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APPENDIX III

FRIDAY, NOVEMBER 13, 1959. Hon. F. A. BANTZ, Under Secretary of the Navy, Washington, D.C.

DEAR MR. SECRETARY: I have for acknowledgment your letter of November 6, 1959, with which you enclosed documents relating to modifications and changes in Navy contract procedures.

This relates to hearings of July 17, 1959, at which time the General Accounting Office reported on certain Navy contracts.

This material will be included by interpolation in the record of that pro ceeding.

Thank you for your continuing interest and for bringing this matter to our attention. Sincerely yours,

F. EDWARD HÉBERT, Chairman.

DEPARTMENT OF THE NAVY,

OFFICE OF THE SECRETARY,

Washington, November 6, 1959. Hon. F. EDWARD HÉBERT, Chairman, Subcommittee for Special Investigations, Committee on Armed Serv

ices, House of Representatives, Washington, D.O. MY DEAR MR. CHAIRMAN : At the hearing last July 17 concerning GAO reports on Navy procurement we requested an opportunity to give the committee a summary of the actions the Navy has taken since the Korean war to improve contracting procedures. This summary is submitted herewith. We would appreciate its inclusion in the record of the hearing.

The principal conclusion of the GAO reports on 14 cases was that in a dozen of them, mostly involving Korean war procurement, the Navy had accepted cost statements for pricing purposes without sufficient analysis or audit. We believe that the summary of procurement instructions submitted herewith shows that the Navy has taken aggressive action since the Korean war to improve the pro ceedures for contract pricing, particularly in regard to the analysis of current cost data at both the prime and subcontract levels and the audit of contractors' cost data relied on in establishing both preliminary and financial contract prices.

Detailed cost estimates have generally been required in the pricing of signi. ficant negotiated contracts. Comprehensive guidelines on conducting cost and price analysis were published in 1953, at which time a standard form for cost analysis was adopted. The criteria of when and how to analyze costs were reemphasized in 1957. In 1959 contractors were made to certify that they were disclosing their most current cost data for pricing of negotiated contracts over $100,000 where the price is based more on the contractor's cost data than on effective competition. Also in 1959 our redetermination clauses were changed to require explicitly that contractors submit the most current data for repricing purposes with the discretionary sanction of suspension of payments until the data are furnished. Beginning in 1953, instructions focused on contractors make-or-buy plans in terms of their effect on contract prices, and in 1954 controls were established for reviewing and approving the pricing of significant subcontracts under fixed-price-type contracts.

Auditing contractors' price proposals has been the general practice for the final pricing of incentive and redeterminable contracts. The importance of auditing in the pricing of fixed-price-type contracts was emphasized in 1957, and in 1958 the Secretary of the Navy notified the bureau chiefs that auditing is “imperative” in complex negotiations of large dollar amounts. In October 1959 auditing requirements were explicitly extended to target prices under incentive con. tracts and to other pricing actions primarily based on contractors' cost data.

While the Navy has initiated many of these improvements in procurement pricing procedures, the General Accounting Office has suggested some of them and we shall continue to welcome GAO recommendations for further improve ment in our procurement procedure. However, as essential good procurement procedures are, we also recognize that we must have informed judgment by our procurement people to achieve close but fair prices. In order to improve the quality of individual performance we have published various training guides such as “Navy Contract Law," "Navy Negotiators Handbook," and "Navy Contract Auditors Handbook.” Also we have conducted and are conducting intensive training courses for negotiators and others in cost and price analysis and contract administration,

We are striving to improve our contract pricing and to learn from our mistakes. At the same time, with Navy procurement in the magnitude of at least $7 billion and 75,000 contracts annually ever since 1953, we think that this enormous undertaking has been done with few exceptions at fair and reasonable prices. Sincerely yours,

F. A. Bantz,
Under Secretary of the Navy.
DEPARTMENT OF THE NAVY,
OFFICE OF THE SECRETARY,

Washington, October 26, 1959.

SUMMARY OF INSTRUCTIONS SINCE KOREAN WAR FOR CLOSE PRICING OF NAVY

CONTRACTS MADE BY NEGOTIATION

SYNOPSIS

I. Navy policy established in 1953 not to award production contracts for

technical equipment requiring significant development or modification in

design.
II. Requirements for cost and price analysis:
A. In general:

1. Detailed cost estimates generally required since 1950.
2. Comprehensive guidelines for cost analysis issued in 1953.
3. Standard cost and price analysis form adopted in 1953.
4. Additional criteria for and techniques of price and cost

analysis issued in 1957; supplemented in 1959.

