LCS - Cost Cap

I’ve long been fascinated by the Congressional cost cap that has been applied to the LCS program.  It’s been interesting to watch Congress’ attempt to apply oversight and fiscal restraint and then observe the Navy’s response.  The cost cap was Congress’ reaction to the combination of controversy about the LCS combined with the early indications of runaway cost growth.  Congress was, in essence, telling the Navy that they weren’t comfortable with the LCS program but that the Navy could continue the program if they could keep the costs below a threshold.  So, how did it all play out?  Let’s review …

The original Navy cost estimate was for a $200M ship.  It’s unclear whether that estimate included the module cost.  As it became clear that that target would not be met, Congress in 2006 passed Section 124 of the FY2006 National Defense Authorization act (H.R. 1815/P.L. 109-163 of January 6, 2006) which set a cap of $220M per ship.

Then, in 2008 the cost cap was changed by Section 125 of the FY2008 National Defense Authorization Act (H.R. 4986/P.L. 110-181 of January 28, 2008) to $460M  per ship.  The cap was applied to all LCS procured from 2008 on.

Later in 2008, the cost cap was amended again by Section 122 of the FY2009 Duncan Hunter National Defense Authorization Act (S. 3001/P.L. 110-417 of October 14,

2008) which deferred the implementation of the cost cap by two years, from 2010 on. 

In 2010 the cost cap was amended again by Section 121(c) and (d) of the FY2010

National Defense Authorization Act (H.R. 2647/P.L. 111-84 of October 28,

2009) to set a cap of $480M.  However, the cap excluded certain costs from being counted against the cap and included provisions for adjusting the $480 million figure over time to take inflation and other events into account, and permitted the Secretary of the Navy to waive the cost cap under certain conditions.  The Navy has stated that the cap equates to $538M as of December 2010, due to inflation.

In summarized form, here’s the progression of the cost cap:

2006     $220M

2008   $460M

2008   $460M  deferred

2010   $480M  inflation and “events” adjustment clause; waivers

2010   $538M  Navy inflation adjustment

What was the Navy’s response to all this?

The Navy sought and obtained the cost cap language that allows the cap to be adjusted and even waived because they know they can’t build the ships for the cap amount.  But wait!  Doesn’t the Navy have a fixed price contract for less than the cap amount?  Doesn’t that prove they can build the LCS for the cap amount?  If you’re asking that, then you haven’t been a regular follower of this blog.

Yes, the Navy has a fixed price contract for less than the cap and, no, they can’t build the LCS for the contracted amount.  I’ve said it before and I’ll repeat it.  The fixed price contract is only for the seaframe (the hull).  The weapons, electronics, computers, fire control software and systems, sensors, radars, and most other equipment is being supplied from another, separate account line that is not included in the cap limit.  Pretty clever of the Navy, huh?  If you can’t meet the cost cap, just split off half the cost into an unregulated account and then you can claim to be building cheap LCSs.  Technically true but bordering on fraudulent in that it is a deliberate ploy to bypass Congress’ intent.  Add to that the fact that the modules, without which the ships are useless, are also being funded from a separate account and you’ve got a pretty fraudulent accounting practice by the Navy.

The real cost of the LCS is the seaframe (~$500M inflation adjusted) plus government supplied equipment ($200M ?) plus module ($30M - $200M) and you’ve got an actual total cost for the LCS of $750M - $900M.

Also, the fixed price contract contains language allowing the manufacturer and the Navy to split cost overruns, 50:50, or even allowing the manufacturer to recover all overrun costs under certain circumstances.  That’s not a fixed price contract!  

I also don't know whether the fixed price contract automatically increases each year due to inflation adjustment or whether it stays at the original contract price.  A few things I've read, including the contract's inflation adjustment clause, hint that the fixed price increases each year.  If so, the current fixed price for the seaframe is actually somewhere around $550M each per the Navy's stated inflation adjustment and allowing for continued adjustment through 2012.  As I said, I'm unsure about this aspect.  If anyone knows for sure, cite a reference and let me know!

Regardless, you’ve got to give the Navy credit.  Faced with a seemingly impossible cost cap, they manipulated the system, bypassed the intent of Congress, and got their LCS program.  That’s some outstanding integrity being demonstrated there, Navy!  What’s wrong with being upfront about the real costs and then letting Congress do their job and decide if it’s worth it to the country?