Defense Trade: Department of Defense Savings From Export Sales Are
Difficult to Capture (Letter Report, 09/17/1999, GAO/NSIAD-99-191).

Pursuant to a congressional request, GAO reviewed the export sales of
five Department of Defense (DOD) weapon systems--the Hellfire missile,
Advanced Medium Range Air-to-Air Missile (AMRAAM), High Mobility
Multipurpose Wheeled Vehicle (HMMWV), Black Hawk Helicopter, and Aegis
Weapon System, focusing on whether: (1) export sales reduced the price
of the five weapon systems; (2) DOD waived the requirement to recover
nonrecurring research and development and production costs associated
with the sales; and (3) DOD included this information when notifying
Congress about the sales or requesting budgetary authority to purchase
weapon systems.

GAO noted that: (1) DOD saved at least $342 million on its purchases of
the five systems because either DOD or its contractors also exported the
systems to foreign governments; (2) however, DOD has not developed
guidance aimed at maximizing savings from export sales, and acquisition
personnel sometimes made decisions that reduced potential savings; (3)
DOD could have realized greater savings if it had combined purchases for
foreign governments with purchases for the U.S. military, negotiated
prices for export sales without giving up U.S. system price reductions,
or required the contractor to perform work in the most economical manner
even if such performance affected offset agreements; (4) savings would
also have been greater if DOD had ensured that the export sales prices
always included a proportionate share of the sustaining engineering and
program management costs; (5) the full impact of contractor direct sales
on the price of DOD weapon systems cannot be assessed because
information concerning the savings from combining material purchases and
from learning efficiencies was not available; (6) consistent with the
Arms Export Control Act, DOD waived about $378 million of costs to
develop the five systems and establish their production facilities; (7)
DOD waived these costs because the buyer was a North Atlantic Treaty
Organization ally and the sale meant that the United States and its
allies would be using similar battlefield weapon systems; (8) when DOD
notified Congress of potential sales of the five systems, it did not
provide, nor was it required to provide, information on whether export
sales reduced the price of weapon systems being acquired for the U.S.
military or whether DOD waived nonrecurring costs associated with the
sales; (9) DOD did not always provide information on savings from export
sales that Congress could use to assess the President's request for
budgetary authority to purchase the five systems; (10) nor did DOD
always reduce its portion of the President's budget to reflect export
sales savings; (11) only the Air Force consistently considered the
impact of export sales in developing a program's budget; (12) beginning
in fiscal year 1996, the Air Force voluntarily reduced the AMRAAM budget
to reflect export-related reductions in the price of U.S. missiles; (13)
the Navy told GAO that its budget was reduced in 2 of the 5 years that
it exported the Aegis Weapon System; (14) the Army made no reductions to
the Hellfire, Black Hawk, or HMMWV budgets; and (15) instead, Army
program offices used excess appropriations to buy additional systems or
system components, or to meet unspecified needs.

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

 REPORTNUM:  NSIAD-99-191
     TITLE:  Defense Trade: Department of Defense Savings From Export
	     Sales Are Difficult to Capture
      DATE:  09/17/1999
   SUBJECT:  Foreign military sales
	     Waivers
	     Defense cost control
	     Prices and pricing
	     Department of Defense contractors
	     Military budgets
	     Financial management
	     Research and development costs
	     Defense economic analysis
	     Weapons systems
IDENTIFIER:  Hellfire Missile
	     Advanced Medium Range Air-to-Air Missile
	     High Mobility Multipurpose Wheeled Vehicle
	     Black Hawk Helicopter
	     Aegis Weapon System

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ns99191 A Report to the Chairman and Ranking Minority Member,
Subcommittee on Readiness and Management Support, Committee on
Armed Services, U. S. Senate

September 1999 DEFENSE TRADE Department of Defense Savings From
Export Sales Are Difficult to Capture

National Security and International Affairs Division

B-283002 Letter September 17, 1999 The Honorable James M. Inhofe
Chairman The Honorable Charles S. Robb Ranking Minority Member
Subcommittee on Readiness and Management Support Committee on
Armed Services

United States Senate In 1998, the Department of Defense (DOD) and
its contractors planned to sell to foreign countries defense
equipment, articles, and services worth a total of about $44.3
billion. One of the U. S. government's goals in exporting

defense items, as articulated in the 1995 Conventional Arms
Transfer Policy, is to allow DOD to meet its defense requirements
at less cost. To determine whether DOD is maximizing this benefit,
we reviewed the sales of five major weapon systems the Hellfire
Missile, Advanced Medium Range Air- to- Air Missile (AMRAAM), High
Mobility Multipurpose Wheeled Vehicle (HMMWV), Black Hawk
Helicopter, and Aegis Weapon System. Specifically, as requested,
we determined whether (1) export sales reduced the price of the
five weapon systems, (2) DOD waived the requirement to recover
nonrecurring research and development and production costs
associated with the sales, and (3) DOD included this information
when notifying the Congress about the sales or requesting
budgetary authority to purchase the weapon systems. Results in
Brief DOD saved at least $342 million on its purchases of the five
systems because either the Department or its contractors also
exported the systems to foreign governments. However, DOD has not
developed guidance aimed at maximizing savings from export sales,
and acquisition personnel sometimes made decisions that reduced
potential savings. DOD could

