Outsourcing DOD Logistics: Savings Achievable But Defense Science Board's
Projections Are Overstated (Letter Report, 12/08/97, GAO/NSIAD-98-48).

Pursuant to a congressional request, GAO reviewed the basis for the
Defense Science Board's (DSB) estimate that the Department of Defense
(DOD) could potentially save $6 billion annually by reducing its
logistics infrastructure costs within the continental United States,
focusing on: (1) the opportunities for logistics infrastructure savings;
and (2) DOD's and GAO's analyses of the DSB's projected logistics
infrastructure savings.

GAO noted that: (1) GAO agrees with the DSB that DOD can reduce the
costs of its logistics activities through outsourcing and other
initiatives; (2) DOD has already achieved over $700 million in savings
from the use of a prime vendor program and other inventory-related
reduction efforts for defense medical supplies; (3) according to studies
by the Center for Naval Analyses, competition for work, including
competition between the public sector and the private sector--regardless
of which one wins--can result in cost savings; (4) many private sector
firms have successfully used outsourcing to reduce their costs of
operations; (5) the DOD Program Analysis and Evaluation (PA&E)
directorate's analysis shows, however, that the DSB's estimated annual
savings of $6 billion is overstated by about $4 billion because of
errors in estimates, overly optimistic savings assumptions, and legal
and cultural impediments; (6) according to PA&E's analysis, this $4
billion includes: (a) $1 billion in overstated contract administration
and oversight savings and one-time inventory savings; and (b) $3 billion
in savings that would be unlikely or would be difficult to achieve
within the Board's 6-year time frame, given certain legislative
requirements and DOD's resistance to outsourcing all logistics
functions; (7) GAO's analysis confirmed PA&E's conclusion that the
Board's estimated savings were overstated; (8) GAO's analysis also
raised questions about the Board's projected savings, but GAO does not
know by how much or whether these questions would change the $2 billion
in savings that PA&E concluded were achievable; (9) GAO questioned
whether DOD would achieve a 25-percent savings from outsourcing, as the
Board assumed, because the savings were based primarily on studies of
public-private competitions in highly competitive private sector
markets; (10) however, competitive markets may not exist in some areas;
(11) notwithstanding GAO's concerns about the magnitude of savings, DOD
can make significant reductions in logistics costs; (12) the Secretary
of Defense recently issued a strategic plan for achieving such
reductions; (13) this report is a step in the right direction; and (14)
DOD now needs an implementation plan based on a realistic assessment of
the savings potential of various cost-reduction alternatives and the
time frames for accomplishing various activities required to identify
and implement the most cost-effective solutions.

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

 REPORTNUM:  NSIAD-98-48
     TITLE:  Outsourcing DOD Logistics: Savings Achievable But Defense 
             Science Board's Projections Are Overstated
      DATE:  12/08/97
   SUBJECT:  Defense cost control
             Military downsizing
             Future budget projections
             Privatization
             Cost effectiveness analysis
             Defense procurement
             Military inventories
             Reductions in force
             Logistics
             Program evaluation
IDENTIFIER:  DOD Quadrennial Defense Review
             DOD Prime Vendor Program
             
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Cover
================================================================ COVER


Report to Congressional Requesters

December 1997

OUTSOURCING DOD LOGISTICS -
SAVINGS ACHIEVABLE BUT DEFENSE
SCIENCE BOARD'S PROJECTIONS ARE
OVERSTATED

GAO/NSIAD-98-48

Outsourcing DOD Logistics

(709266)


Abbreviations
=============================================================== ABBREV

  CNA - Center for Naval Analyses
  CONUS - continental United States
  DOD - Department of Defense
  DSB - Defense Science Board
  LMI - Logistics Management Institute
  PA&E - Program Analysis and Evaluation
  QDR - Quadrennial Defense Review
  OSD - Office of the Secretary of Defense

Letter
=============================================================== LETTER


B-277816

December 8, 1997

Congressional requesters

As you requested, we reviewed the basis for the Defense Science
Board's (DSB) estimate that the Department of Defense (DOD) could
potentially save $6 billion annually by reducing its logistics
infrastructure costs within the continental United States (CONUS).\1
This report provides our analysis of the reasonableness of the
savings projected by the Board.  Specifically, we discuss (1) the
opportunities for logistics infrastructure savings and (2) DOD's and
our analyses of the DSB's projected logistics infrastructure savings. 


--------------------
\1 As discussed in this report, logistics infrastructure refers only
to CONUS logistics. 


   BACKGROUND
------------------------------------------------------------ Letter :1

Faced with a goal of increasing the Department's investments in
modernization without increasing overall defense budgets, DOD has
recently focused on the cost of support operations and their
associated infrastructure, with the objective of finding ways to
provide required support resources and capability at reduced costs.\2
DOD recognizes that portions of its support structure are inefficient
and continue to absorb a large share of the defense budget.  To the
extent support costs can be reduced, available future defense dollars
could be used for modernization or other defense priorities. 


--------------------
\2 We have identified this as a high-risk area.  High-risk areas are
those critical government operations that are highly vulnerable to
waste, fraud, abuse, and mismanagement.  High- Risk Series:  Defense
Infrastructure (GAO/HR-97-7, Feb.  1997) provides further discussion
of our assessment of the defense infrastructure. 


