B-147768, FEB. 15, 1962

B-147768: Feb 15, 1962

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TO THE SECRETARY OF DEFENSE: REFERENCE IS MADE TO LETTER OF DECEMBER 7. WE HAVE ALSO RECEIVED AND CONSIDERED A COPY OF A REVISED DRAFT OF SECTION 3-403 (B) THEREOF. COMPARISON OF THE PROPOSED MATERIAL WITH EXISTING PROVISIONS INDICATES THAT THE PRINCIPAL CHANGE IS ONE OF EMPHASIS. TENDING TO ENCOURAGE USE OF INCENTIVE-TYPE PROVISIONS DESIGNED TO STIMULATE THE PROFIT MOTIVE BY MAKING CONTRACTOR PROFITS MORE PROPORTIONAL TO EXCELLENCE OF PERFORMANCE THAN IS THE CASE WHEN PROFITS ARE TO A LARGE EXTENT FIXED OR LIMITED AND INDEPENDENT OF THE QUALITY OR COST OF PERFORMANCE. WHILE THE LANGUAGE OF THE PROPOSED REGULATIONS IS ADEQUATE TO POINT OUT THE DANGERS AS WELL AS THE BENEFITS OF THE INCENTIVE-TYPE PROCEDURE.

B-147768, FEB. 15, 1962

TO THE SECRETARY OF DEFENSE:

REFERENCE IS MADE TO LETTER OF DECEMBER 7, 1961, FROM THE ACTING ASSISTANT SECRETARY (INSTALLATIONS AND LOGISTICS) REQUESTING OUR COMMENTS ON A PROPOSED REVISION IN THE ARMED SERVICES PROCUREMENT REGULATION OF THE POLICIES COVERING THE SELECTION OF TYPES OF CONTRACTS (ASPR SECTION III, PART 4). WE HAVE ALSO RECEIVED AND CONSIDERED A COPY OF A REVISED DRAFT OF SECTION 3-403 (B) THEREOF, DATED JANUARY 22, 1961, AND A LETTER DATED FEBRUARY 2, 1962, TRANSMITTING COPIES OF YOUR DEPARTMENT'S PRESENTATION TO THE RENEGOTIATION BOARD WITH RESPECT TO YOUR PLANS ON THE USE OF INCENTIVE AND OTHER HIGH RISK CONTRACTS.

COMPARISON OF THE PROPOSED MATERIAL WITH EXISTING PROVISIONS INDICATES THAT THE PRINCIPAL CHANGE IS ONE OF EMPHASIS, TENDING TO ENCOURAGE USE OF INCENTIVE-TYPE PROVISIONS DESIGNED TO STIMULATE THE PROFIT MOTIVE BY MAKING CONTRACTOR PROFITS MORE PROPORTIONAL TO EXCELLENCE OF PERFORMANCE THAN IS THE CASE WHEN PROFITS ARE TO A LARGE EXTENT FIXED OR LIMITED AND INDEPENDENT OF THE QUALITY OR COST OF PERFORMANCE. THE MOST SUBSTANTIAL CHANGE IN ACTUAL IMPLEMENTING AUTHORITY APPEARS TO BE IN THE ELIMINATION OF THE PRESENT REQUIREMENT FOR APPROVAL AT UPPER LEVELS OF CERTAIN INCENTIVE-TYPE CONTRACTS.

WE DO NOT DISAPPROVE OF THIS APPARENT OBJECTIVE, PROVIDED THAT APPLICATION OF THE STATED POLICIES DOES NOT RESULT MERELY IN INCREASING THE OVERALL COSTS OF DEFENSE PROCUREMENT BY INCREASING CONTRACTOR PROFITS WITHOUT CORRESPONDING INCREASED BENEFITS, OR WITHOUT SUBSTANTIALLY DECREASING PROFITS IN CASES OF INFERIOR PERFORMANCE. WHILE THE LANGUAGE OF THE PROPOSED REGULATIONS IS ADEQUATE TO POINT OUT THE DANGERS AS WELL AS THE BENEFITS OF THE INCENTIVE-TYPE PROCEDURE, IT IS NEVERTHELESS SO GENERALIZED AS TO RENDER IT IMPOSSIBLE TO EVALUATE EXCEPT ON THE BASIS OF RESULTS REALIZED IN THE FUTURE. WE ASSUME THAT CLOSE AND CONSTANT SURVEILLANCE WILL BE EXERCISED BY ALL APPROPRIATE AUTHORITIES OVER THE USE MADE OF THE PROCEDURES AUTHORIZED BY THE REGULATIONS.

