United States General Accounting Office

GAO Report to Congressional Committees

September 1993 NAVY CONTRACT

AOE 6 Shipbuilding

Claims Settled but

More Delays and Cost

Growth Likely

GAO/NSIAD-93-298

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-251748 

September 30, 1993

The Honorable Daniel K. Inouye

Chairman, Subcommittee on Defense

Committee on Appropriations

United States Senate

The Honorable Ted Stevens

Ranking Minority Member

Subcommittee on Defense

Committee on Appropriations

United States Senate

The Honorable John P. Murtha

Chairman, Subcommittee on Defense

Committee on Appropriations

House of Representatives

The Honorable Joseph M. McDade

Ranking Minority Member

Subcommittee on Defense

Committee on Appropriations

House of Representatives

The Conference Report on the Dire Emergency Supplemental Appropriations Act for Fiscal

Year 1991 directed us to monitor the process used by the Navy to resolve claims involving cost

growth on the AOE 6 class shipbuilding program. In response to the Conference Report, on

August 23, 1993, we issued a report that is restricted because it contains business sensitive

information. This letter contains an unrestricted summary that identifies the reasons for the

cost growth, discusses the procedures the Navy followed to settle the claims, and assesses

whether additional delays and cost growth can be expected.

We are sending copies of this summary to other appropriate congressional committees; the

Secretaries of Defense and the Navy; and the Director, Office of Management and Budget. We

will also make copies available to others.
B-251748 

This summary was prepared under the direction of Richard Davis, Director, National Security

Affairs, who may be reached on (202) 512-3504 if you or your staff have any questions

concerning this summary. Other major contributors to this summary are Richard J. Herley,

Assistant Director; David R. Fisher, Evaluator-in-Charge; and Harold D. Reich, Site Senior.

Frank C. Conahan

Assistant Comptroller General

Page 2 GAO/NSIAD-93-298 Navy Contract
Summary

Purpose In January 1987, the Navy awarded National Steel and Shipbuilding

Company (NASSCO), San Diego, California, an $862.9-million,1

 fixed-price

incentive contract for the detailed design and construction of the first 

AOE 6 class ship, with options for three additional ships (AOE 7 through

9). However, the program schedule slipped, costs increased, the Navy did

not exercise the AOE 9 option, and it reduced the program from seven to

four ships. By February 1991, NASSCO had submitted over $300 million in

claims against the Navy for cost increases it believed the Navy was

responsible for. As a result, the House and Senate Committees on

Appropriations Conferees directed GAO to monitor the claims resolution

process. Specifically, GAO’s objectives were to identify the reasons for

program cost growth and to document the procedures the Navy followed

in its AOE 6 claims settlement process. In addition, GAO assessed whether

the Navy would incur further program cost increases and schedule delays.

Background The AOE 6 class fast combat support ships are designed to operate as part

of carrier battle groups, resupplying other ships in the battle groups with

food, petroleum products, ammunition, and other supplies. As such, they

are designed to combatant standards. They will be the first Navy ships to

use the newly designed reversing reduction gears, which perform a

function similar to an automobile transmission.

The Navy and NASSCO negotiated a claims settlement on December 26,

1991. In addition to a price increase, the settlement provided for contract

modifications, including slippage of ship and gear delivery dates, and for

the revision of NASSCO’s cost and schedule control system. After the

settlement, Congress provided $500 million for another AOE class ship, the

AOE 10. Also during this time, the threat and national security strategy

that formed the basis for the AOE 6 program has changed or is being

reevaluated, and the size of the aircraft carrier force and the fleet are being

reduced. However, DOD has proceeded with plans to construct the AOE 10.

NASSCO was awarded the contract in January 1993, and construction is

planned to begin during September 1993.

Results in Brief The AOE 6 program was troubled from the beginning, with schedule delay

and cost growth virtually inevitable. The subsequent problems and the

resulting claims stemmed from an optimistically low bid, concurrent

development and construction, inadequate Navy and NASSCO management

attention, and unrealized gains in expected shipyard productivity.

1

All dollar amounts are expressed in program base month March 1986 dollars unless otherwise noted.

Page 3 GAO/NSIAD-93-298 Navy Contract
Summary

The Navy administered the claims evaluation process according to

established procedures. Navy claims files generally documented NASSCO’s

legal entitlement for each claim, the technical and audit analyses, and

support for the Navy’s position. The Navy developed its own cost

estimates for claims.

The lead ship has not been fully tested at sea, where operational problems

may first arise. Thus, although fiscal year 1992 and 1993 funds in the

amount of $500 million are available for another AOE class ship (AOE 10),

the final costs, delivery dates, and the extent AOEs now under

construction will meet operational expectations are still unknown.

Declines in the size of the fleet and carrier force and a reordering of

defense priorities may preclude the need for the AOE 10.

GAO’s Analysis

Reasons for Cost Growth Four principal causes contributed to the increased costs:

• NASSCO submitted an optimistically low bid. NASSCO planned on reducing

the number of labor hours required to build the ship by instituting capital

improvements, applying intense management attention, obtaining

below-market labor rates, and utilizing advanced shipbuilding techniques.

