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entitled 'Defense Acquisitions: Improved Management Practices Could 
Help Minimize Cost Growth in Navy Shipbuilding Programs' which was 
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Report to the Chairman, Subcommittee on Defense, Committee on 
Appropriations, House of Representatives:

United States Government Accountability Office:

GAO:

February 2005:

Defense Acquisitions:

Improved Management Practices Could Help Minimize Cost Growth in Navy 
Shipbuilding Programs:

GAO-05-183:

GAO Highlights:

Highlights of GAO-05-183, a report to the Chairman, Subcommittee on 
Defense, Committee on Appropriations, House of Representatives: 

Why GAO Did This Study:

The U.S. Navy invests significantly to maintain technological 
superiority of its warships. In 2005 alone, $7.6 billion was devoted to 
new ship construction in six ship classes—96 percent of which was 
allocated to four classes: Arleigh Burke class destroyer, Nimitz class 
aircraft carrier, San Antonio class amphibious transport dock ship, and 
the Virginia class submarine.

Cost growth in the Navy’s shipbuilding programs has been a long-
standing problem. Over the past few years, the Navy has used “prior 
year completion” funding—additional appropriations for ships already 
under contract—to pay for cost overruns. This report (1) estimates the 
current and projected cost growth on construction contracts for eight 
case study ships, (2) breaks down and examines the components of the 
cost growth, and (3) identifies any funding and management practices 
that contributed to cost growth.

What GAO Found:

For the eight ships GAO assessed, the Congress has appropriated $2.1 
billion to cover the increases in the ships’ budgets. The GAO’s 
analysis indicates that total cost growth on these ships could reach 
$3.1 billion or even more if shipyards do not maintain current 
efficiency and meet schedules. Cost growth for the CVN 77 aircraft 
carrier and the San Antonio lead ship (LPD 17) has been particularly 
pronounced. 

Increases in labor hour and material costs together account for 77 
percent of the cost growth on the eight ships. Shipbuilders frequently 
cited design modifications, the need for additional and more costly 
materials, and changes in employee pay and benefits as the key causes 
of this growth. For example, the San Antonio’s lead ship’s systems 
design continued to evolve even as construction began, which required 
rebuilding of completed areas to accommodate the design changes. 
Materials costs were often underbudgeted, as was the case with the 
Virginia class submarines and Nimitz class aircraft carriers. For the 
CVN 77 carrier, the shipbuilder is estimating a substantial increase in 
material costs. 

Components of Cost growth: 

[See PDF for image]

[End of figure]

Navy practices for estimating costs, contracting, and budgeting for 
ships have resulted in unrealistic funding of programs, increasing the 
likelihood of cost growth. Despite inherent uncertainties in the ship 
acquisition process, the Navy does not account for the probability of 
cost growth when estimating costs. Moreover, the Navy did not conduct 
an independent cost estimate for carriers or when substantial changes 
occurred in a ship class, which could have provided decision makers 
with additional knowledge about a program’s potential costs. In 
addition, contract prices were negotiated and budgets established 
without sufficient design knowledge and construction knowledge. When 
unexpected events did occur, the incomplete and untimely reporting on 
program progress delayed the identification of problems and the Navy’s 
ability to correct them.

What GAO Recommends:

GAO is making recommendations aimed at improving the Navy’s processes 
for developing cost estimates, establishing realistic contract prices 
and ship budgets, and providing timely and complete reporting on 
program costs to alert managers to potential problems.

www.gao.gov/cgi-bin/getrpt?GAO-05-183.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Paul Francis at (202) 512-
2811 or francisp@gao.gov.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

New Ships Continue to Cost More Than Budgeted:

Labor and Materials Drive Increases in Construction Costs:

Navy Funding and Management Practices Result in Insufficient Provision 
for Risk:

Conclusions:

Recommendations:

Agency Comments and Our Evaluation:

Appendix I: Scope and Methodology:

Appendix II: Arleigh Burke Class Destroyer:

Program Description:

Cost Experience on DDG 91 and DDG 92:

Main Drivers of Cost Growth for DDG 91 DDG 92:

Appendix III: Nimitz Class Aircraft Carrier:

Program Description:

Cost Experience on CVN 76 and CVN 77:

Main Drivers of Cost Growth for CVN 76 and CVN 77:

Appendix IV: San Antonio Class Amphibious Transport Dock Ship:

Program Description:

Cost Experience on LPD 17 and LPD 18:

Main Drivers of Cost Growth for LPD 17 and LPD 18:

Appendix V: Virginia Class Submarine:

Program Description:

Cost Experience on SSN 774 and SSN 775:

Main Drivers of Cost Growth for SSN 774 and SSN 775:

Appendix VI: GAO's Forecast of Additional Costs to Complete 
Construction Contracts:

Appendix VII: Comments from the Department of Defense:

Appendix VIII: GAO Contacts and Staff Acknowledgments:

Tables:

Table 1: Overview of Navy Shipbuilding Programs Represented in GAO's 
Case Studies:

Table 2: Shipbuilding Budget Cost Categories:

Table 3: Growth in Program Budgets for Case Study Ships:

Table 4: GAO's Forecasts of Additional Cost Growth for Construction:

Table 5: Growth in Labor Hour Costs:

Table 6: Reasons Given by Shipbuilders for Labor Hours Cost Growth:

Table 7: Growth in Material Costs:

Table 8: Reasons Given by Shipbuilders for Material Cost Growth:

Table 9: Growth in Overhead Costs and Labor Rates:

Table 10: Reasons Given by Shipbuilders for Overhead and Labor Rate 
Cost Growth:

Table 11: Target Prices for Case Study Ships:

Table 12: Characteristics of Case Study Ships:

Table 13: Major Events in the Acquisition of DDG 91 and DDG 92:

Table 14: Growth in Program Budgets for Case Study Ships:

Table 15: Growth in Labor Hour Costs:

Table 16: Growth in Overhead Costs and Labor Rates:

Table 17: Growth in Material Costs:

Table 18: Major Events in the Acquisition of CVN 76 and CVN 77:

Table 19: Growth in Program Budgets for Case Study Ships:

Table 20: GAO's Forecasts of Additional Cost Growth for Construction:

Table 21: Growth in Material Costs:

Table 22: Growth in Labor Hour Costs:

Table 23: Historical Man-hours Used to Produce Prior Ships Compared to 
CVN 76 Negotiated Man-hours:

Table 24: Growth in Overhead Costs and Labor Rates:

Table 25: Major Events in the Acquisition of LPD 17 and LPD 18:

Table 26: Growth in Program Budgets for Case Study Ships:

Table 27: GAO's Forecasts of Additional Cost Growth for Construction:

Table 28: Growth in Material Costs:

Table 29: Growth in Labor Hour Costs:

Table 30: Growth in Overhead Costs and Labor Rates:

Table 31: Major Events in the Acquisition of SSN 774 and SSN 775:

Table 32: Growth in Program Budgets for Case Study Ships:

Table 33: GAO's Forecasts of Additional Cost Growth for Construction:

Table 34: Growth in Material Costs:

Table 35: Growth in Labor Hour Costs:

Table 36: Growth in Overhead Costs and Labor Rates:

Figures:

Figure 1: Typical Production Times for Various Weapon Systems:

Figure 2: Components of Cost Growth:

Figure 3: GAO and Shipbuilder Construction Cost Growth Forecasts for 
Case Study Ships:

Figure 4: Arleigh Burke Class Destroyer:

Figure 5: Average Sources of Cost Growth on DDG 91 and DDG 92:

Figure 6: Nimitz Class Aircraft Carrier:

Figure 7: Average Sources of Cost Growth on CVN 76 and CVN 77:

Figure 8: San Antonio Class Amphibious Transport Dock Ship:

Figure 9: Average Sources of Cost Growth on LPD 17 and LPD 18:

Figure 10: Virginia Class Submarine:

Figure 11: Average Sources of Cost Growth on SSN 774 and SSN 775:

Figure 12: SSN 774 Lead Ship Labor Hour Growth:

Figure 13: Comparison of Shipbuilders' and GAO's Forecasts of 
Additional Construction Costs for Six Classes of Ships Actively under 
Construction:

United States Government Accountability Office:

Washington, DC 20548:

February 28, 2005:

The Honorable C. W. Bill Young: 
Chairman, Subcommittee on Defense: 
Committee on Appropriations: 
House of Representatives:

Dear Mr. Chairman:

U.S. Navy warships are the most technologically advanced in the world. 
The United States invests significantly to maintain this advantage. In 
2005 alone, the Navy devoted $7.6 billion to new ship construction in 
six ship classes--96 percent of which was allocated to four classes: 
Arleigh Burke class destroyer, Nimitz class aircraft carrier, San 
Antonio class amphibious transport dock ship, and the Virginia class 
submarine.

Cost growth in the Navy's shipbuilding programs has been a long- 
standing problem--one that the Congress has identified and responded to 
by providing both additional funding and direction to the Navy. Over 
the past few years, the Navy has used "prior year completion" funding-
-additional appropriations for ships already under contract--to pay for 
cost overruns. Because of the size and routine occurrence of prior year 
funding, we were asked to analyze cost overruns on Navy shipbuilding 
programs. Specifically, this report (1) estimates the current and 
projected cost growth on selected ship construction contracts, (2) 
breaks down and examines the components of the cost growth, and (3) 
identifies any funding and management practices that contribute to cost 
growth.

To address these objectives, we looked at cost growth in the four 
classes of ships that account for the majority of the funding for new 
shipbuilding and prior year bills, focusing on ships with construction 
contracts that were more than 30 percent complete at the time we began 
our review. Within each class, we selected two ships currently under 
contract as case studies: DDG 91 and DDG 92 in the Arleigh Burke class 
of destroyers, CVN 76 and CVN 77 in the Nimitz class of aircraft 
carriers, LPD 17 and LPD 18 in the San Antonio class of transports, and 
SSN 774 and SSN 775 in the Virginia class of submarines. To estimate 
the total projected cost growth on construction contracts, we used 
contractor performance reports, projecting high and low estimates for 
the costs to complete the ships in the four classes we reviewed. We 
looked at cost growth by comparing the initial budget request to the 
Congress and the updated budget included in the 2005 President's budget 
and by comparing the initial contract award to the latest estimate at 
completion. The latest estimate at completion includes changes to the 
original baseline or scope of work. For all ships currently under 
construction, we also estimated total cost growth since contract award, 
using contractor performance reports to project high and low estimates 
for the costs to complete construction of these ships. To break down 
and examine the components of cost growth on the eight case study 
ships, we analyzed the Navy's cost estimates, its budget requests to 
the Congress, contractor performance reports, and other cost data for 
each of the eight case study ships. To assess funding and management 
practices, we spoke with the shipbuilders, Navy and Defense Contract 
Audit Agency officials, and reviewed supporting documentation. Our work 
was conducted between July 2003 and December 2004 in accordance with 
generally accepted government auditing standards. Our analyses and 
forecasts were based on data available to us in July 2004. To the 
extent significant changes occurred, we incorporated information from 
the fiscal year 2006 President's budget. For a complete description of 
our scope and methodology, see appendix I. Details on the eight case 
study ships are discussed in appendixes II to V.

Results in Brief:

The Navy's shipbuilding programs continue to experience significant 
cost growth. For the eight case study ships alone, the Congress has 
appropriated funds to cover a $2.1 billion increase in the ships' 
budgets. Cost growth was pronounced for the CVN 77 carrier and for the 
lead ships in the two new classes we looked at--the Virginia class and 
especially the San Antonio class. We estimated cost growth could exceed 
$3 billion, and these estimates are likely understated because they 
assume that the shipyards will maintain their current efficiencies and 
meet scheduled milestones. Thus, additional appropriations, in excess 
of $1 billion, will be needed to cover the additional cost growth.

Increases in labor hour and material costs account for 78 percent of 
the cost growth on the eight ships we reviewed, while overhead and 
labor rate increases account for 17 percent. Navy-furnished equipment-
-including radars and weapon systems--represent just 5 percent of the 
cost growth. Shipbuilders cited a number of direct causes for the labor 
hour, material, and overhead cost growth in the eight ships. The most 
common causes were related to design modifications, the need for 
additional and more costly materials, and changes in employee pay and 
benefits. For example, the lack of design maturity when introducing new 
technologies led to rework, increasing growth in labor hours for most 
of the ships. The design of ship systems for LPD 17 continued to evolve 
even as construction proceeded. As a result, workers were required to 
rebuild completed areas of the ship to accommodate design changes. 
Growth in materials costs was due, in part, to the Navy's and 
shipbuilders' underbudgeting of these costs. For example, the 
materials' budget for the first four Virginia class submarines was $132 
million less than quotes received from vendors and subcontractors at 
contract award. Price increases also contributed to the growth in 
materials costs.

Navy practices for estimating costs, contracting, and budgeting for 
ships have resulted in unrealistic funding of programs, increasing the 
likelihood of cost growth. Despite inherent uncertainties in the ship 
acquisition process, the Navy does not measure or provide for the 
probability of cost growth when estimating costs. Moreover, the Navy 
did not conduct independent cost estimates for carriers, which could 
have provided decision makers with additional knowledge about a 
program's potential costs. In addition, contract prices were negotiated 
and budgets established without making full use of design knowledge and 
construction experience. Finally, when unexpected events occurred, the 
incomplete and untimely reporting on program progress delayed the 
identification of problems and the Navy's ability to correct them.

We are making seven recommendations aimed at improving the Navy's 
processes for developing cost estimates, establishing realistic 
contract prices and ship budgets, and providing timely and complete 
reporting on program costs to alert managers to potential problems. In 
its comments on a draft of this report, DOD concurred with two of our 
recommendations and partially concurred with five. We believe the Navy 
needs to take concrete action to establish realistic estimates, prices, 
and budgets and to improve the quality of cost reporting.

Background:

The U.S. Navy currently operates 288 surface ships and submarines. Four 
ship classes, with 23 ships under construction or recently completed, 
make up 96 percent of the Navy's fiscal year 2005 budget for new 
construction shipbuilding. (See table 1.)

Table 1: Overview of Navy Shipbuilding Programs Represented in GAO's 
Case Studies:

Ship class: Arleigh Burke destroyer; 
Mission: Destroyers provide offensive and defensive capabilities; can 
operate independently or as part of strike groups; 
Percent of Navy's fiscal year 2005 new construction and prior year 
shipbuilding budget[A]: 46%; 
Ships under construction or recently completed: 13; 
GAO's case study ships[B]: * DDG 91 (follow-on ship); * DDG 92 (follow-
on ship).

Ship class: Nimitz aircraft carrier; 
Mission: Nuclear-powered aircraft carriers form building block of 
Navy's forward-deployed peacetime presence, crisis response, and 
warfighting forces; 
Percent of Navy's fiscal year 2005 new construction and prior year 
shipbuilding budget[A]: N/A[C]; 
Ships under construction or recently completed: 2; 
GAO's case study ships[B]: * CVN 76 (follow-on ship); * CVN 77 (follow-
on ship).

Ship class: San Antonio amphibious transport dock ship; 
Mission: These amphibious ships provide a sea-based platform for 
transporting, embarking, and landing Marines and their equipment and 
supplies during an assault; 
Percent of Navy's fiscal year 2005 new construction and prior year 
shipbuilding budget[A]: 14%; 
Ships under construction or recently completed: 5; 
GAO's case study ships[B]: * LPD 17 (lead ship); * LPD†18 (follow-on 
ship).

Ship class: Virginia class submarine; 
Mission: This new class of nuclear submarines is designed to combat 
enemy submarines and surface ships; fire cruise missiles at land 
targets; and provide improved surveillance and special operations 
support; 
Percent of Navy's fiscal year 2005 new construction and prior year 
shipbuilding budget[A]: 36%; 
Ships under construction or recently completed: 4; 
GAO's case study ships[B]: * SSN 774 (lead ship); * SSN 775 (lead ship).

Sources: Navy (data); GAO (presentation).

[A] Including completion of ships authorized in prior years:

[B] A lead ship is the first to be built in a class or the first to be 
built after a major redesign of a class of ships. If two different 
shipbuilders are constructing ships that fall within the same class, 
their first ships are also referred to as lead ships. Follow-on ships 
are those built after the lead ship.

[C] Not applicable. CVN 76 and CVN 77 were funded in earlier fiscal 
years and are not included in these percentages.

[End of table]

Navy ships are complex defense systems, using advanced designs with 
state-of-the-art weapons, communications, and navigation technologies. 
Ships require many years to plan, budget, design, and build. Like other 
weapon acquisition programs, ship acquisitions begin with developing a 
system design. For ships, system design is followed by a detail design 
phase where specific construction plans are developed. Ship 
construction follows and typically takes 4 to 7 years. Construction 
time for other defense systems is much shorter--a fighter aircraft 
takes about 2 years from start of production to roll out from the 
factory floor; a tank takes about a year. (See fig. 1.)

Figure 1: Typical Production Times for Various Weapon Systems:

[See PDF for image]

Note: A varying number of years of preliminary planning and early 
design work precede the start of production.

[End of figure]

The long construction times increase the uncertainty that ship cost 
estimates--and budgets--must provide for. Moreover, the total cost for 
a ship must be budgeted for in its first year of construction. 
Provisions are made in the event cost growth occurs during 
construction. The Navy's budgeting for cost growth has changed over the 
past 2 decades. During the early 1970s and through most of the 1980s, 
the Navy used program cost reserves built into ship construction 
budgets and the Ship Cost Adjustment process to manage cost growth. 
During the 1980s, the Navy procured an average of 17 ships each year. 
In fiscal year 1988, the Navy removed program cost reserves from ship 
construction budgets and began exclusively using the Ship Cost 
Adjustment process, shifting funding between shipbuilding construction 
programs underrunning cost to programs that were overrunning costs. 
Following the end of the Cold War, the Navy decreased the procurement 
rate of ships to about 6 per year. Beginning in fiscal year 1999, cost 
increases could no longer be covered using the Ship Cost Adjustment 
process because no shipbuilding program was under cost. In 2001, the 
process was eliminated, which required the Navy to fund cost growth 
through the current mechanism of prior year completion bills.

Components of Shipbuilding Costs:

The cost of building a ship can be broken down into four main 
components: labor, material, and overhead associated with the 
shipbuilders' contract for the basic ship, and Navy-furnished 
equipment--that is, items purchased by the Navy and provided to the 
contractor for installation on the ship. (See table 2.) The 
shipbuilding contract also includes profit (referred to as 
fee).[Footnote 1]

Table 2: Shipbuilding Budget Cost Categories:

Construction: Labor: Labor hours for production, engineering and other 
direct support; 
Costs based on labor hours and the labor rate (the hourly wage paid to 
workers); 
Construction: Materials[A]: 
* Metals (steel, copper, titanium); 
* Tools; 
* Miscellaneous parts (pipe, cables); 
* Subcontracts; 
Construction: Overhead[A]: 
* Medical insurance; 
* Pensions; 
* Holiday pay; 
* Facilities maintenance and utilities; 
* Taxes; 
Navy-furnished equipment: 
* Items purchased by the Navy and provided to the shipbuilder for 
installation on the ship; 
items include ship weapon systems, propulsion equipment, and 
electronics.

Sources: Shipbuilder and Department of Defense (data); 
GAO (analysis).

[A] List is not exhaustive.

