Defense Acquisitions: Improved Management Practices Could Help Minimize Cost Growth in Navy Shipbuilding Programs
Published: 2005-02-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The U.S. Navy invests significantly to maintain technological superiority of its warships. In 2005 alone, $7.6 billion was devoted to new ship construction in six ship classes--96 percent of which was allocated to four classes: Arleigh Burke class destroyer, Nimitz class aircraft carrier, San Antonio class amphibious transport dock ship, and the Virginia class submarine. Cost growth in the Navy's shipbuilding programs has been a long-standing problem. Over the past few years, the Navy has used "prior year completion" funding--additional appropriations for ships already under contract--to pay for cost overruns. This report (1) estimates the current and projected cost growth on construction contracts for eight case study ships, (2) breaks down and examines the components of the cost growth, and (3) identifies any funding and management practices that contributed to cost growth.
section_title: What GAO Found
paragraphs: For the eight ships GAO assessed, the Congress has appropriated $2.1 billion to cover the increases in the ships' budgets. The GAO's analysis indicates that total cost growth on these ships could reach $3.1 billion or even more if shipyards do not maintain current efficiency and meet schedules. Cost growth for the CVN 77 aircraft carrier and the San Antonio lead ship (LPD 17) has been particularly pronounced. Increases in labor hour and material costs together account for 77 percent of the cost growth on the eight ships. Shipbuilders frequently cited design modifications, the need for additional and more costly materials, and changes in employee pay and benefits as the key causes of this growth. For example, the San Antonio's lead ship's systems design continued to evolve even as construction began, which required rebuilding of completed areas to accommodate the design changes. Materials costs were often underbudgeted, as was the case with the Virginia class submarines and Nimitz class aircraft carriers. For the CVN 77 carrier, the shipbuilder is estimating a substantial increase in material costs. Navy practices for estimating costs, contracting, and budgeting for ships have resulted in unrealistic funding of programs, increasing the likelihood of cost growth. Despite inherent uncertainties in the ship acquisition process, the Navy does not account for the probability of cost growth when estimating costs. Moreover, the Navy did not conduct an independent cost estimate for carriers or when substantial changes occurred in a ship class, which could have provided decision makers with additional knowledge about a program's potential costs. In addition, contract prices were negotiated and budgets established without sufficient design knowledge and construction knowledge. When unexpected events did occur, the incomplete and untimely reporting on program progress delayed the identification of problems and the Navy's ability to correct them.

section_title: Letter
paragraphs: U.S. Navy warships are the most technologically advanced in the world.  The United States invests significantly to maintain this advantage. In 2005  alone, the Navy devoted $7.6 billion to new ship construction in six ship  classes—96 percent of which was allocated to four classes: Arleigh Burke  class destroyer, Nimitz class aircraft carrier, San Antonio class amphibious  transport dock ship, and the Virginia class submarine.
Cost growth in the Navy’s shipbuilding programs has been a long-standing  problem—one that the Congress has identified and responded to by  providing both additional funding and direction to the Navy. Over the past  few years, the Navy has used “prior year completion” funding—additional  appropriations for ships already under contract—to pay for cost overruns.  Because of the size and routine occurrence of prior year funding, we were  asked to analyze cost overruns on Navy shipbuilding programs.  Specifically, this report (1) estimates the current and projected cost  growth on selected ship construction contracts, (2) breaks down and  examines the components of the cost growth, and (3) identifies any  funding and management practices that contribute to cost growth.
To address these objectives, we looked at cost growth in the four classes  of ships that account for the majority of the funding for new shipbuilding  and prior year bills, focusing on ships with construction contracts that  were more than 30 percent complete at the time we began our review.  Within each class, we selected two ships currently under contract as case  studies: DDG 91 and DDG 92 in the Arleigh Burke class of destroyers,  CVN 76 and CVN 77 in the Nimitz class of aircraft carriers, LPD 17 and  LPD 18 in the San Antonio class of transports, and SSN 774 and SSN 775 in  the Virginia class of submarines. To estimate the total projected cost  growth on construction contracts, we used contractor performance  reports, projecting high and low estimates for the costs to complete the  ships in the four classes we reviewed. We looked at cost growth by  comparing the initial budget request to the Congress and the updated  budget included in the 2005 President’s budget and by comparing the  initial contract award to the latest estimate at completion. The latest  estimate at completion includes changes to the original baseline or scope  of work. For all ships currently under construction, we also estimated  total cost growth since contract award, using contractor performance  reports to project high and low estimates for the costs to complete  construction of these ships. To break down and examine the components  of cost growth on the eight case study ships, we analyzed the Navy's cost  estimates, its budget requests to the Congress, contractor performance  reports, and other cost data for each of the eight case study ships. To  assess funding and management practices, we spoke with the shipbuilders,  Navy and Defense Contract Audit Agency officials, and reviewed  supporting documentation. Our work was conducted between July 2003  and December 2004 in accordance with generally accepted government  auditing standards. Our analyses and forecasts were based on data  available to us in July 2004. To the extent significant changes occurred, we  incorporated information from the fiscal year 2006 President’s budget. For  a complete description of our scope and methodology, see appendix I.  Details on the eight case study ships are discussed in appendixes II to V.
subsections: section_title: Background
paragraphs: The U.S. Navy currently operates 288 surface ships and submarines. Four  ship classes, with 23 ships under construction or recently completed,  make up 96 percent of the Navy’s fiscal year 2005 budget for new  construction shipbuilding. (See table 1.)
Navy ships are complex defense systems, using advanced designs with  state-of-the-art weapons, communications, and navigation technologies.  Ships require many years to plan, budget, design, and build. Like other  weapon acquisition programs, ship acquisitions begin with developing a  system design. For ships, system design is followed by a detail design  phase where specific construction plans are developed. Ship construction  follows and typically takes 4 to 7 years. Construction time for other  defense systems is much shorter—a fighter aircraft takes about 2 years  from start of production to roll out from the factory floor; a tank takes  about a year. (See fig. 1.)
The long construction times increase the uncertainty that ship cost  estimates—and budgets—must provide for. Moreover, the total cost for a  ship must be budgeted for in its first year of construction. Provisions are  made in the event cost growth occurs during construction. The Navy’s  budgeting for cost growth has changed over the past 2 decades. During the  early 1970s and through most of the 1980s, the Navy used program cost  reserves built into ship construction budgets and the Ship Cost  Adjustment process to manage cost growth. During the 1980s, the Navy  procured an average of 17 ships each year. In fiscal year 1988, the Navy  removed program cost reserves from ship construction budgets and began  exclusively using the Ship Cost Adjustment process, shifting funding  between shipbuilding construction programs underrunning cost to  programs that were overrunning costs. Following the end of the Cold War,  the Navy decreased the procurement rate of ships to about 6 per year.  Beginning in fiscal year 1999, cost increases could no longer be covered  using the Ship Cost Adjustment process because no shipbuilding program  was under cost. In 2001, the process was eliminated, which required the  Navy to fund cost growth through the current mechanism of prior year  completion bills.
subsections: section_title: Components of Shipbuilding Costs
paragraphs: The cost of building a ship can be broken down into four main  components: labor, material, and overhead associated with the  shipbuilders’ contract for the basic ship, and Navy-furnished equipment— that is, items purchased by the Navy and provided to the contractor for  installation on the ship. (See table 2.) The shipbuilding contract also  includes profit (referred to as fee).
section_title: Types of Shipbuilding Contracts
paragraphs: Two broad categories of contracts are used to procure ships: fixed-price  and cost-reimbursement. Fixed price contracts provide for a firm price or  an adjustable price with a ceiling price, a target price, or both. If the  ceiling is reached the shipbuilder is generally responsible for all additional  costs. Cost reimbursement contracts provide for payment of allowable  incurred costs, to the extent prescribed in the contract. If the ship cannot  be completed within agreed upon cost limits, the government is  responsible for the additional costs to complete.
The level of knowledge, or certainty, in the cost estimates for a ship is key  to determining which type of contract to use. Contracts for the first ship of  a new class are often negotiated as cost-reimbursable contracts because  these ships tend to involve a high-level of uncertainty and, thus, high cost  risks. Cost reimbursement contracts were used to procure the San Antonio  and Virginia class ships we reviewed. More mature shipbuilding programs,  where there is greater certainty about costs, are typically fixed-price  contracts with an incentive fee (profit). Fixed-price contracts were used to  procure the Arleigh Burke and Nimitz class ships we reviewed. Both cost- reimbursable and fixed-price incentive fee contracts can include a target  cost, a target profit, and a formula that allows the profit to be adjusted by  comparing the actual cost to the target cost. Construction contracts for  ships generally include provisions for controlling cost growth with  incentive fees, whereby the Navy and the shipbuilder split any savings  when the contract cost is less than its anticipated target. Conversely, when  costs exceed the target, the excess is shared between the Navy and the  shipbuilder.
section_title: New Ships Continue to Cost More Than Budgeted
paragraphs: Ship cost growth continues to pose additional funding demands on the  budget. Budgets for the eight case study ships alone have required  increases of $2.1 billion, and Congress has appropriated funds to cover  these increases. However, the total projected cost growth on contracts for  the eight ships is likely to be higher. Consequently, the Navy will need in  excess of $1 billion in additional appropriations to cover the total  projected cost growth. Cost growth was more pronounced for the lead  ships in the two new classes we looked at—the Virginia class and  especially the San Antonio class—than the more mature Arleigh Burke and  Nimitz classes. (Our forecasts for cost growth on all ships that are more  than 30 percent complete are shown in appendix VI.)
The fiscal year 2005 budget for the eight case study ships was about  $20.6 billion—representing cost growth of $2.1 billion above the initial  budget request of $18.5 billion for these ships. (See table 3.) Ship  construction costs comprise the majority of this increase.
We were not able to determine how much of this increase was due to  changes in the scope of the contract and how much of the growth funded  increases in the costs of completing the initial contract scope. Amounts  identified by shipbuilders and Navy program offices differed substantially.  However, the initial program budgets included funding to support changes  in the scope of the construction contract. These funds amounted to a small  share of the initial program budget: 3 percent for DDGs 91 and 92; 5  percent for CVN 76 and CVN 77; 7 percent for LPD 17 and 4 percent for  LPD 18; and 3 and 4 percent for SSNs 774 and 775, respectively.
