Industry Under the Gun

Nov. 1, 1985

It began in 1983 as a trickle of stories about ridiculously priced spare parts for military systems. The trickle developed rapidly into a flood. And after that came the series of revelations about falsified claims and improper charges by defense contractors.

Consequently, by 1985, waste and fraud had become defense issue number one for many Americans. According to current polls, a major­ity of citizens believes that the gov­ernment is being cheated left and right in military procurements. Val­id or not, that perception now threatens to destroy the consensus, built by Ronald Reagan in the elec­tion campaign of 1980, to revitalize national defense.

Mountains of data have been ac­cumulated on all this. A detailed study on parts pricing was run by the Air Force (see “Scoping the Spares Problem,” January ’84 is­sue), and a zealously active Defense Department Inspector General has conducted 68,000 audits since 1981. The evidence turns up some waste and some fraud, but nothing ap­proaching the level imagined by the public. Data released so far indi­cates that parts overpricing is con­ fined to a fraction of one percent of the defense budget and that fraud is even rarer. The services, the De­fense Department, and industry have put extraordinary effort into rooting out waste and fraud.

The public, however, understands little of the broader context, and its indignation about the abuses is in­tense. Much of the anger has cen­tered on the defense industry. It was against this backdrop that an Aero­space Education Foundation Roundtable met in Washington on August 15 to talk about the integrity of the defense industry in percep­tion and reality.

“There are two pertinent ques­tions that we should ask ourselves,” said Stanley C. Pace, chief execu­tive officer for General Dynamics Corp. since June 1. “First, has the industry done anything wrong? Has it made any mistakes? And the an­swer to that question is yes. The second question is, is the industry managed by corrupt, immoral peo­ple? And the answer to that is no.”

Mr. Pace said that contractors have not taken enough care to fol­low the precise letter of regulations on submission of cost claims. “We in industry can argue that the definition of the unallowables is not crystal clear, and that’s true,” he said. “But we should have done then what we are doing now—that is, define those unallowables our­selves in accordance with the spirit of the regulation. Because we didn’t do it, we’ve left ourselves open to criticism, which is valid. And we’ve left ourselves vulnerable to charges of fraud and corruption, which are not valid. We as an industry could have anticipated this, and if we had, we could have avoided it.”

Panelist Charles W. Corddry of the Baltimore Sun zeroed in on Mr. Pace, whose company was one of those most prominently accused of making improper claims on its de­fense contracts. Mr. Corddry said that beyond the money recovered by the government and the ensuing clarification of what’s allowable, the controversy has probably had a sal­utary effect on the ethics of General Dynamics.

“It was traumatic for us at Gener­al Dynamics,” Mr. Pace said, “but I think we’ve taken some corrective action at a high rate of speed, and it’s my understanding that others in the defense industry have analyzed what happened to General Dynam­ics and have taken parallel or similar actions.”

Is the Perception Wrong

Although the defense procure­ment process could stand improve­ment, Gen. Lawrence A. Skantze, Commander of Air Force Systems Command, said that “it is better to­day than it’s ever been since I start­ed in it twenty years ago. But be­cause of the particular perspective that’s been put forth in the last cou­ple of years, there is an enormous groundswell in the public opinion, catastrophically represented by fall­ing support for the defense process, which has resulted in an over­whelming urge on the part of any­body and everybody to do some­thing, to swat at something, to make it better, to fix something, to fire somebody.”

General Skantze said that a dis­torted picture of weapons acquisi­tion is created when people seize on overpriced hammers and ignore the many—and the more important—success stories.

He said the quality of US weap­ons sets the standard for the rest of the world and cited a list of systems that have performed well beyond their specifications. He also noted that the Air Force’s newest major system, the B-IB bomber, is being delivered ahead of schedule and un­der cost.

Alan C. Chase, professional staff member of the House Armed Ser­vices Committee, agreed that the furor is being driven more by im­pressions than by facts. He said that he has not found reason to question the integrity of the defense industry as a whole and believes that those guilty of wrongdoing are “the great exception to the rule.” He said that defense-minded legislators are con­cerned that the 1980 mandate has been lost or is being lost because of public perceptions about waste and fraud.

