Government Contracting:

Assessment of the Study of Defense Contractor Profitability

NSIAD-87-50: Published: Dec 23, 1986. Publicly Released: Dec 23, 1986.

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In response to a congressional request, GAO evaluated the Department of Defense's (DOD) Defense Financial and Investment Review (DFAIR) to determine its adequacy, the validity of its findings, and the appropriateness of its recommendations.

GAO found that: (1) DFAIR determined that contract pricing, financing, and profit policies were related and should be examined on an integrated basis; (2) the profitability of defense businesses was comparable to commercial businesses from 1970 to 1980 and from 1983 to the present; (3) although DOD reported that a 1980 change in its profit policy resulted in an unintended 0.5- to 1-percent increase in profit objectives, GAO believes that the increase was larger than 1 percent; (4) DFAIR recommended changes to the weighted guidelines to do away with the unintended increase, but profits would have actually increased 25 percent if DOD had implemented all of the recommendations; (5) achieving comparability between defense and commercial businesses will require more than a 1-percent reduction in profit objectives because actual defense business profits have been substantially greater than those DFAIR calculated; and (6) the recently established DOD interim profit policy, based on DFAIR data and analysis, will not achieve the appropriate profit reductions because it uses as a baseline the flawed data analyses contained in DFAIR.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: Two pieces of legislation have been passed which would indicate that this recommendation may be implemented. The 1989 Defense Authorization Act of 1989 contains a requirement for DOD to recommend a financial analysis methodology for any return on investment study. OFPP Act Amendments of 1988 contains a requirement for OFPP to conduct a profit methodology study.

    Matter: Congress should establish a legislative requirement for a Profitability Reporting Program and periodic profit studies.

Recommendation for Executive Action

  1. Status: Closed - Not Implemented

    Comments: DOD remains unconvinced of the GAO position on the methodology to be used in evaluating contractor profitability. DOD did revise its profit policy, but it is not clear on what the new policy is based. GAO will continue to monitor the results of this new policy and report its findings on the results in the future in a separate report. DOD implemented a final rule on profit policy.

    Recommendation: The Secretary of Defense should: (1) initiate, on an expedited basis, new analyses using conventional methods to evaluate profitability; (2) based on these analyses, make appropriate modifications as soon as possible to the interim policy; and (3) develop a means to show in contract negotiations, the effect of government contract financing (for example, rate of progress payments, payment frequency, and speed of payment) and the use of interim/milestone payments on contractors' returns on assets.

    Agency Affected: Department of Defense


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