oversight

Defense Inventory: Growth in Air Force and Navy Unrequired Aircraft Parts

Published by the Government Accountability Office on 1990-03-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

Ma ITI   1 I‘NO
              .
                  DEFENSE
                  INVENTORY
                  Growth in Air Force
                  and Navy Unrequ.ired
                  Aircraft Parts
United States
General Accounting Office
Washington, D.C. 20648

National Security and
International Affairs Division

H-229462

March 6, 1990

The Honorable John Glenn
Chairman, Committee on
  Governmental Affairs
1Jnited States Senate

The Honorable Jim Sasser
Chairman, Committee on
   the Budget
I Jnited States Senate

This report responds to your Committees’ requests that we study defense secondary
inventories, We previously provided you with an overview of inventory growth and are
completing our response with two reports on areas of largest growth. The other report deals
with ship and submarine parts growth, while this report discusses the causes of unrequired
aircraft parts and addresses ways in which such stocks can be minimized.

As arranged with your offices, we plan no further distribution of this report until 30 days
from its issue date, unless you release its contents earlier. At that time, we will send copies to
other interested committees and Members of Congress; the Secretaries of Defense, Navy, and
Air Force; and the Director of the Office of Management and Budget. We will also make
copies available to other parties upon request.

This report was prepared under the direction of Donna M. Heivilin, Director, Logistics Issues
(202) 2758412. Other major contributors are listed in appendix IV.




Frank C. Conahan
Assistant Comptroller General
ljkecutive Summ~


                   from $17.3 billion in 1980 to $53.6 billion in 1988. The Chairmen, Senate
                   Committees on the Budget and on Governmental Affairs, asked GAO to
                   analyze growth for Air Force and Navy stocks in unrequired inventory
                   that would not increase military capability.

                   Specifically, GAO identified (1) the current and past causes for growth in
                   unrequired stock, (2) DOD actions that could minimize growth in unre-
                   quired stock in the future, and (3) growth in required stock inventories
                   that are not needed for wartime or current-year operations.

 I
                   Principal items include such items as aircraft and ships, and secondary
Background         items include such minor end items as compressors and turbines and
                   repair parts. DOD categorizes its secondary inventories into six classifica-
                   tions. Two represent current requirements, that is, required stocks held
                   to meet war reserve and peacetime operating requirements over a 24-
                   month period. The remaining four represent unrequired inventory-
                   stocks that are not needed to meet current requirements but are held, in
                   most cases, to satisfy potential future requirements and possible
                   contingencies.


                   The inventory of unrequired aircraft parts has increased at a faster rate
Results in Brief   than required stocks. Among the major causes of unrequired inventory
                   growth for aircraft items, GAO found procurement management practices
                   contributed to growth in unrequired stock. Moreover, some DOD and Air
                   Force initiatives to improve their reports could reduce visibility over
                   unrequired stock and, consequently, mask the need for management
                   attention. Furthermore, required stocks held to meet other than current-
                   year requirements have grown significantly and are more likely to
                   become obsolete or experience declining demand before they are needed.

                   The reduced oversight and growth in years of required stock on hand
                   suggest that unrequired stocks may continue to grow. Holding more
                   years of stock results in larger required inventories without a stated pol-
                   icy to increase requirements.




                   Page 2                                       GAO/NSL4D-90-100Defense Inventory
                           Executivehmmary




Prirkipal Findings

Direct Causes for          GAO’S evaluation of the growth in the unrequired inventories of 51 judg-
Unrequired Stock           mentally selected secondary aircraft items showed that the most com-
                           mon causes for the growth were overestimated use rates and
                           modifications of aircraft and equipment. Other contributing factors
                           included faster than expected phase-out of older aircraft and decreasing
                           war reserve and safety level requirements. Some of these factors have
                           been the subject of prior reports by GAO and DOD.


Procurement Practices      GAO examined 36 items which had recent contracts for replenishment
Conkribute to Unrequired   buys where on-order quantities were later identified for potential termi-
                           nation because they were excess to requirements. Air Force guidance
Stodk                      tended to discourage terminations. Also, the lack of an effective process
                           to identify and act on potential terminations at one of the Navy’s inven-
                           tory control points also impeded terminations.

                           For five items the Air Force procured and received the materials sooner
                           than required. This practice results in premature inventory investment
                           and unnecessary holding costs and increased risks that material might
                           become obsolete before it is used.

                           The Navy procured three consumable items in excess of requirements
                           using DOD'S technique for determining the purchase quantity that will
                           result in the lowest total cost. GAO has previously recommended that the
                           Navy stop its practice of buying more than that quantity without spe-
                           cific justification because it contributes to the Navy’s unrequired stock.
                           DOD, however, disagreed.



Reporting Changes Impede   Some Air Force and DOD inventory reporting initiatives may aggravate
Efforts to Reduce          problems with unrequired stocks. The Air Force temporarily authorized
                           adding items to stock requirements and therefore on-order material that
Unrequired Stock           should have been reported as unneeded was not reported. It is also con-
                           sidering adding an additional year of requirements to its system for
                           determining requirements. Similarly, DOD proposed adding a year of
                           requirements to its reporting system, and also requirements for
                           purchases to obtain discounts or ensure parts for the life of a system.
                           According to DOD and Air Force representatives, the actions are intended



                           Page 3                                      GAO/NSIAD-W-100Defense Inventory
     I

-I                           Executive Summary
     I




                             to recognize that obtaining unrequired assets can be in the government’s
                             best interest.

                             Identifying the reasons for buying unrequired stocks can help prevent
                             unnecessary growth. However, the above changes to reporting criteria
                             would mask the extent of growth. They could also reduce the quantities
                             of unneeded orders eligible for term ination.


I&creases in Air Force       The growth in the Air Force’s required stock held to meet peacetime
Required Stock Could         requirements beyond the current year may result in continued high
                             levels of unrequired stocks. High levels increase the risk of reduced
ClauseMore Unrequired        demand or obsolescence because requirements may decline when end
Stock                        items are phased out or are modified. The inventory available to satisfy
                             requirements beyond the current year has grown more than other
                             requirements-from     $1.3 billion in 1980 to $6.6 billion in 1988. One-
                             third of the Air Force’s required inventory is excess to wartime or cur-
                             rent year operations.

                             Many of the problems contributing to unrequired inventories have also
                             contributed to inventory growth in required stocks beyond current-year
                             needs, Such items could become unrequired inventory.


                             GAO   makes six recommendations to the Secretary of Defense, that will
Recom m endations
                         . improve procurement practices to m inim ize buying items early and in
                           greater quantities than required and encourage term inating more orders
                           for unneeded items and
                         . ensure more accurate reporting of required versus unrequired items and
                           provide better visibility of unneeded items.


                                   generally agreed with the thrust of GAO'S draft report, and described
Agency Com m ents and        DOD
                             its current efforts to control inventory growth. It agreed with four of
GAO Evaluation               GAO'S six recommendations. After analyzing the agency’s comments, GAO
                             still believes all of its recommendations are valid.

                             DOD   did not agree with GAO'S recommendation that the Air Force stop
                             initiating purchase requests earlier than required, and stated that the
                             practice has no effect on the requested delivery date. However, GAO
                             found that 95 percent of sample deliveries were delivered, on average,
                             over 1 year early.


                             Page 4                                      GAO/NSIADM-100 Defense Inventory
1   I
    (   Executive Summary




        DOD also did not agree with GAO’S recommendation that the Air Force
        forego efforts to add a year to its requirements, and stated that it should
        not have to terminate on-order items if a future need is forecast. GAO
        agrees that needs forecasts are useful, but believes that premature
        expenditures are unnecessary and increase the risk of unrequired
        inventory.




        Page 6                                      GAO/NSLAD-90-100
                                                                   DefenseInventory
Epcutive Summary                                                                                   2

Chapter 1                                                                                          8
Introduction           Management and Reporting of Aircraft Parts Inventory
                       Objectives, Scope, and Methodology
                                                                                                   9
                                                                                                  11

Chapter 2                                                                                         15
Inventory of           Reasons for the Growth in Unrequired Stock
                       Conclusions
                                                                                                  16
                                                                                                  22
Unrequired Aircraft    Agency Comments and Our Evaluation                                         22
Parts Has Shown the
Most Rapid Growth
Chapter 3                                                                                        24
Procurement            Orders for Unrequired Assets Not Terminated
                       Materials Received Sooner Than Required
                                                                                                 24
                                                                                                 27
Management Practices   Procurement Exceeded Economic Order Quantity                              29
Contribute to Growth   Conclusions                                                               30
                       Recommendations                                                           30
in Unrequired Stock    Agency Comments and Our Evaluation,                                       31

Chapter 4                                                                                        33
Related Factors That   Efforts to Improve Inventory Reports
                       Inventory Reporting Initiatives May Impede Control of
                                                                                                 33
                                                                                                 34
Increase the Risk of        Unrequired Stock
Unrequired Stock       Growth in Air Force Required Stocks Beyond Wartime                        37
                            and Current-Year Needs
                       Conclusions                                                               39
                       Recommendations                                                           40
                       Agency Comments and Our Evaluation                                        40

Appendixes             Appendix   I: DOD Classification of Secondary Inventories                 42
                       Appendix   II: Sample of 40 Air Force and 25 Navy Items                   43
                           With   Reported Unrequired Stock as of September
                           1987
                       Appendix   III: Comments From the Department of Defense                   46
                       Appendix   IV: Major Contributors to This Report                          76

Tables                 Table 1.1: DOD’s Aircraft Parts Inventory (1980-1988)                       8


                       Page 6                                      GAO/NSlAD-90-100Defense Inventory
    Contents




    Table 1.2: Aircraft Parts Inventory by Service (1980-                     8
         1988)
    Table 2.1: Increase in Air Force and Navy Inventory of                   15
        Aircraft Parts
    Table 2.2: Major Reasons for Unrequired Stock of 51                      16
        Selected Items




    Abbreviations

    AFN        Air Force Logistics Command
w
    AS0        Aviation Supply Office
    DOD        Department of Defense
    GAO        General Accounting Office


    Page 7                                     GAO/NSIAD-90-100Defense Inventory
Chapter 1

Introduction


                                            The Department of Defense (DOD) classifies its material inventories as
                                            principal items and secondary items. Principal items include aircraft,
                                            tanks, and ships and secondary inventory items include minor end
                                            items, such as compressors and turbines, and repair parts. The value of
                                            DOD’S secondary inventory grew from $43 billion in 1980 to $103 billion
                                            in 1988, an increase of $60 billion. Over half of that growth was in air-
                                            craft parts, which grew from $17.3 billion in 1980 to $53.6 billion in
                                            1988, an increase of $36.3 billion. Table 1.1 shows the dollar change in
                                            the aircraft parts inventory between 1980 and 1988.

Table 1.1: DOD’s Aircraft Parts Inventory
(1?80-1988)                                 Dollars in billions
                                            Year                                                                   Invent05
                                            1980                                                                       $17.3
                                            1981                                                                        19.3
                                            1982                                                                        21.8
                                            1983                                                                        24.2
                                            1984                                                                        29.4
                                            -.1985                                                                      46.5
                                            1986                                                                        47.6
                                            1987                                                                        47.9
                                            1988                                                                        53.6


                                            Although more than half of DOD'S 1988 aircraft parts inventory is held
                                            by the Air Force, the Army and Navy’s aircraft parts inventory grew at
                                            a faster rate between 1980 and 1988, as shown in table 1.2.
-
Table 1.2: Aircraft Parts inventory by
Service (19800 1988)                        Dollars in billions
                                                                                                                     Growth
                                            ..___I_-                               1980     1988      Increase     (percent)
                                            Armv                                    $1.7     $5.7          $4.0          235
                                            Navy                                     4.5      18.5         14.0          311
                                            Air Force                               11.0     29.4          18.4          167
                                            Total                                  $173     $53.8        $36.3"          210
                                            “Total does not add due to rounding.


                                            We did not include the Army in our review because it has a compara-
                                            tively small inventory of aircraft parts. Consequently, our review of air-
                   Y
                                            craft parts management and inventory reporting covers only Air Force
                                            and Navy operations.




                                            Page 8                                         GAO/NSLAD-90-100Defense Inventory
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                         Chapter 1
      I                  Introduction




                         The National Security Act of 1947 requires the Secretary of Defense to
Mahagement and           report annually to the President and the Congress on DOD'S inventory,
Reborting of Aircraft    which includes principal and secondary items. To comply with the act,
Par+ Inventory           DODrequires the services to report their inventories by standard DOD
                         materiel categories, including aircraft parts.

                         The Air Force and Navy differ in what items they report as aircraft
                         parts and how they fund the items. For example, the Air Force’s
                         reported inventory includes only reparable items-items that are
                         repaired, rather than discarded. The Air Force’s consumable aircraft
                         parts (nonrepairable items that are discarded when broken) are
                         reported in the Construction, Industrial, and General Supplies category.
                         The Navy’s aircraft parts inventory includes both reparable and con-
                         sumable items. Reparable items represented about 76 percent of the
                         Navy’s 1987 aircraft parts inventory value, compared to about 24 per-
                         cent for consumable items.

                         Funding of aircraft parts also differs between the two services. The Air
                         Force funds aircraft parts through its procurement appropriation and
                         issues parts to its activities without reimbursing the supply activity.
                         The Navy’s aircraft parts inventory is mostly funded through stock
                         fund accounts, which require Navy activities to reimburse the wholesale
                         supply activity for parts as they are issued.


Management of Aircraft   The Air Force Logistics Command (AFLC) provides logistics support and
Parts                    services through its five air logistics centers. The centers are referred to
                         as inventory control points and as such are responsible for the world-
                         wide management of items and weapon systems support. They deter-
                         mine requirements and provide central procurement and storage of
                         wholesale-level inventories of Air Force-managed items, including repa-
                         rable aircraft parts. The centers use a standard automated system,
                         known as the DO41 system, to forecast the types and quantities of repa-
                         rable parts that will be needed. On a quarterly basis, the system calcu-
                         lates when items should be procured based on parts on hand and on
                         order, amount and timing of projected use (demand), and procurement
                         lead times. The system also recommends terminating quantities of on-
                         order materials that are excess to requirements.

                         The Naval Supply Systems Command administers the Navy’s supply
                         system and provides management polices and procedures to its inven-
                         tory control points. The Aviation Supply Office (ASO) is one of the two
                         Navy inventory control points and is the one responsible for overall


                         Page 9                                       GAO/NSLAD99-199Defense Inventory
                           Chapter 1
                           Introduction




-/
                           management of Navy aircraft parts. ASOuses a special program to fore-
                           cast anticipated demand and program-based requirements. Assets are
                           then compared with requirements for individual items to determine if
                           procurement or termination of assets on order is required.


Reporting Aircraft Parts   AFLC prepares the Air Force’s annual inventory report using inventory
Inyentory                  data from its five air logistics centers. Similarly, ASO is responsible for
                           reporting the Navy’s aircraft parts inventory.

                           The Navy and the Air Force prepare their annual inventory reports
                           based on data from the Central Secondary Item Stratification report.
                           This report allocates all available assets to various requirements to
                           arrive at a net requirement deficit, which forms the basis for budget
                           projections. The report also classifies inventory by the requirement or
                           retention criteria for which it is held. The Air Force classifies its inven-
                           tory four times a year, and bases its annual inventory report on the
                           March stratification report. The Navy classifies its inventory in March
                           and September and bases its annual inventory report on the September
                           stratification report. However, the actual inventory values reported by
                           the services may differ from values in the stratification reports because
                           of adjustments made during preparation of the annual inventory report.

                           DOD  divides its inventory into six classifications. Two of the classifica-
                           tions represent required stocks and four represent unrequired stocks.
                           These required stocks are needed for current operations and wartime
                           use. The approved force acquisition objective represents 24 months of
                           operating needs and war reserves and accounts for almost all required
                           stock. The 24-month period includes the rest of the current year, the
                           following budget year and, if necessary, additional months to complete
                           the 24-month period. Unrequired stock is excess to current acquisition
                           requirements and includes assets held to satisfy potential future
                           requirements and possible contingencies. Appendix I provides a detailed
                           description of the six categories.

                           DOD and service inventory reports identify items that need to be pur-
                           chased and help measure how well managers provide the right items and
                           quantities. Growth in unrequired stock classifications warns inventory
                           managers of areas where changes in requirements or unnecessary
                           purchases have resulted in undesired inventory increases.

                           The Congress is concerned about growth in unrequired inventories,
                           because it indicates that funds are not being spent on the right items or


                           Page 10                                       GAO/NSIAD-90-100Defense Inventory
 .

                             Chapter 1
                             Introduction




                             the right quantities. By minimizing such inventories, DOD can reduce its
                             expenditures for secondary items or use the funds to meet other needs.

                             In July 1988, we issued a report on our macro-analysis of the inventory
                             growth.’ We reported that DOD’S secondary item inventory increased
                             about $51 billion between 1980 and 1987. Required stocks grew about
                             $27 billion, while stocks in excess of requirements grew about $19 bil-
                             lion. About $5 billion of the inventory growth was unstratified.” We
                             found that aircraft parts represented about $31 billion of the $51 billion
                             in inventory growth between 1980 and 1987 and about $9 billion of the
                             $19 billion increase in stocks excess to requirements.


                             The Chairmen, Senate Committees on the Budget and on Governmental
Objbctives, Scope, and       Affairs, requested us to study the growth in DOD’S secondary invento-
Methodology                  ries. They asked that our work include a macro-analysis of the growth
                             and aspects of growth not related to increases in military capability.

                             We reviewed the growth in aircraft parts inventories in the Air Force
                             and Navy not related to increases in military capability. We identified
                             (1) current and past causes for growth in unrequired stock, (2) DOD
                             actions that could minimize growth in unrequired stock in the future,
                             and (3) growth in required stock inventories that are not needed for
                             wartime or current-year operations. Although the Army also centrally
                             manages inventories of aircraft parts, those inventories are relatively
                             small. Therefore, we did not include Army inventories in our review.

                             We performed our work at the Office of the Assistant Secretary of
                             Defense (Production and Logistics); Navy and Air Force headquarters;
                             the Logistics Management Institute, Bethesda, Maryland; and the follow-
                             ing commands and field locations:

                         l Navy Aviation Supply Office, Philadelphia, Pennsylvania;
                         . Air Force Logistics Command, Wright-Patterson Air Force Base, Ohio;
                         . Warner-Robins Air Logistics Center, Robins Air Force Base, Georgia;
                         . Sacramento Air Logistics Center, McClellan Air Force Base, California;
                         l Oklahoma City Air Logistics Center, Tinker Air Force Base, Oklahoma;
                         l San Antonio Air Logistics Center, Kelly Air Force Base, Texas; and
                         l Ogden Air Logistics Center, Hill Air Force Base, Utah.

                             ‘Defense Inventory: Growth in Secondary Items (GAOINSIAD-88-189BR,.July 19, 1988).

                             ‘According to DOD, unstratified stocks represent items in transit.



                             Page 11                                                      GAO/NSIAD-90-100Defense Inventory
                                                                                                    ,

Chapter 1
Introduction




To develop trend information, we analyzed DOD aircraft parts inventory
data for 1980 through 1987 from the supply system inventory reports.
All data in the reports are as of September 30 of each year.

