Contracting for Depot-Level Maintenance

by Captain John R. Withers

As the Department of Defense seeks to save money and increase its efficiency, more depot-level maintenance is contracted to private companies. But how far should this trend go? The author offers his thoughts on the right mix of Government and commercial involvement in this key logistics function.

    The dissolution of the Soviet Union and the end of the Cold War changed the roles and policies of the U.S. military. During the Cold War, the United States prepared for a protracted major land war in Europe against a numerically superior foe. However, the change in the threat after the Cold War led to reductions in force structure and defense spending. The U.S. military has decreased from over 2 million people in arms to just over 1 million, and the budget needed to support them decreased from $403.5 billion in fiscal year 1986 to $260 billion in fiscal year 1997 (in constant 1997 dollars). Similarly, the portion of the budget devoted to depot maintenance has decreased.

Reduced funding has forced the Department of Defense (DOD) to review all of its programs to ensure that it receives a maximum return on the dollars it spends. Currently, the DOD depot maintenance system consists of 22 depots (down from 36 only a few years ago). These depots are an integral part of the maintenance support for 53,000 combat vehicles, 514,000 wheeled vehicles, 372 ships, and 17,300 aircraft. DOD spends approximately $13 to $14 billion annually for depot maintenance support—roughly 5 percent of the defense budget. As one can see, depot maintenance is big business.

In order to reduce its costs, DOD increasingly relies on third-party companies instead of internal assets to perform depot-level maintenance. But what is the best way for DOD to use third-party logistics companies in depot maintenance? How far should the Government go in turning this vital logistics function over to the private sector? What options are available? And what role should DOD's organic depots play in the future? Here are some thoughts on the changing world of depot-level maintenance.

A Public-Private Mix

Depot-level maintenance primarily entails rebuilding and overhauling equipment. This is the highest level of the DOD maintenance system. It uses industrial-type production lines; requires highly sophisticated skills, tools, and test equipment; and is performed in fixed facilities by civilian technicians.

Depot maintenance today is a mixture of public (DOD organic depots) and private sector (third-party companies) support. Title 10 of the United States Code governs the conduct of depot-level maintenance. It requires that DOD maintain the organic repair capability to meet certain essential wartime demands, sustain institutional expertise, and promote competition. In line with these requirements, the Defense Authorization Act of 1996 directed DOD to develop a comprehensive depot maintenance policy that—

Simply stated, current legislation requires DOD to maintain a public depot system capable of providing depot-level maintenance for mission-essential equipment (commonly referred to as core systems). To improve the cost efficiency of depot maintenance, DOD may open depot-level support to competition between the public and private sectors to obtain the best value. The Defense Authorization Act of 1998 allows DOD to use up to 50 percent of its depot maintenance funds for contracting with third parties to do the work. (Previously, DOD could use only 40 percent of its depot funding for outsourcing depot-level maintenance.)

It is difficult to define "core" and "core competencies" when discussing defense operations. For a commercial business, core competencies are the areas in which the company can achieve a definable preeminence and provide unique value for customers. For Government depots, core refers to the minimum depot size and composition (personnel, skills, and plant equipment) required to support the most intense combination of contingencies specified in the Defense Planning Guidance (currently the two major regional conflict scenarios). Each service establishes core programs using the guidance and methodology provided by the Office of the Secretary of Defense. Examples of core programs for the Army are the M1A1 Abrams tank, the Bradley fighting vehicles, and the Patriot missile launcher. So the Army, by law, must maintain the capability to conduct depot-level repairs on this equipment.

Private Sector Interest in Depot Maintenance

The drawdown of the military in recent years has affected not only DOD but also private industry. In an era of reduced defense procurement, commercial contractors have become more interested in sharing DOD's repair and maintenance work loads. Traditionally, many of these businesses were not interested in maintenance work because of its sporadic nature. However, with fewer new systems being procured, their interest in maintenance is beginning to peak. This interest is one of the factors leading to the current use of a public-private mix to perform depot-level maintenance.

DOD organic depots provide much of the depot maintenance for core equipment, while maintenance of noncore items is open to competition between public and private sources of repair. Typically, whoever can provide the best value for the most efficient cost gets the contract. This support is rather costly because, on the average, life-cycle maintenance (of which depot-level maintenance is a subset) is estimated to be twice the price of a system's acquisition cost. The potential for realizing significant cost savings from outsourcing depot maintenance could be great.

