Defense Inventory: Process for Canceling Inventory Orders Needs
Improvement (Letter Report, 06/30/2000, GAO/NSIAD-00-160).

Pursuant to a congressional request, GAO provided information on the
Department of Defense's (DOD) inventory management, focusing on the: (1)
extent to which orders exceeded requirements when the orders were
placed; and (2) processes for cancelling orders that exceeded
requirements.

GAO noted that: (1) for the 490 items reviewed, GAO found no evidence
that inventory orders exceeded requirements when the orders were first
placed; (2) managers had placed orders after ensuring that they were
supported by requirements, consistent with DOD's policies; (3) however,
requirements for the items often changed after the orders were placed,
which caused the items to exceed requirements; (4) because of the large
number of inaccurate records, neither DOD nor the military components
know whether managers are efficiently focusing their efforts to cancel
excess inventory on order, and DOD does not have an accurate view of the
total value of its excess inventory on order; (5) each component's
process for cancelling orders that exceeded requirements differs and
cannot be relied on to consistently identify orders to be considered for
cancellation or to terminate orders when economical; (6) the components
use different criteria for the amount of excess inventory on order they
consider for cancellation; (7) the Army and the Defense Logistics Agency
(DLA) consider orders for cancellation when the inventory ordered
exceeds requirements; (8) the Navy and Air Force consider canceling
orders when the inventory is at higher levels; (9) the Army and the DLA
consider more of their excess inventory on order for cancellation than
the Navy and Air Force do; (10) only the DLA consistently uses its
computer model to determine whether it is more economical to cancel
orders or not; (11) however, of the $696 million its model referred for
consideration during a 3-month period in 1999, less than $11 million in
orders were cancelled; (12) the Army and Air Force infrequently use
their models, and the Navy has not used its model since 1993 because it
overestimated contract termination costs, thus eliminating contracts for
consideration; (13) the lack of use of the models and cancellation of
items referred for consideration raises questions about their
effectiveness; (14) the military components' frequency in reviewing
orders of excess inventory for cancellation ranges from monthly to
quarterly; (15) the longer components wait to consider an item for
cancellation, the less likely cancellation will be cost-effective
because they have to pay the contractor for costs incurred until the
order is cancelled; (16) the components' goals for reducing excess
inventory on order vary and are not comparable; and (17) thus, DOD
cannot evaluate the components' progress in reducing excess inventory on
order in a consistent way.

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

 REPORTNUM:  NSIAD-00-160
     TITLE:  Defense Inventory: Process for Canceling Inventory Orders
	     Needs Improvement
      DATE:  06/30/2000
   SUBJECT:  Defense procurement
	     Logistics
	     Inventory control systems
	     Military cost control
	     Cost effectiveness analysis
	     Spare parts

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GAO/NSIAD-00-160

Appendix I: Objectives, Scope, and Methodology

24

Appendix II: Military Service and Defense Logistics Agency
Criteria for Canceling Excess Inventory on Order

27

Appendix III: Comments From the Department of Defense

32

35

Table 1: Inventory on Order Inaccurately Reported as Excess 10

Table 2: Reported Value of DOD Excess Inventory on Order for
Fiscal Years 1996-99 12

Table 3: Defense Supply Center Richmond Items Identified for
Manager Review 16

Table 4: Service and DLA Goals for Reducing Excess Inventory on
Order 20

Table 5: Reported Value of Items Reviewed 24

Figure 1: DOD's Process for Managing Inventory on Order 6

Figure 2: DOD's Inventory Categories 7

Figure 3: Purchasing an Economic Order Quantity at the Reorder
Point 9

Figure 4: Reported Value of Excess Inventory on Order for Fiscal
Years 1996-99 13

Figure 5: Percentage of Reported Value of Excess Inventory on
Order and Total Inventory on Order for Fiscal Years 1996-99 14

Figure 6: Army, Navy, Air Force, and DLA Criteria for Purchasing
Inventory and Canceling Excess Inventory on Order 15

Figure 7: Army, Navy, Air Force, and DLA Criteria for Purchasing
Inventory and for Canceling and Reporting Excess
Inventory on Order 21

Figure 8: Army Disks Considered for Cancellation 27

Figure 9: Navy Pilot Valve Cartridges Considered for Cancellation 29

Figure 10: Air Force Rotor Blades Considered for Cancellation 31

DOD Department of Defense

DLA Defense Logistics Agency

National Security and
International Affairs Division

B-283680

June 30, 2000

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

This report is one in a series of reports on the Department of Defense's
management of inventory--spare and repair parts and other items that support
the Department's operating forces on land, at sea, and in the air.1 Over the
past several years, we have prepared a number of testimonies and reports
that cite the Department's management of inventory as a high-risk area.2 For
example, we have issued several reports and testimonies related to the
Department's problems involving levels of inventory in excess of current
needs, the lack of adequate systems for determining inventory requirements,
and inaccurate records on the actual amount and value of its inventories. As
of September 30, 1999, the Department reported that it had about $8.1
billion of inventory on order, $1.6 billion of which exceeded
requirements--the amount of inventory the Department indicated as needed to
prevent out-of-stock situations.

As mandated by Senate Report 106-50 relating to the National Defense
Authorization Act for Fiscal Year 2000, we reviewed inventory on order that
exceeded requirements. Specifically, we (1) determined the extent to which
orders exceeded requirements when the orders were placed and
(2) assessed the processes for canceling orders that exceeded requirements.

