Full version of an article featured in National Defense Magazine
The good news – Congress has provided the Department of Defense with a cluster of legal authorities to conduct experimentation, research, development, prototyping, and production that can lead to the fielding of critical defense capabilities in a better, quicker, and less expensive way than DOD’s business as usual approach. The bad news – DOD is poorly organized, led, and educated in the use of these authorities. They are unknown or poorly understood by many DOD organizations that could greatly benefit from their effective use. This results in their underutilization and a failure to leverage their full potential even when they are used.
Key authorities include those in sections 2371, 2371b and 2373 of title 10 United States Code. The first two are generally referred to as “other transactions” (OT), that is, contractual actions that are not standard procurement contracts, grants or cooperative agreements and therefore not subject to procurement or assistance law and regulations. Section 2373 permits purchase “by contract or otherwise” of certain essential technologies or supplies without being subject to the Armed Services Procurement Act and its implementing regulations when purchased in quantities no greater than those needed for experimentation, technical evaluation, assessment of operational utility or to maintain a residual operational capability.
These authorities were once widely used within DOD for science and technology projects, prototype projects, ranging from small single company transactions, to research joint ventures and consortia, to the development of major air, ground, naval and space systems. Global Hawk, Evolved Expendable Launch Vehicle, Advanced Short Take-off and Vertical Landing (ASTOVL) programs were conducted under these authorities as was the Joint Unmanned Combat Air Systems (J-UCAS). The X-47 UCAS won the Collier Trophy. Despite numerous successes and demonstration of better, faster and cheaper approaches to Defense acquisition use of these authorities dropped off dramatically for over ten years. Only recently has DOD’s need for speed and innovation in fielding new capabilities seen a partial resurgence in their use. Congress has repeatedly called for more innovation in defense acquisition and the previous Secretary of Defense created Defense Innovation Unit Experimental to try to bridge the gap between innovative private sector companies and needed defense capabilities.
Origins and Purpose
These statutes have been around for some time. Section 2371 was originally enacted in 1989 and initially was applicable only to the Defense Advanced Research Projects Agency (DARPA). Section 2371b was originally known as “section 845” or “prototype authority” and enacted in 1993. Like 2371 with which it is closely related it was originally DARPA-specific but later extended to all of DOD. The origins of section 2373 go all the way back to the Air Corps Act of 1926. Its scope was expanded several times over the years most recently and importantly in 2015.
The intent behind the enactment of section 2371 was to spur dual-use research and development. The idea was to create an attractive way for companies to do business with DOD while retaining the characteristics of innovative commercial companies; gaining for DOD access to cutting edge technology, taking advantage of economies of scale without burdening the companies with government regulatory overhead which would make them non-competitive in the commercial (non-defense) sector. Defense firms were also encouraged to engage in section 2371 arrangements especially if they sought to adopt commercial practices or standards, diversify into the commercial sector or partner with commercial firms. Given the emphasis on dual-use, joint funding (cost sharing) of projects was baselined if practicable but not mandated. Competition in awarding agreements was also baselined but not absolutely mandated. The mode of competition was not specified but could be adapted to whatever technology domain or industry segment was most relevant to a project. There are other nuances in the statutes that seem challenging to those whose thinking is immersed in a business as usual culture; but, properly understood do not inhibit broad use of this authority.
Section 2371b is closely related to section 2371. The statute states it is “under the authority of” section 2371. As originally enacted section 2371b (“845”) was exempted from the cost sharing feature of 2371. This was because unlike section 2371 it was aimed specifically at defense contractors. Both dual-use and defense specific projects were encouraged under section 2371b. Defense firms could utilize this authority to streamline acquisition processes in a variety of ways. They could execute projects with unique business arrangements such as structuring government funded projects under independent research and development (IR&D) rules rather than charging fully burdened rates. They could create business segments without defense acquisition overhead to pursue prototype projects or recruit innovative commercial firms as sub-contractors without imposing regulatory overhead through the flow down of otherwise mandatory contract clauses. They could also ignore practices and lore (not to be under estimated) which while associated with the regulatory system were actually not mandated by either law or binding regulation.
