oversight

Application Of "Should Cost" Concepts In Reviews Of Contractors' Operations

Published by the Government Accountability Office on 1971-02-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                        .-.




REPORT TO THE CONGRESS




 pplicatisn Of “Should Cost”
Concepts In Reviews Of
Contractors’ 0 perat ions     B - 159696




Department of Defense




BY THE COMPTROLLER GENERAL
OF THE UNITED STATES
            COMPTROLLER GENERAL OF THE UNITED S A T E S
                      WASHINGTON. D.C. 20548




B- 159896




To the President of the Senate and the
Speaker of the House of Representatives

      This is our report on application of "should cost'' con-
cepts in reviews of contractors' operations, Department of
Defense. Our examination was made pursuant to the Budget
and Accounting Act, 1921 (31 U.S.C. 53), and the Accounting
and Auditing Act of 1950 (31 U.S.C. 67).

      Copies of this report a r e being sent to the Director,
Office of Management and Budget; the Secretary of Defense;
and the Secretaries of the Army, Navy, and Air Force.




                               Comptr olle r Gener a1
                               of the United States
        I


        I
        I   COMPTROLLER GENERAL 'S                     APPLICATION OF "SHOULD COST" CONCEPTS IN
        I   REPORT TO P'HE CONGRESS                    REVIEWS OF CONTRACTORS' OPERATIONS
        I
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                                                       Department o f Defense B-7 59896
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        I   D-
            - IG
               --E-
                  ST-
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        I   WHY THE REVIEW WAS MADE
        I
        I
        I          In May 1969, the Subcommittee on Economy i n Government, Joint Economic
        I
        I
                   Committee, reporting on "The Economics of Military Procurement," ex-
        I          pressed concern t h a t the traditional method o f pricing negotiated con-
        I
        I
                   tracts--primarily on the basis o f past or historical costs--did not
        I          protect the interests of the Government adequately.
        I
    I
    I              The Subcommittee recommended t h a t the General Accounting Office (GAO)
    I
    I
                         "study the f e a s i b i l i t y of incorporating i n t o i t s audit
                         and review of contractor performmce the should cost
                         method of estimating contractor costs on t h e basis of in-
    I                    dustrial engineering and finunciaZ management
    I
    I
    I             The should-cost approach attempts t o determine the amount' t h a t weapons
    I             systems or products ought t o cost, given attainable efficiency and econ-
    I
    I             omy of operations.
    I
    I
    I
                   In May 1970, GAO reported to the Congress t h a t i t appeared t o be fea-
    I              sible t o apply should-cost concepts i n i t s reviews. GAO also stated
    I
    I
                   t h a t i t would perform t r i a l reviews o f this type t o o b t a i n additional
    I              information concerning benefits t h a t could be realized and problems
    I
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                   t h a t might be encountered.
    I
    I             T h i s report presents GAO's f i n d i n g s and conclusions based on i t s t r i a l
I
I                  applications of should-cost concepts.
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I
I           FINDINGS AND CONCLUSIONS
I                                                                                                          4
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                  On the basis of four t r i a l reviews applying should-cost techniques, GAO
I                 has concluded t h a t such reviews can be extremely beneficial and t h a t i t
I
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                  should make should-cost-type reviews i n the future.

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                  GAO found a number of areas a t each of four contractor plants where i n -
                  creased management attention could result i n lower costs t o t h e Gover-
                  ment. For example,
I                    --improvements were needed i n production pl anni ng and control
                     --there was a need f o r increased competition i n the procurement o f
                       material from subcontractors, and
            Tear Sheet


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                                                                                     FEB.26,%971
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  --higher q u a l i t y engineering t a l e n t was utilized than was required by   I
                                                                                     I
    the nature of the work being performed.                                          I
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GAO brought the specific f i n d i n g s t o the attention of appropriate con-       I
tractor and agency officials and made suggestions for improvements.                  I
(See pp. 8 t o 10 and 14 t o 15.)                                                    I
                                                                                     I
                                                                                     I
A1 though should-cost review techniques primarily are intended t o f i n d           I
                                                                                     I
o u t how contractors' operations can be improved, they also lead t o d i s -        I
closures of areas where Government contracting or administration prac-               I
                                                                                     I
tices affect contract costs adversely. GAO noted instances of exces-                 I
sive packaging requirements, failure t o consolidate purchasing, and ex-             I
cessive testing requirements. (See p. 14 and 15.)
                                                                                     I
The t o t a l savings which could accrue t o the Government 'as a result of          I
                                                                                     I
the GAO reviews and the resulting improvements i n contractor and Govern-            I
ment management practices cannot be determined readily because the ef-               I
                                                                                     I
fects on costs of certain of the suggestions could not be measured                   I
readily. In those instances where they could be determined, the sav-                 I
                                                                                     I
ings amounted t o almost $6 m i l l i o n . (See p. 33.)                             I
                                                                                     I
The military services have performed should-cost reviews i n order t o be            I
                                                                                     I
i n a better position t o negotiate contract prices for major weapons sys-           I
tems. Recognizing that the negotiation of contract prices is the re-                 I
                                                                                     I
sponsibility of the procuring agency, GAO believes that i t s reviews                I
should not be conducted i n a preaward environment.                                  I
                                                                                     I
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Future GAO reviews therefore will attempt t o evaluate how procuring agen-           I
cies and contract administrators are discharging their responsibilities              I
                                                                                     I
and t o suggest ways i n which contractors can reduce the costs to the               I
Government. (See p. 21 .)                                                            I
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Procuring agencies t h a t perform should-cost reviews prior t o the awards          I
                                                                                     I
of major contracts are i n a strategic position t o obtain contractor co-            I
operation and concurrence in changes needed. Application of should-cost              I
concepts d u r i n g preaward reviews enables Government contracting officers        I
                                                                                         I
t o negotiate from positions of strength because the comprehensive f i n d -             I
ings and observations of the review teams are available during negotia-                  I
                                                                                         1
tions. Since this type of information i s available, the contracting                     I
officer can influence the contractor t o adopt recommendations for im-
proved operations. (See p. 21 .)                                                         1

Although GAO had some success i n encouraging contractors t o study and/
o r improve their operations, GAO could not be as effective as the pro-
curing agencies i n motivating the contractors. There was no o b l i g a t i o n
on the p a r t of contractors t o accept the suggestions of the GAO review
teams, and i n some instances no interest was shown i n considering GAO
proposals objectively. In other instances contractors took a positive
attitude toward reducing the costs of future operations. (See p. 22.)




