Defense Acquisitions
Improved Management Practices Could Help Minimize Cost Growth in Navy Shipbuilding Programs Gao ID: GAO-05-183 February 28, 2005The U.S. Navy invests significantly to maintain technological superiority of its warships. In 2005 alone, $7.6 billion was devoted to new ship construction in six ship classes--96 percent of which was allocated to four classes: Arleigh Burke class destroyer, Nimitz class aircraft carrier, San Antonio class amphibious transport dock ship, and the Virginia class submarine. Cost growth in the Navy's shipbuilding programs has been a long-standing problem. Over the past few years, the Navy has used "prior year completion" funding--additional appropriations for ships already under contract--to pay for cost overruns. This report (1) estimates the current and projected cost growth on construction contracts for eight case study ships, (2) breaks down and examines the components of the cost growth, and (3) identifies any funding and management practices that contributed to cost growth.
For the eight ships GAO assessed, the Congress has appropriated $2.1 billion to cover the increases in the ships' budgets. The GAO's analysis indicates that total cost growth on these ships could reach $3.1 billion or even more if shipyards do not maintain current efficiency and meet schedules. Cost growth for the CVN 77 aircraft carrier and the San Antonio lead ship (LPD 17) has been particularly pronounced. Increases in labor hour and material costs together account for 77 percent of the cost growth on the eight ships. Shipbuilders frequently cited design modifications, the need for additional and more costly materials, and changes in employee pay and benefits as the key causes of this growth. For example, the San Antonio's lead ship's systems design continued to evolve even as construction began, which required rebuilding of completed areas to accommodate the design changes. Materials costs were often underbudgeted, as was the case with the Virginia class submarines and Nimitz class aircraft carriers. For the CVN 77 carrier, the shipbuilder is estimating a substantial increase in material costs. Navy practices for estimating costs, contracting, and budgeting for ships have resulted in unrealistic funding of programs, increasing the likelihood of cost growth. Despite inherent uncertainties in the ship acquisition process, the Navy does not account for the probability of cost growth when estimating costs. Moreover, the Navy did not conduct an independent cost estimate for carriers or when substantial changes occurred in a ship class, which could have provided decision makers with additional knowledge about a program's potential costs. In addition, contract prices were negotiated and budgets established without sufficient design knowledge and construction knowledge. When unexpected events did occur, the incomplete and untimely reporting on program progress delayed the identification of problems and the Navy's ability to correct them.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-05-183, Defense Acquisitions: Improved Management Practices Could Help Minimize Cost Growth in Navy Shipbuilding Programs
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Report to the Chairman, Subcommittee on Defense, Committee on
Appropriations, House of Representatives:
United States Government Accountability Office:
GAO:
February 2005:
Defense Acquisitions:
Improved Management Practices Could Help Minimize Cost Growth in Navy
Shipbuilding Programs:
GAO-05-183:
GAO Highlights:
Highlights of GAO-05-183, a report to the Chairman, Subcommittee on
Defense, Committee on Appropriations, House of Representatives:
Why GAO Did This Study:
The U.S. Navy invests significantly to maintain technological
superiority of its warships. In 2005 alone, $7.6 billion was devoted to
new ship construction in six ship classes”96 percent of which was
allocated to four classes: Arleigh Burke class destroyer, Nimitz class
aircraft carrier, San Antonio class amphibious transport dock ship, and
the Virginia class submarine.
Cost growth in the Navy‘s shipbuilding programs has been a long-
standing problem. Over the past few years, the Navy has used ’prior
year completion“ funding”additional appropriations for ships already
under contract”to pay for cost overruns. This report (1) estimates the
current and projected cost growth on construction contracts for eight
case study ships, (2) breaks down and examines the components of the
cost growth, and (3) identifies any funding and management practices
that contributed to cost growth.
What GAO Found:
For the eight ships GAO assessed, the Congress has appropriated $2.1
billion to cover the increases in the ships‘ budgets. The GAO‘s
analysis indicates that total cost growth on these ships could reach
$3.1 billion or even more if shipyards do not maintain current
efficiency and meet schedules. Cost growth for the CVN 77 aircraft
carrier and the San Antonio lead ship (LPD 17) has been particularly
pronounced.
Increases in labor hour and material costs together account for 77
percent of the cost growth on the eight ships. Shipbuilders frequently
cited design modifications, the need for additional and more costly
materials, and changes in employee pay and benefits as the key causes
of this growth. For example, the San Antonio‘s lead ship‘s systems
design continued to evolve even as construction began, which required
rebuilding of completed areas to accommodate the design changes.
Materials costs were often underbudgeted, as was the case with the
Virginia class submarines and Nimitz class aircraft carriers. For the
CVN 77 carrier, the shipbuilder is estimating a substantial increase in
material costs.
Components of Cost growth:
[See PDF for image]
[End of figure]
Navy practices for estimating costs, contracting, and budgeting for
ships have resulted in unrealistic funding of programs, increasing the
likelihood of cost growth. Despite inherent uncertainties in the ship
acquisition process, the Navy does not account for the probability of
cost growth when estimating costs. Moreover, the Navy did not conduct
an independent cost estimate for carriers or when substantial changes
occurred in a ship class, which could have provided decision makers
with additional knowledge about a program‘s potential costs. In
addition, contract prices were negotiated and budgets established
without sufficient design knowledge and construction knowledge. When
unexpected events did occur, the incomplete and untimely reporting on
program progress delayed the identification of problems and the Navy‘s
ability to correct them.
What GAO Recommends:
GAO is making recommendations aimed at improving the Navy‘s processes
for developing cost estimates, establishing realistic contract prices
and ship budgets, and providing timely and complete reporting on
program costs to alert managers to potential problems.
www.gao.gov/cgi-bin/getrpt?GAO-05-183.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Paul Francis at (202) 512-
2811 or francisp@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
New Ships Continue to Cost More Than Budgeted:
Labor and Materials Drive Increases in Construction Costs:
Navy Funding and Management Practices Result in Insufficient Provision
for Risk:
Conclusions:
Recommendations:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Arleigh Burke Class Destroyer:
Program Description:
Cost Experience on DDG 91 and DDG 92:
Main Drivers of Cost Growth for DDG 91 DDG 92:
Appendix III: Nimitz Class Aircraft Carrier:
Program Description:
Cost Experience on CVN 76 and CVN 77:
Main Drivers of Cost Growth for CVN 76 and CVN 77:
Appendix IV: San Antonio Class Amphibious Transport Dock Ship:
Program Description:
Cost Experience on LPD 17 and LPD 18:
Main Drivers of Cost Growth for LPD 17 and LPD 18:
Appendix V: Virginia Class Submarine:
Program Description:
Cost Experience on SSN 774 and SSN 775:
Main Drivers of Cost Growth for SSN 774 and SSN 775:
Appendix VI: GAO's Forecast of Additional Costs to Complete
Construction Contracts:
Appendix VII: Comments from the Department of Defense:
Appendix VIII: GAO Contacts and Staff Acknowledgments:
Tables:
Table 1: Overview of Navy Shipbuilding Programs Represented in GAO's
Case Studies:
Table 2: Shipbuilding Budget Cost Categories:
Table 3: Growth in Program Budgets for Case Study Ships:
Table 4: GAO's Forecasts of Additional Cost Growth for Construction:
Table 5: Growth in Labor Hour Costs:
Table 6: Reasons Given by Shipbuilders for Labor Hours Cost Growth:
Table 7: Growth in Material Costs:
Table 8: Reasons Given by Shipbuilders for Material Cost Growth:
Table 9: Growth in Overhead Costs and Labor Rates:
Table 10: Reasons Given by Shipbuilders for Overhead and Labor Rate
Cost Growth:
Table 11: Target Prices for Case Study Ships:
Table 12: Characteristics of Case Study Ships:
Table 13: Major Events in the Acquisition of DDG 91 and DDG 92:
Table 14: Growth in Program Budgets for Case Study Ships:
Table 15: Growth in Labor Hour Costs:
Table 16: Growth in Overhead Costs and Labor Rates:
Table 17: Growth in Material Costs:
Table 18: Major Events in the Acquisition of CVN 76 and CVN 77:
Table 19: Growth in Program Budgets for Case Study Ships:
Table 20: GAO's Forecasts of Additional Cost Growth for Construction:
Table 21: Growth in Material Costs:
Table 22: Growth in Labor Hour Costs:
Table 23: Historical Man-hours Used to Produce Prior Ships Compared to
CVN 76 Negotiated Man-hours:
Table 24: Growth in Overhead Costs and Labor Rates:
Table 25: Major Events in the Acquisition of LPD 17 and LPD 18:
Table 26: Growth in Program Budgets for Case Study Ships:
Table 27: GAO's Forecasts of Additional Cost Growth for Construction:
Table 28: Growth in Material Costs:
Table 29: Growth in Labor Hour Costs:
Table 30: Growth in Overhead Costs and Labor Rates:
Table 31: Major Events in the Acquisition of SSN 774 and SSN 775:
Table 32: Growth in Program Budgets for Case Study Ships:
Table 33: GAO's Forecasts of Additional Cost Growth for Construction:
Table 34: Growth in Material Costs:
Table 35: Growth in Labor Hour Costs:
Table 36: Growth in Overhead Costs and Labor Rates:
Figures:
Figure 1: Typical Production Times for Various Weapon Systems:
Figure 2: Components of Cost Growth:
Figure 3: GAO and Shipbuilder Construction Cost Growth Forecasts for
Case Study Ships:
Figure 4: Arleigh Burke Class Destroyer:
Figure 5: Average Sources of Cost Growth on DDG 91 and DDG 92:
Figure 6: Nimitz Class Aircraft Carrier:
Figure 7: Average Sources of Cost Growth on CVN 76 and CVN 77:
Figure 8: San Antonio Class Amphibious Transport Dock Ship:
Figure 9: Average Sources of Cost Growth on LPD 17 and LPD 18:
Figure 10: Virginia Class Submarine:
Figure 11: Average Sources of Cost Growth on SSN 774 and SSN 775:
Figure 12: SSN 774 Lead Ship Labor Hour Growth:
Figure 13: Comparison of Shipbuilders' and GAO's Forecasts of
Additional Construction Costs for Six Classes of Ships Actively under
Construction:
United States Government Accountability Office:
Washington, DC 20548:
February 28, 2005:
The Honorable C. W. Bill Young:
Chairman, Subcommittee on Defense:
Committee on Appropriations:
House of Representatives:
Dear Mr. Chairman:
U.S. Navy warships are the most technologically advanced in the world.
The United States invests significantly to maintain this advantage. In
2005 alone, the Navy devoted $7.6 billion to new ship construction in
six ship classes--96 percent of which was allocated to four classes:
Arleigh Burke class destroyer, Nimitz class aircraft carrier, San
Antonio class amphibious transport dock ship, and the Virginia class
submarine.
Cost growth in the Navy's shipbuilding programs has been a long-
standing problem--one that the Congress has identified and responded to
by providing both additional funding and direction to the Navy. Over
the past few years, the Navy has used "prior year completion" funding-
-additional appropriations for ships already under contract--to pay for
cost overruns. Because of the size and routine occurrence of prior year
funding, we were asked to analyze cost overruns on Navy shipbuilding
programs. Specifically, this report (1) estimates the current and
projected cost growth on selected ship construction contracts, (2)
breaks down and examines the components of the cost growth, and (3)
identifies any funding and management practices that contribute to cost
growth.
To address these objectives, we looked at cost growth in the four
classes of ships that account for the majority of the funding for new
shipbuilding and prior year bills, focusing on ships with construction
contracts that were more than 30 percent complete at the time we began
our review. Within each class, we selected two ships currently under
contract as case studies: DDG 91 and DDG 92 in the Arleigh Burke class
of destroyers, CVN 76 and CVN 77 in the Nimitz class of aircraft
carriers, LPD 17 and LPD 18 in the San Antonio class of transports, and
SSN 774 and SSN 775 in the Virginia class of submarines. To estimate
the total projected cost growth on construction contracts, we used
contractor performance reports, projecting high and low estimates for
the costs to complete the ships in the four classes we reviewed. We
looked at cost growth by comparing the initial budget request to the
Congress and the updated budget included in the 2005 President's budget
and by comparing the initial contract award to the latest estimate at
completion. The latest estimate at completion includes changes to the
original baseline or scope of work. For all ships currently under
construction, we also estimated total cost growth since contract award,
using contractor performance reports to project high and low estimates
for the costs to complete construction of these ships. To break down
and examine the components of cost growth on the eight case study
ships, we analyzed the Navy's cost estimates, its budget requests to
the Congress, contractor performance reports, and other cost data for
each of the eight case study ships. To assess funding and management
practices, we spoke with the shipbuilders, Navy and Defense Contract
Audit Agency officials, and reviewed supporting documentation. Our work
was conducted between July 2003 and December 2004 in accordance with
generally accepted government auditing standards. Our analyses and
forecasts were based on data available to us in July 2004. To the
extent significant changes occurred, we incorporated information from
the fiscal year 2006 President's budget. For a complete description of
our scope and methodology, see appendix I. Details on the eight case
study ships are discussed in appendixes II to V.
Results in Brief:
The Navy's shipbuilding programs continue to experience significant
cost growth. For the eight case study ships alone, the Congress has
appropriated funds to cover a $2.1 billion increase in the ships'
budgets. Cost growth was pronounced for the CVN 77 carrier and for the
lead ships in the two new classes we looked at--the Virginia class and
especially the San Antonio class. We estimated cost growth could exceed
$3 billion, and these estimates are likely understated because they
assume that the shipyards will maintain their current efficiencies and
meet scheduled milestones. Thus, additional appropriations, in excess
of $1 billion, will be needed to cover the additional cost growth.
Increases in labor hour and material costs account for 78 percent of
the cost growth on the eight ships we reviewed, while overhead and
labor rate increases account for 17 percent. Navy-furnished equipment-
-including radars and weapon systems--represent just 5 percent of the
cost growth. Shipbuilders cited a number of direct causes for the labor
hour, material, and overhead cost growth in the eight ships. The most
common causes were related to design modifications, the need for
additional and more costly materials, and changes in employee pay and
benefits. For example, the lack of design maturity when introducing new
technologies led to rework, increasing growth in labor hours for most
of the ships. The design of ship systems for LPD 17 continued to evolve
even as construction proceeded. As a result, workers were required to
rebuild completed areas of the ship to accommodate design changes.
Growth in materials costs was due, in part, to the Navy's and
shipbuilders' underbudgeting of these costs. For example, the
materials' budget for the first four Virginia class submarines was $132
million less than quotes received from vendors and subcontractors at
contract award. Price increases also contributed to the growth in
materials costs.
Navy practices for estimating costs, contracting, and budgeting for
ships have resulted in unrealistic funding of programs, increasing the
likelihood of cost growth. Despite inherent uncertainties in the ship
acquisition process, the Navy does not measure or provide for the
probability of cost growth when estimating costs. Moreover, the Navy
did not conduct independent cost estimates for carriers, which could
have provided decision makers with additional knowledge about a
program's potential costs. In addition, contract prices were negotiated
and budgets established without making full use of design knowledge and
construction experience. Finally, when unexpected events occurred, the
incomplete and untimely reporting on program progress delayed the
identification of problems and the Navy's ability to correct them.
We are making seven recommendations aimed at improving the Navy's
processes for developing cost estimates, establishing realistic
contract prices and ship budgets, and providing timely and complete
reporting on program costs to alert managers to potential problems. In
its comments on a draft of this report, DOD concurred with two of our
recommendations and partially concurred with five. We believe the Navy
needs to take concrete action to establish realistic estimates, prices,
and budgets and to improve the quality of cost reporting.
Background:
The U.S. Navy currently operates 288 surface ships and submarines. Four
ship classes, with 23 ships under construction or recently completed,
make up 96 percent of the Navy's fiscal year 2005 budget for new
construction shipbuilding. (See table 1.)
Table 1: Overview of Navy Shipbuilding Programs Represented in GAO's
Case Studies:
Ship class: Arleigh Burke destroyer;
Mission: Destroyers provide offensive and defensive capabilities; can
operate independently or as part of strike groups;
Percent of Navy's fiscal year 2005 new construction and prior year
shipbuilding budget[A]: 46%;
Ships under construction or recently completed: 13;
GAO's case study ships[B]: * DDG 91 (follow-on ship); * DDG 92 (follow-
on ship).
Ship class: Nimitz aircraft carrier;
Mission: Nuclear-powered aircraft carriers form building block of
Navy's forward-deployed peacetime presence, crisis response, and
warfighting forces;
Percent of Navy's fiscal year 2005 new construction and prior year
shipbuilding budget[A]: N/A[C];
Ships under construction or recently completed: 2;
GAO's case study ships[B]: * CVN 76 (follow-on ship); * CVN 77 (follow-
on ship).
Ship class: San Antonio amphibious transport dock ship;
Mission: These amphibious ships provide a sea-based platform for
transporting, embarking, and landing Marines and their equipment and
supplies during an assault;
Percent of Navy's fiscal year 2005 new construction and prior year
shipbuilding budget[A]: 14%;
Ships under construction or recently completed: 5;
GAO's case study ships[B]: * LPD 17 (lead ship); * LPD†18 (follow-on
ship).
Ship class: Virginia class submarine;
Mission: This new class of nuclear submarines is designed to combat
enemy submarines and surface ships; fire cruise missiles at land
targets; and provide improved surveillance and special operations
support;
Percent of Navy's fiscal year 2005 new construction and prior year
shipbuilding budget[A]: 36%;
Ships under construction or recently completed: 4;
GAO's case study ships[B]: * SSN 774 (lead ship); * SSN 775 (lead ship).
Sources: Navy (data); GAO (presentation).
[A] Including completion of ships authorized in prior years:
[B] A lead ship is the first to be built in a class or the first to be
built after a major redesign of a class of ships. If two different
shipbuilders are constructing ships that fall within the same class,
their first ships are also referred to as lead ships. Follow-on ships
are those built after the lead ship.
[C] Not applicable. CVN 76 and CVN 77 were funded in earlier fiscal
years and are not included in these percentages.
[End of table]
Navy ships are complex defense systems, using advanced designs with
state-of-the-art weapons, communications, and navigation technologies.
Ships require many years to plan, budget, design, and build. Like other
weapon acquisition programs, ship acquisitions begin with developing a
system design. For ships, system design is followed by a detail design
phase where specific construction plans are developed. Ship
construction follows and typically takes 4 to 7 years. Construction
time for other defense systems is much shorter--a fighter aircraft
takes about 2 years from start of production to roll out from the
factory floor; a tank takes about a year. (See fig. 1.)
Figure 1: Typical Production Times for Various Weapon Systems:
[See PDF for image]
Note: A varying number of years of preliminary planning and early
design work precede the start of production.
[End of figure]
The long construction times increase the uncertainty that ship cost
estimates--and budgets--must provide for. Moreover, the total cost for
a ship must be budgeted for in its first year of construction.
Provisions are made in the event cost growth occurs during
construction. The Navy's budgeting for cost growth has changed over the
past 2 decades. During the early 1970s and through most of the 1980s,
the Navy used program cost reserves built into ship construction
budgets and the Ship Cost Adjustment process to manage cost growth.
