PROCUREMENT PRACTICES IN THE DEPARTMENT OF DEFENSE TUESDAY, MAY 3, 1960 HOUSE OF REPRESENTATIVES, SPECIAL SUBCOMMITTEE ON PROCUREMENT PRACTICES IN THE DEPARTMENT OF DEFENSE, Washington, D.C. The subcommittee met at 10:45 a.m., Hon. Carl Vinson (chairman) presiding. Mr. VINSON. The subcommittee will be in order. Now, Mr. Chairman. This is a continuation of the hearing by the subcommittee in reference to military procurement, in its various types of contracts. And, members of the committee, you are indeed fortunate this morning to have a statement from the Chairman of the Renegotiation Board. And when he completes his statement, you will get a true picture of what goes on with reference to these various types of contracts that we have been discussing. It is a pleasure to welcome you here. Mr. COGGESHALL. Thank you, Mr. Chairman. Gentlemen of the Subcommittee on Military Procurement, I am pleased to respond to the request of your chairman to testify before this subcommittee as it proceeds with its study of military procurement policies and practices. As you perhaps know, the Renegotiation Act of 1951 under which we operate provides for fiscal year renegotiation. Renegotiation therefore is conducted not with respect to individual contracts, but with respect to the aggregate receipts or accruals of a contractor under all renegotiable contracts and subcontracts in an entire fiscal year of the contractor. For this reason, generally speaking, the Board does not receive from contractors figures showing, in terms of costs, prices, and profits, the results of performing specific individual contracts. Thus, the Board has little individual contract information of this type. In its records, contracts that have been renegotiated are reflected on a fiscal year basis only. Of course, in the process of reviewing a contractor's renegotiable business for a fiscal year we are informed of the results, during that year, of the contractor's performance under each of the various types of contracts it may have. Thus, if the contractor performed under fixed-price, CPFF, and redeterminable contracts in the year being reviewed, we would have its sales, costs, and profits on each of these types of contracts for that year. But this, again, is not individual contract data; it is data by contract types, and then only on a fiscal year basis. 55096-60- -21 You will appreciate, I am sure, the limitation that the fiscal year approach to renegotiation places upon the Board in its effort to cooperate with this subcommittee by presenting useful and informative material. After consultation with members of the staff of the subcommittee we have concluded that, despite the limitations I have outlined. the data that we can present may be helpful to the subcommittee as a supplement to any contract data obtained by the subcommittee from procurement officials. We have made a study of 25 contractors whose total refunds through December 31, 1959, were the highest under the Renegotiation Act of 1951, as amended and extended. These refunds represented Board determinations in 98 separate renegotiation proceedings, each for an individual fiscal year of the contractor involved. Fiscal periods of these contractors in which no excessive profits were determined were excluded. Before renegotiation, the total renegotiable sales, profits, and average profit percentages developed in this study are as follows: The table-I might run across the table there. You all have it before you. But, as you see, the sales under fixed-price contracts and subcontracts amounted to $4,258 million, representing 16 percent of the total, with profits of $780 million, representing an 18.3 percent margin on sales. Price-redeterminable contracts represented the largest in that group-$9,175 million, or 35 percent of the total, with $973 million of profits and 10.6 reduced to a margin of profit on sales. The cost-plus-fixed-fee and cost-plus-incentive-fee: $4,111 million. or 16 percent of the total, with profits of $200 million, representing 4.9 percent on the sales. Fixed-price-these are always on sales, rather than costs-fixedprice-incentive: $7,976 million-just shy of $8 billion, or 31 percent of the total, and $702 million profit and 8.8 percent on sales. Then there is a small tag end of terminations which may be included $118 million. The CHAIRMAN. All right. Mr. COGGESHALL. And then some fees. Is that sufficient of the table, Mr. Chairman? The CHAIRMAN. That is enough. Mr. COGGESHALL. Yes, sir. (The table follows:) Fixed price.... Price redetermination. TPFF and CPIF! Fixed price incentive. Terminations. Other ... Total 1 Cost-plus-a-fixed fee and cost-plus-incentive-fee. 2 Consists primarily of fees. The above tabulation excludes billings under no-fee facility contracts of $1.235.2 million; however, the losses of approximately three-quarters of a million dollars thereon have been deducted from profits on line "Other." In renegotiation proceedings involving these figures, the Board made 98 determinations of excessive profits in the aggregate amount of $354.4 