Defense Depot Maintenance: Challenges Facing DOD in Managing Working
Capital Funds (Testimony, 05/07/97, GAO/T-NSIAD/AIMD-97-152).

GAO discussed financial management and logistics management issues
relating to the effectiveness and efficiency of the Department of
Defense's (DOD) operations, focusing on the: (1) operations of DOD's
working capital funds; and (2) management of DOD's depot maintenance
program.

GAO noted that: (1) to date, the working capital funds have not yet
accomplished the goal of operating on a break-even basis, and DOD
estimates the fund will have an accumulated operating loss of about $1.7
billion at the end of fiscal year (FY) 1997; (2) since 1993, the working
capital funds have had a cash shortage; (3) to ensure that the cash
balances remained positive, the funds have advance billed their
customers; (4) while the three services have liquidated $3.6 billion of
outstanding advance billings from February 1995 to January 1997, the
outstanding advance billing balance is still $1.6 billion; (5) GAO's
analysis of the FY 1998 prices for five business areas indicates that
they are probably too low to recover the expected FY 1998 operating
costs and/or recover prior year losses by over $300 million; (6) excess
capacity, which is currently about 40 percent in DOD's depot maintenance
system, is a significant contributor toward the inefficiency and high
cost of DOD's maintenance program and is generating significant losses
in the depot maintenance activity group of the service's working capital
fund; (7) DOD has made overly optimistic assumptions about cost savings
that can be achieved from outsourcing depot maintenance activities; (8)
when outsourcing results in increasing, rather than decreasing costs,
expected depot maintenance savings will not be realized; (9) to the
extent projected savings were budgeted, losses will occur; (10) materiel
cost increases are generating losses for the depot maintenance capital
fund; (11) GAO's work also shows that weaknesses in DOD's inventory
management system such as inadequate visibility over items and
purchasing of unneeded stocks have contributed to rising material costs;
(12) in addition, inadequate control of government-furnished material to
contractors has also led to losses in contract depot maintenance; (13)
in conclusion, the inefficient operation of depot maintenance activities
results in a reduction of the military services' purchasing power
through their operations and maintenance funds; (14) in addition, other
factors also impact the cost-effectiveness of depot maintenance
operations, including inventory management practices, repair processes,
and readiness requirements; (15) to their credit, each of the military
services have programs underway to improve depot maintenance and other
logistics activities; and (16) while it is too early to assess the resu*

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

 REPORTNUM:  T-NSIAD/AIMD-97-152
     TITLE:  Defense Depot Maintenance: Challenges Facing DOD in 
             Managing Working Capital Funds
      DATE:  05/07/97
   SUBJECT:  Military cost control
             Cash management
             Financial management
             Logistics
             Cost effectiveness analysis
             Privatization
             Base closures
             Maintenance costs
             Equipment maintenance
             Industrial funds
IDENTIFIER:  Defense Business Operations Fund
             Air Force Working Capital Fund
             Army Working Capital Fund
             DOD Working Capital Fund
             Navy Working Capital Fund
             
Defense Depot Maintenance: Challenges Facing DOD in Managing Working
Capital Funds (Testimony, 05/07/97, GAO/T-NSIAD/AIMD-97-152).

GAO discussed financial management and logistics management issues
relating to the effectiveness and efficiency of the Department of
Defense's (DOD) operations, focusing on the: (1) operations of DOD's
working capital funds; and (2) management of DOD's depot maintenance
program.

GAO noted that: (1) to date, the working capital funds have not yet
accomplished the goal of operating on a break-even basis, and DOD
estimates the fund will have an accumulated operating loss of about $1.7
billion at the end of fiscal year (FY) 1997; (2) since 1993, the working
capital funds have had a cash shortage; (3) to ensure that the cash
balances remained positive, the funds have advance billed their
customers; (4) while the three services have liquidated $3.6 billion of
outstanding advance billings from February 1995 to January 1997, the
outstanding advance billing balance is still $1.6 billion; (5) GAO's
analysis of the FY 1998 prices for five business areas indicates that
they are probably too low to recover the expected FY 1998 operating
costs and/or recover prior year losses by over $300 million; (6) excess
capacity, which is currently about 40 percent in DOD's depot maintenance
system, is a significant contributor toward the inefficiency and high
cost of DOD's maintenance program and is generating significant losses
in the depot maintenance activity group of the service's working capital
fund; (7) DOD has made overly optimistic assumptions about cost savings
that can be achieved from outsourcing depot maintenance activities; (8)
when outsourcing results in increasing, rather than decreasing costs,
expected depot maintenance savings will not be realized; (9) to the
extent projected savings were budgeted, losses will occur; (10) materiel
cost increases are generating losses for the depot maintenance capital
fund; (11) GAO's work also shows that weaknesses in DOD's inventory
management system such as inadequate visibility over items and
purchasing of unneeded stocks have contributed to rising material costs;
(12) in addition, inadequate control of government-furnished material to
contractors has also led to losses in contract depot maintenance; (13)
in conclusion, the inefficient operation of depot maintenance activities
results in a reduction of the military services' purchasing power
through their operations and maintenance funds; (14) in addition, other
factors also impact the cost-effectiveness of depot maintenance
operations, including inventory management practices, repair processes,
and readiness requirements; (15) to their credit, each of the military
services have programs underway to improve depot maintenance and other
logistics activities; and (16) while it is too early to assess the resu*

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

 REPORTNUM:  T-NSIAD/AIMD-97-152
     TITLE:  Defense Depot Maintenance: Challenges Facing DOD in 
             Managing Working Capital Funds
      DATE:  05/07/97
   SUBJECT:  Military cost control
             Cash management
             Financial management
             Logistics
             Cost effectiveness analysis
             Privatization
             Base closures
             Maintenance costs
             Equipment maintenance
             Industrial funds
IDENTIFIER:  Defense Business Operations Fund
             Air Force Working Capital Fund
             Army Working Capital Fund
             DOD Working Capital Fund
             Navy Working Capital Fund
             
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Cover
================================================================ COVER


Before the Subcommittee on Defense,
Committee on Appropriations,
U.S.  Senate

For Release on Delivery
Expected at
10:00 a.m., EDT
Wednesday,
May 7, 1997

DEFENSE DEPOT MAINTENANCE -
CHALLENGES FACING DOD IN MANAGING
WORKING CAPITAL FUNDS

Statement of Henry L.  Hinton, Jr., Assistant Comptroller General,
National Security and International Affairs Division

GAO/T-NSIAD/AIMD-97-152

GAO/NSIAD/AIMD-97-152T

Defense Depot Maintenance

709262, 511616


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

  AGMC -
  BRAC -
  DBOF -
  DOD -
  OSD -
  NAVSEA -
  DLH -
  PEMCO -
  CORM -

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

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss financial management and
logistics management issues relating to the effectiveness and
efficiency of the Department of Defense's (DOD) operations. 
Specifically, we will focus on the operations of DOD's working
capital funds, which collect and disburse over $65 billion annually,
and on DOD's management of the $13 billion depot maintenance program. 
It is important to note that these areas fall within defense
financial management and infrastructure activities, 2 of the 24 areas
we identified as high-risk areas within the federal government.\1

These issues have significant impact on the efficiency and
effectiveness of how DOD spends its operations and maintenance funds. 
DOD has consistently experienced losses in the operations of various
working capital funds, including the depot maintenance activity
group, and has had to request additional funding to support their
operations.  This issue has been an area of concern to this
subcommittee and other congressional committees.  Before we get into
specifics, let's briefly summarize our key points. 


--------------------
\1 Defense Financial Management (GAO/HR-97-3, Feb.  1997) and Defense
Infrastructure Management (GAO/HR-97-7, Feb.  1997).  In 1990, GAO
began a special effort to report on the federal program areas its
work identified as high risk because of vulnerabilities to waste,
fraud, abuse, and mismanagement. 


   WORKING CAPITAL FUNDS' CASH
   MANAGEMENT AND OPERATIONS
   ISSUES
---------------------------------------------------------- Chapter 0:1

Our work on working capital funds cash management and operations
shows the following: 

  To date, the working capital funds have not yet accomplished the
     goal of operating on a break-even basis, and DOD estimates the
     funds will have an accumulated operating loss of about $1.7
     billion at the end of fiscal year 1997.  However, we believe
     that the funds have achieved a measure of success because the
     services are doing a better job of identifying the costs of
     doing business and including those costs in the prices charged
     customers.  Setting prices to recover more of the costs of
     providing goods and services to customers gives managers a
     window into the costs of DOD support operations--including costs
     for direct labor, material, overhead, and contracts.  With a
     more complete cost picture, managers can account for past
     activities, manage current operations, and assess progress
     toward planned objectives.  Further, more accurate
     identification of costs enables those responsible for providing
     oversight to make more informed policy decisions by highlighting
     the cost associated with those decisions. 

  When the Defense Business Operations Fund was established in 1991,
     DOD consolidated the cash balances of the nine industrial and
     stock funds into a single account that was managed centrally by
     the Office of the Secretary of Defense (Comptroller).  In
     February 1995, DOD devolved the responsibility for cash
     management to the military services and DOD components.  We
     agree with DOD's decision to place the responsibility for
     managing the working capital funds' cash at the military service
     and DOD component level because it makes each individual DOD
     component directly accountable for its respective cash balance
     as well as their decisions that impact cash.  Each DOD component
     now has an incentive to more accurately price the goods and
     services that its working capital fund charges customers since
     inaccurate prices could lead to not having enough cash to cover
     day-to-day operating expenses. 

