oversight

Evaluation of Information From Contractors in Support of Claims and Other Pricing Changes on Ship Construction Contracts

Published by the Government Accountability Office on 1971-04-28.

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

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        U   REPORT TO THE CONGRESS




            Evaluation Of Information From
            Contractors In Support Of Claims
            And Other Pricing Changes On
            Ship Construction Contracts       B   -   1717
                                                        7096




            Department of the Navy

             FILE COPY - COP GEN




            BY THE COMPTROLLER GENERAL
            OF THE UNITED STATES



                                     APRIL 28, 1 97 1
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            COMPTROLLER GENERAL OF THE UNITED STATES
                       WASHINGTON, D.C.   20548




B- 171096




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

      This is our report on evaluation of information from con-
tractors in support of claims and other pricing changes on ship
construction contracts issued by the Department of the Navy.

      Our review was made pursuant to the Budget and Ac-
counting Act, 1921 (31 U.S.C. 53); the Accounting and Audit-
ing Act of 1950 (31 U.S.C. 67); and the authority of the
Comptroller General to examine contractors' records, as
set forth in contract clauses prescribed by the United States
Code (10 U.S.C. 2313(b)).

       Copies of this report are being sent to the Director, Of-
fice of Management and Budget; the Secretary of Defense; and
the Secretary of the Navy.




                                Comptroller General
                                of the United States




                50TH ANNIVERSARY 1921-1971
COMPTROLLER GENERAL'S               EVALUATION OF INFORMATION FROM CONTRACTORS
REPORT TO THE CONGRESS              IN SUPPORT OF CLAIMS AND OTHER PRICING
                                    CHANGES ON SHIP CONSTRUCTION CONTRACTS
                                    Department of the Navy B-171096

DI GEST


WHY THE REVIEW WAS MADE

      The General Accounting Office (GAO) has issued several reports to the
      Congress on the Navy's procedures in contracting with private industry
      for ship construction.
      A December 1958 report pointed out that contractors submitted claims
      for price increases which were vague and lacked adequate support, that
      Navy evaluations were inconclusive, and that claims had been settled
      without sufficient data to show the damage sustained by the contractors
      because of Government-caused delays.
      Two other reports, in June and October 1964, pointed out that a lack
      of effective price evaluation procedures had resulted in the negotia-
      tion of unnecessarily high prices for change-order work added to the
      initial contract.
      The review was made to determine whether improvements had been made by
      the Navy in obtaining and evaluating data used in the settlement of
      claims and the negotiation of prices for change orders.

FINDINGS AND CONCLUSIONS

      Claims submitted by three different contractors (referred to as con-
      tractors A, B, and C) during the period April 1965 through January 1969
      for $114,300,000, $486,000, and $1,342,000 were settled for $96,500,000,
      $354,000, and $760,000, respectively. The three contractors involved
      did not provide tangible evidence by which the amounts claimed could be
      related to the additional costs due to interruptions caused by the Gov-
      ernment's actions.
      Contractor A submitted claims totaling $114.3 million, from two differ-
      ent locations. Because the claims were prepared on essentially the
      same basis, we limited our review to the location where about $63.4 mil-
      lion of the $114.3 million was claimed.
      The contractor estimated that an additional 5.6 million labor-hours
      were attributable to actions of the Government. The contractor calcu-
      lated the increased labor-hours by (1)adding the estimated labor-hours
      needed to complete the ships to the labor-hours already expended,
Tear Sheet


                                                   APRIL 28, 197 1
(2)subtracting from that figure the labor-hours originally bid for
the ships and (3)subtracting from the resulting balance, a portion
of the increased hours judged to be a reasonable increase due to its
own inefficiencies. The contractor's proposal, although containing
the reasons for the incurrence of additional costs due to actions of
the Government and examples of the incurrence of such costs, did not
attempt to identify the amount of idle time, substandard performance,
and additional work to show whether they were attributable to Govern-
ment actions. Rather, the contractor's proposal seems to have been
based on the assumption that all additional costs over the amount the
contractor was willing to assume responsibility for were the result of
Government actions. (See pp. 9 to 12.)
Contractor B submitted two claims totaling $486,000 for disruption and
overtime. The proposals contained 95,000 additional labor-hours at-
tributed to disruptions caused by actions of the Government. GAO could
not find documentation to support the contractor's claims. Neither
could GAO find factual data which the Navy could have used in analyzing
the two disruption claims. (See pp. 13 to 15.)
Contractor C, engaged in constructing 3 DE-1040-class destroyer escorts,
submitted a claim for $1,342,000 for delay and disruption' caused by the
late delivery of Government-furnished material and by defects in the
material. The amount represented the cost of 265,300 direct labor-hours
although the contractor did not relate the labor-hours claimed to speci-
fic delays and disruptions. Rather, the contractor determined the addi-
tional costs by comparing the average number of labor-hours used in con-
struction of an earlier class of destroyer escort with the average num-
ber of labor-hours incurred for DE-1040-class destroyer escorts after
making adjustments for physical differences in the vessels. The excess
not explained by physical differences was considered by the contractor
to be due to delay and disruption.' The Defense Contract Audit Agency's
report on the claim accepted only 37,151 labor-hours as reasonable on
the basis of the recommendation of the Navy's technical analyst. Later
technical advisory reports reinstated an additional 138,473 labor-hours
as attributable to delay and disruption, but the basis for the computa-
tion of the additional hours was not included. The Navy ultimately
accepted 175,600 hours as attributable to delay and disruption and, ac-
cordingly, added $760,000 to the contract. (See pp. 16 and 17.)
GAO believes that, without information linking the additional costs to
actions of the Government, the Government had insufficient assurance
that the settlements made were fair and reasonable.
The Department of Defense should take the necessary steps to provide
a more reasonable basis for settling claims for additional costs re-
sulting from acts of the Government than is presently being used by
contracting officials.




                             2
           Historical data and standards were used by certain contractors in pre-
           paring proposals for the pricing of contract changes other than those
           arising from claims. In evaluating those proposals, the Navy generally
           did not obtain that data but relied on the personal judgment and ex-
           perience of its negotiators and analysts. (See pp. 24 to 27.) GAO
           believes that the Navy would have attained a better position for eval-
           uating the proposals and would have gained greater assurance as to the
           reasonableness of the prices negotiated if it had obtained the data used
           by the contrac-trs-a


    RECOMMENDATIONS OR SUGGESTIONS/

I   ,_,The supervisors ofshipbuilding should require contractors to furnish      /
         evtdence-relating the delay and disruption to actions of the Government
         and to provide specific data in support of additional costs claimed.
           The newly implemented !'change order accounting" clause should require
           contractors to segregate their direct costs on constructive changes,
           as well as formal written changes, and such requirement should be
           clearly stated in this regard.
           To facilitate the negotiation of reasonable prices for change orders:
              --Contractors lacking adequate systems to provide a factual basis for
                proposed prices should be encouraged to improve their systems.
              --Whenever appropriate, historical cost data and standards should be
                obtained for evaluation and audit.
              --The Navy should ensure that-the supervisors of shipbuilding are
                obtaining current evaluations by the Defense Contract Audit Agency
                of the estimating systems of contractors located in their respective
                geographic areas and that the evaluations include the bases upon
                which proposed prices are developed.

