cordingly, a total of the hours developed from the individual shop-chart readings at the 71st and 299th planes will develop a total hours per plane of 23,691, which should have been included in our price proposal instead of 24,697.

We believe the basis on which the hours per plane were forecast to be very sound since it gave full consideration to the costs already experienced in the long lead-time shops, thus minimizing the amount of hours which it was necessary to estimate for completion of the segment. The projected hours on the charts as necessary for completion of the segment were the result of the best thinking of management based on facts available at the time this forecast was prepared.

Your report with respect to direct labor further sets forth the following observation: "It was observed that not only was a 74-percent efficiency curve projected, but according to the contractor's price proposal for the follow-on segment of 300 planes, 74 percent was actually experienced. Consequently, with little change in labor rates the cost of performance should approximate the original forecast; however, the forecast exceeded performance by $2,427,400." It should be noted that the chart presented at the time of price redetermination of the second segment indicated a 74-percent trend through the 47th airplane prior to the transfer of the aft fuselage to Kansas City plant as on-site labor. The chart presented at the price redetermination of the follow-on segment of 300 planes showed a 74-percent trend from the 1st through the 299th planes including the effect of the aft from the 48th plane. This indicates that our efficiency in the production of the second segment improved to the extent that we were able to maintain approximately a 74-percent curve including the aft, which would account for at least a part of the amount by which actual performance was under forecast.

S. Direct labor in process overvalued

The contractor agrees that the direct labor in process appears to have been overvalued by $106,000. The cause is undetermined.

FORWARDING PRICING-THIRD SEGMENT OF 300 PLANES

1. Prospective analyses of overhead

Your comments state that the contractor's proposals relating to the third segment did not give full consideration to recent cost experience or to the production periods over which these expenses would be incurred in the areas of manufacturing and general and administrative expenses. In regard to manufacturing expense, you cite, as an example the last 76 planes of the second segment wherein a burden rate of 185 percent, or $59,000 per plane, was experienced as opposed to the $72,000 per plane included in our quotation, which was later reduced to $69,000. It is not agreed that our experience on the last 76 planes of the second segment would have been a basis for forecasting the burden expenditures for the 300 airplanes, for the reason that it did not give effect to phasing out the program.

As stated in our proposal data, we priced the burden in our final segment on the basis of the burden in process at the cutoff date plus the estimated expenses necessary to complete. This was done to the best of our ability to forecast and is our customary basis for pricing. At the time of price reset on this last segment, there were many phase-out items of cost that we could foresee as factors influencing our third segment manufacturing and general and administrative costs, and we included them as we saw them as of that date. This method of pricing may appear to give little consideration to burden rates and past trends; however, we believe that each of these items was given due consideration in estimating the expenditures necessary to complete the contract, as conditions then appeared.

You commented to the effect that the contractor's accelerated delivery schedule had, at the date of actual negotiation, been further accelerated with no evidence that such information was considered in establishing the burden rate. In reviewing the data available on delivery schedule at the date of redetermination it is found that it was anticipated deliveries would be completed in July 1955 and the price was reduced from that proposed to compensate for 1 month's burden. At that time we could not be assured that the planes remaining to be delivered could be completed prior to July 1955, nor that they would be accepted by the Air Force ahead of such date if completion was accomplished.

FORWARD PRICING-SPARE PARTS

Redetermination of prices for spares delivered to mutual defense assistance program (MDAP)

Your comments state that prices for spare parts to be delivered to mutual defense assistance program were to be redetermined, in accordance with contract terms, after the delivery of the 299th plane but that the cost data submitted by the contractor and used as a basis for negotiating the new price of spares set forth cost experience gained by the contractor through delivery of only the 210th plane.

The cost statement submitted relative to MDAP spares and the redetermination of prices after delivery of the 210th airplane was the result of a mutual arrangement between members of AMC and BOP organizations. The cost statement, however, played a very small part in the negotiation of the agreed upon price for MDAP spares.