During the 1980s, the Navy procured an average of 17 ships each year.
In fiscal year 1988, the Navy removed program cost reserves from ship
construction budgets and began exclusively using the Ship Cost
Adjustment process, shifting funding between shipbuilding construction
programs underrunning cost to programs that were overrunning costs.
Following the end of the Cold War, the Navy decreased the procurement
rate of ships to about 6 per year. Beginning in fiscal year 1999, cost
increases could no longer be covered using the Ship Cost Adjustment
process because no shipbuilding program was under cost. In 2001, the
process was eliminated, which required the Navy to fund cost growth
through the current mechanism of prior year completion bills.
Components of Shipbuilding Costs:
The cost of building a ship can be broken down into four main
components: labor, material, and overhead associated with the
shipbuilders' contract for the basic ship, and Navy-furnished
equipment--that is, items purchased by the Navy and provided to the
contractor for installation on the ship. (See table 2.) The
shipbuilding contract also includes profit (referred to as
fee).[Footnote 1]
Table 2: Shipbuilding Budget Cost Categories:
Construction: Labor: Labor hours for production, engineering and other
direct support;
Costs based on labor hours and the labor rate (the hourly wage paid to
workers);
Construction: Materials[A]:
* Metals (steel, copper, titanium);
* Tools;
* Miscellaneous parts (pipe, cables);
* Subcontracts;
Construction: Overhead[A]:
* Medical insurance;
* Pensions;
* Holiday pay;
* Facilities maintenance and utilities;
* Taxes;
Navy-furnished equipment:
* Items purchased by the Navy and provided to the shipbuilder for
installation on the ship;
items include ship weapon systems, propulsion equipment, and
electronics.
Sources: Shipbuilder and Department of Defense (data);
GAO (analysis).
[A] List is not exhaustive.
[End of table]
Types of Shipbuilding Contracts:
Two broad categories of contracts are used to procure ships: fixed-
price and cost-reimbursement. Fixed price contracts provide for a firm
price or an adjustable price with a ceiling price, a target price, or
both. If the ceiling is reached the shipbuilder is generally
responsible for all additional costs. Cost reimbursement contracts
provide for payment of allowable incurred costs, to the extent
prescribed in the contract. If the ship cannot be completed within
agreed upon cost limits, the government is responsible for the
additional costs to complete.[Footnote 2]
The level of knowledge, or certainty, in the cost estimates for a ship
is key to determining which type of contract to use. Contracts for the
first ship of a new class are often negotiated as cost-reimbursable
contracts because these ships tend to involve a high-level of
uncertainty and, thus, high cost risks. Cost reimbursement contracts
were used to procure the San Antonio and Virginia class ships we
reviewed. More mature shipbuilding programs, where there is greater
certainty about costs, are typically fixed-price contracts with an
incentive fee (profit). Fixed-price contracts were used to procure the
Arleigh Burke and Nimitz class ships we reviewed. Both cost-
reimbursable and fixed-price incentive fee contracts can include a
target cost, a target profit, and a formula that allows the profit to
be adjusted by comparing the actual cost to the target cost.
Construction contracts for ships generally include provisions for
controlling cost growth with incentive fees, whereby the Navy and the
shipbuilder split any savings when the contract cost is less than its
anticipated target. Conversely, when costs exceed the target, the
excess is shared between the Navy and the shipbuilder.
New Ships Continue to Cost More Than Budgeted:
Ship cost growth continues to pose additional funding demands on the
budget. Budgets for the eight case study ships alone have required
increases of $2.1 billion, and Congress has appropriated funds to cover
these increases. However, the total projected cost growth on contracts
for the eight ships is likely to be higher. Consequently, the Navy will
need in excess of $1 billion in additional appropriations to cover the
total projected cost growth. Cost growth was more pronounced for the
lead ships in the two new classes we looked at--the Virginia class and
especially the San Antonio class--than the more mature Arleigh Burke
and Nimitz classes. (Our forecasts for cost growth on all ships that
are more than 30 percent complete are shown in appendix VI.)
The fiscal year 2005 budget for the eight case study ships was about
$20.6 billion--representing cost growth of $2.1 billion above the
initial budget request of $18.5 billion for these ships. (See table 3.)
Ship construction costs comprise the majority of this increase.
Table 3: Growth in Program Budgets for Case Study Ships:
Dollars in millions.
Case study ship: DDG 91;
Initial and fiscal year 2005 President's budget: Initial[A]: $917;
Initial and fiscal year 2005 President's budget: FY2005[B]: $997;
Initial and FY 2005 President's budget: FY 2005: $80;
Difference in budgets: Difference due to Navy-furnished equipment: $43;
Difference in budgets: Difference due to construction costs[C]: $37.
Case study ship: DDG 92;
Initial and fiscal year 2005 President's budget: Initial[A]: $925;
Initial and fiscal year 2005 President's budget: FY2005[B]: $979;
Initial and FY 2005 President's budget: FY 2005: $55;
Difference in budgets: Difference due to Navy-furnished equipment:
($7)[D];
Difference in budgets: Difference due to construction costs[C]: $62.
Case study ship: CVN 76;
Initial and fiscal year 2005 President's budget: Initial[A]: $4,476;
Initial and fiscal year 2005 President's budget: FY2005[B]: $4,600;
Initial and FY 2005 President's budget: FY 2005: $124;
Difference in budgets: Difference due to Navy-furnished equipment:
($128)[E];
Difference in budgets: Difference due to construction costs[C]: $252.
Case study ship: CVN 77;
Initial and fiscal year 2005 President's budget: Initial[A]: $4,975;
Initial and fiscal year 2005 President's budget: FY2005[B]: $5,024;
Initial and FY 2005 President's budget: FY 2005: $49;
Difference in budgets: Difference due to Navy-furnished equipment:
$100;
Difference in budgets: Difference due to construction costs[C]:
($51)[F].
Case study ship: LPD 17;
Initial and fiscal year 2005 President's budget: Initial[A]: $954;
Initial and fiscal year 2005 President's budget: FY2005[B]: $1,758;
Initial and FY 2005 President's budget: FY 2005: $804;
Difference in budgets: Difference due to Navy-furnished equipment: $21;
Difference in budgets: Difference due to construction costs[C]: $784.
Case study ship: LPD 18;
Initial and fiscal year 2005 President's budget: Initial[A]: $762;
Initial and fiscal year 2005 President's budget: FY2005[B]: $1,011;
Initial and FY 2005 President's budget: FY 2005: $249;
Difference in budgets: Difference due to Navy-furnished equipment: $3;
Difference in budgets: Difference due to construction costs[C]: $246.
Case study ship: SSN 774;
Initial and fiscal year 2005 President's budget: Initial[A]: $3,260;
Initial and fiscal year 2005 President's budget: FY2005[B]: $3,682;
Initial and FY 2005 President's budget: FY 2005: $422;
Difference in budgets: Difference due to Navy-furnished equipment: $95;
Difference in budgets: Difference due to construction costs[C]: $327.
Case study ship: SSN 775;
Initial and fiscal year 2005 President's budget: Initial[A]: $2,192;
Initial and fiscal year 2005 President's budget: FY2005[B]: $2,504;
Initial and FY 2005 President's budget: FY 2005: $312;
Difference in budgets: Difference due to Navy-furnished equipment: $18;
Difference in budgets: Difference due to construction costs[C]: $294.
Total;
Initial and fiscal year 2005 President's budget: Initial[A]: $18,461;
Initial and fiscal year 2005 President's budget: FY2005[B]: $20,556;
Initial and FY 2005 President's budget: FY 2005: $2,095;
Difference in budgets: Difference due to Navy-furnished equipment:
$145;
Difference in budgets: Difference due to construction costs[C]: $1,951.
Sources: Navy (data); GAO (presentation).
[A] Estimated cost from the President's budget submission for year of
ship authorization.
[B] Includes all prior year requests through fiscal year 2005.
[C] Part of increased cost is due to changes in the scope of the
contract.
[D] Negative reflects savings resulting from the use of a more
economical warfare system than was initially budgeted on the DDG 92.
[E] Negative reflects savings garnered from Navy-furnished reactor
plant equipment.
[F] Negative reflects shifting of funds from the construction contract
to Navy-furnished equipment.
[End of table]
We were not able to determine how much of this increase was due to
changes in the scope of the contract and how much of the growth funded
increases in the costs of completing the initial contract scope.
Amounts identified by shipbuilders and Navy program offices differed
substantially. However, the initial program budgets included funding to
support changes in the scope of the construction contract. These funds
amounted to a small share of the initial program budget: 3 percent for
DDGs 91 and 92; 5 percent for CVN 76 and CVN 77; 7 percent for LPD 17
and 4 percent for LPD 18; and 3 and 4 percent for SSNs 774 and 775,
respectively.
While the Congress has appropriated funds to cover a $2.1 billion
increase in the ships' costs, more funds will likely be needed to cover
additional cost growth likely for these eight ships. At the time we
completed our analysis in 2004, we calculated a range of the potential
growth for the eight case study ships and found that the total
projected cost growth would likely exceed $2.8 billion and could reach
$3.1 billion. (See table 4.)
Table 4: GAO's Forecasts of Additional Cost Growth for Construction:
Dollars in millions:
Forecasts based on data available July 2004:
Case study ship: DDG 91;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $37;
GAO's forecast of total cost growth[A]: $37-37.
Case study ship: DDG 92;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $62;
GAO's forecast of total cost growth[A]: $62-62.
Case study ship: CVN 76;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $252;
GAO's forecast of total cost growth[A]: $252-252.
Case study ship: CVN 77;
Percent of ship construction completed: 45%;
Amount already requested to cover contractor's increased cost:
($51)[B];
GAO's forecast of additional Cost growth: $485-637;
GAO's forecast of total cost growth[A]: $434-586[C].
Case study ship: LPD 17;
Percent of ship construction completed: 93%;
Amount already requested to cover contractor's increased cost: $784;
GAO's forecast of additional Cost growth: $112-197;
GAO's forecast of total cost growth[A]: $896-981.
Case study ship: LPD 18;
Percent of ship construction completed: 69;
Amount already requested to cover contractor's increased cost: $246;
GAO's forecast of additional Cost growth: $102-136;
GAO's forecast of total cost growth[A]: $348-382.
Case study ship: SSN 774;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $327;
GAO's forecast of total cost growth[A]: $327-327[D].
Case study ship: SSN 775;
Percent of ship construction completed: 88;
Amount already requested to cover contractor's increased cost: $294;
GAO's forecast of additional Cost growth: $103-219;
GAO's forecast of total cost growth[A]: $397-513.
Total growth;
Amount already requested to cover contractor's increased cost: $1,951;
GAO's forecast of additional Cost growth: $802-1,189;
GAO's forecast of total cost growth[A]: $2,753-3,140.
Sources: Shipbuilder and Navy (data); GAO (analysis).
[A] Forecast reflects expected price to the Navy.
[B] Negative reflects shifting of funds from the construction contract
to Navy-furnished equipment.
[C] The 2006 budget submission indicates $908 million additional cost
growth on CVN 77 above the fiscal year 2005 budget.
[D] The Navy has requested an additional funding to cover completion of
SSN 774.
[End of table]
These cost growth estimates have already proven to be too conservative.
In its fiscal year 2006 budget submission, the Navy recognizes an
additional cost growth of $223 million for SSN 775 and $908 million for
CVN 77 above its fiscal year 2005 request. In addition, our estimates
assumed that the shipyards will maintain their current efficiency
through the end of their contracts and meet scheduled milestones. Any
slips in efficiency and schedules would likely result in added costs.
For example, the delivery date for SSN 775 is expected to slip by as
many as 9 months, which, according to the fiscal year 2006 President's
budget has increased the final cost of the ship even more. According to
program officials, the delivery date for the LPD 17 has been changed
from December 2004 to May 2005, and the delivery date for the CVN 77 is
expected to slip into 2009.
Cost growth on new ships has a number of implications. Most tangible,
perhaps, is the significant portion of the ship construction budget
that must be devoted to overruns on ships already under construction.
From fiscal years 2001 to 2005, 5 to 14 percent of the Navy's ship
construction budget, which totaled about $52 billion over the 5-year
period, went to pay for cost growth for ships funded in prior years.
This reduces the buying power of the budget for current construction
and can slow the pace of modernization. The Navy is in the early stages
of buying a number of advanced ships, including the Virginia class
submarine, DD(X) destroyer, CVN 21 aircraft carrier, and Littoral
Combat Ship. The Navy's ability to buy these ships as scheduled will
depend on its ability to control cost growth.
Labor and Materials Drive Increases in Construction Costs:
Increases in labor hour and material costs account for 78 percent of
the cost growth on shipbuilding construction contracts, while overhead
and labor rate increases account for 17 percent. Navy-furnished
equipment[Footnote 3]--including radars and weapon systems--represents
just 5 percent of the cost growth. (See fig. 2.) Shipbuilders cited a
number of direct causes for the labor hour, material, and overhead cost
growth in the eight case study ships. The most common causes were
related to design modifications, the need for additional and more
costly materials, and changes in employee pay and benefits.
Figure 2: Components of Cost Growth:
[See PDF for image]
Note: Total growth in construction costs is $3.2 billion, based on
shipbuilders' estimate at completion.
[End of figure]
Design Changes and Lack of Skilled Labor Contributed to Labor Hour Cost
Growth:
Labor hour increases for the eight case study ships ranged from 33
percent to 105 percent--for a total of 34 million extra labor hours.
For example, the shipbuilders for LPD 17 and CVN 76 each needed 8
million additional labor hours to construct the ships:
Cost growth due to increased labor hours totaled more than $1.3
billion. (See table 5.) While the total dollars were the greatest for
LPD 17 ($284 million), the labor cost as a percent of total cost growth
was the greatest for DDG 91 (105 percent).
Table 5: Growth in Labor Hour Costs:
Dollars in millions;
Analysis based on data available July 2004.
Case study ship: DDG 91;
Shipbuilder reported labor Cost growth: $23;
Overhead and labor rate costs on increased labor hours: $24;
Total cost due to increased labor hours: $47;
Labor hour cost as a percent of total contract growth: 105%.
Case study ship: DDG 92;
Shipbuilder reported labor Cost growth: $43;
Overhead and labor rate costs on increased labor hours: $42;
Total cost due to increased labor hours: $85;
Labor hour cost as a percent of total contract growth: 66%.
Case study ship: CVN 76[A];
Shipbuilder reported labor Cost growth: $78;
Overhead and labor rate costs on increased labor hours: $144;
Total cost due to increased labor hours: $222;
Labor hour cost as a percent of total contract growth: 35%.
Case study ship: CVN 77[A];
Shipbuilder reported labor Cost growth: $75;
Overhead and labor rate costs on increased labor hours: $107;
Total cost due to increased labor hours: $182;
Labor hour cost as a percent of total contract growth: 42%.
Case study ship: LPD 17[B];
Shipbuilder reported labor Cost growth: $182;
Overhead and labor rate costs on increased labor hours: $102;
Total cost due to increased labor hours: $284;
Labor hour cost as a percent of total contract growth: 33%.
Case study ship: LPD 18;
Shipbuilder reported labor Cost growth: $117;
Overhead and labor rate costs on increased labor hours: $67;
Total cost due to increased labor hours: $184;
Labor hour cost as a percent of total contract growth: 48%.
Case study ship: SSN 774;
Shipbuilder reported labor Cost growth: $149;
Overhead and labor rate costs on increased labor hours: $10;
Total cost due to increased labor hours: $159;
Labor hour cost as a percent of total contract growth: 55%.
Case study ship: SSN 775;
Shipbuilder reported labor Cost growth: $218;
Overhead and labor rate costs on increased labor hours: ($38);
Total cost due to increased labor hours: $180;
Labor hour cost as a percent of total contract growth: 42.
Total;
Shipbuilder reported labor Cost growth: $885;
Overhead and labor rate costs on increased labor hours: $458;
Total cost due to increased labor hours: $1,342.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures all costs associated with
labor hour growth--including overhead and labor rates. Methodology is
discussed in appendix 1.
[A] Contractor performance reports included $63 million in overhead
costs for CVN 76 and $40 million for CVN 77 that have been disallowed
(not charged to the government).
[B] LPD 17 relied heavily on subcontracts with partners (Bath Iron
Works and Raytheon) to design the ship. Since these costs are captured
as material, we did not include them in our analysis of labor cost
increases.
[End of table]
The lack of design and technology maturity led to rework, increasing
the number of labor hours for most of the case study ships. For
example, the design of LPD 17 continued to evolve even as construction
proceeded. When construction began on DDG 91 and DDG 92--the first
ships to incorporate the remote mine hunting system--the technology was
still being developed. As a result, workers were required to rebuild
completed areas of the ship to accommodate design changes. Most of the
shipbuilders cited a lack of skilled workers as a driver behind labor
hour cost growth. According to the shipbuilders we interviewed, many of
the tasks needed to build ships are complex and require experienced
journeymen to efficiently carry them out. Yet, the majority of the
shipbuilders noted that the shipyards have lost a significant portion
of their highly skilled and experienced workers. Delays in delivery of
materials also resulted in increased labor hours. Table 6 shows the
reasons for labor hour increases for each case study ship.
Table 6: Reasons Given by Shipbuilders for Labor Hours Cost Growth:
Case study ship: DDG 91;
Reasons for increase:
* Inexperienced laborers;
* Design upgrades that result in rework.
Case study ship: DDG 92;
Reasons for increase:
* Introduction of a new construction facility, setting workers back on
the learning curve;
* Design upgrades that result in rework and workarounds;
* Strike increased number of hours needed to construct ship.
Case study ship: CVN 76;
Reasons for increase:
* Less-skilled workers due to demands for labor on other programs at
shipyard;
* Extensive use of overtime;
* Design changes resulting in rework.
Case study ship: CVN 77;
Reasons for increase:
* Late material delivery results in delays and workarounds;
* Design changes resulting in rework.
Case study ship: LPD 17;
Reasons for increase:
* Inexperienced subcontracted labor;
* Design difficulties led to doing work out of sequence and rework;
* Schedule delays;
* Bused workers to meet labor shortages.
Case study ship: LPD 18;
Reasons for increase:
* Increases in LPD 17 translated into more hours for LPD 18.
Case study ship: SSN 774;
Reasons for increase:
* Late material delivery;
* First in class design issues.
Case study ship: SSN 775;
Reasons for increase:
* Quality problems and design changes;
* Inclusion of non-recurring labor hours.
Sources: Shipbuilder (data); GAO (analysis).
[End of table]
Underbudgeting and Price Increases Contributed to Materials Cost Growth:
For several of the case study ships, the costs of materials increased
dramatically above what the shipbuilder had initially planned. (See
table 7.) Materials cost was the most significant component of cost
growth for three ships: LPD 17, SSN 775, and CVN 76. However, for LPD
17, which experienced over 100-percent growth in material costs, 70
percent of the material cost increases were actually costs for
subcontracts to support design of the lead ship.
Table 7: Growth in Material Costs:
Dollars in millions;
Analysis based on data available July 2004.
