A REAPPRAISAL OF COST INCENTIVES IN DEFENSE CONTRACTS
INSTITUTE FOR DEFENSE ANALYSES ALEXANDRIA VA ECONOMIC AND POLITICAL STUDIES DIV
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It is suggested that the introduction of cost-sharing necessitates a payment for risk-bearing which in recent years has exceeded any savings which are obtained from increased efficiency, and that calculations of increased efficiency are themselves likely to be overly optimistic. This skepticism, of course, reflects the assumption that the government is not in the market for insurance, and that contractor absorption of risk is of no particular value to the buyer, at least not in relation to its cost. The popularity of incentive contracts is much more easily explained in terms of sub-optimizing behavior of individual procurement officers than it is in terms of the objectives of the organization as a whole. This conclusion is further strengthened by substantial evidence to the effect that target costs are strongly influenced by other features of the contract. Insofar as target costs are raised as sharing ratios are raised, efficiency in contract performance is overstated, even after taking into account the cost of insurance.
- Economics and Cost Analysis