As previously stated the origins of 2373 go back to the Air Corps Act of 1926 and was an attempt to inject flexibility into the process of acquiring and assessing the utility of aircraft. Additional domains, ordnance, chemical warfare and others were added over the years. Like the Other Transaction (OT) statutes nothing in the statute indicates it is a niche authority. However, like the OT statutes it has only been utilized in a niche manner in recent years. In the 2016 National Defense Authorization Act Congress endorsed 2373 by greatly expanding its scope. It is now applicable to many critical DOD needs.
It should be noted that there have been a number of amendments to the statutes over the years. In the case of section 2373 these have all been essentially positive and useful. With regard to the OT statutes amendments have been a mixed bag of positive, negative and of little consequence. The most profound amendments have been the 2000 amendment that confused the clear dichotomy between the dual use nature of 2371 and the defense specific nature of 2371b; and, the 2016 amendment that added a simplified method of follow on production after a prototype project to 2371b.
Why alternatives, or, why not business as usual?
For those to whom the answer to the question “why not business as usual” is not immediately evident, insights from some knowledgeable observers over the years may be helpful. As far back as the Commission on Government Procurement in 1972 the procurement system was described as a “mass and maze of regulation”. Despite numerous reform efforts over the decades since then the situation has not improved but only gotten worse.
The President’s Blue Ribbon Commission on Defense Acquisition (Packard Commission) in 1986 found that fielding defense systems takes too long and costs too much. Their findings found fault with the requirements process but also noted a need for “informal competition and streamlined procurement processes.”
In writing a history of government contracting James Nagle stated: “If someone were asked to devise a contracting system for the federal government, it is inconceivable that one reasonable person or committee of reasonable people would come up with our current system.”
In 1994 DOD tasked the firm of Coopers & Lybrand to survey and quantify cost drivers unique to DOD acquisition. Just the top ten cost drivers, which generally had no analogue in commercial contracting and had not been tested for value, imposed an eighteen per cent cost premium on the acquisition process. A Government Accountability Office (GAO) review of the Coopers & Lybrand findings in 2000 found that despite several years of “acquisition reform” there had been no appreciable improvement. The RAND Corporation has documented that many estimates of the cost premium for regulatory compliance are much higher than suggested by Coopers & Lybrand. Incidentally avoiding an eighteen per cent cost premium spread over the DOD acquisition budget in recent years would have off-set the entire burden of sequestration.
Former Undersecretary of Defense (Acquisition, Technology & Logistics) Jacques Gansler commented on the body of laws, regulations and practices built up over the decades that govern procurement actions between DOD and its suppliers: “Although each of these may have had a valid historic rationale, the result has been that there are only a few firms skilled in conducting defense business, and they may be totally isolated from, and noncompetitive with, their commercial counterparts.”
Professor Ralph C. Nash, dean of government contract law educators, once commented in the Government Contractor magazine about the stated rationale for a regulatory rejection of a proposal to exempt interim vouchers from DCAA audit. After quoting the rationale Professor Nash noted: “I always liked this description because it seemed to say something about how the regulatory mind worked. It may be ‘perfunctory and unnecessary’ but it looks good and does only a little harm! That’s the regulatory process – an accumulation of hundreds of those critters.” Nash’s view puts Jack Gansler’s generous comment that regulations “may have had a valid…rationale” in perspective.
Another perverse impact of the highly regulated government purchasing system was noted by a former Commissioner of the Atomic Energy Commission (now Nuclear Regulatory Commission) James Ramey: “If you have a system of contracting or administering where everything is written out on what a fellow should do, and there isn’t any room for judgment or discretion…over a period of time, you don’t tend to get good people that are doing your administration or carrying out your contracts.”
Why aren’t OTs thriving?
From the time of the first OT agreement in April 1990 for a decade or more OTs were a growth industry. They were pioneered by DARPA initially for dual-use science and technology projects, then as prototype projects, then went DOD-wide gaining wide acceptance both by senior leadership and at the execution level. In just a few years hundreds of OTs obligating billions of dollars were executed. By the early years of the current century OTs still appeared to be thriving but anti-bodies were at work. Resistance to the new way of doing things by procurement, audit, and oversight officials schooled in and committed to the traditional system had simmered as OTs grew and gained acceptance. OTs were unencumbered by socio-economic policies and some officials seemed to think driving socio-economic policies was an inherent part of contracting. For others a resistance to learning new things or not invented here seemed to be the issue. The limited use of cost-reimbursement contracting and emphasis on milestone payments based on achievement seemed heretical to others.