(a) Price analysis necessary in every procurement.
(b) Criteria for use of cost analysis.
(c) Cost comparisons to be made.
(d) Forecasting future trends in costs from historical

cost experience of primary importance.
(e) Contractor's certificate of disclosure of all current

cost and pricing data generally required for

negotiated contracts over $100,000. III. B. Cost Analysis in price redetermination negotiations:

1. Instructions on cost analysis for price redetermination issued

in 1953. 2. Navy cost analysis form for price redetermination adopted in

1954. 3. Cost analysis for price redetermination reemphasized in 1955. 4. 1959: Revised price redetermination clauses explicitly re

quire contractor to submit most recent cost data.
C. Evaluation of contractor's “make-or-buy” plans:

1. Guidelines issued in 1953 and 1957; supplemented in 1959.
2. Effect of subcontracting on contractor's profit allowance:

Various factors to be considered explained in 1953 and

repeated in 1959.
D. Review and approval of subcontract prices:

1. Basic controls established in 1954.
2. Additional controls provided in 1959.

(a) First-tier subcontractors certificate of disclosure to

prime contractor of all current cost and pricing data generally required for subcontracts in excess

of $100,000. (6) Provision made for repricing prime contracts in light

of subcontract repricing. (c) Standard clause for approval of certain subcontracts

prescribed for fixed-price incentive and redeter

minable prime contracts. E. Special factors for pricing sole source items. F. Neither statutory renegotiation nor contractor's certificate of re

liability of cost data acceptable substitutes for pricing negotiations. III. Requirements for Audit of Contract Prices:

A. Auditing of contractors' proposals for price redetermination and for

final pricing of incentive contracts generally required since 1951. B. Importance of auditing as a pricing aid emphasized in 1957 and

1958:

1. General guidelines set forth in ASPR 3-809 (Feb, 1, 1957). 2. May 1958: Secretary of the Navy policy statement that

auditing is imperative in complex negotiations of large

dollar amounts. C. October 1959: Auditing requirements explicitly extended to target

prices under incentive contracts, conversion of letter contracts, equitable adjustments in contract prices, and other pricing actions primarily based on contractor's cost data:

1. Advisory audit reports required.

2. The auditor as part of the negotiating team. D. Audit of adequacy of contractor's accounting system required prior

to awarding contracts in excess of $300,000 on other than a firm

fixed-price basis. E. Use of auditors in analysis of significant subcontract prices required

whenever audit is made of prime contract pricing. IV. Instructions on use of firm fixed-price and incentive contracts:

A. “Navy Contract Law” (1949) fully explained the advantages of and

limitations of these types of contracts; restated in 1959 edition. B. Navy procurement directives of 1953 repeated basic instructions on

use of fixed-price and incentive contracts. C. “Navy Negotiators Handbook” (1953) contained thorough discussion

of factors appropriate to the selection of fixed-price and incentive

contracts; restated in 1958 edition. D. Current instructions in the Armed Services Procurement Regulation.

1. The firm fixed-price contract shall not be used when con

tingencies proposed in the contract price are considered

unreasonable. 2. Limitations on the use of fixed-price incentive contracts. 3. Criteria for selection of appropriate type of contract extended

to review and approval of proposed subcontracts.

I. NAVY POLICY ESTABLISHED IN 1953 NOT TO AWARD PRODUCTION CONTRACTS FOB

TECHNICAL EQUIPMENT REQUIRING SIGNIFICANT DEVELOPMENT OR MODIFICATION IN DESIGN

NPD 14-106 (Oct. 1, 1953) established this policy, subject to limited excep tions for reasons of “military urgency," to avoid "the increased cost inherent” in such procurement Policy currently set forth in NPD 3-108 (Apr. 1, 1959).

II. REQUIREMENTS FOR COST AND PRICE ANALYBIS A. In general

1. Detailed cost estimates generally required since 1950.A Munitions Board directive of August 24, 1950, established DOD policy "generally to require de tailed estimates of price components on negotiated prime contracts and major subcontracts thereunder" and to require in the administration of price redetermination clauses and incentive-type contracts "a detailed reestimate of price components, together with evidence drawn from the company's cost-control system in a form adequate to disclose the degree of accuracy of the estimating system" (NPD 18–101.5–4b(7) (1952 edition)).

