Defense Acquisitions: Price Trends for Defense Logistics Agency's Weapon
System Parts (Letter Report, 11/03/2000, GAO/GAO-01-22).

Some military commands are reporting concerns over price increases for
weapon system parts. The Defense Logistics Agency (DLA) provides these
parts and related services to the military, Department of Defense
agencies, and other government entities. GAO found that the majority of
DLA's weapon system spare parts experienced a relatively low annual
price change, less than 5 percent, from 1989 through 1998. However, some
parts are increasing in price. Most of the extreme price increases are
due to inaccurate price estimates, outdated prices, or changes in
quantities purchased. For some operating military units, this could have
an adverse effect on their ability to buy needed spare parts.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GAO-01-22
     TITLE:  Defense Acquisitions: Price Trends for Defense Logistics
	     Agency's Weapon System Parts
      DATE:  11/03/2000
   SUBJECT:  Weapons systems
	     Spare parts
	     Prices and pricing
	     Military procurement
IDENTIFIER:  DOD Working Capital Fund

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GAO-01-22

A Report to the Chairman and Ranking Minority Member, Subcommittee on
Readiness and Management Support, Committee on Armed Services U. S. Senate

November 2000 DEFENSE ACQUISITIONS

Price Trends for Defense Logistics Agency's Weapon System Parts

GAO- 01- 22

Lett er

November 3, 2000 The Honorable James M. Inhofe Chairman The Honorable
Charles S. Robb Ranking Minority Member Subcommittee on Readiness and
Management Support Committee on Armed Services United States Senate

This is the second in a series of reports responding to your request that we
review allegations of significant increases in prices the Department of
Defense (DOD) pays for weapon system spare parts. 1 In particular, some
military commands have asserted to the Congress that spare part prices have
been increasing at a higher rate than inflation and have taken an
unanticipated bite out of the limited funds available to meet readiness
requirements. You requested that we examine the Defense Logistics Agency's
(DLA) spare part prices to (1) determine whether prices were increasing over
time and (2) identify the factors that contributed to price increases. DLA
provides parts and related services to the military services, DOD agencies,
and other government entities. DLA purchases items from

vendors and sells them to its customers at a standard price. This standard
price is the amount that customers must pay to purchase the item and is
computed by adding a surcharge 2 to the latest representative price that DLA
paid to a vendor for the item. This surcharge is imposed by DLA to recover
such costs as storage, transportation, and inventory loss. Each

standard price appears in a computerized federal pricing catalog. Many
customers use the catalog to review the prices of items they plan to buy.
This report focuses specifically on “consumable” spare parts.
These are

parts that are consumed in use or discarded when worn out or broken because
they cannot be cost- effectively repaired. To evaluate price trends

1 Earlier this year we issued a report entitled Defense Acquisitions: Prices
of Marine Corps Spare Parts Have Increased (GAO/ NSIAD- 00- 123, July 31,
2000). 2 The surcharge is technically called the “cost recovery
rate.”

for consumable items, we selected for review weapon system spare parts with
at least one DLA procurement in 1996, 1997, or 1998. For each part, we
collected and analyzed its pricing history from 1989 through 1998. (Not all
parts had a pricing history for the full 10- year period). In fiscal year
1998, for example, our universe consisted of 317, 217 parts, of which about
237,000 were requisitioned by DLA's customers. 3 Requisitions totaled about

$1. 5 billion that year. Due to data limitations, we excluded from our
review items that had been transferred to DLA from the military services. 4
We took several steps to address data quality and reliability; however, we
did not validate or verify the pricing data provided by DLA. 5 See appendix
I for details on our scope and methodology.

Results in Brief From 1989 through 1998, an average of 70 percent of parts
requisitioned by DLA's customers experienced an annual price change of less
than 5 percent. This trend applied to all parts requisitioned as well as
those in frequent demand and in specific supply categories, such as aircraft
parts. A relatively small number of parts experienced significant annual
price

increases, that is, increases of 50 percent or more. However, this number
has grown since 1994. A very small percentage experienced
“extreme” increases in price, that is, 1,000 percent or more. In
1998, for example, 2, 993 of the 236,896 requisitioned parts we reviewed had
a price increase of 1,000 percent or more. Parts with these kinds of extreme
price increases did not represent a large portion of DLA customer spare part
spending and they generally did not include higher priced items.
Nevertheless, because customers are often unaware of such increases until
they actually purchase

a part, they experience “sticker shock” and they have raised
concerns about extreme price increases to DLA. Moreover, for some operating
units, such price increases can potentially affect their ability to buy
needed parts. When we analyzed 100 weapon system spare parts with price
increases of 1,000 percent or more, we found that in 64 cases, price
estimates that were

3 We used annual demand quantity, the best available data for the 10- year
period. Annual demand quantity does not account for all canceled or unfilled
requisitions. 4 Other studies have addressed this issue and results of these
studies are included in app. II.

5 Our recent testimony discusses long- standing problems with DOD's ability
to accumulate and report on the value of its inventories. See Department of
Defense: Progress in Financial Management Reform (GAO/ T- AIMD/ NSIAD- 00-
163, May 9, 2000).

made for new parts when a weapon system was fielded turned out to be
inaccurate once the actual procurement was made. In other cases, we found
that prices increased dramatically when there were long time periods-
sometimes decades- between procurements and/ or when there were substantial
changes in the quantity of parts purchased. DLA purchasing officials also
cited a range of other cost drivers that have lead to substantial price
increases, including costs associated with retooling when there is a long
time between buys and increased costs related to emergency procurements and
raw materials.

We are making recommendations to encourage DOD to determine the cost-
effectiveness of ensuring that catalog prices are more accurate and of
making customers aware that certain prices may be inaccurate. In written
comments on a draft of this report, DOD concurred with our findings and
recommendations.

