DOCUMENT RESUME 04406 - B3554808] (Review of Ccntentions by Hewlett-Packard Company regarding Prices Charged to the Government for the Purchase of Goods]. PSAD-78-50; B-114807. December 20, 1977. 8 pp. Peport to Pep. Paul N. McCloskey, Jr.; by Elmer B. Staats, Comptroller Ceneral. Issue Area: Federal Procurement of Goods and Services: Reasonableness of Prices Under Negotiated Contracts and Subcontracts (1904). Contact: Procurement and Systems Acquisition Div. Budget Function: Miscellaneous: financial Management aid. Information Systems (1002). Organizaticn Concerned: Gen'ral Services Administraticn; Federal Supply Service; Hewlett-Packard, Inc. Congressional Relevance: Rep. Paul N. McClosky, Jr. Authority: Wage and Price Stabilization Act. A review was conducted of contentions by th- Hewlett-Packard Company that a GAO report failed to adequately consider differences between commercial and General Srvices Administration (GSA) ctract terms and conditions. The report stated that some contractors charged the Government more for their products than they charged ccmmercial customers who ilrchased smaller cr comparable quanti ies. Hewlett-Packard stated that the terms and conditiors under GSA Federal Supply Schedules differ from those that Hewlett-Packard gives to commercial customers, and these directly affect the price discounts offered the Government. Hewlett-Packard charged that the report failed to consider these differences. Findings/.Conclusions: The company cited GSA multiple-award contracts requiring firm-fixod prices for 12 months, while other customers must use the catalog base price effective when the order is placed, as an example of a difference in disc, untirg. The extent that GSA enefits from requiring fixed prices foL 12 months seems to relate directly to the extent that list prices increase during the 12-month contract period. Any price advantage obtained b the Government as a result of the 12-month fixed prices is minimal. The company cited the 1-year free warranty extended t the Government under multiple-award contracts, while commercial customers receive cnly a 90-day free warranty, as another contract difference. For most product types, the warranty given commercial customers is the same 1-year warranty given the Government. The 90-day delivery requiremcuit generally does not create higher Government contract costs. The Governmert should not be expected tc simply accept thoicontention that benefits provided by original equipment manufacturers warrant an additional discount over that given th_ Government. The most significant shortcoming in GSA's multiple-award schedule contracting process is nonrecognition of Sh= anticipated aggregate amount of Gvernment contract purchases during negotiations. (Author/SW) a it |^3~ COMIROL"R GENERAL OF THE UNITED STATE B-114807 DEC 01977 -t The Honorable Paul N. McCloskey, Jr. ;?1 House of Representatives Dear Mr. McCloskey: Your letter of June 6, 1977, requested that we review contentions by the Hewlett-Packard Company in its May 13, 1977, letter on our report, "Federal Supply Service Not Buying Goods At Lowest Possible Price" (PSAD-77-69, :. 4, 1977). Hewlett-Packard charges that our report fails to adequately consider deif-fer ..c tween -comercial andsGen- : eral Services Administrat ,. iGSA) contract terms and con- ditions. (We reported that sme contractors charged the Government more for tir products than they charged commer- cial customers who r A.ased smaller or comparable quanti- ties.) To respond to your request, we did further review work at Hewlett-Packard headquarters in Palo Alto, California; its regional offices in Santa Clara, California; and Rock- ville, MarylanC and GSA Federal Supply Service headquarters in Washington, D.. he also reviewed pertinent documents, reports, and rec ds and interviewed Hewlett-Packard and GSA officials at headquarters and regional levels. In summary, Hewlett-Packard has provided information that should be considered by GSA when negotiating the most favorable prices for the Government. However, we emphasize that after reviewing Hewlett-Packard's data we still believe that the conclusions and recommendations reached in PSAD-77-69 should not be changed. Our response to the four points raised by Hewlett-Packard follows. DOES THE REPORT -'RRONZOUSLY FOCUS ON DISCOUNTS RATHER THAN TO'AL COSTS? Hewlett-Packard states that the terms and con ons under GSA Federal Supply Schedules differ from those nat Hewlett-Packard gves to commercial customers, and these di- reccly affect the price discounts offered the Government. Hewlett-Packard states that our report failed to consider these differences. PSAD-78-50 (950189) B-114807 Reviewing contractors' sales, we noted the terms rif aggregate purchase agreements varied between the cust,;mer and contractor. Our report stated that GSA's determination of a reasonable price should recognize aggregate annual purchases and should depend on the specific contractor and its arketing j'ractices. We requested that Hewlett-Packard