Case study ship: DDG 91;
Total dollars due to increased material costs: ($22);
Percent increase: (13%)%;
Material cost as a percent of total contract growth: (49%).
Case study ship: DDG 92;
Total dollars due to increased material costs: $30;
Percent increase: 20%;
Material cost as a percent of total contract growth: 23%.
Case study ship: CVN 76;
Total dollars due to increased material costs: $294;
Percent increase: 43%;
Material cost as a percent of total contract growth: 46%.
Case study ship: CVN 77;
Total dollars due to increased material costs: $134;
Percent increase: 13%;
Material cost as a percent of total contract growth: 31%.
Case study ship: LPD 17;
Total dollars due to increased material costs: $400;
Percent increase: 103%;
Material cost as a percent of total contract growth: 47%.
Case study ship: LPD 18;
Total dollars due to increased material costs: $93;
Percent increase: 39%;
Material cost as a percent of total contract growth: 24%.
Case study ship: SSN 774;
Total dollars due to increased material costs: $141;
Percent increase: 43%;
Material cost as a percent of total contract growth: 49%.
Case study ship: SSN 775;
Total dollars due to increased material costs: $209;
Percent increase: 56%;
Material cost as a percent of total contract growth: 49%.
Total;
Total dollars due to increased material costs: $1,280;
Percent increase: 38%.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
Growth in materials costs was due, in part, to the Navy and
shipbuilders' underbudgeting for these costs. For example, the
materials budget for the first four Virginia-class submarines was $132
million less than quotes received from vendors and subcontractors. The
shipbuilder agreed to take on the challenge of achieving lower costs in
exchange for providing in the contract that the shipbuilder would be
reimbursed for cost growth in high value, specialized materials. In
addition, the materials budget for CVN 76 and CVN 77 was based on an
incomplete list of materials needed to construct the ship, leading to
especially sharp increases in estimated materials costs. In this case,
the Defense Contract Audit Agency criticized the shipbuilder's
estimating system, particularly the system for material and subcontract
costs, and stated that the resulting estimates "do not provide an
acceptable basis for negotiation of a fair and reasonable price."
Underbudgeting of materials has contributed to cost growth recognized
in the fiscal year 2006 budget.
Price increases also contributed to the growth in materials costs. For
example, the price of array equipment on the Virginia class submarines
rose by $33 million above the original price estimate. In addition to
inflation, a limited supplier base for highly specialized and unique
materials made ship materials susceptible to price increases.[Footnote
4] According to the shipbuilders, the low rate of ship production has
affected the stability of the supplier base--some businesses have
closed or merged, leading to reduced competition for the services they
once produced and that may be a cause of higher prices. In some cases,
the Navy lost its position as a preferred customer and the shipbuilder
had to wait longer to receive materials. With a declining number of
suppliers, more ship materials contracts have gone to single and sole
source vendors. Over 75 percent of the materials for the Virginia class
submarines--which were reduced in number from 14 to 9 ships over a 10-
year period--is produced by single source vendors.
Spending on subcontracts and leased labor also increased material costs
on some case study ships.[Footnote 5] On LPD 17, for example,
subcontracts to support lead ship design accounted for 70 percent of
the increase in material costs. Table 8 highlights the various reasons
cited for increased materials costs on case study ships.
Table 8: Reasons Given by Shipbuilders for Material Cost Growth:
Case study ship: DDG 91;
Reasons for growth:
* Consolidation with Northrop Grumman allowed for quantity material buy
savings.
Case study ship: DDG 92;
Reasons for growth:
* Rework requiring additional tools, utilities, and shop stock;
* Information technology costs shifted from overhead to materials.
Case study ship: CVN 76;
Reasons for growth:
* Increases in costs for specialized materials;
* Underbudgeted material costs;
* Accounting changes;
* Additional subcontracting.
Case study ship: CVN 77;
Reasons for growth:
* Increases in costs for specialized materials;
* Underbudgeted material costs.
Case study ship: LPD 17;
Reasons for growth:
* Subcontractor engineering design efforts;
* Design tool development, originally assumed to be funded by the state
resulted in additional costs to Northrop Grumman.
Case study ship: LPD 18;
Reasons for growth:
* Increases in LPD 17 translated into more costs for LPD 18.
Case study ship: SSN 774;
Reasons for growth:
* Lack of suppliers for highly unique materials;
* Immature design on material components.
Case study ship: SSN 775;
Reasons for growth:
* Lack of suppliers for highly unique materials;
* Nonrecurring costs for computer integration.
Sources: Shipbuilder (data); GAO (analysis).
[End of table]
Program Overhead and Labor Rates Account for Remaining Ship
Construction Cost Increases:
Program overhead costs, which include increases in labor rates,
represented approximately 17 percent of the total cost growth for the
eight case study ships. (See table 9.) While increases in overhead
dollars totaled more than $1 billion, almost half of the increase was
related to growth in labor hours. (See table 9.)
Table 9: Growth in Overhead Costs and Labor Rates:
Dollars in millions;
Analysis based on data available July 2004.
Case study ship: DDG 91;
Shipbuilder reported overhead growth: $43;
Increase in overhead related to growth in labor hours: $24;
Increase in overhead related to overhead and labor rates: $20;
Overhead cost as a percent of total contract growth: 44%.
Case study ship: DDG 92;
Shipbuilder reported overhead growth: $56;
Increase in overhead related to growth in labor hours: $42;
Increase in overhead related to overhead and labor rates: $14;
Overhead cost as a percent of total contract growth: 11%.
Case study ship: CVN 76[A];
Shipbuilder reported overhead growth: $263;
Increase in overhead related to growth in labor hours: $144;
Increase in overhead related to overhead and labor rates: $119;
Overhead cost as a percent of total contract growth: 19%.
Case study ship: CVN 77[A];
Shipbuilder reported overhead growth: $219;
Increase in overhead related to growth in labor hours: $107;
Increase in overhead related to overhead and labor rates: $113;
Overhead cost as a percent of total contract growth: 26%.
Case study ship: LPD 17;
Shipbuilder reported overhead growth: $277;
Increase in overhead related to growth in labor hours: $102;
Increase in overhead related to overhead and labor rates: $175;
Overhead cost as a percent of total contract growth: 20%.
Case study ship: LPD 18;
Shipbuilder reported overhead growth: $177;
Increase in overhead related to growth in labor hours: $67;
Increase in overhead related to overhead and labor rates: $110;
Overhead cost as a percent of total contract growth: 28%.
Case study ship: SSN 774;
Shipbuilder reported overhead growth: $0;
Increase in overhead related to growth in labor hours: $10;
Increase in overhead related to overhead and labor rates: ($10);
Overhead cost as a percent of total contract growth: (3)%.
Case study ship: SSN 775;
Shipbuilder reported overhead growth: $0;
Increase in overhead related to growth in labor hours: ($38);
Increase in overhead related to overhead and labor rates: $38;
Overhead cost as a percent of total contract growth: 9.
Total;
Shipbuilder reported overhead growth: $1,035;
Increase in overhead related to growth in labor hours: $457;
Increase in overhead related to overhead and labor rates: $579.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures only costs associated with
overhead and labor rate changes. Increases in overhead related to
growth in labor hours are captured in the analysis of labor hour
increases.
[A] Contractor performance reports included $63 million in overhead
costs for CVN 76 and $40 million for CVN 77 that have been disallowed
(not charged to the government).
[End of table]
Increases in program overhead were largely due to decreased workload at
the shipyards. Six of the eight case study ships experienced increased
overhead because there were fewer programs to absorb shipyard operation
costs. Increases in benefit costs, such as pensions and medical care
costs, and labor rate increases--the result of negotiations with labor
unions and inflation--also drove up program overhead costs. Table 10
highlights the various reasons cited for increased overhead costs on
case study ships.
Table 10: Reasons Given by Shipbuilders for Overhead and Labor Rate
Cost Growth:
Case study ship: DDG 91;
Reasons for growth:
* Pension plans affected by financial market changes;
* Increase in medical benefit costs;
* Union negotiations increase labor rates;
* Loss of workload.
Case study ship: DDG 92;
Reasons for growth:
* Medical care cost increases due to inflation and loss of favorable
medical care contract;
* Loss of workload.
Case study ship: CVN 76;
Reasons for growth:
* Changes in accounting of overhead;
* Union negotiations following strike increase labor rates.
Case study ship: CVN 77;
Reasons for growth:
* Changes in accounting of overhead;
* Union negotiations following strike increase labor rates;
* Medical care cost increases;
* Capital investments;
* Pension plans affected by financial market changes;
* Workload changes.
Case study ship: LPD 17;
Reasons for growth:
* Pension plans affected by financial market changes;
* Loss of anticipated workload;
* An over 2-year delay in lead ship delivery and change in the
procurement schedule.
Case study ship: LPD 18;
Reasons for growth:
* Pension plans affected by financial market changes;
* Loss of anticipated workload;
* An over 2-year delay in lead ship delivery and change in the
procurement schedule.
Case study ship: SSN 774;
Reasons for growth:
* Changes in pension, health care, and workman's compensation;
* Overhead rates decreased due to increased workload.
Case study ship: SSN 775;
Reasons for growth:
* Loss of expected business and training new workers;
* Additional costs to restart submarine production capability at the
shipyard.
Sources: Shipbuilder (data); GAO (analysis).
[End of table]
Navy-Furnished Equipment:
Navy-furnished equipment covers the costs for the technologies and
equipment items--such as ship weapon systems and electronics--purchased
by the Navy and provided to the contractor for installation on the
ship. While Navy-furnished equipment accounts for 29 percent of the
budget for the eight case study ships, such equipment accounted for
only 6 percent of the total cost growth. According to Navy officials,
much of the Navy-furnished equipment is common among many programs and,
therefore, benefits from economies of scale. However, the integration
and installation of these systems--especially the warfare systems--
contributes to cost growth and is captured in the shipbuilders' costs
rather than Navy-furnished equipment.
There was considerable variance from program to program. In addition,
in some cases, decreases and increases in Navy-furnished equipment were
the result of funds being reallocated. For example, the Integrated
Warfare System on CVN 77 was originally funded through the shipbuilder
construction contract, but was later deleted from the contract in favor
of an existing system furnished by the Navy.
Navy Funding and Management Practices Result in Insufficient Provision
for Risk:
Navy practices for estimating costs and for contracting and budgeting
for ships have resulted in unrealistic funding of programs and when
unexpected events occur, tracking mechanisms are slow to pick them up.
Tools exist to manage the challenges inherent in shipbuilding,
including measuring the probability of cost growth when estimating
costs, making full use of design and construction knowledge to
negotiate realistic target prices, and tracking and providing timely
reporting on program costs to alert managers to potential problems. For
the eight case study ships, however, the Navy did not effectively
employ them to mitigate risk.
Navy Estimates Do Not Capture Uncertainty and Are Often Not
Independently Evaluated:
In developing cost estimates for the eight case study ships, Navy cost
analysts did not conduct uncertainty analyses[Footnote 6] to measure
the probability of cost growth, nor were independent estimates
conducted for some ships--even in cases where major design changes had
occurred. Uncertainty analyses and independent estimates are
particularly important given the inherent uncertainties in the ship
acquisition process, such as the introduction of new technologies and
volatile overhead rates over time, creating a significant challenge for
cost analysts to develop credible initial cost estimates. The Navy must
develop cost estimates as much as 10 years before ship construction
begins--before many program details are known. As a result, cost
analysts have to make a number of assumptions about certain ship
parameters, such as weight, performance, or software, and about market
conditions, such as inflation rates, workforce attrition, and supplier
base.
In the eight case study ships we examined, cost analysts relied on the
actual cost of previously constructed ships without adequately
accounting for changes in the industrial base, ship design, or
construction methods. Cost data available to Navy cost analysts were
based on higher ship construction rates from the 1980s. As a result,
these data were based on lower costs due to economies of scale--which
were not reflective of the lower procurement rates after 1989. In
addition, in developing cost estimates for DDG 91, DDG 92, LPD 17, and
SSN 774, cost analysts relied on actual cost data from previous ships
in the same class or a similar class but that were less technologically
advanced. By using data from less complex ships, Navy cost analysts
tended to underestimate the costs needed to construct the ships.
For CVN 76, cost analysts used proposed costs from CVN 74 with
adjustments made for design changes and economic factors. However, CVN
74 and CVN 75 were more economical ships because both were procured in
a single year--which resulted in savings from economies of scale. While
cost analysts adjusted their estimates to account for the single-ship
buy, costs increased far beyond the adjustment. Even in more mature
programs--like the Arleigh Burke destroyers and the Nimitz aircraft
carriers--improved capabilities and modifications made the costs of
previous ships in the class essentially less analogous.
Other unknowns also led to uncertain estimates in the case study ships.
Labor hour and material costs were based not only on data from previous
ships but also on unproven efficiencies in ship construction. We found
analysts often factored in savings based on expected efficiencies that
never materialized. For example, cost analysts anticipated savings
through the implementation of computer-assisted design/computer-
assisted manufacturing for LPD 17, but the contractor had not made the
requisite research investments to achieve the proposed savings. Similar
unproven or unsupported efficiencies were estimated for DDG 92 and CVN
76. Changes in the shipbuilders' supplier base also created
uncertainties in the shipbuilders' overhead costs.
Despite these uncertainties, the Navy did not test the validity of the
assumptions made by the cost analysts in estimating the construction
costs for the eight case study ships nor did the Navy identify a
confidence level for estimates.[Footnote 7] Specifically, it did not
conduct uncertainty analyses, which generate values for parameters that
are less than precisely known around a specific set of ranges. For
example, if the number of hours to integrate a component onto a ship is
not precisely known, analysts may put in a low and high value. The
estimate will generate costs for these variables along with other
variables such as--weight, experience, and degree of rework. The result
is a range of estimates that enables cost analysts to make better
decisions on likely costs. Instead, the Navy presented its cost
estimates as unqualified point estimates, suggesting an element of
precision that cannot exist early on and obscures the investment risk
remaining for the programs. While imprecision decreases during the
program's life cycle as more information becomes known about the
program, experts emphasize that to be useful, each cost estimate should
include an indication of its degree of uncertainty, possibly as an
estimated range or qualified by some factor of confidence. Other
services qualify their cost estimates by determining a confidence level
of 50 percent.
The Navy also did not conduct independent cost estimates for some
ships, which is required at certain major acquisition
milestones.[Footnote 8] Independent cost estimates can provide decision
makers with additional insight into a program's potential costs--in
part because these estimates frequently use different methodologies and
may be less burdened with organizational bias. Independent cost
analysts also tend to incorporate cost for risk as they develop their
estimates, which the Navy cost analysts did not do. As a result, these
independent estimates tend to be more conservative--forecasting higher
costs than those forecast by the program office. Department of Defense
officials considered the CVN 68 and DDG 51 programs mature programs
and, therefore, did not require independent estimates. Yet, an
independent cost estimate has never been conducted on a CVN 68 class
carrier because the program for this class of ships began prior to the
establishment of an independent cost-estimating group in DOD. However,
Navy officials noted that every carrier is a new program, different
from previous carriers. Although an independent cost estimate was
conducted for the DDG 51 program, it was conducted in 1993, and since
that time, the DDG ships have undergone four major upgrades.
The Navy has begun taking some actions to improve its cost estimating
capabilities. For example, future programs will be funded at the DOD
independent estimators' level, which should provide a more conservative
estimate and include risk analysis. In addition, Navy officials told us
that they are in the process of revising cost estimating guidance to
include requirements for risk and uncertainty analysis. The degree to
which this guidance will enable the Navy to provide more realistic cost
estimates for its shipbuilding programs will depend on how it will be
implemented on individual programs.
Contract Prices Negotiated and Budgets Set Without Making Full Use of
Design Knowledge and Construction Experience:
Uncertainty about costs is especially high for new classes of ships,
since new classes incorporate new designs and new technologies. Yet,
the Navy's approach to negotiating contract target prices for
construction of the lead ship and early follow-on ships does not manage
this uncertainty sufficiently--evidenced by substantial increases in
the prices of the first several ships. Target prices for detail design
and construction of the lead and early follow-on ships are typically
negotiated at one time.[Footnote 9] In these cases the Navy does not
make use of knowledge gained during detailed design or during
construction of the lead ship to establish more realistic prices. When
this approach to negotiating prices was used, it also affected the
information that was available to the Congress at the time it funded
construction of lead and follow-on ships.
Target prices for all of the case study ships increased, but, as shown
in table 11, the increase was greater for the two San Antonio class
ships and the two Virginia class ships--both new classes of ships.
Increases in the target prices of the LPD 17 and LPD 18 were
particularly pronounced, reaching 139 and 95 percent, respectively.
Table 11: Target Prices for Case Study Ships:
Dollars in millions;
Analysis based on data available July 2004.
Case study ship: DDG 91;
Initial target price: $355;
Shipbuilders' estimated price: $390;
Cost growth: $35;
Percent change: 10%.
Case study ship: DDG 92;
Initial target price: $351;
Shipbuilders' estimated price: $422;
Cost growth: $71;
Percent change: 20%.
Case study ship: CVN 76;
Initial target price: $2,967;
Shipbuilders' estimated price: $3,391;
Cost growth: $424;
Percent change: 14%.
Case study ship: CVN 77;
Initial target price: $3,446;
Shipbuilders' estimated price: $3,879;
Cost growth: $434;
Percent change: 13%.
Case study ship: LPD 17;
Initial target price: $644;
Shipbuilders' estimated price: $1,539;
Cost growth: $896;
Percent change: 139%.
Case study ship: LPD 18;
Initial target price: $391;
Shipbuilders' estimated price: $764;
Cost growth: $373;
Percent change: 95%.
Case study ship: SSN 774;
Initial target price: $1,028;
Shipbuilders' estimated price: $1,301;
Cost growth: $273;
Percent change: 27%.
Case study ship: SSN 775;
Initial target price: $1,084;
Shipbuilders' estimated price: $1,488;
Cost growth: $404;
Percent change: 37%.
Total;
Initial target price: $10,266;
Shipbuilders' estimated price: $13,174;
Cost growth: $2,910;
Percent change: 28%.
Sources: Shipbuilder and Navy (data); GAO (analysis).
[End of table]
The realism of target prices reflects the Navy's approach to
negotiating contract prices--the Navy negotiates target prices for the
first several ships at a stage of the program when uncertainty is high
and knowledge limited. For example, for the San Antonio class ships,
the Navy negotiated prices for the detail design and construction of
the lead ship (LPD 17) and the first two follow-on ships (LPD 18 and
LPD 19) at the same time.[Footnote 10] By negotiating target prices for
these ships before detail design even began, target prices for these
three ships did not benefit from information gained during detail
design about the materials and equipment or specific processes that
will be used to construct the ship. Target prices for the follow-on
ships, LPD 18 and LPD 19, did not benefit from knowledge gained in
initial construction of LPD 17. In contrast, for the Virginia class
ships, the Navy negotiated detail design separately from
construction,[Footnote 11] benefiting from the knowledge gained from
detail design in negotiating prices for construction. However, 2 years
after negotiating the detail design contract, the Navy negotiated
target prices for the SSN 774 and SSN 775, both considered lead ships
for the two shipyards involved in constructing submarines. Target
prices for the first two follow-on ships, SSN 776 and SSN 777 were
agreed on at this time as well. As a result, target prices for these
follow-on ships did not benefit from the knowledge gained from
constructing the lead ships.
