How will the defense industry adjust to new fiscal realities?

Author:Benes, Thomas A.
Position:VIEWPOINT
 
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Given the country's current fiscal and political environment, everyone, including defense industry leaders, is expecting changes in military spending and acquisition policy.

Defense contractors are already feeling the first effects of budget tightening and government "in-sourcing," or buying back contract work. All indicators point to a "new normal" for the industry.

Shrinking defense budgets require change but what form will this take and how best to adjust are issues that are still being debated.

The Quadrennial Defense Review received mixed reactions when first released in February 2010 but deserves another look as the main driver for change in strategy. The QDR calls for rebalancing the force for today's conflicts and reforming the acquisition process. The strategy seems to resonate well with the country's overall mood for better government and fiscal restraint.

The nation's renewed interest in reducing government spending will put pressure on any growth in defense top-line dollars and may force a downturn in the 2013-2016 period. This also coincides with a probable drawdown of Afghanistan efforts and a push to realize some form of "peace dividend" especially following the presidential election.

There are internal budget concerns that have been, building within the Defense Department that will also force change regardless of external forces. The biggest factor includes the services' manpower accounts; the cost of sustaining the all-volunteer force has escalated and now exceeds any real growth potential in the budgets. The result is a plan to generate savings of about $ 100 billion over five years from within the budgets to be able to sustain and modernize the force.

There is also a looming reset bill due for the Army and Marine Corps to replace and modernize large quantities of equipment that was damaged or worn out in recent conflicts.

The biggest internal pressure on the procurement accounts will be the need to recapitalize strategic forces--SSBN ballistic missile submarines, B-52 strategic bombers, tankers, and strategic sealift all come due for replacement starting in 2016. These are huge bills, with 12 SSBN Ohio-class replacements anticipated at $7 billion per boat; the tanker replacement costs estimated at $35 billion; a new bomber program requires $1.7 billion for initial development; and, a new fleet of logistics ships has yet to be addressed.

It's too early to predict how specific programs will play out until actual money is appropriated but trends can be identified to help align industry efforts to better support the government.

There will be less of an appetite for starting major procurement programs. What contractors have enjoyed in terms of major acquisitions with years of assured work is becoming a luxury of the past. There are few new shipbuilding programs on the horizon. The F-35 Joint Strike Fighter is considered to be the last large-quantity production aircraft for the next 20 years; and, modernizing vehicles and equipment for the Army and Marine Corps will be their major procurement focus. According to the QDR, the biggest procurement growth is expected in unmanned systems.

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Expect support contracts to increase to sustain current ships, aircraft, vehicles and equipment. Ships that were built for 25-year lives will have to last 40; aircraft and vehicles are being used at much higher rates than programmed. As a result, resources will shift focus from procurement to the operations and maintenance accounts. Growth can be expected in contracting related to lifecycle support, technology transition and increasing reliability of platforms and hardware. Lifecycle cost accounting, to include energy use, is also emerging as a new requirement for procurement and support contracts.

Government will shift more risk back to the contractor, opting for fixed-price contracts, limited options and cost control. Cost-plus contracts favoring contractor flexibility are getting more scrutiny both for the additional work being performed (and paid for] and government concerns about the performance of major defense programs. The Pentagon will be reducing the numbers and types of service and support contracts to return to pre-9/11 levels. The majority--about 80 percent--of defense contracts are for services and support and 39 percent of the defense work force is made up of contractors. The government is likely to recompete existing contracts at lower prices as labor costs and overhead are becoming major cost drivers.

QDR initiatives to increase cybersecurity and achieve green energy goals will need the expertise found in the private sector. The Defense Department does not currently drive the demand signal for these technologies and will have to form partnerships with industry to move forward. Cyber Command and service cybercomponent organizations are developing requirements that will mostly need to be sourced through industry. Defense leaders are also working to reform information technology acquisition to more closely align with the private sector to integrate emerging technology in months rather than years. The Pentagon is the largest single consumer of petroleum products and is leading the federal government in green energy initiatives. But the Defense Department will have to rely on others to develop the infrastructure needed to support the integration of alternate fuels.

International defense contract opportunities will continue to shrink as countries will need to keep money and jobs at home. Partner defense budgets have already declined and several major allies are cutting procurement and even force structure by as much as 20 percent. Most U.S. activities with partners are taking place at the lower end of the spectrum, such as medical support, small unit security training, and civil affairs projects. Industry will have to adjust and find the right role perhaps if only to facilitate these partnerships for better interoperability with U.S. forces.

What's the way ahead? Getting in front of change for the defense industry doesn't just mean that money will be tight; the work will still be there, but opportunities will shift to new areas with new rules and take on new forms.

The entire procurement and contracting environment is being transformed from requirements development all the way through "what, how and how much" the Defense Department buys. When reinforced by the way the country is moving toward government and fiscal change, the defense industrial base will be forced to adjust to a new normal.

Thomas A. Benes is vice president for corporate development at Alion Science and Technology, a Defense Department contractor based in Alexandria, Va.

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