The cost of each MDAP spare part remaining unshipped as of the end of December 1954 was reestimated on the basis of data then available. The total of these estimated costs as related to the sales prices then existing formed the basis of the percentage of price reduction set forth in our proposal of February 10, 1955, as being applicable to the spares remaining unshipped at the date of delivery of the 299th plane. We do not agree in principle that if these prices had been reset on the basis of the 299th plane they would have had more sound support than that actually used. Each part price, making up the total contract value, is established without relation to the price of any other part; therefore, the actual profit realized on experienced costs applicable to the sale of a relativ ly small portion of parts involved, in our opinion, is not definite assurance that the same rate of profit should necessarily be expected on the remaining parts to be shipped.

GENERAL MOTORS' POLICY OF VOLUNTARY PRICE REDUCTION

Relative to the request in your letter of April 12, 1956, for our comment concerning the application of General Motors' policy of voluntarily refunding any profit on defense procurement in excess of 25 percent of the negotiated rate, we wish to inform you that this policy is administered on an overall corporation defense contract basis. Under the policy, consideration is given to voluntary price reductions in fixed-price contracts as may seem desirable beyond those which would normally result from price redetermination. Since any action in connection therewith would affect the overall corporation position under renegotiation, any refund on a price reduction or voluntary basis is considered at the corporation level and not at the divisional level.

APPENDIX C

Hon. JOSEPH CAMPBELL,

Comptroller General of the United States,

GENERAL MOTORS CORP., Detroit, Mich., June 18, 1957.

Washington, D. C.

DEAR MR. CAMPBELL: Your letter of May 22, 1957, to Mr. Harlow H. Curtice, president, General Motors Corp., together with the draft of the proposed report to Congress resulting from your review of contract No. AF33 (038)-18503 for F-84F aircraft has been directed to me for reply. I appreciate the opportunity to submit our comments inasmuch as the draft of the proposed report to Congress contains only a partial account of the contractor's performance and should be revised to reflect the total picture. The fact that you submitted this for our preliminary review indicates that you, too, are interested in presenting to the Congress the complete account.

Proper emphasis must be placed on the fact that the above contract was a fixed-price contract containing a price-redetermination provision. Mandatory repricing points were established at the delivery of the 71st plane and the 299th plane. In addition either party had the right to make a further demand at intervals of not less than 90 days after the effective date of any prior demand. The absence of a demand by either party under this repricing option is indicative of the competitive reasonableness of the prices negotiated.

The after-the-fact criticism of these negotiations in your report completely overlooks the fixed price aspect of this contract. The parties discussed cost elements but directed the negotiations toward a contract price. Unless the proposed report departs from this strict cost approach it will not reflect the manner in which the price redetermination provisions of the contract were given effect.

Any discussion of this contract should take into consideration the fact that General Motors Corp. financed its participation in this program with no recovery of the funds employed until planes and spare parts were sold. From February, 1951 until June 1953, General Motors' investment grew to a total of $93,464,000 before billing the Government. The unrecovered expenditures reached a peak of $135,846,000 in May 1954. Billings did not offset aggregated expenditures until March 1955.

The proposed report contains certain of the data or the information previously supplied by the contractor. However, I believe that a more complete and more accurate account will be presented if the following information is also included: (1) In footnote (c) of page 2, a statement is made that a profit rate of 8 percent was agreed upon at the time this contract was placed and that the prices negotiated included a contemplated profit of not more than 8 percent. There was no agreement or commitment of any kind that the contractor was to be limited to a profit of 8 percent on actual costs nor was the contractor guaranteed any percentage of profit on costs or protected against loss on the contract. The correspondence between Mr. Harlow H. Curtice, then executive vice president of General Motors Corp. and Brig. Phillips W. Smith, Chief, Procurement Division, Air Materiel Command, Wright-Patterson Air Force Base, dated April 25, May 9, and August 13, 1951, and attached as exhibits A, B, and C, respectively, includes the complete agreement reached at that time.

