THE MONEY IN MISSILES

...Fruehauf, Douglas' subcontractor, fabricated the trailers and Douglas added a profit mark-up...

...The Army promptly cancelled 312 of the 578 units it had ordered from Henney...

...Late in 1959, years after government engineers first suggested it, the Army "broke out" an order for 578 flat-bed missile transport trailers and put it up for competitive bidding...

...Within brotf limits, the prime contractors also miif be clothed with authority to keep certain production work for themselves or farm it out...

...Donald W. Douglas, Jr., the cigar-chomping president of the West Coast aircraft company, protested violently...

...A spokesman explained that the parts were purchased from a "sole source," that is, from the original manufacturer, because technical drawings on which competitors could bid often were unavailable...

...Another was in the disclosure by Senator William Proxmire, Wisconsin Democrat, that there is at least one Pentagon lobbyist for every member of Congress...

...In McClellan's view Western Electric wielded "absolute control" over Army purchasing policy...

...on net investment the twenty earned 30.2 per cent before taxes (Western Electric, 28.3 per cent) and on net worth their before-tax profits were 36 per cent (Western Electric, 32.5 per cent...

...But Smith sidestepped adroitly...

...With defense dollars, industry can bid— with taxpayers' money—for the best available technical talent by paying higher salaries than Congress will allow the Defense Department to pay...

...Over the years Americans have become accustomed to incredible examples of waste which successive battalions of civilian administrators seem unable to control...

...The overall stakes in defense contracts may be measured by the $21.6 billion poured out in prime military contracts last year, half of which went to only nineteen big companies...

...Thomas D. Morris, assistant Secretary of Defense for Logistics, ended the hearings of the McClellan Subcommittee by tossing a bouquet at McClellan for an "excellent" investigation...

...In their testimony the companies related their earnings to those portions of the seventeen contracts for which each was responsible, calculating profits as a percentage of total costs, including bills submitted to them by subcontractors...

...That company added administrative expenses of $6,-478,936, profits of $9,840,475...

...Frue-hauf Trailer Company and Consolidated Western Steel, a division of U. S. Steel, were the major contractors on the third layer of the pyramid...

...Douglas' profits of $45,-580,000 amounted to 7.6 per cent...

...He was told that blueprints were not available...

...The Air Force once placed a "sole source" order for oxygen regulator valves...

...Air Force experience with Boeing on four contracts for Bomarc ground-to-air guided missile did not convince McClellan that the necessary accuracy had been achieved...

...The true facts, as portrayed in the record," said the Senator, "are that Douglas did make $63,800,000 in profits on the Nike program and of this $37,-300,000 represented 'mark-ups' Douglas took on work performed by its subcontractors...

...How high is up when we negotiate fees or profits...

...McClellan mulled over Douglas' arguments for two weeks...

...Graham asked...

...Instead of tunneling all orders through a single prime contractor, the Air Force named five "associates," each responsible for a major missile component...

...Western Electric leased the facilities from the government for $3,075,000, and it recovered that amount from the Army as a cost of Nike production...

...Muskie pointed out that Western Electric's after-tax Nike profits of thirteen per cent on investment compared "rather favorably" with the nine per cent it earned on the manufacture of telephone equipment for AT&T...

...Much of this is sheer waste...

...Even Senator Karl E. Mundt,-' the arch-conservative Republican of South Dakota, remarked at one point that prime contractors have in effect been delegated the authority to appropriate money...

...The Air Force naturally claimed savings of more than $81 million (the "underrun" minus Boeing's incentive profits...

...The military's dependence on business has many of its roots in the pell-mell demobilization of scientific and technical brainpower following World War II...

...While interrogating Smith about earlier missile profits, McClellan and Senator Edmund S. Muskie, Maine Democrat, sought a commitment for a lower profit margin on Zeus...

...Partly because of inertia and partly because it lacked the capability to manage any major part of the missile system itself, the Army acquiesced and continued pumping contracts through Western Electric...