                                  2
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    I         The success of future reviews of this type by GAO probably will depend
    I         almost entirely on the cooperation of contractors and on the extent to
    I
    I         which the Department o f Defense contracting o f f i c i a l s apply GAO f i n d -
    I         i n g s and recommendations during negotiations of contracts. (See p . 22.)
    I


        AGENCY AND COX!T?ACTOR C O W N l ' S

              The Office o f the Assistant Secretary of Defense (Installations and Lo-
    I
              g i s t i c s ) advised GAO t h a t the Department of Defense agencies concerned
              would look into the specific matters reported by GAO a t the contractors'
    I
    I
              plants.
    I
    I         Pertinent contractor comments were:
    I
    I
    I            --GAO should place greater emphasis on reviewing overall Government
    I
    I
                   and contractor procurement systems rather than detailed costs.
    I
    I
    I
                 --There should be some additional evaluation of cost benefits result-
    I              i n g from should-cost reviews versus the costs of accomplishment.
    I
    I
    I
                 --Additional statutory authority f o r GAO may not be necessary.
    I
    I
    I
              GAO does place primary emphasis on evaluating procurement systems rather
    I         than detailed costs, and GAO reviews a r e so designed. GAO also applies
    I         criterl'a t o ensure, insafar as possible, t h a t the benefits resulting
    I
    I         from should-cost reviews wtll be signiffcant i n relation t o the costs
    I         of making the reviews.
    I
    I
    I
    I   MATTERS FOR CONSIDERATION BY TBE COiVGRESS
    I
    I
    I
    I
              Should-cost revl'ews requtre examinations into many facets of contractors '
I             operations and management. The present provisions o f GAO' s statutory
I             authority t o examine contractors' recorck are not broad enough t o en-
              able GAO t o cover a l l of the matters whfch should be considered. The
              Congress therefore may wish t o consider expanding GAO's statutory au-
I
              thority t o enable GAQ t o make effective should-cost reviews on an i n -
              dependent basis.
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I       Tear Sheet
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                       C o n t e n t s
                                                         Page

DIGEST                                                    1
CHAPTIB
   1      INTRODUCTION                                    4
              Scope of trial applications                 5

  2       RESULTS OF GAO TRIAL APPLICATIONS OF SHOULD-
            COST CONCEPTS                                 7
              Comprehensive reviews of contractors'
                operations can provide identification
                of potential savings                      8
              Identification of needed improvements
                in award and administration of con-
                tracts                                   13
                                        I


  .3      SHOULD-COST REVIEWS BY THE MILITARY SERVICES    16
              Department of the Navy review of pro-
                posed costs of engines for the F-111
                aircraft                                 16
              Department of the Army review of pro-
                posed costs f o r HAWK missiles          17
              Current DOD position on future role of
                should-cost reviews in Government
                procurement                              18
  4       CONTRAST BETWEEN DOD AND GAO SHOULD-COST
            REVIEWS                                      21
              Effectiveness of reviews                   21
              Lack of statutory authority for GAO to
                perform should-cost reviews              22

  5       CRITERIA FOR FUTURE APPLICATIONS OF SHOULD-
            COST CONCEPTS BY GAO                         24

  6       DOD AND CONTRACTOR COMMENTS                    26

  7       CONCLUSIONS                                    28
              Matters for consideration by the Con-
                gress                                    29
APPENDIX                                                 Pane
   I       Summary of quantifiable potential savings
             identified through application of should-
             cos t concepts                              33

  I1       Letter dated November 12, 1970, from the
             Deputy Assistant Secretary of Defense
             (Installations and Logistics) to the Gen-
             era1 Accounting Office                      34
 I11       Principal officials of the Department of
             Defense and the military services respon-
             sible for administration of activities
             discussed in this report                    36

                        ABBREVIATIONS

DOD        Department of Defense

GAO        General Accounting Office
COMPTROLLER GENERAL ' S                 APPLICATION OF "SHOULD COST" CONCEPTS IN
REPORT TO THE CONGRESS                  REVIEWS OF CONTRACTORS' OPERATIONS
                                        Department of Defense B-159896

D-
- IG
   --E-
      ST-

WllY T3E REVIEW WAS MADE

     In May 1969, the Subcommittee on Economy i n Government, J o i n t Economic
     Committee, reporting on "The Economics of Military Procurement,'' ex-
     pressed concern t h a t the traditional method o f pricing negotiated con-
     tracts--primarily on the basis of past or historical costs--did not
     protect the interests of the Government adequately.
     The Subcommittee recommended t h a t the General Accounting Office (GAO)
          "stud9 the feasibiZity of incorporating i n t o its audit
          and review of contractor performance the shou2d cost
          method of estimating contractor costs on the basis of in-
          dustrial eng;neering and financia2 management principles. I r
     The should-cost approach attempts t o deterrpine the amount t h a t weapons
     systems or products ought t o cost, given attainable efficiency and econ-
     omy of operations.
     In May 1970, GAO reported t o the Congress t h a t i t appeared t o be fea-
     s i b l e t o apply should-cost concepts i n i t s reviews. GAO also stated
     t h a t i t would perform t r i a l reviews of this type t o obtain additional
     information concerning benef i ts t h a t coul d be real i zed and problems
     t h a t might be encountered.
     T h i s report presents GAO's f i n d i n g s and conclusions based on i t s t r i a l
     applications of should-cost concepts.

FINDINGS AND CONCLUSIOMS
     On the basis of four t r i a l reviews applying should-cost techniques, GAO
     has concluded t h a t such reviews can be extremely beneficial and t h a t i t
     should make should-cost-type reviews i n the future.
     GAO found a number o f areas a t each of four contractor plants where i n -
     creased management attention could r e s u l t i n lower costs t o the Gover-
     ment. For example,
       --improvements were needed i n production planning and control,
       --there was a need for increased competition i n the procurement of
         material from subcontractors and



                                           I
   --higher quality engineering talent was utilized than was required by
     the nature of the work being performed.
 GAO brought the specific f i n d i n g s t o the attentjon of appropriate can-
 tractor and agency official s and made suggestions for improvements.
 (See pp. 8 t o 10 and 14 t o 15.)
 A1 though should-cost review techniques primarily are intended t o f i n d
 o u t how contractors' operations can be improved, they also lead t o d i s -
 closures of areas where Government contracti ng or administration prac-
 tices affect contract costs adversely. GAO noted instances o f exces-
 sive packaging requirements, failure t o consolidate purchasing, and ex-
 cessive testing requirements. (See p. 14 and 15.)
 The total savings which could accrue t o the Government as a result of
 the GAO reviews and the resulting improvements i n contractor and Govern-
 ment management practices cannot be determined readily because the ef-
 fects on costs of certain of the suggestions could n o t be measured
 readily. In those instances where they could be determined, the sav-
 ings amounted t o almost $6 m i l l i o n . (See p . 3 3 . )
-/The military services have performed should-cost reviews i n order t o be
  i n a better position t o negotiate contract prices for major weapons sys-
  tems. Recognizing that the negotiation of contract prices is the re-
  sponsibility of the procuring agency, GAO believes that i t s reviews
  should not be conducted i n a preaward environment.
 Future GAO reviews therefore will attempt t o evaluate how procuring agen-
 cies and contract administrators are discharging their responsibilities
 and t o suggest ways i n which contractors can reduce the costs t o the
 Government. (See p. 21.)
 Procuring agencies that perform should-cost reviews prior t o the awards
 of major contracts are i n a strategic position t o obtain contractor co-
 operation and concurrence i n changes needed. Application of should-cost
 concepts d u r i n g preaward reviews enables Government contracting officers
 t o negotiate from positions of strength because the comprehensive f i n d -
 i n g s and observations of the review teams are available d u r i n g negotia-
 tions. Since this type of information i s available, the contracting
 officer can influence the contractor t o adopt recommendations for i m -
 proved operations, (See p. 21 .)
 Although GAO had some success i n encouraging contractors t o study and/
 o r improve their operations, GAO could not be as effective as the pro-
 curing agencies i n motivating the contractors. There was no o b l i g a t i o n
 on the p a r t of contractors t o accept the suggestions of the GAO review
 teams, and i n some instances no interest was shown i n considering GAQ
 proposals objectively. I n other instances contractors took a positive
 attitude toward reducing the costs o f future operations. (See p. 22.)
     The success of future reviews o f this type by GAO probably will depend
     almost entirely on t h e cooperation of contractors and on t h e extent t o
     which the Department of Defense contracting o f f i c i a l s apply GAO f i n d -
     ings and recommendations during negotiations of contracts. (See p . 22.)