  Since 1993, the working capital funds have had a cash shortage.  To
     ensure that the cash balances remained positive, the funds have
     advance billed their customers.  While the three services have
     liquidated $3.6 billion of outstanding advance billings from
     February 1995 to January 1997, the outstanding advance billing
     balance is still $1.6 billion.  Further, the Navy and Air Force
     advance billed their customers about $2.9 billion during
     calendar year 1996 to ensure that their cash balances remained
     positive. 

  Our analysis of the fiscal year 1998 prices for five business areas
     indicates that they are probably too low to recover expected
     fiscal year 1998 operating costs and/or recover prior year
     losses by over $300 million. 

<head1<CHALLENGES FACING DOD IN IMPROVING THE COST- EFFECTIVENESS OF
DEPOT MAINTENANCE OPERATIONS

Various factors contribute to inefficiencies in DOD's management of
depot maintenance activities. 

  Excess capacity--which is currently about 40 percent in DOD's depot
     maintenance system--is a significant contributor toward the
     inefficiency and high cost of DOD's depot maintenance program
     and is generating significant losses in the depot maintenance
     activity group of the services' working capital funds.  The Navy
     has made the greatest progress in dealing with excess capacity
     through its implementation of base realignment and closure
     (BRAC) recommendations.  Through consolidations, interservicing
     actions, and outsourcing some noncore workloads, the Navy
     expects to reduce its operating rate by about $10 per hour. 
     Based on a forecast of 13 million direct labor hours for fiscal
     year 1999, the Navy expects to produce a savings of about $130
     million.  However, the Army and the Air Force's plans for
     implementing BRAC recommendations will do little to reduce
     excess capacity and will likely result in increased depot
     maintenance prices. 

  DOD has made overly optimistic assumptions about cost savings that
     can be achieved from outsourcing depot maintenance activities. 
     When outsourcing results in increasing, rather than decreasing
     costs, expected depot maintenance savings will not be realized. 
     To the extent projected savings were budgeted, losses will
     occur.  For example, privatization-in-place of the Aerospace
     Guidance and Metrology Center was justified based on achieving
     savings.  However, the Air Force projects that for 1997, costs
     in the privatized facility will be $9 million to $32 million
     more than the cost of the same work before privatization. 
     Similarly, the Air Force is also projecting savings from planned
     competitions of workloads at two closing Air Logistics Centers. 
     If the savings from these competitions are not achieved, a
     similar situation will occur. 

  Material cost increases are generating losses for the depot
     maintenance capital fund.  Material costs represent about 40
     percent of the Air Force depot maintenance costs and during the
     first half of fiscal year 1997, material costs for Air Force
     depots have been about $32.7 million, or
     5.4 percent higher than planned.  Our work also shows that
     weaknesses in DOD's inventory management system, such as
     inadequate visibility over items and purchasing of unneeded
     stocks, have contributed to rising material costs.  In addition,
     inadequate control of government-furnished material to
     contractors has also led to losses in contract depot
     maintenance.  For example, in April 1996, the Air Force Audit
     Agency found problems at Warner Robins Air Logistics Center with
     government-furnished property financial statement balances
     misstated by up to $2.3 billion. 

In conclusion, the inefficient operation of depot maintenance
activities results in a reduction of the military services'
purchasing power through their operations and maintenance funds. 
Stated another way, more operations and maintenance funds will be
required to perform the same level of maintenance.  Depot maintenance
privatization should be approached carefully, allowing for evaluation
of economic, readiness, and statutory requirements that surround
individual workloads.  If not effectively managed, privatizing depot
maintenance activities, including the downsizing of the remaining DOD
depot infrastructure, could exacerbate existing capacity problems and
the inefficiencies inherent in underutilization of depot maintenance
capacity. 

In addition, other factors also impact the cost-effectiveness of
depot maintenance operations.  These include such things as inventory
management practices, repair processes, and readiness requirements. 
We have encouraged DOD to aggressively seek new management practices
to meet these challenges.  To their credit, each of the military
services have programs underway to improve depot maintenance and
other logistics activities.  While it is too early to assess the
results of these programs, we believe they are addressing several key
problems, such as the reduction of repair cycle time. 

In closing, it is important to note that reducing depot maintenance
cost and improving depot maintenance efficiency are complex and
challenging tasks that are compounded by force structure downsizing. 
We have presented some of the key factors that must be addressed and
continue to believe DOD should develop an overall plan for improving
depot maintenance efficiency and effectiveness that clearly defines
how it will deal with this set of complex issues. 


-------------------------------------------------------- Chapter 0:1.1

Mr.  Chairman, this completes the summary of issues contained in our
statement.  Mr.  Brock and Ms.  Denman, as requested, will now
provide more details on these issues. 


WORKING CAPITAL CASH AND
OPERATIONS MANAGEMENT ISSUES
=========================================================== Appendix I

The Department of Defense (DOD) established the Defense Business
Operating Fund (DBOF) in 1991 in an attempt to fundamentally alter
the way DOD managed its resources by fostering a more business-like
culture within selected Defense operations, which include depot
maintenance, transportation, supply management, and finance and
accounting.  DBOF consolidated the nine existing industrial and stock
funds operated by the military services and DOD, as well as the
Defense Finance and Accounting Service, the Defense Industrial Plant
Equipment Service, the Defense Commissary Agency, the Defense
Reutilization and Marketing Service, and the Defense Technical
Information Service into a single financial structure.  The military
services and DOD components continue to be responsible for managing
and operating business activities within the financial structure. 

On December 11, 1996, the Under Secretary of Defense (Comptroller)
reorganized DBOF and created four working capital funds:  Army, Navy,
Air Force, and Defense-wide.  This was done in order to clearly
establish the military services and DOD components responsibilities
for managing the functional and financial aspects of their respective
business areas.  The recently established working capital funds
continue to operate the same way they did under DBOF. 

The primary goal of DBOF and the recently established working capital
funds is to focus the attention of all levels of management on the
total costs of carrying out certain critical DOD business operations
and the management of those costs in order to encourage support
organizations, such as depot maintenance facilities, to provide
quality goods and services at the lowest costs.  Focusing attention
on costs is important, given the size of the working capital funds. 
For fiscal year 1998, the four funds are expected to generate about
$69 billion in revenue and employ about 220,000 civilians and 24,000
military personnel. 

The working capital funds are supposed to generate sufficient
revenues to recover expenses incurred in their operations and are
expected to operate on a break-even basis over time.  However,
setting prices to ensure that the funds do break even is a complex
and difficult task.  DOD policy requires working capital fund
business areas to establish prices prior to the start of each fiscal
year and to apply these predetermined (stabilized or standard) prices
to most orders and requisitions received during the year.  The
process that the business areas use to develop their stabilized
prices begins as early as 2 years before the prices go into effect,
with each business area developing workload projections for the
budget year.  After a business area estimates its workload based on
customer input, it (1) uses productivity projections to estimate how
many people it will need to accomplish its work; (2) prepares a
budget that identifies the labor, material, and other expected costs;
and (3) develops prices, that when applied to the projected workload,
should allow it to recover operating costs from its customers. 
Because sales prices are based on expected rather than actual costs
and workloads, higher-than-expected costs or lower-than-expected
customer demand for goods and services can cause the business areas
to incur losses.  Conversely, lower-than-expected costs or
higher-than expected workloads can result in profits. 

To date, the working capital funds have not yet accomplished their
goal of operating on a break-even basis and DOD estimates that they
will have an accumulated operating loss of $1.7 billion at the end of
fiscal year 1997.  However, we believe that the funds have achieved a
measure of success because they are doing a better job of identifying
the costs of doing business and including those costs in the prices
charged customers.  This provides managers and decisionmakers two
important benefits.  First, setting prices to recover more of the
costs of providing goods and services to customers gives DOD managers
a window into the costs of Defense support operations--including
costs for direct labor, material, overhead, and contracts.  With a
more complete cost picture, managers can account for past activities,
manage current operations, and assess progress toward planned
objectives.  Second, more accurate identification of costs enables
those responsible for providing oversight to make more informed
policy decisions by highlighting the cost associated with those
decisions. 

Over the last several years, various congressional Defense oversight
and appropriations committees have expressed concern with the
management and operations of the funds.  To address these concerns,
DOD was required to conduct a study of its working capital funds as
directed in the National Defense Authorization Act for Fiscal Year
1997.  Not later than September 30, 1997, the Secretary of Defense is
required to submit to the Congress a plan to improve the management
and performance of the industrial, commercial, and support type
activities that are currently managed in the working capital funds. 
We are hopeful that DOD will use this plan as a mechanism to continue
to strengthen its commitment to improving the management and
operations of the working capital funds as well as identifying the
total costs of providing goods and services to customers and
including those costs in the prices charged customers. 


   WORKING CAPITAL FUND CASH
   MANAGEMENT
--------------------------------------------------------- Appendix I:1

Since 1993, the working capital funds have had a cash shortage.  To
address this problem, DOD has taken two actions.  First, in February
1995, DOD devolved the responsibility for cash management to the
military services and the DOD components to better align
accountability and responsibility for management.  Second, to ensure
that the cash balance remains positive, the working capital funds
have advance billed their customers since 1993. 


      THE IMPORTANCE OF CASH FOR
      WORKING CAPITAL FUNDS
------------------------------------------------------- Appendix I:1.1

Cash plays an extremely important role for DOD's working capital
funds since they collect and disburse over $65 billion annually. 
Cash generated from the sale of goods and services is the primary
means by which the working capital funds maintain an adequate level
of cash to pay bills.  Where the cash balances start each year
depends on the outcome of many decisions made during the budget
process with regard to (1) projecting workload, (2) estimating costs,
and (3) setting prices to recover the estimated full cost of the
goods and services.  During the execution of the budget, they operate
much like a checking account:  collections increase the funds'
account balances and disbursements (such as salaries and purchases of
inventory) reduce the account balances.  To the extent that the
decisions made during the budget process are reasonably accurate, the
funds' cash balances should fall between the minimum and maximum
amount required by DOD.  However, if the decisions are not accurate,
the funds could have too much or not enough cash. 

