Defense Acquisitions
Guidance Needed on Navy's Use of Investment Incentives at Private Shipyards Gao ID: GAO-10-686 July 26, 2010As fiscal constraints increasingly shape Navy shipbuilding plans, the pressure to increase efficiency mounts. Modernizing facilities and equipment at shipyards that build Navy ships can lead to improved efficiency, ultimately reducing the cost of constructing ships. In response to a request from the House Appropriations Subcommittee on Defense, GAO (1) identified investments in facilities and equipment at privately-owned shipyards over the last 10 years; (2) determined the Navy's role in financing facilities and equipment investments at these shipyards; and (3) evaluated how the Navy ensures investments result in expected outcomes. To address these objectives, GAO analyzed shipyard investment data over the past 10 years; interviewed shipyard, corporate, and Navy officials; and reviewed contracts, investment business cases, and other Navy and contractor documents.
Over the past 10 years, large shipyards that build Navy ships used public and corporate funds to invest over $1.9 billion in facilities and equipment to improve efficiency, develop new shipbuilding capabilities, and maintain existing capabilities. Examples of each category include the following: (1) Improving efficiency--General Dynamics Bath Iron Works built a new facility--the Ultra Hall--that improves efficiency by allowing shipbuilders to access work space more easily in a climate-controlled environment. (2) Developing capabilities--Northrop Grumman Shipbuilding-Newport News built a replacement pier that allowed shipbuilders to work on two aircraft carriers simultaneously due to a Navy scheduling conflict. (3) Maintaining capabilities--General Dynamics Electric Boat invested to repair docks in order to maintain the shipyard's ability to launch and repair submarines. Investments at two smaller shipyards, Austal USA and Marinette Marine shipyard, were primarily to maintain and develop new capabilities as both are competing for new Navy contracts. Over the last 10 years, the Navy expanded its use of investment incentives and has recently provided some form of investment support at all large shipyards. To incentivize facility and equipment investments, the Navy has (1) released money early from the reserve of contract funds normally held back to ensure ships are delivered according to specifications, (2) accelerated asset depreciation schedules, (3) tied a portion of the contractor's fee to investing in new facilities and equipment, and (4) adjusted the contract share-line to give the contractor more of the savings if costs decrease. The Navy also manages funds appropriated by Congress for Hurricane Katrina relief at shipyards in the Gulf Coast. Outside of Hurricane Katrina funding, the Navy has not supported investments at the two smaller shipyards. Navy officials stated that the Navy has to negotiate investment incentives with large shipyards because limited competition and instability of Navy work does not foster an environment for shipyards to invest without incentives. Shipyard officials argued that instability in Navy shipbuilding plans makes it difficult to invest without guaranteed work from the Navy and incentives are necessary to help meet corporate minimum rates of return needed to justify an investment, especially given the large dollar amounts involved with some investments. The Navy lacks policy to help ensure it achieves goals and objectives from providing facility and equipment investment incentives at private shipyards. Absent this policy, individual program offices and contracting officers make decisions about what type of incentive to use, desired return on investments, and what kinds of investments to support. Without policy, program officers and contracting officers use different methods to validate expected outcomes and safeguard the Navy's financial support. GAO recommends that the Navy develop a policy that identifies the intended goals and objectives of investment incentives, criteria for using incentives, and methods for validating outcomes. The Department of Defense concurred with this recommendation.
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: Belva M. Martin Team: Government Accountability Office: Acquisition and Sourcing Management Phone: (202) 512-4285GAO-10-686, Defense Acquisitions: Guidance Needed on Navy's Use of Investment Incentives at Private Shipyards
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Report to the Chairman, Subcommittee on Defense, Committee on
Appropriations, House of Representatives:
United States Government Accountability Office:
GAO:
July 2010:
Defense Acquisitions:
Guidance Needed on Navy's Use of Investment Incentives at Private
Shipyards:
GAO-10-686:
GAO Highlights:
Highlights of GAO-10-686, a report to the Chairman, Subcommittee on
Defense, Committee on Appropriations, House of Representatives.
Why GAO Did This Study:
As fiscal constraints increasingly shape Navy shipbuilding plans, the
pressure to increase efficiency mounts. Modernizing facilities and
equipment at shipyards that build Navy ships can lead to improved
efficiency, ultimately reducing the cost of constructing ships. In
response to a request from the House Appropriations Subcommittee on
Defense, GAO (1) identified investments in facilities and equipment at
privately-owned shipyards over the last 10 years; (2) determined the
Navy‘s role in financing facilities and equipment investments at these
shipyards; and (3) evaluated how the Navy ensures investments result
in expected outcomes. To address these objectives, GAO analyzed
shipyard investment data over the past 10 years; interviewed shipyard,
corporate, and Navy officials; and reviewed contracts, investment
business cases, and other Navy and contractor documents.
What GAO Found:
Over the past 10 years, large shipyards that build Navy ships used
public and corporate funds to invest over $1.9 billion in facilities
and equipment to improve efficiency, develop new shipbuilding
capabilities, and maintain existing capabilities. Examples of each
category include the following:
* Improving efficiency”General Dynamics Bath Iron Works built a new
facility”the Ultra Hall”that improves efficiency by allowing
shipbuilders to access work space more easily in a climate-controlled
environment.
* Developing capabilities”Northrop Grumman Shipbuilding–Newport News
built a replacement pier that allowed shipbuilders to work on two
aircraft carriers simultaneously due to a Navy scheduling conflict.
* Maintaining capabilities”General Dynamics Electric Boat invested to
repair docks in order to maintain the shipyard‘s ability to launch and
repair submarines.
Investments at two smaller shipyards, Austal USA and Marinette Marine
shipyard, were primarily to maintain and develop new capabilities as
both are competing for new Navy contracts.
Over the last 10 years, the Navy expanded its use of investment
incentives and has recently provided some form of investment support
at all large shipyards. To incentivize facility and equipment
investments, the Navy has (1) released money early from the reserve of
contract funds normally held back to ensure ships are delivered
according to specifications, (2) accelerated asset depreciation
schedules, (3) tied a portion of the contractor‘s fee to investing in
new facilities and equipment, and (4) adjusted the contract share-line
to give the contractor more of the savings if costs decrease. The Navy
also manages funds appropriated by Congress for Hurricane Katrina
relief at shipyards in the Gulf Coast. Outside of Hurricane Katrina
funding, the Navy has not supported investments at the two smaller
shipyards. Navy officials stated that the Navy has to negotiate
investment incentives with large shipyards because limited competition
and instability of Navy work does not foster an environment for
shipyards to invest without incentives. Shipyard officials argued that
instability in Navy shipbuilding plans makes it difficult to invest
without guaranteed work from the Navy and incentives are necessary to
help meet corporate minimum rates of return needed to justify an
investment, especially given the large dollar amounts involved with
some investments.
The Navy lacks policy to help ensure it achieves goals and objectives
from providing facility and equipment investment incentives at private
shipyards. Absent this policy, individual program offices and
contracting officers make decisions about what type of incentive to
use, desired return on investments, and what kinds of investments to
support. Without policy, program officers and contracting officers use
different methods to validate expected outcomes and safeguard the
Navy‘s financial support.
What GAO Recommends:
GAO recommends that the Navy develop a policy that identifies the
intended goals and objectives of investment incentives, criteria for
using incentives, and methods for validating outcomes. The Department
of Defense concurred with this recommendation.
View [hyperlink, http://www.gao.gov/products/GAO-10-686] or key
components. For more information, contact Belva Martin at (202) 512-
4841 or martinb@gao.gov.
[End of section]
Contents:
Letter:
Background:
Private Shipyards Made Investments to Improve, Upgrade, and Maintain
Facilities and Equipment over the Last 10 Years:
The Navy Supports Facilities and Equipment Investments by Offering
Incentives at Most Major Shipyards and Has Expanded This Support over
the Last 10 Years:
The Navy Lacks a Policy to Ensure Investment Incentives Achieve
Expected Outcomes:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Overview of Private Shipyards and Summary of Navy
Investment Incentives:
Appendix III: Comments from the Department of Defense:
Appendix IV: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Selected Investments at Major Shipyards over the Last 10
Years and Associated Costs:
Table 2: Example of the Normal and Accelerated Straight-Line
Depreciation Payment Schedules for a $90 Million Asset:
Table 3: Types of Government Support for Shipyards and Contracts That
Include Them:
Table 4: Expected Outcomes of Selected Projects Receiving Navy
Financial Support:
Table 5: Types of Investment Incentive Safeguards:
Figures:
Figure 1: Navy Shipbuilders, Corporate Ownership, and Associated
Product Lines:
Figure 2: Public and Corporate Investments at Major Shipyards in
Improving Efficiency, Maintaining Capabilities, and Developing
Capabilities (2000-2009):
Figure 3: Bath Iron Works Ultra Hall:
Figure 4: Example of Share-Line Adjustment for a Fixed-Price Incentive
or Cost-Plus Incentive Contract:
Figure 5: Major Navy-Supported Investments in Shipyard Facilities and
Equipment (2000-2009):
Abbreviations:
CAPEX: Capital Expenditures:
FAR: Federal Acquisition Regulation:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
July 26, 2010:
The Honorable Norman D. Dicks:
Chairman:
Subcommittee on Defense:
Committee on Appropriations:
House of Representatives:
Dear Mr. Chairman:
The U.S. Navy builds the most sophisticated, technologically advanced
ships in the world, but the investment required to build these ships
is placing pressure on the Department of Defense's ability to afford
its long-range shipbuilding plans. In its fiscal year 2011 long-range
plan for shipbuilding,[Footnote 1] the Chief of Naval Operations
acknowledged that the Navy faces a serious planning challenge over the
next several decades as it balances legacy ship retirements with the
need for multimission platforms and significantly increased
capabilities of current new-construction ships.
