Background

Under DOD’s supply chain materiel management policy, secondary item  inventory is to be sized to minimize DOD’s investment while providing the  inventory needed to support both wartime and peacetime requirements.  Management and oversight of DLA inventory is a responsibility shared  between the Under Secretary of Defense for Acquisition, Technology and  Logistics and the Director, DLA. The Under Secretary of Defense for  Acquisition, Technology and Logistics is responsible for developing  materiel management policies and ensuring their implementation in a  uniform manner throughout the department, while the Director, DLA, is  responsible for implementing DOD policies and procedures for the assets  DLA manages. DLA provides support in the areas of subsistence, medical,  construction and equipment, clothing and textile, and fuel, as well as  aviation, land, and maritime spare parts. Aviation items are managed at  DLA’s office in Richmond, Virginia; maritime and land items are managed  at DLA’s office in Columbus, Ohio. Inventory managers at these locations  are assigned to manage individual items. DLA has developed guidance and  procedural instructions for computing requirements for its secondary  inventory.

		DLA Has Made Changes to Its Business Practices and Information Systems

In fiscal year 2006, DLA issued its plan to transform how it does business  in order to improve warfighter support and reduce costs through business  process reengineering, workforce development, technology  modernization, and organizational change. The plan notes that DLA  altered its business model, redefined its supporting processes, and  introduced new information systems architecture. DLA also undertook  initiatives in customer relationship management, supplier management  relations, and business systems modernization, which involved a major  information technology reengineering effort. DLA replaced its legacy  materiel management information systems with a new enterprise resource  planning system—called the Enterprise Business System—using  commercial-off-the-shelf software applications. The transition to the  Enterprise Business System took 6 years and achieved full operating  capability in July 2007. DLA continues to enhance the system and resolve  identified problems.
Another major change at DLA involved a reorganization of its inventory  management personnel. Before DLA’s reorganization, item managers were  the sole points of contact for handling orders and the distribution of items  assigned to them. As part of the reorganization, DLA made a major shift,  dividing this responsibility and establishing two main facets of planning:  demand planning and supply planning. Demand planners gather data,  determine how the demand plan will be created, generate the plan, and  provide the plan to others in the organization. In contrast, supply planners  use the demand plan to determine how best to meet the customers’  expected demands and generate supply plans. Within DLA, the demand  and supply planning functions also require input from weapon systems  managers, customer account specialists, and procurement officials.
In addition to these changes DLA has made, decisions made as part of the  Base Realignment and Closure (BRAC) process in 2005 were aimed at  achieving economies and efficiencies related to supply and storage of  secondary inventory. Specifically, the military services were directed to  (1) realign or relocate management and related support functions for the  procurement of depot-level reparables to DLA; (2) relocate consumable  item management to DLA to consolidate missions and reduce excess  capacity; and (3) transfer supply contracting functions for tires, packaged  petroleum products, and compressed gases to DLA, and privatize all other  supply, storage, and distribution functions for these commodities. DOD is  in the process of implementing the BRAC 2005 actions, which are required  to be completed by September 15, 2011. We have recently reported on the  progress made and challenges DLA still faces to consolidate supply-related  functions at 13 depot locations.

		Value of Secondary Inventory Has Varied in Recent Years

DOD reported that the total value of its secondary inventory decreased  from fiscal years 2006 to 2007 before increasing to $94.1 billion as of  September 30, 2008. DOD stratification reports show that the value of  DLA’s secondary inventory—which includes spare parts and other  commodities managed by the agency—followed a similar pattern,  decreasing by $1.1 billion from fiscal years 2006 to 2007 and then  increasing by $4.8 billion in fiscal year 2008 (see table 1). According to  DLA, most of this increase was caused by higher fuel costs. The value of  DLA secondary inventory as a percentage of the DOD total remained  steady at 19 percent in fiscal years 2006 and 2007 before rising to   22 percent in fiscal year 2008.

		DLA’s Process for Determining Needed Amount of Secondary Inventory

DLA determines requirements by calculating the amount of wholesale  inventory it needs to either have in storage (on hand) or purchase (on  order). According to DLA officials, the agency identifies in its stratification  reporting the amount of inventory allocated to meet its requirements  objective, which includes various operating requirements and acquisition  lead time, as well as a calculated economic order quantity that may be  added to these requirements. Operating requirements include low demand  items and war reserves, back orders, and safety levels. Low demand items  are requirements for parts for which demand cannot be forecast but  nevertheless need to be stocked. War reserves include mission-essential  secondary items sufficient to attain and sustain authorized operational  objectives. Back orders are customer-requisitioned materiel that is not  immediately available to issue, but is recorded as a commitment for future  issue. Safety levels are stock that is to be kept on hand in case of minor  interruptions in the resupply process or unpredictable fluctuations in  demand. Acquisition lead time includes both administrative and  production lead time requirements. Administrative lead time requirements  refer to inventory reserves sufficient to satisfy demand from the time that  the need for replenishment of an item is identified to the time when a  contract is awarded for its purchase or an order is placed. Production lead  time requirements refer to inventory purchases sufficient to satisfy  demand from the time when a contract is let or an order is placed for  inventory to the time when the item is received.
When on-hand and on-order inventory levels drop to a threshold level— called the reorder point—the supply manager may place an order for  additional inventory of that item. The reorder point factors in demand for  an inventory item during the reordering period so that DLA can replace it  before it goes out of stock, and a safety level to ensure a supply of stock  during interruptions in production or repair. An economic order  quantity–-the amount of inventory that will result in the lowest total costs  for ordering and holding inventory–-is automatically calculated by a  computer program and is added to the order, if applicable. A purchase  request or purchase order may be terminated or modified if requirements  change.
On-hand and on-order parts that are not needed to meet DLA’s  requirements objective may include some inventory that satisfies 2 years  of estimated future demand. As noted earlier, the approved acquisition  objective incorporates both materiel needed to meet the requirements  objective and materiel needed to meet 2 years of estimated future demand.  Materiel that is on hand or on order that exceeds the approved acquisition  objective is referred to as inactive inventory. Inactive inventory includes  economic retention stock, which is materiel that has been deemed more  economical to keep than to discard because it is likely to be needed in the  future; contingency retention stock, which is material retained for specific  contingencies; and potential excess materiel, which has been identified  for possible disposal but has potential for reutilization. Figure 1  summarizes how DOD inventory categories are aggregated in the context  of DLA stratification reporting.

	A Significant Portion of DLA’s Secondary Inventory Did Not Align with Current Requirements and Had Limited Demand

Our analysis of DLA secondary inventory data for the 3-year period we  examined showed that, on average, about half (52 percent) of DLA’s total  inventory was not needed to meet current requirements (the requirements  objective) and more than one-third (37 percent) was not needed to meet  the approved acquisition objective—the requirements objective plus   2 years of estimated future demand. More than one-third of DLA’s total  inventory (37 percent) was inactive, comprising retention stock and  material DLA had identified as potential excess (for reutilization or  disposal). In addition, according to DLA’s demand forecasts for items  exceeding the requirements objective in fiscal years 2006 and 2008, the  inventory levels of some items were sufficient to meet over 10 years of  demand, or had no projected demand. We also identified on-hand  inventory deficits for some items.

