Defense Contract Incentives and the Health of the Defense Industry DAEC October 7, 2003

1. Defense Contract Incentivesand the Health of the Defense IndustryDAECOctober 7, 2003 Mr. Terry Marlow Vice President Government Division

2. Industry Concern • Public statements indicate a perception that program cost and schedule growth results primarily from contractors’ failure to manage performance • Recently issued profit incentive policies may encourage use of high risk contracts too early in program development • Some recent award fee provisions may result in zero fees for minimal cost growth on risky development contracts

4. Industry Position • Industry shares Government’s Desire to Minimize Cost and Schedule Growth • However, major causes are often beyond contractors’ control • Requirement changes • Unforeseen technical challenges • Inadequate budgets • Cost estimate optimism in competition

5. Current Investment Environment Defense-Industrial Initiatives Group AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- 12/1992 12/1993 12/1994 12/1995 12/1996 12/1997 12/1998 12/1999 12/2000 12/2001 12/2002 Source: Factset, S&P Compustat, CSIS Analysis

6. Industry Proposal • Government/Industry Collaboration to Achieve Balance in Services’ Profit Policies • Aggressive Use of Draft RFPs to Facilitate Discussion of Appropriate Contract Incentives Prior to Implementation in a Competitive Solicitation • Permit changes to draft RFPs to accommodate industry comments • We appreciate Navy and Air Force willingness to work with industry to resolve this matter