Navy Depot Maintenance: Privatizing Louisville Operations in Place Is Not
Cost-Effective (Letter Report, 07/31/97, GAO/NSIAD-97-52).

Pursuant to a congressional request, GAO followed up on its September
1996 report on the Navy's preliminary cost comparison of
privatizing-in-place maintenance workloads at its Louisville, Kentucky,
depot with transferring the workloads to other Navy facilities, focusing
on: (1) whether privatizing the depot maintenance workload in place at
Louisville is more cost-effective than transferring the workload to
other DOD facilities; and (2) the practicability of transferring the
Louisville workload to other defense commercial contractor facilities.

GAO noted that: (1) the Navy's privatization-in-place of the workloads
at the Louisville depot, without reducing excess capacity at its
remaining depots, does not appear to be as cost-effective as
transferring the workloads to underutilized Navy facilities; (2) GAO's
analysis shows that the Navy's final cost comparison understated the
annual savings from transferring the work and overstated the one-time
transfer cost; (3) GAO estimates the one-time transition cost for
transferring the workload is about $10 million less than the Navy
projected; (4) using GAO's estimate, the cost for the transfer option is
about $234 million, or about $100 million more than the
privatization-in-place option; (5) GAO estimates annual savings of $29.9
million for the transfer option, or about $20.6 million more than the
Navy estimated; (6) using GAO's estimates, the transfer option would pay
back the additional one-time transition cost in less than 3.5 years,
compared to the additional 12-year payback period computed using the
Navy estimates; (7) the Navy's analysis recognized that transferring the
workloads to underutilized facilities would reduce the overhead cost for
each production unit; (8) however, the Navy's analysis applied per-unit
savings only to the workloads transferred and not to existing workloads
at receiving locations; (9) GAO estimates that transferring the workload
rather than privatizing-in-place would have resulted in savings of about
$48.6 million over the first 5-year period; (10) after that time,
transferring would result in annual savings of about $29.9 million; (11)
one of the contractors at Louisville could take over part of
Louisville's workload at another industrial activity it operates that
has significant excess capacity; (12) GAO estimates that transferring
the gun repair workload to the Fridley, Minnesota, facility could result
in annual savings of about $9.2 million on the consolidated Navy
workloads performed at that facility; (13) Navy officials stated that
the Navy intends to divest itself of this facility; (14) officials at
the Hughes Missile Systems Company said they could not handle the other
Louisville workload--the Phalanx close-in-weapon system--in existing
facilities without incurring large infrastructure costs; (15) GAO
recently issued a report identifying DOD infrastructure activities as a
high-risk area; (16) GAO's primary concerns related to inefficient
business processes and excess capacity, and GAO pointed out that DOD
needs an overall plan for addressing the problem; and (17) the situation
at Louisville is representative of this overall concern.

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

 REPORTNUM:  NSIAD-97-52
     TITLE:  Navy Depot Maintenance: Privatizing Louisville Operations 
             in Place Is Not Cost-Effective
      DATE:  07/31/97
   SUBJECT:  Base closures
             Naval facilities
             Privatization
             Equipment maintenance
             Military downsizing
             Military cost control
             Navy procurement
             Maintenance services contracts
             Cost effectiveness analysis
             Contract options
IDENTIFIER:  Louisville (KY)
             Phalanx Weapon System
             
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Cover
================================================================ COVER


Report to Congressional Requesters

July 1997

NAVY DEPOT MAINTENANCE -
PRIVATIZING LOUISVILLE OPERATIONS
IN PLACE IS NOT COST-EFFECTIVE

GAO/NSIAD-97-52

Navy Depot Maintenance

(709220)


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

  BRAC -
  DOD -
  FAR -

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


B-275524

July 31, 1997

The Honorable Herbert H.  Bateman
Chairman
The Honorable Norman Sisisky
Ranking Minority Member
Subcommittee on Military Readiness
Committee on National Security
House of Representatives

As requested, we are providing a follow-up to our September 1996
report on the Navy's preliminary cost comparison of
privatizing-in-place maintenance workloads at its Louisville,
Kentucky, depot with transferring the workloads to other Navy
facilities. 

This report provides the results of our review of the Navy's final
cost analysis and early contractor cost data through May 1997.  Our
objectives were (1) to determine whether privatizing the depot
maintenance workload in place at Louisville is more cost-effective
than transferring the workload to other DOD facilities and (2) to
review the practicability of transferring the Louisville workload to
other defense commercial contractor facilities. 


