Defense Acquisitions: Realistic Business Cases Needed to Execute Navy Shipbuilding Programs
Published: 2007-07-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Navy is beset with long-standing problems that affect its ability to accomplish ambitious goals for its shipbuilding portfolio. Significant cost growth and long schedule delays are persistent problems. Making headway on these problems is essential in light of the serious budget pressures facing the nation. This testimony focuses on (1) cost growth in shipbuilding, (2) acquisition approaches in the LPD 17, Littoral Combat Ship, DDG 1000 and CVN 78 programs and (3) steps the Navy can take to improve its acquisition decision-making, particularly the adoption of a knowledge-based framework.
section_title: What GAO Found
paragraphs: The Navy has exceeded its original budget by more than $4 billion for the 41 ships under construction at the beginning of this fiscal year. And more cost growth is coming. Cost growth is not just a problem for lead ships of a new class but also for follow-on ships. For example, costs for the first two Littoral Combat Ships have more than doubled. Similarly, costs for the first two San Antonio class (LPD 17 and LPD 18) amphibious ships have increased by over $1.3 billion--almost a 77 percent increase above the initial budgets. Cost growth of this magnitude leads to lost opportunities for tomorrow's needs. These types of problems point to the wisdom of using solid, executable business cases to design and build ships. A business case requires a balance between the concept selected to satisfy warfighter needs and the resources--technologies, design knowledge, funding, time, and management capacity--needed to transform the concept into a product, in this case a ship. Neither LPD 17 nor the Littoral Combat Ship programs was framed around an executable business case; rather, the programs pushed ahead without a stable design and without realistic cost estimates, resulting in higher costs, schedule delays, and quality problems. The Navy has a more thoughtful business case for its next generation aircraft carrier and destroyer programs (CVN 78 and DDG 1000, respectively) before construction, but the programs remain at risk for cost growth partly because of continuing efforts to mature technologies. GAO's work on best practices highlights the need for a disciplined, knowledge-based approach to help shipbuilding, and other defense acquisition programs achieve more successful outcomes. This approach is predicated on certain essentials, including: ensuring that technology maturity is proven before a design is considered stable and understanding that production outcomes cannot be guaranteed until a stable design is demonstrated; improving cost estimating to develop initial shipbuilding budgets that are realistically achievable; and improving cost management through increased use of fixed-price contracting and comprehensive cost surveillance. A significant challenge to adapting a knowledge-based approach is the lack of a common understanding across programs regarding the definition, timing, and criteria for key knowledge junctures. For example, each shipbuilding program seems to have a different measure as to how much of the design needs to be complete before beginning ship construction. Similarly, there appears to be little criteria across programs regarding how much knowledge--such as the percent of ship units built--is needed at different decision points, including keel lay, fabrication start, and ship launch.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the Department of the Navy’s  shipbuilding programs, including its surface combatant programs. The  Navy has ambitious goals for its shipbuilding programs. The Navy expects  to build more—and often increasingly complex ships—and deliver them to  meet warfighter needs, while still achieving reduced acquisition and/or life  cycle costs. These are admirable goals, representing the Navy’s desire to  provide the fleet with the most advanced ships to meet national defense  and military strategies. However, there is often tension among the Navy’s  cost, schedule, industrial base, and capability goals. While this tension is  embedded at the beginning of shipbuilding programs, its effects are  realized later, during ship construction. Budgets set prior to beginning  construction are not realistically achievable and often include optimistic  dates for delivery to the fleet. The consequence is often that costs increase  after construction has begun, schedule targets slip, and contract scope is  reduced. The LPD 17—the lead ship of the San Antonio class amphibious  ships—is a case in point. The cost to construct the ship has more than  doubled, delivery was delayed by over 3 years, and ship quality ultimately  compromised.
Today, I would like to discuss (1) cost growth in shipbuilding programs,  (2) acquisition approaches in the LPD 17, Littoral Combat Ship (LCS), the  next-generation destroyer and aircraft carrier programs (DDG 1000 and  CVN 78, respectively), and (3) steps the Navy can take to improve its  acquisition decision making, particularly the adoption of a knowledge- based management framework.
subsections: section_title: Cost Growth Remains a Problem in Navy Shipbuilding Programs—and May Threaten Future Success
paragraphs: Cost growth is a persistent problem for shipbuilding programs as it is for  other weapon systems. Over 40 ships were under construction at the  beginning of this fiscal year. If the performance of future shipbuilding  programs continues at the same rate as current programs, the Navy will be  forced to fund cost growth in future budget years at the expense of other  ships in the Navy’s shipbuilding plan.
