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Briefing on the Virginia Class Submarine Contract Award

Presenters: John J. Young, Jr., Assistant Secretary of the Navy for Research, Development and Acquisition
August 14, 2003

(Briefing on the Virginia class submarine contract award. Participating were John J. Young, Jr., assistant secretary of the Navy for research, development and acquisition; and Navy Rear Adm. John D. Butler, program executive officer (submarines).

Staff: Well thanks for coming out tonight. I know you've all been anxiously awaiting the award of the Virginia class submarine contract and are looking forward to hearing more about it. In just a few minutes, Secretary Young will make a brief statement about the contract, and after that, he and Admiral Butler, the program executive officer for submarines, will be available to answer your questions.

We should have plenty of time for each of you to get all the information that you need. As a matter of protocol, I'd like to ask that each of you, before you ask your questions this evening, go ahead and state your name and your media outlet. And then, if you find, after we break for the night, that you have any follow-on questions, please call my office, Navy Public Affairs, and ask for either myself or Lieutenant Elissa Smith. And as most of you know, our number there is 703-697-5342.

Okay, with that, here's Secretary Young.

Young: Well, I agree with Brauna. Thank you all very much on a Thursday afternoon for taking the time. This has been the culmination of a great deal of work, and so it was important to us to try to get information to you, and accurately, as soon as we had it available.

I'm here today to announce, as you know, the signing of a block buy contract with General Dynamics and Northrop Grumman for six submarines over the fiscal year 2003 to 2007 time period. The contract really commits us to the '03 submarine and creates a process or expectation that we will buy additional subs in '04 and out.

The contract is truly a unique step forward in our partnership with industry. It sets realistic target prices, consistent with the base line that was reported earlier this year. It increases -- within those targets, it increases industry's profitability below the target price, incentivizing them to control and underrun the target. It shares the cost above the target, with industry taking a greater share of those costs and in many of our other shipbuilding contracts, thereby discouraging overruns to costs.

Around the target, there are steps in the profit that focus management attention on trying to come in at that target. There's a step process where they can lose 1 percent of their fee when they go over the target, and then again when they go over 102 percent of the target.

Furthermore, workload, health care and pension costs will be on the share line, providing a strong incentive for us to work with industry and industry to work with us as partners to control those costs.

Next we have a portion of the profit in fee form as discrete incentives for key milestone events. These provide excellent management tools for Admiral Butler and Captain Heffron to manage the program. There's roughly $45 million per submarine, one of the largest incentive pools on a ship construction contract, allocated to these discrete incentives.

Incentives are tied to achieving the learning curve projection for labor costs on the submarine, controlling and delivering material to the budget at cost, the schedule performance, achieving the target costs of the submarine, achieving the outfitting levels and the schedule projection for the modules, enhancing the use of small business, and also there are additional production and delivery-related incentives.

The government can even pull back some of the earned near-term incentives if progress is not maintained and the submarine completed at the estimate at completion. I believe it represents a fair balance between risk, performance, and the profit and the cash flow needs of industry.

The Congress -- that addresses, if you will, the block buy contract and the terms we've tried to create for managing the costs of submarines. The contract also includes, subject to approval by the Congress, the right for the Navy to unilaterally convert this contract to a multi-year contract for seven, if you will, additional submarines to be purchased in the fiscal year 2004 to 2008 time frame. Again, I want to be very clear this is a block buy contract for an '03 submarine, but we have prenegotiated the potential, if Congress provides multi-year authority, to convert it to a multi-year contract.

The multi-year contract includes terms and conditions that allow the Department of the Navy, Department of Defense, to adjust the quantity of submarines to six or to five at any time between now and January of 2006, the point at which the FY 2007 president's budget would be submitted. And at this point in time, as you all can see, it should be very clear that the 2007 and 2008 budgets would support the plan to go to two a year and the Virginia Class multi-year.

I believe these contract terms respond to the Congress's concern about locking the department irrevocably into a fixed quantity of submarines and limiting our ability to respond to future budget conditions.

Under the multi-year terms, the Defense Department will save, on average, $155 million per submarine on seven submarines to be bought from '04 to '08, or in excess of $1 billion in total. This is compared to the block buy prices I mentioned earlier. The contract has negotiated terms that save $126 million per submarine if we decreased the buy to six submarines, and we save $80 million on average per submarine if the buy is decreased to five submarines.

With these details, we have much more factual information to take to the Congress and allow them to evaluate the president's request for multi-year authority and economic order quantity funds. We've been working the details of this contract essentially since November. It's been a challenging negotiation. Excellent work has been performed by all. And we've needed this information to go and help the Congress better evaluate the president's request for multi-year authority. But I do believe a multi-year contract provides essential stability for purchasing Virginia-class submarines at the relatively low procurement rates we still will be at.

