oversight

Defense Industry Profit Study

Published by the Government Accountability Office on 1971-03-17.

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

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REPOR ‘T TO THE CONGRESS
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                                 LM095669




Defense Industry
Profit Study  B-159896




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BY THE COMPTROLLER GENERAL
OF THE UNITED STATES


                         KARCH
                             17, 1971
            COMPTROLLER        GENERAL     OF      THE      UNITED    STATES
                             WASHINGTON.    D.C.         20548




Be 159896




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

         This is our report         on our defense    industry    profit  study,
made pursuant          to the provisions    of the Armed       Forces    Appro=
priation    Authorization       Act for fiscal    year 1970, approved        No=
vember      19, 1969 (Pub. L. 91- 121).

         Copies of this report     are being sent to the Director,         Of-
fice of Management       and Budget;       the Secretary     of Defense;  the
Administrator,     National    Aeronautics      and Space Administration;
the Chairman,     Atomic    Energy      Commission;      the Secretary    of
Transportation;     and the Commandant,           United   States   Coast
Guard.




                                                             Comptroller       General
                                                             of the United     States




                   50TH      ANNIVERSARY                   1921-     1971
                        Contents
                                                               Page

DIGEST                                                           1

CHAPTER

  1       INTRODUCTION                                           7
              Development of annual profit      rates for
                period 1966 through 1969                         8
                   Profit   data by customer not dis-
                     closed by contractors'     records          9
                   Complexity of participating      compa-
                     nies                                       10
                  Accounting    alternatives   available        11
              Financial   terms defined                         12

  2       ANNUAL PROFIT RATES OF LARGE DOD CONTRAC-
          TORS                                                  15
             Summary of data for large DOD contrac-
               tors                                             15
                  Return of large DOD contractors         on
                    TCI for DOD and commercial sales            17
                  Profit   data for various categories
                    of large DOD contractors                    18
                  Summary of profits     by type of con-
                    tract                                       23
                  Comparison of actual profit       rates
                    with going-in    profit   rates for
                    DOD contracts    for 74 large DOD con-
                    tractors                                    25
                  Profit   data by product category             27
                  Profit   data for GOCO plants and ser-
                    vice contracts     of 80 large DOD con-
                    tractors                                    29

   3      ANNUAL PROFIT DATA OF SELECTED DEFENSESUB-
          CONTRACTORS                                           30

  4       ANNUAL PROFIT DATA OF SMALLER DEFENSECON-
          TRACTORS                                              32

   5      NEED TO CONSIDER CONTRACTORS'CAPITAL REQUIRE-
          MENTS IN NEGOTIATING PROFIT FACTORS           34
CHAPTER                                                                    Page

              Rates of profit           on 146 contracts                    37
              Effect of Government progress payments
                 on investment          return                              39
              Guidelines       for development of nego-
                 tiated    contract        profit     objectives            41
              Studies and reports concerning consid-
                 eration     of contractor-invested              capital
                 required      to fulfill         Government con-
                 tracts                                                    44
                    Contractor        incentives       for acquiring
                       private      facilities                             44
                    Prior GAO report on increased costs
                       due to lease rather than purchase
                       of fixed assets by contractors                      46
                    ASPR special subcommittee report                       46
                    NASA report on an investment-
                       oriented      profit       analysis    technique    48
              British     consider capital           used in nego-
                 tiating     profit      on noncompetitive         Gov-
                 ernment contracts                                         49
              Use of return on invested capital                   in re-
                 negotiation                                               49

  6       CONTRACTORASSOCIATION COMMENTS                                   50

  7       AGENCYCOMMENTS                                                   52

  8       CONCLUSIONSAND RECOMMENDATION                                    53
             Conclusions                                                   53
             Recommendation                                                55

SCHEDULES

      1   Summary of financial  data before Federal                  in-
            come taxes for 74 large DOD contractors                        59

      2   Summary of financial  data after Federal in-
            come taxes for 74 large DOD contractors                        60

      3   Distribution   of return on TCI before Federal
             income taxes for DOD sales of 74 large DOD
            contractors                                                    61
                                                         Page

4    Distribution   of return on TCI before Federal
        income taxes for commercial sales of 74
        large DOD contractors                             62

 5   Sales by category   for   74 large   DOD contrac-
       tors                                               63

 6   Profit  on sales before Federal income taxes
       for various categories  of large defense
       contractors                                        64

 7   Return on TCI before Federal income taxes
       for various categories of large defense
       contractors                                        65

 8   Return on EC1 before Federal income taxes
       for various categories of large defense
       contractors                                        66

 9   Turnover of TCI for various      categories   of
       large defense contractors                          67

10   Turnover of EC1 for various      categories   of
       large defense contractors                          68

11   Summary of profits  before Federal income
       taxes on DOD sales by type of contract  for
       74 large DOD contractors                           69

12   Summary of profits before Federal income
       taxes on other defense agencies sales by
       type of contract for 74 large DOD contrac-
       tors                                               70

13   Summary of financial data before Federal in-
       come taxes for nine DOD ammunition contrac-
       tors                                               71

14   Summary of financial data before Federal in-
       come taxes for 12 aircraft,  missile, and
       space contractors                                  72
SCHEDULES                                                         Page

  15       Summary of sales and profit   before Federal
             income taxes for GOCO plants and service
             contracts  of large DOD contractors                   73

  16       Summary of financial data before Federal         in-
             come taxes for 10 DOD subcontractors                  74

  17       Summary of financial data before Federal in-
             come taxes for 61 smaller defense agency
             contractors                                           75

APPENDIX

   I       Excerpts from section 408 of Public
             Law 91-121                                            79
                         ABBREVIATIONS
AEC        Atomic Energy Commission
ASPR       Armed Services Procurement Regulation
CPFF       cost plus fixed fee
CPIF       cost plus incentive     fee
DOD        Department of Defense
DOT        Department of Transportation
EC1        equity capital    investment
FFP        firm fixed price
FPI        fixed price incentive
GAO        General Accounting Office
GOCO       Government-owned contractor-operated
NASA       National Aeronautics      and Space Administration
TCI        total   capital investment
COMPTROLLER
          GENERAL'S                                                                          DEFENSE INDUSTRY
REPORT
     TO THECONGRESS                                                                          PROFIT STUDY
                                                                                             B-159896

DIGEST
_-----


WHYTHEREVIEWWASMADE
       The Armed Forces          Appropriation      Authorization        Act for fiscal      year 1970,
       approved     November      19, 1969 (Pub. L. 91-121),             directed      the General      Ac-
       counting     Office      (GAO) to study profits           earned    on negotiated      contracts
       and subcontracts          entered      into by the Department          of Defense    (DOD), Na-
       tional    Aeronautics        and Space Administration            (NASA), and the Coast
       Guard.      Contracts      of the Atomic      Ener y Commission            (AEC) awarded     to meet
       requirements        of   DOD were included.          9 See p. 7.)


FINDINGSANDCONCLUSIONS
       Profit     before       Federal      income taxes,          on defense        work, measured         as a per-
       centage      of sales , was significantly                   lower than on comparable               commercial
       work for 74 large             DOD contractors           included        in the GAO study.            For ex-
       ample,     profits        on DOD contracts           averaged       4.3 percent       of sales       over the
       4 years,       1966 through          1969, but profits             on comparable        commercial        work
       of the 74 contractors                averaged      9.9 percent          of sales    for the same period.
       When profit          was considered          as a percent          of the total       capital      investment
       (total     liabilities          and equity        but exclusive           of Government       capital)       used
       in generating           the sales,        the difference           narrowed--11.2        percent       for DOD
       sales     and 14 percent           for commercial           sales.        Further,   when profit          was
       considered         as a percent         of equity       capital       investment      of stockholders,
       there was little            difference         between      the rate of return           for defense         work
       and that for commercial                 work.      The 74 large           DOD contractors        realized
       average      returns       before      Federal     income taxes of 21.1 percent                  on equity
       capital      allocation         to defense        sales     and 22.9 percent          on equity        capital
       allocated        to commercial          sales.       (See p. 15.)

       The major factor      causing    the rates     of return    on contractor      capital      in-
       vestment    for defense     and commercial      work to be similar         was the substan-
       tial   amount of capital      provided     by the Government      in the form of prog-
       ress payments,     cost reimbursements,          equipment,    and facilities.         This
       reduced   the capital     investment     required      from the contractors       for defense
       work.    (See pp. 15 and 16.)

       In reviewing     congressional       hearings     which     led to this     study,   GAO noted
       some concern    that    contractor      capital     requirements       had not been consid-
       ered in negotiating        defense    contract      prices.      Although     such a review
       was not called      for specifically         in the legislation,          GAO reviewed    146
       negotiated   contracts       to see whether       it was practicable          to develop

 Tear Sheet


                                                                                       MARCH17,1973.
investment        data by contract        and whether  any wide                 range in profits     on
defense     contracts      existed.       The work showed that                  cost,     profit, and in-
vested     capital     data could be developed        by contract                  and that there was
a wide range of profit              rates  on defense  contracts.                     (See pp. 34 to 38.)

The average       rates    of return     for individual          contracts     were substantially
higher     than the average        annual     profit     rates    developed      from GAO's ques-
tionnaires      to 74 large      defense      contractors.         The 146 contracts       examined
cannot     be considered      as a representative             sample,      and it would have been
mere coincidence         if similar      rates     had resulted        in both phases of the
study.       The differences       between     the two were:

   --The large    number of DOD procurement       actions,    over 180,000       a year of
      $10,000  or more, covering     a large   number of different         items   and in-
      dustries  involved    and the work required       to develop   data for each
      made it impracticable     to attempt   to develop     a representative         sample.

   --The data furnished     by contractors                   in response  to the questionnaire
      were on overall   defense  business,                   not on an individual-contract
      basis.

   --GAO considered            only completed          contracts    where profits    or losses were
      ascertainable          and, as a result,            probably    avoided  many, loss con-
      tracts     having      large  unsettled          claims.     (See p. 38.)

Under current        defense       contract      negotiation         procedures,         little       consider-
ation    is given      to the amount of capital                 investment        required         from the
contractor       for contract        performance.            Instead,      profit      objectives         are
developed       as a percentage          of the anticipated             costs     of material,          labor,
and overhead.         As a result          inequities        can and do arise           between        contrac-
tors'    providing       differing       proportions         of capital       required          for contract
performance.         (See PP. 41 t0 43.)

Further,     by relating        profits    to costs,         contractors        in noncompetitive
situations      are not provided          with positive           incentives        to make invest-
ments in equipment           that would increase            efficiency         and result     in re-
duced costs,       especially        where follow-on          contracts        are involved.        Under
the current      system of negotiating              contract        prices,      such investments
tend to lower,        rather      than increase,        profits         in the long run.         Other
factors,     however,      such as whether          the program           will  be continued,       could
be overriding       considerations         affecting        contractors'          decisions     concern-
ing investments         in equipment.          (See pp. 44 and 45.)

GAO believes     that,    in determining       profit      objectives               for  negotiated
Government    contracts     where effective          price    competition              is lacking,
consideration      should   be given to capital            requirements               as well     as to
such other    factors     as risk,    complexity         of the work,               and other     manage-
ment and performance        factors.      (See p. 54.)

Where contractor           capital     requirements      are insignificant,                 such    as in
many service-type            contracts      or contracts     for the operation                 of



                                                      2
        Government-owned            plants,      profit      objectives           would    continue       to be devel-
        oped primarily           through       consideration         of     the    other    factors.         (See p. 54.)

        The system   adopted            should     be used, where            applicable,        by all        Government
        agencies   to simplify             industry    participation.                (See     p. 55.)


CONTRACTOR
        COMMENTS
        GAO requested          comments from five           contractor       associations        on a draft
        of this      report      that was based on incomplete                data.     Two of the associa-
        tions     agreed with          the conclusion      that     investment      should     be considered
        in determining           profits;      however,    they and two other             associations        felt
        that   the report          grossly     overemphasized         the rate of return            on invest-
        ment and reflected               a preoccupation      with the need to consider                 contrac-
        tors'     capital      requirements        in negotiating         profit    factors.         The fifth
        association         did not furnish           any comments on this          point.

        GAO agrees         that    there      are other         factors       that must be considered              in
        negotiating          contract       profit       rates.       Such factors         as the contractors'
        assumption         of cost risk,           difficulty          of the task,         and other        management
        and performance            factors        must be evaluated               and considered.            In some
        cases,      such as for a Government-owned                        contractor-operated              plant,    little
        or no contractor              investment         is involved;           in other     cases the entire             in-
        vestment       required         for contract          performance          is provided       by the contrac-
        tor.      Where the investment                 required        from the contractor             is insignificant,
        the other        factors        naturally        would be the determining                 items in establish-
        ing profit         objectives.            In still        other     cases,     however,       GAO believes
        that,     to the degree that               contractor          capital       is required,        it should        be
        considered.            (See p. 50.)
        Two of the contractor           associations      questioned       GAO statements       that   con-
        tractors      have little     incentive      to invest     in more modern equipment            to
        reduce     costs relating       to many negotiated         procurements.          The associa-
        tions    stated      that GAO had failed       to consider        and recognize      the "real
        world"     competitive     environment       of today's      defense     business.

        For competitive         and other        reasons , contractors           make some investments            in
        facilities       and equipment         for performance          of negotiated       defense      contracts.
        Actually,      however,     little       price     competition      is involved       in much of the
        DOD procurement.           For example,          of the total       dollar    value of DOD procure-
        ment for fiscal         year 1970, only 11 percent                was formally        advertised       and
        an additional       27 percent        was negotiated           on the basis      of price      competi-
        tion.      A total   of 57 percent            was placed       on a sole-source         basis,    and the
        remaining      5 percent       involved       design    or technical       competition.

        There is, of course,             some incentive      to reduce      costs on negotiated        firm
        fixed-price         and fixed-price      incentive     contracts       even if they are sole-
        source      contracts.       Such reductions       in cost,      however,   could reduce       prof-
        its on subsequent           defense   contracts.       Such    contracts    would  be   priced

 Tear   Sheet
   on the basis of prior              cost experience           to a large extent,        and the          prof-
   its would be determined               as a percentage          of estimated     costs.

   The contractor      associations       almost    unanimously      questioned     GAO data for
   the 146 individual        contracts      and stated     that   they felt     that either      an
   unfortunate    selection       of contracts     was involved       or there were flaws         in
   the method of ascertaining           capital    invested     in such contracts.          (See
   p. 51.)

   For reasons       stated      previously,        GAO agrees      that no attempt        was made to
   obtain     a sample representative               of all defense        contracts.       GAO was in-
   terested      in determining         whether       it was feasible       to develop       cost,  profit,
   and invested        capital      data by contract          and, if so, the range of the rate
   of return       on invested        capital     realized      for individual       contracts.       GAO
   found    that it was feasible              to develop      the desired       data for most con-
   tracts     and that      there was a great            range in rates       of return      on investment
   for individual         contracts.          (See p. 51.)

