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Report to the Subcommittee on Readiness and Management Support, 
Committee on Armed Services, U.S. Senate:

United States Government Accountability Office:

GAO:

August 2004:

Defense Management:

Opportunities to Enhance the Implementation of Performance-Based 
Logistics:

GAO-04-715:

GAO Highlights:

Highlights of GAO-04-715, a report to the Subcommittee on Readiness and 
Management Support, Committee on Armed Services, U.S. Senate

Why GAO Did This Study:

The Department of Defense (DOD) is pursuing a policy that promotes 
performance-based logistics at the platform level as the preferred 
product support strategy for its weapon systems, based in part on DOD’s 
perception that this is an industry best practice. GAO was asked to 
compare industry practices for activities using complex and costly 
equipment with life-cycle management issues similar to those of 
military systems to identify lessons learned that can be useful to DOD. 
This is the first of two reports addressing DOD’s implementation of 
performance-based logistics and is intended to facilitate DOD’s 
development of new guidance on the use of this approach.

What GAO Found:

DOD’s current policy for implementing performance-based logistics as a 
preferred support approach at the weapon system platform level does not 
reflect the practices of private-sector companies that support 
expensive and complex equipment with life-cycle management issues. The 
companies GAO interviewed use performance-based contracting as a tool 
rather than as a preferred support concept at the weapon system 
platform level. While 7 of the 14 companies GAO interviewed use some 
type of performance-based contracting, they use it at the subsystem or 
component level—for commodities such as engines, wheels, and brakes—
when it is cost-effective and reduces risk in a noncompetitive 
environment. DOD’s proposed policy of pursuing performance-based 
logistics as the preferred support approach at the platform level 
results in contracting out the program-integration function—a core 
process the private-sector firms consider integral to successful 
business operations. Further, this proposed policy could limit 
opportunities to take advantage of competition when it is available for 
subsystems or components as well as limit opportunities to gain 
purchasing power from volume discounts on components across an entire 
fleet and avoid the administrative costs charged by a prime 
integrator. 

While DOD is proposing the aggressive use of performance-based 
logistics on both older and new weapon system platforms, the companies 
GAO interviewed use performance-based contracting at the subsystem or 
component level when it is cost-effective—often in a noncompetitive 
environment when the manufacturer controls expensive repair parts, such 
as engines. In general company officials said they rely more widely on 
other contracting vehicles, such as time and material contracts, 
particularly for new systems. Company officials noted that in the 
absence of accurate and reliable information on system performance to 
establish a baseline for evaluating the cost-effectiveness of a 
performance-based contract for new systems, the risk of the negotiated 
price’s being excessive is increased. 

The companies GAO interviewed also emphasized the importance of having 
rights to the technical data—such as maintenance drawings, 
specifications, and tolerances—needed to support the management of all 
logistics contracts and, should the service provider arrangements fail, 
to support competition among alternate providers. In contrast, DOD 
program managers often opt to spend limited acquisition dollars on 
increased weapon system capability rather than on rights to the 
technical data—thus limiting their flexibility to perform work in-house 
or to support alternate source development should contractual 
arrangements fail. 

What GAO Recommends:

GAO recommends that DOD (1) revise its policy and guidance to the 
services to reflect the industry practice of using performance-based 
logistics as a tool to achieve economies at the subsystem or component 
level, rather than at the platform-level, and (2) provide for 
sufficient technical data to support alternative support options using 
either the public or the private sector. DOD concurred with our 
recommendations, noting that it would re-emphasize via policy and 
training the use of performance-based logistics at the subsystem level 
and take steps to update acquisition policy to include guidance on 
purchasing rights or long-term access to technical data.

www.gao.gov/cgi-bin/getrpt?GAO-04-715.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact William M. Solis at (202) 
512-8365 or solisw@gao.gov.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

DOD's Current Preferred Approach to Performance-Based Logistics May 
Limit Opportunities for Competition and Savings:

Conclusions:

Recommendations for Executive Action:

Agency Comments and Our Evaluation:

Scope and Methodology:

Appendix I: Comments from the Department of Defense:

Tables:

Table 1: Company Use of Contracting Tools to Outsource Subsystem and 
Component Support:

Table 2: Percentage of Maintenance Dollars for Outsourced Subsystems 
and Components Managed Using Performance-Based Contracts:

Abbreviations:

APU: auxiliary power unit:

DOD: Department of Defense:

United States Government Accountability Office:

Washington, DC 20548:

August 16, 2004:

The Honorable John Ensign: 
Chairman: 
The Honorable Daniel Akaka: 
Ranking Minority Member: 
Subcommittee on Readiness and Management Support: 
Committee on Armed Services: 
United States Senate:

In the past 4 to 5 years, the Department of Defense (DOD) has taken 
steps to manage the total life-cycle support costs of its weapon 
systems and to improve logistics support to the warfighter by 
reengineering its processes for both acquiring and sustaining weapon 
systems. As part of these reengineered processes, DOD has directed 
weapon system program managers to develop acquisition strategies that 
maximize competition, innovation, and interoperability and to 
capitalize on commercial technologies to reduce costs. Within the area 
of weapon system sustainment, DOD is pursuing a policy to implement a 
concept it calls performance-based logistics as the preferred support 
strategy for DOD weapon systems. This concept is a variation on other 
contractor logistics support strategies calling for long-term support 
of military systems by the systems' manufacturers.[Footnote 1] The 
concept involves defining a level of performance for a weapon system 
already fielded or about to be fielded that is to be achieved over a 
fixed period of time for a fixed level of annual funding. More 
recently, in February 2004, the Deputy Secretary of Defense issued a 
memorandum promoting a more aggressive implementation of performance-
based logistics that was in part based on the perception that this is 
an industry best practice.

As requested, we are reviewing DOD's process of implementing 
performance-based logistics as the preferred support strategy for its 
weapon systems. As a part of this review we determined what types of 
contractor logistics support arrangements the private sector uses for 
activities that have complex and costly equipment with life-cycle 
management issues similar to those of military systems, and what 
potential lessons can be learned from a comparison between private-
sector contractor support practices and the contractor logistics 
support practices DOD is urging the services to implement. While 
conducting our work, we learned that DOD soon will be issuing 
additional policy guidance on its use of performance-based logistics. 
This is the first of two GAO reports addressing DOD's implementation of 
performance-based logistics and is intended to provide the Secretary of 
Defense with recommendations that should facilitate DOD's development 
of new guidance. Our follow-on report in early 2005 will determine 
similarities and differences in the way the identified DOD programs are 
structured and managed, identify approaches that appear to offer the 
greatest opportunities to achieve cost effectiveness, and evaluate the 
demonstrated cost savings or improved responsiveness of the new 
DOD concept.

As a part of this review, we examined Office of the Secretary of 
Defense and service policies and guidance; collected data on 
performance-based logistics programs identified by the services; and 
conducted case studies on a limited number of the programs. We also 
reviewed the logistics-contracting practices of 14 private-sector 
companies from the air carrier, maritime shipping, energy exploration, 
mining, and entertainment industries--companies that use complex and 
costly equipment with life-cycle issues similar to those of military 
weapon systems and that are motivated by the desire to minimize costs 
and maximize profits to choose the most cost-effective option.[Footnote 
2] We held group discussions covering standard questions about the 
industries' contractor logistics support practices, and we compared the 
results of these interviews with the preliminary information obtained 
from our analyses of DOD policies and programs. We reviewed the 
reliability of the projected cost and savings data used in this report 
and determined that it was sufficient for our purposes. We performed 
our work from September 2003 through June 2004 in accordance with 
generally accepted government auditing standards. The scope and 
methodology section contains more detailed information about the work 
we performed.

