This is the accessible text file for GAO report number GAO-10-686 
entitled 'Defense Acquisitions: Guidance Needed on Navy's Use of 
Investment Incentives at Private Shipyards' which was released on July 
26, 2010. 

This text file was formatted by the U.S. Government Accountability 
Office (GAO) to be accessible to users with visual impairments, as 
part of a longer term project to improve GAO products' accessibility. 
Every attempt has been made to maintain the structural and data 
integrity of the original printed product. Accessibility features, 
such as text descriptions of tables, consecutively numbered footnotes 
placed at the end of the file, and the text of agency comment letters, 
are provided but may not exactly duplicate the presentation or format 
of the printed version. The portable document format (PDF) file is an 
exact electronic replica of the printed version. We welcome your 
feedback. Please E-mail your comments regarding the contents or 
accessibility features of this document to Webmaster@gao.gov. 

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately. 

Report to the Chairman, Subcommittee on Defense, Committee on 
Appropriations, House of Representatives: 

United States Government Accountability Office: 
GAO: 

July 2010: 

Defense Acquisitions: 

Guidance Needed on Navy's Use of Investment Incentives at Private 
Shipyards: 

GAO-10-686: 

GAO Highlights: 

Highlights of GAO-10-686, a report to the Chairman, Subcommittee on 
Defense, Committee on Appropriations, House of Representatives. 

Why GAO Did This Study: 

As fiscal constraints increasingly shape Navy shipbuilding plans, the 
pressure to increase efficiency mounts. Modernizing facilities and 
equipment at shipyards that build Navy ships can lead to improved 
efficiency, ultimately reducing the cost of constructing ships. In 
response to a request from the House Appropriations Subcommittee on 
Defense, GAO (1) identified investments in facilities and equipment at 
privately-owned shipyards over the last 10 years; (2) determined the 
Navy’s role in financing facilities and equipment investments at these 
shipyards; and (3) evaluated how the Navy ensures investments result 
in expected outcomes. To address these objectives, GAO analyzed 
shipyard investment data over the past 10 years; interviewed shipyard, 
corporate, and Navy officials; and reviewed contracts, investment 
business cases, and other Navy and contractor documents. 

What GAO Found: 

Over the past 10 years, large shipyards that build Navy ships used 
public and corporate funds to invest over $1.9 billion in facilities 
and equipment to improve efficiency, develop new shipbuilding 
capabilities, and maintain existing capabilities. Examples of each 
category include the following: 

* Improving efficiency—General Dynamics Bath Iron Works built a new 
facility—the Ultra Hall—that improves efficiency by allowing 
shipbuilders to access work space more easily in a climate-controlled 
environment. 

* Developing capabilities—Northrop Grumman Shipbuilding–Newport News 
built a replacement pier that allowed shipbuilders to work on two 
aircraft carriers simultaneously due to a Navy scheduling conflict. 

* Maintaining capabilities—General Dynamics Electric Boat invested to 
repair docks in order to maintain the shipyard’s ability to launch and 
repair submarines. 

Investments at two smaller shipyards, Austal USA and Marinette Marine 
shipyard, were primarily to maintain and develop new capabilities as 
both are competing for new Navy contracts. 

Over the last 10 years, the Navy expanded its use of investment 
incentives and has recently provided some form of investment support 
at all large shipyards. To incentivize facility and equipment 
investments, the Navy has (1) released money early from the reserve of 
contract funds normally held back to ensure ships are delivered 
according to specifications, (2) accelerated asset depreciation 
schedules, (3) tied a portion of the contractor’s fee to investing in 
new facilities and equipment, and (4) adjusted the contract share-line 
to give the contractor more of the savings if costs decrease. The Navy 
also manages funds appropriated by Congress for Hurricane Katrina 
relief at shipyards in the Gulf Coast. Outside of Hurricane Katrina 
funding, the Navy has not supported investments at the two smaller 
shipyards. Navy officials stated that the Navy has to negotiate 
investment incentives with large shipyards because limited competition 
and instability of Navy work does not foster an environment for 
shipyards to invest without incentives. Shipyard officials argued that 
instability in Navy shipbuilding plans makes it difficult to invest 
without guaranteed work from the Navy and incentives are necessary to 
help meet corporate minimum rates of return needed to justify an 
investment, especially given the large dollar amounts involved with 
some investments. 

The Navy lacks policy to help ensure it achieves goals and objectives 
from providing facility and equipment investment incentives at private 
shipyards. Absent this policy, individual program offices and 
contracting officers make decisions about what type of incentive to 
use, desired return on investments, and what kinds of investments to 
support. Without policy, program officers and contracting officers use 
different methods to validate expected outcomes and safeguard the 
Navy’s financial support. 

What GAO Recommends: 

GAO recommends that the Navy develop a policy that identifies the 
intended goals and objectives of investment incentives, criteria for 
using incentives, and methods for validating outcomes. The Department 
of Defense concurred with this recommendation. 

View [hyperlink, http://www.gao.gov/products/GAO-10-686] or key 
components. For more information, contact Belva Martin at (202) 512-
4841 or martinb@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Private Shipyards Made Investments to Improve, Upgrade, and Maintain 
Facilities and Equipment over the Last 10 Years: 

The Navy Supports Facilities and Equipment Investments by Offering 
Incentives at Most Major Shipyards and Has Expanded This Support over 
the Last 10 Years: 

The Navy Lacks a Policy to Ensure Investment Incentives Achieve 
Expected Outcomes: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II: Overview of Private Shipyards and Summary of Navy 
Investment Incentives: 

Appendix III: Comments from the Department of Defense: 

Appendix IV: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Selected Investments at Major Shipyards over the Last 10 
Years and Associated Costs: 

Table 2: Example of the Normal and Accelerated Straight-Line 
Depreciation Payment Schedules for a $90 Million Asset: 

Table 3: Types of Government Support for Shipyards and Contracts That 
Include Them: 

Table 4: Expected Outcomes of Selected Projects Receiving Navy 
Financial Support: 

Table 5: Types of Investment Incentive Safeguards: 

Figures: 

Figure 1: Navy Shipbuilders, Corporate Ownership, and Associated 
Product Lines: 

Figure 2: Public and Corporate Investments at Major Shipyards in 
Improving Efficiency, Maintaining Capabilities, and Developing 
Capabilities (2000-2009): 

Figure 3: Bath Iron Works Ultra Hall: 

Figure 4: Example of Share-Line Adjustment for a Fixed-Price Incentive 
or Cost-Plus Incentive Contract: 

Figure 5: Major Navy-Supported Investments in Shipyard Facilities and 
Equipment (2000-2009): 

Abbreviations: 

CAPEX: Capital Expenditures: 

FAR: Federal Acquisition Regulation: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

July 26, 2010: 

The Honorable Norman D. Dicks: 
Chairman: 
Subcommittee on Defense: 
Committee on Appropriations: 
House of Representatives: 

Dear Mr. Chairman: 

The U.S. Navy builds the most sophisticated, technologically advanced 
ships in the world, but the investment required to build these ships 
is placing pressure on the Department of Defense's ability to afford 
its long-range shipbuilding plans. In its fiscal year 2011 long-range 
plan for shipbuilding,[Footnote 1] the Chief of Naval Operations 
acknowledged that the Navy faces a serious planning challenge over the 
next several decades as it balances legacy ship retirements with the 
need for multimission platforms and significantly increased 
capabilities of current new-construction ships. 

The Department of Defense's ability to afford the long-range 
shipbuilding plan is of importance to both the Navy and privately 
owned shipyards. The Navy has repeatedly reshaped and changed this 
long-range shipbuilding plan, placing its goal of a 313-ship fleet in 
jeopardy. In May 2009,[Footnote 2] we reported on several best 
practices used by commercial shipbuilders to deliver ships on time and 
within budget that could be adopted by the Navy. Based on this work, 
we made several recommendations to the Secretary of Defense aimed at 
improving shipbuilding programs including retiring technical risk and 
stabilizing design at key points and moving to fixed-price contracts 
for the first ships built in a class. As the department works to 
implement some of these best practices, privately owned shipyards can 
also contribute to the overall affordability of ships. One way that 
shipyards can contribute is by making capital investments to modernize 
facilities and equipment to improve efficiency, which could ultimately 
decrease the overall cost of ships by reducing the number of labor 
hours needed to build each ship. 

In light of congressional interest in the Navy's ability to afford its 
shipbuilding plan, you asked that we review investments in facilities 
and equipment at privately owned shipyards.[Footnote 3] Specifically, 
we (1) identified what investments in facilities and equipment 
privately owned shipyards made with both public[Footnote 4] and 
corporate funds over the last 10 years; (2) determined the Navy's role 
in financing facilities and equipment investments at shipyards; and 
(3) evaluated how the Navy ensures that its role in facilities and 
equipment investments at private shipyards results in expected 
outcomes. 

To identify facilities and equipment investments over the last 10 
years, we analyzed data on all capital investments over $1 million at 
the seven privately owned shipyards that build Navy ships: General 
Dynamics Bath Iron Works, General Dynamics NASSCO, General Dynamics 
Electric Boat, Northrop Grumman Shipbuilding-Gulf Coast, Northrop 
Grumman Shipbuilding-Newport News, Austal USA, and Marinette Marine 
shipyard. We supplemented our analysis of the data by interviewing 
officials at each shipyard to obtain an understanding of the purpose 
of these investments. We then categorized the investments at major 
shipyards, and shipyard officials confirmed our categorization of the 
investments. To assess the reliability of each shipyard's data, we 
interviewed knowledgeable shipyard officials about the data and 
confirmed that the data are subject to external audits. We determined 
that the data were sufficiently reliable for the purposes of this 
report. To determine the Navy's role in facilities and equipment 
investments at privately owned shipyards, we reviewed shipbuilding 
contracts, legislation making funds available for shipyards affected 
by Hurricane Katrina, and reports to Congress by the Office of the 
Assistant Secretary of the Navy for Ship Programs regarding capital 
investment strategies at shipyards. To supplement this analysis, we 
held discussions with a number of Navy offices responsible for 
shipbuilding programs. To evaluate how the Navy ensures that its role 
in facilities and equipment investments results in expected outcomes, 
we reviewed shipyard business-case analyses and accompanying documents 
for Navy-supported projects and analyzed approaches across programs to 
identify differences. Appendix I further discusses our scope and 
methodology. 