provide additional information about cost differences that would result from the various terms and conditions. Firm-fixed prices Hewlett-Packar-d cited GSA multiple-award contracts requiring firm-fixed prices for 12 months, whereas other cus- tomers must use the catalog base price effective when the order is placed, as an example of a difference in discounting. Hewlett-Packard equates the value of firm prices for its products sold to GSA as an additional 2.4-percent discount. Later discussions with Hewlett-Packard officials disclosed chat this percentage was calculated by comparing the overall Differences between GSA and commercial price changes. Most of the Hewlett-Packard examples in our report were about the procurement of calmlators. The prices of specific calculator remodels tend to decrease rather than increase over time due to competition, improved manufacturing techniques, and new products in the market. For example, of the six Hewlett-Packard calculator models (3 pocket and 3 desk-top) most frequently purchased by the Government from 1973 to 1975, four models decreased in commercial list price, one model in- creased, and one model had no price change. Similarly, GSA noted (in a review of a Hewlett-Packard contract proposal package under the calculator schedule) that from 1973 to 1974 Hewlett-Packard's commercial prices increased on only 6 of 59 product items. The extent that GSA benefits from requiring fixed prices for 12 months (compared to other customers paying the price effective at the time of their order) seems to relate directly to the extent that list prices increased during the 12-month contract period. We found this was usually not the case for Government purchases that consist mostly of desk-top and pocket calculators. Consequently, we believe any price advantage obtained by the Government as a result of the 12-month fixed price is minimal. 2 B-114807 Hewlett-Packard also stated that prices were controlled under the Wage and Price Stabilization Act during our review. Because of the act, Hewlett-PackarJ was required to apply price rollbacks not only to GSA orders but commercial custom- ers as well. Thus, the act has affected both Government and commercial customers equally. Warranty terms Hewlett-Packard cites the -year free warranty extended to the Government under multiple-~ward contracts, while commercial customers receive cnly a 90-day free warranty, as another contract difference. We found that for most product types (including pocket calculators) the warranty given commercial customers is the same 1-year warranty given the Government. Hewlett-Packard's corporate marketing policy manual lists nine product catego- ries and, of these categories, with six the commercial warranty covers a full year. Furthermore, in some instances original equipment manufacturer customers receive a 15-month warranty. (An original equipment manufacturer is defined as a customer that purchases an item for integration into its own product for resale.) Therefore, Hewlett-Packard's claim that Government warranty terms are an added cost to Hewlett-Packard does not apply to most of its prud- ucts. Where the Government does indeed receive a longer war- ranty perJod than other customers, it probably is worth some- thing and should be recognized by GSA in negotiations. How- ever, the longer warranty's worth is dependent on many con- siderations, including whether the Government's extended coverage is needed and used, and to what extent commercial customers purchase additional coverage through Hewlett- Packard service contracts. If commercial customers generally do not purchase coverage beyond the 90-day free warranty, the worth of the extended Government coverage is questionable. In fact, from our discussions with a Hewlett-Packard repre- sentative, we noted that only about 25 to 30 percent of active Hewlett-Packard units are covered by service con- tracts. For the Hewlett-Packard desk-top calculators reviewed in our report, we examined 21 of its maintenance agreements entered into with com'-rcial customers during fiscal years 1974 and 1975. We fc ia that, on the average, these custom- ers waited 14 months after the initial 90-day free warranty period to purchase post-warranty support and service. 3 B-114807 Similarly, our review of 15 Hewlett-Packard maintenance agreements entered into by Government customers for the same models and for the same fiscal years disclosed that these customers waited ii months after the initial 1-year free warranty period to obtain post-warranty coverage. A Hewlett-Packard official stated that most calculator malfunctions generally occur during the first 90 days of operation. Accordingly, we believe that for the remainder of the first year the equipment shculd be expected to operate trouble-free. 90-day delivery requirement Hewlett-Packard notes that a Government agency using the Federal Supply Schedule can order a product and require deliv- ery within 90 days regardless of quantity, provided the maxi- mum order