   In each case GAO, in developing       data for individual      contracts,     presented
   its data to the contractors     involved     and gave them an opportunity         to re-
   view the data and comment on it.          GAO has carefully    considered     the com-
   ments received  and believes    that    the final     data are reasonably     accurate.
   The number of cases involving      factual    disagreements    was relatively
   small.   (See p. 51.)


AGENCY
     COMMENTS
   GAO provided  a draft             of this   report,        based on incomplete  data,  to AEC,
   DOD, the Department             of Transportation           (DOT), and NASA for review   and
   comment.

   All the agencies            agreed that      due consideration            should       be given to the
   total    capital      investment        of contractors          in negotiating           Government       con-
   tracts     which do not involve            price      competition.          DOD pointed        out,     how-
   ever,    that the solution            of highly       complex      administrative          problems       was
   required      before     the policy       could be put into effect.                    Also AEC believes
   that there       is no need for a uniform               Government-wide            fee policy        stress-
   ing consideration            of invested       capital     and feels        that     the development           of
   detailed      uniform      guidelines      could have a serious,                disruptive       effect      on
   the existing         overall      fee policies        of the various          executive       agencies.

   GAO agrees that there           are serious       administrative           problems       in providing
   for consideration        of contractor        total      invested       capital      related    to a
   particular     contract      in negotiating         contract      profit      rates.        DOD had been
   considering      this   matter     since    1962, and GAO believes               that     it is time to
   move ahead.

   GAO agrees     also that      there      are many advantages          to permitting         agencies
   to tailor    their   policies       to their      individual       needs.    Many companies,
   however,   deal with      numerous        Government      agencies,      and GAO believes           that,
   where feasible,      uniform       policies     should     be established         governing       the
   relations    between    Government          and industry.        GAO believes        further     that

                                                        4
    it seems feasible       and desirable        to establish        uniform    Government-wide
    guidelines     for establishing       profit      objectives      for negotiating       Govern-
    ment contracts     where effective          price    competition       is lacking.      (See
    p. 52.)


RECOMMENDATION

    Action     required      to establish       uniform    guidelines      does not require             legis-
    lation.       The Office       of Management        and Budget should        take the lead in
    interagency        development        of uniform     Government-wide       guidelines          for de-
    termining       profit     objectives     for negotiating         Government       contracts       that
    will    emphasize      consideration        of the total       amount of contractor              capital
    required      when appropriate,          where effective        price    competition         is lack-
    ing.      (See p. 55.)




                                                5
                                CHAPTER1

                             INTRODUCTION

        The Armed Forces Appropriation      Authorization    Act for
fiscal    year 1970, approved November 19, 1969 (Pub. L.
91-1211, directed     the General Accounting        Office to study
profits    earned on negotiated   contracts     and subcontracts
entered into by the Department of Defense, National            Aero-
nautics and Space Administration       and the Coast Guard.        Con-
tracts    of the Atomic Energy Commission awarded to meet re-
quirements of DOD were included.         (See app. I.)

        Unless otherwise      stated,   the profits   presented in this
report are before Federal income taxes to prevent any dis-
tortion     due to special tax considerations.           We also felt
that it would be preferable           to obtain data on profits      prior
to reductions      for Renegotiation      Act determinations     of ex-
cessive profits.        Such actions would not have been com-
pleted for much of our data on 1969 profits              and there were
some outstanding       actions pertaining      to prior years.      Fur-
ther, the dollar amounts of excessive profits              determinations
have not been substantial          in recent years in relation       to
the profits     involved.

       For example, our average rate of return on total           capi-
tal investment    for DOD sales of 74 large DOD contractors
was 11.2 percent.      Even if all excessive profit      determina-
tions of the Renegotiation       Board during the period covered
by our study had been considered as applying solely to the
74 large contractors,       the effect   would have been to reduce
this amount by only 0.2 percent,         to 11 percent.    Voluntary
refunds and price reductions        reported by contractors     to the
Renegotiation   Board would normally have been deducted by
the contractors     in arriving    at net income reported to us.
In any event, these amounts would have had an insignificant
effect   on the profit    data presented in this report.

      The costs of defense business include all costs allo-
cable, including    costs unallowable     under section 15 (con-
tract cost principles     and procedures)    of the Armed Services
Procurement Regulation.      This made computations     of profit
rates for defense and commercial work comparable.

                                     7
DEVELOPMENTOF ANNUAL PROFIT RATES
FOR PERIOD 1966 THROUGH1969

        We developed a questionnaire              to obtain information       from
selected contractors           for the years 1966 through 1969 on
sales, profits,        total     capital     investment,   and contractor
equity investment         for defense business and comparable com-
mercial sales.         We asked that noncomparable commercial sales
and related       investment      data be reported under the category
"Other."      This category included such items as sales by
overseas activities           and sales of transportation          and communi-
cation services where the rates were set pursuant to law or
regulation.         The profits      on such noncomparable items and re-
lated data are not discussed in this report.                    Provision     was
made for separate reporting              of the operating     results    for
Government-owned contractor-operated                 (GOCO) facilities       and
similar     activities      requiring      little   or no contractor     invest-
ment, to prevent distortion              of data on return on capital.

       A further   breakdown of defense sales and profits         by
type of contract      was requested,  although the legislation
called for a study of only negotiated          defense contracts,     we
asked for and received information        on all work of the con-
tractors    in order to (1) reconcile     cost allocations     to the
various categories      of sales, (2) reconcile      capital  alloca-
tions to the various sales categories,          and (3) permit com-
parisons of contractors'       rates of profit     on total  defense
business and on commercial work.

       Questionnaires    were sent to 154 contractors          which, as
a group,   had received     (1) about 60 percent of recent DOD
prime contract      awards of $10,000 or more, (2) about 80 per-
cent of similar      NASA contract    awards, and (3) a significant
part of AEC and Coast Guard contract           awards.     The 154 con-
tractors   included the 81 largest       DOD contractors,        excluding
oil companies and nonprofit         companies, taken from a list           of
the 100 contractors       and their   subsidiaries     receiving     the
largest   dollar   volume of military      prime contracts       of $10,000
or more in fiscal      year 1969. Oil companies were excluded be-
cause a major part of the procurement involved had been ad-
vertised   or awarded through price competition            and would not
have been affected      by DOD's policies      in negotiating      profit.
We received excellent       cooperation    from the contractors         in
completing    the questionnaire      and in all phases of the study.


                                       8
      In summarizing data for large DOD contractors,       General
Motors Corporation     was excluded because its great volume of
commercial sales would have substantially      altered   our com-
mercial data and the result      would not have been representa-
tive of most of the companies included in the study.         The
data excluded would have had no appreciable       effect  on the
defense profits    reported.

        We selected 63 contractors      by taking (1) every 72d con-
tractor    from an alphabetical    list   of DOD contractors    receiv-
ing awards of $10,000 or more and totaling          $500,000 or more
in fiscal     year 1968, exclusive     of the 81 top contractors       and
their subsidiary     companies already selected,      and (2) some
AEC contractors.      Two of these contractors      had gone out of
business at the time of our study, so that our results             for
the smaller contractors      are based on replies     for 61 contrac-
tors.

      We also obtained       data from 10 contractors who received
a major part of their        defense business in the form of subcon-
tract awards,

       A random selection     of 40 of the 154 questionnaires              was
made for verification       at the contractors'        plants.       Each   of
the above groups was represented          in the 40 questionnaires
selected.      In addition,   each remaining questionnaire              was
carefully    reviewed and verified      through calls,         letters,     and
follow-up    visits   to the contractors'      offices.

       We checked to see whether the data provided agreed with
similar   data on the contractors'  audited financial   state-
ments and appeared reasonable.     Although we  think that    the
breakdown of profit   data by sales category is reasonable,
there are several factors which make it impossible      to certify
to its absolute correctness.

Profit  data by customer        not disclosed
by contractors'  records

        Contractors'    records are designed for the needs of man-
agement and generally        do not provide breakdowns of sales,
profits,     and related    capital for defense work.  Since the
information      we needed on defense sales was not separately
maintained,      it was developed on an after-the-fact   basis from


                                        9
the available     records.      Accumulating    data involved numerous
individual    judgments as to the degree of accuracy necessary
in relation     to the costs involved.         For example, one contrac-
tor indicated       that its summary records did not segregate
subcontract     sales of commercial-type        items to higher tier
defense contractors        from regular commercial sales,         Individ-
ual sales documents, however, frequently             did contain such
information.       This problem was resolved in one case on the
basis of a detailed       analysis    of a representative     sales sam-
ple and a projection         of the result   to the total    sales.

       Similarly,        allocations    were necessary to determine cap-
ital   investment         for the sales categories     in which we were
interested.         Contractors      were requested to submit allocations
representative          of the extent to which contractor-owned         as-
sets were used in generating             the sales.    We were particu-
larly    interested         in ensuring that allocations     to defense
sales reflected          adequate consideration      of (1) Government
cost reimbursements            and progress payments and (2) Government-
furnished      facilities       and equipment.     The importance of the
latter     is indicated        by data showing that as of June 1969
Government land, buildings,             and equipment costing about
$7 billion      were under the control         of all DOD contractors.
These assets were of various ages.               Data about their depre-
ciated net book value generally             were not maintained.

        Although some capital     allocations were made through
identification       of assets with sales categories,   this was not
possible      in all cases.    In some cases a less desirable   cost-
of-sales     basis was used.

Complexity   of participating      companies

        Many of the companies in our study are complex and in-
clude numerous diversified      subsidiaries     which, in turn, are
made up of a number of operating        segments.     We requested
that data submitted be consolidated         and that it include data
on all majority-owned     domestic subsidiaries,       so that we
could obtain as much data as practicable          on total   defense
profits    of the selected companies.       Although in some cases
operating    segments were almost entirely       engaged in defense
work and thus had data on defense sales readily            available,
this was the exception.       In most cases it was necessary for
the participating     companies to do substantial       work to break

                                    10
out data on defense sales and the other categories of sales
that we requested and to allocate related costs and invested
capital.

Accounting   alternatives     available

       There are acceptable     alternatives     available     for deter-
mining costs under generally         accepted accounting       principles,
We did not attempt to draw up a uniform set of accounting
rules for the purpose of recasting           the results    of operations
for the companies participating          in the study,      The work and
cost involved prohibited       such an approach.         We did,however,
insist   that the profit    data furnished      agree with the data
reported    in the audited financial       statements of the compa-
nies, and we attempted to see that the accounting methods
used were appropriate     to the circumstances.




                                     11
FINANCIAL TERMS DEFINED

         This report      contains   financial     terms which    are defined
below.

         1. DOD sales--Net        sales to DOD under both prime con-
            tracts    and subcontracts,     exclusive   of sales, prof-
            its,   fees or costs for operation        of DOD GOCOplants,
            and performance of operation         and maintenance con-
            tracts    and service contracts.        These latter  con-
            tracts were excluded from sales and identified             sep-
            arately,    since they have the common characteristic
            of requiring     little    or no contractor   capital  in-
            vestment,

         2.   Other defense agency sales--Net     sales to NASA, AEC,
              and the Coast Guard under both prime contracts         and
              subcontracts,  exclusive   of sales, profits,     fees or
              costs for operation    of GOCOplants,    and performance
              of operation  and maintenance contracts       and service
              contracts.

         3.   Commercial sales--Net    sales to commercial customers
              and to State, local,   and foreign      governments ofprod-
              ucts or services which are reasonably comparable to
              those sold to the defense agencies or which involve
              comparable manufacturing     operations.

         4.   Total capital     investment    (TCI)--The     total   invest-
              ment in all assets used in the business,             exclusive
              of any Government-owned items or leased items.                 In
              other words, the total       capital    provided by creditors
              (debt capital)      and the owners of the business
              (equity capital).       We assumed that total        capital
              allocated     to each sales category was composed of
              equity and debt capital       in proportion       to those of
              the business as a whole,

         5.   DOD TCI,    other defense agency TCI, and commercial
              TCI--The    parts of TCI which are allocable to sales
              CDOD,      other defense agencies, and commercial cus-
              tomers,    respectively.




                                        12
     6. Turnover of TCI--Sales  divided by TCI equals the
        number of times TCI of the business,   or segment
        thereof,  turned over during a year.   Another   defini-
        tion of turnover  is the amount of sales dollars
        brought about by, or resulting  from, each dollar      of
        TCI.

     7. Equity capital   investment     (ECI)--The   total    dollars
        assigned to capital     shares, retained     earnings,
        retained-earning    reserves,    minority  interests,      and
        such other equity-type      items as deferred-investment
        tax credits.

     8. DOD ECI, other defense agency ECI, and commercial
        ECI--The parts of total EC1 which are allocable    to
        sales to DOD and other defense agencies and compar-
        able sales to commercial customers,  respectively.

      9. Turnover of ECI--Sales       divided by EC1 equals the
         number of times the EC1 of the business,         or a seg-
         ment thereof,      turned over during a year.     Another
         definition      of turnover  is the amount of sales dol-
    \_   lars    brought   about  by, or  resulting from, each dol-
         lar of equity investment.

    10. DOD and other defense agency profits        before Federal
        income taxes --The,net    income or loss on prime con-
        tracts   and subcontracts    of DOD and other defense
        agencies,   respectively,    after deducting all allo-
        cable costs, whether or not allowable        or recover-
        able.

    11. Commercial profits  before Federal income taxes--The
        net income or loss from sales to commercial cus-
        tomers and to State, local,  and foreign    governments
        of products or services which are reasonably com-
        parable to those sold to the defense agencies or
        which involve comparabie production    processes.

      We believe that of the various ratios       available     for
evaluating   profits earned by contractors      under negotiated
defense contracts,   the percentage of profit      earned on TCI is
the most meaningful    for evaluating    defense profits.       The
rate of return on TCI relates      earning to total     capital

                                  13
employed, regardless        of whether it was provided by the
owners of a business,         its creditors,      or its suppliers,    and
the Government should not be particularly               concerned with
whether contractors        obtain capital      from creditors    or from
stockholders.     Further,       since interest     is not an allowable
cost under Government contracts            and must be paid out of
profits,    it seems only equitable          to consider total    capital
in determining    profits.

       The rate of return on EC1 is primarily       of interest      to
the owners or prospective     owners of a business,        since it
represents    the return on the owners' capital       interest    in
the business.     Ratios of prorit    to costs or sales are im-
portant    to management to determine how profit        margins com-
pare with those of similar     companies.     Cost and sales ratios,
however, are less meaningful     than capital    ratios     in that
cost and sales ratios    do not consider the amount of capital
used in producing the profit     or the period of time the capi-
tal was committed.




