Supply Chain Management: DOD Could More Efficiently Use Its Distribution Centers
Published: 2017-06-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2015, DLA generated $23 billion in revenues from supply chain management sales to the military departments and other customers, such as federal agencies. These sales included commodities and distribution services provided through the Defense-wide Working Capital Fund, a revolving fund.
Senate Report 114-255 and House Report 114-537 included provisions for GAO to evaluate DLA's costs to provide commodities and services using the Defense-wide Working Capital Fund. This report identifies trends in the costs and annual prices that DLA has charged for commodities and distribution services; and evaluates the extent to which DOD has taken steps to more efficiently use its network of U.S. distribution centers. GAO analyzed the most currently available DLA cost data, estimated and actual revenue, and prices for commodities and distribution services since fiscal year 2009; reviewed DOD documentation; and interviewed knowledgeable DOD officials.
section_title: What GAO Found
paragraphs: GAO found that since fiscal year 2009, the Defense Logistics Agency (DLA)—the largest logistics combat support agency for the Department of Defense (DOD)—had reduced costs and maintained fairly constant prices for commodities, such as repair parts, clothing, and food. When developing annual budgets, DLA has generally underestimated revenue from the sales of commodities. The underestimated revenue contributed to gains that were applied to future year prices in the form of reductions, and helped offset inflationary increases in material costs.
GAO also found that since fiscal year 2011, DLA had reduced costs for distribution services (e.g., the processing and storing of inventory) by about 25 percent through the use of existing authorities to reduce infrastructure. However, DLA has often increased annual prices for distribution services by more than 10 percent due, in part, to a declining workload. DLA has generally overestimated revenue from the sales of distribution services. The overestimated revenue contributed to losses as well as to price increases in subsequent years as DLA sought to recover those losses.
DOD has taken steps to increase the use of DLA's 17 U.S. distribution centers to improve efficiency of DLA's operations, but additional opportunities for efficiencies exist across DOD's network of approximately 256 U.S. distribution centers. In January 2017, DOD revised guidance to require storage of government-owned inventory at DLA's distribution centers instead of at privately owned storage when both are located in the same geographic area to reduce costs. DOD has also identified inefficiencies in the provision of its distribution services. Specifically, the military departments, along with DLA, provided distribution services using U.S. distribution centers that often were in close proximity to or located on the same installation. To address inefficiencies, DOD established a program to, among other things, decrease the number of U.S. distribution centers. In October 2014, DOD discontinued the program without implementing its plan to reduce the number of distribution centers. Though DLA has been able to use existing authorities to realign functions and demolish some facilities to gain efficiencies at its distribution centers, DOD officials told us the department needs Base Realignment and Closure authority—a process whereby Congress authorizes an independent federal commission to review and determine whether to forward to the President for approval DOD's proposals to realign and close military installations—to address any additional inefficiencies. GAO found, however, that DOD had not assessed the extent to which the department could further use its existing authorities to minimize unnecessary overlap or duplication in its network of distribution centers. Without assessing the use of its existing authorities, inefficiencies in DOD's network of U.S. distribution centers that the department has previously identified may remain.
section_title: What GAO Recommends
paragraphs: GAO recommends that DOD assess and direct the implementation of actions, as appropriate, that can be taken using existing authorities to close, realign, or dispose of existing infrastructure to more efficiently use the department's network of U.S. distribution centers. DOD concurred with the recommendation.

section_title: Letter
paragraphs: The Department of Defense (DOD) manages a complex, multibillion- dollar system for delivering needed commodities and services to support  U.S. military forces worldwide. DOD’s goal in operating this system,  referred to as the department’s supply chain, is to deliver the right item to  the right place at the right time and at the right cost. The Defense  Logistics Agency (DLA)—DOD’s largest logistics combat support  agency—provides commodities and services to support U.S. military  forces. To operate supply chain management activities, DLA uses the  Defense-wide Working Capital Fund, a revolving fund whereby DLA’s  customers pay for the support that they receive. In fiscal year 2015, DLA  generated $23 billion in revenue to reimburse the fund from supply chain  management sales to the military departments and other customers, such  as federal agencies and U.S. international allies. These sales included  commodities (e.g., troop support items such as clothing, medicine, food,  and consumable repair parts for weapon systems) and distribution  services (e.g., the processing and storing of inventory). While DLA aims  to stabilize its prices during each budget execution year, the military  departments have expressed concerns about fluctuations in distribution  service prices between budget years. In addition, DLA and the military departments operate a large network of approximately 256 distribution  centers. Some of these centers are co-located or in close proximity to  one another.
For more than 25 years, we have identified opportunities for DOD to  improve the effectiveness and efficiency of its supply chain management  to support the needs of U.S. military forces while reducing the  department’s spending to potentially make funds available for other  defense priorities. For example, in 1990 we added DOD’s supply chain  management to our list of high-risk areas in the federal government due,  in part, to weaknesses in inventory management practices and  procedures in forecasting the demand for inventory items and other  challenges. In February 2017, we found that DOD had made significant  progress in improving inventory management, although additional actions  were needed to improve two other aspects of supply chain  management—materiel distribution and asset visibility. Further, in June  2016 we reported on the military departments’ efforts to implement a  2005 Base Realignment and Closure recommendation to transfer retail  supply, storage, and distribution functions from the military departments  to DLA to gain efficiencies in delivering these functions. We found that  the Air Force had transferred all of its retail functions to DLA and that the  Navy had transferred its fleet readiness centers’ retail functions, but not  its shipyards, to DLA. We found that the Army and the Marine Corps had  not transferred their retail functions from their depots to DLA. We  recommended that DOD conduct business case analyses, drawing on  lessons learned, to determine if further transfers of retail functions are  warranted. DOD concurred with our recommendations.
