Defense Depot Maintenance: Weaknesses in the T406 Engine Logistics
Support Decision Methodology (Letter Report, 09/14/98, GAO/NSIAD-98-221).

The V-22 aircraft, known as the Osprey, is a new vertical take-off and
landing plane being fielded primarily for use by the Marine Corps. The
Navy recently designated the V-22 aircraft's T406 engine as a commercial
item for purposes of logistics support and contracted with Allison
Engine Company, the engine manufacturer, for a support arrangement known
as "power by the hour." Members of Congress have raised concerns about
the methodology that the Navy used in deciding to have the engine
maintained by the contractor. This report discusses (1) the criteria
used in determining that the T406 engine is a commercial item for the
purposes of an exemption from the establishment of in-house maintenance
capabilities for new systems identified by the Secretary of Defense
under 10 U.S.C. 2464, (2) the rationale and support for the decision to
designate the T406 as a commercial item, and (3) the extent to which the
cost-effectiveness of the decision was evaluated.

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

 REPORTNUM:  NSIAD-98-221
     TITLE:  Defense Depot Maintenance: Weaknesses in the T406 Engine 
             Logistics Support Decision Methodology
      DATE:  09/14/98
   SUBJECT:  Decision making
             Department of Defense contractors
             Aircraft engines
             Aircraft maintenance
             Spare parts
             Privatization
             Logistics
             Defense cost control
             Cost effectiveness analysis
IDENTIFIER:  V-22 Aircraft
             T406 Engine
             Osprey Aircraft
             
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Cover
================================================================ COVER


Report to the Honorable
Walter B.  Jones
House of Representatives

September 1998

DEFENSE DEPOT MAINTENANCE -
WEAKNESSES IN THE T406 ENGINE
LOGISTICS SUPPORT DECISION
METHODOLOGY

GAO/NSIAD-98-221

Navy Depot Maintenance

(709346)


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

  DOD - Department of Defense
  FAR - Federal Acquisition Regulation

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


B-280621

September 14, 1998

The Honorable Walter B.  Jones
House of Representatives

Dear Mr.  Jones: 

The Navy recently designated the V-22 aircraft's T406\1 engine a
commercial item for purposes of logistics support and contracted with
Allison Engine Company, the engine manufacturer, for a support
arrangement known as "power by the hour."\2 The V-22 aircraft,
otherwise known as the Osprey, is a new vertical take-off and landing
aircraft being fielded primarily for use by the Marine Corps, but
also for the Navy and the Air Force.  You have raised questions about
the methodology the Navy used for its decision to have the engine
maintained by the contractor.  We briefed you on July 16, 1998, and,
as requested, are providing this written statement of our findings. 
This report, as it relates to logistics support, addresses (1) the
criteria used in determining that the T406 engine is a commercial
item for purposes of exemption from establishing in-house maintenance
capabilities for new systems identified by the Secretary of Defense
under 10 U.S.C.  2464, (2) the rationale and support for the decision
to designate the T406 a commercial item, and (3) the extent to which
the cost-effectiveness of the decision was evaluated. 


--------------------
\1 The T406 engine carries a commercial designation of AE1107C and is
the turbo-shaft member of the Allison Engine Company's AE family of
engines.  In this report, we refer to this engine as the T406. 

\2 Under a power-by-the-hour arrangement, the contractor provides
fixed-cost maintenance based on the number of hours flown each year. 
Using this concept, the customer provides a fixed level of funding
and expects, subject to some exclusions, to receive a given level of
support by the contractor.  The contractor expects to be provided a
fixed level of funding up front and anticipates a long-term support
arrangement. 


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

Logistics support decisions are a critical part of the weapon systems
acquisition process.  They affect the ability of operational units to
meet mission objectives and they drive significant portions of the
life-cycle costs of military systems and equipment.  Traditionally,
the services established in-house capabilities for maintaining and
supplying parts for most new systems.  Nonetheless, the services have
also used a combination of military and contractor support for
maintaining and repairing military systems and equipment.  At the
same time, a limited, but growing, number of commercial items or
commercial derivatives are being supported over the life of the
systems through contractor logistics support,\3 generally through
contracts with the original equipment manufacturer.  Department of
Defense's (DOD) policy guidance for supporting military systems,
issued in March 1996, calls for contractor logistics support for most
new systems.  Our prior work shows that DOD is moving toward greater
reliance on the private sector for maintenance.\4 In line with this
evolving strategy, the Navy has adopted a depot maintenance strategy
that provides for performing core\5

maintenance capability in military depots and contracting out noncore
workload to the private sector when it is cost-effective to do so. 

