Defense Acquisitions: Business Case and Business Arrangements Key
for Future Combat System's Success (01-MAR-06, GAO-06-478T).	 
                                                                 
The Future Combat System (FCS) is a networked family of weapons  
and other systems in the forefront of efforts by the Army to	 
become a lighter, more agile, and more capable combat force. When
considering complementary programs, projected investment costs	 
for FCS are estimated to be on the order of $200 billion. FCS's  
cost is of concern given that developing and producing new weapon
systems is among the largest investments the government makes,	 
and FCS adds significantly to that total. Over the last five	 
years, the Department of Defense (DOD) doubled its planned	 
investments in such systems from $700 billion in 2001 to $1.4	 
trillion in 2006. At the same time, research and development	 
costs on new weapons continue to grow on the order of 30 to 40	 
percent. FCS will be competing for significant funds at a time	 
when Federal fiscal imbalances are exerting great pressures on	 
discretionary spending. In the absence of more money being	 
available, FCS and other programs must be executable within	 
projected resources. Today, I would like to discuss (1) the	 
business case needed for FCS to be successful and (2) related	 
business arrangements that support that case.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-478T					        
    ACCNO:   A48057						        
  TITLE:     Defense Acquisitions: Business Case and Business	      
Arrangements Key for Future Combat System's Success		 
     DATE:   03/01/2006 
  SUBJECT:   Army procurement					 
	     Cost analysis					 
	     Defense capabilities				 
	     Military cost control				 
	     Military research and development			 
	     Procurement planning				 
	     Program evaluation 				 
	     Risk assessment					 
	     Weapons systems					 
	     Business planning					 
	     Cost estimates					 
	     Program costs					 
	     Army Future Combat Systems 			 

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GAO-06-478T

     

     * Summary
     * Background
          * Elements of a Business Case
     * Objectives, Scope, and Methodology
     * Improved Business Case Is Needed for the FCS's Success
          * While Progress Has Been Made, Requirements Still Remain Unce
          * FCS Success Hinges on Numerous Undemonstrated Technologies a
          * FCS Acquisition Strategy Will Demonstrate Design Maturity Af
          * FCS's Higher Costs May Result in Funding Challenge
     * FCS Business Arrangements
          * Program Management with A Lead System Integrator
          * Contracting Arrangements
     * Contacts and Staff Acknowledgements
          * Order by Mail or Phone

                 United States Government Accountability Office

Testimony before the Subcommittee on Airland, Committee on Armed Services,

                                  U.S. Senate

For Release on Delivery Expected at 2:30 p.m. EST Wednesday, March 1, 2006

DEFENSE ACQUISITIONS

 Business Case and Business Arrangements Key for Future Combat System's Success

Statement of Paul L. Francis, Director, Acquisition and Sourcing Management

  GAO-06-478T

DEFENSE ACQUISITIONS

Business Case and Arrangements Key for Future Combat System's Success

  What GAO Found

There are a number of compelling aspects of the FCS program, and it is
hard to argue with the program's goals. However, the elements of a sound
business case for such an acquisition program-firm requirements, mature
technologies, a knowledge-based acquisition strategy, a realistic cost
estimate and sufficient funding-are not yet present. FCS began product
development prematurely in 2003. Since then, the Army has made several
changes to improve its approach for acquiring FCS. Yet, today, the program
remains a long way from having the level of knowledge it should have had
before starting product development. FCS has all the markers for risks
that would be difficult to accept for any single system, much less a
complex, multi-system effort. These challenges are even more daunting in
the case of FCS not only because there are so many of them but because FCS
represents a new concept of operations that is predicated on technological
breakthroughs. Thus, technical problems, which accompany immaturity, not
only pose traditional risks to cost, schedule, and performance; they pose
risks to the new fighting concepts envisioned by the Army.

