oversight

Contractual Features and Related Matters in the S-3A Aircraft Program

Published by the Government Accountability Office on 1971-03-29.

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

                                    I                               --

                          k+ORl+!&  THE CHAIRMAN         .J?
                          PREPAREDNESS INVESTIGATING
                          SUBCOMMITTEE, SENATE COMMITTEE
                          ON ARMED SERVICES
                                                      3


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                          Contractual Features And
                          Related Matters In
                          The S-3A Aircraft Program                                                                               6.163058




                          Department                        of the Navy




                          BY THE COMPTROLLER GENERAL
                          OF THE UNITED STATES    -
                 COMPTROLLER     GENERAL         OF      THE   UNITED    STATES
                               WASHINGTON.        D.C.     20543




B-l    63058




Dear     Mr.    Chairman:

        This is our report     on contractual     features  and related
matters    in the Navy’s    S-3A aircraft     program.     Our review
was made in response        to your request      dated July 9, 1970.
The significant    contents    of the report    are summarized      in
the digest which is bound in the report.

        During the course of our review       we provided       copies
of our report   draft to representatives      of the Department
of Defense and the Department         of the Navy for review        and
discussion.    We did not submit the report        to officials    of
the Department     of Defense for written     comments.

       We plan to make no further       distribution   of this re-
port unless copies are specifically       requested,   and then
copies will be distributed    only after your agreement        has
been obtained  or public announcement          has been made by
you concerning   the contents    of the report.

                                                      Sincerely         yours,



                                             L                    Mb
                                                      Comptroller           General
                                                      of the United         States

The Honorable    John C. Stennis,       Chairman
Preparedness    Investigating      Subcommittee
Committee    on Armed      Services
United States Senate




               50 TH ANNIVERSARY             1921- 1971
        I   -

        I       . COMPTROLLERGENERAL'S                                              CONTRACTUAL FEATURES AND
        I
        I
                  REPORT TO THE CHAIRMM,                                            RELATED MATTERS IN THE
     I            PREPAREDNESSINVESTIGATING SUBCOMMITTEE,                           S-3A AIRCRAFT PROGRAM
    II            SENATE COMUTTEE ON ARMED SERVICES                                 Department of the Navy
     I
                                                                                    B-163058

    I

    I            DIGEST
                 -we---

                 WHY THE REVIEW WAS MADE

                        The Chairman of the Preparedness   Investigating Subcommittee,         Senate Com-
                        mittee on Armed Services,  asked the General Accounting       Office     (GAO) to
                                                                          contractual
                                                                         3sa?m              features
                                                                             cc?-+mpP~F~.*,, "-        of



                        It was suggested that GAO include in its review areas of the structure
                        of the contract,    cost and pricing  provisions, management controls,    and
                        extent of concurrency    between development and production;  that is, how
                        much production   is under way before development of the aircraft      is cotn-
                        pleted.

    I
                 FINDINGS AND CONCLUSIONS
    8
                        ProbZems of infZ!exibib<tu

                        Essentially     the contract   is a "total   package procurement,"       in that de-
                        velopment of the aircraft        and its production     are tied together     in one
                        contract    which was awarded after      one competition.      The contractor    is the
                        Lockheed-California       Company of the Lockheed Corporation.

                        From a strictly      legal   standpoint,    the contract   appears   to protect    the
                        Government's    interests     adequately.

                        However, a possible   vulnerable  feature     is that the contract  may be
                        tightly  drawn in favor of the Government to an unrealistic        degree. Un-
                        foreseen technical   or financial   problems,    or both, may prove that to be
                        true.   (See p. 10.)

                        Development by its very nature involves           uncertainty,       and there should be
                        flexibility       in the early stages of a development program.             That flexi-
                        bility      should include appropriate    pricing   provisions       and allowance for
                        alternative       approaches,  with costs and technical        factors   being continually
                        assessed by the Government and the contractor.

                        When serious     problems    come to light    in an inflexible   contract     situation,
                        the attention     of both    parties tends    to shift   from the primary     goal of
I
I
I                Tear   Sheet
achieving     an acceptable    product.  The contractor             tends to search for     ways   '
to acquire additional       funds, and the Government             tends to concentrate      on
strict    enforcement   of the contract.

The situation      can deteriorate     until the highest officials     of the Depart-
ment of Defense, the Congress, or ultimately             the courts must resolve the
matter.     By then, the Government is in an untenable position.             It still
needs the weapon system, and forcing           the contractor    out of business will
not get it.      The Government cannot easily begin again with a new contrac-
tor because that could bring prohibitive           costs and delay; moreover,       it is
difficult     to transfer    technical   and engineering     knowledge from one con-
tractor   to another.

The only viable course is to introduce      flexibility,      belatedly,            by ignor-
ing the original    tight   contract terms, relaxing     specifications             realisti-
cally,  and providing     more money to get the job done.

Contract     structure

The S-3A contract       was developed in a period of transition                 between the
former Department of Defense (DOD) administration                  and the present one.
It contains    features     reflecting      the procurement      policies     of both.      On
the one hand, it combines development and production                     in a single con-
tract,   and development is procured on a fixed-price                  incentive     basis.
(See p. 16.)      On the other hand, it permits the Government to delay the
start   of various production          phases until    prescribed      goals have been
reached in development,          or for 6 months3 whichever          is earlier.       (See
p. 22.)    A full    discussion      of contractual     features     is in chapter 2,
pages 8 to 42.

The optimism that was characteristic               of previous major weapon acquisi-
tion programs seems to be present in the S-3A program.                     Department of-
ficials    have testified       that,    at the start    of any development program,
there are "driving        forces"     that make for a lack of realism and for a
sense of optimism.          Planners tend to overstate         the threat,     which means
overstated    requirements.          Technical    people, in both industry        and Govern-
ment, are always optimistic             about achieving    performance     characteristics,
the length of time development will take, and cost.                    The Government
wants the weapon system and the contractor                wants to produce it, so both
have incentive      to underestimate         costs so that the project       will be ap-
proved.

Evidences of optimistic           pricing       and a tightly   drawn contract   include
the following facts.
  --Navy's     cost estimate       for the development effort   was about $45 mil-
     lion,    or 11 percent       higher than Lockheed's estimate.    (See p. 13.)

  --Navy's   cost        estimate  for production        option lots was $69 million,      or
     6.5 percent         higher than Lockheed's         estimate.   (See p. 13.)

  --Lockheed's     price for the development effort   was some $30 million
     lower than its competitor,     although the Lockheed proposal offered                   a
     more sophisticated     weapon system.   (See p. 13.)
                                            2
        I   .
        I
                5
                         .
                             --The records of negotiation       clearly indicate      that the Navy expects
        I
                                Lockheed will experience      costs over target      on the development work.
        1                       (See p. 13.)
        I
                             --The basic    aspects of the contract      structure    that   impose substantial
                                financial   risks on the contractor      are:

                               1. The development portion       of the contract       is on a fixed-price      in-
                                  centive    basis.    In any major weapon system development,            there is
                                  a significant      degree of technical     uncertainty.       If unexpected
                                  technical     problems are encountered,       the contractor     must bear a
                                  major portion      of the resulting    financial      burden.

                               2. The contract   provides options for production       quantities   of air-
                                  craft  under binding ceiling    prices.     Under such an arrangement,
                                  the contractor    is subject  to the effect    on production    of unex-
                                  petted development problems.
    I
                         Although the Navy did not obtain more favorable            prices from Lockheed
                         during negotiations,     it did require   certain    provisions      that had.not
                         been mentioned in the request for proposals.            These provisions       increased
                         Lockheed's   financial   risks,  yet they were accepted at no increase             in
                         price.    The new provisions    included the Variable       Quantity     Option provi-
                         sion and the Pricing     of Changes clause.       (See p. 14.)

                         Additionally,      Lockheed had predicated      its proposal on the inclusion     in
                         the contract     of a clause providing     for abnormal economic inflation      ad-
                         justments     to each of the production      lot option prices.     The Government
                         agreed to adjustments      for abnormal economic inflation        only with respect
                         to the last two option lots.        Furthermore,      the abnormal inflation   cover-
                         age that was agreed to is incomplete.             (See pp. 30 to 32.)

                         Management    controls

                         The management controls   for the S-3A include Navy and contractor          project
                         management organizations,    a contractor    performance  measuring and report-
                         ing system, and various   techniques     for program assessment by top offi-
                         cials of DOD. Generally,     the controls    appear adequate,   if properly     ap-
                         plied.

                         Extent    of concurrency

                         The extent of planned       concurrency     between development      and production      of
                         the S-3A is described       in chapter    4, pages 51 to 54.)


8                   MATTERS FOR CONSIDERATION BY THE SUBCOMMITTEE
I
                         Potential problem areas are listed   in chapter 5, pages 55 to 59.                    Some
I                        of the more important  areas are described   below.

I
I               Tear Sheet
I



                                                               3
Possib7Ye need for          relief   for     contractor

The conservative   pricing   and tight    structuring   of the contract may force
the contractor   to seek relief     from the Government in order to continue
work.   (See pp. 8 to 15.)      Potential    events that could precipitate  such
a need and, thus, should be monitored         by the Subcommittee,   are

  --an increase    in the rate              of economic       inflation or even a continuance
     of the present   rate for              a prolonged       time (see p. 55);

  --the      occurrence      of major       development       problems   (see p. 55);   and

  --ordering       by the Navy of minimum, or near minimum, quantities  of the
     aircraft,      as permitted under the production  options (see p* 55.)

Production       decision

A decision    on whether the S-3A will        go into production    is scheduled in
February or March 1972.          That date may be premature and may not allow
time for technical       data from tests that would be available        in a few
months more to the decisionmakers.            Also, it appears that the decision
will    be made in an atmosphere where program advcxates          are overly   influ-
ential.     GAO believes     that consideration     should be given to conducting
an assessment of the S-3A, independent            of Iprogram management, prior     to
the production     decision.      (See p. 56.)


Concurrency       of development           and production.

Under the plan to start     production      before development       is completed,
there is the real possibility       that,    after many aircraft        are manufactured
or in production,    tests  will  show    that    significant     changes  are needed
to ensure an effective     weapon system.         Changes then would have to be
made to completed or partially        completed units and would require            sub-
stantial  additional    amounts of time and money.            (See p. 57.)

Responsibility        for    total   system     performance

The contract      purports     to impose total     responsibility      for performance   of
the S-3A system on the prime contractor               (Lockheed).      However, the Navy
negotiator     states    that,   under some circumstances9        the Government must
pay for modifying        Government-furnished       equipment so that it will         be
suitable    for use in the S-3A.          An attorney     for the Naval Air Systems
Command disagrees.          The variance    in interpretation       indicates    that a
dispute    may arise in that area.          (See pa 58.)
                           Contents
                                                                  Page

DIGEST                                                              1

CHAPTER

  1       INTRODUCTION                                              5
              The S-3A mission                                      5

  2       CONTRACTUAL   ARRANGEMENTS                                8
             Contract award background                              8
             Overall merits of contractual             arrange-
               ments                                               10
                  Fixed price development with pro-
                     duction options                               12
                  Conservative      pricing                        13
             Contract description                                  16
             Key contract      clauses                             17
                  Clause granting        options to pur-
                     chase additional        quantities            19
                  Project milestones                               22
                  Ordering-Date      Extension                     26
                  Defects                                          26
                  Economic Escalation                              30
                  Pricing    of Changes                            33
                  Installment      Funding                         36
                  Performance responsibility            prime
                     and associate       contractor     rela-
                     tionships                                     38
                  Stop-Work Order                                  41
                  Restraint      of Competition                    41

  3       MANAGEMENT  CONTROLS                                     43
             Project management organization                       43
             Performance measurement                               43
             Other management tools                                45
             Development Concept Paper                             45
             Thresholds                                            46
             Defense Systems Acquisition    Review
                Council                                            48
             Independent assessment needed by Defense
                Systems Acquisition  Review Council for
                production decision                                49
CHAPTER                                                            Page

  4        EXTENT OF CONCURRENCY                                    51
               Areas of primary technical          risk             53
  5        POTENTIAL PROBLEMSTO BE MONITORED                        55
              Possibility      of need for extra con-
                 tractual     relief                                55
               Upcoming production          decision                56
               Concurrency of development and produc-
                 tion                                               57
               Cost threshold        for production     aircraft    57
              Less than total system performance re-
                 sponsibility                                       58
              Possible side effects            from the pricing
                 of changes clause                                  58
              Possible side effects            from restraint
                 of competition         clause                      59

  6        SCOPEOF ANALYSIS                                         60

APPENDIX

           Letter dated July 9, 1970, from Chairman,
             Preparedness Investigating  Subcommittee,
              Senate Committee on Armed Services                    63

                            ABBREVIATIONS

ASPR       Armed Services     Procurement    Regulation

AWACS      Airborne   Warning and Control       System

DOD        Department    of Defense

GAO        General Accounting      Office
. COMPTROLLERGENERJL'S                                           CONTRACTUAL FEATURES AND
  REPORTTO THE CHAIRMAN,                                         RELATED MATTERS IN THE
  PREPAREDNESSINVESTIGATINGSUBCOIMITTEE,                         S-3A AIRCRAFT PROGRAM
  SENATECOMMITTEEON ARMEDSERVICES                                Department of the Navy
                                                                 B-163058


 DIGEST
 ---e-e

 WHYTHE REVIEW WASMADE
      The Chairman of the Preparedness       Investigating      Subcommittee,        Senate Com-
      mittee on Armed Services,      asked the General Accounting          Office     (GAO) to
      assist  the subcommittee     in its analysis      of the contractual       features    of
      the Navy's program for developing        and producing a twin-jet,           four-man-
      crew, carrier-based    antisubmarine    aircraft,      the S-3A.