“When you add up all this effort that the President and his Adminis­tration have put into modernizing our forces and all the money that goes into this, it’s really inevitable that the defense sector would come in for increased attention and pres­sure,” Mr. Chase said. “It didn’t take many revelations of waste, fraud, and abuse to focus national attention on the Pentagon and its shortcomings.

“To a lesser extent, the defense sector has been a lightning rod to those who oppose the policies of the Administration on political and phil­osophical grounds. Perhaps the only accessible chink in the Presi­dent’s armor are these abuses, both alleged and real, relating to the cen­terpiece of the Administration—that is, a strong defense.”

Robert F. Daniell, president and chief operating, officer of United Technologies Corp., observed that the realities of defense procurement are complex and dull for the layman. “That may explain,” he said, “why the focus of the attention by the news media and others on the overall subject of defense spending has been on the sensationalism side of it rather than on that very com­plex, dry subject of procurement policy.”

In response, newsman Corddry said, “Some of the things that have happened are sensational, and we have simply reported them. We re­ported them straight.” About Gen­eral Skantze’s point that success stories go unnoticed, Mr. Corddry said the total picture is a mixed one. “It isn’t all successful B-Is, and it isn’t all successful this, that, or the other,” he said.

Various panelists took the news media to task for reporting bad news but not good news.

“I am not impressed when a de­fense contractor does exactly what the contract calls for him to do and the public gets its money’s worth,” Mr. Corddry said. “I don’t think that’s anything for the press to go around waving the flag about. I think the only time we should wave the flag is when it’s a red flag, say­ing, ‘Hold on there, let’s have a look.’ “

Thomas V. Jones, chairman and chief executive officer of the Nor­throp Corp., said it appears that “the problem’s of great interest and the solution is of no interest. I would ask the learned people of the press how we can make people interested in their security, because that’s what we’re talking about.”

“I think that the people are inter­ested in security,” Mr. Corddry re­plied. “Otherwise, they would not have put the defense budget on a higher plateau than it’s customarily been on—and where it will stay. Reagan has won the defense battle. Now it will stay on a high plateau. Nobody is talking about cutting it back. But I think the people are also quite rightly interested in getting their money’s worth.” Mr. Corddry added that “good news from the point of view of industry does make the front pages. General Dynamics returning to the good graces of the Navy was on the front page of a couple of papers that are occasion­ally mentioned in this town, and also [on the front page of] mine.”

The Problem of Confidence

“I consider the key problem in front of us to be gaining back the confidence of the American people in our system,” said Dr. James P. Wade, Jr., Assistant Secretary of Defense for Acquisition and Logis­tics. “We’ve got to be able to dem­onstrate to them that we are provid­ing the product that is worthy of the resources that we put into it.”

It is important, he said, “that we all recognize that business as usual is not a condition that we can accept or maintain.” When a defense con­tractor is out of line, Dr. Wade said, “then there has to be an appropriate level of pain. Otherwise, discipline will break down, and the whole pro­cess will fail.”

Sometimes it is an arcane feature of the acquisition rules that leads to misunderstanding and the loss of public confidence. For example, a statutory provision new this year—use of a “standard work hour” in billing labor costs—seems almost certain to generate the sort of misin­terpretation that has so often en­raged the taxpayers. General Skantze pronounced it “an enor­mous club with which we could be beaten continuously.”

“Very few people on the Hill real­ly understand what a standard hour is and how you arrive at it,” he said. “It is the calculation made by an industrial engineer who picks out a point in the production cycle where changes have slowed down, where there’s stability in the design, and where the people are trained. He says that under these ideal circum­stances, [a given job] should take x number of hours.”

Used properly, the standard hour is a handy tool for estimating and pricing. Applied as an absolute yardstick at the beginning of pro­duction, though, it may be off by a factor of five or ten, General Skantze said.

“So someone will take that data, as they have over the past six months, and say the industry is only one-third or one-fifth or one-tenth as efficient as it should be and that they’re wasting all the taxpayers’ money,” General Skantze said. “We’re going to have a terrible problem with it, because we’ve got to provide the data, and it will be interpreted by those people who want to use it for their own pur­poses.”