                                     14
                                CHAPTER 2

         ANNUAL PROFIT RATES OF LARGE DOD CONTRACTORS

        The data submitted by 74 large DOD contractors               on an-
nual profit     showed that profit,      as a percent of sales, was
much lower on defense sales than on commercial sales.                    When
profit    was considered as return on contractor          TCI and ECI,
however, the profit      rates for commercial and DOD sales were
closer to each other,        One explanation      for this is
Government-furnished       capital   in the form of progress pay-
ments, cost reimbursements,        and industrial     facilities       and
equipment.      Further details     on this and other points are
set out in the schedules and analyses which follow.                   To give
an indication      of the effect    of Federal income taxes on
profits,    we have provided summary data on profits              both be-
fore and after      Federal income taxes for the 74 large DOD
contractors     included in our study.       The after-tax        data is
presented in schedule 2. All the other profits                 presented
are before Federal income taxes, unless otherwise                 stated.

         Data are presented separately,        in schedule 15, relat-
ing to (1) the operation         of GOCO plants for fees and (2) the
performance of service contracts           requiring     little      or no
contractor     capital.      Six of our large DOD contractors            re-
ported that their        DOD work was almost entirely            under ser-
vice contracts.         Therefore much of the defense procurement
data that followpertainsto          74 of the 80 large DOD contrac-
tors from which we obtained data.             Some of the 74 contrac-
tors are operating        with substantial     quantities        of Govern-
ment facilities.         They also have major investments             in fa-
cilities     of their    own, however, and they are paid for the
items produced, rather than for the operation                   of the facil-
ities.

SUMMARYOF DATA FOR LARGE DOD CONTRACTORS

      Defense and comparable commercial sales over the
4 years we covered averaged S94 billion  a year for 74 large
DOD contractors  included in our study.  The $94 billion   in
sales were 25 percent to DOD, 71 percent to commercial cus-
tomers, and 4 percent to the other defense agencies.     The



                                     15
average profit   rate on sales for commercial business,
9.9 percent,   was significantly  higher than the DOD sales
rate of 4.3 percent or the other defense agency sales rate
of 4.9 percent.

      Profits measured as a percentage of TCI and as a per-
centage of EC1 were more nearly the same for defense and
commercial sales.    The commercial rates of return,   however,
remained higher than the rates for DOD sales.      The rates of
return for the less significant    sales to the other defense
agencies were actually   higher than the rates for the com-
mercial sales,as  shown below.

                                               Four-year   average
                                             Profit      Return on
                 Category                     sales    TCI       EC1

                                                     (percent)
        DOD                                    4.3      11.2     21.1
        Other defense       agencies           4.9      15.0     27.5
        Commercial                             9.9      14.0     22.9

       The narrow range of the rates of return on capital           in-
vestment for the three sales categories,          compared with the
wider range in profit      rates on sales, is due largely       to the
effect   of Government-furnished        capital, as mentioned pre-
viously.    The relatively       smaller amount of capital   required
of the contractor     for defense work also shows up in the
higher capital    turnover     rates (sales divided by related TCI
and ECI, respectively)       for these sales compared with com-
mercial   sales, as shown below.

                                                          Four-year average
                                                            turnover rates
                 Category                                  TCI             EC1

DOD business                                               2.3            4.9
Business with other      defense       agencies            2.8            5.6
Commercial business                                        1.3            2.3

(For further   details      see sch. 1.1




                                        16
Return of large DOD contractors  on
TCI for DOD and commercial sales

       As shown in the following    table,     the range in rates of
return on total   capital   investment     was fairly     wide for both
DOD and comparable commercial sales of the 74 large DOD
contractors.    A larger percentage of DOD sales dollars           was
in the loss category in 3 of the 4 years, but the losses on
commercial sales extended to a significantly            lower range in
3 of the 4 years.     The rate of return on profitable           DOD
sales extended to a significantly         higher range than profit-
able commercial sales in 3 of the 4 years.            In general,    the
average return on total     capital    investment was higher on
commercial sales in each of the 4 years.

                                         Return    on TCI
                            DOD                               Commercial
Year           Average            Range             Average                Range


1966             11.3         -27   to    +60         16.2           -16     to    +61
1967             12.1         - 6   to    +85         12.2           -27     to    +44
1968             11.9         -22   to    +81         15.6           -50     to    +46
1969              9.5         -12   to    +96         12.4           -33     to    +39

(For further      details    see schs.         3 and 4.)




                                          17
Profit     data for various         categories        of
large     DOD contractors

       We were interested     in seeing whether profit  rates var-
ied for contractors      of various sizes and types.    For this
purpose the 74 large DOD contractors       were divided into the
following   three categories.

         1. High-volume     defense         contractors--Contractors            having:

            (a> At least 10 percent               of total     company business
                in defense sales.

            (b) Over $200 million             in average       annual defense
                sales.

         2. Medium-volume        defense      contractors--Contractors             hav-
            ing:

            (a> At least 10 percent               of total     company business       in
                defense sales.

            (b) Average annual             defense    sales    of less   than
                $200 million.

         3. Commercially        oriented      defense      contractors--Contrac-
            tors having:

            (a> Less than 10 percent               of total     company business
                in defense sales.

            (b)   Substantial      defense        business.

      The data shown in schedules 5 through 10 represent   the
same data shown in schedule 1 but segregated into the three
categories   of contractors.  Some of the more significant
points follow.
         Sales

      The major part of defense work is concentrated  in
32 high-volume  defense contractors, as shown in the follow-
ing breakdown of sales data for 74 large DOD contractors



                                             18
for the 4-year period 1966 through 1969.    The 13 commer-
cially   oriented contractors account for about the same
amount of commercial sales as do the 61 defense-oriented
contractors.

                                      Annual average sales 1966-69
                                   Defense-oriented
                                     contractors          13 commercially
                              32 high     29 medium All       oriented
       Sales category         volume       volume    61     contractors

                                                        (billions)

 DOD                           $19.0            $2.6          $21.6   $ 2.0

 Other defense agencies          2.8             0.1            2.9     0.4

 Commercial                     27.5
                                --               6.5           34.0    32.9

       Total                   $49.3            $9.2          $58.5
                                                               ~      $35.3
 (For further    details   see sch. 5.)


       Profit    on sales

        Profit      as a percent of sales is lowest on DOD sales;
slightly       higher on other defense agency sales, except for
the medium-volume contractors;            and significantly     higher on
commercial sales.          The operations    of the large commercially
oriented       defense contractors,     as a group, appear to be more
profitable        than those of the defense-oriented        contractors,
as shown below.
                                       Profit/sales  average 1966-69
                                    Defense-oriented
                                      contractors           13 commercially
                                32 high 29 medium A=            oriented
       Sales category           volume       volume   61
                                                      -       contractors
                                                -(percent)-

 DOD                              3.8             6.1          4.1     6.5
 Other defense agencies           4.4             3.7          4.4     8.1
 Commercial                       8.2             8.6          8.3    11.6
 Overall                          6.3             7.8          6.5    11.2

  (For further   details    see sch. 6.)



                                           19
      Return   on TCI

        The commercially       oriented     contractors    had an average
15.2 percent rate of return on TCI compared with an average
12.3 percent rate of return for the defense-oriented                 con-
tractors.      It is interesting         to note that the average rate
of return on DOD work was almost the same for commercially
oriented    and defense-oriented           contractors,    (11.1 and
11.2 percent,      respectively).          Thus, as shown below, a major
part of the overall        difference       in rates of return is at-
tributable     to commercial work on which the defense-oriented
contractors      averaged 12.6 percent return on TCI and the
commercially      oriented    companies averaged 15.4 percent.           In
addition,    the commercially         oriented     companies had a much
greater proportion        of their     sales from their more profitable
commercial customers.

                                         Return on TCI
                          Defense-oriented
                            contractors             13 commercially
                     32 high     29 medium All           oriented
Sales category       volume         volume     -61     contractors

                                              (percent)

 DOD                       11.0        12.2        11.2        11.1
 Other defense
   agencies                16.3         6.4        15.3        14.1
 Commercial                12.6        12.3        12.6        15.4
 Overall                   12.3        12.2        12.3        15.2

(For further     details      see sch. 7.)

      Return   on EC1

        As shown below, the three classes of contractors      com-
pare very closely     on return on EC1 the averages for the
4-year period being 22.7 percent for 32 high-volume        defense
contractors,     21.4 percent for 29 medium-volume defense con-
tractors,    and  23.1 percent for the commercially  oriented
contractors.

     The defense-oriented          contractors      were able to approach
the commercially   oriented        contractors      in return on EC1

                                      20
because a smaller part of TCI of the defense contractors
was ECI.    In other words, the defense contractors   in our
study relied    on borrowed capital for a greater proportion
of their   capital  needs.

                                         Return on EC1
                           Defense-oriented
                             contractors             13 commercially
                      32 high     29 medium All          oriented
Sales category        volume         volume     -61    contractors

                                                    (percent)

 DOD                       21.4              21.9        21.5   18.4
 Other defense
   agencies                31.6              10.3        29.6   21.8
 Commercial                22.8              21.4        22.5   23.3
 Overall                   22.7              21.4        22.5   23.1

(For further     details     see sch.        8.1

      Turnover    rates     of TCI and EC1

       The average annual capital           turnover   rates, determined
by dividing      sales by capital,        were higher for the defense-
oriented     contractors        than for the commercially     oriented
contractors.        Also the rates were higher for the high-volume
defense contractors           than for the medium-volume contractors.
As mentioned before, this reflects              the effect   of Government-
furnished     capital     in the form of progress payments, cost
reimbursements,        facilities,      and equipment.     A summary of the
turnover     rates for the various categories           of contractors
follows.




                                        21
                             Defense-oriented
                               contractors              13 commercially
                         32 high    29 medium     All      oriented
 Sales category          volume       volume     -61      contractors

Turnover of TCI:
     DOD                   2.5          1.8      2.4           1.6
     Other defense
       agencies            3.4          1.3      3.2           1.7
     Commercial            1.4          1.3      1.4           1.3
     Overall               1.7          1.4      1.7           1.3
Turnover of ECI:
     DOD                   5.6          3.6      5.3           2.8
     Other defense
       agencies            7.1          2.8      6.7           2.7
     Commercial            2.8          2.5      2.7           2.0
     Overall               3.6          2.7      3.4           2.1

(For further   details     see schs.    9 and 10.)




                                   22
Summary of profits      by type of contract

      The types of negotiated        contracts  covered are those
most commonly used in recent years by the Department of De-
fense: cost-plus-fixed-fee         (CPFF), cost-plus-incentive-fee
(CPIF), fixed-price      incentive    (FPI), and firm fixed-price
(FFP) contracts.      Formally advertised      contracts     are also
covered.

     Profit   rates were about        the same for     prime   contract
and subcontract    sales.

      The bulk of the DOD sales fell  in the FPI and FFP con-
tract categories,  while the sales to other defense agencies
were concentrated   in the CPFF and CPIF contract categories.

       Advertised      prime contracts        appeared to be the least
profitable      in that contractors         reported   losses for 3 of the
4 years on DOD work and for 2 of the 4 years on other de-
fense agency work.            The dollar volume of such contracts          is
relatively      small.      It amounts to about 6 percent of total
sales reported.          It is probable that our data on formally
advertised      contracts      are not representative,       since certain
industries      that perform the bulk of their defense con-
tracts     under advertised       contracts,      such as petroleum com-
panies and construction           companies, were not included in our
review.

     Following is a summary of average profit      data, by type
of contracts,    for the 74 large DOD contractors.     Profit data
for DOD work and work of the other defense agencies are
shown separately.




                                     23
                                                                Other defense
                                       DOD                           agencies
                              Prime                            Prime
   Type of                     con-      Subcon-                con-        Subcon-
   contract                 tractor      tractor             tractor        tractor

CPFF:
     Sales                  $ 1,849       $     186          $1,044         $ 70
     Profit                      4.4            4.7              3.6         3.6
CPIF:
     Sales                    2,738             299           1,182          236
     Profit                      5.3            5.5              5.2         3.8
FPI:
     Sales                    6,564             533              71           12
     Profit                      3.9            0.7             8.7          6.5
FFP:
     Negotiated
        sales                 7,234           2,132             241          145
     Profit                      5.3             5.0           10.1          6.0
Advertised:
     Sales                    1,151                                6
     Profit                    -3.4                             0.7

         Total
           sales            $19,536       $3,150             $2,544         $463

         Profit                  4.2            4.2             5.0          4.5

Notes:
  1. Sales in millions           of dollars.
  2. Profit  as percent          of sales.

(For further      details     see schs.        11 and 12.)




                                          24
Comparison of actual profit  rates with
going-in  profit rates for DOD contracts
for 74 large DOD contractors

        The actual rates of profit   reported by the DOD contrac-
tors for FPI contracts      and for FFP negotiated  contracts
were substantially     below the average going-in   profit    rates
DOD has reported     in recent years for these types of con-
tracts.     "Going in" rates are rates anticipated     at the time
of contract     award and are based on estimated   costs.

        Following    are the actual profit      rates reported by con-
tractors     as a percent of sales compared with the average
going-in     profit   rates DOD reported    for the years 1966 through
1969 for the major types of negotiated             DOD contracts,      Since
the actual profit        rates are after deduction of all costs,
we have added to the actual rates a percentage estimated                  to
cover costs unallowable         under DOD negotiated       contracts   as
provided in section 15 of the Armed Services Procurement
Regulations.        Until June 30, 1970, it was not mandatory to
apply section 15 in negotiating          FPI and FFP negotiated        con-
tracts.      For the purpose of this comparison,          however, we
assumed the provisions         were applied to all negotiated         con-
tracts.      The 1.4 percent adjustment       that we added was de-
veloped during our review of individual             contracts    discussed
in chapter 5 of this report.


                              Profit  as a percent   of sales
                           Estimated                                Actual
                          adjustment                   Average       rate
  Megotiated    Average        for       Adjusted          DOI!     under
   contract     actual    unallowable     actual       going-      going-in
     _tvpe      profit        cost        profit       --in rate     rate

     CPFF          4.4         1.4          5.8          6.3         4.5
     CTIF          5.3         1.4          6.7          7.0         -0.3
     FPI           3.9         2.4          5.3           9.2       -3.9
     FFP           5.3         1.4          6.7           9.8       -3.1

       The small differences      in the cost-type     contracts are
not significant       and are probably due, in large part, to
unallowable       cost exceeding our estimated      figure of 1.4 per-
cent or to cost incurred        above that on which the fee was
based.    The reductions      in actual profit   rates compared with
going-in    profit    rates for the FFP and FPI types of contracts
are significant.
                                     25
        We also recomputed the overall       profits and rates of
return,    reported by the 74 large DOD contractors,        on the
basis of what they would have been if the contractors           had
realized     the going-in    profit  rates on the prime contracts
shown above.       Following    is a comparison of the results.
The average actual commercial rates of profit          of the 74 con-
tractors     are also included for comparison.

                                                         Profits
                                                     DOD
                                              Actual   Revised     Commercial

Profit     as   a percent    of sales           4.3         6.3        9.9
Profit     as   a percent    of total
   capital      investment                     11.2       15.8        14.0
Profit     as   a percent    of equity
  capital       investment                     21.1       31.1        22.9




                                         26
Profit     data by product     category

       Most of the 74 large DOD contractors          sell more than one
product line to the Government, and many diversified              com-
panies sell a great variety         of products.     The sales and
profit   data we obtained    from contractors       were not broken
down by product category.          In analyzing    contract  awards to
the 74 large DOD contractors,         however, we noted that some
had received   a preponderance       of their    awards in one of two
product categories:      (1) ammunition and (2) aircraft,          mis-
sile,   and space work.     Profit    data for these contractors       are
discussed below.

