United States General Accounting Office

GAO Report to Congressional Committees

April 1998 DEFENSE INDUSTRY

RESTRUCTURING

Updated Cost and

Savings Information

GAO/NSIAD-98-156

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-279390.2 

April 30, 1998

The Honorable Ted Stevens

Chairman

The Honorable Daniel K. Inouye

Ranking Minority Member

Subcommittee on Defense

Committee on Appropriations

United States Senate

The Honorable C. W. Bill Young

Chairman

The Honorable John P. Murtha

Ranking Minority Member

Subcommittee on National Security

Committee on Appropriations

House of Representatives

Section 8092 of the Department of Defense (DOD) Appropriations Act,

1998,1

 required us to report by April 1, 1998, on restructuring costs of

defense contractors involved in business combinations since 1993. This is

a non-proprietary version of our April 1, 1998, proprietary report.

The legislation required us to analyze the specific costs associated with

workforce reductions, the services provided to workers affected by

business combinations, and the savings reached from the business

combinations relative to the restructuring costs paid by DOD. This report

provides the requested information and also discusses the budgetary

implications of reported restructuring savings.2

The legislation also requested that we analyze the effectiveness of the

services provided to assist laid-off workers gain new employment. In our

April 1997 report on defense restructuring costs, we described the factors

that precluded us from determining the effectiveness of such services.3

Consequently, as agreed with your offices, we limited our efforts in this

area. We did, however, obtain descriptive information on the assistance

1

Public Law 105-56, October 8, 1997.

2

Section 804 of the National Defense Authorization Act for Fiscal Year 1998 requires us to provide

updated information on restructuring costs paid and savings realized by DOD by December 1, 1998.

3

Defense Restructuring Costs: Information Pertaining to Five Business Combinations

(GAO/NSIAD-97-97, Apr. 1, 1997).

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provided by business combinations and included such information, as

appropriate, in this report.

To accomplish our work, we obtained information in February 1998 on six

business combinations for which DOD certified that the proposals’

estimated savings will exceed their projected costs. These combinations

include:

• the United Defense Limited Partnership (UDLP), a joint venture between

FMC Corporation’s Defense Systems Group and Harsco Corporation’s

BMY Combat Systems Division;

• Martin Marietta Corporation’s acquisition of General Electric Company’s

aerospace and other business segments;

• Martin Marietta’s acquisition of General Dynamics Space Systems

Division;

• Northrop Corporation’s acquisitions of the Grumman Corporation and the

Vought Aircraft Company to form the Northrop Grumman Corporation;

• the merger of the Lockheed Corporation and Martin Marietta to form the

Lockheed Martin Corporation; and

• Hughes Electronics’ acquisition of CAE-Link Corporation.

We also obtained information pertaining to a seventh combination, Hughes

Aircraft Company’s acquisition of General Dynamics’ missile operations.

This combination was consummated prior to the requirement for DOD to

certify that savings will exceed costs. However, DOD has included this

combination in its reports to Congress on defense industry restructuring.

Background In July 1993, DOD changed a long-standing practice and permitted defense

contractors to charge restructuring costs to transferred4

 flexibly priced5

contracts, provided (1) the restructuring costs were allowable under the

Federal Acquisition Regulation and (2) a DOD contracting officer

determined the business combination would result in overall reduced

costs to DOD or preserve a critical defense capability.

Concerns over the payment of such costs led Congress to pass legislation

requiring that certain conditions be met before DOD reimbursed defense

4

Following a business combination, contracts may be transferred from one contractor to another

through a written agreement executed by the seller, buyer, and government, under which the

government agrees to the transfer of its contracts.

5

Flexibly priced contracts comprise a family of contracts under which the total amount paid to the

contractor is dependent upon the allowable costs the contractor incurs in performing the contract.

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contractors for restructuring-related expenses.6 The legislation required, in

part, that

• a senior DOD official certify that projections of restructuring savings are

based on audited cost data;

• DOD’s share of projected savings exceeds allowed costs; and

• the Secretary of Defense reports to Congress on DOD’s experience with

defense contractor business combinations, including whether savings

associated with each restructuring actually exceed restructuring costs.

