Defense Inventory: Management Actions Needed to Improve the Cost Efficiency of the Navy's Spare Parts Inventory
Published: 2008-12-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Since 1990, GAO has designated the Department of Defense's (DOD) inventory management as a high-risk area. It is critical that the military services and the Defense Logistics Agency effectively and efficiently manage DOD's secondary inventory to ensure that the warfighter is supplied with the right items at the right time. It is also imperative that they maintain good stewardship over the billions of dollars invested in their inventory. GAO reviewed the Navy's management of secondary inventory and determined (1) the extent to which on-hand and on-order secondary inventory reflected the amount needed to support current requirements and (2) causes for the Navy's having secondary inventory in excess of current requirements or, conversely, for having inventory deficits. To address these objectives, GAO analyzed Navy secondary inventory data (spare parts such as aircraft and ship engines and their components and accessories) from fiscal years 2004 through 2007.
section_title: What GAO Found
paragraphs: For the 4-year period GAOexamined, the Navy had significantly more inventory than was needed to support current requirements. The Navy also experienced some inventory deficits, though to a far lesser extent. GAO's analysis of inventory data identified an annual average of about $18.7 billion of Navy secondary inventory for fiscal years 2004 to 2007, of which about $7.5 billion (40 percent) exceeded current requirements. About half of the $7.5 billion of inventory exceeding current requirements was retained to meet anticipated future demands, and the remainder was retained for other reasons or identified as potential excess. Based on Navy demand forecasts, inventory that exceeded current requirements was sufficient to satisfy several years, or even decades, of anticipated supply needs. Also, a large proportion of items that exceeded current requirements had no projected demand. The Navy also had an annual average of about $570 million of inventory deficits over this 4-year period. Some items experienced persistent deficits for the 4 years covered in GAO's review. Navy inventory did not align with current requirements over this 4-year period because (1) the Navy has not established the cost efficiency of its inventory management, (2) its demand forecasting effectiveness is limited and requirements for items may change frequently after purchase decisions are made, and (3) it has not adjusted certain inventory management practices in response to the unpredictability in demand. As a result, the Navy had billions of dollars in excess inventory against current requirements each year. DOD's supply chain management regulation requires the military services to take several steps to provide for effective and efficient end-to-end materiel support. For example, the regulation directs the components to size secondary item inventories to minimize DOD investment while providing the inventory needed. However, while the Navy has performance measures related to meeting warfighter needs, it lacks metrics and targets for tracking and assessing the cost efficiency of its inventory management. In addition, although Navy managers most frequently attributed the accumulation and retention of inventory exceeding current requirements to changes in demand, the Navy has not systematically evaluated the effectiveness of its demand forecasting. Problems with demand forecasting that contribute to excess inventory include incomplete and inaccurate data and a lack of communication and coordination among key personnel. Finally, the Navy has not adjusted certain management practices--in areas such as initial provisioning, modifying purchase decisions for inventory that is on order and not yet in its possession, and retention--to provide flexibility for responding to changes in demand. First, initial provisioning of spare parts based on engineering estimates can result in the purchase of unneeded stock when these estimates prove to be inaccurate. Second, the Navy's management practices for on-order items limit flexibility in modifying purchase decisions in cases where demand has changed. Third, although prior studies have identified weaknesses in inventory retention practices, the Navy has not implemented recommended corrective actions. Also, the Navy's designation of new chief and deputy chief management officer positions provides an opportunity for enhanced oversight of inventory management improvement efforts. Strengthening the Navy's inventory management--while maintaining high levels of supply availability and meeting warfighter needs--could reduce support costs and free up funds for other needs.

section_title: Letter
paragraphs: The military services and the Defense Logistics Agency (DLA) procure and  manage large supplies of spare parts to keep military equipment operating.  At a time when U.S. military forces and their equipment are in high  demand, it is critical that the services and DLA effectively and efficiently  manage the Department of Defense’s (DOD) secondary inventory to  ensure that the warfighter is supplied with the right items at the right time.  Because the military services and DLA face challenges in competing for  resources at a time when the nation faces an increasingly constrained  fiscal environment, it is also imperative that they have good stewardship  over the billions of dollars invested in their inventory. DOD reported that  the total value of its secondary inventory as of September 30, 2007, was  about $82.6 billion. Since 1990, we have identified DOD inventory  management as a high-risk area due to ineffective and inefficient inventory  management practices and procedures and to excessively high levels of  inventory beyond what is needed to support current requirements. These  high levels extend to both on-hand and on-order inventory. Inventory in  DOD’s possession is considered to be on hand. Inventory not in DOD’s  possession but for which contracts have been awarded or funds have been  obligated is considered to be on order.
In response to your request that we review DOD components’ secondary  inventory, this report addresses the management of the Navy’s secondary  inventory. Our objectives were to (1) determine the extent to which the  Navy’s on-hand and on-order secondary inventory reflects the amount  needed to support current requirements and (2) identify causes, if  applicable, for the Navy’s having secondary inventory in excess of current  requirements or, conversely, for having inventory deficits. We previously  reported on the management of the Air Force’s secondary inventory, and  we plan to report separately on the management of the Army’s secondary  inventory.
To determine the extent to which the Navy’s on-order and on-hand  secondary inventory reflects the amount of inventory needed to support  current requirements, we analyzed fiscal years 2004 through 2007  stratification data, including summary reports and item-specific data as of  September 30 for each fiscal year. We determined the total number of  items that had more or less than enough inventory to satisfy current  requirements, and for each of these items also determined the number and  value of parts that were either in excess of or less than needed to satisfy  current requirements. In presenting the value of inventory in this report,  we converted then-year dollars to constant fiscal year 2007 dollars using  DOD Operations and Maintenance price deflators. To determine the  primary causes for the Navy having inventory in excess of current  requirements or having inventory deficits, we selected a random  probability sample of inventory items that met these conditions and sent  surveys to Navy inventory personnel who are responsible for item  management. Because we used a random probability sample, the results of  our survey analysis statistically weight up to represent the population of  all Navy items that met our selection criteria. To gain additional  understanding about the management of secondary inventory, we  interviewed numerous Navy inventory personnel and discussed 70 items in  more detail. Appendix I provides further information on our scope and  methodology. We conducted this performance audit from November 2007  to December 2008 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. “For wholesale stock replenishment, the maximum authorized quantity of stock for an  item. It consists of the sum of stock represented by the economic order quantity, the safety  level, the repair-cycle level, and the authorized additive levels.”
We used the requirements objective as our baseline because it includes the  requirements used to determine when to order new parts (collectively  called the “reorder point”). In other words, if the Navy had enough parts to  meet the requirements objective, it would not purchase new parts. We use  the term “inventory deficit” to describe items that have an amount of on- hand inventory that falls below reorder point thresholds. We used this  baseline because it reflected the Navy’s ability to respond to an immediate  demand for a secondary inventory item. The categories DOD and the Navy  use to characterize and manage inventory are discussed further in the  background section of this report.
subsections: section_title: Background
paragraphs: Under DOD’s supply chain materiel management policy, the secondary  item inventory should be sized to minimize DOD’s investment while  providing sufficient inventory to support both peacetime and war  requirements. The Offices of the Secretary of Defense and the Navy share  the responsibility for management and oversight of the secondary item  inventory. The Under Secretary of Defense for Acquisition, Technology,  and Logistics is responsible for the uniform implementation of inventory  management policies throughout the department, while the Secretary of  the Navy is responsible for implementing DOD inventory policies and  procedures. Navy inventory management functions are primarily the  responsibility of the Naval Inventory Control Point, a component of the  Navy Supply Systems Command that has offices in Philadelphia and  Mechanicsburg, Pennsylvania. Aviation and maritime items are managed in  Philadelphia and Mechanicsburg, respectively. The Navy prescribes  guidance and procedural instructions for computing requirements for its  secondary inventory. Navy managers develop inventory management plans  for their assigned items, which include developing budgetary requirements  for procurement and repair, monitoring and discussing inventory  performance with contractors and repair depots, evaluating requests for  stocking from individual DOD activities, and processing requisitions for  materiel that cannot be satisfied by automated processes.
subsections: section_title: Value of Navy’s Secondary Inventory Decreased Since 2004
paragraphs: DOD requires each service and DLA to semiannually prepare inventory  stratification reports, which are primarily used to determine procurement  and repair budget requirements, and potential excess or reutilization  stock. Stratification is a process that identifies and prioritizes  requirements and allocates inventory to those requirements based on  availability. DOD annual stratification reports show that for the 4 years  covered in our review, the value of the Navy’s secondary inventory  decreased both in dollar amounts and as a percentage of DOD’s overall  secondary inventory (see table 1).