		About $7.1 Billion, or 52 Percent, of DLA’s On- Hand and On-Order Inventory Value Exceeded the Requirements Objective Each Year

Our analysis of DLA secondary inventory data showed that, for the 3 fiscal  years 2006 through 2008, an average of about $6.5 billion (48 percent) of  the total annual inventory value was needed to meet the requirements  objective, whereas $7.1 billion (52 percent) was not needed for these  requirements. Measured by total number of parts, 45 percent applied to the  requirements objective on average each year, and the remaining 55 percent  did not apply to these requirements. Our analysis revealed that DLA  managed an average of about 1.7 million unique items each year, and many  of these had more parts than were needed to meet the requirements. Table  2 shows DLA’s spare parts secondary inventory grouped by stratification  category. DLA identified $1.0 billion on average each year as potential  excess to be reviewed for possible reutilization or disposal.
In table 2, the approved acquisition objective includes the requirements  objective subtotal ($6.5 billion) plus the 2 years of forecasted demand  ($2.1 billion). Using the approved acquisition objective as a criterion,  about $8.6 billion (63 percent) of the total inventory was needed to meet  these requirements, and $5.1 billion (37 percent) was not needed. In effect,  DLA had already purchased a significant amount of inventory toward its  future needs. If some of these forecasted demands do not materialize, the  purchased parts may become part of DLA’s inactive inventory and may  eventually be marked for potential reutilization or disposal.
Our data analysis also showed some variability from year to year in the  balance between inventory meeting current requirements (the  requirements objective) and inventory beyond those requirements  (composed of both the 2-year forecasted demand and the inactive  inventory). For example, both the requirements objective and the  forecasted demand increased each year, whereas the inactive inventory  increased from fiscal years 2006 to fiscal year 2007 and then decreased in  fiscal year 2008. Figure 2 shows the data for each of the 3 years included in  this review.
On average during the 3-year period, about 68 percent of the value of  DLA’s total inventory was on hand and 32 percent of the value was on  order. The relative portion of DLA’s on-hand and on-order inventory varied  somewhat over this period, with the value of on-order inventory rising  from 26 percent of the total in 2006 to 34 percent in 2008 (see fig. 3).

		Inventory Beyond Requirements Objective Varied by Supply Chain, and Some Items Had Many Years of Projected Demands

Much of DLA’s inventory beyond the requirements objective was  concentrated in the aviation supply chain. Table 3 shows the average  number and value of parts beyond the requirements objective for each of  the three supply chains. Additional analysis of the data on only the portion  of the inventory beyond the requirements objective showed that the  aviation supply chain had about three-fourths (73 percent) of DLA’s total  number of spare parts and more than half (61 percent) of the total value of  DLA’s spare parts beyond the requirements objective. In contrast, the land  supply chain accounted for a relatively small percentage (6 percent) of the  number of parts beyond the requirements objective, although the value of  these parts was about $900 million, or 12 percent of the value of DLA’s  spare parts that were beyond the requirements objective.
Applying DLA forecasts of future demand for those items where our  analysis indicated quantities were beyond the requirements objective, we  found that some of DLA’s inventory for fiscal years 2006 and 2008 was  sufficient to meet over 10 years of demand. In addition, many items  showed no projected demand. Figure 4 shows the values associated with  the spare parts beyond the identified requirements grouped into projected  years of supply.
As shown in figure 4, about $1.4 billion of the inventory beyond the  requirements objective in fiscal year 2008 would supply up to 2 years of  forecasted demand, about $1.1 billion of parts would meet more than   2 and up to 10 years of forecasted demand, and about $1.4 billion of parts  would meet forecasted demand for over 10 years. A comparison of the  supply data for the 2 fiscal years suggests some positive changes occurred.  Specifically, the value of inventory forecasted to be used in the next   2 years was higher in 2008 than in 2006, and the value of inventory with  more than 2 years of supply was lower. Similarly, our analysis further  showed that the value of inventory with no forecasted demand decreased  from $2.3 billion in fiscal year 2006 to $1.6 billion in fiscal year 2008.
Other information provided by DLA supply distribution centers also  indicated that the agency had large amounts of on-hand inventory as of  September 2008 for which there was little to no demand. Specifically, this  information showed that DLA held parts valued at about $3.2 billion that  had no demand in the past 2 or more years. (The value of these parts was  calculated based on the cost that would be charged to customers and thus  differed from the cost data associated with the stratification reports that  we used for our analysis.) Of this total, parts valued at about $1 billion had  no demands for at least the past 8 years. DLA estimated it incurred about  $2.5 million in costs for storing these items with 8 years or more of no  demand. At a DLA warehouse we visited, we saw some of these items on  the shelves, including 3 packaged circuit boards with a total value of  $730,140, 15 cable assembly parts valued at $59,086, and 74 contact  assembly boards with a value of $26,270. In each case, DLA has had no  demand for the items in 8 or more years.

		On-Hand Inventory Deficits Were Identified for Some Items

DLA had on-hand inventory deficits for some items—that is, DLA had an  insufficient level of on-hand inventory to meet operating requirements.  For fiscal years 2006 through 2008, DLA had on-hand inventory levels  below operating requirements for an average of about 166,000 items worth  an estimated $1.5 billion. DLA experienced more on-hand inventory  deficits for aviation items than for maritime and land items each year.  Figure 5 shows the estimated value of DLA’s on-hand inventory deficits, by  supply chain, for each of the fiscal years included in our review.
DOD and DLA officials said they would not consider inventory to be in a  true deficit position if inventory levels have reached the reorder point and  new parts are on order. They noted that inventory managers typically will  place an order for new parts when an item’s inventory falls to the reorder  level. We subsequently analyzed the fiscal year 2006 to 2008 data and  determined that, on average, about 44,000 (27 percent) of the items with  an estimated value of about $712 million (47 percent) had sufficient  inventory on order to meet the on-hand deficits we identified. DLA  inventory managers told us that deficits occur and can persist for various  reasons, including when there is an unexpected surge in requirements for  parts or when a supplier is no longer in business or producing the needed  part and a new, qualified supplier must be found. We could not determine  the criticality of the on-hand inventory deficits we identified because this  information is not available in stratification reporting.

	Several Factors Contributed to DLA’s Having Inventory Levels of Spare Parts That Did Not Align with Current Requirements

On the basis of our audit, we identified several inventory management  factors that contribute to a mismatch between DLA inventory levels and  current requirements for secondary spare parts. These factors involve  deficiencies in (1) accurately forecasting customer demands,   (2) estimating lead times for acquiring parts, (3) meeting the services’  estimated additional requirements for spare parts, (4) improving  communications among stakeholders to ensure purchase decisions are  based on accurate and timely data, (5) modifying or canceling planned  purchases of items that may no longer be needed to meet currently  estimated requirements, (6) determining whether inventory being stored  as contingency retention stock is still needed, and (7) assessing and  tracking the overall cost efficiency of its inventory management.
These factors overlap with one another but can be grouped into three  major categories. The first three factors relate to determining how many  parts to buy. The next three factors relate to DLA initiatives that, while  showing promise for reducing the acquisition and retention of parts not  needed to meet requirements, do not appear to be achieving their full  potential due to limits on their implementation. The last factor—assessing  and tracking the overall cost efficiency of its inventory management— reflects a deficiency in DLA’s current ability to determine the extent to  which it is fulfilling DOD guidance directing the military components to  size secondary item inventories to minimize DOD’s investment while  providing the inventory needed. According to DLA officials, some of these  factors—such as determining the need to retain contingency retention  stocks—requires a collaborative approach among DLA; the Office of the  Under Secretary of Defense for Acquisition, Technology and Logistics; and  the military services.

		Inaccurate Demand Forecasts May Result in Acquiring More Spare Parts Than Needed to Meet Requirements

