Defense Inventory: Analysis of Consumption of Inventory Exceeding
Current Operating Requirements Since September 30, 2001 	 
(02-AUG-04, GAO-04-689).					 
                                                                 
Since 1990, GAO has identified the Department of Defense's (DOD) 
inventory management as a highrisk area. Ineffective management  
practices--such as the use of inaccurate data, lack of inventory 
controls and visibility, and information system weaknesses--have 
contributed to high levels of inventory. DOD has reduced its	 
inventory since 1990, from about $100 billion to about $67	 
billion as of September 30, 2002. However, at the start of	 
Operation Enduring Freedom, about half of the inventory exceeded 
current operating requirements. GAO, under its statutory	 
authority, analyzed the extent to which inventory that exceeded  
current operating requirements as of September 30, 2001, was	 
consumed through cutoff dates ranging from March through October 
2003 and identified three ineffective and inefficient inventory  
management practices.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-689 					        
    ACCNO:   A11166						        
  TITLE:     Defense Inventory: Analysis of Consumption of Inventory  
Exceeding Current Operating Requirements Since September 30, 2001
     DATE:   08/02/2004 
  SUBJECT:   Defense cost control				 
	     Defense economic analysis				 
	     Inventory control					 
	     Inventory control systems				 
	     Logistics						 
	     Military inventories				 
	     Military systems analysis				 
	     Property and supply management			 
	     Spare parts					 
	     Surplus federal property				 

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GAO-04-689

                 United States Government Accountability Office

                     GAO Report to Congressional Committees

August 2004

DEFENSE INVENTORY

 Analysis of Consumption of Inventory Exceeding Current Operating Requirements
                            Since September 30, 2001

                                       a

GAO-04-689

Highlights of GAO-04-689, a report to Senate and House Committees on Armed
Services and the Subcommittees on Defense, Senate and House Committees on
Appropriations

Since 1990, GAO has identified the Department of Defense's (DOD) inventory
management as a highrisk area. Ineffective management practices-such as
the use of inaccurate data, lack of inventory controls and visibility, and
information system weaknesses- have contributed to high levels of
inventory. DOD has reduced its inventory since 1990, from about $100
billion to about $67 billion as of September 30, 2002. However, at the
start of Operation Enduring Freedom, about half of the inventory exceeded
current operating requirements.

GAO, under its statutory authority, analyzed the extent to which inventory
that exceeded current operating requirements as of September 30, 2001, was
consumed through cutoff dates ranging from March through October 2003 and
identified three ineffective and inefficient inventory management
practices.

GAO recommends that DOD take actions to correct inventory management
practices related to the military components' use of inventory storage
cost estimates, the lack of an Air Force systemwide process for correcting
causes of inventory discrepancies, and the improper coding of items that
the Air Force wants to retain.

In its comments, DOD generally concurred with GAO's report and
recommendations.

August 2004

DEFENSE INVENTORY

Analysis of Consumption of Inventory Exceeding Current Operating Requirements
Since September 30, 2001

GAO's analysis of 1.5 million items with $35.1 billion of inventory on
hand that exceeded current operating requirements as of September 30,
2001, showed that about $4.0 billion was consumed-$2.5 billion was used,
$0.5 billion was disposed of, and $1.0 billion was condemned-since the
onset of Operation Enduring Freedom and through the initial phases of
Operation Iraqi Freedom. GAO found that, once disposals and condemnations
were accounted for, 539,000 items had inventory that was used, 18,000 had
inventory gains, and 937,000 had neither inventory usage nor gains. Of the
1.5 million items, customers did not make demands for 923,000 items during
the period of review.

Consumption of Inventory Exceeding September 30, 2001, Current Operating
Requirements

$0.5 billion of inventory disposed of

$1.0 billion of inventory condemned

$2.5 billion of inventory used

Source: GAO analysis of DOD data.

aInventory amounts do not total to $35.1 billion because of rounding.

GAO also identified three ineffective and inefficient inventory management
practices that may affect inventory levels, including the inventory
exceeding current operating requirements. First, although Defense
Logistics Agency (DLA) has begun to charge its customers for inventory
storage based on the actual space occupied by items, the military
components are not using the DLA storage cost data, and instead continue
to use estimated storage costs in their inventory management
decision-making processes. Second, the Air Force does not have a
systemwide process for correcting the causes of discrepancies between the
inventory for which item managers are accountable and the inventory
reported by bases and repair centers. Third, Air Force item managers are
not required to enter codes into the Air Force inventory system for items
that are categorized as potential reutilization and/or disposal materiel,
but that the Air Force wants to retain; thus, the items are not properly
categorized and are at risk of disposal.

www.gao.gov/cgi-bin/getrpt?GAO-04-689.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact William M. Solis at (202)
512-8365 or [email protected].

Contents EUR

  Letter

Scope and MethodologyEURResults in BriefEURBackgroundEURAbout $4.0 Billion
of the Inventory Exceeding Current Operating EUR

Requirements Was Consumed Since September 30, 2001 Some DOD Practices
Contribute to Ineffective and Inefficient

Inventory Management Conclusions Recommendations for Executive Action
Agency Comments and Our Evaluation 1

3 6 9

12

16 22 23 23

Appendix I Comments from the Department of Defense

  Table

Table 1: Comparison of Differences between Estimated Storage Costs and
Storage Costs Charged by DLA for Army, Navy, and DLA Items

  Figures

Figure 1: Categorization of Inventory for a Navy Power Supply 10 Figure 2:
Consumption of Inventory Exceeding September 30, 2001, Current Operating
Requirements 13

Figure 3: Percent Distribution of Items and Value of Inventory Exceeding
Current Operating Requirements as of September 30, 2001, by Usage Since
That Date 14

Abbreviations

DLA Defense Logistics Agency DOD Department of Defense

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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separately.

United States Government Accountability Office Washington, DC 20548

August 2, 2004

Congressional Committees

The Department of Defense (DOD) maintains a secondary inventory of spare
and repair parts1 to support its war-and peace-time missions. The
effective and efficient management of this inventory is critical to ensure
that the warfighter is supplied with the right items at the right time,
especially as the department and the services are called upon for new
missions in locations such as Afghanistan, Iraq, and the Philippines, as
well as protecting the homeland.

