Hearings

For a year past, the U.S.-flag berth lines and MSTS have been in dispute or uncertainty as to whether rates under the MSTS shipping contracts were fair and reasonable. To help resolve that dispute, the Federal Maritime Commission has carried forward an elaborate investigation, FMC docket 65-13. For their part, the carriers in all the principal trades have produced searching cost studies which broke new ground in steamship accounting. These studies indicate that MSTS rates are substantially less than the commercial rates on comparable goods.

On April 4, 1966, a witness for the Department of Defense announced in FMC docket 65-13 a new policy for the carriage of defense cargoes. This would be done under contracts procured by competitive bidding by the individual lines or, in cases where this was not feasible, by individually negotiated contracts. The commander, Military Sea Transportation Service, has recently declared his intention to open bids and have the system in operation by July 1.

The steamship industry believes that any such system spells disaster to the industry and will preclude the Department of Defense traffic agencies from accomplishing their mission. They summarize their position as follows:

1. The effect on the lines: (a) For nearly a century, without known exception, rate competition among ocean steamship berth lines has always produced a rate war in which rates were driven far below costs.

(b) This uniform history is not an accident, but results from the fact that over 75 percent of the costs of a berth operation are fixed, so that any return over the 25 percent of variable costs is better than free-space. In the case of the FIO defense cargoes, about 83 percent of the costs are fixed.

(c) The MSTS cargo represents close to half of the outbound cargoes carried by the U.S.-flag lines on the principal MSTS trade routes. None of the lines on those routes can do without this cargo.

(d) Under a competitive bidding system, each line will in normal times be forced to bid low enough to insure that it obtains at least its share of this indispensable cargo, with the inevitable and classic result of bids below fully distributed costs and approaching the added costs of cargo handling and vessel loading time costs for the MSTS cargoes.

(e) The apparently proposed absence of restriction upon bidders will in all likelihood stimulate the formation of transient steamship lines which will offer low bids for selected routes when vessel charter rates are low and desert the damaged trade when these rates rise.

(f) The unsubsidized lines will be forced to abandon U.S.-flag service almost immediately after the return to a normal period of excess tonnage. The subsidized lines could hang on longer, but with up toward half their cargoes carried at a loss their eventual survival would be equally doubtful.

2. The effect on MSTS: (a) MSTS has often enough indicated its need for berth services and for fast modern ships. There will be no vessel replacement for services conducted at a loss, and MSTS would sooner or later be forced into sole dependence upon its own fleet. The costs, we believe all agree, would greatly exceed those resulting from use of the berth lines.

(b) MTMTS, which is responsible for Department of Defense traffic management and terminals, was opposed last September to any system of competitive rate bidding on the ground that it could not discharge its function if it had to deal with line-by-line routes, rates and priorities. It was not consulted on the Department of Defense policy announced on April 4.

(c) The Department of Defense negotiates with rate bureaus, not individual roads, to obtain railroad rates. It accepts the CAB determinations for fair rates for military cargoes and personnel. The steamship industry, with its unvarying history of destructive rate wars whenever rates are fixed by competition, would seem the last, not the first, transportation industry in which to procure rates by competition.

(d) For 15 years past, the berth lines have felt themselves obliged to meet all MSTS requests, whether or not the voyage would produce a loss and whatever their competing obligations to commercial shippers. One simply cannot expect an MSTS contract holder, who obtained his contract by competitive bidding below the cost of service, to be willing to take on costly obligations beyond the perimeter f his contract. Negotiations and special costs will replace automatic and unompensated compliance with special requests.

(e) At this moment, something of a rarity in steamship history, the lines are not short of cargoes. In 1966, but not as a rule, we should expect a sharp increase in MSTS freight rates if competitive bids are substituted for continuing contracts. Senator BREWSTER. We will also include in the record Senator Magnuson's letter to Secretary McNamara of May 4 of this year. For the purposes of clarification, I want to read two paragraphs from the chairman's letter to the Secretary of Defense:

I enclose for your information a copy of S. 3297 which I have just introduced, along with a copy of my explanatory statement which I made on the floor of the Senate. I should hope that the Department of Defense will, at our May 9th and 10th hearings, be prepared to make full comment on this bill and to give full explanation of its proposed competitive bidding procedures.

It seems to me of first importance that the Department delay institution of its new procedures until the Congress has had an opportunity to consider the basic issues of policy which are involved. The system of uniform, Government-fixed rates for defense cargoes has been in use for the past twenty years. Hearings have been expedited so that this system can be continued for another few months while the Congress considers the matter.