While the Congress has appropriated funds to cover a $2.1 billion increase  in the ships’ costs, more funds will likely be needed to cover additional  cost growth likely for these eight ships. At the time we completed our  analysis in 2004, we calculated a range of the potential growth for the eight  case study ships and found that the total projected cost growth would  likely exceed $2.8 billion and could reach $3.1 billion. (See table 4.)
These cost growth estimates have already proven to be too conservative.  In its fiscal year 2006 budget submission, the Navy recognizes an  additional cost growth of $223 million for SSN 775 and $908 million for  CVN 77 above its fiscal year 2005 request. In addition, our estimates  assumed that the shipyards will maintain their current efficiency through  the end of their contracts and meet scheduled milestones. Any slips in  efficiency and schedules would likely result in added costs. For example,  the delivery date for SSN 775 is expected to slip by as many as 9 months,  which, according to the fiscal year 2006 President’s budget has increased  the final cost of the ship even more. According to program officials, the  delivery date for the LPD 17 has been changed from December 2004 to  May 2005, and the delivery date for the CVN 77 is expected to slip into  2009.
Cost growth on new ships has a number of implications. Most tangible,  perhaps, is the significant portion of the ship construction budget that  must be devoted to overruns on ships already under construction. From  fiscal years 2001 to 2005, 5 to 14 percent of the Navy’s ship construction  budget, which totaled about $52 billion over the 5-year period, went to pay  for cost growth for ships funded in prior years. This reduces the buying  power of the budget for current construction and can slow the pace of  modernization. The Navy is in the early stages of buying a number of  advanced ships, including the Virginia class submarine, DD(X) destroyer,  CVN 21 aircraft carrier, and Littoral Combat Ship. The Navy’s ability to buy  these ships as scheduled will depend on its ability to control cost growth.
section_title: Labor and Materials Drive Increases in Construction Costs
paragraphs: Increases in labor hour and material costs account for 78 percent of the  cost growth on shipbuilding construction contracts, while overhead and  labor rate increases account for 17 percent. Navy-furnished equipment— including radars and weapon systems—represents just 5 percent of the  cost growth. (See fig. 2.) Shipbuilders cited a number of direct causes for  the labor hour, material, and overhead cost growth in the eight case study  ships. The most common causes were related to design modifications, the  need for additional and more costly materials, and changes in employee  pay and benefits.
subsections: section_title: Design Changes and Lack of Skilled Labor Contributed to Labor Hour Cost Growth
paragraphs: Labor hour increases for the eight case study ships ranged from 33 percent  to 105 percent—for a total of 34 million extra labor hours. For example,  the shipbuilders for LPD 17 and CVN 76 each needed 8 million additional  labor hours to construct the ships  Cost growth due to increased labor hours totaled more than $1.3 billion.  (See table 5.) While the total dollars were the greatest for LPD 17  ($284 million), the labor cost as a percent of total cost growth was the  greatest for DDG 91 (105 percent).
The lack of design and technology maturity led to rework, increasing the  number of labor hours for most of the case study ships. For example, the  design of LPD 17 continued to evolve even as construction proceeded.  When construction began on DDG 91 and DDG 92—the first ships to  incorporate the remote mine hunting system—the technology was still  being developed. As a result, workers were required to rebuild completed  areas of the ship to accommodate design changes. Most of the shipbuilders  cited a lack of skilled workers as a driver behind labor hour cost growth.  According to the shipbuilders we interviewed, many of the tasks needed to  build ships are complex and require experienced journeymen to efficiently  carry them out. Yet, the majority of the shipbuilders noted that the  shipyards have lost a significant portion of their highly skilled and  experienced workers. Delays in delivery of materials also resulted in  increased labor hours. Table 6 shows the reasons for labor hour increases  for each case study ship.
section_title: Underbudgeting and Price Increases Contributed to Materials Cost Growth
paragraphs: For several of the case study ships, the costs of materials increased  dramatically above what the shipbuilder had initially planned. (See  table 7.) Materials cost was the most significant component of cost growth  for three ships: LPD 17, SSN 775, and CVN 76. However, for LPD 17, which  experienced over 100-percent growth in material costs, 70 percent of the  material cost increases were actually costs for subcontracts to support  design of the lead ship.
Growth in materials costs was due, in part, to the Navy and shipbuilders’  underbudgeting for these costs. For example, the materials budget for the  first four Virginia-class submarines was $132 million less than quotes  received from vendors and subcontractors. The shipbuilder agreed to take  on the challenge of achieving lower costs in exchange for providing in the  contract that the shipbuilder would be reimbursed for cost growth in high  value, specialized materials. In addition, the materials budget for CVN 76  and CVN 77 was based on an incomplete list of materials needed to  construct the ship, leading to especially sharp increases in estimated  materials costs. In this case, the Defense Contract Audit Agency criticized  the shipbuilder’s estimating system, particularly the system for material  and subcontract costs, and stated that the resulting estimates “do not  provide an acceptable basis for negotiation of a fair and reasonable price.”  Underbudgeting of materials has contributed to cost growth recognized in  the fiscal year 2006 budget.
Price increases also contributed to the growth in materials costs. For  example, the price of array equipment on the Virginia class submarines  rose by $33 million above the original price estimate. In addition to  inflation, a limited supplier base for highly specialized and unique  materials made ship materials susceptible to price increases. According to  the shipbuilders, the low rate of ship production has affected the stability  of the supplier base—some businesses have closed or merged, leading to  reduced competition for the services they once produced and that may be  a cause of higher prices. In some cases, the Navy lost its position as a  preferred customer and the shipbuilder had to wait longer to receive  materials. With a declining number of suppliers, more ship materials  contracts have gone to single and sole source vendors. Over 75 percent of  the materials for the Virginia class submarines—which were reduced in  number from 14 to 9 ships over a 10-year period—is produced by single  source vendors.
Spending on subcontracts and leased labor also increased material costs  on some case study ships. On LPD 17, for example, subcontracts to  support lead ship design accounted for 70 percent of the increase in  material costs. Table 8 highlights the various reasons cited for increased  materials costs on case study ships.
section_title: Program Overhead and Labor Rates Account for Remaining Ship Construction Cost Increases
paragraphs: Program overhead costs, which include increases in labor rates,  represented approximately 17 percent of the total cost growth for the eight  case study ships. (See table 9.) While increases in overhead dollars totaled  more than $1 billion, almost half of the increase was related to growth in  labor hours. (See table 9.)
Increases in program overhead were largely due to decreased workload at  the shipyards. Six of the eight case study ships experienced increased  overhead because there were fewer programs to absorb shipyard  operation costs. Increases in benefit costs, such as pensions and medical  care costs, and labor rate increases—the result of negotiations with labor  unions and inflation—also drove up program overhead costs. Table 10  highlights the various reasons cited for increased overhead costs on case  study ships.
section_title: Navy-Furnished Equipment
paragraphs: Navy-furnished equipment covers the costs for the technologies and  equipment items—such as ship weapon systems and electronics— purchased by the Navy and provided to the contractor for installation on  the ship. While Navy-furnished equipment accounts for 29 percent of the  budget for the eight case study ships, such equipment accounted for only  6 percent of the total cost growth. According to Navy officials, much of the  Navy-furnished equipment is common among many programs and,  therefore, benefits from economies of scale. However, the integration and  installation of these systems—especially the warfare systems—contributes  to cost growth and is captured in the shipbuilders’ costs rather than Navy- furnished equipment.
There was considerable variance from program to program. In addition, in  some cases, decreases and increases in Navy-furnished equipment were  the result of funds being reallocated. For example, the Integrated Warfare  System on CVN 77 was originally funded through the shipbuilder  construction contract, but was later deleted from the contract in favor of  an existing system furnished by the Navy.
section_title: Navy Funding and Management Practices Result in Insufficient Provision for Risk
paragraphs: Navy practices for estimating costs and for contracting and budgeting for  ships have resulted in unrealistic funding of programs and when  unexpected events occur, tracking mechanisms are slow to pick them up.  Tools exist to manage the challenges inherent in shipbuilding, including  measuring the probability of cost growth when estimating costs, making  full use of design and construction knowledge to negotiate realistic target  prices, and tracking and providing timely reporting on program costs to  alert managers to potential problems. For the eight case study ships,  however, the Navy did not effectively employ them to mitigate risk.
subsections: section_title: Navy Estimates Do Not Capture Uncertainty and Are Often Not Independently Evaluated
paragraphs: In developing cost estimates for the eight case study ships, Navy cost  analysts did not conduct uncertainty analyses to measure the probability  of cost growth, nor were independent estimates conducted for some  ships—even in cases where major design changes had occurred.  Uncertainty analyses and independent estimates are particularly important  given the inherent uncertainties in the ship acquisition process, such as  the introduction of new technologies and volatile overhead rates over  time, creating a significant challenge for cost analysts to develop credible  initial cost estimates. The Navy must develop cost estimates as much as  10 years before ship construction begins—before many program details  are known. As a result, cost analysts have to make a number of  assumptions about certain ship parameters, such as weight, performance,  or software, and about market conditions, such as inflation rates,  workforce attrition, and supplier base.
In the eight case study ships we examined, cost analysts relied on the  actual cost of previously constructed ships without adequately accounting  for changes in the industrial base, ship design, or construction methods.  Cost data available to Navy cost analysts were based on higher ship  construction rates from the 1980s. As a result, these data were based on  lower costs due to economies of scale—which were not reflective of the  lower procurement rates after 1989. In addition, in developing cost  estimates for DDG 91, DDG 92, LPD 17, and SSN 774, cost analysts relied  on actual cost data from previous ships in the same class or a similar class  but that were less technologically advanced. By using data from less  complex ships, Navy cost analysts tended to underestimate the costs  needed to construct the ships.
