The record of negotiation of prices paid by the Government for military engines did not identify any allowances made to the Government in recognition of the benefits to commercial piston engines from use of these facilities during the period 1951 through 1959. It was therefore our view that such commercial use under these conditions during this period was not only inequitable to the Government but resulted in Pratt & Whitney's receiving economic benefits not generally available to other manufacturers. Accordingly, we recommended that the Secretary of the Navy collect a reasonable rental from Pratt & Whitney for its use of Government-owned facilities in commercial piston engine production during the years 1951 through 1959.

Our report, B-146886 dated May 21, 1964, covers our review of employee relocation costs charged to the Government under defense and space contracts held by the Lockheed Missiles & Space Co., Sunnyvale, Calif. We disclosed that unnecessary costs during a 12-month period, totaled $101,200. These excessive payments were caused by Lockheed's practice of paying employees transferred from one location to another a daily relocation allowance for a period greatly in excess of the period actually needed to establish a new residence. We found that under Lockheed's policy, employees received daily relocation allowances for a full 30-day period without regard to the actual number of days required to relocate. Lockheed's Government contracts are about 99 percent cost-reimbursement type and we did not recommend a voluntary refund as indicated by the Assistant Secretary of Defense. Our recommendation, in effect, was that contracting officers review their actions in approving the reasonableness of the relocation expenses for reimbursement and to disallow any amounts found to be unreasonable.

After we presented our findings to the company, Lockheed revised its relocation policy to limit such per diem payments to the actual number of days require to establish residence. Also, we were advised by the Department of Defense in February 1965 that $99,000 had been disallowed in negotiation of 1962 overhead at the Sunnyvale plant. The Department earlier advised us that it had decided not to reopen past negotiations, for to do so would require reopening other elements of overhead which the Department felt had been settled generally in the Government's favor. Since this general statement does not disclose the types or amounts of expense the agency anticipates the contractor would claim, we may, if time and circumstances permit, review prior year's settlements of overhead for the purpose of evaluating the basis for this decision.

Another report the Assistant Secretary of Defense discussed in his statement is B-146901, dated August 24, 1964.

In this report we disclosed that the Army purchased from the Raytheon Co. about $1.1 million worth of spare parts for Hawk missile field maintenance test equipment which were unneeded because the test equipment had been replaced. Under a cost-reimbursable contract Raytheon had undertaken broad responsibilities for the development and production of the Hawk missile system, including the requirement to furnish the Army with spare parts lists for this system. The unnecessary procurement was a result of Raytheon's submission to the Army of superseded spare parts lists. This was done with the knowledge that the items on the lists were for nontactical equipment that had been superseded by new tactical equipment already on quantity procurement. Raytheon also knew that the spare parts lists submitted would be used by the Army for the purposes of determining procurement needs. Furthermore, Raytheon failed to question the validity of the Army's orders in quantity even though it had knowledge that the parts had been superseded and that the orders were placed on spare parts lists which were outdated.

The Assistant Secretary of Defense, in his testimony before this subcommittee, stated that the procurement of the unneeded spare parts was not a result of any failure on the part of the contractor, as contended in our report, but was due instead to the action of the Government in accelerating deliveries, thereby disrupting the orderly process of spare parts provisioning.

We do not believe this to be a valid reason for relieving Raytheon because Raytheon had agreed to provide the required information for spare parts procurements by means of major item repair parts lists. Raytheon had been well aware that the field maintenance test equipment had undergone a major design change. Raytheon had a liaison engineer at the subcontractor's plant, whose express duties were to review and monitor repair parts documentation, and Raytheon had been recently advised by the Missile Command that it was late in submitting documentation. Nevertheless, at about the same time that production of new

redesigned tactical equipment was initiated, Raytheon prepared major item repair parts lists which erroneously indicated to the Missile Command that the nontactical assemblies were repair parts for the tactical equipment. It is our belief that Raytheon did not properly discharge its obligation to the Government when it did not question the validity of the unnecessary procurement when the orders were received. We consider the charges for these unnecessary procurements to be unreasonable under the applicable contracts and, therefore, requested the Secretary of Defense to withhold $1 million from payments due Raytheon. However, as you know, the Department of Defense has declined to do so.

