Air Force Depot Maintenance:

Improved Pricing and Cost Reduction Practices Needed

GAO-04-498: Published: Jun 17, 2004. Publicly Released: Jun 17, 2004.

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The Air Force depot maintenance activity group in-house operations generate about $5 billion in annual revenue principally by repairing aircraft, missiles, engines, and other assets. In doing so, the group operates under the working capital fund concept, where customers are to be charged the anticipated costs of providing goods and services to them. The group's average price for in-house work almost doubled between fiscal years 2000 and 2004 from $119.99 per hour to $237.84 per hour. GAO was asked to determine (1) what factors were primarily responsible for the price increase, (2) if the prices charged recovered the reported actual costs of performing the work, and (3) if the Air Force has taken effective steps to improve efficiency and control the activity group's costs.

GAO identified five primary factors that showed why the Air Force depot maintenance activity group's average price increased from $119.99 per direct labor hour of work in fiscal year 2000 to $237.84 per hour in fiscal year 2004. An increase in material costs accounted for about 67 percent of the total increase and was by far the most significant factor. The Air Force has identified some of the causes of the higher material costs such as aging aircraft, but has yet to complete an effective and comprehensive analysis of material cost increases. As a result, it (1) cannot quantify the extent to which individual causes contributed to higher costs and (2) does not know if it has identified all of the major causes. GAO's analysis of the other four factors showed that (1) the increase in labor costs was due largely to events beyond the group's control, such as annual salary increases, (2) the increase in business operations costs was due partly to costs related to implementing a new accounting system, (3) a surcharge intended to recoup anticipated losses on work carried over from the previous fiscal year may have been unnecessary, and (4) a surcharge intended to generate additional cash in fiscal year 2004 for the Air Force Working Capital Fund was unnecessary. GAO's analysis showed that due in part to these surcharges (1) the Air Force Working Capital Fund, which includes the depot maintenance and several other activity groups, had a $2.5 billion cash balance as of January 31, 2004 and (2) this balance was more than $1.3 billion higher than the maximum level allowed by DOD policy. Either the Office of the Secretary of Defense or the Congress could use this unneeded cash to satisfy other requirements. DOD officials told us that they are exploring options on what to do with the excess cash. GAO's analysis of the group's financial reports showed that prices charged customers were not set high enough to recover about $1.1 billion of the group's reported costs for fiscal years 2000 through 2003. The activity group is required by DOD policy to set prices to recoup the cost of doing work. However, Air Force officials informed us that the prices were artificially constrained to help ensure that the group's customers would be able to get needed work done with the amount of funds provided to them through the budget process. The Air Force changed its sales price development philosophy to bring prices charged customers in fiscal year 2004 more in line with operating costs. In addition, the Air Force allowed out-of-cycle price increases in fiscal years 2002 and 2003 to alleviate projected losses. Further, the Air Force Materiel Command has not been successful in its efforts to control costs. Although several promising initiatives are underway, the Command has not (1) developed a successful methodology for analyzing the reasons for the rapid material cost increase and (2) effectively utilized an established data repository for sharing cost-saving ideas among the three air logistics centers on process improvements and to demonstrate whether its cost savings initiatives have been successful.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: In response to GAO's recommendation, Congress reduced the Air Force fiscal year 2005 Operations and Maintenance appropriations by $1,133,200,000 due to excessive cash amounts in the Air Force Working Capital Fund.

    Matter: The congressional defense committees have shown interest in the amount of cash in the Defense Working Capital Fund in past years. The Air Force Working Capital Fund cash balance has exceeded the maximum cash requirement by over $1.3 billion for each of the first four months of fiscal year 2004. If DOD does not take action to reduce the cash balance to the 7 to 10 day requirement, the Congress may wish to take action to reduce the amount of excess cash in the Air Force Working Capital Fund.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: DOD concurred with our recommendation and stated that the Air Force would establish a schedule to periodically review the data repository and periodically brief DOD on the status of this initiative. On December 11, 2006, AFMC announced the development and implementation of a new web-based cost/benefit analysis and report planning tool to share standardized process improvement data with the three centers. AFMC has real-time access to all the information in the financial data repository and reviews it at least twice annually for accuracy and usefulness.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of the Air Force should direct the Commander, Air Force Materiel Command to periodically review the data contained in the data repository to (1) determine whether the data provided by the air logistics centers is complete and useful and (2) identify ways to consolidate initiatives and share lessons learned from the initiatives with the three centers.