This is an excellent contract. It reflects a true partnership between the Navy and industry. The leadership of General Dynamics and Northrop Grumman, Mike Toner and Tom Schievelbein and their teams, have done an exceptional job of planning this program, identifying ways to save tax dollars and accepting the challenge of managing the program to or below the budget.

Admiral John Butler and Captain John Heffron and the Virginia-class team have likewise done an outstanding job of representing the Defense Department's interests and creating management tools within their contract for the Navy.

Negotiation of this contract, as I said, has been complicated and very detailed, and I want to note the essential contributions of Chris Deegan, Will Vance, Sarah Ainey and Mike Lempke to these negotiations.

Finally, many people reviewed the details, as you might guess in the Defense Department, and ensured compliance with applicable law and made sure everyone understood. I specifically want to note the efforts of Sophie Krasik and Anne Brennan, Captain Reid Davis, Commander Mike Douglass on the Navy RDA team, Bob Hogue in the Navy's financial management office, Doug Larsen, Roger Pitkin and other members of the OSD staff, as well as Admiral Tracy's team and Operational Navy OPNAV code N77. Comptroller Dov Zakheim was also especially helpful in reviewing and supporting the final details of the contract.

This concludes my remarks. And I appreciate, again, your time and attention. And I welcome the chance to answer questions on the part of myself or Admiral Butler.

Yes?

Q: Sir, Hunter Keeter with Sea Power Magazine. I wanted to ask about the compromise that this deal represents. To some extent, this is stepping back from the initial goal that was set out in the multi-year argument. And that argument essentially, at the time, had stated that savings that can be achieved with this multi-year procurement, as well as the ability to go to the faster build rate or the greater build rate per year, were -- the Navy was getting to the point where those two things were really kind of essential to keeping the submarine program, in general, going. You won't get there unless they give you the authority to go to multi- year procurement for the seven boats '04 to beyond. Is this enough? Is this step enough? Is there still some jeopardy here? Do you still have some work to do in convincing the Hill and making sure that they get the message that they need to give you that multi-year procurement authority?

Young: I'd restate what I said. I mean, the Hill did not have all of this information in making their decision as to whether to support a multi-year or not. And that's unfortunate, but those negotiations have been complex. We've had to do two things, and that's, really, negotiate a contract for now and try to get several management incentive tools into that contract, which I perceive many in the Congress have been interested in.

As you know, the Navy's had -- generated a lot of concern on Capitol Hill with our prior-year completion requirements and the fact that we've had to request substantial dollars to complete ships under contract. So I think there's been pressure on us to develop tools and incentives to better manage shipbuilding programs, and we've done that. In conjunction with that, we also negotiated an unprecedented multi-year, where we had the ability to essentially partially terminate that multi-year, either because of budget conditions and affordability or whatever set of factors. And furthermore, I think that recognized the concerns on the Hill and the fact that two committees are saying five submarines might be the limit.

So trying to balance all those mutual interests, I don't think we've stepped back from anything. I mean, it's very clear this contract provides for conversion to a multi-year as soon as Congress grants such authority and provides the funds; a multi-year at seven submarines, that gets us to the rate of two a year, that meets the Navy's operational requirements. And it lays on the table a savings of $155 million per submarine, on average, if we can get to that. And it makes very clear -- that is a substantial savings, you know, a billion dollars, over buying these through a block-buy concept.

And as you all know, you're very familiar with shipbuilding, you step those savings down if you buy reduced quantities, but you still achieve substantial savings for the taxpayer by entering into a multi- year. And you need to do that in a program where we have two shipyards building at essentially very low-rate production. So I think it's been very positive for the team to negotiate this degree of savings.

And I would give credit -- I think the Congress's concerns and desire to see the details on this multi-year, in conjunction with our desire to negotiate good terms for the '03 submarine, has it put a lot of pressure in an environment where, you know, there isn't competition, there is the desire to work as a team, but there's a desire -- there's been a strong desire on the part of both the Navy and industry to get to this contract. But I think all those forces -- the Congress's interests, and then our push for management tools -- have pressurized everybody to get to an excellent point in this contract, and it is a very good contract.

Yes, sir?

Q: Sir, Nathan Hodge from Defense Week. Last week you postponed this announcement. Could you characterize what caused the -- what were the last-minute concerns that prompted this?

Young: I think exactly what I -- you know, I meant it; it is a complicated and detailed contract, and depending on how you interpret these various provisions that allow us to step down to six or five between now and January of 2006; one, it took a substantial amount of time for the team to negotiate all those contingencies and incorporate them into the contract, and then we -- probably with not as much time as we should have -- presented all this information to the entire Navy team and the OSD team. And we needed some more time to make sure we complied with all the rules. They needed a little extra time to look through the details and think about all the contingencies that maybe all of us had not thought through. And it took about a week to get there, and I think we're -- we've done it. And we did not want to push the envelope. I needed everyone to support this. And in the end, as I said, several people -- OSD team, up to Secretary Zakheim, came to understand and support the contract. They were very helpful.

