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to the acquisition of major weapon systems, which largely employ similar outsourcing
relationships.
The standard example is where ex-ante competitive bidding leads to an ex-post
bilateral monopoly situation. The risk is that the winning supplier can lock-in the government
by making investments in productive assets that are specific to the relationship (and that
have little value outside the relationship). While initially advantageous, such investments in
specific assets can make it prohibitively costly for other companies to compete in
subsequent re-bidding of the contract. As a result, outsourcing relationships can involve
extra transaction costs such as measurement, monitoring, and negotiation costs that can
quickly overwhelm a simple 10% production cost advantage.
The lesson is that transaction cost considerations need to be added to the current
exclusive focus on production costs in OMB Circular A-76. This also suggests more
attention be granted to: the proper bundling of goods and services; investing in a welldefined
Performance-Work Statement; clearly defining the terms of the contract—to include
appropriate incentives; understanding the true costs of the transaction; and carefully
designing mechanisms that will govern the outsourcing relationship. The next step is to
extend these insights to DoD acquisition management practices.3
C) Outline of the Report
Section 2 of this report offers a summary and synthesis of the TCE literature. It
explores the issues of incentives built into contracts, hedged (or tapered) outsourcing, and
issues of governance. Section 3 presents a description of the principle components of
defense acquisition transactions that are the most typical: research & development and
procurement of weapon systems, along with a summary and synthesis of associated
practices in defense acquisition management—to include contract structure and governance
of the relationship. Finally, Section 4 offers a synthesis of these two bodies of knowledge. It
considers similarities and differences in perspectives and explores possibilities for mutually
beneficial sharing of concepts. The section concludes with proposals based on applying
TCE principles and insights to DoD acquisitions.
3 To do so requires collaboration with those having a practitioner’s expertise in this area. This
occurred when our co-author John Dillard joined this research project. He is largely responsible for
the comprehensive review of transaction components and current practices described in Section 3 of
the study.
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