As the defense procurement com­munity knows well by now, it is diffi­cult to explain the peculiarities of the process when citizens see an obvious low-value item with a high price tag on it. When a contractor gets an order to custom-manufac­ture a small number of parts, the cost of producing them inherently leads to a terrible price. That se­quence of events set up many of the overpriced parts scandals of the past three years.

Finally recognizing this, the gov­ernment now tries to avoid placing small orders for custom manufac­ture. And in some instances, indus­try is choosing to eat the cost of parts it has made rather than risk another public-relations disaster.

Mr. Pace said that General Dy­namics was asked by the Navy re­cently to reprice an order for twelve items, including three gaskets, two bearings, and a pin, that came to $1,300. “Compared to what people on the street would understand about the value of those parts, the price we have to put on them was too high,” Mr. Pace said. “We re­funded the whole $1,300. We said, ‘You’ve got them for free.’ Now that bypasses the process. It bypasses the issue.”

The trend in industry, he said, is to examine a parts price list and ask, “Is there anything here that looks wrong?” If there is, the contractor reprices it to a level that looks right, even if it involves selling at a loss.

Media commentaries on com­parative inefficiency in defense con­tracting are often based on inaccu­rate assumptions. On July 16, col­umnist Jack Anderson—quoting a Pentagon memo he said he had “ob­tained”—reported that twenty-five procurement professionals in France do the job that requires “tens of thousands of bureaucrats” in this country. How Mr. Anderson figured that twenty-five bureaucrats of any nationality could handle the Defense Department’s 15,000,000 contract actions a year, he did not say. In any case, his source seems to have miscounted. “I assure you [the French] do it with 85,000, not twen­ty-five,” General Skantze said in re­sponse to a question from the Roundtable audience.

Solutions and Nonsolutions

Ten years ago, Mr. Jones said, the scrutiny was concentrated on cost overruns; today, it is on elements of programs. “The focus should be on military effectiveness and the cost of getting it,” he said. This end is not served by excessive attention to the pieces of the problem without considering the process as a whole. It is wrong, he said, to look at one element of an acquisition, such as cost or military capability, in isola­tion.

“If we can justify every cost but the price doesn’t give value, then it’s the wrong system,” Mr. Jones said.

Most of the panelists agreed that the acquisition process should be simplified—the incredible complex­ity of it being a significant source of error and misunderstanding—and that additional legislation is not the answer to the Pentagon’s procure­ment problems.

“In the final analysis,” said Mr. Daniell, “this is a people-intensive business. They are not robbers. They are not going to respond to total legislation. They’re not going to be able to manage appropriately in accordance with that.”

General Skantze said that there are already 4,000 military procure­ment laws on the books. (In a speech last summer, he said that those statutes, along with the imple­menting directives, constitute a “regulatory swamp.”)

“Our ability to just do the on­going job is being severely con­strained by all the legislation we have to absorb and implement,” General Skantze said.

Mr. Chase said that some mem­bers of the House Armed Services Committee are acutely aware that “today’s procurement solutions may be tomorrow’s problems” and share the concern that some re­quirements dictated by Congress may prove counterproductive in the long run.

Roundtable moderator R. James Woolsey—Washington lawyer, member of the Scowcroft Commis­sion on strategic forces, and now a member of the Packard Commission on defense management—cited a personal example of legislative chickens coming home to roost. Mr. Woolsey has held many posts in public service, and from 1970 to 1973, he was general counsel to the Senate Armed Services Committee.

He recalled that later, while he was Under Secretary of the Navy, the day came to award a major con­tract, but at the last moment a sad-looking lieutenant commander ap­peared. (“I knew right away it was bad news. In the Navy, bad news is brought by sad-looking lieutenant commanders. Good news is brought by smiling admirals.”)

The contract had to be held up because of a complicating provision of law that the staff had just found.

“I pulled out my copy of the US Code and looked it up,” Mr. Wool­sey said. “Gritting my teeth about how Congress continually inter­fered in sensible procurement deci­sions in the executive branch, I started to read it. Slowly as I read, it began to sound more and more fa­miliar.

“And as I got down to the bottom line and saw, in the legislative histo­ry footnote, that it had been passed as a rider on the authorization bill in 1973, I remembered drafting it.”