The Secretary of Defense is currently required by 10 U.S.C. 2325 to

determine in writing that the savings will be at least twice the amount of

allowed costs or that projected savings will exceed costs allowed and that

the combination will result in the preservation of a critical capability.

DOD’s process to comply with these provisions requires, in part, that (1) the

contractor submit a restructuring proposal, including details on planned

restructuring activities, their projected costs, and anticipated savings;

(2) the Defense Contract Audit Agency (DCAA) audits the proposal; and

(3) following the audit, a DOD contracting official recommends whether the

proposal should be certified. Assuming a favorable recommendation, a

senior DOD official issues a written certification stating that projected

savings should exceed the projected costs. The certification enables the

contractor to bill restructuring costs to DOD and, in turn, allows DOD to

reimburse the contractor for DOD’s share of such costs.

Through December 31, 1997, DOD issued nine certifications for

restructuring proposals associated with six business combinations. DOD

officials indicated that another six restructuring proposals are in various

stages of review within DOD, and several significant business combinations

may result in future restructuring proposals. This latter category includes

Raytheon’s acquisition of the defense units of Texas Instruments and

Hughes Electronics, respectively, and the merger of Boeing and

McDonnell Douglas.

Results in Brief The seven business combinations estimated they had spent $1.2 billion at

the time of our review for such restructuring activities as the disposal and

relocation of facilities and equipment, consolidation of operations and

systems, relocation of employees, and workforce reductions. Of this

amount, the business combinations spent about $115 million on expenses

6

Public Law 103-337, § 818, October 5, 1994.

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related to workforce reductions. Severance pay constituted the majority of

these expenses, with less amounts provided for temporary health benefits

and outplacement services. Outplacement services included career

transition workshops, resume development, career counseling services,

job listings, and information on state and federal programs. Overall, the

business combinations reported that about 18,000 workers or positions

were eliminated due to restructuring activities.

DOD estimated it would realize a net benefit of about $3.3 billion from

certified restructuring activities. Further, DOD estimated that as of

August 1997 it had realized a net savings of about $1.9 billion, or more than

half of the certified amount. However, DOD’s figures may overstate the

amount that is directly attributable to restructuring. The lack of specific

DOD guidance on evaluating savings may contribute to this condition.

Caution should be exercised when using or interpreting estimates of

restructuring savings. In a budgetary context, the $3.3 billion of estimated

restructuring savings represents a cumulative amount of savings for each

business combination, often spread over a 5-year period. Such savings

constituted less than 1 percent of DOD’s research and procurement budgets

over the period for which the savings were projected. With one exception,

DOD officials told us they did not consider restructuring savings when

formulating DOD’s budget requests. The one case cited by DOD involved two

Air Force and Navy missile programs. While DOD had initially proposed

reducing the programs’ budgets to reflect anticipated restructuring

savings, DOD subsequently agreed with the military services that the

projected savings were needed to fund other program-related needs. In

cases in which restructuring activities influenced a particular weapon

system’s cost, projected savings were often offset by nonrestructuringrelated events.

Restructuring Costs For the seven business combinations we examined, certified restructuring

costs totaled about $1.5 billion. At the time of our review, the businesses

estimated they had spent about $1.2 billion (see table 1). Restructuring

costs are allocated to all of a contractor’s customers; consequently, DOD’s

portion of these costs depends on its share of the contractor’s total

business base. Based on estimates made at the time of certification, DOD

projected it would pay about 56 percent of the restructuring costs.

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Table 1: Certified and Estimated

Restructuring Costs of Seven

Business Combinations

Dollars in millions

Business combination Certified Estimated cost

Hughes-General Dynamics $366.1a $319.1

UDLP 36.4 38.5

Martin Marietta-General Electric 241.6 233.9

Northrop-Grumman-Vought 70.4 75.1

Martin Marietta-General Dynamics 71.4 63.0

Lockheed-Martin Marietta 686.5 419.5

Hughes-CAE Link 50.1 38.7

Total $1,522.5 $1,187.8

aCosts for the Hughes-General Dynamics combination were not subject to the certification

process.