DLA faces challenges in aligning inventory levels with requirements due, in  part, to inaccurate demand forecasting for the parts it manages. When  customers’ demands for parts are lower than originally forecasted, DLA  can be left holding more inventory than needed to meet requirements.  Conversely, when demands are higher than expected, DLA may have  inventory deficits until new parts can be acquired. Having accurate  demand forecasts is vital to cost-effective inventory management. DOD’s  supply chain regulation states that customer demand shall be part of all  DOD components’ inventory management decisions; that components  shall not stock an item that does not have any possibility of future  demand; and that variance in demand forecasts outside established  parameters should be flagged for management analysis and action. DLA  officials, in discussing demand planning issues with us, also stated that  forecast accuracy is the most significant factor for simultaneously  decreasing inventory levels while maintaining or increasing customer  service.
Our prior reports on the services’ management of their spare parts  inventory found that problems with demand forecasting were the leading  cause of mismatches between inventory levels and their requirements  objectives. DOD agreed with this assessment, has included the issue in the  department’s strategic business management plan, and is studying  potential improvements. In our current audit, we found instances within  our sample of DLA items where inaccurate demand forecasts presented  problems in managing spare parts and minimizing mismatches between  inventory levels and requirements. For example, the March 2009  stratification report showed that for one of our sampled items   (a drive assembly), DLA had a purchase request for 270 parts valued at  $1.3 million. At our request, the demand planner reviewed the item in  August 2009. She found notes in the record indicating the forecast for this  item had been accepted; however, she determined based on her review  that the forecast was too high. Her research showed that there had been a  prior higher demand for this item that was nonrecurring. She told us that  she subsequently reduced the demand forecast for the item.
DLA officials acknowledged that the agency can face challenges in  obtaining accurate demand forecasts for items. DLA has been analyzing  demand forecasting issues, emphasizing the need for better demand  planning, and taking steps aimed at mitigating the impact of inaccurate  demand forecasts. DLA steps include reorganizing its work force to  provide additional resources aimed at improving demand planning,  identifying and tracking initiatives and actions that deserve priority for  management attention for enhancing demand accuracy, and adjusting  forecasting models to account for a greater range of demand patterns.
Despite these positive steps, DLA is still in the early stages of assessing the  issues surrounding inaccurate demand forecasting, and it has not  developed an integrated long-term action plan. For example, although DLA  has identified demand planning issues to focus on, it has not articulated  specific goals, objectives, resources, or time frames for instituting  corrective actions. Without a long-term integrated action plan that  incorporates these elements, DLA may have difficulty sustaining and  expanding its current efforts to improve demand forecasting issues. In  commenting on this factor, DLA officials told us that the agency is  providing greater management visibility and emphasis on cases where  overforecasts caused higher than expected inventory levels. The officials  also stated that improved demand forecasting will require a collaborative  effort among DLA; the Office of the Under Secretary of Defense for  Acquisition, Technology and Logistics; and the military services.

		DLA Has Not Resolved Problems with Estimating Lead Times Needed to Acquire Spare Parts

DLA has not resolved problems in accurately estimating acquisition lead  times for the parts it acquires. Inaccurate lead time estimates can result in  a mismatch between inventory levels and requirements because these  estimates are included in calculations for purchasing parts. For fiscal  years 2006 through 2008, parts needed for lead time requirements had an  annual average value of $2.7 billion (20 percent) of the $13.7 billion in total  inventory value. About $1.9 billion of this lead time value was for  production lead time, and the remaining $0.8 billion was for administrative  lead time.
In 2007, we reported that DLA tended to overestimate lead time  requirements, which resulted in inventory arriving sooner than expected.  For example, in examining about 1 million shipment deliveries during  fiscal year 2005, we found that almost 40 percent had actual lead times  that were at least 90 days shorter than their estimated lead times.
Conversely, about 3 percent of the deliveries had actual lead times that  were at least 90 days longer than their estimated lead times. On the basis  of that earlier analysis, we recommended that DLA review and revise the  methodology and the data it uses to estimate lead time. DOD responded  that our review used data prior to DLA’s implementation of the Enterprise  Business System, and that we had not taken into account the benefits of its  new system and related business processes. In our evaluation of DOD’s  comments, we noted that calculating the lead times in the same manner  but recording the values in a new computer system would not improve the  accuracy of lead time estimates.
Determining the extent to which DLA continues to experience problems in  estimating lead times for acquiring spare parts was not part of our current  review, but we found instances of this problem within our sampled cases.  In one case, a DLA inventory manager identified overstated lead time on a  purchase of 172 helicopter valves costing DLA about $2,624 each, or about  $451,000 in total. According to DLA data, the production lead time for this  item was 601 days. When we discussed this case with DLA officials, they  estimated that the production lead time should have been 272 days (about  45 percent of the production lead time used in the purchase decision) and  said it was not uncommon for production lead times to be overstated.  Using the lower lead time estimate might have reduced the purchase order  requirement and DLA’s investment in these valves. In another example  involving a power inverter, a reduction in the lead time from 720 days to   90 days (about 13 percent of the prior estimated lead time) led DLA to  cancel the purchase of 147 items. With an average price of $1,313, these  canceled items had a total value of about $193,000.
DLA officials acknowledged continuing problems with overstated lead  time requirements, but noted that they had made some changes since 2008  to better estimate administrative lead time. These changes include  evaluating and revising DLA’s internal administrative processing of  purchase requests and purchase orders. The DLA officials stated that  analyzing production lead time—which accounted for about more than  two-thirds of the total lead time requirements for the 3-year period we  analyzed—is particularly difficult because DLA does not have access to  contractor data that would be needed to determine the root causes of  inaccurate production lead time estimates. While the DLA officials  acknowledged that such an analysis could be useful, they said it could be  too costly to require contractors to generate and report the data.

		DLA Faces Challenges in Efficiently Meeting the Services’ Estimated Additional Requirements for Spare Parts

DLA has long faced challenges in efficiently meeting the military services’  requirements for spare parts identified in the form of supply support  requests and special program requirements. These two processes provide  a means by which the services may submit estimated additional  requirements to DLA when they first anticipate that they will need the  agency to supply future spare parts. The services, however, have tended to  overestimate these additional requirements, which may result in DLA’s  acquiring and holding inventory beyond what is needed to meet actual  requirements that materialize. While DLA has internal controls for  evaluating and adjusting purchases in response to the services’ estimated  additional requirements, these internal controls have not always operated  effectively.

			Supply Support Requests Have Included Overstated Requirements Forecasts

Supply support requests are the principal means by which the military  services notify DLA of anticipated requirements, such as spare parts that  will be needed to support the maintenance of a new weapon system. The  services provide forecasted requirements in their supply support requests  to DLA and are required to retain documentation showing how the  forecasts were computed for at least 3 years after the date the parts are  needed to support the weapon system. DLA is supposed to evaluate the  supply support requests and purchase materiel as it deems appropriate to  meet expected requirements.
DLA officials said the services tend to overestimate requirements in their  supply support requests. Data provided by DLA show that the services’  estimates of forecasted requirements for supply support requests were  significantly higher than their actual demands. For example, the services  submitted supply support requests to DLA valued at $1.7 billion in fiscal  year 2008; but by June 2009, the services had requisitioned $34 million   (2 percent) of the requirements that they had forecasted. The problem of  overestimated forecasted requirements in supply support requests has  been known for many years. As far back as 1988, the DOD Inspector  General (DODIG) reported that forecasted requirements submitted by the  services with their supply support requests were frequently excessive.  DODIG reported again in September 1993 that the services’ forecasted  requirements were unnecessary, unreasonable, or unsubstantiated; did not  materialize at times; and resulted in unnecessary or premature investment  in inventory.
Although DLA has long been aware of this issue, internal controls aimed at  minimizing unnecessary purchases of spare parts have sometimes  operated ineffectively. For example, DOD guidance states that integrated  materiel managers (demand planners in DLA) are to validate supply  support requests, and DLA officials identified supply support requests  valued at $2,500 and higher as those that should be validated. DLA  officials, however, said they have typically lacked data from the services  showing how the services’ requirements were calculated and, as a result,  were not able to validate the supply support requests. DLA officials told us  in August 2009 that to improve the implementation of this internal control,  a special demand planning team started to track validations of higher  value supply support requests. These officials also said that a systems  change request has been submitted, but not yet implemented, to enable the  Enterprise Business System to automate and track supply support request  validations. Additional guidance on the supply support request process is  being drafted as part of a revision to DOD guidance (DOD Manual 4140.26- M). Given the long-term nature of the problem, it is uncertain whether  these steps will be effective at improving the efficiency of the supply  support request program without additional DLA emphasis to reinforce  and reinvigorate internal controls.
DLA officials noted that the services lack a financial incentive for  minimizing their supply support requests because they do not purchase  the parts from DLA using their own funds until the parts are actually  needed. If a service does not later purchase all of the requested parts from  DLA, the service does not incur any additional costs for the unused parts.  Instead, the parts remain in DLA’s inventory long term and may result in  the agency having inventory levels for these items beyond requirements.  Under the revolving fund approach used by DOD to finance spare parts,  DLA purchases parts using working capital funds and is reimbursed when  the parts are later sold to a customer. By design, working capital funds,  rather than service funds, are tied up in the inventory until the parts are  requisitioned. DLA officials suggested that the services might have more  incentive to submit accurate supply support requests if they were required  to provide some portion of the up-front funding for DLA’s initial purchase  of the parts. However, the military services have resisted the idea of  providing up-front funding in the past, and DLA-proposed pilot programs  to test the concept have not been implemented. DOD budget officials  confirmed that up-front service funding for supply support requests has  never been formally proposed or evaluated. DLA officials said there could  be challenges in implementing up-front service funding. For example, a  service may not have funds available when the DLA purchase is made.  However, up-front service funding is already required for certain DLA  purchases of clothing and other textiles.