million. These represented 2.9 percent in number of all refund. determinations made by the Board, but they represented 43.2 percent in dollars of total refunds determined. The figure was something over-like $800 million in the aggregate-wasn't it, Mr. Nelson! Mr. NELSON. Yes, Mr. COGGESHALL. $820 million, I think. Viewed in relation to the total renegotiable sales and profits upon which they were based, the refund determinations represent 1.6 percent of sales and 15 percent of profits. The renegotiable sales included in the study were $26 billion. In the same renegotiation proceedings the nonrenegotiable business-of the same contractors-was $71 billion, representing a total sales volume of $97 billion. It must be remembered that the profit percentages mentioned constitute average percentages of profit realized by these contractors; the extremes are not shown. The contractors involved in this study are broadly representative of the major contractors engaged in defense work. The product they manufacture include airframes, aircraft engines and other parts, machine tools, chemicals, tires, aluminum, and so forth. In considering the results of our study, it is well to recognize clearly just what these figures show and what they do not show. Insofar as they reflect large volume performance under different types of contracts over a period of years, they do indicate the average percentages and amount of profits resulting from performance in each category. They also indicate that substantial excessive profits have been determined by the Renegotiation Board in respect of each of the 25 contractors involved. What the figures do not show, however, is why the Board made such determinations, or whether the profits realized from any particular contract or type of contract were reasonable or excessive. In the Board's experience, every type of contract considered in this study has been found in individual instances to yield excessive profits under the factors prescribed in the Renegotiation Act. But one cannot draw a valid conclusion about the reasonableness of profits without a vast amount of information in addition to the bare sales, cost and profit figures. The Renegotiation Act wisely requires the Board to consider such information under the statutory factors set forth therein. The language of the statute itself is as revealing on this point as any explanation I could make. The act provides as follows: in determining excessive profits, favorable recognition must be given to the efficiency of the contractor or subcontractor, with particular regard to attainment of quantity and quality production, reduction of costs, and economy in the use of materials, facilities, and manpower; and in addition, there shall be taken into consideration the following factors: (1) Reasonableness of costs and profits, with particular regard to volume of production, normal earnings, and comparison of war and peacetime products; (2) The net worth, with particular regard to the amount and source of public and private capital employed; (3) Extent of risk assumed, including the risk incident to reasonable pricing policies; (4) Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance; (5) Character of business, including source and nature of materials, complexity of manufacturing technique, character and extent of subcontracting, and rate of turnover. That ends the reading of the statutory factors. Obviously, under this statutory mandate the type of contract used in a procurement is important. Among other things, it bears directly upon the extent of risk assumed by the contractor. It is equally obvious that other factors must be considered. For example, other things being equal, a margin of profit considered reasonable for a million-dollar order might generate unreasonable profits if applied to a hundred-million-dollar contract; or profits considered reasonable for a hundred-million-dollar contract, for a contractor furnishing all its own capital, might be unreasonable if say, two-thirds of its capital, equipment, and facilities were furnished by the Government. These are only a few illustrations of the kind of factual information that is significant in the Board's determinations. The factors themselves will readily suggest many others to you. This brief and partial explanation of how renegotiation works, is presented, as I have said, for the purpose of demonstrating what the figures I have given you do not and cannot reveal. Determinations of excessive profits under the Renegotiation Act of 1951 and its predecessor renegotiation acts, going back to World War II, are the result of judgment exercised under the discipline of the statutory factors. If similar standards are to be applied by the subcommittee in evaluating the efficacy of particular contracting techniques, then extensive factual material of the kind I have cited must be considered along with the figures I have given you showing sales, costs, and profits according to types of contracts. I have pointed out that every type of contract considered in this study