have realized greater savings if it had combined purchases for
foreign governments with purchases for the U. S. military,
negotiated prices for export sales without giving up U. S. system
price reductions, or required the contractor to perform work in
the most economical manner even if such

performance affected offset agreements. 1 Savings would also have
been greater if DOD had ensured that the export sales prices
always included a proportionate share of the sustaining
engineering and program management costs. The full impact of
contractor direct sales on the price of DOD weapon systems cannot
be assessed because information concerning the savings from
combining material purchases and from learning efficiencies was
not available. Consistent with the Arms Export Control Act, DOD
waived about $378 million of costs to develop the five systems and
establish their production facilities. In most cases, DOD waived
these costs because the

buyer was a North Atlantic Treaty Organization (NATO) ally and the
sale meant that the United States and its allies would be using
similar battlefield weapon systems. When DOD notified the Congress
of potential sales of the five systems, it did not provide, nor
was it required to provide, information on whether

export sales reduced the price of weapon systems being acquired
for the U. S. military or whether DOD waived nonrecurring costs
associated with the sales. Similarly, DOD did not always provide
information on savings from export sales that the Congress could
use to assess the President's request for budgetary authority to
purchase the five systems. Nor did DOD always reduce its portion
of the President's budget to reflect export sales savings. Only
the Air Force consistently considered the impact of export

sales in developing a program's budget. Beginning in fiscal year
1996, the Air Force voluntarily reduced the AMRAAM budget to
reflect export- related reductions in the price of U. S. missiles.
The Navy told us that its budget was reduced in 2 of the 5 years
that it exported the Aegis Weapon System. The Army made no
reductions to the Hellfire, Black

Hawk, or HMMWV budgets. Instead, Army program offices used excess
appropriations to buy additional systems or system components, or
to meet unspecified needs. To enhance the economic benefits
derived from defense exports, we are making recommendations to
improve DOD's ability to realize savings and the Department's
processes for disclosing to the Congress the effect of export
savings on weapon system costs. 1 Offsets are industrial or
commercial benefits that a U. S. contractor provides to foreign
governments as inducements or conditions for the purchase of
military goods or services.

Background The role of export sales in reducing the cost of weapon
systems required by the U. S. military is becoming increasingly
important. Between 1989, when the Cold War ended, and October
1998, DOD's total budget declined 30 percent in constant dollars
and its procurement budget declined 50 percent in constant
dollars. To hold down annual acquisition costs and fit the
inventory of weapon systems to the downsized military force
structure, DOD often purchased fewer quantities of individual
weapons than originally planned. Theoretically, purchasing fewer
systems reduces overall costs but increases unit cost. But,
production quantities can be increased and unit cost decreased if
DOD or its contractors sell systems being purchased for the U. S.
military to a foreign government, particularly if contracts for
the export sales are awarded at about the same time as the U. S.
contract is awarded. If the contractor plans to produce additional
units, it can purchase materials in bulk at discounted prices,
realize labor

efficiencies, and spread fixed overhead costs 2 over more units of
production. The U. S. government or contractors may sell defense
items to a foreign government. When the sale is government- to-
government through the foreign military sales program, DOD is
generally required by section 21 of the Arms Export Control Act to
charge the purchaser for a portion of the funds that the U. S.
government invested to develop major defense equipment and
establish a production capability. 3 Prior to 1996, DOD was
authorized to waive these costs only if the sale advanced the U.
S. government's interests in equipment standardization with the
armed forces of NATO countries, Japan, Australia, or New Zealand.
However, in 1996, the Congress authorized DOD to waive
nonrecurring costs if refusing to grant the waiver would likely
result in the loss of the sale or if the sale

2 Fixed overhead costs are costs that an organization incurs
because of its structure, style of operation, methods of selling,
size of productive capacity, and stored- up knowledge of key
individuals. These costs cannot be easily reduced when production
activity declines. Examples of fixed overhead are the cost of
depreciation of facilities and equipment, property taxes, fixed
salaries of supervisory and office personnel, and the base charge
for utilities. 3 Consistent with section 47 (6) of the Arms Export
Control Act, DOD Directive 2140. 2 defines major defense equipment
as any item of significant military equipment listed on the U. S.
Munitions List having a DOD nonrecurring research, development,
test, and evaluation cost of $50 million or a total DOD production
cost of more than $200 million.

would reduce the cost of the U. S. purchase by an amount that
would offset waived funds. 4 Contractors are not required to
collect nonrecurring costs. Since 1992, contractors have been
exempt from collecting and depositing in the U. S.