    AGENCY AND CONTRACTORS ACTIONS AND UNRESOLVED ISSUES

           Navy

           The Navy generally concurred in GAO's recommendations.
           The Navy felt that some of the problem areas mentioned in the report
           are susceptible to improvement but not to total and precise solution.
           It was the Navy's opinion that this was particularly true of any at-
           tempt to achieve total, explicit, and auditable justification of all
           delay and disruption costs. (See p. 35.)
           The Navy agreed that, where necessary, contractors should be encouraged
           to improve their systems for estimating prices for contract changes.
     Tear Sheet


                                          3
     In conjunction with the Defense Contract Audit Agency, it will try to
     develop more detailed criteria for an acceptable estimating system.
     The Navy will take steps to see that cost data and standards are ob-
     tained for evaluation and audit and, with the Defense Contract Audit
     Agency, will develop procedures and guidelines for scheduling and con-
     ducting evaluations of shipbuilder estimating systems.
     Contractors

     One of the three contractors took strong exception to any implication
     that its claim had not been adequately supported but made no comment
     on GAO's proposals.
     The second contractor pointed out some of the problems inherent in ac-
     counting for delay and disruption costs but offered to review any fea-
     sible procedure prepared by the Government to obtain that information.
     The third contractor believed that ample documentary evidence had been
     furnished in support of its claim and that the settlement was quite
     low. This contractor felt that it would be impossible to segregate costs
     relative to delay and disruption because in most cases the effects are
     cumulative and can be evaluated only when the total effect has become
     evident--that is,when the ship is nearly finished.
     GAO believes that, although it may be difficult to account for delay
     and disruption costs, it is not impossible. Such accountability would
     result in greater assurance of equitable results than is obtained from
     the practices currently being followed. (See p. 21.)

MATTERS FOR CONSIDERATION BY THE CONGRESS

     GAO is reporting this matter to the Congress because of the Navy's
     long-standing and uncorrected problem in the area of claims settlement
     and change-order pricing.
                          Contents
                                                         Page
DIGEST                                                     1

CHAPTER

   1       INTRODUCTION                                   5

   2       INADEQUATE SUPPORT FOR CONTRACTOR CLAIMS
           FOR ADDITIONAL COMPENSATION                    8
               Contractor A                               9
               Contractor B                              13
               Contractor C                              16
               Conclusions                               18
               Contractor comments                       21
               GAO proposals                             22
               Agency actions                            22
               Recommendations                           23

   3       CHANGE ORDERS NEGOTIATED WITHOUT REGARD
           TO AVAILABLE COST DATA                        24
               Availability of cost data                 27
               Conclusions                               27
               GAO proposals                             28
               Agency actions                            28
               Recommendations                           29

  4        SCOPE OF REVIEW                               30

APPENDIX

   I       Letter dated April 16, 1970, from the De-
             partment of the Navy to the General Ac-
             counting Office                             33

  II       Principal officials of the Department of
             Defense and the Department of the Navy
             responsible for administration of activi-
             ties discussed in this report               38
COMPTROLLER GENERAL'S              EVALUATION OF INFORMATION FROM CONTRACTORS
REPORT TO THE CONGRESS             IN SUPPORT OF CLAIMS AND OTHER PRICING
                                   CHANGES ON SHIP CONSTRUCTION CONTRACTS
                                   Department of the Navy B-171096

DI GES T

WHY THE REVIEW WAS MADE

     The General Accounting Office (GAO) has issued several reports to the
     Congress on the Navy's procedures in contracting with private industry
     for ship construction.
     A December 1958 report pointed out that contractors submitted claims
     for price increases which were vague and lacked adequate support, that
     Navy evaluations were inconclusive, and that claims had been settled
     without sufficient data to show the damage sustained by the contractors
     because of Government-caused delays.
     Two other reports, in June and October 1964, pointed out that a lack
     of effective price evaluation procedures had resulted in the negotia-
     tion of unnecessarily high prices for change-order work added to the
     initial contract.
     The review was made to determine whether improvements had been made by
     the Navy in obtaining and evaluating data used in the settlement of
     claims and the negotiation of prices for change orders.

FINDINGS AND CONCLUSIONS

     Claims submitted by three different contractors (referred to as con-
     tractors A, B, and C) during the period April 1965 through January 1969
     for $114,300,000, $486,000, and $1,342,000 were settled for $96,500,000,
     $354,000, and $760,000, respectively. The three contractors involved
     did not provide tangible evidence by which the amounts claimed could be
     related to the additional costs due to interruptions caused by the Gov-
     ernment's actions.
     Contractor A submitted claims totaling $114.3 million, from two differ-
     ent locations. Because the claims were prepared on essentially the
     same basis, we limited our review to the location where about $63.4 mil-
     lion of the $114.3 million was claimed.
     The contractor estimated that an additional 5.6 million labor-hours
     were attributable to actions of the Government. The contractor calcu-
     lated the increased labor-hours by (1)adding the estimated labor-hours
     needed to complete the ships to the labor-hours already expended,
(2)subtracting from that figure the labor-hours originally bid for
the ships and (3) subtracting from the resulting balance, a portion
of the increased hours judged to be a reasonable increase due to its
own inefficiencies. The contractor's proposal, although containing
the reasons for the incurrence of additional costs due to actions of
the Government and examples of the incurrence of such costs, did not
attempt to identify the amount of idle time, substandard performance,
and additional work to show whether they were attributable to Govern-
ment actions. Rather, the contractor's proposal seems to have been
based on the assumption that all additional costs over the amount the
contractor was willing to assume responsibility for were the result of
Government actions. (See pp. 9 to 12.)
Contractor B submitted two claims totaling $486,000 for disruption and
overtime. The proposals contained 95,000 additional labor-hours at-
tributed to disruptions caused by actions of the Government. GAO could
not find documentation to support the contractor's claims. Neither
could GAO find factual data which the Navy could have used in analyzing
the two disruption claims. (See pp. 13 to 15.)
Contractor C, engaged in constructing 3 DE-1040-class destroyer escorts,
submitted a claim for $1,342,000 for delay and disruption caused by the
late delivery of Government-furnished material and by defects in the
material. The amount represented the cost of 265,300 direct labor-hours
although the contractor did not relate the labor-hours claimed to speci-
fic delays and disruptions. Rather, the contractor determined the addi-
tional costs by comparing the average number of labor-hours used in con-
struction of an earlier class of destroyer escort with the average num-
ber of labor-hours incurred for DE-1040-class destroyer escorts after
making adjustments for physical differences in the vessels. The excess
not explained by physical differences was considered by the contractor
to be due to delay and disruption. The Defense Contract Audit Agency's
report on the claim accepted only 37,151 labor-hours as reasonable on
the basis of the recommendation of the Navy's technical analyst. Later
technical advisory reports reinstated an additional 138,473 labor-hours
as attributable to delay and disruption, but the basis for the computa-
tion of the additional hours was not included. The Navy ultimately
accepted 175,600 hours as attributable to delay and disruption and, ac-
cordingly, added $760,000 to the contract. (See pp. 16 and 17.)
GAO believes that, without information linking the additional costs to
actions of the Government, the Government had insufficient assurance
that the settlements made were fair and reasonable.
The Department of Defense should take the necessary steps to provide
a more reasonable basis for settling claims for additional costs re-
sulting from acts of the Government than is presently being used by
contracting officials.




                             2
    Historical data and standards were used by certain contractors in pre-
    paring proposals for the pricing of contract changes other than those
    arising from claims. In evaluating those proposals, the Navy generally
    did not obtain that data but relied on the personal judgment and ex-
    perience of its negotiators and analysts. (See pp. 24 to 27.) GAO
    believes that the Navy would have attained a better position for eval-
    uating the proposals and would have gained greater assurance as to the
    reasonableness of the prices negotiated if it had obtained the data used
    by the contractors.

RECOMMENDATIONS OR SUGGESTIONS

     The supervisors of shipbuilding should require contractors to furnish
     evidence relating the delay and disruption to actions of the Government
     and to provide specific data in support of additional costs claimed.
     The newly implemented "change order accounting" clause should require
     contractors to segregate their direct costs on constructive changes,
     as well as formal written changes, and such requirement should be
     clearly stated in this regard.
     To facilitate the negotiation of reasonable prices for change orders:
       --Contractors lacking adequate systems to provide a factual basis for
         proposed prices should be encouraged to improve their systems.
       --Whenever appropriate, historical cost data and standards should be
         obtained for evaluation and audit.
       --The Navy should ensure that the supervisors of shipbuilding are
         obtaining current evaluations by the Defense Contract Audit Agency
         of the estimating systems of contractors located in their respective
         geographic areas and that the evaluations include the bases upon
         which proposed prices are developed.

