Budget discipline can be imposed on contractors, but only intelligently.

Last Thursday, as has been widely reported, the US Court of Federal Claims finally dismissed the lawsuit filed 23 years ago this month over the A-12 debacle. For those who have forgotten, ‘joint prime contractors’ McDonnell Douglas and General Dynamics were selected in January 1988 to develop a replacement to the venerable A-6 jet, and on a fixed-price bid. Their concept, a cleanly shaped, tailless isosceles triangle, was nicknamed the ‘Flying Dorito’, but that’s about all the flying it did. Three years later, Defense Secretary Dick Cheney was aghast that the prototype promised to be 30 percent overweight and much further over budget. He terminated the contract for cause, demanding the return of the $1.35 billion paid to date.

The contractors sued under the Contract Disputes Act of 1978, claiming that the government had failed to provide its “superior knowledge” of stealth bomber design, gained during competitor Northrop’s development of the B-2. The case dragged on for two decades, with one appeal going as far as the US Supreme Court. In the settlement, the government will recover $400 million from the two companies, though in kind, rather than cash. GD will discount the price of its next Zumwalt-class guided missile ship at the Bath Iron Works, and Boeing (which acquired McD-D in 1996) will provide the Navy three free EA-18G Growler electronic jamming aircraft. The arrangement was sufficiently novel that it literally required an act of Congress—a clause in the Fiscal Year 2014 National Defense Authorization Act.

In short, there’s a lot that seems extreme about the A-12 case, and in the intervening 23 years, fixed-price development contracts have garnered a bad reputation. The incentives seem stacked against ‘better buying power,’ as we might put it today. Competitions come sometimes once a decade, so the stakes are high. The winner’s curse can select the bidder whose hubris leaves it mostly likely to over-promise and under-deliver. Because customers feel they simply must have the products, the contractors are then considered too valuable to fail. In the worst case, a sufficiently leveraged defense contractor then winds up with its bankruptcy risk effectively underwritten by the military. With all this in mind, is not fixed-price contracting extreme itself?

We think not always, believing in the occasional power of capitalist wagering and the icy discipline of some laissez-faire disinterest from buyers. We just ask that market discipline be imposed intelligently. Designing the A-12 was as much a matter of R as D—at the start, the two contractors had only vague notions of how they were going summon up the technologies required for the stealth bomber they had never built. They had hoped to secure the technology from the Air Force, which was buying those B-2s. When that agency declined to cooperate with the Navy, its bureaucratic competitor, the contractors had no fall-back plan.

After Textron Systems CEO Ellen Lord’s speech here a few weeks ago, we approvingly wrote of how “she and her corporate colleagues are ready to wager on the company’s ability to meet budgets and deadlines, which stems from the parent company’s commercial ethos.” This makes a great deal of sense with manageable programs like that new Scorpion jet. We don’t generally recommend it for great leaps forward. We like to say that some judicious management today sure beats judicial decisions, 23 years on.

James Hasik is a senior fellow in the Brent Scowcroft Center on International Security.