To develop information on the growth in various categories of required
and unrequired stock, we analyzed Air Force and Navy central second-
ary item stratification reports used to prepare their respective annual
inventory reports. For the Navy we used September 1980 and 1987
reports, and for the Air Force we used March 1980 and 1988 reports.
DOD recognizes that stratification reports have inaccuracies because the
information is not 100 percent validated prior to preparing the annual
inventory report. For example, the Air Force’s 1986 stratification report
contained a $3.3-billion overstatement that was identified by the Air
Force after DOD issued its annual inventory report. We used the stratifi-
cation reports in spite of the recurring errors because they were the only
documents available in sufficient detail to analyze inventory growth in
the various categories of stock. In addition, we would subsequently
detect errors involving our selected items by examining supporting doc-
uments during our review.

To analyze the inventory of unrequired stock and select items for
review, we obtained Navy and Air Force computer tapes containing 97
percent of the Navy’s and 93 percent of the Air Force’s inventory of
unrequired aircraft partsZ1The data represented the Air Force and Navy
inventories as of September 30, 1987. We obtained Air Force procure-
ment history tapes from each of the five air logistics centers to identify
items in unrequired stock that had been recently purchased. The format
of the data prevented us from using the Navy’s procurement history
tape to identify recently purchased items, so we selected from Navy
items that were still on order.

To determine the causes of unrequired stock, we judgmentally selected a
sample of 40 Air Force and 25 Navy items that had recently been pro-
cured or were on order and had large values of unrequired stock for
detailed review. The Air Force tape contained a universe of 42,687 items
with national stock numbers that had unrequired stock valued at $5.9
billion. We identified 1,357 items that had been purchased in fiscal years
1986 and 1987, which accounted for unrequired stock valued at $184.7

“WC did not include some smaller groups of items because they were separately managed. For exam-
plc, Air Force wartime consumable items represented about 3 percent of Air Force aircraft parts and
are managed by a separate automated system. According to AFLC and San Antonio Air Logistics
Ccntcr officials, wartime consumables are a relatively static inventory of items that experience little
fpacctimc demand.



Page 12                                                      GAO/NSIAD-90-100Defense Inventory
I   Chapter 1
I   Introduction




    m illion. W e identified 40 of the items with the largest dollar investment
    in unrequired stock at the five air logistics centers. These 40 items had
    unrequired stock valued at $91.6 m illion, or about 50 percent of recently
    acquired items.

    From 107,470 Navy items with unrequired stock valued at $5.1 billion,
    6,715 items had unrequired stock on hand valued at $227.5 m illion and,
    at the same time, had quantities due in from purchase contracts. The 25
    largest items had unrequired stock valued at $46.3 m illion, or about 20
    percent of the items on order. A description of selected Air Force and
    Navy items is provided in appendix II.

    W e analyzed requirements computation documents and interviewed air
    logistics center and ASO requirements analysts and item management
    personnel. W e were usually able to determine what change in require-
    ments caused items to be reported in unrequired stock. In most cases,
    the lack of historical documents prevented us from reconstructing the
    decision-making process to determine if the item managers should have
    known that requirements were overstated when the items were last pur-
    chased. Many of the problems that we identified as causing growth in
    unrequired inventories also contribute to overstating required invento-
    ries that could eventually end up as unrequired inventories. W e only
    evaluated the causes for growth in unrequired inventories and did not
    determine their impact on required inventories.

    To identify previously reported logistics problems related to the growth
    in unrequired stocks, we reviewed the findings and recommendations in
    prior GAO and DOD audit reports that related to the general problem
    areas identified in our review of selected items. W e also interviewed
    officials at the headquarters, major command, and logistic item manage-
    ment levels.

    Because much of the data used in the services’requirements computa-
    tion systems is from other data systems, we did not attempt to verify
    the accuracy of all the data. However, we did determine the basis for the
    reported unrequired stock on individual items we examined, compared
    this with other available information for consistency, and verified data
    accuracy with the item managers.

    W e obtained official comments from MOD on the draft report. W e incorpo-
    rated them throughout the report as appropriate, and reprinted them in
    appendix III.



    Page 13                                     GAO/NSIAD-90-100DefenseInventory
     Chapter 1
     Introduction




-;
     We conducted our review from January 1988 through April 1989 in
     accordance with generally accepted government auditing standards.




     Page 14                                  GAO/NSIAD-90-100Defense Inventory
Chaibter 2

                            of Unrequired Aircraft Parts Has                                                                                              -
                             Most Rapid Growth

-.-.---L---.-


                                            The largest rate of growth in the aircraft parts inventory has been in
                                            unrequired stocks. We identified 6 major reasons why most of the 65
                                            items we reviewed became unrequired. Overestimated customer use/
                                            demand rates and modification of existing aircraft and equipment were
                                            the most common reasons.

                                            Between 1980 and 1988, the Air Force’s inventory of aircraft parts
                                            increased by $18.8 billion, from $9.2 billion to $28 billion (204 percent).
                                            The Navy’s inventory of aircraft parts increased by $8.3 billion, from
                                            $4.6 billion, in 1980 to $12.9 billion in 1987 (181 percent). As shown in
                                            table 2.1, the increase for Air Force and Navy required stock had the
                                            largest dollar increase, but unrequired stock had the greatest percentage
                                            increase.

Table 2.1: Increase in Air Force and Navy
Inveqtory of Aircraft Parts                 Dollars in millions
                                                                                     Increase in Air Force                     Increase in Navy
                                                                                   inventoryiygch    1980 to               inventory{ ;;7pt. 1980 to
                                                                                                  a                                       a
                                            Inventory classificationb                  Amount         Percent                  Amount         Percent
                                            Approved force acquisition
                                            obiective                                    $12,886                 179            $4,601                 153
                                            Approved force retention                               c                   c            90
                                                              .~       ~~ .~~ ~.~                                                                ..__~ 105
                                            Total required stock                         $12,886                 179            $4,691                 151
                                            Economic retention                            $2,850                 740              $378         ---_ 141
                                            Contingency-retention
                                                                               .__ _ _-- ._--.-2,847
                                                                                                   _.._ -__--.-_.--181       ---..3,742 ~~-.__~.     --565
                                            Potential excess                                     210               429             (517)                (95)
                                            Total unrequlred stock
                                            Total                                           $5,907
                                                                                          $18.793      .-..--295              $3,603
                                                                                                                  204 ..-~a~294          .-------244
                                                                                                                                        --._- --..181

                                            “Stratification values may not agree with DOD’s reported inventory because the serwces made adjust-
                                            ments in prepanng their annual Inventory reports.
                                            “See appendix I for definltlons.

                                            “The Air Force does not use the approved force retention category in its inventory stratlflcation.


                                            DOD’Sreported inventory includes many items that need repair. Stratifi-
                                            cation reports for 1987 showed that over half the Air Force and Navy
                                            unrequired aircraft parts needed repair.

                                            Some of the inventory management factors causing unrequired stocks
                                            have been previously reported by us and the audit organizations of the
                                            military services. Although actions have been taken on some of these
                                            problems, our tests of the largest line items with unrequired inventory




                                            Page 16                                                          GAO/NSLAD-90-100Defense Inventory
                                          Chapter 2
                                          Inventory of Unrequired Aircraft Parts Has
                                          Shown the Most Rapid Growth




                                          show that these factors continue to create much of the unrequired
                                          inventory.


                                          We reviewed 65 items (40 Air Force and 25 Navy) to determine why
R4asonsfor the                            stock had become unrequired. We found that 10 items were erroneously
Gkowth in Unrequired                      reported and, in fact, did not have unrequired stock. Because of a lack of
Stpck                                     documentation, we could not determine why four other items had unre-
                                          quired stock. Table 2.2 shows the 6 major reasons why the remaining 51
                                          items had unrequired stock.

Table 2.2: Major Reasons for Unrequired
Stokk of 51 Selected Items                                                                       Items with unrequired stock
                                          Reason                                     Air Force           Navy          Total     Percent
                                          use rates overestimated                            9               7            16          31
                                          Modifications reduced
                                          demand                                             3              7             10          20
                                          items became reDairable                            5              3              8          1%
                                          Aircraft Dhased out                                4              4              8          16
                                          War reserves or safety levels
                                          reduced                                            5              0              5          10
                                          Reliabilitv imtxoved                               3              1              4           8
                                          Total                                             29             22            51          101”
                                          aTotal is more than 100 due to rounding.


                                          Four of the six reasons related to those identified in earlier reports. We
                                          did not find prior audits that identified unrequired stock caused by con-
                                          sumable items that became repairable, or items that experienced
                                          improved reliability.

                                          In our sample, we usually identified what caused quantities of items to
                                          be reclassified from required to unrequired stock. However, for most
                                          items, we were not able to determine if requirements were overstated
                                          when the items were last purchased because requirement computations
                                          that justified the last purchases were not available.

                                          The following sections describe each of the above problem areas and
                                          prior related audits, The prior audits describe the kinds of problems
                                          encountered and actions taken in the past. Except where specifically
                                          noted, the descriptions of prior findings are not intended to represent
                                          the circumstances existing now.




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                             Inventory of Unrcquired Aircraft Parts Has
                             Shown the Most Rapid Growth




Use!Rates Overestimated      Unrequired stock for 16 of the 51 items, or 31 percent, resulted because
                             estimated use rates decreased. The Air Force’s and Navy’s automated
                             systems use 2 years of historical use data to develop demand forecasts
                             for items in the supply system considering such factors as failure rate
                             and field versus depot repair. However, new items entering the supply
                             system or items undergoing engineering or design changes do not have
                             past use data that represent future requirements. Therefore, demand
                             rates are based on information from maintenance, contractor, and user
                             personnel or the demand rates of similar items, If demand rates are
                             wrong, requirements will be overstated or understated.

                             An example of a new item in unrequired stock is a compressor rotor
                             blade for the F-404 engine, which powers the F/A-18 aircraft. The blade
                             was last purchased in July 1985, when the Navy bought 4,615 blades.
                             AKI based this procurement on an initial estimated replacement rate of
                             35 percent. However, the current historical replacement rate is about 4
                             percent. As a result, 6,464 blades valued at $1.3 million were in unre-
                             quired stock as of September 30, 1987.

                             A case assembly for the F-100 engine, which powers the F-15 and F-16
                             aircraft, was an example of an older item in unrequired stock. In 1985,
                             the San Antonio depot maintenance activity did not meet overhaul pro-
                             duction goals for the F-100 engine. Because a parts shortage contributed
                             to the problem, air logistics center item management and depot mainte-
                             nance personnel revised spare part requirements for the engine. The
                             equipment specialist revised requirements for the case assembly using
                             an estimated 20-percent condemnation rate in the requirements compu-
                             tation.’ In fiscal years 1986 through 1987, the Center awarded contracts
                             to buy 629 case assemblies for $4.1 million based on that estimate. By
                             September 1987, requirements for the case were again being automati-
                             cally computed based on actual historical data and the condemnation
                             rate dropped to 1 percent. As a result, 665 case assemblies valued at
                             $4.6 million were in unrequired stock. Documents were not available to
                             determine whether the estimated 20 percent condemnation rate used in
                             1985 was justified at the time.

Prior Reports Dealing With   In February 1986, the Air Force Audit Agency reported that the Air
Related Issues               Force had based 13 percent of its requirements for aircraft parts on esti-
                             mated use rates.:! In a judgmental sample of 60 items using estimated

                             ‘The condemnation rate is the proportion of items needing repair that are uneconomical to repair.

                             ‘Heview of Selected Estimated IJsage Rates for Recoverable Items (Air Force Audit Agency, Project
                             No. 5126117, Feb. 13, 1986).



                             Page 17                                                     GAO/NSIAD-90-100Defense Inventory
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                            Inventory of Unrequired Aircraft Parts Has
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                            rates, the Audit Agency found that 23 items (38 percent) had invalid use
                            rates that overstated requirements by at least $44.8 million. For exam-
                            ple, had the Air Force relied on actual use rates for 10 items instead of
                            contractor estimates (5 years of actual use history was available)
                            requirements could have been reduced by $34.1 million. The Audit
                            Agency recommended that AFLC develop a management product to iden-
                            tify items with estimated use rates that had 2 years or more of historical
                            use data. It also recommended that supervisors and review teams use
                            the product to identify items most likely to have misstated require-
                            ments. In response, AFLC emphasized to its air logistics centers the need
                            to review active items that used estimated factors when 2 years or more
                            historical data were available, and agreed to provide a product that
                            identified such items for the air logistics centers on request.

                            In April 1985, the Air Force Audit Agency reported that AFLC'S initial
                            and follow-on requirements for spare parts were misstated or provided
                            inconsistent levels of supply support for the F-lGC/D aircraft.:’ Initial
                            spare part requirements were overestimated by $4.4 million for seven of
                            nine items. Further, 15 of 18 items had requirements overstated by
                            $85.9 million because estimated failure rates did not consider expected
                            reliability improvements. The Audit Agency recommended the use of
                            estimated failure rates that correspond to reliability growth rate charts.
                            AFLC concurred and agreed to include the requirement’in revisions to its
                            regulations.

Modifications Resulted in   Unrequired stock for 10 of the 51 items, or 20 percent, resulted from
Declining Demand or         modifications of aircraft or equipment that reduced demand or caused
Obsolescence                complete obsolescence. Modification programs to correct deficiencies
                            and improve capabilities of weapon systems and equipment involve
                            replacing items managed by the services. During a modification pro-
                            gram, requirements for old or replaced items decrease while require-
                            ments for new installed parts increase.

                            To illustrate, 1 of the 10 items was a duct segment for the F-100 engine.
                            In November 1985, the San Antonio Air Logistics Center purchased
                            73,000 duct segments for $8 million in the second year of a multiyear
                            contract. However, as of September 1987,41,365 duct segments valued
                            at $4.7 million were in unrequired stock. According to the equipment
                            specialist, the duct segment is being replaced by a new item as part of
                            the “improved life core” engine modification program.

                            “Spares Support for the F-16 C/D Aircraft (Air Force Audit Agency, Project No. 4126121, Apr. 4,
                            1985).



                            Page IS                                                    GAO/NSIAD-90-100Defense Inventory
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                                      chapter 2
                                      Inventory of Unrequired Aircraft Parts Has
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                                      Another example is a power supply that had 48 unrequired assets on
                                      hand worth $1.5 m illion as of September 30, 1987. According to ASOoffi-
                                      cials, this item is in unrequired stock because the electronic warfare test
                                      set it supports is being replaced with a more modern test set.

       Prioi- Reports Dealing W ith   In October 1982, we reported4 that Air Force managers were not rou-
       Relited Issues                 tinely advised of modification programs that reduced or elim inated
           I                          demand for their items, and that managers spent m illions of dollars
                                      purchasing and repairing unneeded items. We recommended increased
                                      emphasis to improve the modification coordination process. DOD and Air
                                      Force officials concurred with our findings and outlined plans to (1)
                                      revise procedures to improve and monitor the coordination process and
                                      (2) develop commandwide training on coordinating modification
                                      programs.

                                      In August 1984, the Air Force Audit Agency reported that AFLC had
                                      initiated unnecessary parts repairs of $2.7 m illion and processed unnec-
                                      essary purchase requests of $4.7 m illion primarily because modification
                                      program data in the requirements system were either out of date or
                                      invalid. The Audit Agency recommended that AFLC modify its system
                                      and revise its regulations to require that each air logistics center ensure
                                      that requirement computations are updated with modification data.
                                      AFLC concurred with the recommendations.



       Consumable Item s Became       Unrequired stock for 8 of the 51 items, or 16 percent, was caused princi-
       Reparable                      pally by consumable items that became economically reparable. Aircraft
                                      and equipment components fall into two general categories-those dis-
                                      carded when they fail (consumable) and those repaired and reused (rep-
                                      arable). Since consumable items are not generally repaired, procurement
                                      is primarily based on how often they fail. In contrast, a portion of the
                                      requirement for reparable items can be met through repair rather than
                                      purchase. Consumable items can become repairable when item managers
                                      and equipment specialists determ ine that the items are economical to
                                      repair. This can happen if either the price increases or the cost to repair
                                      drops, making it more economical to repair the item than to buy it. Such
                                      a change would reduce the computed requirements for new purchases
                                      because broken items would be replaced by a repaired item instead of a

                                      ‘Improving the Air Force Modification Process Will Benefit Management of Spare Parts in the Air
                                      Force and Defense Logistics Agency (GAO/PLRD _83 -3,0 ct. 16, 1982).
                                      ‘Requirements Computations for Spare Parts Affected by Modification Programs (Air Force Audit
                                      Agency, Project No. 4010215, Aug. 15, 1984).



                                      Page 19                                                    GAO/NSLAD-90-100Defense Inventory
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                                                                                                                                                 ,

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                                                     Chapter 2
                                                     Inventory of Unrequired Aircraft Parta Has
                                                     Shown the Most Rapid Growth




..,..   8..   -.   .^...   .I   -....-   -..-..-I.




                                                     new item. We did not identify prior reports that relate to consumable
                                                     items becoming repairable.


Older Aircraft Phased Out                            Unrequired stock for 8 of the 51 items, or 16 percent, was the result of
                                                     older aircraft being replaced. In such cases, flying hour requirements
                                                     declined because the number of applicable aircraft were phased down or
                                                     out of the inventory earlier than originally scheduled. Requirements and
                                                     subsequent procurements for items applicable to these aircraft are
                                                     determined based on flying hour programs for the aircraft. Therefore,
                                                     changes in flying hours cause changes in requirements and inventories
                                                     of these items. For example, one of the eight items was a fuel control for
                                                     the F-4 aircraft engine. In May 1986, 26 fuel controls were purchased
                                                     for $759,200 to rebuild engines. However, in July 1987 the rebuild pro-
                                                     gram was canceled because of an accelerated phase-out of the F-4 air-
                                                     craft. Between March 1986 and September 1987, the flying hours
                                                     projected for 1988 in the fuel control’s requirement computation
                                                     dropped 57 percent. As a result, 107 fuel controls valued at $3.2 million
                                                     were in unrequired stock as of September 30, 1987.

Prior Report Dealing With                            In November 1984, we reported” that two air logistics centers had over-
Mated Issues                                         stated their needs, by a projected $31.1 million, for spare parts for air-
                                                     craft that were being phased down or out. We also projected that the
                                                     centers had understated spare parts requirements for new aircraft by
                                                     $28.8 million. The errors were attributed to the fact that automated sys-
                                                     tems did not always identify all aircraft on which a part was used and
                                                     incorrectly computed flying hour ratios by using standard time periods
                                                     rather than actual procurement lead time. We recommended manage-
                                                     ment reviews to ensure that accurate weapon system application data
                                                     are maintained in the requirements system. We also recommended revis-
                                                     ing the forecasting system so that the flying hour ratio considers the
                                                     actual aircraft model using the part and the estimated procurement lead
                                                     time. DOD and the Air Force agreed with our first recommendation but
                                                     did not agree with using lead time in computing the flying hour ratio.
                                                     They believed that using actual lead time might result in buying excess
                                                     inventories. We disagreed because using standard times could result in
                                                     buying too much in some cases and too little in others.




                                                     “The Air Force Can Improve Its Forecasts of Aircraft Spare Parts Requirements (GAO/NSIAD-85-2,
                                                     Nov. 19, 1984).