2. Comprehensive guidelines for cost analysis issued in 1953.—Chapter 4 of the "Navy Negotiators Handbook,” issued in 1953 by the Office of Naval Material, comprehensively discussed the types and extent of cost data and cost analysis necessary to the close pricing of negotiated fixed-price and cost-reimbursement contracts. These guidelines are continued in chapter 4 of the 1958 edition of the handbook.

3. Standard cost and price analysis form adopted in 1953.—ASPR 16-002 (June 29, 1953) prescribed DD Form 633 (Cost and Price Analysis) for use in all cases "requiring price analysis, except where the accounting system of a proposed contractor makes the use of the contractor's form more practicable and where the form used by the contractor is adequate to provide the necessary data in an acceptable form.”

1 One copy of secs. B-D of ch. of "Navy Negotiators Handbook" (NavEsos P-1001 (1953)) is being submitted to the House Armed Services Committee for the record.

4. Additional criteria for and techniques of price and cost analysis issued in 1957; supplemented in 1959.-

(a) Price analysis necessary in every procurement: "Some form of price analysis should be made in every procurement, even when competitive proposals have been submitted.” ASPR 3-808.2(a) (Feb. 1, 1957), currently ASPR 3-807.3(a) (Oct. 1, 1959). "In the absence of effective price competition, the negotiating team must make a thorough analysis of contractors' proposals and must be in possession of current, complete, and correct cost or pricing data before decisions are made on contract prices.” ? ASPR 3-807.3(a) (Oct. 1, 1959). [Emphasis added.) “Rough yardsticks may often be developed (in such terms as dollars per pound, per horsepower, or other units) to point up apparent gross inconsistencies which should be subjected to additional pricing techniques, including cost analysis. Such yardsticks should be considered as an indispensable adjunct to cost analysis since a study of a single offeror's estimated costs in sole source situations will not indicate whether the proposed price is fair and reasonable in comparison with other products of the same kind" (ASPR 3-808.2 (c) (Feb. 1, 1957), currently ASPR 3-807.3(c) (Oct. 1, 1959)).

(6) Criteria for use of cost analysis: Pursuant to ASPR 3-808.3(a) (Feb. 1, 1957), currently ASPR 3-807.4(a) (Oct. 1, 1959), cost analysis is “desirable" when

(i) "effective competition has not been obtained" or "a valid basis for price comparison has not been established";

(ii) "price comparisons have revealed apparent inconsistencies" or "the prices quoted appear to be excessive";

(iii) “the proposed contract is of a significant amount and is to be awarded to a sole source"; or

(iv) “a cost-reimbursement, incentive, price redeterminable, or time and material contract is negotiated." (c) Cost comparisons to be made: ASPR 3-808.3(c) (Feb. 1, 1957), currently ASPR 3-807.4(c) (Oct. 1, 1959), provided that “among the several types of cost comparisons that should be made are comparisons of a contractor's or offeror's current estimated costs with

"(i) actual costs previously incurred by the contractor or offeror; and with its last prior estimate for the same or similar item or with a series of prior estimates;

“(ii) current estimates from other possible sources; and

“(iii) prior estimates or historical costs of other contractors manufacturing the same or related items." (d) Forecasting future trends in costs from historical cost experience of primary importance in pricing: ASPR 3-808.3(d) (Feb. 1, 1957), currently ASPR 3-807.4(d) (Oct. 1, 1959).

(e) Contractor's certificate of disclosure of all current cost and pricing data generally required for negotiated contracts over $100,000 : : This certificate “shall be obtained from the prime contractor immediately prior to agreement on negotiated prices, targets, or price revisions.” In the contracting officer's discretion the "certificate may be obtained when lesser amounts are involved." ASPR 3-807.3(a) (Oct. 1, 1959). The form of certificate, set forth in ASPR 3-807.7 (Oct. 1, 1959), provides :

“This is to certify, to the best of my knowledge and belief, that in the preparation of the proposal for

being (to be) produced under the terms of (contract, proposal, quotation, etc.) No. ---- (i) all available actual or estimated costs or pricing data have been considered in preparing the price estimate, and made known to the Contracting Officer for his use in evaluating the estimate, and (ii) any significant changes in the above data which have occurred since the preparation of the above proposal through the

of B. Cost analysis in price redetermination negotiations

(Date) also have been made known in the price negotiations (Month), (Year) to the Government negotiator.

