United States General Accounting Office

GAO Report to Congressional Committees

April 1996 DEFENSE

CONTRACTOR

RESTRUCTURING

First Application of Cost

and Savings Regulations

G O A

years

1921 - 1996

GAO/NSIAD-96-80

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-270798 

April 10, 1996

The Honorable Strom Thurmond

Chairman

The Honorable Sam Nunn

Ranking Minority Member

Committee on Armed Services

United States Senate

The Honorable Floyd Spence

Chairman

The Honorable Ronald V. Dellums

Ranking Minority Member

Committee on National Security

House of Representatives

Section 818 of the National Defense Authorization Act for Fiscal Year 1995

(P.L. 103-337) restricts Department of Defense (DOD) payments to

contractors for costs associated with business combinations. Specifically,

it prohibits the payment of restructuring costs, such as those associated

with closing facilities and eliminating jobs, until a senior DOD official

certifies that projected savings from the restructuring are based on audited

data and should result in overall reduced costs to DOD. In response to

section 818 requirements, DOD issued interim regulations on restructuring

costs effective December 29, 1994.

In accordance with section 818 requirements, we reviewed the

implementation of DOD’s restructuring regulations.1

 Our review sought to

determine whether the certification process was carried out in accordance

with the interim regulations and whether restructuring had resulted in

lower DOD contract prices. We focused on the United Defense, Limited

Partnership business combination between FMC Corporation’s Defense

Systems Group and Harsco Corporation’s BMY-Combat Systems

Division—two manufacturers of tracked combat vehicles for the Army.

United Defense had the first and only restructuring proposal certified as of

May 1995, when we started our review. This business combination is

particularly significant because the implementation of DOD’s restructuring

regulations at United Defense could be a model for future restructuring

efforts. The Defense Contract Management Command (DCMC), which has

lead responsibility for implementing DOD’s restructuring regulations, is

1

As also required by section 818, we previously reported on the adequacy of DOD’s interim

restructuring regulations in Defense Restructuring Costs: Payment Regulations Are Inconsistent With

Legislation (GAO/NSIAD-95-106, Aug. 10, 1995).

Page 1 GAO/NSIAD-96-80 Defense Contractor Restructuring
B-270798 

currently tracking 30 business combinations, 7 of which involve over

$450 million in audited restructuring costs and about $1 billion in audited

restructuring savings over a 5-year period.

To protect proprietary data, we do not disclose specific dollar amounts

applicable to any aspect of the United Defense restructuring.

Results in Brief DOD’s actions in reviewing and certifying the United Defense combination

generally complied with the interim restructuring regulations. As required,

the Defense Contract Audit Agency (DCAA) reviewed United Defense’s

restructuring proposal, and in May 1995, a senior DOD official certified that

the restructuring should result in overall reduced costs. However, the

projected net cost reduction certified by DOD represents less than

15 percent of the savings FMC and Harsco projected to DOD 2 years earlier

when they sought support for the proposed partnership.

Subsequent to restructuring, DOD awarded United Defense a major

contract to remanufacture combat vehicles at a price less than the price

charged prior to restructuring. Company officials believe that most of the

savings resulted from the restructuring.

Background DOD’s procurement funding for tracked combat vehicles declined by

86 percent between 1983 and 1994. In response, FMC Corporation and

Harsco Corporation combined portions of their operations to form a

limited partnership that became effective in January 1994. The United

Defense partnership created one of the largest U.S. manufacturers of

armored tracked combat vehicles.

To eliminate excess capacity and staffing resulting from the partnership,

United Defense began restructuring its operations by combining two

divisions—the California-based Ground Systems Division, previously part

of FMC, and the Pennsylvania-based Combat Systems Division, previously

part of Harsco-BMY. United Defense is moving the final assembly and test

of most product lines from California to Pennsylvania. According to

United Defense, the majority of the restructuring costs are the result of

this move. The company is also consolidating redundant staff functions,

such as finance and human resources.