   BACKGROUND
------------------------------------------------------------ Letter :1

During the 1995 Base Realignment and Closure (BRAC) process, the
Department of Defense (DOD) recommended that the Louisville depot be
closed and its workloads transferred to several DOD facilities.  The
naval gun repair workload was projected to transfer to the Norfolk
Naval Shipyard, Virginia; the Phalanx ship close-in-air defense
system to the Naval Surface Warfare Center, Crane, Indiana; and the
engineering support functions to the Naval Surface Warfare Center,
Port Hueneme, California. 

During the BRAC Commission's review of DOD's recommendations, the
city of Louisville proposed that DOD privatize the depot workload in
place.  The Commission found that the Navy's savings estimate did not
include all costs at the Norfolk Naval Shipyard and that an
additional $18 million could be required.  Further, the Commission
found that the Navy did not include $13.4 million in closure-related
moving costs and that these additional costs could increase the
one-time cost to close to $136 million.  While the additional closure
costs could extend the closure payback period from 3 to 4 years, the
Navy's cost estimate supporting closure was accepted by the
Commission.  The Commission also found that the gun systems
engineering functions at Louisville are consistent with operational
requirements, and that the maintenance and overhaul functions
performed at the facility have contributed substantially to the
effectiveness of the facility in serving the Department of the Navy. 
The Commission recommended the following: 

     "close the Naval Surface Warfare Center, Crane Division
     Detachment, Louisville.  Transfer workload, equipment and
     facilities to the private sector or local jurisdiction as
     appropriate if the private sector can accommodate the workload
     onsite; or relocate necessary functions along with necessary
     personnel, equipment and support to other naval technical
     activities, primarily the Naval Shipyard, Norfolk; Naval Surface
     Warfare Center, Hueneme, California; and the Naval Surface
     Warfare Center, Crane, Indiana."

Subsequently, the Navy made a preliminary decision to
privatize-in-place the Louisville depot's operations, with some Navy
program management positions remaining at the privatized facility. 
The decision was made to retain the field engineering support
function at the privatized Louisville depot.\1

On the basis of our review of the Navy's preliminary cost analysis,
we reported in September 1996 that privatization-in-place did not
appear to be the most cost-effective approach given excess capacity
in DOD's depot maintenance system and in the private sector.\2 We
stated that privatization-in-place would not reduce excess capacity
and that such privatization, if not effectively managed, including
the downsizing of remaining depot infrastructure, could exacerbate
inefficiencies inherent in underutilized depot maintenance capacity. 
For example, the Norfolk Naval Shipyard and Crane Naval Surface
Warfare Center, the primary depot facilities that could have received
the Louisville workloads, are expected to have 7.1 million and 1.8
million direct labor hours of excess capacity in 1999. 

According to industry representatives, the private sector has been
reducing its excess capacity through mergers, closures, and
consolidations, but DOD has not made comparable reductions in its
infrastructure.  For example, a recent Defense Science Board study
team concluded that privatization-in-place should be avoided, since
it tends to preserve excess capacity.  A privatization task force
comprised of top executives from the aerospace industry that was
formed in 1996 by the governor of California concluded that
privatization-in-place

     "inhibits the realization of cost savings intended from base
     closures and the performance goal improvements that
     privatization is intended to achieve.  Privatization-in-place,
     therefore, does not solve the excess capacity problem within
     either the public or private sector of the defense industrial
     base."

Our September 1996 report was based on preliminary Navy estimates
that were updated just prior to contract award.  As you are aware,
the Secretary of the Navy notified Congress on June 13, 1996, that as
provided for in the Competition in Contracting Act, the Navy
intended--in the public interest--to award non-competitive contracts
to the two defense contractors selected by the Louisville local
redevelopment authority.  On July 19, 1996, the Navy awarded
contracts to Hughes Missile Systems Company for the Phalanx ship
close-in-air defense system and to United Defense Limited Partnership
for gun repair workloads. 


--------------------
\1 The 170 Navy civilians in the Louisville engineering support pool
are assigned to the Naval Surface Warfare Center, Crane Division. 

