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remarks. The first series of lines, before the broken line, is the table referred to on page 3. Mr. HÉBERT. It will be made a part of the record. (The table is as follows:)
1 Includes $1,240,500 to cover engineering changes for which the related costs were not segregated from airplane costs.
* We were unable to determine from the record of negotiations the contemplated costs and profit comprising the price negotiated for the retroactive portion of the contract.
3 According to the record of negotiations, a profit rate of 8 percent was agreed upon at the time this contract was placed. The contractor's price proposals, as well as the final prices negotiated, included a profit factor of 8 percent or less. The contractor's letter to AMC dated Apr. 25, 1951, set forth General Motors' agree ment to apply in contract bids on F-84F airplanes a profit rate of 8 percent of costs and further indicated that all contract bids would be subject to redetermination and General Motors would benefit to the extent that savings are accomplished through good performance. (See appendix C, exhibit A.)
Mr. POWERS. In response to our request for comments on the final draft of this report, General Motors Corp.’s reply, dated June 18, 1957, stated that the absence of a demand by either party under the repricing option of the contract indicated reasonableness of the prices negotiated. Contractor's comment on this is contained on page 31 of appendix C to our report.
We do not agree with this assumption. From the absence of a demand for repricing by General Motors, it is reasonable to assume that the contractor was satisfied with the prices, but the absence of a demand by the agency does not mean that the Air Force considered the prices to be reasonable, since the Air Force was not in a position to compare the contract prices with the contractor's continuing cost experience. The cost data furnished by the contractor to AMC was not adequate for ascertaining the desirability of exercising price revision options nor did the cost data furnished conform with provisions of the contract.
From the tabulation that I have referred to previously and as shown on the blackboard, it can be seen that the Air Force reduced the estimated costs proposed by the contractor for the forward portion of the contract by $9.4 million. The contractor, in his comments dated May 3, 1956, as shown in appendix B of our report, and in his later comments dated June 18, 1957, attempted to minimize the significance of our findings by maintaining that our observations were applicable only to the original price proposed by the contractor and that the items totaling $8,322,000 which we questioned in the contractor's proposal were more than offset by the $9.4 million. In our examination, full recognition was given to the $9.4 million reduction made in negotiations and reflected in the negotiated price. However, our findings, which are summarized below and discussed in detail hereafter, showed that substantial price reductions in addition to the $9.4 million should have been attained.
They are as follows:
$1,700, 000 Direct labor estimate--
842, 000 Manufacturing overhead estimate --
4,500,000 General and administrative overhead estimate-
Total.. Profit (8 percent).
7, 397, 000
8, 322, 000 Known reductions in subcontractor's prices
First, in dealing with the known reductions in the subcontractor's prices, the contractor's actual costs of materials purchased from outside suppliers for the second segment covering 228 airplanes were approximately $4,350,000 lower than the estimated costs of such materials included in his price proposal. Of this total reduction in material costs, about $1,700,000 was known to the contractor prior to the date of his price proposal for the first forward price redetermination but was not recognized in that proposal, which stated that:
The unit prices shown for materials purchased from outside suppliers are firm and are supported by purchase orders. No exception was taken in negotiations to the contractor's estimate for materials purchased from outside suppliers.
An example of the known price reductions making up the overstatement of $1,700,000 is the reduction in the price of an assembly purchased from Vendo, Inc., which was shown in the contractor's proposal at a unit cost of $1,507 for 228 units. However, this price applied to only the first 68 assemblies and the remaining 160 assemblies were priced at approximately $400 per unit, a total reduction of $177,000. Although the supplier and the contractor had redetermined the price of this assembly prior to the submission by the contractor of his proposal, the reduction in price was not recognized in the proposal.
Since the contractor had firm agreements with subcontractors at prices lower than those represented as his anticipated material costs, the use of only the higher prices constituted an incorrect statement of the prices to be paid for purchased parts. This statement was submitted as a part of the cost data to be considered and acted upon by the Government in negotiating revised prices and worked to the benefit of the contractor and to the detriment of the Government. The incorrect statement and the contractor's excessive estimates of these and other costs in the price negotiations have resulted, in our opinion, in unreasonably high prices being paid by the Government.
