United States General Accounting Office

GAO Testimony

Before the Subcommittee on Seapower, Committee on

Armed Services, U.S. Senate

For Release on Delivery

Expected at

2:30 p.m., EST

Thursday

March 28, 1996

C-17 AIRCRAFT

Comments on Air Force

Request for Approval of

Multiyear Procurement

Authority

Statement of Louis J. Rodrigues, Director, Defense

Acquisitions Issues, National Security and International

Affairs Division

G O A

years

1921 - 1996

GAO/T-NSIAD-96-137

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss the proposed multiyear

procurement of the C-17 aircraft. This is a particularly critical decision

because this multiyear proposal would require legislation to authorize a

7-year multiyear contract. The short time frame for congressional

consideration (McDonnell’s offer expires on June 1, 1996) also places an

unusual burden on decisionmakers. Mr. Chairman, I want to emphasize

that we are commenting on a proposal for a contract that has not been

drafted. We are, therefore, unable to comment on the specifics of the

proposed contract.

Results in Brief Approval of multiyear procurement authority has historically depended on

the ability to obtain significant savings, a sufficiently stable weapon

system design, an adequately validated requirement, and a commitment to

stable funding over the life of the contract.

The Air Force estimates that approval of its request for multiyear

procurement authority to complete the planned C-17 program will save

about $896 million. However, the amount of savings likely to occur as a

result of a multiyear procurement is overstated. At least some of the

savings—about $300 million—could be achieved without entering into a

multiyear agreement. The government could have invested a portion of the

proposed multiyear funding in additional cost-reduction initiatives such as

those that have been funded by the contractor in response to the 1994,

C-17 settlement and other cost-reduction initiatives funded by the

government. Additional savings have been characterized by the contractor

as a “management challenge.”

The savings from the engine manufacturer are estimated at $122 million

but in reality are likely to be less. The contractor has indicated a

willingness to offer an $88-million discount for a multiyear contract.

In January 1994, the C-17 program manager estimated that a 120 aircraft

program would cost about $43 billion. At that time DOD reduced the

program to 40 C-17’s unless McDonnell Douglas significantly improved the

cost, schedule, and performance of the aircraft. Since then the Department

of Defense (DOD) has reported airframe cost savings of about 20 percent as

a result of actions by the government and the contractor. However, this

savings along with the savings that will accrue from both the accelerated

production rate called for in the multiyear proposal and the estimated

Page 1 GAO/T-NSIAD-96-137
multiyear savings are needed to keep costs from exceeding the

January 1994, $43 billion estimate.

The next criteria used in judging a multiyear contract is the extent that the

design is stable and can be produced at the designated rate. We have

several concerns about the stability of the design and the inherent risks in

the increase in production which is called for in the multiyear proposal.

First, there are several unresolved problems that could require engineering

changes to the aircraft that were identified during the C-17 initial

operational test and evaluation (IOT&E). Second, the Air Force has

identified about $1 billion in research and development funds that will be

needed to develop improvements to the aircraft and about $1.8 billion that

will be needed to accommodate engineering changes, product

improvements, and planned modifications between 1997 and 2004. Finally,

the C-17 is about 18 months away from having an aircraft configuration

that fully conforms to the required specifications.

In addition to the possible changes to the aircraft that could affect the

viability of a multiyear proposal, the contractor is currently implementing

changes in aircraft design and production methods that have been

identified as cost savings improvements. It is not clear how these changes

will affect the contractor’s ability to meet the proposed production

schedules.

Another criteria for evaluating a multiyear procurement is a assurance that

the number of aircraft to be acquired is the correct number. Based on

work that we are currently doing at the request of Congresswoman

Elizabeth Furse, we do not believe that 120 C-17 aircraft are needed to

meet current requirements.

Finally, before approving a multiyear procurement, Congress should be

assured that funding to support the contract at the proposed production

rates has been included in DOD’s planned future procurement. It appears

from looking at the Future Years Defense Plan that the Air Force has

identified sufficient funds to support the proposal.

Overall, we believe some savings could be achieved from a multiyear

procurement of the C-17. However, the savings will likely be less than the

current $896 million estimate and will entail both costs and risks. Given

the uncertainty regarding the design stability and the risk associated with

increasing production, we believe a further assessment of the merits of a

Page 2 GAO/T-NSIAD-96-137
C-17 multiyear program may be warranted and can be accommodated

under the current proposal.

Background The C-17 military transport, being produced for the Air Force by the

McDonnell Douglas Corporation, is designed to airlift substantial payloads

over long ranges without refueling. The Air Force intends the C-17 to be its

core airlifter and the cornerstone of its future airlift force. Through fiscal

year 1996, the Congress had appropriated about $20.5 billion for the C-17

program, including $5.9 billion for research and development, $14.6 billion

for procurement, and $170 million for military construction. The Congress

had approved the acquisition of 40 C-17s.

Multiyear procurement can benefit the government by saving money and

improving contractor productivity through a more stable production run.

