Defense Acquisitions: Use of Cost Reduction Plans in Estimating F-22
Total Production Costs (Testimony, 06/15/2000, GAO/T-NSIAD-00-200).

Pursuant to a congressional request, GAO discussed the Air Force's F-22
Raptor Program and its impact on production cost reduction plans,
focusing on the: (1) status of cost reduction plans, including some
plans not yet implemented, and identifying Air Force procedures for
reporting on the plans; and (2) comparison of 1999 cost estimates
developed by the Air Force and the Office of the Secretary of Defense
with the congressional cost limitation.

GAO noted that: (1) of the total $21 billion in cost reductions
identified by the F-22 contractors in their plans, about half of that
amount is categorized as implemented and the other half as not yet
implemented; (2) GAO's review of 10 cost reduction plans not yet
implemented indicates that achieving reductions from 3 of the plans will
depend on decisions by the Office of the Secretary and Congress; (3) in
addition, one of the three plans--to delay establishing an Air Force
depot maintenance capability for the F-22--may only defer the costs to
future years; (4) also, one of the three plans, estimated to reduce
costs by almost a half billion dollars, was so uncertain that neither
the Office of the Secretary nor the Air Force considered it to be likely
to achieve the cost reduction proposed; (5) both the Office of the
Secretary and Air Force cost estimators projected F-22 production costs
that exceeded the congressional cost limitation of $39.8 billion in
effect at that time; (6) in 1999, after considering the potential of all
the cost reduction plans, the Air Force estimated F-22 production costs
at $40.8 billion, and the Office of the Secretary estimated production
costs at $48.6 billion; (7) both estimates were based on the production
of 339 aircraft; (8) the Office of the Secretary's estimate exceeded the
Air Force's estimate by $7.8 billion, or 19 percent; (9) the difference
is attributable to the Office's higher estimates of the cost of
production ($3.7 billion) and lower estimates of the impact of
production cost reduction plans not yet implemented ($4.1 billion); (10)
the Office of the Secretary cost estimates exceeded the congressional
cost limitation by about $8.8 billion; (11) putting the higher estimate
in perspective, if the Office of the Secretary estimate is correct and
additional cost reduction plans are not developed and implemented, GAO
estimates that the Air Force would have to buy about 85 fewer F-22
aircraft than now planned to stay within the congressional cost
limitation; (12) although Air Force cost estimators projected a total of
$40.8 billion in production costs, the official Air Force cost position
was $39.8 billion, the same as the congressional cost limitation; (13)
Air Force officials said that the Air Force selected the $39.8 billion
as its official cost estimate because the detailed breakout of the
estimate for fiscal years 2001 through 2005 was about the same as that
budgeted for those years; and (14) the difference between the estimate
and the budget is primarily associated with the estimate for years after
2005.

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

 REPORTNUM:  T-NSIAD-00-200
     TITLE:  Defense Acquisitions: Use of Cost Reduction Plans in
	     Estimating F-22 Total Production Costs
      DATE:  06/15/2000
   SUBJECT:  Air Force procurement
	     Cost analysis
	     Military cost control
	     Fighter aircraft
	     Comparative analysis
	     Military budgets
	     Future budget projections
IDENTIFIER:  F-22 Aircraft
	     Air Force F-22 Raptor Program
	     F-22 Raptor Aircraft
	     Joint Strike Fighter

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GAO/T-NSIAD-00-200

Testimony

Before the Subcommittee on National Security, Veterans Affairs, and
International Relations, Committee on Government Reform, House of
Representatives

For Release on Delivery

Expected at

10:00 a.m.

Thursday, June 15, 2000

DEFENSE ACQUSITIONS

Use of Cost Reduction Plans in Estimating F-22 Total Production Costs

Statement of Allen Li, Associate Director

Defense Aquisitions Issues

National Security and International Affairs Division

GAO/T-NSIAD-00-200

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our ongoing work on the impact that
production cost reduction plans are projected to have on the Air Force's
F-22 Raptor Program.

