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Defense Depot Maintenance: Privatization and the Debate Over the Public-Private Mix (Testimony, 04/17/96, GAO/T-NSIAD-96-148).

Pursuant to a congressional request, GAO discussed the privatization of
defense depot maintenance activities. GAO noted that: (1) the Department
of Defense's (DOD) evolving depot maintenance policy includes a
public-private mix and shifts work to the private sector where feasible;
(2) depot privatization could worsen excess maintenance capacity and
inefficiencies if not carefully managed; (3) DOD policy reports provide
an overall framework for managing depot maintenance activities and
substantial implementation flexibility, but the policy is not consistent
with congressional guidance on public-private competition for non-core
workloads; (4) privatizing depot maintenance is not likely to achieve
the 20-percent savings DOD projects, since most savings have come from
competition rather than privatization; (5) most depot maintenance
private-public competitions have been won by the public sector and
averaged fewer than two competitors; (6) DOD plans to privatize in place
and delay downsizing and closure of two air logistics centers will
probably cost more than closing them and relocating their workloads to
underutilized defense or private facilities; and (7) statues governing
competition and base closures may have to be repealed or amended before
DOD can proceed with its privatization efforts.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-NSIAD-96-148
     TITLE:  Defense Depot Maintenance: Privatization and the Debate 
             Over the Public-Private Mix
      DATE:  04/17/96
   SUBJECT:  Military downsizing
             Equipment maintenance
             Privatization
             Base closures
             Military bases
             Military cost control
             Base realignments
             Defense contracts
             Maintenance services contracts

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


Before the Subcommittee on Readiness, Committee on Armed Services,
U.S.  Senate

For Release and Delivery
Expected at
9:30 a.m., EDT
Wednesday
April 17, 1996

DEFENSE DEPOT MAINTENANCE -
PRIVATIZATION AND THE DEBATE OVER
THE PUBLIC-PRIVATE MIX

Statement of David Warren, Director, Defense Management
Issues, National Security and International Affairs Division

GAO/T-NSIAD-96-148

GAO/NSIAD-96-148T


(709195)


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

  AFGE - American Federation of Government Employees
  BRAC - Base Realignment and Closure
  CORM - Commission on Roles and Missions
  DOD - Department of Defense
  OMB - Office of Management and Budget

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss defense depot maintenance
issues.  As requested by the Committee, my testimony will focus on
our preliminary analysis of the March 1996 Department of Defense
(DOD) report responding to the congressional mandate for a
comprehensive depot maintenance policy.  It will also address issues
related to the allocation of depot maintenance workload between the
public and private sectors, such as ongoing privatization
initiatives, including privatization-in-place.\1 Specific issues I
will address are

  -- DOD's depot maintenance management model in the post cold war
     era,

  -- the extent to which DOD's proposed depot maintenance policy is
     consistent with congressional direction and guidance,

  -- the savings that DOD is anticipating from privatization of depot
     maintenance activities, and

  -- the cost-effectiveness of privatization-in-place as an
     alternative for closing depots. 

Before I discuss specifics, I'd like to summarize the key
observations from our ongoing work. 

First, the new model for managing depot maintenance is evolving. 
DOD's proposed model continues to be a mix between the public and
private sectors.  However, DOD's policy report signals a clear intent
to shift workloads to the private sector when readiness,
sustainability, and technology risks can be overcome.  Such a shift,
if not effectively managed, including the downsizing of remaining
depot infrastructure, could exacerbate existing excess capacity
problems and the inefficiencies inherent in underutilization of depot
maintenance infrastructure. 

Second, we have several initial observations on the DOD policy
report. 

  -- It provides an overall framework for managing defense depot
     maintenance activities. 

  -- It sets forth a clear preference for moving workload to the
     private sector that will likely result in a much smaller core
     capability than exists today. 

  -- It is not consistent with congressional guidance in one key
     area--the use of public-private competitions for non-core
     workloads. 

  -- It provides substantial flexibility on how the policy will be
     implemented.  As a result, the precise effects of this policy on
     such factors as public-private mix, cost, and excess capacity
     remain uncertain. 

Third, privatizing depot maintenance workloads in the current
environment, is not likely to achieve the savings DOD expects and may
even be more costly.  Saving estimates of 20 percent were based on
the May 1995 report of the Commission on Roles and Missions (CORM) of
the Armed Services.  This report relied primarily on results from
public-private competitions for commercial activities under Office of
Management and Budget (OMB) Circular A-76.  Our analysis showed that
the public sector won about half of these competitions and that the
savings were therefore the result of competition rather than
privatization.  Further, these competitions involved activities that
more readily lend themselves to private sector competition.  These
include family housing, real property and vehicle maintenance,
civilian personnel administration, food service, security and law
enforcement, and other support services.  These activities--unlike
depot maintenance-- generally required low-skilled labor,
uncomplicated and repetitious work tasks, small capital investment to
enter the market, and were common to the private sector.  Also, many
offerors participated in the competitions. 

Recognizing the influence of competition on potential savings from
privatization initiatives, we examined results from the Department's
public-private competition program for depot maintenance and reviewed
contracting actions for depot maintenance work by 12 DOD buying
activities to determine the competitiveness of the private sector
market, and where possible, to make price comparisons.  Our review of
the depot maintenance public-private competition program revealed
that 67 percent of the 95 non-ship competitions were won by DOD
depots--with winning public sector bids averaging 40 percent less
than their closest private sector competitor.  For 23 percent of
these public-private competitions there were no private sector
offerors and for another 35 percent, only one private sector offeror. 
Additionally, we analyzed 240 active depot maintenance contracts,
finding that 182--or 76 percent--were awarded sole-source.  Further,
about 86 percent of the full and open competitions had 4 or less
offers.  Finally, our analysis of a limited number of military
systems or components that are dual-sourced--that is, repaired by
both a DOD depot and a private sector firm--determined that DOD depot
prices were lower for 62 percent of the items.  Accordingly,
privatizing without public-private competition and/or privatizing
into a non-competitive environment would not likely result in
expected savings and may actually be more costly. 

