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C-17 Aircraft: Comments on Air Force Request for Approval of Multiyear Procurement Authority (Testimony, 03/28/96, GAO/T-NSIAD-96-137).

GAO discussed the Air Force's proposed multiyear procurement of the C-17
aircraft. GAO noted that: (1) the Air Force's estimate that the
multiyear procurement could save about $896 million is overstated; (2)
the Air Force could save about $300 million without entering into the
multiyear agreement and a portion of this savings could be invested in
cost-reduction initiatives; (3) savings from the C-17 engine contractor
are also overstated; (4) the multiyear procurement will be based on the
Lot VIII contract which contains fixed-price options and incentives; (5)
the government and contractor have reduced costs and accelerated the
aircraft's production rate in order to keep total costs from exceeding
the 1994 $43-billion estimate; (6) C-17 engineering problems, excessive
research and development costs, and changing configuration requirements
could adversely affect the aircraft's design stability and production
rate; (7) it is unclear how the changes that the contractor is making to
the aircraft's design and production methods will affect the proposed
production schedule; (8) the Air Force has identified sufficient funds
to support the proposed procurement at the planned production rate; and
(9) the C-17 multiyear procurement needs to be reassessed.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-NSIAD-96-137
     TITLE:  C-17 Aircraft: Comments on Air Force Request for Approval 
             of Multiyear Procurement Authority
      DATE:  03/28/96
   SUBJECT:  Air Force procurement
             Military aircraft
             Military cost control
             Military contracts
             Multi-year procurement
             Aircraft research
             Proposed procurement
             Future budget projections
             Aircraft engines
IDENTIFIER:  C-17 Aircraft
             DOD Future Years Defense Program
             Stealth Aircraft
             F-117 Aircraft
             
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Cover
================================================================ COVER


Before the Subcommittee on Seapower, Committee on Armed Services,
U.S.  Senate

For Release on Delivery
Expected at
2:30 p.m., EST
Thursday
March 28, 1996

C-17 AIRCRAFT - COMMENTS ON AIR
FORCE REQUEST FOR APPROVAL OF
MULTIYEAR PROCUREMENT AUTHORITY

Statement of Louis J.  Rodrigues, Director, Defense Acquisitions
Issues, National Security and International Affairs Division

GAO/T-NSIAD-96-137

GAO/NSIAD-96-137T


(707169)


Abbreviations
=============================================================== ABBREV

  DAB -
  DOD -
  ECO -
  EOQ -
  IOT&E -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss the proposed multiyear
procurement of the C-17 aircraft.  This is a particularly critical
decision because this multiyear proposal would require legislation to
authorize a 7-year multiyear contract.  The short time frame for
congressional consideration (McDonnell's offer expires on June 1,
1996) also places an unusual burden on decisionmakers.  Mr. 
Chairman, I want to emphasize that we are commenting on a proposal
for a contract that has not been drafted.  We are, therefore, unable
to comment on the specifics of the proposed contract. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:1

Approval of multiyear procurement authority has historically depended
on the ability to obtain significant savings, a sufficiently stable
weapon system design, an adequately validated requirement, and a
commitment to stable funding over the life of the contract. 

The Air Force estimates that approval of its request for multiyear
procurement authority to complete the planned C-17 program will save
about $896 million.  However, the amount of savings likely to occur
as a result of a multiyear procurement is overstated.  At least some
of the savings--about $300 million--could be achieved without
entering into a multiyear agreement.  The government could have
invested a portion of the proposed multiyear funding in additional
cost-reduction initiatives such as those that have been funded by the
contractor in response to the 1994, C-17 settlement and other
cost-reduction initiatives funded by the government.  Additional
savings have been characterized by the contractor as a "management
challenge."

The savings from the engine manufacturer are estimated at $122
million but in reality are likely to be less.  The contractor has
indicated a willingness to offer an $88-million discount for a
multiyear contract. 

In January 1994, the C-17 program manager estimated that a 120
aircraft program would cost about $43 billion.  At that time DOD
reduced the program to 40 C-17's unless McDonnell Douglas
significantly improved the cost, schedule, and performance of the
aircraft.  Since then the Department of Defense (DOD) has reported
airframe cost savings of about 20 percent as a result of actions by
the government and the contractor.  However, this savings along with
the savings that will accrue from both the accelerated production
rate called for in the multiyear proposal and the estimated multiyear
savings are needed to keep costs from exceeding the January 1994, $43
billion estimate. 

