The defense industry will have to shut down unneeded facilities and possibly lay off workers in the coming years, as the Pentagon begins to trim its weapons budget and bring troops back from wars abroad.
But the Pentagon does not want the industry to shrink indiscriminately. With the U.S. military still involved in two major conflicts, the Defense Department must ensure that certain sectors of the supply base remain financially healthy, says the Pentagon’s Director of Industrial Policy Brett B. Lambert.
The Pentagon’s industrial policy shop is steering in a different direction than previous administrations, Lambert tells National Defense in a recent interview. It does not plan to be an advocate for industry but rather to engage in a closer dialogue with the private sector so the Pentagon is better informed about the financial health of critical suppliers. This will help the Defense Department anticipate “points of failure” in the supplier base and save taxpayer dollars by avoiding costly rescues of failing companies, Lambert says.
“I think we will be more forward leaning. We’ll try to get ahead of issues,” he says.
When the military budget was headed for a steep downturn after the Cold War, then-Secretary William Perry warned the CEOs of major defense contractors that they needed to consolidate into fewer companies if they wanted to stay in business. The industry subsequently underwent a rapid consolidation during the mid-1990s that created a handful of mega-corporations that to this day dominate the market.
The weapons acquisition budget is again about to enter a downward cycle, but industry consolidation ’90s-style is not the solution this time around, Lambert says. One problem with the mergers and acquisitions of the past decade is that the surviving companies grew bigger but did not eliminate enough excess capacity. “We were fairly effective at consolidating companies but not necessarily capabilities and facilities, so taxpayers continue to bear the cost of the underutilization of facilities,” says Lambert. “We need to address this.”
The Pentagon now is not as concerned with the financial standing of the large top-tier contractors but instead wants to gain a solid grasp of the health of smaller companies in the lower echelons of the supply chain.
“Too often the Defense Department has focused on competition among prime suppliers,” Lambert says. “What we are seeing increasingly is that all primes rely on a single source, or point of failure, that is down at the second, third or fourth tier” of the supplier base, he says. “I believe we don’t have adequate insight into those critical subcomponents.”
Lambert especially will turn his attention to subcontractors that currently supply the primes but are commercial firms that regard military sales as an afterthought. When military orders go down and it becomes unprofitable to make defense-unique components, these firms may decide to end production of those items. Other subcontractors may go out of business altogether because of declining orders. Rather than wait to be told that certain components are no longer available, the Pentagon wants to know ahead of time, so it can take action to preserve critical sources of supplies, Lambert says. “We want to get in front of it” before a company files for bankruptcy.
The Pentagon’s own contracting databases only capture information about the top-tier industrial base, so Lambert’s office will be reaching out to the CFOs of prime contractors to gain access to their subcontractor data. “I’m a big fan of numbers and analytical rigor,” he says.
One way to help key industries survive a down cycle will be to better predict and communicate future Defense Department needs, Lambert says. The more companies can anticipate what the military will buy, the more accurately they can plan for future production and secure capital. Small companies particularly are vulnerable now in the midst of the nation’s severe economic recession, says Lambert. The Pentagon, by committing to long-term orders, can help firms secure capital from financial institutions. This saves taxpayers money because it would prevent an expensive government-funded rescue of a critical subcontractor.
“When we terminate programs, the cascading effects on the lower tiers can be catastrophic,” he says. “The bulk of our resources goes to primes but my concern is the lower level. … That’s where I think we are experiencing the difficulty.”
Another item on Lambert’s to-do list is to forecast work force gaps in the industrial base, such as whether contractors have enough skilled workers to support the Defense Department’s future programs.
The aerospace sector has been vocal on this issue, especially after Defense Secretary Robert Gates announced new budget priorities in April. The end of the F-22 fighter production and the termination of big-ticket helicopter and satellite programs sent shivers through the aerospace industry. Top executives have been sounding alarms about their ability to retain skilled engineers in the face of declining Pentagon funding for new aircraft and satellite designs.
Industry officials note that the production lines for U.S. military aircraft — the C-17, C-130J, F/A-18E/F, F-22, F-15, F-16 — are scheduled to end between 2010 and 2015.
“Without prototype programs, how long can we hang on to these design teams on our own nickel?” asks a senior aerospace executive who spoke on the condition of anonymity. “Who are the people we need to keep until the Air Force launches its next program?” Increased spending on unmanned aircraft is not significantly going to arrest decline in the aerospace industry in the absence of programs to design major weapons systems such as new fighter jets or bombers, the executive says.
Joel Johnson, a defense industry consultant and analyst at the Teal Group, says it will be hard to keep aeronautical engineers in the current numbers. “The concern is about specialties that cannot be recreated if they go away.”
Lambert says his office wants to have an “open dialogue” with industry about these issues. “In the Defense Department we are focused on preserving skills necessary to support our war fighters in the near term and long term.”
But Lambert cautions that while the Defense Department intends to preserve essential skills, it still is not clear exactly what those skills are. “Not all jobs are skills, not all skills are jobs,” he says. He suggests that debates about critical skills are biased toward white-collar positions and often neglect to take into account the Defense Department’s needs for experienced trade and craft workers.
The prevailing mentality is that a welder is a job, he says. “I consider it a skill, not a job, one that would be hard to replicate.” Historically industrial policy has viewed white-collar positions as skills and blue collar as jobs. That’s not the way it works anymore, Lambert says.
His office is having discussions with industry about how many of those “must keep” jobs are skilled labor, he says. It’s important to tease out what specifically the Defense Department will need, says Lambert. A company threatening to close down a factory and lay off 400 workers is not a strong enough reason to support a program, he says. Considering that the defense budget has ballooned 45 percent since 2001, as wars wind down, companies should expect to have to shut down some of their industrial capacity.
“Where it makes sense to protect certain skills, we are looking at that,” says Lambert. “But we’re not in the business of propping up individual sectors or industries just because we used them in the past.”
One bit of good news for the industry is that the Pentagon is aggressively engaged in trying to reform export regulations to help U.S. firms sell more products internationally.
Industry has for years been asking for modifications to Cold War-era rules that restrict the export of U.S. technology for security reasons. The government still will protect sensitive technologies, but much of what is currently restricted from exports are technologies that are sold in the open market by many other countries. That puts U.S. companies at a huge competitive disadvantage, industry officials argue.
The Obama administration is attuned to these issues and sees as an imperative for change the need to strengthen the industrial base, Lambert says. “The more we can export, the lower the cost [of military systems] to the taxpayer … It creates jobs and keeps our lines open.”
The administration is determined to reform export controls, Lambert says. The departments of Commerce, State and Defense are all taking steps in that direction, he says. “You’ll see some positive action in the next few months.”