                                                     Page 20                                                  GAO/NSIAD-90-100Defense Inventory



                                                                                                                                            ”   ,..
                             Chapter 2
                             Inventory of Unrequired Aircraft Parta Has
                             Shown the Most Rapid Growth




Wa< Reserve or Safety        IJnrequired stock for 5 of the 51 items, or about 10 percent, resulted
Level Requirements           primarily from decreases in Air Force requirements for war reserve
                             material or safety levels for peacetime stocks. For example, recent Air
Decreased                    Force policy decisions reduced war reserve requirements. In March
                             1987, the Air Force reduced the number of tactical aircraft expected to
                             be mission capable from 20 to 18 (out of a 24-aircraft squadron). In
                             April 1987, AFLC estimated that the change reduced the gross war readi-
                             ness spares kit requirements by $1.2 billion.

                             Also, the Air Force adds a variable safety level to peacetime needs to
                             minimize the chance of being out of stock. Fluctuating safety levels can
                             also cause unrequired stock. For example, one of the five items was a
                             recorder for a reconnaissance system. In September 1986, the Ogden Air
                             Logistics Center spent $7.9 million for 60 recorders, of which 31 record-
                             ers were to satisfy a variable safety level. By September 1987, the varia-
                             ble safety level decreased to six and resulted in $1.6 million of
                             unrequired recorders.

Prior Reports Dealing With   In November 1986, the Air Force Audit Agency reported that factors
ReMted Issues                used to compute wartime needs for electronic countermeasure systems
                             were not supported by use datae7The Audit Agency reviewed five sub-
                             systems and found that their computations were based on unsupported
                             estimates because the Strategic and Tactical Air Commands did not col-
                             lect or retain actual peacetime use data. For one undelivered subsystem,
                             the buy requirement of $711 million was overstated by about $464 mil-
                             lion. In response, the Commands included peacetime use data in their
                             computations of wartime needs.

                             In February 1985, the Air Force Audit Agency reported that the acquisi-
                             tion quantities for many items involving millions of dollars may have
                             been overstated by unnecessary increases in variable safety levels.” In
                             response, AFLC determined that a programming error during conversion
                             from one computer system to another had caused the overstatement. In
                             a follow-up sample after the programming error was corrected, the
                             Audit Agency found that 206 of 385 items had reductions of $227 mil-
                             lion in the safety level requirement. Of the $227 million in reductions,
                             item managers terminated $104.7 million in purchase requests, but left


                             ‘Review of the Support for the Fiscal Year 1986 Spares Budget Requirements in AFLC (Air Force
                             Audit Agency, Project No. 5126123, Nov. 14, 1986)
                             HFluctuations in the Variable Safety Level Requirements for Recoverable Items (Air Force Audit
                             Agency, Project No. 4126125, Feb. 17, 1985).



                             Page 2 I                                                   GAO/NSIADSO-100Defense Inventory
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                       another $114.1 million on order to purchase stocks for future-year rou-
                       tine requirements and war reserves not in DOD'S budget. Item managers
                       did not terminate the remaining $8.2 million because of excessive termi-
                       nation costs.


Reliability Improved   Unrequired stock for 4 of the 51 items, or 8 percent, was primarily the
                       result of improved parts reliability, Improvements occur from modifica-
                       tions, improved manufacturing or repair processes, and changes in air-
                       craft mission. For example, in September 1986, 539 turbine blades for
                       the A-7 aircraft engine were purchased for $748,164. After the blades
                       were received, a new repair process was developed that increased the
                       life of the blade. This action increased stock availability and resulted in
                       1,039 blades valued at $1.5 million in unrequired stock by September 30,
                       1987. We did not identify prior reports related to improved part
                       reliability.


                       Four of the six reasons that the items included in our review became
Conclusions            unrequired are related to factors that have been the subject of prior
                       audits. Although DOD and the services have taken steps to correct many
                       of the previously reported problems, our current review reinforces the
                       need to control or at least to better anticipate and plan for the causal
                       factors. Such factors include overestimated use rates, modifications that
                       reduce demand, phase-out of older aircraft, and fluctuation in war
                       reserve and safety level requirements.


                            agreed with the thrust of findings and conclusions in this chapter,
Agency Comments and    DOD
                       and said that top level emphasis and controls are needed to attack the
Our Evaluation         growth in unrequired inventories. M)D said a major program is under-
                       way to reduce unnecessary inventory growth. DOD cited efforts to cata-
                       log items to eliminate duplicate items, revise policy on retention and
                       inventory stratification, reduce leadtimes, terminate more excess on
                       order materiel, incorporate a weapon systems management program,
                       and modernize data processing systems.

                       DOD also stated that because our analysis focused on unrequired stocks
                       with a recent or in-process procurement, we did not address such other
                       major additional causal factors as increased material returns, a con-
                       servative disposal policy, and price differences from 1980 to 1988.




                       Page 22                                      GAO/NSIAD-90-100Defense Inventory
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We agree that our analyses focused on actions during recent years, and
that the analyses would not reflect causes outside that scope. We
focused on the period for which the Air Force and Navy retained
records of transactions and requirements computations. Also, that
period would be most relevant to current DOD policies and procedures.
We considered in our tests the causal factors cited by DOD. We discussed
price differences in our July 1988 report, and the differences accounted
for a significant portion of overall item value, but not for the greater
rate of increase for unrequired items. The other factors did not arise as
major causes for our selected items.




Page 23                                      GAO/NSIAD-90-100Defense Inventory
   ,
Chapter 3

F%-ocurementManagement Practices Contribute
d Growth in Unrequired Stock

                          Three procurement management practices contributed to the growth in
                          unrequired stock for some items we reviewed. These include

                        . not evaluating whether orders for unneeded assets should be
                          terminated,
                        . receiving material before required, and
                        . procuring items in excess of the economic order quantity.

                          The DOD Inspector General and               GAO   have previously reported on these
                          problem areas.


                          To prevent buying unrequired items, Air Force and Navy requirements
Orders for Unrequired     systems identify quantities of material that are on order for potential
Assets Not Terminated     termination because they are excess to requirements. At least 36 of the
                          55 selected items’ that had unrequired stock had quantities identified
                          for potential termination when last on order. The 36 items included 26
                          of 33 Air Force items and 10 of 22 Navy items. Because it appeared a
                          great deal of excess material was on order, our sample was designed to
                          show the general magnitude of the excess rather than a precise value,
                          which would have required much more work. Prior audit reports have
                          recommended that the Air Force and Navy terminate more orders for
                          unrequired material. Both services are increasing terminations, but
                          could take further action.

                          Changes in item use, production lead times, repair cycles, and other fac-
                          tors can reduce requirements for items after they have been ordered. To
                          prevent acquiring unrequired items, the requirement computation sys-
                          tem identifies orders that exceed requirements for possible termination.
                          Item managers check the computation and consider such factors as how
                          much production lead time has passed and whether any of the order has
                          been delivered. They forward recommendations for termination to pro-
                          curement personnel who decide whether termination is in the govern-
                          ment’s best interest by considering such factors as the amount of
                          termination costs that might be incurred.

                          Based on available documentation, at least 26 of the 33 Air Force items
                          had quantities on order identified for potential termination. Of the
                          remaining seven items, two were not identified for termination, and no
                          documentation was available to conclude whether the other five items

                          ‘l’hc 55 items include the 51 with reasons for growth identified in table 2.2 and the 4 with unknown
                          reasons for growth.



                          Page 24                                                     GAO/NSIAD-90-100Defense Inventory
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                         were ever identified for termination. Of the 26 identified, item managers
                         recommended 5 for termination, but only terminated 2. Procurement
                         personnel cited excessive contract termination costs as the reason for
                         not terminating the other three. For 11 of the remaining 21, item mana-
                         gers cited management decisions based on anticipated future use as the
                         reason for not terminating. Item managers for 3 of the 11 items provided
                         documentation showing their decisions were not solely based on
                         accepted item management principles, but were also based on meeting
                         budget obligation goals that were set to encourage spending appropri-
                         ated funds. In the remaining cases the reasons cited for not cancelling
                         the Air Force items met Air Force criteria, or the item was erroneously
                         recommended for termination because of errors in the requirement
                         computation.

                         Item managers recommended terminating quantities on order for 10 of
                         the 22 Navy items in unrequired stock. ASOterminated contracts for
                         three items. It did not terminate the other seven orders primarily
                         because it believed that termination costs were excessive, or because
                         most of the items had already been delivered.

                         In response to recent audits, however, AFLC and ASOare both taking
                         actions to terminate more orders for unrequired items.


Air Force Terminations   In January 1987, the DOD Inspector General reported that the San
                         Antonio Air Logistics Center had improved spare parts availability for
                         the FlOO engine, but that orders for unrequired engine parts were not
                         being terminated.” The report cited orders for 13 items valued at $34
                         million that exceeded current requirements. The Air Force then empha-
                         sized to the Center the need to process terminations according to Air
                         Force policy.

                         In August 1987, we reported that two air logistics centers had orders for
                         aircraft parts that exceeded requirements by $103.2 million.:’ Out of a
                         sample of 44 items with on order excess of $74.2 million, the centers had
                         terminated only $1.8 million (3 percent), although it would have been
                         cost-effective to terminate an additional $24.9 million. In commenting on
                         that report, DOD agreed that improvement was needed and stated that it

                         "FlOO Aircraft Engine Spare Parts (DOD Office of the Inspector General, Report No. 87-069, Jan. 16,
                         1987).
                         “Military Procurement: Air Force Should Terminate More Contracts for On-Order Excess Spare Parts
                         GAOINSIAD87_ _141 , Aug. 12, 1987).



                         Page 26                                                    GAO/NSIAD-90-100Defense Inventory
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                        would issue new policy guidance to improve the Air Force’s termination
                        process upon receipt of additional information from an ongoing DOD
                        Inspector General review.

                        In a February 1988 follow-up, we reported4 that the Air Force’s value of
                        on-order excess material continued to grow but that actions taken or
                        planned by the Air Force should improve the termination process. AFLC
                        officials said the process would improve when AFLC implemented revised
                        policies, including an economic model software package to determine
                        whether on-order excesses could be economically terminated. In June
                        1988, AFLC implemented both aspects. However, guidance at the time of
                        our current review still discouraged terminating the maximum number
                        of orders for unrequired items.

                        Portions of current AFLC guidance on amending purchase requests and
                        terminating orders, which are summarized below, discourage item mana-
                        gers from reducing quantities on order.

                    l An April 1986 AFLC memorandum stated that reducing quantities on
                      order could hinder the Command’s budget execution goals and jeopard-
                      ize weapon system support. AFLC prohibited changes in quantities on
                      order if they resulted only from a change in the variable safety level.
                    . A March 1987 AFIC memorandum to air logistics centers regarding
                      reduced Air Force war reserve requirements instructed the centers to
                      “ . . . have your item managers closely scrutinize the March 1987 DO41
                      computations and avoid terminating on-order assets or amending pur-
                      chase requests whenever prudent.”

~---
Navy Terminations       Prior audits have also identified weaknesses in Navy terminations of
                        orders for unrequired items. For example, in March 1985, we reported
                        that the Navy could terminate more orders for unrequired material.h
                        From sampled items with $60.5 million on order identified for potential
                        termination, $25 million could have been recommended for termination,
                        but only $1 million was recommended by the item manager. Of this
                        amount, only $429,000 was actually terminated. We recommended revis-
                        ing thresholds used to identify potential terminations, timely review of
                        potential terminations, supervisory review of termination decisions, and

                        “Air Force Budget: Potential for Reducing Requirements and Funding for Aircraft Spares (GAO/
                                   9Ol3R, Feb. 18, 1988).

                        “The Navy Can Increase Cancellations of Procurement for Unneeded Material (GAO/NSIAD-86-65,
                        Mar. 22, 19%).



                        Page 26                                                   GAO/NSIAD-90-100Defense Inventory
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                       discontinuing the practice of adding requirements to items with poten-
                       tial terminations. DOD agreed with all but the last of these
                       recommendations.

                       In May 1988, the DOD Inspector General reported that ASO still did not
                       have an effective process for identifying and terminating unrequired
                       assets on order.‘; In response, ASOofficials stated that they planned to
                       revise termination policy to provide better internal controls over the
                       process. At the time of our review, the new termination policies were
                       still in draft and had not been implemented at ASO.


                       In addition to the reasons previously cited for growth in unrequired
Materials Received     inventories, 5 of the 29 Air Force items identified in table 2.2 also had
Sooner Than Required   overestimated procurement lead times. Procurement lead time repre-
                       sents the administrative and production time required to order and
                       receive parts. It begins with the purchase request and ends with the
                       first significant delivery (10 percent of the total contract quantity). Pro-
                       curement lead time determines when an order must be placed. If the
                       time is underestimated, inventories of an item could run out. If the time
                       is overestimated, items could arrive sooner than necessary.

                       For example, one of the five items was a transmitter for radar on the
                       F-16 aircraft, In July 1986, 251 transmitters valued at $1.4 million were
                       purchased. The supporting March 1986 requirement computation used a
                       total estimated lead time of 3 1 months based on contractor estimates.
                       However, the actual lead time proved to be only 13 months. Mainly as a
                       result of this factor, 212 transmitters valued at $1.2 million were in
                       unrequired stock as of September 1987. Because the procurement was
                       more than 2 years ago, we could not determine if a more accurate esti-
                       mate of production lead time could have been made from information
                       available at that time. However, the Logistics Management Institute has
                       reported that many contractors overestimate or “pad” their production
                       lead time to cover administrative delays and to avoid delinquency
                       problems.

                       In 1986, we reported on a related problem that resulted in material
                       being received sooner than required.7 We found that two air logistics

                       “Contract Terminations At the Naval Aviation Supply Office (DOD Office of the Inspector General,
                       Kcport No. 88-153, May 23, 1988).

                       ‘Military Logistics: Buying Spares Too Early Increases Air Force Costs and Budget Outlays (GAO/
                       mAD-86-149,
                         L              Aug. 1, 1986).



                       Page 27                                                   GAO/NSIAD-90-100Defense Inventory
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centers routinely initiated purchases of aircraft spares up to 14 months
earlier than necessary. If the centers had not initiated the early
purchases, they could have (1) avoided a premature investment of
$374.6 million, (2) avoided holding costs of $52.2 million, (3) effected
one-time reductions in funding requests, obligations, and outlays of
about $125.4 million for 1984 procurement, and (4) reduced the risk of
acquiring materiel that might become obsolete before it is used. We rec-
ommended compliance with AFLC Regulation 57-4, which stipulates that
routine purchases should be initiated at times that will allow them to be
received when needed, considering procurement lead times.

In response to our 1986 report, DOD stated that early initiation did not
necessarily result in the receipt of material before it was needed because
the Air Force contracts for a specific delivery date and can refuse to
accept early deliveries. DOD also stated that the requirements system is
self correcting since on-order assets are applied against future require-
ments. Although DOD disagreed with our 1986 findings, it stated that it
would limit early initiation to 12 months because more than 12 months
early could result in premature obligation of funds.

We considered a 12-month limitation inadequate to resolve the problems
we had identified. For several years the air logistics centers had rou-
tinely included standard provisions in their spare parts contracts
authorizing contractors to deliver early. Of 140 purchases in our review,
133 had actually been delivered and accepted early. We also expressed
concern with DOD'S statement that the requirements system is self cor-
recting. The statement assumes that future requirements will not change
and spare parts purchased prematurely will ultimately be used. If the
assumption is incorrect, it could result in procurement of material that
may not be used. Even if requirements do not change, early procurement
is not necessary and causes premature outlays, increased budgets, and
unnecessary holding costs.

In February 1988, we reported on a follow-up review where we found
that the Air Force’s fiscal year 1987 and 1988 buy guidelines did not
contain a 12-month limitation and could be interpreted as authorizing
premature initiation.” Moreover, the Oklahoma City Air Logistics
Center’s buy guidelines required that purchase requests be initiated
more than a year earlier than needed.


‘Air Force Budget: Potential for Reducing Requirements and Funding for Aircraft Spares (GAO/
            OBR,Feb.18,1988).



Page 28                                                   GAO/NSIAD-90-100Defense Inventory
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                      procurement Management Practices
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                      During our current review, we found provisions in the Air Force’s fiscal
                      year 1989 buy guidelines and the five centers’ supplemental instructions
                      encouraging early procurement initiation to meet budget obligation
                      goals.


                      For 3 of the 22 Navy items identified in table 2.2, inventory managers
Pqcurement Exceeded   procured consumable assets in excess of economic order requirements.!’
Ecbnomic Order        The amount purchased in excess of the recommended quantity for the
Quhtity               three Navy items totaled 3,597 units valued at $396,895. For example,
                      ASOinitiated a purchase for 6,541 consumable compressor rotor blades
                      costing $84 each. Only 2,236 of these were needed to bring the stock
                      position up to the reorder level. The economic order quantity principle
                      would have added 723 blades for a total of 2,958. A policy to buy at
                      least a l-year supply increased the procurement by 3,583 blades costing
                      about $300,000.

                      In January 1988, we reported that the practice of buying more than the
                      economic order quantity contributed to the Navy’s growing inventory of
                      unrequired stock.1oAt that time, we recommended that the Navy not
                      buy more than the economic order quantity unless a larger procurement
                      would result in quantity discounts that more than offset the additional
                      holding costs.

                      In response to that recommendation, DOD said the Navy would (1) in the
                      future buy the economic order quantity for items with well-established
                      demand patterns, and (2) buy l- to 2.5-years worth of items that it
                      believes have stable or very stable demand. DOD cited changes in con-
                      tracting that could result in orders being placed weekly and as many as
                      four buys being in process at the same time. DOD also stated that a 1986
                      study concluded that buying under a l-year policy would reduce total
                      variable costs by 7 percent.

                      We did not believe DOD’S reasons justified buying a year’s or more worth
                      of stable demand items. We noted that existing controls should prevent
                      multiple buys in process. We also examined the study cited by DOD and
                      found that it concluded that increasing the ordering quantity from 3 to

                      “The economic order quantity principle is a mathematical technique used to determine the purchase
                      quantity with the lowest total costs for ordering and holding inventory to meet requirements. DOD
                      policy generally requires an order quantity of not less than 3 months nor more than 3 years of
                      supply.
                      “‘Navy Supply: Economic Order Quantity and Item Essentiality Needs More Consideration (GAO/
                      NaAD-88-64, #Jan.6,1988).



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                  12 months would increase total variable costs by 7 percent, not reduce
                  them.

                  The Logistics Management Institute subsequently reached a conclusion
                  similar to ours. In August 1988, the Institute reported that from 1984 to
                   1985, the services increased their minimum order quantities from a 3-
                  month supply to a l-year supply to take advantage of price reductions
                  and to offset procurement lead times. The Institute found that larger
                  order quantities had resulted in price breaks for some items and reduced
                  procurement work load. At the same time, (1) order quantities had
                  doubled since 1983, (2) the annual holding costs had increased by more
                  than $600 million, and (3) unrequired stock had grown by over $14 bil-
                  lion, an 86 percent increase. The Institute recommended that DOD direct
                  the services to eliminate the l-year minimum order quantity, use the
                  economic order quantity principle to determine order quantities, and
                  override it only when larger quantities are cost-effective.

                  The Institute did not include Air Force recoverable items in its study
                  because the Air Force requirement system does not compute a specific
                  order quantity. However, according to an Institute official, the Air
                  Force, as well as the Navy and Army, uses a minimum order quantity
                  that consists of procurement lead time requirements, plus a 12-month
                  supply.


                  We believe that DOD, Navy, and Air Force actions on terminating unnec-
Conclusions       essary orders, initiating purchase requests, and applying the economic
                  order quantity principle are not adequate. Although the services have
                  tried to terminate more orders, the Air Force still has conflicting guid-
                  ance for inventory managers, and the Navy still has weaknesses in its
                  termination process.

