United States General Accounting Office

GAO Testimony

Before the Subcommittee on Defense,

Committee on Appropriations,

U.S. Senate

For Release on Delivery

Expected at

10:00 a.m., EDT

Wednesday,

May 7, 1997

DEFENSE DEPOT

MAINTENANCE

Challenges Facing DOD in

Managing Working Capital

Funds

Statement of Henry L. Hinton, Jr., Assistant Comptroller

General, National Security and International Affairs

Division

GAO/T-NSIAD/AIMD-97-152

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss financial management and

logistics management issues relating to the effectiveness and efficiency of

the Department of Defense’s (DOD) operations. Specifically, we will focus

on the operations of DOD’s working capital funds, which collect and

disburse over $65 billion annually, and on DOD’s management of the

$13 billion depot maintenance program. It is important to note that these

areas fall within defense financial management and infrastructure

activities, 2 of the 24 areas we identified as high-risk areas within the

federal government.1

These issues have significant impact on the efficiency and effectiveness of

how DOD spends its operations and maintenance funds. DOD has

consistently experienced losses in the operations of various working

capital funds, including the depot maintenance activity group, and has had

to request additional funding to support their operations. This issue has

been an area of concern to this subcommittee and other congressional

committees. Before we get into specifics, let’s briefly summarize our key

points.

Working Capital

Funds’ Cash

Management and

Operations Issues

Our work on working capital funds cash management and operations

shows the following:

• To date, the working capital funds have not yet accomplished the goal of

operating on a break-even basis, and DOD estimates the funds will have an

accumulated operating loss of about $1.7 billion at the end of fiscal year

1997. However, we believe that the funds have achieved a measure of

success because the services are doing a better job of identifying the costs

of doing business and including those costs in the prices charged

customers. Setting prices to recover more of the costs of providing goods

and services to customers gives managers a window into the costs of DOD

support operations—including costs for direct labor, material, overhead,

and contracts. With a more complete cost picture, managers can account

for past activities, manage current operations, and assess progress toward

planned objectives. Further, more accurate identification of costs enables

those responsible for providing oversight to make more informed policy

decisions by highlighting the cost associated with those decisions.

1

Defense Financial Management (GAO/HR-97-3, Feb. 1997) and Defense Infrastructure Management

(GAO/HR-97-7, Feb. 1997). In 1990, GAO began a special effort to report on the federal program areas

its work identified as high risk because of vulnerabilities to waste, fraud, abuse, and mismanagement.

Page 1 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
• When the Defense Business Operations Fund was established in 1991, DOD

consolidated the cash balances of the nine industrial and stock funds into

a single account that was managed centrally by the Office of the Secretary

of Defense (Comptroller). In February 1995, DOD devolved the

responsibility for cash management to the military services and DOD

components. We agree with DOD’s decision to place the responsibility for

managing the working capital funds’ cash at the military service and DOD

component level because it makes each individual DOD component directly

accountable for its respective cash balance as well as their decisions that

impact cash. Each DOD component now has an incentive to more

accurately price the goods and services that its working capital fund

charges customers since inaccurate prices could lead to not having

enough cash to cover day-to-day operating expenses.

• Since 1993, the working capital funds have had a cash shortage. To ensure

that the cash balances remained positive, the funds have advance billed

their customers. While the three services have liquidated $3.6 billion of

outstanding advance billings from February 1995 to January 1997, the

outstanding advance billing balance is still $1.6 billion. Further, the Navy

and Air Force advance billed their customers about $2.9 billion during

calendar year 1996 to ensure that their cash balances remained positive.

• Our analysis of the fiscal year 1998 prices for five business areas indicates

that they are probably too low to recover expected fiscal year 1998

operating costs and/or recover prior year losses by over $300 million.

Challenges Facing

DOD in Improving the

Cost-Effectiveness of

Depot Maintenance

Operations

Various factors contribute to inefficiencies in DOD’s management of depot

maintenance activities.

• Excess capacity—which is currently about 40 percent in DOD’s depot

maintenance system—is a significant contributor toward the inefficiency

and high cost of DOD’s depot maintenance program and is generating

significant losses in the depot maintenance activity group of the services’

working capital funds. The Navy has made the greatest progress in dealing

with excess capacity through its implementation of base realignment and

closure (BRAC) recommendations. Through consolidations, interservicing

actions, and outsourcing some noncore workloads, the Navy expects to

reduce its operating rate by about $10 per hour. Based on a forecast of

13 million direct labor hours for fiscal year 1999, the Navy expects to

produce a savings of about $130 million. However, the Army and the Air

Force’s plans for implementing BRAC recommendations will do little to

reduce excess capacity and will likely result in increased depot

maintenance prices.

Page 2 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
• DOD has made overly optimistic assumptions about cost savings that can

be achieved from outsourcing depot maintenance activities. When

outsourcing results in increasing, rather than decreasing costs, expected

depot maintenance savings will not be realized. To the extent projected

savings were budgeted, losses will occur. For example,

privatization-in-place of the Aerospace Guidance and Metrology Center

was justified based on achieving savings. However, the Air Force projects

that for 1997, costs in the privatized facility will be $9 million to

$32 million more than the cost of the same work before privatization.

Similarly, the Air Force is also projecting savings from planned

competitions of workloads at two closing Air Logistics Centers. If the

savings from these competitions are not achieved, a similar situation will

occur.

• Material cost increases are generating losses for the depot maintenance

capital fund. Material costs represent about 40 percent of the Air Force

depot maintenance costs and during the first half of fiscal year 1997,

material costs for Air Force depots have been about $32.7 million, or 

5.4 percent higher than planned. Our work also shows that weaknesses in

DOD’s inventory management system, such as inadequate visibility over

items and purchasing of unneeded stocks, have contributed to rising

material costs. In addition, inadequate control of government-furnished

material to contractors has also led to losses in contract depot

maintenance. For example, in April 1996, the Air Force Audit Agency

found problems at Warner Robins Air Logistics Center with

government-furnished property financial statement balances misstated by

up to $2.3 billion.

In conclusion, the inefficient operation of depot maintenance activities

results in a reduction of the military services’ purchasing power through

their operations and maintenance funds. Stated another way, more

operations and maintenance funds will be required to perform the same

level of maintenance. Depot maintenance privatization should be

approached carefully, allowing for evaluation of economic, readiness, and

statutory requirements that surround individual workloads. If not

effectively managed, privatizing depot maintenance activities, including

the downsizing of the remaining DOD depot infrastructure, could

exacerbate existing capacity problems and the inefficiencies inherent in

underutilization of depot maintenance capacity.

In addition, other factors also impact the cost-effectiveness of depot

maintenance operations. These include such things as inventory

management practices, repair processes, and readiness requirements. We

Page 3 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
have encouraged DOD to aggressively seek new management practices to

meet these challenges. To their credit, each of the military services have

programs underway to improve depot maintenance and other logistics

activities. While it is too early to assess the results of these programs, we

believe they are addressing several key problems, such as the reduction of

repair cycle time.

In closing, it is important to note that reducing depot maintenance cost

and improving depot maintenance efficiency are complex and challenging

tasks that are compounded by force structure downsizing. We have

presented some of the key factors that must be addressed and continue to

believe DOD should develop an overall plan for improving depot

maintenance efficiency and effectiveness that clearly defines how it will

deal with this set of complex issues.

Mr. Chairman, this completes the summary of issues contained in our

statement. Mr. Brock and Ms. Denman, as requested, will now provide

more details on these issues.

Page 4 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
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Appendix I 

Working Capital Cash and Operations

Management Issues

The Department of Defense (DOD) established the Defense Business

Operating Fund (DBOF) in 1991 in an attempt to fundamentally alter the

way DOD managed its resources by fostering a more business-like culture

within selected Defense operations, which include depot maintenance,

transportation, supply management, and finance and accounting. DBOF

consolidated the nine existing industrial and stock funds operated by the

military services and DOD, as well as the Defense Finance and Accounting

Service, the Defense Industrial Plant Equipment Service, the Defense

Commissary Agency, the Defense Reutilization and Marketing Service, and

the Defense Technical Information Service into a single financial structure.

The military services and DOD components continue to be responsible for

managing and operating business activities within the financial structure.

On December 11, 1996, the Under Secretary of Defense (Comptroller)

reorganized DBOF and created four working capital funds: Army, Navy, Air

Force, and Defense-wide. This was done in order to clearly establish the

military services and DOD components responsibilities for managing the

functional and financial aspects of their respective business areas. The

recently established working capital funds continue to operate the same

way they did under DBOF.

