Index

Defense Acquisitions: Recent F-22 Production Cost Estimates Exceeded
Congressional Limitations (Letter Report, 08/15/2000, GAO/NSIAD-00-178).

Pursuant to a congressional request, GAO provided information on the Air
Force F-22 Raptor production cost estimate, focusing on: (1) the status
of cost reduction plans, including some plans not yet implemented, and
Air Force procedures for reporting on the plans; and (2) a comparison of
the 1999 production cost estimates with the congressional cost
limitation.

GAO noted that: (1) about half of the $21.0 billion in cost reductions
identified by the F-22 contractors and program office have not yet been
implemented; (2) however, the Air Force may not be able to achieve the
expected results from some of the plans because they are beyond the Air
Force's ability to control; (3) GAO reviewed 10 plans estimated to
reduce costs by $6.8 billion; (4) GAO found that cost reductions for 4
of the plans, which accounted for $5.6 billion in potential cost
reductions, may not be achievable because they were dependent on
decisions or later determinations that must be made by the Office of the
Secretary of Defense or Congress; (5) although the Air Force and its
contractors have procedures to track the status of the production cost
reduction plans, and the Air Force has reported quarterly to the Under
Secretary of Defense concerning the total estimated cost of F-22
production, the Air Force reports have not regularly included a summary
of the status of production cost reduction plans; (6) both Office of the
Secretary and Air Force cost estimators projected F-22 production costs
that exceeded the congressional cost limitation of $39.8 billion in
effect at that time; (7) in 1999, after considering the potential of all
the cost reduction plans, the Air Force estimated F-22 production cost
at $40.8 billion, and the Office of the Secretary of Defense estimated
production costs at $48.6 billion; (8) in comparing the cost estimates,
GAO found that: (a) although both estimates were based on the production
of 339 aircraft, the two estimating groups did not use the same
estimating methods, nor did they make the same estimating assumptions;
(b) the cost estimators did not make the same assumptions about which
cost reduction plans were already implemented or about the cost
reductions achievable from plans not yet implemented; (c) the Office of
the Secretary's estimate of F-22 total production cost exceeded the Air
Force's estimate by $7.8 billion, or 19 percent; (d) although Air Force
cost estimators projected a total of $40.8 billion in production costs,
the official Air Force cost position was $39.8 billion, the same as the
congressional cost limitation; and (e) DOD officials noted that it will
be some time before actual production cost trends emerge and before they
will know whether the Air Force or the Secretary of Defense estimate is
more realistic.

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

 REPORTNUM:  NSIAD-00-178
     TITLE:  Defense Acquisitions: Recent F-22 Production Cost
	     Estimates Exceeded Congressional Limitations
      DATE:  08/15/2000
   SUBJECT:  Air Force procurement
	     Department of Defense contractors
	     Defense cost control
	     Cost analysis
	     Financial management
	     Fighter aircraft
IDENTIFIER:  Joint Strike Fighter
	     F-22 Raptor Aircraft

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GAO/NSIAD-00-178

Appendix I: Objectives, Scope, and Methodology

20

Appendix II: Comments From the Department of Defense

22

Appendix III: GAO Contact and Staff Acknowledgments

28

Table 1: Summary of Contractors' Production Cost Reduction
Plans 7

Table 2: Production Cost Estimates for the F-22 14

National Security and
International Affairs Division

B-285360

August 15, 2000

The Honorable Christopher Shays
Chairman, Subcommittee on National Security,
Veterans Affairs, and International Relations
Committee on Government Reform
House of Representatives

Dear Mr. Chairman:

The Air Force F-22 Raptor is an air superiority aircraft being developed to
replace F-15 fighter aircraft. Lockheed Martin Corporation and Pratt &
Whitney Corporation are the contractors for the airframe and engine,
respectively. Development, which started in 1991, is scheduled to be
completed in August 2003. The Air Force plans to enter low-rate initial
production in December 2000.

Projections of higher production costs have been a source of concern for
several years. In 1996, because of potential cost increases, the Air Force
established a team--known as the Joint Estimating Team--to review the total
estimated cost of the F-22 program. The team concluded that the cost of
production could grow substantially from the amounts planned, but that cost
reduction initiatives could be implemented to offset that cost growth. The
Office of the Under Secretary of Defense for Acquisition, Technology, and
Logistics generally adopted the team's recommendations to change certain
aspects of the program as well as a plan to define and implement cost
reduction initiatives. F-22 production costs were also discussed in the
National Defense Authorization Act for Fiscal Year 1998 (P.L. 105-85,
Nov. 18, 1997). That act limited the total cost of F-22 production but did
not specify the total number of aircraft to be procured. The most recent
production costs estimates were completed by the Air Force and the Office of
the Secretary of Defense in late 1999. The Air Force's estimate of
$40.8 billion and the Office of the Secretary's estimate of $48.6 billion
both considered the potential impact of cost reduction initiatives known as
production cost reduction plans. The airframe and engine contractors had
identified about 1,240 of these plans--totaling $21 billion--in
participation with the Air Force's F-22 program office. The Under Secretary
of Defense for Acquisition, Technology, and Logistics reviews the status of
the F-22 program quarterly, including its cost and affordability.