			Special Program Requirements Have Often Not Materialized

Special program requirements refer to nonrepetitive requirements for  spare parts that cannot be forecast based on demand data and which have  the greatest probability of materializing and resulting in the eventual  submission of requisitions. As with supply support requests, the services  use special program requirements to plan future supply support from DLA.  As part of the requirement submitted to DLA, the service identifies a  specific anticipated date that the parts will be needed. On or about the  specified support date, the customer is expected to submit its requisition  for the parts. However, requisitions for the services’ special program  requirements often have not materialized.
DODIG has reviewed special program requirements and found issues  similar to those with supply support requests. In 1990, DODIG reported  that the majority of special program requirements submitted to DLA from  the services included overstated and unsubstantiated forecast estimates.  It further found that internal controls had not been put in place by either  the services or DLA to account for specific procurements and  transactions, or to monitor the overall effectiveness of this program. A  2004 DODIG review found some internal control improvements aimed at  minimizing the investment in inventory to support special program  requirements, although these improvements were limited to one DLA  supply center (Philadelphia). Our current review of 90 sampled items  showed that DLA has continued to experience problems in economically  managing special program requirements. For example, March 2009  inventory data showed DLA had a purchase order to satisfy a one-time  special program requirement for about 1,650 mechanical drive housing  parts with a total value of about $850,000. However, DLA inventory  managers said the customer had requisitioned only 44 percent of the parts  by the support date specified in the special program requirement  submission. Upon further review of this item, the managers told us the  customer may have incorrectly identified this item as a recurring need,  unnecessarily increasing the quantity of parts ordered.
With regard to internal controls, DODIG’s 2004 report focused on two  initiatives that, at the time, had been implemented at DLA’s Philadelphia  supply center. One was a streamlined validation process. The streamlined  process was designed to automatically cancel a special program  requirement if the organization submitting the requirement did not validate  it within specified time frames. While this process was operating at the  time of our current review, DLA lacked data demonstrating its  effectiveness. For example, DLA lacked data comparing prevalidation  requirements to modified procurement quantities. According to DLA  officials, these data have not been available since the transition to the  Enterprise Business System. Furthermore, a relatively small percentage of  special program requirements were identified as being validated by the  services. For example, according to DLA data, the agency received special  program requirements for a total of about 400,000 items for fiscal years  2007 through 2009, but requirements for only about 16,000 items (or   4 percent) had been validated.
The second internal control for managing special program requirements  was a program to track the services’ requisition, or “buy-back,” rates. The  buy-back program was aimed at tracking the rates at which the services’  requisitioned parts compared with their previously submitted special  program requirements and then adjusting future procurements based on  these buy-back rates. DODIG found the buy-back program to be effective  at reducing procurement quantities, and thereby minimized investment for  some inventory. Prior to the buy-back program, DLA procured 100 percent  of the special program requirements, according to DODIG. Despite the  positive effects from the program noted in the DODIG report, our current  audit found that DLA stopped updating its buy-back rates in 2006,  coinciding with the implementation of the Enterprise Business System. In  May 2009, DLA began again to update buy-back rates. As a result, during  this period when rates were not updated, DLA may not have been  optimizing investment in inventory purchased for special program  requirements.

		DLA Inventory Managers Do Not Consistently Have Accurate, Timely Data to Make Informed Purchase Decisions

DLA inventory managers do not consistently have accurate, timely data  needed to make informed purchase decisions, which may lead to the  acquisition of parts that are not needed to meet requirements. Although  DLA recognizes that sound supply chain management principles  emphasize the need for effective communication within the agency and  externally with all other stakeholders in the supply chain, we found that  DLA inventory managers have experienced gaps in effective  communication and data exchange. Our review of sampled items  identified cases where inventory managers, as a result of these gaps,  lacked accurate, timely data that could have influenced purchase  decisions. For example:    DLA received a purchase request in June 2008 for 230 aircraft access  covers at a cost of about $3,900 each for a total cost of about $897,000.  Because March 2009 inventory data indicated that DLA had significant  inventory for this item beyond its requirements objective, we asked DLA to  review this purchase request. Inventory managers indicated that they had  not recently communicated with the customer for this item. When the  inventory managers obtained updated information following our inquiry,  they determined that the purchase request should have been reduced from  230 to 35 parts costing about $136,500.
DLA issued a purchase order in June 2008 for 37 pad assemblies for Navy  aircraft, with a total value of about $402,000. However, DLA determined  later that year that the part was obsolete and the purchase order should be  canceled. The contractor estimated that termination costs for canceling  the order would be about $111,000. The purchase order was canceled in  early 2009.
DLA purchased parts kits for an Army vehicle but was not aware until later  that the customer’s original requirement was no longer valid. Specifically,  DLA inventory data as of September 2008 showed that the agency had  17,737 kits on hand and had placed a purchase order for 47,146 additional  kits. The total value of the purchase order was about $1.3 million. In May  2009, DLA had 60,717 kits on hand and 3,574 on order, indicating that  requirements for the total amount of inventory (including both on-hand  and on-order parts) had remained about the same. When we inquired  about this item, inventory managers told us there had been several months  of no demand and that the monthly forecast had been reduced from 144 to  1. Furthermore, DLA checked with its Army customer and learned that the  Army did not need the item as indicated in its purchase request.
DLA in 2005 began an initiative called demand data exchange to improve  collaboration between the agency and customers on the management of  certain items. Under this program, DLA works collaboratively with  customers on selected items to evaluate historical demand data and tailor  procurement plans. Participating customers select items that they  anticipate would benefit from this enhanced collaboration. For example,  an item may be selected because requirements are expected to fluctuate.  As of November 2009, DLA had rolled out the program to about   80 customers and for about 47,500 items. DLA officials told us that they  were reviewing performance data from their existing demand data  exchange activities and these data indicated the demand data exchange  program effectively improved collaboration in some instances but not in  others. However, DLA had not yet conducted a formal program evaluation,  and it was unclear at the time of our review whether or to what extent  DLA was planning to expand this initiative to incorporate additional  customers and items.

		DLA Process for Modifying or Canceling Unneeded Purchases of Spare Parts Has Been Implemented on a Limited Basis

