WAR CONTRACTS
Of all the business activities of the American Government in the
World War, none aroused in the business men of America more interest
or more concern than the Government’s employment of its function of
making contracts with industry for the production and delivery of war
supplies. There is little danger of putting too much emphasis upon
the importance of the war contract. After the declaration of war, the
Government rapidly assumed unprecedented powers over business, until
in the heavy productive months of 1918 it occupied a supreme position.
The War Industries Board had virtually commandeered all important raw
materials and was distributing them at fixed prices. The Government
had become the sole dealer in wool; it was closely regulating the
prices of, and determining priorities in the use of, such commodities
as copper and steel; through the United States Fuel Administration it
was in full control of the production, distribution, and use of fuels;
and its position was equally monopolistic toward all other important
basic materials. Of the labor, the machinery, and the processes which
normally manufactured these materials into the commodities of American
commerce, the Government had become almost the only employer; only now
it had woven these facilities, the industrial facilities of the largest
of industrial nations, into the intricate texture of an arsenal.
Mechanical industry for private enterprise had almost disappeared.
On the day of the armistice the factories of the United States were
working practically as a unit in the production of munitions. While
the Navy, the United States Shipping Board, and the military missions
of the principal Allies were also prosecuting extensive war industrial
projects in America, the War Department alone had entered into some
30,000 contracts directly with builders and producers, these contracts
upon their consummation obligating the Government to pay out a sum in
excess of $7,500,000,000. Of this production, less than half (reckoning
it in money value) had been completed on the day of the armistice.
It follows that the instrument which commanded and set in motion all
this effort--the war contract--must have been a thing exceedingly
important to America. The 30,000 war department contracts, as a body,
constituted in themselves the charter under which the preponderant
part of American industry existed for nearly two years. As wisdom or
unwisdom appeared written into the provisions of the war contracts,
so fared well or badly not only the half of the population directly
associated with industry, but the other half as well, and the
Government, too. As an example, it was charged with some degree of
justice that one great class of war department contracts, the so-called
cost-plus contracts, was the chief factor in the rapidly mounting
cost of living during the war. In other ways also these writings,
which defined the terms of existence for American industry, profoundly
affected every person in the United States. We may leave to lawyers and
economists the discussion of the academic legal questions involved in
the war contracts and still find in them plenty of interest common to
all.
When an individual person goes out to buy anything, he normally
procures it by paying the price fixed by the seller. Business houses,
too, commonly follow this custom in procuring their usual supplies. If,
however, the individual person or business house is going into some
relatively large operation in which he will require goods and services
in extensive quantity, then it is customary to ask for bids from those
in a position to supply the needs, and to contract thereafter with
the concern which offers to supply the goods and services at the best
price. The law requires the Government to follow this procedure in
procuring practically all its supplies. Each federal department must
advertise its needs publicly, giving complete specifications, must call
publicly for bids to supply the materials specified, and must allot
the business to the one tendering the best bid; provided only that the
bidder is responsible and is known to have the ability to produce goods
of the quality desired. The courts have held that a contract written
under any other conditions is void.
The law, however, permits certain exceptions. The War Department,
for instance, is permitted by law to increase the size of a contract
already properly made. It can deal directly, without advertising, with
a manufacturer who is a sole source of supply, provided that previous
advertising has elicited no bids. These exceptions are the reflection
of experience in governing, exceptions granted by Congress to the end
that the Government’s necessary business may not be impeded by the
operation of the legal checks and balances.
Now there was to the federal contracting rule one other exception
which was, for our purposes here, the most important of all. The
law authorized the Secretary of War to enter into contracts without
the formality of advertising and soliciting bids, _in the event
of a national emergency_. We had not yet been a week at war with
Germany when the Secretary of War issued proclamation declaring such
an emergency to exist. His signature to this document swept away
the most serious legal restrictions which circumscribed the War
Department’s contracting powers. The hand of the Department had been
further strengthened by the National Defense Act (passed in 1916),
which empowered the Secretary of War, “in time of war, or when war
is imminent,” to command a manufacturer to produce supplies for the
United States at prices fixed by the War Department itself; and if
the producer refused this arrangement, then the Act empowered the
Secretary to commandeer and take over the producer’s business, paying
the producer, however, a fair and just compensation.
