If I were to make the case for cost-plus contracts I would say that for really important safety stuff, you'd rather the firm overspend than underspend.
For example, a government office building might last 20 years longer and be considerably safer if you give the company building it a cost-plus contract instead of a fixed-price contract.
I don’t know what the right method is, but I do know that American military contractors in WW2 used a cost-plus method of compensation. It seemed to work pretty well, but it may be dependent on a level of patriotism that is only present in huge conflicts like WW2.
“ Freedom's Forge: How American Business Produced Victory in World War” goes into detail on the subject:
I agree with your framing of the risk dynamics leading to a preference for cost-plus paradigms. If the buyer (the government in this case) really wanted to enforce to fixed cost system, wouldn't they need a large pool of willing bidders to participate in the process? I work in a high-tech industry, and while there are lots of innovations possible, and there is a need for clear incentives to drive those innovations, I think they could sometimes be too unpredictable for high-tech bidders to consider fixed costs contracts. What if the R&D team finds unexpected and expensive challenges?
Another solution could be to incentivize bidders with bonus rewards or conditional milestones payments, but assure them that a cost-plus approach will prevent unexpected losses. What do you think?
Yes, they would, or else they would have to offer some sort of insuring of risk. It’s a tradeoff, but one which could be estimated. In some cases, it would be worthwhile, but I can’t say anything more than a direction.
Bonuses founder when the innovation can’t be neatly specified in advance. Also making something the default is meaningful.
One thing to consider is the definite mess of the deliverable. In defense contracts, the government sometimes does not know exactly what it wants. So each bidder’s proposal, if fixed-price, is idiosyncratic. You have to compare more than just price. There is probably a spectrum on this.
If I were to make the case for cost-plus contracts I would say that for really important safety stuff, you'd rather the firm overspend than underspend.
For example, a government office building might last 20 years longer and be considerably safer if you give the company building it a cost-plus contract instead of a fixed-price contract.
This was covered under payoffs not being ascertainable.
I don’t know what the right method is, but I do know that American military contractors in WW2 used a cost-plus method of compensation. It seemed to work pretty well, but it may be dependent on a level of patriotism that is only present in huge conflicts like WW2.
“ Freedom's Forge: How American Business Produced Victory in World War” goes into detail on the subject:
https://www.amazon.com/dp/0812982045/
I agree with your framing of the risk dynamics leading to a preference for cost-plus paradigms. If the buyer (the government in this case) really wanted to enforce to fixed cost system, wouldn't they need a large pool of willing bidders to participate in the process? I work in a high-tech industry, and while there are lots of innovations possible, and there is a need for clear incentives to drive those innovations, I think they could sometimes be too unpredictable for high-tech bidders to consider fixed costs contracts. What if the R&D team finds unexpected and expensive challenges?
Another solution could be to incentivize bidders with bonus rewards or conditional milestones payments, but assure them that a cost-plus approach will prevent unexpected losses. What do you think?
Yes, they would, or else they would have to offer some sort of insuring of risk. It’s a tradeoff, but one which could be estimated. In some cases, it would be worthwhile, but I can’t say anything more than a direction.
Bonuses founder when the innovation can’t be neatly specified in advance. Also making something the default is meaningful.
One thing to consider is the definite mess of the deliverable. In defense contracts, the government sometimes does not know exactly what it wants. So each bidder’s proposal, if fixed-price, is idiosyncratic. You have to compare more than just price. There is probably a spectrum on this.