AGENCY AND CONTRACTOR C O W f l T S

     The Office of the Assistant Secretary of Defense (Installations and bo-
     g i s t i c s ) advised GAO that the Department o f Defense agencies concerned
     would look into the specific matters reported by GAO a t the contractors'
     plants.
      Pertinent contractor comments were:
                                                d
        --GAO should place greater emphasis on reviewing overall Government
          and contractor procurement systems rather than detai 1ed costs.
        --There should be some additional evaluation of cost benefits result-
          i n g from should-cost reviews versus the costs of accomplishment.
        - - Additional statutory authority f o r GAO may not be necessary.

     GAO does place primary emphasis on eval uatj ng procurement systems rather
     than detailed costs, and GAO reviews a r e so designed. WO also applies
     c r i t e r i a t o ensure, insofar as possible, t h a t the benefits resulting
     from should-cost reviews wfll Be significant i n relation t o the costs
     of making the reviews.

MATTERS FOR CONSIDERALPIOfl BY T%E COMGRESS
     Should-cost review require examinations into many facets of contractors '
     operations and management. The present provisions o f GAO's statutory
     authority t o examine contractors' records are not broad enough to en-
     able GAO t o cover a l l of the matters which should be considered. The
     Congress therefore may wish t o consider expanding GAO's statutory au-
     t h o r i t y t o enable GAO t o make effective should-cost reviews on an i n -
     dependent basis.




                                        3
j:   I   _,




                                          CHAPTER 1

                                         INTRODUCTION
                       At the request of the Subcommittee on Economy in Gov-
                  ernment, Joint Economic Committee, the General Accounting
                  Office has studied the feasibility of applying should-cost
                  concepts in reviews of contractor operations.
                       The should-cost approach attempts to determine the
                  amount'that weapons systems or products ought to cost, given
                  attainable efficiency and economy of operation.
                       Emphasis, in this type of review, is placed on a study
                  and evaluation of a contractor's system of managing and
                  controlling costs and on the procedures instituted to pro-
                  vide surveillance of these activities and costs to achieve
                  economy and efficiency. Should-cost reviews utilize the
                  concepts employed by the Department of Defense (DOD) in
                  price proposal reviews, including use of historical data,
                  but place primary emphasis on ways and means of improving
              .   upon prior cost experience.
                       In our report to the Congress, entitled ttFeasibility
                  of Using 'Should Cost' Concepts in Government Procurement
                  and Auditing" (B-159896, May 20, 1970), we stated that:
                       --It was feasible to apply should-cost concepts during
                         the prenegotiation and/or the postnegotiation phase
                         of the Government's procurement process.

                       --The greatest opportunity for the Government to bene-
                         fit from the application of should-cost was through
                        ;its
                        . -  use, on a selective basis, in preaward evalua-
                         cions of contractors' price proposaLs,
                          i
                       --Gbvernment agenctes should also provide a continuing
                         capability to perform, on a selective basis, should-
                         cost types of reviews after contracts were awarded.
                                                                           %


                       --The degree of effectivene8s that could be expected
                         from should-cost reviews w1 a s dependent on the con-
                         tractor's willingness io cooperate fully with the re-
                         view team.
                                              4
     --GAO would perform trial should-cost reviews which
       would provide additional data relative to (1) the
       benefits that could be expected to result from
       should-cost reviews, (2) the problems which might be
       encountered in performance of such reviews, and (3)
       the size of programs or contractors and the types of
       contracts which should be selected for review.
     This report presents the findings and conclusions re-
sulting from our applications of should-cost concepts at
four contractor locations.
SCOPE OF TRIAL APPLICATIONS
     Four contractors were selected for our trial should-
cost reviews. Because GAO lacks firm authority for access
to much of the contractor data essential to the effective
performance of a should-cost review, we were able to per-
form our reviews only at those contractors plants that vol-
untarily agreed to cooperate with us on a trial basis, To
effectively evaluate the various cont*actor functions and
perform this review on a timely basis, we selected contrac-
tor plants of medium size, The types of products produced
by these contractors varied and their manufacturing opera-
tions ranged from mass production to job-order processing,
In our selection process we also considered the types of
programs that the contractors were involved in and the
types of contracts that they had been awarded. In our re-
view we included contractors operating under cost-type and
incentive-type contracts as well as firm fixed-price con-
tracts.
     We did not attempt, at each location, to make a com-
prehensive review of all aspects of the contractors' man-
agement. Rather, we limited our reviews to those areas
that appeared to warrant attention on the basis of previous
Government reviews and other preliminary investigation. In
general, our reviews included examinations into such areas
as (1) the contractors' management of direct and indirect
labor; (2) the effectiveness and adequacy of the contrac-
tors' systems for estimating labor hours and material costs;
(3) the adequacy and usefulness of the contractors' sys-
tems for estimating, accumulating, and recording contract
costs; and (4) the effects of Government procurement poli-
cies and practices on contractors' operations and efficiency.

                             5
     In performing the should-cost reviews, our objectives
were to (1) evaluate the efficiency and effectiveness of
the contractor's operating practices, (2) examine into the
reasonableness of costs, and (3) identify conditions which,
in our opinion, either resulted in unnecessary costs or
precluded the Government and contractor from establishing
a reasonable price.