         Ammunition   contractors

        We identified      nine major DOD contractors        whose contract
awards for ammunition averaged more than 80 percent of their
total    annual DOD contract        awards for the period 1966 through
1969.     These contractors        accounted for about 24 percent of
the total     DOD contract      awards for this commodity.          Their
total    annual DOD sales averaged $700 million             a year for all
products.      The award and sales figures           are not comparable,
however, since there is a production              time lag and since the
sales figures,        although primarily      for ammunition,     include
some sales of other products.              These contractors    produce
ammunition components, and the sales data presented here do
not include any data relating            to operation    of GOCO ammuni-
tion load, assembly, and pack plants or other GOCO plants
where the contractors          were paid fees for operating         the
plants.

       Average profit,    as a percent of sales, for these nine
contractors     was about the same for their defense business
and for their      commercial business (10.3 percent and 10.1 per-
cent, respectively).        Profit  as a percent of TCI and as a
percent of EC1 was considerably         higher on defense business
than on comparable commercial business.            As shown on page 28,
these nine contractors       also had profits     on their  defense
business that were substantially         higher than the average
profit    fqr the balance of our total       group of 74 large DOD
contractors     after  the nine ammunition contractors       and 12 air-
craft   missile    and space contractors     were excluded.



                                      27
      Aircraft,                 missile                       and space contractors

      We identified   12 other major DOD contractors      whose con-
tract   awards for aircraft,   missile   or space work averaged
more than 80 percent of their      total  annual DOD contract
awards for the period 1966 through 1969.         Contract awards to
these companies accounted for more than 55 percent of the
total   DOD contract  awards for this product grouping during
the years covered by our study.        Their total   annual average
DOD sales amounted to over $9 billion        per year for all
products.

       The average profit      on sales to DOD for these 12 contrac-
tors was the same as the average profit            for the major DOD
contractors--4.3      percent.     However, the average 12.9 percent
rate of return on TCI related          to sales to DOD by these 12
contractors      was about 34 percent higher than the average
9.6 percent for the 53 other major DOD contractors.                 This
indicated     that these 12 contractors       had more Government fi-
nancing than the average contractor           in the total     group.
These 12 contractors       had a rate of return on their defense
business considerably       better   than on their commercial busi-
ness.     The following    table presents comparative        profit    data
for the nine ammunition contractors;            the 12 aircraft,      mis-
sile,   and space contractors;       and the 53 other large defense
contractors.       The data presented represents       weighted average
data for the 4 years, 1966 through 1969.
                                                                                          Contractor        groups
                                                                                                 Aircraft,              53 other
                                                                                                   missile,           large     DOD
                                                                     Ammunition                   and space          COY.traCtOrS

        Sales      (in billions)
               DOD                                                      5          .7               $ 9.1                $13.9
               Other    defense          agencies
               Commercial                                                     i.9                      i::                5::;
        Profit       as percent          of       sales:
               UJD                                                          10.3                                            4.0
               Other    defense          agencies                                                      E
               Commercial                                                   10.1                       616                1Z
        Profit       as percent          of      TCI:
                DOD                                                         28.3                     12.9                  9.6
               Other    defense          agencies                                                    20.8                 11.5
               Commercial                                                   li.5                     10.0                 14.8
        Profit       as percent          of      ECI:
                COD                                                         54.4                     28.0                 16.9
              Other      defense         agencies                                                    43.2                 19.3
              Commercial                                                    19.2                     17.8                 23.8
        Total    TIC1 turnover                rate:
              DDD                                                             2.6                      2.7                  2.0
              Other      defense         agencies                                                      4.0                  2.1
              Co-nwrcial                                                      LO                       1.3                  1.3
        EC1     turnover      rate:
                DOD                                                           5.3                                           4.2
                Other     defense        agencies                                                      is;
                Conwrcial                                                     T.9                      217                  4:;

        (For     further       details            see      schs.   13 and          14.)


                                                                            28
Profit  data for GOCO plants and
service contracts  of 80 large DOD contractors

     We obtained  separate     data pertaining    to the operation
of GOCOplants,   contracts    for operation       and/or maintenance
of Government facilities,     and service contracts         for DOD and
the other defense agencies (NASA and AK).              The characteris-
tic common to these contracts     is that they require          little
or no investment   of contractor    capital.        If we included
data on these contracts,     our overall     profit    data would be
distorted.

       Of the 80 large DOD contractors,       six reported all,   or
practically   all,   their defense business in GOCO-type sales,
and 38 others reported       some sales of this type to DOD or
other defense agencies.        The volume of GOCObusiness re-
ported was about Z-l/Z times greater        for DOD than for the
other defense agencies ($2.1 billion        and $0.8 billion,   re-
spectively).      The profit   on sales for the other defense
agency business was about 32 percent higher than for DOD
business (4.1 percent and 3.1 percent,         respectively).

       The difference in profit   between DOD and the other de-
fense agencies on GOCO sales may be explained,         in part,   by
the nature of the work performed.       The bulk of GOCO sales
to DOD were for the operation     of Government-owned ammuni-
tion plants and to NASA were largely       for technical   services.
GOCO sales to AEC were divided between support services and
GOCOplant operations.     Cost-type    contracts   were the con-
tracts   most widely used by both DOD and other defense agen-
cies for this work.

      (For further   details   see sch.   15.1




                                   29
                                 CHAPTER3

                  ANNUAL PROFIT DATA OF SELECTED

                        DEFENSE SUBCONTRACTORS

       Data were obtained from 10 companies that perform about
80 percent of their defense work under subcontracts        and
only about 20 percent under prime contracts.        Generally
speaking, defense sales of these companies were for raw or
semifinished   materials  rather than completed end products.
Defense work accounted for about 9 percent of their sales;
commercial work accounted for 91 percent,       Their sales to
other defense agencies were relatively    insignificant.

       The 10 companies, which we will refer to as subcontrac-
tors,    earned a higher profit        on sales (7.1 percent)        on de-
fense business than the 74 large DOD contractors                 earned
(4.3 percent).        The subcontractors,       however, had a lower
rate of return on total        capital      and equity capital     assigned
to both defense and commercial production               than the major
defense contractors.         This was caused by the fact that the
majority    of these contractors        provided raw materials        to
prime contractors       and were reimbursed upon delivery            of their
products.      Thus, their progress payments were relatively
minor and they had very little            in the way of Government-
owned facilities.        The relatively       small amount of Govern-
ment capital      they had, however, resulted         in a higher rate
of return on their       investment     for defense work as compared
with their     commercial work.        Their capital     turnover rates
were lower than those of the 74 large defense contractors
but were higher for defense work than for commercial work,




                                      30
                                          10 major        74 large
                                          defense         defense
    Average   4 years    1966-69       subcontractors   contractors

Profit    as percent of sales:
       DOD                                    7.1             4.3
       Commercial                             7.5             9.9
Profit    as percent of TCI:
       DOD                                    9.4            11.2
       Commercial                             7.8            14.0
Profit    as percent of ECI:
       DOD                                   15.4           21.1
       Commercial                            12.2           22.9
Turnover of TCI (Sales/TCI):
       DOD                                    1.1             2.3
       Commercial                             0.9             1.3
Turnover of EC1 (Sales/ECI):
       DOD                                    2.2             4.9
       Commercial                             1.6             2.3

(For furth er details,     see schs.   1 and 16,)
                                CHAPTER 4

                   ANNUAL PROFIT DATA OF SMALLER

                         DEFENSE CONTRACTORS

        As discussed earlier        in this report,       our sample of
smaller defense contractors            represents     a random selection
of 61 defense contractors,            exclusive     of the 74 large DOD
contractors,       10 subcontractors,        and six GOCO contractors
 separately     covered.       The data presented should not be con-
sidered representative           of all such contractors       because over
180,000 procurement actions of $10,000 or more were negoti-
ated by DOD in each year covered by our study for hundreds
of thousands of different           items.      The large sampling neces-
sary to get representative            profit    data for the great number
of industries        involved precluded our attempting          it in this
 study.     Further,     we felt that the cost was not justified
since we had accounted for almost 60 percent of the DOD
procurement dollars          through our coverage of 80 of the
largest     DOD contractors.

       The 61 smaller contractors      were considered commercially
oriented   because only about 5 percent of their sales were
to DOD. Their average profit        rate on sales to DOD of 4 per-
cent was 40 percent of the average profit         rate they earned
on commercial sales,      It   was, however,  only   slightly below
the 4.3-percent    profit   rate on sales earned by the 74 major
DOD contractors.

      The rates of return on TCI and EC1 on DOD sales for
these contractors    were less than rates they earned on com-
mercial  sales and the rates earned by 74 large DOD contrac-
tors on DOD sales.     The fact that the capital  turnover    rates
of these contractors     for their DOD business were not much
more than their rates for commercial sales indicates       that
they received little     Government capital.

        Following   is a summary of profit   data,      before Federal
income taxes, for the 61 smaller contractors             compared with
similar     data for the larger contractors.




                                    32
                                                             4-year   averages
                                                      61 smaller          74 large
                                                      contractors       contractors

Sales (in billions              of dollars):
     DOD                                                $ 0.7              $23.7
     Other defense          agencies                        .2               3.3
     Commercial                                          11.8               66.8

             Total                                      $12.7               $93.8

Profit      as percent      of sales:
         DOD                                               4.0                4.3
         Other defense      agencies                       2.7                4.9
         Commercial                                       10.0                9.9

Profit      as percent      of TCI:
         DOD                                               7.3               11.2
         Other defense      agencies                       5.8               15.0
         Commercial                                       13.0               14,o

Profit    as percent        of ECI:
      DOD                                                 10.6               21.1
       Other defense        agencies                       8.0               27.5
       Commercial                                         20.9               22.9

TCI turnover   (Sales/TCI):
    DOD                                                    1.4                2.3
    Other defense agencies                                 1.6                2.8
    Commercial                                             1.2                1.3

EC1 turnover   (Sales/ECI):
    DOD                                                    2.7                4.9
    Other defense agencies                                 3.0                5.6
    Commercial                                             2.1                2.3

(For further         details,       see schs.       17 and 1.)




                                               33
                                     CHAPTER5

       NEED TO CONSIDER CONTRACTORS‘CAPITAL REQUImENTS
                      IN NEGOTIATING PROFIT FACTORS

       Although not called for specifically                    in the legislation,
we reviewed 146 negotiated               Government contracts.           We found
that contractors'           rates of return        on capital      employed in
contract     performance varied greatly.                These contract        rates
varied from a loss of 78 percent to a profit                       of 240 percent
of total     capital      investment.         This wide range is due, to
some degree, to the fact that,                 under present policies,            Gov-
ernment procurement personnel give little                      consideration         to
contractors'        capital     requirements        in developing profit           rate
objectives       for negotiated         contracts.      Profit     objectives        are
usually    developed as percentages               of various cost elements.
Further,     by relating        profits      to costs in noncompetitive              sit-
uations,     the higher the costs the higher the profits.                          Thus,
in many cases, contractors                are not provided with a positive
incentive      to invest in more efficient              facilities      because an
investment       in facilities         that would lower unit costs would
also result        in lower profits.

       In reviewing      congressional      hearings which led to this
study, we noted some concern that contractor                  capital   re-
quirements were not considered             in negotiating       defense con-
tract    prices.      To determine whether it was practical              to de-
velop investment        data by contract       and to see if there was a
wide range in profits          as a percent of invested capital,            we
selected     146 negotiated      contracts     for review at 37 contractor
locations.         The contracts   totaled     about $4.3 billion        in ex-
penditures       for such items as aircraft,          missiles,     space equip-
ment, ship repairs,         weapons, ammunition,        electronics,      and
communications        equipment.     Contract     types involved were those
commonly used by DOD: CPFF, CPIF, FPI, and FFP contracts.
Our selection        was limited   to recently       completed negotiated
contracts     and was made without         regard to profitability.

      The selection    of locations    for contract   reviews was
made primarily    from the top 80 defense contractors        after
considering    such factors   as significance     of dollar  value of
awards and types of products being furnished.            Consideration

                                            34
was also given to obtaining     coverage of some awards of each
of the defense agencies.     Certain   contractors  were excluded
whose work was predominantly     of a maintenance or service na-
ture rather than manufacturing.       Also, we excluded GOCO
plant activities.

     We computed    profit    as a percentage of sales and of costs
for each contract.      We also computed profit       as a percentage
of the contractor's      capital   employed in contract    performance.
We excluded consideration        of Government-furnished    capital
and leased assets as we were interested          in the rate of re-
turn on resources provided by the contractor.            Our computa-
tion of total capital      employed included provision      for the
following  asset elements.

      1, Cost of work in process, finished         goods, and accounts
         receivable--On      a monthly basis, we totaled      costs in-
         curred under the contract,       deducting progress pay-
         ments and cost or other reimbursements          received from
         the Government.       From these data, we computed the
         average amount the contractor       had invested in work
         in process,    finished    goods, and accounts receivable.

      2. Investment    in fixed assets (including         land)--In     de-
         veloping the contractor's         average investment       in
         fixed assets for the contract,          we generally      deter-
         mined (1) depreciation        charged to the contract         and
         (2) the ratio between depreciation           charged to the
         contract   and total depreciation        charges during the
         contract   period.      Using this ratio,     we computed the
         approximate     fixed-asset    investment.     We based the
         investment   allocation      on the contractor's      net book
         value of assets.

      3. Other assets--We used several methods to allocate
         assets such as cash, raw materials        inventories,       and
         prepaid expenses.    For example, in some cases, in-
         vestment in raw materials    inventories      was allocated
         by using the ratio   of the value of material          issued
         to the contract   to total material     issued during the
         period involved.    Prepaid expenses were allocated
         in the same proportion    as other more directly          allo-
         cable items.


                                     35
       The assets discussed above were financed on an overall
basis by current       liabilities,     long-term    debt, and equity
capital.      We refer to this overall         investment  in assets as
total    capital   invested (TCI).        In computing rate of return
on TCI, we added interest           expense to net profit,    since in-
terest represents        the return to the providers       of debt cap-
ital.

       After determining     average contract       TCI and computing
the rate of annual profit,         we  computed   the  approximate      con-
tract ECI.      This was done on the basis of the overall             cor-
porate relationship      of equity capital      to the total     liabil-
ities    and capital.    The rate of return on equity capital
was based on net contract         income before Federal income taxes
but after deducting all contractor           expenses allocable       to the
contract,    including   interest     expense.




                                    36   ’
RATES OF PROFIT ON 146 CONTRACTS

     Overall rates of return,  before Federal                    income taxes,
and other data on the 146 contracts   follow.

