The case for the $435 hammer - investigation of Pentagon's procurement

Washington Monthly, Jan, 1987 by James Fairhall

the CASE FOR THE $435 HAMMER

"You want how much for abeer?!' asks the patron of a bar in the cartoon strip "Motley's Crew.'

"Four bucks,' the bartender replies.

Says the patron: "That must be the same outfitthat sells hammers to the Pentagon.'

Claw hammers, to be exact. The kind you buyat your local hardware store for between $7 and $10; billed to the Pentagon for $435 a piece. In the three years since the story broke, the $435 hammer has become synonymous with waste in the Department of Defense (DOD). From Beetle Bailey to Walter Mondale, everyone has expressed outrage at this apparent swindle. The hammer contract has been investigated by Congress, discussed during the 1984 presidential debates, and used as Exhibit A by politicians, journalists, and businessmen in their recent calls for military reform.

But here's the rub: the DOD didn't pay $435for a hammer. It's a good bet we paid too much for it (for reasons related in part to something called the equal allocation method and in part to larger problems in defense procurement). But the Pentagon didn't pay nearly $428 too much.

Hints of a rip-off

In 1981 the Navy decided to offer a sole-sourcecontract to the electronics company that manufactured the flight instrument trainer for the T-34C aircraft. That made the Simulation Systems Division of Gould, Inc., the lone provider of a comprehensive list of more than 400 different parts needed to keep trainers in the field in good repair. In June 1982, the Naval Training Equipment Center (NTEC) at Orlando, Florida, issued the contract. Of the items ordered, some were peculiar to the trainer and would have to be manufactured by Gould; others, known as "buy-and-sell items,' could be bought at an ordinary hardware store. Since the Gould plant is located on Long Island, the job of reviewing and negotiating Gould's proposal fell to the Defense Contract Administration Services Management Area (DCASMA) in Garden City, New York.

An outpost of the Defense Logistics Agency,DCASMA Garden City does a variety of tasks for the buying offices of the military. A man whom I shall call Dave Johnson, an administrative contracting officer there, was put in charge of the proposal. In November, his negotiating team brought Gould's price down from $896,011 to $847,000. This came close to the recommended price resulting from reports by an engineer, a price analyst, and a Defense Contract Audit Agency (DCAA) auditor. Johnson submitted his memo of negotiation and a contractual amendment to the Garden City Board of Review, whose five members saw nothing wrong with it. Then, after Gould had signed the amendment, he too signed it, making it legal and binding. The price it showed for the claw hammer was $435.

Why did no one protest? Because the equalallocation formula makes line item prices meaningless. Under this system the line item price does not reflect the item's true value. The equal allocation method calculates prices for large numbers of items in a contract by assigning "support' costs such as indirect labor and overhead equally to each item. Take a contract to provide spare parts for a set of radar tracking monitors. Suppose a monitor has 100 parts and support costs amount to a total of $100,000. Using the equal allocation method each part is assigned $1,000 in such costs, even though one item may be a sophisticated circuit card assembly, which requires the attention of high-salaried engineers and managers, and another item may be a plastic knob. Add $1,000 to the direct cost of the part and you get a billing price. This is what the government is billed, though not what the part is really worth--the circuit card being undervalued, the knob being overvalued. The need for billing prices arises because contractors want to be paid up front for items that are shipped earlier than others.

The problem with the equal allocation methodis that it's easier for contractors to overstate support costs when negotiating one price for all of these costs in a contract instead of haggling over them for each individual line item. And if the Pentagon doesn't know the real price it is paying for each spare part, it is also difficult for it to determine whether it is spending too much in support costs.

Few people are familiar with the price distortionscreated by this method. When the chief petty officer in the repair department of a naval air station in Florida saw the unit-price list for the T-34C trainer in 1983, he started asking how anyone in his right mind could have paid $435 for a common hammer. His inquiries led to press stories and investigations by a number of agencies including the Navy Audit Service which, on May 27, reported that the Gould contract contained "excess costs of about $729,000.'

These investigations led the Pentagon to announceon July 27 that Gould had overcharged the Navy "hundreds of thousands of dollars' for the hammer and other items under the same contract. Secretary of the Navy John Lehman sent a letter to Gould demanding repayment, and Secretary of Defense Caspar Weinberger gave notice that the DOD had to make "major changes' in its procurement of spare parts.