Funding for the 41 ships under construction is over $56 billion, almost   $4.6 billion above initial budget requests. Congress has already  appropriated additional funds to cover most of these cost increases   (see table 1).
Breaking these costs down further reveals the dynamics of shipbuilding  cost growth and the challenges it presents for the 30 year shipbuilding  plan. For example, cost growth in mature programs, like the Arleigh Burke  class destroyers (DDG 100-112) is low because most cost growth has  already been captured in earlier ships. Cost growth in the Virginia class  submarines (SSN 775-783) and the Lewis and Clark class auxiliary ships  (T-AKE 1-9) is also low because they include several ships early in  construction—before cost growth tends to occur. On the other hand, cost  growth is particularly high on lead ships of a new class (see fig. 1).
Cost growth for recent lead ships has been on the order of 27 percent. The  Navy is developing two lead ships in the LCS program—each with a unique  design. These ships have already experienced a 128 percent cost growth.  Cost increases are also significant if the second ship is assembled at a  different shipyard than the first ship. This is the case with SSN 775, which  has had cost growth of well over $500 million. Although the ship has been  delivered, the Navy continues to incur costs for unfinished work.
Follow-on ships in many cases are also experiencing significant cost  increases in construction. Although LPD 18 is the second ship of the class,  construction costs grew by over $500 million—a more than 90 percent  increase over its initial budget for construction. LPD 18 has recently been  delivered, but the Navy requested an additional $20.6 million in  reprogrammed funding in 2007 to complete the ship. Cost growth is  particularly prevalent where major changes were made to an existing ship  design. For example, CVN 77 is the final aircraft carrier of the Nimitz class  and is based on the design of previous carriers, but it included over 3,500  design changes. CVN 77 has experienced cost growth in construction of  over $847 million—a 17 percent increase over the initial budget.
Besides lead and mature ships, a number of ships under construction may  not have realized the full extent of cost growth—which tends to lag behind  the initial budget request by several years. In fact, the magnitude of cost  growth occurs in later phases of construction—after ships are 60 percent  or more complete (see fig. 2).
Total corowth (doll in million)
The current budgets for many ships have already proven inadequate to  cover the likely costs to complete construction. Funding has been  transferred from other Navy programs, obtained through prior year  completion requests or shifted away from future build plans. The most  prominent example is the LCS program. The Navy has already  reprogrammed almost $485 million to fund cost increases for the first two  LCS and deleted three Flight 0 ships from its budgets. The Navy  transferred about $62 million in funding from future T-AKE ships to cover  cost increases on the first two ships under construction. In the Virginia- class program, the Navy estimates about $130 million shortfall and plans to  cover the shortfall from transfers from within the program. In December  2006, the Navy believed that about $67 million would be needed to  complete LPD 20 and LPD 21. However, Navy officials stated that these  estimates are too conservative because they represent cost growth against  the current contract baseline for LPD ships under construction. The Navy  anticipates increasing the baseline for the LPD 17 ships—resulting in even  higher completion costs.
If current patterns of performance continue in the future, the Navy’s  shipbuilding plan will be in jeopardy. The Navy outlined its strategy for  achieving a 313-ship force in its updated long-range shipbuilding plan.  Over the next 5 years, the Navy plans to significantly increase the rate of  construction and introduce nine new classes of ships, including the Ford- class aircraft carrier (CVN 78) and the Zumwalt-class destroyer (DDG  1000). To support the plan, the Navy will require shipbuilding funding  significantly above current levels—on the order of $5 billion more by fiscal  year 2013. The Navy recognizes that the success of the plan will depend on  its ability to realistically estimate and control shipbuilding costs. Over the  next year the Navy will begin construction of CVN 78, DDG 1000, and LHA  6 amphibious assault ship. The Navy estimates that these ships alone will  require nearly $20 billion in construction funding, representing the Navy’s  most costly lead ships. Even a small percentage of cost growth on the big  ships could lead to the need for hundreds of millions of dollars in  additional funding.
section_title: Shipbuilding Programs Often Have Unexecutable Business Cases
paragraphs: Navy shipbuilding programs are often framed around an unexecutable  business case, whereby ship designs seek to accommodate immature  technologies, design stability is not achieved until late in production, and  both cost and schedule estimates are unrealistically low. This situation has  recently been evidenced in the LPD 17 and LCS programs, which have  required costly out-of-sequence work during construction. The DDG 1000  and CVN 78 programs are at risk because of lingering technology  immaturity, coupled with cost and schedule estimates with little margin  for error.