DOD's policy requires the funds to maintain cash levels to cover 7 to
10 days of operational costs and 4 to 6 months of capital asset
disbursements, which is about $2.3 billion to $3.4 billion for the
four funds.  If the level of cash becomes low and there is a
possibility of incurring an Antideficiency Act\1 violation, immediate
actions will be taken to resolve the cash shortages by advance
billing customers. 

Before DBOF was established, each industrial and stock fund had a
separate cash balance and managers were responsible for ensuring
sufficient cash was available to cover fluctuations in collections
and disbursements that occurred from one month to another.  When DBOF
was implemented, DOD consolidated the cash balances of the nine
industrial and stock funds into a single account that was managed
centrally by the Office of the Secretary of Defense (OSD)
(Comptroller).  OSD centrally managed DBOF's cash for about 3 years. 
In February 1995, DOD devolved responsibility for cash management as
well as Antideficiency Act responsibilities to the military services
and the DOD components. 


--------------------
\1 The Antideficiency Act, 31 U.S.C.  1341(a)(1), 1517, provides that
no officer or employee of the government shall make or authorize an
expenditure or obligation exceeding the amount of an appropriation of
funds available for the expenditure or obligation. 


      OUR VIEWS ON DOD'S DECISION
      TO DEVOLVE THE CASH
      MANAGEMENT RESPONSIBILITY
------------------------------------------------------- Appendix I:1.2

We agree with DOD's decision to place the responsibility for managing
the working capital funds' cash at the military service and defense
agency level and to likewise devolve the Antideficiency Act
responsibility.  In our view, decentralized cash management should
result in better cash management and more responsible business
decisions. 

According to DOD officials, the cash management responsibility was
devolved to the Army, the Navy, the Air Force, and the defense
agencies to better align accountability and responsibility for
managing cash.  DOD pointed out that the operational control of
actions taken by each fund activity, which results in cash
disbursements and collections, always has resided and continues to
reside with the individual DOD components. 

We believe that there are a number of benefits associated with the
decentralization of cash management responsibilities.  The
decentralization makes each individual DOD component directly
accountable for its respective cash balance as well as their
decisions that impact cash, including any violation of the
Antideficiency Act.  One DOD component cannot spend money generated
by another DOD component.  When cash management was centralized, DOD
did not have reports that showed the cash balances for the individual
DOD components--the reports only provided information on (1) DBOF's
overall cash balance and (2) collection and disbursement data for
each of the DOD components.  With the decentralization of cash
management, the Department of the Treasury provides DOD with a cash
balance for each of the five DOD components. 

There are still other advantages associated with the decentralization
of cash management: 

  Each DOD component now has an incentive to more accurately price
     the goods and services that its working capital fund charges
     customers since inaccurate prices could lead to not having
     enough cash to cover day-to-day operating expenses. 

  The management of cash is closer to where cash decisions are
     made--the business area and the activity level. 

  OSD and the DOD components have started working more as a team to
     resolve cash problems.  Under the centralization of cash, there
     was less incentive for the DOD components to respond to cash
     problems since OSD was responsible for cash and there was only
     one cash balance.  When the DOD components became responsible
     for their individual cash balances, they raised more questions
     on the accuracy and timeliness of the information on collections
     and disbursements.  Such increased attention should help improve
     the accuracy of collection and disbursement data reported in the
     working capital funds' financial statements, which are prepared
     under the Chief Financial Officers Act of 1990. 


      DOD HAS ADVANCE BILLED
      CUSTOMERS TO ALLEVIATE CASH
      SHORTAGE
------------------------------------------------------- Appendix I:1.3

Since 1993--with the transfer of $5.5 billion from DBOF as required
by the National Defense Authorization Act for Fiscal Year 1993--the
funds have been advance billing customers because they have not been
able to generate enough cash to pay their bills.  In July 1994, the
Comptroller of Defense stopped the advance billing at all activities
except for the Naval shipyards and research and development
activities.  Although these activities had been tentatively scheduled
to stop advance billing in January 1995, this did not occur. 

DOD officials informed us that when the responsibility for cash
management was returned to the DOD components in February 1995, the
amount of cash returned to the services was not sufficient to cover
outstanding DBOF liabilities.  DBOF's financial reports indicate that
this was the case, with each service facing cash shortages. 
Therefore, according to DOD, it was necessary for the military
services to continue to advance bill customers so that their cash
portion of DBOF would not go negative. 

Since 1995, the military services have made some progress in
liquidating (working off) their outstanding advance billing balances. 
However, the Navy and the Air Force had to advance bill customers
again during calendar year 1996 to ensure that their cash balances
remained positive.  Specifically, the Navy advance billed customers
about $1.7 billion and the Air Force advance billed customers $1.2
billion during calendar 1996.  Further, the Navy had advance billed
their customers $100 million in February 1997.  The following figures
show the reported (1) cash balances for the Army, the Navy, the Air
Force, OSD, and the defense agencies portion of the funds and the (2)
cash balances for these components if they did not advance bill their
customers from February 1995--when DOD returned the responsibility
for cash to these five DOD components--through January 1997. 

   Figure I.1:  Working Capital
   Fund Cash Balances (dollars in
   millions)

   (See figure in printed
   edition.)

Note to above figures:  We did not independently verify the financial
information shown in the figures, which was taken from DOD and
Treasury reports. 

As shown in figure I.1, the Army, the Navy, and the Air Force would
have had negative cash balances when they received the responsibility
for cash in February 1995 had they not advance billed customers.  The
figures also show that

  the three services have liquidated $3.6 billion of outstanding
     advance billings from February 1995 through January 1997;

  as of January 1997, the outstanding advance billing balance was
     $1.6 billion;

  the Army has liquidated almost all of its outstanding advance
     billing balance;

  the Navy's cash balance would have been negative for most of the
     time period from February 1995 through January 1997 if it had
     not advance billed customers; and

  the Air Force liquidated most of its outstanding advance billing
     balance until it needed to advance bill customers over a billion
     dollars in December 1996 to ensure that its cash balance would
     remain positive. 

According to Army and Air Force officials, they plan to liquidate all
their outstanding advance billing balances by the end of fiscal year
1998.  Navy officials informed us that they now plan to liquidate the
Navy's outstanding advance billing balance by the end of fiscal year
1999. 


      CASH OUTLOOK FOR FISCAL
      YEARS 1997 AND 1998
------------------------------------------------------- Appendix I:1.4

DOD's cash plans, dated January/February 1997, show that the working
capital funds will disburse about $2.3 billion more than they collect
during fiscal year 1997.  To offset most of the cash drain that DOD
expects to occur during fiscal year 1997, DOD plans to increase
fiscal year 1998 prices to recoup losses and generate cash.  DOD
plans also show that it expects to collect about $2.2 billion more
than it disburses during fiscal year 1998.  This information is
summarized as follows. 



                               Table I.2
                
                 DOD's Working Capital Fund Annual Cash
                   Plans Dated January/February 1997

                         (Dollars in millions)

                                Estimated fiscal      Estimated fiscal
                                       year 1997             year 1998
                                collections less      collections less
Component                          disbursements         disbursements
--------------------------  --------------------  --------------------
Army                                    ($173.4)                 $27.2
Navy                                   (1,427.7)                 984.5
Air Force                                (154.5)               493.4\a
Defense Agencies                         (511.0)                 669.4
======================================================================
Total                                 $(2,266.6)              $2,174.5
----------------------------------------------------------------------
\a Air Force fiscal year 1998 figure includes U.S.  Transportation
Command's net collections of $102.6 million. 

Based on our analysis of DOD's cash plan and past trends, we believe
that the Navy may have to advance bill customers during the remainder
of fiscal year 1997 in order to ensure that its cash balance remains
positive.  Based on our review of the cash and outstanding advance
billing balances for the period October 1996 through March 1997, it
is too close to tell if the Army and the Air Force will have to
advance bill their customers during the remainder of fiscal year
1997. 


   WORKING CAPITAL FUND OPERATIONS
--------------------------------------------------------- Appendix I:2

The four DOD working capital funds have added surcharges to their
fiscal year 1998 sales prices in order to recoup the $1.7 billion
accumulated operating loss that they expect to have at the end of
fiscal year 1997.  As a result of this accumulated operating loss,
the customers will need $1.7 billion in appropriated fiscal year 1998
funds so that they can reimburse the working capital funds for prior
year losses rather than buy goods and services. 

Our limited review of five business areas and the assumptions used to
develop their fiscal year 1998 prices (which could change as fiscal
year 1998 approaches) indicates that the price increases may not be
enough to eliminate the $1.7 billion accumulated operating loss. 
Based on the requirements in the National Defense Authorization Act
for Fiscal
Year 1997, we reviewed the fiscal year 1998 prices for Army depot
maintenance, Air Force depot maintenance, Navy shipyards, Navy
ordnance, and Navy research and development.  In performing our work,
we reviewed DOD's assumptions--which were finalized about 9 months
before the beginning of fiscal year 1998--on the fiscal year 1998
estimated revenue, costs, operating results, and workload (direct
labor hours) to determine if the prices are likely to (1) recover
fiscal year 1998 operating costs and (2) achieve a zero accumulated
operating result at the end of fiscal year 1998. 

Our analysis indicates that the fiscal year 1998 prices for four of
the five business areas reviewed are probably too low to recover
expected fiscal year 1998 operating costs and/or recoup prior year
losses by over $300 million.  The results of our work is summarized
below. 



