Will 2012 Be the Year When the Bottom Falls Out?

Just because there will be no doomsday in 2012 doesn’t mean scary things won’t be happening in the defense and security business.
For all the sky-is-falling rhetoric about Pentagon budget cuts, sequestration, industry job losses at what not, one thing is certain: The United States in 2012 still will have a military that it can’t afford, and election-year demagoguery will distract everyone from making tough decisions and planning for the long run.
So here’s some year-end notes and nuggets, and what we can expect to see in 2012 and beyond:
The Pentagon Will Continue to Live in Denial About the Approaching Fiscal Train Wreck
Yes, a budget train wreck is a shopworn cliché inside the Beltway. It dates back to 1995, when the Center for Strategic and International Studies published, “Averting the Defense Train Wreck in the New Millennium.” One of the authors, industry analyst Daniel Gouré, admits that the Pentagon has so far avoided fiscal disaster. The post 9/11 spending surge prevented the Defense Department from fixing its weapons cost-growth problem and only exacerbated an imbalance between tooth and tail. But with the nation in dire financial straits and its leaders incapable of addressing the debt crisis, “We know the train wreck is inevitable,” says Gouré. “We choose not to think about it because it’s not here right now.”
The trends that the CSIS report brought to light in 1995 have not changed, he says. “Nobody wants to address cost growth in major systems.” At the time, the message was that the Defense Department needed to make strategic choices of whether to modernize its aging equipment or reduce its work force. The same dilemma exists, and it’s only been made worse by the huge increases in the cost of military personnel.
Regardless of the election outcome, Gouré predicts, whoever takes over has to come to grips with the reality that the current defense apparatus is unaffordable.
 New Buzzwords Will Masquerade Old Thinking
Pentagon strategists and think tanks have a history of becoming infatuated with “concepts,” which also can be described as the Pentagon’s worldview captured in three-letter acronyms. The decade of the 1990s was all about NCW (network centric warfare) which morphed into RMA (revolution in military affairs). Then came EBO (effects-based operations), coupled with CBR (capabilities based requirements) or TBR (threat based requirements).
Changes in buzzwords didn’t really bring about innovative thinking, however, says Frank Hoffman, military analyst at the National Defense University. “We suffer from strategic amnesia,” he says, “and continue to repeat [mistakes of] the past.”
The latest trendy concept that is now taking hold in the post-Iran and post-Afghanistan era is “air-sea battle,” which assumes that the next war will be fought by air and sea forces against a technologically advanced competitor, most likely in Asia. The infatuation is with the “anti-access threat,” Hoffman says. The Defense Department is becoming “obsessed with the high tech problem” while forgetting that dangeorus three-letter threats still exist on the ground (i.e., IEDs, RPGs, EFPs, PGMs).
ASB still doesn’t deal with the anti-access area denial — A2AD — challenge, says Hoffman.
The Much-Anticipated Strategic Review Will Be More of the Same
Defense Secretary Leon Panetta is scheduled to soon unveil a strategic review of U.S. military roles, responsibilities and global posture in the context of a shrinking budget. The review initially was requested by President Obama in April when he directed the Pentagon to cut expenses by $400 billion over the next decade. The idea was to have the Defense Department do “less with less,” as opposed to “more with less.”
Roles-and-missions reviews have a poor track record of creating sweeping reforms, or recommending that the United States scale back any commitments. In fact U.S. military officials in recent months have called for greater global engagements, especially an expansion of military presence in Asia.
“There is no change in foreign policy,” says Gouré. “We continue expanding. No end to nuclear deterrence, or to being the world’s policeman. … We are still doing more.”
Unless the president directed a major scaling back of U.S. military presence overseas, the Pentagon is not going to want to walk back on current commitments, says Gouré. “We are going to continue to have a crazy mismatch [between resources and missions] until it becomes impossible to sustain,” he adds. “The military is saying they can absorb cuts and still do the job. That’s nonsense.”
The problem with the current review, just like every other review since the end of the Cold War, is that it is driven by budgets, not by geopolitical strategy. “A truly comprehensive review would boil down America's key activities into a concrete list of five or six enduring advantages and then think about how the U.S. can maintain these core competencies into the future,” saysMackenzie Eaglen, defense analyst at the Heritage Foundation.
Procurement Reforms Will Extend Losing Streak; Weapons Are Going to Cost More
Despite a soaring budget budget over the past decade, the pace of recapitalization of military equipment has not improved significantly from the 1990s. This remains a “major issue facing the Defense Department now and in the coming years,” says Todd Harrison, senior fellow at the Center for Strategic and Budgetary Assessments. Modernization programs have been plagued by the piling on of “exquisite” requirements, which have driven up costs and stretched out procurement schedules, he notes. The perennial “bow wave” of equipment needs that get pushed out year after year remains in place. “Acquisition costs increased while the inventory of equipment grew smaller and older,” says Harrison. “In short, the department is now spending more but not getting more.”
