Cost plus contracts are well intentioned, but create perverse incentives. It's also a big issue in the defense industry. The idea is that a contract pays a company the cost of producing a product, plus N% for profit. Thus, profit is fixed and companies cant profit too much off public money.
But in practice, this means that in order to increase profit companies have to increase costs. If you're building a product and you can spend $10 million to build it efficiently or $20 million to build it inefficiently, it's actually beneficial to do the latter. It's disincentivizing cost reductions and incentivizing cost increases.
A better way to align incentives would be to have the bids specify fixed profits and a value engineering process. You bid $10m + $1m profit. The project baloons to a $20m project, you still make $1m. The project meets it's goals with a $5m budget, you get $1m and a percentage of the shortfall. It can still be gamed, but to a much lesser degree.
I worked on a 9-figure construction project and there were two full-time engineers specifically tasked with looking for ways to reduce the cost of the project, because it was essentially free money for the contractor. These two people generated millions in profit for the company.
There are a lot of games you can play to make say rent look like a cost on a contract while another entity makes a profit from that rent. Worse you still have incentives to offload costs onto a contract. For example someone finishes an unrelated contract your might as well move them to a profit + contract rather than benching them or immediately laying them off.
In the end markets simply aren’t efficient without pricing information. If you can’t get someone to bid a fixed price you might as well keep in in house.
Those games you play are a lot easier to deal with oversight-wise. I disagree with your conclusion. You're assuming in-house doesn't have the same perverse incentives. Also, pricing information can be impossible to discover. You often hear on HN how nobody can realistically estimate large software programs. Under that regime, what good is a firm fixed price contract? What'll happen is that the company, once it goes over-budget, will stop work and/or go bankrupt depending on the legal contract it signed. Then the client has no choice but to add more money into the pot - which suddenly sounds like a cost+ contract.
I have worked on plenty of successful fixed price software projects. The simple reality is when you fix costs quality becomes the flexible metric, but meeting the minimum project goals becomes really important. However, considering how many software projects fail, reaching the agreed upon minimum at the agreed upon price is vastly better than what generally happens.
As to failing to finish a project the wonders of fixed price contracting is you can pay at completion of some milestone. Of course that means people need to pad the price even more ahead of time to assume that risk, but price becomes a really useful signal.
> I worked on a 9-figure construction project and there were two full-time engineers specifically tasked with looking for ways to reduce the cost of the project, because it was essentially free money for the contractor.
Semi-related story:
Way back I was a trainee for a company, which won a contract to upgrade the the branch servers for some other company, about 500 of them.
The on-site process involved copying over files from the old Unix server to a new NT4 server running Citrix, split maildir and home directory and set proper user-level permissions on each users home and mail directory.
The whole rollout was going on for just a few months, so we had tons of folks doing this in parallel at each site. During the first site I saw the manual our project team had created, and it specified us doing the copying and permission setting using Windows Explorer. To change the ACL that meant scrolling down to find the right abbreviated user name matching the directory name... fun when there was hundred employees at a branch.
I figured there had to be a better way, and started writing some batch scripts. After about a day I had automated the whole process, including sending a mail to our phones (the phone company had a service turning number@phone-company.com into an SMS).
So I just launched the script, went for a 1-2 hour lunch until the phone beeped. Then I just had to go over the logs and verify there were no errors, and job done.
Back at base, I shared the scripts with my coworkers, which obviously loved not having to do the tedious process as specified.
It was only after the end of the project that I learned that the contract included a fixed rate of 3-5 days per site for one or two techs, depending on size. After all, changing all those permissions manually took a lot of time. After I wrote the scripts nobody used more than half a day...
Did I get any extra compensation for that? Of course not, and I was too young and shy to ask.
Fresh out of high school, I worked for a telecom contractor, installing large cross-connect machines. (Think 20-30 racks of equipment, a few thousand DS3s worth of capacity, which in the late 1990s was a lot.) We'd do the physical install and some very basic continuity testing, then hand over the keys to the vendor's own tech who would "turn up" the machine, thoroughly testing it and making it ready for service, before finally handing it to the customer who would provision their actual traffic on it.
The turn-up procedure was documented in the manual and technically anyone could do it, it was just customary to have the vendor do it. And they charged handsomely for it, flying out a tech who would spend 2-3 weeks on site running through the procedure. It was quite a lot of manual work, adding and deleting connections throughout the whole range, and plugging a T-Berd tester into the patchbay to verify transmission of every single circuit. The tech was quite busy during those weeks.
My company decided (at a level way above me) that we were gonna try to get into this line of work. As the pimply-faced youth with some computer experience, I got tapped for it, and paired with a graybeard who had done something similar back in the 80s and had a sense of the lay of the land. The logic was that our first few jobs might not make us any money, but we'd get better, and anyway just saving the airfare would be a win.
The manual specified typing all the commands directly into the machine's (TL1) prompt, but I wanted to avoid typos, so I typed everything into Wordpad first and then pasted it into the prompt. Which meant I was creating a log of all the necessary commands, and I could search-and-replace various parts to advance through the range of valid circuits. Less typing, more pasting. By the end of our second day, we were screaming through the testing (still doing everything by the book, just typing an effective 500wpm and making zero typos) way faster than the vendor's tech ever did. Running back and forth with patch cords and T-Berds was the principal limit.
