The Spare Parts Rip-Off

General Dynamics Corporation tried to bill the Pentagon $9,609 for a tiny wrench worth 12 cents in a hardware store, and $7,417 for a 3-inch length of wire that an electronics store was willing to give away free. Boeing Corporation actually sold the Pentagon a plastic cap that fits on an airplane stool for $1,118, while the Defense Department bought a part from Pratt & Whitney that increased in price 442 percent between the time the part was ordered and its delivery date.

These stories and many others have surfaced in recent months, prompting a steady stream of investigations by Congress, the General Accounting Office, the Small Business Administration, and the Pentagon itself. In probing for the root causes of such massive overspending, most investigations point to the close relationship between the Pentagon and large, or prime, military contractors, and the relatively weak influence of parts suppliers.

With massive financial and administrative resources and strong influence in defense circles, a handful of large military contractors dominate Pentagon spending (see table, p.8). But these companies, makers of heavy military equipment such as aircraft (Boeing and Pratt & Whitney), naval ships (Litton Industries and Todd Shipyards), and radar (McDonnell-Douglas), also purchase and distribute parts made by subcontractors, which range from the giant Western Electric to small firms. For example, Pratt & Whitney, the largest producer of aircraft engines, buys 80 percent of the parts it sells to the Pentagon from such firms.

The prime contractors take advantage of their relations with suppliers in a number of ways:

• Direct Mark-ups. The prime contractors claim that the mark-up price - some-times as much as 50 percent or more-covers their service costs; a claim that in some cases is true. But as Frank Miller of the Small Business Administra tion notes, it is "hard to justify a 900 percent mark-up" in cases where the part was shipped directly from the subcontractor's plant to the military, with the prime contractor never having seen the part. Even "reasonable" mark-ups are inflated, he says, when the fact that the Pentagon can purchase directly from the parts manufacturer is considered.

• Political Muscle. Prime contactors will often use their considerable prestige and influence with the Pentagon to secure control over contracts for parts. Companies have been known to intimidate lowand middle-rank Pentagon employees into dealing only with them by claiming that other companies cannot produce quality parts. If their advice is disregarded, they might complain to the employees' supervisors.

• Withholding Information. As one review by the Defense Department's Inspector General's office found, prime contractors often refuse to provide lists of their parts producers. Thus the agency does not know which firms produce the parts it orders and cannot contact them directly.

• Design Rights. Companies may claim patent-style rights over the design of parts they develop. Tom Amlie, a financial officer with the U.S. Air Force who reviewed this problem for the Pentagon, says that companies often claim such rights even when the Pentagon "paid every penny of development costs." Without design information, Pentagon engineers cannot show potential competitors what they need.

• Contract Loopholes. Until recently, a number of contracts allowed companies the option of covering costs unexpected at the time of order by jacking up the price of the article upon delivery. For example, a part that Pratt & Whitney originally estimated to cost $277 was delivered to the Pentagon door bearing a pricetag for $1,308-a 372 percent increase. In response to recent protest, Defense Secretary Caspar Weinberger directed the Pentagon to phase out this contract provision in July 1983.

• Bullying the Small Guys. Some prime contractors even threaten to cut off business or sue subcontractors if they contract directly with the Pentagon.

This situation is little helped by Pentagon personnel. Investigations by both the General Accounting Office and the Deputy Inspector General of the Defense Department have found that Pentagon personnel fail to question large contractors' claims of control over part designs and seldom seek competitive bids on a contract. Open competition occurs for only one percent of all expenditures on spare parts, the Inspector General's report found.

Air Force officer Tom Amlie believes all of this happens because Pentagon buyers work under a "backward" system of incentives. "We rate our buyers on how many [purchases] they process-in effect, how much money they spend, instead of how much they save," he says.

The large corporations agree that there is an overpricing problem, but shift the blame onto the Pentagon. In particular, they highlight the Pentagon's practice of buying parts in small, uneconomical quantities. This is the "largest single reason for prices higher than [the part's] value," said Malcolm Stomper, president of Boeing Corporation. "It's a mistake to say that companies have been greedy," says George Weiss of Boeing. "Pratt & Whitney has not overcharged the government," says Jim Linse, spokesperson for that company. And, he emphasizes, "prices mark-up are determined by specifically negotiated contracts with the government, not unilaterally or arbitrarily."

But a report by the Small Business Administration helps to estimate the magnitude of the problem. The report studied 1,410 parts which were sold to the Pentagon by corporations, and then opened to competitive bidding with parts suppliers' participation. The new contracts resulted in savings of $24.5 million. Thus for the total 4.1 million types of parts ordered by the Department of Defense, billions of dollars are being needlessly spent.

Over the years, the Pentagon has sponsored in-house programs to challenge overpricing. But since these programs have been largely ineffective, the Pentagon is making new efforts to respond to public criticisms of military spending. New personnel have been hired in order to increase direct contracting with parts suppliers and to encourage competition in general. Lately, the Department of Defense and a few companies have been offering rewards of $1,000 or more to buyers who find lower prices.

Whether these programs will be effective remains an open question. Whistle blowers within the defense industry or the Pentagon ,have not been treated kindly in the past. At a November 14 congressional subcommittee hearing, two Pentagon employees criticized the military bureaucracy for its inability to police prime contractors. "You can beat up on the little guys, but it's not considered good form to beat up on the giant contractors," said A. Ernest Fitzgerald, who was fired from the Pentagon after disclosing huge cost overruns on the Lockheed C5A cargo plane in 1969. Fitzgerald was reinstated in his job last year after a prolonged legal battle.

One group that could gain from a more careful scrutiny of the spending practices of military contractors is the International Association of Machinists and Aerospace Workers (IAM), the union that represents most defense industry workers. According to IAM research director Reginald Newall, last year the Pentagon instructed the prime contractors to reduce overcharges by keeping labor prices down-a move the IAM "strongly resisted." "We told them to look for the real price cutting areas in these overruns," he said.

But to many American taxpayers, the issue goes beyond price savings to the enormous level of military spending. As Tom Schlesinger, author of a recent study on military production in the southern U.S., put it, "The question is not merely one of big versus small business, but good versus bad business."