oversight

Outsourcing DOD Logistics: Savings Achievable But Defense Science Board's Projections Are Overstated

Published by the Government Accountability Office on 1997-12-08.

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

                  United States General Accounting Office

GAO               Report to Congressional Requesters




December 1997
                  OUTSOURCING DOD
                  LOGISTICS
                  Savings Achievable But
                  Defense Science
                  Board’s Projections
                  Are Overstated




GAO/NSIAD-98-48
                              United States
GAO                           General Accounting Office
                              Washington, D.C. 20548

                              National Security and
                              International Affairs Division

                              B-277816

                              December 8, 1997

                              Congressional requesters

                              As you requested, we reviewed the basis for the Defense Science Board’s
                              (DSB) estimate that the Department of Defense (DOD) could potentially save
                              $6 billion annually by reducing its logistics infrastructure costs within the
                              continental United States (CONUS).1 This report provides our analysis of the
                              reasonableness of the savings projected by the Board. Specifically, we
                              discuss (1) the opportunities for logistics infrastructure savings and
                              (2) DOD’s and our analyses of the DSB’s projected logistics infrastructure
                              savings.


                              Faced with a goal of increasing the Department’s investments in
Background                    modernization without increasing overall defense budgets, DOD has
                              recently focused on the cost of support operations and their associated
                              infrastructure, with the objective of finding ways to provide required
                              support resources and capability at reduced costs.2 DOD recognizes that
                              portions of its support structure are inefficient and continue to absorb a
                              large share of the defense budget. To the extent support costs can be
                              reduced, available future defense dollars could be used for modernization
                              or other defense priorities.


DSB Studies Project           The Office of the Secretary of Defense (OSD) requested that DSB identify
Infrastructure Cost Savings   DOD activities that the private sector could do more efficiently and to

From Outsourcing and          determine the expected savings from outsourcing. DSB, a civilian advisory
                              board to DOD, issued two reports in 1996 addressing outsourcing and other
Other Initiatives             opportunities for substantially reducing DOD support services.3 The first
                              focused solely on outsourcing and privatization issues.4 The second,
                              incorporating findings from the earlier report, had a broader scope that

                              1
                               As discussed in this report, logistics infrastructure refers only to CONUS logistics.
                              2
                               We have identified this as a high-risk area. High-risk areas are those critical government operations
                              that are highly vulnerable to waste, fraud, abuse, and mismanagement. High-Risk Series: Defense
                              Infrastructure (GAO/HR-97-7, Feb. 1997) provides further discussion of our assessment of the defense
                              infrastructure.
                              3
                               Report of the Defense Science Board Task Force on Outsourcing and Privatization, August 1996, and
                              Report on the Defense Science Board 1996 Summer Study on Achieving an Innovative Support
                              Structure for 21st Century Military Superiority: Higher Performance at Lower Costs, November 1996.
                              4
                               DOD defines outsourcing as the transfer of a function, previously performed in-house, to an outside
                              provider. Privatization is a subset of outsourcing that involves the transfer or sale of government
                              assets to the private sector.



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               included other methods for reducing infrastructure costs. In preparation
               for the Quadrennial Defense Review (QDR), OSD’s Program Analysis and
               Evaluation (PA&E) directorate assessed the DSB’s savings estimates from
               the second report.5 Our analysis also focused on the second report’s
               findings and recommendations.

First Study    The first DSB task force concluded that DOD could realize savings of 30 to
               40 percent of logistics costs and achieve broad improvements in service
               delivery and responsiveness by outsourcing support services traditionally
               done by government personnel. The report cited evidence from the Center
               for Naval Analyses (CNA) public-private competition studies of commercial
               and depot maintenance activities. The Board also noted that an
               Outsourcing Institute study found that the private sector saved about 10 to
               15 percent by outsourcing but that the public sector savings from
               outsourcing would be higher because of the inefficiency of government
               service organizations.6 The DSB task force stated that an aggressive DOD
               outsourcing initiative could generate savings ranging from $7 billion to
               $12 billion annually by fiscal year 2002.

Second Study   Building on the earlier study, DSB’s second task force report provided a
               new vision wherein DOD would only provide warfighting, direct battlefield
               support, policy- and decision-making, and oversight activities. All other
               activities would be done by the private sector. DSB said that DOD would
               need to make an investment of about $6 billion but would ultimately save
               about $30 billion annually by the year 2002, primarily through outsourcing
               support functions.

               Of these $30 billion in annual savings, $6 billion was to come from CONUS
               logistics infrastructure activities, which DSB defined as including inventory
               control points, distribution depots, maintenance depots, and installation
               supply and repair. About $4.2 billion of the savings would be achieved by
               outsourcing these activities; the remaining $1.8-billion savings would be
               achieved through improvements in inventory management practices and
               equipment reliability. Table 1 shows a breakout of the estimated logistics
               infrastructure savings.



               5
                The QDR is required by the Military Force Structure Review Act of 1996, which was included as part
               of the National Defense Authorization Act for Fiscal Year 1997. DOD designed the QDR to be a
               fundamental and comprehensive examination of America’s defense needs from 1997 to 2015. The
               review examines potential threats, strategy, force structure, readiness posture, military modernization
               programs, defense infrastructure, and other elements of the defense program.
               6
                The Outsourcing Institute, founded in 1993, is a professional association that provides information on
               the strategic use of outside resources.