Many decisions can be anticipated that will involve trade-offs the
Government will make in the program. Facts of life, like technologies not
working out, reductions in available funds, and changes in performance
parameters, must be anticipated. It is important, therefore, that the
business arrangements for carrying out the FCS program-primarily in the
nature of the development contract and in the lead system integrator (LSI)
approach- preserve the government's ability to adjust course as dictated
by these facts of life. At this point, the $8 billion to be spent on the
program through fiscal year 2006 is a small portion of the $200 billion
total. DOD needs to guard against letting the buildup in investment limit
its decision making flexibility as essential knowledge regarding FCS
becomes available. As the details of the Army's new FCS contract are
worked out and its relationship with the LSI evolves, it will be important
to ensure that the basis for making additional funding commitments is
transparent. Accordingly, markers for gauging knowledge must be clear,
incentives must be aligned with demonstrating such knowledge, and
provisions must be made for the Army to change course if the program
progresses differently than planned.

                 United States Government Accountability Office

                                    Summary

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss the Department of the Army's
Future Combat System (FCS), a networked family of weapons and other
systems. FCS is in the forefront of efforts to help the Army transform
itself into a lighter, more agile, and more capable combat force by using
a new concept of operations, new technologies, and a new information
network that links whole brigades together. This is a tremendous
undertaking that will involve a total investment cost on the order of $200
billion.

The context within which the FCS investment is being made is important.
Fiscal imbalances faced by the federal government will continue to
constrain discretionary spending. One of the single largest investments
the government makes is the development and production of new weapon
systems. Over the last five years, the Department of Defense (DOD) has
doubled its planned investments in new weapon systems from about $700
billion in 2001 to nearly $1.4 trillion in 2006. At the same time,
research and development cost growth on new weapons maintains its
historical level of about 30 to 40 percent. This is the lens that must be
used to look at major new investments, such as FCS, because more money may
not be an option for the future. Rather, the key to getting better
outcomes is to make individual programs more executable.

Today, I would like to discuss (1) the business case that is necessary for
the FCS to be successful and (2) the related business arrangements for
carrying out the FCS program.

The critical role played by U.S. ground combat forces is underscored today
in Operation Iraqi Freedom. That the Army should ensure its forces are
well equipped with the capabilities they will need in the coming years is
unquestioned. Moreover, the top-level goals the Army has set for its
future force seem inarguable: to be as lethal and survivable as the
current force, but significantly more sustainable and mobile. However, the
Army's approach to meeting these needs-embodied in the FCS and its
complementary systems-does raise questions.

On the one hand, the FCS is the result of the Army leadership's taking a
hard look at how it wants its forces to fight in the future. Army
leadership has had the courage to break with tradition on FCS; it would
have likely been much easier to win support for successor vehicles to the
Abrams and Bradley. On the other hand, FCS does not present a good
business case for an acquisition program. It is necessary that a major new
investment like

                                   Background

FCS have a compelling, well-thought out concept, but this alone is not
sufficient. FCS began the product development prematurely in 2003, and
today is a long way from having the level of knowledge it should have had
before committing the high level of resources associated with a new
product development effort. The elements of a sound business case-firm
requirements, mature technologies, a knowledge-based acquisition strategy,
a realistic cost estimate and sufficient funding-are not yet present. FCS
has all the markers for risks that would be difficult to accept for any
single system. They are even more daunting in the case of FCS not only
because of their multiplicity but because FCS represents a new concept of
operations that is predicated on technological breakthroughs. Thus,
technical problems, which accompany immaturity, not only pose traditional
risks to cost, schedule, and performance; they pose risks to the new
fighting concepts envisioned by the Army.

We are still early in the long journey that FCS entails. Many decisions
lie ahead that will involve trade-offs the government will make. Facts of
life, like technologies not working out, reductions in available funds,
and changes in performance parameters, must be anticipated. It is
important, therefore, that the business arrangements made for FCS,
primarily the development contract and the lead system integrator
approach, preserve the government's ability to adjust course as dictated
by facts and circumstances. At this point, the $8 billion to be spent on
the program through the end of fiscal year 2006 is a small portion of the
$200 billion total. DOD needs to guard against letting the buildup in
investment from limiting its decision making flexibility as essential
knowledge regarding FCS becomes available. As the details of the Army's
new FCS contract are worked out and its relationship with the lead system
integrator evolves, it will be important to ensure that the basis for
making additional funding commitments is transparent. Accordingly, markers
for gauging knowledge must be clear, incentives must be aligned with
demonstrating such knowledge, and provisions must be made for the Army to
change course if the program progresses differently than planned.