Restructuring after a business combination includes a wide range of

activities, such as the disposal and modification of facilities, consolidation

of operations and systems, relocation of workers and equipment, and

workforce reductions. We grouped the estimated amount of restructuring

costs incurred by the seven business combinations into broad categories

(see table 2). Of the $1.2 billion in estimated restructuring costs, disposal

and relocation of facilities and equipment was the largest cost category.

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Table 2: Estimated Restructuring

Costs by Category Dollars in millions

Category Estimated cost

Nonemployee-related cost

Disposal, modification, or relocation of facilities and

equipment

$547.4

Consolidation of operations and systems 93.7

Restructuring planning and implementation 124.8

Other 146.3

Cost for employees remaining with company

Relocation 140.4

Retraining 10.5

Other 9.3

Cost of benefits and services for laid-off workers

Severance pay 95.8

Continuation of health benefits 4.1

Outplacement services 4.1

Other 11.4

Total $1,187.8

Impact on Defense

Workers

The seven business combinations included in our review projected that

about 21,000 workers or positions would be eliminated as a result of

restructuring activities. The business combinations also reported that, at

the time of our review, about 18,000 workers or positions had actually

been eliminated (see table 3).

Table 3: Projected and Actual Number

of Workers or Positions Eliminated as

a Result of Restructuring

Business combination Projected Actual

Hughes-General Dynamics 6,600 6,441

UDLP 483 500

Martin Marietta-General Electric 1,453 1,504

Northrop-Grumman-Vought 450 450

Martin Marietta-General Dynamics 1,150 1,250

Lockheed-Martin Marietta 10,678 7,049

Hughes-CAE Link 548 665

Total 21,362 17,859

While the job losses attributed to restructuring are significant, the losses

reflect the overall downsizing in defense-related employment. DOD

estimates that defense-related industry employment will decrease from

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about 2.7 million workers in 1993 to about 2.1 million workers by the end

of 1998.

Costs of Benefits and

Services Provided to

Laid-Off Workers

The seven business combinations estimated they spent about

$115.4 million—or about 10 percent—of the total restructuring costs for

benefits and services associated with workforce reductions. The majority

of these costs were for severance pay, with less amounts for temporary

health benefits and outplacement services. Outplacement included such

services as career transition workshops, resume development, career

counseling services, job listings, and information on state and federal

programs. The costs for worker benefits and services varied by business

combination, ranging from 3 percent to 14 percent of the combination’s

total restructuring costs.

A key determinant in whether laid-off workers received severance

payments was whether the company provided such benefits prior to the

business combination. For example, General Dynamics, Northrop, and the

Vought corporations did not provide severance benefits to their workers

prior to the combination; consequently, workers who were laid off as a

result of restructuring received no severance benefits from their former

employer. For those companies that provided severance pay, the amount

varied, depending on such factors as whether the workers were salaried or

hourly employees and the length of time they had been with the

corporations.

Laid-off workers may also be provided benefits and services that were not

funded by DOD. For example, the state of California, through the San Diego

Consortium and the Private Industry Council, awarded Martin Marietta

$935,000 to assist General Dynamics’ laid-off employees.

Some Reported

Savings May Not Be

Directly Attributable

to Restructuring

Each of the combinations that sought payment for restructuring activities

was required to demonstrate that DOD’s share of the estimated savings

from the restructuring would exceed DOD’s share of the projected costs.

Overall, DOD estimates that it should realize a net savings of about

$3.3 billion from restructuring activities (see table 4). DOD’s figures

indicate that for each dollar of restructuring costs it expects to pay, it will

receive about $4.81 in benefits. However, not all of the reported savings

may be directly attributable to restructuring.