[End of table]

Types of Shipbuilding Contracts:

Two broad categories of contracts are used to procure ships: fixed- 
price and cost-reimbursement. Fixed price contracts provide for a firm 
price or an adjustable price with a ceiling price, a target price, or 
both. If the ceiling is reached the shipbuilder is generally 
responsible for all additional costs. Cost reimbursement contracts 
provide for payment of allowable incurred costs, to the extent 
prescribed in the contract. If the ship cannot be completed within 
agreed upon cost limits, the government is responsible for the 
additional costs to complete.[Footnote 2]

The level of knowledge, or certainty, in the cost estimates for a ship 
is key to determining which type of contract to use. Contracts for the 
first ship of a new class are often negotiated as cost-reimbursable 
contracts because these ships tend to involve a high-level of 
uncertainty and, thus, high cost risks. Cost reimbursement contracts 
were used to procure the San Antonio and Virginia class ships we 
reviewed. More mature shipbuilding programs, where there is greater 
certainty about costs, are typically fixed-price contracts with an 
incentive fee (profit). Fixed-price contracts were used to procure the 
Arleigh Burke and Nimitz class ships we reviewed. Both cost- 
reimbursable and fixed-price incentive fee contracts can include a 
target cost, a target profit, and a formula that allows the profit to 
be adjusted by comparing the actual cost to the target cost. 
Construction contracts for ships generally include provisions for 
controlling cost growth with incentive fees, whereby the Navy and the 
shipbuilder split any savings when the contract cost is less than its 
anticipated target. Conversely, when costs exceed the target, the 
excess is shared between the Navy and the shipbuilder.

New Ships Continue to Cost More Than Budgeted:

Ship cost growth continues to pose additional funding demands on the 
budget. Budgets for the eight case study ships alone have required 
increases of $2.1 billion, and Congress has appropriated funds to cover 
these increases. However, the total projected cost growth on contracts 
for the eight ships is likely to be higher. Consequently, the Navy will 
need in excess of $1 billion in additional appropriations to cover the 
total projected cost growth. Cost growth was more pronounced for the 
lead ships in the two new classes we looked at--the Virginia class and 
especially the San Antonio class--than the more mature Arleigh Burke 
and Nimitz classes. (Our forecasts for cost growth on all ships that 
are more than 30 percent complete are shown in appendix VI.)

The fiscal year 2005 budget for the eight case study ships was about 
$20.6 billion--representing cost growth of $2.1 billion above the 
initial budget request of $18.5 billion for these ships. (See table 3.) 
Ship construction costs comprise the majority of this increase.

Table 3: Growth in Program Budgets for Case Study Ships:

Dollars in millions.

Case study ship: DDG 91; 
Initial and fiscal year 2005 President's budget: Initial[A]: $917; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $997; 
Initial and FY 2005 President's budget: FY 2005: $80; 
Difference in budgets: Difference due to Navy-furnished equipment: $43; 
Difference in budgets: Difference due to construction costs[C]: $37.

Case study ship: DDG 92; 
Initial and fiscal year 2005 President's budget: Initial[A]: $925; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $979; 
Initial and FY 2005 President's budget: FY 2005: $55; 
Difference in budgets: Difference due to Navy-furnished equipment: 
($7)[D]; 
Difference in budgets: Difference due to construction costs[C]: $62.

Case study ship: CVN 76; 
Initial and fiscal year 2005 President's budget: Initial[A]: $4,476; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $4,600; 
Initial and FY 2005 President's budget: FY 2005: $124; 
Difference in budgets: Difference due to Navy-furnished equipment: 
($128)[E]; 
Difference in budgets: Difference due to construction costs[C]: $252.

Case study ship: CVN 77; 
Initial and fiscal year 2005 President's budget: Initial[A]: $4,975; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $5,024; 
Initial and FY 2005 President's budget: FY 2005: $49; 
Difference in budgets: Difference due to Navy-furnished equipment: 
$100; 
Difference in budgets: Difference due to construction costs[C]: 
($51)[F].

Case study ship: LPD 17; 
Initial and fiscal year 2005 President's budget: Initial[A]: $954; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $1,758; 
Initial and FY 2005 President's budget: FY 2005: $804; 
Difference in budgets: Difference due to Navy-furnished equipment: $21; 
Difference in budgets: Difference due to construction costs[C]: $784.

Case study ship: LPD 18; 
Initial and fiscal year 2005 President's budget: Initial[A]: $762; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $1,011; 
Initial and FY 2005 President's budget: FY 2005: $249; 
Difference in budgets: Difference due to Navy-furnished equipment: $3; 
Difference in budgets: Difference due to construction costs[C]: $246.

Case study ship: SSN 774; 
Initial and fiscal year 2005 President's budget: Initial[A]: $3,260; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $3,682; 
Initial and FY 2005 President's budget: FY 2005: $422; 
Difference in budgets: Difference due to Navy-furnished equipment: $95; 
Difference in budgets: Difference due to construction costs[C]: $327.

Case study ship: SSN 775; 
Initial and fiscal year 2005 President's budget: Initial[A]: $2,192; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $2,504; 
Initial and FY 2005 President's budget: FY 2005: $312; 
Difference in budgets: Difference due to Navy-furnished equipment: $18; 
Difference in budgets: Difference due to construction costs[C]: $294.

Total; 
Initial and fiscal year 2005 President's budget: Initial[A]: $18,461; 
Initial and fiscal year 2005 President's budget: FY2005[B]: $20,556; 
Initial and FY 2005 President's budget: FY 2005: $2,095; 
Difference in budgets: Difference due to Navy-furnished equipment: 
$145; 
Difference in budgets: Difference due to construction costs[C]: $1,951.

Sources: Navy (data); GAO (presentation).

[A] Estimated cost from the President's budget submission for year of 
ship authorization.

[B] Includes all prior year requests through fiscal year 2005.

[C] Part of increased cost is due to changes in the scope of the 
contract.

[D] Negative reflects savings resulting from the use of a more 
economical warfare system than was initially budgeted on the DDG 92.

[E] Negative reflects savings garnered from Navy-furnished reactor 
plant equipment.

[F] Negative reflects shifting of funds from the construction contract 
to Navy-furnished equipment.

[End of table]

We were not able to determine how much of this increase was due to 
changes in the scope of the contract and how much of the growth funded 
increases in the costs of completing the initial contract scope. 
Amounts identified by shipbuilders and Navy program offices differed 
substantially. However, the initial program budgets included funding to 
support changes in the scope of the construction contract. These funds 
amounted to a small share of the initial program budget: 3 percent for 
DDGs 91 and 92; 5 percent for CVN 76 and CVN 77; 7 percent for LPD 17 
and 4 percent for LPD 18; and 3 and 4 percent for SSNs 774 and 775, 
respectively.

While the Congress has appropriated funds to cover a $2.1 billion 
increase in the ships' costs, more funds will likely be needed to cover 
additional cost growth likely for these eight ships. At the time we 
completed our analysis in 2004, we calculated a range of the potential 
growth for the eight case study ships and found that the total 
projected cost growth would likely exceed $2.8 billion and could reach 
$3.1 billion. (See table 4.)

Table 4: GAO's Forecasts of Additional Cost Growth for Construction:

Dollars in millions: 
Forecasts based on data available July 2004: 

Case study ship: DDG 91; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $37; 
GAO's forecast of total cost growth[A]: $37-37.

Case study ship: DDG 92; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $62; 
GAO's forecast of total cost growth[A]: $62-62.

Case study ship: CVN 76; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $252; 
GAO's forecast of total cost growth[A]: $252-252.

Case study ship: CVN 77; 
Percent of ship construction completed: 45%; 
Amount already requested to cover contractor's increased cost: 
($51)[B]; 
GAO's forecast of additional Cost growth: $485-637; 
GAO's forecast of total cost growth[A]: $434-586[C].

Case study ship: LPD 17; 
Percent of ship construction completed: 93%; 
Amount already requested to cover contractor's increased cost: $784; 
GAO's forecast of additional Cost growth: $112-197; 
GAO's forecast of total cost growth[A]: $896-981.

Case study ship: LPD 18; 
Percent of ship construction completed: 69; 
Amount already requested to cover contractor's increased cost: $246; 
GAO's forecast of additional Cost growth: $102-136; 
GAO's forecast of total cost growth[A]: $348-382.

Case study ship: SSN 774; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $327; 
GAO's forecast of total cost growth[A]: $327-327[D].

Case study ship: SSN 775; 
Percent of ship construction completed: 88; 
Amount already requested to cover contractor's increased cost: $294; 
GAO's forecast of additional Cost growth: $103-219; 
GAO's forecast of total cost growth[A]: $397-513.

Total growth; 
Amount already requested to cover contractor's increased cost: $1,951; 
GAO's forecast of additional Cost growth: $802-1,189; 
GAO's forecast of total cost growth[A]: $2,753-3,140.

Sources: Shipbuilder and Navy (data); GAO (analysis).

[A] Forecast reflects expected price to the Navy.

[B] Negative reflects shifting of funds from the construction contract 
to Navy-furnished equipment.

[C] The 2006 budget submission indicates $908 million additional cost 
growth on CVN 77 above the fiscal year 2005 budget.

[D] The Navy has requested an additional funding to cover completion of 
SSN 774.

[End of table]

These cost growth estimates have already proven to be too conservative. 
In its fiscal year 2006 budget submission, the Navy recognizes an 
additional cost growth of $223 million for SSN 775 and $908 million for 
CVN 77 above its fiscal year 2005 request. In addition, our estimates 
assumed that the shipyards will maintain their current efficiency 
through the end of their contracts and meet scheduled milestones. Any 
slips in efficiency and schedules would likely result in added costs. 
For example, the delivery date for SSN 775 is expected to slip by as 
many as 9 months, which, according to the fiscal year 2006 President's 
budget has increased the final cost of the ship even more. According to 
program officials, the delivery date for the LPD 17 has been changed 
from December 2004 to May 2005, and the delivery date for the CVN 77 is 
expected to slip into 2009.

Cost growth on new ships has a number of implications. Most tangible, 
perhaps, is the significant portion of the ship construction budget 
that must be devoted to overruns on ships already under construction. 
From fiscal years 2001 to 2005, 5 to 14 percent of the Navy's ship 
construction budget, which totaled about $52 billion over the 5-year 
period, went to pay for cost growth for ships funded in prior years. 
This reduces the buying power of the budget for current construction 
and can slow the pace of modernization. The Navy is in the early stages 
of buying a number of advanced ships, including the Virginia class 
submarine, DD(X) destroyer, CVN 21 aircraft carrier, and Littoral 
Combat Ship. The Navy's ability to buy these ships as scheduled will 
depend on its ability to control cost growth.

Labor and Materials Drive Increases in Construction Costs:

Increases in labor hour and material costs account for 78 percent of 
the cost growth on shipbuilding construction contracts, while overhead 
and labor rate increases account for 17 percent. Navy-furnished 
equipment[Footnote 3]--including radars and weapon systems--represents 
just 5 percent of the cost growth. (See fig. 2.) Shipbuilders cited a 
number of direct causes for the labor hour, material, and overhead cost 
growth in the eight case study ships. The most common causes were 
related to design modifications, the need for additional and more 
costly materials, and changes in employee pay and benefits.

Figure 2: Components of Cost Growth:

[See PDF for image]

Note: Total growth in construction costs is $3.2 billion, based on 
shipbuilders' estimate at completion.

[End of figure]

Design Changes and Lack of Skilled Labor Contributed to Labor Hour Cost 
Growth:

Labor hour increases for the eight case study ships ranged from 33 
percent to 105 percent--for a total of 34 million extra labor hours. 
For example, the shipbuilders for LPD 17 and CVN 76 each needed 8 
million additional labor hours to construct the ships:

Cost growth due to increased labor hours totaled more than $1.3 
billion. (See table 5.) While the total dollars were the greatest for 
LPD 17 ($284 million), the labor cost as a percent of total cost growth 
was the greatest for DDG 91 (105 percent).

Table 5: Growth in Labor Hour Costs:

Dollars in millions; 
Analysis based on data available July 2004.

Case study ship: DDG 91; 
Shipbuilder reported labor Cost growth: $23; 
Overhead and labor rate costs on increased labor hours: $24; 
Total cost due to increased labor hours: $47; 
Labor hour cost as a percent of total contract growth: 105%.

Case study ship: DDG 92; 
Shipbuilder reported labor Cost growth: $43; 
Overhead and labor rate costs on increased labor hours: $42; 
Total cost due to increased labor hours: $85; 
Labor hour cost as a percent of total contract growth: 66%.

Case study ship: CVN 76[A]; 
Shipbuilder reported labor Cost growth: $78; 
Overhead and labor rate costs on increased labor hours: $144; 
Total cost due to increased labor hours: $222; 
Labor hour cost as a percent of total contract growth: 35%.

Case study ship: CVN 77[A]; 
Shipbuilder reported labor Cost growth: $75; 
Overhead and labor rate costs on increased labor hours: $107; 
Total cost due to increased labor hours: $182; 
Labor hour cost as a percent of total contract growth: 42%.

Case study ship: LPD 17[B]; 
Shipbuilder reported labor Cost growth: $182; 
Overhead and labor rate costs on increased labor hours: $102; 
Total cost due to increased labor hours: $284; 
Labor hour cost as a percent of total contract growth: 33%.

Case study ship: LPD 18; 
Shipbuilder reported labor Cost growth: $117; 
Overhead and labor rate costs on increased labor hours: $67; 
Total cost due to increased labor hours: $184; 
Labor hour cost as a percent of total contract growth: 48%.

Case study ship: SSN 774; 
Shipbuilder reported labor Cost growth: $149; 
Overhead and labor rate costs on increased labor hours: $10; 
Total cost due to increased labor hours: $159; 
Labor hour cost as a percent of total contract growth: 55%.

Case study ship: SSN 775; 
Shipbuilder reported labor Cost growth: $218; 
Overhead and labor rate costs on increased labor hours: ($38); 
Total cost due to increased labor hours: $180; 
Labor hour cost as a percent of total contract growth: 42.

Total; 
Shipbuilder reported labor Cost growth: $885; 
Overhead and labor rate costs on increased labor hours: $458; 
Total cost due to increased labor hours: $1,342. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures all costs associated with 
labor hour growth--including overhead and labor rates. Methodology is 
discussed in appendix 1.

[A] Contractor performance reports included $63 million in overhead 
costs for CVN 76 and $40 million for CVN 77 that have been disallowed 
(not charged to the government).

[B] LPD 17 relied heavily on subcontracts with partners (Bath Iron 
Works and Raytheon) to design the ship. Since these costs are captured 
as material, we did not include them in our analysis of labor cost 
increases.

[End of table]

The lack of design and technology maturity led to rework, increasing 
the number of labor hours for most of the case study ships. For 
example, the design of LPD 17 continued to evolve even as construction 
proceeded. When construction began on DDG 91 and DDG 92--the first 
ships to incorporate the remote mine hunting system--the technology was 
still being developed. As a result, workers were required to rebuild 
completed areas of the ship to accommodate design changes. Most of the 
shipbuilders cited a lack of skilled workers as a driver behind labor 
hour cost growth. According to the shipbuilders we interviewed, many of 
the tasks needed to build ships are complex and require experienced 
journeymen to efficiently carry them out. Yet, the majority of the 
shipbuilders noted that the shipyards have lost a significant portion 
of their highly skilled and experienced workers. Delays in delivery of 
materials also resulted in increased labor hours. Table 6 shows the 
reasons for labor hour increases for each case study ship.

Table 6: Reasons Given by Shipbuilders for Labor Hours Cost Growth:

Case study ship: DDG 91; 
Reasons for increase: 
* Inexperienced laborers; 
* Design upgrades that result in rework.

Case study ship: DDG 92; 
Reasons for increase: 
* Introduction of a new construction facility, setting workers back on 
the learning curve; 
* Design upgrades that result in rework and workarounds; 
* Strike increased number of hours needed to construct ship.

Case study ship: CVN 76; 
Reasons for increase: 
* Less-skilled workers due to demands for labor on other programs at 
shipyard; 
* Extensive use of overtime; 
* Design changes resulting in rework.

Case study ship: CVN 77; 
Reasons for increase: 
* Late material delivery results in delays and workarounds; 
* Design changes resulting in rework.

Case study ship: LPD 17; 
Reasons for increase: 
* Inexperienced subcontracted labor; 
* Design difficulties led to doing work out of sequence and rework; 
* Schedule delays; 
* Bused workers to meet labor shortages.

Case study ship: LPD 18; 
Reasons for increase: 
* Increases in LPD 17 translated into more hours for LPD 18.

Case study ship: SSN 774; 
Reasons for increase: 
* Late material delivery; 
* First in class design issues.

Case study ship: SSN 775; 
Reasons for increase: 
* Quality problems and design changes; 
* Inclusion of non-recurring labor hours.

Sources: Shipbuilder (data); GAO (analysis).

[End of table]

Underbudgeting and Price Increases Contributed to Materials Cost Growth:

For several of the case study ships, the costs of materials increased 
dramatically above what the shipbuilder had initially planned. (See 
table 7.) Materials cost was the most significant component of cost 
growth for three ships: LPD 17, SSN 775, and CVN 76. However, for LPD 
17, which experienced over 100-percent growth in material costs, 70 
percent of the material cost increases were actually costs for 
subcontracts to support design of the lead ship.

Table 7: Growth in Material Costs:

Dollars in millions; 
Analysis based on data available July 2004.

Case study ship: DDG 91; 
Total dollars due to increased material costs: ($22); 
Percent increase: (13%)%; 
Material cost as a percent of total contract growth: (49%).

Case study ship: DDG 92; 
Total dollars due to increased material costs: $30; 
Percent increase: 20%; 
Material cost as a percent of total contract growth: 23%.

Case study ship: CVN 76; 
Total dollars due to increased material costs: $294; 
Percent increase: 43%; 
Material cost as a percent of total contract growth: 46%.

Case study ship: CVN 77; 
Total dollars due to increased material costs: $134; 
Percent increase: 13%; 
Material cost as a percent of total contract growth: 31%.

Case study ship: LPD 17; 
Total dollars due to increased material costs: $400; 
Percent increase: 103%; 
Material cost as a percent of total contract growth: 47%.

Case study ship: LPD 18; 
Total dollars due to increased material costs: $93; 
Percent increase: 39%; 
Material cost as a percent of total contract growth: 24%.

Case study ship: SSN 774; 
Total dollars due to increased material costs: $141; 
Percent increase: 43%; 
Material cost as a percent of total contract growth: 49%.

Case study ship: SSN 775; 
Total dollars due to increased material costs: $209; 
Percent increase: 56%; 
Material cost as a percent of total contract growth: 49%.

Total; 
Total dollars due to increased material costs: $1,280; 
Percent increase: 38%.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

Growth in materials costs was due, in part, to the Navy and 
shipbuilders' underbudgeting for these costs. For example, the 
materials budget for the first four Virginia-class submarines was $132 
million less than quotes received from vendors and subcontractors. The 
shipbuilder agreed to take on the challenge of achieving lower costs in 
exchange for providing in the contract that the shipbuilder would be 
reimbursed for cost growth in high value, specialized materials. In 
addition, the materials budget for CVN 76 and CVN 77 was based on an 
incomplete list of materials needed to construct the ship, leading to 
especially sharp increases in estimated materials costs. In this case, 
the Defense Contract Audit Agency criticized the shipbuilder's 
estimating system, particularly the system for material and subcontract 
costs, and stated that the resulting estimates "do not provide an 
acceptable basis for negotiation of a fair and reasonable price." 
Underbudgeting of materials has contributed to cost growth recognized 
in the fiscal year 2006 budget.

