United States General Accounting Office

GAO Report to Congressional Committees

September 1996 DEFENSE

RESTRUCTURING

COSTS

Projected and Actual

Savings From

Martin-Marietta

Acquisition of GE

Aerospace

G O A

years

1921 - 1996

GAO/NSIAD-96-191

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-272422 

September 5, 1996

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 V. Dellums

Ranking Minority Member

Committee on National Security

House of Representatives

Section 818 of the National Defense Authorization Act for Fiscal Year 1995

(P.L. 103-337) restricts Department of Defense (DOD) payments of

restructuring costs1

 associated with defense contractor business

combinations. Specifically, it prohibits the payment of restructuring costs

until a senior DOD official certifies in writing that projected savings from

the restructuring are based on audited data and should result in overall

reduced costs to DOD. In response to section 818, DOD issued interim

regulations, effective December 29, 1994, on the allowability of

restructuring costs.2

The act also calls for our office to periodically report on the

implementation of these DOD regulations. We have already issued two

reports on the subject.3

 This report discusses the 17 restructuring projects

proposed for payment by Martin Marietta Corporation,4

 as a result of its

1

Restructuring costs cover a wide range of expenses, such as personnel relocations, severance pay,

early retirement incentives, equipment relocations, plant rearrangements, and facility closings.

2

DOD published the final regulation on restructuring costs in the Federal Register dated April 18, 1996.

Differences between the interim and final regulations have no bearing on the matters discussed in this

report.

3

Defense Restructuring Costs: Payment Regulations Are Inconsistent With Legislation

(GAO/NSIAD-95-106, Aug. 10, 1995) and Defense Contractor Restructuring: First Application of Cost

and Savings Regulations (GAO/NSIAD-96-80, Apr. 10, 1996).

4

Martin Marietta Corporation and Lockheed Corporation merged operations on March 15, 1995, to

form the Lockheed Martin Corporation. We are using the former name—Martin Marietta

Corporation—in the report because the merger with Lockheed Corporation had not taken place at the

time the General Electric business segments were acquired.

Page 1 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

acquisition of General Electric Company’s aerospace business segments.5

DOD has certified 8 of the 17 projects. We reviewed in detail the first five

projects certified, and our review indicated the other three projects are

similar. The objectives of our review were to determine whether (1) the

certification process for the five projects was carried out in accordance

with the regulations, (2) the savings were in line with the original

estimates, and (3) the restructuring resulted in lower DOD contract prices.

To avoid the disclosure of proprietary data, we do not discuss specific

dollar amounts applicable to Martin Marietta Corporation’s restructuring.

Results in Brief Our review indicated DOD’s actions to review and certify the first five

projects complied with the restructuring regulations. As required by those

regulations, the contractor submitted restructuring proposals for the

projects, which were then audited; a senior DOD official certified that the

audited projects should result in overall reduced costs to DOD; and finally,

advance agreements6

 were executed on the projects.

Documented savings from business combinations have not always been as

great as initially expected. In the case of Martin Marietta Corporation’s

acquisition of the General Electric business units, estimated restructuring

savings for the eight certified projects are less than half of the contractor’s

initial rough-order-of-magnitude estimates. This difference exists primarily

because the contractor lowered its estimated savings at the time it

prepared detailed restructuring proposals and DOD negotiated reductions

in the proposed savings during the certification process.

Although certified savings are less than initially estimated, the contractor’s

overhead costs are lower as a result of savings from these projects.

Consequently, the government official responsible for negotiating

overhead costs and rates provided procuring activities with lower

overhead rates for use in pricing DOD contracts.

Background The Defense Contract Management Command (DCMC) has lead

responsibility for implementing DOD’s restructuring regulations and is

currently tracking 32 defense contractor business combinations. For three

5

The acquisition also included General Electric’s government services operations.

6

The advance agreements contain pertinent information about restructuring projects, including a

description of the projects, estimated restructuring savings and costs, and the way that restructuring

costs will be charged to contracts.

Page 2 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

of these combinations,7 the Under Secretary of Defense (Acquisition &

Technology) has certified an estimated net DOD savings of $390.4 million.

The Defense Contract Audit Agency (DCAA) has completed audits of

restructuring proposals for three additional business combinations and is

reviewing proposals submitted for four other combinations.

Martin Marietta Corporation entered into formal discussions with General

Electric Company on October 30, 1992, to acquire its aerospace and

certain other business operations. The acquisition was effective April 2,

1993, and combined two of the nation’s leading aerospace research and

development organizations. After the acquisition, Martin Marietta

Corporation began restructuring the new organization by establishing 

17 projects, which ranged from consolidating corporate headquarters in

Bethesda, Maryland, to relocating and consolidating selected operations at

its facilities in Orlando, Florida.