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Table 1: Breakout of DSB Savings
Estimates for CONUS Logistics      Dollars in billions
Infrastructure                     Savings initiative                                                                         Savings
                                   Use of prime vendors and contractor logistics support
                                       Filling orders and repairing equipment                                                      $3.5
                                       Wholesale inventory                                                                          0.7
                                   Subtotal                                                                                         4.2
                                   Reductions from other initiatives
                                       Inventory management improvements for non-deploying units                                    0.3
                                       Equipment reliability improvements                                                           1.5
                                   Subtotal                                                                                         1.8
                                   Total                                                                                           $6.0
                                   Source: DSB.



                                   According to the DSB estimates, the $6-billion savings represents an
                                   approximate 40-percent reduction in the $14 billion the Board estimated
                                   DOD spends annually for CONUS logistics activities. According to a DSB task
                                   force member, estimates for the cost of installation supply and repair
                                   activities were unavailable. Therefore, the group used $14 billion as a
                                   rough estimate to approximate total CONUS logistics cost, not including
                                   activities already contracted out. Although we were unable to substantiate
                                   those numbers, the data that is available indicates that DSB’s estimate of
                                   $14 billion for CONUS logistics costs is conservative. For example, the Navy
                                   has reported that more than $8.5 billion of Navy resources was applied in
                                   fiscal year 1996 to maintenance programs in support of fleet ships and
                                   aircraft.7

                                   The report also stated that to gain economies and achieve significant
                                   savings, DOD needs to consider dramatic changes in the way it does
                                   business. DSB said the Department must get out of the material
                                   management/distribution and repair business by expanding contractor
                                   logistics support to all fielded weapon systems and by expanding the use
                                   of “prime vendors” for all commodities. Contractor logistics support,
                                   which relies on a contractor to provide long-term, total life-cycle logistics
                                   support, combines depot-level maintenance with wholesale and selected
                                   retail material management functions. Under the “prime vendor” concept,
                                   DOD would rely on a single vendor to buy, warehouse, and distribute
                                   inventory to the customer as needed, thus removing the Defense Logistics
                                   Agency and the services from their present middleman role.

                                   7
                                    Navy Regional Maintenance: Substantial Opportunities Exist to Build on Infrastructure Streamlining
                                   Progress (GAO/NSIAD-96-30, Nov. 13, 1997).



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                   Overall, we agree with the Defense Science Board that DOD can reduce the
Results in Brief   costs of its logistics activities through outsourcing and other initiatives.
                   DOD has already achieved over $700 million in savings from the use of a
                   prime vendor program and other inventory-related reduction efforts for
                   defense medical supplies. Also, according to studies by the Center for
                   Naval Analyses, competition for work, including competition between the
                   public sector and the private sector—regardless of which one wins—can
                   result in cost savings. Further, many private sector firms have successfully
                   used outsourcing to reduce their costs of operations.

                   The Program Analysis and Evaluation’s analysis shows, however, that the
                   Defense Science Board’s estimated annual savings of $6 billion is
                   overstated by about $4 billion because of errors in estimates, overly
                   optimistic savings assumptions, and legal and cultural impediments.
                   According to the Program Analysis and Evaluation’s analysis, this
                   $4 billion includes (1) $1 billion in overstated contract administration and
                   oversight savings and one-time inventory savings and (2) $3 billion in
                   savings that would be unlikely or would be difficult to achieve within the
                   Board’s 6-year time frame, given certain legislative requirements and DOD’s
                   resistance to outsourcing all logistics functions.

                   Our analysis confirmed the Program Analysis and Evaluation’s conclusion
                   that the Board’s estimated savings were overstated. Our analysis also
                   raised questions about the Board’s projected savings, but we do not know
                   by how much or whether these questions would change the $2 billion in
                   savings that the Program Analysis and Evaluation concluded were
                   achievable. For example, we found that the Board’s estimated savings
                   from improvements to equipment reliability were overstated by at least
                   $1.2 billion. Further, we question whether DOD would achieve a 25-percent
                   savings from outsourcing, as the Board assumed, because the savings were
                   based primarily on studies of public-private competitions in highly
                   competitive private sector markets. However, competitive markets may
                   not currently exist in some areas. For example, we reported that
                   91 percent of recent nonship depot maintenance contracts were awarded
                   on a sole-source basis.

                   Notwithstanding our concerns about the magnitude of savings, DOD can
                   make significant reductions in logistics costs. The Secretary of Defense
                   has recently issued a strategic plan for achieving such reductions. This
                   report is a step in the right direction. DOD now needs an implementation
                   plan based on a realistic assessment of the savings potential of various
                   cost-reduction alternatives and the time frames for accomplishing various



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                           activities required to identify and implement the most cost-effective
                           solutions. This plan should be presented to Congress to provide a basis for
                           congressional oversight.


                           Our reviews of best practices within the private sector and ongoing work
Opportunities Exist        at DOD indicate that DOD has significant opportunities for reducing logistics
for Logistics              costs and improving performance by changing its business processes. This
Infrastructure Savings     work also indicates that determining the most cost-effective processes to
                           use requires an evaluation of costs and benefits of each situation. These
                           findings are consistent with the general theme of the DSB’s reports that
                           opportunities exist for savings in the operation of DOD’s logistics support
                           activities. However, DSB focused on outsourcing, while our work has
                           focused first on reengineering and streamlining, and outsourcing where
                           appropriate and more cost-effective.


DOD Can Reduce Logistics   Over the past several years, DOD has considered a number of actions to
Costs                      improve the efficiency and effectiveness of its logistics system. As with the
                           private sector, such actions should include using highly accurate
                           information systems, consolidating certain activities, employing various
                           process streamlining methods, and outsourcing. For example, defense
                           maintenance depots have about 40-percent excess capacity, and we have
                           advocated consolidating workloads to take advantage of economies of
                           scale and eliminate unnecessary duplication.8 Consolidating workloads
                           from two closing depots would allow the Air Force, for instance, to
                           achieve annual savings of over $200 million and reduce its excess capacity
                           from 45 percent to about 8 percent.

