Navy Contract: AOE 6 Shipbuilding Claims Settled But More Delays and Cost
Growth Likely (Letter Report, 09/30/93, GAO/NSIAD-93-298).

In January 1987, the Navy awarded an $863 million, fixed-price incentive
contract for the design and construction of the first AOE 6 class ship,
with options for three more ships.  Because of program schedule delays
and cost increases, however, the Navy reduced the program from seven to
four ships.  By February 1991, the contractor, National Steel and
Shipbuilding Company, had submitted more than $300 million in claims
against the Navy for cost increases that it believed the Navy was
responsible for.  GAO concludes that these problems and resulting claims
stemmed from an optimistically low bid, concurrent development and
construction, inadequate Navy and contractor management attention, and
unrealized gains in expected shipyard productivity.  The Navy
administered the claims evaluation process according to established
procedures.  The lead ship has yet to be fully tested at sea, where
operational problems may first arise.  Thus, the final costs, delivery
dates, and extent to which the ships under construction will meet
expectations are still unknown.  Declines in the size of the fleet and
carrier force and a reordering of defense priorities may preclude the
need for another AOE class ship, the AOE 10.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-93-298
     TITLE:  Navy Contract: AOE 6 Shipbuilding Claims Settled But More 
             Delays and Cost Growth Likely
      DATE:  09/30/93
   SUBJECT:  Navy procurement
             Shipbuilding industry
             Shipyards
             Construction contracts
             Military vessels
             Labor-management relations
             Productivity
             Military cost control
             Claims settlement
             Contract costs
IDENTIFIER:  AOE-6 Class Fast Combat Support Ship
             AOE-10 Class Fast Combat Support Ship
             DDG-51 Destroyer
             
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Cover
================================================================ COVER


Report to Congressional Committees

September 1993

NAVY CONTRACT - AOE 6 SHIPBUILDING
CLAIMS SETTLED BUT MORE DELAYS AND
COST GROWTH LIKELY

GAO/NSIAD-93-298

Navy Contract

(701023)


Abbreviations
=============================================================== ABBREV

  DOD - Department of Defense
  NASSCO - National Steel and Shipbuilding Company

Letter
=============================================================== LETTER


B-251748

September 30, 1993

The Honorable Daniel K.  Inouye
Chairman, Subcommittee on Defense
Committee on Appropriations
United States Senate

The Honorable Ted Stevens
Ranking Minority Member
Subcommittee on Defense
Committee on Appropriations
United States Senate

The Honorable John P.  Murtha
Chairman, Subcommittee on Defense
Committee on Appropriations
House of Representatives

The Honorable Joseph M.  McDade
Ranking Minority Member
Subcommittee on Defense
Committee on Appropriations
House of Representatives

The Conference Report on the Dire Emergency Supplemental
Appropriations Act for Fiscal Year 1991 directed us to monitor the
process used by the Navy to resolve claims involving cost growth on
the AOE 6 class shipbuilding program.  In response to the Conference
Report, on August 23, 1993, we issued a report that is restricted
because it contains business sensitive information.  This letter
contains an unrestricted summary that identifies the reasons for the
cost growth, discusses the procedures the Navy followed to settle the
claims, and assesses whether additional delays and cost growth can be
expected. 

We are sending copies of this summary to other appropriate
congressional committees; the Secretaries of Defense and the Navy;
and the Director, Office of Management and Budget.  We will also make
copies available to others. 

This summary was prepared under the direction of Richard Davis,
Director, National Security Affairs, who may be reached on (202)
512-3504 if you or your staff have any questions concerning this
summary.  Other major contributors to this summary are Richard J. 
Herley, Assistant Director; David R.  Fisher, Evaluator-in-Charge;
and Harold D.  Reich, Site Senior. 

