Weapons Production: Impacts of Production Rate Changes on Aircraft Unit Costs

Published by the Government Accountability Office on 1990-12-18.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                      United   States   General   Accounting   Office

                      Report to Congressional Requesters

    December   1990
                      Impacts of Production
                      Rate Changes on
                      Aircraft Unit Costs

                   United States
                   General Accounting Office
                   Washington, D.C. 20548

                   National Security and
                   International Affairs Division


                   December     18,199O

                   The Honorable Robert C. Byrd
                   Chairman, Committee on Appropriations
                   United States Senate

                   The Honorable Daniel K. Inouye
                   Chairman, Subcommittee on Defense
                   Committee on Appropriations
                   I inited States Senatcl

                   As you requested. we have reviewed the sensitivity of estimated pro-
                   curement costs of selected military aircraft programs to reductions in
                   numbers of aircraft purchased per year.’

                   The growing need t,o decrease the federal budget deficit and a dimin-
Background         ishing threat from the Soviet lJnion and the virtual collapse of the
                   Warsaw Pact as a military alliance make the defense budget a prime
                   candidate for budget cuts. The Department of Defense’s (DOD) efforts to
                   identify where these cuts can be made have caused it to examine
                   weapon systems’ quantity requirements and procurement rates. For
                   example, a recent ma,jor aircraft review by the Secretary of Defense pro-
                   posed significant reductions in the procurement of the C-17, B-Z, and
                   A-l 2 aircraft.

                   The Congress has been concerned that D@D has historically planned for
                   higher production rates of its weapon systems and lower unit costs than
                   are actually realized. When funding limitations reduce the planned
                   annual procurement rate, unit costs generally increase. The Congress
                   has called for an end to this optimistic planning and is evaluating the
                   appropriate level of procurement for several weapon systems.

                    Aircraft procurement unit costs generally increase as their procurement
Results in Brief    rates decrease. However. some mature Air Force and Navy procurement
                    programs, including those for the KC-135R engine modification, F/A-18,
                    F-l 6. AV-SB, and F- 15. would not show as significant a unit cost increase
                    as other aircraft programs if their procurement rates were decreased.
                    For example, using Navy assumptions, a 25 percent decrease in the

                    ‘The number of aircraft systrms the Air Forcr and Navy are authorized to buy per year is sometimes
                    referrpd tn as the procuremt~nt rate

                    Page 1                                                     GAO/NSIAD91-12 Aircraft Unit Costs

                   The data in the following tables show the effect of only short-term and
                   unanticipated production rate changes. IJnit cost increases can be sub-
                   stantially moderated by the extent contractors can plan for production
                   rate changes and are willing to make reductions in overhead and other
                   fixed costs.

                   Initiatives such as multiyear procurements can assist the contractors in
                   planning for such reductions. For example, when the AV-8B was reduced
                   from a 56-per-year annual procurement to a 23-per-year multiyear pro-
                   curement, the unit cost increased 12 percent. Representatives of one
                   major aircraft manufacturer stated that the earlier they know of a rate
                   change the less sensitive the unit costs will be to the changes.

                   In some cases production rate changes in one program can impact the
                   unit cost of other programs. For example, the F-15 contractor’s facility
                   currently houses two other aircraft production programs (the F/A-18
                   and the AV-8B).

KC-135R Aircraft   The KC-135R’s unit cost is relatively insensitive to the rate at which the
                   engines are procured and the modification kits are installed. The Air
                   Force is modifying KC-135A strategic tanker aircraft to replace the
                   existing engines, strengthen the main landing gear, and make other
                   system improvements. The modified aircraft, designated KC-135R, was
                   first delivered in .June 1982. The design of the modification is stable,
                   having been in production for 8 years. The Air Force procured 29 air-
                   craft modifications with fiscal year 1990 funding.

                   The cost of engines to be installed during the modification efforts repre-
                   sents over 60 percent of the annual component cost of the program.
                   Because the engine is primarily produced for commercial use and,
                   according to the contractor’s representative, a clause in the Air Force
                   contract provides for varying quantities within certain limits, changes in
                   the Air Force’s procurement rates do not significantly affect the unit
                   cost of that engine.