We conducted this performance audit from October 2009 to July 2010 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

Background: 

The shipbuilding industry in the United States is predominantly 
composed of three different types of shipyards: (1) privately owned 
shipyards that build naval vessels; (2) small privately owned 
shipyards that build commercial vessels; and (3) U.S. government-owned 
naval shipyards that conduct maintenance, repairs, and upgrades on 
Navy and Coast Guard vessels.[Footnote 5] As a result of 
consolidation, two major corporations--General Dynamics and Northrop 
Grumman--own most of the private shipyards that build Navy ships. 
General Dynamics owns Bath Iron Works in Bath, Maine; Electric Boat in 
Groton, Connecticut, and Quonset Point, Rhode Island; and NASSCO in 
San Diego, California. Northrop Grumman owns Northrop Grumman 
Shipbuilding-Gulf Coast with locations in Pascagoula, Mississippi, and 
New Orleans, Louisiana; and Northrop Grumman Shipbuilding-Newport News 
in Virginia. Some of these shipyards maintain additional support 
facilities in other locations to assist in production processes, such 
as Gulf Coast's Gulfport, Mississippi facility that constructs 
lightweight ship components also known as composites. Along with these 
five major shipyards,[Footnote 6] there are two midsized shipyards 
that construct smaller Navy ships. Marinette Marine Corporation in 
Marinette, Wisconsin, is owned by the Italian shipbuilder Fincantieri, 
and Austal USA in Mobile, Alabama, is owned by Austal, which is 
headquartered in Western Australia. Figure 1 shows the location and 
the current product lines of each shipyard. 

Figure 1: Navy Shipbuilders, Corporate Ownership, and Associated 
Product Lines: 

[Refer to PDF for image: illustrated map] 

Map of the Continental USA, depicting the following: 

Marinette Marine Corporation (Midsized Shipyard): 
Marinette, Wisconsin: 
Smaller surface ships. 

Bath Iron Works (Major Shipyard): 
Bath, Maine: 
General Dynamics: 
Surface combatants. 

Electric Boat (Major Shipyards): 
Groton, Connecticut, and Quonset Point, Rhode Island: 
General Dynamics: 
Submarines. 

Newport News (Major Shipyard): 
Newport News, Virginia: 
Northrop Grumman Shipbuilding: 
Submarines and aircraft carriers. 

Austal USA (Midsized Shipyard): 
Mobile, Alabama: 
Smaller surface ships. 

Gulf Coast (Major Shipyard): 
New Orleans, Louisiana, and Pascagoula, Mississippi: 
Northrop Grumman Shipbuilding: 
Auxiliary ships, surface combatants, and amphibious ships. 

NASSCO (Major Shipyard): 
San Diego, California: 
General Dynamics: 
Auxiliary ships. 

Sources: GAO (data), MapArt (map). 

[End of figure] 

Several of these shipyards have specialized production capabilities 
that constrain and dictate the types of vessels each can build and 
limit opportunities for competition within the shipbuilding sector. 
For instance, of the five major shipyards, only Newport News is 
capable of building nuclear-powered aircraft carriers, and only 
Newport News and Electric Boat have facilities for constructing 
nuclear submarines. Furthermore, of the five major shipyards, only 
NASSCO builds commercial ships alongside Navy ships. It typically 
builds Navy auxiliary ships, such as the T-AKE class of dry cargo/ 
ammunition vessels, that share similarities with commercial ships, 
and, according to the shipbuilder, production processes and equipment 
are shared between the two types of projects. 

When the Navy contracts with these shipyards, it must follow 
provisions in the Federal Acquisition Regulation (FAR), which 
establishes uniform policies and procedures for acquisition by all 
executive agencies. In addition, the Cost Accounting Standards provide 
uniformity and consistency in cost accounting practices across 
government contracts.[Footnote 7] As a general policy under the FAR, 
contractors are usually required to furnish all facilities and 
equipment necessary to perform government contracts. However, in 
specific situations, including when it is clearly demonstrated that it 
is in the government's best interest or when government requirements 
cannot otherwise be met, the government may provide government 
property[Footnote 8] to contractors to perform a contract. For 
example, as part of the DDG 1000 destroyer contract, the Navy included 
a requirement for Bath Iron Works to purchase unique equipment 
necessary to produce the DDG 1000. This equipment was acquired as 
government property because the equipment is unique to DDG 1000 
construction and the contractor is unlikely to use it to perform 
another contract. 

When a contractor furnishes facilities and equipment to perform a 
contract, the government recognizes the costs associated with these 
items by paying depreciation and facilities capital cost of money 
costs allocated to the contract. Depreciation and facilities capital 
cost of money costs are indirect contract costs, or costs incurred for 
the general operation of the business that are not specifically 
applicable to one product line or contract.[Footnote 9] The FAR, in 
conjunction with the Cost Accounting Standards, includes provisions 
for how a contractor recovers costs such as depreciation and 
facilities capital cost of money as part of indirect contract costs 
allocated to government contracts.[Footnote 10] By recovering 
depreciation costs, the contractor recoups the cost of an asset--a 
facility or a piece of equipment--over the asset's estimated useful 
life. Facilities capital cost of money acknowledges the opportunity 
cost for a contractor when it uses its funds to invest in facilities 
and equipment in lieu of other investments such as relatively risk-
free bonds. Facilities capital cost of money is determined by 
multiplying the net book value of the contractor's capital assets by a 
cost-of-money rate, which is a rate tied to the U.S. treasury rate. 

With respect to Navy shipbuilding, a shipyard's indirect costs, 
including depreciation and facilities capital cost of money, are 
allocated to the Navy's shipbuilding contracts at the shipyard in 
accordance with the Cost Accounting Standards.[Footnote 11] When a 
shipyard makes facilities and equipment investments, all ships under 
contract during the life of those assets are allocated a portion of 
the assets' indirect costs. Therefore, if the number of ships under 
construction at a given time in a shipyard increases, the indirect 
costs per ship decrease, and if the number of ships under construction 
at a given time in a shipyard decreases, the indirect costs per ship 
increase. 

Private Shipyards Made Investments to Improve, Upgrade, and Maintain 
Facilities and Equipment over the Last 10 Years: 

Over the last 10 years, major shipyards used public and corporate 
funds to invest more than $1.9 billion in facilities and equipment 
that improved shipbuilding efficiency, developed new capabilities, and 
maintained existing capabilities. Figure 2 shows the amount of money 
invested in each category. 

Figure 2: Public and Corporate Investments at Major Shipyards in 
Improving Efficiency, Maintaining Capabilities, and Developing 
Capabilities (2000-2009): 

[Refer to PDF for image: vertical bar graph] 

Investment category: Improving Efficiencies; 
Totals for Major Private Shipyards: $671 million. 

Investment category: Maintaining Capabilities; 
Totals for Major Private Shipyards: $479 million. 

Investment category: Developing Capabilities; 
Totals for Major Private Shipyards: $762 million. 

Source: GAO analysis of data supplied by Bath Iron Works, Electric 
Boat, Gulf Coast, NASSCO, and Newport News. 

Note: Some investments could be placed in more than one category, but 
each investment is only included in the category that best describes 
its primary purpose. This figure excludes approximately $374 million 
spent at Gulf Coast's Pascagoula and Gulfport facilities to repair 
damage from Hurricane Katrina. 

[End of figure] 

These categories are defined as follows: 

* Improving shipbuilding efficiency. Investments in improving 
shipbuilding efficiency generally reduce the number of hours 
shipbuilders spend on a given task, and often allow shipbuilders to 
reorder the sequence of shipbuilding work to achieve new efficiencies. 
For example, investments in improving efficiency can make it possible 
for shipbuilders to complete more work in specially-designed workshops 
and modular assembly buildings, thus having to complete less of the 
work later on in the shipbuilding process inside the more constrained 
environments of almost-completed areas of the ship. To illustrate how 
these investments improve efficiency, shipyard officials often 
describe the "1-3-8 rule of thumb" of shipbuilding work: work that 
takes 1 hour to complete in a workshop, takes 3 hours to complete once 
the steel panels have been welded into units (sometimes called 
modules), and 8 hours to complete after a block has been erected or 
after the ship has been launched.[Footnote 12] For example, inside the 
recently-constructed Ultra Hall at Bath Iron Works, shipbuilders can 
now access work spaces more easily in a climate-controlled environment 
allowing them to finish units at a higher stage of completion before 
they are erected and then moved into the water. Figure 3 is a photo of 
a unit being moved out of the Ultra Hall. 

Figure 3: Bath Iron Works Ultra Hall: 

[Refer to PDF for image: photograph] 

Source: General Dynamics Bath Iron Works. 

[End of figure] 

* Developing new capabilities. Shipyards make investments to develop 
new capabilities so that they can complete new types of tasks. In some 
cases, shipyards need these new capabilities to meet the Navy's 
technical requirements for new ships. For example, to build a newly- 
designed aircraft carrier with heavier metal plate requirements than 
those of previous aircraft carriers, Newport News invested in new 
facilities and equipment. These investments included building a heavy- 
plate facility, and upgrading a crane to make it capable of lifting 
heavier modules. Other shipyards also identified purchasing cranes as 
examples of investments to develop new capabilities. 

* Maintaining capabilities. From time to time, shipyards make major 
investments to replace or repair facilities and equipment. This allows 
the shipyards to maintain existing capabilities for years or decades. 
For example, Electric Boat officials explained that its shipyard had 
to make a major investment in dock repair in order to maintain the 
shipyard's ability to launch and repair submarines. 

