United States General Accounting Office

GAO Report to Congressional Requesters

May 1995 DEFENSE

DOWNSIZING

Selected Contractor

Business Unit

Reactions

GAO/NSIAD-95-114

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-258875 

May 3, 1995

The Honorable Floyd D. Spence

Chairman

The Honorable Ronald V. Dellums

Ranking Minority Member

Committee on National Security

House of Representatives

The Honorable James V. Hansen

The Honorable Norman Sisisky

House of Representatives

In accordance with a September 26, 1994, request from the former

Chairman and Ranking Minority Member, we examined the impact of the

recent decline in defense expenditures on individual business units of

major defense contractors. We compared defense expenditures over a

number of years and changes in the business units’ (1) sales and

employment levels and (2) their spending on independent research and

development and bid and proposal (IR&D/B&P)1

 preparation, capital

improvements, and facilities. To provide comparability and perspective, all

of the sales and spending levels in this report are expressed in fiscal year

1995 dollars and measured from various base years.

We selected business units from 6 of the top 10 defense contractors in

1993—General Dynamics, General Motors, Lockheed, Martin Marietta,

McDonnell Douglas, and United Technologies. The units selected were

primarily engaged in defense work and comprised an important part of

their corporations’ total government sales.2

 To protect proprietary data,

we have not disclosed the identities of the business units and have

frequently interchanged the business unit labels (A-F) used throughout

this report. While the changes at these business units are not projectable

to the entire defense industry, they provide some insight into the impact of

defense downsizing.

1

IR&D is research and development initiated and conducted by contractors but is not specified under

any contract or grant. It is funded and managed at the contractor’s discretion from contractor

controlled resources, with a portion of the costs later recovered through overhead. B&P is the cost

incurred in preparing, submitting, and supporting bids and proposals (solicited and unsolicited) on

potential government or nongovernment contracts.

2

Includes sales made to foreign governments through the U.S. government.

Page 1 GAO/NSIAD-95-114 Defense Downsizing
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Background The Congress wants a strong defense industrial base and has directed the

Secretary of Defense to report annually on the ability of industry to

support U.S. national security objectives. The Congress directed the

Secretary to consider in the analysis for that report such factors as levels

of spending for capital investment and research and development. In

June 1993, the Department of Defense’s (DOD) Inspector General criticized

DOD’s first report as being of limited use in helping congressional leaders

make informed judgments because DOD lacked an adequate information

system to carry out the assessment.

Defense industry representatives also criticized that report. One common

criticism was that the majority of the report’s data applied to corporations

rather than their defense segments. The second DOD report, released in

September 1994, also concentrated on the corporate level rather than

individual business units. Other studies of the effects of the spending

decline have also assessed the impact at the corporate level rather than

the individual business unit. Another shortcoming in many of these

assessments was that they measured the severity of the decline in defense

expenditures only from the peak years of the 1980s and not from other

years in the cycle of defense expenditures as well.

Results in Brief Measured from their peak years, the six business units we visited had

experienced sales decreases ranging from 21 percent to 54 percent

through 1993 and estimated declines ranging from 50 percent to 73 percent

through the latest year projected. The resulting employment reductions

ranged from 30 percent to 76 percent through 1993 and planned reductions

ranging from 44 percent to 79 percent through the latest year projected.

From their peak year spending levels through 1993, the six units had

reduced IR&D/B&P spending ranging from 31 percent to 71 percent and

projected reductions ranging from 41 percent to 84 percent through the

latest year projected. The six units had also reduced expenditures for

capital improvements by an average of 80 percent through 1993 and,

through the latest year projected, estimated an average reduction of

76 percent in these expenditures.

Although these business units have significantly reduced spending in these

areas, projections by some of the units are still higher than their (1) 1976

levels—the lowest peacetime defense spending level since the Korean War

buildup—and (2) 1980 levels—the year before the Reagan administration

military buildup.

Page 2 GAO/NSIAD-95-114 Defense Downsizing
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The defense industry has adjusted to previous spending reductions. The

current post-Cold War reduction is only 2 percentage points greater than

the reduction after the Vietnam War and is taking place over a period that

is 2 years longer. However, unlike other drawdowns, defense contractors

view the current decline as permanent and have developed a variety of

strategies to deal with reduced defense spending.