Various statutes affect the mix of depot maintenance workloads
between the public and private sectors.  The provision directly
affecting the issues discussed in this report is 10 U.S.C.  2464,
which requires the Secretary of Defense to identify and maintain a
core logistics capability that is government-owned and -operated
unless the Secretary specifically waives that requirement.  The 1998
Defense Authorization Act, Public Law 105-85, amended 10 U.S.C.  2464
to require that repair capability be established in military depots
for a new system that is identified as a core system (except special
access programs, nuclear carriers, and commercial items) within
4 years of a system's achievement of initial operational capability. 
The determination as to whether an item is a commercial item for
purposes of meeting this exception to 10 U.S.C.  2464 is a matter of
agency judgment.  The agency determination will be upheld unless
shown to be unreasonable.  Moreover, there is no requirement that the
agency document the bases for those determinations, or to maintain
any supporting documentation. 

On September 10, 1996, the V-22 program office identified the V-22
T406 engine as a commercial item as defined in 41 U.S.C.  403 and
decided to procure the engine using a commercial item acquisition
strategy, and then to explore the option of using contractor
logistics support.  Early in 1998, subsequent to the amendment to 10
U.S.C.  2464, the V-22 program office determined that the T406 engine
was a commercial item under 10 U.S.C.  2464.  Accordingly, the engine
could be excluded from the 10 U.S.C.  2464 requirement for
establishing a core logistics capability.  Subsequently, on March 2,
1998, the Naval Air Systems Command decided that the engine did not
require a core depot maintenance capability because of the commercial
item determination.  Between March and April 1998, the program office
negotiated a contract modification with Allison Engine Company to
finalize the number of engines to be procured and to provide for
logistics support.  During this period, the Navy also conducted a
cost analysis of contractor logistics support and completed a cost
analysis comparing contractor logistics support with military
support.  Subsequently, on May 8, 1998, the Navy finalized its T406
engine logistics support decision and executed the contract
modification that included both the purchase of 287 T406 engines and
the logistics support for those engines that will be operational
between fiscal year 1999 and 2003. 

During the first 6 years of logistics support, we estimate that those
logistics support costs will range from $6 million to $19 million,
based on an initial cost of approximately $200 per flying hour.  Over
the early years of the program, the relatively small numbers of
aircraft and engines in the system will limit the overall flying
hours and the support costs for the engine.  However, as the number
of engines increase over the next
20 years, these costs would be expected to increase proportionately
with the growth of the flying hour program.  The estimated logistics
support costs for a 55-year period is $2.3 billion. 

The T406 contract has a separate line item for logistics support for
each fiscal year, with different quantities of engines to be
supported and different hourly rates.  The contract contains options
for each of these items, which the Navy may exercise by the specified
dates. 


--------------------
\3 Contractor logistics support is contractor-provided, long-term,
total life-cycle logistics support that combines depot level
maintenance along with wholesale and selected retail material
management functions. 

\4 Defense Depot Maintenance:  DOD Shifting More Workload for New
Weapon Systems to the Private Sector (GAO/NSIAD-98-8, Mar.  31,
1998).  Also, see DOD Regulation 500.2-R. 

\5 Core capability is the equipment and resources required to be
maintained in government facilities to assure having the ability to
respond to contingency situations and to otherwise provide mission
critical activities. 


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

As provided by 10 U.S.C.  2464, the Navy has determined that the T406
engine is a commercial item and that it is not required to establish
maintenance capability for the engine in a military depot.  The
determination as to whether an item is a commercial one for purposes
of meeting this exception to 10 U.S.C.  2464 is a matter of agency
judgment.  Given the discretion the agency has for making this
determination, we cannot conclude that the Navy's judgment was
unreasonable in determining that the T406 engine is a commercial
item.  However, we found that the Navy's methodology for its
commercial item determination was inconsistent and poorly document. 

