Cost-Plus Contracts Reward Inefficiency and Penalize Frugal Contractors

Cost-plus contracts, which reimburse a contractor for all allowable costs plus a fixed fee or percentage profit, account for a substantial share of major defense procurement. Under this structure, the contractor's profit increases as costs increase, creating a perverse incentive to spend more rather than less. A contractor that finishes under budget earns a smaller absolute fee, while one that runs over budget -- through scope creep, slow execution, or gold-plated engineering -- earns more. This matters because it directly inflates the cost of national defense. The F-35 Joint Strike Fighter program, originally estimated at $233 billion, has ballooned to over $400 billion in acquisition costs alone, with lifetime sustainment costs projected above $1.7 trillion. The Littoral Combat Ship program doubled in per-unit cost from $220 million to over $450 million. These overruns are not anomalies; they are the predictable outcome of a contracting structure that treats cost growth as a feature rather than a bug. The downstream consequences are severe. Every dollar wasted on cost overruns is a dollar not spent on readiness, maintenance, or modernization. Troops in the field wait longer for replacement parts. Aging platforms like the B-52 and KC-135 stay in service decades past their intended retirement because replacement programs consume their budgets through overruns. The military's ability to maintain technological superiority erodes not because of a lack of funding, but because funding is absorbed by inefficiency. The structural reason this persists is that cost-plus contracts shift risk from the contractor to the government, making them attractive for programs with high technical uncertainty. The Pentagon uses them precisely because no contractor will accept a firm-fixed-price contract for bleeding-edge technology where requirements change constantly. But this creates a moral hazard: once the contract is signed, the contractor has little incentive to control costs, and the government program office -- often understaffed and outmatched by contractor expertise -- lacks the capacity to enforce discipline. Reform efforts like the Better Buying Power initiatives and increased use of fixed-price incentive contracts have had limited impact because the underlying dynamic remains: Congress funds programs based on optimistic estimates, requirements creep after contract award, and neither the contractor nor the program office faces meaningful consequences for cost growth. The system is structurally designed to produce the outcomes it produces.