Inventory Management: Greater Use of Best Practices Could Reduce DOD's Logistics Costs

Published by the Government Accountability Office on 1997-07-24.

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

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on National Security,
                          International Affairs, and Criminal Justice, Committee on
                          Government Reform and Oversight, House of

For Release on Delivery
Expected at
12:00 p.m., EDT
July 24, 1997             MANAGEMENT

                          Greater Use of Best
                          Practices Could Reduce
                          DOD’s Logistics Costs
                          Statement of David R. Warren, Director, Defense
                          Management Issues, National Security and International
                          Affairs Division

                   Mr. Chairman and Members of the Subcommittee:

                   We are pleased to be here to discuss the Department of Defense’s (DOD)
                   use of innovative business practices to improve inventory management
                   and the opportunities we see for further application of best practices to
                   DOD’s operations. We have identified defense inventory management as
                   1 of our 25 high risk areas in the federal government because of
                   vulnerabilities to waste, fraud, and abuse.1 Today, we will discuss DOD’s
                   management of consumable items, which represent $18.7 billion, or
                   27 percent of the total secondary inventory dollar value.2 As requested, our
                   testimony today will focus on (1) an overview of the success DOD has had
                   in using prime-vendor-type programs for medical, food, and clothing items;
                   (2) the feasibility of using prime vendor systems for hardware items (such
                   as bearings, valves, and bolts); and (3) our observations on recently
                   introduced legislation that pertains to improving DOD’s inventory
                   management practices.

                   DOD  has successfully applied best practices to improve the management of
Results in Brief   medical and food items, which account for 2 percent of the consumable
                   items DOD manages. DOD’s prime vendor program for medical supplies,
                   along with other DOD inventory reduction efforts, has resulted in savings
                   that we estimate exceed $700 million. More importantly, this program has
                   moved DOD out of the inventory storage and distribution function for these
                   supplies, emptying warehouses, eliminating unnecessary layers of
                   inventory, and reducing the overall size of the DOD supply system. Also,
                   DOD buys only the items that are currently needed because consumers can
                   order and receive inventory within hours of the time the items are used.

                   Despite the success of its prime vendor program for medical supplies and,
                   to a lesser extent, food items, DOD has made little progress in adopting best
                   practices for hardware supplies, which account for 97 percent of the
                   consumable items. DOD continues to manage hardware items using
                   inefficient and outdated business practices, which have resulted in
                   excessive inventory levels, poor customer service, and delays in the repair

                    In 1990, we began a special effort to review and report on the federal program areas we identified as
                   high risk because of vulnerabilities to waste, fraud, abuse, and mismanagement. This effort, which was
                   supported by the Senate Committee on Government Affairs and the House Committee on Government
                   Reform and Oversight, brought a much needed focus on problems that were costing the government
                   billions of dollars. We identified DOD’s secondary inventory management as a high risk area at that
                   time because of too high levels of unneeded inventory and inadequate systems for determining
                   inventory requirements.
                    Consumable items are items discarded after use rather than repaired.

                   Page 1                                              GAO/T-NSIAD-97-214 Inventory Management
                of expensive military equipment. Although the private sector has
                developed solutions to these problems, DOD’s efforts to adopt such
                practices are limited in scope and represent only a small part of its
                logistics operations.

                Since 1991, we have issued a series of reports highlighting best practices
                we believe have direct application to DOD’s operations.3 However, DOD has
                not applied these best practices to the majority of DOD consumable items,
                and inefficiencies in DOD’s logistics systems remain. In this context,
                proposed legislative initiatives, if enacted, would encourage DOD to change
                its inventory management practices. Also, congressional oversight will
                continue to be a critical element as DOD establishes plans, goals,
                objectives, and milestones for addressing its inventory management

                We strongly support the need to improve DOD’s business practices and
                further reduce the logistics infrastructure. Because of the potential impact
                improved business practices would have on DOD inventory levels,
                operating costs, and the repair of weapon systems and component parts,
                we believe DOD must be more aggressive in expanding the use of new
                management techniques for these items.

                The Defense Logistics Agency (DLA) is the primary manager of DOD’s
DOD Inventory   consumable items and acts as the custodian of military aircraft, ship, and
Management      vehicle parts. To perform these functions, DLA operates a massive logistics
Overview        system that currently contains about 4 million items with a total inventory
                value of $11.1 billion.4 To store and distribute DOD’s secondary inventory,
                DLA has reported that it uses storage structures at 27 sites that provide
                531 million cubic feet of storage space. According to DLA, it employed
                more than 30,000 people in its material management operations in 1996.

