oversight

Defense Trade: Department of Defense Savings From Export Sales Are Difficult to Capture

Published by the Government Accountability Office on 1999-09-17.

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

                   United States General Accounting Office

GAO                Report to the Chairman and Ranking
                   Minority Member, Subcommittee on
                   Readiness and Management Support,
                   Committee on Armed Services, U.S.
                   Senate
September 1999
                   DEFENSE TRADE

                   Department of
                   Defense Savings From
                   Export Sales Are
                   Difficult to Capture




GAO/NSIAD-99-191
United States General Accounting Office                                                 National Security and
Washington, D.C. 20548                                                           International Affairs Division



                                    B-283002                                                                Letter

                                    September 17, 1999

                                    The Honorable James M. Inhofe
                                    Chairman
                                    The Honorable Charles S. Robb
                                    Ranking Minority Member
                                    Subcommittee on Readiness and Management Support
                                    Committee on Armed Services
                                    United States Senate

                                    In 1998, the Department of Defense (DOD) and its contractors planned to
                                    sell to foreign countries defense equipment, articles, and services worth a
                                    total of about $44.3 billion. One of the U.S. government’s goals in exporting
                                    defense items, as articulated in the 1995 Conventional Arms Transfer
                                    Policy, is to allow DOD to meet its defense requirements at less cost. To
                                    determine whether DOD is maximizing this benefit, we reviewed the sales
                                    of five major weapon systems—the Hellfire Missile, Advanced Medium
                                    Range Air-to-Air Missile (AMRAAM), High Mobility Multipurpose Wheeled
                                    Vehicle (HMMWV), Black Hawk Helicopter, and Aegis Weapon System.
                                    Specifically, as requested, we determined whether (1) export sales reduced
                                    the price of the five weapon systems, (2) DOD waived the requirement to
                                    recover nonrecurring research and development and production costs
                                    associated with the sales, and (3) DOD included this information when
                                    notifying the Congress about the sales or requesting budgetary authority to
                                    purchase the weapon systems.



Results in Brief                    DOD saved at least $342 million on its purchases of the five systems
                                    because either the Department or its contractors also exported the systems
                                    to foreign governments. However, DOD has not developed guidance aimed
                                    at maximizing savings from export sales, and acquisition personnel
                                    sometimes made decisions that reduced potential savings. DOD could
                                    have realized greater savings if it had combined purchases for foreign
                                    governments with purchases for the U.S. military, negotiated prices for
                                    export sales without giving up U.S. system price reductions, or required the
                                    contractor to perform work in the most economical manner even if such




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        performance affected offset agreements.1 Savings would also have been
        greater if DOD had ensured that the export sales prices always included a
        proportionate share of the sustaining engineering and program
        management costs. The full impact of contractor direct sales on the price
        of DOD weapon systems cannot be assessed because information
        concerning the savings from combining material purchases and from
        learning efficiencies was not available.

        Consistent with the Arms Export Control Act, DOD waived about
        $378 million of costs to develop the five systems and establish their
        production facilities. In most cases, DOD waived these costs because the
        buyer was a North Atlantic Treaty Organization (NATO) ally and the sale
        meant that the United States and its allies would be using similar battlefield
        weapon systems.

        When DOD notified the Congress of potential sales of the five systems, it
        did not provide, nor was it required to provide, information on whether
        export sales reduced the price of weapon systems being acquired for the
        U.S. military or whether DOD waived nonrecurring costs associated with
        the sales. Similarly, DOD did not always provide information on savings
        from export sales that the Congress could use to assess the President’s
        request for budgetary authority to purchase the five systems. Nor did DOD
        always reduce its portion of the President’s budget to reflect export sales
        savings. Only the Air Force consistently considered the impact of export
        sales in developing a program’s budget. Beginning in fiscal year 1996, the
        Air Force voluntarily reduced the AMRAAM budget to reflect
        export-related reductions in the price of U.S. missiles. The Navy told us
        that its budget was reduced in 2 of the 5 years that it exported the Aegis
        Weapon System. The Army made no reductions to the Hellfire, Black
        Hawk, or HMMWV budgets. Instead, Army program offices used excess
        appropriations to buy additional systems or system components, or to meet
        unspecified needs.

        To enhance the economic benefits derived from defense exports, we are
        making recommendations to improve DOD’s ability to realize savings and
        the Department’s processes for disclosing to the Congress the effect of
        export savings on weapon system costs.



        1
         Offsets are industrial or commercial benefits that a U.S. contractor provides to foreign governments as
        inducements or conditions for the purchase of military goods or services.