AGENCY AND CONTRACTORS ACTIONS AND UNRESOLVED ISSUES

     Navy

     The Navy generally concurred in GAO's recommendations.
     The Navy felt that some of the problem areas mentioned in the report
     are susceptible to improvement but not to total and precise solution.
     It was the Navy's opinion that this was particularly true of any at-
     tempt to achieve total, explicit, and auditable justification of all
     delay and disruption costs. (See p. 35.)
     The Navy agreed that, where necessary, contractors should be encouraged
     to improve their systems for estimating prices for contract changes.



                                   3
     In conjunction with the Defense Contract Audit Agency, it will try to
     develop more detailed criteria for an acceptable estimating system.
     The Navy will take steps to see that cost data and standards are ob-
     tained for evaluation and audit and, with the Defense Contract Audit
     Agency, will develop procedures and guidelines for scheduling and con-
     ducting evaluations of shipbuilder estimating systems.
     Contractors

     One of the three contractors took strong exception to any implication
     that its claim had not been adequately supported but made no comment
     on GAO's proposals.
     The second contractor pointed out some of the problems inherent in ac-
     counting for delay and disruption costs but offered to review any fea-
     sible procedure prepared by the Government to obtain that information.
     The third contractor believed that ample documentary evidence had been
     furnished in support of its claim and that the settlement was quite
     low. This contractor felt that it would be impossible to segregate costs
     relative to delay and disruption because in most cases the effects are
     cumulative and can be evaluated only when the total effect has become
     evident--that is,when the ship is nearly finished.
     GAO believes that, although it may be difficult to account for delay
     and disruption costs, it is not impossible. Such accountability would
     result in greater assurance of equitable results than is obtained from
     the practices currently being followed. (See p. 21.)

MATTERS FOR CONSIDERATION BY THE CONGRESS

     GAO is reporting this matter to the Congress because of the Navy's
     long-standing and uncorrected problem in the area of claims settlement
     and change-order pricing.




                                  4
                        CHAPTER 1

                       INTRODUCTION

     We have issued several reports to the Congress concern-
ing the methods used by the Navy in contracting for ship
construction with private industry.

     In our report dated December 4, 1958 (B-133088), we
pointed out that contractors engaged in shipbuilding for
the Navy submitted claims for price increases which were
vague and lacked adequate support, that Navy evaluations
were inconclusive, and that claims had been settled without
sufficient data to show the actual damages sustained by the
contractors because of Government-caused delays. In reports,
dated June 30, 1964 (B-146751), and October 16, 1964
(B-146898), we reported that a lack of effective price eval-
uation procedures had resulted in the negotiation of unnec-
essarily high prices for change-order work added to the
initial contract. Our current review was undertaken to de-
termine whether the Navy still settled claims and negotiated
prices for change orders without adequate data.

     Our review of the claims did not include a review of
the legal bases of the contractors' entitlement to price
adjustments. Rather, our review was limited to a consider-
ation of the adequacy of the contractors' demonstrations of
the validity of the amounts claimed and the Navy's evalua-
tions thereof.

     The Naval Ship Systems Command is responsible for the
acquisition of naval vessels constructed at either naval or
private commercial shipyards.

     A contract for construction of a ship consists of the
initial award and work added after the contract has been
awarded. Contracts awarded to private shipyards for the
construction of naval vessels generally have been fixed-
price type, awarded on an advertised basis. The prices for
additional work are negotiated on a sole-source basis be-
cause, when the work is ordered, the ships may be immobi-
lized at the contractors' yards in a semifinished state.



                             5
     The Naval Ship Systems Command delegates the responsi-
bility for the administration of ship construction contracts
awarded to private shipyards to the supervisors of ship-
building, conversion, and repair, located in the various
naval districts. As part of their administrative responsi-
bilities, the supervisors of shipbuilding frequently nego-
tiate prices for changes to contracts.

     The bulk of the contract change orders cover either
additional costs claimed by the contractor to have resulted
from some actions by the Government or additional costs due
to a change in the scope of the work.

     Contractors may make claims for additional compensation
when they believe that their operations were delayed or
disrupted, or that they otherwise incurred additional costs,
because of acts of the Government. These acts might in-
clude late delivery of Government-furnished material or the
furnishing to the contractor of defective specifications.
Claims may be settled through negotiation by the parties,
or a judicial review may be necessary.

     Generally, the elements of a change order for work
added to a contract cover material quantities, labor-hours,
material prices, labor rates, and overhead rates.

     The procedures to be followed by the supervisors of
shipbuilding in pricing changes give recognition to the non-
competitive nature of such transactions and call for a
careful review of the proposals submitted by the contrac-
tors. Guidelines for the supervisors of shipbuilding in
negotiating prices for contract changes are provided in the
Ship Acquisition Contract Administration Manual, which im-
plements the provisions of Navy procurement directives and
the Armed Services Procurement Regulation. In general,
these guidelines state that the use of the most current
available cost information is the best basis for establish-
ing reasonable change-order prices.

     The Defense Contract Audit Agency reviews proposed labor
and overhead rates, verifies material prices to vendor
quotations or purchase orders, and submits its findings to
the negotiators in advisory audit reports. Technical ana-
lysts in the offices of the supervisors of shipbuilding are

                             6
responsible for determining the reasonableness of (1) the
number of labor-hours and (2) the quantities of material
contained in contractors' proposals. Their determinations
are submitted to the negotiators in technical advisory re-
ports.

     The technical advisory reports and the advisory audit
reports are the primary tools available to the negotiators
for establishing a negotiating position. Thus, it can be
seen that the effectiveness of the Navy's negotiation of
prices for changes depends upon the (1) completeness of the
contractors' proposals, (2) adequacy of the technical ad-
visory report and the advisory audit report, (3) effective-
ness of the negotiator's evaluation of these reports, and
(4) degree of skill exercised during the negotiation pro-
cess,. Inadequacies in any of these elements are signif.i-
cant because changes are negotiated on a sole-source basis,
and the forces of competition are not present to encourage
the development of reasonable prices.

    The principal officials of the Department of Defense
and the Department of the Navy responsible for administra-
tion of activities discussed in this report are listed in
appendix II.

    The scope of our review is discussed in chapter 4.




                             7
                         CHAPTER 2

             INADEQUATE SUPPORT FOR CONTRACTOR

            CLAIMS FOR ADDITIONAL COMPENSATION

     In December 1958 we issued a report on problems asso-
ciated with contractor claims for additional compensation
under Navy ship construction contracts. We have found re-
cent evidence that problems still exist despite the issu-
ance of instructions on this subject by the Navy. We ex-
amined claims, submitted by three contractors during the
period April 1965 through January 1969, in which the con-
tractors held that the Government was responsible for their
incurring additional costs in that the contractors' opera-
tions were delayed and disrupted because of the Government's
imposition of impossible specifications and administrative
failures. The contractors did not provide tangible evi-
dence by which the amount claimed could be related to the
additional costs due to interruptions caused by the Govern-
ment's actions.

     The claims totaled about $116,128,000 and were settled
for approximately $97,614,000, as follows:
                       Amount of claim    Settlement

       Contractor A     $114,300,000     $96,500,000
       Contractor B          486,000         354,000
       Contractor C        1,342,000         760,000

In the absence of tangible evidence of the cost to the con-
tractor resulting from acts of the Government, the Navy, in
our opinion, could not adequately evaluate the validity of
the amounts claimed.