...Don't blame us, the company was saying in effect...

...He also agreed that fees allowed prime contractors must be related more realistically to effort and responsibility...

...Certainly the generals and the chiefs of big corporations often collaborate, particularly when Congress is about to vote the Defense Department budget...

...Since 1954 the Air Force has budgeted $15 billion for intercontinental ballistic missiles, including some $5 billion for the first generation Atlas...

...expenses, and profits or fees...

...In buying the Atlas the Air Force modified the Army's "systems manager" concept...

...For the most part it can only review the results, criticize— and hope...

...In turn, the accretion of technical skills helps industry retain the power of decision, closing a circle increasingly difficult to break...

...fees included $1.4 million spent for institutional advertising, some of it "in coordination with the military services...

...Nor was he at all defensive about the profit his company earned on the rent of two government-owned plants in North Carolina...

...Its profits were $1,111,807...

...With military spending -drastically curtailed, scientists and engineers flocked into corporate laboratories and research centers...

...RCA spent $1,-150,333 supervising and inspecting the work...

...Thus, hundreds of millions of dollars of reimbursed costs are in excess of those anticipated at the outset of the contract," Morris said...

...This meant, said Adlerman, that companies at the apex of the pyramid took profits "off the back of subcontractors...

...The Army wound up paying $182,182,070 —or $26,674,070 more than the costs and profits rung up by the actual manufacturer, Consolidated Western Steel...

...Colonel John W. Graham, commander of the Army's New York ordnance district, frankly acknowledged the lack of such criteria...

...Douglas landed the contract for 100 new-type trailers ($34,000 each, including development costs...

...it also assumed responsibility for continuing development, coordination, supervision, and technical advice...

...Then in hot anger this conservative Senator accused the aircraft company of seeking to "diminish or conceal" its Nike profits...

...McClellan's investigators and accountants spent months analyzing the eight-year total of seventeen separate missile production contracts...

...Sometimes the needed technical data could not be found among the 13,-000,000 design blueprints stocked in Air Force warehouses...

...Among the unallowed Nike costs he listed more than $23 million that had been spent to develop commercial airliners...

...Digging into the third contractor tier, the investigators found that profits on the installation of launch control equipment at three Atlas bases came to 17.1 per cent of original costs...

...On the same launchers Western Electric listed administrative expenses of $737,889...

...Skills developed in commercial production contributed to the know-how needed for missile manufacture, Douglas claimed, and it enabled the company to recruit technicians more easily...

...For the three top layers they "broke-out" —separated—actual production costs, general overhead and administrative JERRY LANDAUER is a Washington correspondent who has covered the Mc-Clellan Committee investigation...

...Smith said the company earned every cent it collected from the Army...

...By all accounts Western Electric turned in a fine job...

...But McClellan's glimpse at the military-industrial link re-' vealed not so much a passionate alliance as an uneasy, fretful liaison of necessity, with the Pentagon often negotiating from weakness and dependency, while industry increasingly dictates the terms...

...I think we would like to wait until production is in the offing," he said, "and then we will be glad to sit down and negotiate...

...The Secretary candidly conceded that contractors working under cost-plus-fixed-fee arrangements ($8.9 billion last year) frequently ran up costs twenty per cent higher than target estimates...

...Company figures showed that its ten-year weighted average of after-tax profits on defense work totaled 28.8 per cent of net assets, more than 250 per cent above the average of all manufacturing companies...

...McClellan's inquiry sharply revealed the conflicts-of-interest in which a number of major contractors are involved...

...The bristling report created hardly a ripple of interest...

...Incentive contracts depend, of course, on the accuracy of the target estimates...

...General Dynamics spent only $175,-269 but its profits were $1,084,800...

...One index to the intimacy of the relationship was a House subcommittee's finding in 1960 that 728 former high-ranking officers were employed by the Pentagon's 100 leading contractors...

