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Cover
================================================================ COVER


High-Risk Series

February 1997

DEFENSE INVENTORY MANAGEMENT

GAO/HR-97-5

Defense Inventory Management


Abbreviations
=============================================================== ABBREV

  CIM - Corporate Information Management
  DBOF - Defense Business Operations Fund
  DLA - Defense Logistics Agency
  DOD - Department of Defense

Letter
=============================================================== LETTER



February 1997

The President of the Senate
The Speaker of the House of Representatives

In 1990, the General Accounting Office began a special effort to
review and report on the federal program areas its work identified as
high risk because of vulnerabilities to waste, fraud, abuse, and
mismanagement.  This effort, which was supported by the Senate
Committee on Governmental Affairs and the House Committee on
Government Reform and Oversight, brought a much-needed focus on
problems that were costing the government billions of dollars. 

In December 1992, GAO issued a series of reports on the fundamental
causes of problems in high-risk areas, and in a second series in
February 1995, it reported on the status of efforts to improve those
areas.  This, GAO's third series of reports, provides the current
status of designated high-risk areas. 

This report describes our concerns about the Department of Defense's
management of supplies that support the military services.  It
focuses on the need for the Department to be more aggressive in
changing its management culture by taking advantage of new management
practices, technologies, and logistics systems so that inefficiencies
can be eliminated. 

Copies of this report series are being sent to the President, the
congressional leadership, all other Members of the Congress, the
Director of the Office of Management and Budget, and the heads of
major departments and agencies. 

James F.  Hinchman
Acting Comptroller General
of the United States


OVERVIEW
============================================================ Chapter 0

The Department of Defense (DOD) uses its secondary inventory--spare
and repair parts, clothing, medical supplies, and other items--to
support its operating forces.  In September 1995, DOD reported that
it had a secondary inventory valued at $69.6 billion.  Based on DOD
data, we estimate that about half of the inventory includes items
that are not needed to be on hand to support DOD war reserve or
current operating requirements. 


   THE PROBLEM
---------------------------------------------------------- Chapter 0:1

In 1992, we reported that DOD had wasted billions of dollars on
excess supplies.  We reported that the problem resulted because
inherent in DOD's culture was the belief that it was better to
overbuy items than to manage with just the amount of stock needed. 
Had DOD used effective inventory management and control techniques
and modern commercial inventory management practices, it would have
had lower inventory levels and would have avoided the burden and
expense of storing excess inventory. 

In 1995, we reported that managing DOD's inventory presented
challenges that partially stemmed from the downsizing of the military
forces.  We reported that DOD needed to move aggressively to identify
and implement viable commercial practices and to provide managers
with modern, automated accounting and management systems to better
control and monitor its inventories. 


   PROGRESS
---------------------------------------------------------- Chapter 0:2

DOD has clearly had some success in addressing its inventory
management problems, but much remains to be done.  DOD has
implemented, in a limited manner, certain commercial practices such
as direct vendor delivery for medical and food items.  However, these
initiatives address only about 3 percent of the items for which this
concept could be used.  DOD is in the midst of changing its inventory
management culture.  Also, it has reduced its inventory since our
1995 high-risk report.  However, we believe that much of the
reduction was the result of reduced force levels, which reduced
overall demands on DOD's logistics systems. 

DOD has also made little progress in developing the management tools
needed to help solve its long-term inventory management problems.  It
has not achieved the desired benefits from the Defense Business
Operations Fund (DBOF), and the Corporate Information Management
(CIM) initiative has not produced the economies and efficiencies
anticipated.  In December 1996, the Defense Comptroller dissolved
DBOF and created separate Army, Navy, Air Force, and Defense-wide
working capital funds.  The four funds will continue to operate under
the revolving fund concept--using the same policies, procedures, and
systems as they did under DBOF. 

DOD also abandoned its initial strategy to deploy a set of integrated
systems across all inventory control points and has embarked on a
strategy to deploy the systems individually at selected sites without
taking the steps necessary to ensure that the effort will bring
positive results. 

As a result of the lack of progress with some of the key initiatives,
it has become increasingly difficult for inventory managers to manage
DOD's multibillion-dollar inventory supply system efficiently and
effectively.  Large amounts of unneeded inventory, inadequate
inventory oversight, overstated requirements, and slowness to
implement modern commercial practices are evidence of the lack of
progress. 


