Over the past few years, military readiness has been a headline concern of U.S. defense policy. While not all military leaders agree on the severity of the readiness issue, Secretary of Defense Jim Mattis has made it clear he believes this is a major problem. Readiness must be a priority to ensure U.S. superiority in an increasingly competitive global security environment.
The current Department of Defense budget stands at $611 billion, more than China, Russia, Saudi Arabia, India, France, the U.K. and Japan combined. And the proposed 2019 budget of $686 billion will likely only widen this lead.
This comparison of defense budgets suggest that the readiness issue facing the U.S. military goes beyond simple resource availability to how to utilize the available resources most effectively for fleet sustainment. Contracting with performance-based logistics, or PBL, is a strategy derived from private sector fleet-management approaches with a track record of increasing readiness at equal or reduced cost to the government customer.
Yet, despite years of encouragement from top levels, the use of PBL in U.S. defense acquisition and sustainment contracting is relatively uncommon and appears to be declining.
PBL (also known as performance-based contracting or contracting for readiness) is a contracting approach that reconsiders the traditional “pay for parts and services” (transactional) model and instead bases the contract primarily on expected performance outcomes. For example, PBL could be used to design a fixed-price contract stipulating that 80 percent of an acquired fleet is always available for use. This example gives the vendor greater opportunity for profit by finding ways to reduce the need for maintenance work, but also means there is greater risk if the platform is not performing. A careful calculation of benefits and risks is required in contract negotiation to ensure the goals of the vendor and the DoD are aligned.
To understand how PBL can help achieve DoD goals and why usage may have stalled, it is critical to understand incentives. The Defense-Industrial Initiatives Group at the Center for Strategic and International Studies recently released a report sponsored by the Naval Postgraduate School, “Use of Incentives in Performance-Based Logistics,” that details the opportunities and barriers to using PBL as a contract mechanism. DIIG’s research examines how the U.S. and its allies, namely the U.K. and Australia, utilize different incentive strategies within PBL, offering insight on how the U.S. can learn from our allies to support a more efficient defense acquisition and sustainment strategy.
Within the DoD, financial incentives are the most common tool used in PBL. The DoD’s PBL contracts tie payments to factors such as meeting the military customer’s needs, the scope of work performed by the vendor and the number of performance measures available. Rewards and penalties are established according to predefined performance criterion specified in the contract.
Not all financial incentives work alike, however. Penalties for low performance turn out to be more effective than rewards for overperformance. Somewhat surprisingly — although PBL contracts are typically fixed-price — the DoD’s PBL approach sometimes uses cost-plus contracting or the middle ground of incentive fees, which share vendor profit or loss with the government when expenses significantly exceed or come in under expectations. While less popular with some commercially oriented vendors and suppliers, this approach offers a solution to some of the challenges of uncertainty and relationship building when starting a PBL, particularly for young systems where actual cost data is unavailable and there are kinks not yet worked out.
While the U.S. heavily focuses on financial incentives, the greater opportunity for the DoD may be in time-based incentives, which refer to the initial maximum contract length and the mechanisms for extension. This strategy is beneficial because it reduces uncertainty, giving the contractor the long-term security needed to invest in the mechanisms that can increase efficiency or improve performance and reliability. This contractor innovation should also benefit the government customer over time.
Unfortunately, U.S. regulation and practice limit the use of time-based incentives, and the duration of DoD PBL contracts appears to have fallen in recent years, reducing contractors’ incentive to deliver improved performance. U.S. allies, however, have embraced time-based incentives in various ways. For example, the U.K. has several long-term through-life sustainment contracts (like a 34-year contract with Boeing for its Chinook helicopter fleet), while Australia uses rolling contracts to offer consistent and well-regulated extensions that give the contractor security while allowing the government to maintain more control.
U.S. law and regulation, combined with the military services’ concerns about maintaining in-house capacity, preclude the United States from fully emulating Britain’s or Australia’s approach to PBL. The present stall in American PBL contracting has many likely sources, like the inherent complexity of drafting a contract based on outcomes and overcoming mistrust between government and industry. But simple steps like better communication or even colocation of engineering teams can help mitigate these barriers.
To address present readiness concerns, acquisition experts and policymakers should take lessons from U.S. allies and find a pragmatic way to better implement performance-based logistics.