ACHIEVEMENT OF THE OBJECTIVE STATED WOULD ALSO APPEAR TO BE DEPENDENT TO A GREAT EXTENT UPON SOME SATISFACTORY METHOD OF CO ORDINATING THE STANDARDS FOR USE IN INCENTIVE-TYPE CONTRACTS WITH THOSE APPLIED IN RENEGOTIATION BOARD PROCEEDINGS, ATTENTION BEING DIRECTED PARTICULARLY TO THE DECISION OF THE TAX COURT IN BOEING AIRPLANE CO. V. RENEGOTIATION BOARD, 37 T.C. NO. 64, JANUARY 10, 1962.

AS TO PARTICULAR PROVISIONS OF THE REGULATIONS, WE OFFER THE FOLLOWING COMMENTS:

WE BELIEVE THAT THE REGULATIONS WOULD BE MORE EASILY USEABLE IF THERE WERE INCLUDED BEFORE THE SPECIFIC TREATMENT OF THE VARIOUS TYPES OF CONTRACTS A COMPLETE LIST OR TABULATION OF THE SEVERAL TYPES AND SUB TYPES, WITH APPROPRIATE REFERENCES TO THE PARTICULAR SECTIONS APPLICABLE TO EACH.

THE LAST SENTENCE OF SECTION 3-402 (A) (2) PERMITS THE CONTRACTING OFFICER TO PROVIDE THE CONTRACTOR WITH A HIGH PROFIT POTENTIAL WHEN IN THE CONTRACTING OFFICER'S JUDGMENT THE ESTIMATED COSTS ARE AS REALISTIC AS IS FEASIBLE AT THE TIME, EVEN THOUGH THE ESTIMATED COSTS MAY NOT BE AT ALL REALISTIC. WE SUGGEST THAT THE SENTENCE BE CHANGED TO READ,"IN CONTRAST, IF THE CONTRACTING OFFICER NEGOTIATED ESTIMATED COSTS ON THE BASIS OF CURRENT, COMPLETE, AND ACCURATE COST DATA AT THE TIME OF NEGOTIATION, A CONTRACT TYPE PROVIDING A HIGH PROFIT POTENTIAL AND CONCOMITANT CONTRACTOR RISKS, ADEQUATELY SUPPORTED, MAY BE ENTIRELY APPROPRIATE EVEN THOUGH THERE IS A POSSIBILITY THAT ACTUAL COSTS WILL VARY WIDELY FROM THE ESTIMATE.'

SECTION 3-403 (A) (2) STATES THAT "URGENCY OF THE REQUIREMENT" MAY BE THE PRIMARY CONSIDERATION IN THE SELECTION OF CONTRACT TYPE. WE BELIEVE IT WOULD BE DESIRABLE TO IMPLEMENT THIS STATEMENT BY PROVIDING SOME MORE SPECIFIC GUIDES, AS BY REFERENCE TO ILLUSTRATIVE EXAMPLES.

IN SECTION 3-404.2 (B) (II), NEGOTIATION OF A FIRM FIXED-PRICE CONTRACT IS JUSTIFIED WHERE ,PRIOR PURCHASES OF THE SAME OR SIMILAR SUPPLIES OR SERVICES PROVIDE REASONABLE PRICE COMPARISON.' WE BELIEVE THAT EXPERIENCE HAS SHOWN THAT PRIOR PURCHASES MAY NOT ALWAYS PROVIDE ADEQUATE BASIS FOR REASONABLE PRICE COMPARISON, BECAUSE THE

EARLIER PRICES MAY NOT HAVE BEEN BASED ON COST DATA. WE THEREFORE SUGGEST THAT THE CLAUSE BE MODIFIED BY INSERTING AFTER THE WORD "SERVICES," THE PHRASE "UNDER COMPETITIVE CONDITIONS OR SUPPORTED BY VALID COST DATA.'

