DOD corrective action: The Air Force agrees that the contract files should contain sufficient data and documentation fully supporting prices, including the computations made and the evaluations performed by the contracting parties, and allowances for such anticipated increases in future production costs. Increased field support through emphasis on field surveys of contractors' procedures, current Armed Services Procurement Regulations, Air Force Procurement Instructions and pricing guide instructions furnish adequate guidance for providing contract files with sufficient data and documenation. Since the time these two contracts were negotiated (April 1959) there has been considerable improvement in the documentation in support of the rationale employed in the pricing of contracts. ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE Problem The report states that target prices negotiated by the Air Force and Boeing for 140 B-52G airplanes under contracts AF 33(600)-34670 and AF 33(600) – 37481 included target costs which were based on cost estimates for sustaining tooling labor, production labor, and subcontracting that were overstated by about $7,575,500. The report further states that unless the contract prices are adjusted to eliminate the overstated cost estimates indicated, the Government will incur increased costs of about $1,261,000 in the form of unearned profit to Boeing. GAO recommendations (a) That the Secretary of Defense take vigorous action to obtain for the Government appropriate reductions in the contract prices for the overstated cost estimates included in the target prices negotiated by the Air Force and Boeing for the B-52G airplanes purchased under contracts -34670 and -37481. (b) That this report be brought to the attention of responsible Government officials to stress the importance of (1) requiring contractors to document fully in writing, and to furnish to the Government's contracting officials, the bases and methods used in preparing cost estimates included in proposed prices and (2) carefully evaluating contractors' proposals and documenting clearly in writing the nature and extent of the evaluations made of the various elements of costs in relation to costs previously experienced and costs which reasonably should be expected for future production. Statement The Air Force agrees with GAO's findings pertaining to overstated subcontract costs of $492,506 under contract -37481, as in fact has Boeing. An appropriate adjustment will be made to cover this matter at the time of final contract price negotiations during February 1965. In addition, supplemental agreement No. 34 to contract -37481 was issued on April 29, 1963, accomplishing a reduction of $104,834 for overstated subcontract termination costs as recommended in the report. The Air Force does not agree, however, that the estimated costs in sustaining tooling labor and production labor, alleged to have been overstated, should be adjusted. It is our opinion that adequate tests of reasonableness of these estimated costs were made by the Air Force negotiating team at the time of negotiation. Respecting GAO's second recommendation, we are constantly striving for improvements in the documentation in support of the rationale employed in the pricing of Air Force contracts. Our contracting officials presently require Boeing, and other contractors dealing with the Air Force under negotiated procurements, to furnish all appropriate data and rationale employed in the preparation and support of proposed prices. A management review of all Air Force negotiation objectives is made prior to negotiations with a contractor. One of the objectives of this review is to assure that the contractor will provide all appropriate data. In addition to increased field support through emphasis on field surveys of contractors' procedures, it is our opinion that current armed services procurement regulations, Air Force procurement instuctions and pricing guide instructions provide adequate guidance in the areas of the second recommendation. For this reason, further action on the recommendation is not considered necessary. Details of Air Force position in disagreeing with GAO on sustaining tooling labor and production labor follow: (1) Sustaining tooling labor GAO comment It is stated that in the preparation of target cost estimates for sustaining tooling labor for the airplanes purchased under contracts -34670 and -37481, Boeing failed to give proper consideration to its prior experience in producing B-52G airplanes. Sustaining tooling labor is used to support and maintain the tools and equipment utilized in production. In view of this reflected relationship to production, the GAO stated that sustaining tooling labor had been estimated by Boeing as a percentage of production labor. According to the GAO, Air Force records of negotiations for B-52G airplanes indicated that the G was essentially a new airplane compared to prior models, as a result of numerous engineering changes incorporated to reduce the airframe weight and to increase the defensive capabilities of the airplane. It is stated that in the preparation of the proposal for the firm targeting of contract -34670 for 101 G's in April 1959, Boeing estimated that 1,425,000 sustaining tooling hours would be expended, based on a computation of 11.7 percent of the estimated production labor hours. This rate is