The FCS concept is part of a pervasive change to what the Army refers to
as the Future Force. The Army is reorganizing its current forces into
modular brigade combat teams, meaning troops can be deployed on different
rotational cycles as a single team or as a cluster of teams. The Future
Force is designed to transform the Army into a more rapidly deployable and
responsive force and to enable the Army to move away from the large
division-centric structure of the past. Each brigade combat team is
expected to be highly survivable and the most lethal brigade-sized unit
the Army has ever fielded. The Army expects FCS-equipped brigade combat
teams to provide significant warfighting capabilities to DOD's overall
joint military operations. The Army is implementing its transformation
plans at a time when current U.S. ground forces are playing a critical
role in the ongoing conflicts in Iraq and Afghanistan.

The FCS family of weapons includes 18 manned and unmanned ground vehicles,
air vehicles, sensors, and munitions that will be linked by an information
network. These vehicles, weapons, and equipment will comprise the majority
of the equipment needed for a brigade combat team. The Army plans to buy
15 brigades worth of FCS equipment by 2025.

Elements of a Business We have frequently reported on the importance of
using a solid, executable business case before committing resources to a
new product

Case

development. In its simplest form, this is evidence that (1) the
warfighter's needs are valid and can best be met with the chosen concept,
and (2) the chosen concept can be developed and produced within existing
resources-that is, proven technologies, design knowledge, adequate
funding, and adequate time to deliver the product when needed.

At the heart of a business case is a knowledge-based approach to product
development that demonstrates high levels of knowledge before significant
commitments are made. In essence, knowledge supplants risk over time. This
building of knowledge can be described as three levels or knowledge points
that should be attained over the course of a program:

     o First, at program start, the customer's needs should match the
       developer's available resources-mature technologies, time, and
       funding. An indication of this match is the demonstrated maturity of
       the technologies needed to meet customer needs.
     o Second, about midway through development, the product's design should
       be stable and demonstrate that it is capable of meeting performance
       requirements. The critical design review is that point of time because
       it generally signifies when the program is ready to start building
       productionrepresentative prototypes.
     o Third, by the time of the production decision, the product must be
       shown to be producible within cost, schedule, and quality targets and
       have demonstrated its reliability and the design must demonstrate that
       it performs as needed through realistic system level testing.

The three knowledge points are related, in that a delay in attaining one
delays the points that follow. Thus, if the technologies needed to meet
requirements are not mature, design and production maturity will be
delayed.

To develop the information on the Future Combat System program's progress
toward meeting established goals, the contribution of critical
technologies and complementary systems, and the estimates of cost and
affordability, we interviewed officials of the Office of the Under
Secretary of Defense (Acquisition, Technology, and Logistics); the Army
G-8; the Office of the Under Secretary of Defense (Comptroller); the
Secretary of Defense's Cost Analysis Improvement Group; the Director of
Operational Test and Evaluation; the Assistant Secretary of the Army
(Acquisition, Logistics, and Technology); the Army's Training and Doctrine
Command; Surface Deployment and Distribution Command; the Program Manager
for the Future Combat System (Brigade Combat Team); the Future Combat
System Lead Systems Integrator; and other contractors. We reviewed, among
other documents, the Future Combat System's Operational Requirements
Document, the Acquisition Strategy Report, the Baseline Cost Report, the
Critical Technology Assessment and Technology Risk Mitigation Plans, and
the Integrated Master Schedule. We attended and/or reviewed the results of
the FCS System of Systems Functional Review, In-Process Reviews, Board of
Directors Reviews, and multiple system demonstrations. In our assessment
of the FCS, we used the knowledgebased acquisition practices drawn from
our large body of past work as well as DOD's acquisition policy and the
experiences of other programs. We conducted the above in response to the
National Defense Authorization Act of Fiscal Year 2006, which requires GAO
to annually report on the product development phase of the FCS
acquisition. We performed our review from June 2005 to March 2006 in
accordance with generally accepted auditing standards.