                               Table I.2
                
                  Estimated Impact of Fiscal Year 1998
                   Pricing Assumptions on End-of-Year
                     Accumulated Operating Results

                        Estimated end-of-year accumulated operating
Business area           result
----------------------  ----------------------------------------------
Army depot maintenance  Greater than $100 million loss

Air Force depot         Greater than $100 million loss
maintenance

Navy shipyards          Between $25 million and $100 million loss

Navy ordnance           Between $25 million and $100 million loss

Navy research and       On target for zero accumulated operating
development\a           result
----------------------------------------------------------------------
\a Naval surface warfare center and Naval undersea warfare center
divisions only. 

Our previous reports\2 have identified some of the primary causes of
business area losses.  For example, several reports have identified
such long-standing and well-documented causes as (1) overly
optimistic productivity assumptions, (2) unrealistic cost-reduction
goals, and (3) lower-than-expected workloads.  As illustrated below,
we believe that the funds will incur losses in fiscal year 1998 for
the same reasons. 

  The Army depot maintenance business area is likely to end fiscal
     year 1998 with an accumulated operating loss of more than $100
     million.  The expected loss is due, in large part, to
     significant changes made to the depot-level budget, resulting in
     cost-reduction goals that we believe will not be fully realized. 
     Specifically, the Army's Industrial Operations Command proposed
     a composite fiscal year 1998 sales price of $107.03 per direct
     labor hour, which would have been a 19-percent increase over the
     fiscal year 1997 price.  However, this price was reduced by
     $10.18 per hour by the Army Materiel Command in an effort to
     hold down prices and reduce the cost of depot operations.  The
     fiscal year 1998 price reduction has created a situation where
     expected revenues for fiscal year 1998 will be significantly
     less than originally expected by the depots.  In order to offset
     this revenue reduction, the depots need to reduce operational
     costs by about $68 million in fiscal year 1998.  The Army was
     aware of the potential for significant losses and is attempting
     to identify areas where it can reduce its costs. 

  The Air Force depot maintenance business area is likely to have an
     accumulated operating loss of more than $100 million at the end
     of fiscal year 1998 primarily because disruptions related to
     on-going actions to close two Air Logistics Centers will
     probably prevent its workforce from achieving productivity goals
     that were incorporated into budget estimates for fiscal years
     1997 and 1998.  In fact, our review of other closure actions and
     the business area's actual productivity for the first 5 months
     of fiscal year 1997 indicates that the workforce's actual
     productivity is much more likely to decline significantly than
     to improve.  For example, when the Air Force Aerospace Guidance
     and Metrology Center was closed in September 1996, its
     workforce's productivity had declined about 26 percent during
     the preceding 2 years.  Similarly, the productivity of the Air
     Force depot maintenance business area's workforce for the first
     5 months of fiscal year 1997 is about 6.5 percent below budgeted
     levels for fiscal year 1996 and 8.5 percent below the budgeted
     levels for fiscal year 1997. 

  It is likely that the Naval shipyard business area will have an
     accumulated operating loss between $25 million and $100 million
     at the end of fiscal year 1998.  This is due, in part, to
     workload delays and cancellations--two problems that have
     adversely affected the shipyards' operations in the past\3 and
     are likely to affect their operations in fiscal years 1997 and
     1998.  For example, the Navy's February 1997 budget submission
     was based partly on the assumption that repairs and alterations
     for one ship would require about 491,000 direct labor hours. 
     However, in April 1997, about 4 months before work was scheduled
     to start, a major portion of this work was deferred.  As a
     result, the workload estimate for the ship has been reduced by
     about 71 percent to about 144,000 direct labor hours.  A Naval
     Sea Systems (NAVSEA) Command official stated that the shipyard
     cannot reduce its direct personnel and overhead costs in
     sufficient time to offset the lost revenue, which we estimate at
     about $20 million for direct labor, overhead, and surcharges. 

In another instance, our analysis of budget documents identified a
change in workload estimates for a ship scheduled to begin repairs in
May 1998.  Budget documents indicated that Navy customers planned to
spend about $16 million for ship repairs, while the shipyard planned
to receive about $36 million in revenue for working on the ship.  A
NAVSEA official stated that workload was reduced about 68 percent
from 400,000 DLHs to 128,000 DLHs, but the change was not reflected
in the workload estimates used to set fiscal year 1998 prices.  In
this case, the shipyard has 1 year to reduce its costs, renegotiate
the workload reduction, or find additional revenue sources. 
Otherwise, a significant reduction in workload can result in
significant losses. 

  It is likely that the Navy ordnance business area will have an
     accumulated operating loss between $25 million and $100 million
     at the end of fiscal year 1998.  As part of an initiative to
     restructure its ordnance business area and reduce costs, the
     Navy plans to drastically reduce the scope of operations at
     selected ordnance weapons stations.  Accordingly, when it
     developed the prices that the business area will charge
     customers in fiscal year 1998, the Navy reduced weapons
     stations' cost estimates for overhead contract costs (for such
     things as utility bills and real property maintenance) from $126
     million to $87 million, a reduction of $39 million, or 31
     percent.  However, the Navy has historically underbudgeted
     overhead contract costs for the weapons stations.  For example,
     the reported actual overhead contract costs exceeded budgeted
     costs for fiscal years 1994, 1995, and 1996 by $33 million, $81
     million, and $43 million, respectively.  Furthermore, the Navy
     has not yet developed a detailed plan to achieve the budgeted
     cost reductions.  Consequently, we believe it is very likely
     that the Navy ordnance weapons stations' actual overhead
     contract costs will exceed budgeted costs. 

Because the budget process used to develop business areas' stabilized
prices begins as long as 2 years before the prices go into effect,
some variance between budgeted and actual operating results is
inevitable.  However, in some business areas, sales prices have
yielded revenues that have been lower than actual costs for several
years in a row.  This indicates that there may be systemic problems
with either the operation of the business areas or the methodology
and assumptions used to estimate future costs and workloads.  Until
these problems are corrected, some business areas will continue to
incur losses from their day-to-day operations and will need to
increase future prices to recover these losses. 


--------------------
\2 Air Force Depot Maintenance:  Improved Pricing and Financial
Management Practices Needed (GAO/AFMD-93-5, Nov.  17, 1992);
Financial Management:  Navy Industrial Fund Has Not Recovered Costs
(GAO/AFMD-93-18, Mar.  23, 1993); Defense Business Operations Fund: 
Improved Pricing Practices and Financial Reports Are Needed to Set
Accurate Prices (GAO/AIMD-94-132, June 22, 1994); Financial
Management:  Army Industrial Funds Did Not Recover Costs
(GAO/AIMD-94-16, Nov.  26, 1993); and Navy Ordnance:  Analysis of
Business Area Price Increases and Financial Losses
(GAO/AIMD/NSIAD-97-74, Mar.  14, 1997). 

\3 Defense Business Operations Fund:  Improved Pricing Practices and
Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132,
June 22, 1994). 


KEY FACTORS IMPACTING THE
COST-EFFECTIVENESS OF THE DEFENSE
DEPOT MAINTENANCE PROGRAM
========================================================== Appendix II

DOD's depot maintenance program costs more than $13 billion annually
and involves an extensive public and private sector industrial base. 
Depot maintenance is one of the areas where DOD plans to achieve
savings that can be used to fund shortfalls in modernization
accounts.  However, DOD is not achieving expected cost reductions in
its depot maintenance program.  In some instances, depot maintenance
costs, in general, and unit repair costs, in particular, have
actually increased and are expected to go higher.  The waste and
inefficiency in DOD's logistics system, including its depot
maintenance program, is one of the key reasons we identified DOD's
infrastructure activities as 1 of 24 high-risk areas within the
federal government.\1

A number of factors are preventing DOD from achieving expected
savings in its depot maintenance costs.  First, excess capacity in
the industrial repair and overhaul capability of the public and
private sectors contributes significantly to inefficiencies and
higher costs in both sectors.  Second, DOD is not achieving expected
savings from outsourcing.  Third, inefficiencies in DOD's supply
system, along with other factors, increase the cost of material, yet,
because needed parts are often not available, cause disruptions in
depot maintenance operations.  Also, other factors, such as
inadequate information systems and readiness requirements, can
influence depot inefficiencies and increase costs.  To the military
services' credit, each has programs underway to improve the
effectiveness and efficiency of its depot maintenance activities. 


--------------------
\1 Defense Infrastructure (GAO/HR-97-7, Feb.  1997).  In 1990, GAO
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. 


   BACKGROUND
-------------------------------------------------------- Appendix II:1

Depot maintenance is a key part of the total DOD logistics system
that supports millions of equipment items, over 52,000 combat
vehicles,
351 ships, and over 17,000 aircraft.  Depot maintenance is a vast
undertaking that requires extensive shop facilities, specialized
equipment, and highly skilled technical and engineering personnel (1)
to perform major overhauls of weapon systems and equipment; (2) to
completely rebuild parts and end items; (3) to modify systems and
equipment by applying new or improved components; (4) to manufacture
parts unavailable from the private sector; and (5) to program the
software that is an integral part of today's complex weapon systems. 
This work is done in both military depots and the private sector. 
DOD facilities and equipment are valued at over $50 billion.  A large
but unknown amount of government-owned depot plant equipment is used
by private contractors--many of which are original equipment
manufacturers of weapons or major systems and components.  DOD spends
about $13 billion--5 percent of its $250 billion fiscal year 1997
budget--on depot maintenance activities.  Over $1 billion of this
amount is procurement funding rather than operation and maintenance
funding for contractor logistics support, interim contractor support,
and some software maintenance. 


