Structuring Steady-State Performance-Based Logistics Contracts
Abstract
For fifteen years, performance-based logistics (PBL) contracting has been used to reduce weapon system sustainment costs and increase system reliability. In its simplest formulation, PBL “explicitly identifies what is required, but the contractor determines how to fulfill the requirement.” Often, the most significant improvements occur relatively early on in the PBL program. The proposed research will examine how these programs should be structured for the longer term, as incremental improvements become more difficult to achieve. The research will be conducted by the Center for Public Policy and Private Enterprise (CPPPE) at the University of Maryland’s School of Public Policy. Senior Research Scholar and Interim Director William Lucyshyn will serve as the principal investigator. Typically, PBL programs evolve along a common trajectory. With new systems, cost-reimbursement contracts are used in order to provide the government customer and the provider with a cost baseline. Once the costs, risk factors, and system failure modes and rates have stabilized, the program transitions to the use of fixed-price contracts where providers are paid a fixed cost or fixed rate (e.g. per hour, per mile) so long as operational readiness is achieved at the specified level(s). Over time, the provider makes improvements to its supply chain, logistics networks, operations, and the system itself in order to reduce its costs and maximize profitability. In the “terminal stage” of its evolution, the exemplary PBL is characterized by high availability, reduced inventories, and efficient sustainment processes. The program operates at lower risk from both a cost and technical perspective. Once this stage is reached, however, obtaining further price reductions can be more challenging, in part because much of the low hanging fruit has been picked. Recently, a high-profile, award-winning PBL program, the High Mobility Artillery Rocket System, transitioned inventory management from the contractor to the government and reverted to cost-reimbursement contracts in an effort to reduce costs. It is unclear whether this approach will yield the intended results. It should be emphasized that under the traditional PBL paradigm inventory management is a core function of the provider who is incentivized financially to meet availability requirements at reduced costs through deliberate and strategic supply chain decisions (e.g. inventory levels, spare-parts, redundant capacities, etc.). Indeed, there is ample evidence, both theoretical and practical, indicating that fixed-price performance-based contracts induce the provider to choose the optimal inventory level—one that balances costs against risk. At the same time, some theoretical models indicate that when suppliers’ decisions regarding cost reduction efforts and inventory are observable and contractible, a nonperformance arrangement may be optimal from the customer’s perspective. Given that PBL customers accumulate substantial knowledge of costs, failure rates, and parts requirements over the course of the program, contractor actions may become partially observable over time, through either indirect means or as a result of negotiations that entail the disclosure of contractor costs. The objective of this research is to determine whether distortions to the existing PBL paradigm are warranted in such instances and/or whether a “steady-state” PBL—one that generates continuous value to the customer—can be achieved, and if so, how to structure the optimal arrangement. The proposed study will rely primarily on structured interviews with program personnel in both the public and private sectors; the application of the academic literature (on contracting, management science, agency theory, and transaction cost economics) to PBL; and in-depth case studies of mature PBLs wherein program cost data is rigorously analyzed.
Document Details
- Document Type
- DoD Grant Award
- Publication Date
- Nov 29, 2016
- Source ID
- N002441710006
Entities
People
- William Lucyshyn
Organizations
- Office of the Secretary of Defense
- University of Maryland