Fifty-four years ago, the brand-new Secretary of Defense Robert McNamara thought he could bring Pentagon spending on everyday items under control by applying efficiencies he had used to help turn around Ford Motor Co.

Instead, he created a monster. McNamara’s creation, known as the Defense Logistics Agency, has grown into a global, $44 billion operation that, were it a private enterprise, would rank in the Fortune 50. Its 25,000 employees process roughly 100,000 orders a day for everything from poultry to pharmaceuticals, precious metals to aircraft parts. In terms of Pentagon contracts, it is nearly as large as Boeing and Lockheed Martin, the Pentagon’s largest contractors, combined.

Air Force Lt. Gen. Andrew Busch is director of the Defense Logistics Agency. "Being audited... puts us in a position to more fully explain to the American public what we're doing with all of those dollars." Denise Parker oversees DLA's audit readiness effort at its network of distribution centers. "When we started we didn't know how to check it as well as we do know." Simone Reba is the DLA's deputy director of finance. "Stuff we thought should be on our books we didn¹t have it in our records. Our financial system was not reflecting the right inventory." Sen. Charles Grassley, a senior member of the Budget and Finance Committees, has demanded the Pentagon undergo a full financial audit for years. "This broken accounting system isn't an option. The Constitution requires that we know where the money is spent." Arnold Punaro is a retired Marine Corps general and the former staff director of the Senate Armed Services Committee. He believes that a major problem with DLA is that it¹s effectively a business "run by three-star [generals or admirals] with no management experience." Mae Devincentis retired as the agency¹s vice director in 2012 after more than three decades at DLA. A major financial challenge for the agency, she says, is its sheer size. "When you get more missions you get a higher level of complexity."


Led by military officials with little or no private-sector experience, DLA lacks the redeeming features of the lean and efficient business McNamara envisioned. A trail of inspector general reports shows how DLA is systemically overcharged for parts. It buys things the military doesn’t need — like 80 years worth of aircraft frames for a plane that will likely be out of use long before then. The Government Accountability Office in 2010 estimated that about half of the agency's inventory — said to be worth nearly $14 billion at the time — was just taking up space.

"How do you buy $7 billion of stuff you don't need?" exclaimed Arnold Punaro, a retired major general in the Marine Corps Reserve who is currently overseeing a special task force on logistics for the Pentagon's Defense Business Board. "If a company did that they'd be out of business. Even Wal-Mart."

Congress is now demanding that the entire Department of Defense undergo its first-ever financial audit. And DLA, which after three years of preparation says it is ready for a full scrub of its books, is the test case. A series of mock audits underway for three years demonstrate the enormous challenge.

“We found out the first year how much we really didn’t know,” Simone Reba, the deputy director of finance for the DLA, said in an interview at the agency’s Fort Belvoir, Virginia, headquarters outside Washington. “Stuff we thought should be on our books we didn’t have it in our records. Our financial system was not reflecting the right inventory."

Even those who are intimately familiar with the Pentagon’s notorious reputation for waste are shocked by what the audits are finding — or rather not finding.

In some instances, DLA recently found, there was simply no way to locate inventory. Remarked Reba: “It seems it would be pretty easy to track a firetruck."

***

In 1961, the administration of John F. Kennedy was new, and so was the thinking among his new generation of "whiz kids" who descended on Washington from Ivy League schools and corporate America. It was a good time to reform a system that had grown flabby and complacent.

Attempts had been made in the previous decade to streamline purchasing by giving each military branch authority over broad sectors — the Army had food and clothing, the Navy had fuel and medical supplies and the Air Force handled electronics, for example. But the lack of uniformity undermined the intent of the reform.

The 44-year-old McNamara, who had spent World War II analyzing the effectiveness of bombers operating in the Pacific theater, was well-suited to the task of reining in a budget for logistics.

It has often been said that the history of the Pentagon was defined by two eras: before McNamara and after McNamara, due to the reforms he initiated in how the armed forces prepared for and fought wars but also the administrative and managerial reforms he instituted.