By the end of the first week, I had written a QBASIC program to obviate the search-and-replace, and just spit out bespoke commands for any given range, or for a whole machine at once if you wanted to feed it the whole config. The output was a many-thousand-line text file which you would then drip-feed to the machine while doing the needful with patch cords and your trusty T-berd. As long as nothing went wrong, it was literally just one long file-send with pauses for jogging across the office. And as our installers were very good, things rarely went wrong. (I did find out that the machine's input buffer was only a few hundred characters, thank goodness the terminal software had an inter-line paste delay!)
Our very first job came in at less than half the time we'd bid, and it only improved from there. After our third job, I believe, I went solo. I bought a pair of WPC11 cards and parked one laptop at the machine's console port, carried the other with me to the patchbay, and eliminated the running-back-and-forth time too. Wizardry! Laziness! Profit!
I proceeded to reverse-engineer quite a lot of that machine, finding undocumented debug interfaces that saved tons of time when things did go wrong, so we could avoid the blind combinatorics specified in the manual, and instead directly zero in on the errant signal. When things went smoothly, I was 3-5x faster than the vendor's own tech. When things went wrong, I was 10x faster.
Extra money? Nah. But I was having the time of my life.
I don't know, it just seems to me that having two engineers devoted to find ways that you can save money, whom, presumably also get rewarded by how much they save (this could just be a nice speech by someone but I think if you saved significant amounts maybe a bonus?) would inevitably lead to some situations where they realize that the grade of cement or something similar had not been specified for something and it probably means that, barring significant seismic events in an area that has a fault that has not done anything significant for a century, the thing being built would not need any repair for 45 years instead of 65.
Obviously this example is not a real world one as construction is not my area of expertise but I do think I have insights into mundane human mendacity. Then again I am also prone to cynicism.
In the US, on large structural projects, things are generally well-specified, either by standard code, or long before the project goes to bid. The owner (usually another firm representing the government that's paying for it) and the contractor inspect and measure all the work done each day. There are undoubtedly going to be mistakes and corners cut, but that's what safety factors are for and it's hard for problems like that to be endemic without some serious corruption.
On a related note to using the wrong concrete, things like this can be an opportunity to see master craftspeople in their element. We had a truck of concrete show up and the foreman rejected it with almost no hesitation. "Why the f*&($ won't you sign on off this!?" the driver yelled. "It's smells wrong", said the foreman. Nobody else noticed anything amiss, but he was the boss, so the truck went back to the plant and sure enough, they'd mixed it wrong.
This is an interesting point. There have been a number of construction-related scandals in the last thirty years of building public housing estates in Hongkong. Either the contractor used weak cement, insufficient rebar, or didn't drive piles deep enough. The fact that they were not caught until the building was completed is terrible. It says the QA by gov't was seriously flawed. (It has since improved a lot!)
I think the offset is to have a mixture of QA/checkers and gov't regulators who are onsite checking things. With huge civil engineering projects, sometimes the gov't will hire a competing civil engineering firm just to be onsite checking the work. That balance probably works.
All these approaches have plusses and minuses and their own risks. The risks with the approach you have described are that:
a) Unless very carefully managed, you can end up with contractors being incentivised to cut corners (i.e. We make more money if we buy the cheapest doors possible, regardless of if they only last a few weeks).
b) If contractors have fixed profits at their bid-price, they will have zero incentive to accept any change requests (unless they come with additional margin, in which case, overspends will magically turn into change requests).
This assumes that every relevant detail is speced out. In many projects you don't know exactly what something is going to look like at the end of the project, so over-spec'ing is just as much a problem.
On the types of projects I mentioned, and I assume to an even greater degree for spaceships, the details are in the spec, which is stamped by an engineer. If you're installing a curb, all of the dimensions are there, the finish on each side, how far below ground it goes, what type of gravel goes under it, the mortar you use to set it, and it will say what kind of granite is specified. If you want to change any of that, you need to get approval (and probably won't).
This isn't software where you have hand-wavy goals written by people with no training and can refactor when your tests fail :)
If the specification is that precice, the best fit is usually a fixed price contract.
Typically open-book contracts is to account for uncertainty / flexibility / changes without having to raise endless CRs/WOs. Those fixed price contracts can still have gainshare mechanisms to identify joint cost saving.
In theory the regulating agency overseeing the cost plus contract is supposed to scrutinize the expenses of the overseen entity to prevent this. In practice just form a matter of program complexity this is hard to do. When you bring in politics it gets even worse, "You don't want to endanger our pilots by giving them any less than the most gold plated fighter jets, do you?" argue the defense lobbyists.
The worst example I can think of would probably be the nuclear industry where operators providing grid power on cost plus contracts teamed up with environmentalists after Three Mile Island to get laws passed insisting that nuclear power had to be as safe as possible regardless of cost, which turned into essentially a license to print money.
> In theory the regulating agency overseeing the cost plus contract is supposed to scrutinize the expenses of the overseen entity to prevent this
The entire point of getting the private sector is that their insentive should be to do it in the most efficient manner possible, and noone has to manage them - the inefficient ones just die out.
The second-best approach is to have the government manage the whole thing, where they have no real incentive to be efficient.
But what we have here is employing the private sector and incentivising them to be as inefficient as possible, and the government must still hire an army of accountants and experts to keep them in check. it's combines the worst aspects of both!
>The entire point of getting the private sector is that their incentive should be to do it in the most efficient manner possible
It seems like a common misconception that businesses do anything in 'the most efficient manner possible'. A business's incentive is to do things in 'the most profitable manner possible'. It happens that efficient and profitable have a lot of overlap, and business schools love case studies about eliminating inefficiencies, but in the real world it is often easier to boost profit thru marketing/client relations/lobbying than thru searching for possible inefficiencies.