\2 Navy Depot Maintenance:  Cost and Savings Issues Related to
Privatizing-in-Place at the Louisville, Kentucky, Depot
(GAO/NSIAD-96-202, Sept.  18, 1996). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

The Navy's privatization-in-place of the workloads at the Louisville
depot, without reducing excess capacity at its remaining depots, does
not appear to be as cost-effective as transferring the workloads to
other underutilized Navy facilities.  Our analysis shows that the
Navy's final cost comparison of the proposed privatization-in-place
versus the transfer of workloads to other Navy facilities understated
the annual savings from transferring the work and overstated the
one-time transfer cost.  We estimate the one-time transition cost for
transferring the workload is about $10 million less than the Navy
projected.  Using our estimate, the cost for the transfer option is
about $234 million, or about $100 million more than the
privatization-in-place option.  We estimate annual savings of $29.9
million for the transfer option, or about $20.6 million more than the
Navy estimated.  Using our estimates, the transfer option would pay
back the additional one-time transition cost in less than 3.5 years,
compared to the additional 12-year payback period computed using the
Navy estimates. 

The Navy's analysis recognized that transferring the workloads to
underutilized facilities would reduce the overhead cost for each
production unit.  However, the Navy's analysis applied per-unit
savings only to the workloads transferred and not to existing
workloads at receiving locations.  Our analysis applies overhead
per-unit savings to workloads at the receiving locations as well as
for those being transferred.  We estimate that transferring the
workload rather than privatizing-in-place would have resulted in
savings of about $48.6 million over the first 5-year period. 
Further, after that time, transferring would result in annual savings
of about $29.9 million. 

One of the contractors at Louisville could take over part of
Louisville's workload at another industrial activity it operates that
has significant excess capacity.  The United Defense Limited
Partnership has the capability and the capacity to handle the gun
repair workload at a government-owned, contractor-operated facility
in Fridley, Minnesota, which currently manufactures gun systems.  We
estimate that transferring the gun repair workload to the Fridley
facility could result in annual savings of about $9.2 million on the
consolidated Navy workloads performed at that facility.  Navy
officials stated that the Navy intends to divest itself of this
facility.  Officials at the Hughes Missile Systems Company in Tucson,
Arizona, said they could not handle the other Louisville
workload--the Phalanx close-in-weapon system--in existing facilities
without incurring large infrastructure costs. 

We recently issued a report identifying DOD infrastructure activities
as a high-risk area.\3

Our primary concerns related to inefficient business processes and
excess capacity.  We pointed out that DOD needs an overall plan for
addressing the problem.  The situation at Louisville is
representative of this overall concern. 


--------------------
\3 High-Risk Series:  Defense Infrastructure (GAO/HR-97-7, Feb. 
1997). 


   ANNUAL RECURRING COSTS MAKE
   PRIVATIZING-IN-PLACE THE LESS
   COST-EFFECTIVE OPTION
------------------------------------------------------------ Letter :3

Our analysis of the Navy's comparative cost study shows that the Navy
overstated transfer cost by about $10 million and understated annual
recurring savings by about $20.6 million.  Using the revised data, we
estimate that privatizing-in-place the Louisville depot workload will
cost about $48.6 million over the 5-year contract period, rather than
save $63.7 million as the Navy estimated.  Further, beyond the
initial 5-year contract period, we estimate that transferring the
workload would result in additional annual savings of at least $29.9
million.  The actual annual savings could be higher or lower
depending on future workloads and capacity utilization at both
Louisville and the Navy shipyards and warfare centers. 


      ANALYSIS OF NAVY STUDY
---------------------------------------------------------- Letter :3.1

The Navy's comparative cost analysis of the workload transfer and
privatization options considered annual recurring and one-time
transition cost elements.  The Navy reported that transferring the
workload to other depots would result in higher annual savings, but
would require larger one-time transition costs.  Based on this
information, the Navy estimated that it could save about $63.7
million over the 5-year contract period by privatizing-in-place
rather than transferring the workloads to other depots, as shown in
table 1. 



                                Table 1
                
                 Summary of the Navy's Cost Analysis of
                Transfer and Privatization Options Over
                       the 5-Year Contract Period

                         (Dollars in millions)

                        Cost by closure option
----------------------------------------------------------------------
                                                  Privatizat  Differen
Type of cost                            Transfer         ion        ce
--------------------------------------  --------  ----------  --------
One-time                                  $243.6      $133.4    $110.2
Annual recurring                           427.4       473.9     -46.5
======================================================================
Total                                     $671.0      $607.3     $63.7
----------------------------------------------------------------------
Source:  Navy cost analysis. 