      WORKLOAD AND PERSONNEL HAVE
      BEEN REDUCED SINCE THE COLD
      WAR ENDED
------------------------------------------------------ Appendix II:1.1

DOD's depot maintenance workload has declined significantly in recent
years, in large part because of the downsizing of the military force
structure and reductions in spending for new weapon systems and
equipment that followed the end of the Cold War.  Other factors that
have contributed to this decline, and which must be shared among all
potential sources of repair--both public and private--include efforts
by some services to do more repairs in field-level maintenance
activities and the increased reliability, maintainability, and
durability of some systems and equipment. 

The defense depot system employs about 76,000 DOD civilian personnel,
including laborers, highly trained technicians, engineers, and
top-level managers.  As shown in figure II.1, the number of depot
maintenance personnel has been reduced by about 71,000 personnel--a
48-percent reduction since 1990.  Over the same period, the organic
depot maintenance workload had a similar decline of about 43 percent,
while the total depot maintenance budget declined by a margin of only
12 percent. 

   Figure II.1:  Reductions in
   DOD's Depot Maintenance Budget,
   Depot Maintenance Personnel,
   and Direct Labor Hours

   (See figure in printed
   edition.)


      EXCESS CAPACITY EXISTS IN
      THE PUBLIC AND PRIVATE
      SECTORS
------------------------------------------------------ Appendix II:1.2

DOD has extensive excess capacity in the form of large numbers of
underutilized buildings and equipment.  While DOD has substantially
reduced depot maintenance requirements and the number of depot
maintenance personnel has been similarly reduced, DOD has not
completed complementary reductions in its depot maintenance
infrastructure--despite four rounds of base closures.  Also, private
sector production workload for new systems and equipment has
generated significant excess production capacity--which the private
sector estimates to be about 57 percent for military work and 56
percent for commercial work. 

We identified excess capacity by determining maintenance facilities'
potential for doing more work than they are programmed to accomplish. 
This approach, which assumes that additional trained personnel would
be available to accomplish the added workloads, is the same approach
that was used during the Base Realignment and Closure (BRAC) process
to identify opportunities to consolidate similar workloads and to
thereby, improve capacity utilization and reduce redundancies. 
However, DOD normally uses an approach that constrains facilities'
capacity based on (1) the availability of trained personnel and the
organization of work stations and (2) operation on one 8-hour shift
each day, for a 5-day workweek.  The private sector usually considers
a maximum potential capacity utilization between 75 and 85 percent to
be an efficient operating level.  Using maximum potential capacity
estimates, DOD is predicted to have excess capacity in fiscal year
1999 of about 50 percent.  Figure II.2 shows excess capacity using
both the maximum potential capacity and DOD's available capacity
approach. 

   Figure II.2:  Comparison of
   Depot Capacity and Workload

   (See figure in printed
   edition.)

Table II.1 provides projections of each military depot's workload and
excess capacity for fiscal year 1999 using maximum potential capacity
and available capacity for 1999. 



                                    Table II.1
                     
                       Capacity and Workload Forecasts for
                       Defense Depots for Fiscal Year 1999

                       ((Direct labor hours in thousands))

           Maximum                              Availabl  Percentage  Percentage
Maintena  potentia  Availabl           Maximum         e   excess of   excess of
nce              l         e  Worklo  capacity  capacity     maximum   available
depot     capacity  capacity      ad    excess    excess    capacity    capacity
--------  --------  --------  ------  --------  --------  ----------  ----------
Naval
 aviation
Cherry       5,735     3,797   3,620     2,115       177          37           5
 Point
Jacksonv     7,158     5,572   5,355     1,803       217          25           4
 ille
North        7,772     4,318   4,027     3,745       291          48           7
 Island
================================================================================
Subtotal   0,665 1   3,687 1   3,002    ,663 6      85 3         7 5
 2                                 7
Naval
 shipyard
Norfolk     15,851    12,000   8,723     7,128     3,277          45          27
Pearl        8,032     5,320   3,739     4,293     1,581          53          30
 Harbor
Portsmou     7,996     7,028   3,209     4,787     3,819          60          54
 th
Puget       14,919    14,000  11,717     3,202     2,283          21          16
 Sound
================================================================================
Subtotal    46,798    38,348  27,388    19,410    10,960          41          29
Other
 Navy
Albany       1,883     1,215   1,089       794       126          42          10
Barstow      1,563     1,037     928       635       109          41          11
Crane        2,451       974     583     1,868       391          76          40
Keyport      1,141       672     555       586       117          51          17
 NUWC
================================================================================
Subtotal     7,038     3,898   3,155     3,883       743          55          19
Air
 Force
Oklahoma    12,863     7,881   7,624     5,239       257          41           3
 City
Ogden        9,005     8,371   4,596     4,409     3,775          49          45
San         15,220     1,575   1,606    13,614      (31)          89          -2
 Antonio
Sacramen    10,291     1,724     989     9,302       735          90          43
 to
Warner       9,913     7,605   5,508     4,405     2,097          44          28
 Robins
================================================================================
Subtotal   7,291 2   7,156 2   0,323   6,968 6    ,833 6         5 2           5
 5                                 3
Army
Anniston     4,512     3,192   2,614     1,898       578          42          18
Corpus       4,714     4,009   3,338     1,376       671          29          17
 Christi
Letterke     3,707       213     164     3,543        49          96          23
 nny
Red          4,684     1,534     898     3,786       636          81          41
 River
Tobyhann     7,606     5,091   2,736     4,870     2,355          64          46
 a
================================================================================
Subtotal   5,223 1   4,040 9  ,750 1   5,473 4    ,290 6         1 3           1
 2
================================================================================
Total      157,016    97,129  73,618    83,398    23,511          53          24
--------------------------------------------------------------------------------

   WORKLOAD CONSOLIDATION PROVIDES
   SIGNIFICANT OPPORTUNITIES TO
   REDUCE COSTLY EXCESS CAPACITY
-------------------------------------------------------- Appendix II:2

There are essentially two options for reducing a maintenance depot's
excess capacity:  downsizing-in-place or increasing the volume of
workload.  Downsizing-in-place by mothballing or tearing down
buildings and disposing of equipment may reduce the cost of
maintaining some facilities and equipment, but it does not eliminate
the costly infrastructure that supports the operations of a military
installation.  Also, it does not promote the efficiencies that can be
achieved through consolidation.  During the BRAC process, it was
generally the case that the most cost-effective way to reduce
maintenance costs was to close some depots and to consolidate their
workloads at the remaining depots or in existing private sector
capacity.  This approach allowed the remaining facilities to achieve
production efficiencies and to spread their fixed overhead over an
increased volume of work. 

The defense depot system currently has about 40-percent excess
capacity.  With the exception of the Navy's privatization-in-place
efforts, our work shows that the Navy has been the most successful at
addressing the issue of closing excess industrial capacity and
consolidating it to achieve economies of operation.  On the other
hand, the Army and the Air Force have not succeeded in making
significant reductions in their excess capacity.  Both services are
incurring rising prices because they have too much depot
infrastructure for the available workload.  Further, DOD's
privatization of selected depots has contributed to the excess
capacity problem and ultimately will continue to drive up maintenance
costs.  Additionally, the Air Force plans to compete workloads at two
closing depots may be more costly than redistributing the workload to
other depots.  Such cost increases mean that military service
customers can buy less depot maintenance with available operation and
maintenance dollars. 


      NAVY IS SAVING BY
      EXPEDITIOUSLY CLOSING
      AVIATION DEPOTS AND
      SHIPYARDS, BUT IS MISSING
      SAVINGS OPPORTUNITIES BY
      PRIVATIZING WORKLOAD
------------------------------------------------------ Appendix II:2.1

The Navy has closed three of its six aviation depots and has
consolidated most of their workloads at the three remaining depots to
improve capacity utilization and reduce excess capacity.  These
actions, while costly and difficult, will significantly increase
utilization and reduce excess capacity in the remaining three naval
aviation depots.  Specifically, following the 1993 BRAC Commission's
approval of a recommendation to close aviation depots at Pensacola,
Florida, Alameda, California, and Norfolk, Virginia, the Navy
completed the closures in about 3 years versus the 6-year period
allowed under the BRAC legislation.  The Navy estimates that these
closures and workload redistribution actions, along with
interservicing actions and outsourcing some noncore workloads, will
reduce its projected operating rate by about $10 per hour.  Based on
a forecast of 13 million direct labor hours for fiscal year 1999,
this forecast is expected to produce a savings of about $130 million. 

Our work shows that based on a maximum potential capacity and fiscal
year 1999 workload forecasts, the three remaining naval aviation
depots will have an average excess capacity of 37 percent,
substantially lower than the other services.  Further, because the
Navy reallocated most of the closing depots' workloads and
specialties to its remaining aviation depots, and reengineered work
spaces in the process, Navy officials state that given the
availability of depot maintenance personnel, capacity utilization
will be about 95 percent.  This represents an increase of 36 percent
after the workload transition is completed. 

The Navy has closed four of its eight naval shipyards, significantly
reducing excess capacity in the public sector.  However, excess
capacity remains, particularly in nuclear capability.  The amount of
that excess capacity depends on how much depot level ship repair work
the Navy assigns public shipyards. 


         THE NAVY'S
         PRIVATIZATION-IN-PLACE OF
         THE LOUISVILLE DEPOT WAS
         LESS COST-EFFECTIVE THAN
         REDISTRIBUTING THE
         WORKLOAD
---------------------------------------------------- Appendix II:2.1.1

The Navy's privatization of its Louisville depot was not the most
cost-effective choice--it could have saved more through consolidation
of workloads and improved use of capacity in remaining industrial
activities.\2 The Louisville, Kentucky, Detachment of the Naval
Surface Warfare Center, Crane Division, a depot recommended for
closure by the 1995 BRAC Commission, supported the overhaul and
remanufacture for naval surface ship gun and missile systems.  In
analyzing the cost of privatizing the Louisville workload in-place
versus transferring it to another depot, the Navy estimated that the
contract alternative would cost more on an annual recurring basis and
the one-time cost of transferring the workload to another depot would
be prohibitive.  However, we found the Navy's analyses understated
the annual savings of transferring the workloads to other underused
facilities and overstated the one-time transfer costs. 

