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late as June 1957. The competition apparently lowered their quote thereafter because substantial quantities of these items were purchased from another source at prices slightly lower than ours. Subsequently, as our learning curve improved and certain non-capitalized starting costs were recovered, we offered bids of $210.00, each, on new quotes.

We feel that the subject report expresses a grossly unfair attitude on the part of the General Accounting Office which seriously abridges our rights under the free-enterprise system by focusing attention on one individual item out of several hundred different designs produced, and excluding therefrom the overall nature of our business as it affects each product sold.

We have, on many occasions in the past, explained to the Government our pricing and cost-estimating policies as well as our cost accounting procedures wherein all non-inventory costs are averaged over all orders and provide the means of processing between five and six hundred separate contracts per month, with a minimum of overhead. The cost-estimating procedure employed is far more indicative of the true costs since appropriate factors to cover unusual engineering design and test development costs can be included. It is, therefore, impossible for persons unskilled in the technical nature of our business to accurately determine the costs accruing to any one item by referring only to the accounting records of materials, assembly labor and manufacturing burden against that one item. It would also be unnecessarily and prohibitively costly to attempt accounting for each increment of total cost on every one of our contracts to include normal start-up expenses in tooling, engineering and test, plus many extra customer requirements such as accelerated schedules, special processing, overtime premium, etc. Our standard policy of averaging these costs over total sales has been consistently acceptable in the past and allows us to povide the Government enormous benefits in research and development for the future on the fruits of earlier accomplishments. Surely our average annual operating profit of 512% for the period under discussion is not excessive.

If it is to be the policy of the Government, now, to penalize a supplier by pinpointing one particular product on which he shows a profit merely by the manner in which he happens to keep his books, to the exclusion of all other products, then manufacturers ilke ourselves, whose business is over 95% military, will of necessity be forced to charge the Government directly for all pro posal, experimental and development costs which we presently bear at our own expense under the free-enterprise system of marketing proprietary items. This unwarranted encroachment upon our liberties can only result in additional cost to the Government which in the final analysis comes out of the taxpayer's pocket. To summarize, we would like to suggest :

1. A conference be arranged with competent representatives from your organization to discuss the appropriateness of your methods of cost evaluation as applied to our particular business activity.

2. All detailed data submitted by your analysts be made available to our accountants for substantiation and comment.

3. The present draft of the subject report be held in abeyance until action on the above suggestions is carried out.

4. All persons who may have already received copies of this report be advised of the above suggested pending action. Very truly yours,

WHITTAKER CONTROLS DIVISION

OF TELECOMPUTING CORPORATION, FRANK P. McCORD,

Administrative Manager. FPM/gp

APPENDIX B

GENERAL MOTORS CORPORATION General Motors Building, 3044 West Grand Boulevard, Detroit 2, Michigan

JANUARY 20, 1959. Mr. C. M. BAILEY, Associate Director, Defense Accounting and Auditing Division, U.S. General Accounting Office, Washington 25, D.C.

DEAR MR. BAILEY: Your letter of December 22, 1958 addressed to Mr. J. F. Gordon, President of General Motors Corporation, with respect to certain purchases made by Allison Division of General Motors Corporation from the Telecomputing Corporation, Whittaker Controls Division, has been referred to me for reply. Your letter summarizes its attached report as follows:

“The report discloses that unreasonably high prices were paid for valves because Allison did not require, nor did Telecomputing furnish, evidence in

support of prices quoted.” Your report states on Page 4 that on nine purchase orders covering the procurement of 4,079 valves, Whittaker's cost averaged $124.87 as compared with an average unit price of $247.00. From the foregoing it would appear that your Office is of the opinion that the prices paid were unreasonably high, measured by the costs computed by your Office, and further, that these prices could not have been established properly because Allison did not require cost estimates in support of prices.