Specifically, the Navy stated that it was relying on the contractor's
assurance of 90-percent common parts between the T406 engine and
others in the Allison engine family and also cited the technical
judgment of program officials.  However, neither the Navy nor the
contractor had recently evaluated the extent of common parts in
advance of the Navy's determination that the T406 was a commercial
item.  A subsequent analysis was made by the Allison Engine Company
to support the claim of 90 percent common parts, but our evaluation
showed about 79 percent common to at least one of the other engines
in the AE family.  The Navy also stipulated that the limited number
of engine modifications required to produce the T406 engine was a
factor in its commercial item determination.  However, data were not
available to enable us to assess the value of those engine
modifications. 

The Navy calculated that using contractor support rather than the
military support system would save $487 million over the 55-year life
of the program.  Our limited review of that analysis identified
significant errors and inconsistencies that could both overstate and
understate the differences in cost between the two alternatives.  For
example, the Navy did not consider the impact of a reduction in the
T406 engine price on the cost of other elements such as the estimated
cost of spares, which resulted in a net overstatement of the military
alternative of $476.6 million.  Additionally, the Navy used a higher
reliability factor for the commercial alternative, which resulted in
a $96.7 million understatement of the cost of the commercial
alternative.  We discussed our findings with the Navy, and Navy
officials are continuing to update their analysis. 


   LOGISTICS COMMERCIAL ITEM
   CRITERIA
------------------------------------------------------------ Letter :3

An item is exempt from the requirement in 10 U.S.C.  2464 regarding
core logistics capabilities if it is deemed to be a commercial item
that has been sold or leased in substantial quantities to the general
public and is purchased in the same form that is sold in the
commercial market or with minor modifications to meet federal
government requirements.  The basic definition of a commercial item
for the purposes of governmentwide procurement is set forth in 41
U.S.C.  403 (12).  That section states that a commercial item is one
of a type customarily used by the general public or by
nongovernmental entities for other than governmental purposes.  There
is no requirement that the item have actually been sold--only that it
have been offered for sale. 

In our view, to be considered a commercial item under 10 U.S.C. 
2464, the item would first have to meet the criteria set forth in 41
U.S.C.  403, along with the added requirements that the item has
actually been sold in substantial quantities in the commercial market
and meets government requirements with only minor modifications.  The
concept of minor modifications also appears in 41 U.S.C.  403.  Minor
modifications, which have been the subject of a number of bid protest
decisions, are defined in section 2.101 of the Federal Acquisition
Regulation (FAR).  Both the FAR and our bid protest decisions provide
that minor modifications are ones that do not significantly alter the
nongovernmental function or essential physical characteristics of the
item that is modified. 

Factors to be considered in determining whether modifications are
minor include the value and size of the modifications and the
comparative value and size of the modifications to the final product. 
There is no definitive test for assessing whether modifications are
minor; the decision is left to an agency's judgment.  Also, there is
no requirement in the applicable statute or regulation that an
agency's analysis supporting its commercial item determinations must
be documented. 


   WEAKNESSES IN THE NAVY'S
   METHODOLOGY FOR T406 COMMERCIAL
   ITEM DETERMINATION
------------------------------------------------------------ Letter :4

Our review identified various weaknesses in the Navy's methodology
for reaching its determination that the engine was a commercial item. 
Although the Navy stated that the T406 had parts that were 90 percent
common to those in other engines in the Allison engine family,
neither the Navy nor the contractor had documented support for that
position at the time the Navy made its determination and we found
that the subsequent documentation overstated the percentage. 
Further, while the Navy stated that the number of modifications was
limited, neither the Navy nor the contractor could provide us the
value of the modifications required to produce the T406 engine. 


      NAVY DID NOT INDEPENDENTLY
      ANALYZE THE EXTENT OF COMMON
      PARTS BEING USED
---------------------------------------------------------- Letter :4.1

In making its February 2, 1998, commercial item determination under
10 U.S.C.  2464, the Navy stated that 90 percent of the parts in the
T406 engine are common to Allison's AE commercial family of
engines.\6 While
10 U.S.C.  2464 does not specifically contain a requirement for an
analysis of common parts, the Navy used the concept of common parts
as an indicator that the engine was a commercial item. 

The Navy concluded that the engine was a commercial item based
largely on statements provided by the engine manufacturer that 90
percent of the T406 engine's parts were common to the AE family of
engines.  The Navy also relied on program office officials' expertise
regarding technical aspects of the aircraft and the engine.  The
program office did not make its own assessment of common usage of
parts between the T406 engine and other engines in the AE family
because, according to program officials, it did not have access to
information about the parts in Allison's other engines. 

