On June 28, 2011, the Project on Government Oversight (POGO) reported that, “taxpayers were massively overcharged in dozens of transactions between the Army and Boeing for helicopter spare parts,” based on a DOD Inspector General audit report that POGO had obtained. The DOD IG report had been issued in redacted (edited) form on the IG website, but POGO had obtained a 154-page unredacted version which it published at this link. POGO reported that—

Overall, for 18 of 24 parts reviewed, the DoD OIG found that the Army should have only paid $10 million instead of the nearly $23 million it paid to Boeing for these parts—overall, taxpayers were overpaying 131.5 percent above “fair and reasonable” prices. The audit says Boeing needs to refund approximately $13 million Boeing overcharged for the 18 parts. Boeing had, as of the issuance of the audit, refunded approximately $1.3 million after the DoD OIG issued the draft version of its report. Boeing also provided a ‘credit’ to the Army for another part for $324,616.

That sounds pretty bad, doesn’t it? If the above paragraph weren’t damning enough, POGO also provided another link to even more examples of “spare parts ripoffs” allegedly perpetrated by Boeing. Examples reported by POGO included—

• A “straight pin” (NSN 5315-00-823-8682) which the Defense Logistics Agency (DLA) would have charged the Army $0.04 each, but for which Boeing charged the Army $71.01.

• A “spur gear” used in a Chinook helicopter (NSN not provided) which the DLA would have provided to the Army for $12.51 each, but for which Boeing charged $623.74.

Et cetera, et cetera. As the POGO article summarized—

… in case after case examined by the DoD OIG, the Army was buying parts for much more money from Boeing that DLA already had in its inventory at significantly lower prices. In some cases, Boeing bought parts from DLA (one part of DoD) and resold them at a higher price to the Army (another part of DoD). From 2007 to 2009, Boeing bought $3.1 million in parts from DLA and sold them to the Army for $4.2 million.  ‘[B]ased on the data Boeing provided us, Boeing made a 35 percent profit on the parts that it bought from DLA,’ the audit report states.

Certainly, the POGO report sounded pretty bad. We decided to first review the (redacted) DOD IG report that was intended to be made available to the public, a copy of which we provide here.

The first thing we noticed was that the DOD IG aimed much of its criticism at the Army itself, and not at Boeing. The audit report stated—

AMCOM officials did not effectively use $339.7 million of existing DoD inventory before procuring the same parts from Boeing because DoD had inadequate policies and procedures addressing inventory use. We identified $242.8 million to $277.8 million of excess inventory that AMCOM could use to satisfy CCAD contract requirements.

The DOD IG report continued—

AMCOM officials did not effectively negotiate prices for 18 of 24 high-dollar parts reviewed because neither AMCOM officials nor Boeing officials performed adequate cost or price analyses, and Boeing officials submitted cost or pricing data that were not current, complete, and accurate … . [Because of those lapses] [w]e calculated that Boeing charged the Army about $13 million or 131.5 percent more ($23 million versus $10 million) than fair and reasonable prices for the 18 parts.

The DOD IG audit report also stated—

… AMCOM officials did not use the most cost-effective source of supply for consumable items because DoD had not developed an effective material management strategy. We identified that the Defense Logistics Agency (DLA) had sufficient inventory to satisfy annual contract requirements for 1,635 parts on the follow-on contract, and the Boeing contract price for those items was $8.0 million, or 51.2 percent, higher than the DLA price.

Okay. From the foregoing we can see that Boeing’s conduct was far from perfect and that its actions deserve criticism. But from what we saw, the DOD IG’s target was AMCOM and the findings centered on AMCOM’s ineffective management of its contractor. It seems to us that the POGO allegations treated the DOD IG’s report as if it were a DCAA report—i.e., an audit of Boeing’s contract—instead of being an audit of the Army’s contractor management. In support of our assertion, we noted that the DOD IG’s recommendations for process improvement were largely focused on AMCOM and not on Boeing.

So the real story is not that Boeing “ripped-off” the U.S. Army. No, the real story is that AMCOM didn’t effectively manage Boeing and, more specifically, AMCOM didn’t source—or direct Boeing to source—parts from internal DLA stockpiles, and permitted Boeing to reprocure items at a higher (and completely unnecessary) cost.

That said—and as we noted previously—Boeing’s conduct was apparently far from being above reproach. The unredacted DOD IG report asserted that—

• Boeing did not use adequate cost or price analysis to establish the reasonableness of proposed subcontractor prices.

• Boeing’s pricing data was based on low-volume quantities—e.g., quantities of one or two or three items, which were allegedly based on “outdated” historical use data that had “no relationship to the quantities [actually] required or the actual price Boeing negotiated with its subcontractors.” Allegedly, Boeing routinely failed to share pricing/quantity discounts that it obtained from subcontractor negotiations with its customer.

• For seven parts audited, Boeing’s cost or pricing data allegedly was not accurate, current, or complete—resulting in “defective pricing” for those parts.

As the result of such alleged behavior, the DOD IG concluded that “Boeing charged the Army about $13 million … more than the fair and reasonable prices” for 18 parts audited.

A couple of concluding thoughts on this matter.

First, defective pricing is a serious concern and, where Boeing was subject to the Truth-in-Negotiations Act (TINA) then its AMCOM customer has recourse to obtain unilateral price reductions plus interest on any overpayments. That said, we don’t know all the circumstances. For example, what quantities was Boeing told to bid on? If AMCOM told Boeing to bid on quantities of one or two or three items each, then that’s what Boeing was required to do. And if Boeing had the business acumen to negotiate volume pricing discounts with its subcontractors then (assuming no defective pricing) there was absolutely no requirement for Boeing to pass on those savings. If AMCOM wanted to share in savings Boeing negotiated, then it shouldn’t have awarded a Firm, Fixed-Price (FFP) contract type to Beoing.

Second, we were interested in the DOD IG methodology for determining what prices Boeing should have charged AMCOM. In the unredacted report, the DOD IG states that its methodology was to add 34 percent to Boeing’s actual direct costs incurred, so as to account for “overhead, general and administrative costs, and the negotiated profit rate.” Well. We certainly don’t know Boeing’s business model, but that strikes us as a ludicrously low number. Take away 15 percent for profit and you have 19 percent to cover overhead (including payroll taxes, fringe benefits, facilities and utilities, etc.) and G&A (including allocations from local, sector, and corporate management. We would be very, very surprised to learn that those values represented Boeing’s true indirect cost rates for this effort.

So to conclude, there seems to be quite a bit of blame to throw at the various entities. As the DOD IG did. We didn’t even mention the IG’s criticism of DCMA’s Contractor Purchasing System Review (CPSR) of Boeing’s Philadelphia operation or the fact that one of the recommendations from the IG audit report was that DCMA should categorize Boeing’s purchasing system as “high risk”. And we didn’t get into the IG’s criticism of the Contracting Officer for failing to heed DCAA’s problems with Boeing’s proposal(s).

Glossing over the DOD IG’s questionable methodology, it seems pretty clear that AMCOM did not have much of a clue. Boeing apparently submitted a (partially) defectively priced proposal—either by customer direction or through its own lax procedures. But as usual, the situation was more complex and nuanced that POGO’s “knee-jerk” headline would lead the casual reader to believe.