     The Ship Acquisition Contract Administration Manual re-
quires that contractors' claims for disruption should in-
clude such supporting information as:

     1. Description of disruptive elements and of the man-
        ner by which the work has been or will be disrupted.



                             8
    2. Period of time when the disruption occurred, or will
       occur.

    3. Area(s) aboard ship where the disruption occurred or
       will occur.

    4. Trade(s) disrupted, with a breakdown of man-hours
       for each trade.

     5. Schedules of trades before and during the period of
        disruption.

     6. Measures the contractor took to mitigate or preclude
        the disruption.

     The manual also provides that, in the event a   contrac-
tor refuses to furnish supporting information, the   contrac-
tor be advised that consideration of the claim for   disrup-
tion will be held in abeyance until the supporting   informa-
tion has been received.

     Details of the claims and the negotiation of prices
with the three contractors follow.

CONTRACTOR A

     The contractor submitted claims to the Navy totaling
$108.5 million for additional costs incurred, or expected
to be incurred, because of acts of the Government in the
construction of DE-1052 destroyer escorts (see picture on
p. 10) at two of its shipyards. These claims were later
increased to $114.3 million. The bases for the claims in-
cluded defective specifications for dynamic analysis, shock
resistance, and noise reduction and administrative failures
of the Government, such as failure to furnish design data
in time. The claims were settled for $96.5 million.

     Because the claims submitted at both of the contrac-
tor's locations were prepared on essentially the same basis,
we limited our review to the location where about $63.4
million of the $114.3 million was claimed.

     About $46 million of the amount claimed at this loca-
tion was for increased labor costs. The remainder was

                             9
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         10
attributable to additional material costs and subcontractor
claims.

     We were particularly concerned with the contractor's
demonstration of the amount of additional labor-hours which,
it claimed, were incurred because of the Government's ac-
tions.

     In its claim, the contractor estimated that Government-
caused delays and disruption resulted in its incurring an
additional 5.6 million labor-hours over the original amount
estimated to complete construction of the ships involved.
We found that the contractor calculated the increased labor-
hours by (1) adding the estimated labor-hours needed to com-
plete the ships to the labor-hours already expended, (2)
subtracting from this number the labor-hours originally bid
for the ships, and (3) subtracting from the resulting bal-
ance a portion of the increased hours judged by the contrac-
tor to be due to its own inefficiencies. Initially, the
contractor was willing to assume responsibility for 10 per-
cent of an additional 4,181,179 labor-hours incurred,
418,117 labor-hours. Subsequently, the contractor increased
its estimate of the additional labor-hours incurred to
5.6 million but was unwilling to assume responsibility for
more than 418,117 hours.

     To estimate total labor-hours through ship completion,
the contractor segregated labor-hours into two groups--pro-
duction (which included work performed by the various crafts
such as electricians, pipefitters, and welders)--and non-
production (which included planning and scheduling, material
handling, and engineering services).

     The estimated production hours represented the majority
of the total labor-hours, determined by projecting the hours
expended on the lead ship as of a specific date after giving
consideration to the stage of completion at that date. The
resulting hours were then adjusted for the anticipated fu-
ture growth caused by change orders, suspension of work, and
other acts of the Government.

     The contractor's estimate of nonproduction labor-hours,
which comprised about 10 percent of the additional hours
claimed, was based on the contractor's engineering judgment.
     After determining the increased labor-hours supposedly
caused by the Government's actions, the contractor allocated
these labor-hours to the causative elements cited in the
claim. The contractor advised us that the allocation by
causative elements was made on the basis of engineering
judgment.

     In reviewing the contractor's claims, the Navy selected
items of equipment that it thought best represented the de-
lay and disruptive effects of each causative element cited
in the contractor's claim. After it had selected several
items, the Navy (1) examined the cost groups showing the
most significant increases in labor-hours, (2) reviewed
labor-hour runs and budget data, (3) held discussions with
the contractor's personnel to obtain a detailed account of
the increased labor-hours required to fabricate and install
the shipboard equipment, and (4) reviewed ship plans and
drawings to ascertain the delay and disruptive effects in
various sections of the ships. The Navy then estimated the
increased labor-hours attributable to actions of the Govern-
ment. We believe that, under the circumstances, the Navy
did as well as could be expected in negotiating the claim.

     The contractor's proposal contained the reasons for
the incurrence of additional costs because of acts of the
Government and examples illustrating the incurrence of such
costs. It did not, however, attempt to identify the amount
of idle time, substandard performance, additional work,
etc.; analyze each instance to show whether it was attribut-
able to the Government's actions; and compute a total of
those instances found to have been caused by the Government.
Rather, the contractor's proposal seems to have been based
on the assumption that all additional costs over the amount
that the contractor was willing to assume responsibility
for were the result of Government actions.

     In our opinion, the material submitted in the contrac-
tor's proposal did not adequately demonstrate that the
amounts claimed were caused entirely by acts of the Govern-
ment and not possibly caused by the contractor's inefficien-
cies and/or an unrealistically low bid. It appears to us
that the approach for determining the increased labor-hours
in the settlement of this claim is not favored by the Court
of Claims and it has been stated by the Court that it may
be used only where there is no alternative.
                             12
CONTRACTOR B

     We found that contractor B included claims totaling
$486,000 for disruption and overtime in the prices proposed
for two change orders. Negotiation files showed that the
Navy accepted $354,000.

     The proposal for one of the change orders contained
76,000 additional hours attributed to disruption. The pro-
posal was accompanied by a letter detailing the crafts and
the areas aboard ship affected and the reason for ineffi-
ciencies. The proposal for the second change order did not
contain any explanation for an additional 19,000 hours ex-
pected to be incurred because of the disruption, except to
state that 6,000 of the 19,000 hours represented overtime.

     From an examination of the contractor's records, we
could not find documentation to support the contractor's
contention that disruption resulting in costs of $486,000
would occur. We were unable to determine how the contractor
knew it would be necessary to utilize 95,000 additional
hours because of disruption. Further, we could not find
factual data which the Navy could have used in analyzing
the two disruption claims.

     The contractor's chief estimator stated that disruption
claims were based on highly intangible judgment factors and,
in his opinion, were impossible to accurately detail. He
also informed us that he thought the justification letter
satisfied the requirements of the Supervisor of Shipbuild-
ing Manuall except the requirement for a description of the
disruptive elements and a statement of exactly what work
had been disrupted. He said that he could not pinpoint the
disruption because of its intangible nature and that strict
adherence to the requirements of the manual was not practi-
cable. In commenting on our draft report, however, the

1The provisions covering disruption costs in the Ship Ac-
 quisition Contract Administration Manual were incorporated
 in the Supervisor of Shipbuilding Manual in April 1965.
 Thus, both publications are basically the same in this
 respect.


                             13
contractor cited an example of disruption and stated that
not only were the craft or crafts performing the work dis-
rupted but other crafts working in the same areas were also
affected by the change.

     The Navy's technical analyst stated that disruption
claims were based on personal judgments of a very complex
item and that he relied on his professional judgment to de-
termine if amounts proposed were reasonable. Further, he
said that, when large differences of opinion on disruption
claims occurred, he attempted to reconcile the differences
with the contractor through discussion.
     Regarding the proposal which claimed 19,000 labor-
hours for disruption, the technical advisory report showed
that the hours were proposed and accepted with the explana-
tion that this number of hours could have been expended.
The Navy files did not contain documentation indicating how,
where, or when the disruption occurred.

     The Navy's analyst informed us that the very nature of
the work on this change, sandblasting and painting, would
have resulted in work stoppages and that, in addition to
affecting most skilled trades, it affected the most impor-
tant areas of the ship and had had a far-reaching effect on
the ship's total work force. He did not, however, tell us
the extent of the work stoppages, or the cost. He said
that the disruption resulting from rescheduling and inef-
ficiency was an intangible item and not subject to a line-
by-line analysis.

