United States General Accounting Office

GAO Report to Congressional Committees

June 1996 WEAPONS

ACQUISITION

Warranty Law Should

Be Repealed

G O A

years

1921 - 1996

GAO/NSIAD-96-88

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-259383 

June 28, 1996

Congressional Committees

This report addresses the use of major weapon system warranties required by 10 U.S.C. 2403

and discusses whether weapon system warranties (1) provide the expected benefits to the

government and (2) are compatible with the weapon systems acquisition process. This report

contains recommendations to the Secretary of Defense and a recommendation to the Congress,

both of which are intended to improve weapon system warranty policies and processes. We

conducted this review under our basic legislative responsibilities.

We are sending this report to you because of your Committees’ interest in these issues. Copies

are also being sent to the President of the Senate; Speaker of the House of Representatives;

Secretaries of Defense, the Air Force, the Army, and the Navy; and the Director of the Office of

Management and Budget. We will also make copies available to others upon request.

This report was prepared under the direction of Louis J. Rodrigues, Director, Defense

Acquisitions Issues, who may be reached on (202) 512-4841 if you or your staff have any

questions concerning this report. Other major contributors are listed in appendix III.

Henry L. Hinton, Jr.

Assistant Comptroller General
B-259383 

List of Congressional Committees

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 Dellums

Ranking Minority Member

Committee on National Security

House of Representatives

Page 2 GAO/NSIAD-96-88 Weapons Acquisition
B-259383 

Page 3 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

Purpose As part of the 1985 Department of Defense (DOD) Authorization Act,

Congress enacted legislation requiring DOD to obtain cost-effective

warranties on weapon systems. The warranties were expected to improve

weapon system reliability by providing a mechanism to hold contractors

liable for poor performance. Past reviews by GAO1

 and others concluded

that DOD was not properly managing its warranty program. This report

assesses whether the warranties being obtained for weapon systems

provide the expected benefits to the government and whether warranties,

as required by 10 U.S.C. 2403, are compatible with weapon system

acquisitions.

Background The warranty provisions contained in the 1985 DOD Authorization Act and

codified as 10 U.S.C. 2403 changed DOD’s approach to administering

weapon system warranties. The legislation requires warranties on weapon

systems that have a unit cost of more than $100,000 or an expected total

procurement cost of more than $10 million. The law requires the prime

contractor to guarantee that the item will (1) conform to the design and

manufacturing requirements delineated in the contract, (2) be free from all

defects in materials and workmanship at the time it is delivered to the

government, and (3) comply with the essential performance requirements

delineated in the contract.

DOD, in 1992, proposed repealing the warranty law. In 1993, the Acquisition

Law Advisory Panel also recommended that Congress repeal the warranty

law, citing the heavy administrative burden the law imposes and DOD’s

failure to realize expected warranty benefits. The Federal Acquisition

Streamlining Act of 1994 (P. L. 103-355) deleted the requirement for an

annual waiver report to Congress, but continued to require waiver

notifications to the defense committees. It also directed the Office of the

Secretary of Defense to establish guidelines for obtaining cost-effective

warranties and seeking waivers when necessary.

Results in Brief Requiring the use of warranties in weapon system acquisitions is not

practical and does not provide the government much in the way of

benefits. GAO estimated that the military services spend about $271 million

annually for weapon system warranties. These expenditures have resulted

in a financial return of approximately 5 cents for every dollar spent.

Congress expected that warranties would ensure that contractors provide

1

DOD Warranties: Improvements Needed in Implementation of Warranty Legislation

(GAO/NSIAD-87-122, July 21, 1987) and DOD Warranties: Effective Administration Systems Are

Needed to Implement Warranties (GAO/NSIAD-89-57, Sept. 27, 1989).

Page 4 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

quality weapon systems to DOD or be held accountable and would provide

an incentive for contractors to improve the weapon systems. However,

having DOD obtain warranties, in practice, is an expensive method of

resolving product failures with the contractor.

Although Congress never intended for DOD to obtain warranties that were

not cost-effective, and provided authority in the law for waivers, program

officials are discouraged from seeking waivers by a statutory waiver

process which has become burdensome and protracted. Consequently,

warranties are almost always obtained. Further, the services are not

generally conducting post-award assessments, which could provide the

basis for deciding whether or not to obtain future warranties.

Even though DOD is moving toward a more commercial acquisition system,

it retains many methods to validate the quality of weapon systems. It is

often involved in designing the system and approving the production and

quality assurance processes used by the manufacturer. It is these methods

that, while not always successful, focus on developing and producing a

high quality weapon system. A warranty simply provides a way to obtain

repairs or monetary compensation from the contractor, after a problem

has occurred, without necessarily contributing to the overall quality of the

product.

The government has traditionally self-insured because its large resources

make protection against catastrophic loss unnecessary. Further, it is often

the only buyer for a product and cannot share the insurance cost with

other buyers. As a result, a contractor cannot allocate the cost of insuring

against the risk of failure among multiple buyers. DOD will bear the entire

estimated cost. Also, DOD program officials told GAO that warranties do not

motivate contractors to improve the quality of their products. As a result,

requiring the use of warranties in weapon system acquisition is not

practical and does not provide the government much in the way of

benefits. GAO believes the warranty law should be repealed and the

decision to obtain a warranty, in appropriate cases, should be left to the

program manager.

Principal Findings

DOD’s Warranty Costs

Exceed Benefits

Based on the contracts GAO reviewed, DOD’s costs for warranties have

greatly exceeded any financial return it has received. For contracts on

Page 5 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

which DOD could provide both price and claim data, GAO estimated that DOD

received about $1 in direct benefit for every $19 paid to a contractor for a

warranty. One cause of this negative return is the low submission rate for

warranty claims.

Conceptually, warranties provide unquantifiable benefits such as prepaid

maintenance support and a mechanism for resolving product performance

disputes. For example, under a warranty, a contractor performs repairs

and charges them against the warranty. In the end, however, the

contractor profits by keeping the difference between actual claims and the

warranty price, a total of $89 million for the eight contracts GAO reviewed

that had both price and claims data. In addition, although some military

service officials said that repairs were performed quicker under a

warranty, others said the reverse was true and contractors routinely

contested warranty claims.

Waiver Process Is Not

Used as Expected

Obtaining a waiver of the warranty requirement is not considered a viable

alternative by the majority of acquisition officials GAO interviewed. Under

10 U.S.C. 2403, only the Secretary of Defense or an Assistant Secretary of

Defense or a military service can waive the warranty requirement if the

warranty is (1) not cost-effective or (2) not in the interest of national

defense. In addition, congressional defense authorization and

appropriations committees must be notified before a waiver is granted for

major weapon systems.2

 Both requirements discouraged program officials

from seeking waivers, even when a cost-effectiveness analysis clearly

showed that a warranty was not in the best interest of the government.3

Since 1985, only 21 waivers have been requested DOD-wide, and 15 were

approved.

Cost-Benefit Analysis Are

Not Adequate

DOD regulations require that a cost-benefit analysis be performed and

documented in the contract file to determine if the warranty is

cost-effective. The Navy conducted only one cost-benefit analysis in the

contracts reviewed by GAO. For the Air Force and Army contracts we

reviewed, GAO found the cost-benefit analyses that were conducted were

inadequate because (1) warranties were sometimes not separately priced,

thereby omitting a major cost; (2) the analyses failed to account for the

2

For 10 U.S.C. 2403, a major weapon system is one subject to the Selected Acquisition Reports in 

10 U.S.C. 2432.

3

Prior to the Federal Acquisition Streamlining Act of 1994, DOD also had to submit an annual warranty

waiver report for waivers that were not covered by the notification requirement.

Page 6 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

government’s administrative costs; (3) the analyses often assumed that all

potential defects would be identified and claims submitted; and (4) the

services did not conduct present value analyses, which allow the

comparison of current expenses with future benefits.

Warranty Post-Award

Assessments Are Generally

Not Being Performed

Post-award assessments are required by each of the services’ regulations.

These include an in-process assessment required by all the services, and a

final payoff assessment only required by the Army. These assessments are

used to determine whether the warranty costs are commensurate with the

benefits received and to identify the advantageous and disadvantageous

warranty provisions for future contracts. The military services, however,

conducted post-award assessments for only 3 of the 38 contracts GAO

reviewed.

Weapon Acquisitions

Seldom Benefit From

Warranties

Conceptually, a warranty in weapon system acquisitions may provide

three functions: insurance, assurance-validation, and incentivization.4

These functions have distinct purposes; however, none of them have really

worked to DOD’s advantage and GAO did not find any cases that justified the

expense of buying a warranty to perform one of these functions.