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Background   The role of export sales in reducing the cost of weapon systems required by
             the U.S. military is becoming increasingly important. Between 1989, when
             the Cold War ended, and October 1998, DOD’s total budget declined
             30 percent in constant dollars and its procurement budget declined
             50 percent in constant dollars. To hold down annual acquisition costs and
             fit the inventory of weapon systems to the downsized military force
             structure, DOD often purchased fewer quantities of individual weapons
             than originally planned. Theoretically, purchasing fewer systems reduces
             overall costs but increases unit cost. But, production quantities can be
             increased and unit cost decreased if DOD or its contractors sell systems
             being purchased for the U.S. military to a foreign government, particularly
             if contracts for the export sales are awarded at about the same time as the
             U.S. contract is awarded. If the contractor plans to produce additional
             units, it can purchase materials in bulk at discounted prices, realize labor
             efficiencies, and spread fixed overhead costs 2 over more units of
             production.

             The U.S. government or contractors may sell defense items to a foreign
             government. When the sale is government-to-government through the
             foreign military sales program, DOD is generally required by section 21 of
             the Arms Export Control Act to charge the purchaser for a portion of the
             funds that the U.S. government invested to develop major defense
             equipment and establish a production capability. 3 Prior to 1996, DOD was
             authorized to waive these costs only if the sale advanced the U.S.
             government’s interests in equipment standardization with the armed forces
             of NATO countries, Japan, Australia, or New Zealand. However, in 1996,
             the Congress authorized DOD to waive nonrecurring costs if refusing to
             grant the waiver would likely result in the loss of the sale or if the sale




             2
              Fixed overhead costs are costs that an organization incurs because of its structure, style of operation,
             methods of selling, size of productive capacity, and stored-up knowledge of key individuals. These
             costs cannot be easily reduced when production activity declines. Examples of fixed overhead are the
             cost of depreciation of facilities and equipment, property taxes, fixed salaries of supervisory and office
             personnel, and the base charge for utilities.
             3
              Consistent with section 47 (6) of the Arms Export Control Act, DOD Directive 2140.2 defines major
             defense equipment as any item of significant military equipment listed on the U.S. Munitions List having
             a DOD nonrecurring research, development, test, and evaluation cost of $50 million or a total DOD
             production cost of more than $200 million.




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                           would reduce the cost of the U.S. purchase by an amount that would offset
                           waived funds.4

                           Contractors are not required to collect nonrecurring costs. Since 1992,
                           contractors have been exempt from collecting and depositing in the U.S.
                           Treasury nonrecurring research and development and production costs
                           when making direct sales to foreign governments.

                           Contractors often provide commercial or industrial benefits to foreign
                           governments that purchase military goods. These benefits, known as
                           offsets, may be offered as inducements or may be required by the foreign
                           government as a condition of the purchase. Offset agreements may include
                           subcontracting with the purchasing country’s industries for component
                           parts, providing the country’s businesses with financial or marketing
                           assistance, or undertaking a broad array of other activities that increase the
                           foreign country’s business base. The U.S. government is not a party to
                           offset agreements and assumes no liability under the agreements.



DOD Realized Savings       DOD reduced the cost of the five weapon systems we reviewed when it or
                           its contractors also exported the systems to foreign governments.
From Export Sales but      However, DOD has no guidance on how to maximize savings from export
Could Have Achieved        sales and personnel responsible for negotiating and administering
                           contracts that included U.S. and/or export requirements sometimes made
More                       decisions that prevented DOD from maximizing savings.


Export Sales Resulted in   According to our analysis, DOD reduced its cost to purchase the Hellfire,
Reduced Costs of Weapon    AMRAAM, HMMWV, Black Hawk, and Aegis Weapon System by at least
                           $342.3 million as a result of export sales. The sales of each of these systems
Systems                    increased the quantity of systems DOD purchased and reduced the
                           systems’ unit prices because contractors could buy materials in bulk at
                           discounted prices, realize labor efficiencies, and/or spread fixed overhead
                           costs over more units of production. Table 1 displays our estimates of the
                           quantifiable savings by system.


                           4
                            Although this new waiver authority was included in section 4303 of the National Defense Authorization
                           Act for Fiscal Year 1996 (P.L. 104-106), DOD could not exercise its new waiver authority until the
                           President introduced and the Congress passed legislation that fully offset the estimated revenues that
                           would be lost from the additional waivers. In September 1996, the Congress allowed the President to
                           sell a portion of the National Defense Stockpile. The funds from this sale were used in part to offset the
                           funds that DOD estimated would be lost between 1997 and 2005 as a result of the new waiver authority.




