HD34 - Review of the Virginia Distribution Center


Executive Summary:
Item 20 of the 2000 Appropriation Act directed the Joint Legislative Audit and Review Commission (JLARC) to study the distribution of food and housekeeping products from the Virginia Distribution Center (VDC) to State and local government agencies (Appendix A). The review included an examination of VDC's current operations and financing, the adequacy of VDC's services and products, the appropriateness of VDC as a mandated source of food and housekeeping products, and the impact of this mandate on State agencies. The review also examined alternative approaches for the distribution of food and housekeeping products for State and local government agencies and the feasibility of either privatizing VDC's services or expanding its services to local government agencies and nonprofit organizations.

VDC, which is located in Richmond, was created in 1960. Since its establishment, VDC's mission has been to purchase high volume, standardized items for resale to State agencies and localities. It currently offers more than 900 products, most of which are food and food-related items, janitorial supplies, and paper products. It does not stock perishable foods such as produce. While available to all State agencies and local governments, VDC's primary customers are prisons, mental health and mental retardation facilities, and universities - agencies with substantial food and janitorial supply requirements. It is a mandatory source of food and housekeeping products for State agencies and an optional source of supplies for local government agencies.

The Department of General Services (DGS) has statutory authority over VDC and is responsible for administering it. VDC operates as an internal service fund, covering its expenses with an eight percent markup on all goods sold.

The JLARC staff's review of the VDC and of agencies' processes for procuring food and housekeeping products resulted in the following findings:

• There are important differences across State agencies in terms of their food and housekeeping product and service needs. These differences, in turn, affect the determination of which product delivery system best meets the needs of each agency.

• VDC's products and services currently appear to meet the food and housekeeping product requirements of institutional organizations such as the Department of Corrections (DOC) and Department of Mental Health, Mental Retardation and Substance Abuse Services (DMHMRSAS) in a cost-effective manner.

• However, VDC faces some operational and financial challenges that it needs to address to remain viable. In particular, VDC's sales have been flat during the past few years while its expenses have increased. With the additional commitment to pay for a new warehouse out of VDC earnings, a rate adjustment, additional sales, and control of expenses appear needed.

• VDC does not appear to adequately meet the food product requirements of retail-oriented customers such as the State's public four-year universities. Instead, these agencies may be better served by use of a prime vendor (a single wholesale distributor that provides the majority of an agency's product needs).

Framework for Assessing Food and Housekeeping Product Procurement Approaches

There were three primary questions that guided the JLARC assessment of food and housekeeping product procurement approaches:

• Which approach provides the level of product quality needed?

• Which approach provides the level of service needed?

• Which approach is the least costly, given the set of quality and service requirements?

JLARC staff found that the food and housekeeping product and service needs of agency users vary by the type of agency. DOC and DMHMRSAS operate institutions that provide meals daily to more than 38,000 persons who are either incarcerated or hospitalized. Together, these two large State agencies accounted for 72 percent of VDC's sales in FY 2000 (see figure page III). These agencies purchase the majority of their food and housekeeping products from the VDC.

VDC's major institutional customers (DOC and DMHMRSAS) serve populations with requirements quite different from those of the other major category of purchaser the institutions of higher education. Universities have food service operations that more nearly mirror retail food establishments. Currently, Radford University, Christopher Newport University (CNU) and Virginia Tech are the only three public universities that operate their own dining facilities. The other 12 public four-year colleges and universities contract with managed food service providers that handle all aspects of their food service programs, including food procurement.

Meeting the nutritional needs of an incarcerated or hospitalized population that is totally dependent upon the institution for basic sustenance diverges from meeting the needs of college students who expect to have many food options. The types of food services provided by these State agencies with widely varying missions in turn drive their food product and inventory requirements. For example, due to security concerns, staff at DOC facilities prefer to minimize the number of vendors and deliveries. They also have taken steps to reduce the number of food products used. In contrast, universities have complex food service operations that use an extensive range of food products and require frequent deliveries. Based on these differing product and service needs, it does not appear that a "one size fits all" approach is appropriate for Virginia's government agencies.

VDC Generally Meets the Food and Housekeeping Procurement Needs of Institutional Users

It appears that VDC adequately meets the food and housekeeping procurement requirements of the State's institutional users and does so in a cost-effective manner. The figure on page IV displays the JLARC staff assessment of the extent to which the VDC meets the needs of its primary customers. Although it carries a much smaller number of products than a typical private sector prime vendor, VDC's strength is its ability to provide the basic food and housekeeping products primarily used by State institutions, at low cost. For example, purchases from VDC account for about 90 percent of DOC facilities' food expenditures outside of its own agribusiness operation. Further, review of comparative pricing data showed that VDC is generally able to provide products to agencies at lower cost than private sector vendors. Therefore, it appears reasonable to continue operation of the VDC at this time.

Universities May Be Better Served by the Use of a Prime Vendor

While the VDC adequately meets the needs of institutional users, it does not adequately address the needs of the State's retail-oriented food service operations, which are typical at universities. As previously stated, CNU, Radford University, and Virginia Tech operate retail-oriented food service programs that require access to a variety of brand name products within specific time frames. VDC does not stock the range of food products needed by these universities, nor does it provide the delivery frequency needed.

