and integration of the H model into the production operations. However, the GAO pointed out that the Air Force record of negotiation indicated that the introduction of the B-52H model would have an adverse effect upon production operations, but nevertheless the proposed 77,287 hours was not accepted by the Air Force.

Air Force Reply

A review of the Air Force pricing files relative to the production costs included in the negotiated initial targets for contract -37481 reveals that the facts as stated by the GAO are essentially correct. It has been confirmed by information contained in the price negotiation memorandum (PNM) covering the initial pricing action that production labor hours were estimated by using the negotiated unit hours agreed to in the firm target pricing of contract -34670 as a base, projecting on a 78 percent learning curve to the midpoint of this procurement. This projection appears to have yielded about 87,191 average hours per unit. The PNM clearly states that an increase in hours was considered for engineering changes as applicable and for the factors of (a) reduced monthly delivery schedule, (b) phaseout of the B-52G Model, (c) reduced lot sizes for fabrication, and (d) integration of the B-52H Model into the assembly line during the last 5 months of production of the G model. The negotiated unit costs were based upon 96,516 production hours, an increase of 9,325 from the projection.

It is considered pertinent that Boeing's proposal for the pricing action was based upon an estimate to be agreed upon by both the Air Force and Boeing for the establishment of interim "billing prices" for the subject contract pending later negotiation of target prices. The contractor's position with regard to the establishment of a target price, as was ultimately established (FPIS-type contract), was stated in his letter of transmittal dated April 11, 1959. This position stated that in the event targe prices were established in this negotiation, adequate and proper consideration must be given to conditions attendant to an extremely early target. In view of this, it is believed that any increased costs considered in the negotiations for a more firm target than the proposal had anticipated, could very well have been as a result of blackboard presentations or across-thetable discussions for such extra considerations. Alternatively, Boeing could have elected to utilize the time consuming method of reproposing on the basis of establishing an FPIS target. The Air Force was desirous of establishing an incentive from the outset in lieu of operating under billing prices which would have been about the equivalent of a letter contract. Specific data contained in the pricing files relative to labor losses in efficiency is limited. Notes relative to these increased hours reflected that a 7-percent integration factor was considered based upon RB to B-47 experience, thus generating about 213,000 hours on this program. Other considerations mentioned in the notes indicated that the end of the G program would tend to increase rework and replacement costs since the higher skilled personnel were being transferred to the H model productions. Reductions in lot sizes and monthly delivery schedules were also considered, although no specific information could be found which indicated the number of hours considered in each instance. Phaseout, or toe-up costs are at times considered very real and sizable expenditures. A review of various contracts wherein toe-up costs were considered revealed that such costs have represented as much as 7 percent of the total negotiated costs. In this instance, according to the GAO, these costs represented approximately 2 percent of the total target cost. Consideration for such costs in any amount is reduced to a matter of judgment on the part of the negotiating team, as to its applicability, in view of the procurement situation.

These costs were clearly considered legitimate and applicable at the time the initial contract targets were negotiated. The validity of such an estimate or judgment is attested by the amount of actual cost incurred. Negotiations were conducted with Boeing in March 1960 for the purpose of establishing firm targets for this contract. Boeing proposed 77,287 hours at this time, to cover model change infiltrations, as indicated in the GAO report. According to the price negotiation memorandum authored by the chief negotiator (who was also the chief negotiator at the time the initial targets were established), these hours were removed, in the process of negotiating the firm target prices on a total contract pricing basis, although it was pointed out that model change infiltration would continue to have an adverse effect upon production operations. It should be remembered that the total initial target cost and profit was negotiated in

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good faith by both the Air Force and Boeing, based upon costs that, at the time, were reasonably expected to be incurred. In this case, it was the judgment of the Air Force that toe-up costs were legitimately considered as a portion of the total initial target. Although the amount proposed by Boeing for impact of model change infiltration was removed by the negotiator in the process of negotiating the firm targets on a total price basis, it was recognized that the conditions which supported the allowance for toe up in the initial targets would continue to have an adverse affect upon production operations. In view of this, it is not considered that there is any basis for seeking adjustment in the contract prices.