                             6
                        CHAPTER 2

            RESULTS OF GAO TRIAL APPLICATIONS

                  OF SHOULD-COST CONCEPTS
     Our trial reviews demonstrated that GAO could effec-
tively apply should-cost concepts. We found that these re-
views could be effective in identifying ways to reduce con-
tract costs because they permitted a comprehensive evalua-
tion of the efficiency and effectiveness of contractors'
operations and DOD procurement and contract administration
activities.
      In general, we found a number of areas at each of four
contractor plants in which increased management attention
could result in lower costs to the Government. We noted,
for example, that (1) improvements were needed in produc-
tion planning and control, (2) increa'sed competition was
needed in the procurement of material from subcontractors,
and ( 3 ) proposed engineering costs were not representative
of the efforts required. Although should-cost review tech-
niques were primarily intended to ascertain how contractors'
operations could be improved, they also led to disclosures
of aspects of Government contracting or administration
practices that adversely affected contract costs. In this
connection, we noted instances of excessive packaging re-
quirements, failure to consolidate procurements, and exces-
sive quality control procedures.
     In our opinion, the problems disclosed in our trial
reviews could have been identified and/or correctkd by more
effective procurement practices and contract administration.
We therefore believe that one of the major benefits of fu-
ture GAO should-cost-type reviews will be the identifica-
tion of ways in which the overall Government procurement
process can be improved.
     The total savings which could accrue to the Government
as a result of our reviews cannot be determined readily be-
cause the effects on costs of certain of our recommenda-
tions could not be quantified readily. In those instances


                             7
    where savings could be measured, however, they amounted to
    almost $6 million. These savings are summarized in appen-
    dix 1.

         Further details of our findings folilow.

    COMPREHENSIVE REVIEMS OF CONTRACTORS '
    OPERATIONS CAN PROVIDE IDENTIFICATION
    OF POTENTIAL SAVINGS
         In the past, reviews of contractors' records were pri-
    marily financial in nature, with the objective of validating
    recorded historical costs, These costs then became the
    bases of estimated costs on future contracts. The emphasis
    in the should-cost approach, however, was to utilize the
    skills of engineers, mathematicians, and audit personnel to
    determine how costs could be reduced in the future.
         GAO previously utilized selected should-cost concepts
    in functional reviews of contractor management and issued
    a number of reports pointing out the need for improvements.
    The current reviews, however, have indicated that a compre-
    hensive analysis of many aspects of a contractor's opera-
    tions can also be beneficial because the review team obtains
    a better understanding of the contractor's overall manage-
    ment policies and practices. The following are examples of
    some of our findings,
         Savings attainable by the use of an effective
         production planning and control system
         A production planning and control system is supposed
    to achieve efficient performance by coordinating and guid-
    ing the physical activities of manufacturing a product. We
,   found that 6ne contractor's production control system was
    in need of improvement because
         --the manufacturing schedule did not include provi-
           sions for all parts which were to be manufactured,
         --manufacturing start and finish dates had not been
           established for parts included on the schedule,



                                 8
price competition on the material purchases for follow-on
contracts. This action could reduce costs on follow-on
contracts by about $150,000 each year.
     Higher quality engineering talent
     was utilized than was required
     by the nature of the work being performed
     The work of designing and developing a fully opera-
tional weapon system, along with the capability to produce
it in production quantities, requires the efforts of
highly skilled engineering and technical personnel. As a
program reaches the production stage, the major functions
of design, analysis, and testing are reduced, and the need
for highly skilled engineers decreases,
     At one location we found that engineering labor costs
for a €allow-on production contract were being proposed at
hourly rates which included those for highly skilled engi-
neers, even though the need f o r such engineering support
had diminished and their skills were no longer required on
a continuing basis. The contractor agreed that the hourly
cost of engineering support was increasing as the effort
changed from research and development to production. They
stated that the reasons for the increased costs were three-
fold: (1) need to have a few highly skilled engineers ca-
pable of responding to various technical requirements which
might occur, ( 2 ) reduction in requirements for lesser skilled
engineers, and ( 3 ) inflation, We estimated that the use of
engineering talent, overhead included, which was no longer
commensurate with the engineering effort required, could
increase the 1970 production contract price by about
$99,000.

     Opportunities to apply
     economic-order-quantity techniques
     The economic-order-quantity concept is designed to re-
duce total costs by balancing the costs to procure an item
against the holding costs, such as investment and storage.
     One contractor could have reduced its annual overall
costs by between $174,000 and $297,000 if economic order
quantities had been utilized. The fewer purchases which

                             10
would have resulted from the application of economic order
quantities would have reduced costs substantially, while
the increased holding costs of a larger inventory would
have been relatively minor.

     The contractor agreed with our conclusions and said
that it would utilize economic-order-quantity techniques in
the future.
     During our reviews we observed other conditions which,
we believed, had adversely affected the ability to control
contract costs. We were not able to quantify the effect
that these conditions would have on costs, but we believe
that improvements will result in the negotiation of more
reasonable contract prices. These improvements include:
     --The need for better documentation and support for
                            .
       make- or- buy decisions

     --The need to make the material estimating systems
       more responsive to changes in make-or-buy decisions.

     --The need to establish new systems or to refine ex-
       isting systems to provide for the segregation of re-
       curring and nonrecurring engineering and manufactur-
       ing costs.
     --The need for more equitable distribution of general
       and administrative-type expenses between contractor
       divisions operating at the same location,
     --The need to account for and control labor and mate-
       rial charges for end items that must be reworked be-
       cause of defective material, wor'kmanship,or engi-
       neering changes,

     --The need for improvements i n plant layouts to provide
       for (1) arrangement of machine tools in relationship
       to their operational sequence, ( 2 ) sufficient spac-
       ing of machines, and ( 3 ) a sufficient number of
       material-staging areas.
     --The need for management systems which will measure
       labor efficiency and productivity.        1




                                11
--The need for establishing labor groupings and com-
  posite rates which are more representative of the
  task to be performed.
--The need for accurate recording of labor charges.
--The need for the accumulation of labor hours by part
  number and by production lots.

--The need f o r production labor standards to be inter-
 related with accounting records so that equivalent
 unit costs can be determined during the life of a
 contract .
--The need for updated and reliable labor hour stan-
  dards.
--The need for information that shows in greater detail
  the composition of proposed overhead costs, includ-
  ing the additional costs which will be distributed
  to Government contracts as a result of decreasing
  production and excess plant capacity.

--The need for contractor and Government representa-
  tives to utilize learning-curve techniques in the
  preparation and evaluation of proposed labor hours.