    Agency Affected: Department of Defense: Department of the Air Force

  2. Status: Closed - Implemented

    Comments: In response to GAO's recommendation, the Command issued a memorandum to the air logistic centers on January 31, 2005, reiterating the requirements contained in the instruction for recording complete and accurate data into the data repository.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of the Air Force should direct the Commander, Air Force Materiel Command to hold the air logistics centers' managers accountable for compliance with the Command's mandatory Instruction 21-137 requiring the centers to enter all initiatives and related data into the data repository completely and accurately. This should include initiative information on costs, return on investment, and quantifiable results for all process improvement initiatives. At a minimum, the Command needs to issue a memorandum to the air logistics centers reiterating their responsibilities for compliance with the instruction.

    Agency Affected: Department of Defense: Department of the Air Force

  3. Status: Closed - Implemented

    Comments: The Air Force implemented a new cost accounting system titled "Depot Maintenance and Production System" that should greatly improve its cost visibility. The system allows the Air Force depots to track costs to specific workloads and improve accuracy of forecasting material increases due to consumption and also improve visibility of material price increases by commodity. In June 2006, a DOD Inspector General official reported that the Air Force had verified to the Office of the Undersecretary of Defense (Comptroller)'s satisfaction that the new cost accounting system provides quality data with orders validated against bills of material and job order numbers to compare actual costs to standards as well as validating quantities and frequencies to better control material costs.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of the Air Force should direct the Commander, Air Force Materiel Command to develop and complete a viable, systematic methodology for analyzing material cost variances that encompasses both the price paid for material and material usage that would enable the Air Force Materiel Command to better understand the underlying causes of the rapidly increasing material costs and take actions to control material costs, as appropriate.

    Agency Affected: Department of Defense: Department of the Air Force

  4. Status: Closed - Implemented

    Comments: In June 2004, GAO reported that the prices that the Air Force depot maintenance activity group charged customers were not set high enough to recover the group's reported costs of performing the work for fiscal years 2000 through 2003. Air Force officials told GAO that the prices were constrained to help ensure that the activity group's customers would be able to get needed work done with the amount of funds provided them through the budgeting process. In part, because the sales prices were constrained, the activity group reported losing about $1.1 billion in the four-year period. GAO recommended that the Secretary of Defense direct the Secretary of the Air Force to develop prices that cover the total cost of providing goods and services to customers and not constrain prices as has been done in the past. DOD concurred with our recommendation and stated that the OSD (Comptroller) would perform a more intensive review of the Air Force depot maintenance billing rates to ensure that the proposed pricing structure is adequate to cover the total cost of operations. Thus, the activity group reported a $307 million accumulated gain in fiscal year 2004 and expects to show a $310 million accumulated gain in fiscal year 2005. Further, at the end of fiscal year 2006, the activity group expects to report a zero accumulated operating result--complying with DOD policy on operating on a break-even basis. By setting the prices to cover the full cost of operations, the activity group can operate on a break-even basis as intended--that is, not make a profit or incur a loss.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of Defense should direct the Secretary of the Air Force to develop prices that cover the total costs of providing goods and services to customers and not constrain prices as has been done in the past.

    Agency Affected: Department of Defense

  5. Status: Closed - Implemented

    Comments: In our draft report dated April 14, 2004, we recommended that the Secretary of Defense take action to reduce the amount of excess cash in the Air Force Working Capital Fund. In responding to this recommendation, Defense took action to eliminate excess cash balances in the Air Force Working Capital Fund. Specifically, on April 28, 2004, Defense transferred $1.1 billion of excess cash from the Air Force Working Capital Fund to the Operation and Maintenance appropriations of the Army ($979 million) and the Navy ($121 million) to meet operational needs. According to a DOD budget official, the transfer reduced DOD's need to request an additional similar amount of funds since the funds were already provided by means of the transfer and used to pay Army and Marine Corps bills.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of Defense should take action to reduce the amount of excess cash in the Air Force Working Capital Fund.

    Agency Affected: Department of Defense

  6. Status: Closed - Implemented

    Comments: In order to track the costs and benefits associated with process improvement initiatives at the depots in compliance with our recommendation, AFMC announced the development and implementation of a new web-based cost/benefit analysis and report planning tool to share standardized process improvement data with the three centers on December 11, 2006. The new tool tracks both tangible and intangible benefits of the process improvement initiatives, along with the process improvement initiatives' costs. The process improvement initiatives' costs and benefits are required to be updated in the database annually for 15 years or until the transformed process is no longer required.

    Recommendation: To improve the business operations of the Air Force Working Capital Fund including cash management and the setting of prices and efforts to control costs of the depot maintenance activity group, the Secretary of the Air Force should direct the Commander, Air Force Materiel Command to summarize and determine the actual savings and/or real benefits as compared to the costs from the improvement initiatives already contained in the repository.

    Agency Affected: Department of Defense: Department of the Air Force

 

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