Frank C.  Conahan
Assistant Comptroller General


SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

In January 1987, the Navy awarded National Steel and Shipbuilding
Company (NASSCO), San Diego, California, an $862.9-million,\1
fixed-price incentive contract for the detailed design and
construction of the first
AOE 6 class ship, with options for three additional ships (AOE 7
through 9).  However, the program schedule slipped, costs increased,
the Navy did not exercise the AOE 9 option, and it reduced the
program from seven to four ships.  By February 1991, NASSCO had
submitted over $300 million in claims against the Navy for cost
increases it believed the Navy was responsible for.  As a result, the
House and Senate Committees on Appropriations Conferees directed GAO
to monitor the claims resolution process.  Specifically, GAO's
objectives were to identify the reasons for program cost growth and
to document the procedures the Navy followed in its AOE 6 claims
settlement process.  In addition, GAO assessed whether the Navy would
incur further program cost increases and schedule delays. 


--------------------
\1 All dollar amounts are expressed in program base month March 1986
dollars unless otherwise noted. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

The AOE 6 class fast combat support ships are designed to operate as
part of carrier battle groups, resupplying other ships in the battle
groups with food, petroleum products, ammunition, and other supplies. 
As such, they are designed to combatant standards.  They will be the
first Navy ships to use the newly designed reversing reduction gears,
which perform a function similar to an automobile transmission. 

The Navy and NASSCO negotiated a claims settlement on December 26,
1991.  In addition to a price increase, the settlement provided for
contract modifications, including slippage of ship and gear delivery
dates, and for the revision of NASSCO's cost and schedule control
system.  After the settlement, Congress provided $500 million for
another AOE class ship, the AOE 10.  Also during this time, the
threat and national security strategy that formed the basis for the
AOE 6 program has changed or is being reevaluated, and the size of
the aircraft carrier force and the fleet are being reduced.  However,
DOD has proceeded with plans to construct the AOE 10.  NASSCO was
awarded the contract in January 1993, and construction is planned to
begin during September 1993. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

The AOE 6 program was troubled from the beginning, with schedule
delay and cost growth virtually inevitable.  The subsequent problems
and the resulting claims stemmed from an optimistically low bid,
concurrent development and construction, inadequate Navy and NASSCO
management attention, and unrealized gains in expected shipyard
productivity. 

The Navy administered the claims evaluation process according to
established procedures.  Navy claims files generally documented
NASSCO's legal entitlement for each claim, the technical and audit
analyses, and support for the Navy's position.  The Navy developed
its own cost estimates for claims. 

The lead ship has not been fully tested at sea, where operational
problems may first arise.  Thus, although fiscal year 1992 and 1993
funds in the amount of $500 million are available for another AOE
class ship (AOE 10), the final costs, delivery dates, and the extent
AOEs now under construction will meet operational expectations are
still unknown.  Declines in the size of the fleet and carrier force
and a reordering of defense priorities may preclude the need for the
AOE 10. 


   GAO'S ANALYSIS
---------------------------------------------------------- Chapter 0:4


      REASONS FOR COST GROWTH
-------------------------------------------------------- Chapter 0:4.1

Four principal causes contributed to the increased costs: 

  -- NASSCO submitted an optimistically low bid.  NASSCO planned on
     reducing the number of labor hours required to build the ship by
     instituting capital improvements, applying intense management
     attention, obtaining below-market labor rates, and utilizing
     advanced shipbuilding techniques. 

  -- NASSCO believed the reversing reduction gear design was
     nondevelopmental and equipment was readily available.  However,
     as revealed during the claims process, before awarding the
     contract, the Navy knew that specifications for some gear
     components were developmental and probably could not be
     manufactured and tested in the time allowed in the contract. 
     The Navy did not disclose this information at the time the
     original contract was awarded. 

  -- Higher priority work with the DDG 51 class destroyer interrupted
     the Navy from working on design specifications for the AOE 6. 
     When the Navy resumed AOE 6 work a year later, different
     personnel were assigned.  This lack of continuity resulted in
     deficient design specifications.  Also, because of emerging
     shipyard problems and the addition of other contracts, NASSCO
     managers were not able to manage the AOE 6 ship construction as
     intensively as intended. 

  -- Because some major components were delivered much later than
     planned, NASSCO was unable to fully implement advanced
     shipbuilding techniques or realize expected work force
     productivity.  As planned, NASSCO began to build the second ship
     before completing the first to meet the construction schedule. 
     As a result, it had to hire and train many additional workers. 
     NASSCO's low wage scale compounded difficulties because NASSCO
     could not attract and keep the skilled craftsmen and engineers
     it needed. 