Competition for the Government’s contracts under the normal procedure
would have been fatal to both speed and secrecy in the procurement of
war supplies, and therefore the law wisely permitted the War Department
to abandon competition in the emergency of war. But, with the safeguard
of the competitive bid abandoned, it is reasonable to suppose that the
officers of the War Department, if they were faithful servants of the
public, would seek to protect the Government against the extortioner
by the substitution of other devices not open to the objection either
of delaying the war manufacturing program or of betraying its nature
and extent. And so they did. And although the methods of applying the
protection were numerous, the essence of it was that the contractor
was required by the terms of his contract to produce war supplies at
cost, plus a profit for himself, the profit being reckoned in various
ways. A contract of this sort was known as a cost-plus contract.
Contracts of the normal, older sort, in which the Government dealt with
the lowest bidder or with a producer with whom the law empowered the
federal purchasers to deal directly without competition, were known as
fixed-price or lump-sum contracts.
The cost-plus contract was not entirely unknown to American business
before the war, but it had been employed only sparingly. The war
brought the form into great prominence, since much of the most
important war business was conducted on the cost-plus plan. It is
noteworthy that the form has persisted to some extent in American
private business, and particularly in the building industry, since the
armistice.
Although under the circumstances the cost-plus contract was a necessity
and its advantages were many, nevertheless the form was endowed with an
inherent weakness (from the Government’s standpoint) most difficult to
overcome. In a lump-sum contract the profit of the contractor increased
according as he was able to keep down his costs. If his costs ran too
high, he faced actual loss. In the cost-plus contract of the simplest
form--cost of production, plus a percentage of the cost as profit--it
was just the other way. The higher a producer’s costs, the greater his
profit; and though a producer might not deliberately seek to augment
his costs, yet if he were relieved of the necessity of maintaining
a normal business wariness, bargaining for his raw materials, and
resisting wage advances, the best interests of the Government might not
be served. There is no question that the elementary form of cost-plus
war contract in the early months of the war added considerable impetus
to the procession of higher costs of living, higher wages, and higher
costs again in the vicious circle. It was to retard this tendency, to
add an inducement to the producer to control and keep down his costs,
that the Government evolved the many modifications and refinements of
the cost-plus contract.
At several points in these narratives we have called attention to the
train of evils which followed the attempt of the War Department in
1917 to conduct its enterprise in the production of munitions with
an organization feudal in character and, one might almost say, in
antiquity. Five virtually independent bureaus--the Ordnance Department,
the Quartermaster Department, the Corps of Engineers, the Signal
Corps, and the Medical Department--and, later, after the creation of
the Construction Division, the Air Service, and the Chemical Warfare
Service, eight, set forth to procure their own war supplies as
competitors, each determined to attain its own ends at the expense,
if necessary, of the others. This plan of operation soon drew up near
the edge of disaster, as factories and the more accessible industrial
districts were overloaded with war contracts by the undirected
distribution of the Government’s business, and transportation both on
rail and ocean was nearly throttled by the congestions of freight at
various seaboard and inland terminals.
Here again, in considering the war contracts, we stumble once more
across the trail of this faulty organization. The war contracts
were practically as diverse in their provisions and types as the
Government’s contracting agencies were numerous; and here it should be
noted that some of the main procurement bureaus were in turn subdivided
into smaller purchasing agencies, each of which drew its war contracts
according to its own lights. About all the early war contracts had in
common were the legal provisions protecting the Government against
fraud and graft. There was no such thing as a standard contract, and no
uniformity anywhere. The Government was being obligated in contracts
to the tune of billions by contracting officers almost out of touch
with the responsible heads of the administration.
The Government was soon forced to take cognizance of this state of
affairs. In the spring of 1917 the Secretary of Commerce convened
the so-called Interdepartmental Conference to consider the war
contracts--the first attempt to bring harmony into the confused
business situation. To the conference came the representatives of
the various departments, boards, and administrations interested in
contracts, and to the sessions of the conference also the opponents of
the cost-plus contract brought their objections to it. There were those
who held it almost solely responsible for the great increase in costs
of all sorts during 1917.
It was soon evident to the conferees, however, that the cost-plus
contract had come to stay in the war business, regardless of its
obvious dangers and disadvantages. If an evil, it was a necessary one.
True, the Government could still go into fixed-price contracts for the
procurement of many important war supplies. These were such supplies as
food, clothing, and tools--commodities essentially like those produced
and consumed in time of peace. The producers of these commodities were
not perplexed by costs; their facilities and processes were ready to
begin production; and therefore the War Department could, and did
until the end of hostilities (except when shortages made it necessary
to deal with single responsible manufacturers in order to gain early
deliveries), procure such supplies on fixed-price contracts let after
competitive bidding. But such supplies, although they bulked large
in the cash balance, contributed little to the solution of the main
munitions problem. It was in the production of artillery, of airplanes
and airplane engines, of ammunition, of explosives, even of buildings
in which to house the war department enterprises, that the cost-plus
contract had become a necessity.
