Defense Management: DOD Needs to Demonstrate That Performance-Based Logistics Contracts Are Achieving Expected Benefits
Released: 2005-09-09T00:00:00

Letter

Background

DOD has increasingly relied on contractors to provide logistics support for weapon system maintenance. These logistics support arrangements have taken various forms. In fiscal year 1998, DOD directed the armed services to pursue logistics support “reengineering” efforts with contractors to achieve cost savings and improve efficiency. A 1999 DOD study identified 30 pilot programs to test logistics support concepts that placed greater reliance on the private sector. Some of the pilot programs involved performance-type arrangements that were subsequently converted to, or designated as, performance-based logistics contracts. DOD’s Quadrennial Defense Review Report advocated the implementation of performance- based logistics, with appropriate metrics, to compress the supply chain by removing steps in the warehousing, distribution, and order fulfillment processes; reducing inventories; and reducing overhead costs while improving the readiness of major weapon systems and commodities.

Over the last few years, DOD has issued guidance on the implementation of performance-based logistics. In November 2001, the Office of the Deputy Under Secretary of Defense issued guidance recommending that program managers conduct a sound business case analysis to decide whether they should implement performance-based logistics for new systems and major acquisitions for already fielded systems. In an August 2003 memorandum to the military departments, the Under Secretary of Defense (Acquisition, Technology and Logistics) stated that DOD should continue to increase its use of performance-based logistics acquisitions. On February 4, 2004, the Deputy Secretary of Defense (1) directed the Under Secretary of Defense (Acquisition, Technology and Logistics), in conjunction with the Under Secretary of Defense (Comptroller), to issue clear guidance on purchasing logistics support using performance criteria and (2) directed each service to provide a plan to aggressively implement performance-based logistics for current and planned weapon system platforms. Then, based on recommendations in our August 2004 report, the Under Secretary of Defense (Acquisition, Technology and Logistics) issued a memorandum reemphasizing that the use of this type of support strategy was intended to optimize weapon system availability while minimizing costs and the logistics footprint and may be applied to weapon systems, subsystems, and components. The memorandum also provided specific definitions of performance metrics to be used.

DOD describes performance-based logistics as the process of (1) identifying a level of performance required by the warfighter and (2) negotiating a performance-based arrangement between the government and a contractor or government facility to provide long-term total system support for a weapon system at a fixed level of annual funding. Instead of buying spare parts, repairs, tools, and data in individual transactions, DOD program offices that use a performance-based logistics arrangement buy a predetermined level of performance that meets the warfighter’s objectives. Although established performance measures should be tailored to reflect the unique circumstances of each performance-based logistics arrangement, the measures are expected to support five general objectives: (1) percentage of time that a weapon system is available for a mission (operational availability); (2) percentage of mission objectives met (operational reliability); (3) operating costs divided by a specified unit of measure (cost per unit usage); (4) size or presence of support required to deploy, sustain, or move a weapon system (logistics footprint); and (5) period of time that is acceptable between the demand or request for support and the satisfactory fulfillment of that request (logistics response time). Currently, a DOD task force is refining these objectives into DOD standard performance definitions to be used by program offices in every service when preparing performance-based logistics arrangements.

DOD guidance recommends that program offices prepare a business case analysis prior to adopting a performance-based logistics approach to support a weapon system. The aim of the business case analysis is to justify the decision to enter into a performance-based logistics contract. The business case analysis is to include cost savings that are projected as a result of using a performance-based logistics approach and the assumptions used in developing the business case analysis. Furthermore, DOD guidance states that program offices should update their business case analyses at appropriate decision points when sufficient cost and performance data have been collected to validate the assumptions used in developing the business case analyses, including the costs of alternative approaches, projected cost savings, and expected performance levels. Further, GAO Internal Control Standards state that it is necessary to periodically review and validate the propriety and integrity of program performance measures and indicators. Also, actual performance data should be continually compared against expected or planned goals, and any difference should be analyzed. Additionally, management should have a monitoring strategy that emphasizes to program managers their responsibility for internal controls (i.e., to review and validate performance measures and indicators) and that includes a plan for periodic evaluation of control activities.