Defense Expenditures Since the World War II drawdown, defense spending has experienced

three peaks associated with the Korean War, the Vietnam War, and the

Reagan administration military buildup. In fiscal year 1989, defense

expenditures3

 reached their highest peacetime level since World War II,

exceeding defense spending at the peak of the Korean War and almost

matching spending during the Vietnam War. Defense expenditures in fiscal

year 1989 were $354.1 billion, but had declined to $274.5 billion by fiscal

year 1994, a reduction of $79.6 billion or 22 percent. The Clinton

administration is projecting defense expenditures of $224.5 billion in fiscal

year 2000, which represents a $129.6-billion, or a 37-percent, decline in

defense spending since fiscal year 1989. Figure 1 shows the trend in

defense expenditures after the end of World War II.

3

Many of the studies that assessed the impact of defense downsizing used budget authority to measure

the impact. However, we used budget expenditures because expenditures provide a more accurate

assessment of the impact.

Page 3 GAO/NSIAD-95-114 Defense Downsizing
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Figure 1: Defense Expenditures

Korean War

Vietnam War

48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99

0

100

200

300

400

500

Fiscal year

Dollars in billions

Reagan buildup

Note: Figures for fiscal years 1995 through 2000 are executive branch projections.

Although most defense authorities agree that the post-Cold War decline in

spending is significant, it is comparable to the Vietnam War drawdown. As

shown in table 1, the current decline is only 2 percentage points greater

than the Vietnam War drawdown, which was spread over an 8-year period,

whereas the post-Cold War drawdown is currently projected over a

10-year period. However, unlike the Vietnam War drawdown, defense

contractors view the current decline as permanent, not cyclical.

Page 4 GAO/NSIAD-95-114 Defense Downsizing
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Table 1: Cyclical Declines in Defense

Expenditures (1995 Dollars in Billions) Time period Expenditures

Vietnam War drawdown

1968 $358.0

1976 $231.0

Overall reduction 35 percent

Time span 8 years

Post-Cold War drawdown

1989 $354.1

1999 $223.8

Overall reduction 37 percent

Time span 10 years

Measured against other years, the $260.2 billion in defense spending

projected for fiscal year 1995 is about 13 percent greater than the

$231 billion expended during fiscal year 1976 and about 4 percent greater

than the $251.4 billion expended in fiscal year 1980. Fiscal year 1976 is a

significant benchmark because it represents the lowest level in peacetime

defense spending since the Korean War. Fiscal year 1980 is significant

because it was the year prior to the beginning of the Reagan

administration defense buildup. Based on current projections, peacetime

defense spending will remain above the fiscal year 1976 level until fiscal

year 1998, when spending is projected to decline to $225.1 billion.

Decline in Selected

Business Unit Sales

According to officials of the six business units we visited, the decline in

defense spending since the late 1980s has significantly affected their

defense sales. We compared the peak sales by these business units during

the mid-to-late 1980s with their sales in 1993 and the latest year projected.4

Measured from their peak sales years, we found that the business units’

sales decreases ranged from 21 percent to 54 percent through 1993 and

that the units were estimating decreases ranging from 50 percent to

73 percent through the latest year projected. The projected weighted

average decline over the businesses was about 55 percent. Figure 2 shows

the actual and projected sales decreases by business unit.

4

Projected sales are presented for the latest year forecasted by the business units at the time of our

visits. The latest years forecasted varied from 1997 to 2001, and peak years varied from 1985 to 1989.

Page 5 GAO/NSIAD-95-114 Defense Downsizing
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Figure 2: Actual and Projected

Reduction in Sales

ABCDEF

0

20

40

60

80

29

21

54

48

36

42

62

73

51

62

50

55

In percent

Peak to 1993 Peak to latest projected year

Although sales declines from the peak years are significant, several of the

business units had sales that were actually lower in 1976 and 1980 than

their future projections. Table 2 compares the business units’ forecasted

sales with their 1976 and 1980 sales. As shown, two of the business units

projected their future sales to be higher than their 1976 sales, and three of

the business units projected their future sales to be higher than their 1980

sales.