The primary goal of DBOF and the recently established working capital

funds is to focus the attention of all levels of management on the total

costs of carrying out certain critical DOD business operations and the

management of those costs in order to encourage support organizations,

such as depot maintenance facilities, to provide quality goods and services

at the lowest costs. Focusing attention on costs is important, given the size

of the working capital funds. For fiscal year 1998, the four funds are

expected to generate about $69 billion in revenue and employ about

220,000 civilians and 24,000 military personnel.

The working capital funds are supposed to generate sufficient revenues to

recover expenses incurred in their operations and are expected to operate

on a break-even basis over time. However, setting prices to ensure that the

funds do break even is a complex and difficult task. DOD policy requires

working capital fund business areas to establish prices prior to the start of

each fiscal year and to apply these predetermined (stabilized or standard)

prices to most orders and requisitions received during the year. The

process that the business areas use to develop their stabilized prices

begins as early as 2 years before the prices go into effect, with each

business area developing workload projections for the budget year. After a

business area estimates its workload based on customer input, it (1) uses

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Appendix I 

Working Capital Cash and Operations

Management Issues

productivity projections to estimate how many people it will need to

accomplish its work; (2) prepares a budget that identifies the labor,

material, and other expected costs; and (3) develops prices, that when

applied to the projected workload, should allow it to recover operating

costs from its customers. Because sales prices are based on expected

rather than actual costs and workloads, higher-than-expected costs or

lower-than-expected customer demand for goods and services can cause

the business areas to incur losses. Conversely, lower-than-expected costs

or higher-than expected workloads can result in profits.

To date, the working capital funds have not yet accomplished their goal of

operating on a break-even basis and DOD estimates that they will have an

accumulated operating loss of $1.7 billion at the end of fiscal year 1997.

However, we believe that the funds have achieved a measure of success

because they are doing a better job of identifying the costs of doing

business and including those costs in the prices charged customers. This

provides managers and decisionmakers two important benefits. First,

setting prices to recover more of the costs of providing goods and services

to customers gives DOD managers a window into the costs of Defense

support operations—including costs for direct labor, material, overhead,

and contracts. With a more complete cost picture, managers can account

for past activities, manage current operations, and assess progress toward

planned objectives. Second, more accurate identification of costs enables

those responsible for providing oversight to make more informed policy

decisions by highlighting the cost associated with those decisions.

Over the last several years, various congressional Defense oversight and

appropriations committees have expressed concern with the management

and operations of the funds. To address these concerns, DOD was required

to conduct a study of its working capital funds as directed in the National

Defense Authorization Act for Fiscal Year 1997. Not later than

September 30, 1997, the Secretary of Defense is required to submit to the

Congress a plan to improve the management and performance of the

industrial, commercial, and support type activities that are currently

managed in the working capital funds. We are hopeful that DOD will use

this plan as a mechanism to continue to strengthen its commitment to

improving the management and operations of the working capital funds as

well as identifying the total costs of providing goods and services to

customers and including those costs in the prices charged customers.

Page 7 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix I 

Working Capital Cash and Operations

Management Issues

Working Capital Fund

Cash Management

Since 1993, the working capital funds have had a cash shortage. To

address this problem, DOD has taken two actions. First, in February 1995,

DOD devolved the responsibility for cash management to the military

services and the DOD components to better align accountability and

responsibility for management. Second, to ensure that the cash balance

remains positive, the working capital funds have advance billed their

customers since 1993.

The Importance of Cash

for Working Capital Funds

Cash plays an extremely important role for DOD’s working capital funds

since they collect and disburse over $65 billion annually. Cash generated

from the sale of goods and services is the primary means by which the

working capital funds maintain an adequate level of cash to pay bills.

Where the cash balances start each year depends on the outcome of many

decisions made during the budget process with regard to (1) projecting

workload, (2) estimating costs, and (3) setting prices to recover the

estimated full cost of the goods and services. During the execution of the

budget, they operate much like a checking account: collections increase

the funds’ account balances and disbursements (such as salaries and

purchases of inventory) reduce the account balances. To the extent that

the decisions made during the budget process are reasonably accurate, the

funds’ cash balances should fall between the minimum and maximum

amount required by DOD. However, if the decisions are not accurate, the

funds could have too much or not enough cash.

DOD’s policy requires the funds to maintain cash levels to cover 7 to 

10 days of operational costs and 4 to 6 months of capital asset

disbursements, which is about $2.3 billion to $3.4 billion for the four funds.

If the level of cash becomes low and there is a possibility of incurring an

Antideficiency Act1

 violation, immediate actions will be taken to resolve

the cash shortages by advance billing customers.

Before DBOF was established, each industrial and stock fund had a separate

cash balance and managers were responsible for ensuring sufficient cash

was available to cover fluctuations in collections and disbursements that

occurred from one month to another. When DBOF was implemented, DOD

consolidated the cash balances of the nine industrial and stock funds into

a single account that was managed centrally by the Office of the Secretary

of Defense (OSD) (Comptroller). OSD centrally managed DBOF’s cash for

about 3 years. In February 1995, DOD devolved responsibility for cash

1

The Antideficiency Act, 31 U.S.C. 1341(a)(1), 1517, provides that no officer or employee of the

government shall make or authorize an expenditure or obligation exceeding the amount of an

appropriation of funds available for the expenditure or obligation.

Page 8 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix I 

Working Capital Cash and Operations

Management Issues

management as well as Antideficiency Act responsibilities to the military

services and the DOD components.

Our Views on DOD’s

Decision to Devolve the

Cash Management

Responsibility

We agree with DOD’s decision to place the responsibility for managing the

working capital funds’ cash at the military service and defense agency

level and to likewise devolve the Antideficiency Act responsibility. In our

view, decentralized cash management should result in better cash

management and more responsible business decisions.

According to DOD officials, the cash management responsibility was

devolved to the Army, the Navy, the Air Force, and the defense agencies to

better align accountability and responsibility for managing cash. DOD

pointed out that the operational control of actions taken by each fund

activity, which results in cash disbursements and collections, always has

resided and continues to reside with the individual DOD components.

We believe that there are a number of benefits associated with the

decentralization of cash management responsibilities. The decentralization

makes each individual DOD component directly accountable for its

respective cash balance as well as their decisions that impact cash,

including any violation of the Antideficiency Act. One DOD component

cannot spend money generated by another DOD component. When cash

management was centralized, DOD did not have reports that showed the

cash balances for the individual DOD components—the reports only

provided information on (1) DBOF’s overall cash balance and (2) collection

and disbursement data for each of the DOD components. With the

decentralization of cash management, the Department of the Treasury

provides DOD with a cash balance for each of the five DOD components.

There are still other advantages associated with the decentralization of

cash management:

• Each DOD component now has an incentive to more accurately price the

goods and services that its working capital fund charges customers since

inaccurate prices could lead to not having enough cash to cover day-to-day

operating expenses.

• The management of cash is closer to where cash decisions are made—the

business area and the activity level.

• OSD and the DOD components have started working more as a team to

resolve cash problems. Under the centralization of cash, there was less

incentive for the DOD components to respond to cash problems since OSD

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Appendix I 

Working Capital Cash and Operations

Management Issues

was responsible for cash and there was only one cash balance. When the

DOD components became responsible for their individual cash balances,

they raised more questions on the accuracy and timeliness of the

information on collections and disbursements. Such increased attention

should help improve the accuracy of collection and disbursement data

reported in the working capital funds’ financial statements, which are

prepared under the Chief Financial Officers Act of 1990.

DOD Has Advance Billed

Customers to Alleviate

Cash Shortage

Since 1993—with the transfer of $5.5 billion from DBOF as required by the

National Defense Authorization Act for Fiscal Year 1993—the funds have

been advance billing customers because they have not been able to

generate enough cash to pay their bills. In July 1994, the Comptroller of

Defense stopped the advance billing at all activities except for the Naval

shipyards and research and development activities. Although these

activities had been tentatively scheduled to stop advance billing in

January 1995, this did not occur.

DOD officials informed us that when the responsibility for cash

management was returned to the DOD components in February 1995, the

amount of cash returned to the services was not sufficient to cover

outstanding DBOF liabilities. DBOF’s financial reports indicate that this was

the case, with each service facing cash shortages. Therefore, according to

DOD, it was necessary for the military services to continue to advance bill

customers so that their cash portion of DBOF would not go negative.

Since 1995, the military services have made some progress in liquidating

(working off) their outstanding advance billing balances. However, the

Navy and the Air Force had to advance bill customers again during

calendar year 1996 to ensure that their cash balances remained positive.

