DEFENSE DEPARTMENT

Managing the Defense Industry: Stalinism or Smart Business?

11/1/2011
By Sandra I. Erwin
America’s arms manufacturers are asking the Pentagon to step up and protect the industry from an imminent collapse. The way they see things, budgets for new weapons systems are drying up, big-ticket programs are few and far between, and many of the military’s top suppliers soon could be shoved off the proverbial cliff.

Chief executives of major Pentagon contractors contend that now is the time for the Defense Department to do what it hasn’t done since World War II: “manage” the weapons-making industry to ensure that critical skills and facilities don’t wither away in the coming defense downturn.

Such cries for industrial policy — which come after every post-war builddown — have fallen on deaf ears at the Defense Department. The Pentagon has shown little appetite for picking winners and losers, and has been more comfortable with a laissez-faire approach. After the Cold War ended, the Defense Department stepped out of the way and for five years let contractors consolidate at will. The government finally drew the line in 1997 when it stopped the merger of industry giants Lockheed Martin and Northrop Grumman.

Industrial policy mandates have existed since the 1950s but most administrations have ignored them, particularly in the post-Reagan era when even the suggestion that the government should manage the private sector is laughed off as a grandiose Stalin five-year plan.

But as the current wars wind down and the military prepares for an era of restrained spending, the alarms about the future of the defense industry are ringing louder than ever.

A recent study by the nonpartisan Center for Strategic and Budgetary Assessments predicts an “erosion of design capabilities for military-unique products” and calls for the Defense Department to actively protect segments of the defense industrial base that are “truly important to retain,” such as tactical aviation, nuclear submarines and spy satellites. “It is not unrealistic to foresee a day in which the U.S. defense industry no longer possesses the design or production capabilities for certain weapons systems,” says the study.

The prevailing attitude that the defense industry is a free-market, Darwinian system is a myth, CSBA analysts contend. They note that the defense industry is a highly regulated sector of the U.S. economy in which the government is both the sole customer and the regulator. It is a “serious misunderstanding of the realities of weapons acquisition in the United States to think that the U.S. defense industry operates like a normal free market,” says the study.

Defense policymakers assume that the industry has the ability to automatically resize as demand changes and still maintain competitiveness, but that is not how it works, says Marty Bollinger, director of Booz & Company’s aerospace and defense practice.

Within the core of defense companies that produce military-unique equipment, the idea that there is a free market or real competition is a fairy tale, Bollinger says.

He says it is important to draw the distinction between the “legacy” and the global/commercial industrial base. The current debate is really about the legacy industrial base, which includes the Pentagon’s top weapons contractors (with the exception of Boeing) that live and breathe to support the U.S. military, and have no other customers.

These legacy suppliers, although highly specialized, are still profit-making companies that are under enormous shareholder pressure to make money. Analysts fear that investors may flee once they foresee the bottom falling out of the market, although it is too early to ring the death knell, Bollinger says. But there are signs that the stock market already is reacting. The entire U.S. defense industry is now worth less than Google, he says. Apple Inc. alone could buy Lockheed Martin, Northrop Grumman and Raytheon just with the cash it has on hand. Defense is not an industry that is being viewed as having a lot of headroom for growth, says Bollinger.

If these analysts are right, and the Pentagon is at risk of losing key suppliers, what then to do?

The way you fix this is “with programs,” says Barry Watts, a co-author of the CSBA study and a former Northrop Grumman executive. If the Pentagon wants to secure specialized engineering talent, all it has to do is fund development programs, says Watts. In the early ‘90s, his former employer estimated that it cost $100 million a year to maintain a design team for advanced combat aircraft. But funding programs that only keep designers employed and do not lead to lucrative mass production deals are not acceptable for many for-profit companies whose shareholders expect quarterly dividends.

There are no simple answers to the Pentagon’s industrial-policy dilemmas. One problem is that the debate inevitably takes an emotional turn. Even the mention of industrial policy often makes the hair on the back of people’s necks stand up, Bollinger says. “It sounds too much like Stalinism.”

But what if instead of calling it “industrial policy,” they called it “best practices” or “corporate strategic sourcing?” he suggests. These corporate buzzwords are in fact what industrial policy really is about. Toyota, Ford or any major corporation does industrial planning on a routine basis. They scrutinize their supply base, identify areas where they want competition, and select suppliers with which they want long-term relationships.

These are rather simple, smart business practices that maybe the Pentagon should consider. Just don’t call them “industrial policy.”

Topics: Defense Department, DOD Leadership, DOD Policy

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