In commenting on our observations, the contractor furnished us with a copy of a letter to AMC dated October 25, 1956—see appendix C, exhibit D, page 43, of our report-in which General Motors acknowledged that, in some cases, for the second segment of 228 planes they had firm prices for components applicable to a portion of the planes and lower prices for the components for use on the remainder of the planes of that segment. General Motors stated that in such cases they generally used the highest prices in their proposal for the entire segment rather than the average or actual prices. The reasons given by General Motors were: (1) To protect the corporation in the event the Air Force terminated the contract or requested a further price redetermination during the second segment of the contract; and (2) to provide for the possibility, in proper circumstances, of granting suppliers upward adjustments of firm prices of materials.
We believe that the contractor was adequately protected in the event of termination by the contract's termination provisions and that in any additional price-redetermination negotiations the contractor's experienced costs of materials would receive due consideration. Therefore, in our opinion, the possibility of termination or additional price redetermination taking place did not warrant the contractor's overstatement of estimated material costs. With respect to increase in suppliers' firm prices, we believe that suppliers, as well as prime contractors, should generally be expected to live within firm prices agreed upon, and therefore the prime contractor's estimates of the cost of materials should have been based on known firm prices, with any significant deviations therefrom in the contractor's price proposal clearly set forth for consideration by Air Force negotiators.
In April 1956 we brought our findings, including the known reductions of $1,700,000 in subcontractors' prices, to the attention of AMC and General Motors. At a meeting on September 26, 1956, attended by the Deputy Director for Procurement, Directorate of Procurement and Production, Headquarters AMC, and the controller, General Motors Corp., it was suggested that General Motors consider, as a matter of principle, a refund of $1,700,000 to the Air Force. In rejecting this suggestion, General Motors cited a number of reasons why, in their opinion, there was no basis for any misunderstanding of the facts on the part of any of the parties participating in the priceredetermination negotiations. I refer you to appendix C, exhibit D, of our report.
Based on the information available to us, including General Motors' comments dated June 18, 1957, on our draft report, there is serious question as to the legal validity of the negotiated prices. In order to resolve this matter, additional information has been requested by the Comptroller General of the United States from the Secretary of the Air Force by letter dated July 8, 1957. This letter is contained as appendix D in our report, Mr. Chairman.
With respect to the second element, of direct labor estimates, adequate evaluation of the contractor's direct labor estimate for the first forward price-redetermination period could have resulted in a reduction of approximately $842,000 in the contractor's projection of direct labor.
The contractor estimated that 24,697 direct-labor hours would be required for each of the 228 airplanes from No. 72 through 299. On the basis of independent calculations, AMC accepted this estimate as being fairly accurate, but reduced it by 1,500 hours per airplane. We understand that this change was made to reflect efficiencies anticipated
on work brought into the plant which previously had been performed by another division of General Motors.
Our review of statistical data prepared by the contractor from experienced costs of the first 71 airplanes produced under the contract, and projected forward, disclosed a clerical error in the original estimate of 1,600 hours per airplane. The difference amounted to an overstatement of direct labor costs of $736,000. The contractor's direct labor estimate was overstated also by an additional $106,000, the difference between the amount of direct-labor inventory in process included in the proposal and the amount of such labor as shown by the contractor's records. Consequently, the cost information used in the negotiations did not conform to the contractor's actual experience.
Although the Air Force reduced the contractor's direct labor projections by 1,500 hours, this reduction was apparently made to reflect anticipated efficiencies and not to correct errors in the contractor's proposals. We believe that, if the contracting officials had been aware of the errors in the contractor's proposal, they would have applied to the corrected estimate an adjustment for anticipated efficiency, thereby obtaining further price reductions. That such an adjustment would have been appropriate appears to be demonstrated by the fact that actual direct labor for this phase of the contract was about 19,700 hours per airplane compared with the 23,000 hours accepted by the Air Force in negotiations.
