This reflects a misunderstanding of the comments in our letter to you of June 1, 1964. Our reason for encouraging fixed price contracting stems from the obvious efficiencies and economies that this form of contracting promotes and not from any desire to avoid responsibility for exercising cost controls where appropriate. To the extent that cost-type contracts continue to be used, we will continue to exercise close surveillance over the contractor's method of performance and we will closely scrutinize and audit the contractor's costs. We do not believe, however, that anyone would seriously suggest that even the most rigorous Government surveillance and audit could take the place of the profit motive as a means of assuring effective cost control. The key to maximum economy and efficiency in Government contracting is not more Government surveillance but greater use of contracting procedures that give the profit motive a chance to function effectively. In short, we believe there is no substitute for a strongly and properly motivated contractor. Hence, the growing use of fixed price contracts and contracts with wide-ranging incentives in defense procurement. As far as the Bainbridge contract is concerned, we think that you are mistaken if you believe that Navy surveillance and cost control under the cost type letter contract could have been as effective in inducing economical performance as the prospect of increased profits under the fixed-price arrangement. We have gone into these matters at some length because we believe that your position in this case is fairly typical of the GAO attitude toward fixed-price contracting generally. Your reports acknowledge the advantages of fixed-price and incentive contracts but they evince a distrust of these contracts whenever there is an element of risk or uncertainty. In these situations, it is our impression that the reports reflect a strong concern with the possibility of excessive profit but considerably less concern with the possibility of the higher total costs that may result from the use of cost-type contracts or after-the-fact pricing. In brief, the point we wish to make is that, while it is your view that in the case of the Bainbridge, the Navy "overvalued the advantages of fixed-pricing," we believe, on the contrary, that there is a tendency in GAO reports to undervalue the significance of fixed-price contracting as a means of controlling and reducing total costs to the Government. The reports on the Bainbridge make one further argument which appears to result either from a lack of information or a misunderstanding of our previous comments. In our reply to the original report, we said that the Navy relied primarily on its own independent estimates rather than on the estimates and other data prepared by the contractor. From this, you evidently have drawn the inference that the Navy failed to examine the contractor's data for possible duplications, errors, and other discrepancies that might have provided a basis for negotiating a lower fixed price. In this connection the report makes the following comment: "The Department's comments on this matter point out what we consider to be a basic flaw in the Bureau of Ships' approach to the negotiation of contract prices. As indicated by the Department, the approach followed by the Navy in this and numerous other ship construction contracts is to compare the estimates of cost prepared by the Navy with the estimates of cost prepared by the contractor. In such circumstances, both the Navy and the contractor argue the relative merits of their respective cost estimates. "It is our view that a far better approach to negotiating As is clear from the record of the negotiations on the Bainbridge, the method that you suggest is precisely the method that Navy used. From the very first proposal submitted by Bethlehem in January 1959 to the final proposal submitted in late 1961, the Navy used full scale audit in depth to analyze the elements of the contractor's estimates, and the resulting information was fully utilized in the negotiations with the contractor. Audit reports were used in combination with the Navy's own independent estimates as a basis for negotiation. Under the circumstances, and in view of the record of hard bargaining extending over a period of almost three years, the inference in the report that a lower price could somehow have been negotiated must be regarded as purely conjectural. Finally, a fact that should be noted is the excellent record of performance of the Bainbridge in its various tests and sea trials. This is pertinent because the relatively low costs incurred in completing the Bainbridge may be understood in light of the unusually high quality of the construction work which reduced to a minimum the repeated tests and costly corrections that would normally have been expected in the case of a unique and unproven design. The Navy entered into the contract with full awareness of the possibility that this might occur. The Navy recognized that if none of the potential contingencies occurred and if the contractor exercised sound contract management, a relatively high profit could result in the run-out portion of the work. This was considered preferable to continuing with a cost-type arrangement in which the contractor's profit could be restricted but in which the total costs chargeable to the Government would be subject to considerably less effective control. To sum up our position: (1) The Department of Defense believes strongly in using contract procedures that exploit the profit motive to the fullest as a primary means for inducing greater efficiency and lower costs. Current policies therefore encourage the use of fixed-price and other types of contracts that make effective use of this motivation while discouraging contracts in which this motivation is lacking. (2) In the case of the Bainbridge, we believe that the Navy acted reasonably in concluding (a) that, at 75 percent of progress, it was not too late for the Government to derive substantial benefits from a fixed price arrangement, and (b) that the amount needed to get the contractor to agree to a fixed price was not too much to pay in view of these benefits and in view also of the potential risks of remaining with the letter contract. (3) The Navy decision was informed and deliberate and was made only after thorough consideration of the pertinent facts. This decision did not result from misrepresentation of any sort. Accordingly, we believe there is no basis in law or equity for the Government to attempt to set aside the resultant contract and seek a price adjustment from the contractor. Sincerely yours, IGNED ROBERT H. McCUTCHEON Acting Deputy Assistant Secretary 48-132 O-65-46 APPENDIX IG-TITLE PAGE, TRANSMITTAL LETTER AND SUMMARY FROM GAO REPORT B-114878 OF JANUARY 10, 1962 REPORT TO THE CONGRESS OF THE UNITED STATES REVIEW OF ATOMIC ENERGY COMMISSION AND DEPARTMENT OF THE NAVY LARGE SURFACE SHIP REACTOR WESTINGHOUSE ELECTRIC CORPORATION Herewith is our report on the review of the Atomic Energy Commission (AEC) and Department of the Navy Large Surface Ship Reactor, AlW land-based prototype project (AlW project), constructed under contracts with Westinghouse Electric Corporation (Westinghouse). The AlW project was directed toward the development, construction, and testing of a nuclear propulsion plant suitable for installation in a large naval surface ship. The project involved the design, construction, and operation of a land-based prototype and necessary site facilities located at AEC's National Reactor Testing Station in Idaho. Construction of the AlW project was carried out by Westinghouse through subcontracts with Newport News Shipbuilding and Dry Dock Company and other subcontractors. Our review disclosed that the terms of the contracts were consistent with the applicable legislation and that the purposes of the contracts were successfully accomplished. A summary of the scope of our review and the results of our review, including our major conclusions and a recommendation for the consideration of the Commission, is presented on pages 1 through 5. The Commission's views on the recommendation are presented on page 4. This report is also being sent today to the President of the Senate and to the Chairman, Joint Committee on Atomic Energy. Copies are being sent to the President of the United States, the Commissioners of the Atomic Energy Commission, and the Secretaries of Defense and the Navy. Sincerely yours, Bupa Campbell Comptroller General Enclosure |