      DSB STUDIES PROJECT
      INFRASTRUCTURE COST SAVINGS
      FROM OUTSOURCING AND OTHER
      INITIATIVES
---------------------------------------------------------- Letter :1.1

The Office of the Secretary of Defense (OSD) requested that DSB
identify DOD activities that the private sector could do more
efficiently and to determine the expected savings from outsourcing. 
DSB, a civilian advisory board to DOD, issued two reports in 1996
addressing outsourcing and other opportunities for substantially
reducing DOD support services.\3 The first focused solely on
outsourcing and privatization issues.\4 The second, incorporating
findings from the earlier report, had a broader scope that included
other methods for reducing infrastructure costs.  In preparation for
the Quadrennial Defense Review (QDR), OSD's Program Analysis and
Evaluation (PA&E) directorate assessed the DSB's savings estimates
from the second report.\5 Our analysis also focused on the second
report's findings and recommendations. 


--------------------
\3 Report of the Defense Science Board Task Force on Outsourcing and
Privatization, August 1996, and Report on the Defense Science Board
1996 Summer Study on Achieving an Innovative Support Structure for
21st Century Military Superiority:  Higher Performance at Lower
Costs, November 1996. 

\4 DOD defines outsourcing as the transfer of a function, previously
performed in-house, to an outside provider.  Privatization is a
subset of outsourcing that involves the transfer or sale of
government assets to the private sector. 

\5 The QDR is required by the Military Force Structure Review Act of
1996, which was included as part of the National Defense
Authorization Act for Fiscal Year 1997.  DOD designed the QDR to be a
fundamental and comprehensive examination of America's defense needs
from 1997 to 2015.  The review examines potential threats, strategy,
force structure, readiness posture, military modernization programs,
defense infrastructure, and other elements of the defense program. 


         FIRST STUDY
-------------------------------------------------------- Letter :1.1.1

The first DSB task force concluded that DOD could realize savings of
30 to 40 percent of logistics costs and achieve broad improvements in
service delivery and responsiveness by outsourcing support services
traditionally done by government personnel.  The report cited
evidence from the Center for Naval Analyses (CNA) public-private
competition studies of commercial and depot maintenance activities. 
The Board also noted that an Outsourcing Institute study found that
the private sector saved about 10 to 15 percent by outsourcing but
that the public sector savings from outsourcing would be higher
because of the inefficiency of government service organizations.\6
The DSB task force stated that an aggressive DOD outsourcing
initiative could generate savings ranging from $7 billion to $12
billion annually by fiscal year 2002. 


--------------------
\6 The Outsourcing Institute, founded in 1993, is a professional
association that provides information on the strategic use of outside
resources. 


         SECOND STUDY
-------------------------------------------------------- Letter :1.1.2

Building on the earlier study, DSB's second task force report
provided a new vision wherein DOD would only provide warfighting,
direct battlefield support, policy- and decision-making, and
oversight activities.  All other activities would be done by the
private sector.  DSB said that DOD would need to make an investment
of about $6 billion but would ultimately save about $30 billion
annually by the year 2002, primarily through outsourcing support
functions. 

Of these $30 billion in annual savings, $6 billion was to come from
CONUS logistics infrastructure activities, which DSB defined as
including inventory control points, distribution depots, maintenance
depots, and installation supply and repair.  About $4.2 billion of
the savings would be achieved by outsourcing these activities; the
remaining $1.8-billion savings would be achieved through improvements
in inventory management practices and equipment reliability.  Table 1
shows a breakout of the estimated logistics infrastructure savings. 



                                Table 1
                
                 Breakout of DSB Savings Estimates for
                     CONUS Logistics Infrastructure

                         (Dollars in billions)

Savings initiative                                             Savings
----------------------------------------------------------  ----------
Use of prime vendors and contractor logistics support
----------------------------------------------------------------------
Filling orders and repairing equipment                            $3.5
Wholesale inventory                                                0.7
======================================================================
Subtotal                                                           4.2

Reductions from other initiatives
----------------------------------------------------------------------
Inventory management improvements for non-deploying units          0.3
Equipment reliability improvements                                 1.5
======================================================================
Subtotal                                                           1.8
======================================================================
Total                                                             $6.0
----------------------------------------------------------------------
Source:  DSB. 

According to the DSB estimates, the $6-billion savings represents an
approximate 40-percent reduction in the $14 billion the Board
estimated DOD spends annually for CONUS logistics activities. 
According to a DSB task force member, estimates for the cost of
installation supply and repair activities were unavailable. 
Therefore, the group used $14 billion as a rough estimate to
approximate total CONUS logistics cost, not including activities
already contracted out.  Although we were unable to substantiate
those numbers, the data that is available indicates that DSB's
estimate of $14 billion for CONUS logistics costs is conservative. 
For example, the Navy has reported that more than $8.5 billion of
Navy resources was applied in fiscal year 1996 to maintenance
programs in support of fleet ships and aircraft.\7

The report also stated that to gain economies and achieve significant
savings, DOD needs to consider dramatic changes in the way it does
business.  DSB said the Department must get out of the material
management/distribution and repair business by expanding contractor
logistics support to all fielded weapon systems and by expanding the
use of "prime vendors" for all commodities.  Contractor logistics
support, which relies on a contractor to provide long-term, total
life-cycle logistics support, combines depot-level maintenance with
wholesale and selected retail material management functions.  Under
the "prime vendor" concept, DOD would rely on a single vendor to buy,
warehouse, and distribute inventory to the customer as needed, thus
removing the Defense Logistics Agency and the services from their
present middleman role. 


--------------------
\7 Navy Regional Maintenance:  Substantial Opportunities Exist to
Build on Infrastructure Streamlining Progress (GAO/NSIAD-96-30, Nov. 
13, 1997). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Overall, we agree with the Defense Science Board that DOD can reduce
the costs of its logistics activities through outsourcing and other
initiatives.  DOD has already achieved over $700 million in savings
from the use of a prime vendor program and other inventory-related
reduction efforts for defense medical supplies.  Also, according to
studies by the Center for Naval Analyses, competition for work,
including competition between the public sector and the private
sector--regardless of which one wins--can result in cost savings. 
Further, many private sector firms have successfully used outsourcing
to reduce their costs of operations. 