• The insurance function protects a buyer against catastrophic financial loss

or excessive operating costs as well as the risks of repair or replacement

costs. This concept is flawed in weapon system acquisitions because

insurance is based on the principle of shared risk. However, the

government is usually the only purchaser of a weapon system and the

contractor cannot allocate the cost of insuring against that risk among

multiple buyers. The complete cost for the estimated risk must be borne

by the sole buyer or absorbed by the contractor. If it is borne by the buyer

it becomes the price of the warranty. If it is absorbed by the contractor,

then it is a cost that must be covered by the price of the system. In both

cases the buyer, DOD, pays. In addition, even a large, key defense

contractor would most likely be unable to absorb a catastrophic loss and

would be protected by the government from going out of business in

attempting to pay that loss.

• The assurance-validation function ensures that all the products conform to

the design, quality, and performance levels specified in the contract.

However, DOD is extensively involved in creating the design, approving the

production processes, and conducting tests and inspections of the weapon

4

Robert E. Kuenne, Paul H. Richanbach, Frederick R. Ridell, and Rachel Kaganoff, Warranties in

Weapon System Procurement: Theory and Practice, Westview Press, (1988).

Page 7 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

system. The only potential benefit this warranty function appears to

provide the government is protection against the failure of these

processes.

• The incentivization function theoretically motivates a contractor to

improve product quality, thereby minimizing any repair costs. However,

the vast majority of procurement officials GAO interviewed do not believe

they induce the contractors to improve the quality of weapon systems.

Contractors calculate the cost of projected failure rates and repair costs

and include these costs in the warranty price.

The only real benefit that a warranty seemed to provide is to extend

beyond acceptance the period in which DOD can determine that a product

does not conform to contract specifications and requirements and require

the contractor to make repairs.

Recommendations to

the Secretary of

Defense

GAO recommends that the Secretary of Defense establish an expedited

waiver process that will limit the disincentives inherent in the current

process. GAO also recommends that the Secretary of Defense revise DOD’s

acquisition policies to adequately manage those warranties that the

military services determine should be obtained. Consideration should be

given to (1) requiring that all weapon system warranties be separately

priced in order to allow meaningful cost-benefit analyses; (2) improving

cost-benefit analyses through more realistically reflecting the likelihood of

claim submission, performing present value analyses, and including the

government’s administrative costs; and (3) ensuring that the services

enforce the regulations requiring post-award assessments of weapon

system warranties so that the services will know why these warranties

were or were not beneficial to the government. GAO also recommends that

the Secretary of Defense direct the Secretaries of the Air Force and the

Navy revise their regulations to specifically require a final payoff

assessment for weapon system warranties as the basis for purchasing

more beneficial follow-on warranties and building institutional knowledge

for procuring and administering effective warranties.

Recommendation to

Congress

The administrative problems that GAO has identified appear to be

unintended consequences of the warranty law due to the de facto

mandatory nature of warranties. Attempts to administratively correct the

problems have not been very successful. Since DOD continues to have

problems administering weapon system warranties and the warranties

provide minimal benefits for the costs incurred, Congress should

Page 8 GAO/NSIAD-96-88 Weapons Acquisition
Executive Summary

repeal 10 U.S.C. 2403. Were the warranty requirement repealed, DOD and

the services would still have management flexibility to obtain warranties

for major weapon systems when deemed appropriate. As was done prior

to the warranty law, DOD and the services would rely on the Federal

Acquisition Regulation and their own policies to determine when it is

appropriate to obtain a weapon system warranty. The decision should be

documented as part of the system acquisition strategy.

Agency Comments

and GAO’s Evaluation

In commenting on a draft of this report, DOD stated that it “strongly

supports” GAO’s recommendation that Congress should repeal 10 U.S.C.

2403. Since 1992, DOD has supported the need for congressional repeal of

the weapon system warranty law. DOD only partially concurred with the

recommendations to the Secretary of Defense, stating that the solution to

the problems cited by GAO is repeal of the law. DOD indicated that it will ask

the military departments to review their warranty waiver process. DOD

noted, however, that in order to remove the disincentives and streamline

the waiver process it needs relief from the congressional notification

requirement and the warranty waiver approval level.

DOD stated that it did not see the need to separately price warranties

because it has insight into warranty costs through cost reporting and can

project warranty cost from actual claim data. Although DOD currently has

insight into warranty costs, GAO found that this information is often not

used in the cost-benefit analyses. Therefore, GAO believes that separately

pricing the warranty would permit DOD to perform better warranty

cost-benefit analyses.

DOD stated that all the military departments have in place regulations that

require post-award assessments, but acknowledged that the military

departments were not fully complying with existing regulations. DOD stated

that it would reiterate the importance of such assessments in a

memorandum to the military departments. GAO’s review indicated,

however, that only the Army’s regulation specifically requires a final

pay-off assessment to determine the economic benefit derived from a

warranty. GAO believes that the Air Force and the Navy regulations should

be revised to explicitly require final payoff assessments.

Page 9 GAO/NSIAD-96-88 Weapons Acquisition
Contents

Executive Summary 4

Chapter 1 

Introduction

12

Warranty Law Requirements 12

Types of Warranties 13

Prior Reviews 14

Objectives, Scope, and Methodology 15

Chapter 2 

Weapon System

Warranties Are

Expensive and Have

Provided Little

Benefit

17

Weapon System Warranties Are Not Cost-Effective 17

Warranty Waivers Are Not Used as Expected 21

Cost-Benefit Analyses Are Not Adequate 25

Warranty Post-Award Assessments Are Generally Not Being

Prepared

27

Conclusions 29

Chapter 3 

Warranties Often Not

Appropriate for Use in

Weapon Acquisitions

30

Insurance Aspect Is Not Typically a Good Reason for Obtaining a

Warranty

30

Warranties Are Not Generally a Good Means of Assuring Quality

Systems

32

Warranties May Not Provide Much Incentive to Improve Product

Quality

33

Warranties May Confer Limited Benefits at Great Expense 34

Conclusions 35

Recommendations to the Secretary of Defense 36

Recommendation to Congress 36

Agency Comments and Our Evaluation 36

Appendixes Appendix I: Quantified Costs and Benefits of Warranties 38

Appendix II: Comments From the Department of Defense 39

Appendix III: Major Contributors to This Report 44

Figure Figure 2.1: Air Force Waiver Approval Process for the F-16 23

Abbreviations

FAR Federal Acquisition Regulation

DFARS Defense Federal Acquisition Regulation Supplement

DOD Department of Defense

GAO General Accounting Office

Page 10 GAO/NSIAD-96-88 Weapons Acquisition
Page 11 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 1 

Introduction

In the 1970s and the 1980s, Congress received numerous reports about

problems with the weapon acquisition process, namely that weapon

systems often failed to meet their military missions, were operationally

unreliable, and had defects in materials or workmanship. To address

manufacturing deficiencies and performance shortcomings, Congress

began requiring the Department of Defense (DOD) to obtain written

warranties on all production contracts for weapon systems costing over

$100,000 per unit or whose eventual acquisition cost is more than

$10,000,000.1

 Congress expected that obtaining cost-effective warranties

would enable DOD to hold contractors accountable for the performance of

their systems and that the risk of financial consequences would encourage

contractors to improve the quality and reliability of the systems.

In 1984, when the warranty provision was first enacted, many DOD and

industry officials criticized the law as being impractical, unworkable, and

potentially costly. An amended version enacted in the 1985 DOD

Authorization Act and codified as 10 U.S.C. 2403, was intended to correct

the problems.

For most non-weapon system purchases, the Federal Acquisition

Regulation (FAR) prescribes the procedures and purposes of obtaining a

warranty. Under the FAR, the use of a warranty is not mandatory. The FAR

allows contracting officers to require contractors to provide warranties on

products sold to the government. The decision is based on a determination

that a warranty would be in the government’s best interest. In addition, the

Defense Federal Acquisition Regulation Supplement (DFARS) provides

additional guidance on when it is appropriate to obtain a weapon system

warranty.

Warranty Law

Requirements

Under 10 U.S.C. 2403, an agency head is prohibited from entering into a

production contract for a weapon system with a per unit cost greater than

$100,000, or a total system cost over $10 million, unless the prime

contractor provides a warranty. The prime contractor must warrant that

items provided under the contract (1) conform to the design and

manufacturing requirements delineated in the contract, (2) are free from

all defects in materials and workmanship at the time of delivery, and

(3) meet the essential performance requirements delineated in the

1

The statute uses the term guarantee. However, warranty is the more commonly used term to describe

the extended contractual relationships envisioned by the law, so we will use that term in this report.

Page 12 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 1 

Introduction

contract.2 Contractors are not required to provide a warranty on

government-furnished equipment.

If the Secretary of Defense determines that a warranty is not in the interest

of national defense or that a warranty will not be cost-effective, he may

waive all or part of the warranty requirement. The Secretary cannot

delegate the waiver authority below the level of an Assistant Secretary of

Defense or of a military department. The Secretary must also notify the

Senate Committee on Armed Services and the House Committee on

National Security before granting a waiver for a major weapon system.3

Types of Warranties Generally, warranties require that the contractor repair or replace

noncomplying or defective goods covered by the warranty without cost to

the government and/or pay the government’s costs of correcting the

defective condition. Warranted defects or deficiencies may be caused by

poor design, faulty manufacturing processes, or the use of materials that

do not meet contract specifications. The cost and coverage of warranties

are negotiated on a contract-by-contract basis.4

 Typical weapon system

warranties fall into one of the following three categories: failure-free,

threshold, and systemic.