                   The prime contractor has several other manufacturing and modification
                   programs in its business base. If the annual quantities of the KC-135R
                   are reduced, the contractor can move some direct and sustaining labor to

                    Page 3                                      GAO/NSIADSl-12 Aircraft Unit Costs

                                       decreased by 25 percent (from 72 to 54 aircraft). If the procurement
                                       rate is halved, however, there will be a 24 percent increase in unit cost.

Table 2: Sensitivity of Unit Cost to
F/A-18 Quantities Procured             Dollars III millions
(Fiscal Year 1990)
                                       Proc<rerkt&te          decrease/    Quantity                    Unit cost percent
                                       increase                           procured      Unit cost                change
                                       50% decrease                               36        $31 9                    t24
                                       25% decrease                              54          27 8                      53
                                       Est~r&ed~program                          72    -~    25 7                        0
                                       25% bncrease                              90          24 0                      -7
                                       50% mcrease                              108          22 9                    -Ii

F-l 6 Aircraft                         The F-16 aircraft’s unit cost is also relatively insensitive to procurement
                                       rate changes when the rate is reduced by 25 percent. It has been in pro-
                                       duction since 1977 The Air Force has acquired the F-16 under multiyear
                                       contracts since 1982 and is currently negotiating a multiyear contract to
                                       fill fiscal year 1990 through 1993 procurement requirements. The F-16
                                       has had many configuration changes that have increased the cost of the
                                       aircraft. According to the prime contractor, multiyear contracting has
                                       helped offset the magnitude of the potential cost increases by stabilizing
                                       the production line and by permitting t.he contractor to obtain volume
                                       discounts for some parts and materials.

                                       The contractor also has sold a relatively large number of F-16s to for-
                                       eign customers for many years. It has sold over 100 F-16 aircraft each to
                                       Egypt, Israel, Turkey, and the Netherlands. In fiscal year 1990, the Air
                                       Force reduced its procurement request to 108 per year, expecting that
                                       foreign sales would keep production at a minimum efficient rate of
                                       120 aircraft per year.

                                       Table 3 shows the Air Force’s projected F-16 procurement unit cost sen-
                                       sitivity at varying rates. It projects an increase of about 12 percent in
                                       procurement unit costs if the procurement rate is decreased by 25 per-
                                       cent (from 120 to 90 aircraft). It also projects that if the number of air-
                                       craft bought is halved, there would be a 34 percent increase in unit cost.

                                        Page 5                                         GAO/NSIADSl-12 Aircraft Unit Costs

Table 4: AV-8B Procurement      Unit Costs
(III Fiscal Year 1989 Prices)                Dollars in mullions
                                                                                U.S. Navy-           Foreign
                                             Fiscal year                         quantity            quantity      Total units       Unit price
                                             1986                                       46                  24              70            $122
                                             I 987                                      42                  24              86             110
                                             i 988189                                   32                  24              56             11 1
                                             1989/MYPd                                  16                    7             23              12.4
                                             199O/MYP                                    24                  0               24              124
                                             1991lMYP                                    24                  0               24              124
                                             aMYP IS the acronym for multlyear procurement

F-l 5 Aircraft                               The Air Force’s F- 15 is also relatively insensitive to procurement rate
                                             changes when the number of aircraft to be bought is reduced by 25 per-
                                             cent. It has been in production since the early 1970s and has been pro-
                                             duced in five major models. The final procurement of the current
                                             version, the F-lSE, is scheduled for fiscal year 1991. The history of
                                             F- 15 production shows how labor and overhead can be minimized when
                                             production rates are reduced.

                                             According to the prime contractor, it could absorb the impact of modest
                                             reductions in the F-15 procurement rate by moving some of its direct
                                             factory labor to other production lines in the facility where additional
                                             personnel are needed to fill attrition or program expansion vacancies. It
                                             could also move some of its sustaining engineers to fill vacancies in
                                             other in-house programs.

