The April issue of National Defense Magazine brought a well-written article by Susan Cassidy and her colleagues at Covington & Burling LLP on a recent DOD IG report analyzing (and criticizing) spare aviation parts pricing, even though the report concluded that the contractor in question had complied with the Truthful Cost or Pricing Data Act. The article addresses the IG’s concept of a fair profit – which is abjectly divorced from reality – and it notes that the GAO has been conducting a study of spare parts purchasing with a promise of recommendations to improve transparency in this area. I commend the article to anyone who operates in the spares market and wants to know where the Government is heading in relation to spares pricing.
With the IG and the GAO injecting themselves – yet again – into the spare parts market and decrying the rapacious contractors who dare to sell at prices that the Government regards as outrageous (after all, why in the world would anyone think that a profit rate in excess of 15% on a firm fixed price contract was reasonable?) it seems like a good time to revisit the reasons why the Government’s periodic complaints about spare parts pricing are generally myopic and wrong. And so, because no criticism of Government contractors ever goes away forever, I offer for your consumption a refresher: the re-publication of a posting that I authored in November 2014, entitled “How Dare You Charge That for a Spare Part!” – The Untold Story of the X27 Interface Assembly” –
The pricing of spare parts has been a subject of Government criticism for decades. Pick up any DCAA or IG audit report relating to spare parts or any intra-agency memorandum on the topic and you will sense the dudgeon with which the Government reacts to the prices of those parts.
These criticisms are intended to, and often do, engender a similar reaction from commentators, bloggers, and ordinary citizens, who pen irate letters to the editor bemoaning the greed of the contractors who “hold the government hostage” in the spare-parts realm.
Let’s put a little context around this issue. One way to do that is with the saga of the “X27 interface assembly.” The X27, of course, does not exist, but – if it did – its life story might look something like this.
The X27 is a specialized assembly that mates key components of the QRS system that was introduced in the 1980’s. It was originally manufactured under a firm fixed price production subcontract, purchased by the prime contractor in bulk, and installed by the prime contractor in its integration of the system.
During the production of the system, the Government would occasionally approach the prime contractor for spare X27’s. The prime contractor would provide them from stock, priced on the basis of the bulk price charged by the subcontractor when producing the X27 in volume on a “hot” production line. With the exception of packaging and shipping, there was really no difference between the material price of the X27’s integrated in the system and the spare X27’s purchased by the agency.
Fast forward 30 or so years. The system is out of production. The X27 is out of production. The original subcontractor has gone out of business. The X27 tooling has long since been scrapped. The Government doesn’t know for sure whether it ever acquired rights in data with respect to the X27, because the records are ancient and the Government cannot find them. But the system is still in use and it needs to be maintained, and that means the Government needs spare parts. From where do they come?
Not from Home Depot – these are specialized assemblies with specific dimensions, tensile strength, and torqueing requirements.
Not from the system prime contractor – it is no longer making the system, so it is no longer buying X27’s in bulk, and its bulk stock was exhausted many years ago.
Not from the original subcontractor – it does not even exist anymore.
No, what the Government needs now is some enterprising supplier who can:
• Locate and license whatever intellectual property may be needed to do the job or be willing and able to expend the time and money needed to reverse engineer the X27;
• Fabricate the tooling needed to manufacture the X27;
• Establish a production line;
• Employ sufficient personnel and have sufficient processes and procedures to satisfy all Government requirements with respect to, e.g.,
• Pricing, in accordance with Part 15 of the FAR;
• Quality control;
• Testing and inspection.
Oh… and one other thing – the Government only wants one X27. That’s right – one – a/k/a uno, une, eins, or “1.” And the Government won’t commit to buying any more than that one lone eagle. It is hardly surprising that the newly manufactured X27 is orders of magnitude more expensive than those purchased long ago, in a galaxy far, far away. But, all too often, it is in that long ago galaxy that the Government’s institutional pricing memory is fixed. How many times, when reviewing a DCAA or IG audit report relating to spare parts, and reference is made to prior prices, do you see any discussion of:
• Who the prior manufacturer was?
• Whether the prior acquisition was off of a “hot” production line?
• What the volume of that prior purchase was?
• Whether the prior supplier was the OEM?
• Whether the OEM is still producing the product?
• Who controls the IP?
• What the supplier paid to obtain the IP?
• What it would cost to reverse engineer the product?
• Whether the tooling exists or had to be created for the acquisition?
• What quantity is being purchased now?
• What guarantee there is of any additional sales over which to amortize the non-recurring costs?
It seems to me that these are pretty important and relevant questions. If you don’t ask them, you don’t know the answers. And if you don’t know the answers, you cannot prepare a reasonable audit report. All you can do is offer baseless criticism. Last time I looked, movie critics actually watch the movie before writing their reviews. Maybe DCAA and the IG should follow that practice.