A significant source of multiyear savings results from larger lot buys from

vendors and suppliers, or economic order quantities (EOQ). However,

multiyear procurement contracts decrease annual budget flexibility. If

DOD’s budget is reduced and multiyear contracts are maintained, those

programs not under multiyear authority would have to be reduced

disproportionately. A multiyear procurement contract also entails certain

risks if it is changed or terminated.

The C-17 proposal is unique because it requests authority for a 7-year

multiyear contract. The current statutory limit is 5 years. In the past, it was

not uncommon for multiyear candidates to request even shorter terms,

such as 3 or 4 years. It is also unique because it is being proposed out of

the normal authorization cycle and the offer expires on June 1, 1996.

The C-17 multiyear procurement proposal calls for an accelerated buy

profile as shown in table 1.

Table 1: C-17 Multiyear Proposed Buy

Profile Fiscal year 1997 1998 1999 2000 2001 2002 2003

Number 8 9 13 15 15 15 5

It also calls for the government to provide $300 million in EOQ funds

beginning in 1996, to allow for the build up of inventory and for

cost-reduction projects. The $300 million, which would be treated as a

down payment to be recouped in subsequent years, is a combination of

existing funds from a variety of sources from prior fiscal years as follows:

Page 3 GAO/T-NSIAD-96-137
Table 2: Source of Economic Order

Quantity Funds Fiscal year 1994

millions

Fiscal year 1995

millions

Fiscal year 1996

millions

$70 NDAAa Funds

30 Lot VI OTPb

$50 Lot VII OTP

50 ECOc Funds

$100 Affordability

Funds

aNon Developmental Airlift Aircraft

bOver Target Protection

cEngineering Change Order

The multiyear contract has not yet been negotiated. However, Air Force

officials told us that a multiyear contract would be based on the recently

signed Lot VIII contract which contains fixed-price options for lots 9

through 11—30 aircraft. It also contains fixed-price incentive/successive

target options for the remaining lots covering the final 50 aircraft of the

120 aircraft buy. The Air Force must negotiate a separate firm fixed-price

contract before exercising any of these options. Program officials told us

that this arrangement gives them the flexibility to accommodate future

uncertainties that could occur in such a lengthy procurement period.

Program officials also negotiated an extensive variation in quantity clause,

which included an accelerated production schedule. However, this clause

requires that once a production rate has been reached, it cannot be

decreased, except for the final lot. Further, once the production rate has

exceeded 12 aircraft, it must be increased to the maximum rate of 15 a

year. If these conditions are not met, the remaining option prices are

invalid and must be renegotiated. The multiyear contract will only include

the accelerated schedule from Lot VIII. However, both Air Force and

company officials told us that they intend to include a provision in the

multiyear contract that would allow the government to revert back to the

Lot VIII annual buy contract options without renegotiating those option

prices, if neither of the above conditions have been violated. That means a

decision would be required before approval of the fiscal year 1999 defense

authorization and appropriation acts when the production rate is

scheduled to reach 13 aircraft.

The multiyear offer is also contingent upon the use of performance based

financing provisions. This is a departure from the normal 75-percent

progress payment arrangement based on the amount of budget expended.

It entails negotiating pre-determined events and payments for each of the

events for the remaining 80 aircraft. These include such events as major

component completion, wing joining, roll out, and delivery. The contractor

Page 4 GAO/T-NSIAD-96-137
will receive financing based on the agreed to prices, which Air Force

officials told us will include profit, after it has completed these events. The

events have been identified; however, each event must still be defined as

to what would constitute completion and the amount of financing that

would be provided for completion of the event. Program officials told us

that the effect of this financing arrangement is equivalent to a 90-percent

progress payment rate.

C-17 Multiyear

Proposal Savings

In the past, the Congress generally required 10-12 percent savings from

multiyear procurement. The C-17, at 5 percent, is at the low end of the

spectrum when compared to other multiyear programs such as the KC-10,

F-16, or B-1B, each of which estimated savings at 9 to 17 percent. Although

savings could result from a multiyear procurement of the C-17, the claimed

savings are overstated. The C-17 multiyear procurement is estimated by

the Air Force to save $896 million in then year dollars. The majority of this

savings stems from two sources, the airframe and engine contracts.

McDonnell Douglas has offered to reduce its contract price for the

remaining 80 aircraft by 5 percent which the Air Force estimates to be

about $760 million. The Air Force has estimated that it will achieve

another $122 million (6 percent) savings from the Pratt & Whitney engine

contract. In addition, the Air Force has estimated an additional $14 million

in savings from other sources. An Air Force official were not able to

identify the savings from “other sources.”

Airframe Savings Traditionally, a major portion of the savings from multiyear procurement

comes from lower prices on economic order quantity buys from vendors

or subcontractors. These savings are generally achieved with the EOQ

money provided by the government. In this instance, however, McDonnell

Douglas characterizes its offer of five percent savings as a “management

challenge.” In fact, its initial offer was closer to 3-percent. Program

officials told us that McDonnell Douglas is still struggling to identify how it

will use the EOQ funding.

A major part of McDonnell Douglas’ effort to achieve the 5-percent savings

will depend on its suppliers. It has given its key suppliers cost-reduction

targets; however, according to Air Force officials, the supplier responses

have been somewhat disappointing. McDonnell Douglas is still working

with suppliers to try to achieve the overall 5-percent reduction.