The Department of Defense's ability to afford the long-range
shipbuilding plan is of importance to both the Navy and privately
owned shipyards. The Navy has repeatedly reshaped and changed this
long-range shipbuilding plan, placing its goal of a 313-ship fleet in
jeopardy. In May 2009,[Footnote 2] we reported on several best
practices used by commercial shipbuilders to deliver ships on time and
within budget that could be adopted by the Navy. Based on this work,
we made several recommendations to the Secretary of Defense aimed at
improving shipbuilding programs including retiring technical risk and
stabilizing design at key points and moving to fixed-price contracts
for the first ships built in a class. As the department works to
implement some of these best practices, privately owned shipyards can
also contribute to the overall affordability of ships. One way that
shipyards can contribute is by making capital investments to modernize
facilities and equipment to improve efficiency, which could ultimately
decrease the overall cost of ships by reducing the number of labor
hours needed to build each ship.
In light of congressional interest in the Navy's ability to afford its
shipbuilding plan, you asked that we review investments in facilities
and equipment at privately owned shipyards.[Footnote 3] Specifically,
we (1) identified what investments in facilities and equipment
privately owned shipyards made with both public[Footnote 4] and
corporate funds over the last 10 years; (2) determined the Navy's role
in financing facilities and equipment investments at shipyards; and
(3) evaluated how the Navy ensures that its role in facilities and
equipment investments at private shipyards results in expected
outcomes.
To identify facilities and equipment investments over the last 10
years, we analyzed data on all capital investments over $1 million at
the seven privately owned shipyards that build Navy ships: General
Dynamics Bath Iron Works, General Dynamics NASSCO, General Dynamics
Electric Boat, Northrop Grumman Shipbuilding-Gulf Coast, Northrop
Grumman Shipbuilding-Newport News, Austal USA, and Marinette Marine
shipyard. We supplemented our analysis of the data by interviewing
officials at each shipyard to obtain an understanding of the purpose
of these investments. We then categorized the investments at major
shipyards, and shipyard officials confirmed our categorization of the
investments. To assess the reliability of each shipyard's data, we
interviewed knowledgeable shipyard officials about the data and
confirmed that the data are subject to external audits. We determined
that the data were sufficiently reliable for the purposes of this
report. To determine the Navy's role in facilities and equipment
investments at privately owned shipyards, we reviewed shipbuilding
contracts, legislation making funds available for shipyards affected
by Hurricane Katrina, and reports to Congress by the Office of the
Assistant Secretary of the Navy for Ship Programs regarding capital
investment strategies at shipyards. To supplement this analysis, we
held discussions with a number of Navy offices responsible for
shipbuilding programs. To evaluate how the Navy ensures that its role
in facilities and equipment investments results in expected outcomes,
we reviewed shipyard business-case analyses and accompanying documents
for Navy-supported projects and analyzed approaches across programs to
identify differences. Appendix I further discusses our scope and
methodology.
We conducted this performance audit from October 2009 to July 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
Background:
The shipbuilding industry in the United States is predominantly
composed of three different types of shipyards: (1) privately owned
shipyards that build naval vessels; (2) small privately owned
shipyards that build commercial vessels; and (3) U.S. government-owned
naval shipyards that conduct maintenance, repairs, and upgrades on
Navy and Coast Guard vessels.[Footnote 5] As a result of
consolidation, two major corporations--General Dynamics and Northrop
Grumman--own most of the private shipyards that build Navy ships.
General Dynamics owns Bath Iron Works in Bath, Maine; Electric Boat in
Groton, Connecticut, and Quonset Point, Rhode Island; and NASSCO in
San Diego, California. Northrop Grumman owns Northrop Grumman
Shipbuilding-Gulf Coast with locations in Pascagoula, Mississippi, and
New Orleans, Louisiana; and Northrop Grumman Shipbuilding-Newport News
in Virginia. Some of these shipyards maintain additional support
facilities in other locations to assist in production processes, such
as Gulf Coast's Gulfport, Mississippi facility that constructs
lightweight ship components also known as composites. Along with these
five major shipyards,[Footnote 6] there are two midsized shipyards
that construct smaller Navy ships. Marinette Marine Corporation in
Marinette, Wisconsin, is owned by the Italian shipbuilder Fincantieri,
and Austal USA in Mobile, Alabama, is owned by Austal, which is
headquartered in Western Australia. Figure 1 shows the location and
the current product lines of each shipyard.
Figure 1: Navy Shipbuilders, Corporate Ownership, and Associated
Product Lines:
[Refer to PDF for image: illustrated map]
Map of the Continental USA, depicting the following:
Marinette Marine Corporation (Midsized Shipyard):
Marinette, Wisconsin:
Smaller surface ships.
Bath Iron Works (Major Shipyard):
Bath, Maine:
General Dynamics:
Surface combatants.
Electric Boat (Major Shipyards):
Groton, Connecticut, and Quonset Point, Rhode Island:
General Dynamics:
Submarines.
Newport News (Major Shipyard):
Newport News, Virginia:
Northrop Grumman Shipbuilding:
Submarines and aircraft carriers.
Austal USA (Midsized Shipyard):
Mobile, Alabama:
Smaller surface ships.
Gulf Coast (Major Shipyard):
New Orleans, Louisiana, and Pascagoula, Mississippi:
Northrop Grumman Shipbuilding:
Auxiliary ships, surface combatants, and amphibious ships.
NASSCO (Major Shipyard):
San Diego, California:
General Dynamics:
Auxiliary ships.
Sources: GAO (data), MapArt (map).
[End of figure]
Several of these shipyards have specialized production capabilities
that constrain and dictate the types of vessels each can build and
limit opportunities for competition within the shipbuilding sector.
For instance, of the five major shipyards, only Newport News is
capable of building nuclear-powered aircraft carriers, and only
Newport News and Electric Boat have facilities for constructing
nuclear submarines. Furthermore, of the five major shipyards, only
NASSCO builds commercial ships alongside Navy ships. It typically
builds Navy auxiliary ships, such as the T-AKE class of dry cargo/
ammunition vessels, that share similarities with commercial ships,
and, according to the shipbuilder, production processes and equipment
are shared between the two types of projects.
When the Navy contracts with these shipyards, it must follow
provisions in the Federal Acquisition Regulation (FAR), which
establishes uniform policies and procedures for acquisition by all
executive agencies. In addition, the Cost Accounting Standards provide
uniformity and consistency in cost accounting practices across
government contracts.[Footnote 7] As a general policy under the FAR,
contractors are usually required to furnish all facilities and
equipment necessary to perform government contracts. However, in
specific situations, including when it is clearly demonstrated that it
is in the government's best interest or when government requirements
cannot otherwise be met, the government may provide government
property[Footnote 8] to contractors to perform a contract. For
example, as part of the DDG 1000 destroyer contract, the Navy included
a requirement for Bath Iron Works to purchase unique equipment
necessary to produce the DDG 1000. This equipment was acquired as
government property because the equipment is unique to DDG 1000
construction and the contractor is unlikely to use it to perform
another contract.
When a contractor furnishes facilities and equipment to perform a
contract, the government recognizes the costs associated with these
items by paying depreciation and facilities capital cost of money
costs allocated to the contract. Depreciation and facilities capital
cost of money costs are indirect contract costs, or costs incurred for
the general operation of the business that are not specifically
applicable to one product line or contract.[Footnote 9] The FAR, in
conjunction with the Cost Accounting Standards, includes provisions
for how a contractor recovers costs such as depreciation and
facilities capital cost of money as part of indirect contract costs
allocated to government contracts.[Footnote 10] By recovering
depreciation costs, the contractor recoups the cost of an asset--a
facility or a piece of equipment--over the asset's estimated useful
life. Facilities capital cost of money acknowledges the opportunity
cost for a contractor when it uses its funds to invest in facilities
and equipment in lieu of other investments such as relatively risk-
free bonds. Facilities capital cost of money is determined by
multiplying the net book value of the contractor's capital assets by a
cost-of-money rate, which is a rate tied to the U.S. treasury rate.
With respect to Navy shipbuilding, a shipyard's indirect costs,
including depreciation and facilities capital cost of money, are
allocated to the Navy's shipbuilding contracts at the shipyard in
accordance with the Cost Accounting Standards.[Footnote 11] When a
shipyard makes facilities and equipment investments, all ships under
contract during the life of those assets are allocated a portion of
the assets' indirect costs. Therefore, if the number of ships under
construction at a given time in a shipyard increases, the indirect
costs per ship decrease, and if the number of ships under construction
at a given time in a shipyard decreases, the indirect costs per ship
increase.
Private Shipyards Made Investments to Improve, Upgrade, and Maintain
Facilities and Equipment over the Last 10 Years:
Over the last 10 years, major shipyards used public and corporate
funds to invest more than $1.9 billion in facilities and equipment
that improved shipbuilding efficiency, developed new capabilities, and
maintained existing capabilities. Figure 2 shows the amount of money
invested in each category.
Figure 2: Public and Corporate Investments at Major Shipyards in
Improving Efficiency, Maintaining Capabilities, and Developing
Capabilities (2000-2009):
[Refer to PDF for image: vertical bar graph]
Investment category: Improving Efficiencies;
Totals for Major Private Shipyards: $671 million.
Investment category: Maintaining Capabilities;
Totals for Major Private Shipyards: $479 million.
Investment category: Developing Capabilities;
Totals for Major Private Shipyards: $762 million.
Source: GAO analysis of data supplied by Bath Iron Works, Electric
Boat, Gulf Coast, NASSCO, and Newport News.
Note: Some investments could be placed in more than one category, but
each investment is only included in the category that best describes
its primary purpose. This figure excludes approximately $374 million
spent at Gulf Coast's Pascagoula and Gulfport facilities to repair
damage from Hurricane Katrina.