Through investments to improve efficiencies and develop new 
capabilities, major shipyards modernized their facilities and 
equipment, thus transforming their shipbuilding processes. Some of 
these investments completely changed the physical layouts of 
shipyards. For example, Bath Iron Works completed a Land Level 
Transfer Facility in 2001, replacing an inclined-way transfer facility 
used since 1890. Bath Iron Works officials explained that with the 
Land Level Transfer Facility, the shipyard now has the capability to 
construct ships in larger, more fully outfitted units on any one of 
three construction lanes. The shipyard also has a floating dry dock 
that it can move to any of the three construction lanes to transfer 
the ship into the water. With this arrangement, the shipyard can 
better manage when a ship is ready to be moved to the water. Another 
example includes NASSCO's facility expansion project, which 
fundamentally changed the layout of the shipyard to increase 
production capacity, throughput, and efficiency. In particular, NASSCO 
added new production lanes to reduce shipyard congestion, allowing 
builders to move units around the shipyard with reduced bottlenecks, 
and added a modern blast and paint facility to improve paint process 
efficiency while reducing emissions. Finally, Newport News built a new 
pier, thus increasing its capacity for servicing and completing 
construction of aircraft carriers. 

Table 1 shows selected investments at each major shipyard, sometimes 
funded through public or corporate funds, over the last 10 years. 
These selected investments highlight examples of projects by 
investment category as well as the magnitude of some investments at 
shipyards. 

Table 1: Selected Investments at Major Shipyards over the Last 10 
Years and Associated Costs: 

Corporation, shipyard: General Dynamics; Bath Iron Works; 
Investment: Ultra Hall; 
Investment category and description: Improving Efficiency--Allows 
shipbuilders to construct larger, more complete units before joining 
the units together during ship assembly; 
Years: 2006-2008; 
Cost: $226 million for the three investments. 

Corporation, shipyard: General Dynamics; Electric Boat; 
Investment: Long-term dock repair; 
Investment category and description: Maintaining Capabilities--Extends 
the life of three graving docks, which are used for new-construction 
postdelivery work, as well as overhaul and repair; 
Years: 2004-2009; 
Cost: $226 million for the three investments. 

Corporation, shipyard: General Dynamics; NASSCO; 
Investment: Facility expansion project; 
Investment category and description: Improving Efficiency--Improved 
production efficiency by shifting painting to earlier in the building 
process and increasing preoutfitting capabilities for modules; 
Years: 2007-2009; 
Cost: $226 million for the three investments. 

Corporation, shipyard: Northrop Grumman; Newport News; 
Investment: Pier 3; 
Investment category and description: Developing Capabilities--Allowed 
Newport News to accelerate building a replacement pier so that it 
could support work on two aircraft carriers at the same time due to a 
Navy scheduling conflict; 
Years: 2003-2007; 
Cost: $85 million. 

Corporation, shipyard: Northrop Grumman; Gulf Coast; 
Investment: Pascagoula Panel Line; 
Investment category and description: Improving Efficiency--Improves 
steel panel quality and reduces panel distortion with more accurate 
machines and processes; 
Years: 2005-2008; 
Cost: $79 million. 

Source: GAO analysis of data supplied by Bath Iron Works, Electric 
Boat, NASSCO, Newport News, and Gulf Coast. 

[End of table] 

Two Midsized Shipyards Invested in Facilities and Equipment Mostly to 
Develop New Capabilities or Maintain Capabilities: 

Two midsized shipyards, Austal USA and Marinette Marine Corporation, 
started construction of two different designs of the Littoral Combat 
Ship for the Navy in 2005, and their investments have focused 
primarily on maintaining shipyard capabilities and developing new 
capabilities in order to compete for Navy contracts. Austal USA used 
both public and corporate money to complete investments of 
approximately $155 million in facilities and equipment since 1999, and 
Austal USA officials said these investments were mostly to develop new 
capabilities to compete for Navy business. For example, Austal USA 
officials said that to develop the capacity to work on new Navy ships, 
their shipyard invested approximately $85 million to build the Modular 
Manufacturing Facility. Shipyard officials said that with this 
facility, the yard constructs ships in a modular fashion to maximize 
productivity, efficiency, and throughput. Marinette Marine Corporation 
officials stated that investments over the last 10 years have largely 
been to maintain capabilities, but the shipyard's new owner, 
Fincantieri, plans to make significant investments in the future. 

The Navy Supports Facilities and Equipment Investments by Offering 
Incentives at Most Major Shipyards and Has Expanded This Support over 
the Last 10 Years: 

To incentivize investments, the Navy has provided support to most 
major shipyards with four mechanisms: early release of contract 
retentions, accelerated depreciation, special contract-incentive fees, 
and contract share-line adjustments. However, the Navy has not 
incentivized investments at the two midsized shipyards. Navy officials 
cited the lack of competition and instability of Navy work in 
shipbuilding as major reasons why the Navy needs to incentivize 
investments in facilities and equipment at major shipyards. At the 
shipyards, officials argued that they cannot secure corporate support 
for many investments without Navy incentives. Shipyard officials also 
pointed to instability in the Navy's long-range shipbuilding plans as 
a reason their shipyards usually do not pursue investments without 
Navy support. Over the last 10 years, the Navy has expanded its use of 
investment incentives and is now involved with providing some form of 
investment support at all major shipyards. 

The Navy Negotiated Facilities and Equipment Incentives with Most 
Major Shipyards: 

The Navy has provided support to most major shipyards with four types 
of investment incentives: early release of contract retentions, 
accelerated depreciation, special contract-incentive fees, and share- 
line adjustment. 

* Early release of contract retentions. By releasing contract 
retentions early, the Navy disburses money to a shipyard earlier than 
scheduled from a reserve normally retained to ensure ships are 
delivered according to specifications. For example, instead of holding 
3.75 percent of the contract payments in retentions, the Navy might 
hold only 1.5 percent of the contract payments, releasing the 
remaining 2.25 percent early to a shipyard in exchange for the 
shipyard investing in facilities or equipment. Navy officials said 
that with this incentive, the Navy does not provide additional funds 
to the shipyard, but rather provides funds to the contractor it would 
receive anyway upon successful completion of the contract. 
Shipbuilders said the early release of contract retentions provides 
funds with which the shipyard can make investments that it might 
otherwise not be able to make.[Footnote 13] The early release of 
contract retentions may fund the entire capital investment or a 
portion of the investment. 

* Accelerated depreciation. When accelerating depreciation,[Footnote 
14] the Navy pays the shipyard higher payments for depreciation of an 
asset over a shortened timeline than under a normal depreciation 
payment schedule. In exchange, the shipyard agrees to fund the 
investment. This benefits the shipyard because it recoups its 
investment faster than it would have under a normal depreciation 
schedule. For example, if a shipyard asset has a useful life of 9 
years, the shipyard recoups a portion of the investment each year over 
that span. However, if an incentive agreement accelerated the 
depreciation schedule, the shipyard would receive larger payments 
earlier and over fewer years. Navy and shipbuilding officials 
explained that this kind of incentive can help bridge a gap between an 
investment's expected rate of return and the corporation's desired 
rate of return to help justify making an investment. See table 2 for a 
comparison of normal and accelerated straight-line depreciation. 

Table 2: Example of the Normal and Accelerated Straight-Line 
Depreciation Payment Schedules for a $90 Million Asset: 

Year: 1; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $30 million. 

Year: 2; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $30 million. 

Year: 3; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $30 million. 

Year: 4; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Year: 5; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Year: 6; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Year: 7; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Year: 8; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Year: 9; 
Normal Depreciation Payment: $10 million; 
Accelerated Depreciation Payment: $0. 

Total: 
Normal Depreciation Payment: $90 million; 
Accelerated Depreciation Payment: $90 million. 

Source: GAO. 

Note: This example assumes that the piece of equipment or facility 
does not have a salvage value at the end of its useful life. 

[End of table] 

* Special contract-incentive fee. While incentive fees are used in 
contracts across the Department of Defense generally to motivate 
contractor efforts, the Navy also uses special contract-incentive fees 
to specifically encourage investments in facilities and equipment. On 
a contract that includes such a special incentive fee, a shipyard may 
earn a fee for making an investment. This special fee is available to 
the shipyard only if it agrees to make a Navy-approved investment. The 
special fee may pay for all or part of the investment. In some cases, 
the incentive bridges the difference between the corporation's desired 
rate of return and the projected return on an investment. 

* Contract Share-Line Adjustment. The contract share-line defines what 
share of underruns or overruns will accrue to the contractor and the 
Navy. By adjusting the contract share-line ratio, the Navy can 
incentivize a contractor to invest in facilities or equipment that 
will reduce costs. For example, during original contract negotiations 
for a fixed-price incentive or cost-plus incentive contract, the two 
parties may agree to an even share of the savings if the total 
negotiated or allowable cost ends up being less than the total target 
cost. Through a contract modification, the Navy could change the 
original sharing ratio so that more of the savings are given to the 
contractor. Under this modification, the contractor is incentivized to 
invest in a facility or equipment that may reduce costs so that it 
earns a higher fee. The Navy will benefit from these lower costs on 
all future contracts. See figure 4 for an example of a share line 
adjustment. 

Figure 4: Example of Share-Line Adjustment for a Fixed-Price Incentive 
or Cost-Plus Incentive Contract: 

[Refer to PDF for image: illustration] 

Expected cost: $100 million
Actual cost: $80 million
Savings: $20 million. 

Original contract–50/50 share: 
Savings to government: $10 million; 
Savings to contractor: $10 million. 

Modified contract–20/80 share: 
Savings to government: $4 million; 
Savings to contractor: $16 million. 

Source: GAO. 

[End of figure] 

The Navy also manages Hurricane Katrina relief funds, which Congress 
appropriated for infrastructure improvements at shipyards that build 
Navy ships in states affected by Hurricane Katrina. This support 
differs from incentive programs at other shipyards because it is 
direct federal funding and is not tied to a specific Navy shipbuilding 
program. These funds were not directed to repairing specific damage 
from the hurricane, but can be used for a variety of projects at 
eligible shipyards.[Footnote 15] 

Table 3 provides an overview of investment incentive mechanisms and 
how the Navy has used each incentive to support investments at 
shipyards. Appendix II includes additional details of the investment 
incentives at each shipyard. 

Table 3: Types of Government Support for Shipyards and Contracts That 
Include Them: 

Government support: Investment Incentives; Early release of contract 
retentions; 
Navy actions: The Navy releases money early from the reserve of 
contract retentions normally held back to ensure ships are delivered 
according to specifications; 
Shipyard benefit: The shipyard has more financial resources than it 
would otherwise have to make new investments; 
Supported contracts or shipyard (projects): 
* DDG 51 (Ultra Hall and Land Level Transfer Facility); 
* T-AKE (facility expansion project); 
* Sealift (new cranes). 

