When do you think a final decision will be made on this program? Secretary LEHMAN. Again, we fully support the initiative to second source that program. I will provide the dates for award for the record. [CLERK'S NOTE.-The Department was unable to provide a response in time to be printed in this hearing volume.] Mr. ADDABBO. In a recent study, our Survey's and Investigative staff found great resistance to competing the AN/SQR-19 towed array system. Yet, it is reported that the Navy could save over $150 million. Ultimately, do you intend to have two sources for this program no matter which system proves to be the most effective? Secretary LEHMAN. Yes, very definitely, and the resistance that you identify here and in the previous systems is the built-in bureaucratic resistance that I referred to at the beginning of my testimony. That is part of the system that has evolved over the last 30 years and it takes steady effort, with your support to bring about the changes. We are committed to second sourcing the SQR-19. Mr. ADDABBO. The gentleman from Pennsylvania, Mr. McDade. TOOLING AND TESTING EQUIPMENT COSTS Mr. McDADE. Thank you very much, Mr. Chairman. Mr. Secretary, recently you directed that the Navy discontinue paying for the upfront costs associated with tooling and test equipment. What was the basis for your decision? Secretary LEHMAN. It is important to understand what kind of tooling the Navy now, as policy, does not pay for. We found in looking at the criticisms that have been levied by some in Congress over excessive profits in the defense industry over the last several years, that profits of our Navy contractors as a percentage of sales were not excessive. They were healthy, and when, as in the F-18, they were linked to superior performance, justified-but essentially not a major problem. Where there was a great anomaly compared to the top Fortune 500 and most profitable companies was in profit as a percentage of assets, which is a more valid measure of fairness of return on investment. There, we saw that the average Navy contractor had about a 26 percent profit per year, which we thought was excessive. The reason this disparity between profit as a percent of sales and profit as a percent of assets was the socialist culture that had evolved in the Pentagon which had shifted to the government owning all of the assets. That is typical Gosplan-type theory, and it results in a cost base rather than a price-centered procurement system. So we have said we want the contractors to stop investing in Jones and Locklin and in Flexible Bus divisions and taking their profits out of defense and diversifying into other industries. What was a more disturbing trend was their buying back their own stock, using profits instead of plowing it back into productivity and capital investment, as capitalist theory would suggest. They were taking it out of defense and having the taxpayer pay for all their capital plant. That is wrong. We want to shift to contractor investment when we get to the point of production, where their risk is minimal, because in fact the Pentagon is probably the most reliable customer anywhere in the world once we get past the DSARC III stage. We have said we will cover the risk through advanced and fullscale development and in some cases pilot production tooling where there is clear risk of cancellation of the program, where we have not yet committed to production, but once we have committed to production and gone through DSARC III, then it is time for the contractors to invest capital to sell us products, which is normal in the rest of the country. We do not ask them to bear inordinate risk and we don't ask them to step up to that risk and investment until we have made a firm commitment and Congress has made its intentions known with regard to a system like the V-22 or the F-18. At that point, we want our contractors to invest their profits in capital plant, and that has been very successful. We did that in the second sourcing of the Pratt & Whitney 404, when we took the Navy F-404 engine that GE had developed for us and provided it to Pratt & Whitney, Pratt & Whitney stockholders invested in the tooling to build that second source because they wanted to get into the business. In the V-22, we have just signed an agreement where the Navy will buy the initial pilot production tooling which will be in the high risk period. Then when we get into production two thirds of the tooling will be bought by the contractors, thus saving an investment of $600 million from the taxpayers. This policy is now swinging along very well. We did it in the T-45 and we have done it in a lot of smaller programs. It is the way to go to bring the cost of defense down in every case. Mr. McDADE. Can you tell us what the savings are from a program like this? Secretary LEHMAN. Yes. There are two sources of savings. One, if we buy the