Overhead Costs

Senior Pentagon officials have expressed concern that contractor overhead rates may drive up procurement costs as a result of declines in Defense Department spending. Declining defense spending since the late 1980s has reduced sales by defense contractors and has reduced the business bases against which they charge overhead. This report reviews (1) initiatives taken by six individual business units of large defense contractors--General Dynamics, General Motors, Lockheed, Martin Marietta, McDonnell Douglas, and United Technologies--to reduce overhead costs and (2) the issue of whether the units' actions would avoid increases in overhead rates.

GAO found that: (1) declining defense spending since the late 1980s has resulted in reduced sales by defense contractors and a concurrent reduction in the business bases against which they charge overhead; (2) at the six business units GAO visited, for instance, sales declined by an average of 39 percent between the peak years and 1993 and were projected to fall by an average of 55 percent between the peak years and latest projected years; (3) however, in response to their declining business bases, the business units had taken action to reduce their overhead costs; (4) specifically, the six units reduced their overhead costs by an average of 35 percent between their peak years and 1993 and were anticipating on average a total reduction of 53 percent between their peak years and latest projected years; (5) to reduce overhead costs, the business units had taken measures such as reducing the number of indirect employees, cutting employee health care benefits, consolidating facilities, and reducing independent research and development and bid and proposal expenditures; (6) despite these efforts, overhead costs at four of the six business units were not declining as rapidly as their sales; thus, these units were forecasting increases in their overhead rates; (7) one unit, for example, was projecting the overhead rate to increase by 17 percent in real terms between 1993 and 2001, meaning that the business unit charged $1.50 in overhead costs for every one dollar in direct labor in 1993, but will charge $1.76 in overhead costs for every one dollar in direct labor by 2001; and (8) unless these four business units can identify additional cost reductions or increase their sales, their overhead rates will continue to rise, a condition that could result in increased procurement costs.