The most important matter adjusted in the conferences of Mr. Cramp with Mr. Whitney was the arrangement of the form of contract so that it might be, within a narrow margin, flexible or elastic. The operation of other contracts had clearly shown the need of such modification, and a solution was reached without difficulty, though not without much deliberation.
The matter under immediate consideration was the form of contract for the “Baltimore.” The guarantee to be required was that her engines should develop a mean of 9000 collective indicated horse-power for four consecutive hours, a lower or minimum limit being also prescribed. They had before them the form of contract for the Roach ships.
Mr. Cramp remarked that the guarantee for the “Baltimore” was 9000 indicated horse-power.
“Suppose, Mr. Secretary,” he said, “that we should use that form of contract, and the engines of the ‘Baltimore’ should develop only 8999 indicated horse-power, what could you do?”
“Well, Mr. Cramp, under this form of contract, construed according to law, I could not accept her. There ought to be a way of averting such a possibility. What can you suggest?”
Mr. Cramp then proposed to apply to our naval contracts the principle often recognized in agreements for construction of merchant steamships and also in the naval contracts of foreign governments, namely, a sliding scale of penalties for deficiency in performance, with a minimum limit; and, in case the ship should prove unable to reach the minimum limit after a fair number of trials, the owner (if a merchant vessel) or the government (if a naval ship) might at will either reject her altogether or accept her under a supplemental agreement. Mr. Cramp also explained the usual basis upon which penalties for deficiency were computed and imposed in our own merchant practice and in foreign navies.
The Secretary assented to this suggestion, and pronounced it the only business-like plan for solution of the difficulty he had heard. But he said that, in order to make the arrangement perfectly equitable, there should be a premium for excess over and above guaranteed performance, corresponding to or commensurate with the penalty for deficiency.
These discussions led to the adoption of what became known as the premium system. Some time afterward, when Mr. Whitney was before the Naval Committee, the subject came up, and one member referred to it as “a bonus to contractors.”
“If you use the word ‘bonus’ in the sense of a gift,” said the Secretary, “it is a misapprehension. It is part of an equitable transaction. Performance is a prime element of value in a ship-of-war. We stipulate in our contracts for a specific performance. We consider the guaranteed performance as representing the normal value of the ship. If upon trial the performance falls below the normal, it reduces the value of the ship to that extent, and we meet it with proportionate penalties deducted from the contract price. But if upon trial the performance exceeds the normal, the value of the ship is increased, and we propose to meet such cases with premium proportionate to the excess of guaranteed performance. In either case we simply pay for as good a ship as we get, be it above or below the normal. It is a poor rule that won’t work both ways.”
Mr. Whitney’s terse observations embodied the whole logic of the penalty and premium system, and his argument was so conclusive that no further discussion seemed to be desired. The system remained in effect nearly ten years, and was applied to every vessel built for the new navy up to and including the “Iowa” and “Brooklyn.” Every ship built by Mr. Cramp earned a premium for excess of either indicated horse-power or speed. None of his ships exhibited deficiency. The list is rather interesting, because it exhibits more graphically than any other method could do the actual extent to which the contract requirement was exceeded in each case.