There was no way of telling in advance what would be the costs of
producing these more important supplies. Many of them were of types and
designs entirely new to American manufacturing experience. It was hard
enough for the government agents to induce manufacturers to undertake
these contracts even on a cost-plus basis. Had the War Department
attempted to advertise the specifications of such a mechanism as the
French hydropneumatic recuperator, it would never have received a bid.
The only possible terms on which any sane manufacturer would take such
a contract would be the payment of his costs, plus a profit.
Many of the contracts for the more difficult sorts of supplies were
bound to continue over an extended period before all the deliveries
could be made. It was often impossible for such contractors to make
commitments in advance for all their raw materials. Therefore they
faced a rising market and prices which they could not predetermine.
They also faced almost certain increases in the wages paid to their
employees; yet here again they could not anticipate what these
increases would be. The costs of a maker of optical instruments for
the Army depended partially upon what he should have to pay for
optical glass, but the glass was to come from a new war industry
which had not yet begun production and therefore could not estimate
what it would charge for glass. With its designs for war implements
the War Department did the best it could, founding its specifications
upon the latest and best information at its command. Yet so rapid
was the evolution of war materials resulting from their intensive
use that sometimes the Department found a design obsolete before its
production was fairly begun. Its designers therefore made changes in
the specifications at the factory, and these changes involved heavy
manufacturing costs. Every contractor knew that his work was to be
subject to such changes in the specifications; yet no one could
foretell whether changes would be made or what they would cost.
These purely manufacturing considerations were enough in themselves
to explain the prevalence of the cost-plus contracts. Another element
was the time required to prepare specifications and advertise for
bids--time not to be spared in war. But there was still another reason
to account for the cost-plus contract, a reason in war finance,
even more cogent. The successful prosecution of the war meant that
practically the entire industrial equipment of the United States would
have to be devoted to the production of war supplies. Before the war
only large concerns with great financial resources were able to put
through great government projects in which the delivery dates were
far removed from the dates of starting the work. A war contract often
involved a tremendous preliminary expenditure of money in factory
expansion and in commitments for raw materials. The Government’s
practice was to pay for supplies only upon their delivery. Under such
conditions the small manufacturer could not work for the Government. In
normal times, perhaps, the possession of a government contract might
have enabled him to finance his operation through the banks in the
usual way, but with every manufacturer needing special financing, the
effect upon the banks was to make them less liberal in their commercial
loans. The banks had their own solvency to look out for first.
The cost-plus contract proved to be one of the solutions of this
problem. Most of the cost-plus contracts provided that the War
Department could pay the manufacturing costs as they accrued, in
installments. Thus, by securing partial advance payments from the
Government, the small producers, and the large, too, were able to
finance their projects and even to take advantage of the cash discounts
in their purchases of raw materials. Naturally, the War Department was
careful to make such arrangements only with contractors of recognized
probity, men who were deserving of confidence, but who often lacked
working capital to enable them to become successful producers of war
supplies.[6]
The Interdepartmental Conference, far from disapproving or attempting
to abolish the cost-plus contract, recognized its necessity, but
registered a preference for forms of it which best protected the
interests of the people and of the Government. The elemental cost-plus
contract obligated the Government to pay manufacturing costs, plus
an agreed-upon percentage of the costs as profit. Costs included not
only the charges for labor and materials, but also certain overhead
and depreciation charges. This contract form was vicious in principle,
and the Conference did not approve it. Meanwhile various contracting
officers of the Government had been improving the cost-plus contract
with provisions which either removed the tendency for the contractor
to increase his costs or added inducements to him to keep his costs
down. One of these improvements was a cost-plus form providing for a
fixed profit to the contractor, regardless of what his costs might be.
This form removed the incentive to increase costs. A still further
refinement made it of material advantage to a contractor to keep down
his costs and penalized the man who was careless about costs. In this
form the Government agreed to pay all costs and a fixed profit, but the
contract also fixed in advance an estimated unit price for the product,
this price being known as “bogey,” a term borrowed from the ancient
and honorable game of golf. If the contractor succeeded in holding his
costs, plus his fixed profit, under the unit bogey price, he was paid
a share of the saving. If, however, his costs and profits ran above
bogey, then he was penalized a percentage of the excess, the penalty
being subtracted from his fixed profit when the War Department came
to pay for the supplies. This form not only put a premium upon plant
efficiency, but it stimulated the speed of production; for the briefer
the factory processes, the smaller the costs, as a rule, and the sooner
the contractor would get his money. The Interdepartmental Conference
approved both these forms.