[End of figure]
These categories are defined as follows:
* Improving shipbuilding efficiency. Investments in improving
shipbuilding efficiency generally reduce the number of hours
shipbuilders spend on a given task, and often allow shipbuilders to
reorder the sequence of shipbuilding work to achieve new efficiencies.
For example, investments in improving efficiency can make it possible
for shipbuilders to complete more work in specially-designed workshops
and modular assembly buildings, thus having to complete less of the
work later on in the shipbuilding process inside the more constrained
environments of almost-completed areas of the ship. To illustrate how
these investments improve efficiency, shipyard officials often
describe the "1-3-8 rule of thumb" of shipbuilding work: work that
takes 1 hour to complete in a workshop, takes 3 hours to complete once
the steel panels have been welded into units (sometimes called
modules), and 8 hours to complete after a block has been erected or
after the ship has been launched.[Footnote 12] For example, inside the
recently-constructed Ultra Hall at Bath Iron Works, shipbuilders can
now access work spaces more easily in a climate-controlled environment
allowing them to finish units at a higher stage of completion before
they are erected and then moved into the water. Figure 3 is a photo of
a unit being moved out of the Ultra Hall.
Figure 3: Bath Iron Works Ultra Hall:
[Refer to PDF for image: photograph]
Source: General Dynamics Bath Iron Works.
[End of figure]
* Developing new capabilities. Shipyards make investments to develop
new capabilities so that they can complete new types of tasks. In some
cases, shipyards need these new capabilities to meet the Navy's
technical requirements for new ships. For example, to build a newly-
designed aircraft carrier with heavier metal plate requirements than
those of previous aircraft carriers, Newport News invested in new
facilities and equipment. These investments included building a heavy-
plate facility, and upgrading a crane to make it capable of lifting
heavier modules. Other shipyards also identified purchasing cranes as
examples of investments to develop new capabilities.
* Maintaining capabilities. From time to time, shipyards make major
investments to replace or repair facilities and equipment. This allows
the shipyards to maintain existing capabilities for years or decades.
For example, Electric Boat officials explained that its shipyard had
to make a major investment in dock repair in order to maintain the
shipyard's ability to launch and repair submarines.
Through investments to improve efficiencies and develop new
capabilities, major shipyards modernized their facilities and
equipment, thus transforming their shipbuilding processes. Some of
these investments completely changed the physical layouts of
shipyards. For example, Bath Iron Works completed a Land Level
Transfer Facility in 2001, replacing an inclined-way transfer facility
used since 1890. Bath Iron Works officials explained that with the
Land Level Transfer Facility, the shipyard now has the capability to
construct ships in larger, more fully outfitted units on any one of
three construction lanes. The shipyard also has a floating dry dock
that it can move to any of the three construction lanes to transfer
the ship into the water. With this arrangement, the shipyard can
better manage when a ship is ready to be moved to the water. Another
example includes NASSCO's facility expansion project, which
fundamentally changed the layout of the shipyard to increase
production capacity, throughput, and efficiency. In particular, NASSCO
added new production lanes to reduce shipyard congestion, allowing
builders to move units around the shipyard with reduced bottlenecks,
and added a modern blast and paint facility to improve paint process
efficiency while reducing emissions. Finally, Newport News built a new
pier, thus increasing its capacity for servicing and completing
construction of aircraft carriers.
Table 1 shows selected investments at each major shipyard, sometimes
funded through public or corporate funds, over the last 10 years.
These selected investments highlight examples of projects by
investment category as well as the magnitude of some investments at
shipyards.
Table 1: Selected Investments at Major Shipyards over the Last 10
Years and Associated Costs:
Corporation, shipyard: General Dynamics; Bath Iron Works;
Investment: Ultra Hall;
Investment category and description: Improving Efficiency--Allows
shipbuilders to construct larger, more complete units before joining
the units together during ship assembly;
Years: 2006-2008;
Cost: $226 million for the three investments.
Corporation, shipyard: General Dynamics; Electric Boat;
Investment: Long-term dock repair;
Investment category and description: Maintaining Capabilities--Extends
the life of three graving docks, which are used for new-construction
postdelivery work, as well as overhaul and repair;
Years: 2004-2009;
Cost: $226 million for the three investments.
Corporation, shipyard: General Dynamics; NASSCO;
Investment: Facility expansion project;
Investment category and description: Improving Efficiency--Improved
production efficiency by shifting painting to earlier in the building
process and increasing preoutfitting capabilities for modules;
Years: 2007-2009;
Cost: $226 million for the three investments.
Corporation, shipyard: Northrop Grumman; Newport News;
Investment: Pier 3;
Investment category and description: Developing Capabilities--Allowed
Newport News to accelerate building a replacement pier so that it
could support work on two aircraft carriers at the same time due to a
Navy scheduling conflict;
Years: 2003-2007;
Cost: $85 million.
Corporation, shipyard: Northrop Grumman; Gulf Coast;
Investment: Pascagoula Panel Line;
Investment category and description: Improving Efficiency--Improves
steel panel quality and reduces panel distortion with more accurate
machines and processes;
Years: 2005-2008;
Cost: $79 million.
Source: GAO analysis of data supplied by Bath Iron Works, Electric
Boat, NASSCO, Newport News, and Gulf Coast.
[End of table]
Two Midsized Shipyards Invested in Facilities and Equipment Mostly to
Develop New Capabilities or Maintain Capabilities:
Two midsized shipyards, Austal USA and Marinette Marine Corporation,
started construction of two different designs of the Littoral Combat
Ship for the Navy in 2005, and their investments have focused
primarily on maintaining shipyard capabilities and developing new
capabilities in order to compete for Navy contracts. Austal USA used
both public and corporate money to complete investments of
approximately $155 million in facilities and equipment since 1999, and
Austal USA officials said these investments were mostly to develop new
capabilities to compete for Navy business. For example, Austal USA
officials said that to develop the capacity to work on new Navy ships,
their shipyard invested approximately $85 million to build the Modular
Manufacturing Facility. Shipyard officials said that with this
facility, the yard constructs ships in a modular fashion to maximize
productivity, efficiency, and throughput. Marinette Marine Corporation
officials stated that investments over the last 10 years have largely
been to maintain capabilities, but the shipyard's new owner,
Fincantieri, plans to make significant investments in the future.
The Navy Supports Facilities and Equipment Investments by Offering
Incentives at Most Major Shipyards and Has Expanded This Support over
the Last 10 Years:
To incentivize investments, the Navy has provided support to most
major shipyards with four mechanisms: early release of contract
retentions, accelerated depreciation, special contract-incentive fees,
and contract share-line adjustments. However, the Navy has not
incentivized investments at the two midsized shipyards. Navy officials
cited the lack of competition and instability of Navy work in
shipbuilding as major reasons why the Navy needs to incentivize
investments in facilities and equipment at major shipyards. At the
shipyards, officials argued that they cannot secure corporate support
for many investments without Navy incentives. Shipyard officials also
pointed to instability in the Navy's long-range shipbuilding plans as
a reason their shipyards usually do not pursue investments without
Navy support. Over the last 10 years, the Navy has expanded its use of
investment incentives and is now involved with providing some form of
investment support at all major shipyards.
The Navy Negotiated Facilities and Equipment Incentives with Most
Major Shipyards:
The Navy has provided support to most major shipyards with four types
of investment incentives: early release of contract retentions,
accelerated depreciation, special contract-incentive fees, and share-
line adjustment.
* Early release of contract retentions. By releasing contract
retentions early, the Navy disburses money to a shipyard earlier than
scheduled from a reserve normally retained to ensure ships are
delivered according to specifications. For example, instead of holding
3.75 percent of the contract payments in retentions, the Navy might
hold only 1.5 percent of the contract payments, releasing the
remaining 2.25 percent early to a shipyard in exchange for the
shipyard investing in facilities or equipment. Navy officials said
that with this incentive, the Navy does not provide additional funds
to the shipyard, but rather provides funds to the contractor it would
receive anyway upon successful completion of the contract.
Shipbuilders said the early release of contract retentions provides
funds with which the shipyard can make investments that it might
otherwise not be able to make.[Footnote 13] The early release of
contract retentions may fund the entire capital investment or a
portion of the investment.
* Accelerated depreciation. When accelerating depreciation,[Footnote
14] the Navy pays the shipyard higher payments for depreciation of an
asset over a shortened timeline than under a normal depreciation
payment schedule. In exchange, the shipyard agrees to fund the
investment. This benefits the shipyard because it recoups its
investment faster than it would have under a normal depreciation
schedule. For example, if a shipyard asset has a useful life of 9
years, the shipyard recoups a portion of the investment each year over
that span. However, if an incentive agreement accelerated the
depreciation schedule, the shipyard would receive larger payments
earlier and over fewer years. Navy and shipbuilding officials
explained that this kind of incentive can help bridge a gap between an
investment's expected rate of return and the corporation's desired
rate of return to help justify making an investment. See table 2 for a
comparison of normal and accelerated straight-line depreciation.
Table 2: Example of the Normal and Accelerated Straight-Line
Depreciation Payment Schedules for a $90 Million Asset:
Year: 1;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $30 million.
Year: 2;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $30 million.
Year: 3;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $30 million.
Year: 4;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Year: 5;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Year: 6;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Year: 7;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Year: 8;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Year: 9;
Normal Depreciation Payment: $10 million;
Accelerated Depreciation Payment: $0.
Total:
Normal Depreciation Payment: $90 million;
Accelerated Depreciation Payment: $90 million.
Source: GAO.
Note: This example assumes that the piece of equipment or facility
does not have a salvage value at the end of its useful life.