Yes, sir?

Q: Dale Eisman with The Virginian-Pilot. Two questions. Did this one-week delay produce any changes in the contract, the additional review? And if you get to the multi-year, if you get the authorization, what will be the value of the multi-year contract? This block-buy contract is valued at 8.7 billion (dollars). What would be the value of a seven-ship contract?

Young: The first answer is, I believe that the week produced not a single dot on an I or a cross of a T or a period change in the contract.

Staff: Right. No changes.

Young: And I think -- I have often attempted to look -- I think the value of the full contract at the multi-year level is $10.2 billion.

Staff: I can verify that number. (Off mike.)

(Pause.)

Young: Sorry. I brought some things, don't necessarily have everything. (Pause.)

I want to get you an answer. I'll see if we can --

Staff: It's an 10.872 (billion dollars).

Young: It's an 10.872. That's the contract unit with General Dynamics and Northrop Grumman. That -- there's GFE portion of the contract also, just to be clear.

Yes, sir?

Q: David Lerman with the Newport News Daily Press. How does this $8.7 billion figure compare with the bid you got in December? I thought that was about $8 billion. Did the shipyards come down in price, did you guys go up? How does it compare to what you got before?

Young: Hmm. I'm not sure. I mean, the price relative to the bid has come down as we've worked through all the details. So I don't know -- would you answer this question?

Butler: Yes, sir.

We took the initial bid price through conscious negotiation by both parties. We actually closed -- you're talking about the $1 million referenced early on in the negotiations?

Q: The billion dollars.

Butler: I'm sorry, billion dollars.

Young: No, he's just relating the 8 to --

Q: Yeah. How does this 8.7 compare to the price you got in December, which I forget what it was?

Butler: It is -- it is nearly the entirety of that gap having been closed, the billion that we're talking about.

Q: So the initial bid was about 9.7 and you brought it down to 8.7.

Butler: Not quite 9.7.

Staff: I don't think we've disclosed the initial bid.

Staff: I don't think we have said that it was -- I think we said it hasn't been appropriate to disclose the amount of the initial bid.

Young: No, I didn't mean -- I just didn't know how to reconcile those numbers.

Q: But you have said the initial bid was a billion dollars too high.

Young: I said about a billion dollars.

Q: Oh, so then you came down a billion?

Young: There are a lot of puts and takes in that process. I mean, in the initial bid, I think we would say the industry team did not assume any risk whatsoever on their part. And not only that, they made some highly conservative assumptions about labor rates, material and other things, and then they made pessimistic assumptions about health care costs and other things. We sat down and we talked through all these issues and closed the gap to a price point where they are very comfortable, we're very comfortable. And obviously, with these more aggressive share lines, they would not have signed if their risk and equities weren't properly reflected here.

So I don't know how to relate -- answer your first question about where the two numbers are, and I really don't, you know, want to talk about the specifics of the first bid to where we are, other than, as we've said in the public, it was something on the order of a billion dollars higher than we expected. I think the companies agree that some of the assumptions in that contract were extremely conservative, and we worked through them together as a team. We've got more experience under our belt; I mean Virginia is in the water now. So there have been some bad aspects to the fact that it's taken a long time to negotiate the contract, but companies, as I've experienced in other ship-building programs, the more experience they have under their belt with the lead haul, the more comfortable they are in deciding where their risk point and where their cost points are. And Virginia is now at 91 percent complete and in the water. And so the evolution in time has paid some dividends to us in closing that price gap.

Q: Could you clarify -- Tony Capaccio with Bloomberg News. As clearly as you can, can you distinguish how the cost incentive provisions in here to both incentivize and penalize differ in severity and generosity from some of your past experiments in this management tool? And put the $45 million per sub in perspective; is this $45 million of $200 million of profit, or $45 million of $50 million? Or just put some context on that.

Young: Well, the contract on the '03 sub provides for 12.5 percent profit, and then on the future subs, provides for 12 percent profit. On this share-line process, where at 95 percent of the target and below there's a 10-90 split where industry keeps -- gets to keep 90 cents on the dollar if they deliver the sub for 95 percent or less of the targeted cost. Between 95 and 100 percent of the targeted cost, the share-line is 30-70, so that industry can keep 70 cents on the dollar if they underrun the target. Once you step over the target, you lose 1 percent of your fee. Once you step -- you have a band there, because we understand that people can't be perfect. But we really want to be at or below target. Between 100 and 102 percent of the target, the fee is stable. At 102 percent, you drop another percent in fee.