Acquisition program managers decide on the source of repair for their weapon systems. Their decisions drive billions of dollars in support costs and affect near-term investments in support equipment, repair parts, training, and technical data (engineering drawings and technical manuals). In the recent past, acquisition program managers selected organic DOD maintenance depots for core equipment. However, it became obvious that commercial sources could execute depot maintenance work that exceeded organic capacities and capabilities; they also could do the work when DOD's capability had not yet been established. The result has been a trend toward greater private sector involvement in depot-level maintenance. Approximately 10 years ago, organic depots performed the maintenance for 75 percent of all equipment. Today, the private sector provides 40 to 50 percent of depot-level maintenance.

Benefits of a Public-Private Mix

There are three advantages to the current public-private mix in performing depot-level maintenance: competition, cost, and readiness. Most important, according to the General Accounting Office (GAO), is competition. GAO maintains that competition between public and private sources is the main factor in reducing the cost of depot-level repair. This reduction occurs in both the public and private sectors. Competition with the private sector has caused Government depots to use better commercial practices and improve their operations. This has made them more competitive and greatly improved their ability to provide low-cost depot maintenance. Depot maintenance now is cheaper than third-party maintenance 62 percent of the time. Using depot maintenance also meets congressional mandates for readiness. Maintaining organic capability ensures that DOD will meet its requirement of supporting two major regional conflicts simultaneously; the depots will be able to surge quickly to meet increased work load requirements.

However, these advantages do not come without a price. There are disadvantages as well. First, because there are multiple choices for obtaining depot maintenance, the program manager must conduct a thorough cost comparison analysis. This process can be time consuming and possibly expensive. Second, maintaining a public depot system capable of supporting the demands of two major regional conflicts simultaneously means that depots must have excess peacetime capacity. Currently, excess capacity is estimated to be 40 to 45 percent; in other words, DOD depots could conduct 40 to 45 percent more work. This excess capacity translates into the customer paying more for the maintenance performed (although, as we noted, 62 percent of the time depots are cheaper than the private sector).

Outsourcing to Third-Party Companies

In light of all these factors, DOD is looking at alternatives to the public-private mix for obtaining depot-level maintenance. One of the changes under review is using third-party companies to provide all depot maintenance.

Outsourcing is rapidly becoming one of the dominant practices in commercial business today, particularly in logistics. Outsourcing is the transfer of a function previously performed in house to an outside provider. It involves the movement of work, but often not the transfer of responsibility and accountability or oversight, to the external provider. Using a third-party logistics company to provide logistics support is considered outsourcing.

Many businesses find that they can increase their profits by focusing on their core competencies and outsourcing functions not considered core. This is particularly true for maintenance support. For example, Southwest Airlines contracts out all aircraft maintenance to a third-party provider. By doing this, Southwest can avoid costly investments in facilities, personnel, and inventory. It uses the resulting savings to focus on what it does best—providing convenient, efficient air travel at low costs.

How does this compare to the Government, which already has invested billions of dollars in its depot maintenance infrastructure? The current argument for outsourcing revolves around the discussion of core competencies. According to Emmett Paige, former Assistant Secretary of Defense for Command, Control, Communications, and Intelligence, "Anything not directly involved in warfighting should be outsourced." The Commission on Roles and Missions of the Armed Forces established by Congress several years ago found that DOD needed to outsource more functions. It rejected the notion of core systems and recommended outsourcing depot maintenance for all equipment, including all depot maintenance for new weapon systems, to third-party providers. The Defense Science Board, a civilian advisory panel for DOD, has reached similar conclusions. It recommended that DOD only engage in direct warfighting policy, decision making, and oversight activities and that all other activities, especially depot maintenance, be outsourced to third-party providers.

There are several reasons why outsourcing can be the right decision for private companies. Outsourcing can save money, which then can be spent on strengthening core competencies. By concentrating on core competencies, companies can prevent competitors from overtaking them in the marketplace. Outsourcing also leverages the third-party provider's expertise in that particular field. Finally, outsourcing increases flexibility.

Government agencies weigh many of the same factors when considering outsourcing. By turning to outsourcing, they hope to—

Outsourcing thus can be an attractive strategy for DOD as it works to create a smaller, more lethal, and more flexible military force during a time of decreasing funding. As then Deputy Secretary of Defense John White observed several years ago, "Outsourcing and privatization can provide a critical means of obtaining increased funding for the modernization of DOD's military equipment and systems." One of the big candidates for outsourcing, of course, is depot maintenance.

