6 ms·

Cost plus contracts are well intentioned, but create perverse incentives. It's also a big issue in the defense industry. The idea is that a contract pays a comp

• dr_orpheus 5y ago
  Yes, the theory of cost-plus contracts is good. It is a way of saying "this is a new piece of technology with ill defined requirements and we need help developing it along the way." Theoretically, it allows for changes and adaptations in developments of technology. This is all in theory though and what proponents of cost-plus would say. It does suffer from some of the issues you have mentioned above. I think there is a time and a place for cost-plus but there is definitely move towards more fixed price contracts in civil and defense. Becoming somewhat more common now is a hybrid approach of cost-plus/fixed. Contracts for development phases up to a certain milestone are set up as a cost plus contract and then production comes under a fixed price contract.
  • tomatotomato37 5y ago
    I wonder if some of the risks of cost-plus could be mitigated by associating it with industry average running costs rather than a per-project basis. So contractors would get a yearly payment with as long as they are making progress on a project, but any changes to the project are 1-to-1 with additional costs so there would be no benefit to either aggressive cost cutting or sandbagging expenses. Maybe also make it so profit would be rewarded at project completion in proportion to the running costs of however long the project took to prevent pointlessly lagging or rushing projects. Of course there would also have to be bullshit like opportunity cost compensation and shit because these companies are so profit-driven as to crash a project meant for the public good if it means more profit from interest on a 0.5% bank account
    • klodolph 5y ago
      Cost-plus is supposed to be primarily for research and development, where the costs are highly variable to begin with.
• nynx 5y ago
  There must be some way to structure contracts to allow for cost of developing new technologies yet incentivizes minimizing that cost.
  • bluGill 5y ago
    R&D is about managing risk. You can have more micro-managers to ensure that costs are minimized, but the cost of all that management can be more than the abuse of cost-plus (not to mention people hate being micro-manged) The only good answer I've heard is for the agency to have enough technical experts that they can spot bad things. However that means the government needs to develop technical experts.
    • kitsunesoba 5y ago
      > The only good answer I've heard is for the agency to have enough technical experts that they can spot bad things. However that means the government needs to develop technical experts. It's probably beneficial for the contracted company to have technically inclined individuals in leadership too, ranging all the way from the lowest levels up through CEO. Engineering-minded management is much more likely to spot potential troublemakers and risks for runaway costs in the planning phases where someone with a background in management or finance is more likely to fudge things and say "yes we can do this at X unrealistic low cost" just to win a bid. They're also less likely to make bad calls on how to fix budget problems that crop up midway through the contract.
  • dr_orpheus 5y ago
    There are Fixed Price Incentive (FPI) contracts that try to address this. Instead of a single price for the contract as in an Firm Fixed Price (FFP) there is a "target" price at which the contractor will get some level of profit. Above that you set a cap on the total cost of a project that you are willing to pay, but the profit of the company goes down as you approach the cost cap. So contractors still have the incentive to minimize cost because if they get cost below the "target" price the contractor still gets that as profit. However, people aren't usually a fan of them because it requires all of the overhead/audits of a cost-plus contract which typically minimizes how cost effective they can actually be at getting below the target price. There are also some development-type projects where the government will fund a project, but still require some amount of funds (like 25%) to come from the contractor. But this is really early development type stuff. Basically it is a way to influence where a company is spending their R&D money. Its not really for any operational systems.
• treeman79 5y ago
  This is also where free markets shine. If someone is making absurd profits building in-efficient widgets. It won’t be that long before other people get the idea to make that same widget for less or better quality or both. But first company will then go out of business or become efficient. Survival of the fittest evolution style for business.
  • WheatM 5y ago
  • x86_64Ubuntu 5y ago
    This assumes that there are no intellectual property encumberances held by the old company, and that the barrier to entry isn't terribly high. And no one with a budget and a deadline is going to wait for one company to go out of business so they can get it cheaper.
  • ipaddr 5y ago
    The first company has first movers advantage which lets them signs exclusive deals and builds a regulatory moat plus gains brand awareness. The new company may be cheaper or have better quality but that isn't an automatic win. The second company needs more money or an event to superseed the first story.
• fatbird 5y ago
  You're leaving out a significant factor in cost-plus contracts in their favour: the buyer pays the actual cost, not the cost-plus-contingency that's built into fixed price contracts. It may not work out that way for the reasons you mention, but the problem of baking in risk costs to fixed priced bids returns. And in observing "how does the contractor increase profits", another issue with fixed price bids is that it encourages corner-cutting internally: anywhere the contractor can save money, it goes into their pocket, which can mean a lot of tissue-thin requirements fulfillment that goes wrong later.