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Table 1: Weapon System Savings From Export Sales

Dollars in millions
System                             Hellfire                     AMRAAM                    HMMWV              Black Hawk Aegis Weapon System
Time period reviewed               1986-97                        1993-98                  1989-98              1984-99                       1988-98
Pricea and quantity of U.S.       $1,285.4                        $1,148.7                $1,757.2              $4,173.5                      $2,792.3
systems
                                    42,660                            3,657                 51,463                 1,086                             50
     a
Price and quantity of                 $92.6                         $909.4                  $372.4                $296.9                        $501.0
foreign military sales
                                      3,255                           3,138                   9,251                    65                               8
Pricea and quantity of                Price                 No contractor                    Price                  Price               No contractor
contractor export sales        unavailableb                         sales             unavailableb           unavailableb                       sales
                              Total quantity                          None                 12,027d                   336                          None
                               unavailable c
Estimated quantifiable                 $1.9                         $223.0                    $71.3                 $7.4                         $38.7e
savings
                                               a
                                                   All prices are those recorded at contract award.
                                               b
                                                   Corporate policy restricts the disclosure of this data.
                                               c
                                                The Hellfire II contractor reported that it sold 1,394 missiles directly to foreign governments. We were
                                               unable to collect information on the quantity of basic Hellfire missiles sold directly to foreign
                                               customers.
                                               d
                                                The Light Tactical Vehicles Program Office reported direct contractor sales for 1989-97. The quantity
                                               shown in the chart does not include any direct sales made by the contractor in 1998.
                                               e
                                                Aegis Weapon System savings include the effect of export sales on the prime contract only. Aegis
                                               Program Office officials told us that additional savings were realized when the government purchased
                                               system components and provided them to the prime contractor for integration into the Aegis Weapon
                                               System.


                                               Information that could be used to determine how much DOD saved through
                                               export sales varied among the five systems. AMRAAM and Hellfire savings
                                               that resulted from larger production quantities could easily be calculated
                                               by comparing identified unit prices with and without export sales. Black
                                               Hawk savings could also be easily determined because price adjustments
                                               were documented in the contract.

                                              The savings from HMMWV and Aegis Weapon System export sales were
                                              less easily determined, and our estimates of these savings were less
                                              precise. Documents that clearly identified the savings from export sales



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                              were available for only one of the five export sales of the Aegis Weapon
                              System and for none of the HMMWV sales. We estimated savings for these
                              two systems by discussing with the contractors the elements of product
                              cost affected by increased production and then analyzing their proposal
                              data for those cost elements to isolate and estimate the effect of export
                              sales on unit prices.

                              Our analysis of Aegis Weapon System proposal data did not allow us to
                              estimate the system’s total savings. The contractor said that for three of
                              the sales, savings were included in contract underruns.5 Because the
                              government and contractor shared savings from the underruns, DOD’s
                              costs were reduced. However, the underruns were attributable to a
                              number of factors, and we could not isolate the savings created by export
                              sales.


Larger Savings Were           DOD issued no guidance to aid acquisition personnel in maximizing savings
Possible                      from export sales. Our analysis showed that savings from export sales
                              could have been larger if contracts had been negotiated or administered
                              differently. DOD’s benefit from export sales was less when the military
                              services (1) purchased weapon systems for the United States and export
                              sales separately, (2) negotiated prices for export sales that required giving
                              up price reductions for DOD systems, (3) allowed the contractor to incur
                              higher material costs to satisfy an offset agreement, or (4) failed to
                              implement an effective method to spread production costs evenly over
                              units produced for the U.S. military and foreign buyers.

Timing of Purchases Affects   Our analysis showed that the timing of foreign sales was important. We
Savings                       observed that contractors reduced weapon system prices when DOD
                              combined its purchases for foreign customers with its purchases for the
                              U.S. military. Of the five weapon systems we reviewed, only the AMRAAM
                              program office managed its export sales so that the U.S. and export
                              requirements could be combined. Each year, DOD asked U.S. embassies in
                              countries likely to purchase AMRAAM missiles to determine if those
                              governments planned to make purchases in the coming year. According to
                              program officials, foreign countries understand that their AMRAAM
                              purchases must be combined with DOD’s purchases to achieve the lowest
                              possible price. Since 1993, with only two exceptions, the Air Force has


                              5
                                A contract is underrun when the contractor produces systems at less than the target price established
                              by the contract.




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                                combined purchases for foreign sales with U.S. purchases. This acquisition
                                strategy enabled the Air Force to reduce the cost of U.S. Air Force and
                                Navy AMRAAM missiles about $223 million. Our analysis also showed that
                                the Army could have saved an additional $2.9 million in the cost of Hellfire
                                missiles by simultaneously purchasing missiles for export and Army
                                requirements. Similarly, an Aegis Weapon System contract representative
                                told us that if DOD purchased a larger quantity of systems at the time it
                                awarded its annual production contract, the price of each system would be
                                lower.