The F-22 Raptor is an air superiority aircraft being developed to replace
F-15 fighter aircraft. Lockheed Martin Corporation and Pratt & Whitney
Corporation are the contractors for the airframe and engine, respectively.
Development, which started in 1991, is scheduled to be completed in August
2003. The Air Force plans to enter low-rate initial production in December
2000. Appendix I lists products we have issued that relate to the F-22
program.

Projections of higher production costs have been a source of concern for
several years. In 1996, because of potential cost increases, the Air Force
established a team--known as the Joint Estimating Team--to review the total
estimated cost of the F-22 program. The team concluded that the cost of
production could grow substantially from the amounts planned, but that cost
reduction initiatives could be implemented to offset that cost growth. The
Office of the Undersecretary of Defense for Acquisition, Technology, and
Logistics generally adopted the team's recommendations to change certain
aspects of the program, as well as a plan to define and implement cost
reduction initiatives. F-22 production costs were also discussed in the
National Defense Authorization Act for Fiscal Year 1998 (P.L. 105-85, Nov.
18, 1997). That act limited the total cost of F-22 production but did not
specify the total number of aircraft to be procured. The most recent
production costs estimates were completed by the Air Force and the Office of
the Secretary of Defense in 1999. Both of these estimates considered cost
reduction initiatives known as production cost reduction plans. Hundreds of
these plans-totaling $21 billion--had been identified by the airframe and
engine contractors, with participation by the Air Force's F-22 program
office.

At the Subcommittee's request, we are now reviewing the impact of the
production cost reduction plans on F-22 costs, specifically focusing on (1)
determining the status of cost reduction plans, including some plans not yet
implemented, and identifying Air Force procedures for reporting on the
plans, and (2) comparing the 1999 cost estimates developed by the Air Force
and the Office of the Secretary of Defense with the congressional cost
limitation. My statement today presents our preliminary observations.

RESULTS IN BRIEF

Of the total $21 billion in cost reductions identified by the F-22
contractors in their plans, about half of that amount is categorized as
implemented and the other half as not yet implemented. Our review of 10 cost
reduction plans not yet implemented indicates that achieving reductions from
3 of the plans will depend on decisions by the Office of the Secretary
and/or the Congress; implementing these cost reduction plans is therefore
beyond the Air Force's ability to control. In addition, one of the three
plans--to delay establishing an Air Force depot maintenance capability for
the F-22--may only defer the costs to future years. Also, one of the three
plans, estimated to reduce costs by almost a half billion dollars, was so
uncertain that neither the Office of the Secretary nor the Air Force
considered it to be likely to achieve the cost reduction proposed.

Both Office of the Secretary and Air Force cost estimators projected F-22
production costs that exceeded the congressional cost limitation of $39.8
billion in effect at that time. In 1999, after considering the potential of
all the cost reduction plans, the Air Force estimated F-22 production costs
at $40.8 billion, and the Office of the Secretary of Defense estimated
production costs at $48.6 billion. Both estimates were based on the
production of 339 aircraft. The two estimating groups did not use the same
estimating methods, nor did they make the same assumptions about which cost
reduction plans were already implemented or about the cost reductions
achievable from plans not yet implemented. For example, for cost reduction
plans that were not yet implemented, the Air Force's estimating group
allowed $10.2 billion (of the total estimate of $10.8 billion) for potential
future cost reductions, and estimators from the Office of the Secretary
allowed $6.1 billion. The Office of the Secretary's estimate exceeded the
Air Force's estimate by $7.8 billion, or 19 percent. The difference is
attributable to the Office's higher estimates of the cost of production
($3.7 billion) and lower estimates of the impact of production cost
reduction plans not yet implemented ($4.1 billion). The Office of the
Secretary cost estimates exceeded the congressional cost limitation by about
$ 8.8 billion. Putting the higher estimate in perspective, if the Office of
the Secretary estimate is correct and additional cost reduction plans are
not developed and implemented, we estimate that the Air Force would have to
buy about 85 fewer F-22 aircraft than now planned to stay within the
congressional cost limitation. Although Air Force cost estimators projected
a total of $40.8 billion in production costs, the official Air Force cost
position was $39.8 billion, the same as the congressional cost limitation.
Air Force officials said that the Air Force selected the $39.8 billion as
its official cost estimate because the detailed breakout of the estimate for
fiscal years 2001 through 2005 was about the same as that budgeted for those
years. They said the difference between the estimate and the budget is
primarily associated with the estimate for years after 2005.