For CVN 76, cost analysts used proposed costs from CVN 74 with  adjustments made for design changes and economic factors. However,  CVN 74 and CVN 75 were more economical ships because both were  procured in a single year—which resulted in savings from economies of  scale. While cost analysts adjusted their estimates to account for the  single-ship buy, costs increased far beyond the adjustment. Even in more  mature programs—like the Arleigh Burke destroyers and the Nimitz  aircraft carriers—improved capabilities and modifications made the costs  of previous ships in the class essentially less analogous.
Other unknowns also led to uncertain estimates in the case study ships.  Labor hour and material costs were based not only on data from previous  ships but also on unproven efficiencies in ship construction. We found  analysts often factored in savings based on expected efficiencies that  never materialized. For example, cost analysts anticipated savings through  the implementation of computer-assisted design/computer-assisted  manufacturing for LPD 17, but the contractor had not made the requisite  research investments to achieve the proposed savings. Similar unproven  or unsupported efficiencies were estimated for DDG 92 and CVN 76.  Changes in the shipbuilders’ supplier base also created uncertainties in the  shipbuilders’ overhead costs.
Despite these uncertainties, the Navy did not test the validity of the  assumptions made by the cost analysts in estimating the construction  costs for the eight case study ships nor did the Navy identify a confidence  level for estimates. Specifically, it did not conduct uncertainty analyses,  which generate values for parameters that are less than precisely known  around a specific set of ranges. For example, if the number of hours to  integrate a component onto a ship is not precisely known, analysts may  put in a low and high value. The estimate will generate costs for these  variables along with other variables such as—weight, experience, and  degree of rework. The result is a range of estimates that enables cost  analysts to make better decisions on likely costs. Instead, the Navy  presented its cost estimates as unqualified point estimates, suggesting an  element of precision that cannot exist early on and obscures the  investment risk remaining for the programs. While imprecision decreases  during the program’s life cycle as more information becomes known about  the program, experts emphasize that to be useful, each cost estimate  should include an indication of its degree of uncertainty, possibly as an  estimated range or qualified by some factor of confidence. Other services  qualify their cost estimates by determining a confidence level of  50 percent.
The Navy also did not conduct independent cost estimates for some ships,  which is required at certain major acquisition milestones. Independent  cost estimates can provide decision makers with additional insight into a  program’s potential costs—in part because these estimates frequently use  different methodologies and may be less burdened with organizational  bias. Independent cost analysts also tend to incorporate cost for risk as  they develop their estimates, which the Navy cost analysts did not do. As a  result, these independent estimates tend to be more conservative— forecasting higher costs than those forecast by the program office.  Department of Defense officials considered the CVN 68 and DDG 51  programs mature programs and, therefore, did not require independent  estimates. Yet, an independent cost estimate has never been conducted on  a CVN 68 class carrier because the program for this class of ships began  prior to the establishment of an independent cost-estimating group in  DOD. However, Navy officials noted that every carrier is a new program,  different from previous carriers. Although an independent cost estimate  was conducted for the DDG 51 program, it was conducted in 1993, and  since that time, the DDG ships have undergone four major upgrades.
The Navy has begun taking some actions to improve its cost estimating  capabilities. For example, future programs will be funded at the DOD  independent estimators’ level, which should provide a more conservative  estimate and include risk analysis. In addition, Navy officials told us that  they are in the process of revising cost estimating guidance to include  requirements for risk and uncertainty analysis. The degree to which this  guidance will enable the Navy to provide more realistic cost estimates for  its shipbuilding programs will depend on how it will be implemented on  individual programs.
section_title: Contract Prices Negotiated and Budgets Set Without Making Full Use of Design Knowledge and Construction Experience
paragraphs: Uncertainty about costs is especially high for new classes of ships, since  new classes incorporate new designs and new technologies. Yet, the  Navy’s approach to negotiating contract target prices for construction of  the lead ship and early follow-on ships does not manage this uncertainty  sufficiently—evidenced by substantial increases in the prices of the first  several ships. Target prices for detail design and construction of the lead  and early follow-on ships are typically negotiated at one time. In these  cases the Navy does not make use of knowledge gained during detailed  design or during construction of the lead ship to establish more realistic  prices. When this approach to negotiating prices was used, it also affected  the information that was available to the Congress at the time it funded  construction of lead and follow-on ships.
Target prices for all of the case study ships increased, but, as shown in  table 11, the increase was greater for the two San Antonio class ships and  the two Virginia class ships—both new classes of ships. Increases in the  target prices of the LPD 17 and LPD 18 were particularly pronounced,  reaching 139 and 95 percent, respectively.
The realism of target prices reflects the Navy’s approach to negotiating  contract prices—the Navy negotiates target prices for the first several  ships at a stage of the program when uncertainty is high and knowledge  limited. For example, for the San Antonio class ships, the Navy negotiated  prices for the detail design and construction of the lead ship (LPD 17) and  the first two follow-on ships (LPD 18 and LPD 19) at the same time. By  negotiating target prices for these ships before detail design even began,  target prices for these three ships did not benefit from information gained  during detail design about the materials and equipment or specific  processes that will be used to construct the ship. Target prices for the  follow-on ships, LPD 18 and LPD 19, did not benefit from knowledge  gained in initial construction of LPD 17. In contrast, for the Virginia class  ships, the Navy negotiated detail design separately from construction,  benefiting from the knowledge gained from detail design in negotiating  prices for construction. However, 2 years after negotiating the detail  design contract, the Navy negotiated target prices for the SSN 774 and  SSN 775, both considered lead ships for the two shipyards involved in  constructing submarines. Target prices for the first two follow-on ships,  SSN 776 and SSN 777 were agreed on at this time as well. As a result,  target prices for these follow-on ships did not benefit from the knowledge  gained from constructing the lead ships.
The practice of setting target prices early on affects not only the realism of  the contract target prices, but also the realism of the budgets approved by  the Congress to fund these contracts. In order to fund a contract covering  both detail design and lead ship construction, authorization and funding  for detail design and lead ship construction is approved by the Congress in  one budget year, before detail design begins. For example, the Congress  funded detail design and construction of LPD 17 in the fiscal year 1996  budget. While the follow-on ships, LPDs 19 and 20, were funded in  later years, budgets were still unrealistic because the target prices were  used as a basis for the budget request.
The size of the budget and the contract conditions can also affect the  realism of target prices. In negotiating the contract for the first four  Virginia class ships, program officials stated that the target price they  could negotiate was limited to the amount included in approved or  planned budgets. The shipbuilders said that they accepted a challenge to  design and construct these ships for $748 million less than their estimated  costs because the contract protected their financial risk. The contract  included a large minimum fee (profit), in addition to the incentive fee that  would be reduced in the event of cost growth. Moreover, the contract was  structured so that the Navy would pay the full cost of increases for  specialized, highly engineered components rather than share the cost  increases with the shipbuilder. The Navy also was responsible for the full  amount of growth in certain labor costs.
Recently, the Navy has supported the preparation of more realistic budget  requests. Program managers are encouraged to budget to their own  estimate of expected costs rather than at target prices that are not  considered realistic. For example, for the LPD 17, an acquisition decision  memorandum stated that the program will be budgeted to the Cost  Analysis Improvement Group estimate. Also, in negotiating recent  contracts for additional Virginia class and San Antonio class ships, the  Navy structured the contracts to encourage more realistic target prices.
section_title: Other Factors Affect Budget Realism
paragraphs: Beyond target prices, shifting priorities, and inflation accounting can have  a significant impact on the realism of ship budgets. Specifically, budget  requests are susceptible to across-the-board reductions to account for  other priorities, such as national security and changes in program  assumptions. Competing priorities create additional management  challenges for programs that receive a reduced budget without an  accompanying reduction in scope. For example, during the budget review  cycles of 1996 through 2003, the initial cost estimate for DDGs 89-92 was  decreased by $119 million—or 55 percent of the total cost growth for the  four DDGs. Had the initial estimate not been reduced, the cost growth  would have only amounted to $96 million.
Inflation rates can also have a significant impact on ship budgets. Until  recently, Navy programs used Office of the Secretary of Defense and  Office of Management and Budget inflation rates. Inflation rates  experienced by the shipbuilding industry have historically been higher.  As a result, contracts were signed and executed using industry specific  inflation rates while budgets were based on the lower inflation rates,  creating a risk of cost growth from the outset. For the case study ships,  the difference in inflation rates, while holding all other factors constant,  explains 30 percent of the $2.1 billion in cost growth for these ships.
In February 2004, the Navy changed its inflation policy directing program  offices to budget with what the Navy believes are more realistic inflation  indices. The Navy anticipates this policy change should help curtail future  requests for prior year completion funds.
section_title: Cost Reporting Weaknesses Delayed Efforts to Mitigate Cost Risks
paragraphs: While DOD guidance allows some flexibility in program oversight, we  found that reporting on contractor performance was inadequate to alert  the Navy to potential cost growth for the eight case study ships. With the  significant risk of cost growth in shipbuilding programs, it is important  that program managers receive timely and complete cost performance  reports from the contractors. However, earned value management—a tool  that provides both program managers and the contractor insight into  technical, cost, and schedule progress on their contracts—was not used  effectively. Cost variance analysis sections of the reports were not useful  in some cases because they only described problems at a high level and  did not address root causes or what the contractor plans were to mitigate  them.
Earned value management provides an objective means to measure  program schedule and costs incurred. Among other requirements, DOD  guidance on earned value management requires that “at least on a monthly  basis” schedule and cost variances be generated at levels necessary for  management control. Naval Air Systems Command, which is considered a  center of excellence for earned value management, recommends that cost  performance reports be submitted at a minimum on a monthly basis, in  part to help the program manager mitigate risk. Officials from the  command stressed that because earned value management acts as an early  warning system, the longer the time lapse in receiving the cost  performance report, the less valuable the data become.