Promises of lower cost and faster delivery are heard often but not likely to materialize. Fundamentally, as long as the Defense Department has to abide by the current procurement regulations, systems are going to be expensive and take years to build. The MRAP (mine resistant ambush protected) program, hailed as the poster child of how to do business differently in the Defense Department, was an exception that is not likely to be repeated, said a senior acquisitions official speaking on condition of anonymity. “We proved through MRAP that if you want a capability you can deliver it in a year, if you do away with the acquisition rules and you throw as much money as the government can stand.” That’s not the case any more. The Marine Corps wants to field a new amphibious vehicle in four years? “Not unless we had a lot more money and less acquisition rules to follow.”
Innovation Will Take Back Seat as Defense Tech Investors Sit on Sidelines
Self-described “serial entrepreneur” Allan Bignall saw in 2007 an opportunity to commercialize tiny robots that researchers at the University of Minnesota designed with Defense Department funding. He founded ReconRobotics, which is now a profitable venture. Dozens of companies started that way, as investors saw money-making prospects in selling equipment to the military. Bignall expects such activity to dramatically slow down as investors become more cautious about the defense market.
“It’s a weird time right now,” says Bignall. “There’s a lot of cash sitting out there. It’s a weird environment in the economy. Angel investors and entrepreneurs are looking at things and saying, ‘Ok, these are good ideas but why should I spend my cash?’”
Venture capitalists are “unsure about where things are going,” he says. “They see a lack of effective leadership” in Washington.
Without private funding to help dig viable technologies out of the “valley of death” at universities, many potentially innovative products will never see the light of day, let alone the battlefield.
Internecine Warfare Over Resources Will Intensify
The so-called "resource war" has already started. The Army, fearful that it will be bearing the brunt of future force reductions, ispushing back against the emerging narrative in Washington that the next war will be a sea-air show. The Pentagon’s new “air sea battle” concept for future wars emphasizes Navy and Air Force high-tech weaponry as key to countering rising powers in Asia, but reportedly fails to address the role of ground forces.
“When I read that [air-sea battle] concept, what was striking to me was the total focus on systems and platforms and no recognition of the Army's role” in securing basing rights, transit agreements, border crossings or other means of entering a foreign land, said Fred Svedarsky, chief of the concepts division at the Army’s combined arms concept directorate, in Fort Leavenworth, Kan.
Ground warfare analysts are troubled that the current debate on future wars assumes that “anti access” threats are predominantly long-range missiles and submarines, and overlooks how enemies might attempt to foil U.S. forces on the ground with automatic weapons, shoulder-fired missiles, roadside bombs — the same low-tech arms that insurgents have deployed successfully in Iraq and Afghanistan.
Army Maj. Gen. Tony Cucolo, director of force development, says the Army is ready to position itself as a major player in the Pentagon’s new “joint strategy” for future conflicts, known as “prevent, shape and win.”
While the air-sea battle concept focuses on Air Force and Navy systems, it is worth noting that for most of the nation’s allies in the Pacific, their dominant forces are their armies, says Cucolo. “Over the last four months, I’ve been to New Delhi [India] to talk about armored vehicles, and I‘ve spoken to the Indonesian War College,” he says, making a point that the Army has a major role to play in U.S. engagements with Asian nations.
Defense Industry Will Face Do-or-Die Decisions
Pentagon suppliers are headed for a period of “turbulence,” says retired Air Force Gen. Charles F. Wald, director of Deloitte Services, a consulting firm. Companies will be consolidating, downsizing, shedding overhead and striving to maintain their core skills, he says.
Gouré estimates that many contractors have about a one-to-two-year window to make drastic decisions, such as whether to stick around or exit the market. “You already saw companies such as ITT, Northrop Grumman and BAE Systems” shedding assets, he says. “They’ll either get out or buy up others’ assets and hope like heck that things turn around. … If you’re not in position over the next year for the beginning of the train wreck you’re going to be out of luck.”
The defense budget, however, still will be gigantic by historical standards. It is expected to stay above $600 billion (including war funding) for the next several years.
But until the sequestration issue is resolved, many Pentagon contracts will be slowed down or not started, Wald predicts. “There will be pressure on large platforms. He foresees cutbacks in new ground-vehicle procurements, and a slowdown in ship construction. A replacement long-range bomber that the Air Force wants is unlikely to materialize for at least a decade. 
Byron Callan, defense industry analyst at Capital Alpha Partners, says the May-September 2012 period will be “critical” for industry as it will set the tone for 2013-15 earning expectations.
“There is a natural tendency to think that 2012 could be a lot like 2011,” Callan writes in a note to investors. But 2012 could be a volatile year for the defense sector, particularly as a clearer picture emerges on who the Republican candidate could be. If Mitt Romney wins the nomination, defense stocks might trade higher, says Callan. If Republicans gain a majority in the Senate it might be a mixed picture for defense contractors as Sen. John McCain, R-Ariz., an ardent critic of defense industry, would become chairman of the Senate Armed Services Committee. Callan expects that Panetta will be leaving the Pentagon by early 2013, regardless of who wins in November.

Topics: Business Trends, Defense Department, DOD Budget, DOD Leadership