                        12
IDENTIFICATION OF NEEDED IMPROVEMENTS IN
AWARD AND ADMINISTRATION OF CONTRACTS

     In commenting on our report on the feasibility of GAO
applying should-cost concepts, DOD officials stated that the
Armed Services Procurement Regulations and contract admin-
istration and audit manuals provide for the application of
should-cost review techniques in the Government's preaward
evaluation of contractor cost proposals and in the day-to-
day monitoring of contractor activities. Those officials
observed that, if all current policies were adhered to and
if the cognizant audit and administrative organizations
were fully effective, there would be no need for the type
of reviews discussed in this report.
     We agree that prescribed DOD policies provide for the
application of should-cost concepts on a continuing basis.
We believe, however, that the results of recently completed
should-cost efforts by the Army and the Navy, as well as
our reviews, demonstrate that the traditional Government
preaward reviews of contractor proposals and the day-to-day
functional audits and reviews of contractor management have
not been fully effective.
      Although a should-cost review is intended primarily to
.evaluate a contractor's operations, it also serves to ob-
 jectively evaluate (1) the effect of Government procurement
 procedures on costs and contractor operations and (2) the
 adequacy and effectiveness of contract proposal and func-
 tional reviews performed by cognizant DOD audit and admin-
 istrative activities. This ability to identify problem
 areas and to suggest corrective action is, in our opinion,
 another major benefit accruing from should-cost reviews.
     The following are some examples of observations which,
in our opinion, demonstrate that procurement and adrninis-
trative policies can adversely affect contract costs and
that should-cost reviews can be an invaluable tool with
which to identify problem areas within the Government's pro-
curement processes,




                             13
Savings obtainable through reduced
packaging requirements for spare parts
     A review of the packaging requirements f o r certain
spare parts being produced at one contractor's plant re-
vealed that, although the spare parts were being used for
overhaul purposes in the continental United States, they
were being packaged for indeterminate storage or overseas
shipment. In mid-1967 the Government procuring officer no-
tified the contractor and the cognizant administrative con-
tracting officer to reduce the level of packaging, Due to
a misinterpretation of the notification and subsequent di-
rectives relating to this subject, however, the packaging
was not changed
     Contractor and cognizant Government procurement and
administration officials agreed that the packaging level
should be reduced for spare parts to be used in overhaul
and that savings would result, Based on variances in quan-
tities procured, changes in delivery schedules, and other
factors, annual savings could range between $200,000 and
$600 ,3000e

Savings achievable in consolidating
procurements based on cost-impact studies
     One procurement activity could realize substantial
savings if procurements were based on cost-impact studies
to determine the economies of consolidating procurements
at the time total requirements first become known. These
savings are attributable to lower prices associated with
volume orders, the availability of more favorable prices
during a period of rising costs, and the related reduction
in the contractor's administrative efforts. Although we
could not readily measure the total effect of incremental
ordering practices, we estimated that savings of about
$116,000 could have been realized under a current contract
if three separate orders had been consolidated,
     Contractor representatives agreed that savings could
have been realized on the current contract had requirements
been consolidated into a single order, Furthermore, we
were advised that similar economies could have been realized
on two earlier contracts where orders were placed in the

                            14
same piecemeal manner. Procuring office representatives
advised us that consolidation of their requirements was not
affected by funding limitations and that trade-offs between
lead time and cost were not considered. We were advised
that, as a result of a recent DOD review in this area, the
total requirements for a single fiscal year would be pro-
cured on a test basis.

Use of more realistic
acceptance-test procedures

     The military specifications for an item being produced
by one contractor required that all production items be ac-
ceptance tested under stringent sampling and test require-
ments until the production quality warranted less stringent
testing.
     We analyzed in detail the contractor's test procedures
and the results of the inspection program. On the basis of
this analysis, it appeared that more flexible requirements
might be implemented. We discussed our findings with con-
tractor and Government quality-assurance representatives
and they acknowledged the validity of our observations. The
following actions represent the initial steps taken by a
joint Government-contractor task force established to re-
view the problem.
     --Full teardown inspection of one model has been
       changed from one in ten to one in twenty. For two
       other models, as well as a critical component used
       in all models, full teardown inspection has been
       changed from 100 percent to 10 percent.
                                                       P



     --Other test requirements have generally been reduced
       from 100 percent to a 10-percent sample.
     We estimate that, on the basis of recent production
levels, the reduced level of testing could result in future
annual savings of about $1.1 million.




                             15
                          CHAPTER 3

                     SHOULD-COST REVIEGaS
                  BY THE MILITARY SERVICES
     Should-cost reviews have been and are currently being
utilized by the three military departments as an aid in the
negotiation of lower prices for major weapons systems. The
results to date indicate that such reviews are an effective
tool in identifying ways in which contractors can produce
more efficiently and economically and therefore reduce con-
tract costs.
     On the basis of the reviews completed to date, it ap-
pears that the should-cost team approach has a significant
advantage over the usual method of developing data for Gov-
ernment contract negotiators. The negotiation of a price
for a major contract often involves the efforts of a number
of dif'ferent organizations, such as the Defense Contract
Audit Agency, the Defense Contract Administration Service,
and the procuring activity. It is frequently difficult to
coordinate the organizations' diverse efforts so as to pro-
vide the Government contract negotiator with all the infor-
mation needed at the proper time. The should-cost teamo on
the other hand, can make a coordinated and timely effort
which enables the negotiator to discuss contract provisions
with better data at his disposal.
     Following are summaries of the results of major should-
cost reviews that have been completed by the Departments of
the Navy and the Army and a discussion of the future use of
should-cost reviews in the DQD procurement process.
DEPARTIGNT OF THE NAVY REVIF33
OF PROPOSED COSTS OF ENGINES
FOR THE F-111 AIRCRAFT

     This review was conducted during an 11-month period in
1967 and 1968 by a team of highly skilled individuals se-
lected from various DOD activities. The Navy concluded that
such a review was necessary because the c~ntractor~s   pro-
posed costs f o r 2,053 aircraft engines appeared to be arnrea-
sonablee




                                 16
     The should-cost review indicated that savings substan-
tially in excess of $100 million could be realized out of
total costs which the contractor originally estimated at
about $1.5 billion. Some of the areas in which potential
savings were identified were:
     1. Lack of adequate labor standards.
     2. Inefficient plant layout.
     3 . Noncompetitive procurements from subcontractors.
     4. Poor production scheduling and control.
      Subsequent to the negotiation of the contract, the
F-3.11 program was drastically reduced and the anticipated
savings were not fully realized.

D E P M m OF THE iU?i?E REVIW
OF PROPOSED COSTS FOR HAWK MISSILES

          In May 1970, Army officials estimated that utilization
of should-cost concepts in the preaward review of a $96 116.1-
lion proposal for the production of 600 HAW missiles re=
s u l t e d in a substantial reduction in contract costs. Addi-
tional mmagement improvements which the contractor will
institute in the future may produce additional savings of
about $14 million.
     As in the case of the review conducted by the Navy, a
team of DOD personnel w a s assembled for a period of"2 months
during 1969. The impetus f o r this effort w a s the signifi-
cant increases in the production costs of HAWK missiles over
a period of time.

     Army offfciabs believe that, in addition to identifying
areas for increased contractor efficiency and economy simi-
lar to those disclosed by the Navy review, should-cost re-
views :
     --Provide the contracting officer with a negotiation
       objective we11 supported by facts.

     --Result in m c h improved coordination and integration
       of previously fragmented prenegotiation activities.
     --Help to identify and reward truly efficient producers.

