Contract Pricing: Pricing of F-16 Mid-Life Update Program Contracts
(Letter Report, 09/24/96, GAO/NSIAD-96-232).

GAO reviewed the pricing of selected contracts and subcontracts awarded
under the F-16 Aircraft Mid-Life Update (MLU) Program.

GAO found that: (1) the prime contractors proposed and the Air Force
accepted different rates and factors for pricing MLU contracts; (2)
because of the different rates and factors, the European governments'
contract prices were $9.4 million higher; (3) the forward pricing rate
agreement (FPRA) used in the Lockheed Martin MLU contract was the same
FPRA used to price other Lockheed contracts; (4) the Air Force
negotiated two other contracts with Lockheed on the same day as the MLU
negotiation, using lower FPRA rates; (5) the Air Force used a general
and administrative overhead rate for foreign military sales in the
Northrop Grumman contract, rather than a lower domestic rate, thus
increasing the European participants' costs by $1.4 million; (6) Air
Force negotiators conducted the preaward audits of the prime
contractors' price proposals to assist them in negotiating lower prices
for the prime contracts; (7) there are indications that the prime
contractors overpriced material items by as much as $947,000; and (8)
Lockheed awarded the Hazeltine subcontract competitively and the
Honeywell subcontract noncompetitively, using rates and factors
recommended by the U.S. government contract administration activity, and
employing safeguard techniques required by U.S. procurement regulations.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-96-232
     TITLE:  Contract Pricing: Pricing of F-16 Mid-Life Update Program 
             Contracts
      DATE:  09/24/96
   SUBJECT:  Contract administration
             Prime contractors
             Manufacturing contracts
             Department of Defense contractors
             Subcontracts
             Contract costs
             Contract negotiations
             Foreign governments
             Procurement regulation
             Air Force procurement
IDENTIFIER:  F-16 Aircraft Mid-Life Update Program
             F-16 Aircraft
             Belgium
             Denmark
             Netherlands
             Norway
             F-16 Multinational Fighter Program
             
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Cover
================================================================ COVER


Report to the Heads of the National Audit Offices of Belgium,
Denmark, the Netherlands, and Norway

September 1996

CONTRACT PRICING - PRICING OF F-16
MID-LIFE UPDATE PROGRAM CONTRACTS

GAO/NSIAD-96-232

Contract Pricing

(707173)


Abbreviations
=============================================================== ABBREV

  DCAA - Defense Contract Audit Agency
  DOD - Department of Defense
  FPRA - forward pricing rate agreement
  G&A - general and administrative
  MLU - Mid-Life Update
  SAI - Supreme Audit Institutions

Letter
=============================================================== LETTER


B-274243

September 24, 1996

Baron Jerome van de Velde
First President of the Court of Accounts
Belgium

Mr.  Henrik Otbo
Auditor General
Denmark

Mr.  Henk E.  Koning
President of the Netherlands Court of Audit
The Netherlands

Mr.  Bjarne Mï¿½rk-Eidem
Auditor General
Norway

As requested, we reviewed the pricing of selected contracts and
subcontracts awarded under the F-16 aircraft Mid-Life Update (MLU)
program.  The MLU program is designed to develop, produce, and
install upgrades to F-16 fighter aircraft owned by Belgium, Denmark,
the Netherlands, and Norway to improve their performance. 

We determined (1) if the rates and factors used to price two selected
prime contracts were the same as those used to price contemporaneous
U.S.  government contracts, (2) how Air Force negotiation officials
used the Defense Contract Audit Agency's\1 (DCAA) recommendations in
negotiating the prime contract prices, and (3) if the material and
subcontract costs included in the prime contract prices were fair and
reasonable.  Also, as requested, we reviewed the pricing of two
selected subcontracts.  This report does not contain proprietary data
under
18 U.S.C.  1905. 


--------------------
\1 The Defense Contract Audit Agency is responsible for performing
all contract audits for the Department of Defense (DOD) and for
providing accounting and financial advisory services regarding
contracts and subcontracts to all DOD components responsible for
procurement and contract administration. 


   BACKGROUND
------------------------------------------------------------ Letter :1

On June 10, 1975, the U.S.  government executed a Memorandum of
Understanding with the governments of Belgium, Denmark, the
Netherlands, and Norway to produce F-16 aircraft under a program
known as the F-16 Multinational Fighter Program.  Of the 998 aircraft
produced under this program, the U.S.  Air Force purchased 650 and
the European participating governments purchased the remaining 348. 

