Spare parts are defined as repair parts and components, including kits, assemblies, and subassemblies required for the maintenance of all equipment. Repair parts and components can include repairable parts, which are returned to the supply system to be fixed when they are no longer in working condition, and consumable parts, which cannot be repaired cost-effectively. The Navy owns and operates about 4,000 aircraft. These aircraft contain about 70,000 repairable spare parts, such as landing gear, navigational computers, and hydraulic pumps. These spare parts, in turn, consist of thousands of individual parts or items. When any of these spare parts or individual items fails to perform properly, or reaches the end of its service life, it must be replaced with a repaired or newly purchased part. This maintenance work takes place at government repair facilities and commercial contractor facilities across the country. Providing logistics support for these aircraft is the responsibility of the Naval Air Systems Command and the Naval Supply Systems Command. Overall Navy logistics policies and procedures are the responsibility of the Deputy Chief of Naval Operations (Logistics). The Navy's repairable spare parts are managed under the Navy Working Capital Fund. This is a revolving fund that relies on revenues generated from the sale of parts and services to customers, which are then used to finance subsequent operations. The fund is expected to generate sufficient revenues to cover the full cost of operations and to break even over time-- that is, not to have a gain or a loss. Customers order parts from the Navy's supply system and pay the working capital fund from their budgets. Each fiscal year, the Navy establishes the prices for spare parts, setting them to correspond with the customers' aggregate budgeted amounts. This concept, in theory, ensures that customers have, in the aggregate, sufficient funds budgeted to purchase their anticipated requirements of spare parts. The process of setting prices for spare parts begins 2 years before the fiscal year in which the prices take effect and involves customers, a number of Navy entities, and the Office of the Under Secretary of Defense (Comptroller). During this process, the customer price is set on the basis of projected customer requirements, as well as anticipated repair costs and management overhead fees. Figure 1 shows the major elements that are considered in developing the customer price for Navy spare parts. In our recent review of prices for a selected group of spare parts for three Navy aircraft and their engines that we examined in the November 2000 report, we found that prices continued to rise. Our analysis suggested that the major factor driving these increases was the cost of the materials used to repair spare parts, while other factors, such as higher overhead fees and growing labor costs, also contributed. However, because of the lack of relevant information in the Navy's maintenance and repair databases, we were unable to determine what the underlying reasons were for the increases and as a result, what management action might be appropriate to reduce or stabilize the prices. The prices of repairable aviation spare parts continued to increase dramatically. Between fiscal year 1999 and 2002, the total cost of spare parts increased from $1.6 billion to $2.7 billion. Of this total, the repair portion rose from $1.2 billion to $1.8 billion, an increase of 50 percent and represented 6.6 and 8.3 percent, respectively, of the Navy and Marine Corps' operation and maintenance funds that are used to sustain the readiness of the operating forces. Our analysis of 453 selected spare parts showed that the prices paid by customers increased an average of 37 percent between fiscal year 1999 and 2002 (see app. II). We looked at these because they were the most costly repair parts from three aircraft (the H-53 helicopter, the F/A-18 Hornet fighter and attack aircraft, and the AV-8B Harrier attack aircraft) and their engines. We found that the prices for 195 of the 453 parts dropped an average of almost 35 percent (see app. III) due to reductions in both repair costs and overhead fees. The prices for the remaining 258 parts, however, spiraled dramatically--an average of 91.5 percent during the 3-year period (see app. IV). The price hikes for 233 of the 258 spare parts (90 percent) were primarily due to higher repair costs, while those for the remaining 25 (10 percent) were due to higher management overhead fees. We selected 31 spare parts from the total population of 453 to identify the factors driving increases in repair costs. These parts were all repaired at government depots. As table 1 shows, the average increases in total repair costs for these 31 parts varied widely--from a modest 8 percent for the F/A-18 Hornet aircraft to more than 200 percent for two engine systems (F-402 and T-64). A closer look at the repair data indicated that the largest increases were generally attributable to the higher costs of the materials used to repair the spare parts, while a smaller increase resulted from higher labor costs. For example, one of the parts, a rotor compressor for the F-402 engine, increased over 86 percent in price from $48,890 in fiscal year 1999 to $91,060 in fiscal year 2002. The material portion of the costs for repair had increased from $16,386 to $57,727 (over 252 percent), while labor had decreased from $10,739 to $9,092 (approximately 15 percent) and overhead had increased less than 12 percent from $21,765 to $24,241. (See app. V for detailed repair cost data for each part.) Figure 2 shows how the cost components contributed to the price that customers paid for another of these parts, a $45,120 turbine rotor for the F-404 engine in fiscal year 2002. It shows that a significant portion ($30,893, or 69 percent) of the price stemmed from the