You asked us to determine the impact these production cost reduction plans
are projected to have on the program's production cost estimate. This report
discusses (1) the status of cost reduction plans, including some plans not
yet implemented, and Air Force procedures for reporting on the plans and (2)
a comparison of the 1999 production cost estimates with the congressional
cost limitation.

To assess the status of cost reduction plans, we reviewed documentation from
the contractors and discussed the plans and the Air Force procedures for
reporting on such plans with contractor and Air Force officials. To evaluate
a sample of the cost reduction plans, we judgmentally selected 10 of the
plans that were projected to have high dollar values. The estimated
reductions from these plans were $6.8 billion. Our objectives, scope, and
methodology are described in appendix I.

About half of the $21.0 billion in cost reductions identified by the F-22
contractors and program office have not yet been implemented. However, the
Air Force may not be able to achieve the expected results from some of the
plans because they are beyond the Air Force's ability to control. We
reviewed 10 plans estimated to reduce costs by $6.8 billion. We found that
cost reductions for four of the plans, which accounted for $5.6 billion in
potential cost reductions, may not be achievable because they were dependent
on decisions or later determinations that must be made by the Office of the
Secretary of Defense or the Congress. For example, one cost reduction plan
estimated to reduce F-22 production costs by about
$1.5 billion requires congressional approval for multiyear procurement of
the F-22. The other six plans we reviewed, which were estimated to reduce
costs by $1.2 billion may be achievable. Although the Air Force and its
contractors have procedures to track the status of the production cost
reduction plans, and the Air Force has reported quarterly to the Under
Secretary of Defense concerning the total estimated cost of F-22 production,
the Air Force reports have not regularly included a summary of the status of
production cost reduction plans.

Both Office of the Secretary and Air Force cost estimators projected F-22
production costs that exceeded the congressional cost limitation of
$39.8 billion in effect at that time. In 1999, after considering the
potential of all the cost reduction plans, the Air Force estimated F-22
production costs at $40.8 billion, and the Office of the Secretary of
Defense estimated production costs at $48.6 billion. In comparing the cost
estimates, we found the following:

 Although both estimates were based on the production of 339 aircraft, the
two estimating groups did not use the same estimating methods, nor did they
make the same estimating assumptions.

 The cost estimators did not make the same assumptions about which cost
reduction plans were already implemented or about the cost reductions
achievable from plans not yet implemented. Accordingly, the cost estimators
differed in the amounts of plans they considered implemented or not yet
implemented. For example, for cost reduction plans that were not yet
implemented, the Air Force's estimating group allowed $10.2 billion (of the
total estimate of $10.8 billion) for potential future cost reductions, and
estimators from the Office of the Secretary allowed $6.1 billion.

 The Office of the Secretary's estimate of F-22 total production cost
exceeded the Air Force's estimate by $7.8 billion, or 19 percent. The
difference is attributable to the Office's higher estimates of the cost of
production ($3.7 billion) and lower estimates of the impact of production
cost reduction plans not yet implemented ($4.1 billion). The Office of the
Secretary cost estimates exceeded the congressional cost limitation by about
$ 8.8 billion. Putting the higher estimate in perspective, if the Office of
the Secretary estimate is correct and additional cost reduction plans are
not developed and implemented, we estimate that the Air Force would have to
buy about 85 fewer F-22 aircraft than now planned to stay within the
congressional cost limitation.

 Although Air Force cost estimators projected a total of $40.8 billion in
production costs, the official Air Force cost position was $39.8 billion,
the same as the congressional cost limitation. Air Force officials said that
the Air Force selected the $39.8 billion as its official cost estimate
because the detailed breakout of the estimate for fiscal years 2001 through
2005 was about the same as that budgeted for those years. They said the
difference between the estimate and the budget is primarily associated with
the estimate for years after 2005. Department of Defense officials noted
that it will be some time before actual production cost trends emerge and
before they will know whether the Air Force or Office of the Secretary of
Defense estimate is more realistic.

This report provides recommendations to the Secretary of Defense that focus
on (1) the need for regular Air Force reports that summarize the status of
cost reduction plans and (2) reconciling the requirement for F-22s with the
congressional cost limitation and assessing the implications of having to
procure fewer F-22s because of potentially higher costs. The Department of
Defense, in commenting on a draft of this report, did not agree with our
first recommendation because it believes that the Department has sufficient
mechanisms in place to monitor F-22 costs, and that additional direction
from the Secretary of Defense regarding reporting of that information was
not warranted. We believe that achievement of the cost reduction plans is so
critical to completing F-22 production within the cost limitation that
quarterly reports that include a summary of the status of the plans would be
important and useful. We modified our first recommendation to more
specifically state the type of information the Department should review each
quarter. The Department partially agreed with our second recommendation that
requirements for F-22s be reconciled with the congressional cost limitation,
stating that an upcoming Quadrennial Defense Review will accomplish such a
reconciliation, but that it is now premature to make a reconciliation. We
believe the Department's upcoming review will be responsive to our
recommendation.