Those two steps are important to me and the team, because I believe the day an industry program manager reports that they have stepped from 99.9 percent to 100.1 percent and lost 1 percent of the fee, that's going to focus executive attention on bringing that program back into control and managing it. Furthermore, these tools and the precision of these steps strongly incentivized people to use what they're already using, but use them with more confidence and more energy, and that's the earned value of management system that they have in the yards.

Above 104 percent of the target, the share line is 45-55. And so, industry -- that is relative to several other shipbuilding programs. And certainly -- well, without being specific, that's better than most of our programs, and industry will pay 55 cents on the dollar if we start to seriously overrun the target.

And then, on shipbuilding programs, we pay profit as we go -- as they perform work and bill us for that work. And typically, we pay that to the agreed-upon basis, and frequently, to an estimate at completion. We are going to tie that directly to their cost performance index. So, if it appears they are going to overrun the target, we will start early in the program, degrading their profit payments to a level consistent with where the program is likely to come out in cost and on that share line. So, that's one piece of it.

The other piece is there's another 3.7 percent of incentives -- that's roughly $45 million a submarine -- tied to very discreet things: delivery of labor at or below the projected learning curve; delivery of the material to the budgeted costs; the enhanced use of small businesses, I mentioned earlier; it's tied to delivering the modules on schedule and to a percentage of outfitting, which is critical.

We had an Executive Committee Review earlier this week and talked through the fact that it's essentially one hour in the factory, if you will, three hours in the module before the pressure hulls close, and five hours when you close the pressure hull?

Butler: Three in the shop.

Young: Three in the shop.

Butler: Six in the module and eight when you --

Young: Eight. So you pay a price for not getting that outfitting. And so we have incentives tied to delivering hulls, at outfitting; we have incentive the pressure hull complete and floating. The Virginia happened this past week. There's an incentive fund for pressure hull complete on target. These are discreet, measurable events that industry understands very well, we understand very well. They're not subjective; they're more deterministic. And the incentives are not to penalize industry, but they're to all of us to use our earned value management to identify the critical path that delivers the submarine, and to pay people when they perform on that critical path.

Q: Twelve percent, what is that, roughly, in dollars so that we can --

Young: I don't want to do too much math on the stage. But at $45 million --

Butler: Well, 3.7 percent is $45 million, so you can do the math to calculate 12 percent; 12 divided by 3.7, that's 45.

Young: It would be something on -- a little less than $150 million.

Q: About $150 million a sub?

And one, finally, how does any of this differ from your past -- from the past cost-sharing arrangements you've had? It's just more -- it's just more discreet or how is it different?

Young: Well, my understanding is this is the largest incentive pool of any ship construction Navy fixed-price incentive contract. The incentives are back-end weighted to the later stages of the program so that we don't pay people a lot of incentive money up-front. I forgot to mention that if the submarine doesn't come in at the cost, some of the incentives -- the government can request that some of the incentives be paid back to the government. So these are unprecedented things in a contract.

And I don't -- the -- oh, there's another point. This profit share -- this 12 percent is one of the lowest profit on the share line levels in a ship construction contract.

Q: What's it on average? Is it 15 or 16 percent?

Young: It varies. I'd rather not -- because I'm going to end up talking about carriers and everything other than submarines, which -- I really want to talk about submarines.

Yes, sir?

Q: Mr. Secretary, could you talk about how you could pull back from some of the multi-year and what conditions you could do that in and if that entails some penalties on the part of the Navy also?

Young: I think they're not penalties in the sense of writing a check, but they are -- as I said, we pre-negotiated the cost of the submarine at the level -- at seven or six or five, at the quantity levels. And so I guess you could argue that the higher prices that are reality, because when you put -- at these low rates of production, when fewer submarines go through the yard, the yard has a certain fixed overhead with its ability to build Virginia Class. And so you end up with higher overhead allocations and higher rates on the remaining submarines.

We pre-negotiated that, so we're not putting ourself at risk when -- if the quantity goes down. So it's not really a penalty, but we know there's a higher cost we have to pay for the remaining submarines if there's a reduction in quantity. Does that answer your question?

Q: Well, you said earlier that you could withdraw partially --

Young: Through January of 2006, we can make the decision to step from seven to six and six to five. Making those steps will implement these -- the pricing variations that I talked to you -- that the teams negotiated. At the time it happens, it will lock us into a new price scheme for the six submarines or for the five submarines, and tell us how we to some degree have to re-phase any advanced procurement and economic quarter -- economic order quantity money, and then proceed to buy the submarines that are budgeted at that point in time.

Staff: And we'll buy the EOQ equipment and spares they've already procured.

