LATE LAST MONTH, the Air Force asked two of its largest contractors to return $208 million in "unearned" profits they had pocketed selling spare parts to the Pentagon.
The extraordinary request may have suited the current public mood and mollifed some congressional critics. Whether it was fair is another matter.
The Pentagon made deals with General Electric Co. and Pratt & Whitney, a division of United Technologies, to buy spare parts at an agreed-upon price, and now the Pentagon wants to welsh. If those firms earned $208 million more than the Pentagon thinks they should have, it's only because the Pentagon was naive, careless or just plain unlucky in negotiating the contracts in the first place.
The Air Force's refund request apparently was intended to signal a new "get-tough" policy toward defense contractos and to help quiet the growing public clamor for procurement reform. Those who believe that industry has exploited the administration's arms buildup with shoddy weapons and $750 pliers no doubt welcomed the move.
But if the request sends any signal to industry, it's the wrong one: that a fixed-price contract with the Defense Department is really written with disappearing ink. Defense contractors facing cost overruns have long operated on the premise that a contract is a contract until they start to lose money. The Pentagon now promises to enforce the terms of defense contracts. That rhetoric will ring hollow if the government also says it can rewrite contracts when companies make too much.
Admittedly, some may have difficulty casting General Electric as the victim in any story involving the Pentagon. Isn't this the same General Electric, after all, that earned $6.5 billion in profits during the first three years of the Reagan administration, paid no federal income taxes and then claimed a refund of $283 million for taxes paid before President Reagan took office?
And isn't this the same GE that was recently indicted in Philadelphia for bilking the military on contracts to build Minuteman nuclear warheads?
Well, yes. It's also the same United Technologies that claimed "its best year ever in 1984," thanks in large part to "improving profitability" selling helicopters to the Pentagon.
Certainly, the spare-parts contracts now being questioned contributed to the good fortune of both companies. That's laid out pretty clearly in a March 21 audit by the Defense Department's assistant inspector general, John W. Melchner.
But the audit, while urging the Air Force to seek a refund of $168 million from GE, doesn't allege any wrongdoing by the company. (Pratt & Whitney is accused of engaging in "defective pricing," accounting for a portion of the $40 million refund the Air Force wants, but the Defense Contract Audit Agency already was pursuing that claim independently.)
Instead, Melchner spells out a series of Pentagon practices that repeatedly allowed companies to get better deals from the services than they thought they were giving.
The Navy and the Air Force both buy engine parts from GE, for example, but they don't talk to each other before negotiating contracts. If they did, they might get better terms, Melchner said in his report. Even within the Air Force, the San Antonio Air Logistics Center doesn't coordinate purchasing strategy with the Oklahoma City Air Logistics Center as they hammer out separate contracts with the same firms.
GE is also charged with reaping "unearned" profits on its overhead costs. The Air Force negotiated an overhead reimbursement rate with GE. When the actual overhead was less than that rate, the company pocketed the difference.
The Defense Department, in fact, has hired thousands of auditors to prevent precisely that problem by analyzing contracts to determine, for future reference, true overhead costs. The inspector general found, however, that this analysis is not being done. The auditors at GE's Evendale, Ohio, plant, for example, had fallen so far behind that they had not completed reviewing 1979 contracts, the inspector general said.
Similarly, it used to be that contracting officers couldn't sign any deal for more than $100,000 without asking auditors to check it out. The Reagan administration raised that floor to $500,000 -- and even that requirement often is ignored.
"We found that the San Antonio and Oklahoma City Air Logistics Centers repeatedly waived field pricing reports and audits on individual spare parts proposals," Melchner wrote. "Instead, the procuring contracting officer relied on . . . data furnished by the contractor to determine the fairness and reasonableness of the proposed prices."
That practice, the report notes, "could simply perpetuate unreasonable prices paid in the past."
The contracts also included an inflation fudge factor that the Air Force and Navy negotiated with the company. If real inflation had been higher than the estimate, the company would have had to absorb the added cost. Now that real inflation has turned out to be lower than the estimate built into contracts, the Air Force wants its bill reduced.
In the bad old days in the Pentagon, most contracts were "cost- plus." Whatever the contractor spent, the government reimbursed. Now, officials boast, they are moving toward a "fixed-price" mentality. If a company performs well, its profits increase; if poorly, the risk belongs to the private sector.
Too often, of course, the government ends up eating the loss even on "fixed-price" contracts. Through change orders and other forms of "contract nourishment," those contracts frequently grow.
But that is no excuse for the government to bend the contracts in the other direction. It may well be, as the inspector general suggests, that GE and Pratt & Whitney earned "excess" profits, not by improving efficiency and cutting costs, as one would hope, but by taking advantage of government procurement officers who failed to do their homework, made mistakes or simply guessed wrong, as anyone might in predicting the future.
If so, perhaps the system should be improved. The Pentagon can't let itself off the hook if it hopes to hold industry accountable.