subsections: section_title: Elements of a Business Case
paragraphs: We have frequently reported on the wisdom of using a solid, executable  business case before committing resources to a new product development  effort. In its simplest form, a business case requires a balance between the  concept selected to satisfy warfighter needs and the resources— technologies, design knowledge, funding, time, and management  capacity—needed to transform the concept into a product, in this case a  ship. At the heart of a business case is a knowledge-based approach that  requires that managers demonstrate high levels of knowledge as the  program proceeds from technology development to system development  and, finally, production. Adapting this approach to shipbuilding is a  challenge, as I will discuss later. Ideally, in such an approach, key  technologies are demonstrated before development begins. The design is  stabilized before the building of prototypes or, in the case of ships,  construction begins. At each decision point, the balance among time,  money, and capacity is validated. In essence, knowledge supplants risk  over time.
A sound business case would establish and resource a knowledge-based  approach at the outset of a program. We would define such a business  case as firm requirements, mature technologies, and an acquisition  strategy that provides sufficient time and money for design activities  before construction start. The business case is the essential first step in  any acquisition program that sets the stage for the remaining stages of a  program, namely the business or contracting arrangements and actual  execution or performance. If the business case is not sound, the contract  will not correct the problem and execution will be subpar. This does not  mean that all potential problems can be eliminated and perfection  achieved, but rather that sound business cases can get the Navy better  shipbuilding outcomes and better return on investment. If any one element  of the business case is weak, problems can be expected in construction.  The need to meet schedule is one of the main reasons why programs  cannot execute their business cases. This pattern was clearly evident in  both the LPD 17 and LCS programs. In both cases, the program pushed  ahead with production even when design problems arose or key  equipment was not available when needed. Short cuts, such as doing  technology development concurrently with design and construction, are  taken to meet schedule. In the end, problems occur that cannot be  resolved within compressed, optimistic schedules. Ultimately, when a  schedule is set that cannot accommodate program scope, delivering an  initial capability is delayed and higher costs are incurred.
In shipbuilding programs, the consequences of moving forward with  immature technologies or an unstable design become clear once ship  construction begins. Ships are designed and constructed with an optimal  sequence—that is, the most cost-efficient sequence to construct the ship.  This includes designing and building the ship from the bottom up and  maximizing the units completed in shipyard shops and installed in the dry  dock while minimizing tasks performed when the ship is already in the  water, which tend to be costlier than tasks on land. Once units are  installed access to lower decks of the ship becomes more difficult. If  equipment is not ready in time for installation, the shipbuilder will have to  work around the missing equipment. Additional labor hours may be  needed because spaces will be less accessible and equipment may require  more time for installation.
section_title: Business Cases Deteriorated with Construction of LPD 17 and Littoral Combat Ships
paragraphs: What happens when the elements of a solid business case are not present?  Unfortunately, the results have been all too visible in the LPD 17 and the  LCS. Ship construction in these programs has been hampered throughout  by design instability and program management challenges that can be  traced back to flawed business cases. The Navy moved forward with  ambitious schedules for constructing LPD 17 and LCS despite significant  challenges in stabilizing the designs for these ships. As a result,  construction work has been performed out of sequence and significant  rework has been required, disrupting the optimal construction sequence  and application of lessons learned for follow-on vessels in these programs.
In the LPD 17 program, the Navy’s reliance on an immature design tool led  to problems that affected all aspects of the lead ship’s design. Without a  stable design, work was often delayed from early in the building cycle to  later, during integration of the hull. Shipbuilders stated that doing the  work at this stage could cost up to five times the original cost. The lead  ship in the LPD class was delivered to the warfighter incomplete and with  numerous mechanical failures, resulting in a lower than promised level of  capability. These problems continue today—2 years after the Navy  accepted delivery of LPD 17. Recent sea trials of the ship revealed  problems with LPD 17’s steering system, reverse osmosis units, shipwide  area computing network, and electrical system, among other deficiencies.  Navy inspectors noted that 138 of 943 ship spaces remained unfinished  and identified a number of safety concerns related to personnel,  equipment, ammunition, navigation, and flight activities. To date, the Navy  has invested over $1.75 billion constructing LPD 17.