When a system is covered by a failure-free warranty, the contractor is

obligated to correct all defects that occur during the warranty period.

Although a failure-free warranty is easy to implement, it is associated with

high costs due to the higher risks assumed by the contractor. A threshold

warranty requires a contractor to remedy a defect when a threshold, such

as a predetermined number of part or system failures, is exceeded. This

type of warranty recognizes that all weapon systems malfunction to some

degree, and the warranty only requires action if the weapon system does

not meet the agreed-upon reliability levels.

A systemic warranty covers a system against a defect that occurs with

regularity throughout a production lot or fleet. In the case of systemic

warranties, the government must prove that the defects are occurring

regularly by either conducting its own investigation or supervising an

2

As defined in the statute, “essential performance requirements” are the operating capabilities or

maintenance and reliability characteristics of the system that the Secretary of Defense determines are

necessary for the system to fulfill the military requirement for which it is designed.

3

For 10 U.S.C. 2403, a major weapon system is one subject to the Selected Acquisition Reports of 

10 U.S.C. 2432.

4

Negotiable items include the duration of the warranty and the maximum financial exposure of the

contractor under the warranty.

Page 13 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 1 

Introduction

investigation by the contractor. Once the government proves that a

systemic defect exists, the contractor is responsible for replacing or

repairing all of the items produced under the circumstances that caused

the defect. Some systemic warranties also require the contractor to

redesign warranted items if the defect is the result of a design problem.

A DOD weapon system may be covered by multiple types of warranties. For

example, an item may be covered by a failure-free warranty until it is

transferred to a unit, and then covered by a systemic warranty.

Prior Reviews In 1987, we reported5

 that the military services were obtaining warranties

without assessing cost-effectiveness. We also found that warranty terms

and conditions were not clearly stated in most contracts. Also, many

warranties did not delineate whether redesign was a remedy if

performance requirements were not met. We concluded that this situation

could result in warranty administration problems.

In 1989, we reported6

 that (1) the Office of the Secretary of Defense was

not actively overseeing warranty administration by the services; (2) the

services had not established a fully effective warranty administration

system; (3) the procurement activities had problems performing

cost-effectiveness analyses; and (4) the services, therefore, did not know

whether they should seek warranty waivers. We concluded that DOD had

little assurance that warranty benefits were being fully realized.

DOD’s Director for Defense Procurement, in 1992, proposed repealing the

warranty law. This initiative was included as Section 620 of DOD’s

Legislative Program for the 103rd Congress.

In a January 1993 report,7 DOD’s Acquisition Law Advisory Panel, referred

to as the Section 800 Panel, recommended repealing the warranty law

based upon two reviews8

 that highlighted significant problems with the

5

DOD Warranties: Improvements Needed in Implementation of Warranty Legislation

(GAO/NSIAD-87-122, July 21, 1987).

6

DOD Warranties: Effective Administration Systems Are Needed to Implement Warranties

(GAO/NSIAD-89-57, Sept. 27, 1989).

7

DOD’s Acquisition Law Advisory Panel, Streamlining Defense Acquisition Laws (Jan. 1993), pp. 2-113

to 2-119.

8

The reviews were MKI, Inc., Warranty Guidebook Research Summary, Defense Systems Management

College (1992) and Office of the Deputy Director for Defense Systems Procurement Strategies, Report

on the Administration of Department of Defense Weapon System Warranties (Sept. 1992).

Page 14 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 1 

Introduction

administration and effectiveness of the law. These reviews found that

(1) waiver requests were not seriously considered, (2) the use of waivers

had been “virtually nil,” (3) contractor expenses for warranty repairs were

less than the negotiated price for the warranty in four out of five cases,

(4) only two out of seven threshold warranties ever reached the threshold,

(5) no claims had been made on systemic warranties reviewed, and

(6) service regulations requiring post-award reviews of warranty

cost-effectiveness were not enforced. The Panel’s alternate

recommendation was to revise 10 U.S.C. 2403 to address the

implementation problems. The Section 800 Panel sought greater flexibility

in implementing and tailoring warranties, as well as limiting warranties to

major weapon systems. Furthermore, the Section 800 Panel recommended

that the waiver approval authority be lowered from the Assistant Secretary

level and that a policy statement be issued encouraging the use of waivers

when a warranty is not cost-effective.

Congress did not repeal the warranty law. Instead, the Federal Acquisition

Streamlining Act of 1994 (P.L. 103-355) modified the congressional

notification requirement so that an annual report of waivers granted is no

longer required, although the defense committees are still to be notified

before a waiver is granted for a major weapon system. The act also

required DOD to issue guidance on negotiating cost-effective warranties

and on waivers. In response, DOD revised subpart 246.7 of DFARS to stress

that the use of weapon system warranties may not be appropriate in all

situations and that a waiver should be obtained if a warranty is not

cost-effective or in the interest of national defense.

Objectives, Scope,

and Methodology

Our objectives were to determine whether the warranties being obtained

for weapon systems provide the expected benefits to the government, and

to assess whether the use of warranties, as required by law, is compatible

with the acquisition of weapon systems. We analyzed the warranty

legislation, DOD and service policy guidance and regulations, and

procurement activity guidelines governing the use of warranties in weapon

system acquisitions. To obtain insight into the types of issues faced in

managing a warranty program, we gathered warranty information from 22

ongoing acquisition programs and reviewed the results of warranty studies

performed by the DOD Inspector General, the Office of Defense

Procurement, the Acquisition Law Advisory Panel, and others. We selected

systems based on the contract value and the type of weapon system for

contracts awarded between 1984 and 1994. Our report focuses on the use

warranties for DOD major weapon systems and does not cover the use of

Page 15 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 1 

Introduction

warranties on commercial subcomponents in weapon systems or

commercial items. In some instances, the information available in contract

files was limited because the services had not collected the information or

there was a lack of centralized documentation.

Our work was performed primarily at the six commands responsible for

managing the major acquisition programs we selected for our review. The

following are the procurement commands visited:

Air Force

Air Force Material Command

Army

Aviation and Troop Command

Missile Command

Tank-Automotive and Armaments Command

Navy

Naval Sea Systems Command

Naval Air Systems Command

At the procurement commands, we reviewed contract files, including basic

contract information, warranty and inspection clauses, cost-effectiveness

studies, and correspondence. We supplemented the information by

interviewing program management, as well as defense contracting, policy,

and legal officials. We also held discussions with officials from the Office

of the Secretary of Defense and the Defense Systems Management College.

In addition, we contacted selected contractor and professional association

officials to obtain their viewpoints on the advantages and disadvantages of

using warranties in major weapon system acquisitions.

We performed our review from November 1994 through February 1996 in

accordance with generally accepted government auditing standards.

Page 16 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 2 

Weapon System Warranties Are Expensive

and Have Provided Little Benefit

DOD is obtaining weapon system warranties that are not cost-effective

because it does not use waivers as expected by Congress and does not

perform adequate cost-benefit analyses or post-award assessments to

ensure that the decisions to obtain or not to obtain a warranty are based

on a valid foundation. Congress did not intend for DOD to obtain warranties

that were not cost-effective. Therefore, the warranty law allows the

Secretary of Defense to waive the use of a warranty if the Secretary

determines that it would not be cost-effective.1

 However, none of the

warranties we reviewed, where claim and price data was available, were

cost-effective. We found that the government paid $94 million and

collected $5 million on these weapon system warranties. We also calculate

that the military services spend approximately $271 million annually to

pay for warranties.2

 Further, this cost is only the warranty price paid to the

contractor. It does not include the additional costs to the government of

negotiating and administering warranties. Reviews by others have also

found that weapon system warranties are generally not cost-effective.

Weapon System

Warranties Are Not

Cost-Effective

Warranties have both quantified and unquantified costs. The quantified

cost is the negotiated price for the warranty, while the unquantified cost

includes the negotiation and subsequent administration of warranties.

Warranties also provide both quantified and unquantified benefits. The

quantified benefit to the government includes financial compensation

received as a result of claims and low-cost or no-cost proposals to correct

problems, while the unquantified benefits claimed by program officials

include prepaid maintenance support for field units and the value of

having a process in place for readily resolving product performance

problems.

We found that the weapon system warranties purchased by DOD were not

cost-effective. We were able to obtain warranty price and claim data on

four weapon systems and eight contracts. In every case where price and

claim data was available, the warranty price exceeded the value of the

claims made. The combined warranty price was $94 million, the value of

the warranty claims was $5 million, and the quantified price exceeded the

quantified benefit by $89 million. (See app. I.) For example:

1

See subsection (d) of 10 U.S.C. 2403. A waiver may also be granted if the Secretary determines that

the waiver is necessary in the interest of national defense.