...Often they decide which subcontractors will do what and for how much...

...In the end the Defense Department conceded that untold millions had been wasted in the making of missiles...

...To head off cost padding, he said, the armed services are moving rapidly toward incentive-type contracts...

...The system of procurement which would permit the taking of profits in this fashion surely requires prompt revision and correction...

...The astronautics division of General Dynamics Corporation, one of the five associate contractors, certified $1,113,103,680 as the total of its own costs plus the bills submitted by subcontractors...

...The term "profit-pyramiding" developed from the Subcommittee's alternative method of analyzing earnings...

...On one order for 1,396 launchers (cost: $13,460,428), Douglas certified its down-to-the-penny engineering and supervisory costs as a mere $3,316.21...

...Western Electric already has received $600" million worth of research contracts and naturally it expects to become the prime production contractor...

...Why," he asked, "should you have an RCA in there as a middle contractor charging sub-stanially as much profits [RCA actually charged more] as all three producers of the original work charged, and then go on to a prime contractor, and it makes another profit on the same thing...

...Douglas subsequently insisted that the "fees" allowed his company by the Army could not be regarded as clear profits...

...On sales to the government the twenty others earned 11.1 per cent compared to Western Electric's 6.9 per cent...

...Again, the top contractor earned more than the producing subcontractor...

...our competitors earned more...

...Measured this way, Western Electric's profits of $112,500,000 worked out to 7.9 per cent of costs...

...Commercial work, he said, saved money for the Army because it absorbed part of the fixed overhead and depreciation that would otherwise have been charged to the Nike contract...

...It appears fair," Smith explained, "that there should be some return for making these facilities, as well as our own, productive...

...The Ordinance Corps did not press for, and Western Electric was in no hurry to supply, the mass of technical data, specifications, and blueprints without which the Army could not call for competitive bids...

...He accused the staff of childish arithmetic manipulations and "gross distortions...

...In their report to the Senate, McClellan and a majority on the Subcommittee undoubtedly will demand a radical reshaping of Defense Department contracting procedures, particularly those followed by the Army...

...In the end only an insignificant fraction of the missile system was purchased through the competitive process...

...Similarly, penalties may be inflicted for "overruns...

...The launchers, by the way, were shipped directly from Consolidated to an Army staging area...

...Taking production orders only, Western Electric's invoices to the Army totaled $1,432,600,000, of which all except $359,300,000 represented costs and profits billed to Western Electric by subcontractors...

...Yet its profits on the launchers were $1,211,771...

...Joseph V. Mc-Kee, a Henney executive, hurried to the Pentagon, demanding a chance to bid on the bigger units...

...Morris gave assurances that the Pentagon high command is moving to curb waste in every possible way...

...McClellan's staff traced the profit pyramiding process by toting up the additional costs and profits that were added to $137,978,000 worth of Nike launcher-loaders manufactured by Consolidated Western Steel...

...Shortly thereafter, however, the old contractors persuaded the Army that it needed a newer, bigger trailer to haul ready-to-fire missiles...

...Zeus could become the most expensive weapon of all time—Army estimates of eventual cost range from $6 to $9 billion...

...With a growing arms industry clamoring for bigger profits (Douglas said aerospace companies required healthier earnings to keep their technological muscle flexed), the hope for genuine reform in defense spending seems dim indeed unless the perplexed Pentagon can find some way to bail out the long-suffering taxpayers...

...It sent bills for $155,508,000 to Douglas...

...McCellan retorted that somebody had to know, "sometime, somehow, somewhere...

...In 1945 the Army asked Western Electric Company to develop a guided missile that could track and destroy enemy bombers...

...Adlerman pointed out that in carving up some contracts Western Electric acted as a "broker," simply doling out slices to subcontractors...

...They ran up bills of $53,849,-327 and $155,508,000, respectively...

...Western Electric's role in the production process was minimal...

...The price: $13,260—not for the regulator but for each valve...

