Uninformed Procurement Decisions for Commercial Products Are Costly

Published by the Government Accountability Office on 1977-10-26.

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

                                  DOCUMENT RE S UE

04139 - [B3014274]

Uniniormed Proclurement Decisions for Commercial Pro6ucts Are
Costly. PSAD-77-170: B-178214. October 26, 1977. 26 pp. + 9
apperLdlces (18 pp).)

iePort to the Congress; by Robert F. gellez, Acting Comptroller

Issui    Area: Federal Procurement of Goods and Services (1900).
Ccntact: Procurement and Systems Acquisition Div.
Budqct Function: General Government: General Property and
      Fecords Management (304); Naticnal Defense: Department of
      Defense - Procurement & Contracts (058).
Orqanization Concerned: Department of Defense: General Services
      Administration; Veterans Administration; Cffic-e of
      .anaqemelt and Budget: Office of federal   Procurement Policy;
      Detense Loqistics   Agency.
Corqressional Reievance: House Committee on Are6d Services;
      Senate Comm.itee on Armed Services; Congreas.
Authority: Foreign Hilitary Sales Act of 1968, as amended (P.L.
      94-329).   =-fense Production Act. Strategic and Critical
       .aterials Stockpiling Act of 1939. P.L, 91-129. P.L. 93-400.

         Federal Government expenditures icr ccmmercial Ercducts
will command a sizable portion of the $66 billi,_n estimated for
~ederal procurement in fiscal    year (EY) 107/. Although the
Government is usuaily  able   to buy prcducts at a lowei unit price
if purchased ior       stock in    large volume, the use of commercial
distLibution channels is frequently mor.                advantageous.      The
Commissron on Government Procurement              recomaended      in   1972 that,
in making procurement and stockaqe dccisiors, the Defense
.oqistrcs agency (DLA) , General Services Administration {GSA),
and thi Veterans Administration (VA,, should consider the full
cost of any Government distribution system invclved. These tiree
aqtncies are the Government's primary supply agencies; during FY
1975, they     spent about $8. 1 billicn cn commercial              and
commnercial-type supplies and had an ending inventory valued at
about 4.1 billion.   Findings/Conclusions: Many itcas purchased,
stocked, and distributed by these supply agencies are seldom, if
ever,   in   demand.   During 1975,      37% of the 1.4 million items
stocked by DLA were not requested. For another 28% cf the items,
annual requisitions         totaled    less    than $17 each. Purchasing,
stocking, and disposing cf seldom-used items is costly.                         From FY
1971 to 1975, DLA scrapped $658 million worth of new but
o bsolete goods at a loss           of from 92% tc 95ยง          of the original
purchase     price.    Money    may  have   been     saved   if  the items had been
oDtained      tarouqgi  the   commercial     distribution        system.   Hcuever,
tn-     supply ag.ncies, particularly            GSA and DLI, have -een
reluctant       to develop and/or use cost data necessary.Ato evaluate
 wilcni method of procurement and distribution                   would be mcre
effective.       Tht VA has developed and is              using cost data, but some
improvements are needed in its              system to make sure all           cost
elements are considered. Policy of the Office cf Procurement
Policy requires agencies to use commercial distr&tutior c.hannels
unless it is cost effective to do otherwise.   _Qece"erQ.da ions:
Tha Administrator of GSA should complete the develacment of full
cos.t information and use this informetion to Paie*ecost effective
procurement decisions. The Secretary of Defense should require
the Directsr of DLI to do the same. The AdainiFtrator of
%eterans Affairs should act to improve the agency's full ccst
information and increase its effectiveness in ueking procu-ement
decisions. (Author/SW)

.- $7,;;OF        THE UNITED STATES

              Uninformed Procurement
              Decisions For Commercial
              Products Are Costly

              The Defense Logistics Agency, General Ser-
              vices Administration, and, to a lesser extent,
              the Veterans Administration do not consider
             all costs when deciding how to procure com-
              mon commercial items. For this reason these
             agencies have chosen to procure, stock, and
             distribute goods themselves rather than to
             buy them commercially. However, often it is
             more economical to use commercial distribu-
             tion channels to supply products directly to
             The Defense Logistics Agency and General
             Services Administration should develop in-
             formation on all costs to enable them to
             make the best procurement decisions. The
             Veterans Administration should improve its
             cost information to make more cost-effective
             procurement decisions.

             PSAD-77-170                                       OCTOBER 26, 1977
                         WASHINGTON, D.C.   20548


To the President of the Senate and the
Speaker of the House of Representatives

     Tnis report deals with the need for Federal agencies to
consider full costs in making procurement and stockage deci-
sions recommended by the Commission on Government Procurement.

     We made our review because Federal agencies have made
little progress in implementing the Commission's recommenda-

     We made our review pursuant to the Budget and Accounting
Act, 1921 (31 U.S.C. 53), and the Accounting and Auditing Act
of 1950 (31 U.S.C. 67).

     We are sending copies of this report to the Directors,
Office of Management and Budget and Office of Federal Procure-
ment Policy; the Administrators of General Services and
Veterans Affairs; and the Secretary of Defense.

                           ACTING Comptroller General
                                  of the United states
                                          PRODUCTS ARE COSTLY

              During fiscal year 1975, the Government's
              three primary supply agencies--the Defense
              Logistics Agency, General Services Adminis-
              tration, and Veterans Administration--spent
              about $8.1 billion on commercial and
              commercial-type supplies and had an ending
              inventory valued at about $4.1 billion.
              Commercial items include food, hardware,
              office furniture, and automotive supplies.
              Commercial-type items are those sold com-
              mercially that have been tailored to meet
              Government specifications, for example,
              Army pup tents.
              Many items purchased, stocked, and distrib-
              uted by these supply agencies are seldom,
              if ever, in demand. During 1975, 37 percent
              of the 1.4 million items stocked by the De-
              fense Logistics Agency were not requested.
              For another 28 percent of the items, annual
              requisitions totaled less than $17 each.

              Purchasing, stocking, and disposing of
              seldom-used items is costly. From fiscal
              years 1971 to 1375, the Defense Logistics
              Agency scrapped $658 million worth of new but
              obsolete goods at a loss of from 92 to 95
              percent of their original purchase price.
              In many of these cases, it would have saved
              money if the supply agencies had never
              stocked the item but had simply arranged for
              agencies using the items to get them through
              the commercial distribution system. However,
              the supply agencies, particularly General
              Services and Defense Logistics, have been
              reluctant to develop and/or use cost data
              necessary to ev3luate which method of procure-
              ment and distribution would be more effec-
              This problem is not new. GAO reports for the
              past 13 years have shown that the supply
              agencies have had problems in stocking and
              managing inventories. GAO as well as the
              Commission on Government Procurement have
t"   sht. Upon removal, the report
cover   te should be noted hereon.i
 recommended that interagency supply activities
 should consider all operating costs when decid-
 ing whether to purchase and stock an item in
 their warehouses.

 Defense Logistics has not acted on this recom-
 mendation because it believes that using data
 on all costs would lead to decisions favoring
 the commercial distribution system. The Agency
 believes that the commercial distribution sys-
 tem cannot meet many of its military require-

GAO questions this position, since Defense
Logistics agrees that the Defense Procurement
Act and Strategic and Critical Materials
Stockpiling Act provide adequate legislative
authority for the Depa::tment of Defense to
obtain needed supplies and equipment in times
of emergency.   In addition, only a small per-
centage of the items the Agency stocks are
designated as needed to support critical mil-
itary programs.

Although General Services agrees with the
recommendation to compare all costs, it is
not using the concept.  General Services did
test a full cost disclosure system, but offi-
cials describe their work on the system as
only exploratory.  Accordingly, the project
has received low priority for staffing and
funds, and General Services data base has
not been updated since 1973.  General Serv-
ices is again developing a system to dis-
close all costs which should be finished in

The Veterans Administration has developed
and is using cost data, but some improve-
ments are needed in its system to make sure
all cost elements are considered.

In May 1976 the Office of Federal Procure-
ment Policy issued a policy statement requir-
ing Government supply agencies to use commer-
cial distribution channels to supply commer-
cial products to users.  When the supply
agencies cannot prove that stocking and dis-
tributing items themselves is more econom-
ical, they must use commercial distribution
channels.  If the policy is used effectively,

              it will reduce the (1) number of slow-movilg
              items in supply inventories and (2) millions
              lost each year through obsolescence.
              This policy should be carried out aggres-
              sively, and the supply agencies should begin
              using cost data to help them Adentify items
              that need to be kept in stock. To determine
              cost effectiveness the supply agencies need
              to consider total costs of procuring and
              stocking goods versus the costs of using the
              commercial distribution system. In GAO's
              opinion, cost data is available to use in
              making a feasible cost analysis.
              The Defense Logistics' Agency, General Serv-
              ices, and Veterans Administration should,
              with some exceptions, place and/or keep
              in their warehouses only those commercial
              items they can justify on the basis of
              economy to the Government.   (See ch. 4.)
              To do this, the agencies should act promptly
              to use full cost data.