At the time the commercial item determination was made, neither the
Navy nor the contractor had completed a quantitative analysis to
document how common were the parts in the T406 engine with the other
engines.  Contractor officials stated that they had performed a parts
number comparison in 1992, but they noted that this comparison was no
longer relevant because the numbers used to identify the parts had
changed since that time. 

In response to our request, the contractor performed an analysis to
quantify how common were the parts.  Comparing the parts in the T406
engine core with the parts in the core of other Allison engines, the
contractor concluded that about 90 percent of the parts in the T406
engine core were common to one or more of the engines in the AE
family.\7 To verify the contractor's calculations, we obtained parts
lists for the T406 core and each engine core identified as being in
the AE family of engines and analyzed the extent to which common
parts were in use.  We measured the parts from three perspectives,
each of which resulted in a lower indication of common parts than the
Navy reported in its determination.  We found that common parts
ranged from 44 to 79 percent, in contrast with the Navy's claim and
the contractor's subsequent statement that 90 percent were common. 

In completing our analysis, we first measured common parts by using
the combined parts lists from the entire family of engines--the
approach used by the contractor in calculating 90-percent common
parts.  We found that about 79 percent of the T406 parts are on at
least one of the other engines in the AE family.  We determined that
the difference between Allison's calculation of common parts and our
calculation of 79 percent was caused by their overstatement of the
total number of parts used as a base for the Allison calculation.  We
discussed our finding with the Allison officials responsible for
their analysis.  Allison officials noted that to reduce differences
among the engines, they are continuing to make changes to improve the
extent to which common parts are in use. 

Second, we compared the T406 engine with the individual engines in
the AE family and determined that four of the engines had about 44 to
46 percent parts in common and the other three about 76 percent. 
(See table 1). 



                                Table 1
                
                 Our Analysis of Parts' Commonality of
                    T406 Engine and Other Allison AE
                      Commercial Family of Engines

                                          No. of parts
                                             in common
                                                  with   Percentage of
Engine type                                T406 engine    common parts
--------------------------------------  --------------  --------------
AE2100A                                            419            76.2
AE2100C                                            420            76.4
AE2100D3                                           416            75.6
AE3007A                                            245            44.5
AE3007A1                                           244            44.4
AE3007C                                            248            45.1
AE3007H                                            255            46.4
Weighted average of common parts                   343            64.0
----------------------------------------------------------------------
Third, to provide another perspective on the rate of common parts in
use across the Allison family of engines, we calculated a weighted
average,\8 which indicated that about 64 percent of the parts were
common.  Moreover, there is a broad range of quantities and
percentage of common parts among the seven engine types.  A weighted
average provides one means to gauge the volume of common parts across
the family.  Since common parts' usage is a significant driver in the
ability to produce logistics support cost reductions, we believe this
can be an important indicator in commercial item determinations. 


--------------------
\6 According to the contractor, the AE family of engines includes the
AE3007A and the AE3007A1, which are in the Embraer ERJ-145 and
ERJ-135 aircraft; the AE3007C, which is in the Cessna Citation X; the
AE3007H, which is in the Teledyne Ryan Global Hawk; the AE2100D3,
which is in the Lockheed Martin C-130J; the AE2100A, which is in the
SAAB 2000; and the AE2100C, which is in the IPTN N-250. 

\7 While the Navy's earlier statements did not specify the engine
core as the basis of comparison, we based our quantitative analysis
only on part numbers in the engine core, as did the contractor. 

\8 To calculate the weighted average, we multiplied the number of
each type of engines by the number of common parts and then divided
by the total number of engines to calculate a weighted per engine
average of common parts. 


      RELATIVE VALUE OF T406
      MODIFICATIONS NOT AVAILABLE
---------------------------------------------------------- Letter :4.2

In making its commercial item determination, the Navy stated that it
based its decision also on the limited number of modifications
required to produce the engine.  However, the Navy did not quantify
the value of the modifications required to produce the T406 engine or
develop information regarding the cost of the modifications relative
to the overall engine cost.  Thus, the value of the changes required
to modify the commercially used engine to satisfy the Navy's
requirements is unclear.  FAR 2.101 states that the value and size of
the modifications and the comparative value and size of the final
product are factors to be considered when determining whether
modifications are minor.  The Navy did not develop data to measure
the comparative value and size of the T406 engine modifications. 

