Index

Air Force Depot Maintenance: Budgeting Difficulties and Operation
Inefficiencies (Letter Report, 08/15/2000, GAO/AIMD/NSIAD-00-185).

Pursuant to a legislative requirement, GAO provided information on the
financial and management issues related to the depot maintenance
activity group of the Air Force Working Capital Fund.

GAO noted that: (1) for years the depot maintenance activity group has
experienced difficulties in accurately budgeting for material costs,
workforce productivity, and savings to be achieved through productivity
improvements and other reform initiatives; (2) these difficulties have
adversely impacted the activity group's financial operations, resulting
in hundreds of millions of dollars in operating losses and limited the
grou'ps ability to provide timely support to its customers; (3) although
actions are underway to improve some problems, it is uncertain to what
extent the Air Force's long-standing problems are likely to be resolved
in the short-term; (4) because of inaccurate pricing information from
the Air Force's supply management activity group and ineffective
internal controls over depot material costs and usage, the depot
maintenance activity group's actual material costs per direct labor hour
of work accomplished were $12.40 higher than the budgeted amount in
fiscal year (FY) 1998, $7.13 higher in FY 1999, and $21.48 higher during
the first 6 months of FY 2000; (5) the Air Force is acting to resolve
the higher-than-budgeted material cost problem by: (a) stabilizing the
supply management activity group's price-setting process; and (b) having
the Air Force Audit Agency review the accuracy of the proposed prices
that the supply management activity group will charge the depot
maintenance activity group for material; (6) an 11.3 percent decline in
reported worker productivity that occurred from FY 1992 through FY 1999
caused a corresponding increase in labor costs per unit of work
accomplished; (7) additionally, because budget estimates for fiscal
years 1994 through 1999 were repeatedly based on overly optimistic
productivity assumptions, the workforce did not accomplish as much work
as projected; (8) this, in turn: (a) caused labor costs for the work
that was accomplished to be about $838 million higher than budget
estimates; and (b) created a higher backlog of work which, in turn,
limited the group's ability to provide timely support to customers; (9)
the depot maintenance activity group budgeted to save an average of $77
million a year from fiscal years 1996 through 1999 through planned
management reforms; (10) however, the activity group repeatedly revised
the original budgeted savings downward to an average of $30 million a
year-a 61 percent reduction-in subsequent budget estimates; and (11) the
Air Force has recently acted to better estimate savings by involving the
air logistics centers in the estimation process.

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

 REPORTNUM:  AIMD/NSIAD-00-185
     TITLE:  Air Force Depot Maintenance: Budgeting Difficulties and
	     Operation Inefficiencies
      DATE:  08/15/2000
   SUBJECT:  Equipment maintenance
	     Losses
	     Financial management
	     Prices and pricing
	     Military cost control
	     Internal controls
	     Logistics
	     Air Force supplies
	     Aircraft maintenance
IDENTIFIER:  Air Force Working Capital Fund
	     DOD Depot Maintenance Accounting and Production System

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GAO/AIMD/NSIAD-00-185

A

Report to the Chairman, Subcommittee on Military Readiness, Committee on
Armed Services, House of Representatives

August 2000 AIR FORCE DEPOT MAINTENANCE

Budgeting Difficulties and Operational Inefficiencies

GAO/ AIMD/ NSIAD- 00- 185

Letter 3 Appendixes Appendix I: Comments From the Department of Defense 34

Appendix II: GAO Contacts and Staff Acknowledgments 40 Tables Table 1: The
Activity Group's Budgeted and Actual Total

Material Costs, Direct Labor Hours, and Material Costs per Direct Labor Hour
for Fiscal Years 1997 Through 2000 11 Table 2: Original and Revised Budget
Estimates for the Air

Force Depot Maintenance Activity Group's Savings for Fiscal Years 1996
Through 1999 25 Table 3: Depot Maintenance Activity Group's Total
Anticipated

Savings by Major Initiative for Fiscal Years 2000 Through 2007 26 Table 4:
Depot Maintenance Activity Group's Anticipated

Savings for Fiscal Years 2000 Through 2007 27 Figures Figure 1: Depot
Maintenance Activity Group's Budgeted

and Actual Material Costs per Direct Labor Hour of Work Accomplished 10
Figure 2: Comparison of the Depot Maintenance Activity Group's

Budgeted and Actual Output- per- Paid- Man- Day for Fiscal Years 1988
Through 2000 and Budgeted for Fiscal Year 2001 18

Accounting and Information Management Division

Lett er

B- 285446 August 15, 2000 The Honorable Herbert H. Bateman Chairman,
Subcommittee on Military Readiness Committee on Armed Services House of
Representatives

Dear Mr. Chairman: The Air Force depot maintenance activity group supports
combat readiness by providing the depot repair services necessary to keep
Air Force units operating worldwide. The group generates about $5 billion in
annual revenue principally by repairing and overhauling a wide range of
assets including aircraft, missiles, aircraft engines, electronics,
avionics, software, and repairable inventory items for military services,
other government agencies, and foreign governments. In doing so, this group
operates under the working capital fund concept, where customers are to be
charged the anticipated actual costs of providing goods and services to
them.

This is the second report in response to your request that we review
financial and management issues related to the depot maintenance activity
group of the Air Force Working Capital Fund. In December 1999, we reported 1
that the depot maintenance activity group incurred losses totaling about
$623 million 2 during fiscal years 1994 through 1998 on sales of about $21.
8 billion. We also reported on the different methods that the Air Force used
to recover the losses. This second report addresses how financial operations
have been and may continue to be adversely affected by (1) higher- than-
budgeted material costs and inadequate internal controls over material, (2)
lower- than- budgeted productivity, and (3) the failure to attain expected
savings from reform initiatives.

1 Air Force Depot Maintenance: Analysis of Its Financial Operations( GAO/
AIMD/ NSIAD- 0038, December 10, 1999). 2 The $623 million loss includes a
$98.8 million accounting adjustment that does not need to be recovered from
customers.

Results in Brief For years the depot maintenance activity group has
experienced difficulties in accurately budgeting for material costs,
workforce productivity, and

savings to be achieved through productivity improvements and other reform
initiatives. These difficulties have adversely impacted the activity group's
financial operations, resulting in hundreds of millions of dollars in
operating losses and limited the group's ability to provide timely support
to its customers. Although actions are underway to improve some problems,
such as poor budget estimation and operational inefficiencies including
declining productivity rates, it is uncertain to what extent the Air Force's
long- standing problems are likely to be resolved in the short- term. More
specifically, we found the following.