In the LCS program, design instability resulted from a flawed business  case as well as changes to Navy requirements. From the outset, the Navy  sought to concurrently design and construct two lead ships in the LCS  program in an effort to rapidly meet pressing needs in the mine  countermeasures, antisubmarine warfare, and surface warfare mission  areas. The Navy believed it could manage this approach, even with little  margin for error, because it considered each LCS to be an adaptation of an  existing high-speed ferry design. It has since been realized that  transforming a high-speed ferry into a capable, networked, survivable  warship was quite a complex venture. Implementation of new Naval Vessel  Rules (design guidelines) further complicated the Navy’s concurrent  design-build strategy for LCS. These rules required program officials to  redesign major elements of each LCS design to meet enhanced  survivability requirements, even after construction had begun on the first  ship. While these requirements changes improved the robustness of LCS  designs, they contributed to out of sequence work and rework on the lead  ships. The Navy failed to fully account for these changes when establishing  its $220 million cost target and 2-year construction cycle for the lead ships.
Complicating LCS construction was a compressed and aggressive  schedule. When design standards were clarified with the issuance of Naval  Vessel Rules and major equipment deliveries were delayed (e.g., main  reduction gears), adjustments to the schedule were not made. Instead,  with the first LCS, the Navy and shipbuilder continued to focus on  achieving the planned schedule, accepting the higher costs associated with  out of sequence work and rework. This approach enabled the Navy to  achieve its planned launch date for the first Littoral Combat Ship, but  required it to sacrifice its desired level of outfitting. Program officials  report that schedule pressures also drove low outfitting levels on the  second Littoral Combat Ship design as well, although rework requirements  have been less intensive to date. However, because remaining work on the  first two ships will now have to be completed out-of-sequence, the initial  schedule gains most likely will be offset by increased labor hours to finish  these ships.
The difficulties and costs discussed above relate to the LCS seaframe only.  This program is unique in that the ship’s mission equipment is being  developed and funded separately from the seaframe. The Navy faces  additional challenges integrating mission packages with the ships, which  could further increase costs and delay delivery of new antisubmarine  warfare, mine countermeasures, and surface warfare capabilities to the  fleet. These mission packages are required to meet a weight requirement  of 180 metric tons or less and require 35 personnel or less to operate  them. However, the Navy estimates that the mine countermeasures  mission package may require an additional 13 metric tons of weight and   7 more operator personnel in order to deploy the full level of promised  capability. Because neither of the competing ship designs can  accommodate these increases, the Navy may be forced to reevaluate its  planned capabilities for LCS.
section_title: DDG 1000 and CVN 78 Have More Thoughtful Business Cases, but Significant Technical Risks Remain
paragraphs: Elements of a successful business case are present in the Navy’s next- generation shipbuilding programs—CVN 78 and DDG 1000. The Navy’s  plans for these programs call for a better understanding of the designs of  these ships prior to beginning construction, thereby reducing the risk of  costly design changes after steel has been bent and bulkheads built. Yet  some elements of their business cases put execution within budgeted  resources at risk. While the Navy has recognized the need to mature each  ship’s design before beginning construction, CVN 78 and DDG 1000 remain  at risk of cost growth due to continuing efforts to mature technologies.  Success in these programs depends on on-time delivery and installation of  fully mature and operational technologies in order to manage construction  costs. Budgets and schedules for each ship leave little if any margin for  error.
The DDG 1000 development has been framed by challenging multi-mission  requirements, resultant numerous technologies and a tight construction  schedule driven by industrial base needs. In the DDG 1000 program, the  Navy estimates that approximately 75 percent of detail design will be  completed prior to the start of lead ship construction in July 2008.  Successfully meeting this target, however, depends on maturing 12  technologies as planned. Currently, three of these technologies are fully  mature. Two DDG 1000 technologies—the volume search radar and total  ship computing environment—have only completed component-level  demonstrations and subsequently remain at lower levels of maturity.  Schedule constraints have also forced the Navy to modify its test plans for  the integrated power system and external communication systems.
The volume search radar, one of two radars in the dual band radar system,  will not have demonstrated the power output needed to meet  requirements even after integrated land-based testing of the prototype  radar system is completed in 2009. Production of the radars, however, is  scheduled to begin in 2008, introducing additional risk if problems are  discovered during testing. According to Navy officials, in the event the  volume search radar experiences delay in testing, it will not be integrated  as part of the dual band radar into the DDG 1000 deckhouse units that will  be delivered to the shipbuilders. Instead, the Navy will have to task the  shipbuilder with installing the volume search radar into the deckhouse,  which program officials report will require more labor hours than  currently allocated. The DDG 1000 program’s experience with the dual  band radar has added significance as the same radar will be used on   CVN 78.
