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Acquisition Requirements: Impact on Company Structures and Operations
(Letter Report, 04/19/94, GAO/NSIAD-94-20).

Several efforts are underway to overhaul the Pentagon's acquisition
system.  Widespread support exists for streamlining the defense
acquisition process to ease the administrative burden on the Defense
Department and its contractors and to integrate the defense and
commercial sectors of industry.  GAO, which strongly supports
acquisition reform, recently visited eight contractors and talked to
experts and trade associations about this issue.  This report discusses
(1) how the eight contractors integrate or separate their structures and
operations to do business with the defense and commercial structures and
(2) whether these structures and operations are caused or influenced by
defense acquisition laws, regulations, practices, and specifications.

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

 REPORTNUM:  NSIAD-94-20
     TITLE:  Acquisition Requirements: Impact on Company Structures and 
             Operations
      DATE:  04/19/94
   SUBJECT:  Defense procurement
             Procurement policies
             Procurement procedures
             Procurement regulation
             Contracting procedures
             Department of Defense contractors
             Defense contracts
             Corporations
             Industrial statistics
IDENTIFIER:  C-17 Aircraft
             
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Cover
================================================================ COVER

Report to the Chairman, Subcommittee on Defense Technology,
Acquisition and Industrial Base, Committee on Armed Services, U.S. 
Senate

April 1994

ACQUISITION REQUIREMENTS - IMPACT
ON COMPANY STRUCTURES AND
OPERATIONS

GAO/NSIAD-94-20

Acquisition Requirements

Abbreviations
=============================================================== ABBREV

  ALCOA - x
  DOD - x
  GE - x
  IBM - x
  R&D - x

Letter
=============================================================== LETTER

B-253864

April 19, 1994

The Honorable Jeff Bingaman
Chairman, Subcommittee on Defense Technology,
 Acquisition and Industrial Base
Committee on Armed Services
United States Senate

Dear Mr.  Chairman: 

A number of efforts are underway to reform the Department of
Defense's (DOD) acquisition system.  It is widely held that the
defense acquisition system should be streamlined to, among other
things, reduce the administrative burden it poses for DOD and its
contractors and foster greater integration between the defense and
commercial sectors of industry.  We strongly support the need for
acquisition reform. 

We recently visited eight contractors to discuss this issue and
talked to various experts and trade associations.  As agreed with
your staff, we are providing our observations for use by your
subcommittee and others in considering acquisition reforms.  This
report discusses in broad terms (1) how eight contractors integrate
or separate their structures and operations to do business with the
defense and commercial sectors and (2) whether these structures and
operations are caused or influenced by defense acquisition laws,
policies, regulations, practices, and specifications.  Such
requirements are henceforth referred to as acquisition requirements. 

   BACKGROUND
------------------------------------------------------------ Letter :1

Companies that sell goods to the defense market vary widely in terms
of the total dollar volume and proportion of their sales to that
market.  Although some companies, both large and small, sell only in
the defense market, many companies have a mix of defense and
commercial business. 

For fiscal year 1992, DOD awarded contracts of $135 billion for goods
and services, as compared to $65 billion in contract awards made by
all other federal civilian agencies combined, according to the
government's contract data reporting system. 

Defense acquisition requirements stipulate how companies do business
with DOD.  They include such requirements as those relating to cost
and pricing data; cost accounting standards; contract specifications;
government rights to technical data; financing arrangements, such as
progress payments; socioeconomic requirements; and flowdown of
contract requirements to subcontractors.  Many of these requirements
are intended to serve as safeguards to protect the government's and
taxpayers' interests, while others are intended to assist suppliers
or help achieve a variety of national goals, including providing
contracting opportunities for small and small disadvantaged
businesses. 

No database exists concerning the organizational structures and
operations of companies that produce the same or similar defense and
commercial products and services.  Likewise, quantitative data on the
impact of acquisition requirements are very limited.  Accordingly,
data are not available to fully assess the extent to which companies'
defense and commercial structures and operations are integrated or
the impact of acquisition requirements. 

A number of studies have addressed the extent to which contractors
separate their defense and commercial business structures and
operations.  The studies we reviewed are listed in appendix I. 

   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Integration of the U.S.  defense and commercial industrial sectors is
a complex issue covering a broad spectrum of conditions.  We reviewed
eight companies and found varying forms and degrees of integration in
their administrative, research and development (R&D), and production
activities.\1

For example, all but one of the eight companies either separated
their defense and commercial administrative operations or assigned
additional people to comply with acquisition requirements.  On the
other hand, the companies generally have integrated production in
terms of using, to the extent warranted by similarities in the
products,\2 the same facilities and production lines for defense and
commercial customers.  Research and development operations were
integrated to varying degrees. 

Company officials advised us that several factors influenced their
decisions about separating or integrating their companies' structures
and operations, including the similarity of items produced,
acquisition requirements, and economic considerations. 

The extent to which greater integration will provide DOD with (1)
savings in development and production costs, (2) access to new
technologies, and (3) a broader defense and technology base, is
uncertain.  Any reform efforts to foster greater integration must
recognize (1) the diversity and complexity of the universe of
companies involved or potentially involved in producing defense goods
and services and (2) the lack of quantitative or empirical data to
assess the impact of such reforms. 

