I heard once that cost-plus is related to the bloating of US defense budget and Boeing, Lockheed etc post WW2. Could someone familiar share some thoughts on what differences there are w this in pharma?
It is definitely related to the bloating of the military budget but Cuban's pharma idea is different than the "cost-plus" of the military. It's an unfortunate name collision that seems like an unforced error by Cuban since people like you (and many others) make the same association, even though the name is quite descriptive and accurate when used correctly.
What follows is a lengthy explanation of federal contract types, awards, and some light commentary on what you posited.
Federal contracts are usually, but not always issued under the rules of the FAR. Within the FAR there are several types of contracts supported including among others Firm Fixed Price (FFP), Cost Plus Incentive, Cost Plus Fixed Fee (CPFF), and Time and Materials (T&M). The other way that contracts can be issued is via an OTA or (Other Transactional Authority) and I won't really discuss those contracts as apart from semantics they usually obey the FAR rules as pertains to this discussion.
In a Firm Fixed Price contract, the contractor is considered to be holding all of the risk. The contractor is responsible for fulfilling the terms of the contract and must meet those requirements even if in doing so they lose money. When bidding a FFP contract, you develop an estimate of the work required, determine what the risks are and assign mitigation costs and likelihoods, determine what your desired profit margin is, and offer the government you best and lowest price. Usually these contracts are competitively awarded although that is not always the case (a). The "Firm" in FFP does not mean that the price can not increase. If the government changes what is desired or incurs costs on the contractor that were not specified in the original contract, the contractor can request equitable adjustment. FFP contracts are most commonly used when producing goods with known qualities that already exist or require slight modification of existing goods in the market.
Cost Plus contracts (Cost Plus Incentive or CPFF) entail cost sharing between the government and the contractor. In a Cost based contract, the government is considered to hold some of the risk. These contracts are generally used as development contracts when a new or significant evolution of an existing system is required. The government is responsible for reimbursing the contractor their costs incurred during development. These costs include both direct and indirect costs. Direct costs are what you would usually assume is meant by cost, e.g. the actual cost of the people and equipment used in pursuit of a single contract objective. Indirect costs are costs that are incurred in support of multiple contract objectives e.g. lighting and power for a building, HR and finance people. Significant portions of the FAR are involved in cost pooling and I won't get into it much more here. Because the government is responsible for reimbursing costs the contractor is not under as great of an obligation to minimize those costs. Effectively, there is a very low risk of losing money on a Cost contract because your actual costs are reimbursed. In cost contracts, the government can use the allocation of profit (fee) as an incentive to have the contractor meet time or total cost goals but is still responsible for reimbursing all reasonable costs. Most major new systems development happens under the guise of Cost contracts although some have been developed using FFP or OTA mechanisms. If the contractor fails to perform, the government will usually still reimburse the costs up to the point where work was stopped. It requires a lengthy legal battle to recover costs in a breach of contract suit.
Time and Material contracts are the most disfavored by the government. They have no performance objective apart from labor. The contractor is required to supply labor in a desired quantity and place but no actual performance (e.g. those 10 guys actually finish digging the ditch) is embedded. These contracts are fairly rare but are used occasionally.
To address the asked question regarding budgets post WW2. The Department of Defense publishes a daily list of every contract awarded above a certain value (I think 2 million) here https://www.defense.gov/Newsroom/Contracts/. Contract modifications (and new delivery orders under an existing IDIQ contract vehicle) Most of the largest of these contracts seem to be awarded via the sole-source justification. It is hard to put the blame squarely on cost contracts. There are cases, say developing a novel weapon system, where the government can not fully articulate it's needs at the starting point. Over-specification of requirements will cause the bidders on an FFP to give higher prices because they must be able to account for every requirement in their bids. When developing a brand new system, cost contracts can be effective although I do agree that the mechanism is over applied. I also believe that the sole source justification to avoid competition significantly undermines the cost control measures of both FFP and Cost contracts.
Now to briefly discuss what I believe is happening with this company. They appear to be functioning under rules most similar to CPFF, so I will analyze along those lines. Do they have a contractual goal? Yes, they have to produce the drugs needed based on transactions and contracts they accept. Do they have a reason to minimize their costs? Yes, their entire existence is predicated on the price differential between their products and those of other members of the market. If they allow their costs to balloon beyond a certain point, it will diminish their marketability. It doesn't mean that the stated margin will be over raw material and production costs as marketing is also included. I would like to see a public commitment to price transparency including all major line items in the cost similar to what is done with not for profit organizations (they have alluded to doing so with the statement "We will let everyone know what it costs to manufacture, distribute, and market our drugs to pharmacies.")
Source: In a previous life I was heavily involved in the bidding and management of DoD contracts.