In doing our review, we focused on the criteria that the services and the
Defense Logistics Agency use to purchase inventory, identify inventory
orders for cancellation, determine the economic benefits of canceling
orders, and report the amount of inventory on order that exceeds
requirements. We based our analysis on 490 Army, Navy, Air Force, and
Defense Logistics Agency items that had about $375 million worth of
inventory on order that was in excess of requirements. For the 490 items, we
selected some items that had the highest values of inventory on order in
excess of requirements and a cross section, based on value, of the remaining
items. The 490 items included 360 Navy and Air Force items that we reviewed
as part of prior audit work.3 The scope and methodology of our work are
described in greater detail in appendix I.

For the 490 items we reviewed, we found no evidence that inventory orders
exceeded requirements when the orders were first placed. Managers had placed
orders after ensuring that they were supported by requirements, consistent
with the Department of Defense's policies. However, requirements for the
items often changed after the orders were placed, which caused the items to
exceed requirements. For example, the demand for helicopter control
indicators decreased from the original requirement for 184 indicators to 107
after the order was placed. Further, because of inaccurate inventory
records, 182 of the 490 items (valued at $170 million) were reported as
excess, but were not actually excess to requirements. For example, after
orders were placed, some inventory was counted once as on hand and again as
on order, causing the inventory on order to exceed requirements. Because of
the large number of inaccurate records, neither the Defense Department nor
the military components know whether managers are efficiently focusing their
efforts to cancel excess inventory on order, and the Department does not
have an accurate view of the total value of its excess inventory on order.

Each component's process for canceling orders that exceeded requirements
differs and cannot be relied on to consistently identify orders to be
considered for cancellation or to terminate orders when economical.

Specifically:

ï¿½ The components use different criteria for the amount of excess inventory
on order they consider for cancellation. The Army and Defense Logistics
Agency consider orders for cancellation when the inventory ordered exceeds
requirements; the Navy and Air Force consider canceling orders when the
inventory is at higher levels. Thus, the Army and Defense Logistics Agency
consider more of their excess inventory on order for cancellation than the
Navy and Air Force do.

ï¿½ Only the Defense Logistics Agency consistently uses its computer model to
determine whether it is more economical to cancel orders or not. However, of
the $696 million its model referred for consideration during a 3-month
period in 1999, less than $11 million in orders were canceled. The Army and
Air Force infrequently use their models, and the Navy has not used its model
since 1993 because it overestimated contract termination costs, thus
eliminating contracts for consideration. The lack of use of the models and
cancellation of items referred for consideration raises questions about
their effectiveness.

ï¿½ The military components' frequency in reviewing orders of excess inventory
for cancellation ranges from monthly to quarterly. The longer components
wait to consider an item for cancellation, the less likely cancellation will
be cost-effective because they have to pay the contractor for costs incurred
until the order is canceled.

ï¿½ The components' goals for reducing excess inventory on order vary and are
not comparable. Thus, the Department of Defense cannot evaluate the
components' progress in reducing excess inventory on order in a consistent
way.

We are recommending that the Department of Defense review and improve its
processes for identifying and canceling excess inventory on order. In
written comments on a draft of this report, the Department of Defense agreed
with our recommendations.

Inventory management comprises several major functions, including
determining what is needed; buying needed items; and storing, maintaining,
distributing, and disposing of these items. The military services and the
Defense Logistics Agency (DLA) use automated inventory management models
that identify the need to place orders when the total inventory falls below
a predetermined level. The models also periodically consider whether orders
exceed requirements and are candidates for cancellation. After the models
identify orders that are candidates for cancellation, the services and DLA
use other models or analyses to determine whether canceling the orders is
economical. The Department of Defense's (DOD) general process for placing an
order and subsequently evaluating the order to determine if it is a
candidate for cancellation is shown in figure 1.

In general, DOD categorizes inventory as follows and as illustrated in
figure 2:

1. The requirements objective represents the amount of inventory to be
purchased and includes

ï¿½ war reserves, requisitions that have not been shipped, and a "safety
level" of stock;4

ï¿½ stock to satisfy demands during the "lead time"--the period between the
placement of orders and their receipt; and

ï¿½ an economic order quantity, or a quantity that should result in the lowest
total costs for ordering and holding inventory.

2. The approved acquisition objective defines the amount of inventory DOD
budgets for and includes inventory needed to satisfy 2 years of demand for
items above the requirements objective.

3. Inventory that exceeds the approved acquisition objective is categorized
as economic retention, contingency retention, and potential reutilization
and/or disposal materiel.5

Although the services and DLA reported $1.6 billion of inventory on order
that exceeded requirements, we found no evidence that orders were in excess
of requirements when they were placed for the 490 items we reviewed.6
Generally, requirements for the items decreased after orders were placed,
which resulted in the items having inventory on order that exceeded
requirements. However, DOD inventory records showed that $170 million worth
of excess inventory on order reviewed was still needed. The $170 million, or
45 percent of the amount reviewed, was erroneously reported as excess
because of inaccurate records. As a result, neither DOD nor the military
components know whether managers are efficiently focusing their efforts to
cancel excess inventory on order, and the Department does not have an
accurate view of the total value of its excess inventory on order.

