Cashing In on Contractors

By Katherine McIntire Peters

June 1, 1996

Three years after the Walter Reed Army Medical Center began stocking its pharmacies through a commercial vendor, the results are still astonishing to Fred Sharp, chief of automation and budget in the center's directorate of logistics.

The center previously used seven warehouses to store pharmaceutical supplies, but now it needs just half of one. As a result, the center cut 32 staff positions and saved $400,000 in annual leasing and utility costs. One former warehouse was converted to a medical training and convention center, which generates about $1.2 million in revenue annually.

By 1993, the year Walter Reed began participating in the Defense Logistics Agency's prime vendor demonstration project, the facility's pharmacy budget was rising 7 percent to 10 percent a year. The first year under the prime vendor contract, expenditures dropped by 7.6 percent, for a savings of $2 million, Sharp says. Since then, spending has held steady with inflation. Cuts in supply, staffing and property costs, and the adoption of modern business practices have resulted in an annual savings of about $7 million.

Defense officials estimate they have saved $1.5 billion a year by "outsourcing," or contracting for services previously provided in-house. Outsourcing has been so successful, Pentagon leaders launched a campaign to substantially increase it. To that end, the Pentagon has proposed legislation that would exempt Defense from many of the legal constraints that prohibit the transfer of government work to the private sector. Current law requires 60 percent of core logistics work be performed by government employees. Pentagon leaders want Congress to repeal that law and grant a broader definition of core functions.

"We will not outsource things which we consider core; that is, activities that the military considers to be central to the mission and where there would be too much risk if we were to ask the private sector to do it," says Deputy Secretary of Defense John White. In addition, the Defense Department will not contract out work for which there is not a competitive market.

"The legal constraint [the 60-40 rule] which we are asking relief from does inhibit us from what we think . . . is the best mix to provide us with the best outcome in terms of efficiency, effectiveness and responsiveness to our strategy," White says. If the rule is lifted, service officials predict the amount of in-house depot work would fall to 56 percent in the Army, 51 percent in the Navy and 46 percent in the Air Force.

White anticipates further savings "in the billions" as the military services transfer more support functions to the private sector. "I can't give you a number because we haven't done all the analyses. But we're convinced that there are major opportunities for savings," he says. Savings will be plowed back into the services' weapons modernization programs, which have sustained heavy cuts in recent Defense budgets.

Among the new initiatives, the Air Force will contract out software maintenance on the B-2 stealth bomber and maintenance on the F-117 combat aircraft. Military officials also are considering contracting out more non-depot work in areas such as base operations, warehouse management, housing maintenance and transportation.

"The Defense Logistics Agency has been a leader in terms of the efficiencies that can be gained from outsourcing," White says. The agency's prime vendor program is one example of how the agency is trying to leverage commercial business practices and the private sector to improve service and cut costs. The prime vendor program uses commercial distributors and electronic data processing to supply geographically clustered customers. The program has cut costs by dramatically reducing storage and handling costs for a variety of products used at Defense.

Better Service

At Walter Reed, the prime vendor program for pharmaceuticals has been a boon to service. The contract ensures pharmaceutical supplies will be delivered within 24 hours-a significant improvement over the previous system, in which an employee would type up a purchase request, pass it up the chain of command to a contracting officer, who would shop around for the best deal and make a purchase. If a pharmacist was lucky, supplies would arrive a month later.

Because the requisition system was so cumbersome, Walter Reed was paying thousands of dollars in penalties for late payments to vendors. Under the new system, orders and payments are placed electronically, virtually eliminating payment penalties for considerable savings. In March, for example, Walter Reed paid $20,000 in non-prime vendor penalties, compared with $60 in prime-vendor penalties, Sharp says.

Walter Reed is negotiating additional prime vendor contracts for other medical supplies, although some of those are proving to be more difficult than the pharmaceuticals, Sharp says. Because pharmaceuticals carry a national drug code under Federal Drug Administration regulations, it is relatively easy to compare prices and products among different vendors. But other medical supplies are not regulated the same way. For example, the same bandage may be identified under several different catalog numbers, depending on the vendor, and prices may vary widely.

To get a handle on the situation, Walter Reed officials have decided that beginning in June, medical supplies to be considered for purchase under the prime vendor program must carry a unit product number from the manufacturer. That way, identical products marketed by different companies can be identified as the same product.

"We're trying to get to the point where we have five or six prime vendors to handle all supplies," Sharp says. If the pharmaceutical program is any indication of how things will go, the Defense Department can expect to reap big savings.


By Katherine McIntire Peters

June 1, 1996

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