Senate Report 114-255 and House Report 114-537, to accompany bills  for the National Defense Authorization Act for Fiscal Year 2017, include  provisions for us to evaluate DLA’s overhead costs to provide  commodities and distribution services funded using the Defense-wide  Working Capital Fund. We examined material costs of commodities and  operating costs—including direct and indirect costs—to provide  commodities and distribution services. We also examined the  relationship between costs, estimated revenue, and the prices that DLA  has charged for its commodities and distribution services. Specifically, we  identified any trends since fiscal year 2009 in (1) the costs and the annual  prices that DLA has charged for commodities and (2) the costs and the  annual prices that DLA has charged for distribution services; and we (3)  evaluated the extent to which DOD has taken steps to more efficiently  use its network of U.S. distribution centers.
For objectives one and two, we reviewed the process that DLA used to  set prices for commodities and distribution services. Specifically, we  reviewed cost data, estimated and actual revenue, and prices that DLA  ultimately charged for commodities and for distribution services. In  addition, we reviewed sections in DOD’s Financial Management  Regulation specific to working capital funds. For commodities, we  analyzed operating costs as a percentage of the material costs of  commodities sold, as reported in DOD budget justification materials  submitted to Congress for fiscal years 2009 through 2015. We began with  fiscal year 2009 to provide us with a 7-year period of data on actual costs.  Unlike for commodities, DOD does not have an approach to report DLA’s  operating costs to provide distribution services in budget justification  materials for the Defense-wide Working Capital Fund because DOD is not  required to report this information. Therefore, we requested data from  DLA on its operating costs, including direct and indirect costs, for  distribution services for fiscal years 2009 through 2015. We began with  fiscal year 2011 because DLA did not have complete data available for  fiscal years 2009 and 2010 and ended with fiscal year 2015 because this  was the last full year available with complete data on actual costs at the  time of our review. We adjusted the operating costs for inflation into  constant fiscal year 2015 dollars.
In addition, we obtained data from DLA’s business system database on  estimated and actual revenue for commodities and distribution services  for fiscal years 2009 through 2015. Our analysis ends with fiscal year  2015 because this was the last full year with complete available data on  actual revenue at the time of our review. We adjusted the estimated and  actual revenue into constant fiscal year 2015 dollars. We compared  estimated revenue with actual revenue for commodities and for  distribution services to identify any differences. We also analyzed data on  aggregate price changes for commodities from DOD’s budget materials  from fiscal years 2009 through 2017. For distribution services, we  analyzed data on prices for selected distribution services from DOD’s  budget materials from fiscal years 2009 through 2017. We adjusted the  prices into constant fiscal year 2017 dollars and calculated the annual  percent change. We interviewed officials from the Office of the Under  Secretary of Defense, Comptroller (OUSD Comptroller) and Defense  Logistics Agency, Finance (DLA Finance) to obtain information on the  relationship between costs, revenue, and annual prices within the context  of the Defense-wide Working Capital fund. We verified the completeness  and accuracy of the data we obtained with OUSD Comptroller and DLA  Finance officials and determined that the data were sufficiently reliable for  the purposes of addressing our reporting objectives with attribution to  DOD and the source documents.
For objective three, we interviewed officials from DLA, the OUSD  Comptroller, and two offices within the Office of the Under Secretary of  Defense for Acquisition, Technology, and Logistics—Logistics and  Materiel Readiness and Energy, Installations, and Environment—and  obtained documentary evidence to understand how DOD’s network of  U.S. distribution centers are managed for improved efficiency. We  reviewed documents associated with a DOD efficiency initiative, the  Strategic Network Optimization program. We compared DOD’s efforts to  manage its network of distribution centers with responsibilities assigned in  DOD Directive 5134.01, Under Secretary of Defense for Acquisition,  Technology, and Logistics to assess the extent to which the department  has used DOD’s existing systems, facilities, and services to avoid  unnecessary overlap and duplication to achieve maximum efficiency and  economy.
We conducted this performance audit from May 2016 to June 2017 in  accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Roles and Responsibilities
paragraphs: The DOD supply chain is a global network through which DLA and the  military departments provide commodities and distribution services to the  U.S. military forces. The Office of the Under Secretary of Defense for  Acquisition, Technology, and Logistics and its subordinate, the Office of  the Assistant Secretary of Defense for Logistics and Materiel Readiness,  prescribe policies and procedures for the conduct of logistics,  maintenance, materiel readiness, and sustainment support, to include  supply and transportation, and monitor and review these activities. The  Office of the Assistant Secretary of Defense for Logistics and Materiel  Readiness also exercises authority, direction, and control over DLA. In  addition, the Office of the Under Secretary of Defense for Acquisition,  Technology, and Logistics has overall responsibility and oversight of DOD  real property, including the infrastructure in DOD’s network of distribution  centers, and its subordinate, the Office of the Assistant Secretary of  Defense for Energy, Installations, and Environment, is responsible for  managing policy for DOD’s real property. The Secretaries of the military  departments also have specific assigned responsibilities for real property  management that include implementing policies and programs to acquire,  manage, and dispose of real property.