Plus once the contract is signed and you're a few years into the process there's not really any competition to speak of. Sure the govt could scrap the whole thing and go with another competitor, but in some industries there's effectively one option now for a particular thing and for larger projects like jets it's a decades long process to get to start building anything, and there are of course costs and delays associate with that because you have to start the same broken process over again. To top it all off the next contractor doesn't have much of an incentive to do things cheaply either because they're in the same broken system.
For what it's worth, while on any single contract you might get bad behavior from a contractor, their reputation will matter when they go for a recompete or bid on a new contract vehicle.
Not all contracts are automatically won by the lowest-cost bidder. Yes, it allows corruption on the part of the person doing the hiring, but it's better than the alternative.
In California, Tutor Perini seems to be famous for winning government construction contracts despite constant failures and unexpected price increases, because the law does require lowest bidder and doesn't allow ignoring low bids from known liars.
You must be somebody who's never had to remove an underperforming colleague on a public project.
What happens is that they get promoted to another team, or put on a project that has absolutely no future, and everyone knows it.
Why is it difficult to remove people? Because in the old days, newly elected executives would clear out the civil service and hire or contract with people that supported their election campaign.
Underperforming colleague is a different problem - the cost differences we are talking about here are not 50%, they are 5X, those only come from structural problems, not 'this one guy only works 5 hours a day"
They wouldn't have a reason rip themselves off, but the decision-makers may not be well-incentivized to control cost (or might be incentivized to make "safe" choices over "smart" ones).
I have wondered if we could ~endow government agencies in a way that would let them fail, and do the same to spin up ~internal competitors when we feel like turning up competition/innovation.
But it's not something I have gamed out enough steps to feel confident about...
> the private sector is that their insentive should be to do it in the most efficient manner possible
"efficiency" is a very overloaded term, and can also mean "got the most profit from the smallest input", and in that case, yes, they are being efficient, just not in the way the client expected
Yes, the theory of cost-plus contracts is good. It is a way of saying "this is a new piece of technology with ill defined requirements and we need help developing it along the way." Theoretically, it allows for changes and adaptations in developments of technology. This is all in theory though and what proponents of cost-plus would say. It does suffer from some of the issues you have mentioned above. I think there is a time and a place for cost-plus but there is definitely move towards more fixed price contracts in civil and defense.
Becoming somewhat more common now is a hybrid approach of cost-plus/fixed. Contracts for development phases up to a certain milestone are set up as a cost plus contract and then production comes under a fixed price contract.
I wonder if some of the risks of cost-plus could be mitigated by associating it with industry average running costs rather than a per-project basis. So contractors would get a yearly payment with as long as they are making progress on a project, but any changes to the project are 1-to-1 with additional costs so there would be no benefit to either aggressive cost cutting or sandbagging expenses. Maybe also make it so profit would be rewarded at project completion in proportion to the running costs of however long the project took to prevent pointlessly lagging or rushing projects. Of course there would also have to be bullshit like opportunity cost compensation and shit because these companies are so profit-driven as to crash a project meant for the public good if it means more profit from interest on a 0.5% bank account
One of the areas where this seems to have happened is at the NSA, which usually keeps its contracts very secret, but due to William Binney's whistleblowing, it was revealed that the inexpensive solution (ThinThread) was passed over in favor of the expensive solution (TrailBlazer).
Part of the problem here is that the government actors selecting the contracts also want more money flowing through their agency, and they seem to get kickbacks in the form of 'retirement positions' with the very private contractors they're directing contracts to.
This is why it's ridiculous that the US Affordable Care Act (Obamacare) "caps" profit for health insurers as a fraction of premiums collected. It provides a direct incentive for them to increase healthcare costs, absolutely the opposite of what government policy should be doing.
The issue is that without the caps, the insurance companies would be much more motivated to deny lots & lots of claims. Imagine you're a regular person with a middle-class income, you urgently need treatment and the insurance company algorithm says 'denied' because they're simply saying 'no' to x% of claims that week. What are your options? Litigation? Yes insurance companies have regulators, but the sheer scale of denials would start to overwhelm them. At a huge scale, this would degrade the quality of American healthcare even more. It would become normal for legitimate claims to be denied all the time.
Anyways, this was the explicit reasoning of the ACA drafters when they included the profit cap. Maybe they were wrong, but this was thought about & discussed a great deal at the time
To give some color: there were a large number of (small) insurance companies that were paying less than 50% of their revenues in actual medical payments. In those cases most of the costs were in bonuses to the executives. This was a measure to kill of those (which it did). Now we are left with somehow controlling the excesses on the other side.
>It's disincentivizing cost reductions and incentivizing cost increases.
Competetive bids drive costrs down. The alternative to cost plus is? Not having fixed profit margins, in which case there is still incentives to increase costs.
In both cases the limit to costing is competition and the contracting side.
Another way to think of it is cost plus lowers costs by lowering risk. If the company were on the hook for uncertainty (which is the case on ANY project), then they would have to price that into the original proposal, as would their competitors, ensuring more costs to cover the risk.
By lowering risk to companies, it provides another avenue to lower costs. This happens in lots of markets - look at cost margins where there is volatility versus margins where there is predictability.
Cost plus isn't used just at NASA. It's even more evil in other arenas, like electricity in California. Our regulators allow for a fixed profit margin for opex and a higher fixed profit margin for capex. This has the twin effects of running things to failure (and igniting the state) in order to avoid opex and instead claim capex, and also motivating as-high-as-possible costs for everything. No competitive bids are possible.
