How the Defense Industry Price Gouges the Pentagon
As a matter of practice, military contractors have overcharged the Pentagon for years—at the expense of both taxpayers and the military.
However, several members of Congress are working to end the practice. Last year, Senators Warren (D-MA), Braun (R-IN), and Grassley (R-IA) teamed up with Reps. Garamendi (D-CA) and Deluzio (D-PA) to introduce legislation that will address the legal loopholes that enable military price gouging.
Acquisition experts understand these loopholes well, but unfortunately, most lawmakers are still unaware of how common it is for contractors to overcharge the military. Without a better understanding of the true scale of military price gouging, Congress is unlikely to pass legislation to prevent it.
That’s why Congress should include in the final FY 2025 defense policy bill Rep. Doggett’s (D-TX) provision to investigate potential overcharging by sole-source suppliers of military products and services. Due to unchallenged market power, sole-source contractors are well positioned to profiteer. Doggett’s provision would establish a panel to review sole-source military contracts and “determine whether the Department of Defense paid fair and reasonable prices.” By focusing on sole-source contracts, the panel would shine much-needed light on the issue of military price gouging writ large, the scale of which is near impossible to discern because so much of it is legal.
Over the course of decades, military contractors have consolidated and harnessed market power to slowly obscure military price gouging. Industry consolidation began when the Cold War ended, and the Clinton administration slashed defense spending. However, as Richard Loeb—former Executive Secretary and Counsel of the Cost Accounting Standards Board in the Office of Management and Budget—has pointed out, the administration simultaneously catalyzed an era of “acquisition reform” to protect contractor profits even as defense spending plummeted and the number of prime military contractors shrank from over fifty to just five. Merger mania has continued, further concentrating market power among the few. Military contractors wield that power on Capitol Hill, lobbying Congress to gradually chip away at acquisition laws designed to protect the government from unfair pricing schemes on military contracts. In so doing, lawmakers have left the Pentagon in the dark about contract negotiations with the defense industry.
Acquisition reform and industry consolidation have helped contractors overbill the military in pursuit of excess profits. As a result, military contractors have overcharged the Pentagon to the tune of hundreds of millions of dollars on a single program, generating nearly 40 percent in excess profits. Indeed, a CBS investigation last year revealed that the Pentagon saved $550 million on the Patriot PAC-3 missile after conducting a 2015 cost review of Lockheed Martin and Boeing’s previous work on the program. Both contractors are repeat offenders, and they have long been among the top five prime contractors dominating the defense industry. The Pentagon’s internal watchdog exposed Boeing for inflating prices on spare parts in 2013 and 2011. In one case, the company charged over 177,000 percent above the fair and reasonable price for a helicopter spare part—$71.01 for a tiny metal pin worth 4 cents at the time. The trend continues. Just last month, two Lockheed subsidiaries agreed to a $70 million settlement with the Navy for doing the same thing—inflating prices on spare parts.
The Pentagon can’t negotiate reasonable prices with military contractors because it doesn’t have sufficient bargaining power. Contractors are often exempt from providing the Pentagon with “certified cost or pricing data.” Without this information, the Pentagon has little idea what companies’ costs are and, thus, what their profit margins might look like. Contracts may be valued below the mandatory disclosure threshold. Contractors may also produce a product that’s considered commercial—and theoretically, price competitive. However, the statutory definition of “commercial” is overly broad, encompassing products that aren’t sold to the public and sometimes never have been. Lawmakers expanded the commercial definition and raised the mandatory disclosure threshold for certified data at the behest of industry and under the guise of cutting red tape.
Without legal requirements for certified data, the Pentagon may ask contractors for historic or uncertified cost and pricing data. Yet, the Pentagon has few tools to ensure that this data meets requisite standards; among them, these include “the minimum information necessary to permit a determination that the proposed price is fair and reasonable.” According to the Pentagon, current statutory and regulatory requirements discourage officials from requesting uncertified data. Instead, contracting officers often rely on historical cost and pricing data. Still, according to the Pentagon Inspector General, the department cannot evaluate price reasonableness “based solely on historical price comparison.” This is particularly concerning given the watchdog’s extensive analysis of contract pricing in recent years, which shows that price analysis methods like historical cost comparison enable “sole source contractors to earn excess profits without detection by contracting officers.” Effectively, military contractors can provide the Pentagon with any cost figures without consequence—even if they give zero indication of how reasonable current prices are. In other words, contractors can price gouge the military legally, likely under the government’s radar.
