Staff Sgt. Frank Rohrig/U.S. Air Force
U.S. Air Force F-16 Fighting Falcons fly in formation behind a KC-135 Stratotanker after aerial refueling, December 8, 2021.
Two years ago, the Defense Department’s inspector general released a report showing that TransDigm, a contractor that makes spare aviation and maritime parts, relentlessly ripped off the U.S. government in contracting negotiations. The IG found $16.1 million in overcharges on a sample of $29.7 million in contracts. After a contentious congressional hearing, TransDigm returned the money to the government.
That brings us to this week. The Pentagon IG released another report, looking at another sample of TransDigm contracts. This time, out of the $38.3 million in contracts, TransDigm received “excess profit” (defined as a profit margin above 15 percent) of $20.8 million. The IG again recommended that TransDigm return the money. TransDigm spokesperson Jaimie Stemen said the company is “reviewing” the audit report.
The future of military auditing, then, seems to be one of endless reports of endless TransDigm contracts showing endless rip-offs. “It’s pretty remarkable; we just scratched the surface with the initial $16 million,” said Rep. Ro Khanna (D-CA), who chaired the 2019 hearing on TransDigm in the House Oversight Committee and has been a leading critic of the company’s practices. “There’s nothing that angers the American public more than people making money on the backs of our military men and women who risk their lives in service. Arthur Miller wrote a whole play about it, All My Sons. Harry Truman ascended to the presidency because of his investigations into war profiteering.”
Khanna’s citations, going back 75 years, make clear that defense contractor swindling is an enduring feature of American life. In fact, this week’s IG report notes that it has issued nine other reports over the past 23 years that pinpoint the exact problem at issue in the TransDigm case, which allows them to mark up prices without government knowledge.
A majority of TransDigm’s net sales are derived from sole-source parts, where they are the only provider.
At a time of constant chatter about inflation, this is the enduring inflation story buried beneath the surface: consistent, outrageous charges on military equipment, inching up costs in the largest single line item in the U.S. budget. But in the report, the Pentagon reveals a novel solution to the TransDigm problem, which would involve taking them out of the supply chain entirely. Will the government finally exact some accountability for what they have painstakingly demonstrated as repeated fleecing?
TransDigm is a private equity–style firm with a business model of acquiring companies to corner the market on various spare parts. A majority of TransDigm’s net sales are derived from sole-source parts, where they are the only provider. Of the 107 TransDigm parts the IG studied, 94 of them were sole-source.
Sole-sourcing creates a sense of urgency among procurement officials. These spare parts keep planes in the air; they have to purchase them to continue operations. But TransDigm is the only supplier, and corporate-friendly contracting rules give the procurement officers no leverage to make a decent deal.
For contracts below a $2 million threshold (recently increased from $750,000 by the Truth in Negotiations Act, or TINA), contractors are not obligated to provide cost data (i.e., how much it actually costs to produce the parts) that officials can analyze to determine a fair and reasonable price. Procurement officials can ask contractors for cost data, but contractors are under no obligation to supply it. In the contracts studied, officials asked for cost data on 27 contracts; TransDigm provided that data for just two. In the vast majority of those other cases, TransDigm’s excess profit was well over 100 percent.
Without cost data, procurement officials are flying blind. They can use historical price comparisons, but if a company has been jacking up the price for years, those comparisons are ineffective; you’d just be comparing price-gouging to price-gouging. For example, the IG report looked at 46 TransDigm acquisitions of companies making spare parts. In 44 out of 46 cases, TransDigm immediately increased the price, as much as 247 percent in one case.
After the fact, the IG was able to obtain the cost data it needed from TransDigm, enabling the IG to see how much profit TransDigm was earning above a “reasonable” 15 percent level. Excess profits were found on 106 of the 107 spare parts studied. A contract for a check valve yielded a 1269.9 percent excess profit; a quick-disconnect coupling half earned 1697.7 percent. The highest markup was an astronomical 3850.6 percent.
“DoD will continue to pay higher prices on spare parts if contractors use market-based pricing in a sole-source environment when contract values are low and uncertified cost data is not provided,” the IG report states.
These spare parts will never add up to the cost of an F-35. More than 95 percent of TransDigm contracts in the time frame studied were under that TINA threshold, and the company works to keep it that way. In numerous cases, DOD had to buy the same parts from TransDigm over and over again. But while the Defense Logistics Agency (DLA) attempted to award multiyear or multipart contracts that would rise above the TINA threshold, TransDigm didn’t agree to the terms, preferring to fly below the radar.
TransDigm has taken issue with the report’s analysis. “TransDigm acted consistent with all laws and regulations, and in many other areas, the report contains flawed analysis and misleading conclusions,” spokesperson Jaimie Stemen told the Prospect.
Of course, this is what TransDigm said about the 2019 IG report, which it then tacitly acknowledged as accurate by repaying the $16.1 million. “Are they saying the men and women who serve in the Pentagon are biased?” Khanna asked. “There’s one institution in America that has public support, not Congress, not the White House or journalists. It’s the military. If you want to argue against the only institution with a 90 percent approval rating in America, go ahead.”
Khanna, who first became interested in TransDigm’s activities in 2017, told the Prospect that he is working with his staff on holding another Oversight Committee hearing about the company. He believes TransDigm should refund the additional $20.8 million in excess profits, issue an apology, and submit a plan to reform its practices.
But how many chances should TransDigm be given? How many reports need to come out about excess profits before the government says enough? Khanna said that “everything is on the table,” including removing TransDigm as a contractor, though he didn’t want to prejudge before a congressional inquiry.
The Defense Department submitted two legislative proposals last year mandating that procurement officials obtain cost data before negotiating a contract. Neither of them made it into the National Defense Authorization Act last year, or this year. Despite the Defense Department being relatively unquestioned on Capitol Hill, in this case the military is screaming for help from being continuously overcharged, and Congress gave them the brush-off.
Khanna chalked up the failure to the dearth of members who make procurement a high priority, though he promised to raise his colleagues’ awareness before next year’s NDAA comes before them. But the military is not inclined to wait. The IG revealed that the Defense Logistics Agency is working on two initiatives, both of which would be groundbreaking.
The first, a Reverse Engineering Initiative, would identify sole-source parts that the military can reverse engineer and make themselves, rather than relying on TransDigm and other price-gougers. Already, 394 aviation parts have been approved as candidates for reverse engineering. In a separate Strategic Supplier Alliance Initiative, DLA is encouraging 14 original equipment manufacturers (OEMs) to cancel their licensing agreements with TransDigm, and instead begin to manufacture the parts themselves.
It’s not every day in Washington that an agency announces a plan to engage in its own manufacturing. But it seems like the best way to deal with a monopoly, by encouraging competition, and the best way to deal with a rogue contractor, by cutting them out of the process. “It’s a drastic thing for DOD to call for; I haven’t seen it before,” Khanna said. “It should show that what TransDigm is doing is particularly egregious.”
Whether through legislation or the military just taking over production, there should be some urgency to avoid the need for another report in 2023, showing that TransDigm once again snookered the Defense Department for millions of dollars in markups. And another in 2025. And so on.