While the total reported value of DOD’s secondary inventory decreased by  almost $2 billion from fiscal year 2004 through fiscal year 2007, the  reported value of the Navy’s inventory decreased by more than $7 billion.  According to Navy inventory managers, this decrease was attributable to  the following factors: (1) a greatly accelerated disposal rate for items in  the F-14 program, (2) an accounting cleanup of records on unserviceable  parts in transit, (3) sales of inventory that had accrued in support of major  war operations in 2002 and 2003, (4) an increase in aviation assets that  could not be repaired and therefore were disposed of, and (5) the transfer  of inventory control for consumable aviation items from the Navy to DLA.
section_title: Navy’s Process for Determining Needed Amount of Secondary Inventory
paragraphs: The Navy uses a process called requirements determination to calculate  the respective amounts of inventory it either needs to have available in  storage (on hand) or needs to purchase (on order). A central database  called the Master Item File provides data for the requirements  determination process. The Navy also uses the Master Item File to develop  a stratification report showing the amount of inventory allocated to meet  specific requirements, including operating and acquisition lead time  requirements.
Operating requirements include the war reserves authorized for purchase;  customer-requisitioned materiel that has not yet been shipped (also known  as due-outs); a safety level of reserve to be kept on hand in case of minor  interruptions in the resupply process or unpredictable fluctuations in  demand; minimum quantities for essential items for which demand cannot  normally be predicted (also referred to as numeric stockage objective or  insurance items); and inventory reserve sufficient to satisfy demand while  broken items are being repaired (also referred to as repair cycle stock).
Acquisition lead time requirements include administrative lead time  requirements, which refer to inventory reserves sufficient to satisfy  demand from the time that the need for replenishment of an item is  identified to the time when a contract is awarded for its purchase or an  order is placed; and production lead time requirements, which refer to  inventory reserves sufficient to satisfy demand from the time when a  contract is let or an order is placed for inventory to the time when the item  is received.
When the combined total of on-hand and on-order inventory for an item  drops to a threshold level—called the reorder point—the item manager  may place an order for additional inventory of that item, to avoid the risk  of the item’s going out of stock in the Navy’s inventory. The reorder point  includes both operating requirements and acquisition lead time  requirements. An economic order quantity–-the amount of inventory that  will result in the lowest total costs for ordering and holding inventory–-is  automatically calculated by a computer program and is added to the order.  The reorder point factors in demand for inventory items during the  reordering period so that Navy managers can replace items before they go  out of stock, and a safety level to ensure a supply of stock during  interruptions in production or repair. A purchase request can be  terminated or modified if requirements change.
These requirements collectively constitute the requirements objective,  which we refer to as the Navy’s current requirements in this report. An  assessment of the Navy’s requirements or requirements determination  process was outside the scope of our review. In accounting for its  inventory, the Navy uses the stratification process to allocate, or apply,  inventory to each requirement category. On-hand inventory in serviceable  condition is applied first, followed by on-hand inventory in unserviceable  condition. On-order inventory is applied when on-hand inventory is  unavailable to be applied to requirements. We refer to situations when on- hand inventory is insufficient to satisfy reorder point requirements as  inventory deficits.
Inventory that exceeds current requirements may include  inventory that satisfies 2 years of projected future demand, which together  with current requirements is known as the approved acquisition  objective;    economic retention inventory, which exceeds the approved acquisition  objective but has been deemed more economical to keep than to discard  because it will likely be needed in the future;    contingency retention inventory, which exceeds the economic retention  inventory but is retained for specific contingencies; and    potential excess materiel, which exceeds contingency retention inventory  and has been identified for possible disposal but has potential for  reutilization.
section_title: A Significant Portion of the Navy’s Secondary Inventory Exceeded Current Requirements
paragraphs: Our analysis of Navy secondary inventory data for the 4-year period we  examined showed that, on average, about $11.3 billion (60 percent) of the  average annual total inventory value of $18.7 billion was needed to meet  current requirements and $7.5 billion (40 percent) exceeded current  requirements. About half of the inventory that exceeded current  requirements was being retained for demands anticipated within 2 years,  and the remainder was held as economic retention inventory, contingency  retention inventory, or marked as potential excess. According to the  Navy’s demand forecasts for items exceeding current requirements in  fiscal years 2004 and 2007, inventory levels of some items were sufficient  to meet many years and sometimes decades of demand. A large proportion  of items that exceeded current requirements had no projected demand.  Reparable inventory that exceeded current requirements included both  serviceable and unserviceable parts, and the proportion of items  associated with steady programs—that is, programs that were not  significantly growing or declining—was similar for inventory meeting and  exceeding current requirements. Relatively few inventory deficits were  identified, but these persisted for some items during the 4 years we  reviewed.
subsections: section_title: About $7.5 Billion, or 40 Percent, of the Navy’s On- Hand and On-Order Inventory Value Exceeded Current Requirements Each Year
paragraphs: Our analysis of Navy secondary inventory data showed that, on average,  about $11.3 billion (60 percent) of the total annual inventory value was  needed to meet current requirements, whereas $7.5 billion (40 percent)  exceeded current requirements. Measured by number of parts, these  percentages were reversed: 40 percent of the parts applied to current  requirements on average each year, and the remaining 60 percent  exceeded current requirements. Our data for the 4-year period revealed  that 121,380 (65 percent) of the Navy’s 186,465 unique items with reported  inventory had parts in excess of current requirements. Table 2 shows the  stratification of Navy secondary inventory for the 4-year period, including  inventory meeting requirements and inventory exceeding requirements.
The data in table 2 show that the Navy has applied a significant amount of  inventory to future demand as well as to current requirements. On  average, about 1.1 million parts comprising 6 percent of total parts and 20  percent of total inventory value were designated for future demand.  Furthermore, the average value of these parts ($3.7 billion) was nearly half  the average value of the parts needed to meet annual operating  requirements ($7.6 billion). The balance between inventory meeting  current requirements and inventory exceeding current requirements  stayed relatively constant from year to year (see fig. 1).
The secondary inventory data further showed that while the aviation  community had fewer spare parts than the maritime community, these  parts constituted a higher average value; conversely, the maritime  community had more parts but at lower average value. Table 3 shows the  average number and value of parts exceeding current requirements for  each of these communities at the end of each fiscal year.
section_title: Inventory Excess to Current Requirements Was Retained for Anticipated Future Needs
paragraphs: Of the nearly $7.5 billion in Navy secondary inventory that exceeded  current requirements in the time frame we examined, about half was being  retained for demands anticipated within 2 years, while the remainder was  being retained either as economic retention inventory, contingency  retention inventory, or potential excess (see fig. 2).