In the case of the DDG 1000 total ship computing environment, the Navy is  developing hardware infrastructure and writing and releasing six blocks of  software code. Although development of the first three software blocks  progressed in line with cost and schedule estimates, the Navy has been  forced to defer some of the functionalities planned in software release  four to software blocks five and six due to changes in availability of key  subsystems developed external to the program, introduction of non  development items, and changes in program integration and test needs.  The Navy now plans to fully mature the integrated system following ship  construction start—an approach that increases program exposure to cost  and schedule risk in production.
The DDG 1000 program also faces challenges completing testing for its  integrated power system and external communications systems. Currently,  shipbuilder-required equipment delivery dates for these systems do not  permit time for system-level land-based integration testing prior to  delivery. As a result, the Navy has requested funds in fiscal year 2008 for  the third shipset of this equipment so that testing can be completed  without interrupting the planned construction schedules of the first two  ships. However, in the event problems are discovered, DDG 1000  construction plans and costs could be at risk.
The Navy has completed the basic design of CVN 78, and the shipbuilder is  currently developing the carrier’s more detailed design. According to the  shipbuilder, about 70 percent of CVN 78’s design is complete, with almost  all of the very low decks of the ship completely designed. Progress in  designing CVN 78 is partially the result of a longer preparation period that  has enabled the shipbuilder to design more of the ship prior to  construction than was the case on previous carriers. However, the Navy  may face challenges in maintaining its design schedule because of delays  in the development of the ship’s critical technologies. Such delays could  impede the completion of the ship’s design and interfere with the  construction of the ship.
CVN 78 will feature an array of advanced technologies such as a new  nuclear propulsion and electric plant, an electromagnetic aircraft launch  system (EMALS) and an improved aircraft arresting system. These  technologies, along with an expanded and improved flight deck, are  designed to significantly improve performance that the Navy believes will  simultaneously reduce acquisition and life cycle costs compared to  previous carriers. The Navy has focused much attention on developing  technologies and has retired much risk. Yet risk remains. The schedule for  installing CVN 78’s technologies takes advantage of construction  efficiencies. The shipbuilder has identified key dates when technologies  need to be delivered to the yard in order to meet its optimal construction  schedule. A number of CVN 78’s technologies have an increased potential  to affect this schedule because they are (1) located low in the ship and  needed early in construction or (2) highly integrated or embedded in the  ship’s design. The dual band radar is integrated into the design of the  carrier’s island and is critical to the smaller island design. EMALS crosses  48 of the ship’s 423 zones (or separate units that make up the ship’s  design). For example, problems with EMALS could have a cascading effect  on other areas of the ship.
While the Navy has mitigated the risk posed by some technologies, like the  nuclear propulsion and electric plant, key systems, in particular, EMALS,  the advanced arresting gear, and the dual band radar have encountered  difficulties during development that will likely prevent timely delivery to  the shipyard. Challenges include the following:    EMALS encountered technical difficulties developing the prototype  generator and meeting detailed Navy requirements, which led to  increased program costs and an over 15-month schedule delay. To meet  shipyard dates for delivering equipment, the contractor eliminated all  schedule margin, normally reserved for addressing unknown issues.  Yet, significant challenges lay ahead—the Navy will begin testing a  production representative system in 2008, and the shipboard system  will be manufactured in a new facility inexperienced with production.  If problems occur in testing or production, the contractor will not be  able to meet its delivery date to the shipyard, causing work to be done  out of sequence.
The advanced arresting gear program faced difficulties delivering  drawings to the Navy, leading to program delays. Schedule delays have  slipped the production decision and delivery to CVN 78 by 6 months. In  an effort to maintain shipyard delivery dates, the Navy has  consolidated upcoming test events—increasing test cycles and  eliminating schedule margin. However, by compressing test events, the  Navy will have little time to address any problems prior to production  start. Late delivery of the advanced arresting gear will require  installation after the flight deck has been laid. The shipbuilder will  expend additional labor to lower the system into place through a hole  cut in the flight deck.
The dual band radar presents the most immediate risk to the DDG  1000 program, but delays in production could cascade down to CVN  78—affecting delivery to the shipyard. Moreover, upcoming land-based  testing will not include certain demonstrations of carrier-specific  performance. In particular, the Navy has not yet scheduled tests to  verify the radar’s air traffic control capability, but expects such  demonstrations will occur by the end of fiscal year 2012. This leaves  little to no time to make any necessary changes before the radar’s 2012  in-yard date.