cost of the materials used to fix the rotor. A recent Naval Air Systems Command study underscored that rising material costs used in repairing spare parts are a contributing factor to price increases. The study compared repair costs in its maintenance facilities for the first quarter of fiscal year 1997 with those for the first quarter of fiscal year 2000. It concluded that while the average annual repair costs for more than 26,000 parts increased by 5 percent, the cost of materials rose by 8 percent; in contrast, labor costs rose less than 1 percent. Furthermore, the study showed that in the case of 105 high- demand parts material costs jumped by about 16 percent while labor costs increased by 3 percent. We found a similar link between higher material costs and repairable spare parts price increases. Our examination of the aggregate prices of individual repair items used in the 31 spare parts indicated that three factors may have contributed to higher material costs for 25 of these parts: (1) higher prices for individual repair parts used, (2) the use of more parts in the repair process, and (3) changes in the mix of repair parts used. Another possible factor identified through discussions with Navy officials was that some repairs used new, more expensive repair parts. However, the Navy's data systems did not provide sufficient information on each repair event to allow us to determine why the prices increased for each spare part. For example, we could discern that more material had been used in a repair, but we could not determine why this had happened: Had maintenance procedures changed? Was the repairable part in unusually poor condition? Had there been extensive cannibalization of the part's components? Or were there other reasons? Without more specific information on each spare part or repair event, management would not be able to determine--or address--the reasons for rising repair costs. As noted above, our ability to determine the reasons for rising spare part costs was impaired because the Navy lacked an effective data system to collect and analyze information relevant to material costs and usage. The current data system tracks repair costs for groups of spare parts but not for individual parts. The costs are accumulated for the group, divided by the number of spare parts in the group and analyzed as an average cost per item in the group. As a result, government repair facilities cannot determine the cause of significant increases in repair costs for an individual spare part. For example, the average reported material cost for individual repair parts needed to repair compressors for the F-402 engine increased from $14,269 in fiscal year 1998 to $65,494 in fiscal year 2000. While the detailed requisition data identifies what materials were ordered, it is impossible to determine--when more than one repair is associated with the requisition--how much of the material was used in a specific repair. Consequently, the fact that more material is being used on multiple repairs can be discerned, but not the reason for the increased usage. In addition, there is no indication of whether the differences in materials ordered are due to the repair of one part or to the group as a whole. The Navy has made little progress in identifying the underlying causes of spare parts price increases. While it has various initiatives aimed at reducing overall costs, it does not have a planned set of actions to identify the underlying causes of price increases. The Navy has only partially implemented a recommendation we made in our November 2000 report to identify and implement solutions to reduce and stabilize prices. It has undertaken several initiatives to control repair costs, but these have centered on enhancing the reliability and maintenance process, which could help stabilize prices for repairable parts. However, they do not deal with the underlying reasons for cost increases. One new initiative, which will allow the Navy to track individual spare part items by their serial numbers, may provide the tool it needs to effectively monitor and control its spare part prices. Also, the Navy might learn from DLA's efforts to address price increases for consumable spare parts. Of three recommendations we made in our November 2000 report, the first one, which was directly concerned with investigating why prices were rising, has been only partially implemented. This one recommended that the Secretary of Defense ensure that the Navy follow through on the results of its planned studies by identifying and implementing solutions to reduce and stabilize prices. See appendix VI for a discussion of the other two recommendations. To start addressing this recommendation, the Navy has undertaken some cost-controlling initiatives aimed at improving the reliability of spare parts and is implementing a serial number tracking program to improve inventory management. However, to date, the initiatives have not focused on identifying the reasons for price increases. The Navy's recent initiatives and studies (by contractors, headquarters, and repair depots) center on improving the reliability of its aviation spare parts in order to control its flying hour costs. Conceptually, if the reliability of parts used in the Navy's aviation systems is improved, then the demand for those parts will fall since they will not be replaced as often, and the cost to the flying hour program will be reduced. While this approach has merit, it focuses only on the demand side of the total flying hour program cost equation. As a result, significant price increases or decreases can occur without management being aware of the underlying causes. An April 2001 study by the Center for Naval Analyses showed that the cost of repairable parts continued to climb, even though the number of Navy flight hours recorded decreased. In examining why the cost per flying