2

Based on our case studies, we calculated that the average price of a warranty, for the contracts we

reviewed, is about 0.87 percent of the total contract’s value. We applied this percentage to the average

amount of the contracts awarded by DOD for fiscal years 1992-95. We obtained the contract values

from DOD’s DD350 database.

Page 17 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 2 

Weapon System Warranties Are Expensive

and Have Provided Little Benefit

• The government paid $12 million for the F-15E (1) design and manufacture

and (2) materials and workmanship warranties for the 1989 and 1990

contracts, which covered the purchase of 72 aircraft. The program office

identified 260 potential warranty claims, of which 134 were agreed to and

corrected by the contractor. There were 126 claims that were not agreed

to by the contractor for a variety of reasons, including the fact that failed

parts were unavailable for contractor inspection. The program office

estimated that the average cost to fix each problem was $3,000 and that

the total financial benefit to the government was $402,000. The quantified

costs, therefore, exceeded the quantified benefits by about $11.6 million.

• The F-16 Multiyear II warranty price for 720 aircraft procured between

1986 and 1989 was $27.86 million. In a 1991 study,3

 the program office

calculated that the warranty benefit was $2.78 million, or about 10 percent

of the warranty price. While the warranty coverage had not expired at the

time, the study did project a total potential benefit of $9.94 million for this

warranty, or 36 percent of the warranty price. The study found “little

tangible return on investment” for this warranty. The program office was

unable to provide final claim figures.

• The Multiple Launch Rocket System 1985 warranty cost $1.584 million.

The estimated value of the warranty claims was $126,000. Therefore, the

quantified cost exceeded the quantified benefit by $1.458 million.

In 1992,4

 the Army found a similarly large imbalance between the costs

incurred and the total dollars recovered under several warranties. A

review of 36 expired warranties on 12 weapon systems at the Missile

Command through December 1990 showed that the warranty cost for

these contracts was $27.9 million and the dollar value of the warranted

repairs was $12.5 million—meaning that these warranties had a negative

monetary return on investment of $15.4 million.

The Air Force has also recognized that it has been obtaining some

non-cost-effective warranties. The Deputy Assistant Secretary of the Air

Force for Contracting, stated in a memorandum in 1992, “. . . we agree that

warranties are not always cost-effective. Recent experience indicates that

contractors are unwilling to provide reasonable cost proposals in some

cases, even when historical warranty cost data is available that suggests a

much lower warranty price is appropriate.”

3

Analysis of F-16 Multiyear II Engineering Change Proposals for Correction of Deficiencies, F-16

System Program Office (Feb. 22, 1991).

4

Evaluation of the U.S. Army Warranty Program, U.S. Army Materiel Systems Analysis Activity

(Technical Report No. 547, Aug. 1992), p. 49.

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The warranty price does not include all warranty costs to the government.

The costs not included in the warranty price are associated with warranty

development, administration, training, the need to obtain and provide

special data, in-plant warranty monitoring, special transportation,

increased spare component requirements because of longer logistical

repair times, decreased competition opportunities, and reduced

self-sufficiency of the military services. We did not estimate these

additional costs to the government. In some cases, we had no basis for an

estimate and in others the additional costs due to the warranty could not

be readily identified.

Not All Potential Claims

Submitted

One cause for the quantified cost exceeding quantified benefits is the low

claims submission rate for warranted items. Air Force officials told us that

one reason for the low claims rate is that submitting warranty reports and

holding parts for warranty purposes is contrary to the primary mission of

field units—to repair the equipment as soon as possible so that the

equipment and the unit can resume its mission. A warranty functions

contrary to the primary mission by requiring maintenance personnel to

hold parts until a determination can be made as to whether the part is

warranted and how it should be repaired.

In addition, maintenance personnel sometimes replace broken parts on

one system with good parts from one or more other systems to keep the

maximum number of weapon systems operating and available, thereby

fulfilling their primary mission. As a consequence, the broken or defective

parts are moved from their original weapon system. This can void a

warranty, which can require that the part submitted for a warranty claim

come from the original weapon system that the contractor delivered to the

service.

The Tank-Automotive and Armaments Command official responsible for

their cost-effectiveness analyses said that historically contractors only

accept about 30 percent of potential claims. As a result of the claims

submission problem, the Tank-Automotive and Armaments Command is

primarily obtaining systemic warranties instead of threshold warranties.

However, according to this official, the Tank-Automotive and Armaments

Command has never successfully filed a systemic warranty claim, and the

probability that claims will be filed under a systemic warranty is zero.

A report on the Army’s warranty program further supports the claims

submission problem. “Claims submission from the field is low. Only a

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fraction of the work orders are submitted for claims. For many of these,

the data are inaccurate and incomplete.” The report looked at several

commands and weapon systems and calculated that, at the

Tank-Automotive and Armaments Command, only 537 actual claims were

made out of 8,567 potential claims for 21 contracts.5

The Air Force faces similar low claims submission problems. Officials

from the Air Force Materiel Command stated that the lack of reports filed

on warranted items from the field is a serious problem. They further stated

that the most important mission to field personnel is to repair the items as

soon as possible so that the aircraft can resume its mission. Many Air

Force warranties rely on the submission of product quality deficiency

reports for filing claims. An Air Force Inspector General’s report6

estimated that only 15 to 20 percent of failures are actually reported on

these forms because they are complicated and cumbersome for

maintenance personnel to fill out. Therefore, the Air Force estimates that

80 to 85 percent of failures go unreported.

In addition to the lack of incentives for field staff to track and report

warranty claims, there is a lack of credible data systems and manpower to

administer warranty claims. One Air Force official responsible for

overseeing warranties at a major command said that because no system is

in place to track the warranties or to process claims efficiently,

administering the program is a “nightmare.” The Deputy Assistant

Secretary of the Air Force for Contracting indicated in 1992 that (1) the

problems with warranty administration are not new and (2) the Air Force

does not possess and has not been able to develop data systems designed

to track warranted items. He added that the lack of necessary manpower

resources in the field and in the program offices for accomplishing

warranty administration compounded this problem.

Benefits Claimed for

Warranties May Be

Questionable

Claimed warranty benefits include providing support that could be viewed

as a form of prepaid maintenance and a process for resolving product

performance problems. Viewed as prepaid maintenance, warranties pay

contractors a sum of money up front based on an estimate of the number

of defects that the government might claim. The contractor keeps the

difference between actual claims and the warranty price as his profit. If

5

Evaluation of the U.S. Army Warranty Program, U.S. Army Materiel Systems Analysis Activity

(Technical Report No. 547 Aug. 1992).

6

Process Effectiveness Review: Product Quality Deficiency Reporting, Office of the Inspector General,

Headquarters Air Force Materiel Command (PN 92-06, April 20 -July 29, 1992).

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the 1989 and 1990 F-15E contracts were considered a form of prepaid

maintenance, then the government paid the contractor $12 million and

made claims totaling $402,000. The contractor kept as profit $11.6 million.

Further, the warranty provides the government a process for dealing with

the contractor and delineates the contractor’s responsibilities. However,

the value of this process seems to vary from system to system. While

several program officials told us that the contractors settled claims and

fixed problems much more quickly under a warranty, other officials said

that the penalties to the contractor are low under a warranty and that

contractors routinely dispute government claims. According to one Air

Force official, the Air Force has had poor results in getting a return on the

claims it has filed. Warranty officials stated that contractors often stall and

argue about claims because (1) the contractor asserts that it could have

repaired the item more quickly or efficiently, if government maintenance

personnel repair an item and bill the contractor; (2) the maintenance

personnel did not keep the broken part for contractor inspection; (3) the

contractor may believe that the weapon system was operated outside the

performance parameters to which it was designed or the maintenance

personnel damaged the part using improper procedures, and (4) the

contractor may find that the defective part has been shifted from the

original weapon system in which it was delivered to the government.

Warranty Waivers Are

Not Used as Expected

Congress included a provision in the warranty law that allows the

Secretary of Defense or his designee (no lower than an Assistant Secretary

of Defense or a military department) to waive the requirement for a

weapon system warranty for either national defense or cost-effectiveness

reasons. However, since 1985 only 21 waiver requests DOD-wide have

reached the assistant secretary level. Of those, 15 have been approved. The

conference report accompanying the bill repealing the 1984 warranty law

and enacting the current section 2403 noted clearly that the House and

Senate Committees on Armed Services did not intend DOD obtain to

warranties that are not cost-effective. The report stated that “a failure to

conduct cost-benefit analyses and to process waivers where cost-effective

guarantees are not obtainable would defeat the legislative intent of

congressional warranty initiatives.”