DOD's inventory management comprises several major functions, including
determining what is needed; buying needed items; and storing, maintaining,
distributing, and disposing of inventory. DOD retains inventory that
exceeds items' requirements objectives2 for different reasons, including:
(1) to satisfy projected demands for 2 fiscal years beyond the current
operating requirements; (2) for economic reasons, because it would be less
costly to retain rather than dispose of and repurchase the items; and (3)
for specific contingencies, such as when the source of supply for an
item-a specific parts manufacturer, for example-is no longer available.

Since 1990, we have identified the department's management of its
inventory as a high-risk area and have reported on and made
recommendations to address issues that contribute to ineffective and
inefficient inventory management.3 We have reported on such issues as
inaccurate data, not canceling orders for inventory that is no longer

1 DOD's inventory consists of a wide variety of parts that includes
communication and detection equipment; electrical and electronic equipment
components; engines, turbines, and their components; aircraft components
and accessories; instruments and laboratory equipment; aircraft and
airframe structural components; fire control equipment; guided missiles;
electric wire and power and distribution equipment; medical supplies; and
clothing and textiles.

2 DOD refers to the amount of inventory that it needs to have on hand or
on order to support current operations as the requirements objective.
Hereinafter, we refer to an item's requirements objective as its current
operating requirements.

3 U.S. General Accounting Office, Major Management Challenges and Program
Risks: Department of Defense, GAO-03-98 (Washington, D.C.: January 2003).

needed, lack of controls and visibility over inventory, and information
EURsystem weaknesses. For example, in May 2001, we reported4 that the
EURmilitary components5 did not have sound analytical support for
EURdetermining when it is economical to retain or dispose of inventory
thatEURexceeds current operating requirements. Taken together, these and
other EURissues have contributed to the accumulation of high levels of
inventory. EUR

DOD maintains that, while it does not purchase inventory that exceeds
EURcurrent operating requirements, much of the inventory, once purchased,
EURwill eventually be needed. Nevertheless, in response to our work and to
EURcongressionally mandated inventory-reduction goals, DOD reduced
itsEURoverall inventory levels throughout the 1990s-from over $100 billion
in EUR1990 to a low of about $61 billion as of September 30, 1998.
However, inEURrecent years the trend has been reversed, with inventory
levels increasingEURto about $67 billion as of September 30, 2002. EUR

DOD further maintains that seeking inventory-reduction goals leads
toEURinefficient management. However, in response to our May 2001 report,
andEURbecause Congress had directed6 the department to examine its
retention EURpractices, DOD is reviewing its policies and procedures for
retaining EURinventory that exceeds the items' current operating
requirements. EUR

In May 2003,7 we reported a snapshot of DOD's inventory as ofEURSeptember
30, 2001. We reported that large imbalances in the department's
EURinventory continued to exist as of that date-523,000 items needed
EURadditional inventory to satisfy current operating requirements while
EUR1.7 million items had inventory on hand and on order that exceeded
EURcurrent operating requirements. Our work showed that about EUR1.6
million items had about $36.0 billion of inventory on hand that EUR

4 U.S. General Accounting Office, Defense Inventory: Approach for Deciding
Whether to Retain or Dispose of Items Needs Improvement, GAO-01-475
(Washington, D.C.: May 25, 2001).

5 In this report, we refer to the Army, Navy, and Air Force collectively
as the military services, and the Army, Navy, Air Force, and the Defense
Logistics Agency as the military components.

6 National Defense Authorization Act for Fiscal Year 2000, Pub. L. No.
106-65, S: 362 (1999).

7 U.S. General Accounting Office, Defense Inventory: Overall Inventory and
Requirements Are Increasing, but Some Reductions in Navy Requirements Are
Possible, GAO-03-355 (Washington, D.C.: May 8, 2003).

  Scope and Methodology

exceeded the items' current operating requirements, which amounted to
roughly half of DOD's inventory at that time.

We prepared this report under our statutory authority and are providing it
to you because of your oversight responsibilities for defense issues. In
this report we (1) analyze the extent to which inventory on hand exceeding
current operating requirements as of September 30, 2001, was consumed
during subsequent operations; and (2) discuss three practices we
identified that further contribute to the ineffective and inefficient
management of inventory.

To determine how much of the inventory that exceeded current operating
requirements as of September 30, 2001, was consumed (used, disposed of, or
condemned) since that date, we obtained and analyzed data from the
military components for the items that we had identified in our May 2003
report that had inventory exceeding the items' current operating
requirements as of September 30, 2001. We interviewed DOD, Defense
Logistics Agency (DLA), and service inventory management officials to
discuss the data needed and our analytical approach. As a result of these
discussions, we requested the following consumption-related data for each
item that had inventory exceeding current operating requirements as of
September 30, 2001:

o  inventory demanded from the supply system (demands);

o  inventory returned to the supply system for repair (returns);

o  ~inventory condemned because the parts could not be repaired
(condemnations); and

o  inventory that was otherwise processed for disposal (disposals).

The data we obtained covers different periods, depending on the military
component providing the data. Although the period of review for all of the
military components began on October 1, 2001, the data we obtained had
different cutoff dates as follows:

o  For the Navy and Air Force, the cutoff date was March 31, 2003.

o  ~For the Army, the cutoff dates ranged from June 2003 through October
2003, depending on the inventory control location that provided the data.

o  For DLA, the cutoff date was September 30, 2003.

According to the officials providing the data, 119,000 items of the 1.6
million items that had on-hand inventory exceeding current operating
requirements as of September 30, 2001, were no longer in the military
components' inventory systems as of the data cutoff dates. The 119,000
items had about $966 million of on-hand inventory that exceeded current
operating requirements as of September 30, 2001. Therefore, our analysis
only concerns the remaining 1.5 million items with $35.1 billion of
on-hand inventory exceeding current operating requirements as of September
30, 2001.

Our analysis to determine how much of the inventory that exceeded current
operating requirements was consumed since September 30, 2001, involved
several steps. For each of the 1.5 million items:

o  ~We first subtracted the quantity that was disposed of from the
quantity that exceeded current operating requirements.

o  Next, we subtracted the quantity of inventory that was condemned.

o  ~For each item, we also computed net demands by subtracting the
inventory returns from inventory demands.

o  ~To determine how much of the inventory was used, we then compared the
net demands to the inventory exceeding current operating requirements that
had not been disposed of or condemned.