Acquisition Decisions Reduced   DOD’s acquisition decisions affected savings. The Army could have
DOD’s Savings                   reduced the cost of Hellfire missiles another $1.4 million if it had not
                                insisted on lower prices for export missiles. The Hellfire contract required
                                a price reduction if additional missiles were purchased within 60 days of a
                                U.S. order. In early 1996, the Army purchased additional missiles within the
                                required time frame. However, the agency gave up its right to a reduction
                                in the unit price of its missiles that totaled about $0.9 million in exchange
                                for a lower missile price for the foreign government. Later in 1996, the
                                contractor offered to reduce the U.S. price by $2.4 million because the
                                Army was purchasing additional export missiles for another foreign
                                customer 5 months after the U.S. order. However, the lower price for the
                                U.S. missiles was contingent upon the foreign government paying a higher
                                price to convert the missiles to the export configuration and to cover the
                                cost risk associated with the sale.6 The Army negotiated a $1.9 million cost
                                reduction, rather than the $2.4 million offered by the contractor, giving up
                                the additional $0.5 million so that the contractor would agree to include
                                less profit in the export missile price. The Army did not explain its
                                rationale for this action.

                                Acquisition decisions also affected Aegis Weapon System savings. The
                                Navy reduced its potential savings about $3 million when it allowed the
                                contractor for the Aegis Weapon System to purchase rather than make
                                system subcomponents to satisfy an offset agreement. The contractor
                                originally proposed to make the subcomponents at a cost of about
                                $22.5 million. However, when the contractor found that it was not meeting
                                its agreement with the foreign government to purchase $97 million of


                                6
                                 According to a contractor representative, foreign customers typically require more technical support
                                than DOD, and export missile warranties are often more expensive than estimated. Defense Federal
                                Acquisition Regulation Supplement 215.404-71-3 (d) (3) allows DOD to pay a contractor more profit
                                than normal in sales where the contractor can demonstrate that there are substantial risks above those
                                normally present in DOD contracts for similar items.




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                                subcomponents or parts from that country’s industries, the contractor
                                decided to buy additional subcomponents for DOD systems from the
                                foreign manufacturers. According to an audit completed by the Defense
                                Contract Audit Agency (DCAA), this decision will cause the contractor to
                                pay about $27.7 million for the parts—about $5.2 million more than it cost
                                to make them.7 In addition, DCAA said the loss of production in the
                                contractor’s plant would result in an additional $0.8 million in overhead
                                costs. The decision to purchase the parts will not affect the weapon’s
                                target price under the Navy’s fixed-price incentive contract. However, the
                                contractor has underrun target prices since 1988 and, according to the
                                terms of the contract, shared the savings equally with DOD. If the
                                contractor were to reduce this contract’s costs as much as it did some
                                earlier contracts, the decision to buy the subcomponents could result in
                                about $6 million less in savings, which would reduce DOD’s share by
                                $3 million.

Full Allocation of Production   We examined four Black Hawk production contracts where the Army
Costs Necessary to Maximize     purchased additional helicopters for export sale after initial contract
Savings                         award. Three of the four contracts allocated all sustaining engineering and
                                program management costs to the units initially purchased on the contract
                                and none to the additional units, although these units also benefited from
                                these activities.8 In two of the contracts, the Army directed the contractor
                                to remedy the situation by adding a surcharge to the export units.
                                However, the surcharge fell short of distributing the costs evenly to all
                                helicopters purchased under the contract. In only one case did we have
                                sufficient data to quantify the potential savings that the Army might have
                                realized if these costs had been allocated evenly. In that case, we
                                calculated that the Army could have recovered an additional $3.4 million
                                from export sales by evenly distributing the contractor’s sustaining
                                engineering and program management costs.




                                7
                                  The contractor agreed that its decision to purchase rather than make the parts will increase cost, but
                                estimates that the increase will be only about $0.6 million. DCAA’s and the contractor’s loss estimates
                                differ because the contractor (1) estimated the cost to make the parts at current prices rather than the
                                price negotiated at contract award, (2) deleted additional material cost from the estimate to buy the
                                parts that is normally added to all purchased hardware, (3) assumed that its production loss and
                                personnel retraining cost would not affect negotiated overhead rates, and (4) predicted that the foreign
                                contractor would not require increased engineering support to produce the parts.
                                8
                                 We were unable to determine how sustaining engineering and program management costs were
                                allocated to units purchased under the fourth contract.




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Savings Attributable to       Contractors’ direct export sales also reduced the cost of DOD’s weapon
Direct Sales by Contractors   systems, but we could not always determine the amount of the reductions
                              or whether the contractors considered all cost reductions when pricing
Is Unknown                    DOD’s systems. Our analysis showed that the Hellfire, HMMWV, and Black
                              Hawk contractors sold those systems directly to foreign governments and
                              included their direct sales in calculations of their overhead rates, which
                              resulted in lower rates. Since these rates are the contractor’s means of
                              assigning overhead costs, such as equipment depreciation, property taxes,
                              and administrative costs to a contract, a lower rate results in lower
                              contract costs and a reduced weapon system unit cost. However, the
                              Hellfire and Black Hawk contractors either did not have data or considered
                              it too time consuming to develop data that would allow us to assess what
                              the overhead rates would have been had there been no export sales. None
                              of the contractors provided data that would allow us to determine whether
                              material and labor costs decreased when the contractors increased
                              production quantities by selling directly to foreign governments or whether
                              these reductions, if they occurred, reduced the price of DOD’s weapon
                              systems. Neither could DOD officials provide information that would allow
                              us to quantify the impact of contractors’ direct sales on the price of U.S.
                              weapon systems.