Under the ongoing MLU program, the Europeans are upgrading their F-16
aircraft by equipping them with new cockpits and avionics systems. 
On behalf of the four European participating governments, the U.S. 
Air Force awarded prime contracts to Lockheed Martin Tactical
Aircraft Systems\2 and Northrop Grumman Corporation\3 valued at
$622.7 million and $106.5 million, respectively, to provide the
aircraft upgrades.  The U.S.  government participated in the
development phase of the MLU program, but it withdrew from the
production phase in November 1992. 

The European countries' Supreme Audit Institutions (SAIs) have raised
a number of issues regarding the pricing of the MLU contracts.  The
U.S.  and European participating governments agreed that they would
"endeavor to establish the same price for the same articles when they
were procured under the same conditions from the same source." Due to
the proprietary nature of the information affecting the negotiation
of the contracts, SAIs are precluded from having access to this
information.  On December 15, 1994, a meeting, involving
representatives from the U.S.  and the European participating
governments, was held during which agreement was reached to provide
assurance that the MLU contract prices were fair and reasonable. 

Among the issues discussed were the rates and factors used to price
the MLU contracts.  According to the minutes of the meeting, the
European representatives were assured that the ".  .  .  rates and
factors that are used for MLU contracts are the same for all other
LFWC [Lockheed Fort Worth Company] F-16 contracts with the U.S. 
Government." Since these rates and factors are proprietary, the
Netherlands representative asked if the United States could provide
certification that the same rates are used on all U.S.  government
contracts.  The Defense Plant Representative Office Commander agreed
to provide the certification and did so on March 24, 1995.\4


--------------------
\2 Formerly known as the Lockheed Fort Worth Company.  The name was
changed to Lockheed Martin Tactical Aircraft Systems as a result of
the merger between Martin Marietta Corporation and Lockheed
Corporation in March 1995. 

\3 Formerly known as Westinghouse Electric Corporation.  Northrop
Grumman Corporation acquired Westinghouse's defense and electronic
systems business in March 1996. 

\4 Defense Plant Representative Offices are located at major
contractor plants and are responsible for carrying out various
contract administration activities, including negotiating rates and
factors. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

The prime contractors proposed and Air Force negotiators accepted
rates and factors to price the two MLU contracts that were different
from those used to price contemporaneous U.S.  government contracts. 
The contract prices for the European participating governments were
$9.4 million higher due to the use of different rates and factors. 

In the case of the Lockheed Martin contract, the Defense Plant
Representative Office Commander certified that the forward pricing
rate agreement\5

(FPRA) rates and factors used to price the MLU contract were the same
as those used to price all other contracts awarded to Lockheed Martin
during the effective period of the agreement.  Despite this
certification, a special set of higher rates and factors was used to
price the MLU contract rather than those called for in the FPRA, thus
increasing the price for the European participating governments by $8
million.  In addition, the Air Force negotiated two other contracts
with Lockheed Martin using the lower FPRA rates and factors on the
same day the MLU contract was negotiated. 

As for the Northrop Grumman contract, Air Force negotiators used a
general and administrative\6 (G&A) overhead rate established for use
in pricing foreign military sales contracts rather than a lower
domestic rate established for pricing U.S.  government contracts.  In
addition, Air Force negotiators used two incorrect rates in pricing
the MLU contract.  These two conditions increased the price to the
European participating governments by $1.4 million. 

DCAA conducted preaward audits of the prime contractors' price
proposals and questioned various costs.  In addition, DCAA reported
large amounts of unresolved costs because audits had not been made of
several subcontractor price proposals.  Except for the rates and
factors used for the Lockheed Martin contract, Air Force negotiators
used DCAA's audit results to assist them in negotiating lower prices
for the prime contracts. 

Lockheed Martin and Northrop Grumman employed safeguard techniques
required by U.S.  procurement regulations\7 to evaluate and negotiate
subcontract and material prices for the prime contracts.  Air Force
negotiators accepted the proposed and negotiated subcontract prices
as fair and reasonable based on the prime contractors' evaluation and
negotiation efforts.  There are indications, however, that material
in the two prime contracts may be overpriced by as much as $947,000. 
We provided this information to the cognizant DCAA offices, and, at
the time we completed our review, they were conducting postaward
audits\8 of the prime contracts. 