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Table 4: DOD’s Share of Projected

Restructuring Costs and Savings Dollars in millions

Business combination Savings Cost

Net

savings Ratio

Hughes-General Dynamicsa $505.8 $132.5 $373.3 3.82 - 1

UDLP 79.7 29.1 50.6 2.74 - 1

Martin Marietta-General Electric 305.4 156.3 149.1 1.95 - 1

Northrop-Grumman-Vought 263.4 46.7 216.7 5.64 - 1

Martin Marietta-General Dynamics 139.6 50.7 88.9 2.75 - 1

Lockheed-Martin Marietta 2,675.8 405.9 2,269.9 6.59 - 1

Hughes-CAE Link 148.1 35.0 113.1 4.23 - 1

Total $4,117.8 $856.2 $3,261.6 4.81 - 1

aWith the exception of Hughes-General Dynamics, all costs and savings figures reflect the values

used in DOD’s certification decision. As the Hughes-General Dynamics combination occurred

prior to the requirement for DOD to certify that savings will exceed costs, DOD did not prepare a

comparable figure for total restructuring savings. The $505.8 million shown in table 4 reflects

DOD’s share of a March 1997 estimate of total restructuring savings; the cost figure represents

DOD’s original estimate of costs.

DCAA’s guidance on auditing restructuring proposals may not provide

sufficient criteria to ensure that the proposed savings are directly due to

restructuring. DCAA’s guidance discusses at length factors to consider in

evaluating proposed costs, but it provides far less guidance on evaluating

savings. Relative to evaluating projected restructuring savings, the

guidance notes that contractor restructuring efforts are intended to result

in the combinations of facilities, operations, or workforce that eliminate

redundant capabilities, improve future operations, and reduce overall

costs. It further notes that it is the contractor’s responsibility to establish

and support the reasonableness of the baseline to measure restructuring

savings, but notes that various techniques can be used to do so. Finally,

the guidance requires DCAA auditors to ensure that the estimates of future

savings are reasonable and not due to other factors, such as changes in

inflation or interest rates.

This broad framework may result in DOD’s accepting proposed savings that

are not directly attributable to restructuring. For example, as part of our

ongoing work at Lockheed Martin’s Space and Strategic Missiles sector,

we attempted to isolate the effects of restructuring from nonrestructuringrelated activities. The overall savings from this sector are considerable,

amounting to about 43 percent of the total amount of projected

restructuring savings from the seven combinations in our review. Of the

savings accepted by DOD for certification purposes, about $489 million was

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attributed to increased operational efficiencies at one location through the

adoption of improved business practices.

Contractor officials acknowledged that some of the improvements and

associated savings could have been implemented without restructuring,

noting that the contractor had various efforts to improve its operational

efficiency underway or planned prior to restructuring. However, these

officials believed that the business combination provided the means to

overcome organizational and cultural barriers that might otherwise have

hindered these efforts. A senior Lockheed Martin official emphasized that

the merger provided the company a unique opportunity to evaluate and

implement the best practices from four Lockheed and Martin Marietta

facilities.

DCAA officials told us that during their audit of the restructure proposal for

certification, they did not consider whether such savings could have been

accomplished in the absence of restructuring. They noted, however, that

they did not believe that DCAA’s guidance provides sufficient criteria to

distinguish savings attributable to restructuring from those savings that

would have occurred regardless of the restructuring.

The Department of Justice and the Federal Trade Commission face a

similar issue during their reviews of proposed mergers and acquisitions. In

April 1997, the agencies issued revised guidance that discusses the types of

efficiencies they consider germane to their reviews. In general, while the

agencies will consider savings as part of their analysis, these agencies

consider only those savings that are specific to the merger and that are

unlikely to be accomplished in the absence of the merger. For example,

the guidance notes that efficiencies resulting from shifting production

among facilities formerly owned by the separate firms are more likely to

be related to the merger. On the other hand, the guidance notes that other

efficiencies, such as those relating to management improvements, are less

likely to be specifically related to the merger. In our view, while evaluating

proposed savings requires flexibility and the use of professional judgment,

reflecting a similar approach in DCAA’s guidance would provide a better

depiction of the impact of restructuring activities.