With regard to on-order inventory, the Navy marked approximately $10  million (1 percent) of this inventory each year as potential excess to be  reviewed for possible disposal. This means that demands had decreased  significantly since the time the order was placed, yet the Navy had not  terminated the order. Navy managers told us that on-order inventory  marked as potential excess is routinely cancelled to prevent the immediate  disposal of new inventory. We did not independently verify whether this  practice was consistently followed. Table 4 shows the amount of potential  excess inventory the Navy had on order at the end of fiscal years 2004 to  2007.
section_title: Excess Inventory Was Sufficient to Meet Many Years of Projected Demands
paragraphs: The Navy’s forecasts for items with a recurring demand in fiscal years 2004  and 2007 showed that inventory for some items exceeded the current  requirements necessary to meet many years and sometimes decades of  demand. In addition, a substantial amount of this inventory showed no  projected demand. The results of this analysis are shown in figure 3.
As shown in figure 3, about $1.9 billion (27 percent) of the inventory  exceeding current requirements in fiscal year 2007 was sufficient to satisfy  2 years of demand, $2.5 billion (36 percent) was sufficient to meet between  2 and 10 years of supply, and $0.5 billion (8 percent) was sufficient to meet  demand for 10 years or more. In addition, the Navy in fiscal year 2007 had  $1.9 billion (28 percent) of inventory exceeding current requirements for  which there was no forecasted demand. About $1.1 billion (60 percent) of  these items were being retained because of economic or contingency  retention requirements, and the remaining $0.8 billion (40 percent) were  considered for disposal or reutilization. In commenting on a draft of this  report, the Navy stated that a majority of these items are in low demand,  are used on older weapon systems, and can no longer be procured, so the  Navy will retain inventory as requirements trend down. We could not  independently verify the Navy’s statement using the stratification data, and  the Navy did not provide supporting data.
section_title: Inventory Exceeding Current Requirements Included Both Serviceable and Unserviceable Assets
paragraphs: Reparable inventory that exceeded current requirements included both  serviceable and unserviceable parts. The Navy pays storage costs for all  items regardless of condition. Based on DLA data, we estimate that the  Navy incurred at least $18 million in storage costs for its wholesale  secondary inventory that exceeded current requirements in fiscal year  2007. In fiscal year 2007, serviceable parts constituted about 45 percent of  the total reparable parts exceeding current requirements and about 39  percent of the total value (see fig. 4).
section_title: Program Status Was Not Significantly Different for Items Exceeding Current Requirements and Items Meeting Current Requirements
paragraphs: The proportion of Navy secondary inventory associated with steady  programs was similar for inventory meeting and exceeding current  requirements. Each Navy inventory item is assigned a program status that  indicates whether the item or the item’s higher assembly is part of a  weapon system program that is growing, staying steady, declining, or  obsolete. In fiscal year 2007, 81 percent of the value of aviation parts and  79 percent of the value of maritime parts which met current requirements  were associated with steady programs. For items exceeding current  requirements, these proportions were similar—79 and 73 percent for  aviation and maritime items, respectively. Table 5 shows the percentage of  items in each category by program status.
section_title: Relatively Few Inventory Deficits Were Identified, but Some Items Had Persistent Deficits
paragraphs: The Navy had inventory deficits for some items—that is, an insufficient  level of inventory on hand to meet the reorder levels identified in its  current requirements. As of the September 30 stratification report date for  fiscal years 2004 through 2007, the Navy had insufficient on-hand  inventory to meet reorder-level requirements for an average of about  15,000 items annually, totaling about $570 million in inventory deficits  each year. Normally, inventory managers will place an order for new parts  when an item’s inventory falls to the reorder level, but in fiscal year 2007  there were a total of 13,775 items with an inventory deficit, of which 6,315  (46 percent) had no inventory on order. In commenting on our report the  Navy said some of these deficit items will not be procured because they  are obsolete or have been replaced by other items. However, of the 6,315  items on order, only 840 were in declining programs where items would  not be procured. Further, 21 percent of items with deficits had unfilled  requisitions from previous time periods, indicating that some items had  persistent deficits over time. Navy inventory managers said that deficits  occur and can persist for various reasons, including cases in which a  supplier is no longer in business or producing the part needed, and a new,  qualified supplier must be identified to produce the item. Our random  sample of items with inventory deficits in fiscal year 2007 showed that 35  percent of these items had an inventory deficit in each of the 4 years we  reviewed. We could not determine the criticality of these deficits because  this information is not available in stratification reporting. In terms of  number of parts, the Navy had fewer inventory deficits for aviation items  than for maritime items, but the aviation items constituted a higher  average value. Figure 5 shows the value of Navy’s inventory deficits for  each of the fiscal years included in our review.
However, the Navy would need considerably more inventory to meet its  total requirements objective for these items. For example, when both on- hand and on-order inventory are included, in fiscal year 2007 the Navy had  a total deficit against the total requirements objective of about 880,000  parts valued at about $1.5 billion This amount is about three times the  level of its on-hand deficits alone.
section_title: Several Factors Contributed to the Navy’s Having Large Inventory Levels in Excess of Current Requirements
paragraphs: Our review identified several factors that contributed to the Navy’s having  secondary inventory that did not align with current requirements,  including significant levels of inventory that were in excess of these  requirements over the 4-year period. While the Navy strives to provide  effective supply support in meeting warfighter needs and reports meeting  or almost meeting many of its own supply availability targets, it has placed  less emphasis on doing so at least cost. The Navy has not established  metrics and goals for tracking and assessing the cost efficiency of its  inventory management. In addition, although changes in demand account  for much of the inventory in excess of current requirements, the Navy has  not systematically evaluated why demand forecasting is unpredictable and  how to better manage it. Further, the Navy has not adjusted certain  inventory management practices to allow for flexibility in responding to  unpredictable demand.
In addition, our review noted that although the Navy’s newly established  chief management officer and deputy chief management officer will  oversee business transformation, the Navy has not yet defined their  respective roles in overseeing inventory management improvement efforts.  These new designations provide an opportunity to enhance oversight of  such efforts.
subsections: section_title: Navy Has Not Established Metrics and Goals for Tracking and Assessing the Cost Efficiency of Inventory Management
paragraphs: Although the Navy has emphasized the need to meet warfighter needs as  measured by supply support performance metrics and goals, it has not  established metrics and goals to track and assess the cost efficiency of its  inventory management practices. As a result, the Navy does not know  whether it is meeting inventory requirements at least cost as required by  DOD’s supply chain management regulation.
DOD’s supply chain management regulation requires the military services  to take several steps to provide for effective and efficient end-to-end  materiel support. The regulation also sets out a number of management  goals and directs the components to take a number of steps including  sizing secondary item inventories to minimize the DOD investment while  providing the inventory needed; considering all costs associated with  materiel management in making best-value logistics decisions; balancing  the use of all available logistics resources to accomplish timely and quality  delivery at the lowest cost; and measuring total supply chain performance  based on timely and cost-effective delivery. To ensure efficient and  effective supply chain management, the regulation also calls for the use of  metrics to evaluate the performance and cost of supply chain operations.  These metrics should, among other things, monitor the efficient use of  DOD resources and provide a means to assess costs versus benefits of  supply chain operations. However, the regulation does not prescribe  specific cost metrics and goals for the services to use to track and assess  the efficiency of their inventory management practices.
