Until that ambitious effort is complete, nobody will know exactly how bad the overpricing problem is. Initially, the Air Force will screen the 88,000 different items it plans to buy in FY ’84, and then begin expanding the work to cover the 834,000 kinds of spares the Air Force manages.
A special task force called the Air Force Management Analysis Group (AFMAG), however, has now estimated the outer boundaries of the problem and has made comprehensive recommendations for dealing with it.
The AFMAG study, released to the public in November, says the Air Force is vulnerable to overpricing on thirty-one percent of the spare parts it buys. That vulnerability centers on low-value expendable parts. It amounts to a danger zone of some $300 million a year, about six percent of the total spare parts budget.
It will require the efforts of a thousand additional people over several years to find the extent of actual overpricing within those vulnerability percentages and to establish a fair price for each part, AFMAG says.
Deciding What’s Reasonable
Full-blown value engineering work will have to be run on the more complex parts. For simpler ones, the screening may amount to no more than looking at a sample of the part or a picture of it. Up to now, orders for low-cost items have been filled by the numbers, with order fillers seldom having any idea what they were buying.
In fact, the main fuze to the spare parts controversy was lit when the Air Force’s Zero Overprice program finally put the price tag for spare parts into the hands of people who knew what the parts were. (See “Beyond the $916 Stool Cap,” September ’83 issue.) Since that program was begun, sharp-eyed watchers on flight lines and in maintenance shops have reported 18,000 instances where they thought over-charges might have occurred. Excessive costs have been verified in four percent of those cases.
Discovery of overpricing, then, is hardly the rare or random event it is sometimes depicted to be. On the other hand, the Air Force acknowledges that its grasp on the problem is less than total, in large part because of a spare parts data system that one AFMAG spokesman characterizes as “out of the Stone Age.”
Competition and Quantity
“Two major forces contribute to the attainment of economical prices,” the AFMAG said. “They are competition and buying economical quantities.”
The Air Force is least vulnerable to overpricing when it has more than one supplier competing to sell a product. That happy situation exists for only thirty-four percent of the parts bought, representing twenty-two percent of the money spent on spares. (See accompanying chart.) A decade ago, 37.5 percent of all spares were bought on a competitive basis, but since then, a variety of factors has greased the slide to sole sources.
The best substitute for competition is to negotiate a spares buy with audited, certified cost and pricing data. This procedure is followed for about half of the spare parts spending, but is employed mostly for high-value parts.
Barring competition or negotiation with good data, the next best thing is to avoid buying in dribs and drabs. Over the past few years, the Air Force has bought about half of its reparable spare parts in batches of five or fewer, and thirty-nine percent of its non-reparables in quantities of twenty or less. AFMAG figures that the minimum order to get a decent price should be ten reparable items or fifty nonreparable ones.
Repetitive small quantity purchases were frequently made because the spare parts account was under-funded. In addition to driving up the cost of the parts themselves, the succession of small orders added to administrative expense.
Whenever none of these approaches – competition, use of cost and pricing data, or reasonable quantity buys – is taken, the Air Force is wide open to overpricing. That is the zone of vulnerability that AFMAG identified.
The basic story the AFMAG report tells is one of too few people with too little data taking shortcuts in the face of a rising workload. Between 1973 and 1979, Air Force Logistics Command lost more than 22,000 personnel authorizations, and experience levels dropped across the board. This came just as the Air Force was modernizing its tactical fleet and as the amount of spares work to be done was increasing. Big items had to be given priority; so little items were often left to shift for themselves. Any spare part with an annual buy value of less than $7,500 was not even screened as a candidate for competitive procurement when a reorder came in.
Several stopgap-pricing methodologies emerged. One called “statistical pricing” was used for parts in the $1,000 to $5,000 cost range. A sample to ten percent of these items was selected out for individual pricing attention; price proposals for the remaining ninety percent were accepted automatically.
Another approach was “formula pricing,” in which pre-negotiated factors and standards were applied to a buy lot of considerable size. The price of some items in the big lot might be high, others low, but as a total package, it ought to work out about right.
These techniques allowed a limited number of people to cope with a great volume of business, but the potential for overpricing was omnipresent. Until the analysis of all 834,000 parts in the in the inventory is completed, however, it is impossible to say for sure if these methodologies were as faulty as the horror stories suggest.
Still another technique was to rely on price history. If, after factoring out inflation and differences attributable to the size of the buy, the new price was about the same as before, no further checking was done. The weak point here is the assumption that the lasts price paid was reasonable.
Inside the Horror Stories
The outrageous-sounding prices that made the headlines came about in a variety of ways. With the $916 stool cap, for instance, it was a matter of an order processor being totally ignorant of what the item was Boeing was being asked to toll up from scratch to produce two or three little plastic parts. There was not way the Boeing could have produced the item in that quantity at a reasonable price. The solution, no painfully clear, is that such parts should be bought from manufacturers who are in business to produce them – and not bought two or three at a time.