                                              In fiscal year 1989, the F-15 procurement quantity was reduced from 42
                                              to 36 aircraft per year. The negotiated unit price did not increase signifi-
                                              cantly (less than 4 percent). Total program funding (in 1989 dollars)
                                              was reduced by about $38 million.

                                              Table 5 shows the Air Force’s projected unit procurement cost sensi-
                                              tivity for varying annual quantities. It projects a recurring flyaway unit,
                                              cost increase of about 10 percent when the procurement rate is
                                              decreased by 25 percent, (from 36 to 27 aircraft).’ If the number to be
                                              purchased per year is halved, there will be a 28 percent increase in unit

                                              ‘The F-16 data is presented as recurrmg flyaway costs becausethat is how the program office figures
                                              F-IF, c&s. Recurring flyaway costs should mclude those elements (such as fabrication, assembly, and
                                              manufacturing) that o(‘cw rep~~trdly dunng production.

                                              Page 7                                                     GAO/NSIADSl-12      Aircraft Unit Costs

the office of the Assistant Secretary of Defense for Production and

Our work was conducted between September 1989 and July 1990 in
accordance with generally accepted government auditing standards.

As requested we did not obtain written agency comments on this report.
However, we discussed a draft of this report with DOD and Air Force
officials, and their comments have been incorporated where

I.nless you publicly announce its contents earlier, we plan no further
distribution of this report until 7 days from the date of this letter. At
that time, we will send copies of this report to the Chairmen, House
Committees on Appropriations and on Government Operations and
Senate Committee on Governmental Affairs, and the Secretaries of
Defense, the Navy, and the Air Force. Copies will be made available to
other interested parties on request.

This report was prepared under the direction of Paul F. Math, Director,
Research. Development, Acquisition and Procurement Issues, who may
be reached on (202) 2754587 if you or your staff have any questions.
The major contributors to this report are listed in appendix I.

 Frank C. Conahan
 Assistant Comptroller General

 Page 9                                       GAO/NSLADSI-12 Aircraft Unit Costs
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P. 0. Box 6015
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Ths-i-~~A~alli,~L~                                                                                             27K
Appendix I

Major Contributors to This Report

                        Michael E. Motley, Associate Director
National Security and   James Wiggins, Assistant Director
International Affairs   Thomas Mills, Issue Area Adviser
Division, Washington,   John Potochney, Senior Evaluator


                        Robert Murphy, Issue Area Manager
Cincinnati Regional     Rae Ann Sapp, Evaluator-In-Charge
Office                  .JamesGabriel, Evalrlator
                        .Johnetta Gatlin-Hrown, Evaluator

(xw725)                 Page 10                                 GAO/NSIAW91-12 Aircraft Unit Costs
                                       _~-.---               ~   ~

Table 5: Sensitivity of Unit Cost to
F-15 Quantities Procured                         Dollarsin millions
(Fiscal Year 1990)                                                                                                Unit cost percent
                                                 Proc&ement rate decrease/           Quantity
                                                 increase                           procured       Unit cost                change
                                                 50% decrease                               18         $42 9                    +28
                                                 25% decrease                               27          368                     +10
                                                 Estimated program                          36          33 5                        0
                                                 25% ncrease                                45          32 0                     -4
                                                 SO% Increase                               54          31 2                     -7

                                                 The fact that thc~unit cost of some aircraft systems could be less sensi-
Conclusions                                      tive to a decreasesin production rates than others is not by itself suffi-
                                                 cient reason to fa\-or extending production at lower rates. From the
                                                 point of view of wving money, t,erminating production might be the
                                                 more sensible choicts. It should also be noted that unit costs are less sen-
                                                 sitive when rate rt>ductions are planned and fixed costs can be reduced.
                                                 For this reason (.ontract ors should be given sufficient advanced notice of
                                                 production rak tl~c~as~s. In any case, the information in this report
                                                 should not be inttq~rctc~d as meaning that stretching out production is
                                                 preferable to terminating programs. Each aircraft system must be evalu-
                                                 ated on a case-by-(XiIsehasis. Nevertheless, L~H)D’ unit
                                                                                                      s cost pro.jections for
                                                 aircraft and othtlr dcfcnse systems could assist the Congress in deter-
                                                 mining the costs of strt,tching out production of some systems.