DOD has discontinued public-private competitions arguing that the
depot accounting systems are inadequate to fully capture costs.  We
recognize that improvements must be made in this area, but
implementation of improved internal controls, the use of the cost
comparability handbook, and review and approval of the accounting
systems and proposals by the Defense Contract Audit Agency should
provide a reasonable basis for public-private comparability. 

Fourth, based on our preliminary analysis, DOD's plans to
privatize-in-place and delay closure and most workforce reductions
until 2001 at the Sacramento and San Antonio Air Logistics Centers
are not likely to be as cost-effective as closing the military
facilities and reallocating depot maintenance work to other centers
or private sector facilities having underutilized capacity.  DOD
states that its plan reflects concerns regarding the near-term costs
of the closures and the potential effects on local communities and
Air Force readiness.  The Base Realignment and Closure (BRAC)
Commission considered these factors and concluded that large
potential savings and excess capacity of the Air Force depot system
necessitated the difficult decision to close these activities and
consolidate work at remaining depots. 

Our analysis indicates that savings of about $182 million annually
can be achieved by transferring the centers' depot maintenance
workloads to the remaining depots, which have about 45 percent excess
capacity in fiscal year 1996 and are significantly underutilized. 
Further, our analysis of privatization-in-place at the Aerospace
Guidance and Metrology Center at Newark Air Force Base, Ohio
indicates that maintenance costs will likely increase rather than
decrease as a result of this privatization initiative.  Existing
statutes concerning the performance of core workload and requirements
for competition affect various privatization initiatives, including
privatization-in-place, and it is not clear how DOD would proceed if
these statutes are not repealed. 

To conclude my summary, I think it is important to note that the
future of the DOD depot system under the Department's new policy is
uncertain.  DOD depots would be used sparingly for public-private
competitions since the depots could not compete for non-core
workloads where "adequate private sector competition" exists even
though they may offer the most cost-effective source of repair.  If
not effectively managed, over the long term, DOD depots could become
an economic liability rather than a cost-effective partner in the
total DOD industrial base.  Accordingly, as workloads are moved to
the private sector, further downsizing--including additional
closures--will be required.  With these observations in mind, depot
maintenance privatization should be approached carefully, allowing
for the evaluation of economic, readiness, and statutory requirements
that surround individual workloads.  With that as a summary, let me
turn to my detailed remarks. 


--------------------
\1 For purposes of this testimony, privatization means assigning or
transferring work to private sector contractors whose employees
perform the work in a facility that is usually not owned by the
federal government, although depot plant equipment may be government
owned.  Privatization-in-place means the work will be performed at a
former DOD facility. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

Depot maintenance is a key part of the total DOD logistics effort and
is a vast undertaking, supporting millions of equipment items, 53,000
combat vehicles, 514,000 wheeled vehicles, 372 ships, and 17,300
aircraft of over 100 different models.  Depot maintenance requires
extensive shop facilities, specialized equipment, and highly skilled
technical and engineering personnel to perform major overhaul of
weapon systems and equipment, to completely rebuild parts and end
items, to modify systems and equipment by applying new or improved
components, or to manufacture parts unavailable from the private
sector.  DOD's depot maintenance facilities and equipment are valued
at over $50 billion.  DOD annually spends about $15 billion--or about
6 percent of its $243 billion fiscal year 1996 budget--on depot
maintenance activities.  About $2 billion of this amount includes
contractor logistics support, interim contractor support, and funds
for labor associated with the installation of some major
modifications and parts of software maintenance, which are contracted
to the private sector using procurement, rather than operation and
maintenance funds. 

The DOD depot system, which is actually comprised of four systems,\2
employs about 89,000 DOD civilian personnel, ranging from laborers to
highly trained technicians to engineers and top-level managers.  Our
recent report on closing maintenance depots provides a history of
each of the services' depot systems.\3 While the number of depot
personnel has been reduced by over 40 percent relative to when the
DOD depot system was at its peak in 1987, depot facilities and
equipment have not been similarly downsized.  At the time of the 1995
BRAC process, the DOD depot system had 40 percent excess capacity,
based on an analysis of maximum potential capacity for a 5-day week,
one 8-hour-per-day shift operation.  The Air Force, which had not
closed a U.S.  depot since the 1960s, had 45 percent excess capacity. 
Currently, there are 29 major DOD depot maintenance facilities--Army
depots, Air Force logistics centers, naval aviation depots, naval
shipyards, naval warfare centers, and Marine Corps logistics
bases--that perform depot maintenance work--of which 10 are in the
process of being closed as DOD maintenance depots as a result of BRAC
decisions.\4 Additionally, DOD uses over 1,300 U.S.  and foreign
commercial firms to support its depot maintenance requirements. 

Statutes and regulations influence the mix of maintenance work
performed by the public and private sectors.  For example, as early
as 1974, legislation prescribed a specific dollar value mix for
public and private sector performance of alteration, overhaul, and
repair work for naval vessels.  Since then, workload allocation
decisions have been influenced by percentage goals found in DOD
policy guidance and legislation. 

DOD Directive 4151.1, "Use of Contractor and DOD Resources for
Maintenance of Materiel," directed the services to plan for not more
than 70 percent of their depot maintenance to be conducted in DOD
depots to maintain a private sector industrial base.  The most basic
of the legislative mandates governing the performance of depot-level
workloads is 10 U.S.C.  2464, which provides for a "core" logistics
capability to be identified by the Secretary of Defense and
maintained by DOD unless the Secretary waives DOD performance as not
required for national defense.  Traditionally, core was defined as
the capability, including personnel, equipment, and facilities, to
ensure timely response to a mobilization, national contingency, or
other emergency requirement.  The composition and size of this core
capability are at the heart of the depot maintenance public-private
mix debate. 