                           In addition, our work has pointed out the benefits of outsourcing when
                           careful economic analysis indicates the private sector can provide
                           required support at less cost than a DOD activity can. For example, the
                           Defense Logistics Agency has successfully taken steps to use prime
                           vendors to supply personnel items directly to military facilities.9 The
                           consumable items under these vendor programs account for 2 percent of
                           the consumable items DOD manages. DOD’s prime vendor program for
                           medical supplies, along with other inventory reduction efforts, has
                           resulted in savings that we estimate exceed $700 million. More

                           8
                            Defense Depot Maintenance: Challenges Facing DOD in Managing Working Capital Funds
                           (GAO/T-NSIAD/AIMD-97-152, May 7, 1997).
                           9
                            Inventory Management: Greater Use of Best Practices Could Reduce DOD’s Logistics Costs
                           (GAO/T-NSIAD-97-214, July 24, 1997).



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                         importantly, this program has moved DOD out of the inventory storage and
                         distribution function for these supplies, thus emptying warehouses,
                         eliminating unnecessary layers of inventory, and reducing the overall size
                         of the DOD supply system. Also, service is improved because DOD buys only
                         the items that are currently needed and consumers can order and receive
                         inventory within hours of the time the items are used.

                         While DOD has achieved benefits from outsourcing, it has been shown that
                         adequate competition has been key to achieving significant reductions.
                         Public-private competition studies by CNA have stressed this point. In its
                         1993 review of the Navy’s Commercial Activities Program, CNA noted that
                         about half the competitions were won by the in-house team and that when
                         competitions with no savings were excluded, the savings from contracts
                         awarded to the public sector were 50 percent and those to the private
                         sector were 40 percent.10 CNA officials concluded that because of
                         competition both sectors were spurred to increase efficiency and reduce
                         costs and DOD achieved greater savings. CNA also concluded that savings
                         would have been less had the public sector been excluded from
                         competition. Likewise, our review of DOD’s public-private competition
                         program for depot maintenance determined that such competitions
                         resulted in reduced costs.


Private Sector Closely   Facing increasing pressures to maintain market competitiveness, private
Analyzes Outsourcing     companies have been reevaluating their organization and processes to cut
Decisions                costs and improve customer service. The most successful improvements
                         include (1) using highly accurate information systems that provide cost,
                         tracking, and control data; (2) consolidating and/or centralizing certain
                         activities; (3) employing various methods to streamline work processes;
                         and (4) shifting certain activities to third-party providers.11 Each
                         company’s overall business strategy and assessment of “core
                         competencies” guide which tools to use and how to use them.



                         10
                            Analysis of the Navy’s Commercial Activities Program, Center for Naval Analyses, July 1993 and
                         Outsourcing and Competition: Lessons Learned From DOD Commercial Activities Programs, Center
                         for Naval Analyses, October 1996.
                         11
                          Reports on this include: Best Management Practices: Reengineering the Air Force’s Logistics System
                         Can Yield Substantial Savings (GAO/NSIAD-96-5, Feb. 21, 1996); Inventory Management: The Army
                         Could Reduce Logistics Costs for Aviation Parts by Adopting Best Practices (GAO/NSIAD-97-82,
                         Apr. 15, 1997); Base Operations: Challenges Confronting DOD as It Renews Emphasis on Outsourcing
                         (GAO/NSIAD-97-86, Mar. 11, 1997); Contract Management: Fixing DOD’s Payment Problems Is
                         Imperative (GAO/NSIAD-97-37, Apr. 10, 1997); Defense Infrastructure: Enhancing Performance
                         Through Better Business Practices (GAO/T-NSIAD/AIMD-95-126, Mar. 23, 1995); and Financial
                         Management Outsourcing Finance and Accounting (GAO/AIMD/NSIAD-98-43, Oct. 17, 1997).



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                       Private companies use a variety of approaches to meet their logistics
                       support needs. For example, Southwest Airlines contracts out almost all
                       maintenance, thus avoiding costly investments in facilities, personnel, and
                       inventory. However, in contrast, having already made a significant
                       investment in building infrastructure and training personnel, British
                       Airways reached a different decision about its support operations. While it
                       has sold off and/or outsourced some activities (namely engine repair and
                       parts supply) and improved remaining in-house repair operations, the
                       airline now has become a third-party supplier of aircraft overhaul.

                       Whether the organization decides to consolidate, reengineer, or outsource
                       activities, or to do some combination thereof, the private firms and
                       consultants with whom we met stressed that identifying and
                       understanding the organization’s core activities and obtaining accurate
                       cost data for all in-house operations are critical to making informed
                       business decisions and assessing overall performance. Core activities are
                       those that are essential for meeting an organization’s mission.

                       Before making decisions on what cost-saving options should be used, an
                       organization should develop a performance-based, risk-adjusted analysis
                       of benefits and costs for each option to provide (1) the foundation for
                       comparing the baseline benefits and costs with proposed options and (2) a
                       basis for decisionmakers to use in selecting a feasible option that meets
                       performance goals.12 The organization should also factor into the analysis
                       the barriers and risks in implementing the options. Thus, the best practice
                       would be to make an outsourcing decision only after a core assessment
                       and comprehensive cost-benefit analysis have been performed rather than
                       to take a blanket approach and outsource everything in a certain area.