Page 6 GAO/NSIAD-95-114 Defense Downsizing
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Table 2: Comparison of Forecasted

Sales With 1976 and 1980 Sales Change in sales

Business unit

1976 through last year

forecasted

1980 through last year

forecasted

A 74-percent increase 13-percent increase

B 33-percent increase 17-percent increase

C 54-percent decrease 16-percent decrease

D Not available 62-percent decrease

E Not available 29-percent increase

F Not available Not available

Contractors Reduce

Spending in Response

to Sales Declines

Defense contractors have taken and are continuing to take aggressive

actions to reduce spending as a result of post-Cold War sales declines. The

following discussion deals with actions taken in the areas of employment

levels, IR&D/B&P expenditures, capital improvements, and facilities.

Cutbacks in Employees The six business units have made large reductions in the number of

employees since their peak employment years5

 of the mid-to-late 1980s.

Through 1993, the units’ workforce reductions ranged from 30 percent to

76 percent. Through the latest projected year, the units’ estimated

reductions ranged between 44 percent to 79 percent. Three of the units

projected reductions of over 75 percent, while the other three units

projected reductions ranging from 44 percent to 57 percent. Figure 3

provides an overview of actual and projected employment reductions by

business unit.

5

Peak employment years varied from 1983 to 1989, and the latest projected years varied from 1996 to

2001.

Page 7 GAO/NSIAD-95-114 Defense Downsizing
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Figure 3: Actual and Projected

Reductions in Total Employment

ABCDEF

0

20

40

60

80

100

38 40

61

42

76

30

54

44

78

57

77 79

In percent

Peak to 1993 Peak to latest projected year

Unlike sales where several of the business units projected higher figures in

the future than in 1976 and 1980, all of the units for which data were

available projected lower employment levels in the future than they had in

1976 and 1980. Table 3 compares projected employment with the 1976 and

1980 levels.

Page 8 GAO/NSIAD-95-114 Defense Downsizing
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Table 3: Comparison of Forecasted

Employment With 1976 and 1980

Employment

Change in employment

Business unit

1976 through last year

forecasted

1980 through last year

forecasted

A 17-percent decrease 43-percent decrease

B 11-percent decrease 35-percent decrease

C 5-percent decrease 37-percent decrease

D Not available 77-percent decrease

E Not available 68-percent decrease

F Not available Not available

The downward employment trend at these six business units is consistent

with the findings of other studies on the private sector defense industry

workforce. One report,6

 for example, showed that defense-related private

employment had declined from about 3.7 million workers in 1987 to about

2.7 million workers in 1993, which represents a 26-percent employment

decline over the period. According to that report, the 20 leading defense

contractors had experienced an average employment reduction of

22 percent between 1987 and 1993. Other studies have projected a

continuing downward trend in defense employment over the next several

years. For example, a report7

 prepared by the Logistics Management

Institute for the Defense Conversion Commission estimated that private

sector defense-related employment would likely decline by about 803,000

jobs, or 27 percent, from 1992 to 1997.

Declines in IR&D/B&P

Expenditures

Similar to the reductions in employment levels, the six business units had

made substantial cuts in their IR&D/B&P expenditures. Between their peak

spending years8

 and 1993, these units had reduced IR&D/B&P expenditures

ranging from 31 percent to 71 percent and projected reductions ranging

from 41 percent to 84 percent through the latest year projected. Figure 4

shows the actual and projected reductions.

6

Backgrounder—The U.S. Defense Industry in 1993: A Year-End Review, Defense Budget Project

(Jan. 17, 1994).

7

The DOD Drawdown: Planned Spending and Employment Cuts, Logistics Management Institute

(Jan. 1993).

8

Peak IR&D/B&P expenditure years varied from 1984 to 1988, and the latest projected years varied

from 1997 to 2001.

Page 9 GAO/NSIAD-95-114 Defense Downsizing
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Figure 4: Actual and Projected

Reduction in IR&D/B&P Expenditures

ABCDEF

0

20

40

60

80

100

48

57

71

31

45

52

41

84

62 61

48

59

In percent

Peak to 1993 Peak to latest projected year

The six business units’ forecasts show that they plan to spend an average

of 54 percent less for IR&D/B&P than they spent during the mid-to-late 1980s.