Your attention is called particularly to the following statement in exhibit A: All contract bids will be subject to redetermination and it is my understanding that we will benefit to the extent savings are accomplished through good performance.

(2) Subcontractor's prices: This portion of the proposed report concerns two subjects. The first is the claimed overstatement of $1,700,000 in the bill of material submitted just prior to the negotiation of the second segment prices in September 1954. The second relates to the right and ability of the contractor to negotiate price adjustments required by the thousands of engineering changes. The contractor's position with respect to the alleged overstatement of $1,700,000 was fully set forth in the letter of October 25, 1956, from Mr. John F. Gordon, vice president, General Motors Corp., to Brig. Gen. William T. Thurman, United States Air Force, Deputy Director, Procurement, Headquarters, Air Materiel Command. It is requested, therefore, that a copy of the letter which is attached as exhibit D be incorporated in the proposed report. As this letter stated, the contractor was unable to find any basis for any misunderstanding of the facts on the part of any of the parties participating in the price negotiation conference of September 1954. Furthermore, as the terms of the contract required that the negotiations were to be on the basis of price, not on the basis of segregated cost elements, and the procedure followed at this conference conformed to this requirement, there was no deviation from contract terms or from negotiating principles.

The report also discusses the recovery of costs resulting from engineering changes. The contractor was well aware that engineering change costs were recoverable under the "changes" provision of the contract. There were no costs of this nature included in the proposed prices for second and third segment planes.

The contractor agrees with the statement in the report that suppliers should "be expected to live within firm fixed prices agreed upon." In the establishment of its subcontract structure, the contractor directed its efforts to securing dependable and qualified suppliers. It followed its normal business practices with these suppliers. When these suppliers demonstrated need for price relief because of the many delays and other interruptive Air Force actions, it granted such relief if otherwise equitable.

(3) Direct labor estimate: The report states that there was an error of 1,600 hours per airplane in the estimated direct labor hours for airplanes Nos. 72 through 299, and an overvaluation of direct labor inventory in process. From this premise, the report proceeds to the conclusion that there was an overstatement of approximately $842,000 in the direct labor costs. On page 8 the report

recognizes that the Air Force negotiators used other labor data in the price redetermination negotiations. In other words, the direct labor as estimated by

General Motors was not the basis for the redetermined prices.

The report also overlooks the fact that the direct labor estimate which is claimed to be overstated was related to the proposed unit price of $442,000 per airplane. The negotiators ultimately arrived at a redetermined price per airplane of $420,000 for airplanes 72 through 299. It must be realized that the contractor at no time was apprised of the basis for the reductions proposed by the Air Force negotiators.

(4) Manufacturing overhead estimate: The proposed report criticizes the contractor for not selecting cost experience on manufacturing overhead for a short period as a basis of future cost projection. It must be borne in mind that the costs to be experienced after March 1955 were a matter of estimate based on the proposed schedule. In the light of past experience, the contractor had every reason to project its estimates on a broader basis than figures quoted by the auditors.

Manufacturing overhead includes indirect labor and supervision, supplies, expenditures related to buildings, machinery and equipment, etc., necessary to maintain the basic organization as long as that operation continues, regardless of the level of production volume attained within any short period of time. This overhead organization must be retained during interim periods of low production if schedule requirements are to be met. Otherwise a manufacturer is faced with the additional cost and delay of rebuilding an organization necessitated by a return to higher production requirements.

The record of fluctuating volume throughout the first two segments of the contract was an important influence on manufacturing overhead costs in all forward pricing. The following tabulation sets forth the manufacturing overhead costs actually incurred by months starting with the first month of deliveries and ending with the last full month of operations preceding the date on which prices were redetermined for the last segment of 300 airplanes.

The manufacturing overhead cost incurred remained relatively constant each month regardless of deliveries, which were unpredictable for reasons beyond the contractor's control. During this period of fluctuating volume the contractor had to maintain its basic organization in order that the contract could be brought to a successful conclusion.