Treasury nonrecurring research and development and production
costs when making direct sales to foreign governments. Contractors
often provide commercial or industrial benefits to foreign
governments that purchase military goods. These benefits, known as
offsets, may be offered as inducements or may be required by the
foreign government as a condition of the purchase. Offset
agreements may include subcontracting with the purchasing
country's industries for component parts, providing the country's
businesses with financial or marketing assistance, or undertaking
a broad array of other activities that increase the foreign
country's business base. The U. S. government is not a party to
offset agreements and assumes no liability under the agreements.

DOD Realized Savings DOD reduced the cost of the five weapon
systems we reviewed when it or From Export Sales but its
contractors also exported the systems to foreign governments.
However, DOD has no guidance on how to maximize savings from
export Could Have Achieved

sales and personnel responsible for negotiating and administering
More

contracts that included U. S. and/ or export requirements
sometimes made decisions that prevented DOD from maximizing
savings.

Export Sales Resulted in According to our analysis, DOD reduced
its cost to purchase the Hellfire,

Reduced Costs of Weapon AMRAAM, HMMWV, Black Hawk, and Aegis
Weapon System by at least Systems $342.3 million as a result of
export sales. The sales of each of these systems increased the
quantity of systems DOD purchased and reduced the

systems' unit prices because contractors could buy materials in
bulk at discounted prices, realize labor efficiencies, and/ or
spread fixed overhead costs over more units of production. Table 1
displays our estimates of the

quantifiable savings by system. 4 Although this new waiver
authority was included in section 4303 of the National Defense
Authorization Act for Fiscal Year 1996 (P. L. 104- 106), DOD could
not exercise its new waiver authority until the President
introduced and the Congress passed legislation that fully offset
the estimated revenues that would be lost from the additional
waivers. In September 1996, the Congress allowed the President to
sell a portion of the National Defense Stockpile. The funds from
this sale were used in part to offset the funds that DOD estimated
would be lost between 1997 and 2005 as a result of the new waiver
authority.

Table 1: Weapon System Savings From Export Sales

Dollars in millions

System Hellfire AMRAAM HMMWV Black Hawk Aegis Weapon System

Time period reviewed 1986- 97 1993- 98 1989- 98 1984- 99 1988- 98
Price a and quantity of U. S. $1,285.4 $1, 148. 7 $1,757.2 $4,173.
5 $2, 792.3 systems 42, 660 3,657 51,463 1, 086 50

Price a and quantity of $92.6 $909. 4 $372.4 $296. 9 $501.0
foreign military sales 3,255 3, 138 9,251 65 8

Price a and quantity of Price No contractor

Price Price

No contractor contractor export sales unavailable b sales
unavailable b unavailable b sales

Total quantity None 12,027 d 336 None

unavailable c Estimated quantifiable $1.9 $223. 0 $71.3 $7. 4
$38.7 e savings a All prices are those recorded at contract award.

b Corporate policy restricts the disclosure of this data. c The
Hellfire II contractor reported that it sold 1, 394 missiles
directly to foreign governments. We were unable to collect
information on the quantity of basic Hellfire missiles sold
directly to foreign customers. d The Light Tactical Vehicles
Program Office reported direct contractor sales for 1989- 97. The
quantity shown in the chart does not include any direct sales made
by the contractor in 1998. e Aegis Weapon System savings include
the effect of export sales on the prime contract only. Aegis
Program Office officials told us that additional savings were
realized when the government purchased system components and
provided them to the prime contractor for integration into the
Aegis Weapon

System. Information that could be used to determine how much DOD
saved through export sales varied among the five systems. AMRAAM
and Hellfire savings that resulted from larger production
quantities could easily be calculated by comparing identified unit
prices with and without export sales. Black

Hawk savings could also be easily determined because price
adjustments were documented in the contract. The savings from
HMMWV and Aegis Weapon System export sales were less easily
determined, and our estimates of these savings were less precise.
Documents that clearly identified the savings from export sales

were available for only one of the five export sales of the Aegis
Weapon System and for none of the HMMWV sales. We estimated
savings for these two systems by discussing with the contractors
the elements of product cost affected by increased production and
then analyzing their proposal

data for those cost elements to isolate and estimate the effect of
export sales on unit prices. Our analysis of Aegis Weapon System
proposal data did not allow us to estimate the system's total
savings. The contractor said that for three of the sales, savings
were included in contract underruns. 5 Because the government and
contractor shared savings from the underruns, DOD's costs were
reduced. However, the underruns were attributable to a