Results in Brief:

DOD's current policy for implementing performance-based logistics as a 
preferred support approach at the weapon system platform level does not 
reflect the practices of private-sector companies that support 
expensive and complex equipment with life-cycle management issues. A 
Deputy Secretary of Defense memorandum to the services cites the 
private sector's use of performance-based logistics as the basis for 
aggressively pursuing this concept. Private-sector companies we 
interviewed having complex and expensive assets with life-cycle issues 
similar to those of military weapon systems do not use performance-
based contracting this way. Although 7 of the 14 companies we 
interviewed use some type of performance-based contracting, they use it 
at the subsystem or component level, when it is cost-effective and 
reduces risk in a noncompetitive environment. The companies rely more 
widely on other contracting methods to benefit from competition for 
those subsystems or components where it is practicable. DOD's approach 
supports aggressive implementation of performance-based logistics at 
the weapon system platform level and for new as well as older systems. 
As a result, DOD's proposed approach to implementing performance-based 
logistics could limit opportunities for achieving cost savings from 
competition, volume discounts, and reduced administrative costs. 
Further, it could result in the contracting out of the program-
integration function--a core process that the private-sector firms 
consider integral to successful business operations. Private-sector 
company officials we interviewed reported that their firms use the 
following approaches:

* Use performance-based contracting selectively when it is cost-
effective--often in a noncompetitive environment when the manufacturer 
controls expensive repair parts, such as engines. In general, company 
officials said they rely more widely on other contracting vehicles, 
such as time and material contracts, particularly for newer systems 
that don't have a performance history. DOD's approach, in contrast, 
proposes aggressive implementation of performance-based contracts on 
both older and newer weapon systems. Company representatives emphasized 
that in the absence of accurate and reliable information on system 
performance to establish a baseline for evaluating the cost-
effectiveness of a performance-based contract for new systems, the risk 
of the negotiated price being excessive is increased.

* Use performance-based logistics at the subsystem or component level, 
such as for engines; DOD's approach, in contrast, proposes to support 
implementation at the weapon system platform level, such as was tried 
for the T-45 trainer aircraft. We found no private-sector performance-
based contracts being used at the platform level. The company 
representatives preferred to retain the program integration function 
that they consider a core function essential to the success of their 
business operations. Additionally, they prefer to (1) take advantage of 
competition when it is available for subsystems or components, (2) gain 
purchasing power from volume discounts on subsystems or components 
across their entire fleet, and (3) avoid the administrative costs that 
would be charged by a prime integrator. Indeed, Navy officials told us 
that the T-45 platform level performance-based logistics contract 
resulted in their paying the contractor for hours that the Navy did not 
fly and that the contract was not cost-effective. But by dividing the 
airframe and engine into separate contracts, adding a sortie completion 
metric, and competing the airframe workload, the Navy projects that 
savings of $144 million ($118 for the airframe and $26 million for the 
engine) can be achieved over 5 years.

* Emphasize the importance of having rights to the technical data 
needed to support the management of all logistics contracts--such as 
detailed maintenance drawings, specifications, and tolerances--and, 
should the companies' service provider arrangements fail, to support 
competition among alternate providers. DOD program managers, in 
contrast, often opt to spend limited acquisition dollars on increased 
weapon system capability rather than on the rights to technical data. 
This trade-off limits DOD's flexibility, because although DOD may be 
obtaining access to technical data needed to manage performance-based 
contracts, it may not be developing product-support strategies that 
provide for the future delivery of technical data when required to 
support competition or alternate source development if performance-
based logistics arrangements were to fail.

We are making recommendations that, if followed and included in the 
soon to be issued guidance, should improve the implementation of 
performance-based logistics in the department. In commenting on a draft 
of this report, DOD concurred with our findings and recommendations. 
DOD's response is included as appendix I.

Background:

Performance-based logistics is the DOD term for the process of 
(1) identifying a level of performance required by the warfighter and 
(2) negotiating a performance-based contract between the government and 
the product support integrator--that is generally the original 
equipment manufacturer of the total system--to provide long-term total 
system support for a weapon system at a fixed level of annual funding. 
Instead of buying spares, repairs, tools, and data in individual 
transactions, the method in a performance-based logistics arrangement 
is to buy a predetermined level of availability that meets the 
warfighter's objectives. To implement performance-based logistics, DOD 
selects a product support integrator to serve as the single point of 
accountability, integrating support from all sources to achieve the 
performance outcome metrics specified in the performance-based support 
agreement. The metrics used include operational availability (a measure 
of the degree to which an item is in an operable state and can be 
committed at the start of a mission when the mission is called for at 
an unknown point in time); mission capability (the material condition, 
indicating that it can perform at least one and potentially all of its 
designated missions); and customer wait time (the total elapsed time 
between issuance of a customer order and fulfillment of that order). 
For example, the Navy now uses two metrics for its performance-based 
contract for the T-45 aircraft system[Footnote 3]--"ready for 
training," which requires that the contractor have a minimum number of 
aircraft ready for training at 7:00 AM each business day in order to 
achieve a 57 percent aircraft availability; and "sortie completion," 
which requires that the contractor meet 98 percent of the requirements 
for the scheduled training flights. As an incentive, the contract pays 
a performance bonus (maximum of $5 million annually) if the contractor 
exceeds the performance metrics. If the contractor only meets--or fails 
to meet--the minimum metrics, the contractor then receives none of the 
annual performance bonus.

DOD Directive 5000.1, the Defense Acquisition System, highlights the 
department's preference for using performance-based logistics at the 
platform level, stating, "Program Managers shall develop and implement 
performance-based logistics strategies that optimize total system 
availability while minimizing cost and logistics footprint." As part of 
its implementation of this strategy, in 2003 DOD proposed that the 
Congress adopt legislative changes that would allow the services to 
increase the appropriations allocation flexibility within a weapon 
system program, allowing the program manager to use funds from 
different accounts (such as operation and maintenance; research, 
development, test, and evaluation; and procurement) to pay for system 
support costs. Although this proposal was not adopted, DOD continues to 
pursue various avenues that would support the overall objective of 
having greater flexibility by using a single line of support funding 
managed by the program office for total system operation and 
maintenance costs. Most recently, on February 4, 2004, the Deputy 
Secretary of Defense (1) directed the Under Secretary of Defense 
(Acquisition, Technology, and Logistics) in conjunction with the Under 
Secretary of Defense (Comptroller) to issue clear guidance on 
purchasing using performance criteria; and (2) directed each service to 
provide a plan to aggressively implement performance-based logistics, 
including transferring appropriate funding as needed,[Footnote 4] on 
current and planned weapon system platforms for fiscal years 2006-2009.

