Page 1 GAO-06-256R Defense Infrastructure

United States Government Accountability Office

Washington, D.C. 20548

A

December 22, 2005

The Honorable John Warner

Chairman

The Honorable Carl Levin

Ranking Minority Member

Committee on Armed Services

United States Senate

The Honorable Duncan L. Hunter

Chairman

The Honorable Ike Skelton

Ranking Minority Member

Committee on Armed Services

House of Representatives

Subject: Pilot Project to Expand Merchandise Sold in Commissary Stores 

Will Likely Have a Negligible Impact on the Exchange Dividend

The Department of Defense (DOD) has three military exchanges—the 

Army and Air Force Exchange Service, the Navy Exchange, and the Marine 

Corps Exchange—that operate retail and other specialty stores. During 

fiscal years 2000 through 2004, the three exchanges provided more than 

$300 million annually, an average of 55 to 70 percent of their profits, in the 

form of a dividend to support the military services’ morale, welfare, and 

recreation programs.1

 DOD, through the Defense Commissary Agency 

(DeCA), also operates commissaries that sell groceries and authorized 

household products at the lowest practical price, charging patrons only for 

the cost of goods sold plus a 5 percent surcharge. The funds generated by 

the surcharge are used to construct new and modernize existing 

commissaries. 

The Ronald W. Reagan National Defense Authorization Act for Fiscal Year 

2005 authorized the Secretary of Defense to conduct a pilot project 

involving the sale of film, one-time use cameras, and telephone cards in not 

less than 10 commissary stores for a period selected by the Secretary, but 

1

 DOD’s morale, welfare, and recreation programs—such as gymnasiums, libraries, and child 

care centers—provide for the physical, cultural, and social needs and the well-being of 

servicemembers, their families, and eligible civilians and are intended to provide a sense of 

community among patrons to make individuals more satisfied with military life and to 

attract people to military careers.
Page 2 GAO-06-256R Defense Infrastructure

not less than 6 months.2 Previously, these items had only been sold by the 

exchanges. Concerns were expressed by some associated with the 

exchanges that allowing the commissary stores to sell these items could 

adversely affect the exchange dividend, which could reduce the funding for 

the military services’ morale, welfare, and recreation programs. The 

legislation also included a requirement that we examine that issue. In 

response to the 2005 act, we determined (1) the status of the pilot project 

to sell film, one-time use cameras, and telephone cards in select 

commissaries; and (2) the potential impact that the pilot project could have 

on the exchange dividend.

We performed our work at the Office of the Under Secretary of Defense 

(Personnel and Readiness), Arlington, Virginia; Army and Air Force 

Exchange Service headquarters, Dallas, Texas; Navy Exchange 

headquarters, Virginia Beach, Virginia; Marine Corps Exchange 

headquarters, Quantico, Virginia; and DeCA Washington Office, 

Washington, D.C. To determine the status of the pilot project, we reviewed 

the memorandum of agreement that instituted the pilot project and 

interviewed officials at the headquarters of the three exchanges and DeCA. 

To determine the potential impact of the pilot project on the exchange 

dividend, we analyzed sales data for film, one-time use cameras, and 

telephone cards for fiscal years 2003, 2004, and 2005 through September 30, 

2005.3

 We also reviewed financial reports on the amount of exchange 

dividends for fiscal years 2000 through 2004. Finally, we obtained data on 

the percentage of funding for the services’ morale, welfare, and recreation 

programs from the exchange dividend compared to self-generated revenue 

and appropriated funding for fiscal year 2004. We determined that the data 

used were sufficiently reliable for purposes of this review. We conducted 

our review from September through November 2005 in accordance with 

generally accepted government auditing standards.

Summary Officials from the three exchanges and DeCA signed a memorandum in 

November 2005 agreeing to institute a pilot project to sell film, one-time 

use cameras, and telephone cards at 10 commissaries in the continental 

United States. DOD implemented the pilot project at one location in 

November 2005 and plans to implement it at the other nine locations in 

2

 Pub. L. No. 108-375, Section 651 (Oct. 28, 2004).

