Honorable Melvin R. Laird Secretary of Defense APPENDIX IV January 27, 1970 Dear Mr. Secretary: I have reappointed the Ad Hoc Subcommittee on Research and Development, which again will be chaired by Senator McIntyre, to review and report on the DOD FY 1971 authorization request for the Rescared, Development, Test and Evaluation appropriations. In addition, I have requested the Subcommittce to conduct hearings and make a separate recommendation on S. 3003, relative to independent research and development, which, as you know, was the subject of considerable controversy on the floor of the Senate last year. Answers to the following questions are needed to assist the Subcommittee in preparation for these hearings: What specific implementing actions would be involved if the Congress established a specific dollar ceiling for independent research and development applicable to appropriations authorized for FY 1STL first on the assumption that such a ceiling would be established at the DOD level and not identified as to individual appropriation or millecry service; and, secondly, on the assumption that the ceiling were established as a single line item in each of the Procurement and FDTRE appropriations for each service? In reply to these questions, it should be assumed that independent research and development includes bid and proposal costs and other tecknical efforts. If there are preferable alternative methods of control other than a specific dollar ceiling, such proposals also should be submitted. The information should be submitted by February 9, 1970, since it is anticipated that hearings will be scheduled shortly thereafter. It is assumed that substantial thought has been given to these questions already so that the Department should be able to respond by that date. Sincerely yours, John C. Stennis HF: pab (2699) INSTALLATIONS AND LOGISTICS ASSISTANT SECRETARY OF DEFENSE WASHINGTON, D.C. 20301 Honorable John C. Stennis Chairman, Committee on Armed Services United States Senate Washington, D. C. 20510 Dear Mr. Chairman: The Secretary of Defense has requested me to reply to your letter of January 27, 1970 advising that the Ad Hoc Subcommittee chaired by Senator McIntyre will conduct hearings on Senate Bill S. 3003 relative to Independent Research and development (IR & D), Bid and Proposal (B&P) expense and Other Technical Effort (OTE). In your letter you asked us to supply answers to the following questions: 1. 2. What specific implementing actions would be in- Same question as above except that the ceiling would In addition to the two questions, you also asked us to submit any As you anticipated in your letter, we have given considerable IR & D, B&P and OTE costs are not part of the direct effort called for in a contract. Instead, they are incurred as part of the cost of operating a company and keeping it technically competent and competitive. Such costs are part of the overhead expense and are recovered by allocating the total incurred over the direct effort incurred on all contracts. In any one of his fiscal years, a contractor may be performing both commercial and Government contracts. In addition, Government contracts will include a mixture of funds that have been appropriated in various fiscal years. This mixture of funds has beer. the cause of a serious problem in our attempt to implement Section 403 of the 1970 Military Procurement Authorization Act and would cause a similar problem in attempting to administer an amount established as a budget line item. Let me explain. The limitation imposed on the appropriation for FY 1970 requires us to keep track of contracts that include those dollars so that we can make sure that the specific limitations on IR&D, B&P and OTE are complied with. Since we have different criteria for determining the amounts of IR&D, B&P and OTE that can be allowed on all other contract not subject to this limitation, we now have two administrative procedure. instead of one. If FY 1971 funds have still a different limitation, we would find ourselves with three sets of records to keep. Since some contracts run for a period of several years, it is apparent that in a short time we could have contracts subject to five or six different statutory limitations in any plant at one time. This could be further complicated by contracts which involve funds of various years. The additional administrative effort required to sort out all these funds and see that costs applicable to each was proper would be formidable. Another major problem is that we don't know of any effective or equitable way to divide the fixed dollar figure among contractors. It should be recognized that IR &D, B&P and OTE costs are very different from line items presently appearing in the budget. At present, budget line items relate to specific items required by the DoD. As such, they become a line item on a contract with one or several contractors. On the other hand, a line item for IR&D, B&P and OTE costs might involve every contractor who does business with the DoD. That is, instead of placing the item on direct contract with one or two contractors, we would be faced with the task of trying to find some equitable, consistent procedure for spreading this item over all the contracts we write that include FY 1971 