Background DLA, headquartered in Fort Belvoir, Virginia, provides consumable
supplies, spare parts, and technical and logistics services to the military
services, DOD agencies, federal civil agencies, and selected foreign
governments. As part of its mission, the agency manages over 4.1 million
consumable items for its customers to support their weapon systems and other
assets. These parts range from low- cost commonly used items, such as
fasteners and gasket material, to high- priced, sophisticated spare parts,
such as microswitches, miniature components, and precision valves- all of
which are vital to operating major weapon systems. Spare parts are received,
stored, and shipped from 24 distribution depots. Three supply

centers manage the consumable hardware items that are the subject of this
report: the Defense Supply Centers in Columbus, Ohio; Philadelphia,
Pennsylvania; and Richmond, Virginia. DLA's supply management operations are
part of the Defense- Wide Working Capital Fund, which operates on a
revolving fund principle. The goal of the revolving fund is to financially
break even over the long term. Customers use appropriated funds to buy parts
from DLA. DLA then uses revenue it receives from customers to procure parts
from vendors. In principle, DLA

should recover the acquisition cost of the parts it sells, as well as its
own operating costs, from its customers while not making a profit or
incurring a loss.

Most Spare Parts About 70 percent, on average, of spare parts requisitioned
by DLA's

Incurred Small Price customers experienced an annual price change of less
than 5 percent from

fiscal years 1989 through 1998. This trend was consistent for parts with
Change frequent demand and all categories of parts examined. At the same
time, we found that the number of parts with significant price increases-
though relatively small- has steadily increased, and that, for some parts,
price increases have been extremely high.

Most Spare Parts Of the parts requisitioned in fiscal years 1989 through
1998, an average of Experienced Price Change about 70 percent experienced an
annual price change of less than 5 percent

of Less Than 5 Percent across the 10- year period. The percentage of parts
with annual price increases of 50 percent or more was relatively small
during this time period, but it has grown in recent years. During this same
period, the

Producer Price Index ranged from a positive 2.6 percent to a negative 0.4
percent. Figure 1 illustrates the percentage of price changes. As shown in
the figure, the number of parts with requisitions in our analysis universe
increased over the 10- year period. Figure 2 illustrates the median price
change, which stayed within the 3- percent to 5- percent range in most
years. 6

6 The median is the midpoint in a distribution. That is, it is the point
above which and below which one- half of the data fall. The median is a
useful measure of price change, but it is not an average. In our case, the
mean was highly skewed due to the presence of items with extreme price
changes (see p. 12). For this reason, we believe the median is a more
appropriate measure of price change for the population as a whole.

Figure 1: Percentage of Price Change for Parts Requisitioned

Percent of spare parts 177,738 187, 888 194,984 200, 136 202,446 211, 084
232,695 241, 565 236,896 100%

80% 60% 40% 20%

0% 19891990 19901991 19911992 19921993 19931994 19941995 19951996 19961997
19971998

Fiscal year <0% 0 to < 5% 5 to < 50% 50% or more

Figure 2: Median Price Change for Parts Sold

30% Percent 25% 20% 15% 10%

5% 0% -5% 10%

1989 1990 1991 1992 1993 1994 1995 1996 19971990

1991 1992

1993 1994

1995 1996

1997 1998

Fiscal year

As illustrated in figures 1 and 2, there were 2 fiscal years in which prices
did not follow the same trend. Specifically, prices increased substantially
in fiscal year 1991 and decreased substantially in fiscal year 1993. The
1991

price increase was attributable to a 1989 DOD decision to include supply
operations costs (that is, the cost of purchasing, storing, and distributing
items) in the surcharge. Prior to this decision, all operating costs of
supply activities were financed through operations and maintenance accounts.
DLA officials attributed the 1993 price decrease to a decline in operational
costs at the supply centers and an increase in the sales base. The increase

in the sales base was partly due to the transfer of consumable items from
the military services to DLA in 1992. This transfer was intended to
eliminate duplication in managing DOD's consumable items by consolidating
these items within DLA. Surcharge rates at DLA's supply

centers decreased as a result of the transfer since costs were spread over a
larger number of DLA- managed items. Appendix II discusses this transfer in
greater detail.

Parts in Frequent Demand Our analysis also found that spare parts in
frequent demand by DLA's Followed Same Trend

customers experienced price trends similar to the overall universe of parts.
Of the spare parts included in our review, 160,016 had requisitions every
fiscal year from 1993 to 1998. We used fiscal year 1993 as a base year
because we wanted to review spare parts with recent, consistent
requisitions. Our analysis showed that over 70 percent of the parts, on

average, had an annual price change of less than 5 percent over the 6- year
period. Additionally, the number of parts in frequent demand whose price
increased 50 percent or more has grown steadily.

Figure 3: Price Change for Parts With Frequent Demand

Percent of spare parts 160,016 160,016

160,016 160,016 160, 016 100% 80% 60% 40% 20%

0% 1993- 1994 1994- 1995 1995- 1996 1996- 1997 1997- 1998

Fiscal year <0% 0 to < 5% 5 to < 50% 50% or more

Price Trend for Parts in Six Because a number of military commands have been
specifically concerned

Supply Groups about high prices for aircraft parts, we reviewed spare part
prices in three

federal supply groups that contained these types of parts. In addition, we
examined price trends in the three federal supply groups that had the
highest dollar value of requisitions in fiscal years 1996 through 1998. 7
Altogether, these six groups accounted for about 53 percent of the total
value of requisitions in those years.

Our analysis of price changes for the six groups revealed results similar to
our other analyses. That is, an average of 70 percent of the parts
requisitioned over our 10- year review period experienced an annual price
change of less than 5 percent. As with the overall universe of parts
requisitioned, the number of parts in these groups with annual price
increases of 50 percent or more has grown. Table 1 illustrates this trend by
specific federal supply groups.