The practice of setting target prices early on affects not only the
realism of the contract target prices, but also the realism of the
budgets approved by the Congress to fund these contracts. In order to
fund a contract covering both detail design and lead ship construction,
authorization and funding for detail design and lead ship construction
is approved by the Congress in one budget year, before detail design
begins. For example, the Congress funded detail design and construction
of LPD 17 in the fiscal year 1996 budget. While the follow-on ships,
LPDs 19 and 20, were funded in later years, budgets were still
unrealistic because the target prices were used as a basis for the
budget request.
The size of the budget and the contract conditions can also affect the
realism of target prices. In negotiating the contract for the first
four Virginia class ships, program officials stated that the target
price they could negotiate was limited to the amount included in
approved or planned budgets. The shipbuilders said that they accepted a
challenge to design and construct these ships for $748 million less
than their estimated costs because the contract protected their
financial risk. The contract included a large minimum fee (profit), in
addition to the incentive fee that would be reduced in the event of
cost growth. Moreover, the contract was structured so that the Navy
would pay the full cost of increases for specialized, highly engineered
components rather than share the cost increases with the shipbuilder.
The Navy also was responsible for the full amount of growth in certain
labor costs.
Recently, the Navy has supported the preparation of more realistic
budget requests. Program managers are encouraged to budget to their own
estimate of expected costs rather than at target prices that are not
considered realistic. For example, for the LPD 17, an acquisition
decision memorandum stated that the program will be budgeted to the
Cost Analysis Improvement Group estimate.[Footnote 12] Also, in
negotiating recent contracts for additional Virginia class and San
Antonio class ships, the Navy structured the contracts to encourage
more realistic target prices.
Other Factors Affect Budget Realism:
Beyond target prices, shifting priorities, and inflation accounting can
have a significant impact on the realism of ship budgets. Specifically,
budget requests are susceptible to across-the-board reductions to
account for other priorities, such as national security and changes in
program assumptions. Competing priorities create additional management
challenges for programs that receive a reduced budget without an
accompanying reduction in scope. For example, during the budget review
cycles of 1996 through 2003, the initial cost estimate for DDGs 89-92
was decreased by $119 million--or 55 percent of the total cost growth
for the four DDGs. Had the initial estimate not been reduced, the cost
growth would have only amounted to $96 million.
Inflation rates can also have a significant impact on ship budgets.
Until recently, Navy programs used Office of the Secretary of Defense
and Office of Management and Budget inflation rates.[Footnote 13]
Inflation rates experienced by the shipbuilding industry have
historically been higher. As a result, contracts were signed and
executed using industry specific inflation rates while budgets were
based on the lower inflation rates, creating a risk of cost growth from
the outset. For the case study ships, the difference in inflation
rates, while holding all other factors constant, explains 30 percent of
the $2.1 billion in cost growth for these ships.
In February 2004, the Navy changed its inflation policy directing
program offices to budget with what the Navy believes are more
realistic inflation indices. The Navy anticipates this policy change
should help curtail future requests for prior year completion funds.
Cost Reporting Weaknesses Delayed Efforts to Mitigate Cost Risks:
While DOD guidance allows some flexibility in program oversight, we
found that reporting on contractor performance was inadequate to alert
the Navy to potential cost growth for the eight case study ships. With
the significant risk of cost growth in shipbuilding programs, it is
important that program managers receive timely and complete cost
performance reports from the contractors. However, earned value
management--a tool that provides both program managers and the
contractor insight into technical, cost, and schedule progress on their
contracts--was not used effectively.[Footnote 14] Cost variance
analysis sections of the reports were not useful in some cases because
they only described problems at a high level and did not address root
causes or what the contractor plans were to mitigate them.
Earned value management provides an objective means to measure program
schedule and costs incurred. Among other requirements, DOD guidance on
earned value management requires that "at least on a monthly basis"
schedule and cost variances be generated at levels necessary for
management control. Naval Air Systems Command, which is considered a
center of excellence for earned value management, recommends that cost
performance reports be submitted at a minimum on a monthly basis, in
part to help the program manager mitigate risk. Officials from the
command stressed that because earned value management acts as an early
warning system, the longer the time lapse in receiving the cost
performance report, the less valuable the data become.
However, shipbuilders for the Nimitz and Virginia class ships we
reviewed submitted their official earned value management cost
performance reports to the Navy on a quarterly basis instead of
monthly,[Footnote 15] delaying the reports--and corrective action--by 3
to 4 months. Had the reporting been monthly, negative trends in labor
and materials on the Virginia class submarine would have been revealed
sooner and enabled corrective action to occur quickly in areas of work
that were not getting completed as planned. Earlier reporting would
have also alerted managers of cost performance problems on the CVN 76
carrier. Because data on actual cost expenditures for CVN 76 were
provided incrementally and late, the program manager did not identify a
funding shortage until it was too late to remedy the problem. As a
result, a contractwide stop-work order was given. LPD 17 also
experienced cost and schedule problems. To allow for better tracking of
schedule and costs and more timely response to problems, the program
manager changed the cost performance reporting requirement from
quarterly to monthly.
The quality of the cost performance reports, whether submitted monthly
or quarterly, was inadequate in some cases--especially with regard to
the variance analysis section, which describes any cost and schedule
variances and the reasons for these variances and serves as an
official, written record of the problems and actions taken by the
shipbuilder to address them. Both the Virginia class submarine and the
Nimitz class aircraft carrier programs' variance analysis reports
discussed the root causes for any cost growth and schedule slippage and
described how these variances were affecting the shipbuilders'
projected final costs. However, the remaining case study ship programs
generally tended to report only high-level reasons for cost and
schedule variances with little to no detail regarding root cause
analysis or mitigation efforts[Footnote 16]--making it difficult for
managers to identify risk and take corrective action.
Finally, the periodic reassessment of the remaining funding
requirements on a program and a good faith estimate at completion--
another part of earned value management--were inadequate to forecast
the amount of anticipated cost growth. Managers are required to
evaluate the estimate at completion and report it in the cost
performance report, updating when required. The Defense Contract Audit
Agency recently observed the importance of the shipbuilders' developing
credible estimates at completion and ensuring all estimates at
completion revisions are justified and made in a timely manner.
However, the shipbuilders' estimates for the study ships tended to be
optimistic--that is, they fell at the low end of our estimated cost
growth range. Specifically, shipbuilder estimates for four ships that
are still under construction were near our low estimate, (See fig. 3),
leading management to believe that the ships will cost less than what
is likely to be the case.
Figure 3: GAO and Shipbuilder Construction Cost Growth Forecasts for
Case Study Ships:
[See PDF for image]
[End of figure]
See appendix VI for more details on the cost growth forecasts for ships
currently under construction.
Conclusions:
The challenge in accurately estimating and adequately funding the
construction of Navy ships is framed by the long construction time cost
estimates must account for and the fact that ships must be fully funded
in the first year of their construction. Thus, an underestimation of
costs, a budget reduction, or an increase in cost, creates a need for
additional money that must be requested and appropriated. The fact that
requests have been sizable and have occurred routinely over the years
suggests that the Navy can do better in getting a match between the
estimated costs of new ship construction and the money it budgets to
pay for them. The goal is not necessarily to eliminate all requests for
additional funds, for that could lead to overbudgeting or deferring
necessary design changes. Rather, the goal is to get a better match
between budgeted funds and costs in order that the true impact of
investment decisions is known.
Our work shows that currently, the Navy's cost estimating, budgeting,
and contracting practices do not do a good enough job of providing for
the likely costs of building ships. This is particularly true for first
of class ships, for which uncertainty is highest. Moreover, when actual
costs begin to go astray of budgeted funds, management tools intended
to flag variances and enable managers to act early are not always
effectively employed. If these practices are to lead to more realistic
results---and reduced overruns--they will have to produce and take
advantage of higher levels of knowledge. In some cases, improved
techniques, such as performing uncertainty analyses on cost estimates,
can raise the level of knowledge. In other cases, such as contracting
for detail design and construction on first-of-class ships, contracting
in smaller steps can allow necessary knowledge to build before major
commitments are made.
The Navy has recognized the need to get a better match between funding
and cost and is providing guidance to achieve this match. The success
of this guidance will depend on how well it is implemented on
individual programs. There are additional steps the Navy can take,
which are detailed in our recommendations. Taking these steps now is
especially important for the Navy as it embarks on a number of new,
sophisticated shipbuilding programs. If a better match between funding
and cost is not made, additional funds needed for cost growth will
continue to compete for the funds needed for new investments in ships
or other capabilities. Difficult budget choices are ahead making it
essential that priorities are set with a clear understanding of the
financial implications of different spending and investment
alternatives. To the extent unplanned demands on the budget can be
reduced, better informed decisions can be made.
Recommendations:
We are recommending that the Secretary of Defense take the following
seven actions.
To improve the quality of cost estimates for shipbuilding programs and
reduce the magnitude of unbudgeted cost growth, we recommend the
Secretary of Defense:
* conduct independent cost reviews for all follow-on ships when
significant changes occur in a program and establish criteria as to
what constitutes significant changes to a shipbuilding program,
* conduct independent reviews of every acquisition of an aircraft
carrier, and:
* direct the Secretary of the Navy to develop a confidence level for
all ship cost estimates, based on risk and uncertainty analyses.
To assure that realistic prices for ship construction contracts are
achieved, we recommend that the Secretary of Defense direct the
Secretary of the Navy to:
* negotiate prices for construction of the lead ship separately from
the pricing of detail design and:
* separate pricing of follow-on ships from pricing of lead ships,
negotiating prices for early ships in the budget year in which the ship
is authorized and funded.
To improve management of shipbuilding programs and promote early
recognition of cost issues, we recommend that the Secretary of Defense
direct the Secretary of the Navy to:
* require shipbuilders to submit monthly cost performance reports and:
* require shipbuilders to prepare variance analysis reports that
identify root causes of reported variances, associated mitigation
efforts, and future cost impacts.
Agency Comments and Our Evaluation:
DOD agreed with our recommendations to conduct independent reviews of
every aircraft carrier and to develop a confidence level for all ship
cost estimates, based on risk and uncertainty analysis. DOD partially
agreed with our recommendations about contract pricing and cost
performance reporting--areas the Navy noted it has taken some measures
to improve. While the Navy has taken steps in the right direction, we
believe more must be done to reduce ship cost overruns, consistent with
our recommendations.
We made a recommendation in our draft report that independent reviews
be conducted for all follow-on ships when significant changes to the
program occur. DOD responded that it will request additional
assessments, if needed after Milestone B. It is important that criteria
be established for determining when additional assessments are needed.
Programs may undergo several changes after the required estimate, such
as the Arleigh Burke destroyer, which underwent four major upgrades
since its only independent estimate in 1993. We believe DOD needs to
establish criteria concerning what significant changes to a program
trigger an independent cost estimate and have modified our
recommendations accordingly. DOD could clarify whether these changes
include baseline, profile, or major systems upgrades, for instance.
DOD stated that it will consider, on a case-by-case basis, negotiating
detail design separately from the lead ship and negotiating early
follow-on ships separately from the lead ship. We believe that this
approach should be the normal policy, if overruns are to be reduced.
Ships represent a substantial investment--more than $1 billion for each
destroyer and amphibious transport, about $2.5 billion for the lead
ship in the next class of destroyers, $2.5 billion for submarines, and
several billion for carriers. Ships costing substantially less--for
example, $220 million for each Littoral Combat Ship--are the exception
rather than the norm. A realistic target price is important for
structuring contract incentives and providing informed budgets to the
Congress. Deciding prices for the lead ship and follow-on ships
together before detail design has even begun on the lead ship is
unlikely to yield realistic prices. Insight gained into material costs
and labor effort even in the first year of detail design will make
realistic pricing of the lead ship more feasible. Similarly, experience
gained in the first years of construction can benefit the realism of
prices for follow-on ships.
DOD noted that the Navy is already requiring shipbuilders to submit
cost performance reports monthly with one exception. With the Nimitz
class program beginning monthly reporting in March 2006, the Virginia
class will be the only program to submit quarterly instead of monthly
cost performance reports. DOD states that the Navy has access to labor
hour data in the interim. While informal access to timely data is
preferable to delayed access, without written, formal cost reporting
there is less visibility or accountability from the last formal report
to the next cost performance report 3 months later. The Virginia class
program has experienced significant cost increases and experienced one
of the largest prior year funding requests of programs we reviewed. LPD
17 and carrier program officials recognized that more frequent formal
reporting and review of cost performance helped them to better manage
cost growth and changed their program reporting requirements from
quarterly to monthly. Although variance analysis reporting is required
as part of cost performance reporting and is being conducted by the
shipbuilders, we observed that there is wide variation in the quality
of these reports. DOD rightly observes that these reports are one of
many tools used by the shipbuilders and DOD to track performance. To be
a useful tool, however, we believe it is important that shipbuilders
provide the government with detailed analyses of the root causes and
impacts of cost and schedule variances. Cost performance reports that
consistently provide thorough analysis of the causes of variances,
their associated cost impacts, and mitigation efforts will allow the
Navy to more effectively manage, and ultimately reduce, cost growth.
DOD's detailed comments are provided in appendix VII.
As agreed with your office, unless you announce its contents, we will
not distribute this report further until 30 days from its date. At that
time, we will send copies to the Secretary of Defense, the Secretary of
the Navy and interested congressional committees. We will also make
copies available to others upon request. In addition, the report will
be available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions concerning this report, please
contact me at (202) 512-4841 or Karen Zuckerstein, Assistant Director,
at (202) 512-6785. Key contributors to the report are identified in
appendix VIII.
Sincerely yours,
Signed by:
Paul L. Francis:
Director:
Acquisition and Sourcing Management:
[End of section]
Appendix I: Scope and Methodology:
Our methodology for all three objectives included a case study analysis
of eight ships. These ships were in four ship classes: Virginia class
submarines, LPD 17 amphibious assault ships, Arleigh Burke destroyers,
and Nimitz class carriers. We selected these ship classes and these
ships based on data contained in the "Naval Sea Systems Command
Quarterly Progress Report for Shipbuilding and Conversion Status of
Shipbuilding Programs," dated July 1, 2003. This report identifies all
ships under construction and the progress in terms of "percent
complete" for each ship. We looked only at new construction and
excluded ship conversions. This report identified eight ship classes
with ships under construction. In addition to the four ship classes
that we studied, the report identified ships in the Seawolf attack
submarine, LHD amphibious assault ship, T-AKE cargo ship, and T-AKR
vehicle cargo ship classes. We did not review the Seawolf and T-AKR
ship classes because construction of these classes was at an end and
were unlikely to affect future budgets. We did not include ships from
the remaining two classes because we limited the ship selection to
those ships that were more that 30 percent complete and none of the
ships in those two classes met those criteria.
We selected two ships per class for the four classes we reviewed. Where
possible, we chose a lead and follow-on ship. We also looked at which
shipyards were building these ships in order to get coverage of the
major shipyards. We limited the selection to ships more than 30 percent
complete so we had sufficient information on program performance. Three
Virginia-class submarines, three amphibious assault ships, two
carriers, and 12 destroyers met this criterion. For the Virginia class
program, we initially chose SSN 774 and SSN 776; both built and
integrated at the Electric Boat, Connecticut shipyard.[Footnote 17] As
we gained knowledge of the program and Newport News' role in
constructing and launching half of the submarines in this class, we
substituted the SSN 775 for the SSN 776.
Characteristics of the ships we selected are summarized in table 12.
Table 12: Characteristics of Case Study Ships:
Shipyard;
Amphibious assault ships: LPD 17: Avondale Operations;
Amphibious assault ships: LPD 18: Avondale Operations;
Virginia class submarines: SSN 774: Electric Boat;
Virginia class submarines: SSN 775: Newport News Shipbuilding;
Nimitz class carriers: CVN 76: Newport News Shipbuilding;
Nimitz class carriers: CVN 77: Newport News Shipbuilding;
Arleigh Burke destroyers: DDG 91: Ingalls Operations;
Arleigh Burke destroyers: DDG 92: Bath Iron Works.
Percent complete as of July 2003;
Amphibious assault ships: LPD 17: 86;
Amphibious assault ships: LPD 18: 43;
Virginia class submarines: SSN 774: 87;
Virginia class submarines: SSN 775: 79;
Nimitz class carriers: CVN 76: 99;
Nimitz class carriers: CVN 77: 35;
Arleigh Burke destroyers: DDG 91: 96;
Arleigh Burke destroyers: DDG 92: 89.
Lead/follow;
Amphibious assault ships: LPD 17: Lead;
Amphibious assault ships: LPD 18: Follow;
Virginia class submarines: SSN 774: Lead;
Virginia class submarines: SSN 775: Lead[A];
Nimitz class carriers: CVN 76: Follow;
Nimitz class carriers: CVN 77: Follow;
Arleigh Burke destroyers: DDG 91: Follow;
Arleigh Burke destroyers: DDG 92: Follow.
Source: Navy (data), GAO (presentation):
[A] SSN 775 is considered the lead ship for Newport News.
[End of table]
Because a large percentage of the ship construction budget is allocated
to fund the shipbuilding contracts, we assessed the shipbuilders' cost
performance for the four classes of ships in our study. To make these
assessments, we applied earned value analysis techniques to data
captured in shipbuilder cost performance reports. We also developed a
forecast of future cost growth. For ships currently under construction
(and more than 30 percent complete), we compared the initial target
costs with the likely costs at the completion of the contracts using
established earned value formulas. We based the lower end of our cost
forecast range on the costs spent to date added to the forecast cost of
work remaining. The remaining work was forecast using the cumulative
cost performance index efficiency factor. Studies have shown that using
this method is a reasonable estimate of the lower bound of the final
cost. For the upper end of our cost range, we relied on either the
actual costs spent to date added to the forecast of remaining work with
an average monthly cost and schedule performance index or a cost/
percent complete trend analysis, whichever was higher.
In order to understand the components of cost growth, we used cost data
provided by the shipbuilders for each of the case study ships. In most
cases we compared the initial target cost to the current target cost.
As a result some of the increases in target cost could have resulted
from additional contract modifications initiated by the Navy, cost
overruns due to the shipbuilder, or unanticipated events. Most
shipbuilders allocate contract costs into three categories: material
costs, labor costs, and overhead costs. We, however, used these data to
allocate costs into the following categories: labor hours, material
costs, and labor and overhead rates. Since labor costs and overhead
costs can change due to labor hours, and labor and overhead rates, we
separated the program overhead cost associated with an increase in
labor and overhead rates from the program overhead cost associated with
an increase in labor hours. This was accomplished by holding each
component constant to isolate the impact. After we isolated the program
overhead cost associated only with additional labor hours, we added
this to the shipbuilders' reported labor cost growth and subtracted
this from the shipbuilders' reported overhead cost growth. Our analysis
captures all costs associated only with overhead and labor rate
changes. Increases in overhead related to growth in labor hours are
captured only in our analysis of labor hour increases.
We used the latest cost performance data available to us in July 2004.