hour increased from fiscal year 1992 to fiscal year 1999, the study concluded that the main reasons were a decline in the number of hours flown and the increased age of Navy aircraft. The study also found that price increases for spare parts, overhead costs, quantity of materials ordered, and the mix of spare parts ordered also contributed significantly to higher flying hour costs. Price increases were identified as a significant factor that should be studied further. A Navy logistics official told us the service has used the study to justify a potential 2 percent budget increase for repairable spare parts starting in fiscal year 2000. The Navy has recently undertaken a number of initiatives, such as the Logistics Engineering Change Proposals program, that are designed to control the costs of individual spare parts by improving their reliability. These efforts focus on improving the reliability of repairable parts, and thereby reducing demand while reducing or eliminating support costs. Repairable parts are selected for the study on the basis of their high historical costs and low reliability. Then the proposals are evaluated to determine whether a change in the part would be justified based on the anticipated investment return equal to two times the cost within 5 years. While these efforts have resulted in some significant reported cost savings, they have been geared toward increasing the reliability of parts, thereby reducing the total costs of these parts. Other ongoing initiatives are directed at streamlining the maintenance operations at government repair facilities, and thus potentially lowering the overhead costs that are charged to repairs. The Business Process Reengineering effort, which began in fiscal year 1999, focuses on the repair and modification process at the government repair facilities. Through this effort, the Navy expects to reduce its acquisition costs and overhead charges by adopting new acquisition methods, such as prime vendors, direct vendor deliveries, and electronic commerce. It also expects to reduce its labor costs by automating the requisition process, outsourcing material handling functions, and improving the workload forecasting process. It plans to achieve additional savings from its component repair segment in the form of increased part reliability. Another related initiative is the Manufacturing Resource Planning effort, scheduled for completion by the end of fiscal year 2002. This initiative is designed to cut costs by reducing inventories and shortening lead times on parts requisitions at government repair facilities. It will do this by developing a more efficient and effective process for forecasting the demand for repair parts and more closely aligning this demand with ordering parts with anticipated workloads. One promising initiative--a serial number tracking system for the Navy's inventory of parts--has the potential for identifying the underlying reasons for price changes. This effort was initiated by the Naval Aviation Maintenance Supply Readiness group, which recognized that the Navy needed to acquire comprehensive information on its entire inventory in order to reduce its overall costs. As a result, in November 1998 it tasked the Naval Supply Systems Command to begin developing a serial number tracking system designed to (1) reduce total inventory ownership costs, (2) reduce secondary inventory levels, and (3) enhance customer satisfaction. This tracking system is designed to collect data on individual parts throughout the Navy's supply and maintenance systems. The Navy recently completed testing its serial number tracking effort and began installing "smart buttons" (an automatic identification technology) on depot-level repairable parts for the H-53 helicopters. The smart buttons store all of the necessary identification (including part and serial number), mission configuration, repair requirements, and repair history information for that particular part. The Navy plans to install this technology throughout its fleet by fiscal year 2005, at an estimated cost of $58 million appropriated over fiscal years 2002 through 2005. Navy officials believe the tracking system will be helpful in identifying the causes of rising parts costs and decreases in reliability. For example, it could be used to analyze parts usage at maintenance facilities and the effectiveness of maintenance actions. It could also be used to evaluate different maintenance concepts, such as performing complete overhauls versus only repairing parts as necessary. As stated in our April 2002 report, DLA has undertaken a range of efforts to address significant consumable spare parts price increases. It recently completed two price trend analyses, is examining the causes for these increases, and plans to provide detailed explanations and remedies in a report to DOD. In addition, DLA has other efforts underway, including three technology initiatives, aimed at providing better information for determining price reasonableness. As the overall prices of repairable spare parts continue to rise, the Navy is making efforts to control total costs by improving the reliability of spare parts and by reducing its overhead maintenance costs. However, it does not have clear accountability and a planned approach to determine why the prices are changing--increasing or decreasing. Consequently, the Navy lacks the information to identify what management steps it can take to control prices. The deployment of a serial number tracking system, designed to accumulate detailed repair and use information on individual spare parts and their components, represents a vehicle for providing managers with the information they need to identify underlying causes for price increases. In addition, DLA has efforts underway to address underlying causes for price increases. In order to develop the information and action necessary