Recent Changes in the Defense Department's Profit Policy--Intended Results Not Achieved

PSAD-79-38: Published: Mar 8, 1979. Publicly Released: Mar 8, 1979.

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As the result of a study on the profitability of defense contractors, a profit and pricing policy for most negotiated production-type contracts became effective on October 1, 1976. To encourage greater investment, the Department of Defense (DOD) allowed the imputed cost of capital for facility investment on most negotiated defense contracts and recognized the level of facility investment in establishing a profit objective for use in negotiating a profit rate with contractors.

Contractors did not respond positively to attempts by DOD to encourage greater investments in new or upgraded plants and equipment which would lower production costs, since limited emphasis was given to facilities investment in establishing the government's prenegotiation profit objectives. The new policy provided that only 10 percent of the government's profit objectives would be based on the level of the contractors' investments in plant and equipment. Unfortunately, the new profit policy did not encourage contractors to increase their investments in cost reducing facilities, but resulted instead in the negotiation of higher profit rates on an overall basis.

Recommendation for Executive Action

  1. Status: Closed

    Comments: Please call 202/512-6100 for additional information.

    Recommendation: The Secretary of Defense should: (1) increase emphasis on capital investment of facilities and further reduce the portion of the prenegotiation profit objectives that is based on estimated contract costs; (2) perform additional analysis to determine more precisely the impact of the new profit policy on overall negotiated profit rates and the need to increase the offset factor to approximate the amount of imputed interest on facilities capital; (3) establish more definitive criteria and procedures to enable contracting officers to determine appropriate profit allowances for contractors' facilities capital investments, cost risk, and productivity improvements subject to special profit rewards; (4) develop safeguards to prevent negotiating profits significantly greater than government objectives without a complete explanation and review of the rationale and consideration of possible alternatives; and (5) monitor more extensively the implementation of the new profit policy, and revisions made thereto, to provide greater assurance that the desired results are achieved.

    Agency Affected:

 

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