The latest available cost performance reports for the case study ships
were as follows:
* DDG 91 June 2004,
* DDG 92 May 2004,
* CVN 76 July 2003,
* CVN 77 March 2004,
* LPD 17 and LPD 18 May 2004, and:
* SSN 774 and SSN 775 July 2004.
In order to understand the funding and management practices that
contribute to cost growth, we reviewed Navy acquisition guidance and
reviewed best practices literature for weapons systems construction. To
better understand the budgeting of ships and the acquisition process we
met with officials at the Navy and Office of Secretary of Defense
Comptroller. Based on indicators from our case study analysis that cost
estimating practices may contribute to cost growth, we met with cost
estimators, including those from Naval Sea Systems Command, Cost
Analysis Improvement Group, and the Navy Cost Analysis Division. We
reviewed DOD and Navy cost estimating policies, procedures, and
guidance. Additionally, we met with cost estimators from the Naval Air
Systems Command, the Air Force, and the Army to compare how Naval Sea
Systems Command estimating practices vary from other military cost
estimating practices. We interviewed program officials, contracting
officers, and shipbuilders and reviewed shipbuilder reports, which
included explanations for cost growth. We met with officials at
Supervisor of Ships and the Defense Contract Audit Agency both at the
shipyards and at headquarters to review their oversight policies,
procedures, and practices. We met with Navy Audit Service officials to
gain information on earned value management reviews at shipyards. We
also reviewed contract documentation and audit reports.
Our analysis relied on shipbuilders' earned value data. To establish
the reliability of the data, we examined the integrated baseline
reviews that are conducted at the beginning of a contract. We also
confirmed that the shipbuilders had validated earned value systems.
We performed our review from July 2003 to December 2004 in accordance
with generally accepted government auditing standards.
[End of section]
Appendix II: Arleigh Burke Class Destroyer:
Program Description:
The USS Arleigh Burke class destroyer (DDG 51) provides multimission
offensive and defensive capabilities, and can operate independently or
as part of carrier strike groups, surface action groups, and
expeditionary strike groups. The DDG 51 class, which is intended to
replace earlier surface combatant classes, was the first U.S. Navy ship
designed to reduce radar cross-section and its detectability and
likelihood of being targeted by enemy sensors and weapons. Originally
designed to defend against Soviet aircraft, cruise missiles, and
nuclear attack submarines, the ship is to be used in high-threat areas
to conduct antiair, antisubmarine, antisurface, and strike operations.
As of May 2004, 43 Arleigh Burke destroyers have been delivered to the
Navy, with a total of 62 to be delivered at the end of the production.
Funding for the lead ship (DDG 51) was provided in fiscal year 1985.
The lead ship construction contract was awarded to Bath Iron Works in
April 1985. With the award of the follow-on ship--DDG 52--to Ingalls
Shipbuilding Incorporated--a second shipbuilder was established. The
DDG 91 and DDG 92, which are covered in this report, include a number
of upgrades, such as the most current Aegis weapons system;
installation of a remote mine-hunting system capability and the
introduction of commercially built switchboards.
Figure 4: Arleigh Burke Class Destroyer:
[See PDF for image]
[End of figure]
Table 13: Major Events in the Acquisition of DDG 91 and DDG 92:
May 1996;
* Initial estimate for three ships developed using actual costs from
DDG 70--the last ship of the prior configuration in preparation for the
1998 President's budget.
September 1996;
* Congress authorizes procurement of 4 DDGs--DDGs 89-92.
August 1997;
* Competition to determine contract awards. Navy uses "Profit Related
to Offers" strategy, where the lower offeror receives a larger
proportion of the contract's target profits, while the higher offeror
receives a smaller proportion. Both shipbuilders stated that they
proposed aggressively low costs in an effort to win the higher profit
margin on the contract that included DDG 91 and DDG 92.
January 1998;
* Fiscal Year 1999 Presidential Budget submission is $119 million less
than the initial budget estimate due to across the board DOD and Office
of Management and Budget reductions.
March 1998;
* Bath Iron Works receives a contract for the DDG 92 with an initial
target price of $351 million. Ingalls Shipbuilding receives a contract
for the DDG 91 with an initial target price of $355 million.
September 2000;
* DDG 91 construction begins.
December 2000;
* DDG 92 construction begins.
April 2001;
* Northrop Grumman Ship Systems acquired Ingalls Shipbuilding.
June 2002;
* Northrop Grumman Ship Systems and Bath Iron Works agree to a swap in
which LPDs (including LPD 19) will be built by Northrop Grumman and
future DDG ships will be built at Bath Iron Works.
October 2003;
* DDG 91 delivered.
May 2004;
* DDG 92 delivered.
Sources: Navy and shipbuilders (data).
[End of table]
Cost Experience on DDG 91 and DDG 92:
DDG 91 and DDG 92 cost $135 million more than budgeted. (See table 14.)
The Congress has appropriated almost $100 million to cover these
increases.
Table 14: Growth in Program Budgets for Case Study Ships:
Dollars in millions.
Case study ship: DDG 91;
Initial and FY 2005 President's budget: Initial: $917;
Initial and FY 2005 President's budget: FY2005: $997;
Initial and FY 2005 President's budget: FY 2005: $80;
Difference in budgets: Difference due to Navy-furnished equipment: $43;
Difference in budgets: Difference due to construction costs[A]: $37.
Case study ship: DDG 92;
Initial and FY 2005 President's budget: Initial: $925;
Initial and FY 2005 President's budget: FY2005: $979;
Initial and FY 2005 President's budget: FY 2005: $55;
Difference in budgets: Difference due to Navy-furnished equipment:
($7)[B];
Difference in budgets: Difference due to construction costs[A]: $62.
Total;
Initial and FY 2005 President's budget: Initial: $1,842;
Initial and FY 2005 President's budget: FY2005: $1,976;
Initial and FY 2005 President's budget: FY 2005: $135;
Difference in budgets: Difference due to Navy-furnished equipment: $36;
Difference in budgets: Difference due to construction costs[A]: $99.
Sources: Navy (data); GAO (presentation).
[A] Part of the increased cost is due to changes in the scope of the
contract.
[B] Negative reflects savings resulting from the use of a more
economical warfare system than was initially budgeted on the DDG 92.
[End of table]
Main Drivers of Cost Growth for DDG 91 DDG 92:
Construction costs--especially the costs associated with the number of
labor hours needed to build the ships--were the major source of cost
growth. Navy-furnished equipment, including the Aegis weapon system,
was also a significant source of cost growth for the two DDGs,
representing 21 percent of the cost growth. Increases in the number of
labor hours account for 67 percent of the cost growth on shipbuilding
construction contracts. We found that ship overhead--such as employee
benefits and shipyard support costs--and labor rate increases accounted
for 21 percent of cost growth. The two DDGs actually underran material
costs, due to DDG 91 material cost savings.
Figure 5: Average Sources of Cost Growth on DDG 91 and DDG 92:
[See PDF for image]
[End of figure]
Labor Hours:
Labor hour increases account for the majority of the cost growth on DDG
91 and DDG 92. (See fig. 5.) DDG 91 required almost 1 million hours of
additional labor hours and DDG 92 required an additional 2 million
hours above the original contract proposal. DDG 91 and DDG 92
incorporated a number of new technologies in their design, including
the remote mine-hunting system, which consists of a remote operated
vehicle and a launch and recovery system stored within the ship. To
accommodate this system, designers had to make significant structural
changes to 26 of the ship's 90 design zones. When construction began on
DDG 91 and DDG 92, the remote mine-hunting system's design was not
mature. As a result, significant details of the design could not be
captured in the shipbuilders' planned contract costs. Moreover, the
shipbuilders anticipated that the system's design would be completed in
July 1999--several months before the start of ship fabrication in
November 1999. However, it was not completed until November 2001, with
additional revisions to the design occurring through March 2003.
Because the design was changing as installation of the system began,
laborers re-installed parts of the system, increasing the engineering
and production hours.
As the number of hours to construct the ship increased, total labor
costs grew, with the shipbuilder paying for additional employee wages
and overhead costs. As table 15 shows, we separated the overhead and
labor rates associated with the additional hours and added this to the
shipbuilders reported labor cost growth. Our analysis thus captures all
costs associated with labor hour growth--including overhead and labor
rates. The methodology we used to separate the overhead costs
associated with rate increases and labor hour increases is discussed in
appendix 1.
Table 15: Growth in Labor Hour Costs:
Dollars in millions;
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.
Case study ship: DDG 91;
Shipbuilder reported labor dollar growth: $23;
Overhead and labor rate dollars on increased labor hours: $24;
Total dollars due to increased labor hours: $47;
Labor hour cost as a percent of total contract growth: 105%.
Case study ship: DDG 92;
Shipbuilder reported labor dollar growth: $43;
Overhead and labor rate dollars on increased labor hours: 42;
Total dollars due to increased labor hours: $85;
Labor hour cost as a percent of total contract growth: 66%.
Total;
Shipbuilder reported labor dollar growth: $66;
Overhead and labor rate dollars on increased labor hours: $66;
Total dollars due to increased labor hours: $132.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
According to the shipbuilder, additional labor hours were also needed
to complete DDG 91 because many experienced workers had left the trade
in favor of higher paying jobs in the area and, as a result, less
experienced workers took longer to finish tasks and made mistakes that
required rework. For DDG 92, workers encountered challenges in building
the ship due to a new transfer facility that enabled the shipyard to
construct a greater proportion of the ship on land. The ship was
constructed using larger subsections or units. While the shipbuilder
expects that the facility will improve efficiency, on DDG 92, workers
had to learn new processes and had difficulties aligning larger units
of the ship to one another. Labor hours increased as workers spent
additional time realigning and combining the units to make larger
sections of the ship.
Navy-Furnished Equipment:
About $38 million of Navy-furnished equipment cost growth is associated
with the Aegis weapon system, specifically the purchase of an
additional SPY-D radar used in system testing.[Footnote 18] The Navy
originally planned to move the developmental radar from the engineering
and development site to the final testing and certification center.
However, increased complexity involved with the introduction of a new
radar and new computing plant required more development time than was
originally planned. In order to ensure timely delivery of DDG 91, the
Navy procured a second radar for the testing facility, allowing the
Navy to simultaneously finish final development of the radar, while at
the same time beginning testing and certification of the Aegis weapon
system computer program.
Overhead Rate Increases:
Our analysis shows that program overhead costs and increases in labor
rates accounted for approximately 21 percent of the cost growth on the
DDG 91 and 92 contracts. Table 15 includes overhead increases that were
a consequence of labor hour increases. Table 16 isolates the remaining
portion of overhead increases due to increases in rates.
Table 16: Growth in Overhead Costs and Labor Rates:
Dollars in millions;
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.
Case study ship: DDG 91;
Shipbuilder reported overhead growth: $43;
Portion related to growth in labor hours: $24;
Portion related to overhead and labor rates: $20;
Overhead cost from rate increases as a percent of total contract
growth: 44%.
Case study ship: DDG 92;
Shipbuilder reported overhead growth: $56;
Portion related to growth in labor hours: $42;
Portion related to overhead and labor rates: $14;
Overhead cost from rate increases as a percent of total contract
growth: 11%.
Total;
Shipbuilder reported overhead growth: $99;
Portion related to growth in labor hours: $66;
Portion related to overhead and labor rates: $34.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
Despite savings incurred through the consolidation of Ingalls Shipyard
into Northrop Grumman,[Footnote 19] overhead rates were about 13
percent higher than anticipated in 2001. According to shipbuilders,
increases in overhead rates can be attributed largely to changes in the
shipyard's workload and employee benefit costs. After the cancellation
of the construction contract for a commercial cruise ship due to the
company's bankruptcy and the delay in signing the contract for the next
generation destroyer, overhead costs had to be absorbed by the
remaining contracts at the yard, including the DDG 91. Similarly, on
DDG 92, the shipbuilder based its overhead rates on anticipated work
from the construction of the next generation destroyer and the San
Antonio class ships. When these programs did not materialize as
expected, the other programs at the yard assumed overhead costs. At
both shipyards health and dental care costs increased. For example, at
one shipyard, the shipbuilder negotiated a favorable medical insurance
contract but the insurance company went bankrupt, forcing the
shipbuilder to become self-insured--at a higher cost.
Both shipbuilders were also affected by labor rate increases. Following
a strike at Bath Iron Works, the union negotiated a $1.12 increase in
labor rates or a $6 million increase above the costs projected in the
contract. For Northrop Grumman, between the initial proposal and the
latest estimate, the labor rate increased by $1.50 per hour for a total
impact on the DDG 91 of $7 million.
Material Costs:
As shown in table 17, material cost increases did not represent a major
source of cost increases for DDG 91 and DDG 92--largely because the
materials were purchased for four ships at one time.
Table 17: Growth in Material Costs:
Dollars in millions;
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.
Case study ship: DDG 91;
Increased material costs: ($22);
Percent increase: (13%)%;
Material cost as a percent of total contract growth: (49%).
Case study ship: DDG 92;
Increased material costs: $30;
Percent increase: 20%;
Material cost as a percent of total contract growth: 23%.
Total;
Increased material costs: $8.
Sources: Navy (data); GAO (analysis).
[End of table]
However, DDG 92 overran its material budget by $30 million--73 percent
of which was due to information technology, small tooling, and other
material costs. Although these costs comprise only 17 percent of the
material cost budget, their costs are driven by labor hour usage--as
additional labor hours were needed to construct DDG 92, additional
tools were needed, raising material costs. Material costs also
increased because the shipbuilder began allocating information
technology costs to materials--not overhead, as it had initially done.
DDG 91 experienced a $22 million underrun of material costs. According
to the shipbuilder, the underrun was due to efficiencies gained through
the consolidation of Ingalls Shipyard with nearby Avondale Shipyard--
also owned by Northrop Grumman Ship Systems. With the consolidation,
Northrop Grumman stated it could purchase materials for both shipyards-
-creating cost savings that were not anticipated in DDG 91's original
material cost budget.
[End of section]
Appendix III: Nimitz Class Aircraft Carrier:
Program Description:
The mission of the Nimitz class nuclear powered aircraft carriers--
which are intended to replace the Navy's conventionally powered
carriers--is to provide a sustained presence and conventional
deterrence in peacetime; act as the cornerstone of joint allied
maritime expeditionary forces in crises; and support aircraft attacks
on enemies, protect friendly forces, and engage in sustained
independent operations in war. Nine Nimitz class nuclear carriers--CVN
68 through CVN 76--have been delivered since acquisition of the first
ship in October 1967. CVN 77, the tenth and final ship of the class, is
a modified version of CVN 76 and will serve as a transition ship to the
next generation of aircraft carriers. Both CVN 76 and CVN 77 included
several significant design changes, including a bulbous bow; larger air-
conditioning plants; a redesigned island; weapons elevator
modifications; and an integrated communications network.
Figure 6: Nimitz Class Aircraft Carrier:
[See PDF for image]
[End of figure]
Table 18: Major Events in the Acquisition of CVN 76 and CVN 77:
August 1993;
* Initial estimate for CVN 76 developed based on CVN 74/75 proposal
data with adjustments made for design and economic factors.
September 1994;
* Congress appropriates funding for the construction of CVN 76.
December 1994;
* Navy awards a fixed-price incentive fee contract for detailed design
and construction of CVN 76 to Newport News Shipbuilding for a target
price of $2.5 billion.
May 1995;
* Construction of CVN 76 begins.
April 1999;
* 4-month strike at Newport News causes work stoppage on construction
of CVN 76.
July 2000;
* Congress appropriates funding for the construction of CVN 77.
January 2001;
* Navy awards a fixed-price incentive fee contract for detailed design
and construction of CVN 77 to Newport News Shipbuilding for a target
price of $3.4 billion.
February 2001;
* Navy requests $86 million for CVN 76 and $20 million for CVN 77 in
prior year funding to cover cost growth.
June 2001;
* Construction begins on CVN 77. Advanced construction began in 1998 to
provide sustaining work for the shipyard.
February 2002;
* Prior year request of $94 million for CVN 76 and $75.4 million for
CVN 77.
September 2002;
* Development delays prompt Navy to revert to a legacy warfare system
on CVN 77. Costs for warfare system are transferred from the
shipbuilder to the Navy.
December 2002;
* Original contract delivery date for CVN 76.
June 2003;
* CVN 76 delivered to the Navy--6 months later than the original
delivery date.
August 2003;
* Navy initiates a contract wide stop work order on CVN 76 to prevent
depletion of program funding. Stop work order is rescinded 3 months
later.
February 2005;
* Navy requests $870 million in prior year funding over fiscal years
2006 to 2008 for CVN 77. This includes an increase in $908 million in
construction costs and a $38 million decrease in Navy- furnished
equipment.
March 2008;
* Initial expected delivery date for CVN 77.
January 2009;
* Current expected delivery date for CVN 77.
Sources: Shipbuilder and Navy (data), GAO (presentation).
[End of table]
Cost Experience on CVN 76 and CVN 77:
The Fiscal Year 2005 President's Budget showed that budgets for the CVN
case study ships had increased by $173 million, and the Congress has
appropriated funds to cover these increases. However, based on March
2004 data, we projected additional cost growth on contracts for the
carriers is likely to reach $485 million and could be higher.
Therefore, the Navy will need additional appropriations to cover this
cost growth.
The fiscal year 2005 budget for the carriers is about $9.6 billion--
$173 million more than the initial budget request for these ships. (See
table 19.) As a result, the Navy has requested $275.4 million through
both the prior year completion bill and other financial transfers to
fund cost increases on the CVN program.[Footnote 20] Ship construction
costs comprise the majority of this increase.
On CVN 76, ship construction costs grew by $252 million above the
initial budget. As a result of cost growth, CVN 76 was in danger of
running out of funding. The program office issued over 75 stop work
orders--including one contract wide stop work order to temporarily save
funding. Lower priority work was cancelled or halted to avoid further
cost growth. While stop work orders saved money in the short term, they
resulted in significant costs later. On CVN 76 some work had to be
completed in a post-delivery contract--at a higher cost.
Table 19: Growth in Program Budgets for Case Study Ships:
Dollars in millions.
Case study ship: CVN 76; Initial and FY 2005 President's budget:
Initial: $4,476;
Initial and FY 2005 President's budget: FY 2005: $4,600;
Initial and FY 2005 President's budget: FY 2005: $124;
Difference in budgets: Difference due to Navy-furnished equipment:
($128);
Difference in budgets: Difference due to construction costs[A]: $252.
Case study ship: CVN 77;
Initial and FY 2005 President's budget: Initial: $4,975;
Initial and FY 2005 President's budget: FY 2005: $5,024;
Initial and FY 2005 President's budget: FY 2005: $49;
Difference in budgets: Difference due to Navy-furnished equipment:
$100;
Difference in budgets: Difference due to construction costs[A]: ($51).
Total;
Initial and FY 2005 President's budget: Initial: $9,451;
Initial and FY 2005 President's budget: FY 2005: $9,624;
Initial and FY 2005 President's budget: FY 2005: $173;
Difference in budgets: Difference due to Navy-furnished equipment: $28;
Difference in budgets: Difference due to construction costs[A]: $201.