We limited the quantities of inventory that were disposed of, condemned,
or used to the inventory that exceeded current operating requirements as
of September 30, 2001. We considered items with more returns than
inventory disposals, condemnations, and demands to have inventory gains;
items with returns equal to disposals, condemnations, and demands were
considered to have neither inventory usage nor gains. We used the above
methodology to determine how many of the items had their entire inventory
exceeding current operating requirements consumed. We further used the
demand data provided to determine how many of the items had and did not
have demands during the period of our review. In our analyses, unless
otherwise indicated, inventory values are expressed in billions of
dollars, and items are rounded to the nearest thousand. We did not revalue
the inventory that needs to be repaired to recognize the repair cost, and
we did not value inventory that is to be disposed of at salvage prices.
Also, our analyses did not include fuel, certain inventory held in units,
and Marine Corps inventory. Fuel and inventories held by units are not
stratified by requirement, and the Marine Corps inventory represents a
small part of the universe. In addition, to ascertain some of the reasons
why inventory exceeding current operating requirements was being retained,
we selected non-representative samples

of 78 Army items and 118 Air Force items with inventory that exceeded
current operating requirements as of September 30, 2001, prepared detailed
questionnaires for item managers, and visited the Army Aviation and
Missile Command, Huntsville, Alabama, and Warner Robins Air Logistics
Center, Warner Robins, Georgia, to collect and analyze the responses. We
selected these inventory control locations based upon the value of the
inventory they managed that exceeded current operating requirements as of
September 30, 2001, when compared to other Army and Air Force inventory
control locations. Because we used non-representative samples, we cannot
project these observations to the universe. Although our work highlights
the large amount of inventory exceeding current operating requirements
that DOD retains, we neither performed detailed analyses of DOD's policies
and procedures relating to that inventory, nor selected samples of Navy
and DLA items, because we have initiated a separate review of DOD
inventory retention policies.

To address the inventory management practices that we identified in the
course of assessing our non-representative samples, we obtained
information and data from DLA about how it determines what to charge the
military components for storing secondary inventory, and interviewed
responsible officials from the military components to determine whether
they were using this data to make relevant management decisions. We also
reviewed Air Force policies related to, and interviewed responsible Air
Force officials about, the reconciliation of inventory discrepancies, and
the retention of inventory categorized as potential reutilization and/or
disposal materiel. Through our analysis of the DLA storage cost charges
and by examining our non-representative sample of Air Force items, we
identified specific examples of these inefficient and ineffective
management practices. We also obtained information from the 2001 Supply
System Inventory Report to get a rough estimate of how the department
revalues inventory held as potential reutilization and/or disposal
materiel.

We assessed the reliability of the data used in this report by (1)
performing electronic testing of required data elements, (2) reviewing
existing information about the data and the systems that produced them,
and (3) interviewing officials knowledgeable about the data. We determined
that the data were sufficiently reliable for the purposes of this report.
We performed our review from June 2003 through May 2004 in accordance with
generally accepted government auditing standards.

  Results in Brief

Our analysis of approximately 1.5 million items with inventory on hand
valued at $35.1 billion that exceeded current operating requirements as of
September 30, 2001, showed that about $4.0 billion was consumed- including
$2.5 billion that was used, $0.5 billion disposed of, and $1.0 billion
condemned-since the onset of Operation Enduring Freedom and through the
initial phases of Operation Iraqi Freedom. Additional analyses of the 1.5
million items showed that:

o  ~After we accounted for parts that were disposed of or condemned, (1)
about 539,000 items had demands that exceeded the amount of parts returned
for repair by about $2.5 billion; (2) nearly 18,000 items had inventory
gains of $0.9 billion, where more broken parts were returned for repair
than were demanded, condemned, or disposed of; and (3) about 937,000 items
with $24.4 billion of on-hand inventory exceeding current operating
requirements as of September 30, 2001, had neither inventory usage nor
inventory gains.

o  ~About 199,000 items had their entire $1.8 billion of on-hand inventory
exceeding current operating requirements as of September 30, 2001, used,
disposed of, or condemned since that date.

o  ~About 923,000 items with on-hand inventory of $14.8 billion exceeding
current operating requirements as of September 30, 2001, had no demands
during the period of review, while the remaining 571,000 items with $20.2
billion of on-hand inventory exceeding current operating requirements as
of September 30, 2001, had demands.

Our analysis of non-representative samples of Army and Air Force items,
performed to ascertain some of the reasons why the 1.5 million items with
on-hand inventory exceeding current operating requirements were being
retained, showed that the items in the samples supported a variety of
weapon systems and that most of the items (1) had inventory categorized as
either economic or contingency retention stock; and (2) had been in the
inventory system for 15 or more years, including several that had been
first placed into service during the 1960s.

While reviewing Air Force and Army items to determine why inventory
exceeding current operating requirements was being retained, we identified
three inventory management practices that may affect inventory levels,
including the inventory exceeding requirements. These inefficiencies do
not necessarily lead to the accumulation of inventory exceeding current
operating requirements. Instead, they can lead to having critical items in
short supply, to persistent difficulties in accurately and reliably
forecasting the availability of assets, and to the inappropriate disposal
of inventory.

o  ~First, the military components use storage cost estimates rather than
actual storage cost data in making key decisions, such as determining the
levels of inventory that are needed to be retained or ordered. DLA now
determines how much to charge the military components for storage on a
per-item basis and provides this data to the components. Because
computations based on the actual storage cost data would be more accurate,
the military components could be purchasing or retaining inappropriate
amounts of inventory. For example, depending on the item, DLA's actual
charges for storage could be either less than or greater than the item's
estimated storage costs, which would make it more or less economical to
retain the same amount of inventory. To assess the significance of these
differences, we compared the actual storage costs charged by DLA to the
Army, Navy, and DLA with the components' storage cost estimates for about
1.5 million inventory items and found that, for about half of the items
reviewed, the estimated storage costs were at least 10 times greater than
the costs charged by DLA. However, because DLA has only recently begun to
compute the storage charges on a per-item basis, the Army, Navy, and DLA
have not determined whether it would be beneficial to use the DLA storage
cost data rather than estimated storage costs in their inventory
management decision-making processes.

