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. 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). 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. 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. 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. 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.