Price increases also contributed to the growth in materials costs. For 
example, the price of array equipment on the Virginia class submarines 
rose by $33 million above the original price estimate. In addition to 
inflation, a limited supplier base for highly specialized and unique 
materials made ship materials susceptible to price increases.[Footnote 
4] According to the shipbuilders, the low rate of ship production has 
affected the stability of the supplier base--some businesses have 
closed or merged, leading to reduced competition for the services they 
once produced and that may be a cause of higher prices. In some cases, 
the Navy lost its position as a preferred customer and the shipbuilder 
had to wait longer to receive materials. With a declining number of 
suppliers, more ship materials contracts have gone to single and sole 
source vendors. Over 75 percent of the materials for the Virginia class 
submarines--which were reduced in number from 14 to 9 ships over a 10- 
year period--is produced by single source vendors.

Spending on subcontracts and leased labor also increased material costs 
on some case study ships.[Footnote 5] On LPD 17, for example, 
subcontracts to support lead ship design accounted for 70 percent of 
the increase in material costs. Table 8 highlights the various reasons 
cited for increased materials costs on case study ships.

Table 8: Reasons Given by Shipbuilders for Material Cost Growth:

Case study ship: DDG 91; 
Reasons for growth: 
* Consolidation with Northrop Grumman allowed for quantity material buy 
savings.

Case study ship: DDG 92; 
Reasons for growth: 
* Rework requiring additional tools, utilities, and shop stock; 
* Information technology costs shifted from overhead to materials.

Case study ship: CVN 76; 
Reasons for growth: 
* Increases in costs for specialized materials; 
* Underbudgeted material costs; 
* Accounting changes; 
* Additional subcontracting.

Case study ship: CVN 77; 
Reasons for growth: 
* Increases in costs for specialized materials; 
* Underbudgeted material costs.

Case study ship: LPD 17; 
Reasons for growth: 
* Subcontractor engineering design efforts; 
* Design tool development, originally assumed to be funded by the state 
resulted in additional costs to Northrop Grumman.

Case study ship: LPD 18; 
Reasons for growth: 
* Increases in LPD 17 translated into more costs for LPD 18.

Case study ship: SSN 774; 
Reasons for growth: 
* Lack of suppliers for highly unique materials; 
* Immature design on material components.

Case study ship: SSN 775; 
Reasons for growth: 
* Lack of suppliers for highly unique materials; 
* Nonrecurring costs for computer integration.

Sources: Shipbuilder (data); GAO (analysis).

[End of table]

Program Overhead and Labor Rates Account for Remaining Ship 
Construction Cost Increases:

Program overhead costs, which include increases in labor rates, 
represented approximately 17 percent of the total cost growth for the 
eight case study ships. (See table 9.) While increases in overhead 
dollars totaled more than $1 billion, almost half of the increase was 
related to growth in labor hours. (See table 9.)

Table 9: Growth in Overhead Costs and Labor Rates:

Dollars in millions; 
Analysis based on data available July 2004.

Case study ship: DDG 91; 
Shipbuilder reported overhead growth: $43; 
Increase in overhead related to growth in labor hours: $24; 
Increase in overhead related to overhead and labor rates: $20; 
Overhead cost as a percent of total contract growth: 44%.

Case study ship: DDG 92; 
Shipbuilder reported overhead growth: $56; 
Increase in overhead related to growth in labor hours: $42; 
Increase in overhead related to overhead and labor rates: $14; 
Overhead cost as a percent of total contract growth: 11%.

Case study ship: CVN 76[A]; 
Shipbuilder reported overhead growth: $263; 
Increase in overhead related to growth in labor hours: $144; 
Increase in overhead related to overhead and labor rates: $119; 
Overhead cost as a percent of total contract growth: 19%.

Case study ship: CVN 77[A]; 
Shipbuilder reported overhead growth: $219; 
Increase in overhead related to growth in labor hours: $107; 
Increase in overhead related to overhead and labor rates: $113; 
Overhead cost as a percent of total contract growth: 26%.

Case study ship: LPD 17; 
Shipbuilder reported overhead growth: $277; 
Increase in overhead related to growth in labor hours: $102; 
Increase in overhead related to overhead and labor rates: $175; 
Overhead cost as a percent of total contract growth: 20%.

Case study ship: LPD 18; 
Shipbuilder reported overhead growth: $177; 
Increase in overhead related to growth in labor hours: $67; 
Increase in overhead related to overhead and labor rates: $110; 
Overhead cost as a percent of total contract growth: 28%.

Case study ship: SSN 774; 
Shipbuilder reported overhead growth: $0; 
Increase in overhead related to growth in labor hours: $10; 
Increase in overhead related to overhead and labor rates: ($10); 
Overhead cost as a percent of total contract growth: (3)%.

Case study ship: SSN 775; 
Shipbuilder reported overhead growth: $0; 
Increase in overhead related to growth in labor hours: ($38); 
Increase in overhead related to overhead and labor rates: $38; 
Overhead cost as a percent of total contract growth: 9.

Total; 
Shipbuilder reported overhead growth: $1,035; 
Increase in overhead related to growth in labor hours: $457; 
Increase in overhead related to overhead and labor rates: $579.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures only costs associated with 
overhead and labor rate changes. Increases in overhead related to 
growth in labor hours are captured in the analysis of labor hour 
increases.

[A] Contractor performance reports included $63 million in overhead 
costs for CVN 76 and $40 million for CVN 77 that have been disallowed 
(not charged to the government).

[End of table]

Increases in program overhead were largely due to decreased workload at 
the shipyards. Six of the eight case study ships experienced increased 
overhead because there were fewer programs to absorb shipyard operation 
costs. Increases in benefit costs, such as pensions and medical care 
costs, and labor rate increases--the result of negotiations with labor 
unions and inflation--also drove up program overhead costs. Table 10 
highlights the various reasons cited for increased overhead costs on 
case study ships.

Table 10: Reasons Given by Shipbuilders for Overhead and Labor Rate 
Cost Growth:

Case study ship: DDG 91; 
Reasons for growth: 
* Pension plans affected by financial market changes; 
* Increase in medical benefit costs; 
* Union negotiations increase labor rates; 
* Loss of workload.

Case study ship: DDG 92; 
Reasons for growth: 
* Medical care cost increases due to inflation and loss of favorable 
medical care contract; 
* Loss of workload.

Case study ship: CVN 76; 
Reasons for growth: 
* Changes in accounting of overhead; 
* Union negotiations following strike increase labor rates.

Case study ship: CVN 77; 
Reasons for growth: 
* Changes in accounting of overhead; 
* Union negotiations following strike increase labor rates; 
* Medical care cost increases; 
* Capital investments; 
* Pension plans affected by financial market changes; 
* Workload changes.

Case study ship: LPD 17; 
Reasons for growth: 
* Pension plans affected by financial market changes; 
* Loss of anticipated workload; 
* An over 2-year delay in lead ship delivery and change in the 
procurement schedule.

Case study ship: LPD 18; 
Reasons for growth: 
* Pension plans affected by financial market changes; 
* Loss of anticipated workload; 
* An over 2-year delay in lead ship delivery and change in the 
procurement schedule.

Case study ship: SSN 774; 
Reasons for growth: 
* Changes in pension, health care, and workman's compensation; 
* Overhead rates decreased due to increased workload.

Case study ship: SSN 775; 
Reasons for growth: 
* Loss of expected business and training new workers; 
* Additional costs to restart submarine production capability at the 
shipyard.

Sources: Shipbuilder (data); GAO (analysis).

[End of table]

Navy-Furnished Equipment:

Navy-furnished equipment covers the costs for the technologies and 
equipment items--such as ship weapon systems and electronics--purchased 
by the Navy and provided to the contractor for installation on the 
ship. While Navy-furnished equipment accounts for 29 percent of the 
budget for the eight case study ships, such equipment accounted for 
only 6 percent of the total cost growth. According to Navy officials, 
much of the Navy-furnished equipment is common among many programs and, 
therefore, benefits from economies of scale. However, the integration 
and installation of these systems--especially the warfare systems-- 
contributes to cost growth and is captured in the shipbuilders' costs 
rather than Navy-furnished equipment.

There was considerable variance from program to program. In addition, 
in some cases, decreases and increases in Navy-furnished equipment were 
the result of funds being reallocated. For example, the Integrated 
Warfare System on CVN 77 was originally funded through the shipbuilder 
construction contract, but was later deleted from the contract in favor 
of an existing system furnished by the Navy.

Navy Funding and Management Practices Result in Insufficient Provision 
for Risk:

Navy practices for estimating costs and for contracting and budgeting 
for ships have resulted in unrealistic funding of programs and when 
unexpected events occur, tracking mechanisms are slow to pick them up. 
Tools exist to manage the challenges inherent in shipbuilding, 
including measuring the probability of cost growth when estimating 
costs, making full use of design and construction knowledge to 
negotiate realistic target prices, and tracking and providing timely 
reporting on program costs to alert managers to potential problems. For 
the eight case study ships, however, the Navy did not effectively 
employ them to mitigate risk.

Navy Estimates Do Not Capture Uncertainty and Are Often Not 
Independently Evaluated:

In developing cost estimates for the eight case study ships, Navy cost 
analysts did not conduct uncertainty analyses[Footnote 6] to measure 
the probability of cost growth, nor were independent estimates 
conducted for some ships--even in cases where major design changes had 
occurred. Uncertainty analyses and independent estimates are 
particularly important given the inherent uncertainties in the ship 
acquisition process, such as the introduction of new technologies and 
volatile overhead rates over time, creating a significant challenge for 
cost analysts to develop credible initial cost estimates. The Navy must 
develop cost estimates as much as 10 years before ship construction 
begins--before many program details are known. As a result, cost 
analysts have to make a number of assumptions about certain ship 
parameters, such as weight, performance, or software, and about market 
conditions, such as inflation rates, workforce attrition, and supplier 
base.

In the eight case study ships we examined, cost analysts relied on the 
actual cost of previously constructed ships without adequately 
accounting for changes in the industrial base, ship design, or 
construction methods. Cost data available to Navy cost analysts were 
based on higher ship construction rates from the 1980s. As a result, 
these data were based on lower costs due to economies of scale--which 
were not reflective of the lower procurement rates after 1989. In 
addition, in developing cost estimates for DDG 91, DDG 92, LPD 17, and 
SSN 774, cost analysts relied on actual cost data from previous ships 
in the same class or a similar class but that were less technologically 
advanced. By using data from less complex ships, Navy cost analysts 
tended to underestimate the costs needed to construct the ships.

For CVN 76, cost analysts used proposed costs from CVN 74 with 
adjustments made for design changes and economic factors. However, CVN 
74 and CVN 75 were more economical ships because both were procured in 
a single year--which resulted in savings from economies of scale. While 
cost analysts adjusted their estimates to account for the single-ship 
buy, costs increased far beyond the adjustment. Even in more mature 
programs--like the Arleigh Burke destroyers and the Nimitz aircraft 
carriers--improved capabilities and modifications made the costs of 
previous ships in the class essentially less analogous.

Other unknowns also led to uncertain estimates in the case study ships. 
Labor hour and material costs were based not only on data from previous 
ships but also on unproven efficiencies in ship construction. We found 
analysts often factored in savings based on expected efficiencies that 
never materialized. For example, cost analysts anticipated savings 
through the implementation of computer-assisted design/computer- 
assisted manufacturing for LPD 17, but the contractor had not made the 
requisite research investments to achieve the proposed savings. Similar 
unproven or unsupported efficiencies were estimated for DDG 92 and CVN 
76. Changes in the shipbuilders' supplier base also created 
uncertainties in the shipbuilders' overhead costs.

Despite these uncertainties, the Navy did not test the validity of the 
assumptions made by the cost analysts in estimating the construction 
costs for the eight case study ships nor did the Navy identify a 
confidence level for estimates.[Footnote 7] Specifically, it did not 
conduct uncertainty analyses, which generate values for parameters that 
are less than precisely known around a specific set of ranges. For 
example, if the number of hours to integrate a component onto a ship is 
not precisely known, analysts may put in a low and high value. The 
estimate will generate costs for these variables along with other 
variables such as--weight, experience, and degree of rework. The result 
is a range of estimates that enables cost analysts to make better 
decisions on likely costs. Instead, the Navy presented its cost 
estimates as unqualified point estimates, suggesting an element of 
precision that cannot exist early on and obscures the investment risk 
remaining for the programs. While imprecision decreases during the 
program's life cycle as more information becomes known about the 
program, experts emphasize that to be useful, each cost estimate should 
include an indication of its degree of uncertainty, possibly as an 
estimated range or qualified by some factor of confidence. Other 
services qualify their cost estimates by determining a confidence level 
of 50 percent.

The Navy also did not conduct independent cost estimates for some 
ships, which is required at certain major acquisition 
milestones.[Footnote 8] Independent cost estimates can provide decision 
makers with additional insight into a program's potential costs--in 
part because these estimates frequently use different methodologies and 
may be less burdened with organizational bias. Independent cost 
analysts also tend to incorporate cost for risk as they develop their 
estimates, which the Navy cost analysts did not do. As a result, these 
independent estimates tend to be more conservative--forecasting higher 
costs than those forecast by the program office. Department of Defense 
officials considered the CVN 68 and DDG 51 programs mature programs 
and, therefore, did not require independent estimates. Yet, an 
independent cost estimate has never been conducted on a CVN 68 class 
carrier because the program for this class of ships began prior to the 
establishment of an independent cost-estimating group in DOD. However, 
Navy officials noted that every carrier is a new program, different 
from previous carriers. Although an independent cost estimate was 
conducted for the DDG 51 program, it was conducted in 1993, and since 
that time, the DDG ships have undergone four major upgrades.

The Navy has begun taking some actions to improve its cost estimating 
capabilities. For example, future programs will be funded at the DOD 
independent estimators' level, which should provide a more conservative 
estimate and include risk analysis. In addition, Navy officials told us 
that they are in the process of revising cost estimating guidance to 
include requirements for risk and uncertainty analysis. The degree to 
which this guidance will enable the Navy to provide more realistic cost 
estimates for its shipbuilding programs will depend on how it will be 
implemented on individual programs.

Contract Prices Negotiated and Budgets Set Without Making Full Use of 
Design Knowledge and Construction Experience:

Uncertainty about costs is especially high for new classes of ships, 
since new classes incorporate new designs and new technologies. Yet, 
the Navy's approach to negotiating contract target prices for 
construction of the lead ship and early follow-on ships does not manage 
this uncertainty sufficiently--evidenced by substantial increases in 
the prices of the first several ships. Target prices for detail design 
and construction of the lead and early follow-on ships are typically 
negotiated at one time.[Footnote 9] In these cases the Navy does not 
make use of knowledge gained during detailed design or during 
construction of the lead ship to establish more realistic prices. When 
this approach to negotiating prices was used, it also affected the 
information that was available to the Congress at the time it funded 
construction of lead and follow-on ships.

Target prices for all of the case study ships increased, but, as shown 
in table 11, the increase was greater for the two San Antonio class 
ships and the two Virginia class ships--both new classes of ships. 
Increases in the target prices of the LPD 17 and LPD 18 were 
particularly pronounced, reaching 139 and 95 percent, respectively.

Table 11: Target Prices for Case Study Ships:

Dollars in millions; 
Analysis based on data available July 2004.

Case study ship: DDG 91; 
Initial target price: $355; 
Shipbuilders' estimated price: $390; 
Cost growth: $35; 
Percent change: 10%.

Case study ship: DDG 92; 
Initial target price: $351; 
Shipbuilders' estimated price: $422; 
Cost growth: $71; 
Percent change: 20%.

Case study ship: CVN 76; 
Initial target price: $2,967; 
Shipbuilders' estimated price: $3,391; 
Cost growth: $424; 
Percent change: 14%.

Case study ship: CVN 77; 
Initial target price: $3,446; 
Shipbuilders' estimated price: $3,879; 
Cost growth: $434; 
Percent change: 13%.

Case study ship: LPD 17; 
Initial target price: $644; 
Shipbuilders' estimated price: $1,539; 
Cost growth: $896; 
Percent change: 139%.

Case study ship: LPD 18; 
Initial target price: $391; 
Shipbuilders' estimated price: $764; 
Cost growth: $373; 
Percent change: 95%.

Case study ship: SSN 774; 
Initial target price: $1,028; 
Shipbuilders' estimated price: $1,301; 
Cost growth: $273; 
Percent change: 27%.

Case study ship: SSN 775; 
Initial target price: $1,084; 
Shipbuilders' estimated price: $1,488; 
Cost growth: $404; 
Percent change: 37%.

Total; 
Initial target price: $10,266; 
Shipbuilders' estimated price: $13,174; 
Cost growth: $2,910; 
Percent change: 28%.

Sources: Shipbuilder and Navy (data); GAO (analysis).

[End of table]

The realism of target prices reflects the Navy's approach to 
negotiating contract prices--the Navy negotiates target prices for the 
first several ships at a stage of the program when uncertainty is high 
and knowledge limited. For example, for the San Antonio class ships, 
the Navy negotiated prices for the detail design and construction of 
the lead ship (LPD 17) and the first two follow-on ships (LPD 18 and 
LPD 19) at the same time.[Footnote 10] By negotiating target prices for 
these ships before detail design even began, target prices for these 
three ships did not benefit from information gained during detail 
design about the materials and equipment or specific processes that 
will be used to construct the ship. Target prices for the follow-on 
ships, LPD 18 and LPD 19, did not benefit from knowledge gained in 
initial construction of LPD 17. In contrast, for the Virginia class 
ships, the Navy negotiated detail design separately from 
construction,[Footnote 11] benefiting from the knowledge gained from 
detail design in negotiating prices for construction. However, 2 years 
after negotiating the detail design contract, the Navy negotiated 
target prices for the SSN 774 and SSN 775, both considered lead ships 
for the two shipyards involved in constructing submarines. Target 
prices for the first two follow-on ships, SSN 776 and SSN 777 were 
agreed on at this time as well. As a result, target prices for these 
follow-on ships did not benefit from the knowledge gained from 
constructing the lead ships.

The practice of setting target prices early on affects not only the 
realism of the contract target prices, but also the realism of the 
budgets approved by the Congress to fund these contracts. In order to 
fund a contract covering both detail design and lead ship construction, 
authorization and funding for detail design and lead ship construction 
is approved by the Congress in one budget year, before detail design 
begins. For example, the Congress funded detail design and construction 
of LPD 17 in the fiscal year 1996 budget. While the follow-on ships, 
LPDs 19 and 20, were funded in later years, budgets were still 
unrealistic because the target prices were used as a basis for the 
budget request.

The size of the budget and the contract conditions can also affect the 
realism of target prices. In negotiating the contract for the first 
four Virginia class ships, program officials stated that the target 
price they could negotiate was limited to the amount included in 
approved or planned budgets. The shipbuilders said that they accepted a 
challenge to design and construct these ships for $748 million less 
than their estimated costs because the contract protected their 
financial risk. The contract included a large minimum fee (profit), in 
addition to the incentive fee that would be reduced in the event of 
cost growth. Moreover, the contract was structured so that the Navy 
would pay the full cost of increases for specialized, highly engineered 
components rather than share the cost increases with the shipbuilder. 
The Navy also was responsible for the full amount of growth in certain 
labor costs.

Recently, the Navy has supported the preparation of more realistic 
budget requests. Program managers are encouraged to budget to their own 
estimate of expected costs rather than at target prices that are not 
considered realistic. For example, for the LPD 17, an acquisition 
decision memorandum stated that the program will be budgeted to the 
Cost Analysis Improvement Group estimate.[Footnote 12] Also, in 
negotiating recent contracts for additional Virginia class and San 
Antonio class ships, the Navy structured the contracts to encourage 
more realistic target prices.

