Outsourcing U.S. Defense: National Security Implications - UPDATED

By Scott Hamilton
Catch-22: A situation in which a desired outcome or solution is impossible to attain because of a set of inherently illogical rules or conditions.

The classic and satirical book and movie, Catch-22, perfectly describes the dilemma confronting the Defense Department today as it faces replacing worn-out equipment, conflicting procurement policies regarding the reliance on foreign suppliers and looming budget cuts.

Politicians and labor unions demand that the Defense Department buy American when, in fact, the reliance on foreign suppliers has increased sharply in the last decade and is likely to do so even more in the future.

The growing influence of anti-government lawmakers and the budget cuts that are being recommended by the bi-partisan National Commission on Fiscal Responsibility may only exacerbate the problem. With potentially fewer defense contracts, U.S. primes are already seeking to increase sales to foreign governments. But these deals often come with a requirement to use local suppliers, which conflicts with Buy American sentiment for common systems, such as jet fighters that are sold to the U.S. military as well as foreign countries.

U.S. primes are already using foreign suppliers that are considered adversaries in some war planning scenarios. China, for example, produces about 97 percent of rare earth materials — not so much because the country has most of the resources, although it does — but because most of the Western world, including the United States, stopped production for cost reasons. Russia is the world’s largest producer of titanium, an indispensable component in aircraft. Russia is also one of the world’s biggest producers of cobalt, a key component in aircraft engines, along with Canada and Australia, Cuba and several countries in Africa. The United States doesn’t produce any of its own cobalt.

The risks to national security are clear. The use of foreign suppliers and concern about the decline of the U.S. defense industrial base has been on the radar among some for years. As far back as 2003, this magazine noted that “The U.S. is becoming dependent on countries such as China, India, Russia, France and Germany for critical weapons technology. It is conceivable that one of these governments could tell its local suppliers not to sell critical components to the United States because they do not agree with U. S. foreign policy.”

In the controversial competition between The Boeing Co. and EADS for the Air Force’s KC-X tanker contract, the debate over U.S. jobs and the possibility of a European company (in this case, EADS/Airbus) winning has been a major part of the public relations and political campaign supporting Boeing.

The KC-X award is for 179 airplanes at the low production rate of 15 per year. It will take 12 years to fulfill this contract, which would amount to less than 3 percent of annual deliveries by Boeing and Airbus, the commercial subsidiary of EADS. Spread out over 12 years, the $35 billion KC-X procurement is $2.9 billion per year. In defense terms, this is a gnat on an elephant’s ample rear end. The political rhubarb ignores that France, Germany, Spain and England are NATO allies and U.S. law treats these countries’ firms as if they were American suppliers.

The Defense Department has a long history of procurement from abroad:

• Britain’s BAE Systems obtains about 50 percent of its revenues from U.S. Defense Department contracts and in 2009 was ranked number five in the list of the Pentagon’s top 10 suppliers. The company provides sensitive equipment such as armor for ground troops in the Iraq and Afghan wars.

• A combination of BAE, Northrop Grumman and iRobot are bidding on the Army’s Ground Combat Vehicle, in which iRobot will serve as the systems integrator.

• The U.S. military’s fifth generation fighter jet, the F-35, has more than 100 international suppliers, with Italy alone the home to 19 third- and fourth-tier suppliers.

• The U.S. shipbuilding industry has already been truncated to such a point that it is pricing itself out of competition and Northrop Grumman wants to sell its shipbuilding division. The competing designs in the Navy’s littoral combat ships competition are based on European and Australian concepts.

• EADS North America, one of two competitors for the KC-X tanker that is such a target of scorn, is already the supplier for the C-212 and CN-235 small transport and maritime patrol planes for the U.S. Coast Guard; and the Eurocopter is the basis for the UH-72A Lakota helicopter used by the Army, National Guard, FBI and other law enforcement agencies.

• Had it not been canceled for cost overruns, the new presidential helicopter would have been outsourced to Italy’s AugustaWestland, even though Lockheed Martin was the prime contract and integrator of the systems.