According to Navy officials, they have processes and controls for  efficiently managing secondary inventory. For example, they use a  requirements-setting process for determining secondary items necessary  to meet performance goals, while evaluating the trade-offs between the  requirements and acceptable risk of being out of stock. They also compare  requirements to available assets and identify funding needed during the  next 2-year budget period. After budget approval, they use a supply   demand review process and repair workload forecasting to initiate  procurements and plan repairs throughout the year. The supply demand  reviews enable them to determine significant requirement changes and  recommend additional procurement or termination of existing  procurements. They also stated that the semiannual stratification review  acts as a check and balance. They noted that Navy item managers are  required to meet goals that ensure that the Navy does not unnecessarily  build inventories but rather balances the costs for terminating a contract  against that of initiating a new contract in the near future. They said they  are confident that these processes and controls work because the Navy is  able to meet required performance goals at budgeted costs.
Moreover, the Navy uses metrics to track and assess performance toward  meeting inventory support goals. These include metrics showing supply  material availability and customer wait time. For example, the Navy  tracks the extent to which it is meeting supply material availability goals— which are set at 85 percent (except for nuclear propulsion-related  material, which has a goal of 95 percent)—as well as average customer  wait time. Recent data show that the Navy generally meets or almost  meets these goals, although we did not independently verify these  performance data during our review. The Navy also measures financial  performance by the extent to which budgeted amounts are obligated and  net sales plans are achieved. In this way inventory managers may be  accountable for goals related to supply material availability and customer  wait time, as well as budget performance.
The Navy, however, has not established metrics and goals for determining  whether it is meeting its performance goals at least cost. For example, it  has not established a metric related to its cost efficiency in meeting the  supply material availability goal. The overall secondary inventory data we  analyzed show that the Navy carried about $1.66 in inventory for every $1  in requirements to meet its supply material availability goal during the 4- year period of fiscal years 2004 through 2007. Such a metric, in  combination with other cost metrics and established goals, could give the  Navy the capability to track trends and assess progress toward achieving  greater cost efficiency. Because cost metrics and goals have not been  established, Navy managers are not held accountable and lack incentives  for achieving efficient supply support. Measuring performance goals such  as supply material availability and average customer wait time without  also tracking cost metrics encourages higher levels of inventory. As a  result, the Navy carries billions of dollars in excess inventory against  current requirements each year without having to demonstrate that these  inventory levels are cost effective.
section_title: Demand Forecasting Procedures Have Not Been Systematically Evaluated
paragraphs: Our review showed that unpredictability in forecasting demand for spare  parts was a primary cause of the Navy’s inability to align inventory levels  with current requirements. DOD’s supply chain regulation states that  customer demand shall be part of all DOD components’ inventory  management decisions, components shall not stock an item that does not  have any possibility of future demand, and variance in demand forecasts  outside established parameters should be flagged for management analysis  and action. According to Navy managers, demand is the single most  significant data element for forecasting requirements and a driving factor  in identifying the reorder point. While Navy managers agreed that  accurately forecasting demand is a long-standing difficulty, they said that  they forecast demand as best as they can and could not readily identify  ways to significantly improve on their current procedures. However, they  could not show where the Navy has systematically evaluated its demand  forecasting procedures to identify areas where forecasts have been  consistently inaccurate in order to correct any systemic weaknesses.
Another related difficulty, according to Navy managers we interviewed, is  a lack of timely communications among stakeholders, including promptly  relaying changes in programs and other decisions that affect purchases of  spare parts. More prompt communication of demand updates could help  to mitigate the effects of demand fluctuations, they said.
Navy item managers who responded to our survey most frequently cited  changes in demand as the reason inventory did not align with current  requirements. Changes may include demand decreasing, fluctuating, or not  materializing at all, resulting in inventory exceeding current requirements;  or demand increasing, resulting in inventory deficits. Table 6 shows the  results of our representative survey of items with inventory excesses (384  items), and table 7 shows the results of our survey for items with inventory  deficits (40 items).
Responses in the “other” category varied but included issues related to  procuring and retaining minimum quantities of parts, obsolescence, or  other explanations of demand changes.  Regarding parts excess to current  requirements, for example, one respondent said the Navy has upgraded to  a new module, but support is still required to meet Air Force requirements.  Regarding a deficit, for example, one respondent said they are working  with a sole source vendor and the estimated shipping date slipped.
In follow-up discussions Navy managers confirmed that changes in  demand were the main cause of inventory exceeding current requirements  or inventory deficits. In some cases, they attributed these changes to  incomplete or inaccurate demand data, owing to a lack of communication  among the various key participants in the demand-forecasting process. In  several cases, they cited poor communications with other service  components that were generating the demand. The following cases  illustrate challenges Navy managers face in predicting demands for items:    An example of an item in excess due to demand changes was the  blades used in the F404 engine that goes into the Navy’s F-18 model  A/D aircraft. The Navy had 13,852 of these parts valued at $3.6 million  as excess to current requirements. The next higher assembly is now on  a contract under which the contractor supplies the item, so the demand  for the blades disappeared. Thus, the Navy’s anticipated demand for  these parts never materialized. In commenting on our draft report, the  Navy stated that all 13,852 parts were being offered to the contractor in  return for a cost reduction on the contract.
Another example of an item with inventory excess to current  requirements was a special cable assembly also used on the Navy’s F- 18 model A/D aircraft’s forward-looking infrared radar. The item was  being phased out by the Navy, and the last purchase was in fiscal year  2006 for six parts valued at $76,087 to support the Coast Guard’s  continued use of the item. However, since the Navy did not know the  Coast Guard requirements for this item, it did not determine the proper  level of inventory to carry for this item.
An example of an inventory deficit that should have been more  predictable because it involved a planned program alteration was a  valve assembly used on various ship hulls for firefighting and air  conditioning systems. The item is being phased in to support a planned  ship alteration. We identified it as having an on-order excess of 16 parts  valued at $77,021 in our analysis as of September 30, 2007, but by  March 2008 this item was in a deficit position. This case illustrates the  challenges Navy managers face in predicting demand for an item, even  when demand is driven by a planned program change.
Navy managers said that demands Navy-wide have been decreasing for  reasons they did not fully understand, and they provided data submitted  by managers of ships’ inventory showing that two-thirds of demand  forecasts were incorrect by more than 10 percent. In order to meet  materiel availability support goals, managers said, they need to err on the  side of having rather than not having the items.
Furthermore, incomplete or inaccurate data can cause widespread  problems in cases where the Navy relies on automated data processing for  past recurring demand requisition history to predict future customer  demands, then adjust these data when changes occur that are significant  enough to be flagged. Navy managers said they actively manage items that  are in high demand, costly, or identified for other reasons; the remaining  items often require less attention. They said that Navy policy allows for  automated procurements of all items costing less than $50,000. In the  aviation community, these buys represented an average of about 52  percent of the total buys and 7 percent of the total value of procurements  between fiscal years 2005 and 2007. With thousands of items to manage  and generally little time to spend on all but the highest value, most  significant, or problem items, Navy managers rely on the historical  demand data provided electronically from requisitions.
Navy managers observed that some customers and some secondary  inventory items are more predictable than others. They cited problems,  including a lack of communication and coordination among key personnel.  For example, they said that the nuclear propulsion community is better  coordinated because the engineers, contract managers, and inventory  managers are collocated and work closely with program officials,  maintenance locations, and contractors. However, for aviation and  maritime support equipment such as mobile generators or test equipment,  a variety of issues have made demands more difficult to predict. For  example, support equipment is used on multiple platforms, needs periodic  calibration, and may have more obsolescence issues. They observed that  having timely, complete, and reliable data, as well as coordinated  communications among contract, maintenance, program, inventory, and  contractor officials and other suppliers, can improve demand data  predictability.