• Symmetry 5y ago
  In theory the regulating agency overseeing the cost plus contract is supposed to scrutinize the expenses of the overseen entity to prevent this. In practice just form a matter of program complexity this is hard to do. When you bring in politics it gets even worse, "You don't want to endanger our pilots by giving them any less than the most gold plated fighter jets, do you?" argue the defense lobbyists. The worst example I can think of would probably be the nuclear industry where operators providing grid power on cost plus contracts teamed up with environmentalists after Three Mile Island to get laws passed insisting that nuclear power had to be as safe as possible regardless of cost, which turned into essentially a license to print money.
  • ClumsyPilot 5y ago
    > In theory the regulating agency overseeing the cost plus contract is supposed to scrutinize the expenses of the overseen entity to prevent this The entire point of getting the private sector is that their insentive should be to do it in the most efficient manner possible, and noone has to manage them - the inefficient ones just die out. The second-best approach is to have the government manage the whole thing, where they have no real incentive to be efficient. But what we have here is employing the private sector and incentivising them to be as inefficient as possible, and the government must still hire an army of accountants and experts to keep them in check. it's combines the worst aspects of both!
    • themitigating 5y ago
      The government would have no reason to rip itself off as well unless there's corruption but that should be investigated.
      • krapht 5y ago
        You must be somebody who's never had to remove an underperforming colleague on a public project. What happens is that they get promoted to another team, or put on a project that has absolutely no future, and everyone knows it. Why is it difficult to remove people? Because in the old days, newly elected executives would clear out the civil service and hire or contract with people that supported their election campaign.
• lumost 5y ago
  In R&D, incentivizing a private enterprise to spend more could be beneficial. Assuming the client (NASA) has some oversight this leads to more engineering freedom and an exploration of a larger design space, whereas fixed cost would incentivize racing towards the best solution as fast as possible. Depending on program goals, both approaches have their place. However for projects like Artemis which tried to minimize R&D cost and save time through component re-use, the latter approach would clearly be better.
• ChrisLomont 5y ago
  >It's disincentivizing cost reductions and incentivizing cost increases. Competetive bids drive costrs down. The alternative to cost plus is? Not having fixed profit margins, in which case there is still incentives to increase costs. In both cases the limit to costing is competition and the contracting side. Another way to think of it is cost plus lowers costs by lowering risk. If the company were on the hook for uncertainty (which is the case on ANY project), then they would have to price that into the original proposal, as would their competitors, ensuring more costs to cover the risk. By lowering risk to companies, it provides another avenue to lower costs. This happens in lots of markets - look at cost margins where there is volatility versus margins where there is predictability.
  • edmundsauto 5y ago
    This only works if the bids represent the same work, at the same quality, on the same delivery schedule, with the same feedback pathways and the same risk mitigations. In other words, it is the “spherical cow” of contracting.
    • ChrisLomont 5y ago
      >This only works if the bids represent the same work, at the same quality, on the same delivery schedule, with the same feedback pathways and the same risk mitigations. Why would this possibly be true? Two groups can bid on the same project with different tradeoffs. Projects are complex, and there are zillions of tradeoffs to make a competitive bid. The group offering the project then evaluates the bids, often with multiple rounds of feedback. And generally then these projects initially got to several competitors, with fewer getting follow-on work, causing them all to try really hard to deliver good work. Future projects are always worth more than current projects, so only an idiot does bad or over-cost work often. Such groups eventually don't get more work. I've worked on such bids for decades. Multiple groups bid, with a statement of work. The other side evaluates the bids. Cost plus simply allows groups, when bidding to not have to use larger multipliers to mitigate risk, since some of the risk goes to the offeror. If you were running a company, and you had two ways to bid a contract, firm fixed price vs cost plus, which do you think provides less risk to you? And how does a company account for risk? Higher prices, end of story. This is simple economics. It's why less risk results in smaller margins throughout pretty much all industries. It allows stable planning.