The Program Analysis and Evaluation's analysis shows, however, that
the Defense Science Board's estimated annual savings of $6 billion is
overstated by about $4 billion because of errors in estimates, overly
optimistic savings assumptions, and legal and cultural impediments. 
According to the Program Analysis and Evaluation's analysis, this $4
billion includes (1) $1 billion in overstated contract administration
and oversight savings and one-time inventory savings and (2) $3
billion in savings that would be unlikely or would be difficult to
achieve within the Board's 6-year time frame, given certain
legislative requirements and DOD's resistance to outsourcing all
logistics functions. 

Our analysis confirmed the Program Analysis and Evaluation's
conclusion that the Board's estimated savings were overstated.  Our
analysis also raised questions about the Board's projected savings,
but we do not know by how much or whether these questions would
change the $2 billion in savings that the Program Analysis and
Evaluation concluded were achievable.  For example, we found that the
Board's estimated savings from improvements to equipment reliability
were overstated by at least $1.2 billion.  Further, we question
whether DOD would achieve a 25-percent savings from outsourcing, as
the Board assumed, because the savings were based primarily on
studies of public-private competitions in highly competitive private
sector markets.  However, competitive markets may not currently exist
in some areas.  For example, we reported that 91 percent of recent
nonship depot maintenance contracts were awarded on a sole-source
basis. 

Notwithstanding our concerns about the magnitude of savings, DOD can
make significant reductions in logistics costs.  The Secretary of
Defense has recently issued a strategic plan for achieving such
reductions.  This report is a step in the right direction.  DOD now
needs an implementation plan based on a realistic assessment of the
savings potential of various cost-reduction alternatives and the time
frames for accomplishing various activities required to identify and
implement the most cost-effective solutions.  This plan should be
presented to Congress to provide a basis for congressional oversight. 


   OPPORTUNITIES EXIST FOR
   LOGISTICS INFRASTRUCTURE
   SAVINGS
------------------------------------------------------------ Letter :3

Our reviews of best practices within the private sector and ongoing
work at DOD indicate that DOD has significant opportunities for
reducing logistics costs and improving performance by changing its
business processes.  This work also indicates that determining the
most cost-effective processes to use requires an evaluation of costs
and benefits of each situation.  These findings are consistent with
the general theme of the DSB's reports that opportunities exist for
savings in the operation of DOD's logistics support activities. 
However, DSB focused on outsourcing, while our work has focused first
on reengineering and streamlining, and outsourcing where appropriate
and more cost-effective. 


      DOD CAN REDUCE LOGISTICS
      COSTS
---------------------------------------------------------- Letter :3.1

Over the past several years, DOD has considered a number of actions
to improve the efficiency and effectiveness of its logistics system. 
As with the private sector, such actions should include using highly
accurate information systems, consolidating certain activities,
employing various process streamlining methods, and outsourcing.  For
example, defense maintenance depots have about 40-percent excess
capacity, and we have advocated consolidating workloads to take
advantage of economies of scale and eliminate unnecessary
duplication.\8 Consolidating workloads from two closing depots would
allow the Air Force, for instance, to achieve annual savings of over
$200 million and reduce its excess capacity from 45 percent to about
8 percent. 

In addition, our work has pointed out the benefits of outsourcing
when careful economic analysis indicates the private sector can
provide required support at less cost than a DOD activity can.  For
example, the Defense Logistics Agency has successfully taken steps to
use prime vendors to supply personnel items directly to military
facilities.\9 The consumable items under these vendor programs
account for 2 percent of the consumable items DOD manages.  DOD's
prime vendor program for medical supplies, along with other inventory
reduction efforts, has resulted in savings that we estimate exceed
$700 million.  More importantly, this program has moved DOD out of
the inventory storage and distribution function for these supplies,
thus emptying warehouses, eliminating unnecessary layers of
inventory, and reducing the overall size of the DOD supply system. 
Also, service is improved because DOD buys only the items that are
currently needed and consumers can order and receive inventory within
hours of the time the items are used. 

While DOD has achieved benefits from outsourcing, it has been shown
that adequate competition has been key to achieving significant
reductions.  Public-private competition studies by CNA have stressed
this point.  In its 1993 review of the Navy's Commercial Activities
Program, CNA noted that about half the competitions were won by the
in-house team and that when competitions with no savings were
excluded, the savings from contracts awarded to the public sector
were 50 percent and those to the private sector were 40 percent.\10
CNA officials concluded that because of competition both sectors were
spurred to increase efficiency and reduce costs and DOD achieved
greater savings.  CNA also concluded that savings would have been
less had the public sector been excluded from competition.  Likewise,
our review of DOD's public-private competition program for depot
maintenance determined that such competitions resulted in reduced
costs. 


--------------------
\8 Defense Depot Maintenance:  Challenges Facing DOD in Managing
Working Capital Funds (GAO/T-NSIAD/AIMD-97-152, May 7, 1997). 

\9 Inventory Management:  Greater Use of Best Practices Could Reduce
DOD's Logistics Costs (GAO/T-NSIAD-97-214, July 24, 1997). 

\10 Analysis of the Navy's Commercial Activities Program, Center for
Naval Analyses, July 1993 and Outsourcing and Competition:  Lessons
Learned From DOD Commercial Activities Programs, Center for Naval
Analyses, October 1996. 