DOD Waived                    Consistent with the Arms Export Control Act, DOD declined to charge
                              foreign purchasers $377.8 million of nonrecurring costs that it incurred to
Nonrecurring Research         develop the five weapon systems and establish their production facilities.
and Production Costs          Of the $377.8 million, DOD waived $289.6 million because the exports
                              increased standardization of weapon systems between the United States
                              and its NATO allies and $29.6 million to avoid the loss of export sales. The
                              remaining $58.6 million was not collected when the Air Force and the
                              Defense Security Cooperation Agency created hybrid sales agreements for
                              some sales made in January 1995 and January 1996.

                              DOD considered the hybrid sales as the contractor’s direct sales because
                              the contracts were between the contractor and foreign purchasers and
                              imposed no financial obligation on the U.S. government. But the sales were
                              treated in many respects as government-to-government sales, with Air
                              Force personnel negotiating, writing, and administering the contract. An
                              AMRAAM program official said the foreign customers would not have
                              purchased AMRAAM missiles if the $58.6 million of nonrecurring costs
                              were included in the purchase price. Therefore, DOD could not classify the
                              sales as foreign military sales because legislation in effect at the time would



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                                       not have allowed DOD to waive these costs to avoid the loss of the sales. 9
                                       Neither did the contractor sell the missiles directly to the foreign
                                       customers without DOD participation, which would have exempted the
                                       countries from paying the nonrecurring costs, because the Air Force
                                       recommended that the program office sell the AMRAAM only through the
                                       foreign military sales program.

                                       Table 2 shows the amount of waived nonrecurring costs for each weapon
                                       system.



Table 2: Waived Nonrecurring Costs

                                                                                                                             Aegis Weapon
Cost                                       Hellfire           AMRAAM                 HMMWV            Black Hawk                   System
Collectable nonrecurring costs        $12,617,768         $349,739,466            $1,365,060         $10,304,380               $130,418,000
Waived nonrecurring costs              $1,802,188         $310,803,404                       0a                   0             $65,152,000
Percent of collectable nonrecurring          14.28                 88.87                     0                     0                    49.96
costs waived
                                       a
                                        The Army was able to locate data for only 88 percent of the HMMWV foreign military sales that would
                                       allow us to assess whether nonrecurring costs were waived. For those sales that we could assess, we
                                       found that all nonrecurring costs were collected.




Decisionmakers                         Each time DOD or its contractors sought to export the Hellfire, AMRAAM,
                                       HMMWV, Black Hawk, or Aegis Weapon System, the President notified the
Received Little                        Congress—giving it a chance to object to the system’s export—and each
Information on Savings                 year the President asked the Congress to appropriate funds to purchase the
                                       systems.10 Sections 36 (b) and (c) of the Arms Export Control Act require
or Waivers                             that the notifications include such information as the name of the
                                       purchasing country or international organization, the dollar amount of the
                                       sale, the number of items included in the sale, and a description of the item
                                       being sold. The notifications did not include, nor were they required to


                                       9
                                        DOD’s authority to waive the nonrecurring costs to avoid the loss of a sale became effective September
                                       1996. The Air Force created hybrid sales agreements for sales made in January 1995 and January 1996.
                                       10
                                         The Arms Export Control Act requires the President to report to the Congress proposed foreign
                                       military sales of defense articles or services for $50 million or more, design and construction services
                                       for $200 million or more, or major defense equipment for $14 million or more. The act also requires the
                                       President to report to the Congress contractors’ applications for licenses for the export of major
                                       defense equipment to be sold under a contract in the amount of $14 million or more, or defense articles
                                       or services to be sold under a contract in the amount $50 million or more.




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include, information on whether or by how much anticipated export sales
would reduce the cost of DOD’s weapon systems, or whether DOD had
waived nonrecurring research and development and production costs.
Similarly, the President’s budget requests did not always advise the
Congress of the impact of export sales on program budgets, and DOD did
not consistently reduce its budget request to account for savings resulting
from export sales.

Only the Air Force consistently reduced its budget request to reflect
savings from anticipated export sales. Beginning in 1994, AMRAAM
program office personnel recognized that export sales of the AMRAAM
were likely to significantly impact AMRAAM production costs.11 According
to a program official, the Air Force estimated the number of missiles that
would be sold and reduced its AMRAAM budget request to account for the
expected savings. In those cases where the actual savings exceeded the
budget reduction, the program office used the additional funds to purchase
more AMRAAMs.