[End of table]
* Special contract-incentive fee. While incentive fees are used in
contracts across the Department of Defense generally to motivate
contractor efforts, the Navy also uses special contract-incentive fees
to specifically encourage investments in facilities and equipment. On
a contract that includes such a special incentive fee, a shipyard may
earn a fee for making an investment. This special fee is available to
the shipyard only if it agrees to make a Navy-approved investment. The
special fee may pay for all or part of the investment. In some cases,
the incentive bridges the difference between the corporation's desired
rate of return and the projected return on an investment.
* Contract Share-Line Adjustment. The contract share-line defines what
share of underruns or overruns will accrue to the contractor and the
Navy. By adjusting the contract share-line ratio, the Navy can
incentivize a contractor to invest in facilities or equipment that
will reduce costs. For example, during original contract negotiations
for a fixed-price incentive or cost-plus incentive contract, the two
parties may agree to an even share of the savings if the total
negotiated or allowable cost ends up being less than the total target
cost. Through a contract modification, the Navy could change the
original sharing ratio so that more of the savings are given to the
contractor. Under this modification, the contractor is incentivized to
invest in a facility or equipment that may reduce costs so that it
earns a higher fee. The Navy will benefit from these lower costs on
all future contracts. See figure 4 for an example of a share line
adjustment.
Figure 4: Example of Share-Line Adjustment for a Fixed-Price Incentive
or Cost-Plus Incentive Contract:
[Refer to PDF for image: illustration]
Expected cost: $100 million
Actual cost: $80 million
Savings: $20 million.
Original contract–50/50 share:
Savings to government: $10 million;
Savings to contractor: $10 million.
Modified contract–20/80 share:
Savings to government: $4 million;
Savings to contractor: $16 million.
Source: GAO.
[End of figure]
The Navy also manages Hurricane Katrina relief funds, which Congress
appropriated for infrastructure improvements at shipyards that build
Navy ships in states affected by Hurricane Katrina. This support
differs from incentive programs at other shipyards because it is
direct federal funding and is not tied to a specific Navy shipbuilding
program. These funds were not directed to repairing specific damage
from the hurricane, but can be used for a variety of projects at
eligible shipyards.[Footnote 15]
Table 3 provides an overview of investment incentive mechanisms and
how the Navy has used each incentive to support investments at
shipyards. Appendix II includes additional details of the investment
incentives at each shipyard.
Table 3: Types of Government Support for Shipyards and Contracts That
Include Them:
Government support: Investment Incentives; Early release of contract
retentions;
Navy actions: The Navy releases money early from the reserve of
contract retentions normally held back to ensure ships are delivered
according to specifications;
Shipyard benefit: The shipyard has more financial resources than it
would otherwise have to make new investments;
Supported contracts or shipyard (projects):
* DDG 51 (Ultra Hall and Land Level Transfer Facility);
* T-AKE (facility expansion project);
* Sealift (new cranes).
Government support: Investment Incentives; Accelerated depreciation;
Navy actions: The Navy accelerates the depreciation schedule for an
asset;
Shipyard benefit: The shipyard recoups its investment more quickly.
This helps to bridge the gap between an investment's projected rate of
return and the corporation's desired rate of return;
Supported contracts or shipyard (projects):
* Newport News (pier construction);
* Electric Boat (dock modernization);
* Virginia-class submarine (Block I projects)[A].
Government support: Investment Incentives; Special contract-incentive
fee;
Navy actions: The Navy ties some of the contractor's fee to investing
in facilities and equipment;
Shipyard benefit: The shipyard earns a fee for making certain approved
investments. The incentive can help bridge the gap between an
investment's projected rate of return and the corporation's desired
rate of return;
Supported contracts or shipyard (projects):
* DDG 51 (Ultra Hall);
* CVN 21 (projects supporting the new carrier design);
* Virginia-class submarine (Capital Expenditures (CAPEX) projects).
Government support: Investment Incentives; Contract share-line
adjustment;
Navy actions: The Navy adjusts the share line between itself and the
contractor to give the contractor a greater share of the savings if
lower costs are achieved;
Shipyard benefit: The shipyard receives a greater profit if it invests
in a facility or equipment that leads to cost savings;
Supported contracts or shipyard (projects):
* DDG 51 (Ultra Hall).
Government support: Hurricane Katrina Relief; Federal Hurricane
Katrina funds;
Navy actions: The Navy administers funds appropriated by Congress to
improve shipyard facilities and equipment in the states affected by
Hurricane Katrina;
Shipyard benefit: Shipyards receive money to help support projects
approved by the Navy. These projects are not tied to any particular
shipbuilding contract;
Supported contracts or shipyard (projects):
* Austal Modular Manufacturing Facility;
* Gulf Coast Pascagoula Panel Assembly Line;
* Gulf Coast Gulfport Composites Manufacturing Facility.
Source: GAO analysis of Navy data.
[A] The Navy purchases the Virginia-class submarines in blocks. The
first block includes four submarines, the second block includes six
submarines, and the third block includes eight submarines.
[End of table]
The Navy has not negotiated investment incentives at the two midsized
shipyards, Austal USA and Marinette Marine Corporation, which are both
competing for the Littoral Combat Ship contract, though both received
other forms of federal government support for facilities and equipment
investments. Both shipyards received grants from the U.S. Department
of Transportation's Maritime Administration, which are available to
small shipyards for capital and related improvements that foster
efficiency and competitive operations. For example, Marinette Marine
Corporation officials said that their shipyard received $1.4 million
to help finance investments for new cranes. In addition, Austal
received almost $34 million of federal Hurricane Katrina funds to help
finance its Modular Manufacturing Facility. Both midsized shipyards
have plans for further expansions, but as of now, neither shipyard
plans to request Navy investment incentives to execute these plans.
Incentives May Encourage Major Shipyards to Make Facilities and
Equipment Investments That They Might Not Make on Their Own:
Navy officials, shipyard officials, and corporate officials from
Northrop Grumman and General Dynamics provided different perspectives
on reasons for using incentives to encourage investment in the Navy
shipbuilding market.
Navy officials told us that the Navy negotiates investment incentives
with major shipyards because limited competition in the market does
not foster an environment that encourages shipyards to invest without
incentives. For example, Newport News is the only shipyard capable of
building aircraft carriers. A Navy contracting officer said that, as a
result, there may be a disincentive for Newport News to invest in
projects that improve efficiency. Generally speaking, at contract
negotiation, the government's proposed contractor fee is based on a
percentage of total estimated allowable contract costs, with the
percentage reflecting various weighted risk factors. Newport News, as
a sole supplier, will likely construct all future aircraft carriers
but could earn a lower fee if new efficiencies reduce the total cost
of construction.[Footnote 16] Even in cases where there is limited
shipbuilding competition, such as with surface combatants, shipyards
may face similar disincentives to invest. If the shipyard invests to
improve efficiency, these investments will likely reduce the price of
a ship and can lower future profits. However, where some competition
exists, better efficiency may lead to winning a greater allocation of
future work. Navy officials added that shipyards that are not
confident Navy work will materialize or be funded as scheduled are
reluctant to make capital investments without government incentives.
Officials from major shipyards argued that instability in long-range
Navy shipbuilding plans discourages shipyards from making investments
without guaranteed Navy work. Because major shipyards generally do not
perform commercial work, there are few other inducements to invest in
new facilities and equipment other than Navy shipbuilding
opportunities. For example, at one shipyard, an official explained
that it had invested in a facility in anticipation of an upcoming
contract. The Navy changed the shipbuilding program and did not award
the contract, rendering this facility underutilized until receipt of
another contract several years later. The official emphasized that
this shipyard will never invest again in new facilities without a
signed contract guaranteeing future work. The official added that to
do otherwise would not be a prudent business decision.
Officials from major shipyards also argued that their shipyards need
Navy incentives because many potential investments in facilities and
equipment do not meet the corporation's desired rate of return. In
addition, some shipyard officials stated that since they cannot secure
corporate investments for many projects, they often looked first for
state or federal support for new investments to help to bridge the gap
between their corporation's desired rate of return and the expected
rate of return of the investment.
Corporate officials argued that the low rates of shipbuilding
production, low shipbuilding fees relative to invested capital, and
length of time it takes to build a ship sometimes mean investments
take too long to generate an acceptable return, or will never generate
an acceptable return. Moreover, officials stated that shipyard
investments are large, sometimes exceeding $25 million for a single
investment. Furthermore, other sectors of these corporations are often
better positioned than shipyards to propose investments that achieve
the corporation's desired rate of return because these sectors can use
less expensive investments to improve processes for high-volume
products. Corporate officials agreed that corporations would generally
make investments in maintaining capabilities without meeting a
corporation's desired rate of return because these investments are
necessary to stay in business.
The Navy Increased Support for Investments at Major Shipyards over the
Past 10 Years, Generally by Expanding the Use of Investment Incentives:
Over the past 10 years, the Navy has moved from providing onetime
support of major capital investments to more routine support of
investment spending at all five major shipyards.[Footnote 17] In 2000,
Bath Iron Works was in the process of completing construction of its
Land Level Transfer Facility, which was an investment that the Navy
incentivized through early release of contract retentions. Since then,
the Navy has used investment incentives to facilitate facilities and
equipment investments at four of the five major shipyards, across
multiple shipbuilding programs. At the fifth major shipyard, Gulf
Coast, the Navy administered Hurricane Katrina recovery money to
support investments. Since 2007, the Navy has actively supported
investments at all major shipyards with investment incentives or
Hurricane Katrina recovery funding. Figure 5 shows the Navy's expanded
support to private shipyards over the last 10 years.
Figure 5: Major Navy-Supported Investments in Shipyard Facilities and
Equipment (2000-2009):
[Refer to PDF for image: illustrated table]
Austral USA:
2007-2009: Hurricane Katrina funding.
General Dynamics Bath Iron Works:
2000: Early release of contract retentions;
2006: Early release of contract retentions;
2007: Special contract-incentive fee;
2008: Share-line adjustment.