Because of inaccurate pricing information from the Air Force's supply
management activity group and ineffective internal controls over depot
material costs and usage, the depot maintenance activity group's actual
material costs per direct labor hour of work accomplished were $12. 40
higher than the budgeted amount in fiscal year 1998; $7.13 higher in fiscal
year 1999; and $21.48 (45 percent) higher during the first 6 months of
fiscal year 2000. These increases resulted in overall material costs that
were about $361 million and $307 million higher than the group's budget
estimate in fiscal years 1998 and 1999, respectively, and contributed to
operating losses. The Air Force is acting to resolve the higher- than-
budgeted material cost problem in several ways, including (1) stabilizing
the supply management activity group's price- setting process and (2) having
the Air Force Audit Agency review the accuracy of the proposed prices that
the supply management activity group will charge the depot maintenance
activity group for material. The Air Force is also strengthening controls
over material usage. An 11.3 percent decline in reported worker productivity
that occurred

from fiscal year 1992 through fiscal year 1999 caused a corresponding
increase in labor costs per unit of work accomplished. Additionally, because
budget estimates for fiscal years 1994 through 1999 were repeatedly based on
overly optimistic productivity assumptions, the workforce did not accomplish
as much work as projected. This, in turn, (1) caused labor costs for the
work that was accomplished to be about $838 million higher than budget
estimates and (2) created a higher backlog of work which, in turn, limited
the group's ability to provide timely support to customers. The group's
fiscal year 2001 budget estimate assumes that productivity will improve
about 13. 4 percent over the actual productivity level for the first half of
fiscal year 2000. However, our analysis indicates that improvements of this
magnitude

will be difficult to achieve and that productivity shortfalls against goals
are, therefore, likely to continue. The depot maintenance activity group
budgeted to save an average of

$77 million a year from fiscal years 1996 through 1999 through planned
management reforms. However, the activity group repeatedly revised the
original budgeted savings downward to an average of $30 million a year- a 61
percent reduction- in subsequent budget estimates, which were developed the
following year based on updated information. Since projected savings were a
factor used to set customer prices, these revisions, in turn, increased the
group's financial losses. The activity group now has major initiatives
underway that it expects will result in even higher savings, equal to an
average annual amount of $347 million, about $2.8 billion from fiscal years
2000 through 2007. The Air Force has recently acted to better estimate
savings by involving the air logistics centers- which are to achieve the
savings- in the estimation process. Because of the magnitude of these
savings, it is important that the Air Force accurately determine the amount
of actual savings achieved each year so that it can effectively adjust the
activity group's subsequent years' budgets and prices. However, the Air
Force does not have the systems and processes in place necessary to do so.

We are making recommendations to the Secretary of the Air Force to improve
the depot maintenance activity group's (1) budget estimates and (2)
management of material costs and usage. In its comments on a draft of this
report, the Air Force concurred with our recommendations and identified
actions it was taking to correct the identified deficiencies. For example,
the Air Force plans to require an analysis of material usage as a matter of
policy and develop material management metrics that will allow Air Force
depot maintenance officials to monitor and determine causes of material cost
variances. The Department of Defense's comments are included in appendix I.

Background The Air Force depot maintenance activity group is part of the Air
Force Working Capital Fund, a revolving fund that relies on sales revenue
rather

than direct congressional appropriations to finance its operations.
Department of Defense (DOD) policy requires working capital fund activity
groups to (1) establish sales prices that allow them to recover their
expected costs from their customers and (2) operate on a break- even basis
over time- that is, not make a profit nor incur a loss. DOD policy also
requires the activity groups to establish their sales prices prior to the
start of each fiscal year and to apply these predetermined or
“stabilized” prices

to most orders received during the year- regardless of when the work is
actually accomplished or what costs are actually incurred.

The process that activity groups use to develop their stabilized prices
begins as early as 2 years before the prices go into effect, with each
activity group developing workload projections for the budget year. After an
activity group estimates its workload based on customer input, it (1) uses
productivity projections to estimate how many people it will need to
accomplish the work, (2) prepares a budget that identifies the labor,
material, and other expected costs, as well as projected cost savings, and
(3) develops sales prices that, when applied to the projected workload,
should allow it to recover operating costs from its customers.

In order for an activity group to operate on a break- even basis, it is
extremely important that the activity group accurately estimate the work it
will perform and the costs of performing the work. Higher- than- expected
costs or lower- than- expected customer demand for goods and services can
cause activity groups to incur losses. Conversely, lower- than- expected
costs or higher- than- expected customer demand for goods and services can
result in profits. However, with sales prices based on assumptions that are
made as long as 2 years before the prices go into effect, some variance
between expected and actual costs is inevitable.

Major Changes Affecting the As discussed in our December 1999 report, the
depot maintenance activity

Activity Group's Operations group has undergone major changes since the
early 1990s that have

affected the activity group's financial operations. More specifically, as
discussed below, these changes significantly affected the scope and mix of
workload to be performed by the depot maintenance activity group and the
productivity of its workforce.

In response to the declining force structure and the increasing amount of
work that is being contracted out, the Air Force reduced the number of
activity group employees from about 31,000 permanent employees at the end of
fiscal year 1991 to about 21,000 at the end of fiscal year 1999- about a 32-
percent reduction. This reduction of employees affected the experience and
skills of workers. From fiscal year 1993 through fiscal year 1997, the Air
Force converted

its existing three- level depot maintenance operations (organization,
intermediate, and depot) to two levels (organization and depot) for selected
avionics and engine items. This resulted in more engine work being performed
by the depot maintenance activity group. Since the

engine work was very material intensive, the average material cost per hour
charged by the activity group and the average customer price per hour both
increased. From fiscal year 1995 to the present, the Air Force has been in
the

process of closing two air logistics centers and transferring their work to
other sources of repair. For example, during fiscal years 1998 and 1999,
about one- third of the group's workload was competed or realigned. This (1)
affected the location and the amount of work performed by the depots, (2)
significantly increased hiring and training needs at the gaining activities,
and (3) affected the productivity of the workforce.

The Activity Group's We have previously reported that DOD has had long-
standing problems in

Financial Reports Are Not preparing accurate working capital fund financial
reports. In addition, the

Accurate DOD Inspector General and/ or the Air Force Audit Agency have not
been

able to express an opinion on the accuracy of the working capital fund 3
financial statements for fiscal years 1993 through 1999. The auditors
reported that the financial information was unreliable and financial systems
and processes, as well as associated internal control structures, were
inadequate to produce reliable financial information. For example, the Air
Force depot maintenance systems lacked a single transactiondriven general
ledger for reliable financial reporting, did not follow the percentage- of-
completion method of accounting for revenue, and continued to account for
cost of goods sold and work- in- process at estimated amounts instead of
actual costs.

To help improve the depot maintenance activity group's financial management
operations by more accurately accounting for costs in providing goods to
customers, the Air Force is in the process of implementing a new system
called the Depot Maintenance Accounting and Production System. According to
the Air Force, this system- which is scheduled to be implemented by June
2001, will provide accurate cost visibility at the task level to support
financial analysis and cost

3 Prior to fiscal year 1997, the DOD Inspector General was responsible for
auditing and rendering an opinion on the financial statements of the Defense
working capital funds, which were called the Defense Business Operations
Fund at that time. The Defense Working Capital Fund financial statements
included the Air Force depot maintenance activity group's financial
statements. In 1997, the Department of Defense delegated the responsibility
for auditing the Air Force Working Capital Fund financial statements,
including the Air Force depot maintenance activity group's statements, to
the Air Force Audit Agency.

management. The system will also improve the timeliness, accuracy,
completeness, reliability, and consistency of the financial information.

Objectives, Scope, and The objectives of our review were to determine how
the financial

Methodology operations of the depot maintenance activity group have been and
may

continue to be adversely affected by (1) higher- than- budgeted material
costs, (2) lower- than- budgeted productivity, and (3) the failure to attain
expected savings from reform initiatives. This review is a continuation of
our work on the depot maintenance activity group's price increases and
financial losses. 4

To determine how the financial operations of the depot maintenance activity
group have been and may continue to be adversely affected by higher- than-
budgeted material costs, we obtained and analyzed budget and accounting
documents that provided information on budgeted and actual material costs
from fiscal year 1997 to fiscal year 2000. When variances occurred between
budgeted and actual reported information, we met with responsible budgeting
and accounting officials to ascertain why there were differences. We also
met with officials to determine what actions they were taking to get a
better understanding of why material costs were increasing and how the Air
Force Materiel Command could better control and reduce material costs.