      PRIVATE SECTOR CLOSELY
      ANALYZES OUTSOURCING
      DECISIONS
---------------------------------------------------------- Letter :3.2

Facing increasing pressures to maintain market competitiveness,
private companies have been reevaluating their organization and
processes to cut costs and improve customer service.  The most
successful improvements include (1) using highly accurate information
systems that provide cost, tracking, and control data; (2)
consolidating and/or centralizing certain activities; (3) employing
various methods to streamline work processes; and (4) shifting
certain activities to third-party providers.\11 Each company's
overall business strategy and assessment of "core competencies" guide
which tools to use and how to use them. 

Private companies use a variety of approaches to meet their logistics
support needs.  For example, Southwest Airlines contracts out almost
all maintenance, thus avoiding costly investments in facilities,
personnel, and inventory.  However, in contrast, having already made
a significant investment in building infrastructure and training
personnel, British Airways reached a different decision about its
support operations.  While it has sold off and/or outsourced some
activities (namely engine repair and parts supply) and improved
remaining in-house repair operations, the airline now has become a
third-party supplier of aircraft overhaul. 

Whether the organization decides to consolidate, reengineer, or
outsource activities, or to do some combination thereof, the private
firms and consultants with whom we met stressed that identifying and
understanding the organization's core activities and obtaining
accurate cost data for all in-house operations are critical to making
informed business decisions and assessing overall performance.  Core
activities are those that are essential for meeting an organization's
mission. 

Before making decisions on what cost-saving options should be used,
an organization should develop a performance-based, risk-adjusted
analysis of benefits and costs for each option to provide (1) the
foundation for comparing the baseline benefits and costs with
proposed options and (2) a basis for decisionmakers to use in
selecting a feasible option that meets performance goals.\12 The
organization should also factor into the analysis the barriers and
risks in implementing the options.  Thus, the best practice would be
to make an outsourcing decision only after a core assessment and
comprehensive cost-benefit analysis have been performed rather than
to take a blanket approach and outsource everything in a certain
area. 


--------------------
\11 Reports on this include:  Best Management Practices: 
Reengineering the Air Force's Logistics System Can Yield Substantial
Savings (GAO/NSIAD-96-5, Feb.  21, 1996); Inventory Management:  The
Army Could Reduce Logistics Costs for Aviation Parts by Adopting Best
Practices (GAO/NSIAD-97-82,
Apr.  15, 1997); Base Operations:  Challenges Confronting DOD as It
Renews Emphasis on Outsourcing (GAO/NSIAD-97-86, Mar.  11, 1997);
Contract Management:  Fixing DOD's Payment Problems Is Imperative
(GAO/NSIAD-97-37, Apr.  10, 1997); Defense Infrastructure:  Enhancing
Performance Through Better Business Practices (GAO/T-NSIAD/AIMD-95-
126, Mar.  23, 1995); and Financial Management Outsourcing Finance
and Accounting (GAO/AIMD/NSIAD-98-43, Oct.  17, 1997). 

\12 Business Process Reengineering Assessment Guide
(GAO/AIMD-10.1.15, Apr.  1997). 


   PA&E ANALYSIS RAISES QUESTIONS
   ON DSB SAVINGS ESTIMATES
------------------------------------------------------------ Letter :4

PA&E's analysis of the DSB's estimated $6 billion in annual logistics
savings found that the estimate was overstated by about $1 billion
and that another $3 billion in projected savings would be difficult
to achieve or unlikely to be achieved.\13

According to PA&E officials, DSB's $6-billion savings estimate was
overstated by about $1 billion because contract administration and
oversight costs were understated and one-time inventory savings
(spread over 6 years) was claimed as steady state savings.  Further,
in assessing the degree of difficulty in achieving the savings, PA&E
concluded that about $1 billion would be difficult to achieve, but
was possible if Congress changed the required 60/40 public-private
split to 50-50, which has since occurred.\14 PA&E also believed that
another $2 billion was unlikely to be saved primarily because of
timing and DOD's culture.  It did not believe that DOD could carry
out the proposals within the DSB's 6-year schedule, if at all. 

PA&E's assessment concluded that the remaining $2 billion of the
DSB's $6-billion savings estimate was achievable or already
identified in DOD's future year defense program.  PA&E officials
defined as achievable those savings that they believed could be
realized given DSB's 25-percent savings assumption and the
then-current legal restrictions on outsourcing depot maintenance
activities.  About $0.2 billion in savings would involve maximizing
the use of outsourcing under legislative constraints as they existed
at that time, such as the 60/40 rule.\15 The remainder of the
achievable savings have already been identified in DOD's future year
defense program.  Table 2 shows PA&E's revised estimate of the DSB's
logistics savings. 



                                Table 2
                
                    PA&E's Revised Estimate of DSB's
                           Logistics Savings

                         (Dollars in billions)

                                                               Savings
----------------------------------------------------------  ----------
DSB                                                                 $6

PA&E
----------------------------------------------------------------------
Understated costs/overstated savings                               (1)
Savings hard to achieve                                            (1)
Unlikely savings                                                   (2)
Achievable savings                                                  $2
----------------------------------------------------------------------
Source:  PA&E. 


--------------------
\13 The PA&E estimates have been rounded.  PA&E's figures are
slightly higher than DSB's because PA&E used 1997 constant dollars. 
According to PA&E officials, the analysis required a quick
turnaround, which limited its scope to considering costing factors
such as investment costs and the double- counting of savings.  The
officials noted that PA&E did the analysis "in the same spirit" as
DSB, therefore, it did not question the DSB's underlying assumptions,
such as the savings potential from technological improvements or
outsourcing. 

\14 In addition to the 60/40 rule, other relevant statutes that
govern depot-level activities have been amended, and new provisions
added by the recently enacted 1998 DOD Authorization Act.  For
example, the 1998 Authorization Act provides for a new section 2460
in title 10, which for the first time would establish a statutory
definition of depot-level maintenance and repair.  Also, section 2464
of
title 10 is amended to provide for the first time a DOD-maintained
core logistics capability that is required to be government-owned and
government-operated.  The provision now requires the performance of
core workloads necessary to maintain this capability within the
public depots and that these facilities be assigned sufficient
workloads to ensure cost-efficient operation and sufficient surge
capacity.  The impact of these changes remains to be seen. 