Defense Department Action

About half of the $21.0 billion in cost reductions identified by the F-22
contractors and program office have not yet been implemented. These proposed
cost reduction plans affect production technology, manufacturing techniques,
and acquisition practices. We reviewed plans estimated to reduce future
costs by $6.8 billion. We found that cost reductions of $5.6 billion of the
$6.8 billion were dependent on decisions or future determinations by the
Office of the Secretary of Defense or the Congress; consequently, the Air
Force may not realize all of the cost reductions it anticipates. We did not
question the validity of plans estimated to reduce costs by $1.2 billion.
The Air Force and the airframe and engine contractors have procedures to
track the status of each cost reduction plan, but Air Force quarterly
reports to the Under Secretary of Defense for Acquisition, Technology, and
Logistics have not always included status information on the plans.

In response to recommendations of the Joint Estimating Team, contractors and
the F-22 program office proposed cost reduction plans to use enhanced
production technology, improved manufacturing techniques, and revised
acquisition principles to buy materials. These plans show changes to
business design, processes, and practices to realize cost reductions. The
Air Force and contractors' criteria for determining if a cost reduction plan
is implemented include whether

 the contractor has submitted a firm-fixed price proposal that recognizes
the impact of the cost reduction,

 the impact of the reduction has been reflected in a current contract
price--either with the prime contractor (Lockheed Martin) or a supplier to
the prime contractor,

 the contractor has reduced the standard number of hours allocated to a
specific task,

 the reduction has been negotiated in a forward pricing rate agreement,1 or

 the reduction has been negotiated with a subcontractor or vendor.

Plans are categorized as "to be implemented" if none of the criteria are
met.

The contractors estimated the value of the F-22 production cost reduction
plans at about $21.0 billion. The cost reductions and the
contractor-reported status of plans are described in table 1. The table is a
summary of the inventory of cost reduction plans as defined by the
contractors. However, it does not show a relationship of the total cost
reductions to the total estimated cost of F-22 production and is not readily
reconciled with total production cost estimates made by the Air Force and
the Office of the Secretary. Cost estimators of the Air Force and Office of
the Secretary used these plans in making cost estimates for F-22 production;
however, they did not always agree on what plans were implemented.

    Then-year dollars in billions

         Reason for reduction          Implemented        To be      Total
                                                      implemented
 Improve manufacturing processes and
 incorporate new technology            $2.7         $5.2             $7.9
 Improve efficiency and reduce
 supplier costs                        2.0          1.7              3.7
 Resolve obsolescence and diminishing
 sources issues                        1.3          0.3              1.6
 Improve material procurement
 strategies                            0.7          0.3              1.0
 Apply performance-based contracting
 practices                             0.5          0                0.5
 Defer or avoid government investment
 in depot maintenance capability       3.0          0.3              3.3
 Award production contracts for
 multiple years                        0            1.8              1.8
 Manufacture Joint Strike Fighter and
 F-22 components in the same plants    0            1.2              1.2
 Total                                 $10.2        $10.8            $21.0

Note: The F-22 program office provided input to the contractors' plans.

Source: F-22 program office data.

Allocated equally over a planned procurement of 339 F-22 aircraft, a
$21-billion cost reduction equates to about $62 million per F-22 to be
produced. This amount of reduction per F-22, if achievable, is significant.
For example, F-15E aircraft, derivatives of the F-15C that the F-22 is
planned to replace, were procured in fiscal years 1996-1998 at an average
unit cost of about $46 million. Although that procurement occurred several
years ago and the amounts are not fully comparable to the costs that might
be incurred if they were to be procured today, the comparison shows the
significance of the planned cost reductions.

Achievement of cost reductions of at least $5.6 billion will depend on
decisions and future determinations of the Office of the Secretary of
Defense and/or the Congress. Thus, the Air Force cannot control
implementation of those cost reduction plans. The plans involve cost
reductions that would result from deferring establishment of a depot-level
maintenance capability for the F-22, a favorable impact on F-22 costs if the
Congress approves acquisition of the Joint Strike Fighter, approval of
multiyear procurement of the F-22, and use of materials from the National
Defense Stockpile Center for production of F-22s.

 One plan estimates a cost reduction of about $2.6 billion and proposes
that all F-22 depot-level maintenance be performed by the contractor until
at least 2008. Under this proposal, the Air Force would not have to develop
a capability to perform depot-level maintenance during production and would
thus save production costs. Before this plan can be implemented, the
Secretary of the Air Force must determine it conforms to 10 U.S.C. 2464 and
10 U.S.C. 2466, both of which affect the Air Force's ability to contract
with the private sector for depot-level maintenance services. Section 2464
requires the Secretary of Defense to identify and maintain a core logistics
capability that is owned and operated by the government. A core capability
is the equipment, personnel, and services needed to repair or maintain
weapon systems or other military equipment to ensure an effective and timely
response to mobilization, national defense contingencies, or other
emergencies. Section 2466 governs the allocation of depot-level maintenance
workload between the public and private sectors and stipulates that not more
than 50 percent of the available funds for depot-level maintenance in a
fiscal year can be used for contracting with the private sector. This
percentage applies to each military department.

