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Over the past several decades, increases in acquisition costs for U.S. Navy combatants have outpaced the rate of inflation. To understand why, the authors of this book examined two principal source categories of ship cost escalation (economy-driven factors and customer-driven factors) and interviewed various shipbuilders. Based on their analysis, the authors propose some ways the Navy might reduce ship costs in the future.
Former Chief of Naval Operations' Perspective and the Significance of the Problem
Over the past four decades, U.S. Navy ship costs have exceeded the rate of inflation. In written testimony to Congress, Admiral Vernon Clark, former Chief of Naval Operations (CNO), noted cost increases of four types of ships-nuclear attack submarines (SSNs), guided missile destroyers (DDGs), amphibious ships, and nuclear aircraft carriers (CVNs)-between 1967 and 2005 that ranged from 100 to 400 percent (Clark, 2005). The specifics for each ship type are shown in Table 1.1. Based on these values, we have calculated a real, annual growth rate (i.e., the annual increase in costs above inflation) for building these ships. It ranges from 1.8 to 4.3 percent (see Table 1.1).
This cost escalation concerns many in the Navy and the government. The real cost growth means that ships are becoming more expensive and outstripping the Navy's ability to pay for them. Given current budget constraints, including those from increasing budget deficits and costs for continued operations in Iraq, the Navy is unlikely to see an increase in its shipbuilding budget. The problems that increasing costs and fixed budgets present to the Navyare further complicated by requirements for several new ship classes such as next-generation destroyers (DD[X]s), aircraft carriers (CVN-78s), amphibious transport docks (LPD-17s), maritime prepositioning force ships (MPF[F]s), costing billions of dollars per hull.
To demonstrate how this real growth erodes the ability to buy ships and sustain a fleet, we projected how increasing ship costs causes a decrease in the number of ships per year that may be acquired. This decrease in acquisition rate, in turn, results in a smaller sustainable fleet size. Figure 1.1 shows the average number of ships per year that may be acquired as a function of time for three different budget-level assumptions. We assumed the budget levels to be fixed in real terms-that is, budgets would increase only to offset inflation. The real growth in the price of ships was the same as shown in Table 1.1. We also assumed that the Navy would buy ships in the same proportion as they exist in the current fleet-in other words, the composition of the fleet would not change. The starting cost for a given type (carrier, surface combatant, etc.) was assumed to be the same as the 2005 values in Table 1.1 (e.g., a new carrier would cost approximately $6.1 billion). For each year, we escalated that cost by the real annual growth rate shown in Table 1.1. Thus, every year each vessel becomes more expensive to acquire, while the budget remains fixed. This results in fewer ships that may be purchased.
As can be seen in Figure 1.1, there is a steady decrease in the average number of ships per year. In 2005, the average number of ships per year ranges from just over five ships for an $8 billion budget to about eight ships for a $12 billion budget. The corresponding steady-state fleet size (the largest fleet that can be sustained at the average acquisition rate) ranges from about 180 ships for an $8 billion annual budget to 260 ships for a $12 billion annual budget. This assumes an average ship life of 30 years except for carriers with an assumed life of 50 years. By 2025, the average number of ships per year, and their corresponding steady-state fleet sizes, is nearly halved.
Admittedly, this analysis is quite simplistic in that it does not account for a number of factors, such as a changing mix of ships, the actual forecast cost of newer proposed hulls (e.g., for the Littoral Combat Ship [LCS], LHA[R], CVN-21, or DD[X]), the fact that escalation is not uniform, and the actual retirement or replacement patterns of the existing fleet. A more detailed analysis by the Congressional Budget Office (CBO) estimated that, on average, 7.4 ships per year would need to be built in order to have a fleet size of 260 ships with a corresponding annual budget of approximately $14 billion (FY 2005 dollars) (excluding the cost of nuclear refueling) for the 2006-2035 time frame.
Regardless of the top line budget number, there will be a steady decline in the real purchasing power of the Navy as ship costs escalate. All the budget curves shown in Figure 1.1 converge to lower procurement rates with time. Clearly, the Navy will not be able to sustain a fleet of nearly 300 ships at these acquisition rates, and the problem will only become more difficult with time.
Ship Cost Escalation and Complexity
Cost escalation for weapon systems and the difficulties that result from it is not a new problem, nor one limited to naval ships. Two decades ago, Norman Augustine, having demonstrated that the cost of an aircraft increased by a factor of four every ten years, famously quipped, "In the year 2054, the entire defense budget will purchase just one aircraft. This aircraft will have to be shared by the Air Force and the Navy three and one half days each per week except for leap year, when it will be made available to the Marines for the extra day" (Augustine, 1986). Augustine observed that aircraft unit cost was more closely related to the passage of time than modifications in speed, weight, or technical specifications. This "law" has, over time, been considered to apply to other military weapon systems.