However, shipbuilders for the Nimitz and Virginia class ships we reviewed  submitted their official earned value management cost performance  reports to the Navy on a quarterly basis instead of monthly, delaying the  reports—and corrective action—by 3 to 4 months. Had the reporting been  monthly, negative trends in labor and materials on the Virginia class  submarine would have been revealed sooner and enabled corrective action  to occur quickly in areas of work that were not getting completed as  planned. Earlier reporting would have also alerted managers of cost  performance problems on the CVN 76 carrier. Because data on actual cost  expenditures for CVN 76 were provided incrementally and late, the  program manager did not identify a funding shortage until it was too late  to remedy the problem. As a result, a contractwide stop-work order was  given. LPD 17 also experienced cost and schedule problems. To allow for  better tracking of schedule and costs and more timely response to  problems, the program manager changed the cost performance reporting  requirement from quarterly to monthly.
The quality of the cost performance reports, whether submitted monthly  or quarterly, was inadequate in some cases—especially with regard to the  variance analysis section, which describes any cost and schedule  variances and the reasons for these variances and serves as an official,  written record of the problems and actions taken by the shipbuilder to  address them. Both the Virginia class submarine and the Nimitz class  aircraft carrier programs’ variance analysis reports discussed the root  causes for any cost growth and schedule slippage and described how these  variances were affecting the shipbuilders’ projected final costs. However,  the remaining case study ship programs generally tended to report only  high-level reasons for cost and schedule variances with little to no detail  regarding root cause analysis or mitigation efforts—making it difficult for  managers to identify risk and take corrective action.
Finally, the periodic reassessment of the remaining funding requirements  on a program and a good faith estimate at completion—another part of  earned value management—were inadequate to forecast the amount of  anticipated cost growth. Managers are required to evaluate the estimate at  completion and report it in the cost performance report, updating when  required. The Defense Contract Audit Agency recently observed the  importance of the shipbuilders’ developing credible estimates at  completion and ensuring all estimates at completion revisions are justified  and made in a timely manner. However, the shipbuilders’ estimates for the  study ships tended to be optimistic—that is, they fell at the low end of our  estimated cost growth range. Specifically, shipbuilder estimates for four  ships that are still under construction were near our low estimate, (See  fig. 3), leading management to believe that the ships will cost less than  what is likely to be the case.
See appendix VI for more details on the cost growth forecasts for ships  currently under construction.
section_title: Conclusions
paragraphs: The challenge in accurately estimating and adequately funding the  construction of Navy ships is framed by the long construction time cost  estimates must account for and the fact that ships must be fully funded in  the first year of their construction. Thus, an underestimation of costs, a  budget reduction, or an increase in cost, creates a need for additional  money that must be requested and appropriated. The fact that requests  have been sizable and have occurred routinely over the years suggests that  the Navy can do better in getting a match between the estimated costs of  new ship construction and the money it budgets to pay for them. The goal  is not necessarily to eliminate all requests for additional funds, for that  could lead to overbudgeting or deferring necessary design changes.  Rather, the goal is to get a better match between budgeted funds and costs  in order that the true impact of investment decisions is known.
Our work shows that currently, the Navy’s cost estimating, budgeting, and  contracting practices do not do a good enough job of providing for the  likely costs of building ships. This is particularly true for first of class  ships, for which uncertainty is highest. Moreover, when actual costs begin  to go astray of budgeted funds, management tools intended to flag  variances and enable managers to act early are not always effectively  employed. If these practices are to lead to more realistic results---and  reduced overruns—they will have to produce and take advantage of higher  levels of knowledge. In some cases, improved techniques, such as  performing uncertainty analyses on cost estimates, can raise the level of  knowledge. In other cases, such as contracting for detail design and  construction on first-of-class ships, contracting in smaller steps can allow  necessary knowledge to build before major commitments are made.
The Navy has recognized the need to get a better match between funding  and cost and is providing guidance to achieve this match. The success of  this guidance will depend on how well it is implemented on individual  programs. There are additional steps the Navy can take, which are detailed  in our recommendations. Taking these steps now is especially important  for the Navy as it embarks on a number of new, sophisticated shipbuilding  programs. If a better match between funding and cost is not made,  additional funds needed for cost growth will continue to compete for the  funds needed for new investments in ships or other capabilities. Difficult  budget choices are ahead making it essential that priorities are set with a  clear understanding of the financial implications of different spending and  investment alternatives. To the extent unplanned demands on the budget  can be reduced, better informed decisions can be made.
section_title: Recommendations
paragraphs: We are recommending that the Secretary of Defense take the following  seven actions.
To improve the quality of cost estimates for shipbuilding programs and  reduce the magnitude of unbudgeted cost growth, we recommend the  Secretary of Defense    conduct independent cost reviews for all follow-on ships when significant  changes occur in a program and establish criteria as to what constitutes  significant changes to a shipbuilding program,    conduct independent reviews of every acquisition of an aircraft carrier,    direct the Secretary of the Navy to develop a confidence level for all ship  cost estimates, based on risk and uncertainty analyses.
To assure that realistic prices for ship construction contracts are achieved,  we recommend that the Secretary of Defense direct the Secretary of the  Navy to     negotiate prices for construction of the lead ship separately from the  pricing of detail design and    separate pricing of follow-on ships from pricing of lead ships, negotiating  prices for early ships in the budget year in which the ship is authorized  and funded.
To improve management of shipbuilding programs and promote early  recognition of cost issues, we recommend that the Secretary of Defense  direct the Secretary of the Navy to  require shipbuilders to submit monthly cost performance reports and  require shipbuilders to prepare variance analysis reports that identify root  causes of reported variances, associated mitigation efforts, and future cost  impacts.
section_title: Agency Comments and Our Evaluation
paragraphs: DOD agreed with our recommendations to conduct independent reviews  of every aircraft carrier and to develop a confidence level for all ship cost  estimates, based on risk and uncertainty analysis.   DOD partially agreed  with our recommendations about contract pricing and cost performance  reporting—areas the Navy noted it has taken some measures to improve.  While the Navy has taken steps in the right direction, we believe more  must be done to reduce ship cost overruns, consistent with our  recommendations.
We made a recommendation in our draft report that independent reviews  be conducted for all follow-on ships when significant changes to the  program occur. DOD responded that it will request additional  assessments, if needed after Milestone B. It is important that criteria be  established for determining when additional assessments are needed.  Programs may undergo several changes after the required estimate, such  as the Arleigh Burke destroyer, which underwent four major upgrades  since its only independent estimate in 1993. We believe DOD needs to  establish criteria concerning what significant changes to a program trigger  an independent cost estimate and have modified our recommendations  accordingly. DOD could clarify whether these changes include baseline,  profile, or major systems upgrades, for instance.
DOD stated that it will consider, on a case-by-case basis, negotiating detail  design separately from the lead ship and negotiating early follow-on ships  separately from the lead ship. We believe that this approach should be the  normal policy, if overruns are to be reduced. Ships represent a substantial  investment--more than $1 billion for each destroyer and amphibious  transport, about $2.5 billion for the lead ship in the next class of  destroyers, $2.5 billion for submarines, and several billion for carriers.  Ships costing substantially less—for example, $220 million for each  Littoral Combat Ship—are the exception rather than the norm. A realistic  target price is important for structuring contract incentives and providing  informed budgets to the Congress. Deciding prices for the lead ship and  follow-on ships together before detail design has even begun on the lead  ship is unlikely to yield realistic prices. Insight gained into material costs  and labor effort even in the first year of detail design will make realistic  pricing of the lead ship more feasible. Similarly, experience gained in the  first years of construction can benefit the realism of prices for follow-on  ships.
DOD noted that the Navy is already requiring shipbuilders to submit cost  performance reports monthly with one exception. With the Nimitz class  program beginning monthly reporting in March 2006, the Virginia class will  be the only program to submit quarterly instead of monthly cost  performance reports. DOD states that the Navy has access to labor hour  data in the interim. While informal access to timely data is preferable to  delayed access, without written, formal cost reporting there is less  visibility or accountability from the last formal report to the next cost  performance report 3 months later. The Virginia class program has  experienced significant cost increases and experienced one of the largest  prior year funding requests of programs we reviewed. LPD 17 and carrier  program officials recognized that more frequent formal reporting and  review of cost performance helped them to better manage cost growth and  changed their program reporting requirements from quarterly to monthly.  Although variance analysis reporting is required as part of cost  performance reporting and is being conducted by the shipbuilders, we  observed that there is wide variation in the quality of these reports. DOD  rightly observes that these reports are one of many tools used by the  shipbuilders and DOD to track performance. To be a useful tool, however,  we believe it is important that shipbuilders provide the government with  detailed analyses of the root causes and impacts of cost and schedule  variances. Cost performance reports that consistently provide thorough  analysis of the causes of variances, their associated cost impacts, and  mitigation efforts will allow the Navy to more effectively manage, and  ultimately reduce, cost growth.
DOD’s detailed comments are provided in appendix VII.
As agreed with your office, unless you announce its contents, we will not  distribute this report further until 30 days from its date. At that time, we  will send copies to the Secretary of Defense, the Secretary of the Navy and  interested congressional committees. We will also make copies available  to others upon request. In addition, the report will be available at no  charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact me at (202) 512-4841 or Karen Zuckerstein, Assistant Director, at  (202) 512-6785. Key contributors to the report are identified in  appendix VIII.
section_title: Appendix I: Scope and Methodology
paragraphs: Our methodology for all three objectives included a case study analysis of  eight ships. These ships were in four ship classes: Virginia class  submarines, LPD 17 amphibious assault ships, Arleigh Burke destroyers,  and Nimitz class carriers. We selected these ship classes and these ships  based on data contained in the “Naval Sea Systems Command Quarterly  Progress Report for Shipbuilding and Conversion Status of Shipbuilding  Programs,” dated July 1, 2003. This report identifies all ships under  construction and the progress in terms of “percent complete” for each  ship. We looked only at new construction and excluded ship conversions.  This report identified eight ship classes with ships under construction. In  addition to the four ship classes that we studied, the report identified ships  in the Seawolf attack submarine, LHD amphibious assault ship, T-AKE  cargo ship, and T-AKR vehicle cargo ship classes. We did not review the  Seawolf and T-AKR ship classes because construction of these classes was  at an end and were unlikely to affect future budgets. We did not include  ships from the remaining two classes because we limited the ship  selection to those ships that were more that 30 percent complete and none  of the ships in those two classes met those criteria.