                DLA’s 1996 material management costs, excluding the management of fuels,
                were reported at about $8.3 billion. Of that amount, approximately
                $5.5 billion was spent to purchase consumable items and $2.8 billion was
                spent to manage and distribute inventory. Also, DLA reported that it
                disposed of $1.1 billion of excess consumable material in 1996.

                 See Related GAO Products at the end of this testimony.
                 The $11.1 billion value of the inventory was estimated using the last acquisition cost of each item. In
                reporting the value to Congress, DOD reduced the amount to $9.5 billion, because excess inventory
                was valued at salvage value (3.2 percent of the last acquisition cost).

                Page 2                                                GAO/T-NSIAD-97-214 Inventory Management
                         DOD recognizes that it can no longer continue to operate a costly and
                         inefficient logistics system. In addition, DOD needs to achieve significant
                         savings in its support infrastructure to help increase funding for weapon
                         system modernization and meet the goal of increasing procurement
                         funding from about $40 billion to over $60 billion between fiscal year 1997
                         and 2002. DOD is relying on initiatives, such as outsourcing and
                         privatization, acquisition reforms, organizational streamlining and
                         consolidations, management process reengineering, base realignments and
                         closures, personnel reductions, and inventory reductions to help produce
                         savings in its support areas.

                         In this connection, the Secretary of Defense has established, as part of the
                         Quadrennial Defense Review, a Defense Reform Task Force to review the
                         Office of the Secretary of Defense, defense agencies, DOD field activities,
                         and the military departments to look at ways DOD can consolidate
                         functions, eliminate duplication of effort, and improve efficiency. The
                         Task Force plans to consult with Congress and business executives who
                         have streamlined their corporations in recent years. The Secretary has
                         directed the Task Force to submit its findings and report by November 30,

                         We have identified several best practices that have been successfully used
Best Practices Have      in the private sector to reduce inventory levels and logistics costs. In
Reduced Private          general, these practices provide inventory users with a capability to order
Sector Logistics Costs   supplies as they are needed and then delivering those items directly to the
                         customer within hours after the order is placed. Ordering supplies only as
                         they are needed, combined with quick logistics response times, enable
                         companies to reduce or eliminate inventory levels, buy only the items that
                         are currently needed, reduce or eliminate the possibility of inventory
                         spoilage or obsolescence, and reduce overall supply system costs.

                         Since 1991, we have highlighted three best practices—prime vendor, local
                         distribution centers/supplier parks, and integrated supplier—that reflect
                         the new business philosophy in the management of consumable items (see
                         table 1). These techniques resulted in significant savings for the companies
                         that have used them to improve their inventory management systems. We
                         recommended that DOD test these concepts and expand them, where
                         feasible, to other defense facilities.

                         Page 3                                 GAO/T-NSIAD-97-214 Inventory Management
Table 1: Best Practices Recommended
by GAO                                Concept                   Description
                                      Prime vendor              A single vendor (prime vendor) buys inventory from a
                                                                variety of suppliers and stores the inventory in its
                                                                warehouse. This concept is characterized by a close
                                                                partnership between the prime vendor and customer. The
                                                                customer orders supplies from the prime vendor, using
                                                                electronic ordering systems that, in some cases, are
                                                                provided by the prime vendor. The prime vendor delivers
                                                                inventory items to the customer within hours of receiving
                                                                the order.
                                      Local distribution        One or more suppliers locate a distribution center within
                                      centers/supplier parks    close proximity to their customers. From this location, the
                                                                supplier delivers items to the customer within 24 hours or
                                                                less of receiving an order. The supplier is linked
                                                                electronically with the customer. In some cases, the
                                                                supplier can perform the receiving function for the
                                                                customer in the local distribution center before the
                                                                inventory leaves the facility.
                                      Integrated supplier       An integrated supplier assumes almost total inventory
                                                                management responsibilities for a customer. This is the
                                                                most aggressive form of a supplier partnership where a
                                                                supplier representative works in the customer’s facility,
                                                                ordering supplies as they are needed, and replenishing
                                                                storage locations. Inventory is stored by the supplier in
                                                                the supplier’s warehouse until ordered and then delivered
                                                                on a “just-in-time” basis. An integrated supplier can also
                                                                perform quality inspections, maintain data on usage, test
                                                                the quality of parts, prepare parts kits, establish electronic
                                                                data interchange links and bar coding, and provide
                                                                vendor selection management.