F-22 COST REDUCTION PLANS WORTH BILLIONS

HAVE NOT YET BEEN IMPLEMENTED AND SOME DEPEND

ON CONGRESSIONAL OR DEFENSE DEPARTMENT ACTION

In response to recommendations of the Joint Estimating Team, contractors and
the F-22 program office proposed cost reduction plans to use enhanced
production technology, improved manufacturing techniques, and revised
acquisition principles to buy materials. These plans show changes to
business design, processes, and practices to realize cost reductions. Cost
reduction plans are categorized "implemented" if they meet one of several
criteria such as the impact of the reduction being reflected in a current
contract price. The estimated value of cost reduction plans is shown in
table 1.

Table 1: Status of Contractors' Production Cost Reduction Plans

Then-year dollars in billions

 Reason for reduction                  Implemented   To be           Total
                                                     implemented
 Improve manufacturing processes and
 incorporate new technology            $2.7          $5.2            $7.9
 Improve efficiency and reduce
 supplier costs                        2.0           1.7             3.7
 Resolve obsolescence and diminishing
 sources issues                        1.3           .3              1.6
 Improve material procurement
 strategies                            .7            .3              1.0
 Apply performance-based contracting
 practices                             .5            0               .5
 Defer or avoid government investment
 in depot maintenance capability       3.0           .3              3.3
 Award production contracts for
 multiple years                        0             1.8             1.8
 Manufacture Joint Strike Fighter and
 F-22 components in the same plants    0             1.2             1.2
 Totals                                $10.2         $10.8           $21.0

Note: The F-22 program office provided input to the contractors' plans.

Source: F-22 program office data.

As shown in table 1, about half of the estimated value of the identified
cost reduction plans are categorized as implemented. Allocated equally over
a planned procurement of 339 F-22 aircraft, a $21-billion cost reduction
equates to about $62 million per F-22 to be produced. This amount of
reduction per F-22, if achievable, is significant. For example, F-15
aircraft, were procured in fiscal years 1996-98 at an average unit cost of
about $46 million.

Implementation of Some Remaining

Cost Reduction Plans Not Ensured

Achievement of reductions from 3 of the 10 plans not yet implemented that we
reviewed will depend on decisions of the Office of the Secretary of Defense
and/or the Congress. Thus, the Air Force cannot control implementation of
the cost reduction plans.

One of the three plans estimates a cost reduction of about $2.6 billion and
proposes that all F-22 depot-level maintenance be performed by the
contractor until at least 2008. Under this proposal, the Air Force would not
have to develop a capability to perform depot-level maintenance during
production and would thus save production costs. Before this plan can be
implemented, the Secretary of the Air Force must determine it conforms to 10
U.S.C. 2464, which describes the maintenance of a core logistics capability,
and 10 U.S.C. 2466, which establishes a ceiling on contractor performance of
depot maintenance.

This plan may only defer some costs until after completion of production.
The plan states that its purpose is to reduce costs by delaying the
establishment of government depot capabilities until the system matures,
which is defined as accumulating 100,000 flying hours in fiscal year 2008.
It also states that the contractor support concept will be implemented to
reduce the required depot investment and that most of that expense to
develop an Air Force capability will be deferred until about 2012. The last
buy of F-22 production aircraft is scheduled for fiscal year 2011. The Air
Force would decide at that time whether to fund the costs of an Air Force
depot-maintenance capability with procurement or operation and maintenance
appropriations. If these costs are deferred until after the F-22 production
program is complete, they will no longer count against the congressional
cost limitation.

