Defense Industry Gives Secretary Panetta a Vote of Confidence

By Sandra I. Erwin

Ever since former Defense Secretary Robert Gates warned in 2009 that the “spigot of defense funding opened by 9/11 is closing,” Pentagon suppliers have fretted and become increasingly worried about their financial future.
Industry launched a major lobbying push last year in an effort to avert further budget cuts that would lead to big-ticket program cancellations. Industry officials have argued that if austerity goes too far, the Pentagon will not have access to critical equipment in the future.
A series of meetings with Defense Secretary Leon Panetta in recent months have reassured industry CEOs that the leadership of the Pentagon at least understands the issue and is taking some reasonable steps to protect the industrial base, said Fred Downey, vice president of national security at the Aerospace Industries Association.
“Panetta gets it,” Downey said March 7 during a presentation at the Air Force Association. Deputy Secretary Ashton Carter, acquisitions chief Frank Kendall and industrial policy director Brett Lambert also “get it,” said Downey.
“We’re beginning to see consideration of the industrial base enter the rhetoric of the planning process,” he said.
But even the support of the Pentagon’s top civilians doesn’t guarantee results, Downey noted. There are still parts of the Pentagon that “don’t get it, or don’t want to get it.”
The Defense Department’s funding request for fiscal years 2013-2017 squeezes $259 billion out of the Pentagon’s budget. Over the next two years, most of the reductions will come from procurement accounts. Industry CEOs told Panetta that the currently projected cuts of $487 billion over the next decade would be “manageable,” Downey said. But corporate executives fear more cuts are coming, and they have stressed to Panetta that if that were the case, the industrial base might become too weak to support a future war.
Executives appear to be satisfied with Panetta’s reassurances that he would not allow the industrial base to wither, Downey said. “We are beginning to set a pattern of dialogue to make better informed decisions. … At least the dialogue is happening.”
Although the budget outlook is far from settled, Downey said industry leaders are confident that “as long as [Panetta’s] team is in place, we’ll see this improve. Some of the concerns will be addressed. Some are just too hard to address.”
One of the actions that Carter has spearheaded is a study of Pentagon suppliers. The goal is to identify weak links in the supply chain and prevent their collapse before they go out of business.
Downey said that top Pentagon contractors are seeing growing pressure from their investors and boards of directors to make tough decisions about whether to stay in the defense market.
“When you see the pattern we’re seeing in the Defense Department budget, in a broader economic context,” he said, companies’ immediate priority is to “mitigate risk.”
Panetta has insisted that budget cuts in the out-years will be more balanced and will not fall disproportionately on weapon programs. But CEOs have been skeptical, said Downey. They told Panetta to “prove them wrong.”
CEOs’ unease is being fueled by a number of clues from the 2013 funding request, said Downey. One is the use of “budget gimmicks” such as assuming that $60 billion of the $259 billion in spending cuts will come from “efficiencies.”
“Nobody on the planet believes that, certainly none of our people,” he said. That large amount of unspecified savings is stirring worries that the cuts ultimately will come from procurement accounts.
Another red flag for industry is the Pentagon’s decision to stretch out programs and slow them down rather than terminate them. On the surface, that should be good news because “we dodged a bullet,” Downey said. But delaying programs can be just as bad or worse than cancellations because “everything now got more expensive,” he said. “It’s economics 101. If you stretch out the F-35 Joint Strike Fighter and cut the buy, you raise unit cost. The higher costs will occur at a time when you’re taking the biggest cuts.”
The Pentagon is able to save money in the short term -- program delays in the 2013-2017 budget add up to $75 billion -- but it is creating the conditions for future sticker shock like what was experienced in the F-22 fighter program, he said. “There are clues in the fiscal 2013 budget that lead us that way.” Navy submarines could suffer the same fate. “This path absolutely guarantees there’ll be additional cuts” and is making CEOs increasingly suspicious, said Downey.
The cost of future weapon systems also could inflate over time if prime contractors begin to acquire their financially weaker suppliers and become more vertically integrated, Downey said. “You’ll see more corporate acquisitions.”
If procurement budgets do fall off a cliff, companies believe the most significant impact for the Pentagon will be the loss of specialized skills, as companies will lose designers, engineers and factory experts.
Keeping a skilled work force tops the list of concerns, Downey said. In the past two years, he said, the aerospace sector shed 40,000 workers. Although that is a small portion of the 3.5 million U.S. aerospace and defense work force, some of the most skilled positions are difficult to replace, according to AIA studies.
Investors, too, are becoming antsy about the defense sector, said Downey. Although company profits are lower than in other industries, in the past this was counterbalanced by higher stock prices because of the greater reliability of the government as a customer. “That model is certainly under stress,” he said.
Kendall, the acting undersecretary of defense for acquisition, technology and logistics, said many of these issues were debated within his staff during a two-day “offsite” meeting in January. In a February speech at the Center for Strategic and International Studies, Kendall said one of his priorities is to “institutionalize” procurement policies that make smarter use of taxpayer dollars. “A lot of our problems stem from culture,” Kendall said.
The industrial base survey that was started two years ago is still ongoing, he said. The goal is to make the data available to all procurement officials so they “understand industrial base implications” of their decisions. “When we know there’s a problem, we can do assessments on how we might intervene,” he said. But Kendall warned that “interventions will be rare, as resources are limited.”
Downey said industry remains cautiously optimistic. “We have had in the United States a somewhat adversarial relationship between industry and the Pentagon,” he said. “The secretary is chipping away at that, but it still exists in a lot of places.” Industry is not interested in an “incestuous relationship” with the government, he said. “I’m talking about a strategic plan for the industrial base.”

Topics: Business Trends, Doing Business with the Government, Mergers and Acquisitions, Defense Contracting, Defense Department, Defense Watch, Procurement

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