Inventory Management: Greater Use of Best Practices Could Reduce DOD's
Logistics Costs (Testimony, 07/24/97, GAO/T-NSIAD-97-214).

Pursuant to a congressional request, GAO discussed the Department of
Defense's (DOD) use of innovative business practices to improve
inventory management and the opportunities GAO sees for further
application of best practices to DOD's operations, focusing on: (1) the
success DOD has had in using prime-vendor-type programs for medical,
food, and clothing items; (2) the feasibility of using prime vendor
systems for hardware items (such as bearings, valves, and bolts); and
(3) recently introduced legislation that pertains to improving DOD's
inventory management practices.

GAO noted that: (1) DOD has successfully applied best practices to
improve the management of medical and food items, which account for 2
percent of the consumable items DOD manages; (2) DOD's prime vendor
program for medical supplies, along with other DOD inventory reduction
efforts, has resulted in savings that GAO estimates exceed $700 million;
(3) more importantly, this program has moved DOD out of the inventory
storage and distribution function for these supplies, emptying
warehouses, eliminating unnecessary layers of inventory, and reducing
the overall size of the DOD supply system; (4) also, DOD buys only the
items that are currently needed because consumers can order and receive
inventory within hours of the time the items are used; (5) despite the
success of its prime vendor program for medical supplies and, to a
lesser extent, food items, DOD has made little progress in adopting best
practices for hardware supplies, which account for 97 percent of the
consumable items; (6) DOD continues to manage hardware items using
inefficient and outdated business practices, which have resulted in
excessive inventory levels, poor customer service, and delays in the
repair of expensive military equipment; (7) although the private sector
has developed solutions to these problems, DOD's efforts to adopt such
practices are limited in scope and represent only a small part of its
logistics operations; (8) since 1991, GAO has issued a series of reports
highlighting best practices GAO believes have direct application to
DOD's operations; (9) however, DOD has not applied these best practices
to the majority of DOD consumable items, and inefficiencies in DOD's
logistics systems remain; (10) in this context, proposed legislative
initiatives, if enacted, would encourage DOD to change its inventory
management practices; (11) also, congressional oversight will continue
to be a critical element as DOD establishes plans, goals, objectives,
and milestones for addressing its inventory management processes; (12)
GAO strongly supports the need to improve DOD's business practices and
further reduce the logistics infrastructure; and (13) because of the
potential impact improved business practices would have on DOD inventory
levels, operating costs, and the repair of weapon systems and component
parts, GAO believes DOD must be more aggressive in expanding the use of
new management techniques for these items.

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

 REPORTNUM:  T-NSIAD-97-214
     TITLE:  Inventory Management: Greater Use of Best Practices Could 
             Reduce DOD's Logistics Costs
      DATE:  07/24/97
   SUBJECT:  Proposed legislation
             Inventory control systems
             Military inventories
             Military cost control
             Federal supply systems
             Logistics
             Federal property management
             Surplus property
IDENTIFIER:  DOD Prime Vendor Program
             
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Cover
================================================================ COVER


Before the Subcommittee on National Security, International Affairs,
and Criminal Justice, Committee on Government Reform and Oversight,
House of Representatives

For Release on Delivery
Expected at
12:00 p.m., EDT
Thursday,
July 24, 1997

INVENTORY MANAGEMENT - GREATER USE
OF BEST PRACTICES COULD REDUCE
DOD'S LOGISTICS COSTS

Statement of David R.  Warren, Director, Defense Management Issues,
National Security and International Affairs Division

GAO/T-NSIAD-97-214

GAO/NSIAD-97-214T

Inventory Management

(709285)


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

  DLA - Defense Logistics Agency
  DOD - Department of Defense

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here to discuss the Department of Defense's
(DOD) use of innovative business practices to improve inventory
management and the opportunities we see for further application of
best practices to DOD's operations.  We have identified defense
inventory management as
1 of our 25 high risk areas in the federal government because of
vulnerabilities to waste, fraud, and abuse.\1 Today, we will discuss
DOD's management of consumable items, which represent $18.7 billion,
or 27 percent of the total secondary inventory dollar value.\2 As
requested, our testimony today will focus on (1) an overview of the
success DOD has had in using prime-vendor-type programs for medical,
food, and clothing items; (2) the feasibility of using prime vendor
systems for hardware items (such as bearings, valves, and bolts); and
(3) our observations on recently introduced legislation that pertains
to improving DOD's inventory management practices. 