   OUTLOOK FOR THE FUTURE
---------------------------------------------------------- Chapter 0:3

Unless DOD takes more aggressive actions, its inventory management
problems will continue into the next century. 

In the short term, DOD needs to emphasize the efficient operation of
its existing inventory systems.  This includes ensuring the accuracy
of inventory requirements to preclude the acquisition of unneeded
inventory.  It also needs to make greater use of proven commercial
practices where more immediate savings can be achieved. 

In the long term, DOD must establish goals, objectives, and
milestones for changing its culture and adopting new management tools
and practices.  These solutions include (1) setting aggressive
milestones for substantially expanding the use of modern commercial
practices and (2) providing managers with the tools--critical to
managing inventory efficiently--that it had planned to provide
through the DBOF and CIM initiatives.  DOD must also continue to
explore other alternatives, such as using business case analyses to
identify opportunities for outsourcing logistics functions. 

At the same time, continued close congressional oversight is key to
helping to ensure that financial resources are not wasted through the
acquisition of additional inventories that are not needed and that
DOD obtains the tools necessary for efficient and effective inventory
management. 


MANAGING DOD'S INVENTORY PRESENTS
CHALLENGES
============================================================ Chapter 1

Between 1989 and 1995, DOD's forces decreased significantly.  Active
duty soldiers, sailors, marines, and airmen and airwomen decreased
from 2.1 million to 1.5 million; attack and fighter aircraft dropped
from 2,800 to 1,784; ships decreased from 570 to 372; and active Army
divisions decreased from 18 to 12.  For the near future, DOD is
predicting less drastic decreases. 

Between 1989 and 1995, the inventories being held to support DOD's
forces decreased from $92.5 billion to $69.6 billion. 

Parallel to the force and inventory decreases, DOD's total budget
also decreased, from $291 billion in 1989 to $252 billion in 1996. 
Part of the decrease was directly related to reductions in funds
available for the purchase of inventory.  Between 1989 and 1996, the
Congress reduced DOD's procurement and operations and maintenance
budgets by about $7.5 billion to prevent the acquisition of unneeded
inventory and to encourage DOD to improve its inventory management
practices.  For example, in 1992, the Congress rescinded $1 billion
of fiscal year 1992 operations and maintenance budget authority due
to excessive on-hand inventory.  Also, in 1992, the Congress reduced
DOD's fiscal year 1993 operations and maintenance budget requests for
purchases of supplies and materials by $2.9 billion because of
excessive inventories. 

DOD has spent billions of dollars on inventory that is not needed to
be on hand to support war reserve or current operating requirements
and burdened itself with managing and storing the unneeded inventory. 
Much of DOD's unneeded inventory was acquired because of outdated and
inefficient inventory management practices.  While downsizing of the
military forces contributed to some of DOD's excess inventory, both
downsizing and congressional budget reductions were also factors in
reducing the inventory. 

DOD has begun to modernize its inventory management culture. 
However, cultural changes, by their nature, are slowly achieved. 
Managing DOD's multibillion-dollar inventory during this period of
cultural change, budget reductions, and force downsizing presents a
tremendous challenge to DOD's logistics managers.  The challenge of
supporting a high level of readiness is made more difficult by
outdated and inefficient practices, unsolved working capital fund
problems, and the shift in CIM strategy. 


FURTHER CHANGES ARE NEEDED IN
DOD'S INVENTORY MANAGEMENT
PRACTICES
============================================================ Chapter 2

DOD has made tremendous progress in reducing its inventory since
1989.  However, virtually all the problems that contributed to
billions of dollars of unneeded inventory still exist.  For example,
DOD still lacks adequate oversight of its inventory, financial
accountability remains weak, and requirements continue to be
overstated.  DOD has not been as aggressive as possible in
implementing modern commercial practices; operations using working
capital funds continue to be hindered by DOD's inability to correct
problems; and the CIM initiative currently is not likely to provide
the benefits originally anticipated. 


