Demobilization

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.

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.

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.