                              19
     CURRENT DOD POSITION ON FUTURE ROLE OF
     SHOULD-CQST REVIENS IN GOV-       PR0C"T

          Each of the military services has taken a somewhat
     differeat approach toward the future role of should-cost
     reviews. Following is a summary of military services'cur-
     rent applications and future plans,
     Department of the Navy
          The Navy is currently involved in its second should-
     cost review. This review is being performed at two poten-
     tial ,contractors and several selected subcontractors prior
     to the award of a production contract f o r MK-48 torpedos.
     The contractors have been involved in the development of
     competing torpedo designs and have been awarded prototype
     production contracts. One contractor will be selected for
     production after evaluation of the pei..formmceand costs of
     the two models. The should-cost effort is one segment of a
     three-part review which is divided into (1) a production
     cost (should cost) study, (2) a product-engineering review,
     and ( 3 ) performance requirements ( i . . e e 9performance-cost
     trade-off) analysis. A s opposed to other should-cost ef-
     forts which were performed by teams comprised entirely of
     Government personnel, this review is being performed en-
     tirely by consultant firms.
          The production cost study portion of the overall re-
     view will require a broad-based industrial engineering ef-
     fort €or about 1 year. During the initial phase the con-
     sultant's work primarily will be investigative in nature to
     arrive at preliminary conclusions about what the competing
     torpedo models should c o s t and to prepare a plan for fur-
     ther investigation of major cost segments that appear to
     have cost-reduction potential. During the second phase the
     consultant firm will continue the investigation supported
     by special studies structured to determine the full cost-
     reduction potential for several alternative production
     schedules
          We have been informed by Navy officials that, barring
     unforeseen special circuanstances such as a significant rise
c    in a particular program's C Q S ~ S ,the Navy does not plan to
a.
     perform additional should-cost reviews, Instead, the Navy

                                    18
plans to upgrade and more fully train its field organiza-
tions so that the routine reviews of contractors' cost pro-
posals and operations will be more effective and useful to
the procuring activities. Navy officials believe that, if
such improvements are made to the existing procurement sys-
tem, the need for should-cost reviews will be very limited.
Department of the Army
     In addition to performing a review of costs for the
HAW missile (see p. 171, the Army is currently performing
a review of W-1 helicopter production costs and is making
plans for a third review in the near future. Army offi-
cials believe that the should-cost technique is fully con-
sistent with the Armed Services Procurement Regulation Man-
ual. for contract pricing. It was their opinion that the
primary 'differences between the traditional preaward review
and the should-cost technique are essentially the depth to
which the ~ontractor~s  management and operations are ana-
lyzed. and the use of a combined audit, engineering, and
pr'icing team to perform the evaluation;

     h y officials have informed us that9 whereas the tra-
ditional approach to contract negotiation has been to ac-
cept the contractor's mode of operations, the Army's
should-cost approach is based on (1) a challenge of the
contractor's operating practices, (2) a coordinated in-
depth analysis of the contractor's manufacturing operations,
management controls, purchasing practices, etc. 9 and (3) an
identification of reasonably attainable economies and effi-
ciencies.
     The Army does not intend to apply the substantial ef-
fort involved in a should-cost review to every contract
where inefficiencies are suspected. Rather, such reviews
will be limited to a small number of contractors when it is
determined that cost, delivery, or technical problems make
such an effort appropriate.
Department of the Air Force                                    9


     The Department of the Air Force recently initiated its
first should-cost review. In the past the Air Force has


                              19
maintained industrial management assistance survey efforts,
which in some respects were comparable to should-cost
reviews.




                                       '.




                          1        i




                              20
                            CHAPTER 4

     CONTRAST BETWEEN BOD AND GAO SHOULD-COST REVIEWS

     The military services have performed should-cost reviews
in order to be in a position to better negotiate contract
prices for selected major weapons systems. GAO, on the
other hand, recognizing that the negotiation of contract
prices is the responsibility of the procuring agency, be-
lieves that its reviews cannot be conducted prior to awards
of the contracts. Future GAO reviews will therefore have
the objectives of evaluating how procuring agencies and
contract administration activities are discharging their
responsibilities and of suggesting ways in which contractors
can reduce future costs to the Government.

     Although similar techniques have been utilized by DOD
agencies and by GAO to accomplish should-cost-type reviews,
the basic differences in the objec.tives and in the time
fr&s   in wh-ichthe reviews are conducted will have an im-
pact on the benefits which can be realized. Furthermore,
GAO is currently faced with the fact that there is no firm
statutory authority for it to perform should-cost reviews.

     These.matters are discussed in the following sections.

EFFECTIVENESS OF REVIWS
     In our o p i n i o n , procuring agencies t h a t perform should-
cost reviews prior to the awards of major contracts are in
an excellent position to obtain Contractor cooperation and
concurrence in needed changes. Application of should-cost
concepts during preaward reviews enables Government contrac-
ting officers to negotiate from positions of strength be-
cause the comprehensive findings and observations of the
review teams are available during negotiations., Since this
type of data is available, the contracting officer can in-
fluence the contractors to adopt recommendations for im-
proved operations.

     A s a result of the findings of the should-cost review
conducted prior to the negotiation of the contract for the
engines for the F-111 aircraft, the contractor was required

                                 21
    by the terms of the production contract to study and effect
    improvements in selected management functions. Similarly,
    in the case of the HAWK missile, the Army included eight
    management improvement goals as part of the production con-
    tract.

         Although we had some degree of success in encouraging
    contractors to study and/or improve their operations, we
    could not be as effective as the procuring agencies in moti-
    vating the contractors. There was no obligation,onthe part
    of contractors to accept the recommendations'ofthe GAO re-
    view teams, and in some instances no interest was shown in
    objectively considering our proposals. It should be noted,
    however, that we did call our findings to the attention of
    the cognizant Government procurement and contract adminis-
    tration activities, and it is probable that many of the re-
    commendations will be actively considered during negotiations
    of future contracts.

         In other instances, contractors took an active interest
    and a positive attitude toward reducing the costs of future
    operations. It seemed clear, therefore, that the success of
    future GAO reviews of. this type would depend on the coopera-
    tion demonstrated by the contractors and the extent to which
    DQD contracting officials utilize our findings and recommen-
    dations during negotiations'of future contracts.

    LACK OF STATUTORY AUTHORITY FOR
    GAO TO PERFORM SHOULD-COST REVIEWS

         Should-cost reviews performed by procuring agencies are
    accomplished in connection with preaward analyses of con-
    tractors' proposals. A s sucho there is no question as to
    the Government's right to analyze contractors' operations
    and to suggest ways in which costs can be reduced.
I        W Q r s right to examine contractorsP records, however,
    is limited to those books, documents, gapers, and records
    directly pertaining to a particular contract in question.
    There are many aspects of a sontractorasmanagement and
    operations which appear to be outside the scope of that au-
    thority but whish must be incorporated in should-cost re-
    views. Our current trial reviews were conducted at loca-
    tions where management voluntarily agreed to cooperate with

                                  22
GAO. E f f e c t i v e a p p l i c a t i o n of should-cost concepts i n t h e
f u t u r e , however, w i l l r e q u i r e t h a t GAO be c a p a b l e ’ o f making
independent s e l e c t i o n s of c o n t r a c t o r s t o be t h e s u b j e c t s of
reviews.