Depot maintenance is outsourced more readily than the other levels of maintenance. Maintenance at depots is similar to private-sector industry in many ways. It is performed in fixed structures, using production-line procedures, by civilian technicians. Commercial contractors produce all DOD equipment and could contract for the life-cycle maintenance of the equipment. Furthermore, some of the DOD equipment inventory has commercial counterparts. For many items, such as small engines and airframes, there are several commercial sources of repair available to choose from, which ensures that there will be competition for DOD maintenance.

Advocates of outsourcing depot maintenance cite many advantages. Outsourcing should result in lower costs. Using third parties also increases DOD's flexibility by allowing it to focus on its core warfighting competencies. Finally, in a period of reduced procurements, outsourcing will help maintain a healthy industrial base.

The Outsourcing Institute claims that outsourcing noncore competencies to third parties saves 10 to 20 percent over performing those functions in house. The Defense Science Board and the Commission on Roles and Missions of the Armed Forces expect DOD to achieve similar savings by outsourcing depot maintenance. They reached this conclusion by comparing possible depot maintenance savings to recent A-76 savings obtained by DOD. (Office of Management and Budget Circular A-76 allows public-private competitions for commercial activities on military installations.) Apparently, DOD saves 20 percent by privatizing food service, grass cutting, civilian personnel administration, and similar functions.

These savings increase DOD's flexibility by allowing the department to focus more time and money on core competencies. DOD can use these funds to finance current force modernization programs. DOD is convinced that 50 percent of the entire logistics budget could be outsourced, which would free $12 billion for modernization and significantly reduce the amount of DOD infrastructure.

Finally, in a time of less defense procurement spending, advocates believe outsourcing depot maintenance will help maintain a healthy industrial base. As previously mentioned, many commercial businesses that were not interested in maintenance work during the Cold War are becoming much more interested now. This is primarily because defense procurements have decreased in recent years.

Downside to Outsourcing

There seem to be numerous advantages for using third parties for all depot maintenance. But there also are disadvantages, and, paradoxically, they include increased costs, reduced competition, and reduced readiness.

GAO has disputed the claims made by the Defense Science Board and the Commission on Roles and Missions of the Armed Forces that outsourcing results in lower costs. A GAO study of 254 items subject to depot-level maintenance in both the public and private sectors found that 201 of those items had higher maintenance costs after being outsourced. The annual net increase in costs was over $6 million. The Navy recently outsourced the depot repair of one of its engines and paid $204 million more annually than when the work was performed in its depots.

Outsourcing advocates claim that outsourcing alone results in lower costs. GAO believes that outsourcing can produce savings but attributes this to the effects of competition, not outsourcing alone. However, DOD outsourcing is not always conducted through competition. This often is caused by the unique nature of much DOD equipment, which does not have commercial counterparts. These DOD-unique items typically have a sole provider (usually the manufacturer), who is able to conduct depot-level maintenance. Since DOD has begun seeking to expand the use of outsourcing, it has been contracting many items from a sole source. Program managers often choose the original equipment manufacturer as the source of repair for depot maintenance.

There also is an alarming trend among procurement program managers of not purchasing the technical data rights for their equipment. Technical data provides the engineering drawings and information needed to repair equipment at the depot level. Not acquiring technical data from the manufacturer severely affects DOD's ability to solicit competition for future depot repairs. As of 1998, 46 of 71 ongoing acquisition programs had made source of repair decisions. Thirty-three of those 46 programs selected private companies as their source for depot-level repair, and 14 of those 33 did not buy the technical data for their equipment. For those 14 programs, future competition for depot maintenance is unlikely. In such cases, DOD is at the mercy of the manufacturer. Unfortunately, most program managers did not conduct a cost comparison before selecting the private sector as the source of repair.

Finally, outsourcing all depot maintenance may reduce readiness. The current depot structure maintains excess capacity to meet the possible surge requirements of two simultaneous major regional conflicts. It is unlikely that commercial maintenance managers will maintain such excess capacity because to do so is costly and cuts into their profit margins. As a consequence, they will not be able to expand production rapidly to meet surge requirements. More importantly, DOD will not have the skilled people it needs to assist in such a situation. GAO believes that outsourcing all depot maintenance will be more expensive and result in unacceptable readiness.