Government support: Investment Incentives; Accelerated depreciation; 
Navy actions: The Navy accelerates the depreciation schedule for an 
asset; 
Shipyard benefit: The shipyard recoups its investment more quickly. 
This helps to bridge the gap between an investment's projected rate of 
return and the corporation's desired rate of return; 
Supported contracts or shipyard (projects): 
* Newport News (pier construction); 
* Electric Boat (dock modernization); 
* Virginia-class submarine (Block I projects)[A]. 

Government support: Investment Incentives; Special contract-incentive 
fee; 
Navy actions: The Navy ties some of the contractor's fee to investing 
in facilities and equipment; 
Shipyard benefit: The shipyard earns a fee for making certain approved 
investments. The incentive can help bridge the gap between an 
investment's projected rate of return and the corporation's desired 
rate of return; 
Supported contracts or shipyard (projects): 
* DDG 51 (Ultra Hall); 
* CVN 21 (projects supporting the new carrier design); 
* Virginia-class submarine (Capital Expenditures (CAPEX) projects). 

Government support: Investment Incentives; Contract share-line 
adjustment; 
Navy actions: The Navy adjusts the share line between itself and the 
contractor to give the contractor a greater share of the savings if 
lower costs are achieved; 
Shipyard benefit: The shipyard receives a greater profit if it invests 
in a facility or equipment that leads to cost savings; 
Supported contracts or shipyard (projects): 
* DDG 51 (Ultra Hall). 

Government support: Hurricane Katrina Relief; Federal Hurricane 
Katrina funds; 
Navy actions: The Navy administers funds appropriated by Congress to 
improve shipyard facilities and equipment in the states affected by 
Hurricane Katrina; 
Shipyard benefit: Shipyards receive money to help support projects 
approved by the Navy. These projects are not tied to any particular 
shipbuilding contract; 
Supported contracts or shipyard (projects): 
* Austal Modular Manufacturing Facility; 
* Gulf Coast Pascagoula Panel Assembly Line; 
* Gulf Coast Gulfport Composites Manufacturing Facility. 

Source: GAO analysis of Navy data. 

[A] The Navy purchases the Virginia-class submarines in blocks. The 
first block includes four submarines, the second block includes six 
submarines, and the third block includes eight submarines. 

[End of table] 

The Navy has not negotiated investment incentives at the two midsized 
shipyards, Austal USA and Marinette Marine Corporation, which are both 
competing for the Littoral Combat Ship contract, though both received 
other forms of federal government support for facilities and equipment 
investments. Both shipyards received grants from the U.S. Department 
of Transportation's Maritime Administration, which are available to 
small shipyards for capital and related improvements that foster 
efficiency and competitive operations. For example, Marinette Marine 
Corporation officials said that their shipyard received $1.4 million 
to help finance investments for new cranes. In addition, Austal 
received almost $34 million of federal Hurricane Katrina funds to help 
finance its Modular Manufacturing Facility. Both midsized shipyards 
have plans for further expansions, but as of now, neither shipyard 
plans to request Navy investment incentives to execute these plans. 

Incentives May Encourage Major Shipyards to Make Facilities and 
Equipment Investments That They Might Not Make on Their Own: 

Navy officials, shipyard officials, and corporate officials from 
Northrop Grumman and General Dynamics provided different perspectives 
on reasons for using incentives to encourage investment in the Navy 
shipbuilding market. 

Navy officials told us that the Navy negotiates investment incentives 
with major shipyards because limited competition in the market does 
not foster an environment that encourages shipyards to invest without 
incentives. For example, Newport News is the only shipyard capable of 
building aircraft carriers. A Navy contracting officer said that, as a 
result, there may be a disincentive for Newport News to invest in 
projects that improve efficiency. Generally speaking, at contract 
negotiation, the government's proposed contractor fee is based on a 
percentage of total estimated allowable contract costs, with the 
percentage reflecting various weighted risk factors. Newport News, as 
a sole supplier, will likely construct all future aircraft carriers 
but could earn a lower fee if new efficiencies reduce the total cost 
of construction.[Footnote 16] Even in cases where there is limited 
shipbuilding competition, such as with surface combatants, shipyards 
may face similar disincentives to invest. If the shipyard invests to 
improve efficiency, these investments will likely reduce the price of 
a ship and can lower future profits. However, where some competition 
exists, better efficiency may lead to winning a greater allocation of 
future work. Navy officials added that shipyards that are not 
confident Navy work will materialize or be funded as scheduled are 
reluctant to make capital investments without government incentives. 

Officials from major shipyards argued that instability in long-range 
Navy shipbuilding plans discourages shipyards from making investments 
without guaranteed Navy work. Because major shipyards generally do not 
perform commercial work, there are few other inducements to invest in 
new facilities and equipment other than Navy shipbuilding 
opportunities. For example, at one shipyard, an official explained 
that it had invested in a facility in anticipation of an upcoming 
contract. The Navy changed the shipbuilding program and did not award 
the contract, rendering this facility underutilized until receipt of 
another contract several years later. The official emphasized that 
this shipyard will never invest again in new facilities without a 
signed contract guaranteeing future work. The official added that to 
do otherwise would not be a prudent business decision. 

Officials from major shipyards also argued that their shipyards need 
Navy incentives because many potential investments in facilities and 
equipment do not meet the corporation's desired rate of return. In 
addition, some shipyard officials stated that since they cannot secure 
corporate investments for many projects, they often looked first for 
state or federal support for new investments to help to bridge the gap 
between their corporation's desired rate of return and the expected 
rate of return of the investment. 

Corporate officials argued that the low rates of shipbuilding 
production, low shipbuilding fees relative to invested capital, and 
length of time it takes to build a ship sometimes mean investments 
take too long to generate an acceptable return, or will never generate 
an acceptable return. Moreover, officials stated that shipyard 
investments are large, sometimes exceeding $25 million for a single 
investment. Furthermore, other sectors of these corporations are often 
better positioned than shipyards to propose investments that achieve 
the corporation's desired rate of return because these sectors can use 
less expensive investments to improve processes for high-volume 
products. Corporate officials agreed that corporations would generally 
make investments in maintaining capabilities without meeting a 
corporation's desired rate of return because these investments are 
necessary to stay in business. 

The Navy Increased Support for Investments at Major Shipyards over the 
Past 10 Years, Generally by Expanding the Use of Investment Incentives: 

Over the past 10 years, the Navy has moved from providing onetime 
support of major capital investments to more routine support of 
investment spending at all five major shipyards.[Footnote 17] In 2000, 
Bath Iron Works was in the process of completing construction of its 
Land Level Transfer Facility, which was an investment that the Navy 
incentivized through early release of contract retentions. Since then, 
the Navy has used investment incentives to facilitate facilities and 
equipment investments at four of the five major shipyards, across 
multiple shipbuilding programs. At the fifth major shipyard, Gulf 
Coast, the Navy administered Hurricane Katrina recovery money to 
support investments. Since 2007, the Navy has actively supported 
investments at all major shipyards with investment incentives or 
Hurricane Katrina recovery funding. Figure 5 shows the Navy's expanded 
support to private shipyards over the last 10 years. 

Figure 5: Major Navy-Supported Investments in Shipyard Facilities and 
Equipment (2000-2009): 

[Refer to PDF for image: illustrated table] 

Austral USA: 
2007-2009: Hurricane Katrina funding. 

General Dynamics Bath Iron Works: 
2000: Early release of contract retentions; 
2006: Early release of contract retentions; 
2007: Special contract-incentive fee; 
2008: Share-line adjustment. 

General Dynamics Electric Boat: 
2000-2002: Accelerated depreciation; 
2003-2009: Special contract-incentive fee; 
2004-2007: Accelerated depreciation; 
2006-2009: Accelerated depreciation. 

General Dynamics NASSCO: 
2000-2001: Early release of contract retentions; 
2006-2009: Early release of contract retentions. 

Northrop Grumman Shipbuilding–Gulf Coast: 
2006-2009: Accelerated depreciation. 

Northrop Grumman Shipbuilding–Newport News: 
2003-2007: Accelerated depreciation; 
2003-2009: Special contract-incentive fee; 
2004-2009: Special contract-incentive fee. 

Source: GAO analysis of Navy and contractor data. 

[End of figure] 

Senior-level Navy officials stated that negotiating facilities and 
equipment incentives are becoming a routine part of contract 
negotiations, but officials expressed different opinions over which 
mechanisms are most useful. While the Navy has used early release of 
retentions and accelerated depreciation throughout the past 10 years, 
it has recently started to negotiate special contract-incentive fees 
during contract negotiation as a part of its cost-control strategy, 
such as during the Virginia-class submarine Block II and Block III 
contract negotiations. Senior-level Navy officials have differing 
views on whether it is better to include incentives as part of a 
contract or to negotiate after the Navy awards a contract. One 
contracting officer observed that the length of time involved in 
obtaining the required Cost Accounting Standards Board waiver for 
accelerated depreciation may have led officials to pursue other 
investment incentives. 

Potential exists that contractors may ask the Navy and other services 
to expand the scope of current incentive activities. Shipyards have 
already started to request incentives for a variety of projects 
outside of investments in facilities and equipment, and a shipyard 
recently requested funding assistance for lean six-sigma process-
improvement training. In addition, the T-AKE contract includes a cost-
reduction initiative in which the Navy paid for projects that reduced 
costs through design and producibility improvements, but did not 
require new investments in facilities or equipment. Moreover, we were 
told by one company that corporate divisions supporting other 
government-related product lines have expressed interest in these 
types of facilities and equipment incentives. 

The Navy Lacks a Policy to Ensure Investment Incentives Achieve 
Expected Outcomes: 

The Navy does not have a policy outlining its goals and objectives for 
providing financial incentives to shipyards to encourage facilities 
and equipment investments. Without such a policy, the Navy has not 
identified if there is a minimum return on investment expected for 
this support and the kinds of investments that are in the best 
interest of the Navy to support. The Navy has also not considered the 
extent to which investment incentives affect depreciation and 
facilities capital cost of money at shipyards. Navy officials also 
lack guidance on how to validate outcomes and safeguard financial 
interests, thus resulting in varying approaches across programs. 