General Dynamics Electric Boat:
2000-2002: Accelerated depreciation;
2003-2009: Special contract-incentive fee;
2004-2007: Accelerated depreciation;
2006-2009: Accelerated depreciation.
General Dynamics NASSCO:
2000-2001: Early release of contract retentions;
2006-2009: Early release of contract retentions.
Northrop Grumman Shipbuilding–Gulf Coast:
2006-2009: Accelerated depreciation.
Northrop Grumman Shipbuilding–Newport News:
2003-2007: Accelerated depreciation;
2003-2009: Special contract-incentive fee;
2004-2009: Special contract-incentive fee.
Source: GAO analysis of Navy and contractor data.
[End of figure]
Senior-level Navy officials stated that negotiating facilities and
equipment incentives are becoming a routine part of contract
negotiations, but officials expressed different opinions over which
mechanisms are most useful. While the Navy has used early release of
retentions and accelerated depreciation throughout the past 10 years,
it has recently started to negotiate special contract-incentive fees
during contract negotiation as a part of its cost-control strategy,
such as during the Virginia-class submarine Block II and Block III
contract negotiations. Senior-level Navy officials have differing
views on whether it is better to include incentives as part of a
contract or to negotiate after the Navy awards a contract. One
contracting officer observed that the length of time involved in
obtaining the required Cost Accounting Standards Board waiver for
accelerated depreciation may have led officials to pursue other
investment incentives.
Potential exists that contractors may ask the Navy and other services
to expand the scope of current incentive activities. Shipyards have
already started to request incentives for a variety of projects
outside of investments in facilities and equipment, and a shipyard
recently requested funding assistance for lean six-sigma process-
improvement training. In addition, the T-AKE contract includes a cost-
reduction initiative in which the Navy paid for projects that reduced
costs through design and producibility improvements, but did not
require new investments in facilities or equipment. Moreover, we were
told by one company that corporate divisions supporting other
government-related product lines have expressed interest in these
types of facilities and equipment incentives.
The Navy Lacks a Policy to Ensure Investment Incentives Achieve
Expected Outcomes:
The Navy does not have a policy outlining its goals and objectives for
providing financial incentives to shipyards to encourage facilities
and equipment investments. Without such a policy, the Navy has not
identified if there is a minimum return on investment expected for
this support and the kinds of investments that are in the best
interest of the Navy to support. The Navy has also not considered the
extent to which investment incentives affect depreciation and
facilities capital cost of money at shipyards. Navy officials also
lack guidance on how to validate outcomes and safeguard financial
interests, thus resulting in varying approaches across programs.
The Navy Has Not Defined Objectives for Providing Investment Support
to a Shipyard:
In a 2008 report to Congress, the Navy recognized a need to clarify
its priorities and objectives for supporting investments at shipyards,
but has not yet developed this clarifying guidance. Navy officials
stated that program offices and contracting officers negotiate
incentives on a program-by-program basis and there is no guidance on
which investment mechanism is appropriate under which circumstances.
Use of special contract incentives fees is becoming common, yet some
Navy officials suggested that adjustments in contract terms such as a
share-line adjustment provide a strong incentive for successful
program implementation.
While reducing cost is the goal of many facilities and equipment
investment incentives, the Navy does not define a metric or minimum
desired level for these reductions in cost. This results in
differences in expected outcomes across investment mechanisms. Table 4
highlights variations in the types of expected outcomes with examples
by shipyard, investment, and investment mechanism. Given the variation
in the expected outcomes, it is difficult to ascertain if the Navy has
a minimum return it expects to receive by providing financial support
or if just any return is sufficient.
Table 4: Expected Outcomes of Selected Projects Receiving Navy
Financial Support:
Shipyard: Bath Iron Works;
Investment: Ultra Hall;
Investment mechanism: Early release of contract retentions, special
contract-incentive fee, and share-line adjustment;
Expected outcome: Labor hour reduction over two ships.
Shipyard: Electric Boat;
Investment: Automation in light fabrication;
Investment mechanism: Virginia-class submarine Block II--special
contract-incentive fee;
Expected outcome: Labor hour savings between 2006 and 2023.
Shipyard: NASSCO;
Investment: Facility expansion plan;
Investment mechanism: Early release of contract retentions;
Expected outcome: Labor hour savings, overhead and volume savings, and
escalation savings over several ships.
Shipyard: Northrop Grumman Shipbuilding-Gulf Coast;
Investment: Ingalls operations panel assembly line;
Investment mechanism: Hurricane Katrina relief funds;
Expected outcome: Cost savings per panel.
Shipyard: Northrop Grumman Shipbuilding-Newport News;
Investment: 900-ton crane upgrade;
Investment mechanism: CVN 21 special contract-incentive fee;
Expected outcome: Cost savings between 2008 and 2013.
Source: GAO analysis of Navy and contractor documents.
[End of table]
Moreover, our review of the Virginia-class submarine Block II capital
expenditures (CAPEX) clause showed that the Navy lacks a desired level
of return within this investment mechanism. Navy officials responsible
for approving business cases for the incentive stated that contractors
are only required to demonstrate that the investment will result in
savings on the Block II submarines and long-term savings to the
government. Officials explained that their methodology is guided by
the following contract language:
the Contractor shall be eligible to receive a special incentive based
upon the Contractor and/or Major Subcontractor Newport News
Shipbuilding investing in such projects that result in savings to the
Government for the submarines under this contract and long term
savings to the Government for the Virginia Class submarine program.
As a result of this contract language, the contractors are not
required to include return on investment calculations, calculate the
net present value of savings on future submarines, or consider the
share-line ratio to calculate actual savings to the government.
Reviewing officials stated that even when contractors included return-
on-investment calculations in the business cases, the officials did
not review it because such calculations were not required in the
contract language. The contracting officer responsible for managing
Virginia-class submarine CAPEX stated that this contract language is
too vague concerning when to approve or disapprove a project based on
estimated savings, and if a similar incentive is used again, the
contract should include criteria for when to approve or disapprove a
project. To illustrate, the contracting officer stated that a
contractor submitted a business case under Block II CAPEX for a
project expected to cost $4 million with $10,000 in expected savings
on Block II submarines and additional saving accruing on future
submarines beyond Block II. The contracting officer stated that the
Navy did not approve the project because the expected savings on Block
II were so low, but such a decision was difficult to support based on
the contract language.[Footnote 18]
Individual program offices and contracting officers also make
decisions about which types of investments to pursue, without any
policy from the Navy about the kinds of investments that are in its
best interest. Most of the investments the Navy supported fall into
the category of improving efficiency at the shipyards. Some of the
more recent investments, however, could also be considered as
maintaining or developing capabilities at the shipyards. It is unclear
whether or not the Navy has determined that these investments are in
fact in its best interest. For example, according to officials, the
Virginia-class submarine Block II and Block III clauses do not
prohibit approving maintenance projects as long as these projects
generate cost savings. In 2009, the Navy paid a special contract-
incentive fee to Electric Boat to refurbish equipment past its normal
service life in order to prevent major failures that would result in
an injury or equipment damage and affect production schedules. In a
similar manner, Newport News submitted a business case to receive a
special contract-incentive fee to support repairs to its foundry,
stating that near-term investment was necessary because the average
age of most of the equipment is well past its average useful service
life and at a high risk of mechanical failure. The Navy did not
approve this business case under the Block II special contract
incentive fee because Newport News was unable to demonstrate savings
on the Block II submarines, a stipulation in the contract language.
However, the Navy encouraged the shipyard to resubmit the proposal if
it could demonstrate savings on future submarine construction. Such
investments to maintain capabilities are likely to generate some cost
savings and may better position the shipyards to increase submarine
production rates, but some officials indicated that such investments
should actually be contractor responsibilities.
The Navy Has Not Considered the Extent to Which Investment Incentives
Affect Indirect Costs at Shipyards:
The Navy also lacks policy on how to determine an incentivized
investment's effect on indirect costs to the Navy. As the Navy is
incentivizing investments up front, it is unclear whether contractors
should be able to recover indirect costs associated with these assets
through depreciation and facilities capital cost of money. While the
Navy did not allow the contractor to recover depreciation and
facilities capital cost of money for investments supported with
Hurricane Katrina funds, some agreements explicitly provide that the
contractor can recover costs for incentivized facilities and equipment
investments. However, Defense Contract Audit Agency officials
questioned a facilities capital cost of money claim that one shipyard
included in its indirect costs because the Navy provided an incentive
to construct the facility. Nonetheless, officials concluded that the
contractor could recover these costs from the Navy because it was
unclear in the terms of the contract, and neither the Federal
Acquisition Regulation nor the Cost Accounting Standards address
recovery of facilities capital cost of money for facilities receiving
incentive support. Defense Contract Audit Agency officials stated that
they believe it is unfair that contractors can recover facilities
capital cost of money costs on incentivized facilities and this issue
needs to be reevaluated if the Navy continues to incentivize
investments.
In instances where the incentive agreement explicitly states that the
contractor can recover these long-term costs, officials evaluating
business cases stated that they do not always consider these long-term
costs when comparing the cost of the project with potential savings.
Specifically, Navy officials stated that they did not consider the
effect of depreciation when evaluating Virginia-class submarine Block
II CAPEX projects.
Differences Exist for Validating Expected Outcomes and Safeguarding
Financial Interest If Expected Outcome Is Not Achieved:
In the absence of Navy guidance, approaches vary by investment
incentive for validating whether or not a project achieves expected
outcomes and safeguarding Navy financial interest if a project does
not achieve expected outcomes. Some investment incentives require
validation of anticipated savings whereas others only require a
validation of project construction milestones. For example, officials
described a lengthy review of savings validation associated with the
first Virginia-class submarine CAPEX Block II project, but later
indicated the process has evolved over time and other validations have
been more straightforward. According to Navy officials managing the
Virginia-class CAPEX incentive, the contract provides little guidance
on how to validate outcomes, so program officials developed the
current validation process after the contract was signed. However, the
CVN 21 program office did not validate anticipated savings after
investments were complete, but validated investments based on
construction milestones. Because the Navy negotiated a lower target
cost for the future carrier, Navy officials stated that it is not
necessary to validate the savings associated with these projects.