                       Objectives, Scope, and Methodology

             Improved Business Case Is Needed for the FCS's Success

An improved business case for the FCS program is essential to help ensure
that the program is successful in the long run. The FCS is unusual in that
it is developing 18 systems and a network under a single program office
and lead system integrator in the same amount of time that it would take
to develop a single system. It also started development with less
knowledge than called for by best practices and DOD policy.

While Progress Has Been Made, Requirements Still Remain Uncertain

The Army has made significant progress defining FCS's system of systems
requirements, particularly when taking into account the daunting number of
them involved-nearly 11,500 at this level. Yet system-level requirements
are not yet stabilized and will continue to change, postponing the needed
match between requirements and resources. Now, the Army and its
contractors are working to complete the definition of system level
requirements, and the challenge is in determining if those requirements
are technically feasible and affordable. Army officials say it is almost
certain that some FCS system-level requirements will have to be modified,
reduced, or eliminated; the only uncertainty is by how much. We have
previously reported that unstable requirements can lead to cost, schedule,
and performance shortfalls. Once the Army gains a better understanding of
the technical feasibility and affordability of the systemlevel
requirements, trade-offs between the developer and the warfighter will
have to be made, and the ripple effect of such trade-offs on key program
goals will have to be reassessed. Army officials have told us that it will
be 2008 before the program reaches the point which it should have reached
before it started in May 2003 in terms of stable requirements.

FCS Success Hinges on Numerous Undemonstrated Technologies and
Complementary Programs

Development of concrete program requirements depends in large part on
stable, fully mature technologies. Yet, according to the latest
independent assessment 1 , the Army has not fully matured any of the
technologies critical to FCS's success. Some of FCS's critical
technologies may not reach a high level of maturity until the final major
phase of acquisition, the start of production. The Army considers a lower
level of demonstration as acceptable maturity, but even against this
standard, only about one-third of the technologies are mature. We have
reported that going forward into product development without demonstrating
mature technologies increases the risk of cost growth and schedule delays
throughout the life of the program. The Army is also facing challenges
with several of the complementary programs considered essential for
meeting FCS's requirements. Some are experiencing technology difficulties,
and some have not been fully funded. These difficulties underscore the gap
between requirements and available resources that must be closed if the
FCS business case is to be executable.

1

Technology Readiness Assessment Update, Office of the Deputy Assistant
Secretary of the Army for Research and Technology, April 2005

Page 5 GAO-06-478T

FCS Acquisition Strategy Will Demonstrate Design Maturity After Production
Begins

Technology readiness levels (TRL) are measures pioneered by the National
Aeronautics and Space Administration and adopted by DOD to determine
whether technologies were sufficiently mature to be incorporated into a
weapon system. Our prior work has found TRLs to be a valuable
decision-making tool because they can presage the likely consequences of
incorporating a technology at a given level of maturity into a product
development. The maturity levels range from paper studies (level 1), to
prototypes tested in a realistic environment (level 7), to an actual
system proven in mission operations (level 9). Successful DOD programs
have shown that critical technologies should be mature to at least a TRL 7
before the start of product development.

In the case of the FCS program, the latest independent technology
assessment shows that none of the critical technologies are at TRL 7, and
only 18 of the 49 technologies currently rated have demonstrated TRL 6,
defined as prototype demonstration in a relevant environment. None of the
critical technologies may reach TRL 7 until the production decision in
fiscal year 2012, according to Army officials. 2 Projected dates for FCS
technologies to reach TRL 6 have slipped significantly since the start of
the program. In the 2003 technology assessment, 87 percent of FCS's
critical technologies were projected to be mature to a TRL 6 by 2005. When
the program was looked at again in April 2005, 31 percent of the
technologies were expected to mature to a TRL 6 by 2005, and all
technologies are not expected to be mature to that level until 2009.

The knowledge deficits for requirements and technologies have created
enormous challenges for devising an acquisition strategy that can
demonstrate the maturity of design and production processes. Several
efforts within the FCS program are facing significant problems that may
eventually involve reductions in promised capabilities and may lead to
cost overruns and schedule delays. Even if requirements setting and
technology maturity proceed without incident, FCS design and production
maturity will still not be demonstrated until after the production
decision is made. Production is the most expensive phase in which to
resolve design or other problems.