Using this data, it would take 12 years to pay back the one-time cost
difference. 

However, we found that the Navy's cost analysis: 

  -- overstated one-time transition costs to transfer workload to
     other depots by $9.4 million and

  -- excluded $20.6 million in annual recurring savings at the
     receiving depots ($103 million over the 5-year contract period). 

Using this data, we estimate that the Navy would save about $48.6
million over the 5-year contract period by transferring the
Louisville workload to other depots, as shown in table 2. 



                                Table 2
                
                   Our Cost Analysis of Transfer and
                 Privatization Options Over the 5-Year
                            Contract Period

                         (Dollars in millions)

                        Cost by closure option
----------------------------------------------------------------------
                                                  Privatizat  Differen
Type of cost                            Transfer         ion        ce
--------------------------------------  --------  ----------  --------
One-time                                  $234.2      $133.4    $100.8
Annual recurring                           324.5       473.9    -149.4
======================================================================
Total                                     $558.7      $607.3    -$48.6
----------------------------------------------------------------------
Using this data, we estimate the cost of transferring this work would
pay back the one-time cost difference in about 3.5 years. 


      ONE-TIME TRANSITION COSTS TO
      TRANSFER OVERSTATED
---------------------------------------------------------- Letter :3.2

Transition costs are one-time, up-front costs that are incurred to
disestablish the Louisville facility as a government-owned and
operated activity and to establish operations to perform the required
work under the privatization-in-place or transfer options.  The key
transition cost elements for the privatization-in-place option were
personnel separation and relocation costs and civilian retraining,
administrative, and environmental costs.  The key transition cost
elements for the transfer option were personnel separation and
relocation costs; equipment relocation and military construction
costs; and other property transportation, administrative, repair
process documentation, and environmental costs. 

The Navy estimated that the transition costs would be about $243
million for the transfer option and $133 million for
privatizing-in-place--a one-time cost difference of about $110
million to transfer the workloads.  Our analysis shows this cost
difference is overstated by $9.4 million because the Navy (1) did not
justify about $8 million in administrative costs for the transfer
option and (2) did not adjust the estimated personnel relocation
costs by about $1.4 million to reflect the smaller number of
employees that would be needed.  Adjusting the Navy's estimate for
these factors reduces the difference between the two options to about
$100 million, as shown in table 3. 



                                Table 3
                
                Our Estimate of One-Time Transition Cost
                 Estimates to Privatize-in-Place Versus
                 Transfer Louisville Depot Workload to
                           Other Navy Depots

                                 Cost
----------------------------------------------------------------------
                                       Transfer  Privatizati  Differen
Transition cost categories               option    on option        ce
-------------------------------------  --------  -----------  --------
Military construction                   $32,820
Environmental                            11,204       $5,225
Personnel transfer/severance           76,192\a       64,339
Civilian retraining                       3,824       11,380
Transportation                           12,466        1,740
Property disposal                             2        3,033
Phone services                                6           12
Equipment relocation                     42,127        3,993
Equipment disposal                          232           20
Interim contract costs                    4,600        2,355
Administrative                         3,108 \b       11,829
Minor construction                        1,480        3,225
Repair/refurbishment                      3,617        1,640
Other procurement                         3,726          322
Other costs                              38,800       24,239
======================================================================
Total costs                            $234,204     $133,352  $100,852
----------------------------------------------------------------------
\a We reduced the Navy's personnel relocation cost estimate by $1.4
million to reflect the actual number of people that would be needed
at the receiving depot. 

\b We reduced the Navy's administrative cost estimate for $8 million
in unjustified costs. 

Source:  Navy cost analysis, with our adjustments as footnoted. 