Other Factors Affect Budget Realism:

Beyond target prices, shifting priorities, and inflation accounting can 
have a significant impact on the realism of ship budgets. Specifically, 
budget requests are susceptible to across-the-board reductions to 
account for other priorities, such as national security and changes in 
program assumptions. Competing priorities create additional management 
challenges for programs that receive a reduced budget without an 
accompanying reduction in scope. For example, during the budget review 
cycles of 1996 through 2003, the initial cost estimate for DDGs 89-92 
was decreased by $119 million--or 55 percent of the total cost growth 
for the four DDGs. Had the initial estimate not been reduced, the cost 
growth would have only amounted to $96 million.

Inflation rates can also have a significant impact on ship budgets. 
Until recently, Navy programs used Office of the Secretary of Defense 
and Office of Management and Budget inflation rates.[Footnote 13] 
Inflation rates experienced by the shipbuilding industry have 
historically been higher. As a result, contracts were signed and 
executed using industry specific inflation rates while budgets were 
based on the lower inflation rates, creating a risk of cost growth from 
the outset. For the case study ships, the difference in inflation 
rates, while holding all other factors constant, explains 30 percent of 
the $2.1 billion in cost growth for these ships.

In February 2004, the Navy changed its inflation policy directing 
program offices to budget with what the Navy believes are more 
realistic inflation indices. The Navy anticipates this policy change 
should help curtail future requests for prior year completion funds.

Cost Reporting Weaknesses Delayed Efforts to Mitigate Cost Risks:

While DOD guidance allows some flexibility in program oversight, we 
found that reporting on contractor performance was inadequate to alert 
the Navy to potential cost growth for the eight case study ships. With 
the significant risk of cost growth in shipbuilding programs, it is 
important that program managers receive timely and complete cost 
performance reports from the contractors. However, earned value 
management--a tool that provides both program managers and the 
contractor insight into technical, cost, and schedule progress on their 
contracts--was not used effectively.[Footnote 14] Cost variance 
analysis sections of the reports were not useful in some cases because 
they only described problems at a high level and did not address root 
causes or what the contractor plans were to mitigate them.

Earned value management provides an objective means to measure program 
schedule and costs incurred. Among other requirements, DOD guidance on 
earned value management requires that "at least on a monthly basis" 
schedule and cost variances be generated at levels necessary for 
management control. Naval Air Systems Command, which is considered a 
center of excellence for earned value management, recommends that cost 
performance reports be submitted at a minimum on a monthly basis, in 
part to help the program manager mitigate risk. Officials from the 
command stressed that because earned value management acts as an early 
warning system, the longer the time lapse in receiving the cost 
performance report, the less valuable the data become.

However, shipbuilders for the Nimitz and Virginia class ships we 
reviewed submitted their official earned value management cost 
performance reports to the Navy on a quarterly basis instead of 
monthly,[Footnote 15] delaying the reports--and corrective action--by 3 
to 4 months. Had the reporting been monthly, negative trends in labor 
and materials on the Virginia class submarine would have been revealed 
sooner and enabled corrective action to occur quickly in areas of work 
that were not getting completed as planned. Earlier reporting would 
have also alerted managers of cost performance problems on the CVN 76 
carrier. Because data on actual cost expenditures for CVN 76 were 
provided incrementally and late, the program manager did not identify a 
funding shortage until it was too late to remedy the problem. As a 
result, a contractwide stop-work order was given. LPD 17 also 
experienced cost and schedule problems. To allow for better tracking of 
schedule and costs and more timely response to problems, the program 
manager changed the cost performance reporting requirement from 
quarterly to monthly.

The quality of the cost performance reports, whether submitted monthly 
or quarterly, was inadequate in some cases--especially with regard to 
the variance analysis section, which describes any cost and schedule 
variances and the reasons for these variances and serves as an 
official, written record of the problems and actions taken by the 
shipbuilder to address them. Both the Virginia class submarine and the 
Nimitz class aircraft carrier programs' variance analysis reports 
discussed the root causes for any cost growth and schedule slippage and 
described how these variances were affecting the shipbuilders' 
projected final costs. However, the remaining case study ship programs 
generally tended to report only high-level reasons for cost and 
schedule variances with little to no detail regarding root cause 
analysis or mitigation efforts[Footnote 16]--making it difficult for 
managers to identify risk and take corrective action.

Finally, the periodic reassessment of the remaining funding 
requirements on a program and a good faith estimate at completion-- 
another part of earned value management--were inadequate to forecast 
the amount of anticipated cost growth. Managers are required to 
evaluate the estimate at completion and report it in the cost 
performance report, updating when required. The Defense Contract Audit 
Agency recently observed the importance of the shipbuilders' developing 
credible estimates at completion and ensuring all estimates at 
completion revisions are justified and made in a timely manner. 
However, the shipbuilders' estimates for the study ships tended to be 
optimistic--that is, they fell at the low end of our estimated cost 
growth range. Specifically, shipbuilder estimates for four ships that 
are still under construction were near our low estimate, (See fig. 3), 
leading management to believe that the ships will cost less than what 
is likely to be the case.

Figure 3: GAO and Shipbuilder Construction Cost Growth Forecasts for 
Case Study Ships:

[See PDF for image]

[End of figure]

See appendix VI for more details on the cost growth forecasts for ships 
currently under construction.

Conclusions:

The challenge in accurately estimating and adequately funding the 
construction of Navy ships is framed by the long construction time cost 
estimates must account for and the fact that ships must be fully funded 
in the first year of their construction. Thus, an underestimation of 
costs, a budget reduction, or an increase in cost, creates a need for 
additional money that must be requested and appropriated. The fact that 
requests have been sizable and have occurred routinely over the years 
suggests that the Navy can do better in getting a match between the 
estimated costs of new ship construction and the money it budgets to 
pay for them. The goal is not necessarily to eliminate all requests for 
additional funds, for that could lead to overbudgeting or deferring 
necessary design changes. Rather, the goal is to get a better match 
between budgeted funds and costs in order that the true impact of 
investment decisions is known.

Our work shows that currently, the Navy's cost estimating, budgeting, 
and contracting practices do not do a good enough job of providing for 
the likely costs of building ships. This is particularly true for first 
of class ships, for which uncertainty is highest. Moreover, when actual 
costs begin to go astray of budgeted funds, management tools intended 
to flag variances and enable managers to act early are not always 
effectively employed. If these practices are to lead to more realistic 
results---and reduced overruns--they will have to produce and take 
advantage of higher levels of knowledge. In some cases, improved 
techniques, such as performing uncertainty analyses on cost estimates, 
can raise the level of knowledge. In other cases, such as contracting 
for detail design and construction on first-of-class ships, contracting 
in smaller steps can allow necessary knowledge to build before major 
commitments are made.

The Navy has recognized the need to get a better match between funding 
and cost and is providing guidance to achieve this match. The success 
of this guidance will depend on how well it is implemented on 
individual programs. There are additional steps the Navy can take, 
which are detailed in our recommendations. Taking these steps now is 
especially important for the Navy as it embarks on a number of new, 
sophisticated shipbuilding programs. If a better match between funding 
and cost is not made, additional funds needed for cost growth will 
continue to compete for the funds needed for new investments in ships 
or other capabilities. Difficult budget choices are ahead making it 
essential that priorities are set with a clear understanding of the 
financial implications of different spending and investment 
alternatives. To the extent unplanned demands on the budget can be 
reduced, better informed decisions can be made.

Recommendations:

We are recommending that the Secretary of Defense take the following 
seven actions.

To improve the quality of cost estimates for shipbuilding programs and 
reduce the magnitude of unbudgeted cost growth, we recommend the 
Secretary of Defense:

* conduct independent cost reviews for all follow-on ships when 
significant changes occur in a program and establish criteria as to 
what constitutes significant changes to a shipbuilding program,

* conduct independent reviews of every acquisition of an aircraft 
carrier, and:

* direct the Secretary of the Navy to develop a confidence level for 
all ship cost estimates, based on risk and uncertainty analyses.

To assure that realistic prices for ship construction contracts are 
achieved, we recommend that the Secretary of Defense direct the 
Secretary of the Navy to:

* negotiate prices for construction of the lead ship separately from 
the pricing of detail design and:

* separate pricing of follow-on ships from pricing of lead ships, 
negotiating prices for early ships in the budget year in which the ship 
is authorized and funded.

To improve management of shipbuilding programs and promote early 
recognition of cost issues, we recommend that the Secretary of Defense 
direct the Secretary of the Navy to:

* require shipbuilders to submit monthly cost performance reports and:

* require shipbuilders to prepare variance analysis reports that 
identify root causes of reported variances, associated mitigation 
efforts, and future cost impacts.

Agency Comments and Our Evaluation:

DOD agreed with our recommendations to conduct independent reviews of 
every aircraft carrier and to develop a confidence level for all ship 
cost estimates, based on risk and uncertainty analysis. DOD partially 
agreed with our recommendations about contract pricing and cost 
performance reporting--areas the Navy noted it has taken some measures 
to improve. While the Navy has taken steps in the right direction, we 
believe more must be done to reduce ship cost overruns, consistent with 
our recommendations.

We made a recommendation in our draft report that independent reviews 
be conducted for all follow-on ships when significant changes to the 
program occur. DOD responded that it will request additional 
assessments, if needed after Milestone B. It is important that criteria 
be established for determining when additional assessments are needed. 
Programs may undergo several changes after the required estimate, such 
as the Arleigh Burke destroyer, which underwent four major upgrades 
since its only independent estimate in 1993. We believe DOD needs to 
establish criteria concerning what significant changes to a program 
trigger an independent cost estimate and have modified our 
recommendations accordingly. DOD could clarify whether these changes 
include baseline, profile, or major systems upgrades, for instance.

DOD stated that it will consider, on a case-by-case basis, negotiating 
detail design separately from the lead ship and negotiating early 
follow-on ships separately from the lead ship. We believe that this 
approach should be the normal policy, if overruns are to be reduced. 
Ships represent a substantial investment--more than $1 billion for each 
destroyer and amphibious transport, about $2.5 billion for the lead 
ship in the next class of destroyers, $2.5 billion for submarines, and 
several billion for carriers. Ships costing substantially less--for 
example, $220 million for each Littoral Combat Ship--are the exception 
rather than the norm. A realistic target price is important for 
structuring contract incentives and providing informed budgets to the 
Congress. Deciding prices for the lead ship and follow-on ships 
together before detail design has even begun on the lead ship is 
unlikely to yield realistic prices. Insight gained into material costs 
and labor effort even in the first year of detail design will make 
realistic pricing of the lead ship more feasible. Similarly, experience 
gained in the first years of construction can benefit the realism of 
prices for follow-on ships.

DOD noted that the Navy is already requiring shipbuilders to submit 
cost performance reports monthly with one exception. With the Nimitz 
class program beginning monthly reporting in March 2006, the Virginia 
class will be the only program to submit quarterly instead of monthly 
cost performance reports. DOD states that the Navy has access to labor 
hour data in the interim. While informal access to timely data is 
preferable to delayed access, without written, formal cost reporting 
there is less visibility or accountability from the last formal report 
to the next cost performance report 3 months later. The Virginia class 
program has experienced significant cost increases and experienced one 
of the largest prior year funding requests of programs we reviewed. LPD 
17 and carrier program officials recognized that more frequent formal 
reporting and review of cost performance helped them to better manage 
cost growth and changed their program reporting requirements from 
quarterly to monthly. Although variance analysis reporting is required 
as part of cost performance reporting and is being conducted by the 
shipbuilders, we observed that there is wide variation in the quality 
of these reports. DOD rightly observes that these reports are one of 
many tools used by the shipbuilders and DOD to track performance. To be 
a useful tool, however, we believe it is important that shipbuilders 
provide the government with detailed analyses of the root causes and 
impacts of cost and schedule variances. Cost performance reports that 
consistently provide thorough analysis of the causes of variances, 
their associated cost impacts, and mitigation efforts will allow the 
Navy to more effectively manage, and ultimately reduce, cost growth.

DOD's detailed comments are provided in appendix VII.

As agreed with your office, unless you announce its contents, we will 
not distribute this report further until 30 days from its date. At that 
time, we will send copies to the Secretary of Defense, the Secretary of 
the Navy and interested congressional committees. We will also make 
copies available to others upon request. In addition, the report will 
be available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions concerning this report, please 
contact me at (202) 512-4841 or Karen Zuckerstein, Assistant Director, 
at (202) 512-6785. Key contributors to the report are identified in 
appendix VIII.

Sincerely yours,

Signed by: 

Paul L. Francis: 
Director: 
Acquisition and Sourcing Management:

[End of section]

Appendix I: Scope and Methodology:

Our methodology for all three objectives included a case study analysis 
of eight ships. These ships were in four ship classes: Virginia class 
submarines, LPD 17 amphibious assault ships, Arleigh Burke destroyers, 
and Nimitz class carriers. We selected these ship classes and these 
ships based on data contained in the "Naval Sea Systems Command 
Quarterly Progress Report for Shipbuilding and Conversion Status of 
Shipbuilding Programs," dated July 1, 2003. This report identifies all 
ships under construction and the progress in terms of "percent 
complete" for each ship. We looked only at new construction and 
excluded ship conversions. This report identified eight ship classes 
with ships under construction. In addition to the four ship classes 
that we studied, the report identified ships in the Seawolf attack 
submarine, LHD amphibious assault ship, T-AKE cargo ship, and T-AKR 
vehicle cargo ship classes. We did not review the Seawolf and T-AKR 
ship classes because construction of these classes was at an end and 
were unlikely to affect future budgets. We did not include ships from 
the remaining two classes because we limited the ship selection to 
those ships that were more that 30 percent complete and none of the 
ships in those two classes met those criteria.

We selected two ships per class for the four classes we reviewed. Where 
possible, we chose a lead and follow-on ship. We also looked at which 
shipyards were building these ships in order to get coverage of the 
major shipyards. We limited the selection to ships more than 30 percent 
complete so we had sufficient information on program performance. Three 
Virginia-class submarines, three amphibious assault ships, two 
carriers, and 12 destroyers met this criterion. For the Virginia class 
program, we initially chose SSN 774 and SSN 776; both built and 
integrated at the Electric Boat, Connecticut shipyard.[Footnote 17] As 
we gained knowledge of the program and Newport News' role in 
constructing and launching half of the submarines in this class, we 
substituted the SSN 775 for the SSN 776.

Characteristics of the ships we selected are summarized in table 12.

Table 12: Characteristics of Case Study Ships:

Shipyard; 
Amphibious assault ships: LPD 17: Avondale Operations; 
Amphibious assault ships: LPD 18: Avondale Operations; 
Virginia class submarines: SSN 774: Electric Boat; 
Virginia class submarines: SSN 775: Newport News Shipbuilding; 
Nimitz class carriers: CVN 76: Newport News Shipbuilding; 
Nimitz class carriers: CVN 77: Newport News Shipbuilding; 
Arleigh Burke destroyers: DDG 91: Ingalls Operations; 
Arleigh Burke destroyers: DDG 92: Bath Iron Works.

Percent complete as of July 2003; 
Amphibious assault ships: LPD 17: 86; 
Amphibious assault ships: LPD 18: 43; 
Virginia class submarines: SSN 774: 87; 
Virginia class submarines: SSN 775: 79; 
Nimitz class carriers: CVN 76: 99; 
Nimitz class carriers: CVN 77: 35; 
Arleigh Burke destroyers: DDG 91: 96; 
Arleigh Burke destroyers: DDG 92: 89.

Lead/follow; 
Amphibious assault ships: LPD 17: Lead; 
Amphibious assault ships: LPD 18: Follow; 
Virginia class submarines: SSN 774: Lead; 
Virginia class submarines: SSN 775: Lead[A]; 
Nimitz class carriers: CVN 76: Follow; 
Nimitz class carriers: CVN 77: Follow; 
Arleigh Burke destroyers: DDG 91: Follow; 
Arleigh Burke destroyers: DDG 92: Follow.

Source: Navy (data), GAO (presentation):

[A] SSN 775 is considered the lead ship for Newport News.

[End of table]

Because a large percentage of the ship construction budget is allocated 
to fund the shipbuilding contracts, we assessed the shipbuilders' cost 
performance for the four classes of ships in our study. To make these 
assessments, we applied earned value analysis techniques to data 
captured in shipbuilder cost performance reports. We also developed a 
forecast of future cost growth. For ships currently under construction 
(and more than 30 percent complete), we compared the initial target 
costs with the likely costs at the completion of the contracts using 
established earned value formulas. We based the lower end of our cost 
forecast range on the costs spent to date added to the forecast cost of 
work remaining. The remaining work was forecast using the cumulative 
cost performance index efficiency factor. Studies have shown that using 
this method is a reasonable estimate of the lower bound of the final 
cost. For the upper end of our cost range, we relied on either the 
actual costs spent to date added to the forecast of remaining work with 
an average monthly cost and schedule performance index or a cost/ 
percent complete trend analysis, whichever was higher.

In order to understand the components of cost growth, we used cost data 
provided by the shipbuilders for each of the case study ships. In most 
cases we compared the initial target cost to the current target cost. 
As a result some of the increases in target cost could have resulted 
from additional contract modifications initiated by the Navy, cost 
overruns due to the shipbuilder, or unanticipated events. Most 
shipbuilders allocate contract costs into three categories: material 
costs, labor costs, and overhead costs. We, however, used these data to 
allocate costs into the following categories: labor hours, material 
costs, and labor and overhead rates. Since labor costs and overhead 
costs can change due to labor hours, and labor and overhead rates, we 
separated the program overhead cost associated with an increase in 
labor and overhead rates from the program overhead cost associated with 
an increase in labor hours. This was accomplished by holding each 
component constant to isolate the impact. After we isolated the program 
overhead cost associated only with additional labor hours, we added 
this to the shipbuilders' reported labor cost growth and subtracted 
this from the shipbuilders' reported overhead cost growth. Our analysis 
captures all costs associated only with overhead and labor rate 
changes. Increases in overhead related to growth in labor hours are 
captured only in our analysis of labor hour increases.

We used the latest cost performance data available to us in July 2004. 
The latest available cost performance reports for the case study ships 
were as follows:

* DDG 91 June 2004,

* DDG 92 May 2004,

* CVN 76 July 2003,

* CVN 77 March 2004,

* LPD 17 and LPD 18 May 2004, and:

* SSN 774 and SSN 775 July 2004.

In order to understand the funding and management practices that 
contribute to cost growth, we reviewed Navy acquisition guidance and 
reviewed best practices literature for weapons systems construction. To 
better understand the budgeting of ships and the acquisition process we 
met with officials at the Navy and Office of Secretary of Defense 
Comptroller. Based on indicators from our case study analysis that cost 
estimating practices may contribute to cost growth, we met with cost 
estimators, including those from Naval Sea Systems Command, Cost 
Analysis Improvement Group, and the Navy Cost Analysis Division. We 
reviewed DOD and Navy cost estimating policies, procedures, and 
guidance. Additionally, we met with cost estimators from the Naval Air 
Systems Command, the Air Force, and the Army to compare how Naval Sea 
Systems Command estimating practices vary from other military cost 
estimating practices. We interviewed program officials, contracting 
officers, and shipbuilders and reviewed shipbuilder reports, which 
included explanations for cost growth. We met with officials at 
Supervisor of Ships and the Defense Contract Audit Agency both at the 
shipyards and at headquarters to review their oversight policies, 
procedures, and practices. We met with Navy Audit Service officials to 
gain information on earned value management reviews at shipyards. We 
also reviewed contract documentation and audit reports.