Navy ships also have sources of high and increasing costs that are unique compared with other weapon systems and commercial ships. Much of their high cost lies in the fact that the design and construction of naval ships is one of the more complicated tasks of weapon system engineering and manufacturing that a country can undertake. Naval shipbuilding requires both heavy manufacturing and high-tech systems integration, including a complex integration of communication, control, weapons, and sensors that must work together as a coherent system. These components, or subsystems, are a mix of various technologies, including electronics, mechanical systems, and software. These technologies, particularly for weapon systems, are state of the art and may still be undergoing development when a program begins.
Beyond their direct military mission, naval ships must perform so-called hotel functions associated with housing and feeding hundreds of sailors who staff the ship. Warships also need to provide for the health of the crew and thus require medical facilities. All these capabilities must be sustained for several months at sea, requiring a significant amount of equipment and provision storage. These non-mission capabilities of warships make them unique compared with other military assets, such as tanks and aircraft.
Given the size and complexity of warships, manufacturing them requires substantial design, engineering, management, testing, and production resources. The workforce at a typical naval shipyard numbers in the thousands and includes many engineering specialties (e.g., electrical, mechanical, naval architecture). Modern naval ships are designed using sophisticated, three-dimensional computer-aided design tools, requiring a highly skilled and educated workforce. Production requires such diverse skills and trades as electricians, welders, and pipe fitters. Testing complex systems on ships requires commissioning and test specialists to verify functionality; for some skills-for example, those performed by nuclear-qualified welders and commissioning engineers-it might take years to become proficient.
U.S. naval ship production predominantly serves one customer: the U.S. government. The products are fully tailored (i.e., customized) for the mission of the vessel. In other words, few existing designs can serve as a basis for modification as is usually done in commercial shipbuilding. Naval ship production rates are low compared with those for commercial ships and production varies from three years to more than a decade. Production is allocated between producers when there is more than one shipyard capable of producing a class.
Despite these differences in product, market, and manufacturing for naval and commercial ships, naval shipbuilding is often compared with other industries in the consumer economy, with observers frequently commenting on the lack of benefits from a highly competitive market with multiple buyers and sellers and the attendant efficiencies gained through high-volume production. The expectation of such comparisons is that naval shipbuilding retains many of the dynamics of the commercial shipbuilding industry. This report addresses, in part, the validity of such comparisons and what may be learned from them by identifying specific areas in which naval shipbuilding costs have exceeded those for commercial industries and some of the reasons for this greater escalation.
Study Objectives and Overview
The escalation in ship costs and its implications recently led the Office of the Chief of Naval Operations (OPNAV) to ask the RAND Corporation to explore several questions related to ship cost escalation, including:
What has been the magnitude of cost escalation for Navy ships? How does this cost escalation compare with other areas in the economy and with other weapon systems?
What are the sources of the cost escalation for Navy ships?
Can this escalation be reduced or minimized?
Our approach is a "top-down" analysis that highlights and explores the issues related to ship cost escalation and what, if anything, can be done to mitigate it. This work takes a "macro-level" approach, examining overall industrial and technological trends and their correlation with ship cost. We analyze ship cost and economic data to define the trends and factors related to cost escalation, including how technical, performance, capability, requirement, and other variables have changed and might influence cost escalation.
Our core concern, as noted, is cost escalation. We use this term to describe the general changes, typically for a similar item or quantity, in cost between periods of time. We distinguish between cost escalation and cost growth. Cost growth is traditionally defined as the difference between actual and estimated costs. We are not concerned with evaluating these; rather, we are studying how the actual cost for an item changes as time passes.
Cost escalation can be measured by cost increase. Cost increase is the percentage change in cost between time periods. Algebraically, it is
[Cost.sub.2] is the cost at time period 2
[Cost.sub.1] is the cost at time period 1.
If, for example, [Cost.sub.2] is $5 and [Cost.sub.1] is $4, then the cost increase is 0.25, or 25 percent.
Because we examine cost increases over varying periods of time, we calculate annual growth rates to normalize cost increases to a common baseline. Algebraically, we define annual cost growth as
rate = ([Year.sub.2] - [Year.sub.1]) [square root of ([Cost.sub.2]/[Cost.sub.1])]-1, (1.2)
[Cost.sub.2] is the cost at [Year.sub.2] [Cost.sub.1] is the cost at [Year.sub.1].