     The technical advisory report on the contractor's pro-
posal for $388,520 of disruption costs showed the following
percentages of direct labor-hours proposed by the contractor
and recommended for acceptance by the Navy's analyst.




                            14
     Hull number   Type of labor   Proposed   Recommended

          1        Yard             45.5%       45.5%
          2        Engineering       60.6        60.6
          3        Yard              75.9        50.0
          4        Yard              14.5          -

     The Navy analyst informed us that the disruption claim
relating to hull number 4 was not accepted because the
change was issued about 8 months before the ship arrived at
the yard. This appeared to be sufficient advance notice to
plan for the change and thus to obviate any delay and dis-
ruption to be encountered by the contractor.

     On this contract the contractor submitted several
claims for disruption totaling approximately $2 million.
The Navy accepted about $1.6 million of this amount, in-
cluding the $354,000 previously mentioned.




                             15
CONTRACTOR C

     The contractor, engaged in constructing 3 DE-1040-
class destroyer escorts, submitted a claim for $1,342,000
for delay and disruption caused by the late delivery of
Government-furnished material and by defects in the mate-
rial. The amount represented the cost of 265,300 direct
labor-hours although the contractor did not relate the
labor-hours claimed to the delay and disruption. The claim
was subsequently settled for $760,000. Navy officials
stated that the settlement was based on judgment and, in
their opinion, was a good settlement because the amount was
considerably less than the amount proposed in the contrac-
tor's revised proposal.

     In submitting its claim the contractor set forth addi-
tional steps that had to be taken because of the late deliv-
ery and/or failure of Government-furnished material. The
contractor determined the additional costs by comparing the
average number of labor-hours used in construction of
DE-1030-class destroyer escorts with the average number of
labor-hours incurred for DE-1040-class destroyer escorts
after making adjustments for physical differences in the
vessels. The excess not explained by physical differences
was considered by the contractor to be due to delayand
disruption.

     The Defense Contract Audit Agency questioned $1,181,000
of the $1,342,000 claimed by the contractor, accepting only
37,151 hours of the estimated delay and disruption as rea-
sonable on the basis of the recommendation of the Supervi-
sor of Shipbuilding's technical analyst.

     The audit report pointed out that (1) an analysis of
the contractor's internal management report indicated that
the contractor underestimated the hours required to con-
struct the hulls involved and (2) although the contractor
had considerable experience constructing the DE-1030-class
ship used as a basis for comparison, its work on the
DE-1040 ship represented its initial effort on a larger,
heavier, and dissimilar vessel.




                            16
     The audit report was forwarded on November 28, 1966,
to the Naval Ship Systems Command, along with a technical
evaluation of the contractor's claim, for review by the Su-
pervisor of Shipbuilding. The evaluation indicated that
the claim had some areas of merit, and these were shown in
the audit report--the 37,151 hours originally accepted.
Other areas of the contractor's claim, the remaining
228,229 hours, did not merit consideration in the technical
analyst's opinion.

     A technical advisory report of January 22, 1968, rein-
stated 101,500 hours for delay, disruption, and loss of
utilization of facilities, which were to be added to the
37,151 hours originally accepted.

     Although the technical advisory report cited, as jus-
tification for the reinstatement, the fact that (1) late
delivery of Government-furnished material caused delay and
disruption, (2) failure of Government-furnished material
caused delay, (3) late delivery and installation of elec-
tronic equipment resulted in additional costs, and (4) the
contractor lost the use of its facilities for other work
because of the delays, the report did not show the basis on
which the number of additional hours were computed.

     On February 16, 1968, the contractor submitted a letter
which reiterated the reasons for the claim and pointed out
the intangible nature of disruption and delay. It did not
present data on which labor-hours could be computed. On
May 10, 1968, another technical advisory report was pre-
pared adding an additional 36,973 labor-hours to the hours
already allowed. The justification cited in the report was
again late delivery of Government-furnished material, and
again the basis for the computation of additional hours
allowed was not included.

     The Navy ultimately accepted 175,600 hours as attrib-
utable to the disruption and, accordingly, added $760,000
to the contract.




                            17
CONCLUSIONS

     Although the contractors' claims that we examined
were based on causes which could be attributed to Govern-
ment actions, the records made available to us did not con-
tain information as to the specific equipment that was de-
layed nor contain information as to the effect the delay
had on increasing the cost of the contractors' operations.
We realize that such matters as delay and disruption are
complex. However, we believe that better information can
be obtained than is being furnished.

     We believe that in the absence of such information,
there is not sufficient assurance that the settlements made
were fair and reasonable. The practices presently being
followed in settling claims could lead to an erosion of the
contractor's incentive to control costs with a correspond-
ing decline in the effectiveness of firm-fixed-price con-
tracting.

     We believe that the Department of Defense should take
the necessary steps to ensure that settlements of claims
are supported by factual and reliable data relating the spe-
cific amount claimed to acts of the Government.

     On March 6, 1970, the Navy issued its Procurement Cir-
cular Number 15 which set forth certain revisions to its
procurement directives geared to lessening the problem of
settling contractor claims. The revisions include a
"changes" clause which may be used by contracting officers
in procurements where constructive changes, as well as for-
mal written changes, such as in major development or ini-
tial production contracts are anticipated. The clause
states that, if the contractor considers that any written
or oral communication received from a representative of the
Government (or any other act or omission of the Government)
constitutes a change order, the contractor shall so advise
the contracting officer within 10 days (or another time pe-
riod to be specified by the procuring activity) and shall
request his written confirmation thereof. The contractor
is to take no further action on the matter until it has
been advised by the contracting officer as to the disposi-
tion thereof.


                            18
     The contracting officer is required to (1) countermand
the communication regarded as a change order or (2) deny
that the communication, act, or omission described in the
contractor's notice constitutes a change order or (3) con-
firm, in writing, that the communication, act, or omission
described in the contractor's notice is a change order.
The clause also states that, if the contractor complies
with any order, direction, interpretation, or determination
from someone other than the contracting officer without pro-
viding the notice and receiving the response provided above,
it shall be at the contractor's risk; and the Government
shall not be liable for any increased costs, delay in per-
formance, or contract nonconformance by the contractor.

     Failure by the Government to respond within the time
stipulated in the clause shall be deemed a confirmation by
the Government. Any claim by the contractor for price ad-
justment under this clause must be asserted within 30 days
from the date of receipt by the contractor of a written
change notice from the contracting officer. The contracting
officer, if he decides that the facts justify such action,
may receive and act upon any such claim at any time prior
to final payment under the contract.

      The revised Navy procurement directives also include a
change-order accounting clause which may be used to obtain
change-order cost segregation, where feasible, in contracts
where the procuring activity reasonably can anticipate the
issuance of change orders for which individual costs of per-
formance can amount to $100,000 or more. The clause states
that:

     "Except where a change is promulgated in a supple-
     mental agreement adjusting the contract (price/
     estimated cost and fee/target cost and target
     profit) with respect to such term, the Contracting
     Officer shall state in each change order issued
     pursuant to this contract--where its estimates so
     indicate--that the cost of the changed work is es-
     timated by the Government to exceed $100,000, and
     the Contractor, with respect to each such change
     order, shall maintain separate accounts *** of all
     segregable direct costs (less allocable credits)
     incurred in performing the changed work, whether


                            19
     such work was added, deleted, or otherwise
     changed, and whether changed immediately or con-
     sequentially, including without limitation delay
     and disruption elements of changed work."

     Although the revised procurement directives appear to
improve the Government's position in settling contractor
claims, we feel that further improvement can still be made.
The revised directives are not clear as to whether or not
the new change-order accounting clause applies to both con-
structive changes and formal written changes. We feel that
the clause should require contractors to segregate their
direct costs on both types of changes and that such require-
ment should be clearly stated in this regard. Otherwise,
the weaknesses in negotiating contractor claims disclosed
in this report will not have been eliminated.