The OUSD Comptroller establishes the policies and procedures for  DOD’s financial management, including the Defense-wide Working  Capital Fund. As part of this role, the OUSD Comptroller provides  guidance in DOD’s Financial Management Regulation to operate the  Defense-wide Working Capital Fund and to set prices for commodities  and services that are to reimburse the fund. In addition, the OUSD  Comptroller provides oversight of the prices set by DLA during the annual  budget process.
DLA is responsible for the effective and efficient provision of commodities  and services that have been determined to be appropriate for integrated  management by a single agency on behalf of all DOD components, or  that have been otherwise specifically assigned. To carry out this  responsibility, DLA is organized into five management subgroups for  commodities that provide troop support—clothing and textiles,  construction and equipment, industrial hardware, medical, and  subsistence—three subgroups for commodities that support weapons  systems—aviation, land, and maritime—and one subgroup for distribution  services.
section_title: Price and Cost Recovery
paragraphs: During the annual budget formulation process, DLA establishes a price to  charge its customers for commodities and distribution services for that  upcoming budget year. In the current budget year, however, these prices  remain unchanged. This “stabilized” price is intended to protect DLA’s  customers, who are appropriated funds based on the expected price,  from any market price volatility. Instead, the cash balance of the Defense- wide Working Capital Fund absorbs any fluctuations in the costs to  procure or to provide the commodity or distribution services during the  current budget year. According to DOD’s Financial Management  Regulation, the goal of the fund is to remain revenue-neutral—to neither  make a gain nor incur a loss—over time. At the end of execution of each  budget year, DLA assesses its actual revenue against its actual costs.  Any gains are returned to customers as reductions to future prices. Any  losses will be added as increases to future prices, with the aim of  ultimately recovering all costs to the fund. A price increase resulting from  a loss will apply to all consumers of the good or service, regardless of the  impact of their demand on DLA’s costs. This practice results in some  cross-subsidization across the military departments.
DLA considers three components to set prices for a budget year: costs,  price adjustments, and estimated workload.
Costs: DLA’s commodities include two types of costs, material costs  and operating costs, while DLA’s distribution services involve only  operating costs. Material cost is the cost of procuring a commodity  from a vendor (e.g., purchasing fabric and having uniforms sewn) and  operating costs are the non-material costs to provide a commodity  (e.g., storing uniforms and shipping once ordered). Operating costs— also referred to as “overhead”—are further defined as direct or indirect  costs. A direct cost is associated with direct support to a specific  mission (e.g., labor to process uniform orders) while an indirect cost is  associated with support provided to multiple missions or agency-wide  operational activities (e.g., information technology). Both direct and  indirect costs can include labor and non-labor costs.
Price adjustments: There are four types of price adjustments that can  be used to increase or decrease cash balances with the fund. These  include responses to revenue gains or losses as well as cash  surcharges, capital surcharges, and depreciations. DLA adjusts prices  for both commodities and distribution services based on revenue  gains or losses to remain revenue-neutral over time. In addition, DLA  may use cash surcharges, capital surcharges, and depreciation to  adjust prices for commodities. Cash surcharges are used to recover  unplanned investments in inventory to ensure that the appropriate  cash balance is maintained. Capital surcharges or depreciations are  used to cover the costs associated with capital or infrastructure- related investments, depending on the number of years needed to  recover the cost to prevent steep increases in the year-to-year price.
Estimated workload: DLA’s estimation of its customers’ requirements  for a future budget year is based on input from the military  departments on their budget planning decisions and execution data  from prior years. These estimates may be made as early as 18  months before the budget year.
The sum of the costs and all price adjustments represents the amount of  revenue that is required to break even. This total is divided by the  estimated workload to determine a price, as shown in figure 1.
section_title: DLA Has Contributed to Reductions in Costs and Has Maintained Fairly Constant Prices for Commodities since 2009
paragraphs: Since fiscal year 2009, DLA has contributed to reductions in the costs to  provide its commodities and has maintained fairly constant prices for  them. Specifically, our analysis showed that DLA’s operating costs, as a  percentage of material costs, declined by almost 6 percent between fiscal  years 2009 and 2015. When developing annual budgets, DLA has also  generally underestimated revenue for commodities, which has contributed  to gains that were subsequently applied as reductions to future prices.  Lastly, we found that DLA has maintained fairly constant prices for  commodities, which have not exceeded an annual increase of more than  3.3 percent due, in part, to the reductions in costs and revenue gains.  OUSD Comptroller officials told us that they consider increases above 5  percent to be significant.
subsections: section_title: DLA’s Operating Costs to Provide Commodities Has Declined by Almost 6 Percent
paragraphs: Since fiscal year 2009, DLA’s operating costs to provide commodities to  the military departments and other customers has declined by almost 6  percent. As discussed earlier, DLA’s commodities include two types of  costs, material costs (i.e., the cost of procuring a commodity from a  vendor) and operating costs (i.e., the non-material costs to provide a  commodity). DOD monitors the operating costs that DLA charges by  assessing the proportion of these costs to the material cost, and then  reports this information in budget justification materials for the Defense- wide Working Capital Fund.