Young: Right. We have the option -- you know, if we are under way, exactly as Admiral Butler said, to build submarines -- some of these items are complex, long-lead items, and we have requested from the Congress the necessary economic order quantity funds to begin to buy seven submarines and do so on this efficient multi-year schedule. So once -- even in '04, we will start buying parts for the '07 and '08 submarines, and we've, in the contract, negotiated the option to complete those long lead items as spares for the existing submarines or spares -- or the starting point, if you will, for the '09 submarines or terminate them altogether, but we have that option.

Yes, sir.

Q: I'm Mike Mays (sp) from the Hartford Courant. What are you looking for from the Congress now? Would they essentially endorse this concept at the five that they have been talking about but include your language that says we can go to seven under these conditions? Or what are you -- do they endorse this plan? Is that the best-case scenario?

Young: Well, I think this is an important point to what I just said. The president and Secretary of Defense Rumsfeld have requested roughly $400 million in economic order quantity funds in fiscal year '04 and the multiyear authority for seven submarines. I think if we can go -- now that we've done our homework -- and explain all this to the Congress and give them the data they didn't have before, our hopes is that they will look at -- look at and support the president's request for a seven-ship, multiyear in the economic order quantity funds.

An important point is, if you make a reduction in those economic order quantity funds such that we cannot start the second '07 and the second '08 submarines, we -- the decision will be made. We will have to implement the multiyear at the lower levels. So we do need the FY '04 requested economic order quantity funds or the savings and the submarines will be gone, because the contract doesn't really let you go back and increase the quantities. The contract is structured to let you sign for seven, and then, over the next three years, look at the budget environment, look at the cost performance on the contract, whatever factors would factor into that, and make a decision without excessive paying to the government to step down and do so, you know, between now and January of '06. But it's not tailored to start at five and go up.

Q: So, you address their concerns returns, but start at that seven, and have the ability to go down if you need to.

Young: Yes.

Yes? I forget who I haven't touched. Have I asked -- yeah, I'd like to rotate around.

Q: Sure. (Name inaudible.) -- with Defense Daily. I just wanted to ask how the decision to go to -- like, the decision to convert to the multi-year -- to move to multi-year, how is that tied in with the incentives package that -- or, the performance metrics that you all have set out? And, you know, if they reach a certain percentage of those performance parameters, then they can go ahead to go to multi-year? How much is the multi-year decision tied to how they're meeting expectations?

Young: I think two things. The incentives that we've worked to negotiate are part of the block buy contract. They attach themselves to each submarine and they attach themselves to the submarines whether they are in a block buy contract or a multi-year contract. And so, that's almost a separate issue from the fact that once you've made -- A, because the military requirements demand submarines to be purchased, really, at a rate higher than we are buying now, and even at this rate, it's a low rate for two yards in our industrial base. It's clear, and it's clear in the negotiated pricing of the contract, that even if you stay at lower rates, one to two a year, you can save money -- it is best for industry and for the department's budget to stably and in a planned manner buy those lower rates of procurement submarines.

You know, if we were buying lots of submarines, it would be a different calculus. But I think the incentives are what we need to manage the program. Multi-year is what we need to save some money and control the cost of the program and give our industry partner a chance to deliver the program for those costs. We need the stability of multi-year, especially when we're building at these low rates of procurement.

So I'd say it differently. It's -- I don't believe this is conditional, I believe we -- and that's why I think the budget requested it -- we need to go to multi-year. We have the data, I think, to support multi-year.

And I'm going to use this as a chance to tell you some things. We had an Executive Committee Review this past Monday with the requirement sponsor, the fleet, industry -- all the team -- to look through Virginia. The first submarine is 91 percent complete in the water, and to all of our great joy, it will be christened this coming weekend.

There are metrics here that are different than any shipbuilding program that give, I think, Admiral Butler and Captain Heffron and the team a lot of confidence. The number of months from float-off to delivery, this submarine will deliver -- the Virginia will deliver in June of 2004, nine months from the time you floated it off in the water; Sea Wolf was 27 months, Ohio was 31 months, Los Angeles was 32 months.

The percent complete on the submarine -- I talked about this level of outfitting which is critical, so you don't work inside the submarine, you do it in the shop factory, as Admiral Butler mentioned. When we closed the pressure hull on Virginia, Virginia was 81 percent complete; Sea Wolf was 57, Ohio was 48 percent complete, Los Angeles class was 33 percent complete. I mean, this is a submarine that is dramatically more mature than what we have experienced in past submarine builds.

The lead ship manhours on this submarine; Virginia right now, we're targeted at 15.5 million manhours to complete Virginia; Sea Wolf was 23.3 million manhours, Ohio was 24.6 million manhours.

I mean, the design-build process you hear people talk about, these are a set of facts that tell you what it means. It means you build the sub in a shorter time period, you bring the sub to a higher level of completion, you do less work inside the sub and more work outside where it's more efficient, the workers can get to things.