Sources: Navy (data); GAO (presentation).
[A] Part of the increased cost is due to changes in the scope of the
contract.
[End of table]
We calculated a range of the potential growth for CVN 77 and found that
the total projected cost growth is likely to exceed $485 million and
could reach $637 million.[Footnote 21] (See table 20.)
Table 20: GAO's Forecasts of Additional Cost Growth for Construction:
Dollars in millions;
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.
Case study ship: CVN 76;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $252;
GAO's forecast for additional cost growth for construction: $0-0;
GAO's forecast of total Cost growth: $252-252.
Case study ship: CVN 77;
Percent of ship construction completed: 45%;
Amount already requested to cover contractor's increased cost:
($51)[A];
GAO's forecast for additional cost growth for construction: $485-637;
GAO's forecast of total Cost growth: $434-586.
Total growth;
Amount already requested to cover contractor's increased cost: $201;
GAO's forecast for additional cost growth for construction: $485-637;
GAO's forecast of total Cost growth: $686-838.
Sources: Navy (data); GAO (analysis).
Note: Cost growth is from original contract target price, not from the
current contract target price. Forecast reflects expected price to the
Navy.
[A] Negative reflects shifting of funds from the construction contract
to Navy-furnished equipment.
[End of table]
Our cost growth estimates have proven to be understated. The Fiscal
Year 2006 President's Budget recognizes cost growth of $908 million for
ship construction above the prior year's budget request. In addition,
we assumed that the shipbuilder will maintain its current efficiency
through the end of the contracts and meet scheduled milestones. For
example, Navy officials told us that delivery of CVN 77 is likely to
slip to January 2009, further increasing the final cost of the ship.
Main Drivers of Cost Growth for CVN 76 and CVN 77:
Based on 2004 data, increases in labor hour and material costs account
for 80 percent of the cost growth on CVN 76 and CVN 77, while the costs
for Navy-furnished equipment--including propulsion and weapon systems-
-declined.[Footnote 22] (See fig. 7.) The remaining 23 percent of cost
growth resulted from increases in overhead costs. The shipbuilder cited
a number of direct causes for the labor hour, material, and overhead
cost growth in the case study ships. The most common causes were
related to demands for labor on other programs at the shipyard, the
need for additional and more costly materials, and changes in employee
pay and benefits.
Figure 7: Average Sources of Cost Growth on CVN 76 and CVN 77:
[See PDF for image]
[End of figure]
Materials:
Material costs increased on CVN 76 by $294 million and on CVN 77 by
$134 million since the contracts were first awarded.
Table 21: Growth in Material Costs:
Dollars in millions;
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.
Case study ship: CVN 76;
Total dollars due to increased material costs: $294;
Percent increase: 43%%;
Material cost as a percent of total contract growth: 46%.
Case study ship: CVN 77;
Total dollars due to increased material costs: $134;
Percent increase: 13%;
Material cost as a percent of total contract growth: 31%.
Total;
Total dollars due to increased material costs: $428.
Sources: Navy (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
On both CVN 76 and CVN 77, material costs grew, in part, because the
shipbuilder underestimated the original budget for materials. In April
2002--7 years after construction began on CVN 76--about $32 million in
errors in material purchase estimates were revealed. CVN 77 has also
experienced a significant increase in material costs due to under
budgeting. According to the shipbuilder, a compressed construction
schedule on CVN 77 resulted in the budget for materials being
established prior to the completion of the carrier's design and even
the completion of design work on certain systems on CVN 76. As a
result, the true magnitude of the carrier's material costs was not
known at the time of the contract negotiation. Early in CVN 77
construction, however, the shipbuilder reassessed the materials needed
for construction in order to have a more realistic estimate of final
material costs. The Navy and the Defense Contract Audit Agency
recognized the absence of needed information on materials during its
review of the shipbuilder's proposal and expressed concerns about the
adequacy of the cost estimating system. According to Newport News
officials, the shipyard and Defense Contract Audit Agency are working
to resolve their concerns. The shipbuilder is estimating $200 million
in material cost increases and additional funds are being requested to
cover this increase.
According to the shipbuilder, material cost increases on both CVN 76
and CVN 77 can be attributed to increases resulting from a declining
supplier base and commodity price increases. Both carriers' material
costs have been affected by an over 15 percent increase in metals
costs, which, in turn, increases costs for associated components used
in ship construction. Moreover, many of the materials used in the
construction of aircraft carriers are highly specialized and unique--
often produced by only one manufacturer. With fewer manufacturers
competing in the market, the materials are highly susceptible to cost
increases.
Other reasons for material cost increases include the following:
CVN 76:
* Expenses of about $20 million in non-nuclear engineering effort that
were subcontracted for in late 1997 and of about $50 million for
information services were transferred from overhead to material in the
middle of the project.
CVN 77:
* The expansion of commercial-off-the-shelf equipment in CVN 77
resulted in additional costs to test the materials to make sure
military specifications were met.
Labor Hours:
Costs on both carriers grew because of additional labor hours required
to construct the ships. At delivery, CVN 76 required 8 million hours of
additional labor hours to construct, while CVN 77 has required 4
million hours. As the number of hours to construct the ship increased,
total labor costs grew, with the shipbuilder paying for additional
employee wages and overhead costs.
Table 22: Growth in Labor Hour Costs:
Dollars in millions;
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.
Case study ship: CVN 76;
Shipbuilder reported labor dollar growth: $78;
Overhead and labor rate dollars on increased labor hours[A]: $144;
Total dollars due to increased labor hours: $222;
Labor hour cost as a percent of total contract growth: 35%.
Case study ship: CVN 77;
Shipbuilder reported labor dollar growth: $75;
Overhead and labor rate dollars on increased labor hours[A]: $107;
Total dollars due to increased labor hours: $182;
Labor hour cost as a percent of total contract growth: 42%.
Total;
Shipbuilder reported labor dollar growth: $153;
Overhead and labor rate dollars on increased labor hours[A]: $251;
Total dollars due to increased labor hours: $404.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. We separated the overhead and labor rates
associated only with the additional hours and added this to the
shipbuilders' reported labor cost growth. Our analysis captures all
costs associated with labor hour growth--including overhead and labor
rates.
[A] Contractor performance reports included $63 million in overhead
costs for CVN 76 and $40 million for CVN 77 that have been disallowed
(not charged to the government).
[End of table]
Increases in labor hours were due in part to an underestimation of the
labor hours necessary to construct the carriers. The shipbuilder
negotiated CVN 76 for approximately 39 million labor hours--only 2.7
million more labor hours than the previous ship--CVN 75. However, CVN
75 was constructed more efficiently because it was the fourth ship of
two concurrent ship procurements. (See table 23.) CVN 76 and CVN 77, in
contrast, were procured as single ships. As table 23 shows, single ship
procurement is historically less efficient than two ship procurements,
requiring more labor hours.
Table 23: Historical Man-hours Used to Produce Prior Ships Compared to
CVN 76 Negotiated Man-hours:
Man-hours in millions.
Hull: CVN 70;
Total man-hours: 36.4;
Labor-hour change: 0;
Type of ship buy: Single;
Contract award date: April 1974.
Hull: CVN 71;
Total man-hours: 44.3;
Labor-hour change: 7.9;
Type of ship buy: Single;
Contract award date: September 1980.
Hull: CVN 72;
Total man-hours: 42.7;
Labor-hour change: (1.6);
Type of ship buy: Two;
Contract award date: December 1982.
Hull: CVN 73;
Total man-hours: 38.2;
Labor-hour change: (4.5);
Type of ship buy: Two;
Contract award date: December 1982.
Hull: CVN 74;
Total man-hours: 36.9;
Labor-hour change: (1.3);
Type of ship buy: Two;
Contract award date: July 1988.
Hull: CVN 75;
Total man-hours: 36.3;
Labor-hour change: (0.6);
Type of ship buy: Two;
Contract award date: July 1988.
Hull: CVN 76;
Total man-hours: 39.0;
Labor-hour change: 2.7;
Type of ship buy: Single;
Contract award date: December 1994.
Sources: Navy, Shipbuilder (data); GAO (analysis).
[End of table]
The shipbuilder and Navy budgeted the same number of hours to construct
CVN 77 as to construct CVN 76, despite forecasts showing that at 55
percent complete CVN 76 would need almost 2 million more hours above
the negotiated hours to complete the ship. To date, CVN 77 is expected
to incur over 4 million man-hours more than negotiated.
Some of the labor hour increase on CVN 76 occurred as a result of
demands for labor on other programs at the shipyard. During
construction of CVN 76, 1 million hours of labor were shifted from the
construction of the carrier to work on the refueling and overhaul of
CVN 68. The Navy deemed the carrier overhaul and refueling effort as a
higher priority than new ship construction because carriers were needed
back in the fleet to meet warfighting requirements. Many of the most
skilled laborers were moved to the refueling effort, leaving fewer
workers to construct CVN 76. Without many of the necessary laborers to
construct the ship, the CVN 76 construction schedule was delayed. In
order to meet construction schedule deadlines employees were tasked to
work significant overtime hours. Studies have shown, however, that
workers perform less efficiently under sustained high overtime.
Problems with late material delivery also led to labor hour increases
on both CVN 76 and CVN 77. When material did not arrive on time, the
shipbuilder tried to work around the missing item in order to remain on
schedule--which is less efficient than had the material been available
when planned. On CVN 77, for example, parts for a critical piping
system were delivered over a year late, necessitating work-arounds and
resequencing of work, driving labor costs up.
Other reasons for labor hour increases on CVN 76 and CVN 77:
CVN 76:
* A 4-month strike in 1999 led to employee shortages in key trades,
contributing to a loss of learning with many employees not returning to
the shipyard. According to Navy officials, the shipbuilder was given
$51 million to offset the strike's impact.
CVN 77:
* Program schedule required concurrent design, planning, material
procurement, and production activities. Additional labor hours were
spent responding to design changes, which ultimately affected CVN 77
cost and schedule.
* Due to unavailability of large-sized steel plates the shipbuilder had
to re-plan the ship's structure so it could be constructed with smaller-
sized plates. This required not only extensive redesign, but resulted
in additional production hours because laborers needed additional time
to fit and weld the smaller plates together.
Overhead and Labor Rates:
While the total overhead and labor rate costs on both the CVN 76 and
CVN 77 grew by $232 million over the life of the contract, labor hour
increases accounted for over half of that amount (See table 6.)
According to Navy officials, some of the overhead cost growth on CVN 76
can be attributed to three major accounting changes since the contract
was awarded in late 1994. While these accounting changes increased
overhead costs, they resulted in a reduction of material costs.
According to the shipbuilder, overhead cost increases on CVN 77 can be
attributed to increases in pension and healthcare costs. Changes in the
shipyard's workload and employee benefit costs also led to overhead
cost increases on CVN 77. After delays in signing contracts for a
carrier overhaul and the next generation aircraft carrier, overhead
costs had to be absorbed by the CVN 77 program.
Table 24: Growth in Overhead Costs and Labor Rates:
Dollars in millions;
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.
Case study ship: CVN 76;
Shipbuilder reported overhead growth[A]: $263;
Increase in overhead related to growth in labor hours: $144;
Increase in overhead related to overhead and labor rates: $119;
Overhead cost as a percent of total contract growth: 19%.
Case study ship: CVN 77;
Shipbuilder reported overhead growth[A]: 219;
Increase in overhead related to growth in labor hours: $107;
Increase in overhead related to overhead and labor rates: $113;
Overhead cost as a percent of total contract growth: 26%.
Total;
Shipbuilder reported overhead growth[A]: $482;
Increase in overhead related to growth in labor hours: $251;
Increase in overhead related to overhead and labor rates: $232.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures only costs associated with
overhead and labor rate changes. Increases in overhead related to
growth in labor hours are captured in the analysis of labor hour
increases.
[A] Contractor performance reports included $63 million in overhead
costs for CVN 76 and $40 million for CVN 77 that have been disallowed
(not charged to the government).
[End of table]
According to the shipbuilder, labor rate increases on CVN 76 resulted
from union negotiations following a strike at the shipyard, as well as
significant use of overtime labor, which is more expensive than normal
hourly wages. According to Navy officials, between 30 and 40 percent of
the work on CVN 76 was done on overtime in 2003.
Navy-Furnished Equipment:
Navy-furnished equipment did not represent an area of cost growth on
CVN 76 and CVN 77. On CVN 76, the costs for propulsion equipment
decreased by close to $145 million--driving down the overall cost of
Navy-furnished equipment. Since 2001, costs for Navy-furnished
equipment on CVN 77, however, have grown by $100 million. This growth
on CVN 77 can be attributed to increases in the cost associated with
the Integrated Warfare System--the carrier's combat system. The
Integrated Warfare System included new phased array radar that was
being developed by the next generation destroyer program. However, when
the radar technology did not become available as planned, the Navy
decided to install a legacy system on the ship. Because the shipbuilder
was suppose to buy and install the Integrated Warfare System as part of
the original contract scope, the costs for the Integrated Warfare
System were removed from the contract and used by the Navy to procure a
legacy system as Navy-furnished equipment.
[End of section]
Appendix IV: San Antonio Class Amphibious Transport Dock Ship:
Program Description:
The San Antonio class amphibious transport dock ship is designed to
transport Marines and their equipment and allow them to land using
helicopters, landing craft, and amphibious vehicles. The class is
expected to increase operational flexibility and survivability over
each ship's 40-year lifespan and to operate at lower cost than previous
amphibious transport ship classes. The new class is also designed to
reduce crew size and provide significant improvements in command,
control, communications, computer, intelligence, and quality of life.
In acquiring LPD 17, the lead ship in the class, a three-dimensional
computer-aided design tool and a shared data tracking system has been
used. The shared data tracking system was intended to provide
significant savings within the San Antonio class program through the
reuse of critical data in future design, construction, and operational
activities. We focused our review on the LPD 17 and 18.
Figure 8: San Antonio Class Amphibious Transport Dock Ship:
[See PDF for image]
[End of figure]
Table 25: Major Events in the Acquisition of LPD 17 and LPD 18:
February 1996;
* Citing industrial base concerns and LPD 17's improved survivability
features, Congress authorized the LPD 17, accelerating the Navy's
schedule by 2 years.
March 1996;
* Initial estimate developed for the class in support of a milestone
review. In developing the estimate, cost analysts used data from the
LHD and LSD amphibious ships, which were constructed in the 1980s. The
LHD is larger than the LPD, and the LSD is less technologically
complex. Cost analysts assumed that technologies would mature on
schedule and that acquisition reforms would produce savings.
December 1996;
* LPD 17 cost-plus award fee contract awarded after a competitive
selection of the Avondale Alliance for detail design and construction
of LPD 17. The contract included options for construction of LPD 18 and
19. Target costs were set for LPD 17 and LPD 18 at $644 million and
$391 million, respectively.
December 1998;
* Contract modified to exercise option for construction of LPD 18.
August 1999;
* Litton Shipbuilding purchased LPD 17's prime contractor, Avondale
Industries.
December 1999;
* Design schedule delays cause a 10-month slip in anticipated delivery
of LPD 17.
August 2000;
* LPD 17 construction begins.
February 2001;
* The Navy and Litton Alliance reassess the lead ship construction
schedule and delay LPD 17 delivery another 14 months to November 2004.
April 2001;
* Northrop Grumman Ship Systems assumed responsibility as primary
contractor for the LPD 17 program through an acquisition that included
Avondale.
September 2001;
* Cost growth led to renegotiation of the contract.
September 2001;
* The contract was converted to cost-plus incentive fee contract. For
LPD 17, the original award fee was based on the total cost of the ship
over its operational lifetime. The incentive fee contract tied the fee
to controlling construction costs. This shifted the focus of the
program from lowering future maintenance costs to delivering the ship.
November 2001;
* Cost growth by more than 43 percent triggered a Nunn- McCurdy unit
cost breach, causing a new baseline to be established in June 2002 and
requiring $1.4 billion in additional funding.
February 2002;
* LPD 18 construction begins.
June 2002;
* With the Navy's approval, Northrop Grumman Ship Systems and Bath Iron
Works agreed to a swap that shifts all LPD construction, including LPD
19, to Northrop Grumman and all future DDG 51 ships to Bath Iron Works.
February 2005;
* Navy requests $25 million in additional prior year completion funding
for LPD 18.
May 2005;
* LPD 17 expected delivery date.
September 2005;
* LPD 18 expected delivery.
Sources: Navy, shipbuilder (data); GAO (presentation).
[End of table]
Cost Experience on LPD 17 and LPD 18:
Budgets for the two LPD case study ships have grown by $1 billion, and
funds have been appropriated to cover these increases. However, the
Navy could need additional appropriations of $200 million to $300
million to fund projected cost growth.
For detail design and construction of LPD 17, the Congress initially
appropriated $953.7 million to fund the construction contract (the
basic contract plus a budget for future changes) and acquisition of
Navy-furnished equipment. The Congress later appropriated $762 million
to fund LPD 18 construction. (See table 26.)
Table 26: Growth in Program Budgets for Case Study Ships:
Dollars in millions.
Case study ship: LPD 17;
Initial and FY2005 President's budget: Initial: $954;
Initial and FY2005 President's budget: FY2005: $1,758;
Initial and FY 2005 President's budget: FY 2005: $804;
Difference in budgets: Difference due to Navy-furnished equipment: $21;
Difference in budgets: Difference due to construction costs[A]: $784.
Case study ship: LPD 18;
Initial and FY2005 President's budget: Initial: 762;
Initial and FY2005 President's budget: FY2005: 1,011;
Initial and FY 2005 President's budget: FY 2005: $249;
Difference in budgets: Difference due to Navy-furnished equipment: $3;
Difference in budgets: Difference due to construction costs[A]: $246.
Total;
Initial and FY2005 President's budget: Initial: $1,716;
Initial and FY2005 President's budget: FY2005: $2,769;
Initial and FY 2005 President's budget: FY 2005: $1,053;
Difference in budgets: Difference due to Navy-furnished equipment: $24;
Difference in budgets: Difference due to construction costs[A]: $1,030.
Sources: Navy (data); GAO (presentation).
[A] Part of the increased cost is due to changes in the scope of the
contract.
[End of table]
Since that time, the Congress has appropriated $1 billion to cover the
increases in the ships' costs. However, more funds will likely be
needed to cover additional cost growth for these two ships. We project
that, if the current schedule is maintained, total cost growth for the
LPD 17 and LPD 18 will exceed $1.2 billion and possibly reach $1.4
billion. (See table 27.)
Table 27: GAO's Forecasts of Additional Cost Growth for Construction:
Dollars in millions;
Analysis based on data through May 2004.
Case study ship: LPD 17;
Percent of ship construction completed: 95%;
Amount already requested to cover increased cost: $784;
GAO's forecast for additional Cost growth: $112-$197;
GAO's forecast of total Cost growth: $896-$981.
Case study ship: LPD 18;
Percent of ship construction completed: 67;
Amount already requested to cover increased cost: 246;
GAO's forecast for additional Cost growth: $102-136;
GAO's forecast of total Cost growth: $348-382.