Our analysis shows a one-time cost of $243 million and an annual
savings of $59 million by transferring the workload.  The annual
savings would offset the one-time cost in about 4 years.  The Navy's
annual savings estimate recognized that transferring the workloads to
underused facilities would reduce the overhead cost for those
production units being considered for transfer.  However, the
per-unit savings were applied only to the workloads transferred and
not to existing workloads at receiving locations.  So, while
privatizing the workload in place avoided short-term cost for
transitioning the workload, it is likely to be more costly for the
Navy over the long run. 


--------------------
\2 Navy Depot Maintenance:  Cost and Savings Issues Related to
Privatizing-in-Place at the Louisville, Kentucky, Depot
(GAO/NSIAD-96-202, Sept.  18, 1996). 


         OPERATING WITH COSTLY
         EXCESS CAPACITY IS
         RESULTING IN INCREASED
         PRICES FOR ARMY DEPOTS
---------------------------------------------------- Appendix II:2.1.2

Based on the actions taken thus far, the Army has not effectively
downsized its depot maintenance infrastructure to significantly
reduce costly excess capacity.\3 We reported in September 1996\4 that
tentative plans for implementing the 1995 BRAC decisions by
allocating some workloads from realigned depots to remaining depots
will likely achieve some reduction in excess capacity and savings at
two remaining depots.  However, the Army's failure to follow through
with the closure of the Letterkenny Depot--by consolidating of repair
workloads at other Army depots, and retaining the Red River Depot as
directed by the BRAC Commission--is expected to increase costly
excess capacity in the Army depots, from 42 to 46 percent over the
next 3 years. 

This increase is caused by several factors including:  (1) a
forecasted decrease in future year depot-level workload; (2) the
Army's preliminary plan to retain most depot operations for missiles
at Letterkenny, while privatizing or transferring to Tobyhanna Army
Depot only about
14 percent of the workload; and (3) the delay in the transfer of the
ground communications-electronics workload from the Sacramento depot
to the Tobyhanna depot.  In our September 1996 report, we recommended
that DOD reassess this delay, which is costing the Army about $24
million annually.  Subsequently, on March 13, 1997, the Defense Depot
Maintenance Council approved the Air Force's proposal for a 3-year
workload transfer beginning in 1998 with the transfer of 20 percent
of the workload in the first year, and 40 percent each in the second
and third years with full-operational capability at the Tobyhanna
Depot in 2001. 


--------------------
\3 Although the Army closed the Lexington-Blue Grass, Sacramento, and
Tooele Army depots, excess capacity was still 42 percent in 1995. 

\4 Army Depot Maintenance:  Privatization Without Further Downsizing
Increases Costly Excess Capacity (GAO/NSIAD-96-201, Sept.  18, 1996). 


      DELAY IN IMPLEMENTING DEPOT
      CLOSURE IS INCREASING AIR
      FORCE DEPOT MAINTENANCE
      COSTS
------------------------------------------------------ Appendix II:2.2

The Air Force has the most serious excess capacity problem.  Delays
in closing two depots identified for closure during the 1995 BRAC
extends the period that the Air Force will operate five depots. 
During this period, each depot will operate with declining workloads,
excess facilities, and personnel.  This situation will increase the
cost of Air Force depot maintenance operations and result in
projected losses of about $90 million in its depot operations during
fiscal year 1997.  Three of the six Air Force depots that existed in
1992 were recommended for closure during the 1993 and 1995 BRAC
processes.  The Air Force has opted to privatize-in-place one of
these depots and is in the process of using public-private
competitions to decide where the workloads from the other two closing
depots will be performed. 


   BRAC DECISIONS AND HOW DOD IS
   APPROACHING IMPLEMENTATION
-------------------------------------------------------- Appendix II:3

Despite major force structure reductions and significant excess
capacity in the Air Force depot maintenance system, none of the Air
Force's five large, multicommodity logistics centers or their
maintenance depots were recommended by DOD for closure during the
first four BRAC rounds.  These five depots have about 57 million
direct labor hours of capacity to accomplish about 32 million direct
labor hours of work, leaving about 26 million hours of excess
capacity--or about 45 percent.  Also, the Air Force maintenance
depots' workloads are projected to decline to about 20 million direct
labor hours of work in 1999.  At this workload level, the Air Force
depots would have about 65 percent unused capacity.  Although the
commission identified depots at the Sacramento and San Antonio
centers for closure during the 1995 BRAC process, the executive
branch, citing readiness, up-front costs, and potential effects on
the local community, indicated that these workloads should be
privatized-in-place or in the local communities.  Subsequently, DOD
announced that it will use public-private competitions as a means for
determining who will perform the workload from the closing depots. 

In December 1996, we reported that if the remaining depots do not
receive additional workloads, they are likely to continue to operate
with significant excess capacity and to become more inefficient and
expensive as workloads continue to dwindle due to downsizing and
outsourcing initiatives.\5 Our analysis indicates that redistributing
8.2 million direct labor hours of work from the two closing Air Force
depots to the three remaining depots would (1) reduce the projected
excess capacity in 1999 from about 65 percent to about 27 percent,
(2) lower the hourly rates by an average of $6 at receiving locations
by spreading fixed-cost over a larger workload, and (3) save as much
as $182 million annually as a result of economies of scale and other
efficiencies.  This estimate was based on a workload redistribution
plan that would relocate only 78 percent of the available hours to
Air Force depots.  About one-half of the remaining 22 percent was
captured in savings the Army projected would be achieved through
consolidating ground communications and electronics workload at
Tobyhanna Army depot.  Table II.2 shows an overview of the projected
savings achievable through consolidation and increased use of
capacity in the remaining three Air Force depots. 



                               Table II.2
                
                 Potential Savings From Air Force Depot
                             Consolidation

                                        Direct      Labor/
                                         labor    overhead
Depot location                           hours       rates        Cost
----------------------------------  ----------  ----------  ----------
Before consolidation
----------------------------------------------------------------------
Oklahoma City                        7,122,421      $59.11  $421,006,3
                                                                    05
Ogden                                4,939,623      $65.47  323,397,11
                                                                     8
Warner Robins                        6,763,218      $59.55  402,749,63
                                                                     2
Sacramento                           3,222,409      $63.81  205,621,91
                                                                     8
San Antonio                          5,000,190      $58.24  291,211,06
                                                                     6
======================================================================
Total cost                                                  $1,643,986
                                                                  ,039

After consolidation
----------------------------------------------------------------------
Oklahoma City                       12,214,902      $50.22  $613,432,3
                                                                    78
Ogden                                6,626,348      $59.68  395,460,44
                                                                     9
Warner Robins                        8,206,611      $55.17  452,758,72
                                                                     9
======================================================================
Total cost                                                  $1,461,651
                                                                  ,556
======================================================================
Total potential savings                                     $182,334,4
                                                                    83
----------------------------------------------------------------------
According to management officials at the three remaining centers, it
would cost about $475 million to absorb all of the Sacramento and San
Antonio workloads.  Using our estimate of $182 million in projected
annual consolidation savings, net savings could occur within 2.6
years of the consolidation.\6 The Air Force believes that the
competition process will demonstrate if outsourcing or workload
redistribution is the best value. 


--------------------
\5 Air Force Depot Maintenance:  Privatization-in-Place Plans Are
Costly While Excess Capacity Exists (GAO/NSIAD-97-13, Dec.  31,
1996). 

\6 In addition, the Army estimates that the BRAC Commission mandated
transfer of about 1.2 million hours of ground communications workload
from the Sacramento depot to the Tobyhanna Army Depot will save an
additional $24 million annually. 


   MATERIAL COST INCREASES ARE
   GENERATING LOSSES FOR THE DEPOT
   MAINTENANCE ACTIVITY GROUP
-------------------------------------------------------- Appendix II:4

While material costs vary for different commodities and depot
maintenance actions, the cost of reparable and consumable parts is a
significant portion of the cost of depot maintenance activities and
of the composite rates charged depot maintenance customers.  For this
reason, inefficiencies in the DOD supply system and inaccurate
information about the quantity and price of spare and repair parts
required in the repair processes may lead to increased costs and
losses in the depot maintenance capital fund.  For example, about 40
percent of Air Force depot maintenance costs are material costs. 
During fiscal year 1997, Air Force depots are experiencing a
9-percent loss due to increased cost of material.  The total effect
of awaiting parts on the depot repair cycle process is not known
because its measurement is said to be incomplete and inconsistent. 
However, one study reported that partial data indicates that it is a
pervasive and serious problem--in one case, as much as 12 percent of
an annual negotiated program was not completed because parts were not
available.\7


--------------------
\7 The Depot Repair Cycle Process:  Opportunities for Business
Practice Improvement, LG406MR1, May 1996, The Logistics Management
Institute. 


      INVENTORY MANAGEMENT
      INEFFICIENCIES TO CONTRIBUTE
      TO HIGH-MAINTENANCE COSTS
------------------------------------------------------ Appendix II:4.1

Since 1992, we have reported that DOD had wasted billions of dollars
on excess supplies, including spare and repair parts used in the
depot maintenance repair process.  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, DOD
would have had lower inventory levels and would have avoided the
burden and expense of storing excess inventory.  In a 1995 report, we
stated that managing DOD's inventory presented challenges that
partially stemmed from the downsizing of the military forces.\8 We
reported that DOD needed to move aggressively to identify and
implement viable commercial practices and provide managers with
modern, automated accounting and management systems to better control
and monitor its inventories. 