                       PA&E’s analysis of the DSB’s estimated $6 billion in annual logistics savings
PA&E Analysis Raises   found that the estimate was overstated by about $1 billion and that
Questions on DSB       another $3 billion in projected savings would be difficult to achieve or
Savings Estimates      unlikely to be achieved.13




                       12
                         Business Process Reengineering Assessment Guide (GAO/AIMD-10.1.15, Apr. 1997).
                       13
                         The PA&E estimates have been rounded. PA&E’s figures are slightly higher than DSB’s because
                       PA&E used 1997 constant dollars. According to PA&E officials, the analysis required a quick
                       turnaround, which limited its scope to considering costing factors such as investment costs and the
                       double-counting of savings. The officials noted that PA&E did the analysis “in the same spirit” as DSB,
                       therefore, it did not question the DSB’s underlying assumptions, such as the savings potential from
                       technological improvements or outsourcing.



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According to PA&E officials, DSB’s $6-billion savings estimate was
overstated by about $1 billion because contract administration and
oversight costs were understated and one-time inventory savings (spread
over 6 years) was claimed as steady state savings. Further, in assessing the
degree of difficulty in achieving the savings, PA&E concluded that about
$1 billion would be difficult to achieve, but was possible if Congress
changed the required 60/40 public-private split to 50-50, which has since
occurred.14 PA&E also believed that another $2 billion was unlikely to be
saved primarily because of timing and DOD’s culture. It did not believe that
DOD could carry out the proposals within the DSB’s 6-year schedule, if at all.


PA&E’s  assessment concluded that the remaining $2 billion of the DSB’s
$6-billion savings estimate was achievable or already identified in DOD’s
future year defense program. PA&E officials defined as achievable those
savings that they believed could be realized given DSB’s 25-percent savings
assumption and the then-current legal restrictions on outsourcing depot
maintenance activities. About $0.2 billion in savings would involve
maximizing the use of outsourcing under legislative constraints as they
existed at that time, such as the 60/40 rule.15 The remainder of the
achievable savings have already been identified in DOD’s future year
defense program. Table 2 shows PA&E’s revised estimate of the DSB’s
logistics savings.




14
  In addition to the 60/40 rule, other relevant statutes that govern depot-level activities have been
amended, and new provisions added by the recently enacted 1998 DOD Authorization Act. For
example, the 1998 Authorization Act provides for a new section 2460 in title 10, which for the first time
would establish a statutory definition of depot-level maintenance and repair. Also, section 2464 of
title 10 is amended to provide for the first time a DOD-maintained core logistics capability that is
required to be government-owned and government-operated. The provision now requires the
performance of core workloads necessary to maintain this capability within the public depots and that
these facilities be assigned sufficient workloads to ensure cost-efficient operation and sufficient surge
capacity. The impact of these changes remains to be seen.
15
  At the time of the PA&E report, 10 U.S.C. 2466 prohibited the use of more than 40 percent of the
funds made available in a given fiscal year for the depot-level maintenance for performance of
maintenance activities by nonfederal personnel. The provision has been amended by the 1998 DOD
Authorization Act to increase the percentage to 50 percent.



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Table 2: PA&E’s Revised Estimate of
DSB’s Logistics Savings               Dollars in billions
                                                                                                                                 Savings
                                      DSB                                                                                            $6
                                      PA&E
                                        Understated costs/overstated savings                                                          (1)
                                        Savings hard to achieve                                                                       (1)
                                        Unlikely savings                                                                              (2)
                                      Achievable savings                                                                             $2
                                      Source: PA&E.




                                      Our analysis confirms PA&E’s conclusion that the DSB’s logistics savings
Our Analysis Also                     estimates are not well supported and are unlikely to be as large as
Raises Questions                      estimated. Specifically, we found that (1) the Board’s projected annual
About DSB Savings                     savings from reliability improvements are overstated by over $1 billion;
                                      (2) the DSB’s 25-percent savings rate from outsourcing appears to be overly
Estimates                             optimistic; and (3) DSB, while recognizing it would be difficult to do so,
                                      assumed that DOD would overcome impediments that prevent the
                                      outsourcing of all logistics functions. We do not know by how much or
                                      whether these questions would change the $2 billion in savings that PA&E
                                      concluded were achievable.


Savings From Reliability              In addition to overstating inventory management savings noted by PA&E,
Improvements Overstated               the DSB task force overstated its estimate of annual savings from
                                      equipment reliability improvements. The Board’s estimate of $1.5 billion in
                                      annual savings by year 2002 (6 years from the year of DSB’s study) is
                                      overstated by at least $1.2 billion. DSB based its estimate on a Logistics
                                      Management Institute (LMI) study that assessed the reductions of operation
                                      and support costs that result from improved reliability and maintainability
                                      due to technological advancements.16 Such advancements may include
                                      using improved materials and fewer component parts; thus reducing the
                                      number of spare purchases and the need for scheduled and unscheduled
                                      maintenance. Accomplishing these advancements requires an investment
                                      that must be evaluated in light of the expected return on investment.

                                      For its study, LMI assumed an aggressive technology improvement
                                      program. For example, it assumed a 9 to 1 return on investment that would

                                      16
                                         Using Technology to Reduce Cost of Ownership, Volume 1: Annotated Briefing (LG404RD4,
                                      Apr. 1996).



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                            accrue over 20 years, with savings starting the second year. Further, it
                            assumed that any given investment would generate a savings stream for at
                            least 10 years. Based on these assumptions and its analysis, LMI concluded
                            that with an annual investment starting at $100 million and leveling at
                            $500 million within 5 years, DOD could achieve $300 million in savings in
                            the sixth year. DOD would not achieve the $1.5-billion savings that DSB
                            included in its savings estimate until the fourteenth year. Thus, even
                            without questioning LMI’s aggressive assumptions, the DSB’s savings
                            estimate is overstated by at least $1.2 billion.