              The Office of Federal Procurement Policy
              agrees with GAO's recommendation. General
              Services and Veterans Administration also
              agree with GAO's recommendation and are
              beginning to gather essential cost data from
              their accounting systems. Although during
              GAO's review Defense Logistics objected to
              using full cost data, it now agrees with the

                             C on tents

DIGEST                                                      i
      1     INTRODUCTION                                1
                Scope of review                         2
             DECISIONS                                  3
               Full cost considerations could
                 limit uneconomical procurement
                 practices                              4
               Role of the Office of Federal
                 Procurement Policy                     5
               Conclusion                               6
               Veterans Administration                  7
               Effect on stockage decisions             9
               Conclusion                              11
               Defense Logistics Agency                11
               Determining the most economical
                 method of supply                      12
               Cost data will improve management of
                 foreign military sales                15
               Conclusion                              16
  4        REASONS FOR DELAY                           17
               Defense Logistics Agency                17
               Conclusions on DLA's
                  reasons for delay                    21
               General Services Administration         21
               Conclusions on GSA's use of full
                 cost disclosure system                24
               Recommendations                         24
  5        AGENCY COMMENTS                             25

  I        Prior GAO reports that have shown a
             need for developing and using full cost
             data in managing inventories              27
 II        Sample format of VA supply determination
             sheet                                     32
APPENDIX                                                 Pag_
 III       List of DLA items determined by GAO
             to be more economical if stocked and
             distributed thruugh DLA's depot              33
     IV    List of DLA's items determined by
             GAO to be more economical to use com-
             mercial distribution systems                 34
      V    Letter dated April 24, 1977, from the Ad-
             ministrator, Office of Federal Procure-
             ment Policy                                  35
     VI    Letter dated March 3, 1977, from the
             Acting Assistant Secretary of Defense
             (Installations and Logistics)                37
 VII       Letter dated February 23, 1977, from
             the Acting Administrator of General
             Services                                     38
VIII       Letter dated February 2, 1977, from the Ad-
             ministrator of Veterans Affairs              41
     IX    Principal officials responsible for
             matters discussed in this report             43
DLA        Defense Logistics Agency
DOD        Department of Defense
FMS        foreign military sales
FSS        Federal Supply Service
GAO        General Accounting Office
GSA        General Services Administration
OFPP       Office of Federal Procurement Policy
OMB        Office of Mangement and Budget
VA         Veterans Administration
                           CHAPTER i

      Federal Government expenditures for commercial and
 c-nmercial-type products will command a sizable portion of
 the $66 billion estimated for Federal procurement in fiscal
 year 1977. In addition to these expenditures, extensive
 costs are associated with requirement and specification de-
 velopment, purchasing and contracting, warehouse operations,
 transportation, distribution, administrative handling, and
 inventory investment.
      Many commercial produc:s are used in various agency and
interagency supply support programs. The agencies respon-
sible for most of this support are the Defense Logistics
Agency (DLA), General Services Admi; istration (GSA), and
Veterans Administration (VA). In fiscal year 1975, these
agencies spent about $8.1 billion for commercial and
commercial-type products and had about $4.1 billion in in-
ventory as of June 30, 1975. The Office of Federal Procure-
ment Pclicy (OFPP) within the Office of Management and  Bud-
get (jNB) directs overall Federal procurement policy and
prescribes Government-wide procurement policies and regula.

     This report deals with procurement policy decisions
affecting interagency supply support, discusses alterna-
tives that ma: be useful in eliminating some uneconomical
consequence} of current policies, and focuses on the pro-
curement an;: inventory management operation of DLA, GSA,
and VA.

      In 1969 the Commission on Government Procurement was
created by Public Law 91-129 to study and recommend procure-
ment methods that would pr,)mote economy, efficiency, and
effectiveness in executive branch purchase decisions. The
Commission sent its final report to the Congress in Decem-
ber 1972. In that report, the Commission said the purpose
of the Government's procurement system should be to provide
users with required goods and seLrices in the most
and economical way. The Commission concluded that efficient
ernment's current purchase and supply policies did not Gov-
essarily meet this end because they overemphasize purchase
prices. As such, administration, warehousing, and other
associated overhead costs were often not included when
supply agencies decided how best to provide a commercial
product 'o Government users.

     Although the GoveLnment is usually able to buy
ucts at a lower unit price if purchased for stock in prod-

volume, considering the full costs of stockage and
distribution frequently discloses that using commercial dis-
tribution channels is more advantageous. The Commission rec-
ommended that in making procurement and stockage decisions
DLA, GSA, and VA should consider the full cost of any Govern-
ment distribution system involved.

     During the review we (1) identified the progress that
DLA, GSA, and VA have made in using full cost information in
procurement decisions, (2) analyzed the reasons why full
cost information has not been developed and used in procure-
ment decisions as recommended by the Procurement Commission,
and (3) identified potential benefits that would accrue to
these agencies if full cost information were used in the prc-
curement decision process. This work was done at DLA head-
quarters, Alexandria, Virginia; GSA's Federal Supply Service
headquarters, Alexandria, Virginia, and VA headquarters in
Washington, D.C. We also visited field locations of these
agencies including DLA's Construction Supply Center, Colum-
bus, Ohio; Do-.'s Electronics Supply Center, Dayton, Ohio;
Fort Knox, Kentucky; Wright Patterson Air Force Base, Day-
ton Ohio; Naval Aerospace and Regional Medical Center, Pen-
sacola, Florida; Naval Weapons Station, Concord, California;
and VA's Marketin] Center, Hines, Illinois. Our review
covered the perioc January 1975 through December 1976.

                                                   CHAPTER 2
                                  FULL COST CONSIDERATIONS
                                  IN PROCUREMENT DECISIONS
     There are basically three ways DLA, GSA, and VA can
satisfy a 'user's needs: (1) provide all supply services,
including centrally managing, buying, stocking, and distrib-
uting needed items, (2) manage and buy needed items
but let the commercial sector distribute directly to centrally
and (3) let individual users buy the items directly without
help from the interagency supply activity.

     The full cost of providing a supply item to a Govern-
ment user under these three options includes the price paid
for the item and its allocated share of support cost of the
system used to acquire and deliver it. The elements of full
cost discussed in this report are:

                                         ELEMENTS OF FULL COST

     THIS               PRICE PAID TO SUPPLIER                -                 _ --       $   $-   -

                                             STORAGE                                       I
                COVERNMENT                   DELIVERY              S
                COSTS                /HANDLINC                     $        S          _
                                             ADMINISTRATIVE                 $              J

                  i_                 A
                           EQUALTHIS     )                        FULL COST AT POINT OF USE


     At the interagency supply level, these costs include
those relating to requirements determination, order proc-
essing, procurement, item cost, Transportation, receiving
and storage, invoice and payment processing, credit returns,
repackaging, distribution, inspection and quality control,
and disposal of obsolete and excess stock. Also included
are indirect costs associated with personnel support, de-
preciation, and interest on investment in cash, receivables,
inventory, and real and personal property.

     VA includes most of the full cost elements in its
procurement process and makes procurement decisions that
approximate the full cost alternative recommended by the
Commission, but DLA and GSA do not. For example, DLA does
-n-1consider personnel support costs or the cost of dispos-
ing of obsolete stock when deciding how best to satisfy a
user's needs for a commercial product.

     DLA and GSA have not developed the data and techniques
needed to measure the total cost of fulfilling users' needs
for supply items. Personnel and other full cost elements
are funded by direct appropriation. Thus, from a funding
standpoint, there has been no need to develop a system that
would consider these appropriated costs when making supply
fund decisions. These appropriations are significant--
$822 million for DLA and $113 million for GSA in fiscal year
1975. Approximately 70 percent of these amounts are incurred
in managing the item and 0 percent in warehousing and re-
lated costs.

     To compare prices between the use of commercial and
Government interagency supply activities, the Procurement
Commission noted that DLA and GSA must incorporate appropri-
ated costs in their procurement `ecision processes.

     We believe that if full cost data were used in making
procurement decisions, it would reduce the number of inactive
and slow-moving items in DLA's and GSA's inventories and re-
duce losses stemming from inventory obsolescence. Our re-
ports for the past 13 years have shown that DLA and GSA have
had problems in stocking and managing inventories. For ex-
ample, in 1963 we reported 1/ that Department of Defense
(DOD) activities, including DLA, did not consider the commer-
cial off-the-shelf nature of an item or the cost of central
management and distribution in their procurement and ware-
housing decisions. The report cited hundreds of thousands
of slow-moving items in DOD's inventory that were readily
available from commercial sources and pointed out that many
of these items could be managed centrally for direct deliv-
ery to users. The report concluded that this approach would
-educe supply inventories by about $275 million.

1/B-146828, "Uneconomical Management of Commercially Avail-
  able Items," November 29, 1963.

     Our followup reviews in 1967 and 1971 showed that DLA's
supply system still included sizable inventories of commer-
cially available slow-moving items that were unnecessarily
costing taxpayers millions of dollars. The 1971 report, for
example, stated that DOD estimated its supply system included
about 800,000 inactive items that might warrant elimination.

     During this period DLA tried to eliminate slow-moving
items under a variety of managemernt programs, such as the
Defense Inactive Item Progra... Although DLA has improved
its inventory mangement system, many problems have persisted
because it has ov'eremphasized its warehousing operations.
This has caused many commercially available items to be
supplied unnecessarily. For example, during 1975 the dollar
volume of requisitions for about 624,500 items, or 75 per-
cent of those demanded, totaled less than $400 per item.
Another 524.000 items of the 1.4 mil-lon in stock had not
been requisitioned at all.

     DLA cost studies show that obsolete items are the lead-
ing contributor to annual inventory carrying costs. Obso-
lete items are those removed from inventory because of
technology changes or reduced use. As of March 1976 there
were about 92,000 obsolete supply items in DLA's inventory
system awaiting disposal.

      Purchasing, stocking, and disposing of supply items
that are never used is expensive. For example, from fiscal
year 1971 to 1975 DrTA disposed of $658 million in obsclete
inventory. DLA property disposal officials said that the
Government is able to recover only 5 to 8 percent of the
original cost of this stock through sales or use by other
agencies. GSA has a similar situation with its inventory
items. During fiscal years 1971 to 1975, GSA disposed of
obsolete stock worth about $31 million and recovered only
$1 million for it.
     Many items DLA and GSA manage and stock are readily
available from commercial firms at batter full cost prices
than those DLA and GSA charge.  If DLA and GSA quit stocking
these items, they could reduce their investment in inven-
tories by millions of dollars and lessen the chances of
accumulating large amounts of obsolete inventory.
     in response to the Procurement Commission's first rec-
ommendation, Public Law 93-400 created the Office of Fed-
eral Procurement Policy (OFPP) within the Office of Manage-
mert and Budget. It began operations oni December 31, 1974.

     One of OFPP's responsibilities is to establish positions
on many of the Procurement Commission's recommendations and
to issue guidelines for implementing these positions.  OFPP
has issued a policy requiring Government supply agencies to
use commercial distribution channels to supply commercial
products unless it is cost effective to do otherwise.

     OFPP implementing guidelines require the supply agen-
cies to use full cost comparisons to demonstrate that in-
house warehousing and distribution is economically justified
before items are purchased and stocked.  As such, the supply
agencies will need to apply reasonable, meaningful, and use-
ful cost data in complying with the economic analysis por-
tions of OFPP's instructions implementing its policy.

     OFPP officials said that the policy is designed to limit
development and that use of Government-unique items and to
emphasize the need for Government supply agencies to rely
more on commercial off-the-shelf products.


     We believe that the OFPP policy should be implemented
aggressively and the supply agencies should develop reason-
able, meaningful, and useful cost data to aid them in iden-
Lifying those items that should be stocked.

     We have reported on unnecessary stockage of items for
tne past 13 years.  In each instance, the agency involved
arceed to solve the problem cited.   In our opinion, a major
reason that these problems still exist is the lack of a good
management system to develop and use adequate cost data in
the decisionmaking process.

     We ha\% also reported on other ways in which cost data
would help supply agencies more effectively manage inter-
agency supply activities.   Topics include fund management,
stockage criteria, and advanced inventory management tech-
niques.  Summaries of these reports and action promised
are included in appendix I.