Since receipt of your letter, we have asked Whittaker to confirm the unit cost attributed in your letter to their valves. Whittaker advised that they had recieved from you a proposed Report which you intended to make as a result of your review of certain of their records applicable to the aforesaid nine Allison purchase orders. Whittaker has provided us with a copy of their reply to you in which Whittaker states that the costs in your letter are incorrect and incomplete. Whittaker also indicates in their reply that they have no means by which they can reconcile the GAO-stated costs with their true costs. With respect to these purchase orders, Whittaker has also informed you that only a reasonable profit was earned by them. Viewed in the light of this information provided by Whittaker, your comments and conclusions would appear to require a reappraisal to determine their validity.

We believe that Allison procurements from Whittaker, including those which your Office has singled out, have been made on a sound basis.

The basic Allison procurement policy has been and is that firm fixed prices should be obtained, based on competitive bids. Procurements are only made on a basis other than this when it is not possible to secure competitive prices for the same end item from two or more sources.

When a specific company has developed a highly technical product, as a proprietary item, to perform a certain function, the competition then becomes one of not only price but also performance, quality and delivery. Also, the selection of a proprietary item requires time and funds to qualify the item to the satisfaction of the Air Force and Allison for use on an engine. Competitive bidding is not economically feasible unless another source offer an item that serves the same functional purpose and unless the Government and Allison are willing to incur the added costs and to take the time required for the testing necessary for the qualification of the product of the second source.

Allison has been purchasing valves of various descriptions from Whittaker since approximately 1946, and followed normal procurement practice in negotiating prices. The specific valve on which the General Accounting Office has commented is used on the J–71 jet engine and is interchangeable with a valve for which another valve manufacturer was the original and sole source. Allison had experienced serious delivery difficulties with the original source company and consequently endeavored to establish a second source. Because of the complicated performance and test facilities required for these valves, the poten. tial sources were limited to a very few companies.

Whittaker was established as an alternate source not only because of the delivery problems but also because of the Government policy of establishing alter

nate sources whenever practicable. In this manner the prime contractor insures compliance with his delivery requirements, has a greater opportunity to evaluate prices and broadens the base for continued engineering development.

Allison solicited Whittaker's assistance and outlined the function and speci. fications required of this part. Whittaker submitted a prototype and outline drawings of a proprietary valve designed and developed by it to meet Allison's requirements. It did not provide Allison with manufacturing or other details and did not grant to Allison any right to manufacture this valve.

When Whittaker submitted its proposed prices Allison measured its price by the products and prices available from the original source company, the price of other valve suppliers and other related data. Allison also measured these prices in the light of its delivery and quality requirements. Whittaker's initial price for a limited quantity was somewhat higher than the original source company price. However, Whittaker's subsequent price for production quantities, as submitted, was lower than the then current original source company price.

As previously stated Allison has been purchasing from Whittaker since 1946 and was acquainted with its pricing policies. Allison was aware of the fact that Whittaker priced on the basis of its evaluation of the market potential and amortized starting up costs over the anticipated market. The subsequent Whittaker prices reflected this policy of stable prices over extended time periods. No specific engineering and tooling charges were paid by Allison for the development and production of this part.

On the substantial number of procurements of these and other valves from both of these sources, the prices paid by Allison evaluated in the light of its procurement policies and the need for dual sources have generally been in a reasonable range. In certain instances one source has been lower, and in others the remaining source has been lower.

As a further test of the reasonableness of Whittaker's overall cost-price relationship, we have been advised that their profit rates before taxes based on published data for the fiscal years 1953 through 1957 ranged from a low of 4.3% to a high of 10.3% and averaged approximately 7.5%. In the Telecomputing Corporation Annual Report for 1957 we find the statement that the local Regional Board of the Renegotiation Board has made a finding that no excessive profits were realized by Whittaker in the fiscal years ended April 30, 1955 and April 30, 1956. It is also stated that in the opinion of management no excessive profits were realized by the Whittaker Company subsequent to the fiscal year 1956. The following is contained in the notes of the financial statement certified by their Public Accountants, Arthur Andersen & Co.:

(6) RENEGOTIATION–Wm. R. Whittaker Co., Ltd. has entered into tentative settlements with the local regional board of the Renegotiation Board which provide for refunds of excessive profits ($209,387 after deducting applicable tax reductions) from contracts subject to the Renegotiation Act of 1951 covering the fiscal years ended April 30, 1953 and 1954, and was notified by the agency that no excessive profits were realized in the fiscal years 1955 and 1956. The agreements are subject to approval by the Renegotiation Board in Washington, D.C., and have not yet been approved. The amounts of the tentative settlements are reflected as a liability in the accompanying consolidated balance sheet.