The Navy Has Not Defined Objectives for Providing Investment Support 
to a Shipyard: 

In a 2008 report to Congress, the Navy recognized a need to clarify 
its priorities and objectives for supporting investments at shipyards, 
but has not yet developed this clarifying guidance. Navy officials 
stated that program offices and contracting officers negotiate 
incentives on a program-by-program basis and there is no guidance on 
which investment mechanism is appropriate under which circumstances. 
Use of special contract incentives fees is becoming common, yet some 
Navy officials suggested that adjustments in contract terms such as a 
share-line adjustment provide a strong incentive for successful 
program implementation. 

While reducing cost is the goal of many facilities and equipment 
investment incentives, the Navy does not define a metric or minimum 
desired level for these reductions in cost. This results in 
differences in expected outcomes across investment mechanisms. Table 4 
highlights variations in the types of expected outcomes with examples 
by shipyard, investment, and investment mechanism. Given the variation 
in the expected outcomes, it is difficult to ascertain if the Navy has 
a minimum return it expects to receive by providing financial support 
or if just any return is sufficient. 

Table 4: Expected Outcomes of Selected Projects Receiving Navy 
Financial Support: 

Shipyard: Bath Iron Works; 
Investment: Ultra Hall; 
Investment mechanism: Early release of contract retentions, special 
contract-incentive fee, and share-line adjustment; 
Expected outcome: Labor hour reduction over two ships. 

Shipyard: Electric Boat; 
Investment: Automation in light fabrication; 
Investment mechanism: Virginia-class submarine Block II--special 
contract-incentive fee; 
Expected outcome: Labor hour savings between 2006 and 2023. 

Shipyard: NASSCO; 
Investment: Facility expansion plan; 
Investment mechanism: Early release of contract retentions; 
Expected outcome: Labor hour savings, overhead and volume savings, and 
escalation savings over several ships. 

Shipyard: Northrop Grumman Shipbuilding-Gulf Coast; 
Investment: Ingalls operations panel assembly line; 
Investment mechanism: Hurricane Katrina relief funds; 
Expected outcome: Cost savings per panel. 

Shipyard: Northrop Grumman Shipbuilding-Newport News; 
Investment: 900-ton crane upgrade; 
Investment mechanism: CVN 21 special contract-incentive fee; 
Expected outcome: Cost savings between 2008 and 2013. 

Source: GAO analysis of Navy and contractor documents. 

[End of table] 

Moreover, our review of the Virginia-class submarine Block II capital 
expenditures (CAPEX) clause showed that the Navy lacks a desired level 
of return within this investment mechanism. Navy officials responsible 
for approving business cases for the incentive stated that contractors 
are only required to demonstrate that the investment will result in 
savings on the Block II submarines and long-term savings to the 
government. Officials explained that their methodology is guided by 
the following contract language: 

the Contractor shall be eligible to receive a special incentive based 
upon the Contractor and/or Major Subcontractor Newport News 
Shipbuilding investing in such projects that result in savings to the 
Government for the submarines under this contract and long term 
savings to the Government for the Virginia Class submarine program. 

As a result of this contract language, the contractors are not 
required to include return on investment calculations, calculate the 
net present value of savings on future submarines, or consider the 
share-line ratio to calculate actual savings to the government. 
Reviewing officials stated that even when contractors included return-
on-investment calculations in the business cases, the officials did 
not review it because such calculations were not required in the 
contract language. The contracting officer responsible for managing 
Virginia-class submarine CAPEX stated that this contract language is 
too vague concerning when to approve or disapprove a project based on 
estimated savings, and if a similar incentive is used again, the 
contract should include criteria for when to approve or disapprove a 
project. To illustrate, the contracting officer stated that a 
contractor submitted a business case under Block II CAPEX for a 
project expected to cost $4 million with $10,000 in expected savings 
on Block II submarines and additional saving accruing on future 
submarines beyond Block II. The contracting officer stated that the 
Navy did not approve the project because the expected savings on Block 
II were so low, but such a decision was difficult to support based on 
the contract language.[Footnote 18] 

Individual program offices and contracting officers also make 
decisions about which types of investments to pursue, without any 
policy from the Navy about the kinds of investments that are in its 
best interest. Most of the investments the Navy supported fall into 
the category of improving efficiency at the shipyards. Some of the 
more recent investments, however, could also be considered as 
maintaining or developing capabilities at the shipyards. It is unclear 
whether or not the Navy has determined that these investments are in 
fact in its best interest. For example, according to officials, the 
Virginia-class submarine Block II and Block III clauses do not 
prohibit approving maintenance projects as long as these projects 
generate cost savings. In 2009, the Navy paid a special contract-
incentive fee to Electric Boat to refurbish equipment past its normal 
service life in order to prevent major failures that would result in 
an injury or equipment damage and affect production schedules. In a 
similar manner, Newport News submitted a business case to receive a 
special contract-incentive fee to support repairs to its foundry, 
stating that near-term investment was necessary because the average 
age of most of the equipment is well past its average useful service 
life and at a high risk of mechanical failure. The Navy did not 
approve this business case under the Block II special contract 
incentive fee because Newport News was unable to demonstrate savings 
on the Block II submarines, a stipulation in the contract language. 
However, the Navy encouraged the shipyard to resubmit the proposal if 
it could demonstrate savings on future submarine construction. Such 
investments to maintain capabilities are likely to generate some cost 
savings and may better position the shipyards to increase submarine 
production rates, but some officials indicated that such investments 
should actually be contractor responsibilities. 

The Navy Has Not Considered the Extent to Which Investment Incentives 
Affect Indirect Costs at Shipyards: 

The Navy also lacks policy on how to determine an incentivized 
investment's effect on indirect costs to the Navy. As the Navy is 
incentivizing investments up front, it is unclear whether contractors 
should be able to recover indirect costs associated with these assets 
through depreciation and facilities capital cost of money. While the 
Navy did not allow the contractor to recover depreciation and 
facilities capital cost of money for investments supported with 
Hurricane Katrina funds, some agreements explicitly provide that the 
contractor can recover costs for incentivized facilities and equipment 
investments. However, Defense Contract Audit Agency officials 
questioned a facilities capital cost of money claim that one shipyard 
included in its indirect costs because the Navy provided an incentive 
to construct the facility. Nonetheless, officials concluded that the 
contractor could recover these costs from the Navy because it was 
unclear in the terms of the contract, and neither the Federal 
Acquisition Regulation nor the Cost Accounting Standards address 
recovery of facilities capital cost of money for facilities receiving 
incentive support. Defense Contract Audit Agency officials stated that 
they believe it is unfair that contractors can recover facilities 
capital cost of money costs on incentivized facilities and this issue 
needs to be reevaluated if the Navy continues to incentivize 
investments. 

In instances where the incentive agreement explicitly states that the 
contractor can recover these long-term costs, officials evaluating 
business cases stated that they do not always consider these long-term 
costs when comparing the cost of the project with potential savings. 
Specifically, Navy officials stated that they did not consider the 
effect of depreciation when evaluating Virginia-class submarine Block 
II CAPEX projects. 

Differences Exist for Validating Expected Outcomes and Safeguarding 
Financial Interest If Expected Outcome Is Not Achieved: 

In the absence of Navy guidance, approaches vary by investment 
incentive for validating whether or not a project achieves expected 
outcomes and safeguarding Navy financial interest if a project does 
not achieve expected outcomes. Some investment incentives require 
validation of anticipated savings whereas others only require a 
validation of project construction milestones. For example, officials 
described a lengthy review of savings validation associated with the 
first Virginia-class submarine CAPEX Block II project, but later 
indicated the process has evolved over time and other validations have 
been more straightforward. According to Navy officials managing the 
Virginia-class CAPEX incentive, the contract provides little guidance 
on how to validate outcomes, so program officials developed the 
current validation process after the contract was signed. However, the 
CVN 21 program office did not validate anticipated savings after 
investments were complete, but validated investments based on 
construction milestones. Because the Navy negotiated a lower target 
cost for the future carrier, Navy officials stated that it is not 
necessary to validate the savings associated with these projects. 
These officials added that it would be difficult to calculate an 
accurate baseline against which to compare labor hours with and 
without the new investments because the new carrier had never been 
constructed. 

In the absence of a Navy policy, program and contracting officials 
also negotiate various methods to safeguard the Navy's financial 
interest in the event that expected outcomes for the investment 
incentive are not achieved. The range of methods is seen in table 5. 

Table 5: Types of Investment Incentive Safeguards: 

Safeguard measure: Recoupment; 
Navy action: The Navy takes back its financial support if the 
contractor does not meet predetermined construction milestones or 
anticipated savings thresholds; 
Benefit to the Navy: The Navy can receive returned funds from the 
contractor if the project is not executed properly. This safeguard 
encourages the contractor to complete the investment in accordance 
with the terms of the investment mechanism; 
Example of incentive mechanism using safeguard: Virginia-class 
submarine special contract-incentive fee (CAPEX)--The Navy can recoup 
the incentive if the project does not meet the proposed schedule or 
generate the anticipated cost savings. The contracts state that all or 
any portion of the incentive can be recouped, but do not detail how 
the percentage would be determined. 
CVN 21 special contract-incentive fee--The Navy can recoup the special 
incentive fee associated with these investments in the event that the 
contractor fails to substantially complete a facility when it would be 
needed to support CVN 21's construction schedule. 

Safeguard measure: Modified contract terms; 
Navy action: The Navy renegotiates terms on current contracts; 
Benefit to the Navy: This safeguard encourages the contractor to 
achieve the outcomes expected from the investment and to protect the 
Navy's interest if the contractor did not achieve these outcomes; 
Example of incentive mechanism using safeguard: Ultra Hall--The Navy 
and the contractor negotiated changes to target price and other 
elements of the incentive fee structure for two DDG 51 destroyers. 