--------------------
\1 The companies are Aluminum Company of America (ALCOA); General
Electric (GE) Aircraft Engines; Hewlett-Packard Company;
International Business Machines Corporation (IBM); Litton Systems,
Inc., Navigation, Guidance, and Control Systems Group; Reynolds
Metals Company; Sundstrand Corporation; and United Technologies'
Pratt and Whitney. 

\2 Our review did not examine the extent to which alternatives to the
contract specifications and standards would effectively meet DOD's
needs and result in increased acquisition of commercial products. 

   COMPANIES' STRUCTURES VARIED
   WIDELY
------------------------------------------------------------ Letter :3

Our review indicated that the extent of integration by contractors
doing business with both the defense and commercial sectors varies. 
According to the companies, administration was largely separated,
either by maintaining separate groups for similar functions (e.g.,
accounting) or by adding staff for work that was unique to defense
contracts (e.g., screening unallowable costs).  Four companies (the
two aircraft engine manufacturers, plus Litton and IBM) reported
having separate organizations for administering government
contracts.\3 Three others in three different industry sectors
(Hewlett-Packard, Reynolds Metals, and Sundstrand) reported that they
assign additional people to their single administrative organization
for the specific purpose of ensuring compliance with acquisition
requirements.  For example, Sundstrand reported having 27 employees
for government financial administration, who do only government
contract work.  It also has other organizations that do both
government and commercial work for contract functions, such as
pricing and cost management.  The remaining company, ALCOA, also has
a single administrative organization, but ALCOA officials said they
do not have additional people to deal with the acquisition
requirements.  However, officials of ALCOA, as well as
Hewlett-Packard, stated that their companies place a significant
limitation on their sales to the government, selling on a commercial
basis only.\4

The companies we reviewed have generally integrated production in
terms of using, to the extent feasible based on similarities in the
products for defense and commercial customers, the same facilities
and production lines.  For example, Litton manufactures its
newest-generation gyro for an inertial navigation system that it
sells to both defense and commercial customers.  Although these items
are sold through different divisions, one for commercial sales and
one for military sales, Litton uses the same production line for both
items, to the extent that the items are the same.  Where commonality
stops, the gyros are split off of the line and tailored for their
intended user. 

Officials at the two aircraft engine manufacturers we visited told us
that their companies have integrated production of parts but separate
the final assembly according to the model number of the end product,
regardless of whether the product is for a defense or commercial
customer.  Both metals processing companies produce all their
products, defense and commercial, via the same processes.  For
example, Reynolds Metals uses the same processes to produce wing
skins for the C-17 aircraft as it does to produce commercial aircraft
wing skins. 

R&D operations were integrated to varying degrees.  Three companies
in three different industry sectors (IBM, Litton, and Pratt &
Whitney) maintain separate organizations for defense and commercial
R&D operations.  Two other companies, GE Aircraft Engines and
Sundstrand, have single R&D organizations that serve both defense and
commercial purposes.  The remaining three companies, including both
of the metals processing companies and Hewlett-Packard, have limited
or no government R&D and do not maintain separate R&D organizations
for commercial and government business. 

--------------------
\3 According to the companies, administering government contracts
includes such functions as marketing and sales, pricing, accounting,
finance, quality control, contract management, and audit liaison. 

\4 ALCOA and Hewlett-Packard described "commercial basis" as
including selling to the government only if the procurement is
competitive, the product meets the definition of a commercial product
sold in substantial quantities to the public, or the company obtains
a waiver to acquisition requirements such as cost and pricing data. 

   SEVERAL FACTORS INFLUENCE
   COMPANIES' STRUCTURES
------------------------------------------------------------ Letter :4

The companies we reviewed cited the acquisition requirements as one
of several factors influencing the integration or separation of their
structures and operations.  According to company officials, a number
of factors influenced their decisions to integrate or separate
company structures or operations, including the similarity of the
goods they produced for DOD and commercial customers; the acquisition
requirements, especially government oversight/audit requirements,
cost accounting standards, and cost and pricing data for the
administrative function and rights in technical data for R&D; and
other economic factors, such as decreasing opportunities in either
government or commercial business.  Product similarity affected
decisions about production structures and operations.  The
acquisition requirements primarily affected decisions about
administrative structures and operations, although some companies
also reported that they refuse to sell directly to the government if
it would subject them to certain requirements.  Economic factors
ranged in their effect on decisions, from a choice to integrate only
one function to actually limiting business with any one customer. 

      PRODUCT SIMILARITY
---------------------------------------------------------- Letter :4.1

The similarity of goods that a company sells to DOD and commercial
customers influences how it organizes production.  The eight
companies we studied use the same production lines to make the same
or similar items for their defense and commercial customers.  For
example, products that Sundstrand manufactures for commercial and
military customers use the same basic technologies and are assembled
on common production lines.  Both military and commercial products
are tailored for their intended uses toward the end of the production
process.  According to some of these companies (GE Aircraft Engines,
Litton, and Pratt & Whitney), product similarity makes it more
economical, despite the acquisition requirements, to maintain a
single production organization.  In addition, ALCOA and
Hewlett-Packard use the same production line for their government and
commercial customers because they sell only commercial products to
the government. 