The Navy told us that its budget for the Aegis Weapon System was reduced
to account for savings from export sales in 2 of the 5 years that it exported
the system. In fiscal year 1994, the Navy voluntarily reduced its budget
request $11 million to account for an expected decrease in the weapon
system’s production cost caused by an export sale. In addition, the
Congress reduced the Aegis budget by $3.8 million in fiscal year 1998 when
the Aegis Program Office disclosed that another export sale would reduce
the cost of DOD’s purchases.

The Army did not decrease its Black Hawk, Hellfire, or HMMWV budget
requests to reflect savings from export sales. According to Army officials,
when budget requests were prepared, DOD was unsure whether
anticipated export sales would occur. The officials said that it was too
risky to reduce budgets when savings might not be achieved. However,
when export sales later produced savings, the Army did not inform the
Congress of the savings or reduce its subsequent budget requests. Instead,
the program offices used the excess funds to purchase additional systems
or system components or to meet other unspecified needs.




11
 Because DOD begins to formulate each fiscal year’s budget request 2 years in advance of its
submission to the Congress, the Air Force’s recognition of production cost reductions in 1994 did not
result in reduced budget requests until fiscal year 1996.




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Conclusions       Although DOD reduced its cost to purchase five weapon systems when the
                  systems were also sold to foreign governments, DOD did not maximize the
                  potential for savings. In addition, the Congress lacked information that
                  would have helped it oversee weapon system acquisitions and export sales.

                  DOD provided no guidance on how to maximize savings from export sales.
                  As a result, program offices often handled export sales differently. We do
                  not believe that every contract should be negotiated and administered in
                  the same way. However, guidance could point out actions that have been
                  shown to maximize savings. These actions include combining purchases of
                  weapon systems for the U.S. military with purchases for foreign countries,
                  negotiating and enforcing clauses that reduce weapon system prices if
                  export sales are made within a reasonable time after DOD contracts are
                  awarded, requiring contractors to perform work in the most economical
                  manner, and allocating sustaining engineering and program management
                  costs evenly over all units produced under a contract.

                  In addition, DOD provided the Congress with little information on the
                  impact of foreign military and contractors’ direct export sales on the price
                  of the five weapon systems, the waivers that were part of some sales
                  agreements, or the potential for budget reductions created by savings from
                  weapon system exports. Although DOD is not required to provide this
                  information, the data could have helped the Congress determine whether
                  export sales achieved the goal of reducing the cost of U.S. weapon systems
                  and whether DOD required all of the funds it requested to purchase weapon
                  systems.



Recommendations   We recommend that the Secretary of Defense develop guidance that will
                  assist the military services in maximizing savings from export sales.



Matters for       DOD does not always reduce its annual budget request to reflect savings
                  from export sales or inform the Congress so that it may consider doing so.
Congressional     As evidenced by the Congress’ reduction of the Aegis Weapon System’s
Consideration     1998 budget, information on savings due to export sales can be useful to
                  the Congress in making budget decisions. In addition, the Congress may
                  find information on cost savings and waivers of nonrecurring costs useful
                  when reviewing proposed export sales. The Congress could use this
                  information to judge the extent to which such sales will contribute to the
                  cost reduction goal articulated by the Conventional Arms Transfer Policy.



                  Page 12                                        GAO/NSIAD-99-191 Defense Trade
                      B-283002




                      Accordingly, the Congress may wish to consider requiring that the
                      Secretary of Defense develop guidance to ensure that budget requests
                      reflect actual and projected savings from foreign military sales. In addition,
                      the Congress may wish to consider requiring that the Secretary of Defense
                      provide information on projected foreign military sales savings and waivers
                      of nonrecurring costs when notifying the Congress of proposed sales.
                      Finally, the Congress may wish to consider tasking the Secretary to assess
                      the feasibility of collecting information that would quantify the impact of
                      contractors’ direct export sales on the price of U.S. weapon systems. If
                      DOD is successful in collecting this data, it could also be reflected in
                      budget requests and sales notifications.



Agency Comments and   In commenting on a draft of this report, DOD concurred with our
                      recommendation to develop guidance that will assist the military services
Our Evaluation        in maximizing savings from export sales. DOD did not concur with our
                      recommendation that it include information about the impact of export
                      sales on each program’s funding request. DOD noted that consideration of
                      export sales is already a normal part of the budgeting process and that
                      isolating the impact of export sales from other factors that affect program
                      cost estimates would have no benefit. Neither did DOD concur with our
                      recommendation that the Secretary of Defense collect information that
                      would allow an assessment of the impact of export sales on the price of
                      U.S. weapon systems. DOD said its requirement to provide cost and pricing
                      data in sole-source acquisitions and its reliance on price competition in
                      competitive acquisitions ensure that DOD obtains a reasonable price for its
                      weapon systems.