                                      The companies that have adopted these best practices have significantly
                                      reduced their logistics costs. For example, as we reported in
                                      December 1991, Vanderbilt University Medical Center reduced inventory
                                      levels by $1.7 million (38 percent) through the use of a prime vendor
                                      program. In 1993, we reported PPG Industries eliminated $4.5 million
                                      (80 percent) in maintenance and repair supplies and saved approximately
                                      $600,000 in annual operating costs by locating 10 suppliers’ activities at a
                                      supplier park about 600 yards from the PPG facility. In 1996, we found that
                                      a leading distributor of aircraft supplies reported its integrated supplier
                                      program reduced one customer’s inventory by $7.4 million (84 percent),
                                      while filling 98 percent of the customer’s orders within 24 hours.

                                      Page 4                                   GAO/T-NSIAD-97-214 Inventory Management
                       Starting in 1993, DOD has successfully applied the prime vendor concept to
DOD Has Achieved       its management of medical supplies. The prime vendor, which delivers the
Success With Medical   items to the DOD hospitals when ordered, has enabled DOD to reduce the
and Food Prime         need to store and distribute medical supplies. As a result, DOD has been
                       able to reduce its inventory and supply system resource requirements.
Vendor Programs
                       DOD implemented this prime vendor program within a relatively short
                       period of time. The overall implementation strategy was to test and
                       evaluate the concept first in one geographic region (the National Capital
                       Area), and expand the concept nationwide to 20 other geographic regions.
                       DOD began first with pharmaceutical items, such as aspirin and antibiotics,
                       then followed with medical supplies, such as syringes and surgical gloves.
                       According to DLA, nationwide roll-out of the pharmaceutical and medical
                       prime vendor programs took a total of 20 and 40 months, respectively.
                       Presently, DLA reported that almost 200 DOD medical facilities use a prime
                       vendor to meet most of their pharmaceutical and medical supplies needs.

                       As the prime vendor program was established nationwide, inventory levels
                       began to decline, and warehouses once filled with these items were being
                       emptied (see fig. 1). At one of DLA’s primary storage depots for medical
                       supplies, DLA estimated that storage space requirements dropped by about
                       40 percent over a 3-year period.

                       Page 5                                GAO/T-NSIAD-97-214 Inventory Management
Figure 1: DOD Medical Inventory
Levels and Prime Vendor Trends
                                  Dollars in billions                                                 Percent
                                  $1.0                                                                 100%




                                  $0.0                                                                 0%
                                            1991        1992   1993      1994     1995     1996

                                                               Inventory  % Sales
                                                                 Value Prime Vendor

                                  In addition, as a result of the prime vendor program, logistics systems at
                                  DOD medical facilities were shrinking. Walter Reed Army Medical Center
                                  officials, for example, estimate the prime vendor program reduced
                                  inventory lines stocked by the Medical Center from 4,342 to 534, reduced
                                  inventory levels from $17.4 million to $1.8 million, reduced personnel
                                  levels from 72 to 36 full-time equivalents, and closed 6 out of 7
                                  warehouses. Walter Reed officials estimate that they save approximately
                                  $6 million each year as a result of the prime vendor program. Table 2
                                  summarizes our estimate of savings that have accrued DOD-wide from 1991
                                  to 1996 as a result of the medical prime vendor program and other related
                                  inventory reduction efforts.

                                  Page 6                                   GAO/T-NSIAD-97-214 Inventory Management
Table 2: Estimated DOD Medical
Inventory Savings                Dollars in millions
                                 Type of savings                                              Estimated amount
                                 Inventory reductions                                                    $409.5
                                 Holding cost reductions                                                  118.9
                                 Product cost reductions                                                  154.0
                                 Distribution cost reductions                                               31.3
                                 Total                                                                   $713.7

                                 As table 2 illustrates, this estimate includes realized savings from reduced
                                 inventory levels and the associated holding and distribution costs and
                                 realized reduced product costs. For example, in 1995, DOD estimated that
                                 the amount paid by medical facilities for the top 16 prime vendor
                                 pharmaceutical items was $37.7 million lower than 1993 prices.

                                 The medical prime vendor program has also provided a quicker pipeline
                                 between the manufacturer and end users, which has moved the
                                 procurement decision closer to the time the items are actually used. Under
                                 the traditional military logistics system, hospital warehouses would wait
                                 an average of 20 days to receive supplies ordered from DLA warehouses.
                                 DLA would take an average of 90 days to order and receive items from
                                 manufacturers. The prime vendor can deliver supplies directly to the
                                 hospital within 1 day of receiving the order and can order and receive
                                 supplies from manufacturers within 7 days. Therefore, the process that
                                 used to take an average of 110 days has been reduced to 8 days.