Our analysis relied on shipbuilders' earned value data. To establish 
the reliability of the data, we examined the integrated baseline 
reviews that are conducted at the beginning of a contract. We also 
confirmed that the shipbuilders had validated earned value systems.

We performed our review from July 2003 to December 2004 in accordance 
with generally accepted government auditing standards.

[End of section]

Appendix II: Arleigh Burke Class Destroyer:

Program Description:

The USS Arleigh Burke class destroyer (DDG 51) provides multimission 
offensive and defensive capabilities, and can operate independently or 
as part of carrier strike groups, surface action groups, and 
expeditionary strike groups. The DDG 51 class, which is intended to 
replace earlier surface combatant classes, was the first U.S. Navy ship 
designed to reduce radar cross-section and its detectability and 
likelihood of being targeted by enemy sensors and weapons. Originally 
designed to defend against Soviet aircraft, cruise missiles, and 
nuclear attack submarines, the ship is to be used in high-threat areas 
to conduct antiair, antisubmarine, antisurface, and strike operations.

As of May 2004, 43 Arleigh Burke destroyers have been delivered to the 
Navy, with a total of 62 to be delivered at the end of the production. 
Funding for the lead ship (DDG 51) was provided in fiscal year 1985. 
The lead ship construction contract was awarded to Bath Iron Works in 
April 1985. With the award of the follow-on ship--DDG 52--to Ingalls 
Shipbuilding Incorporated--a second shipbuilder was established. The 
DDG 91 and DDG 92, which are covered in this report, include a number 
of upgrades, such as the most current Aegis weapons system; 
installation of a remote mine-hunting system capability and the 
introduction of commercially built switchboards.

Figure 4: Arleigh Burke Class Destroyer:

[See PDF for image]

[End of figure]

Table 13: Major Events in the Acquisition of DDG 91 and DDG 92:

May 1996; 
* Initial estimate for three ships developed using actual costs from 
DDG 70--the last ship of the prior configuration in preparation for the 
1998 President's budget.

September 1996; 
* Congress authorizes procurement of 4 DDGs--DDGs 89-92.

August 1997; 
* Competition to determine contract awards. Navy uses "Profit Related 
to Offers" strategy, where the lower offeror receives a larger 
proportion of the contract's target profits, while the higher offeror 
receives a smaller proportion. Both shipbuilders stated that they 
proposed aggressively low costs in an effort to win the higher profit 
margin on the contract that included DDG 91 and DDG 92.

January 1998; 
* Fiscal Year 1999 Presidential Budget submission is $119 million less 
than the initial budget estimate due to across the board DOD and Office 
of Management and Budget reductions.

March 1998; 
* Bath Iron Works receives a contract for the DDG 92 with an initial 
target price of $351 million. Ingalls Shipbuilding receives a contract 
for the DDG 91 with an initial target price of $355 million.

September 2000; 
* DDG 91 construction begins.

December 2000; 
* DDG 92 construction begins.

April 2001; 
* Northrop Grumman Ship Systems acquired Ingalls Shipbuilding.

June 2002; 
* Northrop Grumman Ship Systems and Bath Iron Works agree to a swap in 
which LPDs (including LPD 19) will be built by Northrop Grumman and 
future DDG ships will be built at Bath Iron Works.

October 2003; 
* DDG 91 delivered.

May 2004; 
* DDG 92 delivered.

Sources: Navy and shipbuilders (data).

[End of table]

Cost Experience on DDG 91 and DDG 92:

DDG 91 and DDG 92 cost $135 million more than budgeted. (See table 14.) 
The Congress has appropriated almost $100 million to cover these 
increases.

Table 14: Growth in Program Budgets for Case Study Ships:

Dollars in millions.

Case study ship: DDG 91; 
Initial and FY 2005 President's budget: Initial: $917; 
Initial and FY 2005 President's budget: FY2005: $997; 
Initial and FY 2005 President's budget: FY 2005: $80; 
Difference in budgets: Difference due to Navy-furnished equipment: $43; 
Difference in budgets: Difference due to construction costs[A]: $37.

Case study ship: DDG 92; 
Initial and FY 2005 President's budget: Initial: $925; 
Initial and FY 2005 President's budget: FY2005: $979; 
Initial and FY 2005 President's budget: FY 2005: $55; 
Difference in budgets: Difference due to Navy-furnished equipment: 
($7)[B]; 
Difference in budgets: Difference due to construction costs[A]: $62.

Total; 
Initial and FY 2005 President's budget: Initial: $1,842; 
Initial and FY 2005 President's budget: FY2005: $1,976; 
Initial and FY 2005 President's budget: FY 2005: $135; 
Difference in budgets: Difference due to Navy-furnished equipment: $36; 
Difference in budgets: Difference due to construction costs[A]: $99.

Sources: Navy (data); GAO (presentation).

[A] Part of the increased cost is due to changes in the scope of the 
contract.

[B] Negative reflects savings resulting from the use of a more 
economical warfare system than was initially budgeted on the DDG 92.

[End of table]

Main Drivers of Cost Growth for DDG 91 DDG 92:

Construction costs--especially the costs associated with the number of 
labor hours needed to build the ships--were the major source of cost 
growth. Navy-furnished equipment, including the Aegis weapon system, 
was also a significant source of cost growth for the two DDGs, 
representing 21 percent of the cost growth. Increases in the number of 
labor hours account for 67 percent of the cost growth on shipbuilding 
construction contracts. We found that ship overhead--such as employee 
benefits and shipyard support costs--and labor rate increases accounted 
for 21 percent of cost growth. The two DDGs actually underran material 
costs, due to DDG 91 material cost savings.

Figure 5: Average Sources of Cost Growth on DDG 91 and DDG 92:

[See PDF for image]

[End of figure]

Labor Hours:

Labor hour increases account for the majority of the cost growth on DDG 
91 and DDG 92. (See fig. 5.) DDG 91 required almost 1 million hours of 
additional labor hours and DDG 92 required an additional 2 million 
hours above the original contract proposal. DDG 91 and DDG 92 
incorporated a number of new technologies in their design, including 
the remote mine-hunting system, which consists of a remote operated 
vehicle and a launch and recovery system stored within the ship. To 
accommodate this system, designers had to make significant structural 
changes to 26 of the ship's 90 design zones. When construction began on 
DDG 91 and DDG 92, the remote mine-hunting system's design was not 
mature. As a result, significant details of the design could not be 
captured in the shipbuilders' planned contract costs. Moreover, the 
shipbuilders anticipated that the system's design would be completed in 
July 1999--several months before the start of ship fabrication in 
November 1999. However, it was not completed until November 2001, with 
additional revisions to the design occurring through March 2003. 
Because the design was changing as installation of the system began, 
laborers re-installed parts of the system, increasing the engineering 
and production hours.

As the number of hours to construct the ship increased, total labor 
costs grew, with the shipbuilder paying for additional employee wages 
and overhead costs. As table 15 shows, we separated the overhead and 
labor rates associated with the additional hours and added this to the 
shipbuilders reported labor cost growth. Our analysis thus captures all 
costs associated with labor hour growth--including overhead and labor 
rates. The methodology we used to separate the overhead costs 
associated with rate increases and labor hour increases is discussed in 
appendix 1.

Table 15: Growth in Labor Hour Costs:

Dollars in millions; 
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.

Case study ship: DDG 91; 
Shipbuilder reported labor dollar growth: $23; 
Overhead and labor rate dollars on increased labor hours: $24; 
Total dollars due to increased labor hours: $47; 
Labor hour cost as a percent of total contract growth: 105%.

Case study ship: DDG 92; 
Shipbuilder reported labor dollar growth: $43; 
Overhead and labor rate dollars on increased labor hours: 42; 
Total dollars due to increased labor hours: $85; 
Labor hour cost as a percent of total contract growth: 66%.

Total; 
Shipbuilder reported labor dollar growth: $66; 
Overhead and labor rate dollars on increased labor hours: $66; 
Total dollars due to increased labor hours: $132. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

According to the shipbuilder, additional labor hours were also needed 
to complete DDG 91 because many experienced workers had left the trade 
in favor of higher paying jobs in the area and, as a result, less 
experienced workers took longer to finish tasks and made mistakes that 
required rework. For DDG 92, workers encountered challenges in building 
the ship due to a new transfer facility that enabled the shipyard to 
construct a greater proportion of the ship on land. The ship was 
constructed using larger subsections or units. While the shipbuilder 
expects that the facility will improve efficiency, on DDG 92, workers 
had to learn new processes and had difficulties aligning larger units 
of the ship to one another. Labor hours increased as workers spent 
additional time realigning and combining the units to make larger 
sections of the ship.

Navy-Furnished Equipment:

About $38 million of Navy-furnished equipment cost growth is associated 
with the Aegis weapon system, specifically the purchase of an 
additional SPY-D radar used in system testing.[Footnote 18] The Navy 
originally planned to move the developmental radar from the engineering 
and development site to the final testing and certification center. 
However, increased complexity involved with the introduction of a new 
radar and new computing plant required more development time than was 
originally planned. In order to ensure timely delivery of DDG 91, the 
Navy procured a second radar for the testing facility, allowing the 
Navy to simultaneously finish final development of the radar, while at 
the same time beginning testing and certification of the Aegis weapon 
system computer program.

Overhead Rate Increases:

Our analysis shows that program overhead costs and increases in labor 
rates accounted for approximately 21 percent of the cost growth on the 
DDG 91 and 92 contracts. Table 15 includes overhead increases that were 
a consequence of labor hour increases. Table 16 isolates the remaining 
portion of overhead increases due to increases in rates.

Table 16: Growth in Overhead Costs and Labor Rates:

Dollars in millions; 
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.

Case study ship: DDG 91; 
Shipbuilder reported overhead growth: $43; 
Portion related to growth in labor hours: $24; 
Portion related to overhead and labor rates: $20; 
Overhead cost from rate increases as a percent of total contract 
growth: 44%.

Case study ship: DDG 92; 
Shipbuilder reported overhead growth: $56; 
Portion related to growth in labor hours: $42; 
Portion related to overhead and labor rates: $14; 
Overhead cost from rate increases as a percent of total contract 
growth: 11%.

Total; 
Shipbuilder reported overhead growth: $99; 
Portion related to growth in labor hours: $66; 
Portion related to overhead and labor rates: $34. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

Despite savings incurred through the consolidation of Ingalls Shipyard 
into Northrop Grumman,[Footnote 19] overhead rates were about 13 
percent higher than anticipated in 2001. According to shipbuilders, 
increases in overhead rates can be attributed largely to changes in the 
shipyard's workload and employee benefit costs. After the cancellation 
of the construction contract for a commercial cruise ship due to the 
company's bankruptcy and the delay in signing the contract for the next 
generation destroyer, overhead costs had to be absorbed by the 
remaining contracts at the yard, including the DDG 91. Similarly, on 
DDG 92, the shipbuilder based its overhead rates on anticipated work 
from the construction of the next generation destroyer and the San 
Antonio class ships. When these programs did not materialize as 
expected, the other programs at the yard assumed overhead costs. At 
both shipyards health and dental care costs increased. For example, at 
one shipyard, the shipbuilder negotiated a favorable medical insurance 
contract but the insurance company went bankrupt, forcing the 
shipbuilder to become self-insured--at a higher cost.

Both shipbuilders were also affected by labor rate increases. Following 
a strike at Bath Iron Works, the union negotiated a $1.12 increase in 
labor rates or a $6 million increase above the costs projected in the 
contract. For Northrop Grumman, between the initial proposal and the 
latest estimate, the labor rate increased by $1.50 per hour for a total 
impact on the DDG 91 of $7 million.

Material Costs:

As shown in table 17, material cost increases did not represent a major 
source of cost increases for DDG 91 and DDG 92--largely because the 
materials were purchased for four ships at one time.

Table 17: Growth in Material Costs:

Dollars in millions; 
Analysis based on June 2004 (DDG 91) and May 2004 (DDG 92) data.

Case study ship: DDG 91; 
Increased material costs: ($22); 
Percent increase: (13%)%; 
Material cost as a percent of total contract growth: (49%).

Case study ship: DDG 92; 
Increased material costs: $30; 
Percent increase: 20%; 
Material cost as a percent of total contract growth: 23%.

Total; 
Increased material costs: $8.

Sources: Navy (data); GAO (analysis).

[End of table]

However, DDG 92 overran its material budget by $30 million--73 percent 
of which was due to information technology, small tooling, and other 
material costs. Although these costs comprise only 17 percent of the 
material cost budget, their costs are driven by labor hour usage--as 
additional labor hours were needed to construct DDG 92, additional 
tools were needed, raising material costs. Material costs also 
increased because the shipbuilder began allocating information 
technology costs to materials--not overhead, as it had initially done. 
DDG 91 experienced a $22 million underrun of material costs. According 
to the shipbuilder, the underrun was due to efficiencies gained through 
the consolidation of Ingalls Shipyard with nearby Avondale Shipyard-- 
also owned by Northrop Grumman Ship Systems. With the consolidation, 
Northrop Grumman stated it could purchase materials for both shipyards-
-creating cost savings that were not anticipated in DDG 91's original 
material cost budget.

[End of section]

Appendix III: Nimitz Class Aircraft Carrier:

Program Description:

The mission of the Nimitz class nuclear powered aircraft carriers-- 
which are intended to replace the Navy's conventionally powered 
carriers--is to provide a sustained presence and conventional 
deterrence in peacetime; act as the cornerstone of joint allied 
maritime expeditionary forces in crises; and support aircraft attacks 
on enemies, protect friendly forces, and engage in sustained 
independent operations in war. Nine Nimitz class nuclear carriers--CVN 
68 through CVN 76--have been delivered since acquisition of the first 
ship in October 1967. CVN 77, the tenth and final ship of the class, is 
a modified version of CVN 76 and will serve as a transition ship to the 
next generation of aircraft carriers. Both CVN 76 and CVN 77 included 
several significant design changes, including a bulbous bow; larger air-
conditioning plants; a redesigned island; weapons elevator 
modifications; and an integrated communications network.

Figure 6: Nimitz Class Aircraft Carrier:

[See PDF for image]

[End of figure]

Table 18: Major Events in the Acquisition of CVN 76 and CVN 77:

August 1993; 
* Initial estimate for CVN 76 developed based on CVN 74/75 proposal 
data with adjustments made for design and economic factors.

September 1994; 
* Congress appropriates funding for the construction of CVN 76.

December 1994; 
* Navy awards a fixed-price incentive fee contract for detailed design 
and construction of CVN 76 to Newport News Shipbuilding for a target 
price of $2.5 billion.

May 1995; 
* Construction of CVN 76 begins.

April 1999; 
* 4-month strike at Newport News causes work stoppage on construction 
of CVN 76.

July 2000; 
* Congress appropriates funding for the construction of CVN 77.

January 2001; 
* Navy awards a fixed-price incentive fee contract for detailed design 
and construction of CVN 77 to Newport News Shipbuilding for a target 
price of $3.4 billion.

February 2001; 
* Navy requests $86 million for CVN 76 and $20 million for CVN 77 in 
prior year funding to cover cost growth.

June 2001; 
* Construction begins on CVN 77. Advanced construction began in 1998 to 
provide sustaining work for the shipyard.

February 2002; 
* Prior year request of $94 million for CVN 76 and $75.4 million for 
CVN 77.

September 2002; 
* Development delays prompt Navy to revert to a legacy warfare system 
on CVN 77. Costs for warfare system are transferred from the 
shipbuilder to the Navy.

December 2002; 
* Original contract delivery date for CVN 76.

June 2003; 
* CVN 76 delivered to the Navy--6 months later than the original 
delivery date.

August 2003; 
* Navy initiates a contract wide stop work order on CVN 76 to prevent 
depletion of program funding. Stop work order is rescinded 3 months 
later.

February 2005; 
* Navy requests $870 million in prior year funding over fiscal years 
2006 to 2008 for CVN 77. This includes an increase in $908 million in 
construction costs and a $38 million decrease in Navy- furnished 
equipment.

March 2008; 
* Initial expected delivery date for CVN 77.

January 2009; 
* Current expected delivery date for CVN 77.

Sources: Shipbuilder and Navy (data), GAO (presentation).

[End of table]

Cost Experience on CVN 76 and CVN 77:

The Fiscal Year 2005 President's Budget showed that budgets for the CVN 
case study ships had increased by $173 million, and the Congress has 
appropriated funds to cover these increases. However, based on March 
2004 data, we projected additional cost growth on contracts for the 
carriers is likely to reach $485 million and could be higher. 
Therefore, the Navy will need additional appropriations to cover this 
cost growth.

The fiscal year 2005 budget for the carriers is about $9.6 billion-- 
$173 million more than the initial budget request for these ships. (See 
table 19.) As a result, the Navy has requested $275.4 million through 
both the prior year completion bill and other financial transfers to 
fund cost increases on the CVN program.[Footnote 20] Ship construction 
costs comprise the majority of this increase.

On CVN 76, ship construction costs grew by $252 million above the 
initial budget. As a result of cost growth, CVN 76 was in danger of 
running out of funding. The program office issued over 75 stop work 
orders--including one contract wide stop work order to temporarily save 
funding. Lower priority work was cancelled or halted to avoid further 
cost growth. While stop work orders saved money in the short term, they 
resulted in significant costs later. On CVN 76 some work had to be 
completed in a post-delivery contract--at a higher cost.

Table 19: Growth in Program Budgets for Case Study Ships:

Dollars in millions.

Case study ship: CVN 76; Initial and FY 2005 President's budget: 
Initial: $4,476; 
Initial and FY 2005 President's budget: FY 2005: $4,600; 
Initial and FY 2005 President's budget: FY 2005: $124; 
Difference in budgets: Difference due to Navy-furnished equipment: 
($128); 
Difference in budgets: Difference due to construction costs[A]: $252.

Case study ship: CVN 77; 
Initial and FY 2005 President's budget: Initial: $4,975; 
Initial and FY 2005 President's budget: FY 2005: $5,024; 
Initial and FY 2005 President's budget: FY 2005: $49; 
Difference in budgets: Difference due to Navy-furnished equipment: 
$100; 
Difference in budgets: Difference due to construction costs[A]: ($51).

Total; 
Initial and FY 2005 President's budget: Initial: $9,451; 
Initial and FY 2005 President's budget: FY 2005: $9,624; 
Initial and FY 2005 President's budget: FY 2005: $173; 
Difference in budgets: Difference due to Navy-furnished equipment: $28; 
Difference in budgets: Difference due to construction costs[A]: $201.

Sources: Navy (data); GAO (presentation).

[A] Part of the increased cost is due to changes in the scope of the 
contract.

[End of table]

We calculated a range of the potential growth for CVN 77 and found that 
the total projected cost growth is likely to exceed $485 million and 
could reach $637 million.[Footnote 21] (See table 20.)

Table 20: GAO's Forecasts of Additional Cost Growth for Construction:

Dollars in millions; 
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.

Case study ship: CVN 76; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $252; 
GAO's forecast for additional cost growth for construction: $0-0; 
GAO's forecast of total Cost growth: $252-252.

Case study ship: CVN 77; 
Percent of ship construction completed: 45%; 
Amount already requested to cover contractor's increased cost: 
($51)[A]; 
GAO's forecast for additional cost growth for construction: $485-637; 
GAO's forecast of total Cost growth: $434-586.

Total growth; 
Amount already requested to cover contractor's increased cost: $201; 
GAO's forecast for additional cost growth for construction: $485-637; 
GAO's forecast of total Cost growth: $686-838.

Sources: Navy (data); GAO (analysis).