While the Navy recognizes that unpredictable demand is a driving factor in  the lack of alignment between inventory and current requirements, it has  not systematically evaluated why its demand-based forecasts fluctuate,  why demands across the Navy inventory are decreasing, and how demand  fluctuations vary among item manager groups or across items. The Navy  does not formally track the accuracy of its demand forecasts or what can  be done to improve them. Navy officials also said that many Navy  secondary inventory items require long production lead times, rendering  orders for these items more vulnerable to inaccuracy due to demand  fluctuations. In addition, they said that while they could improve demand  forecasting, this would increase administrative support costs and would  not be affordable across the Navy supply system. However, the Navy could  not provide data specifying what these costs would be. In addition, the  Navy has not determined the extent to which it could avoid costs by  purchasing fewer items in accordance with more accurate, updated  demand data.
section_title: Navy Has Not Adjusted Certain Inventory Management Practices in Response to Demand Unpredictability
paragraphs: Although the Navy acknowledged that demand unpredictability is a driving  factor in the lack of alignment between inventory and current  requirements, it has not adjusted certain inventory management practices  to incorporate flexibility for accommodating demand fluctuations. We  identified three specific areas—initial provisioning management, on-order  management, and retention management—where current practices  contributed to the Navy having significant amounts of inventory in excess  of current requirements.
subsections: section_title: Initial Provisioning Practices Can Result in the Purchase of Unneeded Stock
paragraphs: Under DOD’s supply chain management regulation, calculated risks may  be taken during the initial provisioning for selected items when program  uncertainties or other circumstances make such risks acceptable. Navy  inventory managers told us they rely on weapon system program managers  to identify inventory requirements needed to meet initial provisioning  estimates. However, they said these estimates often prove to be  inaccurate. For example, configuration changes may be made to the  system or parts may last longer or shorter than initially estimated. As a  result, some items that are purchased based on the initial provisioning  estimates are ultimately not needed to meet requirements. For example:    One item, a sonar set used on the Los Angeles Class submarine, had  nine parts in inventory of which seven (valued at $69,314) were  identified as excess to current requirements. The estimated demand for  these parts—which went through initial provisioning in 1991—did not  materialize. The parts have been in inventory since that time. Navy  managers noted this was not uncommon with initial provisioning.
Another item, an electronic module used in a number of ship and air  combat systems by the Navy and the Air Force, was last purchased in  1988. Nineteen parts were purchased, of which 15 (valued at $48,363)  were currently identified as excess. Initial provisioning demand was  based on engineering estimates that proved to be inaccurate. Navy  managers said that inaccurate high or low estimates happen with some  regularity.
section_title: On-Order Management Practices Limit Flexibility in Modifying Purchases
paragraphs: The Navy’s inventory management practices for on-order items limit  flexibility in modifying purchase decisions in cases where demand has  changed. Modifying purchase decisions can include reducing or canceling  the quantities being purchased. The Navy identifies purchase requests and  contracts for modification when quantities being purchased exceed the  sum of requirements and an added “termination protection level.” The  amount of a contract that is canceled is the portion that exceeds the  protection level. Because the protection level often exceeds an item’s  economic order quantity, purchase requests and contracts for inventory  that exceeds requirements often are not considered for cancellation or the  amount of a contract that is canceled is limited by a protection level. Thus,  while modification of purchase contracts can be triggered when assets  exceed protection levels, these protection levels are often set so high that  they limit modification actions.
Navy managers said they reduce or cancel purchases only when quantities  of an item exceed established protection levels. They added that  protection levels provide an effective safeguard against canceling a  purchase decision only to have to place new orders when demand for an  item increases. In our follow-up discussions with 10 Navy aviation  managers who had on-order inventory that exceeded current  requirements, none of the items involved a termination action. In one  example involving a holdback bar assembly, the Navy had 31 on-order  parts valued at $103,124 that exceeded current requirements. Although  items are reviewed at least quarterly for termination, managers took no  action on this item because of the established protection level. Also,  managers had been informed that some of these items might potentially be  needed for use in Iraq.
While cancellation of on-order inventory can reduce purchases of  unneeded inventory in response to changes in demand, a relatively small  proportion of the Navy’s total inventory exceeding requirements is on  order compared to the amount that is already on hand. As shown in figure  6, about 98 percent of the value of the Navy’s secondary inventory that  exceeded current requirements was on hand and just 2 percent of the  value was on order in the years we reviewed.
DOD’s supply chain materiel management regulation addresses  management of on-order items, and includes a number of provisions  intended to provide for effective and efficient end-to-end support. For  example, when economic order quantity methods are used in making  purchase decisions, the regulation requires that every attempt shall be  made to purchase materiel under indefinite delivery and indefinite quantity  contracts so that the order quantity and delivery times are reduced. Our  analysis of Navy inventory data showed that the preponderance of items  purchased as economic order quantity was already on hand. Of the $1.63  billion applied to economic order quantity in fiscal year 2007, about $1.37  billion (84 percent) was on hand and $260 million (16 percent) was on  order. More closely managing the purchase of economic order quantities  can add some flexibility in minimizing investments in secondary inventory.  However, the Navy loses this flexibility once the inventory is delivered.
section_title: Navy Has Not Adjusted Retention Practices in Response to Prior Recommendations
paragraphs: Although prior studies by our office and LMI have identified weaknesses in  DOD components’ inventory retention practices, the Navy has not  implemented corrective actions recommended in these reports. As a  result, the Navy’s inventory retention practices have contributed to the  significant levels of secondary inventory exceeding current requirements,  including a substantial amount of inventory that had no projected demand.  As discussed earlier, our analysis showed the Navy annually held about  $1.9 billion of its secondary inventory in economic and contingency  retention categories in fiscal years 2004 through 2007.
The Navy has a retention and disposal program aimed at identifying  inventory that should be retained and inventory that is potential excess  and should be considered for disposal or reutilization. The Navy’s  inventory retention policy calls for an economic retention level to ensure  that an item is available for a specified number of years. Economic  retention formulas are applied to inventory items based in part on program  status. For example, in a steady program the Navy wants a minimum of  three items to be available for economic retention for 8 years. Different  formulas would apply to secondary inventory associated with increasing  or declining programs. According to Navy managers, they annually review  the program status of inventory items to ensure correct economic  retention formulas are applied to each.
Additionally, the Navy has contingency retention requirements to preclude  disposal of assets that might be needed for future nonrecurring demand,  such as outfitting or planned maintenance actions; items used primarily in  wartime which have limited use in peacetime; and future foreign military  sales. The Navy policy also directs that material normally not be disposed  of within 7 years of its material support date with some exceptions, to  prevent premature disposal decisions based on initial provisioning  forecasts. These economic and contingency retention requirements, along  with potential excess stock, are to be reviewed on a semiannual basis and  prior to disposal and the results of these reviews are to be provided in  briefings to the Naval Supply Systems Command prior to the final  stratification report.
Prior reports by our office and LMI have identified weaknesses in DOD  components’ retention practices and recommended corrective actions. In  2001, we reported that DOD components had not properly documented the  approaches they have taken in making economic retention decisions,  lacked sound analytical support for the maximum levels they used, and  had not annually reviewed their methodologies for making economic  retention decisions as required by DOD’s supply chain regulation. We  recommended that DOD establish milestones for reviewing approaches  used for making decisions on whether to hold or dispose of economic  retention inventory and to annually review their approaches to meet DOD  regulations to ensure that they have sound support for determining  economic retention inventory levels. In responding to our report, DOD  stated that further study of retention practices was needed, noting that the  National Defense Authorization Act for Fiscal Year 2000 directed DOD to  sponsor an independent study on secondary inventory and parts  shortages.