   DOD CONTINUES TO STORE LARGE
   AMOUNTS OF UNNEEDED INVENTORY
---------------------------------------------------------- Chapter 2:1

As shown in figure 1, DOD reduced its inventory from $92.5 billion in
1989 to $69.6 billion in 1995, a $22.9 billion reduction. 

   Figure 1:  DOD's Inventory
   (fiscal years 1989-95)

   (See figure in printed
   edition.)

However, as in 1992, about half of the $69.6 billion inventory is
beyond what is needed to support war reserve or current operating
requirements.  Included in the inventory beyond what is needed to
support war reserve or current operating requirements is $299 million
in inventory that DOD designated for reuse and disposal that had an
acquisition cost of about $12 billion.  (See
fig.  2.)

   Figure 2:  DOD's Inventory (as
   of Sept.  30, 1995)

   (See figure in printed
   edition.)


   DOD'S INVENTORY MANAGEMENT
   CULTURE IS SLOWLY CHANGING
---------------------------------------------------------- Chapter 2:2

We previously reported that DOD had acknowledged the necessity to
change its inventory management culture but was slow in taking steps
to do so. 

In 1990, DOD initiated an inventory reduction plan to meet the
challenge of resizing its inventories while maintaining high levels
of readiness.  Some of the objectives of the 1990 plan are
articulated in DOD's current logistics strategic plan.  The
continuity of DOD's inventory reduction plans indicates that top
management has made a long-term commitment to change the Department's
inventory management culture and provide an efficient and effective
supply system.  To some extent, the large inventory reductions that
have taken place since 1989 can be attributed to DOD's change in
culture. 

Some of DOD's logistics objectives have been implemented; others have
not and will not be for many years to come.  In 1992, we reported
that academic experts and business executives generally agreed that a
culture change is a long-term effort that takes at least 5 to 10
years to complete.  Although a change in DOD's management culture is
underway, continued support of its top managers is critical to
successful completion of the cultural change. 


   ADEQUATE INVENTORY OVERSIGHT
   HAS YET TO BE ACHIEVED
---------------------------------------------------------- Chapter 2:3

In 1995, we reported that DOD's 1994 strategic plans for logistics
called for improving asset visibility in such areas as in-transit
assets, retail-level stocks, and automated systems.  The asset
visibility plans were to be completely implemented by 1996. 
According to DOD's current plan, the total asset visibility
initiative will not be completely implemented until 2001. 

The lack of adequate visibility over operating materials and supplies
substantially increases the risk that millions of dollars will be
spent unnecessarily.  For example, in August 1996, we reported that
Navy managers did not have adequate visibility over $5.7 billion in
operating materials and supplies on board ships and at 17
redistribution sites.  We estimated that because of the lack of
oversight in the first half of 1995, item managers ordered or
purchased items in excess of operating level needs and that as a
result, the Navy will incur unnecessary costs of about $27 million. 


   REQUIREMENTS CONTINUE TO BE
   OVERSTATED
---------------------------------------------------------- Chapter 2:4

In 1992 and 1995, we reported that DOD had problems in accurately
determining how much inventory it needs to buy.  Our recent work
shows that continues to be the case. 

In recent work, we reported that DOD had made limited progress in
reducing acquisition lead times because its initiatives had not been
evenly implemented by the military services and Defense Logistics
Agency (DLA).  We reported that DOD could reduce its lead time by 25
percent over a 4-year period and save about $1 billion.  DOD could
achieve this reduction by renewing its emphasis on prompt
implementation of its 1990 lead-time reduction initiatives,
periodically validating and updating old data for long lead-time
items, and considering lead-time reductions as a factor in deciding
whether to continue purchasing spare parts from the prime contractor
or to purchase them from the actual manufacturer. 

In January 1995, we reported that the Navy and the DLA stock millions
of dollars of unnecessary "insurance items" (parts that are not
expected to fail through normal usage).  The unnecessary inventories
accrued because the DOD components do not periodically review
insurance items to ensure that they are mission essential and stocked
in appropriate quantities.  Additionally, DOD spends millions of
dollars each year to manage and maintain these unnecessary
inventories. 

In March 1996, we reported that the Air Force and the Navy budgeted
$132 million more than was needed for aviation spare parts because of
questionable policies concerning the determination of requirements
and the accountability for depot maintenance assets.  The Air Force
did not consider $72 million of on-hand assets, and the Navy counted
$60 million in depot maintenance requirements twice. 