As for the two subcontracts selected by SAIs for review (Hazeltine
and Honeywell), Lockheed Martin awarded the Hazeltine subcontract
competitively and the Honeywell subcontract noncompetitively.  In
negotiating the price of the Honeywell subcontract, Lockheed Martin
used rates and factors recommended by the cognizant U.S.  government
contract administration activity and employed the safeguard
techniques required by U.S.  procurement regulations.  The Air Force
accepted the prices of these two subcontracts as fair and reasonable. 


--------------------
\5 A forward pricing rate agreement is a written agreement between a
contractor and the government in which the contractor agrees to make
negotiated rates and factors available during a specified period for
use in pricing contracts. 

\6 G&A overhead includes a wide range of indirect expenses such as
salaries and wages, operating supplies, telephone, insurance, and
maintenance. 

\7 Executive agencies of the U.S.  government are required to follow
a single, uniform regulationï¿½the Federal Acquisition Regulationï¿½in
buying supplies and services.  DOD has issued a supplement to the
Federal Acquisition Regulation containing requirements unique to DOD. 
The supplement is called the Defense Federal Acquisition Regulation
Supplement. 

\8 DCAA conducts postaward audits, in accordance with the Truth In
Negotiations Act (10 U.S.C.  2306a), to determine whether contractors
submitted or disclosed accurate, complete, and current cost or
pricing data to the government prior to reaching contract price
agreement.  The government is entitled to recover overpricing when it
determines that a contractor did not submit or disclose accurate,
complete, and current cost or pricing data.  In the case of the MLU
contracts, the participating governments would directly benefit from
recovery of any overpricing. 


   RATES AND FACTORS USED TO PRICE
   MLU CONTRACTS
------------------------------------------------------------ Letter :3

Lockheed Martin and Northrop Grumman proposed and Air Force
negotiators used rates and factors to price the two MLU prime
contracts that were different from those used to price
contemporaneous U.S.  government contracts.  Also, Air Force
negotiators used two incorrect rates in pricing the Northrop Grumman
prime contract.  These two conditions increased the prime contract
prices by a total of $9.4 million. 


      LOCKHEED MARTIN
---------------------------------------------------------- Letter :3.1

The rates and factors used to price the Lockheed Martin MLU contract
were not the same as those used to price U.S.  government contracts. 
Instead, on December 23, 1994, Lockheed Martin proposed a "special"
set of rates to price the MLU contract rather than using the lower
FPRA rates in effect at that time.  The Air Force used the special
rates in negotiating the MLU contract prices.  This action increased
the contract price by $8 million. 

During the December 1994 working group meeting involving U.S.  and
European representatives, the Defense Plant Representative Office
Commander stated he would certify that the rates used to price the
MLU contract would be the same as those used to price all U.S. 
government contracts.  Subsequently, in a March 24, 1995, written
certification, the Commander stated ".  .  .  that the applicable
FPRA rates and factors used in the MLU program are the same as all
other programs negotiated between the LFWC [Lockheed Fort Worth
Company] and the U.S.  Government." However, contrary to the
Commander's certification, the Air Force negotiated two other
contracts with Lockheed Martin on the same day the MLU contract was
negotiated using lower FPRA rates and factors. 

Neither Lockheed Martin nor the Air Force withdrew from the FPRA that
was in effect at the time the MLU contract price was agreed to.  The
Defense Federal Acquisition Regulation Supplement stipulates that
FPRA rates must be used to price contracts unless waived by the head
of the contracting activity.  No such waiver was requested or
obtained for the special rates used to price the MLU contract. 
Furthermore, there was no evidence in the contract negotiation
records or files that the special rates were audited by DCAA or
approved for use by the Defense Plant Representative Office. 
Lockheed Martin proposed and Air Force negotiators used the lower
FPRA rates to establish the negotiation objective for the contract
price.  Before contract price agreement was reached, however,
Lockheed Martin provided Air Force negotiators the special set of
rates and factors that they accepted and used to price the contract. 