Our review of this information shows DLA’s proportion of operating costs  to the total cost declined by 5.7 percent, from 14.0 percent in fiscal year  2009 to 13.2 percent in fiscal year 2015. DLA officials told us they have  contributed to reductions in their operating costs, in part through various  actions such as improvements to customer delivery methods and  integration of information technology systems. For example, for items that  are readily available from commercial vendors, such as most medical and  subsistence commodities, DLA keeps operating costs low by not  purchasing or storing these items. Instead, DLA has these items shipped  directly from the vendors to DLA’s customers when ordered. In addition,  DLA consolidated different legacy financial and business operation  databases into one enterprise-wide system to streamline business  functions across DLA and to improve the quality and timeliness of data  used to inform DLA’s operations.
section_title: DLA Has Generally Underestimated Revenue for Its Commodities
paragraphs: For fiscal years 2009 through 2015, DLA underestimated annual revenue  for commodities in all but 2 fiscal years, as shown in figure 2. DLA  develops annual revenue estimates based on operating costs and the  military departments’ estimated workload demands during the annual  process to develop a budget and set prices for commodities. When actual  revenue is more than estimated revenue, DLA must adjust future prices to  return the gained revenue to its customers. Similarly, when actual  revenue is less than estimated, DLA must increase future prices to make  up for lost revenue.
In the fiscal years that DLA underestimated revenue for commodities, the  difference between the estimated and actual revenue ranged between 9.9  percent and 26.4 percent. For these years, DLA yielded a gain above  estimated costs that ranged between $1.9 billion and $5.2 billion in fiscal  year 2015 dollars. According to DLA officials, in years for which they  underestimated revenue, the military departments had more workload  demand than DLA had initially anticipated. Specifically, the military  departments purchased more commodities than anticipated when DLA  was formulating the budget for that fiscal year, a process that typically  occurs more than 18 months earlier. Some of the difference can be  explained by unanticipated changes in DLA’s actual workload that were  not part of the estimated workload demand. For example, in 2010, the  Defense Health Agency implemented a home prescription service that  increased revenue for DLA’s medical supply chain group. Also, in 2014,  the firefighting equipment and materials, known as “stock group 80”, was  transferred from the General Services Administration to DLA, increasing  DLA’s customers for the items to all federal, state, and local firefighters.
In contrast, in fiscal years 2013 and 2014, DLA overestimated revenue by  3.2 percent and 4.4 percent, respectively, and experienced lost revenue  of approximately $670 million and $970 million, respectively, in fiscal year  2015 dollars. These losses are much smaller in magnitude compared with  the gains in other fiscal years. The workload demand in these 2 fiscal  years was less than DLA had initially anticipated. For example, DLA  officials told us that the military departments’ workload demand when  formulating the budget for fiscal year 2013 did not anticipate the  sequestration ordered in March 2013, which triggered a reduction in  spending authority across all DOD accounts funded with nonexempt  discretionary amounts. Also, when formulating the budget for fiscal year  2014, the workload estimates did not anticipate lower enacted funding  than DOD planned due to the Budget Control Act of 2011.
Our prior work has found that, while challenging to do, the military  departments can take action to better estimate their workload demand for  commodities. For example, we identified weaknesses in the demand  forecasts for spare parts that have contributed to the military departments  creating at times inventory in excess of current need and backorders of  spare parts across DOD. DOD has taken steps to address weaknesses  in this forecasting for commodities through the implementation of the  department’s Comprehensive Inventory Management Improvement  Plan. As part of this effort, the Office of the Assistant Secretary of  Defense for Logistics and Materiel Readiness, in collaboration with the  military departments and DLA, began using two metrics to track and  monitor each organization’s performance in accurately forecasting the  workload demand for spare parts. We have found that DOD has taken  actions that have resulted in greater accuracy in its forecasts and that  DOD continues to implement additional actions aimed at improved  forecasting, including efforts to measure the accuracy of planning  factors.
section_title: DLA Has Maintained Fairly Constant Prices for Commodities
paragraphs: DLA has maintained fairly constant prices for commodities since fiscal  year 2009, due in part to reductions in operating costs and large gains in  revenue, as previously discussed. Specifically, we found that the  aggregate price for all commodities that DLA offers has increased  marginally since fiscal year 2009, but that year-to-year fluctuations did not  exceed an increase of 3.3 percent between fiscal years 2009 and 2017,  as shown in figure 3. DOD reports the year-to-year change in price in the  annual budget justification materials submitted to Congress. OUSD  Comptroller officials told us that they consider increases above 5 percent  to be significant.
As discussed earlier, for all but 2 of the fiscal years we reviewed, DLA  reduced the costs to provide commodities and returned the gains from  prior fiscal years to its customers in the form of reductions in future fiscal  year prices. For example, in fiscal year 2009, DLA had a revenue gain of  about $5.2 billion that could be applied to reduce future prices. Such  revenue gains have contributed to the marginal increases in DLA’s annual  prices for commodities by offsetting inflationary increases in material  costs and the relatively smaller revenue losses of fiscal years 2013 and  2014, among other things. OUSD Comptroller officials told us they collect  information on the aggregate year-to-year change in price for  commodities to understand any potential impacts on the budget and to  monitor growth in prices attributed to an increase in the costs to provide  the commodities. Officials told us they conduct a review when prices  increase above 5 percent, seek additional details to understand the  specific costs that are influencing the increase, and direct DLA, when  necessary, to make adjustments in how it allocates cost when setting a  price.