--------------------
\1 In 1990, we began a special effort to review and report on the
federal program areas we identified as high risk because of
vulnerabilities to waste, fraud, abuse, and mismanagement.  This
effort, which was supported by the Senate Committee on Government
Affairs and the House Committee on Government Reform and Oversight,
brought a much needed focus on problems that were costing the
government billions of dollars.  We identified DOD's secondary
inventory management as a high risk area at that time because of too
high levels of unneeded inventory and inadequate systems for
determining inventory requirements. 

\2 Consumable items are items discarded after use rather than
repaired. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:1

DOD has successfully applied best practices to improve the management
of medical and food items, which account for 2 percent of the
consumable items DOD manages.  DOD's prime vendor program for medical
supplies, along with other DOD 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, emptying warehouses,
eliminating unnecessary layers of inventory, and reducing the overall
size of the DOD supply system.  Also, DOD buys only the items that
are currently needed because consumers can order and receive
inventory within hours of the time the items are used. 

Despite the success of its prime vendor program for medical supplies
and, to a lesser extent, food items, DOD has made little progress in
adopting best practices for hardware supplies, which account for 97
percent of the consumable items.  DOD continues to manage hardware
items using inefficient and outdated business practices, which have
resulted in excessive inventory levels, poor customer service, and
delays in the repair of expensive military equipment.  Although the
private sector has developed solutions to these problems, DOD's
efforts to adopt such practices are limited in scope and represent
only a small part of its logistics operations. 

Since 1991, we have issued a series of reports highlighting best
practices we believe have direct application to DOD's operations.\3
However, DOD has not applied these best practices to the majority of
DOD consumable items, and inefficiencies in DOD's logistics systems
remain.  In this context, proposed legislative initiatives, if
enacted, would encourage DOD to change its inventory management
practices.  Also, congressional oversight will continue to be a
critical element as DOD establishes plans, goals, objectives, and
milestones for addressing its inventory management processes. 

We strongly support the need to improve DOD's business practices and
further reduce the logistics infrastructure.  Because of the
potential impact improved business practices would have on DOD
inventory levels, operating costs, and the repair of weapon systems
and component parts, we believe DOD must be more aggressive in
expanding the use of new management techniques for these items. 


--------------------
\3 See Related GAO Products at the end of this testimony. 


   DOD INVENTORY MANAGEMENT
   OVERVIEW
---------------------------------------------------------- Chapter 0:2

The Defense Logistics Agency (DLA) is the primary manager of DOD's
consumable items and acts as the custodian of military aircraft,
ship, and vehicle parts.  To perform these functions, DLA operates a
massive logistics system that currently contains about 4 million
items with a total inventory value of $11.1 billion.\4 To store and
distribute DOD's secondary inventory, DLA has reported that it uses
storage structures at 27 sites that provide 531 million cubic feet of
storage space.  According to DLA, it employed more than 30,000 people
in its material management operations in 1996. 

DLA's 1996 material management costs, excluding the management of
fuels, were reported at about $8.3 billion.  Of that amount,
approximately $5.5 billion was spent to purchase consumable items and
$2.8 billion was spent to manage and distribute inventory.  Also, DLA
reported that it disposed of $1.1 billion of excess consumable
material in 1996. 

DOD recognizes that it can no longer continue to operate a costly and
inefficient logistics system.  In addition, DOD needs to achieve
significant savings in its support infrastructure to help increase
funding for weapon system modernization and meet the goal of
increasing procurement funding from about $40 billion to over $60
billion between fiscal year 1997 and 2002.  DOD is relying on
initiatives, such as outsourcing and privatization, acquisition
reforms, organizational streamlining and consolidations, management
process reengineering, base realignments and closures, personnel
reductions, and inventory reductions to help produce savings in its
support areas. 

In this connection, the Secretary of Defense has established, as part
of the Quadrennial Defense Review, a Defense Reform Task Force to
review the Office of the Secretary of Defense, defense agencies, DOD
field activities, and the military departments to look at ways DOD
can consolidate functions, eliminate duplication of effort, and
improve efficiency.  The Task Force plans to consult with Congress
and business executives who have streamlined their corporations in
recent years.  The Secretary has directed the Task Force to submit
its findings and report by November 30, 1997. 


--------------------
\4 The $11.1 billion value of the inventory was estimated using the
last acquisition cost of each item.  In reporting the value to
Congress, DOD reduced the amount to $9.5 billion, because excess
inventory was valued at salvage value (3.2 percent of the last
acquisition cost). 