Food and Clothing Prime          As with medical supplies, DLA’s use of prime vendors for food has reduced
Vendor Programs                  DOD logistics costs and improved customer service. In 1994, DLA began
                                 testing the use of prime vendors to supply food to military dining facilities.
                                 By the end of fiscal year 1997, DLA plans to have prime vendors supporting
                                 all military dining halls in the continental United States.

                                 Since fiscal year 1994, DLA has reduced peacetime food inventories by over
                                 40 percent. In a demonstration test of the prime vendor concept in a
                                 four-state area (Florida, Georgia, South Carolina, and Alabama), DOD
                                 estimated that it saved $16.8 million in food inventory reductions and
                                 related costs. Another location outside the test area using the prime
                                 vendor concept estimated that it saved about $7 million. At one facility we
                                 visited, service officials were able to vacate two warehouses that
                                 previously were needed to store food items. Officials we spoke with were
                                 more satisfied with the delivery service provided by the prime vendor than

                                 Page 7                                  GAO/T-NSIAD-97-214 Inventory Management
                       that provided by the traditional DOD supply system. For example, the prime
                       vendor can deliver food to dining facilities within 1 to 2 days instead of
                       30 days under the DOD system. DLA is projecting that the potential savings
                       associated with this program could be as much as $1 billion over the next
                       5 years.

                       DLA’s adoption of the prime vendor concept for clothing items is not as
                       advanced as the medical and food prime vendor programs. In April 1994,
                       we recommended that DOD test the prime vendor concept to improve
                       management of high-usage uniform items. In March 1996, DOD began
                       testing a prime vendor program at the Air Force recruit induction center
                       located at Lackland Air Force Base. This test is expected to continue for
                       2 more years. Since 1993, based on DLA’s records, clothing inventory has
                       decreased 12 percent, from $1.7 billion to $1.5 billion. According to our
                       analysis, this inventory could meet DOD’s requirements for the next
                       1.5 years, based on demands received in 1996.

                       DOD’s  use of best practices is least advanced for hardware items (such as
DOD Uses Inefficient   bearings, valves, and bolts), which represent 97 percent of DLA’s inventory
and Ineffective        items. DOD continues to use outdated and inefficient business practices
Management             that require DOD to buy and store hardware items in DLA warehouses and
                       base-level supply systems in an attempt to ensure that inventory will be
Techniques for         available to customers. In some cases, DOD buys inventory years in
Hardware Items         advance of when the items are actually used. For example, based on our
                       analysis of DOD records, over 60 percent of DOD hardware items, valued at
                       $2.7 billion, did not have a demand from September 1995 to August 1996.
                       Despite this inventory investment, however, in many cases, hardware
                       inventory is not available when needed by DOD customers. When hardware
                       inventory is not available, the repair of costly weapon systems and
                       components is delayed. Although DOD has taken steps to improve its
                       logistics practices and reduce inventories, more aggressive steps could
                       provide better customer service, enhance readiness, and reduce logistics

                       During fiscal year 1996, DLA reported it purchased $2.6 billion in hardware
                       supplies and sold $3.1 billion in supplies to the military services.5 When the
                       services order hardware supplies from DLA, the supplies are sent from the
                       DLA warehouses to the military services, which, according to DOD records,
                       takes an average of 25 days. The services operate a base-level logistics

                        DLA buys inventory using working capital funds. The services purchase inventory from DLA using
                       operations and maintenance funds appropriated by the Congress.

                       Page 8                                            GAO/T-NSIAD-97-214 Inventory Management
                                         system to deliver the inventory to the end user. This system usually
                                         requires that the inventory be stored in three separate locations—bulk
                                         storage warehouses, central distribution storerooms, and end-user
                                         locations. When DLA and service-owned inventories are combined, the total
                                         inventory levels could meet current DOD requirements, in some cases, for
                                         several years. Figure 2 is an illustration of the traditional multilayered
                                         logistics system, as highlighted in our April 1997 report on the Army’s
                                         logistics system, and shows the millions of dollars of hardware inventory
                                         that a service facility can hold.

Figure 2: DOD’s Logistics System Used at Corpus Christi Army Depot

 DOD Wholesale Supply System                               Corpus Christi Depot Supply System

                                                                    Depot                               Maintenance
                                                                    Automated                           Shop Storage
                                                                    Distribution                        (72 Locations)
                                             Depot Bulk
 Manufacturers          W holesale
                        Inventory a

                                                                                                          End users
                       $7.2 billion          $23 million             $23 million
                       on hand               on hand                 on hand

                                                                                                       Unknown amount
                                                                                                       on hand

                                         DLA inventory is stored at multiple locations nationwide to support all DOD customers.