      In addition, the Navy is taking certain actions which
are designed to reduce the number and amount of contractor
claims. We are evaluating these actions in a separate re-
view.




                              20
CONTRACTOR COMMENTS

     One of the three contractors to whom the preliminary
draft was submitted took strong exception to any implication
that its claim had not been adequately supported. However,
it did not comment on our proposals.
     The second contractor pointed out some of the problems
inherent in allocating costs related to delay and disruption
but stated that it would be amenable to reviewing any fea-
sible procedure prepared by the Government to obtain this
information.
     The third contractor stated its belief that it had
furnished ample documentary evidence in support of the claim
and that the amount of settlement was quite low. This con-
tractor felt that it would be impossible to institute a
procedure for segregating costs relative to delay and dis-
ruption since in most cases the effects were cumulative and
could only be evaluated when the total effect had become
evident and the ship was nearly finished.
     Although we agree that accounting for delay and disrup-
tion costs presents difficulties, we believe that they are
not insurmountable. In our opinion basic elements of delay
and disruption are idle time and substandard performance.
It appears to us that a foreman or leadman who is aware of
what his people-are doing could readily provide the basis
for accounting for idle time. Similarly, we believe that
substandard performance can be determined if standard per-
formance is identified. It appears that, in both instances,
the causes would be determinable and one could verify
whether it was due to actions of the Government.
     We recognize that delay and disruption cannot be ac-
counted for with the same precision as other costs. We
believe, however, that a reasonable method of accounting
for such factors as idle time and substandard production
must be found in order to provide greater assurance of equi-
table results than is obtained-from the practices currently
being followed.
     In our opinion, the agency may not be adequately pro-
tecting the Government's interest unless it insists upon an
adequate demonstration by the contractor connecting the
amount claimed with actions of the Government.


                             21
GAO PROPOSALS

     In our preliminary draft report, we proposed that the
supervisors of shipbuilding require contractors to furnish
information in support of their claims as required by the
provisions of the Ship Acquisition Contract Administration
Manual.  (See p. 6.)  In particular, contractors should be
required to furnish evidence relating the delay and disrup-
tion to actions of the Government and also to provide spe-
cific data in support of the additional costs claimed to
have resulted from such delay and disruption.

     We also proposed that the manual be revised to provide
that contractors immediately notify the Supervisor of Ship-
building when delay and disruption occur so that an early
agreement can be reached with the contractor on appropriate
procedures to be instituted to segregate costs which relate
to the interrupted activity.

AGENCY ACTIONS

     By letter dated April 16, 1970 (app. I), the Assistant
Secretary of the Navy advised us that it was the Navy's
opinion that some of the problems mentioned in our draft re-
port lend themselves to improvement only rather than to a
precise and total solution, particularly in the area of ex-
plicit and auditable justification of all delay and disrup-
tion costs.

     The Assistant Secretary stated that it had been and
would continue to be the policy of the Navy that contractors
should adequately support their claims. He added that the
Naval Material Command had recently established a Claims
Group to ensure compliance with this policy on all major
claims. He stated further that the Naval Ship Systems Com-
mand had established special teams to process the settlement
of all shipbuilder claims and, in conjunction with the Ship-
building Industry Advisory Council, was revising the Ship
Acquisition Contract Administration Manual to better reflect
acceptable procedures for documenting and negotiating dis-
ruption claims. The Assistant Secretary stated also that
alternate procedures under which disruption costs would be
adjudicated solely on the basis of each change involved


                             22
rather than on the basis of total cumulative action to any
given point in time would be investigated.

     The Navy agreed that prompt notification of the occur-
rence of delay and disruption by contractors was needed.
The Navy felt that in many instances it would be difficult
to segregate costs resulting from delay and disruption.

RECOMMENDATIONS

     Because of the long-standing problem in the area of
claims, we recommend that the supervisors of shipbuilding
require contractors to furnish evidence relating the delay
or disruption to actions by the Government and also to pro-
vide specific data in support of the additional costs
claimed to have resulted from such delay and disruption.

     We recommend also that Navy regulations be further re-
vised by clarifying the new change-order accounting clause
so that it will require contractors to segregate their di-
rect costs on both constructive changes and formal written
changes. This would further strengthen the Government's
position in settling contractor claims.




                             23
                         CHAPTER 3


                 CHANGE ORDERS NEGOTIATED

           WITHOUT REGARD TO AVAILABLE COST DATA

     At the offices of the four supervisors of shipbuilding
visited, we found that four of the five contractors re-
viewed used historical cost data and standards as the bases
for proposing prices for 20 change orders. In evaluating
these proposals, however, the Navy generally did not obtain
this data but relied on the personal judgment, experience,
and knowledge of its negotiators and analysts.

     We recognize that the exercise of professional judgment
is an essential part of the evaluation process. However,
the acquisition and analysis of the factual data upon which
a contractor's estimate is prepared appears to be an essen-
tial prerequisite to making an adequate evaluation of the
estimate. Analysis of the data permits verification of its
accuracy and enables the analysts to affirm the validity of
the judgmental factors used to arrive at the estimate.
Thus, both parties have access to the pertinent facts and
are placed on equal footing, and the negotiation of fair
and reasonable prices is facilitated.

     For supplemental work done on a firm-fixed-price basis,
it is the Navy's policy to negotiate final prices using the
estimates provided by the contractors and, to the extent
possible, to agree on a price prior to completion of work
called for by the change. When a change is ordered, the
contractor is required to prepare a proposal showing the
estimated price of the required work. Instructions of the
Naval Ship Systems Command stipulate that a price breakdown
should be obtained with each proposal made by a contractor.
Further, paragraph 3-807.3 of the Armed Services Procurement
Regulation, relating to the implementation of the Truth-in-
Negotiations Act (Public Law 87-653), requires that the ne-
gotiator be in possession of current, complete, and accurate
cost or pricing data before decisions are made on contract
prices and obtain from the contractor a certificate of cur-
rent cost or pricing data.



                             24
     Following are examples of the evaluation techniques
followed by the Navy in negotiating prices for change orders.

     We found at the office of one Supervisor of Shipbuild-
ing that the Navy accepted the labor-hours proposed for
change orders negotiated with two contractors, one for
$161,000 and the other for $100,200, without obtaining from
the contractors the information that they had used to de-
velop their proposed prices. Both contractors based their
proposals on labor-hour estimates included in their original
bids. However, the Navy did not determine how the contrac-
tors arrived at these figures. According to the negotiator
he was aware of no standards which could be applied and,
instead, relied on his own experience and judgment and the
judgment of the technical analyst to establish the validity
of the costs proposed.

     In view of the above circumstances, we inquired of the
Proposal Evaluation Division at the same office as to the
policy followed in obtaining cost data. We were advised
that contractors had never been requested to provide histor-
ical cost data upon which estimates were based and that it
was believed that the data were not adequate for application
to current work. A contractor, which had extensive files
of indexed and cross-referenced historical costs accumulated
over the years, informed us that the Supervisor of Ship-
building had not examined its files.

     At the office of another Supervisor of Shipbuilding,
primary reliance was placed on the technical and audit re-
ports. We found, however, that the technical analysts relied
heavily on their judgment in evaluating proposals and did
not obtain the factual data used by the contractor for con-
sideration and analysis.

     The contractor was using historical costs as a basis
for its estimates when proposing prices for change-order
work. For example, on one change order the contractor used
117 hours per ton of steel on the basis of its past experi-
ence in hull construction for similar vessels under prior
contracts. Contractor officials stated that their account-
ing system for labor provided statistical and experienced
labor cost data. The system was designed to provide for
the evaluation and control of labor performance and to

                             25
provide comparisons of planned and budgeted labor-hours with
actual labor-hours.

