IMPACT OF DEFENSE PROCUREMENT THURSDAY, JANUARY 28, 1960 U.S. SENATE, SUBCOMMITTEE ON DEFENSE PROCUREMENT OF THE Washington, D.C. The subcommittee met, pursuant to notice, at 10 a.m., in room G-308, New Senate Office Building, Senator Paul H. Douglas, chairman, presiding. Present: Senators Douglas, Sparkman, O'Mahoney, Javits; Representatives Patman and Curtis. The CHAIRMAN. The subcommittee on Military Procurement will come to order. Due to the weather conditions, Senator Javits is delayed in flying in from New York, and Congressman Curtis from Missouri, but we will go ahead with the members who are here. The question of military supplies is one of the most important and relatively most ignored features in Government. For the fiscal year 1960, estimates are that the Defense Department will spend $23.9 billion on supplies and equipment. This is almost precisely 30 percent of the total national budget. Our very competent staff associates, Mr. Ray Ward and Mr. Richard J. Newman, have prepared a chart which shows the magnitude of the operations, with the Department of Defense having property holdings of $150 billion, of which $33 billion is in the form of land, buildings, and fixed equipment, $70 billion in the form of major weapons, and $47 billion in the form of supplies. I hold in my hand a report on Federal real and personal property, U.S. Government, issued by the Committee on Government Operations. These figures are as of June 30, 1959. On page 135 of that report the total supply system inventories as of that date for the Department of Defense are listed as $44.2 billion. This differs slightly from the $47 billion figure, as it is on a different basis. Of this, $3 billion of the $44.2 billion are undistributed stocks, $15.3 billion peacetime operating stocks, $11.5 billion mobilization reserve stocks. Putting these three together, we get a total of something like $30 billion. Then economic retention stocks, contingency retention stocks, and excess stocks, which I think is the more charitable interpretation-all three could be regarded as excess come to about $13 billion. There is a very real question as to whether there is not excess in the preceding $30 billion. The Department of Defense has written this off its surplus stocks at the rate of $6 billion a year and then $8 billion, and now at the rate of $10 billion a year, and they are also paying for the direct costs of sales. They net somewhere between 2 1 and 212 percent on the original cost of the equipment and supplies. They thus take a loss of between 97.5 and 98 percent of the annual volume of sales of from $6 billion to $10 billion. There are various questions raised by this. First, how and why were these excess stocks accumulated in the first place? Second, are they being disposed of in the most efficient manner? Third, have the original contract terms and prices paid been excessive? Fourth, is the Department of Defense buying new material, either identical to or substantially similar to the material which is being disposed of, and a whole series of other questions. We are very fortunate in having the Comptroller General of the United States, Mr. Joseph Campbell, with us this morning. Like his predecessor, Mr. Lindsay Warren, I regard Mr. Campbell as one of the great public servants of this country, and I want to commend him and his staff for the work which they have been doing. These men do a lot of hard and patient drudgery. They are exposed to the fire of the departments whose expenditures they scrutinize. They do not receive the popular approval and commendation which I think they deserve, and they must at times feel very lonely and friendless. I want to assure them that the Congress, whose agents they are, not the agent of the Executive, is deeply appreciative of their work. While the public does not fully express its gratitude, there is a very real feeling that they are watchdogs of the public purse. We should remember that it is the people's money which is being spent. Now, Mr. Campbell, we are very glad to have you here. You are among your friends. You have a long term of office, fortunately. You cannot be removed. I think the term is 14 years. STATEMENT OF JOSEPH C. CAMPBELL, COMPTROLLER GENERAL OF THE UNITED STATES, ACCOMPANIED BY LAWRENCE J. POWERS, JR., ASSISTANT TO THE COMPTROLLER GENERAL; CHARLES BAILEY, DEPUTY DIRECTOR, DEFENSE ACCOUNTING AND AUDITING DIVISION, GAO; AND J. EDWARD WELCH, DEPUTY GENERAL COUNSEL, GAO Mr. CAMPBELL. Fifteen years. The CHAIRMAN. You have only served about 5 years? The CHAIRMAN. So I hope you continue with unabated vigor and without fear of the future. Like the President, you cannot succeed yourself. Mr. CAMPBELL. That is right. Thank you, Mr. Chairman. I have with me today Mr. Lawrence Powers, who is on my right. Mr. Powers is at present Assistant to the Comptroller General, but for some time past has been Director of our Defense Accounting and Auditing activities. I also have with me Mr. Charles Bailey, Associate Director of that Division, and also