                          CHAPTER 3
     The use of cost data to approximate the full cost of
procurement and supply decisions is, i, our opinion, fea-
sible. At VA and DLA we used existing accounting data
to identify such costs as purchase price, transportation,
and total overhead for each agency. An overhead rate was
computed for comparison and applied to individual items.
Although not completely refined, we feel this data pro-
vided a reasonably sound basis for making procurement and
stockage decisions.
     The purpose of our analysis at VA and DLA was to
demonstrate that the full-cost concept can be applied in
an operational environment without developing a costly,
complex cost accumulation system. Details on the meth-
odology used and the results at VA and DLA follow.

     VA finances all supply operations through a revolving
supply fund. The agency charges customers a percentage
markup in addition to the item's purchase price. The mark-
up, which is currently between 6 and 15 percent (depending
on the items), is used by VA's Marketing Center to balance
the VA supply fund. The markup recovers out-of-pocket
costs, such as personnel, transportation, and other operat-
ing expenses.

     The central purchase functions of VA's supply service
are done by the VA Marketing Center, Hines, Illinois. The
Marketing Center supports 235 VA stations, such as hospi-
tals, clinics, and medical centers throughout the Nation.
Items stored in the three VA depots are available to VA
stations on request. For certain other items not stored
in the depots, the Marketing Center contracts with sup-
p]iers so that stations can order items for direct delivery.
VA stations can also order items foom GSA depots, suppliers
under Federal Supply Schedules, other Government sources,
and local suppliers.

     In fiscal year 1975 VA hospitals purchased about $590
million worth of goods and nonpersonal services. The Market-
ing Center contracted for about $152 million of these
goods and services, and the remaining $438 million was pur-
chased locally by the hospitals without help from Market-
ing Center personnel.

     Some cost elements, such as depreciation and an imputed
rate of return on investment, are not included in the VA
markup. Partly to consider these costs in purchase deci-
sions, VA has established minimum savings criteria which
it uses to decide when an item should be entered in the
supply system or stocked in the warehouse.
      In this decision process VA uses a form called method
of supply determination sheet.   (See app. II.)  Basically,
the commercial cost of the item is solicited from vendors
who quote a price based on VA's estimated annual demand.
This quote is compared to the price VA is currently paying
for the item plus a markup of from 6 to 15 percent to
recover operating expenses. The difference between the
commercial price and VA's cost including the markup must
exceed an established percentage which VA calls its mini-
mum savings criteria. If the minimum savings criteria is
met, the item will be stocked. The process is also ap-
plied to items already stocked when VA wants to see if an
items should be kept in the system.

     This use of the minimum savings criteria in addition
to the basic VA markup closely approximates full cost even
though not all cost elements are included. To identify
the effect of not including these elements, we calculated
costs by major commodity groups and found that they differ
from the VA criteria as shown in the following table.

                          VA minimum
                           savings                      Our
       Major               criteria                 calculated
     commodity             combined                 full cost
       group              with markup                 markup
Medical supplies              15                        17
  medical supplies         17 to 22                    18
    Frozen meat           15 to 16                     15
    Frozen other          24 to 25                     39
    Nonperishable         16 to 17                     23
Drugs end chemicals          16                         8
     We developed the comparison figures by using data
available in the present VA cost-accounting system. Costs
of the depot warehouse proqLam were allocated by using

data in a VA Marketing Center time study. Investment costs
were based on a rate of 10 percent 1/ as specified by OMB.
These investment costs were applied to actual inventory
values and proportionate parts of cash, accounts receivable,
and personnel and real property. Depreciation charges were
based on data from the "Report of the Commission on Govern-
ment Procurement." We allocated other costs using avail-
able information, such as number of purchase orders and
depot line items.
     The use of the minimum savings criteria in addition
to the basic VA markup produces good stockage decisions for
most items. For example, most medical supplies are centrally
bought, stocked, and distributed at significant savings.
Centrally stocking drugs and chemicals is also more economical.
Examples are shown in the following table.

                           Depot     Savings or      price     Savings or
                Commer-    price     loss (-)     with our     loss (-)
                 cial     with VA      over       full cost      over
 Commodity       cost      markup    commercial     markup    commercial

  (pair)        $8.70     $3.37         $5.33      $3.69        $5.01

Wood tonque
  depressor      2.06      1.07           .99       1.17          .89

Surgical ad-
  hesive tape    6.78      3.23          3.55       3.53         3.25

  tablet        49.50     28.36         21.14      28.62        20.88

 oral sus-
  pension        1.78       .77          1.01        .78         1.00

  tablets       41.60     29.51         12.09      29.79        11.81

1/Although the rate used in this report is frcm OMB Circular
  A-94, dated March 27, 1972, a more appropriate rate would
  have been based on the average yield of U.S. Treasury
  long-term bonds.

     However, there are other commodities where the use of
full cost data could lead to a better stockage decision.
For example, we reviewed the VA Marketing Center's method
of supply studies for frozen food items in the depot ware-
house program and compared the savings to the Government
using the current markups with our full cost markups. The
results are shown in the following table.

                                    Savings  Depot    Savings
                             Depot     or    price      or
                             price loss(-) with GAO   loss(-)
                   Commer-    with    over    full     over
    Commod-         cial       VA    commer-  cost    commer-
      ity           cost     markup    ial   markup    cial
Frozen meat:
    Beefsteak    $1.66/lb    $1.57   $0.09   $1.71    $-0.05
    Pork chops    2.22/lb     2.20     .02    2.40      -.18
      beef        3.64/lb     3.45     .19    3.76      -. 12
Frozen other:
      pie        9.00/case    8.83     .17   10.64     -1.64
    Peach pie    8.00/case   8.00      -      9.64     -1.64
     As demonstrated, the Marketing Center's frozen food
program has items that would not be stocked if all VA cost
elements had been compared with commercial costs. At the time
of our review, there were 64 items in the program--21 meat and
poultry and 43 other frozen foods, such as pies, juices, and
vegetables.  VA distributes these products by renting freezer
space ac eight commercial warehouses to service its hospitals
in various geographic locations.

     The Marketing Center uses a markup of 6 percent for
frozen meat and 15 percent for other frozen food. If all
costs associated with the operation of this program were
considered, the VA markups would have 15 percent for meat
and 39 percent for other frozen foods. However, these mark-
ups are subject to changes depending on various economic
conditions at any given tincl. We estimate that the frozen
food program lost about $150,000 in fiscal year 1975. Be-
cause the supply fund operates on a break-even basis, the
loss on the frozen food program is being subsidized by other
supply divisions and other activities of the supply fund.


     By using minimum savings criteria, in addition to a
basic markup, in many cases VA has found it more economical
to use commercial distribution systems than to stock and
distribute items to VA hospitals. For example, VA centrally
buys, stocks, and distributes only about 10 percent of its
total supply items, as opposed to DLA which does the same
for about 73 percent of its supply items. Even though VA's
method does not include all elements of full costs, it is
sufficiently accurate to support reasonable decisions.
Minor refinements could enable VA to use the commercial
distribution system even more.

      DLA provides integrated logistics support to the mili-
tary services and to various civil agencies of the Federal
Government. DLA manages consumable common-use, commercial-
type supply items--such as bathroom plumbing fixtures,
circuit breakers, electrical lamps, chain and wife rope,
and X-ray equipment--which constitute 49 percent of the
total items in the DOD supply system. Its supply centers
stock about 1.4 million different items valued at $3.6 bil-

     DLA's stocked inventories are mostly low-value items
that are seldom requisitioned. During fiscal year 1975 about
614,640 items had annual demands amounting to less than
$400. Another 518,350 items had not been requisitioned
at all. The data for four supply centers follows.

                                             Items :ith some demands
                         No-demand items             Low-value items
Supply         Tocal               per-                       per-
center        stocked     number   cent       Total   number   cent
  tion         229,929      90,649    39.4   139,280    94,560   67.9
  ics          532,677     225,775    42.4   306,902   241,876   78.8
General        125,449      42,246    33.7    83,203    53,575   64.4
  trial        436,438     159,680    36.6   276,758   224,629   81.2
    (note a) 1,324,493     518,350    29.1   806,143   614,640   76.3
a/Statistics were obtained from DLA's summary fractionation re-
  port for 1975.


      The most advantageous benefit of full
                                            cost data is the
savings available to the Government in selecting
ply method with the lowest overall costs. DLA's the sup-
purchase criteria, however, favor stocking items present
ernment warehouses. For example, 73 percent       in Gov-
it manages are centrally stocked. Commercial of  all items
or distribution costs are not considered in deciding
whether users will order items through DLA for
livery from commercial sources or requisition direct de-
                                               them from in-
teragency warehouses.

     To apply full cost to items stocked by DLA,
                                                   we selected
a random sample of 70 items at the Defense Electronics
ply Center in Dayton, Ohio, and 139 items at              Sup-
Construction Supply Center in Columbus, Ohio. the  Defense
DLA's cost to supply the sampled items (purchaseWe compared
total operating costs) with what suppliers said price plus
cost to deliver the same item to the military     it would
quantity normally ordered.                     user  in the

     In making this comparison, we used the number
DLA issued annually. The direct price to the       of units
based on the contractor's quote for the quantity   was
user normally ordered. DLA's price was established      the
ing the normal selling price and applying the        by tak-
puted for total operating costs.              factor  ccm-

      To estimate total operating costs, we used the
computed by the Commission on Government Procurement. estimate
1972 the Commission estimated that it cost DLA           In
                                                about $64 to
purchase and distribute $100 worth of stock
grams. The Commission arrived at this figurein depot pro-
                                               by determining
total DLA operating costs for fiscal year 1971
lion), divided by total DLA sales for the same ($1.1 bil-
billion). The operating costs can be broken     period ($1.7
                                              down into
categories of

    -- program costs,
    -- storage,

    -- transportation,
    --annual unfunded inventory costs, and

    -- inventory losses and adjustments including
       economic loss through obsolescence.

     As shown above, in fiscal year 1971, the Commission
estimated DLA's operating costs to be about $1.1 billion.
This figure consists of $0.7 billion in actual expenditures
and $0.4 billion in noncash costs, such as unfunded invest-
ment costs, econonic loss through obsolescence, and
adjustments.                                        inventory

     In our opinion, the Commission's 1972 estimate
cost to purchase and distribute $100 worth of stock on the
                                                    in the
depot is still valid, as the following table illustrates.