GAO Report, B-133251, November 25, 1964

71. Title: "Overstatement of Target Cost of AN/FPS-7 Radar Equipment Under Fixed-Price Incentive Contracts AF 30 (635)-12300 and AF 30 (635) – 11072 With General Electric Co., Heavy Military Electronics Department, Syracuse, N.Y." (OSD case No. 1891).

GAO finding: Target costs were overstated, the major portion of which is attributable to the failure of General Electric to use the most current cost information pertaining to purchased parts and components during negotiations. GAO estimate of unnecessary costs: About $103,000.

Time period of GAO report: Contract -12300, December 19, 1958-March 23, 1959. Contract -11072, June 1959.

How

DOD comments on GAO finding: Concurred in the recommendations. ever, since the time of these negotiations, changes of major importance have been made in DOD contracting methods and procedures. Instructions and directives subsequently issued are believed to have essentially accomplished the purposes of the recommendations.

DOD comments on costs: Concurred with GAO finding.

DOD corrective action: The Air Force is continuing its efforts to effect appropriate adjustments to the final target price of the contracts. An intensive cost reduction program is in effect in purchasing activities throughout DOD involving a wide variety of measures such as mandatory increased use of audit services, more effective procedures for obtaining and thoroughly considering cost data in noncompetitive procurements, substantially increasing the use of competition in defense procurement, reducing the relatively inefficient form of contracting such as the cost-plus-fixed-fee type of procurement, and expanding use of fixed price and incentive contracts. These are some of the wide ranges of measures that have been implemented under the DOD cost reduction program, all of which give strong evidence of the awareness and concern by contracting officials throughout the DOD with the importance of reducing the cost of military supplies and equipment utilizing the most efficient and economical procedures for accomplishing this result.

ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE

Problem

The contractor overstated the estimated target costs on the subject contracts by about $538,000. This resulted from contractor's failure to utilize the most current cost information available at the time the contracts were negotiated. Unless the target prices are appropriately adjusted, the contractor will receive approximately $103,000 in unearned target and incentive profits under these contracts.

GAO recommendation

That the Air Force continue its efforts to effect appropriate adjustments to the final target prices of contracts AF 30(635)-12300 and -11072.

Statement

We are continuing our efforts to obtain adjustments of approximately $538,000 for overstated target costs. By letter of April 6, 1965, the commander, Air Force Logistics Command, wrote to the president of General Electric requesting his personal consideration of this matter, since GE's general manager for its Heavy Military Electronics Department had refused to offer more than a token downward adjustment of $41,700 in target cost for the two contracts. General Electric is expected to respond to this letter by May 30, 1965. If the

response is unsatisfactory, the case will be forwarded by AFLC to Headquarters, USAF, with recommendations for further action.

Section III, part 8 of ASPR requires the use of current data in the negotiation of contracts and provides appropriate guidance for negotiation of contract prices.

As a result of this GAO report, ROAMA, the procuring activity, tightened its procedures to assure closer analysis of contractor's proposals.

There is no legal basis upon which to obtain the downward adjustment desired here, and all efforts made will be on an equitable basis.

Status: Case open-Pending final resolution of the price adjustment effort.

GAO Report, B-146882, November 30, 1964

72. Title: "Unnecessary Costs Resulting From Indirect Procurement of Transmitters From Hamilton Standard Division of United Aircraft Corp." (OSD case No. 2009).

GAO finding: The Air Force decision to have Hamilton Standard, prime contractor, acquire transmitters for $472,600 instead of procuring them directly from the manufacturer for $368,600 and supplying them as Government-furnished equipment (GFE) resulted in unnecessary costs. The difference consists primarily of indirect costs of Hamilton Standard, including material handling and general and administrative expenses, and provision for profit.

GAO estimate of unnecessary costs: About $104,000.

Time period of GAO report: April 1961.

DOD comment on GAO finding: The Air Force is in substantial agreement with GAO findings and also agrees that the decision was of questionable merit. Investigation revealed that the procurement action taken was, at the most, an error in judgment.