These officials added that it would be difficult to calculate an
accurate baseline against which to compare labor hours with and
without the new investments because the new carrier had never been
constructed.
In the absence of a Navy policy, program and contracting officials
also negotiate various methods to safeguard the Navy's financial
interest in the event that expected outcomes for the investment
incentive are not achieved. The range of methods is seen in table 5.
Table 5: Types of Investment Incentive Safeguards:
Safeguard measure: Recoupment;
Navy action: The Navy takes back its financial support if the
contractor does not meet predetermined construction milestones or
anticipated savings thresholds;
Benefit to the Navy: The Navy can receive returned funds from the
contractor if the project is not executed properly. This safeguard
encourages the contractor to complete the investment in accordance
with the terms of the investment mechanism;
Example of incentive mechanism using safeguard: Virginia-class
submarine special contract-incentive fee (CAPEX)--The Navy can recoup
the incentive if the project does not meet the proposed schedule or
generate the anticipated cost savings. The contracts state that all or
any portion of the incentive can be recouped, but do not detail how
the percentage would be determined.
CVN 21 special contract-incentive fee--The Navy can recoup the special
incentive fee associated with these investments in the event that the
contractor fails to substantially complete a facility when it would be
needed to support CVN 21's construction schedule.
Safeguard measure: Modified contract terms;
Navy action: The Navy renegotiates terms on current contracts;
Benefit to the Navy: This safeguard encourages the contractor to
achieve the outcomes expected from the investment and to protect the
Navy's interest if the contractor did not achieve these outcomes;
Example of incentive mechanism using safeguard: Ultra Hall--The Navy
and the contractor negotiated changes to target price and other
elements of the incentive fee structure for two DDG 51 destroyers.
Safeguard measure: Savings included in future contract;
Navy action: The Navy includes savings associated with incentivized
projects in subsequent contracts;
Benefit to the Navy: This safeguard allows the Navy to further
incentivize the contractor's achievement of anticipated savings and
ensure its receipt of savings regardless of investment completion;
Example of incentive mechanism using safeguard: CVN 21 special
contract-incentive fee--The contractor agreed to reflect savings for
investments made under the CVN 78 construction preparation contract in
the construction proposal.
Ultra Hall--The contractor agreed to include savings associated with
the Ultra Hall in its proposed costs for future contracts.
Virginia-class submarine CAPEX--Navy officials stated that all savings
for investments made under Block II CAPEX were included in the Block
III contract.
Safeguard measure: Staggered disbursement;
Navy action: The Navy disburses the incentive to the contractor in
increments triggered by construction progress or other milestones;
Benefit to the Navy: Staggered disbursement allows the Navy to
encourage progression toward expected outcomes before it provides the
entire incentive amount to the contractor, thus reducing the project's
risk;
Example of incentive mechanism using safeguard: Federal Hurricane
Katrina funds--The Navy pays a defined portion of the project's cost
after the contractor demonstrates that it has completed specified
construction tasks.
Virginia-class submarine CAPEX--The contractor receives half of the
incentive amount for Virginia-class submarine Block II CAPEX projects
when the Navy approves the project and the remaining amount when the
contractor implements the project.
Source: GAO analysis of Navy and contractor documents.
[End of table]
In addition to variation in the types of safeguards used across
incentive mechanisms, the Navy has used the same investment mechanism--
early release of contract retentions--for two different programs, but
the safeguarding mechanism differed. The Navy modified the terms of
the DDG 51 contract by negotiating changes to target price as a
safeguard when it agreed to support the Ultra Hall investment through
early release of contract retentions and payment of a special contract-
incentive fee. In comparison, when the Navy agreed to an early release
of contract retentions to support the facilities expansion project at
NASSCO, program officials stated that the Navy did not renegotiate the
terms of the T-AKE contract. In both instances, officials stated that
the maturity of the DDG 51 and T-AKE programs were factors in deciding
to release contract retentions early; the Navy awarded Bath Iron Works
the first DDG 51 destroyer contract in 1985 and NASSCO started
construction of the T-AKE class in 2003.
Conclusions:
Over the past 10 years, the Navy has expanded the use of investment
incentives to encourage shipyards to make investments that may reduce
costs of future ships. In a 2008 report to Congress, the Navy
acknowledged a need to clarify its priorities and objectives for
providing investment incentives to shipyards. However, the Navy has
yet to do this, and the absence of policy leaves the overall goals and
intended outcomes of this support unclear. Decisions about when a
particular incentive should be chosen, what returns are acceptable
across programs, and what types of investments the Navy should support
are made on a case-by-case basis without guidance. Also, it is unclear
whether or not contractors should be able to claim recovery for
certain indirect costs related to assets supported by incentive
mechanisms. Further, given the absence of policy, inconsistencies
exist regarding the importance attached to validating outcomes and how
to safeguard the Navy's financial support in the event that the
expected outcome is not achieved.
Recommendations for Executive Action:
We recommend that the Secretary of Defense direct the Secretary of the
Navy to develop a policy that identifies the intended goals and
objectives of investment incentives, criteria for using incentives,
and methods for validating outcomes.
Agency Comments and Our Evaluation:
The Department of Defense agreed with our recommendation to develop a
policy that identifies the intended goals and objectives of investment
incentives, criteria for using incentives, and methods for validating
outcomes. The department stated that the Navy intends to include
guidance for program managers and contracting officers in a Navy best-
practices guidebook.
The department's written comments can be found in appendix III of this
report. The department also provided technical comments, which were
incorporated into the report as appropriate.
We are sending copies of this report to interested congressional
committees, the Secretary of Defense, and the Secretary of the Navy.
The report also is available at no charge on the GAO Web site at
[hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-4841 or martinb@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major
contributions to this report are listed in appendix IV.
Sincerely yours,
Signed by:
Belva Martin:
Acting Director:
Acquisition and Sourcing Management:
[End of section]
Appendix I: Scope and Methodology:
To identify facilities and equipment investments over the last 10
years, we obtained and analyzed data on all capital investments over
$1 million at all major, privately owned shipyards including General
Dynamics Bath Iron Works, General Dynamics NASSCO, General Dynamics
Electric Boat, Northrop Grumman Shipbuilding-Gulf Coast, Northrop
Grumman Shipbuilding-Newport News, and two smaller, privately owned
shipyards, Austal USA and Marinette Marine shipyard. We supplemented
our analysis of the data by interviewing officials at each shipyard to
obtain an understanding of the purpose of these investments. We then
categorized the investments at major shipyards into three groups, and
shipyard officials confirmed our categorization of the investments. In
our analysis we excluded some investments such as investments that
exclusively supported nuclear aircraft carrier and submarine
refuelings, modernizations, and service life extensions programs. We
also excluded information-technology investments and annual operating
capital. To assess the reliability of each shipyard's data, we
interviewed knowledgeable shipyard officials about the data and
confirmed that the data are subject to external audits. We determined
that the data were sufficiently reliable for the purposes of this
report. We also interviewed officials at each shipyard's Supervisor of
Shipbuilding, Conversion, and Repair to understand investments over
the past 10 years and how those investments may have affected each
shipyard's work flow and processes. We also interviewed relevant
Defense Contract Audit Agency officials at major private shipyards.
To determine the role the Navy had in facilities and equipment
investments at privately owned shipyards, we reviewed shipbuilding
contracts, legislation making funds available for shipyards affected
by Hurricane Katrina, and Deputy Assistant Secretary of the Navy for
Ship Programs reports to Congress regarding capital-investment
strategies at shipyards. To assist with identifying when the Navy has
provided support for facilities and equipment investments, we held
discussions with: the CVN 21 program office; DDG 51 program office;
Joint High Speed Vessel program office; T-AKE program office; Virginia-
class submarine program office; Program Executive Office, Ships;
Supervisor of Shipbuilding, Conversion, and Repair (Bath, Groton, Gulf
Coast, and Newport News); and Naval Sea Systems Command-Contracts.
After identifying which mechanisms the Navy uses to provide support to
shipyards for facilities and equipment investments and when these
investments were used, we analyzed the data to determine any trends
over the past 10 years. To supplement this analysis, we met with
officials from the Office of the Deputy Assistant Secretary of the
Navy-Ships, the Office of the Deputy Assistant Secretary of the Navy-
Acquisition and Logistics Management, and the Office of the Secretary
of Defense-Industrial Policy to understand how the Navy's role in
investment support at shipyards has evolved over the past 10 years. We
also met with officials from General Dynamics Marine Systems and
Northrop Grumman Shipbuilding to understand their corporate processes
for when to make facilities and equipment investments and how the
Navy's support is considered during that process.
To evaluate how the Navy ensures its role in facilities and equipment
investments results in expected outcomes, we reviewed shipyard
business-case analyses and accompanying documents for Navy-supported
projects and analyzed approaches across programs to identify
differences and presence of formal validation of attainment of
expected benefits. We supplemented this analysis with interviews of
officials responsible for managing investment incentives including the
CVN 21 program office; T-AKE program office; Virginia-class submarine
program office; Program Executive Office, Ships; Supervisor of
Shipbuilding, Conversion, and Repair (Bath, Groton, Gulf Coast, and
Newport News).
We conducted this performance audit from October 2009 to July 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
[End of section]
Appendix II: Overview of Private Shipyards and Summary of Navy
Investment Incentives:
Austal USA:
Corporation and Location:
Austal is an Australian-based company with a U.S. location in Mobile,
Alabama.