Another cost reduction plan that is dependent on decisions by the Congress
and the Office of the Secretary estimates that F-22 costs will be reduced by
about $1.05 billion through lower overhead rates and increased buying power,
since many of the same contractors and subcontractors that are building the
F-22 will also build the Joint Strike Fighter. The Congress and the Office
of the Secretary control the schedule and quantity of the Joint Strike
Fighter aircraft. Therefore, this cost reduction is dependent on decisions
being made on a program external to the F-22. If the Joint Strike Fighter
program is not approved or is delayed, then the F-22 production program will
not achieve the projected cost reductions.

The third cost reduction plan requires the Congress to approve the multiyear
procurement of the F-22, which the airframe contractor estimates will reduce
the cost of production by about $1.5 billion. The contractor proposes that
production be contracted for 5 years in advance, beginning in 2004.
According to the plan, because of cost reductions available through
long-term commitments such as a 5-year contract, the subcontractors and the
contractor would accept lower prices for the aircraft being procured. A
multiyear contract must meet specific criteria and be approved by the
Congress. Specifically, the multiyear contract must result in substantial
savings compared to awarding annual contracts, the item being bought must
have a stable design and not have excessive technical risks, and the
estimated cost of the system and the estimated cost avoidance from the
multiyear procurement are realistic. The Air Force plans to award a
multiyear contract for fiscal year 2004 contract and will need congressional
approval for a multiyear contract in fiscal year 2003 to support advance
procurement funding. Since the F-22 development program is not scheduled for
completion until August 2003, the potential exists that the F-22 program
will not meet the multi-year procurement criteria by 2003.

Status of One Cost Reduction Plan Is Uncertain

Another cost reduction plan of uncertain status involves obtaining titanium
sponge from the Defense Logistics Agency's National Defense Stockpile Center
at no cost and providing it to the manufacturer instead of paying the
manufacturer for the raw material. This plan is estimated to ultimately
reduce the production cost of the F-22 by $458 million. It assumes that the
cost of titanium sponge would be $3.00 per pound if purchased by the
contractor and that about 30 million pounds would be needed. It further
assumes that the funds not expended for titanium sponge, about $90 million,
would be used to invest in additional cost reduction plans, and thus reduce
the total cost by $458 million. Although the plan assumes that $4.00 to
$5.00 in cost reductions will be achieved for each dollar invested, the
contractor and the Air Force have not identified the specific projects in
which the funds would be invested. This plan was not used to reduce
estimated production costs by either cost estimators from the Office of the
Secretary or the Air Force because of the uncertainty of congressional
approval.

Although this plan might reduce F-22 production costs, the cost to the
government would not be reduced by that amount. If the National Defense
Stockpile Center does not give titanium sponge to the F-22 program, it can
sell it to the private sector and create income for its own fund. In fiscal
year 1999 the Center's sales of titanium sponge averaged $1.94 per pound.
Since the Air Force will need about 30 million pounds of titanium sponge for
F-22 production, the lost revenue to the Center could be about $60 million
($1.94 per pound times 30 million pounds). Therefore, what may be
significant cost reduction for the F-22 program could result in some lost
revenue for the Defense Logistics Agency.

Individual Plans Tracked but

Regular Reporting Not Accomplished

The Air Force and airframe and engine contractors have established
procedures to track the status of the production cost reduction plans. Both
contractors have developed an information system that records the identified
plans, the expected cost reduction from each of them, and their
implementation status. The systems and the procedures were established to
generate, evaluate and implement cost reduction plans. The Air Force and the
contractors monitor the status of the plans using data from the system.

