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Report on Review of Department of the Air Force Contract AF 33 (038)–18053 with General Motors Corp., Buick-Oldsmobile-Pontiac assembly division, Kansas City, Kans.
We appreciate your courtesy in making a copy of the advance draft available to us and concur in the analysis that the high rate of profit actually earned by the contractor is attributable in part to the failure of contracting officials to analyze and evaluate effectively the contractor's forward pricing proposals.
In forward or prospective pricing on a firm basis we attempt to negotiate a fair and reasonable price with the full realization that the contractor on that basis has an opportunity or incentive to earn a larger profit by effecting economies in performance during the firm price period. It is normally expected that because of this incentive, which is the strongest possible when price is firm, the contractor will actively work to achieve economies, and as a result the Government will be able to obtain substantial price reductions in future pricing periods or in follow-on procurements. In this instance we feel that, despite the lack of complete evaluation, our negotiation procedures did produce substantial savings as evidenced by the reduction in firm unit prices of approximately 63 percent in the third segment of the contract as compared to the second segment.
Regardless of the foregoing, however, we are desirous of doing a better job of review and analysis of contractor's cost projections and price negotiation in general. Even though some of our better contracting personnel have been assigned to procurements such as the instant case which covered a time period from early 1952 through early 1955, and even though they feel that they performed adequately, we are satisfied that there is room for improvement. To this end we have already developed an advanced course in pricing which is now, for the first time, being given to 20 of our top people from AMC buying activities. This Air Force Advanced Pricing School is a 13-week, full-time course. We are also planning on such advanced training for 50 more people in 2 courses during the fiscal year. It is expected that this school will be continued for the foreseeable future on a semiannual basis.
We concur in the need for emphasizing to contracting officials the importance of adequate review and evaluation of contractors' cost projections. This is already a part of our formal training programs and will also be emphasized in the review of buyers' price objectives in prenegotiation briefings. In addition, personnel of your Defense Accounting and Auditing Division have suggested that properly disguised examples, such as this case, could profitably be brought to the attention of all contracting officers, price and cost analysts, through the medium of pricing bulletins. We consider this an excellent idea and intend to follow your suggestion.
With regard to the role of agency auditors in their capacity as advisers to contracting officers, the Air Force had a major share in developing the recently published armed services procurement regulation, section III, part 8, on pricing negotiation policies and techniques. This new ASPR provides in part that forecasting future trends in cost from historical experience is of primary importance in pricing. It specifically, in paragraph 3–809, treats with audit as a pricing aid. In part it provides that "the audit services within the military departments should be utilized as a pricing aid by the contracting officer to the fullest extent appropriate * * * Judicious use of audit services will expedite proper pricing * * *. Except for contracts containing retroactive price revision clauses, pricing techniques are concerned mainly with estimates of future costs * * *. Therefore, audit reports for either retroactive or prospective pricing should not only establish costs accrued to a specific cutoff point for price proposal purposes, but also should include cost trends and other available information which would be of assistance to the contracting officer in pricing negotiation ***. Such audit reports will serve a useful purpose in:
“(i) The evaluation of contingency allowances, overhead allocations, purchasing management efficiency, and similar cost elements ;
“(ii) Both the initial and subsequent pricing of contracts containing price revision clauses."
It further provides that "some of the conditions under which the contracting officer should consider the use of audit services include: * * *
" (iii) Procurement of a new product for which cost experience is lacking; and “(iv) Contract performance requiring a substantial period of time.”
Further, in connection with the development of a proposed Department of Defense directive and companion instruction of audit policies, the Air Force favors such auditing activities providing technical advice and assistance on accounting and related financial matters in negotiation, administration, repricing, and settlement of contracts. We also feel that audit activities should make recommendations, as appropriate with respect to establishing procedures in each military department, concerning the accuracy and reliability of contractors' cost representations. AMC and the Auditor General are actively working together now to establish the best possible working team relationships between procurement and audit personnel.
With regard to the General Motors Corp. alleged policy on voluntary refunds of profits exceeding 125 percent of the negotiated profit, we have been unsuccessful in obtaining any refund on this contract. AMC requested a refund in a letter to General Motors dated June 14, 1956. In a letter dated June 27, 1956, signed by Mr. John F. Gordon, vice president, Buick-Oldsmobile-Pontiac division, General Motors' reply included the following statements :
“May we also point out that the adjustment of contract prices to effect a revision of earned profit ratios is a matter for internal consideration by General Motors in the overall administration of its affairs and does not constitute a commitment of any nature.
“You may be advised that we have considered our profit position in the instant case and it was and is the final decision of General Motors that there is no reason to further revise the F-84F contract prices."
Subsequently, on January 3, 1957, in a personal discussion on this subject with the Deputy Director for Procurement at Headquarters, AMC, Mr. R. C. Mark, controller, General Motors Corp., in effect stated that they considered the matter closed and that the existence or operation of General Motors policy on adjustment of contract prices was an internal matter.
The opportunity to informally discuss this proposed report has been appreciated. Should you or members of your staff desire further discussion on this matter it will be welcomed. Sincerely yours,
DUDLEY C. SHARP, Assistant Secretary of the Air Force.