While DLA has a process for identifying and limiting the purchase of spare  parts not needed to meet requirements, several factors have limited its  implementation and potential for minimizing investment in unneeded  inventory. Through this “over-procurement” process, DLA identifies  purchase requests and purchase orders that may no longer be needed to  meet currently estimated requirements; evaluates each case in more detail  to determine whether to proceed with, or to cancel part or all of, the  purchase; and then executes cancellation decisions when applicable. DLA  data for fiscal year 2009 showed that a total of $275 million in purchase  orders and purchase requests were reviewed, with $123 million  recommended for cancellation and $44 million actually cancelled. The  canceled amount represented 16 percent of the $275 million reviewed and  about 36 percent of the $123 million recommended for cancellation. Where  the data distinguished between purchase orders and purchase requests,  the analysis indicated that most of the cancellations were purchase  requests. Our review of 90 sampled items identified cases where DLA had  planned purchases that appeared to exceed requirements but for some  reason did not go through the over-procurement process. For example:    DLA inventory data for a combustion chamber liner showed that as of  March 2009, the agency had 527 parts on hand and another 762 parts on  order. The average unit price for the item was $3,748, and the total value  for all 1,289 parts was $4.8 million. Inventory managers told us that even  though this item was identified as being in the top 5 percent in dollar value  of aviation inventory, it did not have demand every month, and a more  recent computation indicated the item may be over-procured by 403 parts  priced at $1.5 million. We were told that this item was not selected for an  over-procurement review until we requested information.
For another item, an instrument mounting part for B1B aircraft, DLA had a  purchase order for 86 parts. With an average unit price of $13,410, the total  value of parts on the purchase order was $1.2 million. Inventory officials  said the production lead time was recently extended from 322 days to  between 800 and 1,000 days, but they did not know why. The officials  added that the item appeared over-procured by 31 parts valued at about  $416,000. They said they would not have reviewed this item if we had not  brought it to their attention.
DLA officials expressed the view that these cases of missed opportunities  are not representative of the overall success of the over-procurement  process at identifying and reducing purchases of unneeded parts.  However, DLA has not formally evaluated the effectiveness of the over- procurement process. In addition, while we agree the over-procurement  process has shown promise, our example cases indicate that it may have  greater potential for minimizing investment in inventory than has been  achieved to date. We identified several factors that may be limiting the  impact of the over-procurement process. These factors include the  following:  First, purchases are not identified and reviewed as potential over- procurements if they do not meet or exceed DLA-established minimum  thresholds. DLA initially established a minimum threshold of 150 percent  of the requirements objective for identifying a potential over- procurement—that is, the value of the purchase request or purchase order  had to exceed the value of the requirements objective by at least   50 percent in order to be flagged for review. In 2008, DLA lowered the  threshold to 125 percent of the requirements objective, which flagged a  greater number of potential over-procurements for further review.
Second, items are not identified and reviewed for potential over- procurement if they support programs that have been exempted from the  process. A number of items in our sample supported the Mine Resistant  Ambush Protected vehicle—a program exempted from over-procurement  review—and were identified by inventory managers as being in over- procured positions at the time of our site visit. For example, March 2009  inventory data for a winch parts kit for the vehicle showed that DLA had   4 kits on hand and an existing purchase order for 220 kits. A purchase  request for 1,200 additional kits was generated in February 2009, a  purchase order was placed in April 2009, and the items were received in  May 2009. In the meantime, forecasted demand for this item dropped in  April 2009 from about 51 per month to 6 per month. At the demand rate of  6 per month, the 1,424 kits represented about 20 years of supply and a total  value of about $691,000.
Third, items flagged as potential over-procurements may go through a  lengthy review process, which can make it more difficult to execute a  cancellation decision. Although DLA lacked summary data on the overall  timeliness of the process, individual cases may take several months from  the time a potential over-procurement is identified through when a final  decision is reached. For example, inventory data for one of our sampled  items, an antenna accessory kit, showed that DLA had 26 parts on hand  and 46 on order as of August 2008. With an average unit cost of about  $3,000, the total value of these 72 parts was about $216,000. The inventory  manager told us that, due to a drop in demand, the item was in an over- procurement position. Over-procurement reports for this item were  generated in February 2009, May 2009, and September 2009. When the  supply planner tried to cancel the on-order parts after receiving the  September report, the contract administrator determined the planner’s  request was not timely, and the cancellation was not executed. This review  process may be lengthy because numerous individuals are involved in  evaluating and reviewing the decision, particularly for higher value  purchases where a cancellation has been recommended. In addition, the  supply planner responsible for the item may not have extensive  experience with the item, which could increase the time needed to  evaluate a potential over-procurement. With responsibility for thousands  of items, each planner has limited time to spend on any particular item and  must make trade-offs in how to use the available time. DLA officials said  recent management emphasis has been placed on making the processing  of over-procurement reports more timely.
Fourth, according to DLA officials and inventory managers we interviewed  for our sample, other factors can limit the impact of the over-procurement  process. For example, data on customers’ requirements for the items may  be inaccurate or obsolete; circumstances related to a potential over- procurement can be complex; canceling or amending purchase orders may  be difficult because of a high termination cost; and canceling a purchase  request within DLA becomes more difficult the closer it gets to contract  award because of the amount of time and work invested.
DLA officials identified plans to improve the over-procurement process in  fiscal year 2010. First, DLA planned to expand the number and value of  purchases flagged for over-procurement review. Also, DLA officials said  they planned to target more attention on identifying and reducing  purchase orders. Finally, DLA officials said tighter goals have been set,  including at least a 10 percent improvement compared to fiscal year 2009  performance. These planned improvements in the over-procurement  process recognize that there is greater potential for minimizing investment  in inventory than has been achieved to date.

		DLA Has Reported Progress in Reducing the Proportion of Inventory That Is Inactive, but the Agency Continues to Store Large Amounts of Contingency Retention Stock

DLA has reported progress toward its goal of rebalancing its inventory and  reducing the proportion of inactive inventory—those items in the  inventory that are not needed to meet the requirements objective plus   2 years of future supply (collectively referred to as the approved  acquisition objective). In July 2008, DLA observed that, as measured in  value, half of its inventory was active and the other half inactive, a split  that the agency determined was too heavily weighted on the inactive side.  To help rebalance its inventory, DLA established active inventory goals for  individual supply chains, including aviation (75 percent), maritime   (74 percent), and land (80 percent). DLA reported that it made progress  toward rebalancing its inventory, although it had not met its specific goals  for these supply chains as of June 2009 (see table 4).
DLA officials attributed the progress in rebalancing inactive and active  inventory to its efforts in fiscal years 2008 and 2009 to dispose of parts.  Despite this progress, DLA continues to have large amounts of  contingency retention stock. Our data analysis for fiscal years 2006  through 2008 showed that the agency annually held an average of about  $2.6 billion of its secondary inventory as contingency retention, and the  data presented in figure 4 show that DLA reported having about $2 billion  in contingency retention stock as of June 2009. Some of this inventory may  no longer be needed. However, DLA has not determined the extent that its  contingency retention stock is no longer needed because the services have  not provided input needed to make these determinations.
DLA has a retention and disposal program aimed at identifying items in its  contingency retention stock that should be retained and items that are  potential excess and should be considered for disposal or reutilization.  The agency’s contingency retention requirements are aimed at precluding  disposal of assets that might be needed for future nonrecurring demand,  such as provisioning or planned maintenance actions; items used primarily  in wartime which have limited use in peacetime; and future foreign  military sales. Since DLA holds contingency retention stock for the  services, DLA depends on the services to provide input on which  contingency inventory items are no longer needed and should be  considered for disposal or reutilization.
DOD regulations require DLA to annually evaluate and attest to the extent  that its contingency retention stock should be retained. Specifically, the  DOD regulations require that DLA ensure that mechanisms are in place to  take proper retention, redistribution, and disposal actions against items in  that category of inventory. To ensure that contingency retention stocks  correspond with the needs for current and future force levels, DLA is to  review and validate its methodologies for making contingency retention  decisions. Contingency retention reviews should focus on verifying that  the reason for contingency retention still exists and the reason is properly  recorded. The inventory management organization commander or  designee is required to attest in writing to the validity of the annual review  decisions. According to DLA officials, they cannot achieve the goals of the  regulation without service input, and information from the services would  enable the agency to reduce unneeded contingency retention stock in its  inventory. However, they noted that the services have not been providing  input to DLA. DLA has informed the services that all contingency retention  levels must be validated or eliminated in fiscal year 2010. However, if the  services do not provide the necessary information to DLA, then DLA may  continue to carry unneeded inventory.