DSB’s Outsourcing Savings   DSB assumed that outsourcing all logistics activities would reduce DOD’s
Assumption Is Overly        logistics costs by 25 percent. The Board based this projection on
Optimistic                  public-private competition studies, industry studies by such companies as
                            Caterpillar and Boeing, and anecdotal evidence. While we believe that
                            savings can be achieved through appropriate outsourcing, these savings
                            are a result of competition rather than from outsourcing itself. The studies
                            DSB cited were primarily for commercial activities—such as base
                            operations, real property maintenance, and food service.17 As we have
                            reported, these activities generally have highly competitive markets.18 For
                            some logistics activities, such as nonship depot maintenance, our recent
                            work has shown that competitive markets do not currently exist. To the
                            extent that competitive markets do not exist, the amount of savings that
                            can be generated through outsourcing may be reduced.

                            As we reported in 1996, 76 percent of the 240 open depot maintenance
                            contracts we examined were awarded noncompetitively (i.e., sole
                            source).19 More recently, we reported that the percentage of
                            noncompetitive depot maintenance contracts had increased for activities
                            other than shipyards. For the three services, about 91 percent of the 15,346
                            new depot maintenance contracts awarded from the beginning of fiscal
                            year 1996 to date were sole source.20 Moreover, the DSB recommended
                            contractor logistics support arrangements for new and modified weapon

                            17
                               Analysis of the Navy’s Commercial Activities Program, Center for Naval Analyses, July 1993 and
                            Outsourcing and Competition: Tools to Increase Efficiency (briefing to DSB), Center for Naval
                            Analyses, January 1995.
                            18
                             Defense Depot Maintenance: Commission on Roles and Mission’s Privatization Assumptions Are
                            Questionable (GAO/NSIAD-96-161, July 15, 1996) and Navy Maintenance: Assessment of the Public and
                            Private Shipyard Competition Program (GAO/NSIAD-94-184, May 25, 1994).
                            19
                             Defense Depot Maintenance: Commission on Roles and Mission’s Privatization Assumptions Are
                            Questionable (GAO/NSIAD-96-161, July 15, 1996).
                            20
                             Defense Depot Maintenance: Challenges Facing DOD in Managing Working Capital Funds
                            (GAO/T-NSIAD/AIMD-97-152, May 7, 1997).



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                          systems. Our past work demonstrates that most contractor logistics
                          support depot work is sole sourced to the original equipment
                          manufacturer, raising cost and future competition concerns. Furthermore,
                          eliminating the public sector from competition, as advocated by DSB, could
                          further decrease savings.


Impediments Limit DOD’s   In developing its savings estimates for CONUS logistics, DSB assumed that
Outsourcing of All        DOD would outsource all logistics activity. However, certain barriers,

Logistics Activities      including legal and cultural impediments, must be overcome to fully
                          implement DSB’s recommendations. While it may be possible to implement
                          DSB’s recommendations, in some cases, implementation may require
                          congressional action, and in others, implementation may take substantially
                          longer than DSB’s 6-year estimate. We did not quantify how much these
                          impediments will reduce DSB’s savings, but consistent with PA&E’s analysis,
                          these factors will mitigate portions of the projected savings.

Legislative Barriers      Although it recommended that essentially all logistics—including material
                          management and depot maintenance, distribution, and other activities—be
                          outsourced, DSB recognized that outsourcing is limited or precluded by
                          various laws and regulations. For example, fundamental to determining
                          whether or not to outsource is the identification of core functions and
                          activities. Section 2464 of title 10 U.S.C. states that DOD activities should
                          maintain the government-owned and government-operated core logistics
                          capability necessary to maintain and repair weapon systems and other
                          military equipment needed to fulfill national strategic and contingency
                          plans.

                          The delineation of core activities has historically proven to be extremely
                          difficult. For example, proponents of increased privatization have
                          questioned the justification for retaining many support activities as core
                          and have recommended revising the core logistics requirement. Section
                          311 of the 1996 DOD Authorization Act directed the Secretary of Defense to
                          develop a comprehensive depot maintenance policy, including a definition
                          of DOD’s required core depot maintenance capability. While DOD has
                          identified a process for determining core depot maintenance capability
                          requirements, it has not completed its evaluation. Moreover, DOD has not
                          developed a process for identifying core requirements for other logistics
                          functions and activities. Thus, core requirements in these areas are also
                          unknown. The 1998 DOD Authorization Act again requires that the
                          Department identify its core depot maintenance requirements, this time
                          under the new provisions described above.



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                        Additionally, 10 U.S.C. 2466 states that no more than 50 percent of the
                        depot maintenance funds made available in a given fiscal year may be
                        spent for depot maintenance conducted by nonfederal personnel. This
                        provision, along with other relevant provisions significantly affects DSB’s
                        savings estimate because about 50 percent of depot maintenance would
                        not be subject to outsourcing.21

                        Section 2469 of title 10 states that DOD-performed depot maintenance and
                        repair workloads valued at not less than $3 million cannot be changed to
                        contractor-performed work without using competitive procedures that
                        include both public and private entities.22 This requirement for
                        public-private competition affects the DSB savings estimate because DSB
                        assumed the requirement would be eliminated. The 1998 DOD
                        Authorization Act also added a new section 2469a to title 10 that affects
                        public-private competitions for certain workloads from closed or realigned
                        installations.

