The Pentagon’s 2013 budget marks the beginning of the end of the post 9/11 era of no-holds barred military spending. But even under the worst-case scenario, defense budgets in the coming decade will be larger than they were in the last year of the Bush administration.
The upshot for defense industry is that it can expect the Pentagon to spend at least a trillion dollars on new equipment between now and 2023.
“We’re not going to take a procurement holiday like we did after the Cold War,” said Frank Kendall, acting undersecretary of defense for acquisition, technology and logistics. “National security threats are not declining … perhaps they are even increasing,” he said last month in a speech at the Center for Strategic and International Studies.
The post-Iraq and Afghanistan builddown is not going to push defense industry off a cliff, he said. “Everyone thinks [the coming downturn] will be like the post Cold War downsizing,” Kendall said. “I don’t think we’re going to see that kind of cuts. That was very traumatic for industry.”
The outlook for military contractors, however, is far from rosy.
The proposed 2013 budget for procurement, research and development — about $170 billion — is about $22 billion less than what the administration had projected a year ago.
Long term, the reductions will be modest compared to previous post-war downsizings, according to the administration’s budget forecast.
But one trend that bodes badly for Pentagon suppliers is that the military remains unsure of what it wants to buy and when. Much dilly dallying over the past decade has cost the Pentagon more than $50 billion in canceled programs, according to the Center for Strategic and Budgetary Assessments. The Defense Department since 9/11 has spent more than a trillion dollars on new equipment but has not advanced the state of technology, said CSBA President Andrew Krepinevich. It was a “hollow buildup,” he said.
Rather than move weapon systems forward, the Pentagon goes back and forth. Army leaders two years ago declared that the service absolutely needed a new ground combat vehicle by 2017. But the GCV program was officially put on hold last month because of a routine industry protest, and it is not clear where it is headed.
The Navy’s former chief Adm. Gary Roughead told contractors last year that he had set a hard deadline in 2018 for the deployment of a new unmanned combat jet aboard aircraft carriers. That project has been slowed down pending future budget drills. The Air Force similarly had proclaimed that it would field a new bomber by 2018, only to have the program sent back to the drawing board by the defense secretary. The latest plan is for a new bomber to emerge in the mid-2020s.
The Marine Corps, after losing its prized Expeditionary Fighting Vehicle, said it would immediately start designing a new amphibious vehicle replacement because there is an urgent need. Contractors were told that a vehicle would be acquired within four years, but the project is now on pause as the Corps has yet to firm up the technical requirements.
The dominant theme in the Pentagon’s budget for the coming years is uncertainty, said Todd Harrison, senior budget analyst at CSBA.
Although the Obama administration is seeking $613 billion for defense in 2013 ($525 billion for routine Pentagon accounts and $88 billion for war expenses), the automatic sequester that Congress enacted last August technically would force the Pentagon to cut another $52 billion per year, beginning Jan. 2. “That’s the law,” said Harrison. Until the sequester is either enforced or Congress finds a way to waive it, the precise level of funding for 2013 is not going to be known, he said. “We’re in a period of unusual fiscal uncertainty.”
Amid the fog of fiscal confusion, there are several caveats for industry to ponder.
The biggest one is whether the Pentagon takes any meaningful action to slow down the rising costs of payroll and benefits. Personnel expenses make up one-third of the Pentagon’s budget, but account for just one-ninth of the proposed reductions, said Harrison. Payroll and benefits costs have been on a steady climb of 4.2 percent annually for more than a decade, and will put pressure on other areas of the budget, he said. If funding remains flat and no cuts are made to compensation, healthcare or retirement benefits, by 2039, personnel costs will consume the entire defense budget.
Despite repeated assurances from Defense Secretary Leon Panetta that the defense industrial base will be “protected,” contractors are jittery, and justifiably so, Krepinevich said.
“The U.S. defense industry isn’t Wal-Mart,” where the shelves can be easily restocked, he said. If the government slows down procurement, companies that are traded on Wall Street will see investors flee, he said.
Companies also should worry about the Pentagon’s “pernicious” practice of cutting back on orders, which drives up the per-unit cost of weapon systems, he said. If the Pentagon tells Lockheed Martin to build manufacturing capacity and hire workers to produce 48 Joint Strike Fighters and then chops the order to 36, he noted, the company is stuck with 33 percent excess capacity and the government ends up paying higher prices as a result.
Another unsettling issue for many companies is the expectation that the Pentagon will step back from high-risk technological innovations and leave it to the private sector to make the seed investments.
“Increasingly I’m hearing that the Department of Defense is expecting more contractors to take more risks,” said Michael Helmstetter, president and CEO of MRIGlobal, a high-tech firm in Kansas City.
“It is a very high concern for me,” he said. There is growing support in Congress to shift the costs of “applied research” to industry so the government can focus on basic science, said Helmstetter. “Industry is not going to take the risk and jump in early in the applied research and development stage,” he said. “We need balance.”
The industry also will be watching whether the Pentagon delivers on its promise to reform its plodding procurement process. Kendall said his office is working on new “agile acquisition” guidelines that contractors should welcome because it will help programs move forward and prevent technologies from being stuck in the proverbial valley of death.
“Today there is only one acquisition process: DoD 5000,” said Tom McDermott, director of the Georgia Tech Research Institute. The same rules apply to big-ticket items, information systems and small items. That makes no sense and creates huge inefficiency, he said.
Analysts for years have criticized the Pentagon for chronically failing to invest for the future and for preparing to fight the last war. The guidance that President Obama issued in January calls for the Pentagon to shift its focus from ground wars to naval and air combat, but it remains to be seen how that road map translates into equipment buying decisions.
One concern is that this shift is based more on wishful thinking than on the realities on the ground. A recent study by the Rand Corp. said the U.S. military could end up being caught off guard as Israel’s defense forces were in 2006 during the war with Hezbollah in Lebanon.
Enemies such as Hezbollah — a non-state organization that is equipped with high-tech weaponry — are more likely than conventional nation-states to emerge as potential U.S. adversaries in a future war, said David E. Johnson, the author of the Rand study.
The Pentagon says it wants to stay away from ground wars, but if any conflicts do erupt, it would be wise for the Defense Department to make sure U.S. forces are equipped appropriately, the Rand study warns. To fight a “hybrid” enemy such as Hezbollah, U.S. troops will need advanced protection for armored vehicles against anti-tank guided missiles, rockets and shoulder-fired missiles, Johnson said. Investments also are needed in intelligence systems that would allow U.S. forces to find enemies in dug-in positions and hidden among civilians.
While these debates over spending priorities unfold, military suppliers will be watching and wondering how the rhetoric will translate into actual programs.
“The new strategic guidance issued by the Pentagon prioritizes air and sea power and shifts focus to the Asia-Pacific region,” Harrison said. “But strategy is reflected in the real choices the department makes.”