The Assistant Secretary of Defense also expressed disagreement with our finding that the Lane Construction Corp. contract was illegal. Our position on this case, we believe, was adequately discussed in our testimony on May 11, 1965.

PRICING POLICY

The Assistant Secretary of Defense indicated that there was a difference between our views and those of the Department of Defense on pricing policy. He characterized the disagreement as primarily a difference between the costtype approach to defense contracting and the fixed-price approach. He stated that our office has tended to criticize the use of fixed-price contracts when uncertainties or risks have been involved.

First, let me say that the public record is replete with evidence that we support the Assistant Secretary's concern for the inherent lack of incentives for reducing costs under cost-type contracts. There should be no question of our position on that point. It is also public knowledge that we have consistently supported legislation designed to promote increased use of formally advertised fixed-price contracts.

However, our criticisms have been directed at those instances where the allowance of substantial provisions for contingencies or other conditions have relieved the contractor of much of the risk factor that encourages economical performance. As we have stated in the Bainbridge case it is our opinion that the Navy was not compelled to accept an excessive price in order to obtain a definitive contract. The extra motivation for efficiency and economy which fixed-price contracting normally provides was greatly diminished in this case because three-quarters of the work had already been completed on a cost-reimbursable basis. We believe the Navy overvalued the advantages of fixed-price contracting in this case when it accepted a price which included provisions for contingencies of about $3.4 million and duplications and overstatements of costs of about $1.6 million. Had further negotiations been unsuccessful the ship could have been completed under the terms of the letter contract and the price and other terms could have been settled on a quantum meriut basis; that is, the Government would only pay the reasonable value of the services performed.

The Assistant Secretary of Defense also states that we have criticized the Department of Defense in certain cases in which cost-type contracts were converted, during the course of performance, to fixed-price contracts. He stated that in these cases we have expressed concern that the contractor earned a profit considered by us to be excessive because actual costs turned out to be lower than anticipated. The testimony does not identify the cases to which the Assistant Secretary refers; however, we believe one case in point to be our report on the Spanish base construction program, B-118763, dated December 30, 1960. In this case, the Navy converted a contract with Brown-Raymond-Walsh (a joint venture) from a cost-plus-a-fixed-fee basis to a fixed-price basis on certain portions of the contract. Our review disclosed that this action may have added as much as $9.4 million to the cost to complete the Spanish base construction program without providing any material increase in the scope of the contractor's services. The fixed price established to complete the program included administrative costs that were about $6.7 million in excess of a reasonable amount to be incurred based on the contractor's prior cost experience under the cost-plus-afixed-fee portion of the contract. Also, the price included a profit and contingency allowance to the contractor which was about $2.6 million in excess of the fee the Government would have borne had the contract been completed on a cost-plus-a-fixed-fee basis.

This report was the subject of hearings before the Subcommittee for Special Investigations, Committee on Armed Services, House of Representatives. On April 28, 1961, a Navy official informed the subcommittee that, by placing additional work under the contract with little or no allowance for the contractor's

related administrative costs as of April 1, 1961, the Navy had recovered $5.1 million of the excess cost allowance reported by us. He further stated that negotiations would be studied with the contractor to insure full recovery prior to contract closing.

In a followup review, we found that the Navy had erred in its computations. Actual recovery resulting from placing additional work under the contract amounted to only about $3 million. In reply to our followup review, the Department of Defense advised that further action by the Department would be inappropriate and stated that the contractor will receive special separate attention by the Renegotiation Board.

We believe our positions in these cases are sound.

GOVERNMENT INVOLVEMENT IN THE INTERNAL AFFAIRS OF DEFENSE CONTRACTORS The Assistant Secretary of Defense referred to a series of reports in which the General Accounting Office had criticized the Department of Defense for indirect procurement of components and assemblies. We had stated that unnecessary costs have been incurred because the military departments permitted weapons systems contractors to purchase equipment, components, and accessories under circumstances where, in our opinion, it would have been more economical for the Government to purchase the item directly from the manufacturers and furnish them to the prime contractors as Government-furnished equipment.