number of factors, and we could not isolate the savings created by
export sales. Larger Savings Were DOD issued no guidance to aid
acquisition personnel in maximizing savings Possible

from export sales. Our analysis showed that savings from export
sales could have been larger if contracts had been negotiated or
administered differently. DOD's benefit from export sales was less
when the military services (1) purchased weapon systems for the
United States and export sales separately, (2) negotiated prices
for export sales that required giving up price reductions for DOD
systems, (3) allowed the contractor to incur higher material costs
to satisfy an offset agreement, or (4) failed to implement an
effective method to spread production costs evenly over

units produced for the U. S. military and foreign buyers. Timing
of Purchases Affects Our analysis showed that the timing of
foreign sales was important. We Savings observed that contractors
reduced weapon system prices when DOD combined its purchases for
foreign customers with its purchases for the U. S. military. Of
the five weapon systems we reviewed, only the AMRAAM program
office managed its export sales so that the U. S. and export

requirements could be combined. Each year, DOD asked U. S.
embassies in countries likely to purchase AMRAAM missiles to
determine if those governments planned to make purchases in the
coming year. According to program officials, foreign countries
understand that their AMRAAM purchases must be combined with DOD's
purchases to achieve the lowest possible price. Since 1993, with
only two exceptions, the Air Force has 5 A contract is underrun
when the contractor produces systems at less than the target price
established by the contract.

combined purchases for foreign sales with U. S. purchases. This
acquisition strategy enabled the Air Force to reduce the cost of
U. S. Air Force and Navy AMRAAM missiles about $223 million. Our
analysis also showed that the Army could have saved an additional
$2.9 million in the cost of Hellfire missiles by simultaneously
purchasing missiles for export and Army

requirements. Similarly, an Aegis Weapon System contract
representative told us that if DOD purchased a larger quantity of
systems at the time it awarded its annual production contract, the
price of each system would be lower. Acquisition Decisions Reduced

DOD's acquisition decisions affected savings. The Army could have
DOD's Savings

reduced the cost of Hellfire missiles another $1.4 million if it
had not insisted on lower prices for export missiles. The Hellfire
contract required a price reduction if additional missiles were
purchased within 60 days of a U. S. order. In early 1996, the Army
purchased additional missiles within the required time frame.
However, the agency gave up its right to a reduction in the unit
price of its missiles that totaled about $0.9 million in exchange

for a lower missile price for the foreign government. Later in
1996, the contractor offered to reduce the U. S. price by $2.4
million because the Army was purchasing additional export missiles
for another foreign customer 5 months after the U. S. order.
However, the lower price for the U. S. missiles was contingent
upon the foreign government paying a higher

price to convert the missiles to the export configuration and to
cover the cost risk associated with the sale. 6 The Army
negotiated a $1. 9 million cost reduction, rather than the $2. 4
million offered by the contractor, giving up the additional $0.5
million so that the contractor would agree to include less profit
in the export missile price. The Army did not explain its
rationale for this action.

Acquisition decisions also affected Aegis Weapon System savings.
The Navy reduced its potential savings about $3 million when it
allowed the contractor for the Aegis Weapon System to purchase
rather than make system subcomponents to satisfy an offset
agreement. The contractor originally proposed to make the
subcomponents at a cost of about

$22.5 million. However, when the contractor found that it was not
meeting its agreement with the foreign government to purchase $97
million of

6 According to a contractor representative, foreign customers
typically require more technical support than DOD, and export
missile warranties are often more expensive than estimated.
Defense Federal Acquisition Regulation Supplement 215.404- 71- 3
(d) (3) allows DOD to pay a contractor more profit than normal in
sales where the contractor can demonstrate that there are
substantial risks above those normally present in DOD contracts
for similar items.

subcomponents or parts from that country's industries, the
contractor decided to buy additional subcomponents for DOD systems
from the foreign manufacturers. According to an audit completed by
the Defense Contract Audit Agency (DCAA), this decision will cause
the contractor to pay about $27.7 million for the parts about $5.2
million more than it cost to make them. 7 In addition, DCAA said
the loss of production in the contractor's plant would result in
an additional $0. 8 million in overhead costs. The decision to
purchase the parts will not affect the weapon's

target price under the Navy's fixed- price incentive contract.
However, the contractor has underrun target prices since 1988 and,
according to the terms of the contract, shared the savings equally
with DOD. If the contractor were to reduce this contract's costs
as much as it did some

earlier contracts, the decision to buy the subcomponents could
result in about $6 million less in savings, which would reduce
DOD's share by $3 million. Full Allocation of Production We
examined four Black Hawk production contracts where the Army Costs
Necessary to Maximize purchased additional helicopters for export
sale after initial contract Savings