Managers had made purchases for the 490 items we reviewed consistent with
DOD's model for purchasing inventory. (See fig. 3). The model identifies
items to be purchased when inventory falls to a certain level called the
reorder point. After managers review requirements and available assets to
validate the need to purchase inventory, they place orders for a quantity of
inventory that is supposed to represent the lowest total costs for ordering
and holding inventory called an economic order quantity. The requirements
objective comprises the reorder point and the economic order quantity.

The most common reason for inventory on order being in excess of the
requirements objective was that requirements decreased after orders were
placed. For example, the Army manager for a control indicator used on the
de-icing system for the UH-60A helicopter used a February 1997 requirement
computation to support the purchase of 184 indicators valued at $1.4
million. After the order was placed, demand for the item decreased,
resulting in a lower requirements objective. Consequently, 107 of the
indicators on order exceeded the lower requirements objective.

Accurate data are necessary for the services' and DLA's inventory management
models to properly identify items with excess inventory on order for
managers to review. However, as shown in table 1, the recorded data on 182
of the 490 items we reviewed showed that there was excess inventory valued
at $170 million, or 45 percent of the total reviewed, when other records
showed there was no excess. Determining whether inventory is in fact
excess--even though at the time of ordering the records may have been
correct--increases managers' workloads.

 Dollars in millions
                 Items reviewed          Items with errors

 Component   Number  Reported value    Number  Reported value
                       of excess                 of excess
 Army        49      $30.9             20      $16.9
 Navy        200     48.3              83      14.9
 Air Force   160     162.4             32      26.3
 DLA         81      133.1             47      111.9
 Total       490     $374.7            182     $170.0

Source: DOD inventory records.

Generally, excess inventory on order was misstated because the components'
inventory management models did not accurately reflect requirements or
available inventory. For example, September 30, 1999, data on a turbine
nozzle used on the engine for the H-53 helicopter showed that DLA had an
excess of 693 nozzles on order. We found, however, that a large number of
nozzles, costing $359 each, were erroneously recorded twice in inventory
records--once as on hand and once as on order. After the item's manager
corrected the inventory records in December 1999, DLA needed to order an
additional 33 nozzles.

Twenty of the 49 Army items reviewed had inaccuracies that caused an
overstatement of the amount of excess inventory on order. For example,
September 1999 inventory records show that 71 valves used on an aircraft
engine and valued at $3,391 each were on order and exceeded requirements.
However, after the order was placed, the valve was replaced with a different
type. The Army had made arrangements for the contractor to provide the
replacement valves but did not update the inventory records to reflect this
change. Thus, there was no excess on order. Officials at the Army's Aviation
and Missile Command told us that in 1999 they tried to reduce excess
inventory on order by identifying for special review the top 30 items that
had excess orders valued at over $67 million. The review determined that the
value of excess inventory on order identified as excess was overstated by
over $10 million. Causes for the overstated inventory included inventory
records that reflected inaccurate amounts of inventory on hand and on order
and understated requirements.

In November 1999, we reported on inaccuracies in Air Force records.7 For
example, Air Force records for September 30, 1997, showed that 24 thermal
insulation tiles used on the B-2 aircraft were on hand and an additional
7 were on order. By May 1998, the Air Force was using a different type of
insulation tile, and when the manager attempted to terminate the order for
the seven tiles, he was informed by a contracting official that the records
showing the quantity on order were in error. The tiles, which cost $5,400
each, had been delivered a year earlier in May 1997. The Air Force has begun
an initiative to improve its data accuracy by 2003.

Decisions

The DOD processes used to cancel excess inventory on order cannot be relied
upon to consistently identify orders to be considered for cancellation. Our
analyses of DOD inventory records showed that the amount of DOD's reported
excess inventory changed little during fiscal years 1996-99. While the Army,
Navy, Air Force, and DLA purchase inventory to meet the requirements
objective, our analyses showed that some processes (1) limited the extent to
which orders were considered for cancellation, (2) resulted in few
cancellations, and (3) did not identify some orders for cancellation in a
timely manner. As a result, the components missed opportunities to cancel
orders for excess items. In addition, differences in the components'
measures of excess inventory on order prevent DOD from evaluating the
components' progress in a consistent and comparable manner.

Overall, DOD's excess inventory on order changed little during fiscal years
1996-99. We based our analyses on the requirements objective and the
approved acquisition objective for those years because the requirements
objective represents the level of inventory that managers buy, and the
approved acquisition objective represents the level of inventory for which
the components budget. (See table 2.)

  Dollars in millions
                            Excess inventory on       Excess inventory on
                               order based on       order based on approved
                           requirements objective   acquisition objective
         Total reported
 Fiscal     value of         Reported                 Reported
  year    inventory on        value     Percent        value      Percent
             order
 1996    $8,852.2         $1,711.6     19           $708.4       8
 1997    8,002.7          1,470.6      18           608.9        8
 1998    7,867.6          1,355.6      17           464.7        6
 1999    8,145.6          1,572.1      19           515.4        6

Source: DOD inventory records.