To determine how the financial operations of the depot maintenance activity
group have been and may continue to be adversely affected by lower- than-
budgeted productivity, we obtained and analyzed budget and actual data on
(1) hours worked, (2) the amount of work accomplished, (3) worker
productivity, and (4) labor and overhead costs. When variances occurred
between budgeted and actual reported information, we met with responsible
officials to ascertain why there were differences and what actions they were
taking to more accurately budget for productivity. Finally, to determine if
the productivity improvement goals used to develop the fiscal year 2001
budget estimate are realistic, we documented and evaluated the corrective
actions being taken to improve productivity.

To determine how the financial operations of the depot maintenance activity
group have been and may continue to be adversely affected by the

4 Air Force Depot Maintenance: Analysis of Its Financial Operations( GAO/
AIMD/ NSIAD- 0038, December 10, 1999).

failure to attain expected savings from reform initiatives, we obtained and
analyzed budget documents that provided information on savings for fiscal
years 1996 through 1999. We also obtained and analyzed information on
budgeted savings for fiscal year 2000 through fiscal year 2007. When
variances occurred between budgeted and actual reported information, we met
with responsible officials to ascertain (1) why there were differences, (2)
the difficulties they were encountering in determining actual savings, and
(3) what actions they were taking to more accurately budget for future
savings.

We performed our work at the headquarters offices of the Under Secretary of
Defense (Comptroller) and the Secretary of the Air Force, Washington, D. C.;
Air Force Materiel Command, Dayton, Ohio; the Oklahoma City Air Logistics
Center, Tinker Air Force Base, Oklahoma; the Ogden Air Logistics Center,
Hill Air Force Base, Utah; the Sacramento Air Logistics Center, McClellan
Air Force Base, California; the Warner Robins Air Logistics Center, Robins
Air Force Base, Georgia; and the Air National Guard, Arlington, Virginia. We
did not verify the accuracy of the accounting and budget information used in
the tables and charts in this report, all of which was provided by the Air
Force. We conducted our work from November 1999 through May 2000 in
accordance with generally accepted government auditing standards. We
requested comments on a draft of this report from the Secretary of Defense
or his/ her designee. We have reprinted the comments in appendix I of this
report.

Higher- Than- Budgeted The depot maintenance activity group's fiscal year
1998 and 1999 material

Material Costs and costs were about $361 million and $307 million higher
than its budget

estimate, respectively. Such higher- than- expected costs, in turn,
negatively Internal Control

affected the group's financial operations. The higher material costs can be
Weaknesses Adversely

attributed primarily to the activity group paying higher prices than
Affected the Activity

budgeted for material purchased from the Air Force supply management
activity group. Further, depot maintenance activities were not following

Group's Financial internal control procedures designed to control material,
and the activity

Operations group did not have a systematic process for identifying and
analyzing

variances between expected and actual material usage. As shown in both
figure 1 and table 1, the activity group's actual material costs per direct
labor hour of work accomplished (direct product standard

5 ) increased from (Per direct labor hour)

hours $43.62 per hour in fiscal year 1997 to $69.31 per hour for the first 6
months of fiscal year 2000, or by about 59 percent. Viewed annually from a
budgeting perspective, actual material costs per direct labor hour of work
accomplished were $12. 40 higher than the budgeted amount in fiscal year
1998; $7. 13 higher in fiscal year 1999; and $21.48 (45 percent) higher
during the first 6 months of fiscal year 2000.

Figure 1: Depot Maintenance Activity Group's Budgeted and Actual Material
Costs per Direct Labor Hour of Work Accomplished

$75 $69.31

$70 $65

$60.23 $60.92

$60 $53.79 $55

$47.83 $47.83 $50

$43.62 $45

$42.57 $40 $35 $30

1997 1998 1999 2000 Fiscal year

Budget Actual

5 A direct product standard hour is the amount of acceptable quality work
that can be accomplished in 1 hour by qualified workers, following
prescribed methods, working at a normal pace and experiencing normal fatigue
and delays.

Table 1: The Activity Group's Budgeted and Actual Total Material Costs,
Direct Labor Hours, and Material Costs per Direct Labor Hour for Fiscal
Years 1997 Through 2000

Fiscal year 1997 Fiscal year 1998 Fiscal year 1999 Fiscal year 2000
Description Budget Actual Budget Actual Budget Actual Budget Actual

Total material $1, 204.5 $1,180.9 $1, 210.9 $1, 571.7 $1, 207. 7 $1, 514. 6
$1,038. 9 $1,551. 5 costs (in millions) Direct labor hours

28. 297 27. 075 25.317 26.094 22. 451 24. 861 21. 719 22. 386 (in millions)
Material costs per

$42.57 $43.62 $47. 83 $60. 23 $53.79 $60.92 $47.83 $69.31 direct labor hour
Note: Fiscal year 2000 actual data is a straight- line projection of the
first 6 months of actual data.

Source: Air Force.

Depot Maintenance Air Force depot maintenance officials believe, and our
work confirmed,

Received Inaccurate that the depot maintenance activity group's recent
problems with higherthan-

Material Prices From the budgeted material costs can be attributed largely
to inaccurate

material prices. These prices came from the Air Force supply management
Supply Management

activity group 6 and were developed during the budget process. This became
Activity Group During the

a problem in fiscal year 1998 when the supply group changed its pricesetting
Budget Process

methodology. In June 1998, we reported 7 that the new price- setting
methodology 8 used for allocating the supply management activity group's
operational cost to individual inventory items, combined with data
reliability problems, resulted in price changes that varied significantly
not only from one item to the next but also from one month to the next.
Altogether, prices changed

6 The supply management activity group is part of the Air Force Working
Capital Fund and is the depot maintenance activity group's primary source of
spare parts. 7 Air Force Supply Management: Analysis of Activity Group's
Financial Reports, Prices, and Cash Management( GAO/ AIMD/ NSIAD- 98- 118,
June 8, 1998).

8 In October 1997, the Air Force made two major changes in the supply
management activity group's cost allocation procedures to better match costs
with the prices customers were being charged. First, the supply group
identified the estimated costs associated with individual supply activities-
the five air logistics centers- and allocated each center's costs to only
those items that it managed. Second, the estimated cost of procuring
inventory items to replace repairable items that can no longer be repaired
economically (condemned items) was recouped by adding a surcharge to the
cost of the item being replaced rather than by adding a surcharge to all
repairable items, which was the previous practice.

seven times during fiscal year 1998, and the net effect of the changes was
that some customers, including the depot maintenance activity group, had to
pay more for material than they budgeted, others paid less. Specifically,
the depot maintenance activity group had to pay an additional $168 million
after Air Force headquarters officials decided to make all of the price
changes retroactive to the beginning of fiscal year 1998.

This same problem reoccurred when the supply management activity group
changed its price- setting methodology again for fiscal year 2000. Because
of this change, the Air Force estimates that the depot maintenance activity
group will have higher- than- budgeted material costs of about $119. 1
million in fiscal year 2000.

Air Force officials realize that the supply management activity group needs
to develop and provide more accurate pricing information and they are
undertaking improvement efforts. Specifically, they plan to
“stabilize” the supply activity group's price- setting
methodology (that is, not change the methodology for setting prices in
future years) in order to enable the Air Force to develop more consistent
historical trend data on supply group customers' funding needs, which, in
turn, should provide a better basis for developing customer budgets.