We attempted to collect information regarding the value of the
modifications and the comparative value of the engines.  However, the
Navy did not have this information and the contractor stated it would
be difficult to develop it.  Accordingly, we were not able to obtain
the modifications cost information.  We recognize that other factors
in addition to modifications could affect cost differences. 
Nonetheless, we did determine that the Navy is paying significantly
more for the T406 engine than Lockheed Martin is paying for the
AE2100D3 engine, an AE family engine that closely resembles the T406
engine.\9


--------------------
\9 The AE2100D3 is used to power Lockheed Martin's C130J aircraft. 
The Air Force is purchasing the C130J using a commercial item
acquisition strategy. 


   NAVY'S EVALUATION OF
   COST-EFFECTIVENESS
------------------------------------------------------------ Letter :5

Having made the commercial item determination, the Navy decided to
evaluate the estimated difference in costs between performing repair
and maintenance activities in house and having it done by the private
sector.  The Navy calculated that using a commercial source to repair
the T406 engine would save about $487 million over the projected
55-year life of the V-22 aircraft.  We made a limited review of the
Navy's cost analysis and found (1) inconsistencies between the way
the Navy estimated the in-house and commercial support costs and (2)
significant errors in the data used in the analysis.  We did not
determine the full extent of the errors or the net effect on the cost
estimate. 

According to Navy officials, to award a logistics support contract
for the T406 engine, the outcome of the Navy's cost analysis had to
reflect savings to the government through the use of a commercial
source.  In August 1996, the Navy initially evaluated the comparative
costs of contractor versus military logistics support, projecting
that contractor support would be about $200 million more than
military support over the program's life.  Navy officials stated that
they carefully reviewed the key cost drivers and were able to reduce
the cost of contractor support through negotiations with the
contractor.  According to program office officials, the Navy reduced
the power-by-the-hour rate and engine price.  After negotiations, the
Navy updated its cost analysis and projected that contractor support
would save $487 million over the life of the program. 

Our review of the Navy's analysis determined that when the Navy
updated its cost analysis to reflect the results of contractor
negotiations, it did not consider the impact of a reduction in the
T406 engine price on the cost of other elements, such as the
estimated cost of spares.\10 This factor affected both the military
and commercial cost projections and resulted in about a $551.9
million overstatement of material costs to the military alternative
and about a $75.3 million overstatement of exclusion costs\11 in the
commercial alternative--a net overstatement of about $476.6 million
to the cost of the military alternative.  Navy officials said they
inadvertently overlooked this factor and did not adjust the cost
analysis to reflect changes resulting from changes to the engine
price.  Our review of the Navy's cost analysis identified other
errors and/or omissions that could both overstate and understate the
differences in cost between both alternatives.  We found that the
Navy

  -- did not include a cost estimate for jet fuel used in T406 test
     cells during maintenance, which understated the military
     alternative cost by $5 million;

  -- did not include a cost estimate for the value of engine
     modifications for the military alternative, which understated
     that alternative by an estimated $36.8 million; and

  -- overstated the indirect logistics support cost in the commercial
     alternative by an estimated $21.5 million. 

We also identified inconsistencies in the assumptions used and in the
way data were collected.  For example, the Navy used a higher engine
reliability factor for the commercial alternative, which resulted in
a $96.7 million understatement of the alternative's cost.  It also
used a two-level maintenance strategy for the commercial alternative
but a three-level maintenance strategy for the military alternative. 
Thus, the military alternative included about $836 million for
establishing and operating intermediate maintenance capability. 

V-22 program office officials stated that a two-level strategy was
not allowable under the Navy's Operational Requirements Document. 
While we did not independently review the potential costs and
benefits of that strategy for the military alternative, it would
appear to have been a viable option given that the Navy is pursuing a
similar two-level strategy in-house for another engine.  With regard
to historic engine repair cost data used to estimate labor and
material costs for the T406 engine, the Navy did not use the same
baseline data.  For example, the Navy used fiscal year 1990 through
1994 data for the military option and fiscal year 1994 and 1995 data
for the commercial option. 

We did not completely review the Navy's cost analysis; therefore, we
cannot project what would have been the net effect of the errors and
omissions.  At the time of our review, the Navy was continuing to
correct and update its cost analysis. 