While this directive does not preclude the services from using 
performance-based logistics contracts below the platform level, it does 
express DOD's intent to apply the concept at the platform level as a 
preferred practice. As we discuss in the next section, DOD has 
established separate goals for implementing performance-based service 
contracts, and the services have identified many contracts as 
performance-based logistics arrangements that are, in fact, below the 
platform level. However, according to Office of Secretary of Defense 
officials, DOD would like to implement performance-based logistics at 
the platform level to move from contracting for material availability 
to weapon system availability. DOD considers that the platform level 
offers the metrics needed to implement a true performance-based 
logistics arrangement.

DOD Performance-Based Logistics Evolving from Its Use of Performance-
Based Service Contracting:

The Office of Management and Budget indicates that performance-based 
service contracting, from which performance-based logistics has 
evolved, has been referenced in regulation, guidance, and policy for 
more than two decades, and federal agencies have used performance-based 
contracting to varying degrees for acquiring a range of services. In 
1991 the Office of Management and Budget issued a policy letter 
establishing the use of a performance-based approach for service 
contracting, and in 1994 it initiated a governmentwide pilot project to 
encourage the use of performance-based service contracts in federal 
agencies, including DOD. The use of performance-based service contracts 
to acquire services offers a number of potential benefits, particularly 
when services are acquired by means of a fixed price agreement. 
Performance-based contracts can encourage contractors to be innovative 
and to find cost-effective ways of delivering services for a fixed 
level of funding. By shifting the focus from process to results, these 
contracts can potentially produce better outcomes and reduced costs.

In view of the potential benefits, Congress has been encouraging 
greater use of performance-based service contracting.[Footnote 5] In an 
August 2003 memorandum to the military departments, the Under Secretary 
of Defense (Acquisition, Technology and Logistics) stated that DOD 
should continue to increase its use of performance-based service 
acquisitions. He noted that DOD has a goal to award 50 percent of 
contract actions and dollars using performance-based specifications by 
fiscal year 2005.

The more specific concept of performance-based logistics as an approach 
for supporting military systems emerged from DOD's 1999 study, Product 
Support for the 21st Century, which identified 30 pilot programs (10 in 
each military department) to test logistics support reengineering 
concepts that placed greater reliance on the private sector. Many of 
the pilots involved various types of contractor logistics support, 
prime vendor support, or performance-based type arrangements. Others 
focused on including reduced operation and support costs and improved 
readiness as performance requirements for new system 
development.[Footnote 6] The September 30, 2001, Quadrennial Defense 
Review advanced DOD's move toward this concept by advocating the 
implementation of performance-based logistics with appropriate metrics 
that would be designed to compress the supply chain and improve the 
readiness of major weapon systems and commodities. [Footnote 7] A 
November 2001 Office of the Deputy Under Secretary of Defense document, 
Product Support for the 21st Century: A Program Manager's Guide to 
Buying Performance, intended as a guide for program managers, stated 
that program managers will implement performance-based logistics on all 
new systems and on acquisition category I and II fielded systems 
selected on the basis of a sound business case.

It is unclear how many performance-based logistics programs the 
services have implemented. In response to our inquiries, the Army 
identified 74 performance-based logistics programs, the Navy identified 
106, the Air Force 4, and the Marine Corps 1. We noted a broad range of 
contract arrangements is identified under the performance-based 
logistics umbrella, with many of them initiated under a different name, 
such as contractor logistics support or total systems support 
responsibility and later identified as performance-based logistics 
arrangements. Most of the DOD performance-based logistics arrangements 
currently identified by the services are used for subsystems or 
components rather than for weapon system platforms.

Fiscal years 2003 to 2007 Defense Planning Guidance required the 
services to submit plans that identified their implementation schedules 
for performance-based logistics to all new weapon systems and 
acquisition category I and II fielded systems. Similarly, a February 
13, 2002, letter from the Under Secretary of Defense (Acquisition, 
Technology, and Logistics) to the services emphasized the need for the 
plans required by the Defense Planning Guidance and directed that the 
plans be issued by May 1, 2002.

But although the services issued plans, they did not take an aggressive 
approach toward adopting this concept, according to Office of Secretary 
of Defense logistics officials. An October 2003 Defense Business Board 
report encouraged the department to move more quickly in adopting the 
performance-based logistics, stating, "Performance-based logistics is 
an industry best practice and a DOD best practice. DOD should consider 
using it for all its weapon systems, new and legacy, provided it is 
supported by a business-case analysis."[Footnote 8] This task force was 
chartered by the Under Secretary of Defense (Comptroller) and Chief 
Financial Officer to describe private-sector best practices used in 
managing supply chain partnering arrangements and to propose how to 
apply such practices to the supply chain processes used by DOD. Citing 
this task force report, the aforementioned February 2004 Deputy 
Secretary of Defense memorandum to the military departments stated, 
"Delay in implementing this practice complicates our funding, limits 
industry flexibility, and increases DOD inventory. We must streamline 
our contracting and financing mechanisms aggressively to buy 
availability and readiness measured by performance criteria."[Footnote 
9]

DOD's Current Preferred Approach to Performance-Based Logistics May 
Limit Opportunities for Competition and Savings:

Because DOD proposes using performance-based logistics at the platform 
level as the predominant support strategy for its military systems, it 
may limit opportunities for savings from competition, volume discounts, 
and reduced administrative costs. Also, by often not contracting for 
long-term access to technical data, programs officials are further 
limiting their support options.

In the private sector, performance-based contracting is a tool used 
according to the applicability of subsystem or component and 
circumstance, when it is cost-effective and reduces risk in a 
noncompetitive environment. DOD, by contrast, proposes using it as the 
predominant product support strategy for its military systems. Further, 
when private-sector companies use performance-based contracting, they 
use it at the subsystem or component level, retaining the program 
integration function themselves as a core business function essential 
to successful business operations. Conversely, DOD policy memoranda 
support using performance-based contracting at the platform level and 
using the contractor as the support integrator. Moreover, private 
sector companies emphasize the importance of having the rights to 
contracts and competition. DOD, in contrast, is frequently not 
acquiring the same level of technical data in its acquisition of new 
programs.

Performance-Based Contracting for Logistics Used as a Tool in Industry 
Rather Than a Preferred Support Concept as Proposed by DOD:

While our review of private sector companies did find that half of 
those we interviewed are using performance-based contracting, the 
industry approach is much different from DOD's preferred approach for 
performance-based logistics. As previously discussed, Office of the 
Secretary of Defense guidance has over the past several years 
encouraged the services to use performance-based logistics at the 
weapon system level as the preferred approach for life-cycle management 
of military systems. DOD officials have stated that this is an industry 
best practice and should be adopted more aggressively, but in 7 of 14 
companies we interviewed that used some type of performance-based 
contracting, this agreement was used at the subsystem or component 
level--that is, for engines, auxiliary power units, wheels, or brakes-
-and it was generally used for older systems.

The following chart characterizes the companies we interviewed by 
industry type, by the extent to which they outsource logistics support 
activities, by the predominant contracting practices used, and by the 
types of subsystems or components outsourced using performance-based 
contracting. Pseudonyms are used rather than the actual company names. 
These companies generate annual revenue generally exceeding $1 billion, 
and they use complex and expensive equipment for which they require 
high levels of availability and reliability as well as efficiency in 
managing lifecycle costs. The life-cycle management issues are 
comparable to those of DOD in managing its weapon system sustainment 
programs.

