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Pentagon Plans to Punish Serial Contract Protesters

By Rich Smith - Apr 30, 2016 at 10:13AM

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Which companies are in the crosshairs, and how much will it cost them?

"We expect [defense contract protests] to be rare.
We expect it not to be used frivolously."
-- Secretary of Defense Ashton Carter

Image source: Department of Defense photo by Master Sgt. Ken Hammond, U.S. Air Force, via Wikipedia.

Once the Pentagon acquisitions chief, now its Secretary of Defense, Ashton Carter has long fought the plague of defense contractors protesting contract awards, dragging out the process, and delaying the delivery of needed equipment to soldiers in the field. Mostly to no effect.

In just the past few months, we've seen Lockheed Martin (LMT 0.57%) protest Oshkosh's (OSK -0.41%) contract to build the Army's Joint Light Tactical Vehicle, and Boeing (BA 3.52%) challenge Northrop Grumman's (NOC 1.09%) winning the Air Force B-21 Bomber contract (aka the B-3). Similar examples from past contract disputes are legion.

But now, the Pentagon may finally get the tools it needs to put an end to the practice.

A problem long in the making
For as long as I can remember, Pentagon contract awards have more or less followed the following schedule:

  • First, the Pentagon invites companies to bid on a contract.
  • Next, the companies submit their bids.
  • The Pentagon picks a winner, and finally...
  • ...the winner executes the contract, the losers protest the award, the losers file a lawsuit challenging the denial of their protest, the losers appeal the rejection of their lawsuit, and the winner -- finally -- gets to execute the contract.

Of course, by that time, six months have passed, the contract "winner" has had to reduce revenue guidance, and possibly take a charge to earnings to account for the delay -- and the troops still don't have the weapons they were promised. It's a fiasco of a system, and it has to end.

A do-nothing Congress prepares to do something
Last week, House Armed Services Committee Chairman Mac Thornberry (R-Texas) announced plans to fix this mess. During the next several days, Thornberry and his colleagues will "debate" inserting into the 2017 National Defense Authorization Act new rules to require a defense contractor who protests a contract award to a rival and loses that protest to pay a penalty for its obstructionism.

One such penalty might be to fine unsuccessful protestors. That, however, would make the protest process an exercise in mathematics. A contractor will consider the fine, weigh whether it can do enough damage to a rival by protesting or have a good-enough chance of succeeding in its protest to make risking the fine worthwhile, and proceed based on the results of that calculation.

An alternative, more persuasive penalty might be to ban serial protestors from bidding on future contracts, potentially imposing a much higher cost on recalcitrance. But so far, no one seems to be talking about doing that.

Who's at risk?
Whether anything substantive emerges from Congress's debate remains to be seen. But assuming it does, which companies are at risk of getting hit with penalties?

Actually, probably most of them. All the big companies, from Boeing and Lockheed Martin on down, play this game -- sometimes as protestor, other times as protestee. While Lockheed Martin protested Oshkosh's JLTV win last year, in 2008, it was Lockheed getting protested against -- by Oshkosh and Northrop Grumman -- on a previous JLTV contract. Simply put, everyone in the defense business has something to gain, and something else to lose, if Congress permits the Pentagon to penalize serial contract protestors.

In the end, I suspect that permitting the penalization of frivolous challenges to DoD awards would have a net-zero effect on the contractors. But investors will get better visibility into their investments' revenue streams, and soldiers on the line will get their equipment faster. For us and for them, penalties pose a "risk" that really has no downside.

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Stocks Mentioned

The Boeing Company Stock Quote
The Boeing Company
BA
$132.23 (3.52%) $4.50
Lockheed Martin Corporation Stock Quote
Lockheed Martin Corporation
LMT
$450.56 (0.57%) $2.57
Oshkosh Corporation Stock Quote
Oshkosh Corporation
OSK
$92.61 (-0.41%) $0.38
Northrop Grumman Corporation Stock Quote
Northrop Grumman Corporation
NOC
$470.76 (1.09%) $5.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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