funds. Let me discuss the problems associated with this for a moment. Depending upon the type of product produced, the contractor's position in industry as a designer/creator or a copier, the need for new business or the number and type of proposals the Government may request in any one year, contractors' needs for IR&D, B&P and OTE may vary considerably as between companies. Moreover, any particular contractor's requirements may vary appreciably from year to year. This is especially true of smaller contractors. With this in mind, consider the administrative actions that would be required. At the time we receive a new appropriation the procurement line items are separated out and sent to various purchasing offices for procurement action. This can't be done with an IR&D, B&P, OTE line item. Instead, some portion of the funds established in the IR & D, B&P, OTE line item would have to be attached to each of the other procurement items. At this point, however, we would not have sent out requests for proposals and would seldom know which contractors we would be selecting for award and the amounts of IR&D, B&P and OTE involved. Thus, the distribution of IR&D, B&P and OTE costs would have to wait until contract negotiations were completed in order to know the actual amount of these costs that should be included. A further complicating factor is that all procurements are not placed at one time. In fact, contract changes may be negotiated months or years later. Thus, we would not be able to determine all the costs of IR&D, B&P and OTE that we would be requested to reimburse and compare them to the amount available from the line item authorization. Therefore, we would not be able to determine the percent of costs incurred that should be allowed each contractor. This means that some contractors would probably receive no reimbursement because the funds were exhausted. In the meantime, a new procedure would have to be established for processing contracting officer's requests for IR&D, B&P, OTE funds to complete contract negotiations. Another related problem is the question of how to establish the amount needed for a line item. It would not be feasible to ask all contractors how much IR&D, B&P, OTE cost they proposed to charge against line items on a proposed new budget because at that time we would not know who the contractors for these future projects would be. The only way such an amount could be established would be to arbitrarily use a percent of the procurement budget. Such a computation, unsupported by any rationale based on industry needs or DoD benefits, is completely contrary to the major points of Congressional concern stated in the Senate Bill S. 3003, that there should be a relationship between the DoD expenditures in this area and benefits received. it would not be as effective as our current procedure. In this respect, You requested that preferred alternate methods of control be submitted. We believe there are basically two such approaches and we are happy to describe them to you. We have been in the process of evaluating each approach over a considerable period of time, and we believe that either approach would be an improvement over our present practices. The first alternative that we believe merits consideration is the formula approach that was developed into a draft of a proposed policy and circulated to industry and other Government agencies some months ago. This method of controlling costs is based on each individual contractor's historical expenditures and results in a positive dollar ceiling for IR&D and B&P costs at the individual contractor level. OTE costs, which are R&D or B&P in nature, were included in the definition of IR & D and B&P and the term OTE was eliminated because it is not definable or appropriate. The merits of the formula approach are that it has relationship to the specific experience of each individual contractor, it is objective and requires no subjective judgements by Government negotiators, it tends to keep the proportion of IR&D and B&P per dollar of contract price at a constant level, requires contractors to absorb increases unvil such amounts become part of the historical average and it can be easily adjusted to raise or lower the rates of contractor recovery of IR&D and B&P cost which, of course, will raise or lower the DoD costs for IR&D and B&P. Criticisms of the formula approach stem primarily from the fact that the formula does not provide a means whereby factors other than historical expenditures are considered in determining the IR&D and B&P costs to be allowed. In the proposed policy that we drafted, we included a feature to overcome this objection in the more flagrant cases. This feature consisted of an appeal and review procedure under which cases could be reviewed by Military Service Secretaries and revised limitations established where appropriate. The second alternative that we would propose is an approach that we have been considering that would require mandatory advance agreements with all major contractors establishing the amount of IR&D and B&P costs that would be recognized. These agreements would cover all such costs allocated to any DoD contract regardless of whether the contract was funded with FY 71 money or an appropriation 42-060 O 70 - 15 |