                                                 To evaluate the stbnsitivity of procurement unit costs to procurement
Scope and                                        rate changes, MV’obtained and analyzed cost data from the DOD planning
Methodology                                      and budgeting cyc4t5s.We also reviewed program office cost estimates
                                                 and compared that information with other DOD documents.

                                                 We discussed with program officials and prime contractors the various
                                                 factors that could influence aircraft unit costs. To obtain an under-
                                                 standing of the aircraft manufacturing process and the factors that can
                                                 influence unit costs. M’Omet with officials from McDonnell Douglas Air-
                                                 craft Corporation. St. lJouis, Missouri; General Dynamics Corporation,
                                                 Fort Worth, Texas; and Hoeing Military Airplane Company, Wichita,
                                                 Kansas. We also tolu-4 their aircraft facilities,

                                                 In addition. w(’dkussed these factors with DODofficials located at each
                                                 contractor facility. 1)rogram office manufacturing and cost-estimating
                                                 specialists, Air Forrr and Navy headcmarters officials. and officials in

                                                 Pa@?A                                           GAO/NSIADSl-12 Aircraft Unit Costs

Table 3: Sensitivity of Unit Cost to
F-16 Quantities Procured               Dollars in mllllons
tF\scalYear 1990)
                                       Procurement rate decrease/                       Quantity                           Unit cost percent
                                       increase                                        procured           Unit cost                  change
                                       50%d<cre:se                                             60             $341                       t34
                                       25% decrease                                            90      -~       286                      t12
                                       EstlmGed Program                                      120     ~.         255                             0
                                       25% \ncrease                                           150               235                          -0
                                       50% ncrease                                           -180               230                         -10

AV-8B Aircraft                         The Navy’s AV-8B Marine Corps attack aircraft unit cost is relatively
                                       insensitive to procurement rate changes. In fiscal year 1989, the Navy
                                       was given the authority to enter into a 3-year contract for annual quan-
                                       tities of 24 AV-SB aircraft.” This quantity was significantly below the
                                       prior years’ procurement quantities. The reduction increased the pro-
                                       curement unit cost by about 12 percent. According to the Navy, unit
                                       costs would have increased more significantly, but multiyear procure-
                                       ment enabled the contractor to stabilize the work force and to obtain
                                       volume discounts for parts and materials. According to the Navy, for-
                                       eign military sales avoided production line stoppages.

                                       Table 4 shows Navy AV-8B contract prices at various procurement
                                       quantitiesI’ Foreign procurements are included because they are priced
                                       along with the Navy procurements. Despite a total quantity decrease of
                                       over 62 percent (from 66 in fiscal year 1987 to 23 in fiscal year 1989), a
                                       comparison of the lowest unit price ($11 million in fiscal year 1987)
                                       with the multiyear unit price ($12.4 million) shows an increase of about,
                                       12 percent in unit price.

                                       ‘In fiscal year 1988,S aircraft were prospectively priced for fiscal year 1989. As a result, the multi-
                                       year quantity of 24 aircraft was derremed to 16 for 1989.

                                       "'The table shows contrwl pncing information becausethe AV-8R program office did not provide unit
                                       rest sensltwity data

                                       Page 6                                                         GAO/NSL&D-91.12 Aircraft Unit asts

                                       other projects in the facility.4 The ability to shift labor to other projects
                                       in which personnel are needed to fill vacancies can reduce potential
                                       increases in both direct labor and overhead charges.

                                       Table 1 shows the Air Force’s projected KC-135R procurement unit cost
                                       sensitivity for varying annual procurement rates in fiscal year 1990.
                                       This table projects an increase of about 3 percent in unit cost if the
                                       number to be purchased is decreased by 33 percent (from 36 to 24 air-
                                       craft) and a 6 percent increase in unit cost if the quantity is halved
                                       (from 36 to 18).