Additionally, in response to recommendations we made in our June 1998
report, the Air Force is taking steps to ensure that the supply activity
group's price changes and customers' budget estimates are more reliable.
First, it has begun ensuring that the prices it establishes for individual
items are consistent with the approved composite price change. 9 In the
July/ August 1999 time frame, the Air Force Audit Agency analyzed the supply
activity group's fiscal year 2000 prices and, after ensuring that some
erroneous prices were corrected, confirmed that the fiscal year 2000 prices
would result in a composite price change that was consistent with the
approved composite price increase of 0. 1 percent. 10 The Air Force Audit

9 The supply management activity group's composite price change is expressed
in terms of a percentage from one year to the next. This change is used to
develop customer funding levels. The depot maintenance activity group is a
customer of the supply group and buys materials from supply.

10 The Air Force Audit Agency's analysis indicated that the composite price
increase was 1. 57 percent for fiscal year 2000. The Air Force Materiel
Command determined that fiscal year 1999 prices were 1. 5 percent too low,
which resulted in an actual difference of .07 percent for fiscal year 2000.

Agency will perform a similar analysis of the supply group's fiscal year
2001 prices.

Second, the supply activity group is beginning to estimate the impact of
actual price changes on individual customers. Although the actual composite
price increase for fiscal year 2000 was 0. 07 percent, an analysis performed
by a contractor on behalf of the supply activity group indicated that the
impact on individual customers ranged from a 151 percent increase to a 93
percent decrease. For fiscal year 2001, supply group officials plan to
determine the impact of their price changes on individual customers prior to
the start of the fiscal year so that the information can be used by Air
Force headquarters officials to reallocate funds among the activity group's
Air Force customers, if necessary.

If properly implemented, these actions should provide reasonable assurance
that the supply activity group's price changes are properly synchronized
with its customers' budget estimates. However, as the next section further
discusses, additional actions are still needed on the part of maintenance
depots to effectively control material usage and costs.

Depot Maintenance Our reviews and other studies have shown that the depot
maintenance

Activities Are Not activities were not following internal control procedures
designed to

Effectively Controlling manage material and thus were not effectively
controlling material usage.

Material Usage While actions have recently been taken to rectify this
problem, the Air

Force still lacks a mechanism for ensuring their successful implementation.

In the early 1990s, both we 11 and the Air Force Audit Agency reported that
Air Force depot maintenance activities did not have adequate internal
controls to ensure that issued materials were charged to the appropriate
jobs or limited to established job requirements. As a result, materials were
issued improperly to jobs and material usage and related costs for specific
jobs were not correctly reported. Eight years later, a February 1999 study
performed by the Air Force Materiel Command on material standards identified
problems similar to the ones found by us and the Air Force Audit Agency, as
the following examples illustrate.

11 Management letter to the Commander, Air Force Logistics Command (GAO/
AFMD- 9133ML, February 26, 1991).

Some material managers either were not receiving or were not analyzing
reports that indicated excessive material usage for individual repair tasks.
As a result, they could not assess why material usage was higher than
expected and, in turn, take effective corrective measures. Some material
managers were not receiving automated reports that

identified the Bill of Material 12 with low accuracy (some information on
the Bill of Material document, such as material needed to repair an item, is
not accurate) and, therefore, had neither identified nor taken appropriate
corrective action to address the causes of the inaccuracies. Also, some
material managers who received the automated reports did not determine the
reason( s) for the inaccuracies. When reviews of excessive material usage
were conducted, planners, in

many cases, found that material was ordered for the wrong job. Required
approval for higher- than- expected material usage was not

always obtained. The Air Force Materiel Command study resulted in 102
recommendations made to headquarters and each of the centers, including
recommendations that called for policy changes, system changes, new
requirements, a new training course, and stricter enforcement of current
policies. According to an Air Force Materiel Command official, as of April
2000, 80 of the 102 recommendations contained in the study have been
implemented. By the end of the fiscal year, the Air Force expects to
implement the final 22.

Air Force Materiel Command logistics officials had originally planned to
have the Air Force Inspector General review the air logistics centers'
compliance with material management policy during biannual unit compliance
inspections. However, the Air Force Materiel Command and the Inspector
General subsequently decided, in conducting those inspections, to review
only critical items affecting safety of flight or compliance with laws.
Since material management did not meet this criteria, it was removed from
the unit compliance inspections and made a self- inspection annual
requirement. Consequently, at this time, there is no organization external
to the air logistics centers monitoring compliance with the material
management requirements. Such independent monitoring

12 A document commonly known as the Bill of Material, or material standard,
is a descriptive and quantitative list of the material and component parts
that, based on historical data and other factors, are expected to be needed
during the manufacture, overhaul, or repair of individual items.

is important given the compliance problems that have existed at the air
logistics centers since the early 1990s.

Air Force Has Not In addition to the problems identified in the 1999 Air
Force report, we also

Performed an Analysis of found that the activity group did not have a
systematic process for

Expected and Actual identifying and analyzing variances between expected and
actual material

Material Usage and usage at the depot maintenance activity group level. Such
an analysis is

normally used in the manufacturing process to determine whether material
Quantified Its Results

usage has increased and the effect of the increased material usage on
material costs. The analysis could also be used to determine and validate
Air Force officials' view that increased material usage is caused by
external factors beyond the Air Force Materiel Command's control, such as
aging of the aircraft and engine inventory.

Air Force officials told us that the air logistics centers used to perform
usage variance analyses; however, the staff who conducted these studies were
cut during downsizing efforts that took place during the early and mid-
1990s. Officials said that the Command and the centers are presently
attempting to hire personnel to perform this type of analysis again.

Air Force Materiel Command officials also stated that they are in the
process of developing a data warehouse to serve as a central depository for
all depot maintenance data, including material data, in order to enhance
material management. By having access to historical and current files in a
single database and ensuring that the data are correct, Air Force Materiel
Command officials should be able to develop performance metrics necessary to
identify problem areas and take appropriate corrective actions.

Productivity- Related Productivity- related problems have adversely affected
the depot

Problems Have maintenance activity group's financial operations and have
limited its

ability to provide timely support to its customers. For example, an
Adversely Affected the

11. 3 percent decline in reported worker productivity that occurred from
Activity Group's

fiscal year 1992 through fiscal year 1999 caused a corresponding increase in
Operations

labor costs per unit of work accomplished. Additionally, because actual
productivity from fiscal year 1994 through fiscal year 1999 was consistently
less than budget estimates, the workforce did not accomplish as much work as
expected. In turn, because labor rates were based on these higher
expectations, this resulted in the activity group maintenance depots not

recouping some of their labor and overhead costs and increased the depots'
backlog of funded work.

The activity group, which overestimated its workforce's productivity in
every budget since fiscal year 1988, based its fiscal year 2001 budget
estimate on the assumption that the workforce's overall productivity would
improve about 13.4 percent over its actual productivity level for the first
6 months of fiscal year 2000. However, our work showed that (1) for some
workloads, the ongoing transfer of work from two closing air logistics
centers to three remaining centers will continue to have a negative effect
on productivity during fiscal year 2001 and (2) the activity group's
workforce- related initiatives are long- term efforts that are unlikely to
result in significant productivity improvements before the end of fiscal
year 2001. As a result, the activity group is unlikely to achieve its fiscal
year 2001 productivity improvement goal and the problems identified above
are likely to persist.

Productivity Has To measure the overall productivity of their workforce, Air
Force depot

Consistently Been Less maintenance managers rely on a performance indicator
called the Outputper-

Than Budgeted Paid- Man- Day. This statistic measures the relationship
between

production, measured in Direct Product Standard Hours (DPSH), 13 and total
labor time available (for both direct labor and overhead personnel). For
example, a budgeted Output- per- Paid- Man- Day value of 4.0 means that
depot maintenance managers expect the workforce to complete 4.0 DPSHs of
work for every 8 hours of payroll time.

