Pilot Project to Expand Merchandise Sold in Commissary Stores	 
Will Likely Have a Negligible Impact on the Exchange Dividend	 
(22-DEC-05, GAO-06-256R).					 
                                                                 
The Department of Defense (DOD) has three military exchanges--the
Army and Air Force Exchange Service, the Navy Exchange, and the  
Marine Corps Exchange--that operate retail and other specialty	 
stores. During fiscal years 2000 through 2004, the three	 
exchanges provided more than $300 million annually, an average of
55 to 70 percent of their profits, in the form of a dividend to  
support the military services' morale, welfare, and recreation	 
programs. DOD, through the Defense Commissary Agency (DeCA), also
operates commissaries that sell groceries and authorized	 
household products at the lowest practical price, charging	 
patrons only for the cost of goods sold plus a 5 percent	 
surcharge. The funds generated by the surcharge are used to	 
construct new and modernize existing commissaries. The Ronald W. 
Reagan National Defense Authorization Act for Fiscal Year 2005	 
authorized the Secretary of Defense to conduct a pilot project	 
involving the sale of film, one-time use cameras, and telephone  
cards in not less than 10 commissary stores for a period selected
by the Secretary, but not less than 6 months. Previously, these  
items had only been sold by the exchanges. Concerns were	 
expressed by some associated with the exchanges that allowing the
commissary stores to sell these items could adversely affect the 
exchange dividend, which could reduce the funding for the	 
military services' morale, welfare, and recreation programs. The 
legislation also included a requirement that we examine that	 
issue. In response to the 2005 act, we determined (1) the status 
of the pilot project to sell film, one-time use cameras, and	 
telephone cards in select commissaries; and (2) the potential	 
impact that the pilot project could have on the exchange	 
dividend.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-256R					        
    ACCNO:   A43857						        
  TITLE:     Pilot Project to Expand Merchandise Sold in Commissary   
Stores Will Likely Have a Negligible Impact on the Exchange	 
Dividend							 
     DATE:   12/22/2005 
  SUBJECT:   Funds management					 
	     Military bases					 
	     Military facilities				 
	     Military policies					 
	     Program evaluation 				 
	     Recreation 					 
	     Sales						 
	     Pilot programs					 
	     Program implementation				 

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GAO-06-256R

     

     * Summary
     * Background
     * Pilot Project In Process of Being Implemented
     * Pilot Project Should Have Negligible Impact on the Exchange Dividend
     * Agency Comments
     * Enclosure: Comments from the Department of Defense
     * end of correspond & Test.pdf
          * PDF6-Ordering Information.pdf
               * Order by Mail or Phone

A

United States Government Accountability Office Washington, D.C. 20548

December 22, 2005

The Honorable John Warner Chairman The Honorable Carl Levin Ranking
Minority Member Committee on Armed Services United States Senate

The Honorable Duncan L. Hunter Chairman The Honorable Ike Skelton Ranking
Minority Member Committee on Armed Services House of Representatives

Subject: Pilot Project to Expand Merchandise Sold in Commissary Stores
Will Likely Have a Negligible Impact on the Exchange Dividend

The Department of Defense (DOD) has three military exchanges-the Army and
Air Force Exchange Service, the Navy Exchange, and the Marine Corps
Exchange-that operate retail and other specialty stores. During fiscal
years 2000 through 2004, the three exchanges provided more than $300
million annually, an average of 55 to 70 percent of their profits, in the
form of a dividend to support the military services' morale, welfare, and
recreation programs.1 DOD, through the Defense Commissary Agency (DeCA),
also operates commissaries that sell groceries and authorized household
products at the lowest practical price, charging patrons only for the cost
of goods sold plus a 5 percent surcharge. The funds generated by the
surcharge are used to construct new and modernize existing commissaries.

The Ronald W. Reagan National Defense Authorization Act for Fiscal Year
2005 authorized the Secretary of Defense to conduct a pilot project
involving the sale of film, one-time use cameras, and telephone cards in
not less than 10 commissary stores for a period selected by the Secretary,
but

1 DOD's morale, welfare, and recreation programs-such as gymnasiums,
libraries, and child care centers-provide for the physical, cultural, and
social needs and the well-being of servicemembers, their families, and
eligible civilians and are intended to provide a sense of community among
patrons to make individuals more satisfied with military life and to
attract people to military careers.

not less than 6 months.2 Previously, these items had only been sold by the
exchanges. Concerns were expressed by some associated with the exchanges
that allowing the commissary stores to sell these items could adversely
affect the exchange dividend, which could reduce the funding for the
military services' morale, welfare, and recreation programs. The
legislation also included a requirement that we examine that issue. In
response to the 2005 act, we determined (1) the status of the pilot
project to sell film, one-time use cameras, and telephone cards in select
commissaries; and (2) the potential impact that the pilot project could
have on the exchange dividend.