3

 The exchanges operate on the retail fiscal year, which runs from February through January.
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December 2005. The pilot project is scheduled to last for 2 years. As 

designed, the pilot project is a test of convenience. The commissaries will 

purchase the selected film, one-time use cameras, and telephone cards 

from the exchanges at the exchanges’ retail price and sell the items at the 

same price as the exchanges. The commissaries will receive a management 

fee equal to 2 percent of the sale price of the items to offset the costs for 

handling the pilot project items and will not collect a surcharge on these 

items.

The pilot project should have a negligible impact on the exchange dividend 

because of the design of the pilot project and the small percentage of sales 

from film, one-time use cameras, and telephone cards. The commissaries 

will purchase all pilot project items from the exchanges, less a 2 percent 

management fee. Further, based on our analysis of the exchanges’ sales 

data, the sale of all film, one-time use cameras, and telephone cards 

comprise a very small percentage (less than 1 percent from fiscal years 

2003 through 2005) of annual total exchange sales, and the pilot project 

calls for only selling 8 varieties of these items at 10 locations. Moreover, the 

exchanges would continue to sell the items at their locations throughout 

the pilot project. Based on fiscal year 2004 sales and dividend data, we 

determined that the fiscal year 2004 exchange dividend would have 

decreased by about $600,000, or 0.2 percent, if all sales of all varieties of 

these items were made at the commissaries. Our estimate represents a 

worst case scenario because it includes the sale of all film, one-time use 

cameras, and telephone cards, rather than the eight items selected for the 

pilot project; assumes that all sales of film, one-time use cameras, and 

telephone cards would occur at the commissaries instead of the exchanges; 

and assumes that the sales of these items remain the same as when they 

were only sold in the exchanges.

In written comments on a draft of this report, DOD concurred with the 

overall report.

Background The three military exchanges—the Army and Air Force Exchange Service, 

the Navy Exchange, and the Marine Corps Exchange—are nonappropriated 

fund activities that are established by, controlled by, and operated for the 

benefit of DOD components. The military exchanges have a dual mission of 

providing (1) authorized patrons with articles of merchandise and services 

necessary for their health, comfort, and convenience; and (2) a source of 

funding for the military services’ morale, welfare, and recreation programs. 
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The exchanges operate retail stores, similar to department stores, and 

provide a host of other services and specialty stores, including furniture 

stores, florist shops, barber and beauty shops, optical shops, liquor stores, 

and fast-food restaurants. For fiscal year 2004, the exchange services had 

almost $11 billion in sales. While the exchanges use different methods to 

determine their dividend, between 55 and 70 percent of the exchange 

services’ profits from sales were allocated to morale, welfare, and 

recreation activities through the exchange dividend over the past 5 fiscal 

years and the remaining profits were reinvested in the exchange system 

and used primarily to build new exchange facilities and related capital 

improvements. 

The exchanges’ dividend has fluctuated somewhat over the past 5 years. 

Figure 1 shows the exchange dividend for each exchange for fiscal years 

2000 through 2004. 

Figure 1: Exchange Dividend by Exchange for Fiscal Years 2000 - 2004

Note: The Navy Exchange data do not include the Ships’ Stores.

0

50

100

150

200

250

300

2000 2001 2002 2003 2004

Dollars in millions

Source: DOD.

Fiscal year

Army and Air Force Exchange Service

Navy Exchange

Marine Corps Exchange 
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The Army and Air Force Exchange Service’s dividend fluctuated from a 

high in 2000 of $260.4 million to a low in 2002 of $220.1 million before 

increasing again to $242.2 million in 2004. Similarly, the Navy Exchange’s 

dividend was at its high of $53.3 million in 2000, at a low of $41.4 million in 

2002, and was around $50 million in 2003 and 2004. The Marine Corps 

Exchange’s dividend fluctuated from year to year, but remained near $30 

million, with the exception of its lowest year, 2004, when the dividend was 

$26.1 million.

The exchange dividend makes up a small portion of the total funding for 

the services’ morale, welfare, and recreation programs—less than 10 

percent of each service’s total morale, welfare, and recreation funding in 

fiscal year 2004, as shown in figure 2. 

