New Battle Over Defense Profits

HOW profitable is the business of building aircraft, tanks, missiles and other weapons for the Pentagon? Defense contractors contend that their earnings average no more--and often less--than those of other manufacturers, and the current difficulties of the Lockheed Corp. seem to bear them out. Yet charges have often been leveled that defense contractors make excessive profits on contracts for the military, frequently without much risk. Last week the controversy was given new life when a draft report by the Government's General Accounting Office leaked out after GAO staffers became fearful that its findings might be watered down. The report's conclusion: producing arms for the Pentagon is far more rewarding than is commonly realized.

The report, due to be issued this month in its full form, caused an immediate storm. It was condemned by spokesmen of the aerospace industry. The Pentagon--treated to an advance look--strongly urged the GAO to do its sums over again. The Pentagon's concern over the GAO's "interim" findings was understandable enough. The report contains startling disparities between the pretax profits that defense and space contractors acknowledged in reply to a GAO questionnaire and the GAO's findings after a detailed study of 146 recently completed contracts totaling $4,256,000,000. This is how they compared:

Pretax Profits Reply to Questtionaire GAO Study of 146 Contracts

As a percentage of costs 3.9% 6.9%

As a return on total capital 10.2% 28.3%

As a return on equity capital 19.8% 56.1%

By comparison, the pretax profits of all U.S. manufacturing corporations in 1969 averaged 20.1% on stockholders' equity. The results of the GAO study of the 146 contracts carries the strong implication that the average profit of 56.1% applies to most other defense contracts as well. The GAO claims that defense work is so lucrative because of a device that often removes much of the risk from Pentagon contracting: progress payments, made weekly, for up to 90% of the costs incurred. Progress payments rose from $3.3 billion in 1964 to $10 billion last year. Such payments are a common practice in business, particularly in construction. They amount to interest-free loans that enable contractors to operate almost entirely on the customers' money. In addition, defense contractors often use Government plants and equipment. As of 1967, the Government owned $2.6 billion worth of industrial production machinery; of that amount, 84% was used by 15 companies, including nine of the largest military contractors.

Who Is Right? "In general," says the report, "the higher the costs, the higher the profits," because most Pentagon contracts are cost-plus. There is not much incentive for a company to invest in modern equipment, since greater efficiency might well lower both costs and profits. The report concludes that the amount of capital a company risks should be taken into account when the Pentagon negotiates a contract.

Defense industry spokesmen, who decline to be named, argue that the 146 contracts selected by the GAO are misleading and unrepresentative, partly because none involved competitive bidding. The spokesmen suggest--without saying why--that the GAO's accounting methods are wrong, and they contend that it is impossible to separate profits contract by contract. Who is right? Perhaps no one will ever know. The GAO, which is responsible to Congress, was forbidden by the House Operations Committee in 1965 to name companies or cite specific contracts after it was severely criticized before the committee for being overzealous in its audits. Accordingly, the Defense Department refused to let GAO officials write down any figures from Lockheed's cash flow statement--which usually gives a broad picture of a company's finances--before reporting to Congress this month on $2 billion of cost overruns in producing the C-5A transport aircraft. Congress will have to decide later this year, partly on the basis of the GAO's report, whether to vote Lockheed more money to continue producing C-5As.

The GAO survey of defense profits coincides with the publication of a new book by Richard Kaufman, economist counsel for the Congressional Joint Economic Committee and a longtime critic of military spending. In The War Profiteers (Bobbs-Merrill; $8.50), Kaufman contends that defense contractors have "learned to make large amounts, and in some cases the largest amounts, of their profits practically undetected by old-fashioned auditing methods." They do so, he says, by padding costs, using Government equipment for commercial work, and persuading the Pentagon to cover cost overruns.

Pentagon officials have long conceded that there are bound to be some "horror stories" among the approximately 22,000 contracts that the military services let each year. Kaufman insists that "literally every contract is a horror story." He cites case after case of overruns, from the Gama Goat, an amphibious cargo carrier that cost $304 million more than expected to develop, to the C-5A and General Dynamics' F-111 fighter-bombers, which went up from $4,000,000 to $13.7 million each.

Inflation and Shortage. Defense contractors see the problem in a different light. Lockheed, for example, blames much of its trouble on former Defense Secretary Robert McNamara's Total Package Procurement, under which the company agreed in 1965 to deliver the C-5A four years later at a fixed price. In between came inflation and shortage of parts and machinery during the Viet Nam buildup of the mid-1960s. The result, says a Lockheed spokesman, was "the emergence of catastrophic risk--risk of a magnitude that could bankrupt defense contractors and their subcontractors, and perhaps even threaten the survival of their creditors."

If the GAO and Kaufman have correctly analyzed the military profit machine, there is considerable urgency about reforming the Pentagon's contracting practices. In 1969 alone, the go-ahead signal was given for two new fighter aircraft--the Navy's F-14 and the Air Force's F-15--as well as a new supersonic bomber, several new missiles and torpedoes, a new antisubmarine aircraft, a landing helicopter assault ship, the anti-ballistic missile system (ABM), and a new bomber defense system. Last year the Pentagon requested only $2.2 billion to begin all this work, but it has since added a request for $44 million to allow a start to be made on ULMS (Underwater Long-Range Missile System).

That is only the beginning. Adding up the projected total cost of all these programs over the next decade, and allowing for the now-common increases in the price of new weapons, Pennsylvania Representative William S. Moorhead estimates that the ultimate outlay would run between $161 billion and $176 billion. Whatever the final cost, taxpayers and Congress have a right to be reassured that the money is to be spent with adequate safeguards against waste and excess profits.

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