Estimating Actual

Savings Inherently

Difficult

While DOD reports to Congress its estimates of whether savings associated

with each business combination actually exceed restructuring costs, it

acknowledges that making accurate estimates is inherently difficult. DOD

reported that, as of August 1997, it had reimbursed defense contractors

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approximately $294.3 million in restructuring-related expenses, while it

estimated that savings of about $2.2 billion had been realized (see table 5).

As a result, DOD estimated that it has realized a net benefit of about

$1.9 billion, or more than half the $3.3 billion in net savings certified for

the seven business combinations. The savings reported by DOD were

generally not developed from a detailed analysis of the effect of

restructuring on individual contract prices, but rather were calculated

using the same or similar methodologies employed during the certification

process.

Table 5: DOD Estimates of Its Share of

Paid Restructuring Costs and Realized

Savings as of August 31, 1997

Dollars in millions

Business combination Paid cost

Realized

savings Net savings

Hughes-General Dynamics $121.4 $505.8a $384.4

UDLP 14.0 37.6b 23.6

Martin Marietta-General Electric 71.9 198.2 126.3

Northrop-Grumman-Vought 14.5 98.2c 83.7

Martin Marietta-General Dynamics 26.4 163.7 137.3

Lockheed-Martin Marietta 35.3 1,118.4d 1,083.1

Hughes-CAE Link 10.8 32.1 21.3

Total $294.3 $2,154.0 $1,859.7

aThe report indicated that the Hughes-General Dynamics savings related to only eight contracts;

however, the estimate was for the total business combination.

bDCAA reported that the UDLP savings were inadvertently overstated by about $10.3 million.

cEstimated savings are based on two of the six projects certified. These two projects accounted

for 90 percent of total projected savings.

dThe estimated savings reflect about $869 million attributed to restructuring activities at two of

Lockheed Martin’s business units. At one unit, due to time constraints, DCAA limited its review to

determining whether the claimed savings were consistent with those accepted during

certification, and did not verify savings to specific contracts or verify the accuracy of the amounts

claimed. To a lesser degree, time constraints also limited DCAA’s efforts at the other unit.

However, DCAA did reject about 13 percent of the savings claimed by Lockheed Martin at these

locations.

Caution should be exercised when interpreting the reported savings. DOD

has consistently said that it is inherently difficult to precisely identify the

amount of actual savings realized through restructuring activities several

years after the initial estimate. For example, DOD has stated it is not

feasible to completely isolate the effects of restructuring from such other

factors as fluctuations in a contractor’s business base, changes in the

inflation rate, accounting system changes, subsequent reorganizations, and

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unexpected events, which also impact a contractor’s cost of operations.

Recognizing such difficulties, DOD initially agreed that it would not require

validation of the projected savings for two business combinations, noting

in one agreement that such a validation was not practical because of

business dynamics and future uncertainties. However, DOD estimates

actual savings resulting from these two business combinations in response

to the reporting requirement.

The difficulty in isolating the effect of nonrestructuring activities and their

impact on estimating savings is illustrated by restructuring activities

following Martin Marietta’s acquisition of General Dynamics Space

Systems Division. In this case, DCAA used a different business base in

estimating actual restructuring savings than was used to estimate the

certified savings. The use of a different business base led, in part, to DOD’s

share of net savings shown in table 5—$137.3 million—being considerably

higher than the $88.9 million of net savings expected at certification. DCAA

officials told us that they were unaware of any way to isolate changes in

Martin Marietta’s current business base to make it comparable to that used

during the certification process.

Impact of

Restructuring Savings

on DOD Budget

Requirements Has

Been Limited

The impact of restructuring savings on DOD’s budget requirements has

been limited. Projected savings constituted a small percentage of DOD’s

budgets and were generally not considered by DOD officials in formulating

budget requests. Also, even when restructuring activities influenced a

weapon system’s cost, the impact was often offset by nonrestructuringrelated events or used to fund other program-related needs.