We performed our work at the Office of the Under Secretary of Defense
(Personnel and Readiness), Arlington, Virginia; Army and Air Force
Exchange Service headquarters, Dallas, Texas; Navy Exchange headquarters,
Virginia Beach, Virginia; Marine Corps Exchange headquarters, Quantico,
Virginia; and DeCA Washington Office, Washington, D.C. To determine the
status of the pilot project, we reviewed the memorandum of agreement that
instituted the pilot project and interviewed officials at the headquarters
of the three exchanges and DeCA. To determine the potential impact of the
pilot project on the exchange dividend, we analyzed sales data for film,
one-time use cameras, and telephone cards for fiscal years 2003, 2004, and
2005 through September 30, 2005.3 We also reviewed financial reports on
the amount of exchange dividends for fiscal years 2000 through 2004.
Finally, we obtained data on the percentage of funding for the services'
morale, welfare, and recreation programs from the exchange dividend
compared to self-generated revenue and appropriated funding for fiscal
year 2004. We determined that the data used were sufficiently reliable for
purposes of this review. We conducted our review from September through
November 2005 in accordance with generally accepted government auditing
standards.

Officials from the three exchanges and DeCA signed a memorandum in

                                    Summary

November 2005 agreeing to institute a pilot project to sell film, one-time
use cameras, and telephone cards at 10 commissaries in the continental
United States. DOD implemented the pilot project at one location in
November 2005 and plans to implement it at the other nine locations in

2 Pub. L. No. 108-375, Section 651 (Oct. 28, 2004). 3 The exchanges
operate on the retail fiscal year, which runs from February through
January.

Page 2 GAO-06-256R Defense Infrastructure

                                   Background

December 2005. The pilot project is scheduled to last for 2 years. As
designed, the pilot project is a test of convenience. The commissaries
will purchase the selected film, one-time use cameras, and telephone cards
from the exchanges at the exchanges' retail price and sell the items at
the same price as the exchanges. The commissaries will receive a
management fee equal to 2 percent of the sale price of the items to offset
the costs for handling the pilot project items and will not collect a
surcharge on these items.

The pilot project should have a negligible impact on the exchange dividend
because of the design of the pilot project and the small percentage of
sales from film, one-time use cameras, and telephone cards. The
commissaries will purchase all pilot project items from the exchanges,
less a 2 percent management fee. Further, based on our analysis of the
exchanges' sales data, the sale of all film, one-time use cameras, and
telephone cards comprise a very small percentage (less than 1 percent from
fiscal years 2003 through 2005) of annual total exchange sales, and the
pilot project calls for only selling 8 varieties of these items at 10
locations. Moreover, the exchanges would continue to sell the items at
their locations throughout the pilot project. Based on fiscal year 2004
sales and dividend data, we determined that the fiscal year 2004 exchange
dividend would have decreased by about $600,000, or 0.2 percent, if all
sales of all varieties of these items were made at the commissaries. Our
estimate represents a worst case scenario because it includes the sale of
all film, one-time use cameras, and telephone cards, rather than the eight
items selected for the pilot project; assumes that all sales of film,
one-time use cameras, and telephone cards would occur at the commissaries
instead of the exchanges; and assumes that the sales of these items remain
the same as when they were only sold in the exchanges.

In written comments on a draft of this report, DOD concurred with the
overall report.

The three military exchanges-the Army and Air Force Exchange Service, the
Navy Exchange, and the Marine Corps Exchange-are nonappropriated fund
activities that are established by, controlled by, and operated for the
benefit of DOD components. The military exchanges have a dual mission of
providing (1) authorized patrons with articles of merchandise and services
necessary for their health, comfort, and convenience; and (2) a source of
funding for the military services' morale, welfare, and recreation
programs.

The exchanges operate retail stores, similar to department stores, and
provide a host of other services and specialty stores, including furniture
stores, florist shops, barber and beauty shops, optical shops, liquor
stores, and fast-food restaurants. For fiscal year 2004, the exchange
services had almost $11 billion in sales. While the exchanges use
different methods to determine their dividend, between 55 and 70 percent
of the exchange services' profits from sales were allocated to morale,
welfare, and recreation activities through the exchange dividend over the
past 5 fiscal years and the remaining profits were reinvested in the
exchange system and used primarily to build new exchange facilities and
related capital improvements.