      ANNUAL RECURRING SAVINGS
      FROM TRANSFER OPTION
      UNDERSTATED
---------------------------------------------------------- Letter :3.3

Our analysis shows the Navy estimate of $9.3 million annual recurring
savings from transferring the workloads to underutilized facilities
was understated by $20.6 million.  We estimate annual recurring
savings to be $29.9 million, or about $150 million over the 5-year
contract period.  The Navy estimated the impact of overhead rate
savings on workloads being transferred to the underutilized
facilities but did not apply the overhead rate to existing workloads
at those facilities.  We developed our estimate using labor rate data
from the potential receiving Navy locations at the Norfolk and Crane
facilities and revised it to reflect the reduction in overhead costs
that would result from spreading fixed overhead costs over a larger
workload base.  As shown in table 4, reduction in rates at the
Norfolk and Crane facilities would produce annual savings of about
$20.6 million on their existing workloads. 



                                Table 4
                
                  Our Estimate of Annual Overhead Rate
                  Savings on the Existing Workloads at
                            Receiving Depots

                                        Direct
                                         labor   Reduction
Receiving depots                         hours    in rates     Savings
----------------------------------  ----------  ----------  ----------
Norfolk Naval Shipyard               8,969,051       $1.32  $11,807,21
                                                                     5
Crane Surface Warfare Center         4,337,000        2.02   8,776,380
======================================================================
Total                                                       $20,583,59
                                                                     5
----------------------------------------------------------------------
Note:  Direct labor hours and rate reductions are yearly averages
over the period of the privatization contracts. 

The draft of this report we provided to DOD for comment stated that
the $29.9-million consolidation savings were in addition to the BRAC
Commission's $28.6 million savings estimate.  Navy officials did not
agree that the total BRAC savings should be added to the
consolidation savings estimate.  They noted that the estimated BRAC
savings were based on the elimination of depot and nondepot personnel
and base operating costs.  They further stated that much of the
nondepot related savings had been achieved under privatization, and
that the depot related savings were reflected in the $29.9-million
estimate.  After reviewing supporting Navy and BRAC data, we agree
that some, but not all of the BRAC savings from eliminating nondepot
personnel and operating support costs had been achieved and depot
savings were reflected in our $29.9-million estimate.  The data
showed that about $12 million of the BRAC savings was achieved by
eliminating nondepot personnel and operating costs.  However, we
could not determine exactly how much of this amount had been saved. 

In its 1995 report, the BRAC Commission expressed concern about
savings that were not included in the Cost of Base Realignment
Actions model.  Specifically, the Commission identified the exclusion
of savings achievable by consolidating functions at fewer locations. 
The Commission reported that even though savings from consolidation
are difficult to estimate, they are a legitimate savings due to the
closure process. 


      DECLINING WORKLOAD MAY
      FURTHER INCREASE COSTS
---------------------------------------------------------- Letter :3.4

Declining workloads and the impact of these declines on maintenance
cost have been key reasons for closing depots through the base
realignment and closure process.  Consolidating workloads from the
closed facilities with workloads in remaining depot facilities was to
improve capacity utilization at remaining facilities and reduce costs
by spreading fixed overhead costs over a larger number of production
units.  According to Navy officials, over the 4-year period between
1992 and 1995, the Louisville depot's workload declined about 32
percent.  They noted that further Navy workload declines are likely. 

DOD officials stated that the repair workload for the Phalanx system
is about what was projected for the fiscal year 1997 contract period. 
However, the gun repair workload initially projected for fiscal year
1997 has not materialized.  In July 1996, at the time of contract
award, the contractor's overhead rates were based on a projected
funded workload valued at about $44.9 million.  In September 1996,
United Defense Limited Partnership rates for fiscal year 1997 were
renegotiated based on a lower projected funded workload valued at
about $35.2 million.  According to Defense Contract Management
Command and contractor officials, the actual value of the 1997 funded
gun repair workload could be as low as $21 million--a reduction of
over 50 percent from the initially projected funded workload.  As a
result, United Defense Limited Partnership has an increasingly fewer
number of production units to share its fixed overhead costs,
resulting in increased costs for each unit produced.  As an indicator
of these increased costs, in May 1997, United Defense increased its
estimate of funding required for 13 contract items by $3.3
million--an increase of 26 percent.  These 13 items are the only line
items from the
46 funded line items in the gun repair workload for which the
contractor has reported any costs for fiscal year 1997.  According to
Navy officials, under the cost-type contract used at the Louisville
depot, it is likely that additional Navy workload declines will
increase costs further.  Contractor and local reuse authority
officials note that efforts are being made to bring in other gun
repair workload as well as some commercial work.  However, officials
stated that the high overhead rates make it difficult for the
Louisville depot to attract new work.  We have reported that workload
declines in Navy shipyards have also resulted in losses that will
require rate increases.\4

One of the key advantages of the transfer option was to broaden the
workload base at the receiving location to lessen the impact of
temporary shifts in workload.  As workloads continue to decline, a
larger industrial facility with a broader workload base could
potentially reassign laborers to another workload with less impact on
the total cost of operations. 