However, as shown in table 4, two of the business units projected future

expenditures for IR&D/B&P to be more than they spent in 1976. Two other

business units forecasted their future expenditures to be more than they

spent in 1980.

Page 10 GAO/NSIAD-95-114 Defense Downsizing
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Table 4: Comparison of Forecasted

IR&D/B&P Expenditures With

Expenditures in 1976 and 1980

Change in IR&D/B&P expenditures

Business unit

1976 through last year

forecasted

1980 through last year

forecasted

A 9-percent increase 52-percent decrease

B 4-percent decrease 15-percent decrease

C 28-percent increase 43-percent decrease

D Not available 45-percent increase

E Not available 7-percent increase

F Not available Not available

Several studies showed a correlation between the level of defense

expenditures and the amounts contractors spend on IR&D. One study,9

 for

example, stated that the level of defense procurement directly affects IR&D

activities, which are supported to a large extent by overhead charges in

production contracts. The report stated that when large production runs

were the rule, many companies willingly invested their own funds in IR&D

because they could reasonably expect to recover their investment.

Another report10 predicted that, with fewer defense procurements, IR&D

payments would decrease and companies might not be willing to risk

conducting their own IR&D.

To determine whether these reports applied to the business units we

visited, we compared the changes in the business units’ spending levels for

IR&D/B&P with changes in their sales. For four of the six business units, we

found that changes in IR&D/B&P expenditures generally correlated to their

sales volume. For illustration purposes, figure 5 compares the trend in one

business unit’s sales and its IR&D/B&P expenditures.

9

“The Future of the Defense-Related Industrial Base in the United States”, Parameters, Journal of the

U.S. Army War College (Summer 1994).

10Defense R&D in the 1990s, Congressional Research Service Issue Brief (Feb. 24, 1994).

Page 11 GAO/NSIAD-95-114 Defense Downsizing
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Figure 5: Percent Change in Sales and

IR&D/B&P Expenditures

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

0

50

100

150

200

Percent change from 1980

Sales IR&D/B&P

Note: Figures for years 1994 through 1997 are estimates.

Because of concerns that the quantity and quality of IR&D would decline as

budget cuts forced the defense industry to limit overhead costs, the

Congress made substantial legislative revisions11 to the IR&D program in

fiscal years 1991 and 1992 to encourage defense contractors to continue

IR&D activities. Even with these revisions, defense contractors have

continued to cut their IR&D/B&P expenditures, as their defense sales have

declined.

11In this legislation, the Congress (1) broadened the criteria for allowable IR&D efforts to include any

work of “potential interest” to DOD; (2) removed all negotiated ceilings on allowable costs, mandating

an automatic 5-percent increase in pre-existing ceilings through the end of fiscal year 1995 with full

reimbursement of DOD’s share of incurred IR&D costs beginning in fiscal year 1996; and (3) eliminated

mandatory on-site technical reviews of industry projects and abolished the formal mechanisms by

which DOD could appraise and score industry’s IR&D efforts.

Page 12 GAO/NSIAD-95-114 Defense Downsizing
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Reductions in Capital

Expenditures

The six business units we visited have significantly cut their capital

expenditures from their peak spending levels in the 1980s.12 The units had

made reductions through 1993 ranging from 52 percent to 92 percent and

estimated reductions ranging from 55 percent to 85 percent through the

latest projected year. The units projected a weighted average reduction of

76 percent in their capital expenditures. Figure 6 shows the actual and

projected reductions in capital expenditures.

Figure 6: Actual and Projected

Reduction in Capital Expenditures

ABCDEF

0

20

40

60

80

100

92

73

89

52

88

82

85 83 84

55

74

82

In percent

Peak to 1993 Peak to latest projected year

Table 5 compares the business units forecasted expenditures with their

1976 and 1980 expenditures. When 1976 was used as the base year, three

business units projected higher capital expenditures in the future, but

when 1980 was used as a base year, one business unit projected higher

12Peak capital expenditure years varied from 1980 to 1988, and the latest projected years varied from

1997 to 2001.

Page 13 GAO/NSIAD-95-114 Defense Downsizing
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capital expenditures. Similar to IR&D/B&P expenditures, there is not a

consistent trend in capital expenditures. For example, although Company

A and Company C projected higher capital expenditures compared to

1976, the companies projected lower capital expenditures when compared

to 1980. However, we found that changes in capital expenditures at three

of the units correlated to the units’ sales volume.