KANSAS CITY PLANT,
GENERAL MOTORS CORP.,
Kansas City, Kans., May 3, 1956. UNITED STATES GENERAL ACCOUNTING OFFICE, Regional Audit Office, Kansas City, Mo.
(Attention : Mr. Forrest R. Browne, regional audit manager.) GENTLEMEN: This refers to your letter dated April 12, 1956, relative to your review of the procedures utilized in the procurement of F-84F aircraft under contracts AF 33 (038)-18503 and 18504. Since the latter contract concerned only facilities, and no comment was made in connection therewith, no further reference is made herein to this contract.
The attachment to your letter sets forth a list of tentative findings with respect to the second (228 planes) and third (300 planes) segments and spare parts under the supply contract. While we are replying to each of your findings in more detail in the attachment hereto, we should like to point out certain principles which it is believed should be kept in mind. The price negotiated was not for each element of cost, but was for the end product. Further, in establishing the prices of planes in each of the first and second segments, the two segments were considered by both parties as a package deal. Therefore, to select certain elements of cost from one segment for comment in connection with the pricing procedure utilized would not seem to be in accordance with the pricing philosophy used by the negotiators.
Details of our estimate supporting our proposed price were furnished to the Air Force which, together with an independent audit, a review by the Air Force Cost Analytical Section, and much discussion at the negotiating sessions, formed the basis for the price negotiated for the end product.
Our proposed price for the 228 planes in the second segment was $442,890 each, which we reduced to $440,000 at the start of the negotiating conference. Your comments point out that after analyzing the data at hand our estimate was overstated approximately $10,000 per plane. In other words, we should have proposed a price of approximately $430,000 each. The negotiated price was $420,000 per airplane.
The third segment follows a similar pattern. Our proposed price was $293,160 per plane. Your comments indicate insufficient consideration of experience in manufacturing and administrative expenses, resulting in an overstatement of our proposed price of some $15,000 per plane. In the negotiations, our proposed price was reduced $22,000 and a fixed price of $271,165 per plane was accepted.
In the final analysis, if full and complete consideration had been given to the comments attached to your letter of April 12, 1956, and if the items set forth therein had been factored into the contractor's proposed prices, such action would not have resulted in prices as favorable to the Government as the prices ultimately incorporated in contract AF33(038)-18503. By sincere, across-the-table negotiation, representatives of the Government and the contractor made careful and detailed analyses of the data available. At the same time, they necessarily took into contemplation those factors requiring reasonable anticipation in the light of phasing out an aircraft program. On this basis, these representatives in good faith were able to negotiate prices equitable to both the Government and the contractor. Criticisms of isolated data many months after the completion of these negotiations must necessarily fall far short of a true appreciation of the efforts of the parties and the results accomplished. Very truly yours,
T. P. MURPHY, Resident Comptroller.
FORWARD PRICING SECOND SEGMENT OF 228 PLANES
1. Bill of materials—outside suppliers and allied suppliers
(a) Outside suppliers.—Your findings state that a review of the priced bill of materials submitted by the contractor reveals that firm prices supported by purchase orders amounted to $1,700,000 less than that shown on the bill of materials, which accounted, in part, for the fact that experienced costs were less by $4,353,000 than the contractor's quotation as accepted in negotiations. Your findings further state that, generally, the priced bill of materials were amounts to be costed into inventory for initial planes of the second segment; however, the quotation was presented as being applicable to the entire segment.
At the time our price proposal was prepared for the 228-plane segment, it was impossible to predict what would happen during the production of this segment. The F-84F was still not completely engineered and important changes were still contemplated. Our experience with suppliers and subcontractors bas indicated that, even though we have purchase orders and contracts setting forth prices presumed to be firm, these sources many times get into difficulties and, in the interest of proper performance on the contract, it is necessary for us to give aid, when merited, both financial and otherwise, to such sources. Once we were in the fixed-price cycle of the prime contract, we were obligated to live within the forward prices and, accordingly, pursued our normal business practices, so that the forward prices were based on a realistic evaluation of our suppliers and their problems. 2. Forecast of direct labor cost
Your report refers to a discrepancy in the plotting of the overall plant directlabor chart, resulting in an increased amount of $888,000 in the direct labor forecasted. Further, you believe that the direct-labor hours per plane forecasted should have been 22,759 as compared to 24,697 forecasted by the contractor. It is now understood that your office has revised the amounts projected by your organization to $736,000 and 23,090 hours per plane, respectively.
The overall plant chart does not represent the total hours of direct labor included in our price quotation, but merely reflects an overall trend. The direct-labor hours included in our proposed price were developed on the basis of projecting each shop chart from the point of the equivalent number of planes produced through the 299th plane, and then summarizing the reading from these charts at the 71st and 299th planes to arrive at the total of 24,697 hours per plane for the segment. However, in reviewing our calculations of the forecasted hours per plane (24,697) we have discovered a clerical error which resulted in the forecasted hours per plane being overstated by 1,006 hours. This accounts for a substantial portion of the difference (1,607) between the projection made by your office and that included in the price quotation. Accordingly, 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
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.
GENERAL MOTORS CORP.,
Detroit, Mich., June 18, 1957. Hon. JOSEPH CAMPBELL, Comptroller General of the United States,
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.