      It was suggested that GAO include in its review areas of the structure
      of the contract,    cost and pricing  provisions, management controls,    and
      extent of concurrency    between development and production;  that is, how
      much production   is under way before development of the aircraft      is com-
      pleted.


 FINDINGS AND CONCLUSIONS
                   --


      Essentially     the contract   is a "total   package procurement,"    in that de-
      velopment of the aircraft        and its production  are tied together     in one
      contract    which was awarded after one competition.        The contractor    is the
      Lockheed-California       Company of the Lockheed Corporation.

      From a strictly      legal   standpoint,    the contract   appears   to protect    the
      Government's    interests     adequately.

      However, a possible   vulnerable  feature     is that the contract  may be
      tightly  drawn in favor of the Government to an unrealistic        degree. Un-
      foreseen technical   or financial   problems,    or both, may prove that to be
      true.   (See p. 10.)

      Development by its very nature involves           uncertainty,       and there should be
      flexibility       in the early stages of a development program.             That flexi-
      bility      should include appropriate    pricing   provisions       and allowance    for
      alternative       approaches,  with costs and technical        factors   being continually
      assessed by the Government and the contractor.

      When serious     problems    come to light    in an inflexible   contract     situation,
      the attention     of both    parties tends    to shift   from the primary     goal of




                                              1
achieving     an acceptable    product.  The contractor             tends to search 'for   ways
to acquire additional       funds, and the Government             tends to concentrate     on
strict    enforcement   of the contract.

The situation      can deteriorate     until the highest officials      of the Depart-
ment of Defense, the Congress , or ultimately            the courts must resolve the
matter.     By then, the Government is in an untenable position.              It still
needs the weapon system, and forcing           the contractor     out of business will
not get it.      The Government cannot easily begin again with a new contrac-
tor because that could bring prohibitive           costs and delay; moreover,        it is
difficult     to transfer    technical   and engineering     knowledge from one con-
tractor   to another.

The only viable course is to introduce      flexibility,      belatedly,           by ignor-
ing the original    tight   contract terms, relaxing     specifications            realisti-
cally,  and providing     more money to get the job done.

Contract     structure

The S-3A contract       was developed in a period of transition                between the
former Department of Defense (DOD) administration                 and the present one.
It contains    features    reflecting      the procurement     policies      of both.      On
the one hand, it combines development and production                    in a single con-
tract,   and development is procured on a fixed-price                 incentive     basis.
(See p. 16.)      On th e other hand, it permits the Government to delay the
start   of various production         phases until prescribed         goals have been
reached in development,         or for 6 months, whichever          is earlier.       (See
p. 22.)    A full    discussion     of contractual    features      is in chapter 2,
pages 8 to 42.

The optimism that was characteristic               of previous major weapon acquisi-
tion programs seems to be present in the S-3A program.                     Department of-
ficials    have testified       that,    at the start    of any development program,
there are "driving        forces"     that make for a lack of realism and for a
sense of optimism.          Planners tend to overstate         the threat,     which means
overstated    requirements.          Technical    people, in both industry        and Govern-
ment, are always optimistic             about achieving    performance     characteristics,
the length of time development will take, and cost.                    The Government
wants the weapon system and the contractor                wants to produce it, so both
have incentive      to underestimate         costs so that the project       will be ap-
proved.
Evidences of optimistic           pricing       and a tightly   drawn contract   include
the following facts.
  --Navy's     cost estimate       for the development effort   was about $45 mil-
     lion,    or 11 percent       higher than Lockheed's estimate.    (See p. 13.)

  --Navy's   cost        estimate  for production        option lots was $60 million,      or
     6.5 percent         higher than Lockheed's         estimate.   (See p. 13.)

  --Lockheed's     price for the development effort   was some $30 million
     lower than its competitor,     although the Lockheed proposal offered                  a
     more sophisticated     weapon system.   (See p. 13.)

                                            2
.
         .
    *          --The records of negotiation       clearly indicate      that the Navy expects
                  Lockheed will experience      costs over target      on the development work.
                  (See p. 13.)

               --The basic    aspects of the contract      structure    that   impose substantial
                  financial   risks on the contractor      are:

                  1. The development portion       of the contract      is on a fixed-price      in-
                     centive    basis.    In any major weapon system development,           there is
                     a significant      degree of technical     uncertainty.      If unexpected
                     technical     problems are encountered,       the contractor    must bear a
                     major portion      of the resulting    financial     burden.

                  2. The contract   provides options for production      quantities   of air-
                     craft  under binding ceiling   prices.     Under such an arrangement,
                     the contractor    is subject to the effect    on production    of unex-
                     pected development problems.

             Although the Navy did not obtain more favorable            prices from Lockheed
             during negotiations   , it did require    certain    provisions     that had not
             been mentioned in the request for proposals.            These provisions      increased
             Lockheed's financial     risks,  yet they were accepted at no increase            in
             price.    The new provisions    included the Variable       Quantity    Option provi-
             sion and the Pricing     of Changes clause.       (See p. 14.)

             Additionally,      Lockheed had predicated      its proposal on the inclusion    in
             the contract     of a clause providing     for abnormal economic inflation      ad-
             justments     to each of the production      lot option prices.     The Government
             agreed to adjustments      for abnormal economic inflation        only with respect
             to the last two option lots.        Furthermore,      the abnormal inflation   cover-
             age that was agreed to is incomplete.             (See pp. 30 to 32.)

             Management controh
             The management controls   for the S-3A include Navy and contractor          project
             management organizations,    a contractor    performance  measuring and report-
             ing system, and various techniques       for program assessment by top offi-
             cials of DOD. Generally,     the controls    appear adequate,   if properly     ap-
             plied.

             Extent of ooncurrency
             The extent of planned      concurrency     between development      and production     of
             the S-3A is described      in chapter    4, pages 51 to 54.)


        MATTERSFOR CONSIDERATION
                               BY THE SUBCOMMITTEE
             Potential  problem areas are listed   in chapter 5, pages 55 to 59.                  Some
             of the more important   areas are described   below.
PossibZe      need for      reZief    for     contractor

The conservative   pricing   and tight structuring     of the contract    may force
the contractor   to seek relief     from the Government in order to continue
work.   (See pp. 8 to 15.)      Potential   events that could precipitate     such
a need and, thus, should be monitored        by the Subcommittee,    are

  --an increase    in the rate              of economic       inflation or even a continuance
     of the present rate for                a prolonged       time (see p. 55);

  --the      occurrence      of major       development       problems   (see p. 55);   and

  --ordering        by the Navy of minimum , or near minimum, quantities  of the
     aircraft,       as permitted under the production   options (see p. 55.)

Production       decision

A decision   on whether the S-3A will go into production          is scheduled in
February or March 1972.         That date may be premature and may not allow
time for technical      data from tests that would be available       in a few
months more to the decisionmakers.           Also, it appears that the decision
will be made in an atmosphere where program advocates are overly influ-
ential.    GAO believes     that consideration     should be given to conducting
an assessment of the S-3A, independent           of program management, prior to
the production    decision.      (See p, 56.)


Ccmcurmnq          of de~elqtmm-t           and produe-tion

Under the plan to start     production    before development is completed,
there is the real possibility       that,   after many aircraft     are manufactured
or in production,    tests will show that significant         changes are needed
to ensure an effective     weapon system.        Changes then would have to be
made to completed or partially        completed units and would require       sub-
stantial  additional    amounts of time and money.         (See p. 57.)

Responsibiliiy        for     total   system performance

The contract     purports   to impose total       responsibility      for performance  of
the S-3A system on the prime contractor              (Lockheed).      However, the Navy
negotiator    states that,     under some circumstances,         the Government must
pay for modifying       Government-furnished       equipment so that it will be
suitable   for use in the S-3A.          An attorney     for the Naval Air Systems
Command disagrees.        The variance     in interpretation       indicates    that a
dispute may arise in that area.            (See p. 58.)




                                               4
                                    CHAPTER1

                                 INTRODUCTION

        The General     Accounting     Office     has performed         an analysis
of the Department        of the Navy contract            for development       and
production      of the S- 3A aircraft        weapon system.           Our analysis
was performed       in response      to the request         dated July 9, 1970,
from the Chairman,         Preparedness       Investigating        Subcommittee,
Committee     on Armed Services,        United      States     Senate.     (See
app. I.>      In the same request,          the Chairman also requested
a similar     analysis     of the Department          of the Air Force con-
tract    for development       and production         of the Airborne        Warn-
ing and Control        System (AWACS).          The   AWACS    analysis    is  the
subject     of a separate      report.

       The Chairman expressed         an interest    in our opinions        on
the merits   of the management and contractual             aspects     of the
S-3A program and any potential           problem   areas that should be
monitored.     The Chairman wanted our analyses             to include      the
areas of contractual      structure,       cost and pricing      provisions,
management controls     and the extent         of concurrency     between
development    and production       in the S-3A program.

THE S-3A MISSION

       The mission    of the S-3A is antisubmarine             warfare:      to
 seek and destroy     hostile      submarines.       The S-3A is a twin-
jet engine aircraft       with a four-man         crew, designed       to oper-
 ate from an aircraft        carrier.      The jet engines will          be the
newly developed      TF-34-2 General        Electric    high-bypass       turbo-
 fan engines   developing       about 9,000 pounds of thrust             each.

        The heart of the S-3A weapon system will                      be its highly
sophisticated      and complex avionics              (aviation       electronics)
subsystems.       For example,       one of the key avionics                 subsystems
is the Univac general-purpose                digital      computer.        This com-
puter will     do such things        as preflight           checkout      of other
subsystems,     navigational        computations,           tactical      data process-
ing, acoustic      contacts      classification,            and weapon trajecto-
ries calculation        and will      indicate       when one of the subsystems
is malfunctioning.


                                          5
     We have included   an illustration      of the S-3A in order
to describe the overall   physical      dimensions of the aircraft
and point out such features as the folded wings and tail
that are characteristic   of carrier-based       aircraft.  (See
fig. 1, p. 7.1




                                 6
              .,..,_T   --.-- .___

          i


  .
t
Ri




      7
                               CHARTER2

                     CONTRACTUALARRANGEMENTS

CONTRACTAWARDBACKGROUND

       In late December 1967 the Navy issued requests for pro-
posals to the aircraft        industry.   Five major defense con-
tractors    responded.      Two of these contractors,   the Convair
Division    of General Dynamics and the Lockheed-California
Company of the Lockheed Corporation,          were awarded contracts
for contract     definition     in August 1968 and were requested
to submit firm cost and technical         proposals for engineering
development and production         of the S-3A.

       In August 1969 Lockheed was declared the winner of the
competition    and was awarded a fixed-price          incentive  contract
for the engineering      development of the S-3A and for six re-
search and development aircraft          at a ceiling     price of
$461 million:       The contract     also includes five options for
additional    aircraft.      The first   option lot (contract      lot
II) for two additional        research and development aircraft
was exercised on October 1, 1970. The other four options
are for production      aircraft.

       The contract was originally   structured   so that eight
research and development aircraft     were included in a single
lot.    However, for funding reasons, two of the research and
development aircraft   were placed in a second lot before con-
tract award, with six aircraft     remaining in lot I.

       The S-3A weapon system contract was the result of in-
tensive competition    during the contract   definition      phase.
In 1969, which has been labeled by the financial           community
as a disaster year for the aerospace industry,          the compe-
tition   was intensive  because both contractors      were seeking
the award of a contract     for development and production       of
the S-3A weapon system valued at about $1.7 billion.

      In a procurement environment such as this, the Govern-
ment has considerable   bargaining   power in establishing con-
tract terms and conditions.      Each contender tends to acqui-
esce to the Government's conditions     for fear that the other

                                   8
contractor   will accept and that this will result      in the loss
of the multibillion-dollar       procurement prize to the reluc-
tant contractor.        The Government and defense contractors
are well aware of the hazards of this procurement system.
Both competitors      for the S-3A program had encountered sig-
nificant   problems on prior Government programs:       General
Dynamics with its F-111 program and Lockheed with its C-5A
transport,    AH-56A Cheyenne helicopter,    and Short Range At-
tack Missile motor programs.
       The optimism that has characterized         prior major weapon
acquisition      programs also seems to be present in the S-3A
program.       At congressional    hearings DOD officials   have tes-
tified     that, at the beginning of any new development pro-
g--b     there are "driving     forces" which make for a lack of
realism and a sense of optimism.           Planners tend to overstate
the threat,      which means overstated     requirements.    Then the
technical      people, both in industry     and in Government, are
always optimistic       about the performance characteristics       they
can achieve, how long the development will take, and what it
will cost.       The user wants the new weapon system and the
contractor      wants to produce it, so both have a great incen-
tive to underestimate        the cost so that the project will be
approved.