to address the underlying causes for price increases, we recommend that the Secretary of Defense direct the Secretary of the Navy to: Develop an overall plan with implementation milestones, resource requirements, and accountability within the Naval Supply Systems Command to identify the underlying reasons for price increases in aviation spare parts. The plan should include, but not be limited to, using the comprehensive data on individual spare parts from the serial number tracking system now under development, as well as lessons learned from DLA's efforts to address price increases. Utilize information generated from the plan's initiatives to develop management strategies, which provide assurance that future prices represent a reasonable cost to the customer. In written comments on a draft of this report, DOD generally agreed with our principle findings and recommendations. The comments focused on the positive steps the Navy has taken to address the rising costs associated with spare parts within the flying hour program. In particular DOD stressed that ongoing initiatives such as Logistics Engineering Change Proposals are implemented to reduce overall costs to the Navy, not hold them steady. This report was adjusted to reflect this point. However, DOD's response did not address the need to develop an overall plan with accountability to identify the underlying reasons for price increases in aviation spares. We continue to believe these actions are necessary and, as part of our normal follow-up process, in the future will assess the actions taken and make any additional recommendations that we believe are appropriate. The Department's comments are reprinted in their entirety in appendix VII. We are sending copies of this report to interested congressional committees, the Secretaries of Defense and the Navy; the Commandant of the Marine Corps; 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. Please contact me at (202) 512-8412 if you or your staff have any questions regarding this report. Key contributors to this report were Richard Payne, John Wren, Daniel Omahen, Nancy Rothlisberger, Jason Jackson, John Van Schaik, and Nancy Benco. To identify the key factors contributing to price increases, we performed an analysis of selected repairable spare parts. Specifically, we chose 453 repairable parts used in the F/A-18, AV-8B, and H-53 aircraft and helicopters and their engines and analyzed the pricing and repair cost trends. These three systems and their engines had been identified, in our November 2000 report, as having experienced higher-than-average price increases. The 453 were the most costly parts, in terms of the amounts that Navy customers spent (the unit price multiplied by the quantity sold), based on the most recent data available at the time of our review. Our review of the 453 parts showed that prices increased primarily because of higher repair costs. We then selected 38 parts that had the largest repair cost increases for further review. We found that 31 of these parts were repaired at government facilities, and we obtained and analyzed their costs during fiscal years 1999 through 2002 as provided by either the Naval Inventory Control Point or the applicable Naval Aviation Depot. After finding that increased repair costs were due to higher material costs used in the repairs, we obtained detailed lists of the orders for these materials. To better understand the general reasons for the cost increases, we analyzed the quantities ordered and the prices paid for them during fiscal years 1998 through 2001. We also discussed the reasons for major material and labor cost increases with officials at the Naval Aviation Depots at Cherry Point, North Carolina, and Jacksonville, Florida. To assess the Navy's progress in identifying and addressing the underlying causes for increased prices of spare parts, we (1) identified and reviewed prior GAO reports as well as Navy studies and initiatives relating to controlling total costs and (2) evaluated Navy actions to implement the recommendations of our November 2000 report. We obtained studies on the rising costs of repair parts and held discussions with responsible officials at the Center for Naval Analyses, the Naval Center for Cost Analysis, and the Naval Audit Service. We also discussed and obtained information on the status of the Navy's Aviation Maintenance Supply Readiness Group's efforts to address the repair part cost and reliability issues with Naval Air Systems Command officials as well as information on the status of corrective actions from the Navy's Web Site. We also reviewed the Navy's Logistics Transformation Plan for fiscal year 2000 and the Navy and Marine Corps' report on the best commercial inventory practices for the third quarter of fiscal year 2001 to identify initiatives aimed at mitigating price increases. We discussed several of these and other initiatives with officials at the Naval Supply Systems Command, Naval Inventory Control Point, Naval Air Systems Command, and Naval Aviation Depots at Jacksonville, Florida, and Cherry Point, North Carolina. In evaluating the Navy's progress in implementing our recommendations, we relied on information gathered on various studies and initiatives as well as on discussions with officials at Navy headquarters and the Naval Supply Systems Command. We did not independently verify the pricing data provided by the Naval Supply Systems Command or the Naval Aviation Depots. However, recognizing that it was official data, we took several steps to address its quality. Specifically, we tested the completeness of the data, looking for empty or questionable fields. We identified some discrepancies in the data and discussed them with Naval Supply Systems Command and depot officials. Where appropriate, we adjusted the data based on additional information they provided. We performed our review