Because the Output- per- Paid- Man- Day performance indicator takes into
consideration both direct labor and overhead time, it is affected by changes
in not only direct labor efficiency 14 but also by the number and efficiency
of overhead personnel. For example, if the activity group hires 10 overhead
personnel to help ensure better management of material, these additional
personnel would initially cause the Output- per- Paid- Man- Day to decline.
However, if these additional personnel could help ensure that needed

13 A DPSH is the amount of acceptable quality work that can be accomplished
in 1 hour by a qualified worker, following prescribed methods, working at a
normal pace, and experiencing normal fatigue and delays.

14 Direct labor efficiency is the ratio of the number of DPSHs of work
accomplished to the number of direct labor hours worked. For example, if a
mechanic works 10 hours to accomplish a job that should take 9 hours, then
the direct labor efficiency is 90 percent.

component parts are available when direct labor personnel need them, the
delay time could be reduced, the direct labor efficiency could improve, and
the net effect of hiring the planners could be an increase in Output-
perPaid- Man- Day. As shown in figure 2, the activity group workforce's
productivity has been less than its budgeted productivity for every year
since fiscal year 1988.

Output- Activity Group's Budgeted and Actual per- paid- man- day Figure 2:
Comparison of the Depot Maintenance Output- per- Paid- Man- Day for Fiscal
Years

1988 Through 2000 and Budgeted for Fiscal Year 2001 4.25

4.17 4.14

4.12 4.05

3.99 4.00

3.97 4.00

3.94 3.95 3.94 3.91

3.89 3.84 3.87

3.84 3.82

3.78 3.75

3.74 3.70 3.70

3.66 3.65

3.56 3.57

3.54 3.54

3.52 3.50

3.25 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Fiscal year Budget Actual

Note: Fiscal year 2000 actual data is as of March 31, 2000. Source: Air
Force.

Air Force depot maintenance officials believe that three factors have been
primarily responsible for this pattern of overly optimistic productivity
assumptions. First, they believe that the depot maintenance workforce has
frequently been unable to react quickly and efficiently to unanticipated

changes in the amount and type of work requested by its customers. 15
Second, unanticipated delays in and problems with the transfer of work from
the two closing centers caused productivity to be less than expected. Third,
the centers have frequently not achieved the “stretch”
productivity improvement goals that have been incorporated into their budget
estimates.

Because the activity group's budget estimates are based on assumptions that
are made long before the start of the fiscal year, some variance between
budgeted and actual results is inevitable. However, when assumptions are
consistently overly optimistic, it is likely that there are systemic
problems with either the methodology used to develop the assumptions or with
the effectiveness of operations. We identified two problems with the
methodology the activity group uses to develop its productivity assumptions.
First, in establishing productivity improvement goals, the activity group
does not first develop a plan that specifies how, when, and by whom the
improvements will be made. Second, the activity group establishes its
productivity improvement goals without adequately considering historical
data. Thus, little assurance exists that the goals can feasibly be attained.

The activity group's fiscal year 2001 productivity improvement goal- to
increase the workforce's Output- per- Paid- Man- Day from 3. 52 during the
first 6 months of fiscal year 2000 to 3. 99 in fiscal year 2001- illustrates
both of these problems. Depot maintenance officials believe that the
workforce's productivity will improve as (1) the two closing air logistics
centers phase out their operations, (2) workloads are consolidated at the
three remaining centers (thereby allowing these centers to achieve economies
of scale), and (3) workers at the remaining centers become more adept at the
new work that has been transferred to them. However, the activity group does
not have a plan that specifies how, when, and by whom this substantial
improvement will be achieved.

Further, our work indicates that an Output- per- Paid- Man- Day of 3.99
presents a difficult challenge. First, as shown in figure 2, the workforce's
actual Output- per- Paid- Man- Day was never higher than 3. 94 during fiscal
years 1988 through 1999, and has not been higher than 3. 70 since fiscal
year

15 This problem is discussed in our report entitled Air Force Depot
Maintenance: Improved Pricing and Financial Management Practices Needed(
GAO/ AFMD- 93- 5, November 17, 1992).

1996. Second, the largest 1- year improvement in productivity during this
period was the 5.7 percent increase that occurred from fiscal year 1990
through fiscal year 1991. Third, depot maintenance officials believe that,
for some workloads, it will not be until fiscal year 2002, 16 and possibly
longer, that productivity will no longer be adversely affected by the depot
closures and workload transfers.

Productivity Problems Have Our analysis of the activity group's budgeted and
actual operating results

Adversely Affected for fiscal years 1994 through 1999 showed that lower-
than- budgeted

Financial Operations and productivity prevented the workforce from
accomplishing as much work as

Customer Support expected. This, in turn, adversely affected the activity
group's financial

operating results because it (1) caused labor costs for the work that the
workforce accomplished to be about $838 million higher than budget estimates
and (2) prevented the activity group from recovering about $230 million of
fixed overhead costs. 17

The workforce's failure to accomplish as much work as expected is also a
primary reason the activity group has had and is likely to continue having a
large backlog of funded work. DOD policy requires depot maintenance
activities to have some funded work on hand at the end of the fiscal year in
order to ensure a smooth transition from one fiscal year to the next.
However, any amount more than 3 months is considered by DOD to be excess and
an indication that scarce resources are not being used costeffectively and
customers are not receiving timely support.

At the end of fiscal year 1999, the activity group's maintenance depots had
a reported $972.9 million, or 3.27 month, backlog of funded work. Further,
budget documents indicate that the backlog is likely to remain above DOD's
3- month criteria through the end of fiscal year 2001, even if budgeted
productivity goals are achieved. In several areas, such as

16 The Sacramento and San Antonio Air Logistics centers are scheduled to
close by July 2001. However, some of these centers' depot maintenance work
will be performed by contractors until (1) the remaining centers develop a
repair capability for that type of work and/ or (2) existing contracts
expire.

17 The activity group exceeded its production goals during fiscal years 1998
and 1999, despite lower- than- budgeted productivity, because (1) the actual
number of regular and overtime hours were both higher than budget estimates
and (2) the activity group hired private contractors to do some of the work.

software engineering, the backlog is expected to remain above 6 months of
work.

Causes of the Workforce's Our discussions with activity group managers
indicate that most of the

Productivity Decline decline in worker productivity that has occurred since
fiscal year 1992 can

be attributed to two factors. The first and most significant factor is that
the workforce experienced almost continuous turbulence during the 1990s-
initially because of downsizing and more recently because of depot closures
and related workload transfers. The second factor is that the activity group
has implemented a repair- on- demand concept, but has made little progress
in developing the flexible workforce needed to operate efficiently under
this initiative. Both factors are discussed in further detail below.

Continuous Personnel In 1990, in an effort to better plan for future
workload changes, Air Force

Turbulence Has Adversely depot maintenance officials compared their existing
repair capability with

Affected Worker Productivity their projected workload for fiscal years 1991
through 1995. They

determined that factors, such as a declining force structure, would cause
their workload to decline faster than the workforce could be reduced through
normal attrition. As a result, during fiscal year 1991, Air Force depot
maintenance activities released their temporary and on- call employees,
facilitated early retirements, and released 1, 211 permanent employees
through a reduction- in- force.

These actions adversely affected worker productivity in two ways. First, the
release of all temporary and on- call workers reduced the workforce's
ability to quickly and efficiently react to unanticipated changes in the
levels and types of workload, which, in turn, drove down worker
productivity. 18 Second, depot maintenance officials stated that the
reduction- in- force created a large retraining requirement which, in turn,
decreased the productivity of many workers. This reduced productivity
occurred because federal personnel regulations allowed employees in
positions that were eliminated to “bump” employees with less
tenure even if the “bumped” employees are better trained for the
position.