Page 2 GAO/NSIAD-96-80 Defense Contractor Restructuring
B-270798 

DOD Actions

Generally Complied

With Regulations

Our review indicates that DOD’s actions in approving payment of

restructuring costs for the United Defense combination generally complied

with the interim restructuring regulations, three major elements of which

are submission of a restructuring proposal, audit of that proposal, and

certification of net benefit. United Defense submitted the required

restructuring proposal on January 3, 1995. The contractor’s proposed

savings were based entirely on workforce reductions. DCAA reviewed the

contractor’s proposal and questioned a small portion of the costs and

savings. United Defense subsequently agreed to reduce its proposed costs

and savings by the questioned amounts.

In its audit report, DCAA pointed out that the regulations require the

Administrative Contracting Officer (ACO)2

 to immediately adjust overhead

rates upon submission of a restructuring proposal to ensure that DOD

benefits from savings projected. The ACO instead required United Defense

to submit updated rates upon negotiation of the restructuring proposal.

Since United Defense was not awarded any major firm fixed-price3

contracts before it updated the rates, DOD was not adversely impacted by

this delay. However in future restructuring efforts, such actions could

place the government at risk, if contracts are awarded without a

downward price adjustment clause before rates are updated.

On May 15, 1995, the Under Secretary of Defense (Acquisition and

Technology) certified that projections of future cost savings were based

on audited cost data and should result in overall reduced cost to DOD.

Under this projection, for every dollar in costs, DOD should realize $2.49 in

total savings, or $1.49 in net savings.

Lower Savings Than

Originally Projected

Projected net savings at the time of DOD certification represent less than

15 percent of the estimate FMC and Harsco originally presented to DOD. In

late 1992, the companies requested Army financial support for the

proposed partnership, in terms of sharing the costs of restructuring, as the

Army stood to benefit from the partnership. According to FMC, the

consolidation of manufacturing and overhead functions would lower the

Army’s product costs. The companies projected that every dollar in

restructuring costs would generate over $10.00 in net savings. To put this

2

The ACO is responsible for day-to-day contract administration functions, such as determining the

allowability of contract costs and negotiating overhead rates with the contractor, subsequent to the

award of a contract.

3

Under firm fixed-price contracts, the contractor agrees to furnish supplies or services at a specified

price that is not subject to adjustment based on costs incurred.

Page 3 GAO/NSIAD-96-80 Defense Contractor Restructuring
B-270798 

projection into perspective, the Deputy Secretary of Defense advised a

congressional subcommittee in mid-1994 that based on rough data

estimated projected savings for four restructurings at that time ranged

from one and a half to seven times the projected cost. Later in these

hearings, however, the Deputy Secretary told the subcommittee that future

restructuring savings could range from four to seven times the projected

cost. In other words, for every dollar DOD invests in restructuring costs, it

could realize savings from $1.50 to $7.00.

Several factors account for the difference between the original savings

estimate of $10.00 and the current estimate of $1.49. For example, the

initial estimate was based on reductions in specific elements of cost,

including overhead, manufacturing, and material. In addition, the initial

estimate included savings from improved facility utilization resulting from

potential increases in foreign sales. However, because section 818 and

DOD’s implementing regulations only required that United Defense

demonstrate that restructuring should result in reduced costs, United

Defense chose to base its current estimate solely on elements of cost

related to workforce reductions. Also, the initial estimate was spread over

an 8-year period and was adjusted for inflation, while the current estimate

was spread over 5 years and was not adjusted for inflation. DCMC and DCAA

guidance issued subsequent to the initial estimate indicated that savings

should be calculated over a 5-year period. In addition, the initial estimate

was considered a rough-order-of-magnitude, according to DOD officials.

Restructuring

Contributed to a

Reduction in Unit

Price

At the time of our review, DOD had awarded United Defense only one new

contract that was comparable to a contract awarded prior to restructuring.