award. Three of the four contracts allocated all sustaining
engineering and program management costs to the units initially
purchased on the contract and none to the additional units,
although these units also benefited from these activities. 8 In
two of the contracts, the Army directed the contractor to remedy
the situation by adding a surcharge to the export units. However,
the surcharge fell short of distributing the costs evenly to all
helicopters purchased under the contract. In only one case did we
have sufficient data to quantify the potential savings that the
Army might have

realized if these costs had been allocated evenly. In that case,
we calculated that the Army could have recovered an additional $3.
4 million from export sales by evenly distributing the
contractor's sustaining engineering and program management costs.
7 The contractor agreed that its decision to purchase rather than
make the parts will increase cost, but estimates that the increase
will be only about $0. 6 million. DCAA's and the contractor's loss
estimates differ because the contractor (1) estimated the cost to
make the parts at current prices rather than the price negotiated
at contract award, (2) deleted additional material cost from the
estimate to buy the

parts that is normally added to all purchased hardware, (3)
assumed that its production loss and personnel retraining cost
would not affect negotiated overhead rates, and (4) predicted that
the foreign contractor would not require increased engineering
support to produce the parts. 8 We were unable to determine how
sustaining engineering and program management costs were allocated
to units purchased under the fourth contract.

Savings Attributable to Contractors' direct export sales also
reduced the cost of DOD's weapon Direct Sales by Contractors
systems, but we could not always determine the amount of the
reductions Is Unknown

or whether the contractors considered all cost reductions when
pricing DOD's systems. Our analysis showed that the Hellfire,
HMMWV, and Black Hawk contractors sold those systems directly to
foreign governments and included their direct sales in
calculations of their overhead rates, which resulted in lower
rates. Since these rates are the contractor's means of assigning
overhead costs, such as equipment depreciation, property taxes,
and administrative costs to a contract, a lower rate results in
lower contract costs and a reduced weapon system unit cost.
However, the Hellfire and Black Hawk contractors either did not
have data or considered it too time consuming to develop data that
would allow us to assess what the overhead rates would have been
had there been no export sales. None of the contractors provided
data that would allow us to determine whether material and labor
costs decreased when the contractors increased production
quantities by selling directly to foreign governments or whether

these reductions, if they occurred, reduced the price of DOD's
weapon systems. Neither could DOD officials provide information
that would allow us to quantify the impact of contractors' direct
sales on the price of U. S. weapon systems. DOD Waived Consistent
with the Arms Export Control Act, DOD declined to charge
Nonrecurring Research foreign purchasers $377. 8 million of
nonrecurring costs that it incurred to

develop the five weapon systems and establish their production
facilities. and Production Costs Of the $377.8 million, DOD waived
$289.6 million because the exports increased standardization of
weapon systems between the United States and its NATO allies and
$29.6 million to avoid the loss of export sales. The remaining
$58.6 million was not collected when the Air Force and the Defense
Security Cooperation Agency created hybrid sales agreements for
some sales made in January 1995 and January 1996.

DOD considered the hybrid sales as the contractor's direct sales
because the contracts were between the contractor and foreign
purchasers and imposed no financial obligation on the U. S.
government. But the sales were treated in many respects as
government- to- government sales, with Air Force personnel
negotiating, writing, and administering the contract. An AMRAAM
program official said the foreign customers would not have

purchased AMRAAM missiles if the $58.6 million of nonrecurring
costs were included in the purchase price. Therefore, DOD could
not classify the sales as foreign military sales because
legislation in effect at the time would

not have allowed DOD to waive these costs to avoid the loss of the
sales. 9 Neither did the contractor sell the missiles directly to
the foreign customers without DOD participation, which would have
exempted the countries from paying the nonrecurring costs, because
the Air Force recommended that the program office sell the AMRAAM
only through the foreign military sales program. Table 2 shows the
amount of waived nonrecurring costs for each weapon

system.

Table 2: Waived Nonrecurring Costs Aegis Weapon Cost Hellfire
AMRAAM HMMWV Black Hawk System

Collectable nonrecurring costs $12,617,768 $349, 739, 466 $1,365,
060 $10,304, 380 $130,418, 000 Waived nonrecurring costs $1, 802,
188 $310, 803, 404 0 a 0 $65,152, 000 Percent of collectable
nonrecurring 14.28 88. 87 0 0 49.96 costs waived a The Army was
able to locate data for only 88 percent of the HMMWV foreign
military sales that would allow us to assess whether nonrecurring
costs were waived. For those sales that we could assess, we found
that all nonrecurring costs were collected.