     At the other two offices visited, we found the situa-
tion to be similar to those described above, in that the
Navy did not get detailed information in support of the con-
tractors' claims. At one of these offices, we found that
one contractor was modifying its present accounting system
to provide for the accumulation of historical cost data.




                             26
AVAILABILITY OF COST DATA

     We visited five private shipyards to determine whether
contractors had available cost data that could be used by
the Supervisor of Shipbuilding in evaluating proposals.

     We found that three accumulated and used historical
cost data in preparing original bids and in proposing prices
for change orders. At a fourth shipyard, although the con-
tractor relied primarily on the judgment and experience of
its estimators, we noted that it also used standards in pre-
paring estimates. As mentioned previously on page 26 an-
other contractor was modifying its cost accumulation system
to provide better cost data which could be used to estimate,
evaluate, and negotiate fair and reasonable prices.

     Presented below are some examples of the data accumu-
lated by selected contractors.

     One contractor informed us that its labor-hour esti-
mates normally were based upon historical costs experienced
in each production shop or department and recorded and filed
by individual line items of work. Upon completion of a job
order, each shop retains a data package showing materials
used, labor-hours estimated, and actual hours used. Our
examination of these records indicated that they were very
extensive and were well indexed and cross-referenced for
easy use.

     Another contractor's system provides for presentation
of labor-hour data by ship structural elements, shop, and
craft operations. The system is designed to provide for
the evaluation and control of labor performance and provides
comparisons of planned and budgeted labor-hours with actual
labor-hour cost. We were advised that the labor-hour data
provided a historical cost record with respect to estimates
for new construction as well as to prices for change orders.

CONCLUSIONS

     The reliance placed by the Navy on the personal judg-
ment, experience, and knowledge of its personnel in evalu-
ating prices proposed for change orders might be acceptable
when reliable cost information is not available. We found,


                             27
however, that four of five contractors that we examined
were using historical cost data and standards as bases for
their proposals and that the fifth contractor was willing to
consider their use. We believe that, under these circum-
stances, the Navy would have been in a better position to
evaluate the proposals had it obtained the data and would
have gained greater assurance as to the reasonableness of
the prices negotiated.

GAO PROPOSALS

     To facilitate the negotiation of reasonable prices for
change orders, we proposed in a draft of this report that:

     1. Contractors' not having adequate systems to provide
        factual bases for proposed prices should be encour-
        aged to modify their systems.

     2. Whenever it is appropriate, historical cost data and
        standards should be obtained for evaluation and
        audit.

     3. The Naval Ship Systems Command conduct a program of
        active surveillance to ensure that the supervisors
        of shipbuilding obtain current Defense Contract
        Audit Agency evaluations of the estimating systems
        of contractors located in their respective geo-
        graphic areas and that the evaluations include the
        bases upon which proposed prices are developed.

AGENCY ACTIONS

     The Navy agreed that improvements in procedures and
methodology for evaluating contractors' proposed prices for
changes to ship construction contracts were desirable. It
stated, however, that the collection of usable historical
costs and the development of valid standards which both the
contractor and the Government would consider an aid for fu-
ture pricing had proven difficult in the shipbuilding in-
dustry and that it was probable that this industry would
not be able to proceed as far in obtaining such standards
as would many other types of industries.



                            28
     We noted that in some instances contractors and Naval
shipyards had developed data on which to base estimates for
the pricing of changes, and the methods used appeared valid
to us.

     The Navy stated that it would, in conjunction with the
Defense Contract Audit Agency, investigate the feasibility
of developing more detailed criteria for what constitutes
an acceptable estimating system and of contractually re-
quiring shipbuilders to establish formal estimating systems
to meet such criteria.

     The Navy also agreed with our suggestion that histor-
ical cost data and standards should be obtained for evalua-
tion and audit. The Navy will emphasize this policy and
will revise the guidance for the preparation of technical
advisory reports to require that each report reflect the
extent to which such evaluation has been made.

RECOMMENDATIONS

     To facilitate the negotiation of reasonable prices for
change orders, we recommend that:

     --Contractors that do not have adequate systems to pro-
       vide factual bases for proposed prices should be en-
       couraged to modify their systems.

     -- Whenever appropriate, historical cost data and stand-
        ards should be obtained for evaluation and audit.

     -- The Navy ensure that the supervisors of shipbuilding
        obtain current evaluations by the Defense Contract
        Audit Agency of the estimating systems of contractors
        located in their respective geographic areas and that
        the evaluations include the bases upon which proposed
        prices are developed.




                             29
                         CHAPTER 4

                      SCOPE OF REVIEW

     Our review covered claims of three contractors for ad-
ditional costs totaling $116,128,000 incurred because of
actions of the Government. We also reviewed 20 change or-
ders with a gross value of $4.4 million.

     At the office of each Supervisor of Shipbuilding, we
reviewed the claim and change-order files including corre-
spondence, audit reports, technical advisory reports, fund-
ing data, scope letters, and prenegotiation and postnegotia-
tion business clearances. We held discussions with person-
nel of the offices of each Supervisor of Shipbuilding to de-
termine what factors were considered in evaluating proposals
for each selected change order. We also reviewed the Ship
Acquisition Contract Administration Manual to determine the
Navy's policies and procedures for evaluating the reasonable-
ness of the proposals.

     For the claims and change orders selected, we examined
the contractors' price proposals and related documentation
and discussed the amount of each claim and the pricing of
each change order with contractor officials to obtain an ex-
planation of the basis for each estimate. In addition, we
reviewed the contractors' policies and procedures for proc-
essing contract changes and accumulating the related costs.




                            30
APPENDIXES




 31
                                                             APPENDIX I
                                                                 Page 1

                    DEPARTMENT OF THE NAVY
                     OFFICE OF THE SECRETARY
                      WASHINGTON, D. C. 20350




                                                    16 APR 1970
Mr. Charles M. Bailey
Director, Defense Division
U. S. General Accounting Office
Washington, D. C. 20548

Dear Mr. Bailey:
     Assistant Secretary of the Navy (FM) letter of 3 March 1970
advised you of the reasons for the Navy's inability to reply to
the GAO draft report on the Navy's evaluation of contractors'
proposed prices for changes to ship construction contracts by
the date you requested, and informed you of the date by which a
substantive-reply could be expected.

     The evaluation of the matters covered by the GAO report has
been completed, and I am enclosing the Navy reply to the report.

                                      Sincerely yours,




                                       R
                                  Assistant Secretary ofthe Navy

Encl:
(1) Navy Reply to GAO Draft Report of 5 Jan 1970 on Evaluation of
    Contractors' Proposed Prices for Changes to Ship Construction
    Contracts (OSD Case #3062)




                                    33
APPENDIX I
    Page 2
                              Navy Reply

                                  to

                 GAO Draft Report of 5 January 1970

                                  on

            Evaluation of Contractors' Proposed Prices for

               Changes to Ship Construction Contracts

                           (OSD Case #3062)




I.   GAO Findings and Recommendations

    GAO issued two reports to Congress in 1964 which stated that a
lack of effective price evaluation procedures had resulted in the
negotiation of unnecessarily high prices for change order work added
to the initial contract. Subject report is the result of GAO's
recent review which was undertaken to ascertain the extent to which
the Navy had improved its techniques for evaluating proposed prices
for change orders.

     GAO found that,



                         [See GAO note.




           two contractor claims totaling about $1.83 million were
settled for about $1.11 although the contractors provided no tangible
evidence that could relate the amounts claimed to the interrupted
construction allegedly caused by the Government's actions. The
amounts the Government agreed to pay were based primarily on the
judgment of its negotiators. GAO considers that the Navy could not
adequately evaluate the validity of the amounts claimed because of
the absence of evidence of the cost to the contractors of the delay
and disruption.