o  ~Second, the Air Force does not have a systemwide process for
correcting the causes of discrepancies between the inventory for which
item managers are accountable and the inventory reported by bases and
repair centers.8 Because accurate data is necessary to make accurate
decisions, item managers-who are responsible for purchasing inventory-must
persistently deal with inventory discrepancies, cannot accurately
determine the number of available assets, and cannot reliably forecast the
availability of assets. Consequently, in some instances the Air Force is
at risk of buying inventory that it does not need and in other instances
of not buying enough inventory. At the Warner Robins Air Logistics Center,
we identified 35 out of 118 items with inventory valued at $135 million
that was recorded on item managers' records, but was not accounted for by
bases and repair centers.

o  ~Third, Air Force item managers are not required to enter codes into
the Air Force inventory system for items that are categorized as potential
reutilization and/or disposal materiel, but that the Air Force wants to

8 We did not identify discrepancies in the Army inventory records based on
the review of our non-representative sample of Army items. Therefore, this
analysis is limited only to the Air Force.

retain.9 As a result, the items are not properly categorized and the Air
Force is at risk of disposing inventory that it may need to later
repurchase. Air Force policy allows item managers to retain inventory
categorized as potential reutilization and/or disposal materiel when there
is a valid reason for doing so. Item managers, when justified, are
authorized but are not required to enter a deferred disposal code that
will result in the inventory being recategorized as contingency retention
stock. We observed at the Warner Robins Air Logistics Center that $277
million10 of inventory remained categorized as potential reutilization
and/or disposal materiel even though the Air Force expressed a valid
reason for retaining it. For example, the center had 50 transmitter
drivers used on an electronic warfare system for the B-1B aircraft that
were categorized as potential reutilization and/or disposal materiel. The
center was retaining the drivers to support the aircraft until the year
2040 when the Air Force expects to remove the last of the aircraft from
its inventory. However, no code was entered into the system. Additionally,
DOD reports the value of inventory categorized as potential reutilization
and/or disposal materiel at a rate of approximately 2 percent of its
latest acquisition cost and, therefore, is significantly understating the
amount of inventory it is retaining in a key inventory management report.

Because we have initiated a separate review of DOD's inventory retention
policies, we are not making recommendations regarding the retention of
inventory exceeding current operating requirements that had no demands. We
are, however, recommending that the Secretary of Defense take actions to
improve the inventory management practices we identified, including the
components' use of inventory storage cost estimates, the lack of an Air
Force systemwide process for correcting causes of inventory discrepancies,
and the improper coding of items that the Air Force wants to retain.

In written comments on a draft of this report, DOD generally concurred
with the report and our recommendations. Our evaluation of DOD's comments
is discussed on page 23.

9 While we selected a non-representative sample of Army items, the
available Army data did not identify items categorized as potential
reutilization and/or disposal materiel. Therefore, this analysis is
limited only to the Air Force.

10 Inventory valued at latest acquisition cost.

Background

DOD defines the requirements objective (current operating requirements) as
the amount of inventory needed to be on hand or on order to support
current operations. The current operating requirements includes inventory
requirements for a reorder point and an economic order quantity.11 The
reorder point is the point at which inventory replenishment will normally
prevent out-of-stock situations from occurring and includes:

o  ~war reserves, requisitions that have not been filled, and a "safety
level" of stock;12

o  stock to satisfy demands while broken items are being repaired; and

o  ~stock to satisfy demands during the "lead time"-the period between the
placement of orders and their receipt.

Because the reorder point provides for inventory to be used during the
time needed to order and receive inventory and for a safety level, item
managers are able to place orders so that the orders arrive before
out-of-stock situations occur.

Generally, an item manager purchases an amount of inventory needed to
satisfy the reorder point and an economic order quantity-a quantity that,
when ordered and received, results in the lowest total cost for ordering
and holding inventory.

The approved acquisition objective defines the amount of inventory that
DOD budgets for and includes inventory needed to satisfy the current
operating requirements, 2 years of demand above the current operating
requirements, and, if applicable, additional war reserves. While DOD
budgets funds to purchase inventory to satisfy the approved acquisition
objective, item managers do not purchase inventory unless an item's
inventory falls to or below its reorder point; therefore, item managers do
not purchase inventory to satisfy the approved acquisition objective.

Inventory that exceeds the approved acquisition objective is categorized
as economic retention, contingency retention, and potential reutilization
and/or disposal materiel:

11 The Air Force requirements computation system does not include an
economic order quantity.

12 War reserves are authorized to be purchased to ensure fast mobilization
in the event of war. A safety level is stock kept on hand in case of minor
interruptions in the resupply process or unpredictable demand.

o  ~Economic retention inventory exceeds the approved acquisition
objective and has been determined to be more economical to keep than to
dispose of because it is likely to be needed in the future.

o  ~Contingency retention inventory exceeds the economic retention
inventory and would normally be categorized as potential reutilization
and/or disposal materiel, but is instead retained for specific
contingencies.

o  ~Potential reutilization and/or disposal materiel exceeds contingency
retention inventory and has been identified for possible disposal but with
potential for reutilization.

A Navy computer power supply used on the radar for the FA-18 aircraft
demonstrates the above inventory categories. On September 30, 2003, the
Navy had 147 of the $353,000 power supplies on hand. As shown in figure 1,
52 of the power supplies satisfied the item's current operating
requirements. Of the remaining 95 power supplies, 56 were designated to
satisfy the 2 years of additional demand, 11 were held as economic
retention stock, 2 were held as contingency retention stock, and 26 were
categorized as potential reutilization and/or disposal materiel.

Figure 1: Categorization of Inventory for a Navy Power Supply

Approved acquisition objective

Source: GAO analysis of Navy data.

95 power supply units that exceed current operating requirements and that would
                                not be purchased

52 power supply units that satisfy current operating requirements and that would
                                  be purchased

Overall, the amount of DOD's inventory exceeding current operating
requirements has decreased since 1996. On-hand inventory that exceeded
current operating requirements decreased from $41.3 billion, or 59
percent, of the $69.7 billion of on-hand inventory on September 30, 1996,
to $36.0 billion, or 52 percent, of the $69.8 billion inventory on hand on
September 30, 2001.