...Douglas pinned on profits of $10,354,659 (its expenses were paid under a different contract) and handed up a $165,862,659 bill to Western Electric...

...McNamara has blocked a production go-ahead on the ground that Zeus is still unproved...

...McClellan's bewilderment scrambled his syntax...

...The insulation of vast quantities of defense work from cost-reducing competition has been a matter of increasing concern over the years...

...It is the huge size of the pie and the obviously close cooperation between industry and the Pentagon in dividing it that led President Eisenhower to voice concern in his farewell warning about the unwarranted influence of what he called the military-industrial complex...

...Time and again the company informed the Army that it could not accept responsibility for the performance of contracts over which it had no control (and on which it would not collect a profit mark-up...

...As Morris reported, reimbursed production outlays under cost-plus contracts often ran twenty per cent beyond the estimates, "with many programs running much higher...

...Douglas and Western Electric each earned more on the launchers than the manufacturer...

...On the day McClellan ended his hearings, the General Accounting Office accused the Air Force of spending $63 million to develop and produce a helicopter of the type the Army already had in stock...

...Jerome S. Adlerman, Senator McClellan's chief counsel, argued back, and McClellan agreed, that if the contractors did not want profits measured against the work each contributed, then it followed logically that some of the profits were earned on the work of subcontractors...

...Profits totaled $67,007,-244, or six per cent of costs...

...The installation contractors, small firms all, spent $16,-924,261 and earned $751,304, or a modest 4.6 per cent...

...Instead of relating profits to overall "costs"—which included subcontractors' profits—McClellan's in-vesigators calculated each company's profit against its "own effort"—value of that portion of the work each contractor completed "in house," in its own plants and shops...

...These permit contractors to earn a basic fee plus fifteen per cent of any "under-runs"—the amount by which final costs fall below initial estimated targets...

...Douglas Aircraft Company, which fabricated the missile air frame, was the chief subcontractor...

...Countervailing pressures to offset profit pyramiding are consequently absent...

...That was a present," remarked Representative Daniel J. Flood, a Pennsylvania Democrat who claims to have caught the Air Force buying pigeons from the same "sole source" supplier since the Spanish-American war...

...From now on, he promised, the planners will make sure that weapons components can be "broken out" for competitive procurement early in the production stage...

...Douglas' claim that the cited expenses were in any way attributable to the missile program makes him guilty of the very "gross distortion" charge he had hurled at the subcommittee, McClellan declared...

...and profits exceeded the supervisory, engineering, administrative, and miscellaneous outlays ($3,207,699) necessary to manage the subcontractor's effort...

...But the company's accountants went on to add a profit of $209,000, which the Ordnance Corps unquestioningly paid...

...A major behind-the-scenes factor in this phase of the hearings was a pending decision by Defense Secretary Robert S. McNamara regarding the Army's Nike-Zeus missile-killer missile...

...Production of the Nike missile began in 1952...

...The town of Canastota (population 5,000) in New York became a depressed area...

...In procuring the Nike family of missiles the Army ran into one obstacle after another when it tried to spread contracts among the lowest responsible bidders...

...Douglas billed Western Electric for $598,960,000, of which 82.8 per cent represented work (plus profits) that had been farmed out to third-tier subcontractors...

...Only a continuing, relentless scrutiny can generate the harsh, embarrassing publicity necessary to check lax or arrogant management, excessive profits, or plain squandering of taxpayers' money...

...Obviously the Pentagon cannot prepare a shopping list for weapons that exist only in the military imagination...

...A chart prepared by Western Electric showed that average ten-year earnings of the twenty other largest defense contractors were sharply higher than its own...

...That is what has been our problem...

...McClellan challenged this contention, pointing among other things to "contingencies" of ten and fifteen per cent which the Air Force generously allowed Boeing to include in one of the negotiated target estimates...

...Nearly all development and production orders—which totaled $2.5 billion—were channeled through Western Electric and from the prime contractor they flowed to a widening base of subcontractors, sub-subcontractors, and suppliers...