		DLA Does Not Assess and Track the Cost Efficiency of Its Inventory Management

Although DOD’s supply chain regulation directs the military components  to size secondary item inventories to minimize DOD’s investment while  providing the inventory needed, DLA does not assess and track the cost  efficiency of its inventory management to determine whether it is meeting  this requirement. DLA has effectiveness-related metrics aimed at  measuring the extent to which the agency is able to satisfy customer  requisitions and other aspects of its performance, but it lacks goals and  metrics to measure the cost efficiency of its inventory management. As a  result, DLA does not know whether it is meeting inventory requirements at  least cost.
DOD’s supply chain management regulation emphasizes a need for both  effective and efficient management of materiel. The regulation sets out  management goals such as considering all costs associated with materiel  management in making best-value logistics decisions, and directs DOD  components and DLA to take a number of steps to implement these goals.  These steps include balancing the use of all available logistics resources to  accomplish timely and quality delivery at the lowest cost; and measuring  total supply chain performance based on timely and cost-effective  delivery. To help ensure efficient and effective supply chain management,  the regulation also calls for the use of metrics to evaluate the performance  and cost of supply chain operations. These metrics should, among other  things, monitor the efficient use of DOD resources and provide a means to  assess costs versus benefits of supply chain operations. However, the  regulation does not prescribe specific cost metrics and goals that the  services or DLA should or must use to track and assess the efficiency of  their inventory management practices.
DLA has numerous metrics for assessing and tracking supply chain  performance. None of these, however, enable DLA to monitor the efficient  use of resources for inventory management or to provide a means for  assessing costs versus benefits. Examples of DLA’s current key metrics  include orders received, materiel availability, unfilled orders, and purchase  requests awarded. Other DLA performance metrics track demand plan  accuracy; inventory turnover; the timeliness, quantity, quality, and  documentation of filled orders; the receipt and transportation of materiel;  and customer satisfaction. Two additional metrics that track supply chain  financial performance are cash performance plan (the difference between  monthly disbursements and collections) and net operating result (metrics  that track revenue and expenses monthly, assess performance against the  budget, and identify variances early in the fiscal year). DLA officials told  us they are developing a framework for integrating effectiveness measures  with supply chain costs, but they have not developed milestones for  completing the design or implementation of this framework. They also told  us that they believe the Office of the Secretary of Defense should be  involved in developing any additional metrics to monitor the efficient use  of DOD resources and provide a means to assess costs versus benefits of  supply chain operations.
DLA officials also expressed the view that a lack of cost-efficiency metrics  does not necessarily mean that DLA is being wasteful. They asserted that  DLA strives to be a good steward of government resources. However,  without such metrics, DLA cannot demonstrate that it is minimizing  inventory costs consistent with the DOD regulation. In addition, without  such metrics, DLA is likely to have difficulty in establishing (1) a baseline  for the agency’s collective efforts to improve efficiencies in various areas  of inventory management, (2) a means for DLA to demonstrate progress  against the baseline, and (3) a basis for understanding and responding to  any positive or negative cost-efficiency trends that may occur in the future.
Moreover, the National Defense Authorization Act for Fiscal Year 2010  requires the Secretary of Defense to submit a comprehensive plan to the  congressional defense committees for improving the inventory  management systems of the military departments and DLA with the  objective of reducing the acquisition and storage of secondary inventory  that is excess to requirements. The Secretary of Defense’s comprehensive  plan is to include (among other things): (1) a plan for a comprehensive  review of demand forecasting procedures to identify and correct any  systematic weaknesses in such procedures, including the development of  metrics to identify bias toward over-forecasting and adjust forecasting  methods accordingly; (2) a plan to reduce the average level of on-order  secondary inventory that is excess to requirements, including a  requirement for the systemic review of such inventory for possible  contract termination; (3) a plan for the review and validation of methods  used by the military departments and DLA to establish economic retention  requirements; (4) a plan for an independent review of methods used by the  military departments and DLA to establish contingency retention  requirements; and (5) a plan for a comprehensive assessment of inventory  items on hand that have no recurring demands, including metrics to track  years of no demand for items in stock and procedures for ensuring the  systemic review of such items for potential reutilization or disposal.

	Conclusions

Our review showed that DLA can enhance its efforts to manage spare parts  more effectively primarily by focusing on the front end of the process  when decisions are being made on what items to buy and how many in  response to requirements. Our analysis showed that DLA had substantial  mismatches between spare parts inventory levels and its current  requirements for each of the 3 fiscal years we reviewed, and it has invested  in large amounts of inventory that now have little or no projected demand.  The accumulation of inventory beyond either the requirements objective  or the approved acquisition objective is caused by many overlapping  factors, including some that have been identified in prior audits. The best  opportunities for minimizing investment in unneeded inventory while still  meeting required inventory levels are at the front end of the process when  the agency is making decisions on what and how much to purchase. In  addition, DLA needs to have effective policies and practices in place to  modify planned purchases as appropriate when demands for parts change.  DLA has been taking positive steps to correct problems it has identified in  its inventory management. In addition to enterprisewide changes in  business practices and replacement of legacy information systems, DLA  has efforts aimed at improving specific inventory management practices,  such as the over-procurement process and the demand data exchange  initiative. While some of DLA’s steps are relatively recent and may not be  fully implemented, the magnitude of inventory levels beyond current  requirements suggests that the agency has additional opportunities to  minimize its investment in secondary inventory while still meeting  required inventory levels. If DLA does not take additional actions to better  align inventory levels and requirements, it will continue to invest in spare  parts long before they are needed to meet customer demand or in the  future become potential excess stock. Acquiring inventory for which  demand is much lower than expected reduces the amount of funding  available for other military needs. The recent legislative requirement  directing the Secretary of Defense to submit a comprehensive plan for  improving inventory management practices provides further impetus for  addressing the factors we identified in this review that contribute to  mismatches between inventory levels and requirements.

	Recommendations for Executive Action

To minimize investment in unneeded spare parts inventory, we  recommend that the Secretary of Defense direct the Director, Defense  Logistics Agency, to take the following five actions:    Establish an action plan for completing the agency’s evaluation of  identified demand planning issues, and include goals, objectives,  resources, and time frames in this action plan.
Develop an approach for working with suppliers to assess the root causes  of inaccurate production lead time estimates and implement corrective  actions linked to these root causes.
Reinforce and reinvigorate effective internal controls aimed at evaluating  and making adjustments to the military services’ estimated additional  requirements, including both supply support requests and special program  requirements.
Conduct a program evaluation of the demand data exchange initiative to  determine what, if any, additional actions should be taken to (1) improve  communication and data exchange internally and with military customers  and suppliers and (2) expand the initiative across the enterprise (for  example, to other customers, items, and processes).
Evaluate the effectiveness of the agency’s process for identifying and  reducing potential over-procurements and determine the feasibility of  applying the process on a wider scale.
In addition, we recommend that the Secretary of Defense direct the Under  Secretary of Defense for Acquisition, Technology and Logistics, in  conjunction with the Director, Defense Logistics Agency, and the  Secretaries of the Army, the Navy, and the Air Force, to take the following  two actions:    Formally evaluate and report on the feasibility of requiring up-front  military service funding for a portion of their supply support requests.
Establish goals and metrics for tracking and assessing the cost efficiency  of inventory management in accordance with DOD’s policy requiring DLA  and the services to minimize investment in secondary item inventory while  providing inventory needed; develop and implement an approach for  integrating these goals and metrics with inventory management  improvement efforts; and incorporate the goals and metrics into existing  management and oversight processes.
Finally, we recommend that the Secretary of Defense direct the  Secretaries of the Army, the Navy, and the Air Force to certify to DLA  which items and what quantities of the contingency reserve stock should  be retained, in response to DLA’s requests that they do so, and direct the  Under Secretary of Defense for Acquisition, Logistics and Technology to  provide guidance and oversight of this certification process.