The majority of program officials we interviewed said that they do not

consider waivers a viable option because of (1) the high placement of the

waiver approval authority required by the warranty law (2) the potential

for negative attention being focused on the program by these high level

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officials, and (3) the administrative burden of processing a waiver request.

The result of this reluctance to seek waivers is that warranties have

become essentially mandatory for all major contracts. This was noted by

the DOD Acquisition Law Advisory Panel (the Section 800 Panel) in a

January 1993 report where it stated that “the reluctance of DOD to issue

warranty waivers fosters the use of warranties without regard to their

cost-effectiveness.”

Service officials at several major commands and at the assistant secretary

level said that requests for waivers bring unwanted and often negative

attention to an acquisition program. One service official stated that there is

a definite “stigma” attached to waiver requests and another referred to it

as a “nightmare.” Further, waiver requests impose a significant burden on

the program office, which has to generate all the necessary paperwork,

including cost-benefit analyses, and brief them up the chain of command

to the assistant secretary level, with little or no expectation that a waiver

will be approved.

As an example, the F-16 program office sought a waiver for the essential

performance warranty of the third F-16 multiyear contract in

November 1991. The entire process—from the completion of the

cost-benefit analysis and decision to seek a waiver to the rejection of the

waiver request—took 11 months. This was the first attempt by this

program office to obtain a waiver for the weapon system. The second

attempt, on the 1994 procurement, was rejected after 8 months. The Air

Force waiver approval process for the F-16 is shown in figure 2.1.

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Figure 2.1: Air Force Waiver Approval Process for the F-16

SPO initiates waiver

request based of

results of CBA

SPO may be asked to redo CBA,

provide additional documents,

 and/or perform other tasks

AFMC/Contracting

and AFMC/FM

evaluate CBA

and package

SAF/AQCS Evaluates

Waiver Package

Denied

OK

Rejected

SAF/AQ notifies 

Congressional defense 

committees

Approved

Approved Commander, AFMC

 reviews request

Rejected

Denied

OK Package sent for

coordination and

Comment to:

SAF/AQCS

SAF/AQC

AF/PEO

PEM

AF/LGM

SAF/FM

SAF/GCQ

SAF/LL

Comments sent

Back for resolution

Selective coordination

if necessary with:

SAF/GCQ, PEM,

SAF/LL, PEO

Final review and

coordination from

SAF/AQC

Assistant Secretary

of the Air Force (Acquisition)

approves waiver

request

30 day waiting period

from date of letters to

Congress

Comments RCVD SAF/AQCS & SAF/LL

resolve comments and

issues

Comments resolved

and coordinated;

changes made as

needed

No Comments Received 

Approved waiver

sent to SAF/AQCS

Assistant Secretary

of the Air Force (Acquisition)

reviews waiver

request

Sent to AFMC Denied Approved for Distribution

to SPO

OK

Commander, ASC

reviews request

ASC/FM reviews

cost benefit analysis

OK

SAF/PEO

reviews request

Approved

Denied

Rejected

Legend: SPO-System Program Office; ASC-Aeronautical Systems Center; FM-Financial

Management; AFMC-Air Force Materiel Command; CBA-Cost-Benefit Analysis; SAF-Secretary of

the Air Force; PEO-Program Executive Office; AF-Air Force; AQ-Acquisition; AQC-Contracting;

GCQ-General Counsel for Acquisition; LL-Legislative Liaison; LGM-Directorate of Maintenance;

AQCS-Programs Division, PEM-Program Element Monitor.

Source: GAO, developed from interviews with Air Force officials.

The cost-benefit analysis for the third multiyear warranty concluded that

both the design and manufacture as well as the materials and

workmanship warranties would not be cost-effective. According to an Air

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Force program official involved in seeking these waivers, the program

office did not request a waiver on these parts of the warranty because it

believed it would be impossible to get approval. In addition, the official

said that the program office was certain that it would be directed to

renegotiate these warranties with the contractor. Rather than seek a

waiver for these warranties, the program office focused on what it

considered its strongest case for a waiver, the essential performance

warranty. The contractor had produced approximately 1,500 F-16s when

the program office began seeking a waiver and, according to an official in

the program office, the program office knew how the aircraft would

perform and also knew that the essential performance warranty would

provide no benefit to the government. The program office therefore sought

a waiver, which was denied because the warranty covered only

subsystems rather than the entire weapon system. The assistant secretary

indicated a warranty covering the entire weapon system was needed

before a decision on whether to grant a waiver could be made.

The F-16 program office again sought and was denied a waiver for the

essential performance requirement warranty for the fiscal year 1994

procurement. According to Air Force officials, a determination was made

at the assistant secretary level that, pursuant to the law, a front-line fighter

(a major weapon system) should have a warranty and the F-16, because it

is a system that has been in production for many years, should have

enough data to craft a valid warranty. Therefore, the waiver request was

rejected. The warranty obtained contained no risk to the contractor

because the warranty was tied to performance measurements that the

system had already passed, a fact the contractor and the government

already knew. The warranty thresholds have a mission reliability of

90 percent and aircraft availability of 85 percent. The aircraft achieved a

mission reliability rate of 97.2 percent and an aircraft availability rate of

91 percent during the official measurement period. This warranty was a

warranty in name only.

It was clear to us from discussions with several officials that they believe

that obtaining a warranty requires a relatively small amount of time and

effort for the program office compared to the amount of time and effort

required to avoid spending that money by obtaining a waiver. In addition,

according to officials at a major Air Force command, contractors are

aware that waivers are exceedingly difficult to obtain and may insist on a

high warranty price if the program office seeks an effective warranty. This

in turn may drive the program office to obtain reduced warranty coverage

to reduce the warranty price. Program managers do not request a waiver

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because they believe it will not be granted and, consequently, unnecessary

or costly warranties are purchased.

As required by the Federal Acquisition Streamlining Act of 1994

(P.L.103-355), DOD revised DFARS regarding weapon system warranties. The

new regulations provide guidelines for contracting officers and program

managers to use when developing and negotiating weapon system

warranties. These regulations state that the use of a weapon system

warranty may not be appropriate in all situations. Further, a waiver should

be requested if it is determined that obtaining a warranty is not

cost-effective or is inconsistent with the national defense. However,

program managers still need to obtain a waiver before deciding not to

obtain a warranty. That process has not been affected by the revised

regulations.

Cost-Benefit Analyses

Are Not Adequate

The warranty law requires DOD to obtain a warranty unless the Secretary of

Defense determines that warranty would not be cost-effective or in the

interest of the national defense. Applicable regulations (DFARS

246.770-7) require that a cost-benefit analysis be conducted and

documented in the contract file to determine if the warranty is

cost-effective. The Air Force and the Army had conducted cost-benefit

analyses for 21 of the warranties on the 30 contracts we reviewed. The

cost-benefit analyses performed, however, were inadequate because

(1) the warranties were often not separately priced, (2) the government’s

administrative costs were not fully included, (3) the analyses assumed all

potential defects would be identified and claims submitted, and (4) they

did not include a present value analysis.

The Navy conducted only one cost-benefit analysis and has not adhered to

DFARS 246.770-7, which states that “in assessing the cost effectiveness of a

proposed warranty, perform an analysis which considers both the

quantitative and qualitative costs and benefits of the warranty.” The Navy’s

policy is to obtain what it calls “no-cost” warranties. However, no

warranty is without cost, and not separately pricing a warranty does not

mean the government does not incur a cost for the warranty, only that the

price of the warranty is built into the cost of the system.7

Warranties Often Not

Separately Priced

Contracts in all services are often signed without separately pricing the

warranty. Of the 38 contracts we reviewed, 24 warranties were not

7

Warranty Guidebook, Defense Systems Management College (Oct. 1992).

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separately priced. Instead, the warranty price was included in the price of

the product, thereby making it almost impossible to perform a realistic

cost-benefit analysis. The services have different policies on pricing a

warranty. Although the Air Force’s policy since 1994 has been to

separately price all warranties, the Army does not require that the

warranty be separately priced, and the Navy maintains that it is not

appropriate to negotiate additional costs for weapon system warranties. In

addition, we were told by a DOD official that the government often pays

twice for the warranty, once in the actual price of the product and

separately in the price of a warranty.

Government

Administrative Costs Not

Included

The services performed cost-benefit analyses for 22 out of the 38 contracts

we reviewed. In general, these cost-benefit analyses do not appear to fully

include the administrative costs paid by the government for warranty

development and administration. Thus, the cost element of the analysis is

kept artificially low. However, the Tank-Automotive and Armaments

Command uses an estimate, developed in the early 1980s, that calculates

the administrative costs of processing each warranty claim as $150. The

Army could not provide us with a copy of the study from which this figure

was obtained.

Low Claims Submission

and Acceptance

The cost-benefit analyses generally assume that all or a high percentage of

claims will be made and accepted. We found that the U.S. Army Missile

Command and the U. S. Army Tank-Automotive and Armaments Command

sometimes made greatly different claims submission and acceptance

assumptions when analyzing the costs and benefits of warranties. The

1989 Multiple Launch Rocket System cost-benefit analysis by the Missile

Command assumed claims would always be filed and accepted when

warranted items break.