DOD’s estimate of restructuring savings—which includes those savings that

may not be directly related to restructuring—represents a cumulative

amount of savings, often spread over a 5-year period, for each business

combination. Overall, DOD estimated it would realize a net savings of about

$3.3 billion between 1993 and 2000.7

 In comparison, DOD’s approved or

projected budgets for research and procurement totaled more than

$658 billion over that same period. Consequently, DOD’s share of certified

savings constitutes less than 1 percent of DOD’s budgets.

A senior DOD budget official stated that DOD generally has not considered

restructuring savings when formulating its budget requests and relied on

the individual program offices to do so. He acknowledged, however, that

7

The actual figure for DOD’s share of net savings is slightly higher than the figure reflected above,

principally because restructuring costs are generally amortized. Consequently, while certified savings

are to be realized between 1993 and 2000, DOD will incur restructuring costs through 2004.

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DOD’s budget guidance does not specifically require the program offices to

consider restructuring savings. This official also told us that the one

exception that he was aware of involved Raytheon’s recent acquisition of

Hughes’ defense business, for which DOD considered reducing the

projected budgets for the advanced medium range air-to-air missile

(AMRAAM), a joint Air Force/Navy program, and the Navy’s standard missile

program to reflect anticipated savings. Regarding the AMRAAM, Air Force

officials argued that any savings that resulted from the business

combination were needed to fund future programmatic needs. According

to Navy officials, the savings were used to budget for additional missiles

for both programs. DOD subsequently agreed not to reduce the proposed

budgets to reflect restructuring savings.

Our work provides two other examples of how restructuring activities

influenced the costs of major weapon systems without directly affecting

budgetary requirements. For example, following the Northrop Grumman

business combination, several restructuring activities, including closing

Grumman’s former headquarters in Bethpage, New York, were

undertaken. Consequently, the amount of corporate overhead costs

allocated to Northrop Grumman’s business units, including the B-2

program, was less than projected before the business combination. B-2

program officials told us that no adjustments were made to the B-2

program’s estimated costs or future budget requests due to restructuring.

According to these officials, projected savings from the combination may

have been reflected in new overhead rates, which would then be used in

preparing new contract proposals or finalizing overhead rates on existing

flexibly priced contracts. In fact, the B-2’s general and administrative

overhead rate—to which corporate overhead costs are allocated—actually

rose significantly from 1993 to 1996, due principally to the decrease in the

planned procurement of B-2s. Consequently, while the lower corporate

overhead costs resulted in the B-2’s general and administrative overhead

rate being slightly lower than it would have been without the

restructuring, the changes in planned procurement more than offset the

impact of restructuring.

Similarly, the Air Force’s Titan IV launch vehicle program was affected by

the Martin Marietta-General Dynamics and Lockheed-Martin Marietta

business combinations. According to Lockheed Martin, restructuring

activities resulted in a benefit of over $600 million to the Titan IV program.

Titan IV program officials agreed that restructuring activities reduced

projected program costs, but indicated that it was not possible to precisely

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quantify the impact of restructuring. These officials explained that a

number of changes were occurring concurrently on the Titan program,

including a reduction in the number of launch vehicles and the

implementation of various acquisition reform initiatives.8

 Nevertheless,

program officials told us that restructuring activities contributed to their

ability to absorb congressional, DOD, or Air Force budget cuts or to fund

other program-related needs.

Recommendation Our work indicates that DCAA’s guidance does not provide sufficient

criteria to evaluate restructuring savings, particularly savings that may

have been achievable without restructuring. Estimates based on this

guidance may not accurately depict the savings associated with

restructuring. Consequently, we recommend that the Secretary of Defense

direct the Director, DCAA, to clarify DCAA’s guidance on evaluating

restructuring savings. In particular, the guidance should discuss how to

evaluate proposed savings based on activities that were ongoing or

planned prior to restructuring or that could have been achieved absent

restructuring, such as those achievable by management improvements.