18 This problem is discussed in our report entitled Air Force Depot
Maintenance: Improved Pricing and Financial Management Practices Needed(
GAO/ AFMD- 93- 5, November 17, 1992).

Further, although these actions were supposed to align the size of the
activity group's workforce with its projected workload through fiscal year
1995, the workload declined even more than expected. As a result, depot
maintenance activities continued to experience personnel turbulence over the
next several years as they reduced the size of their workforce from 31, 213
permanent employees at the end of fiscal year 1991 to 26, 939 at the end of
fiscal year 1995. Finally, as noted previously, the 1995 decision to close
two of the five air logistics centers exacerbated the activity group's
personnel turbulence problem.

Implementation of Agile Under an umbrella concept initially called Lean
Logistics and later renamed

Logistics Increased the Need for Agile Logistics, the Air Force explored
ways to adopt logistical concepts

a Flexible Depot Maintenance that have proven to be effective in the private
sector. As part of this effort,

Workforce Air Force depot maintenance officials began testing a repair- on-
demand

concept- a significant change for the Air Force. Previously, repair levels
were negotiated quarterly based on projections of what items would fail or
require scheduled repair. Now, decisions on how many and which items to
repair are made daily based on the most current data available on customer
needs and depots repair capabilities.

The full implementation of the repair- on- demand concept, which began in
June 1997, has greatly increased the need for a flexible workforce that can
quickly and efficiently respond to unanticipated changes in the size and mix
of the workload. However, as of March 2000, temporary workers accounted for
less than 2 percent of the workforce. Further, although some preliminary
actions have been taken to develop multiskilled positions, several
additional actions are needed before actual training can begin. 19

Workforce Initiatives Are Air Force Materiel Command officials have
developed a comprehensive

Commendable, But Timely plan to improve the skill level and productivity of
the depot maintenance

Resolution of Problems Is workforce. Specifically, they have undertaken
initiatives to (1) validate and,

Unlikely if appropriate, improve their workers' skill levels, (2) enhance
the

workforce's ability to respond efficiently and effectively to workload
fluctuations, and (3) develop the reliable labor standards needed to
effectively monitor and evaluate worker performance. As discussed below,

19 This problem is discussed in our report Air Force Depot Maintenance:
Management Changes Would Improve Implementation of Reform Initiatives( GAO/
NSIAD- 99- 63, June 25, 1999).

these initiatives are long- term efforts whose short- term impact on
productivity is more likely to be negative than positive.

First, the Air Force Materiel Command headquarters is implementing a
“Back- to- Basics” initiative to ensure, among other things,
that depot maintenance technicians are properly trained and are performing
their work in accordance with established policies and procedures. Air Force
officials believe this initiative, which is being implemented because of
concerns raised during a 1999 headquarters review of depot maintenance
operations, will improve the effectiveness of their workforce. However, the
three remaining air logistics centers estimate that they will need 355
additional overhead people to fully implement the initiative. Further, the
initiative will significantly increase training requirements for direct
labor employees. As a result, the initiative's impact on productivity, at
least in the short- term, will be negative.

Second, the depot maintenance activity group has a strategic objective to
develop a qualified and flexible workforce that is “right-
sized” to execute the depot maintenance mission through fiscal year
2005. To accomplish this objective, activity group managers plan to (1)
develop projections of the activity group's workload through fiscal year
2005, (2) use these projections as the basis for determining how many jobs
and what skills will be needed, (3) implement an “enhanced technical
training program” to cross- train workers so that workers will have
multiple skills and, in turn, be more versatile, and (4) determine what mix
of permanent, temporary, term, and contract field team employees will
optimize their ability to cover planned and unplanned peaks in workload.
However, the Air Force does not expect to complete this plan until September
2000 and thus far little progress, if any, has been made in hiring temporary
workers or developing a multiskilled workforce. 20

Third, the depot maintenance activity group plans to develop engineered
labor standards (estimates for the amount of time required to perform repair
tasks) that more accurately reflect expected repair times. This initiative,
which will provide a more reliable basis for monitoring and evaluating
worker performance, is expected by the Air Force to save customers about
$185.7 million from fiscal year 2000 through fiscal year

20 Our report entitled Air Force Depot Maintenance: Management Changes Would
Improve Implementation of Reform Initiatives( GAO/ NSIAD- 99- 63, June 25,
1999), discussed the Air Force's development of a multiskilled workforce.

2007 since (1) customer prices are based on labor standards rather than
actual costs and (2) depot maintenance officials' preliminary analyses
indicate that the estimated amount of time required to perform a task (labor
standard) is more likely to decrease than increase when it is based on
updated engineered estimates.

The Air Force Has In December 1999 we reported 21 that the depot maintenance
activity group

Difficulty Accurately incurred financial losses, in part, because its prices
have repeatedly been

based on anticipated savings that were not realized. This situation could
Estimating Budgeted

become a more significant problem in the future since the activity group
Savings

now expects to budget for savings that, on an average annual basis, are over
four times the average annual amount of the savings it budgeted for in the
past. For fiscal years 2000 through 2007, the activity group has major
initiatives underway that the Air Force expects will result in savings equal
to an average annual amount of about $347 million a year, or about $2. 8
billion over the 8- year period.

Because of the magnitude and impact of savings on the depot maintenance
activity group's financial operations, it is vital that the Air Force be
able to determine the amount of savings actually achieved each year. Knowing
the actual savings achieved is necessary in order to more accurately adjust
the activity group's subsequent year budgets, and thus customer prices, to
help minimize any losses incurred due to not achieving the budgeted savings.
However, for several reasons- such as the lack of data systems for tracking
actual savings and disagreements on the methodology used to determine
overhead savings achieved- it will be difficult for the Air Force to
determine to what extent the activity group is achieving its expected
savings.

Budgeted Savings Have Not For fiscal years 1996 through 1999, our work
showed that the Air Force has

Materialized in the Past been overly optimistic in budgeting for savings.
Specifically, the Air Force's

revised budgets for the depot maintenance activity group have always reduced
the amount of anticipated savings that were included in the activity group's
original budgets when the group's customer prices were determined. As shown
in table 2, savings originally budgeted for during that

21 Air Force Depot Maintenance: Analysis of Its Financial Operations( GAO/
AIMD/ NSIAD- 0038, December 10, 1999).

time totaled $309 million. Based on updated information used to develop
subsequent year budgets, this amount was eventually reduced by 61 percent to
$119.1 million.

Table 2: Original and Revised Budget Estimates for the Air Force Depot
Maintenance Activity Group's Savings for Fiscal Years 1996 Through 1999

Dollars in millions

Total Fiscal year

Fiscal year Fiscal year

Fiscal year fiscal years

1996 1997 1998 1999 1996- 1999

Savings in $151.3 $54.5 $35. 0 $68. 2 $309. 0 the original budget

Savings in 65.3 4. 2 10. 0 39. 6 119. 1

the revised budget

Difference 86.0 50.3 25.0 28. 6 189. 9 Source: Air Force Working Capital
Fund Budget Submissions to Congress.

Although the savings were expected to be achieved primarily through
productivity improvements by the Air Force's air logistics centers,
cognizant officials at the centers we visited (the three that are to remain
open) told us that they had little input to the budgeted savings. Air Force
Materiel Command headquarters officials acknowledged that there was little
involvement by the air logistics centers in developing the savings that were
budgeted for during fiscal years 1996 through 1999. They further stated that
the savings estimates originally budgeted for had to be revised (reduced) in
subsequent year budgets because anticipated productivity improvements did
not materialize.