Safeguard measure: Savings included in future contract; 
Navy action: The Navy includes savings associated with incentivized 
projects in subsequent contracts; 
Benefit to the Navy: This safeguard allows the Navy to further 
incentivize the contractor's achievement of anticipated savings and 
ensure its receipt of savings regardless of investment completion; 
Example of incentive mechanism using safeguard: CVN 21 special 
contract-incentive fee--The contractor agreed to reflect savings for 
investments made under the CVN 78 construction preparation contract in 
the construction proposal. 
Ultra Hall--The contractor agreed to include savings associated with 
the Ultra Hall in its proposed costs for future contracts. 
Virginia-class submarine CAPEX--Navy officials stated that all savings 
for investments made under Block II CAPEX were included in the Block 
III contract. 

Safeguard measure: Staggered disbursement; 
Navy action: The Navy disburses the incentive to the contractor in 
increments triggered by construction progress or other milestones; 
Benefit to the Navy: Staggered disbursement allows the Navy to 
encourage progression toward expected outcomes before it provides the 
entire incentive amount to the contractor, thus reducing the project's 
risk; 
Example of incentive mechanism using safeguard: Federal Hurricane 
Katrina funds--The Navy pays a defined portion of the project's cost 
after the contractor demonstrates that it has completed specified 
construction tasks. 
Virginia-class submarine CAPEX--The contractor receives half of the 
incentive amount for Virginia-class submarine Block II CAPEX projects 
when the Navy approves the project and the remaining amount when the 
contractor implements the project. 

Source: GAO analysis of Navy and contractor documents. 

[End of table] 

In addition to variation in the types of safeguards used across 
incentive mechanisms, the Navy has used the same investment mechanism--
early release of contract retentions--for two different programs, but 
the safeguarding mechanism differed. The Navy modified the terms of 
the DDG 51 contract by negotiating changes to target price as a 
safeguard when it agreed to support the Ultra Hall investment through 
early release of contract retentions and payment of a special contract-
incentive fee. In comparison, when the Navy agreed to an early release 
of contract retentions to support the facilities expansion project at 
NASSCO, program officials stated that the Navy did not renegotiate the 
terms of the T-AKE contract. In both instances, officials stated that 
the maturity of the DDG 51 and T-AKE programs were factors in deciding 
to release contract retentions early; the Navy awarded Bath Iron Works 
the first DDG 51 destroyer contract in 1985 and NASSCO started 
construction of the T-AKE class in 2003. 

Conclusions: 

Over the past 10 years, the Navy has expanded the use of investment 
incentives to encourage shipyards to make investments that may reduce 
costs of future ships. In a 2008 report to Congress, the Navy 
acknowledged a need to clarify its priorities and objectives for 
providing investment incentives to shipyards. However, the Navy has 
yet to do this, and the absence of policy leaves the overall goals and 
intended outcomes of this support unclear. Decisions about when a 
particular incentive should be chosen, what returns are acceptable 
across programs, and what types of investments the Navy should support 
are made on a case-by-case basis without guidance. Also, it is unclear 
whether or not contractors should be able to claim recovery for 
certain indirect costs related to assets supported by incentive 
mechanisms. Further, given the absence of policy, inconsistencies 
exist regarding the importance attached to validating outcomes and how 
to safeguard the Navy's financial support in the event that the 
expected outcome is not achieved. 

Recommendations for Executive Action: 

We recommend that the Secretary of Defense direct the Secretary of the 
Navy to develop a policy that identifies the intended goals and 
objectives of investment incentives, criteria for using incentives, 
and methods for validating outcomes. 

Agency Comments and Our Evaluation: 

The Department of Defense agreed with our recommendation to develop a 
policy that identifies the intended goals and objectives of investment 
incentives, criteria for using incentives, and methods for validating 
outcomes. The department stated that the Navy intends to include 
guidance for program managers and contracting officers in a Navy best- 
practices guidebook. 

The department's written comments can be found in appendix III of this 
report. The department also provided technical comments, which were 
incorporated into the report as appropriate. 

We are sending copies of this report to interested congressional 
committees, the Secretary of Defense, and the Secretary of the Navy. 
The report also is available at no charge on the GAO Web site at 
[hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-4841 or martinb@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff who made major 
contributions to this report are listed in appendix IV. 

Sincerely yours, 

Signed by: 

Belva Martin: 
Acting Director: 
Acquisition and Sourcing Management: 

[End of section] 

Appendix I: Scope and Methodology: 

To identify facilities and equipment investments over the last 10 
years, we obtained and analyzed data on all capital investments over 
$1 million at all major, privately owned shipyards including General 
Dynamics Bath Iron Works, General Dynamics NASSCO, General Dynamics 
Electric Boat, Northrop Grumman Shipbuilding-Gulf Coast, Northrop 
Grumman Shipbuilding-Newport News, and two smaller, privately owned 
shipyards, Austal USA and Marinette Marine shipyard. We supplemented 
our analysis of the data by interviewing officials at each shipyard to 
obtain an understanding of the purpose of these investments. We then 
categorized the investments at major shipyards into three groups, and 
shipyard officials confirmed our categorization of the investments. In 
our analysis we excluded some investments such as investments that 
exclusively supported nuclear aircraft carrier and submarine 
refuelings, modernizations, and service life extensions programs. We 
also excluded information-technology investments and annual operating 
capital. To assess the reliability of each shipyard's data, we 
interviewed knowledgeable shipyard officials about the data and 
confirmed that the data are subject to external audits. We determined 
that the data were sufficiently reliable for the purposes of this 
report. We also interviewed officials at each shipyard's Supervisor of 
Shipbuilding, Conversion, and Repair to understand investments over 
the past 10 years and how those investments may have affected each 
shipyard's work flow and processes. We also interviewed relevant 
Defense Contract Audit Agency officials at major private shipyards. 

To determine the role the Navy had in facilities and equipment 
investments at privately owned shipyards, we reviewed shipbuilding 
contracts, legislation making funds available for shipyards affected 
by Hurricane Katrina, and Deputy Assistant Secretary of the Navy for 
Ship Programs reports to Congress regarding capital-investment 
strategies at shipyards. To assist with identifying when the Navy has 
provided support for facilities and equipment investments, we held 
discussions with: the CVN 21 program office; DDG 51 program office; 
Joint High Speed Vessel program office; T-AKE program office; Virginia-
class submarine program office; Program Executive Office, Ships; 
Supervisor of Shipbuilding, Conversion, and Repair (Bath, Groton, Gulf 
Coast, and Newport News); and Naval Sea Systems Command-Contracts. 
After identifying which mechanisms the Navy uses to provide support to 
shipyards for facilities and equipment investments and when these 
investments were used, we analyzed the data to determine any trends 
over the past 10 years. To supplement this analysis, we met with 
officials from the Office of the Deputy Assistant Secretary of the 
Navy-Ships, the Office of the Deputy Assistant Secretary of the Navy- 
Acquisition and Logistics Management, and the Office of the Secretary 
of Defense-Industrial Policy to understand how the Navy's role in 
investment support at shipyards has evolved over the past 10 years. We 
also met with officials from General Dynamics Marine Systems and 
Northrop Grumman Shipbuilding to understand their corporate processes 
for when to make facilities and equipment investments and how the 
Navy's support is considered during that process. 

To evaluate how the Navy ensures its role in facilities and equipment 
investments results in expected outcomes, we reviewed shipyard 
business-case analyses and accompanying documents for Navy-supported 
projects and analyzed approaches across programs to identify 
differences and presence of formal validation of attainment of 
expected benefits. We supplemented this analysis with interviews of 
officials responsible for managing investment incentives including the 
CVN 21 program office; T-AKE program office; Virginia-class submarine 
program office; Program Executive Office, Ships; Supervisor of 
Shipbuilding, Conversion, and Repair (Bath, Groton, Gulf Coast, and 
Newport News). 

We conducted this performance audit from October 2009 to July 2010 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

[End of section] 

Appendix II: Overview of Private Shipyards and Summary of Navy 
Investment Incentives: 

Austal USA: 

Corporation and Location: 
Austal is an Australian-based company with a U.S. location in Mobile, 
Alabama. 

Year Acquired (Corporation): 
Not applicable: 

Product Line: 
Smaller surface ships: 

Navy Program Overview: 
Austal USA is the Navy's prime contractor for the Joint High Speed 
Vessel and teamed with General Dynamics Bath Iron Works for 
construction of the Littoral Combat Ship. The Navy has contracted with 
Austal USA for three Joint High Speed Vessels and an option for seven 
more. The Navy has also contracted with General Dynamics Bath Iron 
Works for two Littoral Combat Ships built at Austal USA shipyard. 
Austal is currently competing as the prime contractor for the next 10 
Littoral Combat Ships. 

Navy Investment Incentives over the Past 10 Years: 
Hurricane Katrina relief funds: 

Description of Investment Incentives: 
In June 2006, Congress enacted the Emergency Supplemental 
Appropriations Act for Defense, the Global War on Terror, and 
Hurricane Recovery, 2006, which included funding for infrastructure 
improvements at Gulf Coast shipyards that had existing Navy 
shipbuilding contracts and were damaged by Hurricane Katrina. 
Following this legislation, the Assistant Secretary of the Navy for 
Research, Development and Acquisition issued a memorandum that 
outlined goals for competitively awarding the funding, provided 
general instructions for how contractors should develop business cases 
supporting funding requests, and established a panel to review 
contractor proposals for funding. The panel awarded Austal USA a 
contract supporting construction of the Modular Manufacturing 
Facility. Disbursement of funds from the Navy to Austal USA was based 
upon completion of predetermined construction milestones. 

Bath Iron Works: 

Corporation and Location: 
Bath Iron Works operates facilities principally in Bath, Maine, and 
has support facilities in Brunswick, Maine. 

Year Acquired (Corporation): 
1995 (General Dynamics): 

Product Line: 
Surface combatants: 

Navy Program Overview: 
Bath Iron Works builds surface combatants including DDG 51 and DDG 
1000. 

Navy Investment Incentives over the Past 10 Years: 
Early release of retentions, share-line adjustment, special contract- 
incentive fees: 

Description of Investment Incentives: 
The Navy used early release of retentions to help support the Bath 
Iron Works investments in a Land Level Transfer Facility. 

The Navy supported Ultra Hall construction by modifying the terms of 
the DDG 51 contract and adding three incentive mechanisms. As part of 
the incentives, the Navy also negotiated a reduced maximum price for 
each DDG 51 ship. 