                                         As of September 1996, DLA reported it stored $7.2 billion worth of
                                         hardware items in distribution depots and warehouses. On the basis of
                                         inventory levels and past demands for items, we estimate that this
                                         inventory could satisfy DOD’s requirements, on average, for the next
                                         2.3 years.

                                         Page 9                                            GAO/T-NSIAD-97-214 Inventory Management
                         Despite DOD’s large investment in inventory, the supply system frequently
                         does not meet the needs of its customers. As of September 1996, DLA
                         reported it had over 574,000 customer orders, valued at $843 million, that
                         it could not fill because it did not have the right stock on hand. Customers
                         had been waiting on these parts for an average of over 3 months. Also, the
                         base-level supply system frequently did not meet orders placed by
                         mechanics and other customers. For example, according to Army records,
                         the base warehouse at one Army depot did not fully meet customer orders
                         76 percent of the time during 1996. At four other locations we examined,
                         base-level systems did not meet customer needs between 30 and
                         72 percent of the time.

                         When hardware supplies and other parts are not immediately available to
                         mechanics, it delays the timely repair of weapon systems and their
                         components. For example, the Navy calculates that the lack of parts
                         increases the repair time for aviation parts by as much as 74 percent. As of
                         January 1997, the Navy reported it had stopped repairing over 12,000
                         broken aircraft components, valued at $516 million, because parts were
                         not available to complete repairs. The Navy had packaged and moved the
                         partially repaired items to a warehouse next to the repair facility. At the
                         time of our review, these items had been in storage for an average of
                         230 days. Also, according to Air Force records, mechanics at one Air Force
                         depot location had stopped repairs on 2,748 items, valued at $193 million,
                         because necessary parts were not available.

                         To its credit, DLA has tried new inventory practices for managing hardware
DOD Could Build on       items. However, the efforts are limited in scope and represent only a small
Efforts to Adopt Best    part of its logistics operations. To attain the same level of success that DOD
Practices for            has achieved with the medical prime vendor program and to realize the
                         dramatic inventory reductions and infrastructure savings we have seen in
Hardware Items           the private sector, we believe DOD should expand the prime vendor
                         concept and fully use the services offered by prime vendor and integrated
                         supplier programs.

DOD Should Move Beyond   Since 1992, the use of a direct vendor delivery program has been one of
Direct Vendor Delivery   DLA’s main improvement initiatives. Under the direct vendor delivery

Concepts                 initiative, DLA uses long-term contracts and electronic data systems to
                         enable certain suppliers to deliver items directly to the military customers
                         instead of having the items delivered to DLA warehouses. In fiscal
                         year 1996, DLA reported that 17 percent of hardware inventory sales were

                         Page 10                                 GAO/T-NSIAD-97-214 Inventory Management
                                    filled using the direct vendor delivery program. This percentage has not
                                    varied much since 1992. Figure 3 shows the direct delivery sales and
                                    inventory levels from fiscal year 1992 to 1996.

Figure 3: DOD Hardware Inventory
Levels and Direct Delivery Trends
                                    Dollars in billions                                                   Percent
                                    $10                                                                    100%

                                     $8                                                                    75%

                                     $5                                                                    50%

                                     $3                                                                    25%

                                     $0                                                                    0%
                                              1992        1993       1994        1995        1996

                                                             Inventory    % Sales
                                                               Value   Direct Delivery

                                    Although the direct delivery program eliminates the need to store and
                                    distribute inventory from DLA warehouses, lowering the cost to the DOD
                                    customer, it does not provide a quick response to customer orders. For
                                    example, according to DLA records, the cost recovery rate for some
                                    hardware items is reduced from 46.6 percent to 7.4 percent under the
                                    direct vendor delivery program. However, under the direct delivery
                                    program, it took an average of 54 days for customers to receive items
                                    ordered, or twice as long as the 25-day delivery average for items stocked
                                    in DLA warehouses. As shown in figure 4, both of these delivery times are

                                    Page 11                                 GAO/T-NSIAD-97-214 Inventory Management
                                     significantly longer than that achieved by prime vendors or integrated
                                     suppliers, which can often deliver parts within hours of receiving an order.