                             Fiscal year               Fiscal year
      Category                  1971                      1975
Actual expenditures               $0.7                    $0.8
Noncash costs (note a)             0.4                     0.5
    Total operating costs          1.1                    1.3
Total stock sales                 $1.7                   $1.9
Percent of total
  operating costs to sales         64                     68
a/For noncash costs, such as unfunded investment costs,
  econonic loss through obsolescence, and inventory
  ments, we are assuming that the percentage relationship
  sales would be approximately the same in 1975 as it     to
                                                      was in
Central stockage cost effective

     Our analysis showed that DLA could economically
stocking 58 of the 139 commercially available items justify
                                                     at a
total annual savings of $22,333. For example:

    -- Pipe plug (NSN 4730-00-222-9637) had an annual demand
       of 1,9i6 units during the previous 12 months. A sup-
       plier said that he could furnish the item to Govern-
       ment users within 30 days after receipt of an order.
       Delivery price quoted by the supplier was $5.95.
       price, including total operating costs, was $1.15. DLA's
       By stocking the item, DLA saved the Government $7,998.
    --Piece thread (NSN 4730-00-594-1637) had an annual
      mand of 1,875 units during the previous 12 months.
      A supplier said that he could furnish the item to
      ernment users within 30 days after receipt of an
      order. Delivery price quoted by the supplier was

       $4.51.  DLA's price, including total operatir.g costs,
       was $1.74.  By stocking the item, DLA saved the Gov-
       ernment $3,236.

     See appendix III for further details on the 58 items.
Commercial distribution systen    t effective
     For the other 81 items of the 139 sampled, DLA could
have saved $23,745 annually if it had used the commercial dis-
tribution system to satisfy user needs. For example:
     -- Shutoff ock (NSN 4820-30-254-8637). As of May 5,
        1975, 628 units with a DLA standard price of $2.24
        each were stocked in the Defense Construction
        Supply Center's inventory. The item had demands of
        4i1 units during the previous 12 months. Four sup-
        Fliers said that they could furnish this item to
        government users within 30 days after receipt of
        an order. Delivery price quoted by the suppliers
        ranged from $0.75 to $2.07. If DLA personnel had
        compared the full cost o r Delivering 431 of the
        items to individual users at the vendor's price of
        $0.75 with DLA's price of $2.24, they could have
        saved the Government $1,221.45 by asking suppliers to
        furnish the item directly to users. The lower price
        accounted for $642.19 of the savings and the remain-
        ing $579.26 represented the additional overhead it
        cost DLA to manage and distribute the item from its

     --Wearing ring (NSN 2930-00-469-9841). As of May 5,
       1975, the standard unit price charged by DLA wis
       $6.60. The item had demands of 63 units during the
       previous 12 months. Four commercial suppliers said
       that they could furnish this item to Government users
       within 10 days after receipt of an order at a price
       that ranged from $5.25 to $7.20. Comparison of the
       full cost of delivering 63 of the items to users at
       the vendor's price of $5.25 to DLA's price of $6.60
       showed that the Defense Construction Supply Center
       could save the Government $334.53 annually if sup-.
       pliers furnished the item directly to individual
       users. A better price to users accounts for $85.05
       of the savings, whereas the remaining $249.43
       represents additional costs of DLA's inventory
       operations that could be avoided.

     See appendix IV for further details on the 81 items.

     Regarding use of the commercial distribution system,
our report entitled "Greater Use cf Commercial Distribution
Systems for Minor Low-Use Supply Items Can Reduce Defense
Logistics Costs" (LCD-76-422, August 9, 1976) pointed out
that if DLA relied more on the commercial distribution sys-
tem it could reduce operating costs at two of its supply
centers by about $17 million and inventory investment by
about $100 million.
     In addition to the benefits of considering full costs
in making procurement decisions, full cost data would im-
prove the management of our foreign military sales program.
Over the past decade, increased public and congressional
attention has focused on U.S. foreign military sales (FMS).
From a comparatively modest billion dollar program in fis-
cal year 1967, foreign sales orders grew to over $10 billion
in fiscal year 1975.
     Full cost recovery of FMS is authorized by legisla-
tion. The Foreign Military Sales Act of 168, as amended by
Public Law 94-329, dated June 30, 1976, :equires the !i.S
Government to recover "* * * not less than the actua      e
thereof * * * or * * * the estimated cost of replace          *   *"
for goods and services sold to eligible countries or    er-
national organizations.
     DLA manages common commercial-type supply items that
usually have a recognized market value. Many of these items
are purchased by foreign governments, which raises a ques-
tion of whether DLA's surcharge is suificient to recover the
full estimated costs of (1) administering the FMS program
and (2) using DLA's plant and production equipnment.

     Generally, DOD's policy is to apply a surcharge to
the price of contractual services and materials sold to
foreign governments to recover administrative costs. The
rate of the surcharge depends on the contractual arrange-
ment. In supply support arrangements an administrative charge
of 5 percent is supposed to be added, while the administr:-
tive charge for material and services is 2 percent.

     In 1972 the Commission on Coverrment Procurement stated
that the cost of support activities by agencies such as
DLA was expensive and that they should consider all the
costs associated with their business if sound economical
policies and decisions were to be made concerning the

customers using the system. As previously noted, the
Commission reported that DLA spent $64 to purchase and
distribute each $100 worth of stock in depot programs.
     Therefore, on the average DLA   is spendinq about $60 more
per $100 worth of material sold in   the FMS program than it
is authorized to collect back from   FMS customers.  Consider-
ing the fact that DLA sales in the   FMS program for fiscal
year 1975 were $112 million, it is   possible that DLA is not
recovering about $67 million worth   of overhead directly in-
curred from this program.

     Using full cost data would help DLA actually determine
the costs of supporting, at arms-length, business such as
the FMS program. This would allow DSA to comply with Public
Law 94-329, which requires that it include appropriate charges
for administrative services and the use of plant and produc-
tion equipment in the amount charged for goods and services
offered for sale to eligible countries and international

     We believe that the Government supply agencies can
optimize savings by usinc full cost data in evaluating the
cost of procurement and stockage vetsus the cost of using
the commercial distribution system. OFPP policy requires
agencies to use commercial distribution channels unless it
is cost effective to do otherwise. Only by applying full
cost information were we able to identify which commercial
products should continue to be stocked and distributed by
the interagency supply system and which products should be
distributed through the commercial distribution system.   If
DLA and GSA considered full costs, they could reduce the
number of inactive and slow-moving items in their inventories
and reduce losses stemming from inventory obsolescence.
Finally, the use of full costs would improve management
of our foreign military sales programs.

                           CHAPTER 4
                      REASONS FOR DELAY
     Agency officials for DLA and GSA cited several reasons
why they have not acted on the Commission's recommendation.
These reasons ranged froin a discussion of whether a full
cost system could be effectively used in a military environ-
ment to how the commercial distribution system could satisfy
overseas users .- ds. The principal reasons given by each
agency and our evaluation follow.


     DLA has resisted developing and using full cost con-
cepts because it believes that would lead to purchase deci-
sions favoring commercial distribution of supply items. DLA
believes that increased use of commercial distribution

     -- Limit its ability to meet emergency military require-

     -- Place too much reliance on commercial distribution

     -- Inhibit collecting demand data for mobilization
     -- Require information showing what costs would be in-
        curred by customers to purchase supplies directly
        from commercial sources.
     --Affect its ability to satisfy overseas users needs.

Emergency military requirements
     DLA's own data shows that the use of full costs in
procurement decisions would not materially affect meeting
emergency requirements. Although its supply system must be
oriented to military support for both emergency and peace-
time conditions, only 200,000 of a total of 1.4 million
items stocked by DLA are designated for mobilization re-
serves or weapon system support programs. As such, DLA
would want to stock many of these items regardless of the
outcome of any full cost comparisons with the commercial
distribution system. Further, using full cost concepts in
the procurement decision process would prevent DLA from
rapidly expanding its logistical structure in the event
of an emergency.
Reliance on commercial distribution systems
in times of national emergenc_

     In 1950 the Congress passed the Defense Production Act
to make sure the military would have adequate supplies auring
national emergencies.  The Secretary of Defense used his
authority under this act to insure delivery of petroleum
products to the Armed Forces during the recent energy crises.

     In addition, the Strategic and Critical Materials
Stockpiling Act of 1939 provides for acquiring and retain-
ing certain strategic and critical materials needed to sup-
ply industrial and military needs during a national emer-

     DLA officials have agreed that no additional legi:la-
tive authority is needed to insure commercial product deliv-
ery during periods of national emer-ency or short supply.

Inhibit collection of demand
data for mobiizat1ion planning

     DLA officials said that they were concerned about losing
control over user demand data if items were distributed by
commercial sources.    First,OFPP policy does not plan to dis-
mantle DLA's procurement process--it merely advocates reduc-
ing the -unber of Government-unique items and slow-moving
and inactive items stocked in warehouses.       As such, DLA will
not lose visibility   over  demand  data.   For example, DLA had
a program that permitted    direct  commercial  support of over-
seas users needs  for  commercially   available  automotive re-
pair parts.  This  program   permitted  DLA  to track  the demand
history for these  items   because  firms  supplying  parts  had
signed contracts  with  the  Government   allowing DLA  to  get  in-
formation on the  total   number of  items  ordered.   We  believe
that DLA can satisfy many of its information needs under
similar contractual-type relationships.

     Second, in the few instances in which users buy an
item on the local market with.at DLA's help, they could
report the quantity used to DLA.     For example, procurement
personnel at Ft.  Knox,  Kentucky,  said  that they keep con-
sumption information  on  all items  used  and could transmit
the data to DLA  over the  same electronic   communication sys-
tem as used for requisitioning.

Need for customer procurement cost data

     To make effective full cost decisions, DLA officials
said that they need information showing how much it would
cost customers to purchase supplies directly from

commercial sources. They believe that determining this
information would be very difficult.