GAO note:     The deleted comments relate to matters which were
              discussed in the draft report but have been de-
              leted from this final report.
                                              Enclosure (1)

                                   34
                                                          APPENDIX I
                                                              Page 3

    To facilitate the negotiation of reasonable prices for change
orders GAO recommends that: (1) Contractors without an adequate
system to provide a factual basis for proposed prices should be
encouraged to modify their systems, (2) historical cost data and/or
standards should be obtained for evaluation and audit, (3) the Navy
ensure that SUPSHIPS are obtaining current evaluations by DCAA of
the estimating systems of contractors in their respective geographic
area. In regard to the negotiation of claims for delay and disruption,
GAO makes two additional recommendations: (4) SUPSHIPS require con-
tractors to furnish evidence and specific data in support of addi-
tional costs claimed to have resulted from Government actions-relating
to such delay and interruption, and (5) Navy regulations be revised
to require contractors to notify SUPSHIPS immediately when delay and
disruption occurs.

II. Navy Position

     The Navy concurs that improvement in procedures and methodology
for evaluation of contractors' proposed prices for changes to ship
construction contracts is desirable. The Navy is desirous that ship-
builders utilize a system providing a factual basis for pricing
changes to the maximum extent possible. All shipbuilders have methods
and procedures for estimating. Historical data are used to the extent
they are available to develop empirical relationships and estimating
"thumb rules" which are tempered by experience and judgment in pre-
paring individual estimates. The collection of usable historical
costs and development of valid standards which both the contractor
and the Government would consider believable enough to use as an aid
for future pricing have proven difficult in this industry as well as
others. It is probable that the shipbuilding industry will not be
able to proceed as far in obtaining good standards as many other types
of industries. This is particularly true in ship construction and
installation operations as opposed to shop operations. Consequently,
contractors tend to continue to rely heavily on professional esti-
mators and their individual skills in interpreting and extrapolating
the cost data and standards available.

     The Navy concurs with the intent of Recommendations 1 through 4.
Definite actions are being taken to ensure full implementation. How-
ever, it is the opinion of the Navy that some of the problems mentioned
by GAO lend themselves only to improvement rather than precise and
total solution. This is particularly true in the area of total explicit,
and auditable justification of all delay and disruption costs. The
Navy concurs only with the general intent of Recommendation 5. Spe-
cific comments related to each recommendations are listed below:

Recommendation 1

     Contractors that do not have an adequate system to provide a
factual basis for proposed prices should be encouraged to modify their
systems.


                                   35
APPENDIX I
    Page 4

Navy Comment

     Concur. The Navy will encourage contractors to make more effec-
tive use of historical data and to develop better standards. Spe-
cifically, the Navy will, in conjunction with DCAA, investigate the
feasibility of developing more detailed criteria for what constitutes
an "acceptable estimating system" and of levying a specific con-
tractual requirement for shipbuilders to establish formal estimating
systems that meet such criteria.

Recommendation 2

     Whenever appropriate, historical cost data and/or standards
should be obtained for evaluation and audit.

Navy Comment

     Concur. NAVSHIPS will promulgate a notice to all SUPSHIPS re-
emphasizing this policy. Furthermore, the guidance for preparation
of TARs (Technical Advisory Report) will be revised to require that
each TAR reflects to what extent such evaluation was made.

Recommendation 3

     The Navy ensure that SUPSHIPS are obtaining current evaluations
by the DCAA (Defense Contract Audit Agency) of the estimating system
of contractors located in their respective geographic areas, including
the basis on which proposed prices are developed.

Navy Comment

     Concur. NAVSHIPS and DCAA Headquarters will develop appropriate
procedures and guidelines for scheduling and conducting evaluation
of shipbuilder estimating systems.

Recommendation 4

     We recommend that SUPSHIPS require contractors to furnish infor-
mation in support of their claim as required by the provisions of the
SACAM (Ship Acquisition Contract Administration Manual) and as out-
lined on page 15 of the report. In particular, contractors should be
required to furnish evidence relating to the interruption to actions
by the Government and also to provide specific data in support of the
additional costs claimed to have resulted from such delay and dis-
ruption.

Navy Comment

     Concur. It has and will continue to be the policy of the Navy
that contractors adequately support claims. NAVMAT has recently
established a Claims Group to assure compliance with this policy for


                                  36
                                                          APPENDIX I
                                                               Page 5

all major claims of its Systems Commands. NAVSHIPS had previously
established an intensive program and organized special teams with
central headquarters coordination to process to settlement all ship-
builder claims. Also, NAVSHIPS is currently, in conjunction with the
Shipbuilding Industry Advisory Council, revising SACAM better to
reflect acceptable procedures for documenting and negotiating dis-
ruption claims. In addition, action will be initiated to investigate
alternatives to the present procedure under which disruption costs
are adjudicated solely on the basis on individual changes, rather
than on the basis of total cumulative Government actions to any
given point in time. The aim of the investigation will be to develop
procedures to facilitate more timely settlement of disruption claims.

Recommendation 5

     We also recommend that SACAM be revised to provide that con-
tractors immediately notify SUPSHIPS when delay and disruption occur
so that an early agreement can be reached with the contractor on
appropriate procedures to be instituted to segregate costs which
relate to the interrupted activity.

Navy Comment

     Concur that prompt notification of occurrence of delay and dis-
ruption by contractors is needed. Do not concur that such notifica-
tion will in itself resolve the most difficult of the problems
related to segregation of related costs. In addition, it is observed
that the SACAM is not contractually binding on a contractor and is
only directory to the SUPSHIP.

     In the case of delays, the following clause already appears in
all shipbuilding contracts:

     "DELAYS. In the event of any delay in the construction of
     any of the vessels the Contractor shall give the Department
     prompt notice thereof/in sufficient detail to permit the
     Department to take appropriate action to minimize the effect
     of such delay."

The Navy is considering inclusion of a contract clause in future con-
tracts requiring the contractor to give timely notice with regard to
disruption and this will be pursued concurrent with the investigative
action noted under Recommendation 4.




                                  37
APPENDIX II


                  PRINCIPAL OFFICIALS OF

               THE DEPARTMENT OF DEFENSE AND

                THE DEPARTMENT OF THE NAVY

       RESPONSIBLE FOR ADMINISTRATION OF ACTIVITIES

                 DISCUSSED IN THIS REPORT


                                       Tenure of office
                                       From          To

                   DEPARTMENT OF DEFENSE

SECRETARY OF DEFENSE:
    Melvin R. Laird                 Jan.     1969    Present
    Clark M. Clifford               Mar.     1968    Jan. 1969
    Robert S. McNamara              Jan.     1961    Mar. 1968

ASSISTANT SECRETARY OF DEFENSE
  (INSTALLATIONS AND LOGISTICS):
    Barry J. Shillito               Feb. 1969       Present
    Thomas D. Morris                Sept. 1967      Jan. 1969
    Paul R. Ignatius                Dec. 1964       Aug. 1967


                  DEPARTMENT OF THE NAVY

SECRETARY OF THE NAVY:
    John H. Chafee                  Jan.    1969    Present
    Paul R. Ignatius                Aug.    1967    Jan. 1969
    Charles F. Baird (acting)       Aug.    1967    Aug. 1967
    Robert H. B. Baldwin (acting)   July    1967    Aug. 1967
    Paul H. Nitze                   Nov.    1963    June 1967

ASSISTANT SECRETARY OF THE NAVY
  (INSTALLATIONS AND LOGISTICS):
    Frank Sanders                   Feb.    1969    Present
    Barry J. Shillito               Apr.    1968    Jan. 1969
    Vacant                          Feb.    1968    Apr. 1968
    Graeme C. Bannerman             Feb.    1965    Feb. 1968

                                                    U.S. GAO Wash., D.C.

                             38