DOD annually summarizes its secondary inventory in its Supply System
Inventory Report. This report is based on financial inventory and other
inventory reports prepared by the military components. The report
summarizes inventories by DOD component and inventory category. DOD
officials use the report as a management tool to monitor changes in the
levels of its inventory. These officials include the Under Secretary of
Defense for Acquisition, Technology, and Logistics, who is responsible for
developing and ensuring the uniform implementation of DOD inventory
management policies throughout the department, for monitoring the overall
effectiveness and efficiency of the DOD logistics system, and for
continually developing improvements. In addition, the Secretaries of the
Army, the Navy, and the Air Force, and the Director, DLA, are responsible
for implementing DOD inventory policies and procedures.

  About $4.0 Billion of the Inventory Exceeding Current Operating Requirements
  Was Consumed Since September 30, 2001

Our analysis of approximately 1.5 million items with inventory on hand
valued at $35.1 billion13 that exceeded current operating requirements as
of September 30, 2001, showed that about $2.5 billion of the inventory was
used, $0.5 billion was disposed of, and $1.0 billion was condemned since
the onset of Operation Enduring Freedom and through the initial phases of
Operation Iraqi Freedom. As illustrated in figure 2, the inventory
exceeding current operating requirements that was consumed14 since
September 30, 2001-that is, the sum of the inventory used, disposed of, or
condemned-amounted to $4.0 billion. Roughly $31.0 billion15 of the on-hand
inventory that exceeded current operating requirements as of September 30,
2001, was not used, disposed of, or condemned during the period of our
review.

13 While we identified 1.6 million items with $36.0 billion of inventory
on hand that exceeded current operating requirements as of September 30,
2001, in our prior work, the analysis in this report did not include about
119,000 items with about $966 million of inventory on hand that exceeded
current operating requirement as of September 30, 2001, because the items
were no longer in the inventory as of the data cutoff dates.

14 According to a DOD official, DOD considers an item to be consumed when
a demand for an item occurs, regardless of whether or not a broken part is
returned.

15 The total inventory consumed and the total not consumed do not add to
$35.1 billion because of rounding.

Figure 2: Consumption of Inventory Exceeding September 30, 2001, Current
Operating Requirements

$0.5 billion of inventory disposed of

$1.0 billion of inventory condemned

$2.5 billion of inventory used

aInventory amounts do not total to $35.1 billion because of rounding.

Our analysis also identified how many of the 1.5 million items had
inventory that was used, how many had inventory gains, and how many had
neither inventory that was used nor inventory gains. As depicted in figure
3, our analysis showed:

o  ~About 539,000 items with $7.2 billion of on-hand inventory that
exceeded current operating requirements as of September 30, 2001, had $2.5
billion of that inventory used since then. That is, once disposals and
condemnations were accounted for, demands exceeded returns by $2.5
billion. For example, the Navy had seven infrared receivers, used on FA-18
E/F aircraft, which exceeded current operating requirements as of
September 30, 2001. Through March 2003, two of the $1,610 receivers were
disposed of, four were condemned, and one was used as a result of demands
exceeding returns. The 539,000 items, or 36 percent of the 1.5 million
items reviewed, had 21 percent of the $35.1 billion of on-hand inventory
that exceeded current operating requirements as of September 30, 2001.

o  ~About 18,000 items with $3.5 billion of on-hand inventory exceeding
current operating requirements as of September 30, 2001, had $0.9 billion
in inventory gains as a result of more broken parts returned for repair
than demands, disposals, or condemnations during the period of review. For
example, the Army had two AH-64 helicopter capacitor assemblies, each

valued at $554, which exceeded current operating requirements as of
September 30, 2001. Through August 2003, one of the assemblies was
condemned and the other was demanded. However, four assemblies were
returned for repair, resulting in a gain of two assemblies to the
inventory. The 18,000 items, or 1 percent of the 1.5 million items, had 10
percent of the $35.1 billion of on-hand inventory that exceeded current
operating requirements as of September 30, 2001.

o  ~About 937,000 items with $24.4 billion of on-hand inventory exceeding
current operating requirements as of September 30, 2001, had neither
inventory usage nor gains during the period of review-these items had an
equal amount of inventory returned for repair as was disposed of,
condemned, and demanded. For example, DLA had 294 men's overcoats, valued
at $265 apiece, that exceeded current operating requirements as of
September 30, 2001. Through September 2003, these overcoats had no
disposals, no condemnations, and no demands. The 937,000 items, or 63
percent of the 1.5 million items, had 70 percent of the on-hand inventory
that exceeded current operating requirements as of September 30, 2001.

Figure 3: Percent Distribution of Items and Value of Inventory Exceeding
Current Operating Requirements as of September 30, 2001, by Usage Since
That Date

Source: GAO analysis of DOD data.

              aPercent total does not add to 100 due to rounding.

We also analyzed the 1.5 million items to determine if the entire
inventory EURexceeding current operating requirements was consumed for any
of EURthe items. Our analyses showed that, for about 199,000 of the EUR1.5
million items, all inventory that exceeded the items' September 30,
EUR2001, current operating requirements was used, condemned, or disposed
EURof since that date. The 199,000 items had on-hand inventory valued at
EURabout $1.8 billion that exceeded current operating requirements. For
about EUR1.3 million items, either some or none of the inventory exceeding
current EURoperating requirements was consumed. EUR

Further, 923,000 of the 1.5 million items had no customer demands.EURThese
items represented about $14.8 billion of inventory on hand thatEURexceeded
current operating requirements as of September 30, 2001. The EURremaining
571,000 items had $26.0 billion of demands and $20.7 billion of EURbroken
parts returned for repair. These items represented aboutEUR$20.2 billion
of inventory that exceeded current operating requirements, as EURof
September 30, 2001. EUR

To ascertain some of the reasons why the 1.5 million items with on-hand
EURinventory exceeding current operating requirements was being retained,
EURwe selected non-representative samples of Army and Air Force items. We
EURfound that most of these sample items had inventory categorized as
either EUReconomic or contingency retention stock and had been in the
inventory EURsystem for 15 or more years. At the Army and Air Force
inventory control EURlocations that we visited, we observed that 121 out
of 190 items, or EUR64 percent of the items reviewed, had been placed in
service prior to 1989. EURThese items had about $1.6 billion of inventory
that exceeded the currentEURoperating requirements as of September 30,
2001. Seventeen of the items, EURwith about $107 million of inventory on
hand that exceeded currentEURoperating requirements, were placed in
service during the 1960s. EURThese items included antennae, aircraft
rudders, auxiliary power units, EURpropeller blades, and circuit card
assemblies that were used on versions ofEURthe Air Force's C-130 and F-15
aircraft, the Army's UH-60 helicopter, and EURother weapon systems. EUR