Other statutes affect the extent to which depot-level workloads can
be converted to private sector performance.  Two of the most
significant are 10 U.S.C.  2466 and 10 U.S.C.  2469.  The first
prohibits the use of more than 40 percent of the funds made available
in a fiscal year for depot-level maintenance or repair for private
sector performance:  the so-called "60/40" rule.  The second provides
that DOD-performed depot maintenance and repair workloads valued at
not less than $3 million cannot be changed to performance by another
DOD activity without the use of "merit-based selection procedures for
competitions" among all DOD depots and that such workloads cannot be
changed to contractor performance without the use of "competitive
procedures for competitions among private and public sector
entities." In recent years DOD has sought relief from both these two
statutes. 


--------------------
\2 DOD Directive 5100.1, "Functions of the Department of Defense and
Its Major Components," assigns the Army, Navy, Air Force, and Marine
Corps, under their respective Secretaries, the responsibility for
"providing logistics support for service forces, including
procurement, distribution, supply, equipment, and maintenance, unless
otherwise directed by the Secretary of Defense." To meet the
responsibility to maintain its equipment, each service operates a
depot maintenance system, with the Navy system including three
different types of depots, excluding the Marine Corps. 

\3 Closing Maintenance Depots:  Savings, Workload, and Redistribution
Issues (GAO/NSIAD-96-29, March 4, 1996). 

\4 There are also 16 Army and 9 Navy facilities in the continental
United States for weapons and munitions depot maintenance. 


   DOD DEPOTS WILL HAVE A FUTURE
   ROLE BUT IT WILL BE SMALLER
---------------------------------------------------------- Chapter 0:2

DOD and the Congress are defining the role of DOD depots in the post
cold war era, much in the same way the roles of U.S.  war-fighting
forces are being reshaped.  The new model for managing depot
maintenance has not yet emerged.  However, given DOD's depot
maintenance policy report, the model apparently will be a mix between
public and private sector capabilities, but with a clear shift toward
greater reliance on the private sector.  DOD's March 1996 Depot-Level
Maintenance and Repair Workload Report projected a significant
increase in the depot work that will be privatized.  Further, since
the services periodically reevaluate their core workload
requirements, it is unknown how much more of their current work will
be determined to be non-core and privatized.  Unless effectively
managed, including downsizing of remaining depot infrastructure, a
major shift in depot workloads to the private sector would exacerbate
existing excess capacity in the DOD depot maintenance system. 

Historically, depot maintenance on wartime critical DOD systems has
been largely performed in DOD depots.  Based on both cost and risk
factors, the general DOD policy was to rely on DOD depots to provide
a cost-effective and reliable source of support for wartime readiness
and sustainability.  With some exceptions, peacetime maintenance of
weapon systems with wartime taskings was performed in DOD depots. 
This peacetime workload constituted depot maintenance core.  Core was
determined by quantifying the depot work that would be generated
under war scenarios and then computing the amount of peacetime work
needed to employ the number of people necessary to support the
anticipated wartime surge.  Peacetime workload was composed of a mix
of high and low-surge items allowing employees to transfer from low
surge workload to high surge workload during war.  While there were
always a number of potential war scenarios, the depots were sized to
support a sustained global war. 

During the cold war, there was not much pressure to move work from
DOD depots to the private sector.  Military leaders expressed a clear
preference for retaining much of their work in DOD depots, which were
highly flexible and responsive to changing military requirements and
priorities.  The quality of the DOD depots was high and users were
generally well-satisfied with the depots' work.  Further, the threat
of a global war and the resulting stress on the logistics system were
constant reminders of the need to maintain the flexibility and
responsiveness the depot system provided.  Historically, DOD has
reported that about 70 percent of its depot maintenance work was
performed in DOD depots. 

In our 1994 testimony before the Readiness Subcommittee of the House
Armed Services Committee, we stated that the private sector more
likely receives about 50 percent of the DOD depot maintenance budget. 
We noted that a portion of the funds expended on the maintenance
workload assigned to the public sector ultimately was used for
private sector contracts for parts and materiel, maintenance and
engineering services, and other goods and services.  Additionally,
some types of depot maintenance activities, such as interim
contractor support and contractor logistics support, were not
included in previously reported statistics.\5 Our review of data in
DOD's March 1996 workload report indicates that by fiscal year 1997,
the mix will be about 64 percent in the public sector and 36 percent
in the private sector.  Further analysis indicates that the data does
not include funds reported by the services for interim contractor
support, contractor logistics support, or goods and services that the
DOD depots ultimately buy from the private sector.  Including these
funds would change the mix to about 53 percent in the public sector
and 47 in the private sector.  While the Department's projection for
the public-private mix in 2001 is 50 percent in each sector, our
analysis indicates that it is actually about 37 percent in the public
sector and 63 in the private sector.  Further, since the services are
conducting risk analyses to further define their minimum core
capability, the DOD depots' share of funding could be reduced even
further. 

With the end of the cold war and the subsequent declines in defense
spending, there are increased pressures to privatize more depot
maintenance work.  Those declines affected force structure and the
public and private activities supporting force structure.  As
acquisition programs began to decline, a growing concern arose over
the impact on the defense industrial base.  Particular concern
focused on how that industrial base could be maintained without the
large development and production programs of the past, and attention
began to shift to DOD depot workloads as a potential source of work
to keep the industrial base viable. 

Advocates of more private sector involvement argue that a shift
toward the private sector would not only help keep the private sector
production base healthy during a period of reduced weapon procurement
but also could result in lower costs, since the private sector could
provide depot maintenance at lower cost than the public sector. 
Proponents of the DOD depot system believe the DOD depots have
provided a quality, responsive, and economical source of repair. 
They note that DOD maintenance policy for many years has supported
the outsourcing of depot maintenance work when it was determined to
be cost-effective to do so.  Further, they contend there are
substantial differences between developing and producing new systems
and maintaining fielded ones and that the dollars spent on
maintenance, while not small, cannot fill the void created by
declining production dollars. 