This was not yet the desideratum of standardization in contracts, but
it was a step in that direction and perhaps as much as could be done
in an organization as ill-articulated as that of the War Department
then was. The Interdepartmental Conference possessed only advisory
powers, but it was able to establish a policy for the Government in
its contracting function. By pointing to the more desirable forms of
contracts, its report was at least a moral force in securing greater
uniformity in war contracts. It must be remembered, too, that most of
the contracting officers were men of considerable business experience
and ability. Many of the leading business men of the country were
serving the United States either in uniform or as officers of such
agencies as the Council of National Defense and the War Industries
Board, and the procurement bureaus had the benefit of their study and
advice in the making of contracts.
Under such conditions a great volume of war department business was
placed in the latter part of 1917 and during the early months of 1918.
Then the conditions of war industry finally forced a reorganization of
the War Department, bringing all of its supply activities (with one or
two important exceptions) under the single direction of the Division
of Purchase, Storage, and Traffic, of the General Staff. The Division
of P., S., and T., as it was called, was created early in 1918. One
of the first acts of its director was to appoint a committee to study
the various forms of war department contracts in use and to recommend
standard forms which should keep errors at a minimum and make the War
Department certain at all times as to its rights under its contracts.
Simultaneously the new Division was assuming a centralized control of
war department contracts. Early in June the Secretary of War appointed
a Surveyor of Contracts, who in turn appointed a board of contract
review within each procurement bureau. A bureau board was to pass
upon all proposed contracts drawn by contracting officers, except the
few contracts which involved the Government for trivial amounts of
money. This system, with the Surveyor of Contracts dictating policies
and passing them on down through the bureau boards, was effective
control of the contracting function under a single direction; but in
late July the Secretary of War still further strengthened the scheme
by appointing the Superior Board of Contract Review. The Director of
Purchases and Supplies and the Surveyor of Contracts were the general
members of this Board, and each procurement bureau sent to it a
member, who was either the chief procurement officer of the bureau or
a member of the bureau’s board of contract review. This Superior Board
of Contract Review became the great policy-forming agency of the War
Department in respect of its contracting activities.
Note, however, that not yet had there been any standardization of
contracts. In early August the committee appointed by the Director of
Purchase, Storage, and Traffic to study war contracts and recommend
standards, made its report. The Superior Board of Contract Review
received this report, and early in September promulgated, on the basis
of the report, a series of twenty-four standard contract provisions,
nineteen of them to be included in all war department fixed-price and
cost-plus contracts, and five particular provisions pertaining either
to cost-plus or fixed-price contracts, but not to both. Most of the
standard provisions, except perhaps in their phraseology, were not new,
but had been used in substance variously by the contracting officers.
The importance of standardization was that it required the use of all
of them in the war contracts and also dictated the phraseology. One or
two of the standard clauses, particularly those which anticipated the
end of the war and the termination of the war industry, were new and
most important.
The first six provisions dealt with the Government’s obligations to
furnish raw materials and component parts to the manufacturer, with the
packing and marking of supplies, with the changing of specifications
and the Government’s assumption of increased costs or savings wrought
thereby, with inspection, with the storage of finished products at
plants, and with extensions of the time of the contract under certain
conditions.
[Illustration:
_Photo by Signal Corps_
SENDING OUT THE _STARS AND STRIPES_]
[Illustration:
_Photo by Signal Corps_
GRADUATE A. E. F. STUDENTS AT EDINBURGH UNIVERSITY]
The seventh provision anticipated the end of the war by providing
for the cancellation of contracts under certain circumstances, one of
which was if the public interest required it. This was a new thing in
war contracts. The provision set forth the reimbursements which the
contractor should receive in the event of cancellation.
[Illustration:
_Photo by Howard E. Coffin_
REVIEW OF “PERSHING’S OWN REGIMENT” AT COBLENZ]
[Illustration:
_Photo by Signal Corps_
GAMES IN LE MANS EMBARKATION AREA]
The eighth forbade contractors receiving advance payments from
the Government to mortgage or otherwise pledge articles partially
completed. Thus, if the contract were canceled, the Government could
take over the unfinished work without involving itself in a mesh of
legal complications. The next provision dealt with protection of war
plants. The next was the statutory one forbidding the transfer of
contracts.