Name
Title

Firm
Date

---

* This accords with the GAO recommendation made at p. 6 of its report to the Congress, B-132942, of July 14, 1959, on "Examination of Selected Department of the Navy Con. tracts and Subcontracts," that contracting officials should be required to obtain the most current information available on prior cost experience as well as on estimated costs of future production •

* See note 2, supra.

97

1. Instructions on cost analysis for price redetermination issued in 1953.Chapter V Bd of the "Navy Negotiators Handbook” covered this in detail, including the importance of an independent audit of the contractor's incurred and projected costs. Also it emphasized that the negotiator "should be certain that the cost information which he receives is complete and not merely on items actually delivered."

2. Navy cost analysis form for price redetermination adopted in 1954.-NPD 18-502 (Jan. 1, 1954) required the use of this form "in obtaining actual and projected cost and production data on contracts requiring redetermination."

3. Cost analysis for price redetermination reemphasized in 1955.-NPD 18 102.2a (Jan, 3, 1955) reemphasized that in price redetermination negotiations "full consideration” shall be given, among other things, to the contractor's "cost data including questioned costs and the allocability and reasonableness of costs."

4, 1959: Revised price redetermination clauses explicitly require contractor to submit most recent cost data.Issued as ASPR 7-109 (Apr. 20, 1959), these revised price redetermination clauses explicitly require, among other things, that the contractor furnish for price redetermination current statements of incurred and estimated costs showing the most recent cost data as well as an explanation of significant differences from prior cost statements. Supplementary statements are also required in the event price redetermination is delayed. Additionally provision is made that where the contractor fails to make timely submissions of the required data, the contracting officer may suspend further payments until the data are furnished. O. Evaluation of contractor's "make-or-buyplans

1. Guidelines issued in 1953 and 1957; supplemented in 1959.—Chapter IV O 4b (4) of the “Navy Negotiators Handbook,” issued in 1953, emphasized the impor'tance of evaluating significant costs of items of material in terms of whether such costs could be reduced depending on whether the items were made or purchased by the contractor, or purchased by the Government and furnished to the contractor, as appropriate. Also stressed were criteria for evaluating the effectiveness of the contractor's purchasing practices. Essentially these criteria were later incorporated in ASPR 3-808.5 (b) (Feb. 1, 1957). ASPR 3-901 and 3-902 (Oct. 1, 1959) supplemented the foregoing to require generally the review and approval of the contractor's make-or-buy program and purchasing system where “(i) the item, system, or work is complex, the dollar value, or competition is restricted ; and (ii) cost reimbursement, price redetermination or incentive-type contracts are to be used." Also, ASPR 3–903.3 (Oct. 1, 1959) amplified the criteria for review and approval of the contractor's purchasing system.

2. Effect of subcontracting on contractor's profit allowance: Various factors to be considered explained in 1953 and repeated in 1959.—Chapter 4 C 8C(4) of the "Navy Negotiators Handbook" (1953) set forth the relevant factors by which to appraise a reasonable profit based on the extent of contemplated subcontracting and pointed out the complexity of this matter and the dangers of an oversimplified or automatic approach. Particular emphasis was given to the effect of subcontracting upon the contractor's risktaking and whether or not subcontracting will result in lower overall costs. Also attention was directed to the policy of not reducing the contractor's profit return by virtue of his efforts to promote subcontracting to small business concerns and to broaden the industrial base, as set forth in NPD 18–1300 (Oct. 1, 1952). Essentially these factors are repeated in ASPR 3–808.2(h) (Oct. 1, 1959)." D. Review and approval of subcontract prices

1. Basio controls established in 1954.-NPD 18–105 (Jan. 1, 1954) set forth basic Navy policies and procedures for the close pricing of subcontracts. It provided for obtaining information from prime contractors on the extent of cost or price analysis accomplished on proposed subcontract prices and for "careful

* This form was subsequently superseded by a similar DOD form. See ASPR 16–207 (June 11, 1958).

6 Prior Navy redetermination clauses did not explicitly require the contractor to furnish supplemental cost data if redetermination was delayed, e.g., although they did require the contractor to furnish "such reasonable further information as may be relevant, upon request by the Contracting Officer specifying the information desired." NPD 10, 568a (1945 edition), republished as NPD 7-107 (1957 edition). See also GAO Report, note 2, supra, at 11. . This policy is currently set forth in NPD 3–808.4(a) (Apr. 1, 1959).

See GAO Řeport, note 2, supra, at 37.

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