Year Acquired (Corporation):
Not applicable:
Product Line:
Smaller surface ships:
Navy Program Overview:
Austal USA is the Navy's prime contractor for the Joint High Speed
Vessel and teamed with General Dynamics Bath Iron Works for
construction of the Littoral Combat Ship. The Navy has contracted with
Austal USA for three Joint High Speed Vessels and an option for seven
more. The Navy has also contracted with General Dynamics Bath Iron
Works for two Littoral Combat Ships built at Austal USA shipyard.
Austal is currently competing as the prime contractor for the next 10
Littoral Combat Ships.
Navy Investment Incentives over the Past 10 Years:
Hurricane Katrina relief funds:
Description of Investment Incentives:
In June 2006, Congress enacted the Emergency Supplemental
Appropriations Act for Defense, the Global War on Terror, and
Hurricane Recovery, 2006, which included funding for infrastructure
improvements at Gulf Coast shipyards that had existing Navy
shipbuilding contracts and were damaged by Hurricane Katrina.
Following this legislation, the Assistant Secretary of the Navy for
Research, Development and Acquisition issued a memorandum that
outlined goals for competitively awarding the funding, provided
general instructions for how contractors should develop business cases
supporting funding requests, and established a panel to review
contractor proposals for funding. The panel awarded Austal USA a
contract supporting construction of the Modular Manufacturing
Facility. Disbursement of funds from the Navy to Austal USA was based
upon completion of predetermined construction milestones.
Bath Iron Works:
Corporation and Location:
Bath Iron Works operates facilities principally in Bath, Maine, and
has support facilities in Brunswick, Maine.
Year Acquired (Corporation):
1995 (General Dynamics):
Product Line:
Surface combatants:
Navy Program Overview:
Bath Iron Works builds surface combatants including DDG 51 and DDG
1000.
Navy Investment Incentives over the Past 10 Years:
Early release of retentions, share-line adjustment, special contract-
incentive fees:
Description of Investment Incentives:
The Navy used early release of retentions to help support the Bath
Iron Works investments in a Land Level Transfer Facility.
The Navy supported Ultra Hall construction by modifying the terms of
the DDG 51 contract and adding three incentive mechanisms. As part of
the incentives, the Navy also negotiated a reduced maximum price for
each DDG 51 ship.
* By releasing retentions early, corporate and shipyard officials
stated that the Navy helped Bath Iron Works, and its corporate owner
General Dynamics, avoid negative cash flows during construction, a
primary objective of the shipyard and corporate owner.
* The addition of a special contract-incentive fee gave Bath Iron
Works an opportunity to earn additional profit by investing in the
facility.
* By changing the incentive fee structure, the Navy also gave Bath
Iron Works an incentive to achieve savings.
Electric Boat:
Corporation and Location:
Electric Boat operates two facilities in Groton, Connecticut, and
Quonset Point, Rhode Island.
Year Acquired (Corporation):
1952 (General Dynamics)[Footnote 19]
Product Line:
Submarines:
Navy Program Overview:
General Dynamics Electric Boat is the Navy's prime contractor for
Virginia-class submarines. Through a teaming agreement, Electric Boat
and Northrop Grumman Shipbuilding-Newport News work together to build
the submarines. Each contractor is responsible for building designated
sections and modules, and the contractors alternate final assembly,
outfitting, and delivery. To date, the Navy has contracted to purchase
submarines in three blocks. Block I includes four submarines, Block II
includes six submarines, and Block III includes eight submarines.
Navy Investment Incentives over the Past 10 Years:
Accelerated depreciation, special contract-incentive fees:
Description of Investment Incentives:
Accelerated Depreciation:
In 2000, the Navy agreed to accelerate depreciation on five
investments over the course of the Virginia-class Block I contract.
In 2004, Electric Boat initiated funding long-term repair of three
graving docks. The Navy agreed to accelerate depreciation of the long-
term repairs to 16 years rather than over the docks' entire useful
life, expected to be over 30 years.
Special Contract-Incentive Fees:
The Virginia-class submarine Block II and Block III contracts include
special incentives to reward the contractor if it develops more
efficient and cost-effective practices that contribute to the
production of more affordable submarines. On both contracts, the
contractor can claim a special incentive for investing in facilities
and process-improvement projects. Since the submarines are built at
both Electric Boat and Newport News, both contractors can claim the
incentive under these contracts.
Under the Block II contract, the contractor submits a business-case
analysis to the Supervisor of Shipbuilding, Groton. Within 30 days
after approval by the Supervisor of Shipbuilding and start of the
project, the Navy pays the contractor a special incentive not to
exceed 50 percent of the estimated investment cost. After the
contractor successfully implements the project as defined in the
business-case analysis, the Navy pays the contractor another special
incentive not to exceed 50 percent of the original estimated
investment cost. The sum of the two incentive payments cannot exceed
100 percent of the approved business-case analysis estimated
investment cost.
During the Block III contract negotiations, Newport News and Electric
Boat proposed facilities and equipment investments, and savings from
these investments were included in the target cost. For these
investments, the contractor submits a business case to claim a special
incentive fee tied to the first four submarines for the amount
necessary to achieve the documented corporate minimum return on
investment. To claim a special incentive fee for the last four
submarines on the Block III contract, the process mirrors the process
under Block II. For these projects, the incentive amount can equal up
to 100 percent of the approved business-case analysis estimated
investment cost.
Marinette Marine Corporation:
Corporation and Location:
Marinette Marine Corporation is located in Marinette, Wisconsin.
Year Acquired (Corporation):
2008 (Fincantieri):
Product Line:
Smaller surface ships:
Navy Program Overview:
The Navy has contracted with Lockheed Martin for two Littoral Combat
Ships built at Marinette Marine shipyard. The Navy is currently
holding a competition for remaining Littoral Combat Ships.
Navy Investment Incentives over the Past 10 Years:
None:
NASSCO:
Corporation and Location:
NASSCO operates in San Diego, California.
Year Acquired (Corporation):
1998 (General Dynamics):
Product Line:
Auxiliary ships:
Navy Program Overview:
NASSCO builds auxiliary ships including the T-AKE for Navy sealift
operations. In recent history, NASSCO's work has been divided
approximately as follows: 60 percent new construction for the Navy, 20
percent repair work, and 20 percent new commercial construction.
NASSCO is the only major private shipyard to perform commercial work
along with Navy shipbuilding.
Navy Investment Incentives over the Past 10 Years:
Early release of contract retentions:
Description of Investment Incentives:
The Navy used early release of contract retentions to incentivize
investments at NASSCO three times over the last 10 years. In 2001, the
Navy released retentions early to support the acquisition of new
cranes. In 2006 and 2008, the Navy released retentions early to
support investments at NASSCO, including some support for investments
that were part of NASSCO's facility expansion project. These
investments included projects to modernize the preoutfitting
facilities such as expanding the M-Lane, improving stage of
construction 4 activities, and constructing a new blast and paint
facility. By releasing retentions early, the Navy helped NASSCO
maintain a positive cash flow while the shipyard made new investments,
NASSCO officials said.
Northrop Grumman Shipbuilding-Gulf Coast:
Corporation and Location:
Northrop Grumman Shipbuilding-Gulf Coast operates in Pascagoula,
Mississippi, and New Orleans, Louisiana, with other support facilities.
Year Acquired (Corporation):
2001 (Northrop Grumman):
Product Line:
Surface combatants, amphibious assault ships, auxiliary ships, and
Coast Guard patrol boats (cutters):
Navy Program Overview:
Northrop Grumman Shipbuilding-Gulf Coast builds DDG 51 surface
combatants and the hangar, rear Peripheral Vertical Launching System,
and the composite deckhouse for DDG 1000 surface combatants. It is
also the prime contractor for the LPD 17 amphibious transport ship and
the LHA 6 amphibious assault ship.
Navy Investment Incentives over the Past 10 Years:
Hurricane Katrina relief funds:
Description of Investment Incentives:
In June 2006, Congress enacted the Emergency Supplemental
Appropriations Act for Defense, the Global War on Terror, and
Hurricane Recovery, 2006, which included funding for infrastructure
improvements at Gulf Coast shipyards that had existing Navy
shipbuilding contracts and were damaged by Hurricane Katrina.
Following this legislation, the Assistant Secretary of the Navy for
Research, Development and Acquisition issued a memorandum that
outlined goals for awarding the funding, provided general instructions
for how contractors should develop business cases supporting funding
requests, and established a panel to review contractor proposals for
funding. Northrop Grumman Shipbuilding-Gulf Coast submitted several
proposals for review and the panel awarded this shipyard one contract
supporting two separate investments, with an option for a third. The
contract includes funding to support purchasing equipment for a panel
line at the Pascagoula, Mississippi, shipyard, an option for funding
to support equipment for a panel line at the New Orleans, Louisiana,
shipyard, and special tooling for the composite manufacturing facility
in Gulfport, Mississippi. Disbursement of funds from the Navy to
Northrop Grumman Shipbuilding-Gulf Coast is based upon completion of
predetermined construction milestones. To date, the Navy has expended
100 percent of funding on the contract for the Pascagoula panel line,
0 percent of funding on the contract for the Avondale panel line, and
approximately 90 percent of funding on the contract for the composite
manufacturing facility. Navy officials stated that funding for the
Avondale panel line is contingent upon Northrop Grumman Shipbuilding-
Gulf Coast demonstrating returns on the panel line in Pascagoula,
Mississippi.
Northrop Grumman Shipbuilding-Newport News:
Corporation and Location:
Northrop Grumman Shipbuilding-Newport News operates in Newport News,
Virginia.
Year Acquired (Corporation):
2001 (Northrop Grumman):
Product Line:
Aircraft carriers, submarines:
Navy Program Overview:
Northrop Grumman Shipbuilding-Newport News is the Navy's prime
contractor for aircraft carriers and refueling and complex overhauls.