(The letter follows:)

MAY 4, 1966.

DEAR MR. SECRETARY: I need not reiterate our concern that this Nation should have as strong and as effective a merchant marine as may be possible. The Congress has for half a century proceeded upon the assumption that this goal could not be achieved, at least for the berth liner or common carriers, if their rates were fixed by unrestrained competition. Accordingly, the Shipping Act, 1916, authorized conference rate making and P.L. 87-346 in 1961 authorized dual rate contracts in order to make conference rate-fixing effective.

The current proposal of the Department of Defense to ship defense cargoes under a competitive bidding system is viewed by the steamship industry with the utmost alarm. I am not at this point prepared to say that the competitive bidding proposal is right or wrong. I am, however, entirely clear that it presents an issue of basic policy which should be considered and evaluated by the Congress.

I should be very glad to have as prompt advice as may be feasible that the Department will delay inauguration of the proposed competitive bidding system until the Congress has had an opportunity during the present session to carefully consider the matter.

Sincerely yours,

WARREN G. MAGNUSON, Chairman. Senator BREWSTER. Our first witness this morning will be the Honorable Robert C. Moot, Deputy Assistant Secretary for Logistics, Department of Defense.

Mr. Moot, we welcome you here. We are very glad you are able to give us your time. In your remarks, sir, I would appreciate it if you would address yourself to Senator Magnuson's request that your new procedures be withheld until Congress has a chance to look into this. Please go ahead.

STATEMENT OF ROBERT C. MOOT, DEPUTY ASSISTANT SECRETARY OF DEFENSE (LOGISTICS SERVICES), INSTALLATIONS AND LOGISTICS; ACCOMPANIED BY MARVIN H. MORSE, ASSISTANT COUNSEL, OFFICE OF COUNSEL, DEPARTMENT OF DEFENSE

Mr. Moor. Thank you, Mr. Chairman. I am here today at your request to comment for the Department of Defense on S. 3297, a bill "to authorize the carriage of military cargoes by U.S. flag vessels at reduced rates which are fair and reasonable." In introducing this bill, requested by major carriers, it was recognized that the Department intends to actively seek price competition in the procurement of ocean freight services and the committee was so advised in a letter from the Department dated April 2, 1966. Because our analysis of S. 3297 was made against the background of this decision to seek price competition, I would like to discuss briefly the considerations that led the Department to such a conclusion prior to commenting specifically on the provisions of S. 3297.

The Department of Defense through its operating agency, the Military Sea Transportation Service, is procuring commercial ocean freight services at an annual rate of more than $400 million in shipping costs. Approximately 50 percent of these ocean freight shipments move in berth or liner service. Rates applicable to these shipments for the most part are negotiated between MSTS and carrier organizations which have been granted antitrusts immunity by the Federal Maritime Commission pursuant to section 15 of the Shipping Act of 1916.

Procurement of ocean transportation service to move the above mentioned volume of cargo has been for all practical purposes on a sole source basis. No price competition is involved. Rates have been negotiated with the intent of excluding costs such as brokerage fees and cargo handling expense which are not applicable to the movement of military cargo to the same extent as such expense is involved in the movement of cargo for commercial shippers.

The legislative requirement that the armed services procure transportation services only from U.S. ships stems from the act of April 28, 1904, which, as revised and codified as section 2631 of title 10, United States Code, provides as follows:

Only vessels of the United States or belonging to the United States may be used in the transportation by sea of supplies bought for the Army, Navy, Air Force, or Marine Corps. However, if the President finds that the freight charged by those vessels is excessive or otherwise unreasonable, contracts for transportation may be made as otherwise provided by law. Charges made for the transportation of those supplies by those vessels may not be higher than the charges made for transporting like goods for private persons.

The contract law in force at the time of the passage of the Cargo Preference Act of 1904 made it mandatory for the Army and Navy to utilize the transportation provided by the company submitting the lowest bid. The effect of the 1904 law was to restrict bidding to U.S. shipowners. Therefore, the opening of competition to foreign shipowners is not at issue in connection with the newly announced change in Department of Defense procurement practice; neither is the question of world conference of United States and foreign flag carriers directly involved.

Overall armed services purchasing techniques were revised as a result of the Armed Services Procurement Act of 1947 which provides that all Department of Defense procurements shall be by formal advertising with the exception of 17 numbered instances where negotiation is permitted. In procuring ocean contract carriage services by negotiation, the Military Sea Transportation Service has been utilizing exception No. 10 which permits other than formal advertising when "the purchase or contract is for property or services for which it is impracticable to obtain competition." MSTS has traditionally negotiated for ocean common carriage under exception No. 17 which permits other than formal advertising when authorized by law; the law relied on by MSTS is 49 U.S.C. 65(a), as interpreted by the Comptroller General. It is clear that the exceptions which permit negotiation are permissive and not mandatory. Regardless of such exceptions, the major intent of the Armed Services Procurement Act of 1947 was that procurement be conducted on a competitive basis to the maximum practicable extent.