2

When the program started seven of 32 technologies were rated at TRL 6 and
one was at TRL 7.

Page 6 GAO-06-478T

The Army's acquisition strategy for FCS does not reflect a knowledgebased
approach. Figure 1 shows how the Army's strategy for acquiring FCS
involves concurrent development, design reviews that occur late, and other
issues that are out of alignment with the knowledge-based approach
outlined in DOD policy.

Figure 1: Differences between Best Practices' Acquisition Approach and FCS
                                    Approach

Ideally, the preliminary design review occurs at or near the start of
product development. Doing so can help reveal key technical and
engineering challenges and can help determine if a mismatch exists between
what the customer wants and what the product developer can deliver. An
early preliminary design review is intended to help stabilize cost,
schedule, and performance expectations. The critical design review ideally
occurs midway into the product development phase. The critical design
review should confirm that the system design is stable enough to build
production-representative prototypes for testing.

The FCS acquisition schedule indicates several key issues:

     o The program did not have the basic knowledge needed for program start
       in 2003. While the preliminary design review normally occurs at or
       near the start of product development, the Army has scheduled it in
       fiscal year 2008, about 5 years after the start of product
       development.
     o Instead of the sequential development of knowledge, major elements of
       the program are being conducted concurrently.
     o The critical design review is scheduled in fiscal year 2010, just 2
       years after the scheduled preliminary review and the planned start of
       detailed design. The timing of the design reviews is indicative of how
       late knowledge will be attained in the program, assuming all goes
       according to plan.
     o The critical design review is also scheduled just 2 years before the
       initial FCS low-rate production decision in fiscal year 2012, leaving
       little time for product demonstration and correction of any issues
       that are identified at that time.

The FCS program is thus susceptible to late-cycle churn, which refers to
the additional-and unanticipated-time, money, and effort that must be
invested to overcome problems discovered late through testing.

FCS's Higher Costs May Result in Funding Challenge

The total cost for the FCS program, now estimated at $160.7 billion (then
year dollars), has climbed 76 percent from the Army's first estimate.
Because uncertainties remain regarding FCS's requirements and the Army
faces significant challenges in technology and design maturity, we believe
the Army's latest cost estimate still lacks a firm knowledge base.
Furthermore, this latest estimate does not include complementary programs
that are essential for FCS to perform as intended, or all of the necessary
funding for FCS spin-outs. The Army has taken some steps to help manage
the growing cost of FCS, including establishing cost ceilings or targets
for development and production; however, program officials told us that
setting cost limits may result in accepting lower capabilities.

As FCS's higher costs are recognized, it remains unclear whether the Army
will have the ability to fully fund the planned annual procurement costs
for the FCS current program of record. FCS affordability depends on the
accuracy of the cost estimate, the overall level of development and
procurement funding available to the Army, and the level of competing
demands.

At the start of product development, FCS program officials estimated that
the program would require about $20 billion in then-year dollars for
research, development, testing, and evaluation and about $72 billion to
procure the FCS systems to equip 15 brigade combat teams. At that time,
program officials could only derive the cost estimate on the basis of what
they knew then-requirements were still undefined and technologies were
immature. The total FCS program is now expected to cost $160.7 billion in
then-year dollars, a 76 percent increase. Table 1 summarizes the growth of
the FCS cost estimate.

Table 1: Comparison of Original Cost Estimate and Current Cost Estimate
for FCS Program (in billions of then-year dollars)

     Original Revised estimate Percentage estimate (as of 1/2006) increase

Research, development, testing, and evaluation $19.6 $30.5 56%

                          Procurement $71.8 $130.2 81%

                             Total $91.4 $160.7 76%

Source: Army (data); GAO (analysis and presentation).