Specifically, the Navy advance billed customers about $1.7 billion and the

Air Force advance billed customers $1.2 billion during calendar 1996.

Further, the Navy had advance billed their customers $100 million in

February 1997. The following figures show the reported (1) cash balances

for the Army, the Navy, the Air Force, OSD, and the defense agencies

portion of the funds and the (2) cash balances for these components if

they did not advance bill their customers from February 1995—when DOD

returned the responsibility for cash to these five DOD

components—through January 1997.

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Appendix I 

Working Capital Cash and Operations

Management Issues

Figure I.1: Working Capital Fund Cash Balances (Dollars in millions)

Cash policy requires about $2.3 billion to $3.4 billion.

2/95 6/95 1/96 6/96 12/96 -1,000

0

1,000

2,000

3,000

4,000

5,000

6,000 Cash balance

W/O adv. bill.

Cash policy requires about $360 million to $515 million.

2/95 6/95 1/96 6/96 12/96 -400

-200

0

200

400

600

800 Cash balance

W/O adv. bill.

Cash policy requires about $625 million to $900 million.

2/95 6/95 1/96 6/96 12/96

-3,000

-2,000

-1,000

0

1,000

2,000

3,000 Cash balance

W/O adv. bill.

Cash policy requires about $465 million to $670 million.

2/95 6/95 1/96 6/96 12/96 -400

-200

0

200

400

600

800

1,000

1,200 Cash balance

W/O adv. bill.

2/95 6/95 1/96 6/96 12/96

0

20

40

60

80

100

120

140

160

Cash policy requires about $885 million to $1.3 billion.

2/95 6/95 1/96 6/96 12/96 0

500

1,000

1,500

2,000

Overall Working Capital Fund Army Working Capital Fund

Navy Working Capital Fund Air Force Working Capital Fund

Office of the Secretary of Defense

(which does not advance bill)

Defense Agencies

(which do not advance bill)

Page 11 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix I 

Working Capital Cash and Operations

Management Issues

Note to above figures: We did not independently verify the financial information shown in the

figures, which was taken from DOD and Treasury reports.

As shown in figure I.1, the Army, the Navy, and the Air Force would have

had negative cash balances when they received the responsibility for cash

in February 1995 had they not advance billed customers. The figures also

show that

• the three services have liquidated $3.6 billion of outstanding advance

billings from February 1995 through January 1997;

• as of January 1997, the outstanding advance billing balance was

$1.6 billion;

• the Army has liquidated almost all of its outstanding advance billing

balance;

• the Navy’s cash balance would have been negative for most of the time

period from February 1995 through January 1997 if it had not advance

billed customers; and

• the Air Force liquidated most of its outstanding advance billing balance

until it needed to advance bill customers over a billion dollars in

December 1996 to ensure that its cash balance would remain positive.

According to Army and Air Force officials, they plan to liquidate all their

outstanding advance billing balances by the end of fiscal year 1998. Navy

officials informed us that they now plan to liquidate the Navy’s

outstanding advance billing balance by the end of fiscal year 1999.

Cash Outlook for Fiscal

Years 1997 and 1998

DOD’s cash plans, dated January/February 1997, show that the working

capital funds will disburse about $2.3 billion more than they collect during

fiscal year 1997. To offset most of the cash drain that DOD expects to occur

during fiscal year 1997, DOD plans to increase fiscal year 1998 prices to

recoup losses and generate cash. DOD plans also show that it expects to

collect about $2.2 billion more than it disburses during fiscal year 1998.

This information is summarized as follows.

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Appendix I 

Working Capital Cash and Operations

Management Issues

Table I.2: DOD’s Working Capital Fund

Annual Cash Plans Dated

January/February 1997

Dollars in millions

Component

Estimated fiscal year 1997

collections less

disbursements

Estimated fiscal year 1998

collections less

disbursements

Army ($173.4) $27.2

Navy (1,427.7) 984.5

Air Force (154.5) 493.4a

Defense Agencies (511.0) 669.4

Total $(2,266.6) $2,174.5

aAir Force fiscal year 1998 figure includes U.S. Transportation Command’s net collections of

$102.6 million.

Based on our analysis of DOD’s cash plan and past trends, we believe that

the Navy may have to advance bill customers during the remainder of

fiscal year 1997 in order to ensure that its cash balance remains positive.

Based on our review of the cash and outstanding advance billing balances

for the period October 1996 through March 1997, it is too close to tell if the

Army and the Air Force will have to advance bill their customers during

the remainder of fiscal year 1997.

Working Capital Fund

Operations

The four DOD working capital funds have added surcharges to their fiscal

year 1998 sales prices in order to recoup the $1.7 billion accumulated

operating loss that they expect to have at the end of fiscal year 1997. As a

result of this accumulated operating loss, the customers will need

$1.7 billion in appropriated fiscal year 1998 funds so that they can

reimburse the working capital funds for prior year losses rather than buy

goods and services.

Our limited review of five business areas and the assumptions used to

develop their fiscal year 1998 prices (which could change as fiscal 

year 1998 approaches) indicates that the price increases may not be

enough to eliminate the $1.7 billion accumulated operating loss. Based on

the requirements in the National Defense Authorization Act for Fiscal 

Year 1997, we reviewed the fiscal year 1998 prices for Army depot

maintenance, Air Force depot maintenance, Navy shipyards, Navy

ordnance, and Navy research and development. In performing our work,

we reviewed DOD’s assumptions—which were finalized about 9 months

before the beginning of fiscal year 1998—on the fiscal year 1998 estimated

revenue, costs, operating results, and workload (direct labor hours) to

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Working Capital Cash and Operations

Management Issues

determine if the prices are likely to (1) recover fiscal year 1998 operating

costs and (2) achieve a zero accumulated operating result at the end of

fiscal year 1998.

Our analysis indicates that the fiscal year 1998 prices for four of the five

business areas reviewed are probably too low to recover expected fiscal

year 1998 operating costs and/or recoup prior year losses by over

$300 million. The results of our work is summarized below.

Table I.2: Estimated Impact of Fiscal

Year 1998 Pricing Assumptions on

End-of-Year Accumulated Operating

Results

Business area Estimated end-of-year accumulated operating result

Army depot maintenance Greater than $100 million loss

Air Force depot maintenance Greater than $100 million loss

Navy shipyards Between $25 million and $100 million loss

Navy ordnance Between $25 million and $100 million loss

Navy research and

developmenta

On target for zero accumulated operating result

aNaval surface warfare center and Naval undersea warfare center divisions only.

Our previous reports2 have identified some of the primary causes of

business area losses. For example, several reports have identified such

long-standing and well-documented causes as (1) overly optimistic

productivity assumptions, (2) unrealistic cost-reduction goals, and

(3) lower-than-expected workloads. As illustrated below, we believe that

the funds will incur losses in fiscal year 1998 for the same reasons.

• The Army depot maintenance business area is likely to end fiscal year 1998

with an accumulated operating loss of more than $100 million. The

expected loss is due, in large part, to significant changes made to the

depot-level budget, resulting in cost-reduction goals that we believe will

not be fully realized. Specifically, the Army’s Industrial Operations

Command proposed a composite fiscal year 1998 sales price of $107.03 per

direct labor hour, which would have been a 19-percent increase over the

fiscal year 1997 price. However, this price was reduced by $10.18 per hour

by the Army Materiel Command in an effort to hold down prices and

reduce the cost of depot operations. The fiscal year 1998 price reduction

2

Air Force Depot Maintenance: Improved Pricing and Financial Management Practices Needed

(GAO/AFMD-93-5, Nov. 17, 1992); Financial Management: Navy Industrial Fund Has Not Recovered

Costs (GAO/AFMD-93-18, Mar. 23, 1993); Defense Business Operations Fund: Improved Pricing

Practices and Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132, June 22, 1994);

Financial Management: Army Industrial Funds Did Not Recover Costs (GAO/AIMD-94-16, Nov. 26,

1993); and Navy Ordnance: Analysis of Business Area Price Increases and Financial Losses

(GAO/AIMD/NSIAD-97-74, Mar. 14, 1997).

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Working Capital Cash and Operations

Management Issues

has created a situation where expected revenues for fiscal year 1998 will

be significantly less than originally expected by the depots. In order to

offset this revenue reduction, the depots need to reduce operational costs

by about $68 million in fiscal year 1998. The Army was aware of the

potential for significant losses and is attempting to identify areas where it

can reduce its costs.