Newport News is currently constructing CVN 78, the lead ship of the
new CVN 21 class of nuclear-powered aircraft carriers.
Through a teaming agreement, Northrop Grumman Shipbuilding-Newport
News also works with General Dynamics Electric Boat to build the
Virginia-class submarines. Each contractor is responsible for building
designated sections and modules, and the contractors alternate final
assembly, outfitting, and delivery. To date, the Navy has contracted
to purchase submarines in three blocks. Block I includes four
submarines, Block II includes six submarines, and Block III includes
eight submarines.
Navy Investment Incentives Over the Past 10 Years:
Accelerated depreciation, special contract-incentive fees:
Description of Investment Incentives:
Accelerated Depreciation:
In 2003, the Navy and Newport News signed a memorandum of agreement to
accelerate depreciation of a new pier, known as Pier 3. Before
construction of Pier 3, Newport News had one pier where it could
perform work on aircraft carriers. This pier was in use for almost 60
years and Newport News was planning to replace it in 2012. Due to a
Navy scheduling conflict, Newport News was going to have two aircraft
carriers that needed to be at this pier at the same time in fiscal
year 2007. To address the scheduling conflict, the Navy agreed to
accelerate depreciation of the new pier if Newport News accelerated
its planned timeline to construct the pier. Under this agreement,
Newport News is allowed to depreciate the pier over 7 years rather
than over the estimated useful life of the pier, expected to be 40
years.
Special Contract-Incentive Fees:
Virginia-class submarine. The Virginia-class submarine Block II and
Block III contracts include special incentives to reward the
contractor if it develops more efficient and cost-effective practices
that contribute to the production of more affordable submarines. On
both contracts, the contractor can claim a special incentive for
investing in facilities and process-improvement projects. Since the
submarines are built at both Electric Boat and Newport News, both
contractors can claim the incentive under these contracts.
Under the Block II contract, the contractor submits a business-case
analysis to the Supervisor of Shipbuilding, Groton. Within 30 days
after approval by the Supervisor of Shipbuilding and start of the
project, the Navy pays the contractor a special incentive not to
exceed 50 percent of the estimated investment cost. After the
contractor successfully implements the project as defined in the
business-case analysis, the Navy pays the contractor another special
incentive not to exceed 50 percent of the original estimated
investment cost. The sum of the two incentive payments cannot exceed
100 percent of the approved business-case analysis estimated
investment cost.
During the Block III contract negotiations, Newport News and Electric
Boat proposed facilities and equipment investments, and savings from
these investments were included in the target cost of the contract.
For these investments, the contractor submits a business case to claim
a special incentive fee tied to the first four submarines for the
amount necessary to achieve the documented corporate minimum return on
investment. To claim a special incentive fee for the last four
submarines on the Block III contract, the process mirrors the process
under Block II. For these projects, the incentive amount can equal up
to 100 percent of the approved business-case analysis estimated
investment cost.
CVN 78 Construction-Preparation Contract. The CVN 78 construction-
preparation contract includes a special contract-incentive fee
available to Newport News if it invests in 10 facilities identified
during contract negotiations as investments that would contribute to
reducing the construction cost of CVN 21 aircraft carriers. The
special contract incentive fee for each facility is a portion of the
total cost of the facility. The Navy pays the special incentive fee
for each facility based upon Newport News's progress constructing the
facility. Newport News agreed to include savings from these facilities
in the construction proposal.
[End of section]
Appendix III: Comments from the Department of Defense:
Note: Page numbers in the draft report may differ from those in this
report.
Office Of The Assistant Secretary Of Defense:
Acquisition:
3015 Defense Pentagon:
Washington, DC 20301-3015:
July 9, 2010:
Mrs. Belva Martin:
Acting Director, Acquisition and Sourcing Management:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, DC 20548:
Dear Mrs. Martin,
This is the Department of Defense (DoD) response to the GAO draft
report, GAO-10-686, "Defense Acquisitions: Guidance Needed on Navy's
Use of Investment Incentives at Private Shipyards" dated June 8, 2010,
(GAO Code 120846). The Department concurs with the recommendation in
the report and the written response is attached.
The Department appreciates the opportunity to comment on the draft
report. For further questions concerning this report, please contact
CDR Brad Busch, Shipbuilding Sector Analyst, Industrial Policy, 571-
256-2975.
Sincerely,
Signed by:
Brett Lambert:
Director:
Industrial Policy:
Enclosures: As stated:
[End of letter]
GAO Draft Report Dated June 8, 2010:
GAO-10-686 (GAO Code 120846):
"Defense Acquisitions: Guidance Needed On Navy's Use Of Investment
Incentives At Private Shipyards"
Department Of Defense Comments To The GAO Recommendations:
Recommendation 1: The GAO recommends that the Secretary of Defense
direct the Navy to develop a policy that identifies the intended goals
and objectives of investment incentives, criteria for using
incentives, and methods for validating outcomes. (See page 31/GAO
Draft Report.)
DoD Response: The Department concurs with the GAO's recommendation.
The Navy agrees to issue guidance on the intended goals and objectives
of investment incentives, criteria for using incentives, and methods
for validating outcomes. When shipyard investment is considered, it is
done as part of a holistic approach to negotiating a contract.
Recognizing that there is no one-size-fits-all approach for contract
incentives, the Navy's guidance will provide direction to the program
managers and contracting officers while preserving their flexibility
to tailor investment incentives appropriate to their particular
program needs. The Navy intends to include the guidance in a Navy best
practices guidebook.
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
Belva Martin, (202) 512-4841 or martinb@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Karen Zuckerstein (Assistant
Director), Matthew Butler, Kristine Hassinger, Michelle Liberatore,
Aron Szapiro, and Molly Traci made major contributions to this report.
[End of section]
Footnotes:
[1] U.S. Navy, Report to Congress on Annual Long-Range Plan for
Construction of Naval Vessels for FY 2011 (February 2010).
[2] GAO, Best Practices: High Levels of Knowledge at Key Points
Differentiate Commercial Shipbuilding from Navy Shipbuilding,
[hyperlink, http://www.gao.gov/products/GAO-09-322] (Washington, D.C.:
May 13, 2009).
[3] In addition to this work, GAO has ongoing work examining the
material condition of public shipyards and the extent to which the
Navy is investing in capital improvements at these shipyards.
[4] Public funds include federal, state, and local dollars.
[5] The Navy operates four publicly owned shipyards located in Pearl
Harbor, Hawaii; Puget Sound, Washington; Seavey Island, Maine; and
Portsmouth, Virginia.
[6] We refer to Northrop Grumman Shipbuilding-Gulf Coast as one
shipyard with two primary locations: Pascagoula, Mississippi, and New
Orleans, Louisiana.
[7] The Cost Accounting Standards, codified at 48 C.F.R. § 9904,
govern the measurement, assignment, and allocation of costs to certain
government contracts. 41 U.S.C. § 422(f)(1); 48 C.F.R. § 9901.302(b).
The applicability of the Cost Accounting Standards to a proposed
government contract is addressed in 48 C.F.R. § 9903.201-1.
[8] Government property includes (1) government-furnished property,
which is property in the possession of or acquired by the government
and furnished to the contractor for performance of a contract; and (2)
contractor-acquired property, which is property acquired, fabricated,
or otherwise provided by the contractor for performing a contract and
to which the government has title. Federal Acquisition Regulation
(FAR) § 45.101.
[9] More specifically, an indirect cost means any cost not directly
identified with a single, final cost objective, but identified with
two or more final cost objectives or with at least one intermediate
cost objective. FAR § 2.101. Depreciation costs are generally
allocated as indirect costs, but may be charged directly in certain
circumstances. 48 C.F.R. § 9904.409-40; Defense Contract Audit Agency,
Contract Audit Manual (DCAAM 7640.1), sec. 8.409-1e.
[10] The FAR provides that depreciation and facilities capital cost of
money are allowable contract costs. FAR §§ 31.205-10(b), 31.205-11(a).
A cost is allowable when the cost complies with all of the following
requirements: reasonableness; allocability; standards promulgated by
the Cost Accounting Standards Board, if applicable, generally accepted
accounting principles and practices appropriate to the circumstances;
terms of the contract; and any limitations set for in subpart 31.2 of
the Federal Acquisition Regulation. FAR § 31.201-2. Procedures for
allocating depreciation costs and facilities capital cost of money
costs to government contracts are provided in 48 C.F.R. § 9904.409 and
§ 9904.414, respectively.
[11] 48 C.F.R. §§ 9904.409, 9904.414.
[12] Some shipbuilders identify slightly different numbers of hours
for the second and third phases (block and posterection/postlaunch
construction) cited in the rule. These numbers of hours tend to
increase as the complexity and outfitting density of a ship increase.
[13] Early release of contract retentions also provides financial
benefit to shipyards because of the time-value of money: money today
has more value than the same amount in the future. However, major
private shipyards and Navy officials did not emphasize this benefit
and focused on the cash-flow benefit of the early release of
retentions incentive.
[14] To use this incentive, the Navy needs to secure a waiver from the
Cost Accounting Standards Board.
[15] See Emergency Supplemental Appropriations Act for Defense, The
Global War on Terror, and Hurricane Recovery, 2006, Pub. L. No. 109-
234, § 2203.
[16] Newport News officials told us that despite operating as the sole
supplier of aircraft carriers, the shipyard does make efficiency
improvements. They added that without such efficiency improvements,
aircraft carriers could become prohibitively expensive for the Navy to
buy.
[17] The Navy has used accelerated depreciation and early release of
contract retentions prior to 2000 to encourage investments at
shipyards.
[18] Shipyard officials responsible for submitting this business case
stated that they have since reevaluated the project and resubmitted a
new business case for the Navy's review.
[19] General Dynamics was formed by a 1952 combination of Electric
Boat, Canadair Ltd. and other companies.
[End of section]
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