Section 311 of the National Defense Authorization Act for Fiscal Year
1996 is an indication of congressional intent regarding the continued
need for DOD depots: 

It is the sense of Congress that there is a compelling need for the
Department of Defense to articulate known and anticipated core
maintenance and repair requirements, to organize the resources of the
Department of Defense to meet those requirements economically and
efficiently, and to determine what work should be performed by the
private sector and how such work should be managed. 

Section 311 also directed the Secretary of Defense to develop a
comprehensive policy on the performance of depot-level maintenance
and repair for the Department of Defense that maintains the core
capability described in 10 U.S.C.  2464 and report to the Senate
Committee on Armed Services and House Committee on National Security. 
The section further directed that in developing the policy, the
Secretary should include certain elements such as interservicing,
environmental liability, and exchange of technical data. 

The Congress supports preserving a DOD depot maintenance system to
support core requirements.  With no additional BRACs scheduled, the
Department was charged with developing a depot maintenance policy
that provides adequate workloads to ensure cost efficiency and
technical proficiency in time of peace. 


--------------------
\5 Depot Maintenance:  Issues in Allocating Workload Between the
Public and Private Sectors,(GAO/T-NSIAD-94-161, Apr.  12, 1994). 


   PRELIMINARY OBSERVATIONS
   REGARDING DOD'S DEPOT
   MAINTENANCE POLICY REPORT
---------------------------------------------------------- Chapter 0:3

We are analyzing DOD's depot maintenance policy and workload analysis
reports, as required by Section 311, and will be reporting our
findings by May 18, 1996.  However, as requested, I am providing our
observations to date on the policy report.  First, it provides an
overall framework for managing DOD depot maintenance activities. 
Second, it sets forth a clear preference for moving workload to the
private sector, which will likely result in a much smaller core
capability than exists today.  Third, it is not consistent with
congressional guidance in one key area--the use of public-private
competitions.  Fourth, the policy provides substantial latitude in
implementation.  As a result, the precise affect of this policy on
such factors as public-private mix, cost, and excess capacity remain
uncertain. 


      POLICY REPORT PROVIDES DEPOT
      MAINTENANCE FRAMEWORK
-------------------------------------------------------- Chapter 0:3.1

In response to the congressional requirement for a comprehensive
statement of depot maintenance policy, DOD provided an overall
framework for managing DOD depot maintenance activities.  The policy
report reiterates some past policies and identifies some new
initiatives for depot-level maintenance.  It references other
directives, publications, memorandums, and decisions and notes that
DOD plans to develop an updated single publication with applicable
maintenance policy guidance.  Our assessment is based on observations
to date about the policy report and other related documents. 


      POLICY REPORT SETS FORTH A
      PREFERENCE FOR PRIVATIZATION
-------------------------------------------------------- Chapter 0:3.2

The policy report clearly states that the Department has a preference
for privatizing maintenance support for new systems and for
outsourcing non-core workload.  It represents a fundamental shift in
the historical policy of relying on DOD depots to provide for the
readiness and sustainment of wartime tasked weapon systems. 

Section 311 of the authorization act states that the DOD policy
should provide that core depot-level maintenance and repair
capabilities are performed in facilities owned and operated by the
United States.  It also states that core capabilities include
sufficient skilled personnel, equipment, and facilities that are of
the proper size to ensure a ready and controlled source of technical
competence, and repair and maintenance capability necessary to meet
the requirements of the National Military Strategy and other
requirements, and to provide for rapid augmentation in time of
emergency. 

Core, as set forth in the policy and workload reports, no longer
means that wartime work will be performed primarily by DOD depots. 
DOD's core concept is for its depots to perform maintenance
requirements that the service secretaries identify as too risky for
the private sector to perform.  In determining core workloads, the
DOD policy calls for maintaining only "minimum capability"--which
does not necessarily mean an actual workload for a depot.  What once
was calculated as core is now called pre-risk core.  For those
mission essential workloads that historically would dictate retention
of a core capability, the services will conduct a risk assessment\6
to determine if the work should be made available for competition
within the private sector.  The policy guidance provides some limited
criteria for performing a risk assessment, but DOD has not yet
developed guidelines for making those assessments in a consistent
manner.  It is unclear the extent measured criteria or subjective
judgement will be used for such assessments. 

In a similar vein, DOD's policy on depot maintenance seeks to
severely limit the use of DOD depots for new weapon systems.  Section
311 provides for the performance of maintenance and repair for any
new weapon systems defined as core in facilities owned and operated
by the United States.  On the other hand, the Department reported to
the Congress in August 1995 that it intended to privatize depot
maintenance for new systems and reported in its January 1996 depot
maintenance privatization initiative that it intended to freeze the
transition of new workloads to DOD depots.  The policy report and
other recently issued DOD guidance, such as DOD Instruction 5000.2,
also show that DOD's maintenance concept for new and modified systems
will minimize the use of DOD depots. 

This preference, in combination with DOD's minimum core concept and
limited public-private competitions, if not effectively
managed--including reducing infrastructure and developing competitive
markets--would likely result, over the long term, in DOD depots
becoming an economic liability rather than a cost-effective partner
in the total DOD industrial base.  The DOD policy report states that
the Department will provide for cost efficiency, sufficient workload,
and technical proficiency in its depots.  However, accomplishing this
objective will be difficult given that the depots already are
underutilized and the policy providing for additional outsourcing
would exacerbate that situation, unless there are additional depot
closures.  Further, the report does not provide a clear indication,
aside from recognizing ongoing BRAC actions, on how the Department
intends to downsize to minimum core. 


--------------------
\6 DOD's policy report requires three risks to be assessed: 
readiness, sustainability, and technology.  It is unclear, however,
what procedures should be used for making these assessments. 