In a September 1996 report on the fiscal year 1997 DOD budget, we
identified potential reductions of $723 million in the inventory
management area.  The potential reductions were based on (1)
reclaiming spare parts from excess aircraft; (2) considering parts on
hand at the depot maintenance facilities as an offset to spare and
repair parts requirements; (3) eliminating duplicated depot
maintenance requirements; (4) reducing requirements that were
overstated due to inaccurate lead times, demand rates, and due-out
quantities; and (5) correcting inaccurate budget data. 


   FINANCIAL ACCOUNTABILITY AND
   CONTROL REMAIN WEAK
---------------------------------------------------------- Chapter 2:5

In 1992 and 1995, we reported that DOD lacked financial
accountability and control over its inventory but that it was taking
corrective actions.  Improvements, however, have been minimal, and
accountability and controls remain weak.  In his February 1996 annual
statement of assurance required by the Federal Managers' Financial
Integrity Act, the Secretary of Defense summarized the status of
high-risk areas relative to inventory management. 

Regarding DOD's financial accounting process and systems, the
Secretary identified inadequate internal controls and other
significant deficiencies such as the

  -- use of a variety of nonintegrated systems;

  -- inability of current systems to respond rapidly to change;

  -- lack of automated indicators that measure, or are linked to,
     costs, performance measurements, or other output measurements;

  -- difficulties with consistently valuing and reconciling physical
     inventories to financial account balances; and

  -- inaccuracies in the valuation of property, plants, and
     equipment. 


   DOD CAN MAKE MORE USE OF
   COMMERCIAL PRACTICES
---------------------------------------------------------- Chapter 2:6

In 1992 and 1995, we reported that DOD could save millions by
implementing private sector practices that streamline logistics
operations and reduce layers of inventory. 

DOD's large inventory levels reflect the management practice of
buying and storing supplies at both wholesale and retail locations to
ensure they are available to customers--sometimes years in advance of
their need.  DOD often stores inventories in as many as four
different layers between suppliers and end users.  These practices
result in inventory that turns over slowly and produce large amounts
of old, obsolete, and excess items. 

In contrast, the private sector logistics philosophy includes (1)
using "just-in-time" business practices that shift responsibilities
for storing and managing inventory to suppliers, (2) shifting
responsibility for managing items to suppliers through the use of
long-term agreements with only a few key suppliers, (3) using direct
delivery practices that bypass the need for intermediate handling and
storage, and (4) eliminating paperwork and speeding up ordering by
using electronic ordering systems and bar coding. 

While DOD has begun to move toward modern commercial practices, its
initiatives have generally been limited in scope and represent only a
small portion of DOD's overall operations.  For example, in July
1996, we reported that while the Navy was working to improve its
logistics system, it was not taking the opportunity to incorporate
the airline industry's best practices, which have the potential to
save hundreds of millions of dollars.  Specific practices that have
enabled companies to save money include (1) repairing items promptly
after they break; (2) reorganizing the repair process to bring all
resources required--tooling and support equipment, personnel, and
inventory--together in one location; (3) using local distribution
centers and integrated supplier programs to improve consumable item
support and reduce "just-in-case" inventory; and (4) using
third-party logistics providers to manage logistics functions. 

Also, in February 1996, we reported that the Air Force had begun a
reengineering program aimed at redesigning its logistics operations. 
While the effort includes testing some leading-edge private sector
practices, the Air Force could include additional practices such as
the greater use of third-party logistics services, closer
partnerships with suppliers, the use of local distribution centers,
the use of centralized repair facilities, and the modification of
repair facilities to accommodate these practices. 

DLA's use of best inventory practices is best exemplified for
personnel (medical, food, and clothing) items.  Since 1993, DLA has
taken steps to use prime vendors to supply personnel items directly
to military facilities.  However, this initiative represents only
about 3 percent of the items for which this concept could be used. 

DLA can do more to achieve substantial savings.  It continues to
store large amounts of hardware items, such as bolts, valves, and
fuses, that cost millions of dollars to manage and store.  DLA
inventories of hardware items existing in 1992 are expected to
decrease only 20 percent by 1997.  Even then, hardware inventories
could last for more than 2 years. 