Total growth;
Amount already requested to cover increased cost: $1,030;
GAO's forecast for additional Cost growth: $214-333;
GAO's forecast of total Cost growth: $1,244-1363.
Sources: Navy, Shipbuilder (data); GAO (analysis).
Note: Cost growth is measured from original contract price, not from
the current contract target price. Forecast reflects expected price to
the Navy.
[End of table]
Our cost growth estimates--both low and high--are likely understated
because we assumed that the shipyards will maintain their current
efficiency through the end of their contracts and meet scheduled
milestones. LPD 17 did not meet the planned December 2004 delivery
date. Delivery is now scheduled for May 2005, increasing the final cost
of the ship.
Main Drivers of Cost Growth for LPD 17 and LPD 18:
Increases in labor hour and material costs account for 76 percent of
the cost growth on LPD 17 and LPD 18 construction contracts. Navy-
furnished equipment--including radars, propulsion equipment, and weapon
systems--represents just 2 percent of the cost growth. The remaining 22
percent was due to increases in overhead and labor rates. (See fig. 9.)
Figure 9: Average Sources of Cost Growth on LPD 17 and LPD 18:
[See PDF for image]
[End of figure]
The shipbuilder cited a number of direct causes for the labor hour,
material, and overhead cost growth in the two case study ships. The
most common causes were related to the concurrent development of a new
and unproven design tool and design of the lead ship, initial focus on
controlling total lifetime costs, and changes in employee pay and
benefits.
Materials:
Engineering costs (classified as material costs) associated with use of
a three-dimensional product model to design LPD 17 were a key
contributor to material cost growth. The design tool was not fully
developed and subsequent problems affected all aspects of the design.
Subcontracts for engineering design doubled, accounting for $215
million in cost growth on LPD 17. Development of an integrated
production data environment, originally assumed to be funded by the
state, has instead been shifted to the contract, representing an
additional $35 million in cost spread across LPD. (See table 28.)
Table 28: Growth in Material Costs:
Dollars in millions;
Analysis based on data through May 2004.
Case study ship: LPD 17;
Increased material costs: $400;
Percent increase: 103%%;
Material cost as a percent of total contract growth: 47%.
Case study ship: LPD 18;
Increased material costs: $93;
Percent increase: 39%;
Material cost as a percent of total contract growth: 24%.
Total;
Increased material costs: $493.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
Labor Hours:
Labor hours, the second largest component of cost growth, increased
significantly for the LPD 17 and LPD 18. For example, engineering labor
hours for the LPD 17 increased by over 100 percent from the original
proposal.
As the number of hours to construct the ship increased, total labor
costs grew, with the shipbuilder paying for additional overhead costs
and employee wages. We separated the overhead and labor rates
associated only with the additional hours and added this to the
shipbuilder's reported labor cost growth. (See table 29.) Our analysis
captures all cost growth associated with labor--including labor hours,
overhead, and labor rates.
Table 29: Growth in Labor Hour Costs:
Dollars in millions; Analysis based on data through May 2004.
Case study ship: LPD 17 [A];
Shipbuilder reported labor Cost growth: $182;
Overhead and labor rate costs for increased labor hours: $102;
Total cost due to increased labor hours: $284;
Labor hour cost as a percent of total contract growth: 33%.
Case study ship: LPD 18;
Shipbuilder reported labor Cost growth: $117;
Overhead and labor rate costs for increased labor hours: 67;
Total cost due to increased labor hours: $184;
Labor hour cost as a percent of total contract growth: 48%.
Total;
Shipbuilder reported labor Cost growth: $299;
Overhead and labor rate costs for increased labor hours: $169;
Total cost due to increased labor hours: $468.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures all costs associated with
labor hour growth, including overhead and labor rates.
[A] LPD 17 relied heavily on subcontracted labor to design the ship.
Since these costs are captured as material, we did not include them in
our analysis of labor cost increases.
[End of table]
Factory inefficiencies and loss of skilled laborers, including
significant employee attrition (35 percent annually) contributed
significantly to labor hour increases. Difficulties with the design
tool and turnover in engineering staff led to increases in engineering
labor hours and delayed achieving a stable design. Without a stable
design, work was often delayed from early in the building cycle to
later, during integration of the hull. Shipbuilders stated that doing
the work at this stage could cost up to five times the original cost.
On LPD 17, 1.3 million labor hours were moved from the build phase to
the integration phase. Consequently, LPD 17 took much longer to
construct than originally estimated. Moreover, a diminished workforce
at Avondale required the busing of shipyard workers from Ingalls
Shipyard in Pascagoula, Mississippi to Avondale in New Orleans,
Louisiana and the subcontracting of skilled labor.
Program Overhead and Labor Rates:
While the total overhead costs on both the LPD 17 and 18 grew by $0.5
billion over the life of the contract, labor hour increases contributed
to about half of that amount. (See table 30.)
Table 30: Growth in Overhead Costs and Labor Rates:
Dollars in millions;
Analysis based on data through May 2004.
Case study ship: LPD 17;
Shipbuilder reported overhead growth: $277;
Portion related to growth in labor hours: $102;
Portion related to overhead and labor rates: $175;
Overhead cost rate increases as a percent of total contract growth:
20%.
Case study ship: LPD 18;
Shipbuilder reported overhead growth: $177;
Portion related to growth in labor hours: $67;
Portion related to overhead and labor rates: $110;
Overhead cost rate increases as a percent of total contract growth:
28%.
Total;
Shipbuilder reported overhead growth: $454;
Portion related to growth in labor hours: $169;
Portion related to overhead and labor rates: $285.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures only costs associated with
overhead and labor rate changes. Increases in overhead related to
growth in labor hours are captured in the analysis of labor hour
increases.
[End of table]
According to Northrop Grumman, increases in overhead costs not related
to labor hour growth can be attributed largely to changes in the
shipyard's workload and employee benefit costs. Beginning in 2001, the
shipyard experienced a rise in overhead rates. For example, the
overhead rates in the 2004 latest estimate by Northrop Grumman are 39
percent higher than what was originally proposed on the LPD 17 in 1996.
Several factors helped to increase overhead. For example;
due to the loss of the bulk military cargo T-AKE ship, the cancellation
of the construction of a commercial ship (American Classics Voyage),
and the delay in signing the contract for the next generation
destroyer, overhead costs had to be absorbed by the remaining contracts
at the yard, including LPD. This led to 36 percent of the increase in
overhead rates--24 percent for the T-AKE and cruise ship and 12 percent
for DD(X).
According to the shipyard, changes in the financial market affected the
pension fund and the rise in medical care costs were responsible for 16
percent of the increase in the shipyards overhead rates.
Labor rates rose due to inflation impacts of an over 2-year delay in
lead ship delivery and subsequent changes in the procurement schedule
and wage rates negotiated with labor unions.
Navy-Furnished Equipment:
According to program officials, cost growth for Navy-furnished
equipment on the LPD 17 was due to increased costs for a shock wave
test that was not anticipated in the original cost estimate. This cost
was a one-time increase, affecting only LPD 17 costs.
[End of section]
Appendix V: Virginia Class Submarine:
Program Description:
The Virginia-class attack submarine, the newest class of nuclear
submarines, is designed to combat enemy submarine and surface ships,
fire cruise missiles at land targets, and provide improved surveillance
and special operations support to enhance littoral warfare. Because the
Virginia class is designed to be smaller than the Seawolf and slightly
larger than the Los Angeles class submarines--ships the new class will
eventually replace--the Virginia class is better suited for conducting
shallow-water operations. Major features of this new class of submarine
include new acoustic, visual, and electronic systems for enhanced
stealth. An objective of Virginia class is to reduce the life-cycle
cost through better design and engineering resulting in one third fewer
man-hours than were needed to construct Seawolf (SSN 21), the lead ship
in the previous class of attack submarines. The first ship, the SSN
774, was delivered in October 2004. Our review focused on the SSN 774
and 775.
Figure 10: Virginia Class Submarine:
[See PDF for image]
[End of figure]
Table 31: Major Events in the Acquisition of SSN 774 and SSN 775:
October 1991;
* Program initiated with focus on building more versatile and less
costly submarines.
July 1994;
* Initial estimate developed for Virginia class based on historical
data from Seawolf (SSN 21) and Los Angeles (SSN 688) classes. A sole
source contract with Electric Boat was planned. Major challenges
involved estimating new technologies still under development and
estimating the cost impact of a 6-year gap in submarine production.
January 1996;
* Contract for $1.4 billion awarded to Electric Boat for detail design
of Virginia class. Approximately 3.4 million man-hours for one-time
production start up activities were included.
February 1997;
* Cost analysts updated estimates to reflect proposed shipbuilder
teaming agreement between Electric Boat and Newport News Shipbuilding
assuming teaming would be less expensive than dual sources due to
shipbuilder collaboration. Costs were increased to reflect additional
non-recurring effort for Newport News to reconstitute submarine
production.
February 1998;
* Based on congressional direction that teaming agreement would be the
most efficient way to produce submarines in a low rate production
environment, the Navy authorized a teaming agreement between Electric
Boat and Newport News Shipbuilding. Deliveries of the ships would
alternate between shipyards with Electric Boat delivering the first
ship. According to the Navy, this change increased the estimated cost
of developing and building 30 submarines when compared to building them
in a single yard.
September 1998;
* Contract is modified by $1.028 billion to fund construction of
Electric Boat's SSN 774 lead ship. Options for construction of SSN
775 - 777 were included.
October 1998;
* Construction of SSN 774 begins.
December 1998;
* Contract is modified by $1.084 billion to initiate construction of
Newport News Shipbuilding's SSN 775 lead ship.
September 1999;
* Construction of SSN 775 begins.
February 2001;
* Navy requests $119 million for Virginia class in prior year funding
to cover cost growth.
December 2001;
* Northrop Grumman Corporation acquires Newport News Shipbuilding
creating Northrop Grumman Newport News.
February 2002;
* Prior year completion request of $227 million for Virginia class.
April 2003;
* Prior year completion request of $327 million for Virginia class
triggers a Nunn-McCurdy unit cost breach.
June 2004;
* Planned delivery date for SSN 774.
October 2004;
* SSN 774 delivered 4 months late, an improvement over the Seawolf and
Los Angeles lead ships which were delivered 25 and 26 months late,
respectively.
February 2005;
* Fiscal Year 2006 President's Budget recognizes an increase in the
budget of $82 million for SSN 774 and $223 million for SSN 775. These
increases are funded through transfer of funds and prior year funding
of $28 million for SSN 774 and $97 million for SSN 775.
June 2005;
* Initial planned delivery date for SSN 775.
March 2006;
* Current planned delivery date for SSN 775.
Sources: Navy, shipbuilder (data); GAO (presentation).
[End of table]
Cost Experience on SSN 774 and SSN 775:
The Fiscal Year 2005 President's Budget showed that budgets for the two
Virginia class case study ships have increased by $734 million.
However, based on data of July 2004, we projected additional cost
growth on contracts for the two ships is likely to reach $840 million
and could be higher. In fiscal year 2006 budget, the Navy has requested
funds to cover cost increases that are now expected to reach
approximately $1 billion.
The fiscal year 2005 budget for the SSN 774 and SSN 775 is about $6.2
billion, compared with the initial fiscal year 1998 budget request of
$5.5 billion. (See table 32.) Ship construction costs comprise the
majority of this increase.
Table 32: Growth in Program Budgets for Case Study Ships:
Dollars in millions.
Case study ship: SSN 774;
Initial and FY2005 President's budget: Initial: $3,260;
Initial and FY2005 President's budget: FY2005: $3,682;
Initial and FY 2005 President's budget: FY 2005: $422;
Difference in budgets: Difference due to Navy-furnished equipment: $95;
Difference in budgets: Difference due to construction costs[A]: $327.
Case study ship: SSN 775;
Initial and FY2005 President's budget: Initial: 2,192;
Initial and FY2005 President's budget: FY2005: 2,504;
Initial and FY 2005 President's budget: FY 2005: $312;
Difference in budgets: Difference due to Navy-furnished equipment: $18;
Difference in budgets: Difference due to construction costs[A]: $294.
Total;
Initial and FY2005 President's budget: Initial: $5,452;
Initial and FY2005 President's budget: FY2005: $6,186;
Initial and FY 2005 President's budget: FY 2005: $734;
Difference in budgets: Difference due to Navy-furnished equipment:
$113;
Difference in budgets: Difference due to construction costs[A]: $621.
Sources: Navy (data); GAO (presentation).
[A] Part of the increased cost is due to changes in the scope of the
contract.
[End of table]
While the Congress has appropriated funds to cover the increases in the
ships' costs, more funds will be needed to cover additional cost growth
for these two ships. In its fiscal year 2006 budget submission the Navy
is requesting an additional $125 million in prior year completion
funding between fiscal years 2006 to 2007 for the case study ships. We
calculated a range of the potential growth for the two case study ships
and found that the total projected cost growth is likely to exceed $724
million and could reach $840 million or higher. (See table 33.)
Table 33: GAO's Forecasts of Additional Cost Growth for Construction:
Dollars in millions; Analysis based on July 2004 data.
Case study ship: SSN 774;
Percent of ship construction completed: Delivered;
Amount already requested to cover contractor's increased cost: $327[A];
GAO's forecast for additional Cost growth: $0-0;
GAO's forecast of total Cost growth: $327-327.
Case study ship: SSN 775;
Percent of ship construction completed: 88%;
Amount already requested to cover contractor's increased cost: $294;
GAO's forecast for additional Cost growth: $103-219;
GAO's forecast of total Cost growth: $397-513.
Total growth;
Amount already requested to cover contractor's increased cost: $621;
GAO's forecast for additional Cost growth: $103- 219;
GAO's forecast of total Cost growth: $724-840.
Sources: Navy (data); GAO (analysis).
[A] Program officials indicated that $70 million in additional funding
has been requested for SSN 774 completion.
[End of table]
Our cost growth estimates--both low and high--may be understated
because we assumed that the shipbuilders will maintain their current
efficiency through the end of their contracts and meet scheduled
milestones. Any slips in efficiency and schedules would likely result
in added costs. For example, the delivery date for SSN 775 is expected
to slip by as many as 8.5 months, which could increase the final cost
of the ship.
Main Drivers of Cost Growth for SSN 774 and SSN 775:
Our analysis shows that the submarine contract costs have grown because
initial construction costs were underestimated--especially the costs
associated with the cost of material and number of labor hours needed
to build the ships. For the two case study ships we examined, we found
that increases in the number of labor hours and material costs to build
the submarines accounted for 83 percent of the cost growth on
shipbuilding construction contracts. Navy-furnished equipment,
including radars, propulsion equipment, and weapon systems, caused 14
percent of the cost growth. We found that ship overhead--such as
employee benefits and shipyard support costs--and labor rate increases
accounted for 3 percent of cost growth.
Figure 11: Average Sources of Cost Growth on SSN 774 and SSN 775:
[See PDF for image]
[End of figure]
In negotiating the contract for the first four Virginia class ships,
program officials stated they were constrained in negotiating the
target price to the amount funded for the program, thereby risking cost
growth at the outset. The shipbuilders said that they accepted a
challenge to design and construct these ships for $748 million less
than their estimated costs because the contract protected their
financial risk. Despite the fact that there was significant risk of
cost growth, the Navy, based on guidance at the time, did not identify
any funding for probable cost growth.
We analyzed shipbuilder contract costs to identify the sources of cost
growth. Using shipbuilder cost data, we allocated the sources of
shipbuilder cost growth on the contract into three categories--labor
hours; material costs; and labor and overhead rates. Since labor costs
and overhead costs can change due to labor hours, labor rates, and
rates associated with individual elements of overhead--or a combination
of these--we examined each in isolation by separating the program
overhead cost associated with an increase in labor hours from costs
that resulted from an increase in overhead rates, such as an increase
in health care costs.
Materials:
Due to high risk that specialized material could not be procured for
the amount budgeted, the Navy agreed to purchase this material as a
cost plus fixed fee item. This agreement protected the shipbuilder from
having to fund any resulting cost increases for highly specialized
material. Indeed, cost growth for material increased by $350 million
for the two Virginia class submarines we examined.
Table 34: Growth in Material Costs:
Dollars in millions;
Analysis based on July 2004 data.
Case study ship: SSN 774;
Total dollars due to increased material costs: $141;
Percent increase: 43%;
Material cost as a percent of total contract growth: 49%.
Case study ship: SSN 775;
Total dollars due to increased material costs: $209;
Percent increase: 56%;
Material cost as a percent of total contract growth: 49%.
Total;
Total dollars due to increased material costs: $350;
Percent increase: 99%.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events.
[End of table]
The Navy and shipbuilders attribute material cost growth to several
factors including:
* unrealistic budgets not supported by current vendor costs,
* diminished supplier base for highly specialized materials,
* nonrecurring costs for Computer Data Integration between shipbuilder
teams,
* lack of design maturity for certain electronic components, and:
* full funding of ships in the year of authorization.
Shipbuilders stated they based more than 70 percent of their estimate
for major material costs on updated vendor quotes while the Navy relied
on historical costs that were not analogous to the low number of
submarines being planned for construction. While the Navy knew there
would be a price penalty for a 6-year gap in submarine production,
there were no studies or actual data to support what the overall effect
would be. Thus, Navy cost estimators assumed that costs for major
material items would increase by 20 percent. When the Navy negotiated
the costs for Virginia-class high value, specialized material, the
shipbuilder agreed to take on the challenge of achieving lower costs in
exchange for funding these materials on a cost-plus-fixed-fee
basis.[Footnote 23] By the time the lead ship was delivered 8 years
later, the true cost increase for highly specialized material was
closer to 60 percent more than historical costs.
Following the cancellation of the prior submarine program--Seawolf--and
a decrease in submarine production of three to four submarines per year
to one over a period of 6 years, many vendors left the nuclear
submarine business and focused instead on more lucrative commercial
product development. As a result, prices for highly specialized
material increased due to less competition and a lack of business. For
example, many vendors were reluctant to support the Virginia class
submarine contract because costs associated with producing small
quantities of highly specialized materials were not considered worth
the investment--especially for equipment with no other military or
commercial applications.
Material costs also increased due to nonrecurring costs for integrating
computer data so that the shipbuilders could work from a common design.
In addition, costs to develop high-risk systems like the array and
exterior communication system were underestimated. Recognizing the
significant cost risk involved, the Navy procured these systems under a
separate contract line item that guaranteed the shipbuilders a fixed
fee and made the Navy responsible for funding all cost growth.
Finally, the Navy believes that the block-buy contract has contributed
to increased material costs. Under a block-buy contract, subcontracts
for submarine materials are for single ships spread over several years.
According to the Navy, this type of acquisition approach does not take
advantage of bulk-buy savings and incurs the risk that funding will not
be available in time to order the material when needed. In addition,
since ships are funded individually, the Navy believes suppliers are
unwilling to risk investing in technology improvements due to the
uncertainty that future ships will not be purchased. To stabilize the
vendor base, the Navy awarded a multiyear contract that commits the
Navy to purchasing additional submarines. While a multiyear contract
can provide such savings, a program must meet criteria to demonstrate a
sufficient level of stability for such a contract. In June 2003, we
noted several aspects of the Virginia class program that indicated
instability.[Footnote 24] Another factor to be considered in using
multiyear contracts is the budget flexibility the government gives up
in exchange for the commitment of funds for the future years of the
contract.