                                   9
OVERALLMERITS OF CONTRACTUALARRANGEMENTS

      From a strictly      legal point of view, we are of the opin-
ion that the S-3A contractual         instrument    adequately protects
the interest   of the Government in that, except for the mat-
ter discussed on page 38, there are no obvious "loopholes"
or ambiguities    providing      an opportunity   for the contractor
to evade the apparent intent of the contract            clauses.   It
is our opinion that, if the S-3A contract            does contain a vul-
nerable feature,      it is the possibility      that unforeseen tech-
nical and/or financial        problems may prove that the contract
is too tightly    drawn in favor of the Government.
       The ultimate      purpose of a contractual       instrument      is to
define the rights and duties of the respective                parties     and,
at least in Government contracts,            to equitably     allocate     the
financial     risks to be assumed by the parties,             A contract
which places undue risk on the contractor--either                 by means
of contract       type or by means of too tightly         drawn risk-
allocating      clauses--may    fail because it will not allow deliv-
ery of an acceptable product within contractual                limitations.
The result      of such a contract      is that the Government pays
more than the contractual          price for the end product and
possibly     more than the price for which the end product
could have been secured had a more realistic               contract     orig-
inally    been entered into.        Thus, the recent proposed "re-
structuring"       of the C-5A contract     into a "fixed      loss" con-
tract,    in effect,     ignores the terms of the original           contract
document to allow delivery          of an acceptable end product.
While the financial        pressure forcing such restructuring
stems, in part, from the reduced levels of both defense and
commercial business,         the pressure may also be said to stem,
at least in part, from overburdensome contracts.

       The apparent economy of a tightly           drawn, tightly       priced
contract,     therefore,    may be illusory      because the total cost
to the Government may exceed the contractually                 stated amounts
by the amount necessary to deliver             acceptable end-items to
the Government in the event extracontractual                relief   is
agreed upon.       Further,   the efficiency      of the contractor        and,
therefore,     the interests     of the Government, may decrease to
a marked extent as contractor          officials     direct    their atten-
tion to the problem of searching out ways to acquire addi-
tional    funds, either by claims or changes within the

                                     10
   .


contract   scope or by building  a case for extracontractual
assistance   outside its scope.   This management concentration
on contractual    concerns, as opposed to the more important
concern of developing and producing an acceptable product,
can also spread to Government management as more emphasis
is placed on holding the contractor    strictly  to his contract
rather than on using reason and judgment to arrive at equi-
table solutions     to problems.
        As indicated    in the previous section,         the S-3A contract
was negotiated       in a highly competitive        atmosphere.     The re-
sult was that the contractor          made‘concessions       to the Govern-
ment which otherwise might have been resisted.                 The S-3A
contract,     at  least   on paper,    is  a "tough"    one,  preserving
to the Government the right to require performance within
contractual      cost constraints.        The problem of "buy in"--the
quoting of overoptimistic          cost, schedule, and performance
estimates with the hope of recouping during performance by
means of changes-- appears to have been prevented by the use
of the modified-total-package-contract              type requiring     cost
ceilings     for development and production           and the inclusion     of
a Pricing of Changes clause designed to control                contractor-
initiated      changes.

        It remains to be seen, however, whether cost estimates
made under the pressure of strong competition                for Govern-
ment business together with contractual              terms barring      later
recoupment will become problems in the S-3A contract.                     Lock-
heed has indicated        confidence    in its cost figures and its
ability    to meet schedule and performance requirements                while
remaining under ceiling.           However, the conservative          nature
of Lockheed's cost proposal,          the use of a fixed-price           incen-
tive features      for the development portion of a contract                call-
ing for inclusion        of a sophisticated      avionics package in a
carrier-based      airplane,     the options for production         quantities
of aircraft     under binding ceiling        prices,    and the failure        to
provide for adjustment in the case of abnormal escalation                      in
the economy until        the 5th contract year, could all combine
with Lockheed's already precarious            financial     condition      to
create a situation        where extracontractual        assistance     may be
necessary to allow completion of the contract.                  (Lockheed's
financial     report shows a net loss, after taxes, of $32.6 mil-
lion in 1969. Final settlement            with DOD to limit its losses
under the C-5A and Cheyenne programs is still                pending.)
                                        11
'We emphasize that we do not anticipate    that this will be the
 case.  However, it is our opinion that, if the contract
 becomes a problem in the S-3A procurement,     it will be be-
 cause of the contract's tightness   rather than its looseness.

 Fixed price    development    with    production   options

        In our opinion experience has shown that the use of
fixed-price       development contracts with binding production
options,      total package procurement,           is generally     inad-
visable     in a major weapon system procurement because of the
risk that contractually             imposed inflexibility       will bring
about contract         failure    if major development problems arise
or if the contract           is too tightly    priced.       The current phi-
losophy within DOD is that development contracts                    should be
on a cost-qpe         basis as opposed to a fixed-price             basis be-
cause of the increased flexibility               provided by the cost qpe.
Additionally,        recent pronouncements by top officials              of DOD
indicate      that development and production             of future weapon
systems may be contracted             for separately      rather than purchased
by so-called       total package or modified total package con-
tracts;    in fact, the most recent major weapon system to go
into engineering          development,    the B-l bomber, contains no
production       options.
       The structuring      of the S-3A contract   took place before
DOD established      the policies    described above. With the ex-
ception of the clause providing         that production  options are
to be slipped until certain development milestones           have
been passed or for 6 months, whichever is earlier,           the S-3A
contract   generally    reflects   the procurement policies    and
practices   which were in effect throughout most of the 1960's.

       In our opinion,   if the development risk has been deter-
mined to be sufficiently      low and pricing is realistic,   no
impediment exists to the use of a fixed-price       development
contract   or for that matter to the inclusion     of development
work with binding production      options in a single contract.
      The Navy chose to use a fixed-price     development con-
tract with binding production     options for the S-3A because,
in the Navy's engineering    judgment, the development risk in-
volved was sufficiently    low to ensure development within
contractually   required targets and/or ceilings.      Our visits
to Lockheed, to major subcontractors,     and to the Naval
                                      12
Development Test Center, Warminster, Pennsylvania,        disclosed
no major development problems.        We cannot conclude, there-
fore, that the determination       to use a fixed-price  develop-
ment contract with binding production       options in the S-3A
program was not a proper exercise of the discretion        vested
in the Navy contracting    officials.

Conservative      pricing

       However, as indicated        earlier,   several interrelated
factors   including,     but not limited     to, the use of a fixed-
price development contract          with binding production      options
could, under certain        circumstances,     combine to result     in
contract    failure.     A review of the records of negotiations
indicates     that the prices accepted by Lockheed in the S-3A
competition      may actually    have been so conservative       as to
lead to the possibility         that, under adverse conditions,         the
contract    ceilings   could be breached.
       This view is supported by the fact that the Navy's in-
dependent cost estimate for S-3A research and development
(lot I, which at that time consisted               of eight research and
development aircraft)        was some $45 million,           or 11 percent,
higher than the cost initially             proposed by Lockheed.          Fur-
ther, Lockheed's price for this work was some $30 million
lower than its competitorls            although,     according to negoti-
ation records,      the Lockheed proposal,           technically      speaking,
called for a more sophisticated             weapon system than its com-
petitor.     Finally,    the Navy's cost estimate for lots II
through V was some $60 million,             or 6.5 percent, higher than
Lockheed's cost estimate,           The Headquarters,          Naval Material
Command, approval of the Request for Authority                   to Contract
for the S-3A program stated, with respect to the conserva-
tive nature of the Lockheed proposal,                that, in view of the
admitted probability        that Lockheed would exceed target and
possibly    even reach ceiling         on lots I and II, “it would be
prudent, in this case, to budget on some other basis than
target price"      (the usual budget base).             Also, the Request
for Authority      to Contract stated that Lockheed's assumption
of a 70:30 cost-sharing         ratio in the development portion               of
the contract     (whereby Lockheed pays 30 percent of all costs
over target up to ceiling),            coupled with its conservative
lot I estimate and its agreement to be bound by variable                       op-
tion quantity      production     ceiling     indicated,     'Ia willingness      to

                                        13
assume considerably    more cost risk than is ordinarily            asso-
ciated with fixed-price    incentive  contracts."

       Although the Navy made no attempt during negotiations
to obtain more favorable        prices from Lockheed, it did re-
quire the contractor        to accept certain provisions       in the
contract which had not been mentioned in the request for
proposals.      Although these provisions       increased the con-
tractor's    financial    risks under the contract,       they were
accepted by the contractor         at no increase in price.       The new
provisions     included the Variable Quantiv         Option provision
and the Pricing       of Changes clause.

       Additionally,        Lockheed had predicated        its proposal on
the inclusion        in the contract     of a clause providing       for
adjustments     to-each of the production          lot option prices for
abnormal economic inflation.             The Government, however, would
agree to adjustments          for abnormal economic inflation          only
with respect to the last two option lots, thus the prices of
lots I through IV were left unprotected               from abnormal infla-
tion.    Since negotiation         of the contract,      inflation   has
increased at a rate significantly             in excess of that antic-
ipated by either party.            Although both the Navy and Lockheed
have expressed confidence           that ceilings     through lot IV will
not be exceeded in spite of the abnormal inflation                  experi-
ence, the absorption          of the unanticipated       inflation   within
the unescalated        ceilings    obviously   reduces the cost flexi-
bility   originally      contemplated     by the choice of a 130-per-
cent ceiling.

       Finally,     in April 1969, after negotiations     had been
completed but before the contract was awarded, the Director
of Defense Research and Engineering was briefed           on the re-
sults of negotiations.         At this meeting the Director     stated
his belief      that the Navy should require that the contract
include provisions       for delay of production    options until
such time as major development milestones          had been met.
The Deputy Secretary of Defense subsequently          agreed with
this recommendation.         The Navy then reopened negotiations
and included the Project Milestones         clause in the contract.
Lockheed accepted inclusion        of this clause at no increase



                                   14
in price,   although contractor    financial     risk was increased.
It was agreed to include,      in addition    to the Project Mile-
stone clause, a 6-months extension of the schedule for the
research and development portion        of the contract     in order
to render milestone accomplishments,         particularly     the avi-
onics portion    of the contract,    less risky.       This schedule
stretch-out    somewhat balances the increased financial          risk
represented    by the milestone requirement.




                                   15
CONTRACTDESCRIPTION

       The S-3A prime contract     continues the practice      followed
in recent major weapon system acquisitions          of obtaining     bind-
ing production    commitments at the same time development is
contracted   for.    This practice   was designed to obtain compe-
tition   in the pricing   of both the development and production
portions   of the required effort.        This feature is the most
important element of the so-called         total package procurement
concept.

       The S-3A program was the next aircraft      program in DOD
to go into full-scale    development following     the F-14 program.
Due to this proximity    and to the fact that the F-14 is a
Navy program, the F-14 contract      served as the chief example
for the Navy in structuring     the S-3A contract.      In most re-
spects the two contracts    are very much alike.       Important
differences   are noted in following     sections of this report.
       The S-3A contract        with Lockheed is a fixed-price               incen-
 tive contract.       The initial      phase of the contract          (lots I
and II) provides for design, development, and testing,                        and
 the furnishing     of weapon system data and eight S-3A research
and development aircraft           at a target cost of $371.2 million,
a target profit       of $44.6 million       or 12 percent of target
cost, and a ceiling         price of $482.6 million,            or 130 percent
of target cost.        These    target   and   ceiling     prices   reflect      the
movement of certain work from lot II to lot III and contract
changes through November 29, 1970. Under the fixed-price
incentive     formula, the contractor          is to receive 30 percent
of the amount by which his costs underrun target costs and
pay 30 percent of the amount by which his costs exceed the
target cost.       The Government receives or pays 70 percent of
the amount of costs under or over target cost, as applicable.
In a fixed-price       incentive     contract,      the margin between tar-
get and ceiling      prices and the cost-sharing              ratio are the
two most important        individual     factors      in the contract       in al-
locating    risks between the contractor              and the Government.

       The pricing   features of the research and development
portion of the S-3A contract      are similar     to those of the
F-14 contract,     except that the latter     contract provides for
a target profit     of 10 percent and a price ceiling      of 125 per-
cent.

                                         16
       Unlike the F-14 contract,        the S-3A contract    provides
for cost incentives        only; that is, no provision     is made for
profit   incentives      based on demonstrated weapon system per-
formance.      The contract,     however, does have a negative in-
centive against the late delivery           of the four aircraft      sched-
uled for the Navy's Board of Inspection           and Survey tests
(the first     four aircraft     in lot III).    The contract    provides
that specified      liquidated     damages will be assessed against
the contractor      for each day each of the four aircraft          is de-
livered    late up to a maximum of $3 million         for all aircraft.
      The S-3A contract    includes options for production   air-
craft in addition    to the research and development efforts
under lots I and II.     These options are discussed in consid-
erable detail   under a separate heading.

       Progress payments will be made at the rate of 80 per-
cent of the contractor's    total costs incurred under the con-
tract;   however, the aggregate amount of progress payments
may not exceed 71.5 percent of the total contract     price.
       Research and development,      in contrast to production,
involves the delivery     of relatively    little hardware which
could be billed     to the Government as deliveries      are made.
Therefore,    the S-3A contract    provides that partial    payments
will be made for research and development effort          (excluding
lot II effort)     on the basis of satisfactory     accomplishment
of specified     events.