More recently, we reported that while DOD has clearly had some
success in addressing its inventory management problems, much remains
to be done.\9 DOD has made little progress in developing the
management tools needed to help solve its long-term inventory
management problems.  It has not achieved the economies and
efficiencies hoped for from the Defense Business Operations Fund and
the Corporate Information Management initiatives.  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 $69
billion spare and repair parts inventory efficiently and effectively,
including determination of budget requirements.  Large amounts of
unneeded inventory, inadequate inventory oversight, overstated
requirements, and slowness to implement modern commercial practices
are evidence of the lack of progress.  For example: 

  In our 1995 report, we stated 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. 
     Although the asset visibility plans were to be completely
     implemented by 1996, DOD currently does not project to complete
     the total asset visibility initiative until 2001.  Further, the
     lack of adequate visibility over operating materials and
     supplies substantially increases the risk that millions of
     dollars will be spent unnecessarily. 

  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 this continues to be the case.  For example, we
     reported that DOD had made limited progress in reducing
     acquisition lead times and that DOD could reduce its lead time
     by 25 percent over a 4-year period and save about $1 billion.\10

  We have found that despite DOD's huge investment in spare and
     repair parts, depots often do not have the spare and repair
     parts to perform required maintenance.  For example, we recently
     reported that inadequate consumable parts that are used in large
     quantities to repair aircraft components were the primary cause
     for repair delays at the Corpus Christi Army depot.\11 Also, we
     found that not having required parts has delayed the
     installation of the night vision modification for the F-16
     aircraft because required parts had not been procured--resulting
     in a production loss of 31,000 hours.  According to Air Force
     officials, if this work had been contracted out, the contractor
     would file a claim to be reimbursed for lost production time
     where nonavailability of parts impacted contractor performance. 
     As a result of this and other production changes, Ogden
     officials stated the depot is currently 126,000 hours below
     planned 1997 production levels, causing a net loss of about $5
     million. 


--------------------
\8 High-Risk Series:  Defense Inventory Management (GAO/HR-95-5, Feb. 
1995). 

\9 High-Risk Series:  Defense Inventory Management (GAO/HR-97-5, Feb. 
1997). 

\10 Defense Supply:  Acquisition Leadtime Requirements Can Be
Significantly Reduced (GAO/NSIAD-95-2, Dec.  1994). 

\11 Inventory Management:  The Army Could Reduce Logistics Costs for
Aviation Parts by Adopting Best Practices (GAO/NSIAD-97-82, Apr.  15,
1997). 


      INADEQUATE CONTROL OF
      GOVERNMENT-FURNISHED STOCKS
      CAN CONTRIBUTE TO LOSSES IN
      CONTRACT DEPOT MAINTENANCE
------------------------------------------------------ Appendix II:4.2

Long-standing problems in managing government-furnished property,
government-furnished equipment, and government-furnished material are
adding millions of dollars to DOD's depot level maintenance
contracting costs and resulting in losses in the Air Force's contract
maintenance portion of the working capital fund. 

DOD buying commands can choose to provide contractors property,
equipment, and materials for use in repairing items.  Contractors are
to report annually to the services the amount of property and
equipment they have on hand that was furnished by the commands, and
the commands are to reconcile these reports with their records. 
Material for use in the repair of items is to be furnished timely and
monitored for proper use.  Failure to provide government-furnished
material in a timely manner can result in a claim for compensation
from the contractor.  Further, since the Air Force, unlike the other
military services, includes contract depot maintenance in its working
capital fund, increased costs over what is budgeted will lead to
losses in the working capital fund. 


         MANAGEMENT AND
         ACCOUNTABILITY HAS NOT
         ALWAYS BEEN EFFECTIVE
---------------------------------------------------- Appendix II:4.2.1

DOD's problems in managing and accounting for government-furnished
stocks have been long-standing.  For example, in 1993, the Secretary
of the Army requested the Army Audit Agency to examine controls over
government-furnished property because we identified this as a
weakness during our audit of the Army's fiscal year 1991 financial
statements.  The Army Audit Agency found many problems Army-wide,
including the inability to determine the accuracy of contractors'
reports.  For instance, at the Missile Command, contractors reported
having about $1.3 billion in government-furnished property for which
the command's annual summary report of property in the custody of
contractors did not identify.  In April 1996, the Air Force Audit
Agency found similar problems at Warner Robins Air Logistics Center
with government-furnished property financial statement balances that
could have been misstated by up to $2.3 billion.  The following are
three cases we found where inadequate control over
government-furnished material resulted in increased depot maintenance
costs: 

  The Warner Robins Air Logistics Center experienced a $113-million
     cost overrun on F-15 maintenance work.  Since the early 1980s,
     the Center has contracted with Korean Airlines and Israel Air
     Industries for maintenance of F-15's overseas.  In 1989, the
     Center began experiencing cost overruns, which it determined
     were directly related to government-furnished material.  Our
     review shows that the F-15 program managers had sufficient
     information about the government-furnished material issue from
     reports that were periodically generated from the Center's
     automated systems.  However, no actions were taken to resolve
     the government-furnished material problem until the contract was
     being administratively closed out in 1996.  The Center maintains
     that some of the problems have been corrected but that others
     have not.  We observed the government-furnished material status
     on the current F-15 contract and found that a similar pattern of
     cost overrun is occurring. 

  In another case, the Air Force paid $24.9 million to settle claims
     related, in part, to its failure to provide the contractor,
     PEMCO, timely government-furnished material.  PEMCO had filed
     claims for compensation between November 1994 and June 1996 for
     alleged problems related to programmed depot maintenance for the
     KC-135 aircraft and had planned to file additional claims.  In
     September 1996, the Air Force and PEMCO reached a "global
     settlement" of $24.9 million where the Air Force conceded fault
     in several areas, including the failure to provide material on
     time. 

  According to program office officials, increased costs resulting
     from the contractor's use of government-furnished material is
     one of several factors leading to losses resulting from the
     privatization of the Aerospace Guidance and Metrology Center
     (AGMC) in Newark, Ohio. 


   OVERLY OPTIMISTIC ASSUMPTIONS
   OF COST SAVINGS FROM
   OUTSOURCING COULD LEAD TO
   FURTHER PRICE INCREASES
-------------------------------------------------------- Appendix II:5

Unanticipated losses in outsourced workloads are another factor
influencing cost growth in the depot maintenance program and losses
in the working capital fund.  Reported projections of 20- to
40-percent savings from outsourcing depot maintenance and other
logistics operations have influenced DOD assumptions that outsourcing
will lead to significant savings.  Because assumptions about
outsourcing savings were overly optimistic, expected savings are not
being achieved. 


      AGMC OUTSOURCING ILLUSTRATES
      HOW OVERLY OPTIMISTIC SAVING
      ASSUMPTIONS LEAD TO LOSSES
------------------------------------------------------ Appendix II:5.1

The Air Force reported to the Congress that the privatization of the
AGMC would result in savings, and it did not budget for increased
costs for post-privatization operations.  Customers of the privatized
facility--the Boeing Guidance Repair Center--are not paying enough to
recoup the costs of ongoing repair work and the Air Force Working
Capital Fund is therefore expected to incur losses during fiscal year
1997.  The Air Force has recognized that costs will be higher during
fiscal year 1998 and is increasing its prices by $19 million. 
Nonetheless, a just released Air Force Materiel Command study, which
was undertaken at our request, states that privatized repair
operations for missile and aircraft inertial navigation systems could
range between about $9 million and $32 million--a 12- to 47-percent
increase--with a most likely increase of $17.1 million. 


      ASSUMPTIONS REGARDING
      OUTSOURCING SAVINGS ARE
      BASED ON COMPETITION, BUT
      MANY CURRENT DEPOT
      MAINTENANCE CONTRACTS ARE
      SOLE SOURCE
------------------------------------------------------ Appendix II:5.2

Facing large shortfalls in its modernization accounts, DOD plans to
reduce costs and generate savings for modernization through the
outsourcing of support activities, including depot maintenance. 
DOD's projected savings level is based largely on estimates made
through studies by the Commission on Roles and Missions (CORM) and
Defense Science Board that outsourcing depot maintenance and other
activities will save 20 to 40 percent.  Our review shows that savings
of this magnitude are questionable for several reasons.  For example
(1) projections were based on the Office of Management and Budget
Circular A-76 competitions between the public and private sector,
with the public sector winning about half of the competitions; (2)
the activities being competed were simple, commercial activities like
mowing grass, maintaining buildings, and operating motor pools where
requirements could readily be identified and for which there were
many private sector offerors who could compete for the work; and (3)
savings estimates were estimated, not actual, and where audited,
savings estimates were not achieved.  While we believe savings may be
achieved from outsourcing some depot maintenance workloads, our
analysis indicates that little or no savings would result from
outsourcing depot maintenance in the absence of competition. 

However, our April 1996 testimony and July 1996 CORM report noted
that much of the depot work contracted to the private sector was
awarded sole source and that obtaining competition for remaining
noncore workloads may be difficult and costly.\12 For example, to
test for the extent of competition, we sampled 240 contracts,
totaling $4.3 billion, that 12 DOD buying commands had open during
1995.  Of these 240 contracts, 182, about 76 percent, were awarded on
a sole-source basis--about 45 percent of the total dollar value. 

Recently, we asked the DOD buying commands to classify as competitive
or sole source all the new contracts awarded from the beginning of
fiscal year 1996 to date.  As shown in table II.3, of the 15,346
contracts totaling $2.2 billion, 13,930--about 91 percent--were
awarded sole source.  The sole-source contracts totaled about $1.5
billion, or about 68 percent of the total dollars awarded. 



