The Case of the Profitable Bloodhound

Abstract

The pricing of defence contracts is a matter that has attracted much attention on both sides of the Atlantic in recent years. In the United States, the Secretary of Defence, Mr. Robert McNamara, has made a great effort to reduce the cost to the government of equipment bought from private manufacturers. He has advocated a greater use of fixedprice contracts in which the contractor has an incentive to keep his costs down since he retains all his cost savings in addition to the agreed profit. In order to induce manufacturers to accept such contracts, Mr. McNamara is prepared to allow a widening of profit margins to a maximum of 25% on cost in exceptional circumstances. He believes that, despite this increased profit margin, the fixed-price contract results in a lower price than where the manufacturer has not such a strong incentive to limit costs.' In Britain, the results of one such fixed-price contract have aroused considerable public interest and comment. They are a useful indication of the difficulties and pitfalls facing Mr. McNamara in his task. The contract in question was that placed with Ferranti Ltd., a leading manufacturer of electronic equipment for the production of the guidance system of a missile known as Bloodhound I. A government enquiry in July, 1964 revealed that Ferranti had made a profit of over ?5.7 million in selling the missiles to the government for ?12 million on a fixed-price contract. The profit was so large that it raised serious doubts about the effectiveness of fixed-price contracts-and indeed about the efficiency of the entire system of government contracting.