Table 1: Company Use of Contracting Tools to Outsource Subsystem and 
Component Support:

Industry/company: Air carrier industry: Company A; 
Percent outsourced: 65%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Airframes.

Industry/company: Air carrier industry: Company A; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, auxiliary power units 
(APUs), avionics, wheels and brakes.

Industry/company: Air carrier industry: Company B; 
Percent outsourced: 20%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Airframe, engines, avionics.

Industry/company: Air carrier industry: Company B; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: APUs, avionics, wheels and brakes.

Industry/company: Air carrier industry: Company C; 
Percent outsourced: 38%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Engines.

Industry/company: Air carrier industry: Company C; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, APUs.

Industry/company: Air carrier industry: Company D; 
Percent outsourced: 90%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Airframes, engines, APUs, avionics.

Industry/company: Air carrier industry: Company D; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, avionics, wheels and 
brakes.

Industry/company: Air carrier industry: Company E; 
Percent outsourced: 76%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Airframes, engines, avionics.

Industry/company: Air carrier industry: Company E; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, APUs, wheels and brakes.

Industry/company: Air carrier industry: Company F; 
Percent outsourced: 33%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Airframes, engines, APUs, avionics.

Industry/company: Air carrier industry: Company F; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, APUs, brakes.

Industry/company: Energy exploration and mining industries: Company G; 
Percent outsourced: 75%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Engines.

Industry/company: Energy exploration and mining industries: Company G; 
Predominate type of contracting tool: Performance-based; 
Subsystem or component outsourced: Engines, transmission, torque 
converters, wheels and brakes.

Industry/company: Energy exploration and mining industries: Company H; 
Percent outsourced: 5%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: All components.

Industry/company: Energy exploration and mining industries: Company I; 
Percent outsourced: 65%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Engines, pumps.

Industry/company: Energy exploration and mining industries: Company J; 
Percent outsourced: 65%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Engines, hydraulics, pumps, 
transmissions.

Industry/company: Maritime and entertainment industries: Company K; 
Percent outsourced: 75%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Subsystems/components.

Industry/company: Maritime and entertainment industries: Company L; 
Percent outsourced: 75%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Subsystems/components.

Industry/company: Maritime and entertainment industries: Company M; 
Percent outsourced: 35%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Subsystems/components.

Industry/company: Maritime and entertainment industries: Company N; 
Percent outsourced: 20%; 
Predominate type of contracting tool: Fixed price--time and material; 
Subsystem or component outsourced: Subsystems/components. 

Source: GAO analysis of company data.

[End of table]

As shown above, performance-based contracting in the companies we 
interviewed is most widely used in the air carrier industry, and it 
also has limited use in the energy exploration and mining industry. 
According to air carrier officials, time and material contracts are 
more prevalent than performance contracts, because industry prefers to 
use short-term (2 to 3 years) competitive contracts when possible. In a 
sole-source environment companies sometimes use longer-term (10 to12 
years) performance-based contracts for supporting some subsystems such 
as engines, if they have sufficient historical data to establish an 
accurate baseline. For example, all but one of the air carrier industry 
companies had performance-based contracts for one or more engines. The 
amount of engine workload managed by performance-based contracts varied 
from company to company. For example, Company C, which outsourced 
38 percent of its total maintenance workload, used performance-based 
contracts for one-fifth of its outsourced engine work; while Company A, 
which outsourced 65 percent of its maintenance workload, used 
performance-based contracts for all of its engine work. The air carrier 
companies did not use performance-based contracts for contracted work 
on airframes, work that generally comprises about 30 percent of the 
commercial aviation maintenance and repair market.[Footnote 10] Table 2 
provides information regarding the percentage of dollars spent on the 
repair of each type of subsystem or component managed using 
performance-based contracts by the air carrier companies and the one 
non-air carrier company that used performance-based contracts. The 
subsystems or components for which the companies used performance-based 
contracts most widely were auxiliary power units and wheels and brakes.

Table 2: Percentage of Maintenance Dollars for Outsourced Subsystems 
and Components Managed Using Performance-Based Contracts:

Out sourced subsystems and components: Engines; 
Companies: A: 100%; 
Companies: B: 0%; 
Companies: C: 20%; 
Companies: D: 90%; 
Companies: E: 57%; 
Companies: F: 28%; 
Companies: G: 45%.

Out sourced subsystems and components: Auxiliary power units; 
Companies: A: 90%; 
Companies: B: 100%; 
Companies: C: 100%; 
Companies: D: 0%; 
Companies: E: 100%; 
Companies: F: 41%; 
Companies: G: N/A.

Out sourced subsystems and components: Avionics; 
Companies: A: 36%; 
Companies: B: 35%; 
Companies: C: 0%; 
Companies: D: 5%; 
Companies: E: 0%; 
Companies: F: 0%; 
Companies: G: N/A.

Out sourced subsystems and components: Wheels and brakes; 
Companies: A: 100%; 
Companies: B: 100%; 
Companies: C: 0%; 
Companies: D: 100%; 
Companies: E: 100%; 
Companies: F: 80%[A]; 
Companies: G: 25%.

Out sourced subsystems and components: Transmission and torque 
converters; 
Companies: A: N/A; 
Companies: B: N/A; 
Companies: C: N/A; 
Companies: D: N/A; 
Companies: E: N/A; 
Companies: F: N/A; 
Companies: G: 100%. 

Source: GAO analysis of company data.

Note: N/A = Not applicable because some subsystems and components are 
not applicable to all industries.

[A] Includes only brakes. Wheels are maintained in-house.

[End of table]

Company officials noted that performance-based contracts are a tool 
most often used selectively in a noncompetitive environment in an 
effort to control cost and reduce risk. Additionally, they said that 
performance-based contracting works better for subsystems and 
components where available cost and performance data are sufficient to 
establish a good business case analysis, noting that this is more 
difficult to accomplish for new systems, where performance data are 
uncertain. Performance-based contracts differ from traditional 
logistics contracts by focusing on the purchase of weapon system 
sustainment as an integrated package based on output measures--such as 
a predetermined level of system availability. In contrast, traditional 
transaction-based time and material contracts are used to purchase 
logistics inputs--such as quantities of spare parts, specific repair 
tasks, and engineering studies. Under transaction-based contracts, the 
government pays for each transaction as a separate deliverable; whereas 
under a performance-based contract, the contractor is being paid for 
achieving an outcome performance metric, regardless of what he does to 
achieve that performance.

In concept, performance-based contracts encourage the contractor to 
achieve a high level of performance at a fixed cost. However, air 
carrier industry officials we interviewed said that entering into a 
performance-based contract without good baseline data introduces a 
higher level of risk that the arrangement may not be cost-effective. 
For example, officials from one company said they used a performance-
based contract for the older of the two types of engines in the 
company's inventory. Officials said they would wait to collect 
sufficient performance data on the newer engine before considering a 
performance-based contract. The officials noted that they had 
originally used a performance-based contract on the newer engine, but 
found that, because the reliability of the engine was greater than 
expected, the contract arrangement was not cost-effective. The company 
was able to change the contract to a time and material contract, to 
allow time to collect sufficient performance data to support a fact-
based business case analysis to determine the company's "should" cost 
amount for a performance-based contract.

