In November 1995, the Department of Defense (DOD) announced plans to buy an additional 80 C-17 aircraft. Initial spares for the C-17 are being procured under two contracts. Higher Costs for Parts Made In-House

The Air Force paid higher prices for 33 spare parts than appears reasonable when compared to McDonnell Douglas’ historical costs. The St. Louis Division’s estimated costs were from 4 to 56 times greater than the prices that Long Beach had paid outside vendors several years earlier. McDonnell Douglas refunded that amount in December 1995. Data for Pricing Spare Parts

Our review of the data submitted to support the pricing of selected spare parts orders showed that McDonnell Douglas’ St. Louis Division used outdated pricing information when proposing costs under intercompany work orders with the Long Beach Division for the C-17 spares. We found that the selected items were overpriced by $117,000, or about 34 percent of the negotiated value of the items reviewed. Profit Under Spare Part Orders

Our review indicated that the profits awarded for some orders under contract-2109 appear higher than warranted. For example, the profit objective for a fixed-price contract normally would be higher than that for a cost-type contract because the cost risk to the contractor is greater under the former. However, rather than calculate separate profit objectives and negotiate profit rates for individual orders, DPRO and McDonnell Douglas negotiated two predetermined profit rates, documented in a memorandum of agreement, that would apply to subsequent pricing actions. The profit rates were 10 percent for parts that McDonnell Douglas purchased from subcontractors, and 15 percent for spare parts that McDonnell Douglas manufactured. Based on profit rates of 6 percent for purchased parts and 13 percent for parts made in-house, both of which could have been justified according to our calculations, McDonnell Douglas would have received less profit. Using one order as an example, McDonnell Douglas (1) negotiated spare parts prices with its subcontractor on January 25, 1993; (2) negotiated prices with the government on April 11, 1994; and (3) scheduled the parts for delivery on May 27, 1994. The contracting officer’s use of the alternate range for performance risk, combined with the use of a fixed-price value for contract type, led to the negotiation of a profit rate of 10 percent for the buy orders; in contrast, we calculated that using a cost-type contract risk factor, the standard range for performance risk, and McDonnell Douglas’ estimate of facilities capital employed would have resulted in an overall profit objective of 6 percent for the buy orders. Agency Comments and Our Evaluation

In commenting on a draft of this report, DOD said that it had taken appropriate action to address our finding of overpricing.
Why GAO Did This Study

Pursuant to a congressional request, GAO reviewed the pricing of certain spare parts for the C-17 aircraft, focusing on those spare parts that experienced significant price increases when McDonnell Douglas decided to produce them in-house rather than purchase them from outside vendors.

What GAO Found

GAO found that: (1) GAO's review indicates that the Air Force paid higher prices for spare parts than is justified; (2) for 33 selected spare parts formerly procured under subcontracts, costs are from 4 to 56 times higher after McDonnell Douglas moved the work in-house; (3) for example, McDonnell Douglas paid an outside vendor $389 to machine a door hook that it subsequently machined in-house at its St. Louis Division at an estimated cost of $8,842; (4) costs for some spare parts are higher than justified because McDonnell Douglas used outdated pricing data that overstated its proposed prices; (5) in developing the proposed costs of selected spare parts, McDonnell Douglas used outdated labor variance factors, which resulted in prices being overstated by 34 percent ($117,000) for 37 parts; (6) the profits awarded on some orders under contract-2109 appear higher than warranted; (7) the contracting officer used Defense Federal Acquisition Regulation Supplement guidelines to calculate profit objectives and negotiate profit rates with the contractor that are documented in a memorandum of agreement; (8) the contracting officer developed the government's objectives based on the risks of a fixed-price contract; (9) however, most costs were known when the order prices were negotiated; therefore, the contractor's risks were lower than in a fixed-price environment; (10) also, the contracting officer used a higher performance risk factor than appears appropriate when McDonnell Douglas is buying spare parts from subcontractors; and (11) based on profit rates that GAO's calculations suggest could have been justified, McDonnell Douglas would have received less profit. GAO also found that: (1) as GAO discussed its findings with Department of Defense (DOD) officials during GAO's review, they began taking actions to address those findings; (2) for example, the Defense Contract Management Command's Defense Plant Representative Office at McDonnell Douglas calculated that the overpricing of spare parts was $182,000 and recovered that amount from McDonnell Douglas in December 1995; and (3) DOD stated that other actions are being taken to prevent these overpricing problems on other spare parts.