Total value         of contracts                                  $ 4.3 billion
Profit as a         percent of costs                                6.9a
Annual rate         of return on total     capital                 28,3%a
  II      II        f?      II   II equity     I'                  56.1%a

aPercentages         weighted   by costs,        TCI, or ECI, as appropriate.

      The great range in return              on TCI is shown in the fol-
lowing schedule of the average               rates we developed for the
146 contracts,

                                     Number of         Percent of total
           Return     on TCI         contracts         Contracts  Sales

         loss  contracts:
              78% to 0%                     17              12          8.2
         Return of:
                0.1% to       20%           46              32        17.7
               20.1 to        40            43              29        23.1
               40.1    to     60            19              13        16.2
               60.1 to        80             9               6        27.2
               80.1 to       100             4               3         1.9
              100.1 to       240             8               5         5.7

                     Total                                           100.0

         The range in profits    is also indicated     by the fact that
the     contractor   who made 240 percent on his TCI on one con-
tract     suffered    losses of about 14 percent and 25 percent of
TCI     on two other contracts    we reviewed.     This contractor
had     an overall   loss on TCI of 4 percent on all contracts
that     we reviewed.

        The average rates of return for individual     contracts
were substantially     higher than the average annual profit
rates developed from our questionnaires       to 74 large DOD con-
tractors.     The 146 contracts   examined cannot be considered
as a representative      sample, and it would have been pure


                                            37
coincidence   if similar    rates had resulted  in both     phases of
our study.    The differences     between the two were:

      --The large number of DOD procurement actions,        over
         180,000 a year of $10,000 or more, covering a large
         number of different    items and industries   involved
         and the work required     to develop data for each made
         it impracticable    to attempt to develop a representa-
         tive sample.

      --The data furnished       by contractors     in response to our
         questionnaire    were on overall      defense business not
         on an individual-contract       basis.

      --We considered only completed contracts    where profits
         or losses were ascertainable   and, as a result,  prob-
         ably avoided many loss contracts   having large un-
         settled  claims.

        This phase of the study was not for the purpose of
validating      the profits  as reported by the contractors        in
replying     to the questionnaire.        This was done, to the ex-
tent possible,      by site verification      of 40 questionnaires
selected at random, as discussed earlier           in this report.
Our purpose was to determine           (1) whether it was practicable
to develop cost, profit,        and invested capital     data by con-
tract and (2) whether any wide range in profits            on DOD work
existed.       The work showed that cost, profit,       and invested
capital     data could be developed by contract       and that there
was a wide range of profit         rates on DOD contracts,




                                  38
EFFECT OF GOVERNMENTPROGRESSPAYMENTS
ON INVESTMENTRETURN

     Government progress payments significantly              reduce   the
need for contractor  capital.

       Under defense contracts,         there are usually provisions
for reimbursing      contractors    periodically      in whole or in part
as costs are incurred.          This reduces the working capital          re-
quired for contract       performance.       Cost contracts     generally
provide for reimbursement         of costs on a monthly or more fre-
quent basis.      Other types of defense contracts,           involving
predelivery     or unbillable     partial    performance expenditures
that will have material         impact on the contractors'        working
capital,    provide for periodic        progress payments of 85 per-
cent of total      costs incurred     for small business concerns and
80 percent for larger companies.

      For 12 contracts   involving   eight different    contractors,
we computed the rates of return on TCI with progress pay-
ments and without progress payments.         In all cases, the
rates of return were substantially       higher when progress pay-
ments were received.     The overall    average increase,    weighted
for TCI required    for each contract,     is shown below.

        Annual rate of return on TCI with
          progress payments                                  45.3%
        Annual rate of return on TCI if
          progress payments had not been
          received                                           25.1%
              Increase in rate of return        due
                 to progress payments                        20.2%

      The increase in rate of return (20.2% i 25.1%) because
of the progress payments was 80 percent.

        In one case, we noted that a contractor    was selling
the same item under a Government prime contract        and under a
subcontract.       The Government, however, provided progress
payments under the prime contract       whereas the contractor
did not receive progress payments from the prime contractor
under the subcontract.        Also, the Government paid for de-
liveries    within   an average of 29 days whereas the

                                     39
subcontractor   did not receive payments for deliveries   under
the subcontract    until an average of 131 days after deliv-
ery.

     Although this case is probably not representative,    it
does demonstrate the effect   of progress payments and the
time difference  in payment for deliveries.

                             Prime
                            contract     -Subcontract     Difference



Profit rate on costs,
  over or short (-1            10.9            14.2           -3.3
Annual return on TCI           29.7            16.6           13.1
    II     11   " EC1          49.4            27.5           21.9

      Return on TCI on the prime contract   was substantially
more than on the subcontract    because of progress payments
and more timely payments after delivery    of the items or-
dered, even though profit    as a percent of cost was 3.3 per-
cent higher under the subcontract.

        Government-furnished    facilities,   of course, have a
similar    effect   in reducing the capital     investment required
of contractors.




                                  40
GUIDELINES FOR DEVELOPMENTOF NEGOTIATED
CONTRACTPROFIT OBJECTIVES

        Guidelines     used by DOD procurement officials         to de-
velop profit       objectives     are set forth in section 3-808 of
the Armed Services Procurement Regulation              (ASPR). In the
absence of price competition           and where analysis     of the con-
tractor's     proposed costs is required,         a procedure known as
the weighted guidelines          method is used.     Using this method,
procurement officials          prepare a systematic     analysis    of
profit    objectives      before they begin negotiations,          The fac-
tors and weights considered           in developing the profit       objec-
tive are:

                                                                  Profit
                                                                   range       Estimate
                           Factors                              (note a>   X     cost     =   Profit
Contractor's         Input to Total         Performance:
     Direct        materials:
            Purchased parts                                     1% to 4%
            Subcontracted           items                       1 to 5
            Other materials                                     1 to 4
     Engineering          labor                                 9 to 15
             I,           overhead                              6 to 9
     Manufacturing            labor                             5 to 9
                II            overhead                          4 to 7
     General and administrative                 expense         6 to 8

                  Total
Composite Rate on Cost Input (profit                    computed
  above divided by total  estimated                  cost shown
  above)




                                                           41
                                                                                       Profit
                                                                                       range
                                 *Factors                                             (note a)                Profit
                                                                                                 (percent)
ADD:     Specific percentages assigned below:
       Contractor's     Assumption of Contract Cost Risk:                                                     0 to     +7
            By type of contract:
                  CPFF                                                                  Oto            1
                  CPIF (cost incentive)                                                 1to            2
                  CPIF (cost-performance-delivery)                                 l-1/2 to            3
                  FPI (cost incentive)                                                  2to            4
                  FPI (cost-performance-delivery)                                       3to            5
                  Prospective    price redetermination                                  4to            5
                  FFP                                                                   5to            7
           Reasonableness of cost estimates
            Difficulty    of task                                                          i:;
       Record of Contractor's        Performance:                                                            -2   to   +2
            Considerations:
                  1. Management
                  2. Cost efficiency                                                       I2
                  3. Reliability     of cost estimates                                     (a>
                  4. Cost reduction program accomplish-
                        ments
                  5. Value engineering accomplishments
                  6. Timely deliveries
                  7. Quality of product
                  8. Inventive and development contri-
                        butions                                                            (a>
                  9. Small business and labor surplus
                        area participation                                                 (a)
       Selected Factors:                                                                                     -2   to   +2
            Source of resources                                                        -2      to       0
            Special achievement                                                              0 to     -l-2
            Other                                                                          (a>
       Special Profit      Consideration                                                                     -r-l to t-4

                         Total     profit        rate
       Profit      Objective      (total       profit        rate   x total   recognized
          costs)                                                                                             5

'NS--No specific          weight       range designated.

         As shown above,                   there        is    no provision       to    consider               the
amount     of contractor       investment  capital
                                           required     during    con-
tract performance.   Further,  only minor consideration        is
given to the use of Government-owned facilities       under the
source of resources factor.    This could amount to a penalty
of as much as minus 2 percent for a contractor      with Govern-
ment facilities.   We have found, however, that the penalty
assessed usually has not exceeded 1 percent,      even where all

                                                             42
facilities   were Government owned. In the case of a contrac-
tor having no Government facilities,           there is no provision
for increasing   his profit    percentage to compensate him for
adding privately    owned facilities.        In fact,   since the ac-
quisition   of improved facilities      should result      in reduced
costs, his profits    on negotiated     follow-on     contracts   would
probably be reduced if such facilities            were added.

      ASPR states that normal             progress payments         shall   not be
weighted in developing profit              objectives.

       The other agencies included in our profit                     study gener-
ally follow profit        negotiation       policies     similar      to those of
the Department of Defense.             In fact,      the Coast Guard uses
the Department of Defense weighted guidelines                      to negotiate
some contracts.        Although NASA has not adopted the weighted
guidelines    method, NASA's procurement regulation                     calls for
consideration      of essentially        the same profit         factors     cov-
ered in the guidelines.           AEC provides in its procurement
guidelines    that contractor        investment will be considered                 in
determining     profit    objectives       and has developed maximum fee
curves which are based, in part, upon invested capital.
There are, however, no formalized               procedures for development
and consideration       of invested capital            in negotiating        indi-
vidual contracts.




                                         43
STUDIES AND REPORTSCONCERNINGCONSIDERATION
OF CONTRACTOR-INVESTEDCAPITAL REQUIRED
TO FULFILL GOVERNMENTCONTRACTS

        Several studies have been made which conclude that some
consideration     should be given to contractor-invested      capital
requirements    when negotiating  the profit    factor   of noncom-
petitive    Government contracts.    These studies are summarized
below.

Contractor    incentives      for   acquiring    private    facilities

         A study was completed by the Logistics        Management In-
stitute      in September 1967 at the request of the Assistant
Secretary      of Defense (Installations      and Logistics).     Its
objective      was to develop and propose ways of improving the
incentives      for contractors     to acquire and maintain   efficient
facilities.        Some significant    parts of the study are quoted
below.

               "Facility      investments,      soundly made, generally
      reduce total          contract   costs.     Under the present
      ASPR, however, facilities              investment       tends to lower
      rather       than increase profit         dollars      on negotiated
      contracts.           Lower profits    result      from lower esti-
      mated costs for labor, materials,                   and overhead.
      This is the most significant               deficiency       in the
      incentives         for defense contractors           to acquire
      facilities."
               'IThe acquisition        of facilities    that increase
      efficiency      may affect        the ability   to obtain a
      contract.       Under the present rules,           however, if a
      contractor       can get the business without           additional
      facilities       investment,       he can expect more dollars,
      and a higher        percentage       of profit  on invested cap-
      ital by refraining            from investment     as much as pos-
      sible and allowing            or causing expected costs to be
      as high as will            be acceptable."
             "Other things being equal, a modern efficient
      plant   can be expected to have lower labor and ma-
      terial   costs than one with less up-to-date       facil-
      ities.     Therefore,    the present Guidelines   applied
      on individual     contract   negotiation  tend to

                                       44
establish        a lower dollar profit  objective    for an
efficient        plant with a large investment    in facil-
ities     than     it would for a less efficient   plant
producing        the same output."'

         "Most of the contractors       stated frankly      that
they invest as little          capital  as possible     in fa-
cilities      for production     on negotiated    contracts
in order to avoid reducing their return on invested
capital.       Since more than half of the defense
procurement dollars         are spent on contracts       negoti-
ated on the basis of cost analysis,            it would appear
that a change in profit          policy giving greater con-
sideration       to invested capital     would be equitable
for defense industry         and beneficial    to the Depart-
ment of Defense."

One of several        recommendations   made in the report
was as follows:

         "Percentages    of profit  on net book value of
plant and operating        capital  (equity     plus debt less
facilities      and outside investments)        should be
included in the Weighted Guidelines             for determining
profit     objectives.     The present percentages        on
labor, material        and overhead costs and the per-
centages to be applied to the capital              elements
should be adjusted as necessary to accomplish
overall     DOD profit    objective  policies."




                               45
Prior GAO report on increased      costs due to lease
rather than purchase of fixed      assets by contractors

        In November 1967, GAO issued a draft report entitled
"Effect    on Cost to the Government of the Leasing of Land and
Buildings    by Contractors,  Department of Defense" (B-156818).

      The report concluded that contractors'      decisions  to
lease land and buildings     result  in greater cost to the Gov-
ernment than if facilities      were purchased.   Defense policies
do not offer an inducement to contractors       to purchase facil-
ities   as opposed to leasing them. Defense and industry        rep-
resentatives    should study possible methods of acquisition
which would be most advantageous to industry       and most eco-
nomical to the Government.

      We recommended that (1) DOD consider modifying          the
weighted guidelines     profit  factors  to distinguish    between
contractors   who purchase facilities      and contractors    who
lease them and (2) Defense policies        provide contractors    with
a financial   incentive    to acquire facilities    in a manner which
would be least costly to the Government.

        Subsequently,  the Department of Defense revised ASPR
to provide that rental      costs under long-term    leases would
be allowable     only up to the amount that the contractor     would
be allowed had he purchased the building,        unless the con-
tractor    could demonstrate that the leasing costs would re-
sult in less cost to the Government over the anticipated
life of the property.

ASPR Special   Subcommittee   Report

        A special subcommittee was established       in December 1967
by the ASPR Committee to consider the Logistics            Management
Institute     recommendation.    The ASPR Committee is part of the
Office of the Assistant       Secretary  of Defense (Installations
and Logistics)     and is responsible    for developing any needed
amendments to ASPR. The Special Subcommittee was given a
specific    task to (1) develop and test procedures for giving
greater weight in prenegotiation        profit  objectives    to capi-
tal employed, (2) evaluate the results         of the test,     and (3)
if appropriate,     recommend any needed changes to ASPR.


                                  46
      The Subcommittee issued a report,          in March 1968, pre-
senting a test plan and procedures for developing               informa-
tion on contractor     capital    employed in contract      performance.
After further    study, in October 1968, the proposal was pre-
sented to a panel of the Defense Industry           Advisory Council
which was chartered      to explore ways and means for fostering
a healthy defense industrial        base.    (The Defense Industry
Advisory Council was established          in 1962 to provide a means
for direct    and regular    contact between the Secretary          of De-
fense and his assistants       and industry    representatives.)

       Subsequently,    in June 1969, the Defense Industry   Advi-
sory Council recommended to the Secretary       of Defense that,
in addition    to costs, DOD profit   policy should recognize and
provide for adequate return on company capital       employed.
Since then progress has been slow.        However, a new ASPR Sub-
committee has been established      and in October 1970 the sub-
committee distributed      for comment draft forms for gathering
preliminary   data.

      In regard to DOD progress in this area, Dr. Robert N.
Anthony, a former DOD comptroller,   appearing before the Sub-
committee on Economy in Government of the Joint Economic
Committee on May 21, 1970, stated:

              "Fees are based on capital       employed in pub-
      lic utilities        and in public rate negotiations
      generally.       Defense procurement is one of the few
      important      areas where cost-based     pricing   still
      prevails.       In Great Britain,    Defense contract
      pricing     recently    was shifted  to a return-on-capital
      basis.      The possibility     has been discussed in the
      Department of Defense at least since 1962.                It is
      time to act."