   BEST PRACTICES HAVE REDUCED
   PRIVATE SECTOR LOGISTICS COSTS
---------------------------------------------------------- Chapter 0:3

We have identified several best practices that have been successfully
used in the private sector to reduce inventory levels and logistics
costs.  In general, these practices provide inventory users with a
capability to order supplies as they are needed and then delivering
those items directly to the customer within hours after the order is
placed.  Ordering supplies only as they are needed, combined with
quick logistics response times, enable companies to reduce or
eliminate inventory levels, buy only the items that are currently
needed, reduce or eliminate the possibility of inventory spoilage or
obsolescence, and reduce overall supply system costs. 

Since 1991, we have highlighted three best practices--prime vendor,
local distribution centers/supplier parks, and integrated
supplier--that reflect the new business philosophy in the management
of consumable items (see table 1).  These techniques resulted in
significant savings for the companies that have used them to improve
their inventory management systems.  We recommended that DOD test
these concepts and expand them, where feasible, to other defense
facilities. 



                                Table 1
                
                   Best Practices Recommended by GAO

Concept             Description
------------------  --------------------------------------------------
Prime vendor        A single vendor (prime vendor) buys inventory from
                    a variety of suppliers and stores the inventory in
                    its warehouse. This concept is characterized by a
                    close partnership between the prime vendor and
                    customer. The customer orders supplies from the
                    prime vendor, using electronic ordering systems
                    that, in some cases, are provided by the prime
                    vendor. The prime vendor delivers inventory items
                    to the customer within hours of receiving the
                    order.

Local distribution  One or more suppliers locate a distribution center
centers/supplier    within close proximity to their customers. From
parks               this location, the supplier delivers items to the
                    customer within 24 hours or less of receiving an
                    order. The supplier is linked electronically with
                    the customer. In some cases, the supplier can
                    perform the receiving function for the customer in
                    the local distribution center before the inventory
                    leaves the facility.

Integrated          An integrated supplier assumes almost total
supplier            inventory management responsibilities for a
                    customer. This is the most aggressive form of a
                    supplier partnership where a supplier
                    representative works in the customer's facility,
                    ordering supplies as they are needed, and
                    replenishing storage locations. Inventory is
                    stored by the supplier in the supplier's warehouse
                    until ordered and then delivered on a "just-in-
                    time" basis. An integrated supplier can also
                    perform quality inspections, maintain data on
                    usage, test the quality of parts, prepare parts
                    kits, establish electronic data interchange links
                    and bar coding, and provide vendor selection
                    management.
----------------------------------------------------------------------
The companies that have adopted these best practices have
significantly reduced their logistics costs.  For example, as we
reported in December 1991, Vanderbilt University Medical Center
reduced inventory levels by $1.7 million (38 percent) through the use
of a prime vendor program.  In 1993, we reported PPG Industries
eliminated $4.5 million
(80 percent) in maintenance and repair supplies and saved
approximately $600,000 in annual operating costs by locating 10
suppliers' activities at a supplier park about 600 yards from the PPG
facility.  In 1996, we found that a leading distributor of aircraft
supplies reported its integrated supplier program reduced one
customer's inventory by $7.4 million (84 percent), while filling 98
percent of the customer's orders within 24 hours. 


   DOD HAS ACHIEVED SUCCESS WITH
   MEDICAL AND FOOD PRIME VENDOR
   PROGRAMS
---------------------------------------------------------- Chapter 0:4

Starting in 1993, DOD has successfully applied the prime vendor
concept to its management of medical supplies.  The prime vendor,
which delivers the items to the DOD hospitals when ordered, has
enabled DOD to reduce the need to store and distribute medical
supplies.  As a result, DOD has been able to reduce its inventory and
supply system resource requirements. 

DOD implemented this prime vendor program within a relatively short
period of time.  The overall implementation strategy was to test and
evaluate the concept first in one geographic region (the National
Capital Area), and expand the concept nationwide to 20 other
geographic regions.  DOD began first with pharmaceutical items, such
as aspirin and antibiotics, then followed with medical supplies, such
as syringes and surgical gloves.  According to DLA, nationwide
roll-out of the pharmaceutical and medical prime vendor programs took
a total of 20 and 40 months, respectively.  Presently, DLA reported
that almost 200 DOD medical facilities use a prime vendor to meet
most of their pharmaceutical and medical supplies needs. 

As the prime vendor program was established nationwide, inventory
levels began to decline, and warehouses once filled with these items
were being emptied (see fig.  1).  At one of DLA's primary storage
depots for medical supplies, DLA estimated that storage space
requirements dropped by about 40 percent over a 3-year period. 