• The Air Force depot maintenance business area is likely to have an

accumulated operating loss of more than $100 million at the end of fiscal

year 1998 primarily because disruptions related to on-going actions to

close two Air Logistics Centers will probably prevent its workforce from

achieving productivity goals that were incorporated into budget estimates

for fiscal years 1997 and 1998. In fact, our review of other closure actions

and the business area’s actual productivity for the first 5 months of fiscal

year 1997 indicates that the workforce’s actual productivity is much more

likely to decline significantly than to improve. For example, when the Air

Force Aerospace Guidance and Metrology Center was closed in

September 1996, its workforce’s productivity had declined about

26 percent during the preceding 2 years. Similarly, the productivity of the

Air Force depot maintenance business area’s workforce for the first 

5 months of fiscal year 1997 is about 6.5 percent below budgeted levels for

fiscal year 1996 and 8.5 percent below the budgeted levels for fiscal year

1997.

• It is likely that the Naval shipyard business area will have an accumulated

operating loss between $25 million and $100 million at the end of fiscal

year 1998. This is due, in part, to workload delays and cancellations—two

problems that have adversely affected the shipyards’ operations in the

past3

 and are likely to affect their operations in fiscal years 1997 and 1998.

For example, the Navy’s February 1997 budget submission was based

partly on the assumption that repairs and alterations for one ship would

require about 491,000 direct labor hours. However, in April 1997, about 4

months before work was scheduled to start, a major portion of this work

was deferred. As a result, the workload estimate for the ship has been

reduced by about 71 percent to about 144,000 direct labor hours. A Naval

Sea Systems (NAVSEA) Command official stated that the shipyard cannot

reduce its direct personnel and overhead costs in sufficient time to offset

the lost revenue, which we estimate at about $20 million for direct labor,

overhead, and surcharges.

In another instance, our analysis of budget documents identified a change

in workload estimates for a ship scheduled to begin repairs in May 1998.

3

Defense Business Operations Fund: Improved Pricing Practices and Financial Reports Are Needed to

Set Accurate Prices (GAO/AIMD-94-132, June 22, 1994).

Page 15 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix I 

Working Capital Cash and Operations

Management Issues

Budget documents indicated that Navy customers planned to spend about

$16 million for ship repairs, while the shipyard planned to receive about

$36 million in revenue for working on the ship. A NAVSEA official stated that

workload was reduced about 68 percent from 400,000 DLHs to 128,000 DLHs,

but the change was not reflected in the workload estimates used to set

fiscal year 1998 prices. In this case, the shipyard has 1 year to reduce its

costs, renegotiate the workload reduction, or find additional revenue

sources. Otherwise, a significant reduction in workload can result in

significant losses.

• It is likely that the Navy ordnance business area will have an accumulated

operating loss between $25 million and $100 million at the end of fiscal

year 1998. As part of an initiative to restructure its ordnance business area

and reduce costs, the Navy plans to drastically reduce the scope of

operations at selected ordnance weapons stations. Accordingly, when it

developed the prices that the business area will charge customers in fiscal

year 1998, the Navy reduced weapons stations’ cost estimates for overhead

contract costs (for such things as utility bills and real property

maintenance) from $126 million to $87 million, a reduction of $39 million,

or 31 percent. However, the Navy has historically underbudgeted overhead

contract costs for the weapons stations. For example, the reported actual

overhead contract costs exceeded budgeted costs for fiscal years 1994,

1995, and 1996 by $33 million, $81 million, and $43 million, respectively.

Furthermore, the Navy has not yet developed a detailed plan to achieve

the budgeted cost reductions. Consequently, we believe it is very likely

that the Navy ordnance weapons stations’ actual overhead contract costs

will exceed budgeted costs.

Because the budget process used to develop business areas’ stabilized

prices begins as long as 2 years before the prices go into effect, some

variance between budgeted and actual operating results is inevitable.

However, in some business areas, sales prices have yielded revenues that

have been lower than actual costs for several years in a row. This indicates

that there may be systemic problems with either the operation of the

business areas or the methodology and assumptions used to estimate

future costs and workloads. Until these problems are corrected, some

business areas will continue to incur losses from their day-to-day

operations and will need to increase future prices to recover these losses.

Page 16 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

DOD’s depot maintenance program costs more than $13 billion annually

and involves an extensive public and private sector industrial base. Depot

maintenance is one of the areas where DOD plans to achieve savings that

can be used to fund shortfalls in modernization accounts. However, DOD is

not achieving expected cost reductions in its depot maintenance program.

In some instances, depot maintenance costs, in general, and unit repair

costs, in particular, have actually increased and are expected to go higher.

The waste and inefficiency in DOD’s logistics system, including its depot

maintenance program, is one of the key reasons we identified DOD’s

infrastructure activities as 1 of 24 high-risk areas within the federal

government.1

A number of factors are preventing DOD from achieving expected savings

in its depot maintenance costs. First, excess capacity in the industrial

repair and overhaul capability of the public and private sectors contributes

significantly to inefficiencies and higher costs in both sectors. Second, DOD

is not achieving expected savings from outsourcing. Third, inefficiencies in

DOD’s supply system, along with other factors, increase the cost of

material, yet, because needed parts are often not available, cause

disruptions in depot maintenance operations. Also, other factors, such as

inadequate information systems and readiness requirements, can influence

depot inefficiencies and increase costs. To the military services’ credit,

each has programs underway to improve the effectiveness and efficiency

of its depot maintenance activities.

Background Depot maintenance is a key part of the total DOD logistics system that

supports millions of equipment items, over 52,000 combat vehicles, 

351 ships, and over 17,000 aircraft. Depot maintenance is a vast

undertaking that requires extensive shop facilities, specialized equipment,

and highly skilled technical and engineering personnel (1) to perform

major overhauls of weapon systems and equipment; (2) to completely

rebuild parts and end items; (3) to modify systems and equipment by

applying new or improved components; (4) to manufacture parts

unavailable from the private sector; and (5) to program the software that is

an integral part of today’s complex weapon systems. This work is done in

both military depots and the private sector. DOD facilities and equipment

are valued at over $50 billion. A large but unknown amount of

government-owned depot plant equipment is used by private

contractors—many of which are original equipment manufacturers of

1

Defense Infrastructure (GAO/HR-97-7, Feb. 1997). In 1990, GAO began a special effort to review and

report on the federal program areas its work identified as high risk because of vulnerabilities to waste,

fraud, abuse, and mismanagement.

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Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

weapons or major systems and components. DOD spends about

$13 billion—5 percent of its $250 billion fiscal year 1997 budget—on depot

maintenance activities. Over $1 billion of this amount is procurement

funding rather than operation and maintenance funding for contractor

logistics support, interim contractor support, and some software

maintenance.

Workload and Personnel

Have Been Reduced Since

the Cold War Ended

DOD’s depot maintenance workload has declined significantly in recent

years, in large part because of the downsizing of the military force

structure and reductions in spending for new weapon systems and

equipment that followed the end of the Cold War. Other factors that have

contributed to this decline, and which must be shared among all potential

sources of repair—both public and private—include efforts by some

services to do more repairs in field-level maintenance activities and the

increased reliability, maintainability, and durability of some systems and

equipment.

The defense depot system employs about 76,000 DOD civilian personnel,

including laborers, highly trained technicians, engineers, and top-level

managers. As shown in figure II.1, the number of depot maintenance

personnel has been reduced by about 71,000 personnel—a 48-percent

reduction since 1990. Over the same period, the organic depot

maintenance workload had a similar decline of about 43 percent, while the

total depot maintenance budget declined by a margin of only 12 percent.

Page 18 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

Figure II.1: Reductions in DOD’s Depot Maintenance Budget, Depot Maintenance Personnel, and Direct Labor Hours

FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97

60

80

100

120

140

160

0

2

4

6

8

10

12

14

Personnel (in thousands) /Hours (in millions) Budget (in billions of dollars)

Depot maintenance budget Depot maintenance personnel Direct labor hours

Excess Capacity Exists in

the Public and Private

Sectors

DOD has extensive excess capacity in the form of large numbers of

underutilized buildings and equipment. While DOD has substantially

reduced depot maintenance requirements and the number of depot

maintenance personnel has been similarly reduced, DOD has not completed

complementary reductions in its depot maintenance

infrastructure—despite four rounds of base closures. Also, private sector

production workload for new systems and equipment has generated

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Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

significant excess production capacity—which the private sector

estimates to be about 57 percent for military work and 56 percent for

commercial work.

We identified excess capacity by determining maintenance facilities’

potential for doing more work than they are programmed to accomplish.