One of our reports in this series was a report issued in December 1964, wherein we disclosed evidence that higher costs of about $4.1 million had been incurred in the procurement by the Navy of aircraft because certain components had been purchased by the airframe manufacturer rather than furnished by the Government. One of the components was a horizontal situation indicator system, an item common to both Navy and Air Force aircraft. We found that whereas the Air Force found it feasible and economical to purchase these systems direct from the manufacturer and furnish them to the airframe manufacturers for installation in the aircraft, the Navy considered it necessary that the systems for its aircraft be purchased by the airframe manufacturers. The Government incurred estimated increased costs of about $1.2 million with respect to the indicator systems for Navy aircraft. After the results of our review were brought to the Navy's attention, they acknowledged to the House Appropriations Committee that they were remiss in not providing this item as Government-furnished equipment earlier. We were further advised by the Navy that arrangements had been made with the Air Force to consolidate Navy procurement needs with Air Force procurements for the horizontal situation indicator system and to furnish this system to applicable Navy airframe manufacturers as Government-furnished equipment in fiscal year 1965.

In another report, issued in December 1963, we reported on a situation where the Air Force required certain electronic equipment for modification of aircraft to be procured by the contractor. We found that the Navy was procuring identical items of electronic equipment directly from equipment suppliers to meet their requirements. Had the Air Force purchased on the same basis, the Government should have avoided increased costs of about $1.1 million.

The Assistant Secretary of Defense also included in his testimony certain comments on the contents of a draft report of the General Accounting Office which had been furnished to the Department to obtain its views before completing our report. Those views have not been furnished to us to date and the report has not been released. He stated that we had recommended in this report that the Department of Defense adopt a general policy under which it would furnish to prime contractors all subsystems and components except where the prime contractor makes a major contribution to the production of the item or in providing technical assistance to the contractor.

One important point which the Assistant Secretary of Defense omitted should be called to your attention. The primary theme of this draft report which was submitted to the Department of Defense on March 11, 1965, was the lack of definitive policy on furnishing subsystems to prime contractors with the result that higher costs are incurred.

We pointed out that the general policy provided in the Armed Services Procurement Regulation gives broad latitude to the military departments and there appears to be a wide variance among the military departments and commands in the implementation of the general policy enunciated by the Department of Defense. For example, the Air Force in its policy directives has taken the position that its responsibility as a system acquisition manager cannot be contracted

out and has provided procedures requiring that, where economical to do so, components be purchased by the Government to the maximum extent feasible. The Navy's Bureau of Ships has taken the opposite view. The Bureau's position, as indicated in its directives, is that when the Government agrees to furnish material to a shipbuilder, it undertakes a contractual obligation and that this obligation should not be assumed without thorough consideration of whether the material can be delivered in time to meet the shipbuilder's construction schedule. Accordingly, the Bureau's procedures provide that furnishing of material to shipbuilders be reduced to an absolute minimum.

The Assistant Secretary pointed out some of the dangers in the Government furnishing material to contractors which must be considered; namely, the criticality of the item, the stability of design, the effect on the prime contractor's performance responsibility, the effect on production schedules, and the extra administrative costs to the Government. We agree that these factors do play an important part in decisions as to whether the Government shall furnish components and assemblies to the prime contractor.

He also outlined the profit policy as contained in the Armed Services Procurement Regulation, pointing out that it was designed to provide a range of fee or profit depending on the prime contractor's responsibility, its risk assumed in the subcontracting, and its technical contributions to the subcontracted effort. However, in most of the cases we have reported on, the negotiation records indicated that a flat fee or profit allowance was applied to all costs, including subcontracted items, and there was no evidence to establish that a composite rate was used that took into consideration the various levels of effort required or the risks assumed by the contractor.

Another area mentioned by the Assistant Secretary of Defense as one in which the Department disagrees with our Office involves the recommendations contained in our reports dealing with the lease versus the purchase of electronic computers in contractors' plants and the use of General Services Administration sources for certain operating supplies and equipment. He stated that the basie trend in Defense procurement policy is to place maximum responsibility on the contractor for performing the contract, including the responsibility for selecting and acquiring all necessary equipment and facilities instead of having them furnished by the Government. He stated the problem is particularly important with respect to computers and that it is essential in a system of free enterprise that such decisions not be imposed by the Government but that they be made by the contractors.

