In praise of outsourcing

Feb. 1, 2004
In the wake of the war in Iraq, following revelations of Halliburton Corp. overcharging the Pentagon for rebuilding the Iraqi oil fields, outsourcing is coming under attack again.

By John Rhea

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WASHINGTON — In the wake of the war in Iraq, following revelations of Halliburton Corp. overcharging the Pentagon for rebuilding the Iraqi oil fields, outsourcing is coming under attack again. This has been a smoldering issue for at least 40 years, by my observation, and I think it's time to speak out in support of this practice.

I hope to do so as a taxpayer and not as an employee of a magazine published for the defense industry. Simply put, it's a matter of dividing up the work to support this country's national defense so that each function is performed by the organization best suited to perform it.

The core competency of the armed forces is warfighting, not all the mundane tasks of logistics support. A century ago, the efficiency expert Frederick Winslow Taylor said, "every job in a company should be accomplished by the lowest-paid person capable of doing it."

I wouldn't go that far, but I think he was on to something. Clearly, the defense establishment is not qualified to produce sophisticated weapon systems. That's why we have a defense industry in this country.

We didn't always have this industry. In the Civil War ships and firearms were produced in government shipyards and arsenals, sort of the government-owned, contractor-operated (GOCO) facilities of their time. During World War II we didn't have any new cars because the automobile industry was operating around the clock producing warplanes for the military.

The latest in a long line of criticisms I've seen came from James Surowiecki, financial columnist for The New Yorker. Writing in the Jan. 12 issue under the revealing title "Army Inc.," Surowiecki excoriates Halliburton, concluding "the notion that the government is fundamentally inefficient and unproductive has become conventional wisdom."

I remember the unfavorable way the economist John Kenneth Galbraith described the conventional wisdom 40-odd years ago in his classic book, The Affluent Society, and I think his skepticism holds true today in this case.

Moreover, I don't think Halliburton or, for that matter, any of the companies in the energy industry is typical of the defense industry. Different economic ground rules apply.

Unlike the somewhat static energy industry, the defense industry has sorted itself out in the post–Cold War period into a three-level entity with a shrinking number of prime contractors at the apex, vendors of commodity components at the base, and in the middle the subsystem integrators that have given the industry its dynamism.

I don't think we can go back to the days of the 1960s, when vertical integration was all the rage. The automobile industry was held up as the classical example, with raw materials pouring into one end of the elaborate factories and cars being driven out the other. Volkswagen ran that idea off the road, and other foreign automakers soon followed.

As a Pentagon reporter in the mid-1970s, during Secretary of Defense Donald Rumsfeld's first tour of duty, I remember being somewhat surprised to see a private security firm handling building security. Surely, the military could secure its own building, I reasoned, but it was simply a case of following Taylor's dictum that each task should be performed at minimum cost.

Those were also the days of the notorious $500 toilet seats, which I thought were more for entertainment value than any substantive indictment of procurement practices. The toilet seats, and many other mundane items bought by the military, were merely overspecified by procurement people who were too timid or unimaginative to tailor the specifications to the function.

The acquisition reforms set in motion by Defense Secretary William Perry in 1994 corrected that situation with what appears to have been minimal discomfort all around and launched the current era of commercial off-the-shelf (COTS) technology.

Even before Perry arrived, I remember some foresighted people were exploring the idea of buying functions from the defense suppliers rather than hardware. One example that sticks in my mind is battlefield radar. The contractors would have the responsibility for keeping the radars operational, even to the point of servicing them on the battlefield, and would be paid accordingly.

That idea never went far for the obvious reason that civilians are not normally exposed to the dangers that are part of the job for uniformed military personnel. Yet, I see the same situation arising again in Iraq, where some employees of a South Korean contractor that was repairing the Iraqi power grid walked off the job after two of their colleagues were killed by guerillas.

The issue isn't in-house vs. contracting out, I submit, but rather the way the outsourcing is managed. The key to any viable outsourcing program is assuring open competition among those firms best qualified to do the job.

This is where Halliburton — headed by Vice President Dick Cheney from 1995 to 2000 — is a legitimate target of criticism. As taxpayers, executives of defense companies should be just as outraged as everybody else.

In that regard, the method of contracting does make a difference. During the Apollo days of the 1960s, NASA officials took great pride in shifting the agency's contracts from the conventional cost-plus-fixed-fee (CPFF) mode, in which the contractors were actually motivated to run up costs in order to maximize their profits, to the more competitive cost-plus-incentive fee (CPIF) and the even more competitive firm-fixed-price (FFP) contracts, in which the contractors had to live by their own initial bids.

Outsourcing has had remarkable success throughout American industry in allowing companies to focus on their core competencies. Rather than rolling it back, I think imaginative executives in the defense industry could explore useful ways to extend this concept into other industries that have traditionally been dominated by in-house government operation. What they would bring to the party, to use the old Silicon Valley metaphor, is their management capabilities and their technology. I think all of us taxpayers would be well served.

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