The budget hit list has been revealed. Defense industry should breathe a sigh of relief. There are no big-ticket program cancellations, although several weapon systems are being put temporarily on hold.
Ground forces are bearing the brunt of the cuts. The Pentagon wants to reduce the size of the Army and the Marine Corps by 100,000 troops by 2017.
The top line reductions for the 2013-2018 period amount to $259 billion, which would put the Defense Department on a path to cut $487 billion over the next decade. But even with these reductions, the budget "still makes a $614 billion [$525 billion base budget and $89 billion war budget] investment in our nation's security," said Chairman of the Joint Chiefs of Staff Gen. Martin Dempsey at a Jan. 26 news conference.
The budget, Dempsey insisted, "maintains our military's decisive edge and helps sustain America's global leadership."
Ever since President Obama announced last April that the Pentagon would have to cut at least $400 billion in spending over the next decade, defense industry has been bracing for a bloodbath. Analysts and contractors had predicted that most of the cuts would come from weapons programs.
Defense Secretary Leon Panetta, also speaking at the news conference, noted that even after losing 100,000 troops, the Army and Marine Corps will still end up larger than they were before 9/11. The Army’s active-duty force will drop from 570,000 to 490,000, and the Marine Corps’ from 202,000 to 182,000. The reductions are in line with the Obama administration's new strategic guidance that calls for a shift from ground wars to high-tech conventional warfare and an increased military presence in the Asia-Pacific region.
The Army, even before the new strategic guidance was completed, had been weighing tough hardware-or-people budget choices. Historically, the Army has been able to fund most of its high-priority procurement programs as long as personnel stays at less than 46 percent of the Army’s total budget, which was about $145 billion for fiscal year 2012. Equipment accounts — research, development and acquisitions — make up 20 to 25 percent of the Army’s budget.
Army Maj. Gen. Anthony A. Cucolo III, director of force development, said in December that personnel costs now are consuming 48 percent of the Army’s budget. That sparked worries about the possibility of having to cancel or delay a large chunk of the Army’s procurement portfolio. The Army’s goal is to allocate 20-25 percent of its budget for equipment.
Panetta's plan redirects part of the savings from personnel cuts to investments in weapons systems that would equip the military to expand its presence in Asia Pacific.
The budget preserves the Air Force's current bomber fleet, and includes funds for a new bomber. It maintains 11 Navy aircraft carriers and 10 air wings. Ship construction programs will be delayed but funds are being requested to add new weaponry to existing submarines and surface ships.
Among the budget decisions that might affect contractors the most are the slowdown of Joint Strike Fighter procurement, delay of the Army Ground Combat Vehicle, reduced purchases of a new cruise-missile defense airship and of a new missile that would replace the Hellfire, and the termination of one of the military’s four variants of the Global Hawk unmanned aircraft. Army helicopter modernization will be delayed by three to five years. A major satellite program, the Defense Weather Satellite, is getting the boot. The Pentagon also plans to cut back on purchases of commercial satellite imagery and terminate a Humvee upgrade program.
Such slew of program cutbacks and delays, however, is not going to push industry over a cliff, analysts said.
“Our military industrial complex will survive,” said Kevin Ryan, a retired Army officer and executive director at Harvard University’s Belfer Center for Science and International Affairs.
“We are still spending a huge amount,” Ryan said. “Panetta [has made it clear] he will try to protect the military industrial base. … You won’t see [top tier contractors] Raytheon or Lockheed closing.”
One reason why this round of budget cuts will not deliver as big a blow as had been expected, Ryan said, is that industry has been taking preemptive action over the past two years, since former Defense Secretary Robert Gates launched a series of “efficiency” efforts and program terminations.
Companies already have been laying off employees and closing down facilities, said Ryan. “They already knew what was going to happen. They knew sales are going fall. They’re self cutting as opposed to reacting to fewer orders.”
But the industry still will be in relatively good health, said Ryan. “After the budget cuts, as big as they are, we are left with a large military force, despite the ground force reductions.”
Industry has been slashing costs more aggressively in anticipation of an age of austerity, said David Melcher, CEO of ITT Exelis.
“We could see the writing on the wall,” Melcher told National Defense. “We anticipated the top line was going to come down.” For the past two years, ITT has gotten rid of excess overhead, he said. “We continue to do that,” he added. “If you’re not watching your cost, you bear the risk of being non-competitive.”
Industry investors also have adjusted to the new budget outlook, Melcher said. “Defense stocks in the aggregate look about what they did in 1991” at the beginning of the post Cold War downturn,” he said.
Melcher, like other aerospace and defense executives, is optimistic that the new Pentagon strategy that shifts focus from counterinsurgency land wars to high-end warfare in the Pacific will benefit companies that produce advanced technology.