But the verdict on many of those reforms, like his handling of the Vietnam War, was not always kind.

"Many of his reforms were seen as impractical. Even if they were conceptually sound, the quantity and quality of organizational effort required to carry out McNamara's innovations frequently exceeded the Pentagon's capacity, as well as its will," an assessment published by Harvard University, where McNamara had previously taught, concluded nearly three decades later.

McNamara's order in October of ‘61 established what was then called the Defense Supply Agency, which oversaw eight different supply centers. But it was just the beginning of a consolidation of military supply and logistics activities that advanced over the next several decades.

In the early 1970s, the supply agency went international, put in charge of "worldwide procurement, management, and distribution of coal and bulk petroleum products," as well as all food to feed the troops, according to an official DLA history.

In the 1980s, by which time it had been renamed the Defense Logistics Agency, it was given another mission: stockpiling "strategic materials" such as precious metals and industrial grade diamonds. The materials, once stored in caves and now kept in a bank vault and other secure locations, are hoarded for national security in case a global war cuts off access to international supplies. The diamonds, for instance, are essential to sharpen machine tools and to make components for tanks, warships and bombers.

But as it grew — including taking on the purchasing of some items for other customers such as the Federal Emergency Management Agency and the U.S. Forestry Service and responding to a host of humanitarian disasters around the world — so did the warning signs that DLA was becoming too large for its own good.

A 1999 Pentagon report to Congress estimated that there were 300 separate reform initiatives focused on improving the military's logistics support system — "an unprecedented level of emphasis on management improvement." But all the reforms couldn’t quite solve the problems. The department's inspector general cited "poor logistics management" and "cumbersome financial management” and criticized the Pentagon for paying "excessive prices for spare parts." The review also hit the agency for "poor visibility" over the location of items in transit to military units and for failing to transfer unneeded items to other branches before disposing of them.

The reports — and their monotonously similar complaints — just keep coming.

One recent example is the purchase of spare parts from Bell Helicopter and Boeing for the V-22 Osprey tiltrotor aircraft — a process managed by DLA for the Naval Supply Systems Command.

The Pentagon inspector general reviewed 53 parts at random and discovered that DLA bought 22 too many of them, at a total cost of $9 million. The report concluded, with some understatement, that DLA “did not effectively manage government-owned V-22 Osprey spare parts.”

One of those parts was aircraft frames. Even though on average only two replacements are needed each year, DLA had purchased 166. That's a nearly 80-year supply, which is decades longer than the expected usefulness of the V-22 fleet. The inspector general also estimated that it will cost the Pentagon $700,000 to store all the unneeded equipment over the next five years.

In response to the findings, DLA officials insisted they regularly review quantities of spare parts to prevent "over-procurements." But the investigators found that while the process evaluated existing purchase orders, it "did not evaluate whether existing spare parts inventory quantities were reasonable."

Another recent Pentagon IG report calculated that the government could save $7.2 million over six years if DLA would stop buying cars and trucks for government agencies that didn’t need them.

What it buys, it often overpays for. Earlier this year, DLA contracted to buy aircraft braking systems, but the officer in charge didn’t do a sufficient price analysis, as required by regulations. According to an internal review designated "for official use only," this oversight resulted in $8.5 million being overpaid for 32 different parts that were purchased without seeking other bids.

The GAO, the oversight arm of Congress, has repeatedly flagged systemic management problems at the agency. The congressional watchdog found in 2010 that "the average annual value of the inventory for the 3 years reviewed was about $13.7 billion. Of this total, about $7.1 billion (52 percent) was beyond the amount needed to meet the requirements objective."

Translation: Half of what the DLA has purchased may never be used. Wal-Mart, by comparison, turns over its entire worldwide inventory eight times a year.

"When you get more missions, you get a higher level of complexity," said Mae Devincentis, who retired as the agency's vice director in 2012 after more than three decades at DLA. "That has been part of their problem."