     To determine whether users purchase commercial items
locally and if it costs more to do so, we contacted two
military activities that use the types of items DLA car-
ries in stock. Although these activities represent a very
small sample of interagency supply users nationwide, their
comments suggest that local procurement costs are nominal
compared with DLA's supply and distribution costs. For

     -- Fort Knox supply officials said that locally purchased
        material normally accounts for a major portion of the
        installation's total purchases. For example, $30.5
        million worth of material was bought locally during
        fiscal year 1975. This amount involved about 47 per-
        cent of total purchases. Statistics on delivery
        times kept by this activity show that Fort Knox was
        able to get better delivery on the items purchased
        commercially than those ordered from DLA supply cen-
        ters. These officials felt that they could purchase
        up to 60 percent of all purchases in this manner with-
        out significant extra costs or procurement workloads
        because many of the additional items would be pur-
        chased from the same vendors they are already dealing
        with. Therefore, in many cases the additional busi-
        ness would not require negotiation of a new contract
       or preparation of an additional check and would often
       be no more than the addition of a line item to an

     -- In fiscal year 1975, the Naval Weapons Station, Con-
        cord, California, was one of the largest users of
        DLA-supplied wood products. Officials of this sta-
        tion said that under the present interagency supply
        distribution system the activity is forced to keep a
        $1 million inventory of wood products to buffer the
        normal 5 to 6 months' ordering lead time. The offi-
        cials said that they could purchase most of the same
        wood products locally without incurring significant
        costs. They felt that this would reduce ordering
        lead time by 2 to 3 months and allow the activity to
        lower inventory levels.

     In summary, the two activities already buy much of their
supplies directly from commercial vendors and feel that they
can purchase many additional items currently provided by DLA
directly from these same commercial sources at little or no
additional cost.

Ability to satisfy overseas users needs

     DLA believes that many items have to be stocked, or
centrally managed, for overseas customers regardless of the
cost benefit relationships of using DLA or the commercial
distribution system in the continental United States.
According to DLA, the decision to stock centrally or not is
a complex issue related to the type of alternative support
structures available in various ov'rseas locations.

     The Procurement Commission ilso addressed the overseas
supply issue.  It concluded that-

     -- Purchase of American-made commercial products by over-
        seas activities provided a potential for savings over
        shipment of these items from the continental United

     -- Indefinite delivery contracts can be used to simplify
        procurement of American-made products by overseas

     --Overseas delivery should not be required to order
       material from the continental United States without
       consideration of alternatives that may be more cost-

     OMB solicited comments from the private sector on the
Commission's conclusions.  In response to the "Notice for
Comment" in the "Federal Register," dated February 11, 1974,
3M stated:

     "The 3M Company manufactures and distributes world-
     wide a variety of commercial products which are
     used by all segments of industry, government, in-
     stitutions, and the general public.  3M has sub-
     sidiaries in 36 countries throughout the world.
     In countries where there is no subsidiary, distri-
     bution is performed through the use of dealers or
     distributors.  Our worldwide organization has
     been developed to provide users of our products
     with the most effective production, marketing,
     and customer service possible.  Customer service
     includes assistance on a local basis in product
     selection, equipment maintenance and repair, use
     and warranty action."

     If the Government used commercial outlets overseas
along with full cost comparisons, the 3M Company felt it
could provide DOD and other Government agencies with more

dependable support because then they would be regular
customers and part of the overseas market.

     During our review DLA hid a program underway that per-
mitted direct vendor support. to overseas users for commer-
cially available nonstocked automotive repair parts. DLA
officials said that this program, using indefinite delivery
contracts, has substantially reduced the time required to
fill overseas orders.
     As of December 1974, DLA stocked only 10,000 items
for overseas users who were unable to buy the items locally
because either the purchase was prohibited or the items were
not available.
     In summary, although supporting overseas requirements
deserves careful consideration, we do not see it as a major
barrier to DLA in decentralized procurement of more commer-
cial items.
     DLA has not acted on the Commission's recommendation.
We believe DLA's reasons for inaction are questionable be-
because (1) only a small percentage of the items it manages
are designated as needed to support critical military pro-
grams and mobilizations reserve stocks can be established
for such needs, (2) DLA has legislative authority to obtain
available commercial products in cases of national emer-
gency, (3) OFPP's policy does not contemplate dismantling
DLA's present procurement system so DLA will have the same
data on demand it has always had, (4) in instances of local
purchase, user activities can provide use data to DLA for
military planning purposes, (5) users already buy many of
their supplies directly from commercial vendors and feel
that they can purchase many of the DLA items from the same
sources at very little, if any, additional cost and, (6)
many overseas requirements can be satisfied from established
overseas commercial distribution systems.


     GSA accepts the Procurement Commission's recommendation
on using full cost comparisons, but it has been slow in
applying the concept. Since 1973 the Federal Supply Service
(FSS) has spent an estimated $212,818 studying full cost
recovery and full cost disclosure systems. Although once
a low-priority project, the full cost concept is being pur-
sued actively by FSS at the request of OMB. The target for
achieving full cost disclosure is 1980.

 Total cost not recovered

     The current funding structure of GSA's suapply division,
FSS, includes appropriations and a general zUpply fund.    The
item-pricing objective is to maintain a treok-even operation
in the supply fund. Selling prices for .tock items are com-
puted by adding a markup to the national weighted average
unit cost of the item. The markup, as irl DA, recovers only
the item's purchase price, inventory adjustrients, and trans-
portation in and out.  These have been thec nl~ costs recov-
ered since fiscal year 1953, and no provision is made for
consideration of expenses financed with appzCopriated funds.
The appropriated funds expended since 19711ere:

  1971      1972       1973         1974      97 5      1976
------------------------(000 omitted)------
$86,352   $90,324    $94,740    $132,381   $166,078   $159,667
FSS efforts toward full cost implementation

     FSS management initially studied ful 1 cOst recovery for
supply operations during 1973.  The study group concluded
that conversion to a full cost recovery oper-ation was essen-
tial and that FSS could remain competitivewfit    the commer-
cial marketplace by doing so.  Beside spendi.n   approximately
$75,000 on the in-house study, FSS contracteed vwith two con-
sulting firms to study use of the full cost system. Both
firms concluded that the concept was sound and that it was
needed at FSS. Among other recommendations, trhese firms
said that FSS should use total cost in makigr9 procurement

     In 1974 FSS personnel sent a proposed c hamge in legis-
lation to OMB which would allow the GSA suppwly fund to oper-
ate as an industrial fund.  An implementatio nd ate of July 1,
1975, was established.  Primarily because of DOD objections,
OMB did not actively support this legislatio n. GSA agreed
that a parallel program would be needed by D efe nse before
GSA's supply division, FSS, could pursue Suc ha system. As
a result, the legislation was dropped.

     FSS officials believed that certain par ts Of the pro-
posal, namely a full cost disclosure system, co uld be devel-
oped and used without changing FSS legisljti-4n.   Full cost
disclosure was intended to identify all expeense s by type of
methods for supply (such as stock, nonstock, schedules) and
permit a higher level of management effectiveness in making
method-of-supply decisions. The first major ef fort toward
full cost disclosure was to develop a cost-aCcotiting system

to allocate costs to methods of supply support. This effort
was deferred because of internal funding constraints in fis-
cal years 1976 and 1977.
Special emphasis project   to identify total
economic costs

     In 1968 a Method of Supply Evaluation System (MOSES)
model was introduced in FSS. It was an automatic data proc-
essing model designed for making method-of-supply decisions
on a per-item basis. It has not been updated since 1973.
During this time, OMB has provided a total of $175,000 for
automatic data programing, processing, and manpower re-
     The MOSES model was originally designed to identify
only the variable costs, demand history, and item character-
istics for items in the supply system. Fixed costs were not
considered. Several problems made the model ineffective to
use. Agency officials indicated that MOSES should be updated
and that it has the capability to determine the total cost
to supply an item.

     Due to the deferral and significant costs (estimated at
$2 million to 5 million) of developing a full-scale cost-
accounting system, the full cost concept was revised and led
to establishment of a special emphasis project for fiscal
year 1977. The project's objective is to "develop and im-
plement methods of determining the total economic costs of
FSS services and major alternative means of providing those
services." According to FSS officials, full cost disclosure
will not be achieved before 1980. Current efforts are under-
way to update and revamp the MOSES model to facilitate its
use in making method-of-supply decisions.

Method of supply economic model
     One phase of the special emphasis project involves de-
velopment of an economic model for making method-of-supply
decisions. According to FSS officials, this model is more
sophisticated and encompasses many factors not considered in
the MOSES model but is more flexible. A final model has
been developed and is being tested. Total economic costs
and total costs of the Office or Procurement and Supply Dis-
tribution have been included in the model. PSS personnel
believe these latter costs to be the most significant in
determining total economic costs to supply an item.

DISd:   c3E     iYSgM
       Tbe Procurement Commission, GAO, and various consultants
nav~ p~inted out the advantage of identifying total economic
costs on naking procurement decisions. Although progress
Oeen sJo0w, FSS intends to pursue development and use
                                                       of full


        Ir- view of the potential savings involved, we recommend
that: tr'e Admil istrator of General Services complete
                                                        the de-
velOPNent of full cost information and use this information
to rake cost-effective procurement decisions.      Also, we recom-
mend triat the Secretary of Defense require the Director,
Defnse Logistics Agency, to do the same.       We recommend that
the Adrninistrator of Veterans Affairs act to improve
a9er-c3y' s full cost information and increase its effectiveness
inrlaking Procurement decisions.

                         CHAPTER 5

                      AGENCY COMMENTS
     The Office of Federal Procurement Policy, Defense
Logistics Agency, General Services, and the Veterans
Administration have provided comments on our report. (See
apps. V, VI, VII, and VIII.)  In summary, OFPP agrees
with our recommendations. DLA, GSA, and VA also concur
that it is necessary to develop and use full cost data
to make cost-effective procurement decisions for common
commercial items. We hope that these supply agencies
will now act quickly to develop and use a full cost sys-

     After we received the agencies' comments, we revised
the report. Each agency was given an opportunity to com-
ment on the revised version. The comments of OFPP, DLA,
GSA, and VA follow.

OFPP comments

     OFPP agreed with the recommendations in our report.
(See app. V.)
DLA comments

     DLA also agreed with our recommendations. DLA initiated
a major study in March 1975, which resulted in the collection
of cost data. Recommendations based on this data are cur-
rently in the process of review within DOD. (See app. VI.)

GSA comments

     Although GSA officials generally agreed with our recom-
mendations, they believed that the report did not properly
consider GSA's experience with full cost disclosure. We
have revised the report accordingly.  (See app. VII.)
VA comments

     VA fully agreed with our rtzommendations. The most
significant area of difference was over our estimate that
the VA frozen food program lost $400,000 in fiscal year
1975. VA estimates that only a $42,069 loss occurred.
Our figure was based on allocations of various costs,
whereas VA's figure is based on actual costs obtained
through studies.

     We examined   VA's computation and found that it did not
consider certain   fixed overhead costs.  Using VA's data and
adding the fixed   overhead costs, we believe a more accurate
estimate of VA's   loss would be about $150,000.  We have re-
vised the report   accordingly.  (See app. VIII.)