Performance-based contracting offers DOD opportunities to 
provide contractors incentives to achieve desired levels of operational 
performance at a fixed cost when the department has historical 
performance information. But in the absence of reliable and 
complete performance data as a baseline, the adoption of this approach 
as the preferred support strategy for new weapon systems could 
undermine DOD's ability to negotiate cost-effective terms--
particularly since the performance-based contracts at the weapon system 
level have cost-reimbursement elements, while the private-sector 
companies generally used fixed-price agreements. Private-sector 
officials noted that it is important to use fixed prices for materials, 
since the high price of materials is a key factor driving the companies 
to use performance-based contracts.

Private Sector Applies Performance-Based Logistics at the Subsystem or 
Component Level Rather Than at the Platform Level and Retains System 
Integrator Function:

DOD policy promotes using performance-based contracting differently 
from the way private-sector firms use it in supporting complex and 
expensive systems. The companies we reviewed generally used 
performance-based contracting at the subsystem level for engines and 
certain other components rather than at the platform level, as proposed 
by DOD. Furthermore, when using performance-based contracting, these 
companies do not contract out the program integration function, as the 
military services are doing.

We found no performance-based contracts for maintenance of airframes or 
maintenance of any equipment platform among the private-sector 
companies we reviewed. Industry officials cited three reasons why they 
believe the use of performance contracts is more advantageous at the 
subsystem or component level. First, they prefer to take advantage of 
competition whenever it is available and to manage support contracts 
through the use of competitive procedures. For example, because 
airframe maintenance support is available from a competitive market, 
the companies generally use a combination of fixed price and time and 
material contracts for this category of service. Conversely, 
performance-based contracts are often used for engine repair because of 
the high cost of spare and repair parts that are available only from 
the original equipment manufacturer. Officials said that there are too 
few third-party repair vendors to foster competition. Second, company 
officials emphasized the importance of gaining purchasing power from 
volume discounts on subsystems or components across their entire fleet 
of systems as a reason for not implementing performance contracting at 
the platform level. Finally, by having contracts at the subsystem or 
component level, companies can avoid the administrative costs that 
would be charged by a prime integrator.

Similar to the approach used by the companies we reviewed, we noted 
that the Navy has used performance-based contracts primarily at the 
subsystem or component level. Navy officials said that implementation 
at this level is easier because the service could implement this 
concept more readily under DOD's current funding structure. The funding 
is handled through the working capital fund, with reimbursement to the 
fund coming from the sale of subsystems or components to the fleet. 
Navy officials also noted that by implementing performance-based 
logistics at this level, they can save money by competing subsystems or 
components where a competitive market exists, consolidating the 
requirements of multiple programs and leveraging their buying power to 
obtain a pricing advantage, and reducing administrative costs--
advantages also recognized by the private sector.

The Navy's history of using a performance-based contract for logistics 
support of the T-45 trainer aircraft illustrates how savings may be 
achieved by implementing the concept at the subsystem level rather than 
the weapon system level. The program office originally had a 
performance-based contract for the entire weapon system with the 
original equipment manufacturer. The contract was a 5-year firm-fixed 
price with an option for a sixth year period. Program office officials 
said the sole metric used, ready-for-training aircraft, resulted in 
there being an insufficient number of aircraft available to fly 
scheduled training sorties. Additionally, because actual flying hours 
were fewer than forecasted, the Navy was paying for flying hours it was 
not flying. Concluding that benefits weren't as expected, that the 
costs were too high, and that savings were achievable by negotiating 
separate contracts for the airframe and engine, the program office 
chose not to exercise the option. The new engine contract is a 
performance-based contract awarded on a sole-source basis to the engine 
manufacturer, and the airframe performance-based contract was awarded 
competitively. According to Navy program office officials, the revised 
approach resulted in a projected savings of $37 million in the first 
year and projected savings of $144 million at the end of a 5-year 
period.[Footnote 11] The savings are being achieved through elimination 
of the administrative costs charged by the prime contractor for the 
engine work and through competition for the aircraft system.

Another potential adverse effect of awarding a performance-based 
contract at the weapon system level is the loss of management control 
and expertise over the system that private-sector firms said was 
essential to the success of their business operations. Industry 
officials said that managing their supplier base and ensuring the 
availability of their equipment to generate revenue is too critical to 
entrust to a second party. Further, they believe that contracting out 
support at a platform level by using a system integrator limits the 
potential to optimize savings through competition and volume discounts 
and adds administrative costs charged by the prime integrator for 
managing subcontractors.

Not Obtaining Sufficient Rights to Technical Data Could Limit Long-Term 
Support Options and Could Increase Long-Term Costs:

The spokespersons for every company we visited told us that when they 
purchase equipment they make sure to acquire the technical 
data[Footnote 12] necessary to support it, regardless of whether the 
company intends to support the equipment in-house or outsource some of 
its support operations. Company officials said that this data was 
essential to their own management and oversight functions. For example, 
officials from a company that outsources most of its repairs pointed 
out that its engineers use the data to perform such tasks as 
establishing reliability metrics, evaluating performance, and revising 
repair standards. Additionally, officials stated that owning the 
technical data afforded their companies the flexibility that enabled 
them either to perform the work in-house or to offer the work up for 
competition. Several company officials said that it is best to obtain 
the technical data at the time the equipment is purchased, when the 
buyer has the most leverage in its negotiations with the manufacturer. 
Trying to obtain the technical data at a later time is difficult to 
negotiate and more expensive. These companies do not price their 
technical data items separately. DOD program offices, however, 
negotiate a price for maintenance-and-repair technical data separately 
from the price of the military hardware systems. According to service 
competition-advocate officials, program managers faced with limited 
acquisition dollars often make trade-off decisions to buy increased 
weapon system capability in lieu of technical data.

We reported in 2002 that DOD program offices have often failed to put 
adequate emphasis on obtaining needed technical data during the 
acquisition process.[Footnote 13] We recommended that DOD emphasize the 
importance of obtaining technical data and consider including a priced 
option for the purchase of technical data when considering proposals 
for new weapon systems or modifications to existing systems. DOD 
concurred with our recommendation, noting that there was a requirement 
in DOD 5000.2R for program offices to provide long-term access to data 
required for the competitive sourcing of systems support throughout the 
life cycle. Additionally, by implementing total life-cycle systems 
management, DOD would strengthen its emphasis on acquiring technical 
data when negotiating support agreements with logistics providers. 
Nonetheless, the DOD has further diminished the emphasis it places on 
the need to acquire rights to technical data. For example, in May 2003, 
DOD replaced its acquisition regulation with a streamlined 
instruction,[Footnote 14] which eliminated the prior regulation's 
requirement for the program manager to provide for long-term access to 
data required for the competitive sourcing of weapon system support 
throughout the life cycle of the system. This language is now provided 
as guidance in the Interim Defense Acquisition Guidebook, but it is not 
mandatory that this guidance be followed.