Figure 2: Source of Morale, Welfare, and Recreation Program Funding, Fiscal Year 

2004

0

10

20

30

40

50

60

70

80

90

100

Marine 

Corps

Air Navy

Force

Army

Percent

Military service

Exchange dividends

Self-generated revenue

Appropriated funding

Source: DOD.
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DeCA is DOD’s designated agency for managing commissary stores 

worldwide. DeCA’s mission is to provide beneficiaries with groceries and 

authorized household products at the lowest practical price, charging 

patrons only for the cost of goods sold plus a 5 percent surcharge. The 

funds generated by the surcharge are used to acquire (including acquisition 

by lease), construct, repair, maintain, and equip the physical infrastructure 

of commissary stores. DeCA ended fiscal year 2004 with 273 stores and 

sales over $5 billion. 

Pilot Project In Process 

of Being Implemented 

Officials from the three exchanges and DeCA signed a memorandum in 

November 2005 agreeing to institute a pilot project to sell film, one-time 

use cameras, and telephone cards at 10 commissaries in the continental 

United States.4

 DOD implemented the pilot project at one location in 

November 2005 and plans to implement it at the other nine locations in 

December 2005. The exchanges and DeCA selected eight specific items for 

the pilot project—two types of film, three types of one-time use cameras, 

and three types of telephone cards.5

 Exchange officials said that the items 

selected for the test were the exchanges’ best selling items in these 

categories. The pilot project is scheduled to last for 2 years; however after 1 

year the exchange services and DeCA can agree to terminate the pilot 

project. 

As designed, the pilot project is a test of convenience. The 10 commissaries 

will purchase the pilot project items from the exchanges at the exchanges’ 

retail price and sell the items at the same price as the exchanges. The 

exchanges will continue to sell the pilot project items in the exchanges. 

The exchanges will pay the commissaries a management fee equal to 2 

percent of the sales price of the pilot project items to offset the cost of 

4

 The 10 commissaries chosen for the pilot project are Andrews Air Force Base, Maryland; 

Buckley Air Force Base, Colorado; Fort Bliss, Texas; Fort Knox, Kentucky; Fort Lee, 

Virginia; Norfolk Naval Base, Virginia; Patuxent River Naval Air Station, Maryland; Port 

Hueneme, California; Quantico Marine Corps Base, Virginia; and Wright-Patterson Air Force 

Base, Ohio.

5

 The items included in the pilot project are Kodak 800 speed film, 4 pack; Kodak 400 speed 

film, 4 pack; Kodak One-time Use Camera, Zoom; Kodak One-time Use Camera, Max Flash; 

Kodak One-time Use Camera, Funsaver; AT&T 100 Unit Global Phone Card (Army and Air 

Force Exchange System)/ 150 Unit (Navy Exchange, Marine Corps Exchange); AT&T 200 

Unit Global Phone Card (Army and Air Force Exchange System)/ 300 Unit (Navy Exchange, 

Marine Corps Exchange); and AT&T 550 Unit Global Phone Card.
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handling the pilot project items. The commissaries will not collect a 

surcharge on the sale of pilot project items.

Pilot Project Should 

Have Negligible Impact 

on the Exchange 

Dividend

The pilot project should have a negligible impact on the exchange dividend 

used to support the military services’ morale, welfare, and recreation 

programs. The exchanges will not lose any sales of film, one-time use 

cameras, or telephone cards to the commissaries during the pilot project 

because the commissaries will purchase the items from the exchanges and 

will continue to sell the items themselves. However, the exchanges will pay 

DeCA a 2 percent management fee on the sale of these items. In addition, 

the sales of all film, one-time use cameras, and telephone cards represented 

less than 1 percent of the total sales for the three exchanges for fiscal years 

2003 through 2005. 

According to DOD officials, the pilot project was designed to have minimal 

impact on the exchange dividend. Specifically, as previously mentioned, the 

10 commissaries involved in the pilot project will purchase the pilot project 

items from the exchanges, rather than an outside vendor, and sell the items 

at the same price as the exchanges. Because the commissaries will 

purchase all items from the exchanges and the exchanges will continue to 

sell the items in their locations, the exchanges will not lose any sales of 

film, one-time use cameras, and telephone cards to the commissaries.