The first set back was an amendment to section 845 (current 2371b) in the year 2000 that added a requirement for significant involvement of non-traditional companies (defined in narrow and arcane fashion) in projects or 1/3 private sector cost share. This substantially reduced the attractiveness of OTs to defense contractors. Moreover, injecting any arbitrary conditions into OT statutes is contrary to the spirit and philosophy of OT contracting and will ultimately destroy the flexibility and utility associated with their non-regulatory freedom of contract approach.
Next in 2005 came trouble with the Army’s largest acquisition program, Future Combat System (FCS), which was being conducted under an OT agreement. Not only was the program troubled but its lead systems integrator, Boeing, made headlines for ethical lapses unrelated to FCS. In hearings before the Senate Armed Service Committee selected witnesses insinuated the OT agreement was a primary problem as it lacked the “protections” of a traditional government procurement contract. Their testimony was profoundly misleading and even suggests they had never actually read the agreement. The early Phase FCS agreement when jointly managed by DARPA and the Army was less than thirty pages. However, when the Army took sole control in later phases the OT agreement ballooned to well in excess of a hundred pages looking almost identical to a procurement contract and contained the so-called “protections” of such an instrument. Only a few innovative sub-contractors had commercial style agreements without flow down of mandatory clauses. Interestingly when a GAO witness offered a critique of the FCS program no mention was made of the OT agreement as contributing to program problems. The Institute for Defense Analyses did a review of the FCS program. Their review’s chapter on the FCS OT agreement concluded the program benefitted from being conducted as an OT!
The fact that the FCS OT agreement had been criticized and that the program was later reorganized as a procurement contract resulted in much uninformed commentary on the role of the OT agreement in the FCS program. It was widely believed in parts of the procurement community that something was wrong with OTs and they should not be used for large programs or perhaps not used at all. The policy leader for prototype OTs, the director, office of procurement and acquisition policy propagated the misinformation rather than correcting it; including in a conversation with your author.
The pall of misinformation seemed to affect some government agreement officers, administrators and lawyers that were involved in OT agreements. New processes were added, delays, renewal of discussion on issues long decided and other impedimenta arose in what had been satisfactory relationships. A major company which the leader in a highly successful OT consortium not only withdrew from the consortium but stopped doing OT business with the government altogether. That same company had been a leader in an industry association (Integrated Dual-Use Commercial Companies) that had as its mission promoting acceptance and wider use of OTs in government. The company withdrew from IDCC as well.
There have been numerous studies of OTs over the years. They have been almost universally positive in finding that a number of benefits flow from use of OTs with few drawbacks. One drawback noted in the most disciplined study (by Logistic Management Institute in 2007) and a few other studies has been inadequate training of personnel involved in executing OT projects. As already noted OTs have their critics. In addition to those mentioned, the DOD Inspector General has made comments skeptical of OTs in a number of reports. In general the gist of these comments are that OTs are not business as usual and the traditional system “has served us well.” The IG fails to note the cost premium and opportunity costs associated with the traditional system.
While the 2000 amendment and misinformation related to the 2005 FCS hearing were seminal events other developments adversely affected OTs. A number of highly successful OT programs were pioneered by DARPA or under the Office of the Secretary of Defense. Foremost among these were the Dual-use Applications Program a successor to DARPA’s Technology Reinvestment Project and the Commercial Operations and Support Savings Initiative (COSSI). A net present value analysis of COSSI projects over a period of years demonstrated 36 Operations and Maintenance (O&M) dollars saved for each R&D dollar expended. Despite the success of these programs once they were transitioned to military department management they eventually faded away with their resources allocated to other priorities.