Decisionmakers Each time DOD or its contractors sought to export
the Hellfire, AMRAAM, Received Little HMMWV, Black Hawk, or Aegis
Weapon System, the President notified the Congress giving it a
chance to object to the system's export and each Information on
Savings year the President asked the Congress to appropriate funds
to purchase the or Waivers

systems. 10 Sections 36 (b) and (c) of the Arms Export Control Act
require that the notifications include such information as the
name of the purchasing country or international organization, the
dollar amount of the sale, the number of items included in the
sale, and a description of the item

being sold. The notifications did not include, nor were they
required to 9 DOD's authority to waive the nonrecurring costs to
avoid the loss of a sale became effective September 1996. The Air
Force created hybrid sales agreements for sales made in January
1995 and January 1996. 10 The Arms Export Control Act requires the
President to report to the Congress proposed foreign military
sales of defense articles or services for $50 million or more,
design and construction services for $200 million or more, or
major defense equipment for $14 million or more. The act also
requires the President to report to the Congress contractors'
applications for licenses for the export of major defense
equipment to be sold under a contract in the amount of $14 million
or more, or defense articles or services to be sold under a
contract in the amount $50 million or more.

include, information on whether or by how much anticipated export
sales would reduce the cost of DOD's weapon systems, or whether
DOD had waived nonrecurring research and development and
production costs. Similarly, the President's budget requests did
not always advise the Congress of the impact of export sales on
program budgets, and DOD did not consistently reduce its budget
request to account for savings resulting from export sales. Only
the Air Force consistently reduced its budget request to reflect
savings from anticipated export sales. Beginning in 1994, AMRAAM
program office personnel recognized that export sales of the
AMRAAM were likely to significantly impact AMRAAM production
costs. 11 According

to a program official, the Air Force estimated the number of
missiles that would be sold and reduced its AMRAAM budget request
to account for the expected savings. In those cases where the
actual savings exceeded the budget reduction, the program office
used the additional funds to purchase more AMRAAMs. The Navy told
us that its budget for the Aegis Weapon System was reduced

to account for savings from export sales in 2 of the 5 years that
it exported the system. In fiscal year 1994, the Navy voluntarily
reduced its budget request $11 million to account for an expected
decrease in the weapon system's production cost caused by an
export sale. In addition, the Congress reduced the Aegis budget by
$3.8 million in fiscal year 1998 when the Aegis Program Office
disclosed that another export sale would reduce the cost of DOD's
purchases. The Army did not decrease its Black Hawk, Hellfire, or
HMMWV budget requests to reflect savings from export sales.
According to Army officials, when budget requests were prepared,
DOD was unsure whether anticipated export sales would occur. The
officials said that it was too risky to reduce budgets when
savings might not be achieved. However, when export sales later
produced savings, the Army did not inform the

Congress of the savings or reduce its subsequent budget requests.
Instead, the program offices used the excess funds to purchase
additional systems or system components or to meet other
unspecified needs.

11 Because DOD begins to formulate each fiscal year's budget
request 2 years in advance of its submission to the Congress, the
Air Force's recognition of production cost reductions in 1994 did
not result in reduced budget requests until fiscal year 1996.

Conclusions Although DOD reduced its cost to purchase five weapon
systems when the systems were also sold to foreign governments,
DOD did not maximize the potential for savings. In addition, the
Congress lacked information that would have helped it oversee
weapon system acquisitions and export sales.

DOD provided no guidance on how to maximize savings from export
sales. As a result, program offices often handled export sales
differently. We do not believe that every contract should be
negotiated and administered in the same way. However, guidance
could point out actions that have been shown to maximize savings.
These actions include combining purchases of weapon systems for
the U. S. military with purchases for foreign countries,
negotiating and enforcing clauses that reduce weapon system prices
if export sales are made within a reasonable time after DOD
contracts are awarded, requiring contractors to perform work in
the most economical manner, and allocating sustaining engineering
and program management costs evenly over all units produced under
a contract. In addition, DOD provided the Congress with little
information on the impact of foreign military and contractors'
direct export sales on the price of the five weapon systems, the
waivers that were part of some sales agreements, or the potential
for budget reductions created by savings from weapon system
exports. Although DOD is not required to provide this information,
the data could have helped the Congress determine whether export
sales achieved the goal of reducing the cost of U. S. weapon
systems and whether DOD required all of the funds it requested to
purchase weapon systems.

Recommendations We recommend that the Secretary of Defense develop
guidance that will assist the military services in maximizing
savings from export sales. Matters for DOD does not always reduce
its annual budget request to reflect savings Congressional from
export sales or inform the Congress so that it may consider doing
so. As evidenced by the Congress' reduction of the Aegis Weapon
System's

Consideration 1998 budget, information on savings due to export
sales can be useful to the Congress in making budget decisions. In
addition, the Congress may

find information on cost savings and waivers of nonrecurring costs
useful when reviewing proposed export sales. The Congress could
use this information to judge the extent to which such sales will
contribute to the cost reduction goal articulated by the
Conventional Arms Transfer Policy.