                                            23
      Effective application of the techniques of should-cost
analysis requires that any aspect of a contractor's manage-
ment that could affect contract costs be open to inquiry.
A s a practical matter, however, it is necessary to limit the
areas of review to those matters that appear to offer poten-
tial for substantial savings. The review team must there-
fore make maximum use of prior reviews by both Government
activities and by internal contractor organizations in order
to identify those functional areas requiring more detailed
review. On the basis of our trial applications, we believe
that the following areas, as a minimum, should be considered
during the preliminary phases of a should-cost review.
      --Labor standards and direct labor controls.
      --Production processes and controls.
      --Plant layout.
      --Material controls.
      --Procurement practices.
      --Make-or-buy policies.
      --Accounting and cost estimating systems.
      --Indirect expense controls and allocations.
      --Quality-control procedures.




                             25
                        CHAPTER 6

               DOD AND CONTRACTOR COMMENTS
     By letter dated November 12, 1970, the Deputy Assistant
Secretary of Defense (Installations and Logistics) advised
us that the cognizant DOD components would look into the
specific matters noted at the various contractors' plants
during our reviews. The Secretary's letter also stated that
DOD would continue to apply should-cost techniques whenever
conditions warrant. (See app. 11.1
     Outlined'below are the pertinent comments of the con-
tractors that were included in our review and our evalua-
tions of their comments.

     1. GAO should place greater emphasis on reviewing the
        overall Government
                     -     procurement system as well as
        contractors' systems rather than on reviewing de-
        tailed costs. GAO's detailed should-cost analysis
        was essentially a direct duplication of those func-
        tions normally accomplished by the Defense Contract
        Administration Services and the Defense Contract
        Audit Agency.



        We agree with the contractor's position that GAO
        should place greater emphasis on procurement systems
        rather than on detailed costs in conducting should-
        cost reviews. It is not our objective in conducting
        these reviews to verify or analyze detailed contract
        cost data, but rather to evaluate the efficiency and
        economy of the contractors' operations and the ef-
        fectiveness of the Government's procurement pro-
          I
        cesses.  With respect to duplication of effort, our
        review procedures are designed to utilize the data
        available from other Government agencies to minimize
        duplication of effort.
     ?. There was no measure of the costs to the Government
        and to the contractor of making the study; and the



                            26
 potential savings therefore appear to be overstated.
 Some additional evaluation of cost benefits versus
 cost detraction should be made.



  The cost of our studies was considerably less than
  the quantifiable potential savings that we identi-
  fied. Certainly, studies such as these should not
  be undertaken without some reasonable basis for
  anticipating that the benefits will outweigh the
  costs. It should be realized? however, that many
  of the benefits of a should-cost study are long-term
  and not readily measurable and that the cost of mak-
  ing a review, as opposed to the immediate measurable
  benefits, should not be the prime determining fac-
  tor.

3 . The proposed request for additional statutory au-
    thority seems inappropriate in the context of a
  should-cost study. GAO already has authority to
  review the procuring agency's actlvities. The em-
  phasis on the cooperation required for successful
  should-cost reviews seems to belie the need for au-
  thority for additional access to plants, personnel?
  and records and contains a comotation of duress
  which would defeat the purpose.



  We have found? in the great majority of cases, that
  contractors will cooperate with Government audit
  agencies and will provide the necessary data and
  personnel. On occasions, however, there have been
  differences of opinion as to the right of Government
  personnel to examine certain records and/or to look
  into selected aspects of contractors' operations.
  To avoid such problems in the future and to enable
  GAO to make effective independent examinations, we
  believe that the Congress should clearly state its
  intent concerning the extent of GAO's authority to
  review contractors' operations.



                        27
                                    CHAPmR 7

                                  CONCLUSIONS

          A s a result of our t r i a l reviews, w e believe t h a t
should-cost concepts can be e f f e c t i v e l y applied t o contrac-
t o r operations and t h a t GAO should continue t o make such
reviews. In our opinion, however, t h e g r e a t e s t b e n e f i t s
w i l l accrue when t h i s type of review i s performed by procur-
ing a c t i v i t i e s as p a r t of t h e i r preaward analyses of con-
t r a c t o r s ' proposals. A t t h a t time, t h e r e s u l t s of should-
c o s t reviews would be of maximum effectiveness i n a s s i s t i n g
Government negotiators i n a r r i v i n g a t f a i r and reasonable
prices. m e n more importantly, p o t e n t i a l Government con-
t r a c t o r s w i l l be more l i k e l y t o accept should-cost findings
and t o implement any needed c o r r e c t i v e procedures p r i o r t o
t h e award of a major contract.

         Should-cost review techniques can be e f f e c t i v e l y ap-
p l i e d by GAO as a means of identifying p o t e n t i a l economies
through improvement i n contractor operations and as a means
of evaluating t h e effectiveness of agency procurement p o l i -
c i e s and p r a c t i c e s , preaward proposal reviews, and contract
a u d i t and administration activities. GAO, however, has no
firm s t a t u t o r y a u t h o r i t y t o make these reviews and, u n t i l
t h e Congress grants such a u t h o r i t y , GAO w i l l have t o depend
on t h e voluntary cooperation of contractors f o r access t o
t h e i r p l a n t s and records.

         Whether performed by procuring agencies o r by GAO, t h e
o v e r a l l success of any should-cost review w i l l be l a r g e l y
dependent upon t h e cooperation and a t t i t u d e of t h e contrac-
t o r . These reviews require f u l l d i s c l o s u r e , f r e e and com-
p l e t e access t o t h e c o n t r a c t o r ' s p l a n t and management per-
sonnel, and an objective a t t i t u d e by t h e contractor toward
t h e constructive c r i t i c i s m of t h e should-cost review team.

          In our opinion, should-cost-review emphasis should be
given t o l a r g e r contractors, operating under negotiated
c o n t r a c t s , i n a noncompetitive atmosphere. Within t h i s
broad c r i t e r i o n , both the bases f o r s e l e c t i o n of a s p e c i f i c
c o n t r a c t o r f o r review and t h e extent and depth of t h e ap-
p l i c a t i o n of should-cost concepts should remain f l e x i b l e


                                         28
and should be based on consideration of p a s t c o n t r a c t o r c o s t
performance on s p e c i f i c c o n t r a c t s and on evaluation of ef -
f o r t s made t o implement previous recommendations f o r improve-
ments.