Of the original 17 projects, DOD eliminated 3 from consideration under

section 818 because they involved normal internal downsizing efforts,

unrelated to the business combination, or were not applicable to defense

work. The Under Secretary of Defense (Acquisition and Technology)

issued a certification of net benefit for five projects on September 19, 1995,

and for three additional projects on February 14, 1996. At the time we

completed our review, six projects remained to be certified.

DOD Actions

Complied With

Interim Regulations

Martin Marietta Corporation started its restructuring before the interim

regulations were issued; nonetheless, DOD’s actions to review and certify

the five restructuring projects complied with the regulations. The

regulations direct the administrative contracting officer, for example, to

require the contractor to submit a restructuring proposal, request an audit

of the proposal, and negotiate an advance agreement between the

government and contractor. The regulations also require a senior-level DOD

official to issue a certification of net benefit for the restructuring.

For the five projects we reviewed, Martin Marietta Corporation submitted

proposals showing restructuring savings would result in a net reduction of

projected overhead costs8

 for the applicable business segments. DCAA

reviewed the proposals and issued audit reports in March 1995. Through

7

The three business combinations are United Defense, Martin Marietta Corporation-General Electric

Aerospace (8 of 14 projects), and Northrop-Grumman.

8

Costs such as facilities and equipment, general office support, and supervisors’ salaries are typically

classified as overhead costs, or indirect costs, because they are not directly assignable to a specific

contract but benefit more than one contract.

Page 3 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

negotiations with the contractor, the administrative contracting officer

obtained agreement on most of the restructuring costs and savings DCAA

questioned and recommended the net benefits be certified. On

September 19, 1995, the Under Secretary of Defense (Acquisition and

Technology) certified the net benefit for the five projects. After

certification, the administrative contracting officer executed advance

agreements for the projects containing the negotiated restructuring costs

and savings, cost ceilings, and other pertinent information.

Savings Were Less

Than Originally

Projected

As part of the public announcements of new business combinations,

defense contractors generally provide a rough-order-of-magnitude

estimate of restructuring savings. Such estimates were discussed in

congressional hearings leading up to enactment of section 818. The Deputy

Secretary of Defense, for example, testified before a congressional

subcommittee in mid-1994 that early estimates from four recently

announced business combinations indicated that projected savings ranged

from one and a half to seven times the projected cost. Later in those

hearings, however, the Deputy Secretary told the subcommittee that

savings on future business combinations could range from four to seven

times the projected costs. In other words, for every dollar DOD invests in

restructuring costs, it could realize savings of $1.50 to $7.00. Savings

achieved on the two business combinations we reviewed fall on the low

side of the Deputy Secretary’s projection.

Restructuring savings resulting from Martin Marietta Corporation’s eight

certified projects are less than its initial rough-order-of-magnitude

estimates. In its initial restructuring projection for the eight projects,

Martin Marietta estimated that $1.00 in restructuring costs would reduce

overhead costs by $2.73 for the first five projects and $76.84 for the last

three projects. These projected reductions in overhead included both the

contractor’s and DOD’s share.

After the projects were certified, $1.00 in restructuring costs was projected

to reduce overhead costs by $2.41 for the first five projects and $8.02 for

the last three projects. These reductions also included both the

contractor’s and DOD’s share. Certified savings for the first five projects

were therefore about 88 percent of the contractor’s original estimates, but

certified savings for the last three projects were only about 10 percent of

the original estimates.

Page 4 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

When considering all eight projects together, $1.00 in restructuring costs

was originally projected to reduce overhead costs by $5.24. After

certification, $1.00 in restructuring costs was projected to reduce

overhead costs by $2.57, which represents only about 49 percent of the

contractor’s original projection.

Projected savings are lower than initially estimated because the contractor

reduced its projection of savings when it prepared detailed restructuring

proposals for the projects. Also, DOD negotiated reductions in the

contractor’s proposed restructuring savings during the certification

process. For example, the government negotiator did not categorize the

elimination of General Electric’s corporate overhead costs as restructuring

savings in the project where the contractor proposed to do this because

the elimination resulted from the business combination itself and not from

actions taken after the combination. The contractor agreed to the

negotiator’s categorization on a nonprecedence-setting basis in order to

proceed with the certification process.

This project comprised $2.42, or about 46 percent, of the $5.24 reduction

in overhead costs the contractor initially projected for the eight projects,

but it comprised only $0.04, or about 2 percent, of the $2.57 certified

reduction in overhead costs. While most of the proposed savings from this

project were not accepted by the government as restructuring savings, the

contractor contended the government would still realize savings from the

elimination of General Electric’s corporate overhead.9

The history of the first eight projects certified, coupled with the fact that

the United Defense restructuring10 achieved savings of less than 15 percent

of the original estimate,11 shows that certified savings have been

considerably less than initially estimated. These results are consistent with

the Federal Trade Commission staff’s conclusion that mergers do not

9

The amount of government savings from eliminating General Electric corporate overhead would

depend on a number of factors, including the number of contracts transferred to Martin Marietta that

were fixed price versus cost, length of the remaining performance periods of the contracts, and the

amount of government sales at the business segments where the contracts were transferred. The

contractor agreed these factors would reduce the amount of savings the government would realize.