Rather than recognizing the close relationship of section 2371 and 2371b and their common potential to address innovations in DOD business and technology approaches, DOD has stove piped policy leadership for these authorities in a business as usual fashion. Section 2371b falls under the Director, Procurement and Acquisition Policy while 2371 has been placed with the Assistant Secretary of Defense (Research & Engineering). Section 2371b has been denominated exclusively as acquisition a word not used in the statute while 2371 has been considered assistance and tagged with the terminology Technology Investment Agreement. Actually in addition to acquisition or assistance both statutes authorize projects that may be something other than acquisition or assistance. There is considerable overlap between the two statutes. Neither policy office has demonstrated effective leadership in promoting these authorities and in certain instances has appeared lacking in interest and knowledge or openly hostile. At times the same lack of leadership has been reflected in the military departments and defense agencies.
After years in the doldrums, obligations under these authorities has seen a slight rise in the last few years but remain a miniscule fraction of DOD’s R&D budget, much less its total acquisition budget. A residual pocket of OT expertise is maintained at DARPA and a few other contracting offices. OTs have been used by some contracting offices primarily to form consortia. A single contracting office currently is responsible for the vast majority of OT agreements and obligations. In many instances, however, process oriented regulatory thinking has found its way into projects where it is unnecessary and counter-productive.
In general it is probably correct to say that the original spirit of the early practitioners of OTs is lacking within DOD. A risk averse, process heavy approach has limited the potential of the way OTs are being used. This seems based on a combination of factors. First, the deficiency of education and understanding on OTs among DOD lawyers, program managers, contracting personnel, and financial managers is a profound handicap. Second, the requirement that agreements officers (those with authority to sign and modify OT agreements on behalf of the government) must be warranted contracting officers has placed a cadre of people with almost exactly the wrong set of skills and experience at the center of OT contracting. At DARPA the first OTs were signed by the agency director and later by the deputy director for management. When contracting officers were eventually delegated authority as agreements officers and despite the fact that DARPA had only senior contracting officers on staff, barely half proved capable of operating in an OT environment. Those that did generally had experience in business or contracting outside the DOD procurement system.
Revitalizing Innovative Contracting: Selected Issues
It is certainly possible to revitalize the use of the key innovative contracting authorities within DOD. The essential ingredients include people – people who are willing and want to accomplish mission goals and are unafraid to step outside business as usual to do so. Can do people, program managers, contracting personnel, fiscal experts, and lawyers need to be equipped with the knowledge that enables them make maximum use of business judgment and common sense; and, envision ways of doing things that have seldom or never been done before. It may be necessary to establish entirely new offices to execute innovative contracting in order to insulate practitioners from business as usual thinking. Selecting good people and educating them will not work in the long run absent positive leadership from the top, from intermediate levels and at the working level. Leaders themselves need to be educated on what might be possible using OTs and other available authorities. Nothing short of culture change is required.
Many elements of DOD thrive on standardization. However, in the world of innovative contracting standardization of policies, procedures, prescriptive guidance, forms, templates and the like can do more harm than good. Education rather than regulation should be the by-word. OTs allow freedom of contract and freedom to think. Current DOD guidance on OTs pay lip service to use of common sense and business judgment but revert to prescriptive concepts or terminology in areas where flexibility and judgment should be used. Revised guidance is needed.
In this article it is not possible to record a comprehensive list of all the misinformation, misunderstanding and erroneous concepts about OTs that have been evident within DOD at one time or another. A few will be discussed as examples of dross that needs to be cleared away in order for OTs to reach their potential to contribute to DOD goals and missions.
The feasible or appropriate standard of section 2371 has been widely misunderstood. Section 2371 is used for basic, applied and advanced research projects when standard instruments are not feasible or appropriate. Within DOD it is virtually always appropriate to use a 2371 OT for those purposes vice a procurement contract, grant or cooperative agreement. The purpose of the Armed Services Procurement Act and procurement contracts entered into under its authority and that of the Federal Acquisition Regulation (FAR) is to acquire property or services with appropriated funds for use by the federal government. However, the FAR itself states the most R&D contracts are unlike contracts for supplies and services and that the purpose of contracted R&D is to advance scientific and technical knowledge and apply that knowledge to achieve agency and national goals. In DOD’s context and consistent the general policy reflected in FAR, the primary purpose of R&D is neither procurement nor assistance. Therefore standard procurement or assistance instruments are typically not appropriate within the meaning of section 2371 for basic, applied and advanced research projects. In addition to which section 2371 (a) specifically states that its authority is in addition to any other authority to conduct R&D through contracts, grants or cooperative agreements under section 2358 of title 10.