                                     47
NASA report on an investment-oriented
profit  analysis technique

        NASA has developed a contract       negotiation     procedure
that includes consideration       of contractor       investment     re-
quired during contract     performance.       The procedure was de-
veloped in 1968 by George Washington University               and pre-
sented to NASA procurement personnel during a 3-day course
in profit    and fee analysis.      NASA then decided to conduct a
test of the new procedure.        Each NASA procurement office
was asked to furnish     data on new procurements          over $100,000,
outlining    the profit  negotiated.      In addition,      the negoti-
ators were asked to furnish       an estimated profit         objective
using the return on investment        analysis    technique,       The lat-
ter was not to be used, however, in actual contract                negoti-
ations.

       NASA awarded a contract    to George Washington University
to monitor the test and to evaluate data.          On June 29, 1970,
we received a copy of an interim       report on the test which
concluded that (1) it was feasible        to develop the requisite
investment   data from contractors     and (2) NASA personnel were
able to employ the new technique under operational          conditions
for research and development and hardware contracts.           NASA
cautioned,   however, that the wisdom and practicableness          of
using a return on investment      approach to determine profit
compensation was still     being explored and that NASA was not
prepared,   at  the  time, to endorse any particular     return on
investment   technique.

      The NASA and DOD proposed procedures for developing       in-
vested capital     data differ.   For example, to compute operat-
ing capital    used, DOD uses accounting data from the most re-
cent fiscal    year in computing the estimated operating    capi-
tal required    for a new contract.    In contrast, NASA uses a
monthly forecast     of the estimated costs to be incurred,   less
progress payments, during performance of the new contract.




                                    48
BRITISH CONSIDER CAPITAL USED IN NEGOTIATING
PROFIT ON NONCOMPETITIVE GOVERNMENTCONTRACTS

      The relationships     between Government and industry        are
not the same in the United Kingdom as in the United States.
It is of interest      to note, however, that capital       used has
been considered     for some time in negotiating     profit    rates
for noncompetitive      Government contracts.     Their objective
is to provide a rate of return on noncompetitive            Government
work that approximates       the overall  average return earned
by British   industry    in the years 1960 to 1966.

      Recently the British     system was revised to provide that
contracts   involving   an excessive realized   profit   or loss
may be referred     to a review board.   The findings    of the
board are binding to both parties,        It is still  too early
to determine how well the system will operate.

USE OF RETURN ON INVESTED CAPITAL
IN RENEGOTIATION

       Capital    employed is one of the factors         specified     in the
Renegotiation      Act to be taken into consideration           in determin-
ing excessive profits.       In view of the differences            we found
in proportionate      amounts of contractor      capital     allocated    to
defense and commercial business,       we met with Renegotiation
Board representative      to discuss this matter.          Board repre-
sentatives     told us that capital   allocations        were made, for
the most part, on a cost-of-sales         basis.     In a few instances,
the Board had requested allocations         from contractors         on the
basis of the extent that assets were used on defense work
but had not been very successful        in obtaining       them.

       In view of our findings,      Board representatives    said
that further    consideration     would be given to obtaining     better
contractor    capital  allocations     for defense work when Govern-
ment resources were furnished.




                                     49
                                    CHAPTER6

                    CONTRACTORASSOCIATION COMMENTS

       Comments were requested from five contractor              associa-
tions on a draft of this report that was based on incomplete
data.     Two of the associations      agreed with the conclusion
that investment      should be considered     in determining       profits;
however, they and two other associations            stated that the re-
port grossly overemphasized the rate of return on investment
and reflected     a preoccupation    with the need to consider con-
tractors'    capital    requirements   in negotiating     profit    factors.
The fifth    association     did not furnish   any comments on this
point.

       We agree that there are other factors                    that must be con-
sidered in negotiating         contract       profit     rates.         Such factors
as the contractors'        assumption of cost risk,                 difficulty      of
the task, and other management and performance factors                             must
be evaluated and considered.              In some cases, such as a GOCO
plant,    little     or no contractor       investment        is involved,
whereas in others the entire            investment         required        for con-
tract performance is provided by the contractor.                            Where the
investment       required  from the contractor             is insignificant,
the other factorsnaturallywould                be the determining              items in
establishing        profit objectives,         In still      other cases, how-
ever, to the degree that contractor                  capital      is required,       it
should be considered.

        Two of the contractor    associations            questioned GAO
statements that contractors       have little            incentive   to invest
in more modern equipment to reduce costs                   relating  to many
negotiated    procurements.     The associations              stated that GAO
had failed    to consider and recognize the                "real world" com-
petitive    environment   of today's defense             business,

      For competitive      and other reasons, contractors     make
some investments      in facilities     and equipment for performance
of negotiated     defense contracts*       Actually, however, little
price competition       is involved in much of the DOD procurement.
For example, of the total dollar          value of DOD procurement
for fiscal    year 1970, only 11 percent was formally        adver-
tised and an additional         27 percent was negotiated   on the


                                          50
basis of price competition.      A total of 57 percent was
placed on a sole-source    basis, and the remaining 5 percent
involved design or technical     competition.

       There is, of course, some incentive        to reduce costs
on negotiated    firm fixed-price    and fixed-price      incentive
contracts   even if they are sole-source       contracts.      Such re-
ductions in cost, however, could reduce profits             on subse-
quent defense contracts.        Such contracts    would be priced on
the basis of prior cost experience to a large extent,               and
the profits    would be determined as a percentage of estimated
costs.

      The contractor    associations    almost unanimously ques-
tioned our data for the 146 individual         contracts   and stated
that they felt that either        there was an unfortunate    selec-
tion of contracts    involved or there were flaws in the method
of ascertaining    capital   invested in such contracts.

       For reasons stated earlier       in this report,      GAO agrees
that no attempt was made to obtain a sample representative
of all defense contracts.         GAO was interested      in determining
 (1) whether it was feasible        to develop cost, profit,        and
invested capital      data by contract    and (2) if so, the range
of the rate of return on invested capital           realized    for in-
dividual   contracts.      We believe that it is feasible         to de-
velop the desired data for most contracts,and             we found that
there was a great range in rates of return on investment
for individual     contracts.

        In each case of developing data for individual          con-
tracts,    we presented our data to the contractors        involved
and gave them an opportunity         for review and comment. We
carefully    considered    the comments received and believe that
the final data are reasonably accurate.            The number of cases
involving    factual   disagreements    was relatively   small.




                                    51
                                CHARTER7

                            AGENCYCOMMENTS

     We provided a preliminary          draft of this     report   to ARC,
DOD, DOT, and NASA for review          and comment.

       All the agencies agreed that due consideration                should
be given to the TCI of contractors            in negotiating      Government
contracts     which do not involve price competition.              DOD
pointed out, however, that the solution              of highly complex
administrative       problems was required       before the policy could
be put into effect.           Also, AEC believes     that there is no
need for a uniform Government-wide            fee policy    stressing    con-
sideration     of invested capital       and feels that the develop-
ment of detailed        uniform guidelines      could have a serious,
disruptive     effect    on the existing    overall     fee policies    of
the various executive          agencies.

      We agree that there are serious administrative        problems
in providing  for consideration     of contractor   TCI related     to
a particular  contract   in negotiating    contract  profit   rates.
DOD has been considering     this matter since 1962 and we be-
lieve that it is time to move ahead.

        We agree also that there are many advantages to per-
mitting    agencies to tailor      their policies     to their   individ-
ual needs.     Many companies, however, deal with numerous
Government agencies.        Webelieve    that, where feasible,       uni-
form policies     should be established       governing    the relations
between Government and industry.           We believe further       that
it seems feasible      and desirable     to establish    uniform
Government-wide     guidelines    for establishing      profit   objectives
for negotiating     Government contracts       where effective      price
competition     is lacking.




                                     52
                                   CHAPTER 8

                   CONCLUSIONSAND RECOMMENDATION

CONCLUSIONS

      Profit  measured as a percent of sales was significantly
lower on defense work than on comparable commercial work for
the 74 large DOD contractors     included in our study.      However,
when we measured profit    as a percent of the contractors'      TCI
used in generating    the sales, the difference    narrowed.    Fur-
ther, when we measured profit      as a percent of EC1 of the
stockholders,   we found very little    difference  in the rate of
return for defense and commercial work.

      The major factor     involved in making the rates of re-
turn on contractor     capital    investment for defense and com-
mercial work similar     was the substantial     amount of capital
provided by the Government in the form of progress payments,
cost reimbursements,     equipment, and facilities.        Government
resources,   of course, reduce the capital       investment   required
of the contractor    for defense work.

      The 10 large companies that do the bulk of their de-
fense business in the form of subcontracts           earned a con-
siderably    higher rate of profit      on defense sales than the
74 large DOD contractors.       When profit     was measured as a per-
cent of TCI and of ECI, however, the subcontractors           had a
lower average rate of return than the 74 large DOD contrac-
tors.     The subcontractors   did realize     a higher rate of re-
turn on capital     for defense work than on their comparable
commercial work.       In our opinion,    this was due to the effect
of Government-furnished      capital,    even though the subcontrac-
tors have use of relatively        fewer Government resources than
the 74 large DOD contractors.

       Under current      defense contract          negotiation     procedures,
little   consideration        is given to the amount of capital               in-
vestment required       from the contractor            for contract     perfor-
mance. Instead,        profit       objectives     are developed as a per-
centage of the anticipated              costs of material,       labor,   and
overhead.     As a result,          inequities     can and do arise among
contractors    providing        differing      proportions     of the capital


                                         53
required    for contract    performance.      Also, by relating      prof-
its to costs,    contractors     have little     incentive    to make in-
vestments in equipment which would increase efficiency                and
reduce costs.     Such investments       tend to lower rather      than
increase profits     in the long run.        Of course, other factors,
such as whether or not the program will be continued,                could
be an overriding     consideration     in bringing      about contractor
investments    to reduce costs.

       We believe that it is essential              to change the present
system in order to motivate            contractors        to reduce costs un-
der Government noncompetitive             negotiated        contracts.      Where
the acquisition       of more efficient        facilities        by contractors
will    result    in savings to the Government in the form of
lower contract       costs,    contractors     should be encouraged to
make such investments.           Proper consideration            of contractor
provided capital        can cause a greater reliance               on private
capital     to support defense production.               To accomplish this,
it is essential       that capital      investment       be substituted        for
estimated      costs as a basis for negotiating               profit   rates,
We realize      that other factors        are also important,such             as the
specificity       and life    expectancy of a Government program.
Most important,       the present strong incentive               for contractors
to minimize their         investments     for Government work should be
eliminated.

        We believe that,        in determining        profit   objectives     for
negotiated       Government contracts         where (1) effective         price
competition       is lacking and (2) the amount of contractor                   cap-
ital    required    is a significant         factor,     consideration     should
be given to total         contractor      capital     requirements.       Consid-
eration     should, of course, continue to be given to such
other factors       as risk,      complexity      of the work, and other
management and performance            factors.        Where contractor       capi-
tal requirements        are insignificant,           such as in many service-
type contracts        or contracts      to operate Government-owned
plants,    profit     objectives     would continue to be developed
primarily      through consideration          of the other factors.

       In our opinion,     a system providing  for consideration
of capital    requirements    in negotiating  profit rates would
be fairer   than the present system to both contractors         and
the Government.


                                         54
      We believe      also that the system adopted should be used
where applicable       by all Government agencies to simplify in-
dustry participation.

RECOMMENDATION

        Action required       to establish     uniform guidelines      does
not require      legislation.        Accordingly,     we recommend that the
Office    of Management and Budget take the lead in interagency
development of uniform Government-wide                guidelines   for deter-
mining profit      objectives      for negotiating      Government con-
tracts    that will     emphasize consideration         of the total    amount
of contractor      capital     required    when appropriate      where ef-
fective     price competition        is lacking,




                                                                                  “. ,
                                                                                 J, :.




                                     55
     SCHEDULES




57
                     SUMMARYOF FINANCIAL DATA BEFORE FEDERAL INCOMETAXES
                                FOR 74 LARGE DOD CONTRACTORS
                                                            1                             Weighted
Line No.                                     1966    1967        i968        1969          Average-
     SALES (in billions of dollars)
1. DOD                                       19.1    24.1        25.8        25.8            23.7
2. Other defense agencies                     4.3     3.2         3.1         2.6             3.3
3. Commercial                                59.1    60.6        72.3        75.0            66x---
4.       Totals                              82.5    87.9       101.2       103.4     !      93.8
     PROFIT AS PERCENTOF SALES

5.    DOD                                     4. 7    4.7         4.5         3.4             4.3
6.    Other defense cpencies                  cc.6    5.0         5.1         5.0             4.9-
7.    Commercial                             11.2     8.7        10.8         a.9     !       9.9
                                               -
        PROFIT AS PERCENTOF TCI
8.    DOD                                     11.3   12.1        11.9         9.5            11.2
9.    Other defense Egencies
                          --                  15.8   14.7        15.5
                                                                  --         14.0--          15.0
10.   COXUfi~rCiai           .-            -- 16.2   12.2
                                                       ._        15.6        12.4            14.0
                                                                                            --
       -PROFTT AS PERCENT3F EC1
11.   DOD                                    21.4    22.9        22.6        17.4     I      21.1
12.   Other defense Egencies                 28.7    27.1        28.9        24.8            27.5
13.   Corlmercigl                      f     26.4    19.6        25.8   ,    20.4            22.9
       TCI TURNOVER(sales/TCI)
14.   DOD
15.   Other defense aqerxies
16.   Cozxercial




-
                     SUMHARYCF FINANCIAL DATA AFTER FEDERAL INCOME TAXES
                                FOR 74 LARGZ DOD CONTRACTORS
                                           --                                     ---        El
                                                                                  Weighted
Line No.                                        1966    1967      1968     1969   average    2
     SALES (in billions    of dollars)                                                       N

