Mr. VINSON. What is your viewpoint about the regulation?

Mr. COURTNEY. Well, it covers the waterfront.

Mr. KILDAY. Mr. Welch, you mentioned the fact that apparently the Judiciary Committee, in its codification, added a definition of "negotiation."

Mr. WELCH. Yes, sir.

Mr. KILDAY. Which is very restricted.

Mr. COURTNEY. Yes, sir.

Mr. KILDAY. We probably ought to consider amending that, to bring into they have just defined a negotiation as meaning "make without formal advertising."

Mr. WELCH. That is our problem. You see

Mr. KILDAY. Let me continue, so you can discuss both of them at once, Mr. Welch.

Mr. WELCH. Yes.

Mr. KILDAY. What would you think if we put in there, after the definition "to make without formal advertising," "and under such regulations as the Secretary of Defense may prescribe, written or oral discussions"?

Mr. WELCH. Well, that is what the situation is now.

The Secretary of Defense, under that definition, which says that negotiations can be anything other than formal advertising, can make regulations which will permit them to invoke any procedure they want. And that is what they have done here. And this is our problem.

We cannot raise any question on negotiation procedures, regardless of what they are, under the law as it now stands.

Mr. VINSON. Your position, Mr. Kilday, is that "negotiations" is to be more restricted in definition and more positive, and it should not be so contingent upon the regulations of the Department?

Mr. KILDAY. Of course, I don't know what caused it. But it is highly suspicious that the Judiciary Committee incorporated language requested by the military departments and the Department of Defense, in defining "negotiation," when this committee had not defined

it.

Mr. WELCH. Well, I know that that was their position before this definition was put into the act, that negotiation did permit them to adopt any procedure they saw fit.

Mr. KILDAY. It happens frequently that the Judiciary writes regulations into our law when they go to codify. It happens all the time. Mr. COURTNEY. That is right.

Mr. VINSON. The whole objective is to try, when the field of negotiation is opened up, to get the best price we can for the Government. And that is the objective of it. And the regulations and what we passed bears that in mind.

Now, can we not, by rephrasing this, accomplish the objective, without meeting such an impasse?

Mr. Courtney?

Mr. WELCH. We would be glad to work further with the committee staff on this, Mr. Chairman.

Mr. VINSON. Go ahead, Mr. Courtney.

Mr. COURTNEY. Well, I think the committee could benefit by the discussion very much.

Now, yesterday, or Wednesday, I asked Mr. Bannerman, who was discussing this subject when we broke up, to submit his answer or his observations on the question of eliminating contingencies under the circumstances as I described.

And here it is:

During the discussion of subsection (e) of the bill in the hearing on June 1, the question was raised as to how we can be assured, when award is made on the basis of contractors' initial proposals without subsequent written or oral discussions, that unreasonable contingencies have not been included in the price quotation of the most favorable offer received and, therefore, are not also included in the price at which the contract is awarded.

We do not award on the basis of initial proposals without written or oral discussion except when we can assure that unreasonable contingencies have not been included. There may be two bases for our having this assurance:

(1) Where there is very substantial competition in these special procurements, we can be sure that a price proposal which includes unreasonable contingencies would not be competitive or—

This is where there are a number of bidders.

(2) Where we have full, audited, cost experience from previous contracts for the same or similar item, thereby enabling us to evaluate the reasonableness of the prices offered.

Furthermore, our regulation, ASPR 3-805 (b) —

the one I just read

as revised in September of 1958 to accommodate the views of this committee, requires, as a condition precedent to award without written or oral discussion, that the request for proposals must put all offerors on notice that award may be made without any discussion of the proposals received and, hence, that proposals should be submitted initially on the most favorable terms from a price and technical standpoint, which the offeror can submit to the Government.

In sum, by limiting the use of this procedure to situations where (1) all offerors are warned to quote their best prices initially, and (2) very substantial competition is available, or (3) extensive prior audited cost experience is available, we can assure, even though award is made without written or oral discussions, that we are not paying for any unreasonable contingencies.

Mr. BAILEY. Mr. Chairman, may I mention just one case that illustrates an action that took place along these lines, that may be helpful to the committee?

Mr. VINSON. All right, let's hear it.