DOD comments on costs: A detailed review of the indirect costs and profit of $389.55 per unit has been made. The Navy Audit Office advised that the contractor's consistent practice was not to include or seek recovery of GFE handling charges in its bid price. Accordingly, the material handling charges ($137.55 per unit) for contractor-furnished equipment (CFE) cannot be considered duplicate charges. General and administrative expense ($168 per unit) consisted of indirect charges allocated on the basis of generally accepted accounting principles and pursuant to ASPR 15-201.4. Profit ($84 per unit) was negotiated at 5 percent of costs, which is considered commensurate with the type of contractor effort involved. In summary, no duplicate costs were found and no legal or equitable basis exists on which to seek refund.

DOD corrective action: This case resulted in the commander, Air Force Logistics Command (AFLC) reemphasizing to his people that all procurements should be made directly from the manufacturer unless there is a sound reason to the contrary. A joint Air Force Systems (AFSC) and Logistics Commands task group has made a study on the overall problem of direct procurement from manufacturers. AFLC has published a new regulation expanding the procurement and supply of GFE to contractors under AFLC contracts. AFSC will conduct a review of AFR 70-9, "Systems Procurement" for possible expansion.

ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE

Problem

GAO found that the Air Force decision to acquire TED-9 transmitters through Hamilton Standard Division, United Aircraft Corp., instead of the Air Force providing this item as a replacement for the transmitters originally specified as Government-furnished equipment resulted in unnecessary costs of about $104,000. The Air Force paid Hamilton Standard $472,600 for 267 TED-9 transmitters, even though they could have been procured direct from Rauland-Borg, the actual manufacturer, for $368,600. The $104,000 difference consists primarily of indirect costs of Hamilton Standard, including material handling and general and administrative expense, and provision for profit.

In its response to the draft report the Air Force advised that it was in substantial agreement with the GAO findings regarding the procurement and agreed also that the decision to procure the TED-9 transmitters as contractor-furnished equipment, rather than directly from the manufacturer, was of questionable

merit. The basis for the decision was a desire to eliminate the administrative time required to process a military interdepartmental purchase request.

The Air Force also advised that it was investigating whether any of the costs negotiated with Hamilton Standard for procurement of the TED-9 transmitters duplicate costs which were already included in the contract for installation of the AN/GRT-3 transmitters. If so, a refund would be sought for the full amount of such duplication. On the other hand, if no duplication exists, there would be no grounds for requesting a refund. The decision criticized herein was made by the Air Force alone and the contractor was merely responsive to its desires. The GAO was told also that the commander of the Air Force Logistics Command (AFLC) has reemphasized to his people that all procurements should be made directly to the manufacturer unless there is a sound reason to the contrary. GAO recommendations

That the Secretary of the Air Force:

(a) Inform GAO of the results of the Air Force investigation to establish the amount of any refund due.

(b) Inform GAO of the planned date for completion of the AFLC study on the overall problem of direct procurement from the manufacturer and that he furnish a copy of the study together with a statement of proposed action pursuant thereto.

Statement

(a) Extensive investigation revealed no duplication of costs; therefore, there are no grounds for requesting a refund. GAO was so advised by letter of March 10, 1965.

(b) The Air Force Systems and Logistics Commands have completed their review of the study made regarding the overall problem of direct procurement from manufacturers. The study was based upon the objective that procurement be made direct from the actual manufacturers unless there is sound reason to the contrary, and was based primarily on the application of the "competition with confidence" approach as embodied in AFSC/AFLC regulation 57-6. This approach envisions the contractor preparing and coding a parts list of his equipment indicating those items which could be procured directly by the Government from the manufacturer. Only those items appearing on the list with a unit cost of $500 or more would be considered for direct procurement. These lists would be submitted to the applicable AFSC systems project office (SPO) for final determination as to method of procurement.