   Figure 1:  DOD Medical
   Inventory Levels and Prime
   Vendor Trends
   1991-1996

   (See figure in printed
   edition.)

In addition, as a result of the prime vendor program, logistics
systems at DOD medical facilities were shrinking.  Walter Reed Army
Medical Center officials, for example, estimate the prime vendor
program reduced inventory lines stocked by the Medical Center from
4,342 to 534, reduced inventory levels from $17.4 million to $1.8
million, reduced personnel levels from 72 to 36 full-time
equivalents, and closed 6 out of 7 warehouses.  Walter Reed officials
estimate that they save approximately $6 million each year as a
result of the prime vendor program.  Table 2 summarizes our estimate
of savings that have accrued DOD-wide from 1991 to 1996 as a result
of the medical prime vendor program and other related inventory
reduction efforts. 



                                Table 2
                
                Estimated DOD Medical Inventory Savings

                         (Dollars in millions)

Type of savings                                       Estimated amount
----------------------------------------  ----------------------------
Inventory reductions                                            $409.5
Holding cost reductions                                          118.9
Product cost reductions                                          154.0
Distribution cost reductions                                      31.3
======================================================================
Total                                                           $713.7
----------------------------------------------------------------------
As table 2 illustrates, this estimate includes realized savings from
reduced inventory levels and the associated holding and distribution
costs and realized reduced product costs.  For example, in 1995, DOD
estimated that the amount paid by medical facilities for the top 16
prime vendor pharmaceutical items was $37.7 million lower than 1993
prices. 

The medical prime vendor program has also provided a quicker pipeline
between the manufacturer and end users, which has moved the
procurement decision closer to the time the items are actually used. 
Under the traditional military logistics system, hospital warehouses
would wait an average of 20 days to receive supplies ordered from DLA
warehouses.  DLA would take an average of 90 days to order and
receive items from manufacturers.  The prime vendor can deliver
supplies directly to the hospital within 1 day of receiving the order
and can order and receive supplies from manufacturers within 7 days. 
Therefore, the process that used to take an average of 110 days has
been reduced to 8 days. 


      FOOD AND CLOTHING PRIME
      VENDOR PROGRAMS
-------------------------------------------------------- Chapter 0:4.1

As with medical supplies, DLA's use of prime vendors for food has
reduced DOD logistics costs and improved customer service.  In 1994,
DLA began testing the use of prime vendors to supply food to military
dining facilities.  By the end of fiscal year 1997, DLA plans to have
prime vendors supporting all military dining halls in the continental
United States. 

Since fiscal year 1994, DLA has reduced peacetime food inventories by
over 40 percent.  In a demonstration test of the prime vendor concept
in a four-state area (Florida, Georgia, South Carolina, and Alabama),
DOD estimated that it saved $16.8 million in food inventory
reductions and related costs.  Another location outside the test area
using the prime vendor concept estimated that it saved about $7
million.  At one facility we visited, service officials were able to
vacate two warehouses that previously were needed to store food
items.  Officials we spoke with were more satisfied with the delivery
service provided by the prime vendor than that provided by the
traditional DOD supply system.  For example, the prime vendor can
deliver food to dining facilities within 1 to 2 days instead of
30 days under the DOD system.  DLA is projecting that the potential
savings associated with this program could be as much as $1 billion
over the next 5 years. 

DLA's adoption of the prime vendor concept for clothing items is not
as advanced as the medical and food prime vendor programs.  In April
1994, we recommended that DOD test the prime vendor concept to
improve management of high-usage uniform items.  In March 1996, DOD
began testing a prime vendor program at the Air Force recruit
induction center located at Lackland Air Force Base.  This test is
expected to continue for
2 more years.  Since 1993, based on DLA's records, clothing inventory
has decreased 12 percent, from $1.7 billion to $1.5 billion. 
According to our analysis, this inventory could meet DOD's
requirements for the next
1.5 years, based on demands received in 1996. 


   DOD USES INEFFICIENT AND
   INEFFECTIVE MANAGEMENT
   TECHNIQUES FOR HARDWARE ITEMS
---------------------------------------------------------- Chapter 0:5

DOD's use of best practices is least advanced for hardware items
(such as bearings, valves, and bolts), which represent 97 percent of
DLA's inventory items.  DOD continues to use outdated and inefficient
business practices that require DOD to buy and store hardware items
in DLA warehouses and base-level supply systems in an attempt to
ensure that inventory will be available to customers.  In some cases,
DOD buys inventory years in advance of when the items are actually
used.  For example, based on our analysis of DOD records, over 60
percent of DOD hardware items, valued at $2.7 billion, did not have a
demand from September 1995 to August 1996.  Despite this inventory
investment, however, in many cases, hardware inventory is not
available when needed by DOD customers.  When hardware inventory is
not available, the repair of costly weapon systems and components is
delayed.  Although DOD has taken steps to improve its logistics
practices and reduce inventories, more aggressive steps could provide
better customer service, enhance readiness, and reduce logistics
costs. 