Lockheed Martin officials told us a special set of rates and factors
was required to negotiate the MLU contract because the existing FPRA
was only valid through calendar year 1997.  They explained that the
MLU contract performance period covered calendar years 1993 through
2001 and that rates and factors for the outyears were required.  They
believe that the special rates benefited the MLU customers because a
new FPRA, negotiated shortly after the MLU contract, included higher
rates than those used for the MLU contract. 

In responding to a draft of this report, the Air Force agreed a
special set of rates and factors was used to price the MLU contract,
but it believed the use of those rates and factors was in the best
interest of the European participating governments.  The Air Force
also stated that the Defense Plant Representative Office Commander
signed the certification in good faith, based on his knowledge at
that time, and with full intention of being consistent with the
pricing agreement between the U.S.  and the European participating
governments.  The Air Force further stated that the Defense Plant
Representative Office was negotiating a new FPRA while MLU contract
negotiations were going on and had already offered Lockheed Martin
higher rates and factors than were in the existing FPRA.  The Air
Force pointed out that Lockheed Martin would never have accepted the
lower existing FPRA rates and factors, which covered the period 1993
through 1997. 

We agree that the certification was signed in good faith.  We also
agree that the existing FPRA extended only through 1997 and that
rates and factors were needed to cover the MLU contract performance
period.  However, when changing conditions cause rates in an FPRA to
be no longer valid, defense procurement regulations provide approved
methods for dealing with the situationï¿½either withdraw from the rate
agreement or obtain a waiver from the head of the contracting
activity.  Air Force negotiators did neither.  We found that the
Defense Plant Representative Office had issued recommended rates and
factors covering 1998 and 1999.  Thus, Air Force negotiatorsï¿½using
the existing FPRA and recommended ratesï¿½had rates and factors
covering 1993 through 1999.  According to negotiation records, this
period accounted for 99 percent of the MLU contract value. 
Furthermore, the $8-million increase to the MLU contract is not due
to higher rates and factors for the years beyond the FPRA period. 
Rather, the increase is due to increased rates and factors for 1993
through 1997ï¿½the same period covered by the existing FPRA. 

In addition, the MLU contract awarded to Northrop Grumman for radar
systems encountered the same situation as the Lockheed Martin
contractï¿½that is, it extended beyond the period covered by the
existing FPRA.  However, in contrast to the Lockheed Martin
situation, the Air Force used existing FPRA rates and factors to
price the radar contract.  The contract performance period extended
into the year 2002, while the existing FPRA went through only 1996. 
Northrop Grumman proposed and the Air Force used the existing FPRA
rates and factors and projected these rates and factors over the
remaining contract performance period. 


      NORTHROP GRUMMAN
---------------------------------------------------------- Letter :3.2

Northrop Grumman proposed and the Air Force accepted a G&A overhead
rate established for pricing foreign military sales contracts rather
than a lower domestic rate established for pricing U.S.  government
contracts.  Use of the G&A rate for foreign military sales contracts
increased the MLU contract price by $1.3 million. 

Northrop Grumman officials told us they used the G&A rate for foreign
military sales contracts because of the additional costs in doing
business with foreign customers.  They also stated they were unaware
of any requirement to use the same rates applied to U.S.  government
contracts.  They further stated that such a requirement was not made
known to the corporation in the Air Force's request for proposal or
subsequent contract award. 

In commenting on a draft of this report, the Air Force pointed out
that use of the foreign military sales G&A rate was proper on the
Northrop Grumman MLU contract.  The Air Force advised us that the
contractor could not use and the Air Force could not accept the
domestic G&A rate for pricing the contract because it would be a
misallocation of costs.  The Air Force also pointed out that use of
the foreign military sales G&A rate did not violate the intent or the
spirit of the agreement between the U.S.  and the European
participating governments. 

It should be noted that while the Air Force contends that it would
have been improper to use the domestic G&A rate for pricing the
Northrop Grumman contract, the Air Force used a domestic G&A rate to
price the Lockheed Martin MLU contract.  The Air Force did not
explain this inconsistency. 

In addition to using the higher G&A rate for foreign military sales
contracts, Air Force negotiators used two incorrect rates in pricing
the MLU contract, which caused its price to be increased by $163,600. 
The Air Force concurred that use of the incorrect rates was an
oversight.  In total, the MLU contract price was increased by $1.4
million as a result of using the higher G&A rate for foreign military
sales contracts and two incorrect rates. 