In the opinion of management, no excessive profits were realized by Wm. R. Whittaker Co., Ltd. under contracts subject to the Act for periods subsequent to the fiscal year 1956. Also, in the opinion of management, no excessive profits have been realized under such contracts by Telecomputing

Corporation and its subsidiaries through October 31, 1957. As the Services are aware, it has not been our practice to require suppliers to subject themselves to audits by General Motors or to submit cost data in support of proposed prices. This is true whether the supplier is delivering a part for a defense program or for our non-defense operations. We firmly believe that the audit function in a defense procurement should be restricted to the Government agencies and the several contract clauses required by statutes and procurement regulations are to this effect. From a practical standpoint, we feel that it would be an unproductive duplication of effort to superimpose prime contractor cost reviews on top of audits conducted by Government agencies.

We also have the firm conviction that in most instances the reasonableness of suppliers prices can be tested more adequately by competitive bids, by price comparisons, by evaluations of the suppliers' capabilities, and by our knowledge and experience with the suppliers and with substantially similar products. Such evaluations afford the Government and Allison adequate protection in the negotiation of reasonable prices. We recognize, however, that there may be the unusual situation in which the requirement for a cost submission is appropriate. Furthermore, in those instances in which a prime contractor is required to supply part or all of a subcontractor's facilities, financing, tooling, etc., the prime contractor is justified in requesting cost and other financial data in order to evaluate properly the unusual investment and cost.

The objective of the Government and the prime contractor in the negotiations of subcontractor's prices should be procurement at the lowest price possible rather than the consideration of isolated cost elements or profit rates. In those situations where General Motors is a supplier to other commercial organizations which are subcontractors or prime contractors on negotiated contracts with the Government, we recognize the right of the Government to audit our books and records but we question any attempted intrusion by a commercial organization to examine our books or to require the submission of cost breakdowns. All of the foregoing has even greater application in situations such as the instant one where a proprietary item is being purchased.

In summary, we disagree with the conclusion reached in your letter and we request the opportunity to review this subject with you before a final report is submitted. Very truly yours,

ALLISON DIVISION,
GENERAL MOTORS CORPORATION,
E. B. NEWILL, General Manager.

APPENDIX II

COMPTROLLER GENERAL OF THE UNITED STATES,

Washington, October 14, 1959. Hon. F. EDWARD HÉBERT, Chairman, Subcommittee for Special Investigations, Committee on Armed Services, House of Representatives.

DEAR MR. CHAIRMAN: Enclosed for the use of your subcommittee is a copy of our report to the Congress on examination of the pricing of Department of the Air Force negotiated fixer-price contract AF 09 (603)-32239 with General Motors Corp., AC Spark Plug Division, Milwaukee, Wis.

The report presents our finding that the contract price was negotiated on the basis that almost 100 percent of the work would be subcontracted. The contractor subsequently decided to perform the work in its own plant, and this was accomplished at substantially lower costs than the estimates upon which the contract price was established. We brought this matter to the attention of the contractor, who subsequently offered to refund $105,872 to the Air Force.

We are recommending to the Secretary of the Air Force that in the negotiation of fixed-price contracts the agency generally provide for unlimited downward and limited upward adjustment of the price if there is a significant change in the extent of subcontracting from that established in negotiating the contract price. We are recommending also that any such instructions to agency contracting personnel emphasize the need for recognizing, where appropriate, the contractor's right to share in any savings resulting from legitimate changes in the contemplated subcontract structure. Sincerely yours,

JOSEPH CAMPBELL, Comptroller General of the United States.