* By releasing retentions early, corporate and shipyard officials 
stated that the Navy helped Bath Iron Works, and its corporate owner 
General Dynamics, avoid negative cash flows during construction, a 
primary objective of the shipyard and corporate owner. 

* The addition of a special contract-incentive fee gave Bath Iron 
Works an opportunity to earn additional profit by investing in the 
facility. 

* By changing the incentive fee structure, the Navy also gave Bath 
Iron Works an incentive to achieve savings. 

Electric Boat: 

Corporation and Location: 
Electric Boat operates two facilities in Groton, Connecticut, and 
Quonset Point, Rhode Island. 

Year Acquired (Corporation): 
1952 (General Dynamics)[Footnote 19] 

Product Line: 
Submarines: 

Navy Program Overview: 
General Dynamics Electric Boat is the Navy's prime contractor for 
Virginia-class submarines. Through a teaming agreement, Electric Boat 
and Northrop Grumman Shipbuilding-Newport News work together to build 
the submarines. Each contractor is responsible for building designated 
sections and modules, and the contractors alternate final assembly, 
outfitting, and delivery. To date, the Navy has contracted to purchase 
submarines in three blocks. Block I includes four submarines, Block II 
includes six submarines, and Block III includes eight submarines. 

Navy Investment Incentives over the Past 10 Years: 
Accelerated depreciation, special contract-incentive fees: 

Description of Investment Incentives: 

Accelerated Depreciation: 
In 2000, the Navy agreed to accelerate depreciation on five 
investments over the course of the Virginia-class Block I contract. 

In 2004, Electric Boat initiated funding long-term repair of three 
graving docks. The Navy agreed to accelerate depreciation of the long- 
term repairs to 16 years rather than over the docks' entire useful 
life, expected to be over 30 years. 

Special Contract-Incentive Fees: 
The Virginia-class submarine Block II and Block III contracts include 
special incentives to reward the contractor if it develops more 
efficient and cost-effective practices that contribute to the 
production of more affordable submarines. On both contracts, the 
contractor can claim a special incentive for investing in facilities 
and process-improvement projects. Since the submarines are built at 
both Electric Boat and Newport News, both contractors can claim the 
incentive under these contracts. 

Under the Block II contract, the contractor submits a business-case 
analysis to the Supervisor of Shipbuilding, Groton. Within 30 days 
after approval by the Supervisor of Shipbuilding and start of the 
project, the Navy pays the contractor a special incentive not to 
exceed 50 percent of the estimated investment cost. After the 
contractor successfully implements the project as defined in the 
business-case analysis, the Navy pays the contractor another special 
incentive not to exceed 50 percent of the original estimated 
investment cost. The sum of the two incentive payments cannot exceed 
100 percent of the approved business-case analysis estimated 
investment cost. 

During the Block III contract negotiations, Newport News and Electric 
Boat proposed facilities and equipment investments, and savings from 
these investments were included in the target cost. For these 
investments, the contractor submits a business case to claim a special 
incentive fee tied to the first four submarines for the amount 
necessary to achieve the documented corporate minimum return on 
investment. To claim a special incentive fee for the last four 
submarines on the Block III contract, the process mirrors the process 
under Block II. For these projects, the incentive amount can equal up 
to 100 percent of the approved business-case analysis estimated 
investment cost. 

Marinette Marine Corporation: 

Corporation and Location: 
Marinette Marine Corporation is located in Marinette, Wisconsin. 

Year Acquired (Corporation): 
2008 (Fincantieri): 

Product Line: 
Smaller surface ships: 

Navy Program Overview: 
The Navy has contracted with Lockheed Martin for two Littoral Combat 
Ships built at Marinette Marine shipyard. The Navy is currently 
holding a competition for remaining Littoral Combat Ships. 

Navy Investment Incentives over the Past 10 Years: 
None: 

NASSCO: 

Corporation and Location: 
NASSCO operates in San Diego, California. 

Year Acquired (Corporation): 
1998 (General Dynamics): 

Product Line: 
Auxiliary ships: 

Navy Program Overview: 
NASSCO builds auxiliary ships including the T-AKE for Navy sealift 
operations. In recent history, NASSCO's work has been divided 
approximately as follows: 60 percent new construction for the Navy, 20 
percent repair work, and 20 percent new commercial construction. 
NASSCO is the only major private shipyard to perform commercial work 
along with Navy shipbuilding. 

Navy Investment Incentives over the Past 10 Years: 
Early release of contract retentions: 

Description of Investment Incentives: 
The Navy used early release of contract retentions to incentivize 
investments at NASSCO three times over the last 10 years. In 2001, the 
Navy released retentions early to support the acquisition of new 
cranes. In 2006 and 2008, the Navy released retentions early to 
support investments at NASSCO, including some support for investments 
that were part of NASSCO's facility expansion project. These 
investments included projects to modernize the preoutfitting 
facilities such as expanding the M-Lane, improving stage of 
construction 4 activities, and constructing a new blast and paint 
facility. By releasing retentions early, the Navy helped NASSCO 
maintain a positive cash flow while the shipyard made new investments, 
NASSCO officials said. 

Northrop Grumman Shipbuilding-Gulf Coast: 

Corporation and Location: 
Northrop Grumman Shipbuilding-Gulf Coast operates in Pascagoula, 
Mississippi, and New Orleans, Louisiana, with other support facilities. 

Year Acquired (Corporation): 
2001 (Northrop Grumman): 

Product Line: 
Surface combatants, amphibious assault ships, auxiliary ships, and 
Coast Guard patrol boats (cutters): 

Navy Program Overview: 
Northrop Grumman Shipbuilding-Gulf Coast builds DDG 51 surface 
combatants and the hangar, rear Peripheral Vertical Launching System, 
and the composite deckhouse for DDG 1000 surface combatants. It is 
also the prime contractor for the LPD 17 amphibious transport ship and 
the LHA 6 amphibious assault ship. 

Navy Investment Incentives over the Past 10 Years: 
Hurricane Katrina relief funds: 

Description of Investment Incentives: 
In June 2006, Congress enacted the Emergency Supplemental 
Appropriations Act for Defense, the Global War on Terror, and 
Hurricane Recovery, 2006, which included funding for infrastructure 
improvements at Gulf Coast shipyards that had existing Navy 
shipbuilding contracts and were damaged by Hurricane Katrina. 
Following this legislation, the Assistant Secretary of the Navy for 
Research, Development and Acquisition issued a memorandum that 
outlined goals for awarding the funding, provided general instructions 
for how contractors should develop business cases supporting funding 
requests, and established a panel to review contractor proposals for 
funding. Northrop Grumman Shipbuilding-Gulf Coast submitted several 
proposals for review and the panel awarded this shipyard one contract 
supporting two separate investments, with an option for a third. The 
contract includes funding to support purchasing equipment for a panel 
line at the Pascagoula, Mississippi, shipyard, an option for funding 
to support equipment for a panel line at the New Orleans, Louisiana, 
shipyard, and special tooling for the composite manufacturing facility 
in Gulfport, Mississippi. Disbursement of funds from the Navy to 
Northrop Grumman Shipbuilding-Gulf Coast is based upon completion of 
predetermined construction milestones. To date, the Navy has expended 
100 percent of funding on the contract for the Pascagoula panel line, 
0 percent of funding on the contract for the Avondale panel line, and 
approximately 90 percent of funding on the contract for the composite 
manufacturing facility. Navy officials stated that funding for the 
Avondale panel line is contingent upon Northrop Grumman Shipbuilding-
Gulf Coast demonstrating returns on the panel line in Pascagoula, 
Mississippi. 

Northrop Grumman Shipbuilding-Newport News: 

Corporation and Location: 
Northrop Grumman Shipbuilding-Newport News operates in Newport News, 
Virginia. 

Year Acquired (Corporation): 
2001 (Northrop Grumman): 

Product Line: 
Aircraft carriers, submarines: 

Navy Program Overview: 
Northrop Grumman Shipbuilding-Newport News is the Navy's prime 
contractor for aircraft carriers and refueling and complex overhauls. 
Newport News is currently constructing CVN 78, the lead ship of the 
new CVN 21 class of nuclear-powered aircraft carriers. 

Through a teaming agreement, Northrop Grumman Shipbuilding-Newport 
News also works with General Dynamics Electric Boat to build the 
Virginia-class submarines. Each contractor is responsible for building 
designated sections and modules, and the contractors alternate final 
assembly, outfitting, and delivery. To date, the Navy has contracted 
to purchase submarines in three blocks. Block I includes four 
submarines, Block II includes six submarines, and Block III includes 
eight submarines. 

Navy Investment Incentives Over the Past 10 Years: 
Accelerated depreciation, special contract-incentive fees: 

Description of Investment Incentives: 

Accelerated Depreciation: 
In 2003, the Navy and Newport News signed a memorandum of agreement to 
accelerate depreciation of a new pier, known as Pier 3. Before 
construction of Pier 3, Newport News had one pier where it could 
perform work on aircraft carriers. This pier was in use for almost 60 
years and Newport News was planning to replace it in 2012. Due to a 
Navy scheduling conflict, Newport News was going to have two aircraft 
carriers that needed to be at this pier at the same time in fiscal 
year 2007. To address the scheduling conflict, the Navy agreed to 
accelerate depreciation of the new pier if Newport News accelerated 
its planned timeline to construct the pier. Under this agreement, 
Newport News is allowed to depreciate the pier over 7 years rather 
than over the estimated useful life of the pier, expected to be 40 
years. 

Special Contract-Incentive Fees: 
Virginia-class submarine. The Virginia-class submarine Block II and 
Block III contracts include special incentives to reward the 
contractor if it develops more efficient and cost-effective practices 
that contribute to the production of more affordable submarines. On 
both contracts, the contractor can claim a special incentive for 
investing in facilities and process-improvement projects. Since the 
submarines are built at both Electric Boat and Newport News, both 
contractors can claim the incentive under these contracts. 