DLA has made some progress becoming more efficient over the years, but a study published earlier this fall by the Center for Strategic and International Studies shows how far it has to go to reach McNamara’s vision. For example, if DLA adopted business practices for spare parts commonly utilized by private industry — particularly the airline industry, the report’s authors suggested — it could save a billion dollars a year.

Punaro, the member of the Defense Business Board, believes a major problem with DLA is that it is effectively a government-run business. But like other similar Pentagon enterprises — including agencies that acquire health and information services or run military commissaries and missile defense programs — it doesn't use the same business practices.

LEFT: "This is kind of hard to read. It's all blurry," remarked a warehouse technician as he inventoried a new shipment of circuit board assemblies at DLA's Pennsylvania distribution center this fall. RIGHT: A DLA lift operator retrieves a bell crank to be packaged and shipped to the USS America. | POLITICO

"They don't treat them like businesses and they don't run them like businesses. They are run by three-star [generals or admirals] with no management experience," said Punaro, who also served as staff director of the Senate Armed Services Committee. "In the private sector, everything runs on one system," he added. At DLA, "they don't have a single database that tracks everything."

Yet Punaro also believes that some of the underlying forces are out of DLA's control.

DLA has "a terrible customer" in the Pentagon, he said. "It has no sense of value or time. No one in the Pentagon is looking for a bargain on most days. It's a cultural thing. These are people that will ship a pallet of water on a C-17” cargo plane.

***

DLA’s inventory flows in and out of 28 massive distribution facilities around the world. One of them is the Susquehanna Distribution Center, in New Cumberland, Pennsylvania, a few hours from Washington.

Inside the sprawling complex is a massive repository, nearly seven stories tall, that has been dubbed the “high rise.” On a recent afternoon, a technician operating an elevated crane slid into the shadows between two of the hulking gray storage towers to retrieve a small bell crank — to be shipped to the USS America.

It took a few minutes to locate the palm-sized item, box it and send it on its way — a success by most measures. But the truth is that no one can say with certainty what the exact contents of this distribution center are, which is why it is ground zero for the attempt to pass a financial audit.

Inside policy circles, the fact that the Pentagon, a $700-billion-a-year enterprise, has never been audited is emblematic of government’s complacency about waste. An accounting of what money comes in and how exactly it goes out, of course, is considered the norm in private industry.

But there’s little that’s routine about an audit of the military, as the Marine Corps’ recent experience attests. In 2013, Pentagon officials selected the Corps, the smallest of the branches, to be audited first. When the Pentagon inspector general last year gave it a clean audit opinion for its 2012 budget, military officials trumpeted it as a major milestone. Then-Secretary of Defense Chuck Hagel even gave the Marine Corps an award.

This year, after further scrutiny by the GAO and others, the audit had to be withdrawn. There were allegations that Pentagon officials approved it even though they knew the books were incomplete and some of the data inaccurate. The accounting firm that prepared the Marine Corps audit, Grant Thornton LLP, was fired earlier this year as a result.

Sen. Chuck Grassley, an Iowa Republican who has been among the most dogged members of Congress in demanding an audit of the Pentagon, took to the Senate floor this summer to rail against the Marine Corps effort, calling it "a disaster."

The DLA is trying desperately to avoid another one. But the challenges are proving immense — requiring an army of independent outside auditors, including one to be selected under a new contract DLA will award early next year.

Audits depend on a paper trail. But DLA has had difficulty locating basic contracts, known as "interdepartmental purchase requests," it inks with other agencies that specify the supplies or services being provided or requested.

"We couldn't find them," Reba, the agency's deputy director of finance, said. "You could show them there was a new roof, but did you pay the right amount? And can you pull those documents very quickly? If it takes you three months to pull it, [the auditors] don't think you have good control over your processes."

***

Across the Pennsylvania distribution center from the "high rise" storage units, a technician sat at a sparsely decorated metal desk with a computer in the middle of the vast facility surrounded by boxes filled with circuit board assemblies, each packaged in a shiny padded envelope.

