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Four Trains Running: The Race to Unscramble Technology Procurement

All the great quotes come from the great villains. For example the archenemy in the Dudley Doright cartoons, Snidely Whiplash, who delighted in roping the heroine to the railroad tracks, said: “It's hard to sneak up on somebody with a train.” However we respectfully disagree, because for the past six months there have been four trains running headlong toward a crash that will change the fundamentals of Federal R&D contracting, but very few professionals in the industry see the collision coming.

The four trains in question are separate Government initiatives that were launched at different times and by different agencies, each to meet critical objectives or to comply with legislative mandates, each representing a major shift in the way DOD buys technology. In combination, these four initiatives may be transformational, with significant risk to both Government and its suppliers.

Train #1: DOD initiatives to access commercial technologies and alternative suppliers

The first, and most widely publicized, initiative comes from the highest levels of DOD, with extensive involvement from Undersecretary of Defense for Acquisition, Technology, and Logistics (AT&L), Frank Kendall; Deputy Secretary of Defense, Robert Work; and Secretary of Defense, Ashton Carter. The objective, to accelerate and improve DOD access to R&D and technology, was articulated by Secretary of Defense Ashton Carter in a speech last month:

“I often say that we in the Pentagon need to think outside our five-sided box. Because innovation is happening all over the country...DOD has to tap into all those streams of innovation and emerging technology, and it has to do so much more quickly…”

To accelerate and increase engagement with the commercial technology sector, DOD has established an office in Silicon Valley called Defense Innovation Unit X (DIUx), to identify breakthrough and emerging technologies and help commercial industry find new ways to work with the military. This initiative was followed quickly by formal policy direction from both Kendall and Work changing the guidance on conferences and forums to encourage increased government interaction and participation in technology forums and events.

Announcement of these initiatives drew a mixed reaction from the traditional Defense contractors and from the trade press. Some wondered aloud whether the DOD relationship with these more agile commercial firms was a competitive threat to the traditional contractors. Others noted that the procurement system is made for large capital expenditures, not for agility or adaptability.

Even the more streamlined commercial item regulations (FAR Part 12) include requirements that are either unique to Government contracting or may be handled differently in commercial vs Federal:

•  Reporting of executive compensation

•  Service Contract Act

•  Limitations on subcontracting

•  Utilization of Small Business concerns

•  Combatting trafficking in persons

At a minimum, start-up companies and commercial technology companies would need to make significant changes to internal policies and procedures in order to operate within the Federal acquisition system. This baseline requirements grow more complex as the Government continues to add additional regulations.

Train #2: Changes to Independent Research and Development (IRAD) rules

At the same time that DOD was reaching out to non-traditional contractors, changes were being made to the technology approach in the traditional defense marketplace. In the April 9, 2015 launch of the Better Buying Power 3.0 (BBP3) initiative, DOD introduced new guidelines to require endorsement from “an appropriate technical DOD sponsor” prior to initiation of a company IRAD project and a written report to the Government of research results obtained following the completion of the research. The stated reason for tightening the IRAD rules was that “a high fraction of IRAD is being spent on near-term competitive opportunities and on de minimis investments primarily intended to create intellectual property.”

This element of the new BBP3 was immediately controversial, with industry objecting to the loss of control and potential delay resulting from the new DOD sponsorship process. Mr. Kendall was more reassuring:

“People have overreacted to my initiative a little bit. I'm not going to make any fundamental changes…I'm looking for a little bit more of a check on what industry is doing to make sure it's technically meaningful work…But I want to do that with as light a touch as I can have. I don't want to create a whole new bureaucracy and I don't want industry to have to wait for government approval before they can do something.”

Within the framework of BBP3 the DOD objective is to shift the IRAD emphasis of the Defense companies from competitive advantage toward military capability. The exact shape of the formal rulemaking that results from BBP3 will determine the degree of Government engagement and the specific controls imposed.

Train #3: Changes to commerciality rules

So if the technology strategy of DOD is to gain greater access to commercial technologies while simultaneously gaining stronger oversight of defense technologies, where is the conflict? These objectives could only become conflicted if the distinctions between commercial and defense became scrambled in the regulations. Here comes the third train.

This train originates in legislation: Section 831 of the National Defense Authorization Act for FY2013 required DOD to issue guidance and provide training related to the information contracting officers may request to determine the reasonableness of contract prices. The legislation also required the General Accounting Office (GAO) to make an assessment of the extent that DOD needed cost data to assess the reasonableness of prices.

