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.

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