      POLICY REPORT IS
      INCONSISTENT WITH
      CONGRESSIONAL DIRECTION
      REGARDING THE USE OF
      PUBLIC-PRIVATE COMPETITION
-------------------------------------------------------- Chapter 0:3.3

While we are in the process of reviewing the policy report for
consistency with congressional direction and guidance, our
observation to date is that the report is inconsistent in one key
area--the use of public-private competitions for allocating non-core
depot maintenance workloads. 

Section 311(d)(5) of the act provides that in cases of workload in
excess of the workload to be performed by DOD depots, DOD's policy
should provide for competition "between public and private entities
when there is sufficient potential for realizing cost savings based
upon adequate private-sector competition and technical capabilities."
DOD's report provides a policy that is inconsistent with this
instruction.  According to DOD, it will engage in public-private
competition for workloads in excess of core only when it determines
"there is not adequate competition from private sector firms alone."
The report did not clarify what would constitute adequate
competition.  Under this policy, DOD depots would be used sparingly
for public-private competitions and DOD depots cannot compete for all
non-core workloads, where adequate private sector competition exists,
even though the DOD depots could offer the most cost-effective source
of repair. 

We have reported that public-private depot maintenance competitions
can be a beneficial tool for determining the most optimum
cost-effective source of repair for non-core workloads.  As noted in
our recent reports on the Navy's depot maintenance public-private
competition programs for ships and aviation, we found that these
competitions generally resulted in savings and benefits and provided
incentives for DOD depot officials to reengineer maintenance
processes and procedures, to develop more cost-effective in-house
capability and to ensure that potential outsourcing to the private
sector is more cost effective than performing the work in DOD
depots.\7

We recognize that DOD's public-private depot maintenance competition
program raised concerns about the reliability of DOD's depot
maintenance data and the adequacy of its depot maintenance management
information systems.  These deficiencies are not insurmountable.  As
we noted in prior reports, many of the problems were internal control
deficiencies that can be addressed with adequate top-level management
attention.  We also noted that some corrective actions have already
been undertaken and additional improvements can be made.  Further, we
recommended that the Defense Contract Audit Agency be used to certify
internal controls and accounting policies and procedures of DOD
depots to assure they are adequate for identifying, allocating, and
tracking costs of depot maintenance programs and to ensure proper
costs are identified and considered as part of the bids by DOD
depots.  DOD has stated that it plans to use the Defense Finance and
Accounting Service to review and certify the accounting systems of
DOD depots. 


--------------------
\7 Navy Maintenance:  Assessment of the Public-Private Competition
Program for Aviation Maintenance (GAO/NSIAD-96-30, Jan.  22, 1996)
and Navy Maintenance:  Assessment of the Public and Private Shipyard
Competition Program (GAO/NSIAD-94-184, May 25, 1994). 


      POLICY PROVIDES WIDE
      LATITUDE FOR IMPLEMENTATION
-------------------------------------------------------- Chapter 0:3.4

The policy report provides wide implementation latitude in a number
of key areas.  For example, it provides for a DOD depot capability,
but the ultimate extent of such capability, and hence DOD depot
requirements, could be substantially reduced depending on future core
workload assessments of privatization, readiness, sustainability, and
technology risks. 

Depending on implementation, the policy's preference for
privatization and the lack of a clear and consistent methodology for
determining risks will likely lead to significant amounts of workload
previously designated as core being reclassified as non-core and
privatized.  For example, with respect to the Aerospace Guidance and
Metrology Center, the Air Force is privatizing depot maintenance
operations involving 627,000 direct labor hours of work--100 percent
of which had been previously defined as core--stating that because
the workload is being privatized-in-place, the risk is manageable. 
It is unclear how risky that privatization may turn out to be,
particularly in light of the contractor's interest in divesting
itself of its defense business.  However, a similar rationale is
being used to support other in-place privatizations.  With this
predilection, it is likely that future core will represent something
far different than it did in the past.  For example, DOD's March 1996
workload report noted that core would ensure "that the Air Force
establishes and retains the capabilities needed to assure competence
in overseeing depot maintenance production that has both public and
private sector elements"--a significantly different mission than that
historically envisioned for DOD's core capability.  Further, DOD's
March 1996 report to Congress, Improving the Edge Through
Outsourcing, included intermediate maintenance of DOD weapons and
equipment--another function traditionally considered core--as one
which the Department will now consider privatizing. 

The policy also provides wide latitude in several areas where the
decision for determining public or private sector source of repair is
based on an assessment of what is "economical" or "efficient." For
example, the policy states that non-core workloads be made available
for only private sector competition when it is determined that the
private sector can provide the required capability with acceptable
risks, reliability, and efficiency.  This efficiency requirement does
not require the inclusion of the public sector to ensure that
privatization is the most cost-effective option. 


   DOD'S ASSUMPTION THAT DEPOT
   MAINTENANCE PRIVATIZATION WILL
   ACHIEVE 20-PERCENT SAVINGS IS
   UNSUPPORTED
---------------------------------------------------------- Chapter 0:4

The underlying assumption behind DOD's depot maintenance
privatization initiative is the expectation that savings of 20
percent will be achieved and these savings will be made available to
support the services' modernization programs.  Our analysis indicates
that this assumption is unsupported.  The data cited by Department
officials to support this savings assumption is the Report of the
Commission on Roles and Missions of the Armed Forces. 

In May 1995 the CORM concluded that 20 percent savings could be
achieved by the privatization of various commercial activities and
recommended that DOD transfer essentially all depot maintenance to
the private sector.  The Commission rejected the notion of core and
recommended that DOD (1) outsource all new support requirements,
particularly the depot-level logistics support of new and future
weapon systems and (2) establish a time-phased plan to privatize
essentially all existing depot-level maintenance.  In its August 1995
response to the Congress on the CORM report, DOD noted that the
Department agreed with the Commission's recommendation to outsource a
significant portion of its depot maintenance work, including depot
maintenance activities for new systems.  However, the DOD response
noted that DOD must retain a limited core depot maintenance
capability to meet essential wartime surge demands, promote
competition, and sustain institutional expertise. 