During fiscal year 1996, DLA reported it purchased $2.6 billion in
hardware supplies and sold $3.1 billion in supplies to the military
services.\5 When the services order hardware supplies from DLA, the
supplies are sent from the DLA warehouses to the military services,
which, according to DOD records, takes an average of 25 days.  The
services operate a base-level logistics system to deliver the
inventory to the end user.  This system usually requires that the
inventory be stored in three separate locations--bulk storage
warehouses, central distribution storerooms, and end-user locations. 
When DLA and service-owned inventories are combined, the total
inventory levels could meet current DOD requirements, in some cases,
for several years.  Figure 2 is an illustration of the traditional
multilayered logistics system, as highlighted in our April 1997
report on the Army's logistics system, and shows the millions of
dollars of hardware inventory that a service facility can hold. 

   Figure 2:  DOD's Logistics
   System Used at Corpus Christi
   Army Depot

   (See figure in printed
   edition.)

\a DLA inventory is stored at multiple locations nationwide to
support all DOD customers. 

As of September 1996, DLA reported it stored $7.2 billion worth of
hardware items in distribution depots and warehouses.  On the basis
of inventory levels and past demands for items, we estimate that this
inventory could satisfy DOD's requirements, on average, for the next
2.3 years. 

Despite DOD's large investment in inventory, the supply system
frequently does not meet the needs of its customers.  As of September
1996, DLA reported it had over 574,000 customer orders, valued at
$843 million, that it could not fill because it did not have the
right stock on hand.  Customers had been waiting on these parts for
an average of over 3 months.  Also, the base-level supply system
frequently did not meet orders placed by mechanics and other
customers.  For example, according to Army records, the base
warehouse at one Army depot did not fully meet customer orders 76
percent of the time during 1996.  At four other locations we
examined, base-level systems did not meet customer needs between 30
and 72 percent of the time. 

When hardware supplies and other parts are not immediately available
to mechanics, it delays the timely repair of weapon systems and their
components.  For example, the Navy calculates that the lack of parts
increases the repair time for aviation parts by as much as 74
percent.  As of January 1997, the Navy reported it had stopped
repairing over 12,000 broken aircraft components, valued at $516
million, because parts were not available to complete repairs.  The
Navy had packaged and moved the partially repaired items to a
warehouse next to the repair facility.  At the time of our review,
these items had been in storage for an average of
230 days.  Also, according to Air Force records, mechanics at one Air
Force depot location had stopped repairs on 2,748 items, valued at
$193 million, because necessary parts were not available. 


--------------------
\5 DLA buys inventory using working capital funds.  The services
purchase inventory from DLA using operations and maintenance funds
appropriated by the Congress. 


   DOD COULD BUILD ON EFFORTS TO
   ADOPT BEST PRACTICES FOR
   HARDWARE ITEMS
---------------------------------------------------------- Chapter 0:6

To its credit, DLA has tried new inventory practices for managing
hardware items.  However, the efforts are limited in scope and
represent only a small part of its logistics operations.  To attain
the same level of success that DOD has achieved with the medical
prime vendor program and to realize the dramatic inventory reductions
and infrastructure savings we have seen in the private sector, we
believe DOD should expand the prime vendor concept and fully use the
services offered by prime vendor and integrated supplier programs. 


      DOD SHOULD MOVE BEYOND
      DIRECT VENDOR DELIVERY
      CONCEPTS
-------------------------------------------------------- Chapter 0:6.1

Since 1992, the use of a direct vendor delivery program has been one
of DLA's main improvement initiatives.  Under the direct vendor
delivery initiative, DLA uses long-term contracts and electronic data
systems to enable certain suppliers to deliver items directly to the
military customers instead of having the items delivered to DLA
warehouses.  In fiscal
year 1996, DLA reported that 17 percent of hardware inventory sales
were filled using the direct vendor delivery program.  This
percentage has not varied much since 1992.  Figure 3 shows the direct
delivery sales and inventory levels from fiscal year 1992 to 1996. 