Our reviews on leasing of electronic data processing systems have been made at plants of contractors engaged either predominantly or solely in Government work and at Government-owned facilities operated by contractors. Generally, we have found that the leasing of electronic data processing systems by contractors is substantially more costly to the Government in the form of reimbursable costs to the contractor and elements of contract prices paid by the Government than it would be for the Government to purchase this equipment and furnish it to the contractor for use on Government work. In 24 reports covering various Department of Defense contractors we have shown that leasing costs would exceed purchase costs by an estimated $61 million if leasing continued at each plant for a period of 5 years. The excess costs would be substantially more for any additional years the equipment would be leased. Moreover, although the Government would have paid during these periods the indicated amounts in excess of full purchase prices plus maintenance costs, the Government would not own the equipment and would be required to continue payment of rental for further use.

Under these circumstances, the contractor is, in effect, making a decision for the Government, and in view of the overall increase in use of data processing equipment in the Government and the likelihood that it could be used on Government work at some other location, we believe the Government should participate in these decisions or limit reimbursement to the contractor to the costs of ownership.

Similarly, our reports concerning the use by contractors of General Services Administration sources of supply for items such as office furniture, office supplies, housekeeping, and maintenance items have been confined to contractors performing either solely or predominantly Government work. In our report B-132992 dated February 9, 1965, we reported that during the 3-year period 1960 through 1962 procurements by the Martin-Marietta Corp., Denver division, through commercial sources rather than through General Services Administration

sources, resulted in additional costs to the Government of over $422,000 for certain selected supplies. Less than one-tenth of 1 percent of the sales of this division during the period of our review was for other than Government work. In another report, B-146975, dated April 30, 1965, we pointed out that during 1962 alone the procurement by the Lockheed Missiles & Space Co., Sunnyvale, Calif., through commercial sources rather than through General Services Administration sources resulted in additional costs to the Government of over $218,000 for selected items of office furniture. During the period covered by our review, over 98.3 percent of Lockheed Missiles & Space Co.'s sales were to the Government under cost-reimbursable type contracts, over 1.6 percent were under Government-negotiated fixed-price contracts and about one-tenth of 1 percent of the total sales was not identified as Government work.

We believe it is incumbent upon management officials responsible for administration of Government contracts such as those in effect at Martin-Marietta Corp. and Lockheed Missiles & Space Co. to insure that the Government's requirements under the contracts are obtained at the lowest possible cost. Decisions on costs which affect primarly the financial interests of the Government rather than the financial interests of the contractor should not be left entirely to the contractor. We believe it is appropriate for the Government to take advantage of reduced costs under cost-reimbursable-type contracts through the use of General Services Administration supply sources as recommended in our reports. Concerning the Assistant Secretary's concern that our recommendation would displace the normal private commercial marketing and distribution channels for these items, it is significant to note that in general any responsible bidder can solicit and compete for Government business through the General Services Administration. According to a recent report of the Senate Select Committee on Small Business, over half of the dollar volume of General Services Administration's total prime contract awards went to small business companies.

In addition, wages and other contractor expenditures resulting from the contractor's operations in a particular locality can be presumed to have found their way into the local economy and rather than displacing normal private commercial marketing and distribution channels should result in additional trade and income for local concerns.

Mr. Chairman, this concludes my statement. We will be glad to answer any further questions you may have.

Mr. HOLIFIELD. At this point we are going to ask the Deputy Director of the Budget, Mr. Staats, to please come forward.

(Brief recess.)

Mr. HOLIFIELD. The subcommittee will be in order.

Mr. Staats, you may proceed.

Mr. STAATS. Mr. Chairman, I have a brief statement. With your permission, I would like to read it into the record at this point. Mr. HOLIFIELD. Please proceed.

STATEMENT OF ELMER B. STAATS, DEPUTY DIRECTOR, BUREAU OF THE BUDGET; ACCOMPANIED BY ARTHUR B. FOCKE, GENERAL COUNSEL; ELLIS H. VEATCH, CHIEF, MILITARY DIVISION; AND GEORGE MULLINS, CHIEF, PROPERTY AND SUPPLY MANAGEMENT BRANCH

Mr. STAATS. I am pleased to respond to the committee's invitation to testify with regard to the Bureau of the Budget's interest in and review of General Accounting Office reports on their audits and investigations.

The President has taken considerable interest in the matter of audit reports. On May 2, 1964, he told the heads of departments and major agencies:

I want all reports made by the General Accounting Office and any congressional committee to be given prompt and thorough attention.