A decision to contract for depot-level maintenance will need to consider the
requirements of these statutes. Under section 2464, it may not be possible
to contract for all depot-level maintenance services if there is the need to
maintain a core logistics capability for the F-22 within the Air Force.
Concerning section 2466, as of March 2000, preliminary data indicate that
the Air Force would be close to the
50 percent ceiling through 2004. In addition, Air Force long-term contracts
for depot maintenance are expected to increase in value and the Air Force is
implementing initiatives to contract for depot maintenance on 64 new or
modified systems.2 As a result of these statutory provisions, the potential
exists that this proposed cost reduction plan might not be implemented.

The plan may only defer costs until after completion of production. The plan
states that its purpose is to achieve a cost reduction by delaying the
establishment of government depot capabilities until the system matures,
which is defined as accumulating 100,000 flying hours in fiscal year 2008.
It also states that the contractor support concept will be implemented to
reduce the required depot investment and that most of that expense to
develop an Air Force capability will be deferred until about 2012. The last
buy of F-22 production aircraft is scheduled for fiscal year 2011. The Air
Force would decide at that time whether to fund the costs of an Air Force
depot-maintenance capability with procurement or operation and maintenance
appropriations. If these costs are deferred until after the F-22 production
program is complete, they will no longer count against the congressional
cost limitation.

 Another cost reduction plan that is dependent on decisions by the Congress
and the Office of the Secretary estimates that F-22 costs will be reduced by
about $1.05 billion through lower overhead rates and increased buying power,
since many of the same contractors and subcontractors that are building the
F-22 will also build the Joint Strike Fighter. The Congress and the Office
of the Secretary control the schedule and quantity of the Joint Strike
Fighter aircraft. Therefore, this cost reduction is dependent on decisions
being made on a program external to the F-22. If the Joint Strike Fighter
program is not approved or is delayed, then the F-22 production program will
not achieve the projected cost reductions.

 Another cost reduction plan requires the Congress to approve multiyear
procurement of the F-22, which the airframe contractor estimates will reduce
the cost of F-22 production by about $1.5 billion. The contractor proposes
that F-22 production be contracted for 5 years in advance, beginning in
2004. According to the plan, because of cost reductions available through
long-term commitments such as a 5-year contract, the subcontractors and the
contractor would accept lower prices for the aircraft being procured. Under
10 U.S.C. 2306b, a multiyear contract must meet specific criteria and be
approved by the Congress before any reductions from this type of cost
reduction plan can be achieved. The criteria that must be met include the
following: (1) the multiyear contract must result in substantial savings
compared to awarding annual contracts; (2) the item being bought must have a
stable design and not have excessive technical risks; and (3) the estimated
cost of the system and the estimated cost avoidance from the multiyear
procurement are realistic. The Air Force plans to award a multiyear contract
for fiscal year 2004 and will need congressional approval for a multiyear
contract in fiscal year 2003 to support advance procurement funding.3 Since
the F-22 development program is not scheduled for completion until August
2003, the potential exists that the F-22 program will not meet the multiyear
procurement criteria by 2003.

 Another cost reduction plan of uncertain status involves obtaining
titanium sponge from the Defense Logistics Agency's National Defense
Stockpile Center at no cost and providing it to the manufacturer instead of
paying the manufacturer for the raw material. This plan is estimated to
ultimately reduce the production cost of the F-22 by $458 million. It
assumes that the cost of titanium sponge would be $3.00 per pound if
purchased by the contractor and that about 30 million pounds would be
needed. It further assumes that the funds not expended for titanium sponge,
about $90 million, would be used to invest in additional cost reduction
plans, and thus reduce the total cost by $458 million. Although the plan
assumes that $4.00 to $5.00 in cost reductions will be achieved for each
dollar invested, the contractor and the Air Force have not identified the
specific projects in which the funds would be invested. This plan was not
used to reduce estimated production costs by either cost estimators from the
Office of the Secretary or the Air Force because of the uncertainty of
congressional approval.

Although this plan might reduce F-22 production costs, the cost to the
government would not be reduced by that amount. If the National Defense
Stockpile Center does not give titanium sponge to the F-22 program, it can
sell it to the private sector and create income for its own fund. In fiscal
year 1999, the Center's sales of titanium sponge averaged $1.94 per pound.
Since the Air Force will need about
30 million pounds of titanium sponge for F-22 production, the lost revenue
to the Center could be about $60 million ($1.94 per pound times 30 million
pounds). Therefore, what may be a significant cost reduction for the F-22
program could result in some lost revenue for the Defense Logistics Agency.

The Air Force and airframe and engine contractors have established
procedures to track the status of the production cost reduction plans. Both
contractors have developed an information system that records the identified
cost reduction plans, the expected cost reduction from each of them, and
their implementation status. The systems and the procedures were established
to generate, evaluate, and implement cost reduction plans as well as to
monitor them.