The next criteria used in judging a multiyear contract is the extent
that the design is stable and can be produced at the designated rate. 
We have several concerns about the stability of the design and the
inherent risks in the increase in production which is called for in
the multiyear proposal.  First, there are several unresolved problems
that could require engineering changes to the aircraft that were
identified during the C-17 initial operational test and evaluation
(IOT&E).  Second, the Air Force has identified about $1 billion in
research and development funds that will be needed to develop
improvements to the aircraft and about $1.8 billion that will be
needed to accommodate engineering changes, product improvements, and
planned modifications between 1997 and 2004.  Finally, the C-17 is
about 18 months away from having an aircraft configuration that fully
conforms to the required specifications. 

In addition to the possible changes to the aircraft that could affect
the viability of a multiyear proposal, the contractor is currently
implementing changes in aircraft design and production methods that
have been identified as cost savings improvements.  It is not clear
how these changes will affect the contractor's ability to meet the
proposed production schedules. 

Another criteria for evaluating a multiyear procurement is a
assurance that the number of aircraft to be acquired is the correct
number.  Based on work that we are currently doing at the request of
Congresswoman Elizabeth Furse, we do not believe that 120 C-17
aircraft are needed to meet current requirements. 

Finally, before approving a multiyear procurement, Congress should be
assured that funding to support the contract at the proposed
production rates has been included in DOD's planned future
procurement.  It appears from looking at the Future Years Defense
Plan that the Air Force has identified sufficient funds to support
the proposal. 

Overall, we believe some savings could be achieved from a multiyear
procurement of the C-17.  However, the savings will likely be less
than the current $896 million estimate and will entail both costs and
risks.  Given the uncertainty regarding the design stability and the
risk associated with increasing production, we believe a further
assessment of the merits of a C-17 multiyear program may be warranted
and can be accommodated under the current proposal. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

The C-17 military transport, being produced for the Air Force by the
McDonnell Douglas Corporation, is designed to airlift substantial
payloads over long ranges without refueling.  The Air Force intends
the C-17 to be its core airlifter and the cornerstone of its future
airlift force.  Through fiscal year 1996, the Congress had
appropriated about $20.5 billion for the C-17 program, including $5.9
billion for research and development, $14.6 billion for procurement,
and $170 million for military construction.  The Congress had
approved the acquisition of 40 C-17s. 

Multiyear procurement can benefit the government by saving money and
improving contractor productivity through a more stable production
run.  A significant source of multiyear savings results from larger
lot buys from vendors and suppliers, or economic order quantities
(EOQ).  However, multiyear procurement contracts decrease annual
budget flexibility.  If DOD's budget is reduced and multiyear
contracts are maintained, those programs not under multiyear
authority would have to be reduced disproportionately.  A multiyear
procurement contract also entails certain risks if it is changed or
terminated. 

The C-17 proposal is unique because it requests authority for a 7-
year multiyear contract.  The current statutory limit is 5 years.  In
the past, it was not uncommon for multiyear candidates to request
even shorter terms, such as 3 or 4 years.  It is also unique because
it is being proposed out of the normal authorization cycle and the
offer expires on June 1, 1996. 

The C-17 multiyear procurement proposal calls for an accelerated buy
profile as shown in table 1. 



                                Table 1
                
                  C-17 Multiyear Proposed Buy Profile

Fiscal year             1997   1998   1999   2000   2001   2002   2003
---------------------  -----  -----  -----  -----  -----  -----  -----
Number                     8      9     13     15     15     15      5
----------------------------------------------------------------------
It also calls for the government to provide $300 million in EOQ funds
beginning in 1996, to allow for the build up of inventory and for
cost-reduction projects.  The $300 million, which would be treated as
a down payment to be recouped in subsequent years, is a combination
of existing funds from a variety of sources from prior fiscal years
as follows: 



                                Table 2
                
                Source of Economic Order Quantity Funds

Fiscal year 1994        Fiscal year 1995        Fiscal year 1996
millions                millions                millions
----------------------  ----------------------  ----------------------
$70 NDAA\a Funds        $50 Lot VII OTP         $100 Affordability
30 Lot VI OTP\b         50 ECO\c Funds          Funds
----------------------------------------------------------------------
\a Non Developmental Airlift Aircraft

\b Over Target Protection

\c Engineering Change Order

The multiyear contract has not yet been negotiated.  However, Air
Force officials told us that a multiyear contract would be based on
the recently signed Lot VIII contract which contains fixed-price
options for lots 9 through 11--30 aircraft.  It also contains fixed-
price incentive/successive target options for the remaining lots
covering the final 50 aircraft of the 120 aircraft buy.  The Air
Force must negotiate a separate firm fixed-price contract before
exercising any of these options.  Program officials told us that this
arrangement gives them the flexibility to accommodate future
uncertainties that could occur in such a lengthy procurement period. 

