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Defense Industry In Search of The New Normal
By Sandra I. Erwin

Weapons manufacturers face tectonic shifts in the business landscape. Defense contractors must not only cope with military spending cuts by the world’s major powers but also with changing security priorities, warns a new report by the consulting firm Deloitte.

In “Global Defense Outlook 2013,” a team of Deloitte analysts projects that the defense market in the coming years will be upended as nations choose to protect domestic programs at the expense of military spending, and sales of big-ticket conventional weapons begins to dry up.

The U.S. defense sector, as the world’s largest, has the most to lose as these shifts materialize. Companies that intend to stay in this market must define the “new normal” and invest accordingly, said Charles F. Wald, retired Air Force general and head of Deloitte's defense practice.

The United States today accounts for 41 percent of total global military spending of $1.6 trillion. In 2011, the nation spent more than the combined defense spending of the next 14 countries.

But U.S. defense budgets have been on a down slope since 2010, and the Pentagon now faces a 10 percent annual reduction over the next 10 years as a result of congressionally mandated cuts to all federal spending.

U.S. defense budgets are projected to decline 20 percent between the post-9/11 peak reached in 2010 and 2017.

The defense business will be shrinking, but it is not all bad news for contractors, Wald said in an interview. The oft-heard lament that the defense market is “not there anymore” is only true if one defines the market as warplanes, armored vehicles, ships and other traditional military hardware, Wald said. The United States and other wealthy nations are still buying some of those expensive items, although the market is already saturated and there is little prospect of growth, he said. Even the booming drone market is “pretty filled up,” he noted.

The bright spot in the defense sector will be in “affordable high-tech” hardware and software, Wald said. “There is a market in a more connected global economy.” Products that will see growing demand include communications, information systems, cyberwar tools and tactical gear for special operations forces. “That’s where the new market is going to be,” both in the United States and overseas, Wald said.

From the changing conditions will emerge new winners, and losers. More countries increasingly will invest in special operations forces and information technology, which is what they believe they will need to combat terrorism and extremist groups, Wald said. Major weapon systems such as fighter aircraft will still be sold, but in small numbers and to a diminishing number of countries, he said. “That’s the new world we live in.”

This will be the reality “unless you believe that China is going to attack the United States or Russia will attack Europe,” said Wald. “We don’t live in that world anymore. … The world is still dangerous, but you are not going to attack insurgents in Mali [Africa] with a Joint Strike Fighter.”

The rise of special operations forces at the expense of conventional ground armies is inevitable, Wald said. A bellwether is the proposed reorganization of U.S. Special Operations Command into a “global SOF network. “That is a big deal,” said Wald. That will make SOCOM less dependent on the conventional military and could set a path for other countries to follow. “They are developing their own capacity as the world puts more emphasis on SOF,” said Wald. “Conventional forces will have to decrease. It’s a zero-sum game.”

From 2006 to 2012, the number of countries with a publicly disclosed special operations force increased by 40 percent, Deloitte noted in the study. “Special operations capabilities are increasingly aligned with counterterrorism and counterinsurgency missions — a trend established after the 9/11 attacks.” Two-thirds of the countries that are adding SOF are lower-income countries, where many terrorist-related attacks occur.

Cold War–era force structure, “with its dependence on general-purpose forces and strategic nuclear weapons, is giving way to new structures built around special operations capability and emerging concepts of operations relating to information networks,” the study said.

How the U.S. defense industry will adjust to the changing environment remains to be seen, Wald said. Manufacturers of big-ticket weapons such as tanks and aircraft carriers still live in denial, said Wald. Too many communities and congressional districts still depend on those systems for their livelihood, he said. “People don’t want their world to go away.” It becomes an emotional debate. “People believe in what they are doing. You are going to have a theological argument as the world shifts, and that’s why it’s so hard.” Members of Congress are going to fight for those jobs, and “they could not care less about the big picture,” said Wald. “To make this shift is not easy. But it’s a fact of life. … There has to be some risk taken.”

The Pentagon’s ongoing “strategic choices and management review” is only a time-buying exercise and, most likely, will not recommend any substantive change, Wald predicted.

Several Washington think tanks in recent months have rolled out dozens of reports with recommendations on how to contain defense spending. But Wald said those studies tend to focus on funding cuts and not on fundamental questions about what the United States should prepare to fight against. “People don’t want to go down that line of questions because it threatens their livelihood,” he said. There is a fiscal reality on one side and a new world on the other. “People haven’t put that together yet.”

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