between June 2001 and May 2002 in accordance with generally accepted government auditing standards. The 453 most costly repair parts for the 3 aircraft and their engines, which we focused on in our November 2000 report, have continued to experience price increases since fiscal year 1999. Table 2 summarizes the average increase in the repair cost for the parts, the average increase in what the supply system charged its customers, as well as the annual rate of increase for the parts selected for review. Overall, the average increase in the price charged to customers for these parts was 37.2 percent between fiscal year 1999 and fiscal year 2002. Within the population of 453 parts, there were 195 parts that experienced a drop in the customer price between fiscal year 1999 and 2002. Table 3 summarizes the average decrease in the repair cost, the average decrease in what the supply system charged its customers, and the annual rate of decrease for the parts. The average decrease in price for these 195 parts was about 35 percent. Almost 60 percent, 258 of the 453 parts experienced an increase in price between fiscal year 1999 and 2002. Table 4 summarizes the average increase in the repair cost, the average in what the supply system charged its customers, and the annual rate of increase for these parts. Price increases for these 258 parts averaged 91.5 percent. Appendix V: Reported Repair Cost Increases for 31 Parts FY99 material cost ($) FY99 government repair cost ($) FY02 material cost($) FY02 government repair cost ($) Change in government repair (%) Change in material (%) FY99 material cost ($) FY99 government repair cost ($) FY02 material cost($) FY02 government repair cost ($) Change in material (%) Change in government repair (%) The Navy's efforts to implement the recommendations from our November 2000 report on the rising prices of aviation depot-level repairable parts have been mixed. The report contained three recommendations: (1) the Secretary of Defense ensure that the Navy follow through on the results of its planned studies by identifying and implementing solutions to reduce and stabilize prices and surcharge rates, (2) the Secretary of Defense direct the Navy to allocate condemnation costs to the specific parts or groups of parts incurring the costs, and (3) the Secretary of Defense report to the Congress on the Navy's progress in addressing these recommendations. The Navy has only partially implemented our first recommendation. The Navy has undertaken some cost controlling measures aimed at improving reliability and is implementing a serial number tracking program to improve inventory management, as discussed above. The Navy has implemented the second recommendation by adjusting its pricing practice such that condemnation costs are being allocated to specific groups of repairable parts. Beginning in fiscal year 1999, the Navy started allocating certain costs to the parts that incur those costs. Initially, transportation costs were allocated using this approach. The Navy began allocating condemnation and obsolescence costs in this manner in fiscal year 2000. At the same time, the Navy instituted a tiered pricing strategy to allocate general overhead costs and specific, identifiable costs based on the level of management required. These efforts have resulted in a better match of expenses with specific parts. In response to our third recommendation, the Navy has only partially reported the results of its efforts to implement the first two recommendations to the Congress. In its fiscal year 2003 budget submission, the Navy reported its efforts to allocate condemnation costs, as well as transportation and obsolescence costs, to specific groups of parts. In addition, the Navy reported it was taking action to limit the general overhead rate to 30 percent or less. However, the Navy did not report any specific actions to reduce and stabilize prices.

Summary:
Since fiscal year 1999, the Navy's budget for repairing spare parts to support its aviation weapons systems has increased by about 50 percent, from $1.2 billion to $1.8 billion. Some military commands have asserted that the escalating cost of these parts has adversely impacted the funds available for the readiness of military forces. Overall, the prices for Navy repairable spare parts continue to climb for the three aircraft and their engines that GAO focused on in its November 2000 report. GAO's assessment of selected parts being repaired showed that while nearly 45 percent of the parts decreased in price, about 55 percent increased an average of 91.5 percent between fiscal year 1999 and 2002. The price increases were primarily due to the dramatically higher costs of the materials needed to repair spare parts, although other factors, such as overhead fees and labor rates, contributed. However, GAO could not determine the underlying causes for the rising material costs because the Navy's database lacked key information on each repair. The Navy's progress in developing an overall plan to identify and address the reasons for higher spare parts prices has been limited. It has not yet identified and implemented ways to reduce and stabilize prices. Further, the Navy has undertaken several initiatives, but most of these efforts focused on improving the reliability or the maintenance processes for repairing spare parts rather than on identifying why prices continue to rise. One initiative, the establishment of an automated serial number tracking system for spare parts, however, has potential for providing the specific information needed to determine why the spare parts prices are increasing and develop a strategy for stabilizing them. In addition, the Navy may learn from the Defense Logistics Agency's efforts to address causes for price increases--thereby allowing the Navy to better apply its resources supporting the readiness of the forces.