                               Table II.3
                
                DOD Depot Maintenance Contracts Awarded
                         From Year 1996 to Date

                         (Dollars in millions)


Command                 Number   Value  Number   Value  Number   Value
----------------------  ------  ------  ------  ------  ------  ------
Army                         2      $1      40    $540      42    $541
Air Force                1,263     443   1,268     336   2,531     779
Navy                       151     253  12,622     638  12,773     891
======================================================================
Total                    1,416    $697  13,930  $1,514  15,346  $2,211
----------------------------------------------------------------------
Table II.4 compares the services' use of competition for contracts we
sampled in 1995 with that used in contracts awarded since the
beginning of fiscal year 1996.  The Air Force had the greatest
percent of competitive contracts in 1995 and 1996.  The Army's use of
competition decreased, and the Navy's use was low for both periods. 



                               Table II.4
                
                   DOD's Use of Competition for Depot
                            Maintenance Work

                          (Numbers in percent)


                                 Total     Total       Total     Total
Service                         number     value      number     value
--------------------------  ----------  --------  ----------  --------
Army                                23        53           5        .2
Air Force                           39        62          50        57
Navy                                 8        39           1        28
----------------------------------------------------------------------

--------------------
\12 Defense Depot Maintenance:  Privatization and the Debate Over the
Public-Private Mix (GAO/T-NSIAD-96-148, Apr.  17, 1996) and Defense
Depot Maintenance:  Commission on Roles and Mission's Privatization
Assumptions Are Questionable (GAO/NSIAD-96-161, July 15, 1996). 


      COMPETITION CITED AS REASON
      FOR SOLE-SOURCE AWARDS
------------------------------------------------------ Appendix II:5.3

Our review also showed that, for existing weapon systems, obtaining a
competitive market may be costly for DOD because it has not acquired
the technical data rights for many of its weapon systems.  In
examining the reasons for sole-source contracting, we observed that
the justification most often cited was that competition was not
possible because DOD did not own the technical data rights for the
items to be repaired.  Officials from the DOD buying commands told us
that DOD would have to make costly investments to promote full and
open competition for many of its weapon systems.  Also, we found that
savings through competition may be adversely affected by private
businesses that choose not to compete for maintenance workloads that
have (1) small volumes, (2) obsolete technology, (3) irregular
requirements, and (4) unstable funding.  DOD may be able to encourage
more competition through bundling common work and offering contracts
with terms and conditions such as multiple options and multiyear
performance periods. 


   OTHER FACTORS EFFECTING DEPOT
   INEFFICIENCIES AND COSTS
-------------------------------------------------------- Appendix II:6

In addition to the factors we have already discussed, there are a
number of others that impact the efficiency and cost of depot
maintenance operations.  In particular, our work shows that:  (1)
lengthy depot repair cycles are costly, (2) DOD has been unsuccessful
in implementing effective information systems to adequately support
its depot maintenance, and (3) defense depots must support
inefficient workloads and changing budgets and requirements of their
customers.  It is important to note that each of the services has
initiated programs to improve their depot maintenance operations. 
However, while these programs are concentrating on key problems, it
is too soon to assess effectiveness of these initiatives. 


      REDUCING REPAIR CYCLE DAYS
      CAN REDUCE COSTS
------------------------------------------------------ Appendix II:6.1

Reducing the length of the depot repair cycle process is of vital
importance in reducing costs.  Reducing repair cycle time reduces the
number of items that must be purchased to support weapon systems and
equipment.  One study estimated that for depot level reparables, the
dollar-weighted organic/contractor depot repair cycle time is 86.8
days, with a resultant repair cycle level investment requirement of
$4.4 billion.  That requirement would be decreased an average of $51
million for each day the repair cycle time is reduced.\13

In our April 1997 report, we stated that the Army's efforts to
improve its logistics pipeline for aviation parts and reduce
logistics costs could be enhanced by incorporating best practices we
have identified in the private sector.  The Army's current repair
pipeline, characterized by a $2.6-billion investment in aviation
parts, is slow and inefficient.  For example, in one case we
examined, it took the Army four times longer than a commercial
airline to ship a broken part to the depot and complete repairs. 
Also, for
24 different types of items examined, we calculated it took the Army
an average of 525 days to repair and ship the parts to field units. 
The Army estimates only 18 days (3 percent) should have been needed
to repair the items.  The remaining 507 days (97 percent) were used
to transport or store the parts or were the result of unplanned
repair delays.  Because of this lengthy pipeline time, the Army buys,
stores, and repairs more parts than would be necessary with a more
efficient system.  We reported that implementing industry best
practices can be used to achieve significant improvements and cost
reduction.  These practices are the prompt repair of items, the
reorganization of the repair process, the establishments of
partnerships with key suppliers, and the use of third-party logistics
services.  Our work in the Navy and the Air Force depot activities
found similar opportunities for improvement exist.\14


--------------------
\13 The Depot Repair Cycle Process:  Opportunities for Business
Practice Improvement, LG406MR1, May 1996, Logistics Management
Institute. 

\14 Inventory Management:  Adopting Best Practices Could Enhance Navy
Efforts to Achieve Efficiencies and Savings (GAO/NSIAD-96-156, July
12, 1996) and Best Management Practices:  Reengineering the Air
Force's Logistics System Can Yield Substantial Savings
(GAO/NSIAD-96-5, Feb.  21, 1996). 


      TIMELY AND ACCURATE
      INFORMATION SYSTEMS ARE
      ESSENTIAL TO IMPROVE DEPOT
      OPERATIONS AND COSTS
------------------------------------------------------ Appendix II:6.2

Current information systems used to manage the depot repair process
do not provide timely and accurate information essential for
improving depot operations and reducing costs.  In 1989, DOD
established the Corporate Information Management Initiative to
dramatically improve the way DOD conducts business, primarily by
adopting best business practices used in the public and private
sectors and building the automated information systems to support
those improved practices.  In November 1992, DOD adopted a plan for
identifying the best operational logistics information systems and
deploying them among all the services and defense agencies.  This
strategy failed to produce the dramatic gains in efficiency and
effectiveness that DOD anticipated. 

Our review of depot maintenance systems envisioned under this plan
found that even if the migration effort was successfully implemented
as envisioned, the planned depot maintenance standard system would
not dramatically improve depot maintenance operations in DOD.\15 DOD
planned to invest more than $1 billion to develop a depot maintenance
standard system that would achieve less than 2.3 percent in reduced
operational costs over a 10-year period.  Such incremental
improvement is significantly less than the order-of-magnitude
improvements DOD has said could be achieved through reengineering
business processes--efforts that were being postponed until after the
development of the standard systems. 

DOD subsequently terminated the Depot Maintenance Information System
and the depots had to write off their investment in this effort.  Air
Force depots wrote off about $34 million of their investment in this
program in 1996, adding to their depot activity group losses that
year. 


--------------------
\15 Defense IRM:  Strategy Needed for Logistics Information
Technology Improvement Efforts (GAO/AIMD-97-6, Nov.  14, 1996). 


      ORGANIC DEPOTS' MISSION IS
      TO SUPPORT MILITARY
      CUSTOMERS' PROGRAMS, WHICH
      CONTAIN SOME INHERENT
      INEFFICIENCIES
------------------------------------------------------ Appendix II:6.3

While the organic depots can and must implement improvements to
reduce the cost of their depot maintenance operations, they have some
mission requirements that are inherently inefficient.  However,
performing these missions is necessary to meet the readiness and
support needs of their customers.  For example: 

  Many of the depot level reparable components that organic depots
     must be prepared to repair have uncertain and infrequent repair
     requirements.  For example, a contingency response or special
     training exercises may require expedited and/or increased repair
     needs to support key weapon systems and equipment.  Likewise,
     depots are required to maintain repair capabilities to support
     end items and components that may be obsolete, are maintained in
     low quantities and/or have infrequent, sporadic requirements. 
     Neither of these situations are conducive to supporting low-cost
     operations, but are necessary to meet the readiness needs of the
     customer. 

  Changing operational requirements and changing budget requirements
     frequently result in changes to the production schedules. 
     Production changes would result in losses when the volume of
     work declines or the mix of resulting work generates less
     revenue than planned.  As previously discussed, budgets are
     developed 2 years in advance.  Depot officials stated that
     changes in the production schedule that impact projected versus
     actual revenues are significant. 


      ALL SERVICES HAVE
      INITIATIVES TO IMPROVE DEPOT
      OPERATIONS
------------------------------------------------------ Appendix II:6.4

Each of the military services have individual programs designed to
address some depot maintenance inefficiencies.  We have recommended
such actions and are encouraged by these efforts.  While it is too
early to assess the specific results, our initial impression is that
the programs are focusing on key problem areas, such as reducing
repair cycle time.  Some examples of the services improvement
initiatives over the past few years include: 

  The concept of regional maintenance in the Navy focuses on properly
     sizing the shore maintenance infrastructure to support a smaller
     naval force while maintaining the Fleet in a high state of
     readiness. 

  The Air Force's Lean Logistics Program is designed to maximize
     operational capability by using high velocity transportation and
     just-in-time stockage principles to shorten cycle times, reduce
     inventories and cost, and shrink the mobility footprint, and
     providing flexibility to manage mission and logistics
     uncertainties. 

  The Integrated Sustainment Maintenance Program in the Army
     regionalizes the repair of components to achieve efficiencies
     and cost savings. 

  The Marine Corps' Precision Logistics Program is a change in
     culture and a pursuit of smart business practices regarding the
     speed and accuracy of information, speed and fluidity of
     distribution, and reduction in support cycle times. 


------------------------------------------------------ Appendix II:6.5

Mr.  Chairman, this concludes our statement.  We would be pleased to
answer any questions you or the Subcommittee may have at this time. 


*** End of document. ***