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TITLE VIII--ACQUISITION POLICY, ACQUISITION MANAGEMENT, AND RELATED MATTERS

Subtitle B—Acquisition Policy and Management

JWNDAA Section

House Conference Report 109-702

(1) a fixed-price type contract (including a fixed price incentive contract); or

(2) a cost type contract.

(d) Conditions With Respect to Authorization of Cost Type Contract- As modified under subsection (b), the regulations shall provide that the Milestone Decision Authority may authorize the use of a cost type contract under subsection (c) for a development program only upon a written determination that--

(1) the program is so complex and technically challenging that it would not be practicable to reduce program risk to a level that would permit the use of a fixed-price type contract; and

(2) the complexity and technical challenge of the program is not the result of a failure to meet the requirements established in section 2366a of title 10, United States Code.

(e) Justification for Selection of Contract Type- As modified under subsection (b), the regulations shall require the Milestone Decision Authority to document the basis for the contract type selected for a program. The documentation shall include an explanation of the level of program risk for the program and, if the Milestone Decision Authority determines that the level of program risk is high, the steps that have been taken to reduce program risk and reasons for proceeding with Milestone B approval despite the high level of program risk.

The Senate amendment contained a provision (sec. 807) that would require the Secretary of Defense to modify Department of Defense regulations regarding a preference for the use of fixed-price contracts in development programs.

The House bill contained no similar provision.

The House recedes with an amendment that would require the Secretary to modify Department regulations regarding the determination of contract type in development programs. The conferees believe that the Department requires additional tools to address the continuing problem of cost and schedule growth in the Department’s major acquisition programs. Congress enacted section 807 of the National Defense Authorization Act for Fiscal Year 1989 (Public Law 100–456) to prohibit the use of fixed-price development contracts because of the Department’s aggressive use of fixed-price contracts, regardless of the level of program risk associated with the program, resulted in cost and schedule overruns. The conferees believe that program risk should be reduced to the degree that the use of a fixed-price development contract for a major acquisition program may be appropriate. The conferees agree to repeal section 807 and would require the Secretary to modify Department regulations to require the Milestone Decision Authority for a major defense acquisition program to document the basis for the contract type selected at Milestone B approval (or Key Decision Point B approval in the case of a space program) that is consistent with the level of program risk for the program.

Senate Armed Services Committee Report 109-254

The committee recommends a provision that would require the Secretary of Defense to modify Department of Defense regulations regarding the use of fixed-price contracts in development programs. The provision would permit contracts other than fixed-price contracts, only if the Secretary determines that the program is so complex and technologically challenging that it would not be practical to reduce program risk to the level that would permit the use of a fixed-price contract. The provision would also repeal section 807 of the National Defense Authorization Act for Fiscal Year 1989 (Public Law 100-456), which prohibited the use of fixed-price development contracts.

Twenty years ago, the Department experimented with the aggressive use of fixed-price development contracts, and learned that the use of such contracts is not practicable in development programs with a high degree of technical risk. In response, Congress enacted section 807, which prohibits the use of fixed-price type development contracts unless a waiver is granted by the Secretary of Defense. In testimony before the Committee on Armed Services of the House of Representatives on March 29, 2006, Mr. Terry R. Little, Acquisition Advisor to the Director, Missile Defense Agency, stated:

In particular, the Department applied fixed-price contracts to very high-risk development programs and, typically, the program selected the low bidder as the winning contractor. These two factors together produced contracts with very unrealistically low prices and predictable bad results as the work unfolded.

Unfortunately, the prohibition on the use of fixed-price development contracts appears to have contributed to widespread cost and schedule growth on major defense acquisition programs. Mr. Little further explained:

The certain prospect of a cost reimbursable contract encourages contractors and acquirers to undertake developments that are excessively high risk. A new development that relies on essential technologies that are immature, manufacturing processes that not yet proven, or beyond the state-of-the-art breakthroughs is surely going to be disappointing. It's going to cost more, take longer, and deliver less than anyone expected when it started. I argue that most everything the Department needs to develop today can proceed in low-risk stages with each stage providing an increment of capability. The expectation for that capability should be consistent with what we know we can provide at low-risk and in a short, predictable development time. Therefore, each increment should also be compatible with a fixed price contract; if it's truly not, then the risk is probably too high to start.

The committee and the Department have consistently recognized the importance of reducing program risk by avoiding the incorporation of immature technologies and unproven manufacturing processes into major defense acquisition programs. Over the past several months, a series of major studies have reaffirmed the need for reducing program risk, including a July 2005 report by the Center for Strategic and International Studies, a January 2006 report of the Defense Acquisition Program Assessment, a February 2006 report by the Defense Science Board, and the 2006 Quadrennial Defense Review. One of the common themes that ran through all these reports was the need for program stability and reduced program risk.

In a March 2006 report, entitled `Improved Business Case Is Needed for Future Combat System's Successful Outcome,' the Government Accountability Office (GAO) highlighted the use of technology readiness levels (TRL) as:

a valuable decision-making tool because they can presage the likely consequences of incorporating a technology at a given level of maturity into a product development. The maturity level of a technology can range from paper studies (level 1), to prototypes that can be tested in a realistic environment (level 7), to an actual system that has proven itself in mission operations (level 9).

The GAO noted that `best practices of leading commercial firms and successful DOD programs have shown that critical technologies should be mature to at least a TRL 7 before the start of product development.'

According to Department acquisition policy, a technology should have been demonstrated in a relevant environment (TRL 6) or, preferably, in an operational environment (TRL 7) to be considered mature enough to use for product development in systems integration. DOD Instruction 5000.2 states that at the time of entry into the System Demonstration phase of a program:

The management and mitigation of technology risk, which allows less costly and less time-consuming systems development, is a crucial part of overall program management and is especially relevant to meeting cost and schedule goals. * * * If technology is not mature, the DOD component shall use alternative technology that is mature and that can meet the user's needs.

The committee believes that fixed-price contracts are preferable, if the Department has a firm grasp of the requirements and the technology to meet these requirements. A prudent application of technology readiness levels should enable the Department to lower risk and develop a better understanding of program costs. At the same time, the committee recognizes that this contract type will not be appropriate for all situations. Therefore, the provision would authorize the Secretary to make a determination on the use of different types of contracts in appropriate to the circumstances.

For production programs, as for development programs, the contract type selected should reflect the level of risk in the program. A major defense acquisition program that meets the criteria in DOD Instruction 5000.2 for production programs should be a relatively low-risk program for both the Department and the contractor. Absent unusual circumstances, the contract type selected should reflect that level of risk.

Finally, the committee notes that the reduction of manufacturing risks may be measured, consistent with the recommendations of the Defense Science Board and in accordance with industry standards, through the use of Manufacturing Readiness Levels (MRL's). Similarly, the system interoperability may be measured through Interoperability Readiness Levels (IRL's). The committee directs the Department to report to the congressional defense committees by no later than March 1, 2007, on the feasibility of incorporating MRL's and IRL's into DOD Instruction 5000.2 as explicit criteria for milestone decisions.