When considered individually, the amount of the services' and DLA's excess
inventory on order varied, regardless of whether based on the requirements
objective or the approved acquisition objective (see fig. 4). The Army and
Navy had the lowest reported amounts of excess inventory on order. While the
Air Force's reported excess inventory on order decreased during fiscal years
1996-1998, the amount of Air Force excess inventory on order increased
substantially for fiscal year 1999. According to an Air Force official, the
excess increased in 1999 primarily because the Air Force Materiel Command
directed managers to consider canceling excess inventory on order only if it
was valued at $100,000 or more so that they could devote more time to budget
preparation. While DLA's reported excess on order inventory remains high
relative to the Army and Navy, DLA has decreased its excess on order over
the last 2 years.

1996−99

Source: DOD inventory records.

While the reported value of Army and Navy excess inventory on order
(regardless of how computed) was generally about $100 million or less, Air
Force and DLA excesses were much larger. This was also the case when the
reported excesses were measured as a percentage of the total inventory on
order, as shown in figure 5.

Inventory on Order for Fiscal Years 1996−99

Source: DOD inventory records.

Considered for Cancellation

The criteria that the military services and DLA use to consider excess
inventory on order for cancellation impose different limits on the amount of
excess inventory on order to be analyzed for cancellation. Figure 6 shows
that while the services and DLA purchase inventory to satisfy the
requirements objective, only the Army and DLA use that objective to identify
inventory on order to consider for cancellation. The Navy and Air Force
cancellation criteria resulted in considering for cancellation excess
inventory on order ranging from quantities that exceeded the requirements
objective to quantities that exceeded the approved acquisition objective.
Thus, the Navy and Air Force would not even consider canceling orders for
excess inventory on order that the Army and DLA would consider. The Navy
uses the higher cancellation criteria to preclude canceling orders for items
that may be needed as demand fluctuates. The Air Force is considering
reducing its levels. Appendix II contains a more detailed discussion of the
military components' criteria for considering excess inventory on order for
cancellation.

DLA and the services also exclude low-value excess inventory on order from
consideration for cancellation in order to focus managers' efforts on
higher-value excess inventory on order, in an effort to maximize savings
from canceling orders and to reduce manager workloads. While this practice
does reduce workloads, it also results in the receipt of millions of dollars
of inventory on order in excess of their requirements objective that becomes
part of DOD's inventory on hand.

Depending on the item, DLA's inventory management model requires that
on-order quantities exceed an item's economic order quantity by 25 to
100 percent, and the excess must meet minimum dollar values ranging from
$400 to $50,000 in order to be considered for cancellation. As shown in
table 3, the DLA and Richmond Supply Center criteria precluded review of
$147.8 million of inventory due in8 that exceeded the requirements
objective. The minimum dollar and percentage criteria reduced workload by
preventing 34,826 items from being considered for cancellation. Some of the
excess inventory on order not considered for cancellation will become part
of DLA's inventory, even though it is not needed.

    Dollars in millions
                                   Items              Excess due in
                              Number  Percent    Reported value  Percent
 Identified for review        5,309   13         $550.3          79
 Not identified for review    34,826  87         147.8           21
 Total                        40,135             $698.1

Source: DOD inventory records.

In addition, the Center has a budget policy that managers not routinely
cancel or reduce contracts under $10,000. For example, DLA had a
requirements objective for 43 dial and light assemblies used on the T-37
aircraft. Forty assemblies, valued at $798 each, were on hand and an
additional 15 were on order. The manager did not take action to cancel the
12 assemblies on contract that exceeded the requirements objective because
the $9,600 excess on order was less than the $10,000 minimum.

In contrast, the Army's Aviation and Missile Command, Huntsville, Alabama,
has much lower minimum dollar limits. The Command identifies all missile
item excesses valued at $1 or more and all aviation item excesses valued at
$55 or more for cancellation review. Managers, however, are expected to
focus their efforts on canceling higher value excesses first.

The Navy currently identifies excesses that are valued at $1,000 or more for
managers to review but is considering increasing the minimum dollar value to
$5,000 due to workload concerns. The Air Force policy, on the other hand, is
that all items with excess inventory on order will be reviewed for
cancellation. However, as discussed earlier, for items reviewed in the
September 1999 time frame, the Air Force required managers to review orders
for excess inventory on order only if they were valued at $100,000 or more.

Effectiveness

The Army, Air Force, and DLA have models designed to determine whether it is
more economical to cancel an order for excess inventory on order or receive
the order and store it as part of inventory. Although we did not validate
the models used, we found that they varied in design and the data used to
determine the economic benefit of canceling orders. For example, the Army
and DLA consider obsolescence cost,9 whereas the Air Force does not. The Air
Force, unlike the Army and DLA, considers the item's cost when procuring the
item in the future. DLA uses its termination model consistently but cancels
few orders as a result, the Army and Air Force seldom use theirs, and the
Navy quit using its model in 1993. Thus, the effectiveness of the models is
in question.

The DLA model is integrated into its automated inventory management model
and automatically determines whether or not it is economical to cancel
contracts for items that have inventory in excess of the requirements
objective and that exceed DLA's percentage and low-dollar criteria. Results
are automatically provided to managers at their computerized workstations.
As a result, the termination model evaluates all DLA items. DLA reported
that, from July through September 1999, its model referred $696 million of
inventory in excess of the requirements objective to managers for review.
Managers recommended contract cancellation for $42 million of the amount,
but less than $11 million of excess inventory on order was actually
canceled.

