Defense industry targets $150B weapons maintenance market.

• Author: Erwin, Sandra I.
• Position: Industry

The defense industry's new favorite acronym: O&S.

Operations and support, or operations and sustainment, is military-speak for the unglamorous work of maintaining, refurbishing and overhauling Pentagon hardware, some of which is decades old.

Whereas military contractors' Holy Grail for decades has been the production of new weapon systems, O&S now is garnering the attention of the industry's top guns.

And for good reason.

The Willie Sutton principle applies to defense logistics: It's where the money is. A report by Deloitte Consulting LLP estimated that yearly military spending on maintenance of equipment, with associated supplies and transportation, is upwards of $150 billion. "It is a huge percentage of the DoD's discretionary spending," the study said. If the trend holds, O&S accounts--about $80 billion for weapons maintenance and $70 billion for supplies and spare parts--eventually will dwarf the Pentagon's $100 billion annual budget for procurement of new equipment.

The relatively large sums that the Defense Department is projected to spend on O&S do not, however, guarantee easy money for industry. Companies in pursuit of opportunities in this sector can expect cutthroat competition both from other firms and from government depots that have powerful allies in Congress. Contractors in this market also will see growing pressure from military customers to lower prices and, in some instances, to relinquish proprietary weapon-system designs to the government so that more of the workload can be shifted to public depots.

O&S dollars also could become targets of budget cutters, especially as current wars wind down and a peacetime mentality kicks in.

To secure long-term survival, companies will have to position themselves in the right niches, said a senior Defense Department official who spoke off the record at an industry meeting.

"Post war, we will have excess capacity," he said. "Some of it needs to be protected, some needs to go away."

Most of the military's logistics and support work today is performed by the private sector. But manufacturers of major weapon systems would like to see the Defense Department pursue more aggressive outsourcing. Rather than award a company a contract for a narrow task, such as a specific repair or maintenance job, manufacturers contend, the Pentagon should embrace "performance-based logistics" contracts. These long-term agreements can be set up in ways that benefit both government and industry, supporters contend. The military has to determine what outcomes it wants--such as x number of airplanes on the flight line or y number of Humvee trucks ready for use each day--and the contractor has to figure out the most efficient and least costly way to deliver that service.

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Performance-based logistics, or PBL, came into vogue in the 1990s, but has fallen out of favor since the mid-2000s, when military officials began to openly criticize PBL contractors for price gouging.

Estimated Annual Spending on Equipment Maintenance $150 billion Annual Budget for Procurement of New Equipment $100 billion Note: Table made from bar graph. Today, less than 5 percent of the Defense Department's maintenance work is being performed under PBL deals. The current number of PBL contracts is 87, compared to more than 200 in 2005.

In response to criticism, then-Deputy Assistant...