DOD subsequently tasked LMI in 2001 and again in 2003 to examine  whether current economic retention policy requirements and procedures  could be improved. LMI’s review yielded recommendations similar to ours.  In 2006, we reported that DOD had yet to implement our 2001  recommendations on economic retention inventory management, and we  reiterated the need to implement them. We noted in that report that DOD  places emphasis on purging from its inventory items which no longer  support its mission and needlessly consume warehouse space. We further  found that some DOD components had not followed DOD policies and  procedures to ensure they were retaining the appropriate amount of  contingency retention inventory.
A separate LMI study of the Air Force’s economic retention practices  identified the need to incorporate new techniques for accommodating  demand uncertainty. DOD then tasked LMI to repeat the analysis for the  other components and to address the retention of materiel in the DOD  supply system. LMI reported in July 2007 that the question of retaining or  disposing of inventory is subject to demand uncertainties. It found that  the DOD regulation correctly defines the economics of retention and the  need to use economic analysis and up-to-date cost factors when deciding  what to retain. Among other things, LMI linked retention practices with  demand forecasting and called for components to use additional  techniques for more accurately determining the probability of future  demand or repurchase. For example, it called on the services to determine  whether an item with no recent demand history is still part of a weapon  system configuration and said that items with extended periods of no  demand should be candidates for item reduction. LMI also recommended  augmenting traditional demand forecast accuracy metrics with a measure  of bias to identify the potential for overforecasting, and adjust forecasting  methods accordingly. It noted that some forecast methods have a  tendency for positive bias, with the result that forecasts are too high more  often than they are too low. This leads to inflated inventory levels,  especially for low-demand items which can be harder to sell than high- demand items. LMI called for monitoring demand forecasting methods to  identify bias which can lead to overinvestment in inventory.
We found no evidence that the Navy had taken these actions. On the basis  of our review, we believe they could strengthen the management of the  Navy’s secondary inventory. For example, although the Navy continues to  have a substantial amount of inventory each year for which it shows no  projected demand (about 85,700 unique items valued at over $1.9 billion in  fiscal year 2007), data have not been developed to show whether these  items are still part of a current weapon system configuration, have had  extended periods of no demand, and should be candidates for item  reduction.
In addition, the Navy could not document that it has conducted required  annual reviews to validate its retention decision practices. DOD’s  regulation states that to ensure that economic and contingency retention  stocks correspond with current and future force levels, the components  shall review and validate their methodologies for making economic and  contingency retention decisions. The review shall occur at least annually,  and the inventory management organization commander or designee shall  attest to its validity in writing. The methodology used to set economic  retention levels should be based on economic analysis that balances the  cost of retention and the costs of disposal. Under the regulation, the  service components’ reviews should focus on better analyses supporting  retention decisions by using forecasting models that take into account  potential upward or downward trends in demand and/or the uncertainties  of predicting long-term demand based on historical data, and improved  estimates for costs used in retention decision making. Contingency  retention reviews should focus on verifying that the reason for  contingency retention still exists and the reason is properly recorded.
Navy officials said briefings provided to the Navy Supply Systems  Command prior to the final stratification review include economic  retention data. However, we do not believe these briefings fulfill the DOD  requirement for an annual review which the commander attests to in  writing. In addition, these briefings do not address the elements set out in  DOD’s regulation, such as validation that retention levels are based on  economic analysis balancing retention and disposal costs. Navy officials  also said they performed a full study of the execution of the Navy’s  economic retention policy in 2005. During the study they verified that the  model was in compliance with policy. They also performed sensitivity  analysis of the model, which confirmed the model continues to perform  cost-effective retention computations. They provided a briefing that  summarized the results of this study and recommended maintaining  economic retention policy “as is,” continually monitoring the retention  policy to identify methods to improve cost estimates, explore benefits of  no-demand options, explore reductions in minimum retention limits, and  continue to proactively dispose of obsolete material and monitor DLA  warehousing costs. While this study may be useful to the Navy in  managing retention inventory, as stated above, we do not believe it fulfills  the requirement for an annual review which the commander attests to in  writing.
section_title: Navy Has Not Defined Oversight Role of Chief and Deputy Chief Management Officers Regarding Inventory Management Improvements
paragraphs: Although the Navy has established a chief management officer and deputy  chief management officer for business transformation, it has not defined  what, if any, role these individuals will play in overseeing inventory  management improvement. The costs of DOD’s business operations have  been a continuing concern. In April 2008, for example, the Defense  Business Board raised concerns that DOD had not aggressively reduced  the overhead costs related to supporting the warfighter, which it noted  accounted for about 42 percent of DOD’s total spending each year. The  Defense Business Board recommended that DOD align strategies to focus  on reducing overhead while supporting the warfighter.
In May 2007, DOD established a chief management officer position with  responsibility for improving and evaluating the overall economy,  efficiency, and effectiveness of the department’s business activities. The  Navy also established a chief management officer, effective April 2008.  Both DOD and the Navy planned to have a deputy chief management  officer actively implementing business transformation by October 2008.  Although the Navy’s chief management officer and deputy chief  management officer would not likely have direct responsibility for  inventory management, they have been assigned responsibility for  transforming DOD’s business operations. Therefore, these newly  designated positions provide an opportunity for an enhanced level of  oversight of inventory management improvement.
section_title: Conclusions
paragraphs: The Navy has accumulated and retained levels of secondary inventory  each year that exceed current requirements without justifying that these  inventory levels are sized to minimize DOD’s investment. When the Navy  invests in the purchase of inventory items that become excess to its  requirements, these funds are not available to meet other military needs.  Taking steps to reduce the levels of inventory exceeding requirements  could help to ensure that DOD is meeting supply performance goals at  least cost. The Navy lacks metrics and goals for tracking and assessing  cost efficiency along with supply availability, customer wait time, and  other supply performance metrics and goals. Among other things, cost- efficiency metrics and goals could provide a basis for effective  management and oversight of inventory reduction efforts. Much of the  inventory that exceeded current requirements or had inventory deficits  resulted from inaccurate demand forecasts, which the Navy attributed to  unpredictability of demand. However, the Navy has not systematically  evaluated and addressed demand unpredictability or adjusted certain  inventory management practices to enhance flexibility in adapting to  fluctuations in demand. In the absence of such actions, the Navy will likely  continue to purchase and retain items that it does not need and then spend  additional resources to handle and store these items. Finally, since  inventory management is part of the Navy’s broader business operations  and transformation, it is reasonable to expect the newly established chief  management officer and deputy chief management officer to exercise  some level of oversight of the Navy’s inventory management improvement  efforts.  Strengthening the Navy’s inventory management—while  maintaining high levels of supply availability and meeting warfighter  needs—could reduce support costs and free up funds for other needs.
section_title: Recommendations for Executive Action
paragraphs: To improve the management of the Navy’s secondary inventory, we  recommend that the Secretary of Defense direct the Secretary of the Navy,  in conjunction with the Commander, Navy Supply Systems Command, and  the Commander, Naval Inventory Control Point, to take the following four  actions:    Establish metrics and goals for tracking and assessing the cost  efficiency of inventory management and incorporate these into existing  management and oversight processes.
Evaluate demand forecasting procedures to identify areas where  forecasts have been consistently inaccurate, correct any systemic  weaknesses in forecasting procedures, and improve communications  among stakeholders, to include promptly relaying changes in programs  and other decisions that affect purchases of spare parts. Further, the  Commander, Naval Supply Systems Command, and the Commander,  Naval Inventory Control Point, should develop an evaluation plan and  interim milestones for assessing the impact of ongoing efforts and take  additional corrective actions, if warranted, to improve demand  forecasting for secondary inventory.