The Army and Air Force models are separate from the automated inventory
management models and managers must manually enter data such as lead times,
requirements, assets, and storage costs to determine whether or not it is
economical to cancel or reduce contracts for excess inventory on order. Army
headquarters officials told us that their model was not widely used. Of the
49 Army items with $30.9 million of excess on order we reviewed, we
identified 5 items for which the model was used. In two of these cases, use
of the model resulted in the cancellation of inventory worth $799,450. In
other cases, managers decided not to cancel orders based on their knowledge
of the items. Similarly, the Air Force termination model recommended the
cancellation of contracts for excess inventory on order in 6 out of 25 cases
where the model was actually used. A 1997 Air Force review of excess on
order found that the model was generally not used correctly or at all.
According to the Air Force, $12.4 million of contracts were canceled in
fiscal year 1999. Army officials were unable to provide overall data on the
number and value of excess on order inventory canceled.

Even though the Navy discontinued using its termination model in 1993, the
Navy canceled contracts for $28 million in excess inventory on order in
fiscal year 1999. According to Navy officials, the Navy suspended the use of
its model because it overestimated contract termination costs and thus
eliminated contracts from being considered for cancellation. Instead, the
Navy decided to pursue the cancellation of all contracts that met its
criteria.

The military components' frequencies for reviewing excess inventory on order
for cancellation ranges from monthly to quarterly and varies by component.
For example, at the Army Aviation and Missile Command, missile parts are
identified for review on a quarterly basis; aviation parts and other
commodities are examined every 6 weeks. The Navy evaluates ship parts
monthly but evaluates aviation parts quarterly. DLA identifies all items
with inventory on order in excess of requirements in February, May, August,
and November. For the intervening 2 months, only those items that had not
been previously identified as excess are highlighted for review. The Air
Force reviews all inventory items quarterly.

Contractor costs are one of the factors used in the military components'
termination models to determine whether or not a contract is economical to
cancel. The longer it takes to make a decision to terminate a contract, the
more costs the contractor incurs and the less likely it will be economical
to cancel the contract. For example, an Air Force contracting official said
that each day cancellation was delayed on a contract for torque landing gear
collars, the contractor incurred an additional $5,000 in costs that the
government would have to pay to cancel the contract.

Studies of Air Force and DLA cancellation efforts show that when managers
deferred making cancellation decisions, contractor costs increased and it
was frequently too late to economically terminate. For example, a 1997
internal Air Force study determined that managers often deferred
cancellation decisions until it was no longer economical to cancel. Also,
the DOD Inspector General reported in 1998 that prompt action is critical to
minimize the government's costs. To illustrate this point, the report
pointed out that DLA's Columbus Supply Center had processed 69 of 119 items
identified for cancellation within 30 days, whereas DLA's Richmond Center
had processed 10 out of 132 within 30 days.10 The cancellation rate for the
Columbus items was more than double the rate for the Richmond items because
contractors' costs increased during the delays.

In some instances, the need to validate assets and requirements can delay
the timeliness of cancellation efforts. For example, in October 1996, the
manager for a bracket and bubble assembly used on the C-135 aircraft ordered
346 assemblies based on requirements from Warner Robins Air Force Base. The
item was identified for cancellation in October 1998. Because the
requirements had to be validated, the manager attempted to contact the Air
Force customer, who did not respond to the information request. As a result,
the order was not canceled, and as of December 1999, DLA had 97 assemblies,
valued at $1,441 each, on hand that exceeded the requirements objective.

and Are Not Comparable

The services and DLA have made efforts to reduce excess inventory on order
and have established goals to measure their progress. The goals, shown in
table 4, range from 2 percent of total inventory on order to
10 percent.11 However the goals are not comparable because, as discussed
earlier, each of the services and DLA use different criteria to identify the
amount of excess inventory on order. For example, the Army's goal was
based on excess inventory on order above the requirements objective, while
the Air Force's goal was based on excess inventory on order above the
approved acquisition objective. The Navy and DLA also base their goals on
the approved acquisition objective.

 Component Goals, expressed as a percentage of
           total inventory on order
 Army      10
 Navy      5.5 or 7
 Air Force 4
 DLA       2 to 5.8

Source: DOD data.

The services and DLA have initiated a variety of efforts to reach their
goals. For example, the Army Aviation and Missile Command initiated a
special one-time project to review the 30 items in its inventory with the
highest amount of excess on order. The Navy has long maintained a history of
tracking excess items on order against its goals. The Air Force initiated
processes to define the causes of excess items on order, including
high-dollar items, data errors, and untimely cancellations. DLA initiated an
improvement program, which included establishing an oversight coordinator
position, reporting measurements against goals for reducing excess inventory
on order, and increasing efforts to reduce data errors.

Figure 7 shows that the services and DLA use different criteria to purchase
inventory, identify the amount of inventory not subject to cancellation, and
report excess inventory on order. Only the Army makes purchases, identifies
excess inventory on order for cancellation, and measures its progress based
on the requirements objective. While the Navy, Air Force, and DLA also make
purchases based on the requirements objective, they identify items for
cancellation and report excess inventory on order at levels ranging from
quantities that exceed the requirements objective to quantities that exceed
the approved acquisition objective.

In addition, the Air Force and DLA measures did not include all of the items
managed. The Air Force excludes items managed by contractors, while DLA does
not report on items that have no or low demands.