--------------------
\4 Defense Depot Maintenance:  Challenges Facing DOD in Managing
Working Capital Funds (GAO/T/NSIAD/AIMD-152, May 7, 1997). 


   POTENTIAL FOR USING EXISTING
   CONTRACTOR FACILITIES FOR THE
   LOUISVILLE WORKLOAD
------------------------------------------------------------ Letter :4

We examined the potential for consolidating portions of the
Louisville workloads with compatible military programs currently
being accomplished in DOD contractor facilities to determine if
consolidation savings could be achieved.  The Louisville depot's gun
repair workload constitutes about 46 percent of the total maintenance
workload at that facility.  We determined that this workload fits the
existing capabilities and available capacity of the government-owned,
contractor-operated United Defense Limited Partnership facility in
Fridley, Minnesota, which currently operates with significant excess
capacity.  Such a move could result in a gross annual savings of
about $13.9 million for Fridley's existing workload.  However,
because labor rates are higher at the Fridley facility, the
transferred workload would cost $4.7 million more per year than at
the Louisville depot, reducing the potential annual savings for the
consolidated workload to $9.2 million. 

Navy officials stated that consolidation at the Fridley facility is
not a realistic option since the Navy plans to divest itself of that
facility.  It is uncertain where the contractor may decide to locate
the current Fridley research and development, production support, and
manufacturing workloads.  Since the Louisville depot has related
workload with significant excess capacity, it is one option that may
be considered.  If these workloads were moved to the Louisville
depot, significant overhead savings could be achieved for the gun
repair workloads currently performed there. 

We also reviewed the potential for transferring the Phalanx close-in
weapon system, which accounts for the remaining 56 percent of the
depot's workload, to the Hughes Missile Systems Company facility in
Tucson, Arizona.  This does not appear to be a feasible option
because previous Hughes production consolidation initiatives, which
resulted in the closure of unneeded facilities to reduce excess
capacity, limited available capacity to the production of circuit
cards.  Hughes officials stated that prior to their consolidation
initiatives, the Tucson facilities would likely have had the
necessary capacity to absorb Louisville's Phalanx workload. 


   CONCLUSIONS AND RECOMMENDATIONS
------------------------------------------------------------ Letter :5

Costly excess capacity in the Navy depot infrastructure has been
aggravated by the recent privatization-in-place of the Louisville
depot.  Our February 1997 report on defense infrastructure identified
infrastructure activities as a high-risk area that requires breaking
down cultural resistance to change, overcoming service parochialism,
and setting forth a clear framework for a reduced defense
infrastructure to avoid waste and inefficiency.  Our primary concerns
related to inefficient business processes and excess capacity.  We
pointed out that DOD needs an overall plan for addressing the
problem.  The situation at the Louisville depot is representative of
this overall concern.  While this facility is now leased by the local
reuse authority and operated by the contractors, it is increasingly
inefficient as the workload continues to decline.  The Navy must pay
the cost for this inefficiency and the inefficiency of other
facilities that could have been made more productive and
cost-effective had the Louisville workloads been consolidated there. 

We recommend that the Secretary of Defense direct the Secretary of
the Navy to (1) develop a plan for reducing excess depot maintenance
capacity and costs and (2) prior to exercising any contract options
for the Louisville workload, conduct a cost analysis that would
compare the cost-effectiveness of privatizing the Louisville workload
in place with transferring it to underutilized DOD or contractor
facilities.  The cost analysis should also include the total cost and
savings associated with overhead cost reduction that would be
realized at underutilized DOD and contractor facilities for workloads
already produced at these locations. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :6

DOD's response to our draft report, which is provided in appendix I,
generally concurred with our recommendations.  DOD concurred with the
intent of our recommendation to develop a plan to reduce excess
capacity but stated that it would be inappropriate to wait until such
a plan is developed before deciding to exercise the contract renewal
options for the Louisville workload.  The DOD response noted that in
deciding whether or not to exercise the Louisville contract options,
the Navy must follow the Federal Acquisition Regulation (FAR).  While
we recognize that the Navy must follow the FAR in executing contract
options, the regulations provide the Navy with some degree of
latitude in deciding whether to execute contract options.  If it
develops an overall plan for reducing excess capacity, the Navy can
consider the cost implications of excess capacity at other DOD depots
before executing contract renewal options on the Louisville workload. 
Nonetheless, we revised our recommendation so the development of a
plan to reduce excess capacity is separate from our recommendation
related to exercising the option on the Louisville workload.  DOD
agreed that there is a need to reduce excess depot maintenance
capacity. 