\15 At the time of the PA&E report, 10 U.S.C.  2466 prohibited the
use of more than 40 percent of the funds made available in a given
fiscal year for the depot-level maintenance for performance of
maintenance activities by nonfederal personnel.  The provision has
been amended by the 1998 DOD Authorization Act to increase the
percentage to 50 percent. 


   OUR ANALYSIS ALSO RAISES
   QUESTIONS ABOUT DSB SAVINGS
   ESTIMATES
------------------------------------------------------------ Letter :5

Our analysis confirms PA&E's conclusion that the DSB's logistics
savings estimates are not well supported and are unlikely to be as
large as estimated.  Specifically, we found that (1) the Board's
projected annual savings from reliability improvements are overstated
by over $1 billion; (2) the DSB's 25-percent savings rate from
outsourcing appears to be overly optimistic; and (3) DSB, while
recognizing it would be difficult to do so, assumed that DOD would
overcome impediments that prevent the outsourcing of all logistics
functions.  We do not know by how much or whether these questions
would change the $2 billion in savings that PA&E concluded were
achievable. 


      SAVINGS FROM RELIABILITY
      IMPROVEMENTS OVERSTATED
---------------------------------------------------------- Letter :5.1

In addition to overstating inventory management savings noted by
PA&E, the DSB task force overstated its estimate of annual savings
from equipment reliability improvements.  The Board's estimate of
$1.5 billion in annual savings by year 2002 (6 years from the year of
DSB's study) is overstated by at least $1.2 billion.  DSB based its
estimate on a Logistics Management Institute (LMI) study that
assessed the reductions of operation and support costs that result
from improved reliability and maintainability due to technological
advancements.\16 Such advancements may include using improved
materials and fewer component parts; thus reducing the number of
spare purchases and the need for scheduled and unscheduled
maintenance.  Accomplishing these advancements requires an investment
that must be evaluated in light of the expected return on investment. 

For its study, LMI assumed an aggressive technology improvement
program.  For example, it assumed a 9 to 1 return on investment that
would accrue over 20 years, with savings starting the second year. 
Further, it assumed that any given investment would generate a
savings stream for at least 10 years.  Based on these assumptions and
its analysis, LMI concluded that with an annual investment starting
at $100 million and leveling at $500 million within 5 years, DOD
could achieve $300 million in savings in the sixth year.  DOD would
not achieve the $1.5-billion savings that DSB included in its savings
estimate until the fourteenth year.  Thus, even without questioning
LMI's aggressive assumptions, the DSB's savings estimate is
overstated by at least $1.2 billion. 


--------------------
\16 Using Technology to Reduce Cost of Ownership, Volume 1: 
Annotated Briefing (LG404RD4, Apr.  1996). 


      DSB'S OUTSOURCING SAVINGS
      ASSUMPTION IS OVERLY
      OPTIMISTIC
---------------------------------------------------------- Letter :5.2

DSB assumed that outsourcing all logistics activities would reduce
DOD's logistics costs by 25 percent.  The Board based this projection
on public-private competition studies, industry studies by such
companies as Caterpillar and Boeing, and anecdotal evidence.  While
we believe that savings can be achieved through appropriate
outsourcing, these savings are a result of competition rather than
from outsourcing itself.  The studies DSB cited were primarily for
commercial activities--such as base operations, real property
maintenance, and food service.\17 As we have reported, these
activities generally have highly competitive markets.\18 For some
logistics activities, such as nonship depot maintenance, our recent
work has shown that competitive markets do not currently exist.  To
the extent that competitive markets do not exist, the amount of
savings that can be generated through outsourcing may be reduced. 

As we reported in 1996, 76 percent of the 240 open depot maintenance
contracts we examined were awarded noncompetitively (i.e., sole
source).\19 More recently, we reported that the percentage of
noncompetitive depot maintenance contracts had increased for
activities other than shipyards.  For the three services, about 91
percent of the 15,346 new depot maintenance contracts awarded from
the beginning of fiscal year 1996 to date were sole source.\20
Moreover, the DSB recommended contractor logistics support
arrangements for new and modified weapon systems.  Our past work
demonstrates that most contractor logistics support depot work is
sole sourced to the original equipment manufacturer, raising cost and
future competition concerns.  Furthermore, eliminating the public
sector from competition, as advocated by DSB, could further decrease
savings. 


--------------------
\17 Analysis of the Navy's Commercial Activities Program, Center for
Naval Analyses, July 1993 and Outsourcing and Competition:  Tools to
Increase Efficiency (briefing to DSB), Center for Naval Analyses,
January 1995. 

\18 Defense Depot Maintenance:  Commission on Roles and Mission's
Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July
15, 1996) and Navy Maintenance:  Assessment of the Public and Private
Shipyard Competition Program (GAO/NSIAD-94-184, May 25, 1994). 

\19 Defense Depot Maintenance:  Commission on Roles and Mission's
Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July
15, 1996). 

\20 Defense Depot Maintenance:  Challenges Facing DOD in Managing
Working Capital Funds (GAO/T-NSIAD/AIMD-97-152, May 7, 1997). 