COMPTROLLER GENERAL OF THE UNITED STATES,

Washington, October 14, 1959. B-133021 Hon. SAM RAYBURN, Speaker of the House of Representatives.

DEAR MR. SPEAKER : Enclosed is our report on examination of the pricing of Department of the Air Force negotiated fixed-price contract AF 09 (603)-32259 with General Motors Corp., AC Spark Plug Division, Milwaukee, Wis.

The report presents our finding that the contract price was negotiated on the basis that almost 100 percent of the work would be subcontracted. The contractor subsequently decided to perform the work in its own plant, and this was accomplished at substantially lower costs than the estimates upon which the contract price was established. We brought this matter to the attention of the contractor, who subsequently offered to refund $105,872 to the Air Force.

We are recommending to the Secretary of the Air Force that in the negotiation of fixed-price contracts the agency generally provide for unlimited downward and limited upward adjustment of the price if there is a significant change in the extent of subcontracting from that established in negotiating the contract price. We are recommending also that any such instructions to agency contracting personnel emphasize the need for recognizing, where appropriate, the contractor's right to share in any savings resulting from legitimate changes in the contemplated subcontract structure.

This report is also being sent today to the President of the Senate, and copies are being furnished to the Secretary of Defense and the Secretary of the Air Force. Sincerely yours,

JOSEPH CAMPBELL,

Comptroller General of the United States. Enclosure.

REPORT ON EXAMINATION OF PRICING OF DEPARTMENT OF THE AIR FORCE CONTRACT AF 09 (603)-32259 WITH GENERAL MOTORS CORPORATION, AC SPARK PLUG DIVISION, MILWAUKEE, WISCONSIN

The General Accounting Office has examined the pricing of Department of the Air Force negotiated fixed-price contract AF 09 (603)-32259 held by General Motors Corporation, AC Spark Plug Division, Milwaukee, Wisconsin. Our examination was made pursuant to the Budget and Accounting Act, 1921 (31 U.S.C. 53), the Accounting and Auditing Act of 1950 (31 U.S.C. 67), and the authority of the Comptroller General to examine contractors' records, as set forth in 10 U.S.C. 2313(b).

BACKGROUND INFORMATION

AC Spark Plug was one of four major suppliers selected by the Air Force for production of the ME-5 Bombing Navigational Computer. Contract AF 09 (603)-32259 dated January 10, 1957, was for 1,414 modification kits and 206 related spare parts for the ME-5 Bombing Navigational Computer at a total price of $527,495. These modification kits consist of 3 units of an AC Servo motor and gear train assembly identified as part 620756, 6 dowel pins, and 1 additional component supplied without charge by the Government. The contract was awarded by Warner Robins Air Materiel Area and was administered by the Milwaukee Air Procurement District. The Auditor General, United States Air Force, has audit responsibility at the contractor's plant but was not required to audit this procurement.

FINDINGS AND RECOMMENDATIONS

COST SAVINGS RESULTING FROM SUBSTANTIAL REDUCTION IN SUBCONTRACTING

REFUNDED BY CONTRACTOR

The price for contract AF 09 (603)-32259 was negotiated on the basis that almost 100 percent of the work would be subcontracted. The contractor subsequently decided to perform the work in its own plant, and this was accomplished at substantially lower costs than the estimates upon which the contract price was established. We brought this matter to the attention of the contractor, who subsequently offered to refund $105,872 to the Air Force.

In October 1956, AC Spark Plug submitted its proposal to the Air Force for 1,414 modification kits. This proposal, which was accepted by the Air Force on January 10, 1957, resulted in establishing a firm price of $503,653.

The proposal contained an estimate of $449,779 for material costs. Approximately $448,000 was estimated for the purchase from a subcontractor of the Servo motor and gear train assembly (part 620756), based on the contemplated

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