DLA and OUSD Comptroller officials told us that while aggregate prices  have remained stable, the individual prices of commodities that DLA  offers its customers may experience price increases between fiscal years,  and that such increases are usually generated by growth in material  costs. To help control increases in material costs, DLA has implemented  numerous initiatives that have further contributed to the relative price  stability. For example, DLA awarded more long-term contracts (whereby  prices are set over the contract period) and introduced reverse auctions  (whereby suppliers can view other suppliers’ bids with the intent of  increasing competition among the suppliers to lower bids).
section_title: DLA Has Contributed to Overall Reductions in Costs but Has Often Significantly Increased Prices for Its Distribution Services
paragraphs: Between fiscal years 2011 and 2015, DLA has contributed to reductions  by about 25 percent in its overall operating costs for providing distribution  services, in part, through the use of existing authorities to reduce  infrastructure, while the indirect portion of these costs increased by 9.4  percent. This increase in indirect costs was due, in part, to policy-driven  changes such as to achieve audit readiness. However, DLA has  consistently overestimated revenue since fiscal year 2009 for distribution  services, which resulted in losses that DLA must eventually recover in  future year prices. Finally, we found that DLA had often increased annual  prices above 10 percent for fiscal years 2009 through 2015 as a result of  a declining workload and the need to recoup losses, among other things.
subsections: section_title: DLA Has Contributed to Reductions in Operating Costs to Provide Distribution Services, but Indirect Costs Have Increased
paragraphs: DLA has contributed to an overall reduction in operating costs of about 25  percent to provide distribution services to the military departments and  other customers between fiscal years 2011 and 2015. DLA’s operating  costs for distribution services can either be direct (e.g., the labor to  operate a distribution center) or indirect (e.g., administrative support).  According to DLA’s data, direct costs have declined by more than half (or  55.8 percent) from about $1.1 billion in fiscal year 2011 to $480 million in  fiscal year 2015. DLA has achieved cost reductions, in part, by using  existing infrastructure-related authorities to implement the following steps:
Demolishing facilities: DOD has authority to dispose of infrastructure  assets under certain conditions. As part of DLA’s initiative to reduce  excess inventory, officials took steps to demolish warehouses in poor  condition that DOD determined were no longer needed through its  demolition approval process. Since 2012, DLA has taken action to  demolish 42 buildings, totaling 4.6 million gross square feet. These  efforts were concentrated at distribution centers in Richmond, Virginia;  Mechanicsburg, Pennsylvania; and San Joaquin, California.  According to DLA officials, this effort contributed to reducing DLA’s  costs to operate the facilities and achieved cost savings for the  department.
Closing and realigning operations: DOD has authority to close or  realign facilities outside of a Base Realignment and Closure process  based on certain thresholds. In 2013, DLA used this authority to  consolidate all of its San Joaquin regional operations at its Tracy  Defense Distribution Depot and to terminate its operations at Sharpe  Army Depot, reducing costs to DLA by about $8.5 million in fiscal year  2015. According to officials, this effort achieved a cost savings and  future cost avoidance for DLA, but the Army continues to operate the  space that DLA formerly used at Sharpe Army Depot. Therefore, the  effort did not achieve a cost savings for the department as a whole.
Although direct costs have declined, indirect costs have increased for  distribution services by 9.4 percent over the same period. Specifically,  DLA identified three different categories of indirect costs that have  significantly increased since fiscal year 2011. Most of these costs are  considered policy-driven changes, but DLA has taken steps to manage  growth in these areas and continues to look for opportunities to reduce them in the future. The indirect costs, which have been adjusted into  constant fiscal year 2015 dollars, are as follows:
Audit readiness: The costs associated with achieving audit readiness  across DLA increased from $1.3 million in fiscal year 2011 to $151.9  million in fiscal year 2015, more than a hundredfold increase. DLA  officials stated they allocated an average of 1.6 percent of these costs  to distribution services. According to DLA officials, in order to add  inventory controls associated with the department’s congressionally  mandated efforts to become auditable, DLA had to invest in  technology and hire additional civilian employees to implement the  inventory controls. To manage growth in audit readiness costs, DLA  officials told us that they have taken steps to consolidate contract  support and rely more heavily on its existing workforce.
Information technology: Information technology costs across DLA  increased from $842.8 million in fiscal year 2011 to $974.4 million in  fiscal year 2015, an increase of about 15.6 percent. DLA officials  stated they allocated 7 percent of these costs to distribution services.  DLA officials also stated that the increase in information technology  costs were primarily for sustainment and the modernization of  information technology infrastructure to improve business operations  and capabilities as well as to purchase greater data storage and more  bandwidth to ensure the continuity of business operation systems and  secure communications. DLA officials also told us they have taken  steps to manage growth in information technology costs. For example,  DLA leveraged the Defense Information Services Agency’s lower cost  teleconferencing and voice services.