Figure 4: Delivery Time Comparison






                                           Sy DOD

                                                          og ry


                                                        Pr elive








DOD Has Applied a                    In fiscal year 1997, DOD began using the prime vendor concept, called the
Limited Form of the Prime            virtual prime vendor program, for hardware supplies on a limited basis.
Vendor Concept to                    One of the two testing areas was supply support of repair depot
                                     operations. In February 1997, DOD began using a prime vendor program to
Hardware Items                       support the C-130 propeller repair shop at the Warner-Robins Air Logistics
                                     Center. By the end of fiscal year 1997, the Air Force, the Navy, and DLA
                                     plan to have prime vendor demonstration projects at three other repair
                                     facilities. We estimate these demonstration projects will account for about
                                     2 percent of DLA’s $3.1 billion annual sales of hardware items.

                                     Also in February 1997, DLA began using the prime vendor concept for
                                     facility maintenance supplies, such as plumbing, electrical, and lumber
                                     items. Under this concept, a prime vendor will serve a geographic region

                                     Page 12                                    GAO/T-NSIAD-97-214 Inventory Management
                         where all military facilities within the region can elect to order
                         maintenance supplies from the vendor. In the first test region, four military
                         facilities have elected to use the prime vendor, representing about
                         $8 million in annual sales. By the end of 1997, DLA plans to have a prime
                         vendor under contract for 10 geographic regions.

                         The Under Secretary of Defense (Comptroller)/Chief Financial Officer
                         endorsed these initiatives in June 1997 and asked the DLA Director, along
                         with each of the military services, to develop a regional implementation
                         blueprint for the facilities maintenance supplies prime vendor program. He
                         asked that the blueprint identify the critical events and site designations
                         for regional implementation within 12 months and nationwide availability
                         by the middle of fiscal year 1999. This blueprint is critical to the success of
                         this particular prime vendor program because it will demonstrate top
                         management support and encourage military units to use the prime vendor
                         services once they are established.

DOD Could Use Prime      DOD’s  prime vendor programs for hardware items are similar to the best
Vendor and Integrated    practices we observed in the private sector. We believe, however, that DOD
Supplier Programs to a   can build on this concept to achieve greater savings and improve service.
                         For example, neither DLA’s direct delivery nor prime vendor programs
Greater Extent           streamline the service’s base-level logistics systems to the extent that we
                         have seen in the private sector. DOD personnel still perform the function of
                         ordering, receiving, storing, and distributing material to the end users. If
                         DOD was more aggressive in its approach to streamlining its system and
                         transferred these functions to a prime vendor or to an integrated supplier,
                         it could achieve substantial reductions in resource requirements and
                         improved service to its customers. For example, at Walter Reed, the prime
                         vendor program resulted in a 50-percent reduction in full time equivalents
                         associated with the supply system within the Medical Center. Figure 5
                         illustrates the potential impact an integrated supplier program could have
                         on the traditional DOD supply system for hardware supplies.

                         Page 13                                 GAO/T-NSIAD-97-214 Inventory Management
Figure 5: Potential Impact of an Integrated Supplier on DOD’s System

       Traditional Supply System                                                                           Maintenance
                                                                    Depot Automated

                                                                                                           Shop Storage
                                                                                                           (72 Locations)

                                    Inventory a
                                                     Depot Bulk


       Interated Supplier Concept
                                                                                                          Shop Storage
        a                           Vendor


                                                  As the illustration shows, the integrated supplier concept could by-pass
                                                  the DLA wholesale system and two of the three primary storage points in
                                                  the base-level supply system. The integrated supplier would deliver
                                                  inventory directly to either maintenance shop storage points or end-user
                                                  locations. In the private sector, having the supplier deliver inventory
                                                  directly to these locations has improved the availability of inventory and
                                                  has actively involved the supplier as a “partner” in the customer’s
                                                  operations. The supplier also becomes involved in testing parts for quality,
                                                  monitoring part usage, and ordering supplies as they are needed.

                                                  Our discussions with DLA and Air Force officials indicated that the main
                                                  reason that a more aggressive approach has not been adopted is that a
                                                  cost comparison of the prime vendor and DOD systems may be required. A
                                                  prime vendor program that would replace the base-level supply system
                                                  (considered a commercial activity) and involve more than 10 government

                                                  Page 14                                GAO/T-NSIAD-97-214 Inventory Management
                         personnel generally may not be contracted out without a cost comparison
                         in accordance with Office of Management and Budget Circular A-76.
                         According to the Air Force, the Warner-Robins Air Logistics Center has
                         approximately 219 government personnel involved in supply operations.
                         Air Force officials stated that, if these positions were eliminated through
                         the prime vendor program, a cost comparison would first be required that
                         may take 2 years to complete. We agree that A-76 could be a significant
                         issue in implementing these programs. Our work has consistently shown,
                         however, that outsourcing is cost-effective because competition generates
                         savings—usually through a reduction in personnel—whether the
                         competition is won by the government or the private sector.