Other spare parts stories have sounded more outrageous than they really were. The AFMAG study describes how the famous Navy diode appeared to leap from four cents to $110.34 because of a quirk in cost allocation. The diode’s misfortune was to be bought as a line item on a spare parts order that also included six power supply units. Following usual procedure, the supplier prorated material-handling costs and overhead equally to each line item on the order, then added profit margins based on the individual totals.
The overall bill to the government was the same as if costs had been allocated to each item according to its intrinsic value. The appearance, however, was that a cosmic price has been paid for the diode. Nobody noticed the great deal on the power supply units.
This isn’t to say that every high-priced spare part can be written off to administrative peculiarities. Prime contractors acquire many parts from subcontractors for resale to the government, usually at an appreciable profit. Sometimes the prime gets the part in a semi-finished condition and must do further work on it. In other instances, the prime may only inspect or repackage the part – or do nothing at all. One Air Logistics Center compared the markup rate on parts by prime contractors and found that it ranged from twenty-eight percent to 250 percent.
The image of bumbling and malfeasance was inflamed last summer when a wildly inaccurate draft report on aircraft engine spares by the Defense Department Inspector General was leaked all over Washington. That draft overlooked 957 instances in which spare parts had decreased in price and grossly overstated the cost increase on others. DoD acknowledged the document was fatally flawed and sent it back to the auditors for reworking, but official debunking of the leaked version has been extraordinarily mild.
Voids in the Data
The heart of the spare parts problem is data, not only to tell the buyers what they’re buying, but also to foster competition among spare parts vendors. Unless the air Force can give valid engineering data to a potential second-source supplier, it is stuck with a single source for a part.
At present, the air Force does not even know the status of data on thirty-nine percent of the parts it has coded with a procurement source code. This is because the value of those items is below the dollar threshold set for screening. Data is either missing or inadequate for another sixteen percent of the parts. And in the case of eight percent, producers claim the data is proprietary – developed by them and the exclusive right to use it held by them.
AFMAG source say that as early work on a system progresses, it is not unusual for 1,000 to 2,000 engineering data changes to be made a month. More changes will come later, although at a slower rate. Too often, the Air Force has taken a square-filling approach to getting data from its contractors. Emphasis has been on format and reporting schedules rather than on collecting accurate data and keeping it current. Based on what they have seen so far, AFMAG analysts suspect that much of the thirty-nine percent now categorized as “unknown” will turn out to be junk.
Inadequacy and unavailability of spare parts information, the AFMAG report says, is “the greatest inhibitor to the Air Force’s ability to increase competition.” Consequently, a major thrust of the Air Force’s response to the problem will be development of good data systems for buying spare parts.
Eventually, it will incorporate the pricing information that the 1,000 new workers come up with. An AFMAG spokes man also envisions the data systems as allowing the call-up of a picture of each part on a desktop computer screen.
The goal is not competition on every spare part. In hot sections of engines, for example, tolerances are so close and traceability of materials is so important that it would be hazardous to try putting vital components together with parts from here and there.
Moreover, the defense industrial base has shrunk from 6,000 suppliers twenty years ago to 3,500 today. That reduces the number of sources available to compete. Many of the remaining suppliers and subcontractors would prefer to continue to deal through prime contractors, thus avoiding the red tape and bureaucratic headaches of selling directly to the government. Small businesses are often scared away by the instability and unpredictability of defense procurements driven by year-to-year budgets instead of multiyear funding.
The AFMAG task force was headed by Maj. Gen. Dewey K. K. Lowe, Commander of Sacramento Air Logistics Center. The group began last June, working under the auspices of the Air Force Inspector General in the Pentagon.
Because of the urgency of the problem and the public uproar about it, AFMAG briefed its findings to top decision-makers as it went along. Some of its recommendations were put into effect immediately.
Each of the five Air Logistics Centers, for example, has already established an office to increase competition in parts purchases and to conduct value analysis of spares prices. Work has already started toward improvement of the spare parts data-processing system.
The group made a long list of specific recommendations. It said the Air Force must buy its parts in economic quantities, and, where it can, use multiyear procurements. As rapidly as possible, shortcut-pricing methods should be dropped in favor of individual parts pricing. Cost allocation procedures should be revised to reflect the intrinsic value of parts, thus avoiding the perception of overpriced parts because of administrative distortion.
With the AFMAG study and other actions taken over recent months, the Air Force has served notice that it will be a very tough, very critical customer when it buys spare parts. The aerospace industry, as embarrassed by the horror stories as the Air Force was, is cooperating fully.
The Air Force has announced that it will eliminate the practice of parts pricing based on statistical sampling techniques. Greater effort will be made to buy spares directly from suppliers.
In FY ’84, USAF’s goal will be to break out spares purchases representing thirty percent of the dollar value of vendor-produced items from prime system contracts. Proprietary data rights will be recognized for only five years after delivery of the first item employing that proprietary data.
With the creation of the new Joint Air Force Acquisition Logistics Center, spare parts and supportability of systems will get more priority in the early stages of future systems.
The great value of the AFMAG report is that it examines the spare parts problem comprehensively and proposes a workable plan for attacking the problem systematically. That, finally, should enable the Air Force to get out of the no-win mode of responding to horror stories one by one and to start dealing with the basic malady instead of the symptoms.