the Deputy General Counsel of the General Accounting Office, Mr. Welch, on my left. Mr. Chairman and members of the subcommittee, at your request, I appear before you today to present a summary of the more significant matters disclosed by the audits and examinations made by the General Accounting Office in the Department of Defense and the three military departments during the past 2 years. We have included in this summary those matters which we believe will be of particular interest to your committee. They pertain primarily to military procurement, transportation, storage, disposal, and other supply management activities. With estimated budget expenditures for the fiscal year 1960 for the Department of Defense military functions, together with military assistance programs, totaling approximately $42.8 billion, or 55 percent of the Federal budget, close control and prudent management of defense and military assistance expenditures are essential. In our reports we have pointed to areas in which significant improvements can be made in the Department's controls and management and have made recommendations which, we believe, will lead to such improvements. In our statement today, we will summarize these areas and recommendations and, to the extent possible, give you the corrective action already taken or contemplated by the military departments concerned. However, time has not permitted us to update such information in all cases. Our findings will be discussed under four general activity classifications: Procurement. Supply and service management. Other activities. SCOPE OF PROCUREMENT NEGOTIATED CONTRACTS 80-90 PERCENT OF TOTAL Annual budget expenditures for defense procurement exceed $17 billion and account for approximately 40 percent of the total Department of Defense budget including military assistance. It has been estimated that as much as 80 to 90 percent, by value, of all military purchases are made by negotiated contracts. Where contracts cannot be awarded on the basis of full and free competition under advertised bid and award procedures, which is the preferred method of Government procurement, the Congress has authorized military departments to place contracts by negotiation under circumstances specified in the Armed Services Procurement Act of 1947. Procurement by negotiation is designed for use in situations in which procurement by advertised bidding is either impractical or inappropriate. Negotiated contract prices are based largely on estimated costs to produce the articles required. Such estimates must, therefore, be as sound and realistic as possible in order to arrive at fair and reasonable prices. While competition can, in many instances, be maintained in negotiated procurements, such competition is not always effective and the Government does not always have the assurance of fair and reasonable pricing normally afforded by the forces of full and free competition. The complexity of modern-day equipment, devices, and systems needed by the Department of Defense makes it increasingly difficult to secure effective competition or to forecast production costs with a reasonable degree of accuracy. Preparation of accurate cost estimates upon which to base reasonable and equitable contract prices requires the sound and earnest cooperative efforts of the contracting officials of both the Government and the contractor. Cost estimates represent not only a basis for establishing prices for a given item or service but can also provide the contractor with an incentive for attaining efficient and economical operations. For example, under firm fixedprice contracts, prices based on estimates of the cost of production plus a profit allowance give the contractor an incentive to hold production costs to the minimum in order to earn a greater profit. Under incentive-type contracts, production cost estimates are used to establish target costs which, together with the target profit, make up the target price. The contractor's incentive participation in cost increases or reductions is determined by comparing the cost actually incurred in performing the contract with the target costs, hence the incentive to reduce actual costs of performance. However, if cost estimates or targets are not realistically prepared, that is, if they are either intentionally or inadvertently stated higher than current production cost experience and other available pertinent information would indicate to be reasonable to anticipate for future production, profits resulting from lower costs become a windfall rather than profits earned through efficiency. Our examinations have disclosed numerous cases where negotiation of prices has lacked the diligent administration and cooperation on the part of both contracting parties necessary to avoid excessive costs to the Government. The most common types of uneconomic procurement practices and their causes are summarized as follows: Failure to negotiate close prices Our examinations have disclosed many instances where we believe the Government paid