His task was to make sure all of them were recorded in the computer, the quantities matched with what was originally ordered, they were stored in their designated place and labeled with their correct shelf life, and that the items were also "matched with the purchase manager folks so they know they are in custody and can pay the vendor," explained Denise Parker, who is overseeing DLA's audit readiness efforts at its network of distribution centers.

Easier said than done.

"This is kind of hard to read. It's all blurry," said the warehouse technician.

In another section of the vast facility called the "walk and pick," red bins filled with specialty items lined either side of a long conveyor belt. Employees handpicked the items to fill orders — at a rate of 35 per hour. There were bins filled with signal horns, magnifier lenses, toggle switches, pistol grips, belts, buckles and various types of hoses. Here, as part of the audit prep, DLA has instituted a "floor to book" process designed to physically track supplies and match them with the ledgers.

"When we started, we didn't know how to check it as well as we do now," Parker said. "We didn't know how to audit the transactions as well."

DLA officials stress that unlike the Marine Corps, which completed only a statement of budget activity — outlining budget authority and how it is broadly being spent — DLA is preparing to complete the more rigorous, multistep process followed in the private sector, including preparing a balance sheet that lists assets and liabilities, a statement of yearly revenue and a so-called statement of net position that delineates transactions for several years.

"We are ready for audit. We believe we have done enough to pass. No one is as far along as we are," said Reba.

The hope is the audit of DLA will finally account for how all — or at least the vast majority — of DLA's funds are being spent. And lead to real change.

"We are accountable to the American public for every one of those dollars," Air Force Lt. Gen. Andrew Busch, DLA's current director, told POLITICO in a statement. "Being audited, even just being audit ready, helps us better manage what we do and puts us in a position to more fully explain to the American public what we're doing with all of those dollars."

But he acknowledged the obstacles that lie ahead.

"There is no real experience in DoD to perform audits, no one to scout out the path on how to do this gargantuan task," he explained. "We went through a number of iterations, but it wasn't until we decided to have professional auditors come and show us what it meant to be audited, to prepare for an audit, did we finally realize what right looks like."

Nearly seven stories tall, the "high rise" at the Susquehanna Distribution Center is a massive storage repository operating seven days a week where spare parts, machinery, and other pieces of equipment are stored and shipped to military bases and units around the world.

Passing an independent audit — first at DLA and then across the whole Pentagon — is increasingly seen by the department's own leadership as critical in an era of tighter budgets.

John Conger, a senior Pentagon official, told a Senate panel last month that the Pentagon suffers from a "credibility" problem due to its lack of financial accountability.

"Without a clean audit, it is harder to make the case that we are efficiently using all of the funds Congress has provided us, even as we request more," he said.

"I think a lot is riding on it," added Devincentis, the agency's former vice director. "DLA is viewed as one of the more complex. It will help reveal what it takes to pass these audits. They know there are going to be issues that are going to be uncovered."

If the agency at which she worked for more than three decades can succeed, she added, an enduring challenge will be to remain in an "audit ready state" — in other words, to keep the books accurate.

"You can take a snapshot at a point in time, but the problems arise when you change your processes and change data flows — now you have undone things."

Many who have watched the agency closely for years are deeply wary that the agency can get a clean bill of financial health anytime soon — including Charles Murphy, a longtime aide to Grassley who has tracked the government's lack of financial accountability for more than two decades.

Murphy said he has serious doubts about the accuracy of the data that are available.

"It is not just the documentation that is the problem," Murphy said in an interview. "It is also the accuracy of the accounting information in these systems. You need the documentation to support those entries. But the entries themselves are largely inaccurate. The transaction data is just not reliable."

"This broken accounting system isn't an option," Grassley told POLITICO. "The Constitution requires that we know where the money is spent. So what DLA says they are ready to do? I hope they are right.”

But even the cleanest financial audit in the world won't solve what many observers insist is a much bigger problem:

Why did the agency buy all this stuff in the first place?