The budget crunch, fixed price contracts, and lessons of the past.

• Author: Chierichella, John
• Position: Viewpoint

There are two general types of government contracts: fixed price and cost reimbursable. The key difference between them is their allocation of cost risk. Under a fixed-price contract, costs over the fixed price are borne as "red ink" by the contractor. However, because cost contract are used when the work cannot be predicted with sufficient confidence to support a fixed price--typically involving complex, sophisticated, emerging systems--the contractor stops work when the funds are exhausted. The government can always decide to fund the cost growth, but in that event the contractor receives no added profit for the unanticipated costs it incurs.

Cost reimbursable contracts are a favorite target of politicians, who lament shameless cost overruns and declare that it is time to do away with cost-plus contracts. And that is precisely what the Obama administration has tried to do, with a presidential memorandum, an Office of Management and Budget memorandum, and revised procurement regulations uniformly criticizing cost-based contracting as high risk, wasteful and inefficient.

As a result, fixed-price contracting now is the strongly preferred approach, and administrative bathers have been erected to deter contracting professionals from using cost-based contracts. The shift is an easy sell in the public's eye. Contractors make convenient scapegoats, and fixed prices sound like an easy way to help alleviate the budget crisis.

The government tries to defend its policy shift on the ground that cost-based contracting is unnecessary when a federal agency is sure of what it wants. And therein lies the rub, because the government rarely knows what it wants with sufficient specificity to support reasonable fixed prices for evolving, complex or sophisticated products to be delivered years later.

Ask anyone who actually understands the process what can go wrong when agencies forget that fixed-price contracts are ill-suited to...