   Figure 3:  DOD Hardware
   Inventory Levels and Direct
   Delivery Trends
   1992-1996

   (See figure in printed
   edition.)

Although the direct delivery program eliminates the need to store and
distribute inventory from DLA warehouses, lowering the cost to the
DOD customer, it does not provide a quick response to customer
orders.  For example, according to DLA records, the cost recovery
rate for some hardware items is reduced from 46.6 percent to 7.4
percent under the direct vendor delivery program.  However, under the
direct delivery program, it took an average of 54 days for customers
to receive items ordered, or twice as long as the 25-day delivery
average for items stocked in DLA warehouses.  As shown in figure 4,
both of these delivery times are significantly longer than that
achieved by prime vendors or integrated suppliers, which can often
deliver parts within hours of receiving an order. 

   Figure 4:  Delivery Time
   Comparison

   (See figure in printed
   edition.)


      DOD HAS APPLIED A LIMITED
      FORM OF THE PRIME VENDOR
      CONCEPT TO HARDWARE ITEMS
-------------------------------------------------------- Chapter 0:6.2

In fiscal year 1997, DOD began using the prime vendor concept, called
the virtual prime vendor program, for hardware supplies on a limited
basis.  One of the two testing areas was supply support of repair
depot operations.  In February 1997, DOD began using a prime vendor
program to support the C-130 propeller repair shop at the
Warner-Robins Air Logistics Center.  By the end of fiscal year 1997,
the Air Force, the Navy, and DLA plan to have prime vendor
demonstration projects at three other repair facilities.  We estimate
these demonstration projects will account for about 2 percent of
DLA's $3.1 billion annual sales of hardware items. 

Also in February 1997, DLA began using the prime vendor concept for
facility maintenance supplies, such as plumbing, electrical, and
lumber items.  Under this concept, a prime vendor will serve a
geographic region where all military facilities within the region can
elect to order maintenance supplies from the vendor.  In the first
test region, four military facilities have elected to use the prime
vendor, representing about $8 million in annual sales.  By the end of
1997, DLA plans to have a prime vendor under contract for 10
geographic regions. 

The Under Secretary of Defense (Comptroller)/Chief Financial Officer
endorsed these initiatives in June 1997 and asked the DLA Director,
along with each of the military services, to develop a regional
implementation blueprint for the facilities maintenance supplies
prime vendor program.  He asked that the blueprint identify the
critical events and site designations for regional implementation
within 12 months and nationwide availability by the middle of fiscal
year 1999.  This blueprint is critical to the success of this
particular prime vendor program because it will demonstrate top
management support and encourage military units to use the prime
vendor services once they are established. 


      DOD COULD USE PRIME VENDOR
      AND INTEGRATED SUPPLIER
      PROGRAMS TO A GREATER EXTENT
-------------------------------------------------------- Chapter 0:6.3

DOD's prime vendor programs for hardware items are similar to the
best practices we observed in the private sector.  We believe,
however, that DOD can build on this concept to achieve greater
savings and improve service.  For example, neither DLA's direct
delivery nor prime vendor programs streamline the service's
base-level logistics systems to the extent that we have seen in the
private sector.  DOD personnel still perform the function of
ordering, receiving, storing, and distributing material to the end
users.  If DOD was more aggressive in its approach to streamlining
its system and transferred these functions to a prime vendor or to an
integrated supplier, it could achieve substantial reductions in
resource requirements and improved service to its customers.  For
example, at Walter Reed, the prime vendor program resulted in a
50-percent reduction in full time equivalents associated with the
supply system within the Medical Center.  Figure 5 illustrates the
potential impact an integrated supplier program could have on the
traditional DOD supply system for hardware supplies. 

   Figure 5:  Potential Impact of
   an Integrated Supplier on DOD's
   System

   (See figure in printed
   edition.)

As the illustration shows, the integrated supplier concept could
by-pass the DLA wholesale system and two of the three primary storage
points in the base-level supply system.  The integrated supplier
would deliver inventory directly to either maintenance shop storage
points or end-user locations.  In the private sector, having the
supplier deliver inventory directly to these locations has improved
the availability of inventory and has actively involved the supplier
as a "partner" in the customer's operations.  The supplier also
becomes involved in testing parts for quality, monitoring part usage,
and ordering supplies as they are needed. 