said to have been developed by Boeing on the basis that airplanes under contract -34670 were comparable to the 225 airplanes previously procured although the Air Force and Boeing had agreed that the G was a completely new airplane. According to the GAO, only 53 airplanes (the previous B-52G buy) should have been considered comparable to those to be produced under contract -34670. Thus, it is said, had Boeing estimated sustained tooling labor as it estimated other cost elements in its proposal, it would have developed a sustaining tooling rate of about 7.8 percent of the estimated production hours. The GAO stated that the use of the 7.8 percent factor would have provided a sound basis for reducing its estimate by about 426,000 hours, reflecting a target cost reduction of $3,216,000 on contract -34670. Similarly, the GAO stated, that in the proposal in April 1950 for the initial target price for 39 B-52G airplanes on contract -37481, 417,234 sustaining tooling hours were included, representing 10.9 percent of the estimated production hours. Here, again, the GAO stated that the 10.9 percent factor was based on 326 B-52 airplanes as comparable experience, although only the last 154 airplanes (53 and 101 G's) should have been considered. According to the GAO, had Boing based its estimate on G experience only, a factor of 6.5 percent would have been developed. The reflected reduction indicated by the GAO in its 6.5 percent application amounts to 165,000 hours, or $1,283,000. Air Force Reply A review was accomplished of Air Force pricing data used in the April 1959 negotiation for firm targeting the 101 B-52G airplanes on contract -34670. This review revealed that Boeing estimated that 1,425,000 hours would be needed to support production requirements in the form of sustaining tooling labor. This estimate was developed by projecting 75,000 hours per month, starting with the first unit entering the assembly area (December 1958) and ending with the delivery of the last unit (June 1960), for a total of 19 months. The 75,000 hours per month was based upon an analysis of prior B-47 and B-52 programs which indicated that from 70,000 to 80,000 hours per month of sustaining tooling labor had been expended, and would probably be expended on this program. Application of 75,000 hours to 19 months effort generated the 1,425,000 hours proposed by Boeing or, as the GAO stated, a factor of 11.7 percent of the estimated production hours. This estimate was also supported by the learning curve approach, utilizing an 80 percent curve, experienced on prior B-52 programs to project the estimated percentage of production labor to represent tool sustaining labor on this contract. The sustaining tooling hours reflect a rate of 11.7 percent of the production hours considered in the Air Force breakdown of the negotiated target cost. This rate was considerably less than had been previously experienced, and represented considerable improvement over a period of time. It is also noted that sustaining engineering labor, another element that supports production, was estimated in the same manner, i.e., average hours per month, based on prior B-52, A, B, C, D, and G experiences. Sustaining developmental labor represented a percentage of sustaining engineering labor. Elements comprising the estimated total target price in the negotiations which established the initial target pricing of contract -37481 were evaluated in the same manner as were the elements included in the firm target negotiation on contract -34670. As the GAO has indicated, the initial targets were negotiated on contract -37481 immediately following negotiations which established the firm targets for contract -34670. Sustaining tooling labor considered in the target of AF-37481 represented 10.9 percent of production labor. This gave recognition to additional learning to be acquired on this purchase of 39 airplanes. It was noted that in the evaluation of production costs on both contracts negotiated in April 1959, some elements of production labor were evaluated by utilizing only the experience obtained from the earlier B-52G program. However, tests of the reasonableness of estimated production costs were made by the Air Force in six different ways to assure fairness to both parties involved. Because of the interrelationship of costs of various elements of contract performance, it is the policy of the Air Force to negotiate a fair and reasonable total price. Sustaining tooling hours actually indicated 10.6 and 7.8 percent of production hours expended per respective contract. On the basis of this comparison, it appears that the target costs on both contracts were adequately priced. (2) Production labor GAO comments The GAO has stated that the initial target cost of contract -37481 included an Air Force allowance of $2,479,000 to compensate Boeing for anticipated losses in labor efficiency during the production of the last 39 B-52G airplanes without any support or assurance that such costs would be incurred. It is said that the Air Force record of negotiation of this initial target shows that the production labor hours estimate was based on estimated hours per unit accepted in the negotiations that had been just completed on the firm targeting of the 101 buy on contract -34670. This production labor hour estimate was reportedly increased by the Air Force to compensate Boeing for (a) reduced