The practicability standards relating to cost sharing and competition are often misunderstood. The very first OT agreement with Gazelle Microcircuits in 1990 is instructive in both regards. That agreement did not require any cost sharing and was not competitively awarded at least in the sense that no publicly announced solicitation was issued. The rational for no cost sharing was that Gazelle was a firm entirely supported by venture capital investment and had no revenue stream from product sales or other sources. In simple terms if cost sharing aids in execution of the project it is practicable. If cost sharing precludes entering into an agreement or makes it more difficult, it is not practicable. There was no formal announcement soliciting proposals for the Gazelle agreement but the DARPA program officer had diligently canvased the industry and determined Gazelle had a unique technology approach and capability.
That original agreement and its terms are significant in part because DOD issued a press release about it at the time of signing and later Deputy Secretary of Defense Donald Atwood was questioned about it in a Senate hearing. He testified that the agreement had been approved in advance and that the Department stood by the agreement. Eventually Gazelle’s gallium arsenide components and devices found their way into a variety of DOD systems and DARPA received a partial return on its funding from royalties on commercial sales. Subsequently Congress authorized and funded a series of programs that specifically mentioned OTs as a funding mechanism. The courts view such after the fact action as a legislative confirmation of an executive agency’s interpretation of its statutory authority.
The feasible or appropriate proviso of 2371 and its basic cost sharing proviso do not apply to section 2371b. A prototype project may be executed under 2371b even if a standard procurement contract could be issued for the same purpose. However, as noted above with the 2000 amendment there is another cost sharing requirement that applies if no non-traditional performer is significantly involved in a project. There is also an over-ride possible for that requirement if the applicable senior procurement executive makes a determination that unique business arrangements require use of an OT. The over-ride has seldom if ever been used.
One of the misconceptions related to the requirement for non-traditional participation is evident in a number of OT consortium arrangements executed in recent years. A consortium is eligible for a prototype OT award without cost sharing if the basic consortium membership includes a non-traditional company that is significantly involved, as for example, a member of the consortium management committee. Once that threshold is passed there is no statutory basis for mandating that each individual task funded under the consortium require the significant involvement of a non-traditional company or any other standard. Such a requirement does not benefit the government or the consortium participants. The fact that this requirement has been added in many consortia illustrates that imposition of extraneous requirements, process-oriented thinking, and a “do what has been done before” attitude is evident among some OT agreements officers and reviewing officials.
There has also been a follow the leader tendency in requiring consortia to make filings under the National Cooperative Research and Production Act (which mitigates potential anti-trust liability). This is profoundly a matter for consortium governance not something the government should mandate in its solicitation for consortium formation. In some cases it might well make sense to bring this up in negotiation but it is contrary to the spirit of OTs for the government to unilaterally impose mandates on such issues.
Innovative contracting is best done through a true team approach. For the government execution team narrow stove piped interests need to be abandoned and all available skills and insights shared. A government team with complementary strengths has been found best for OT execution. The technical or program manager will typically be a key participant and driving force. Warranted contracting officers can be important participants on the team. Upon acquiring education and experience applicable to OTs, motivated contracting officers with the OT spirit and not over burdened with a heavy regulatory predilection or commitment to business as usual attitudes may indeed prove their worth as agreements office. DOD contracts lawyers also need to realize that some of their training and experience in fiscal law and general contracting is useful. They need to free themselves from a regulatory mindset when dealing with OT issues.
Projects should be executed as a team between the government and industry. Win-win solutions rather than an adversarial relationship should be the hallmark of OT contracting. Open discussion of goals and interests of the participants should precede exchanging predetermined terms and conditions. Memorializing the discussion of goals and interests in a negotiated preamble to the agreement can facilitate the subsequent negotiation of specific terms and conditions.
The Way Forward
The words culture change have been mentioned in this article. Most of the emphasis has been on contracting in a narrow sense but use of flexible and innovative contracting approaches will affect what might be deemed possible (perceived needs or requirements) as well as how projects are managed. Currently few program managers are rewarded for “failing early” but failing early and changing course are inherent in getting the best results when cutting edge technologies are being investigated and deployed. Thus the culture change involves more than just the technique of contracting.
