The Department of Defense’s entrenched procurement model is characterized by high costs, low volumes, and sole-source contracts. Given the demands of modern warfare, it represents a critical vulnerability in the US defense apparatus, particularly against peer and near-peer adversaries. As we have recently outlined, the DOD needs a paradigm shift in procurement practices that utilizes free market principles—transparent pricing, open competition, enforceable contracts, and supply-demand dynamics—to foster a competitive and innovative defense industrial base.

　　The Challenge

　　The DOD has ended up in a self-defeating trap wherein it spends heavily on RD in a way that works well for generating technical overmatch, differentiation, and exquisite capability, but fails utterly for the low-cost production of commodity parts at scale. A great deal of thought has gone into the problem of reforming the DOD purchasing system in order to acquire weapons and platforms at lower cost and to get them into the field faster. As one of the present authors recently observed, the price of advanced munitions is drastically increased by “a highly bureaucratic, antiquated manufacturing and contracting system.” As a result:

　　a Tomahawk missile costs $1.5-2M today, the United States only has about 4,000 of them, and the supply is likely to shrink to less than 1000 units as part of an ongoing modernization program. Similarly, a modern torpedo costs as much as several million dollars. Lightweight Mark 54 systems are cheaper but still in the million dollar per unit range, a Harpoon anti-ship missile costs $1.5M, and Patriot anti-aircraft missile unit costs are in the $4M range.

　　This system sufficed in a world where the main goal of the defense industrial base was the generation of technical differentiation and overmatch of non-peer adversaries, and where cost was not a decisive source of differentiated advantage. A defense acquisitions culture that gave a very small number of contractors the room to develop very high-performance systems, in small volumes, made sense in this context. And scaling the production of munitions on the assumption that the US would be fighting small wars against non-peer adversaries meant that even a modest capacity for production would be adequate for replenishing reserves between wars.

　　This is not the world in which we live today. We are fighting, once again—through proxies and allies for now—peer and near-peer adversaries. And we are failing to provide our proxies with the means to achieve swift and decisive victories. This is in no small part because we are hesitating to deplete our own stockpiles of key munitions. Our capacity to replenish these munitions is simply not up to the task of supporting long wars against Russia, China, Iran, and their various allies and proxies, particularly as these wars involve Large-Scale Combat Operations (LSCO).

　　Today, we behave like autocrats in our DOD purchasing, implementing many of the worst aspects of a top-down, centrally planned, limited-sourced, monopolistic acquisitions system. In fact, the autocrats are outperforming us. Russia’s economy, in GDP terms, is roughly comparable to that of Mexico. It is unreasonable that Russia should be able to go toe to toe with NATO in terms of output of drones and munitions. But Russia, with help from their Chinese and Iranian allies, is outstripping the West in the production of munitions and consumables.

　　We should be leveraging the power of capitalism and free markets to drive down costs and increase capacity. That means more than just signing new contracts with the same old DOD primes. It means a fundamentally different attitude toward building military systems and consumables.

　　Changing the Business Model

　　There’s a different business model for building these parts that the DOD should explore, where the DOD seeks to act as a good customer. By being a good customer, the DOD will be able to leverage innovation, capital, expertise, and competence from industry in order to dramatically improve availability of both commodity and advanced munitions to the warfighter.

　　But, one might ask, why bother? Does cost matter? History suggests that it does. When fighting near-peer or peer adversaries in conventional conflicts, all things being equal, the side that can arm more men with more and better weapons, and faster, is more likely to win. That means that the side that’s able to generate to-scale quantities of quality armaments at a low price has a decisive advantage, especially in any war of attrition. If the goal is to spend the adversary into oblivion, and the two economies are roughly the same size, the side that generates munitions and military systems at a lower cost and higher quality has a decisive advantage.

　　We have a tool at our disposal for doing this that our adversaries do not: the free market. It’s time we started to use it. Four characteristics of the free market are particularly relevant: transparent pricing, enforceable contracts, open competition, and prices determined by supply and demand.

　　The DOD’s own fickle behavior invites this monopoly trap. It tends to preserve the right to cancel contracts for any or no reason and with little or no warning.

