To encourage defense contractor consolidations, DOD announced in July 1993 that it would pay for restructuring costs on transferred flexibly priced contracts in certain circumstances. These circumstances were that (1) the restructuring costs were allowable under the Federal Acquisition Regulation and (2) a DOD contracting officer determined that the business combination was expected to result in overall reduced costs to DOD or preserve a critical defense capability. Concerns over the payment of restructuring costs led Congress in 1994 to pass section 818 of Public Law 103-337, requiring that certain conditions be met before DOD could reimburse defense contractors for restructuring-related expenses. The legislation required that a senior DOD official certify that projections of restructuring savings were based on audited cost data and that the projected savings should result in overall reduced costs to DOD. The legislation also required the Secretary of Defense to report annually to Congress on DOD’s experience with defense contractor business combinations, including whether savings associated with each restructuring actually exceeded restructuring costs. In 1996, Congress passed section 8115 of Public Law 104-208, which stipulated that for business combinations occurring after September 30, 1996, projected savings had to (1) be at least twice the amount of costs allowed or (2) exceed the costs allowed, provided the Secretary of Defense determined that the combination would result in the preservation of a critical capability. In November 1997, section 804 of Public Law 105-85 made these requirements permanent. None of the seven business combinations we examined were subject to the two-to-one ratio requirement because they occurred before this requirement was established. We have issued several products on defense contractor restructuring. See Related GAO Products for specific references. DOD expects that it will save $3.3 billion between 1993 and 2000 as a result of restructuring activities carried out by the seven business combinations we examined. Table 1 shows total projected restructuring savings and DOD’s share of these savings for each of the seven business combinations. As part of the process to ensure that expected restructuring savings exceed projected costs, DOD regulations require contractors to submit a proposal that includes details on planned restructuring activities, projected costs, and anticipated savings. The regulations do not require contractors to propose or demonstrate savings on individual contracts or use any particular method or approach in estimating restructuring savings. As a result, the seven business combinations used a variety of estimating methods. These methods included estimating the savings on eight contracts and subsequently extrapolating the estimate across the contractor’s entire business base (over 1,000 contracts), comparing incurred costs at two companies before their combination with the projected costs at the restructured company, computing average salary and fringe benefits for employees to be laid off due to restructuring activities and multiplying these averages by up to 5 years, estimating reductions in operational costs from closing facilities and disposing of equipment, and projecting the impact that transferring work from the acquired company had on the overhead costs charged to the acquiring company’s existing or anticipated contracts. The Defense Contract Audit Agency’s (DCAA) guidance on reviewing restructuring proposals states that the contractor is responsible for establishing and supporting the reasonableness of the restructuring savings estimates. In April 1998, we reported that the broad framework provided under this guidance may result in DOD accepting proposed savings that are not directly attributable to restructuring. We noted that our work at Lockheed Martin’s Space & Strategic Missiles sector indicated that some of the operational improvements and their associated savings could have been accomplished without restructuring. Subsequently, we found that Lockheed Martin did not fully consider the impact of normal downsizing activities when estimating restructuring savings. For example, Lockheed Martin attributed 1,153 support personnel reductions at its Missiles & Space segment in 1995 to restructuring activities. However, before its merger with Martin Marietta was complete, Lockheed had forecasted that its total personnel level at this segment would decrease by 849 in 1995. Because Lockheed Martin did not consider reductions that were already planned, the amount of savings that was directly attributed to restructuring for 1995 may be overstated by $170 million. Lockheed Martin officials pointed out that this amount would not have affected DOD’s decision to pay restructuring costs because of the large amount of projected savings from the business combination. DOD realizes benefits from restructuring when its contract prices are lower than they would have been if restructuring had not occurred. The price of a typical government contract consists of indirect and direct costs.Restructuring activities that reduce indirect costs generally result in lower forward pricing rates and lower contract prices. Similarly, restructuring activities that reduce direct costs will be reflected in contract prices in the form of lower costs for such elements as direct labor or material costs. Five of the contractor business segments we visited included only indirect cost reductions in their estimated restructuring savings, whereas