The sales of all film, one-time use cameras, and telephone cards comprised 

less than 1 percent of total retail sales for the exchanges from fiscal years 

2003 through 2005, as shown in figure 3. Telephone cards were the largest 

proportion of the three categories in terms of dollar sales, ranging from a 

low of 0.08 percent of sales at the Marine Corps Exchange in fiscal year 

2003 to a high of 0.70 percent of sales at the Army and Air Force Exchange 

System in fiscal year 2005. 
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Figure 3: Exchange Sales of All Film, One-Time Use Cameras, and Telephone Cards 

as a Percentage of Total Exchange Sales, Fiscal Years 2003-2005

Notes: The sales data include the sales of all film, one-time use cameras, and telephone cards, not 

only those eight items selected for the pilot project. The Navy Exchange data do not include the Ships’ 

Stores. 

As previously noted, the pilot project includes eight items and not all the 

film, one-time use cameras, and telephone cards sold in the exchanges. 

Comparable data on the sales of only the 8 items and 10 installations 

included in the pilot project were not available. To show the potential 

impact on the exchange dividend, we assumed that the commissary stores 

accounted for the sale of all film, one-time use cameras, and telephone 

cards. Based on fiscal year 2004 sales and dividend data, we determined 

that the exchange dividend would have been reduced by about $600,000, or 

0.2 percent, as shown in table 1. 

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Marine Corps

Exchange

Army and Air Force Navy Exchange

Exchange Service

Percent

Source: GAO analysis of DOD data.

Fiscal year

Film

One-time use cameras

Phone cards

2003 2004 2005 2003 2004 2005 2003 2004 2005

17
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Table 1: Potential Impact of the Pilot Project on the Exchange Dividend Based on 

Fiscal Year 2004 Data

Source: GAO analysis of DOD data.

Note: The Navy Exchange data do not include the Ships’ Stores.

Our estimate represents the worst case scenario because it includes the 

sale of all film, one-time use cameras, and telephone cards, and not just the 

8 items included in the pilot project or the 10 locations selected for the pilot 

project. In addition, we assumed that the commissaries would account for 

all sales since we have no basis to determine the extent to which sales 

would be split between the exchange stores and the commissary stores. In 

addition, our analysis does not consider whether the overall sales of these 

items would increase or whether the pilot project could reduce sales of 

other items at the exchanges due to a loss of foot traffic.

Agency Comments In commenting on a draft of the report, the official performing the duties of 

the Principal Deputy Under Secretary of Defense (Personnel and 

Readiness) concurred with the overall report. DOD also provided technical 

comments which were incorporated as appropriate. DOD’s comments are 

reprinted in the enclosure of this report.

We are sending copies of this report to the Secretary of Defense; the Under 

Secretary of Defense (Personnel and Readiness); the Commander, Army 

and Air Force Exchange System; the Commander, Navy Exchange 

Command; the Director, Personal and Family Readiness Division, U.S. 

Marine Corps; the Chairman, Commissary Operating Board; the Director, 

DeCA, and the Director, Office of Management and Budget. We will make 

Dollars in thousands

Exchange

Actual exchange 

dividend (2004)

Potential decrease in exchange 

dividend

Dollars Percentage

Army and Air Force 

Exchange Service

$242,179 $370 0.15

Navy Exchange 48,667 203 0.42

Marine Corps Exchange 26,141 22 0.08

Total $316,987 $595 0.19
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available at no charge on GAO’s Web site at http://www.gao.gov.

Please contact me at (202) 512-5581 if you or your staff have any questions 

concerning this report. Contact points for our Offices of Congressional 

Relations and Public Affairs may be found on the last page of this report. 

Major contributors to this report were Michael Kennedy, Assistant 

Director; Hilary Murrish; James Nelson; and Alissa Czyz.

Barry W. Holman

Director

Defense Capabilities and Management 

Enclosure
Page 11 GAO-06-256R Defense Infrastructure

Enclosure: Comments from the Department of 

Defense

(350751)
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