We selected two ships per class for the four classes we reviewed. Where  possible, we chose a lead and follow-on ship. We also looked at which  shipyards were building these ships in order to get coverage of the major  shipyards. We limited the selection to ships more than 30 percent  complete so we had sufficient information on program performance.  Three Virginia-class submarines, three amphibious assault ships, two  carriers, and 12 destroyers met this criterion. For the Virginia class  program, we initially chose SSN 774 and SSN 776; both built and integrated  at the Electric Boat, Connecticut shipyard. As we gained knowledge of the  program and Newport News’ role in constructing and launching half of the  submarines in this class, we substituted the SSN 775 for the SSN 776.
Characteristics of the ships we selected are summarized in table 12.
Because a large percentage of the ship construction budget is allocated to  fund the shipbuilding contracts, we assessed the shipbuilders’ cost  performance for the four classes of ships in our study. To make these  assessments, we applied earned value analysis techniques to data captured  in shipbuilder cost performance reports. We also developed a forecast of  future cost growth. For ships currently under construction (and more than  30 percent complete), we compared the initial target costs with the likely  costs at the completion of the contracts using established earned value  formulas. We based the lower end of our cost forecast range on the costs  spent to date added to the forecast cost of work remaining. The remaining  work was forecast using the cumulative cost performance index efficiency  factor. Studies have shown that using this method is a reasonable estimate  of the lower bound of the final cost. For the upper end of our cost range,  we relied on either the actual costs spent to date added to the forecast of  remaining work with an average monthly cost and schedule performance  index or a cost/percent complete trend analysis, whichever was higher.
In order to understand the components of cost growth, we used cost data  provided by the shipbuilders for each of the case study ships. In most  cases we compared the initial target cost to the current target cost. As a  result some of the increases in target cost could have resulted from  additional contract modifications initiated by the Navy, cost overruns due  to the shipbuilder, or unanticipated events. Most shipbuilders allocate  contract costs into three categories: material costs, labor costs, and  overhead costs. We, however, used these data to allocate costs into the  following categories: labor hours, material costs, and labor and overhead  rates. Since labor costs and overhead costs can change due to labor hours,  and labor and overhead rates, we separated the program overhead cost  associated with an increase in labor and overhead rates from the program  overhead cost associated with an increase in labor hours. This was  accomplished by holding each component constant to isolate the impact.  After we isolated the program overhead cost associated only with  additional labor hours, we added this to the shipbuilders’ reported labor  cost growth and subtracted this from the shipbuilders’ reported overhead  cost growth. Our analysis captures all costs associated only with overhead  and labor rate changes. Increases in overhead related to growth in labor  hours are captured only in our analysis of labor hour increases.
We used the latest cost performance data available to us in July 2004. The  latest available cost performance reports for the case study ships were as  follows    DDG 91  June 2004,    DDG 92  May 2004,    CVN 76  July 2003,    CVN 77  March 2004,    LPD  17 and LPD 18 May 2004, and    SSN 774 and SSN 775 July 2004.
In order to understand the funding and management practices that  contribute to cost growth, we reviewed Navy acquisition guidance and  reviewed best practices literature for weapons systems construction. To  better understand the budgeting of ships and the acquisition process we  met with officials at the Navy and Office of Secretary of Defense  Comptroller. Based on indicators from our case study analysis that cost  estimating practices may contribute to cost growth, we met with cost  estimators, including those from Naval Sea Systems Command, Cost  Analysis Improvement Group, and the Navy Cost Analysis Division. We  reviewed DOD and Navy cost estimating policies, procedures, and  guidance. Additionally, we met with cost estimators from the Naval Air  Systems Command, the Air Force, and the Army to compare how Naval  Sea Systems Command estimating practices vary from other military cost  estimating practices. We interviewed program officials, contracting  officers, and shipbuilders and reviewed shipbuilder reports, which  included explanations for cost growth. We met with officials at Supervisor  of Ships and the Defense Contract Audit Agency both at the shipyards and  at headquarters to review their oversight policies, procedures, and  practices. We met with Navy Audit Service officials to gain information on  earned value management reviews at shipyards. We also reviewed contract  documentation and audit reports.
Our analysis relied on shipbuilders’ earned value data. To establish the  reliability of the data, we examined the integrated baseline reviews that  are conducted at the beginning of a contract. We also confirmed that the  shipbuilders had validated earned value systems.
We performed our review from July 2003 to December 2004 in accordance  with generally accepted government auditing standards.
section_title: Appendix II: Arleigh Burke Class Destroyer
subsections: section_title: Program Description
paragraphs: The USS Arleigh Burke class destroyer (DDG 51) provides multimission  offensive and defensive capabilities, and can operate independently or as  part of carrier strike groups, surface action groups, and expeditionary  strike groups. The DDG 51 class, which is intended to replace earlier  surface combatant classes, was the first U.S. Navy ship designed to reduce  radar cross-section and its detectability and likelihood of being targeted by  enemy sensors and weapons. Originally designed to defend against Soviet  aircraft, cruise missiles, and nuclear attack submarines, the ship is to be  used in high-threat areas to conduct antiair, antisubmarine, antisurface,  and strike operations.
As of May 2004, 43 Arleigh Burke destroyers have been delivered to the  Navy, with a total of 62 to be delivered at the end of the production.  Funding for the lead ship (DDG 51) was provided in fiscal year 1985. The  lead ship construction contract was awarded to Bath Iron Works in April  1985. With the award of the follow-on ship—DDG 52—to Ingalls  Shipbuilding Incorporated—a second shipbuilder was established. The  DDG 91 and DDG 92, which are covered in this report, include a number of  upgrades, such as the most current Aegis weapons system; installation of a  remote mine-hunting system capability and the introduction of  commercially built switchboards.
section_title: Cost Experience on DDG 91 and DDG 92
paragraphs: DDG 91 and DDG 92 cost $135 million more than budgeted. (See table 14.)  The Congress has appropriated almost $100 million to cover these  increases.
section_title: Main Drivers of Cost Growth for DDG 91 DDG 92
paragraphs: Construction costs—especially the costs associated with the number of  labor hours needed to build the ships—were the major source of cost  growth. Navy-furnished equipment, including the Aegis weapon system,  was also a significant source of cost growth for the two DDGs,  representing 21 percent of the cost growth. Increases in the number of  labor hours account for 67 percent of the cost growth on shipbuilding  construction contracts. We found that ship overhead—such as employee  benefits and shipyard support costs—and labor rate increases accounted  for 21 percent of cost growth. The two DDGs actually underran material  costs, due to DDG 91 material cost savings.
subsections: section_title: Labor Hours
paragraphs: Labor hour increases account for the majority of the cost growth on  DDG 91 and DDG 92. (See fig. 5.) DDG 91 required almost 1 million hours  of additional labor hours and DDG 92 required an additional 2 million  hours above the original contract proposal. DDG 91 and DDG 92  incorporated a number of new technologies in their design, including the  remote mine-hunting system, which consists of a remote operated vehicle  and a launch and recovery system stored within the ship. To accommodate  this system, designers had to make significant structural changes to 26 of  the ship’s 90 design zones. When construction began on DDG 91 and  DDG 92, the remote mine-hunting system’s design was not mature. As a  result, significant details of the design could not be captured in the  shipbuilders’ planned contract costs. Moreover, the shipbuilders  anticipated that the system’s design would be completed in July 1999— several months before the start of ship fabrication in November 1999.  However, it was not completed until November 2001, with additional  revisions to the design occurring through March 2003. Because the design  was changing as installation of the system began, laborers re-installed  parts of the system, increasing the engineering and production hours.
As the number of hours to construct the ship increased, total labor costs  grew, with the shipbuilder paying for additional employee wages and  overhead costs. As table 15 shows, we separated the overhead and labor  rates associated with the additional hours and added this to the  shipbuilders reported labor cost growth. Our analysis thus captures all  costs associated with labor hour growth—including overhead and labor  rates. The methodology we used to separate the overhead costs associated  with rate increases and labor hour increases is discussed in appendix 1.
According to the shipbuilder, additional labor hours were also needed to  complete DDG 91 because many experienced workers had left the trade in  favor of higher paying jobs in the area and, as a result, less experienced  workers took longer to finish tasks and made mistakes that required  rework. For DDG 92, workers encountered challenges in building the ship  due to a new transfer facility that enabled the shipyard to construct a  greater proportion of the ship on land. The ship was constructed using  larger subsections or units. While the shipbuilder expects that the facility  will improve efficiency, on DDG 92, workers had to learn new processes  and had difficulties aligning larger units of the ship to one another. Labor  hours increased as workers spent additional time realigning and  combining the units to make larger sections of the ship.
section_title: Navy-Furnished Equipment
paragraphs: About $38 million of Navy-furnished equipment cost growth is associated  with the Aegis weapon system, specifically the purchase of an additional  SPY-D radar used in system testing. The Navy originally planned to move  the developmental radar from the engineering and development site to the  final testing and certification center. However, increased complexity  involved with the introduction of a new radar and new computing plant  required more development time than was originally planned. In order to  ensure timely delivery of DDG 91, the Navy procured a second radar for  the testing facility, allowing the Navy to simultaneously finish final  development of the radar, while at the same time beginning testing and  certification of the Aegis weapon system computer program.
section_title: Overhead Rate Increases
paragraphs: Our analysis shows that program overhead costs and increases in labor  rates accounted for approximately 21 percent of the cost growth on the  DDG 91 and 92 contracts. Table 15 includes overhead increases that were  a consequence of labor hour increases. Table 16 isolates the remaining  portion of overhead increases due to increases in rates.
Despite savings incurred through the consolidation of Ingalls Shipyard into  Northrop Grumman, overhead rates were about 13 percent higher than  anticipated in 2001. According to shipbuilders, increases in overhead rates  can be attributed largely to changes in the shipyard’s workload and  employee benefit costs. After the cancellation of the construction contract  for a commercial cruise ship due to the company’s bankruptcy and the  delay in signing the contract for the next generation destroyer, overhead  costs had to be absorbed by the remaining contracts at the yard, including  the DDG 91. Similarly, on DDG 92, the shipbuilder based its overhead rates  on anticipated work from the construction of the next generation  destroyer and the San Antonio class ships. When these programs did not  materialize as expected, the other programs at the yard assumed overhead  costs. At both shipyards health and dental care costs increased. For  example, at one shipyard, the shipbuilder negotiated a favorable medical  insurance contract but the insurance company went bankrupt, forcing the  shipbuilder to become self-insured—at a higher cost.