The exchanges' dividend has fluctuated somewhat over the past 5 years.
Figure 1 shows the exchange dividend for each exchange for fiscal years
2000 through 2004.

Figure 1: Exchange Dividend by Exchange for Fiscal Years 2000 - 2004
Dollars in millions

2000 2001 2002 2003 2004 Fiscal year

Army and Air Force Exchange Service Navy Exchange Marine Corps Exchange

Source: DOD.

Note: The Navy Exchange data do not include the Ships' Stores.

The Army and Air Force Exchange Service's dividend fluctuated from a high
in 2000 of $260.4 million to a low in 2002 of $220.1 million before
increasing again to $242.2 million in 2004. Similarly, the Navy Exchange's
dividend was at its high of $53.3 million in 2000, at a low of $41.4
million in 2002, and was around $50 million in 2003 and 2004. The Marine
Corps Exchange's dividend fluctuated from year to year, but remained near
$30 million, with the exception of its lowest year, 2004, when the
dividend was $26.1 million.

The exchange dividend makes up a small portion of the total funding for
the services' morale, welfare, and recreation programs-less than 10
percent of each service's total morale, welfare, and recreation funding in
fiscal year 2004, as shown in figure 2.

Figure 2: Source of Morale, Welfare, and Recreation Program Funding, Fiscal Year

2004 Percent 100

90

80

70

60

50

40

30

20

10

0 Army Air Navy Marine Force Corps

Military service

Exchange dividends Self-generated revenue Appropriated funding Source:
DOD.

                 Pilot Project In Process of Being Implemented

DeCA is DOD's designated agency for managing commissary stores worldwide.
DeCA's mission is to provide beneficiaries with groceries and authorized
household products at the lowest practical price, charging patrons only
for the cost of goods sold plus a 5 percent surcharge. The funds generated
by the surcharge are used to acquire (including acquisition by lease),
construct, repair, maintain, and equip the physical infrastructure of
commissary stores. DeCA ended fiscal year 2004 with 273 stores and sales
over $5 billion.

Officials from the three exchanges and DeCA signed a memorandum in
November 2005 agreeing to institute a pilot project to sell film, one-time
use cameras, and telephone cards at 10 commissaries in the continental
United States.4 DOD implemented the pilot project at one location in
November 2005 and plans to implement it at the other nine locations in
December 2005. The exchanges and DeCA selected eight specific items for
the pilot project-two types of film, three types of one-time use cameras,
and three types of telephone cards.5 Exchange officials said that the
items selected for the test were the exchanges' best selling items in
these categories. The pilot project is scheduled to last for 2 years;
however after 1 year the exchange services and DeCA can agree to terminate
the pilot project.

As designed, the pilot project is a test of convenience. The 10
commissaries will purchase the pilot project items from the exchanges at
the exchanges' retail price and sell the items at the same price as the
exchanges. The exchanges will continue to sell the pilot project items in
the exchanges. The exchanges will pay the commissaries a management fee
equal to 2 percent of the sales price of the pilot project items to offset
the cost of

4 The 10 commissaries chosen for the pilot project are Andrews Air Force
Base, Maryland; Buckley Air Force Base, Colorado; Fort Bliss, Texas; Fort
Knox, Kentucky; Fort Lee, Virginia; Norfolk Naval Base, Virginia; Patuxent
River Naval Air Station, Maryland; Port Hueneme, California; Quantico
Marine Corps Base, Virginia; and Wright-Patterson Air Force Base, Ohio.

5 The items included in the pilot project are Kodak 800 speed film, 4
pack; Kodak 400 speed film, 4 pack; Kodak One-time Use Camera, Zoom; Kodak
One-time Use Camera, Max Flash; Kodak One-time Use Camera, Funsaver; AT&T
100 Unit Global Phone Card (Army and Air Force Exchange System)/ 150 Unit
(Navy Exchange, Marine Corps Exchange); AT&T 200 Unit Global Phone Card
(Army and Air Force Exchange System)/ 300 Unit (Navy Exchange, Marine
Corps Exchange); and AT&T 550 Unit Global Phone Card.

      Pilot Project Should Have Negligible Impact on the Exchange Dividend

handling the pilot project items. The commissaries will not collect a
surcharge on the sale of pilot project items.

