President Obama ordered an overhaul yesterday of the way the US government awards defense and other contracts, saying that more competition is needed to drive down costs and declaring that “the days of giving government contractors a blank check are over.” Boston Globe, March 5, 2009

The first thing to understand about “no bid” contracts is that there is literally no such thing. What is referred to as “no bid” really means “sole sourced.” Sole sourced contracts are not put out to competitive bid, but are rather aimed at one supplier. The single supplier is given a request for a bid on a specified item or service, the supplier responds with a bid, the government accepts or rejects the bid, and if accepted, a contract is then negotiated and signed.

Obama is wrong in asserting that a sole-sourced contract is anything like a blank check. The vendor signs a contract to deliver goods or services for a predetermined price on a predetermined schedule. If the vendor contracts to deliver titanium bolts for $5 apiece, and for some reason titanium becomes scarce, there is nothing in the contract that bails the contractor out. If the government thinks the bid from the vendor is unreasonably high in the first place, the government can decide not to award the contract and to put it out in competitive bid instead.

So why not just put out all contracts to competitive bid? Running a competition takes considerable time and is often expensive. The competitive bidding process requires informing industry, soliciting and incorporating comments of the specifics of the bidding opportunity, forming a team to evaluate the technical proposals, and auditing all the cost proposals. This process may be worthwhile, and for the largest defense procurements it is almost always worthwhile, but there are many occasions when it would be a waste of taxpayer money.

To take the easiest case, suppose only one company possesses the needed technology. The company might even have a patent on it. The bidding process time and expense will then yield only one qualified bidder. There are a raft of other legal reasons: urgency does not allow time for the bidding process; there are purposes of promoting an industry or acquiring unique expertise; an international agreement may mandate sources; sole source may required for socio-economic programs, like purchases from specified Native American companies; and national security sometimes precludes public solicitation. 1

Because the bidding precess is time consuming and expensive, government agency administrative costs are reduced by having fewer competitions. That may not be best for the taxpayer, because while the item cost may be increased due to lack of competition. One way to provide an illusion of competitive bidding is to bundle procurements into larger contracts.

Suppose the Army needs to buy tanks and boots. A competition might be held for “infantry support” that includes the buying of tanks and boots under one contract. Since tanks are the dominant cost, the tank vendor will then get the problem of deciding how the boots will be provided. They might even decide that the contract is an opportunity to enter the new business of making boots. The Army is happy because they get credit for having boot items bid competitively, and the tank vendor is happy to get a contract for boots, where they will get a percentage for subcontracting. The taxpayer, however, is likely to end up paying too much for boots, because there was no separate competition for that item.

Tanks-and-boots is an unlikely example, but the pattern is common. Buying something like an aircraft provides an opportunity to bundle in everything associated with the aircraft. Breaking out separate items requires the government to write separate specification for each of the sub-items, a difficult and time consuming job.

If sole-sourced contracts are not a giveaway, then perhaps sole-sourced cost-plus contracts are the scandal. Cost-plus contracts are issued when the quantities of goods and services cannot be determined in advance, so the costs are passed along to the government. Often the fee for administering the contract is fixed, so the contractor cannot make more profit by incurring greater costs. Government auditors examine the claimed costs.

Aside from lowering the percentage of profits, and hence lowering the return on investment, the contractor also has a risk of labor and overhead costs rising above what was bid. Those costs are not reimbursed. Halliburton had a sole-sourced cost-plus contract for support services after the invasion in Iraq. In committing to an overhead rate, they had assumed that the country would be pacified by the military after Saddam fell. In fact, they incurred insurance costs ten times what they had bid, resulting in major losses on the contract.

President Obama’s “giving contractors a blank check” statement was beyond naive. To use official presidential terminology, it was stupid. There are no blank checks, and requiring more competitive bidding may reduce competition through the encouraging of contract bundling. Government procurement policies can certainly be improved, but is the classic problem of trying to make bureaucracy efficient.