   DCAA AUDIT WORK USED TO
   NEGOTIATE MLU CONTRACTS
------------------------------------------------------------ Letter :4

DCAA conducted preaward audits of both prime contract proposals and
questioned various costs.  DCAA also reported large amounts of
proposed subcontract costs as unresolved because several
subcontractor price proposals had not been audited at the time of its
preaward audits.  Price negotiation memorandums showed DCAA helped
the Air Force evaluate updated contractor proposals during
fact-finding\9 prior to contract price negotiations.  In addition to
making specific recommendations on proposed costs, DCAA also provided
Air Force negotiators with information on deficiencies in the
contractors' estimating systems, material management and accounting
systems, and other operations. 

The price negotiation memorandums clearly show that Air Force
negotiators used DCAA recommendations to assist in establishing
objectives and negotiating lower prices for the two prime contracts. 
The memorandum for the Lockheed Martin contract, for example, shows
DCAA reported a substantial amount of proposed subcontract costs as
unresolved because audits of the subcontracts had not been completed
at the time of DCAA's review.  DCAA reported the same condition for
the Northrop Grumman contract.  Audits of the subcontractor proposals
were subsequently obtained, and Air Force negotiators used the
information in negotiating the contract prices. 

Air Force negotiators also used other DCAA recommendations in
negotiating the prices of the contracts.  On the Northrop Grumman
contract, for example, they extensively used DCAA's recommendations
on proposed material costs.  The price negotiation memorandum showed
Air Force negotiators were able to obtain most of DCAA's recommended
cost reductions for material. 


--------------------
\9 After issuing its preaward audit report, DCAA often helps the
procurement activity review the contractor's updated cost or pricing
data.  This process is called fact-finding and occurs before contract
price negotiations start. 


   REASONABLENESS OF SUBCONTRACT
   AND MATERIAL COSTS
------------------------------------------------------------ Letter :5

We reviewed the fairness and reasonableness of subcontract and
material costs negotiated in the prime contracts because these costs
comprised about 88 percent of the combined negotiated contract
prices.  Subcontracts and material under the Lockheed Martin contract
totaled $572.7 million, or about 92 percent, of the $622.7-million
contract price.  Subcontracts and material under the Northrop Grumman
contract comprised $66.2 million, or about 62 percent, of the
$106.5-million price. 


      SUBCONTRACT COSTS
---------------------------------------------------------- Letter :5.1

For competitively priced subcontracts, we examined the supporting
records and, if adequate competition occurred, we accepted the prices
as fair and reasonable.  For noncompetitively priced subcontracts, we
examined the negotiation records to determine if appropriate
safeguard techniques were used to negotiate the prices. 

At the time of the prime contract price agreement dates, Lockheed
Martin had negotiated firm prices for 10 of its 11 major
subcontracts, and Northrop Grumman had negotiated firm prices for
both of its major subcontracts.  The contractors used the pricing
techniques required by the Federal Acquisition Regulation in
negotiating subcontract prices.  Subcontract files and other records
showed that Lockheed Martin and Northrop Grumman (1) obtained cost or
pricing data,\10 (2) conducted cost analyses,\11 (3) conducted price
negotiations, and (4) and obtained certificates of current cost or
pricing data.\12 The cognizant Defense Plant Representative Offices
also obtained audits from DCAA or the participating governments'
audit agencies of the subcontractor price proposals and provided the
audit reports to Air Force negotiators. 

For the subcontract that was not priced at the time of prime contract
price agreement, Lockheed Martin, as required by the Federal
Acquisition Regulation, obtained cost or pricing data from the
subcontractor and prepared a cost analysis of the subcontract
proposal. 

Air Force negotiators accepted the proposed and negotiated
subcontract prices as fair and reasonable based on the prime
contractors' evaluation and negotiation efforts. 


--------------------
\10 Cost or pricing data consist of all facts existing up to the time
of agreement on contract price that prudent buyers and sellers would
reasonably expect to significantly affect price negotiations.  Cost
or pricing data can be independently verified and consist of such
information as vendor quotations, nonrecurring costs, and information
on changes in production methods. 

\11 A cost analysis is a review and evaluation of a contractor's cost
or pricing data and of the judgmental factors applied in projecting
estimated costs based on the data.  It assesses the individual
elements of a contractor's proposed cost and profit and generally
establishes minimum and maximum target prices for use in subsequent
contract price negotiations. 