KEY CONTRACT    CLAUSES

      This section of the report is devoted to evaluation       of
the clauses and provisions     of the S-3A contract,   which ap-
pear 9 in our judgment, to be most noteworthy.       Most of these
clauses are considered particularly     important because they
seek (as do the ceiling    price margin and the cost-sharing
ratio which were mentioned previously)     to allocate   the finan-
cial risks of unexpected events in performance of the con-
tract between the contractor     and the Government.
     One clause, the Project Milestone   clause, was selected
because of the importance attached to it by top officials     in
DOD. The S-3A marks the first   use of this clause in a de-
fense weapon contract.

                                     17
       The Restraint    of Competition     clause is discussed since
it represents     an attempt to avoid      some of the past problems
in subsequent purchases of spare         parts and assemblies di-
rectly   from actual manufacturers       rather than through the
prime contractor.       This clause is    relatively  new and has
been used previously       in only two   or three defense contracts.




                                  18
Clause granting   options to
purchase additional    quantities

      In addition   to lots I and II, which cover research and
development and the furnishing      of eight developmental  air-
planes, the contract     contains four options for production
lots of aircraft.      (See schedule below.)   The option for
the first  production    lot must be exercised by April 1, 1972,
if the milestones     have been successfully  demonstrated.
(See p. 23.)

                Schedule of Production      Lot Options

                                      Ceiling prices
              Range of                       for
             uuantities            median quantities              Option
Lots     Minimum Maximum        Quantity      Ceiling price        date
 III        7          26            17a     $    265,648,566     4-l-72
   IV      23          92            52a          379,221,527      2-l-73
     V     30          92            60           381,503,819    11-l-73
   VI      30         -92            62           383,243,983    lo-l-74

           90        302            pJ       $1,409,617,895

aCurrent plans indicate  that       four   aircraft   will    be shifted
 from lot III to lot IV.

       Lots I and II are to be considered together for final
pricing    with the ceiling   prices added together for this
purpose.      The price of each production      lot option (lots III
through VI) will be negotiated       separately     on a fixed-price
or fixed-price      incentive basis at the choice of the Covern-
ment.
       The ceiling  prices for the production          lot options are
contingent   upon authorization       of long-lead-time     funding in
accordance with a schedule set out in the contract.                Iong-
lead-time funding is required         to enable the contractor        to
begin production    of components which take exceptionally
long periods of time to produce.           Failure   to provide full
and timely long-lead-time       funding entitles       the contractor
to an adjustment in ceiling        prices and delivery      terms, as
may be appropriate.

                                    19
      The contract provides that prices for the production
 lot options may not exceed the ceiling     prices.     However,
the ceiling   prices may be equitably   adjusted as a result of
change orders and contract modifications       or as permitted
under various contractual     clauses or provisions,     such as
the funding-delay    adjustment mentioned above.       Perhaps the
best example of such a clause is the one providing         for ad-
justments for abnormal economic escalation.          (See p. 30.)

      Variable    quantity   option        provision
       The number of aircraft       in each production        option lot
can be varied about 50 percent,           either plus or minus.         For
example,    on  lot III the    Government     has the   right   to  order
from seven to 26 aircraft.          This is known as the variable
quantity    option provision.       Ceiling prices have been estab-
lished in the contract      for the varying quantities            of air-
craft which may be ordered under each option lot.                  The unit
price of each aircraft       in the lot will increase or decrease
depending on the quantity        ordered; that is, smaller quan-
tities   will mean higher unit prices and greater quantities
will   mean lower ones. The prescribed            delivery     schedule is
also subject to adjustment in accordance with guidance set
forth in the contract.

         The variable     quantity    option provision     allows the Gov-
ernment a considerable           degree of flexibility      under the con-
 tract.     For example, if progress in development is not as
good as desired,        the Government could order fewer than the
medianquantitiesunder            the option lots.      The same alterna-
tive would be useful if funding constraints               are imposed by
the Secretary of Defense or by the Congress.                  Extracon-
tractual     considerations,       however, may reduce the apparent
flexibility      provided by this provision.           In our review of the
F-14 aircraft       program for the Subcommittee, we found indi-
cations that, if the minimum lot quantities               permitted under
thatcontractwere         ordered, the contractor        might find it
necessary to seek extracontractual            financial     relief   from
the Government.

      In connection with the S-3A program, Lockheed offi-
cials have informed us that two of its major subcontractors
will not accept a variable  quantity  option provision   simi-
lar to the one contained in the prime contract;     the parties

                                      20
are still   negotiating   this matter, however.    Specifically,
these subcontractors    will not accept a subcontract      which
allows orders for less than the median quantities         of the
options as set out in the prime contract.        This situation
conceivably    could result   in substantial losses to the prime
contractor   if the Government chose to exercise the produc-
tion option lots in the minimum or near minimum quantities.

      Acceptance    of design   deficiencies

        The contract    contains specific       provisions     concerning
production    aircraft      in the event that the Government chooses
not to require correction           of a design deficiency       following
Navy acceptance tests (Board of Inspection               and Survey trials)
but, instead,     desires to continue procuring            the aircraft.
The applicable       specifications     for all aircraft       to be deliv-
ered in the future will be changed to reflect                 the perfor-
mance attained      during the tests.         The price of all aircraft
on order, both delivered           and undelivered,     will be adjusted
in accordance with the Inspection             and the Defects clauses to
reflect    the design deficiency.          The ceiling     price of air-
craft on option but not yet ordered will not be adjusted,
the rationale      apparently      being that the design deficiency
will be a factor in negotiating            the firm price or firm target
prices for the option lots when the options are exercised.

      On the other hand, if the Government chooses not to re-
quire correction   of a deficiency   in delivered   aircraft     but
to require its correction     in all others,   the specifications
will remain unchanged.     The nonrecurring    cost of correcting
the deficiency   in all lots will be charged to lot I, and a
downward equitable   adjustment will be made in the price of
those aircraft   in which the correction     is not required.

         The provisions    discussed here concerning the treatment
of design deficiencies         are of interest    primarily    because
they frankly       suggest the possibility     that the Government
may choose to accept an S-3A system with less performance
capability      than that specified     in the contract.       The same
provisions      were used in the F-14 contract.          The Navy advised
us that use of such provisions          in that contract      was consid-
ered realistic        since the Government generally        had accepted
less performance capability         in major weapon systems than
initially      specified.

                                    21
                                                            i)




Pro.ject   milestones

        The S-3A program is the first            major weapon system pro-
gram to provide,       by contract,        strong Government remedies
for the contractor's        failure      to meet specified      development
milestones     (also variously        called risk assessment milestones,
project    milestones,     progress milestones,          etc.).    This fea-
ture requires      that, until      the contractor       demonstrates that
development of the system has passed specified                  technical
milestones,     the Government may delay the actions it must
take, such as allotment          of funds and the exercising           of op-
tions for additional        aircraft,         MO ordering date can be ex-
tended more than 6 months, however, without loss of that
option as well as future options.                The development mile-
stone provision       represents      an attempt to avoid the adverse
situations     associated with entering production              before sig-
nificant    problems of development are solved,
       The development milestone feature subsequently has
been included,    in one form or another, in the following  de-
fense contracts     for major weapon systems:  Airborne Warning
and Control System (AWACS), the P-15, the B-l, the
AN/TPQ-27 ground-directed     bombing system, and the AZd/TPN-19
landing control     system.

        Top officials     of DOD have indicated       that milestones
will be included in all future major weapon system develop-
ment contracts        in which substantial     degrees of development
risk are present.         A special study group established         by the
Deputy Assistant        Secretary of Defense (Procurement)         recently
completed a review of development milestones              as related to
defense contracting.          The groupss recommendations for Armed
Services Procurement Regulation            (ASPR) coverage of mile-
stones was communicated to the ASPR Committee.               The proposed
coverage is confined mainly to broad, policy-type               discus-
sion and provides flexibility          to Government procurement of-
ficials    in devising milestones        for particular    contracts,

      We believe that the milestone provision,   in appropriate
cases, should be a useful device in helping the Government
avoid committing large sums of money to production    before
major development problems are solved.     The success of this
new feature,    in those cases where it has been used, can


                                     22
only be determined by experience.    Sufficient         time has not
yet elapsed to permit such a determination.

       Top officials   of DOD have recently      announced changes
in procedures for acquiring        major weapon systems which, in
our opinion,     will greatly   reduce the need for development
milestone provisions      in contracts.     The important    changes
in this regard involve acquisition         of a weapon system under
separate development and production         contracts   and using a
cost-type   rather than a fixed-price-type        contract   for de-
velopment where significant        development risk is present.
The most recent major aircraft        weapon system to go into en-
gineering    development,    the B-l bomber, reflected     these
changes.

      The best application     of the milestone concept in con-
tracts appears to be where both development and production
are covered under one contractual       effort    (i.e.,  total pack-
age procurements).      In contracts  of this type, exercise
of production   options can be made dependent upon meeting
the milestone   development events.      Development milestones
are established    by the B-l contract;     however, the contrac-
tor's failure   to meet these milestones       results   only in a
lessened award fee.

      The use of a milestone provision    in a contract   for de-
velopment only,seems even less useful if the contract        is on
a cost-type  basis.   This is because the Government bears
essentially  all financial   risks under a cost-type    contract,
thus no strong penalties    can be put into such a contract       to
motivate the contractor    to meet the designated milestones.
      Milestones   in the S-3A contract

       Five developmentmilestonesare            provided for in the
S-3A contract.        The first     two milestones,     1 and 2, are re-
quired to be demonstrated on or before March 15, 1972, as a
prerequisite      to ordering production        lot III by April 1,
1972. The critical         antisubmarine     warfare avionics    data
processing,     control,    and displays must be successfully         in-
tegrated     in the laboratory       for milestone     1. This means
that critical       avionic subsystems must be able to intercon-
nect and to "'talk to one another."             It means also that,
with a given laboratory          signal input, the proper computer

                                    23
actions must take place, data must properly              interchange      be-
tween the various pieces of avionic equipment, and the
proper information       must be displayed    on the televisionlike
screens.       Although this is an important      demonstration,       it
does not guarantee that these critical           avionic units will
perform in the same manner outside the carefully                con-
trolled     laboratory   environment.    Milestone     2 is a 30-minute
first   flight     of the S-3A (the airframe and engines without
avionics)      to demonstrate the aircraft's      ability      to fly.

       The significance    of these milestones   is that the most
risky elements of the avionic system will have been con-
figured and integrated      to the point where they successfully
meet mission requirements       at least in the laboratory  and
that   the engine and airframe have progressed to a point
where all preflight     requirements    have been met and safe
operation   of the airframe and engine together are possible.

         The second two milestones,          3 and 4, are required to be
demonstrated on or before January 15, 1973, as a prerequi-
 site to ordering production           lot IV by February 1, 1973.
Milestone 3 is an evaluation             of the flying     qualities    and
performance and a demonstration              that the airframe and engine
will fly within the design flight               envelope; i.e.,      speed,
altitude,     loiter    capability,      fuel consumption, maneuver-
ability,     etc.    Milestone 4 is an assessment of the avionics
performance during the flight             test program which utilizes
a P-3 aircraft       as a flying     laboratory.       It should be noted
that these milestone events separately                assess the flying
qualities     of the S-3A as an air vehicle and the performance
of its avionics       in the detection        of submarines and in with-
standing a typical        flight    environment.

       The fifth    and final milestone is the delivery        of S-3A
aircraft   configured     for the Board of Inspection       and Survey.
This delivery     is scheduled on or before October 15, 1973, as
the prerequisite      to the Navy's exercise of the option for
60 additional     S-3A aircraft   in lot V by November 1, 1973.
It  should be noted that this delivery        is only the start of
a series of Navy tests and evaluations          culminating    in the
formal acceptance of the S-3A. This apparent concurrency
risk should be tempered by the fact that, prior to Octo-
ber 15, 1973, the Navy is planning to conduct a series of
five preliminary      evaluations   to monitor and verify      the

                                     24
progress of Lockheed's flight     test    program on the original
eight developmental   S-3A aircraft.

        The purpose of these Navy preliminary        evaluations      is
to provide assurance that the first          four production     air-
craft are indeed ready for Board of Inspection             and Survey
trials.     In recent years, the Navy has been modifying its
development approach to place additional           emphasis on the
preliminary     evaluations.     The Board of Inspection      and Sur-
vey testing,     which in itself    requires    the existence    of pro-
duction aircraft,       is not a high-risk    element in the complete
evaluation     sequence.




                                   25
Ordering-Date     Extension

      In addition      to the Project Milestone clause the S-3A
contract   contains another new clause which is somewhat sim-
ilar in that it permits the Government to delay exercising
production    options.       This clause, called the Ordering-Date
Extension clause, states that the Government may unilaterally
extend the ordering date for an optional             lot of aircraft   for
a reason other than one which would entitle              it to such an
extension under the Project Milestone            clause.    The maximum
amount of time a date may be extended under this clause is
4 months.     Little,     if any, financial    risk accrues to the
contractor    due to this clause since the Government must con-
tinue to fund the contractor's          progress during the option
slip.    Contract     prices   or other  terms of the contract are
not affected     as a result of extending an ordering date under
this clause.
      A DOD official    acquainted with this clause told us that
it was included in the S-3A contract        as protection   against
delay in the passage of a DOD appropriation         bill.   The
clause would serve to allow 4 additional        months for funds to
become available     to permit exercise of an option.       A similar
clause is included in the Air Force AWACScontract.            That
clause, however, allows a slip of 14, rather than 4, months
and applies only to the first      production   option lot.