Privatization in Place

Fortunately, there is another choice for the future of depot maintenance: privatization in place. At first glance, this may seem exactly like outsourcing. However, while privatization in place is a type of outsourcing, it has some significant differences.

Privatization in place involves the transfer or sale of Government assets to the private sector. When privatizing, the Government relinquishes control of, and investment in, the activity. As J. Michael Brower, a program specialist with the Immigration and Naturalization Service who previously worked in the Office of the Assistant Secretary of the Army for Financial Management, notes, "The Government farms out the function and often the wherewithal to do it, getting out of a business more logically performed by private sector."

Under privatization in place, DOD turns a depot over to a private contractor. The contractor (a third-party company) then performs depot-level maintenance in the depot using former DOD employees. DOD has outsourced the depot to a third party, but the local community keeps the installation and the jobs. The employees work for a third-party company such as Boeing or United Defense instead of Uncle Sam. Unlike regular outsourcing, which results in the Government closing the depot outright, privatization in place keeps the depot operating and maintains jobs within the local community.

The Defense Science Board and the Commission on Roles and Missions of the Armed Forces claim that privatization in place will result in savings of 20 percent, based on comparisons with recent A-76 savings. Saving jobs in local communities makes privatization in place popular among civilian elected leaders. Emmett Paige warned, in talking about outsourcing all depot maintenance, that one should "expect Congress to defend their constituencies." Perhaps privatization in place represents a good compromise.

The depots that have been privatized in place thus far were slated for closing by the Base Realignment and Closure Commission. Two of them are the Naval Surface Warfare Center, Crane Division, in Kentucky, and the Air Force Aerospace Guidance and Metrology Center (now called the Boeing Guidance Repair Center) in Ohio. Certainly the local communities in these cases were happy that the depots did not close but only changed ownership.

The disadvantage of privatization in place is cost. Again, there is disagreement among agencies about the actual savings realized by privatization in place. According to GAO, privatization in place initiatives have resulted in increased costs rather than cost reductions. A GAO study found that maintenance at the Boeing center in Ohio costs $13 to $23 million more annually than when the Air Force operated the facility, and maintenance at the former Navy Crane facility costs $59 million more annually. This is a great difference from the 10 to 20 percent savings quoted by the Defense Science Board and the Commission on Roles and Missions of the Armed Forces. The main reason for this discrepancy was that the board and the commission compared A-76 competitions, involving relatively low-skilled labor, to depot maintenance that typically requires highly skilled technicians. Furthermore, the A-76 functions require little capital investment for outsourcing, which encourages more companies to compete. Depot maintenance requires much more capital investment and infrastructure, which tends to limit competition.

Each of the alternatives—the existing mix of public and private performance of depot-level maintenance, outsourcing, and privatization in place—has merit. The current depot system offers competition, arguably lower costs, and a ready source of repair personnel in case of national emergency. Completely outsourcing depot maintenance allows DOD to focus on its warfighting competencies by alleviating some of the logistics burden. Privatization in place also alleviates some of the logistics burden while keeping the depots in the local communities.

Three reasons are cited for outsourcing: to reduce costs, to focus on core competencies, and to increase flexibility. The principal reason for outsourcing is reduced costs. However, the outsourcing alternatives do not make a strong case for reduced costs. In fact, investigation by the GAO shows depot maintenance by third-party providers often results in increased costs.

In a period of decreasing budgets and changing missions, DOD must look for ways to increase efficiency and decrease spending. Measures that reduce the $13 to $14 billion spent annually on depot maintenance undoubtedly will free up funds for other requirements such as modernization. Alternatives that use all third-party providers or privatize some depots in place appear, at first glance, to be viable options. However, research shows that the best method of providing depot maintenance is the current one.

Using a mixture of public (depots) and private (third-party companies) sources for depot-level maintenance provides the lowest costs, ensures competition between the public and private sectors, and enhances readiness. To ensure future competition, DOD should continue to buy the technical data rights for all procurements. Availability of technical data allows DOD to open the depot repair of equipment to competition for the best value.

DOD should continue to seek ways to reduce spending and enhance readiness. For now, the best option for performing depot-level maintenance is the current one.

Captain John R. Withers is pursuing a master's degree from the Florida Institute of Technology. He wrote this article in partial fulfillment of the requirements for graduation from the Army Logistics Management College's Logistics Executive Development Course.