\12 In those cases where a subcontractor is required to submit cost
or pricing data, the prime contractor is required to obtain from the
subcontractor a certificate of current cost or pricing data
certifying that to the best of its knowledge and belief, the cost or
pricing data provided were accurate, complete, and current at the
time agreement is reached on the subcontract price. 


      MATERIAL COSTS
---------------------------------------------------------- Letter :5.2

We did not examine material items on the Lockheed Martin contract
because they comprised less than 1 percent of the contract price.  As
for the Northrop Grumman contract, we examined the pricing of
selected material items because material costs comprised about 9
percent of the contract price.  Northrop Grumman used appropriate
safeguard techniques to price material items. 

None of the eight high dollar items we selected for review were
priced at the time of prime contract price agreement.  Northrop
Grumman based its proposed prices for four of the items on supplier
competitive quotations.  Northrop Grumman received multiple
quotations for the four items; therefore, we accepted the competitive
prices as fair and reasonable. 

Northrop Grumman based its proposed prices for the other four items
on noncompetitive quotations, and it conducted price analyses\13 for
the items.  For two of the items, the price quotations fell below the
maximum prices established by the price analyses, and Northrop
Grumman accepted the proposed prices as fair and reasonable. 
Quotations for the other two items were higher than the maximum price
established by the price analyses, and Northrop Grumman
decremented\14 the quotations and submitted the lower prices to Air
Force negotiators. 

During prime contract price negotiations, Air Force negotiators
applied an additional decrement against the proposed prices for all
eight items. 

There are indications that material is overpriced by as much as
$947,000 under the two prime contracts because the prime contractors
did not provide government negotiators with accurate, complete, and
current data available for the items at the time of the contract
price agreement dates.  We provided this information to the cognizant
DCAA offices, and they are reviewing material prices in both prime
contracts to determine the extent of overpricing.  The amount of
overpricing may change as DCAA continues its review. 


--------------------
\13 A price analysis is the process of examining and evaluating a
proposed price without evaluating its separate cost elements and
proposed profit.  A price analysis may be done, for example, by
comparing current quotations with prior prices paid for the same or
similar items or with independently developed estimates. 

\14 Decrement means to reduce the proposed price of an item by a
percentage.  Contractors normally are able to negotiate prices lower
than their vendors initially quote; therefore, the decrement is a
technique used to adjust the proposed price of an item to account for
an anticipated reduction in price as a result of negotiations. 


   PRICING OF TWO MLU SUBCONTRACTS
------------------------------------------------------------ Letter :6

As requested, we reviewed the pricing of the subcontracts Lockheed
negotiated with Hazeltine for the advanced identification friend or
foe system and with Honeywell for the color multifunction display
system.  The Hazeltine subcontract was awarded on a competitive
basis, while the Honeywell subcontract was awarded on a
noncompetitive basis. 


      HAZELTINE
---------------------------------------------------------- Letter :6.1

The subcontract awarded to Hazeltine was competed between Hazeltine
and three other vendors.  Lockheed Martin subjected the responsive
proposals to a technical evaluation, management evaluation, risk
analysis, and cost evaluation and determined that Hazeltine had the
lowest risk approach with the highest probability of successful
completion.  Hazeltine was the only supplier that proposed to meet
all of the technical requirements.  Lockheed Martin concluded
Hazeltine's proposed price was fair and reasonable and awarded the
subcontract.  Air Force negotiators also accepted the subcontract
price as fair and reasonable. 


      HONEYWELL
---------------------------------------------------------- Letter :6.2

Lockheed Martin used the same safeguard techniques in negotiating the
Honeywell subcontract that are required to be used in negotiating
subcontracts under U.S.  government prime contracts.  There was not
an FPRA with Honeywell at the time the subcontract price was
negotiated; however, recommended rates and factors\15 had been issued
for Honeywell contracts.  Lockheed Martin used the recommended rates
and factors in negotiating the subcontract price.  Air Force
negotiators accepted the negotiated price as fair and reasonable. 


--------------------
\15 Forward pricing rate recommendations contain rates and factors
established unilaterally by the administrative contracting officer
for use by government negotiators when FPRA rates and factors are not
available. 