the other five segments included both direct and indirect cost reductions. Restructuring activities have enabled contractors to reduce their projected operating costs by hundreds of millions of dollars. The following four examples illustrate how restructuring enabled reductions in projected operating costs: The Hughes - CAE-Link business combination led to closing most of CAE-Link’s Binghamton, New York, operations and terminating 548 employees. The projected savings resulting from these activities—about $212 million—was computed by taking the total operating costs of the segments of the two companies that were to be combined and comparing that amount with the projected operational costs after restructuring. For example, in the year before restructuring, the two segments had combined operating costs of $195.3 million. Hughes subsequently projected that the operating costs for these segments would decrease to about $161.9 million in the first year of restructuring and about $150.8 million annually for the next 4 years. We verified that these lower costs were reflected in Hughes’ forward pricing rates that were made available to DOD contracting officers to price contracts. For the Northrop - Grumman - Vought business combination, we reviewed proposed savings from reductions in corporate overhead costs. After the business combination, several restructuring activities were undertaken, including closing Grumman’s headquarters in Bethpage, New York. Northrop Grumman estimated that closing this facility would save about $215 million over a 5-year period. About $100 million of the savings represented the labor and fringe benefit costs associated with laying off approximately 250 workers. Consequently, the amount of corporate overhead costs allocated to Northrop Grumman’s B-2 bomber program was less after restructuring than it would have been if restructuring had not occurred. After its acquisition of General Electric Aerospace, Martin Marietta restructured the operations of its Electronics & Missiles segment, thereby reducing projected overhead costs by $101 million over a period of about 5 years. The reductions consisted of (1) $68 million for vacating facilities, consolidating activities, eliminating jobs, and obtaining concessions in property taxes; (2) $18 million in concessions for employee wages and benefits, water, sewage, and electricity charges; (3) $11 million for relocating data processing activities and personnel; and (4) about $4 million in concessions in long-distance telephone rates. We traced these savings into the contractor’s overhead expense pools and its forward pricing rates. The lower rates were made available to DOD contracting officers to price contracts. After the merger of Lockheed and Martin Marietta, Lockheed Martin’s Missiles & Space business segment restructured its operations, including reducing overhead and support personnel and consolidating various administrative functions. As a result, the contractor was able to reduce its projected indirect labor costs by $739 million. Lockheed Martin reflected these indirect labor cost reductions in its August 1996 forward pricing rates. Determining the impact that restructuring activities had on a contract price requires isolating the effect of restructuring from nonrestructuring- related factors, such as changes in quantities or improvements in manufacturing efficiencies. In its annual reports to Congress, DOD has acknowledged that other factors, such as inflation, business fluctuations, accounting system changes, and subsequent reorganizations, also impact the contractors’ overall cost of operations. DOD noted that it is not feasible to precisely isolate the impact of restructuring from the impact of these other factors. Our work substantiates DOD’s position. United Defense provided the clearest example of a contract price reduction related to restructuring. For a fixed-price foreign military sales contract for self-propelled howitzers, the contracting officer had included a “reopener” clause, requiring the contractor to reduce the contract price after restructuring its operations. The contracting officer negotiated a $1.8 million reduction—or about 4 percent—to the contract’s $48.5 million price. This reduction was negotiated based on a proposal developed by the contractor that showed the impact of restructuring on the contract. Contractors offered other examples that they believed demonstrated how contract prices were affected by restructuring. However, we were unable to isolate the impact of restructuring from the impact that other factors had on the contract prices. For example, our analysis of Hughes Aircraft Company contract data showed the Army purchased 12,600 Tube-launched Optically-tracked Wire-guided (TOW) antiarmor missiles at an average unit price of $16,800 before restructuring and 8,758 TOW missiles at a unit price of $15,677 after restructuring in 1993. Despite the 30-percent decrease in quantities, the average unit price of the missile was $1,123, or almost 7 percent, lower after restructuring. Hughes officials attributed the reduction in part to lower overhead rates after Hughes’ acquisition of General Dynamics’ missile operations. However, Hughes officials pointed out that other factors, such as changes in quantities and production rates, learning curve efficiencies, and fluctuations in business volume, also affected the unit price of the missile. Neither we nor the contractor could isolate the effect of restructuring from the influence of these other factors on the unit price.