According to DOD and service logistics officials, program managers 
should develop strategies that provide the government with sufficient 
and affordable technical data rights to enable them to put the work out 
for competition or develop alternate public or private sources for 
weapon system support if performance-based logistics arrangements fail 
or become too expensive. Logistics officials recognize that program 
managers who implement performance-based logistics contracts on new 
weapon systems may wish to delay taking delivery of technical data 
early in the life of the system, because unlike the stable designs of 
commercial equipment purchased in the private sector, the data for 
cutting edge technology lacks maturity and is frequently changed. 
Alternatively, program managers sometimes pay the original equipment 
manufacturers both to maintain the technical and weapon system 
configuration data and to provide the program managers with sufficient 
access to enable them to manage and oversee the performance-based 
logistics contract. However, logistics officials agree that the product 
support strategy should clearly provide for the future delivery of the 
technical data when required to support competition or alternative 
source development.

Service logistics and competition-advocate officials said that it is 
critical that this strategy be developed during the weapon system 
acquisition phase, when the program office has its greatest leverage in 
negotiating the price of the technical data and the conditions under 
which the manufacturer must deliver the data. For example, in the 
course of the acquisition of the V-22 aircraft engine, the Navy program 
office obtained a technical data license agreement, according to which 
the manufacturer agreed to deliver a complete data package if it failed 
to perform in compliance with the statement of work at the agreed-to 
price and schedule. Conversely, when the program office does not obtain 
the technical data at the time of purchase, the future costs for 
obtaining these data are not knowable and, without the leverage of the 
original package purchase, could be prohibitively expensive. In our 
review of data collected from DOD's performance-based logistics program 
offices, we noted that DOD had not negotiated for the maintenance 
drawing packages for the Javelin missile, F-117 aircraft, and TOW 
missile improved target acquisition system, and DOD would have to 
purchase them at a later date at a price to be negotiated.

In April 2004, the Logistics Management Institute reported in a review 
of performance-based logistics arrangements that it found no evidence 
to indicate either the quantity or the quality of logistics management 
data--including technical data--available to the government was 
compromised by the use of performance-based logistics 
arrangements.[Footnote 15] This report also noted, however, that the 
acquisition guidance published by the Office of the Secretary of 
Defense does not address strategies for terminating interim contractor 
support or performance-based logistics contracts. The Logistics 
Management Institute report recommended that the Defense Acquisition 
Working Group include performance-based logistics "exit strategy" 
guidance in the defense acquisition guidebook. Nonetheless, as we have 
previously noted, guidance in this handbook is not mandatory.

Conclusions:

The use of performance-based contracting for the support of complex 
and costly military systems offers opportunities for military program 
managers to incentivize contractors to achieve desired levels of weapon 
system performance. However, our review of the use of the practice in 
private-sector firms indicates that DOD's proposed guidance to adopt 
performance-based logistics aggressively at the platform level could 
limit competition, and such guidance might not be the most cost-
effective approach for using this concept. Additionally, although DOD 
based its rationale for using performance-based logistics at least 
partially on the perception that this is an industry best practice, it 
appears that perception is not the case. DOD's approach toward 
implementing the concept appears inconsistent with the way private-
sector companies we interviewed use performance-based contracting in 
acquiring support for their equipment, and DOD's approach has risks 
that should be addressed as it develops its guidance for using 
performance-based logistics.

Using performance-based logistics as the preferred approach for 
managing the support of major weapon system programs--even though 
private-sector company officials use performance-based contracting 
selectively, when appropriate and cost-effective--carries the risk of 
increasing life-cycle cost. Both private-and public-sector experiences 
with performance-based contracting illuminate the challenges involved 
in developing a meaningful baseline for establishing a performance-
based arrangement for new systems, because not enough is known early in 
the program about performance characteristics and because there is risk 
to both the program office and the contractor that may translate into 
high cost. Additionally, the use of performance-based logistics can 
limit the competition that would be available for providing logistics 
support when support decisions are made at the subsystem or component 
level rather than at the platform level. Using performance-based 
logistics at the platform level also creates risk by contracting out 
the program integration function--a core function that private 
contractors consider essential for the cost-effective management of 
costly and complex systems over their life cycle.

Finally, adopting performance-based logistics at the weapon system 
platform level may be influencing program offices to obtain access only 
to technical data necessary to manage the performance-based contract 
during the acquisition phase--and not to provide a strategy for the 
future delivery of technical data in case the performance-based 
arrangement fails. In such a case, the program manager would have 
limited flexibility in choosing whether to perform maintenance in-
house, select an alternative vendor, or offer the work for competition.

Recommendations for Executive Action:

In order for the department to improve the implementation of 
performance-based logistics, we recommend that the Secretary of Defense 
direct that the Under Secretary of Defense (Acquisition, Technology and 
Logistics) and the Under Secretary of Defense (Comptroller) implement 
the following two recommendations:

1. Incorporate in DOD's guidance to the services the private sector's 
practice of using performance-based logistics as a tool to achieve 
economies at the subsystem or component level, rather than as a 
preferred practice at the platform level. Also, incorporate the private 
sector's practice of using it when sufficient performance data are 
available to establish a meaningful cost baseline and:

2. Consider requiring program offices, during weapon system 
acquisition, to develop acquisition strategies that provide for the 
future delivery of sufficient technical data to enable the program 
office to select an alternate source--public or private--or to offer 
the work out for competition if the performance-based arrangement fails 
or becomes prohibitively expensive.

Agency Comments and Our Evaluation:

In commenting on a draft of this report, DOD concurred with our 
recommendations to enhance the implementation of performance-based 
logistics.

Regarding our recommendation to incorporate in its performance-based 
logistics guidance to the services the private sector's practice of 
using performance-based logistics as a tool to achieve economies at the 
subsystem or component level, DOD's response stated that the department 
recognizes the need to re-emphasize the use of performance-based 
logistics for subsystems and components in its policy memorandum and 
guide books. Nonetheless, the response noted that the department 
believes that it is still prudent to pursue performance-based logistics 
strategies at the platform level where supported by a business case 
analysis. The private sector companies we interviewed noted that the 
more cost effective alternative is to use competitive procedures where 
practicable at the subsystem or component level supported by a cost 
analysis using reliable performance data.

Regarding our comment that DOD also incorporate in its guidance the 
private sector practice of using performance-based logistics when 
sufficient performance data are available to establish a meaningful 
cost baseline, DOD stated that its policy is that a business case 
analysis should be performed to help make the determination to use 
performance-based logistics or traditional logistics support 
arrangement, and that the business case analysis incorporate the use of 
performance data, if available, in establishing a meaningful cost 
baseline. DOD stated that it will emphasize the use of performance data 
in a revised policy memorandum on performance-based logistics. However, 
based on information we obtained from the private sector companies we 
interviewed, developing reliable cost and performance data to support a 
valid cost analysis at the platform level for a new system will be a 
challenge and may not be reliable in identifying the most cost-
effective support option over the life cycle of the system. As we noted 
in our report, one company tried a performance-based contract for a new 
engine but found that because the reliability of the engine was greater 
than expected, this contract management was not cost-effective. Company 
officials said they preferred to collect reliable performance data over 
a period of time to support negotiations for a performance-based 
contract.

In response to our recommendation to consider requiring program offices 
to develop acquisition strategies that provide for the future delivery 
of sufficient technical data to select an alternate source--public or 
private--or to offer the work out for competition if the performance-
based arrangement fails or becomes prohibitively expensive, DOD stated 
that it will take steps to address this issue in the next iteration of 
the DOD Directive 5000.1 and DOD Instruction 5000.2 acquisition 
regulation policy. According to the response, the new policy will 
require the program manager to establish a data management strategy 
that requires access to the minimum data necessary to sustain the 
fielded system, recompete or reconstitute sustainment if necessary, 
promote real time access vice delivery of the data, and provide for the 
availability of quality data at the point of need for the intended 
user. According to DOD, for performance-based logistics arrangements, 
these actions will include acquiring the appropriate technical data to 
support an exit strategy should the arrangement fail or become too 
expensive.