has been found in individual instances to yield excessive profits. This has happened because inherent in each type of contract, and indeed in all contracting, is an evaluation of future events, conditions, and developments. Obviously, the future cannot always be forecast accurately. All that can be expected is an honest, competent judgment based upon all available information. Let me illustrate this proposition as applied to the four predominant types of procurement contracts. A typical fixed-price contract contains a price set before any performance under the contract is undertaken. The price is based 100 percent upon an evaluation of future events. If this evaluation is correct, the contract will yield the anticipated profits; if it is inaccurate, the result will be different. For example, if the cost of materials, labor, or overhead goes up after the contract price is set, the contract may result in a loss or a low profit. Conversely, if the cost of labor, materials, or overhead falls below that anticipated in setting the contract price, the contract will yield higher profits than originally intended. Such profits may be excessive. Or the contract price may include substantial provision for contingencies which do not in fact occur during performance, resulting in a windfall which may amount to excessive profits. Even the cost-plus-a-fixed-fee contract is vulnerable because it, too, is based on a forecast of future developments. The fixed fee is of necessity set on the basis of the work to be done under the contract or, in other words, the cost to be incurred under the contract. It may develop that the actual costs incurred are substantially less than those anticipated. In such a case, since the fee remains fixed even though it was based in part upon costs never actually incurred, the result may be excessive profits. Under a contract providing for a price redetermination, the price is redetermined after a specified percentage of the contract has been performed. The redetermination is based upon costs already incurred and estimated costs to be incurred, with the redetermined price or prices made applicable both retroactively and prospectively. Here, too, if after redetermination the costs are lower than estimated, excessive profits could result. Let me pause at this point to make one thing clear. By no means am I implying that whenever actual costs are less than anticipated costs in the performance of any of these contracts, the difference automatically represents excessive profits in the contractor's hands. Nothing could be further from my intention, or from the thinking of the Renegotiation Board, or from the truth. No determination of excessive profits is ever made in renegotiation except after consideration of all relevant facts and circumstances in the light of the judgment factors prescribed in the statute. My sole purpose in reviewing the major types of procurement contracts at this time is to illustrate, for the benefit of the subcommittee, some of the many ways in which excessive profits may be realized from any of such contracts. I assure you, however, that there is nothing automatic or mechanical in the renegotiation consequences of such happenings. You may be sure, too, that when cost reductions are shown by the contractor to have been achieved by means entitling him to favorable consideration for his efforts, such consideration is willingly accorded by the Board. I proceed now to the incentive-type contract, which is a good deal more complicated than any of the other contractual forms. A brief explanation of the nature and operation of this type of contract may be helpful at the outset of my analysis. In a typical contract of this type, a tentative target cost is established when the contract is first negotiated. The final target cost is negotiated at a later date, after a portion of the contract has been performed, and is based upon already incurred costs and estimated future costs. A target profit is also negotiated, representing the reward deemed reasonable for performance of the contract if the target cost should prove to be the actual cost. The target price is the sum of the target cost and the target profit, and this price is applied both retroactively and prospectively to all units delivered under the contract. If the final cost of performing the contract proves to be less than the estimated or target cost, the contractor and the Government share the "cost savings" on the basis of a previously negotiated formula-usually 20 percent to the contractor and 80 percent to the Government. Conversely, an overrun of the target cost reduces the contractor's profit. In the incentive contract, the incentive formula operates automatically whenever costs are less than estimated and without reference to the reasons therefor. It is obvious, then, that for reasons wholly unrelated to the contractor's efficiency, the contract may yield greater profits than could reasonably have been foreseen. Such profits may be due to erroneous estimates of target costs; they may also arise. |