  Some DOD Practices Contribute to Ineffective and Inefficient Inventory
  Management

While reviewing Air Force and Army items to determine why inventory
exceeding current operating requirements was being retained, we identified
three ineffective and inefficient inventory management practices that may
affect inventory levels, including the inventory exceeding current
operating requirements. First, although DLA has begun to charge its
customers for inventory storage based on the actual space occupied by
items, the military components are not using the DLA storage cost data,
and instead continue to use estimated storage costs in their inventory
management decision-making processes. Second, the Air Force does not have
a systemwide process for correcting the causes of discrepancies between
the inventory for which item managers are accountable and the inventory
reported by bases and repair centers.16 Third, Air Force item managers are
not required to enter codes into the Air Force inventory system for items
that are categorized as potential reutilization and/or disposal materiel,
but that the Air Force wants to retain; thus, the items are not properly
categorized and are at risk of disposal.17 The inefficiencies we
identified do not necessarily lead to the accumulation of inventory
exceeding current operating requirements; however, they can lead to having
critical items in short supply, to persistent difficulties in accurately
and reliably forecasting the availability of assets, and to
inappropriately disposing of inventory.

    Military Components Are Not Using Actual Storage Cost Data in Making
    Inventory Management Decisions

Although DLA has begun to charge its customers for inventory storage based
on the actual space occupied by items, the military components are not
using the DLA data, and instead continue to use estimated storage costs in
their inventory management decision-making processes. We noted that the
estimated storage costs ranged from being over 1,000 times more than the
actual costs charged to customers, to being up to 10 times less than the
actual charges. Because using actual storage cost data would result in
more accurate computations, the military components could be purchasing or
retaining inappropriate amounts of inventory. However, because DLA only
recently began to compute the storage charges on a per-item basis, the
Army, Navy, and DLA have not determined whether it would be beneficial to
use actual data rather than estimated storage costs in their inventory
management decision-making processes.

16 This analysis is limited only to the Air Force, because our analysis of
our Army sample did not identify inventory records discrepancies as a
problem in the Army.

17 This analysis is limited only to the Air Force, because the available
Army data did not identify items categorized as potential reutilization
and/or disposal materiel.

The Defense Logistics Agency is responsible for storing inventory for the
military services and for its own defense supply centers. Beginning in
fiscal year 2003, DLA began charging for inventory stored in its
warehouses by (1) determining the cubic-feet of space occupied by an
individual item, (2) multiplying the space occupied by a single item by
the number of items stored to yield the total space occupied, and (3)
multiplying the stored items' total occupied space by a rate charged for
the type of storage space used (open, covered, or specialized). As a
result, the DLA computes storage costs charged to its customers on a
per-item basis.

According to DLA officials, the agency provides data to the military
services and the DLA supply centers on a quarterly basis that would allow
them to take these charges into account when making inventory management
decisions. Such decisions might include:

o  ~determining how much inventory to retain for safety level
requirements, which is the amount of inventory held in case of minor
interruptions in the resupply process or fluctuations of demand;

o  ~computing economic order quantities, which are the quantities of an
item that are purchased that results in the lowest cost for ordering and
holding inventory;

o  ~determining when it is more economical to retain extra inventory, as
opposed to disposing of it and then satisfying future requirements through
new procurements and/or repairs of broken items; and

o  ~determining whether orders for inventory that is no longer needed are
economical to cancel.

The consideration of storage costs as a factor in making these kinds of
inventory management decisions varies among the components. For example,
the Army, Navy, and DLA factor in storage costs when computing economic
order quantities. The Air Force's requirements computation system does not
compute an economic order quantity. The Army and Navy models for
determining economic retention levels factor in storage costs, whereas the
Air Force and DLA set economic retention levels based on years of supply.
And, the Army, Air Force, and DLA factor in storage costs when determining
whether it is economical to cancel or cut back orders for inventory that
is no longer needed to satisfy requirements.

When the military components factor in storage costs to make inventory
management decisions, they use estimated storage costs-as they have done
historically-rather than the actual, per-item costs now charged by

DLA. For example, the Army, Navy, and DLA estimate storage costs to be
equal to 1 percent of the inventory value. According to an Air Force
Materiel Command official, the Air Force uses estimated charges from the
DLA Storage Occupancy Report. However, according to a DLA official, the
report, which is no longer issued, identifies the space occupied by items,
but not the cost of storing a specific item.

Generally, storage costs charged to customers are lower than the estimated
costs (1 percent of inventory value) currently used by the Army, Navy, and
DLA. In order to ascertain the significance of using estimated costs in
lieu of actual charges, we compared the actual storage costs charged by
DLA to the Army, Navy, and DLA with 1-percent cost estimates for about 1.5
million inventory items. We found that for about half of the items, the
estimated storage costs were at least 10 times greater than the costs
charged by DLA for storing the inventory. For over 242,000 items, about 16
percent of the items in our analysis, the estimated storage costs were at
least 100 times greater than the costs charged for storing the items (see
table 1).

Table 1: Comparison of Differences between Estimated Storage Costs and
Storage Costs Charged by DLA for Army, Navy, and DLA Items

                                Number of items

     Estimated storage cost was:    Army     Navy       DLA   Total   Percent 
     1,000 or more times greater   1,829   4,247   39,950    46,026   
         than actual charge                                           
     100 times up to 1,000 times   4,094  18,368   173,900   196,362  
     greater than actual charge                                       
      10 times up to 100 times     13,525 43,101   456,508   513,134  
     greater than actual charge                                       
0 times up to 10 times greater  15,495 32,044   516,160   563,699  
         than actual charge                                           
up to 10 times less than actual 6,132   8,183   192,778   207,093  
               charge                                                 
                Total              41,075 105,943 1,379,296 1,526,314    100a 

Source: GAO analysis of DOD data.