• photochemsyn 5y ago
  One of the areas where this seems to have happened is at the NSA, which usually keeps its contracts very secret, but due to William Binney's whistleblowing, it was revealed that the inexpensive solution (ThinThread) was passed over in favor of the expensive solution (TrailBlazer). https://whistleblower.org/whistleblower-profiles/thinthread-whistleblowers/ https://whistleblower.org/whistleblower-profiles/thinthread-... Part of the problem here is that the government actors selecting the contracts also want more money flowing through their agency, and they seem to get kickbacks in the form of 'retirement positions' with the very private contractors they're directing contracts to.
• colordrops 5y ago
  > Cost plus contracts are well intentioned Are they though? If a casual layman internet reader can see the problem and see that they always get taken advantage of for profit, couldn't also the NASA officials and contractors signing these contracts? They know exactly what they are doing. SpaceX signed non-cost plus contracts and delivered far more quickly and cheaply than the rest.
  • travisporter 5y ago
    The problem is Congress tells NASA do this with this money this way. NASA has little flexibility. Recently with the CLPS program NASA flexed it’s muscle and it’s paying off so far.
• efsavage 5y ago
  A better way to align incentives would be to have the bids specify fixed profits and a value engineering process. You bid $10m + $1m profit. The project baloons to a $20m project, you still make $1m. The project meets it's goals with a $5m budget, you get $1m and a percentage of the shortfall. It can still be gamed, but to a much lesser degree. I worked on a 9-figure construction project and there were two full-time engineers specifically tasked with looking for ways to reduce the cost of the project, because it was essentially free money for the contractor. These two people generated millions in profit for the company. https://www.fhwa.dot.gov/construction/cqit/vecp.cfm https://www.fhwa.dot.gov/construction/cqit/vecp.cfm
  • bryanrasmussen 5y ago
    Good, but often people reduce costs by using lower quality supplies so that isn't necessarily foolproof either.
    • throwawaylinux 5y ago
      They do that anyway. The evaluation process in the contract has to deal with that.
      • bryanrasmussen 5y ago
        I don't know, it just seems to me that having two engineers devoted to find ways that you can save money, whom, presumably also get rewarded by how much they save (this could just be a nice speech by someone but I think if you saved significant amounts maybe a bonus?) would inevitably lead to some situations where they realize that the grade of cement or something similar had not been specified for something and it probably means that, barring significant seismic events in an area that has a fault that has not done anything significant for a century, the thing being built would not need any repair for 45 years instead of 65. Obviously this example is not a real world one as construction is not my area of expertise but I do think I have insights into mundane human mendacity. Then again I am also prone to cynicism.
• gabereiser 5y ago
  This has been my experience as well through contracts with the government. To further this, there is also no incentive and funds to modernize an already existing product. If it was written in Java 6 using J2EE, it’s going to continue to be that until it dies. Folks I worked with also didn’t care to up skill or learn new ways of doing things because the incentive wasn’t there. Their cost was fixed, their price was fixed, their profit was fixed. They will do the bare minimum to satisfy the contract.
• avalys 5y ago
  This is why it's ridiculous that the US Affordable Care Act (Obamacare) "caps" profit for health insurers as a fraction of premiums collected. It provides a direct incentive for them to increase healthcare costs, absolutely the opposite of what government policy should be doing.
  • hash872 5y ago
    The issue is that without the caps, the insurance companies would be much more motivated to deny lots & lots of claims. Imagine you're a regular person with a middle-class income, you urgently need treatment and the insurance company algorithm says 'denied' because they're simply saying 'no' to x% of claims that week. What are your options? Litigation? Yes insurance companies have regulators, but the sheer scale of denials would start to overwhelm them. At a huge scale, this would degrade the quality of American healthcare even more. It would become normal for legitimate claims to be denied all the time. Anyways, this was the explicit reasoning of the ACA drafters when they included the profit cap. Maybe they were wrong, but this was thought about & discussed a great deal at the time
    • larkost 5y ago
      To give some color: there were a large number of (small) insurance companies that were paying less than 50% of their revenues in actual medical payments. In those cases most of the costs were in bonuses to the executives. This was a measure to kill of those (which it did). Now we are left with somehow controlling the excesses on the other side.
  • maxerickson 5y ago
    They do potentially face competition (though there is one marketplace insurer operating in my area, so...).
• cryptonector 5y ago
  > Cost plus contracts are well intentioned For some definition of well intentioned!
• whiddershins 5y ago
  Doesn’t Obamacare essentially turn the entire healthcare industry in the United States into cost plus?
  • r00fus 5y ago
    No, the first move in that was "Medicare advantage" by GW Bush.