tooling, we have to have the contractor buy it under the defense acquisition regulations which means we pay top dollar. If you put $300 million in the budget for tooling, $300 million will be spent for tooling. If however, we require the company to go to its board of directors to get investment capital, it will be the lowest possible cost required. As a benchmark, the cost estimators accurately, according to the regulations, required us to put $250 million in to tool up Bath Iron Works, as you will recall, three years ago and you took it out. One reason was we felt that Bath didn't need that much. We ended up spending less than $40 million of which only about $15 million was actually for tooling. When the contractor had to pay for it himself, it became $15 million compared to $250 million. Similarly, for the F-404 engine the estimate for what we would have had to put in the budget for tooling for Pratt & Whitney was $300 million. When Pratt & Whitney had to invest, they invested less than $50 million to do the same thing. The second source of saving occurs once you get into a competitive environment. For instance with the V-22, we allow the two companies producing, to depreciate and sell back to us as an allowable expense a straight-line percentage of the investment. If the program is set for eight years, they can sell us one-eighth of their investment back, as allowable costs, every year. But they have a strong incentive not to do that and instead to keep it in their capital account, because, if they put it in their price to us, their price will go up and they will lose to their competitors. So, those are the two ways you save, by having a lower initial investment and second by keeping the investment in the stockholders' pocket rather than having the taxpayer pay for it as an allowable expense. Mr. McDADE. I invite you to amplify the record in order to identify the dollar savings from the program. Secretary LEHMAN. We have saved more than $200 million for tooling on second sourcing for the Aegis cruiser, and $300 million in second sourcing of the F-404 engine. Those are the kinds of magnitudes of numbers we are talking about. I think it is a fundamental shift that will make defense far more affordable in the future. [The information follows:] In addition to the information above on the F-18 engine, V-22 airframe, and the Aegis cruiser the following information is provided: 1 V-22 Engine-the $17.7M savings are due to the discounted value of money over time; an additional $32.0M may be saved due to pressure of competition. 2 T-45TS-Savings of $13.7M represents more prudent investment by the contractor ($9.7M) and the discounted value of money over time ($4.0M). Mr. McDADE. What about the response of the private contractors on this issue? Secretary LEHMAN. Collectively they have shrieked that the world is coming to an end, that we are driving them into bankruptcy and that this is very unwise policy. Individually, we have negotiated a successful agreement embodying those principles, with every one that we have gotten into negotiation with, despite their screams. Obviously they don't like to invest, they would rather buy other things. Our attitude is that we are not going to dictate terms to any of our contractors. If they don't want to do business with us on this basis, they shouldn't sign the contract. They have all signed. Mr. McDADE. What about the other services? Have they implemented this approach? Secretary LEHMAN. This approach is not popular with the other services. Mr. McDADE. Can you tell me why? Secretary LEHMAN. Because, with ownership of the tooling comes control. You can put more people in the plants and have more say over things. They want more control. That is why we have a thou sand bureaucrats in the McDonnell-Douglas plants because the bureaucracy likes micromanagement Mr. CHAPPELL. Would the gentleman yield? What is being done about getting some of those excessive numbers of bureaucrats out of there? Secretary LEHMAN. First of all, they are not all excessive. Some are necessary. We need auditors, although one reform that I hope will be addressed is to give the services; project managers audit authority, which was taken away from them when it was consolidated in DCAA. We need to give the guy whom I hold responsible and whom you, through me, hold responsible, the authority to do audits. Now it is disconnected. Mr. CHAPPELL. Where is the problem? Secretary LEHMAN. Well, the problem is- Secretary LEHMAN. Well, the problem with the audits is that the DCAA consolidation took the authority away. I am not saying that the Secretary of Defense ought not have an audit authority because he must. But the guy who is held responsible for the program, the project manager or the SUPSHIP, needs to have audit authority over his contractors. Today it is chaos if you listen to the contractors, because they have a thousand