1.   DOD                                        19.1    24.1      25.8     25.8     23.7
2,   Other defense agencies                      4.3     3.2       3.1      2.6      3.3
3.   Commercial    ___-                         59.1    60.6      72.3     75.0     66.8
      PROFIT AS PERCENTOF SALES
4. ND                                             2.5    2.5       2.3      1.8      2.3
5, Other defense agencies                         2.4    2.6       2.5      2.5      2.5
iCommercial
6                                                 6.0    4.9       5.6      4.6      5.3
     PROFIT AS PERCENTOF TCI
7, DOD                                           6.5     7.0        6.8     5.8      6.5
8. Other defense agencies                        8.8     8.3        8.4     7.7      8.3
9
A--  Commercial
___------ -- -.-_-                               82      7.3   .-Z-L-P 5    7.0      7.9
      PROFIT AS PERCENTOF EC1
10. DOD                                          11.4   12.0      11.6      9.2     11.0
11. Other defense agencies                       15.3   14.3      14.4     12.5     14.2
12. Commercial
--.-.__--_____                   -~      -   --- 14.3   11.1      13.4     10.5     12
                                                                                     -& 2
       TCI TURNOVER(sales/XI)
13. DOD                                           2.2    2.3       2.4      2.3      2.3
14, Other defense agencies                        3.2    2.7       2.8      2.5      2.8
15. Commercial
h---.p                                            1.4    1.3   ~___1.3      1.3      1.3
       EC1 TURNOVER(salcs/ECI)
l6, DOD                                          4.6     4.8       5.1      5.1      4.9
17. Other defense agencies                       6.3     5.5       5.7      4.9      5.6
18. Commercial                                   2.4     2.2       2.4      2.3      2.3
                    DISTRIBUTION OF RETURN ON TCT BEFORE FEDERAL INCOME TAXES
                           FOR DOD SALES OF 74 LARGE DOD COWRACTORS
                                                  -
                          1966                  1967                                             69
                 Percent of total      Percent of total                                          of   total
Return   on         Con-                  Con-
GI               tractors      Sales   tractors      Sales .                                          Sales    .
LOSS (%)              5.4        0.5         5.4       2.4                                             19.5
PROFIT (%>
0.1 to 5            17.6       11.1       10.8         8.0      8.1       15.3         10.8            10.4
5.1 to 10           13.5       lZ.5       16.2        26.1     17.5       22.2         17.6            14.1
10.1 to 15          39.2       46.2       27.0   1    26.5     ‘)E   7    -8-l   r-l   oc   -I
                                                                                                       25.7
15.1 to 20           9.5         6.7      25.7   1    20.8                                             12.1
20.1 to 25          13.5       21.8        5.4   ]     6.8                                             13.9
25.1 to 30                                 1.4   1     0.4                                              2.8
30.1 to 50                                 2.7         7.8                                              0.8
50.1 to 100          1.3        0.2        5.4         1.2                                              0.7
Total              100,o      100.0      100.0       100.0

Total sales
   (billions)                 $19.1                  $24.1               $25.8                        $25.8
Return on TCI
  spread by
  year              -27% to d-60%          -6% to +85%         -22% to -Ml"/,          -12% tc. t-96%

Average return
  on TCI                       11.3%                 12.1%               11.9%                          9.5%
                   DISTRIBUTION OF RETURN OX TCI BEFORE FEDERAL INCOME TAXES
                       FOR COUXERCIALSALES OF 74 LARGE DOD CONTRACTORS


           --‘               1966                           1967                         1968            I          1969
                               3f total          Percent      of total           Percent   of total      1 Percent of total
Return on                                           Con-        I                   Con-    I            I Con-        I
TCI               tractors          Sales        tractors         Sales          tractors     Sales        tractors      Sales
LOSS (%>                4.0           1.0             8.1             1.8             8.1        0.8           10.8          3.0
PROFIT ('7)
0.1 toto   5           4.0
5.1 to     10          9.5
10.1 to      15       35.1                                                                                                  A3    3
15.1 to      20       16.2           ii:7
                                     21.1            5;:;
                                                     18.9      1-     '6:;          U'*"
                                                                                    17.6         is:;;         ;t:;         ;;;:;
20.1 to     25        16.2           20.1             6.8            16.6            6.8           2.9           5.4          6.2
25.1 to     30         6.8-           5.6             4.0              5.3           5.4           5.0           5.4          6.0
30.1 to     50         6.8            3.7             4.0              3.1           5.4           8.7           4.0          2.9
50.1 to     100        1.4                  I
Total                100.0          100.0          100.0            100.0          100.0        100.0         100.0        NO!0
                                            II                 I             I              I            II            I
Total. sales
  (billions)                        ss9.0                           $60.6                       $72.3                      $75.0
Return on TCI
  spread by
  year                -16%,to       +61%            -27% to +44%                    -50% to +46%              -33% to +39%

Average return
  on TCI                             16.2% .                         12.2%                       15.6%                     12.4%
                                           SALES BY CATEGORY FOR 74 LARGE M3D CONTRACTORS
==fz.----                       I__----                                                                                    _- -_-
L+ne                                                                                                                 Weighted
No,                          Description                                                                                average
                                                                                          (billions)
            32 HIGH-VOLUMZ DEFENSE CONTRACTORS
   1.       DOD                                                    $15.5      $19.4       $20.5           $20.5           $19.0
   2.       Other defense agencies                                   3.6         207        2.6              2.2             2.8
   3.       Commercial                                              23.4        25.7       29.7            31.1            27.5
   4.          -.Tp_tal
                  -. - -_---.~-
                        _-._-. ----.--_-_ 1;-11_Y_1====:- ----&?,~5-
                                                                 -- -.-    .LxL      8    $52.8        $53T&              s49AJb
            29 MEDIUM-VOLUME DEFENSE CONTRACTORS
  5. DOD                                                         $ 1.9        $ 2.6       $ 3.0           $ 3.2           $ 2.6
  6. Other defense agencies                                        0.2          0.1         0.1             0.1             0.1
  7. Commercial                                                                             6.7                             6.5
-~8.       To-L&-          __                                    $ z          $ :."6      $ 9.8           al:.;           $ 9.2
     TOTAT. FOR 61GH-          AND MEDIUM-
     -??kJME        DEFENSE CONTRACTORS
  9. DOD                                                         $17.4        $22.0       $23.5           $23.7           $21.6
10. Other defense agencies                                          3.8       . 2.8          2.7             2.3             2‘9    '
11. Comme_rcial                                                   29.1         31.7        36.4            38.6            34.0
12. ~a?L& --..----~                                              $50.3
                                                                  ---.-       $56.5       $62.6           $64-. 6         $58.5
                                                                                                                    --_____-
     13 COMMERCIALLY ORIENTED DEFENSE
             CONTRACTORS
13. DOD                                                          $ 1.7        $ 2.0       $ 2.2           $ 2.1           $ 2.0
14. Other defense              agencies                            0.5          0.4         0.4             0.3              0.4
15. Commercial                                                    30.0         29.0        35.9            36.5             32.9
16.      Total                                                   $32.2        $31.4       $38.5           $38.9           $35
                                                                                                                           -- 3
            TOTALS FOR ALL 74 CONTRACTORS
17.         DOD                                                  $19.1        $24.1       $25.8           $25.8           $23.7
18.         Other defense agencies                                 4.3          3.2        7z.:              2.6            3.3
19.         Commercial                                            59.1         60.6                        75.0            66.8
20.              Total              -                            $82.5        $87.9      $101.2          $103.4           $93.8 -

Some columns            do not add due to rounding.
                         PROFIT ON SALES BEFORE FEDERAL INCOME TAXES
                     FOR VARIOUS CATEGORIESOF LARGE DEFENSE CONTRACTORS
                                                                                    -
Line                                                                              Weighted
No.                Description              1966        1967    1968      1969    average
       32 HIGH-VOLUMEDEFENSE CONTRACTORS

  1. DOD                                    4.6%         4.4%    3.8%     2.6%     3.8%
  2. Other defense agencies                 4.5          4.6     4.6      3.9      4.4
-3. Commercial                          \   9.2          7.8     a.4      7.5      a.2
  4.     Total                              7.1          6.2     6.5      5.5      6.3
     29 MEDIUM-VCLUP!EDEFENSE CONTRACTORS
  5. DOD                                     2.7         6.0     7.6       6.9     6.1
  6. Other defense agencies                  0.3         2.7     8.0       6.7     3.7       I
                                            10.5         8.6     8.3       7.5     8.6
 '8.. Commercial
          Total                              a.4         7.7     8.1       7.3     7.8
      TOTALS FOR 61 HIGH- AND MEDIUM-
        VOLUMEDEFENSE CONTRACTORS
  9. DOD                                     4.4         4.6     4.3       3.2     4.1
10. Other defense agencies                   4.3         4.5     4.8       4. 1    4.4
11. Commercial                               9.5 .~_~    7.9     8.4       7.5     a.3
12.
---Y-     Total                              7.3        -6.4     6.7       5.8     6.5
      13 COMMERCIALLYORIENTED DEFENSE
        _CONTRACTORS
13. DOD                                      7.5         6.3     6.2       6.0     6.5
14. Other defense a&encies                   6.5         a.1     7.2      11.4     8.1
15. Commercial                              12.9         9.6    13.2      10.4    11.6
16.     Total                               12.5         9.4    12.7      10. 2   11.2
    TOTALS FOR ALL 74 CONTRACTORS
1.7. DOD                                     4.7         4.7     4.5       3.4     4.3
18. Other defease agencies                   4.6         5.0     5.1       5.0     4.9
19. Commercial                              11.2         8.7    10.8       a.9     9.9       _
20.      Total                               9.4         7.5     9.0       7.5     8.3
                                                   RETURNON TCI BEFORE FEDERAL INCOME TAXES
                                            FOR VARIOUS CATEGORIESOF LARGE DEFENSE CONTRACTORS
      Line                                                         -                                                           ---
      No.                             Description                                                                                  Weighted
             32 HIGH-VOLUMEDEFENSE                                        1966             1967        1968        1969            averape
                                                      CONTRACTORS
        1. DOD                                                            12.1%            12.3%      11.3%          8.4%            11.0%
       2.    Other
       3. Corrbnercial    defense        agencies                         18.1             16.1       16.6        13.7               16.3
                                                                          14.1             12.2       13.5        11.3               12.6
     - 4 -- I -Total
     --•%---         ------L-zz~------                  --
                                                        ______-_     -23.     7
                                                                       -.__._.-      _---  12.3       13.0  -     10.6         --.- 12.3 - -
             29 MEDIUM-VOLUMEDEFENSE CONTRACTORS
       5. Other.defense
       6.    DOD                                                           5.6            11.9        13.0        14.2               12.2
       7.    Commercial                  agencies                          2.1              5.5       11.7          7.5                6.4
       8.                      1                                         15.5             12.3        11.7        10.7               12.3
     ----.-.      a.ta --- ~-                                           --_I_
                                                                         13 1             12.1        12.4        11.4               12.2    _
             TOTALS FOR 61 HIGH- AND MEDIUM-
%               VOLUMEDEFENSE CONTRACTORS                                                                                    I
       9.    DOD
     10. Other defense                                                   11.1             12.3       12.0           9.4              11.2
     11. Comnercial                     agencies                         16.5             15.1       16.2         12.9              15.3
     12.            Total                                                14.4             12.2       13.1         11.2              12.6
              ---                                                        13.6    '        12.3       12.9         10.8       1      12.3
                                                                     .        :-+-----~:                                             :-
            13 COMMERCIALLYORIENTED DEFENSE
                     CONTRACTORS
     13. DOD                                                             12.3             10.8       11.4        10.0               11.1
     14. Other defense agencies                                          12.9             13.3       13.3        17.5               14.1
    15. Commercial                                                       17.8            12.3        17.9        13.7               L5.4
    16
    _L_---.
    -.____         Total
                     __.__.
                   -_-----                          -                   17.5             12.2     -17AJ --=-=- 13 !-_- 6         -15.2 ___
                                                                      _---_:.m---
           TOTALS FOR ALL 74 CONTRACTORS
    17. DOD                                                             11.3             12.1        11.9          9.5              11.2
    18. Otller defense agencies                                         15.8             14.7        15.5        14.0              15.0
    19. Commercial                                                      16.2             12.2        15.6        12.4              14.0-
    20.
    ~z.~~-~-~: Total    :-::.. -_
                               -.-_-.
                                  _.__--       _-=z= _  ___ _._._.___-
                                                              --        15.3
                                                                       --.------         12.2
                                                                      ..-- ------.--.--z----.--L-    15   0 -2 _ 12.0
                                                                                                                   z--T=-=;--*- 13 5
                                                                                                                            1
                                          RET'JRN ON ECI BEFORE FEDERAL INCOME TAXES                                               Y?
                                     FOR VARIO'JS CATEGORIES_ ---OF LARGE DEFENSE
                                                                           :r-    CONTRACTORS                                      j!
Line                                                                                                                Weighted       E?
No.                 Description                                1966         1967          1968           1969       average
                                                                                                                                   is
       32 HIGH-VOLUME DEFENSE CONTRACTORS                                                                                          M
 1.    D3D                                                     24.0%          24.4%      22.0% '         15.7%        21.4%    _   co
  2. Other defense             agencies                        34.9           31.7       32.6            26.0         31.6
  3. Commercial                                                25.7           21.9       23.9            20.4         22.8
  4                                                      -_--_ 25.7-- ----- --22.8       23.6            19.5         22.7
--- .     Total                        -_____-___                              _____ _-.;L------.e----
       29 MEDIUPl-VOLUME              DEFENSE CONTRACTORS
  5. DOD                                                        9.1          20.9         27.9           25.6         21.9
 6. Other defense              agencies                         1.1           8.5        23.5            11.1         10.3
 7. Commercial                                                 29.0          20.9        20.2            18.0          21.4
 a.      Total                   -                             24.3          20.7     -- 22.0            19.5          21.4
       TOTALS FOR 61 HIGH- AND MEDIU?k
         --VOLUME- DEFENSE CONTRACTORS
 9. DOIJ                                                       21.6          23.8         23.1           17.7          21.5
10. Other    defense            agencies                       31.9          29.7         31.8           23.9          29.6
11. Commercial                                                 26.4          21.7         23.1           19.9          22.5
12.       Total
       -rzZZ===-                                               25.4          22.4         23.3           19.5          22.5
       13 COMMER_CIALLY ORIENTED DEFENSE
          CONTRACTORS
13. WD                                                         20.1          18.0          19.6          16.2          18.4
14. Other defense               agencies                     , 19.4          20.6          20.9          27.0          21.8
15. Commercial                                                 26.5          la.1          27.9          20.8          23.3
16.      Total                                                 26.1          18.1          27.5          20.7          23.1
         --
       ‘JJJ’ALS      FOR ALL 74 CONTRACTORS
17.    DOD                                                     21.4          22.9           22.6          17.4          21.1
15.    Other  defense           agencies                       28.7        27.1             28.9          24.8          27.5
19.    Commercial                                              2604        19.6             25.8          2004          22.9
 20
 -2-p.-           Total
                     - - - -UP---
                            ___----                        -25
                                                         -- ---- i 8 a--.- 20.3
                                                                            ------          25.4
                                                                                       -----__     _      20   1
                                                                                                         --r=.,=LT22.8-
                            TURNOVEROF TCI FOR VARIOUS CATEGORIES
                                OF LARGE DEFENSECONTRACTORS
                                                                                            ~-
Line                                                                                       Weighted
No.                   gescription           1966       1967     1968            1969       average
       32 HIGH-VOLUMEDEFENSE CONTRACTORS
 1.    DOD                                  2.4        2.5      2.6             2.5               2.5
 2.    Other defense agencies              3.8         3.3      3.3             3.1               3.4
 3.    Commercial                           1.4        1.4      1.4             1.3               1.4
 4
72           Total                          1.8        1.8      1.8             1.6               1.7
       29
       - MEDIUM-VOLUMEDEFENSECONTRACTORS
  5.   DOD                                  1.6        1.8      1.8             1.8    I          1.8
  6.   Other defense agencies               1.7        1.3      1.2             0.9               1*3
  7.   Ccmmercial                           1.4        1.3      1.2             1.2               1.3
  8
--2-         Total                        -1.4         1.4      1.4             1.3               1.4-
       TOTALS FOR 61 HIGH- AND MEDIUM-
         VOLUKZ
         --        DEFENSE CONTRACTORS
 9.    DOD                                 2.3         2.4      2.4             2.4               2.4
10.    Other defense agencies              3.6         3.1      3.1             2.8               3.2
11.    Commercial                          1.4         1.4      1.4             1.3               1.4
12.          Total                         1.7         1.7      1.7             1.6               1.7
              _--.
       13 COMMERCIALLYORIENTED DEFENSE
              CONTRACTORS
13.    DOD                                  1.5        1.6      1.7             1.5               1.6
14.    Other defense agencies               1.9        1.5      1.7             1.5               1.7
15.    Comercial                            1.3        1.2      1.3             1.2               1.3
16.          Total                          1.4    -   1.2
                                                        --      1.3
                                                                --_-_----       1.3             - 1.3--
       TOrALS FOR ALL 74 CONTRACTORS
17.    DOD                                  2.2        2.3       2.4            2.3               2.3
le.    Other defense agencies              3.2         2.7       2.8            2.5               2.8
19.    Commercial                           1.4        1.3       1.3            1.3               1.3
20.         -Total
               ---                --   --   1.6        1.5    __-1.5        -   1.4        .-     1.5
                              TURNOVEROF EC1 FOR VARIOUS CATEGORIES
                                  OF LARGE DEFENSE CONTRACTORS
Line                                                                                   Weighted
No.                Description               1966      1967      1968       1969       average
       32 HIGH-VOLUMEDEFENSECONTRACTORS
  1. DOD                                      5.2      5.5       5.8        5.9          5.6
  2. Other defense agencies                   7.8      7.0       7.0        6.6          7.1
  3. Commercial                               2.8      2.8       2.8        2.7          2.8
-4s      Total                                3.6      3.7       3.7        3.5          3.6
       29 MEDIUM-VOLUMEDEFENSE CONTRACTORS
 5. DOD                                       3.3      3.5       3.7        3.7          3.6
 6. Other defense agencies                    3.9      3.1.      2.9        1.7          2.8
 7. Commercial                                2.8      2.4       2.4        2.4          2.5
 8.     Total                                 2.9      2.7       2.7        2.7          2.7
       TOTALS FOR 61 HIGH- AND MZDIUM-
         VOLUMEDEFENSECONTRACTORS
 9. DOD                                       4.9      5.2       5.4        5.5          5.3
10. Other defense agencies                    7.4      6.6       6.7        5.9          6.7
11. Commercial                                2.8      2.7       2.7        2.6          2.7
12.     Total                                 3.5      3.5       3.5        3.3          3.4
       13 COMMERCIALLYORIENTED DEFENSE
           CONTRACTORS
 13. DOD                                     2.7       2.8       3.2        2.7          2.8
 14. Other defense agencies                  3.0       2.5       2.9        2.4          2.7
 15. Commercial                              2.1       1.9       2.1        2.0          2.0
 16.     Total                               2.1       1.9       2.2    ,   2.0    I     2.1
                                                                        6
     TOTALS FOR ALL 74 CONTRACTORS
-17. DOD                                     4.6       4.8       5.1        5.1          4.9
 18. Other defense agencies                  6.3       5.5       5.7        4.9          5.6
 19. Commercial                              2.4       2.2       2.4        2.3          2.3
 20.     Total                               2.8       2.7       2.8        2.i          2.7
                                                      SUMMARY OF PROFITS BEFORE FEDEIUL INCOME TAXES
                                               ON DOD SALES BY TYPE OF CONTRACT FOR 74 LARGE DOD CONTRACTORS