Defects

       The Defects clause contained in the S-3A contract                 is
 essentially      the same as the clause used by the Navy in the
 F-14 contract       and is designed to extend contractor         liability
 for defects in workmanship or material           or for failure       to
meet specifications         beyond the time of Government acceptance.
 Because the exercise of production          options is not tied to the
 completion of Navy Board of Inspection           and Survey trials,
the likelihood        exists that production     aircraft    will be ac-
cepted before these trials         are completed.        Since these
trials    can be expected to pinpoint       defects requiring        correc-
tion, the Defects clause extends the Government's right to
correction      for either 1 year from the date the last aircraft
is accepted for Navy Board trials          or 2 years from the date
the first      such aircraft    is accepted, whichever is earlier.
Alternatively,        the clause provides for downward equitable

                                    26
adjustment in contract   price should the Government elect to
accept defective  or nonconforming   supplies without correc-
tion, during the warranty period.

        The clause disclaims   any implied warranties      of merchant-
ability    or fitness   for a particular    purpose and, in a de-
parture from the standard ASPR Inspection          clause, limits   the
Government's right to correction         of latent defects (those
not evident upon proper inspection),         with regard to all but
the first     six research and development aircraft,       to the
same periods stated above for patent,          or obvious, defects.
       Finally,     the Defects clause states that the contrac-
tor's liability,       "for the destruction      of or damage to an
aircraft     resulting    from an accident proximately       caused by a
breach of the warranty,"          shall be limited    to $100,000 for
each occurrence.         In return,    the contractor   warrants that no
charge for insurance is included in the contract              price for
such damage.

      Although costs incurred     for correction   of defects are
allowable for purposes of determining        final contract    price,
no adjustments   for correction    of defects are permitted       by
the clause in target cost, target fee, or ceiling          price nor
is any adjustment permitted     for defect correction      after a
final contract  price is established.

       The purpose of the Defects clause is to provide the
Government with time beyond acceptance to discover        and re-
quire the correction   of defects and, at the same time, to
provide assurance to the contractor    that his liability     will
not extend beyond that explicitly    set out in the contract.

       The limitation       of potential     contractor    liability    under
warranty is an important          consideration      from the Government's
viewpoint    because it is designed to eliminate              the inclusion
of contingency       amounts, either hidden or identified            as such,
in contractor       proposals,   particularly      in areas where there
is little    likelihood      that the Government would or could en-
force contractual        rights to correction        or replacement.

      For example,     in its request to the ASPR Committee for             a
blanket deviation      from the ASPR requirement of unlimited


                                      27
liability     for latent defects,           the Navy pointed out that, al-
though contractors          could justifiably        be expected to include
"substantial      price increases"          to cover unlimited   latent de-
fect liability,       little     likelihood      existed that the Govern-
ment would derive any benefit               from such extended liability
because of the probability              that most latent defects would be
discovered      before the expiration           of the warranty period and
therefore     be correctable        and because of the difficulty        of
establishing      that a defect discovered            after the warranty pe-
riod is, in fact, latent.

         Contractors   have stated that in the past it has not
been the practice       of the Government to require contractor
liability      for proximate damages and that as a result contrac-
tors have generally        not insured against such liability       nor
have they included contingency         amounts in their contract
prices to cover such potential         loss.     However, the question
of whether the Government should enforce proximate damage
liability      has been raised recently      and has been brought to a
head by a pending lawsuit in which it is contended that a
Government prime contractor         and a subcontractor    are jointly
liable     for the value of an aircraft       lost as a result of the
malfunction       of an inexpensive   component part.

       The consensus of both Government and industry            opinion
seems to be that contractors--particularly           relatively     small
subcontractors    --should not be exposed to the potentially            cat-
astrophic    financial    loss which the loss of an aircraft         or
other proximate damage would impose on them and that such
potential    loss cannot be economically      insured against.        They
feel that the Government should, therefore,           be a self-
insurer in this area.         While the subject was being considered
by the ASPR Committee, no regulation         had been issued and the
$100,000 limitation       in the S-3A Defects clause appears to be
a fair resolution      of the problem.

      Although the warranty rights reserved to the Government
by the Defects clause confer a potentially         valuable benefit
upon the Government, some question exists as to the extent
to which the exercise of such rights is feasible.           The prob-
lems of identifying     and correcting   defects after field de-
ployment could well result      in the failure   to correct defects
for which correction     would be required by the clause.       One
of the most significant     of these problems is the one of

                                    28
proving that an apparent defect in an item which has been in
the hands of the Government for some time is an actual de-
feet; that is, proving that the defect is the fault of the
contractor  rather than the Government.
       We understand that the Defects clause was used in the
S-3A contract at the insistence       of the contractor.       Presum-
ably, the contractor       prefers the treatment accorded latent
defects and proximate damages by the Defects clause since,
in other respects,      the Defects clause seems more favorable
to the Government than the Inspection        clause.    This is sig-
nificant   since it would indicate     the contractor    believed
more financial     risk attached to latent defects and proximate
damages than it did to the possibility        of losses due to the
additional    time provided by the Defects clause for the dis-
covery and correction       of patent defects (the warranty provi-
sion).




                                   29
Economic Escalation

      The Economic Escalation         clause provides,    in effect,
that, if future economic inflation          varies significantly       from
that estimated for the purpose of pricing            the contract,     the
contract    ceiling     price will be adjusted upward or downward,
accordingly.        This clause, however, is only applicable         to
the last two lots provided         for by the contract--lots       V and
VI.   The options for these lots are to be exercised in cal-
endar years 1973 and 1974, respectively.

        The escalation    clause provides protection         to the con-
tractor    for only so-called       abnormal inflation.       Protection
against ordinary       or anticipated     inflation   is provided for
in the prices negotiated         for each contract      lot.   In prepar-
ing its price proposal,         Lockheed included a factor for in-
flation    based on a price rate increase of 4 percent per
year for material       and 3 and 3.5 percent per year for labor
 (depending on the type labor).
       In essence, the escalation        clause provides for adjust-
ments to the ceiling       price of lot Vif       actual price levels
at March 31, 1973, vary more than specified             amounts from
the levels predicted       for this date.      The option for lot V
is to be exercised by November 1, 1973, some 7 months la-
ter.    The ceiling    price for lot VI is similarly        adjusted
for actual price levels at March 31, 1974. The option for
this lot must be exercised by October 1, 1974, or 6 months
later.    The significance      of these dates is discussed in a
subsequent paragraph.         The predicted    levels are based on
rates slightly     higher than those used by the contractor          in
preparing his proposal.         Price levels will be determined by
reference   to certain     Bureau of Labor Statistics       indexes.

        As calculated   by Lockheed using the indexes specified
in the escalation      clause, inflation   has been increasing     at
an annual rate of 6.22 percent for material          and 6.35 per-
cent for labor.       These rates contrast    sharply with the
4-percent     rate for material   and the 3- and 3.5-percent
rates for labor which were used in establishing          the option
ceiling    prices.    The Lockheed calculation     was based on ex-
perience for the 3-year period ending September 1970 for
material    and for the. 3-year period ending July 1970 for la-
bor.

  ,                                 30
       As noted above, the escalation     clause is applicable
only to the last two production     lots.     Based on median
quantities,    the ceiling prices of 69 production      aircraft,
or more than one third of the total production         aircraft   un-
der option, are thus unprotected      from abnormal inflation      as
are the prices for the two research and development lots.
If rates of economic inflation     continue at present levels,
the lack of abnormal inflation     protection    until  lot V could
place a heavy economic burden on the prime contractor.

        The contractor     originally      proposed inflation        coverage
on all lots, including         lot I, applicable       retroactively       to
actual costs.       When the Government stated that this ar-
rangement would not be accepted, Lockheed revised its pro-,
posal by raising       its proposed profit        rate in lot I from 10
percent to 12 percent (but with no increase in ceiling
price).      One of the Government negotiators            of the S-3A con-
tract advised us that the Government felt the 130-percent
ceiling    prices,   together with the other pricing             provisions
in the contract,       provided sufficient        protection     to the con-
tractor    in connection with work up to lot V. He explained
that, in early 1969 when the contract              was negotiated,        no
one anticipated      that inflation       would reach and stay at the
level it has. He further            stated, in retrospect,         that ab-
normal inflation       coverage of the early lots should have
been allowed.

       The abnormal inflation        coverage for lots V and VI is
incomplete.       As noted on the previous page, these lots are
required to be ordered 7 and 6 months, respectively,                subse-
quent to the dates on which any economic escalation                adjust-
ment to their prices will be determined.             Production     effort
relative    to each lot (except for relatively          minor long-
lead-time     effort)   occurs over an approximate Z-year period
following     option exercise.       This means, assuming the op-
tions are exercised at the latest            dates possible,    that work
in connection with lots V and VI will not be completed un-
til approximately        2% years after their prices have been
adjusted for abnormal inflation           and that no further      adjust-
ment will be made for any abnormal inflationoccurring                 dur-
ing these periods.          Furthermore,   the escalation    clause does
not allow slipping        the dates which determine the escalation
price adjustments       in the event the option ordering dates
are slipped under the Project Milestone or Ordering-Date

                                      31
Extension clauses.   This incomplete coverage of abnormal
economic escalation  on lots V and VI could also place a
heavy economic burden on the prime contractor.




                             32
Pricing   of Changes

       The Pricing of Changes clause was devised to discour-
age vast numbers of contractor-initiated         engineering    change
proposals and to provide stronger Government controls            over
technical    changes deemed desirable      or necessary.     On many
prior major weapon system programs, large numbers of tech-
nical changes were made. The resulting          contract   changes
were usually authorized       by the Government before they were
priced or, in many cases, even before formal estimates of
their costs were received.         It was felt in many Government
quarters that contract      changes were being used by major
weapon system contractors       to "get well" under contracts
 (eventually   make a profit)    which they had "bought into";
i.e. had accepted at unreasonably        low prices.

        In the 16 months between the signing of the S-3A con-
tract and November 29, 1970, only 18 contract modifications
affecting     price were made. These changes in total de-
creased the combined target price of lots 1 and II by some
$8 million.        (Work valued at another $8 million       was trans-
ferred from lot II to lot III.)            This is considered a very
small number of changes in comparison with prior aircraft
contracts     which did not contain such a clause,          The S-3A
contracting      officer  attributes    the relatively   small number
of changes to the Pricing          of Changes clause and to the
tightness     of the S-3A program budget,

      This clause seeks to control        engineering   change pro-
posals in four major respects.         First,   it provides that
changes valued at $35,000 or less be made at no change in
contract    price and that changes valued between $35,000 and
1 percent of the original      cost of the production       lots af-
fected by the change be negotiated         at a lesser profit     rate
than would normally be expected.          This  feature   was  appar-
ently designed to discourage an excessive number of small
contractor-initiated     engineering    change proposals and also
to reduce the administrative       costs of processing      such small
changes.

      The second controlling  feature of the clause stipu-
lates that the price negotiated    for each change shall not
exceed the target price or ceiling     originally proposed by
the contractor  for the change.     In the case of changes

                                  33
which would result   in reduced rather than increased costs,
the clause states that the price reduction    negotiated for
the change shall not be less than the price reduction    pro-
posed by the contractor.

         The third controlling     feature of the clause provides
that the binding price ceiling          or minimum price reduction
accompany the engineering         change proposal when it is sub-
mitted to the Government.          The fourth feature is not ex-
plicitly     included in the clause.        We were told by a Navy
attorney,     however,  that   it  is  implicitly       included.     This
feature provides that the prices of proposed changes iden-
tify the impact of the change not only on the authorized
portions     of the contract but on the options as well.                The
last three features       discussed are designed to ensure that
the Government will have available            realistic,      timely,   and
complete cost estimates when it makes its decision as to
whether a contractor-proposed          change should be adopted.

      The scope of the Pricing of Changes clause is narrowed
by the fact that certain types of engineering          change pro-
posals are excluded from coverage.          One of the most signif-
icant exclusions    has to do with proposals submitted by the
contractor    in connection with the value engineering        pro-
gram established    by the contract.       Value engineering    pro-
grams are established      to encourage elimination     of "nice to
have"' but unessential     technical  features.    The clause does
not apply to certain      other types of engineering      change pro-
posals.    Among these exclusions     are proposals resulting
from requirements    for improvements in the S-3A aircraft
which would overcome deficiencies        in Government-furnished
equipment and proposals which would change the basic mission
of the S-3A system.

       Lockheed officials indicated    to us that this clause,
together with the current economic climate,       makes it haz-
ardous for the contractor    to propose changes.      These offi-
cials stated that the provisions     requiring   binding price
proposals at the time a change was proposed had already re-
sulted in some losses to the company. They indicated         that
their course in regard to future change proposals would be
 (1) to not bother with smaller changes, (2) to make no
change proposals at all unless they were relatively        sure


                                     34
the change would "sell"  (a change proposal costs from
$3,000 to $4,000 to prepare),   and (3) to include a contin-
gency factor of from 5 to 50 percent as a separate line
item in all proposals in order to overcome the potential
loss represented  by the binding ceiling  estimate.
      Government control over contract       changes is further
strengthened     by the requirement   that all engineering     change
proposals and all requests for deviations         from or waivers
of specifications      must be prepared in accordance with
MIL-STD-480 (Military      Standard, Configuration    Control-
Engineering     Changes, Deviations   and Waivers) dated Octo-
ber 30, 1968. We were advised that this military           standard
provides tighter     Government control    over contract   changes
than did the Navy document which it replaced.