We found that the Commission's assumptions on savings from
privatization generally were based on reports of projected savings
from public-private competitions for various commercial activities as
part of the implementation of OMB Circular A-76.  These commercial
activities reviews included various base operating support functions,
such as family housing, real property and vehicle maintenance,
civilian personnel administration, food service, security and law
enforcement, and other support services.  While these activities were
varied in nature, they had similarities in that they generally
involved low-skilled labor; required little capital investment;
generally involved routine, repetitious tasks that could readily be
identified in a statement-of-work; and had many private sector
offerors who were interested and had the capability to perform the
work. 

Our review of A-76 competitions and public-private competitions for
depot-level maintenance found that the conditions under which A-76
competitions resulted in lower private sector prices were often not
present or applicable to depot maintenance.  Specifically, we found
that: 

  -- Reengineered government activities won about half of the A-76
     competitions because they could provide the work cheaper.  Our
     work shows that for public-private competitions involving depot
     maintenance activities, a program authorized by the Congress and
     implemented independently from A-76, DOD depots won 67 percent
     of the non-ship competitions.  Public-private competitions for
     ships provided a unique situation wherein private sector
     offerors could bid marginal or incremental costs while DOD
     depots were required to bid full costs--a condition which, in
     concert with the more competitive nature of the ship repair
     market, led to the public shipyards not being competitive.\8

  -- When the private sector won A-76 competitions, savings were
     significantly higher than when the government function was
     performed by military personnel.  The additional costs of
     military pay and benefits when coupled with productivity losses
     incurred for additional duties resulted in decreased
     competitiveness of the military personnel assigned to these
     duties.  Depot maintenance, on the other hand, is performed
     almost exclusively with civilian personnel. 

  -- The A-76 competitions did not involve activities comparable to
     depot maintenance--which is far more complex, less repetitious,
     and involves many unique systems not found in the private
     sector. 

  -- Problems associated with statements of work in A-76 competitions
     resulted in cost increases for privatized work because of
     contract modifications to more explicitly define required
     work--a condition we also identified in our review of DOD's
     public-private program for depot maintenance.  The impact of
     this cost growth for depot maintenance competitions can be
     illustrated by submarine repair competitions.  While the average
     award amount for private shipyards was 16 percent less than that
     for competitions won by the public sector, greater cost growth
     in the private sector resulted in the average actual costs being
     about the same. 

  -- While the A-76 commercial activity competitions resulted in
     savings, the savings were not readily quantifiable, did not
     consider the cost of the competition or the administration of
     the contracts, and for those competitions that were audited,
     savings were often less than projected.  We had similar findings
     in our review of public-private competitions for depot
     maintenance.  Additionally, we found that for the non-ship depot
     maintenance competitions won by a DOD depot, the DOD depots'
     bids averaged 40 percent less than the lowest private sector
     offeror.  Where we observed cost growth in the limited number of
     depot competitions we analyzed, the growth was not sufficient to
     result in the DOD depots' costs exceeding the bid of the lowest
     private sector offeror. 

  -- The A-76 competitions were conducted in a highly competitive
     private sector market--frequently involving 4 or more offerors,
     with 10 percent of the competitions involving 11 or more
     offerors.  Savings were much higher for those A-76 competitions
     won by the private sector where there were 5 or more private     sector offerors.  Our review of DOD's 95 non-ship depot
     maintenance public-private competitions showed the private
     sector market to be significantly less competitive.  Twenty-two
     of the competitions had no private offerors and 33 had only one. 
     Only 28 of these competitions had three or more offerors, while
     the number of offerors averaged less than two per competition. 


--------------------
\8 Navy Maintenance:  Assessment of the Public and Private Shipyard
Competition Program (GAO/NSIAD-94-184, May 25, 1994). 


      CURRENT DEPOT MAINTENANCE
      MARKET IS NOT HIGHLY
      COMPETITIVE
-------------------------------------------------------- Chapter 0:4.1

Recognizing the influence of competition on achieving savings from
privatization, we analyzed the competitiveness of DOD's non-ship
depot maintenance repair contracts.  We asked 12 DOD buying commands
to identify depot maintenance contracts that were open during 1995. 
They identified 8,452 contracts valued at $7.3 billion and, based on
high dollar value, we selected 240 contracts valued at $4.3 billion
to analyze the commands' use of competitive procedures for the
contracted workloads. 

The following table shows the results of our analysis. 



                                      Table 1
                      
                           Procedures for Contract Award

                               (Dollars in billions)



Co
mm
an
d     Number     Value    Number     Value    Number     Value    Number     Value
--  --------  --------  --------  --------  --------  --------  --------  --------
Ar        10     $.578         3     $.017        43     $.538        56    $1.133
 my
Ai        37     1.348         1      .100        60      .900        98     2.348
 r
 F
 o
 r
 c
 e
Na         2      .286         5      .048        79      .518        86      .852
 vy
==================================================================================
To        49    $2.212         9     $.165       182    $1.956       240    $4.333
 t
 a
 l
----------------------------------------------------------------------------------
\a Limited competition refers to those which are conducted using
other than full and open competition. 

As shown, the 12 buying commands awarded (1) 182, or 76 percent, of
the contracts through sole-source negotiation; (2) 49, or 20 percent,
through full and open competition, and (3) 9, or 4 percent, by
limited competition.  The 49 fully competitive awards accounted for
about 51 percent of the total dollar value while the 182 sole-source
contracts accounted for about 45 percent of the dollar value. 

In reviewing the number of offerors for the 49 contracts valued at
$2.2 billion that were awarded through full and open competition, we
found that the commands averaged 3.6 offers for the 49
contracts--ranging from a low of only 2 offers to a high of 10.  For
30 of the 49 contracts--about
86 percent of the $2.2 billion--the number of offers was 4 or less. 
Five contracts valued at $525.8 million had only two offers, while
only
19 contracts valued at $309.4 million had five or more offers. 