MATTERS FOR CONSIDERATION BY THE CONG'RFSS

          As pointed out on page 22, GAO has only l i m i t e d author-
i t y t o examine c o n t r a c t o r s ' records, and many a s p e c t s of
c o n t r a c t o r s ' operations and management would appear t o be
o u t s i d e of t h e scope of t h a t a u t h o r i t y , The Congress t h e r e -
f o r e may wish t o consider appropriate l e g i s l a t i o n t o expand
our a u t h o r i t y and t o c l a r i f y t h e i n t e n t of t h e Congress con-
cerning t h e scope of reviews t o be undertaken by GAO i n con-
tractors' plants,




                                         29
APPENDIXES
                                                             APPENDIX I

                            SUMMARY OF

       QUANTIFIABLE POTENTIAL SAVINGS IDENTIFIED THROUGH
               APPLICATION OF SHOULD-COST CONCEPTS

                                                         Potential annual
                 Observation                               cost savims
1. Savings attainable through a contractor's
   implementation of an effective production
   control system (required one-time invest-
   ment of approximately $580,000)                         $3,100,000
2. Increased use of competition by a prime
  contractor in awarding subcontracts                         150,000
3. Reduction in labor cost by elimination of
   costs related to engineering organizations
   and skills which are no longer required to
   support items being produced                                99,000
4. Reduction in annual contractor procurement
   costs through use of economic order guan-
   tity techniques ($174,000 to $297,000, de-
   pending on volume of purchases)                            297,000

5 . Reduction in the level of packaging re-
   quirements for spare parts produced for use
   in overhaul activities within the conti-
   nental United States ($200,000 to $600,000,
   depending on contract quantities)                           600,000
6. Change from extensive contractor acceptance
   test procedures to more realistic testing
   for the purpose of product verification                   1,100,000

7. Consolidation of Government and contractor-
   operated motor pools located at the same
   location and utilization of regularly
   scheduled service rather than chauffeured
   service to and from airports                                209,000
8. Elimination of prime contractor profit on
   subcontracted effort where about 90 percent
   of the total effort is subcontracted to one
   vendor and the prime contractor has minfmal
   responsibility                                    !          77,000
9. Reduction in indirect labor force due to a
   more efficient use of personnel                              75,000
                                                            $5,707,000
                                   33
      APPENDIX I1
           Page 1

                                     ASSISTANT SECRRARY OF DEFENSE
                                           WASHINGTON, D.C. 20301




                                                                                   12 NOV 1970
INS?ALLAlION5 AND LOOlSTlCS




        Mr. C. M. Bailey
        D i r e c t o r , Defense Division
        U. S , G e n e r a l Accounting Office
        Washington, D. C. 20548

        Dear Mr. Bailey:

        T h i s is i n r e s p o n s e to your l e t t e r of October 14, 1970 transmitting
        f o r comment your d r a f t r e p o r t titled, "Application of 'Should Cost'
        Concepts i n (GAO) Reviews of Contractors' Operations'' (OSD Case
        #3192).

        The d r a f t r e p o r t p r e s e n t s the r e s u l t s of a GAO test f o r utilizing the
        "should cost" concept i n performing GAO audit reviews. This t e s t
        w a s made in response to a recommendation by the Subcommittee on
        Economy and Government Joint Economic Committee in its r e p o r t
        of May 1969. The GAO r e p o r t s t a t e s that four trial reviews utilizing
        the "should cost" concept w e r e conducted. It is concluded that such
        reviews can be beneficial and that GAO should continue to make such
        reviews. No specific recommendations a r e made. However, the
        r e p o r t m a k e s the observation that the p r e s e n t statutory authority of
        GAO to examine contractor's r e c o r d s 4 s not broad enough to enable
        it to examine all the matters which should be considered in "should
        co st" reviews        .
        Though your r e p o r t contains no specific recommendations a d d r e s s e d
        to the Department of Defense, it does provide comment on s e v e r a l
        matters of suggested improvement noted in connection with the GAO
        review at the four c o n t r a c t o r plants mentioned i n the r e p o r t . The
        cognizant DoD components will, of c o u r s e , look into t h e suggested
        management improvements             .



                                                      34
                                                        APPENDIX I1
                                                             Page 2

With respect to your basic observation that GAO can utilize the "should
cost" concept in conducting its audit reviews, we a r e hopeful that the
GAO m a y benefit f r o m the DoD experiences. A s the GAO report notes,
DoD has used this technique on a very selected basis. We a r e prepared
to perform such reviews wherever conditions warrant. However, our
experience demonstrates that this approach requires a substantial
number of talented personnel f o r an extended period.

We appreciate this opportunity to comment upon your report.




                                   35
APPENDIX I11
      Page 1

                        PRINCIPAL OFFICIALS OF

                      THE DEPARTMENT OF DEFENSE

                      AND THE MILITARY .SERVICES
         RESPONSIBLE FOR ADMINISTRATION OF ACTIVITIES

                      DISCUSSED I N THIS REPORT


                                             T e n u r e of o f f i c e
                                             -
                                             From                   -
                                                                    To

                         DEPARTMENT OF DEFENSE

SECRETARY OF DEFENSE:
    Melvin R. L a i r d                  Jan.     1969      Present
    Clark M. C l i f f o r d             Mar.     1968      Jan. 1969

ASSISTANT SECRETARY OF DEFENSE
  (INSTALLATIONS AND LOGISTICS) :
     B a r r y J. S h i l l i t o         Jan. 1969         Present
     Thomas D. Morris                     S e p t . 1967    Jan. 1969


                        DEPARTMENT OF THE ARMY

SECRETARY OF THE ARMY:
    Stanley R. Resor                      July    1965      Present

ASSISTANT SECRETARY OF THE ARMY
  (INSTALLATIONS AND LOGISTICS) :
     J. Ronald Fox                        June 1969         Present
     Vincent P. Huggard (acting)          Mar. 1969        -June 1969
     D r . Robert A. Brooks               O c t . 1965      Feb. 1969


                        DEPARTMENT OF THE NAVY

SECRETARY OF THE NAVY:
    John H. Chafee                        Jan.    1969      Present
    P a u l R. Ignatius                   Aug.    1967      Jan. 1969


                                  36
                                                         APPENDIX I11
                                                               Page 2

                        PRINCIPAL OFFICIALS OF
                       THE DEPARTMENT OF DEFENSE
                       AND THE MILITARY SERVICES
            RESPONSIBLE FOR ADMINISTRATION OF ACTIVITIES
                       DISCUSSED IN THIS REPORT (continued)

                                             Tenure of office
                                             -
                                             From             -
                                                              To

                        DEPARTMENT OF THE NAVY (continued)
ASSISTANT SECRETARY OF THE NAVY
  (INSTALLATIONS AND LOGISTICS) :
    Frank Sanders                         Feb. 1969        Present
    Barry J. Shillito                     Apr. 1968        Jan. 1969

                       DEPARTMENT OF THE AIR FORCE
SECRETARY OF THE AIR FORCE:
    DP. Robert C. Sewans, Jr.             Jan. 1969        Present
    Dr. Harold Brown                      Oct. 1965        Jan. 1969

ASSISTANT SECRETARY OF THE AIR
  FORCE (INSTALLATIONS AND LOGIS-
  TICS) :
    Phillip N. Whitaker                   May  1969        Present
    Robert H a Charles                    Nov. 1963        May 1969




U.S. GAO Wash.. D.C.
                                                     t
                                    37