Labor Hours:
Labor cost increases have led to $339 million in cost growth for the
SSN 774 and SSN 775 combined. Problems with mastering state-of-the art
design tools, first in class technical and teaming issues, and material
availability all contributed to the labor cost growth.
Table 35: Growth in Labor Hour Costs:
Dollars in millions;
Analysis based on July 2004 data.
Case study ship: SSN 774;
Shipbuilder reported labor Cost growth: $149;
Overhead and labor rate costs for increased labor hours: $10;
Total cost due to increased labor hours: $159;
Labor hour cost as a percent of total contract growth: 55%.
Case study ship: SSN 775;
Shipbuilder reported labor Cost growth: $218;
Overhead and labor rate costs for increased labor hours: ($38);
Total cost due to increased labor hours: $180;
Labor hour cost as a percent of total contract growth: 42%.
Total;
Shipbuilder reported labor Cost growth: $367;
Overhead and labor rate costs for increased labor hours: ($28);
Total cost due to increased labor hours: $339.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures all costs associated with
labor hour growth, including overhead and labor rates.
[End of table]
We found that SSN 774 required almost 3 million additional labor hours
than planned, reflecting a growth of 25 percent. (See fig. 12.) In
addition, we found that SSN 775 required almost 4 million more labor
hours than planned. Approximately 3.4 million nonrecurring labor hours
for SSN 774 were procured on a separate contract line item and
therefore not included in our analysis while some SSN 775 nonrecurring
labor hours are embedded in the labor hours for that ship.
Figure 12: SSN 774 Lead Ship Labor Hour Growth:
[See PDF for image]
[End of figure]
Technical issues commonly associated with first-in-class ships also
contributed to the overall labor cost growth. For example, shipbuilders
experienced problems with crossed hydraulic lines on the lead ship. In
addition, problems with the torpedo tube and weapons handling design
issues also contributed to labor hour growth in both ships. Labor hours
also increased as quality problems discovered for a component made by
one shipyard were reworked by the shipyard integrating the components.
Because the shipyard doing the integration was not as familiar with the
effort, the work was not completed as efficiently.
Late material deliveries also disrupted the work-flow sequence. Because
many vendors either went out of business or focused on developing new
commercial products in response to low demand, the Navy was no longer
considered a preferred customer. In cases where there was no ready
supplier, the shipbuilder had to request old subcontractors to supply
the highly specialized material. This caused delays in material
deliveries as well as quality problems arising from strict inspection
processes that subcontractors were no longer familiar with. Although
the shipbuilders tried to work around late material deliveries when
they could, this caused workers to perform less efficiently than had
the material been available when scheduled. Moreover, when the material
did arrive, the shipbuilders had to work overtime to make up the
schedule causing additional growth in labor costs.
Navy-Furnished Equipment:
According to Navy program officials, radar costs increased due to more
design effort needed to fix problems associated with the Seawolf
program. Other costs increases were driven by changes in how certain
items were purchased. For example, the advanced display system was
recently established as a line item in the budget when in the past it
was paid for as part of the shipbuilder's construction contract.
Moreover, the Navy initially planned to use research and development
funds to cover costs for the propulsor but switched to ship
construction funds instead, leading to an increase in the program's
budget for Navy-furnished equipment.
Ship Overhead and Labor Rates:
Our analysis shows that program overhead costs and increases in labor
rates were not significant sources of cost growth--causing
approximately 3 percent of the cost growth. To isolate true increases
in overhead rates from increases that were a consequence of labor hour
increases, we separate the two in table 36.
Table 36: Growth in Overhead Costs and Labor Rates:
Dollars in millions;
Analysis based on July 2004 data.
Case study ship: SSN 774;
Shipbuilder reported overhead growth: $0;
Increase in overhead related to growth in labor hours: $10;
Increase in overhead related to overhead and labor rates: ($10);
Overhead cost as a percent of total contract growth: (3%).
Case study ship: SSN 775;
Shipbuilder reported overhead growth: $0;
Increase in overhead related to growth in labor hours: ($38);
Increase in overhead related to overhead and labor rates: $38;
Overhead cost as a percent of total contract growth: 9%.
Total;
Shipbuilder reported overhead growth: $0;
Increase in overhead related to growth in labor hours: ($28);
Increase in overhead related to overhead and labor rates: $28.
Sources: Shipbuilder (data); GAO (analysis).
Note: We compared initial target cost to the current estimate at
completion to determine total contract cost growth. Cost growth may be
due to Navy changes in contract scope, shipbuilder performance, or
unanticipated events. Our analysis captures only costs associated with
overhead and labor rate changes. Increases in overhead related to
growth in labor hours are captured in the analysis of labor hour
increases.
[End of table]
Costs associated with growth in labor hours are shown in table 35
calculations.
According to the shipbuilder, overhead and labor rate increases were
related to pension, workers compensation, and health care costs rising
beyond what was expected. Furthermore, when other ship acquisitions did
not materialize, shipyard overhead costs were spread over a fewer
number of contracts causing an increase in the Virginia class overhead
costs. Similarly, the loss of business caused the shipbuilders to lay
off skilled workers. According to the shipbuilders, many of the
experienced workers did not return to the shipyard. Hiring and training
new workers increased costs.
[End of section]
We found that one shipbuilder was affected by labor rate increases.
Following a strike at the shipyard, union negotiations resulted in four
pay increases totaling an average of $3.10 per hour.
[End of section]
Appendix VI: GAO's Forecast of Additional Costs to Complete
Construction Contracts:
This appendix discusses GAO's forecast of future cost growth for all
ships in construction that are more than 30 percent complete. The
forecast is also compared with the shipbuilders' forecasts of estimated
costs at completion.
Figure 13: Comparison of Shipbuilders' and GAO's Forecasts of
Additional Construction Costs for Six Classes of Ships Actively under
Construction:
[See PDF for image]
Notes: Active construction in this table means ships are at least 30
percent complete. Cost growth figures are in millions of dollars.
Ships' names that are bolded are case study ships.
[A] We based the lower end of our cost forecast range on the costs
spent to date added to the forecast cost of work remaining. The
remaining work was forecasted using the cumulative cost performance
index efficiency factor. Studies have shown that using this method is a
reasonable estimate of the lower bound of the final cost.
[B] For the upper end of our cost range, we relied on either the actual
costs spent to date added to the forecast of remaining work with an
average monthly cost and schedule performance index or a cost/percent
complete trend analysis, whichever was higher.
[End of figure]
* CVN 76 and CVN 77: CVN 76 was delivered to the Navy in 2003. While we
forecasted an overrun of up to $586 million over the initial target
price for CVN 77, the fiscal year 2006 budget request indicates a need
of $870 million in prior year funding.
* SSN 774-SSN 777: SSN 774 was delivered to the Navy in October 2004.
We found that the contractors' forecasts are unlikely to be achieved
based on continuing cost growth on the remaining 3 ships. In addition,
the SSN 776 and SSN 777 are the follow-on ships to a new class and
still may experience production problems that could lead to future cost
growth.
* DDG 91-DDG 101: The DDGs have experienced cost growth at both
shipyards. All the DDGs under construction at Bath Iron Works and more
than 30% complete have experienced cost growth. Similarly, cost growth
is also expected on the DDGs built by Northrop Grumman.
* LPD 17-LPD 20: LPDs currently under construction are likely to
experience significant cost overruns. On all of the LPDs, with the
exception of LPD 18, the shipbuilder is estimating overall cost growth
to be at the lower end of our predicted range. Hence we believe, the
shipbuilder's forecast of cost growth is optimistic.
* T-AKE: Major cost growth is being predicted for T-AKE 1. We estimate
that costs could grow more than $70 million beyond the initial contract
price. The shipbuilder believes that escalating material costs
resulting from rising commodity prices and unfinalized vendor
subcontracts are driving contract cost growth.
* LHD 8: It also has the potential for significant cost growth--as much
as $177 million more than what was anticipated. Cost growth thus far is
attributed to increases in overhead and general and administrative
costs.
[End of section]
Appendix VII: Comments from the Department of Defense:
OFFICE OF THE UNDER SECRETARY OF DEFENSE:
ACQUISITION, TECHNOLOGY AND LOGISTICS:
3000 DEFENSE PENTAGON:
WASHINGTON, DC 20301-3000:
FEB 01 2005:
Mr. Paul L. Francis:
Director, Acquisition and Sourcing Management:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Francis:
This is the Department of Defense (DoD) response to the Government
Accountability Office (GAO) draft report, "DEFENSE ACQUISITIONS:
Improved Management Practices Could Help Minimize Cost Growth in Navy
Shipbuilding Programs," dated December 23, 2004 (GAO Code 120237/GAO-
05-183).
The Department has reviewed the draft report and concurs with two of
the recommendations and partially concurs with the remainder. I am
enclosing specific DoD comments that address each of the seven
recommendations. We have previously provided technical comments
directly to the GAO staff for consideration.
We appreciate the opportunity to comment on the draft report.
Sincerely,
Signed for:
Glenn F. Lamartin:
Director:
Defense Systems:
Enclosure: As stated:
GAO DRAFT REPORT - DATED DECEMBER 23, 2004
GAO CODE 120237/GAO-05-183:
"DEFENSE ACQUISITIONS: IMPROVED MANAGEMENT PRACTICES COULD HELP
MINIMIZE COST GROWTH IN NAVY SHIPBUILDING PROGRAMS"
DEPARTMENT OF DEFENSE COMMENTS TO THE RECOMMENDATIONS:
RECOMMENDATION 1: The GAO recommended that the Secretary of Defense
conduct independent reviews for all follow-on ships when significant
changes occur to the program. (p. 28/GAO Draft Report):
DOD RESPONSE: Partially concur.
In accordance with Title 10, USC Sec. 2434, an independent cost
estimate (ICE) is required for all major defense acquisition programs
(MDAPs). The current Department of Defense practice is to have the ICE
prepared by the Office of the Secretary of Defense (OSD) Cost Analysis
Improvement Group (CAIG) in support of Milestone B decisions on Navy
MDAPs, including ship programs, that are designated ACAT 1D. The
USD(AT&L) will request the CAIG conduct additional independent cost
estimates or assessments, if needed, to support follow-on ship
decisions after Milestone B. For Navy MDAPs designated as ACAT 1C,
whereby the Navy Service Acquisition Executive is the Milestone
Decision Authority, the Naval Cost Analysis Division performs the
independent cost estimate.
RECOMMENDATION 2: The GAO recommended that the Secretary of Defense
conduct independent reviews of every acquisition of an aircraft
carrier. (p. 28/GAO Draft Report):
DOD RESPONSE: Concur.
This recommendation is consistent with the Department's current
approach for the CVN 21 aircraft carrier program.
RECOMMENDATION 3: The GAO recommended that the Secretary of Defense
direct the Secretary of the Navy develop a confidence level for all
ship cost estimates, based on risk and uncertainty analysis. (p. 28/GAO
Draft Report):
DOD RESPONSE: Concur.
The Navy is already pursuing this action and therefore the Secretary of
Defense does not need to provide further direction to implement the
recommendation. The Naval Sea Systems Command conducted training of 60
staff members in quantitative risk analysis in October 2004 to support
introduction of these techniques in shipbuilding platform cost
estimating.
RECOMMENDATION 4: The GAO recommended that the Secretary of Defense
direct the Secretary of the Navy to negotiate prices for construction
of the lead ship separately from the pricing of detail design. (p. 29/
GAO Draft Report):
DOD RESPONSE: Partially concur.
The Department will consider this on a case-by-case basis as the
Department develops the acquisition strategy for each individual
program. The Navy currently negotiates the lead ship construction and
the detail design prices as separate distinct contract line items based
on the best information available, within the negotiation process.
Negotiation of ship contracts is an involved and time-consuming process
that can extend several months. Separating pricing of the lead ship
until detail design is complete could result in loss of significant
leverage in the contract negotiations and might not be a cost effective
strategy for smaller shipbuilding programs with shorter construction
periods.
RECOMMENDATION 5: The GAO recommended that the Secretary of Defense
direct the Secretary of the Navy to separate pricing of follow-on ships
from pricing of lead ships, negotiating prices for early ships in the
budget year in which the ship is authorized and funded. (p. 29/GAO
Draft Report):
DOD RESPONSE: Partially concur.
The Department will consider this on a case-by-case basis as the
Department develops the acquisition strategy for each individual
program. Negotiation of ship contracts is an involved and time-
consuming process that can extend several months. In programs with a
lengthy period of time between ship procurements (i.e., aircraft
carriers), this is the Department's current practice. However, this
concept proves difficult to implement in programs with annual
procurements (i.e., submarines). In the early stages of an annual
procurement program, there is little cost data from the previous (or
lead) ship that the Navy can use as a baseline. Until actual cost data
is available, the Navy uses the cost estimate based on the best data
available at the time. Additionally, because of the rigorous
negotiations that are common to shipbuilding, in an annual procurement
cycle, negotiations for the next ship would have to begin within three
months of the award for the previous ship contract.
RECOMMENDATION 6: The GAO recommended that the Secretary of Defense
direct the Secretary of the Navy to require that shipbuilders submit
monthly cost performance reports. (p. 29/GAO Draft Report):
DOD RESPONSE: Partially concur.
The Navy is currently undertaking this initiative with every program
and therefore the Secretary of Defense does not need to provide further
direction to implement the recommendation. All of the programs examined
by the GAO, with the exception of the CVN 77 and SSN 774 programs,
receive reports on a monthly basis. The CVN 77 program will begin
receiving monthly cost performance reports in March 2006. The SSN 774
Virginia class program receives bi-weekly labor hour performance data,
typically within ten days of the close of the accounting period through
the Integrated Management and Control System. General Dynamics,
Electric Boat provides the SSN 774 data for both of the construction
shipyards.
RECOMMENDATION 7: The GAO recommended that the Secretary of Defense
direct the Secretary of the Navy to require shipbuilders to prepare
variance analysis reports that identify root causes of reported
variances, associated mitigation efforts, and future cost impacts. (p.
29/GAO Draft Report):
DOD RESPONSE: Partially concur.
The Navy already requires shipbuilders to do this because they have
invoked the DoD and industry guidance that requires variance reporting
and analysis as part of earned value management. Therefore the
Secretary of Defense does not need to provide further direction to
implement the recommendation. Variance analysis is only one of many
tools available to the Program Manager. The Program Office must also
maintain oversight and monitor performance at the shipyard and major
Government Furnished Equipment (GFE) vendors. The Supervisor of
Shipbuilding monitors shipyard performance and the Defense Contract
Management Agency provides contract oversight for major Navy furnished
equipment procurement. Both organizations provide on-site
representation and maintain daily communication with the Program
Office. Furthermore, the Navy holds quarterly production reviews with
the shipbuilders to resolve cost and schedule issues. These reviews
occur throughout the entire construction/production process to identify
root causes for many issues, including reported variances.
[End of section]
Appendix VIII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Paul L. Francis (202) 512-2811;
Karen Zuckerstein (202) 512-6785:
Acknowledgments:
In addition to the contacts named above, Margaret B. McDavid, Christina
Connelly, Diana Dinkelacker, Christopher R. Durbin, Jennifer Echard, R.
Gaines Hensley, Ricardo Marquez, Christopher R. Miller, Madhav Panwar,
Karen Richey, Karen Sloan, Lily Chin, and Marie Ahearn made key
contributions to this report.
FOOTNOTES
[1] The contract also includes funds for the cost of money.
[2] See Federal Acquisition Regulation Part 16.
[3] These costs are items provided by the Navy to the contractor for
installation on the ship. The Navy pays for this equipment--not the
shipbuilder.
[4] Cost estimates are based, in part, on the number of units produced
and learning curves--the more units produced, the less expensive each
unit is expected to be. Thus, if contractors and subcontractors are
assured a high, consistent level of business, they are able to produce
the ship and ship parts at a lower cost. Conversely, if purchases are
erratic or dip to historically low levels, the ship and ship parts will
be more expensive to produce, although the exact amount is uncertain.
[5] Subcontracted labor is labor performed to a fixed price contract.
Leased labor is the employment of outside workers under the direct
supervision of the shipyard management and foreman systems.
[6] According to Navy cost analysts, while they did not conduct
uncertainty analyses, they did perform sensitivity analyses in which
they examined the effects of different variables, including changes in
procurement quantities and labor rates.
[7] A level of confidence depicts how much confidence the estimators
have, stated as a percentage, in a budget or schedule estimate. The
higher the confidence level, the lower the risk.
[8] 10 U.S.C. §2434. These milestones include Milestone B, which marks
the beginning of the system development and demonstration phase.
Milestone C marks the beginning of the production and deployment phase.
[9] The Virginia class was an exception to this practice. For this
program, the Navy separated the funding of detail design from
construction.
[10] LPD 18 and LPD 19 were included in the contract as options to buy.
[11] The practice followed with the San Antonio class ships of
negotiating detail design and lead ship construction together is a
common Navy practice. For example, over the next 3 years, the Navy's
acquisition plans call for awarding contracts covering both detail
design and lead ship construction for three new ship classes: DD(X)
surface combatant, CVN 21 aircraft carrier, and the Littoral Combat
Ship.
[12] The Cost Analysis Improvement Group provides independent cost and
risk assessments and analyses of Major Defense Acquisition Programs for
the Office of the Secretary of Defense.
[13] The Office of the Secretary of Defense and Office of Management
and Budget inflation indices are based on a forecast of the implicit
price deflator for the Gross Domestic Product prepared by the Office of
Management and Budget and the White House Council of Economic Advisors.
The Gross Domestic Product includes all U.S. goods and services and is
a general economic indicator overarching many different commodities.
[14] For more information on the importance of Earned Value Management
see Appendix IV of our report GAO-03-600 entitled "Missile Defense:
Additional Knowledge Needed in Developing System for Intercepting Long-
Range Missiles."
[15] Beginning in March 2006 the Navy will require monthly cost
reporting for CVN 77.
[16] A recent Defense Contract Audit Agency audit found that while one
shipbuilder identified material cost and schedule variances in its
variance analysis report, it did not provide written documentation
related to the reasons for the variance or provide explanation for the
variances in the cost performance report.
[17] Under a teaming arrangement, two-thirds of the SSN 774 and 776 is
constructed at Electric Boat with the remaining third built at Newport
News and shipped to Electric Boat for final assembly. For the SSN 775,
the inverse is true.
[18] These costs are non-recurring, affecting only DDG 91 costs.
[19] According to the shipbuilder, consolidation of Ingalls
shipbuilding and Avondale shipyards into Northrop Grumman reduced
overhead costs by approximately 3 percent.
[20] $180 million was for CVN 76 and $95.4 million for CVN 77.
[21] We did not project cost growth for CVN 76 because the ship has
been delivered to the Navy.
[22] Analysis is based on data available through March 2004.
[23] Under this arrangement, the Navy is responsible for any cost
growth.
[24] GAO-03-895R, Multiyear Procurement Authority for the Virginia
Class Submarine Program, (Washington, D.C.: June 23, 2003).
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