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Business Risk in Federal Contracting

Business Risk in Federal Contracting. NCMA World Congress 2005. April 25, 2005 John H. Young Vice President, Corporate Contracts and Pricing Northrop Grumman Corporation. Business Risk in Federal Contracting. Third Party Liability Contract Structures - Aligning Risk and Reward

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Business Risk in Federal Contracting

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  1. Business Risk in Federal Contracting NCMA World Congress 2005 April 25, 2005 John H. Young Vice President, Corporate Contracts and Pricing Northrop Grumman Corporation

  2. Business Risk in Federal Contracting • Third Party Liability • Contract Structures - Aligning Risk and Reward • Organizational Conflict Of Interest (OCI)

  3. Business Risk in Federal Contracting • Third Party Liability • Contract Structures - Aligning Risk and Reward • Organizational Conflict Of Interest (OCI)

  4. 3rd Party Liability Post 9-11 THE PROBLEM The Acquisition System, Designed Prior To 9-11, Provides Insufficient Protections Against Catastrophic Liability Of Contractors, Post 9-11. Both Government And Industry Need To Be Creative, Flexible And Innovative In Order To Mitigate Third Party Liability Risks And Ensure Adequate Competition Where Significant 3rd Party Liability Exists. THE SOLUTION

  5. 3rd Party Liability Post 9-11 Potential Risk Mitigation • Extend Coverage Under FAR 52.228-7 “Insurance-Liability To Third Persons” to All Contract Types • Draft Contracts to Maximize Protection Under the Government Contractor Defense • Government and Contractor Jointly Determine Use of COTS • Inclusion of CLIN for Special Insurance Coverage • Government Advocate / Sponsor Safety Act Certification • 85-804 Coverage Where Other Mitigation is Inadequate

  6. Business Risk in Federal Contracting • Third Party Liability • Contract Structures- Aligning Risk and Reward • Organizational Conflict Of Interest (OCI)

  7. Contract Structure Contract Type and Geometry COST TYPE FLATTER SHARELINES FIXED PRICE STEEPER SHARELINES LOW Funding Level HIGH < 100 % Gov’t Independent Cost 100 % BALANCING REWARD RISK Technical Maturity HIGH LOW Program Risk LOW HIGH Aligning Program Characteristics withContract Structure

  8. Apparent Risk-Reward Disconnect in the Defense Business... Industry Revenue Volatility versus Average Operating Margin 1980-2003 (weighted by revenue) CSIS DIIG Analysis 25.0% S&P Pharm & Biotech S&P Software & Services 20.0% Publicly Owned Electric Utilities 15.0% Average Operating Margin (% of revenue) Target Margins Given the Risk S&P 500 S&P Tech Hardware 10.0% S&P Capital Goods DoD Proc & RDT&E Outlay Risk-Reward Disconnect in the Defense Market 5.0% 0.0% 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 Revenue Volatility Index Sources: FactSet, S&P Compustat, Energy Information Administration, Congressional Reports, CSIS Analysis

  9. One Way to Cope, Consolidation Has Generated Stability... Industry Revenue Volatility versus Average Operating Margin, 1980-2003 (weighted by revenue) CSIS DIIG Analysis 25% S&P Pharm & Biotech S&P Software & 20% Services DoD Procurement & Publicly Owned RDT&E Outlays Electric Utilities 15% S&P 500 Average Operating Margin S&P Tech Hardware S&P Capital CSIS 10% Goods Defense Big 5 CSIS Defense Other 5% 0% 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 Revenue Volatility Index Industry Achieved Stability Via Acquisitions – Bought Revenue/Backlog Sources: FactSet, S&P Compustat, Energy Information Administration, National Defense Budget Estimates for FY2004, Company Reports, CSIS Analysis.

  10. Financial Response to the Policy and Market Realities... Sources: FactSet, S&P Compustat, Energy Information Administration, Congressional Reports, CSIS Analysis

  11. Industry “Returned To the Line” Via Acquisition and Cuts in Investment/Capital ... Industry Revenue Volatility versus Cash Flow Return on Investment (HOLT CFROI) 1987-2003 (weighted by invested capital, CSIS DIIG Analysis) MSCI Pharm & Biotech MSCI Software & Services S&P 500 CSIS Defense Big 5 CSIS Defense Other HOLT CFROI MSCI Tech Hardware MSCI Industrials Revenue Volatility Index Sources: FactSet, S&P Compustat, Energy Information Administration, Congressional Reports, CSIS Analysis

  12. Business Risk in Federal Contracting • Third Party Liability • Contract Structures – Aligning Risk and Reward • Organizational Conflict Of Interest (OCI)

  13. Organizational Conflict of Interest (OCI) • Far 9.5 - An OCI Exists When The Nature Of The Work To Be Performed Under Proposed Government Contract May: • Result In An Unfair Competitive Advantage For The Contractor; Or • Impair The Contractor’s Objectivity In Performing The Contract Work

  14. Management Support Services Consultant Or Other Professional Services Contractor Performance Of Or Assistance In Technical Evaluations Systems Engineering And Technical Assistance (SETA) Work Performed By A Contractor That Does Not Have Overall Contractual Responsibility For Development Or Production Where OCIs Are More Likely to Occur

  15. OCI Mitigation Approaches Establishment Of An Employee OCI Awareness And Compliance Program Physical Separation Of Employees Working On OCI Effort Organizational Separation OCI Mitigation Approaches Limitation On Personnel Transfers Controlled Access To Sensitive Information Non-Disclosure Agreements

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