Scope and Methodology:

The objectives of our review were to determine (1) what types of 
contractor support practices the private sector used to support complex 
and costly equipment that have life-cycle management issues similar to 
military weapons systems and (2) what potential lessons could be 
learned through a comparison of private sector contractor logistics 
support practices that DOD currently uses, or plans to use, under its 
implementation of performance-based logistics.

To identify commercial industries that use complex and costly equipment 
with life-cycle management issues similar to military weapon systems, 
we interviewed DOD depot maintenance and logistics policy officials. We 
also conducted a literature search to identify appropriate industry 
groups and interviewed officials from the Industrial College of the 
Armed Forces, the Aerospace Industries Association, the American 
Association of Port Authorities, International Council of Cruise Lines, 
the Society for Mining Metallurgy and Exploration, the Construction 
Industry Institute, and the Council of Logistics Management to validate 
and refine the identified industries and to identify appropriate 
candidate companies within the industry groups. Within the air carrier, 
maritime shipping, energy exploration, mining, and entertainment 
industries, we identified over 250 companies and selected 67 companies 
based on sales/revenues, production rankings, and management awards 
that might be good candidates for our study. We eliminated three 
companies that did not outsource significant amounts of logistics 
support, and 50 companies either did not respond to our initial 
inquires or declined to participate in the study. Fourteen companies 
agreed to participate and completed our interviews and follow-up 
questions. Thirteen of the 14 companies we interviewed agreed to be 
identified and are listed below by industry group: Air carriers 
(Continental Airlines, Houston, Texas; Delta Air Lines, Atlanta, 
Georgia; FedEx Corp., Memphis, Tennessee; Southwest Airlines, Dallas, 
Texas; and United Airlines, San Francisco, California); Energy 
Exploration and Mining (British Petroleum, Houston, Texas; Diamond 
Offshore, Houston, Texas; Phelps Dodge, Phoenix, Arizona; and Vulcan 
Material, Birmingham, Alabama); Maritime (Carnival Cruises, Miami, 
Florida; Conoco Philips Polar Tanker, Long Beach, California; and 
Disney Cruise, Orlando, Florida); and Entertainment (Disney World, 
Orlando, Florida).

To identify private sector support practices, including performance-
based logistics, we conducted group discussions with respective company 
officials responsible for maintenance and support operations, 
budgeting, and contracting. To collect consistent information among the 
companies, we developed standard group discussion questions based on 
our literature search and discussions with industry experts. We also 
included questions to determine how the companies addressed logistics 
and contracting issues similar to those that DOD faced in implementing 
performance-based logistics. We analyzed the responses to identify the 
prevailing industry practices in supporting complex and costly 
equipment, especially focusing on the contracting approaches and 
practices used to outsource support functions and activities.

We reviewed and discussed with Office of the Secretary of Defense and 
military department officials at the headquarters and major acquisition 
commands the department's plans, policies, and procedures for using 
performance-based logistics. We also collected policy and guidance 
(published and under development) by the Office of the Secretary of 
Defense as well as the military departments' policies and 
implementation plans.

To assess what lessons could be drawn from the private sector 
companies' experiences to guide DOD's logistics support efforts, we 
interviewed DOD officials and reviewed ongoing logistics programs. We 
assessed the reliability of the projected cost and savings data we used 
in this report by reviewing supporting documentation and interviewing 
knowledgeable personnel; and we determined that it was sufficient for 
our purposes. We compared and contrasted the contract logistic 
approaches and practices used by private sector activities with those 
currently used by DOD and envisioned under its plans for implementing 
performance-based logistics. This comparison included such elements as 
the (1) use of performance-based contracting and the extent of its 
application, (2) assigning a single integrator for equipment or weapons 
system maintenance and logistics support on a platform level, 
(3) management and oversight including the importance of technical 
data, and (4) the degree of competitive sourcing and the importance of 
leveraging purchasing power. As part of our continuing review we are 
also conducting case studies on DOD performance-based logistics weapon 
systems to further compare the new DOD approach and practices with 
those of the private sector. This work is continuing and we expect to 
complete our final report early in 2005.

We performed our work from September 2003 through June 2004 in 
accordance with generally accepted government auditing standards.

We are sending copies of this report to the appropriate congressional 
committees, and it will be available at no charge on GAO's Web site at 
http://www.gao.gov. We are continuing with our review of performance-
based logistics in the private sector and in DOD and plan to report the 
results early in 2005.

If you or your staff have any questions on the matters discussed in 
this letter, please contact me at (202) 512-8412 or solisw@gao.gov or 
my assistant director, Julia Denman, at (202) 512-4290 or 
denmanj@gao.gov. Larry Junek, Thom Barger, Pamela Valentine, Judith 
Collins, and Cheryl Weissman were major contributors to this report.

Signed by: 

William Solis, Director: 
Defense Capabilities and Management:

[End of section]

Appendix I: Comments from the Department of Defense:

Note: A GAO comment supplementing those in the report text appears at 
the end of this appendix.

Note: Page numbers in the draft report may differ from those in this 
report.

DEPUTY UNDER SECRETARY OF DEFENSE FOR LOGISTICS AND MATERIEL READINESS:  
3500 DEFENSE PENTAGON: 
WASHINGTON, DC 20301-3500:

July 30, 2004:

Mr. William Solis:
Director, Defense Capabilities and Management: 
U.S. General Accounting Office:
441 G Street, N.W.: 
Washington, DC 20548:

Dear Mr. Solis,

This is the Department of Defense (DoD) response to the GAO draft 
report, "DEFENSE MANAGEMENT: Opportunities to Enhance the 
Implementation of Performance-Based Logistics," dated July 6, 2004 (GAO 
Code 350424/GAO-04-715).

The Department concurs with the findings and recommendations presented 
in the report. The findings indicate that industry on the whole uses 
Performance-Based Logistics (PBL)-type arrangements on the subsystem or 
component level, as opposed to an entire platform. The DoD will re-
emphasize via policy and training the use of PBL at the subsystem and 
component level as well as the platform level where viable. Regarding 
the finding on technical data, the Department concurs, and will take 
steps to update Acquisition Policy documents such as the 5000 series of 
DoD regulations to include guidance to Program Managers on purchasing 
rights or long term access to technical data.

Detailed DoD comments on the draft GAO recommendations are provided in 
the enclosure. The DoD appreciates the opportunity to comment on the 
draft report.