                         Several legislative proposals have been introduced this year in Congress
Objectives of Recently   relating to inventory management and the adoption of best commercial
Introduced Legislation   practices. For example, the proposed Defense Reform Act of 1997
Can Be Met Through       (H.R. 1778) was a legislative initiative introduced in June 1997 that related
                         to defense personnel reforms, defense business practice reforms, and
the Use of Best          additional miscellaneous defense reforms. We generally agreed with many
Practices                of the aims of this particular legislation. Pertinent provisions of H.R. 1778
                         were incorporated into the recently passed House version of the proposed
                         National Defense Authorization Act of 1998 (H.R. 1119). We believe that
                         two specific sections of H.R. 1119—one dealing with a reduction to the
                         acquisition work force and another with a reduction in overhead costs of
                         inventory control points—can be addressed by DOD to a certain degree by
                         adopting best practices.

                         Section 1302 of H.R. 1119 would require DOD to reduce its acquisition work
                         force by 42 percent by October 1, 2001. If DOD were to aggressively pursue
                         best practices in the form of an integrated supplier concept for
                         consumable items, DOD could reduce its work force involved in
                         procurement, storage, and distribution of consumable items. For example,
                         the prime vendor program at Walter Reed resulted in a 50-percent
                         reduction in full time equivalents associated with the medical supply

                         Section 1421 of H.R. 1119 would require DOD inventory control points to
                         reduce their overhead costs to 8 percent of net sales by the end of fiscal
                         year 2000. This goal is a very aggressive goal, considering that the current
                         cost recovery rate (the rate applied to the cost of goods to recover
                         overhead costs) for some DOD hardware items is as high as 41.4 percent.
                         However, DOD has accomplished the goal for medical supplies through the

                         Page 15                                GAO/T-NSIAD-97-214 Inventory Management
          use of the prime vendor program in that DLA reduced the rate for medical
          supplies from 21.7 in fiscal year 1992 to 7.9 percent in fiscal year 1997.

          We also support several requirements of the recently passed Senate
          version of the proposed National Defense Authorization Act of 1998
          (S.936) that relate to the application of best business practices at
          depot-level activities and the expansion of best inventory management
          practices of DLA commodities. For example, section 312, which deals with
          the designation of depot-level activities as “Centers of Industrial and
          Technical Excellence,” contains provisions requiring DOD to establish a
          policy to encourage the military services and defense agencies to
          reengineer their processes and adopt best business practices in
          connection with their core competency requirements. The section also
          allows the services to conduct pilot programs to test practices they believe
          will contribute to the efficiency and effectiveness of depot-level
          operations, improve support to the military users of such activities, and
          enhance readiness by reducing the time it takes to repair equipment.

          Section 366 of the act deals with the implementation of best inventory
          practices for DLA-managed supplies and equipment. This section requires
          the DLA Director to develop and submit to Congress, not later than
          180 days after enactment of the act, a schedule for implementing practices
          that the Director defines as the best commercial inventory practices
          applicable to the acquisition and distribution of medical supplies, food and
          subsistence, clothing and textiles, commercially available electronics,
          construction supplies, and industrial supplies. The act requires that the
          schedule for completing implementation of such practices be completed
          not later than 3 years after the date of enactment.

          In closing, we have identified the specific practices that warrants DOD’s
Summary   consideration and recommended that DOD test best practice concepts and
          expand the most successful ones to its logistics operations, where
          applicable. However, DOD has not applied these best practices to the
          majority of DOD consumable items, and inefficiencies in DOD’s logistics
          systems remain. In this regard, proposed legislative initiatives, if enacted,
          would help encourage DOD to change its inventory management practices.
          In addition, congressional oversight will continue to be a critical element
          as DOD establishes plans, goals, objectives, and milestones for addressing
          its inventory management processes.

          Page 16                                 GAO/T-NSIAD-97-214 Inventory Management
Mr. Chairman, this concludes our statement. We would be happy to
answer any questions you or the members of the Subcommittee may have.

Page 17                            GAO/T-NSIAD-97-214 Inventory Management
Page 18   GAO/T-NSIAD-97-214 Inventory Management
Page 19   GAO/T-NSIAD-97-214 Inventory Management
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              Inventory Management: The Army Could Reduce Logistics Costs for
              Aviation Parts by Adopting Best Practices (GAO/NSIAD-97-82, Apr. 15, 1997).

              Defense Inventory Management: Problems, Progress, and Additional
              Actions Needed (GAO/T-NSIAD-97-109 Mar. 20, 1997).