The Tank-Automotive and Armaments Command official responsible for

its cost-effectiveness analyses used a range of 20 to 90 percent for the

probability that claims would be filed. As discussed previously, Army and

Air Force studies indicate that actual claims submission from the field is

low. In the case of the Air Force, possibly as low as 15 to 20 percent of

actual failures.

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Present Value Analysis

Excluded

Nine of 12 cost-benefit analyses we sampled did not conduct a present

value analysis as part of the cost-effectiveness review.8

 Cost-benefit

analyses normally involve comparing different costs incurred at different

times. For two or more alternatives to be compared on an equal economic

basis, it is necessary to consider the costs of each alternative currently or

at their “present values.” This recognizes that money has earning power

over time. A present value analysis is important because it allows the

comparison of current expenses with expected future benefits by taking

into account the time value of money. Without a present value analysis,

comparing a contract with and without a warranty cannot be done

because the stream of dollars involved are not comparable.

Warranty Post-Award

Assessments Are

Generally Not Being

Prepared

Our review indicated that the services had not prepared post-award

assessments in 35 of 38 warranties that we reviewed. There are two types

of post-award assessments required, an in-process assessment and a final

payoff assessment. The in-process assessments evaluate whether the

claims made under a warranty justify its cost and document the desirable

and undesirable warranty provisions and tasks for follow-on

procurements. A final payoff assessment evaluates the economic benefits

derived from the warranty compared to the cost of corrective actions had

there been no warranty. Army regulations specifically require an

in-process and final payoff assessments. Air Force regulations only require

annual assessments and specify how the assessments should be

performed. Navy regulations only require that data be collected to perform

an annual assessment of warranty activity but does not require a final

payoff assessment.

We found that none of the services had prepared the annual in-process

assessments. In two cases, the Army did prepare final payoff assessments,

it concluded in one that the 1985 Multiple Launch Rocket System warranty

cost the government $1,458,040 more than the benefits it provided and

therefore the warranty was ineffective. In the other case, the Army

decided that the 1987 Multiple Launch Rocket System warranty, while

appropriate, might have negatively affected the reliability of the system.

According to the Army Audit Agency,

Cost-effectiveness analyses and final payoff assessments provide the management tools

and internal controls that are essential and critically needed to make sure the intent of the

law is satisfied in a way that adequately protects the interests of the Army. Without

8

One of the cost-benefit analyses did conduct a present value analysis and two did not have sufficient

documentation to make a determination.

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cost-effectiveness analyses and warranty assessments, there is little assurance that the

warranties obtained and the associated costs were commensurate with the benefits

received.

According to Air Force officials with one program office, their office

knows it will have to obtain warranties “no matter what,” so there is no

reason for a post-award assessment. These officials were referring to the

difficulty of receiving a waiver from the requirement to obtain a warranty,

discussed previously.

For the 18 Army contracts we reviewed, the Army either ignored the

requirement9

 to conduct the final payoff assessments or ignored findings

that showed the warranty benefits did not justify the costs. For example,

the 1987 Multiple Launch Rocket System final payoff assessment

specifically cited the fact that the thresholds were set so that the

government would repair the first four failures on each launcher, but only

about one claim was actually filed per launcher. Because the performance

thresholds were set so high, the warranty was unlikely to serve as an

incentive to the contractor to improve the system’s reliability and the

warranty may have had a negative effect on reliability. The Army obtained

a follow-on warranty.

Air Force regulations covering post-award assessments require the

program manager to monitor warranty feasibility and cost-effectiveness

using annual warranty activity reports submitted by the contractor or the

government. These assessments are to include a remarks section that

“identifies the warranted tasks or services that are considered desirable or

undesirable based on the claim frequency, failure mode, and dollar value.”

The Air Force had not completed this annual assessment on any of the 12

Air Force contracts we reviewed.

In 1987, the Navy10 issued instructions on warranties and stated that the

Chief of Naval Operations will develop a system for collecting and

analyzing actual warranty use and claim data on an annual basis. To date,

the Navy has not approved a warranty information system. We found only

one of the eight naval systems we reviewed had performed a post-award

assessment.

Air Force program officials stated that final payoff assessments and

post-award assessments are difficult to perform for two reasons. First, the

9

Army Regulation 700-139 (Apr. 10, 1986).

10Secretary of the Navy Instruction 4330.17 (Sept. 1987).

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warranty is not always separately priced. Second, the weapon system

warranted may have had many engineering changes from the time the

contract was initially signed until the end of the warranty period. These

changes make comparing expected costs and benefits to actual costs and

benefits difficult because the initially projected and actually produced

weapon systems are different.

Conclusions Weapon system warranties are generally not cost-effective. They have

resulted in a significant cost to the government that substantially exceeds

their benefit. The necessity of negotiating and administering the

warranties also imposes a large, but unquantified burden on the services.

The waiver process has resulted in a system in which warranties are

virtually mandatory. In this system, the program office seeking a waiver

must demonstrate why a warranty would not be cost-effective and seek

approval from an assistant secretary. It is easier and less disruptive for

that program office to obtain a warranty, regardless of whether it is

necessary or cost-effective, than it is to seek a waiver. Because the waiver

process is so burdensome and protracted, warranties are obtained without

regard to their cost-effectiveness and the officials in the program offices

have no incentive to conduct rigorous cost-benefit analyses. In addition,

post-award assessments have little value to program officials as tools to

identify desirable and undesirable warranties for future contracts because

they believe warranties will have to be obtained “no matter what.”

The current DFARS revision, which stresses that weapon system warranties

may not be appropriate in all situations, is a step in the right direction.

However, it is inadequate to resolve the difficulties in obtaining a waiver

because the regulation could not change the high level required for

approving waivers. The waiver approval authority is stipulated in the law

itself, and the incentives that arise from it could not have been changed by

this revision. As DOD and Congress proceed with acquisition reform, we

believe they need to reexamine the need for and practical implementation

of weapon system warranties.

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Weapon Acquisitions

Requiring the routine use of warranties in weapon system acquisitions is

often not appropriate and does not provide the government much in the

way of benefits. The Institute for Defense Analyses has identified three

functions of a warranty in weapon system acquisitions—insurance,

assurance-validation, and incentivization.1

 In the commercial marketplace,

warranties have similar functions. Commercial buyers believe warranties

protect them against catastrophic financial losses and excessive operating

costs through a warranty’s insurance aspect. A warranty may also indicate

to a buyer that a product is of better quality, which can be equated to the

assurance-validation function,2

 and may motivate the contractor to

maintain product quality, which equates to the incentivization function.3

However, these functions are not as significant in weapon system

acquisitions as they are in buying a commercial product on the open

market.

For insurance to be cost-effective to the buyer, the risk must be shared

and spread over many insured customers, which is not the case in weapon

acquisitions. DOD is the only buyer of most weapon systems and must pay

the full cost of the insurance provided by the warranty. Also, DOD already

has quality assurance processes built into its contracts to ensure that the

product complies with all contract specifications. This lessens the need for

a warranty’s assurance-validation function. Finally, in our review of 20

weapon systems, we could not find any evidence that indicated that a

warranty was a factor in improving system reliability. Since none of the

traditional benefits conferred by warranties apply to weapon system

purchases, the main benefit that warranties seem to provide is the

extension of the time period DOD has to identify defects to be corrected by

the contractor.

Insurance Aspect Is

Not Typically a Good

Reason for Obtaining

a Warranty

Commercial buyers are interested in stabilizing their operating costs and

protecting themselves against catastrophic losses. A manufacturer’s

warranty provides a commercial buyer with a measure of insurance

against the risks of repair or replacement costs. If a warranted product

does not perform as specified, the buyer whose product failed does not

face a total financial loss.

1

Robert E. Kuenne, Paul H. Richanbach, Frederick R. Ridell, and Rachel Kaganoff, Warranties in

Weapon System Procurement: Theory and Practice, Westview Press (1988).

2

Lt. Col. John P. Clark, USAF, Report of the Working Group to Define an Implementable Warranty

Program, U.S. Air Force.

3

Wallace R. Blischke and D.N. Prabhakar Murthy, Warranty Cost Analysis, Marcel Dekker, Inc. (1994).

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Weapon Acquisitions

The concept of insurance is based on the principle of shared risk. In the

commercial marketplace, the cost of offering a warranty is shared by many

buyers who individually pay a small amount of the total warranty as part

of the product’s price. Manufacturers generally estimate how many of their

products will be defective and price the product to cover this risk.