excessive prices for goods or services received because of the administrative agency's failure to obtain and adequately evaluate latest available cost data in establishing prices and incentive targets. In 16 cases reported to the Congress, excessive costs aggregated about $27.8 million. To date $18 million of these excess payments, including civil penalties, has been recovered by the Government. In many of these cases the Government's contract negotiators did not adequately review cost data submitted by the contractor in support of pricing proposals and frequently did not request an audit of cost data when obtained. Typical of this deficiency in administrative procedure was a case in which the contractor's cost estimate submitted in support of his price proposal included estimates of subcontracted work at prices paid on previous subcontracts. However, these prices were higher than the maximum prices established between the prime contractor and the subcontractor prior to negotiation of the prime contract price. The Government negotiator did not obtain and consider the information on the lower subcontract prices in effect at the time of negotiations. As a result, the Government was overcharged, in this case, in excess of $1.5 million. We have found other cases in which the administrative agencies did not achieve close pricing because prices were negotiated before contractors had sufficient production experience to develop cost data upon which to base reasonable prices. In such cases, it may be expected that contractors will include in their price proposals contingency factors to protect themselves adequately against losses. Recoveries in two of these cases totaled in excess of $2.7 million. In other cases, excess costs were not recovered. PRIME CONTRACTOR REWARDED FOR HIS EFFICIENCY Another area in which agency contracting officials have frequently failed to achieve close pricing involved the failure of prime contractors or agency officials to obtain and adequately evaluate cost data in support of price proposals by subcontractors. These included cases where (1) cost information upon which to evaluate the reasonableness of prices was not requested by the prime contractor, (2) firm fixed prices were accepted before the subcontractor had sufficient production and cost experience to forecast production costs accurately, and (3) the prime contractor did not obtain the most current available cost data in support of the subcontractor's price proposal. Excessive subcontract cost estimates result in excessive prime contract prices and unwarranted profit to the prime contractor since the prime contractor, generally, also receives a profit on subcontractors' charges. In situations of this nature the prime contractor, in practice, is rewarded for his inefficiency. Benefits of competition in procurement prevented by inadequate provisions for use of contractor-prepared drawings developed for and at expense of the Government We believe that the Government is frequently denied the benefits of competition through failure of procurement officials to obtain or reserve the right to obtain manufacturing drawings prepared by contractors at Government expense. In a selective review at one large procurement office, we found that the Government has not been in a position to realize the maximum benefits of competition in many procurements of military items, components, and spare parts. This was due to inadequate contract provisions requiring that the Government. be furnished with complete manufacturing drawings of items developed for and at the expense of the Government to be used in the subsequent procurement of the same items by the Government. We also found unnecessarily restricted interpretations by the procurement office of prior contracts where use of contractor-furnished drawings is not expressly restricted. The procurement office's controls and procedures were inadequate regarding the receipt and issue of drawings for procurement purposes. In our tests, we found that over 25 percent of the requests from other procuring activities for manufacturing drawings to be used in reprocurement were denied because their records showed that the Government did not have the right to reproduce and distribute the drawings to other contractors for procurement purposes. Other uneconomical procurement practices There are other procurement practices disclosed by our audits which if corrected would contribute substantially to a more efficient procurement operation. For example, failure to adjust contract prices for changes in the scope of contract work has resulted in excess charges to the Government. In an off-shore procurement of 120 aircraft engines, the record of negotiations indicated an agreement that about one-third of the engines to be delivered would be of a certain type while the balance of the engines to be furnished would be an improved and more expensive model. Because of delays in the development of the new model, the entire contract quantity was filled with the original and less |