To date, DLA has not tested the most innovative commercial practices
GAO has seen used by companies to reduce inventories and costs, such
as using "supplier parks" and other techniques that give established
commercial distribution networks the responsibility to manage, store,
and distribute inventory on a frequent and regular basis directly to
end users.  If DLA adopted these practices, hardware inventories and
related management costs could be significantly reduced. 


   DOD IS EXPLORING OUTSOURCING
   OPTIONS
---------------------------------------------------------- Chapter 2:7

According to DOD's logistics strategic plan, outsourcing--drawing on
the abilities of the commercial sector--is a key tool for
streamlining logistics business processes.  The plan calls for
developing outsourcing initiatives for functions currently carried
out by DLA's Defense Reutilization and Marketing Service,
distribution depots, and inventory control points.  By drawing on the
private sector's abilities to do logistics activities, DOD hopes to
provide more efficient and effective support for its military forces. 


   KEY INITIATIVES LANGUISH
---------------------------------------------------------- Chapter 2:8

DBOF and CIM were key to improving inventory management.  DBOF
accounted for most of DOD's inventory, while the CIM initiative was
to provide simplified and reengineered computer systems for
distribution and logistics. 

In 1992, we reported that DOD had begun these two key initiatives. 
In 1995, we reported that DBOF operations had been hindered by DOD's
inability to correct problems, such as inaccurate financial reports,
and that little progress had been made in implementing the CIM
initiative.  Currently, neither of the initiatives is providing the
benefits--gains in efficiency and effectiveness--originally
anticipated, and benefits will not be realized until far in the
future, if they are realized at all. 

In March 1995, we reported that DBOF faced serious problems and that
after 3 years of operations little had changed in the DBOF's
day-to-day operations.  Specifically, we reported the following: 

  -- DOD did not have a systematic process in place to ensure that
     DBOF's policies were implemented consistently, and managers
     lacked necessary guidance to execute day-to-day operations. 

  -- DOD had selected most of DBOF's interim computer systems without
     first determining the total estimated cost to enhance and
     implement these systems across DBOF's business areas. 

  -- DOD was having difficulty preparing accurate financial reports. 

  -- DOD had returned control of cash to the individual components,
     which was a major departure from the benefit of a single cash
     balance. 

The 1997 Defense Authorization Act required DOD to conduct a
comprehensive study of DBOF and to present an improvement plan to
Congress for approval.  Pending the results of this study, the
Defense Comptroller, in December 1996, dissolved DBOF and created
separate Army, Navy, Air Force, and DOD-wide working capital funds. 
The four funds will continue to operate under the revolving fund
concept--using the same policies, procedures, and systems as they did
under DBOF. 

Regarding the CIM initiative, we reported in September 1996 that DOD
had determined that its goal of developing nine standard integrated
systems to improve aspects of inventory management, such as
requirements determination, would cost more than originally
estimated.  DOD abandoned the strategy of implementing the standard
systems across all inventory control points.  It now plans to deploy
each system at a selected site as the system is developed.  DOD has
embarked on this new strategy without taking steps to ensure that the
additional millions of dollars to be spent on logistics systems, as
well as money already invested, will bring positive results. 
Specifically, DOD did not conduct economic and risk assessments, did
not justify the change in strategy through its own oversight process,
and proceeded to deploy new systems without testing them. 


WHAT NEEDS TO BE DONE
============================================================ Chapter 3

In 1992, we reported that major changes were needed in all levels of
DOD's inventory management system.  We noted that top managers needed
to take long-range actions to (1) change the organizational culture
to eliminate the overstocking of items, (2) increase the use of
commercial practices, (3) establish and monitor improved performance
measures that stress cost-effectiveness and inventory reductions, and
(4) improve the computer systems used in inventory management. 

In 1995, we reported that DOD needed to avoid burdening its supply
system with the management problems and costs associated with
accumulating, storing, and maintaining large unneeded inventories. 

While we continue to see pockets of improvement, DOD has made little
overall progress in correcting systemic problems that have
traditionally resulted in large unneeded inventories.  DOD top
management needs to continue its commitment to changing its inventory
management culture so that it provides its forces with necessary
supplies in a timely manner while avoiding the accumulation of
unneeded materials. 