      ACQUISITION REQUIREMENTS
---------------------------------------------------------- Letter :4.2

Acquisition requirements seem to have the greatest effect on
administrative structures and operations.  According to company
officials, seven of the eight companies either maintain two separate
administrative structures or assign additional people to
administration, for at least some of their defense work.  Four
companies (GE Aircraft Engines, IBM, Litton, and Pratt & Whitney)
have a separate administrative structure for government sales, and
two other companies (Reynolds Metals and Sundstrand) have added
employees to their administration to handle their government
contracts, in order to ensure compliance with the acquisition
requirements.  The remaining two companies (ALCOA and
Hewlett-Packard) have subsidiaries that they reportedly keep
separated to avoid being burdened with requirements, especially cost
accounting standards and cost and pricing data requirements. 

R&D structures are affected to some extent by the acquisition
requirements.  Three companies (IBM, Litton, and Pratt & Whitney)
said they have separated defense and commercial R&D structures in
order to protect their commercial business from acquisition
requirements.  A fourth company (Hewlett-Packard) reported that, in
order to protect its technical data rights, it does not accept
government R&D funds. 

      OTHER ECONOMIC FACTORS
---------------------------------------------------------- Letter :4.3

Other economic factors can greatly affect how a company structures
production or otherwise does business.  For example, officials of
Litton told us that nongovernment market conditions recently
influenced their company to combine production of a product sold to
defense and commercial customers into a plant previously used only
for military production.  Hewlett-Packard also reported that it
limits the amount of business that it does with any one customer,
including DOD. 

   AGENCY COMMENTS
------------------------------------------------------------ Letter :5

We obtained comments on an earlier draft of this report from DOD, the
Office of Technology Assessment, the Center for Strategic and
International Studies, and the eight companies we visited.  As a
result of the comments received, we have streamlined the final report
to focus on the results of our work at the eight companies.  In so
doing, we have deleted discussions of other studies listed in
appendix I. 

   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

We interviewed officials, experts, and other representatives, and
obtained documents from various U.S.  government agencies; seven
trade associations; academic and independent research organizations;
and eight companies.\5

We also toured companies' facilities in order to better understand
their operations.  In addition, we reviewed available reports and
discussed relevant ongoing studies. 

We selected eight companies to study their structures and operations
and the effect of requirements on those structures.  The selection
process was a complex one.  Because no database on company structures
was available, we consulted officials at the Analytical Sciences
Corporation, the Center for Strategic and International Studies, the
law schools of George Washington University and George Mason
University, and trade associations.  Criteria for selecting companies
included the following:  (1) companies reported to be integrated and
those reported to have separated structures/operations; (2) large and
smaller companies; (3) a mix of industry-paired companies that
manufacture different types of products, from metals to electronics
and computers; and (4) manufacturers of subsystems, components, and
materials.  We did not select large contractors that assemble weapon
systems because we believe that these companies' issues are different
from others that primarily manufacture systems, components, or parts
of systems.  We conducted our review from November 1991 to January
1994 in accordance with generally accepted government auditing
standards. 

--------------------
\5 IBM declined to continue in our study after our preliminary data
collection ended.  However, company representatives did review the
information we collected and provided clarifying information. 

---------------------------------------------------------- Letter :6.1

We are sending copies of this report to the Secretary of Defense and
interested congressional committees.  We will also provide copies to
others upon request. 

I may be reached on (202) 512-4587 if you or your staff have any
questions concerning this report.  Major contributors are listed in
appendix II. 

Sincerely yours,

David E.  Cooper
Director, Acquisition Policy, Technology,
 and Competitiveness Issues

STUDIES RELATING TO INTEGRATION
=========================================================== Appendix I

Integrating Commercial and Military Technologies for National
Strength:  An Agenda for Change, Center for Strategic & International
Studies, March 1991. 

Redesigning Defense--Planning the Transition to the Future U.S. 
Defense Industrial Base, Office of Technology Assessment, July 1991. 

National Security Assessment of the Domestic and Foreign
Subcontractor Base:  A Study of Three U.S.  Navy Weapon Systems, U.S. 
Department of Commerce, March 1992. 

Adjusting to the Drawdown, Defense Conversion Commission, December
1992. 

Krikorian, George.  Unpublished data on company structures prepared
as part of study for the Section 800 Panel, Defense Systems
Management College, 1992. 

Integrating Civilian and Military Technologies:  An Industry Survey,
Center for Strategic & International Studies, April 1993. 

MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Rosa Johnson
Kevin M.  Tansey

   NORFOLK REGIONAL OFFICE
-------------------------------------------------------- Appendix II:2

John R.  Beauchamp
Leslie Gregor
Fred S.  Harrison
Linda H.  Koetter
Allison C.  Pike

   OFFICE OF THE GENERAL COUNSEL
-------------------------------------------------------- Appendix II:3

John A.  Carter
William T.  Woods
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