APPENDIX I                                            APPENDIX I


                     IN MANAGING INVENTORIES
Year   Agency             Title             Summary of findings
1968    GSA       "Need to Improve The    Cost data used by GSA to
                  Cost-Information Sys-   determine the most eco-
                  tem to Achieve More     nomical method of supply
                  Economical Supply       was inadequate in many
                  Programs" B-114807,     instances to permit
                  June 26, 1968.          valid methods of supply.
Action promised
GSA agreed that comparative Government-wide costs should, in
large part, govern the decision on the appropriate method of
supply and that more refined costing data would improve the
basis for this decision. Accordingly, GSA promised to act on
our recommendation by giving appropriate priority to comple-
tion of the study of supply methods it started in October
1966. GSA was to implement whatever refined cost data system
the study established to be economically justified.

Year   Agency            Title              Summary of findings
1968   GSA      "Opportunities for        Our review showed that
                Reducing the Cost of      of the 32,000 items
                Providing Federal         available to agencies
                Agencies With Certain     through the Stores Pro-
                Supplies" B-114807,       gram, 377 common-use
                May 24, 1968.             items, including fire
                                          extinguishers, light
                                          bulbs, spark plugs,
                                          step ladders, and of-
                                          fice furniture, were
                                          also available through
                                          Federal Supply Sched-
                                          ule contracts.
                                          We felt that it was un-
                                          necessary for GSA to
                                          act as a secondary dis-
                                          tributor for the bulk
                                          of aiencies' needs for
                                          these items because the
                                          agencies could acquire
                                          them at identical costs
                                          and terms as GSA by

APPENDIX I                                                APPENDIX I

Year   Agency             Title              Summary of    findings

                                           ordering directly from
                                           Federal Supply Schedule

                                           We estimated savings at
                                           about $1 million annu-
                                           ally and pointed out
                                           What GSA's investment
                                           in inventories of the
                                           377 items, which aver-
                                           aged about $3.2 million
                                           during fiscal year 196/,
                                           could be reduced sub-

I.ction promised

GSA said that relative economies of different methods of sup-
ply would be studied in the cost-benefit project currently
underway to determine the optimum criteria for methods of
supply.  GSA intended to apply any developed system selec-
tively and on a priority basis to commodity areas where im-
proved economic decisions offered the greatest possibility
for savings.

Year   Agency              Title             Summary of findings

1972     DOD       "Action Needed to Re-   We reviewed the charges
                   cover Full Costs to     for work performed for
                   the Government on       foreign governments by
                   Producing Weapons for   two of DOD's many in-
                   Sale to Foreign Gov-    dustrial activities.
                   ernments" B-174901,
                   Sept. 7, 1972.          DOD regulations re-
                                           quired these industrial
                                           activities to charge
                                           non-Federal Government
                                           customers, including
                                           foreign governments,
                                           for the use of plant
                                           and equipment and other
                                           so-called unfunded
                                           costs applicable to the
                                           work performed.   Neither
                                           activity had complied
                                           with these regulations
                                           and DOD had not recov-
                                           e.ed about $396,000 of
                                           unfunded costs on

APPENDIX I                                            APPENDIX I

Year    Agency           Title             Summary of findi

                                         contracts for foreign
                                         governments completed
                                         during fiscal years 1969
                                         and 1970.

                                         We also reported that
                                         foreign governments
                                         were not being charged
                                         for the cost of
                                         Government-owned equip-
                                         ment used by contrac-
                                         tors to produce weapons
                                         for sale to such gov-

DOTD (1) moved to correct the deficiencies documented ill this
report on DOD industrial activities, (2) agreed with oLr rec-
ommendation that a fair share of the cost of Government-owned
plants aad equipment should be recovered when defense equip-
ment is produced in. Government-owned, contractor-operated
plants, and (3) agreed in principle that the Government
should recover a fair share of the cost of Government-owned
equipment used rent free in contractor-owned plants to pro-
duce equipment for sale to foreign governments and (4) said
that it would scudy ways to best implement our recommendation.

Year   Agency            Title             SummaLy of findins
1974     DOD     "Proper Use of the      We reported that the
                 Economic Order Quan-    Government was no<' sav-
                 tity [EOQ] Principle    ing as much as it could
                 Can lead to Work Sav-   in operating costs nd
                 ings" B-133396,         ree'ced inventory i,.
                 June 27, 1974.          vestment because these
                                         organizations were not
                                         applying the EOQ prin-
                                         ciple properly or fully.

                                         T1   report further
                                         stated some of the mis-
                                         application of EOQ in-
                                         volved using an inade-
                                         qua- e number of factors
                                         to accurately reflect
                                         current costs.

APPENDIX I                                             APPENDIX I

Action promised

All agencies generally agreed that they could improve their
application of the EOQ principle of inventory management and
would study ways to use its application within theiL agency.

Year   Agency            Title             Summary of findings

1974    DSA       "Better Use of Man-     Our review of contracts
                  power Possible by Re-   and observations of
                  ducing Source Inspec-   source and destination
                  tions of Simple Low-    inspections showed that
                  Cost Commercial-type    many inspections of
                  Items" B-166920,        simple low-cost
                  Oct. 3, 1974.           commercial-type items
                                          at the contractor's
                                          facility could have
                                          been made more econom-
                                          ically at the Govern-
                                          ment's warehouse or
                                          final destination.  We
                                          found that such itcms
                                          as casters for push
                                          carts, candles, bear-
                                          ings for diesel en-
                                          gines, etc., generally
                                          could be inspected at
                                          the final destination
                                          with the same degree
                                          of quality assurance
                                          attained by source .,-

Action promised

DSA officials agreed that they should use judgment when se-
lecting the point of inspection for simple low-cost
commercial-type items and that there was a need for greater
coordination and understanding between buying and contract
administration activities on the use of these source inspec-

Year   Agency             Title             Summary of findings

1975     VA       Letter report to the    VA hospitals had pur-
                  Administrator of Vet-   chased identical and
                  erans Arfairs.          functionally similar
                                          items from commercial
                                          sources without deter-
                                          mining the most effec-
                                          tive and economical
                                          method of supply.

APPENDIX I                                            APPENDIX I
Year   Agency             Title             Summary of findings
                                          The VA Marketing Center
                                          had not developed ade-
                                          quate criteria for de-
                                          termining the most cost-
                                          effective method of sup-
                                          ply for centrally man-
                                          aged items,
Action promised
The director of VA's Supply Service acknowledged the high
inventory levels and commented that the supply service con-
tinually strives to reduce inventories. The director pointed
out that in the quarter ended June 30, 1975, inventories were
reduced by $16 million, and Lhat the supply service plans to
continue analyzing ways to reduce inventories without reduc-
ing service to users.

Year   Agency             Title             Summary of findings
1976    DLA       "Greater Use of Com-    Overemphasis on central
                  mercial Distribution    stockage was a major
                  Systems for Minor,      factor in limiting the
                  Low-Use Supply Items    use of commercial dis-
                  Can Reduce Defense      tributicn systems and
                  Logistics Costs"        may have caused many
                  LCD-76-422, August 9,   commercially available
                  1976                    items to enter and re-
                                          main in the central
                                          supply system unneces-
Action promised
DOD told us that it intended to make greater use of commer-
cial distribution systems. It also said that several issues,
such as overseas support and the need for a viable support
structure in wartime, tend to make decisions to stock or not
stock somewhat more complex.

APPENDIX II                                                                                                                      APPENDIX II

                                                  SAMPLE FORMAT OF VA SUPPLY
                                                     DETERMINATION SHEET

VAMC METHOD OF SUPPLY DETERMINATION SHEET:                                                                      DATE OF STUDY

NOMENCLATURE:                           __       ____                  _____


SPECIFICATION                        IDENTIFICATION:             ___


       a.       COMMERCIAL COST ..........................                                           ................ $

        b.       FSS SCHEDULE COST                      .              ........................                                          $------

        c. OTHER COST FACTORS ....................                                              ..................


3. UNIT COST OF ITEM THRU DEPOT STORES .........................                                                                         $

4.      UNIT COST OF ITEM THRU D/C SCHEDULE ........................ $

S. UNIT COST OF ITEM THRU DIRECT DELIVERY ......................-----

6.      UNIT COST OF                   ITEM THRU CONSOLIDATED QUARTERLY PURCHASES                                            .....$ _

7. SAVINGS TO THE GOVERNMENT .                                                                                $

        RECOMMENDED SOURCE OF SUPPL'                                                           _                _    _               -

8. REASON OTHER THAN SAVING TC ESTABLISH/OR RETAIN                                                              ITEM UNDER

                                                            -    - -    -      --------       - ------------             -    ----
                                                                                                                               - ---------

----------------------------------                                                                                           -----


                                             -   ---    ------         ----               ---- --------------                                      ----




 APPENDIX III                                                           APPENDIX III



                                                                   unit price   Computed
 Item                                                 Commercial   including     annual
number         NSN                Description         unit price   full cost     savings