So I think we have an exceptional level of confidence in the program. The submarine -- let me see if I can make sure it's right. The christening date that we're delivering to this weekend was set in 1998. The delivery date is per the contract. We are going to christen and deliver Virginia per a set of dates set back in 1998. Those factors give you the confidence that entering into multi-year's not a question for us. Persuading the Congress that we've done our homework, we now have prices for them to look at and we also now have a submarine that's at a higher level of completion than any other lead ship, those are the facts that we need to make sure we get to them so they can make their decision.

Yes, sir?

Q: Do you contemplate any changes in the teaming arrangement? Will Newport News continue to build the same segments of these submarines that it's been building, and Electric Boat the same segments? Is there any change in the way the submarines will be constructed?

Young: I think that's still subject to their evaluation. I have been interested in that because my objective here is to save taxpayer money, get the most product for the least tax dollar. And I think there may be some additional steps that could be taken in that industrial base to accomplish that. And that's why I point to those underrun share lines. I am happy if they'll bring -- if they'll take any steps to make it more efficient. It doesn't have to be in realigning industrial base. Whatever steps it takes, up to and including any realignment of work between the two yards to help them underrun the target will let them make a higher profit and keep that profit. And importantly for me, you know, there are going to be more Virginias. We have not met the user's requirement for submarines within this multi-year. So if I can bring that baseline down, then the next buy of submarines will be that much cheaper.

So the direct answer to your question is, the aggressive underrun share lines are our effort to incentivize the industry partners, who are working together in an exceptional way, but to further incentivize them to try to do their best as a partner with us to bring this in for the least number of tax dollars.

Yes, sir?

Q Just if I can clarify two points. Is it fair to say that this contract guarantees funding for six submarines? Or is it because it's still a block buy --

Young: It's a block buy. We are signing for the '03 submarine which has been authorized and appropriated by Congress.

Q: It's the only thing still guaranteed.

And the other is, can you say of this 8.7 billion, how much would go to Northrop Grumman and how much to General Dynamics roughly? Is it roughly 50/50, or ---

Young: (Inaudible.)

Butler: The profit is split 50/50, but the --

Young: (Inaudible.)

Butler: It'll be the fifth ship of the class, and the delivering yard will be Electric Boat, and about 70 percent of the effort is done by the delivering yard. So about 70 percent of the effort will be Electric Boat and 30 percent will be --

Young: You mean in the '03 -- that's just --

Butler: On the '03 ship, yeah.

Q: But in general, are we talking 50/50 in terms of the whole --

Butler: How they split that between them, they negotiate that between them, and I think it works to pretty much be 50/50.

Q: Over the long-run --

Young: Over two submarines, it's roughly 50/50 -- (inaudible; cross talk) -- which submarine you pick.

Q: If you get to the multiyear though, that's a total of 11 submarines -- the four you've got and seven more. And if you continue to alternate that, Electric Boat would have number 11, which would mean it would be getting a larger overall share, am I right?

Butler: Well, actually, once we got to '07, we've got two boats in-yard, and that actually drops the price dramatically because had both yards working on their own boat starting in '07 with two ships. So the paradigm of alternating yards at that point is sort of out of the picture. They each have one.

Q: So it's roughly 50/50 over the course of the --

Butler: Over the course of all the boats, it's about a 50/50.

Q: But the programs begins to look more like the Arleigh Burke Class destroyer program that closer you get to the two per year on that, correct? I mean, you'll have two yards essentially building each their own boats and so on?

Young: I guess in the sense of two yards building product, but not in any other sense, because in Arleigh Burke, each yard builds an entire submarine -- I mean, a DDG, and in this case, both yards are interdependent on each other. There are certain modules that only Newport News builds, and there are certain modules only Electric Boat builds. So no one builds a complete submarine, if you will, in its entirety.

Staff: Yes, sir? How are you doing?

Q: Okay, sir. Chris Castelli with Inside the Navy. Under the block buy and the multi-year, what are the prices per sub, under those two scenarios?

And the other thing is, are there any special conditions that you have to think about or work out when you switch the number you're buying per year, if you're in a multi-year and you go from six to five or seven to six?

Young: Well, that's what we've done in advance, is work out those pricing conditions. So I don't think there are any additional conditions we have to work out.

The price of the submarines, on the average, is $2.1 billion. I don't think I have -- actually, I might be able to -- but these -- the numbers I could give you, beyond saying it's about $2.1 billion --

Q: (Off mike.) -- isn't Captain Heffron saying about 2.2 --

Young: It's $2.2 billion. I'm sorry. Two-point-two billion dollars.

Q: Okay.

Young: Well, let me let them answer that question, so I can -- we can get it right, because there's -- you've also got to talk about the price under the contract and the price including the GFE.

Q: (Off mike.)

Q: Yeah, I'm not understanding it, because the 2.2 (billion dollars) times six would be over $12 billion.

