Procurement: March 12, 2003

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British defense manufacturer BAE took a major fiscal hit when they agreed to fixed price contracts for designing and building three new nuclear subs (the Astute class) and three new naval recon aircraft (Nimrods). The 1990s era contract was originally worth $7.6 billion. The first sub and aircraft were to be in service by 2001. But now the first sub is not expected until 2008 and the first Nimrod won't enter service until 2009. BAE will eat $1.2 billion in cost overruns, but will get another billion dollars to complete the projects, and an incentive plan if they come in under budget, and protection from most losses if they go over budget. The problem with this contract is an old one. Both the sub and aircraft projects involved developing a lot of new technology. But it was politically expedient a decade ago for BAE to offer a fixed price deal. That was fine if they were dealing with predictable risks. But they weren't, and no one at the top in BAE or the government were willing to admit that these fixed price contracts rarely work. And it's not just because of the uncertain cost of new technologies, but because the government usually tries to change the specifications, without wanting to pay for the extra work. As a result, many firms refuse to undertake defense work, or will only do so on contract terms that are practical and fair, not political and hopeless. 

 


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