We also found that a large portion of the dollar value of the
contracts went to a relatively small number of contractors.  Although
the total number of contractors involved in the 240 contracts was 71,
13 of these contractors had most of the workload, about 76 percent of
the $4.3 billion.  Three of these 13 contractors had workload valued
at $1.3 billion, about 30 percent of the $4.3 billion. 

Our analysis of depot maintenance contracts showed that the private
sector market was more competitive for certain types of systems and
equipment than for others.  For example, awards for repair of ground
vehicles, trucks, airframes, engines, and other items were more often
competitive while sole-source contracts were prevalent for fire
control systems, communications and radar equipment, electronic
components, and other components.  We found that the buying commands
sometimes used both DOD depots and private sector sources for repair
of a limited number of items.  To make price comparisons, we looked
at 414 items that buying activities identified as being maintained in
both sectors.  For 62 percent of the items, the contract price was
higher than the price for the same item repaired in a DOD depot. 

We also analyzed the impact of other conditions relevant to creating
a competitive environment.  Regarding the ability to clearly define
the service to be provided, the buying commands reported that depot
maintenance activities present a difficult challenge.  For much of
the depot maintenance work, specific tasks that must be done, spare
and repair parts that will be required, and the type and skill-level
of the labor required cannot be identified until the equipment or
component is inducted into the repair facility for inspection and
repair.  Our review of depot maintenance contracts showed the
difficulty in constraining cost growth in this
environment--particularly when cost-type contracts are used.  It also
showed the large costs normally associated with drafting statements
of work, conducting the competitions, and administering the
contracts.  At one buying activity which obligates about $180 million
per year for depot maintenance contracts, we found sole-source
contracts were used 100 percent of the time--many of which were also
cost reimbursable.  Officials said they did not have the manpower,
technical data, technical manpower, or contracting skills to use
competitive contracting.  Additionally, officials noted that the
process for qualifying repair sources is difficult and
time-consuming. 


   PRIVATIZATION-IN-PLACE PLANS DO
   NOT APPEAR TO OPTIMIZE SAVINGS
---------------------------------------------------------- Chapter 0:5

There have been a number of recent initiatives to privatize depots
recommended for closure or realignment by BRAC.  The most prominent
among these so-called "in-place" privatization initiatives involve
the Aerospace Guidance and Metrology Center, a depot recommended for
closure by the 1993 BRAC Commission and located on Newark Air Force
Base, Ohio, and the Sacramento and San Antonio Air Logistics Centers,
which were recommended for closure by the 1995 BRAC Commission and
are located on McClellan Air Force Base, California, and Kelly Air
Force Base, Texas, respectively. 

We previously reported that, although it may be several years before
the total cost of privatizing the Aerospace Guidance and Metrology
Center's depot maintenance workload can be identified, our
preliminary analysis indicated that this privatization will likely
increase, rather than decrease, depot maintenance costs.\9 In
addition, our recent analysis of 254 contract items disclosed that
(1) unit costs were higher after privatization for 201, or about 79
percent, of the items and (2) overall, there was a net cost increase
of $6.01 million for the 254 items.\10 Further, although the Air
Force is projecting annual savings of $5 million for the last 4 years
of the 5-year contract, we found that the Air Force did not include
all relevant costs in its analysis.  For example, our analysis showed
that the Air Force's estimated prices for eight contract items did
not include such items as material costs totalling $15 million. 

We also reported on the potential impact of privatizing the San
Antonio Air Logistics Center's engine workload in place rather than
transferring the work to the Oklahoma City Air Logistics Center.\11
Specifically, we reported that consolidating San Antonio's engine
workload with Oklahoma City's engine workload would reduce Oklahoma
City's overhead rate for engine work by as much as $10 an hour and
would result in an estimated annual savings of $76 million.  As
requested by Chairman Spence, we are conducting a more thorough
review of the Department's privatization-in-place initiatives,
particularly those underway at San Antonio and Sacramento.  Our
preliminary observations on these initiatives follow. 


--------------------
\9 Aerospace Guidance and Metrology Center:  Cost Growth and Other
Factors Affect Closure and Privatization (GAO/NSIAD-95-60, December
9, 1994). 

\10 This is a conservative estimate because it ignores contractor
profits, lease costs, and other privatization costs that have not yet
been determined. 

\11 Depot Maintenance:  Opportunities to Privatize Repair of Military
Engines, (GAO/NSIAD-96-33, March 5, 1996). 


      PRIVATIZATION-IN-PLACE AT
      SACRAMENTO AND SAN ANTONIO
      WILL BE COSTLY
-------------------------------------------------------- Chapter 0:5.1

The BRAC Commission's July 1995 report to the President noted that
the decision to close the Sacramento and San Antonio Air Logistics
Centers was a difficult one to make, but was necessary given the Air
Force's significant excess depot capacity and limited defense
resources.  The Commission report also concluded that these actions
should save about $151.3 million over the 6-year implementation
period and $3.5 billion over 20 years.  Since this announcement, DOD
has moved forward with its privatization efforts at these locations,
including the announcement that contracts for five prototype
workloads are to be awarded by the close of 1997. 

When the President forwarded the BRAC Commission recommendations to
the Congress, he stated that his intent was to privatize the work in
place or in the local communities in order to (1) avoid the immediate
costs and disruption in readiness that would result from the
relocation of the centers' missions, (2) mitigate the impact on the
local communities, and (3) preserve important defense work forces. 
The administration also decided to delay the centers' closures until
the year 2001 to further mitigate the adverse impact on the local
communities. 