Air Force and airframe contractor representatives meet quarterly to review
the status of cost reduction plans, while the Air Force and engine
contractor representatives meet weekly to review the status of proposed cost
reduction actions. The Air Force monitors the status of the cost reduction
plans in their information system using the integrated product team
structure. Through this structure, Air Force and contractor personnel serve
on teams to manage various functions in aircraft development and production.
For the F-22, the teams represent areas such as air vehicle, engine, and
avionics. Among their other responsibilities, these teams also generate,
evaluate, implement, and monitor the status of cost reduction plans.

The Under Secretary of Defense for Acquisition, Technology, and Logistics
requested the Air Force to report quarterly on the status of F-22 costs. The
Air Force reported quarterly, detailing many factors affecting F-22 costs.
However, even though achieving the planned cost reductions is critical for
completing F-22 production within the congressional limitation, Air Force
quarterly reports to the Under Secretary have not included status
information on cost reduction plans since June 1999. The data are available
to make detailed or summary reports. For example, the Air Force is able to
categorize plans as implemented or yet to be implemented and to perform
specific searches of the contractor's information system.

Congressional Cost Limitation

The Air Force and the Office of the Secretary cost estimating groups both
based their estimates on production of 339 aircraft, but they did not use
the same methods to estimate the cost of F-22 production, nor did they use
the same assumptions about which cost reduction plans were implemented or
not yet implemented. After considering the potential cost reductions, both
estimates ($40.8 billion by the Air Force, and $48.6 billion by the Office
of the Secretary) exceeded the congressional cost limitation of $39.8
billion that was in effect at the time the estimates were prepared. However,
the Air Force used the cost limitation as its cost position.

Estimates

The two groups used different estimating methods, such as different
assumptions regarding (1) production rates, (2) the impact of breaks in
production, and (3) which historical data to use. These differences caused
the Office of the Secretary estimate to be higher than the Air Force
estimate for the following reasons:

 Air Force cost estimators assumed that the eight production representative
test vehicles approved for purchase in fiscal years 1999 and 2000 would
generally be produced as two lots of four aircraft each, based on the
contractors' delivery schedules. Office of the Secretary estimators treated
the eight aircraft as a single lot of eight aircraft for estimating
purposes.

 Office of the Secretary and Air Force cost estimators disagreed on whether
a break in production on four avionics items occurred. Air Force estimators
assumed there was a break in production of certain items. They assumed that
after a break in production, the higher rate of cost improvement normally
experienced in manufacturing early units would again be experienced after a
break in production. Office of the Secretary estimators did not assume there
was a break in production so, according to their analysis, the higher rate
of cost improvement would not occur on the later units.

 The Air Force and the Office of the Secretary used different historical
cost data to estimate the cost of the F-22 avionics. For example, the Air
Force used experience on F/A-18 avionics and the Office of the Secretary
used experience on multiple systems.

The Air Force estimated that costs would be reduced by $10.2 billion as
additional cost reduction plans are implemented, while the Office of the
Secretary estimated they would achieve $6.1 billion. Among the reasons for
the different amounts allowed for additional reductions are that the
estimators used different baselines from which to calculate a reduction,
different estimated returns on funds invested to reduce costs, and different
assumptions on the percent of reductions likely to occur by eliminating
nonproductive steps. As a result of the differences, the Office of the
Secretary allowed less for cost reductions than the Air Force. Examples of
these differences are as follows:

 Office of the Secretary and Air Force estimators agreed on the percentage
to reduce the estimated cost as a result of awarding contracts for 5 years
in advance (that is, multiyear procurement), but since their baseline
estimates against which the percentage was applied were different, the
amount of the expected reduction was different.

 Some cost reduction actions involve investing funds to bring about lower
costs; that is, they involve investing in projects to improve manufacturing
processes or incorporate new technology. Both the Air Force and the Office
of the Secretary used C-17 cargo aircraft historical data to estimate the
return on the dollars invested. Because of different methodologies to assess
the cost reductions applicable to the invested dollars, however, the Air
Force and the Office of the Secretary differed on the cost reductions
applicable to the plans. The Air Force assumed that the return on an
invested dollar would be $11.00, $9.00, or $6.00 depending on the numbers of
aircraft that would be affected by the improved process or technology. The
Office of the Secretary's analysis calculated the cost reduction based on
the amount of dollars that remained to be spent on the program. The Office
of the Secretary's analysis resulted in a return rate of $4.00 for each
dollar invested.

 Other cost reductions result from improving contractor efficiencies and
reducing supplier costs. The Air Force used reductions from 9 percent to
13.5 percent depending on the planned work location. The Office of the
Secretary used 5 percent as a general reduction percentage for all work
locations.

According to Air Force officials, there were some differences because the
two estimating groups used different assumptions about which plans were
already implemented. For example, the Office of the Secretary considered
about $1 billion in reductions associated with the Joint Strike Fighter and
radar production as implemented. Because the Joint Strike Fighter has not
been approved for production, the Air Force did not consider that cost
reduction to have been implemented.