limitation is not exceeded. Hewlett-Packard indi- cates that comparable commercial agreements allow the supplier to deliver as best meets its production schedule. The 90-day delivery requirement under GSA contracts appears reasonable for standard off-the-shelf commercial prod- ucts In reviewing 12 Hewlett-Packard weekly availability schedules for the period December 6, 1974, to July 18, 1977, we found that for the 6 Hewlett-Packard calculator models normally purchased by the Government, Hewlett-Packard was able to ship to both commerc.l nd Government customers well within 90 days. For example, Hewlett-Packard was able to ship pocket calculators within 2 weeks and desk-top calcu- lators within a 4- to 5-week period. We examined Hewlett-Packard's weekly availability sched- ules for the period June 27, 1977, to July 18, 177, for 11 of its other popular models occasionally purchased by the Government. We found that Hewlett-Packard could ship these products to commercial customers in 2 to 13 weeks, but usu- ally in 4 weeks. Thus, the 90-day delivery requirement generally does not appear to create higher Government con- tract costs. DOES THE REPORT INCORRECTLY ASSUME THAT CONTRACTORS WILL AUTOMATICALLY OFFER HIGHER DISCOUNTS? Hewlett-Packard states that our report is silent about any analysis of contractors that were not awarded contracts; it supposes that no GSA bid rejections were reviewed. Hewlett-Packard notes that one test of whether GSA is getting the best possible prices is whether there are rejections 4 B-i14807 and states that potential savings in our report are pure conjecture, because there is no assurance that contractors would agree to sell to the Government at reduced prices. We believe that the main concern is whether the dis- counted prices offered the Government are fair and reasonable compared with prices given to a supplier's other customers. The potential savings amounts in our report are to show how the prices given GSA compare with discounted prices given a supplier's other customers. If a supplier is unwilling to give the Government a fair and reasonable price, it should not be awarded a contract. To do otherwis- would be unfair to other suppliers. Since GSA multiple-award contracts generally involve products (such as calculators) for which there are numerous suppliers seeking Government sales, rejecting some suppliers' offers should be expected. This should not be a problem as long as the Government finds an adequate number of contrac- tors willing to supply Government needs at fir and reason- able prices. DOES THE CONCLUSION THAT THE GOVERNMENT IS ENTITLED TO ORIGINAL EQUIPMENT MANUFACTURER DISCOUNTS IGNORE THE FUNCTION PERFORMED BY THE ORIGINAL EQUIPMENT MANUFACTURER? We considered the functions performed by an original equipment manufacturer and on several occasions we requested t"-at ewlett-Packard rovide documented costs explaining the disparity between discounts available to original equipment manufacturers and those given to the Government. Hewlett- Packard did not dc so, maintaining that the lower price given original equipment manufacturers was not based on any demon- strated cost savings or consideration of any particular set of cost factors. We were provided with a summary of discount policies. These policies stated that the original equipment manufacturer is typically given an additional 10-percent dis- count in recognition of the function performed by the origi- nal equipment manufacturer, but Hewlett-Packard made no attempt to measure the related cost savings. We reviewed sales brochures distributed by Hewlett- Packard original equipment manufacturers. In each instance when a Hewlett-Packard calculator is incorporated into the original equipment manufacturer's product, the calculator is simply plugged into the original equipment manufacturer's product. In these instances it does not B-114807 appear that the original equipment manufacturer performs -ny major modifications to ewlett-Packard items that would warrant additional discounts. We agree that Hewlelt-Packard does receive benefits from an original equipment manufacturer, primarily a definite com- mitment to combine its product with a Hewlett-Packard product. Hewlett-Packard also probably benefits from the manufacturer's marketing d advertising. However, Hewlett-Packard also receives benefits from GSA. For instance, GSA performs some of the marketing functions cited by Hewlett-Packard as performed by the original equipment manufacturer. When a supplier receives a GSA contract, access is automatically gained to the Federal market. To order, the Federal customer need only examine a supplier's catalog and prepare an order form--terms and conditions have already been negotiated by GSA. The Government should not be expected to simply accept the contention that benefits pro'vided by original equipment manufacturers warrant an additional discount over that given the Government. We believe the Government should strive for prices comparable to those given a