DOD’s resistance to widespread adoption of innovative contracting methods has been so intransigent in recent years that leadership from the very top is needed to get defense acquisition on track. DOD is poorly positioned to execute using the authorities Congress has provided. Expertise has atrophied through attrition of knowledgeable personnel, lack of use, and generally uninspired use when it has taken place. The mandate for improvement must be clear.
The President of the United States should challenge DOD leadership to create the environment for quantifiable improvement in defense acquisition practices. Congress should create a fiscal environment that permits flexibility in program execution as well as further improve and simplify flexible contracting laws.
The Secretary of Defense should issue new guidance on innovative contracting and consider creation of an organization responsible for promoting innovation within the Department. The military departments and selected defense agencies and components should be directed to take the following actions:
- designate a lead contracting activity to become fully capable of using alternative contracting authorities in an effective manner and acting as a lead center for alternative contracting
- conduct a review of policy guidance at all levels, including delegations of authority, to identify impediments to effective use of alternative contracting authorities
- plan and implement training at all contracting activities with the potential to use alternative contracting authorities
- encourage the flexible and innovative implementation of these authorities, rather than prescribing exact use
- request any delegation of authority needed to implement the innovative contracting authorities if not previously granted
In addition to critical actions such as those outlined above there are numerous other initiatives that could be facilitated using OTs. Prototyping, either competitive or involving dissimilar approaches, could be combined with a Systems Engineering and Programmatic Assessment of Alternatives (as recommended by the Defense Science Board in 2009) to help refine requirements while establishing credible data on both performance and cost.
Relying on the “in addition” to other authority language of section 2371 (a), OTs could be used as funding instruments in the Small Business Innovation Research Program, a program for which they seem particularly well suited. Former Marine Corps Commandant Gen. Al Gray led a study in the 1990’s that recommended dual-use be DOD’s default position to executing science and technology projects. OTs have clearly demonstrated their effectiveness in the context of dual-use S&T. At a minimum OTs should be available in addition to traditional award instruments in all Broad Agency Announcements.
The prospect for substantial improvements in defense acquisition awaits the leadership and commitment to exploit the untapped potential of “other transactions.” OTs and related authorities that permit innovations in contracting and business arrangements can lead to rethinking on a range of related issues. They can be a catalyst for critical changes and innovation throughout DOD.
Hi: A Q. on cost-share for Research OT’s – do they absolutely, generally, or almost never require a 50/50 cost-share? According to DoD Nov. ’18 OT GUIDE,
In order to be compliant with 10 U.S.C. §2371, the project team must ensure the following:
i. The focus of the project is basic, applied, or advanced research.
ii. To the maximum extent practicable, the research contemplated in the instant project does not duplicate research being done under other DoD programs.
iii. To the maximum extent practicable, the funds from the Government do not exceed the total amount provided by the other parties. This resource sharing requirement is intended to highlight the dual use focus of this authority and show commitment on the part of the performing team to pursue and/or commercialize the technology in the future. While the default position in the statute is generally a 50/50 resource share, the final amount of the share should be based on full consideration of factors such as the partner’s resources, prior investment in the technology, commercial vs. military relevance, unusual performance risk, and precompetitive nature of the project
iv. A statement is made by the Government team that the use of a standard contract, grant, or cooperative agreement for this project was not feasible or appropriate.
To address your comments:
i. “basic, applied, and advanced research” is an attempt to broaden the original understanding of 2371 “advanced research projects”, in either case the words mean “the kinds of things DARPA does and has done.” The words are not limited by definitions in the Financial Management Manual.
ii. “Duplication of effort” is basically a throw away provision.
iii. The word “maximum” is not in the statute. The statute requires first consideration of whether any cost-sharing (words not used in the statute) is practicable. If so, start by considering 50/50 and have a rationale for a variation. In many cases (academia, small poorly capitalized company, little or no dual-use potential) cost-sharing will not be practicable. First OT had no cost-sharing and was endorsed before Congress by DEPSECDEF.
iv. No “statement” is necessary. See “Appropriate Contractual Instruments for R&D” on this website. OT’s should be the default instrument for R&D projects. If you are complying with i then an OT is appropriate (compare FAR 35.002 and 35.003).