The policy of the Armed Services Procurement Act was outlined by the President in his statement to the Secretary of Defense upon the signing of that bill. He stated, in part, at that time:

This bill grants unprecedented freedom from specific procurement restrictions during peacetime. That freedom is given to permit the flexibility and latitude needed in present day national defense activities. The basic need, however, remains to assure favorable price and adequate service to the Government. To the degree that restrictions have been diminished, therefore, responsibility upon the defense establishment has been increased. There is danger that the natural desire for flexibility and speed in procurement will lead to excessive placement of contracts by negotiation and undue reliance upon large concerns, and this must not occur.

Directly pertinent to the procurement of transportation services are the objectives outlined in the 1962 Presidential message to the Congress relative to the transportation system of the United States wherein the President stated

The basic objective of our Nation's transportation system must be to assure the availability of fast, safe, economical transportation services needed in a growing and changing economy to move people and goods, without waste or discrimination, in response to private and public demands at the lowest cost consistent with health, convenience, national security, and other broad public objectives ***. This basic objective can and must be achieved * * * under the incentives of private profit and checks of competition to the maximum extent practicable.

In keeping with the legislative intent of Congress the Defense Department, for all goods and services, has since 1961 been steadily increasing the proportion of procurement contracts awarded on a competitive basis in contrast with what is for all practical purposes a sole source basis. Since the beginning of fiscal year 1961 the percentage of price competitive contracts has been increased from 33 percent in 1961 to over 43 percent of the total value of awards. Savings accrued through the first half of fiscal year 1966 from this shift in more than $4 billion in annual procurement funds are estimated to amount to now $1 billion per year. As related to commercial maritime operations, Secretary McNamara, in 1962, expressed himself as feeling very strongly that the fundamental premise on which we develop our transportation programs must be that the incentives of private profit and

the checks of competition be used to the maximum extent practicable. The decision to seek price competition in the acquisition of ocean freight services, is therefore, consistent with the overall objectives of the Department.

Early in 1965 a new steamship line initiated service between the U.S. east and gulf coast and Europe/United Kingdom at rates substantially below shipping contract rates then in effect. Other steamship lines subsidized and non-subsidized-met the competition of this new line. The effect of the rate reduction on MSTS ship space cost was significant. In the case of MSTS general cargo the space rate was reduced by more than 25 percent.

This successful experience with price competition in the acquisition of ocean freight service occurred during a period when the Department was reviewing its procurement practice in this area. August the background of clear legislative intent and a positive management objective to secure maximum competition in procurement, the Department's review of all available data led to the inescapable conclusion that the introduction of price competitive procurement was timely, feasible, and potentially beneficial to all parties.

In the implementation of this revised practice for procurement of ocean freight services, it is important to understand that the Department of Defense considers it is in a unique customer relationship with the shipping industry. By law, all military cargo must move on U.S.flag ships when they are available which means that the world's largest volume shipper has constraints under national policy as to the scope of carriers it can use. It is against this background of a single, large volume shipper dealing exclusively with U.S.-flag operators that competitive price procurement procedures will be developed.

These are the considerations which led the Department to the conclusion that price competition should be actively sought. The provisions of S. 3297 have been analyzed with these considerations in mind, As a result of this analysis, the Department of Defense is opposed to the enactment of this bill for the following reasons.

PROPOSED SECTION 45

Subsection (f) would establish a mandatory preference for commion carrier berth operators over other American-flag operators. The result would be to deny Department of Defense cargoes to a substantial segment of the American-flag shipping industry. The Department of Defense needs all segments of the U.S. merchant marine and all segments should be given fair opportunities to carry defense cargoes. In addtion, this section would require the Department of Defense to use the most costly method of transporting military cargoes.

Subsection (f) calls for establishment of a mandatory allocation system which would eliminate the operational flexibility of the Department to employ prudent management in its operations.

Subsection (a) would authorize carriers to negotiate rates for carriage of defense cargoes which are less than those prescribed in their commercial tariffs. Nothing in existing law prevents the Department of Defense from obtaining lower rates and it has been the exception rather than the rule for the Department of Defense to pay commercial tariff rates.

66-769-66- -2

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