The same madness happens here in Australia too. Just recently I did an IT project for a local electric utility company and they were blowing $200K on firewalls for a system used by 10 people. Similarly they “upgraded” a perfectly good 10 Gbps fixed line to 200 Gbps for the same group of users. They can utilise maybe 1 Gbps on a busy day.
They also get a fixed profit ratio relative to capex. So they burn giant piles of money to get their percentage from the government…
Electric companies tend to be regulated monopolies, and suffer from the same perverse incentives with models like being allowed a 10% profit. The more they spend replacing poles and building new pole lines, the bigger the profit the regulations allow.
This only works if the bids represent the same work, at the same quality, on the same delivery schedule, with the same feedback pathways and the same risk mitigations.
In other words, it is the “spherical cow” of contracting.
>This only works if the bids represent the same work, at the same quality, on the same delivery schedule, with the same feedback pathways and the same risk mitigations.
Why would this possibly be true? Two groups can bid on the same project with different tradeoffs. Projects are complex, and there are zillions of tradeoffs to make a competitive bid. The group offering the project then evaluates the bids, often with multiple rounds of feedback.
And generally then these projects initially got to several competitors, with fewer getting follow-on work, causing them all to try really hard to deliver good work.
Future projects are always worth more than current projects, so only an idiot does bad or over-cost work often. Such groups eventually don't get more work.
I've worked on such bids for decades. Multiple groups bid, with a statement of work. The other side evaluates the bids. Cost plus simply allows groups, when bidding to not have to use larger multipliers to mitigate risk, since some of the risk goes to the offeror.
If you were running a company, and you had two ways to bid a contract, firm fixed price vs cost plus, which do you think provides less risk to you?
And how does a company account for risk?
Higher prices, end of story. This is simple economics.
It's why less risk results in smaller margins throughout pretty much all industries. It allows stable planning.
Higher prices, end of story. This is simple economics."
The job of the company is to manage risk of the project they are delivering, and let the ones that do it well win. What the hell is the point of private sector if the taxpayer pics up the tab every time something goes wrong?
I don't know what bids you dealt with, the ones I did looked nothing klike what you describe. For any non-mundane work, that's not like, paving a street, you low-ball the bid, deliver the bare minimum the paperwork allows and then keep milking the government for improvements because what you've delivered is not good enough.
If the bid is about new technology, the tradeoffs cannot be understood by non-experts, and are difficult to pinpoint even for experts. The expertiese required to access how good is the bid is the same as the expertiese needed to design the system -> if you have that expertiese on hand, you would not need to outsource the design.
The process is insanely time intensive, expensive, and difficult to navigate. Not because government is inefficient, but because taht's the nature of new technology.
> Future projects are always worth more than current projects, so only an idiot does bad or over-cost work often. Such groups eventually don't get more work.
In UK Capita get work again and again despite fucking it up all the time
Contracts where the contracting party agrees to a % of responsibility. When the project runs over the profit is reduced by the overrun * the percent responsibility.
Lets say the agreement has 25 million in profit and 40% responsibility. If the project runs over by $2m, the contractor eats $2m * .4 = $800k reduction in profit so now it's $24.2m.
Then they're actually incentivized to not have overruns.
>Contracts where the contracting party agrees to a % of responsibility.
Except no big agency does this because it's a legal nightmare. The others (cost plus and firm fixed) are well explored.
>Then they're actually incentivized to not have overruns.
Everyone has incentives not to overrun - it means you're less likely to get future work, and future work is worth much more than overrunning current work.
>Except no big agency does this because it's a legal nightmare.
agencies are starting to do it more and more often. It won't get explored if people are scared, but it will get explored if people actually want to fix the problems with procurement overruns.
>Everyone has incentives not to overrun
in cost plus your overrun often directly leads to you making more money. So no, not exactly.
>it means you're less likely to get future work, and future work is worth much more than overrunning current work.
Maybe, maybe not. Lots of things have few competitive bidders, or bidders who bid knowing they're going to make overruns and claims to make the contract profitable when their bid never was. it's often called 'buying the job' in other industries.
In R&D, incentivizing a private enterprise to spend more could be beneficial. Assuming the client (NASA) has some oversight this leads to more engineering freedom and an exploration of a larger design space, whereas fixed cost would incentivize racing towards the best solution as fast as possible.
Depending on program goals, both approaches have their place. However for projects like Artemis which tried to minimize R&D cost and save time through component re-use, the latter approach would clearly be better.
Are they though? If a casual layman internet reader can see the problem and see that they always get taken advantage of for profit, couldn't also the NASA officials and contractors signing these contracts? They know exactly what they are doing.
SpaceX signed non-cost plus contracts and delivered far more quickly and cheaply than the rest.
The problem is Congress tells NASA do this with this money this way. NASA has little flexibility. Recently with the CLPS program NASA flexed it’s muscle and it’s paying off so far.
You're leaving out a significant factor in cost-plus contracts in their favour: the buyer pays the actual cost, not the cost-plus-contingency that's built into fixed price contracts. It may not work out that way for the reasons you mention, but the problem of baking in risk costs to fixed priced bids returns. And in observing "how does the contractor increase profits", another issue with fixed price bids is that it encourages corner-cutting internally: anywhere the contractor can save money, it goes into their pocket, which can mean a lot of tissue-thin requirements fulfillment that goes wrong later.
This has been my experience as well through contracts with the government.
To further this, there is also no incentive and funds to modernize an already existing product. If it was written in Java 6 using J2EE, it’s going to continue to be that until it dies.