However, because DOD is usually the only buyer for a weapon system, the

contractor cannot allocate the cost of insuring against that risk among

multiple buyers. The complete cost for the estimated risk must be borne

by the sole buyer or absorbed by the contractor. If it is borne by the buyer

it becomes the price of the warranty. If it is absorbed by the contractor

then it is a cost that must be covered by the price of the system. In both

cases the buyer pays. A further factor in the cost of a warranty is the

extent of unproven technology or innovative design that a weapon system

encompasses, which may cause the contractor to perceive its financial risk

is significant. This will tend to drive up the warranty price to the

government and causes the contractors to try to limit warranty coverage

as much as possible. As a result, insuring against weapon system failures

generally is not beneficial to the government since the government will be

responsible for 100 percent of the estimated cost of that risk. The

government will only achieve a positive financial result if failures in the

system substantially exceed the contractor’s estimates of risk.

While it may seem that a warranty would make sense in cases where the

extent of system failures exceeds the cost of the warranty, this occurs in

very few instances and the cost of insuring all weapon systems to cover

costs in these instances is not a good financial decision. It is for this

reason that the government maintains a policy of self-insurance against

losses in almost all other areas. A RAND study reported that shifting

financial risk to the manufacturer is seldom an appropriate or sufficient

rationale for obtaining a weapon system warranty, for the same reason

that it is not to the government’s advantage to buy insurance from a

commercial firm.4

Another factor limiting the potential insurance benefits of warranties is the

relationship of the government to major defense contractors. If a

contractor were someday to incur large losses as a result of a warranty on

a weapon system, the threat of insolvency might cause the government to

excuse the contractor from its warranty obligation. Historically, when a

defense firm incurs large losses because of a contract, the government has

taken action to provide relief and prevent the firm from going out of

4

James P. Stucker and Giles K. Smith, Warranties for Weapon: Theory and Initial Assessment, RAND

Corp. (N-2479-AF, Apr. 1987).

Page 31 GAO/NSIAD-96-88 Weapons Acquisition
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Warranties Often Not Appropriate for Use in

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business. DOD’s ability to provide extraordinary contractual relief to a

defense contractor is recognized in Public Law 85-804. From 1959 to 1993,

DOD used this provision to provide over $4.3 billion (in constant 1996

dollars) in relief to assist contractors in recovering from losses.5

 As a

result, the utility of warranties may be limited to collecting small or

marginal amounts from a contractor rather than making good a

catastrophic loss.

Warranties Are Not

Generally a Good

Means of Assuring

Quality Systems

The second purpose of warranties is assurance-validation. Applied to

weapon systems, assurance-validation means assuring DOD that the

manufacturer’s product conforms to the design, quality, and performance

levels specified in the contract. Although DOD is moving more toward a

commercial acquisition system, it uses many quality assurance processes

to verify product quality and contract conformance independent of the

warranty clauses. Since the cognizant contract administration office is

responsible for verifying that the accepted product conforms to the

specifications in the contract, the assurance-validation function of a

weapon system warranty may not be necessary.

In weapon system acquisitions, DOD uses many different program

management tools to reduce the inherent risks of the acquisition process.

DOD’s weapon acquisition policies seek to reduce the risk of obtaining a

poor quality product by establishing a disciplined multiphased process

that (1) translates mission needs into stable and affordable programs;

(2) acquires quality products; and (3) provides a program management

structure that has clear lines of responsibility, authority, and

accountability. As each weapon system progresses through the phases, it

is subject to comprehensive programmatic reviews. During the reviews, an

assessment is made of the program’s accomplishments to date, plans for

the next phase, and acquisition strategies for the remainder of the

program. Additionally, the program risks and risk management planning is

evaluated. In theory, for each of the acquisition phases, program-specific

results are required before a program is permitted to proceed to the next

phase. For example, a program may be required to demonstrate the

maturity of a manufacturing process before being permitted to start

production. Techniques available to manage risk include the use of

technology demonstrations and prototyping to test hardware, software,

manufacturing processes and/or critical subsystems. Another technique is

5

David V. Anthony and Carl L. Vacketta eds. Extraordinary Contractual Relief Reporter. Federal

Publications, Inc. (1996).

Page 32 GAO/NSIAD-96-88 Weapons Acquisition
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Warranties Often Not Appropriate for Use in

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to test and evaluate the weapon system or its components to determine

system maturity and identify technical risks.

Finally, DOD establishes quality assurance programs to provide confidence

that a weapon system will conform to the technical requirements and

provide satisfactory performance. A warranty is one more management

tool at DOD’s disposal to assure quality as the weapon system begins to be

put in use. Given the extensive quality assurance efforts made over the

whole development and production cycle, however, a warranty may

actually be insurance against the failure of the quality assurance process.

Warranties May Not

Provide Much

Incentive to Improve

Product Quality

Finally, warranties are supposed to serve as an incentive to manufacturers

to improve quality. Conceptually, all warranties motivate a manufacturer

to improve product quality because the goal is to maximize profits by not

having to perform warranty service. However, when a commercial

manufacturer provides a warranty, it generally knows the projected failure

rates of the product and the probable repair costs. The costs for these

failures are included in the cost of the product. Efforts to keep commercial

prices competitive probably undercuts the incentive to make additional

profit by pricing the warranty higher than its expected cost.

In the commercial market, a warranty may also signal product quality to

the buyer because the commercial buyer generally is not familiar with how

the product was made and does not know how the product will perform.6

Therefore, the warranty becomes a marketing tool to help sell the product

by convincing the buyer it is a superior product.7

In weapon acquisition, the contractor is generally not faced with direct

price competition. Absent direct price competition, there is no incentive

for the contractor to limit its ability to fully cover the estimated cost of

risks of system failure being warranted. Further, the marketing aspects of

a warranty are for the most part irrelevant to DOD. The warranty’s

indication of manufacturer confidence in product quality is not needed

because, as shown in the previous section, DOD is not a typical consumer.

DOD is knowledgeable about how the weapons it obtains are made and in

some cases helped to design the system. Generally, DOD knows how the

6

Nancy A. Lutz, The Economic Theory of Warranties, Virginia Polytechnic Institute and State

University (Jan. 1993).

7

A warranty, in the commercial market, also limits the manufacturers’ liability for loss or damage

caused by a product’s malfunction or defect. Usually, the maximum recoverable by a buyer under a

warranty is the full price of the item.

Page 33 GAO/NSIAD-96-88 Weapons Acquisition
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Warranties Often Not Appropriate for Use in

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product will perform and uses other management techniques to maintain

product quality.

In addition, the majority of officials in the weapon system program offices

we visited stated that either (1) the warranties had not induced the

contractors to take actions to improve the quality of their warranted

products or (2) if there were quality and reliability improvements due to

the warranty, those improvements were marginal and unmeasurable. For

example, the F-15 warranty manager stated that the contractor has not

designed components of the weapon system differently nor is the

contractor building the weapon system differently because of the

warranty. The F-110 engine warranty manager also said that the warranty

has not helped to improve the reliability of the engine.

In a report issued in August 1992, the U.S. Army Materiel Systems Analysis

Activity, reached a similar conclusion regarding different warranties on

several systems. The report stated: “It is extremely unlikely that hardware

improvements that were performed under the warranty would not have

been performed had there not been a warranty. Therefore, it is unlikely

that any reliability growth from these improvements could be attributed to

the warranty.” The report stated that no models were available that could

be used to measure reliability improvements resulting from a warranty.

Warranties May

Confer Limited

Benefits at Great

Expense

With or without a warranty, a contractor is obligated to produce a product

that complies with the terms delineated in the contract, including all

design, manufacturing, and performance specifications. During DOD’s

inspection and quality assurance processes, the government needs to

identify defects or deficiencies and notify the contractor of problems at

the earliest reasonable time. If DOD did not obtain a warranty, the

contractor could be released from any further obligation to correct

problems once the government accepted the product.8

 A warranty extends

beyond acceptance the period during which the government can identify

defects and require the contractor to correct them at no charge.

Prior to acceptance, if defects are discovered, the government, even

without a warranty, can (1) order the contractor to correct the defects at

no additional charge, (2) reject the nonconforming product, (3) terminate

the contract for default, or (4) seek a price reduction. A warranty obligates

the contractor to correct defects, even if the government did not identify

8

Acceptance does not relieve the contractor of its obligation to correct latent defects. Kaminer Const.

Co v. United States, 488 F. 2d 980 (Ct. Cl. 1973).

Page 34 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 3 

Warranties Often Not Appropriate for Use in

Weapon Acquisitions

them before acceptance. This can reduce disputes because the warranty

eliminates the need to prove where and when a defect came into

existence. For example, in the case of a failure-free warranty, the

government merely needs to demonstrate that an item does not work.

A warranty also supplements inspection by providing the opportunity to

observe the product’s performance during a period of use when additional

problems may become apparent. However, a properly structured test

program could identify such problems early in the acquisition process,

when it is less costly to address deficiencies.9

In a contract without a warranty, the government’s acceptance of the

product generally ends the contractor’s obligation.10 Even without a

warranty, however, the government can revoke its acceptance and hold

the contractor financially accountable if latent defects are discovered. In

cases of latent defects, the government must demonstrate that the defects

existed at the time of delivery, but could not have been discovered by a

reasonable inspection.