                  As previously reported, the Air Force routinely initiates purchase
                  requests before the necessary procurement lead time and the Navy
                  unnecessarily buys assets over the economic order quantity. Both prac-
                  tices contribute to the acquisition of inventory before it is needed.


                  We recommend that the Secretary of Defense direct the Secretaries of
Recommendations   the Air Force and Navy to improve its procurement management prac-
          Y




                  Page 30                                     GAO/NSIAD-90-100Defense Inventory
\                           Chapter 3
                            Procurement Management Practicea
                            Ckmtribute to Growth in &we&red Stock




                            tices that have contributed            to the growth in unrequired stocks,
                            Specifically,

                          . the Secretaries of the Air Force and Navy should review their policies on
                            terminating orders for unrequired items at all levels to ensure they
                            clearly support termination whenever practical;
                          . the Secretary of the Air Force should stop the practice of initiating pur-
                            chase requests earlier than required; and
                          . the Secretary of the Navy should stop the practice of buying more than
                            the economic order quantity, unless there is such specific justification in
                            each case as a quantity discount which more than offsets additional
                            holding costs.

                      1
                                 agreed with our findings and recommendation regarding orders for
    Agency Comments and     DOD
                            unrequired assets not terminated and procurements that exceeded the
    Our Evaluation          economic order quantity. DOD described progress and ongoing actions in
                            both areas. For example, DOD recently clarified its order quantity policy
                            to reestablish the need to use economic order quantity methods and to
                            preclude the use of arbitrary 1 e-month or larger order quantity floors.

                            DOD  did not agree with our recommendation that early initiation of pur-
                            chase requests be stopped because the practices have resulted in, or con-
                            tributed to, buying items sooner than needed. According to DOD, it may
                            need items any time within the fiscal year, and it supports initiating pro-
                            curement documentation early within the fiscal year. DOD cited an exam-
                            ple whereby, if the Air Force had implemented our recommendation,
                            only about 25 percent of the funded requirements would be obligated
                            within the appropriation year, DOD said that since the time of our 1986
                            recommendation, no new information had been provided to warrant a
                            change in the DOD position,

                            We believe DOD'S disagreement with our recommendation is inconsistent
                            with DOD'S response to our similar recommendation in August 1989 con-
                            cerning Army spare parts. I1In that case, DOD concurred and noted Army
                            actions to stop unauthorized buy-ahead procurements.

                            Furthermore, in February 1988 we reported on our follow-up of DOD'S
                            1986 comments that its actions do not affect delivery dates. We noted
                            that 95 percent of sample deliveries was delivered and accepted early;

                            ’‘Military Logistics: Buying Army Spares Too Soon Creates Excess Stocks and Increases Costs (GAO/
                            NSAD-89-196, Aug. 28,1989).



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an average of 12.2 months at one air logistics center visited and 14.1
months at the other. Thus it has been clearly established that DOD and
Air Force policies and actions were resulting in unnecessarily early
deliveries.

DOD's  improved contracting efficiency from initiating procurement
requests early and its reduced ability to obligate funds do not automati-
cally justify buying items too early. As with the use of economic order
quantity principles, we believe that reduced procurement costs must be
shown to outweigh additional inventory costs before DOD overrides
requirements computations. If not shown to be cost-effective for other
reasons, spending money sooner than needed just to improve budget
obligation rates is inappropriate.

DOD partially concurred with our recommendation that the Navy should
stop procurements of more than the economic order quantity, indicating
our recommendation should not exclude other factors, We did not
exclude other factors, and clarified our recommendation.




Page 32                                     GAO/NSIAD-90400 Defense Inventory
Chapter 4




                     In addition to causes that directly contributed to the growth of unre-
                     quired stocks for specific items we selected, we identified factors that
                     may hinder management’s control over the growth in unrequired inven-
                     tories. The primary factors are (1) some DOD inventory reporting initia-
                     tives that reduce visibility of unrequired inventories and (2) growth in
                     Air Force stocks held to meet future requirements that could increase
                     the risk of unrequired stock.

                     Some DOD and Air Force initiatives to improve inventory reports may
                     aggravate existing problems with accurately reporting unrequired
                     stocks. Although certain efforts would improve the accuracy of inven-
                     tory data and reports, the efforts to redefine DOD material classifications
                     would, in many cases, mix required and unrequired stocks. The mixing
                     would reduce the visibility of unrequired items and could reduce the
                     quantities of unneeded orders eligible for termination.

                     With the growth in the Air Force’s required stock held to meet peace-
                     time requirements beyond the current year, continued high levels of
                     unrequired stocks could be experienced as some items become obsolete
                     or have declining demand. The precise level cannot be readily identified
                     because of the way required stocks are reported. However, since 1980,
                     stock held for the budget year (the year following the current fiscal
                     year) increased more than 400 percent to $6.6 billion for Air Force air-
                     craft parts alone. Stocks held for long-term use have higher rates of
                     obsolete items.


                           has expressed concern about the timeliness, accuracy, and complete-
Efforts to Improve   DOD
                     ness of its inventory reports. To improve the reports, in April 1988 DOD
Inventory Reports    requested its Logistics Systems Analysis Office to examine reporting
                     sources and compilation processes used by DOD components for the
                     agency’s annual inventory report. The Office completed the study in
                     February 1989 and found numerous weaknesses in existing reports. WD
                     officials hope to improve the reporting process, for example, by having
                     all components use the same cut-off date to meet the December 31
                     inventory report date.

                     The Air Force is also attempting to improve its reports. According to
                     AFLC officials, prior to 1987 the air logistics centers could not correct
                     errors in the stratification data used to prepare the annual inventory
                     report due to limitations in the automated requirements system. As a
                     result, inventory reports for prior years contained significant errors. For



                     Page 33                                      GAO/NSIAD-90-100Defense Inventory
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                             Chapter 4
                             Related Factors That Increase the Ris k of
                             Unrequired Stock




                             example, 1986 reports contained a $3.3-billion error because 4 units of
                             an item were erroneously entered as 1,000,004 units .

                            In September 1987, the Air Force was able for the firs t time to rerun its
                            s tratification reports after correcting and validating the data by means
                            of a new automated requirements database. AFLC'S firs t attempt at elimi-
                            nating errors in the report resulted in reductions of both required and
                            unrequired inventory. The value of the required aircraft parts inventory
                            decreased from $19.5 billion to $18.9 billion, and unrequired s toc k
                            decreased from about $12 billion to $8 billion. Despite these efforts, file
                            maintenance and s y s tem errors s till occur. Our 40 selec ted Air Force
                            items inc luded 7 that had been incorrectly reported in unrequired s toc k .
                            For example, one item’s data were wrong because the item manager had
                            erroneously entered 17,250 assets on hand ins tead of the correct number
                            of 160 into the requirement computation.

                            The Navy follows a s imilar process of validating, correcting, and restra-
                            tify ing its inventory before preparing the annual inventory report, but
                            is also continuing to experience s y s tem errors. W e found that 3 of our 25
                            selec ted Navy items had been erroneously reported in unrequired s toc k .


                                 and Air Force changes to reporting criteria would show some unre-
Inventory Reporting         DOD
                            quired inventory as required inventory. According to W D and Air Force
Initiatives May             representatives, the actions are intended to recognize that certain unre-
Impede Control of           quired assets were obtained in the best interes ts of the government.
                            However, the actions would reduce the v is ibility of unrequired s toc k
Unrequired Stoc k           and could reduce the quantities of unneeded orders eligible for
                            termination.


D O D Initiatives That      DOD   is considering actions to add
Reclas s ify Unrequired   . a third year of requirements to inventory reports,
Stoc k                    . requirements to cover quantities exceeding requirements if purchased to
                            obtain discounts, and
                          . requirements to cover life-of-type buys (purchases made to ensure
                            future availability of parts when faced with the los s of a supplier).

                            By adding an additional year of requirements to the exis ting 24-month
                            requirements forecasting period, D O D plans to reclas s ify as required
                            s toc k assets currently unrequired. They are not projected to be required
                            until the year following the budget year, more than 24 months in the


                            Page 34                                       GAO/NSIAD-90-100Defense Inventory
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                                       Belatad Factors That Increase the Risk of
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                                       future. Similarly, DOD would reclassify as required stock assets that
                                       were purchased over computed requirements because it was economi-
                                       cally in the best interest of the government, such as in economic order,
                                       minimum quantity, or life-of-type buys.

                                       Even though it may be useful to recognize that stocks were obtained by
                                       intent even if not currently required, decisionmakers need to know the
                                       extent of purchases that exceed requirements. Even when justified,
                                       these purchases should be separately identified and not commingled
                                       with required stock for reporting purposes.


Air Force Initiatives That             In April 1988, Air Force headquarters directed AFLC to increase the
Reclassify Unrequired                  approved force acquisition objective and the criteria used to identify
OC,,l.                                 unneeded items on order for potential termination. The Air Force
rl)LUCK
                                       expressed concern that the growth in unrequired items on order and the
                                       relatively low percentage of terminations leaves the items open to con-
                                       gressional budget cuts. In response, AFLC

                                   l temporarily authorized an additive to prevent on-order excesses from
                                     being reported as unrequired once the Air Force has decided not to ter-
                                     minate the order and
                                   . is considering adding another year of requirements to the termination
                                     period to reduce the number of orders for potential termination.

                                       In addition, Air Force headquarters reclassified assets that were
                                       believed to be uneconomical to repair as unstratified (in transit) stock in
                                       1987 and plans to report them as required in the future. Such stocks
                                       were previously identified as potential excess (having no economic or
                                       defense reasons for retention).

Additive Used in 1988 to Prevent       In June 1988, AFLC authorized air logistics center personnel to manually
Some Unrequired Stocks From            add items to requirements in its automated system to reclassify
Eking Reported as Such                 unneeded stock on order to required stock, if personnel decided not to
                                       terminate the order. For the Air Force’s system to reclassify the on-
                                       order excess material, the additive must be large enough to cover not
                                       only the unneeded stock on order, but also all quantities of unrequired
                                       stock already on hand. AFLC reports show that the additive moved
                                       approximately $600 million in stock from unrequired to required, as of
                                       March 1988.

                                       Four of the five air logistics centers expressed concerns about the addi-
                                       tive. The centers believed the additive would


                                       Page 36                                     GAO/NSIAD-30-100Defense Inventory
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                                     Related Factors That Increase the Risk of
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                                 l conflict with AFLC Regulation 57-4, which precludes the use of an addi-
                                   tive to change an excess item to a required one;
                                 . cause unrequired stock to be reported as required stock to the Congress;
                                 . be difficult to control and could result in “all kinds of errors,” including
                                   recommending a buy for an unneeded item; and
                                 l distort repair requirements.

                                     During our review, we expressed concern to AFLC officials about the
                                     additive, and the officials said they would direct the air logistics centers
                                     to manually reverse that portion of the additive that covered on-hand
                                     inventory, but not the portion on order. In November 1988, however,
                                     AFIX cancelled the use of the additive entirely. According to an AFLC offi-
                                     cial, the air logistics centers had complained about increased work load
                                     for item managers and difficulty in controlling the additive. AFLC identi-
                                     fied additive-related errors which had resulted in erroneous buy
                                     requirements for 212 items valued at $7.1 million. AFW= corrected these
                                     errors and did not order the items.

Required Stock on Order May Be       AFLC  is also considering extending the termination period in its computa-
Redefined to Include Some            tions. Assets on order that exceed the requirement are now identified by
Unrequired Stocks                    the system for potential termination. Extending the termination period
                                     would add an amount equal to another year of requirements. Thus, the
                                     system would identify fewer assets on order for potential termination.
                                     According to AFLC officials, extending the termination period would per-
                                     mit items on order to remain on order, but would not permit the initia-
                                     tion of more orders for unrequired items.

                                     AFLC  plans to test implementing the change manually. If the test sub-
                                     stantially reduces reports of unrequired assets on order, AFLC plans to
                                     implement the change manually at its air logistics centers, until a pro-
                                     gramming change can be made to the automated system.

                                     This planned Air Force change demonstrates how DOD'S proposed
                                     changes in reporting criteria can affect how its inventories are managed.
                                     Reducing the quantities of unneeded items eligible for termination will
                                     reduce the effectiveness of terminations as a means of minimizing the
                                     acquisition of unneeded items.

Unrequired Stock Reclassified        In 1987, the Air Force reported $765 million of stocks that are not eco-
                                     nomical to repair as unstratified (in transit). In 1986, the stocks had
                *                    been reported as potential excess (having no economic or defense reason
                                     for retention). The Air Force’s stratification program projects that a cer-
                                     tain amount of the on-hand inventory of repairable assets will be


                                     Page 36                                      GAO/NSIA@90-100Defense Inventory
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                      Related Factors That Increase the Risk of
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                      uneconomical to repair. The program identifies these assets for eventual
                      disposal. However, if 1988 AFLC instructions are followed, the Air Force
                      will report such stocks, now totaling $759 million, as required stocks.
                      DOD instructions state that assets anticipated to be unrepairable should
                      be classified as potential excess.

                      Such items are not excess to requirements, but are of no value because
                      they cannot be economically repaired. In these cases, we agree with the
                      Air Force that potential excess may not be an appropriate category and
                      that some form of “pending disposition” category may better describe
                      the status. However, changes should be coordinated with DOD to ensure
                      consistent treatment throughout the agency.


                      We found significant growth in the Air Force’s inventory of secondary
Growth in Air Force   aircraft items used to satisfy operational requirements beyond the cur-
R&quired Stocks       rent year. The precise level of such stocks cannot be readily identified
Beyond Wartime and    because of the way required stocks are reported. This growth suggests
                      that unrequired stocks could increase to the extent that the required
Current-Year Needs    stock is subject to the same factors responsible for increases in unre-
                      quired stocks.

                      The Air Force generally identifies stock not needed in the current year
                      as budget year stocks (wartime needs are identified separately).
                      Between 1980 and 1988, the inventory available to satisfy budget year
                      requirements grew $5.3 billion (416 percent), from about $1.3 billion to
                      $6.6 billion, The budget year category is 1 of 10 requirement categories
                      in Air Force reports, but it represented 41 percent of the total $12.9
                      billion for the Air Force’s required inventory growth for aircraft parts
                      between 1980 and 1988. As a result, the aircraft parts inventory held
                      for budget year demands grew from 18 percent of the total aircraft
                      parts required inventory in 1980 to 33 percent in 1988.

                      Similarly, unrequired stocks held in an economic retention category for
                      future peacetime needs beyond the budget year grew $2.9 billion (740
                      percent) from $.4 billion to $3.2 billion between 1980 and 1988. Air
                      Force officials said this does not mean that the Air Force has unnecessa-
                      rily purchased items to meet future requirements. They said the
                      increased procurement lead times have made it necessary to project and
                      then buy for requirements further into the future to maintain an ade-
                      quate level of support.




                      Page 37                                     GAO/NSIAD-90-100Defense Inventory
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                              Increased procurement lead times necessitate ordering items sooner, but
                              only to ensure that items arrive in time to meet requirements. If lead
                              times are overestimated, causing items to arrive sooner than necessary,
                              then stocks not needed in the current year could increase. For example,
                              AFLC programmed its system in 1986 to increase the administrative lead
                              time to 9 months for all repairable items regardless of actual experience.
                              AFLC said this was to anticipate the administrative requirements in com-
                              plying with Competition in Contracting Act of 1984. However, when
                              AFLC allowed the system to again use actual data, the average lead time
                              fell to 7.8 months by September 1987.


Airy Force Spending           Appropriated funds for aircraft spares are available for obligation over
Guidelines May Contribl Ite   a 3-year period. Prior to fiscal year 1986, Air Force policy provided that
                              current year funds could only be used to buy current year requirements
to Earlier Purchases of       (i.e., 1985 funds could only satisfy 1985 requirements). In response to
Items                         DOD'S concern that the Air Force had not fully obligated available funds,
                              the Air Force changed its funding policy in October 1985. Under the new
                              policy, any available funds could be obligated to satisfy current or
                              future year funded requirements. For example, unobligated fiscal year
                              1989 funds will be available to satisfy fiscal year 1990 and 1991
                              requirements when those years are approved for funding. DOD also
                              established a goal that 92 percent of its current-year funding be obli-
                              gated in the first year. In commenting on our report, DOD said the Air
                              Force changes were based on the content and cumulative nature of spare
                              parts budgets, not in response to DOD pressure.

                              As cited in our February 1988 report, AFLC stated it was $898.4 million
                              behind its planned obligation of funds for fiscal year 1985 through
                              August 3 1, 1987. The Air Force said the obligation shortfall occurred
                              because fiscal year 1985 funds were used to satisfy fiscal year 1987
                              requirements. Thus, funds budgeted for 1987 were no longer needed for
                              the purposes originally justified.

                              In January 1988, AFLC advised the air logistics centers that because of
                              limited funding their fiscal year 1988 budget obligation goal had
                              increased from 92 to 100 percent. AFLC also noted that the large unobli-
                              gated balances in fiscal years 1986 and 1987 “cannot be tolerated,” and
                              that unobligated balances for both years must be closed out prior to
                              March 31, 1988, and funds not obligated by then would be redistributed.




                              Page 38                                     GAO/NSIAD-90-100Defense Inventory
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              R&ted     Factore That Incmase the Risk of
              Unrequlred Stock




-----A-
          I
              AFLCand the air logistics center guidelines stress the importance of
              meeting budget obligation goals. They encourage early initiation of pur-
              chase requests and the use of multiyear contracts and quantity discount
              buys. Such guidance can result in buying items before they are needed.
              For example, one of the Air Force items in our sample was last pur-
              chased on a multiyear contract. In that case, the last procurement of $8
              million was in excess of computed requirements and the purchase was
              made with 1984 funds in the last year of their availability. Since it is
              unlikely the unrequired stocks on hand will be used before the item is
              phased out of the U.S. inventory, the Air Force decision is not likely to
              be cost-effective.


              We believe that efforts by DODand the Air Force that reclassify unre-
Conclusions   quired stock as required stock could be counterproductive. The efforts
              may mask the need to address the growth in unrequired stock and could
              reduce the quantity of unneeded on-order items eligible for termination.

              Less visibility over the inventory would impede efforts by deci-
              sionmakers and managers to identify and address problems contributing
              to the growth in unrequired items. Decisionmakers need to know the
              extent of purchases that exceed program requirements because of such
              factors as quantity discounts or life-of-type buys. They will not know
              the extent of unrequired stocks if DODand the Air Force implement poli-
              cies that would include such purchases among required stocks.

              The reclassification of stocks could also reduce the quantities of unre-
              quired orders eligible for termination. DODhas proposed to increase the
              approved force acquisition objective to include war reserves and 36
              months of peacetime operating stocks. Although the specific impact of
              such a change on DOD-wide purchases is not clear, the Air Force is con-
              sidering changing its computer program to not recommend termination
              of unneeded items on order unless the order would result in more than 3
              years of peacetime operating stocks on hand. The Air Force criteria for
              termination was previously up to 2 years of stock accepted.

              The large growth of Air Force-required peacetime stocks for use beyond
              current-year operations can also increase the risk of reduced demand or
              obsolescence before the items are used. The significant increase in the
              value of the inventory available to satisfy future requirements in the
              budget year category- to $6.6 billion in 1988-portends continued
              problems with unrequired stock where obsolescence or reduced
              demands occur.


