February 10, 2016

DoD Seeks to Curtail Use of Independent Research and Development

Arnold & Porter Advisory

As a follow-on to its series of Better Buying Power (BBP) initiatives, the Department of Defense (DoD) has issued an advance notice of proposed rulemaking (ANPR), seeking public comment and a public meeting regarding intended revisions to the DoD Federal Acquisition Regulation Supplement (DFARS) involving the use of Independent Research and Development (IR&D). 81 Fed. Reg. 6488 (Feb. 8, 2016). Whereas the notice aspires to be generic about DoD’s interest in a uniform method to evaluate bid prices when contractors propose IR&D to reduce evaluated bid prices, DoD’s further tinkering with IR&D could have wider-ranging ramifications and reflects a serious policy debate over the benefits and management of efforts to innovate. Industry should be attuned to meaningful participation in the regulatory process.

The treatment of IR&D has had a tortured history since first included in procurement regulations in 1940. Although the Government removed a complicated system of calculating ceilings on allowable IR&D for major contractors in the early 1990s, BBP 3.0 suggests that the regulatory structure dissolved all DoD supervision of IR&D; this is a gross overstatement. DFARS 231.205-18 maintains a Congressional imperative that conditions allowable IR&D on “projects that are of potential interest to DoD.” Contractors must report projects to the Defense Technical Information Center and Administrative Contracting Officers are to assess the potential interest to DoD. It is unclear to industry, and the Government itself cannot confirm, to what extent the Government even takes advantage of the tools presently available.

Without reference to any empirical data, DoD asserts in BBP 3.0 that a “laissez faire approach” has prioritized investments in technologies “that will provide a competitive advantage” over pursuit of “technologies that may improve military capability.” This perception is puzzling, given that the “competitive advantage” in DoD procurements, particularly where investments in R&D would be relevant and material, is the relative “military capability” of a contractor’s offering. DoD’s response in BBP 3.0 to the expressed concern is to remove the “I” from IR&D and condition allowable R&D expenditures on the endorsement of a technical DoD sponsor. BBP 3.0 also flatly declares that it will issue regulations to “preclude use of substantial future IRAD expenses as a means to reduce evaluated bid prices in competitive source selections.”

In the ANPR, DoD seems to have taken a slight step back by suggesting

an approach whereby solicitations would require offerors to describe in detail the nature and value of prospective IR&D projects on which the offeror would rely to perform the resultant contract. Then as a standard approach, DoD would evaluate proposals in a manner that would take into account that reliance by adjusting the total evaluated price to the Government, for evaluation purposes only, to include the value of related future IR&D projects.

This proposal seems to ignore pre-existing obligations, and simultaneously opens a Pandora’s box in an attempt to standardize an amorphous assessment of reliance in order to evaluate price. This appears to eviscerate professional judgment on the part of evaluators and ingenuity on the part of contractors.

The approach the ANPR suggests is potentially problematic, and shifts to DoD the role of picking “winners” in terms of what technologies secure R&D expenditures, as well as penalizing the advantages that motivates a firm to pursue R&D. The approach also potentially tilts the competitive playing field in favor of incumbent and old technology rather than innovative solutions. The very concept behind IR&D is that a single innovative technology can benefit multiple programs and customers, and so costs to develop that technology are allocated indirectly. The ANPR would reverse that structure and include those R&D costs in the evaluated costs as part of the competition for every contract that makes use of the new technology, although the program would not incur the actual costs; thus, improperly and simultaneously treating R&D costs as both direct and indirect, in contravention of Cost Accounting Standard 402 and Federal Acquisition Regulation 31.202(a). In contrast, if a competitor offers up a technology developed under and recycled from a past or different program, then those already-incurred development costs would not be added to the evaluated costs. The older technology, or technology developed by funding other than IR&D, thus gains a competitive cost advantage through the ability to leverage that prior developmental investment in order to propose a lower price, while an IR&D-funded technology does not get the same treatment. This contrast creates a risk that an innovative solution will not get equivalent competitive price evaluation treatment, and places thoughtful R&D investments looking to the future at a competitive disadvantage.

Industry should take advantage of the opportunity to engage DoD in the rulemaking process, in order to have a better understanding of the protocol and to influence the process in a way that is meaningful and competitively fair to industry, and to the concept of IR&D itself.

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