L9 - Political Economy of Procurement in Space

Question 1

Explain the procurement process and the role of the space agencies

Answer 1

• Principal + agent + contract = procurement transaction
• 3 Agents: fund providers (politicians), bureaucracies (agencies), and producer groups (firms)
• Step 1: govt allocates space budget to agency (agency is bidder for $ ∴ maximizes budget, coinciding w/goals of space industrial base)
• Step 2: agency allocates federal resources to space industrial base via contracts (firms are bidders for $ and agency becomes distributor of $ ∴ minimizes budget, opposing goals of space industrial base)
• Why space agencies? Avoid costly R&D duplication, national security concerns (public not private coordination), allocate public money, provide social goods

Question 2

Explain the moral hazard and adverse selection implications in procurement

Answer 2

• Moral hazard – ability of one party to alter their behaviour once they have entered into a contract o People work harder to get something than to keep it
• Adverse selection – ability of one party to use its superior information to its advantage in the transaction (assuming there is no cost in acquiring this information)

Question 3

Explain the behaviour of space agencies and their decision implications

Answer 3

• Objectives o Minimize costs o Minimize rents/profits to industry o Enhance competitiveness of national industry in commercial markets
• Methods o Choice of programs and equipment o Choice of contract o Choice of contractor o Choice of process/institutions in making choices and following them up

Question 4

Explain key contracting relationships and types of contracts and their cost-risk implications as applied by major space agencies

Answer 4

• Profit of firm, Π = Πe + s(Ce-Co) where Πe is estimated profits, s is the sharing coefficient, Ce is the estimated costs, and Co is the actual costs
• s is always between 0 – 1, rate at which cost differences are shared between agency and contractor AND reflects trade-offs between incentives and rent extraction
• if s=0 the firm has no incentive to minimize realized costs o cost plus contract o agency pays firm costs plus a reasonable fee – agency controls rent the firm receives at expense of high project costs and high level of risks o assumed to include profit to firm as % of costs o Cost plus fixed fee– reimburses contractor for actual costs of project + predetermined rent payment
• If minimum cost risk, they will pick this o Cost plus award fee o Cost plus incentive fee o Used in cases of uncertainty surround effort required of project o Used by NASA
• if s=1 the firm has strong incentive to minimize costs BUT no profit control and can realize substantial rents/losses o Firm fixed price – specifies price agency has to pay for good
• If max cost risk, they will pick this o Fixed price w/economic adjustment – allows possibility of changes in price of factors exogenous to the firm o Fixed price incentive o Fixed price with Award fees o Used by ESA
• if 0 < s < 1 o target cost/incentive fee contract o fee related to performance and costs in a predetermined way o maximum price liability for govt o Incentive contracts – link target costs and profits of project at a given level of project specs i.e. if firm obtains target at lower costs the target profit is adjusted upwards

Question 5

Explain key implications for efficiency from govt decisions

Answer 5

• Competitive vs. non-competitive
• Best to have competition in bidding for contracts BUT that requires a large number of firms, in opposition to the trend of cost savings via industry consolidation and economies of scale
• ESA can directly contract to subcontracts to assist small business enterprises but raises accountability implications for prime contractor