Sincerely,

Signed for: 

Bradley Berkson 
Acting:

Attachment As stated:

GAO DRAFT REPORT - DATED JULY 6, 2004 GAO CODE 350424/GAO-04-715:

"DEFENSE MANAGEMENT: Opportunities to Enhance the Implementation of 
Performance-Based Logistics":

DEPARTMENT OF DEFENSE COMMENTS TO THE RECOMMENDATIONS:

RECOMMENDATION 1: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Acquisition, Technology and 
Logistics) and the Under Secretary of Defense (Comptroller) incorporate 
in DoD's guidance to the Services the private sector's practice of 
using performance-based logistics as a tool to achieve economies at the 
subsystem or component level, rather than as a preferred practice at 
the platform level. Also, incorporate the private sector's practice of 
using it when sufficient performance data are available to establish a 
meaningful cost baseline. (Page 22/GAO Draft Report):

DOD RESPONSE: Concur. The DoD believes it is prudent to pursue PBL 
strategies at the platform level where supported by a business case 
analysis, but we also recognize the need to re-emphasize the use of PBL 
for subsystems and components. The vast majority of current DoD PBLs 
are at the component or subsystem level. The Department will continue 
to focus on that aspect in future policy memoranda and guidebooks. 
Regarding the private sector practice of using PBLs when there is 
sufficient performance data to establish a meaningful cost baseline, 
the Department has stated in policy that a Business Case Analysis 
should be performed to help make the determination to use PBL, and the 
BCA should incorporate use of performance data, if available, in 
establishing a meaningful cost baseline. The Department will emphasize 
this in our upcoming revised policy memoranda on PBL.

RECOMMENDATION 2: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Acquisition, Technology and 
Logistics) and the Under Secretary of Defense (Comptroller) to consider 
requiring program offices, during weapon system acquisition, to develop 
acquisition strategies that provide for future delivery of sufficient 
technical data to enable the program office to select an alternate 
source-public or private-or to offer the work out for competition if 
the performance-based arrangement fails or becomes prohibitively 
expensive. (Page 22/GAO Draft Report):

DOD RESPONSE: Concur. As stated in the draft report on pages 18-19, the 
DoD had previously required Program Managers to ensure long term access 
to technical data in the previous edition of the DoD Regulation 5000.2-
R, but this was rescinded in 2002. The Department concurs that 
technical, product, and logistics data should be acquired by the PM to 
support the development, production, operation, sustainment, 
improvement, demilitarization 
and disposal of a system. Data management guidance has been added to 
the Defense Acquisition Guidebook and the draft updated "Performance 
Based Logistics: A Program Manager's Product Support Guide" which is 
currently in coordination. Both of these documents convey the 
importance of having a Data Management strategy that considers life 
cycle requirements in the decision to acquire data for use throughout 
the product life cycle. However, since these documents are guidance in 
nature and not considered "mandatory" by the Program Managers, the 
Department will take steps to include, in the next iteration of the 
DoDD 5000.1 and DoDl 5000.2 acquisition regulations, policy that will 
require the program manager to establish a data management strategy 
that requires access to the minimum data necessary to sustain the 
fielded system, recompete or reconstitute sustainment if necessary, 
promote real time access vice delivery of data, and provide for the 
availability of quality data at the point of need for the intended 
user. For a PBL arrangement, this will include acquiring the 
appropriate technical data needed to support an exit strategy should 
the PBL fail or become too expensive. 

GAO's Comment:

1. Only 7 of the 14 companies we interviewed use some type 
of performance-based contracting arrangements. None of the 
performance-based arrangements in the seven companies using them were 
at the platform level.

[End of section]

FOOTNOTES

[1] There is a performance-based logistics agreement between the 
program office and the Tobyhanna Army Depot to support the Common 
Ground Station.

[2] This equipment includes airline and air cargo aircraft, cruise 
ships and oil tankers, heavy mining equipment, offshore drilling and 
production platforms, and unique electronic equipment.

[3] Initially the Navy had one contract for the entire T-45 aircraft 
system and had only one metric, aircraft availability, for evaluating 
the contract. Under this approach the Navy was paying the contractor 
based on its forecasted flying hours rather than actual hours. Because 
forecasted hours were more than actual hours, the Navy paid for hours 
it was not flying. The Navy added the second metric and a fixed labor 
rate for over-and-above work when it revised the T-45 performance 
approach and negotiated separate contracts for the aircraft and engine 
systems. 

[4] DOD officials suggest this might involve establishing a single line 
of accounting for all operations and maintenance funding for a program 
that would be managed by the system program office. Today, operation 
and maintenance funds are managed by different parties including the 
operational commands, the weapon system managers, and the program 
offices. We have previously reported that warfighters have expressed a 
concern about the loss of flexibility of operational commanders when 
system operation and maintenance funding is fenced and controlled by 
the program manager. See U.S. General Accounting Office, Defense 
Logistics: Air Force Lacks Data to Assess Contractor Logistics Support 
Approaches, GAO-01-618 (Washington, D.C.: Sept. 7, 2001) and Defense 
Logistics: Opportunities to Improve the Army's and Navy's Decision-
making Process for Weapons Systems Support, GAO-02-306 (Washington, 
D.C.: Feb. 28, 2002).

[5] In October 2000, Congress passed section 821 (b) of the National 
Defense Authorization Act for Fiscal Year 2001, which allows DOD to 
treat performance-based service contracts or task orders as contracts 
for the procurement of commercial items under certain conditions 
(Public Law No. 106-398).

[6] U.S. General Accounting Office, Best Practices: Setting 
Requirements Differently Could Reduce Total Ownership Costs, GAO-03-57 
(Washington, D.C.: Feb. 11, 2003), emphasized the need to include total 
ownership cost goals and readiness rates as performance metrics equal 
to any others in the development of major weapon systems. 

[7] Supply chain management refers to all of the inter-related 
components and processes required to ensure that the correct amount of 
product is in the correct location at the right time and at the lowest 
cost. 

[8] The Supply Chain/Performance-Based Logistics Task Group's October 
15, 2003, report to the Senior Executive Council provided this group's 
perspective regarding what needed to be done to implement performance-
based logistics in the Department of Defense. 

[9] Memorandum from the Deputy Secretary of Defense to the Secretaries 
of the Military Departments and the Under Secretary of Defense 
(Comptroller), February 4, 2004.

[10] Additionally, 29 percent of the total is for engines, 23 percent 
for line maintenance, and 19 percent for components.

[11] The savings estimates were calculated independent of the program 
office by the Naval Air System Command's cost estimators within the 
Research and Engineering Competency, and they follow a standard 
methodology called the "Maintenance and Trade Analysis." A baseline was 
established by updating the original baseline cost analysis supporting 
the initial contract with actual costs from the 2001 through 2004. The 
calculation also quantified the pass-through administrative cost 
charged by the prime contractor for the engine work. This analysis 
identified that the Navy would save $118 million on the new 
competitively awarded airframe contract and $26 million on the new 
engine contract.

[12] Technical data includes detail maintenance drawings and repair 
publications containing specifications and tolerances.

[13] U.S. General Accounting Office, Defense Logistics: Opportunities 
to Improve the Army's and Navy's Decision-making Process for Weapons 
Systems Support, GAO-02-306 (Washington, D.C.: Feb. 28, 2002). 

[14] DOD Regulation 5000.2-R, Mandatory Procedures for Major Defense 
Acquisition Programs and Major Automated Information System Acquisition 
Programs was replaced by DOD instruction 5000.2, Operation of the 
Defense Acquisition System, to create a simplified and flexible 
management framework for acquisition. 

[15] Logistics Management Institute, Visibility of Maintenance Data in 
Performance-Based Logistics Arrangements, LG301L4 (McLean, Va.: Apr. 
2004.)

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