According to the Army, the current cost estimate is more realistic, better
informed, and based on a more reasonable schedule. It accounts for the
restructure of the FCS program and its increased scope, the 4-year
extension to the product development schedule, the reintroduction of four
systems that had been previously deferred, and the addition of a spin-out
concept whereby mature FCS capabilities would be provided, as they become
available, to current Army forces. It also reflects a rate of production
reduced from an average of 2 brigade combat teams per year to an average
of 1.5 brigades per year. Instead of completing all 15 brigades by 2020,
the Army would complete production in 2025. This cost estimate has also
benefited from progress made in defining system of systems requirements.

Figure 2 compares the funding profiles for the original program and for
the latest restructured program.

Figure 2: Comparison of Original Cost Estimate and Current Cost Estimate
for FCS Program between Fiscal Years 2003 and 2026 (in millions of
then-year dollars)

Dollars in millions16,000

14,000

                                      2005

                                 2007 2009 2011

3

                                       3

                                      2015

                                2017 2019 2021 3

                                      2025

200

                                      201

                                      202

Year

Original estimate

Current estimate Source: U.S. Army.

The current funding profile is lower than the original through fiscal year
2013, but is substantially higher than the original after fiscal year
2013. It still calls for making substantial investments before key
knowledge has been demonstrated. Stretching out FCS development by 4 years
freed up about $9 billion in funding through fiscal year 2011 for
allocation to other Army initiatives. Originally, FCS annual funding was
not to exceed $10 billion in any one year. Now, the cost estimate is
expected to exceed $10 billion in each of 9 years. While it is a more
accurate reflection of program costs than the original estimate, the
latest estimate is still based on a low level of knowledge about whether
FCS will work as intended. The cost estimate has not been independently
validated, as called for by DOD's acquisition policy. The Cost Analysis
Improvement Group will not release its updated independent estimate until
spring 2006, after the planned Defense Acquisition Board review of the FCS
program.

The latest cost estimate does not include all the costs that will be
needed to field FCS capabilities. For instance,

     o Costs for the 52 essential complementary programs are separate, and
       some of those costs could be substantial. For example, the costs of
       the Joint Tactical Radio System Clusters 1 and 5 programs were
       expected to be about $32.6 billion (then-year dollars). 3
     o Some complementary programs, such as the Mid-Range Munition and
       Javelin Block II, are currently not funded for their full development.
       These and other unfunded programs would have to compete for already
       tight funding.
     o Procurement of the spin-outs from the FCS program to current Army
       forces is not yet entirely funded. Procuring the FCS items expected to
       be spun out to current forces is expected to cost about $19 billion,
       and the needed installation kits may add $4 billion. Adding these
       items brings the total required FCS investment to the $200 billion
       range.

Through fiscal year 2006, the Army will have budgeted over $8 billion for
FCS development. Through fiscal year 2008, when the preliminary design
review is held, the amount budgeted for FCS will total over $15 billion.
By the time the critical design review is held in 2010, about $22 billion
will have been budgeted. By the time of the production decision in 2012,
about $27 billion will have been budgeted.

The affordability of the FCS program depends on several key assumptions.
First, the program must proceed without exceeding its currently projected
costs. Second, the Army's annual procurement budget-not including funds
specifically allocated for the modularity initiative-is expected to grow
from between $11 billion to $12 billion in fiscal year 2006 to at least
$20 billion by fiscal year 2011. The large annual procurement costs for
FCS are expected to begin in fiscal year 2012, which is beyond the current
Future Years Defense Plan period (fiscal years 2006-2011). FCS procurement
will represent about 60-70 percent of Army procurement from fiscal years
2014 to 2022. This situation is typically called a funding bow wave. 4 As
it prepares the next Defense Plan, the Army will face the challenge of
allocating sufficient funding to meet the increasing needs for FCS
procurement in fiscal years 2012 and 2013. If all the needed funding

3

The ongoing operational assessment of the Joint Tactical Radio System
functionality could result in a program restructure, which would have an
impact on the program's costs.

4

The term bow wave is used to describe a requirement for more funds just
beyond the years covered in the Future Years Defense Plan that are subject
to funding constraints.