	Agency Comments and Our Evaluation

In its written comments on a draft of this report, DOD concurred with our  recommendations and identified corrective actions to be completed. The  planned actions were generally responsive to our recommendations. The  department’s written comments are reprinted in appendix II.
DOD concurred with our recommendation that DLA establish an action  plan for completing an evaluation of identified demand planning issues.  DOD stated that DLA will establish an action plan that will include goals,  objectives, resources, and time frames and that will be completed in the  fourth quarter of fiscal year 2010. DOD cited a number of actions that are  already underway to evaluate and adjust demand inputs and also  commented that over-forecasting in the Enterprise Business System does  not always equate to over-buying because of actions to mitigate supply  planning impacts of over-estimated demand. We believe that DOD’s  planned action is responsive to our recommendation.
DOD concurred with our recommendation that DLA develop an approach  for assessing the root causes of inaccurate production lead time estimates  and implement corrective actions linked to these root causes. DOD stated  that DLA has already identified several root causes for inaccurate lead  times, including suppliers not accurately predicting lead time from  subcontractors, suppliers including “buffers” in their projected production  time, and suppliers relying on past lead times for current purchase  requests. DOD also identified DLA management actions to challenge the  lead time quotes from vendors to ensure the quotes are realistic, look at  required delivery dates on contracts, conduct reviews to identify  suspected excessive production lead times, and adjust these lead times as  appropriate. It said that DLA will continue to work with suppliers to  improve estimates and noted that DLA has been able to reduce production  lead time over-estimates since early 2009. We recognize the value of these  actions and believe DLA’s efforts could be further enhanced by identifying  in measurable terms the extent to which specific root causes are  contributing to inaccurate production lead time estimates, and then using  these data as benchmarks to assess the effectiveness of corrective actions.
DOD concurred with our recommendation that DLA reinforce and  reinvigorate effective internal controls aimed at evaluating and making  adjustments to the military services’ supply support requests and special  program requirements. According to DOD, DLA will reinforce effective  internal controls and has already enhanced internal controls for special  program requirements. DOD cited, for example, a recent effort to  eliminate ongoing discrepancies and issues with Army special program  requirements. DOD said this effort eliminated over $200 million in Army  special program requirement submissions. Although we did not review this  effort or the results cited by DOD, it highlights the potential positive  effects that further reinforcing and reinvigorating internal controls might  have if such actions are implemented.
DOD concurred with our recommendation to conduct a program  evaluation of the demand data exchange initiative to determine what, if  any, additional actions should be taken to improve and expand the  initiative. DOD said that DLA has an evaluation of the initiative underway,  with completion set for February 2011. As part of its evaluation, DLA will  review items as potential candidates for collaboration partnerships with  additional customers and suppliers and will also look to continue  improving forecast accuracy with its current collaboration customers.  DOD also cited actions by DLA to modify its business rule logic, in  response to feedback from current customers, and to begin holding  collaboration forums in August 2010 to, among other things, expand the  use of demand data exchange. We believe these actions are responsive to  our recommendation.
DOD concurred with our recommendation that DLA evaluate the  effectiveness of the agency’s process for identifying and reducing potential  over-procurements and determine the feasibility of applying the process  on a wider scale. DOD commented that DLA has made significant progress  in reducing its over-procurements. For example, in 2009, the aviation  supply chain initiated a review of its over-procurement process, and initial  findings from that review have been adopted DLA-wide, resulting in  significant cancellations of purchase requests. DLA will also evaluate ways  to increase purchase order cancellations and, by October 2010, will  complete a review and validation of items currently being excluded from  the over-procurement process. According to DOD, DLA will ensure that  any items it continues to exclude from the systemic over-procurement  process will be subject to a separate review process that allows for  cancellation of purchase requests and purchase orders exceeding  requirements. We believe the actions cited by DOD are positive steps.  Because this process provides opportunities on a continuing basis for DLA  to identify and limit the purchase of spare parts that may no longer be  needed to meet currently estimated requirements, the agency would  benefit from a thorough evaluation of the over-procurement process,  including identifying any factors that may be limiting its potential impact.
DOD concurred with our recommendation to formally evaluate and report  on the feasibility of requiring up-front funding from the military services  for a portion of their supply support requests. It said that the Office of the  Under Secretary of Defense for Acquisition, Technology and Logistics, in  conjunction with the Office of the Under Secretary of Defense  (Comptroller) and the military services, will evaluate and report on the  feasibility of requiring up-front funding of supply support requests. DOD  also said that DLA is pursuing a pilot effort with the Navy and the Marine  Corps to support the H-1 helicopter, wherein DLA and the services share  the burden of investment risk. The concept of this initiative is to have the  Navy and the Marine Corps pay half of the total cost of the supply support  request investment in advance of the anticipated support date. DLA, in  turn, will honor the total supply support request requirement and buy both  retail and wholesale quantities. We believe these planned actions are  positive steps and responsive to our recommendation, although DOD did  not cite time frames for completing either its evaluation or the pilot  project involving the H-1 helicopter.
DOD concurred with our recommendation to establish goals and metrics  for tracking and assessing the cost efficiency of inventory management.  DOD stated the department is undertaking a comprehensive review of its  inventory management practices, to include establishing goals and metrics  for tracking inventory management improvement initiatives and cost  efficiency. DOD is developing an improvement plan that will include goals,  objectives, metrics, targets, and a governance process for overseeing  execution and refreshing the plan on a regular basis. The target for  publishing the plan is the last quarter of fiscal year 2010. We believe the  inclusion of cost-efficiency goals and metrics as part of overall efforts to  improve inventory management is responsive to our recommendation.
DOD concurred with our recommendation aimed at identifying which  items and what quantities of these items to retain as contingency reserve  stock. It said the military services and DLA are collaboratively reviewing  contingency retention inventory and the Office of the Under Secretary of  Defense for Acquisition, Technology and Logistics will review the results  of that review once complete. In addition, the department stated that, in  conjunction with its previously discussed plan for improving inventory  management practices, it will conduct an independent review of  contingency retention methodologies. That review, according to DOD, will  highlight any changes in guidance necessary to improve the contingency  retention process. We believe DLA’s planned actions are responsive to the  recommendation.
As arranged with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date. At that time, we will send copies to interested congressional  committees; the Secretary of Defense; the Secretaries of the Army, the  Navy, and the Air Force; the Under Secretary of Defense for Acquisition,  Technology and Logistics; the Director, DLA; and the Director, Office of  Management and Budget. In addition, the report will be available at no  charge on the GAO Web site at http://www.gao.gov/.
If you or your staff have any questions concerning this report, please  contact me on (202) 512-8246 or edwardsj@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. Key contributors to this report are listed in  appendix III.