The eleventh provision dealt with subcontractors, normally not of any
interest to the Government, but in war of vital interest, since the
failure of a subcontractor might greatly delay an entire project, and
since also a cost-plus contract offered an opportunity to a prime
contractor to conspire with a subcontractor to increase costs. The
provision gave the Government full control over the subcontracting and
extended to the subcontractors the Government’s rights of cancellation.
The twelfth was the statutory one forbidding any member of Congress
from sharing in the benefits of a contract, except that a congressman
was permitted to own stock in a corporation accepting war contracts.
The next provision wiped out the horde of fly-by-night commission
brokers who had flocked to Washington to grow rich on commissions
paid by gullible producers who accepted the theory that it took pull
and influence to secure a war contract. Since these commissions went
into the manufacturer’s costs and therefore were paid eventually by
the Government, the Attorney General had issued a ruling forbidding
the government departments to pay manufacturing costs that included
brokers’ commissions. Established selling agencies, however, were
exempted from this rule. The thirteenth standard contract provision
wrote this prohibition into the contracts themselves.
The next provision dealt with indemnifications for the invasion of
patent rights. The fifteenth provided for the settlement of disputes
and claims arising out of questions of performance or nonperformance
under contracts. Later the Board of Contract Adjustment was organized
to fulfill this function. The next three provisions dealt with hours
of labor, the settlement of wage disputes, and the conditions of labor
at war plants. Then came a provision requiring the producer to make
periodic reports of the progress of his work, one defining what costs
would be allowed in a cost-plus contract, one allowing the contractor
to appeal to the Board of Contract Adjustment in the event that a
contracting officer of the Department disallowed costs in excess of
$5,000, one providing for uniformity in contractors’ cost accounting,
one forbidding the payment of wages above current local rates, and a
final provision vesting in the United States the title to all materials
in course of manufacture under a cost-plus contract.
Such were the standard contract provisions, protective and fair to the
Government and the producers alike. They were not adopted until the end
of the summer of 1918, and therefore no important amount of government
business was placed on their identical terms. As stated, however,
most of their requirements in substance had been written into the war
department contracts previously drawn.
The cost-plus contract under which the immense building
construction program of the War Department was carried through
was of a peculiar form, not used elsewhere. It was known as the
cost-plus-with-sliding-scale-and-fixed-maximum-fee contract. The
distinguishing feature of it was that each contractor was paid a
percentage of the cost as profit up to the extent of a fixed maximum
profit, and he could not be paid more than this profit whatever the
cost of the job. The profit percentage diminished on a sliding scale
as the cost mounted. In its latest form this contract paid a profit of
7 per cent to contractors on jobs costing less than $100,000, and the
profit declined gradually in percentage until it reached the low mark
of 2½ per cent paid as profit for work costing more than $9,650,000. No
building contractor, however, could be paid more than $250,000 profit
on a job, whatever its cost; and out of his “profit” he still had to
pay his overhead operating expenses.
In its building program the War Department became one of the largest
employers of labor in the country, and its building contract was
roundly attacked as a chief element in the swift rise in wages. To meet
this attack the Department convened a board of construction engineers
and other experts to study the contract. Instead of condemning the
form of contract, the report of this board endorsed it in unqualified
terms and declared that, if anything, the contract tended to check
extravagances in the work.
While the tendency was all toward the cost-plus-fixed-profit form of
contract, when it came to the production of materials entirely new
and strange to our industry the War Department could not escape the
cost-plus-percentage form. The Government’s powder-bag-loading plants
were operating on the basis of the payment of operating costs, plus 14
per cent. Several of the shell-loading plants worked under contracts
providing for the payment of costs, plus 10 per cent. Silk cartridge
cloth was manufactured at cost, plus 10 per cent as profit. This
profit, as the skill of the cloth weavers increased, was gradually
stepped down to 3 per cent. The Modified Enfield rifles were made at
cost, plus 10 per cent. When the War Department commandeered plants, it
engaged operating companies to run them on a basis of costs paid, plus
a fixed monthly remuneration. Certain patriotic contractors built large
munitions plants for the Government at cost, plus the statutory $1 as
profit.
Then there was the combination contract, adopted for work new to our
industrial experience--a cost-plus form graduating into a fixed-profit
form as the actual work developed what the costs would be. The Browning
machine guns were produced under contracts of this sort.
Contracts for the production of aircraft were not brought under the
centralized administration of war department contracts. The aircraft
contracts provided for the payment of costs by the Government, plus
fixed profits, with bonuses for the producers if they kept under the
estimated costs.