The CVN 78 business case also faces risks in the area of cost because the  estimate that underpins the budget is optimistic. For example, the Navy  estimates that fewer labor hours will be needed to construct CVN 78 than  the previous two carriers—even though it is a lead ship that includes  cutting edge technologies and a new design. Although the Navy is working  with the shipbuilder now to reduce costs prior to the award of a  construction contract (scheduled for early next year) through such  measures as subsidizing capital expenditures to gain greater shipyard  efficiency, costs will likely exceed budget if technologies or other  materials are delivered late or labor hour efficiencies are not realized.
section_title: A Disciplined, Knowledge-Based Process Is Key to Better Outcomes
paragraphs: How can the Navy achieve better outcomes in its shipbuilding programs?  Our work on best practices highlights the need for a disciplined,  knowledge-based approach so that programs proceed with a high  probability of success. This means technology maturity must be proven  before a design can be considered stable, and production outcomes cannot  be guaranteed until a stable design is demonstrated. The challenge in  adapting such an approach to shipbuilding is determining when these  levels of knowledge should be reached in shipbuilding programs and what  standards should serve as criteria for demonstrating this knowledge. It  seems that no two shipbuilding programs are run the same way. For  example, it can be agreed that key aspects of a ship’s detail design must be  completed before construction begins. However, what those aspects are or  how they should be measured is not defined. What may be acceptable in  one shipbuilding program is not acceptable in another. In our reviews of  ship programs, the definition of phases, strategies, and decision points  varies from program to program. In addition to defining key junctures of  knowledge, standards, and corresponding decision points for shipbuilding  programs, there are other steps the Navy could take that would better  inform its acquisition decision making in shipbuilding programs. These  include:    ensuring that initial shipbuilding budgets are realistically achievable by  improving cost estimating, and  improving cost management through increased use of fixed-price  contracting and comprehensive cost surveillance.
subsections: section_title: Aligning Knowledge and Decision Points Consistently across Shipbuilding Programs
paragraphs: Each shipbuilding program seems to embody its own strategy for making  decisions. In programs other than shipbuilding, the Milestone B decision  represents the commitment to design and develop a system, at which time  requirements should be firm and critical technologies mature. Milestone B  means different things in different shipbuilding programs. The CVN 21  program held its Milestone B review shortly before a preliminary design  review, and 3 years before the planned approval for the construction  contract. The Milestone B review for DDG 1000—called DD(X) at the time- -occurred over 1 year after the preliminary design review and shortly after  the critical design review—it was used to authorize negotiation of a  construction contract. The LCS program has received authorization for  construction for six ships—it has yet to hold a Milestone B review.
The need for a common understanding of what Milestone B represents is  all the more important given the requirements for certification at  Milestone B enacted by Congress in 2006. These provisions require the  decision authority to certify that, among other things,  the technology has been demonstrated in a relevant environment,  requirements have been approved by the Joint Requirements Oversight  Council,  the program is affordable, and  the program demonstrates a high likelihood of accomplishing its  intended mission.
We believe that the certification for all shipbuilding programs should take  place at the same point. The uniqueness of individual program strategies  leads to similar challenges in trying to establish what level of knowledge is  needed at subsequent critical junctures in shipbuilding programs. Each  shipbuilding program seems to have a different measure as to how much  of the design needs to be complete—and what constitutes design  readiness—prior to beginning ship construction. It seems to us that there  should be clear metrics for what the Navy expects at key junctures across  all shipbuilding programs. Further, there appears to be few criteria across  shipbuilding programs regarding how much knowledge—such as the  percentage of ship units built—is needed at different decision points,  including keel lay, fabrication start, and ship launch. A clearer  understanding of the key knowledge junctures and corresponding criteria  across shipbuilding programs would help establish a better basis for cost  and schedule estimates.
section_title: Establishing Executable Program Budgets through Improved Cost Estimating
paragraphs: As we have seen, the Navy’s track record for achieving its initial budgets  for shipbuilding programs has not been good. If we expect programs to be  executed within budget, programs need to begin with realistic budgets.  Since ship construction is generally budgeted in 1 fiscal year—or in the  case of CVN 78 and DDG 1000—over 2 years, it is essential that the Navy  understand and plan for the likely costs of the ship when construction is  authorized. A ship’s initial budget will, in large part, determine whether  and how much cost growth will occur and require funding in later years.