This approach, which assumes that additional trained personnel would be

available to accomplish the added workloads, is the same approach that

was used during the Base Realignment and Closure (BRAC) process to

identify opportunities to consolidate similar workloads and to thereby,

improve capacity utilization and reduce redundancies. However, DOD

normally uses an approach that constrains facilities’ capacity based on

(1) the availability of trained personnel and the organization of work

stations and (2) operation on one 8-hour shift each day, for a 5-day

workweek. The private sector usually considers a maximum potential

capacity utilization between 75 and 85 percent to be an efficient operating

level. Using maximum potential capacity estimates, DOD is predicted to

have excess capacity in fiscal year 1999 of about 50 percent. Figure II.2

shows excess capacity using both the maximum potential capacity and

DOD’s available capacity approach.

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Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

Figure II.2: Comparison of Depot Capacity and Workload

Army NAVAIR NAVSEA Navy other Air Force

0

10,000

20,000

30,000

40,000

50,000

60,000

Direct Labor Hours (000s)

Maximum Capacity Available Capacity Workload

Table II.1 provides projections of each military depot’s workload and

excess capacity for fiscal year 1999 using maximum potential capacity and

available capacity for 1999.

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Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

Table II.1: Capacity and Workload Forecasts for Defense Depots for Fiscal Year 1999

(Direct labor hours in thousands)

Maintenance depot

Maximum

potential

capacity

Available

capacity Workload

Maximum

capacity

excess

Available

capacity

excess

Percentage

excess of

maximum

capacity

Percentage

excess of

available

capacity

Naval aviation

Cherry Point 5,735 3,797 3,620 2,115 177 37 5

Jacksonville 7,158 5,572 5,355 1,803 217 25 4

North Island 7,772 4,318 4,027 3,745 291 48 7

Subtotal 20,665 13,687 13,002 7,663 685 37 5

Naval shipyard

Norfolk 15,851 12,000 8,723 7,128 3,277 45 27

Pearl Harbor 8,032 5,320 3,739 4,293 1,581 53 30

Portsmouth 7,996 7,028 3,209 4,787 3,819 60 54

Puget Sound 14,919 14,000 11,717 3,202 2,283 21 16

Subtotal 46,798 38,348 27,388 19,410 10,960 41 29

Other Navy

Albany 1,883 1,215 1,089 794 126 42 10

Barstow 1,563 1,037 928 635 109 41 11

Crane 2,451 974 583 1,868 391 76 40

Keyport NUWC 1,141 672 555 586 117 51 17

Subtotal 7,038 3,898 3,155 3,883 743 55 19

Air Force

Oklahoma City 12,863 7,881 7,624 5,239 257 41 3

Ogden 9,005 8,371 4,596 4,409 3,775 49 45

San Antonio 15,220 1,575 1,606 13,614 (31) 89 –2

Sacramento 10,291 1,724 989 9,302 735 90 43

Warner Robins 9,913 7,605 5,508 4,405 2,097 44 28

Subtotal 57,291 27,156 20,323 36,968 6,833 65 25

Army

Anniston 4,512 3,192 2,614 1,898 578 42 18

Corpus Christi 4,714 4,009 3,338 1,376 671 29 17

Letterkenny 3,707 213 164 3,543 49 96 23

Red River 4,684 1,534 898 3,786 636 81 41

Tobyhanna 7,606 5,091 2,736 4,870 2,355 64 46

Subtotal 25,223 14,040 9,750 15,473 4,290 61 31

Total 157,016 97,129 73,618 83,398 23,511 53 24

Page 22 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

Workload

Consolidation

Provides Significant

Opportunities to

Reduce Costly Excess

Capacity

There are essentially two options for reducing a maintenance depot’s

excess capacity: downsizing-in-place or increasing the volume of

workload. Downsizing-in-place by mothballing or tearing down buildings

and disposing of equipment may reduce the cost of maintaining some

facilities and equipment, but it does not eliminate the costly infrastructure

that supports the operations of a military installation. Also, it does not

promote the efficiencies that can be achieved through consolidation.

During the BRAC process, it was generally the case that the most

cost-effective way to reduce maintenance costs was to close some depots

and to consolidate their workloads at the remaining depots or in existing

private sector capacity. This approach allowed the remaining facilities to

achieve production efficiencies and to spread their fixed overhead over an

increased volume of work.

The defense depot system currently has about 40-percent excess capacity.

With the exception of the Navy’s privatization-in-place efforts, our work

shows that the Navy has been the most successful at addressing the issue

of closing excess industrial capacity and consolidating it to achieve

economies of operation. On the other hand, the Army and the Air Force

have not succeeded in making significant reductions in their excess

capacity. Both services are incurring rising prices because they have too

much depot infrastructure for the available workload. Further, DOD’s

privatization of selected depots has contributed to the excess capacity

problem and ultimately will continue to drive up maintenance costs.

Additionally, the Air Force plans to compete workloads at two closing

depots may be more costly than redistributing the workload to other

depots. Such cost increases mean that military service customers can buy

less depot maintenance with available operation and maintenance dollars.

Navy Is Saving by

Expeditiously Closing

Aviation Depots and

Shipyards, but Is Missing

Savings Opportunities by

Privatizing Workload

The Navy has closed three of its six aviation depots and has consolidated

most of their workloads at the three remaining depots to improve capacity

utilization and reduce excess capacity. These actions, while costly and

difficult, will significantly increase utilization and reduce excess capacity

in the remaining three naval aviation depots. Specifically, following the

1993 BRAC Commission’s approval of a recommendation to close aviation

depots at Pensacola, Florida, Alameda, California, and Norfolk, Virginia,

the Navy completed the closures in about 3 years versus the 6-year period

allowed under the BRAC legislation. The Navy estimates that these closures

and workload redistribution actions, along with interservicing actions and

outsourcing some noncore workloads, will reduce its projected operating

rate by about $10 per hour. Based on a forecast of 13 million direct labor

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Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

hours for fiscal year 1999, this forecast is expected to produce a savings of

about $130 million.

Our work shows that based on a maximum potential capacity and fiscal

year 1999 workload forecasts, the three remaining naval aviation depots

will have an average excess capacity of 37 percent, substantially lower

than the other services. Further, because the Navy reallocated most of the

closing depots’ workloads and specialties to its remaining aviation depots,

and reengineered work spaces in the process, Navy officials state that

given the availability of depot maintenance personnel, capacity utilization

will be about 95 percent. This represents an increase of 36 percent after

the workload transition is completed.

The Navy has closed four of its eight naval shipyards, significantly

reducing excess capacity in the public sector. However, excess capacity

remains, particularly in nuclear capability. The amount of that excess

capacity depends on how much depot level ship repair work the Navy

assigns public shipyards.

The Navy’s

Privatization-in-Place of the

Louisville Depot Was Less

Cost-Effective Than

Redistributing the Workload

The Navy’s privatization of its Louisville depot was not the most

cost-effective choice—it could have saved more through consolidation of

workloads and improved use of capacity in remaining industrial activities.2

 The Louisville, Kentucky, Detachment of the Naval Surface Warfare

Center, Crane Division, a depot recommended for closure by the 1995 BRAC

Commission, supported the overhaul and remanufacture for naval surface

ship gun and missile systems. In analyzing the cost of privatizing the

Louisville workload in-place versus transferring it to another depot, the

Navy estimated that the contract alternative would cost more on an annual

recurring basis and the one-time cost of transferring the workload to

another depot would be prohibitive. However, we found the Navy’s

analyses understated the annual savings of transferring the workloads to

other underused facilities and overstated the one-time transfer costs.

Our analysis shows a one-time cost of $243 million and an annual savings

of $59 million by transferring the workload. The annual savings would

offset the one-time cost in about 4 years. The Navy’s annual savings

estimate recognized that transferring the workloads to underused facilities

would reduce the overhead cost for those production units being

considered for transfer. However, the per-unit savings were applied only

to the workloads transferred and not to existing workloads at receiving

2

Navy Depot Maintenance: Cost and Savings Issues Related to Privatizing-in-Place at the Louisville,

Kentucky, Depot (GAO/NSIAD-96-202, Sept. 18, 1996).

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Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

locations. So, while privatizing the workload in place avoided short-term

cost for transitioning the workload, it is likely to be more costly for the

Navy over the long run.

Operating With Costly Excess

Capacity Is Resulting in

Increased Prices for Army

Depots

Based on the actions taken thus far, the Army has not effectively

downsized its depot maintenance infrastructure to significantly reduce

costly excess capacity.3

 We reported in September 19964 that tentative

plans for implementing the 1995 BRAC decisions by allocating some

workloads from realigned depots to remaining depots will likely achieve

some reduction in excess capacity and savings at two remaining depots.