DOD Program Offices Could Not Demonstrate Cost Savings and Performance Improvement Resulting from the Use of Performance-Based Logistics

DOD program offices could not demonstrate that their use of performance- based logistics arrangements had achieved cost savings and performance improvements because they had not updated their business case analysis as suggested by DOD guidance. Specifically, of the 15 DOD program offices, only 1 updated its business case analysis to validate assumptions concerning cost and performance. Other DOD program offices had not updated their business case analysis in part because they lacked reliable contractor cost and performance data. The program offices typically relied on cost and performance data generated by contractors’ information systems without verifying that the data were sufficiently reliable to update the business case analysis. Two DOD agencies, DCMA and DCAA, have the capability to assist program offices in monitoring fixed-price performance- based contracts, verifying the reliability of contractors’ information systems, and collecting cost and performance data.

Projected Cost Savings and Performance Improvements Were Not Validated

None of the 15 program offices included in our review could demonstrate that use of a performance-based logistics arrangement had achieved cost savings and performance improvements. Although an updated business case analysis based on actual cost and performance data might show that cost savings and performance improvements were being achieved, only 1 of the 15 program offices had updated its business case analysis consistent with DOD guidance. Of the 15 program offices, 11 had developed a business case analysis prior to entering into a performance- based logistics arrangement. In their analysis, these program offices projected that they would achieve significant cost savings. For example, an Army program office projected total cost savings of $508.5 million, and a Navy program office projected cost savings of $29.7 million. However, only the Navy’s T-45 program office had subsequently updated its business case analysis consistent with DOD guidance to determine whether cost savings were being achieved. Realizing that the contractor was not meeting the aircraft availability performance measure, the program office reassessed its business case assumptions and found that costs per flying hour were higher than estimated because the aircraft was flying fewer hours than forecasted. As a result, the program office negotiated separate contracts for the airframes and engines, which resulted in estimated cost savings of $144 million over 5 years.

Performance indicators tracked by the program offices showed that the contractors met or exceeded performance requirements. Of the 15 programs, 10 reported that performance levels exceeded contract requirements, and 5 reported that performance levels were meeting contract requirements. For example, an Army program office reported a weapon system availability rate of 99 percent, which is 7 percent higher than what was projected in the business case analysis. Similarly, a Navy program office reported a weapon system availability rate of 97 percent, which is 7 percent higher than projected.

Despite the reported performance improvements, the program offices had not analyzed the performance data to validate the improvements and determine whether these improvements could be attributed directly to their use of performance-based logistics arrangements to support the weapon systems. In addition, we noted that program offices in the past reported they had also met or exceeded required levels of performance using other contractual arrangements for weapon system maintenance. Moreover, the DOD program offices reporting that performance levels were exceeding contract requirements under performance-based logistics arrangements had not determined the incremental costs associated with achieving these higher levels of performance. As a result, they had no way of knowing whether incremental costs outweighed the benefits derived from achieving performance levels in excess of requirements.

Program officials did not follow DOD guidance to update and validate their business case analyses because they assumed that costs incurred under fixed-price performance-based logistics arrangements would always be lower than costs incurred under more traditional contracting arrangements, and several program officials cited a lack of reliable data needed to validate expected costs savings and improved performance. However, the experience of the T-45 program showed that it is possible for program offices to validate the assumptions in the business case analysis and to determine whether expected cost savings and performance improvements were achieved. There are also other benefits derived from validating the assumptions used in the business case analysis. Validation can provide a better understanding of costs associated with the repair and maintenance of weapon systems, ensure that proper performance metrics are in place to satisfy logistical demand, isolate incremental costs associated with achieving higher levels of performance, and make cost and performance data available for contract renegotiations in order to obtain the best value for the government. Furthermore, we did not find evidence that the Office of the Secretary of Defense had established procedures to monitor whether program offices were following its guidance to update their business case analyses. The results of these updates could be used by DOD to assess the implementation of performance-based logistics arrangements and evaluate the extent to which performance-based logistics arrangements are achieving expected benefits.