Both shipbuilders were also affected by labor rate increases. Following a  strike at Bath Iron Works, the union negotiated a $1.12 increase in labor  rates or a $6 million increase above the costs projected in the contract. For  Northrop Grumman, between the initial proposal and the latest estimate,  the labor rate increased by $1.50 per hour for a total impact on the DDG 91  of $7 million.
section_title: Material Costs
paragraphs: As shown in table 17, material cost increases did not represent a major  source of cost increases for DDG 91 and DDG 92—largely because the  materials were purchased for four ships at one time.
However, DDG 92 overran its material budget by $30 million—73 percent  of which was due to information technology, small tooling, and other  material costs. Although these costs comprise only 17 percent of the  material cost budget, their costs are driven by labor hour usage—as  additional labor hours were needed to construct DDG 92, additional tools  were needed, raising material costs. Material costs also increased because  the shipbuilder began allocating information technology costs to  materials—not overhead, as it had initially done. DDG 91 experienced a  $22 million underrun of material costs. According to the shipbuilder, the  underrun was due to efficiencies gained through the consolidation of  Ingalls Shipyard with nearby Avondale Shipyard—also owned by Northrop  Grumman Ship Systems. With the consolidation, Northrop Grumman  stated it could purchase materials for both shipyards—creating cost  savings that were not anticipated in DDG 91’s original material cost  budget.
section_title: Appendix III: Nimitz Class Aircraft Carrier
subsections: section_title: Program Description
paragraphs: The mission of the Nimitz class nuclear powered aircraft carriers—which  are intended to replace the Navy’s conventionally powered carriers—is to  provide a sustained presence and conventional deterrence in peacetime;  act as the cornerstone of joint allied maritime expeditionary forces in  crises; and support aircraft attacks on enemies, protect friendly forces,  and engage in sustained independent operations in war. Nine Nimitz class  nuclear carriers—CVN 68 through CVN 76—have been delivered since  acquisition of the first ship in October 1967. CVN 77, the tenth and final  ship of the class, is a modified version of CVN 76 and will serve as a  transition ship to the next generation of aircraft carriers. Both CVN 76 and  CVN 77 included several significant design changes, including a bulbous  bow; larger air-conditioning plants; a redesigned island; weapons elevator  modifications; and an integrated communications network.
section_title: Cost Experience on CVN 76 and CVN 77
paragraphs: The Fiscal Year 2005 President’s Budget showed that budgets for the CVN  case study ships had increased by $173 million, and the Congress has  appropriated funds to cover these increases. However, based on March  2004 data, we projected additional cost growth on contracts for the  carriers is likely to reach $485 million and could be higher. Therefore, the  Navy will need additional appropriations to cover this cost growth.
The fiscal year 2005 budget for the carriers is about $9.6 billion— $173 million more than the initial budget request for these ships. (See table  19.) As a result, the Navy has requested $275.4 million through both the  prior year completion bill and other financial transfers to fund cost  increases on the CVN program. Ship construction costs comprise the  majority of this increase.
On CVN 76, ship construction costs grew by $252 million above the initial  budget. As a result of cost growth, CVN 76 was in danger of running out of  funding. The program office issued over 75 stop work orders—including  one contract wide stop work order to temporarily save funding. Lower  priority work was cancelled or halted to avoid further cost growth. While  stop work orders saved money in the short term, they resulted in  significant costs later. On CVN 76 some work had to be completed in a  post-delivery contract—at a higher cost.
We calculated a range of the potential growth for CVN 77 and found that  the total projected cost growth is likely to exceed $485 million and could  reach $637 million. (See table 20.)
Our cost growth estimates have proven to be understated. The Fiscal Year  2006 President’s Budget recognizes cost growth of $908 million for ship  construction above the prior year’s budget request. In addition, we  assumed that the shipbuilder will maintain its current efficiency through  the end of the contracts and meet scheduled milestones. For example,  Navy officials told us that delivery of CVN 77 is likely to slip to January  2009, further increasing the final cost of the ship.
section_title: Main Drivers of Cost Growth for CVN 76 and CVN 77
paragraphs: Based on 2004 data, increases in labor hour and material costs account for  80 percent of the cost growth on CVN 76 and CVN 77, while the costs for  Navy-furnished equipment—including propulsion and weapon systems— declined. (See fig. 7.) The remaining 23 percent of cost growth resulted  from increases in overhead costs. The shipbuilder cited a number of direct  causes for the labor hour, material, and overhead cost growth in the case  study ships. The most common causes were related to demands for labor  on other programs at the shipyard, the need for additional and more costly  materials, and changes in employee pay and benefits.
subsections: section_title: Materials
paragraphs: Material costs increased on CVN 76 by $294 million and on CVN 77 by  $134 million since the contracts were first awarded.
On both CVN 76 and CVN 77, material costs grew, in part, because  the shipbuilder underestimated the original budget for materials. In  April 2002—7 years after construction began on CVN 76—about  $32 million in errors in material purchase estimates were revealed. CVN 77  has also experienced a significant increase in material costs due to under  budgeting. According to the shipbuilder, a compressed construction  schedule on CVN 77 resulted in the budget for materials being established  prior to the completion of the carrier’s design and even the completion of  design work on certain systems on CVN 76. As a result, the true magnitude  of the carrier’s material costs was not known at the time of the contract  negotiation. Early in CVN 77 construction, however, the shipbuilder  reassessed the materials needed for construction in order to have a more  realistic estimate of final material costs. The Navy and the Defense  Contract Audit Agency recognized the absence of needed information on  materials during its review of the shipbuilder’s proposal and expressed  concerns about the adequacy of the cost estimating system. According to  Newport News officials, the shipyard and Defense Contract Audit Agency  are working to resolve their concerns. The shipbuilder is estimating $200  million in material cost increases and additional funds are being requested  to cover this increase.
According to the shipbuilder, material cost increases on both CVN 76 and  CVN 77 can be attributed to increases resulting from a declining supplier  base and commodity price increases. Both carriers’ material costs have  been affected by an over 15 percent increase in metals costs, which, in  turn, increases costs for associated components used in ship construction.  Moreover, many of the materials used in the construction of aircraft  carriers are highly specialized and unique—often produced by only one  manufacturer. With fewer manufacturers competing in the market, the  materials are highly susceptible to cost increases.
Other reasons for material cost increases include the following:    Expenses of about $20 million in non-nuclear engineering effort that were  subcontracted for in late 1997 and of about $50 million for information  services were transferred from overhead to material in the middle of the  project.
The expansion of commercial-off-the-shelf equipment in CVN 77 resulted  in additional costs to test the materials to make sure military  specifications were met.
section_title: Labor Hours
paragraphs: Costs on both carriers grew because of additional labor hours required to  construct the ships. At delivery, CVN 76 required 8 million hours of  additional labor hours to construct, while CVN 77 has required 4 million  hours. As the number of hours to construct the ship increased, total labor  costs grew, with the shipbuilder paying for additional employee wages and  overhead costs.
Increases in labor hours were due in part to an underestimation of the  labor hours necessary to construct the carriers. The shipbuilder negotiated  CVN 76 for approximately 39 million labor hours—only 2.7 million more  labor hours than the previous ship—CVN 75. However, CVN 75 was  constructed more efficiently because it was the fourth ship of two  concurrent ship procurements. (See table 23.) CVN 76 and CVN 77, in  contrast, were procured as single ships. As table 23 shows, single ship  procurement is historically less efficient than two ship procurements,  requiring more labor hours.
The shipbuilder and Navy budgeted the same number of hours to  construct CVN 77 as to construct CVN 76, despite forecasts showing that  at 55 percent complete CVN 76 would need almost 2 million more hours  above the negotiated hours to complete the ship. To date, CVN 77 is  expected to incur over 4 million man-hours more than negotiated.
Some of the labor hour increase on CVN 76 occurred as a result of  demands for labor on other programs at the shipyard. During construction  of CVN 76, 1 million hours of labor were shifted from the construction of  the carrier to work on the refueling and overhaul of CVN 68. The Navy  deemed the carrier overhaul and refueling effort as a higher priority than  new ship construction because carriers were needed back in the fleet to  meet warfighting requirements. Many of the most skilled laborers were  moved to the refueling effort, leaving fewer workers to construct CVN 76.  Without many of the necessary laborers to construct the ship, the CVN 76  construction schedule was delayed. In order to meet construction  schedule deadlines employees were tasked to work significant overtime  hours. Studies have shown, however, that workers perform less efficiently  under sustained high overtime.
Problems with late material delivery also led to labor hour increases on  both CVN 76 and CVN 77. When material did not arrive on time, the  shipbuilder tried to work around the missing item in order to remain on  schedule—which is less efficient than had the material been available  when planned. On CVN 77, for example, parts for a critical piping system  were delivered over a year late, necessitating work-arounds and  resequencing of work, driving labor costs up.
Other reasons for labor hour increases on CVN 76 and CVN 77:    A 4-month strike in 1999 led to employee shortages in key trades,  contributing to a loss of learning with many employees not returning to  the shipyard. According to Navy officials, the shipbuilder was given  $51 million to offset the strike’s impact.
Program schedule required concurrent design, planning, material  procurement, and production activities. Additional labor hours were spent  responding to design changes, which ultimately affected CVN 77 cost and  schedule.