• EADS North America Defense Security and Systems Solutions, provides computer and network security systems and services to government agencies and commercial organizations. The company’s Fairchild Controls provides cooling systems for externally mounted aircraft pods that carry targeting, navigation, reconnaissance and electronic countermeasure systems for U.S. and foreign military services.

The list goes on.

According to an analysis undertaken by Janes Capital Partners, an aerospace and defense investment banking firm, from 2005 to 2010 U.K. companies acquired 95 U.S. defense firms, France acquired 17 and Sweden 11. There were 158 acquisitions of U.S. companies by European firms in this period. Three of the top five U.K. acquirers were BAE Systems, Cobham and QinetiQ. Among the companies acquired: Armor Holdings, United Defense Industries, K&F Industries and Textron.

The Industrial College of the Armed Forces at the National Defense University issues annual reports on the state of various defense industries. According to its Spring 2010 report on aircraft, “some firms disclosed that nearly 75 percent of the parts for their engines come from international suppliers.”

The ICAF study also noted that the F-35 program “illustrates and is an example of the U. S. defense industry reaching out to international partners to share risk in financing and program development. However, these partnerships increase the likelihood of technology and intellectual property transfer.”

Ironically, the International Traffic in Arms Regulations (ITAR) is an impediment to international cooperation that is causing U.S. companies to lose some business to overseas markets and prompting foreign competitors to develop their own products — such as radars, unmanned aircraft and other advanced components. Defense Secretary Robert Gates wants to relax ITAR to permit U.S. companies easier access to foreign markets.

Major defense prime contracts have recognized for several years that the spending associated with the Iraq and Afghan wars will come to an end. Programs have been canceled or cut in recent defense budgets and the Bowles-Simpson panel recommendations will only increase the pain. It proposes trimming $100 billion from the base defense budget by fiscal year 2015, representing fully half of the cuts proposed, and recommends cutting $55 billion from procurement programs.

Boeing’s CEO, Jim McNerney, has said repeatedly that the Boeing Defense, Space and Security (BDS) unit — which comprises between 45 and 55 percent of the company’s revenue depending on the year — has to pursue foreign sales if it is to keep its C-17 cargo-transport line open. Boeing also is pursuing P-8A Poseidon sales overseas to supplement its U.S. Navy contract for 117. Other Boeing programs also are targeted for foreign sales. Boeing would lose three major programs under the Bowles-Simpson commissions cuts: the V-22 Osprey, the Joint Tactical Radio System and the Ground Combat Vehicle. All this means that despite Defense Department concerns, Boeing and other primes will continue to source key components from foreign suppliers, some of whom may or may not be completely friendly or reliable to U.S. interests.

Northrop Grumman and Lockheed Martin, like Boeing, have engaged in more and more outsourcing, citing the need to have “strategic partnerships” in the global economy.

The Defense Department has reached a point of alarm about the deepening reliance on foreign suppliers. It has proposed a provision in the 2012 National Defense Authorization Act that will give it the power to blacklist foreign suppliers for national security reasons, but without disclosing the basis of such exclusion or giving U.S. contractors the opportunity to correct deficiencies. Lockheed Martin, Northrop Grumman, Cisco, Hewlett-Packard and Sprint Nextel are only just a few of the big names that could be challenged by the Defense Department initiative.

Sprint Nextel could be affected by this measure — in Section 815 of the Authorization Act — as it is considering buying equipment from a Chinese supplier. The concern is that offshore suppliers could implant spyware that would facilitate cyberattacks. The Defense Department’s computer networks are the targets of tens of millions of intrusions annually.

The Pentagon leadership and Congress will be making decisions in the coming year that will have long-term effects on the U.S. industrial base. The wrong decisions will have implications for decades into the future.

Scott Hamilton is an aerospace consultant at Leeham Co. LLC, a market analysis firm in Issaquah, Wash.

Textron Corporation was not acquired in its entirety by a U.S. or U.K. company. In 2008, one of Textron's business units (a $645 million sector, out of $10.5 billion total revenues for 2009) was sold.

BAE Systems is the systems integrator for the Ground Combat Vehicle. iRobot is the unmanned ground vehicle integrator.

Topics: Business Trends, Doing Business with the Government, Service Contracts

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