                      We based our recommendations on the Congress’ need for additional
                      information to support the budgetary and arms transfer decision-making
                      processes, not as a substitute for other means of obtaining a fair price. We
                      found during our review that DOD did not consistently reduce military
                      budgets to account for savings from export sales or provide enough
                      information for the Congress to do so. DOD’s disclosure of the budgetary
                      impact of export sales would give the Congress greater oversight of
                      military budgets.

                      Complete data that includes the impact of an export sale on DOD’s weapon
                      system price would also assist the Congress in making an informed arms
                      sales decision. The Congress and the executive branch base decisions on a
                      number of factors. In recent years, one important consideration has been
                      the value that accrues to DOD from export sales in the form of lower unit



                      Page 13                                         GAO/NSIAD-99-191 Defense Trade
              B-283002




              costs. Yet we found during our review that the Congress is asked to
              approve export sales without information regarding the impact of export
              sales on the price of U.S. weapon systems. The Congress could benefit
              from information regarding production cost savings created by export sales
              and waivers of nonrecurring costs associated with the sales. This data
              would allow the Congress to assess whether export sales achieve the goal,
              established by the Conventional Arms Transfer Policy, of reducing the price
              of U.S. weapon systems.

              In our opinion, additional information would improve budgetary oversight
              and assist the Congress in determining the extent to which export sales
              achieve Conventional Arms Transfer Policy goals. Therefore, we have
              deleted recommendations to the Secretary regarding those issues and
              addressed them to the Congress.

              DOD also provided a technical comment on the report. We reviewed
              DOD’s suggestion and made an appropriate change.



Scope and     We conducted our review as a case study of five weapon systems--the
              Hellfire missile, AMRAAM, HMMWV, Black Hawk Helicopter, and Aegis
Methodology   Weapon System. We judgmentally selected the systems because they
              represent acquisitions of each of the U.S. military services, were produced
              by four different contractors, and were of varied price. Because the sample
              is small, we cannot statistically state that the conditions we found in our
              sample would be found in all export sales. However, the sample illustrated
              the diverse actions that affect DOD’s ability to maximize savings from
              export sales.

              We calculated the effect export sales had on the price of DOD’s weapon
              systems by analyzing contractor proposal data and prices and government
              billing adjustments. For the Hellfire and AMRAAM missiles and one Aegis
              Weapon System purchase, we examined the contractors’ proposed prices
              for varying quantities to determine the price DOD would have paid if it had
              purchased only the quantity of weapon systems required by the U.S.
              military. We compared DOD’s price for this lower quantity of systems to
              the Department’s price for a larger quantity that satisfied both U.S. and
              foreign military requirements. The difference between the two prices
              represented system savings. To calculate the remainder of the Aegis
              Weapon System and all HMMWV savings, we determined the elements of
              the systems’ costs that were affected by changes in the production rate.
              Once we identified these elements, we recomputed their cost assuming a



              Page 14                                       GAO/NSIAD-99-191 Defense Trade
B-283002




level of production that satisfied only U.S. requirements. We defined
system savings as the difference between the contractor’s proposed price,
which was based on U.S. plus export requirements, and the price we
calculated using the recomputed cost elements. For the Black Hawk, we
examined government billing adjustments to determine the sustaining
engineering and program management costs that the government
recovered when it added these costs to the contractor’s price for foreign
military sales systems. The Army made this adjustment because the
contractor had charged these costs, which benefited all units, to
helicopters purchased when the Army awarded its annual production
contract and none to units produced for foreign military sales. We
considered all recovered costs as savings. All costs and savings are
reported in current year dollars unless otherwise noted. Data were not
available to estimate dollar savings by year that would allow conversion to
constant dollars.

To accomplish our analysis, we collected documents from and held
discussions with the Air-to-Ground Missile Systems Project Office,
Huntsville, Alabama; the U.S. Army Aviation and Missile Command
(AMCOM) Acquisition Center, Huntsville, Alabama; the Air-to-Air Joint
Systems Program Office, Eglin Air Force Base, Florida; the Light Tactical
Vehicles Program Office, Warren, Michigan; the U.S. Army
Tank-Automotive and Armaments Command (TACOM) Acquisition Center,
Warren, Michigan; the Utility Helicopter Program Management Office,
Huntsville, Alabama; and the Aegis Weapon System Program Office, Crystal
City, Virginia. We also analyzed and discussed proposal data, price
matrices, offset data, overhead analyses, and savings from export sales
with officials at Lockheed Martin Electronics and Missiles, Orlando,
Florida; Raytheon Missile Systems Company, Tucson, Arizona; AM General
Corporation, South Bend, Indiana; Sikorsky Aircraft Corporation,
Stratford, Connecticut; and Lockheed Martin Government Electronic
Systems, Moorestown, New Jersey. While at the contractor locations, we
talked with Defense Contract Management Command and DCAA personnel
about export sales’ impact on contractor overhead rate calculations.