        It seems likely   that an undesirable     side effect of the
Pricing of Changes clause, and perhaps of MIL-STD-480 also,
will be to discourage the contractor         from proposing im-
provements in the S-3A weapon system which the Navy would
want and would approve if proposed.          Another possibility   is
that the binding ceiling       price provision    may cause the con-
tractor    to propose inflated     ceiling  prices for changes,
which could result      in Navy disapproval.




                                 35
Installment     Funding

       This clause is designed to limit the Government's fi-
nancial obligation    to the contractor      at any given time to
predetermined    amounts.    Another purpose is to impose cost
discipline    on the contractor.      The clause is limited to the
research and development portion of the contract           (lot I)
since research and development is incrementally          funded,
whereas production    if fully    funded.

        This clause establishes    a funding schedule by which
the Government is required to obligate money to the contract
for lot I. The schedule, as amended, shows the dates by
which each of 18 funding installments        will be made and the
amounts of each. The total of these installments          is the
target price of lot I. The contractor         may request that the
Government provide funds at a more rapid rate than required
by the schedule, but the Government is not obligated          to
satisfy     such a request.    Change orders affecting   contract
price similarly      affect the funding schedule.

          This clause has the effect of limiting             payments to the
 contractor        in connection with lot I effort          by limiting    obli-
 gations in accordance with the schedule.                  Further,   and most
 importantly,        the clause specifically         provides that, in the
event of contract          termination,      the Government's termination
 liability       to the contractor      for lot I be limited        to the
total funds then obligated             as provided in the schedule.          As
noted previously,          the installment       funding schedule is based
on target price.           This would indicate        that, although the
contract       is on a fixed-price        incentive    basis and thus has a
ceiling       price higher than the target price, the contractor's
reimbursement,          in the event of termination,         would be limited
to target price.           It seems unlikely,        however, that the con-
tractor      would allow his funding protection,             as provided by
the Installment          Funding clause, to lag significantly           behind
experienced costs before he would request the Navy to in-
crease the amounts set forth in that clause.                    This stimulus
to the contractor          is beneficial      to the Government in that
it encourages the contractor             to bring cost growth situa-
tions to the Government's attention                 at an early date.

       The clause states that, if the Government fails   to ob-
ligate   an installment  by the date specified, such action

                                      36
shall have the effect      of the contracting   officer's      ordering
the contractor   to stop    all work under the contract        pursuant
to the Stop-Work-Order      clause.   Stop-work orders can result
in additional   costs to    the Government and to adjustments          in
the delivery   schedule,    as can other provisions       of the con-
tract.

        A similar    clause is contained in the F-14 contract,         A
closely related clause known as the Limitation             of Govern-
ment Obligations        clause has been used in recent Air Force
contracts,      including    the F-15 and the AWACScontracts.        The
chief difference        between the clauses used by the two ser-
vices is that the Air Force clause requires           that the con-
tractor    request adjustments       in the specified   funding several
months (generally         17) in advance of the period in which the
additional     funding is required.       Because of this feature
the Air Force clause seems even more restrictive             on the con-
tractor    than the Navy clause.




                                   37
Performance responsibility--
prime and associate contractor            relationships

       Under the terms of its prime contract,         Lockheed is
charged with responsibility       for total system performance.
The significance     of a contractual    provision     placing perfor-
mance responsibility     on the prime contractor        is governed by
the amount of Government-furnished         aeronautical      equipment
called for by the contract.        The provision     in the S-3A con-
tract is of some significance        because Government-furnished
aeronautical    equipment accounts for approximately           19 percent
of the total program price.        Engines and accessories,        elec-
tronics   and communications,     armament and support are all
furnished    by the Government.

       The prime contractor's     responsibility   for total system
performance,    however, is contingent      on the Government's fur-
nishing it with subsystems which are "suitable         for intended
use," which the contract      states

       "shall    be deemed to require that the Government-
       Furnished Aeronautical       Equipment conform to the
       specifications    and acceptance tests therefor     cited
       in said detail    specification."

        We were advised by an attorney         in the Office of the
General Counsel, Naval Air Systems Command, that the lan-
guage contained in the S-3A contract was designed to over-
come a jet engine integration           problem encountered in the
F-111 aircraft,     in which a dispute arose as to whether the
Government or the prime contractor            was responsible      for an
engine problem which developed during flight              testing.       The
intent of the language, in the eyes of its authors,                  is to
clearly    impose liability      for later failure     of Government-
furnished    aeronautical     equipment on the prime contractor
once the equipment has passed prescribed             acceptance tests
and has been accepted by the Government.              Thus in the case
of a jet engine, if acceptance testing             is prescribed       by the
Government-furnished        aeronautical     equipment contract        speci-
fications    to take place on the ground, failure            to meet the
requirements    of the prime system specification            for in-flight
performance after delivery          of the tested equipment to the
prime contractor     would be the prime contractor's            responsi-
bility.

                                     38
       However, the position        taken by the Navy's contract     ne-
gotiator    in discussions      with us, which position    is also sub-
scribed to by the contractor,           is that, if it can be shown
that a subsystem-- though meeting the specification            and tests
required    by the subsystem contract--does        not permit the
system prime contractor          to meet the prime system specifica-
tion, then the prime contractor           will be relieved   of perfor-
mance responsibility       until    the defect in design or workman-
ship is corrected      and the Government will bear the cost of
correction.

       The Government has traditionally      had problems in fur-
nishing suitable   equipment to contractors.         Should a prob-
lem occur in Government-furnished       aeronautical    equipment
after delivery   to Lockheed and should the stricter         interpre-
tation of prime contractor    responsibility      be advanced by
the Government, a dispute almost certainly         will arise as to
whether the Government or Lockheed must bear the cost of
correction.

       The approach taken by the Air Force in recent major
system contracts      accords with the strict         interpretation
placed on the Navy provision          in that the Air Force places
complete responsibility        for the integrated        performance of
Government-furnished       equipment on the prime contractor             once
the Government-furnished         equipment has been formally          ac-
cepted by the prime contractor.            Protection      is provided the
prime contractor,      however, in that he is not required             to
accept Government-furnished          equipment until he has agreed
in writing     as to the design and/or performance characteris-
tics of the Government-furnished           equipment; the inspection
and acceptance test procedures specified;               and the confor-
mance of the Government-furnished           equipment to such design,
performance,      and test requirements.        No similar      "sign off"
protection     is contained    in the S-3A performance responsi-
bility    provision.

       To escape as many potential        problems connected with
this requirement     as possible--particularly       integration
problems--the    S-3A contract     provides that Lockheed enter
into written    agreements with major Government-furnished
aeronautical    equipment suppliers       (termed "associate     con-
tractors"),   which are designed to encourage and/or require
exchange of data and coordination          between the prime and

                                     39
associate   contractors    with respect to integration       of
Government-furnished      aeronautical  equipment with the prime
weapon system; proposed specification         changes, deviations,
or waivers;   and failure     of Government-furnished      aeronautical
equipment to comply with specifications.           Costs associated
with the agreements between prime and associate contractors
are allowable costs under the respective          contracts.

      These agreements are implemented by the establishment
of formal boards composed of representatives        from the prime
and associate   contractors    (but not from the Government),
which monitor problems as they arise so that those problems
can be resolved expeditiously.       The requirement    for a formal
agreement was first     used in the F-14 contract,     although we
were advised at the time our F-14 report was prepared that
contractors   have typically    set up informal arrangements to
accomplish the same purposes.




                                  40
Stop-Work Order

       The Stop-Work-Order      clause of the S-3A differs      from the
norm in that, while the ASPR-specified          clause precludes ter-
mination for default      following    a stop-work order, the S-3A
clause confers on the Government the right to terminate             the
contract   for either default       or convenience at the expiration
of a stipulated    period.      The ASPR stop-work-order     clause
states that the Government may stop work for up to 90 days,
while reimbursing     standby costs.      At the end of that time,
the Government must either cancel the stop-work order or
terminate    the contract    for convenience.      The S-3A clause, on
the other hand, sets a 30-day limit on the stop-work order
itself   but provides an additional       60 days if termination      is
to be effected    so that the Government may determine whether
such termination     should be for convenience -or default.
       In its request to the ASPR Committee for a deviation
from the prohibition         against default       termination     following
a work stoppage,       the   Navy   stated   that,    upon  determination
that a program of the magnitude of S-3A should be canceled,
additional     time as allowed by the 60-day provision                 is ap-
propriate    for completion of the "formidable               task" of assess-
ing the feasibility         of default     as opposed to convenience
termination      in order to save the extra expense which would
be incurred      if work were allowed to continue pending such
assessment.        Representatives      of Lockheed, however, ex-
pressed the apprehension          that the 60-day provision            could
provide an incentive         to the Government to strain to convert
what would otherwise be a convenience termination                    to one for
default    by searching out technical           but not necessarily          im-
portant deviations        from contractual       requirements.

      Records show that the 60-day feature of the Stop-Work-
Order clause was designed to come into play only in a situa-
tion where termination     is deemed necessary and that the
60 days provided by the provision      was to be used for an
analysis,   in good faith,   of whether the termination   should
be for convenience or default.

Restraint    of Competition

       The so-called  Restraint     of Competition clause requires
that   all data, including    limited   rights data (that which a

                                      41
contractor     furnishes     to the Government or a subcontractor
for explicitly       limited    purposes) furnished     by the contrac-
tor to vendors or subcontractors            for use with regard to the
S-3A contract,       be furnished     to the subcontractors      and kept
up to date without payment.            This clause is included in
order that the Government may purchase directly               from the
subcontractors       and vendors additional      supplies and/or ser-
vices to be used in connection with the S-3A without paying
fees or royalties         to the prime contractor.

        Although this clause does not permit the general dis-
semination of limited        rights data, it does require the con-
tractor     to give up rights in the affected      data for purposes
of present or future buys of spare or replacaent            parts re-
lated to the S-3A airplane.         The clause has application      to
the present contract        as well as to any follow-on    contracts.
This represents      a departure from usual practice      and requires
the contractor      to relinquish   a right without any compensa-
tion.

       The purpose of the clause is to grant the Government
the right to make later purchases of spare or replacement
parts for the S-3A from subcontractors        or vendors where
there is no contribution,       other than the data, by the prime
contractor.     Also, the clause helps overcome the problem, at
least with respect to subcontractor-furnished        parts, of the
wholesale marking by prime contractors        of component part
data as "proprietary"      thereby placing on the Government the
burden of challenging      any markings considered to be inap-
propriate   through a rather cumbersome ASPR-required process
if sole-source    repurchase from the prime contractor      is to be
avoided.

       The Restraint    of Competition   clause is in the contract
because it was demanded by the Government, and the Govern-
ment's strong bargaining      position   resulted    in its acceptance
by Lockheed.      A possible  side effect of using the Restraint
of Competition     clause in prime contracts      could be to en-
courage the prime contractors        to perform work in-house which
otherwise would have been economically          subcontracted.     This
incentive    would be due to the prime contractor's         desire to
retain its data rights.       Such an effect could work to the
disadvantage    of the Government in some cases and could have
implications    for the small business community.

                                   42
                              CHAPTER3

                        MANAGEMENT
                                 CONTROLS

PROJECTMANAGEMENT
                ORGANIZATION

       As in other major weapons system acquisitions,           manage-
ment of the S-3A aircraft        program is vested in a project
manager.     In accordance with usual Navy practices,          the S-3A
project   is lthorizontallytl    rather than slverticallyfl    struc-
tured.    Accordingly,      the S-3A Project Manager draws most of
his support from other, organizationally          independent,     ele-
ments within the Naval Air Systems Command rather than from
a large staff which reports directly         to him,

      Lockheed's S-3A project  office       has complete authority
to direct and control  its functional        organizations.

PERFORMANCE
          MEASUREMENT
       DOD Instruction       7000.2 provides for the application     of
uniform DOD criteria         to contractor    management systems under
major weapons contracts.           The instruction   requires  the use
of cost/schedule        control   systems criteria   by the contrac-
tor's   internal    management to provide an adequate basis for
responsible      decisionmaking     by both contractor    management
and DOD components.
        The contractor   management systems must provide data
which (1) indicate      work progress,    (2) properly   relate cost,
schedule, and technical      performance,     (3) are valid,    timely,
and auditable,      and (4) supply DODmanagers      with a practi-
cable level of summarization.         Subcontracts,    excluding    those
that are firm fixed price,       are selected for application         of
these criteria      by mutual agreement between prime contrac-
tors and the contracting      DOD component, according to the
criticality     of the subcontract     to the program.

      Addendum 6 to the S-3A prime contract       embodies the re-
quirement of Instruction      7000.2.  Lockheed developed its
planning and control     system to comply with Instruction
7000.2.   A demonstration     review was held in March 1970 at
Lockheed, and the Navy's validation       team stated that the
system met the criteria;      however, the Office of Naval

                                   43
Material   questioned whether the Navy should continue to re-
quire Instruction      7000.2 or accept the system being utilized
by Lockheed on its commercial L-1011 system.          We were in-
formed that the Office of Naval Material        accepted Lockheed#s
planning and control      system on October 20, 1970, but wanted
the requirements     reduced.   The Navy has not yet formally
approved (validated)      the Lockheed system as being in accor-
dance with the requirements      of Instruction   7000.2.