Accordingly, the Congress may wish to consider requiring that the
Secretary of Defense develop guidance to ensure that budget
requests reflect actual and projected savings from foreign
military sales. In addition, the Congress may wish to consider
requiring that the Secretary of Defense provide information on
projected foreign military sales savings and waivers of
nonrecurring costs when notifying the Congress of proposed sales.
Finally, the Congress may wish to consider tasking the Secretary
to assess the feasibility of collecting information that would
quantify the impact of contractors' direct export sales on the
price of U. S. weapon systems. If DOD is successful in collecting
this data, it could also be reflected in

budget requests and sales notifications. Agency Comments and

In commenting on a draft of this report, DOD concurred with our
Our Evaluation

recommendation to develop guidance that will assist the military
services in maximizing savings from export sales. DOD did not
concur with our recommendation that it include information about
the impact of export sales on each program's funding request. DOD
noted that consideration of export sales is already a normal part
of the budgeting process and that isolating the impact of export
sales from other factors that affect program

cost estimates would have no benefit. Neither did DOD concur with
our recommendation that the Secretary of Defense collect
information that would allow an assessment of the impact of export
sales on the price of U. S. weapon systems. DOD said its
requirement to provide cost and pricing data in sole- source
acquisitions and its reliance on price competition in competitive
acquisitions ensure that DOD obtains a reasonable price for its
weapon systems. We based our recommendations on the Congress' need
for additional information to support the budgetary and arms
transfer decision- making processes, not as a substitute for other
means of obtaining a fair price. We found during our review that
DOD did not consistently reduce military budgets to account for
savings from export sales or provide enough information for the
Congress to do so. DOD's disclosure of the budgetary impact of
export sales would give the Congress greater oversight of military
budgets. Complete data that includes the impact of an export sale
on DOD's weapon system price would also assist the Congress in
making an informed arms sales decision. The Congress and the
executive branch base decisions on a

number of factors. In recent years, one important consideration
has been the value that accrues to DOD from export sales in the
form of lower unit

costs. Yet we found during our review that the Congress is asked
to approve export sales without information regarding the impact
of export sales on the price of U. S. weapon systems. The Congress
could benefit from information regarding production cost savings
created by export sales and waivers of nonrecurring costs
associated with the sales. This data would allow the Congress to
assess whether export sales achieve the goal, established by the
Conventional Arms Transfer Policy, of reducing the price of U. S.
weapon systems. In our opinion, additional information would
improve budgetary oversight and assist the Congress in determining
the extent to which export sales

achieve Conventional Arms Transfer Policy goals. Therefore, we
have deleted recommendations to the Secretary regarding those
issues and addressed them to the Congress.

DOD also provided a technical comment on the report. We reviewed
DOD's suggestion and made an appropriate change. Scope and

We conducted our review as a case study of five weapon systems--
the Methodology Hellfire missile, AMRAAM, HMMWV, Black Hawk
Helicopter, and Aegis Weapon System. We judgmentally selected the
systems because they

represent acquisitions of each of the U. S. military services,
were produced by four different contractors, and were of varied
price. Because the sample is small, we cannot statistically state
that the conditions we found in our sample would be found in all
export sales. However, the sample illustrated the diverse actions
that affect DOD's ability to maximize savings from export sales.
We calculated the effect export sales had on the price of DOD's
weapon

systems by analyzing contractor proposal data and prices and
government billing adjustments. For the Hellfire and AMRAAM
missiles and one Aegis Weapon System purchase, we examined the
contractors' proposed prices

for varying quantities to determine the price DOD would have paid
if it had purchased only the quantity of weapon systems required
by the U. S. military. We compared DOD's price for this lower
quantity of systems to the Department's price for a larger
quantity that satisfied both U. S. and foreign military
requirements. The difference between the two prices represented
system savings. To calculate the remainder of the Aegis Weapon
System and all HMMWV savings, we determined the elements of the
systems' costs that were affected by changes in the production
rate. Once we identified these elements, we recomputed their cost
assuming a

level of production that satisfied only U. S. requirements. We
defined system savings as the difference between the contractor's
proposed price, which was based on U. S. plus export requirements,
and the price we calculated using the recomputed cost elements.
For the Black Hawk, we examined government billing adjustments to
determine the sustaining engineering and program management costs
that the government recovered when it added these costs to the
contractor's price for foreign military sales systems. The Army
made this adjustment because the contractor had charged these
costs, which benefited all units, to helicopters purchased when
the Army awarded its annual production contract and none to units
produced for foreign military sales. We considered all recovered
costs as savings. All costs and savings are

reported in current year dollars unless otherwise noted. Data were
not available to estimate dollar savings by year that would allow
conversion to constant dollars. To accomplish our analysis, we
collected documents from and held discussions with the Air- to-
Ground Missile Systems Project Office, Huntsville, Alabama; the U.
S. Army Aviation and Missile Command (AMCOM) Acquisition Center,
Huntsville, Alabama; the Air- to- Air Joint Systems Program
Office, Eglin Air Force Base, Florida; the Light Tactical