The contractor has stated that the projected hours were the results of the best thinking of management based on facts available at the time the forecast was made. However, he agreed that the directlabor hours' projection was overstated, through a clerical error, to the extent of 1,006 hours per airplane. This amounts to an overstatement of about $461,000 compared with the $736,000 which we estimated. The contractor agreed, also, that the direct labor in process appears to have been overvalued and stated that the cause is undetermined. I refer you to appendixes B and C of our report.
The Air Force informed us that* * * while the negotiators did review the contractor's presentation in some detail, the hours used in developing the revised price resulted from independent analyses and studies by the negotiators utilizing industry man-hour averages and the experience of other contractors on like airplanes. Therefore, while the contractor's presentation was in error, the error was not reflected in the hours computed by the negotiators.
We believe that use of data unrelated to experience of the contractor on the contract being repriced is not a sufficient guide to the reasonableness of the price being negotiated and should not be substituted for review and analysis of the contractor's own experience. Further, it seems clear that, when a contract provides for price revision on the basis of cost experience, the contract-pricing technique should be tied primarily to the experience of the contractor involved rather than to the costs of other producers.
In our opinion, contractors' labor projections included in pricing proposals should be adequately analyzed and evaluated by contracting officials in order to correct errors such as those indicated above and to determine the reliability of labor trend projections used in establishing contract prices.
With respect to the third element, which constitutes the manufacturing overhead estimate: A thorough analysis and evaluation of
experienced cost data could have resulted in a reduction of the contractor's estimated manufacturing overhead by approximately $15,000 per airplane or a total of $4,500,000.
The contractor's revised proposal for the final 300 airplanes to be produced under the contract included $69,000 per unit for manufacturing overhead, which was reduced in negotiations to $66,500 per unit. However, overhead cost data available at the time the contractor submitted his proposal indicated that, immediately prior to the redetermination point, 76 airplanes had been produced at an average manufacturing overhead cost of $59,000 per airplane and that the average unit cost of the last 26 airplanes of that group had decreased to $53,400. The average cost per airplane could have been expected to continue decreasing over the runout portion of the contract until phase-out conditions arose on the last few airplanes. Such a decrease actually did occur, and the average manufacturing overhead costs for the runout portion of the contract totaled $18,000 per airplane. This was about $6,300,000 less than the manufacturing overhead included in the contractor's proposal and about $5,550,000 less than the amount included in the price negotiated.
In commenting on the manufacturing overhead used in his proposal, the contractor, in a letter dated May 3, 1956— see appendix B in our report—stated :
It is not agreed that our experience on the last 76 airplanes 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.
This reply by the contractor does not evidence consideration of the substantial efficiencies which should have been anticipated in production of the last 300 airplanes and that phase-out conditions would arise only on the last few airplanes. Further, in estimating the overstatement of manufacturing overhead, we took into consideration anticipated phase-out costs estimated by the contractor.
In comments furnished to us on June 18, 1957—see appendix C, page 35, of our report—the contractor included data on the amounts of manufacturing overhead incurred monthly and the number of planes delivered monthly during the period July 1953 through February 1955 to show that overhead was constant in the face of fluctuating deliveries. Since manufacturing overhead was applied by the contractor on the basis of production, not on deliveries, there is no direct relationship between overhead' incurred and the number of planes delivered. Therefore, this data does not furnish a sound basis for evaluation of the reasonableness of the contractor's proposed overhead.
We believe that (1) the overhead cost included in the price negotiated was unreasonably high in view of the lower overhead cost experienced on prior production and in view of the prevailing cost trends available at the time of negotiations and (2) analysis of the contractor's experienced and projected manufacturing overhead would have made evident the contractor's failure to fully recognize in his proposal the declining cost trends.
With respect to the fourth or general and administrative expense estimate: Analysis of the contractor's experienced general and administrative expense showed that the amount negotiated exceeded by $355,000 the amount which could have been reasonably anticipated.