Although the services and DLA were placing orders consistent with their
inventory management models, the dynamics of DOD's inventory and the
mechanics of the management models will always result in some excess
inventory on order. The services and DLA have recognized that excess
inventory on order is a problem and have initiated some corrective actions.
However, the services and DLA have set up a variety of processes that make
efficient management of excess inventory on order difficult. The services'
and DLA's inventory management models erroneously identified a large number
of items for cancellation, and managers reviewed and validated information
only for items that the models identified. As a result, neither DOD, nor the
military components know whether managers are focusing their efforts on the
proper items. Because the military components' processes identified excess
inventory on order for cancellation at different levels and excluded
low-dollar excesses, millions of dollars of excess inventory on order were
not canceled. This situation contributes to the accumulation of higher
levels of excess inventory on hand. Also, some components have longer
intervals between item reviews, causing additional contractor costs to be
incurred and making the cancellation of contracts less likely to be
economical. Termination models were used inconsistently and often did not
recommend cancellation of excess inventory on order. Although the services
and DLA have goals for reducing excess inventory on order, they report
excess inventory on order at different levels and do not include all excess
on order in their measures. As a result, consistent DOD-wide management
oversight of excess inventory on order is difficult to achieve.

Because of the difficulties the services and DLA face in identifying and
canceling excess inventory on order, we recommend that the Secretary of
Defense, in conjunction with the Secretaries of the Army, Navy, and Air
Force, and the Director of the Defense Logistics Agency, review and improve
their processes, focusing on areas such as

ï¿½ the accuracy of inventory management records;

ï¿½ the level at which the services and DLA identify excess inventory on order
that is subject to cancellation review, including low-dollar excess
inventory on order that is excluded from cancellation review;

ï¿½ the timeliness and frequency of reviews for identifying excess items
on-order; and

ï¿½ the validity and use of the military components' termination models in
making economic analyses.

In addition, to improve DOD's oversight of excess inventory on order, we
recommend that the Secretary of Defense require the services and DLA to
report on the amount of all excess inventory on order, identifying inventory
on order that exceeds both the requirements objective and the approved
acquisition objective.

In written comments on a draft of this report, DOD agreed with our
recommendations and cited a number of actions that it plans to take. DOD's
comments are reprinted in their entirety in appendix III.

We are sending copies of this report to the appropriate congressional
committees; the Honorable William S. Cohen, Secretary of Defense; the
Honorable Louis Caldera, Secretary of the Army; the Honorable Richard
Danzig, Secretary of the Navy; the Honorable F. Whitten Peters, Secretary of
the Air Force; Lieutenant General Henry T. Glisson, Director, DLA; and the
Honorable Jacob J. Lew, Director, Office of Management and Budget.

Please contact me at (202) 512-8412 if you have any questions. Key
contributors to this report were Charles Patton, Jr.; Gary Billen; Louis
Modliszewski; and David Keefer.

David R. Warren, Director
Defense Management Issues

Objectives, Scope, and Methodology

Senate Report 106-50 relating to the National Defense Authorization Act for
Fiscal Year 2000 mandated that we review Army, Navy, Air Force, and Defense
Logistics Agency (DLA) inventory on order that exceeded requirements.
Specifically, the report required GAO to (1) determine the extent to which
orders exceeded requirements when the orders were placed and (2) assess the
processes for canceling orders that exceeded requirements.

To identify the extent to which orders exceeded requirements when the orders
were made, we reviewed 490 Army, Navy, Air Force, and DLA items on order
that exceeded their requirements objectives (the amount of inventory for
which there were requirements when the orders were made) as shown in table
5.

 Dollars in millions

 Component           Number of items reviewed  Reported value of excess
                                               inventory on order
 Army                49                        $30.9
 Navy                200                       48.3
 Air Force           160                       162.4
 DLA                 81                        133.1
 Total               490                       $374.7

Note: The Army data were as of September 30, 1998; the Navy data were as of
September 30, 1996; the Air Force data were as of September 30, 1997; and
the DLA data were as of October 28, 1999.

Source: Department of Defense (DOD) inventory records.

Our review covered spare and repair parts and other items that support DOD's
operating forces on land, at sea, and in the air. We did not include such
items as petroleum, oil, and lubricants or items in Marine Corps and retail
level inventories in our analysis because they represent a small part of
DOD's overall inventory or the reorder point and economic order quantity
requirements were not available for these items.

For the Army, Navy, and Air Force we used computerized inventory
stratification reports to identify items with excess inventory on order for
review. Stratification reports match on-hand and due-in inventory to
requirements and are used for budgeting and reporting purposes. For DLA, we
used extracts of data from inventory files to identify items with excess
inventory on order. For the four components, we selected items that had the
highest values of inventory on order in excess of the requirements objective
and a cross section, based on values, of the remaining items at each of the
locations visited. For the Navy and Air Force, we used items reviewed as
part of prior work that addressed similar objectives.12 The items reviewed
were managed by the Army Aviation and Missile Command, Huntsville, Alabama;
the Naval Inventory Control Point's Mechanicsburg and Philadelphia,
Pennsylvania, offices; the Air Force's Air Logistics Centers at Oklahoma
City, Oklahoma, San Antonio, Texas, and Ogden, Utah; and DLA's Defense
Supply Center, Richmond, Virginia. At these locations, we reviewed
documentation used to support the purchases and discussed purchase
justifications with responsible managers.