However, the Army’s failure to follow through with the closure of the

Letterkenny Depot—by consolidating of repair workloads at other Army

depots, and retaining the Red River Depot as directed by the BRAC

Commission—is expected to increase costly excess capacity in the Army

depots, from 42 to 46 percent over the next 3 years.

This increase is caused by several factors including: (1) a forecasted

decrease in future year depot-level workload; (2) the Army’s preliminary

plan to retain most depot operations for missiles at Letterkenny, while

privatizing or transferring to Tobyhanna Army Depot only about 

14 percent of the workload; and (3) the delay in the transfer of the ground

communications-electronics workload from the Sacramento depot to the

Tobyhanna depot. In our September 1996 report, we recommended that

DOD reassess this delay, which is costing the Army about $24 million

annually. Subsequently, on March 13, 1997, the Defense Depot

Maintenance Council approved the Air Force’s proposal for a 3-year

workload transfer beginning in 1998 with the transfer of 20 percent of the

workload in the first year, and 40 percent each in the second and third

years with full-operational capability at the Tobyhanna Depot in 2001.

Delay in Implementing

Depot Closure Is

Increasing Air Force Depot

Maintenance Costs

The Air Force has the most serious excess capacity problem. Delays in

closing two depots identified for closure during the 1995 BRAC extends the

period that the Air Force will operate five depots. During this period, each

depot will operate with declining workloads, excess facilities, and

personnel. This situation will increase the cost of Air Force depot

maintenance operations and result in projected losses of about $90 million

in its depot operations during fiscal year 1997. Three of the six Air Force

3

Although the Army closed the Lexington-Blue Grass, Sacramento, and Tooele Army depots, excess

capacity was still 42 percent in 1995.

4

Army Depot Maintenance: Privatization Without Further Downsizing Increases Costly Excess

Capacity (GAO/NSIAD-96-201, Sept. 18, 1996).

Page 25 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
Appendix II 

Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

depots that existed in 1992 were recommended for closure during the 1993

and 1995 BRAC processes. The Air Force has opted to privatize-in-place one

of these depots and is in the process of using public-private competitions

to decide where the workloads from the other two closing depots will be

performed.

BRAC Decisions and

How DOD Is

Approaching

Implementation

Despite major force structure reductions and significant excess capacity in

the Air Force depot maintenance system, none of the Air Force’s five large,

multicommodity logistics centers or their maintenance depots were

recommended by DOD for closure during the first four BRAC rounds. These

five depots have about 57 million direct labor hours of capacity to

accomplish about 32 million direct labor hours of work, leaving about

26 million hours of excess capacity—or about 45 percent. Also, the Air

Force maintenance depots’ workloads are projected to decline to about

20 million direct labor hours of work in 1999. At this workload level, the

Air Force depots would have about 65 percent unused capacity. Although

the commission identified depots at the Sacramento and San Antonio

centers for closure during the 1995 BRAC process, the executive branch,

citing readiness, up-front costs, and potential effects on the local

community, indicated that these workloads should be privatized-in-place

or in the local communities. Subsequently, DOD announced that it will use

public-private competitions as a means for determining who will perform

the workload from the closing depots.

In December 1996, we reported that if the remaining depots do not receive

additional workloads, they are likely to continue to operate with

significant excess capacity and to become more inefficient and expensive

as workloads continue to dwindle due to downsizing and outsourcing

initiatives.5

 Our analysis indicates that redistributing 8.2 million direct

labor hours of work from the two closing Air Force depots to the three

remaining depots would (1) reduce the projected excess capacity in 1999

from about 65 percent to about 27 percent, (2) lower the hourly rates by an

average of $6 at receiving locations by spreading fixed-cost over a larger

workload, and (3) save as much as $182 million annually as a result of

economies of scale and other efficiencies. This estimate was based on a

workload redistribution plan that would relocate only 78 percent of the

available hours to Air Force depots. About one-half of the remaining

22 percent was captured in savings the Army projected would be achieved

through consolidating ground communications and electronics workload

5

Air Force Depot Maintenance: Privatization-in-Place Plans Are Costly While Excess Capacity Exists 

(GAO/NSIAD-97-13, Dec. 31, 1996).

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Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

at Tobyhanna Army depot. Table II.2 shows an overview of the projected

savings achievable through consolidation and increased use of capacity in

the remaining three Air Force depots.

Table II.2: Potential Savings From Air

Force Depot Consolidation

Depot location

Direct labor

hours

Labor/

overhead rates Cost

Before consolidation

Oklahoma City 7,122,421 $59.11 $421,006,305

Ogden 4,939,623 $65.47 323,397,118

Warner Robins 6,763,218 $59.55 402,749,632

Sacramento 3,222,409 $63.81 205,621,918

San Antonio 5,000,190 $58.24 291,211,066

Total cost $1,643,986,039

After consolidation

Oklahoma City 12,214,902 $50.22 $613,432,378

Ogden 6,626,348 $59.68 395,460,449

Warner Robins 8,206,611 $55.17 452,758,729

Total cost $1,461,651,556

Total potential savings $182,334,483

According to management officials at the three remaining centers, it would

cost about $475 million to absorb all of the Sacramento and San Antonio

workloads. Using our estimate of $182 million in projected annual

consolidation savings, net savings could occur within 2.6 years of the

consolidation.6

 The Air Force believes that the competition process will

demonstrate if outsourcing or workload redistribution is the best value.

Material Cost

Increases Are

Generating Losses for

the Depot

Maintenance Activity

Group

While material costs vary for different commodities and depot

maintenance actions, the cost of reparable and consumable parts is a

significant portion of the cost of depot maintenance activities and of the

composite rates charged depot maintenance customers. For this reason,

inefficiencies in the DOD supply system and inaccurate information about

the quantity and price of spare and repair parts required in the repair

processes may lead to increased costs and losses in the depot

maintenance capital fund. For example, about 40 percent of Air Force

depot maintenance costs are material costs. During fiscal year 1997, Air

Force depots are experiencing a 9-percent loss due to increased cost of

6

In addition, the Army estimates that the BRAC Commission mandated transfer of about 1.2 million

hours of ground communications workload from the Sacramento depot to the Tobyhanna Army Depot

will save an additional $24 million annually.

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Key Factors Impacting the

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Maintenance Program

material. The total effect of awaiting parts on the depot repair cycle

process is not known because its measurement is said to be incomplete

and inconsistent. However, one study reported that partial data indicates

that it is a pervasive and serious problem—in one case, as much as

12 percent of an annual negotiated program was not completed because

parts were not available.7

Inventory Management

Inefficiencies to

Contribute to

High-Maintenance Costs

Since 1992, we have reported that DOD had wasted billions of dollars on

excess supplies, including spare and repair parts used in the depot

maintenance repair process. We reported that the problem resulted

because inherent in DOD’s culture was the belief that it was better to

overbuy items than to manage with just the amount of stock needed. Had

DOD used effective inventory management and control techniques and

modern commercial inventory management practices, DOD would have had

lower inventory levels and would have avoided the burden and expense of

storing excess inventory. In a 1995 report, we stated that managing DOD’s

inventory presented challenges that partially stemmed from the

downsizing of the military forces.8

 We reported that DOD needed to move

aggressively to identify and implement viable commercial practices and

provide managers with modern, automated accounting and management

systems to better control and monitor its inventories.

More recently, we reported that while DOD has clearly had some success in

addressing its inventory management problems, much remains to be done.9

DOD has made little progress in developing the management tools needed

to help solve its long-term inventory management problems. It has not

achieved the economies and efficiencies hoped for from the Defense

Business Operations Fund and the Corporate Information Management

initiatives. As a result of the lack of progress with some of the key

initiatives, it has become increasingly difficult for inventory managers to

manage DOD’s $69 billion spare and repair parts inventory efficiently and

effectively, including determination of budget requirements. Large

amounts of unneeded inventory, inadequate inventory oversight,

overstated requirements, and slowness to implement modern commercial

practices are evidence of the lack of progress. For example:

7

The Depot Repair Cycle Process: Opportunities for Business Practice Improvement, LG406MR1,

May 1996, The Logistics Management Institute.

8

High-Risk Series: Defense Inventory Management (GAO/HR-95-5, Feb. 1995).

