Saturday, August 18, 2012

Government Ammo buys and economies of scale

Thursday I posted an undated letter from a congressional staffer who tried to make the case that Homeland Security's big ammo buy was a no brainer, a cost cutter. But there are aspects to his argument I failed to note in my initial post, and feel I would be remiss if I don't address them.

In assessing Homeland Security's request for pistol ammunition bids, Kevin Doran, a deputy chief of staff for Congressman Lynn Westmoreland (R-GA) wrote:

In this case, DHS entered into a contract that allows them to purchase up to 450 million rounds of 40 caliber ammunition over the next five years.  They cannot exceed 450 million rounds and are not required to purchase 450 million rounds.  Basically, they have a tab with a manufacturer to order more rounds as they are needed over the next five years – not a onetime ammunition order. 
Setting up contracts in this manner allows for a cheaper purchase price, saving money over the long-term.
But does it really? 450 million rounds is a lot of ammo. How much of this order does DHS realistically expect to buy? A similar contract awarded just three years ago for 200 million rounds was also supposed to cover a five year period. Is DHS still accumulating ammo under the first deal? If so, how much? 

Doran's logic also overlooks that there are points in economies of scale that can tip cost structures back to higher levels, not lower. If an ammo maker is obligated to provide the government with 450 million rounds, it's likely the bidders will factor in any potential for lost business incurred as a result of shifting large amounts of production to fulfilling the government contract. Theoretically, lost commercial business would be far more lucrative on a per round basis.

Any manufacturer making a bid on the new proposal would have to price its bid based on contract maximums, contract minimums and points in-between, which ever results in a higher cost to deliver.

A major civilian ammunition retailer also reported rumblings earlier this year that the U.S. military is ramping up ammunition orders to restock supplies depleted in Iraq and Afghanistan. While I've seen no other confirmation of this, it seems logical. And if multiple government agencies are competing with each other for ammunition production capacity, that too could significantly drive up costs of acquisition.

In his letter, Doran attempts to compare the big DHS ammo buy to a family's monthly trip to Costco or Sam's Club to buy in bulk and save some money.

The problem with Doran's analogy is that the DHS order is so big, and there are so many other government ammo orders in the pipeline, that to some of us these orders are starting to look more like customer runs on Home Depot or Lowe's before a big hurricane hits than they do routine trips to Costco or Sam's.

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