Neither we nor DCAA estimated the impact of these factors because the savings were not categorized

as restructuring savings.

10We reported on the United Defense business combination, the first to be officially certified for

payment, in Defense Contractor Restructuring: First Application of Cost and Savings Regulations

(GAO/NSIAD-96-80, Apr. 10, 1996).

11Several factors accounted for the difference between the original and certified estimate of

restructuring savings in the United Defense business combination, including the use of different cost

elements for estimating purposes, different time periods for savings, and a rough-order-of magnitude

estimate versus a detailed cost proposal.

Page 5 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

consistently produce the predicted efficiencies. The Commission’s staff

reached this conclusion after examining the empirical literature on the

results of mergers in general.12

Restructuring

Contributed to Lower

Contract Prices

Although restructuring savings are less than initially estimated, the

contractor’s projected overhead costs are lower at the business segments

where the five restructuring projects are being executed. For every dollar

in restructuring costs for these projects, the contractor reduced DOD’s

share of projected overhead costs by $2.01.13 The reduction in projected

overhead costs is reflected in lower overhead rates for these business

segments, and the lower overhead rates have been provided to procuring

activities for use in pricing DOD contracts. When the procuring activities

use the lower rates, DOD’s contract prices will be lower than they would

have been had it not been for the restructuring under these five projects.

Agency Comments In commenting on a draft of this report, DOD concurred with the report.

DOD suggested several clarifications in the report, and we have

incorporated them in the text where appropriate. DOD’s comments are

presented in their entirety in appendix I.

Scope and

Methodology

We made a detailed examination of the first five certified restructuring

projects because they were the only projects certified when we began our

review. Also, these five projects are representative of the other three

projects that were certified after we initiated our work. In addition, the

other three projects were subjected to the same certification process as

the five projects we reviewed in detail, and DOD’s actions complied with

the same four major elements of the process.

To determine whether the process for the first five projects certified was

carried out in accordance with DOD’s interim regulations, we used a

twofold approach. For those actions taken before the regulations were

issued, we determined whether the actions met the intent of the

regulations. For actions that had not taken place, we compared the

execution of the actions with the specific requirements of the regulations.

In doing this work, we examined the restructuring proposals, audit

12Anticipating the 21st Century: Competition Policy in the New High-Tech, Global Marketplace, Federal

Trade Commission Staff, May 1996.

13DOD’s share of restructuring savings will vary between the project and business segment based on

the total dollar value of DOD’s contracts in relation to the total dollar value of all other contracts,

including commercial and direct foreign sales.

Page 6 GAO/NSIAD-96-191 Defense Restructuring Costs
B-272422 

reports, negotiation memorandums, advance agreements, correspondence,

the net benefit certification, and other related documents and records.

To determine whether the projects resulted in lower DOD contract prices,

we traced the savings in the contractor’s overhead cost proposals and

determined that proposed overhead costs were lower than they would

have been had the restructuring not occurred. We also determined that the

recommended overhead pricing rates were based on the lower overhead

costs and that the lower rates were provided to procuring activities for use

in pricing DOD contracts. In making these determinations, we examined the

contractor’s overhead costs proposals, the results of DCAA’s audits of the

proposals, the recommended overhead pricing rates, and other related

documents and reports.

We discussed various aspects of the restructuring activities with officials

from Martin Marietta Corporation, the Office of the Director of Defense

Procurement, DCMC, and DCAA. We performed our review between

December 1995 and June 1996 in accordance with generally accepted

government auditing standards.

We are sending copies of this report to the Chairmen of the Senate

Committee on Government Affairs, the House Committee on Government

Reform and Oversight, and the Senate and House Appropriations and

Budget Committees; the Secretaries of Defense, the Army, the Air Force,

and the Navy; the Commander, DCMC; the Director, DCAA; and the Chief

Executive Officer, Lockheed Martin Corporation. We will provide copies

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, and Stacey E. Keisling.

David E. Cooper

Associate Director

Defense Acquisitions Issues

Page 7 GAO/NSIAD-96-191 Defense Restructuring Costs
Appendix I 

Comments From the Department of Defense

Page 8 GAO/NSIAD-96-191 Defense Restructuring Costs
Appendix I 

Comments From the Department of Defense

(705127) Page 9 GAO/NSIAD-96-191 Defense Restructuring Costs
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