Conclusions While warranties may have value to a consumer in the commercial world,

obtaining a warranty for a weapon system may be a flawed concept

because (1) the government does not need the insurance coverage

provided by a warranty and cannot share the expense of the warranty with

other customers; (2) warranties are an expensive way to assure the quality

of a weapon system; (3) DOD’s quality assurance activities, should provide

much greater assurance of compliance with contract specifications than

does a warranty; and (4) warranties may not cause contractors to improve

the quality of the weapon systems’ they produce. Further, weapon system

warranties provide very limited benefits to the government. The only

measurable benefit of a warranty is the ability to have the contractor

correct defects for some negotiated period after acceptance of the

product, and as discussed in the prior chapter this comes at a high cost.

9

Michael S. Bridgman and David V. Glass, Better Assessment of Operational Suitability, Logistics

Management Institute (Jan. 1992).

10The government may seek financial recovery if a contractor engaged in fraud, or made gross

mistakes amounting to fraud. In cases of fraud, the contractor willingly and knowingly gives the

government a inferior product. To recover for fraud, the government must prove intent to defraud.

Bar-Ray Products, Inc. v. United States, 340 F. 2d 343 (Ct.Cl. 1964). In the case of gross mistakes, the

government must show deviation from contract specifications, and misrepresentation of its

performance led the government to accept a non-conforming or defective product. Catalytic

Engineering and Manufacturing Corp., 72-1 BCA ¶ 9342 (1972). These cases are rare and very difficult

to prove.

Page 35 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 3 

Warranties Often Not Appropriate for Use in

Weapon Acquisitions

We believe warranties should be used judiciously and only in cases where

their cost-effectiveness can be clearly demonstrated.

Recommendations to

the Secretary of

Defense

We recommend that the Secretary of Defense establish an expedited

waiver process that limits the disincentives inherent in the current

process. We also recommend that the Secretary of Defense revise DOD’s

acquisition policies to adequately manage those warranties that the

military services determine should be obtained. Consideration should be

given to (1) requiring that all weapon system warranties be separately

priced in order to allow meaningful cost-benefit analyses; (2) improving

cost-benefit analyses through more realistically reflecting the likelihood of

claim submission, performing present value analyses, and including the

government’s administrative costs; and (3) ensuring that the services

enforce the regulations requiring post-award assessments of weapon

system warranties so that the services will know why these warranties

were or were not beneficial to the government. We also recommend that

the Secretary of Defense direct the Secretaries of the Air Force and the

Navy revise their regulations to require a final payoff assessment for

weapon system warranties as the basis for purchasing more beneficial

follow-on warranties and building institutional knowledge for procuring

and administering effective warranties.

Recommendation to

Congress

The administrative problems that we have identified appear to be

unintended consequences of the warranty law due to the de facto

mandatory nature of warranties. Attempts to administratively correct the

problem have not been very successful. Since DOD continues to have

problems administering weapon system warranties and the warranties

provide minimal benefits for the costs incurred, Congress should repeal 10

U.S.C. 2403. Were the warranty requirement repealed, DOD and the services

would still have management flexibility to obtain warranties for major

weapon systems only when deemed appropriate. As was done prior to the

warranty law, DOD and the services would rely on the FAR and their own

policies to determine when it is appropriate to obtain a weapon system

warranty. The decision should be documented as part of the system

acquisition strategy.

Agency Comments

and Our Evaluation

In commenting on a draft of this report, DOD stated that it “strongly

supports” our recommendation that Congress should repeal 

10 U.S.C. 2403. Since 1992, DOD has supported the need for congressional

Page 36 GAO/NSIAD-96-88 Weapons Acquisition
Chapter 3 

Warranties Often Not Appropriate for Use in

Weapon Acquisitions

repeal of the weapon system warranty law. DOD only partially concurred

with the recommendations to the Secretary of Defense, stating that the

solution to the problems we cited is repeal of the law. DOD indicated that it

will ask the military departments to review their warranty waiver process.

DOD noted, however, that in order to remove the disincentives and

streamline the waiver process it needs relief from the congressional

notification requirement and the warranty waiver approval level.

DOD stated that it did not see the need to separately price warranties

because it has insight into warranty costs through cost reporting and can

project warranty cost from actual claim data. Although DOD currently has

insight into warranty costs, we found that this information is often not

used in the cost-benefit analyses. Therefore, we believe that separately

pricing the warranty would permit DOD to perform better warranty

cost-benefit analyses.

DOD stated that all the military departments have in place regulations that

require post-award assessments, but acknowledged that the military

departments were not fully complying with existing regulations. DOD stated

that it would reiterate the importance of such assessments in a

memorandum to the military departments. Our review indicated, however,

that only the Army’s regulation specifically requires a final pay-off

assessment to determine the economic benefit derived from a warranty.

We believe that the Air Force and the Navy regulations should be revised

to explicitly require final payoff assessments. DOD’s comments are

reprinted in their entirety in appendix II.

Page 37 GAO/NSIAD-96-88 Weapons Acquisition
Appendix I 

Quantified Costs and Benefits of Warranties

Dollars in millions

Weapon system Contract number

Warranty

price

Warranty

claims Net

Warranty

status

F-15E F33657-89-C-2000 $6.000 $0.048 ($5.952) Expired

F33657-90-C-2319 6.000 0.354 (5.646) Expired

F-16a F33657-84-C-0247 27.860 2.780 (25.080) Expired

F33657-88-C-0037 15.100 1.091 (14.009) Majority

expired

C-17b F33657-89-C-0001 11.563 0.186 (11.377) Expired

F33657-92-C-0030 10.500 0.218 (10.282) Expired

F33657-92-C-0031 15.471 0.276 (15.195) Expired

Multiple Launch

Rocket System

DAAH01-85-C-1134 1.584 0.126 (1.458) Expired

Total $94.078 $5.079 ($88.999)

aFinal figures for the Multiyear II warranty’s claim data were unavailable because the program

office never collected the final numbers. Estimates from a 1991 study put the total potential

warranty claims at $9.94 million. The $2.78 million figure provided to us is the only figure

available. The essential performance requirement warranty for the Multiyear III contract has

expired and the materials and workmanship/design and manufacture warranties are

approximately 80 percent expired, according to the program office.

bClaim figures for the C-17 are actuals through December 31, 1995. They do not reflect the final

numbers. Potential claims may occur as a result of durability, reliability, maintainability, and

availability testing.

Page 38 GAO/NSIAD-96-88 Weapons Acquisition
Appendix II 

Comments From the Department of Defense

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

Page 39 GAO/NSIAD-96-88 Weapons Acquisition
Appendix II 

Comments From the Department of Defense

Now on pp. 7 and 36.

Page 40 GAO/NSIAD-96-88 Weapons Acquisition
Appendix II 

Comments From the Department of Defense

Now on pp. 7 and 36.

See comment 1.

Now on pp. 7 and 36.

See comment 2.

Page 41 GAO/NSIAD-96-88 Weapons Acquisition
Appendix II 

Comments From the Department of Defense

Now on pp. 7 and 36.

Page 42 GAO/NSIAD-96-88 Weapons Acquisition
Appendix II 

Comments From the Department of Defense

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

letter dated April 22, 1996.

GAO Comments 1. Separately pricing the warranty would permit improved analysis of the

benefits derived from warranty coverage. At a minimum, the negotiated

warranty price should be noted in the contract file and used in the

cost-benefit analysis. Further, the Defense Federal Acquisition Regulation

Supplement (DFARS) requires that the warranty cost be included as part of

the cost-benefit analysis.

2. Current Air Force and Navy regulations do not clearly require a final

payoff assessment. The regulations should be revised to clearly require a

final payoff assessment. We recognize that the acquisition community is

downsizing and that additional regulations will not guarantee the

assessments will be conducted; however, DOD and the military

departments have a responsibility to properly execute weapon system

contracts. Part of the responsibility involves building institutional

knowledge on how to procure and administer weapon system warranties

in order to ensure that the government is obtaining the best value for its

procurement dollars.

Page 43 GAO/NSIAD-96-88 Weapons Acquisition
Appendix III 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

David B. Best

Thomas J. Denomme

Brad H. Hathaway

Michele Mackin

Charles W. Perdue

Jose A. Ramos

Office of the General

Counsel Washington,

D.C.

Margaret Armen

John Brosnan

William Woods

Atlanta Field Office Barbara H. Haynes

John W. Randall, Jr

Chicago Field Office Michael J. Jones

Gilbert W. Kruper

Kansas City Field

Office

Charles O. Burgess

William H. Gansler

Los Angeles Field

Office

Dorian R. Dunbar

Noel J. Lance

(707099) Page 44 GAO/NSIAD-96-88 Weapons Acquisition
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