people a month coming through the McDonnellDouglas plant, for instance. That surprises the project manager as much as it surprises McDonnell-Douglas because he does not have any say about bringing defense auditors in except they usually will come if he asks them. But they also come randomly. It is just too large a bureaucracy than is necessary. If we are going to do solesource cost-based acquisition, then the one breeds the other, and that is the problem we have faced in rolling it back. Mr. CHAPPELL. Are you going to face a problem, Mr. Secretary, if there is work being done under one roof and part of it is the Navy's work according to your new directive and the other part is one of the other services with a different directive? Secretary LEHMAN. That is why you need some NAVPRO and AFPRO personnel in the plant. You need the audit capability to see that you don't get into the kind of problems that have been alleged. For instance, in some of the contractors using personnel assigned to a fixed price program on other programs, or changing them to IR&D accounts or charging things to cost-plus accounts when they are actually working on tight fixed-price programs. We have adequate controls and cost accounting to see that that doesn't happen. HARM PRODUCTION BASE Mr. McDADE. We were informed that the HARM production base was to be closed yesterday and an inspection by the Defense Contract Audit group revealed hundreds of quality control problems, dozens of which were classified as major, and that is their word. I am sure you are aware of the decision. Secretary LEHMAN. No, this is the first I have heard about it. Again, the chain for DCAA does not run to me. I will hear about it 59-248 0-86--16 sooner or later. I hear about things like that from the project manager. Mr. McDADE. Please take a look at it and amplify in the record the question of whether or not this is an example of why you have to have some of those bureaucrats out there. Secretary LEHMAN. I am not saying eliminate them. I am just saying that we ought to bring order to it and reduce the numbers. It ought to have been the project manager who did that, not a floating agency that picks and chooses where it attacks. It should be with the line managers. Mr. McDADE. If you need to amplify the question for the record to indicate how you get at that bureaucratic—— Secretary LEHMAN. I would reduce it and I will amplify in the record. I also suggest you invite some of the contractors in to hear their side of the story, about the costs that this excessive micromanagement drives into overhead. If you are going to stay on a cost-plus contract, you need thousands of micromanagers. But, if you get a tight specification, hold them to it, and put them on fixed price, it is their problem to get productivity because they have to meet the spec. Mr. McDADE. Somebody is accountable? Secretary LEHMAN. That is the whole key, accountability. Thank you, Mr. Chairman. [The information follows:] Reducing the bureaucracy in contractor plants can be achieved through a combination of initiatives that all hinge on the basic premise of accountability-giving those responsible for executing a program, whether in industry or government, the authority to make responsible decisions regarding that program and then holding them accountable. For example, the project manager should be able to conduct audits. Concurrently, if the contractors are given firm, fixed price contracts with well written specs and are held closely accountable to those limits, then the huge numbers of micro-managers required tomonitor cost-plus contracts can be eliminated. Contractor owned tooling and the inherent productivity increases that result from the incentive of capital investment will aid in reducing the bureaucracy in two ways. The government won't have the magnitude of oversight responsibility that goes with ownership of millions of dollars worth of tooling and the contractors' increased productivity will further reduce the need for oversight. But, far and away, the most potentially lucrative source for change would be a reduction in the stifling legislative burden that we now operate under. It is a burden that continues to grow. Attempting to keep up with the 1152 linear feet of laws and enacting regulations with interpretations, now on the law library shelves, creates de facto, a bureaucratic oversight problem. That is the area where relief would be the most welcome and have the most far-reaching impact. Mr. CHAPPELL [presiding]. Mr. Dicks. STRATEGIC HOMEPORTING Mr. DICKS. Thank you, Mr. Chairman. Mr. Secretary, Admiral Watkins, General, we are glad to have you today. The reason I was not here for your prepared statement is I was over defending the Navy's homeporting situation before the Military Construction Subcommittee chaired by Mr. Dellums of Califor nia. I want you to know it was an interesting experience. |