Our discussions with DLA and Air Force officials indicated that the
main reason that a more aggressive approach has not been adopted is
that a cost comparison of the prime vendor and DOD systems may be
required.  A prime vendor program that would replace the base-level
supply system (considered a commercial activity) and involve more
than 10 government personnel generally may not be contracted out
without a cost comparison in accordance with Office of Management and
Budget Circular A-76.  According to the Air Force, the Warner-Robins
Air Logistics Center has approximately 219 government personnel
involved in supply operations.  Air Force officials stated that, if
these positions were eliminated through the prime vendor program, a
cost comparison would first be required that may take 2 years to
complete.  We agree that A-76 could be a significant issue in
implementing these programs.  Our work has consistently shown,
however, that outsourcing is cost-effective because competition
generates savings--usually through a reduction in personnel--whether
the competition is won by the government or the private sector. 


   OBJECTIVES OF RECENTLY
   INTRODUCED LEGISLATION CAN BE
   MET THROUGH THE USE OF BEST
   PRACTICES
---------------------------------------------------------- Chapter 0:7

Several legislative proposals have been introduced this year in
Congress relating to inventory management and the adoption of best
commercial practices.  For example, the proposed Defense Reform Act
of 1997
(H.R.  1778) was a legislative initiative introduced in June 1997
that related to defense personnel reforms, defense business practice
reforms, and additional miscellaneous defense reforms.  We generally
agreed with many of the aims of this particular legislation. 
Pertinent provisions of H.R.  1778 were incorporated into the
recently passed House version of the proposed National Defense
Authorization Act of 1998 (H.R.  1119).  We believe that two specific
sections of H.R.  1119--one dealing with a reduction to the
acquisition work force and another with a reduction in overhead costs
of inventory control points--can be addressed by DOD to a certain
degree by adopting best practices. 

Section 1302 of H.R.  1119 would require DOD to reduce its
acquisition work force by 42 percent by October 1, 2001.  If DOD were
to aggressively pursue best practices in the form of an integrated
supplier concept for consumable items, DOD could reduce its work
force involved in procurement, storage, and distribution of
consumable items.  For example, the prime vendor program at Walter
Reed resulted in a 50-percent reduction in full time equivalents
associated with the medical supply system. 

Section 1421 of H.R.  1119 would require DOD inventory control points
to reduce their overhead costs to 8 percent of net sales by the end
of fiscal year 2000.  This goal is a very aggressive goal,
considering that the current cost recovery rate (the rate applied to
the cost of goods to recover overhead costs) for some DOD hardware
items is as high as 41.4 percent.  However, DOD has accomplished the
goal for medical supplies through the use of the prime vendor program
in that DLA reduced the rate for medical supplies from 21.7 in fiscal
year 1992 to 7.9 percent in fiscal year 1997. 

We also support several requirements of the recently passed Senate
version of the proposed National Defense Authorization Act of 1998
(S.936) that relate to the application of best business practices at
depot-level activities and the expansion of best inventory management
practices of DLA commodities.  For example, section 312, which deals
with the designation of depot-level activities as "Centers of
Industrial and Technical Excellence," contains provisions requiring
DOD to establish a policy to encourage the military services and
defense agencies to reengineer their processes and adopt best
business practices in connection with their core competency
requirements.  The section also allows the services to conduct pilot
programs to test practices they believe will contribute to the
efficiency and effectiveness of depot-level operations, improve
support to the military users of such activities, and enhance
readiness by reducing the time it takes to repair equipment. 

Section 366 of the act deals with the implementation of best
inventory practices for DLA-managed supplies and equipment.  This
section requires the DLA Director to develop and submit to Congress,
not later than
180 days after enactment of the act, a schedule for implementing
practices that the Director defines as the best commercial inventory
practices applicable to the acquisition and distribution of medical
supplies, food and subsistence, clothing and textiles, commercially
available electronics, construction supplies, and industrial
supplies.  The act requires that the schedule for completing
implementation of such practices be completed not later than 3 years
after the date of enactment. 


   SUMMARY
---------------------------------------------------------- Chapter 0:8

In closing, we have identified the specific practices that warrants
DOD's consideration and recommended that DOD test best practice
concepts and expand the most successful ones to its logistics
operations, where applicable.  However, DOD has not applied these
best practices to the majority of DOD consumable items, and
inefficiencies in DOD's logistics systems remain.  In this regard,
proposed legislative initiatives, if enacted, would help encourage
DOD to change its inventory management practices.  In addition,
congressional oversight will continue to be a critical element as DOD
establishes plans, goals, objectives, and milestones for addressing
its inventory management processes. 

Mr.  Chairman, this concludes our statement.  We would be happy to
answer any questions you or the members of the Subcommittee may have. 