Page 11 GAO-06-478T

                           FCS Business Arrangements

cannot be identified, the Army will have to consider reducing the FCS
procurement rate or delaying or reducing items to be spun out to current
Army forces. However, reducing the FCS procurement rate would increase the
FCS unit costs and extend the time needed to deploy FCS-equipped brigade
combat teams.

Given the risks facing the FCS program, the business arrangements made for
carrying out the program will be critical to protecting the government's
interests. To manage the program, the Army is using a lead system
integrator (LSI), Boeing. As LSI, Boeing carries greater responsibilities
than a traditional prime contractor. The Army is in the process of
finalizing a new Federal Acquisition Regulation (FAR)-based contract in
response to concerns that the previous Other Transaction Agreement was not
the best match for a program of FCS's size and risks. This contract will
establish the expectations, scope, deliverables, and incentives that will
drive the development of the FCS.

Program Management with A Lead System Integrator

From the outset of the FCS program, the Army has employed a management
approach that centers on the LSI. The Army did not believe it had the
resources or flexibility to field a program as complex as FCS under the
aggressive timeline established by the then-Army Chief of Staff. Although
there is no complete consensus on the definition of LSI, generally, it is
a prime contractor with increased responsibilities. These responsibilities
may include greater involvement in requirements development, design and
source selection of major system and subsystem subcontractors. The
government has used the LSI approach on other programs that require
system-of-systems integration. The FCS program started as a joint Defense
Advanced Research Projects Agency and Army program in 2000. In 2002, the
Army competitively selected Boeing as the LSI for the concept technology
demonstration phase of FCS. The Army's intent is to maintain the LSI for
the remainder of FCS development.

Boeing and the Army established a relationship to work in what has become
known as a "one-team" management style with several first tier
subcontractors to develop, manage, and execute all aspects of the FCS
program. For example, Boeing's role as LSI extends beyond that of a
traditional prime contractor and includes some elements of a partner to
the government in ensuring the design, development, and prototype
implementation of the FCS network and family of systems. In this role,
Boeing is responsible for (1) engineering a system of systems solution,
(2) competitive selection of industry sources for development of the
individual systems and subsystems, and (3) integrating and testing these
systems to satisfy the requirements of the system of systems
specifications. Boeing is also responsible for the actual development of
two critical elements of the FCS information network-the System of Systems
Common Operating Environment and the Warfighter-Machine Interface.

The Army participates in program decisions such as make/buy and
competitive selection decisions, and it may disapprove any action taken
under these processes. The decision structure of the program is made up of
several layers of Integrated Product Teams. These teams are co-chaired by
Army and LSI representatives. Government personnel participate in each of
the integrated product teams. This collaborative structure is intended to
force decision making to the lowest level in the program. Decisions can be
elevated to the program manager level, and ultimately the Army has final
decision authority. The teams also include representation of the Army user
community, whose extensive presence in the program is unprecedented.

The advantages of using an LSI approach on a program like FCS include the
ability of the contractor to know, understand, and integrate functions
across the various FCS platforms. Thus, the LSI has the ability to
facilitate movement of requirements and make trade-offs across platforms.
This contrasts with past practices of focusing on each platform
individually. However, the extent of contractor responsibility in so many
aspects of the FCS program management process, including responsibility
for making numerous cost and technical tradeoffs and for conducting at
least some of the subcontractor source selections, is also a potential
risk. As an example, many of the subcontractor source selections are for
major weapon systems that, in other circumstances, would have been
conducted by an Army evaluation team, an Army Contracting Officer and a
seniorlevel Army source selection authority. These decisions, including
procurement decisions for major weapons systems, are now being made by the
LSI with Army involvement. This level of responsibility, as with other LSI
responsibilities in the program management process, requires careful
government oversight to ensure that the Army's interests are adequately
protected now and in the future.

Thus far, the Army has been very involved in the management of the program
and in overseeing the LSI. It is important that as the program proceeds,
the Army continue to be vigilant about maintaining control of the program
and that organizational conflicts of interest are avoided, such as can
arise when the LSI is also a supplier. As discussed in the next

                            Contracting Arrangements

section, the Army intends the new contract to provide additional
protection against potential conflicts.