We determined whether DOD exercised its authority to waive nonrecurring
research and development and production costs by analyzing foreign
military sales documents and discussing nonrecurring cost waivers with
officials at the AMCOM Security Assistance Management Directorate; the
Air-to-Air Joint Systems Program Office; the TACOM Security Assistance
Center; and the Aegis Weapon System Program Office.




Page 15                                        GAO/NSIAD-99-191 Defense Trade
B-283002




In addition, we reviewed DOD’s export sales notification and budgetary
processes to determine whether DOD provided information on anticipated
savings and waivers to the Congress when notifying it of expected export
sales or requesting budgetary authority to purchase the weapon systems.
We collected documents from and held discussions with officials from the
Defense Security Cooperation Agency, the Air-to-Ground Missile Systems
Project Office, the Air-to-Air Joint Systems Program Office, the Light
Tactical Vehicles Program Office, the Utility Helicopter Program
Management Office, and the Aegis Weapon System Program Office.

We conducted our work from July 1998 through May 1999 in accordance
with generally accepted government auditing standards.


As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from its
issue date. At that time, we will send copies of this report to other
interested congressional committees; the Honorable William Cohen,
Secretary of Defense; the Honorable Louis Caldera, Secretary of the Army;
the Honorable Richard Danzig, Secretary of the Navy; the Honorable F.
Whitten Peters, Secretary of the Air Force; and the Honorable Jacob Lew,
Director, Office of Management and Budget. We will make copies available
to others upon request.

A list of contacts and key contributors for this report is in appendix II.




Henry L. Hinton, Jr.
Assistant Comptroller General




Page 16                                          GAO/NSIAD-99-191 Defense Trade
Page 17   GAO/NSIAD-99-191 Defense Trade
Appendix I

Comments From the Department of Defense                                Appenx
                                                                            Idi




Note: GAO’s comments
supplementing those in the
report text appear at the end
of this appendix.




                                Page 18   GAO/NSIAD-99-191 Defense Trade
                 Appendix I
                 Comments From the Department of Defense




See comment 1.




                 Page 19                                   GAO/NSIAD-99-191 Defense Trade
                 Appendix I
                 Comments From the Department of Defense




See comment 2.




See comment 3.




                 Page 20                                   GAO/NSIAD-99-191 Defense Trade
               Appendix I
               Comments From the Department of Defense




               The following are GAO’s comments on the Department of Defense’s (DOD)
               letter dated August 3, 1999.



GAO Comments   1. The detailed analysis substantiating the computation of the reported
               export sales cost savings was offered to each program office for review.
               Officials from three of the program offices reviewed our data and agreed
               with its results. Officials from the remaining two program offices elected
               not to review the data, but did not indicate any disagreement with the
               savings being reported.

               2. DOD said that the consideration of export sales is already a normal part
               of the budgeting process in that program cost estimates include
               consideration of contractors’ direct and foreign military sales. However,
               our review showed that in only one of the five instances did a program
               office consistently reduce its budget to account for the savings from export
               sales. Officials at four of the five program offices told us that they did not
               reduce their production cost estimates or their planned budget requests to
               account for possible savings from export sales. Only the Advanced
               Medium Rance Air-to-Air Missile (AMRAAM) program office adjusted its
               production cost estimate and consistently decreased its planned budget
               requests once export sales began to reduce weapon system costs.

               3. We reworded our recommendation to more clearly state our intent. Our
               recommendation is based on the need for more information to support the
               arms decision-making process and is not intended as a substitute for other
               means that DOD uses to obtain a fair price. The Congress cannot assess
               whether export sales achieve the goal of reducing the price of U.S. weapon
               systems unless DOD (1) isolates the production savings realized from each
               export sale, regardless of whether the sale is made directly by the
               contractor or through the foreign military sales program and (2) informs
               the Congress of whether the sale resulted in the recovery of some portion
               of the funds spent to develop and establish production facilities for the
               system.




               Page 21                                         GAO/NSIAD-99-191 Defense Trade
Appendix II

GAO Contacts and Staff Acknowledgments                                                        Appe
                                                                                                 nIx
                                                                                                   Idi




GAO Contacts         Katherine Schinasi (202) 512-4841
                     Barbara Haynes (256) 650-1435



Acknowledgments      In addition to those named above, Lee Edwards, Erin Baker, and Marcus
                     Ferguson made key contributions to this report.




(707371)      Lte
                rt   Page 22                                     GAO/NSIAD-99-191 Defense Trade
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