Folks I worked with also didn’t care to up skill or learn new ways of doing things because the incentive wasn’t there. Their cost was fixed, their price was fixed, their profit was fixed. They will do the bare minimum to satisfy the contract.
There are Fixed Price Incentive (FPI) contracts that try to address this. Instead of a single price for the contract as in an Firm Fixed Price (FFP) there is a "target" price at which the contractor will get some level of profit. Above that you set a cap on the total cost of a project that you are willing to pay, but the profit of the company goes down as you approach the cost cap. So contractors still have the incentive to minimize cost because if they get cost below the "target" price the contractor still gets that as profit.
However, people aren't usually a fan of them because it requires all of the overhead/audits of a cost-plus contract which typically minimizes how cost effective they can actually be at getting below the target price.
There are also some development-type projects where the government will fund a project, but still require some amount of funds (like 25%) to come from the contractor. But this is really early development type stuff. Basically it is a way to influence where a company is spending their R&D money. Its not really for any operational systems.
Ditch cost plus contracts and use taxes to curb companies that are just profiting off rent-seeking behavior (like sitting on patents). This was done during WWII, marginal tax rates were set to 100% to discourage war profiteering. Companies would still have an incentive to cut costs, to increase profits. But they'd then be incentivized to reinvest those profits because otherwise those profits would be greatly taxed. Granted, how you'd effectively target these taxes outside of unusual circumstances like a world war might be too complicated to be feasible.
This is also the source of the weird health insurance is provided by companies came from.
Paying for peoples medical care became an alternative way to compensate people more to avoid absurd taxes. Medical care used to be a lot cheaper so it wasn’t a big expense.
R&D is about managing risk. You can have more micro-managers to ensure that costs are minimized, but the cost of all that management can be more than the abuse of cost-plus (not to mention people hate being micro-manged)
The only good answer I've heard is for the agency to have enough technical experts that they can spot bad things. However that means the government needs to develop technical experts.
> The only good answer I've heard is for the agency to have enough technical experts that they can spot bad things. However that means the government needs to develop technical experts.
It's probably beneficial for the contracted company to have technically inclined individuals in leadership too, ranging all the way from the lowest levels up through CEO. Engineering-minded management is much more likely to spot potential troublemakers and risks for runaway costs in the planning phases where someone with a background in management or finance is more likely to fudge things and say "yes we can do this at X unrealistic low cost" just to win a bid. They're also less likely to make bad calls on how to fix budget problems that crop up midway through the contract.
> There must be some way to structure contracts to allow for cost of developing new technologies
Make companies evaluate and eat the risk by allowing them to set the fixed price...
> yet incentivizes minimizing that cost.
... where they are bidding on the contract against other companies.
This only works if you have a market with multiple players, which is possibly the main reason NASA is more heavily leaning towards fixed-price contracts now.
minimizing total cost yes, but bidding wars on contract by contract leads to bad outcomes because the incentive is against doing the what is needed until its too late
its better to have trusted suppliers and relationships that lead to long term waste (cost) reductions and quality output (you know your client and your client knows you)
This is also where free markets shine. If someone is making absurd profits building in-efficient widgets. It won’t be that long before other people get the idea to make that same widget for less or better quality or both.
But first company will then go out of business or become efficient.
Survival of the fittest evolution style for business.
This assumes that there are no intellectual property encumberances held by the old company, and that the barrier to entry isn't terribly high. And no one with a budget and a deadline is going to wait for one company to go out of business so they can get it cheaper.
The first company has first movers advantage which lets them signs exclusive deals and builds a regulatory moat plus gains brand awareness.
The new company may be cheaper or have better quality but that isn't an automatic win. The second company needs more money or an event to superseed the first story.
I disagree. Cost-Plus might not be the right model, but fixed price only works if all the risks are known and so easy to account for.
Plenty of builders can make you a house on a fixed-cost. I used to know one, and every spec house he built was within $1000 of his initial price because he could look at prints and know in an hour how much the lumber, labor, plumbing, electric, cabinets... would cost. He could figure this out even if it was the first time building that print. (spec house was important - if it was custom the owners were use to add $30,000 in upgrades)
SpaceX can quote you a fixed price launch of crew dragon to ISS. However if you want to build a new ship - there are too many unknowns. I'm sure if NASA was content to stick with the opportunity rover design they could have thousands on the surface of mars by now for the budget that has gone into the various programs we have done since then - but we learn a lot more from the new programs that opportunity can't give (perhaps we would know more about mars?).
Most of the things NASA does are things where the risk is far too high for anyone sane to take on all the risk in a fixed price contract. Instead NASA needs to take on the risk in some way. Either that means some form of contract like cost-plus, or a lot of smaller contracts such that everyone can succeed at their contracts while the project itself is a failure (I'll make module X exactly to specs, too bad if you mess up the specs). All forms of such contracts are subject to abuse, NASA needs to figure out how to manage that abuse.
The counter-problem is that a cost-plus contract works the opposite way - you are incentivised to account for none of the risks in your initial bid to make your quote competitive, and the sales strategy is to 'land and expand' (i.e. get the initial contract and then expand it's value - sales teams will openly talk about land and expand behind closed doors).
In practice this means that the quotes you get back are much harder to assess from a commercial perspective, as you are trying to weed out which companies are underquoting.
Also cost plus contracts almost always end up being cost 'plus plus' if you dig enough under the covers in my experiences in procurement/contract management (there are always hidden fees and profit lines, and too many opportunities for conflicts of interest or to charge more to the open book), so even a low % can just mean more 'hidden' profits. You could write a book on all the ways to extract additional profit from an open book contract.