Table 1: Price Trends of Specific Federal Supply Groups for Fiscal Years
1989 to 1998 Percent of parts with price change

Name of group of less than 5 percent

Aircraft and airframe structural components 71. 6 Aircraft components and
accessories 70. 9 Aircraft launching, landing, and ground handling 73. 3
equipment Pipe, tubing, hose and fittings 69. 9

Hardware and abrasives 66. 1 Electrical and electronic equipment components
71. 2 Average for the six groups 70. 5

Finally, we analyzed the prices for all weapon system spare parts managed by
DLA- regardless of whether they had requisitions in some or all of the
fiscal years reviewed. Our analysis revealed that, on average, 72 percent of
the spare parts had an annual price change of less than 5 percent over the
10- year period. Again, the number of parts with annual price increases of 7
Federal Supply Groups are a broad designation, identifying the commodity
area covered by the classes within the group. Each class covers a relatively
homogeneous area of commodities, e. g., in respect to their physical or
performance characteristics.

50 percent or more has been growing. A figure depicting these data is
included in appendix VI. Percentage of Parts With

As noted earlier, the number of parts with significant annual price
Significant Price Increases

increases- 50 percent or more- represents a relatively small portion of Has
Grown

DLA- managed parts. However, this number has grown steadily in recent years.
By 1998, nearly 14 percent of the requisitioned parts fell into this
category, compared with 8 percent in 1995.

Most of the 32,394 items with price increases of 50 percent or more in 1998
were relatively inexpensive. As shown in table 2, about half of the items
cost less than $50 and only about 6 percent cost more than $1,000.

Table 2: Unit Prices of Items With Price Increase of 50 Percent or More in
1998 Percent of total

Cumulative percent of Unit price range Number of items items total items

Less than $1 1, 512 4.7 4. 7 $1 to $4.99 4, 125 12.7 17. 4 $5 to $19. 99 6,
449 19.9 37. 3 $20 to $49.99 5, 378 16.6 53. 9 $50 to $99.99 4, 216 13.0 66.
9 $100 to $199. 99 3, 473 10.7 77. 6 $200 to $999. 99 5, 261 16.2 93. 8 $1,
000 or more 1,980 6. 2 100. 0

Total 32, 394 100.0

In addition, the items that have had these substantial price increases do
not represent a large proportion of DLA's business. In 1998, customers
requisitioned a total of $1. 5 billion for spare parts. About $193 million
of this amount was for parts with price increases of 50 percent or more,

whereas $944 million was for parts with price changes of less than 5
percent.

Most parts that increased 50 percent or more did not experience this level
of escalation in more than 1 year. Of the parts requisitioned by customers
with increases at this rate in any given year from fiscal years 1989 through
1998, 83 percent experienced an increase of this magnitude only once.

Sixteen percent experienced the increase twice over the 10- year period. Of
parts with frequent demand, 91 percent increased at this rate only once from
fiscal years 1993 through 1998, and 9 percent experienced the increase twice
during the period.

Nevertheless, the extent of these increases was extreme in some cases. From
fiscal years 1989 through 1998, the average percent change, as measured by
the mean, was 344 percent. This number is skewed upwards

because of the presence of parts with extremely high price increases- in
some cases exceeding 1 million percent. In fiscal year 1998, 2,993 parts
requisitioned by customers had a price growth of 1,000 percent or more.
Appendix IV shows the mean percent price change.

Factors Contributing to A number of factors contributed to the substantial
price increases in some Substantial Price

weapon system spare parts. First, price estimates made for new spare parts
during the initial stages of a weapon system procurement, which are
Increases

entered into the DOD pricing catalog, often turn out to be far lower than
the actual price. Second, prices increase dramatically when there are long
time periods between procurements and/ or when there are substantial changes
in the quantity of parts being purchased. DLA purchasing officials also
cited a range of cost drivers that can lead to substantial price

increases, such as cost increases related to emergency procurements and raw
materials. For some operating units, unexpected sharp price increases can
potentially limit their ability to buy needed spare parts.

Many Extreme Increases Our analysis of a random sample of spare parts that
had extreme price

Are Due to Inaccurate Price increases showed that most increases were caused
by inaccurate price Estimates

estimates. To determine the cause of extreme price increases, we selected a
sample of 100 requisitioned spare parts whose prices had risen 1,000 percent
or more between fiscal year 1997 and 1998. (See app. V for a list of these
parts.) At our request, DLA reviewed procurement data and contract files to
determine the reasons for these extreme price increases. In 64 of the 100
cases, a contractor had provided the price estimate for a

new part. When DLA procured the part for the first time, the price was
substantially higher than the estimate.

Some estimated prices are obviously inaccurate, but others appear logical,
offering no hint that the actual price may be many times higher. In 1998,
for example:

The initial estimated price of a washer was $0.05, but the actual price
turned out to be $182. 13. The estimated price of a digital microcircuit was
$21.92, but the actual price turned out to be $802.75.

The estimated price of a blind rivet was $67.83, but the actual price was
$1, 775.39. The estimated price of a liquid indicator sight was $28.75, but
the actual

price was $4, 214.70- an increase of 14,560 percent. DOD officials cited
several possible reasons for the discrepancies between estimated and actual
prices. First, they stated that the military services do not have the
manpower and resources needed to perform a thorough price scrub for all new
items the contractor provides when the weapon system is initially delivered
to DOD. (This is known as the “initial provisioning”

process, under which the contractor and the military service identify the
items that are needed to support and maintain a weapon system for an initial
period of service.) The estimated prices are nevertheless entered into the
DOD pricing catalog. In addition, DOD officials suggested that the

contractors' acquisition methods may differ significantly from DLA's. For
example, the contractor may obtain a discount on certain items due to a
large quantity buy- resulting in a price increase if DLA's initial
procurement is for a small quantity of the same item. In other cases,
neither the contractor nor DOD expects that the item will ever be procured
again.

In such instances, a “plug” factor of $0.01 or $0. 99 is entered
into the pricing catalog. Prices Are Not Identified as Estimated prices are
not identified as “estimates” in the DOD pricing

Estimates in Catalog catalog for spare parts. As a result, customers
checking the price of an item have no way of knowing that the price is
merely an estimate and

experience “sticker shock” when they learn that the actual price
they must pay is substantially higher than the catalog price. DLA
headquarters officials, as well as pricing specialists and buyers at the
Defense Supply Centers, told us that they receive many complaints from
customers regarding the large discrepancies between catalog prices and
actual procurement prices and that this problem has existed for many years.

In 1998, a DLA employee submitted a quality improvement suggestion to
specify whether the catalog prices were estimated or actual so that
customers would know what price they could expect to pay. Although the

Defense Supply Center- Philadelphia and the Defense Logistics Information
Service approved this suggestion, it was rejected by the Defense Logistics
Support Command on the basis of an estimated implementation cost of

$700,000 and a 6- year time frame. An official from the command told us
that, because there is no placeholder in the catalog to identify price
estimates, a system change request would have to be implemented. Such a
system change would require the involvement of all military services.

The practice of not identifying estimated prices in the catalog has also
hampered DLA's ability to select apparent price anomalies for analysis and
corrective action. For example, the Defense Logistics Information Service,
which maintains the pricing catalog for all DOD spare parts, annually
distributes a list of the 1,000 parts with highest percent price increases
to each DLA Defense Supply Center and military service to aid them in
purging incorrect prices from the system. However, pricing specialists at
the centers told us that they generally make little use of the list because
experience has shown that most price increases are due to estimates

followed by actual procurements. DLA officials stated that if price
estimates were identified, customers would be more likely to call the item
manager to obtain a more accurate price, a process that would assist them in
managing their budgets.

Furthermore, identifying price estimates would also assist the supply
centers in their efforts to conduct price trend analyses. The officials also
stated that an effort should be made to obtain more accurate prices in the

first place. Recently, at our request, a provisioning policy group, a team
of representatives from DLA and the military services, discussed the fact
that price estimates in the catalog are often inaccurate and are not
identified as

estimates. The group plans to form a team to address these issues. In
addition, DLA is developing a contract pricing tool to produce more accurate
price estimates. If development goes according to plan, the tool

may prove useful for evaluating initial provisioning price estimates for new
parts. Long Time Between

DLA procures many of its spare parts infrequently. According to DLA
Procurements Causes

officials, this is primarily because (1) DLA buys large quantities of an
item Extreme Price Increases

when a new weapon system is fielded and has no need to buy the item again
for many years and (2) there is reduced demand for selected items as older
weapon systems are phased out of service. Because some parts are purchased
infrequently, their prices may remain relatively unchanged for

many years. When DLA procures these parts again, prices can increase
substantially due to years of inflation and other factors such as a change
in material, the need to retool, or a new technology. In addition, in many
cases, DLA purchases initial spares in large quantities- sometimes at a

discounted price. Subsequent buys, sometimes many years later, may be for
much smaller quantities to support a smaller number of units of a fielded
weapon system. Historically, unit prices tend to be higher on purchases that
involve smaller quantities.

When DLA has sufficient stock on hand to issue to customers without making a
new procurement, the price the customer pays is the latest acquisition cost
plus the current year's surcharge rate, even if that acquisition cost was
incurred many years before. 8 If such an item is no longer in stock and DLA
must make a procurement, the customer, in most cases, will be charged the
new, sometimes surprisingly higher, price.

Of the 100 parts in our random sample of parts, 30 were identified by DLA as
having had 3 or more years between procurements. Of these items, 21
experienced more than 10 years between buys. For example:

A set screw increased from $0.05 in 1997 to $17.72 in 1998, an increase of
35,340 percent. DLA had not procured this item for 31 years; its 1997 price
was based on a 1966 purchase. 9

A machine bolt increased from $0. 46 in 1997 to $139. 83 in 1998, a price
jump of 30, 298 percent. This item had not been procured in 21 years.

Some DLA officials are considering the feasibility of capturing inflation on
an annual basis so that items with many years between procurements would
have a more gradual price increase, mitigating sticker shock.

According to officials in the Office of the Under Secretary of Defense
(Comptroller), military services have tried in the past to add an annual
inflation rate to the prices of the items they manage, but the efforts were
unsuccessful and resulted in overpricing. However, the officials stated that

they are awaiting a DLA proposal that would measure the impact of this
problem. 8 The Defense Supply Centers do not have a uniform policy for
updating prices; for example, the Richmond Center does not update prices-
even to reflect the current surcharge rate- for items that have not had
customer demand in the past 2 years. 9 DLA officials noted that for items
with many years between procurements, quantity can also play a role in the
price increase. For the set screw, for example, the 1966 procurement had
been based on a purchase of 8,400 items, compared to only 50 items in the
more recent procurement.

Quantity Changes Of the 100 items in our sample, 26, according to DLA, had
quantity changes

Contributed to Substantial that affected the unit price. In many cases, the
quantity changes also

Price Increases occurred on items with a long time between procurements. For
example:

A change in the quantity of compression springs being purchased by DLA
contributed to a 5,479- percent price hike. Specifically, in 1998, customers
were charged $16.18 for each spring based on a DLA purchase of 60 units.
Previously, they were charged 29 cents a spring based on a DLA purchase of
3, 000 units. A change in the quantity of electric connector plugs led to a
1,127- percent price hike. In 1998, customers were charged $306.08 based

on a DLA purchase of one connector. Previously, they were charged $24.94
based on a purchase of 10 connectors. A change in the quantity of a
transistor procured by DLA caused a

1,525- percent price increase. In 1998, customers were charged $440. 70
based on a DLA purchase of three transistors. Previously, they were charged
$27.12 based on a procurement of 250 transistors. A change in the quantity
of a cable clamp adapter caused a 1,039- percent

increase. In 1998, customers were charged $1,134.01 based on two small-
quantity DLA procurements. Previously, they were charged $99.55 for the
item. A change in the quantity of a threaded pin rivet caused a 2,032-
percent

price increase. In 1998, customers were charged $30.28 based on a DLA
purchase of 15 rivets. Previously, they were charged $1.42 based on a
procurement of 4,000 rivets.

DOD officials noted that, in some cases, it may be a wise business decision
to purchase a limited quantity of some spare parts- even if the unit price
was high compared to historical costs. For example, smaller quantities of
some spare parts may be needed for an aging weapon system with a scheduled
retirement date.

Other Factors Can Cause In addition to the reasons identified in our sample
of 100 parts, DLA

Price Increases purchasing officials cited several other factors that can
cause customer prices to increase. These include the following.

Costs related to first article testing, which is performed on a new item or
an item that has not been procured in many years to ensure that the
contractor can produce the item to specifications. Costs related to
emergency procurements, where delivery of a part must be accelerated if the
customer needs an out- of- stock part quickly.

Increases in raw material costs. The officials emphasized that several
factors can work in tandem to create a large price increase. For example, an
air duct assembly, used on the Apache helicopter, increased in price from
$220 in 1997 to $7,568- or 3, 340

percent- in 1998. 10 This item, which was included in the Defense Logistics
Information Services' list of parts with extreme price increases, had been
transferred to DLA from the Army. According to DLA officials, the price

hike was attributable to the fact that (1) there were 9 years between
procurements, (2) the vendor had to set up and retool machinery to make the
part, (3) the part required first article testing, and (4) there was a
quantity reduction from 61 in 1988 to 4 in 1997.

Conclusions The majority of DLA's weapon system spare parts experienced a
relatively low annual price change- less than 5 percent- from fiscal years
1989

through 1998. At the same time, however, a small but growing number of parts
are increasing in price. Most of the extreme price increases are due to
inaccurate price estimates, outdated prices, or changes in quantities
purchased. Nevertheless, because the DOD pricing catalog does not identify
estimated or substantially outdated prices, the customers buying

these items are often surprised to find that they are paying significantly
more than they expected for parts that are essential to maintaining their
weapon systems. Moreover, for some operating units, this could have an
adverse effect on their ability to buy needed spare parts.

Recommendations for We recommend that the Secretary of Defense determine (1)
why initial Executive Action

provisioning price estimates differ significantly from the price DLA pays
upon procuring the item and how to include more accurate initial
provisioning estimates in DOD's pricing catalog, (2) a cost- effective
method

of adjusting catalog prices to account for inflation for items that DLA has
not procured in many years, and (3) whether estimated and outdated prices
can be cost- effectively identified as such in the catalog so that customers

will be aware that the prices may be incorrect. One way to make these
determinations is to establish a task force with membership representing

10 This item was not included in our data analysis because it was a
consumable item transfer part, but it illustrates the effect of numerous
factors on price.

the Office of the Secretary of Defense, the military services, and DLA. The
task force could report its findings to the Secretary of Defense.

Agency Comments In written comments on a draft of this report, DOD concurred
with our principal findings and recommendations. The Department also
provided technical comments, which we have incorporated where appropriate.

DOD's written comments appear in appendix IX. We are sending copies of this
report to the appropriate congressional committees; the Honorable William S.
Cohen, Secretary of Defense; Lieutenant General Henry Glisson, Director,
Defense Logistics Agency; the Honorable Richard Danzig, Secretary of the
Navy; the Honorable F. Whitten

Peters, Secretary of the Air Force; the Honorable Louis Caldera, Secretary
of the Army; General James L. Jones, Commandant of the Marine Corps; and the
Honorable Jacob J. Lew, Director, Office of Management and Budget.

Please contact me at (202) 512- 4125 if you or your staff have any questions
concerning this report. An additional GAO contact and staff acknowledgments
are listed in appendix X.

David E. Cooper, Director Acquisition and Sourcing Management

Appendi Appendi xes x I

Scope and Methodology To determine the extent to which consumable spare part
prices have increased, we selected for review a “market basket”
of items. Since the Defense Logistics Agency (DLA) does not purchase every
spare part each year, our market basket consisted of all the weapon system
spare parts purchased by DLA during fiscal years 1996 through 1998- the most
current data available at the time we initiated this review. Our initial
market basket

contained about 482,000 items representing 25 federal supply groups and 184
federal supply classes.

We removed from further analyses about 85,000 parts that had been
transferred to DLA from the military services because these parts generally
had very limited price histories. Other items were removed that had unit of
issue changes from one year to the next, missing prices, and zero quantity
and/ or dollar sales. We also removed those items with duplicate records.

These steps left 391,217 consumable weapon system spare parts. To ensure
that our universe contained spare parts used by each military service, we
identified the users of each of the 391,217 parts in our database for fiscal
year 1998. Some parts were used by more than one service.

Figure 4 shows the percentage of parts used by each of the military
services.

Figure 4: Percentage of Spare Parts Used by Each Military Service

Marine Corps Army Air Force

Navy 0 10 20 30 40 50 60 70

In percent

DLA provided us with 10 years of purchase and pricing data for each item in
our market basket. DLA extracted the data, covering fiscal years 1989- 98,
from its Standard Automated Materiel Management System. 1 To determine if
the prices of our selected items had increased, decreased, or remained

unchanged, we calculated the average annual change in standard prices over
our 10- year review period. To perform other price trend analyses, we
refined our universe of 391,217 spare parts into two other categories. The
first contained 236,896 items customers had requisitioned in each of the
paired fiscal years in our review

period. The second contained 160,016 spare parts that customers had
requisitioned every fiscal year from 1993 to 1998. We refer to these as
parts in frequent demand.

In addition, to determine why some spare parts experienced extremely high
price increases, we randomly selected 100 items from a universe of 2,993
parts whose prices increased 1,000 percent or more between fiscal year 1997
and 1998. The reasons for these extreme price increases were determined by
DLA through research of its centralized procurement history database,
supplemented by a review of contract files located at the respective defense
supply centers.

In developing our methodology, we worked extensively with DLA officials from
the headquarters Procurement Management Directorate at Fort Belvoir,
Virginia, and with analysts from the Office of Operations Research and
Resource Analysis in Richmond, Virginia. We did not validate or verify the
pricing data provided by DLA. However, we took several steps to address data
quality. We reviewed the data and performed various quality checks that
revealed several errors and discrepancies in the composition of our database
and in prices or quantities of specific spare parts. These errors and
discrepancies were discussed with DLA officials, and the affected items were
deleted from our universe of spare parts. We also asked DLA officials to
complete a questionnaire concerning reliability of data contained in its
Standard Automated Materiel Management System. This questionnaire covered
such topics as frequency

of system edits, audits, and historical reliability of each of the automated
files from which our data were extracted. Results of this questionnaire

1 The number and composition of spare parts in our market basket varied in
each fiscal year of our review period.

showed that extensive edits and validations were built into the structure of
the computer system. In addition, the DOD Inspector General and GAO had
conducted various reviews of the system, addressing such topics as
configuration management, financial integrity, and year 2000 compliance.

We performed our work at DLA headquarters at Fort Belvoir, Virginia, and at
DLA's Office of Operations Research and Resource Analysis, Richmond,
Virginia. In addition, we interviewed officials and gathered documents from
the Defense Supply Centers in Richmond, Virginia; Philadelphia,
Pennsylvania; and Columbus, Ohio, as well as the Office of the Under
Secretary of Defense in Washington, D. C.

We performed our work from November 1998 to August 2000 in accordance with
generally accepted government auditing standards.

Appendi x II

Consumable Item Transfer Program In 1990, the Department of Defense (DOD)
created the Consumable Item Transfer program to transfer management
responsibility of most weapon system and nonweapon system consumable items
from the military services to DLA. The objective of the program was to
eliminate duplication of management of consumable items within DOD by
consolidating management at DLA. The actual transfer of parts was performed
in two phases. Phase I began in fiscal year 1991 and phase II was completed
in

fiscal year 1999. In total, management responsibility for about 915,000
consumable items was transferred from the military services to DLA.
Presently, these transferred items account for about 22 percent of DLA's
total inventory of spare parts.

Prior to the transfer, DLA managed about 67 percent of DOD's consumable
items. After the transfer, DLA managed about 4 million items, or 93 percent
of the Department's consumables. The military services retained
responsibility for a small percentage of consumable items that met DOD
retention criteria.

The program generated complaints from some military services, which
contended that prices increased significantly after DLA assumed management
of their consumable parts. We did not analyze price trends for

these particular parts because the procurement history database for these
items was too limited to make an accurate assessment. According to DLA
officials, in many cases, the military services provided them with very
limited historical procurement and pricing data for the transferred items.

However, two DOD studies did find that prices for transferred parts
increased substantially. First, a study 1 conducted by the Army in 1996
revealed that DLA's prices had risen by more than 20 percent from fiscal
year 1991 to 1997, after the items had been transferred from the Army. A

subsequent study, conducted by DLA in 1997, largely validated these findings
and attributed some of the price increases to inaccurate initial
provisioning price estimates and exceptionally long periods between
procurements.

1 “Customer- Focused Market Basket,” annotated DLA briefing
dated July 1997. This briefing contains results of the internal Army study.

Appendi x I II

Additional Information on Surcharges Two types of surcharges are computed
annually for each DLA hardware center- a composite rate and variable rates.
As part of the annual DOD budget process, DLA's Comptroller proposes a
composite surcharge rate for each hardware center. This rate is determined
by dividing the centers' projected recoverable costs, such as operating
costs, by the sales base. The proposed rates are adjusted as necessary by
Office of the Under Secretary of Defense (Comptroller) officials, who may
add costs that are not directly related to the supply centers' operations.
For example, Comptroller officials may direct that accumulated cash in the
working capital fund be used to reduce rates or that the composite surcharge
rate be increased to generate cash. Once the composite rates are approved,
each supply center establishes variable surcharge rates for the different
categories of consumable items managed. These variable rates are used to set
the standard price that customers pay. The method for computing the variable
rates varies by center and also from year to year. 1 However, each center's
variable rates must total up to the approved composite rate. Regardless of
which method

is used, the overriding goal of each center is to operate on a break- even
basis.

Figure 5 shows the annual composite surcharge rate for each of the three
hardware centers for our 10- year review period. 2

1 For example, the Defense Supply Center- Philadelphia computes its rates
based on the type of part. It has one variable rate for nuts and washers and
another rate for lumber. On the other hand, most variable rates at the
Defense Supply Centers in Columbus and Richmond are based on the average
dollar value of requisitions they receive. 2 Due to the fact that variable
rates differ by commodity, supply center, and fiscal year, we could not plot
these rates.

Figure 5: DLA Composite Surcharge Rates, Fiscal Years 1989 to 1999

60% Percent

50% 40% 30% 20% 10%

0% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Fiscal year Defense Supply Center- Richmond Defense Industrial Supply Center

a Defense Electronics Supply Center

b Defense Construction Supply Center

b Defense Supply Center- Columbus

a The Defense Industrial Supply Center was incorporated into the Defense
Supply Center- Philadephia in July 1999. b The Defense Electronics Supply
Center and the Defense Construction Supply Center were merged in

January 1996 to create the Defense Supply Center- Columbus.

Average Percent Price Change as Measured by

Appendi x V I the Mean Table 3 shows the mean percent price change for parts
that had requisitions during our 10- year review period. Under the
expenditure- weighted approach, parts with higher requisition value received
larger weights and greater emphasis. 1

Table 3: Mean Percent Price Change for Parts Requisitioned by Customers
Fiscal year 1989- 90 1990- 91 1991- 92 1992- 93 1993- 94 1994- 95 1995- 96
1996- 97 1997- 98

Simple average 39 a 315 103 90 68 306 1, 476 388 309 Expenditureweighted 48
264 113 147 63 653 19,540 247 568

average a Numbers indicate percentage change from one fiscal year to the
next.

Table 4 reflects the price changes, excluding parts with price increases of
1,000 percent or more.

Table 4: Mean Percent Price Change for Parts Requisitioned by Customers
(Excludes Parts With Price Increases of 1,000 Percent or More)

Fiscal year 1989- 90 1990- 91 1991- 92 1992- 93 1993- 94 1994- 95 1995- 96
1996- 97 1997- 98

Simple average 11 a 35 18 4 14 15 18 22 22 Expenditure- weighted

15 40 19 7 14 15 18 18 20 average a Numbers indicate percentage change from
one fiscal year to the next.

1 Weights were calculated by dividing the requisition value of each spare
part into total requisition values for a given year. These weights were then
applied to the percentage change in price from the prior year to determine
the expenditure- weighted price changes.

Sample of 100 Parts With Price Increases of

Appendi x V

1,000 Percent or More The following is a list of the parts in our random
sample of items that had a price increase of 1,000 percent or more in 1998.

Federal supply 1997 Unit

1998 Unit Part number class Name of part price price

000589364 5305 Setscrew $0. 05 $17. 72 004435450 5365 Shim 0. 05 56.00
005990523 5331 O- ring 0. 27 3. 40 006283834 5310 Washer, flat 0.18 2.39
006388237 5306 Bolt, machine 0. 28 5. 88 006851133 5315 Pin, straight,
headless 0. 05 1. 15 007167725 5305 Setscrew 0.16 5.74 007243439 5305
Setscrew 0.29 10. 66 008025136 5360 Spring 0. 29 16.18 008373641 5310
Washer, flat 0.02 1.89 008382767 5360 Spring, helical, compression 0. 16 9.
92 008859720 5306 Bolt, machine 0. 46 139. 83 009308643 5905 Resistor,
variable 5.60 95. 88 009372447 5355 Knob 2. 36 31.96 009548952 5305 Screw,
cap, socket head 1.86 23. 32 010039704 3110 Ball, bearing 0. 04 11.35
010086028 5961 Transistor 27.12 440.70 010272003 5305 Screw, close tolerance
0. 95 24.01 010290061 1560 Plate, structural, aircraft 14. 32 236. 40
010313629 4710 Tube assembly, metal 348. 30 6, 989. 18 010413070 4730 Tee,
tube to boss, aluminum alloy 55.63 1,017.00 010460724 5320 Pin- rivet,
threaded 1.42 30. 28 010500591 5950 Transformer, radio 683.28 11, 700. 92
010597589 5340 Cover access 4.10 97. 34 010619725 5935 Connector, plug,
electric 24. 94 306. 08 011174774 4320 Plate, thrust, rotary pump 101. 00 3,
136. 09 011212712 5305 Screw cap socket head 0.49 15. 43 011288817 5315 Pin,
straight headless 22. 00 532. 39 011312183 5306 Bolt, shear 1. 16 17.94
011810876 4720 Hose, nonmetallic 11. 65 414. 94 011859759 5910 Capacitor
20.63 513.92

(Continued From Previous Page)

Federal supply 1997 Unit

1998 Unit Part number class Name of part price price

011931514 5320 Rivet, blind 67.83 1,775.39 011977638 5995 Cable assembly,
electrical 43. 76 1, 214. 70 011999015 5905 Resistor network, fixed, film
2.47 156.79 012421475 5340 Strap, retaining 0. 02 8. 01 012452182 5905
Resistor, fixed, wire wound 0.63 32. 21 012555321 5935 Adapter, cable clamp
0. 99 117. 14 012555392 4320 Pump, hydraulic ram, hand driven 3.10 364.76
012598962 5340 Cap, protective, dust 0.05 15. 75 012642986 5962
Microcircuit, digital 3. 23 208. 44 012644287 5360 Spring, helical,
compression 3. 09 202. 43 012679232 5365 Shim 1. 19 552. 48 012691835 6220
Lens, light 5. 25 65.90 012821586 5365 Spacer, sleeve 1.28 456.14 012939355
6680 Indicator, sight, liquid 28. 75 4, 214. 70 012954939 5999 Shielding
gasket 5.49 1,237.81 013023802 4710 Tube, vent, fuselage 81. 25 10,080.61
013066164 3040 Hub, body 35. 20 14,528.71 013082390 5342 Lock 20.52 358.81
013167468 1650 Block, tube support 0.01 161.83 013196936 5310 Nut, plain,
hexagon 0. 05 14.67 013366722 5330 Gasket 0. 06 16.98 013388158 5305 Screw,
shoulder 1.82 63. 71 013393297 5305 Screw, machine 0. 03 24.68 013395136
5935 Adapter, cable clamp 99.55 1,134.01 013410650 1680 Filter, aircraft 41.
96 972. 71 013498558 5970 Sleeving, textile 0. 13 6. 22 013538270 5305
Screw, tapping 0.03 21. 68 013545776 5305 Screw, tapping 0.03 17. 94
013575767 5310 Washer, slotted 0. 02 18.94 013644415 4730 Tee, tube to boss
2.43 945.46 013685397 5340 Base, stand 0.01 871.81 013713142 5307 Stud, ball
0.30 5.05 013730005 5962 Microcircuit, memory 30. 30 1, 123. 79 013777431
1005 Handle, breechblock 7.90 622.40 013787778 5305 Screw, machine 0. 25
71.75 013801497 5340 Plug, expansion 0. 01 5. 06

(Continued From Previous Page)

Federal supply 1997 Unit

1998 Unit Part number class Name of part price price

013809147 5305 Screw, cap, socket 0.19 33. 59 013818680 2540 Insulation,
thermal 1.00 3,390.00 013819941 5306 Bolt, machine 0. 45 10.56 013838808
5305 Screw, cap, hexagon 0.10 372.02 013913580 5305 Screw, close tolerance
0. 46 136. 33 013932944 2540 Anchor, drivers hatch 15. 38 1, 084. 80
013958465 6680 Meter, flow rate indicating 5.00 1,511.94 013983743 5331 O-
ring 0. 09 26.53 013990465 5365 Spacer, sleeve 0.10 744.80 014060751 5962
Microcircuit, linear 0.11 5,788.76 014061680 5340 Bracket, mounting 5. 00 3,
139. 16 014062881 5962 Microcircuit, digital 21.92 802.75 014062973 4730
Clamp, hose 0.32 91. 66 014079021 5340 Bracket, mounting 4. 57 73.58
014107601 5995 Cable assembly 11. 50 5, 978. 18 014132049 5310 Washer 0. 05
182. 13 014156970 5310 Nut, plain, hexagon 0. 02 1. 04 014176659 4730 Tee,
tube to boss 25. 00 406. 80 014180358 5355 Knob 1. 20 1, 132. 20 014180555
5905 Resistor network 1. 00 24.60 014207932 4820 Disk, valve 150. 00 2, 810.
99 014218260 5930 Switch, sensitive 4. 50 336. 29 014250907 5306 Bolt,
machine 40.00 1,886.62 014261187 1560 Stiffener, aircraft 125.00 3,416.08
014291232 5975 Panel, electrical 1.00 55. 27 014339888 5305 Screw, cap,
socket head 0.35 467.81 014350216 4730 Nipple, boss 1.00 1,498.38 014352372
5310 Nut, self- locking 2.69 2,185.50 014352820 3040 Bracket, eye, rotating
shaft 0. 76 273. 35 014360190 5940 Terminal, lug 1. 42 638. 23 014397927
5963 Oscillator, crystal controlled 1.00 939.71 014442320 5962 Microcircuit,
hybrid 10. 00 2, 745. 90 014482771 5305 Screw, machine 0. 01 9. 34

Appendi x VI

Price Change for All Items Managed Figure 6 shows the annual price change
for all items managed by DLA over the 10- year period. In fiscal year 1998,
customers requisitioned only 236,896 of these items. Figure 6: Price Change
for All DLA- Managed Items

Percent of spare parts 276,780 296, 229 312,595 327, 970 340,223 354, 426
370,559 383, 910 391,217 100%

80% 60% 40% 20%

0% 1989-

1990- 1991-

1992- 1993-

1994- 1995-

1996- 1997-

1990 1991

1992 1993

1994 1995

1996 1997

1998 Fiscal Years

<0% 0 to < 5% 5 to < 50% 50% or more

Appendi x VII

Producer Price Index Table 5 shows the Producer Price Index inflation rate
for the years included in our review. The data are based on the Bureau of
Labor Statistics' Producer Price Index commodity group “Intermediate
Materials, Supplies and Components,” subgroup “Materials and
Components for Manufacturing” (series wpusop 2140). The index for this
group tracks commodities that have been partly processed but require further
processing to reach the finished goods stage. The subgroup we selected
includes items such as motor vehicle parts, electronic components and
accessories, motors, and generators. It excludes such items as processed
fuels, foods, and feeds. Table 5: Percent of Change in the Producer Price
Index

Fiscal year 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Producer 115.375 118. 350 120.500 121. 750 122.750 123. 975 125.950 126. 800
126.525 126. 025 125.750 Price Index

Percent 0.0258 0. 0182 0. 0104 0. 0082 0.0100 0. 0159 0. 0067 -0.0022
-0.0040 -0. 0022 change

Appendi x VI II

Federal Supply Groups in Our Universe Group 10 Weapons Group 12 Fire control
equipment Group 14 Guided missiles Group 15 Aircraft and airframe structural
components Group 16 Aircraft components and accessories Group 17 Aircraft
launching, landing, and ground handling equipment Group 18 Space vehicles
Group 20 Ship and marine equipment Group 25 Vehicular equipment components
Group 26 Tires and tubes Group 28 Engines, turbines, and components Group 29
Engine accessories Group 30 Mechanical power transmission equipment Group 31
Bearings Group 40 Rope, cable, chain, and fittings Group 43 Pumps and
compressors Group 47 Pipe, tubing, hose, and fittings Group 48 Valves Group
53 Hardware and abrasives Group 58 Communication, detection, and coherent
radiation equipment Group 59 Electrical and electronic equipment components
Group 60 Fiber optics materials, components, assemblies, and accessories
Group 62 Lighting fixtures and lamps Group 66 Instruments and laboratory
equipment Group 95 Metal bars, sheets, and shapes

Appendi x IX Comments From the Department of Defense

See p. 17. See p. 17. See p. 17.

See

Appendi x X

GAO Contact and Staff Acknowledgments GAO Contact Karen S. Zuckerstein (202)
512- 6785 Acknowledgments In addition to the name above, Michele Mackin,
William M. McPhail, D.

Catherine Baltzell, Charles W. Perdue, Julia M. Kennon, Minette D.
Richardson, and Richard S. Krashevski made key contributions to this report.

(707449) Lett er

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GAO United States General Accounting Office

Page 1 GAO- 01- 22 DLA Spare Parts

Contents Letter 3 Appendixes Appendix I: Scope and Methodology 20

Appendix II: Consumable Item Transfer Program 23 Appendix III: Additional
Information on Surcharges 24 Appendix IV: Average Percent Price Change as
Measured

by the Mean 26 Appendix V: Sample of 100 Parts With Price Increases of 1,000

Percent or More 27 Appendix VI: Price Change for All Items Managed 30
Appendix VII: Producer Price Index 31 Appendix VIII: Federal Supply Groups
in Our Universe 32 Appendix IX: Comments From the Department of Defense 33
Appendix X: GAO Contact and Staff Acknowledgments 35

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Appendix I

Appendix I Scope and Methodology

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Appendix I Scope and Methodology

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Appendix II

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Appendix III

Appendix III Additional Information on Surcharges

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Appendix IV

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Appendix V

Appendix V Sample of 100 Parts With Price Increases of 1,000 Percent or More

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Appendix V Sample of 100 Parts With Price Increases of 1,000 Percent or More

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Appendix VI

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Appendix VII

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Appendix VIII

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Appendix IX

Appendix IX Comments From the Department of Defense

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Appendix X

United States General Accounting Office Washington, D. C. 20548- 0001

Official Business Penalty for Private Use $300

Address Correction Requested Bulk Rate

Postage & Fees Paid GAO Permit No. GI00
*** End of document. ***