That is, the annual growth rate is a compound function in which year-to-year increases accumulate. If, for example, [Cost.sub.2] is $5 and [Year.sub.2] is 2004, and [Cost.sub.2] is $4 and [Year.sub.1] is 1998, then the resulting annual growth rate for cost may be calculated as 3.8 percent. "Real" annual growth rates are calculated by using a constant dollar basis (one corrected for inflation).
To organize the analysis and simplify presentation, we split the cost growth factors we examine into two broad categories. The first category comprises economy-driven factors, inputs to ship cost that are largely outside the government's control. These may include worker wages and benefit costs, labor productivity, indirect labor costs, and material and commodity equipment costs.
The second category comprises customer-driven factors, centering on the nature of the product and how it is acquired. These may include such characteristics as size, speed, power generation, stealth, survivability, habitability, and mission and armament systems. In general, a more complex and larger ship will cost more than a smaller and simpler one. Customer-driven factors also include those related to acquisition strategy-such as the number of ships purchased, the timing of purchases, and the number of producers receiving work-and their effects on government costs, as well as government policies directly targeted to shipbuilding, such as worker compensation and environmental regulations. As stated previously, the "customer" is both the Navy and the federal government.
Alternatively, one may analyze the sources of cost escalation through a formal engineering analysis entailing a series of detailed technical evaluations of specific ship classes. In other words, one could explore the specific technical differences between systems (e.g., mission, weapons, and ship), requirements, and standards. One might compare the acquisition cost and performance differences for two ships, such as cost differences for the Aegis SPY-1A and SPY-1D radar systems, or compare how costs have evolved over time for painting and preservation standards of tanks and voids. Resources for this study and client interests, however, dictated that we pursue the top-down approach, to present results both in a timely fashion and in a way that encompasses as many relevant broad topics as possible. Other organizations, such as the Naval Sea Systems Command's (NAVSEA's) Ship Design, Integration and Engineering (Code 05), and shipbuilders have analyzed some of the more detailed issues. We draw upon their work to supplement and support the high-level analysis we have conducted.
As the data allow, we will examine trends from the 1950s through today. This time frame was selected to be consistent with the CNO's analysis. However, we do explore whether the time frame affects our conclusions. Appendix D evaluates the time trends from the 1990s to today.
Sources of Data
We use ship cost data provided by the NAVSEA Cost Engineering and Industrial Analysis Division (Code 017). Primary data were the final "end unit costs" for various Navy ships (by hull) going back approximately five decades. These end unit costs represent the total cost for a ship, including government-furnished equipment (GFE) and advanced procurement funds, but not the related research and development monies. The values are based on the final budget submissions for each hull and are the best long-term, final cost data that were available. The ship and unit costs were also broken down into the standard budget P-5 Exhibit format (planning costs, basic construction and conversion, propulsion equipment, ordnance, electronics, etc.). NAVSEA 017 also provided average engineering and production hours for each class.
To explore how the physical characteristics of Navy ships have evolved in recent decades, we also analyze data on light ship weight (LSW), power generation, shaft horsepower, and crew size. These data were obtained from multiple sources, including the Assessment Division, Office of the Chief of Naval Operations (OPNAV N81); NAVSEA 05; NAVSEA 017; the Naval Vessel Register; and shipbuilders. General Dynamics also provided data on the cost changes due to other, less-measurable features and manufacturing changes, such as survivability improvements and the effect of Occupational Safety and Health Administration (OSHA) regulations.
Finally, to compare cost escalation for naval shipbuilding to that in other industries and the overall economy, we use data compiled by the Bureau of Labor Statistics (BLS).
Excerpted from Why Has the Cost of Navy Ships Risen? by Mark V. Arena Irv Blickstein Obaid Younossi Clifford A. Grammich Copyright © 2006 by RAND Corporation. Excerpted by permission.
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|Ch. 1||The growth of ship costs||1|
|Ch. 2||Historical cost escalation for ships||11|
|Ch. 3||Sources of cost escalation for Navy ships||21|
|Ch. 4||Industry views on ship cost escalation||51|
|Ch. 5||Options for the Navy to reduce ship costs||59|
|App||A Ship classes included in the multivariate regression analysis||73|
|App. B||Multivariate regression for ship cost||75|
|App. C||RAND questions for ship cost||77|
|App. D||Cost escalation over the past 15 years||79|
|App. E||Passenger ship price escalation||89|