Cheaper Spare Parts

Savings: $6.26 million per-year. Approximately 12.4% annual savings
The Defense Logistics Agency entered into a long-term (12 year) contract with Honeywell International, Inc. for provision of spare parts in June 2000. By 2008, DLA began to wonder if the escalated-for-inflation prices it was then paying for certain parts were fair and reasonable. A LSS project involving Government and Honeywell personnel investigated the prices and determined they should be reduced by 9.4 percent ($9.5 million). The project also cancelled another $3.2 million of parts that were overprocured via automated ordering procedures. This case demonstrates the ability of LSS to contribute to solving a problem that has perplexed the U.S. Government for the past five decades.

Problem

For the past 50 years, Congress and the Federal Government have tried various methods to avoid paying excess prices for spare parts that must be bought on non-competitively-awarded, sole-source contracts. From the Truth in Negotiations Act (TINA), to spare parts breakout, to commercial pricing, the overarching goal has always been to reduce prices for spare parts regardless of whether cost-based or price-based procurement procedures were used.

In the 1980s, various audits, Congressional investigations and media disclosures indicated that the Department of Defense (DoD) paid excessive prices for spare parts and supplies. These findings caused both DoD and Congress to take action to improve pricing procedures for spare parts.

Starting in 1998, various audits by the DoD Inspector General again showed that DoD was paying excessive prices for many spare parts and supplies. One of these audits found that the Defense Logistics Agency (DLA) was not able to effectively negotiate fair and reasonable prices for sole-source, noncommercial spare parts procured from Allied Signal Corporation (now Honeywell International, Inc.). In fact, this audit showed that DLA was paying 18% more in price than what would be considered fair and reasonable.

To address this problem, The DLA Director and the Under Secretary of Defense for Acquisition Reform chartered a Rapid Improvement Team to develop a new "Strategic Supplier Alliance" between DLA and Honeywell. This was done and a contract was awarded to Honeywell in June 2000. For this contract (which had a duration of 12 years) prices were negotiated using what is known as the one-pass pricing process. This process included an escalation provision which was designed to provide adjustments to the contract prices that resulted from changes in the national economy so that Honeywell realized neither economic benefit nor loss during the contract period. The contract did not, however, contain a provision for re-pricing anywhere in the 12-year period.

By 2008, concerns started to arise regarding the length of the contract, the lack of a pricing review and the effectiveness of the one-pass pricing process which had been used eight years earlier. To address these concerns, a Lean Six Sigma (LSS) project was initiated in early 2009. Its purpose was to determine whether the one-pass pricing process was valid and if actual prices over the contract term had increased in line with inflation. (1)

Approach

DLA formed a multi-functional team to execute this project with representatives from its own organization, the DoD Office of the Inspector, the DoD LSS Project Office and Honeywell. The team analyzed contract pricing data from 2006, 2007 and 2008, performed extensive statistical analyses, performed As-Is (current state) and To-Be (future state) process mapping and used Cause and Effect analyses to study the situation. The team selected 348 individual spare parts from the contract population of 2,826 for detailed analysis. A metric was defined which judged prices as being acceptable if they remained within a band of plus/minus 15% from the original contract price. Parts for which prices fluctuated outside this band were judged to be "defects." (2)

Results

The analysis found that only 40% of parts were within the acceptable band. 60% were outside it. The actual price increase was determined to be 21.3%. From these findings, the team concluded that a re-pricing mechanism was needed within the contract at the three to five year mark in order to effectively control pricing. For the 348 parts selected, re-pricing was performed and prices were reduced by $9.5 million. This represented a 9.4% reduction in the price of these parts and is projected to result in recurring savings of $3.16 million annually. Further, DLA was able to cancel another $3.2 million of over-procured parts that were bought via automated procedures (another 3% savings).

In addition to the above direct dollar savings, this project also served to shorten the one-pass pricing process from 36 weeks to the range of 12 to 16 weeks by adding a re-pricing step later in the contract term. The improvements to this process have been incorporated into standard operating procedures. DLA also reduced its administrative lead time per contract by 84% to only nine days. Honeywell also reduced administrative costs. (3)

The true significance of this project, though, is the contribution that LSS was able to make to a problem that has been a nagging concern of DoD for decades. Spare parts always need to be bought and DoD buys lots of them. For the upcoming fiscal year 2012, approximately $2.8 billion of spare parts are projected to be bought. (4) If LSS could be applied to all of these procurements and similar results (12.4% total savings) as for the DLA/Honeywell contract could be obtained, savings on the order of almost $350 million could be obtained. It is possible this would bring to an end the continuing problems DoD has experienced with respect to spare parts procurements.

1. Department of Defense Inspector General Report No. D-2011-042, "LSS Project-DLA/Honeywell Long-Term Contract Model Using One-Pass Pricing for Sole-Source Spare Parts," 18 February 2011
2. DoD/IG Report D-2011-042
3. DoD-IG Report D-2011-042
4. Department of Defense Procurement Program for Fiscal Year 2012, P-1 Document, February 2011