Note: Cost growth is from original contract target price, not from the 
current contract target price. Forecast reflects expected price to the 
Navy.

[A] Negative reflects shifting of funds from the construction contract 
to Navy-furnished equipment.

[End of table]

Our cost growth estimates have proven to be understated. The Fiscal 
Year 2006 President's Budget recognizes cost growth of $908 million for 
ship construction above the prior year's budget request. In addition, 
we assumed that the shipbuilder will maintain its current efficiency 
through the end of the contracts and meet scheduled milestones. For 
example, Navy officials told us that delivery of CVN 77 is likely to 
slip to January 2009, further increasing the final cost of the ship.

Main Drivers of Cost Growth for CVN 76 and CVN 77:

Based on 2004 data, increases in labor hour and material costs account 
for 80 percent of the cost growth on CVN 76 and CVN 77, while the costs 
for Navy-furnished equipment--including propulsion and weapon systems-
-declined.[Footnote 22] (See fig. 7.) The remaining 23 percent of cost 
growth resulted from increases in overhead costs. The shipbuilder cited 
a number of direct causes for the labor hour, material, and overhead 
cost growth in the case study ships. The most common causes were 
related to demands for labor on other programs at the shipyard, the 
need for additional and more costly materials, and changes in employee 
pay and benefits.

Figure 7: Average Sources of Cost Growth on CVN 76 and CVN 77:

[See PDF for image]

[End of figure]

Materials:

Material costs increased on CVN 76 by $294 million and on CVN 77 by 
$134 million since the contracts were first awarded.

Table 21: Growth in Material Costs:

Dollars in millions; 
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.

Case study ship: CVN 76; 
Total dollars due to increased material costs: $294; 
Percent increase: 43%%; 
Material cost as a percent of total contract growth: 46%.

Case study ship: CVN 77; 
Total dollars due to increased material costs: $134; 
Percent increase: 13%; 
Material cost as a percent of total contract growth: 31%.

Total; 
Total dollars due to increased material costs: $428.

Sources: Navy (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

On both CVN 76 and CVN 77, material costs grew, in part, because the 
shipbuilder underestimated the original budget for materials. In April 
2002--7 years after construction began on CVN 76--about $32 million in 
errors in material purchase estimates were revealed. CVN 77 has also 
experienced a significant increase in material costs due to under 
budgeting. According to the shipbuilder, a compressed construction 
schedule on CVN 77 resulted in the budget for materials being 
established prior to the completion of the carrier's design and even 
the completion of design work on certain systems on CVN 76. As a 
result, the true magnitude of the carrier's material costs was not 
known at the time of the contract negotiation. Early in CVN 77 
construction, however, the shipbuilder reassessed the materials needed 
for construction in order to have a more realistic estimate of final 
material costs. The Navy and the Defense Contract Audit Agency 
recognized the absence of needed information on materials during its 
review of the shipbuilder's proposal and expressed concerns about the 
adequacy of the cost estimating system. According to Newport News 
officials, the shipyard and Defense Contract Audit Agency are working 
to resolve their concerns. The shipbuilder is estimating $200 million 
in material cost increases and additional funds are being requested to 
cover this increase.

According to the shipbuilder, material cost increases on both CVN 76 
and CVN 77 can be attributed to increases resulting from a declining 
supplier base and commodity price increases. Both carriers' material 
costs have been affected by an over 15 percent increase in metals 
costs, which, in turn, increases costs for associated components used 
in ship construction. Moreover, many of the materials used in the 
construction of aircraft carriers are highly specialized and unique-- 
often produced by only one manufacturer. With fewer manufacturers 
competing in the market, the materials are highly susceptible to cost 
increases.

Other reasons for material cost increases include the following:

CVN 76:

* Expenses of about $20 million in non-nuclear engineering effort that 
were subcontracted for in late 1997 and of about $50 million for 
information services were transferred from overhead to material in the 
middle of the project.

CVN 77:

* The expansion of commercial-off-the-shelf equipment in CVN 77 
resulted in additional costs to test the materials to make sure 
military specifications were met.

Labor Hours:

Costs on both carriers grew because of additional labor hours required 
to construct the ships. At delivery, CVN 76 required 8 million hours of 
additional labor hours to construct, while CVN 77 has required 4 
million hours. As the number of hours to construct the ship increased, 
total labor costs grew, with the shipbuilder paying for additional 
employee wages and overhead costs.

Table 22: Growth in Labor Hour Costs:

Dollars in millions; 
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.

Case study ship: CVN 76; 
Shipbuilder reported labor dollar growth: $78; 
Overhead and labor rate dollars on increased labor hours[A]: $144; 
Total dollars due to increased labor hours: $222; 
Labor hour cost as a percent of total contract growth: 35%.

Case study ship: CVN 77; 
Shipbuilder reported labor dollar growth: $75; 
Overhead and labor rate dollars on increased labor hours[A]: $107; 
Total dollars due to increased labor hours: $182; 
Labor hour cost as a percent of total contract growth: 42%.

Total; 
Shipbuilder reported labor dollar growth: $153; 
Overhead and labor rate dollars on increased labor hours[A]: $251; 
Total dollars due to increased labor hours: $404. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. We separated the overhead and labor rates 
associated only with the additional hours and added this to the 
shipbuilders' reported labor cost growth. Our analysis captures all 
costs associated with labor hour growth--including overhead and labor 
rates.

[A] Contractor performance reports included $63 million in overhead 
costs for CVN 76 and $40 million for CVN 77 that have been disallowed 
(not charged to the government).

[End of table]

Increases in labor hours were due in part to an underestimation of the 
labor hours necessary to construct the carriers. The shipbuilder 
negotiated CVN 76 for approximately 39 million labor hours--only 2.7 
million more labor hours than the previous ship--CVN 75. However, CVN 
75 was constructed more efficiently because it was the fourth ship of 
two concurrent ship procurements. (See table 23.) CVN 76 and CVN 77, in 
contrast, were procured as single ships. As table 23 shows, single ship 
procurement is historically less efficient than two ship procurements, 
requiring more labor hours.

Table 23: Historical Man-hours Used to Produce Prior Ships Compared to 
CVN 76 Negotiated Man-hours:

Man-hours in millions.

Hull: CVN 70; 
Total man-hours: 36.4; 
Labor-hour change: 0; 
Type of ship buy: Single; 
Contract award date: April 1974.

Hull: CVN 71; 
Total man-hours: 44.3; 
Labor-hour change: 7.9; 
Type of ship buy: Single; 
Contract award date: September 1980.

Hull: CVN 72; 
Total man-hours: 42.7; 
Labor-hour change: (1.6); 
Type of ship buy: Two; 
Contract award date: December 1982.

Hull: CVN 73; 
Total man-hours: 38.2; 
Labor-hour change: (4.5); 
Type of ship buy: Two; 
Contract award date: December 1982.

Hull: CVN 74; 
Total man-hours: 36.9; 
Labor-hour change: (1.3); 
Type of ship buy: Two; 
Contract award date: July 1988.

Hull: CVN 75; 
Total man-hours: 36.3; 
Labor-hour change: (0.6); 
Type of ship buy: Two; 
Contract award date: July 1988.

Hull: CVN 76; 
Total man-hours: 39.0; 
Labor-hour change: 2.7; 
Type of ship buy: Single; 
Contract award date: December 1994.

Sources: Navy, Shipbuilder (data); GAO (analysis).

[End of table]

The shipbuilder and Navy budgeted the same number of hours to construct 
CVN 77 as to construct CVN 76, despite forecasts showing that at 55 
percent complete CVN 76 would need almost 2 million more hours above 
the negotiated hours to complete the ship. To date, CVN 77 is expected 
to incur over 4 million man-hours more than negotiated.

Some of the labor hour increase on CVN 76 occurred as a result of 
demands for labor on other programs at the shipyard. During 
construction of CVN 76, 1 million hours of labor were shifted from the 
construction of the carrier to work on the refueling and overhaul of 
CVN 68. The Navy deemed the carrier overhaul and refueling effort as a 
higher priority than new ship construction because carriers were needed 
back in the fleet to meet warfighting requirements. Many of the most 
skilled laborers were moved to the refueling effort, leaving fewer 
workers to construct CVN 76. Without many of the necessary laborers to 
construct the ship, the CVN 76 construction schedule was delayed. In 
order to meet construction schedule deadlines employees were tasked to 
work significant overtime hours. Studies have shown, however, that 
workers perform less efficiently under sustained high overtime.

Problems with late material delivery also led to labor hour increases 
on both CVN 76 and CVN 77. When material did not arrive on time, the 
shipbuilder tried to work around the missing item in order to remain on 
schedule--which is less efficient than had the material been available 
when planned. On CVN 77, for example, parts for a critical piping 
system were delivered over a year late, necessitating work-arounds and 
resequencing of work, driving labor costs up.

Other reasons for labor hour increases on CVN 76 and CVN 77:

CVN 76:

* A 4-month strike in 1999 led to employee shortages in key trades, 
contributing to a loss of learning with many employees not returning to 
the shipyard. According to Navy officials, the shipbuilder was given 
$51 million to offset the strike's impact.

CVN 77:

* Program schedule required concurrent design, planning, material 
procurement, and production activities. Additional labor hours were 
spent responding to design changes, which ultimately affected CVN 77 
cost and schedule.

* Due to unavailability of large-sized steel plates the shipbuilder had 
to re-plan the ship's structure so it could be constructed with smaller-
sized plates. This required not only extensive redesign, but resulted 
in additional production hours because laborers needed additional time 
to fit and weld the smaller plates together.

Overhead and Labor Rates:

While the total overhead and labor rate costs on both the CVN 76 and 
CVN 77 grew by $232 million over the life of the contract, labor hour 
increases accounted for over half of that amount (See table 6.) 
According to Navy officials, some of the overhead cost growth on CVN 76 
can be attributed to three major accounting changes since the contract 
was awarded in late 1994. While these accounting changes increased 
overhead costs, they resulted in a reduction of material costs. 
According to the shipbuilder, overhead cost increases on CVN 77 can be 
attributed to increases in pension and healthcare costs. Changes in the 
shipyard's workload and employee benefit costs also led to overhead 
cost increases on CVN 77. After delays in signing contracts for a 
carrier overhaul and the next generation aircraft carrier, overhead 
costs had to be absorbed by the CVN 77 program.

Table 24: Growth in Overhead Costs and Labor Rates:

Dollars in millions; 
Analysis based on July 2003 (CVN 76) and March 2004 (CVN 77) data.

Case study ship: CVN 76; 
Shipbuilder reported overhead growth[A]: $263; 
Increase in overhead related to growth in labor hours: $144; 
Increase in overhead related to overhead and labor rates: $119; 
Overhead cost as a percent of total contract growth: 19%.

Case study ship: CVN 77; 
Shipbuilder reported overhead growth[A]: 219; 
Increase in overhead related to growth in labor hours: $107; 
Increase in overhead related to overhead and labor rates: $113; 
Overhead cost as a percent of total contract growth: 26%.

Total; 
Shipbuilder reported overhead growth[A]: $482; 
Increase in overhead related to growth in labor hours: $251; 
Increase in overhead related to overhead and labor rates: $232.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures only costs associated with 
overhead and labor rate changes. Increases in overhead related to 
growth in labor hours are captured in the analysis of labor hour 
increases.

[A] Contractor performance reports included $63 million in overhead 
costs for CVN 76 and $40 million for CVN 77 that have been disallowed 
(not charged to the government).

[End of table]

According to the shipbuilder, labor rate increases on CVN 76 resulted 
from union negotiations following a strike at the shipyard, as well as 
significant use of overtime labor, which is more expensive than normal 
hourly wages. According to Navy officials, between 30 and 40 percent of 
the work on CVN 76 was done on overtime in 2003.

Navy-Furnished Equipment:

Navy-furnished equipment did not represent an area of cost growth on 
CVN 76 and CVN 77. On CVN 76, the costs for propulsion equipment 
decreased by close to $145 million--driving down the overall cost of 
Navy-furnished equipment. Since 2001, costs for Navy-furnished 
equipment on CVN 77, however, have grown by $100 million. This growth 
on CVN 77 can be attributed to increases in the cost associated with 
the Integrated Warfare System--the carrier's combat system. The 
Integrated Warfare System included new phased array radar that was 
being developed by the next generation destroyer program. However, when 
the radar technology did not become available as planned, the Navy 
decided to install a legacy system on the ship. Because the shipbuilder 
was suppose to buy and install the Integrated Warfare System as part of 
the original contract scope, the costs for the Integrated Warfare 
System were removed from the contract and used by the Navy to procure a 
legacy system as Navy-furnished equipment.

[End of section]

Appendix IV: San Antonio Class Amphibious Transport Dock Ship:

Program Description:

The San Antonio class amphibious transport dock ship is designed to 
transport Marines and their equipment and allow them to land using 
helicopters, landing craft, and amphibious vehicles. The class is 
expected to increase operational flexibility and survivability over 
each ship's 40-year lifespan and to operate at lower cost than previous 
amphibious transport ship classes. The new class is also designed to 
reduce crew size and provide significant improvements in command, 
control, communications, computer, intelligence, and quality of life.

In acquiring LPD 17, the lead ship in the class, a three-dimensional 
computer-aided design tool and a shared data tracking system has been 
used. The shared data tracking system was intended to provide 
significant savings within the San Antonio class program through the 
reuse of critical data in future design, construction, and operational 
activities. We focused our review on the LPD 17 and 18.

Figure 8: San Antonio Class Amphibious Transport Dock Ship:

[See PDF for image]

[End of figure]

Table 25: Major Events in the Acquisition of LPD 17 and LPD 18:

February 1996; 
* Citing industrial base concerns and LPD 17's improved survivability 
features, Congress authorized the LPD 17, accelerating the Navy's 
schedule by 2 years.

March 1996; 
* Initial estimate developed for the class in support of a milestone 
review. In developing the estimate, cost analysts used data from the 
LHD and LSD amphibious ships, which were constructed in the 1980s. The 
LHD is larger than the LPD, and the LSD is less technologically 
complex. Cost analysts assumed that technologies would mature on 
schedule and that acquisition reforms would produce savings.

December 1996; 
* LPD 17 cost-plus award fee contract awarded after a competitive 
selection of the Avondale Alliance for detail design and construction 
of LPD 17. The contract included options for construction of LPD 18 and 
19. Target costs were set for LPD 17 and LPD 18 at $644 million and 
$391 million, respectively.

December 1998; 
* Contract modified to exercise option for construction of LPD 18.

August 1999; 
* Litton Shipbuilding purchased LPD 17's prime contractor, Avondale 
Industries.

December 1999; 
* Design schedule delays cause a 10-month slip in anticipated delivery 
of LPD 17.

August 2000; 
* LPD 17 construction begins.

February 2001; 
* The Navy and Litton Alliance reassess the lead ship construction 
schedule and delay LPD 17 delivery another 14 months to November 2004.

April 2001; 
* Northrop Grumman Ship Systems assumed responsibility as primary 
contractor for the LPD 17 program through an acquisition that included 
Avondale.

September 2001; 
* Cost growth led to renegotiation of the contract.

September 2001; 
* The contract was converted to cost-plus incentive fee contract. For 
LPD 17, the original award fee was based on the total cost of the ship 
over its operational lifetime. The incentive fee contract tied the fee 
to controlling construction costs. This shifted the focus of the 
program from lowering future maintenance costs to delivering the ship.

November 2001; 
* Cost growth by more than 43 percent triggered a Nunn- McCurdy unit 
cost breach, causing a new baseline to be established in June 2002 and 
requiring $1.4 billion in additional funding.

February 2002; 
* LPD 18 construction begins.

June 2002; 
* With the Navy's approval, Northrop Grumman Ship Systems and Bath Iron 
Works agreed to a swap that shifts all LPD construction, including LPD 
19, to Northrop Grumman and all future DDG 51 ships to Bath Iron Works.

February 2005; 
* Navy requests $25 million in additional prior year completion funding 
for LPD 18.

May 2005; 
* LPD 17 expected delivery date.

September 2005; 
* LPD 18 expected delivery.

Sources: Navy, shipbuilder (data); GAO (presentation).

[End of table]

Cost Experience on LPD 17 and LPD 18:

Budgets for the two LPD case study ships have grown by $1 billion, and 
funds have been appropriated to cover these increases. However, the 
Navy could need additional appropriations of $200 million to $300 
million to fund projected cost growth.

For detail design and construction of LPD 17, the Congress initially 
appropriated $953.7 million to fund the construction contract (the 
basic contract plus a budget for future changes) and acquisition of 
Navy-furnished equipment. The Congress later appropriated $762 million 
to fund LPD 18 construction. (See table 26.)

Table 26: Growth in Program Budgets for Case Study Ships:

Dollars in millions.

Case study ship: LPD 17; 
Initial and FY2005 President's budget: Initial: $954; 
Initial and FY2005 President's budget: FY2005: $1,758; 
Initial and FY 2005 President's budget: FY 2005: $804; 
Difference in budgets: Difference due to Navy-furnished equipment: $21; 
Difference in budgets: Difference due to construction costs[A]: $784.

Case study ship: LPD 18; 
Initial and FY2005 President's budget: Initial: 762; 
Initial and FY2005 President's budget: FY2005: 1,011; 
Initial and FY 2005 President's budget: FY 2005: $249; 
Difference in budgets: Difference due to Navy-furnished equipment: $3; 
Difference in budgets: Difference due to construction costs[A]: $246.

Total; 
Initial and FY2005 President's budget: Initial: $1,716; 
Initial and FY2005 President's budget: FY2005: $2,769; 
Initial and FY 2005 President's budget: FY 2005: $1,053; 
Difference in budgets: Difference due to Navy-furnished equipment: $24; 
Difference in budgets: Difference due to construction costs[A]: $1,030.

Sources: Navy (data); GAO (presentation).

[A] Part of the increased cost is due to changes in the scope of the 
contract.

[End of table]

Since that time, the Congress has appropriated $1 billion to cover the 
increases in the ships' costs. However, more funds will likely be 
needed to cover additional cost growth for these two ships. We project 
that, if the current schedule is maintained, total cost growth for the 
LPD 17 and LPD 18 will exceed $1.2 billion and possibly reach $1.4 
billion. (See table 27.)

Table 27: GAO's Forecasts of Additional Cost Growth for Construction:

Dollars in millions; 
Analysis based on data through May 2004.

Case study ship: LPD 17; 
Percent of ship construction completed: 95%; 
Amount already requested to cover increased cost: $784; 
GAO's forecast for additional Cost growth: $112-$197; 
GAO's forecast of total Cost growth: $896-$981.

Case study ship: LPD 18; 
Percent of ship construction completed: 67; 
Amount already requested to cover increased cost: 246; 
GAO's forecast for additional Cost growth: $102-136; 
GAO's forecast of total Cost growth: $348-382.

Total growth; 
Amount already requested to cover increased cost: $1,030; 
GAO's forecast for additional Cost growth: $214-333; 
GAO's forecast of total Cost growth: $1,244-1363.

Sources: Navy, Shipbuilder (data); GAO (analysis).

Note: Cost growth is measured from original contract price, not from 
the current contract target price. Forecast reflects expected price to 
the Navy.

[End of table]

Our cost growth estimates--both low and high--are likely understated 
because we assumed that the shipyards will maintain their current 
efficiency through the end of their contracts and meet scheduled 
milestones. LPD 17 did not meet the planned December 2004 delivery 
date. Delivery is now scheduled for May 2005, increasing the final cost 
of the ship.