• NASSCO believed the reversing reduction gear design was

nondevelopmental and equipment was readily available. However, as

revealed during the claims process, before awarding the contract, the Navy

knew that specifications for some gear components were developmental

and probably could not be manufactured and tested in the time allowed in

the contract. The Navy did not disclose this information at the time the

original contract was awarded.

• Higher priority work with the DDG 51 class destroyer interrupted the Navy

from working on design specifications for the AOE 6. When the Navy

resumed AOE 6 work a year later, different personnel were assigned. This

lack of continuity resulted in deficient design specifications. Also, because

of emerging shipyard problems and the addition of other contracts, NASSCO

managers were not able to manage the AOE 6 ship construction as

intensively as intended.

• Because some major components were delivered much later than planned,

NASSCO was unable to fully implement advanced shipbuilding techniques or

realize expected work force productivity. As planned, NASSCO began to

Page 4 GAO/NSIAD-93-298 Navy Contract
Summary

build the second ship before completing the first to meet the construction

schedule. As a result, it had to hire and train many additional workers.

NASSCO’s low wage scale compounded difficulties because NASSCO could not

attract and keep the skilled craftsmen and engineers it needed.

Claims Resolution

Followed Process

By early 1991, the construction delays and increased costs left NASSCO in

severe financial difficulty. To prevent NASSCO’s bankruptcy, the Navy

agreed to provide emergency financial relief available under the provisions

of Public Law 85-804 and expedite the claims settlement process. The key

Navy objective was to complete the three ships under construction at the

least cost and earliest possible delivery date.

The Navy administered the claims evaluation process in accordance with

established administrative procedures. The Navy assembled a team of

analysts from the Naval Sea Systems Command, the Office of the

Supervisor of Shipbuilding, Conversion and Repair, and the Defense

Contract Audit Agency. The team was involved in the technical and legal

analyses and the accounting audit to determine if NASSCO was entitled to

compensation and to recommend a settlement amount, if warranted. The

Navy and NASSCO reached an agreement and executed contract

modifications on December 26, 1991.

However, NASSCO’s cost and schedule control system did not comply with

Department of Defense (DOD) standards as required by the contract. The

system did not provide reliable completion estimates for ships under

construction. As a result, excess progress payments of almost $25 million

were paid to NASSCO in 1990, which were, in effect, recovered in calculating

the net settlement amount payable to NASSCO. The Navy and NASSCO also

agreed, as part of settlement, that NASSCO would revise its cost and

schedule control system.

Future Schedule Delays

and Cost Growth Are

Likely

Future contract schedule delays and cost growth are likely. It appears

target prices and delivery schedules will slip again because assumed

shipyard productivity rates, used to calculate the estimated labor hours

needed to complete the ships, have not been achieved and maintained as

expected at the time of settlement. Also, in October 1992, the employees

entered a strike against NASSCO, but after 3 weeks temporarily agreed to

continue work while they negotiated with NASSCO. The Navy reported in

April 1993 that federal mediators had entered the negotiations. NASSCO and

the Navy are assessing the impact of the strike on cost and schedule

Page 5 GAO/NSIAD-93-298 Navy Contract
Summary

estimates. These difficulties could affect the construction schedule and

final cost of the AOE 10.

Further, the AOE 6 will not be fully tested until sea trials after mid-1993. If

problems are revealed, additional costs could be incurred for corrections.

Other factors could affect the future of the AOE 10 as well. The

requirement for AOE 6 class ships was developed in the early 1980s. Since

then, defense budgets have declined, defense priorities have shifted, and

the size of the fleet, including the number of aircraft carrier battle groups,

is being reduced. Together, these factors raise the question of whether the

AOE 10 is still needed.

Recommendation GAO recommends that the Secretary of Defense direct the Secretary of the

Navy to suspend further expenditures under the AOE 10 ship construction

contract until (1) the total cost and operational capabilities of the AOE 6

are known and (2) the risks associated with continuing the program are

identified and controlled. Further, GAO recommends that the Secretary of

Defense direct the Secretary of the Navy to reevaluate the current need for

the AOE 10. If the reevaluation does not support the need for the AOE 10,

GAO recommends that the Secretary of Defense direct the Secretary of the

Navy to terminate the AOE 10 ship construction contract.

Agency Comments On March 18, 1993, DOD provided comments on a draft of this report,

generally agreeing with the report’s findings, but did not agree with a

recommendation in the draft report that award of the AOE 10 construction

contract should be delayed. Shortly after GAO provided the draft report to

DOD for comment, the Navy awarded NASSCO a contract for the AOE 10.

Construction is expected to begin in September 1993. DOD commented that

award was based on NASSCO’s ability to perform and a review and

evaluation of factors that could affect the execution of the program and

the associated risks. DOD believes program risks are now acceptable.

(701023) Page 6 GAO/NSIAD-93-298 Navy Contract
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