      Addendum 6 was originally      expected to be applied to the
two major subcontractors,      Univac and Vought:; but the require-
ment concerning Vought was removed before Addendum 6 could
be applied,   and a modification     to Addendum 6 to reflect
that deletion   had resulted     in a decrease in the contract    of
approximately   $1.5 million.      A modification of the require-
ment is now being considered which would eliminate        Univac.
        Lockheed initially       asserted that strict     compliance
with Addendum 6 represents          added work amounting to approxi-
mately $4 million        at the target cost level for the S-3A
development program.          Lockheed has not been able to sub-
stantiate     this estimate.       Lockheed feels that its planning
and control      system does employ timely approaches for mea-
suring the impact of such significant             program influences       as
inflation,     technical     problems, and subcontractor        pricing;
however, the system does not ensure that decisions                 regard-
ing resolution       of problems will recognize the impacts on
cost, schedule, and technical           performance in other parts of
the management system.           Such information     is available     but
the system does not ensure its use. The planning and con-
trol system provides the potential            to furnish   a wide vari-
ety of additional        reports which the Government might con-
sider beneficial.

      The S-3A project manager stated that, in his opinion,
DOD Instruction     7000.2 was a good idea, philosophically,      but
that he was against the strict      interpretation  being attempted
by the Air Force.      He believed that, as presently     consti-
tuted, Addendum 6 produced more data than was needed and
that a proposed modification      would delete some of the re-
quirements.     The data contained in the formal reports gen-
erated by Instruction     7000.2 are, on the average, 45 days
old and,therefore,the     reports are not as dependable as the


                                    44
other management tools applied.     GAO intends to perform            a
separate review concerning Instruction     7000.2.1

OTHERMANAGEMENT
              TOOLS

       The S-3A project manager informed us that, in addition
to using formal reports generated by Lockheed's planning
and control     system, he applies day-to-day management tools
to ensure effective       control    of the project.       Among these
tools are (1) the weekly action and 'Ire-action"             reports
which point out specific         problem areas and their resolution,
(2) monthly meetings with Lockheed project management,
(3) direct-line-telephone         and data-transmission      hookup with
the Lockheed project office,          and (4) "hot line" reports in-
dicating    significant    problem areas,       The project    office has
not yet received any hot-line          reports.     It is the project
manager's opinion that, if the first            indication    of a signif-
icant problem must be reported via hot line, management is
not doing its job.
@VELOPMENTCONCEPTPAPER

       The Development Concept Paper is considered by the
project manager to be his "contract"       with the Office of the
Secretary of Defense to develop and produce a total S-3A
weapon system within definable      cost, schedule, and perfor-
mance parameters.     Other sections of the Development Con-
cept Paper evaluate enemy threat,       need for the weapon sys-
tem, development risks,    program management, etc.      The De-
velopment Concept Paper was signed by the Secretary of De-
fense in November 1967 when the system was approved for con-
tract definition.

        As directed   by the Secretary of Defense, the Develop-
ment Concept Paper is being revised to include an updated
justification      for the system.    This justification apparently

1
    The report will include data developed at         several contrac-
    tors' plants to evaluate the potential    of      7000.2 for dis-
    closing early problems and their ultimate         impact on cost,
    schedule, and performance to industry   and       DODmanagement.



                                    45
will include a discussion   of the P-3C and the proper mix of
the two aircraft  for antisubmarine  warfare.    The original
submission date for this revision   was September 1, 1970;
however, the submission date is now unknown. The Develop-
ment Concept Paper is required to be revised before April
1972 when the Defense Systems Acquisition     Review Council
meets to consider whether or not the S-3A should be released
for production.

THRESHOLDS
      One section of the Development Concept Paper sets forth
program thresholds     for cost, schedule, and performance.     As
long as the program stays within these thresholds,       program
management is left to the procuring      service.  Crossing a
threshold  may initiate    a review of the program at the Office
of the Secretary of Defense level.

      Thresholds     are set by the Office of Defense Research
and Engineering      to indicate  when a program might be out of
control;    that is, considerable    degradation   from performance
guarantees,     extreme schedule slippage,     and substantial  cost
overruns.

        In light of the previous discussion      of known optimism
in    contract  pricing    and the fact that Lockheed is performing
at    112 percent of target cost, the development cost thresh-
old    may be crossed as the program advances into the criti-
cal    avionics  integration    phase.

      As is the practice   of DOD, the cost threshold    for the
production  aircraft   is quoted at the total program amount.
The S-3A production    cost threshold was set at ceiling     price
rather than between target and ceiling     as was the threshold
of the AWACSprogram.
        Assuming that the production       options are exercised,
the total production        cost will not be known until    substan-
tial aircraft     deliveries    have been made. The selected ac-
quisition    report prepared by the project manager will,         of
course, reflect     estimates to complete, at various points
throughout    the program cycle, and could presumably reveal
an estimated overceiling        situation;   however, estimates in
past programs have tended to be optimistic.           If the total

                                  46
production   threshold is broken, it may occur late in the
program, and any review will,    by its nature, be made near
the completion of the program.

       Thus, as a management tool, a total program cost thresh-
old is largely     ineffective     during most of the production
cycle.     It would seem reasonable instead to break out the
production    threshold     into a yearly,     or similar, period con-
sistent with economic production           runs to provide a manage-
ment gauge of production         costs as the program proceeds.

        The schedule thresholds     are set at 6 months beyond the
contractual    milestone  dates.     The performance thresholds
involve four overall     characteristics       of the aircraft related
to weight, approach speed (carrier          landing),  range, and en-
durance.     If these guarantees are exceeded by 10 percent for
the first    two or reduced by 15 percent for the last two, a
review at the Secretary of Defense level is made. Two
other performance thresholds        apply to the avionics charac-
teristics    of signal recognition       and search bearing accuracy.

      If these performance thresholds      are reached but not
crossed, the Navy will have an S-3A whose performance is
less than anticipated   under the contract.        The performance
thresholds,   however, do represent    an increase over present
antisubmarine   warfare effectiveness.      Officials   at the Na-
val Air Development Center, Warminster, Pennsylvania,          have
stated that these thresholds      were fair and offered reason-
able management control    at the Secretary of Defense level.




                                  47
DEFENSE SYSTEMS ACQUISITION         REVIEW COUNCIL

      The vehicle for program review at the Secretary of De-
fense level is the Defense Systems Acquisition          Review Coun-
cil.   Unless a program threshold       has been crossed, as dis-
cussed previously,     or some other special circumstance        de-
mands, the Council reviews a program three times during its
life,  that is (1) prior to entering contract        definition,
(2) prior to initiating     engineering    development,    and (3)
prior to a production     decision.

        The Council is scheduled to meet in February or March
1972 relative      to a production   decision on the S-3A. The
contract    calls for lot III to be exercised on or before
April 1, 1972. If the contractually            required development
milestone provisions       are met prior to this production           de-
cision,    Lockheed (1) will have made a first         flight    of 30-
minute duration without avionics         and (2) will have substan-
tially    completed integration     of the S-3A's complex avionics
in a bench test under laboratory         conditions.       In addition,
6 to 8 months of airborne avionics          testing utilizing       a
P-3 aircraft     (test bed) will have occurred.          The first     full
systems flight      of the S-3A is scheduled to take place 3-l/2
months after the production        option date.

       The first  four aircraft     in lot III will be used for
various research,     development,    testing,      and Board of Inspec-
tion and Survey trials.        However, because the Navy plans to
recycle these aircraft      for ultimate     delivery    to the fleet,
these four aircraft     are being considered as production          air-
craft and, thus, a production        decision     is demanded by the
Defense Systems Acquisition       Review Council.

      One of the contractual        milestones,   avionics   integra-
tion,    will demonstrate only that the units will work to-
gether and respond to laboratory-generated            inputs and will
not demonstrate whether the system has the capability               to
fully perform its intended antisubmarine            warfare mission.
First flight,    the other milestone        is concerned only with
the basic flying    qualities      of the airplane.      It should be
noted that the flying       avionics    test bed mentioned above
will undergo a Navy preliminary          assessment which is sched-
uled for completion      only 2 months after the option date for
lot III.

                                     48
       The results  of the Navy preliminary      assessment of the
flying   avionics  test bed and the results      of tracking  expe-
rience against friendly    submarines as well as the knowledge
gained from the initial    full-system   flights     of the S-3A
would offer a better basis for a production         decision by the
Defense Systems Acquisition      Review Council.

       The project manager advised us that he and the prime
contractor    were of the opinion that to delay the production
decision    and consider additional   test results would distract
the prime contractor's    attention  from the laboratory  avionics
integration    which they believed  to be of primary importance.

        In our report to the Subcommittee on the F-14 aircraft
.program dated August 17, 1970 (B-1686641, we disclosed       an
 analogous situation    where it appeared that the Defense
 Systems acquisition    Review Council was being called upon to
 make a premature production    decision.  Subsequent to our
 report it was decided at the Secretary of Defense level that
 the F-14 program would be given only a preliminary,       or in-
 terim, production    decision and that a full production    go-
 ahead would be given only after considerable     experience and
 flight   testing had been accomplished.

INDEPENDENTASSESSMENTNEEDEDBY THE
DEFENSESYSTEMSACQUISITION REVIEW
COUNCIL FOR PRODUCTIONDECISION

      When the Defense Systems Acquisition        Review Council
convenes to pass on the production      phase of the S-3A pro-
gram, the status of the program will be presented by the
S-3A Project Office.     We have noted in connection with other
weapon system programs that these submissions          tended to be
very optimistic    and indicated   that potential    problems could
be readily   overcome.    No assessment independent of program
management is given at this critical      stage in the program.

       Various study groups, as well as our office,       have rec-
ommended in the past that DOD utilize        independent oper-
ational    testing    and evaluation  groups to monitor the prog-
ress of various weapon system programs thus neutralizing
to some extent the climate of advocacy.          The Blue Ribbon
Defense Panel, in its July 1970 report,         recommended that
DOD establish      independent operational   testing  and

                                49
evaluation     groups reporting     directly  to the Deputy Secretary
of Defense.       These groups would represent      both the devel-
oper and user but would remain organizationally                independent
of both.      These groups could contribute      significantly         to
decisionmaking       at all levels   and could participate         in the
production     decisions    which theretofore   had been a forum
for optimistic       program advocacy.

        Both the S-3A Project           Manager and an official           of the
Directorate,         Defense Research and Engineering,              believed      the
idea of an independent            assessment      to be impracticable          due
to a lack of individuals              or organizations       that are techni-
cally    qualified       as well as unbiased.           They believed       that,
at present,        those organizations         having a great deal of ex-
pertise      generally     had a biased point          of view and that those
that were unbiased           generally     lacked in-depth        knowledge      of
the technical         aspects    of a given program.           Furthermore,        the
S-3A Project        Manager expressed         his opinion      that an assess-
ment independent          of his office       would conflict       with the con-
cept of project          manager responsibility.

       We still  believe    that consideration   should be given
to establishing      an independent   means of determining    the
progress    of development     prior to entering  production.




                                        50
                                                                              .L




                                  CHAPTER4

                           EXTENT OF CONCURRENCY

      To illustrate the level of planned concurrency between
development and production   in the S-3A, we have taken ex-
cerpts from the program master schedule and presented them
in figure 2 on the following   page of this report.
      In terms of calendar months, the period of significant
concurrency   starts in May 1972, one month after the exer-
cise of the production      option for lot III, and ends in Oc-
tober 1973 with the delivery        of four aircraft    configured
for the Navy's test and evaluations         via its Board of Inspec-
tion and Survey trials,       The ending date of October 1973,
for purposes of concurrency measurement, is based on the
Navy's contention     that delivery    of four Board of Inspection
and Survey aircraft     marks the completion of the development
phase and that all significant        development should be com-
pleted by that date.       In terms of production      aircraft,   there
will be, according to Lockheed's estimate,           10 S-38 produc-
tion aircraft    through the start of the final assembly pro-
cess at the beginning of Board trials          as shown below:

      4 completed      and delivered    to the Navy for    Board trials,

      4 completed and in Lockheed's          production   flight   test
        phase, and

      2 in final      assembly.

The significance of the start of final assembly is that ex-
perience has shown that there is a dramatic increase in the
cost of applying changes beyond this point in comparison
with any other point where changes might be incorporated.

        In    addition     to the above 10 production  aircraft,      there
are the       eight development aircraft      and two nonflying     test
(static       and f a t' ague) airframes purchased under lots      I and II
of the       S-3A program.

      In terms of the total numbers of aircraft              that are
planned to be ordered by the time Board trials               are started,

                                       51
                                   .

                        ,973   .       1974




EXTENT OF CONCURRENCY
    S-3A PROGRAM
     Figure   2

         52
the estimated number is 137, or about 68 percent of the
total planned quantity     of 199. The start of Board trials
is scheduled for October 1, 1973, which is only 30 days
prior to the order date of lot V. We have included lot V
in the number of aircraft     ordered prior to these trials
because lot V is scheduled-to      be ordered when the four air-
craft are delivered    for the trials.     The delivery   of these
four aircraft   is the fifth   and final contractual    milestone.
The following   table oresents the details     of the planned
program showing the numbers of aircraft       that are-planned
to be ordered.