supplier's most favored customer unless the supplier can justify any difference through measurable cost savings. In SA's negotiation of multiple-award schedule con- tracts, any responsive and responsible supplier can be awarded a contract if it offers discounts from its catalog prices that GSA determines to be reasonable. To measure reasonableness, GSA generally requires suppliers to offer discounts at least equal to the largest discount given to any other customer. This is especially important in GSA multiple-award contracts because competition among suppli- ers is limited and the requirement for cost or pricing data is usually waived. IS THE GOVERNMENT A SINGLE CUSTOMER? Hewlett-Packard maintains that the Government represents many customers, not a ingle customer. GSA also adopts this attitude when negotiating multiple-award contract prices. As a result, GSA virtually ignores volume discounts that suppliers give to commercial customers under annual-purchase agreements, which may also only estimate purchases rather than guarantee specific amounts. The most significant shortcoming in GSA's multiple- award schedule contracting process is nonrecognition of the 6 B-114807 anticipated aggregate amount of Government contract purchases during negotiations. A cricical element of any evaluation of the reasonable- ness of a supplier's offer is how the prices offered to the Government compare with prices given to the supplier's other, large volume customers. This evaluation should include price discounts available under annual purchase agreements to recognize cumulative purchases. If a supplier offers volume discounts to non-Government customers, the Government should pursue and receive comparable treatment. Concerning annual purchase agreements, Hewlett-Packard notes that estimated savings based on the first part of exam- ple A in our report may be overstated since the example re- lates to Hewlett-Packard's entire fiscal year (Nov. 1, 1973, to Oct. 30, 1974) but that Hewlett-Packard did not offer annual agreements until July 1974. The example was included in our report to indicate the potential savings available under annual-purchase agreements. Our review was made during calendar years 1974 and 1975 and, cocsequently, we concentrated on fiscal year 1974 sales data. In essence, GSA's multiple-award contracts are annual purchase agreements under which Government agencies purchase about $870 million in goods and services each year. A crit- ical consideration when assessing the reasonableness of a supplier's offer is comparing the prices offered to the Gov- ernment with those the supplier offers to other large-volume customers under annual agreements. In this regard we re- ferred four cases to GSA for further investigation, in which we noted contractors failed to disclose discounts given under annual agreements. To date, the GSA Office of Audits and Investigations has audited three contractors with sales under multiple-award contracts totaling $8 million and has recom- mended refunds totaling $623,000. A serious deficiency in GSA's negotiated-contract phi- losophy is GSA's attitude of negotiating for many individual Government offices individually rather than for the Government as a whole. This view negates one of the benefits associated with centralizing the Government's contracting process. Furthermore, it can effectively leave suppliers with the impression that there is no need to disclose volume discounts available under annual agreements since GSA is interested only in discounts applicable to individual agency orders. 7 B-114807 CONCLUSION Tne primary objective of our original review was to determir.e if GSA obtained fair and reasonable prices for commercial items purchased through its multiple-award pro- gram. Our report demonstrated that GSA could be more effec- tive in its negotiations and should have sought prices com- parable to those given other customers. As a result of our additional review work, we do not believe any significant changes to our report are warranted. We reiterate that our report stated GSA's determination of a reasonable price should recognize aggregate annual pur- chases and should depend on the specific contractor and its marketing practices. In this regard, the information pro- vided by Hewlett-Packard should be considered by GSA when negotiating the most favorable prices for the Government. As arranged ith your office, we are sending copies of this report to the Hewlett-Packard Company. Copies will also be available to other interested parties upon request. We appreciate the opportunity to respond to the objec- tions raised by Hewlett-Packard and would be pleased to answer any further questions you may have. Sincerel yours, Comptroller General of the United States
Review of Contentions by Hewlett-Packard Company Regarding Prices Charged to the Government for the Purchase of Goods
Published by the Government Accountability Office on 1977-12-20.
Below is a raw (and likely hideous) rendition of the original report. (PDF)