Agency Comments

and Our Evaluation

DOD commented on a draft of the proprietary report. DOD disagreed with

our finding that some of the savings it reports may not be directly

attributable to restructuring. DOD also disagreed with our recommendation

that DCAA’s guidance needs to be clarified. DOD believed DCAA’s current

guidance properly implements the legislative requirements. DOD indicated

that in reviewing restructuring proposals, it is most concerned with

ensuring both that savings exceed costs by the required ratio and that

restructuring costs and savings are factored into contract pricing

mechanisms as quickly as possible. DOD further noted that when a

contractor can demonstrate that savings will significantly exceed costs,

there is usually no reason to argue over whether the savings could have

been accomplished without restructuring.

We agree with DOD that it has established a process to comply with the

legislative intent that DOD’s share of projected savings exceeds its

projected share of costs, and strongly agree that DOD should ensure that

the impact of restructuring is factored into contract pricing mechanisms as

8

We reported on the effects that acquisition reform initiatives had on weapon system funding in our

report, Acquisition Reform: Effect on Weapon System Funding (GAO/NSIAD-98-31, Oct. 29, 1997). We

reported that the Titan IV’s estimated cost, measured in terms of changes to its December 1993 and

December 1995 selected acquisition reports, fell from $37.7 billion to $23.6 billion. DOD attributed

$661.8 million of this reduction to acquisition reform initiatives.

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quickly as possible. We also believe DCAA’s guidance provides an overall

framework to evaluate savings. For example, the guidance states

contractor restructuring efforts are intended to result in the combinations

of facilities, operations, or workforce that eliminate redundant

capabilities, improve future operations, and reduce overall costs. The

guidance further states that auditors should ensure that future savings are

reasonable and not due to other factors, such as changes in inflation or

interest rates.

Nevertheless, our work indicates that this broad framework may result in

DOD accepting savings that may not be directly attributable to

restructuring. At one location at which a considerable amount of savings

were proposed due to the adoption of improved business practices,

contractor officials acknowledged that some of the improvements and

associated savings could have been implemented without restructuring,

noting that the contractor had various efforts to improve its operational

efficiency underway or planned prior to restructuring. DCAA officials

indicated that DCAA’s guidance does not provide sufficient criteria to allow

them to question such savings.

Ensuring that such savings are related to restructuring would seem a basic

element necessary to satisfy the legislative criteria and DCAA’s own

guidance. Further, DOD reports annually to Congress on the net savings

expected from combinations certified during the preceding year, as well as

estimates of savings actually realized. While making such estimates is

inherently difficult, the reports should, in our view, attempt to accurately

depict the impact of restructuring to the extent possible. Finally, several

business combinations have recently announced their intent to

restructure, including Raytheon and Boeing. Our discussions with DCAA,

Defense Contract Management Command (DCMC), and contractor officials

indicated that better guidance as to what constitutes restructuring-related

savings would assist in these efforts. Consequently, we believe augmenting

the existing criteria with a discussion of the various factors that auditors

should consider in evaluating savings is a reasonable request.

DOD’s comments are reprinted in appendix I.

Scope and

Methodology

To determine the amount and nature of restructuring costs, we requested

the cognizant DCMC office to provide updated restructuring-related cost

and savings information for each of the business combinations in our

review. We analyzed this information to determine the amount of

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restructuring costs incurred for workforce reductions and to identify the

costs associated with services provided to assist laid-off workers find

reemployment. We did not, however, independently verify the information

provided.

In assessing restructuring savings relative to the restructuring costs paid

by DOD, we relied on the information contained in DOD’s November 22,

1997, report to Congress. We did examine, however, the methodology DCAA

used to estimate the amount of restructuring costs paid by DOD and the

amount of estimated savings at selected units of business combinations at

which we conducted work.

To determine the budgetary implications of restructuring savings, we

compared DOD’s share of certified restructuring savings to DOD’s actual or

projected budgets for the period over which the savings were expected to

be realized. We discussed how DOD uses projected restructuring savings in

formulating its budget requests with officials from the Office of the Under

Secretary of Defense (Comptroller/Chief Financial Officer). We also

discussed how projected restructuring savings were used by the Air

Force’s Titan IV and B-2 program offices in formulating their budget

requests.