Infrastructure support: Infrastructure support costs increased from  $83.4 million in fiscal year 2011 to $125.8 million in fiscal year 2015,  an increase of more than half or about 51 percent. According to DLA  officials, the rise in infrastructure support costs is due to the  sustainment, restoration, and modernization of the aging facilities that  DLA operates and to demolition costs. For example, many of the  buildings that DLA operates at its distribution centers were  constructed during the 1940s and 1950s and are close to the end of  their lifecycle, requiring more funds to maintain. To try to control these  cost increases, DLA officials told us that they fund the suggested  sustainment, restoration, and maintenance costs at a lower  percentage than DOD’s model suggests and prioritize repairs that are  health and safety related, but such a strategy can result in higher  costs over the long term if needed maintenance continues to be  deferred. Also, since fiscal year 2012, DLA has invested about $24.4  million to demolish aged facilities to avoid future infrastructure support  costs.
section_title: DLA Has Consistently Overestimated Revenue for Its Distribution Services
paragraphs: For fiscal years 2009 through 2015, DLA consistently overestimated  revenue for its distribution services. As with commodities, DLA develops  annual revenue estimates based on operating costs and the military  departments’ workload demands during the annual process to develop a  budget and set prices for distribution services in advance of the budget  request. When the actual revenue is less than estimated revenue, DLA  adjusts future prices to recover the loss in its operating costs. Such  adjustments contribute to increasing prices in future budget years.  According to DLA data, distribution services have experienced annual  losses ranging from $39.2 million to $352.9 million in every year from  fiscal year 2009 through fiscal year 2015, as shown in figure 4.
According to DLA officials, they have generated less revenue than  estimated for distribution services because the military departments’  workload demand was less than they had initially anticipated when  formulating the budget for the budget year at least 18 months earlier.  Some of the difference can be explained by unanticipated changes in  DOD’s planned operations. For example, DLA planned in years 2008  through 2010, based on the military departments’ estimates, that the  workload to move equipment and materiel from Iraq to other locations  would be greater in fiscal years 2010 through 2013 than the actual  workload demand for those years. Also, DLA planned in 2011 and 2012,  based on the military department’s plans for withdrawal from Afghanistan  that the workload demand for processing inventory to these locations  would decrease in fiscal years 2013 and 2014. However, the actual  reduction in workload demand was greater than planned.
DLA officials stated there are opportunities for the military departments to  improve their estimates of workload demand for distribution services. As  such, DLA has taken actions since 2014 to work with the military  departments to improve workload estimates by holding quarterly meetings  with senior-level military department representatives from their finance  and logistics offices. According to DLA officials, these quarterly cost  summits are used to discuss estimates of workload demand and how  differences during budget execution can affect DLA’s cost recovery and  the military departments’ budgets. For example, during the November  2016 cost summit, DLA officials provided 5 years of data for second  destination transportation costs—a distribution service cost associated  with processing—that compared the price each military department was  charged based on their combined workload estimates with the cost for the  actual amount each military department had used. DLA officials had not  previously shared these data with the military departments. DLA reported  that over the 5 years, two of the three military departments had used less  second destination transportation than their workload estimate and  cumulatively had overpaid by approximately $100 million, while the third  military department had underpaid by $12.6 million. In response to  questions during the cost summit about the status of the surplus  payments, DLA officials stated that any gains were returned through  reductions in price to all customers regardless of whether they had  previously overpaid or underpaid compared with their workload estimate.  DLA plans to continue to share data that compares estimates with actuals  to encourage the military departments to develop more accurate workload  estimates. In addition, DLA has proposed to the military departments to  not include second destination transportation in the price for processing,  but to bill separately for actual second destination transportation costs.
section_title: DLA Has Often Increased Prices Significantly for Its Distribution Services
paragraphs: Since fiscal year 2009, DLA’s annual prices for distribution services have  often increased above 10 percent. DOD reports its annual prices for  distribution services in the budget justification materials, but does not  include information on the year-to-year change in price. Therefore, we  calculated the year-to-year change in annual price for four types of  distribution services to determine the trends in pricing. The four types of  distribution services—covered storage, open storage, specialized  storage, and processing—all experienced significant price increases. For  example, covered storage prices increased by more than 10 percent in 5  out of the 9 years reviewed. The largest increases in the price for all  distribution services occurred in fiscal year 2017, as shown in figure 5.
As discussed earlier, any losses from prior fiscal years as a result of  overestimated revenue must be eventually recovered by DLA in its future  pricing. In addition to such losses, DLA’s declining workload at its  distribution centers has also contributed to significant increases in annual  prices for distribution services. DLA officials told us that the costs to  operate these centers are relatively fixed and do not fluctuate based on  the workload. As DLA’s workload has declined with combat operations in  Iraq and Afghanistan and through inventory reduction initiatives, DLA has  had to continue to apply the fixed costs of operating these distribution  centers to the declining workload. For example, in fiscal year 2009, DLA  spread the operating cost across a larger storage workload, which  resulted in an average cost per cubic foot for covered storage of $3.05,  but by fiscal year 2012 these costs spread across a smaller workload  resulting in an average cost per cubic foot of $5.67.
Moreover, DLA’s decision to delay recovering its prior revenue losses  when setting prices for distribution services in fiscal years 2014 through  2016 led to the largest price increases for distribution services in fiscal  year 2017 for the period reviewed. Specifically, DLA set lower-than-actual  prices to keep prices constant in fiscal years 2014 through 2016 while  military departments recovered from budgetary cuts due to sequestration.  In fiscal year 2017, DLA returned to its usual procedure and set prices  based on estimated costs, estimated workload, and prior years’ losses.