The Under Secretary of Defense for Acquisition, Technology, and Logistics
requested the Air Force to report quarterly on the status of F-22 costs.
However, Air Force quarterly reports to the Under Secretary have not
included status information on cost reduction plans since June 1999. The
data is available to make detailed reports. For example, the Air Force is
able to categorize plans as implemented or yet to be implemented and to
perform specific searches of the contractor's information system.

OFFICE OF THE SECRETARY AND

AIR FORCE ESTIMATES EXCEEDED

THE CONGRESSIONAL COST LIMITATION

The Air Force and Office of the Secretary cost estimating groups did not use
the same methods to estimate the cost of F-22 production, nor did they use
the same assumptions about which cost reduction plans were implemented or
not yet implemented. After considering the potential cost reductions, both
estimates exceeded the congressional cost limitation that was in effect at
the time the estimates were prepared. However, the Air Force used the cost
limitation as its cost position.

Differences Between the Air Force and the

Office of the Secretary Estimates

The two groups used different estimating methods, such as different
assumptions regarding (1) production rates, (2) the impact of breaks in
production, and (3) which historical data to use. These differences caused
the Office of the Secretary estimate to be higher than the Air Force
estimate for the following reasons:

   * Air Force cost estimators assumed that the eight production
     representative test vehicles approved for purchase in fiscal years 1999
     and 2000 would generally be produced as two lots of four aircraft each,
     based on the contractors' delivery schedules. Office of the Secretary
     estimators assumed the contractors would produce the eight aircraft to
     fit their manufacturing schedules most efficiently.

   * Air Force cost estimators assumed that as a result of a stop in
     production of some of the avionics items, the higher cost reductions
     normally experienced in manufacturing the early units would also occur
     on later units. Cost estimators from the Office of the Secretary did
     not assume the higher cost reductions would be experienced on the later
     units. As a result, the Air Force's estimate was significantly lower
     than the Office of the Secretary's estimate.

   * The Air Force and the Office of the Secretary used different historical
     cost data to estimate the cost of the F-22 avionics. For example, the
     Air Force used experience on F/A-18 avionics and the Office of the
     Secretary used experience on multiple systems.

Different Allowances for Cost Reduction

Plans Not Yet Implemented

The Air Force estimated that costs would be reduced by $10.2 billion as
additional cost reduction plans were implemented, while the Office of the
Secretary estimated it would achieve $6.1 billion in cost reductions. Among
the reasons for the different amounts are that the estimators used different
baselines from which to calculate a reduction, different estimated returns
on funds invested to reduce costs, and different assumptions on the percent
of reductions likely to occur by eliminating nonproductive steps. As a
result of the differences, the Office of the Secretary allowed less for cost
reductions than the Air Force.

According to Air Force officials, there were some differences because the
two estimating groups used different assumptions about which plans were
already implemented. For example, the Office of the Secretary considered
about $1 billion in reductions associated with the Joint Strike Fighter and
radar production as implemented. Because the Joint Strike Fighter has not
been approved for production, the Air Force did not consider that cost
reduction to have been implemented.

Comparison of Estimates With

Congressional Limitation

As shown in table 2, the Air Force estimate was $40.8 billion after allowing
for $10.2 billion of additional expected cost reductions that have not been
implemented. The Office of the Secretary estimate was $48.6 billion after
allowing $6.1 billion for additional cost reductions that have not been
implemented. Both of these estimates exceeded the cost limitation of $39.8
billion in effect at that time.

Table 2 Production Cost Estimates for the F-22

Then-year dollars in billions
                                     Office of the
 Description                         Secretary       Air Force  Difference
                                     estimate        estimate
 Cost estimate after considering
 cost reductions                     $54.7           $51.0      $3.7
 Allowance for cost reductions that
 have not been implemented           (6.1)           (10.2)     4.1
 Net cost estimate                   $48.6           $40.8      $7.8

Note: Parentheses indicate negative numbers.

