Despite Contracting Reforms, Pentagon Seen As Unfriendly to Business

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Pentagon officials have been emphatic about "lowering the barriers" to potential vendors — especially those on the cutting edge of technology — in order to spur competition in a market dominated by big conglomerates.

But the private sector is skeptical. Industry executives say they appreciate the Pentagon's initiatives but so far see them as empty rhetoric.

Defense procurement chief Frank Kendall launched in September a new contracting reform campaignthat specifically calls for the Pentagon to attract new businesses into the military market. He also is seeking congressional support to lighten the regulatory burden, as red tape is the most often cited reason why commercial companies shun the defense business.

But executives contend that Kendall's initiative is not enough to counter a deeply entrenched bureaucratic resistance to doing business differently. They argue that Pentagon buyers are rewarded for squeezing profits out of contractors and make unreasonable demands for companies' intellectual property. Unless conditions change, executives say, the Pentagon will continue to have trouble wooing high-tech vendors that could far more easily sell their products in mainstream commercial markets.

A new white paper by the Lexington Institute, an industry-funded think tank, lays out a litany of reasons why the Pentagon has become an unfriendly customer. They include a reluctance to use commercial contracting methods that are faster and less burdensome on suppliers, and a lack of understanding of how the private sector works even though the Defense Department buys as much as $400 billion of goods and services per year from the defense industry.

"DoD has a strong initiative to increase competition but they do not understand it well," observed the paper's author Scott E. Chandler, an associate fellow at Lexington and a long-time commercial and military aviation executive.

The Pentagon mistakenly believes that new policies by themselves can increase competition, Chandler said. "But they forget that competition fundamentally requires attracting at least two companies willing to do business with you. However, DoD strategy does not seem geared to policy that is designed to be an appealing buyer."

The issue sparked a lively debate last week at the Reagan National Defense Forum in Simi Valley, Calif. During a panel discussion, Kendall reaffirmed his stance that Pentagon is not targeting industry's profits and respects companies' rights to their intellectual property.

Other panelists disagreed. Former Pentagon comptroller during the George W. Bush administration Dov Zakheim accused the Defense Department of being antagonistic toward industry profits. "This country was built on profit," he proclaimed.

Kendall pushed back. "We get it that [profit] is a necessity for business. We respect that," he said. "At the same time, we use profit as a tool to incentivize. ... We need to strike the right balance."

Zakheim fired off a list of complaints. It's not just profits, he said, it's IP (intellectual property) concerns. "Industry invests in its own R&D," Zakheim said, and companies expect to get a return on that investment. "Then the government tells you that you can't make more than 8 or 9 percent profit margin, and they want your IP. Why in God's name would Google hand over their IP to a bunch of civil servants who haven't taken a [technology] course in over 25 years?"

Companies such as Google that are pushing the technology revolution in areas where the Pentagon has fallen behind say "No, thank you," Zakheim added. "Their major market is the entire world."

The Pentagon has contracting rules in place that allow it to buy technology from the commercial market with minimum red tape, but that method typically is used to buy commodities like food and clothing. Purchases of advanced technology usually are done under the traditional procurement process, with the government calling the shots. With commercial contracting, the government simply buys what it needs from open market. "You can get all kinds of innovation, it's quicker, less restrictive, more attractive to industry," Zakheim said. He noted that even though senior leaders such as Kendall have endorsed this approach, the contracting workforce in mid-level management prefers to not use commercial contracting because it restricts government access to corporate IP and cost data.

Kendall defended the Pentagon's buying methods. "We do a fair amount of business with commercial companies," he said. "Some come in as part of the supply chain. We have to be careful about the security of the supply chain." But he recognized that the Defense Department has to change its ways if it hopes to capture private-sector innovation, especially from small businesses. Changes is needed in "how we do accounting, contracting in general," said Kendall. "We are working this hard."

He said commercial contracting can be tricky for Pentagon buyers. "The IP issue is complex," he said. "We respect people's right to their IP. We cannot compel anybody to share IP." On the other hand, "industry uses IP as a weapon to gain competitive advantage," Kendall said. "In the government, there is frustration about not having competition because someone has secured a position [in the market] based on their IP rights."

Over the past several years, he said, the Pentagon has started to require procurement officials to learn how to price and negotiate IP. "We have to be very good at this because it's a complicated thing to do."

The Lexington paper notes that the U.S. government goes to great lengths to provide patents, copyrights and licenses to protect proprietary data, trademarks and industrial secrets. The Pentagon, meanwhile, seeks to dismantle these protections as part of its strategy to spur competition, Chandler argued. He blames the Pentagon for creating an increasingly uncongenial market where vendors are seen as enemies and not as business partners. "It is true that individual companies or contractors misstep from time to time, but the snipe hunt for rampant fraud, waste and abuse is largely unwarranted," he said.

The U.S. government wields enormous power but sometimes that power can undermine its own goals, Chandler contends. The Defense Department can "cancel contracts for convenience; change requirements, purchase quantities, or schedules at will; demands proprietary information even for commercial products for distribution to competitors; and, dictates contract terms and controls margins.” Conversely, a "fundamental objective of business is to seek and grow competitive advantage, while the objective of the government policy and practice is to erase it, artificially if necessary."

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