--------------------
\10 The cost of spare parts was estimated by using a percentage of
the cost of the engine. 

\11 Exclusion costs are those caused by abnormal operations; these
costs are not covered by the contractor's power-by-the-hour rate. 
For example, repairs required as a result of misuse or negligence are
exclusion costs. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

Acting in accordance with the provisions of 10 U.S.C.  2464,
pertaining to core logistics capability, the Navy has determined that
the T406 engine is a commercial item and by virtue of that
designation, that it is not required to establish maintenance
capability in a military depot within 4 years of the establishment of
operational capability.  Given the discretion afforded agencies in
making such determinations, we cannot say that the Navy's action was
unreasonable.  However, we did find a number of weaknesses in the
methodology for its commercial item determination and an absence of
documentation to support that determination.  Further, the accuracy
of the Navy's life-cycle cost comparisons between military and
contractor alternatives is questionable due to data errors and
omissions. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :7

This is the first commercial item determination DOD has made under
the requirements of 10 U.S.C.  2464 as it pertains to logistics
support capability.  However, it is likely that other such
determinations will be made in the future.  Thus, basic guidance
should be provided on the type of supporting data that should
accompany such determinations.  Accordingly, we recommend that the
Secretary of Defense: 

  -- Issue guidance requiring the services to document in the
     contract file support for their commercial item determinations
     under 10 U.S.C.  2464 and subsequent logistics support
     decisions.  On the basis of our review of the T406 case,
     examples of items that might be considered for documentation
     include (1) percentage of common parts, (2) a comparative value
     of the average sales price of the baseline commercial item with
     the estimated price of the item that is the subject of the
     determination, (3) the value of unique support and test
     equipment and tools required to support the military
     requirement, and (4) a cost evaluation documenting that the
     life-cycle logistics support in the private sector is expected
     to result in a lower cost to the government. 

Additionally, we recommend that the Secretary of Defense: 

  -- Require the Secretary of the Navy to complete a new and updated
     cost analysis, correcting previous errors and inconsistencies,
     before executing future option years under the current T406
     contract. 


   AGENCY AND CONTRACTOR COMMENTS
   AND OUR EVALUATION
------------------------------------------------------------ Letter :8

DOD's written comments on the draft of this report are presented in
appendix I.  DOD agreed with our recommendation concerning a new and
updated cost analysis before executing future option years under the
current T406 contract.  It disagreed with our recommendation
concerning the documentation of analyses supporting commercial item
determinations.  DOD stated that such a requirement would impose a
stricter definition and criteria for commercial items subject to
depot repair than the legislative exemption for commercial items with
minor modifications.  It also stated that our recommendation for a
documented analysis of percentage of common parts would restrict
planned use of commercial support for many current and future weapon
systems, would require system component assessments for which there
is no standard industry methodology, and would discourage many
private sector companies from doing business with the government. 

The intent of our draft recommendation was that DOD establish a
consistent management process for documenting the support for
commercial item determinations and their cost-effectiveness under the
provisions of 10 U.S.C.  2464.  In response to DOD's concerns, we
modified our draft recommendation to make it clear the actions we
listed were meant to be illustrative. 

We discussed our draft report with officials of Allison Engine
Company.  These officials asked us to refer to the V-22 engine as the
AE1107C rather than the T406, the designation we used in the draft
report.  In response, we added a footnote indicating that the
commercial designation for the T406 is AE1107C.  Allison officials
also asked us to update our analysis to reflect an additional 12
common parts that they had not identified to us.  We revised the
figures contained in our draft report to reflect this contractor
update.  Additionally, we made several minor technical changes to
reflect other contractor comments. 

We made changes to the report, as appropriate, to address agency
comments. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :9

To identify the legal standards used in assessing the commercial
status of the T406, we interviewed responsible legal advisors at the
Navy's V-22 program office, Patuxent River Naval Air Station,
Patuxent River, Maryland; and the Allison Engine Company's T406
Program Office, Indianapolis, Indiana.  We reviewed applicable
statutes, regulations, and relevant case law to identify the
applicable commercial item criteria. 