The foundation of an executable budget is a realistic cost estimate that  takes into account the true risk and uncertainty in a program. Realistic  cost estimates are important not only because they are used to establish  program budgets, but also because they help enable the Navy to determine  priorities, including whether to proceed with a program. Our past work  has shown that the Navy tends to underestimate the costs needed to  construct ships—resulting in unrealistic budgets and large cost increases  after ship construction has begun. Initial estimates of LPD 17 and LCS 1  assumed significant savings based on efficiencies that did not materialize  as expected. Future ships like CVN 78 make similar assumptions.
One way to improve the cost-estimating process is to present a confidence  level for each estimate, based on risk and uncertainty analyses. By  conducting an uncertainty analysis that measures the probability of cost  growth, the Navy can identify a level of confidence for its estimates and  determine whether program costs are realistically achievable. Navy cost  analysts told us that they used quantitative risk analyses to test the validity  of cost estimates of CVN 78 and DDG 1000. We believe that the Navy and  the Department of Defense (DOD) should take this a step further— requiring a high confidence level threshold when making program  commitments and budget requests. The Defense Acquisition Performance  Assessment Panel recommended an 80 percent confidence level, meaning  that a program has an 80 percent chance of achieving its estimated costs.  Whether this is the right level warrants thoughtful discussion, but it is  worth noting that analyses for CVN 78 and DDG 1000 were well below an  80 percent confidence level (in the case of DDG 1000 at around   45 percent)—increasing the likelihood that costs will grow above budget.
Timing is also an important element for achieving realism in budgets. In  the past, the Navy has generally requested approval for detail design and  construction of the lead ship at the same time. As a result, construction  budgets did not benefit from the knowledge gained in system design or  early stages of detail design. An alternative approach is to separate the  decision to fund detail design from the decision to fund construction. The  benefits of this approach are evident in the funding of DDG 1000. The Navy  first requested funding for detail design and construction of the lead ship  in its fiscal year 2005 budget request, estimating these costs to total   $2.7 billion. Congress did not fund construction of the lead ship, but  instead funded detail design and purchase of some materials in the fiscal  years 2005 and 2006 budgets. In March 2005, the Navy completed a life- cycle cost estimate for the ship that placed the cost of DDG 1000 at   $3.3 billion. DOD independent cost analysts estimated even higher costs.  The budget request for fiscal years 2007 and 2008 included $3.3 billion for  each of the two lead ships, reflecting an improved understanding of budget  requirements compared to the initial fiscal year 2005 request.
section_title: Better Management of Costs through Fixed-Price Contracting and Comprehensive Cost Surveillance
subsections: section_title: Fixed-priced-Contracting for Construction
paragraphs: In an effort to improve cost management, the Navy is promoting fixed- priced contracts for ship construction. In a fixed-price incentive contract,  costs above a target are shared with the contractor, up to a ceiling price.  Both the target cost and price ceiling are negotiated at the outset. The  contractor is responsible for costs above the ceiling price, limiting the  government’s cost risk. In shipbuilding, lead ships are commonly done  under cost-plus-incentive-fee contracts as are some follow-on ships. Under  these contracts, the government is responsible for paying allowable costs  incurred and the fee will be adjusted according to a negotiated formula.  The first five LPD 17 ships use cost-plus-incentive-fee contracts and the  first two LCS are being built under cost-type contracts. The Navy typically  uses fixed-priced incentive contracts for ships that are later in the class,  including DDG 51 class destroyers and CVN 77, and for all ships in the   T-AKE class of auxiliary ships, a less complex ship.
We are encouraged by the Navy’s efforts to move to fixed-price contracts.  Fixed-price contracts limit the government’s risk of cost growth while  encouraging realism in negotiating contract prices and careful cost  management. However, the move to fixed-price contracting is feasible only  if risks can be understood and managed. If the Navy is to use fixed-price  contracts for the second or third ship in the class—or even the lead ship— it must supplant risk with knowledge. We are convinced that a move to  fixed-price contracting will only succeed if the Navy adopts a more  disciplined process, one that ensures that the elements of an executable  business case exist as the development effort begins. If technologies are  still being demonstrated, the delivery of critical systems when needed  cannot be assured. Nor can designs be finalized. Increased used of fixed- price contracting requires that technologies be demonstrated early, the  design stabilized before construction begins, and realistic estimates for  cost and schedule made.