As shown in table 2, the Air Force estimate was $40.8 billion after allowing
for $10.2 billion of additional expected cost reductions that have not been
implemented. The Office of the Secretary estimate was $48.6 billion after
allowing $6.1 billion for additional cost reductions that have not been
implemented. Both of these estimates exceeded the cost limitation of
$39.8 billion in effect at that time.4

 Then-year dollars in
 billions

 Description                  Office of the       Air Force     Difference
                              Secretary estimate  estimate
 Cost estimate after
 considering cost reductions  $54.7               $51.0         $3.7
 Allowance for cost
 reductions that have not     (6.1)               (10.2)        4.1
 been implemented
 Net cost estimate            $48.6               $40.8         $7.8

Note: Parentheses indicate negative numbers.

Source: Office of the Secretary and Air Force data.

Consequently, as a result of the differences in estimating techniques and
allowances for the cost reduction plans, the Office of the Secretary
estimated the cost of the F-22 production program at about $7.8 billion
(19 percent) higher than the Air Force. Officials from the Office of the
Secretary said they consider the 19 percent difference significant; however,
they said that it will be some time before actual production cost trends
emerge and before they will know whether the Air Force or Office of the
Secretary of Defense estimate is more realistic. We agree that the
difference is significant. If the Office of the Secretary estimate is
correct and additional cost reduction plans are not developed and
implemented, we calculated5 that the Air Force would have to buy about 85
fewer aircraft than are now planned to stay within the congressional cost
limitation of $39.8 billion. A cost estimator of the Office of the Secretary
said the number of aircraft that would be unaffordable would be between 75
and 90, depending in part on decisions about the production rate that would
apply.

Although the Air Force cost estimate was $40.8 billion, senior Air Force
officials set the official cost position at the congressional cost
limitation of $39.8 billion. According to Air Force officials, the Air Force
would normally select an estimated cost that would provide an equal chance
that the estimate was either higher or lower than the actual cost of the
program. For the F-22 production cost estimate, that amount was $40.8
billion, which included about $1.2 billion for risk uncertainties. The Air
Force, however, used $39.8 billion (the congressional cost limitation
amount) as its cost position, which, according to Air Force calculations,
was twice as likely to be below the actual cost than above it. The Air Force
said it selected the $39.8 billion as its cost position because the detailed
breakout of the estimate by fiscal year was equal to or less than what the
Air Force budgeted for fiscal years 2001 through 2005, and the estimate for
the years beyond 2005 was more uncertain; that is, the further in the future
the estimate is for, the less likely it is to be accurate. Therefore, rather
than select an estimate that exceeds the cost limitation, the Air Force
selected an estimate equal to the cost limitation.

Our review of the airframe contractor's most significant cost reduction
plans indicates that the Air Force may not be able to achieve the expected
results because they are beyond the Air Force's ability to control. This is
because some planned cost reductions require decisions or later
determinations by the Office of the Secretary or the Congress.

While the status of individual cost reductions is tracked by contractors and
the Air Force's program office, the Air Force has not regularly reported to
the Under Secretary of Defense on the status of these plans so their overall
progress and their impact on the estimated cost of F-22 production can be
assessed. We believe achievement of the estimated cost reductions embodied
in the plans is so critical to completing F-22 production within the
congressional cost limitation that quarterly reporting of summary
information would be important and useful. Regular reporting on the status
would provide a picture of how many cost reduction plans are being
considered at that point in time, how many are implemented, their potential
value, how many have resulted in actual cost reductions, and what those cost
reductions are. Over time, a trend of progress in moving from plans to
actual cost reductions should emerge and successful initiatives--beneficial
"lessons learned" to other acquisition programs--would be highlighted.

After incorporating potential cost reductions, both the Office of the
Secretary and the Air Force produced cost estimates for the F-22 production
program that exceeded the congressionally mandated cost limitation in effect
at the time the estimates were made. The Air Force estimate exceeded the
limitation by about $1.0 billion, while the Office of the Secretary estimate
exceeded the limitation by $8.8 billion. If the Office of the Secretary
estimate is correct and additional cost reduction plans are not developed
and implemented, the Air Force would have to buy about 85 fewer aircraft
than now planned to stay within the congressional cost limitation. In
addition, based on the uncertainties associated with some of the plans, the
Air Force and the Office of the Secretary estimates could rise even more
above the congressional cost limitation if the decisions by the Congress and
the Office of the Secretary do not coincide with the decisions assumed in
the cost reduction plans.

To enhance the visibility of the Air Force's plans to reduce production
costs, we recommend that the Secretary of Defense direct the Air Force to
report to the Under Secretary of Defense for Acquisition, Technology, and
Logistics on the status of the production cost reduction plans each quarter.
For each contractor, this report should include, as a minimum, summary
information such as the total number of cost reduction plans identified, the
number implemented, the total estimated reductions, and the reductions
realized to date. The report should also highlight major changes, such as
additions or deletions from the list of plans, from the previous report.