Table 1: Sensitivity of Unit Cost to
KC-13% Quantities Procured             Dollars in mihons
(Fiscal Year 1990)
                                       Procurement    rate decrease/                  Quantity                          Unit cost percent
                                       increase                                      procured
                                                                                          ~.~          Unit cost                  change
                                       50% decrease                                          18            $187                        46
                                       33% decrease                                          24             18 1                       c3
                                       Estimated program                                     36             176                           0
                                       25% increase                                          45             17 1                       -3
                                       50% bncrease                                          54             165                        -6

F/A-18 Aircraft                        The unit cost for the Navy’s F/A-18 aircraft is relatively insensitive to
                                       the rate at which units are procured, especially when the procurement
                                       rate is reduced by 25 percent. The F/A-18 is a mature program; it had its
                                       first flight in 1978 and reached its initial operating capability in 1983.
                                       According to DOD, the Navy contractor can use foreign military sales to
                                       stabilize the F/A-l8 production line and unit prices. DOD reduced the
                                       planned procurement in fiscal year 1990 from 84 aircraft per year to 72
                                       and then to 66 aircraft, resulting in a reduction of almost $800 million in
                                       planned funding levels. Navy officials considered 84 aircraft per year as
                                       the minimum economical production rate based on an 8-hour workshift
                                       working five days a week. The officials believed that foreign sales could
                                       compensate for the decreased procurement rate and keep the production
                                       line operating at an economic rate.

                                       Table 2 shows the projected unit procurement cost of the F/A-18 in
                                       fiscal year 1990 at various annual procurement rates. It projects an
                                       increase of about 8 percent in unit cost if the procurement rate is

                                       ‘Sustaining labor is labor that supports the manufacturing process. It includes such items as vngi-
                                       neering, tooling, drawing mamtenance,or technical support Direct labor is labor that can be specifi-
                                       cally and consistently identified or assignedto a particular work order/contract and that bears full

                                       Page 4                                                       GAO/NSIADSl-12 Aircraft Unit C&as

                        F/A-18 procurement rate would increase unit cost by about 8 percent;
                        for the E-ZC, however, a 25 percent procurement rate decrease would
                        increase unit cost by 25 percent.2

                        According to contractors, the procurement unit cost of some mature air-
                        craft systems is less sensitive to procurement rate reductions when at
                        least one of the following factors is present: (1) contractors have an
                        opportunity to manage overhead and other costs in anticipation of pro
                        duction rate changes, (2) foreign customers’requirements can offset
                        reductions in the U.S. procurement quantities, and/or (3) multiyear pro-
                        curement can be used to stabilize prices over a longer production period.

                        Also according to contractors, unit cost is especially sensitive to sudden
                        unanticipated changes in production rates. IJnit costs are less sensitive
                        when rate reductions are planned and fixed costs such as overhead and
                        facilities can be reduced.

                        These circumstances demonstrate the importance of program stability.
                        When procurement rate decreases need to be made, contractors should
                        be given sufficient advance notice so they can eliminate unnecessary
                        facility, overhead, and other costs before the production rate decreases

                        Our review of seven mature aircraft programs using military service
Unit Cost Sensitivity   projections indicated that the procurement unit cost of some aircraft
Varies Among Aircraft   may be less sensitive to rate changes than others.3 When the number of
Programs                E-2C and EA-6B aircraft to be purchased per year is decreased by
                        25 percent, their projected unit costs increase 25 and 21 percent, respec-
                        tively. A 50 percent decrease in the E-2C’s and EA-6B’s procurement,
                        rates would increase unit cost by 53 and 64 percent, respectively. On the
                        other hand, unit costs estimates for aircraft programs such as the
                        KC-135R modifications, F/A-18, F-16, AV-BB, and F-15 are not as sensi-
                        tive to decreased procurement rates. Because each of these systems is
                        affected by different conditions, we evaluated unit cost sensitivity to
                        production rate changes on a case-by-casebasis.

                         ‘The E-X is also a mature system, but becauseof its relatively low production rate (six m 1989 and
                         four in 1990). its unit cost is especially sensitive to production rate decreases.

                         “The projections noted m this report are based on the military services’assumptions of charges in
                         overhead and other fixed costs.

                         Page 2                                                      GAO/heyLpelat        Aircraft Unit Costs