Still, the defense industry appears to resist almost any attempt by the Pentagon to evaluate contract price reasonableness. “Sweeping” is a process through which contractors overwhelm the Pentagon with cost and pricing data that was “reasonably available at the time of price agreement” but submitted after the fact. According to Senator Warren, contractors often sweep the Pentagon after price agreements and before contract awards to absolve themselves of the liabilities associated with breaking acquisition law and potentially “to hide data that might give the [Pentagon] a better price.” In other cases, contractors outright refuse to provide the Pentagon cost and pricing data, claim they can’t share it, or delay the provision of such data to the extent that the Pentagon may blindly agree to a contract price due to time sensitivity. So, the Pentagon doesn’t just struggle to obtain certified cost and pricing data. It’s a challenge to get any cost and pricing data—even from sole-source contractors, which are relatively uninhibited by the forces driving price competition.
The Pentagon has admitted that data denials “may be more prevalent [than reported], particularly with respect to sole source commercial items.” This is especially nefarious in a market that looks like a monopsony but operates like a monopoly, where sole-source contractors reign as kings. They have a documented history of refusing to provide even uncertified cost and pricing information. Since 1998, the Pentagon’s Inspector General has published several reports detailing data denials by sole-source contractors. TransDigm, Inc. is the most recent example and perhaps the most notorious. According to the Pentagon, the company “accounted for all Defense Logistics Agency cost and pricing data denials” in FY 2022. The company failed to respond to 401 requests for cost and pricing data from the agency, and that was after the Pentagon Inspector General exposed TransDigm for twice price gouging the Pentagon. The contractor generated a total of nearly $40 million in excess profits.
Ultimately, withholding cost and pricing data bolsters a contractor’s ability to increase profits by charging the Pentagon unfair and unreasonable prices. However, the defense industry already significantly outperforms other industries financially, and this is not just because the United States spends over a trillion dollars annually on national security. In many cases, the Pentagon reimburses contractors for research and development costs. It will even cover some capital costs, including those associated with the depreciation of assets like machinery and equipment. As a result, military contractors enjoy returns on assets and invested capital that are difficult to achieve in other industries where companies make those investments themselves. Still, military contractors leverage special treatment from the government to increase executive compensation and cash paid to shareholders, even at the expense of capital investment and internal research and development.
If the defense industry continues to consolidate, it will only get harder for the Pentagon to negotiate fair prices with military contractors. The department will have to rely on more and more sole-source contractors, which not only increases the risk of overcharging but also presents national security risks, like supply chain vulnerability and reduced availability of certain resources. The entire nuclear triad is already dependent on one company, Northrop Grumman. As far as U.S. contractors go, General Dynamics manufactures a significant portion of tracked combat vehicles. Boeing, Lockheed Martin, and Northrop Grumman produce the military’s fixed-wing aircraft. The distillation of the defense industry to a handful of companies bodes poorly for both the military and taxpayer because it produces waste, not to mention a strong profit incentive for war.
As the defense industry’s primary customer and a steward of taxpayer dollars, the Pentagon needs to be a stronger buyer. However, the never-ending acquisition reform continues to prevent that. Current laws are insufficient even to document price gouging by military contractors, much less prevent or remedy it. If retained in the final defense policy bill, Rep. Doggett’s provision would help the Pentagon better understand the scope of overcharging by sole source contractors—and ultimately, give lawmakers the information they need to hold industry accountable for overcharging the government at the expense of the taxpayer.
Julia Gledhill is a Research Associate for the National Security Reform Program at The Stimson Center. She focuses her research and writing on Pentagon spending, military contracting, and acquisition. In previous roles at the Project On Government Oversight and the Friends Committee on National Legislation, Julia worked on various national security issues related to Pentagon accountability, war powers, civilian protection, drone policy, the torture program, and U.S. lethal strikes.
Image: Mehmet Ali Poyraz / Shutterstock.com.