      IMPEDIMENTS LIMIT DOD'S
      OUTSOURCING OF ALL LOGISTICS
      ACTIVITIES
---------------------------------------------------------- Letter :5.3

In developing its savings estimates for CONUS logistics, DSB assumed
that DOD would outsource all logistics activity.  However, certain
barriers, including legal and cultural impediments, must be overcome
to fully implement DSB's recommendations.  While it may be possible
to implement DSB's recommendations, in some cases, implementation may
require congressional action, and in others, implementation may take
substantially longer than DSB's 6-year estimate.  We did not quantify
how much these impediments will reduce DSB's savings, but consistent
with PA&E's analysis, these factors will mitigate portions of the
projected savings. 


         LEGISLATIVE BARRIERS
-------------------------------------------------------- Letter :5.3.1

Although it recommended that essentially all logistics--including
material management and depot maintenance, distribution, and other
activities--be outsourced, DSB recognized that outsourcing is limited
or precluded by various laws and regulations.  For example,
fundamental to determining whether or not to outsource is the
identification of core functions and activities.  Section 2464 of
title 10 U.S.C.  states that DOD activities should maintain the
government-owned and government-operated core logistics capability
necessary to maintain and repair weapon systems and other military
equipment needed to fulfill national strategic and contingency plans. 

The delineation of core activities has historically proven to be
extremely difficult.  For example, proponents of increased
privatization have questioned the justification for retaining many
support activities as core and have recommended revising the core
logistics requirement.  Section 311 of the 1996 DOD Authorization Act
directed the Secretary of Defense to develop a comprehensive depot
maintenance policy, including a definition of DOD's required core
depot maintenance capability.  While DOD has identified a process for
determining core depot maintenance capability requirements, it has
not completed its evaluation.  Moreover, DOD has not developed a
process for identifying core requirements for other logistics
functions and activities.  Thus, core requirements in these areas are
also unknown.  The 1998 DOD Authorization Act again requires that the
Department identify its core depot maintenance requirements, this
time under the new provisions described above. 

Additionally, 10 U.S.C.  2466 states that no more than 50 percent of
the depot maintenance funds made available in a given fiscal year may
be spent for depot maintenance conducted by nonfederal personnel. 
This provision, along with other relevant provisions significantly
affects DSB's savings estimate because about 50 percent of depot
maintenance would not be subject to outsourcing.\21

Section 2469 of title 10 states that DOD-performed depot maintenance
and repair workloads valued at not less than $3 million cannot be
changed to contractor-performed work without using competitive
procedures that include both public and private entities.\22 This
requirement for public-private competition affects the DSB savings
estimate because DSB assumed the requirement would be eliminated. 
The 1998 DOD Authorization Act also added a new section 2469a to
title 10 that affects public-private competitions for certain
workloads from closed or realigned installations. 

Further, during the congressional deliberation on the 1997 DOD
Authorization Act, DOD provided Congress a list of statutory
encumbrances to outsourcing, including

  -- 10 U.S.C.  2461, which requires studies and reports before
     converting public workloads to a contractor;

  -- 10 U.S.C.  2465, which prohibits contracts for performance of
     fire-fighting and security guard functions;

  -- section 317 of the National Defense Authorization Act for Fiscal
     Year 1987 (P.L.  99-661), which prohibits the Secretary of
     Defense from contracting for the functions performed at Crane
     Army Ammunition Activity or McAllister Army Ammunition Plant;

  -- 10 U.S.C.  4532, which requires the Army to have supplies made
     by factories and arsenals if they can do so economically; and

  -- 10 U.S.C.  2305 (a)(1), which specifies that in preparing for
     the procurement of property or services, the Secretary of
     Defense shall specify the agency's needs and solicit bids or
     proposals in a manner designed to achieve full and open
     competition. 


--------------------
\21 As described earlier, the 1998 DOD Authorization Act changed the
applicable provisions.  For example, a new definition of depot
maintenance was added in 10 U.S.C.  2460 that together with the
amendment to 10 U.S.C.  2464 will impact DOD's ability to outsource
depot maintenance activities. 

\22 For these workloads, OMB Circular A-76 does not apply. 


         CULTURAL BARRIERS
-------------------------------------------------------- Letter :5.3.2

DOD officials have repeatedly recognized the importance of using
resources for the highest priority operational and investment needs
rather than maintaining unneeded property, facilities, and overhead. 
However, DOD has found that infrastructure reductions, whether
through outsourcing or some other means, are difficult and painful
because achieving significant cost savings may require up-front
investments, the closure of installations, and the elimination of
military and civilian jobs.  In addition, according to DOD officials,
the military services fear that savings achieved from outsourcing
would be diverted to support other DOD requirements and may not be
available to the outsourcing organization to fund service needs. 

DSB recognized DOD's cultural resistance to outsourcing logistics
activities and said that overcoming resistance may take some time. 
DOD has a tradition of remarkable military achievement but it also
has an entrenched culture that resists dramatic changes from
well-established patterns of behavior.  In 1992, we reported that
academic experts and business executives generally agreed that a
culture change is a long-term effort that takes at least 5 to 10
years to complete.\23 Although a change in DOD's management culture
is underway, continual support of its top managers is critical to
successful completion of cultural change. 


--------------------
\23 Organizational Culture:  Techniques Companies Use to Perpetuate
or Change Beliefs and Values (GAO/NSIAD-92-105, Feb.  27, 1992). 


   CONCLUSIONS AND RECOMMENDATIONS
------------------------------------------------------------ Letter :6

We agree with DSB that there are many opportunities for significant
reductions in logistics infrastructure costs.  However, the Board's
projected savings are overly optimistic.  Further, savings
opportunities from consolidating and reengineering must be considered
in addition to outsourcing.  Even though the Board recognized that
there are impediments to outsourcing, PA&E's and our analyses show
that because of such impediments, not all logistics activities can be
outsourced.  This is particularly true for the legislative
barriers--principally, the legislated workload mix between the public
and private sectors.  Moreover, PA&E's and our analyses show
estimating errors of about $1 billion for contract administration and
inventory reductions and another $1 billion for reliability
improvements.  These combined adjustments will further reduce the
Board's projected savings by another 30 percent. 