Table 5: Comparison of Forecasted

Capital Expenditures With 1976 and

1980 Capital Expenditures

Change in capital expenditures

Business unit

1976 through last year

forecasted

1980 through last year

forecasted

A 89-percent increase 53-percent decrease

B 493-percent increase 8-percent increase

C 75-percent increase 50-percent decrease

D Not available 85-percent decrease

E Not available 78-percent decrease

F Not available Not available

Two business units had formal programs to limit future capital

expenditures. One unit, for example, established the following four

categories in which proposed capital expenditures would be approved by

management:

• firm contractual commitments required to keep existing products

operational,

• environmental requirements mandated by law,

• health and safety requirements to meet Occupational Safety and Health

Administration standards, and

• new product requirements for specific new products.

According to a report issued in May 1989 by the Center for Strategic and

International Studies, the best measure of the U.S. defense industrial

base’s ability to maintain its technological lead is the amount of capital

spending in industry to expand capacity or improve productivity.

Reductions in Facilities Measured from their peak years,13 five of the business units had reduced

their total square footage by as much as 34 percent through 1993, and five

units projected reductions ranging from 6 percent to 43 percent, or an

average of 26 percent, through the latest projected year. The units

13Peak square footage years varied from 1985 to 1991, and the latest projected years varied from 1997

to 2001.

Page 14 GAO/NSIAD-95-114 Defense Downsizing
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projected most of these reductions in their leased space. Figure 7 shows

the actual and projected reductions in total square footage.

Figure 7: Actual and Projected

Reductions in Facilities

In percent

ABCDE

0

10

20

30

40

11

15

34

3

0.48

43

41 42

10

6 

Peak to 1993 Peak to latest projected year

50

Despite the past and planned reductions in space occupied, most of the

units projected larger square foot usage than in 1976 and 1980. Table 6

compares the changes in the size of the business units’ facilities.

Page 15 GAO/NSIAD-95-114 Defense Downsizing
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Table 6: Comparison of Forecasted

Total Square Footage With 1976 and

1980 Square Footage

Change in total square footage

Business unit

1976 through last year

forecasted

1980 through last year

forecasted

A 65-percent increase 29-percent increase

B 62-percent increase 31-percent increase

C 15-percent increase 14-percent increase

D Not available 34-percent decrease

E Not available 11-percent increase

F Not available Not available

Three business units expected to use more square footage in the future14

than occupied in 1976; four units expected to use more space than they

occupied in 1980. According to Defense Contract Management Command

records, defense contractors have significantly reduced the size of their

facilities through such actions as vacating and selling buildings and

terminating leases.

Scope and

Methodology

We compiled and compared information on the declines and buildups in

defense expenditures since the end of World War II. We also conducted

literature searches and examined various reports, assessments, and other

documents to determine how defense contractors throughout the industry

have been affected by reduced defense spending.

The business units provided us with data on their sales, employment

levels, capital expenditures, IR&D/B&P, and facilities for 1976 through the

latest projected year. We focused our work on these five elements because

we believed they were most representative of the impact of reduced

defense spending on defense contractor business units.

For three of the business units, we were unable to obtain data as early as

1976 and therefore used the earliest data available. We accepted the data

provided by the business units and did not attempt to validate the data. In

some cases, the organization of the business units have changed since

1976, and the units had to compile or estimate data to reflect their

organization since that time.

We conducted our review from March 1994 to January 1995 in accordance

with generally accepted government auditing standards. We did not obtain

14The latest projected years varied from 1997 to 2001.

Page 16 GAO/NSIAD-95-114 Defense Downsizing
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DOD comments on this report; however, we discussed the results of our

work with contractor representatives from each of the six business units.

We are sending copies of this report to the Secretary of Defense, officials

of the six business units, and other interested congressional committees.

We will make copies available to others upon request.

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

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

Harper, George C. Burdette, Anne-Marie Olson, and Amy S. Parrish.

David E. Cooper

Director, Acquisition Policy, Technology,

 and Competitiveness Issues

(705075) Page 17 GAO/NSIAD-95-114 Defense Downsizing
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