monthly delivery schedule, (b) phaseout of the B-52G model, (c) reduced lot sizes for fabrication, and (d) integration of the B-52H model into the assembly line during the last 5 months of production of the G model. A total estimated cost for 3,764,124 production labor hours was accepted by the Air Force and included in the initial target, according to the GAO report. Using the same basis as that stated in the Air Force record of negotiation, the GAO computed 3,453,000 production labor hours that should have been required for the 39 airplanes. This reflected difference of 311,000 hours, according to the GAO, represented an amount which the Air Force allowed to Boeing for anticipated losses in production labor efficiency. The GAO stated that a review of the Air Force negotiation record disclosed no information concerning the basis for the 311,000 hours, in which to substantiate the reasonableness of the allowance. It is said that the Air Force negotiator informed the GAO that the record of negotiations contained the reasons for the increase in production labor hours, but he was unable to locate any data to show how the 311,000 hours allowance was computed. According to the GAO, Boeing officials informed them that information supporting this allowance had been furnished to the Air Force during negotiations. A GAO review of Boeing's experience relative to the transition of production from one B-52 model indicated very little, if any, decrease in production labor efficiency during the transition period. Therefore, the GAO stated, there appears to have been no sound basis for the increase of 311,000 hours in the production labor estimate which resulted in about $2,479,000 increase to the initial target price. The GAO stated that in Boeing's proposal for the firm target negotiations conducted in March 1960 for contract -37481, Boeing included 77,287 labor hours for anticipated losses in labor efficiency caused by phasing out of the G model and integration of the H model into the production operations. However, the GAO pointed out that the Air Force record of negotiation indicated that the introduction of the B-52H model would have an adverse effect upon production operations, but nevertheless the proposed 77,287 hours was not accepted by the Air Force. Air Force Reply A review of the Air Force pricing files relative to the production costs included in the negotiated initial targets for contract -37481 reveals that the facts as stated by the GAO are essentially correct. It has been confirmed by information contained in the price negotiation memorandum (PNM) covering the initial pricing action that production labor hours were estimated by using the negotiated unit hours agreed to in the firm target pricing of contract -34670 as a base, projecting on a 78 percent learning curve to the midpoint of this procurement. This projection appears to have yielded about 87,191 average hours per unit. The PNM clearly states that an increase in hours was considered for engineering changes as applicable and for the factors of (a) reduced monthly delivery schedule, (b) phaseout of the B-52G Model, (c) reduced lot sizes for fabrication, and (d) integration of the B-52H Model into the assembly line during the last 5 months of production of the G model. The negotiated unit costs were based upon 96,516 production hours, an increase of 9,325 from the projection. It is considered pertinent that Boeing's proposal for the pricing action was based upon an estimate to be agreed upon by both the Air Force and Boeing for the establishment of interim "billing prices" for the subject contract pending later negotiation of target prices. The contractor's position with regard to the establishment of a target price, as was ultimately established (FPIS-type contract), was stated in his letter of transmittal dated April 11, 1959. This position stated that in the event targe prices were established in this negotiation, adequate and proper consideration must be given to conditions attendant to an extremely early target. In view of this, it is believed that any increased costs considered in the negotiations for a more firm target than the proposal had anticipated, could very well have been as a result of blackboard presentations or across-thetable discussions for such extra considerations. Alternatively, Boeing could have elected to utilize the time consuming method of reproposing on the basis of establishing an FPIS target. The Air Force was desirous of establishing an incentive from the outset in lieu of operating under billing prices which would have been about the equivalent of a letter contract. Specific data contained in the pricing files relative to labor losses in efficiency is limited. Notes relative to these increased hours reflected that a 7-percent integration factor was considered based upon RB to B-47 experience, thus generating about 213,000 hours on this program. Other considerations mentioned in the notes indicated that the end of the G program would tend to increase rework and replacement costs since the higher skilled personnel were being transferred to the H model productions. Reductions in lot sizes and monthly delivery schedules were also considered, although no specific information could be found which indicated the number of hours considered in each instance. Phaseout, or toe-up costs are at times considered very real and sizable