DOD partially concurred with our recommendation that the Navy conduct
a cost analysis before exercising any renewal options for the
Louisville workload.  DOD stated that it will direct the Secretary of
the Navy to conduct and adequately document a cost analysis in
conjunction with any decision affecting the continuation of
previously privatized workloads from the Louisville depot.  However,
the DOD response noted that the alternatives permitted by BRAC did
not include transferring the Louisville workload to other contractor
facilities, and therefore, that analysis would be inappropriate.  We
continue to believe that reducing excess capacity in both the public
and private sectors is essential to reducing the cost of DOD's depot
maintenance program.  Therefore, in making future workload allocation
decisions for the Louisville workload, DOD and other contractor
facilities should be considered. 

The draft of this report stated that the Navy planned to implement a
pilot program for pension portability at the Louisville depot.\5 The
program would have allowed DOD civilian employees of this depot and
other activities on closed military bases whose jobs were
privatized-in-place to accrue years of federal service for the
purpose of determining eligibility for civil service retirement
benefits for their private sector employment.  Subsequently, the
Deputy Secretary of Defense announced that the Department would not
be establishing a pilot program at Louisville or any other privatized
facility.  We removed the information contained in our draft report
referring to this program. 


--------------------
\5 This program was authorized by section 1616 of the National
Defense Authorization Act for Fiscal Year 1997, P.L.  104-201. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

To examine the cost-effectiveness of the Louisville depot
privatization-in-place relative to transferring the work to other DOD
facilities, including the impact of excess capacity in existing Navy
facilities, we reviewed documents and interviewed officials from the

  -- Office of the Secretary of Defense and the Office of the
     Secretary of the Navy in Washington, D.C.;

  -- Naval Sea Systems Command and Naval Surface Warfare Center
     Headquarters, Arlington, Virginia;

  -- Naval Surface Warfare Center field locations in Louisville,
     Kentucky; Port Hueneme, California; and Crane, Indiana;

  -- Norfolk Naval Shipyard, Virginia; and

  -- Defense Contract Management Command and Defense Contact Audit
     Agency contractor sites at United Defense Limited Partnership,
     Fridley, Minnesota, and Hughes Missile Systems Company, Tucson,
     Arizona. 

To analyze the Navy's cost study, we reviewed the supporting data for
the Navy's cost analysis, comparing estimates under each budget
category.  We reviewed the material cost elements for relevance,
completeness, and accuracy and discussed our observations with
responsible Navy management and contracting officials. 

To determine the feasibility of transferring the Louisville workloads
to DOD contractor facilities, we interviewed officials from the
United Defense Limited Partnership and the Hughes Missile Systems
Company, the two companies awarded 1-year contracts for the
Louisville workload.  We also interviewed Defense Contract Management
Command and Defense Contract Audit Agency officials at each facility,
collected data on contractor operating cost and current workload, and
calculated the cost impact of transferring the workload covered by
the Louisville privatization contracts to these private sector
facilities. 

We conducted our review from July 1996 through February 1997 in
accordance with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :7.1

We are sending copies of this report to the Secretaries of Defense
and the Navy; the Director, Office of Management and Budget; and
interested congressional committees.  Copies will also be made
available to others upon request. 

Please contact me at (202) 512-8412 if you or your staff have any
questions regarding this report.  Major contributors to this report
were Jim Wiggins, Julia Denman, Larry Junek, and John Strong. 

David R.  Warren, Director
Defense Management Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
============================================================== Letter 



(See figure in printed edition.)





RELATED GAO PRODUCTS
============================================================ Chapter 0

Defense Depot Maintenance:  Challenges Facing DOD in Managing Working
Capital Funds (GAO/T/NSIAD/AIMD-152, May 7, 1997). 