When we asked OUSD Comptroller officials about these price increases,  they told us that they do not separately track the aggregate price changes  for distribution services over time. Instead, the officials stated that they  can assess price growth in distribution services through the price change  information reported in the budget justification materials because the  costs for approximately 70 percent of DLA’s distribution services workload  is included in DLA’s prices for commodities. Moreover, when workload  decreases and DLA experiences prior-year revenue losses in providing  distribution services, the Financial Management Regulation allows DLA to  increase prices significantly to recover its full operating costs.
DLA has taken steps to manage growth in indirect costs and to improve  workload estimates for distribution services. In addition, DLA officials  stated they have also sought opportunities to reverse the recent decline in  workload for distribution services in order to lower prices. Specifically, our  analysis of DLA covered storage shows that its usage declined from 70.8  million cubic feet in fiscal year 2009 to 42.1 million cubic feet in fiscal year  2015, a decrease of 41 percent. To address this decline in usage, DLA  reviewed how the department is consuming these services and found  instances where the military departments are using private storage for  government-owned inventory in close proximity to DLA distribution  centers. For example, the Army’s Stryker program stores inventory in  commercial locations that are located near DLA distribution centers in  Anniston, Alabama and Puget Sound, Washington. DLA estimates  moving Stryker inventory from storage owned by private companies to  DLA distribution centers in Anniston, Alabama and San Joaquin,  California could save DOD approximately $4 million in distribution costs in  the first year. In addition, according to DLA officials, they found  instances where the military departments had moved storage workload  from DLA’s distribution centers to their own storage facilities. DLA officials  told us that increasing their workload could contribute to reducing prices  and this could be achieved by changing, when appropriate, the military  departments’ practice of obtaining distribution services outside of DLA.
section_title: DOD Could More Efficiently Use Its Distribution Centers, Including Those That DLA Operates
paragraphs: DOD has taken steps to increase the use of its U.S. distribution centers,  but additional opportunities exist to more efficiently use this network of  distribution centers, including those that DLA operates. For example, the  department has recently taken steps to address the military departments’  use of private storage when DLA distribution centers are in the same  vicinity as the private storage locations. In January 2017, the department  revised DOD Instruction 5000.02, Operation of the Defense Acquisition  System, to require that program managers who are responsible for  contracts with DOD maintenance depots store government-owned  inventory at DLA’s distribution centers when located in the same  geographic area as those depots. According to officials, this revision is  intended to reduce unnecessary costs to DOD’s total budget by utilizing  DOD’s existing investment in DLA’s network. In addition, the department  sought authority from Congress to make DLA’s storage and distribution  services support available to defense weapon system contractors. The  National Defense Authorization Act for Fiscal Year 2017 provided such  authority under a 6-year pilot program whereby DLA and defense weapon  system contractors can enter into a separate contract for the storage and  distribution of materiel and spare parts used in the support of a defense  weapon systems contract.
DOD has other opportunities to more efficiently use its network of  distribution centers to provide distribution services. Specifically, DOD  previously identified inefficiencies, including overlapping and duplicative  distribution service functions, across its distribution network. The Under  Secretary of Defense for Acquisition, Technology, and Logistics has the  responsibility to ensure that its policies and programs are designed and  managed to improve efficiency, among other things, and to use DOD’s  existing systems, facilities, and services to avoid unnecessary overlap  and duplication and to achieve maximum efficiency and economy. As a  subordinate to the Under Secretary of Defense for Acquisition,  Technology, and Logistics, the Assistant Secretary of Defense for  Logistics and Materiel Readiness has been delegated the responsibility  and authority to prescribe policies and procedures in the department for  the conduct of logistics and materiel readiness, to include supply and  transportation, among others. In carrying out this responsibility, starting  in 2010, DOD established a program called Strategic Network  Optimization that identified and undertook actions to address  inefficiencies in its distribution network. The program had a three-phased  approach with each phase primarily focused on one of the following  areas: transportation, inventory, and infrastructure.
In the context of distribution infrastructure, Strategic Network Optimization  program officials identified in 2011 that DLA and the military departments  provided distribution services—including storage and processing—at 256  distribution centers in the United States that often are in close proximity to  one another and, in some cases located on the same installations. In  addition, they found that 91 of the distribution centers accounted for 95  percent of the total network’s historical workload while the other sites  accounted for the remaining 5 percent. To address this issue, Strategic  Network Optimization program officials suggested a number of possible  actions to improve the efficiency of the distribution service network. In  January 2012, the Joint Logistics Board approved an approach whereby 5  DLA distribution centers were designated as the main suppliers within an  assigned region of the United States to the remaining 12 DLA distribution  centers, which are smaller, and to other distribution centers run by the  military departments. The 5 main suppliers would ship inventory to all  customers within the distribution network. Each of the other distribution  centers would be limited to providing service to local customers located  on its individual installation. See figure 6 for an example of the regional  consolidation that was proposed in the redesign of the U.S. distribution  network. This approach was intended to minimize DLA and the military  departments providing unnecessary overlapping or duplicative distribution  services by redistributing the workload. In addition, the workload  redistribution was to have decreased the number of distribution centers  within DOD’s network and increased DLA’s overall distribution services  workload.