                                                                       (sales        in millions        of dollars)


                                   1966                                1967                                  1968                               1969                   Average
                          Prime                 Sub-          Prime                 Sub-          Prime                   Sub-         Prime                 Sub-         Prime      Sub:-
                           con-                 con-           con-                 con-           con-                   con-          con-                 con-          con-      con-
                        tractor               tractor       tractor               tractor       tractor                 tractor      tractor               tractor      tractor    tractbr
CPFF
 Sales              $                     $                $ 1,716.4          $      142.0     $ 1,909.4            $      197.0    $ 2,327.0          $      282.9     $ 1,849    $      186
 Profit
---       (%I            1,44;.; .               12i.i .           4.4                 5.0             4.2                   4.8            4.1                 4.9          4.4        II4.7
                    -
CPU?
Sales                    2,295.g                 258.1       2,835.g                 351.8         3,055.2                 302.0      2,763.0                 283.7       2,738           299
Profit    (%/,>


i&        (o/O) 1        5,07;-;                 33;s;       6,92;;;                 44;;;         6,84;;;                 65;;;      7,41;;&                 6:;;;       6.59           ;;;


 --FFF'-NEG,
Sales                    6,091..6         1,778.4            7,040.5              2,123.8          8,229.g              2,274.6       7,572.g              2,350.2        7,234        2,132
-IPrsfit   (%)                 4.0              7.0                5.6                  4.9              5.9                  4.6           5.3                  4.0         5.3          5.0
ADVERTISED
 Sales                      938.1                            1,367.0                               1,252.0                            1,047.6                             1,151
 Profit   (c/o)              -0.1                                  0.9                                 -5.8                               -9.0                             -3.4
-                                                                                     --~__~                                                                                              -     $
TOTAL
                                                                                                                                                                                                El
Sales               15,844.3              2,494.2           1?,883.5            3,066.6         21,291.g                3,432.g      21,124.3          3,604.7           19,536     3,150       g
Profit    (X.1             4.4                  6.1                4.7                4.3              4.4                    4.6           3.6              2.5             4.2       4.2      M
                                                                                                                                                                                                5
                                           SUMMARYOF PROFITS BEFORE FEDERAL INCOME TAXES
                                                   ON OTHER DEFENSE AGENCIES SALES
                                          BY TYPE OF CONTRACTFOR 74 LARGE DOD CONTRACTORS

                                                    (sales     in millions      of dollars)

                         1966                        1961                       197                     196;                  Average
                     Prime        Sub-         Prime        Sub-          Prime     -Sub-         Prime        Sub-       Prime I .Sub-
                      con-        con-          con-        con-           con-       con-         con-        con-        con-      con-
                   tractor      tractor      tractor      tractor       tractor     tractor     tractor      tractor    tractor    tractor
     CPFF                                                                                                               -+--
     Sales         $ 880.0       $ 89.6     $1,034.2         $ 64.6   $1,175.0        $ 64.9   $1,084.6       $ 59.4    1,043.4      $ 69.6
     Profit (%)        2.9          4.0           3.3           3.9         4.0          3.6         3.9          3.0         3.6        3.6
     CPIF
4    Sales         2,149.6        434.9      1,16i.6         222.7           893.0     178.8      524.6        109.0    1,182.Z        236.4
0    Profit
     __I-   (%)         5.6         2.3           5.6          4.6             4.9       5.4        3.1          5.9         5.2         3.8
     FPI
     Sales            77.6          16.5         73.7           7.7           72.1      12.9        59.5         12.1      70.7         12.3
    .Profit (%I        7.1          10.7         12.4           7.2            7.9       4.0         7.2          3.0       8.7          6.5
                                                                                                                                   =
     FFP-NEG.
    Saies            248.7        130.5        258.7         140.7           244.6     129.1      211.9        179.1      241.0        144.8
    Profit   (%1       6.6          4.4          9.4           5.6            11.0       7.3       14.1          6.4       10.1          6.0
    ADZRTISED
    Sales               7.8          -            512           -             4.2                    8.3                     6.4
    Profit   (%I      -1.4           -            7.7           -            y6.8                    2.2                     0.7
    TOTAL
    --
    Sales          3,363.7        671.5      2,533.4         435.7      2,388.g        385.7    1,888.g        359.6    2,543.7        463.1
    Profit (%I          4.9         3.4           5.2          4.6           5.1         5.4         4.8          5.5        5.0         4.5
                          SUMMARYOF FINANCIAL DATA BEFORE FEDERAL INCOME TAXES
                                  FOR NINE DODAP"SJIUNITIONCONTRACTORS
      ---------_-            -B--I-----=--         -z=-=      --== =   y-_7z7                          ==-~=
                                                                                                    Weighted
      Line
      --
      ---   No
             - -'---                             1966         1967        1968        1969          average
            SALES (in billions of dollars)
      1. WD                                       0.4          0.7         0.8         0.8                0.7
     22    Commercial                             1.8          1.8         2.0   .-    2.2       ----     1.9
            PROFIT AS PERCENTOF SALES
      3. DOD                                      5.5         12.2        11.6         9.7               10.3
     4. Commercial                               13.0         10.7         7.9         9.2               10.1
            PROFIT AS PERCENTOF TCI
-4   5.    M3D                                   11.8         36.3        33.5        28.7               28.3
c    6.    Commercial                            14.8         11.4         9.1        11.1               11.5
                                                                                             I
            PROFIT AS PERCENTOF EC1
      7.   DOD                                   21.6          71.3       66.7        51.9               54.4
     A8    Commercial                            27.1
                                                 --------__I___18.5       14.5        18.1       -19.2
                                                                                                  ---
            TURNOVEROF TCI
     9. DOD                                       1.9          2.8         2.8         2.8                2.6
     10; Commercial                               1.0           .9         1.0         1.0                1.0
          TURNOVER3F EC1                     I            I
     11. DOD                                      3.9          5.8    1    5.8         5.4   I            5.3
     12. Commercial                               2.1          1.7    1    1.8         2.0                1.9
                     SUMMARYOF FINANCIAL DATA BEFOREFEDERAL INCOMETAXES
                       FOR 12 AIRCRAFT, MISSILE, AND SPACE CONTRACTORS
--
___---   -




12. Coirmercial-                            19.4       11.6    20.9       18.7         17.8-
                                                                                      ----
        TCI TURNOVER(sales/TCI)
13. D@D                                      2.6        2.0     2.7        2.7          2.7
 14. Other defense   agencies                4.6        3.6     3.8        3.7          4.0
15    Commercial
-L;---.-----                                 1.3        1.3     1.5        1.2          1.3-
        EC1 TURNOVER (sales/ECI)
16. DOD                                      5.8        6.7     6.5        7.0          6.5
17. Other defense    agencies                9.3        8.1     8.7        8.5          8.7
18. Comercial                                2.6   ,    2.7     2.9   I    2.6   II     2.7 _
                              SmEDULE15



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                   73
SCHEDULE16




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           I-




      -




                      74
                SUMMARYOF FINANCIAL DATA BEFORE FEDERAL INCOME TAXES
                        FOR 61 SMALLERDEFENSEAGENCYCONTRACTORS
                 --~=.---
            ----____                 -   --..- ~~----.._-




PROFIT AS PERCENTOF SALES




PROFIT AS PliliCENT.OF EC1




EC1 TURNOVER(sales/ECI)
                                                                       El
                                                                       2
                                                                       +
APPENDIX




 77
                                                           APPENDIX I
                                                               Page 1

       EXCERPTSFROM SECTION 408 OF PUBLIC LAW 91-121

"(a> The Comptroller      General of the United States (herein-
after in this section referred        to as the "Comptroller       Gen-
eral")   is authorized    and directed,     as soon as practicable
after the date of enactment of this section,            to conduct a
study and review on a selective         representative     basis of the
profits    made by contractors     and subcontractors      on contracts
on which there is no formally        advertised     competitive   bid-
dingenteredinto      by the Department of the Army, the Depart-
ment of the Navy, the Department of the Air Force, the
Coast Guard, and the National        Aeronautics     and Space Adminis-
tration    under the authority     of chapter 137 of title       10,
United States Code, and on contracts          entered into by the
Atomic Energy Commission to meet requirements             of the Depart-
ment of Defense.       The results   of such study and review shall
be submitted to the Congress as soon as practicable,              but in
no event later than December 31, 1970.

I'(b) Any contractor    or subcontractor      referred    to in subsec-
tion (a) of this section shall,        upon the request of the Comp-
troller    General, prepare and submit to the General Account-
ing Office such information      maintained      in the normal course
of business by such contractor       as the Comptroller        General
determines necessary or appropriate         in conducting      any study
and review authorized      by subsection    (a) of this section.
Information    required under this subsection          shall be submit-
ted by a contractor     or subcontractor      in response to a writ-
ten request made by the Comptroller        General and shall be
submitted    in such form and detail     as the Comptroller       General
may prescribe     and shall be submitted within         a reasonable pe-
riod of time.

"(c> In order to determine the costs, including             all types
of direct    and indirect      costs, of performing     any contract  or
subcontract      referred   to in subsection     (a> of this section,
and to determine the profit,           if any, realized   under any such
contract    or subcontract,      either   on a percentage of the cost
basis, percentage of sales basis, or a return on private
capital    employed basis, the Comptroller         General and autho-
rized representatives         of the General Accounting Office are
authorized     to audit and inspect and to make copies of any
books, accounts,        or other records of any such contractor       or
subcontractor.

                                  79
APPENDIX I
    Page 2

l'(d) Upon the request of the Comptroller    General, or any of-
ficer or employee designated by him, the Committee on Armed
Services of the House of Representatives     or the Committee on
Armed Services of the Senate may sign and issue subpoenas re-
quiring  the production   of such books, accounts,   or other rec-
ords as may be material    to the study and review carried    out
by the Comptroller    General under this section.

"(e> Any disobedience  to a subpoena issued by the Committee
on Armed Services of the House of Representatives  or the Com-
mittee on Armed Services of the Senate to carry out the pro-
visions of this section shall be punishable as provided in
section 102 of the Revised Statutes.

 "(f) No book, account, or other record, or copy of any book,
account, or record,       of any contractor    or subcontractor      ob-
tained by or for the Comptroller         General under authority       of
this section which is not necessary for determining              the prof-
 itability    of any contract,    as defined in subsection         (a> of
this section,     between such contractor     or subcontractor       and
the Department of Defense shall be available            for examination,
without the consent of such contractor          or subcontractor,      by
any individual     other than a duly authorized       officer    or em-
ployee of the General Accounting Office;          and no officer      or
employee of the General Accounting Office shall disclose,                to
any person not authorized       by the Comptroller     General to re-
ceive such information,       any information    obtained under au-
thority    of this section relating      to cost, expense, or prof-
itability    on any nondefense business transaction           of any con-
tractor    or subcontractor.

"(g> The Comptroller       General shall not disclose    in any re-
port made by him to the Congress or to either Committee on
Armed Services under authority        of this section any confiden-
tial  information    relating   to the cost, expense, or profit     of
any contractor     or subcontractor    on any nondefense business
transaction     of such contractor    or subcontractor."


?r U.S.GOVERNMENT   PRINTING   OFFICE:1973--729-234/1015        REGION   NO.   3-l




                                                           80
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