              Page 39                                      GAO/NSlAD-99-190Defense Inventory
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                      Some level of unrequired inventory must be viewed as a cost of doing
                      business. Certain proposed DOD and Air Force changes cause concern,
                      because they add to existing pressures to raise required inventories well
                      above the levels actually needed. The changes could allow inventories to
                      increase without a stated policy to increase requirements.

                      The significant growth in unrequired aircraft parts warrants efforts to
                      minimize unnecessary expenditures. We believe that essential steps
                      include improving the visibility of unrequired stock and policy changes
                      to reduce the acquisition of peacetime operating stock well in advance of
                      need.


                      We recommend that the Secretary of Defense (1) separately identify
Rekommendations       unrequired inventory that was obtained in the best interests of the gov-
                      ernment, to ensure that such inventory is properly classified and (2)
                      separately identify assets that are uneconomical to repair and modify
                      non regulations to ensure consistent treatment by the military services.

                      We further recommend that the Secretary of Defense continue to iden-
                      tify unrequired inventory as such and direct the Secretary of the Air
                      Force to cancel efforts to increase the approved force acquisition objec-
                      tive to include an additional year of requirements. Such a change would
                      mean that inventory managers would not have to consider terminating
                      orders that could have been terminated under current criteria.


                      DODagreed that inventory reporting weaknesses have resulted in errors
Agency Comments and   and that it is attempting to improve the reports. DOD concurred with our
Our Evaluation        recommendation to separately identify the reasons unrequired assets
                      were obtained and assets that are uneconomical to repair.

                      WD   disagreed with our recommendation to cancel efforts to increase the
                      approved force acquisition objective to include an additional year of
                      requirements. Also, it said DOD and Air Force changes are not intended
                      to mask unneeded inventories. DoD said its proposed changes would sep-
                      arately identify all additions on stratification displays, and it should not
                      have to terminate on-order items if a future need is forecast. After con-
                      sidering DOD'S response, we believe our recommendation is appropriate
                      for the following reasons:

                  .   DOD  said we had improperly characterized its efforts to improve the
                      stratification process as a means of reducing inapplicable inventory and


                      Page 40                                      GAO/NSlAD-90-100Defense Inventory
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   Itdated Factors That Increase the Risk of
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  avoiding contract terminations. We do not attempt to determine DOD'S
  intent, but our report shows that the effects of its changes include (1)
  decreasing unrequired inventory by increasing the Approved Force
  Acquisition Objective, and (2) reducing the quantity of contracted items
  eligible for termination.
. DOD said that the stratification process has not been updated in over 20
  years, and needs improvement because it does not fully reflect current
  DOD logistics policies and concepts. We agree and our report addresses
  the need to improve the stratification process. Our concern is with DOD
  and Air Force initiatives that could aggravate, rather than alleviate, the
  process’ problems.
  The stratification displays are retained at the service level and are not
  included in reports to DOD and the Congress. Therefore, the changes we
  question would mask the growth from those responsible for oversight.
  We agree that needs forecasts are useful but do not believe that the fore-
  casts justify buying items sooner than needed. Thus, DOD should termi-
  nate such items. DOD’Sconcern that its components “could conceivably
  be budgeting for items that also compute as potential terminations”
  focuses on a valid problem, but implies the wrong solution. We believe
  DOD should not be ordering items to arrive long before the items are
  needed.




  Page 41                                      GAO/NSIAJMO-100Defense Inventory
@D Classification of Secondary Inventories


__”   ..--   :-“.   I   ..-..   ._“-~.




                                         DOD categorizes its secondary inventories into six classifications. Two
                                         classifications represent required stock.’

                                         1. The approved force acquisition objective represents current operating
                                         stocks plus war reserves.’

                                         2. The approved force retention stock is in addition to the approved
                                         force acquisition objective stock and is required to equip and support
                                         the lJ.S. approved forces from the day the war begins until production
                                         equals demand. Unlike approved force acquisition objective stock, DOD
                                         does not budget for retention stocks.

                                         The remaining four classifications represent unrequired stocks, which
                                         are in addition to required stocks.

                                         3. The economic retention stock has no requirement. However, DOD has
                                         decided to retain the stock for future peacetime use instead of satisfying
                                         possible future needs through procurement. Items retained in economic
                                         retention must have a reasonably predictable demand.

                                         4. The contingency retention stock has no predictable demand or quanti-
                                         fiable requirement and normally would be in the Potential Excess cate-
                                         gory. However, DOD has decided to retain the stock’for possible
                                         contingencies.

                                         5. The numeric retention stock is the stock for which disposal is cur-
                                         rently infeasible or uneconomical, and management has decided to
                                         retain it in the supply system. DOD began using this classification in 1982
                                         for some secondary items, but no aircraft items were reported.

                                         6. The potential excess is material excess to all authorized retention
                                         levels, but DOD has not determined it to be excess.



                                         ‘We grouped approved force acquisition objective stock and approved force retention stock together
                                         because they are categories of required stocks. According to DOD officials, the term “long supply” is
                                         used to describe stocks in excess of acquisition requirements. However, DOD’s long supply includes
                                         materials that are not budgeted for but can be used to equip and support U.S.-approved forces from
                                         the day war begins until production equals requirements, Our values for stocks with no requirements
                                         do not include approved force retention stocks because they are defined by DOD as required stocks,
                                         even if they are not in the budget, Thus, our values for unrequited stocks are less than DOD’s values
                                         for long supply.

                                         “War reserves are stocks that are stored in peacetime to satisfy increased wartime consumption; they
                                         are intended to sustain wartime operations until resupply takes plac!c.



                                         Page 42                                                     GAO/NSIAD-90-100Deftmse Inventory
Abpcndix II

Sbmple of 40 Air Force and 25 Navy Items With
Rbported Unrequired Stock as of
S+ptember 1987
                                                                                                             Value of
                                                                            Value of required             unrequired
                  National Stock Number          Item                      inventory on hand      inventory on hand
                  Ogden     Air Logistics
                  .~- --..--.-- __-       Center
                  1        4810-00-962-4394         Regulatorvalve                  $802,967             $15,859,549
                  2                                 Sensorsub-
                            5855-01-049-0175        assemblv                        1,598,890               2,948,602
                  3         1377-01-057-5431        Rocket remover                    321,763               1,937,726
                  __...._-.--.- ~---.--.
                  4                                 Wheel half
                            1630-01-108-4044        assembly                                0
                  _~_.._--~~~-__---                                                               .___   -....1,758,476
                                                                                                                ~~-.~~-
                                                                                                                     ..~
                  5         6720-01-149-3894        Infrared recorder              261330,294                 1,618,666
                   . . . _..-.-..--.-..---
                  6                                 FET amplifier
                            1270-01-153-8700        assemblv                          912,170                1,164,940
                  7         1377-00-322-0778        Mechanical initiator              601,747                1,067,397
                  8         1620-01-071-2308        Landingdragbrace                  929,340        ___-..-- 978,253
                  _--
                       Total                                                     $31,497,171            $27,333,609

                  Oklahoma City Air Logistics Center
                  9     2840-01-160-3158     Compressor rotor                      $5,484,074             $6,215,283
                                                                                                     ~-~_.~-.        -~
                  10       2915-01-116-5741         Main fuel control               5,443,756               3,218,132
                                        --
                  11       2840-01-047-1334         Ennine blade                    3,109,598                1,485,458
                  12       3110-00-540-9997         No.2bearing                       311,126                1,223,194
                                                                                            .______             --_
                  13       2840-01-153-8687         Turbineshaft                      686,002                1,159,968
                  14       6605-01-190-3673         Rotorassemblv
                                    - ...~~_--.-                                           __-0     __~~ 1,093,718
                                                                                                                 ~~---
                  15       1660-00-446-3819         Heatexchanger                   2,726,944
                                       -...--____                                                   ~..___.. 1,054,231
                                                                                                               -~~ -
                  is       6610-00-107-0249         Pressuresensor                  1,133,ooo                  991,375
                       Total                                                     $18,894,500       -__ $16,441,359

                  Sacramento Air Logistics Center                                         ___-        ___.._~~ ~.~
                  17       1260-01-237-2273         Displavoenerator                       $0                $544,698
                  18                                Relay contactor
                           5945-01-116-0859         sensor                             12.594                 256,087
                  19       6105-00-893-1550         MotorAC.                          106,708                 216,300
                  20       6105-00-047-4939         Mot0rA.C.                          87,128                 123,563
                  21       6605-00-736-4315         Computer                          117,020                 117,020
                  22                                Power supply
                           6130-01-100-3027         component                          81,960                  111,232
                  23.                               Auto pilot damper
                           6615-00-480-9422         panel                             221,229                   92,607
                                                                                            ---
                  24       1560-01-117-5272         Tailpipe”A”                        65,148                   87,808
                                                           __.
                       Total                                                        $691,787              $1,549,315
                                                                                                          (continued)

              *




                  Page 43                                                     GAO/NSLAD-SO-100DefenseInventm-y
                                                                                                .

    Appendix II
    Sample of 40 Air Force and 25 Navy Itema
    With Reported Unrequired Stock as of
    September 1987




                                                                                            Value of
                                                           Value of required             unrequired
    National Stock Number       Item                      inventory on hand       inventory on hand
    San
    ---- Antonio Air Logistics Center
    25        2840-01-136-0472      Duct segment                  $3,609,722              $4,682,518
    ------
    26        2840-01-017-1899      Case assembly                    467,888               4,643,961
                                                                                                 ---
    27        2840-00-371-2174      :ii%$ft                        2,154,120               4,455,530
    -..--
    28        2840-01-184-8740      Case assembly                  2561,093                3,749,229
    --~..-                                                                                     --
    29                              Compressor stator
    .-.----_--2840-00-348-6245      vane                             225,456               3,537,623
    30        2840-00-369-5362      13th stage spacer              1,856,371               3,330,745
    ---
    31        2835-01-208-0169      Gear box                               0               2,887,213
    32                              Compressor drive
              2840-01-221-5370      shaft                                                  2,137,909
    __
          Total                                                 $10.874,86~             $29,424,728

    Warner Robins Air Logistics Center
    33                              Control oscillator
             5865-01-100-3768
    .^__-----.~..-----              band I                       $23,875,516              $6,322,765
    34                              Battery pack
             6140-01-131-4686       assembly                         227,192               2,248,758
    35       5865-00-155-9262       Drive control                             0            2,234,812
                         __-.-
    36                              Unformatted
             5821-01-196-6086       message element                        0               1,495,999
    37       5821-01-093-9334       Cockpit TV                       720,752               1,359,909
    38        1270-01-165-0324      Gun control box                   89,462               1,237,553
    .-~-
    39       5865-01-103-3109       Signal processor                       0               1,234,616
    iii                             Band I channel
              5865-01-l   83-0425   assembly                         123,144                 738,864
       Total                                                    $25,036,066             $16,873,276
    Air Force total                                             $86,994,174             $91,622,287

    Navy Aviation  Supply Office
              --____-
    1                               Transmission
    ----~     1615-01-145-2434      assembly                     $42,488,730             $10539,840
    2         2840-01-131-4782      Turbine rotor blade               74,227               3,693,819
                      __-.
    3         5865-00-101-6830      Amplifier detector               633,680               3,104,326
    4                               Swash plate
              1615-00-051-9587      assembly                       I ,858,400              2,601,760
    5                              Compressor
              2835-00-069-7490     impeller                          147,826               1,986,407
                  -_--___-
    6         5841-00-001-7    075 Radar transmitter               1,852,870               1,972,410
    7         1630-01-063-7490     Carrier and lining                  2,350               1,666,150
    8         6130-01-045-0005     Power supply                       96,840               1,549,440
Y
    9         1650-01-090-0142     Actuating cylinder                 43,810               1,388,440
                                                                                         (continued)




    Page 44                                                  GAO/NSIAD@O-100
                                                                           Defense Inventory
,
I
    Appendtx   II
    Bample of 40 Air Force and 25 Navy Itema
    With Reported Uurequired Stock 88 of
    September 1987




                                                                                      Value of
                                                       Value of required           unrequired
    National Stock Number        Item                 inventory on hand    inventory on hand
    i0    5841-00-797-2599       Antenna                         149,760               1,382,400
    11      1650-01-059-2821     Tailplaneactuator               107,600               1,371,900
    12      6615-00-010-1427     Gyroscope                       264,420               1,346,960
    ET      1430-01-226-5313     Radioamplipher                  152,760               1,273,OOO
    -
    14                           Compressor rotor
            2840-01-130-293~   7 blade                           528,068               1,254,016
    15      4730-01-006-9389     Fueling manifold                358,680               1,251,720
    16      1620-00-003-0393     Landinadraabrace                 37,320               1 ,I 19,600
    17      2840-00-121-9351     Accessory gearbox               111,780               1,117,800
    18                           Circuit card
            7021-01-150-7105     assembly                      2,912,ooo               1,081,600
    -_.                                                                      ---        _I_-
    19      1615-01-201-9608     Antifretliner                    98,850               1,026,722
    20                           Wheel and shaft
            2835-00-146-3227     assembly                      2,567,950               1,013,840
    21                           Compressor rotor
            2840-01-130-2939     blade                           307,607                937,033
    22      1680-01-133-6919     Panel indicator                 260,400                937,440
    23      4920-00-834-7790     Controllerassemblv               42,120                905,580
    24                           Compressorstator
            2840-01-131-0569     vane                            185,022                897,522
    25                           Main mast
            1615-01-154-2722     assemblv                        984,540
    Navy total                                              $56,267,610             $46,308,219
    Total                                                  $143,261,704            $137,930,500




    Page 46                                              GAO/NSIAD-90-100Defense Inventory
Ap$mdix      III

@mments From the Department of Defense                                                                              ’


--
Note: GAO comments
sup$lementing those in the
repo/rt text appear at the
end pf this appendix.                              ASSISTANT SECRETARY OF DEFENSE
    /                                                   WASH,NGTON.0 t 20301.8000



                                                                    November   1, 1989


                              Mr. Frank C. Conahan
                              Assistant Comptroller General
                              National Security and International
                                Affairs Division
                              U.S. General Accounting Office
                              Washington, DC 20548
                              Dear Mr. Conahan:
                                    This is the Department of Defense (DOD) response to the General
                              Accounting Office (GAO) draft report, "DEFENSEINVENTORY: Growth In
                              Air Force and Navy Unrequired Aircraft Parts," dated September 7,
                              1989, (GAOCode 391604), OSD Case 8114. While the Department agrees
                              with the overall thrust of the draft GAO report, it disagrees with
                              some of the GAO findings and recommendations.
                                      The Department has an aggressive program underway for reducing
                              unnecessary inventory growth. The program includes:      cataloging
                              actions to eliminate duplicate items; revised policy on retention and
                              inventory stratification;   revisions to requirements computation
                              models; leadtime reduction; termination of excess on order material;
                              transition   to Weapon Systems Management; and ADP system modernization
                              to provide more accurate and timely data for decisions.
                                    As discussed in the enclosure, the DOD is making significant
                             progress in reducing inventory growth, but recognizes that further
                             improvements are needed. Accordingly,     the Department will consider
                             the findings and recommendations in this audit, previous audit
                             reports, DOD studies, and ongoing initiatives    in its assessment of
                             this area. This assessment, along with the internal control assess-
                             ments prepared by the Services, will determine if inventory growth
                             should be identified   as a material weakness in accordance with DOD
                             Directive 5010.38.
                                  The detailed DODcomments on the report findings and
                             recommendations are provided in the enclosure.   The Department
                             appreciates the opportunity to comment on the draft.
                                                                           Sincerely,
                                                                       ?            7




                    Y                                         J




                             Page 46                                            GAO/NSlAD-90-100Defense Inventory
                     Appendix III
                     Comments From the Department of Defense




                               GRODRATTREPORT-DATEDSEPTEMBER  7, 1989
                                   (G&OCODE391604) OSD CASE 8114
                           "DWENSE INVSNTORY: OROlOTBINAIRI'ORCSANDNAVI
                                     DNDSQUIREDAIRCRATTPARTS"
                          I'INDINGS AND RECObadWDATfONS
                                                      TOBEADDRSSSEDINTEE
                                  DODRESPmSE TOTHE GAODRAFTRePORT


                                                  rINDTWOS
                 .   -A:           Xnvento~ Of au?kiwired -t             Pa*6 m' Sh-        ma
                     mt Ramid Growth. The GAO found that, between 1980 and 1988,
                     the Air Force inventory of aircraft      parts increased by $18.8
                     billion,  or 204 percent--rising     from $9.2 billion   to $28 billion.
                     During this same period, the GAO found the Navy inventory of
                     aircraft  parts increased by $8.3 billion,      or 181 percent--rising
                     from $4.6 billion   to $12.9 billion.     The GAOpointed out that the
                     largest dollar increase occurred in required stocks, definedas
                     stocks held to meet war reserve and peacetime operating require-
                     ments over a 24 month period --including      the balance of the
                     current year. The GAO further pointed out, however, that the
                     greatest percentage increase occurred in unrequired stocks,
                     defined as stocks that are not needed to meet current require-
                     ments, but are held (in most cases) to satisfy potential         future
Nowon pp 2,15        requirements and possible contingencies.         (p. 3, pp. 21-22/ GAO
                     Draft Report)
                     ~RESBONSE:       Concur. The Department agrees that the greatest
                     percentage increase occurred in "unrequired" stocks, for many of
                     the same reasons outlined in FINDING B, such as overestimation of
                     item use rates and reduced demand due to modifications.     While it
                     is true that the largest percentage of growth occurred in stocks
                     beyond war reserve and two years of peacetime operating
                     requirements, it should bs noted that historically,    thie stock
                     has averaged 25 percent of the total inventory, with stock for
                     current requirements at 75 percent.     That ratio has not changed
See comment 1        significantly  over the past ten years.
                           The significant increase in the dollar value of the inven-
                     tory is a function of several circumstances. Some of these
                     include: the impacts of inflation,  the way inventories are
See comment 2.       priced, the influx of new weapon systems and growth in force




                                                                             ENCLOSURE




                     Page 47                                           GAO/NSLAD-PO-100
                                                                                     Defense Inventory
                         Appendix III
                         Comments From the Department of Defense




                          structure     (which introduced many new and more expensive items),
                          and the effects of modifications     with the resultant improvements
                          in reliability.
                                 Since the GAOonly analyzed “unrequired” stocks with a
                          recent or in-process procurement, it did not address the major
                          additional   causal factors in inventory growth including:
                          .    Increased  material returned to the wholesale system of both
                               supply and non-supply inventories of items no longer
See comment 3                  required by operating conmnandsdue to the force
                               modernization programs. When a modification     adds new
                               capability  or changes a configuration   of an aircraft  or end
                               item, the result is to buy and repair less to support the
                               old system. Any remaining spares on hand, as well as the
                               previously installed    items for the old system, will become
                               “unrequired” inventory.
                          .    The conservative disposal policy in place since 1984.            Items
See comment 4                  that were originally   purchased to support a population         of
                               end items are currently retained in the inventory,
                               regardless of the decline in the end item density.
                         .     Not taking into account price differences when comparing
                               FY 1960 and FY 1988. Price indexing created significant
                               artificial    growth in the inventory.    For repairable     items,
                               indexing affected older items more dramatically        than newer
See comment 5.                 items.     Since older items comprise a significant     portion     of
                               the excess universe, that universe grew faster.than          the
                               applicable universe.      The Navy estimates that as much as
                               $6.3 billion    of the overall aircraft   parts   growth reflected
                               in the Aviation Supply Office stratification        process (which
                               is the inventory segment included in the $8.3 billion
                               growth), is due to these additional      factors.
                               It should also be recognized that the term “unrequired”
                         stocks is misleading, since much of the stock in this category
See comment 6            will be used in the future.

