Thursday, January 25, 2018

External Restructuring Costs

Defense contractors sometimes consolidate and then restructure to reduce operating costs. Reducing operating costs will then reduce contract costs. At least that's the theory. Back in 1994, Legislation was passed whereby the Defense Department would pick up some of the increased costs so long as contractors could demonstrate either (i) a 2:1 return on investment or (2) that the return would exceed the cost and the business combination would result in the preservation of critical capability that might otherwise be lost to the Defense Department. DoD formulated procurement regulations to go along with the legislation. Those regulations can be found in the DoD FAR Supplement at 231.205-70, External Restructuring Costs.

Recently, Bloomberg published an article discussing Lockheed Martin's proposal for reimbursement of restructuring costs and some of the difficulties Lockheed is encountering is demonstrating a 2:1 return on the Government's investment . You can read the Bloomberg article here.

In 2015, Lockheed Martin purchased Sikorsky Aircraft from United Technologies for $9 billion. Lockheed then submitted a proposal asking DoD to reimburse $212 million in restructuring costs. In return, Lockheed said that it would save taxpayers eight times that amount over the next five years.

DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) are now auditing the proposal and have raised some concerns. According to DCMA, Lockheed's "rationale for proposed savings does not appear to meet the required definition of external restructuring activities". Lockheed has not been able to demonstrate those projected savings are truely the result of external restructuring. The Government thinks that many of the savings are routine or ongoing repositions and deployments of workers or facilities - which do not meet the definition of restructuring activities.

According to DFARS 231.205-70, restructuring costs must be identified as a direct outgrowth of a business combination. A restructuring activity  must be a nonroutine, nonrecurring, or extraordinay activity to combine facilities, operations, or workforce in order to eliminate redundant capabilities, improve future operations, and to reduce overall costs.

It will be interesting to watch this matter develop and find whether the Defense Department is comfortable forking over $212 million in exchange for an estimate of projected savings.

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