The pilot project should have a negligible impact on the exchange dividend
used to support the military services' morale, welfare, and recreation
programs. The exchanges will not lose any sales of film, one-time use
cameras, or telephone cards to the commissaries during the pilot project
because the commissaries will purchase the items from the exchanges and
will continue to sell the items themselves. However, the exchanges will
pay DeCA a 2 percent management fee on the sale of these items. In
addition, the sales of all film, one-time use cameras, and telephone cards
represented less than 1 percent of the total sales for the three exchanges
for fiscal years 2003 through 2005.

According to DOD officials, the pilot project was designed to have minimal
impact on the exchange dividend. Specifically, as previously mentioned,
the 10 commissaries involved in the pilot project will purchase the pilot
project items from the exchanges, rather than an outside vendor, and sell
the items at the same price as the exchanges. Because the commissaries
will purchase all items from the exchanges and the exchanges will continue
to sell the items in their locations, the exchanges will not lose any
sales of film, one-time use cameras, and telephone cards to the
commissaries.

The sales of all film, one-time use cameras, and telephone cards comprised
less than 1 percent of total retail sales for the exchanges from fiscal
years 2003 through 2005, as shown in figure 3. Telephone cards were the
largest proportion of the three categories in terms of dollar sales,
ranging from a low of 0.08 percent of sales at the Marine Corps Exchange
in fiscal year 2003 to a high of 0.70 percent of sales at the Army and Air
Force Exchange System in fiscal year 2005.

Figure3: Exchange Sales of All Film, One-Time Use Cameras, and Telephone
Cards as a Percentage of Total Exchange Sales, Fiscal Years 2003-2005
Percent

1.0

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0.0 2003 2004 2005 2003 2004 2005 2003 2004 2005

Army and Air Force Navy Exchange Marine Corps Exchange Service Exchange

Fiscal year

Film

One-time use cameras

Phone cardsSource: GAO analysis of DOD data.

Notes: The sales data include the sales of all film, one-time use cameras,
and telephone cards, not only those eight items selected for the pilot
project. The Navy Exchange data do not include the Ships' Stores.

As previously noted, the pilot project includes eight items and not all
the film, one-time use cameras, and telephone cards sold in the exchanges.
Comparable data on the sales of only the 8 items and 10 installations
included in the pilot project were not available. To show the potential
impact on the exchange dividend, we assumed that the commissary stores
accounted for the sale of all film, one-time use cameras, and telephone
cards. Based on fiscal year 2004 sales and dividend data, we determined
that the exchange dividend would have been reduced by about $600,000, or

0.2 percent, as shown in table 1.

Table 1: Potential Impact of the Pilot Project on the Exchange Dividend
Based on Fiscal Year 2004 Data

Dollars in thousands  
                                               Potential decrease in exchange
                           Actual exchange              dividend
Exchange               dividend (2004)       Dollars            Percentage
Army and Air Force             $242,179               $370            0.15
Exchange Service                        
Navy Exchange                    48,667           203                 0.42 
Marine Corps Exchange            26,141           22                  0.08 
Total                          $316,987          $595                 0.19 

Source: GAO analysis of DOD data.

Note: The Navy Exchange data do not include the Ships' Stores.

Our estimate represents the worst case scenario because it includes the
sale of all film, one-time use cameras, and telephone cards, and not just
the 8 items included in the pilot project or the 10 locations selected for
the pilot project. In addition, we assumed that the commissaries would
account for all sales since we have no basis to determine the extent to
which sales would be split between the exchange stores and the commissary
stores. In addition, our analysis does not consider whether the overall
sales of these items would increase or whether the pilot project could
reduce sales of other items at the exchanges due to a loss of foot
traffic.

In commenting on a draft of the report, the official performing the duties
of

                                Agency Comments

the Principal Deputy Under Secretary of Defense (Personnel and Readiness)
concurred with the overall report. DOD also provided technical comments
which were incorporated as appropriate. DOD's comments are reprinted in
the enclosure of this report.

We are sending copies of this report to the Secretary of Defense; the
Under Secretary of Defense (Personnel and Readiness); the Commander, Army
and Air Force Exchange System; the Commander, Navy Exchange Command; the
Director, Personal and Family Readiness Division, U.S. Marine Corps; the
Chairman, Commissary Operating Board; the Director, DeCA, and the
Director, Office of Management and Budget. We will make

Page 9 GAO-06-256R Defense Infrastructure

copies available to others upon request. In addition, the report will be
available at no charge on GAO's Web site at http://www.gao.gov.

Please contact me at (202) 512-5581 if you or your staff have any
questions concerning this report. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this report. Major contributors to this report were Michael Kennedy,
Assistant

Enclosure

Enclosure: Comments from the Department of Defense
*** End of document. ***