In October 2014, DOD discontinued the Strategic Network Optimization  program. By this time, DOD had implemented a majority of the actions for  the first two—transportation and inventory—of the program’s three  phases. But DOD had not yet developed a business plan to guide the  implementation of the third phase intended to reduce infrastructure in the  distribution network through consolidation. According to DOD and DLA  officials, all of the remaining actions from the first and second phases of  the program were incorporated into normal business processes. DOD and  DLA officials acknowledged that unnecessary overlap and duplication  continues to exist in DOD’s network of distribution centers. However, in  the case of the effort to reduce infrastructure, the officials stated that  without Base Realignment and Closure authority, they would not be able  to address unnecessary overlap and duplication in functions at DOD’s  U.S. distribution centers, as many of the distribution centers are owned by  the military departments. According to DOD and DLA officials, proposals  within the department on the appropriate course of action to address  unnecessary overlap and duplication in DOD’s network of distribution  centers have evolved since the 2011 study to include options for base  closures. In each annual budget request since fiscal year 2013, the  department has requested Base Realignment and Closure authority, but  Congress has yet to approve DOD’s request.
DOD has existing authorities it can use to minimize unnecessary overlap  and duplication and more efficiently use the department’s network of  distribution centers. For example, DOD could use its existing authorities  to close or realign its installations and functions outside of a Base  Realignment and Closure round. However, if doing so would exceed  certain thresholds set out in 10 U.S.C. § 2687—based on the number of  civilian personnel affected or potentially affected—DOD must notify  Congress and wait 60 days after notification before taking any irreversible  actions. In addition, DOD has authority to dispose of real property  through demolition when a facility’s condition has deteriorated. We found  that DOD had not assessed the extent to which it could use existing  authorities to minimize unnecessary overlap and duplication and more  efficiently use the department’s network of U.S. distribution centers,  beyond the actions DLA has already taken. We previously reported that  while DOD makes hundreds of basing decisions a year that are not  subject to congressional notification, it has yet to take any actions that  require notification. In discussions about DOD’s existing authorities,  officials at the Office of the Assistant Secretary for Energy, Installations,  and Environment told us that the department does not believe 10 U.S.C.  § 2687 is a viable tool to achieve significant base closures because under  that section, DOD’s authorities are narrowly circumscribed and the  statutory requirements are burdensome. However, other DOD  components could assess and implement similar actions as DLA using  existing authorities. Further, in discussing the current fiscal pressures  and budgetary constraints within the department and the need to reduce  lower priority programs to comply with the Bipartisan Budget Act, DOD’s  budget overview for fiscal year 2017 states that “the need to reduce  unneeded facilities is so critical that in the absence of authorization for a  new round of base realignment and closure, the department will explore  any and all authorities that Congress has provided to eliminate wasteful  infrastructure.” While these actions may not entirely address  inefficiencies in its network of U.S. distribution centers, they could achieve  efficiencies and potential cost savings.
Without maximizing the use of its existing authorities in the absence of a  Base Realignment and Closure round, DOD’s network of distribution  centers will continue to result in inefficiencies and pose difficulties in  minimizing price increases for distribution services. In addition, the  department will continue to spend funds on storage and distribution costs  that could be applied to support higher priorities.
section_title: Conclusions
paragraphs: Under current fiscal pressures and budgetary constraints within the  department, DOD has sought to provide its commodities and distribution  services to its U.S. military forces as efficiently as possible while reducing  costs. Further, DOD has identified inefficiencies in how it provides  distribution services at its network of U.S. distribution centers. DOD  maintains that it needs Base Realignment and Closure authority;  however, the department has not assessed whether it can use existing  authorities to minimize unnecessary overlap and duplication, and more  efficiently use this network. Any actions resulting from DOD’s  assessment, if implemented, could also have the potential to realize near- term savings in storage and distribution costs that could be made  available to support higher priorities.
section_title: Recommendation for Executive Action
paragraphs: To minimize unnecessary overlap and duplication and more efficiently  use DOD’s U.S. distribution centers, we recommend that the Secretary of  Defense direct the Under Secretary of Defense for Acquisition,  Technology, and Logistics (or the subsequent Under Secretary for  Acquisition and Sustainment), in conjunction with the Director of DLA, and  the Secretaries of the Army, the Air Force, and the Navy, to assess and  direct the implementation of actions, as appropriate, that can be taken  using existing authorities to close, realign, or dispose of existing  infrastructure.
section_title: Agency Comments
paragraphs: We provided a draft of this report to DOD for review and comment. In its  comments, DOD concurred with our recommendation and cited various  statutes that constrain both the department’s authority to conduct large- scale closures or realignments of installations and small-scale closures,  realignments, or disposals of facilities, including the infrastructure in the  network of U.S. distribution centers. DOD’s comments are reprinted in  their entirety in appendix I. DOD also provided technical comments, which  we incorporated as appropriate.
We are sending copies of this report to the appropriate congressional  committees and to the Secretary of Defense; the Under Secretary of  Defense for Acquisition, Technology, and Logistics; the Under Secretary  of Defense, Comptroller; the Director of DLA, and the Secretaries of the  Air Force, Army, and Navy. In addition, the report is available at no  charge on the GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (213) 830-1011 or vonaha@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made key contributions to this report  are listed in appendix II.
section_title: Appendix I: Comments from the Department of Defense
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Tina Won Sherman (Assistant  Director), Vincent Buquicchio, Tim Carr, Lina Grant, Mae Jones, Susan  Langley, Amie Lesser, Benjamin Sclafani, and Michael Silver made key  contributions to this report.