                                      Number
                                         of
       Date               &&         aircraft      Note            Purpose

Aug.    1,    1969           I            6         (a>          Development
Oct.    1,    1970          II            2                      Development
Apr.    1,    1972        III            13         (b)          Production
Feb.    1,    1973          IV           56         cc>          Production
Nov.    1,    1973            V          60         cc>          Production

   Total                                137

Oct.    1, 1974            VI             62        (4           Production

   Total                                Z199

aThis does not include            the two static   and fatigue     test   air-
 frames.
b The original        baseline quantity was 17, plus or minus
  50 percent;        however, the more recent estimate is 13. (See
  p* 19.)

'These are baseline quantities  and can be varied plus or
  minus about 50 percent by the terms of the contract.   (See
  p. 19.1

AREAS OF PRIERY TECHNICAL RISK

      The S-3A program is somewhat unique, as compared with
other contemporary weapon system development efforts,  in
                                         53
that the technical     risks are primarily          centered within one
major technological      area; namely, avionics.           Actually,      the
risks are concentrated       even further       within certain      limited
areas of avionics.       By comparison to the C-5A, F-111, F-14,
and F-15, this situation       is somewhat nontypical.            In these
other programs, consequential           structural,    materials,      aero-
dynamic, tooling     and manufacturing,         and aircraft    subsystem
developments in engine and airframe were involved.                    In the
S-3A program, these factors are not as risky since the Navy
considers the engine and airframe to be low-risk                items.
This is particularly      important because the lead time and
cost impact for correcting        avionic problems is generally
less than that of major airframe components involving                   heavy
tooling  and manufacturing       facilities.

      Many of the avionic problems can be addressed on the
ground or in avionic flying    test beds, neither     of which is
subject to grounding or intermittent       operations  which can
occur when new airframes and engines are also being tested.
This means that problem solution      can continue in the avion-
ics area to a considerable    degree irrespective     of other
problem areas, particularly    if the program provides for
both adequate laboratory    and flying   test bed tools.

       With regard to the S-3A avionics,        no special problems
or difficulties      are anticipated    in some areas.     For example,
communication,      navigation,    and weapon/armament control
equipment are considered to be within the current state of
the art or to be repackaged or off-the-shelf           items.   The
principal     risks in the S-3A avionic system lie in six spe-
cific   areas, as follows:

    1. The acoustic        data processor.
    2. The central        data processor.

    3. The sonobuoy reference         system.
    4. Total    avionic     system integration     and software.

    5. Degree of success in the man/machine              integration    and
       automation design.

    6. Impact of the rugged carrier    environment            on all   so-
       phisticated  avionic equipment.
                                      54
                                CHAPTER5
                                --

               POTENTIAL PROBLEXSTO BE MONITORED

      As requested,     potential    problem   areas are described
below.

POSSIBILITY OF NEED FOR
EXTRACONTRACTUAL RELIEF

       We believe there is a possibility           that the conserva-
tive pricing     and tight structuring       of the contract       in com-
bination   with certain occurrences might force the contrac-
tor to seek extracontractual        relief    From the Government to
continue work under the contract.            (See pp. 8 to 15.)        We
believe also that the following          potential      events could pre-
cipitate   the need for extracontractual           relief    and thus
should be monitored by the Subcommittee:
      1. An increase in the rate of economic inflation    or
         even a continuance    of the present rate for a pro-
         longed period.     (See p. 30.)

      2. The occurrence      of major development       problems.      (See
         p. IL>

      3. Ordering the minimum or near minimum quantities
         permitted under the production           options.       (See
         p. 20.)    Our opinion on this point is bolstered                by
         the fact that two of the prime contractor's                major
         subcontractors     have refused to accept clauses with
         a variable    quantity     option provision       similar    to the
         one contained in the prime contract.               Specifically,
         these subcontractors        will not allow orders for less
         than the median option lot quantities               set out in
         the prime contract.         This situation      conceivably
         could result     in substantial      losses to the prime
         contractor     should the Government choose to exercise
         the production      option-lots    in the minimum or near
         minimum quantities.
UPCOMINGPRODUCTIONDECISION

       A decision on whether the S-3A aircraft      will go into
production      is scheduled to be made in February or March
1972. We believe that a decision by this date may be pre-
mature.      Further,  it appears that this decision,    in accor-
dance with customary procedures of DOD for making important
decisions     relative   to major weapon systems, will be made in
an atmosphere wherein the program advocates will be overly
influential.

       In our opinion,   the risk of entering the production
phase could be appreciably       reduced if the production   deci-
sion were delayed 3 or 4 months beyond the presently         sched-
uled date for this decision.         The contract would permit
such a delay since it allows slipping         the date for exercis-
ing the first   production     option for up to 4 months, at no
increase in contract     price.

       If the production       decision were delayed 4 months, ad-
ditional     technical     data resulting   from certain        tests would
become available        to the decisionmakers.         We noted that the
first    Navy preliminary      assessment is scheduled for comple-
tion some 3 months after the production               decision and that
the first     flight    of the full S-3A system will come about
4 or 5 months after the production            decision.        The delay
would also permit more information            resulting      from the ongo-
ing avionics       laboratory   integration     tests and the avionics
flying    test bed to become available.

        The Navy's project manager and the prime contractor      do
not agree.      They believe that to delay the production     deci-
sion and consider additional      test results would distract
attention    from the laboratory   avionics   integration (mile-
stone 1) which they consider to be of primary importance.

       In the past, major weapon system decisions have been
made in an atmosphere dominated by advocates of the programs
involved.    We believe that an assessment independent of the
program management should be made of the S-3A program prior
to the production     decision.      The results of this assessment
should be made available        to the officials  charged with mak-
ing the decision.      (See pp. 49 and 50.)


                                     56
CONCURRENCY
          OF DEVEIX)PMENT
                        AND PRODUCTION

       There would be an appreciable            degree of development
and production     concurrency      in the S-3A program even if the
production    decision were delayed as we suggested in point 2
above.     If development,     testing,      and evaluation   show that
the S-3A system will perform as intended and that signifi-
cant changes are not required,            this concurrency    should re-
sult in the system's becoming operational              quicker than it
would have otherwise.         On the other hand, if the tests and
evaluations    disclose    that significant        changes must be made
to ensure an operationally          effective     weapon system, the
problems of making the changes will be compounded.                 The
changes must be made not only to the developmental               units
but to all production       units which have been manufactured or
which are in the process of manufacture.               This could require
substantial    amounts of additional          time and money.     (See
ch. 4.1
COST THRESHOLDFOR PRODUCTIONAIRCRAFT

      The Development Concept Paper sets forth program
thresholds  for cost, schedule, and performance.   As long as
the S-3A program stays within these thresholds,   program
management is left to the Navy. Crossing a threshold     ini-
tiates a review of the program by the Office of the Secre-
tary of Defense.

       As is the practice      of DOD, the S-3A cost threshold       for
production    aircraft     is set at the total program amount. To-
tal program production        cost will not be known until    a sub-
stantial    number of aircraft      have been made. Reports pre-
pared by the S-3A Project Manager will,         of course, reflect
estimates to complete and presumably could reveal an esti-
mated cost exceeding the threshold;         however, estimates     in
past programs have tended to be optimistic.          Thus, as a
management tool, a total program cost threshold          may not be
very effective       during most of the production   cycle.    It
would seem preferable        to break down the planned program cost
by production      lot or by some other subdivision     of the total
production    effort     and have a separate cost threshold    for
each.    (See p. 47.1


                                    57
LESS TRAN TOTAL SYSTEMPERFORMANCE
                                RESPONSIBILITY

       Despite the fact that there is a provision            in the con-
tract which purports       to impose total performance responsi-
bility    for the integrated     weapon system, including
Government-furnished       equipment, on the system prime con-
tractor,     there is some question as to whether its responsi-
bility    for system performance is, in fact, total.             (See
p. 38.) Under some circumstances          it is the position       of the
Navy negotiator,      and concurred in by the contractor,          that
the Government must bear the cost of modifying             Government-
furnished     equipment so that it will be suitable         for use in
the S-3A system.       Further,   it is the Navy negotiator‘s         posi-
tion that the system prime contractor          is relieved     of the af-
fected system performance requirements           until  the Government-
furnished     equipment is corrected.

         On the other hand, we were advised by an attorney               in
the Office of the General Counsel, Naval Air Systems Com-
mand, that the provision          does, in fact, place total respon-
sibility     on the contractor.        We mention this area because
the Government has traditionally           had problems in furnishing
suitable     equipment to contractors       and because the variance
in interpretation         of that contractual    provision     indicates
that, should a problem with Government-furnished                equipment
arise and the performance responsibility             provision     be
strictly     interpreted,      it will probably generate a dispute
as to who is required to bear the cost of its resolution.

POSSIBLE SIDE EFFECTS FROM
THE PRICING OF CHANGESCLAUSE

        The Pricing of Changes clause was designed to ensure
that the Government would have timely,          complete, and realis-
tic cost proposals for contractor-proposed           engineering
changes before they would be approved.            (See p. 35.)   There
is a possibility      that this clause may discourage the con-
tractor    from suggesting     improvements in the S-3A weapon sys-
tem which the Navy would want and would approve if suggested.
Another possibility       is that this clause may cause the con-
tractor    to propose inflated      ceiling prices for changes which
could result      in Navy disapproval.


                                     58
  1



         .




POSSIBLE SIDE EFFECTS FROMTHE
RESTRAINT OF COMPETITIONCLAUSE

        The Restraint   of Competition     clause requires      the sys-
tem prime contractor       to give up many of its data rights
relative    to items it obtains from subcontractors           using the
prime contractor's      design.,     (See p. 42.)    This could have
the effect of encouraging         the prime contractor     to perform
work in-house which it otherwise would have subcontracted.
Such an effect could work to the disadvantage            of the Gov-
ernment in some eases and could have implications               for the
small business community.          On the other hand, there is a
possibility    that the Restraint       of Competition   clause may
not be effective      in permitting     the Government to reorder
supply parts directly       from the subcontractors.         Information
we have received indicates         that, except for major items
such as wings or engines, which are generally            not repur-
chased, direct procurement of spare or replacement parts
may not be feasible      because of the possession by the prime
contractor    of information     and expertise    other than the data
covered by the clause necessary for intelligent             parts pro-
curement.




                                    59
                             CHAPTER6

                        SCOPEOF ANAL,YSIS

       In performing    our analysis,    we reviewed the S-3A con-
tract N00019-69-C-0385 and other pertinent          documentation
and held discussions       with key management personnel of the
S-3A Systems Project Management Office and with contract
negotiation,    technical,     and legal personnel of the Naval
Air Systems Command. We also held discussions           with per-
sonnel representing      the prime contractor     and selected sub-
contractors    of major S-3A subsystems.

      We discussed and researched key contractual      clauses
from such sources as the ASPR Committee.      We attempted to
gain an insight   from other defense contractors     on their
prior experience with selected contractual      clauses,

        We probed technical aspects of the S-3A with represen-
tatives    of the Office of the Director     of Defense Research
and Engineering    and the U.S. Naval Air Development Center;
however, our review did not include an in-depth analysis         of
development progress and technical      risk,

       Our fieldwork  was performed during the period August
through December 1970, and therefore     this report generally
reflects   the status of the S-3A program about 1 year after
contract   award.




                                 60
.




    APPENDIX




               ‘,
                      :.

                    ,.,’

       61
                                                                                           APPENDIX I




                                                        July    9, 1970
       Honorable   Elmer    B. Staats
       Comptroller    General of the United        States
       General Accounting     Office
       441 G Street,   N. W.
       Washington,    D. C.

       Dear     Mr.     Staats:

                 This letter is to request your office to provide assistance        to the
       Preparedness      Investigating   Subcommittee    in performing   an analysis    and
       interpretation    of the contractual    features of the contracts  entered into for
       the S-3A and AWACS aircraft          programs.

                The Preparedness         Investigating  Subcommittee     has for some time
       been monitoring      the status of the major weapon programs           of the Department
       of Defense.     In this regard,      one segment of the Subcommittee’s        continued
       review has been to evaluate the contractual           aspects of these programs.        The
       Subcommittee      is particularly     interested  in the progress    being made in this
       area in the newer      programs.

                As you are aware, your office has been assisting       the Subcommittee        in
       performing    these contractual   analyses on the F-14 and F-15 aircraft       programs
       and providing    the Subcommittee    with opinions and viewpoints    regarding     these
       contractual   matters.    I am very pleased with the results that we have seen to
       date in this work and believe this to be an important      area in our review program.

                  We are again interested         in your opinions on the merits     of the manage-
       ment and contractual          aspects of these programs      and any potential    problem
       areas that should be monitored.              Your analyses   should also include the areas
       of management         controls,    contractual    structure and definiteness,    cost and
       pricing    provisions,      and the extent of concurrency      probable within the program
       structure.

               Your continued      early response      will    provide    great   asslstamoocn‘e
       Subcommittee’s    efforts    in this area.

                                              Si     erely,

                                             IL F
                                                          c .m


                                             4   hn C. Stennis
                                                 hairman,
                                               Investigating
                                                             Preparedness
                                                               Subcommittee


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