Major Initiatives Expected The activity group has undertaken several major
initiatives that it projects

to Achieve Significant will result in budgeted savings totaling about $2. 8
billion from fiscal year

Savings from Fiscal Years 2000 through fiscal year 2007. The overall
objective of these efforts is to

2000 through 2007 reduce the average price that customers pay the activity
group for repair

services by 8 percent by the end of fiscal year 2007. Table 3 describes
these initiatives and the amount of anticipated savings resulting from each.
Table 4 identifies the amount of anticipated savings from these initiatives
to be realized by year.

Table 3: Depot Maintenance Activity Group's Total Anticipated Savings by
Major Initiative for Fiscal Years 2000 Through 2007

Dollars in millions

Anticipated savings for fiscal years Initiative

2000 through 2007

Competition of workload - implementing results of public/ private $2, 071.5

competitions involving workloads at two closing air logistics centers a

Consolidation of noncompeted workload - reduce costs through 216.8 increased
use of equipment and facilities and redistribution of overhead expenses over
a larger workload base

Industrial engineering - reduce labor costs through process 185.7
engineering and methods improvements Material management- improve parts
ordering process to

100.0 preclude purchasing material in excess of requirements Depreciation -
turn- in equipment from closing air logistics

100.0 centers so that depreciation costs will not be incurred Contract
management - improve management of the contract

71. 9 program, such as reducing material provided to contractors Other b 32.
3

Total $2, 778.2

a Savings based on the (1) difference between what it would have cost the
depot maintenance activity group to perform the competed work at the closing
air logistics centers had they remained open and the estimated cost of the
workload as bid on and awarded to the centers that are not closing and (2)
overhead savings expected to be generated by lower overhead rates from the
increased workload awarded to the centers that are to remain open (i. e.,
relatively fixed overhead costs spread over a larger workload base). b Other
includes several small initiatives, such as the Air Force Materiel Command
headquarters

prioritizing the most important studies and analyses that have the greatest
payback to the command as opposed to initiating a myriad of review teams
attempting to solve every problem identified.

Source: Air Force Materiel Command Depot Maintenance Activity Group Fiscal
Year 2000 through 2007 Strategic Plan, dated October 1999.

Table 4: Depot Maintenance Activity Group's Anticipated Savings for Fiscal
Years 2000 Through 2007

Dollars in millions

Fiscal year Amount of budgeted savings

2000 $172. 8 2001 309.3 2002 383.2 2003 376.9 2004 395.8 2005 386.5 2006
376.6 2007 377.1

Total $2, 778.2

Source: Air Force Materiel Command Depot Maintenance Activity Group Fiscal
Year 2000 through 2007 Strategic Plan, dated October 1999.

It is important that the activity group achieve these savings. Savings
estimates impact prices the activity group charges customers each year once
the savings projections are budgeted, and they affect the amount of funding
customers receive in their operating budgets to purchase services from the
activity group. If the budgeted savings are not achieved, the activity group
could incur financial losses.

For several reasons, the Air Force expects its savings budget estimates for
fiscal years 2000 through 2007 to be more accurate than the savings
estimates originally budgeted for in the past. First, the air logistics
centers- which are ultimately responsible for achieving the savings- have
been more involved in developing the estimates. Specifically, the centers
participated in developing the baseline costs, workload bid proposal costs,
and projected overhead savings that could be achieved under the competition
initiative. They were also involved in developing the estimated savings to
be achieved under the nonworkload- related initiatives, such as the
industrial engineering, material management, and contract management
initiatives. Second, the Air Force provided each center with an opportunity
to comment on the initiatives from the perspective of whether the savings
were achievable, the timing was realistic, and if there was any impact from
implementing the initiatives. In written responses to the Air Force Materiel
Command, center officials generally agreed with the savings initiatives.

Systems and Processes Are To more accurately set customer prices, the Air
Force needs to be able to

Not in Place to Determine determine, with some degree of reasonableness,
whether its budgeted

Actual Savings savings for the depot maintenance activity group are actually
being

achieved. This will enable the Air Force to better adjust or revise the
amount of planned savings in the activity group's subsequent years' budgets
that, in turn, will facilitate more accurate prices. Nevertheless, for
several reasons, the Air Force can not determine actual savings achieved.
First, it lacks a system for tracking the extent to which savings targets
were met. Second, it has not updated the baseline for calculating savings
under the competition initiative. Third, the calculation for determining the
amount of overhead savings has been questioned by auditors.

System Needed to Track Actual Air Force Materiel Command headquarters
officials stated that it was their

Savings Achieved goal to track actual savings resulting from their
initiatives, but that they can

not accomplish this task primarily because the command's systems do not have
the capability to capture savings data. 22 In lieu of a tracking system,
depot maintenance officials at the air logistics centers we visited (the
three that are to remain open) as well as at Air Force Materiel Command
headquarters told us that they will determine whether savings are being
achieved primarily by monitoring budget execution. That is, they will
compare actual financial performance against budget targets. Since projected
savings are included in the activity group's budget and taken out up front
as part of the budgeting process, the officials believe that successful
execution of the budget targets will indicate that they have achieved the
projected savings.

We agree that monitoring budget execution can serve as a savings indicator.
However, because many factors impact the financial performance of the depot
maintenance activity group, it will be difficult to examine the specific
types of costs that were expected to decline in order to produce savings.
For example, the activity group's material cost savings initiative is
predicated on ensuring that only parts/ material required for repair are
ordered to preclude the purchase of material that is in excess of
requirements. The group could be successful in ordering only required
material- thus accomplishing the goal of this particular savings initiative-
but have to pay more than budgeted for the material because of unanticipated
price increases charged by the supply management activity

22 Our report, entitled Air Force Depot Maintenance: Management Changes
Would Improve Implementation of Reform Initiatives( GAO/ NSIAD- 99- 63, June
25, 1999), discussed the Air Force's lack of a system for tracking savings.

group. Without analyzing the various factors that can impact financial
performance, it will be difficult, if not impossible, for the Air Force to
determine how much of the activity group's successful or unsuccessful budget
execution can be attributed to the savings initiatives.

Air Force Materiel Command officials told us that they are expecting the
implementation of the Depot Maintenance Accounting and Production System to
help them in tracking/ determining actual savings achieved. This new system
is expected to (1) provide actual cost visibility at the task level to
facilitate financial analysis and cost management and (2) more accurately
tie costs to the specific activity generating the costs. The Air Force plans
to fully implement the system at the remaining air logistics centers by June
2001.

Baseline for Calculating Savings Another obstacle to capturing and
determining actual savings is in the area

Under the Competition Initiative of the competition initiative, which the
Air Force expects to produce about

Has Not Been Updated $2. 1 billion (about 75 percent) of the activity
group's anticipated $2.8 billion

in savings from fiscal years 2000 through 2007. This initiative resulted
from the competition among public and private entities for certain workloads
that were performed at two of the Air Force's five air logistics centers
that are being closed. These workloads were awarded to the three centers
that are to remain open.

Of the $2.1 billion in savings associated with this initiative, $1.5 billion
is based on the difference between the baseline costs (the baseline costs
were derived by determining what it would have cost the Air Force to perform
the work at the two closing logistics centers had they remained open) and
the estimated cost of the workload as bid on and awarded to the three
remaining centers. 23 Any changes in the competed workload from the workload
used in the baseline will make it extremely difficult to determine actual
savings achieved. Specifically, if the amount and/ or type of work does not
materialize as planned, then the workload's associated costs will differ
from those used in the baseline and bid proposals for the competed work, and
as such, render the original baseline virtually useless for measuring
savings achieved.

