oversight

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)

                         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