IMO the best model isn't an either/or approach, it's a mix of models where the right model is used at the right time (including open book, fixed price, rate cards, hybrid contracts e.t.c.) where the contracts are adequately sized & scoped (i.e. several small fixed price contracts with set deliverables which have value on their own rather than one huge contract with one massive deliverable at the end).
SpaceX did bid fixed-price for HLS, the moon lander they're working on. That project will required developing refueling from an on-orbit propellant depot to succeed.
The thing with SLS is it was supposed to be low-risk, based on Space Shuttle heritage - it doesn't do much that's new. Despite that, it's on a cost plus contract that's ballooned.
Not just heritage, the SLS is basically what you get if you move the Space Shuttle engines onto the propellant tank and remove the orbiter vehicle. Then discard the reusability requirement and you've got SLS.
In the process of this, everything is being modernized. This is where all the cost comes from.
Only if you can do that. Most of the large projects the government does nobody else wants. There is no market for aircraft carriers other than the US government (even if there were not export laws), likewise most space exploration, nobody other than NASA is going to buy your mars rover.
Building roads and private parking lots have enough in common that I might risk some of my own money on a better way [do something with them] them because once I develop it I can recoup any losses selling to private parking lots. Most things the government does they have a monopoly on though, and thus once a contract is done there is no possibility to recoup any losses.
This 100% and it is not just super risky things like "exploring space".
If you have ever PIed on a government contract you will know that the program manager will almost certainly deviate from what is in the contract. They will call unbudgeted out of town meetings, ask for unbudgeted reporting, demand unbudgeted changes to the deliverables.
As a contractor working with the government, "cost plus" is the only sane option. The program manager is not going to have the bandwidth to renegotiate (and bid out?) in the almost certain event of a change in scope.
The alternative to "cost plus" is defensive billing where the contractor attempts to devine and account for extra non-contracted work. That lead us in the past to $1000 hammers and no-one liked that either.
NASA doesn't need to be in the business of managing that risk and the abuse that comes with it. NASA can pay a fixed cost equal to the expected cost of the project, and the contractor can buy insurance if they want insurance against cost overruns.
Insurance companies are in a much better place to price this insurance than NASA, because they have the correct financial incentive to do so well, and no political incentives to do so poorly.
You don't get to change the deliverables of cost plus contracts without re-negotiation either. That's not the risk that is being avoided here, the risk is that the company is going to decide to ask for more money for the same service they initially promised.
For example with Boeing's recent starliner tests, they would be asking for more money to fly the orbital flight test that they initially promised, because they fucked it up the first time.
You can negotiate insurance for just about anything (there are sometimes laws against things like taking out life insurance policies against a third party, but none that would apply here). No doubt the insurance company would insist on various forms of audits, similar to what the government insists of for cost plus contracts today. Probably the most successful contractors wouldn't pay an insurance company for this, because it's a stupid model for contracts that wastes resources, but it wastes no more resources than having the government play the role of the insurance company.
I think you need to articulate why you think the govt. is forced into this insurer role. They are no different to any large private buyer.
Any insurance would be expensive, and would be a cost passed to the government, as any other project related costs are. The insurance provider spreads risks across policies but since all these policies would probably be for government contracts, the costs would all be passed on to government. The government would end up paying for all the policies plus the insurance company profit margin.
The only winner here is the insurance company, maybe the contractors. The government will be slightly worse off.
> I think you need to articulate why you think the govt. is forced into this insurer role. They are no different to any large private buyer.
An insurance provider is a party taking financial risk if something goes bad for someone else. In the cost plus contracting model, the government is taking the financial risk if the project goes poorly for the contractor, that is the government is providing insurance.
> The insurance provider spreads risks across policies but since all these policies would probably be for government contracts, the costs would all be passed on to government.
Of course, there is no free money here. However the government can correctly evaluate the costs of the different proposals under a fixed cost contract model, whereas they are not capable of correctly evaluating the cost of the insurance that they add on top in a cost plus model, because they aren't set up to correctly price the insurance they are selling. This means that in the fixed price model, they can get a much better approximation of the cost in the value/cost equation they are trying to maximize when evaluating bids, and it means that contractors are motivated to provide options that maximize the same, instead of being motivated to provide options that maximize the difference between how the government miss-prices the insurance, and the actual value of the insurance. In the end everyone ends up better off, because there is less waste.
They don't have to, but someone will be the insurance provider and the government will pay for it. The government by playing insurance has better options to cut a project if things are getting to expensive, but this requires some willingness to cut project scope which they might not be willing for (and a contract that allows such a thing).
I should probably have been clearer. I understand you can insure all kinds of risks, and that you can ask an underwriter to insure against most anything. My question is more whether this is a well-formed insurance market where coverage is available under economically realistic terms.
I can't say that I'm aware of an active market for insurance similar to this, not that I would necessarily be aware of one.
If one doesn't exist, that should just be a sign that the government really shouldn't be providing it either though, because it isn't profitable. The government isn't somehow better placed to insure R&D work (or whatever you want to call the work being discussed) than any other insurance company is.
The government is better able to set a fixed budget though. R&D as in do X hours of work on FTL is much better than deliver FTL (I intentionally picked something impossible - though in a the world R&D should be about things you think are possible but are not sure of)
What you're describing isn't a cost plus contract, it's a fixed cost contract for a study (assuming cost/hour is fixed). These exist, they're frequently a good idea.