23 The remaining $0. 6 billion in savings associated with the competition
initiative is based on overhead savings expected to be generated by lower
overhead rates resulting from the increased workload awarded to the
remaining centers (i. e., relatively fixed overhead costs spread over a
larger workload base).

Air Force depot maintenance officials told us that because of all the
workload changes that have occurred thus far, they have no real baseline for
measuring savings that are expected to result from the competition
initiative. The officials acknowledged that the baseline costs should be
revised based on workload changes and the projected savings updated
accordingly. However, they stated that the baseline can not be accurately
revised because they do not have the resources to track all the workload
changes that would enable them to do so.

Calculation of Overhead Savings Disagreement exists internally within the
Air Force regarding the

Achieved Under the Competition methodology used by the activity group to
measure/ calculate overhead

Initiative Questioned savings achieved under the competition initiative
involving maintenance of

the C- 5 aircraft being performed at the Warner Robins Air Logistics Center.
The Air Force Audit Agency, in its review 24 of the overhead savings that
the air logistics center achieved during fiscal year 1998, disagreed with
the $30.3 million in savings the center reported achieving and believed that
the center only achieved $8.4 million in overhead savings.

According to the Air Force Audit Agency, the disagreement involves the
methodology that the Warner Robins Air Logistics Center is using to
calculate overhead savings. When calculating overhead savings attributable
to the C- 5 workload, the center includes both production overhead and
general and administrative expenses that are common across all workloads.
The audit agency maintains that the C- 5 workload is unique (that is, it can
not be attributable to other work performed at the center) and therefore,
production overhead expenses should be excluded from the savings
calculation. Air Force depot maintenance officials, on the other hand,
believe that it is appropriate to include such expenses because some
production overhead, such as aircraft painting operations, is common across
all of the center's workloads.

Similarly, the Defense Contract Audit Agency 25 took exception to the
overhead savings reported by the logistics center on the C- 5 workload in
fiscal year 1999. The center reported that it had overhead savings totaling

24 This review was performed as part of a Management Advisory Service review
requested by the Secretary of the Air Force. 25 The Defense Contract Audit
Agency evaluated the accuracy of the center's reported overhead savings at
the request of the Defense Contract Management Command to assist it in
evaluating the accuracy of the center's reported costs incurred in fiscal
year 1999 for the C- 5 workload.

$6. 3 million. However, the audit agency calculated that the center had lost
$3 million in fiscal year 1999. When calculating the overhead savings
achieved in fiscal year 1999, the center excluded certain overhead expenses
because it believed that they were beyond the center's control. The audit
agency recognized that certain adjustments to expenses are necessary, but
could not agree with the center on the merit of excluding the expenses in
question.

Conclusions The Air Force depot maintenance activity group has not developed
accurate material cost, productivity, and savings estimates for developing

its budgets and prices it charges customers. Because the activity group's
annual budget estimates are based on assumptions that must be made long
before the start of the fiscal year, some variance between budgeted and
actual results is inevitable. However, when assumptions are consistently
overly optimistic, there are systemic problems with the efficiency of the
activity group's operations and/ or the methodology used to develop the
assumptions. As a result, the depot maintenance activity group (1) incurs
financial losses and/ or (2) does not accomplish as much work as expected,
which adversely affects the timeliness of the support that it provides to
its customers.

The Air Force has recognized that it needs to improve the depot maintenance
activity group's budgets and is or has taken a number of actions to correct
the problems. However, to maximize the efficiency and effectiveness of depot
maintenance financial operations, the group must do a better job of
determining its material costs, managing material usage, and developing more
realistic productivity assumptions and savings estimates used for budgeting
purposes. Until the depot maintenance activity group takes such actions, it
will continue to underestimate material costs and make overly optimistic
productivity and savings assumptions.

Recommendations We recommend that the Secretary of the Air Force direct the
Commander, Air Force Materiel Command to do the following.

Develop a methodology that will allow the supply management activity group
to reliably estimate the impact of price changes on the funding requirements
of individual customers, such as the depot maintenance activity group,
during the budget process.

Develop a systematic process to identify and analyze variances between depot
maintenance activities' expected and actual material usage. Develop material
management metrics that will allow Air Force depot

maintenance officials to monitor and determine the causes of material cost
variances which will, in turn, help reduce material cost. At a minimum, the
metrics should provide information on unplanned material issues, issues in
excess of maximum quantities, the accuracy of the Bill of Materials, and
variances from budget estimates. Have an organization external to the air
logistics centers, such as the Air

Force Materiel Command Inspector General, Air Force Audit Agency, or the
Directorate of Logistics, Air Force Materiel Command, periodically inspect
the centers' compliance with Air Force material management policy. Use more
realistic productivity assumptions by considering historical

productivity data in developing future depot maintenance budgets and
developing a detailed plan that specifies how, when, and by whom the
productivity improvements will be achieved. Develop a mechanism that will
enable the depot maintenance activity

group to periodically revise the competed workload baseline cost estimates
by taking into account any changes in the planned workload. Use the revised
baseline cost estimates and actual operating results as a

basis for updating projected savings and adjusting the activity group's
future budgets. Reach agreement with the Air Force Audit Agency and Defense
Contract

Audit Agency on the methodology and factors to be used in calculating
overhead savings attributable to the C- 5 aircraft maintenance workload
being performed at the Warner Robins Air Logistics Center.

Agency Comments In its comments on a draft of this report, the Air Force
concurred with our recommendations and identified actions it was taking to
correct the

identified deficiencies. For example, the Air Force plans to require an
analysis of material usage as a matter of policy and develop material
management metrics that will allow Air Force depot maintenance officials to
monitor and determine causes of material cost variances. DOD comments are
reprinted in appendix I.

We are sending copies of this report to Senator John Warner, Chairman, and
Senator Carl Levin, Ranking Minority Member, Senate Committee on Armed
Services; Senator Ted Stevens, Chairman, and Senator Daniel K. Inouye,
Ranking Minority Member, Subcommittee on Defense, Senate

Committee on Appropriations; Representative Solomon P. Ortiz, Ranking
Minority Member, Subcommittee on Military Readiness, House Committee on
Armed Services; and Representative Jerry Lewis, Chairman, and Representative
John P. Murtha, Ranking Minority Member, Subcommittee on Defense, House
Committee on Appropriations. We are also sending copies of this report to
the Honorable William S. Cohen, Secretary of Defense, and the Honorable F.
Whitten Peters, Secretary of the Air Force. Copies will also be made
available to others upon request. If you have any questions about this
report, please call Greg Pugnetti, Assistant Director, at (202) 512- 6240.
Other key contributors to this report are listed in appendix II.

Sincerely yours, Jack L. Brock, Jr. Director, Governmentwide and Defense
Information Systems Accounting and Information Management Division

David R. Warren Director, Defense Management Issues National Security and
International Affairs Division

Appendi Appendi xes xI Comments From the Department of Defense

Appendi xII

GAO Contacts and Staff Acknowledgments GAO Contact Greg Pugnetti, (202) 512-
6240 Acknowledgments In addition, Cristina Chaplain, Karl J. Gustafson,
William A. Hill, Ron L.

Tobias, and Eddie W. Uyekawa made key contributions to this report.

(511675 and 709456) Lett er

GAO United States General Accounting Office

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Appendix I

Appendix I Comments From the Department of Defense

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Appendix I Comments From the Department of Defense

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Appendix I Comments From the Department of Defense

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Appendix I Comments From the Department of Defense

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Appendix II

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