Program officials also negotiated an extensive variation in quantity
clause, which included an accelerated production schedule.  However,
this clause requires that once a production rate has been reached, it
cannot be decreased, except for the final lot.  Further, once the
production rate has exceeded 12 aircraft, it must be increased to the
maximum rate of 15 a year.  If these conditions are not met, the
remaining option prices are invalid and must be renegotiated.  The
multiyear contract will only include the accelerated schedule from
Lot VIII.  However, both Air Force and company officials told us that
they intend to include a provision in the multiyear contract that
would allow the government to revert back to the Lot VIII annual buy
contract options without renegotiating those option prices, if
neither of the above conditions have been violated.  That means a
decision would be required before approval of the fiscal year 1999
defense authorization and appropriation acts when the production rate
is scheduled to reach 13 aircraft. 

The multiyear offer is also contingent upon the use of performance
based financing provisions.  This is a departure from the normal 75-
percent progress payment arrangement based on the amount of budget
expended.  It entails negotiating pre-determined events and payments
for each of the events for the remaining 80 aircraft.  These include
such events as major component completion, wing joining, roll out,
and delivery.  The contractor will receive financing based on the
agreed to prices, which Air Force officials told us will include
profit, after it has completed these events.  The events have been
identified; however, each event must still be defined as to what
would constitute completion and the amount of financing that would be
provided for completion of the event.  Program officials told us that
the effect of this financing arrangement is equivalent to a 90-
percent progress payment rate. 


   C-17 MULTIYEAR PROPOSAL SAVINGS
---------------------------------------------------------- Chapter 0:3

In the past, the Congress generally required 10-12 percent savings
from multiyear procurement.  The C-17, at 5 percent, is at the low
end of the spectrum when compared to other multiyear programs such as
the KC-10, F-16, or B-1B, each of which estimated savings at 9 to 17
percent.  Although savings could result from a multiyear procurement
of the C-17, the claimed savings are overstated.  The C-17 multiyear
procurement is estimated by the Air Force to save $896 million in
then year dollars.  The majority of this savings stems from two
sources, the airframe and engine contracts.  McDonnell Douglas has
offered to reduce its contract price for the remaining 80 aircraft by
5 percent which the Air Force estimates to be about $760 million. 
The Air Force has estimated that it will achieve another $122 million
(6 percent) savings from the Pratt & Whitney engine contract.  In
addition, the Air Force has estimated an additional $14 million in
savings from other sources.  An Air Force official were not able to
identify the savings from "other sources."


      AIRFRAME SAVINGS
-------------------------------------------------------- Chapter 0:3.1

Traditionally, a major portion of the savings from multiyear
procurement comes from lower prices on economic order quantity buys
from vendors or subcontractors.  These savings are generally achieved
with the EOQ money provided by the government.  In this instance,
however, McDonnell Douglas characterizes its offer of five percent
savings as a "management challenge." In fact, its initial offer was
closer to 3-percent.  Program officials told us that McDonnell
Douglas is still struggling to identify how it will use the EOQ
funding. 

A major part of McDonnell Douglas' effort to achieve the 5-percent
savings will depend on its suppliers.  It has given its key suppliers
cost-reduction targets; however, according to Air Force officials,
the supplier responses have been somewhat disappointing.  McDonnell
Douglas is still working with suppliers to try to achieve the overall
5-percent reduction. 

Air Force officials told us that they expect that roughly $200
million of the EOQ funding will be applied to EOQ opportunities.  The
remainder may be used to fund affordability projects.  The
affordability projects which have been identified, are the group that
could have been funded by the government with money appropriated from
the C-17 Producibility Enhancement/Performance Improvement contract. 
These projects are estimated to have a 4 to 1 return ratio.  That is,
for a $100-million investment the return is estimated to be about
$400 million.  The resulting $300 million savings, although included
as part of the multiyear savings, could be available without
commitment to the multiyear. 


      ENGINE SAVINGS
-------------------------------------------------------- Chapter 0:3.2

The F-117 engine contract is a commercial procurement where the
government receives most favored customer pricing discounts.  The
multiyear offer from Pratt & Whitney would increase the discount by
4.3 percent.  This represents a savings of $88 million, not $122
million as the Air Force had quoted in its multiyear package. 