DOD Program Offices Relied on Contractors’ Data Without Verifying the Reliability of the Data

DOD program offices included in our review stated that because of limitations in their own information systems, they typically relied on cost and performance data generated by the contractors’ information systems to monitor performance-based logistics contracts. Program offices acknowledged limitations in their own information systems in providing reliable data to closely monitor contractor cost and performance. Existing systems are capable of collecting some cost and performance information on performance-based logistics contracts; however, according to program officials, the systems are not capturing sufficiently detailed cost and performance information for monitoring performance-based logistics contracts. Program officials told us they had more confidence in the accuracy and completeness of contractor systems than in their legacy systems. The program offices, however, had not determined whether the contractor-provided data were sufficiently reliable to update their business case analyses. As a result, the program offices did not have the reliable data they needed to validate the assumptions used in the business case analysis and to determine whether their performance-based logistics arrangements were achieving expected cost savings and improved performance.

As we noted in a prior report on DOD’s management of depot maintenance contracting, to reduce personnel and save costs, DOD decided to rely more on contractors to manage and oversee fixed-price contracts because these contracts are considered low risk. The contractor assumes most of the risks for fixed-priced contracts, with the government taking a more limited role in monitoring these contracts. In our prior work on defense contract management, we discussed the importance of monitoring contractors’ systems to ensure the accuracy and completeness of information generated by these systems. In addition, during our review of the private sector’s use of performance-based logistics, we noted that private-sector companies that use performance-based logistics contracts, whether fixed price or cost-plus, closely monitor cost and performance information to effectively manage their contracts. These companies said they rely on their own systems and personnel to verify the cost and quality of work performed by the contractor. The private sector takes this approach (1) to ensure that expected costs under the contracts are accurate and meet the company’s reliability standards, (2) to validate the business case decision used to justify a performance-based logistics arrangement, and (3) to obtain the data necessary to renegotiate the contract.

DOD Program Offices Made Limited Use of Resources Available to Assist in Monitoring Performance- Based Logistics Contracts

DCMA and DCAA have the capability to monitor contractor cost and performance, verify the reliability of contractor-provided data, and collect detailed cost and performance data. However, most of the DOD program offices we reviewed made limited use of these agencies’ resources because they viewed fixed-price performance-based logistics contracts to be low risk compared with other types of contracts. Before a contract is awarded, DCMA can provide advice and service to help construct effective solicitations, identify potential risk, select the most capable contractors, and write contracts that meet the needs of DOD customers. After the contract is awarded, DCMA can monitor contractors’ information systems to ensure that cost, performance, and delivery schedules are in compliance with the terms and conditions of the contracts. DCAA performs contract audits for DOD components and provides accounting and financial advisory services during contract negotiation and administration of contracts.

DCMA and DCAA officials said that they have a greater role in monitoring cost information for cost-plus contracts because such contracts are considered high risk. According to DCMA and DCAA officials, their level of oversight is significantly less for fixed-priced contracts, including performance-based logistics arrangements, because DOD considers these contracts to be low risk, thereby diminishing the need for monitoring contractor performance. Without a request from program offices or specific contract clauses, DCMA and DCAA generally would not conduct periodic reviews or audits of fixed-price contracts to verify cost and performance information. DCMA and DCAA officials also said that in the past, monitoring fixed-price contracts was included in their workload, but because of a reduction in staff and streamlining of operations, they focused their efforts on contract areas that have the highest risk for cost growth. DCMA and DCAA officials said they would support increasing their role in monitoring fixed-price performance-based contracts depending on the availability of their resources.

Conclusions

DOD is expanding its use of performance-based logistics as its preferred support strategy in support of weapon systems but has not yet demonstrated that this long-term support strategy is being effectively implemented DOD-wide. DOD guidance states that program offices, after entering into performance-based logistics arrangements, should update their original business case analysis using actual cost and performance data to validate their assumptions, but most of the program offices we reviewed had not followed this guidance, and the Office of the Secretary of Defense was not monitoring whether program offices were following the guidance. The program offices therefore could not substantiate that cost savings and performance improvements for weapon system support were being achieved through the use of performance-based logistics arrangements. Program offices also have lacked reliable cost and performance data needed to validate the results of performance-based logistics arrangements. Reliable data could be collected and analyzed by increasing oversight of these contracts with the assistance of DCMA and DCAA.