Cost plus would be "deliver a FTL ship, we'll pay you X * costs, no it doesn't really matter if you go 10x over what you initially quoted us for the work and still don't have the thing". You can see why contractors under that model are willing to make unrealistic quotes and promises about FTL, or for a real world example why SLS is many years and many billions of dollars behind schedule.
You can get insurance on anything you want. However the more unknowns there are, the more they will charge. You can get fire insurance that will cover even if you burn your house down - but it will cost you (not having insurance and burning your house down might cost $.01 more than buying insurance)
But isn't accounting for risks and having contingencies to minimize their impact part of good engineering practice? Eg. when designing a new rocket, you know that the engines might have issues causing delays, you can't predict exactly what issues but you can estimate how much extra money and time you could lose there.
For instance, as part of their filing for the HLS competition, SpaceX supposedly had around ~400 pages just discussing cryogenic propellant storage and transfer, along with the associated risks and how they would mitigate them.
It's also a bit of a stretch to say NASA isn't taking on risk in fixed price, as they're still paying large sums of money for each agreed upon milestone. The point is that the risk needs to be shared. Cost+ takes away pretty much all of the risk for the company, taking away their incentive to do their best (especially considering that until SpaceX came around and blew the doors open for smaller companies, there were only a handful of competitors who were all basically the same culture wise).
What we could learn from that is a lot less than what we learned from all the other things we have done instead. Eventually you have seen that type of rock before and so all you know is there is a lot of it - which we already have reason to suspect.
I run a consulting company. Working with startups, cost-plus model is the only way to go. It is maddening when customer does not know exactly what they want to do because they figuring things as they go, often "pivioting", but yet asks you to provide a fixed cost estimate for the work and sign contract which often includes penalties or payment on deliveiry. Usually my answer is: I will be glad to give you fixed cost quote if you can provide me with detailed spec of whay you want me to do. But this is exactly what you will get. If you want to have a freedom of changing things on the fly, it must be cost-plus.
Fixed price has cost NASA dearly in the past, because NASA often changes things after making a purchase decision. The 'change orders' are often where contractors make their real money.
Contractors may lose out on the initial fixed-price contract, but they'll make it up on change requests - for any kind of realistic scale, the customer never knows exactly what they want, there are always changes, and by that point it's largely unrealistic to shop those contracts elsewhere.
Not in this case as commercial crew has two providers. So if Boeing doesn’t do the work, they just won’t be paid, and SpaceX will get more flights (and this is exactly what has happened). If this keeps going indefinitely, NASA will on-board a new partner besides Boeing, such as SNC’s Dream Chaser (other potential options include Blue Origin, who eventually want to build an orbital crew vehicle, and even technically Lockheed Martin who own the plans to Orion and are allowed to bid it commercially).
I suppose it depends on the nature of the contract; for launch services I guess that makes sense; but for a development project, it's different - if you give Lockheed Martin the contract to build the Mars Ascent Vehicle, you're probably going to need to revise the requirements through the lifetime of the project, and it's not very credible to say "OK, Boeing's taking over from here" for the change requests.
Funny you say that because NASA is taking a very similar approach to the HLS lander for Artemis. They did start with just one provider (as Starship is the only one they could afford) but they’re trying to include a second lander provider ASAP, partly by the insistence of Congress (who doesn’t like that their typical defense contractor donors didn’t get picked for the first HLS lander).
Over a billion dollars saved for the taxpayer, and a priceless learning opportunity for Boeing (if they choose to take it). A great deal, a real win-win.
If one contrasts the bang for the buck between the 'usual NASA suspects' and the performance of SpaceX, there is a lesson there.
In addition, the NASA Mil-SPEC process is rooted in a far past era that insisted on x-rays of every resistor and part for making sure nothing ever failed. This is the old For want of a nail... https://en.wikipedia.org/wiki/For_Want_of_a_Nail
Modern parts manufacture now makes parts with 7 or higher 9's of reliability.
6 nines = 1 in a million fails, so a spacecraft with a million resistors is a 50:50 effort and so on.
This hunt for more 9's has led Nasa down a cost rabbit hole, exacerbated by these fees+ contracts.
Of course, there are also overlays of accounting and admin verification that can add 25-50% to a project, esp small runs.
On the other hand, we see mention of 60% of Russian weapons fail in various ways in Ukraine - training, bad parts, ruble theft.
I have read stories that maintenance crews in Russian warehouses have sold as many as 50% of the diesel engines as well as gold plated circuit boards and edge connectors have been sold by employees for scrap - as well as ruble diversions for $600,000,000 Italian yachts - I think the SpaceX method is the best.
Companies receiving these contracts (either fixed-price or cost-plus) will be incentivized to maximize profit and the expense of the shareholder. I don't think it's possible to remove this incentive. Instead, the government should be more careful with whom receives the contracts. For instance, SpaceX seems dedicated to doing a good job and driving costs down. Therefore, right now, SpaceX should receive more contracts. SpaceX's focus may change in the future, and it's the government's responsibility to pay attention to those changes and change contractors if SpaceX starts leeching off of government funds. Adequate competition for contracts will align incentives more than the structure of any particular contract. Everyone here saying that Lockheed turns a 10B problem into 20B of work due to cost-plus might be correct. But why can't the government find someone to do the work for 10B? With proper competition, incentives will align.
For those of us who embrace agile methodologies... there is always benefit to cost plus contracts.
Clients never have all the requirements up-front, and even if they did requirements tend to shift as we plan, design, build, test...
It's also nice to not have to go through a lengthy contract negotiation for change orders.