Source: Office of the Secretary and Air Force data.

Consequently, as a result of the differences in estimating techniques and
allowances for the cost reduction plans, the Office of the Secretary
estimated the cost of the F-22 production program about $7.8 billion or 19
percent higher than the Air Force. Officials from the Office of the
Secretary said they consider the 19 percent difference significant. We agree
that the difference is significant. If the Office of the Secretary estimate
is correct and additional cost reduction plans are not developed and
implemented, the Air Force would have to buy about 85 fewer aircraft than
are now planned to stay within the congressional cost limitation of $39.8
billion.

Air Force Selected Cost Limitation

as Its Official Cost Position

Although the Air Force cost estimate was $40.8 billion, its official cost
position is $39.8 billion, the same as the congressional cost limitation.
According to Air Force officials, the Air Force would normally select an
estimated cost that would provide an equal chance that the estimate was
either higher or lower than the actual cost of the program. For the F-22
production cost estimate, that amount was $40.8 billion, which included
about $1.2 billion for risk uncertainties. The Air Force, however, used
$39.8 billion (the congressional cost limitation amount) as its cost
position, which, according to Air Force calculations, was twice as likely to
be below the actual cost than above it. The Air Force said it selected the
$39.8 billion as its cost position because the detailed breakout of the
estimate by fiscal year was equal to or less than what the Air Force
budgeted for fiscal years 2001 through 2005 and the estimate for the years
beyond 2005 was more uncertain; that is, the further in the future the
estimate is for, the less likely it is to be accurate. Therefore, rather
than select an estimate that exceeds the cost limitation, the Air Force
selected an estimate equal to the cost limitation.

_ _ _ _ _

Mr. Chairman, that concludes my statement. I will be happy to respond to any
questions you other Members of the Subcommittee might have.

Contacts and Acknowledgments

For future questions regarding this testimony, please contact Allen Li,
(202) 512-4841, or Robert Murphy, (937) 258-7904. Individuals making key
contributions to this testimony include Mark Abraham, Leonard Benson, C.
Todd Brannon, Edward Browning, and John Van Schaik.

APPENDIX I APPENDIX I

RELATED GAO PRODUCTS

Defense Acquisitions: Decisions on the Joint Strike Fighter Will Be Critical
for Acquisition Reform (GAO/T-NSIAD-00-173, May 10, 2000).

Budget Issues: Budgetary Implications of Selected GAO Work for Fiscal Year
2001 (GAO/OCG-00-8, Mar. 31, 2000).

F-22 Aircraft: Development Cost Goal Achievable If Major Problems Are
Avoided (GAO/NSIAD-00-68, Mar. 14, 2000).

Defense Acquisitions: Progress in Meeting F-22 Cost and Schedule Goals

(GAO/T-NSIAD-00-58, Dec. 7, 1999).

Defense Acquisitions: Progress of the F-22 and F/A-18E/F Engineering and
Manufacturing Development Programs (GAO/T-NSIAD-99-113, Mar. 17, 1999).

F-22 Aircraft: Issues in Achieving Engineering and Manufacturing Development
Goals (GAO/NSIAD-99-55, Mar. 15, 1999).

F-22 Aircraft: Progress of the Engineering and Manufacturing Development
Program (GAO/T-NSIAD-98-137, Mar. 25, 1998).

F-22 Aircraft: Progress in Achieving Engineering and Manufacturing
Development Goals (GAO/NSIAD-98-67, Mar. 10, 1998).

Tactical Aircraft: Restructuring of the Air Force F-22 Fighter Program
(GAO/NSIAD-97-156, June 4, 1997).

Defense Aircraft Investments: Major Program Commitments Based on Optimistic
Budget Projections (GAO/T-NSIAD-97-103, Mar. 5, 1997).

F-22 Restructuring (GAO/NSIAD-97-100BR, Feb. 28, 1997).

(707527)

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