Mr. BAILEY. This case involves a project that was initially advertised by the Corps of Engineers. The quotations of the four bidders who responded were all found to be substantially in excess of the statutory limitation when the bids were opened on December 20, 1955.

The engineer district informed the four bidders by telegram that their bids were rejected as not legally responsive, in that the bids on the housing units exceeded statutory limitations.

In the telegram the bidders were informed also that proposals for negotiated procurement of this work were being solicited to be publicly opened on December 29, 1955, and that the proposals would be based on the same specification and drawings.

In the contractors' subsequent proposals for negotiated procurement, costs were changed between line item in the proposal in order to indicate their compliance with the legislative limitation.

The lowest bidder under the advertised bid procedures also submitted the lowest proposal for the negotiated contract, even though he increased his quotation by $19,418. The three higher bidders decreased their quotations by $15,920 and $40,787 and $91,903, respectively.

The contract was awarded to the lowest bidder on February 17, 1956, without further negotiation with any of the offerors under the negotiated proposal.

The Department of the Army justified this action on the basis that the lowest proposal was 7 percent below the Government estimate and was within 2 percent of the other three proposals and was considered fair and reasonable.

Now, in this case the offeror increased his price, but they still didn't negotiate with him in order to bring his price down to what he had originally offered to do it for when the procurement was advertised. Mr. BATES. Of course, that gets right to the very heart of this

matter.

What we are trying to do is legislate judgment, and you just cannot do it.

Obviously, someone offered on an advertised bid a price of $19,000 lower than the one that was negotiated. And there is a fellow that didn't exercise very good judgment.

Mr. BAILEY. This is true, Mr. Bates.

Mr. BATES. You can write law all day long and you are not going to make him any smarter.

Mr. VINSON. Well, suppose you, Mr. Courtney, you and Mr. Welch, try to work out some proper approach.

The objective, I don't think, is in dispute at all. It is the phraseology and trying to bear in mind that we are trying to see that the Government gets a fair price for the article it has to buy. We don't want anybody to give anything to the Government, but we want the Government not to have to pay exorbitant prices for the articles they buy.

Mr. KILDAY. In the case you mentioned there, did that contracting officer ever make any explanation as to why he did that?

Mr. BAILEY. Well, they were in a hurry to get the contract negotiated before a deadline.

Mr. VINSON. All right, let's take the next one.

Now, with that understanding, Mr. Courtney, you and Mr. Welch see if you can work out something, bearing in mind the regulations. Now, let's see. Go to your next section.

Mr. COURTNEY. Mr. Chairman, there was a further question raised in the discussions with the Department as to whether or not certain categories of purchases ought not to be excepted from the provision. Mr. VINSON. I think there is no dispute that perishables, number (9) of the regulations [sic], should be excluded from this section. Mr. COURTNEY. Perishables, number (9).

Mr. VINSON. That is right.

Mr. COURTNEY. Which seemed to be by definite agreement-not within the scope of this proposed section.

Mr. KILDAY. The language would not prohibit negotiations as to perishables, but would simply not require it.

Mr. COURTNEY. That is right; and the other one had to do with professional services.

Mr. VINSON. That is right. That is in the same category as perishables.

Mr. COURTNEY. And which also covers educational institutions. In brief, categories (3) and (4) of the exceptions were specifically mentioned.

Mr. VINSON. All right.

Now go to section (f).

Mr. COURTNEY. Section (f) begins on the bottom of page 3, line 22: (f) The second sentence of subsection 2306(a) is amended by substituting "(f)" for "(e)."

(g) Section 2306 is amended by adding a new subsection as follows: "(f) No contract negotiated under this title shall contain a profit formula or price redetermination provision that would allow the contractor increased fees or profits for cost reductions or target cost underruns resulting from causes other than those which the contractor can clearly and completely demonstrate are due to his skill, efficiency, or ingenuity in the performance of such contract." Mr. VINSON. Well, of course, the Department is very much opposed to that. That goes to the very heart of the incentive contract. Now, what is your comment?

Mr. WELCH. Ŏurs, Mr. Chairman?

Mr. VINSON. Yes, sir.

Mr. COURTNEY. Your comment.