Since both Office of the Secretary and the Air Force cost estimators
projected that the F-22 production costs would exceed the congressionally
imposed cost limitation and the possibility exists that these cost estimates
could increase further if some cost reductions do not materialize, we
further recommend that the Secretary of Defense reconcile the number of
F-22s that need to be procured with the congressional cost limitation and
report to the Congress on the implications of procuring fewer F-22s because
of potentially higher costs.

In written comments on a draft of this report, the Department of Defense
disagreed with one recommendation and partially agreed with the other
recommendation. The Department noted that the report provides a credible
description of the historical cost estimating differences between the Office
of the Secretary and the Air Force. However, the Department said that the
report did not recognize the degree of detail to which the Office of the
Secretary of Defense is already tracking the cost status of the F-22. With
regard to our first recommendation that the Air Force report on the status
of production cost reduction plans, the Department indicated that it has
continually emphasized cost control on the F-22 program and since the
imposition of the congressional cost limitation, has required the Air Force
to provide quarterly briefings on production costs. The Department indicated
that the quarterly reviews are structured to track the progress of key cost
reduction plans when significant new data is available. The Department
stated that it considers reporting on each production cost reduction plan
unnecessary and did not believe additional direction from the Secretary of
Defense regarding reporting of cost reduction plans was warranted. As a
result of the Department's comments, we modified the recommendation in the
final report to make it clear that the information that should be reported
is summary information and not detailed information about each cost
reduction plan. We recommend that the Air Force's quarterly report, which is
already required to be submitted to the Under Secretary of Defense, include
information such as the total number of cost reduction plans identified, the
number implemented, the total estimated reductions, and the reductions
realized to date. We also indicate that the information provided should
highlight major changes, such as additions and deletions from the past list
of plans, from the previous report. We believe that achievement of the cost
reduction plans is so critical to completing F-22 production within the cost
limitation that quarterly reports that include a summary of the status of
the plans would be important and useful.

The Department partially agreed with our recommendation to reconcile the
number of F-22s that need to be procured within the congressional cost
limitation and report to the Congress on the implications of procuring fewer
F-22s. The Department stated that it was premature for the Secretary of
Defense to reconcile the number of F-22s with the congressional cost
limitation. However, the Department also noted that the Quadrennial Defense
Review planned for next year will examine the force structure requirements
to execute national security policy objectives and will address the quantity
of F-22s that can be procured within the cost limitation, and the results
will be made available to the Congress. We believe the Department's upcoming
review will be responsive to our recommendation.

The Department's comments are reproduced in appendix II. The Department also
suggested additional technical changes, which we incorporated in the report
where appropriate.

We are sending copies of this report to Senator John W. Warner, Chairman,
and Senator Carl Levin, Ranking Minority Member, Senate Committee on Armed
Services; Senator Ted Stevens, Chairman, and Senator Daniel K. Inouye,
Ranking Minority Member, Subcommittee on Defense, Senate Committee on
Appropriations; Representative Floyd D. Spence, Chairman, and Representative
Ike Skelton, Ranking Minority Member, House Committee on Armed Services;
Representative Jerry Lewis, Chairman, and Representative John P. Murtha,
Ranking Minority Member, Subcommittee on Defense, House Committee on
Appropriations; and Representative Rod Blagojevich, Ranking Minority Member,
Subcommittee on National Security, Veterans Affairs, and International
Relations, House Committee on Government Reform. We are also sending copies
of this report to the Honorable William Cohen, Secretary of Defense; the
Honorable F. Whitten Peters, Secretary of the Air Force; and the Honorable
Jacob Lew, Director, Office of Management and Budget. Copies will also be
made available to others on request.

Please contact me at (202) 512-4841 if you or your staff have any questions
concerning this report. Additional points of contact and key contributors to
this report are listed in appendix III.

Sincerely yours,

Allen Li
Associate Director
Defense Acquisitions Issues

Objectives, Scope, and Methodology

Our overall objective was to determine the impact production cost reduction
plans are projected to have on F-22 production cost estimates. Specifically,
we (1) reviewed the status of cost reduction plans, evaluated some plans,
and reviewed the Air Force reporting on the status of the plans and (2)
compared the 1999 production cost estimates by the Office of the Secretary
of Defense and the Air Force with the congressional cost limitation.

To assess the status of cost reduction plans, we reviewed the specific
contractor cost reduction plans to determine the basis for the reductions
expected to be achieved and whether the reduction was implemented or yet to
be implemented. We reviewed the documentation from the contractors and
discussed the plans and the Air Force procedures for reporting on such plans
with contractor and Air Force officials. We also reviewed federal
acquisition regulations and relevant laws. To evaluate a sample of the cost
reduction plans, we judgmentally selected 10 of the plans that were
projected to have high dollar values. The estimated reductions from these
plans were $6.8 billion.