   AIR FORCE AND CONTRACTOR
   COMMENTS
------------------------------------------------------------ Letter :7

Air Force and contractor officials reviewed a draft of this report
and their comments have been incorporated in the text where
appropriate.  Their comments are presented in their entirety in
appendixes I, II, and III. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

SAIs selected two prime contracts for review.  The first prime
contract involved the letter contract the Air Force awarded to
Lockheed Martin on August 17, 1993.  The contract provides for the
production of modification kits to upgrade the cockpit and avionics
systems on the F-16 aircraft.  The Air Force and Lockheed Martin
agreed on the contract price on April 21, 1995, and the final
contract was signed on June 13, 1995.  The second prime contract
involved a letter contract the Air Force awarded to Northrop Grumman
on December 3, 1993.  The contract provides for the production of
modification kits for the AN/APG-66(V)2 fire control radar.  The Air
Force and Northrop Grumman agreed on the contract price on July 15,
1994, and the final contract was signed on September 27, 1994. 

SAIs also selected two subcontracts for review.  Both were awarded
under the prime contract to Lockheed Martin.  The first involved the
subcontract Lockheed Martin awarded to Honeywell (purchase order 354)
on
October 30, 1995, for the production of the F-16 color multifunction
displays.  The second involved the subcontract Lockheed Martin
awarded to Hazeltine (purchase order 4XU) on September 24, 1993, for
the production of the advanced identification friend or foe combined
interrogator/transponder system. 

To determine whether the rates and factors used to price the two MLU
prime contracts were the same as those used to price U.S.  government
contracts, we reviewed Air Force negotiation records to identify the
rates and factors used for the MLU contracts.  We then compared the
MLU rates and factors to those included in FPRAs and forward pricing
rate recommendations in effect at the time the MLU contracts were
negotiated.  Where differences were identified, we determined the
effect on contract prices.  We performed similar work on the
Honeywell subcontract.  We discussed the rates and factors with
contractor, Air Force, DCAA, and Defense Plant Representative Office
officials. 

To determine how Air Force officials used DCAA audit recommendations
in negotiating prices for the prime contracts, we reviewed the DCAA
preaward audit reports and recommendations.  We evaluated contract
negotiation records to determine how Air Force negotiators used
DCAA's work in establishing negotiation objectives and negotiating
the contract prices.  We discussed the use of the audit
recommendations with DCAA and Air Force officials. 

To determine whether subcontract and material costs included in the
contract prices were fair and reasonable, we compared the pricing
safeguard techniques used by the contractors with those required by
the Federal Acquisition Regulation and the Defense Federal
Acquisition Regulation Supplement.  We verified that, when required,
the contractors obtained cost or pricing data, conducted cost or
price analyses, carried out negotiations with subcontractors and
vendors, and obtained certificates of current cost or pricing data. 
We also determined whether DCAA or audit agencies of the European
participating governments made audits of the subcontractor price
proposals.  In addition, we examined negotiation records for the
subcontracts and material items and discussed them with contractor
and Air Force officials. 

We performed our work between May and August 1996 in accordance with
generally accepted government auditing standards. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Secretaries of Defense
and the Air Force; the F-16 System Program Director; the Director,
Defense Contract Audit Agency; the Commander, Defense Contract
Management Command; and the Chief Executive Officers of Lockheed
Martin and Northrop Grumman Corporations.  Copies will be made
available to others upon request. 

If you or your staff have questions about this report, please contact
me at (202) 512-4841 or David E.  Cooper at (202) 512-4587.  Major
contributors to this report are listed in appendix IV. 

Louis J.  Rodrigues
Director, Defense Acquisitions Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE AIR FORCE
============================================================== Letter 



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)




(See figure in printed edition.)Appendix II
COMMENTS FROM LOCKHEED MARTIN
============================================================== Letter 



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)




(See figure in printed edition.)Appendix III
COMMENTS FROM NORTHROP GRUMMAN
============================================================== Letter 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C. 

David E.  Cooper, Associate Director

ATLANTA FIELD OFFICE

George C.  Burdette, Evaluator-in-Charge
Maria Storts, Evaluator
Erin B.  Baker, Evaluator

DALLAS FIELD OFFICE

Joe D.  Quicksall, Assistant Director
Jeffrey A.  Kans, Evaluator
Kimberly S.  Carson, Evaluator


*** End of document. ***