The Army and Boeing entered into a contractual instrument called an Other
Transaction Agreement (OTA). The purpose of the OTA was to encourage
innovation and to use its wide latitude in tailoring business,
organizational, and technical relationships to achieve the program goals.
The original OTA was modified in May 2003 and fully finalized in December
2003 for the Systems Development and Demonstration phase of the FCS
program. The latest major modification to the OTA, to implement the 2004
program restructuring, was finalized in March 2005.

As you know, questions have been raised about the appropriateness of the
Army's use of an OTA for a program as large and risky as FCS. The Airland
Subcommittee held a hearing in March 2005 which addressed this among other
issues. In particular, concern has been raised about the protection of the
government's interests under the OTA arrangement and the Army's choice to
not include standard FAR clauses in the OTA. In April 2005, the OTA was
modified by the Army to incorporate the procurement integrity, Truth in
Negotiations, and Cost Accounting Standards clauses.

In April 2005, the Secretary of the Army decided that the Army should
convert the OTA to a FAR-based contract. A request for proposals was
issued by the Army on August 15, 2005. An interim letter contract was
issued on September 23, 2005. The Systems Development and Demonstration
work through September 2005 will be accounted for under the OTA and all
future work under the FAR-based contract. Boeing/SAIC and all of the FCS
subcontractors were to submit a new certifiable proposal for the remainder
of Systems Development and Demonstration and that will be the subject of
negotiations with the Army. The Army expects the content of the
program-its statement of work-will remain the same and they do not expect
the cost, schedule, and performance of the overall Systems Development and
Demonstration effort to change materially. The target date for completion
of the finalized FAR contract is March 28, 2006. In the coming months, we
will be taking a close look at the new contract as part of our continuing
work on FCS that is now mandated by the Defense Authorization Act for
Fiscal Year 2006.

The FAR-based contract is expected to include standard FAR clauses,
including the Truth in Negotiations and Cost Accounting Standards clauses.
The letter contract includes Organizational Conflict of Interest clauses
whereby Boeing and SAIC can not compete for additional FCS subcontracts.
Also, other current subcontractors can compete for work only if they do
not prepare the request for proposals or participate in the source
selection process.

The last major revision of the OTA in March 2005 had a total value of
approximately $21 billion. Through September 2005 the Army and LSI
estimate that about $3.3 billion will be chargeable to the OTA. The FAR
based contract will cover all activity after September 2005 and is
expected to have a value of about $17.4 billion. Both the OTA and the
FAR-based contract will be cost plus fixed fee contracts with additional
incentive fees. According to the Army, the fee arrangement is designed to
address the unique relationship between the Army and the LSI and to
acknowledge their "shared destiny" by providing strategic incentives for
the LSI to prove out technologies, integrate systems, and move the program
forward to production, at an affordable cost and on schedule. In the OTA,
the annual fixed fee was set at 10 percent of estimated cost and the
incentive fee available was 5 percent.

The Army plans to change the fee structure for the FCS program in the new
contract. The request for proposals for the new contract proposed a 7
percent fixed fee and an 8 percent incentive fee. The OTA established 10
distinct events where LSI performance will be evaluated against
predetermined performance, cost, and schedule criteria. (Those events are
expected to be retained in the FAR contract.) One event has already
occurred-the System of Systems Functional Requirements Review was held in
August 2005. The next event is called the Capabilities Maturity Review and
it is expected to occur in June or July 2006. As the details are worked
out, it is important that the new contract encourage meaningful
demonstrations of knowledge and to preserve the government's ability to
act on knowledge should the program progress differently than planned.

Mr. Chairman, this concludes my prepared statement. I would be happy to
answer any questions that you or members of the Subcommittee may have.

For future questions about this statement, please contact me at (202) 512-

  Contacts and Staff

4841. Individuals making key contributions to this statement include

Acknowledgements Robert L. Ackley, Lily J. Chin, Noah B. Bleicher, Marcus
C. Ferguson, William R. Graveline, Guisseli Reyes, Michael J. Hesse, John
P. Swain, Robert S. Swierczek, and Carrie R. Wilson.

Page 15 GAO-06-478T

    (120523)

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