9

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

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Key Factors Impacting the

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Maintenance Program

• In our 1995 report, we stated that DOD’s 1994 strategic plans for logistics

called for improving asset visibility in such areas as in-transit assets,

retail-level stocks, and automated systems. Although the asset visibility

plans were to be completely implemented by 1996, DOD currently does not

project to complete the total asset visibility initiative until 2001. Further,

the lack of adequate visibility over operating materials and supplies

substantially increases the risk that millions of dollars will be spent

unnecessarily.

• In 1992 and 1995, we reported that DOD had problems in accurately

determining how much inventory it needs to buy. Our recent work shows

that this continues to be the case. For example, we reported that DOD had

made limited progress in reducing acquisition lead times and that DOD

could reduce its lead time by 25 percent over a 4-year period and save

about $1 billion.10

• We have found that despite DOD’s huge investment in spare and repair

parts, depots often do not have the spare and repair parts to perform

required maintenance. For example, we recently reported that inadequate

consumable parts that are used in large quantities to repair aircraft

components were the primary cause for repair delays at the Corpus Christi

Army depot.11 Also, we found that not having required parts has delayed

the installation of the night vision modification for the F-16 aircraft

because required parts had not been procured—resulting in a production

loss of 31,000 hours. According to Air Force officials, if this work had been

contracted out, the contractor would file a claim to be reimbursed for lost

production time where nonavailability of parts impacted contractor

performance. As a result of this and other production changes, Ogden

officials stated the depot is currently 126,000 hours below planned 1997

production levels, causing a net loss of about $5 million.

Inadequate Control of

Government-Furnished

Stocks Can Contribute to

Losses in Contract Depot

Maintenance

Long-standing problems in managing government-furnished property,

government-furnished equipment, and government-furnished material are

adding millions of dollars to DOD’s depot level maintenance contracting

costs and resulting in losses in the Air Force’s contract maintenance

portion of the working capital fund.

DOD buying commands can choose to provide contractors property,

equipment, and materials for use in repairing items. Contractors are to

10Defense Supply: Acquisition Leadtime Requirements Can Be Significantly Reduced

(GAO/NSIAD-95-2, Dec. 1994).

11Inventory Management: The Army Could Reduce Logistics Costs for Aviation Parts by Adopting Best

Practices (GAO/NSIAD-97-82, Apr. 15, 1997).

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Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

report annually to the services the amount of property and equipment they

have on hand that was furnished by the commands, and the commands are

to reconcile these reports with their records. Material for use in the repair

of items is to be furnished timely and monitored for proper use. Failure to

provide government-furnished material in a timely manner can result in a

claim for compensation from the contractor. Further, since the Air Force,

unlike the other military services, includes contract depot maintenance in

its working capital fund, increased costs over what is budgeted will lead to

losses in the working capital fund.

Management and

Accountability Has Not Always

Been Effective

DOD’s problems in managing and accounting for government-furnished

stocks have been long-standing. For example, in 1993, the Secretary of the

Army requested the Army Audit Agency to examine controls over

government-furnished property because we identified this as a weakness

during our audit of the Army’s fiscal year 1991 financial statements. The

Army Audit Agency found many problems Army-wide, including the

inability to determine the accuracy of contractors’ reports. For instance, at

the Missile Command, contractors reported having about $1.3 billion in

government-furnished property for which the command’s annual summary

report of property in the custody of contractors did not identify. In

April 1996, the Air Force Audit Agency found similar problems at Warner

Robins Air Logistics Center with government-furnished property financial

statement balances that could have been misstated by up to $2.3 billion.

The following are three cases we found where inadequate control over

government-furnished material resulted in increased depot maintenance

costs:

• The Warner Robins Air Logistics Center experienced a $113-million cost

overrun on F-15 maintenance work. Since the early 1980s, the Center has

contracted with Korean Airlines and Israel Air Industries for maintenance

of F-15’s overseas. In 1989, the Center began experiencing cost overruns,

which it determined were directly related to government-furnished

material. Our review shows that the F-15 program managers had sufficient

information about the government-furnished material issue from reports

that were periodically generated from the Center’s automated systems.

However, no actions were taken to resolve the government-furnished

material problem until the contract was being administratively closed out

in 1996. The Center maintains that some of the problems have been

corrected but that others have not. We observed the government-furnished

material status on the current F-15 contract and found that a similar

pattern of cost overrun is occurring.

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Key Factors Impacting the

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• In another case, the Air Force paid $24.9 million to settle claims related, in

part, to its failure to provide the contractor, PEMCO, timely

government-furnished material. PEMCO had filed claims for compensation

between November 1994 and June 1996 for alleged problems related to

programmed depot maintenance for the KC-135 aircraft and had planned

to file additional claims. In September 1996, the Air Force and PEMCO

reached a “global settlement” of $24.9 million where the Air Force

conceded fault in several areas, including the failure to provide material

on time.

• According to program office officials, increased costs resulting from the

contractor’s use of government-furnished material is one of several factors

leading to losses resulting from the privatization of the Aerospace

Guidance and Metrology Center (AGMC) in Newark, Ohio.

Overly Optimistic

Assumptions of Cost

Savings From

Outsourcing Could

Lead to Further Price

Increases

Unanticipated losses in outsourced workloads are another factor

influencing cost growth in the depot maintenance program and losses in

the working capital fund. Reported projections of 20- to 40-percent savings

from outsourcing depot maintenance and other logistics operations have

influenced DOD assumptions that outsourcing will lead to significant

savings. Because assumptions about outsourcing savings were overly

optimistic, expected savings are not being achieved.

AGMC Outsourcing

Illustrates How Overly

Optimistic Saving

Assumptions Lead to

Losses

The Air Force reported to the Congress that the privatization of the AGMC

would result in savings, and it did not budget for increased costs for

post-privatization operations. Customers of the privatized facility—the

Boeing Guidance Repair Center—are not paying enough to recoup the

costs of ongoing repair work and the Air Force Working Capital Fund is

therefore expected to incur losses during fiscal year 1997. The Air Force

has recognized that costs will be higher during fiscal year 1998 and is

increasing its prices by $19 million. Nonetheless, a just released Air Force

Materiel Command study, which was undertaken at our request, states that

privatized repair operations for missile and aircraft inertial navigation

systems could range between about $9 million and $32 million—a 12- to

47-percent increase—with a most likely increase of $17.1 million.

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Assumptions Regarding

Outsourcing Savings Are

Based on Competition, but

Many Current Depot

Maintenance Contracts Are

Sole Source

Facing large shortfalls in its modernization accounts, DOD plans to reduce

costs and generate savings for modernization through the outsourcing of

support activities, including depot maintenance. DOD’s projected savings

level is based largely on estimates made through studies by the

Commission on Roles and Missions (CORM) and Defense Science Board

that outsourcing depot maintenance and other activities will save 20 to

40 percent. Our review shows that savings of this magnitude are

questionable for several reasons. For example (1) projections were based

on the Office of Management and Budget Circular A-76 competitions

between the public and private sector, with the public sector winning

about half of the competitions; (2) the activities being competed were

simple, commercial activities like mowing grass, maintaining buildings,

and operating motor pools where requirements could readily be identified

and for which there were many private sector offerors who could compete

for the work; and (3) savings estimates were estimated, not actual, and

where audited, savings estimates were not achieved. While we believe

savings may be achieved from outsourcing some depot maintenance

workloads, our analysis indicates that little or no savings would result

from outsourcing depot maintenance in the absence of competition.

However, our April 1996 testimony and July 1996 CORM report noted that

much of the depot work contracted to the private sector was awarded sole

source and that obtaining competition for remaining noncore workloads

may be difficult and costly.12 For example, to test for the extent of

competition, we sampled 240 contracts, totaling $4.3 billion, that 12 DOD

buying commands had open during 1995. Of these 240 contracts, 182,

about 76 percent, were awarded on a sole-source basis—about 45 percent

of the total dollar value.

Recently, we asked the DOD buying commands to classify as competitive or

sole source all the new contracts awarded from the beginning of fiscal

year 1996 to date. As shown in table II.3, of the 15,346 contracts totaling

$2.2 billion, 13,930—about 91 percent—were awarded sole source. The

sole-source contracts totaled about $1.5 billion, or about 68 percent of the

total dollars awarded.

12Defense Depot Maintenance: Privatization and the Debate Over the Public-Private Mix 

(GAO/T-NSIAD-96-148, Apr. 17, 1996) and Defense Depot Maintenance: Commission on Roles and

Mission’s Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July 15, 1996).