Q: Yeah.

Q: And that says they -- (Inaudible.) -- 8.7 (billion).

Butler: That price includes the GFE that the secretary talked to you about earlier. That's propulsor, is outside of the ship contract. It has some of the reactor plant gear, which is outside of this contract. It has some of the non-propulsion electronics, which is outside of this contract. This contract is for the hull itself.

Q: So wouldn't there be a different --

Butler: Two-point-two is total --

Q: (Off mike.)

Q: For outfitting the submarine, basically.

Butler: Yeah. That's the total cost of it.

Q: Including R&D.

Butler: Right. There's R&D in there as well.

Q: And how does that price fluctuate when you have a multi- year buy versus a block buy? Is it, as we were saying before, like a difference of what, 155 million (dollars) or something like -- what is the price difference?

Q: But it --

Q: It's a saving.

Young: Right. On average, we save $155 million a submarine. Some of those savings are weighted to the back end of the program, when you start getting to two-a-year production rates. But as long as we exercise the multi-year at seven, on average, for those seven submarines, we save 155 million (dollars) a submarine. If the contract is changed to six, we save, on average, $126 million a submarine. And if the contract's changed to be five, we save, on average, $80 million a submarine.

Q: And the 2.2 figure -- is that associated with the block buy, or is that associated with the --

Butler: That's an average cost, in now-year dollars, of a Virginia, fully outfitted, fully loaded, ready to go to sea. She's got a combat system. She's got a reactor, got a propulsor, plus the hull and all of its piping, fitting-outs.

Q: All right. Well, I'll follow up afterwards, I guess, then. I thought there'd be a difference, the price would differ, but maybe I'm wrong.

Butler: Well, we gave you an average --

Q: Wait. Is that 2.2 for the seven ship multi-year, though, or for --

Butler: Two-point-two is the average price of Virginia, it's a seven ship multi-year, we will see $155 million per hull savings on those hulls.

Young: I think we can answer -- we'll follow up; we can answer the question, we just --

Butler: We'll take it as a follow-up.

Young: Yeah. It would be better to get you the accurate numbers. I get your point. We've given you an average number. But there's clearly -- and we have it -- you know, for example, I'll pick a ship -- the FY06 block-buy ship is $1.465 billion.

Q: Okay. Ship-builder costs?

Young: That's just the ship-builder cost, not the GFE, and I'd have to get you a different number. The price comes down to $1.38 billion for the -- under the seven-ship multi-year, and then it grows a little bit if you go to six or five ships.

We can get you those numbers. I perceive they are within the public record of the contract. And rather than sit here and read you a list of numbers, we'll get you the numbers.

Q: I have one final one on the approach you're taking in terms of management tools to incentivize. Is this going to be specifically for Virginia class or are you thinking of incorporating this in San Antonio class and --

Young: My view, it is across-the-board in shipbuilding. And we are working to do this in new contracts we might have on carrier- related work. And the LPD team is working to do this in their contracts. We've discussed doing this on LHAR. And so, across shipbuilding, we are going to seek to implement as many of these tools as makes sense and are reasonable.

Q: But what's the message, then, you want to impart by doing this?

Young: I think there are -- that's a nice question for me, at least. I'm just trying to figure out where to start. One, we need to demonstrate that we are serious about setting consistent -- and frankly, with Secretary Aldridge's view, which I strongly agreed with, we need to set realistic target prices for ships. People -- no one in the department, in business, in industry, understands that when you overrun and create a prior-year completion requirement of $2 (billion) to $3 billion, you have to go find that money, because those ships are under contract. We delay and disrupt, you know, tens to 100 programs to carve out enough money to pay that prior-year bill. We need to set realistic targets for programs and deliver to those targets so the rest of our program also has a chance to stay on schedule and not be a billpayer for the fact that we didn't set a good target.

When we set that good target, we need to incentivize industry and the department to use our earned value management tools to track progress on that program, and when we see deviations, go in and manage through them. Because the industry has the skills to manage these programs to cost, especially if we set realistic targets. But there isn't a good competitive environment, and the strongest tool we have is to affect profits and incentive fees. And so, we want to tie the profits and incentive fees to some elements of those performance factors. We also want to tie it to quality. So it's not all just about cost. It's about quality, it's about meeting the schedule, it's a number of factors we want to tie it to. And so to complete that loop, I need those incentives and the demonstrated effort between industry and ourselves to have tools to manage so we can go to the Congress and we can go to the OSD comptroller and the secretary of Defense and the president and say we believe we can manage your shipbuilding program to cost and not continue to disrupt other programs with prior-year completion bills.

Further, we want to incentivize industry to continue to improve their management tools and manage their programs and monitor them. And frankly, I want to incentivize Admiral Butler and Captain Heffron to clearly identify the program schedule and the critical path through that schedule so they also know what's important to them and what's worth tying fee and profit to as a management tool.