   1     2520-00-432-9637    Plate, clutch             $ 35.28      $ 18.49     $  74.05
   2            -758-0637    Shaft, axle, auto           17.00          9.76         2.77
   3             -944-8637   Parts kit, clutch          257.04       132.00       137.52
   4     2530-00-014-6841    Hose assembly               21.92          5.30      147.84
   5     2805-00-377-5637    Piston, internal comb.      31.12        16.80        25.44
   6     2815-00-148-5759    Cover, balance              29.22        16.30        25.12
   7            -919-4841    Seal kit                     8.23          5.04         8.37
   8            -964-4759    Camshift, engine           382.53       156.00       265.86
   9     2910-00-042-4759    Ring, cam                   70.15        23.60       291.51
 10             -047-3759    Pump, fuel                  29.56         6.00       119.76
 11             -873-1841    Hose, fuel                  12.22         5.80        11.76
 12      2930-00-362-0759    Pump, water                628.11       303.00       143.31
 13             -932-9637    Pulley, fan                 23.10         8.75        27.30
 14      3805-00-686-6637    Bushing                    230.00        50.00       900.0C
 15      3930-00-933-3759    Hose assembly               35.30        14.00        12.90
 16      4310-00-354-7841    Intercooler, comp.          55.20        22.33        58.42
 17      4720-00-984-1637    Hose assembly               33.81        21.10           .45
 18      4730-00-263-3759    Tee, pipe                   31.58        16.80        47.00
 19             -814-8841    Trap, air                   34.00        19.90          2.32
 20      4820-00-203-0637    Valve, gate                 25.84        14.40        33.72
 21      2520-00-080-6759    Plate, spring                2.24         1.05          3.92
 22             -734-8759    Ball, pivot                  1.27           .47       41.38
 23      2530-00-192-8637    Parts kit, hydraulic        14.68         4.35        23.16
 24             -378-7759    Fitting                        .91          .40       17.55
 25             -718-3637    Packing, axle                6.98         2.70        15.96
 26             -826-9841    Hose assembly                7.41         4.50           .21
 27             -860-9841    Parts kit, hydraulic         1.95           .48      450.34
 28      2805-00-078-2631    Mount, engine                1.90         1.15          1.68
 29             -339-5637    Gasket set, valve            5.71         3.02        28.97
 30             -640-8637    Ring, piston                 1.81           .39      731.76
 31      2815-00-070-8841    Lever, insector              2.05         1.21        29.87
 32             -682-7637    Valve, poppet                2.55         1.41          3.23
 33      2910-00-374-3841    Bowl, sediment, fuel           .46          .18        6.64
 34             -885-5637    Block, fuel filter           6.67         2.59        10.10
 35      2930-00-845-3841    Pulley, fan                  7.67         3.30        23.90
 36      2990-00-845-6759    Link                           .55          .32        2.32
 37      3020-00-517-0637    Gear, helical               10.08         4.86        94.46
 38      3040-00-944-1759    Gear, shaft                  4.42         2.05        20.52
 39      4320-00-999-3637    Splined, shaft space         8.83         3.00        16.12
 40      4720-00-494-0759    Hose, preformed              2.67         1.11         8.05
 41      4730-00-265-9759    Tee, pipe                    1.87           .74      103.59
 42             -266-2637    Tee, pipe                      .92          .49        2.58
 43             -269-2841    Elbow, pipe                  1.47           .28       70.52
 44             -277-9759    Connector                    7.95         1.76     1,124.35
 45             -811-1841    Flange, pipe                13.26         2.00       281.68
 46             -828-4841    Union, tube                  2.04           .98       16.05
 47             -896-7759    Adapter                      4.15         2.29         3.88
 48             -908-1637    Elbow, tube                  5.92         2.49        11.61
 49      2530-00-080-2841    Brake, lining kit            9.50         4.23       338.77
 50             -403-0841    Reservoir, hydraulic        55.64        33.10        50.92
 51      28i5-00-042-4637    Insert, valve seat           9.30         5.59        45.92
 52      2815-00-499-4759    Pin, piston                154.00        55.00       660.00
 53      3030-00-859-4829    Belts V, set               213.00        85.00     1,852.80
 54      4320-00-812-7841    Impeller, pump              85.40        47.00       112.20
 55      4730-00-008-4829    Elbow, tube                 30.94        11.80     1,989.90
 56             -222-9637    Plug, pipe                   5.95         1.15     7,998.06
 57             -594-1637    Thread piece                 4.51         1.74     3,236.25
 58      4820-00-274-3637    Cock, plug                   8.40         3.40       568.82

APPENDIX IV                                                                                 APPENDIX IV



 Item                                                         Commercial        DLA            annual
number         NSN                  Descritionr.              unit price     unit price!       saving

    1    2520-00-125-2841      Shifter fork                    $  9.96        $ 11.60             68.80
    2    2530-00-848-1759      Brake shoe                        31.50           38.50          120.40
    3    2805-00-253-5759      Rod, piston                        8.78             7.14             5.29
    4    2815-00-147-1841      Parts kit, engine                 47.60           36.81            11.30
    5           -400-6841      Pulley, idler                     22.72           14.80              5.76
   6     2910-00-848-7759      Tank, fuel                        22.80           16.50            18.00
    7    2920-00-806-0637      Coupling                           6.22           10.00            48.90
   8     2990-00-318-6637      Housing, governor                 22.55           15.30            11.58
   9     3020-00-005-7637      Gear, spur                        11.75           13.54              9.91
  10            -891-3759      Gear                              11.94           17.90          133.60
  11     3030-00-431-6637      Belts V, set                       8.87             6.60           25.35
  12     3805-00-131-1841      Pump, hydraulic                  324.81         362.00           254.39
  13     3930-00-179-6759      Packing kit, tilt                  4.20             5.30           55.64
  14     3950-00-086-2637      Grand cartridge, kit              16.05           i1.70            13.35
  15     4330-00-001-7841      Filter element, fluid             18.00           16.65            77.76
  16     4530-00-103-8637      Valve, regulating                 13.11           11.90            65.23
  17     4820-00-287-5637      Cock, plug                         7.36             8.84         298.50
  18            -702-6841      Valve, safety                     29.45           29.20            69.08
  19     2520-00-622-3841      Pin, gearshift                      .13               .23            5.00
  20            -932-0759      Spring, transmission                .51               .45              .21
  21     2537-00-741-0841      Cup, hydraulic brake                .80             1.00             1.60
  22            -845-2841      Plug, brake                         .46               .30              .56
  23            -971-4759      Pawl                               5.66             3.86           42.83
  24     2540-00-018-2759      Bracket                            2.30             1.60           30.42
  25     2805-00-132-4759      Spring                              .11               .16          10.80
  26            -785-6637      Sleeve, valve spring                .16               .11            2.42
  27     2815-00-035-8637      Valve, poppet                      3.42             3.37           19.72
  28     2910-00-871-2759      Valve, filter                       .38               .26            1.91
  29            -932-4841      Spring, throttle                    .66               .42              .37
  30     2920-00-126-3637      Spark plug                         1.12               .83          99.01
  31            -846-4637      Terminal                            .10               .10        230.52
  32            -847-9637      Fan generator                      1.08               .90             2.16
  33     2930-00-351-7759      Connector, water                   2.42             2.39              1.21
  34     2990-00-456-5841      Bracket, tail pipe                  .51             1.90          164.45
  35     3020-00-196-1759      Link, otfset                       6.37             4.05               .11
  36            -475-0637      Gear, spur                         3.11             3.52            70.62
  37     3805-00-798-4637      Ring backup                         .22               .37             8.56
  38     4510-00-889-9759      Rod, lift                           .44               .39           19.87
  39     4120-00-203-7637      Hose preformed                     2.03             1.30            10.90
  40            -477-1759      Hose assembly                      5.07             4.86            37.88
  41     4730-00-233-0759      Cup, oil     lube                  2.29             2.05              $.3'9
  42            -234-7637      Adapter                             .94               .60             3.62
  43            -266-1841      Adapter                             .61               .85        198.06
  44            -277-2759      dushing, pipe                       .76               .93           29.85
  45            -369-4637      Adapter                             .75               .73           94.89
  46            -478-2637      Reducer, pipe                      1.10               .90             1.70
  47            -722-2759      Adapter                             .35               .50              .45
  48            -842-7841      Plug, pipe                          .30               .36         132.48
  49            -901-0637      Adapter                            1.05               .78           16.24
  50     4820-00-731-1637      Seat, valve                        2.90              3.00             3.80
  51     4930-00-445-0759      Adapter and screw,:                 .43               .83         138.29
  52     2520-00-852-4841      Disk, clutch                      25.13           53.00           537.03
  53            -948-8829      Tube assembly                     47.25           30.40             19.46
  54     2530-00-712-9637      Hydrovac ass'y, brake             41.16           32.60             44.00
  55     2540-00-425-5841      Seat assembly                    174.06          129.00           161.70
  56     2805-00-622-8637      Piston, internal comb.             9.i0              3.20         248.62
  57            -905-9829      Ring set, piston                   4.61             6.75       2,525.32
  58            -962-8637      Pump, oil     engine               5.87             8.40          696.44
  59            -962-8841      Parts Kit, engine                 18.68           16.30        1,309.R0
  60     2815-00-364-3829      Shaft, lube oil                    4.92              5.06         289.02
  61            -779-2829      Piston, internal comb.            13.98           13.39           297.76
  62     2930-00-469-9841      Ring, wearing                      5.25              6.60         334.53
  63     2940-00-884-5759      Filter, intake                     4.69              5.12         364.21
  64     2990-00-318-9637      Governor, diesel                 197.38          140.00           319.44
  65     3020-00-294-9637      Gear, bevel                       21.21            15.00            75.33
  66            -540-8637      Gear, spur                        77.78            51.00          103.14
  67     3030-00-111-6637      Belt, powerband                  354.89          253.00           718.56
  68     3805-00-621-5637      Collar, shifter                   84.35            60.00          361.15
  69     3910-00-441-0637      Roller assembly                   17.66            23.20       1,284.36
  70     3950-00-371-9637      Trolley, I-beam                   84.70            59.00          174.60
  71     4210-00-640-1841      Bracket, fire exting.             18.50            12.00            54.60
  72     4310-00-967-4829      Cylinder/plunge                   20.11            20.00       1,878.62
  73     4330-00-036-3829      Element, filter                    5.30              3.56         134.24
  74     4710-00-822-5891      Pipe, metallic                     4.37              5.34      2,516.92
  75     4720-00-248-0841      Tubing, rubber                      .50                .32          29.83
  76     4730-00-278-8829      Pipe                                .04                .09     1,039.90
  77            -722-2637      Adapter                            2.77              4.89         424.54
  78     4810-00-934-8637      Seat, valve                       18.30            18.50       2,395.60
  79     4820-00-254-8637      Cock, shutoff                       .75              2.24      1,221.45
  80            -422-3841      Valve, expansion                  49.15            52.00          783.15
  81     4930-00-007-4759      Reel, static                      80.00            63.00          228.80

APPENDIX V                                              APPENDIX V

                             WASHINGTON. D.C. 20503


                                AUG 24 1977

Mr. Richard W. Gutmann
Director of Procurement and
  Systems Acquisition Division
General Accounting Office
Washingt    D. C. 20548
Dear Mr. v      nn:
This    in response to your draft of a proposed report
"Uninformed Procurement Decisions for Commercial Products
are Costly".
We fully support the thrust of the report that the Defense
Logistics Agency, Veterans Administration, and General
.SrvicesAdministration justify their procurement of
commercial items for storage and distribution when that
decision is based on cost effectiveness. This is in keeping
with our policy covering the procurement and supply of
commercial products. In this regard, minor modifications to
pages iii and 9 are attached to promote such consistency.
Thank you for the opportunity to review the report in draft
form. If we can be of further assistance, please let me


                                     ster A. Fetti

     APPENDIX V                                          APPENDIX V

                            Modifications to
                        Draft of Proposed Report
                  Uninformed Procurement Decisions for
                     Commercial Products are Costly2

    Page iii, re par., "In May 1976," ***   "to do otherwise"
o   Page 9, last sentence, 2d par., "OFPP has issued" ****      "to do

                           MODIFY TO:
    In May 1976, the OFPP issued a policy on the purchase of
    market acceptable commercial products which requires the
    Government's supply agencies to use commercial distribution
    channels to supply such products to users. The policy
    contemplates the application of cost effective considerations
    when supporting stockage and distribution by the Government's
    depot system.