                        Further, during the congressional deliberation on the 1997 DOD
                        Authorization Act, DOD provided Congress a list of statutory encumbrances
                        to outsourcing, including

                    •   10 U.S.C. 2461, which requires studies and reports before converting
                        public workloads to a contractor;
                    •   10 U.S.C. 2465, which prohibits contracts for performance of fire-fighting
                        and security guard functions;
                    •   section 317 of the National Defense Authorization Act for Fiscal Year 1987
                        (P.L. 99-661), which prohibits the Secretary of Defense from contracting
                        for the functions performed at Crane Army Ammunition Activity or
                        McAllister Army Ammunition Plant;
                    •   10 U.S.C. 4532, which requires the Army to have supplies made by
                        factories and arsenals if they can do so economically; and
                    •   10 U.S.C. 2305 (a)(1), which specifies that in preparing for the
                        procurement of property or services, the Secretary of Defense shall
                        specify the agency’s needs and solicit bids or proposals in a manner
                        designed to achieve full and open competition.

Cultural Barriers       DOD officials have repeatedly recognized the importance of using resources
                        for the highest priority operational and investment needs rather than

                        21
                         As described earlier, the 1998 DOD Authorization Act changed the applicable provisions. For
                        example, a new definition of depot maintenance was added in 10 U.S.C. 2460 that together with the
                        amendment to 10 U.S.C. 2464 will impact DOD’s ability to outsource depot maintenance activities.
                        22
                          For these workloads, OMB Circular A-76 does not apply.



                        Page 12                                            GAO/NSIAD-98-48 Outsourcing DOD Logistics
                  B-277816




                  maintaining unneeded property, facilities, and overhead. However, DOD has
                  found that infrastructure reductions, whether through outsourcing or
                  some other means, are difficult and painful because achieving significant
                  cost savings may require up-front investments, the closure of installations,
                  and the elimination of military and civilian jobs. In addition, according to
                  DOD officials, the military services fear that savings achieved from
                  outsourcing would be diverted to support other DOD requirements and may
                  not be available to the outsourcing organization to fund service needs.

                  DSB  recognized DOD’s cultural resistance to outsourcing logistics activities
                  and said that overcoming resistance may take some time. DOD has a
                  tradition of remarkable military achievement but it also has an entrenched
                  culture that resists dramatic changes from well-established patterns of
                  behavior. In 1992, we reported that academic experts and business
                  executives generally agreed that a culture change is a long-term effort that
                  takes at least 5 to 10 years to complete.23 Although a change in DOD’s
                  management culture is underway, continual support of its top managers is
                  critical to successful completion of cultural change.


                  We agree with DSB that there are many opportunities for significant
Conclusions and   reductions in logistics infrastructure costs. However, the Board’s
Recommendations   projected savings are overly optimistic. Further, savings opportunities
                  from consolidating and reengineering must be considered in addition to
                  outsourcing. Even though the Board recognized that there are
                  impediments to outsourcing, PA&E’s and our analyses show that because of
                  such impediments, not all logistics activities can be outsourced. This is
                  particularly true for the legislative barriers—principally, the legislated
                  workload mix between the public and private sectors. Moreover, PA&E’s
                  and our analyses show estimating errors of about $1 billion for contract
                  administration and inventory reductions and another $1 billion for
                  reliability improvements. These combined adjustments will further reduce
                  the Board’s projected savings by another 30 percent.

                  Notwithstanding the problems with DSB’s estimates, DOD’s effort to reduce
                  costs and achieve savings is extremely important, and we encourage DOD
                  to move forward as quickly as possible to develop a realistic and
                  achievable cost-reduction program. As discussed in our high-risk
                  infrastructure report, breaking down cultural resistance to change,
                  overcoming service parochialism, and setting forth a clear framework for a

                  23
                   Organizational Culture: Techniques Companies Use to Perpetuate or Change Beliefs and Values
                  (GAO/NSIAD-92-105, Feb. 27, 1992).



                  Page 13                                          GAO/NSIAD-98-48 Outsourcing DOD Logistics
                      B-277816




                      reduced defense infrastructure are key to effectively implementing
                      savings.

                      To aid in achieving the most savings possible, we recommend that the
                      Secretary of Defense require the development of a detailed
                      implementation plan for improving the efficiency and effectiveness of
                      DOD’s logistics infrastructure, including reengineering, consolidating,
                      outsourcing logistics activities where appropriate, and reducing excess
                      infrastructure. We recommend that the plan establish time frames for
                      identifying and evaluating alternative support options and implementing
                      the most cost-effective solutions and identify required resources, including
                      personnel and funding, for accomplishing the cost-reduction initiatives.
                      We also recommend that DOD present the plan to Congress in much the
                      same way it presented its force structure reductions in the Base Force
                      Plan and the bottom-up review. This would provide Congress a basis to
                      oversee DOD’s plan and would allow the affected parties to see what is
                      going to happen and when.


                      In commenting on a draft of this report (see app. II), DOD said that DSB had
Agency Comments       considered legal barriers to outsourcing and had expressly sought to
                      identify the savings that could result if they were lifted. As noted in the
                      report, we believe it is unlikely that the legal barriers cited would be lifted
                      within the time frame DSB envisioned. DOD said that actions consistent with
                      our recommendation were underway and there was no need for the
                      recommended plan. Specifically, DOD said that the Secretary of Defense
                      was preparing a more detailed plan for implementing the strategy
                      formulated by QDR.