To compare the recent F-22 production cost estimates of the Air Force and
the Office of the Secretary of Defense with the congressional cost
limitation and to determine the amount of cost reductions considered in
those estimates, we reviewed the Joint Estimating Team's report and various
Air Force briefings. We discussed the estimates with officials in the Office
of the Secretary of Defense and the Air Force's F-22 program office to
determine why they differed. We compared the two estimates, including the
baseline estimate, the estimated reductions from reduction plans, and the
net estimates. We obtained a description of the reasons for the variances
between the two estimates. We also discussed the estimates and the cost
limitation with Air Force and Office of the Secretary of Defense officials.

We determined what the congressional cost limitation was at the time these
cost estimating groups prepared their estimates and compared it with the two
estimates.

To calculate the number of F-22s that could not be procured within the cost
limitation if the higher cost estimate of the Office of the Secretary were
realistic, we considered that the cost limitation was 18.2 percent lower
than the cost estimate by the Office of the Secretary, and that the later
aircraft to be procured would generally be those with the lowest cost. We
determined the number of aircraft, beginning with those planned to be
procured last, that could not be procured if funding were 18.2 percent
short.

In performing our work, we obtained information and interviewed officials
from the Cost Analysis Improvement Group, Office of the Secretary of
Defense, Washington, D.C.; the Air Force Cost Analysis Agency, Washington,
D.C.; the F-22 System Program Office, Wright-Patterson Air Force Base, Ohio;
the Defense National Stockpile Center, Fort Belvoir, Virginia; Lockheed
Martin Aeronautical Systems, Marietta, Georgia; Lockheed Martin Tactical
Aircraft Systems, Fort Worth, Texas; and RAND Corporation, Washington, D.C.

We requested comments on a draft of this report from the Department of
Defense. We obtained comments from the Director, Strategic and Tactical
Systems, Office of the Under Secretary of Defense for Acquisition,
Technology, and Logistics. Those comments are reproduced in appendix II. The
Director also suggested additional technical changes, which we incorporated
in this report where appropriate.

We performed our work from November 1999 through June 2000 in accordance
with general accepted government auditing standards.

Comments From the Department of Defense

The following are GAO comments on the Department of Defense's letter dated
July 17, 2000.

1. We included additional information in the report about the cost data
available to the Under Secretary of Defense to assess the status of the F-22
program.

2. An objective of this report was to compare the 1999 Air Force and Office
of the Secretary cost estimates with the congressional cost limitation. Our
objectives did not include an assessment of the validity of the factors used
by the Air Force or Office of the Secretary to arrive at their cost
estimates. Our report did not intend to determine whether the Air Force or
Office of the Secretary used the more appropriate factors.

3. We have included in the report as appropriate the Department's statement
that it will be some time before they know which cost estimate is more
realistic.

4. We revised the report to include additional information regarding the
data presented to the Under Secretary during the quarterly reviews. We note
that the Air Force last provided summary information to the Under Secretary
of Defense regarding production cost reduction plan data during the
quarterly review in June 1999. According to the Air Force, similar
information was provided as backup, but apparently not briefed, in September
1999. Since successful implementation of production cost reduction plans is
critical to the Air Force's ability to keep the cost of F-22 production
within the congressional limitation, and the summary data such as we
recommended have not been provided on a regular basis to the Under
Secretary, we continue to recommend that the data be reported quarterly.

5. We recommended in our draft report that the Secretary of Defense
reconcile the number of F-22s that need to be procured within the
congressional cost limitation and report to the Congress on the implications
of procuring fewer F-22s because of potentially higher costs. The Department
of Defense said it was premature for the Secretary of Defense to reconcile
the number of F-22s that need to be procured. The Department, however,
partially agreed with this recommendation and stated that it plans to do a
review next year to evaluate force structure needs, which will include
addressing the affordability of the F-22. The review will evaluate cost
trends on the
F-22 and should provide a better understanding of the number of F-22s that
can be bought within the cost limitation. The planned review by the Office
of the Secretary of Defense should be responsive to our recommendation.

GAO Contact and Staff Acknowledgments

Robert D. Murphy (937) 258-7904

In addition to the name above, Mark Abraham, Leonard L. Benson, Christopher
T. Brannon, Edward R. Browning, and John Van Schaik made significant
contributions to this report.

(707459)

Table 1: Summary of Contractors' Production Cost Reduction
Plans 7

Table 2: Production Cost Estimates for the F-22 14
  

1. A written agreement negotiated between a contractor and the government to
make certain rates available during a specified period for use in pricing
contracts or modifications. These rates cover such things as labor and
indirect costs.

2. Depot Maintenance: Air Force Faces Challenges in Managing to 50-50
Ceiling
(GAO/T-NSIAD-00-112 , Mar. 3, 2000).

3. Advance procurement funding is often requested by the Air Force to
initiate procurement of the long lead-time materials and effort that are
necessary to ensure that the delivery schedule can be met for aircraft that
are to be procured in the next fiscal year.

4. In late 1999, the Air Force adjusted the cost limitation to $37.6 billion
and revised the number of aircraft to be procured to 333 because 6 aircraft
that were part of the production program will be procured as part of the
development program and thus are now subject to a separate cost limitation
for F-22 development.

5. The calculation is described under the caption Objectives, Scope, and
Methodology.
*** End of document. ***