Some Clarity on Budgets Emerges, But Industrial Base Outlook Remains Murky

The way ahead for the defense budget is shaping up to be a two-step process. The Defense Department’s 2013-2017 program objective memorandum (POM) has been constructed without reference to the sequester which was triggered by the failure of the Super Committee and, then, Congress to come up with $1.2 trillion in federal spending reductions in November.

The Defense Department will be submitting the fiscal year 2013 budget that meets the first set of spending caps mandated by the August Budget Control Act. The plan amounts to a reduction from the president’s proposed fiscal 2012 budget request of $250 billion over the five years of the POM. The average yearly take is just below $50 billion a year in 2013, growing to around $55 billion a year from 2014 through 2017. Fiscal year 2012 will come in at $525 billion, $28 Billion less than the president’s request of $553 billion.  

The two-step process will materialize if, at a later date, all or part of the sequester has to be activated and the POM reworked. Thus the 2013 budget may be dead on arrival as the saga continues to play out. Some in Congress have suggested reaching a deal that mitigates the sequester’s effect on defense spending, but the president has promised to veto such a move, even if it could get through Congress. The final resolution of any defense budget deal may well have to await the outcome of the 2012 elections. A continuing resolution for 2012 is a real possibility.

The impact of this is to cast a pall of uncertainty over the 2013 budget and the out years of the POM, at least through early 2013.

Some scenarios have the investment accounts coming down $30 billion to $60 billion per year (15 to 30 percent on average). At a recent conference that was hosted by Credit Suisse and NDIA board member Jim McAleese of McAleese & Associates, some significant takeaways emerged.

According to Principal Deputy Undersecretary of Defense/Comptroller Michael McCord, the Defense Department is likely to decrease its budget 28 percent from the recent high. That compares to a 31 percent build-down after Vietnam and 36 percent after the Cold War. McCord also confirmed large restructuring and delays to large programs. He stated that, most likely, the Army will back-end force structure cuts and front-end procurement cuts. Though it is interesting to note that the Army has just announced a reduction of 8,700 civilian workers for 2012. Expect other services and agencies to be announcing early adjustments as we draw closer to the submission of the 2013 budget.

Shay Assad, director of Defense Department pricing, focused on “should cost” reviews, shift to fixed-price contracts, and moves to eliminate time-and-materials contracts for information-technology services, with a preference for fixed price here, too. Assad also emphasized the desire for greater contractor profits if they can bring total price down. No one seems to know just how this can be accomplished.

Brett Lambert, deputy assistant secretary of defense for industrial base policy, essentially foreclosed the notion of mergers among primes, but will support mergers at mid-tier. He also said the investment cuts would comprise 45 to 55 percent of the total decrease in defense budgets. The numbers projected by Credit Suisse support this conclusion. Ominously, he opined that cuts will increase in the out-years, but that the department will seek to protect high technology areas. Research-and-development funding will be employed to keep key technologies and design teams alive.

Gen. Robert Cone, commander of the Training and Doctrine Command, said the Army will get smaller and lighter with a focus on Pacific Asia and the Middle East.

Gen. Joseph Dunford, assistant commandant of the Marine Corps, made a plea for bringing the F-35B out of the penalty box, keeping funding level for programs with rising costs and shifting operational focus to the Pacific.

Vice Adm. Mark Skinner, principal military deputy to the assistant secretary of the Navy for acquisition, said the service would rather have funds expire than sign on to a bad deal. Also, incremental development is the favored strategy over revolutionary programs, and he expects that competition will drive down costs.

Both the Army and the Navy are arguing for an equal distribution of cuts in the budget wars.

Everyone watching this is straining to learn exactly where and how cuts will fall. And what the impact will be on the industrial base. Sadly, the specifics are not in evidence. All we know is that as budgets come down, production rates are decreased, and industry undertakes to size itself to reduced demand, affordability and efficiencies will be even more difficult to achieve. Taming costs to achieve the Pentagon’s mantra of “better, more efficient buying power” while sustaining or increasing contractor profits will be extremely difficult.

Lambert’s statement that research-and-development funds will be used to protect high-tech niche areas and design teams is welcome, but no one has yet said which ones they will be. And there has been no mention of the critical materials — rare earths, for example — petroleum (liquid fuels) or the strategic national stockpile.

Adam Smith more than 200 years ago articulated that industrial capability is the key to national defense. High quality, world-class technology, systems and training, backed up by best-in-world logistics and production capability lie at the basis of Smith’s thesis. So there is much more to talk about and work on than we have heard so far. Stay tuned.

Topics: Defense Department, DOD Budget