                     .   -8:         N       For Growth In Unnquired  Stock. The GAO
                         reviewed 65 items to determine why the stock had become unre-
                         quired--and was able to identify reasons for 51 of the items.




                                                            2




                 Y




                         Page 48                                              GAO/NSIAD-90-100Defense Inventory



                                                    /
                        Appendix III
                        Commenta Prom the Department of Defense




                    The GAO summarized the major reasons for unrequired      stock   of   the
                    51 items, as follows:



                           1. U8e rata8 ovaradmated       9       7    lb     31
                           2. nodiziwtiona lmducul daund 3        7    10     20
                           3. 1taM bocurr raparable       5       3      9    16
                           4. Airorbit phared out         4       4      9    16
                           5. WAramoz7mmlB~Caty   lbvels
                                ZWlUCUl
                           6. seliebility wrom           141:
                           maL                           22       22   lb    m
                           The GAOpointed out that four of the six reasons the 51
                    items became unreguired related to reasons that have been identi-
                    fied in earlier GAOand DODaudit reports--the        exceptions being
                    items that became repairable and items that experienced improved
                    reliability.    The GAOdiscussed examples of unreguired items for
                    each of the six reasons identified,     acknowledging that actions
                    have been taken to correct many of the previously reported
                    problems. While not making any new recommendations based on its
                    current work, the GAO concluded that these results reinforce the
                    need to control, or at least to better anticipate and plan, for
Nowonpp   3,16-22   the causal factors identified.      (p. 5, pp. 22-31/GAO Draft
                    Report)
                    POP:           Concur. The Department agrees that top level
                    emphasis and controls are needed to attack the growth in
                    unreguired inventories.       The DODhas a major program underway for
                    reducing unnecessary inventory growth, including:        cataloging
                    actions to eliminate duplicate items; revised policy on retention
                    and inventory stratification;      revisions to requirements
                    computation models; reduction in leadtimes; aggressive action to
                    terminate excess on order materiel; transition       to Weapon Systems
                    Management; and automated data processing systems modernization
                    to provide more accurate and timely data for decisions.
                          while the Department concurs with the thrust of the GAO
                    finding, the following points need to be recognized:
                    .      The GAO sample was a biased sample and the results cannot be
                           extrapolated to the entire inventory.   The GAO stated:   “To
                           determine the causes of unreguired stock, we judgmentally


                                                       3




                        Page 48                                         GAO/N&W-90-100 Defense inventory
                     Appendix III
                     Comments From the Department of Defense




                       selected a sample of 40,Air Force and 25 Navy items that had
                       recently been procured or were on order and had large values
                       of unreguired stock for detailed review.” This is a biased
                       sample, and its results cannot be used to support the
See yomment 7.         premise, “To identify how unreguired stock occurred. ”
                       First, the selection of items that had recently been
                       procured or were on order presumes the conclusion that
                       unreguired stock came from procurement of secondary items.
                       In addition, the GAOdid not sample ALL items that had
                       unreguired stock (and the sample was not random), nor did
                       the GAO state whether it had determined that unreguired
                       stock came from procurement in the first place.
                 .     A Navy study of the top 50 line items for aviation
                       repairables,     conducted after the March 1989 Secondary Item
                       Stratification,       revealed that 61.7 percent ($365.4 million)
                       of the value of items on hand in an “unreguired” (i.e.
                       inapplicable     to the Budget Year requirement) status were due
                       to aircraft     modifications   with subsequent turn-in of
                       installed     components. In other words, the DOD is now
                       counting in its total inventory, those components that were
                       NOT procured as spares, but rather were previously installed
See comment 8          as part of the aircraft,       thereby inflating the growth in
                       unreguired spares far more than procurement alone could
                       account for.       If the Navy results were extrapolated,    a large
                       percentage of the unrequired stock on hand would be found to
                       be due to the turn-in of formerly installed        equipment, and
                       the subsequent visibility       and valuation of those installs    in
                       the Navy Stock Fund.
                 .     The GAOhas not recognized that the DOD retention policy is
                       a legitimate  reason contributing to this growth. Since 1984
See comment 4          DODhas directed that items applicable to active weapon
                       systems in the inventory will be retained.   The result has
                       been considerable growth in contingency retention stocks
                       that is, in many cases, the only means of support for older
                       weapon   systems.

                 .     The most commoncause cited by the GAO is overestimated use
                       rates.     Estimated rates are used in recoverable item
                       requirements computations when historical      data is either not
                       available     (new items) or is not, in the equipment
                       specialist’s      judgment, a good indicator of the item’s
                       expected activity      due to trends or other changes. Since



                                                   4




                     Page 60                                            GAO/NSIAD-W-100Defense Inventory
        Appendix III
        Comments From the Department of Defense




           these predictions,      which in many cases are contractor or
           engineering estimates, are for projected use and expected
           failures three to four years in the future, the forecasting
           process is not an exact science. Any fluctuation               in the
           lead time, the item's activity,        or the program it supports
           can alter the validity       of the decision.       Relatively   few
           items experience stable demands. when the predicted usage
           does not materialize,       the result is inventory beyond current
           requirements.     Experience has proven, however, that many
           items which appear inapplicable        to current requirements at a
           certain point in time later become required.              As stated in
           the response to the Air Force Audit Agency report (Project
           5126117), the requirement to review items with estimated
           factors that have two years of actual usage history and are
           in a buy, budget or termination status will be included in
           the next revision toAir Force Logistics ConnnandRegulation
           57-4. Publication of that regulation is scheduled for
           December 1989. The predictive         logistics     program in the
           recoverable requirements computation (D041) assists
           equipment specialists       by analyzing 12 quarters of data and
           identifying   those items which exhibit a significant            change,
           forecasts the trend, and plots the trends for review. The
           on-line viewing and change capability           for the program is
           scheduled for implementation into the Requirements Data Dank
           in January 1993 and should enhance the equipment
           specialists'    ability   to forecast future usage. An
           additional   Requirements Data Rank capability,           scheduled for
           1993, will predict reguiredusage for simulated scenarios,
           such as program changes and weapon system support goals.
           This capability     should improve the forecasting process when
           future activity     is expected to undergo change.
    .      The draft report cites modifications      that reduce demands as
           a second reason for growth in "unreguired" stock. When a
           modification     adds new capability  or changes a configuration
           of an aircraft     or end item, it is true the result is to buy
           and repair less to support the old system.       However, any
           remaining spares on hand, as well as the previously
           installed    items for the old system, will become "unreguired"
           inventory.      Some of this stock will be used to support the
           earlier configuration,      but all of the stock will be held
           based on the retention policy cited above. The FlOO engine
           duct segment is cited by the GAOas an "unreguired" item
           bought, even though it was being replaced by a new item as



                                        5




Y




        Page 61                                             GAO/NSIAL%BO-100
                                                                          Defense Inventory
                          Appendix III
                          Comments From the Department of Defense




                              part of the "improved life core" (4000 cycle) engine
                              modification.      The item ia applicable to the 1800 cycle core
                              engine, that will still      be in the Air Force inventory
                              through 1992. A procurement of 73,000 each for $8 million
                              was initiated    in November 1985, using 1984 funds. The item
                              was coded reparable at that time, but due to a pending
See Comment 9.                change to consumable (repair cost exceeded acquisition
                              cost), the quantity procured was computed under Economic
                              Order Quantity methodology, which is demand based. In
                              accordance with Air Force policy, the item could not be
                              transferred    to the consumable system until it was
                              supportable under that concept; therefore,       the assets
                              appeared to be Qnrequired" in the reparable computation
                              system stratification      report.   The item was transferred to
                              Economic Order Quantity in March 1988, and the assets are
                              presently reflected as required stock.        The average annual
                              demand rate on this item is 12,000, which indicates most of
                              the assets will be utilizedby       the end of the support period
                              for the 1800 cycle core engine.
                     .   mc:            B        Tot -.                                  The GAO
                         identified    three procurement management practices that contrib-
                         uted to the growth in the unrequired stock items it reviewed.
                         According to the GAO, one reason for the growth was because Navy
                         and Air Force officials        were not always evaluating whether orders
                         For unneeded assets should be terminated.         The GAOexplained that
                         to prevent buying unneeded items, Air Force and Navy requirements
                         systems identify      quantities of material that are on order for
                         potential   termination,      because they are excess to requirements.
                         The GAO found, however, that 26 of 33 Air Force items and 10 of
                         22 Navy items it reviewed that had unrequired stock had quanti-
                         ties identified     for potential termination when last on order.
                         According to the GAO, Navy and Air Force procurement personnel
                         cited various reasons why the contracts were not terminated--such
                         as anticipated     future use and excessive termination costs.      The
                         GAOpointed out, however, that both it and the DOD Inspector
                         General have previously reported that the Air Force and the Navy
                         need to terminate more orders for unneeded items (OSD Cases 6670,
                         7242, and 7541).
                               In its most recent   report (OSD Case 7541), the GAO found
                         that, although the value    of on order excesses continued to grow,
                         actions have been taken    and are planned by the Air Force Logis-
                         tics Commandto address     the excesses. The GAOobserved; however,



                                                         6




                 Y




                          Page 52                                           GAO/NSIAD-90-100Defense Inventory
       -
,
           I                          Appendix III
                                      CcmunenntsFrom the Department of Defense




                                  that the Air Force guidance on amending purchase requests and
                                  terminating orders tends to discourage item managers from raduc-
                                  ing quantities    on order.   With regard to the Navy items, the GAO
                                  cited a May 1988, DOD Inspector General report that found the
                                  Navy Aviation Supply Office did not have an effective      process for
                                  identifying    and terminating unreguired assets on order.    The GAO
                                  acknowledged that, in response, Navy officials     said they planned
                                  to revise their termination policy to provide better Internal
                                  controls over the process. The GAOpointed out, however, that at
                                  the time of its review, the new termination policies were still
                                  in draft and had not been implemented. Overall, the GAO con-
                                  cluded that, while both Services are increasing terminations,
    Now dn     pp. 3, 24-27       further actions could be taken.      (p. 6, pp. 32-36/GAO Draft
                                  Report)
                                  m:            Concur. The Department concurs that both the
                                  Services have taken action and made progress in increasing
                                  terminations.  The Department also concurs that continued
                                  emphasis and action are required. The Navy and Air Force progress
                                  to date and ongoing actions are as follows.

                                  -m!Y      - The Navy has made significant   progress in identifying
                                  and reducing the number and value of contracts for inapplicable
                                  assets.  Most of the Navy management initiatives    in this area are
                                  now showing positive results.   Some key items:
                                  .     The percentage of on-order    material for "unneeded" items
                                        (Due In Long Supply) was reduced dramatically    between the
                                        September 1988 stratification    and the March 1989
                                        atratification.

                                                            (Dollars   in millions)
                                                          blo*er       1988           March 1989

                                         C0nswMbler            13.4%                    8.5%
                                         Pspairabler           13.9%                   10.2%

                                  .     Terminations have also increased, with $135 million in
                                        termination requests issued between March 1989 and August
                                        1989.




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    Comments From the Department of Defense




.      A revised computerized model for termination reconnnendations
       is being programmed and should ba released to the Aviation
       Supply Office on or about mid-December 1989.
       There are three major issues being addressed under the Navy
comprehensive Inventory Management Improvement Program that have
significant   impact on the whole question of terminations:
       1. Timely transmittal  of              program change information from the
       program managers to the               Inventory Control Point, so action
       can be taken to minimize               any material procurement for
       systems and weapons with               delayed deliveries  or for those
       being phased out.
       2. Improving the demand forecasting decision support system
       ao the item managers have better tools for identifying
       future requirements when there are changes in item use, such
       as when modifications reduce demand and through reliability
       improvements.
       3. The actual termination decision logic itself.    Making the
       termination decision is straightforward  when an item becomes
       obsolete but more complex otherwise because of economic
       tradeoffs inherent in terminating and later reprocuring.
-- J&r 8’OrCQ - The total computed on-order excess has decreased
significantly  since the March 31, 1986 computation cycle.    The
Air Force now has the capability   within the Requirements Data
Bank to detect and correct errors.     This enhancement has resulted
in marked improvement in the error rate and greater confidence in
the validity  of the potential termination amount. The percent
terminated has shown steady improvement since 1986 as illustrated
below.

                i&r    Force    lYaah&kon         Da&a 8s of Maxch of &as& Teal;
                                       (Dollars    in millions)
        Total         Ccqnked       trror8          Valid Potential       Percent
        -m-m
1986                  $1.406       $ .730                 $ .676             8%
1987                   2.388         1.416                   .973           13%
1988                     .911         .198                   .656           18%


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                      Comments From the Department of Defense




                            The large amount of both computed and valid potential
                      terminations in 1987 was due to a policy change which decreased
                      war re3eNe materiel requirements.
                          The Air Force recognized the need for improved termination
                      management and took the following actions:
                           1. A termination workshop was held, resulting in a number
                           of procedural improvements. Interim letter guidance was
                           disseminated, standardizing termination codes, establishing
                           a uniform method for obtaining contract termination costs
                           and directing that all item3 with a computedtermination
                           value in excess of $10,000 be reviewed quarterly,   within 25
                           days of computation notice, for possible termination action.
                          2. In March 1988 the Air Force Logistics Commanddirected
                          mandatory use of a computer software model to assist item
                          managers in making economic termination decisions. Using
                          various factors, the modelweighs the cost to terminate a
                          contract against the cost of continuing procurement.
                             These actions have resulted in notable improvements in the
                      termination process.    The guidance will be included in the
                      revision to Air Force Logistics CommandRegulation 57-4,
                      scheduled for publication   December 1989.
                            With regard to the excerpts from Headquarters Air Force
Seecomment   10       Logistics Commandletters discussed by the GAO, the guidance was
                      intended to address specific cases where termination was
                      inadvisable and is not reflective   of the Air Force general policy
                      on contract terminations.   The April 1986 letter,  for example,
                      was intended to prevent termination in the rare instance when the
                      changes in variable safety levels were not driven by changes in
                      the basic requirements data, such as demand rates, pipeline
                      changes, etc. A very small number of items would fall into this
                      category.   The Air Force policy does and will continue to place
                      emphasis on the importance of making timely and sound termination
                      decisions based not only on economics, but also the logistics
                      posture of the item and the weapon system it supports.
                  .   m:           &&&&J.s RecaismL&xmer~.                  The GAO
                      found that a second procurement practice contributing to growth
                      in unrequired stock items was due to overestimated procurement
                      lead times  for some of the Air Force items. The GAOexplained



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                             Appendix III
                             Comments From the Department of Defense




                          that procurement lead time is important, because it determines
                          when an order must be placed--if        the time is underestimated,
                           inventories could run out; if the time is overestimated, items
                          could arrive sooner than necessary. According to the GAO, it
                           found that 5 of the 29 Air Force items it identified         as having
                          unrequired stock, also had overestimated procurement lead times.
                          As an example, the GAOcited a July 1986, purchase of 251 trans-
                          mitters valued, at $1.4 million.         According to the GAO, the
                           requirements computation used a total estimated lead time of 31
                          months, basedon contractor estimates--but          the actual lead time
                          proved to be only 13 months. The GAO found that, mainly as a
                          result of this factor, 212 transmitters,         valued at $1.2 million,
                          were in unrequired stock as of September 1987. The GAO cited a
                          DOD response to a prior report it issued (OSD Case 6948), wherein
                          the DODagreed to limit early initiation          of Air Force spares to
                           12 months. According to the GAO, It disagreed with only a 12
                          month limitation.      The GAOconsidered the action inadequate to
                          resolve the problems. In addition, the GAO stated it was con-
                          cerned over the DODview that the requirements system is self-
                          correcting,    since if incorrect,    it could result in procurement of
                          material that may not be used. The GAO further pointed out that,
                          in February 1988 (OSD Case 7541), it found Air Force FY 1987 and
                          FY 1988 buy guidelines did not contain a 12 month limitation--and
                          could be interpreted     as authorizing premature initiation.       During
                          its current review, the GAO found provisions in the FY 1989 Air
                          Force buy guidelines and logistic        center supplemental instruc-
                          tions encouraging early procurement initiation         to meet budget
                          obligation   goals. Overall, the GAOconcluded that the Air Force
                          practice of routinely initiating       purchase requests before the
                          necessary procurement lead time results in premature inventory
                          investment and unnecessary holding costs--as well as increased
                          risks that material might become obsolete before it is used. (p.
Nowon pp. 3, 27-29.       6, pp. 36-38/GAO Draft Report)
                          DQD:            Partially concur. The Department agrees that
                          overestimated lead times can contribute to growth in "unrequired"
                          stock.   The Department does not, however, agree with the GAO
                          conclusions that Air Force spending guidelines may contribute to
                          purchasing items earlier than needed.
                                Lead times are based on previous procurements or
                          contractors'   estimates and represent the best available
                          information at the time of the computation of the requirement.
                          If the time it takes to procure and deliver material does not



                                                           10




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      Appendix III
      Comments From the Department of Defense




    exactly match that previously experienced or predicted, the
    result will be too little     or too much stock. The Department has
    an aggressive ongoing program to reduce lead times. A number of
    initiative3    are underway, including increased emphasis on
    long-term multi-year contracting,     streamlining pre-procurement
    screening actions, electronic data exchange, and implementation
    of a mechanized tracking    system with goals for each segment of
    the process. As a result of these initiatives,      the Air Force
    administrative    lead times have decreased from 192 days in 1985,
     (the highest, attributed   to the Competition in Contracting Act),
    to 168 days in 1988. These trends indicate that future
    additional    improvements will be realized.
            The Department does not agree that Air Force spending
    guidelines may contribute to purchasing items earlier than
    needed. As it has in responses to previous reports, the DOD
     continues to point out that the GAO improperly determined the
    point at which the material is needed. While the Air Force
    FY 1989 buy guidelines did not specifically          address a 12-month
     limitation,     the guidelines provided to the air logistics         centers
    by the Air Force Logistics Commanddirected that execution be
    made utilizing      the March DO41 Central Secondary Item
    Stratification      Deficit Listing.     The deficit   listing   reflects   the
    items that the requirements computational system has determined
    need to be procured within the current appropriated fiscal year.
    The computation bases the need for procurement on the point in
    time assets are required to be on hand. While actual deficits
    can fall any time within the fiscal year, the Department
    supports initiation        of procurement documentation early within the
    fiscal year, since this promotes efficiency          by providing     the
    contracting community with the order quantities             and due dates for
    material requirements.         Using this information,      the contracting
    personnel can organize their workload and ensure that major DOD
    policy objectives are achieved.          If the Air Force executed as the
    GAO suggests, purchase requests for a given fiscal year would be
    initiated     anywhere between October and September. Considering an
    average eight month administrative         lead time, only about 25
    percent of the funded requirements would be obligated within the
    actual appropriation        year, if procurement documentation was
    initiated     solely on the computed lead time date.
         This issue was thoroughly evaluated in the DOD response to
    OSD Case 6948, and no new information has been provided to
    warrant a change in the DODposition.    The Air Force will,