In that one contract, United Defense’s restructuring efforts did contribute

to a reduction in the unit price, but the precise amount of savings resulting

from restructuring cannot be determined. U.S. Army Tank-Automotive and

Armaments Command (TACOM) officials compared the negotiated unit

price of that one contract, a follow-on remanufacturing contract that

included the effects of restructuring, to the unit price of the initial contract

that did not include the effects of restructuring. According to TACOM

officials, the unit price of the follow-on contract was 11 percent lower than

the initial contract price, not adjusted for inflation. TACOM’s analysis was

based on the basic contract for 172 vehicles. According to United Defense

officials, the follow-on unit price was 16 percent lower, adjusted for

inflation. United Defense’s analysis was based on the basic contract plus

options, for a total of 272 vehicles.

Page 4 GAO/NSIAD-96-80 Defense Contractor Restructuring
B-270798 

Our analysis indicated that savings could range from 8 to 16 percent. The

range of savings in these three sets of estimates is due primarily to

differences in estimates of the number of units to be remanufactured and

the inflation rate used to adjust the unit price of the initial contract. The

8-percent savings estimate was based on the basic contract and not

adjusted for inflation, as with TACOM’s estimate. The 16 percent savings

was based on the inflation rate United Defense used in its

analysis—approximately 2.6 percent per year over a 2-year period—and

the basic contract plus the options.

TACOM officials believe that the reduction in unit price was due to both

restructuring and downsizing, which would have occurred absent the

restructuring. United Defense officials believe that the vast majority of the

savings was due to lower costs resulting from restructuring. Nevertheless,

our analysis illustrates the sensitivity of the projected savings to the

inflation rate and the number of vehicles purchased.

Agency Comments In commenting on a draft of this report, DOD concurred with the report.

DOD suggested two technical clarifications and we have incorporated them

in the text where appropriate. DOD’s comments are presented in their

entirety in appendix I.

Scope and

Methodology

To assess DOD’s compliance with the interim restructuring regulations, we

analyzed United Defense’s restructuring proposal, the DCAA audit report on

that proposal, and other documents. We also discussed restructuring

activities with officials from United Defense, DCMC, DCAA, TACOM, and

offices of the Director of Defense Procurement, the Secretary of the Army,

and the DOD Inspector General. In addition, we examined information on

overhead rates, business volumes, and unit prices at two United Defense

plant sites and at TACOM.

To determine the impact of restructuring on DOD contract prices, we

examined all contracts awarded after restructuring that were potentially

comparable to those awarded prior to restructuring. We calculated the

unit price of the only comparable contract, which did not include the

effects of restructuring, and compared it to the unit price of the only

similar contract that included the effects of restructuring. Furthermore,

we evaluated similar calculations and comparisons made by United

Defense and TACOM officials to determine the bases for differences in

estimates of savings.

Page 5 GAO/NSIAD-96-80 Defense Contractor Restructuring
B-270798 

We performed our review between May 1995 and January 1996 in

accordance with generally accepted government auditing standards.

We are sending copies of this report to the Chairmen of the Senate

Committee on Governmental Affairs, the House Committee on

Government Reform and Oversight, and the House and Senate Committees

on Appropriations and on the Budget; the Secretaries of Defense and the

Army; the Commander, DCMC; the Director, DCAA; and the Chief Executive

Officer, United Defense. We will also provide copies to others upon

request.

Please contact me at (202) 512-4587 if you or your staff have any questions

concerning this report. The major contributors to this report were John K.

Harper, George C. Burdette, Anne-Marie Olson, and Kelly A. Davis.

David E. Cooper

Associate Director, Defense Acquisitions Issues

Page 6 GAO/NSIAD-96-80 Defense Contractor Restructuring
Page 7 GAO/NSIAD-96-80 Defense Contractor Restructuring
Appendix I 

Comments From the Department of Defense

Page 8 GAO/NSIAD-96-80 Defense Contractor Restructuring
Appendix I 

Comments From the Department of Defense

(705104) Page 9 GAO/NSIAD-96-80 Defense Contractor Restructuring
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