Due to unavailability of large-sized steel plates the shipbuilder had to re- plan the ship’s structure so it could be constructed with smaller-sized  plates. This required not only extensive redesign, but resulted in additional  production hours because laborers needed additional time to fit and weld  the smaller plates together.
section_title: Overhead and Labor Rates
paragraphs: While the total overhead and labor rate costs on both the CVN 76 and  CVN 77 grew by $232 million over the life of the contract, labor hour  increases accounted for over half of that amount (See table 6.) According  to Navy officials, some of the overhead cost growth on CVN 76 can be  attributed to three major accounting changes since the contract was  awarded in late 1994. While these accounting changes increased overhead  costs, they resulted in a reduction of material costs. According to the  shipbuilder, overhead cost increases on CVN 77 can be attributed to  increases in pension and healthcare costs. Changes in the shipyard’s  workload and employee benefit costs also led to overhead cost increases  on CVN 77. After delays in signing contracts for a carrier overhaul and the  next generation aircraft carrier, overhead costs had to be absorbed by the  CVN 77 program.
According to the shipbuilder, labor rate increases on CVN 76 resulted from  union negotiations following a strike at the shipyard, as well as significant  use of overtime labor, which is more expensive than normal hourly wages.  According to Navy officials, between 30 and 40 percent of the work on  CVN 76 was done on overtime in 2003.
section_title: Navy-Furnished Equipment
paragraphs: Navy-furnished equipment did not represent an area of cost growth on  CVN 76 and CVN 77. On CVN 76, the costs for propulsion equipment  decreased by close to $145 million—driving down the overall cost of Navy- furnished equipment. Since 2001, costs for Navy-furnished equipment on  CVN 77, however, have grown by $100 million. This growth on CVN 77 can  be attributed to increases in the cost associated with the Integrated  Warfare System—the carrier’s combat system. The Integrated Warfare  System included new phased array radar that was being developed by the  next generation destroyer program. However, when the radar technology  did not become available as planned, the Navy decided to install a legacy  system on the ship. Because the shipbuilder was suppose to buy and  install the Integrated Warfare System as part of the original contract  scope, the costs for the Integrated Warfare System were removed from the  contract and used by the Navy to procure a legacy system as Navy- furnished equipment.
section_title: Appendix IV: San Antonio Class Amphibious Transport Dock Ship
subsections: section_title: Program Description
paragraphs: The San Antonio class amphibious transport dock ship is designed to  transport Marines and their equipment and allow them to land using  helicopters, landing craft, and amphibious vehicles. The class is expected  to increase operational flexibility and survivability over each ship’s 40-year  lifespan and to operate at lower cost than previous amphibious transport  ship classes. The new class is also designed to reduce crew size and  provide significant improvements in command, control, communications,  computer, intelligence, and quality of life.
In acquiring LPD 17, the lead ship in the class, a three-dimensional  computer-aided design tool and a shared data tracking system has been  used. The shared data tracking system was intended to provide significant  savings within the San Antonio class program through the reuse of critical  data in future design, construction, and operational activities. We focused  our review on the LPD 17 and 18.
section_title: Cost Experience on LPD 17 and LPD 18
paragraphs: Budgets for the two LPD case study ships have grown by $1 billion, and  funds have been appropriated to cover these increases. However, the Navy  could need additional appropriations of $200 million to $300 million to  fund projected cost growth.
For detail design and construction of LPD 17, the Congress initially  appropriated $953.7 million to fund the construction contract (the basic  contract plus a budget for future changes) and acquisition of Navy- furnished equipment. The Congress later appropriated $762 million to fund  LPD 18 construction. (See table 26.)
Since that time, the Congress has appropriated $1 billion to cover the  increases in the ships’ costs. However, more funds will likely be needed to  cover additional cost growth for these two ships. We project that, if the  current schedule is maintained, total cost growth for the LPD 17 and  LPD 18 will exceed $1.2 billion and possibly reach $1.4 billion. (See  table 27.)
Our cost growth estimates—both low and high—are likely understated  because we assumed that the shipyards will maintain their current  efficiency through the end of their contracts and meet scheduled  milestones. LPD 17 did not meet the planned December 2004 delivery date.  Delivery is now scheduled for May 2005, increasing the final cost of the  ship.
section_title: Main Drivers of Cost Growth for LPD 17 and LPD 18
paragraphs: Increases in labor hour and material costs account for 76 percent of the  cost growth on LPD 17 and LPD 18 construction contracts. Navy-furnished  equipment—including radars, propulsion equipment, and weapon  systems—represents just 2 percent of the cost growth. The remaining  22 percent was due to increases in overhead and labor rates. (See fig. 9.)
The shipbuilder cited a number of direct causes for the labor hour,  material, and overhead cost growth in the two case study ships. The most  common causes were related to the concurrent development of a new and  unproven design tool and design of the lead ship, initial focus on  controlling total lifetime costs, and changes in employee pay and benefits.
subsections: section_title: Materials
paragraphs: Engineering costs (classified as material costs) associated with use of a  three-dimensional product model to design LPD 17 were a key contributor  to material cost growth. The design tool was not fully developed and  subsequent problems affected all aspects of the design. Subcontracts for  engineering design doubled, accounting for $215 million in cost growth on  LPD 17. Development of an integrated production data environment,  originally assumed to be funded by the state, has instead been shifted to  the contract, representing an additional $35 million in cost spread across  LPD. (See table 28.)
section_title: Labor Hours
paragraphs: Labor hours, the second largest component of cost growth, increased  significantly for the LPD 17 and LPD 18. For example, engineering labor  hours for the LPD 17 increased by over 100 percent from the original  proposal.
As the number of hours to construct the ship increased, total labor costs  grew, with the shipbuilder paying for additional overhead costs and  employee wages. We separated the overhead and labor rates associated  only with the additional hours and added this to the shipbuilder’s reported  labor cost growth. (See table 29.) Our analysis captures all cost growth  associated with labor—including labor hours, overhead, and labor rates.
Factory inefficiencies and loss of skilled laborers, including significant  employee attrition (35 percent annually) contributed significantly to labor  hour increases. Difficulties with the design tool and turnover in  engineering staff led to increases in engineering labor hours and delayed  achieving a stable 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. On LPD 17, 1.3 million labor hours were moved  from the build phase to the integration phase. Consequently, LPD 17 took  much longer to construct than originally estimated. Moreover, a  diminished workforce at Avondale required the busing of shipyard  workers from Ingalls Shipyard in Pascagoula, Mississippi to Avondale in  New Orleans, Louisiana and the subcontracting of skilled labor.
section_title: Program Overhead and Labor Rates
paragraphs: While the total overhead costs on both the LPD 17 and 18 grew by  $0.5 billion over the life of the contract, labor hour increases contributed  to about half of that amount. (See table 30.)
According to Northrop Grumman, increases in overhead costs not related  to labor hour growth can be attributed largely to changes in the shipyard’s  workload and employee benefit costs. Beginning in 2001, the shipyard  experienced a rise in overhead rates. For example, the overhead rates in  the 2004 latest estimate by Northrop Grumman are 39 percent higher than  what was originally proposed on the LPD 17 in 1996. Several factors  helped to increase overhead. For example; due to the loss of the bulk  military cargo T-AKE ship, the cancellation of the construction of a  commercial ship (American Classics Voyage), and the delay in signing the  contract for the next generation destroyer, overhead costs had to be  absorbed by the remaining contracts at the yard, including LPD. This led  to 36 percent of the increase in overhead rates—24 percent for the T-AKE  and cruise ship and 12 percent for DD(X).
According to the shipyard, changes in the financial market affected the  pension fund and the rise in medical care costs were responsible for  16 percent of the increase in the shipyards overhead rates.
Labor rates rose due to inflation impacts of an over 2-year delay in lead  ship delivery and subsequent changes in the procurement schedule and  wage rates negotiated with labor unions.
section_title: Navy-Furnished Equipment
paragraphs: According to program officials, cost growth for Navy-furnished equipment  on the LPD 17 was due to increased costs for a shock wave test that was  not anticipated in the original cost estimate. This cost was a one-time  increase, affecting only LPD 17 costs.
section_title: Appendix V: Virginia Class Submarine
subsections: section_title: Program Description
paragraphs: The Virginia-class attack submarine, the newest class of nuclear  submarines, is designed to combat enemy submarine and surface ships,  fire cruise missiles at land targets, and provide improved surveillance and  special operations support to enhance littoral warfare. Because the  Virginia class is designed to be smaller than the Seawolf and slightly larger  than the Los Angeles class submarines—ships the new class will  eventually replace—the Virginia class is better suited for conducting  shallow-water operations. Major features of this new class of submarine  include new acoustic, visual, and electronic systems for enhanced stealth.  An objective of Virginia class is to reduce the life-cycle cost through better  design and engineering resulting in one third fewer man-hours than were  needed to construct Seawolf (SSN 21), the lead ship in the previous class  of attack submarines. The first ship, the SSN 774, was delivered in October  2004. Our review focused on the SSN 774 and 775.
section_title: Cost Experience on SSN 774 and SSN 775
paragraphs: The Fiscal Year 2005 President’s Budget showed that budgets for the two  Virginia class case study ships have increased by $734 million. However,  based on data of July 2004, we projected additional cost growth on  contracts for the two ships is likely to reach $840 million and could be  higher. In fiscal year 2006 budget, the Navy has requested funds to cover  cost increases that are now expected to reach approximately $1 billion.
The fiscal year 2005 budget for the SSN 774 and SSN 775 is about  $6.2 billion, compared with the initial fiscal year 1998 budget request of  $5.5 billion. (See table 32.) Ship construction costs comprise the majority  of this increase.
While the Congress has appropriated funds to cover the increases in the  ships’ costs, more funds will be needed to cover additional cost growth for  these two ships. In its fiscal year 2006 budget submission the Navy is  requesting an additional $125 million in prior year completion funding  between fiscal years 2006 to 2007 for the case study ships. We calculated a  range of the potential growth for the two case study ships and found that  the total projected cost growth is likely to exceed $724 million and could  reach $840 million or higher. (See table 33.)