In the short term, DOD needs to continue emphasizing the efficient
operation of its existing inventory systems.  As previously reported,
this includes

  -- committing to improved inventory management by top management's
     emphasis on (1) inventory indicators that highlight reduction
     and disposal of unneeded inventory, (2) implementation of
     efficient and effective inventory management practices, and (3)
     training personnel in those practices and rewarding the right
     behavior;

  -- improving the accuracy of data such as requirements and the
     quantity, condition, and value of inventory items managed
     through current logistics and financial systems; and

  -- aggressively enforcing existing policies and procedures that
     will minimize the acquisition and accumulation of unnecessary
     inventory. 

In the long term, overall solutions include

  -- mapping a strategy for completing DOD's initiatives for changing
     its culture;

  -- setting aggressive goals, objectives, and milestones for
     identifying and implementing viable and more cost-effective
     commercial practices for supplying its forces;

  -- establishing goals, objectives, and milestones for determining
     where outsourcing logistics functions represents a
     cost-effective and efficient alternative to traditional methods;
     and

  -- providing inventory managers with the automated, integrated
     accounting and management systems necessary to manage its
     inventory in a world-class manner. 

Close congressional oversight will continue to be a critical element
as DOD establishes plans, goals, objectives, and milestones for
addressing its inventory management processes. 


RELATED GAO PRODUCTS
============================================================ Chapter 4

1997 DOD Budget:  Potential Reductions to Operation and Maintenance
Program (GAO/NSIAD-96-220, Sept.  18, 1996). 

Defense IRM:  Critical Risks Facing New Materiel Management Strategy
(GAO/AIMD-96-109, Sept.  6, 1996). 

Navy Financial Management:  Improved Management of Operating
Materials and Supplies Could Yield Significant Savings
(GAO/AIMD-96-94, Aug.  16, 1996). 

Inventory Management:  Adopting Best Practices Could Enhance Navy
Efforts to Achieve Efficiencies and Savings (GAO/NSIAD-96-156, July
12, 1996). 

Defense Logistics:  Requirement Determinations for Aviation Spare
Parts Need to Be Improved (GAO/NSIAD-96-70, Mar.  19, 1996). 

Best Management Practices:  Reengineering the Air Force's Logistics
System Can Yield Substantial Savings (GAO/NSIAD-96-5, Feb.  21,
1996). 

Inventory Management:  DOD Can Build on Progress in Using Best
Practices to Achieve Substantial Savings (GAO/NSIAD-95-142, Aug.  4,
1995). 

Best Practices Methodology:  A New Approach for Improving Government
Operations (GAO/NSIAD-95-154, May 1995). 

Defense Business Operations Fund:  Management Issues Challenge Fund
Implementation (GAO/NSIAD-95-79, Mar.  1, 1995). 

High-Risk Series:  Defense Inventory Management (GAO/HR-95-5, Feb. 
1995). 

Defense Supply:  Inventories Contain Nonessential and Excessive
Insurance Stocks (GAO/NSIAD-95-1, Jan.  20, 1995). 

Defense Supply:  Acquisition Leadtime Requirements Can Be
Significantly Reduced (GAO/NSIAD-95-2, Dec.  20 1994). 


1997 HIGH-RISK SERIES
============================================================ Chapter 5

An Overview (GAO/HR-97-1)

Quick Reference Guide (GAO/HR-97-2)

Defense Financial Management (GAO/HR-97-3)

Defense Contract Management (GAO/HR-97-4)

Defense Inventory Management (GAO/HR-97-5)

Defense Weapon Systems Acquisition (GAO/HR-97-6)

Defense Infrastructure (GAO/HR-97-7)

IRS Management (GAO/HR-97-8)

Information Management and Technology (GAO/HR-97-9)

Medicare (GAO/HR-97-10)

Student Financial Aid (GAO/HR-97-11)

Department of Housing and Urban Development (GAO/HR-97-12)

Department of Energy Contract Management (GAO/HR-97-13)

Superfund Program Management (GAO/HR-97-14)

























The entire series of 14 high-risk reports can be ordered using the
order number GAO/HR-97-20SET.