　　For existing, incumbent military systems and components, it should be relatively easy to generate all of these conditions. Note that while aspects of this reasoning also apply to cutting-edge programs aimed at generating technical differentiation and capability overmatch, what we are talking about below is primarily focused on ways to improve the cost and availability of commodities, legacy consumables, and components. In particular, we are focused on military systems that have already been introduced, and for which any upgrades have been exclusive to subsystems that can be easily swapped out, such as new software or new chips in a guidance module. Typically, these systems or munitions will have been expended in the field for many years, and their detailed capabilities and specifications will have been extensively reverse-engineered already by our main adversaries, so the need for sole-sourcing and very tight information security will be greatly mitigated.

　　Being a Better Customer

　　What does it mean for the DOD to be a good customer? It means understanding the constraints and pressures on its vendors and designing its contracts and interactions in such a way that its vendors are likely to be successful, even if doing so requires that the DOD change political and financial incentives within the organization. In the business world, when depending on highly specialized suppliers, the customer has to be very careful. It’s not enough for the customer to seek the most expedient supplier; in many cases, the customer must negotiate the viability of an ecosystem of vendors to make sure that multiple vendors remain viable and that a monopoly trap does not emerge. The DOD has repeatedly fallen into this trap. And of course, once the DOD is stuck behind a monopoly, prices rise almost without limit, and lobbying generates regulatory capture, making it all the more difficult to break these monopolies.

　　The DOD’s fickle behavior invites this monopoly trap. It tends to preserve the right to cancel contracts for any or no reason and with little or no warning. This feature drives down trust while driving up costs which only the most seasoned and well-staffed contractors can satisfy. The regulations within DOD contracts are so extensive and complex that compliance, even for businesses that are pursuing very conventional business models, becomes a significant source of risk. What is more, the requirements and specifications for the program or product often change over time. In a world where building a piece of hardware can take a couple of years from design to production ramp, changing significant requirements at any faster frequency creates devastating delays and essentially resets the program clock to the design phase. Equally detrimental to innovative startups and small businesses, the DOD takes a long time to pay invoices: The pay schedule is unpredictable, and the process of getting paid is so byzantine as to be a full-time job. Finally, when there is congressional budget chaos, DOD is forced to cancel programs and put other programs on hold. This kills innovative startups and small businesses that cannot obtain bridge financing and don’t have multiple months of cash on hand.

　　A customer that insists on behaving in these ways necessarily ends up, in any commercial relationship, being forced into paying for the full development cost of their programs. Asking commercial vendors to find financing from commercial sources given these criteria is nearly impossible.

　　There is, however, an entirely different model, which the DOD should consider for many of its programs. In this model, the DOD would focus on being a good customer, permitting it to entrain the commercial economic benefits of competition. This would entail embracing a number of changes.

　　First, the DOD should embrace time-definite programs. In corporate America, time is the most expensive commodity. The lack of certainty as to when a program will be awarded, how long it will take to get under contract, and what the size of the program will be are all very effective deterrents to commercial organizations engaging with the DOD. Even SBIR funding, which is supposed to be startup-oriented, can take years to be awarded and to get a check cut. It would be better for the DOD to make a habit, when opening bidding for new programs, to always indicate (a) how much funding has been allocated, (b) how long it will take to select awardees, and (c) how many awards they anticipate. Committing to making very fast decisions and then sticking to that commitment, would vastly improve the aggregate performance of DOD-sponsored programs.

　　Second, the DOD should act as a market-maker. For commodity components—say, generic 155mm shells and their components—the DOD could establish an international market among allies where pricing and forecasts are transparent to both vendors and customers. Transparent pricing would encourage new entrants to the market. Furthermore, allowing transparent, public bidding on price, at least within the community, would create a commercial-style dynamic that drives vendors to reduce pricing. The DOD could act as a market-maker by forecasting demand and auctioning off the deliverable contracts with appropriate lead time. Consumables like ammunition should be liquid markets, with all the features of any other commodities market—but with some basic guard rails to protect the national interest and promote appropriate levels of confidentiality.

　　Third, DOD could leverage prestige more effectively. An under-appreciated superpower of the DOD and NATO is the ability to confer prestige and credibility for free, or very inexpensively, on people who might want to work in the defense sector. Very small awards for graduate (and even undergraduate) students or young entrepreneurs, sponsorship of hackathons with prizes for the best results, and coding competitions can be organized with extremely low overhead. There are many talented young people willing to work for low costs who just need a bit of direction.

　　Fourth, DOD must also start matching programs for investment. If the DOD wants more venture and commercial investment in projects intended to serve the DOD, one of the best ways to do that would be to create a mechanism where any VC-backed startup can get their funding matched pro rata. Such a matching program would create a frenzy of venture investment in DOD-relevant activities, assuming that the go/no-go decisions could be made on commercial timelines, i.e., within only a couple of weeks. The decisions about who is qualified would need to be made in advance of the company raising their VC funding, so that they could use it as leverage with investors.