Appendix I: Scope and Methodology

We conducted work at the Defense Logistics Agency’s (DLA) headquarters  and at DLA Supply Centers in Richmond, Virginia, and Columbus, Ohio.  We used DLA stratification data to determine the extent to which the  DLA’s inventory of spare parts reflected the amount needed to support  requirements. The Department of Defense (DOD) requires DLA and each  military service to semiannually prepare inventory stratification reports,  which are used to determine procurement and repair budget requirements  and identify potential excess or reutilization stock. Stratification is a  process that applies assets, by type, for an individual item against  requirements for the same item in a prescribed priority sequence. The  stratification reports serve as a mechanism for matching on-hand and on- order inventory to requirements.
We conducted the following steps in our analysis of inventory data:    Obtained DLA’s stratification summary data for three DLA supply chains— aviation, land, and maritime. We also obtained item-specific electronic  files as of October 30 of each fiscal year from 2006 through 2008. These  data were the most recent available for our analysis. Our analysis was  based on analyzing DLA’s item stratifications within the opening position  table as defined for DOD’s Central Secondary Item Stratification Reports.  Opening position data represent current requirements as of a certain  cutoff date and do not include any forecasted requirements or simulations.  DLA’s secondary inventory data are identified by unique stock numbers  for each unique item, such as an engine for a particular aircraft. DLA may  have in its inventory multiple quantities of the same item, which we refer  to as parts.
Assessed the reliability of the data to be used in our audit. While our  assessments occurred throughout our analyses, most of our efforts to  evaluate the data were concentrated in the initial stages of data analysis.  Those assessments included reviewing DOD requirements for secondary  spare parts inventory reporting, comparing the data we generated from  DLA-provided electronic files to its summary tables, searching for and  reconciling inconsistent information (e.g., out-of-range and missing data),  and discussing DLA’s data and our findings with database managers. After  assessing DLA’s data, we determined that the data were sufficiently  reliable for the purposes of our analysis and findings.
Calculated the value of each unique item by multiplying the quantity of  parts for an item by the item’s moving average unit price, which is the  latest acquisition cost for the item. We computed total values for all items  in DLA’s inventory and recreated the stratification tables. This  computation approach is consistent with DOD’s process for valuing assets  in its annual Supply System Inventory Report. Values do not include DLA  cost recovery rates (overhead charges).
Converted then-year dollars to constant fiscal year 2008 dollars using DOD  operations and maintenance price deflators.
We analyzed the data to determine the extent to which DLA had more  inventory than was needed to satisfy its requirements objective based on  the opening position table of DLA’s budget stratification report. DOD  defines the requirements objective as the maximum authorized quantity of  stock for wholesale items. However, if DLA has more inventory on hand  or on order than is needed to satisfy its requirements objective, it can allot  inventory that is beyond its requirements objective to satisfy forecasted  demands over a 2-year period. When the forecast is added to its  requirements objective, it constitutes the approved acquisition objective.  Inventory beyond an item’s approved acquisition objective is identified as  inactive inventory and is applied to economic retention requirements and  then to contingency retention requirements. Only after applying inventory  to satisfy these additional requirements would DLA consider that it has  more inventory than is needed and would consider this inventory for  potential reutilization or disposal. We used the requirements objective   as a criterion for our analysis because, according to DOD Regulation  4140.1-R, it establishes the target quantity for replenishing an item’s level  of stock through procurement. DOD’s requirements objective process does  not consider the 2-year forecast or inactive inventory as additional  requirements when determining inventory needs. The requirements  objective is reflected in DLA stratification reports as material needed to  meet various operating requirements (comprised of low demand items,  war reserves, back orders, and safety levels) and also factors in the time  required to acquire parts—or acquisition lead time—as well as an  economic order quantity that may be added to these requirements.
We also analyzed the data to determine the extent to which DLA had less  inventory than was needed to satisfy its requirements. We considered DLA  to have inventory deficits if levels of on-hand inventory were insufficient  to meet the operating requirements. We used this criterion level because it  reflects DLA’s ability to respond to an immediate demand for a secondary  inventory item. DOD and DLA officials said they would not consider  inventory to be in true deficit position if new parts are on order. Therefore,  we also analyzed the extent to which on-order inventory for those items  would cover the on-hand inventory deficits identified.
Additionally, we calculated, based on DLA’s forecasted demand, the  number of years of supply for each item with on-hand and on-order  quantities greater than the requirements objective. Our calculations were  based on quantity of parts and demand for those parts at the time of  stratification in October 2006 and October 2008. We identified an annual  demand forecast for individual items with inventory beyond the  requirements objective in the stratification reports for fiscal years 2006  and 2008. We divided inventory beyond the requirements objective by the  annual demand forecast to obtain the number of years of supply the  inventory levels would satisfy. We grouped these data into categories as  follows: up to 2 years, more than 2 to less than 10 years, over 10 years, and  no forecasted demand.
To identify causes for DLA’s having inventory that does not align with  requirements, we used a case study approach using a nonprobability  sample of 90 inventory items for which DLA inventory data indicated a  mismatch between inventory levels and requirements. We used March  2009 stratification data because these were the most recent available when  we selected our case studies. From the data set, we identified those items  with inventory levels that were beyond the requirements objective and  further identified those items with open purchase requests and open  purchase orders. We focused on such items because DLA did not yet have  physical possession of the items and there could be an opportunity for  DLA to modify or cancel the request or order to reflect changes in  demand. Of the items meeting these criteria, we identified those with the  highest purchase request and purchase order values, as determined by  DLA’s moving average price, and further identified items where at least  one-third of the value was stratified to retention or potential disposal  categories. We then selected an equal number of items as case studies  from each of DLA’s three supply chains—aviation, land, and maritime— and selected 10 items with open purchase orders and 10 with open  purchase requests—for a total of 60 items. We selected 30 additional items  for our sample where the March 2009 data showed that there were  insufficient quantities of parts on hand to meet the requirements objective.  We identified these items with purchase requests that also had the greatest  back order deficits by value, as determined by DLA’s moving price  average. Selections based on purchase request value and back order data  helped identify items experiencing more current and critical deficits. We  met with DLA inventory managers responsible for managing the items in  our sample to obtain information on factors that contributed to the  apparent mismatch between inventory levels and requirements. For  example, we discussed and documented the initial requirements, any  adjustments, current status, and future plans. This provided insight into  how inventory management processes were applied to these items.  Because we used a nonprobability sample, our results cannot be projected  to items outside our sample.
We also interviewed DLA headquarters officials and other agency  personnel to obtain information about DLA’s inventory management  policies and practices, inventory improvement initiatives, and other  activities related to managing spare parts.
We conducted this performance audit from February 2009 to May 2010 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.

Appendix II: Comments from the Department of Defense

Appendix III: GAO Contact and Staff Acknowledgments

	GAO Contact

	Staff Acknowledgments

In addition to the contact named above, Thomas Gosling, Assistant  Director; Lionel Cooper; Qahira El’Amin; Foster Kerrison; Elke Kolodinski;  Steve Pruitt; and Minette Richardson made key contributions to this  report.

Related GAO Products

Military Base Realignments and Closures: DOD Needs to Update Savings  Estimates and Continue to Address Challenges in Consolidating Supply- Related Functions at Depot Maintenance Locations. GAO-09-703.  Washington, D.C.: July 9, 2009.
Defense Inventory: Army Needs to Evaluate Impact of Recent Actions to  Improve Demand Forecasts for Spare Parts. GAO-09-199. Washington,  D.C.: January 12, 2009.
Defense Inventory: Management Actions Needed to Improve the Cost  Efficiency of the Navy’s Spare Parts Inventory. GAO-09-103. Washington,  D.C.: December 12, 2008.
Defense Inventory: Opportunities Exist to Save Billions by Reducing Air  Force’s Unneeded Spare Parts Inventory. GAO-07-232. Washington, D.C.:  April 27, 2007.
Defense Inventory: Opportunities Exist to Improve the Management of  DOD’s Acquisition Lead Times for Spare Parts. GAO-07-281. Washington,  D.C.: March 2, 2007.

Summary:
Why GAO Did This Study

The Defense Logistics Agency (DLA) procures and manages large supplies of spare parts to keep military equipment ready and operating. At a time when U.S. military forces and equipment are in high demand and the nation faces long-term fiscal challenges, it is critical that DLA ensure that the warfighter is supplied with the right items at the right time and exercise good stewardship over the billions of dollars invested in its inventories. GAO has identified supply chain management as a high-risk area due in part to high levels of inventory beyond what is needed to support requirements and problems in accurately forecasting demand for spare parts. GAO's objectives were to (1) determine the extent to which DLA's inventory of spare parts reflects the amount needed to support requirements; and (2) identify causes, if applicable, for DLA's having spare parts inventory that does not align with requirements. GAO analyzed DLA inventory data for fiscal years 2006 through 2008.

What GAO Found

GAO's review showed that DLA can enhance its efforts to manage spare parts more effectively primarily by focusing on the front end of the process when decisions are being made on what items to buy and how many in response to requirements. GAO's analysis of DLA data showed the agency had significantly more spare parts secondary inventory than was needed to meet current requirements in fiscal years 2006 through 2008. Current requirements include all the requirements used by DLA to determine when to order new parts, which Department of Defense (DOD) guidance refers to as the "requirements objective." The average annual value of the inventory for the 3 years reviewed was about $13.7 billion. Of this total, about $7.1 billion (52 percent) was beyond the amount needed to meet the requirements objective, and about $5.1 billion (37 percent) was not needed to meet the requirements objective plus 2 years of estimated future demand. Of the $5.1 billion, DLA had an average of $4.1 billion in retention stock (materiel for possible contingencies or materiel deemed to be more economical to keep than to dispose of) and had identified $1 billion as potential excess (for reutilization or disposal). Although DOD policy requires that DLA minimize investment in inventory while also meeting requirements, at least seven factors are continuing to cause DLA to order and stock parts that do not align with requirements. Three factors relate to how many parts to buy: inaccurate demand forecasting for parts, unresolved problems with accurately estimating lead times needed to acquire spare parts, and challenges in meeting the military services' special requests to DLA for future spare parts support for weapon systems. Three more factors relate to DLA initiatives that, while showing promise for reducing the acquisition and retention of parts not needed to meet requirements, do not appear to be achieving their full potential: closing gaps in providing accurate, timely data to inventory managers as input into purchase decisions; modifying or canceling planned purchases that may no longer be needed to meet currently estimated requirements; and reducing contingency retention stock that may no longer be needed. Lastly, DLA is not tracking the overall cost efficiency of its inventory management. Although DLA has recognized and begun to address many of these factors, its current efforts may not be fully effective at reducing the significant mismatches GAO identified between spare parts inventory levels and requirements. Acquiring inventory for which demand is much lower than expected reduces the amount of funding available for other military needs.