section_title: Cost Surveillance
paragraphs: Given the risk of cost growth in shipbuilding, it is equally important that  the Navy strengthen its oversight of shipyard cost performance. Our work  has shown that the Navy may not have adequate management tools  necessary to identify and react to early signs of cost growth. In particular,  in the CVN 78 program the Navy has not effectively used earned value  management data captured in cost performance reports submitted by the  contractor. Earned value management is a tool that provides the  government and contractors with insight into technical, cost, and schedule  progress on their contracts. Although the shipbuilder is designing much of  CVN 78 prior to the award of the construction contract, we found that  contractor cost performance reports do not provide an objective measure  of program schedule and costs incurred. While the Navy expects that  future cost performance reports will better reflect shipyard performance  after the construction contract is awarded and significant construction  work is under way, it has missed an opportunity to gain insight into  current costs—and gauge future shipyard performance. Moreover, the  Navy may not require the shipbuilder to submit monthly cost performance  reports that include variance analyses, which describe the reasons for cost  and schedule variances. Without monthly contractor performance reports  that include variance analyses, the Navy will miss timely information  regarding root causes for cost and schedule problems and mitigation  efforts—making it more difficult to identify risk and take corrective  action.
But timely and complete cost performance reports are not enough.   The Navy must leverage this information to better manage shipbuilder  performance. In particular, the Navy’s Supervisor of Shipbuilding  (SUPSHIP) is not engaged in evaluating shipbuilder cost performance for  all shipbuilding programs. SUPSHIP provides the Navy with unique insight  into program performance because it is located at the shipyard, providing  on-site program surveillance, including independent analysis of  shipbuilder cost and schedule performance. However, SUPSHIP does not  currently have the capability to conduct independent cost surveillance of  the CVN 78 program. We believe that this capability is necessary to  effectively analyze shipbuilder cost data and verify that the data depict  actual conditions and trends.
Cost surveillance at the shipyard is just one element of the management  capacity needed to plan and execute shipbuilding programs. There has  also been considerable discussion of the need to have a workforce with  the right skills in the right numbers. It has been more difficult to arrive at a  firm definition of the size and composition of the workforce needed, and  the appropriate balance between government and contractor personnel.  Sharp declines in the size of the acquisition workforce have occurred over  the last several years. The Navy’s numbers are a case in point. The Navy  reports that staffing at Naval Sea Systems Command headquarters has  decreased by almost 50 percent since 1991, from 4,871 to 2,331 personnel.
Mr. Chairman, that concludes my statement. I would be pleased to answer  any questions.
section_title: Objectives, Scope, and Methodology
paragraphs: To develop information on the status of Navy shipbuilding programs and  practices that can improve the process for acquiring ships, we relied  largely on our prior reporting on shipbuilding programs and updates to  this work, as well as work under way for the committee on the CVN 78  program. In the course of this work, we analyzed program documents,  including program baselines, contractor performance reports, cost  estimates, budget documents and other program assessments, as well as  policy guidance. We also interviewed government, shipbuilding, and other  contractor officials associated with a number of shipbuilding programs,  including CVN 77 and 78, LPD 17, DDG 1000, LCS, and Virginia-class  Submarines.
section_title: Contact and Staff Acknowledgments
paragraphs: For future questions about this statement, please contact me at   (202) 512-4841. Individuals making key contributions to this statement  include Lisa L. Berardi, Noah B. Bleicher, Gwyneth M. Blevins, Lily J. Chin,  Todd Dice, Christopher R. Durbin, Jennifer Echard, Diana Moldafsky,  Moshe Schwartz, and Karen Zuckerstein.
section_title: Related GAO Products
paragraphs: Defense Acquisitions: Progress and Challenges Facing the DD(X)  Surface Combatant Program. GAO-05-924T, Washington, D.C.:   July 19, 2005.
Defense Acquisitions: Assessments of Selected Weapon Programs.   GAO-07-406SP, Washington, D.C.: March 30, 2007.
Defense Acquisitions: Challenges Associated with the Navy’s Long-Range  Shipbuilding Plan. GAO-06-587T, Washington, D.C.: March 30, 2006.
Defense Acquisitions: Challenges Remain in Developing Capabilities   in Naval Surface Fire Support. GAO-07-115, Washington, D.C.:   November 30, 2006.
Defense Acquisitions: Improved Management Practices Could Help  Minimize Cost Growth in Navy Shipbuilding Programs. GAO-05-183,  Washington, D.C.: Feb. 28, 2005.
Defense Acquisitions: Plans Need to Allow Enough Time to Demonstrate  Capability of First Littoral Combat Ships. GAO-05-255, Washington, D.C.:  March 1, 2005.