Recommendations for Executive Action

To demonstrate that performance-based logistics arrangements are resulting in reduced costs and increased performance, and to improve oversight of performance-based logistics contracts, we recommend that the Secretary of Defense direct the Under Secretary of Defense (Acquisition, Technology and Logistics) to take the following two actions: 1. Reaffirm DOD guidance that program offices update their business case analyses following implementation of a performance-based logistics arrangement and develop procedures, in conjunction with the military services, to track whether program offices that enter into these arrangements validate their business case decisions consistent with DOD guidance. 2. Direct program offices to improve their monitoring of performance- based logistics arrangements by verifying the reliability of contractor cost and performance data. The program offices may wish to increase the role of DCMA and DCAA in overseeing performance-based logistics contracts.

Agency Comments and Our Evaluation

In commenting on a draft of this report, DOD concurred with our recommendations regarding the validation of business case decisions for performance-based logistics arrangements and verification of reliability of contractor data. While DOD was generally responsive to our recommendations, specific details on how DOD planned to validate and verify contractor data were not provided.

Regarding our recommendation to reaffirm guidance and develop procedures to track whether program offices validate their business case decisions, DOD stated that the department will reaffirm DOD guidance on updating the business case analysis after implementing performance-based logistics arrangements and will work with the military services to develop procedures to track whether program offices validate their business case decisions consistent with DOD guidance.

With regard to our second recommendation to direct program offices to verify the reliability of contractor cost and performance data, DOD stated that it will issue guidance on verifying the reliability of contractor cost and performance data. DOD did not provide specific information on what the guidance would include nor did it indicate whether it would increase the use of DCMA or DCAA to verify the reliability of contractor cost and performance data.

DOD also provided technical comments, which we have incorporated as appropriate.

Scope and Methodology

To determine whether DOD could demonstrate that cost savings and improved performance were being achieved through the use of performance-based logistics arrangements, we collected and analyzed data on 15 weapon system programs identified by the Office of the Secretary of Defense and the military services as programs that have successfully used performance-based logistics arrangements. The 15 programs are listed in table 1.

We reviewed DOD and service policies, procedures, and guidance related to the use of performance-based logistics and met with program officials to discuss how their performance-based logistics contracts were structured and managed and how these contracts were validated to ensure that cost savings and improved performance were being achieved as a result of using performance-based logistics. We also obtained and analyzed available documentation, including business case analyses, contracts, and related files. We did not assess the methodology program offices used to prepare their business case analyses or the quality of these analyses. We discussed with program officials the systems they used to monitor contractor cost and performance. We also interviewed officials from the Office of the Secretary of Defense and military department headquarters to discuss implementation of performance-based logistics, lessons learned, and the benefits derived from using performance-based logistics approaches and practices. To determine how private-sector companies ensure that cost and performance levels under a performance-based contract are as expected, we reviewed the information provided by seven companies identified in our prior report that used complex and costly equipment that had life-cycle management issues similar to military weapon systems, and outsourced some portion of their maintenance work under performance- based contracts. These seven companies consisted of six airline companies and one mining company. We contacted officials at DCMA and DCAA to determine those agencies’ roles in monitoring the costs and performance of fixed-priced contracts, including performance-based logistics contracts, how audits are requested or initiated, and the procedures for reporting the results of the audits.

We are sending this report to the Chairman and Ranking Minority Member, Senate Subcommittee on Readiness and Management Support, Committee on Armed Services. We will also send copies to the Under Secretary of Defense (Acquisition, Technology and Logistics). Copies of this report will be made available to others upon request. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions on the matters discussed in this report, please contact me at (202) 512-8412 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. GAO staff who made major contributions to this report are listed in appendix II.

Comments from the Department of Defense

GAO Contact and Staff Acknowledgments

GAO Contact

William M. Solis (202) 512-8412 or solisw@gao.gov.

Acknowledgments

In addition to the contact named above, Thomas Gosling, Assistant Director; Thom Barger; Judith Collins; Pamela Valentine; and Cheryl Weissman were major contributors to this report.