Page 32 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
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Key Factors Impacting the

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Table II.3: DOD Depot Maintenance

Contracts Awarded From Year 1996 to

Date Competitive Sole source Total

Dollars in millions

Command Number Value Number Value Number Value

Army 2 $1 40 $540 42 $541

Air Force 1,263 443 1,268 336 2,531 779

Navy 151 253 12,622 638 12,773 891

Total 1,416 $697 13,930 $1,514 15,346 $2,211

Table II.4 compares the services’ use of competition for contracts we

sampled in 1995 with that used in contracts awarded since the beginning

of fiscal year 1996. The Air Force had the greatest percent of competitive

contracts in 1995 and 1996. The Army’s use of competition decreased, and

the Navy’s use was low for both periods.

Table II.4: DOD’s Use of Competition

for Depot Maintenance Work

Competitive contracts open

In 1995

Competitive contracts

awarded from FY 1996 to date

Numbers in percent

Service Total number Total value Total number Total value

Army 23 53 5 .2

Air Force 39 62 50 57

Navy 8 39 1 28

Competition Cited as

Reason for Sole-Source

Awards

Our review also showed that, for existing weapon systems, obtaining a

competitive market may be costly for DOD because it has not acquired the

technical data rights for many of its weapon systems. In examining the

reasons for sole-source contracting, we observed that the justification

most often cited was that competition was not possible because DOD did

not own the technical data rights for the items to be repaired. Officials

from the DOD buying commands told us that DOD would have to make

costly investments to promote full and open competition for many of its

weapon systems. Also, we found that savings through competition may be

adversely affected by private businesses that choose not to compete for

maintenance workloads that have (1) small volumes, (2) obsolete

technology, (3) irregular requirements, and (4) unstable funding. DOD may

be able to encourage more competition through bundling common work

and offering contracts with terms and conditions such as multiple options

and multiyear performance periods.

Page 33 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
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Key Factors Impacting the

Cost-Effectiveness of the Defense Depot

Maintenance Program

Other Factors

Effecting Depot

Inefficiencies and

Costs

In addition to the factors we have already discussed, there are a number of

others that impact the efficiency and cost of depot maintenance

operations. In particular, our work shows that: (1) lengthy depot repair

cycles are costly, (2) DOD has been unsuccessful in implementing effective

information systems to adequately support its depot maintenance, and

(3) defense depots must support inefficient workloads and changing

budgets and requirements of their customers. It is important to note that

each of the services has initiated programs to improve their depot

maintenance operations. However, while these programs are

concentrating on key problems, it is too soon to assess effectiveness of

these initiatives.

Reducing Repair Cycle

Days Can Reduce Costs

Reducing the length of the depot repair cycle process is of vital

importance in reducing costs. Reducing repair cycle time reduces the

number of items that must be purchased to support weapon systems and

equipment. One study estimated that for depot level reparables, the

dollar-weighted organic/contractor depot repair cycle time is 86.8 days,

with a resultant repair cycle level investment requirement of $4.4 billion.

That requirement would be decreased an average of $51 million for each

day the repair cycle time is reduced.13

In our April 1997 report, we stated that the Army’s efforts to improve its

logistics pipeline for aviation parts and reduce logistics costs could be

enhanced by incorporating best practices we have identified in the private

sector. The Army’s current repair pipeline, characterized by a $2.6-billion

investment in aviation parts, is slow and inefficient. For example, in one

case we examined, it took the Army four times longer than a commercial

airline to ship a broken part to the depot and complete repairs. Also, for 

24 different types of items examined, we calculated it took the Army an

average of 525 days to repair and ship the parts to field units. The Army

estimates only 18 days (3 percent) should have been needed to repair the

items. The remaining 507 days (97 percent) were used to transport or store

the parts or were the result of unplanned repair delays. Because of this

lengthy pipeline time, the Army buys, stores, and repairs more parts than

would be necessary with a more efficient system. We reported that

implementing industry best practices can be used to achieve significant

improvements and cost reduction. These practices are the prompt repair

of items, the reorganization of the repair process, the establishments of

partnerships with key suppliers, and the use of third-party logistics

13The Depot Repair Cycle Process: Opportunities for Business Practice Improvement, LG406MR1,

May 1996, Logistics Management Institute.

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Key Factors Impacting the

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services. Our work in the Navy and the Air Force depot activities found

similar opportunities for improvement exist.14

Timely and Accurate

Information Systems Are

Essential to Improve Depot

Operations and Costs

Current information systems used to manage the depot repair process do

not provide timely and accurate information essential for improving depot

operations and reducing costs. In 1989, DOD established the Corporate

Information Management Initiative to dramatically improve the way DOD

conducts business, primarily by adopting best business practices used in

the public and private sectors and building the automated information

systems to support those improved practices. In November 1992, DOD

adopted a plan for identifying the best operational logistics information

systems and deploying them among all the services and defense agencies.

This strategy failed to produce the dramatic gains in efficiency and

effectiveness that DOD anticipated.

Our review of depot maintenance systems envisioned under this plan

found that even if the migration effort was successfully implemented as

envisioned, the planned depot maintenance standard system would not

dramatically improve depot maintenance operations in DOD.

15 DOD planned

to invest more than $1 billion to develop a depot maintenance standard

system that would achieve less than 2.3 percent in reduced operational

costs over a 10-year period. Such incremental improvement is significantly

less than the order-of-magnitude improvements DOD has said could be

achieved through reengineering business processes—efforts that were

being postponed until after the development of the standard systems.

DOD subsequently terminated the Depot Maintenance Information System

and the depots had to write off their investment in this effort. Air Force

depots wrote off about $34 million of their investment in this program in

1996, adding to their depot activity group losses that year.

14Inventory Management: Adopting Best Practices Could Enhance Navy Efforts to Achieve Efficiencies

and Savings (GAO/NSIAD-96-156, July 12, 1996) and Best Management Practices: Reengineering the Air

Force’s Logistics System Can Yield Substantial Savings (GAO/NSIAD-96-5, Feb. 21, 1996).

15Defense IRM: Strategy Needed for Logistics Information Technology Improvement Efforts

(GAO/AIMD-97-6, Nov. 14, 1996).

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Key Factors Impacting the

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Maintenance Program

Organic Depots’ Mission Is

to Support Military

Customers’ Programs,

Which Contain Some

Inherent Inefficiencies

While the organic depots can and must implement improvements to

reduce the cost of their depot maintenance operations, they have some

mission requirements that are inherently inefficient. However, performing

these missions is necessary to meet the readiness and support needs of

their customers. For example:

• Many of the depot level reparable components that organic depots must be

prepared to repair have uncertain and infrequent repair requirements. For

example, a contingency response or special training exercises may require

expedited and/or increased repair needs to support key weapon systems

and equipment. Likewise, depots are required to maintain repair

capabilities to support end items and components that may be obsolete,

are maintained in low quantities and/or have infrequent, sporadic

requirements. Neither of these situations are conducive to supporting

low-cost operations, but are necessary to meet the readiness needs of the

customer.

• Changing operational requirements and changing budget requirements

frequently result in changes to the production schedules. Production

changes would result in losses when the volume of work declines or the

mix of resulting work generates less revenue than planned. As previously

discussed, budgets are developed 2 years in advance. Depot officials stated

that changes in the production schedule that impact projected versus

actual revenues are significant.

All Services Have

Initiatives to Improve

Depot Operations

Each of the military services have individual programs designed to address

some depot maintenance inefficiencies. We have recommended such

actions and are encouraged by these efforts. While it is too early to assess

the specific results, our initial impression is that the programs are focusing

on key problem areas, such as reducing repair cycle time. Some examples

of the services improvement initiatives over the past few years include:

• The concept of regional maintenance in the Navy focuses on properly

sizing the shore maintenance infrastructure to support a smaller naval

force while maintaining the Fleet in a high state of readiness.

• The Air Force’s Lean Logistics Program is designed to maximize

operational capability by using high velocity transportation and

just-in-time stockage principles to shorten cycle times, reduce inventories

and cost, and shrink the mobility footprint, and providing flexibility to

manage mission and logistics uncertainties.

Page 36 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
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Key Factors Impacting the

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Maintenance Program

• The Integrated Sustainment Maintenance Program in the Army

regionalizes the repair of components to achieve efficiencies and cost

savings.

• The Marine Corps’ Precision Logistics Program is a change in culture and

a pursuit of smart business practices regarding the speed and accuracy of

information, speed and fluidity of distribution, and reduction in support

cycle times.

Mr. Chairman, this concludes our statement. We would be pleased to

answer any questions you or the Subcommittee may have at this time.

709262, 511616 Page 37 GAO/T-NSIAD/AIMD-97-152 Defense Depot Maintenance
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