Notwithstanding the problems with DSB's estimates, DOD's effort to
reduce costs and achieve savings is extremely important, and we
encourage DOD to move forward as quickly as possible to develop a
realistic and achievable cost-reduction program.  As discussed in our
high-risk infrastructure report, breaking down cultural resistance to
change, overcoming service parochialism, and setting forth a clear
framework for a reduced defense infrastructure are key to effectively
implementing savings. 

To aid in achieving the most savings possible, we recommend that the
Secretary of Defense require the development of a detailed
implementation plan for improving the efficiency and effectiveness of
DOD's logistics infrastructure, including reengineering,
consolidating, outsourcing logistics activities where appropriate,
and reducing excess infrastructure.  We recommend that the plan
establish time frames for identifying and evaluating alternative
support options and implementing the most cost-effective solutions
and identify required resources, including personnel and funding, for
accomplishing the cost-reduction initiatives.  We also recommend that
DOD present the plan to Congress in much the same way it presented
its force structure reductions in the Base Force Plan and the
bottom-up review.  This would provide Congress a basis to oversee
DOD's plan and would allow the affected parties to see what is going
to happen and when. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :7

In commenting on a draft of this report (see app.  II), DOD said that
DSB had considered legal barriers to outsourcing and had expressly
sought to identify the savings that could result if they were lifted. 
As noted in the report, we believe it is unlikely that the legal
barriers cited would be lifted within the time frame DSB envisioned. 
DOD said that actions consistent with our recommendation were
underway and there was no need for the recommended plan. 
Specifically, DOD said that the Secretary of Defense was preparing a
more detailed plan for implementing the strategy formulated by QDR. 

Subsequently, on November 12, 1997, the Secretary of Defense
announced the publication of the Defense Reform Initiative Report. 
This report contained the results of the task force on defense reform
established as a result of QDR.  The task force, which was charged
with identifying ways to improve DOD's organization and procedures,
defined a series of initiatives in four major areas: 

  -- reengineering, by adopting modern business practices to achieve
     world-class standards of performance;

  -- consolidating, by streamlining organizations to remove
     redundancy and maximize synergy;

  -- competing, by applying market mechanisms to improve quality,
     reduce costs, and respond to customer needs; and

  -- eliminating infrastructure, by reducing excess support structure
     to free resources and focus on competencies. 

This report is a step in the right direction and sets forth certain
strategic goals and direction.  However, the intent of our
recommendation was that a detailed implementation plan be developed,
and we have modified our final recommendations accordingly. 

Our scope and methodology are provided in appendix I. 


---------------------------------------------------------- Letter :7.1

We are sending copies of this report to interested congressional
committees; the Secretaries of Defense, the Army, the Navy, and the
Air Force; the Director of the Office of Management and Budget; and
interested congressional committees.  Copies will be made available
to others upon request. 

Please contact me at (202) 512-8412 if you or your staff have any
questions concerning this report.  Major contributors to this report
were
James Wiggins, Julia Denman, Hilary Sullivan, and Jeffrey Knott. 
John Brosnan from our Office of General Counsel provided the legal
review. 

David R.  Warren, Director
Defense Management Issues


List of Requesters

The Honorable James M.  Inhofe
Chairman
The Honorable Charles S.  Robb
Ranking Minority Member
Subcommittee on Readiness
Committee on Armed Services
United States Senate

The Honorable Neil Abercrombie
The Honorable Saxby Chambliss
The Honorable Tillie K.  Fowler
The Honorable James V.  Hansen
The Honorable John N.  Hostettler
The Honorable Ernest J.  Istook
The Honorable Walter B.  Jones, Jr.
The Honorable Solomon P.  Ortiz
The Honorable Norman Sisisky
The Honorable J.C.  Watts, Jr.
House of Representatives


SCOPE AND METHODOLOGY
=========================================================== Appendix I

The scope of our review was limited to reviewing the Defense Science
Board's (DSB) projected $6 billion annual savings for the continental
United States (CONUS) logistics.  To determine the basis of DSB's
savings estimate and recommendations, we reviewed the two DSB reports
that made savings estimates based on outsourcing:  Report of the
Defense Science Board Task Force on Outsourcing and Privatization,
August 28, 1996, and Report of the Defense Science Board 1996 Summer
Study on Achieving an Innovative Support Structure for 21st Century
Military Superiority:  Higher Performance at Lower Costs, November
1996.  We discussed the assumptions with task force members and
reviewed supporting data that was available to us.  We requested DSB
task force minutes pertaining to these studies; however, we did not
receive them in time to include them in our review. 

We reviewed the Center for Naval Analyses (CNA) studies of
public-private competitions cited by DSB as well as CNA's more recent
studies and discussed those studies with CNA officials.  A CNA
official said that CNA analysts performed limited testing of the
computer-generated data they had used in analyzing the results from
the commercial activity competitions.  He said that the data was
reasonably accurate for the purposes of their studies.  We did not
independently verify the data used in CNA's studies because we did
not rely solely on CNA's studies for our conclusions. 

To further evaluate DSB's savings estimates and recommendations we
(1) reviewed Program Analysis and Evaluation's (PA&E) analysis and
discussed that analysis and conclusions with PA&E officials and (2)
reviewed the Logistics Management Institute's (LMI) study, Using
Technology to Reduce Cost of Ownership, Volume 1:  Annotated Briefing
(LG404RD4, April 1996), and discussed the studies' assumptions and
conclusions with LMI officials.  In addition, we reviewed our past
reports and testimony on depot maintenance, public-private
competitions, and infrastructure reductions. 