We also used the 490 items to assess the processes used to cancel orders
that exceed requirements. We reviewed documents that managers use to
determine whether orders need to be canceled and discussed the documents and
decisions with the managers. We did not evaluate the validity of the
economic termination models used by the military services and DLA.

For overall inventory data such as the amount of excess inventory on order,
we analyzed September 30, 1999, summary inventory stratification reports for
items managed by the military services and DLA. We did not validate any of
the military components' automated inventory databases used to create the
reports; however, we did note database discrepancies during our review of
documents and discussions with managers relating to individual items. In
order to present the military components' inventory values on a comparable
basis, we removed surcharges for operating costs to value inventory items at
the latest acquisition cost.

We also met with Army, Navy, Air Force, and DLA headquarter-level officials
responsible for inventory management to discuss overall efforts to reduce
excess inventory on order, including efforts to set goals for reducing
excess inventory on order and to measure progress in meeting those goals.

We performed our review from July 1999 through May 2000 in accordance with
generally accepted government auditing standards.

Military Service and Defense Logistics Agency Criteria for Canceling Excess
Inventory on Order

The Army and Defense Logistics Agency consider inventory on order that
exceeds an item's requirements objective--the quantity they would normally
buy--as subject to cancellation. For example, a December 1999 Army
requirement computation for a disk used on the gas generator turbine rotor
of the T701C engine recommended a cancellation of 227 disks that were on
order. At that time, the disks, valued at $7,107 each, had a requirements
objective of 72 disks. The Army had 69 disks on hand and another 230 on
order of which only 3 were needed. Figure 8 shows the requirements objective
and quantity of disks the Army would consider for cancellation.

In April 1998, we reported that the Navy adds a "protection level,"
representing as much as 2 years of projected demand, to requirements before
considering inventory on order as excess for cancellation. The Navy cancels
only the amount of the purchases that exceeds the protection level. For
contracts, the Navy defines the protection level as the greater of
2 years of forecasted usage or the item's economic order quantity. By adding
a protection level, the Navy prevents inventory on order above the
requirements objective from being considered for cancellation. For example,
in June 1996, the Navy had 183 pilot valve cartridges on hand and 308 on
order. The item's reorder point requirement was 264, its economic order
quantity was 43, and 2 years of forecasted usage was 168. Figure 9 shows
that because the 2 years of projected demand exceeded the item's economic
order quantity, 125 cartridges--costing $723 each--above the requirements
objective were not considered for cancellation.

In December 1999, Navy officials told us that the Navy is considering the
impact and benefits of reducing the protection level from 8 quarters to
6 quarters of forecasted usage.

In November 1999, we reported on the Air Force's efforts to cancel orders
that exceeded requirements. The Air Force considers inventory on order for
cancellation only if it exceeds what the Air Force calls the "worldwide
termination level." This level includes requirements for (1) a buy period,
(2) a termination period, and (3) an additional quantity. The buy period
represents the economic order quantity and lead time (the time needed to
purchase and receive inventory). Therefore, the buy period is similar to the
requirements objective used by the Army, Navy, and DLA. The Air Force adds
an additional 12 months of requirements to the buy period to determine what
it calls the termination period. To calculate the worldwide termination
level, the Air Force adds an additional quantity based on the greater of
certain buy or termination period requirements.

By adding the termination period and the additional requirements to the buy
period to identify inventory on order for cancellation, the Air Force also
protects inventory on order above the requirements objective from being
considered for cancellation. For example, a September 1997 requirement
computation showed that Air Force had 17,709 rotor blades for the T-33
aircraft engine either on hand or available from repair and an additional
30,249 blades on order. The worldwide termination level consisted of 28,990
blades: (1) buy period requirements (requirements objective) for 23,208
blades, (2) termination period requirements of
5,757 blades, and (3) additional requirements for 25 blades. Based on the
worldwide termination level, 18,968 blades were considered for cancellation.
As shown in figure 10, the termination period and the additional
requirements prevented 5,782 blades, valued at $124 each, above the
requirements objective from being considered for cancellation.

In response to our report on the Air Force's excess inventory on order, the
Secretary of the Air Force said that he had tasked the Air Force Materiel
Command to address our recommendations to examine the need for lengthy
operating and termination periods and the worldwide termination level.

Comments From the Department of Defense

The following is GAO's comment on the Department of Defense's letter dated
June 19, 2000.

1. We added a note to figure 6 to clarify that while the Air Force does not
compute an economic order quantity, it does compute requirements for an
operating period, which it considers to be equivalent to the economic order
quantity.

Related GAO Products

Department of Defense: Progress in Financial Management Reform
(GAO/T-AIMD/NSIAD-00-163 , May 9, 2000).

Defense Inventory: Improvements Needed to Prevent Excess Purchases by the
Air Force (GAO/NSIAD-00-5 , Nov. 10, 1999).

Defense Inventory: Management of Repair Parts Common to More Than One
Military Service Can Be Improved (GAO/NSIAD-00-21 , Oct. 20, 1999).

Financial Management: Better Controls Essential to Improve the Reliability
of DOD's Depot Inventory Records (GAO/AIMD-99-132 , June 28, 1999).