Under the Block II contract, the contractor submits a business-case 
analysis to the Supervisor of Shipbuilding, Groton. Within 30 days 
after approval by the Supervisor of Shipbuilding and start of the 
project, the Navy pays the contractor a special incentive not to 
exceed 50 percent of the estimated investment cost. After the 
contractor successfully implements the project as defined in the 
business-case analysis, the Navy pays the contractor another special 
incentive not to exceed 50 percent of the original estimated 
investment cost. The sum of the two incentive payments cannot exceed 
100 percent of the approved business-case analysis estimated 
investment cost. 

During the Block III contract negotiations, Newport News and Electric 
Boat proposed facilities and equipment investments, and savings from 
these investments were included in the target cost of the contract. 
For these investments, the contractor submits a business case to claim 
a special incentive fee tied to the first four submarines for the 
amount necessary to achieve the documented corporate minimum return on 
investment. To claim a special incentive fee for the last four 
submarines on the Block III contract, the process mirrors the process 
under Block II. For these projects, the incentive amount can equal up 
to 100 percent of the approved business-case analysis estimated 
investment cost. 

CVN 78 Construction-Preparation Contract. The CVN 78 construction- 
preparation contract includes a special contract-incentive fee 
available to Newport News if it invests in 10 facilities identified 
during contract negotiations as investments that would contribute to 
reducing the construction cost of CVN 21 aircraft carriers. The 
special contract incentive fee for each facility is a portion of the 
total cost of the facility. The Navy pays the special incentive fee 
for each facility based upon Newport News's progress constructing the 
facility. Newport News agreed to include savings from these facilities 
in the construction proposal. 

[End of section] 

Appendix III: Comments from the Department of Defense: 

Note: Page numbers in the draft report may differ from those in this 
report. 

Office Of The Assistant Secretary Of Defense: 
Acquisition: 
3015 Defense Pentagon: 
Washington, DC 20301-3015: 

July 9, 2010: 
	
Mrs. Belva Martin: 
Acting Director, Acquisition and Sourcing Management: 
U.S. Government Accountability Office: 	
441 G Street, N.W. 	
Washington, DC 20548: 
	
Dear Mrs. Martin, 
	
This is the Department of Defense (DoD) response to the GAO draft 
report, GAO-10-686, "Defense Acquisitions: Guidance Needed on Navy's 
Use of Investment Incentives at Private Shipyards" dated June 8, 2010, 
(GAO Code 120846). The Department concurs with the recommendation in 
the report and the written response is attached. 

The Department appreciates the opportunity to comment on the draft 
report. For further questions concerning this report, please contact 
CDR Brad Busch, Shipbuilding Sector Analyst, Industrial Policy, 571-
256-2975. 

Sincerely, 

Signed by: 

Brett Lambert: 
Director: 
Industrial Policy: 

Enclosures: As stated: 

[End of letter] 

GAO Draft Report Dated June 8, 2010: 
GAO-10-686 (GAO Code 120846): 

"Defense Acquisitions: Guidance Needed On Navy's Use Of Investment 
Incentives At Private Shipyards" 

Department Of Defense Comments To The GAO Recommendations: 

Recommendation 1: The GAO recommends that the Secretary of Defense 
direct the Navy to develop a policy that identifies the intended goals 
and objectives of investment incentives, criteria for using 
incentives, and methods for validating outcomes. (See page 31/GAO 
Draft Report.) 

DoD Response: The Department concurs with the GAO's recommendation. 
The Navy agrees to issue guidance on the intended goals and objectives 
of investment incentives, criteria for using incentives, and methods 
for validating outcomes. When shipyard investment is considered, it is 
done as part of a holistic approach to negotiating a contract. 
Recognizing that there is no one-size-fits-all approach for contract 
incentives, the Navy's guidance will provide direction to the program 
managers and contracting officers while preserving their flexibility 
to tailor investment incentives appropriate to their particular 
program needs. The Navy intends to include the guidance in a Navy best 
practices guidebook. 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Belva Martin, (202) 512-4841 or martinb@gao.gov: 

Staff Acknowledgments: 

In addition to the contact named above, Karen Zuckerstein (Assistant 
Director), Matthew Butler, Kristine Hassinger, Michelle Liberatore, 
Aron Szapiro, and Molly Traci made major contributions to this report. 

[End of section] 

Footnotes: 

[1] U.S. Navy, Report to Congress on Annual Long-Range Plan for 
Construction of Naval Vessels for FY 2011 (February 2010). 

[2] GAO, Best Practices: High Levels of Knowledge at Key Points 
Differentiate Commercial Shipbuilding from Navy Shipbuilding, 
[hyperlink, http://www.gao.gov/products/GAO-09-322] (Washington, D.C.: 
May 13, 2009). 

[3] In addition to this work, GAO has ongoing work examining the 
material condition of public shipyards and the extent to which the 
Navy is investing in capital improvements at these shipyards. 

[4] Public funds include federal, state, and local dollars. 

[5] The Navy operates four publicly owned shipyards located in Pearl 
Harbor, Hawaii; Puget Sound, Washington; Seavey Island, Maine; and 
Portsmouth, Virginia. 

[6] We refer to Northrop Grumman Shipbuilding-Gulf Coast as one 
shipyard with two primary locations: Pascagoula, Mississippi, and New 
Orleans, Louisiana. 

[7] The Cost Accounting Standards, codified at 48 C.F.R. § 9904, 
govern the measurement, assignment, and allocation of costs to certain 
government contracts. 41 U.S.C. § 422(f)(1); 48 C.F.R. § 9901.302(b). 
The applicability of the Cost Accounting Standards to a proposed 
government contract is addressed in 48 C.F.R. § 9903.201-1. 

[8] Government property includes (1) government-furnished property, 
which is property in the possession of or acquired by the government 
and furnished to the contractor for performance of a contract; and (2) 
contractor-acquired property, which is property acquired, fabricated, 
or otherwise provided by the contractor for performing a contract and 
to which the government has title. Federal Acquisition Regulation 
(FAR) § 45.101. 

[9] More specifically, an indirect cost means any cost not directly 
identified with a single, final cost objective, but identified with 
two or more final cost objectives or with at least one intermediate 
cost objective. FAR § 2.101. Depreciation costs are generally 
allocated as indirect costs, but may be charged directly in certain 
circumstances. 48 C.F.R. § 9904.409-40; Defense Contract Audit Agency, 
Contract Audit Manual (DCAAM 7640.1), sec. 8.409-1e. 

[10] The FAR provides that depreciation and facilities capital cost of 
money are allowable contract costs. FAR §§ 31.205-10(b), 31.205-11(a). 
A cost is allowable when the cost complies with all of the following 
requirements: reasonableness; allocability; standards promulgated by 
the Cost Accounting Standards Board, if applicable, generally accepted 
accounting principles and practices appropriate to the circumstances; 
terms of the contract; and any limitations set for in subpart 31.2 of 
the Federal Acquisition Regulation. FAR § 31.201-2. Procedures for 
allocating depreciation costs and facilities capital cost of money 
costs to government contracts are provided in 48 C.F.R. § 9904.409 and 
§ 9904.414, respectively. 

[11] 48 C.F.R. §§ 9904.409, 9904.414. 

[12] Some shipbuilders identify slightly different numbers of hours 
for the second and third phases (block and posterection/postlaunch 
construction) cited in the rule. These numbers of hours tend to 
increase as the complexity and outfitting density of a ship increase. 

[13] Early release of contract retentions also provides financial 
benefit to shipyards because of the time-value of money: money today 
has more value than the same amount in the future. However, major 
private shipyards and Navy officials did not emphasize this benefit 
and focused on the cash-flow benefit of the early release of 
retentions incentive. 

[14] To use this incentive, the Navy needs to secure a waiver from the 
Cost Accounting Standards Board. 

[15] See Emergency Supplemental Appropriations Act for Defense, The 
Global War on Terror, and Hurricane Recovery, 2006, Pub. L. No. 109- 
234, § 2203. 

[16] Newport News officials told us that despite operating as the sole 
supplier of aircraft carriers, the shipyard does make efficiency 
improvements. They added that without such efficiency improvements, 
aircraft carriers could become prohibitively expensive for the Navy to 
buy. 

[17] The Navy has used accelerated depreciation and early release of 
contract retentions prior to 2000 to encourage investments at 
shipyards. 

[18] Shipyard officials responsible for submitting this business case 
stated that they have since reevaluated the project and resubmitted a 
new business case for the Navy's review. 

[19] General Dynamics was formed by a 1952 combination of Electric 
Boat, Canadair Ltd. and other companies. 

[End of section] 

GAO's Mission: 

The Government Accountability Office, the audit, evaluation and 
investigative arm of Congress, exists to support Congress in meeting 
its constitutional responsibilities and to help improve the performance 
and accountability of the federal government for the American people. 
GAO examines the use of public funds; evaluates federal programs and 
policies; and provides analyses, recommendations, and other assistance 
to help Congress make informed oversight, policy, and funding 
decisions. GAO's commitment to good government is reflected in its core 
values of accountability, integrity, and reliability. 

Obtaining Copies of GAO Reports and Testimony: 

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each 
weekday, GAO posts newly released reports, testimony, and 
correspondence on its Web site. To have GAO e-mail you a list of newly 
posted products every afternoon, go to [hyperlink, http://www.gao.gov] 
and select "E-mail Updates." 

Order by Phone: 

The price of each GAO publication reflects GAO’s actual cost of
production and distribution and depends on the number of pages in the
publication and whether the publication is printed in color or black and
white. Pricing and ordering information is posted on GAO’s Web site, 
[hyperlink, http://www.gao.gov/ordering.htm]. 

Place orders by calling (202) 512-6000, toll free (866) 801-7077, or
TDD (202) 512-2537. 

Orders may be paid for using American Express, Discover Card,
MasterCard, Visa, check, or money order. Call for additional 
information. 

To Report Fraud, Waste, and Abuse in Federal Programs: 

Contact: 

Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]: 
E-mail: fraudnet@gao.gov: 
Automated answering system: (800) 424-5454 or (202) 512-7470: 

Congressional Relations: 

Ralph Dawn, Managing Director, dawnr@gao.gov: 
(202) 512-4400: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7125: 
Washington, D.C. 20548: 

Public Affairs: 

Chuck Young, Managing Director, youngc1@gao.gov: 
(202) 512-4800: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7149: 
Washington, D.C. 20548: