Defense Acquisitions: Navy Needs Plan to Address Rising Prices in
Aviation Parts (31-MAY-02, GAO-02-565). 			 
                                                                 
Since fiscal year 1999, the Navy's budget for repairing spare	 
parts to support its aviation weapons systems has increased by	 
about 50 percent, from $1.2 billion to $1.8 billion. Some	 
military commands have asserted that the escalating cost of these
parts has adversely impacted the funds available for the	 
readiness of military forces. Overall, the prices for Navy	 
repairable spare parts continue to climb for the three aircraft  
and their engines that GAO focused on in its November 2000	 
report. GAO's assessment of selected parts being repaired showed 
that while nearly 45 percent of the parts decreased in price,	 
about 55 percent increased an average of 91.5 percent between	 
fiscal year 1999 and 2002. The price increases were primarily due
to the dramatically higher costs of the materials needed to	 
repair spare parts, although other factors, such as overhead fees
and labor rates, contributed. However, GAO could not determine	 
the underlying causes for the rising material costs because the  
Navy's database lacked key information on each repair. The Navy's
progress in developing an overall plan to identify and address	 
the reasons for higher spare parts prices has been limited. It	 
has not yet identified and implemented ways to reduce and	 
stabilize prices. Further, the Navy has undertaken several	 
initiatives, but most of these efforts focused on improving the  
reliability or the maintenance processes for repairing spare	 
parts rather than on identifying why prices continue to rise. One
initiative, the establishment of an automated serial number	 
tracking system for spare parts, however, has potential for	 
providing the specific information needed to determine why the	 
spare parts prices are increasing and develop a strategy for	 
stabilizing them. In addition, the Navy may learn from the	 
Defense Logistics Agency's efforts to address causes for price	 
increases--thereby allowing the Navy to better apply its	 
resources supporting the readiness of the forces.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-565 					        
    ACCNO:   A03468						        
  TITLE:     Defense Acquisitions: Navy Needs Plan to Address Rising  
Prices in Aviation Parts					 
     DATE:   05/31/2002 
  SUBJECT:   Budget activities					 
	     Military budgets					 
	     Military cost control				 
	     Prices and pricing 				 
	     Spare parts					 
	     AV-8B Aircraft					 
	     F/A-18 Aircraft					 
	     H-53 Helicopter					 
	     Harrier Aircraft					 
	     Hornet Aircraft					 
	     Logistics Engineering Change Proposals		 
	     Program						 
                                                                 

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GAO-02-565
     
Report to Congressional Committees

United States General Accounting Office

GAO

May 2002 DEFENSE ACQUISITIONS

Navy Needs Plan to Address Rising Prices in Aviation Parts

GAO- 02- 565

Page i GAO- 02- 565 Defense Inventory Letter 1

Results in Brief 2 Background 3 Principal Findings 5 Conclusions 12
Recommendations for Executive Action 12 Agency Comments and Our Evaluation
12

Appendix I Scope and Methodology 14

Appendix II 453 Spare Parts with High Costs 16

Appendix III 195 Spare Parts with Reported Price Decreases 17

Appendix IV 258 Spare Parts with Reported Price Increases 18

Appendix V Reported Repair Cost Increases for 31 Parts 19

Appendix VI Implementation of November 2000 GAO Recommendation on Prices of
Navy Aviation Spare Parts 21

Appendix VII Comments from the Department of Defense 22

Tables

Table 1: Changes in Total Repair Costs, by Material and Labor, for Selected
Spare Parts (Fiscal Years 1999 to 2002) 6 Table 2: Reported Increases in
Repair Costs and Customer Prices

for 453 Selected Spare Parts, Fiscal Years 1999 to 2002 16 Contents

Page ii GAO- 02- 565 Defense Inventory

Table 3: Parts with Reported Repair Cost and Customer Price Decreases
Between Fiscal Years 1999 and 2002 17 Table 4: Spare Parts with Reported
Repair Cost and Customer

Price Increases, Fiscal Years 1999 to 2002 18 Table 5: Reported Increases in
Material and Repair Cost for 31

Selected Parts, Fiscal Years 1999 and 2002 19

Page 1 GAO- 02- 565 Defense Inventory

May 31, 2002 The Honorable Daniel K. Akaka Chairman The Honorable James M.
Inhofe Ranking Minority Member Subcommittee on Readiness and Management
Support Committee on Armed Services United States Senate

Since fiscal year 1999, the Navy?s budget for repairing spare parts to
support its aviation weapons systems has increased by about 50 percent, from
$1.2 billion to $1.8 billion. Some military commands have asserted that the
escalating cost of these parts has adversely impacted the funds available
for the readiness of military forces.

This is the fifth in a series of reports on price trends in military spare
parts. 1 This report, along with one on the Defense Logistics Agency (DLA)
issued in April 2002, responds to your most recent request. It follows up on
our November 2000 report on Navy aircraft parts in which we recommended
actions to reduce and stabilize prices and overhead fees for aviation spare
parts. As agreed, we also reviewed (1) the price increases for selected
spare parts to identify the key factors contributing to those increases and
(2) the Navy?s progress in identifying and addressing the underlying causes
for increased repairable spare parts prices.

For this review, we analyzed the repair costs and pricing data, for fiscal
years 1999 to 2002, of 453 selected spare parts from three Navy weapon
systems: the H- 53 helicopter, the F/ A- 18 Hornet fighter and attack
aircraft, and the AV- 8B Harrier attack aircraft and their engines. We chose
these systems because they were the same ones cited in our prior report that
had experienced higher- than- average price increases between fiscal year
1994 and 1999. We then visited two Navy depots to collect detailed

1 U. S. General Accounting Office, Defense Acquisitions: Prices of Marine
Corps Spare Parts Have Increased, GAO/ NSIAD- 00- 123 (Washington, D. C.:
July 31, 2000); Defense Acquisitions: Price Trends for Defense Logistics
Agency?s Weapon System Parts,

GAO- 01- 22 (Washington D. C.: Nov. 3, 2000); and Defense Acquisitions:
Prices of Navy Aviation Parts Have Increased, GAO- 01- 23 (Washington, D.
C.: Nov. 6, 2000). Also, U. S. General Accounting Office, Defense
Acquisitions: Status of Defense Logistics Agency?s Efforts to Address Spare
Part Price Increases, GAO- 02- 505 (Washington, D. C.: Apr. 8, 2002).

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 02- 565 Defense Inventory

information on 31 of the 453 parts to determine why their costs continued to
rise. Our review?s scope and methodology is described in further detail in
appendix I.

Overall, the prices for Navy repairable spare parts continue to climb for
the three aircraft and their engines that we focused on in our November 2000
report. Our assessment of selected parts being repaired showed that while
nearly 45 percent of the parts decreased in price, about 55 percent
increased an average of 91.5 percent between fiscal year 1999 and 2002. The
price increases were primarily due to the dramatically higher costs of the
materials needed to repair spare parts, 2 although other factors, such as
overhead fees and labor rates, contributed. However, we could not determine
the underlying causes for the rising material costs because the Navy?s
databases lacked key information on each repair.

The Navy?s progress in developing an overall plan to identify and address
the reasons for higher spare parts prices has been limited. It has not yet
fully carried out our November 2000 recommendation to identify and implement
ways to reduce and stabilize prices. Further, the Navy has undertaken
several initiatives, but most of these efforts focused on improving the
reliability or the maintenance processes for repairing spare parts rather
than on identifying why prices continue to rise. One initiative, the
establishment of an automated serial number tracking system for spare parts,
however, has potential for providing the specific information needed to
determine why the spare parts prices are increasing and develop a strategy
for stabilizing them. In addition, the Navy may learn from DLA?s efforts to
address causes for price increases- thereby allowing the Navy to better
apply its resources supporting the readiness of the forces.

We are recommending that the Secretary of Defense direct the Secretary of
the Navy to establish accountability within the Naval Supply Systems Command
for preparing an action plan designed to identify and address the underlying
causes of current price increases in aviation spare parts. Such a plan
should incorporate the automated serial number tracking system for
repairable spare parts that is currently under development and

2 Spare parts refer to the components on aircraft, such as airframes,
landing gear assemblies, fuel pumps, and generators that, when they fail to
perform properly or reach the end of their service life, must be replaced
with repaired (reconditioned) or newly purchased parts. These spare parts or
components are manufactured from thousands of individual parts. These
individual parts are also referred to as ?materials? in this report. Results
in Brief

Page 3 GAO- 02- 565 Defense Inventory

lessons from DLA?s efforts to address price increases. While the Department
of Defense (DOD) generally concurred with the recommendations in this
report, its response did not address the need to develop an overall plan
with accountability to identify the underlying reasons for price increases
in aviation spares.

Spare parts are defined as repair parts and components, including kits,
assemblies, and subassemblies required for the maintenance of all equipment.
Repair parts and components can include repairable parts, which are returned
to the supply system to be fixed when they are no longer in working
condition, and consumable parts, which cannot be repaired cost- effectively.
3

The Navy owns and operates about 4,000 aircraft. These aircraft contain
about 70,000 repairable spare parts, such as landing gear, navigational
computers, and hydraulic pumps. These spare parts, in turn, consist of
thousands of individual parts or items. When any of these spare parts or
individual items fails to perform properly, or reaches the end of its
service life, it must be replaced with a repaired or newly purchased part.
This maintenance work takes place at government repair facilities and
commercial contractor facilities across the country. Providing logistics
support for these aircraft is the responsibility of the Naval Air Systems
Command and the Naval Supply Systems Command. Overall Navy logistics
policies and procedures are the responsibility of the Deputy Chief of Naval
Operations (Logistics).

The Navy?s repairable spare parts are managed under the Navy Working Capital
Fund. This is a revolving fund that relies on revenues generated from the
sale of parts and services to customers, which are then used to finance
subsequent operations. The fund is expected to generate sufficient revenues
to cover the full cost of operations and to break even over time- that is,
not to have a gain or a loss. Customers order parts from the Navy?s supply
system and pay the working capital fund from their budgets. Each fiscal
year, the Navy establishes the prices for spare parts, setting them to
correspond with the customers? aggregate budgeted amounts. This concept, in
theory, ensures that customers have, in the aggregate,

3 Most consumable parts are managed by the DLA rather than by the military
services, and thus are not considered in this report, but are discussed in
GAO- 02- 505. Background

Page 4 GAO- 02- 565 Defense Inventory

sufficient funds budgeted to purchase their anticipated requirements of
spare parts.

The process of setting prices for spare parts begins 2 years before the
fiscal year in which the prices take effect and involves customers, a number
of Navy entities, and the Office of the Under Secretary of Defense
(Comptroller). During this process, the customer price is set on the basis
of projected customer requirements, as well as anticipated repair costs and
management overhead fees. 4 Figure 1 shows the major elements that are
considered in developing the customer price for Navy spare parts.

Figure 1: Major Elements Considered in Developing a Customer Price

4 For repairable parts, the Navy sets two prices for its customers, the
standard price and the net price. Standard price represents the cost should
the supply system need to purchase a new part. Net price represents the
standard price reduced by the value of the broken repairable part returned
to the supply system. Since the broken part is returned to the supply system
in about 90 percent of the fleet transactions, we focused on the net price.

Page 5 GAO- 02- 565 Defense Inventory

In our recent review of prices for a selected group of spare parts for three
Navy aircraft and their engines that we examined in the November 2000
report, we found that prices continued to rise. Our analysis suggested that
the major factor driving these increases was the cost of the materials used
to repair spare parts, while other factors, such as higher overhead fees and
growing labor costs, also contributed. However, because of the lack of
relevant information in the Navy?s maintenance and repair databases, we were
unable to determine what the underlying reasons were for the increases and
as a result, what management action might be appropriate to reduce or
stabilize the prices.

The prices of repairable aviation spare parts continued to increase
dramatically. Between fiscal year 1999 and 2002, the total cost of spare
parts increased from $1.6 billion to $2.7 billion. Of this total, the repair
portion rose from $1.2 billion to $1.8 billion, an increase of 50 percent
and represented 6.6 and 8.3 percent, respectively, of the Navy and Marine
Corps? operation and maintenance funds that are used to sustain the
readiness of the operating forces.

Our analysis of 453 selected spare parts showed that the prices paid by
customers increased an average of 37 percent between fiscal year 1999 and
2002 (see app. II). We looked at these because they were the most costly
repair parts 5 from three aircraft (the H- 53 helicopter, the F/ A- 18
Hornet fighter and attack aircraft, and the AV- 8B Harrier attack aircraft)
and their engines. We found that the prices for 195 of the 453 parts dropped
an average of almost 35 percent (see app. III) due to reductions in both
repair costs and overhead fees. The prices for the remaining 258 parts,
however, spiraled dramatically- an average of 91. 5 percent during the 3-
year period (see app. IV). The price hikes for 233 of the 258 spare parts
(90 percent) were primarily due to higher repair costs, while those for the
remaining 25 (10 percent) were due to higher management overhead fees.

We selected 31 spare parts from the total population of 453 to identify the
factors driving increases in repair costs. These parts were all repaired at

5 The most costly repair parts are determined by multiplying the unit price
by the quantity demanded. Principal Findings

Selected Spare Parts Price Increases Are Driven by Higher Material Costs

Prices of Repairable Spare Parts Rise

Cost of Materials Drives Increases in Repair Costs

Page 6 GAO- 02- 565 Defense Inventory

government depots. As table 1 shows, the average increases in total repair
costs for these 31 parts varied widely- from a modest 8 percent for the F/
A- 18 Hornet aircraft to more than 200 percent for two engine systems (F-
402 and T- 64). A closer look at the repair data indicated that the largest
increases were generally attributable to the higher costs of the materials
used to repair the spare parts, while a smaller increase resulted from
higher labor costs.

Table 1: Changes in Total Repair Costs, by Material and Labor, for Selected
Spare Parts (Fiscal Years 1999 to 2002)

System Spare parts (no.)

Avg. increase in labor

cost (%)

Avg. increase in material

cost (%)

Avg. increase in total repair cost

(%)

AV- 8B Harrier 4 1. 7 137.5 39.0 F- 402 engine 6 41.8 407.6 227.6 H- 53
helicopter 6 42.9 94.0 67.4 T- 64 engine 6 23.5 251.8 202.9 F/ A- 18 Hornet
4 29.8 22.4 7. 9 F- 404 engine 5 14.7 284.9 167.1

Total/ average 31 27.4 212.4 129.4

For example, one of the parts, a rotor compressor for the F- 402 engine,
increased over 86 percent in price from $48,890 in fiscal year 1999 to
$91,060 in fiscal year 2002. The material portion of the costs for repair
had increased from $16,386 to $57,727 (over 252 percent), while labor had
decreased from $10, 739 to $9, 092 (approximately 15 percent) and overhead
had increased less than 12 percent from $21, 765 to $24,241. (See app. V for
detailed repair cost data for each part.) 6

Figure 2 shows how the cost components contributed to the price that
customers paid for another of these parts, a $45,120 turbine rotor for the
F- 404 engine in fiscal year 2002. It shows that a significant portion ($
30,893, or 69 percent) of the price stemmed from the cost of the materials
used to fix the rotor.

6 We selected the 31 parts because they represented the most costly items
being repaired for each of the systems, as of March 2001. We did not attempt
to identify the underlying reasons that six of these parts decreased in
price over fiscal years 1999 to 2002.

Page 7 GAO- 02- 565 Defense Inventory

Figure 2: Costs Considered in Establishing the Customer Price for a Turbine
Rotor in Fiscal Year 2002

A recent Naval Air Systems Command study underscored that rising material
costs used in repairing spare parts are a contributing factor to price
increases. The study compared repair costs in its maintenance facilities for
the first quarter of fiscal year 1997 with those for the first quarter of
fiscal year 2000. It concluded that while the average annual repair costs
for more than 26,000 parts increased by 5 percent, the cost of materials
rose by 8 percent; in contrast, labor costs rose less than 1 percent.
Furthermore, the study showed that in the case of 105 highdemand parts
material costs jumped by about 16 percent while labor costs increased by 3
percent.

We found a similar link between higher material costs and repairable spare
parts price increases. Our examination of the aggregate prices of individual
repair items used in the 31 spare parts indicated that three factors may
have contributed to higher material costs for 25 of these parts: (1) higher
prices for individual repair parts used, (2) the use of more parts in the
repair process, and (3) changes in the mix of repair parts used. Another
possible factor identified through discussions with Navy officials was that
some repairs used new, more expensive repair parts. However, the Navy?s data
systems did not provide sufficient information on each

Page 8 GAO- 02- 565 Defense Inventory

repair event to allow us to determine why the prices increased for each
spare part. For example, we could discern that more material had been used
in a repair, but we could not determine why this had happened: Had
maintenance procedures changed? Was the repairable part in unusually poor
condition? Had there been extensive cannibalization of the part?s
components? Or were there other reasons? Without more specific information
on each spare part or repair event, management would not be able to
determine- or address- the reasons for rising repair costs.

As noted above, our ability to determine the reasons for rising spare part
costs was impaired because the Navy lacked an effective data system to
collect and analyze information relevant to material costs and usage. The
current data system tracks repair costs for groups of spare parts but not
for individual parts. The costs are accumulated for the group, divided by
the number of spare parts in the group and analyzed as an average cost per
item in the group. As a result, government repair facilities cannot
determine the cause of significant increases in repair costs for an
individual spare part. For example, the average reported material cost for
individual repair parts needed to repair compressors for the F- 402 engine
increased from $14,269 in fiscal year 1998 to $65,494 in fiscal year 2000.
While the detailed requisition data identifies what materials were ordered,
it is impossible to determine- when more than one repair is associated with
the requisition- how much of the material was used in a specific repair.
Consequently, the fact that more material is being used on multiple repairs
can be discerned, but not the reason for the increased usage. In addition,
there is no indication of whether the differences in materials ordered are
due to the repair of one part or to the group as a whole.

The Navy has made little progress in identifying the underlying causes of
spare parts price increases. While it has various initiatives aimed at
reducing overall costs, it does not have a planned set of actions to
identify the underlying causes of price increases. The Navy has only
partially implemented a recommendation we made in our November 2000 report
to identify and implement solutions to reduce and stabilize prices. It has
undertaken several initiatives to control repair costs, but these have
centered on enhancing the reliability and maintenance process, which could
help stabilize prices for repairable parts. However, they do not deal with
the underlying reasons for cost increases. One new initiative, which will
allow the Navy to track individual spare part items by their serial numbers,
may provide the tool it needs to effectively monitor and control its spare
part prices. Also, the Navy might learn from DLA?s efforts to address price
increases for consumable spare parts. Available Data Limits Ability to

Identify Causes for Price Increases

Navy Lacks an Overall Plan to Identify Underlying Causes of Price Increases

Page 9 GAO- 02- 565 Defense Inventory

Of three recommendations we made in our November 2000 report, the first one,
which was directly concerned with investigating why prices were rising, has
been only partially implemented. This one recommended that the Secretary of
Defense ensure that the Navy follow through on the results of its planned
studies by identifying and implementing solutions to reduce and stabilize
prices. See appendix VI for a discussion of the other two recommendations.

To start addressing this recommendation, the Navy has undertaken some cost-
controlling initiatives aimed at improving the reliability of spare parts
and is implementing a serial number tracking program to improve inventory
management. However, to date, the initiatives have not focused on
identifying the reasons for price increases.

The Navy?s recent initiatives and studies (by contractors, headquarters, and
repair depots) center on improving the reliability of its aviation spare
parts in order to control its flying hour costs. Conceptually, if the
reliability of parts used in the Navy?s aviation systems is improved, then
the demand for those parts will fall since they will not be replaced as
often, and the cost to the flying hour program will be reduced. While this
approach has merit, it focuses only on the demand side of the total flying
hour program cost equation. 7 As a result, significant price increases or
decreases can occur without management being aware of the underlying causes.

An April 2001 study by the Center for Naval Analyses showed that the cost of
repairable parts continued to climb, even though the number of Navy flight
hours recorded decreased. In examining why the cost per flying hour
increased from fiscal year 1992 to fiscal year 1999, the study concluded
that the main reasons were a decline in the number of hours flown and the
increased age of Navy aircraft. The study also found that price increases
for spare parts, overhead costs, quantity of materials ordered, and the mix
of spare parts ordered also contributed significantly to higher flying hour
costs. Price increases were identified as a significant factor that should
be studied further. A Navy logistics official told us the service has used
the study to justify a potential 2 percent budget increase for repairable
spare parts starting in fiscal year 2000.

7 This approach could be more costly to the Navy?s overall budget if the
reliability improvement resulted in substantial parts price increases.
Partial Implementation of Past

Recommendation Related to Price Increases

New Initiatives Focus on Improving Reliability and Repair Processes

Page 10 GAO- 02- 565 Defense Inventory

The Navy has recently undertaken a number of initiatives, such as the
Logistics Engineering Change Proposals program, 8 that are designed to
control the costs of individual spare parts by improving their reliability.
These efforts focus on improving the reliability of repairable parts, and
thereby reducing demand while reducing or eliminating support costs.
Repairable parts are selected for the study on the basis of their high
historical costs and low reliability. Then the proposals are evaluated to
determine whether a change in the part would be justified based on the
anticipated investment return equal to two times the cost within 5 years.
While these efforts have resulted in some significant reported cost savings,
they have been geared toward increasing the reliability of parts, thereby
reducing the total costs of these parts.

Other ongoing initiatives are directed at streamlining the maintenance
operations at government repair facilities, and thus potentially lowering
the overhead costs that are charged to repairs. The Business Process
Reengineering effort, which began in fiscal year 1999, focuses on the repair
and modification process at the government repair facilities. Through this
effort, the Navy expects to reduce its acquisition costs and overhead
charges by adopting new acquisition methods, such as prime vendors, direct
vendor deliveries, and electronic commerce. It also expects to reduce its
labor costs by automating the requisition process, outsourcing material
handling functions, and improving the workload forecasting process. It plans
to achieve additional savings from its component repair segment in the form
of increased part reliability. Another related initiative is the
Manufacturing Resource Planning effort, scheduled for completion by the end
of fiscal year 2002. This initiative is designed to cut costs by reducing
inventories and shortening lead times on parts requisitions at government
repair facilities. It will do this by developing a more efficient and
effective process for forecasting the demand for repair parts and more
closely aligning this demand with ordering parts with anticipated workloads.

One promising initiative- a serial number tracking system for the Navy?s
inventory of parts- has the potential for identifying the underlying reasons
for price changes. This effort was initiated by the Naval Aviation

8 Logistics Engineering Change Proposals are Naval Inventory Control Point
sponsored reliability or maintainability changes designed to reduce or
eliminate support costs while maintaining or improving safety and
performance. Tracking System May Identify

Causes of Repair Cost Hikes

Page 11 GAO- 02- 565 Defense Inventory

Maintenance Supply Readiness group, 9 which recognized that the Navy needed
to acquire comprehensive information on its entire inventory in order to
reduce its overall costs.

As a result, in November 1998 it tasked the Naval Supply Systems Command to
begin developing a serial number tracking system designed to (1) reduce
total inventory ownership costs, (2) reduce secondary inventory levels, and
(3) enhance customer satisfaction.

This tracking system is designed to collect data on individual parts
throughout the Navy?s supply and maintenance systems. The Navy recently
completed testing its serial number tracking effort and began installing
?smart buttons? (an automatic identification technology) on depot- level
repairable parts for the H- 53 helicopters. The smart buttons store all of
the necessary identification (including part and serial number), mission
configuration, repair requirements, and repair history information for that
particular part.

The Navy plans to install this technology throughout its fleet by fiscal
year 2005, at an estimated cost of $58 million appropriated over fiscal
years 2002 through 2005. Navy officials believe the tracking system will be
helpful in identifying the causes of rising parts costs and decreases in
reliability. For example, it could be used to analyze parts usage at
maintenance facilities and the effectiveness of maintenance actions. It
could also be used to evaluate different maintenance concepts, such as
performing complete overhauls versus only repairing parts as necessary.

As stated in our April 2002 report, DLA has undertaken a range of efforts to
address significant consumable spare parts price increases. It recently
completed two price trend analyses, is examining the causes for these
increases, and plans to provide detailed explanations and remedies in a
report to DOD. In addition, DLA has other efforts underway, including three
technology initiatives, aimed at providing better information for
determining price reasonableness.

9 The Naval Aviation Maintenance Supply Readiness group consists of
representatives from Commanders In Chief Atlantic and Pacific Fleets,
Commander of the Naval Air Systems Command, and the Commander of the Naval
Supply Systems Command. DLA?s Efforts to Address

Causes for Price Increases Might Benefit the Navy

Page 12 GAO- 02- 565 Defense Inventory

As the overall prices of repairable spare parts continue to rise, the Navy
is making efforts to control total costs by improving the reliability of
spare parts and by reducing its overhead maintenance costs. However, it does
not have clear accountability and a planned approach to determine why the
prices are changing- increasing or decreasing. Consequently, the Navy lacks
the information to identify what management steps it can take to control
prices. The deployment of a serial number tracking system, designed to
accumulate detailed repair and use information on individual spare parts and
their components, represents a vehicle for providing managers with the
information they need to identify underlying causes for price increases. In
addition, DLA has efforts underway to address underlying causes for price
increases.

In order to develop the information and action necessary to address the
underlying causes for price increases, we recommend that the Secretary of
Defense direct the Secretary of the Navy to:

Develop an overall plan with implementation milestones, resource
requirements, and accountability within the Naval Supply Systems Command to
identify the underlying reasons for price increases in aviation spare parts.
The plan should include, but not be limited to, using the comprehensive data
on individual spare parts from the serial number tracking system now under
development, as well as lessons learned from DLA?s efforts to address price
increases.

Utilize information generated from the plan?s initiatives to develop
management strategies, which provide assurance that future prices represent
a reasonable cost to the customer.

In written comments on a draft of this report, DOD generally agreed with our
principle findings and recommendations. The comments focused on the positive
steps the Navy has taken to address the rising costs associated with spare
parts within the flying hour program. In particular DOD stressed that
ongoing initiatives such as Logistics Engineering Change Proposals are
implemented to reduce overall costs to the Navy, not hold them steady. This
report was adjusted to reflect this point. However, DOD?s response did not
address the need to develop an overall plan with accountability to identify
the underlying reasons for price increases in aviation spares. We continue
to believe these actions are necessary and, as part of our normal follow- up
process, in the future will assess the Conclusions

Recommendations for Executive Action

Agency Comments and Our Evaluation

Page 13 GAO- 02- 565 Defense Inventory

actions taken and make any additional recommendations that we believe are
appropriate.

The Department?s comments are reprinted in their entirety in appendix VII.

We are sending copies of this report to interested congressional committees,
the Secretaries of Defense and the Navy; the Commandant of the Marine Corps;
and the Director, Office of Management and Budget. We will also make copies
available to others upon request. In addition, the report will be available
at no charge on the GAO Web site at http:// www. gao. gov.

Please contact me at (202) 512- 8412 if you or your staff have any questions
regarding this report. Key contributors to this report were Richard Payne,
John Wren, Daniel Omahen, Nancy Rothlisberger, Jason Jackson, John Van
Schaik, and Nancy Benco.

David R. Warren Director, Defense Capabilities

and Management

Appendix I: Scope and Methodology Page 14 GAO- 02- 565 Defense Inventory

To identify the key factors contributing to price increases, we performed an
analysis of selected repairable spare parts. Specifically, we chose 453
repairable parts used in the F/ A- 18, AV- 8B, and H- 53 aircraft and
helicopters and their engines and analyzed the pricing and repair cost
trends. These three systems and their engines had been identified, in our
November 2000 report, as having experienced higher- than- average price
increases. The 453 were the most costly parts, in terms of the amounts that
Navy customers spent (the unit price multiplied by the quantity sold), based
on the most recent data available at the time of our review.

Our review of the 453 parts showed that prices increased primarily because
of higher repair costs. We then selected 38 parts that had the largest
repair cost increases for further review. We found that 31 of these parts
were repaired at government facilities, and we obtained and analyzed their
costs during fiscal years 1999 through 2002 as provided by either the Naval
Inventory Control Point or the applicable Naval Aviation Depot. After
finding that increased repair costs were due to higher material costs used
in the repairs, we obtained detailed lists of the orders for these
materials. To better understand the general reasons for the cost increases,
we analyzed the quantities ordered and the prices paid for them during
fiscal years 1998 through 2001. We also discussed the reasons for major
material and labor cost increases with officials at the Naval Aviation
Depots at Cherry Point, North Carolina, and Jacksonville, Florida.

To assess the Navy?s progress in identifying and addressing the underlying
causes for increased prices of spare parts, we (1) identified and reviewed
prior GAO reports as well as Navy studies and initiatives relating to
controlling total costs and (2) evaluated Navy actions to implement the
recommendations of our November 2000 report. We obtained studies on the
rising costs of repair parts and held discussions with responsible officials
at the Center for Naval Analyses, the Naval Center for Cost Analysis, and
the Naval Audit Service. We also discussed and obtained information on the
status of the Navy?s Aviation Maintenance Supply Readiness Group?s efforts
to address the repair part cost and reliability issues with Naval Air
Systems Command officials as well as information on the status of corrective
actions from the Navy?s Web Site. We also reviewed the Navy?s Logistics
Transformation Plan for fiscal year 2000 and the Navy and Marine Corps?
report on the best commercial inventory practices for the third quarter of
fiscal year 2001 to identify initiatives aimed at mitigating price
increases. We discussed several of these and other initiatives with
officials at the Naval Supply Systems Command, Naval Inventory Control
Point, Naval Air Systems Command, and Naval Aviation Depots at Jacksonville,
Florida, and Cherry Point, North Carolina. Appendix I: Scope and Methodology

Appendix I: Scope and Methodology Page 15 GAO- 02- 565 Defense Inventory

In evaluating the Navy?s progress in implementing our recommendations, we
relied on information gathered on various studies and initiatives as well as
on discussions with officials at Navy headquarters and the Naval Supply
Systems Command.

We did not independently verify the pricing data provided by the Naval
Supply Systems Command or the Naval Aviation Depots. However, recognizing
that it was official data, we took several steps to address its quality.
Specifically, we tested the completeness of the data, looking for empty or
questionable fields. We identified some discrepancies in the data and
discussed them with Naval Supply Systems Command and depot officials. Where
appropriate, we adjusted the data based on additional information they
provided. We performed our review between June 2001 and May 2002 in
accordance with generally accepted government auditing standards.

Appendix II: 453 Spare Parts with High Costs Page 16 GAO- 02- 565 Defense
Inventory

The 453 most costly repair parts for the 3 aircraft and their engines, which
we focused on in our November 2000 report, have continued to experience
price increases since fiscal year 1999. Table 2 summarizes the average
increase in the repair cost for the parts, the average increase in what the
supply system charged its customers, as well as the annual rate of increase
for the parts selected for review. Overall, the average increase in the
price charged to customers for these parts was 37.2 percent between fiscal
year 1999 and fiscal year 2002.

Table 2: Reported Increases in Repair Costs and Customer Prices for 453
Selected Spare Parts, Fiscal Years 1999 to 2002 System Spare parts (no.)
Avg. increase in

repair cost (%) Avg. increase in customer price (%)

Avg. annual rate of customer price

increase (%)

AV- 8B Harrier 99 23.7 24.0 7. 4 F/ A- 18 Hornet 92 37.6 22.9 7. 1 H- 53
helicopter 98 69.9 58.9 16.7 F- 402 engine 66 44.4 37.7 11.2 F- 404 engine
58 35.2 28.1 8. 6 T- 64 engine 40 67.4 62.6 17.6

Total/ average 453 44.8 37.2 11.1

Appendix II: 453 Spare Parts with High Costs

Appendix III: 195 Spare Parts with Reported Price Decreases

Page 17 GAO- 02- 565 Defense Inventory

Within the population of 453 parts, there were 195 parts that experienced a
drop in the customer price between fiscal year 1999 and 2002. Table 3
summarizes the average decrease in the repair cost, the average decrease in
what the supply system charged its customers, and the annual rate of
decrease for the parts. The average decrease in price for these 195 parts
was about 35 percent.

Table 3: Parts with Reported Repair Cost and Customer Price Decreases
Between Fiscal Years 1999 and 2002 System Spare parts (no.) Avg. decrease in

repair cost (%) Avg. decrease in customer price (%)

Avg. annual rate of customer price

decrease (%)

AV- 8B Harrier 48 32.5 33.4 12.7 F/ A- 18 Hornet 53 26.5 34.1 13.0 H53
helicopter 28 22.1 29.1 10.8 F- 402 engine 30 38.8 41.6 16.4 F- 404 engine
24 32.6 36.3 14.0 T- 64 engine 12 29.7 32.8 12.4

Total/ average 195 30.2 34.6 13.2

Appendix III: 195 Spare Parts with Reported Price Decreases

Appendix IV: 258 Spare Parts with Reported Price Increases

Page 18 GAO- 02- 565 Defense Inventory

Almost 60 percent, 258 of the 453 parts experienced an increase in price
between fiscal year 1999 and 2002. Table 4 summarizes the average increase
in the repair cost, the average in what the supply system charged its
customers, and the annual rate of increase for these parts. Price increases
for these 258 parts averaged 91. 5 percent.

Table 4: Spare Parts with Reported Repair Cost and Customer Price Increases,
Fiscal Years 1999 to 2002 System Spare parts (no.) Avg. increase in

repair cost (%) Avg. increase in customer price (%)

Avg. annual rate of customer price

increase (%)

AV- 8B Harrier 51 76.5 78.1 21.2 F/ A- 18 Hornet 39 124.6 100.3 26.1 H53
helicopter 70 106.7 94.1 24.7 F- 402 engine 36 113.7 103.8 26.8 F- 404
engine 34 83.0 73.5 20.2 T- 64 engine 28 109.1 103.4 26.7

Total/ average 258 101.5 91.5 24.2

Appendix IV: 258 Spare Parts with Reported Price Increases

Appendix V: Reported Repair Cost Increases for 31 Parts

Page 19 GAO- 02- 565 Defense Inventory

Table 5: Reported Increases in Material and Repair Cost for 31 Selected
Parts, Fiscal Years 1999 and 2002 National Item Identification Number
System/

engine Description FY99

material cost ($)

FY99 government

repair cost ($)

FY02 material

cost($) FY02

government repair cost ($) Change in

material (%) Change in

government repair (%)

995775996 F- 402 Tube, engine 1,450.00 2,529.80 15,976.00 18,066.99 1001.79
614.17 012016017 F- 404 Stator assembly,

fan 1, 632.00 2,904.00 12,176.00 15,223.00 646.08 424.21 001645872 T- 64
Nozzle,

turbine 4, 078.00 4,980.22 24,847.00 26,021.46 509.29 422.51 990625791 F-
402 Gearbox,

accessory 1,511.00 4,068.62 15,135.00 19,143.67 901.65 370.52 013896529 F-
404 Rotor, low

pressure turbine 3,181.00 6,051.00 25,681.00 27,325.00 707.32 351.58
013514848 T- 64 Nozzle,

turbine 3,078.00 3,571.50 13,997.50 15,063.39 354.76 321.77 013297911 H- 53
Camshaft

assembly 2,073.00 4,338.80 11,500.00 15,256.86 454.75 251.64 012866704 T- 64
Nozzle,

turbine 4, 181.00 6,134.46 18,111.00 19,159.05 333.17 212.32 995550105 F-
402 Hub, rotor,

gas turbine 25,697.00 29,865.40 79,680.00 88,484.40 210.08 196.28 012991530
T- 64 Nozzle,

turbine 3, 401.00 4,480.80 10,998.50 12,155.63 223.39 171.28 011506952 F-
402 Rotor,

compressor 16,386.00 27,125.14 57,727.00 66,818.90 252.29 146.34 013664970
F- 404 Rotor,

turbine 13,040.00 15,524.00 30,893.00 33,193.00 136.91 113.82 011506731 F/
A- 18 Cylinder and

piston 17,107.50 29,006.50 26,060.00 52,990.50 52.33 82.68 011723653 AV- 8B
Servo cylinder 811.00 4,690.26 4,380.00 7,916.65 440.07 68.79

993318213 F- 402 Chamber, combustion 18,814.00 34,927.17 38,766.00 57,166.96
106.05 63.67 012809889 H- 53 Cooler,

fluid gearbox 1, 266.50 2,951.80 706.50 4,684.08 -44.22 58.69 012185661 H-
53 Head,

rotary wing 130,151.00 248,777.73 260,546.00 386,193.26 100.19 55.24
012854668 T- 64 Rotor,

turbine 30,757.00 35,864.21 50,391.00 54,370.11 63.84 51.60 001676758 AV- 8B
Generator,

alternating 6, 992.00 9,403.26 11,966.00 13,710.36 71.14 45.80 013642188 T-
64

Liner, combustion chamber 2,184.50 3,622.79 2,753.50 4,994.88 26.05 37.87

014290072 H- 53 Wheel, landing gear 521.00 1,733.77 869.00 2,345.24 66.79
35.27 013177867 AV- 8B Generator- starter 10,010.00 18,254.88 13,500.00
24,058.96 34.87 31.79

012813618 H- 53 Gearbox, accessory 15,141.00 25,254.12 18,843.50 31,055.58
24.45 22.97

Appendix V: Reported Repair Cost Increases for 31 Parts

Appendix V: Reported Repair Cost Increases for 31 Parts

Page 20 GAO- 02- 565 Defense Inventory

National Item Identification Number System/

engine Description FY99

material cost ($)

FY99 government

repair cost ($)

FY02 material

cost($) FY02

government repair cost ($) Change in

material (%) Change in

government repair (%)

013000940 F/ A- 18 Optics, stabilizer 4,957.00 19,241.00 11,010.00 21,857.00
122.11 13.60

011970008 AV- 8B Landing gear, retractable 11,660.00 22,662.40 12,131.00
24,815.62 4.04 9.51

013513373 F/ A- 18 Servo cylinder 5,573.00 8,120.00 5,112.25 8,034.50 -8.27
-1.05 014077972 F- 404 Stator,

compressor 22,681.67 27,290.00 19,334.00 24,016.67 -14.76 -11.99 013901118
H- 53 Servo cylinder 5,090.50 8,813.59 3,146.00 7,125.62 -38.20 -19.15

011626087 F- 402 Turbine, high pressure 111,006.00 113,923.26 82,099.00
84,727.27 -26.04 -25.63 013693370 F- 404 Chamber,

combustion 9,271.75 12,753.00 4,537.25 7,400.00 -51.06 -41.97 014426420 F/
A- 18 Pylon,

aircraft 27,070.00 32,302.00 6,358.00 11,714.00 -76.51 -63.74

Average 212.40 129.37

Appendix VI: Implementation of November 2000 GAO Recommendation on Prices of
Navy Aviation Spare Parts

Page 21 GAO- 02- 565 Defense Inventory

The Navy?s efforts to implement the recommendations from our November 2000
report on the rising prices of aviation depot- level repairable parts have
been mixed. The report contained three recommendations: (1) the Secretary of
Defense ensure that the Navy follow through on the results of its planned
studies by identifying and implementing solutions to reduce and stabilize
prices and surcharge rates, (2) the Secretary of Defense direct the Navy to
allocate condemnation costs to the specific parts or groups of parts
incurring the costs, and (3) the Secretary of Defense report to the Congress
on the Navy?s progress in addressing these recommendations.

The Navy has only partially implemented our first recommendation. The Navy
has undertaken some cost controlling measures aimed at improving reliability
and is implementing a serial number tracking program to improve inventory
management, as discussed above.

The Navy has implemented the second recommendation by adjusting its pricing
practice such that condemnation costs are being allocated to specific groups
of repairable parts. Beginning in fiscal year 1999, the Navy started
allocating certain costs to the parts that incur those costs. Initially,
transportation costs were allocated using this approach. The Navy began
allocating condemnation and obsolescence costs in this manner in fiscal year
2000. At the same time, the Navy instituted a tiered pricing strategy to
allocate general overhead costs and specific, identifiable costs based on
the level of management required. These efforts have resulted in a better
match of expenses with specific parts.

In response to our third recommendation, the Navy has only partially
reported the results of its efforts to implement the first two
recommendations to the Congress. In its fiscal year 2003 budget submission,
the Navy reported its efforts to allocate condemnation costs, as well as
transportation and obsolescence costs, to specific groups of parts. In
addition, the Navy reported it was taking action to limit the general
overhead rate to 30 percent or less. However, the Navy did not report any
specific actions to reduce and stabilize prices. Appendix VI: Implementation
of November

2000 GAO Recommendation on Prices of Navy Aviation Spare Parts

Appendix VII: Comments from the Department of Defense

Page 22 GAO- 02- 565 Defense Inventory

Appendix VII: Comments from the Department of Defense

Appendix VII: Comments from the Department of Defense

Page 23 GAO- 02- 565 Defense Inventory (350078)

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