Revise inventory management practices to incorporate the flexibility  needed to minimize the impact of demand fluctuations. Specific  attention should be given to revising practices regarding initial  provisioning management, on-order management, and retention  management. Further, the Commander, Naval Supply Systems  Command, and the Commander, Naval Inventory Control Point, should  develop an evaluation plan and interim milestones for assessing the  impact of ongoing efforts and take additional corrective actions, if  warranted, to incorporate flexibility into inventory management  practices.
Ensure that required annual reviews validating methodologies used for  making retention decisions are performed and documented.
We also recommend that the Secretary of the Navy direct that the Navy’s  Chief Management Officer and Deputy Chief Management Officer exercise  appropriate oversight of Navy inventory management improvement to  align improvement efforts with overall business transformation and to  reduce support costs.
section_title: Agency Comments and Our Evaluation
paragraphs: In its written comments on a draft of this report, DOD concurred with our  recommendations and identified corrective actions and estimated dates  for these actions to be completed. On the basis of DOD’s comments, we  have modified two of our recommendations. The Navy also provided  technical comments, which we have incorporated as appropriate. The  department’s written comments are reprinted in appendix II.
Although it concurred with our recommendations, DOD took issue with  our finding that 40 percent of the Navy’s secondary inventory exceeded  current requirements and stated that it was important to frame this finding  in proper context. DOD commented that 50 percent of the inventory we  portrayed as excess to current requirements is applicable to the 2-year  budget horizon, another 10 percent is retained as economic retention  stock which is less expensive to retain than to dispose and later procure,  and 30 percent is contingency retention stock which is held for specific  contingencies, leaving only 10 percent identified as potential excess. It  said the department will continue to focus on reducing potential excess, as  well as improving forecasts and ensuring a correct balance between the  cost to hold inventory and the cost to dispose and repurchase. For the  purposes of our analysis, we defined excess inventory as that portion of  the inventory that exceeds the requirements objective, which is defined in  the department’s supply chain materiel management regulation. As we  noted in the report, we selected the requirements objective as our baseline  because it includes the requirements used to determine when to order new  parts. In other words, if the Navy had enough parts to meet the  requirements objective, it would not purchase new parts. The inventory  categories and data cited by DOD in its comment are discussed in the  report. The department’s comment places too little emphasis on the need  to reduce the accumulation and retention of inventory that exceeds  current requirements, which amounted to about $7.5 billion each year.  When the Navy invests in inventory sooner than it is needed, the chances  increase that more inventory will become excess, and funds used to  purchase inventory before it is needed are not available to meet other  military needs. Thus, we continue to believe that taking steps to reduce the  high levels of inventory exceeding current requirements could help ensure  that the Navy is meeting supply performance goals at least cost. Some of  the actions that DOD identified in its responses to our specific  recommendations should help.
DOD concurred with our recommendation that the Navy establish metrics  and goals for tracking and assessing the cost efficiency of inventory  management. It said the Navy Supply Systems Command will incorporate  into existing management and oversight processes a metric and goal for  tracking and assessing the cost efficiency of inventory management, and  identified October 31, 2009, as the estimated completion date for this  action.
DOD concurred with our recommendation that the Navy improve demand  forecasting procedures and communications among stakeholders.  However, DOD cited ongoing Navy efforts to evaluate current forecasting  procedures and tools, implement a long-planned enterprise business  information system, and continue its annual training of inventory  managers, and it did not identify additional corrective actions beyond  those already planned. DOD estimated these actions would be completed  by September 30, 2010. While the ongoing Navy efforts cited by DOD in its  comment may have a positive impact, we continue to believe that the Navy  could derive benefits from a systemic evaluation of its demand forecasting  procedures. Therefore, the Navy should establish an evaluation plan and  interim milestones for assessing the impact of ongoing efforts and take  additional corrective actions, if warranted. We have modified our  recommendation accordingly.
DOD concurred with our recommendation that the Navy revise inventory  management practices to incorporate flexibility needed to minimize the  impact of demand fluctuations. However, DOD cited ongoing Navy efforts  to improve inventory management practices, including those related to  initial provisioning and on-order inventory management, and estimated  these corrective actions would be completed by September 30, 2010. While  the ongoing Navy efforts cited by DOD in its comment may have a positive  impact, its comment provided no indication that the Navy plans any  changes to the way it conducts business. Therefore, the Navy should  establish an evaluation plan and interim milestones for assessing the  impact of ongoing efforts and take additional corrective actions, if  warranted. We have modified our recommendation accordingly.
DOD concurred with our recommendation that the Navy perform and  document required annual reviews validating methodologies used for  making retention decisions. According to DOD, the Navy Supply Systems  Command will modify its management internal control program to assure  this requirement is met and estimated this corrective action would be  completed by May 31, 2009. We believe this planned action is responsive to  our recommendation.
DOD concurred with our recommendation that the Navy direct its Chief  Management Officer and Deputy Chief Management Officer to exercise  appropriate oversight of Navy inventory management improvement to  align improvement efforts with overall business transformation and to  reduce support costs. DOD said the Navy is developing a business  transformation implementation strategy to align with Office of the  Secretary of Defense actions in this area. Through this development  process, the Navy will determine the appropriate role the Chief  Management Officer should exercise in inventory management oversight.  DOD estimated that it would complete this corrective action by April 30,  2009. We believe this planned action is responsive to our recommendation.
We are sending copies of this report to interested congressional  committees; the Secretary of Defense; the Secretary of the Navy; the  Secretary of the Air Force; the Director, Defense Logistics Agency; the  Under Secretary of Defense for Acquisition, Technology, and Logistics;  and the Director, Office of Management and Budget. We will also make  copies available to others upon request. In addition, the report will be  available at no charge on the GAO Web site at http://www.gao.gov/.
If you or your staff have any questions concerning this report, please  contact me on (202) 512-8365 or solisw@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. Key contributors to this report are listed in  appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine the extent to which the Navy’s on-order and on-hand  secondary inventory reflected the amount needed to support current  requirements, we obtained the Navy’s Central Secondary Item  Stratification Budget Summary and item-specific reports for September 30  of each fiscal year from 2004 through 2007. The stratification reports serve  as a budget request preparation tool and a mechanism for matching assets  to requirements. Our analysis was based on analyzing the Navy’s item  stratifications within the opening position table of the Central Secondary  Item Stratification Reports. To validate the data in the budget  stratification reports we generated summary reports using electronic data  and verified our totals against the summary stratification reports obtained  from the Navy. After discussing the results with Navy managers, we  determined that the data were sufficiently reliable for the purposes of our  analysis and findings. Upon completion of the data validation process, we  revalued the Navy’s secondary inventory items identified in its budget  stratification summary reports because these reports value useable items  and items in need of repair at the same rate, and do not take into account  the cost of repairing broken items. We computed the new value for items  in need of repair by subtracting repair costs from the unit price for each  item. We also removed overhead charges, called cost recovery rates, from  the value of each item. Using information obtained from Navy managers,  we identified and removed from our data set items managed under  Performance Based Logistics (PBL) contracts. According to the Navy,  published stratification data on PBL items are inaccurate because the  Navy does not determine requirements for these items.
Table 8 summarizes the Navy inventory data we used, showing the annual  averages for items, parts, and value of the Navy’s inventory, organized by  supply cognizance code.
In presenting the value of inventory in this report, we converted then-year  dollars to constant fiscal year 2007 dollars using Department of Defense  (DOD) Operations and Maintenance price deflators.