              Defense Logistics: Much of the Inventory Exceeds Current Needs
              (GAO/NSIAD-97-71, Feb. 28, 1997).

              High-Risk Series: Defense Inventory Management (GAO/HR-97-5, Feb. 1997).

              Defense Inventory: Spare and Repair Parts Inventory Costs Can Be
              Reduced (GAO/NSIAD-97-47, Jan. 17, 1997).

              Logistics Planning: Opportunities for Enhancing DOD’s Logistics Strategic
              Plan (GAO/NSIAD-97-28, Dec. 18, 1996).

              1997 DOD Budget: Potential Reductions to Operation and Maintenance
              Program (GAO/NSIAD-96-220, Sept. 18, 1996).

              Defense IRM: Critical Risks Facing New Materiel Management Strategy
              (GAO/AIMD-96-109, Sept. 6, 1996).

              Navy Financial Management: Improved Management of Operating
              Materials and Supplies Could Yield Significant Savings (GAO/AIMD-96-94,
              Aug. 16, 1996).

              Inventory Management: Adopting Best Practices Could Enhance Navy
              Efforts to Achieve Efficiencies and Savings (GAO/NSIAD-96-156, July 12, 1996).

              Defense Logistics: Requirement Determinations for Aviation Spare Parts
              Need to Be Improved (GAO/NSIAD-96-70, Mar. 19, 1996).

              Best Management Practices: Reengineering the Air Force’s Logistics
              System Can Yield Substantial Savings (GAO/NSIAD-96-5, Feb. 21, 1996).

              Inventory Management: DOD Can Build on Progress in Using Best Practices
              to Achieve Substantial Savings (GAO/NSIAD-95-142, Aug. 4, 1995).

              Defense Inventory: Opportunities to Reduce Warehouse Space
              (GAO/NSIAD-95-64, May 24, 1995).

              Page 20                                 GAO/T-NSIAD-97-214 Inventory Management
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Best Practices Methodology: A New Approach for Improving Government
Operations (GAO/NSIAD-95-154, May 1995).

Defense Business Operations Fund: Management Issues Challenge Fund
Implementation (GAO/NSIAD-95-79, Mar. 1, 1995).

Defense Supply: Inventories Contain Nonessential and Excessive
Insurance Stocks (GAO/NSIAD-95-1, Jan. 20, 1995).

Defense Supply: Acquisition Leadtime Requirements Can Be Significantly
Reduced (GAO/NSIAD-95-2, Dec. 20, 1994).

Reengineering Organizations: Results of a GAO Symposium (GAO/NSIAD-95-34,
Dec. 13, 1994).

Commercial Practices: Opportunities Exist to Enhance DOD’s Sales of
Surplus Aircraft Parts (GAO/NSIAD-94-189, Sept. 23, 1994).

Organizational Culture: Use of Training to Help Change DOD Inventory
Management Culture (GAO/NSIAD-94-193, Aug. 30, 1994).

Partnerships: Customer-Supplier Relationships Can Be Improved Through
Partnering (GAO/NSIAD-94-173, July 19, 1994).

Commercial Practices: DOD Could Reduce Electronics Inventories by Using
Private Sector Techniques (GAO/NSIAD-94-110, June 29, 1994).

Commercial Practices: Leading-Edge Practices Can Help DOD Better
Manage Clothing and Textile Stocks (GAO/NSIAD-94-64, Apr. 13, 1994).

Defense Transportation: Commercial Practices Offer Improvement
Opportunities (GAO/NSIAD-94-26, Nov. 26, 1993).

Defense Inventory: Applying Commercial Purchasing Practices Should
Help Reduce Supply Costs (GAO/NSIAD-93-112, Aug. 6, 1993).

Commercial Practices: DOD Could Save Millions by Reducing Maintenance
and Repair Inventories (GAO/NSIAD-93-155, June 7, 1993).

DOD Food Inventory: Using Private Sector Practices Can Reduce Costs and
Eliminate Problems (GAO/NSIAD-93-110, June 4, 1993).

Page 21                               GAO/T-NSIAD-97-214 Inventory Management
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           Organizational Culture: Techniques Companies Use to Perpetuate or
           Change Beliefs and Values (GAO/NSIAD-92-105, Feb. 27, 1992).

           DODMedical Inventory: Reductions Can Be Made Through the Use of
           Commercial Practices (GAO/NSIAD-92-58, Dec. 5, 1991).

           Commercial Practices: Opportunities Exist to Reduce Aircraft Engine
           Support Costs (GAO/NSIAD-91-240, June 28, 1991).

(709285)   Page 22                              GAO/T-NSIAD-97-214 Inventory Management
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