Main Drivers of Cost Growth for LPD 17 and LPD 18:

Increases in labor hour and material costs account for 76 percent of 
the cost growth on LPD 17 and LPD 18 construction contracts. Navy- 
furnished equipment--including radars, propulsion equipment, and weapon 
systems--represents just 2 percent of the cost growth. The remaining 22 
percent was due to increases in overhead and labor rates. (See fig. 9.)

Figure 9: Average Sources of Cost Growth on LPD 17 and LPD 18:

[See PDF for image]

[End of figure]

The shipbuilder cited a number of direct causes for the labor hour, 
material, and overhead cost growth in the two case study ships. The 
most common causes were related to the concurrent development of a new 
and unproven design tool and design of the lead ship, initial focus on 
controlling total lifetime costs, and changes in employee pay and 
benefits.

Materials:

Engineering costs (classified as material costs) associated with use of 
a three-dimensional product model to design LPD 17 were a key 
contributor to material cost growth. The design tool was not fully 
developed and subsequent problems affected all aspects of the design. 
Subcontracts for engineering design doubled, accounting for $215 
million in cost growth on LPD 17. Development of an integrated 
production data environment, originally assumed to be funded by the 
state, has instead been shifted to the contract, representing an 
additional $35 million in cost spread across LPD. (See table 28.)

Table 28: Growth in Material Costs:

Dollars in millions; 
Analysis based on data through May 2004.

Case study ship: LPD 17; 
Increased material costs: $400; 
Percent increase: 103%%; 
Material cost as a percent of total contract growth: 47%.

Case study ship: LPD 18; 
Increased material costs: $93; 
Percent increase: 39%; 
Material cost as a percent of total contract growth: 24%.

Total; 
Increased material costs: $493.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

Labor Hours:

Labor hours, the second largest component of cost growth, increased 
significantly for the LPD 17 and LPD 18. For example, engineering labor 
hours for the LPD 17 increased by over 100 percent from the original 
proposal.

As the number of hours to construct the ship increased, total labor 
costs grew, with the shipbuilder paying for additional overhead costs 
and employee wages. We separated the overhead and labor rates 
associated only with the additional hours and added this to the 
shipbuilder's reported labor cost growth. (See table 29.) Our analysis 
captures all cost growth associated with labor--including labor hours, 
overhead, and labor rates.

Table 29: Growth in Labor Hour Costs:

Dollars in millions; Analysis based on data through May 2004.

Case study ship: LPD 17 [A]; 
Shipbuilder reported labor Cost growth: $182; 
Overhead and labor rate costs for increased labor hours: $102; 
Total cost due to increased labor hours: $284; 
Labor hour cost as a percent of total contract growth: 33%.

Case study ship: LPD 18; 
Shipbuilder reported labor Cost growth: $117; 
Overhead and labor rate costs for increased labor hours: 67; 
Total cost due to increased labor hours: $184; 
Labor hour cost as a percent of total contract growth: 48%.

Total; 
Shipbuilder reported labor Cost growth: $299; 
Overhead and labor rate costs for increased labor hours: $169; 
Total cost due to increased labor hours: $468. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures all costs associated with 
labor hour growth, including overhead and labor rates.

[A] LPD 17 relied heavily on subcontracted labor to design the ship. 
Since these costs are captured as material, we did not include them in 
our analysis of labor cost increases.

[End of table]

Factory inefficiencies and loss of skilled laborers, including 
significant employee attrition (35 percent annually) contributed 
significantly to labor hour increases. Difficulties with the design 
tool and turnover in engineering staff led to increases in engineering 
labor hours and delayed achieving a stable design. Without a stable 
design, work was often delayed from early in the building cycle to 
later, during integration of the hull. Shipbuilders stated that doing 
the work at this stage could cost up to five times the original cost. 
On LPD 17, 1.3 million labor hours were moved from the build phase to 
the integration phase. Consequently, LPD 17 took much longer to 
construct than originally estimated. Moreover, a diminished workforce 
at Avondale required the busing of shipyard workers from Ingalls 
Shipyard in Pascagoula, Mississippi to Avondale in New Orleans, 
Louisiana and the subcontracting of skilled labor.

Program Overhead and Labor Rates:

While the total overhead costs on both the LPD 17 and 18 grew by $0.5 
billion over the life of the contract, labor hour increases contributed 
to about half of that amount. (See table 30.)

Table 30: Growth in Overhead Costs and Labor Rates:

Dollars in millions; 
Analysis based on data through May 2004.

Case study ship: LPD 17; 
Shipbuilder reported overhead growth: $277; 
Portion related to growth in labor hours: $102; 
Portion related to overhead and labor rates: $175; 
Overhead cost rate increases as a percent of total contract growth: 
20%. 

Case study ship: LPD 18; 
Shipbuilder reported overhead growth: $177; 
Portion related to growth in labor hours: $67; 
Portion related to overhead and labor rates: $110; 
Overhead cost rate increases as a percent of total contract growth: 
28%. 

Total; 
Shipbuilder reported overhead growth: $454; 
Portion related to growth in labor hours: $169; 
Portion related to overhead and labor rates: $285.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures only costs associated with 
overhead and labor rate changes. Increases in overhead related to 
growth in labor hours are captured in the analysis of labor hour 
increases.

[End of table]

According to Northrop Grumman, increases in overhead costs not related 
to labor hour growth can be attributed largely to changes in the 
shipyard's workload and employee benefit costs. Beginning in 2001, the 
shipyard experienced a rise in overhead rates. For example, the 
overhead rates in the 2004 latest estimate by Northrop Grumman are 39 
percent higher than what was originally proposed on the LPD 17 in 1996. 
Several factors helped to increase overhead. For example; 
due to the loss of the bulk military cargo T-AKE ship, the cancellation 
of the construction of a commercial ship (American Classics Voyage), 
and the delay in signing the contract for the next generation 
destroyer, overhead costs had to be absorbed by the remaining contracts 
at the yard, including LPD. This led to 36 percent of the increase in 
overhead rates--24 percent for the T-AKE and cruise ship and 12 percent 
for DD(X).

According to the shipyard, changes in the financial market affected the 
pension fund and the rise in medical care costs were responsible for 16 
percent of the increase in the shipyards overhead rates.

Labor rates rose due to inflation impacts of an over 2-year delay in 
lead ship delivery and subsequent changes in the procurement schedule 
and wage rates negotiated with labor unions.

Navy-Furnished Equipment:

According to program officials, cost growth for Navy-furnished 
equipment on the LPD 17 was due to increased costs for a shock wave 
test that was not anticipated in the original cost estimate. This cost 
was a one-time increase, affecting only LPD 17 costs.

[End of section]

Appendix V: Virginia Class Submarine:

Program Description:

The Virginia-class attack submarine, the newest class of nuclear 
submarines, is designed to combat enemy submarine and surface ships, 
fire cruise missiles at land targets, and provide improved surveillance 
and special operations support to enhance littoral warfare. Because the 
Virginia class is designed to be smaller than the Seawolf and slightly 
larger than the Los Angeles class submarines--ships the new class will 
eventually replace--the Virginia class is better suited for conducting 
shallow-water operations. Major features of this new class of submarine 
include new acoustic, visual, and electronic systems for enhanced 
stealth. An objective of Virginia class is to reduce the life-cycle 
cost through better design and engineering resulting in one third fewer 
man-hours than were needed to construct Seawolf (SSN 21), the lead ship 
in the previous class of attack submarines. The first ship, the SSN 
774, was delivered in October 2004. Our review focused on the SSN 774 
and 775.

Figure 10: Virginia Class Submarine:

[See PDF for image]

[End of figure]

Table 31: Major Events in the Acquisition of SSN 774 and SSN 775:

October 1991; 
* Program initiated with focus on building more versatile and less 
costly submarines.

July 1994; 
* Initial estimate developed for Virginia class based on historical 
data from Seawolf (SSN 21) and Los Angeles (SSN 688) classes. A sole 
source contract with Electric Boat was planned. Major challenges 
involved estimating new technologies still under development and 
estimating the cost impact of a 6-year gap in submarine production.

January 1996; 
* Contract for $1.4 billion awarded to Electric Boat for detail design 
of Virginia class. Approximately 3.4 million man-hours for one-time 
production start up activities were included.

February 1997; 
* Cost analysts updated estimates to reflect proposed shipbuilder 
teaming agreement between Electric Boat and Newport News Shipbuilding 
assuming teaming would be less expensive than dual sources due to 
shipbuilder collaboration. Costs were increased to reflect additional 
non-recurring effort for Newport News to reconstitute submarine 
production.

February 1998; 
* Based on congressional direction that teaming agreement would be the 
most efficient way to produce submarines in a low rate production 
environment, the Navy authorized a teaming agreement between Electric 
Boat and Newport News Shipbuilding. Deliveries of the ships would 
alternate between shipyards with Electric Boat delivering the first 
ship. According to the Navy, this change increased the estimated cost 
of developing and building 30 submarines when compared to building them 
in a single yard.

September 1998; 
* Contract is modified by $1.028 billion to fund construction of 
Electric Boat's SSN 774 lead ship. Options for construction of SSN 
775 - 777 were included.

October 1998; 
* Construction of SSN 774 begins.

December 1998; 
* Contract is modified by $1.084 billion to initiate construction of 
Newport News Shipbuilding's SSN 775 lead ship.

September 1999; 
* Construction of SSN 775 begins.

February 2001; 
* Navy requests $119 million for Virginia class in prior year funding 
to cover cost growth.

December 2001; 
* Northrop Grumman Corporation acquires Newport News Shipbuilding 
creating Northrop Grumman Newport News.

February 2002; 
* Prior year completion request of $227 million for Virginia class.

April 2003; 
* Prior year completion request of $327 million for Virginia class 
triggers a Nunn-McCurdy unit cost breach.

June 2004; 
* Planned delivery date for SSN 774.

October 2004; 
* SSN 774 delivered 4 months late, an improvement over the Seawolf and 
Los Angeles lead ships which were delivered 25 and 26 months late, 
respectively.

February 2005; 
* Fiscal Year 2006 President's Budget recognizes an increase in the 
budget of $82 million for SSN 774 and $223 million for SSN 775. These 
increases are funded through transfer of funds and prior year funding 
of $28 million for SSN 774 and $97 million for SSN 775.

June 2005; 
* Initial planned delivery date for SSN 775.

March 2006; 
* Current planned delivery date for SSN 775.

Sources: Navy, shipbuilder (data); GAO (presentation).

[End of table]

Cost Experience on SSN 774 and SSN 775:

The Fiscal Year 2005 President's Budget showed that budgets for the two 
Virginia class case study ships have increased by $734 million. 
However, based on data of July 2004, we projected additional cost 
growth on contracts for the two ships is likely to reach $840 million 
and could be higher. In fiscal year 2006 budget, the Navy has requested 
funds to cover cost increases that are now expected to reach 
approximately $1 billion.

The fiscal year 2005 budget for the SSN 774 and SSN 775 is about $6.2 
billion, compared with the initial fiscal year 1998 budget request of 
$5.5 billion. (See table 32.) Ship construction costs comprise the 
majority of this increase.

Table 32: Growth in Program Budgets for Case Study Ships:

Dollars in millions.

Case study ship: SSN 774; 
Initial and FY2005 President's budget: Initial: $3,260; 
Initial and FY2005 President's budget: FY2005: $3,682; 
Initial and FY 2005 President's budget: FY 2005: $422; 
Difference in budgets: Difference due to Navy-furnished equipment: $95; 
Difference in budgets: Difference due to construction costs[A]: $327.

Case study ship: SSN 775; 
Initial and FY2005 President's budget: Initial: 2,192; 
Initial and FY2005 President's budget: FY2005: 2,504; 
Initial and FY 2005 President's budget: FY 2005: $312; 
Difference in budgets: Difference due to Navy-furnished equipment: $18; 
Difference in budgets: Difference due to construction costs[A]: $294.

Total; 
Initial and FY2005 President's budget: Initial: $5,452; 
Initial and FY2005 President's budget: FY2005: $6,186; 
Initial and FY 2005 President's budget: FY 2005: $734; 
Difference in budgets: Difference due to Navy-furnished equipment: 
$113; 
Difference in budgets: Difference due to construction costs[A]: $621.

Sources: Navy (data); GAO (presentation).

[A] Part of the increased cost is due to changes in the scope of the 
contract.

[End of table]

While the Congress has appropriated funds to cover the increases in the 
ships' costs, more funds will be needed to cover additional cost growth 
for these two ships. In its fiscal year 2006 budget submission the Navy 
is requesting an additional $125 million in prior year completion 
funding between fiscal years 2006 to 2007 for the case study ships. We 
calculated a range of the potential growth for the two case study ships 
and found that the total projected cost growth is likely to exceed $724 
million and could reach $840 million or higher. (See table 33.)

Table 33: GAO's Forecasts of Additional Cost Growth for Construction:

Dollars in millions; Analysis based on July 2004 data.

Case study ship: SSN 774; 
Percent of ship construction completed: Delivered; 
Amount already requested to cover contractor's increased cost: $327[A]; 
GAO's forecast for additional Cost growth: $0-0; 
GAO's forecast of total Cost growth: $327-327.

Case study ship: SSN 775; 
Percent of ship construction completed: 88%; 
Amount already requested to cover contractor's increased cost: $294; 
GAO's forecast for additional Cost growth: $103-219; 
GAO's forecast of total Cost growth: $397-513.

Total growth; 
Amount already requested to cover contractor's increased cost: $621; 
GAO's forecast for additional Cost growth: $103- 219; 
GAO's forecast of total Cost growth: $724-840.

Sources: Navy (data); GAO (analysis).

[A] Program officials indicated that $70 million in additional funding 
has been requested for SSN 774 completion.

[End of table]

Our cost growth estimates--both low and high--may be understated 
because we assumed that the shipbuilders will maintain their current 
efficiency through the end of their contracts and meet scheduled 
milestones. Any slips in efficiency and schedules would likely result 
in added costs. For example, the delivery date for SSN 775 is expected 
to slip by as many as 8.5 months, which could increase the final cost 
of the ship.

Main Drivers of Cost Growth for SSN 774 and SSN 775:

Our analysis shows that the submarine contract costs have grown because 
initial construction costs were underestimated--especially the costs 
associated with the cost of material and number of labor hours needed 
to build the ships. For the two case study ships we examined, we found 
that increases in the number of labor hours and material costs to build 
the submarines accounted for 83 percent of the cost growth on 
shipbuilding construction contracts. Navy-furnished equipment, 
including radars, propulsion equipment, and weapon systems, caused 14 
percent of the cost growth. We found that ship overhead--such as 
employee benefits and shipyard support costs--and labor rate increases 
accounted for 3 percent of cost growth.

Figure 11: Average Sources of Cost Growth on SSN 774 and SSN 775:

[See PDF for image]

[End of figure]

In negotiating the contract for the first four Virginia class ships, 
program officials stated they were constrained in negotiating the 
target price to the amount funded for the program, thereby risking cost 
growth at the outset. The shipbuilders said that they accepted a 
challenge to design and construct these ships for $748 million less 
than their estimated costs because the contract protected their 
financial risk. Despite the fact that there was significant risk of 
cost growth, the Navy, based on guidance at the time, did not identify 
any funding for probable cost growth.

We analyzed shipbuilder contract costs to identify the sources of cost 
growth. Using shipbuilder cost data, we allocated the sources of 
shipbuilder cost growth on the contract into three categories--labor 
hours; material costs; and labor and overhead rates. Since labor costs 
and overhead costs can change due to labor hours, labor rates, and 
rates associated with individual elements of overhead--or a combination 
of these--we examined each in isolation by separating the program 
overhead cost associated with an increase in labor hours from costs 
that resulted from an increase in overhead rates, such as an increase 
in health care costs.

Materials:

Due to high risk that specialized material could not be procured for 
the amount budgeted, the Navy agreed to purchase this material as a 
cost plus fixed fee item. This agreement protected the shipbuilder from 
having to fund any resulting cost increases for highly specialized 
material. Indeed, cost growth for material increased by $350 million 
for the two Virginia class submarines we examined.

Table 34: Growth in Material Costs:

Dollars in millions; 
Analysis based on July 2004 data.

Case study ship: SSN 774; 
Total dollars due to increased material costs: $141; 
Percent increase: 43%; 
Material cost as a percent of total contract growth: 49%.

Case study ship: SSN 775; 
Total dollars due to increased material costs: $209; 
Percent increase: 56%; 
Material cost as a percent of total contract growth: 49%.

Total; 
Total dollars due to increased material costs: $350; 
Percent increase: 99%.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events.

[End of table]

The Navy and shipbuilders attribute material cost growth to several 
factors including:

* unrealistic budgets not supported by current vendor costs,

* diminished supplier base for highly specialized materials,

* nonrecurring costs for Computer Data Integration between shipbuilder 
teams,

* lack of design maturity for certain electronic components, and:

* full funding of ships in the year of authorization.

Shipbuilders stated they based more than 70 percent of their estimate 
for major material costs on updated vendor quotes while the Navy relied 
on historical costs that were not analogous to the low number of 
submarines being planned for construction. While the Navy knew there 
would be a price penalty for a 6-year gap in submarine production, 
there were no studies or actual data to support what the overall effect 
would be. Thus, Navy cost estimators assumed that costs for major 
material items would increase by 20 percent. When the Navy negotiated 
the costs for Virginia-class high value, specialized material, the 
shipbuilder agreed to take on the challenge of achieving lower costs in 
exchange for funding these materials on a cost-plus-fixed-fee 
basis.[Footnote 23] By the time the lead ship was delivered 8 years 
later, the true cost increase for highly specialized material was 
closer to 60 percent more than historical costs.

Following the cancellation of the prior submarine program--Seawolf--and 
a decrease in submarine production of three to four submarines per year 
to one over a period of 6 years, many vendors left the nuclear 
submarine business and focused instead on more lucrative commercial 
product development. As a result, prices for highly specialized 
material increased due to less competition and a lack of business. For 
example, many vendors were reluctant to support the Virginia class 
submarine contract because costs associated with producing small 
quantities of highly specialized materials were not considered worth 
the investment--especially for equipment with no other military or 
commercial applications.

Material costs also increased due to nonrecurring costs for integrating 
computer data so that the shipbuilders could work from a common design. 
In addition, costs to develop high-risk systems like the array and 
exterior communication system were underestimated. Recognizing the 
significant cost risk involved, the Navy procured these systems under a 
separate contract line item that guaranteed the shipbuilders a fixed 
fee and made the Navy responsible for funding all cost growth.

Finally, the Navy believes that the block-buy contract has contributed 
to increased material costs. Under a block-buy contract, subcontracts 
for submarine materials are for single ships spread over several years. 
According to the Navy, this type of acquisition approach does not take 
advantage of bulk-buy savings and incurs the risk that funding will not 
be available in time to order the material when needed. In addition, 
since ships are funded individually, the Navy believes suppliers are 
unwilling to risk investing in technology improvements due to the 
uncertainty that future ships will not be purchased. To stabilize the 
vendor base, the Navy awarded a multiyear contract that commits the 
Navy to purchasing additional submarines. While a multiyear contract 
can provide such savings, a program must meet criteria to demonstrate a 
sufficient level of stability for such a contract. In June 2003, we 
noted several aspects of the Virginia class program that indicated 
instability.[Footnote 24] Another factor to be considered in using 
multiyear contracts is the budget flexibility the government gives up 
in exchange for the commitment of funds for the future years of the 
contract.

Labor Hours:

Labor cost increases have led to $339 million in cost growth for the 
SSN 774 and SSN 775 combined. Problems with mastering state-of-the art 
design tools, first in class technical and teaming issues, and material 
availability all contributed to the labor cost growth.