WE BELIEVE THAT SECTION 3-407 FURNISHES INSUFFICIENT GUIDANCE AS TO WHERE THE TYPES OF INCENTIVE PROVISIONS THEREIN DISCUSSED FALL IN THE CLASSIFICATION OF CONTRACT TYPES. IT DOES NOT APPEAR THAT THESE TYPES ARE MEANT TO BE DISTINCT IN THEMSELVES, INDEPENDENT OF THE MAIN CLASSIFICATIONS OF FIXED-PRICE AND COST-TYPE CONTRACTS; THE PROVISIONS DISCUSSED IN 3-407.2 AND 3-407.3 SEEM RATHER TO BE INTENDED TO BE INCLUDED AS ADDITIONAL PROVISIONS IN CONTRACTS OTHERWISE FALLING INTO ONE OF THE OTHER CATEGORIES. WE THEREFORE RECOMMEND THAT ADDITIONAL DIRECTIONS BE FURNISHED TO INDICATE HOW THESE PROVISONS ARE TO BE INCORPORATED, AND IN CONNECTION WITH WHAT OTHER KINDS OF PRICING PROVISIONS. WE ALSO SUGGEST THE DESIRABILITY OF FURNISHING FORMS FOR USE IN CONNECTION WITH THE SEVERAL TYPES OF INCENTIVE PROVISIONS.

SECTION 3-407.2, CONTRACTS WITH PERFORMANCE INCENTIVES (A), PROVIDES A PERFORMANCE INCENTIVE IN INCREASED FEE OR PROFIT TO THE CONTRACTOR TO SURPASS STATED PERFORMANCE TARGETS, SUCH AS DELIVERY; CAPABILITY, RELIABILITY, AND SERVICEABILITY OF THE PRODUCT; EASE AND SIMPLICITY OF OPERATION; ECONOMY OF MAINTENANCE, ETC. UNDER THE INCENTIVE PROVISIONS, THE CONTRACTOR MAY BE FACED WITH A CHOICE BETWEEN A PRODUCT THAT WILL MEET MAXIMUM PERFORMANCE GOALS OR A PRODUCT THAT MAY NOT ACHIEVE THESE GOALS BUT IS LESS COSTLY TO PRODUCE. THE LIMITATION EXPRESSED IN THE PROPOSED REGULATION, THAT PERFORMANCE INCENTIVES SHOULD ALWAYS BE COUPLED WITH AN INCENTIVE FOR COST CONTROL, APPEARS WISE. HOWEVER, WE BELIEVE IT ADVISABLE TO EMPHASIZE THE NEED FOR MAINTAINING AN APPROPRIATE BALANCE BETWEEN THESE INCENTIVES. FOR INSTANCE, IF THE PERFORMANCE INCENTIVE IS TOO GREAT IN RELATION TO THE COST CONTROL INCENTIVE, IT COULD RESULT IN INFLUENCING THE CONTRACTOR TOWARDS "GOLD PLATING" HIS PRODUCT WITHOUT PROPER REGARD TO COST. BY SO DOING HE WOULD NOT ONLY RECEIVE HIGHER PROFITS BUT WOULD ALSO FURTHER DEVELOP HIS PRODUCT AND COMPETITIVE POSITION AND ENHANCE HIS REPUTATION AS A PRODUCER OF A QUALITY PRODUCT EVEN THOUGH THE BENEFIT TO THE GOVERNMENT FROM THE INCREASE IN QUALITY MAY NOT BE COMMENSURATE WITH THE ADDITIONAL COST.

THE FOLLOWING EDITORIAL CHANGES SHOULD BE CONSIDERED:

1. SECTION 3-404.5 (A) DESCRIPTION--- CHANGE "THIS TYPE OF CONTRACT PROVIDES FOR A FIRM FIXED PRICE OR AN INITIAL PERIOD * * *" TO "THIS TYPE OF CONTRACT PROVIDES FOR A FIRM FIXED PRICE FOR AN INITIAL PERIOD * * *.'

2. SECTION 3-407.2 (C) (2) "IN THE CASE OF CONTRACTS INVOLVING A FEE, THE MAXIMUM FEE SHALL NOT EXCEED THE STATUTORY LIMITATIONS STATED IN 3-405.4 (C) (2)" SHOULD BE "3-405.5 (C) (2).'

WE APPRECIATE THE OPPORTUNITY OF FURNISHING THESE COMMENTS. IT IS NOT TO BE UNDERSTOOD, HOWEVER, THAT FAILURE HEREIN TO OBJECT TO ANY PARTICULAR PROVISION NECESSARILY INDICATES APPROVAL THEREOF, OR THAT ANYTHING SAID HEREIN IS IN ANY WAY RESTRICTIVE OF THE FULL EXERCISE OF OUR PROPER FUNCTIONS IN ANY INSTANCE IN WHICH THE REGULATIONS REFERRED TO MAY BE INVOLVED.