We need to build good schedules. I think -- and I say this to the team sometimes -- when we sign a contract, the outcome's known; the only question is whether we know the outcome. I want us to have a quality of the schedule that we know that outcome, and a value management tool to track progress towards that, and incentives that focus senior leadership attention on an issue if it starts to get off course and correct it before it gets so far off course that we are irrevocably committed to paying, you know, a block of money to buy our way out of a problem rather than manage our way out of a problem.

Q: Can I ask you one more specific figure question. You've alluded a few times to the target cost. Target cost is not 2.1 billion, obviously.

Young: No.

Q: What, in general, are the target costs for these six ships?

Young: Well, they range, as I was talking before -- within the target cost for the '03 submarine is $1.36 billion.

Q: Okay.

Young: I'm looking at --

Butler: They actually, sir, are not each one the same, so --

Young: No, I know that. I just said the '03 submarine.

Butler: We'll get it to you.

Q: But in general, the baseline they're going to be judged against for these incentives or diminutions is --

Young: I told you the target cost -- I'm looking at everybody to nod their heads because I want to make sure my chart is the same chart as theirs. And then the multi-year target prices range from -- it gets complicated, but I'll give you a range. I think the lowest is probably $1.307 billion, and that's within a seven-ship multi-year constraint. And the highest is something on the order of $1.456 billion. But it's very dependent on the time and the workload. But that's a rough range.

Q: (Inaudible.) -- they're being held to a goal -- to a ship of $1.3 billion per ship, roughly, and they're going to --

Young: I'd say $1.4 billion is a better number.

Q: Okay, that's the question --

Butler: Average.

Q: -- that targets are being judged against for whether they make -- (Off mike.)

Young: But there's a discreet target down to the dollar.

Q: Okay, I understand that.

Q: But why would the multi-year target be higher than the '03 target?

Butler: The '03 ship is a block-buy. Multi-year authorization would start with '04. There is no multi-year for the '03 ship; it's strictly a block-buy contract.

Q: Right. But I thought under multi you'd save more money, though.

Butler: You do. The 155 (million dollars), 126 (million dollars) and 80 (million dollars) kick in starting with '04, if you get the authorization.

Young: Well there's -- I think there's also the issue that, you know, we've talked about on the acquisition base lines, and that is, we experience annually labor cost growth because they give the workers in the shipyard a pay raise; we experience material cost growth. So even within a multi-year, each year the price of the sub goes up some, but it comes down because we do it with less -- hopefully, we build it with less labor. But over time, the net of that trend is slightly increasing costs. I think that's the point I'd make to you, is the block-buy is going to go like this. I need multi- year so I can go flatter.

Yes, sir.

Q: Do you all expect to experience any savings, you know, in the multiyear with any sort of, you know, production innovative -- you know, any innovative technologies that, you know, in making certain materials cheaper?

Young: Absolutely. There's a piece -- I mean, I'll give you a short answer and the team can add more to it -- but a piece of the incentives I talked to you about -- the $45 million, 3.7 percent pool -- is tied to facilities modernization, if you will. They're given an opportunity to make capital expenditures that lower the cost of the program, and as long as those prove out, we pay an incentive to them to encourage them to do that and to recognize their performance in doing that.

Yes, Chris.

Q: Yes. Do you see the way that you're structuring incentives in this multiyear plan as a potential model not just for shipbuilding multiyears, but maybe for aircraft multiyears, something like the Osprey, in the future? And by the way, do you have any comment on the signature of the ADM for that program?

Young: I don't. But I view this general concept of having a portion of the profit as incentives and those incentives tied to discrete events that are on the critical path to delivering the product, weighting some of those incentives to the back end of the program, I mean, I think that's a lesson many people feel like we've learned in Reagan or F-22 or other places. You need some incentive money at the back end so if performance is getting off track, you can offer to work with industry and say, focus management attention on this; I'm going to pay you, and I'm going to give you a small incentive to do it. That process of some back-end loading, some tying of incentives to discrete, deterministic events where they make it, they earn it; they don't, they don't, philosophically I'm trying to apply across the Department of the Navy.

We've taken steps to do this in the H-1 program to upgrade the Hueys and Cobras. I've taken steps in the Joint Strike Fighter program, because they have an excellent schedule, so we -- it's been easy to go in and tie some of the incentive money and JSFs to discrete events.

So in every place, we're trying to do this, because I think it's the last space where you give the program manager, the PEO, some tools to work with industry to, again, manage our way through a problem, not buy our way through a problem.

Staff: We'll wrap it up after this one.

Young: Is there -- we may be at a good point to wrap it up.

Thanks a lot for all your patience and your questions, and I think Brauna and the team will do a great job of getting the additional details you need. I thank you very much.

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