    Page iii, 1st sentence of last paragraph,

                           MODIFY TO:
    This policy is in the early stages of implementation and
    places increased pressure on the supply agencies to justify
    their procurement of commercial items for storage and
    distribution when that decision is based on cost effectiveness.

     GAO note:    Page references in this appendix refer to our
                  draft report and do not necessarily agree with
                  page numbers in the final report.

APPENDIX VI                                                              APPENDIX VI

                         ASSISTANT SLNUTARY CF DUER!
                               WAsUeKO, D.C. sseG

Sf  SR                                                      3 MAR 77

    Mr. R. W. Gutmann
    Director, Procurement and Systems
      Acquisition Division
    General Accounting Office
    Washington, D.C. 20548

    Dear f1r. Gutmann:

    This is in reply to your letter of December 17, 1976 to the Secretary of
    Defense forwarding copies of your Draft Report (Audit Code #950323)
    entitled, "Is the Government Using Cost Data to Make Sound Procurement
    Decisions on Commercial Items?" (OSD Case #4497).

    The Draft Report recommendation "that DSA and GSA devote the necessary
    resources to develop full cost information to enable them to make cost
    effective procurement decisions" is concurred in.

    Within the Department of Defense (DoD), we began a significant effort in
    this respect in March 1975 through initiation of a Defense Logistics
    Analysis Office (DLAO) study of Materiel Support to Civil Engineer
    Operations. A considerable amount of cost data was collected as a
    result of the study, and recommendations based upon these cost data are
    in the process of review within the DoD. We are continuing to consider
    cost data in our implementation of Office of Federal Procurement Policy
    (OFPP) policy on procurement and supply of commercial products.

    While the number of commercial items in the DoD system should be reduced
    as a result of the above actions, total cost to the DoD as well as military
    essential requirements for mobilization planning, military readiness and
    product quality assurance will be considered in the decision making

    The opportunity to comment on the subject report in draft form is


                                               E R. BABIONE
                                 Acting Assistmnt Secretary of Defense
                                      (Isfaetio.mAnd Logsits),

APPENDIX VII                                                          APPENDIX VII

                           UNITED STATES OF AMERICA
                              WASHINGTON. DC   20a4

 February 23,       1977

 Honorable Elmer B. Staats
 Comptroller General of the United States
 U. S. General Accounting Office
 Washington, DC 20548

 Dear Mr. Steats:
 Thank you for your letter of December 17, 1976, transmitting a copy of the
 draft report to the Congress entitled "Is the Government using cost data to
 make sound procurement decisions on commercial items?" We appreciate
 the opportunity to comment.

 While we generally concur with the recommendation contained in the report
 and have in fact initiated action to comply, we believe thi report faibs to
 recognize or give proper consideration to our experience with full cost
 disclosure. We believe this may be due to a misunderstanding as there are
 two concepts to which GAO speaks: (1) the full-coat recovery financing
 concept recommenaed by the Commission on Government Procurement, also
 known as industrial funding, and (2) the full-cost disclosure concept which
 we are actively pursuing.

 The full-cost recovery financing has not been pursued by GSA because of
 the reluctance of the Department of Defense to agree with the concept. The
 Federal Supply Service, however, is actively pursuing full-cost discloeure
 criteria and has made extensive efforts to develop cost criteria to help make
 In this regard, FS8 developed and utilied the Method of Supply Evaluation
 System (MOSES). This mechanired system was intended to present commodity
 managers with information that includes total economic cots for use in making
 method of supply decisions for F88-managed items. Most of the items that
 we currently have in our supply system have been subjected to this cost
 analysis. Whereas it is not presently in use because cost elements have not
 been updated, MOSES, nonetheless, is a developed system that has been
 applied in an attempt to measure the Zotal costs of different methods of support
 in satisfying user' supply needs. Modification and development of cost data
 in this area is continuing, however.

APPENDIX VII                                                        APPENDIX VII

   A special emphasis project has been established for Fiscal Year 1977 to
   develop and implement mothods of determining toe total economic costs of
   F88 services and major alternative means of providing these services. The
   basic purpose of this project is to provide sound program justification in
   terms of savings to the Government and return on investment.
  We believe our actions to be in full compliance with the audit recommendation.
  The enclosure to this letter contains additional comments en the flndcngs -id
  recommendations contained in the report.

  Robert T Gri
  Acting Administrator


APPENDIX VII                                                       APPENDIX VII

                      GSA comments on GAO draft report
                           to the Congress entitled
                 "Is the Government Using Cost Data to Make
             Sound Procurement Decisions on Commercial Item, ,?"


 GAO recommends on page 11 that OFPP change the May 1976 policy concerning
 commercial products and require DSA, GSA, and VA to use the commercial
 distribution system, but only when it is cost effective to do so. We strongly
 agree with this recommendation.

 GAO states on page 18 that GSA's stockage criteria shows that decisions to
 stock and retain stock items in inventory are based almost entirely on the
 user's forecasts or actual experienced demand.

GSPR 5A-1. 71 provides basic criteria and constraints for making proper MOS
decision,, and includes many factors beyond demand to be considered in
Method of Supply decisions. These factors include physical adaptability for
storage and issue, rate of deterioration or obsolescence, commercial avail-
ability, emergency end use application, mandatory source, and ability to
forecast requirements. We have reduced the number of NSNs stocked from
approximately 50,000 in FY 70 to 30,000 in FY 76. We satisfy 204,000 items
through our non-stock program and an additional approximate 4 million items
in our Federal Supply Schedule program, both of which utilize the commercial
distribution system. In FY 76, our stores sales were $754.8 million, as compared
to $1.9 billion in the non-stock and Federal Supply Schedule programs. We
believe the statistics reflect a concern beyond demand in making Method of
Supply decisions.

APPENDIX VIII                                                             APPENDIX VIII

                          VETERANS ADMINISTRATION
                              WASHINGTON. D.C.          20420            ,.
                              FEBRUARY 2 -          1977

     Mr. Gregory J. Abart
     Director, Human Resources Division
     U. S. General Accounting Office
     441 G Street, N. W.
     Washington, D. C. 20548

     Dear Mr. Ahart:

               We are forwarding our comments on the General Accounting
     Office (GAO) draft report, "Is the Government Using Cost Data to Make
     Sound Procurement Decisions on Commercial Items?" dated December 17,
     1976. We appreciate the extension of your response date granted by
     Mr. Flynn of the Procurement and Systems Acquisition Division. It
     enabled us to more thoroughly review the report and its relationship
     to our procurement activities.

               The report states the Veterans Administration (VA) includes
     moct of the full cost elements in the procurement process and makes
     procurement decisions which approximate the full cost alternatives
     recommended by the Commission on Government Procurement. We agree
     with the GAO's conclusions that some improvement is needed in refining
     the cost information system we use and in applying the correct costs
     to determine the most effective method of supply to be used for
     individual items. We also concur with the GAO recommendation that
     commercial distribution systems be used when it is cost-effective to
     do so. However, we feel there are some statements in the report which
     require correction or clarification.

                       [See GAO note,              p.    42.]

APPENDIX VIII                                                   APPENDIX VIII

     Mr. Gregory J. Ahart
     Director, Human Resources Division

               Although we are unable to reconcile the GAO calculated full
     cost markups in Chapter 4, we agree with the concept of including all
     cost factors, both direct and indirect, in the comparison of department
     savings with commercial distribution methods. These projected markups
     may be overstated to the extent that they reflect a misconception that
     VA does not include transportation in the markup price.
     [See GAO note 1, p.         .1
               The VA frozen food program did not cost an excess of $400,000
     in FY 75.. Our calculations conclude a $42,069 loss for the fiscal year
     on net operating and related expenses, and a subsequent loss of $15,850
     for FY 76. The entire frozen food program has been under extensive
     review the past year. We anticipate our findings will further improve
     the program and may result i substantial changes in the present system.

               The VA depot system affords savings to the users which,
     although not quantified or used in determining the method of supply,
     are concrete and real. This results from using a simple requisition-
     ing procedure to acquire a multitude of common-use items. These are
     consolidated into one shipment and one billing is made. There are
     more than 200 using activities in the VA; each of them derives man-
     hour savings in purchasing, warehousing, and paying functions from
     using the depot system. Such savings do not accrue when a commercial
     distribution system is used. These cost differences should be quanti-
     fied and added to the commercial prices when determining method of
     procurement and distribution.

                We are in full accord with the GAO recommendations and will
      strive to refine our method of detf rmining the most cost-effective
      procurement methods, insuring that such factors as rate of return on
      investment and depreciation are fully considered.


                                               . ROUDEBUSH

GAO note:    The deleted comments related to matters discussed
             In the draft report but omitted in this final

APPENDIX IX                                              APPENDIX IX



                                            Tenure of office
                                           From           'o

                      DEPARTMENT OF DEFENSE

    Harold R. Brown                   Jan.       1977     Present
    Donald R. Rumsfeld                Nov.       1975     Jan. 1975
    James R. Schlesinger              June       1973     Nov. 1975

                    DEFENSL LOGISTICS AGENCY

Lt. General W.W. Vaughan              jan.       1976     Present
Lt, General Wallace H. Robinso-
   Jr.                                July       1971     Dec. 1975


    Joel W. Solomon                   May        1977     Present
    Robert T. Griffin (acting)        E: ,,      1977     May  1977
    Jack M. Eckerd                    Nc .       1975     Feb. 1977
    Dwight A. Ink (acting)            Oct.       1975     Nov. 1975
    Arthur F. Sampson                 June       1.973    Oct. 1975

                     FEDERAL SUPPLY SERVICE

    Wallace '. Robinson, Jr.          feb.       1976     Present
    Jay H. bolton (acting)            Nov.       1975     Feb. 1976
    Michael J. Timbers                June       1973     Nov. 1975

                     VETERANS ADMINISTRATION

    Max Cleland                       Mar.       1977     Present
    R. L. Roudebush                   Oct.       19'-     Mar. 1977

                         SUPPLY OERVICS

    C. C. Cook                        Sept.      1975     Present

                        MARKETING CENTER

    R. G. Rose                            Apr.   1966     Present

APPENDIX IX                                          APPENDIX IX

                                          Tenure of office
                                         From           To

    Lester A. Fettig                 May 1977        Present
    jamks A. Currie (acting)         Feb. 1977       May 1977
    Hugh E. Witt                     Dec. 1974       Feb. 1977