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                                   Comments From the Department of Defense




                                  however, insure that future issuances of buy guidelines    reflect
                                  the DODpolicy on this issue.
                              .   ILIM)INO:     Beded                 F.                          The
                                  GAO reported that the DODestablished the economic order quantity
                                  principle   as a mathematical technique for determining the pur-
                                  chase quantity that will result in the lowest total cost for
                                  ordering and holding inventory to meet expected requirements.
                                  The GAO found that, for 3 of the 22 Navy items it identified      as
                                  having unrequired stock, inventory managers procured consumable
                                  assets in excess of economic order requirements.      The GAO cited a
                                  January 1988 GAO report (OSD Case 13551, in which it found that
                                  the practice of buying more than the economic order quantity
                                  contributed to the growing inventory of unrequired stock in the
                                  Navy. According to the GAO, at that time it recommended that the
                                  Navy not buy more than the economic order quantity, unless a
                                  larger procurement would result in quantity discounts that more
                                  than offset the additional holding costs.     The GAO reported that
                                  the DODdisagreed with its recommendation, saying the Navy would,
                                  in the future, buy the economic order quantity for items with
                                  well established demand patterns--but    would buy 1 to 2.5 years
                                  worth of items that it believes have stable or very stable
                                  demand. The GAOnoted that the DOD (1) cited changes in con-
                                  tracting that could result in orders being placed weekly with as
                                  many as four buys in process at the same time and (2) also cited
                                  a 1986 study that concluded that buying under a l-year policy
                                  would reduce total variable coats by 7 percent.      In its rebuttal
                                  comments, the GAO indicated that it did not believe the cited
                                  reasons justified   buying a year or more of stable-demand items,
                                  and that existing controls should prevent multiple buys in
                                  process. The GAOalso pointed out that the study referred to by
                                  the DODactually concluded that increasing the ordering quantity
                                  from 3 to 12 months would increase total variable costs by 7
                                  percent, not reduce them. The CA0 further cited an August 1988
                                  Logistics Management Institute   study that reached a conclusion
                                  similar to that of the GAO (and recommended that the Services
                                  eliminate the l-year minimum order quantity, use the economic
                                  order quantity principle   to determine order quantities,   and
                                  override it only when larger quantities are cost effective),
Now   on pp,   3, 29.30           (pp. 6-7, pp. 38-4O/GAO Draft Report)
                              .   -RESPONSE:     Concur. The Department issued a policy memorandum
                                  on June 27, 1989, reestablishing the need to use Economic Order
                                  Quantity methods and precluding the use of arbitrary la-month or



                                                                 12



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I

        I
                     Appendix UI
        I            Comments From the Department of Defense




                    larger order quantity floors.    The policy does, however, provide
                    for overriding the computed Economic Order Quantity when specific
                    analysis supports an alternative   quantity as more cost effective.
                          There is evidence that increased quantities   allow for a
                    better negotiating position for price and delivery,     particularly
                    in the extremely competitive electronics  industry.     The recent
                    Navy approach has been to exceed the computed Economic Order
                    Quantity only for items with stable or increasing demand and for
                    known special program requirements.
                            There are a number of procurement initiatives     underway to
                    utilize    more Indefinite Delivery Type Contracts for long term
                    support; in these vehicles, a two to three year requirement may
                    be used in order to negotiate the best deal and increase
                    competition for-the order.      If quarterly orders are then placed
                    against the contract, the investment and holding costs of the
                    material will be minimized.       The increased requirement may be
                    considerably larger than the Economic Order Quantity, but will
                    provide better and cheaper long term support.         This is
                    particularly    true for material with stable or increasing demand.
                         The GAOstatement regarding the 1986 Fleet Material Support
                    Office study is correct.   The study did conclude that a l-year
                    buy policy would increase total variable costs by 7 percent.    The
                    Department acknowledged this fact in its April 28, 1988, response
                    to a previous GAOReport (OSD Case 7355). This correction does
                    not, however, alter the Department position that the recommended
                    order quantity (derived from Economic Order Quantity models) can,
                    and should be, overridden in those instances where it is
                    beneficial.
                .   ffNDTNG:      ~ToI~Inventorvmo~.                         TheGAO
                    identified  several ways the DOD is attempting to improve its
                    inventory reports.     The GAOreported that an Office of the
                    Secretary of Defense (OSD) study, completed in February 1989,
                    found numerous weaknesses in existing reports.       According to the
                    GAO, OSD officials    hope to improve the reporting process so that
                    all components can use the same cut off date to meet the December
                    31 inventory reporting date. With regard to the Air Force, the
                    GAO reported that, prior to 1907, due to limitations       in the
                    automated requirements system, air logistics      centers could not
                    correct errors in the stratification    data used to prepare the
                    annual inventory report.     The GAO found that, in September 1987



                                                   13




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                                 Appendix III
                                 Comments From the Department of Defense




                                (for the first time),    the Air Force was able to rerun its strati-
                               fication    reports after correcting and validating   the data--by
                               means of a new automated requirements data base. The GAOpointed
                               out that the Air Force Logistics Command's first attempt at
                               eliminating    errors in the report resulted in reductions of both
                               required andunreguired inventory.       The GAOalso found, however,
                               that despite these efforts,      file maintenance and system errors
                               still    occur. As an example, the GAOobserved that, of the 40 Air
                               Force items it selected, I had been incorrectly      reported in the
                               unrequired stock.
                                     The GAOalso observed that the Navy follows a similar
                               process of validating,  correcting, and restratifying    its inven-
                               tory before preparing the annual inventory report, but is also
                               continuing to experience system errors.     In this regard, the CA0
                               reported that 3 of the 25 Navy items it selected had been errone-
Now   on   pp.34   33-34       ously reported in unrequired stock.     (p. 5, pp. 42-421 GAODraft
                               Report)
                               DOD:               Concur. Although there are occasional errors   in
                               categorization,     such as the three observed by the GAO in the
                               draft report, the Navy strives to identify those items with
                               erroneously categorized inventories to ensure the most complete
                               and accurate inventory reports are prepared.      Extensive review
                               efforts are undertaken to ensure the accuracy of all items
                               stratifying     as high value, whether in long supply or as a
                               potential    reorder.
                                      With respect to the Air Force, the Department agrees there
                               were   previously large errors in the data. The ability     to correct
                               errors afforded by the Requirements Data Bank has greatly
                               improved Air Force inventory reporting.       While the mechanical
                               error detection process is better, accurate inventory still
                               depends on factual incoming data. Because data from the 19
                               systems that feed the recoverable requirements computation are
                               not always reliable and result in inaccuracies in the inventory
                               report, the Air Force is implementing a front-end edit on the
                               data before it gets into the computation.      The program will
                               mechanically screen data fields from the systems feeding the DO41
                               system   to identify  variances from previous inputs.    Products from
                               this edit run will then be reviewed by requirements analysts at
                               the air logistics    centers to detect errors, program anomalies and
                               trends. Programming for the edit has been completed and testing
                               should be accomplished by December 31, 1989. Implementation is




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                                          Comments From the Department of Defense




                                          scheduled to be complete in time for the March 31, 1990
                                          computation cycle.
                                                Another improvement to the inventory reporting function is
                                          the assignment of dedicated analysts at the Air Force Logistics
                                          Commandto perform on-going, in-depth analysis of requirements
                                          and inventory.   These personnel will be analyzing the inventory
                                          values, to include growth trends by category, retention by weapon
                                          system, ratio of serviceable to unserviceable, effects of policy
                                          decisions on the inventory, etc. This function is scheduled to
                                          be in place by December 1989.
                                      .   -:              OSDmvInitJ3tLver
                                          Control.                            The GAO found that proposed changes
                                          by both the OSD and the Air Force would show some unreguired
                                          inventory as required.       According to the GAO, the OSD is consid-
                                          ering actions to add (1) a third year of requirements to inven-
                                          tory reports, (2) requirements to cover quantities       exceeding
                                          requirements if purchased to obtain discounts, and (3) require-
                                          ments to cover life-of-type      buys (purchases made to ensure future
                                          availability     of parts when faced with the loss of a supplier).
                                          The GAOexplained that, by adding an additional year of require-
                                          ments to the existing 24 month requirements forecasting period,
                                          the OSD plans to reclassify,      as required stock, assets currently
                                          unrequired--because they are not projected to ba required until
                                          the year following the budget year or more than 24 months in the
                                          future.      The GAO further noted that the OSD would also reclas-
                                          sify, as required stock, assets that were purchased over computed
                                          requirements--because it was in economically in the best inter-
                                          ests of the Government. The GAOconcluded that the DODefforts
                                          to reclassify     unrequired stock to required stock could be coun-
                                          terproductive.      The GAOacknowledged that it may be useful to
                                          recognize stocks were obtained by intent (even if not currently
                                          required).      The GAO concluded, however, that the DoDefforts may
                                          mask the need to address the growth in unrequired stock and could
                                          reduce the quantity of unneeded on order items eligible         for
                                          termination.      The GAO further concluded that less visibility       over
                                          DOD inventories would impede      efforts of policymakers and managers
                                          to identify     and address problems contributing   to growth in
                                          unneeded items. According to the GAO, these officials         will not
                                          know the extent of unrequired stocks if the OSD implements
                                          policies that would include such purchases among required          stocks.
    Now   on   pp.   3-4,34-35.            (pp 'l-0, pp. 44-45, pp. 50-51/GAO Draft Report)




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           Comments  From the Department of Defense




                  PONSE : Nonconcur.     The objective of the changes the DOD
        is making is to provide greater visibility         of the true nature of
        the requirements, not leas visibility.          The DOD chaired a
        meeting of senior logistics       managers and technical experts in
        August 1988, to identify      changes needed in the DODpolicy on
        inventory stratification       (contained in Department of Defense
        Instruction     4140.24).   This initiative    was designated the DOD
        Stratification      Improvement Program. During the meeting it was
        agreed by all the Services that a major revision of the
        stratification      process was required to: (1) support weapon system
        management concepts; (2) address the requirement for a biennial
        budget: and (3) provide improved management information to
        evaluate inventory trends.        One of the specific    changes required
        was to add an additional      year's worth of requirements to the
        Approved Force Acquisition       Objective to allow the stratification
        horizon to extend to the second year of a two-year budget. The
        plan to do this provides for separate identification           of the
        additional     requirements on the stratification     displays.    Contrary
        to the GAO statements, the net effect of this is to provide more,
        rather than less, information to managers and decision makers.
        There is no masking the effects of this action--it          is clearly
        identified     and provides a better portrayal of the inventory and
        the requirements upon which it is based.
    .   #l.EQUU:       &is mm     In-ntomati-8                        tt&Uma&
              01 Of Unreued       Sto&.    The GAO reported   that, in April
         1988, Air Force Headquarters directed the Air Force Logistics
        Commandto increase the Approved Force Acquisition          Objective, and
        the criteria    used to identify   unneeded items on order for poten-
        tial termination.     The GAO found that in response to this direc-
        tion, the Command(1) temporarily authorized inventory control
        points to manually add items to stock requirements, in order to
        reclassify    unneeded stock on order to required stock if personnel
        decided not to terminate the order, and (2) is considering adding
        an additional    year of requirements to its automated requirements
        determination system in order to reduce the number of orders for
        potential termination.      The GAO reported that various concerns
        were raised over the first initiative--and        its use was cancelled
        in November 1988. With regard to the second initiative,           the GAO
        reported that the Commandplans to test the change manually and,
        if it substantially    reduces reports of unneeded assets on order,
        to then implement the change at ita air logistics        centers.    The
        GAO also reported that Air Force Headquarters reclassifiedassets
        that, in 1987, were believed to be uneconomical to repair as



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                             Appendix III
                             Comments From the Department of Defense




                           unstratified    (in transit)    stock and plans to report them, as
                           required, in the future.        The GAOpointed out that such stock
                           were previously identified       as potential excess. The GAOacknowl-
                           edged that separately identifying        the reasons that unrequired
                           stocks were obtained can be useful.          As with the OSD inventory
                           reporting initiatives,       however, the GAOconcluded that the Air
                           Force efforts to reclassify       unreguired stock to required could be
                           counter-productive     and may mask the need to address the growth in
                           unrequired stock and reduce the quantity of unneeded on order
Now    ion pp 3-4, 34-36   items eligible     for termination.     (pp. l-9, pp. 45-48,
                           pp. 50-51/GAO Draft Report)
                           POD:               Partially concur. The Air Force did direct the
                           Air Force Logistics Commandto evaluate the feaaibility        of
Seecommentll               extending the Approved Force Acquisition     Objective/Termination
                           Point in the requirements computation.      Since the budget is baaed
                           on a two year time span, the termination point currently falls in
                           the middle of the budget period; hence the risk of terminating an
                           item one year and reprocuring it the next. Extending the
                           termination point by an additional year would make the
                           computation match the budget process and would preclude
                           perturbations    and turmoil in spares procurement (e.g., minimize
                           buy, terminate and buy-again actions for the same item).         If the
                           evaluation proves that an additional year of requirements
                           inclusion in the termination requirement does not solve the
                           perturbation    problem, it will not be implemented. If it proves
                           feasible,    it will be added to the Requirements Data Dank baseline
                           and implemented in December 1993.
                                 The Air Force use of a termination "additive"     to the
Seecomment                 requirements computation did not emanate from the Air Force
                           guidance on the extension of the termination point, but rather
                           was an effort to conserve resources.    The technique was used to
                           preclude continual review of repetitive    termination notices on
                           items for which conscious, documented decisions had already been
                           made that termination of procurement was not in the best interest
                           of the government. It was not an attempt to reduce unneeded
                           stock, since decisions had been made that the inventory would be
                           required.    Because of the way these actions were coded, their
                           status remained visible in the requirements computations at all
                           times. This action did cause the items to stratify       as required
                           inventory; however, in addition to the perception of an integrity
                           problem, the additive caused unnecessary work for item managers
                           and created other problems in the computation.       For these



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                              Appendix III
                              Comments From the Department of Defense




                              reasons, the use of the additive     was discontinued   in November
                              1988.
                                     The issue regarding the classification     of assets will be
                              resolved consistent with the changes made through the DOD
                              Stratification   Improvement Program.     The policy will be
                              promulgated by December 1990.
                          .   #3imZEUx: ErMh In MI rot                              ~KSUIUWS
                              Wm.                        The GAO found that the inventory avail-
                              able to satisfy requirements beyond the current year has grown
                              more than other requirements-- rising from $1.3 billion      in 1980 to
                              $6.6 billion   in 1988. The GAO reported that, as a result of this
                              large growth, the aircraft     parts inventory held for budget year
                              demands grew to about 33 percent of the total aircraft       parts
                              required inventory in 1988. In addition, the GAO found that
                              unrequired stocks held in an economic retention category for
                              future Peacetime needs beyond the budget year grew fromS0.4
                              billion   in 1980 to $3.2 billion   in 1988. According to the GAO,
                              the Air Force attributed   the growth to increases in procurement
                              lead times, making it necessary to project and buy for require-
                              ments further into the future to maintain an adequate level of
                              support * While acknowledging that increased procurement lead
                              times necessitate ordering items sooner, the GAOobserved that,
                              if lead times are over estimated,      items could arrive sooner than
                              necessary. The GAO further observed that the large growth of Air
                              Force required   peacetime stocks for use beyond current year
                              operations can also increase the risk of reduced demand or
                              obsolescence before the items are used.       The GAOconcluded that
                              many of the problems that have caused growth of unrequired
                              inventories have also contributed to inventory growth in required
                              stocks beyond wartime and current year requirements, and could
                              result in higher levels of future unrequired stocks.        (P. 8,
NQW   0t7 pp    4,37.38       pp. 40-49, p. 51/GAO Draft Report)

                              POD:            Partially  concur. Although the GAO figures are
See   comment       13.       correct, the statements are misleading, because the assets
                              portrayed against budget year demands are only “applied” in the
                              stratification  process and may not necessarily be used to fill
                              the requirement shown. The available assets are applied to
                              requirements in the order in which they appear on the
                              stratification  report.   For example, aaeets are applied to budget
                              year demands before current year safety levels, pipelines,   etc.
                              Therefore, it is incorrect to assume that on hand assets applied



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                              Appendix III
                              Comment8Prom the Department of Defense




                              to budget year demands truly represent stock not needed in the
                              current year. The Department does not, therefore,   consider the
                              comparison of assets applied to budget year requirements in the
                              central secondary item stratification  report to be a valid
                              indication of growth in required stocks.

    See   cdmment   14               The GAOdoes not recognize that current on-hand assets (with
                              the exception of assets that are condemned) are used on a
                              recurring basis, year after year. Most items have been in the
                              inventory for years. The whole concept of investment items is
                              that an asset will be used until it fails:   it will then be
                              repaired and placed back in the inventory to satisfy recurring
                              needs. Procurement of investment items is generally for assets
                              needed to support increased pipelines and to replace
                              condemnations, not to satisfy the recurring yearly demands.
    See   comment   15.               The GAO incorrectly     implies that increased lead times caused
                              the Air Force to buy stocks for economic retention.              The
                              Department does not budget for, or buy assets beyond, the
                              computed budget year requirements, except in those cases where
                              larger quantities       are intentionally    purchased for price breaks,
                              or when life-of-type       buys are made from diminishing sources.
                              Items are budgeted and procured in time to consider the most
                              accurate lead time information available.           When lead times are
                              less than estimated or than previously experienced, the result
                              could ba stock temporarily in economic retention.            By definition,
                              economic retention stock is held to support peacetime
                              requirements for items with reasonably predictable           demands. In
    See   comment   6.        most cases, this stock is utilized.           The Department agrees that
                              some of the same problems could contribute to the growth of both
                              required and VnrequiredV8 stock: however most of the growth in
                              Vnrequired"     stock    is caused by force modernization,       e.g. weapon
                              system phaseout, and modifications,          coupled with the DOD
                              retention policy to hold the items. By viewing a total
                              stratification      report, visibility    of the individual    item or
                              weapon system asset stratification         is lost.   In reality,    most of
                              the assets appearing in the retention and excess ("unrequired")
                              portion of the summary stratification          are for items applicable to
                              obsolete or phasing out weapon systems, while the majority of
                              assets for active items/weapon systems are within the required
                              category.
                          .   ILxBUBU:    .Umct Of AAir sor~linea        cm Earlier purcBaa+n.
                              The GAO found that, prior to FY 1986, Air Force policy provided