We considered Navy inventory to exceed current requirements if more  inventory than needed is available to satisfy its requirements based on the  opening position table of the Navy’s budget stratification report.  Collectively, these requirements are referred to by DOD as the  “requirements objective,” defined as the maximum authorized quantity of  stock for an item. However, if more inventory is on hand or on order than  is needed to satisfy its requirements, the Navy does not consider the  inventory beyond current requirements to be unneeded. Instead, the Navy  uses this inventory to satisfy future demands over a 2-year period,  economic retention requirements, and contingency retention  requirements. Only after applying inventory to satisfy these additional  requirements would the Navy consider that it has more inventory than is  needed and consider this inventory for potential reutilization or disposal.  We do not agree with the Navy’s practice of not identifying inventory used  to satisfy these additional requirements as excess because it overstates the  amount of inventory needed to be on hand or on order by billions of  dollars. The Navy’s requirements determination process does not consider  these additional requirements when it calculates the necessary amount of  on-hand and on-order inventory, which means that if the Navy did not have  enough inventory on hand or on order to satisfy these additional  requirements, the requirements determination process would not result in  additional inventory being purchased to satisfy these requirements.
We consider the Navy to have inventory deficits if levels of on-hand  inventory are insufficient to meet the reorder level, which the Navy defines  as the level of on-hand assets at the time an order must be placed to  achieve the acceptable stock-out risk. Normally, item managers place an  order for the number of parts below the reorder level, plus an economic  order quantity. However, due to variation in acquisition lead times, these  parts may not be delivered when they are needed. We did not include the  procurement cycle (economic order quantity) requirement when  calculating inventory deficits, because this requirement defines the  maximum level of on-hand or on-order inventory that may be above the  reorder level, and does not define a minimum level of on-hand inventory.  For comparison purposes with the excess inventory, we calculated the  amount of inventory that the Navy would have to acquire to meet  acquisition lead time and economic order quantity in order to achieve  current operating requirements for these items where there was a deficit.
To determine the extent to which the Navy’s on-hand and on-order  secondary inventory reflects the amount of inventory needed to support  requirements, we reviewed DOD and Navy inventory management policies,  past GAO products on DOD and Navy inventory management practices for  secondary inventory items, and other related documentation. We also  created a database which compared the Navy’s current inventory to its  current requirements and computed the amount and value of secondary  inventory exceeding or not meeting current operating requirements. We  also determined how the Navy applied the inventory that exceeded current  requirements to future demands, economic retention, contingency  retention, or potential reutilization/disposal. We determined how much of  the Navy’s inventory was in serviceable condition, and compared this  portion to the inventory in unserviceable condition. We also used codes  provided by the Navy to determine the program status of items we  identified as meeting or exceeding current requirements.
We developed a survey to estimate the frequency of reasons why the Navy  maintained inventory items that were not needed to support current  requirements or did not meet requirements. The survey asked general  questions about the higher assembly (component parts) and/or weapon  systems that the items support, and the level of experience of the item  manager with responsibility for the item. In addition, we asked survey  respondents to identify the reason(s) why inventory exceeded current  requirements or was in deficit. We provided potential reasons which we  identified during our discussions with Navy managers from which they  could select. Since the list was not exhaustive, we provided an open-ended  response option to allow other reasons to be provided. In addition to an  expert technical review of the survey by a survey methodologist, we  conducted pretests with Navy managers for aviation and maritime items in  Philadelphia and Mechanicsburg, Pennsylvania, prior to sending out the  final survey instrument. We revised the survey accordingly based on  findings from the pretests.
We e-mailed this electronic survey to specific Navy managers in charge of  sampled unique aviation and maritime items at the Navy’s Inventory  Control Point locations in Philadelphia and Mechanicsburg, Pennsylvania.  We conducted this survey from May 2008 through July 2008. To estimate  the frequency of reasons for inventory not needed to meet requirements  and inventory deficits, we drew a stratified random probability sample of  424 unique items—353 unique items with on-hand inventory not needed to  support current requirements, 31 unique items with on-order inventory not  needed to support current requirements, and 40 unique items with  inventory deficits—from a study population of 126,331 items (112,567 with  inventory not needed to meet current requirements and 13,764 with  inventory deficits). These categories identified a combined value of $6.8  billion of inventory not needed to meet current requirements. All of these  items met our criteria to be included in our study population of items not  needed to meet current requirements. Additionally, based on our analysis  of the stratification data, all of the 13,764 unique items with inventory  deficits, valued at $462 million, met our criteria to be included in our  inventory deficit study population. We stratified using the scheme shown  in table 9, dividing the on-hand and on-order excess into 3 substratum  each by the amount of supply on hand and stratifying within Philadelphia  and Mechanicsburg. With the inclusion of a stratum for inventory deficit  items within each office, our sample contained 14 total strata. The  divisions of the population, sample, and respondents across the strata, as  well as the number of responses by stratum, are also shown in table 9.
We sent 424 electronic surveys—one for each item in the sample—to the  Navy managers identified as being responsible for these items. Inventory  control for three of the items in our sample had recently been transferred  to the Defense Logistics Agency, so we treated these cases as out of scope.  We did not receive completed data collection instruments for 3 of the  remaining items in our sample. We received 418 usable responses to our  surveys, providing a total response rate of 98.6 percent. Each sampled item  was subsequently weighted in the final analysis to represent all the  members of the target population.
Because we followed a probability procedure based on random selections,  our sample of unique items is only one of a large number of samples that  we might have drawn. Because each sample could have provided different  estimates, we express our confidence in the precision of our particular  sample’s results in 95 percent confidence intervals. These are intervals  that would contain the actual population values for 95 percent of the  samples we could have drawn. As a result, we are 95 percent confident  that each of the confidence intervals in this report will include the true  values in the study population. All percentage estimates from our sample  have margins of error (that is, widths of confidence intervals) of plus or  minus 5 percentage points or less, at the 95 percent confidence level  unless otherwise noted.
In addition to sampling errors, the practical difficulties of conducting any  survey may introduce errors, commonly referred to as nonsampling errors.  For example, difficulties in how a particular question is interpreted, in the  sources of information that are available to respondents, or in how the  data are entered into a database or were analyzed can introduce unwanted  variability into the survey results. We took steps in the development of the  survey, the data collection, and the data analysis to minimize these  nonsampling errors. We reviewed each survey to identify unusual,  incomplete, or inconsistent responses and followed up with item  management specialists by telephone to clarify those responses. In  addition, we performed computer analyses to identify inconsistencies and  other indicators of errors and had a second independent reviewer for the  data analysis to further minimize such error.
To determine reasons for the types of answers given in the surveys, we  held additional on-site interviews with Navy inventory managers on 70 of  the items in our sample. We chose an equal number of aviation and  maritime items based on the highest value of inventory to identify 10 each  from on-hand, on-order, and deficits. We also held follow-up discussions  on 10 other items where we found that demand had been increasing, yet  there were excess parts; or conversely where demand had been  decreasing, yet there was an inventory deficit. These cases were atypical  because, according to Navy managers, demand increases would likely lead  to deficits, and, conversely, demand decreases would likely lead to  increases in inventory excess to requirements. These included 5 aviation  items and 5 maritime items based on the pattern of demand forecasts we  observed for these items from fiscal year 2004 through 2007. During these  discussions we obtained additional detailed comments and documentation  related to demand, demand forecasting, acquisitions, terminations, and  retention and disposal actions.
We conducted this performance audit from November 2007 to December  2008 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. On the basis of information  obtained from the Navy on the reliability of its inventory management  systems’ data, and the survey results and our follow-up analysis, we  believe that the data used in this report were sufficiently reliable for  reporting purposes.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Thomas Gosling, Assistant  Director; Carl Barden; Lionel C. Cooper, Jr.; Foster Kerrison; Carl Ramirez;  Minnette Richardson; Steve Pruitt; and Cheryl Weissman made key  contributions to this report.