Page 5 GAO/T-NSIAD-96-137
Air Force officials told us that they expect that roughly $200 million of the

EOQ funding will be applied to EOQ opportunities. The remainder may be

used to fund affordability projects. The affordability projects which have

been identified, are the group that could have been funded by the

government with money appropriated from the C-17 Producibility

Enhancement/Performance Improvement contract. These projects are

estimated to have a 4 to 1 return ratio. That is, for a $100-million

investment the return is estimated to be about $400 million. The resulting

$300 million savings, although included as part of the multiyear savings,

could be available without commitment to the multiyear.

Engine Savings The F-117 engine contract is a commercial procurement where the

government receives most favored customer pricing discounts. The

multiyear offer from Pratt & Whitney would increase the discount by

4.3 percent. This represents a savings of $88 million, not $122 million as

the Air Force had quoted in its multiyear package.

Design and

Producibility

Concerns

In approving a multiyear authority for the C-17, the Congress should be

assured that the design is stable and can be produced at the designated

rate. We have several concerns about the stability of the design and the

inherent risk involved in increasing the production rate.

First, IOT&E was completed by the Air Force on December 5, 1995. Air

Force officials indicated there were 95 open items from the IOT&E report

that could impact the design of the C-17. Air Force officials told us that

they are working on 47 of these items and they consider the remaining 48

to be inconsequential. They could not give us an estimated cost or the time

frames for implementing the production line changes needed to correct

these items.

Second, the Air Force has also identified $1 billion in research and

development funds, a large part of which, will be needed for future

enhancements to the aircraft and an additional $1.8 billion in procurement

funds: $275 million for engineering change orders (ECO), $308 million for

product improvements, and $1.2 billion for modifications (retrofit) to

mature the aircraft. The C-17 program office refers to ECOs as a

management reserve to fund “unknown unknowns”. This money is

estimated to cover any unforeseen problems which may occur through the

production program. The additional funds are for improvements to the

aircraft, many of which have not yet been identified.

Page 6 GAO/T-NSIAD-96-137
Third, there are many outstanding variances from specifications that will

have to be resolved. The Air Force plans to have these resolved by the

scheduled delivery of production aircraft 33 in August 1997.

Our final concern is the extent of design and production changes that are

taking place as a result of cost reduction efforts funded by the contractor

under the C-17 settlement or by the government as cost reduction

initiatives. These projects were initiated to reduce costs on the C-17 in

preparation for the November 1995 DAB. If difficulties occur in

implementing these changes, price or schedule problems could result

which would be exacerbated if the contractor is at the same time

increasing production.

Requirement Stability The decision to acquire 120 C-17s was the result of a Defense Acquisition

Board (DAB) that considered whether to acquire additional C-17s or a mix

of C-17s and non-developmental aircraft to accomplish the airlift mission.

The analysis leading up to that decision included several predetermined

options presented for consideration by the DAB. Our analysis indicates that

an option of 100 C-17s could meet the current strategic mobility

requirement and also fulfill the need for aircraft with the unique military

capabilities of the C-17. That option was not presented to the DAB for

consideration. The possible savings from this alternative would be

significant.

Funding Stability The multiyear justification package states that funding for the proposed

multiyear buy has been included in the Future Years Defense Plan and the

fiscal year 1997 budget, and airlift modernization is a well recognized

priority for DOD. At this point in time, we have no specific basis to question

future funding stability.

Conclusion The proposed C-17 Multiyear contract presents the Air Force with the

opportunity for savings on the C-17 program. However, the savings are, in

our opinion, substantially less than the $896 million that has been

advertised. Further, these potential savings are not without both costs and

risk. The contractor has asked for EOQ funding of $300 million. In our

opinion this should be viewed as $200 million of new funding and

$100 million of funds that would most probably have been provided to

fund cost reduction initiatives. The contractor has also asked for an event

based financing arrangement that will provide a 90 percent equivalent

Page 7 GAO/T-NSIAD-96-137
progress payment structure rather than the usual 75 percent included in

production contracts. In both instances there is a cost of money to the

government that would not exist under annual buy.

There are also risks associated with approving multiyear authority. These

risks concern the extent of stability in the design and the potential for

problems in implementing the producibility enhancement projects that

may create cost and schedule problems.

In our opinion the Congress should require that a provision which would

allow reverting to the Lot VIII annual buy contract is included in any

multiyear contract. With that provision the government would have until

the fiscal year 1999 authorization and appropriation cycle to assess the

contractor’s ability to produce the aircraft at the required rate. If the

contractor’s performance is not adequate, the government could revert to

the Lot VIII annual buy contract without renegotiating the not-to-exceed

option prices for the remaining lots.

The Congress should require the Department to provide assurances along

with its 1999 budget request that the contractor is in actuality ready to

move to the higher production rate.

Mr. Chairman, this concludes my prepared remarks. I would be pleased to

answer any questions you or members of the Subcommittee may have.

(707169) Page 8 GAO/T-NSIAD-96-137
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