program. Both contractors are repeat offenders,
and they have long been among the top five prime contractors
dominating the defense industry. The Pentagon’s internal watchdog
exposed Boeing for inflating prices on spare parts in 2013 and 2011.
In one case, the company charged over 177,000 percent above the fair
and reasonable price for a helicopter spare part—$71.01 for a tiny
metal pin worth 4 cents at the time. The trend continues. Just last
month, two Lockheed subsidiaries agreed to a $70 million settlement
with the Navy for doing the same thing—inflating prices on spare
parts.
The
Pentagon can’t negotiate reasonable prices with military
contractors because it doesn’t have sufficient bargaining power.
Contractors are often exempt from providing the Pentagon with
“certified cost or pricing data.” Without this information, the
Pentagon has little idea what companies’ costs are and, thus, what
their profit margins might look like. Contracts may be valued below
the mandatory disclosure threshold. Contractors may also produce a
product that’s considered commercial—and theoretically, price
competitive. However, the statutory definition of “commercial” is
overly broad, encompassing products that aren’t sold to the public
and sometimes never have been. Lawmakers expanded the commercial
definition and raised the mandatory disclosure threshold for
certified data at the behest of industry and under the guise of
cutting red tape.
Without
legal requirements for certified data, the Pentagon may ask
contractors for historic or uncertified cost and pricing data. Yet,
the Pentagon has few tools to ensure that this data meets requisite
standards; among them, that they include “the minimum information
necessary to permit a determination that the proposed price is fair
and reasonable.” According to the Pentagon, current statutory and
regulatory requirements discourage officials from requesting
uncertified data. Instead, contracting officers often rely on
historical cost and pricing data. Still, according to the Pentagon
Inspector General, the department cannot evaluate price
reasonableness “based solely on historical price comparison.”
This is particularly concerning given the watchdog’s extensive
analysis of contract pricing in recent years, which shows that price
analysis methods like historical cost comparison enable “sole
source contractors to earn excess profits without detection by
contracting officers.” Effectively, military contractors can
provide the Pentagon with any cost figures without consequence—even
if they give zero indication of how reasonable current prices are. In
other words, contractors can price gouge the military legally, likely
under the government’s radar.
Still,
the defense industry appears to resist almost any attempt by the
Pentagon to evaluate contract price reasonableness. “Sweeping” is
a process through which contractors overwhelm the Pentagon with cost
and pricing data that was “reasonably available at the time of
price agreement” but submitted after the fact. According to Senator
Warren, contractors often sweep the Pentagon after price agreements
and before contract awards to absolve themselves of the liabilities
associated with breaking acquisition law and potentially “to hide
data that might give the [Pentagon] a better price.” In other
cases, contractors outright refuse to provide the Pentagon cost and
pricing data, claim they can’t share it, or delay the provision of
such data to the extent that the Pentagon may blindly agree to a
contract price due to time sensitivity. So, the Pentagon doesn’t
just struggle to obtain certified cost and pricing data. It’s a
challenge to get any cost and pricing data—even from sole-source
contractors, which are relatively uninhibited by the forces driving
price competition.
The
Pentagon has admitted that data denials “may be more prevalent
[than reported], particularly with respect to sole source commercial
items.” This is especially nefarious in a market that looks like a
monopsony but operates like a monopoly, where sole-source contractors
reign as kings. They have a documented history of refusing to provide
even uncertified cost and pricing information. Since 1998, the
Pentagon’s Inspector General has published several reports
detailing data denials by sole-source contractors. TransDigm, Inc. is
the most recent example and perhaps the most notorious. According to
the Pentagon, the company “accounted for all Defense Logistics
Agency cost and pricing data denials” in FY 2022. The company
failed to respond to 401 requests for cost and pricing data from the
agency, and that was after the Pentagon Inspector General exposed
TransDigm for twice price gouging the Pentagon. The contractor
generated a total of nearly $40 million in excess profits.
Ultimately,
withholding cost and pricing data bolsters a contractor’s ability
to increase profits by charging the Pentagon unfair and unreasonable
prices. However, the defense industry already significantly
outperforms other industries financially, and this is not just
because the United States spends over a trillion dollars annually on
national security. In many cases, the Pentagon reimburses contractors
for research and development costs. It will even cover some capital
costs, including those associated with the depreciation of assets
like machinery and equipment. As a result, military contractors enjoy
returns on assets and invested capital that are difficult to achieve
in other industries where companies make those investments
themselves. Still, military contractors leverage special treatment
from the government to increase executive compensation and cash paid
to shareholders, even at the expense of capital investment and
internal research and development.
If
the defense industry continues to consolidate, it will only get
harder for the Pentagon to negotiate fair prices with military
contractors. The department will have to rely on more and more
sole-source contractors, which not only increases the risk of
overcharging but also presents national security risks, like supply
chain vulnerability and reduced availability of certain resources.
The entire nuclear triad is already dependent on one company,
Northrop Grumman. As far as U.S. contractors go, General Dynamics
manufactures a significant portion of tracked combat vehicles.
Boeing, Lockheed Martin, and Northrop Grumman produce the military’s
fixed-wing aircraft. The distillation of the defense industry to a
handful of companies bodes poorly for both the military and taxpayer
because it produces waste, not to mention a strong profit incentive
for war.
As
the defense industry’s primary customer and a steward of taxpayer
dollars, the Pentagon needs to be a stronger buyer. However,
never-ending acquisition reform continues to prevent that. Current
laws are insufficient even to document price gouging by military
contractors, much less prevent or remedy it. If retained in the final
defense policy bill, Rep. Doggett’s provision would help the
Pentagon better understand the scope of overcharging by sole source
contractors—and ultimately, give lawmakers the information they
need to hold industry accountable for overcharging the government at
the expense of the taxpayer.
Congress
does not yet have the tools to investigate and root out the full
scale of defense contractor fleecing of the DOD.”
“National Interest” How Defense Industry Price Gouges Pentagon
ABOUT
THE AUTHOR:
Julia
Gledhill is
a Research Associate for the National Security Reform Program at The
Stimson Center. She focuses her research and writing on Pentagon
spending, military contracting, and acquisition. In previous roles at
the Project On Government Oversight and the Friends Committee on
National Legislation, Julia worked on various national security
issues related to Pentagon accountability, war powers, civilian
protection, drone policy, the torture program, and U.S. lethal
strikes.