Vehicles Program Office, Warren, Michigan; the U. S. Army Tank-
Automotive and Armaments Command (TACOM) Acquisition Center,
Warren, Michigan; the Utility Helicopter Program Management
Office, Huntsville, Alabama; and the Aegis Weapon System Program
Office, Crystal

City, Virginia. We also analyzed and discussed proposal data,
price matrices, offset data, overhead analyses, and savings from
export sales with officials at Lockheed Martin Electronics and
Missiles, Orlando, Florida; Raytheon Missile Systems Company,
Tucson, Arizona; AM General Corporation, South Bend, Indiana;
Sikorsky Aircraft Corporation, Stratford, Connecticut; and
Lockheed Martin Government Electronic Systems, Moorestown, New
Jersey. While at the contractor locations, we talked with Defense
Contract Management Command and DCAA personnel about export sales'
impact on contractor overhead rate calculations. We determined
whether DOD exercised its authority to waive nonrecurring research
and development and production costs by analyzing foreign military
sales documents and discussing nonrecurring cost waivers with
officials at the AMCOM Security Assistance Management Directorate;
the

Air- to- Air Joint Systems Program Office; the TACOM Security
Assistance Center; and the Aegis Weapon System Program Office.

In addition, we reviewed DOD's export sales notification and
budgetary processes to determine whether DOD provided information
on anticipated savings and waivers to the Congress when notifying
it of expected export sales or requesting budgetary authority to
purchase the weapon systems. We collected documents from and held
discussions with officials from the

Defense Security Cooperation Agency, the Air- to- Ground Missile
Systems Project Office, the Air- to- Air Joint Systems Program
Office, the Light Tactical Vehicles Program Office, the Utility
Helicopter Program Management Office, and the Aegis Weapon System
Program Office. We conducted our work from July 1998 through May
1999 in accordance with generally accepted government auditing
standards. As agreed with your office, unless you publicly
announce its contents earlier, we plan no further distribution of
this report until 30 days from its issue date. At that time, we
will send copies of this report to other interested congressional
committees; the Honorable William Cohen, Secretary of Defense; the
Honorable Louis Caldera, Secretary of the Army; the Honorable
Richard Danzig, Secretary of the Navy; the Honorable F. Whitten
Peters, Secretary of the Air Force; and the Honorable Jacob Lew,
Director, Office of Management and Budget. We will make copies
available

to others upon request. A list of contacts and key contributors
for this report is in appendix II. Henry L. Hinton, Jr.

Assistant Comptroller General

Appendi I x Comments From the Department of Defense Note: GAO's
comments supplementing those in the report text appear at the end
of this appendix.

See comment 1.

See comment 2. See comment 3.

The following are GAO's comments on the Department of Defense's
(DOD) letter dated August 3, 1999.

GAO Comments 1. The detailed analysis substantiating the
computation of the reported export sales cost savings was offered
to each program office for review. Officials from three of the
program offices reviewed our data and agreed

with its results. Officials from the remaining two program offices
elected not to review the data, but did not indicate any
disagreement with the savings being reported. 2. DOD said that the
consideration of export sales is already a normal part of the
budgeting process in that program cost estimates include
consideration of contractors' direct and foreign military sales.
However, our review showed that in only one of the five instances
did a program office consistently reduce its budget to account for
the savings from export sales. Officials at four of the five
program offices told us that they did not reduce their production
cost estimates or their planned budget requests to account for
possible savings from export sales. Only the Advanced Medium Rance
Air- to- Air Missile (AMRAAM) program office adjusted its

production cost estimate and consistently decreased its planned
budget requests once export sales began to reduce weapon system
costs. 3. We reworded our recommendation to more clearly state our
intent. Our recommendation is based on the need for more
information to support the arms decision- making process and is
not intended as a substitute for other

means that DOD uses to obtain a fair price. The Congress cannot
assess whether export sales achieve the goal of reducing the price
of U. S. weapon systems unless DOD (1) isolates the production
savings realized from each export sale, regardless of whether the
sale is made directly by the contractor or through the foreign
military sales program and (2) informs the Congress of whether the
sale resulted in the recovery of some portion of the funds spent
to develop and establish production facilities for the system.

Appe ndi I I x GAO Contacts and Staff Acknowledgments GAO Contacts
Katherine Schinasi (202) 512- 4841 Barbara Haynes (256) 650- 1435
Acknowledgments In addition to those named above, Lee Edwards,
Erin Baker, and Marcus Ferguson made key contributions to this
report.

GAO United States General Accounting Office

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Appendix I

Appendix I Comments From the Department of Defense

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Appendix II

(707371) Let t e r

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