At the time of the negotiations in March 1955 there was no basis to assume that the accelerated rate of production attained in January and February could be continued and that the contract could be concluded earlier than July 1955, the month established during the negotiations for the completion of deliveries. The contractor's estimates of labor and burden had to be related to the aforesaid completion date and the negotiators, therefore, were faced with the problem of arriving at a contract price which contemplated the retention of the contractor's organization and the incurring of the fixed charges and other burden costs throughout the remaining 5-month period, as well as phasing out costs. The completion of deliveries 2 months in advance of the established date resulted in cost savings which gave rise to this after-the-fact comment by the auditors on the manufacturing overhead estimate.

(5) General and administrative expense estimate: The contractor's response to the comments dealing with manufacturing overhead estimates are applicable to the statements in the report concerning general and administrative expense estimate.

(6) Spare parts for mutual defense assistance program: As indicated, the cost experience available at the time of delivery of the 210th plane was selected by the Air Force and the contractor as the basis of the negotiated prices for spare parts to be delivered during the final segment. It was agreed also that the spare parts prices and the airplane prices were to be redetermined as a whole.

From a practical standpoint, the experienced costs of the delivered spare parts necessarily played a very small part in the forward pricing. The remaining spare parts were for the most part to be manufactured concurrently with the manufacture of identical parts and assemblies of the remaining airplanes. Hence, the negotiators based their bargaining for spare parts prices on data prepared on the same basis as the data proposed for the negotiation of plane prices. A reduction of $850,000 was negotiated.

(7) Refund requested from the contractor: While the proposed report includes a portion of the contratcor's reply of June 27, 1956, to the request of the Air Force for a refund in accordance with the claimed voluntary refund policy of General Motors Corp., the position of General Motors Corp. will be more fully explained if the aforesaid letter is included in full. The contractor has attached this letter as exhibit E and requests that it be included in the report to Congress.

In discussing the refund request, the report loses sight of the fact that the profit rate of 8 percent was a going-in rate of profit, with the understanding that the contractor would benefit to the extent that savings were accomplished through good performance.

Page 3 of the report summarizes as follows the $8,322,000 questioned by the auditor:

Known reductions in subcontractors' prices----
Direct labor estimate___.

Manufacturing overhead estimate--

General and administrative overhead estimate....

Total--

Profit (8 percent).

Total.

Revision of prices for spare parts---

Total____.

$1,700, 000 842, 000 4, 500, 000 355, 000

7,397, 000 592, 000

7, 989, 000 333, 000

8, 322, 000

Even without any consideration of the contractor's explanation for each of these questioned items, the previous page of the report discloses that the reduction negotiated by the parties was $9,400,000. Therefore, the total amount by which the Air Force negotiators reduced the forward prices proposed by the contractor exceeded the total amount by which the report claims that the estimated costs were overstated.

In the final review of his contract, the profit performance should be evaluated on the total results. On this basis, the proposed report indicates a profit rate of 11.2 percent on sales. This contract was subject to the Renegotiation Act of 1951 and profits earned on the contract have been included in the overall profits of General Motors Corp. on defense business reported to the Renegotiation Board for each of the years of contract performance. Gross refunds have been made to the Government totaling $5 million in 1951; $20 million in 1952; $10 million in 1953 and $10 million in 1954.

As a result of such proceedings, the corporation's overall profit rate on renegotiable sales was 10.3 percent in 1951, 10.0 percent in 1952, 9.6 percent in 1953 and 9.8 percent in 1954-margins which were substantially below the profits realized by the corporation on its commercial business. While the corporation has filed with the Renegotiation Board the information required for the years 1955 and 1956, the renegotiation proceedings have not been completed.

Your courtesy in extending to us the opportunity of a preliminary review of your proposed report to Congress was appreciated. It is believed that we have supplied you with substantial additional data. May we request that you incorporate this information in the proposed report.

Respectfully yours,

JOHN F. GORDON, Vice President.