                      Subsequently, on November 12, 1997, the Secretary of Defense announced
                      the publication of the Defense Reform Initiative Report. This report
                      contained the results of the task force on defense reform established as a
                      result of QDR. The task force, which was charged with identifying ways to
                      improve DOD’s organization and procedures, defined a series of initiatives
                      in four major areas:

                  •   reengineering, by adopting modern business practices to achieve
                      world-class standards of performance;
                  •   consolidating, by streamlining organizations to remove redundancy and
                      maximize synergy;
                  •   competing, by applying market mechanisms to improve quality, reduce
                      costs, and respond to customer needs; and



                      Page 14                                 GAO/NSIAD-98-48 Outsourcing DOD Logistics
    B-277816




•   eliminating infrastructure, by reducing excess support structure to free
    resources and focus on competencies.

    This report is a step in the right direction and sets forth certain strategic
    goals and direction. However, the intent of our recommendation was that
    a detailed implementation plan be developed, and we have modified our
    final recommendations accordingly.

    Our scope and methodology are provided in appendix I.


    We are sending copies of this report to interested congressional
    committees; the Secretaries of Defense, the Army, the Navy, and the Air
    Force; the Director of the Office of Management and Budget; and
    interested congressional committees. Copies will be made available to
    others upon request.

    Please contact me at (202) 512-8412 if you or your staff have any questions
    concerning this report. Major contributors to this report were
    James Wiggins, Julia Denman, Hilary Sullivan, and Jeffrey Knott. John
    Brosnan from our Office of General Counsel provided the legal review.




    David R. Warren, Director
    Defense Management Issues




    Page 15                                 GAO/NSIAD-98-48 Outsourcing DOD Logistics
B-277816




List of Requesters

The Honorable James M. Inhofe
Chairman
The Honorable Charles S. Robb
Ranking Minority Member
Subcommittee on Readiness
Committee on Armed Services
United States Senate

The Honorable Neil Abercrombie
The Honorable Saxby Chambliss
The Honorable Tillie K. Fowler
The Honorable James V. Hansen
The Honorable John N. Hostettler
The Honorable Ernest J. Istook
The Honorable Walter B. Jones, Jr.
The Honorable Solomon P. Ortiz
The Honorable Norman Sisisky
The Honorable J.C. Watts, Jr.
House of Representatives




Page 16                              GAO/NSIAD-98-48 Outsourcing DOD Logistics
Page 17   GAO/NSIAD-98-48 Outsourcing DOD Logistics
Contents



Letter                                                                                            1


Appendix I                                                                                       20

Scope and
Methodology
Appendix II                                                                                      22

Comments From the
Department of
Defense
Related GAO Products                                                                             26


Tables                 Table 1: Breakout of DSB Savings Estimates for CONUS Logistics             3
                         Infrastructure
                       Table 2: PA&E’s Revised Estimate of DSB’s Logistics Savings                9




                       Abbreviations

                       CNA       Center for Naval Analyses
                       CONUS     continental United States
                       DOD       Department of Defense
                       DSB       Defense Science Board
                       LMI       Logistics Management Institute
                       PA&E      Program Analysis and Evaluation
                       QDR       Quadrennial Defense Review
                       OSD       Office of the Secretary of Defense


                       Page 18                             GAO/NSIAD-98-48 Outsourcing DOD Logistics
Page 19   GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix I

Scope and Methodology


             The scope of our review was limited to reviewing the Defense Science
             Board’s (DSB) projected $6 billion annual savings for the continental
             United States (CONUS) logistics. To determine the basis of DSB’s savings
             estimate and recommendations, we reviewed the two DSB reports that
             made savings estimates based on outsourcing: Report of the Defense
             Science Board Task Force on Outsourcing and Privatization, August 28,
             1996, and Report of the Defense Science Board 1996 Summer Study on
             Achieving an Innovative Support Structure for 21st Century Military
             Superiority: Higher Performance at Lower Costs, November 1996. We
             discussed the assumptions with task force members and reviewed
             supporting data that was available to us. We requested DSB task force
             minutes pertaining to these studies; however, we did not receive them in
             time to include them in our review.

             We reviewed the Center for Naval Analyses (CNA) studies of public-private
             competitions cited by DSB as well as CNA’s more recent studies and
             discussed those studies with CNA officials. A CNA official said that CNA
             analysts performed limited testing of the computer-generated data they
             had used in analyzing the results from the commercial activity
             competitions. He said that the data was reasonably accurate for the
             purposes of their studies. We did not independently verify the data used in
             CNA’s studies because we did not rely solely on CNA’s studies for our
             conclusions.

             To further evaluate DSB’s savings estimates and recommendations we
             (1) reviewed Program Analysis and Evaluation’s (PA&E) analysis and
             discussed that analysis and conclusions with PA&E officials and
             (2) reviewed the Logistics Management Institute’s (LMI) study, Using
             Technology to Reduce Cost of Ownership, Volume 1: Annotated Briefing
             (LG404RD4, April 1996), and discussed the studies’ assumptions and
             conclusions with LMI officials. In addition, we reviewed our past reports
             and testimony on depot maintenance, public-private competitions, and
             infrastructure reductions.

             To determine other infrastructure savings opportunities for the
             Department of Defense (DOD), we relied on our past reports and testimony
             on commercial “best practices,” public-private competitions, and depot
             maintenance. In addition, we also drew on ongoing work on outsourcing
             practices within the private sector.

             We performed our review at the following locations: Logistics
             Management Institute, Arlington, Va.; DOD’s Office of Maintenance Policy,



             Page 20                               GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix I
Scope and Methodology




Office of Program Analysis and Evaluation; and the Defense Science
Board, Washington, D.C. We also had discussions with officials from the
Center for Naval Analyses, Alexandria, Va.

We conducted our review in July and August 1997, and, except where
noted, in accordance with generally accepted government auditing
standards.