Finally, we discussed various aspects of the restructuring costs and

savings with officials from the business combinations, DOD, DCMC, and

DCAA.

We performed our review between December 1997 and March 1998 in

accordance with generally accepted government auditing standards.

We are sending copies of this report to appropriate congressional

committees; the Secretary of Defense; the Commander, DCMC; and the

Director, DCAA. We will also provide copies to other committees and

Members of Congress upon request.

Page 15 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
B-279390.2 

Please contact me at (202) 512-4841 if you or your staff have any questions

concerning this report. The major contributors to this report are listed in

appendix II.

David E. Cooper

Associate Director

Defense Acquisitions Issues

Page 16 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Page 17 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Contents

Letter 1

Appendix I 

Comments From the

Department of

Defense

20

Appendix II 

Major Contributors to

This Report

25

Tables Table 1: Certified and Estimated Restructuring Costs of Seven

Business Combinations

5

Table 2: Estimated Restructuring Costs by Category 6

Table 3: Projected and Actual Number of Workers or Positions

Eliminated as a Result of Restructuring

6

Table 4: DOD’s Share of Projected Restructuring Costs and

Savings

8

Table 5: DOD Estimates of Its Share of Paid Restructuring Costs

and Realized Savings as of August 31, 1997

10

Abbreviations

AMRAAM advanced medium range air-to-air missile

DCAA Defense Contract Audit Agency

DCMC Defense Contract Management Command

DOD Department of Defense

UDLP United Defense Limited Partnership

Page 18 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Page 19 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix I 

Comments From the Department of Defense

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

Page 20 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix I 

Comments From the Department of Defense

Now on pp. 7-9.

See comment 1.

Page 21 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix I 

Comments From the Department of Defense

See comment 2.

See comment 3.

Page 22 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix I 

Comments From the Department of Defense

Now on p. 13.

Page 23 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix I 

Comments From the Department of Defense

The following are our comments on the Department of Defense’s (DOD)

letter dated March 26, 1998:

GAO Comments 1. Questions regarding the treatment of proposed restructuring savings

have arisen during other certifications. We illustrated it at one business

segment because of the large amount of savings there and the concerns

expressed by the Defense Contract Audit Agency (DCAA), Defense Contract

Management Command (DCMC), and contractor officials regarding the need

for additional guidance. However, we did not intend to imply that

certification of the overall business combination—which had to

demonstrate only that DOD’s share of projected savings exceeded its

projected share of costs—was improper.

It should be noted that the issue as to what constitutes restructuringrelated savings is not limited to the certification process, but also plays a

role in DOD’s report to Congress on realized savings. For example, based in

part on our work at this business segment, DCAA officials rejected

$66 million in savings the contractor claimed on one program. While DCAA

rejected more than $124 million overall at this location, DCAA officials told

us the absence of clear criteria precluded them from questioning

additional amounts of the claimed savings.

2. We would agree that any costs associated with activities that are not

directly related to restructuring should not be subject to the certification

process, but rather should be reviewed under normal auditing practices.

As with savings, eliminating costs that are not restructuring-related would

provide a more accurate depiction of restructuring activities.

3. We did not intend to suggest that DOD should adopt the joint guidance

issued by the Department of Justice and the Federal Trade Commission

per se, but rather we used the joint guidance to illustrate an approach that

DCAA should consider in revising its guidance. We have revised the text

accordingly.

Page 24 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
Appendix II 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

John K. Harper

Timothy J. DiNapoli

Paula J. Haurilesko

John D. Heere

Atlanta Field Office George C. Burdette

Erin B. Baker

Beverly A. Breen

Los Angeles Field

Office

Dorian R. Dunbar

Kenneth H. Roberts

Thaddeus S. Rytel, Jr.

San Francisco Field

Office

Ruth-Ann Hijazi

Donald Y. Yamada

(707349) Page 25 GAO/NSIAD-98-156 Defense Restructuring Cost and Savings
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