      CLAIMS RESOLUTION FOLLOWED
      PROCESS
-------------------------------------------------------- Chapter 0:4.2

By early 1991, the construction delays and increased costs left
NASSCO in severe financial difficulty.  To prevent NASSCO's
bankruptcy, the Navy agreed to provide emergency financial relief
available under the provisions of Public Law 85-804 and expedite the
claims settlement process.  The key Navy objective was to complete
the three ships under construction at the least cost and earliest
possible delivery date. 

The Navy administered the claims evaluation process in accordance
with established administrative procedures.  The Navy assembled a
team of analysts from the Naval Sea Systems Command, the Office of
the Supervisor of Shipbuilding, Conversion and Repair, and the
Defense Contract Audit Agency.  The team was involved in the
technical and legal analyses and the accounting audit to determine if
NASSCO was entitled to compensation and to recommend a settlement
amount, if warranted.  The Navy and NASSCO reached an agreement and
executed contract modifications on December 26, 1991. 

However, NASSCO's cost and schedule control system did not comply
with Department of Defense (DOD) standards as required by the
contract.  The system did not provide reliable completion estimates
for ships under construction.  As a result, excess progress payments
of almost $25 million were paid to NASSCO in 1990, which were, in
effect, recovered in calculating the net settlement amount payable to
NASSCO.  The Navy and NASSCO also agreed, as part of settlement, that
NASSCO would revise its cost and schedule control system. 


      FUTURE SCHEDULE DELAYS AND
      COST GROWTH ARE LIKELY
-------------------------------------------------------- Chapter 0:4.3

Future contract schedule delays and cost growth are likely.  It
appears target prices and delivery schedules will slip again because
assumed shipyard productivity rates, used to calculate the estimated
labor hours needed to complete the ships, have not been achieved and
maintained as expected at the time of settlement.  Also, in October
1992, the employees entered a strike against NASSCO, but after 3
weeks temporarily agreed to continue work while they negotiated with
NASSCO.  The Navy reported in April 1993 that federal mediators had
entered the negotiations.  NASSCO and the Navy are assessing the
impact of the strike on cost and schedule estimates.  These
difficulties could affect the construction schedule and final cost of
the AOE 10. 

Further, the AOE 6 will not be fully tested until sea trials after
mid-1993.  If problems are revealed, additional costs could be
incurred for corrections. 

Other factors could affect the future of the AOE 10 as well.  The
requirement for AOE 6 class ships was developed in the early 1980s. 
Since then, defense budgets have declined, defense priorities have
shifted, and the size of the fleet, including the number of aircraft
carrier battle groups, is being reduced.  Together, these factors
raise the question of whether the AOE 10 is still needed. 


   RECOMMENDATION
---------------------------------------------------------- Chapter 0:5

GAO recommends that the Secretary of Defense direct the Secretary of
the Navy to suspend further expenditures under the AOE 10 ship
construction contract until (1) the total cost and operational
capabilities of the AOE 6 are known and (2) the risks associated with
continuing the program are identified and controlled.  Further, GAO
recommends that the Secretary of Defense direct the Secretary of the
Navy to reevaluate the current need for the AOE 10.  If the
reevaluation does not support the need for the AOE 10, GAO recommends
that the Secretary of Defense direct the Secretary of the Navy to
terminate the AOE 10 ship construction contract. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6

On March 18, 1993, DOD provided comments on a draft of this report,
generally agreeing with the report's findings, but did not agree with
a recommendation in the draft report that award of the AOE 10
construction contract should be delayed.  Shortly after GAO provided
the draft report to DOD for comment, the Navy awarded NASSCO a
contract for the AOE 10.  Construction is expected to begin in
September 1993.  DOD commented that award was based on NASSCO's
ability to perform and a review and evaluation of factors that could
affect the execution of the program and the associated risks.  DOD
believes program risks are now acceptable. 

*** End of document. ***