Our cost growth estimates—both low and high—may be understated  because we assumed that the shipbuilders will maintain their current  efficiency through the end of their contracts and meet scheduled  milestones. Any slips in efficiency and schedules would likely result in  added costs. For example, the delivery date for SSN 775 is expected to slip  by as many as 8.5 months, which could increase the final cost of the ship.
section_title: Main Drivers of Cost Growth for SSN 774 and SSN 775
paragraphs: Our analysis shows that the submarine contract costs have grown because  initial construction costs were underestimated—especially the costs  associated with the cost of material and number of labor hours needed to  build the ships. For the two case study ships we examined, we found that  increases in the number of labor hours and material costs to build the  submarines accounted for 83 percent of the cost growth on shipbuilding  construction contracts. Navy-furnished equipment, including radars,  propulsion equipment, and weapon systems, caused 14 percent of the cost  growth. We found that ship overhead—such as employee benefits and  shipyard support costs—and labor rate increases accounted for 3 percent  of cost growth.
In negotiating the contract for the first four Virginia class ships, program  officials stated they were constrained in negotiating the target price to the  amount funded for the program, thereby risking cost growth at the outset.  The shipbuilders said that they accepted a challenge to design and  construct these ships for $748 million less than their estimated costs  because the contract protected their financial risk. Despite the fact that  there was significant risk of cost growth, the Navy, based on guidance at  the time, did not identify any funding for probable cost growth.
We analyzed shipbuilder contract costs to identify the sources of cost  growth. Using shipbuilder cost data, we allocated the sources of  shipbuilder cost growth on the contract into three categories—labor  hours; material costs; and labor and overhead rates. Since labor costs and  overhead costs can change due to labor hours, labor rates, and rates  associated with individual elements of overhead—or a combination of  these—we examined each in isolation by separating the program overhead  cost associated with an increase in labor hours from costs that resulted  from an increase in overhead rates, such as an increase in health care  costs.
subsections: section_title: Materials
paragraphs: Due to high risk that specialized material could not be procured for the  amount budgeted, the Navy agreed to purchase this material as a cost plus  fixed fee item. This agreement protected the shipbuilder from having to  fund any resulting cost increases for highly specialized material. Indeed,  cost growth for material increased by $350 million for the two Virginia  class submarines we examined.
The Navy and shipbuilders attribute material cost growth to several  factors including    unrealistic budgets not supported by current vendor costs,    diminished supplier base for highly specialized materials,    nonrecurring costs for Computer Data Integration between shipbuilder  teams,  lack of design maturity for certain electronic components, and  full funding of ships in the year of authorization.
Shipbuilders stated they based more than 70 percent of their estimate for  major material costs on updated vendor quotes while the Navy relied on  historical costs that were not analogous to the low number of submarines  being planned for construction. While the Navy knew there would be a  price penalty for a 6-year gap in submarine production, there were no  studies or actual data to support what the overall effect would be. Thus,  Navy cost estimators assumed that costs for major material items would  increase by 20 percent. When the Navy negotiated the costs for Virginia- class high value, specialized material, the shipbuilder agreed to take on the  challenge of achieving lower costs in exchange for funding these materials  on a cost-plus-fixed-fee basis. By the time the lead ship was delivered  8 years later, the true cost increase for highly specialized material was  closer to 60 percent more than historical costs.
Following the cancellation of the prior submarine program—Seawolf— and a decrease in submarine production of three to four submarines per  year to one over a period of 6 years, many vendors left the nuclear  submarine business and focused instead on more lucrative commercial  product development. As a result, prices for highly specialized material  increased due to less competition and a lack of business. For example,  many vendors were reluctant to support the Virginia class submarine  contract because costs associated with producing small quantities of  highly specialized materials were not considered worth the investment— especially for equipment with no other military or commercial  applications.
Material costs also increased due to nonrecurring costs for integrating  computer data so that the shipbuilders could work from a common design.  In addition, costs to develop high-risk systems like the array and exterior  communication system were underestimated. Recognizing the significant  cost risk involved, the Navy procured these systems under a separate  contract line item that guaranteed the shipbuilders a fixed fee and made  the Navy responsible for funding all cost growth.
Finally, the Navy believes that the block-buy contract has contributed to  increased material costs. Under a block-buy contract, subcontracts for  submarine materials are for single ships spread over several years.  According to the Navy, this type of acquisition approach does not take  advantage of bulk-buy savings and incurs the risk that funding will not be  available in time to order the material when needed. In addition, since  ships are funded individually, the Navy believes suppliers are unwilling to  risk investing in technology improvements due to the uncertainty that  future ships will not be purchased. To stabilize the vendor base, the Navy  awarded a multiyear contract that commits the Navy to purchasing  additional submarines. While a multiyear contract can provide such  savings, a program must meet criteria to demonstrate a sufficient level of  stability for such a contract. In June 2003, we noted several aspects of the  Virginia class program that indicated instability. Another factor to be  considered in using multiyear contracts is the budget flexibility the  government gives up in exchange for the commitment of funds for the  future years of the contract.
section_title: Labor Hours
paragraphs: Labor cost increases have led to $339 million in cost growth for the  SSN 774 and SSN 775 combined. Problems with mastering state-of-the art  design tools, first in class technical and teaming issues, and material  availability all contributed to the labor cost growth.
We found that SSN 774 required almost 3 million additional labor hours  than planned, reflecting a growth of 25 percent. (See fig. 12.) In addition,  we found that SSN 775 required almost 4 million more labor hours than  planned. Approximately 3.4 million nonrecurring labor hours for SSN 774  were procured on a separate contract line item and therefore not included  in our analysis while some SSN 775 nonrecurring labor hours are  embedded in the labor hours for that ship.
Technical issues commonly associated with first-in-class ships also  contributed to the overall labor cost growth. For example, shipbuilders  experienced problems with crossed hydraulic lines on the lead ship. In  addition, problems with the torpedo tube and weapons handling design  issues also contributed to labor hour growth in both ships. Labor hours  also increased as quality problems discovered for a component made by  one shipyard were reworked by the shipyard integrating the components.  Because the shipyard doing the integration was not as familiar with the  effort, the work was not completed as efficiently.
Late material deliveries also disrupted the work-flow sequence. Because  many vendors either went out of business or focused on developing new  commercial products in response to low demand, the Navy was no longer  considered a preferred customer. In cases where there was no ready  supplier, the shipbuilder had to request old subcontractors to supply the  highly specialized material. This caused delays in material deliveries as  well as quality problems arising from strict inspection processes that  subcontractors were no longer familiar with. Although the shipbuilders  tried to work around late material deliveries when they could, this caused  workers to perform less efficiently than had the material been available  when scheduled. Moreover, when the material did arrive, the shipbuilders  had to work overtime to make up the schedule causing additional growth  in labor costs.
section_title: Navy-Furnished Equipment
paragraphs: According to Navy program officials, radar costs increased due to more  design effort needed to fix problems associated with the Seawolf program.  Other costs increases were driven by changes in how certain items were  purchased. For example, the advanced display system was recently  established as a line item in the budget when in the past it was paid for as  part of the shipbuilder’s construction contract. Moreover, the Navy  initially planned to use research and development funds to cover costs for  the propulsor but switched to ship construction funds instead, leading to  an increase in the program’s budget for Navy-furnished equipment.
section_title: Ship Overhead and Labor Rates
paragraphs: Our analysis shows that program overhead costs and increases in labor  rates were not significant sources of cost growth—causing approximately  3 percent of the cost growth. To isolate true increases in overhead rates  from increases that were a consequence of labor hour increases, we  separate the two in table 36.
Costs associated with growth in labor hours are shown in table 35  calculations.
According to the shipbuilder, overhead and labor rate increases were  related to pension, workers compensation, and health care costs rising  beyond what was expected. Furthermore, when other ship acquisitions did  not materialize, shipyard overhead costs were spread over a fewer number  of contracts causing an increase in the Virginia class overhead costs.  Similarly, the loss of business caused the shipbuilders to lay off skilled  workers. According to the shipbuilders, many of the experienced workers  did not return to the shipyard. Hiring and training new workers increased  costs.
We found that one shipbuilder was affected by labor rate increases.  Following a strike at the shipyard, union negotiations resulted in four pay  increases totaling an average of $3.10 per hour.
section_title: Appendix VI: GAO’s Forecast of Additional Costs to Complete Construction Contracts
paragraphs: This appendix discusses GAO’s forecast of future cost growth for all ships  in construction that are more than 30 percent complete. The forecast is  also compared with the shipbuilders’ forecasts of estimated costs at  completion.
CVN 76 and CVN 77: CVN 76 was delivered to the Navy in 2003. While we  forecasted an overrun of up to $586 million over the initial target price for  CVN 77, the fiscal year 2006 budget request indicates a need of $870  million in prior year funding.
SSN 774-SSN 777: SSN 774 was delivered to the Navy in October 2004.
We found that the contractors’ forecasts are unlikely to be achieved based  on continuing cost growth on the remaining 3 ships. In addition, the SSN  776 and SSN 777 are the follow-on ships to a new class and still may  experience production problems that could lead to future cost growth.
DDG 91-DDG 101: The DDGs have experienced cost growth at both  shipyards. All the DDGs under construction at Bath Iron Works and more  than 30% complete have experienced cost growth. Similarly, cost growth is  also expected on the DDGs built by Northrop Grumman.
LPD 17-LPD 20: LPDs currently under construction are likely to  experience significant cost overruns. On all of the LPDs, with the  exception of LPD 18, the shipbuilder is estimating overall cost growth to  be at the lower end of our predicted range. Hence we believe, the  shipbuilder’s forecast of cost growth is optimistic.
T-AKE: Major cost growth is being predicted for T-AKE 1. We estimate  that costs could grow more than $70 million beyond the initial contract  price. The shipbuilder believes that escalating material costs resulting  from rising commodity prices and unfinalized vendor subcontracts are  driving contract cost growth.
LHD 8: It also has the potential for significant cost growth—as much as  $177 million more than what was anticipated. Cost growth thus far is  attributed to increases in overhead and general and administrative costs.
section_title: Appendix VII: Comments from the Department of Defense
section_title: Appendix VIII: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the contacts named above, Margaret B. McDavid, Christina  Connelly, Diana Dinkelacker, Christopher R. Durbin, Jennifer Echard, R.  Gaines Hensley, Ricardo Marquez, Christopher R. Miller, Madhav Panwar,  Karen Richey, Karen Sloan, Lily Chin, and Marie Ahearn made key  contributions to this report.