Congress took aim at a key defense contractor Wednesday for what the Pentagon’s acquisition chief called “gouging our taxpayers” using “a disgraceful business model” designed to exploit the law.
A review of a sample of parts TransDigm Group sold the military revealed the company made excess profit ranging from 17% to 4,451% on 46 of 47 part purchases examined. A former TransDigm sales director told the House Oversight and Reform Committee the company saw dealing with the Pentagon like “taking candy from a baby.”
“TransDigm’s basic business model consists of identifying relatively small companies that make spare parts for the military — especially parts that no other companies make,” California Democrat Ro Khanna said Wednesday at the committee’s hearing. “TransDigm then buys up these small companies, purchases the rights to produce their products, and then jacks up the prices. The Pentagon has to pay, knowing that they have a monopoly.”
The Pentagon’s inspector general has set a 15% profit benchmark for contractors. The office found TransDigm made an excess profit of 3,930% on a a part used in F-5 and T-38 aircraft called a quick disconnect coupling half, producing it for $173 and selling it to military for $6,986. A clutch disk used in C-135 transport aircraft costs $32 to produce but $1,443 to purchase, giving TransDigm an excess profit of 4,436%. The company would have earned $4 had the disk been sold at the 15% benchmark. Only one of the 47 parts reviewed met this benchmark.
The inspector general also accused TransDigm officials of concealing cost data from Pentagon contracting officers. The former sales director told the committee, “We were coached not to provide cost data.”
“Often with sole-sourced parts, the price for the part is not what the commercial market would set. Rather when competitive forces are absent, the price becomes what the Department of Defense is willing to pay for the part that is essential for a Department of Defense weapons platform, such as an aircraft,” Theresa Hull, assistant inspector general for acquisition, told the committee.
Commanders in the field require many of the parts TransDigm produces to keep planes and helicopters flying, including the AH-64 Apache attack helicopter and the F-16 fighter aircraft. The company’s high prices force Pentagon officials into a difficult dilemma.
“Is what TransDigm is doing illegal? No,” Kevin Fahey, assistant secretary of defense for acquisition, said during the hearing. “Do I consider gouging our taxpayers for excessive costs immoral and unconscionable in the face of getting our warfighters what they need to fight? Yes.”
“This gets under my skin and makes me sick,” Fahey said.
A policy analyst who has studied TransDigm compared the company’s actions with those of Martin Shkreli, the “Pharma Bro” famous for obtaining rights to a pharmaceutical and raising its price by a factor of 56.
“The industry is asleep on this, totally asleep on this,” said the analyst, who requested anonymity.
TransDigm executives defended the company, arguing that it follows common commercial practices. They explained similar companies will often charge an initially low price for a product and recoup its profits in aftermarket replacements. Only 5%-6% of TransDigm’s sales are direct to the U.S. government, and 43 of the 47 parts reviewed are also used commercially, CEO Kevin Stein told the committee. He said the Pentagon’s small orders of customized parts are a key driver in price determination. “In the military case, in many cases we’re only making a couple parts over decades,” said Stein.
He also disputed the charge that TransDigm simply drives up costs after purchasing smaller companies without adding any value.
“On the contrary, TransDigm undertakes significant engineering projects,” said Stein. “We have about 3,000 engineers and spent almost $300 million in research and development over the last five years alone.”
While TransDigm’s practices outraged defense officials and lawmakers of both parties, the inspector general did not accuse the company of breaking the law. Indeed, Fahey acknowledged no regulations prevent TransDigm’s behavior. But some analysts are not convinced that lets the company off the hook.
“Even if it’s a common practice, it’s not a reasonable one,” Mandy Smithberger, director of the Project on Government Oversight’s Straus Military Reform Project, told the Washington Examiner. “Acquisition laws like the Truth in Negotiations Act are designed to make sure the government only pays what is a fair and reasonable price. That kind of markup is unacceptable.”
Passed in 1962, the Truth in Negotiations Act requires contractors negotiating with the government on goods or services that have no established market price to submit “truthful, accurate, and complete” cost or pricing data. Last year, the acquisition threshold requiring contractors to provide cost data was raised from $750,000 to $2 million, a move considered a major benefit to contractors. Smithberger said that threshold was too high.
“Particularly in a sole-source environment, and when prices go up without any justification, the government has a right to ask whether they’re paying a fair price,” said Smithberger.
While the oversight committee targeted TransDigm, Smithberger noted it is not the only contractor engaging in questionable pricing. A 2014 inspector general report recommended the Air Force not contract with Pratt & Whitney for C-17 cargo plane engine maintenance unless the company provided price information or proved its services were commercial. In 2017, a Kuwaiti company paid the U.S. government $95 million after the Justice Department found it had overcharged the Pentagon for food supply services to U.S. troops from 2003-2010.
The Pentagon inspector general recommended TransDigm repay $16.1 million in excess profits. Khanna prodded executives on why the company had yet to do so.
“Your big risk is that ‘Fox and Friends’ will cover this and you’ll have a presidential tweet asking you to pay back the money,” said Khanna. “The company is worth $1.2 billion, why not just pay back $16 million?”
“We’re still evaluating that,” said Nicholas Howley, the company’s executive chairman and founder. He expressed concern that payment would imply TransDigm did something wrong or illegal in the eyes of shareholders, employees, and customers.
“The money is not the issue here,” said Howley. “We’re trying to balance those conflicting demands to come to a conclusion.”