Notes: We used 1 percent of the September 30, 2001, inventory values to
determine the estimated storage costs, and DLA's fiscal year 2003 storage
rates to determine the actual storage cost charges.

aPercent total does not add to 100 due to rounding.

A change in the storage cost factor used by the components could affect
inventory management decisions. For example, depending on the item, the
actual storage cost charged by DLA could be either less than or greater
than the item's estimated storage cost, which would make it more or less
economical to retain the same amount of inventory. Therefore, by not using
the actual storage costs charged by DLA, the military components that take
storage costs into account when making inventory management

decisions may be recommending the acquisition or retention of an
inappropriate amount of inventory.

According to Army and Navy officials, it may not be cost effective to use
the storage cost data provided by DLA, even if using the data resulted in
more accurate calculations. Several factors besides storage costs are
considered in making inventory decisions. Depending on the calculation,
these other factors can include: the cost of an item; the demand for an
item; the cost to reduce an order; and other holding cost factors,18 such
as obsolescence and storage loss rates. According to one Navy official,
some of these factors have more of an impact on such calculations than do
storage costs. Although the Navy and Army have recently concluded that
their 1-percent estimates are sufficiently accurate for some of their
inventory management decisions, neither service nor DLA has determined if
it would be beneficial to use the newly available storage cost data
instead of estimated costs in their inventory management decision-making
processes.

    Air Force Does Not Systematically Correct the Causes of Inventory
    Discrepancies

The Air Force does not have a systemwide process for correcting the causes
of discrepancies between the inventory for which item managers are
accountable and the inventory reported by bases and repair centers.
Because accurate data is necessary to make accurate decisions, item
managers-who are responsible for purchasing inventory-must persistently
deal with inventory discrepancies, cannot accurately determine the number
of available assets, and cannot reliably forecast the availability of
assets. Consequently, in some instances the Air Force is at risk of buying
inventory that it does not need and, in other instances, of not buying
enough inventory.

Air Force policy provides for asset reconciliation on a quarterly basis.
The reconciliation process compares the quantity of inventory for which
the item manager is responsible to the quantity that bases and repair
centers report as being on hand, in order to identify any variances
between the quantities. If there are three consecutive plus or three
consecutive minus variances, the policy allows item managers to adjust the
inventory quantity by the smallest of the three variances. According to an
Air Force Materiel Command official, in instances where an item manager's
records account for more inventory than was being reported on hand by
bases and repair

18 Storage costs are one of the factors used to compute holding costs.

centers, the variance is recorded on requirement computations and
inventory stratification reports as "due in other" inventory.

At Warner Robins Air Logistics Center, we noted that item manager
inventory records for 35 of 118 items we reviewed showed $135 million of
"due in other" inventory as of March 31, 2003, that was not accounted for
by the bases and repair centers. One item, a countermeasure receiver
subassembly valued at about $58,000, demonstrates the persistent nature of
inventory variances. From December 2000 through June 2003, the
reconciliation process consistently showed that the item manager was
accountable for more assets than were being reported by repair centers and
bases. According to inventory records, the item manager reduced by eight
the quantity that the item manager was responsible for. A first
adjustment, which the item manager performed in September 2002, reduced
the quantity by six. The adjustment was made because of erroneous data
reported by the contractor. A second adjustment, performed in September
2003, occurred because, at the time of the adjustment, the item manager
did not have access to all of the condemnation data for the item. Another
Air Force official entered this data into a system that feeds the main Air
Force inventory system. Had this data been entered before the item manager
reviewed the file, there would have been no need for the adjustment.

Because consistent adjustments indicate that there is something wrong with
the reported information, Air Force policy instructs item managers to
research historical records whenever variances exist and make every effort
to identify and correct the underlying problems, when possible. According
to an Air Force Materiel Command official, some variances are to be
expected. But items that are continuously in variance, or for which
particularly large variances exist, are problematic. In such cases, item
managers cannot accurately determine the number of available assets and
cannot reliably forecast the availability of assets. Knowledge of the
correct number of available assets is critical when deciding whether to
buy inventory, and determining how much to buy.

According to an Air Force Materiel Command official, the Air Force has
sought to identify and correct variances that result from systemic
reasons, such as data interface problems between two inventory systems.
However, officials from Warner Robins Air Logistics Center and from Air
Force Materiel Command say that the Air Force has not systemically
addressed and corrected the causes of variances that item managers
identify during the reconciliation process.

    Air Force Item Managers Are Not Required to Code Items to Prevent Their
    Disposal

Air Force item managers are not required to enter codes into the Air Force
inventory system for items that are categorized as potential reutilization
and/or disposal materiel, but that the Air Force wants to retain. As a
result, the inventory is not properly categorized, and the Air Force is at
risk of disposing of inventory that it may need to later repurchase.
Additionally, because DOD reports the value of inventory categorized as
potential reutilization and/or disposal materiel at a rate of
approximately 2 percent of its latest acquisition cost, the amount of
inventory it is retaining is significantly understated in a key inventory
management report.

Inventory categorized as potential reutilization and/or disposal materiel
is subject to being sent to the Defense Reutilization and Marketing
Service, for (1) reutilization by other DOD components or by other
federal, state, or local government agencies; or (2) disposal through sale
to the public. However, Air Force policy allows potential reutilization
and/or disposal materiel to be retained if there are valid reasons for
doing so. Item managers, when justified, are authorized but are not
required to enter a deferred disposal code into the Air Force inventory
system. The deferred disposal code will result in potential reutilization
and/or disposal materiel being recategorized as contingency retention
stock. Although entering codes is not mandatory, officials from Warner
Robins Air Logistics Center, in response to our questions, said that doing
so is preferred and that the center intended to mandate that item managers
use the codes.