　　If the DOD can move out of the mode of monopsony and monopoly, it will become possible to fully leverage the power of competition.

　　Fifth, along similar lines, DOD can create radically simplified contractual vehicles. Developing very simple contracts that do not include FAR flow-downs or special auditing requirements, and that do not require transfer of IP rights, would greatly aid small and medium businesses in interacting with DOD.

　　One of the most powerful mechanisms that the DOD can employ is a take-or-pay contract structure. In essence, this is a structure where DOD contracts to buy a fixed number of parts, at a fixed price, by a certain date—typically on a rolling basis, with an associated increase in volume and decrease in price. If the parts aren’t delivered or don’t meet specifications, then the DOD does not pay. If the parts are delivered, but DOD no longer needs them, DOD is still obligated to either buy them or pay a significant penalty. All of the implementation and financial risk in such an arrangement lives with the company—they have to raise the money to stand up production. For new entrants trying to build either commodity components or devices where a clear and simple specification and test regimen can be articulated, such a contract gives the supplier assurance that if they’re successful, they’ll get paid. Offering contracts like this to small and medium-sized enterprises (SME’s) eliminates the risk associated with product-market fit and will enable them to raise large amounts of money rapidly to finance RD or capital investments to drive cost reductions. The key with such a program is that the requirements cannot change. If a new requirement emerges, it needs to be a new program, bid separately.

　　Sixth, one of the best strategies DOD can employ is to welcome failure. One nice feature of take-or-pay contracts is that if the program fails, there’s no direct cost to the taxpayer. Of course, if multiple programs fail, then the DOD can end up not getting the parts that they need. But allocating 10 or 20 percent of the spend on a major defense commodity to these kinds of programs, and splitting it among two to five new vendors, will often yield one or two successes. And if the cost reduction goals are set appropriately, those vendors are then able to force incumbent vendors to drive down their own costs. This kind of program will work especially well for commodities where there is little or no “invention” required.

　　Finally, DOD can establish a Cost Abatement and Reduction Projects Administration (C-ARPA). One thing that we’ve seen in recent wars is that being able to rapidly surge capacity for munitions, drones, and other expendable defense articles is critical to the defense of ourselves and our allies. Creating an ARPA organization solely responsible for driving cost reduction is more than warranted. This organization should have broad contracting authority, and its success should be measured in terms of driving down prices to the DOD for a wide variety of defense articles and systems. This could include anything from expendable drones to small arms to artillery shells to entire Arleigh Burke class destroyers.

　　All of this is not to say that DOD should exit the basic research business: Basic research is critical. But production cost reduction is a different game than basic research and the generation of highly differentiated, asymmetric technical capability. In the commodity end of the DOD purchasing universe, the key asymmetries that should be captured are dramatic cost reductions, increased competition, and capacity improvements.

　　Remaking the “Arsenal of Democracy”

　　Industry thrives on open markets, contractual certainty, and transparent pricing. If the DOD can move out of the mode of monopsony and monopoly, and give up its addiction to sole-sourcing, it will become possible to fully leverage the power of competition and the free market for defense acquisitions. This will be especially effective if DOD can make it easy to both buy from and sell to our allies, through the use of whitelists.

　　This is not a matter of forcing vendors of cutting-edge hardware to cross-license their most advanced designs to competitors, though such expedients can be perfectly justifiable in wartime. This is instead about identifying commodity parts, where the specs and requirements are well-understood and mature, and allowing market forces to drive prices down and volumes up. For more advanced consumables and systems, the key is to mature them with DOD RD dollars to the point where a clear specification and set of requirements can be furnished to multiple vendors. This sort of program will be challenging for the most advanced systems, but for everything else, this should be eminently possible. If the ability to surge capacity is important—as it should be—contracts can specify the need to install and demonstrate spare capacity, by buying options on the delivery of larger volumes of parts in the future.

　　Our current purchasing system is not fit for purpose to produce the equipment or the manufacturing infrastructure that we need to fight today’s wars, let alone the wars of tomorrow. It’s time for radical changes, and those radical changes need to leverage the free market, rather than diving into a statist, monopsonist, bureaucratic sink-hole of regulation and inefficiency.

　　(See here for a longer, more detailed version of this essay.)