To determine other infrastructure savings opportunities for the
Department of Defense (DOD), we relied on our past reports and
testimony on commercial "best practices," public-private
competitions, and depot maintenance.  In addition, we also drew on
ongoing work on outsourcing practices within the private sector. 

We performed our review at the following locations:  Logistics
Management Institute, Arlington, Va.; DOD's Office of Maintenance
Policy, Office of Program Analysis and Evaluation; and the Defense
Science Board, Washington, D.C.  We also had discussions with
officials from the Center for Naval Analyses, Alexandria, Va. 

We conducted our review in July and August 1997, and, except where
noted, in accordance with generally accepted government auditing
standards. 




(See figure in printed edition.)APPENDIX II
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I





RELATED GAO PRODUCTS
============================================================ Chapter 0

Air Force Depot Maintenance:  Information on the Cost Effectiveness
of B-1B and B-52 Support Options (GAO/NSIAD-97-210BR, Sept.  12,
1997). 

Navy Depot Maintenance:  Privatizing the Louisville Operations in
Place Is Not Cost Effective (GAO/NSIAD-97-52, July 31, 1997). 

Defense Depot Maintenance:  Challenges Facing DOD in Managing Working
Capital Funds (GAO/T-NSIAD/AIMD-97-152, May 7, 1997). 

Depot Maintenance:  Uncertainties and Challenges DOD Faces in
Restructuring Its Depot Maintenance Program (GAO/T-NSIAD-97-111, Mar. 
18, 1997) and (GAO/T/NSIAD-112, Apr.  10, 1997). 

Defense Outsourcing:  Challenges Facing DOD as It Attempts to Save
Billions in Infrastructure Costs (GAO/T-NSIAD-97-110, Mar.  12,
1997). 

Navy Ordnance:  Analysis of Business Area Price Increases and
Financial Losses (GAO/AIMD/NSIAD-97-74, Mar.  14, 1997). 

High-Risk Series:  Defense Infrastructure (GAO/HR-97-7, Feb.  1997). 

Air Force Depot Maintenance:  Privatization-in-Place Plans Are Costly
While Excess Capacity Exists (GAO/NSIAD-97-13, Dec.  31, 1996). 

Army Depot Maintenance:  Privatization Without Further Downsizing
Increases Costly Excess Capacity (GAO/NSIAD-96-201, Sept.  18, 1996). 

Navy Depot Maintenance:  Cost and Savings Issues Related to
Privatizing-in-Place the Louisville, Kentucky, Depot
(GAO/NSIAD-96-202,
Sept.  18, 1996). 

Defense Depot Maintenance:  Commission on Roles and Mission's
Privatization Assumptions Are Questionable (GAO/NSIAD-96-161,
July 15, 1996). 

Defense Depot Maintenance:  DOD's Policy Report Leaves Future Role of
Depot System Uncertain (GAO/NSIAD-96-165, May 21, 1996). 

Defense Depot Maintenance:  More Comprehensive and Consistent
Workload Data Needed for Decisionmakers (GAO/NSIAD-96-166, May 21,
1996). 

Defense Depot Maintenance:  Privatization and the Debate Over the
Public-Private Mix (GAO/T-NSIAD-96-146, Apr.  16, 1996) and
(GAO/T-NSIAD-96-148, Apr.  17, 1996). 

Military Bases:  Closure and Realignment Savings Are Significant, but
Not Easily Quantified (GAO/NSIAD-96-67, Apr.  8, 1996). 

Depot Maintenance:  Opportunities to Privatize Repair of Military
Engines (GAO/NSIAD-96-33, Mar.  5, 1996). 

Closing Maintenance Depots:  Savings, Personnel, and Workload
Redistribution Issues (GAO/NSIAD-96-29, Mar.  4, 1996). 

Navy Maintenance:  Assessment of the Public-Private Competition
Program for Aviation Maintenance (GAO/NSIAD-96-30, Jan.  22, 1996). 

Depot Maintenance:  The Navy's Decision to Stop F/A-18 Repairs at
Ogden Air Logistics Center (GAO/NSIAD-96-31, Dec.  15, 1995). 

Military Bases:  Case Studies on Selected Bases Closed in 1988 and
1991 (GAO/NSIAD-95-139, Aug.  15, 1995). 

Military Base Closure:  Analysis of DOD's Process and Recommendations
for 1995 (GAO/T-NSIAD-95-132, Apr.  17, 1995). 

Military Bases:  Analysis of DOD's 1995 Process and Recommendations
for Closure and Realignment (GAO/NSIAD-95-133, Apr.  14, 1995). 

Aerospace Guidance and Metrology Center:  Cost Growth and Other
Factors Affect Closure and Privatization (GAO/NSIAD-95-60, Dec.  9,
1994). 

Navy Maintenance:  Assessment of the Public and Private Shipyard
Competition Program (GAO/NSIAD-94-184, May 25, 1994). 

Depot Maintenance:  Issues in Allocating Workload Between the Public
and Private Sectors (GAO/T-NSIAD-94-161, Apr.  12, 1994). 

Depot Maintenance (GAO/NSIAD-93-292R, Sept.  30, 1993). 

Depot Maintenance:  Issues in Management and Restructuring to Support
a Downsized Military (GAO/T-NSIAD-93-13, May 6, 1993). 

Air Logistics Center Indicators (GAO/NSIAD-93-146R, Feb.  25, 1993). 

Defense Force Management:  Challenges Facing DOD as It Continues to
Downsize Its Civilian Workforce (GAO/NSIAD-93-123, Feb.  12, 1993). 

Navy Maintenance:  Public-Private Competition for F-14 Aircraft
Maintenance (GAO/NSIAD-92-143, May 20, 1992). 

*** End of document. ***