   DESIGN AND PRODUCIBILITY
   CONCERNS
---------------------------------------------------------- Chapter 0:4

In approving a multiyear authority for the C-17, the Congress should
be assured that the design is stable and can be produced at the
designated rate.  We have several concerns about the stability of the
design and the inherent risk involved in increasing the production
rate. 

First, IOT&E was completed by the Air Force on December 5, 1995.  Air
Force officials indicated there were 95 open items from the IOT&E
report that could impact the design of the C-17.  Air Force officials
told us that they are working on 47 of these items and they consider
the remaining 48 to be inconsequential.  They could not give us an
estimated cost or the time frames for implementing the production
line changes needed to correct these items. 

Second, the Air Force has also identified $1 billion in research and
development funds, a large part of which, will be needed for future
enhancements to the aircraft and an additional $1.8 billion in
procurement funds:  $275 million for engineering change orders (ECO),
$308 million for product improvements, and $1.2 billion for
modifications (retrofit) to mature the aircraft.  The C-17 program
office refers to ECOs as a management reserve to fund "unknown
unknowns".  This money is estimated to cover any unforeseen problems
which may occur through the production program.  The additional funds
are for improvements to the aircraft, many of which have not yet been
identified. 

Third, there are many outstanding variances from specifications that
will have to be resolved.  The Air Force plans to have these resolved
by the scheduled delivery of production aircraft 33 in August 1997. 

Our final concern is the extent of design and production changes that
are taking place as a result of cost reduction efforts funded by the
contractor under the C-17 settlement or by the government as cost
reduction initiatives.  These projects were initiated to reduce costs
on the C-17 in preparation for the November 1995 DAB.  If
difficulties occur in implementing these changes, price or schedule
problems could result which would be exacerbated if the contractor is
at the same time increasing production. 


   REQUIREMENT STABILITY
---------------------------------------------------------- Chapter 0:5

The decision to acquire 120 C-17s was the result of a Defense
Acquisition Board (DAB) that considered whether to acquire additional
C-17s or a mix of C-17s and non-developmental aircraft to accomplish
the airlift mission.  The analysis leading up to that decision
included several predetermined options presented for consideration by
the DAB.  Our analysis indicates that an option of 100 C-17s could
meet the current strategic mobility requirement and also fulfill the
need for aircraft with the unique military capabilities of the C-17. 
That option was not presented to the DAB for consideration.  The
possible savings from this alternative would be significant. 


   FUNDING STABILITY
---------------------------------------------------------- Chapter 0:6

The multiyear justification package states that funding for the
proposed multiyear buy has been included in the Future Years Defense
Plan and the fiscal year 1997 budget, and airlift modernization is a
well recognized priority for DOD.  At this point in time, we have no
specific basis to question future funding stability. 


   CONCLUSION
---------------------------------------------------------- Chapter 0:7

The proposed C-17 Multiyear contract presents the Air Force with the
opportunity for savings on the C-17 program.  However, the savings
are, in our opinion, substantially less than the $896 million that
has been advertised.  Further, these potential savings are not
without both costs and risk.  The contractor has asked for EOQ
funding of $300 million.  In our opinion this should be viewed as
$200 million of new funding and $100 million of funds that would most
probably have been provided to fund cost reduction initiatives.  The
contractor has also asked for an event based financing arrangement
that will provide a 90 percent equivalent progress payment structure
rather than the usual 75 percent included in production contracts. 
In both instances there is a cost of money to the government that
would not exist under annual buy. 

There are also risks associated with approving multiyear authority. 
These risks concern the extent of stability in the design and the
potential for problems in implementing the producibility enhancement
projects that may create cost and schedule problems. 

In our opinion the Congress should require that a provision which
would allow reverting to the Lot VIII annual buy contract is included
in any multiyear contract.  With that provision the government would
have until the fiscal year 1999 authorization and appropriation cycle
to assess the contractor's ability to produce the aircraft at the
required rate.  If the contractor's performance is not adequate, the
government could revert to the Lot VIII annual buy contract without
renegotiating the not-to-exceed option prices for the remaining lots. 

The Congress should require the Department to provide assurances
along with its 1999 budget request that the contractor is in
actuality ready to move to the higher production rate. 


-------------------------------------------------------- Chapter 0:7.1

Mr.  Chairman, this concludes my prepared remarks.  I would be
pleased to answer any questions you or members of the Subcommittee
may have. 


*** End of document. ***