Depot Maintenance:  Uncertainties and Challenges DOD Faces in
Restructuring Its Depot Maintenance Program (GAO/T/NSIAD-111, Mar. 
18, 1997) and (GAO/T/NSIAD-112, Apr.  10,1997). 

Defense Outsourcing:  Challenges Facing DOD As It Attempts to Save
Billions in Infrastructure Costs (GAO/T/97-110, Mar.  12, 1997). 

High-Risk Series:  Defense Infrastructure (GAO/HR-97-7, Feb.  1997). 

Air Force Depot Maintenance:  Privatization-in-Place Plans are Costly
While Excess Capacity Exists (GAO/NSIAD-97-13, Dec.  31, 1996). 

Army Depot Maintenance:  Privatization Without Further Downsizing
Increases Costly Excess Capacity (GAO/NSIAD-96-201, Sept.  18, 1996). 

Navy Depot Maintenance:  Cost and Savings Issues Related to
Privatizing-in-Place the Louisville, Kentucky, Depot
(GAO/NSIAD-96-202,
Sept.  18, 1996). 

Defense Depot Maintenance:  Commission on Roles and Mission's
Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July
15, 1996). 

Defense Depot Maintenance:  DOD's Policy Report Leaves Future Role of
Depot System Uncertain (GAO/NSIAD-96-165, May 21, 1996). 

Defense Depot Maintenance:  More Comprehensive and Consistent
Workload Data Needed for Decisionmakers (GAO/NSIAD-96-166, May 21,
1996). 

Defense Depot Maintenance:  Privatization and the Debate Over the
Public-Private Mix (GAO/T-NSIAD-96-146, Apr.  16, 1996 ) and
(GAO/T-NSIAD-96-148, Apr.  17, 1996). 

Military Bases:  Closure and Realignment Savings Are Significant, but
Not Easily Quantified (GAO/NSIAD-96-67, Apr.  8, 1996). 

Depot Maintenance:  Opportunities to Privatize Repair of Military
Engines (GAO/NSIAD-96-33, Mar.  5, 1996). 

Closing Maintenance Depots:  Savings, Personnel, and Workload
Redistribution Issues (GAO/NSIAD-96-29, Mar.  4, 1996). 

Navy Maintenance:  Assessment of the Public-Private Competition
Program for Aviation Maintenance (GAO/NSIAD-96-30, Jan.  22, 1996). 

Depot Maintenance:  The Navy's Decision to Stop F/A-18 Repairs at
Ogden Air Logistics Center (GAO/NSIAD-96-31, Dec.  15, 1995). 

Military Bases:  Case Studies on Selected Bases Closed in 1988 and
1991 (GAO/NSIAD-95-139, Aug.  15, 1995). 

Military Base Closure:  Analysis of DOD's Process and Recommendations
for 1995 (GAO/T-NSIAD-95-132, Apr.  17, 1995). 

Military Bases:  Analysis of DOD's 1995 Process and Recommendations
for Closure and Realignment (GAO/NSIAD-95-133, Apr.  14, 1995). 

Aerospace Guidance and Metrology Center:  Cost Growth and Other
Factors Affect Closure and Privatization (GAO/NSIAD-95-60, Dec.  9,
1994). 

Navy Maintenance:  Assessment of the Public and Private Shipyard
Competition Program (GAO/NSIAD-94-184, May 25, 1994). 

Depot Maintenance:  Issues in Allocating Workload Between the Public
and Private Sectors (GAO/T-NSIAD-94-161, Apr.  12, 1994). 

Depot Maintenance (GAO/NSIAD-93-292R, Sept.  30, 1993). 

Depot Maintenance:  Issues in Management and Restructuring to Support
a Downsized Military (GAO/T-NSIAD-93-13, May 6, 1993). 

Air Logistics Center Indicators (GAO/NSIAD-93-146R, Feb.  25, 1993). 

Defense Force Management:  Challenges Facing DOD as it Continues to
Downsize its Civilian Workforce (GAO/NSIAD-93-123, Feb.  12, 1993). 

Navy Maintenance:  Public/Private Competition for F-14 Aircraft
Maintenance (GAO/NSIAD-92-143, May 20, 1992). 

Military Bases:  Information on Air Logistics Centers
(GAO/NSIAD-90-287FS, Sept.  10, 1990). 


*** End of document. ***