Our analysis indicates that delaying the centers' closures until 2001
could increase net costs during the 6-year BRAC implementation period
by hundreds of millions of dollars, primarily because it would limit
the Air Force's ability to achieve recurring savings to offset
expected closure costs.  Additionally, although the closures'
potential impact on local communities and readiness is a valid
concern, actions can be taken to limit the impact.  For example, the
Sacramento community's successful conversion of the Sacramento Army
Depot to private use has demonstrated that this conversion, although
difficult, can be accomplished.  Further, according to Navy depot
maintenance officials, on-going efforts to quickly close three
aviation depots have had no significant impact on readiness. 

Our preliminary analysis also indicates that privatizing the two
centers' depot maintenance workloads in place is likely to be a more
costly alternative than transferring the workloads to the three
remaining centers.  One reason for this is that there are substantial
costs associated with privatization-in-place that do not apply to DOD
maintenance depots.  For example, our analysis indicates that unique
requirements such as the cost of proprietary data rights, contractor
profits, and contractor oversight could add 20 percent, or more, to
the cost of performing the work.  Further, the cost plus contract
that will likely be used is not conducive to generating significant
private sector economies, a situation already unfolding at the
Aerospace Guidance and Metrology Center. 

More significantly, our analysis indicates that
privatization-in-place eliminates the opportunity to consolidate
workloads at the remaining centers and to, thereby, achieve
substantial "economy of scale" savings and other efficiencies.  The
Air Force's five air logistics centers currently have approximately
57.3 million direct labor hours of depot maintenance capacity to
accomplish about 29.3 million hours of workload (projected fiscal
year 1999)--leaving a projected excess capacity of 49 percent in
1999.  The BRAC decision to close the San Antonio and Sacramento Air
Logistics Centers provides the Air Force the opportunity to
redistribute workload to the remaining three air logistics centers,
thereby reducing excess capacity within its depot system to about 8
percent.  Our analysis indicates that redistributing 8.2 million
hours of work from Sacramento and San Antonio to the remaining
centers would allow the Air Force to achieve annual savings of as
much as $182 million.\12 According to financial management officials
at the receiving air logistics centers, one-time workload transition
costs of about $475 million would be required to absorb the
additional workloads, indicating that net savings would occur within
2-1/2 years of the transition completion.\13 On the other hand, if
the remaining centers do not receive additional workload, they will
continue to operate with significant excess capacity, becoming more
and more inefficient and more and more expensive as their workloads
continue to dwindle due to downsizing and privatization initiatives. 

Finally, various statutory restrictions may affect the extent to
which depot-level workloads can be converted to private-sector
performance--through privatization-in-place or otherwise--including
10 U.S.C.  2464, 10 U.S.C.  2466, and 10 U.S.C.  2469.  While each of
these statutes has some impact on the allocation of DOD's depot-level
workload,
10 U.S.C.  2469 constitutes the primary impediment to privatization
in the absence of a public-private competition.  Competition
requirements of
10 U.S.C.  2469 have broad application to all changes to the
depot-level workload valued at $3 million or more currently performed
at DOD installations, including Kelly and McClellan.  The statute
does not provide any exemptions from its competition requirements
and, unlike most of the other laws governing depot maintenance, does
not contain a waiver provision.  Further, there is nothing in the
Defense Base Closure and Realignment Act of 1990--the authority for
the BRAC recommendations--that, in our view, would permit the
implementation of a recommendation involving privatization outside of
the competition requirements of 10 U.S.C.  2469. 

The determination of whether any single conversion to private-sector
performance conforms to the requirements of 10 U.S.C.  2469 depends
upon the facts applicable to the particular conversion.  We do not
have DOD's position regarding how it plans to comply with the
statutory restrictions.\14 While DOD has stated that it will
structure these conversions to comply with existing statutory
restrictions, details of the Department's privatization plans for
Kelly and McClellan are still evolving.  Further, "in-place"
privatizations at Newark, Kelly, and McClellan are now the subject of
litigation.  In March 1996, the American Federation of Government
Employees filed a lawsuit challenging these privatization
initiatives, contending that they violate the public-private
competition requirements of 10 U.S.C.  2469 and other depot
maintenance statutes.\15


--------------------
\12 Because of numerous uncertainties, it is impossible to precisely
estimate the potential savings.  For example, it is uncertain where
some workloads would be transferred.  Further, for systems such as
the C5 aircraft at San Antonio, which could have relocation costs of
about $100 million, privatization--either in-place or at contractor
facilities--may be the most cost-effective alternative. 

\13 This amount includes $318 million for relocating or separating
center personnel, most of which would also be incurred under
privatization-in-place. 

\14 We have, by letter dated January 3, 1996, requested that DOD
provide us with its plans for how it will comply with existing
statutory restrictions in its privatization initiatives at various
locations, including Kelly and McClellan.  DOD has yet to respond to
our request. 

\15 AFGE v.  Clinton, No.  C2 96-0283 ( S.D.  Ohio filed Mar.  18,
1996). 


   CONCLUSION
---------------------------------------------------------- Chapter 0:6

While our analysis of DOD's depot policy report continues, we believe
there are several points the Congress needs to consider as it
contemplates the repeal of 10 U.S.C.  2466 and 10 U.S.C.  2469--two
statutes that influence the allocation of depot maintenance workload
between the public and private sectors. 

First, the policy does not provide for participation of DOD depots in
depot maintenance competitions for non-core workload as directed by
the Congress.  Second, since the policy provides wide latitude during
implementation, likely outcomes of the policy change are difficult to
predict.  Third, cost savings are likely achievable from some depot
privatization, but not in the percentages and scope predicted by the
CORM.  Fourth, privatization-in-place does not appear to be
cost-effective given the excess capacity in DOD's depot maintenance
system. 

Given these considerations, the Congress needs to assure itself that
any new policy has the intended required features and that a process
is in place to monitor readiness, sustainability, and cost
considerations.  Further, the effective implementation of the new
policy will require a further downsizing of the Department's
remaining depot maintenance infrastructure and the development of
more competitive private sector markets. 

Thank you Mr.  Chairman that completes my statement.  I would be
happy to answer questions at this time. 

*** End of document. ***