As of March 2003, we found that item managers at the Warner Robins Air
Logistics Center had not entered deferred disposal codes for 12 of 27
items that had potential reutilization and/or disposal materiel-valued at
$277 million based on the items' latest acquisition cost-that the Air
Force wanted to retain. These 12 items thus remained coded as potential
reutilization and/or disposal materiel. According to letters and memoranda
justifying the retention of the items, the Air Force wanted to retain the
items for a variety of reasons, including for potential future use and for
foreign military sales. The following are examples of the items that the
center had decided to retain, but were not properly coded:

o  ~Inventory retained for Air Force use. Warner Robins Air Logistics
Center had 50 transmitter drivers used on an electronic warfare system for
the B-1B aircraft that were categorized as potential reutilization and/or
disposal materiel. The drivers were valued at $644,000 each. Even though
the fleet of B-1B aircraft is being reduced, the center was retaining the
drivers because the Oklahoma City Air Logistics Center, responsible for
management of the B-1B aircraft, had requested that the parts be retained
to support the aircraft until the year 2040 when the Air Force expects to

remove the last of the aircraft from its inventory. However, no code was
entered into the inventory system that would recategorize the inventory as
contingency retention stock.

o  ~Inventory held for foreign military sales. According to the item
manager responsible for receiver transmitters used on the E-3 aircraft,
the items were no longer used by the Air Force. The center had 87 receiver
transmitters, valued at about $410,000 each, that were categorized as
potential reutilization and/or disposal materiel and were being retained
for foreign military sales.

Warner Robins officials explained that it could take up to 3 months for an
item manager to input the code after receiving the request to retain the
inventory. Nevertheless, we identified items that had letters justifying
their retention dating back to 2001 for which no code had been entered.

Because the Air Force is retaining inventory that it has categorized as
potential reutilization and/or disposal materiel, the value of this
inventory is significantly understated in the Supply System Inventory
Report, a key inventory management report prepared annually. Inventory is
reported at approximately 2 percent of its latest acquisition cost in
these reports, and the $277 million inventory that we identified for our
analysis is valued in the reports at approximately $6 million.

Conclusions ~The large number of items with no demands during Operation
Enduring Freedom and through the initial phases of Operation Iraqi Freedom
indicates that further attention to DOD's inventory retention policies may
be merited. However, because we have initiated a separate review of these
policies, we are not at this time making recommendations regarding the
retention of inventory exceeding current operating requirements that had
no demands.

While the ineffective and inefficient inventory management practices we
identified do not necessarily lead to the accumulation of inventory
exceeding current operating requirements, they can affect whether the
warfighter is receiving the right items at the right time. For example,
the military components are using estimated storage costs to make key
management decisions even though more accurate storage cost data are
available from DLA. While Army and Navy officials have said that their
estimates provide sufficient accuracy, we believe that using more accurate
data is a better business practice. Until the services and DLA determine
whether it would be beneficial to use the more accurate storage cost data

in their computations instead of using estimated storage costs and include
that data in their decision-making models as appropriate, they risk having
critical items in short supply when they are needed. Similarly, until the
Air Force implements a systemwide process to correct the causes of
inventory records discrepancies identified by item managers, the Air Force
remains at risk of being unable to fill critical needs, and item managers
will continue to encounter difficulties in their efforts to accurately
determine the number of available assets and reliably forecast the
availability of assets. Moreover, by not requiring item managers to code
inventory so that it is properly categorized, the Air Force is at risk of
disposing of inventory that it wants to retain.

To address the inventory management shortcomings that we identified, we
recommend that the Secretary of Defense take the following three actions:

                            Recommendations for EUR

  Executive ActionEUR

o  ~direct the military services and the Defense Logistics Agency to
determine whether it would be beneficial to use the actual storage cost
data provided by DLA in their computations, instead of using estimated
storage costs, and include that data in their systems and models as
appropriate;

o  ~direct the Secretary of the Air Force to establish and implement a
systemwide process for correcting causes of inventory discrepancies
between the inventory for which item managers are accountable and the
inventory reported by bases and repair centers; and

o  ~direct the Secretary of the Air Force to revise its policy to require
item managers to code inventory so that the inventory is properly
categorized.

                   Agency Comments EURand Our Evaluation EUR

In commenting on a draft of this report, the Acting Deputy Under Secretary
of Defense for Logistics and Materiel Readiness generally concurred with
this report and all three of our recommendations. DOD's comments also
included compliance dates for each of our recommendations. DOD's comments
are included in appendix I of this report.

In concurring with our recommendation to direct the Secretary of the Air
Force to revise its policy to require item managers to code inventory so
that the inventory is properly categorized, DOD stated that this policy
already exists for the Air Force. To ensure the implementation of our
recommendation, the DOD stated that Air Force Materiel Command would
report on how the policy is being implemented. However, our review of the
policy citations provided by DOD indicates that the Air Force policy, as
stated, does not contain language that would require the use of codes

that would properly categorize the inventory. Therefore, even if the Air
Force ensures compliance with its existing policy, it will remain at risk
of disposing of inventory that it may need to later repurchase, and the
value of the improperly categorized inventory will remain significantly
understated in a key inventory management report. Thus, we continue to
believe that our recommendation to revise the Air Force policy to require
item managers to code inventory so that the inventory is properly
categorized is valid.

We are sending copies of this report to interested congressional
EURcommittees; the Secretary of Defense; the Secretaries of the Army, the
EURNavy, and the Air Force; the Director, Defense Logistics Agency; and
the EURDirector, Office of Management and Budget. We will also make
copiesEURavailable to others on request. In addition, the report will be
available atEURno charge on the GAO Web site at http://www.gao.gov. EUR

If you or your staff have any questions, please call me at (202) 512-8365.
EURKey contributors to this report were Lawson Gist, Jr.; Louis
Modliszewski; EURKevin O'Neill; and R.K. Wild. EUR

William M. Solis, DirectorEURDefense Capabilities and ManagementEUR

List of Congressional Committees

The Honorable John W. WarnerEURChairman EURThe Honorable Carl Levin
EURRanking Minority MemberEURCommittee on Armed Services EURUnited States
Senate EUR

The Honorable Duncan Hunter EURChairman EURThe Honorable Ike Skelton
EURRanking Minority MemberEURCommittee on Armed Services EURHouse of
Representatives EUR

The Honorable Ted Stevens EURChairman EURThe Honorable Daniel K. Inouye
EURRanking Minority MemberEURSubcommittee on Defense EURCommittee on
Appropriations EURUnited States Senate EUR

The Honorable Jerry Lewis EURChairman EURThe Honorable John P. Murtha
EURRanking Minority MemberEURSubcommittee on Defense EURCommittee on
Appropriations EURHouse of Representatives EUR

Appendix I: Comments from the Department of Defense

(350392)

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