WASHINGTON — The Pentagon’s proposed plan to lower the rate of progress and performance payments some companies receive on defense contracts is sending shockwaves through the industry and invited a backlash from three large trade associations.

To incentivize defense firms to work more quickly and more efficiently for the taxpayer, Pentagon leaders want to create a tiered system that recognizes high performing companies with higher performance-based payments. Contractors, however, are balking at the Pentagon’s efforts to make them more accountable.

While obscure to the general public, the proposed rule changes have rattled government contractors, which argue they would choke off funding for innovation, shackle them with more bureaucracy, increase the cost of military equipment— and hurt profits.

The baseline performance- and progress-based payment rate for larger companies would be reset from 80 percent to 50 percent, with incremental increases or decreases based on new criteria proposed by DoD. If a contractor, for instance, delivers end items on time, hits milestone schedules, or avoids serious corrective action requests, it would win 10 percent bumps for each. (Small businesses would have their own schedule of incentives.)

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The National Defense Industrial Association is calling on DoD to rescind the regulation and collaborate with industry to create a different rule. One objection it has is the proposed rule would determine payment rates based on companies’ overall performance, as opposed to contract by contract.

“The marching orders from Congress is we have to be faster, more innovative, to do better for the warfighter,” said NDIA Senior Vice President for Policy Wesley Hallman. But, under the proposed rule, a company that wants to take on a high-risk project that fails, “will later be judged on that thing the following December. They’re incentivized to take a low-risk approach.”

Though Section 831 of the 2017 National Defense Authorization Act encourages DoD to use performance payments, NDIA argues the rule violate’s the law’s intent and that lessening companies' cash flow would slow payments to subcontractors and sap funding for independent research and development.

“We’re doing our best to let them know how this will hurt industry,” said NDIA Director of Regulatory Policy Corbin Evans.

The trade group’s comments were submitted at a public meeting Sept. 14 to consider changes the Pentagon proposed in August to federal acquisitions rules, the Defense Federal Acquisition Regulations Supplement. The Defense Department is holding another public meeting, Oct. 10, before the public comment period ends on Oct. 23.

Both the Professional Services Council and the Aerospace Industries Association, which more than 300 companies in the aerospace and defense industry, also offered presentations in opposition.

The move toward better stewardship of taxpayer dollars comes amid record Pentagon budget growth and amid a reorganization of the Pentagon’s acquisition, technology and logistics office, now due to finish in a few months.

The move falls in line with Under Secretary of Defense for Acquisition and Sustainment Ellen Lord’s efforts to halve the timeline of major defense acquisition programs, which are notoriously slow.

“I believe the lifeblood of most industry is cash flow, so what we will do is regulate the percentage of payments or the amount of profit that can be achieved through what type of performance they demonstrate by the numbers,” Lord said in a Defense News interview last week.

Hence, “we’re going to begin to reward companies through profit or through progress or performance payments, as a function of how they manage all of that, as well as quality and delivery and a variety of other things,” Lord said.

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Though it’s unclear whether DoD will formally move ahead with the rule by a Dec. 1 deadline, investors have already responded negatively to a reports on the changes, according to aerospace and defense sector analysts at Cowen and Company.

“It will be a scramble for companies and DoD to compile the necessary data to evaluate the rate request. Under the current draft rule, DoD would need to evaluate the rate request in just one month for all its suppliers,” Roman Schweizer, of Cowen and Company, said in a note to investors Friday. “We suspect that will be very hard the first time and suggests this year may be too hard.”

Still, Cowen analyst Cai von Rumohr downplayed the near-term effects, especially beyond the major primes. He speculated the proposed rule change will have negligible impact on contractor results in 2019 since it doesn’t apply to any current contracts; it’s very unlikely to go into effect before 2020, if ever; it will not apply to time and materials and fixed-price commercial terms contracts, and because it will only apply to some cost-plus contracts.

Joe Gould was the senior Pentagon reporter for Defense News, covering the intersection of national security policy, politics and the defense industry. He had previously served as Congress reporter.

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