RELATED GAO PRODUCTS

Inventory Management:  The Army Could Reduce Logistics Costs for
Aviation Parts by Adopting Best Practices (GAO/NSIAD-97-82, Apr.  15,
1997). 

Defense Inventory Management:  Problems, Progress, and Additional
Actions Needed (GAO/T-NSIAD-97-109 Mar.  20, 1997). 

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

High-Risk Series:  Defense Inventory Management (GAO/HR-97-5, Feb. 
1997). 

Defense Inventory:  Spare and Repair Parts Inventory Costs Can Be
Reduced (GAO/NSIAD-97-47, Jan.  17, 1997). 

Logistics Planning:  Opportunities for Enhancing DOD's Logistics
Strategic Plan (GAO/NSIAD-97-28, Dec.  18, 1996). 

1997 DOD Budget:  Potential Reductions to Operation and Maintenance
Program (GAO/NSIAD-96-220, Sept.  18, 1996). 

Defense IRM:  Critical Risks Facing New Materiel Management Strategy
(GAO/AIMD-96-109, Sept.  6, 1996). 

Navy Financial Management:  Improved Management of Operating
Materials and Supplies Could Yield Significant Savings
(GAO/AIMD-96-94, Aug.  16, 1996). 

Inventory Management:  Adopting Best Practices Could Enhance Navy
Efforts to Achieve Efficiencies and Savings (GAO/NSIAD-96-156, July
12, 1996). 

Defense Logistics:  Requirement Determinations for Aviation Spare
Parts Need to Be Improved (GAO/NSIAD-96-70, Mar.  19, 1996). 

Best Management Practices:  Reengineering the Air Force's Logistics
System Can Yield Substantial Savings (GAO/NSIAD-96-5, Feb.  21,
1996). 

Inventory Management:  DOD Can Build on Progress in Using Best
Practices to Achieve Substantial Savings (GAO/NSIAD-95-142, Aug.  4,
1995). 

Defense Inventory:  Opportunities to Reduce Warehouse Space
(GAO/NSIAD-95-64, May 24, 1995). 

Best Practices Methodology:  A New Approach for Improving Government
Operations (GAO/NSIAD-95-154, May 1995). 

Defense Business Operations Fund:  Management Issues Challenge Fund
Implementation (GAO/NSIAD-95-79, Mar.  1, 1995). 

Defense Supply:  Inventories Contain Nonessential and Excessive
Insurance Stocks (GAO/NSIAD-95-1, Jan.  20, 1995). 

Defense Supply:  Acquisition Leadtime Requirements Can Be
Significantly Reduced (GAO/NSIAD-95-2, Dec.  20, 1994). 

Reengineering Organizations:  Results of a GAO Symposium
(GAO/NSIAD-95-34, Dec.  13, 1994). 

Commercial Practices:  Opportunities Exist to Enhance DOD's Sales of
Surplus Aircraft Parts (GAO/NSIAD-94-189, Sept.  23, 1994). 

Organizational Culture:  Use of Training to Help Change DOD Inventory
Management Culture (GAO/NSIAD-94-193, Aug.  30, 1994). 

Partnerships:  Customer-Supplier Relationships Can Be Improved
Through Partnering (GAO/NSIAD-94-173, July 19, 1994). 

Commercial Practices:  DOD Could Reduce Electronics Inventories by
Using Private Sector Techniques (GAO/NSIAD-94-110, June 29, 1994). 

Commercial Practices:  Leading-Edge Practices Can Help DOD Better
Manage Clothing and Textile Stocks (GAO/NSIAD-94-64, Apr.  13, 1994). 

Defense Transportation:  Commercial Practices Offer Improvement
Opportunities (GAO/NSIAD-94-26, Nov.  26, 1993). 

Defense Inventory:  Applying Commercial Purchasing Practices Should
Help Reduce Supply Costs (GAO/NSIAD-93-112, Aug.  6, 1993). 

Commercial Practices:  DOD Could Save Millions by Reducing
Maintenance and Repair Inventories (GAO/NSIAD-93-155, June 7, 1993). 

DOD Food Inventory:  Using Private Sector Practices Can Reduce Costs
and Eliminate Problems (GAO/NSIAD-93-110, June 4, 1993). 

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

DOD Medical Inventory:  Reductions Can Be Made Through the Use of
Commercial Practices (GAO/NSIAD-92-58, Dec.  5, 1991). 

Commercial Practices:  Opportunities Exist to Reduce Aircraft Engine
Support Costs (GAO/NSIAD-91-240, June 28, 1991). 

*** End of document. ***