Defense Inventory: Status of Inventory and Purchases and Their Relationship
to Current Needs (GAO/NSIAD-99-60 , Apr. 16, 1999).

Defense Inventory: DOD Could Improve Total Asset Visibility Initiative With
Results Act Framework (GAO/NSIAD-99-40 , Apr. 12, 1999).

Defense Inventory: Navy's Procedures for Controlling In-Transit Items Are
Not Being Followed (GAO/NSIAD-99-61 , Mar. 31, 1999).

Major Management Challenges and Program Risks: Department of Defense
(GAO/OCG-99-4 , Jan. 1999).

High Risk Series: An Update (GAO/HR-99-1 , Jan. 1999).

Inventory Management: More Information Needed to Assess DLA's Best Practices
Initiatives (GAO/NSIAD-98-218 , Sept. 2, 1998).

Navy Inventory Management: Improvements Needed to Prevent Excess Purchases
(GAO/NSIAD-98-86 , Apr. 30, 1998).

Inventory Management: DOD Can Build on Progress by Using Best Practices for
Reparable Parts (GAO/NSIAD-98-97 , Feb. 27, 1998).

Defense Inventory Management: Expanding Use of Best Practices for Hardware
Items Can Reduce Logistics Costs (GAO/NSIAD-98-47 , Jan. 20, 1998).

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

(709429)

Table 1: Inventory on Order Inaccurately Reported as Excess 10

Table 2: Reported Value of DOD Excess Inventory on Order for
Fiscal Years 1996-99 12

Table 3: Defense Supply Center Richmond Items Identified for
Manager Review 16

Table 4: Service and DLA Goals for Reducing Excess Inventory on
Order 20

Table 5: Reported Value of Items Reviewed 24

Figure 1: DOD's Process for Managing Inventory on Order 6

Figure 2: DOD's Inventory Categories 7

Figure 3: Purchasing an Economic Order Quantity at the Reorder
Point 9

Figure 4: Reported Value of Excess Inventory on Order for Fiscal
Years 1996-99 13

Figure 5: Percentage of Reported Value of Excess Inventory on
Order and Total Inventory on Order for Fiscal Years 1996-99 14

Figure 6: Army, Navy, Air Force, and DLA Criteria for Purchasing
Inventory and Canceling Excess Inventory on Order 15

Figure 7: Army, Navy, Air Force, and DLA Criteria for Purchasing
Inventory and for Canceling and Reporting Excess
Inventory on Order 21

Figure 8: Army Disks Considered for Cancellation 27

Figure 9: Navy Pilot Valve Cartridges Considered for Cancellation 29

Figure 10: Air Force Rotor Blades Considered for Cancellation 31
  

1. The Department of Defense refers to these items as secondary inventory.
See a list of related GAO products at the end of this report.

2. In 1990, we began a special effort to review and report on the federal
program areas that we had identified as high risk because of vulnerabilities
to waste, fraud, abuse, and mismanagement. This effort, which was supported
by the Senate Committee on Governmental Affairs and the House Committee on
Government Reform, brought a much needed focus on problems that were costing
the government billions of dollars. We identified inventory management as
high risk in our 1992, 1995, 1997, and 1999 high-risk reports.

3. Navy Inventory Management: Improvements Needed to Prevent Excess
Purchases (GAO/NSIAD-98-86 , Apr. 30, 1998) and Defense Inventory:
Improvements Needed to Prevent Excess Purchases by the Air Force
(GAO/NSIAD-00-5 , Nov. 10, 1999).

4. 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 fluctuations in
demand.

5. 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. Contingency retention
inventory exceeds the economic retention inventory and would normally be
processed for disposal but is retained for specific contingencies. Potential
reutilization and/or disposal materiel exceeds contingency retention and has
been identified for possible disposal but with potential for reutilization.

6. DOD calculates requirements through several different computations and
models. The managers rely on these models and the accuracy of inventory
records to make orders. In prior work, we have questioned some assumptions
in the models as well as the accuracy of the inventory records. See Navy
Inventory Management: Improvements Needed to Prevent Excess Purchases
(GAO/NSIAD-98-86 , Apr. 30, 1998) and Financial Management: Better Controls
Essential to Improve the Reliability of DOD's Depot Inventory Records
(GAO/AIMD-99-132 , June 28, 1999).

7. Defense Inventory: Improvements Needed to Prevent Excess Purchases by the
Air Force (GAO/NSIAD-00-5 , Nov. 10, 1999).

8. The data that DLA provided on inventory due in did not distinguish
between inventory on order and inventory that was in transit. Based on the
audit work that we did, we believe that a small portion of the due-in items
and values did not represent items being purchased.

9. The obsolescence cost is the loss of an item's value when it is no longer
needed.

10. Contract Terminations at Defense Supply Center Columbus and Defense
Supply Center Richmond, DOD Inspector General, Report Number 98-172, July 2,
1998.

11. The Army and Air Force established goals for their total inventory. The
Navy established goals of 7 percent for repairable items and 5.5 percent for
consumable items. DLA has established specific goals for each of its
commodity areas such as clothing, medical, and electronic parts.

12. Navy Inventory Management (GAO/NSIAD-98-86 , Apr. 30, 1998) and Defense
Inventory (GAO/NSIAD-00-5 , Nov. 10, 1999).
*** End of document. ***