In contrast, prime vendors offer a wide assortment of products, including "branded" products and those of various grades. This allows customers to buy the majority of their products from one source, saving on procurement effort. Prime vendors also typically provide frequent deliveries, which is critical for customers with limited storage capacity. Since 1995, Virginia Tech has contracted with a prime vendor to supply the majority of its food needs, and has reported success with its use of this arrangement. It appears that use of a prime vendor would better serve the needs of the other universities' food service operations as well.

To enable CNU and Radford University to pursue a prime vendor arrangement, the Department of General Services needs to amend its mandatory source rule to allow agencies with retail-oriented (non-general funded) operations, such as at universities, to obtain their food products in a manner that allows for the least overall cost to the agency.

A prime vendor approach may also be appropriate for housekeeping products in certain circumstances. In particular, if use of a prime vendor enables an agency to eliminate its warehouse space, and therefore reduce personnel and operating costs, it may be a cost-effective approach. It does not appear that such cost savings are possible at DOC and DMHMRSAS facilities; however, cost savings may be possible at universities that currently use warehouses to store their janitorial supplies. Therefore, universities should analyze their total housekeeping procurement costs, including the cost of any warehouses used for storage, to identify the procurement approach that best meets their needs at the lowest total cost.

VDC Operational Issues Need to Be Addressed

In addition to examining the overall State system for procuring food and housekeeping products, JLARC staff also examined in detail the operations of the VDC. This examination included a review of VDC's processes for product procurement, inventory management, and distribution. JLARC staff reviewed bid files, quality control lab results, customer complaint files, various VDC reports, written procedures, and financial data, and interviewed numerous VDC staff. In addition, material on "best practices" in warehouse management was reviewed.

JLARC staff found that VDC maintains an adequate operation. VDC appears to follow, or is in the process of instituting, a number of warehouse management best practices. For example, VDC has instituted cycle-based inventory counting, which enables the VDC to remain open year-round rather than have to periodically close to take inventory of its stock. Further, JLARC staff found that VDC seeks feedback from its customers on a periodic basis through the use of two advisory committees. A JLARC staff survey of VDC customers found that most customers are satisfied with VDC's performance.

However, there are still a number of areas that VDC needs to address to increase its efficiency and improve customer service. One deficiency with the VDC is its lack of adequate management reports readily available for decision-making purposes. One of the reasons the reports are not available stems from problems associated with documentation of VDC's new warehouse management system computer software. While the system appears to have many strengths, VDC has encountered numerous problems in its implementation, including dealing with the bankruptcy of the software vendor. This has hindered VOC being able to take full advantage of the system. VDC should make it a priority to develop reports that enable staff to better track product and agency usage.

Additional operational problems pertain to VDC's processing of customer orders. VDC works with customers on a periodic basis through the use of the advisory committees; however, VDC staff do not always communicate well with customers regarding individual orders. While VDC reported staffing limitations as the main reason why customers are not always called when they should be (such as when a product substitution is needed), VDC should take measures to ensure that notifications to customers take priority. For example, it should implement the advanced shipping notice feature of its warehouse management system. In addition, VDC should explore options to reduce the amount of time necessary to fill orders.

VDC Needs to Takes Steps to Address Recent Operating Losses

VDC operates as an internal service fund. Virginia has several of these self-supporting funds, which operate by selling goods or services to other governmental units. To cover its expenses, VDC charges an eight percent mark-up on all goods sold. The mark-up must cover VDC's direct and indirect expenses, including the cost to deliver goods to agencies throughout the State.

Over the last five years, VDC has generated small profits in three years and small losses in two years. This pattern is fairly consistent with the idea of a program intended only to cover its costs and not generate significant earnings. However, sales have been flat and expenses continue to increase. Most of the increase in VDC operating expenses over the last five years has resulted from increases in freight costs, employee compensation, and computer-related initiatives. While expenses may not continue to rise as quickly in the next several years (since the computer system is now in place), clearly some expenses may continue to increase. Against this background of rising expenses, VDC also proposes to pay for the construction of a new warehouse (for which it is using a State Treasury loan).

Because the State looks to VDC to cover its expenses and expects it to pay for the construction of the new $12.5 million warehouse, raising the mark-up charged by the VDC may need to be considered. In addition to adjusting its mark-up rate, the VDC needs to focus attention on increasing sales by expanding its customer base and increasing its product offerings. Currently, the VDC conducts very little marketing to promote increased use of the VDC. In order to remain viable in the future, it appears that the VDC will need to begin more aggressively marketing its services.

There appear to be two main targets that the VDC should explore. First, based on the survey of local government and nonprofit organizations, it appears that local and regional jails maintain the type of operation that can be adequately met by the VDC. The second avenue for possible increased sales is State agencies that contract with private firms for janitorial and/or food service. State procurement rules allow a private firm to purchase supplies from the VDC as long as those supplies are used on behalf of a State agency. In particular, DGS should ensure that agencies with janitorial service provider contracts know that their providers can purchase products from the VDC for use on behalf of State or local agencies.

Further, the new warehouse should enable the VDC to increase its product offerings. In particular, there are a number of products that DMHMRSAS facilities have reported they want the VDC to carry.

DGS staff reported that they are currently reviewing options for addressing VDC's recent operating losses. Since the VDC will be moving into a new warehouse in March 2001, it may be appropriate to make an interim rate adjustment, with a possible need for additional adjustments after it determines the full impact (both positive and negative) that the new warehouse will have on its expenses and sales.