“We’re in the camp of companies that like the direction that DoD is going,” said Melcher.
The likelihood is that defense industry will be able to weather the storm, noted Jason Gursky, an analyst at Citi Investment Research. “Broadly speaking, while we expect all defense companies to take some lumps as part of the DoD's savings process, we do not anticipate any franchise-threatening moves,” Gursky wrote. “In our view, aligning weapons procurement to a renewed focus on Asia and on operating in anti-access environments will leave the industrial base in a much healthier spot vs. the impact of the ‘90s procurement holiday.”
Ground force supporters, meanwhile, worry that Panetta’s budget moves are shortsighted and are uncomfortably similar to former Defense Secretary Donald Rumsfeld’s much criticized policies.
“It’s very odd to me that everything that Secretary Rumsfeld tried to do — cutting people and increasing ISR [intelligence, surveillance, reconnaissance] technology, air and naval power — is being resurrected,” said retired Army Lt. Gen. James Dubik, senior fellow at the Institute for the Study of War.
Panetta almost dusted off Rumsfeld’s plan and put a new label on it, Dubik said in an interview.
“This drawdown is based on the false belief” that technology can make up for less manpower, he said. “This was a failed policy under Rumsfeld.”
Dubik said it is “folly to ascertain Asia-Pacific as our future and make that the basis for how we structure our armed forces. … No administration can risk to have ground forces ill prepared for whatever happens.”
The debate over whether the right programs are falling to the budget ax could become dramatically more heated if Congress doesn’t figure out a way to avoid the automatic cuts that the Budget Control Act requires the federal government to make by January 2013. For the Defense Department, that would amount to another $500 billion in cuts over the next decade.
During a meeting with industry CEOs last week, Panetta said he is confident that the department and industry can live with a $487 billion cut, but said he still worries that Congress will fail to act, and that sequestration is a real possibility.
ITT CEO Melcher, who attended the meeting, said that Panetta called on industry to help prevent sequestration. He asked industry to “help articulate to the Congress, to the media and others what the potential impacts of sequestration are,” said Melcher. “Industry is on Secretary Panetta’s side. We don’t want to see cuts above the current cuts.”
Congress will be debating the Pentagon's budget proposal as it also deals with tax issues, an extension of the debt ceiling and, most likely, continuing resolutions to keep the government running. Only a budget resolution that finds another way to cut the deficit would avert sequestration.
Panetta suggested that industry leaders should be talking to members of Congress who have genuine concern for national security, irrespective of politics.
But even if sequestration does not happen, the Defense Department will still see historically high budgets for the foreseeable future.
The administration is requesting $525 billion for its base budget in fiscal year 2013, compared to $531 billion in 2012. The five-year plan calls for a steady increase to $567 billion by 2017. The Pentagon also will ask for $88.4 billion for war costs, which are exempt from the Budget Control Act cuts. The war budget was $115 billion in 2012.
“The proposal to roll back the DoD budget plan for 2013-2017 by $259 billion doesn't amount to much of a reduction from recent spending levels,” said Carl Conetta of the Project on Defense Alternatives. “The difference between planned spending for the next five years and the last five will be about 4 percent in real terms.”
William D. Hartung, defense analyst at the Center for International Policy, said the president’s plan is, at most, a “modest adjustment at a time when military budgets of recent years have been at the highest levels since World War II.”
The real problem, he said, is that the Pentagon and the industry had “unrealistic plans that assumed that the Department of Defense budget would continue to increase indefinitely.
Last year’s president’s budget proposal had envisioned defense spending growing to $622 billion by 2017, compared to the current plan that forecasts $567 billion for 2017.
Hartung characterized these cuts as a “course correction” that is modest when compared with past builddowns, such as those after Korea and Vietnam or at the end of the Cold War.”
“Eliminating one of four versions of the Global Hawk unmanned aerial vehicle, slowing down the F-35 Joint Strike Fighter program, and delaying the start of a new ballistic missile submarine for two years are managerial decisions, not tough budget choices,” he said. “All three make sense if the goal is to buy time to improve cost and performance of key systems or capabilities, but they don't go far enough in assessing the need for those capabilities.”
Panetta’s budget proposal continues the efficiency campaign started by his predecessor Robert Gates. He said management reforms are needed to ensure “more disciplined use of defense dollars.” Among the most controversial items on the efficiency list is the intent to request Congress to authorize a Base Realignment and Closure round. The rest includes a familiar litany of management reforms: improve contracting practices, better use of information technology, cutbacks in official travel, reductions in contract services, deferrals in military construction and cuts to civilian pay raises. Panetta said these reforms will result in $60 billion in savings over the next five years.