Look, I hear the "lack of incentive" argument, but I think it's less about trying to over-bill clients, and more about trying to adapt to ever-changing needs of clients. Not sure "plague" is the right term.
What happens when a fixed-price project hits a delay? Presumably the bidder eats the loss at first but what happens when they run out of appetite? Does the project just... end?
Here's how simple me thinks about it: Cost-plus is just a lazy version of fixed price, where instead of accountants looking at details before new funding is released, there's automatic approval of overruns.
Theoretically the bidder eats the loss and assumes all of the risk in a fixed-price contract. Ending projects certainly is a possibility, but there are typically termination penalties within the contracts as well.
If there is an unanticipated issue contractors will often try and get a contract modification because they consider it new scope of work or something like that.
Yes, the project just ends and it will end sooner than expected under fixed bidding as the government will almost certainly demand non-contracted changes mid-project that in my experience can have dramatic costs.
Most government projects are structured and paid for in phases and there is no assurance that phase 2 starts at the end of phase 1. No approval to proceed means the project just "ends when it ends".
Yes, this definitely happens and is why in some situations people think fixed price contracts can end up costing more.
Contractors will be extreme sticklers about their requirements on a project. So that if anything starts look off-plan or may impact something like a schedule delay they will say "nope, that's outside of our scope of work we need an extension/additional funding".
Contractors will be extreme sticklers about their requirements on a project. So that if anything starts look off-plan or may impact something like a schedule delay they will say "nope, that's outside of our scope of work we need an extension/additional funding".
Yup, change orders are how deal with these issues when it comes to fixed-costs contacts. For better or worse, its almost impossible for a project to be perfectly specced out ahead of time. And anything that even comes close to looking like it conflicts with the spec becomes a change order.
According to the article, this is how money is made on cost-plus contracts
> About that “plague”: NASA has traditionally procured technology from industry using cost-plus contracts, which allow contractors to charge the agency extra for extensions and changes to their plans.
From my experience, the author of that article has no idea what they are talking about.
> What happens when a fixed-price project hits a delay?
It varies. Sometimes the cost of imposing a penalty specified by the contract would be so destructive to the project, and the project delayed but finished would still be worth more than switching vendors (if that's what the penalty would imply, due to bankrupting the original vendor) that the penalty gets waived.
Besides, what happens when a cost-plus project hits a delay? Answer: we pay more and more and more and the project is delayed more and more and more.
> Presumably the bidder eats the loss at first but what happens when they run out of appetite? Does the project just... end?
That's why these contracts go to large companies, as opposed to small ones.
If a small company loses interest in finishing a fixed-cost project, they might go bankrupt, and leave the government up crap creek without a paddle.
If a big company loses interest, they'll keep struggling along, because they can get hit with the stick of 'you'll never get another contract from us ever again.'
> If a big company loses interest, they'll keep struggling along, because they can get hit with the stick of 'you'll never get another contract from us ever again.'
It is an extreme and rare measure for an agency to ban a large contractor for lack of performance and in the rare cases it has happened to large contractors have almost always had the ban lifted upon appeal to the GSA. In most cases where there has been a failure to deliver substantial or primary responsibility can be laid at the feet of the government agency.
Fixed price contracts may cost the government a lot of time and money but they might still be good insurance against political risk. In WWI many companies that won armament fixed price contracts were able to make large profits, partially leading to a backlash in the interwar years over the idea that the US had been led into WWI by corporate interests leading to US isolationism before WWII. By using mostly cost plus contracts in WWII FDR was able to diffuse the political issue.
I sort of worry that even if SpaceX is able to provide launch services for NASA at a far lower rate than other companies, and that even if their absolute profit s are lower than their competitors they'll still have profit margins so high that it'll lead to backlash given the weak competition.
Fixed-price contract prices need to be set so the vendor can make a reasonable profit using current technology and labor costs, and if they develop new technology and methods that let them greatly increase that profit, well, that's great great news, and if the public doesn't like it, the public should be explained the benefit (lower prices on future contracts, new technology, etc.).
While working on a cost plus contract in the early 2010s i cant begin to describe the amount of cool shit i bought with a one line explanation as to its purpose.
Probably isn't as cool if the taxpayer is pick up the bill mind....
Fixed price allows less flexibility if "gotchas" are found during development, which they almost always are.
But you can get to a middle ground: A large project where I work did fixed price but built in $X hours of additional work to the price, to be used on a discretionary basis when unexpected issues arise. More flexible than pure fixed-price and not as open-ended as costs plus.
Still not perfect: the vendor has every incentive to utilize every last $X hour in the pool, but strong oversight kept the worst of that in check.
Let's say you're Lockheed and you have a 10B budget for X but you have a contract that lets you go over. What's to stop you from immediately placing 9B of that in rich pockets and trying to build the damn thing for 1B. After all there's no incentive to actually deliver for the 10B so asking for another 5B - bringing the total actual effort to 2B (see what I did there).
> What's to stop you from immediately placing 9B of that in rich pockets
The government accounting that goes along with the contract. They can waste money or do a bad job, but they can't just say they spent the money on executive bonuses.
Cost+ has also been a bane for many regulated utilities: If you have a fixed profit margin the only way to increase profit is by increasing costs-- even if the new costs are wasteful you'll make more profit.
But in practice, this means that in order to increase profit companies have to increase costs. If you're building a product and you can spend $10 million to build it efficiently or $20 million to build it inefficiently, it's actually beneficial to do the latter. It's disincentivizing cost reductions and incentivizing cost increases.