Page 21                              GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix II

Comments From the Department of Defense




              Page 22      GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix II
Comments From the Department of Defense




Page 23                                   GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix II
Comments From the Department of Defense




Page 24                                   GAO/NSIAD-98-48 Outsourcing DOD Logistics
Appendix II
Comments From the Department of Defense




Page 25                                   GAO/NSIAD-98-48 Outsourcing DOD Logistics
Related GAO Products


              Air Force Depot Maintenance: Information on the Cost Effectiveness of
              B-1B and B-52 Support Options (GAO/NSIAD-97-210BR, Sept. 12, 1997).

              Navy Depot Maintenance: Privatizing the Louisville Operations in Place Is
              Not Cost Effective (GAO/NSIAD-97-52, July 31, 1997).

              Defense Depot Maintenance: Challenges Facing DOD in Managing Working
              Capital Funds (GAO/T-NSIAD/AIMD-97-152, May 7, 1997).

              Depot Maintenance: Uncertainties and Challenges DOD Faces in
              Restructuring Its Depot Maintenance Program (GAO/T-NSIAD-97-111, Mar. 18,
              1997) and (GAO/T/NSIAD-112, Apr. 10, 1997).

              Defense Outsourcing: Challenges Facing DOD as It Attempts to Save
              Billions in Infrastructure Costs (GAO/T-NSIAD-97-110, Mar. 12, 1997).

              Navy Ordnance: Analysis of Business Area Price Increases and Financial
              Losses (GAO/AIMD/NSIAD-97-74, Mar. 14, 1997).

              High-Risk Series: Defense Infrastructure (GAO/HR-97-7, Feb. 1997).

              Air Force Depot Maintenance: Privatization-in-Place Plans Are Costly
              While Excess Capacity Exists (GAO/NSIAD-97-13, Dec. 31, 1996).

              Army Depot Maintenance: Privatization Without Further Downsizing
              Increases Costly Excess Capacity (GAO/NSIAD-96-201, Sept. 18, 1996).

              Navy Depot Maintenance: Cost and Savings Issues Related to
              Privatizing-in-Place the Louisville, Kentucky, Depot (GAO/NSIAD-96-202,
              Sept. 18, 1996).

              Defense Depot Maintenance: Commission on Roles and Mission’s
              Privatization Assumptions Are Questionable (GAO/NSIAD-96-161,
              July 15, 1996).

              Defense Depot Maintenance: DOD’s Policy Report Leaves Future Role of
              Depot System Uncertain (GAO/NSIAD-96-165, May 21, 1996).

              Defense Depot Maintenance: More Comprehensive and Consistent
              Workload Data Needed for Decisionmakers (GAO/NSIAD-96-166, May 21, 1996).




              Page 26                                GAO/NSIAD-98-48 Outsourcing DOD Logistics
Related GAO Products




Defense Depot Maintenance: Privatization and the Debate Over the
Public-Private Mix (GAO/T-NSIAD-96-146, Apr. 16, 1996) and (GAO/T-NSIAD-96-148,
Apr. 17, 1996).

Military Bases: Closure and Realignment Savings Are Significant, but Not
Easily Quantified (GAO/NSIAD-96-67, Apr. 8, 1996).

Depot Maintenance: Opportunities to Privatize Repair of Military Engines
(GAO/NSIAD-96-33, Mar. 5, 1996).

Closing Maintenance Depots: Savings, Personnel, and Workload
Redistribution Issues (GAO/NSIAD-96-29, Mar. 4, 1996).

Navy Maintenance: Assessment of the Public-Private Competition Program
for Aviation Maintenance (GAO/NSIAD-96-30, Jan. 22, 1996).

Depot Maintenance: The Navy’s Decision to Stop F/A-18 Repairs at Ogden
Air Logistics Center (GAO/NSIAD-96-31, Dec. 15, 1995).

Military Bases: Case Studies on Selected Bases Closed in 1988 and 1991
(GAO/NSIAD-95-139, Aug. 15, 1995).

Military Base Closure: Analysis of DOD’s Process and Recommendations
for 1995 (GAO/T-NSIAD-95-132, Apr. 17, 1995).

Military Bases: Analysis of DOD’s 1995 Process and Recommendations for
Closure and Realignment (GAO/NSIAD-95-133, Apr. 14, 1995).

Aerospace Guidance and Metrology Center: Cost Growth and Other
Factors Affect Closure and Privatization (GAO/NSIAD-95-60, Dec. 9, 1994).

Navy Maintenance: Assessment of the Public and Private Shipyard
Competition Program (GAO/NSIAD-94-184, May 25, 1994).

Depot Maintenance: Issues in Allocating Workload Between the Public and
Private Sectors (GAO/T-NSIAD-94-161, Apr. 12, 1994).

Depot Maintenance (GAO/NSIAD-93-292R, Sept. 30, 1993).

Depot Maintenance: Issues in Management and Restructuring to Support a
Downsized Military (GAO/T-NSIAD-93-13, May 6, 1993).




Page 27                                  GAO/NSIAD-98-48 Outsourcing DOD Logistics
           Related GAO Products




           Air Logistics Center Indicators (GAO/NSIAD-93-146R, Feb. 25, 1993).

           Defense Force Management: Challenges Facing DOD as It Continues to
           Downsize Its Civilian Workforce (GAO/NSIAD-93-123, Feb. 12, 1993).

           Navy Maintenance: Public-Private Competition for F-14 Aircraft
           Maintenance (GAO/NSIAD-92-143, May 20, 1992).




(709266)   Page 28                                 GAO/NSIAD-98-48 Outsourcing DOD Logistics
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