Mr. WELCH. Our formal comment is this

Mr. VINSON. Where is that in your statement?

Mr. WELCH. Yes, sir; on page 9, middle of the page.

Mr. VINSON. All right, good. Go right ahead.

Mr. WELCH. Section (g) would add a new subsection to section 2306 prohibiting the negotiation of contracts containing profit formulas or price redetermination provisions allowing the contractor increased fees or profits for cost reductions or target cost underruns resulting from causes other than those which the contractor can clearly demonstrate are due to his skill, efficiency, or ingenuity in performing the contract.

Where sufficient reliable information is not available to make it possible for the parties to negotiate fair and reasonable firm fixed prices, pricing clauses providing for adjustment of the price after cost and production experience have been gained should be used.

One type of negotiated contract that has caused considerable difficulty in establishing fair and reasonable prices is the fixed-priceincentive type.

This type of contract provides for the initial negotiation of an estimated target cost, target profit, ceiling price, and a final profit formula which provides for the contractor to participate in any sayings resulting from reductions of costs below the target cost or in any losses from increases above target costs. Its objective is to give the contractor an incentive to reduce his cost of performance since his profit is increased thereby.

Our audits have disclosed that some target prices have been excessive because of the negotiating parties' failure to base target price estimates on current cost information available to the contractors or their suppliers. In certain instances, both the target prices and subcontract prices on which the target prices were based were excessive because prime contractors were either reluctant or failed to examine the cost records of their suppliers or they did not require submission of cost information in support of proposed prices.

Under the fixed-price-incentive type of contract, when negotiated target costs are not forecast with reasonable accuracy, cost underruns may be due to the initial overestimates of cost and not to the efficiency of the contractor. Thus, the additional profits paid to the contractor under the profit-sharing arrangement are in the nature of a windfall rather than earned profits.

We therefore believe that Congress should consider the desirability of restricting payment of incentive profits to a participation in those savings that result from actual accomplishments of the contractor, as contemplated by section (g) of the bill.

Mr. BATES. Well, that is what we are doing here. We are considering the desirability. But what do you have to say about how the thing can possibly work?

I think it is a laudable goal. The question is, can we write legislation that will accomplish the purpose which we have in mind?

Mr. VINSON. Well, we can try, anyhow. We can say to the contractor, "If you can show by your skill, efficiency, or ingenuity, you have been able to reduce the article, then we will give you a bonus." Mr. WELCH. Mr. Bates, we feel that this section (g), as we have composed it, would accomplish that purpose.

Mr. BATES. You mean in the bill?

Mr. WELCH. In the bill, yes.

Mr. BATES. Well, let's take a situation, now.

"His own ingenuity and his own efficiency.' What does that mean? What if you have take your own procurement officer in a big company. Now, he is going to buy some stuff from the outside. Now, if he gets around there and gets a better price, is that ingenuity and efficiency, or is it not?

Mr. WELCH. Well, looking at it another way, I think it would be easier to determine the overrun that was due to overestimates, to begin with. That wouldn't be too difficult to ascertain.

Mr. BAILEY. No.

I think in your answer to your question, specifically, Mr. Bates, I think if he does come up with a better source of supply than he originally had under the contract, and this source of supply is able to do the job at a cheaper price, that this would be attributable to his efficiency and ingenuity.

Mr. BATES. Then, what would you not include?

Mr. BAILEY. I think the type of thing that Mr. Welch has mentioned, where it is evident upon reexamination of what the contractor did in terms of what it was estimated he would do that this was simply something that wasn't forecast. This would be the type of profits that he would not share in.

We have submitted to this committee

Mr. VINSON. If the target price was so positive as to be correct, based upon audit, it might not be warranted to have a section of this kind.

But in view of the fact that the target price is an estimate, pure and simple, and it is so broad and hasn't been pinpointed to the satisfaction of anyone, we should have some kind of restriction so as not to bring about the payment of a bonus on things that had no relation whatsoever to skill, efficiency or ingenuity, but just because he raised his estimate cost higher.

Mr. WELCH. In other words, we could be positive about the excessive profits that were made which resulted from initial overestimates of cost.

We submitted many reports

Mr. BAILEY. Many report to this committee, as well as the other cognizant committees.