The resulting GAO report (GAO-15-680 dated August 2015) found that in a sample of 32 commercial contracts, contracting officers asked for supplementary information in a minority of cases (12), and for detailed cost or pricing information in only 6 cases. This might be somewhat comforting except that 6/32 (19%) in the overall scale of all commercial sales to the government would be a very large number of transactions.

To fulfill its statutory obligation to issue new guidance, the DOD published a new proposed rule (DFARS Case 2013-D034) on August 3, 2015. In commercial contracting the major changes were the introduction of a new commerciality standard (Market-based pricing) and a preponderance test (50 percent or more to nongovernmental buyers) to qualify for commerciality. This rule met with strong negative criticism from industry trade associations and also from Senator John McCain. The extensive and detailed industry critique focuses on the switch from the 1994 Federal Acquisition Streamlining Act definition of “items sold in substantial quantities” to an undefined Market-based pricing with a percentage test. Critics of the new proposed rule point out that the new and narrower commerciality definition is at odds with the DOD efforts for increased engagement with high-technology commercial firms, expansion of ongoing government venture capital efforts to defense, and creation of the Defense Innovation Unit Experimental (DUIx).

The negative reaction to the proposed rule underscores the conflict between the technology outreach from the senior leadership of DOD and the complex regulatory environment imposed at the working level. The effect of these contradictions could be far-reaching restrictions on DOD access to technology and the cost of developing defense products…

…but wait, there's more.

Train #4: New ITAR regulations

Into this complex DOD scenario comes an additional factor in the form of new State Department revisions to the International Traffic in Arms Regulations (ITAR). The new ITAR Proposed Rule on June 3, 2015 changes the ITAR definitions of defense article, defense services, and technical data, among numerous other changes. Within these definitions: “…software is added to the list of things that are a “defense article” because software is being removed from the definition of “technical data.” This is not a substantive change.” [Emphasis added]

The lack of mention of this provision from the industry export experts who commented initially on this rule suggests that the traditional defense companies were also comfortable that moving software from one part of the regulation to the other was not substantive. In the historic context where the primary defense software is software embedded in weapons systems, this would make perfect sense.

However, in context of the new DOD initiatives for closer engagement and involvement with the technology industry, the new State Department definition deserves a closer reading. The new ITAR software section 120.6(b) reads:

“The following are not defense articles and thus not subject to the ITAR: Information and software that are in the public domain, as described in ITAR part 120.11, arise during or result from fundamental research as described in ITAR part 120.46, concern general scientific, mathematical, or engineering principles commonly taught in schools, and released by instruction in a catalog course or associated teaching laboratory of an academic institution, or appear in patents or open (published) patent applications available from or at any patent office, unless covered by an invention secrecy order.”

This definition represents the fourth train in the train wreck: the potential for commercial software developed in cooperation with DOD to fail the ITAR test, or the commerciality test, or both. More importantly this raises the question why a company that was developing commercial technology, including software, independently in the normal course of business would be subjected to these tests merely because it elected to cooperate with the DOD on a particular project.

Summary

So the four trains are running, each at full speed and each on its own track. Individually, each initiative is powered by a strong public need to access technology, to assure that Government investment is militarily significant, to avoid overpaying for commercial products, to protect national security in a world of cyber threats. However, when the trains collide, the results could cause great harm to the contractor, whether traditional or non-traditional.

In the worst case scenario, the Government acknowledges that its suppliers are Global enterprises, but no matter how small the Government investment or participation in a project, the technology research would be:

•  Subject to Government scrutiny and pre-approval of the technology project, and

•  Once the project is complete, the Government could restrict or retain the intellectual property, and

•  Even if the company retains the intellectual property, the Government could restrict or prevent sales of the technology to Global customers

All four of these initiatives are proposed, none are finalized. In some cases pending legislation could further reshape the policy direction. DOD has expressed a strong willingness to be flexible and collaborative. For example, regarding Better Buying Power 3.0 and the IRAD issue, Mr. Kendall has said “We're still doing some internal debating. We'll share our ideas with industry before we do anything.” Hopefully this collaborative philosophy will also apply to technology, commerciality, and ITAR, so that during the Final Rulemaking process all trains lead to a common objective and not to a collision.

Also, if it is hard to sneak up on somebody with only one train, industry should be paying closer attention to these four.