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                     Appendix III
                     Comments From the Department of Defense




                   that current year funds could only be used to buy current year
                    requirements.    The GAO found, however, that in response to OSD
                   concerns that the Air Force had not fully obligated available
                    funds, the Air Force changed its funding policy in October 1905,
                    so that any available spares funds could be obligated to satisfy
                   current or future year funded requirements.       The GAO reported
                   that, in late 1987, the Air Force Logistics Commandwas about
                   $898.4 million behind in its planned obligations.          According to
                   the GAO, the Air Force said the obligation      shortfall    occurred
                   because FY 1985 funds were used to satisfy FY 1987 requirements
                   and that funds for 1987 were, therefore, no longer needed. The
                   GAO reported that, in January 1988, the Commandadvisedthe air
                   logistics   centers that because of limited funding, the PY 1988
                   budget goal for obligating     current year funding had increased
                   from 92 percent to 100 percent --and that the large unobligated
                   balances in FY 1986 and FY 1987 could not be tolerated.           The GAO
                   observed that these guidelines stress the importance of meeting
                   budget obligation     goals and encourage early initiation     of pur-
                   chase requests and the use of multiyear contracts and quantity
                   discount buys.     The GAO further observed,   however, that such
                   guidance can also result in buying items before they are needed.
                   As an example, the GAO cited an Air Force procurement, made under
                   a multi-year contract, where the purchase was made (1) in excess
                   of computed requirements and (2) used 1984 funds in the last year
                   of their availability--in     order to use the funds before they
                   expired.    According to the GAO, there is now little       chance that
                   the unrequired stocks on hand will ever be used and the Air Force
                   decision is not likely to be cost effective.       The GAO concluded
                   that the Air Force spending guidelines may contribute to earlier
                   purchases of items. The GAOacknowledgedthat some level of
                   unreguired inventory must be viewed as a cost of doing business.
                   Overall, however, the GAOconcluded that the proposed changes
                   cause serious   concern, because they add to existing pressures to
                   raise required inventories well above the levels actually needed.
Nowon   pp.30.39    (pp. 49-51/GAO Draft Report)
                   ~WSPONSE:         Nonconcur. The decision to change Air Force
                   policy regarding year of money/year of requirement was a
                   thoroughly staffed Air Force/OSD decision, based on the content
                   and cumulative nature of the spares budgets, not in response to
                   DODpressure as the GAO states.       The policy letter stated, in
                   part, "it is impractical, and legally unnecessary, to attempt to
                   link specific fiscal year funds with items that are being bought
                    . . . bona fide needs are those items that will be ordered during



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*
                 ,    Appendix III
                      Comments From the Department of Defense




                     the three-year period of availability   of the funds . ..."
                     Additionally,  the GAO inaccurately states that "available spares
                     funds could be obligated to aatisfy current or future year funded
                     requirements."   Spares funds (assuming FY 1989 is the current
                     year) are available to satisfy FY 1988 and FY 1987 requirements.
    Seecomment       FY 1989 funds will only be available for FY 1990 and FY 1991 when
                     FY 1991 becomes the current appropriated year.
                            Although the FY 1987 obligation amount reported by the GAO is
                      correct, the reasons (attributed              to Air Force personnel) are
    Seecomment        incorrect.          Obligations during FY 1987 were somewhat slowed by a
                      substantial         amount of fallout generated during the definitization
                     of FY 1985 undefinitized              contractual actions.    The GAO statement
                     that "since FY 1985 funds were used to satisfy FY 1907
    Seecofnment18     requirements, funds budgeted for FY 1987 were no longer needed"
                       (again attributed         to Air Force personnel) is totally      inaccurate.
                     Since the FY 1987 requirements funded with the FY 1985 fallout
                     were unfunded FY 1987 requirements, there was never a case of
                     Sunds budgeted for FY 1987 not being required.                 It should be
                     noted that large unobligated amounts toward the end of a fiscal
                     year are consistent with the overall pattern of spending, which
                     is driven by the amount of time required to put items on
                     contract.         The Air Force Audit Agency conducted an audit (Project
                     7126123) at the end of FY 1987 to evaluate the effectiveness                 of
                     internal      controls      over   year-end spending for replenishment
                     spares, and to determine whether purchase requests represented
                     valid requirements.              Final analysis indicated that the internal
                     controls used to determine year-end spending were generally
                     effective       and were adequate to assure purchase requests
                     represented valid requirements.                The 100 percent FY 1988
                     obligation        goal cited by the GAOwas an internal Air Force
                     Logistics Commandgoal and not an Air Force or OSD goal.
                           As stated in the DOD response to FINDING D, the Department
                     still  does not concur with the GAOconclusions that Air Force
                     spending guidelines may contribute to purchasing items earlier
                     than needed.
                              The procurement of an FlOO engine duct segment is cited by
                     the GAOas an effort to purchase stock in excess of computed
                     requirements     in order to utilize funds before they expired.    The
                     GAO concluded there is now little     chance that the "unrequired"
                     stocks of this item will ever be used. As discussed in the DOD
                     response to FINDING B, these items are expected to be used by the



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      ,

                                     Appendix III
                                     Comments From the Department of Defense




                                     by the end of the engine's support period.  This purchase was a
Sea   comment         19             legitimate expenditure of FY 1994 funds and was a cost effective
                                     decision


                                                                *****


                                 .   -:                  The GAO recommended that the Secretary of
                                     Defense direct the Secretaries of the Air Force and the Navy to
                                     reconsider prior audit recommendations dealing with the matters
                                     discussed in the GAO report and promptly implement corrective
                                     actions, if they have not already done so. Specifically,    the GAO
                                     recommended that the Secretaries of the Air Force and the Navy
                                     should review their policies on terminating orders for unneeded
                                     items at all levels to ensure they clearly support termination
Now       on   pp 4, 30-31           whenever practical.   (p. 9, p. 41/GAO Draft Report)
                                     m:             Concur. The Air Force and the Navy have reviewed
                                     their policies on terminating orders for unneeded items at all
                                     levels to ensure they clearly support termination whenever
                                     practical.
                                            As indicated in the DOD response provided to FINDING C, the
                                     Navy continues to make substantial progress in terminating orders
                                     for "unreguired" inventory and is planning to implement an
                                     automated program for contract terminations in the December 1989
                                     timeframe.    Achieving continued progress in this area is
                                     receiving high level attention under the Navy comprehensive
                                     Inventory Management Improvement Program.
                                            In response to a previous GAO report (OSD Case 7242), the
                                     Air Force has a strong program underway to improve termination
                                     management and has implemented a number of improvements (as
                                     outlined in the DOD response to FINDING C). The initiatives
                                     added to the termination process and the enhancements in
                                     automated data processing will ensure that the current trend
                                     reflecting   improvement continues.    The Department does not,
                                     however, plan to set arbitrary    goals for amounts to be
                                     terminated.    The DOD response to a previous GAOaudit report (OSD
                                     Case 7541) stated that economics cannot be the sole factor in the
                                     decision process. Other logistics      considerations, such as the



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                                Appendix III
                                Comments From the Department of Defense




                                stability   of demands, planned requirements, projected production
                                plans for the next higher assembly, the item’s supply position
                                and the impact on force readiness require a thorough assessment
                                before considering the economic trade-offs    involved. Additional
                                considerations   such as the adequacy of technical data to
                                reprocure the item in the future, expected long lead time and
                                dintinishing manufacturing sources must also enter in the
                                decision.    The Department will continue its emphasis on contract
                                termination and terminate orders when logical application    of
                                costs and requirements are economical and feasible.
                            .   -2:                    The GAO recommended that the Secretary of
                                Defense direct the Secretaries of the Air Force and the Navy to
                                reconsider prior audit recommendations dealing with the matters
                                discussed in the GAO report and promptly implement corrective
                                actions, if they have not already done so. Specifically,       the GAO
                                recommended that the Secretary of the Air Force should stop the
                                practice of initiating     purchase requests earlier than required.
Nowon pp. 4,30-31                (p. 9, p. 41/GAO Draft Report)
                                Dg):                Nonconcur. The Department previously non-
                                concurred with this recommendation in response to a 1986 GAO
                                report (OSD Case 6948), indicating        that it supports the
                                initiation     of procurements early in the fiscal year on items in a
                                buy position during that fiscal year, rather than waiting for the
                                exact lead time from need point reflected in the requirements
                                computation.       The Air Force contracts for spare parts specify a
                                delivery date based on need as determined by the requirements
                                system or by the item manager, and early initiation        of the
                                procurement document has no effect on the requested delivery
                                dst8.      (See also the DOD response to FINDING D.)
                            .   -3:                  The GAO recommended that the Secretary of
                                Defense direct the Secretaries of the Air Force and the Navy to
                                reconsider prior audit recommendations dealing with the matters
                                discussed in the GAOreport and promptly implement corrective
                                actions, if they have not already done so. Specifically,      the GAO
                                recommended that the Secretary of the Navy should stop th8
                                practice of buying more than the economic order quantity, unless
                                the quantity discount more than offsets the additional    holding
Now   on pp. 4, 30-31           costs.    (p. 9, p. 41/GAO Draft Report)
                                POD:           Partially    concur. The Department concurs that the
                                Economic Order Quantity    methodology should be the baseline for



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-     I
                                Appendix III
                                CommentsFrom the Department of Defense




                               determining target order quantities.    This policy was
                               re-emphasized by the OSD in a memorandumsent to the Services in
                               June 1989. (See also the DOD response to Finding E.) The
Se4       comment    20.       Department disagrees, however, that the Economic Order Quantity
                               should always be used, excluding the consideration of other
                               factors.   The following facts must also be considered:
                               - The existing Economic Order Quantity model does not consider
                               price breaks often associated with procurement of larger
                               quantities.   Procuring quantities over the Economic Order
                               Quantity is a prudent practice    for items with stable or
                               increasing demand.
                               - Strict adherence to the existing model may result In numerous
                               requests in the pipeline simultaneously and place a burdensome
                               workload on an already constrained inventory manager and
                               contracting personnel work force.
                               -4:                 The GAO reconnnended that the Secretary of
                               Defense separately identify unreguired inventory that was
                               obtained in the best interests of the Government--in order to
                               ensure that unrequired inventory is properly classified.
Now       on   pp. 4,40.        (p. 9, p. 52/GAO Draft Report)
                               -RESPONSE:         Concur. This capability   is planned for within the
                               DOD Stratification     Improvement Program initiative  that is
                               currently being developed under the leadership of the OSD. The
                               new policy will be promulgated by December 1990.
                               -5:                The GAO recommended that the Secretary of
                               Defense separately identify those assets which are uneconomical
                               to repair, and modify DOD regulations to ensure consistent
Now       on   pp 4,40         treatment by the Services.   (p. 9, p. 52/GAO Draft Report)

                               ~RESDONSE: Concur. The Stratification      Improvement Program
                               addresses this requirement and provides for consistent treatment
                               of these assets in the proposed change to the DOD stratification
                               process.   The new policy will be promulgated by December 1990.
                               -6:                 The GAOrecommended that the Secretary of
                               Defense direct the Secretary of the Air Force to cancel efforts
                               to increase the Approved Force Acquisition Objective to include
                               an additional year of requirements --because such a change would
                               mean that inventory managers would not have to consider terminat-



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L


                               A p p e n d i xIII
                               C o m m e n tsF r o m the Departmentof Defense




                           ing orders that could h a v e b e e n terminated u n d e r current crite-
    Nowotj   pp.4,40       ria.  (p, 9, p. 5 2 / G A ODraft Report)
                           - R E S P O N S E : Nonconcur. T h e G A Oh a s improperly characterized
                           D O Defforts to improve the stratification                   process as a m e a n s of
                           reducing inapplicable inventory a n d avoiding contract
                           terminations.         This is incorrect a n d ignores the fact that the
                           stratification        process h a s not b e e n u p d a t e d in over twenty years,
                           a n d that it d o e s not fully reflect current D O Dlogistics policies
                           a n d concepts. T h e p r o p o s e d c h a n g e s in the stratification      process
                           will support the D O Dcommitment to w e a p o n system m a n a g e m e n t:
                           allow the Department to comply with n e w b u d g e t i n g requirements
                            (biennial budgets); provide a m o r e accurate portrayal of
                           inventories; a n d provide a credible auditable source of
                           m a n a g e m e ninformation
                                             t            o n D O Drequirements a n d inventories.             The
                           revised stratification         process will also separately identify all
                           additions to the A p p r o v e d Force Acquisition Objective o n the
                           stratification        displays, thereby allowing full visibility               of the
                           impacts of the changes. This will provide m a n a g e m e nat n d the G A O
                           with a n i m p r o v e d capability to look at the inventory from several
                           perspectives.         T h e Department a g r e e s that if the A p p r o v e d Force
                           Acquisition Objective is e x t e n d e d by o n e year, inventory m a n a g e r s
                           w o u l d not consider the s a m e termination orders that w o u l d b e
                           considered u n d e r the current criteria.                T h e w a y the computation
                           a n d the b u d g e t process a r e currently structured, (with the
                           termination point in the middle of the b u d g e t period), the D O D
                           C o m p o n e n tscould conceivably b e b u d g e t i n g for items that also
                           c o m p u t e as potential terminations.            T h e revised stratification
                           process will preclude this from h a p p e n i n g a n d will allow
                           attention       to b e focused o n terminating o n - o r d e r m a terial that
                           exceeds forecasted needs.




                                                                25




                       *




                               P a g e7 1                                                 G A O / N S L 4 D - 9 O - 1Defense
                                                                                                                      O O Inventory
               Appendix III
               Comments From the Department of Defense




               The following are   GAO'S   comments on   DOD'S   letter dated November 1,
               1989.

 1


               1. We reported in July 1988 (Defense Inventory: Growth in Secondary
GAO Comments   Items, GAO/NSIAD-8%189BR, July 19, 1988) that the proportion of unre-
               quired stocks grew from about one quarter of the total in 1980 to one
               third in 1987. We believe the change in the ratio is significant.

               2. These faCtOrS were ah0 noted      in GAO/NSIAD-88-189BR.

               3. The impact of material returns was among the factors considered in
               our tests and could have affected our selected items. The factor did not
               arise as a separate major cause for aircraft parts.

               4. Discussions with DOD and Air Force supply personnel and our analy-
               ses did not identify disposal policies as a major causal factor. In the
               three such cases in our sample, item managers stated they knew of no
               reason why the items should not have been considered for elimination.
               Thus, recent changes in disposal policies were not identified as a factor
               even where disposable items arose in our sample.

               5. Price differences were noted in GAO/NSIAD-88-189bR. The current report
               notes that over half the unrequired aircraft parts needed repair, also
               indicating overstatement of the value of such parts. GAO also has other
               work underway that addresses the Air Force’s financial statements and
               financial controls over its inventory.

               6. The DOD statements that “much of the stock will be used” and “In
               most cases, this stock is utilized,” appear inconsistent with DOD'S subse-
               quent position in the response. For finding I, DOD states that “In reality,
               most of the [unrequired] assets , . . are for items applicable to obsolete or
               phasing out weapon systems.” We would expect that it would be diffi-
               cult to use unrequired stock for obsolete and obsolescent systems,
               because several years’ worth of required inventories must be used
               before total stocks, including unrequired items, are used up. We found
               no DOD analyses showing how much of the stock in the unrequired cate-
               gories had been used in the past or will be used in the future. Also, pre-
               mature investment of funds should be avoided whenever possible,
               regardless of whether stock is eventually used.

               7. WC do not extrapolate the results to the entire inventory. The popula-
               tion was defined to include items for which data was maintained at the


               Page 72                                           GAO/NSIAD-90-100Defense Inventory
b
    I       Appendix III
            Commenta From the Department of Defense




            time of our review. The results are significant in themselves because
            they focus on items on which actions were taken in the previous 2 years.
            The 40 Air Force items we examined accounted for about 50 percent in
            value of the items for which the data needed for analysis were availa-
            ble. The second quote cited by DOD was not in the draft report.

            8. We believe that all items held as spares should be counted, including
            replacements for items that originally came with end items, Not count-
            ing such items would mask an area of unnecessary inventory growth.

            9. The duct segments are reflected on current Air Force records as
            required stock because their system considered the last purchase of
            about 73,000 items to represent 1 year of demand, in spite of far lower
            historical demand and further recent declines in demand. As discussed
            further below, the computed requirements are clearly inconsistent with
            actual experience, and actual experience as adjusted for declining use
            should be the basis for requirements.

        . In addition to the assumed l-year demand, the Air Force’s system fur-
          ther added requirements for 2 more years of routine operating stocks
          and for procurement lead times to arrive at an approved force acquisi-
          tion objective of 290,976 items and an economic retention level of
          1,091,160 items. (The duct segment has been coded by the inventory
          manager to prevent buying toward the computed requirement.)
        l The demand for the 3 months ending June 30,1989, totaled 2,341 units
          (368 for Air Force needs, 500 provided to a contractor, and 1,473 for
          foreign military sales). The previous quarter’s demand totaled 1,061.
        l The low recent use and continued phase-out of the supported end item
          indicates that fewer duct segments will be needed than the 12,000 per
          year estimated by DOD in their response. However, even using DOD'S esti-
          mate, the Air Force’s new approved force acquisition objective equates
          to over 24 years of stock, and the authorized retention levels equate to
          another 90 years. As stated by DOD, the item is to be phased out of the
          U.S. inventory in 1992.
        l Historical demand as modified for known declines would be appropriate
          even though the Air Force transferred the duct segment from the repa-
          rable category to consumable. Because the Air Force had always
          replaced rather than repaired the item, its demand as a reparable would
          be equivalent to its demand as a consumable.

            10. It is not possible to accurately measure how such guidance affects
            the Air Force’s general policy. However, these are examples of actual
            guidance that affected our selected items.


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Appendix III
Comments From the Department of Defense




11, We do not agree that extending the termination point would make
the requirements computation match the budget process or preclude tur-
moil in spares procurement. We agree that a 2-year budget can assist in
estimating future purchases, However, we do not believe that a 2-year
budget should be used as a justification to order and accept items not
yet needed. Extending the termination point would reduce, not preclude
such cancellations. The benefits of minimizing such cancellations must
be weighed against the costs of buying items sooner than necessary and
the increased risk of obsolescence.

12. The decisions were not that items would be required; they were deci-
sions to buy items sooner than called for by the requirements
computation.

13. We evaluated inventories based on DOD'S justification. DOD'S comment
that items might actually be used for a different purpose or in a differ-
ent order than shown in the stratification does not lessen our concern.
For example, if the requirements cited by DOD were stratified before the
budget-year stocks, a similar concern would arise about the degree to
which stocks were actually on hand for a category that should still be on
order.

14. We recognize that reparable assets will be fixed until condemned.
DOD'S distinction between replacing condemnations and satisfying recur-
ring yearly demands is primarily semantic. Both types of demand recur
as a function of failures.

15. Our discussion responds to Air Force officials’ explanations for the
growth in stocks held for use beyond the current year. We agree with
DOD that proper consideration of lead time should not result in unre-
quired stock.

16. DOD'S statement that “FY 89 funds will only be available for FY 90
and FY 91 when FY 91 becomes the current appropriated year” is not
correct. Availability of 1989 funds for fiscal year 1990 can occur before
fiscal year 1991 becomes the current year. Therefore we made no
change in our original statement.

17. The written DOD response to the 1988 GAO report took exception to
the suggestion that there was a rush to execute the budget, but other-
wise concurred with the finding.




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Appendix III
CommentaFrom the Department of Defense




18. We modified the report to state that funds were no longer needed for
the purposes originally justified. We recognize that the funds might be
used to meet revised requirements or to meet requirements in later fiscal
years.

19. We do not agree that the available data supports the Department’s
belief that this purchase was cost effective (see comment 9). To recog-
nize the possible eventual depletion of stocks through foreign military
sales, we modified the report to state that there was little chance the
stocks would be used before the supported item was phased out of the
U.S. inventory.

20. Our draft recommendation did not exclude consideration of other
factors, Our recommendation was that the other factors should be spe-
cifically justified in each case. However, we have clarified our recom-
mendation to more clearly recognize factors other than quantity
discounts.




Page 75                                    GAO/NSLAD-90-100Defense Inventory
Mpndix      IV

Major Contributors to This Report


                      t
National Security and
Idternational Affairs
Dbvision,
Nashington, D.C.
                          1
                              Larry J. Junek, Evaluator-in-Charge
Dbllas Regional Office


Office




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