expenditures. A review of various contracts wherein toe-up costs were considered revealed that such costs have represented as much as 7 percent of the total negotiated costs. In this instance, according to the GAO, these costs represented approximately 2 percent of the total target cost. Consideration for such costs in any amount is reduced to a matter of judgment on the part of the negotiating team, as to its applicability, in view of the procurement situation. These costs were clearly considered legitimate and applicable at the time the initial contract targets were negotiated. The validity of such an estimate or judgment is attested by the amount of actual cost incurred. Negotiations were conducted with Boeing in March 1960 for the purpose of establishing firm targets for this contract. Boeing proposed 77,287 hours at this time, to cover model change infiltrations, as indicated in the GAO report. According to the price negotiation memorandum authored by the chief negotiator (who was also the chief negotiator at the time the initial targets were established), these hours were removed, in the process of negotiating the firm target prices on a total contract pricing basis, although it was pointed out that model change infiltration would continue to have an adverse effect upon production operations. It should be remembered that the total initial target cost and profit was negotiated in 48-132-65-52 good faith by both the Air Force and Boeing, based upon costs that, at the time, were reasonably expected to be incurred. In this case, it was the judgment of the Air Force that toe-up costs were legitimately considered as a portion of the total initial target. Although the amount proposed by Boeing for impact of model change infiltration was removed by the negotiator in the process of negotiating the firm targets on a total price basis, it was recognized that the conditions which supported the allowance for toe up in the initial targets would continue to have an adverse affect upon production operations. In view of this, it is not considered that there is any basis for seeking adjustment in the contract prices. GAO Report, B-133251, November 25, 1964 71. Title: "Overstatement of Target Cost of AN/FPS-7 Radar Equipment Under Fixed-Price Incentive Contracts AF 30 (635)–12300 and AF 30 (635) — 11072 With General Electric Co., Heavy Military Electronics Department, Syracuse, N.Y." (OSD case No. 1891). GAO finding: Target costs were overstated, the major portion of which is attributable to the failure of General Electric to use the most current cost information pertaining to purchased parts and components during negotiations. GAO estimate of unnecessary costs: About $103,000. Time period of GAO report: Contract -12300, December 19, 1958-March 23, 1959. Contract -11072, June 1959. DOD comments on GAO finding: Concurred in the recommendations. However, since the time of these negotiations, changes of major importance have been made in DOD contracting methods and procedures. Instructions and directives subsequently issued are believed to have essentially accomplished the purposes of the recommendations. DOD comments on costs: Concurred with GAO finding. DOD corrective action: The Air Force is continuing its efforts to effect appropriate adjustments to the final target price of the contracts. An intensive cost reduction program is in effect in purchasing activities throughout DOD involving a wide variety of measures such as mandatory increased use of audit services, more effective procedures for obtaining and thoroughly considering cost data in noncompetitive procurements, substantially increasing the use of competition in defense procurement, reducing the relatively inefficient form of contracting such as the cost-plus-fixed-fee type of procurement, and expanding use of fixed price and incentive contracts. These are some of the wide ranges of measures that have been implemented under the DOD cost reduction program, all of which give strong evidence of the awareness and concern by contracting officials throughout the DOD with the importance of reducing the cost of military supplies and equipment utilizing the most efficient and economical procedures for accomplishing this result. ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE Problem The contractor overstated the estimated target costs on the subject contracts by about $538,000. This resulted from contractor's failure to utilize the most current cost information available at the time the contracts were negotiated. Unless the target prices are appropriately adjusted, the contractor will receive approximately $103,000 in unearned target and incentive profits under these contracts. GAO recommendation That the Air Force continue its efforts to effect appropriate adjustments to the final target prices of contracts AF 30(635)–12300 and -11072. Statement We are continuing our efforts to obtain adjustments of approximately $538,000 for overstated target costs. By letter of April 6, 1965, the commander, Air Force Logistics Command, wrote to the president of General Electric requesting his personal consideration of this matter, since GE's general manager for its Heavy Military Electronics Department had refused to offer more than a token downward adjustment of $41,700 in target cost for the two contracts. General Electric is expected to respond to this letter by May 30, 1965. If the |