In an attempt to establish at what point in time, in the acquisition of a weapon system, a list would be available for screening by the SPO the review group considered the procurement cycle of a weapon system. A typical system acquisition (operational production) phase represents a 4 to 5 program-year timespan. Assuming a 5-year system acquisition phase, detailed parts identification and design stabilization would not be available to the Air Force in time to make a reasonable breakout judgment that would allow initial GFE support before the fourth or fifth system program year. This would be approximately the time when the average system acquisition phase is completed. Assuming a normal production leadtime for systems of 18 to 24 months, deliveries from the production contract would not be available until well after the time the second production order must be placed. Therefore, the systems command would have two production orders covering 2 program-year requirements prior to delivery of first hardware and solid identification of the individual parts under the "competition with confidence" approach. Assuming the availability of such a coded list just prior to the need to place the third program year on contract, we can readily see that the necessary screening, decisionmaking, and Government programing and procurement processes could not be available in time to identify the weapon system configuration prior to the need for placement of the third program year buy. Assuming expedited action and little or no difficulty in determing design stability of the parts, together with reasonable estimates of Government programing and financial circles, the Air Force would most likely not be in a position to provide GFE beyond that identified in AFR 70-9 before the fourth program year. Even assuming this timing could be met, we at best would be providing additional GFE on this breakout criteria, in most cases, for just 1 year's program requirement to the system and then only on those systems with a 5-year production run. The study did not establish at what point in the procurement of the weapon system the list would be furnished to AFSC.

The study only contained a statement that the lists would be furnished as early as possible in advance of purchase request initiation data by AFLC.

Any expansion of GFE procurement should be accomplished only after it is deemed that component breakout (i) will not jeopardize the qualitative and delivery requirements of the major end item, and (ii) will result in overall cost savings. Any decision to break out a component for direct procurement by the Government involves a calculated risk. In making a judgment to break out an item for direct procurement, consideration must be given the technical, operational, logistic and administrative factors, as well as the economic factors. Prior to making a final decision to procure the component as GFE the following factors must be considered:

(1) Has the design stabilized?

(2) Is an adequate data package available?

(3) Is technical support available?

(4) Are any reliability, technical, or integration problems known which will require effort by the prime contractor?

(5) Will breakout create interchangeability problems and require additional provisioning actions?

(6) Will the end item contractor's responsibility be materially diluted if the Government furnished the component?

(7) Is time available to procure the component from a new source? (8) Will breakout result in overall cost savings?

A recent review by the deputy for subsystems and equipment management (AFSC) on a limited survey basis of aircraft engines, using the $500 breakout criteria with no consideration given to the factors set forth above reveals that approximately 720 additional items would be eligible for breakout and direct procurement by the Government. The active aeronautical reference numbers (Aernos) for the entire fiscal year 1964 program plotted against the total resources resulted in six-tenths man-years per active Aerno. Based on this experience 432 manpower spaces would be required to convert the 720 items from CFE to GFE. This figure does not include resources necessary to support this management and acquisition function at either Aeronautical Systems Division AFSC staff, SPO's or the Research and Technological Division engineering support. These figures are considered sufficient evidence to substantiate that the manpower impact would be significant in the event of a wholesale increase in GFE items.

Moreover, in the procurement of replenishment spares, the Government is the owner of the equipment being supported. Conversely, in the case of equipment procurement during system acquisition, the system/subsystem contractor bears sole responsibility prior to acceptance by the Government for the reliability and suitability of the system and/or subsystem's performance and operation. Therefore, it is not feasible to use the same criteria for determining when items shall be GFE in these instances.

The study review group concluded that:

(1) The "Competition with Confidence" approach (AFSCR/AFLCR 56-6, appendix 5) is not suitable for expansion of GFE by AFSC under system procurements.

(2) AFR 70-9 "System procurement" provides procedures on CFE versus GFE breakout. The guidance contained in AFR 70-9 and AFSC supplement 1. has evolved through years of experience and effort to arrive at the best breakout possible. The policies contained in this regulation require that components be provided as GFE whenever practicable and that the Air Force will not acquire subsystems or components as CFE, purely as a matter of convenience. As a result of the study, the Logistics Command has published AFLCR 57-10 to assure that under follow-on buys, to the extent it is feasible and desirable, AFLC procurement of installation parts and spares will be accomplished directly from the actual manufacturer and the item furnished as GFE for incorporation in the end item. The regulation states as its policy:

"a. Maximum use of direct procurement and supply of materiel to production/ modification contractors will be made feasible and in the best interests of the Air Force.

"b. The categories of items to be procured and supplied are defined in AFR 70-9 and in AFLC/AFSC supplement 1 thereto. In addition to these items, any item with a unit cost of $500 or more will be considered when quantity buys are involved and savings would be realized.