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Comment by MikeCapone | Hacker News Reader

And prices are expected to rise significantly in the next few years, according to defense department officials. Why? Musk says a lot of the answer is in the government’s traditional “cost-plus” contracting system, which ensures that manufacturers make a profit even if they exceed their advertised prices. “If you were sitting at a n executive meeting at Boeing and Lockheed and you came up with some brilliant idea to reduce the cost of Atlas or Delta, you’d be fired,” he says. “Because you’ve got to go report to your shareholders why you made less money. So their incentive is to maximize the cost of a vehicle, right up to the threshold of cancellation.”

I can't help but think of all the other places where that kind of system operates and makes costs much higher than they should be... How much better would the world be if fewer resources were wasted thus?

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My family has been involved in both mining and construction at various times past and present so I've seen a couple of areas where "cost plus" pricing is used.

Generally speaking, it's a recipe for the provider to stick their snout in the trough as far as it will go. There is absolutely no incentive to lower costs or improve efficiencies. It does indeed become a game of brinkmanship between maximizing costs (profits) and cancellation.

I have seen it used in construction to mitigate risk. One example springs to mind. A particularly wealthy but eccentric individual wanted to build a lavish home. He was notorious for changing his mind, adding to the project and so on. The only way the company in question would touch the construction contract was on a "cost plus" basis.

Whenever you do this you basically have to trust the provider to a certain extent and it only really works if they trade on reputation and a hit to their reputation actually matters (often it doesn't).

>There is absolutely no incentive to lower costs or improve efficiencies.

This is almost never true with cost-plus contracts. There are normally all sorts of incentives and written into the contract. For example, bonuses might be paid if particular milestones are achieved ahead of schedule, or if certain costs come in below estimates. Also, there are usually limits on reimbursement (typically at the level of components rather than the entire project).

If used properly, these incentives and restrictions make it in the contractor's best interest to control costs. I've never seen them used perfectly, but they're often used reasonably well. I've also seen incentives that were designed so poorly that the contractor just ignored them because they weren't worth the effort to try and earn.

I think the main problem is that cost-plus pricing is often used in circumstances where it is not appropriate. Cost-plus should generally be used only for high-risk projects.

It's not just hypothetical -- Robert Zubrin describes exactly that scenario when he was an engineer at Lockheed and had to watch his inventions shelved because they would have undercut the costs of the existing launch technology, which prompted him to quit and start his own company. (See his outstanding book "Entering Space: Creating a Spacefaring Civilization".)

Sadly this book is not on Kindle.

The bright side is that it can't be drm'ed on paper ;-)

If you were asked to bid on a contract to build the space shuttle, with conflicting and changing requirements from the NSA, Air Force and Nasa, with no guarantee on how many they will buy and no ability to sell to any other customer - you woudn't agree to a fixed price contract!

Especially when it would take years and billions of $ to even estimate what the cost to build it would be.

I don't know why this is getting downvoted. This is pretty much exactly why the government (mostly DOD) uses cost-plus in some cases.

The pendulum in government acquisitions tends to swing along multiple axis: sometimes the trend is towards the government do the integration itself, sometimes the trend is towards contracting out the integration to a prime contractor; sometimes the trend is towards cost-plus, sometimes the trend is towards firm-fixed price. Even though one way of doing things might be more popular at any given time, the other options are always considered and often used.

The choice of reimbursement structure (which is not just binary "cost-plus" or "fixed-price," but rather an entire continuum) is based on risk projections. If you insist on fixed price for a very risky project, contractors will bake that risk into their bids, pricing everything for the worst-case scenario. If you don't get the worst-case scenario, you'll still end up paying for it, in which case you would have been better off under a cost-plus contract. Conversely, if you pick the lowest bidder and they didn't bid conservatively enough, and then you do get the worst case scenario, they might very well run out of money, in which case you have a choice of either granting them more money or cancelling the project and eating the sunk costs when the contractor collapses. So, for high-risk projects, cost-plus is generally the best way to go.

I think that the swinging of the pendulum is due in part to a succession of over-corrections: "We used cost-plus too much and contractors wasted money! Lets use fixed-price as much as possible from now on!" Followed by "We used fixed-price too much and ended up paying too much on most contracts! Lets use cost-plus as much as possible from now on!" and then back the other way. However, I think that it's also driven by cycles of technological development: a lot of technology tends to go through phases where one generation of equipment really pushes the edge of what's feasible, and then the next generation mostly just matures and refines the technology used in the previous generation (e.g. Windows Vista and Windows 7). During those "pushing the edge" phases, risk is higher and so cost-plus gets used more; during the "mature and refine" phases, risk is lower and so fixed-price gets used more.

The only way out is to be crazy enough to build it and then sell it to the government. Risk is increased because you can't sell it any foreign one if your local one decides to make their own.

Then hope that the senator for <different state> doesn't block the purchase unless you agree to build it in their state. There is a reason that Nasa has facilities in 50states and it's not just for the airmiles

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