...The Army's arrangement with Western Electric came to be known as the "systems manager" procurement method...

...Though the apex of the contractor pyramid had been lopped off, McClellan's staff nevertheless found pyramided profits building up through the truncated remainder...

...But Smith agreed that the government could have saved money by lending the plants rent free in the first place...

...Moreover, the investigators showed, the top-echelon contractors not only marked up subcontractors' costs, but they also took profits on subcontractors' profits...

...Henney Motor Company, a small firm, landed the order with a bid of $5,305 each, nearly fifty per cent below the costs and profits that had been piled up by the established contractors—Fruehauf, Douglas, and Western Electric...

...Lack of time, lack of detailed knowledge, and conflicting pressures to spend here rather than there long ago diluted the authority of Congress to review the huge, still-growing arms budget in advance...

...But a year ago the Air Force lamely acknowledged that it was buying 30,000 different spare parts for existing aircraft without competitive bidding...

...Henney shut down a trailer plant and reluctantly dismissed 400 workers...

...When1 a company that manufactures military hardware is also hired for overall technical management, the suspicion that its advice may not be disinterested can never be laid to rest...

...Yet Boeing, operating under incentive contracts, managed to slice $90,616,000 from target costs of $684,282,000, thereby earning an additional $9,198,000...

...Other deductions he charged against Nike Herblock in The Washington Post "Where Do You Think the Enemy Is, Anyhow...

...Unreimbursed business expenses reduced "take home" missile profits from $45,580,000 ($63,-800,000 if earlier research and development contracts are included) to $29,800,000, Douglas contended...

...The company, a wholly-owned subsidiary of American Telephone & Telegraph, assigned much of the research work to AT&T's Bell laboratories...

...Figured this way, Douglas' earnings were shown to be 44.3 per cent of effort and Western Electric's, 31.3 per cent...

...The postwar revolution in weaponry forced the armed services to rely heavily on the skills developed in the great corporations, and set the stage for a new concept in contracting for military needs...

...There was no way to measure total profit-taking on the $1,432,600,000 because hundreds of fourth, fifth, and even sixth-tier contractors contributed work or supplies to the missile system...

...In allocating these profits under an accounting method to which General Dynamics agreed, McClellan's staff discovered that the contractor earned $5,733,973 on a $97,047,746 subcontract to Radio Corporation of America on which RCA had made profits of $5,115,150...

...Boeing's incentive profits helped boost the company's Bomarc earnings to $124,200,00 on costs (including costs and profits of subcontractors) of $1,507,400,000...

...So dependent was the Army on Western Electric that it had to request "permission" to "break out" contracts—that is, skip the established contractor tiers and award an order directly to the low bidder...

...Finally, the investigation suggested the need for a permanent Congressional watchdog committee to maintain constant vigilance over the arms budget...

...Muskie's mild phrase softened the hard fact that Western Electric negotiated missile profits ranging up to 44 per cent higher than the Federal Communications Commission allowed it to earn on telephone business...

...The service also hired Space Technology Laboratories for overall supervision and technical advice...

...Consolidated's administrative expenses were $8,245,000 and its earnings were $9,-285,500...

...C. R. Smith, a Western Electric vice president, agreed with Douglas that the allocation of profit to specific subcontracts was merely a bookkeeping device...

...This was Western Electric's role in the Nike program...

...Western Electric not only became the prime contractor for all components of the missile system...

...profits were $995,396...

...Smith attempted to reduce the glare of McClellan's spotlight on Western Electric by suggesting the subcommittee had picked the wrong company to investigate...

...McClellan flared in anger when he learned that the Army paid $26 million for technical data that was not finally delivered until Nike procurement had virtually ceased...

...Thus were profits piled atop profits...

...The fact is," Smith testified, "when we negotiate a contract in the beginning, we are asking so many dollars of profit, and how you get it makes no difference...