To assess the Navy's rationale, justification, and support for
designating the T406 engine a commercial item, we interviewed Navy
V-22 program office officials at the Patuxent River Naval Air Station
and Allison Engine Company officials at the Allison T406 Program
Office.  Using the commercial item criteria, we assessed compliance
through discussions with the Navy and Allison officials.  We reviewed
all documentation the Navy provided to support its determination, and
we independently calculated the rate of parts commonality between the
T406 and other engines using parts lists Allison provided.  We
paralleled Allison's approach for calculating commonality rates
across the family of engines, correcting for inconsistencies between
the numerator and the denominator used.  To calculate the commonality
rates between the T406 and individual engines, we performed a match
of unique T406 parts to each individual engine in the Allison family
(as identified in table 1).  To calculate the weighted average of
common parts, we multiplied the number of each type of engine by the
number of common parts and then divided by the total number of
engines to calculate a weighted per engine average of common parts. 

To evaluate the extent to which the Navy evaluated the
cost-effectiveness of its decision, we interviewed and collected
supporting documentation from the cost evaluation team and V-22
program office officials at the Patuxent River Naval Air Station,
Maryland, and interviewed and collected engine performance and cost
data from officials at the Cherry Point Naval Aviation Depot, North
Carolina; Defense Contract Management Command operating at the
Allison Engine Company facilities, Indiana; and the Air Force's C130J
Aircraft Program Office, Wright Patterson Air Force Base, Ohio.  We
analyzed the supporting data to (1) determine whether the assumptions
the Navy used to structure its cost evaluation were reasonable and
consistently applied between the alternatives the Navy evaluated and
(2) identify errors in the Navy's cost projections.  Our cost
analysis was limited by the time we had available. 

We conducted our review between May 8, 1998, and July 21, 1998, in
accordance with generally accepted auditing standards. 


---------------------------------------------------------- Letter :9.1

We are sending copies of this report to the Chairmen of the Senate
Committees on Appropriations and on Armed Services and the House
Committees on Appropriations and on National Security; the
Secretaries of Defense and the Navy; and the Director of the Office
of Management and Budget.  We will also make copies available to
others on request. 

Please contact me at (202) 512-8412 if you or your staff have any
questions concerning this report.  Major contributors to this report
are included in appendix II. 

Sincerely yours,

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.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Defense's (DOD)
letter dated August 26, 1998. 

GAO COMMENTS

1.  The intent of our recommendation concerning documentation of
commercial item determinations was not that a commercial item
designation be taken away.  Rather, we were indicating the need for
such determinations to be well supported. 

2.  We recognize that program office officials have been working to
deal with problems identified during our review.  That, along with
their plans to complete a new and updated cost analysis prior to
executing contract option years, should provide a more complete basis
for assessing the accuracy and completeness of data and expected
savings. 

3.  We agree that the identified error in the Navy's savings estimate
occurred after the negotiations over engine procurement and
contractor maintenance support were completed.  The post negotiation
rate update referred to by the Navy involved an additional analysis
by the Navy to reassess contractor maintenance support costs.  The
Navy undertook that update because at the time it had concluded its
agreement with the contractor for maintenance support, its analysis
showed there were additional costs, not savings, associated with
contractor logistics support versus in-house performance of this
function.  The update provided the basis for a new cost savings
estimate of $487 million from contractor support.  Our review raised
questions about the reliability of the Navy's new estimate.  Although
the Navy has updated some of the data related to its analysis of
contractor maintenance support costs, it did not make a similar
update to the projected costs of in-house performance; accordingly,
it is not clear to us that the Navy has a full and complete basis for
an updated comparison of in-house versus contractor maintenance
support costs. 

4.  While DOD stated that there is a great degree of commonality
between the T406 and the Allison AE engine family and that many of
the unique parts have only slight or negligible differences,
sufficient data were not available to enable us to make such a
determination.  We attempted to gauge the degree of differences
between dissimilar parts by collecting cost data on parts
modifications, but the Navy and the contractor could not provide such
data.  Thus, we cannot comment whether dissimilar parts are likely to
become common during full-rate production because our analysis was
limited to trying to determine the degree of commonality at the time
the commercial item determination was made. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION
WASHINGTON, D.C. 

Barry W.  Holman
Julia Denman
Leticia Bates

DALLAS FIELD OFFICE

Larry Junek
John Strong

OFFICE OF THE GENERAL COUNSEL

John Brosnan
Stephanie May


*** End of document. ***