Table 35: Growth in Labor Hour Costs:

Dollars in millions; 
Analysis based on July 2004 data.

Case study ship: SSN 774; 
Shipbuilder reported labor Cost growth: $149; 
Overhead and labor rate costs for increased labor hours: $10; 
Total cost due to increased labor hours: $159; 
Labor hour cost as a percent of total contract growth: 55%.

Case study ship: SSN 775; 
Shipbuilder reported labor Cost growth: $218; 
Overhead and labor rate costs for increased labor hours: ($38); 
Total cost due to increased labor hours: $180; 
Labor hour cost as a percent of total contract growth: 42%.

Total; 
Shipbuilder reported labor Cost growth: $367; 
Overhead and labor rate costs for increased labor hours: ($28); 
Total cost due to increased labor hours: $339. 

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures all costs associated with 
labor hour growth, including overhead and labor rates.

[End of table]

We found that SSN 774 required almost 3 million additional labor hours 
than planned, reflecting a growth of 25 percent. (See fig. 12.) In 
addition, we found that SSN 775 required almost 4 million more labor 
hours than planned. Approximately 3.4 million nonrecurring labor hours 
for SSN 774 were procured on a separate contract line item and 
therefore not included in our analysis while some SSN 775 nonrecurring 
labor hours are embedded in the labor hours for that ship.

Figure 12: SSN 774 Lead Ship Labor Hour Growth:

[See PDF for image]

[End of figure]

Technical issues commonly associated with first-in-class ships also 
contributed to the overall labor cost growth. For example, shipbuilders 
experienced problems with crossed hydraulic lines on the lead ship. In 
addition, problems with the torpedo tube and weapons handling design 
issues also contributed to labor hour growth in both ships. Labor hours 
also increased as quality problems discovered for a component made by 
one shipyard were reworked by the shipyard integrating the components. 
Because the shipyard doing the integration was not as familiar with the 
effort, the work was not completed as efficiently.

Late material deliveries also disrupted the work-flow sequence. Because 
many vendors either went out of business or focused on developing new 
commercial products in response to low demand, the Navy was no longer 
considered a preferred customer. In cases where there was no ready 
supplier, the shipbuilder had to request old subcontractors to supply 
the highly specialized material. This caused delays in material 
deliveries as well as quality problems arising from strict inspection 
processes that subcontractors were no longer familiar with. Although 
the shipbuilders tried to work around late material deliveries when 
they could, this caused workers to perform less efficiently than had 
the material been available when scheduled. Moreover, when the material 
did arrive, the shipbuilders had to work overtime to make up the 
schedule causing additional growth in labor costs.

Navy-Furnished Equipment:

According to Navy program officials, radar costs increased due to more 
design effort needed to fix problems associated with the Seawolf 
program. Other costs increases were driven by changes in how certain 
items were purchased. For example, the advanced display system was 
recently established as a line item in the budget when in the past it 
was paid for as part of the shipbuilder's construction contract. 
Moreover, the Navy initially planned to use research and development 
funds to cover costs for the propulsor but switched to ship 
construction funds instead, leading to an increase in the program's 
budget for Navy-furnished equipment.

Ship Overhead and Labor Rates:

Our analysis shows that program overhead costs and increases in labor 
rates were not significant sources of cost growth--causing 
approximately 3 percent of the cost growth. To isolate true increases 
in overhead rates from increases that were a consequence of labor hour 
increases, we separate the two in table 36.

Table 36: Growth in Overhead Costs and Labor Rates:

Dollars in millions; 
Analysis based on July 2004 data.

Case study ship: SSN 774; 
Shipbuilder reported overhead growth: $0; 
Increase in overhead related to growth in labor hours: $10; 
Increase in overhead related to overhead and labor rates: ($10); 
Overhead cost as a percent of total contract growth: (3%).

Case study ship: SSN 775; 
Shipbuilder reported overhead growth: $0; 
Increase in overhead related to growth in labor hours: ($38); 
Increase in overhead related to overhead and labor rates: $38; 
Overhead cost as a percent of total contract growth: 9%.

Total; 
Shipbuilder reported overhead growth: $0; 
Increase in overhead related to growth in labor hours: ($28); 
Increase in overhead related to overhead and labor rates: $28.

Sources: Shipbuilder (data); GAO (analysis).

Note: We compared initial target cost to the current estimate at 
completion to determine total contract cost growth. Cost growth may be 
due to Navy changes in contract scope, shipbuilder performance, or 
unanticipated events. Our analysis captures only costs associated with 
overhead and labor rate changes. Increases in overhead related to 
growth in labor hours are captured in the analysis of labor hour 
increases.

[End of table]

Costs associated with growth in labor hours are shown in table 35 
calculations.

According to the shipbuilder, overhead and labor rate increases were 
related to pension, workers compensation, and health care costs rising 
beyond what was expected. Furthermore, when other ship acquisitions did 
not materialize, shipyard overhead costs were spread over a fewer 
number of contracts causing an increase in the Virginia class overhead 
costs. Similarly, the loss of business caused the shipbuilders to lay 
off skilled workers. According to the shipbuilders, many of the 
experienced workers did not return to the shipyard. Hiring and training 
new workers increased costs.

[End of section]

We found that one shipbuilder was affected by labor rate increases. 
Following a strike at the shipyard, union negotiations resulted in four 
pay increases totaling an average of $3.10 per hour.

[End of section]

Appendix VI: GAO's Forecast of Additional Costs to Complete 
Construction Contracts:

This appendix discusses GAO's forecast of future cost growth for all 
ships in construction that are more than 30 percent complete. The 
forecast is also compared with the shipbuilders' forecasts of estimated 
costs at completion.

Figure 13: Comparison of Shipbuilders' and GAO's Forecasts of 
Additional Construction Costs for Six Classes of Ships Actively under 
Construction:

[See PDF for image]

Notes: Active construction in this table means ships are at least 30 
percent complete. Cost growth figures are in millions of dollars. 
Ships' names that are bolded are case study ships.

[A] We based the lower end of our cost forecast range on the costs 
spent to date added to the forecast cost of work remaining. The 
remaining work was forecasted using the cumulative cost performance 
index efficiency factor. Studies have shown that using this method is a 
reasonable estimate of the lower bound of the final cost.

[B] For the upper end of our cost range, we relied on either the actual 
costs spent to date added to the forecast of remaining work with an 
average monthly cost and schedule performance index or a cost/percent 
complete trend analysis, whichever was higher.

[End of figure]

* CVN 76 and CVN 77: CVN 76 was delivered to the Navy in 2003. While we 
forecasted an overrun of up to $586 million over the initial target 
price for CVN 77, the fiscal year 2006 budget request indicates a need 
of $870 million in prior year funding.

* SSN 774-SSN 777: SSN 774 was delivered to the Navy in October 2004. 
We found that the contractors' forecasts are unlikely to be achieved 
based on continuing cost growth on the remaining 3 ships. In addition, 
the SSN 776 and SSN 777 are the follow-on ships to a new class and 
still may experience production problems that could lead to future cost 
growth.

* DDG 91-DDG 101: The DDGs have experienced cost growth at both 
shipyards. All the DDGs under construction at Bath Iron Works and more 
than 30% complete have experienced cost growth. Similarly, cost growth 
is also expected on the DDGs built by Northrop Grumman.

* LPD 17-LPD 20: LPDs currently under construction are likely to 
experience significant cost overruns. On all of the LPDs, with the 
exception of LPD 18, the shipbuilder is estimating overall cost growth 
to be at the lower end of our predicted range. Hence we believe, the 
shipbuilder's forecast of cost growth is optimistic.

* T-AKE: Major cost growth is being predicted for T-AKE 1. We estimate 
that costs could grow more than $70 million beyond the initial contract 
price. The shipbuilder believes that escalating material costs 
resulting from rising commodity prices and unfinalized vendor 
subcontracts are driving contract cost growth.

* LHD 8: It also has the potential for significant cost growth--as much 
as $177 million more than what was anticipated. Cost growth thus far is 
attributed to increases in overhead and general and administrative 
costs.

[End of section]

Appendix VII: Comments from the Department of Defense:

OFFICE OF THE UNDER SECRETARY OF DEFENSE: 
ACQUISITION, TECHNOLOGY AND LOGISTICS: 

3000 DEFENSE PENTAGON: 
WASHINGTON, DC 20301-3000:

FEB 01 2005: 

Mr. Paul L. Francis:
Director, Acquisition and Sourcing Management: 
U.S. Government Accountability Office:
441 G Street, NW: 
Washington, DC 20548:

Dear Mr. Francis:

This is the Department of Defense (DoD) response to the Government 
Accountability Office (GAO) draft report, "DEFENSE ACQUISITIONS: 
Improved Management Practices Could Help Minimize Cost Growth in Navy 
Shipbuilding Programs," dated December 23, 2004 (GAO Code 120237/GAO- 
05-183).

The Department has reviewed the draft report and concurs with two of 
the recommendations and partially concurs with the remainder. I am 
enclosing specific DoD comments that address each of the seven 
recommendations. We have previously provided technical comments 
directly to the GAO staff for consideration.

We appreciate the opportunity to comment on the draft report.

Sincerely,

Signed for: 

Glenn F. Lamartin: 
Director:
Defense Systems:

Enclosure: As stated:

GAO DRAFT REPORT - DATED DECEMBER 23, 2004 
GAO CODE 120237/GAO-05-183:

"DEFENSE ACQUISITIONS: IMPROVED MANAGEMENT PRACTICES COULD HELP 
MINIMIZE COST GROWTH IN NAVY SHIPBUILDING PROGRAMS"

DEPARTMENT OF DEFENSE COMMENTS TO THE RECOMMENDATIONS:

RECOMMENDATION 1: The GAO recommended that the Secretary of Defense 
conduct independent reviews for all follow-on ships when significant 
changes occur to the program. (p. 28/GAO Draft Report):

DOD RESPONSE: Partially concur.

In accordance with Title 10, USC Sec. 2434, an independent cost 
estimate (ICE) is required for all major defense acquisition programs 
(MDAPs). The current Department of Defense practice is to have the ICE 
prepared by the Office of the Secretary of Defense (OSD) Cost Analysis 
Improvement Group (CAIG) in support of Milestone B decisions on Navy 
MDAPs, including ship programs, that are designated ACAT 1D. The 
USD(AT&L) will request the CAIG conduct additional independent cost 
estimates or assessments, if needed, to support follow-on ship 
decisions after Milestone B. For Navy MDAPs designated as ACAT 1C, 
whereby the Navy Service Acquisition Executive is the Milestone 
Decision Authority, the Naval Cost Analysis Division performs the 
independent cost estimate.

RECOMMENDATION 2: The GAO recommended that the Secretary of Defense 
conduct independent reviews of every acquisition of an aircraft 
carrier. (p. 28/GAO Draft Report):

DOD RESPONSE: Concur.

This recommendation is consistent with the Department's current 
approach for the CVN 21 aircraft carrier program.

RECOMMENDATION 3: The GAO recommended that the Secretary of Defense 
direct the Secretary of the Navy develop a confidence level for all 
ship cost estimates, based on risk and uncertainty analysis. (p. 28/GAO 
Draft Report):

DOD RESPONSE: Concur.

The Navy is already pursuing this action and therefore the Secretary of 
Defense does not need to provide further direction to implement the 
recommendation. The Naval Sea Systems Command conducted training of 60 
staff members in quantitative risk analysis in October 2004 to support 
introduction of these techniques in shipbuilding platform cost 
estimating.

RECOMMENDATION 4: The GAO recommended that the Secretary of Defense 
direct the Secretary of the Navy to negotiate prices for construction 
of the lead ship separately from the pricing of detail design. (p. 29/ 
GAO Draft Report):

DOD RESPONSE: Partially concur.

The Department will consider this on a case-by-case basis as the 
Department develops the acquisition strategy for each individual 
program. The Navy currently negotiates the lead ship construction and 
the detail design prices as separate distinct contract line items based 
on the best information available, within the negotiation process. 
Negotiation of ship contracts is an involved and time-consuming process 
that can extend several months. Separating pricing of the lead ship 
until detail design is complete could result in loss of significant 
leverage in the contract negotiations and might not be a cost effective 
strategy for smaller shipbuilding programs with shorter construction 
periods.

RECOMMENDATION 5: The GAO recommended that the Secretary of Defense 
direct the Secretary of the Navy to separate pricing of follow-on ships 
from pricing of lead ships, negotiating prices for early ships in the 
budget year in which the ship is authorized and funded. (p. 29/GAO 
Draft Report):

DOD RESPONSE: Partially concur.

The Department will consider this on a case-by-case basis as the 
Department develops the acquisition strategy for each individual 
program. Negotiation of ship contracts is an involved and time- 
consuming process that can extend several months. In programs with a 
lengthy period of time between ship procurements (i.e., aircraft 
carriers), this is the Department's current practice. However, this 
concept proves difficult to implement in programs with annual 
procurements (i.e., submarines). In the early stages of an annual 
procurement program, there is little cost data from the previous (or 
lead) ship that the Navy can use as a baseline. Until actual cost data 
is available, the Navy uses the cost estimate based on the best data 
available at the time. Additionally, because of the rigorous 
negotiations that are common to shipbuilding, in an annual procurement 
cycle, negotiations for the next ship would have to begin within three 
months of the award for the previous ship contract.

RECOMMENDATION 6: The GAO recommended that the Secretary of Defense 
direct the Secretary of the Navy to require that shipbuilders submit 
monthly cost performance reports. (p. 29/GAO Draft Report):

DOD RESPONSE: Partially concur.

The Navy is currently undertaking this initiative with every program 
and therefore the Secretary of Defense does not need to provide further 
direction to implement the recommendation. All of the programs examined 
by the GAO, with the exception of the CVN 77 and SSN 774 programs, 
receive reports on a monthly basis. The CVN 77 program will begin 
receiving monthly cost performance reports in March 2006. The SSN 774 
Virginia class program receives bi-weekly labor hour performance data, 
typically within ten days of the close of the accounting period through 
the Integrated Management and Control System. General Dynamics, 
Electric Boat provides the SSN 774 data for both of the construction 
shipyards.

RECOMMENDATION 7: The GAO recommended that the Secretary of Defense 
direct the Secretary of the Navy to require shipbuilders to prepare 
variance analysis reports that identify root causes of reported 
variances, associated mitigation efforts, and future cost impacts. (p. 
29/GAO Draft Report):

DOD RESPONSE: Partially concur.

The Navy already requires shipbuilders to do this because they have 
invoked the DoD and industry guidance that requires variance reporting 
and analysis as part of earned value management. Therefore the 
Secretary of Defense does not need to provide further direction to 
implement the recommendation. Variance analysis is only one of many 
tools available to the Program Manager. The Program Office must also 
maintain oversight and monitor performance at the shipyard and major 
Government Furnished Equipment (GFE) vendors. The Supervisor of 
Shipbuilding monitors shipyard performance and the Defense Contract 
Management Agency provides contract oversight for major Navy furnished 
equipment procurement. Both organizations provide on-site 
representation and maintain daily communication with the Program 
Office. Furthermore, the Navy holds quarterly production reviews with 
the shipbuilders to resolve cost and schedule issues. These reviews 
occur throughout the entire construction/production process to identify 
root causes for many issues, including reported variances. 

[End of section]

Appendix VIII: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Paul L. Francis (202) 512-2811; 
Karen Zuckerstein (202) 512-6785:

Acknowledgments:

In addition to the contacts named above, Margaret B. McDavid, Christina 
Connelly, Diana Dinkelacker, Christopher R. Durbin, Jennifer Echard, R. 
Gaines Hensley, Ricardo Marquez, Christopher R. Miller, Madhav Panwar, 
Karen Richey, Karen Sloan, Lily Chin, and Marie Ahearn made key 
contributions to this report.

FOOTNOTES

[1] The contract also includes funds for the cost of money. 

[2] See Federal Acquisition Regulation Part 16.

[3] These costs are items provided by the Navy to the contractor for 
installation on the ship. The Navy pays for this equipment--not the 
shipbuilder.

[4] Cost estimates are based, in part, on the number of units produced 
and learning curves--the more units produced, the less expensive each 
unit is expected to be. Thus, if contractors and subcontractors are 
assured a high, consistent level of business, they are able to produce 
the ship and ship parts at a lower cost. Conversely, if purchases are 
erratic or dip to historically low levels, the ship and ship parts will 
be more expensive to produce, although the exact amount is uncertain.

[5] Subcontracted labor is labor performed to a fixed price contract. 
Leased labor is the employment of outside workers under the direct 
supervision of the shipyard management and foreman systems.

[6] According to Navy cost analysts, while they did not conduct 
uncertainty analyses, they did perform sensitivity analyses in which 
they examined the effects of different variables, including changes in 
procurement quantities and labor rates. 

[7] A level of confidence depicts how much confidence the estimators 
have, stated as a percentage, in a budget or schedule estimate. The 
higher the confidence level, the lower the risk.

[8] 10 U.S.C. §2434. These milestones include Milestone B, which marks 
the beginning of the system development and demonstration phase. 
Milestone C marks the beginning of the production and deployment phase.

[9] The Virginia class was an exception to this practice. For this 
program, the Navy separated the funding of detail design from 
construction.

[10] LPD 18 and LPD 19 were included in the contract as options to buy. 

[11] The practice followed with the San Antonio class ships of 
negotiating detail design and lead ship construction together is a 
common Navy practice. For example, over the next 3 years, the Navy's 
acquisition plans call for awarding contracts covering both detail 
design and lead ship construction for three new ship classes: DD(X) 
surface combatant, CVN 21 aircraft carrier, and the Littoral Combat 
Ship.

[12] The Cost Analysis Improvement Group provides independent cost and 
risk assessments and analyses of Major Defense Acquisition Programs for 
the Office of the Secretary of Defense.

[13] The Office of the Secretary of Defense and Office of Management 
and Budget inflation indices are based on a forecast of the implicit 
price deflator for the Gross Domestic Product prepared by the Office of 
Management and Budget and the White House Council of Economic Advisors. 
The Gross Domestic Product includes all U.S. goods and services and is 
a general economic indicator overarching many different commodities.

[14] For more information on the importance of Earned Value Management 
see Appendix IV of our report GAO-03-600 entitled "Missile Defense: 
Additional Knowledge Needed in Developing System for Intercepting Long- 
Range Missiles."

[15] Beginning in March 2006 the Navy will require monthly cost 
reporting for CVN 77. 

[16] A recent Defense Contract Audit Agency audit found that while one 
shipbuilder identified material cost and schedule variances in its 
variance analysis report, it did not provide written documentation 
related to the reasons for the variance or provide explanation for the 
variances in the cost performance report.

[17] Under a teaming arrangement, two-thirds of the SSN 774 and 776 is 
constructed at Electric Boat with the remaining third built at Newport 
News and shipped to Electric Boat for final assembly. For the SSN 775, 
the inverse is true.

[18] These costs are non-recurring, affecting only DDG 91 costs.

[19] According to the shipbuilder, consolidation of Ingalls 
shipbuilding and Avondale shipyards into Northrop Grumman reduced 
overhead costs by approximately 3 percent.

[20] $180 million was for CVN 76 and $95.4 million for CVN 77.

[21] We did not project cost growth for CVN 76 because the ship has 
been delivered to the Navy.

[22] Analysis is based on data available through March 2004. 

[23] Under this arrangement, the Navy is responsible for any cost 
growth.

[24] GAO-03-895R, Multiyear Procurement Authority for the Virginia 
Class Submarine Program, (Washington, D.C.: June 23, 2003).

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